# Humana Inc: Form 10-Q for the period ended Jun 30, 2016

- Company: [Humana Inc](/companies/hum.md) (CIK 49071)
- Form: 10-Q
- Filed: 2016-08-03
- Accepted by EDGAR: Aug 3, 2016, 08:05 ET
- Period: 2016-06-30
- Accession: 0000049071-16-000169
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/49071/000004907116000169/hum-20160630x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/49071/000004907116000169/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2016-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2016-04-01 to 2016-06-30 | $14.01bn | us-gaap:Revenues |
| Revenue | 6 months, 2016-01-01 to 2016-06-30 | $27.81bn | us-gaap:Revenues |
| Selling, general and administrative | 3 months, 2016-04-01 to 2016-06-30 | $1.73bn | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 6 months, 2016-01-01 to 2016-06-30 | $3.49bn | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2016-04-01 to 2016-06-30 | $683.0m | us-gaap:OperatingIncomeLoss |
| Operating income | 6 months, 2016-01-01 to 2016-06-30 | $1.23bn | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2016-04-01 to 2016-06-30 | $47.0m | us-gaap:InterestExpense |
| Interest expense | 6 months, 2016-01-01 to 2016-06-30 | $94.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2016-04-01 to 2016-06-30 | $325.0m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2016-01-01 to 2016-06-30 | $571.0m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2016-04-01 to 2016-06-30 | $311.0m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2016-01-01 to 2016-06-30 | $565.0m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2016-04-01 to 2016-06-30 | $2.06 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 6 months, 2016-01-01 to 2016-06-30 | $3.75 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2016-04-01 to 2016-06-30 | $2.08 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 6 months, 2016-01-01 to 2016-06-30 | $3.79 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2016-04-01 to 2016-06-30 | 150,806,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 6 months, 2016-01-01 to 2016-06-30 | 150,851,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 6 months, 2016-01-01 to 2016-06-30 | $206.0m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2016-01-01 to 2016-06-30 | $256.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 6 months, 2016-01-01 to 2016-06-30 | $90.0m | us-gaap:PaymentsOfDividends |
| Share repurchases | 6 months, 2016-01-01 to 2016-06-30 | $73.0m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2016-06-30 | $2.43bn | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2016-06-30 | $17.74bn | us-gaap:AssetsCurrent |
| Total assets | at 2016-06-30 | $27.24bn | us-gaap:Assets |
| Current liabilities | at 2016-06-30 | $9.93bn | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2016-06-30 | $16.36bn | us-gaap:Liabilities |
| Long-term debt | at 2016-06-30 | $3.79bn | us-gaap:LongTermDebtNoncurrent |
| Short-term borrowings | at 2016-06-30 | $300.0m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2016-06-30 | $10.87bn | us-gaap:StockholdersEquity |
| Shares outstanding | at 2016-06-30 | 149,067,340 shares | dei:EntityCommonStockSharesOutstanding |

## Management's discussion and analysis

As filed, 100,403 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 Securities and Exchange Commission, or 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 2015 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, 2016, 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.

### Aetna 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. A copy of the Merger Agreement was filed as Exhibit 2.1 to our Current Report on Form 8-K filed with the SEC on July 7, 2015. Under the terms of the Merger Agreement, at the closing 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. 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 (we agreed that our quarterly dividend will not exceed $0.29 per share) and repurchases of our securities (we agreed to suspend our share repurchase program), restrictions on our ability to enter into material contracts, and negotiated thresholds for capital expenditures, capital contributions, acquisitions and divestitures of businesses.

On October 19, 2015, our stockholders approved the adoption of the Merger Agreement at a special stockholder meeting. Of the 129,240,721 shares voting at the meeting, more than 99% voted in favor of the adoption of the Merger Agreement, which represented approximately 87% of our total outstanding shares of common stock as of the September 16, 2015 record date. Also on October 19, 2015, the holders of Aetna outstanding shares approved the issuance of Aetna common stock in the Merger at a special meeting of Aetna shareholders.

The Merger is subject to customary closing conditions, including, among other things, (i) 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, (ii) the absence of legal restraints and prohibitions on the consummation of the Merger, (iii) listing of the Aetna common stock to be issued in the Merger on the New York Stock Exchange, (iv) subject to the relevant standards set forth in the Merger Agreement, the accuracy of the representations and warranties made by each party, (v) material compliance by each party with its covenants in the Merger Agreement, and (vi) 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) 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.

On June 24, 2016, as permitted under the terms of the Merger Agreement, each of Aetna and Humana delivered written notice to the other that it had elected to extend the “End Date” (as defined in the Merger Agreement) to and including December 31, 2016 (which End Date had previously been June 30, 2016).

On July 21, 2016, the U.S. Department of Justice and the attorneys general of certain U.S. jurisdictions filed a civil antitrust complaint in the U.S. District Court for the District of Columbia against us and Aetna, charging that the Merger would violate Section 7 of the Clayton Antitrust Act and seeking a permanent injunction to prevent the Merger. The DOJ Action could extend beyond December 31, 2016. Together with Aetna, we intend to vigorously defend the Merger in response to the lawsuit, as described further in Note 13 to the condensed consolidated financial statements.

In order to address the DOJ’s perceived competitive concerns regarding Medicare Advantage, on August 2, 2016, we entered into the Humana APA to sell for cash to Molina certain of our Medicare Advantage assets. Also on August 2, 2016, Aetna entered into the Aetna APA to sell for cash to Molina certain of Aetna’s Medicare Advantage assets. The sale price under the Humana APA and the Aetna APA is approximately $117 million in the aggregate, based on the estimated membership in the plans that are involved in the transaction. We believe that taken together, the divestitures contemplated by the Humana APA and the Aetna APA should address the DOJ’s perceived competitive concerns regarding Medicare Advantage.

We made customary representations, warranties and covenants in the Humana APA, including, among others, a covenant, subject to certain exceptions, to conduct our business that is involved in the transactions in the ordinary course between the execution of the Humana APA and the closing of the transactions. In connection with the transactions contemplated by the Humana APA, we expect to provide Molina with certain administrative services related to the Medicare Advantage plans that are involved in our divestiture transaction for a transition period following the closing. The transactions contemplated by the Humana APA and the Aetna APA remain subject to the completion of the Merger, the resolution of the DOJ Action, CMS approvals and actions, and customary closing conditions, including approvals of state departments of insurance and other regulators.

The Merger remains subject to resolution of the DOJ Action and customary closing conditions, including approvals of state departments of insurance and other regulators, and, depending upon the resolution of the DOJ Action, the completion of the transactions contemplated by the Humana APA and the Aetna APA. Given the uncertainty associated with the timing and the resolution of the DOJ Action and the time necessary to close the transactions contemplated by each of the Humana APA and the Aetna APA, we cannot predict when the Merger may close.

### Business Segments

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 Limited Income Newly Eligible Transition, or 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 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 partially offset by the recognition of previously deferred acquisition costs. The recognition of a premium deficiency reserve for our individual commercial medical business compliant with the Health Care Reform Law in the fourth quarter of 2015, and subsequent changes in estimate, also impact the quarterly benefit ratio pattern for this business.

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.

