# Humana Inc: Form 10-Q for the period ended Jun 30, 2015

- Company: [Humana Inc](/companies/hum.md) (CIK 49071)
- Form: 10-Q
- Filed: 2015-07-29
- Accepted by EDGAR: Jul 29, 2015, 09:14 ET
- Period: 2015-06-30
- Accession: 0000049071-15-000075
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/49071/000004907115000075/hum-20150630x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/49071/000004907115000075/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2015-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2015-04-01 to 2015-06-30 | $13.73bn | us-gaap:Revenues |
| Revenue | 6 months, 2015-01-01 to 2015-06-30 | $27.57bn | us-gaap:Revenues |
| Selling, general and administrative | 3 months, 2015-04-01 to 2015-06-30 | $1.82bn | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 6 months, 2015-01-01 to 2015-06-30 | $3.76bn | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2015-04-01 to 2015-06-30 | $573.0m | us-gaap:OperatingIncomeLoss |
| Operating income | 6 months, 2015-01-01 to 2015-06-30 | $1.36bn | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2015-04-01 to 2015-06-30 | $47.0m | us-gaap:InterestExpense |
| Interest expense | 6 months, 2015-01-01 to 2015-06-30 | $93.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2015-04-01 to 2015-06-30 | $362.0m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2015-01-01 to 2015-06-30 | $676.0m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2015-04-01 to 2015-06-30 | $431.0m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2015-01-01 to 2015-06-30 | $861.0m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2015-04-01 to 2015-06-30 | $2.85 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 6 months, 2015-01-01 to 2015-06-30 | $5.67 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2015-04-01 to 2015-06-30 | $2.88 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 6 months, 2015-01-01 to 2015-06-30 | $5.74 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2015-04-01 to 2015-06-30 | 151,148,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 6 months, 2015-01-01 to 2015-06-30 | 151,748,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 6 months, 2015-01-01 to 2015-06-30 | −$501.0m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2015-01-01 to 2015-06-30 | $259.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 6 months, 2015-01-01 to 2015-06-30 | $86.0m | us-gaap:PaymentsOfDividends |
| Share repurchases | 6 months, 2015-01-01 to 2015-06-30 | $371.0m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2015-06-30 | $2.25bn | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2015-06-30 | $16.98bn | us-gaap:AssetsCurrent |
| Total assets | at 2015-06-30 | $25.38bn | us-gaap:Assets |
| Current liabilities | at 2015-06-30 | $8.97bn | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2015-06-30 | $15.30bn | us-gaap:Liabilities |
| Long-term debt | at 2015-06-30 | $3.82bn | us-gaap:LongTermDebtNoncurrent |
| Short-term borrowings | at 2015-06-30 | $300.0m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2015-06-30 | $10.08bn | us-gaap:StockholdersEquity |
| Shares outstanding | at 2015-06-30 | 148,143,674 shares | dei:EntityCommonStockSharesOutstanding |

## Management's discussion and analysis

As filed, 90,925 characters.

### FINANCIAL CONDITION AND RESULTS OF OPERATIONS

*The condensed consolidated financial statements of Humana Inc. in this document present the Company’s financial position, results of operations and cash flows, and should be read in conjunction with the following discussion and analysis. References to “we,” “us,” “our,” “Company,” and “Humana” mean Humana Inc. and its subsidiaries. This discussion includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in filings with the SEC, in our press releases, investor presentations, and in oral statements made by or with the approval of one of our executive officers, the words or phrases like “believes,” “expects,” “anticipates,” “intends,” “likely will result,” “estimates,” “projects” or variations of such words and similar expressions are intended to identify such forward–looking statements. These forward–looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including, among other things, information set forth in Item 1A. – Risk Factors in our 2014 Form 10-K, as modified by any changes to those risk factors included in this document and in other reports we filed subsequent to February 18, 2015, in each case incorporated by reference herein. In making these statements, we are not undertaking to address or update such forward-looking statements in future filings or communications regarding our business or results. In light of these risks, uncertainties and assumptions, the forward–looking events discussed in this document might not occur. There may also be other risks that we are unable to predict at this time. Any of these risks and uncertainties may cause actual results to differ materially from the results discussed in the forward–looking statements.*

### Executive Overview

### General

Humana Inc., headquartered in Louisville, Ky., is a leading health and well-being company focused on making it easy for people to achieve their best health with clinical excellence through coordinated care. Our strategy integrates care delivery, the member experience, and clinical and consumer insights to encourage engagement, behavior change, proactive clinical outreach and wellness for the millions of people we serve across the country.

Our industry relies on two key statistics to measure performance. The benefit ratio, which is computed by taking total benefits expense as a percentage of premiums revenue, represents a statistic used to measure underwriting profitability. The operating cost ratio, which is computed by taking total operating costs, excluding depreciation and amortization, as a percentage of total revenue less investment income, represents a statistic used to measure administrative spending efficiency.

### Proposed Merger

On July 2, 2015, we entered into an Agreement and Plan of Merger, which we refer to in this report as the Merger Agreement, with Aetna Inc. and certain wholly owned subsidiaries of Aetna Inc., which we refer to collectively as Aetna, which sets forth the terms and conditions under which we will merge with, and become a wholly owned subsidiary of Aetna, a transaction we refer to in this report as the Merger. In the Merger, each outstanding share of our common stock will be converted into the right to receive (i) 0.8375 of a share of Aetna common stock and (ii) $125 in cash. The total transaction was estimated at approximately $37 billion including the assumption of Humana debt, based on the closing price of Aetna common shares on July 2, 2015. The Merger Agreement includes customary restrictions on the conduct of our business prior to the completion of the Merger, generally requiring us to conduct our business in the ordinary course and subjecting us to a variety of customary specified limitations absent Aetna’s prior written consent, including, for example, limitations on dividends and repurchases of our securities, restrictions on our ability to enter into material contracts, and negotiated thresholds for capital expenditures, capital contributions, acquisitions and divestitures of businesses.

The transaction is subject to customary closing conditions, including, among other things, (i) approval of the holders of our outstanding shares of common stock entitled to vote on the Merger, (ii) approval of the holders of Aetna outstanding shares to the issuance of Aetna common stock in the Merger, (iii) the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the receipt of necessary approvals under state insurance and healthcare laws and regulations and pursuant to certain licenses of certain of Humana’s subsidiaries, (iv) the absence of legal restraints and prohibitions on the consummation of the Merger, (v) the effectiveness of the registration statement in respect of the Aetna common stock to be issued in the Merger, (vi) listing of the Aetna common stock to be issued in the Merger on the New York Stock Exchange, (vii) subject to the relevant standards set forth in the Merger Agreement, the accuracy of the representations and warranties made by each party, (viii) material compliance by each party with its covenants in the Merger Agreement, and (ix) no “Company Material Adverse Effect” with respect to us and no “Parent Material Adverse Effect” with respect to Aetna, in each case since the execution of and as defined in the Merger Agreement. In addition, Aetna’s obligation to consummate the Merger is subject to (a) the condition that the required regulatory approvals do not impose any condition that, individually or in the aggregate, would reasonably be expected to have a “Regulatory Material Adverse Effect” (as such term is defined in the Merger Agreement), and (b) the Centers for Medicare and Medicaid Services, or CMS, has not imposed any sanctions with respect to our Medicare Advantage, or MA, business that, individually or in the aggregate, is or would reasonably be expected to be material and adverse to us and our subsidiaries, taken as a whole. The Merger is expected to close in the second half of 2016. A copy of the Merger Agreement is filed as an exhibit to our Current Report on Form 8-K filed with the SEC on July 7, 2015.

### Business Segments

On January 1, 2015, we realigned certain of our businesses among our reportable segments to correspond with internal management reporting changes and renamed our Employer Group segment to the Group segment. Our three reportable segments remain Retail, Group, and Healthcare Services. The more significant realignments included reclassifying Medicare benefits offered to groups to the Retail segment from the Group segment, bringing all of our Medicare offerings, which are now managed collectively, together in one segment, recognizing that in some instances we market directly to individuals that are part of a group Medicare account. In addition, we realigned our military services business, primarily consisting of our TRICARE South Region contract previously included in the Other Businesses category, to our Group segment as we consider this contract with the government to be a group account. Prior period segment financial information has been recast to conform to the 2015 presentation.

We manage our business with three reportable segments: Retail, Group, and Healthcare Services. In addition, the Other Businesses category includes businesses that are not individually reportable because they do not meet the quantitative thresholds required by generally accepted accounting principles. These segments are based on a combination of the type of health plan customer and adjacent businesses centered on well-being solutions for our health plans and other customers, as described below. These segment groupings are consistent with information used by our Chief Executive Officer to assess performance and allocate resources.

The Retail segment consists of Medicare benefits, marketed to individuals or directly via group accounts, as well as individual commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products. In addition, the Retail segment also includes our contract with CMS to administer the LI-NET prescription drug plan program and contracts with various states to provide Medicaid, dual eligible, and Long-Term Support Services benefits, collectively our state-based contracts. The Group segment consists of employer group commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and voluntary insurance benefits, as well as administrative services only, or ASO products. In addition, our Group segment includes our health and wellness products (primarily marketed to employer groups) and military services business, primarily our TRICARE South Region contract. The Healthcare Services segment includes services offered to our health plan members as well as to third parties, including pharmacy solutions, provider services, home based services, and clinical programs, as well as services and capabilities to advance population health. We will continue to report under the category of Other Businesses those businesses which do not align with the reportable segments described above, primarily our closed-block long-term care insurance policies.

The results of each segment are measured by income before income taxes. Transactions between reportable segments primarily consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and home based services as well as clinical programs, to our Retail and Group customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often use the same provider networks, enabling us in some instances to obtain more favorable contract terms with providers. Our segments also share indirect costs and assets. As a result, the profitability of each segment is interdependent. We allocate most operating expenses to our segments. Assets and certain corporate income and expenses are not allocated to the segments, including the portion of investment income not supporting segment operations, interest expense on corporate debt, and certain other corporate expenses. These items are managed at a corporate level. These corporate amounts are reported separately from our reportable segments and are included with intersegment eliminations.

### Seasonality

One of the product offerings of our Retail segment is Medicare stand-alone prescription drug plans, or PDPs, under the Medicare Part D program. Our quarterly Retail segment earnings and operating cash flows are impacted by the Medicare Part D benefit design and changes in the composition of our membership. The Medicare Part D benefit design results in coverage that varies as a member’s cumulative out-of-pocket costs pass through successive stages of a member’s plan period, which begins annually on January 1 for renewals. These plan designs generally result in us sharing a greater portion of the responsibility for total prescription drug costs in the early stages and less in the latter stages. As a result, the PDP benefit ratio generally decreases as the year progresses. In addition, the number of low-income senior members as well as year-over-year changes in the mix of membership in our stand-alone PDP products affects the quarterly benefit ratio pattern.

