# Humana Inc: Form 10-Q for the period ended Mar 31, 2017

- Company: [Humana Inc](/companies/hum.md) (CIK 49071)
- Form: 10-Q
- Filed: 2017-05-03
- Accepted by EDGAR: May 3, 2017, 12:00 ET
- Period: 2017-03-31
- Accession: 0000049071-17-000102
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/49071/000004907117000102/hum-20170331x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/49071/000004907117000102/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2017-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2017-01-01 to 2017-03-31 | $13.76bn | us-gaap:Revenues |
| Selling, general and administrative | 3 months, 2017-01-01 to 2017-03-31 | $1.55bn | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2017-01-01 to 2017-03-31 | $1.74bn | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2017-01-01 to 2017-03-31 | $49.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2017-01-01 to 2017-03-31 | $574.0m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2017-01-01 to 2017-03-31 | $1.11bn | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2017-01-01 to 2017-03-31 | $7.49 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2017-01-01 to 2017-03-31 | $7.54 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2017-01-01 to 2017-03-31 | 148,872,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2017-01-01 to 2017-03-31 | $4.21bn | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2017-01-01 to 2017-03-31 | $122.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2017-01-01 to 2017-03-31 | $47.0m | us-gaap:PaymentsOfDividends |
| Share repurchases | 3 months, 2017-01-01 to 2017-03-31 | $1.57bn | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2017-03-31 | $8.43bn | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2017-03-31 | $22.32bn | us-gaap:AssetsCurrent |
| Total assets | at 2017-03-31 | $31.71bn | us-gaap:Assets |
| Current liabilities | at 2017-03-31 | $13.50bn | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2017-03-31 | $21.48bn | us-gaap:Liabilities |
| Long-term debt | at 2017-03-31 | $4.78bn | us-gaap:LongTermDebtNoncurrent |
| Short-term borrowings | at 2017-03-31 | $470.0m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2017-03-31 | $10.23bn | us-gaap:StockholdersEquity |
| Shares outstanding | at 2017-03-31 | 144,314,925 shares | dei:EntityCommonStockSharesOutstanding |

## Management's discussion and analysis

As filed, 68,858 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 2016 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 17, 2017, 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 Merger termination fee and related costs, net, and 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 set forth the terms and conditions under which we agreed to merge with, and become a wholly owned subsidiary of Aetna, a transaction we refer to in this report as the Merger.

The Merger was 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, and (ii) the absence of legal restraints and prohibitions on the consummation of the Merger.

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, alleging that the Merger would violate Section 7 of the Clayton Antitrust Act and seeking a permanent injunction to prevent the Merger from being completed. On January 23, 2017, the Court ruled in favor of the DOJ and granted a permanent injunction of the proposed transaction. On February 14, 2017, we and Aetna agreed to mutually terminate the Merger Agreement, as our Board determined that an appeal of the Court's ruling would not be in the best interest of our stockholders. On February 16, 2017, under terms of the Merger Agreement, we received a breakup fee of $1 billion from Aetna , which is included in our condensed consolidated statement of income in the line captioned Merger termination fee and related costs, net.

### Business Segments

During the three months ended March 31, 2017, we realigned certain of our businesses among our reportable segments to correspond with internal management reporting changes and our previously announced planned exit from the individual commercial medical business on January 1, 2018. Additionally, we renamed our Group segment to the Group and Specialty segment, and began presenting the individual commercial business results as a separate segment rather than as part of the Retail segment. Specialty health insurance benefits, including dental, vision, other supplement health, and financial protection products, marketed to individuals are now included in the Group and Specialty segment. Specialty health insurance benefits marketed to employer groups continue to be included in the Group and Specialty segment. As a result of this realignment, our reportable segments now include Retail, Group and Specialty, Healthcare Services, and Individual Commercial. Prior period segment financial information has been recast to conform to the 2017 presentation. See Note 15 for segment financial information.