### 2016 Highlights

#### Consolidated

- Our pretax results for the three and six months ended June 30, 2016 as compared to the three and six months ended June 30, 2015 reflect year-over-year improvements in pretax results across all segments excluding the continued challenges in our individual commercial medical business.
- Our 2016 results through June 30, 2016 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. We offer providers a continuum of opportunities to increase the integration of care and offer assistance to providers in transitioning from a fee-for-service to a value-based arrangement. These include performance bonuses, shared savings and shared risk relationships. At June 30, 2016, approximately 1,726,800 members, or 61.3%, of our individual Medicare Advantage members were in value-based relationships under our integrated care delivery model, as compared to 1,633,100 members, or 59.3%, at December 31, 2015 and 1,510,400 members, or 55.7%, at June 30, 2015.
- Year-over year comparisons of results are impacted by the June 1, 2015 sale of our former 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 $22 million of transaction costs. In connection with the sale, we recognized a pretax gain, net of transaction costs, of $270 million, or $1.57 per diluted common share in 2015, including $1.18 recognized during the three months ended June 30, 2015 and $1.53 recognized during six months ended June 30, 2015.
- Year-over-year comparisons of results are also impacted by the recognition of a premium deficiency reserve for our individual commercial medical business for the 2016 coverage year as discussed in the Retail segment highlights that follow. During the three months ended June 30, 2016 we increased the premium deficiency reserve $208 million, or $0.86 per diluted common share.
- Likewise, year-over-year comparisons of the benefit ratio are impacted by the recognition of a premium deficiency reserve for our individual commercial medical business as well as the unfavorable seasonal affect of one extra business day's claims from leap year in the six months ended June 30, 2016.
- We recorded transaction and integration costs in connection with the Merger of approximately $26 million, or $0.16 per diluted common shares, and $61 million, or $0.37 million per diluted common share, during the three and six months ended June 30, 2016, respectively. Certain costs associated with the Merger are not deductible for tax purposes.
- As disclosed in Note 2 to the condensed consolidated financial statements included in this report, we elected to early adopt new accounting guidance related to accounting for employee share-based payments, which changes how income tax effects of employee share-based payments are recorded. We adopted this guidance prospectively effective January 1, 2016. The adoption of this new guidance resulted in the recognition of approximately $20 million of tax benefits in net income, or $0.12 per diluted common share, in the first quarter of 2016.
- 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 in the first half of 2015.
- During the six months ended June 30, 2016, operating cash flow provided by operations was $206 million as compared to operating cash flow used in operations of $501 million for the six months ended June 30, 2015. The increase in our operating cash flows for the six months ended June 30, 2016 primarily was due to the favorable timing of working capital items, as discussed further under Liquidity in this report, and higher earnings exclusive of both the gain on the sale of Concentra and the increase in the premium deficiency reserve discussed above.
- In 2016, we expect to pay the federal government an estimated $912 million for the annual non-deductible health insurance industry fee compared to our payment of $867 million in 2015. This fee is not deductible for tax purposes, which significantly increased our effective income tax rate. The health insurance industry fee is further described below under the section titled “Health Care Reform.” The Consolidated Appropriations Act, 2016, enacted on December 18, 2015, included a one-time one year suspension in 2017 of the health insurer fee. This will significantly reduce our operating costs and effective tax rate in 2017.
- During the six months ended June 30, 2016, we paid dividends to stockholders of $90 million.

#### Retail

- On April 4, 2016, CMS announced final 2017 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, risk coding modifications, Star ratings for 2017, and other funding formula changes, indicate 2017 Medicare Advantage funding decreases for us of approximately 1.3% on average. Although the overall rate adjustment is negative, geographic-specific impacts may vary significantly from this average. The beneficial effect of the temporary suspension of the health insurer fee for 2017 discussed above is not reflected in our estimate for our 2017 rate changes. We believe our 2017 Medicare Advantage plan filings, including the applicable level of rate changes, will 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, 2016, our Retail segment pretax income increased by $60 million, or 23.1%, as compared to the three months ended June 30, 2015 and decreased $161 million, or 25.4%, for the six months ended June 30, 2016 as compared to the six months ended June 30, 2015. These changes reflect year-over-year improvement in results across most business lines in the segment offset by a year-over-year decline in results for our individual commercial medical business as discussed in the detailed segment results of operations discussion that follows.
- Our Medicare Advantage results improved year-over-year primarily due to operational execution resulting in favorable year-over-year comparisons of prior-period medical claims reserve development and lower current year utilization than was anticipated in pricing. The primary focus of our operational initiatives centered around expanding the number of members in our clinical programs through improved outreach efforts and member engagement, as well as optimizing the performance of existing initiatives to reduce medical cost trend. In addition our Medicare Advantage membership increased year-over-year as discussed below.
- Individual Medicare Advantage membership of 2,816,500 at June 30, 2016 increased 63,100, or 2.3%, from December 31, 2015 and 107,200 members, or 4.0% from June 30, 2015. Medicare stand-alone PDP membership of 4,856,300 at June 30, 2016 increased 298,400 members, or 6.5%, from December 31, 2015 and 413,800 members, or 9.3%, from June 30, 2015. These increases in membership reflect net membership additions for the 2016 plan year, particularly for our Medicare Advantage Health Maintenance Organization, or HMO, offerings and our Medicare stand-alone PDP Humana-Walmart plan offering.
- Group Medicare Advantage membership of 351,700 at June 30, 2016 decreased 132,400 members, or 27.3%, from December 31, 2015 and 121,400 members, or 25.7%, from June 30, 2015, primarily reflecting the loss of a large account that moved to a private exchange offering on January 1, 2016.
- Our state-based Medicaid membership of 391,600 as of June 30, 2016 increased 17,900 members, or 4.8%, from December 31, 2015 and 39,600 members, or 11.3%, from June 30, 2015, in each case primarily due to the addition of members under our Florida Medicaid contracts.
- Operating results for our individual commercial medical business compliant with the Health Care Reform Law have been challenged. As disclosed in our 2015 Form 10-K, as a result of our assessment of the profitability of our individual medical policies compliant with the Health Care Reform Law, in the fourth quarter of 2015, we recorded a provision for probable future losses (premium deficiency reserve) for the 2016 coverage year of $176 million. As discussed previously, during the three months ended June 30, 2016 we increased the premium deficiency reserve for the 2016 coverage year by $208 million, primarily as a result of unfavorable current and projected claims experience. As of June 30, 2016, the remaining premium deficiency reserve was $337 million.

During 2016, we filed plans with state DOIs to offer on-exchange individual commercial medical plans in 11 states in 2017. We currently offer on-exchange coverage in 15 states. We have limited on-exchange membership in the four states where we intend to discontinue coverage in 2017. We also intend to discontinue substantially all Health Care Reform Law compliant off-exchange individual commercial medical plans in 2017. We expect our 2017 geographic presence for our individual commercial medical offerings to cover no more than 156 counties, down from our 2016 presence in 1,351 counties (covering both on-exchange and off-exchange offerings). We expect 2017 premiums associated with Health Care Reform Law compliant offerings in the range of $750 million to $1 billion versus approximately $3.4 billion projected for full year 2016 reflecting the adjustment to our geographic presence, partially offset by premium increases pending regulatory review. Our individual on-exchange plans for 2017 have yet to be finalized, pending government approval from state and federal regulatory agencies.

We will continue to evaluate the performance of this business for 2016 as it further develops and the corresponding impact on the premium deficiency reserve, if any.

- Individual commercial medical membership of 792,000 at June 30, 2016 decreased 107,100 members, or 11.9%, from December 31, 2015 and decreased 244,700 members, or 23.6%, from June 30, 2015. These decreases primarily reflect the loss of both members in plans compliant with the Health Care Reform Law, primarily on-exchange, as well as members subscribing to plans that are not compliant with the Health Care Reform Law as discussed further in the results of operations discussion that follows. At June 30, 2016, individual commercial medical membership in plans compliant with the Health Care Reform Law, both on-exchange and off-exchange, was 694,000 members, a decrease of 63,900 members, or 8.4%, from December 31, 2015 and 185,600 members, or 21.1%, from June 30, 2015.

#### Group Segment

- For the three and six months ended June 30, 2016, our Group segment pretax income increased $58 million, or 134.9%, and $62 million, or 31.5%, respectively, as compared to the three and six months ended June 30, 2015, respectively, as discussed in the results of operations discussion that follows.
- On July 21, 2016, we were notified by the Defense Health Agency that we were awarded the TRICARE East Region contract. Our current TRICARE South Region contract expires March 31, 2017. The new East Region is a combination of the current North Region and South Region. The East Region and West Region contract awards are subject to protests.

