HUM

Business Context and Reporting Period

Company: Humana Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2004
Business Overview: Humana is a major health benefits company operating in two primary segments: Commercial (employer groups and individuals) and Government (MedicareAdvantage, TRICARE, and Medicaid). As of September 30, 2004, the company served approximately 6.0 million medical insurance members and 1.7 million specialty product members.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 9.1% for the nine-month period compared to the prior year, driven by the acquisition of Ochsner Health Plan and increased per-member premiums.
• Profitability Surge: Net income for the nine-month period rose 43.2% to $232.9 million. The Government segment pretax earnings increased 72.3% to $237.9 million, while the Commercial segment increased 7.3% to $114.7 million.
• Membership Shifts: Total medical membership decreased 9.8% to 5.98 million. This decline was primarily due to a 34.8% drop in TRICARE membership resulting from contract transitions (Regions 2 and 5 lost to a new contractor), partially offset by a 14.4% increase in MedicareAdvantage membership and a 9.2% increase in Commercial membership.
• Acquisition Impact: The April 1, 2004 acquisition of Ochsner Health Plan added approximately 152,600 commercial members and 33,100 MedicareAdvantage members, expanding Humana's presence in Louisiana and Texas.
• Expense Ratios: The consolidated SG&A expense ratio improved to 14.5% (down from 15.3% in the prior year) due to operational efficiencies and the absence of a $17.2 million asset impairment charge recorded in the prior year.

Guidance, Outlook, and Risks

• Outlook: Management expects fully insured commercial per-member premiums to increase 6-8% for the full year 2004. MedicareAdvantage membership is projected to grow approximately 15% for the year. Consolidated SG&A expense ratio is expected to remain in the 14-15% range for 2004.
• Capital Allocation: The company repurchased 3.6 million shares for $63.6 million during the nine-month period. Approximately $36.4 million remains available under the current repurchase authorization expiring in January 2005.
• Liquidity: Cash and cash equivalents decreased to $375.1 million, largely due to investment purchases and the timing of MedicareAdvantage premium receipts. The company maintains a $600 million unsecured revolving credit facility with no outstanding balance as of September 30, 2004.
• Key Risks:
  • Legal Proceedings: Humana is a defendant in the In re Managed Care Litigation class action regarding provider payments and "downcoding." A trial was rescheduled for March 2005, though proceedings were stayed pending appeals.
  • Government Contracts: Significant revenue exposure to MedicareAdvantage and TRICARE programs creates risk regarding legislative changes, reimbursement rate adjustments, and contract renewals.
  • Medical Cost Trends: Profitability is sensitive to medical cost inflation and the accuracy of claims reserve estimates. Commercial medical cost trends are expected to rise 6.5-8.5% for 2004.

Investor Verification Checklist

• Verify the final purchase price adjustment for the Ochsner Health Plan acquisition, which is subject to change based on net equity and claims liability run-out data.
• Monitor the status of the In re Managed Care Litigation class action, specifically the outcome of the Supreme Court petition and the March 2005 trial date.
• Track the transition of TRICARE contracts and the stabilization of membership numbers following the loss of Regions 2 and 5 and the addition of Region 6.
• Review the accuracy of medical expense reserves (IBNR) given the 83.9% medical expense ratio and rising cost trends.
• Assess the impact of the new $600 million credit agreement and the company's ability to maintain compliance with financial covenants.