Our Group segment also experiences seasonality in the benefit ratio pattern. However, the effect is opposite of Medicare stand-alone PDP in the Retail segment, with the Group segment’s benefit ratio increasing as fully-insured members progress through their annual deductible and maximum out-of-pocket expenses. Similarly, certain of our fully-insured individual commercial medical products in our Retail segment experience seasonality in the benefit ratio akin to the Group segment, including the effect of existing previously underwritten members transitioning to policies compliant with the Health Care Reform Law with us and other carriers. As previously underwritten members transition, it results in policy lapses and the release of reserves for future policy benefits and recognition of previously deferred acquisition costs. These policy lapses generally occur during the first quarter of the new coverage year following the open enrollment period.

In addition, the Retail segment also experiences seasonality in the operating cost ratio as a result of costs incurred in the second half of the year associated with the Medicare and individual health care exchange marketing seasons.

### 2015 Highlights

#### Consolidated

- Our 2015 results through June 30, 2015 reflect the continued implementation of our strategy to offer our members affordable health care combined with a positive consumer experience in growing markets. At the core of this strategy is our integrated care delivery model, which unites quality care, high member engagement, and sophisticated data analytics. Our approach to primary, physician-directed care for our members aims to provide quality care that is consistent, integrated, cost-effective, and member-focused, provided by both employed physicians and physicians with network contract arrangements. The model is designed to improve health outcomes and affordability for individuals and for the health system as a whole, while offering our members a simple, seamless healthcare experience. We believe this strategy is positioning us for long-term growth in both membership and earnings. At June 30, 2015, approximately 1,510,400 members, or 55.7%, of our individual Medicare Advantage members were in value-based relationships under our integrated care delivery model, as compared to 1,301,000 members, or 53.6%, at December 31, 2014 and 1,246,700 members, or 52.8%, at June 30, 2014.
- On June 1, 2015, we completed the sale of our wholly owned subsidiary, Concentra Inc., or Concentra, to MJ Acquisition Corporation, a joint venture between Select Medical Holdings Corporation and Welsh, Carson, Anderson & Stowe XII, L.P., a private equity fund, for approximately $1,055 million in cash, excluding approximately $25 million of transaction costs. In connection with the sale, we recognized a pretax gain, net of transaction costs, of $267 million, or $1.53 per diluted common share, consisting of a $0.35 per diluted common share gain recognized in the first quarter of 2015 associated with a tax benefit recorded in connection with the held-for-sale classification of Concentra and a $1.18 per diluted common share gain recognized upon completion of the sale during three months ended June 30, 2015.
- Excluding the impact of the sale of Concentra, our pretax results for the three and six months ended June 30, 2015 as compared to the three and six months ended June 30, 2014 reflect a year-over-year decline in Retail segment pretax results partially offset by year-over-year improvement in the Group and Healthcare Services segment pretax results as discussed in the detailed segment results discussion that follows.
- Year-over-year comparisons of the operating cost ratio are impacted by an increase in 2015 of the non-deductible health insurance industry fee mandated by the Health Care Reform Law. Likewise, year-over-year comparisons of the benefit ratio reflect the increase in this fee in the pricing of our products for 2015.
- Year-over-year comparisons of diluted earnings per common share are favorably impacted by a lower number of shares used to compute diluted earnings per common share reflecting the impact of share repurchases.
- During the six months ended June 30, 2015, operating cash flow used in operations was $501 million as compared to operating cash flow provided by operations of $471 million for the six months ended June 30, 2014. The decrease in our operating cash flows for the six months ended June 30, 2015 primarily reflects the effect of significant growth in individual commercial medical and group Medicare Advantage membership in the prior year, lower earnings exclusive of the gain on the sale of Concentra, and changes in the timing of other working capital items related to the growth in our pharmacy business and the timing of receipts for premiums. Prior year cash flows were favorably impacted from the typical pattern of claim payments that lagged premium receipts related to new membership. Individual commercial medical added 644,200 new members in the 2014 period compared to 42,600 in the 2015 period. Likewise group Medicare Advantage added 50,600 new members in the 2014 period compared to a decline of 16,600 members in the 2015 period.
- In September 2015, we expect to pay the federal government $866 million for the annual non-deductible health insurance industry fee compared to our payment of $562 million in 2014. This fee is not deductible for tax purposes, which significantly increased our effective income tax rate beginning in 2014. The health insurance industry fee is further described below under the section titled “Health Care Reform.”
- During the six months ended June 30, 2015, we repurchased 1.85 million shares in open market transactions for $329 million and paid dividends to stockholders of $86 million. Pursuant to the Merger Agreement with Aetna discussed previously, after July 2, 2015, we are prohibited from repurchasing any of our outstanding securities without the prior written consent of Aetna, other than repurchases of shares of our common stock in connection with the exercise of outstanding stock options or the vesting or settlement of outstanding restricted stock awards. Accordingly, as announced on July 3, 2015, we have suspended our share repurchase program due to the Merger. Our remaining repurchase authorization was $1.04 billion as of July 3, 2015. The Merger does not impact our ability and intent to continue quarterly dividend payments prior to the closing of the Merger, including the cash dividend of $0.29 per share payable on July 31, 2015 to stockholders of record on June 30, 2015. Under the terms of the Merger Agreement we have agreed with Aetna that our quarterly dividend will not exceed $0.29 per share prior to the closing of the Merger.

#### Retail

- On April 6, 2015, CMS announced final 2016 Medicare benchmark payment rates and related technical factors impacting the bid benchmark premiums, which we refer to as the Final Rate Notice. We believe the Final Rate Notice, together with the impact of payment cuts associated with the Health Care Reform Law, quality bonuses, sunset of the Star quality CMS demonstration in 2015, risk coding modifications, and other funding formula changes, indicate 2016 Medicare Advantage funding increases for us of approximately 0.8% on average. Although the overall rate adjustment is positive, geographic-specific impacts may vary from this average. Accordingly, while we believe in some markets that our members’ benefits may be adversely impacted, we believe we have effectively designed Medicare Advantage products based upon the applicable level of rate changes while continuing to remain competitive compared to both the combination of original Medicare with a supplement policy and Medicare Advantage products offered by our competitors. Failure to execute these strategies may result in a material adverse effect on our results of operations, financial position, and cash flows.
- For the three months ended June 30, 2015, our Retail segment pretax income decreased by $140 million, or 35.0%, as compared to the three months ended June 30, 2014. Retail segment pretax income decreased $134 million, or 17.4%, for the six months ended June 30, 2015, as compared to the six months ended June 30, 2014. These declines were primarily due to higher Medicare Advantage and individual commercial medical benefit ratios year-over-year as described further in the results of operations discussion that follows, the impact of changes in estimates for the net reinsurance, risk adjustment and risk corridor, which we collectively refer to as the 3Rs, receivables, as well as a higher mix of members from state-based contracts. These items were partially offset by membership growth in our Medicare Advantage, Medicare stand-alone PDP, and individual commercial medical on-exchange and off-exchange offerings in plans compliant with the Health Care Reform Law.
- Medicare Advantage operating results were negatively impacted by certain pricing assumptions in our plan designs for 2015. This primarily was related to lower-than-expected 2015 financial claim recovery levels and lower-than-anticipated reductions in inpatient admissions from our clinical programs. Overall, year-over-year hospital admissions are down. We believe we have appropriately reflected the recent medical cost experience in our plan designs for 2016 submitted to CMS.
- Operating results for our individual commercial medical business continue to be challenged primarily due to the volatility and morbidity associated with new membership related to the start of the Health Care Reform Law. Medical claims associated with certain products, in particular Health Care Reform Law compliant off-exchange offerings, continue to exceed prior expectations for fiscal year 2015. Additionally, on June 30, 2015, CMS issued data with respect to the reinsurance and risk adjustment premium stabilization programs for the 2014 plan year which indicated a meaningfully different risk profile comparison for our membership relative to state averages than had been previously anticipated. This resulted in adjustments to certain of the 3Rs during the three months ended June 30, 2015. We are in the process of evaluating our pricing and continued participation in certain products for 2016.
- Individual Medicare Advantage membership of 2,709,300 at June 30, 2015 increased 281,400, or 11.6%, from 2,427,900 at December 31, 2014 and increased 350,300 members, or 14.8%, from 2,359,000 at June 30, 2014 reflecting net membership additions, particularly for our Health Maintenance Organization, or HMO, offerings for the 2015 plan year.
- Group Medicare Advantage membership of 473,100 at June 30, 2015 decreased 16,600 members, or 3.4%, from 489,700 at December 31, 2014 and decreased 6,600 members, or 1.4%, from 479,700 at June 30, 2014. The decline from December 31, 2014 primarily reflects the loss of a large group account.
- Medicare stand-alone PDP membership of 4,442,500 at June 30, 2015 increased 448,500 members, or 11.2%, from 3,994,000 at December 31, 2014 and increased 557,000 members, or 14.3%, from 3,885,500 at June 30, 2014 reflecting net membership additions, primarily for our Humana-Walmart plan offering, for the 2015 plan year.
- Our state-based Medicaid membership of 352,000 as of June 30, 2015 increased 35,200 members, or 11.1%, from 316,800 at December 31, 2014 and increased 185,000 members, or 110.8%, from 167,000 at June 30, 2014, in each case primarily due to the addition of members under our Florida Medicaid contract.
- Individual commercial medical membership of 1,190,700 at June 30, 2015 increased 42,600 members, or 3.7%, from 1,148,100 at December 31, 2014 primarily reflecting new sales and better retention for plans compliant with the Health Care Reform Law, both on-exchange and off-exchange. Individual commercial medical membership decreased 53,600 members, or 4.3%, from 1,244,300 at June 30, 2014 primarily reflecting the loss of members subscribing to plans that are not compliant with the Health Care Reform Law partially offset by an increase in membership in plans that are compliant with the Health Care Reform Law, both on-exchange and off-exchange. At June 30, 2015, individual commercial medical membership in plans compliant with the Health Care Reform Law, both on-exchange and off-exchange, was 879,600 members, an increase of 193,300 members, or 28.2%, from December 31, 2014 and an increase of 138,400 members, or 18.7%, from June 30, 2014.

#### Group Segment

- For the three and six months ended June 30, 2015, our Group segment pretax income increased $13 million, or 43.3%, and $23 million, or 13.2%, respectively, as compared to the three and six months ended June 30, 2014, respectively, primarily due to improvement in the operating cost ratios partially offset by increases in the benefit ratios as discussed in the results of operations discussion that follows.
- Membership in HumanaVitality®, our wellness and loyalty rewards program, rose 0.7% to 3,885,200 at June 30, 2015 from 3,856,800 at December 31, 2014 and rose 3.0% from 3,772,000 at June 30, 2014, primarily due to individual Medicare Advantage growth as well as growth in stand-alone sales.

#### Healthcare Services Segment

- Year-over-year comparisons of results of operations are impacted by the completion of the sale of Concentra on June 1, 2015.
- As discussed in the detailed Healthcare Services segment results of operations discussion that follows, our Healthcare Services segment pretax income increased $17 million, or 8.3%, and $62 million, or 15.9%, for the three and six months ended June 30, 2015, respectively, as compared to the three and six months ended June 30, 2014, respectively. This increase was primarily due to revenue growth from our pharmacy solutions and home based services businesses as they serve our growing Medicare membership.
- Programs to enhance the quality of care for members are key elements of our integrated care delivery model. We have accelerated our process for identifying and reaching out to members in need of clinical intervention. At June 30, 2015, we had approximately 512,000 Medicare Advantage members with complex chronic conditions in the Humana Chronic Care Program, a 21.7% increase compared with approximately 420,700 Medicare Advantage members at December 31, 2014, and an increase of 48.6% compared with approximately 344,500 Medicare Advantage members at June 30, 2014. These increases reflect enhanced predictive modeling capabilities and focus on proactive clinical outreach and member engagement. We believe these initiatives lead to better health outcomes for our members and lower health care costs.