#### Healthcare Services Segment

- As noted previously, 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 $48 million, or 21.5%, and $59 million, or 13.0%, for the three and six months ended June 30, 2016, respectively, as compared to the three and six months ended

June 30, 2015, respectively, primarily due to incremental earnings associated with revenue growth from our pharmacy solutions, including mail order, and home based services businesses as they serve our growing individual Medicare Advantage 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. Medicare Advantage membership with complex chronic conditions in the Humana Chronic Care Program rose to approximately 614,200 at June 30, 2016, an increase of 20.0% from June 30, 2015 and 4.0% from December 31, 2015, reflecting a greater focus on members living with the most chronic conditions. Enhanced predictive modeling capabilities and proactive clinical outreach and engagement of those members helped drive increased clinical program participation, offset by the loss of engaged members associated with the group Medicare account that termed on January 1, 2016 as discussed previously. 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. 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 and $11.3 billion in each of 2015 and 2016, with increasing annual amounts starting in 2018, and is not deductible for income tax purposes, which significantly increased our effective income tax rate. Our effective tax rate for full year 2016 is expected to be approximately 49.0% to 51.0%, excluding the impact of transaction costs associated with the Merger expected to be incurred subsequent to June 30, 2016. In 2016, we expect to pay the federal government an estimated $912 million for the annual health insurance industry fee, a 5.2% increase from $867 million in 2015, primarily reflecting growth in our market share. The Consolidated Appropriations Act, 2016, enacted on December 18, 2015, included a one-time one year suspension in 2017 of the health insurer fee. This will significantly reduce our operating costs and effective tax rate in 2017. The health insurance industry fee levied on the insurance industry was previously expected to be $14 billion in 2017.

In addition, the Health Care Reform Law expands 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 our 2015 Form 10-K.

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 or to enroll outside of the annual enrollment period 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. During 2016, we filed plans with state DOIs to offer on-exchange individual commercial medical plans in 11 states in 2017. We currently offer on-exchange coverage in 15 states. We have limited on-exchange membership in the four states where we intend to discontinue coverage in 2017. We also intend to discontinue substantially all Health Care Reform Law compliant off-exchange individual commercial medical plans in 2017. Our individual on-exchange plans for 2017 have yet to be finalized, pending government approval from state and federal regulatory agencies.

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 delayed receipt of amounts due under the commercial risk adjustment, risk corridor, and reinsurance provisions of the Health Care Reform Law). The interim settlement of approximately 12.6% of risk corridor receivables for the 2014 coverage year primarily was received in the fourth quarter of 2015 and funded by HHS in accordance with previous guidance, utilizing funds HHS collected from us and other carriers under the 2014 risk corridor program. The risk corridor program is a three year program and HHS guidance provides that risk corridor collections over the life of the three year program will first be applied to any shortfalls from previous benefit years before application to current year obligations. Risk corridor payables to issuers are obligations of the United States Government under the Health Care Reform law which requires the Secretary of HHS to make full payments to issuers. In the event of a shortfall at the end of the three year program, HHS has asserted it will explore other sources of funding for risk corridor payments, subject to the availability of appropriations.

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 included in this report.

### Comparison of Results of Operations for 2016 and 2015

The following discussion primarily deals with our results of operations for the three months ended June 30, 2016, or the 2016 quarter, the three months ended June 30, 2015, or the 2015 quarter, the six months ended June 30, 2016, or the 2016 period, and the six months ended June 30, 2015, or the 2015 period.

### Consolidated

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

| Revenues: Premiums: | For the three months ended June 30, 2016 | 2015 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Retail | $12,024 | $11,555 | $469 | 4.1% |
| Group | 1,617 | 1,648 | (31) | (1.9)% |
| Other Businesses | 9 | 9 | — | —% |
| Total premiums | 13,650 | 13,212 | 438 | 3.3% |
| Services: |  |  |  |  |
| Retail | 2 | 2 | — | —% |
| Group | 189 | 174 | 15 | 8.6% |
| Healthcare Services | 68 | 228 | (160) | (70.2)% |
| Other Businesses | 3 | 3 | — | —% |
| Total services | 262 | 407 | (145) | (35.6)% |
| Investment income | 95 | 113 | (18) | (15.9)% |
| Total revenues | 14,007 | 13,732 | 275 | 2.0% |
| Operating expenses: |  |  |  |  |
| Benefits | 11,509 | 11,252 | 257 | 2.3% |
| Operating costs | 1,726 | 1,817 | (91) | (5.0)% |
| Depreciation and amortization | 89 | 90 | (1) | (1.1)% |
| Total operating expenses | 13,324 | 13,159 | 165 | 1.3% |
| Income from operations | 683 | 573 | 110 | 19.2% |
| Gain on sale of business | — | 267 | (267) | (100.0)% |
| Interest expense | 47 | 47 | — | —% |
| Income before income taxes | 636 | 793 | (157) | (19.8)% |
| Provision for income taxes | 325 | 362 | (37) | (10.2)% |
| Net income | $311 | $431 | $(120) | (27.8)% |
| Diluted earnings per common share | $2.06 | $2.85 | $(0.79) | (27.7)% |
| Benefit ratio(a) | 84.3% | 85.2% |  | (0.9)% |
| Operating cost ratio(b) | 12.4% | 13.3% |  | (0.9)% |
| Effective tax rate | 51.1% | 45.6% |  | 5.5% |

(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.

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

| Revenues: Premiums: | For the six months ended June 30, 2016 | 2015 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Retail | $23,859 | $23,133 | $726 | 3.1% |
| Group | 3,212 | 3,308 | (96) | (2.9)% |
| Other Businesses | 19 | 19 | — | —% |
| Total premiums | 27,090 | 26,460 | 630 | 2.4% |
| Services: |  |  |  |  |
| Retail | 4 | 6 | (2) | (33.3)% |
| Group | 379 | 343 | 36 | 10.5% |
| Healthcare Services | 133 | 543 | (410) | (75.5)% |
| Other Businesses | 6 | 5 | 1 | 20.0% |
| Total services | 522 | 897 | (375) | (41.8)% |
| Investment income | 195 | 208 | (13) | (6.3)% |
| Total revenues | 27,807 | 27,565 | 242 | 0.9% |
| Operating expenses: |  |  |  |  |
| Benefits | 22,906 | 22,257 | 649 | 2.9% |
| Operating costs | 3,494 | 3,762 | (268) | (7.1)% |
| Depreciation and amortization | 177 | 183 | (6) | (3.3)% |
| Total operating expenses | 26,577 | 26,202 | 375 | 1.4% |
| Income from operations | 1,230 | 1,363 | (133) | (9.8)% |
| Gain on sale of business | — | 267 | (267) | (100.0)% |
| Interest expense | 94 | 93 | 1 | 1.1% |
| Income before income taxes | 1,136 | 1,537 | (401) | (26.1)% |
| Provision for income taxes | 571 | 676 | (105) | (15.5)% |
| Net income | $565 | $861 | $(296) | (34.4)% |
| Diluted earnings per common share | $3.75 | $5.67 | $(1.92) | (33.9)% |
| Benefit ratio(a) | 84.6% | 84.1% |  | 0.5% |
| Operating cost ratio(b) | 12.7% | 13.8% |  | (1.1)% |
| Effective tax rate | 50.3% | 44.0% |  | 6.3% |

(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 $311 million, or $2.06 per diluted common share, in the 2016 quarter compared to $431 million, or $2.85 per diluted common share, in the 2015 quarter. Net income was $565 million, or $3.75 per diluted common share, in the 2016 period compared to $861 million, or $5.67 per diluted common share, in the 2015 period. The 2016 quarter and 2016 period include benefits expense of $0.86 per diluted common share associated with the recognition of an increase in the premium deficiency reserve for our individual commercial medical business for the 2016 coverage year. The completion of the sale of Concentra on June 1, 2015 resulted in an after-tax gain of $1.53 per diluted common share in the 2015 period, 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 increase in the premium deficiency reserve and the sale of Concentra, the increases in the 2016 quarter and 2016 period primarily were due to year-over-year improvement in pretax results across all segments as discussed in the detailed segment results discussion that follows. The 2016 period also reflects the favorable impact of the adoption of new accounting guidance related to accounting for employee share-based payments that resulted in the recognition of tax benefits of approximately $0.12 per diluted common share in the first quarter of 2016 as well as the unfavorable seasonal affect of one extra business day's claims from leap year. In addition, the 2016 quarter and 2016 period include $26 million, or $0.16 per diluted common share, and $61 million, or $0.37 per diluted common share, respectively, of transaction and integration costs associated with the Merger, certain of which are not deductible for tax purposes. 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 2016 quarter and 2016 period.

