HUM

Business Context and Reporting Period

Company: Humana Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2005
Business Overview: Humana is a major health benefits company operating in two primary segments: Government (Medicare Advantage, TRICARE, Medicaid) and Commercial (fully insured, ASO, specialty). As of September 30, 2005, the company served approximately 7.0 million medical members and 1.9 million specialty members.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 20.4% for the quarter and 9.2% for the nine-month period compared to 2004. This was driven primarily by a 57.3% increase in Government segment premiums (due to Medicare Advantage growth and TRICARE contract transitions) and the acquisition of CarePlus Health Plans.
• Profitability Decline: Net income for the quarter dropped 40.7% to $49.9 million from $84.3 million in the prior year quarter. Income before taxes for the quarter fell 43.9% to $71.5 million.
• Segment Performance:
  • Government: Income before taxes increased slightly (0.9%) to $89.6 million, driven by enrollment growth in Medicare Advantage.
  • Commercial: Income before taxes turned negative, reporting a loss of $18.1 million compared to $38.7 million profit in the prior year quarter, due to competitive pricing pressures and membership declines in fully insured groups.
• Acquisitions: Completed the acquisition of CarePlus Health Plans of Florida for approximately $444.9 million in February 2005, adding 50,400 Medicare members.

Guidance, Outlook, and Unusual Items

Unusual Items Impacting Results

• Physician Class Action Settlement: Recorded a pretax expense of $71.9 million ($44.8 million after-tax, or $0.27 per diluted share) in Q3 2005 to settle a nationwide class action lawsuit involving over 700,000 physicians.
• Hurricane Katrina: Recorded pretax expenses of $6.7 million ($4.2 million after-tax, or $0.03 per diluted share) related to operations in Louisiana. Additional costs of approximately $0.07 per diluted share are expected in Q4 2005.
• Tax Benefit: The effective tax rate for the nine-month period was 24.4% (vs. 34.0% in 2004), largely due to a $22.8 million contingent tax gain recognized in Q1 2005.

Outlook and Guidance

• Medicare Growth: Anticipates Medicare Advantage membership to reach 540,000–550,000 by December 31, 2005. Expects significant revenue and earnings growth in 2006 due to the Medicare Modernization Act (MMA) and new prescription drug plans.
• Commercial Segment: Expects fully insured commercial per member premiums to increase 7%–9% for the full year 2005. Membership in consumer-choice products (Smart products) grew 43% since year-end 2004.
• Capital Expenditures: Expects full-year 2005 capital expenditures to range between $155 million and $165 million, up from $114.1 million in 2004, driven by Medicare expansion initiatives.
• Accounting Changes: Adoption of FAS 123R (Share-Based Payment) in 2006 is expected to lower 2006 results by approximately $0.10 per diluted share.

Investor Verification Checklist

• Settlement Finality: Verify the final court approval of the $40 million physician class action settlement scheduled for March 2006.
• Hurricane Impact: Monitor Q4 2005 results for the projected additional $0.07 per share impact from Hurricane Katrina.
• Commercial Membership Trends: Track the rate of decline in fully insured commercial membership versus growth in ASO and consumer-choice products to assess margin recovery.
• Medicare Expansion Execution: Confirm enrollment targets for 2006 Medicare Advantage and Prescription Drug Plan (PDP) offerings.
• Regulatory Capital: Review the need for additional capital ($450m–$650m) required in 2006 to support anticipated Medicare premium growth.