### Health Care Reform

The Health Care Reform Law enacted significant reforms to various aspects of the U.S. health insurance industry. Implementation dates of the Health Care Reform Law began in September 2010 and will continue through 2018, and many aspects of the Health Care Reform Law are already effective and have been implemented by us. Certain significant provisions of the Health Care Reform Law include, among others, mandated coverage requirements, mandated benefits and guarantee issuance associated with commercial medical insurance, rebates to policyholders based on minimum benefit ratios, adjustments to Medicare Advantage premiums, the establishment of federally-facilitated or state-based exchanges coupled with programs designed to spread risk among insurers, and the introduction of plan designs based on set actuarial values. In addition, the Health Care Reform Law established insurance industry assessments, including an annual health insurance industry fee and a three-year $25 billion industry wide commercial reinsurance fee. The annual health insurance industry fee levied on the insurance industry was $8 billion in 2014 with increasing annual amounts thereafter, growing to $14 billion by 2017, and is not deductible for income tax purposes, which significantly increased our effective income tax rate. Our effective tax rate for the full year 2015 is expected to be approximately 46% to 47%, including the favorable impact of the sale of Concentra on June 1, 2015. In 2014, we paid the federal government $562 million for the annual health insurance industry fee. We expect to pay the federal government $866 million for the annual health insurance industry fee in 2015, a 54.1% increase from 2014, primarily reflecting an increase in the total industry fee.

In addition, the Health Care Reform Law has increased and will continue to increase federal oversight of health plan premium rates and could adversely affect our ability to appropriately adjust health plan premiums on a timely basis. Financing for these reforms comes, in part, from material additional fees and taxes on us (as discussed above) and other health plans and individuals which began in 2014, as well as reductions in certain levels of payments to us and other health plans under Medicare as described in this report.

As noted above, the Health Care Reform Law required the establishment of health insurance exchanges for individuals and small employers to purchase health insurance that became effective January 1, 2014, with an annual open enrollment period. Insurers participating on the health insurance exchanges must offer a minimum level of benefits and are subject to guidelines on setting premium rates and coverage limitations. We may be adversely selected by individuals who have a higher acuity level than the anticipated pool of participants in this market. In addition, the risk corridor, reinsurance, and risk adjustment provisions of the Health Care Reform Law, established to apportion risk for insurers, may not be effective in appropriately mitigating the financial risks related to our products. In addition, regulatory changes to the implementation of the Health Care Reform Law that allowed individuals to remain in plans that are not compliant with the Health Care Reform Law may have an adverse effect on our pool of participants in the health insurance exchange. In addition, states may impose restrictions on our ability to increase rates. All of these factors may have a material adverse effect on our results of operations, financial position, or cash flows if our premiums are not adequate or do not appropriately reflect the acuity of these individuals. Any variation from our expectations regarding acuity, enrollment levels, adverse selection, or other assumptions used in setting premium rates could have a material adverse effect on our results of operations, financial position, and cash flows and could impact our decision to participate or continue in the program in certain states.

As discussed above, it is reasonably possible that the Health Care Reform Law and related regulations, as well as future legislative changes, including legislative restrictions on our ability to manage our provider network or otherwise operate our business, or regulatory restrictions on profitability, including by comparison of our Medicare Advantage profitability to our non-Medicare Advantage business profitability and a requirement that they remain within certain ranges of each other, in the aggregate may have a material adverse effect on our results of operations (including restricting revenue, enrollment and premium growth in certain products and market segments, restricting our ability to expand into new markets, increasing our medical and operating costs, further lowering our Medicare payment rates and increasing our expenses associated with the non-deductible health insurance industry fee and other assessments); our financial position (including our ability to maintain the value of our goodwill); and our cash flows (including the receipt of amounts due under the commercial risk adjustment, risk corridor, and reinsurance provisions of the Health Care Reform Law in 2015 related to claims paid in 2014, which payments may be subject to federal administrative action).

We intend for the discussion of our financial condition and results of operations that follows to assist in the understanding of our financial statements and related changes in certain key items in those financial statements from year to year, including the primary factors that accounted for those changes. Transactions between reportable segments primarily consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and home based services as well as clinical programs, to our Retail and Group customers and are described in Note 14 to the condensed consolidated financial statements.

### Comparison of Results of Operations for 2015 and 2014

The following discussion primarily deals with our results of operations for the three months ended June 30, 2015, or the 2015 quarter, the three months ended June 30, 2014, or the 2014 quarter, the six months ended June 30, 2015, or the 2015 period, and the six months ended June 30, 2014, or the 2014 period.

### Consolidated

*(dollars in millions, except per common share results)*

| Revenues: Premiums: | For the three months ended June 30, 2015 | 2014 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Retail | $11,555 | $9,966 | $1,589 | 15.9% |
| Group | 1,648 | 1,600 | 48 | 3.0% |
| Other Businesses | 9 | 18 | (9) | (50.0)% |
| Total premiums | 13,212 | 11,584 | 1,628 | 14.1% |
| Services: |  |  |  |  |
| Retail | 2 | 13 | (11) | (84.6)% |
| Group | 174 | 181 | (7) | (3.9)% |
| Healthcare Services | 228 | 349 | (121) | (34.7)% |
| Other Businesses | 3 | 3 | — | —% |
| Total services | 407 | 546 | (139) | (25.5)% |
| Investment income | 113 | 92 | 21 | 22.8% |
| Total revenues | 13,732 | 12,222 | 1,510 | 12.4% |
| Operating expenses: |  |  |  |  |
| Benefits | 11,252 | 9,627 | 1,625 | 16.9% |
| Operating costs | 1,817 | 1,835 | (18) | (1.0)% |
| Depreciation and amortization | 90 | 79 | 11 | 13.9% |
| Total operating expenses | 13,159 | 11,541 | 1,618 | 14.0% |
| Income from operations | 573 | 681 | (108) | (15.9)% |
| Gain on sale of business | 267 | — | 267 | 100.0% |
| Interest expense | 47 | 35 | 12 | 34.3% |
| Income before income taxes | 793 | 646 | 147 | 22.8% |
| Provision for income taxes | 362 | 302 | 60 | 19.9% |
| Net income | $431 | $344 | $87 | 25.3% |
| Diluted earnings per common share | $2.85 | $2.19 | $0.66 | 30.1% |
| Benefit ratio(a) | 85.2% | 83.1% |  | 2.1% |
| Operating cost ratio(b) | 13.3% | 15.1% |  | (1.8)% |
| Effective tax rate | 45.6% | 46.7% |  | (1.1)% |

(a) Represents total benefits expense as a percentage of premiums revenue.

(b) Represents total operating costs, excluding depreciation and amortization, as a percentage of total revenues less investment income.

*(dollars in millions, except per common share results)*

| Revenues: Premiums: | For the six months ended June 30, 2015 | 2014 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Retail | $23,133 | $19,428 | $3,705 | 19.1% |
| Group | 3,308 | 3,210 | 98 | 3.1% |
| Other Businesses | 19 | 29 | (10) | (34.5)% |
| Total premiums | 26,460 | 22,667 | 3,793 | 16.7% |
| Services: |  |  |  |  |
| Retail | 6 | 27 | (21) | (77.8)% |
| Group | 343 | 374 | (31) | (8.3)% |
| Healthcare Services | 543 | 677 | (134) | (19.8)% |
| Other Businesses | 5 | 6 | (1) | (16.7)% |
| Total services | 897 | 1,084 | (187) | (17.3)% |
| Investment income | 208 | 183 | 25 | 13.7% |
| Total revenues | 27,565 | 23,934 | 3,631 | 15.2% |
| Operating expenses: |  |  |  |  |
| Benefits | 22,257 | 18,751 | 3,506 | 18.7% |
| Operating costs | 3,762 | 3,620 | 142 | 3.9% |
| Depreciation and amortization | 183 | 161 | 22 | 13.7% |
| Total operating expenses | 26,202 | 22,532 | 3,670 | 16.3% |
| Income from operations | 1,363 | 1,402 | (39) | (2.8)% |
| Gain on sale of business | 267 | — | 267 | 100.0% |
| Interest expense | 93 | 70 | 23 | 32.9% |
| Income before income taxes | 1,537 | 1,332 | 205 | 15.4% |
| Provision for income taxes | 676 | 620 | 56 | 9.0% |
| Net income | $861 | $712 | $149 | 20.9% |
| Diluted earnings per common share | $5.67 | $4.54 | $1.13 | 24.9% |
| Benefit ratio(a) | 84.1% | 82.7% |  | 1.4% |
| Operating cost ratio(b) | 13.8% | 15.2% |  | (1.4)% |
| Effective tax rate | 44.0% | 46.5% |  | (2.5)% |

(a) Represents total benefits expense as a percentage of premiums revenue.

(b) Represents total operating costs, excluding depreciation and amortization, as a percentage of total revenues less investment income.

#### Summary

Net income was $431 million, or $2.85 per diluted common share, in the 2015 quarter compared to $344 million, or $2.19 per diluted common share, in the 2014 quarter. Net income was $861 million, or $5.67 per diluted common share, in the 2015 period compared to $712 million, or $4.54 per diluted common share, in the 2014 period. The completion of the sale of Concentra on June 1, 2015 resulted in an after-tax gain of $1.53 per diluted common share, consisting of a $0.35 per diluted common share gain recognized in the first quarter of 2015 associated with a tax benefit recorded in connection with the held-for-sale classification of Concentra and a $1.18 per diluted common share gain recognized upon completion of the sale during the 2015 quarter. Excluding the impact of the sale of Concentra, the decrease in the 2015 quarter and 2015 period were primarily due to a year-over-year decline in Retail segment pretax results partially offset by year-over-year improvement in the Group and Healthcare Services segment pretax results as discussed in the detailed segment results discussion that follows. Year-over-year comparisons of diluted earnings per common share are also favorably impacted by a lower number of shares used to compute diluted earnings per common share in the 2015 quarter and 2015 period reflecting the impact of share repurchases.

#### Premiums

Consolidated premiums increased $1.6 billion, or 14.1%, from the 2014 quarter to $13.2 billion for the 2015 quarter and increased $3.8 billion, or 16.7%, from the 2014 period to $26.5 billion for the 2015 period reflecting higher premiums in both the Retail and Group segments. These increases are primarily due to average membership growth in the Retail segment and an increase in fully-insured group commercial medical per member premiums in the Group segment. Average membership is calculated by summing the ending membership for each month in a period and dividing the result by the number of months in a period. Premiums revenue reflects changes in membership and average per member premiums. Items impacting average per member premiums include changes in premium rates as well as changes in the geographic mix of membership, the mix of product offerings, and the mix of benefit plans selected by our membership.