#### Premiums Revenue

Consolidated premiums increased $438 million, or 3.3%, from the 2015 quarter to $13.7 billion for the 2016 quarter and increased $630 million, or 2.4%, from the 2015 period to $27.1 billion for the 2016 period. These increases are primarily due to higher premiums in the Retail segment partially offset by lower premiums in the Group segment. The increase in Retail segment premiums primarily reflects average individual Medicare Advantage membership growth and per member premium increases for certain lines of business, partially offset by the loss of premiums associated with a large group Medicare account that moved to a private exchange on January 1, 2016. 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 $145 million, or 35.6%, from the 2015 quarter to $262 million for the 2016 quarter, and decreased $375 million, or 41.8% from the 2015 period to $522 million for the 2016 period. These decreases are primarily due to the sale of Concentra on June 1, 2015.

#### Investment Income

Investment income totaled $95 million for the 2016 quarter, decreasing $18 million from $113 million for the 2015 quarter. For the 2016 period, investment income totaled $195 million, decreasing $13 million from $208 million for the 2015 period. These declines primarily reflect lower interest rates partially offset by higher average invested balances. In addition, the 2016 quarter reflects lower realized capital gains as compared to the 2015 quarter.

#### Benefits Expense

Consolidated benefits expense was $11.5 billion for the 2016 quarter, an increase of $257 million, or 2.3%, from the 2015 quarter. For the 2016 period, benefit expense was $22.9 billion, an increase of $649 million, or 2.9% from the 2015 period. These increases are primarily due to an increase in the Retail segment benefits expense. We experienced favorable medical claims reserve development related to prior fiscal years of $95 million in the 2016 quarter as compared to unfavorable medical claims reserve development of $16 million in the 2015 quarter. In the 2016 period, we experienced favorable medical claims reserve development related to prior fiscal years of $435 million as compared to $178 million in the 2015 period as discussed in the detailed segment results discussion that follows.

The consolidated benefit ratio decreased 90 basis points to 84.3% for the 2016 quarter compared to 85.2% for the 2015 quarter primarily due to decreases in the Retail and Group segment ratios as discussed in the segment results of operation discussion that follows. The consolidated benefit ratio for the 2016 period was 84.6%, a 50 basis point increase from 84.1% for the 2015 period, primarily due to an increase in the Retail segment ratio partially offset by a decrease in the Group segment ratio as discussed in the segment results of operations discussion that follows. Favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 70 basis points in the 2016 quarter and unfavorable prior-period medical claims reserve development increased the consolidated benefit ratio by approximatley10 basis points in the 2015 quarter. Favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 160 basis points in the 2016 period versus approximately 70 basis points in the 2015 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 $91 million, or 5.0%, during the 2016 quarter compared to the 2015 quarter and decreased $268 million, or 7.1%, during the 2016 period compared to the 2015 period. These decreases are primarily due to the completion of the sale of Concentra on June 1, 2015 partially offset by transaction and integration costs associated with the Merger in the 2016 quarter and 2016 period.

The consolidated operating cost ratio for the 2016 quarter of 12.4% decreased 90 basis points from the 2015 quarter and decreased 110 basis points to 12.7% in the 2016 period from 13.8% in the 2015 period. These decreases primarily were due to declines in both the Retail and Group segment operating cost ratios as well as the completion of the sale of Concentra on June 1, 2015. Concentra carried a higher operating cost ratio than our Group and Retail segments. In addition, transaction and integration costs associated with the Merger increased the operating cost ratio by 20 basis points in each of the 2016 quarter and 2016 period.

#### Depreciation and Amortization

Depreciation and amortization for the 2016 quarter totaled $89 million compared to $90 million for the 2015 quarter. For the 2016 period, depreciation and amortization totaled $177 million compared to $183 million for the 2015 period.

#### Interest Expense

Interest expense for both the 2016 quarter and 2015 quarter totaled $47 million, and totaled $94 million for the 2016 period compared to $93 million for the 2015 period.

#### Income Taxes

Our effective tax rate during the 2016 quarter was 51.1% compared to the effective tax rate of 45.6% in the 2015 quarter. For the 2016 period our effective tax rate was 50.3% compared to the effective tax rate of 44.0% for the 2015 period. These increases primarily reflect the beneficial effect of the sale of Concentra on June 1, 2015 and the impact of non-deductible transaction costs associated with the Merger during the 2016 quarter and the 2016 period. Non-deductible transaction costs associated with the Merger increased our effective tax rate by approximately 1.6 percentage points for the 2016 quarter and by approximately 2.3 percentage points for the 2016 period. Conversely, 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 2015 period.

The effective tax rate for 2016 also reflects tax benefits associated with adopting new guidance related to the accounting for employee share-based payments effective January 1, 2016 as described in Note 2 to the condensed consolidated financial statements included in this report, which decreased our effective tax rate by approximately 1.7 percentage points for the 2016 period.

### Retail Segment

| Membership: Medical membership: | June 30, 2016 | 2015 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | 2,816,500 | 2,709,300 | 107,200 | 4.0% |
| Group Medicare Advantage | 351,700 | 473,100 | (121,400) | (25.7)% |
| Medicare stand-alone PDP | 4,856,300 | 4,442,500 | 413,800 | 9.3% |
| Total Retail Medicare | 8,024,500 | 7,624,900 | 399,600 | 5.2% |
| Individual commercial | 792,000 | 1,036,700 | (244,700) | (23.6)% |
| State-based Medicaid | 391,600 | 352,000 | 39,600 | 11.3% |
| Medicare Supplement | 212,300 | 154,000 | 58,300 | 37.9% |
| Total Retail medical members | 9,420,400 | 9,167,600 | 252,800 | 2.8% |
| Individual specialty membership (a) | 1,139,300 | 1,203,600 | (64,300) | (5.3)% |

(a) 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, 2016 | 2015 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | $8,050 | $7,434 | $616 | 8.3% |
| Group Medicare Advantage | 1,085 | 1,398 | (313) | (22.4)% |
| Medicare stand-alone PDP | 1,015 | 985 | 30 | 3.0% |
| Total Retail Medicare | 10,150 | 9,817 | 333 | 3.4% |
| Individual commercial | 1,024 | 1,039 | (15) | (1.4)% |
| State-based Medicaid | 678 | 559 | 119 | 21.3% |
| Medicare Supplement | 106 | 74 | 32 | 43.2% |
| Individual specialty | 66 | 66 | — | —% |
| Total premiums | 12,024 | 11,555 | 469 | 4.1% |
| Services | 2 | 2 | — | —% |
| Total premiums and services revenue | $12,026 | $11,557 | $469 | 4.1% |
| **Income before income taxes** | $320 | $260 | $60 | 23.1% |
| Benefit ratio | 86.8% | 87.1% |  | (0.3)% |
| Operating cost ratio | 10.3% | 10.5% |  | (0.2)% |

45

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the six months ended June 30, 2016 | 2015 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | $16,077 | $14,867 | $1,210 | 8.1% |
| Group Medicare Advantage | 2,162 | 2,792 | (630) | (22.6)% |
| Medicare stand-alone PDP | 2,054 | 1,988 | 66 | 3.3% |
| Total Retail Medicare | 20,293 | 19,647 | 646 | 3.3% |
| Individual commercial | 1,917 | 2,060 | (143) | (6.9)% |
| State-based Medicaid | 1,308 | 1,150 | 158 | 13.7% |
| Medicare Supplement | 210 | 147 | 63 | 42.9% |
| Individual specialty | 131 | 129 | 2 | 1.6% |
| Total premiums | 23,859 | 23,133 | 726 | 3.1% |
| Services | 4 | 6 | (2) | (33.3)% |
| Total premiums and services revenue | 23,863 | 23,139 | $724 | 3.1% |
| **Income before income taxes** | $474 | $635 | $(161) | (25.4)% |
| Benefit ratio | 87.2% | 86.5% |  | 0.7% |
| Operating cost ratio | 10.5% | 10.7% |  | (0.2)% |

#### Pretax Results

- Retail segment pretax income was $320 million in the 2016 quarter, an increase of $60 million, or 23.1%, compared to $260 million in the 2015 quarter primarily driven by the year-over-year improvement in results across most business lines in the segment, partially offset by a year-over-year decline in results for our individual commercial medical business, discussed more fully below. Retail segment pretax income was $474 million in the 2016 period, a decrease of $161 million, or 25.4% compared to $635 million in the 2015 period as the year-over-year decline in individual commercial medical results more than offset the improvement in results across all other business lines year-over-year.

