Humana Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods. Dollar amounts are in millions unless stated otherwise. Humana operates health plans and related healthcare services, organized into Retail, Employer Group, Healthcare Services, and Other Businesses.
Financial results and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $10,321 | $9,699 | $20,807 | $19,918 |
| Operating income | $689 | $590 | $1,454 | $1,006 |
| Net income | $420 | $356 | $893 | $604 |
| Diluted EPS | $2.63 | $2.16 | $5.58 | $3.65 |
| Benefit ratio | 83.4% | 83.5% | 83.2% | 84.5% |
| Operating cost ratio | 14.3% | 14.4% | 14.1% | 14.0% |
- Q2 revenue rose 6.4% and net income rose 18.0%; six-month revenue increased 4.5% and net income increased 47.8%. Growth reflected improved operating performance, Medicare Advantage membership gains, and higher Healthcare Services revenue. Diluted EPS also benefited from lower weighted-average shares after repurchases.
- Benefits expense was $8,091 in Q2 and $16,286 for six months. Favorable prior-year medical claims reserve development was $100 in Q2 and $366 for six months, compared with $40 and $181 in 2012, respectively; this materially supported benefit-ratio comparisons.
- Cash from operations was $585 for six months, versus $3,052 in 2012. The prior-year period included approximately $2.1 billion of July Medicare premiums received early, resulting in seven monthly payments versus six in 2013; working-capital timing also affected the comparison. Cash and cash equivalents increased to $1,519 from $1,306 at year-end.
- At June 30, 2013, total assets were $20,848, total liabilities $11,513, and stockholders’ equity $9,335. Current assets of $12,628 exceeded current liabilities of $6,770. Long-term debt was $2,606, nearly unchanged from year-end.
- Investment securities totaled $9,326 in fair value. Approximately 94% of debt securities were investment grade, with an average S&P rating of AA-. A 1% increase in interest rates was estimated to reduce the fair value of securities by approximately $443.
- Six-month capital expenditures were $187; management expected 2013 capital expenditures of approximately $425–$450. The company repurchased 2.83 million shares for $211 and paid $83 in dividends during the six-month period.
Material changes and segment trends
- Retail premiums increased 9.0% for six months, with individual Medicare Advantage membership up 7.1% year over year to 2.03 million and stand-alone PDP membership up 8.4% to 3.22 million. Retail pretax income rose 55.2% to $768; its six-month benefit ratio improved to 85.0% from 85.8%.
- Employer Group premiums increased 7.8% for six months, primarily from group Medicare Advantage growth. Pretax income rose 35.0% to $332; its six-month benefit ratio improved to 81.0% from 81.5%.
- Healthcare Services six-month revenue, including intersegment activity, increased 17.0% to $7,582, principally reflecting the Metropolitan and SeniorBridge acquisitions and growth in provider services. Pretax income was $256, up $3, as growth was largely offset by planned investment in provider practices and chronic-care centers.
- Other Businesses’ six-month premiums fell sharply, principally reflecting the transition to a new TRICARE South Region contract in April 2012, which is accounted for as an administrative-services arrangement rather than as insured premiums and benefits.
- Segment reporting was reorganized in 2013, and prior-period segment results were recast. Interpret historical segment comparisons on the revised presentation.
Outlook, risks and unusual items
- Humana estimated 2014 Medicare Advantage benchmark payment rates would decline 2.8% in aggregate, including risk-coding recalibration and county rebasing. Including the healthcare industry fee, management anticipated needing to address government funding reductions of more than 4%. It warned that benefits, margins, or competitiveness could be affected and that execution of pricing and product plans is not assured.
- The company reported a $31 loss in Q2 on three Puerto Rico Medicaid contracts that were not renewed; coverage transition obligations continue through September 30, 2013, with claims processing thereafter. Management attributed $0.12 of 2013 diluted EPS expense primarily to the contract loss.
- Medicare products represented approximately 74% of six-month premiums and services revenue. CMS risk-adjustment data validation audits could lead to settlements; Humana said its current estimated accruals were not material but could not determine whether future audits would have a material effect.
- Humana reported that all material CMS Medicare contracts had been renewed for 2014, while 2014 product offerings remained subject to CMS approval. It also announced a definitive agreement to acquire American Eldercare, subject to regulatory approvals and expected to close by Q4 2013.
- Healthcare reform provisions, including the non-deductible industry fee and other assessments, Medicare payment changes, and evolving rules, could affect pricing, enrollment, costs, capital and cash flows. Management noted the fee could significantly increase the effective tax rate in 2014.
- Other uncertainties include regulatory reviews and litigation, including a previously dismissed Florida qui tam action with potential appeal activity, and ongoing government information requests concerning certain South Florida provider practices. The filing states possible losses beyond accruals could not be estimated and outcomes could be material.
- Humana said it had adequate liquidity for at least the next twelve months. It had $2,606 of long-term debt, no borrowings under its prior $1 billion revolver at June 30, and $994.5 of remaining capacity; a replacement five-year $1 billion revolver was entered into in July 2013. The company was in compliance with credit covenants.
Key facts for investors to verify
- How much reported earnings growth depended on favorable reserve development and the favorable DoD contract-claims settlement, and whether those benefits recur.
- Whether Medicare Advantage pricing, benefits, and operating plans can offset the estimated 2014 funding reductions and industry fee.
- The ultimate financial effect of Puerto Rico Medicaid contract exits, RADV audits, regulatory matters, and litigation.
- Whether operating cash generation normalizes after the unusual Medicare-payment timing and working-capital movements.
- Integration, returns, and risk exposure associated with Metropolitan and other care-delivery investments, and completion of the proposed American Eldercare acquisition.