#### Services revenue

Consolidated services revenue decreased $139 million, or 25.5%, from the 2014 quarter to $407 million for the 2015 quarter and decreased $187 million, or 17.3%, from the 2014 period to $897 million for the 2015 period. These decreases are primarily due to the loss of certain large group ASO accounts as a result of continued discipline in pricing of services for self-funded accounts amid a highly competitive environment as well as the completion of the sale of Concentra on June 1, 2015.

#### Investment income

Investment income totaled $113 million for the 2015 quarter, increasing $21 million from $92 million for the 2014 quarter. For the 2015 period, investment income totaled $208 million, increasing $25 million from $183 million for the 2014 period. These increases were primarily due to higher realized capital gains in the 2015 quarter and 2015 period, with higher average invested balances being substantially offset by lower interest rates.

#### Benefits expense

Consolidated benefits expense was $11.3 billion for the 2015 quarter, an increase of $1.6 billion, or 16.9%, from the 2014 quarter. For the 2015 period, benefits expense was $22.3 billion, an increase of $3.5 billion, or 18.7%, from the 2014 period. These increases are primarily due to an increase in the Retail segment mainly driven by higher average Medicare Advantage membership and individual commercial medical on-exchange and off-exchange membership in plans compliant with the Health Care Reform Law. We experienced unfavorable medical claims reserve development related to prior fiscal years of $16 million in the 2015 quarter as compared to favorable medical claims reserve development of $49 million in the 2014 quarter. In the 2015 period, we experienced favorable medical claims reserve development related to prior fiscal years of $178 million as compared to $346 million in the 2014 period. The declines in prior-period medical claims reserve development year-over-year primarily were due to Medicare Advantage and individual commercial medical claims development in the Retail segment as discussed further in the segment results of operations discussion that follows.

The consolidated benefit ratio increased 210 basis points to 85.2% for the 2015 quarter compared to 83.1% for the 2014 quarter. The consolidated benefit ratio for the 2015 period was 84.1%, a 140 basis point increase from 82.7% for the 2014 period. These increases are primarily due to increases in the Retail and Group segment ratios as discussed in the segment results of operations discussion that follows. Prior-period medical claims reserve development increased the consolidated benefit ratio by approximately 10 basis points in the 2015 quarter and decreased the consolidated benefit ratio by approximately 40 basis points in the 2014 quarter. Favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 70 basis points in the 2015 period versus approximately 150 basis points in the 2014 period.

#### Operating costs

Our segments incur both direct and shared indirect operating costs. We allocate the indirect costs shared by the segments primarily as a function of revenues. As a result, the profitability of each segment is interdependent.

Consolidated operating costs decreased $18 million, or 1.0%, during the 2015 quarter compared to the 2014 quarter and increased $142 million, or 3.9%, during the 2015 period compared to the 2014 period. The increase in the 2015 period is primarily due to increases in costs mandated by the Health Care Reform Law, including the non-deductible health insurance industry fee, partially offset by operating cost efficiencies.

The consolidated operating cost ratio for the 2015 quarter was 13.3%, decreasing 180 basis points from the 2014 quarter primarily due to decreases in the operating cost ratios in our Group and Retail segments. The consolidated operating cost ratio for the 2015 period was 13.8%, decreasing 140 basis points from the 2014 period primarily due to a decrease in the operating cost ratio in our Group segment with no change in the ratio for the Retail segment.

#### Depreciation and amortization

Depreciation and amortization for the 2015 quarter totaled $90 million, compared to $79 million for the 2014 quarter. For the 2015 period, depreciation and amortization totaled $183 million compared to $161 million for the 2014 period. These increases reflect increased capital expenditures.

#### Interest expense

Interest expense for the 2015 quarter totaled $47 million, compared to $35 million for the 2014 quarter and totaled $93 million for the 2015 period compared to $70 million for the 2014 period, primarily reflecting a higher average long-term debt balance due to the issuance of senior notes in September 2014.

#### Income Taxes

Our effective tax rate during the 2015 quarter was 45.6% compared to the effective tax rate of 46.7% in the 2014 quarter. For the 2015 period our effective tax rate was 44.0% compared to the effective tax rate of 46.5% for the 2014 period. The tax effect of the sale of Concentra reduced our effective tax rate by approximately 6.5 percentage points for each of the 2015 quarter and the 2015 period, partially offset by an increase in the non-deductible health insurance industry fee from 2014.

### Retail Segment

| Membership: Medical membership: | June 30, 2015 | 2014 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | 2,709,300 | 2,359,000 | 350,300 | 14.8% |
| Group Medicare Advantage | 473,100 | 479,700 | (6,600) | (1.4)% |
| Medicare stand-alone PDP | 4,442,500 | 3,885,500 | 557,000 | 14.3% |
| Total Retail Medicare | 7,624,900 | 6,724,200 | 900,700 | 13.4% |
| Individual commercial (a) | 1,190,700 | 1,244,300 | (53,600) | (4.3)% |
| State-based Medicaid | 352,000 | 167,000 | 185,000 | 110.8% |
| Total Retail medical members | 9,167,600 | 8,135,500 | 1,032,100 | 12.7% |
| Individual specialty membership (b) | 1,203,600 | 1,229,500 | (25,900) | (2.1)% |

(a) Individual commercial medical membership includes Medicare Supplement members.

(b) Specialty products include dental, vision, and other supplemental health and financial protection products. Members included in these products may not be unique to each product since members have the ability to enroll in multiple products.

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the three months ended June 30, 2015 | 2014 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | $7,434 | $6,467 | $967 | 15.0% |
| Group Medicare Advantage | 1,398 | 1,366 | 32 | 2.3% |
| Medicare stand-alone PDP | 985 | 941 | 44 | 4.7% |
| Total Retail Medicare | 9,817 | 8,774 | 1,043 | 11.9% |
| Individual commercial | 1,113 | 912 | 201 | 22.0% |
| State-based Medicaid | 559 | 214 | 345 | 161.2% |
| Individual specialty | 66 | 66 | — | —% |
| Total premiums | 11,555 | 9,966 | 1,589 | 15.9% |
| Services | 2 | 13 | (11) | (84.6)% |
| Total premiums and services revenue | $11,557 | $9,979 | $1,578 | 15.8% |
| **Income before income taxes** | $260 | $400 | $(140) | (35.0)% |
| Benefit ratio | 87.1% | 85.2% |  | 1.9% |
| Operating cost ratio | 10.5% | 10.7% |  | (0.2)% |

43

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the six months ended June 30, 2015 | 2014 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | $14,867 | $12,927 | $1,940 | 15.0% |
| Group Medicare Advantage | 2,792 | 2,750 | 42 | 1.5% |
| Medicare stand-alone PDP | 1,988 | 1,806 | 182 | 10.1% |
| Total Retail Medicare | 19,647 | 17,483 | 2,164 | 12.4% |
| Individual commercial | 2,207 | 1,437 | 770 | 53.6% |
| State-based Medicaid | 1,150 | 383 | 767 | 200.3% |
| Individual specialty | 129 | 125 | 4 | 3.2% |
| Total premiums | 23,133 | 19,428 | 3,705 | 19.1% |
| Services | 6 | 27 | (21) | (77.8)% |
| Total premiums and services revenue | $23,139 | $19,455 | $3,684 | 18.9% |
| **Income before income taxes** | $635 | $769 | $(134) | (17.4)% |
| Benefit ratio | 86.5% | 85.3% |  | 1.2% |
| Operating cost ratio | 10.7% | 10.7% |  | —% |

#### Pretax Results

- Retail segment pretax income was $260 million in the 2015 quarter, a decrease of $140 million, or 35.0%, compared to $400 million in the 2014 quarter. Retail segment pretax income was $635 million in the 2015 period, a decrease of $134 million, or 17.4%, compared to $769 million in the 2014 period. These declines were primarily driven by an increase in the benefit ratios in the 2015 quarter and the 2015 period partially offset by Medicare Advantage membership growth.

#### Enrollment

- Individual Medicare Advantage membership increased 350,300 members, or 14.8%, from June 30, 2014 to June 30, 2015 reflecting net membership additions, particularly for our HMO offerings, for the 2015 plan year.
- Group Medicare Advantage membership decreased 6,600, or 1.4%, from June 30, 2014 to June 30, 2015.
- Medicare stand-alone PDP membership increased 557,000 members, or 14.3%, from June 30, 2014 to June 30, 2015 reflecting net membership additions, primarily for our Humana-Walmart plan offering, for the 2015 plan year.
- Individual commercial medical membership decreased 53,600 members, or 4.3%, from June 30, 2014 to June 30, 2015 primarily reflecting the loss of members subscribing to plans that are not compliant with the Health Care Reform Law partially offset by an increase in membership in plans that are compliant with the Health Care Reform Law, both on-exchange and off-exchange.
- State-based Medicaid membership increased 185,000 members, or 110.8%, from June 30, 2014 to June 30, 2015, primarily driven by the addition of members under our Florida Medicaid contract. State-based Medicaid membership at June 30, 2015 includes 16,400 dual-eligible demonstration members from state-based contracts compared to 4,000 members at June 30, 2014.
- Individual specialty membership decreased 25,900 members, or 2.1%, from June 30, 2014 to June 30, 2015, primarily driven by a membership decline in supplemental health and financial protection products.

#### Premiums

- Retail segment premiums increased $1.6 billion, or 15.9%, from the 2014 quarter to the 2015 quarter and increased $3.7 billion, or 19.1% from the 2014 period to the 2015 period. These increases are primarily due to membership growth across our individual Medicare Advantage, state-based Medicaid, and Medicare stand-alone PDP lines of business, as well as a higher percentage of individual commercial medical business in higher premium plans compliant with the Health Care Reform Law (both on-exchange and off-exchange). Average Medicare Advantage membership increased 12.2% for the 2015 quarter and 12.4% for the 2015 period.

#### Benefits expense

- The Retail segment benefit ratio increased 190 basis points from 85.2% in the 2014 quarter to 87.1% in the 2015 quarter and increased 120 basis points from 85.3% in the 2014 period to 86.5% in the 2015 period. These increases primarily reflect higher than expected medical costs as compared to the assumptions used in our pricing, unfavorable year-over-year comparisons of prior-period medical claims reserve development as discussed below, the impact of the change in estimate for the net 3Rs receivables, and higher benefit ratios associated with members from state-based contracts. We experienced higher than expected medical costs as compared to the assumptions used in our pricing for 2015 primarily due to lower-than-expected 2015 Medicare Advantage claim recoveries and lower-than-anticipated reductions in inpatient admissions from our clinical programs. In addition, medical claims associated with certain individual commercial medical products, in particular off-exchange products compliant with the Health Care Reform Law, exceeded the assumptions used when we set pricing for 2015. These items were partially offset by the impact of the increase in the health insurance industry fee included in the pricing of our products. In addition, the 2015 period was favorably impacted by the release of reserves for future policy benefits as individual commercial medical members transitioned to plans compliant with the Health Care Reform Law.
- The Retail segment’s benefits expense for the 2015 quarter included $11 million in unfavorable prior-period medical claims reserve development versus favorable prior-period medical claims reserve development of $58 million in the 2014 quarter. For the 2015 period, the Retail segment's benefits expense included the beneficial effect of $177 million in favorable prior-period medical claims reserve development versus $335 million in the 2014 period. Prior-period medical claims reserve development increased the Retail segment benefit ratio by approximately 10 basis points in the 2015 quarter and decreased the Retail segment benefit ratio by approximately 60 basis points in the 2014 quarter. Favorable prior-period medical claims reserve development decreased the Retail segment benefit ratio by approximately 80 basis points in the 2015 period versus approximately 170 basis points in the 2014 period.
- The year-over-year declines in prior-period medical claims reserve development primarily were due to claim payment processing changes, such as our gradual implementation during 2014 of inpatient authorization review prior to admission as opposed to post adjudication, as well as higher than expected flu associated claims from the fourth quarter of 2014 and continued volatility in claims associated with individual commercial medical products.