#### Enrollment

- Individual Medicare Advantage membership increased 107,200 members, or 4.0%, from June 30, 2015 to June 30, 2016 reflecting net membership additions, particularly for our HMO offerings, for the 2016 plan year.
- Group Medicare Advantage membership decreased 121,400, or 25.7%, from June 30, 2015 to June 30, 2016 reflecting the loss of a large account that moved to a private exchange offering on January 1, 2016.
- Medicare stand-alone PDP membership increased 413,800 members, or 9.3%, from June 30, 2015 to June 30, 2016 reflecting net membership additions, primarily for our Humana-Walmart plan offering, for the 2016 plan year.
- Individual commercial medical membership decreased 244,700 members, or 23.6%, from June 30, 2015 to June 30, 2016 primarily reflecting the loss of membership associated with the discontinuance of certain Health Care Reform Law compliant plans in the first half of 2016, the loss of membership associated with non-payment of premiums or termination by CMS due to lack of eligibility documentation, and the loss of members subscribing to plans that are not compliant with the Health Care Reform Law.
- State-based Medicaid membership increased 39,600 members, or 11.3%, from June 30, 2015 to June 30, 2016, primarily driven by the addition of members under our Florida Medicaid contracts.
- Individual specialty membership decreased 64,300 members, or 5.3%, from June 30, 2015 to June 30, 2016 primarily due to the loss of individual commercial medical members that also had specialty coverage.

#### Premiums Revenue

- Retail segment premiums increased $469 million, or 4.1%, from the 2015 quarter to the 2016 quarter and increased $726 million, or 3.1%, from the 2015 period to the 2016 period. These increases primarily were due to individual Medicare Advantage membership growth and increased per member premiums for certain lines of business, partially offset by declines in group Medicare Advantage and individual commercial medical membership. Average individual Medicare Advantage membership increased 4.1% for the 2016 quarter and 4.4% for the 2016 period.

#### Benefits Expense

- The Retail segment benefit ratio decreased 30 basis points from 87.1% in the 2015 quarter to 86.8% in the 2016 quarter primarily due to the operating initiatives of businesses within the segment resulting in favorable year-over-year comparisons of prior-period medical claims reserve development as well as lower current year utilization than was anticipated in pricing for our Medicare business. These items were partially offset by an increase in the premium deficiency reserve associated with our 2016 individual commercial medical offerings complaint with the Health Care Reform Law as discussed below. The Retail segment benefit ratio increased 70 basis points from 86.5% in the 2015 period to 87.2% in the 2016 period primarily due to the same items impacting the quarter comparisons more than offset by the unfavorable seasonal impact of an extra business day's claims from leap year in the 2016 period and the impact of lower future policy benefit reserve releases year-over-year as individual commercial medical members transitioned to plans compliant with the Health Care Reform Law. As previously disclosed, in the fourth quarter of 2015 we recorded a premium deficiency reserve associated with our 2016 individual commercial medical offerings compliant with the Health Care Reform Law. During the 2016 quarter, we increased the premium deficiency reserve for the 2016 coverage year and recorded a change in estimate of $208 million with a corresponding increase in benefits expense primarily as a result of unfavorable current and projected claims experience. The increase in benefits expense associated with the recognition of the premium deficiency reserve increased the Retail segment benefit ratio by approximately 170 basis points in the 2016 quarter and by approximately 90 basis points in the 2016 period.
- The Retail segment’s benefits expense for the 2016 quarter included $98 million in favorable prior-period medical claims reserve development versus $11 million in unfavorable prior-prior period medical claims reserve development in the 2015 quarter. For the 2016 period, the Retail segment's benefit expense included the beneficial effect of $396 million in favorable prior-period medical claims reserve development versus $177 million in the 2015 period. Prior-period medical claims reserve development decreased the Retail segment benefit ratio by approximately 80 basis points in the 2016 quarter versus increasing the Retail segment benefit ratio by approximately 10 basis points in the 2015 quarter. Favorable prior-period medical claims reserve development decreased the benefit ratio by approximately 170 basis points in the 2016 period versus approximately 80 basis points in the 2015 period.

The year-over-year increases in prior-period medical claims reserve development primarily were due to favorable year-over-year comparisons for our Medicare Advantage and individual commercial medical businesses.

#### Operating Costs

- The Retail segment operating cost ratio of 10.3% for the 2016 quarter decreased 20 basis points from 10.5% for the 2015 quarter. The Retail segment operating cost ratio of 10.5% for the 2016 period decreased 20 basis points from 10.7% for the 2015 period. These decreases primarily were due to administrative cost efficiencies associated with medical membership growth and ongoing operational efficiency efforts in this segment partially offset by the loss of a large group Medicare Advantage account which carried a lower operating cost ratio than our individual Medicare Advantage business. The non-deductible health insurance industry fee impacted the

operating cost ratio by 170 basis points in each of the 2016 quarter and 2016 period and by 160 basis points in each of the 2015 quarter and 2015 period.

### Group Segment

| Membership: Medical membership: | June 30, 2016 | 2015 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | 1,140,100 | 1,179,100 | (39,000) | (3.3)% |
| ASO | 578,400 | 736,600 | (158,200) | (21.5)% |
| Military services | 3,074,800 | 3,071,300 | 3,500 | 0.1% |
| Total group medical members | 4,793,300 | 4,987,000 | (193,700) | (3.9)% |
| Group specialty membership (a) | 5,863,000 | 6,179,700 | (316,700) | (5.1)% |

(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, 2016 | 2015 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | $1,357 | $1,379 | $(22) | (1.6)% |
| Group specialty | 255 | 265 | (10) | (3.8)% |
| Military services | 5 | 4 | 1 | 25.0% |
| Total premiums | 1,617 | 1,648 | (31) | (1.9)% |
| Services | 189 | 174 | 15 | 8.6% |
| Total premiums and services revenue | $1,806 | $1,822 | $(16) | (0.9)% |
| **Income before income taxes** | $101 | $43 | $58 | 134.9% |
| Benefit ratio | 78.8% | 81.4% |  | (2.6)% |
| Operating cost ratio | 23.7% | 24.1% |  | (0.4)% |

48

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the six months ended June 30, 2016 | 2015 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | $2,694 | $2,763 | $(69) | (2.5)% |
| Group specialty | 508 | 535 | (27) | (5.0)% |
| Military services | 10 | 10 | — | —% |
| Total premiums | 3,212 | 3,308 | (96) | (2.9)% |
| Services | 379 | 343 | 36 | 10.5% |
| Total premiums and services revenue | 3,591 | 3,651 | $(60) | (1.6)% |
| **Income before income taxes** | $259 | $197 | $62 | 31.5% |
| Benefit ratio | 76.8% | 77.6% |  | (0.8)% |
| Operating cost ratio | 23.9% | 24.3% |  | (0.4)% |

#### Pretax Results

- Group segment pretax income increased $58 million to $101 million for the 2016 quarter from $43 million in the 2015 quarter, and increased $62 million, or 31.5%, to $259 million for the 2016 period from $197 million in the 2015 period primarily reflecting improvement in the benefit ratios and operating cost ratios as discussed below.

#### Enrollment

- Fully-insured commercial group medical membership decreased 39,000 members, or 3.3%, from June 30, 2015 to June 30, 2016 reflecting lower membership in both large and small group accounts.
- Group ASO commercial medical membership decreased 158,200 members, or 21.5%, from June 30, 2015 to June 30, 2016 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 316,700 members, or 5.1%, from June 30, 2015 to June 30, 2016 primarily due to the loss of several large stand-alone dental and vision accounts as well as the loss of certain fully-insured group medical accounts that also had specialty coverage.