We manage our business with four reportable segments: Retail, Group and Specialty, Healthcare Services and Individual Commercial. 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. 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 and Specialty segment consists of employer group commercial fully-insured medical and specialty health insurance benefits marketed to individuals and employer groups, including dental, vision, and other supplemental health and voluntary insurance benefits and financial protection products, as well as administrative services only, or ASO products. In addition, our Group and Specialty segment includes 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, and clinical care service, as well as services and capabilities to promote wellness and advance population health. The Individual Commercial segment consists of our individual commercial fully-insured medical health insurance benefits. 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 clinical care services, to our Retail, Group and Specialty, and Individual Commercial segment 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.

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 marketing season.

Our Group and Specialty 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 and Specialty segment’s benefit ratio increasing as fully-insured members progress through their annual deductible and maximum out-of-pocket expenses.

Certain of our fully-insured individual commercial medical products in our Individual Commercial segment experience seasonality in the benefit ratio akin to the Group and Specialty 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 impacted the quarterly benefit ratio pattern for this business in 2016.

### 2017 Highlights

#### Consolidated

- Our consolidated pretax results for the three months ended March 31, 2017 as compared to the three months ended March 31, 2016, were primarily impacted by the net gain associated with the terminated Merger Agreement, mainly the break-up fee, and higher Retail segment earnings year-over-year.
- Year-over-year comparisons of diluted earnings per common share reflect the same factors impacting our consolidated pretax income comparisons year-over-year as well as the beneficial effect of the lower effective tax rate in light of pricing and benefit design assumptions associated with the 2017 temporary suspension of the health insurance industry fee. In addition the year-over-year comparisons were favorably impacted by lower number of shares, primarily reflecting share repurchases.
- Our 2017 results through March 31, 2017 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 March 31, 2017, approximately 1,827,600 members, or 64.4%, of our individual Medicare Advantage members were in value-based relationships under our integrated care delivery model, as compared to 1,816,300 members, or 64.0%, at December 31, 2016 and 1,715,100 members, or 61.1%, at March 31, 2016.
- We recorded a net gain associated with the terminated Merger Agreement, consisting primarily of the break-up fee, of approximately $947 million, or $4.26 per diluted common share during the three months ended March 31, 2017. We recorded transaction costs in connection with the Merger of approximately $34 million, or $0.21 per diluted common share during the three months ended March 31, 2016. Certain costs associated with the Merger were previously not deductible for tax purposes, but became deductible, and were recorded as such in the three months ended March 31, 2017 as a result of the termination of the Merger Agreement.
- The annual health insurance industry fee has been suspended for calendar year 2017, but is scheduled to resume in calendar year 2018. Operating cost associated with the health insurer fee attributable to the three months ended March 31, 2016 was $227 million. This fee is not deductible for tax purposes, which significantly increases our effective income tax rate. The one-year suspension in 2017 of the health insurer fee has significantly reduced our operating costs and effective tax rate during the three months ended March 31, 2017.
- On February 14, 2017, we announced we are exiting our individual commercial medical business January 1, 2018. As discussed previously, we have worked over the past several years to address market and programmatic challenges in order to keep coverage options available wherever we could offer a viable product. This has included pursuing business changes, such as modifying networks, restructuring product offerings, reducing the company’s geographic footprint and increasing premiums. All of these actions were taken with the expectation that our individual commercial medical business would stabilize to the point where we could continue to participate in the program. However, based on our analysis of data associated with our healthcare exchange membership following the 2017 open enrollment period, we saw further signs of an unbalanced risk pool. Therefore, we decided that we cannot continue to offer this coverage and plan to exit this business commencing January 1, 2018. The 2017 quarter includes pretax income from our individual commercial business of $63 million, or $0.27 per diluted common share.
- On March 1, 2017, a court ordered the liquidation of Penn Treaty (an unaffiliated long-term care insurance company) which triggered assessments from state guaranty associations that resulted in our recording a $54 million, or $0.23 per diluted common share estimate in operating costs in the three months ended March 31, 2017.
- During the three months ended March 31, 2017, operating cash flow provided by operations was $4.2 billion as compared to $502 million for the three months ended March 31, 2016. Our operating cash flows for the three months ended March 31, 2017 were significantly impacted by the early receipt of the Medicare premium remittance for April 2017 of $3.1 billion in March 2017 because the payment date of April 1, 2017 fell on a weekend. Our operating cash flows were also significantly impacted by the $1 billion receipt of the Merger termination fee. Excluding the timing of the Medicare premium remittance and the Merger termination fee, our operating cash flows were negatively impacted by the timing of working capital items partially offset by higher earnings. See further discussion under the section titled "Liquidity" in this report.

