Business Context and Reporting Period
This summary covers the Quarterly Report on Form 10-Q for WellPoint, Inc. (now Elevance Health) for the period ended June 30, 2010. WellPoint is the largest health benefits company in the U.S. by commercial membership, serving 33.5 million medical members. The company operates through three segments: Commercial, Consumer, and Other. The reporting period reflects the impact of the Patient Protection and Affordable Care Act signed into law in early 2010, the sale of its Prescription Benefit Management (PBM) business in late 2009, and significant membership transitions involving UniCare members moving to Health Care Service Corporation (HCSC).
Key Financial Metrics
| Metric | Six Months Ended June 30, 2010 | Six Months Ended June 30, 2009 |
|---|---|---|
| Total Operating Revenue | $29,093.2 million | $30,564.5 million |
| Net Income | $1,599.2 million | $1,273.9 million |
| Diluted Earnings Per Share (EPS) | $3.68 | $2.59 |
| Benefit Expense Ratio | 82.3% | 83.2% |
| Operating Cash Flow | ($66.8 million) outflow | $1,569.6 million inflow |
| Cash and Cash Equivalents | $2,027.9 million | $4,816.1 million (Dec 31, 2009) |
| Total Debt (Current + Long-term) | $8,548.6 million | $8,399.1 million (Dec 31, 2009) |
Material Changes vs. Prior Period
- Revenue Decline: Operating revenue decreased 5% year-over-year, driven by the transition of UniCare members to HCSC, the conversion of a large municipal account from fully-insured to self-funded status, and the loss of Medicare Part D Low-Income Subsidy (LIS) membership. These were partially offset by higher premiums in Commercial lines and growth in Medicare Advantage.
- Profitability Increase: Net income rose 26% to $1.6 billion. This was primarily due to improved operating results in the Commercial segment, a significant reduction in other-than-temporary impairment (OTTI) losses on investments ($25.8 million in 2010 vs. $379.0 million in 2009), and lower interest expense.
- EPS Growth: Diluted EPS increased 42% to $3.68, driven by higher net income and a 12% reduction in diluted shares outstanding due to aggressive share repurchases.
- Cash Flow Volatility: Operating cash flow turned negative ($66.8 million outflow) compared to a $1.6 billion inflow in the prior year. This was primarily caused by a $1.2 billion tax payment to the IRS related to the 2009 PBM sale and increased incentive compensation payments.
- Segment Performance: The Commercial segment operating gain increased 16% to $1.7 billion. The Consumer segment gain increased 4% to $627 million. The Other segment swung to an operating loss of $6.3 million from a gain of $235.4 million, largely due to the absence of PBM business.
Guidance, Outlook, and Risks
- Health Care Reform: Management notes that the Affordable Care Act will significantly impact operations, including new taxes, fees, and medical loss ratio requirements effective in 2011 and 2014. The company states it is too early to fully understand the impact but anticipates potential impairments of goodwill and intangible assets.
- Cost Trends: The company estimates a 2010 cost of care trend of 8.0% (+/- 50 basis points) for Local Group fully-insured business. Trends are driven more by unit costs than utilization, with inpatient and outpatient costs in the low double-digit range.
- California Individual Market: Management expects to incur significant losses on existing contracts in the California individual market in 2010 due to a strategic decision not to increase premium rates further to avoid destabilizing the business.
- Investment Risks: While OTTI losses decreased significantly, the company warns that market volatility creates a continuing risk of further declines in fair value and potential future impairment charges.
- Litigation: The company is defending numerous class actions regarding out-of-network reimbursement methodologies and the 2001 demutualization. Outcomes remain uncertain.
Investor Verification Checklist
- Tax Payment Impact: Verify the sustainability of operating cash flows given the one-time $1.2 billion tax payment related to the PBM sale.
- California Individual Market Losses: Monitor the magnitude of expected losses in the California individual market and the effectiveness of rate filings.
- Health Reform Implementation: Track regulatory guidance on medical loss ratios and excise taxes to assess potential impacts on future margins and goodwill impairment.
- Membership Trends: Confirm the stabilization of membership numbers following the UniCare to HCSC transition and the impact of economic conditions on fully-insured vs. self-funded conversions.
- Investment Portfolio: Review the composition of the investment portfolio, specifically sub-prime and Alt-A securities, for potential future credit-related impairments.