#### Premiums Revenue

- Group segment premiums decreased $31 million, or 1.9% from the 2015 quarter to $1.6 billion for the 2016 quarter and decreased $96 million, or 2.9%, to $3.2 billion for the 2016 period from $3.3 billion in the 2015 period primarily due to a net decline in fully-insured commercial medical membership as described above, partially offset by an increase in fully-insured commercial medical per member premiums.

#### Services Revenue

- Group segment services revenue increased $15 million, or 8.6%, to $189 million for the 2016 quarter from the 2015 quarter and increased $36 million, or 10.5%, to $379 million for the 2016 period from $343 million in the 2015 period primarily due to higher revenues year-over-year under our TRICARE South Region contract, partially offset by a decline in revenue in our group ASO commercial medical business mainly due to membership declines. Higher revenues under our TRICARE South Region contract for the 2016 quarter and

2016 period reflect our revised estimate of the medical cost trend incentive and revenues associated with a contract change order.

#### Benefits Expense

- The Group segment benefit ratio decreased 260 basis points from 81.4% in the 2015 quarter to 78.8% in the 2016 quarter primarily due to unfavorable medical claims reserve development in the second quarter of 2015 related to claims incurred in the first quarter of 2015. In addition, changes in risk adjustment accruals associated with data received from CMS in June of each year were more favorable in the 2016 quarter than in the 2015 quarter. The Group segment benefit ratio decreased 80 basis points from 77.6% in the 2015 period to 76.8% in the 2016 period primarily due to the beneficial effect of favorable prior-period claims reserve development in the 2016 period, partially offset by the unfavorable seasonal impact of an extra business day's claims from leap year in the 2016 period.
- The Group segment’s benefits expense included $3 million in unfavorable prior-period medical claims reserve development in the 2016 quarter versus $6 million in the 2015 quarter. This unfavorable prior-period medical claims reserve development increased the Group segment benefit ratio by approximately 20 basis points in the 2016 quarter and 40 basis points in the 2015 quarter. The Group segment’s benefits expense included the beneficial effect of a favorable prior-period medical claims reserve development of $38 million in the 2016 period versus unfavorable prior-period medical claims reserve development of $1 million in the 2015 period. This favorable prior-period medical claims reserve development decreased the Group segment benefit ratio by approximately 120 basis points in the 2016 period and had no impact on the Group segment benefit ratio in the 2015 period.

#### Operating Costs

- The Group segment operating cost ratio of 23.7% for the 2016 quarter decreased 40 basis points from 24.1% for the 2015 quarter. For the 2016 period, the Group segment operating cost ratio of 23.9% decreased 40 basis points from 24.3% for the 2015 period. These decreases primarily were due to 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 the fully-insured commercial medical business. The non-deductible health insurance industry fee impacted the operating cost ratio by 140 basis points in the 2016 quarter, the 2015 quarter, the 2016 period, and the 2015 period.

### Healthcare Services Segment

*(in millions)*

| Revenues: Services: | For the three months ended June 30, 2016 | 2015 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Provider services | $19 | $185 | $(166) | (89.7)% |
| Home based services | 42 | 36 | 6 | 16.7% |
| Pharmacy solutions | 7 | 7 | — | —% |
| Total services revenues | 68 | 228 | (160) | (70.2)% |
| Intersegment revenues: |  |  |  |  |
| Pharmacy solutions | 5,435 | 5,077 | 358 | 7.1% |
| Provider services | 427 | 320 | 107 | 33.4% |
| Home based services | 260 | 218 | 42 | 19.3% |
| Clinical programs | 47 | 50 | (3) | (6.0)% |
| Total intersegment revenues | 6,169 | 5,665 | 504 | 8.9% |
| Total services and intersegment revenues | $6,237 | $5,893 | $344 | 5.8% |
| **Income before income taxes** | $271 | $223 | $48 | 21.5% |
| Operating cost ratio | 95.3% | 95.5% |  | (0.2)% |

*(in millions)*

| Revenues: Services: | For the six months ended June 30, 2016 | 2015 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Provider services | $39 | $464 | $(425) | (91.6)% |
| Home based services | 80 | 65 | 15 | 23.1% |
| Pharmacy solutions | 14 | 14 | — | —% |
| Total services revenues | 133 | 543 | (410) | (75.5)% |
| Intersegment revenues: |  |  |  |  |
| Pharmacy solutions | 10,842 | 10,037 | 805 | 8.0% |
| Provider services | 845 | 638 | 207 | 32.4% |
| Home based services | 503 | 408 | 95 | 23.3% |
| Clinical programs | 93 | 99 | (6) | (6.1)% |
| Total intersegment revenues | 12,283 | 11,182 | 1,101 | 9.8% |
| Total services and intersegment revenues | $12,416 | $11,725 | $691 | 5.9% |
| **Income before income taxes** | $512 | $453 | $59 | 13.0% |
| Operating cost ratio | 95.5% | 95.4% |  | 0.1% |

51

#### Pretax Results

- Healthcare Services segment pretax income of $271 million for the 2016 quarter increased $48 million, or 21.5%, from the 2015 quarter. For the 2016 period, the Healthcare Services segment pretax income of $512 million increased $59 million, or 13.0%, from $453 million for the 2015 period. These increases primarily were due to incremental earnings associated with revenue growth from our pharmacy solutions, including mail order, and home based services businesses as they serve our growing individual Medicare Advantage membership. Pretax income for the 2016 quarter and 2016 period also reflect ongoing pressures in our provider services business reflecting significantly lower Medicare rates year over year associated with CMS' risk coding recalibration for 2016 in geographies where provider assets are located.

#### Script Volume

- Humana Pharmacy Solutions® script volumes for Retail and Group segment membership increased to approximately 105 million in the 2016 quarter, up 6.7%, versus scripts of approximately 98 million in the 2015 quarter. For the 2016 period, script volumes for Retail and Group segment membership increased to approximately 209 million, up 7.7%, versus scripts of approximately 195 million in the 2015 period. These increases primarily reflect growth associated with higher average medical membership for the 2016 quarter and 2016 period than in the 2015 quarter and 2015 period.

#### Services Revenues

- Services revenues decreased $160 million, or 70.2%, from the 2015 quarter to $68 million for the 2016 quarter and decreased $410 million, or 75.5%, from the 2015 period to $133 million for the 2016 period primarily due to the completion of the sale of Concentra on June 1, 2015.

#### Intersegment Revenues

- Intersegment revenues increased $504 million, or 8.9%, from the 2015 quarter to $6.2 billion for the 2016 quarter and increased $1.1 billion, or 9.8%, from the 2015 period to $12.3 billion for the 2016 period primarily due to growth in our individual Medicare Advantage and Medicare stand-alone PDP membership as well as increased engagement of members in clinical programs which collectively resulted in higher utilization of services across the segment.

#### Operating Costs

- The Healthcare Services segment operating cost ratio for the 2016 quarter and 2016 period were relatively unchanged from the 2015 quarter and 2015 period, decreasing 20 basis points year-over-year for the 2016 quarter to 95.3% and increasing 10 basis points year-over-year to 95.5% for the 2016 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. Our cash flows are impacted by the timing of payments to and receipts from CMS associated with Medicare Part D subsidies for which we do not assume risk. 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 impact the timing of our operating cash flows, as we build receivables for each coverage year that are expected to be collected in subsequent coverage years. During the six months ended June 30, 2016, we collected $214 million for commercial reinsurance recoverable settlements associated with the 2015 coverage year. We have collected approximately $30 million from HHS for our interim settlement associated with our risk corridor receivables for the 2014 coverage year. The interim settlement of approximately 12.6% of risk corridor receivables for the 2014 coverage year primarily was received in the fourth quarter of 2015 and funded by HHS in accordance with previous guidance, utilizing funds HHS collected from us and other carriers under the 2014 risk corridor program. The risk corridor program is a three year program and HHS guidance provides that risk corridor collections over the life of the three year program will first be applied to any shortfalls from previous benefit years before application to current year obligations. Risk corridor payables to issuers are obligations of the United States Government under the Health Care Reform law which requires the Secretary of HHS to make full payments to issuers. In the event of a shortfall at the end of the three year program, HHS has asserted it will explore other sources of funding for risk corridor payments, subject to the availability of appropriations. The remaining net receivable balance associated with the 3Rs was approximately $900 million at June 30, 2016, including $626 million related to the 2014 and 2015 coverage years, compared to $982 million at December 31, 2015. 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 2015 Form 10-K.