#### Operating costs

- The Retail segment operating cost ratio of 10.5% for the 2015 quarter decreased 20 basis points from 10.7% for the 2014 quarter primarily due to scale efficiencies associated with medical membership growth in the segment partially offset by the increase in the non-deductible health insurance industry fee. The Retail segment operating cost ratio of 10.7% for the 2015 period was unchanged from the 2014 period reflecting the same factors as those for the quarter as well as the recognition of previously deferred acquisition costs as individual commercial medical members transitioned to plans compliant with the Health Care Reform Law primarily in the first quarter of 2015. The non-deductible health insurance industry fee impacted the operating cost ratio by 160 basis points in both the 2015 quarter and 2015 period and by 120 basis points in each of the 2014 quarter and 2014 period.

### Group Segment

| Membership: Medical membership: | June 30, 2015 | 2014 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | 1,179,100 | 1,210,100 | (31,000) | (2.6)% |
| ASO | 736,600 | 1,120,100 | (383,500) | (34.2)% |
| Military services | 3,071,300 | 3,111,300 | (40,000) | (1.3)% |
| Total group medical members | 4,987,000 | 5,441,500 | (454,500) | (8.4)% |
| Group specialty membership (a) | 6,179,700 | 6,576,000 | (396,300) | (6.0)% |

(a) Specialty products include dental, vision, and voluntary benefit products. Members included in these products may not be unique to each product since members have the ability to enroll in multiple products.

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the three months ended June 30, 2015 | 2014 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | $1,379 | $1,321 | $58 | 4.4% |
| Group specialty | 265 | 275 | (10) | (3.6)% |
| Military services | 4 | 4 | — | —% |
| Total premiums | 1,648 | 1,600 | 48 | 3.0% |
| Services | 174 | 181 | (7) | (3.9)% |
| Total premiums and services revenue | $1,822 | $1,781 | $41 | 2.3% |
| **Income before income taxes** | $43 | $30 | $13 | 43.3% |
| Benefit ratio | 81.4% | 78.9% |  | 2.5% |
| Operating cost ratio | 24.1% | 26.9% |  | (2.8)% |

46

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the six months ended June 30, 2015 | 2014 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | $2,763 | $2,650 | $113 | 4.3% |
| Group specialty | 535 | 550 | (15) | (2.7)% |
| Military services | 10 | 10 | — | 0.0% |
| Total premiums | 3,308 | 3,210 | 98 | 3.1% |
| Services | 343 | 374 | (31) | (8.3)% |
| Total premiums and services revenue | $3,651 | $3,584 | $67 | 1.9% |
| **Income before income taxes** | $197 | $174 | $23 | 13.2% |
| Benefit ratio | 77.6% | 75.7% |  | 1.9% |
| Operating cost ratio | 24.3% | 27.0% |  | (2.7)% |

#### Pretax Results

- Group segment pretax income increased $13 million, or 43.3%, to $43 million for the 2015 quarter from the 2014 quarter, and increased $23 million, or 13.2%, to $197 million for the 2015 period from the 2014 period primarily reflecting improvement in the operating cost ratios partially offset by increases in the benefit ratios as discussed below.

#### Enrollment

- Fully-insured commercial group medical membership decreased 31,000 members, or 2.6%, from June 30, 2014 to June 30, 2015 as an increase in small group business membership was more than offset by lower membership in large group accounts.
- Group ASO commercial medical membership decreased 383,500 members, or 34.2%, from June 30, 2014 to June 30, 2015 primarily due to the loss of certain large group accounts as a result of continued discipline in pricing of services for self-funded accounts amid a highly competitive environment.
- Group specialty membership decreased 396,300 members, or 6.0%, from June 30, 2014 to June 30, 2015 primarily due to the loss of certain fully-insured group accounts.

#### Premiums

- Group segment premiums increased $48 million, or 3.0%, to $1.6 billion for the 2015 quarter from the 2014 quarter and increased $98 million, or 3.1%, to $3.3 billion for the 2015 period from the 2014 period primarily due to an increase in fully-insured commercial medical per member premiums partially offset by a net decline in fully-insured commercial medical membership.

#### Services

- Group segment services revenue decreased $7 million, or 3.9%, to $174 million for the 2015 quarter from the 2014 quarter and decreased $31 million, or 8.3%, to $343 million for the 2015 period from the 2014 period primarily due to a decline in group ASO commercial medical membership.

#### Benefits expense

- The Group segment benefit ratio increased 250 basis points from 78.9% in the 2014 quarter to 81.4% in the 2015 quarter and increased 190 basis points from 75.7% in the 2014 period to 77.6% in the 2015 period. The increases primarily reflect the impact of higher specialty drug costs, net of rebates, partially offset by an increase in the non-deductible health insurance industry fee included in the pricing of our products.
- The Group segment’s benefits expense included unfavorable prior-period medical claims reserve development of $6 million in the 2015 quarter versus $7 million in the 2014 quarter. This unfavorable prior-period medical claims reserve development increased the Group segment benefit ratio by approximately 40 basis points in each of the 2015 quarter and the 2014 quarter. The Group segment’s benefits expense included unfavorable prior-period medical claims reserve development of $1 million in the 2015 period versus favorable prior-period medical claims reserve development of $13 million in the 2014 period. The favorable prior-period medical claims reserve development had no impact on the Group segment benefit ratio in the 2015 period and decreased the Group segment benefit ratio by approximately 40 basis points in the 2014 period. The year-over-year decline in favorable prior-period medical claims reserve development primarily was due to a relatively small number of higher severity claims in the 2015 period associated with prior periods.

#### Operating costs

- The Group segment operating cost ratio of 24.1% for the 2015 quarter decreased 280 basis points from 26.9% for the 2014 quarter. For the 2015 period, the Group segment operating cost ratio of 24.3% decreased 270 basis points from 27.0% for the 2014 period. The declines primarily reflect a decline in our group ASO commercial medical membership which carries a higher operating cost ratio than our fully-insured commercial medical membership, as well as operating cost efficiencies associated with our fully-insured business as a result of our cost reduction initiatives. These decreases were partially offset by the impact of an increase in the non-deductible health insurance industry fee. The non-deductible health insurance industry fee impacted the operating cost ratio by 140 basis points in each of the 2015 quarter and 2015 period and 100 basis points in each of the 2014 quarter and 2014 period.

### Healthcare Services Segment

*(in millions)*

| Revenues: Services: | For the three months ended June 30, 2015 | 2014 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Provider services | $185 | $299 | $(114) | (38.1)% |
| Home based services | 36 | 25 | 11 | 44.0% |
| Pharmacy solutions | 7 | 25 | (18) | (72.0)% |
| Total services revenues | 228 | 349 | (121) | (34.7)% |
| Intersegment revenues: |  |  |  |  |
| Pharmacy solutions | 5,077 | 4,204 | 873 | 20.8% |
| Provider services | 403 | 269 | 134 | 49.8% |
| Home based services | 218 | 138 | 80 | 58.0% |
| Clinical programs | 50 | 51 | (1) | (2.0)% |
| Total intersegment revenues | 5,748 | 4,662 | 1,086 | 23.3% |
| Total services and intersegment revenues | $5,976 | $5,011 | $965 | 19.3% |
| **Income before income taxes** | $223 | $206 | $17 | 8.3% |
| Operating cost ratio | 95.6% | 95.2% |  | 0.4% |

*(in millions)*

| Revenues: Services: | For the six months ended June 30, 2015 | 2014 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Provider services | $464 | $583 | $(119) | (20.4)% |
| Home based services | 65 | 48 | 17 | 35.4% |
| Pharmacy solutions | 14 | 46 | (32) | (69.6)% |
| Total services revenues | 543 | 677 | (134) | (19.8)% |
| Intersegment revenues: |  |  |  |  |
| Pharmacy solutions | 10,037 | 8,061 | 1,976 | 24.5% |
| Provider services | 767 | 571 | 196 | 34.3% |
| Home based services | 408 | 256 | 152 | 59.4% |
| Clinical Programs | 99 | 101 | (2) | (2.0)% |
| Total intersegment revenues | 11,311 | 8,989 | 2,322 | 25.8% |
| Total services and intersegment revenues | $11,854 | $9,666 | $2,188 | 22.6% |
| **Income before income taxes** | $453 | $391 | $62 | 15.9% |
| Operating cost ratio | 95.5% | 95.2% |  | 0.3% |

49

#### Pretax results

- Healthcare Services segment pretax income of $223 million for the 2015 quarter increased $17 million, or 8.3%, from the 2014 quarter. For the 2015 period, the Healthcare Services segment pretax income of $453 million increased $62 million, or 15.9%, from $391 million for the 2014 period. These increases are primarily due to revenue growth from our pharmacy solutions and home based services businesses as they serve our growing Medicare membership.

#### Script Volume

- Humana Pharmacy Solutions® script volumes for Retail and Group segment membership increased to approximately 98.4 million in the 2015 quarter, up 20.6% versus scripts of approximately 81.6 million in the 2014 quarter. For the 2015 period, script volumes for Retail and Group segment membership increased to approximately 194.5 million, up 21.4% versus scripts of approximately 160.2 million in the 2014 period. These increases primarily reflect growth associated with higher average medical membership for the 2015 quarter and 2015 period than in the 2014 quarter and 2014 period.

#### Services revenues

- Services revenues decreased $121 million, or 34.7%, from the 2014 quarter to $228 million for the 2015 quarter and decreased $134 million, or 19.8%, from the 2014 period to $543 million for the 2015 period primarily due to the completion of the sale of Concentra on June 1, 2015.

#### Intersegment revenues

- Intersegment revenues increased $1.1 billion, or 23.3%, from the 2014 quarter to $5.7 billion for the 2015 quarter and increased $2.3 billion, or 25.8%, from the 2014 period to $11.3 billion for the 2015 period primarily due to growth in our Medicare membership which resulted in higher utilization of our Healthcare Services segment businesses.

#### Operating costs

- The Healthcare Services segment operating cost ratios for the 2015 quarter and 2015 period were relatively unchanged from the 2014 quarter and 2014 period, increasing 40 basis points for the 2015 quarter to 95.6% and 30 basis points to 95.5% for the 2015 period.

