HUM

Business Context and Reporting Period

Company: Humana Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2005
Business Overview: Humana is a major health benefits company operating in two primary segments: Commercial (employer groups and individuals) and Government (Medicare Advantage, TRICARE, and Medicaid). As of June 30, 2005, the company served approximately 7.0 million medical members and 1.8 million specialty members.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 3.9% year-over-year, driven primarily by a 17.6% increase in Government segment premiums (due to Medicare Advantage growth and the CarePlus acquisition), partially offset by a 7.8% decline in Commercial segment premiums.
• Profitability: Net income rose 30.5% to $193.9 million. This was significantly aided by a lower effective tax rate of 22.7% (vs. 34.0% in 2004) due to a $22.8 million contingent tax gain resolution.
• Acquisition Impact: The February 2005 acquisition of CarePlus Health Plans of Florida added approximately 50,400 Medicare members and $444.8 million in purchase price, increasing goodwill by $336.1 million.
• Membership Shifts: Commercial fully-insured membership declined 16.0% due to competitive pricing and the loss of an unprofitable account. Conversely, Medicare Advantage membership grew 28.9%.
• Debt Levels: Long-term debt increased by $241.7 million, primarily due to $294.0 million borrowed under a credit agreement to finance the CarePlus acquisition.

Guidance, Outlook, and Risks

• Membership Outlook: Management anticipates Medicare Advantage membership to reach 540,000 to 550,000 by December 31, 2005. Commercial fully-insured per member premiums are expected to increase 8% to 10% for group accounts in 2005.
• Expense Guidance: Consolidated SG&A expense ratio is projected to remain between 13.5% and 14.5% for the full year 2005. Capital expenditures are expected to range between $155 million and $165 million.
• Tax Rate: The effective tax rate is expected to be approximately 30% for the full year 2005, with a rate of 34% to 36% for the remaining two quarters.
• Key Risks:
  • Regulatory & Government Contracts: Significant exposure to Medicare Advantage and TRICARE contracts; changes in reimbursement or contract loss could materially impact results. Puerto Rico Medicaid contracts face uncertainty regarding renewal.
  • Medical Cost Inflation: Rising costs of medical services and prescription drugs could outpace premium increases.
  • Legal Proceedings: Ongoing involvement in the "Managed Care Industry Purported Class Action Litigation" regarding provider payments and RICO claims.
  • Accounting Changes: Adoption of FASB Statement No. 123R (Share-Based Payment) beginning January 1, 2006, will require expensing stock options, potentially reducing reported net income.

Investor Verification Checklist

• Verify the sustainability of the 22.7% effective tax rate, noting the one-time $22.8 million tax gain resolution.
• Monitor the integration and profitability of the CarePlus acquisition, including the $336.1 million goodwill recorded.
• Assess the impact of the 16% decline in Commercial fully-insured membership on future revenue stability.
• Review the status of the Puerto Rico Medicaid contract renewal negotiations and potential revenue exposure.
• Track the outcome of the "Managed Care Industry Purported Class Action Litigation" and potential liability exposure.
• Confirm the company's ability to maintain medical expense ratios below 84% amidst rising healthcare inflation.