#### Retail

- On April 3, 2017 CMS issued its announcement of 2018 Medicare Advantage Capitation Rates and Medicare Advantage and Part D payment policies and Final Call Letter, which we refer to collectively as the Final Rate Notice. We expect the Final Rate Notice to result in a 0.45% rate increase for Humana versus CMS’ estimate for the sector of 0.85% increase on a comparable basis. The rate increase excludes the impact of Star quality bonus ratings, the impact of encounter data weighting in risk score calculations and estimates of changes in revenue associated with increased accuracy of risk coding. The primary difference between the estimates is the impact of fee-for-service county rebasing/re-pricing by CMS.
- The achievement of Star Ratings of four or higher qualifies Medicare Advantage plans for premium bonuses. Star Ratings for the 2018 bonus year issued by CMS in October 2016 indicated that the percentage of our July 31, 2016 Medicare Advantage membership in 4-Star plans or higher declined to approximately 37% from approximately 78% of our July 31, 2015 Medicare Advantage membership. The decline in membership in 4- Star rated plans does not take into account certain operational actions discussed below that we have taken and intend to take over the coming months to mitigate any potential negative impact of these published ratings on Star bonus revenues for 2018.

We believe that the decline is primarily attributable to the impact of lower scores for certain Stars measures as a result of our 2015 comprehensive program audit by CMS. The Civil Monetary Penalty imposed by CMS following the audit resulted in a significant reduction to the Beneficiary Access and Plan Performance, or BAPP, measure. Additionally, an issue with the timeliness of appeal decisions noted in the audit resulted in automatic downgrades to two additional Star measures. Moreover, higher threshold levels for certain individual

Star measures as compared to the previous year reduced our ratings on these measures. Thresholds for Star measures are calculated across the sector, without regard to weighted average membership of each plan. Together, these factors more than offset our improved Star rating performance in certain quality measures such as Healthcare Effectiveness Data and Information Set, or HEDIS. Our HEDIS measures, demonstrating the achievement of clinical outcomes, are at record-high results for the company. Accordingly, we believe that our Star ratings for the 2018 bonus year do not accurately reflect our actual performance under certain Star measures.

The ultimate financial impact to us related to 2018 Star bonus revenues is dependent upon multiple variables including, but not limited to, the number of Medicare Advantage members in 4-Star or higher rated plans and the geographic distribution of those members as well as a number of operational initiatives which would serve to mitigate the negative impact of our Star performance. Among those operational initiatives, we continue to evaluate our contract structures for rationalization to mitigate the negative impact on Star bonus revenues for 2018. Star results for the 2018 bonus year are not expected to materially impact our Medicare revenue for 2017 but could be material to 2018 Medicare revenues, pretax results and cash flows.

#### Group and Specialty Segment

- On March 2, 2017, we received notice that the Defense Health Agency, or DHA, had exercised its option to extend the TRICARE South Region contract through March 31, 2018. On July 21, 2016, we were notified by the DHA that we were awarded the contract for the new TRICARE East Region, which is a consolidation of the former North and South Regions, with delivery of health care services expected to commence on October 1, 2017. On March 30, 2017, we received notice that the DHA is moving the date upon which delivery of health care services is expected to commence under the new TRICARE East Region contract from October 1, 2017, to January 1, 2018.The next generation East Region and West Region contract awards are currently subject to protests by an unsuccessful bidder in the U.S. Court of Federal Claims and before the DHA.

#### Healthcare Services Segment

- At March 31, 2017, approximately 51,300 primary care providers were in value-based (shared risk and path to risk) relationships, an increase of 7% from 47,800 at March 31, 2016 and an increase of 2% from 50,400 at December 31, 2016. At March 31, 2017, 64% of our individual Medicare Advantage members were in value-based relationships compared to 61% at March 31, 2016 and 64% at December 31, 2016.
- Medicare Advantage and dual demonstration program membership enrolled in a Humana chronic condition management program rose to 1,035,300 at March 31, 2017, an increase of 11% from 931,500 at March 31, 2016, but declined 6% from 1,099,200 at December 31, 2016. We have undergone an optimization process that ensures the appropriate level of member interaction with clinicians to drive quality outcomes leading to reduced segment earnings but higher returns on investment.

