Humana Inc. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods. Unaudited. Amounts are in millions unless noted.
Business context and reporting period
Humana is a health and well-being company operating Retail, Employer Group, and Healthcare Services segments. Medicare Advantage and Part D are major businesses: Medicare products represented approximately 74% of premiums and services revenue for the first half of 2014. Segment presentation was recast for a January 2014 internal reporting change.
Financial performance and liquidity
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $12,222 | $10,321 | $23,934 | $20,807 |
| Net income | $344 | $420 | $712 | $893 |
| Diluted EPS | $2.19 | $2.63 | $4.54 | $5.58 |
| Operating income | $681 | $689 | $1,402 | $1,454 |
| Benefit ratio | 83.1% | 83.4% | 82.7% | 83.2% |
| Operating cost ratio | 15.1% | 14.3% | 15.2% | 14.1% |
| Effective tax rate | 46.7% | 35.7% | 46.5% | 35.5% |
For Q2, revenue increased 18.4%, while net income fell 18.1%; first-half revenue rose 15.0%, while net income declined 20.3%. The filing attributes the earnings pressure principally to exchange and new state-contract investments, higher specialty-drug costs related to a Hepatitis C treatment, and sequestration. Growth in Medicare and commercial membership partly offset these pressures. The 2014 non-deductible health insurer fee materially raised the tax rate.
- Cash flow: First-half operating cash flow was $471, down from $585. Investing activities provided $404, versus $148 used in 2013; financing activities used $420, versus $224. Cash and cash equivalents ended June 30 at $1,593, compared with $1,138 at December 31, 2013.
- Balance sheet and debt: Total assets were $23,121 and total liabilities $13,121. Current assets of $14,086 compared with current liabilities of $7,880. Long-term debt was $2,595, near the $2,600 year-end level. The company had no revolver borrowings and reported $995 of remaining capacity under its $1.0 billion credit agreement.
- Margins and reserves: First-half benefits expense was $18,751 and operating costs were $3,620. Favorable prior-period claims reserve development was $346 for the first half, versus $366 in 2013.
- Capital returns and investment: First-half dividends paid were $86; share repurchases totaled $112. Capital expenditures were $216 in the first half.
Material changes versus the prior comparable period
- Premiums rose 19.4% in Q2 and 15.8% in the first half, driven mainly by Medicare and individual commercial membership growth. Individual Medicare Advantage membership grew 16.4% year over year, stand-alone PDP membership 20.5%, and individual commercial medical membership 119.0%.
- Operating costs grew faster than revenue, increasing 25.6% in Q2 and 24.5% for the first half. The operating cost ratio worsened by 0.8 and 1.1 percentage points, respectively, reflecting the health insurer fee, exchange and state-contract investments, and higher commissions.
- The consolidated benefit ratio improved year over year, partly because Puerto Rico Medicaid contracts ended in September 2013; underlying segment ratios faced pressure from specialty drug costs and reduced favorable reserve development.
- Healthcare Services first-half pretax income increased 61.6% to $391, supported by pharmacy and home-based services growth. Retail first-half pretax income fell 23.0% to $591, while Employer Group pretax income fell 9.0% to $315.
Outlook, management commentary, risks and contingencies
- Management expected full-year 2014 operating cash flow to decline from 2013. It anticipated building commercial risk-adjustment, risk-corridor, and reinsurance receivables in 2014 for collection in 2015; the receivable could materially affect 2014 operating cash flow. The net receivable associated with these programs was approximately $240 at June 30.
- Management expected approximately $560 to be paid for the 2014 health insurance industry fee in September. The fee is non-deductible; management noted the industry-wide fee rises 41% in 2015, with a similar Humana increase expected absent market-share changes. Expected 2014 capital expenditures were approximately $525–$575.
- Humana estimated 2015 Medicare Advantage funding cuts of approximately 2%. It said it believed it could design competitive products at those rates, but noted execution failure could materially harm results. Product offerings remained subject to CMS approval, expected in fall 2014; material CMS contracts had been renewed for 2015.
- Higher-than-bid Hepatitis C specialty-drug costs increased Medicare Part D subsidy receivables; the net CMS subsidy and discount receivable was $835 at June 30, versus $713 at year-end 2013. Management expected related settlements in 2015.
- Key regulatory exposures include health reform implementation and premium stabilization program estimates, Medicare risk-adjustment coding and RADV audits, sequestration-related provider disputes, and regulatory limits on government-program profitability. The filing says potential RADV effects cannot be determined pending further CMS guidance.
- Legal matters include an appeal in a Florida qui tam case dismissed with prejudice, government information requests and a related unsealed qui tam matter, and other routine litigation and regulatory reviews. The company said it could not estimate possible losses beyond recorded accruals; outcomes could be material.
- Management stated cash, investments, operating cash flows, and available borrowing sources were adequate for operating needs and obligations for at least the next twelve months. It also noted regulatory restrictions on subsidiary dividends and a 1% interest-rate increase could reduce investment fair value by approximately $471.
Important facts for investors to verify
- Whether Medicare membership growth and exchange enrollment can translate into sustainable underwriting returns as medical costs, specialty-drug spending, and operating expenses evolve.
- The scale and timing of 2014–2015 cash collections and payments under commercial risk-sharing programs and Medicare Part D subsidies.
- Actual 2015 Medicare Advantage rates, Star Ratings, CMS product approvals, and the effect of the estimated funding cuts on benefits, enrollment, and margins.
- Claims reserve development and the assumptions underlying benefits payable, risk-adjustment settlements, and RADV audit accruals.
- Potential outcomes of the Florida matters, other investigations, and provider disputes; the filing provides no clear estimate of possible losses beyond accrued amounts.
- The effect of the health insurer fee and other health reform requirements on taxes, pricing, statutory capital, and subsidiary dividend capacity.