Humana Inc. — Q3 2012 Form 10-Q
Business context and reporting period. Humana is a health insurer and provider of health and wellness services, with Retail, Employer Group, and Health and Well-Being Services segments. This unaudited filing covers the quarter and nine months ended September 30, 2012, compared with the same 2011 periods; balance-sheet comparisons are with December 31, 2011. Amounts are in U.S. dollars unless noted.
Financial performance and position
| Metric | Three months ended Sept. 30 | Nine months ended Sept. 30 |
|---|---|---|
| Total revenue | 2012: $9.651 billion; 2011: $9.301 billion | 2012: $29.569 billion; 2011: $27.776 billion |
| Net income | 2012: $426 million; 2011: $445 million | 2012: $1.030 billion; 2011: $1.220 billion |
| Diluted EPS | 2012: $2.62; 2011: $2.67 | 2012: $6.27; 2011: $7.24 |
| Operating income | 2012: $701 million; 2011: $726 million | 2012: $1.707 billion; 2011: $2.004 billion |
| Benefit ratio | 2012: 82.2%; 2011: 80.7% | 2012: 83.7%; 2011: 82.2% |
| Operating cost ratio | 2012: 14.7%; 2011: 14.8% | 2012: 14.3%; 2011: 13.9% |
| Operating cash flow | Nine-month 2012: $1.718 billion; 2011: $3.876 billion |
For the quarter, revenue rose 3.8%, while net income fell 4.3%. For the nine-month period, revenue rose 6.5%, while net income fell 15.6%. Higher benefit costs and weaker Retail segment results were key pressures; Health and Well-Being Services earnings improved. The nine-month 2012 period included an estimated $46 million military-services litigation settlement expense. Favorable prior-year claims reserve development benefited earnings by about $0.21 per diluted share in Q3 2012 versus $0.13 in Q3 2011, and by about $0.39 for the first nine months of 2012 versus $0.57 in 2011.
Balance sheet at September 30, 2012: Cash and cash equivalents were $1.363 billion; current and long-term investment securities totaled $9.895 billion; total assets were $18.797 billion; total liabilities were $10.106 billion; and stockholders’ equity was $8.691 billion. Long-term debt was $1.616 billion, down from $1.659 billion at year-end 2011. The $1.0 billion revolving credit facility had no borrowings outstanding and $995 million of available capacity. The company reported compliance with its debt covenants.
Liquidity and cash flows: Cash was nearly unchanged from year-end 2011. Nine-month investing cash use was $753 million and financing cash use was $979 million, including $513 million of share repurchases and $124 million of dividends. Operating cash flow was substantially lower than in 2011, partly because 2011 included an early $1.796 billion Medicare premium receipt, resulting in ten monthly Medicare payments in that comparison period versus nine in 2012; the filing also cites lower earnings and working-capital timing. Management said available cash, investments, operating cash flow, and financing capacity should fund operating and regulatory needs, acquisitions, expansion, capital spending, debt obligations, and repurchases for at least the next 12 months.
Material changes versus prior comparable period
- Retail premiums increased 13.7% in Q3 and 14.6% for the nine-month period, reflecting Medicare Advantage membership growth. Retail pretax income declined 21.6% in Q3 and 28.2% year to date as benefit ratios rose to 82.3% and 84.6%, respectively.
- Management attributed Retail benefit-ratio pressure to planned positioning for health-reform funding and minimum-ratio requirements, higher costs on new Medicare Advantage membership than assumed in bids, and increased outpatient utilization. Individual Medicare Advantage membership reached 1.912 million, up 18.5% year over year.
- Employer Group premiums increased 14.7% in Q3 and 14.0% year to date, but pretax income declined 6.5% and 5.1%, respectively. Higher benefit ratios were partly offset by improved operating cost ratios.
- Health and Well-Being Services pretax income rose 78.3% in Q3 and 53.4% year to date, primarily from pharmacy growth and greater mail-order utilization.
- TRICARE South transitioned on April 1, 2012 to an administrative-services-fee arrangement in which the federal government retains health-benefit risk. Humana therefore reports related revenue net of estimated health costs, rather than recording premiums and benefit expenses gross as under the former contract. This change substantially affects year-over-year comparisons of Other Businesses revenue and expenses.
Outlook, commentary, risks, and unusual items
- Humana estimated that the average 2013 Medicare premium rate change from CMS would be relatively flat. It cited product design, cost reduction, care coordination, and disease management as responses, while cautioning that successful execution was not assured. The filing provides no specific earnings or EPS guidance.
- CMS renewed all material Medicare contracts for 2013 and approved Humana’s 2013 product offerings. The company said 99% of its Medicare Advantage members were in plans expected to qualify for 2014 quality bonuses; future Star Ratings and bonus eligibility remain uncertain.
- CMS risk-adjustment data validation audits may result in extrapolated payment adjustments. Humana said it awaited further CMS guidance and could not determine whether audits would materially affect results, financial position, or cash flows.
- Humana disclosed an ongoing internal investigation concerning certain Florida operations, voluntarily reported to federal and state authorities, and related government requests for information. A Florida qui tam case was dismissed with prejudice, but the plaintiff sought reconsideration. The company said potential outcomes and losses for described legal and regulatory matters could not be estimated; adverse outcomes could be material.
- Health reform could increase taxes and fees, constrain Medicare payment rates and pricing flexibility, and change product economics. The filing highlights uncertainty over implementation and the risk that future Star Ratings, medical cost trends, coding, or benefit-cost estimates could adversely affect results.
- After quarter-end, Humana announced an agreement to acquire Metropolitan Health Networks for an estimated $850 million plus expenses, subject to shareholder and regulatory approvals, with closing expected by the end of Q1 2013. It also acquired a noncontrolling interest in MCCI in October. The company cited integrated care delivery as the strategic rationale and expected to fund the Metropolitan deal with cash and debt.
- Other notable items: Humana acquired Arcadian and SeniorBridge during 2012; estimated 2012 capital expenditures were approximately $400 million. The Board authorized up to $1 billion of share repurchases through June 30, 2014, with $640 million remaining as of October 31, 2012. A 1% increase in interest rates was estimated to reduce investment portfolio fair value by approximately $420 million.
Most important facts for investors to verify
- Whether Medicare Advantage benefit ratios and new-member costs stabilize relative to pricing and bid assumptions.
- Actual cash generation after adjusting for Medicare receipt timing and changes in working capital.
- CMS audit developments, risk-adjustment settlements, and the status and potential consequences of the Florida investigation and other legal matters.
- Regulatory approvals, financing, purchase accounting, and integration progress for the Metropolitan transaction and other acquisitions.
- Effects of the TRICARE contract’s net-fee accounting on reported growth and comparability, and the impact of upcoming health-reform requirements.