### 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, which is not deductible for income tax purposes, has been suspended for calendar year 2017, but is scheduled to resume in calendar year 2018.

In addition, the Health Care Reform Law expands federal oversight of health plan premium rates. 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 2016 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. For 2017, we are offering on-exchange individual commercial medical plans in 11 states, a reduction from the 15 states in which we offered on-exchange coverage in 2016. In addition, we discontinued substantially all Health Care Reform Law compliant off-exchange individual commercial medical plans effective January 1, 2017. As previously discussed, on February 14, 2017, we announced we are exiting our individual commercial medical business January 1, 2018.

If we fail to effectively implement our operational and strategic initiatives with respect to the implementation of the Health Care Reform Law, our business may be materially adversely affected. Additionally, potential legislative changes, including activities to repeal or replace the Health Care Reform Law or limiting funding of cost-sharing subsidies, creates uncertainty for our business, and we cannot predict when, or in what form, such legislative changes may occur. We may be unable to adjust our product offerings, geographic footprint, or pricing during any given year such legislative changes occur in sufficient time to mitigate any adverse effects.

On November 10, 2016, the U.S. Court of Federal Claims ruled in favor of the government in one of a series of cases filed by insurers, unrelated to us, against HHS to collect risk corridor payments, rejecting all of the insurer’s statutory, contract and Constitutional claims for payment. On November 18, 2016, HHS issued a memorandum indicating a significant funding shortfall for the 2015 coverage year, the second consecutive year of significant shortfalls. Given the successful challenge of the risk corridor provisions in court, Congressional inquiries into the funding of the risk corridor program, and significant funding shortfalls under the first two years of the program, during the fourth quarter of 2016 we wrote-off $583 million in risk corridor receivables outstanding as of September 30, 2016, including $415 million associated with the 2014 and 2015 coverage years. From inception of the risk corridor program through March 31, 2017, we collected approximately $37 million from CMS for risk corridor receivables associated with the 2014 coverage year funded by HHS in accordance with previous guidance, utilizing funds HHS collected from us and other carriers under the risk corridor program. At March 31, 2017, we estimate that we are entitled to collect a total of $613 million from HHS under the commercial risk corridor program for the 2014 through 2016 program years.

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 clinical care services, to our Retail, Group and Specialty, and Individual Commercial segment customers and are described in Note 15 to the condensed consolidated financial statements included in this report.

### Comparison of Results of Operations for 2017 and 2016

The following discussion primarily deals with our results of operations for the three months ended March 31, 2017, or the 2017 quarter, and the three months ended March 31, 2016, or the 2016 quarter.

### Consolidated

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

| Revenues: Premiums: | For the three months ended March 31, 2017 | 2016 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Retail | $11,406 | $10,877 | $529 | 4.9% |
| Group and Specialty | 1,700 | 1,660 | 40 | 2.4% |
| Individual Commercial | 283 | 893 | (610) | (68.3)% |
| Other Businesses | 9 | 10 | (1) | (10.0)% |
| Total premiums | 13,398 | 13,440 | (42) | (0.3)% |
| Services: |  |  |  |  |
| Retail | 2 | 1 | 1 | 100.0% |
| Group and Specialty | 161 | 177 | (16) | (9.0)% |
| Healthcare Services | 88 | 79 | 9 | 11.4% |
| Other Businesses | 2 | 3 | (1) | (33.3)% |
| Total services | 253 | 260 | (7) | (2.7)% |
| Investment income | 111 | 100 | 11 | 11.0% |
| Total revenues | 13,762 | 13,800 | (38) | (0.3)% |
| Operating expenses: |  |  |  |  |
| Benefits | 11,326 | 11,397 | (71) | (0.6)% |
| Operating costs | 1,553 | 1,734 | (181) | (10.4)% |
| Merger termination fee and related costs | (947) | 34 | (981) | (2,885.3)% |
| Depreciation and amortization | 92 | 88 | 4 | 4.5% |
| Total operating expenses | 12,024 | 13,253 | (1,229) | (9.3)% |
| Income from operations | 1,738 | 547 | 1,191 | 217.7% |
| Interest expense | 49 | 47 | 2 | 4.3% |
| Income before income taxes | 1,689 | 500 | 1,189 | 237.8% |
| Provision for income taxes | 574 | 246 | 328 | 133.3% |
| Net income | $1,115 | $254 | $861 | 339.0% |
| Diluted earnings per common share | $7.49 | $1.68 | $5.81 | 345.8% |
| Benefit ratio (a) | 84.5% | 84.8% |  | (0.3)% |
| Operating cost ratio (b) | 11.4% | 12.7% |  | (1.3)% |
| Effective tax rate | 34.0% | 49.2% |  | (15.2)% |