Cash and cash equivalents decreased to approximately $2.4 billion at June 30, 2016 from $2.6 billion at December 31, 2015. The change in cash and cash equivalents for the six months ended June 30, 2016 and 2015 is summarized as follows:

*(in millions)*

|  | 2016 | 2015 |
| --- | ---: | ---: |
| Net cash provided by (used in) operating activities | $206 | $(501) |
| Net cash (used in) provided by investing activities | (297) | 1,222 |
| Net cash used in financing activities | (51) | (406) |
| (Decrease) increase in cash and cash equivalents | $(142) | $315 |

53

### Cash Flow from Operating Activities

The increase in operating cash flows from the 2015 period to the 2016 period primarily was due to the favorable timing of working capital items and higher earnings exclusive of both the gain on the sale of Concentra and the increase in the premium deficiency reserve discussed previously. Significant year-over-year changes in working capital items primarily included the early receipt of certain commercial reinsurance recoveries from HHS for the 2015 coverage year in the first quarter of 2016 as discussed below, the timing of payroll cycles resulting in one less payroll cycle in 2016 than in 2015, and lower management incentive payments in the first quarter of 2016 associated with prior year performance than those paid in the first quarter of 2015. In 2015, commercial reinsurance recoveries associated with the 2014 coverage year primarily were collected in the third quarter of 2015. In the first quarter of 2016, HHS provided issuers with a portion of the estimated full year payment for the 2015 coverage year, with the remainder expected to be paid in the third and fourth quarters of 2016.

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, 2016 and December 31, 2015:

*(in millions)*

|  | June 30, 2016 | December 31, 2015 | 2016 Period Change | 2015 Period Change |
| --- | ---: | ---: | ---: | ---: |
| IBNR (1) | $3,539 | $3,730 | $(191) | $122 |
| Reported claims in process (2) | 670 | 600 | 70 | 47 |
| Premium deficiency reserve (3) | 337 | 176 | 161 | — |
| Other benefits payable (4) | $712 | $470 | 242 | 137 |
| Total benefits payable | $5,258 | $4,976 | $282 | $306 |

(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) Premium deficiency reserve for our individual commercial medical business compliant with the Health Care Reform Law associated with the 2016 coverage year.

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

The increase in benefits payable from December 31, 2015 to June 30, 2016 primarily was due to an increase in the amounts owed to providers under the capitated and risk sharing arrangements, an increase in the premium deficiency reserve associated with our individual commercial medical products, and an increase in the amount of processed but unpaid claims, which fluctuate due to month-end cutoff. These items were partially offset by a decrease in IBNR primarily driven by declines in group Medicare Advantage and individual commercial medical membership in the 2016 period, partially offset by an increase in individual Medicare Advantage membership. During the 2016 quarter, we increased the premium deficiency reserve for the 2016 coverage year, primarily as a result of unfavorable current and projected claims experience. The increase in benefits payable from December 31, 2014 to June 30, 2015 largely was due to an increase in IBNR. IBNR increased primarily as a result of individual Medicare Advantage membership growth. As discussed previously, our cash flows are negatively impacted during periods of decreasing premiums and enrollment. In the 2015 period, membership in fully-insured individual commercial medical plans compliant with the Health Care Reform Law grew as compared with a decline in membership in these plans in the 2016 period. Similarly, while group

Medicare Advantage membership declined in both the 2015 period and 2016 period, the declines were more substantial in the 2016 period negatively impacting the 2016 period change.

The detail of total net receivables was as follows at June 30, 2016 and December 31, 2015:

*(in millions)*

|  | June 30, 2016 | December 31, 2015 | 2016 Period Change | 2015 Period Change |
| --- | ---: | ---: | ---: | ---: |
| Medicare | $2,050 | $765 | $1,285 | $1,128 |
| Commercial and other | 545 | 420 | 125 | (23) |
| Military services | 77 | 77 | — | (23) |
| Allowance for doubtful accounts | (119) | (101) | (18) | (6) |
| Total net receivables | $2,553 | $1,161 | 1,392 | 1,076 |
| Reconciliation to cash flow statement: |  |  |  |  |
| Change in receivables held-for-sale and disposition of receivables from sale of business |  |  | — | 11 |
| Change in receivables per cash flow statement resulting in cash from operations |  |  | $1,392 | $1,087 |

The changes in Medicare receivables for both the 2016 period and the 2015 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 2016 payment from CMS, we collected $779 million associated with the final Medicare risk-adjustment payment for the 2015 plan year. In addition, in connection with our August 2016 payment from CMS, we collected $1.0 billion associated with the mid-year Medicare risk-adjustment payment for the 2016 plan year.

The changes in commercial and other receivables primarily reflect the timing of accruals and related collections associated with Medicaid receivables.

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 impact our operating cash flows as we build receivables for each coverage year that are expected to be collected in subsequent coverage years. As discussed previously, during the 2016 period, we received payments of $214 million for commercial reinsurance recoverables associated with the 2015 coverage year. The net receivable balance associated with the 3Rs was approximately $900 million at June 30, 2016 and $982 million at December 31, 2015, including certain amounts recorded in receivables in the table above. In 2016, we expect to pay the federal government an estimated $912 million for the annual health insurance industry fee as compared to our payment of $867 million in 2015. The Consolidated Appropriations Act, 2016, enacted on December 18, 2015, included a one-time one year suspension in 2017 of the health insurer fee.

### Cash Flow from Investing Activities

We reinvested a portion of our operating cash flows in investment securities, primarily investment-grade fixed income securities, totaling $40 million in the 2016 period. Proceeds from sales and maturities of investment securities exceeded purchases by $464 million in the 2015 period. The proceeds in the 2015 period 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.

Our ongoing capital expenditures primarily relate to our information technology initiatives as well as 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 $256 million in the 2016 period and $259 million in the 2015 period.

### Cash Flow from Financing Activities

Receipts from CMS associated with Medicare Part D claim subsidies for which we do not assume risk were higher than claims payments by $240 million during the 2016 period and lower than claim payments by $270 million during the 2015 period. Our net receivable for CMS subsidies and brand name prescription drug discounts was $1.8 billion at June 30, 2016 compared to $1.9 billion at June 30, 2015 and $2.0 billion at December 31, 2015. Refer to Note 6 to the condensed consolidated financial statements included in this report.

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 $34 million in the 2016 period and by $22 million in the 2015 period.

Receipts from the Department of Health and Human Services, or HHS, associated with cost sharing provisions of the Health Care Reform Law for which we do not assume risk were $15 million higher than claims payments during the 2016 period and $33 million higher than claims payments during the 2015 period.

We repurchased 1.85 million shares for $329 million in the 2015 period under a share repurchase plan authorized by the Board of Directors. There were no share repurchases under share repurchase plans authorized by the board of directors in the 2016 period due to the restrictions of the Merger Agreement. We also acquired common shares in connection with employee stock plans for an aggregate cost of $73 million in the 2016 period and $42 million in the 2015 period.

There were no net proceeds from the issuance of commercial paper in the 2016 period. Net proceeds from the issuance of commercial paper in the 2015 period were $300 million. The maximum principal amount outstanding at any one time during the 2016 period was $475 million.