### Liquidity

The Merger Agreement includes customary restrictions on the conduct of our business prior to the completion of the Merger, generally requiring us to conduct our business in the ordinary course and subjecting us to a variety of specified limitations absent Aetna’s prior written consent. Historically, our primary sources of cash have included receipts of premiums, services revenue, and investment and other income, as well as proceeds from the sale or maturity of our investment securities, borrowings, and proceeds from sales of businesses. Our primary uses of cash historically have included disbursements for claims payments, operating costs, interest on borrowings, taxes, purchases of investment securities, acquisitions, capital expenditures, repayments on borrowings, dividends, and share repurchases. Because premiums generally are collected in advance of claim payments by a period of up to several months, our business normally should produce positive cash flows during periods of increasing premiums and enrollment. Conversely, cash flows would be negatively impacted during periods of decreasing premiums and enrollment. From period to period, our cash flows may also be affected by the timing of working capital items including premiums receivable, benefits payable, and other receivables and payables. The use of operating cash flows may be limited by regulatory requirements of state departments of insurance (or comparable state regulators) which require, among other items, that our regulated subsidiaries maintain minimum levels of capital and seek approval before paying dividends from the subsidiaries to the parent. Our use of operating cash flows derived from our non-insurance subsidiaries, such as in our Healthcare Services segment, is generally not restricted by state departments of insurance (or comparable state regulators).

The effect of the commercial risk adjustment, risk corridor, and reinsurance provisions of the Health Care Reform Law are impacting the timing of our operating cash flows, as we built receivables for the 2014 coverage year that we expect to collect in the second half of 2015 and we are building receivables for the 2015 coverage year that we expect to collect in the second half of 2016. The net receivable balance associated with the 3Rs was approximately $899 million at June 30, 2015, including $639 million related to the 2014 coverage year, and $679 million at December 31, 2014. On June 30, 2015 we received notification from CMS of risk adjustment and reinsurance settlement amounts for 2014. These settlement amounts as well as the corresponding change in estimate for risk corridor are reflected in the 2014 coverage year net 3Rs receivable above. Any amounts receivable or payable associated with these risk limiting programs may have an impact on subsidiary liquidity, with any temporary shortfalls funded by the parent company.

For additional information on our liquidity risk, please refer to the section entitled “Risk Factors” in our 2014 Form 10-K.

Cash and cash equivalents increased to approximately $2.3 billion at June 30, 2015 from $1.9 billion at December 31, 2014. The change in cash and cash equivalents for the six months ended June 30, 2015 and 2014 is summarized as follows:

*(in millions)*

|  | 2015 | 2014 |
| --- | ---: | ---: |
| Net cash (used in) provided by operating activities | $(501) | $471 |
| Net cash provided by investing activities | 1,222 | 404 |
| Net cash used in financing activities | (406) | (420) |
| Increase in cash and cash equivalents | $315 | $455 |

51

### Cash Flow from Operating Activities

The decrease in operating cash flows from the 2014 period to the 2015 period primarily reflects the effect of significant growth in individual commercial medical and group Medicare Advantage membership in the prior year, lower earnings exclusive of the gain on the sale of Concentra, and changes in the timing of other working capital items related to the growth in our pharmacy business and the timing of receipts for premiums. Prior year cash flows were favorably impacted from the typical pattern of claim payments that lagged premium receipts related to new membership. Individual commercial medical added 644,200 new members in the 2014 period compared to 42,600 in the 2015 period. Likewise group Medicare Advantage added 50,600 new members in the 2014 period compared to a decline of 16,600 members in the 2015 period.

The most significant drivers of changes in our working capital are typically the timing of payments of benefits expense and receipts for premiums. We illustrate these changes with the following summaries of benefits payable and receivables.

The detail of benefits payable was as follows at June 30, 2015 and December 31, 2014:

*(in millions)*

|  | June 30, 2015 | December 31, 2014 | 2015 Period Change | 2014 Period Change |
| --- | ---: | ---: | ---: | ---: |
| IBNR (1) | $3,376 | $3,254 | $122 | $656 |
| Reported claims in process (2) | 522 | 475 | 47 | 254 |
| Other benefits payable (3) | 883 | 746 | 137 | (25) |
| Total benefits payable | $4,781 | $4,475 | $306 | $885 |

(1) IBNR represents an estimate of benefits payable for claims incurred but not reported (IBNR) at the balance sheet date and includes unprocessed claim inventories. The level of IBNR is primarily impacted by membership levels, medical claim trends and the receipt cycle time, which represents the length of time between when a claim is initially incurred and when the claim form is received and processed (i.e. a shorter time span results in a lower IBNR).

(2) Reported claims in process represents the estimated valuation of processed claims that are in the post claim adjudication process, which consists of administrative functions such as audit and check batching and handling, as well as amounts owed to our pharmacy benefit administrator which fluctuate due to bi-weekly payments and the month-end cutoff.

(3) Other benefits payable primarily include amounts owed to providers under capitated and risk sharing arrangements.

The increase in benefits payable from December 31, 2014 to June 30, 2015 and from December 31, 2013 to June 30, 2014 largely was due to an increase in IBNR. IBNR increased during the 2015 period primarily as a result of individual Medicare Advantage membership growth while the 2014 period also saw, in addition to individual Medicare Advantage membership growth, significant growth in individual commercial medical and group Medicare Advantage membership. An increase in the amount of processed but unpaid claims, including amounts due to our pharmacy benefit administrator, which fluctuate due to month-end cutoff, also contributed to the benefits payable increase in both periods. In addition, benefits payable increased in the 2015 period from an increase in amounts owed to providers under capitated and risk sharing arrangements. As discussed previously, our cash flows are impacted by changes in enrollment. In the 2014 period (the first period plans compliant with the Health Care Reform Law were effective), membership growth in new fully-insured individual commercial medical plans compliant with the Health Care Reform Law outpaced membership growth in these plans in the 2015 period. In addition, growth in group Medicare Advantage membership in the 2014 period favorably impacted the 2014 period change while a decline in group Medicare Advantage membership in the 2015 period negatively impacted the 2015 period change.

The detail of total net receivables was as follows at June 30, 2015 and December 31, 2014:

*(in millions)*

|  | June 30, 2015 | December 31, 2014 | 2015 Period Change | 2014 Period Change |
| --- | ---: | ---: | ---: | ---: |
| Medicare | $1,792 | $664 | $1,128 | $1,105 |
| Commercial and other | 358 | 381 | (23) | 13 |
| Military services | 83 | 106 | (23) | 9 |
| Allowance for doubtful accounts | (104) | (98) | (6) | (3) |
| Total net receivables | $2,129 | $1,053 | 1,076 | 1,124 |
| Reconciliation to cash flow statement: |  |  |  |  |
| Change in receivables held-for-sale and disposition of receivables from sale of business |  |  | 11 | 13 |
| Change in receivables per cash flow statement resulting in cash from operations |  |  | $1,087 | $1,137 |

The changes in Medicare receivables for both the 2015 period and the 2014 period reflect the typical pattern caused by the timing of accruals and related collections associated with the CMS risk-adjustment model. Significant collections occur with the final and mid-year settlements with CMS in July and August, respectively. In connection with our July 2015 payment from CMS, we collected $495 million associated with the final Medicare risk-adjustment payment for the 2014 plan year. In addition, in connection with our August 2015 payment from CMS, we expect to collect approximately $800 million associated with the mid-year Medicare risk-adjustment payment for the 2015 plan year.

Many provisions of the Health Care Reform Law became effective in 2014, including the commercial risk adjustment, risk corridor, and reinsurance provisions as well as the non-deductible health insurance industry fee. As discussed previously, the timing of payments and receipts associated with these provisions are impacting our operating cash flows as we built a receivable for the 2014 coverage year that we expect to collect in the second half of 2015 and as we build a receivable for the 2015 coverage year that we expect to collect in the second half of 2016. The net receivable balance associated with the 3Rs was approximately $899 million at June 30, 2015 and $679 million at December 31, 2014, including certain amounts recorded in receivables above. In September 2015, we expect to pay the federal government $866 million for the annual health insurance industry fee.

### Cash Flow from Investing Activities

Proceeds from sales and maturities of investment securities exceeded purchases by $464 million in the 2015 period and $551 million in the 2014 period. These proceeds were used to fund normal working capital needs due to an increase in receivables associated with the 3Rs in addition to the timing of payments to and receipts from CMS associated with Medicare Part D reinsurance subsidies, as discussed below.

Our ongoing capital expenditures primarily relate to our information technology initiatives, support of services in our provider services operations including medical and administrative facility improvements necessary for activities such as the provision of care to members, claims processing, billing and collections, wellness solutions, care coordination, regulatory compliance and customer service. Total capital expenditures, excluding acquisitions, were $259 million in the 2015 period and $216 million in the 2014 period reflecting increased spending associated with growth in our provider services and pharmacy businesses in our Healthcare Services segment. Excluding acquisitions, we expect total capital expenditures in 2015 in a range of approximately $475 million to $525 million compared to total capital expenditures of $528 million for full year 2014.

### Cash Flow from Financing Activities

Claims payments were higher than receipts from CMS associated with Medicare Part D claim subsidies for which we do not assume risk by $270 million during the 2015 period and $122 million during the 2014 period. Our net receivable for CMS subsidies and brand name prescription drug discounts was $1.9 billion at June 30, 2015 compared to $835 million at June 30, 2014 and $1.7 billion at December 31, 2014. Refer to Note 6 to the condensed consolidated financial statements.

Under our administrative services only TRICARE South Region contract, health care cost payments for which we do not assume risk exceeded reimbursements from the federal government by $22 million during the 2015 period compared to $29 million during the 2014 period.

Receipts from the Department of Health and Humana Services, or HHS, associated with cost sharing provisions of the Health Care Reform Law for which we do not assume risk were $33 million higher than claims payments during the 2015 period and $24 million higher than claims payments during the 2014 period.

We repurchased 1.9 million shares for $329 million in the 2015 period and 0.9 million shares for $112 million in the 2014 period under share repurchase plans authorized by the Board of Directors. We also acquired common shares in connection with employee stock plans for an aggregate cost of $42 million in the 2015 period and $40 million in the 2014 period.

Proceeds from the issuance of commercial paper were $300 million in the 2015 period and the maximum principal amount outstanding at any one time during the six months ended June 30, 2015 was $300 million. We entered into the commercial paper program in October 2014. Accordingly, there were no commercial paper borrowings during the 2014 period.

We paid dividends to stockholders of $86 million during both the 2015 period and the 2014 period, as discussed further below.

