HUM

Business Context and Reporting Period

Company: Humana Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2002
Business Overview: Humana is a major health benefits company offering coordinated health insurance coverage through traditional and Internet-based plans for employer groups and government-sponsored programs. As of March 31, 2002, the company served approximately 6.5 million medical insurance members and 2.2 million specialty product members. Operations are divided into two segments: Commercial (employer groups and individuals) and Government (Medicare+Choice, Medicaid, and TRICARE).

Key Financial Metrics

Note: Adjusted Net Income for 2001 excludes goodwill amortization of $12.9 million to align with the adoption of FAS 142 in 2002.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 10.9% year-over-year, driven by a 9.5% increase in premium revenues ($2.64 billion) and a 212% increase in administrative services fees ($65.0 million). The fee increase was primarily due to the acquisition of TRICARE Regions 2 and 5.
• Profitability: Net income increased 75.5% to $46.8 million. Adjusted net income increased 18.2% to $46.8 million. The improvement was driven by higher premium yields and a slight decrease in the medical expense ratio.
• Membership Dynamics: Total medical membership grew 32.6% to 6.53 million. This was driven by a 62.7% increase in TRICARE members (due to the Regions 2 and 5 acquisition) and a 13.6% increase in Commercial ASO members. Conversely, Medicare+Choice membership declined 15.0% due to market exits and benefit design changes.
• Accounting Change: The company adopted FASB Statement No. 142 on January 1, 2002, ceasing the amortization of goodwill. Consequently, 2002 results do not include the $13.5 million goodwill amortization expense present in the 2001 period.
• Cash Flow: Operating cash flows showed a net use of $140.1 million, compared to $69.2 million in the prior year. Management notes that pro forma operating cash flows (adjusting for the timing of Medicare+Choice premium receipts) were positive at $76.5 million, a significant improvement over the prior year's pro forma use of $75.1 million.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Membership Growth: Management anticipates fully insured and ASO Commercial medical membership growth in the 3.0% to 3.5% range for the full year 2002.
• Expense Ratios: The SG&A expense ratio is expected to range from 15% to 16% for 2002 as the proportion of revenues from administrative services fees increases.
• Capital Expenditures: Total capital expenditures for 2002 are expected to be approximately $115 million, primarily for technology initiatives and administrative facilities.

Risks and Contingencies

• Legal Proceedings: The company is involved in significant litigation, including In Re Humana Inc. Securities Litigation (appeal scheduled for June 2002) and In re Managed Care Litigation (consolidated class actions regarding RICO and ERISA violations). While the company believes allegations are without merit, outcomes are uncertain.
• Government Contracts: A significant portion of revenue comes from government programs (Medicare+Choice, Medicaid, TRICARE). Legislative proposals regarding Medicare+Choice reimbursement rates and contract renewals pose risks. Specifically, a Florida CMS contract accounted for 16.3% of total premiums and ASO fees; its termination would have a material adverse effect.
• Regulatory Environment: Increased scrutiny on claims payment practices, potential implementation of the Patient Bill of Rights (PBOR), and HIPAA compliance requirements could increase costs and operational burdens.
• Medical Cost Trends: Profitability depends on premiums covering health care costs. Risks include medical inflation, increased prescription drug costs, and potential catastrophes or epidemics.

Investor Verification Checklist

• TRICARE Acquisition Impact: Verify the sustainability of revenue growth driven by the TRICARE Regions 2 and 5 acquisition and the associated administrative fee increases.
• Medicare+Choice Attrition: Monitor the continued decline in Medicare+Choice membership and the effectiveness of strategies to offset this loss.
• Legal Exposure: Track the status of the In re Managed Care Litigation and the securities litigation appeal, as unfavorable rulings could result in substantial damages.
• Government Contract Renewals: Confirm the renewal status of key government contracts, particularly the Florida CMS contract and Puerto Rico Medicaid contracts expiring in June 2002.
• Cash Flow Timing: Distinguish between reported operating cash flows and pro forma cash flows to accurately assess liquidity, given the significant timing fluctuations in Medicare+Choice premium receipts.