We paid dividends to stockholders of $90 million during the 2016 period and $86 million during the 2015 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 2015 and 2016 under our Board approved quarterly cash dividend policy:

*(in millions)*

| Record Date 2015 payments | Payment Date | Amount per Share | Total Amount |
| --- | --- | ---: | ---: |
| 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 |
| 9/30/2015 | 10/30/2015 | $0.29 | $43 |
| **2016 payments** |  |  |  |
| 12/30/2015 | 1/29/2016 | $0.29 | $43 |
| 3/31/2016 | 4/29/2016 | $0.29 | $43 |
| 6/30/2016 | 7/29/2016 | $0.29 | $43 |

The Merger discussed in Note 1 to the condensed consolidated financial statements included in this report does not impact our ability and intent to continue quarterly dividend payments prior to the closing of the Merger consistent with our historical dividend payments. 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 current 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 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, 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. 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 quarter, we repurchased 1.85 million shares for $329 million in the 2015 period under the share repurchase plan authorized by the Board of Directors.

In connection with employee stock plans, we acquired 0.44 million common shares for $73 million and 0.26 million common shares for $42 million during the 2016 period and 2015 period, respectively.

### Senior Notes

We previously issued $500 million of 7.20% senior notes due June 15, 2018, $300 million of 6.30% senior notes due August 1, 2018, $400 million of 2.625% senior notes due October 1, 2019, $600 million of 3.15% senior notes due December 1, 2022, $600 million of 3.85% senior notes due October 1, 2024, $250 million of 8.15% senior notes due June 15, 2038, $400 million of 4.625% senior notes due December 1, 2042, and $750 million of 4.95% senior notes due October 1, 2044.

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 100 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 12.5 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 $8.8 billion at June 30, 2016 and a maximum leverage ratio of 3.0:1. We are in compliance with the financial covenants, with actual net worth of $10.9 billion and an actual leverage ratio of 1.5:1, as measured in accordance with the credit agreement as of June 30, 2016. In addition, the credit agreement includes an uncommitted $250 million incremental loan facility.

At June 30, 2016, we had no borrowings outstanding under the credit agreement and we had no outstanding letters of credit under the credit agreement. Accordingly, as of June 30, 2016, we had $1.0 billion 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

We previously 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, 2016 was $475 million. There were outstanding borrowings of $300 million at June 30, 2016 and $299 million at December 31, 2015.

### 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, 2016 was A- 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 $1.8 billion at June 30, 2016 compared to $1.6 billion at December 31, 2015. This increase primarily was due to operating cash derived from our non-insurance subsidiaries as well as insurance subsidiary dividends in excess of capital contributions from our parent company during the 2016 period. These items were partially offset by capital expenditures and payment of stockholder dividends. Our use of operating cash derived from our non-insurance subsidiaries, such as our Healthcare Services segment, is generally not restricted by departments of insurance (or comparable state regulator).

On November 5, 2015, the National Association of Insurance Commissioners, or NAIC, issued statutory accounting guidance for receivables associated with the risk corridor provisions under the Health Care Reform Law, which requires the receivables to be excluded from subsidiary surplus. This accounting guidance required additional capital contributions into certain subsidiaries during 2015. This statutory accounting guidance does not affect our financial statements prepared in accordance with generally accepted accounting principles, under which we have recorded a receivable for risk corridor amounts due to us as an obligation of the United States Government under the Health Care Reform Law. At June 30, 2016, our gross risk corridor receivable was $542 million.

Certain of our regulated subsidiaries recognized premium deficiency reserves for our individual commercial medical policies compliant with the Health Care Reform Law for the 2016 coverage year. Further, the statutory-based premium deficiency excludes the estimated benefit associated with the risk corridor provisions as a reduction in subsidiary surplus in accordance with the previously discussed November 5, 2015 statutory accounting guidance requiring the exclusion of risk corridor amounts from subsidiary surplus. As a result of the statutory-based premium deficiency, we funded capital contributions into certain regulated subsidiaries of $450 million during the first quarter of 2016.

### 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, 2016, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $6.0 billion, which exceeded aggregate minimum regulatory requirements of $4.7 billion. Subsidiary dividends are subject to state regulatory approval, the amount and timing of which could be reduced or delayed. The amount of dividends paid to our parent company was approximately $663 million during the six months ended June 30, 2016 compared to $457 million during the six months ended June 30, 2015. Subsidiary dividends reflect the impact of losses for our individual commercial medical business compliant with the Health Care Reform Law and the November 5, 2015 revised statutory accounting guidance requiring the exclusion of risk corridor receivables from related statutory surplus described above. 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.

## Market risk

As filed, 2,048 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, 2016. Our net unrealized position increased $287 million from a net unrealized gain position of $92 million at December 31, 2015 to a net unrealized gain position of $379 million at June 30, 2016. At June 30, 2016, we had gross unrealized losses of $43 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 six months ended June 30, 2016. 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 4.1 years as of June 30, 2016 and December 31, 2015. Based on the duration, including cash equivalents, a 1% increase in interest rates would generally decrease the fair value of our securities by approximately $483 million at June 30, 2016.

## 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, 2016.

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, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

## Risk factors

As filed, 4,021 characters.

There have been no changes to the risk factors included in our 2015 Form 10-K other than the following:

***The filing of a civil antitrust complaint against us and Aetna is delaying, and could ultimately prevent, the consummation of the Merger.***

On July 21, 2016, the DOJ filed a civil antitrust complaint (which we refer to as the DOJ Action) against us and Aetna in the U.S. District Court for the District of Columbia, charging that the Merger would violate Section 7 of the Clayton Antitrust Act and seeking a permanent injunction that would prevent the Merger. The filing of the DOJ Action is delaying, and, if we and Aetna are unsuccessful in defending against or settling the DOJ Action, could ultimately prevent, the consummation of the Merger. There can be no assurance that we will be successful in defending against or settling the DOJ Action or that the Merger will be consummated by any particular time, if at all.

In addition, even if we and Aetna enter into a settlement with respect to the DOJ Action, there can be no assurance that we and/or Aetna will not be required to agree to terms, conditions, requirements, limitations, costs or restrictions that could further delay completion of the Merger, impose additional material costs on or limit the revenues of the combined company, or limit some of the synergies and other benefits we presently anticipate to realize following the Merger. We cannot provide any assurance that any such terms, conditions, requirements, limitations, costs or restrictions will not result in a material delay in, or the abandonment of, the Merger.

***Delays in completing the Merger will delay the benefits expected to be achieved by the Merger.***

The need to satisfy conditions and obtain consents, clearances, and approvals for the Merger, as well as the pendency of the DOJ Action, will delay the consummation of the Merger for a significant period of time and may prevent it from occurring. Even if ultimately consummated, the delay in the consummation of the Merger could prevent the combined company from realizing some of the anticipated synergies and other benefits that we and Aetna anticipated had the Merger been successfully completed within its originally expected time frame.

***The timing of the closing of the transactions contemplated by the Humana APA and the Aetna APA is uncertain, and may delay the completion of the Merger for a significant period of time.***

Although we do not believe divestitures should be required to complete the Merger, on August 2, 2016, we entered into the Humana APA and Aetna entered into the Aetna APA in order to address the DOJ’s perceived competitive concerns regarding Medicare Advantage. Depending upon the resolution of the DOJ Action, we may be required to close the transactions contemplated by the Humana APA, and Aetna may be required to close the transactions contemplated by the Aetna APA, in order for us to complete the Merger.

The closings of the transactions contemplated by the Humana APA and the Aetna APA are subject to the completion of the Merger and the resolution of the DOJ Action, as well as separate closing conditions included in each of the Humana APA and the Aetna APA, including CMS approval of the novation to Molina of each of the contracts to be divested under each of the Humana APA and the Aetna APA, and customary closing conditions, including approvals of state departments of insurance and other regulators.

As a result, the time necessary to close the transactions contemplated by each of the Humana APA and the Aetna APA is uncertain.

Any requirement that we close the transactions contemplated by the Humana APA and/or that Aetna close the transactions contemplated by the Aetna APA in order for us to complete the Merger could delay the completion of the Merger for a significant period of time beyond any resolution of the DOJ Action, could extend the completion of the Merger beyond December 31, 2016, and may increase the risk that the Merger will not be completed.

Filed Aug 3, 2016.
Source: SEC EDGAR, the filing index for accession 0000049071-16-000169. Last ingested by Listed: Nov 6, 2026, 14:15 ET. No prices; not investment advice.