### Future Sources and Uses of Liquidity

### Dividends

The following table provides details of dividend payments, excluding dividend equivalent rights, in 2014 and 2015 under our Board approved quarterly cash dividend policy:

*(in millions)*

| Record Date 2014 payments | Payment Date | Amount per Share | Total Amount |
| --- | --- | ---: | ---: |
| 12/31/2013 | 1/31/2014 | $0.27 | $42 |
| 3/31/2014 | 4/25/2014 | $0.27 | $42 |
| 6/30/2014 | 7/25/2014 | $0.28 | $43 |
| 9/30/2014 | 10/31/2014 | $0.28 | $43 |
| **2015 payments** |  |  |  |
| 12/31/2014 | 1/30/2015 | $0.28 | $42 |
| 3/31/2015 | 4/24/2015 | $0.28 | $42 |
| 6/30/2015 | 7/31/2015 | $0.29 | $43 |

The Merger discussed in Note 1 to the condensed consolidated financial statements does not impact our ability and intent to continue quarterly dividend payments prior to the closing of the Merger, including the cash dividend of $0.29 per share payable on July 31, 2015 to stockholders of record on June 30, 2015. Under the terms of the Merger Agreement we have agreed with Aetna that our quarterly dividend will not exceed $0.29 per share prior to the closing of the Merger. Declaration and payment of future quarterly dividends is at the discretion of our Board and may be adjusted as business needs or market conditions change. In addition, under the terms of the Merger Agreement, we have agreed with Aetna to coordinate the declaration and payment of dividends so that our stockholders do not fail to receive a quarterly dividend around the time of the closing of the Merger.

### Stock Repurchases

In September 2014, our Board of Directors replaced a previous share repurchase authorization of up to $1 billion (of which $816 million remained unused) with a new authorization for repurchases of up to $2 billion of our common shares exclusive of shares repurchased in connection with employee stock plans, expiring on December 31, 2016. Under the new share repurchase authorization, shares may be purchased from time to time at prevailing prices in the open market, by block purchases, through plans designed to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, or in privately-negotiated transactions (including pursuant to accelerated share repurchase agreements with investment banks), subject to certain regulatory restrictions on volume, pricing, and timing. Pursuant to the Merger Agreement with Aetna discussed previously, after July 2, 2015, we are prohibited from repurchasing any of our outstanding securities without the prior written consent of Aetna, other than repurchases of shares of our common stock in connection with the exercise of outstanding stock options or the vesting or settlement of outstanding restricted stock awards. Accordingly, as announced on July 3, 2015, we have suspended our share repurchase program due to the Merger. Our remaining repurchase authorization was $1.04 billion as of July 3, 2015.

On November 7, 2014, we announced that we had entered into an accelerated share repurchase agreement, or ASR Agreement, with Goldman, Sachs & Co., or Goldman Sachs, to repurchase $500 million of our common stock as part of the $2 billion share repurchase program authorized in September 2014. Under the ASR Agreement, on November 10, 2014, we made a payment of $500 million to Goldman Sachs from available cash on hand and received an initial delivery of 3.06 million shares of our common stock from Goldman Sachs based on the then current market price of Humana common stock. The payment to Goldman Sachs was recorded as a reduction to stockholders’ equity, consisting of a $400 million increase in treasury stock, which reflected the value of the initial 3.06 million shares received upon initial settlement, and a $100 million decrease in capital in excess of par value, which reflected the value of stock held back by Goldman Sachs pending final settlement of the ASR Agreement. Upon settlement of the ASR on March 13, 2015, we received an additional 0.36 million shares as determined by the average daily volume weighted-average share price of our common stock during the term of the ASR Agreement of $146.21, bringing the total shares received under this program to 3.42 million. In addition, upon settlement we reclassified the $100 million value of stock initially held back by Goldman Sachs from capital in excess of par value to treasury stock.

Excluding the 0.36 million shares received in March 2015 upon settlement of our ASR Agreement for which no cash was paid during the period, share repurchases were as follows during the 2015 quarter and the 2014 quarter:

*(in millions)*

| Authorization Date | Purchase Not to Exceed | Three months ended June 30, 2015 Shares | Cost | 2014 Shares | Cost |
| --- | ---: | ---: | ---: | ---: | ---: |
| September 2014 | $2,000 | 1.85 | $329 | — | $— |
| April 2014 | 1,000 | — | — | 0.81 | 101 |
| April 2013 | 1,000 | — | — | 0.10 | 11 |
| Total repurchases |  | 1.85 | $329 | 0.91 | $112 |

In connection with employee stock plans, we acquired 0.3 million common shares for $42 million and 0.4 million common shares for $40 million during the 2015 period and 2014 period, respectively, which amounts are not included in the table above.

### Senior Notes

In September 2014, we issued $400 million of 2.625% senior notes due October 1, 2019, $600 million of 3.85% senior notes due October 1, 2024 and $750 million of 4.95% senior notes due October 1, 2044. Our net proceeds, reduced for the underwriters' discount and commission and offering expenses, were $1.73 billion. We used a portion of the net proceeds to redeem the 6.45% senior unsecured notes as discussed below. We previously issued $500 million of 6.45% senior notes due June 1, 2016, $500 million of 7.20% senior notes due June 15, 2018, $300 million of 6.30% senior notes due August 1, 2018, $600 million of 3.15% senior notes due December 1, 2022, $250 million of 8.15% senior notes due June 15, 2038, and $400 million of 4.625% senior notes due December 1, 2042.

In October 2014, we redeemed the $500 million 6.45% senior unsecured notes due June 1, 2016, at 100% of the principal amount plus applicable premium for early redemption and accrued and unpaid interest to the redemption date, for cash totaling approximately $560 million. We recognized a loss on extinguishment of debt of approximately $37 million in October 2014 for the redemption of these notes.

Our senior notes, which are unsecured, may be redeemed at our option at any time at 100% of the principal amount plus accrued interest and a specified make-whole amount. The 7.20% and 8.15% senior notes are subject to an interest rate adjustment if the debt ratings assigned to the notes are downgraded (or subsequently upgraded). In addition, each series of our senior notes (other than the 6.30% senior notes) contain a change of control provision that may require us to purchase the notes under certain circumstances. On July 2, 2015 we entered into a Merger Agreement with Aetna that, when closed, may require redemption of the notes if the notes are downgraded below investment grade by both Standard & Poor’s Rating Services, or S&P and Moody’s Investors Services, Inc., or Moody’s.

### Credit Agreement

Our 5-year $1.0 billion unsecured revolving credit agreement expires July 2018. Under the credit agreement, at our option, we can borrow on either a competitive advance basis or a revolving credit basis. The revolving credit portion bears interest at either LIBOR plus a spread or the base rate plus a spread. The LIBOR spread, currently 110 basis points, varies depending on our credit ratings ranging from 90.0 to 150.0 basis points. We also pay an annual facility fee regardless of utilization. This facility fee, currently 15 basis points, may fluctuate between 10.0 and 25.0 basis points, depending upon our credit ratings. The competitive advance portion of any borrowings will bear interest at market rates prevailing at the time of borrowing on either a fixed rate or a floating rate based on LIBOR, at our option.

The terms of the credit agreement include standard provisions related to conditions of borrowing, including a customary material adverse effect clause which could limit our ability to borrow additional funds. In addition, the credit agreement contains customary restrictive and financial covenants as well as customary events of default, including financial covenants regarding the maintenance of a minimum level of net worth of $8.3 billion at June 30, 2015 and a maximum leverage ratio of 3.0. We are in compliance with the financial covenants, with actual net worth of $10.1 billion and an actual leverage ratio of 1.3, as measured in accordance with the credit agreement as of June 30, 2015. In addition, the credit agreement includes an uncommitted $250 million incremental loan facility.

At June 30, 2015, we had no borrowings outstanding under the credit agreement and we had outstanding letters of credit of $1 million secured under the credit agreement. No amounts have been drawn on these letters of credit. Accordingly, as of June 30, 2015, we had $999 million of remaining borrowing capacity under the credit agreement, none of which would be restricted by our financial covenant compliance requirement. We have other customary, arms-length relationships, including financial advisory and banking, with some parties to the credit agreement.

### Commercial Paper

In October 2014, we entered into a commercial paper program pursuant to which we may issue short-term, unsecured commercial paper notes privately placed on a discount basis through certain broker dealers. Amounts available under the program may be borrowed, repaid and re-borrowed from time to time, with the aggregate face or principal amount outstanding under the program at any time not to exceed $1 billion. The net proceeds of issuances have been and are expected to be used for general corporate purposes. The maximum principal amount outstanding at any one time during the six months ended June 30, 2015 was $300 million. As of June 30, 2015 we had $300 million outstanding in our commercial paper program. There were no outstanding borrowings at December 31, 2014.

### Liquidity Requirements

We believe our cash balances, investment securities, operating cash flows, and funds available under our credit agreement and our commercial paper program or from other public or private financing sources, taken together, provide adequate resources to fund ongoing operating and regulatory requirements, acquisitions, future expansion opportunities, and capital expenditures for at least the next twelve months, as well as to refinance or repay debt, and repurchase shares.

Adverse changes in our credit rating may increase the rate of interest we pay and may impact the amount of credit available to us in the future. Our investment-grade credit rating at June 30, 2015 was BBB+ according to Standard & Poor’s Rating Services, or S&P, and Baa3 according to Moody’s Investors Services, Inc., or Moody’s. A downgrade by S&P to BB+ or by Moody’s to Ba1 triggers an interest rate increase of 25 basis points with respect to $750 million of our senior notes. Successive one notch downgrades increase the interest rate an additional 25 basis points, or annual interest expense by $2 million, up to a maximum 100 basis points, or annual interest expense by $8 million.

In addition, we operate as a holding company in a highly regulated industry. Humana Inc., our parent company, is dependent upon dividends and administrative expense reimbursements from our subsidiaries, most of which are subject to regulatory restrictions. We continue to maintain significant levels of aggregate excess statutory capital and surplus in our state-regulated operating subsidiaries. Cash, cash equivalents, and short-term investments at the parent company were $1.9 billion at June 30, 2015 compared to $1.4 billion at December 31, 2014. This increase primarily reflects proceeds from the sale of Concentra on June 1, 2015, subsidiary dividends to the parent company, and proceeds from the issuance of commercial paper partially offset by funding of subsidiary working capital requirements, common stock repurchases, capital expenditures, and payment of stockholder dividends. Statutory accounting for the health insurance industry fee requires us to restrict surplus in the year preceding payment. Therefore, in addition to recording the full-year 2015 assessment in the first quarter of 2015, we are required to restrict surplus for the 2016 assessment ratably in 2015. In September 2015, we expect to pay the federal government $866 million for the annual health insurance industry fee.

### Regulatory Requirements

Certain of our subsidiaries operate in states that regulate the payment of dividends, loans, or other cash transfers to Humana Inc., our parent company, and require minimum levels of equity as well as limit investments to approved securities. The amount of dividends that may be paid to Humana Inc. by these subsidiaries, without prior approval by state regulatory authorities, or ordinary dividends, is limited based on the entity’s level of statutory income and statutory capital and surplus. In most states, prior notification is provided before paying a dividend even if approval is not required. Actual dividends paid may vary due to consideration of excess statutory capital and surplus and expected future surplus requirements related to, for example, premium volume and product mix.

Although minimum required levels of equity are largely based on premium volume, product mix, and the quality of assets held, minimum requirements vary significantly at the state level. Based on the most recently filed statutory financial statements as of March 31, 2015, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $5.4 billion, which exceeded aggregate minimum regulatory requirements of $4.2 billion. The amount of dividends paid to our parent company was approximately $457 million during the six months ended June 30, 2015 compared to $695 million during the six months ended June 30, 2014. The year-over-year decline in dividends to the parent company from the subsidiaries is primarily driven by lower operating results in health plan subsidiaries, including the impact of recording the significantly higher full-year 2015 annual health insurance industry fee in the first quarter of 2015, as required by state regulators. As discussed previously, we expect to pay the federal government $866 million for the annual health insurance industry fee in 2015, a 54.1% increase from $562 million in 2014. Subsidiary dividends are subject to state regulatory approval, the amount and timing of which could be reduced or delayed.

