Business context and reporting period
Humana Inc. filed this Form 10-K for the fiscal year ended December 31, 2019; it also reports fourth-quarter results. The company operates Retail, Group and Specialty, and Healthcare Services segments, with a strategy centered on Medicare and integrated care delivery. At year-end, Humana had approximately 16.7 million medical members and 5.4 million specialty members. Approximately 82% of 2019 premiums and services revenue came from federal-government contracts.
Financial results and key metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total revenue | $64.9 billion | $56.9 billion | +14.0% |
| Operating income | $3.2 billion | $3.1 billion | +3.0% |
| Net income | $2.7 billion | $1.7 billion | +60.8% |
| Diluted EPS | $20.10 | $12.16 | +65.3% |
| Operating cash flow | $5.3 billion | $2.2 billion | Up $3.1 billion |
| Benefit ratio | 85.6% | 83.5% | +2.1 percentage points |
| Operating cost ratio | 11.5% | 13.3% | -1.8 percentage points |
Fourth-quarter 2019 revenue was $16.3 billion, net income was $512 million, and diluted EPS was $3.84. The benefit ratio measures benefits expense as a share of premiums; the operating cost ratio measures operating costs, excluding depreciation and amortization, as a share of revenue excluding investment income.
- Revenue and segments: Retail premiums and services revenue rose 16.9% to $56.3 billion. Retail segment earnings increased 29.0% to $2.2 billion. Healthcare Services earnings rose 4.6% to $789 million. Group and Specialty earnings fell 92.2% to $28 million.
- Claims and margins: Benefits expense increased 17.4% to $53.9 billion, faster than premiums revenue. Favorable prior-year claims reserve development was $336 million in 2019 versus $503 million in 2018. Group and Specialty’s benefit ratio rose to 86.0% from 79.7%, including $50 million of unfavorable prior-year reserve development.
- Liquidity and debt: Year-end cash and cash equivalents were $4.1 billion; cash and investments totaled $15.4 billion. Total debt was $5.7 billion, down from $6.1 billion. Humana reported $2.0 billion of undrawn capacity under its revolving credit agreement and said available resources were adequate for at least 12 months. Debt-to-capitalization under the credit agreement was 32%, against a 50% covenant limit.
- Capital allocation: Humana repurchased $1.0 billion of shares through a 2019 accelerated share repurchase and paid $291 million in dividends. The Board authorized a $3.0 billion repurchase program, with approximately $2.0 billion remaining as of February 2020.
Material changes versus 2018
- Medicare Advantage growth drove higher Retail revenue: individual and group MA membership increased by 550,700, or 15.5%, to 4.1 million. Stand-alone Part D membership declined 12.8% to 4.4 million.
- Consolidated benefit ratio worsened, while the operating cost ratio improved, helped by productivity initiatives, Medicare scale efficiencies, and the 2019 suspension of the health insurance industry fee.
- Net income comparisons benefited from a $786 million loss on the 2018 sale of KMG not recurring in 2019, and from a $506 million favorable change in the fair value of Kindred at Home put and call options, reported in other income. The option valuation is sensitive to assumptions.
- Operating cash flow rose substantially, reflecting higher earnings and premiums collected ahead of claims, as well as working-capital timing. Share repurchases reduced shares used to calculate diluted EPS.
Outlook, management commentary, risks and unusual items
- Management expects 2020 net individual Medicare Advantage membership growth of 270,000–330,000, group Medicare Advantage growth of approximately 90,000, and stand-alone PDP membership decline of approximately 550,000. These are membership expectations, not company-wide earnings guidance.
- CMS’s February 2020 preliminary notice estimated an average 0.93% increase in 2021 MA benchmark funding; Humana said its preliminary estimate was relatively in line. Final rates and proposed policy changes were pending, and the company cautioned that their ultimate impact was uncertain.
- The non-deductible health insurance industry fee resumes in 2020 and is expected to increase Humana’s effective tax rate; current law repeals the fee beginning in 2021. The 2019 suspension also affected product pricing and benefit design.
- Key exposures include dependence on government programs and Medicare, especially Florida MA contracts representing about 15% of consolidated revenue; medical-cost and claims-reserve estimation risk; competition and pricing; changes to government rates or regulation; provider relationships; cybersecurity and privacy; and legal and regulatory proceedings.
- CMS and HHS-OIG are auditing Medicare Advantage risk-adjustment data. A proposed RADV audit approach could permit extrapolation without a fee-for-service adjustment; Humana says the outcome could materially affect results. The DOJ has sought information regarding risk-adjustment practices. Humana also disclosed a False Claims Act case concerning a Part D plan and a lawsuit seeking approximately $611 million of unpaid ACA risk-corridor payments, for which no revenue or receivable was recorded. The filing says loss estimates for certain proceedings cannot be made clearly.
- Humana recorded $47 million of 2019 workforce-optimization charges, with approximately $45 million remaining payable at year-end. Post-year-end events include the approximately $707 million Enclara acquisition and a primary-care partnership expected to develop at least 50 centers over three years.
- Goodwill testing found no impairment, but the clinical reporting unit had only an $11 million fair-value cushion; a 100-basis-point increase in its discount rate would imply an estimated impairment of approximately $62 million.
Important facts for investors to verify
- Whether MA membership growth can be sustained while improving claims costs and maintaining CMS Star ratings and risk-adjustment accuracy.
- How the Group and Specialty benefit-ratio deterioration, provider settlements, and membership mix develop in 2020.
- The final 2021 CMS funding and policy decisions, and any financial exposure from RADV audits, risk-adjustment reviews, or other litigation.
- The assumptions behind the $506 million Kindred at Home option valuation gain and the sensitivity of clinical-services goodwill to revised forecasts.
- Cash-flow quality and working-capital movements, debt maturities, regulated-subsidiary dividend capacity, and execution and financing of planned acquisitions and care-center expansion.