## Market risk

As filed, 2,051 characters.

Our earnings and financial position are exposed to financial market risk, including those resulting from changes in interest rates.

Interest rate risk also represents a market risk factor affecting our consolidated financial position due to our significant investment portfolio, consisting primarily of fixed maturity securities of investment-grade quality with a weighted average S&P credit rating of AA- at June 30, 2015. Our net unrealized position decreased $219 million from a net unrealized gain position of $475 million at December 31, 2014 to a net unrealized gain position of $256 million at June 30, 2015. At June 30, 2015, we had gross unrealized losses of $92 million on our investment portfolio primarily due to an increase in market interest rates since the time the securities were purchased. There were no material other-than-temporary impairments during the three months ended June 30, 2015. While we believe that these impairments are temporary and we currently do not have the intent to sell such securities, given the current market conditions and the significant judgments involved, there is a continuing risk that future declines in fair value may occur and material realized losses from sales or other-than-temporary impairments may be recorded in future periods.

Duration is the time-weighted average of the present value of the bond portfolio’s cash flow. Duration is indicative of the relationship between changes in fair value and changes in interest rates, providing a general indication of the sensitivity of the fair values of our fixed maturity securities to changes in interest rates. However, actual fair values may differ significantly from estimates based on duration. The average duration of our investment portfolio, including cash and cash equivalents, was approximately 4.2 years as of June 30, 2015 and 4.1 years as of December 31, 2014. Based on the duration, including cash equivalents, a 1% increase in interest rates would generally decrease the fair value of our securities by approximately $440 million.

## Controls and procedures

As filed, 1,291 characters.

Under the supervision and with the participation of our Chief Executive Officer, or CEO, our Chief Financial Officer, or CFO, and our Principal Accounting Officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures for the quarter ended June 30, 2015.

Based on our evaluation, our CEO, CFO, and our Principal Accounting Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information the Company is required to disclose in its reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, including, without limitation, ensuring that such information is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

There have been no changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

## Risk factors

As filed, 11,591 characters.

Except as set forth below, there have been no changes to the risk factors included in our 2014 Form 10-K:

### Risks Relating to the Proposed Merger with Aetna

***The merger with Aetna is subject to various closing conditions, including governmental, regulatory and stockholder approvals as well as other uncertainties and there can be no assurances as to whether and when it may be completed.***

On July 2, 2015, we entered into an Agreement and Plan of Merger (which we refer to as the “Merger Agreement”), with Aetna Inc. (or “Aetna”), Echo Merger Sub, Inc. (or “Sub 1”) and Echo Merger Sub, LLC (or “Sub 2”), each a wholly owned subsidiary of Aetna. Under the terms and subject to the conditions set forth in the Merger Agreement, Sub 1 will merge with and into us (the “Merger”). In the Merger, each outstanding share of our common stock will be converted into the right to receive (i) 0.8375 of a share of Aetna common stock and (ii) $125 in cash without interest, subject to any required withholding taxes. Immediately after the Merger, we (as the surviving corporation in the Merger) will be merged with and into Sub 2, with Sub 2 remaining as the surviving entity of that merger and as a wholly owned subsidiary of Aetna, to be renamed Humana LLC. The Merger is expected to close in the second half of 2016.

Consummation of the Merger is subject to customary closing conditions, a number of which are not within our or Aetna’s control, and it is possible that such conditions may prevent, delay or otherwise materially adversely affect the completion of the Merger. These conditions include, among other things, (i) approval of the holders of our outstanding shares of common stock entitled to vote on the Merger, (ii) approval of the holders of Aetna outstanding shares to the issuance of Aetna common stock in the Merger, (iii) the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the receipt of necessary approvals under state insurance and healthcare laws and regulations and pursuant to certain licenses of certain of Humana’s subsidiaries, (iv) the absence of legal restraints and prohibitions on the consummation of the Merger, (v) the effectiveness of the registration statement in respect of the Aetna common stock to be issued in the Merger, (vi) listing of the Aetna common stock to be issued in the Merger on the New York Stock Exchange, (vii) subject to the relevant standards set forth in the Merger Agreement, the accuracy of the representations and warranties made by each party, (viii) material compliance by each party with its covenants in the Merger Agreement, and (viii) no “Company Material Adverse Effect” with respect to us and no “Parent Material Adverse Effect” with respect to Aetna, in each case since the execution of and as defined in the Merger Agreement. In addition, Aetna’s obligation to consummate the Merger is subject to (x) the condition that the required regulatory approvals do not impose any condition that, individually or in the aggregate, would reasonably be expected to have a “Regulatory Material Adverse Effect” (as such term is defined in the Merger Agreement), and (b) the Centers for Medicare and Medicaid Services, or CMS, has not imposed any sanctions with respect to our Medicare Advantage business that, individually or in the aggregate, is or would reasonably be expected to be material and adverse to us and its subsidiaries, taken as a whole. We cannot predict with certainty whether and when any of the required closing conditions will be satisfied or if another uncertainty may arise.

If the Merger does not receive, or timely receive, the required regulatory approvals and clearances, or if any regulatory agencies impose certain conditions relating to the required regulatory approvals that would reasonably be expected to have a "Regulatory Material Adverse Effect", or if an event occurs that delays or prevents the Merger, such failure or delay to complete the Merger may cause uncertainty or other negative consequences that may materially and adversely affect our results of operations, financial position, cash flows and the price per share for our common stock.

***The Merger Agreement limits our ability to pursue alternative transactions to the proposed Merger.***

The Merger Agreement prohibits us from initiating, soliciting, knowingly encouraging, knowingly facilitating or entering into discussions or negotiations with any third party regarding alternative acquisition proposals. This prohibition limits our ability to affirmatively seek offers from other possible acquirers that may be superior to the pending Merger, although we are permitted, subject to compliance with certain procedures specified in the Merger Agreement, to respond to certain unsolicited proposals from third parties to allow our Board of Directors to comply with its fiduciary duties. If we receive an unsolicited proposal from a third party that our Board of Directors determines is a superior proposal (as defined in the Merger Agreement), our Board of Directors may withdraw or otherwise change its recommendation of the Merger. However, we do not have the ability to terminate the Merger Agreement in order to accept a superior proposal. If our Board of Directors withdraws or otherwise changes its recommendation of the Merger, or if we materially breach our obligation not to solicit alternative acquisition proposals, Aetna may terminate the Merger Agreement and we would be contractually obligated to pay a termination fee of $1.314 billion to Aetna. This termination fee may make it less likely that a third party will make an alternative acquisition proposal for us.

***The number of shares of Aetna common stock that our stockholders will receive in the Merger is based on a fixed exchange ratio. Because the market price of Aetna’s common stock will fluctuate, our stockholders cannot be certain of the value of the portion of the merger consideration to be paid in Aetna common stock.***

Upon completion of the Merger, each outstanding share of our common stock will be converted into the right to receive (i) 0.8375 of a share of Aetna common stock and (ii) $125 in cash without interest, subject to any required withholding taxes. The exchange ratio for determining the number of shares of Aetna common stock that our stockholders will receive in the Merger is fixed and will not be adjusted for changes in the market price of Aetna’s common stock, which will likely fluctuate before and after the completion of the Merger. Fluctuations in the value of Aetna’s common stock could result from changes in the business, operations or prospects of Aetna prior to or following the closing of the Merger, regulatory considerations, general market and economic conditions and other factors both within and beyond the control of us or Aetna. In addition, the Merger is expected to be completed a considerable amount of time after the date of our special meeting of stockholders to consider and vote on the Merger. As such, at the time of our special meeting of stockholders to consider and vote on the Merger, our stockholders will not have known the value of the Aetna share consideration that they will receive in the Merger for each of our common shares.

***While the Merger is pending, we are subject to business uncertainties and contractual restrictions that could materially adversely affect our results of operations, financial position and cash flows or result in a loss of employees, customers, members or suppliers.***

The Merger Agreement includes restrictions on the conduct of our business prior to the completion or termination of the Merger, generally requiring us to conduct our business in the ordinary course and subjecting us to a variety of specified limitations absent Aetna’s prior written consent. We may find that these and other contractual restrictions in the Merger Agreement may delay or prevent us from responding, or limit our ability to respond, effectively to competitive pressures, industry developments and future business opportunities that may arise during such period, even if our management believes they may be advisable. The pendency of the proposed Merger may also divert management’s attention and our resources from ongoing business and operations.

Our employees, customers, members and suppliers may experience uncertainties about the effects of the Merger. In connection with the pending Merger, it is possible that some customers, members, suppliers and other parties with whom we have a business relationship may delay or defer certain business decisions or might decide to seek to terminate, change or renegotiate their relationship with us as a result of the Merger. Similarly, current and prospective employees may experience uncertainty about their future roles with us following completion of the Merger, which may materially adversely affect our ability to attract and retain key employees. If any of these effects were to occur, it could materially and adversely impact our results of operations, financial position, cash flows and the price per share for our common stock.

***If the Merger Agreement is terminated, we may, under certain circumstances, be obligated to pay a termination fee to Aetna.***

If the Merger Agreement is terminated, in certain circumstances, we would be required to pay a termination fee of $1.314 billion to Aetna. If the Merger Agreement is terminated under such circumstances, the termination fee we may be required to pay under the Merger Agreement may require us to use available cash that would have otherwise been available for general corporate purposes and other matters.

***Failure to consummate the Merger could negatively impact our results of operations, financial position and cash flows.***

If the Merger is not consummated, our ongoing businesses may be materially and adversely affected and, we will not have realized any of the potential benefits of having consummated the transaction, and we will be subject to a number of risks, including the following:

- matters relating to the proposed Merger (including integration planning) may require substantial commitments of time and resources by our management, which could otherwise have been devoted to other opportunities that may have been beneficial to us;
- the Merger Agreement includes restrictions on the conduct of our business prior to the completion or termination of the Merger, generally requiring us to conduct our business in the ordinary course and subjecting us to a variety of specified limitations absent Aetna's prior written consent. We may find that these and other contractual restrictions in the Merger Agreement may delay or prevent us from responding, or limit our ability to respond, effectively to competitive pressures, industry developments and future business opportunities that may arise during such period, even if our management believes they may be advisable. The pendency of the proposed Merger may also divert management’s attention and our resources from ongoing business and operations;
- we may be required to pay a termination fee to Aetna and would have incurred expenses relating to the Merger; and
- we also could be subject to litigation related to our failure to consummate the Merger or to perform our obligations under the Merger Agreement.

If the Merger is not consummated, these risks may materially and adversely affect our results of operations, financial position, cash flows and the price per share for our common stock.

Filed Jul 29, 2015.
Source: SEC EDGAR, the filing index for accession 0000049071-15-000075. Last ingested by Listed: Nov 10, 2026, 18:12 ET. No prices; not investment advice.