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

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

#### Summary

Net income was $1.1 billion, or $7.49 per diluted common share, in the 2017 quarter compared to $254 million, or $1.68 per diluted common share, in the 2016 quarter. The 2017 quarter includes a net gain associated with the terminated Merger Agreement consisting primarily of the break-up fee representing $4.26 per diluted common share, as well as the estimated guaranty fund assessment expense to support the policyholder obligations of Penn Treaty (an unaffiliated long-term care insurance company) of $0.23 per diluted common share. In addition, the 2017 quarter includes net income from our Individual Commercial segment of $0.27 per diluted common share, and the $0.52 per diluted common share beneficial effect of the lower tax rate in light of pricing and benefit design assumptions associated with the 2017 temporary suspension of the health insurance industry fee, excluding the Individual Commercial business impact. Excluding the impact of the items above, the increase in the 2017 quarter primarily was due to year-over-year improvement in our Retail segment pretax results as discussed in the detailed segment results discussion that follows.

#### Premiums Revenue

Consolidated premiums decreased $42 million, or 0.3%, from the 2016 quarter to $13.4 billion for the 2017 quarter primarily due to lower premiums in the Individual Commercial segment, partially offset by higher premiums in the Retail segment resulting from our Medicare Advantage business, as discussed in the detailed segment results discussion that follows.

#### Services Revenue

Consolidated services revenue decreased $7 million, or 2.7%, from the 2016 quarter to $253 million for the 2017 quarter primarily due to a decrease in services revenue in the Group and Specialty segment as discussed in the detailed segment results discussion that follows.

#### Investment Income

Investment income totaled $111 million for the 2017 quarter, increasing $11 million, or 11.0%, from $100 million for the 2016 quarter primarily reflecting higher realized capital gains and higher average invested balances in the 2017 quarter, partially offset by lower interest rates.

#### Benefits Expense

Consolidated benefits expense was $11.3 billion for the 2017 quarter, a decrease of $71 million from the 2016 quarter, primarily due to a decrease in the Individual Commercial segment benefits expense, partially offset by an increase in the Retail and Group and Specialty segments benefits expense. We experienced favorable medical claims reserve development related to prior fiscal years of $231 million in the 2017 quarter as compared to $340 million in the 2016 quarter.

The consolidated benefit ratio decreased 30 basis points to 84.5% for the 2017 quarter compared to 84.8% for the 2016 quarter primarily due to a decrease in the Retail segment ratio, partially offset by an increase in the Group and Specialty segment ratio as discussed in the segment results of operation discussion that follows. Favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 170 basis points in the 2017 quarter versus approximately 250 basis points in the 2016 quarter.

#### 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 $181 million, or 10.4%, during the 2017 quarter compared to the 2016 quarter, primarily due to the temporary suspension of the health insurance industry fee for the calendar year 2017, partially offset by the estimated guaranty fund assessment expense recorded to support the policyholder obligations of Penn Treaty (an unaffiliated long-term care insurance company).

The consolidated operating cost ratio for the 2017 quarter of 11.4% decreased 130 basis points from the 2016 quarter primarily due to the temporary suspension of the health insurance industry fee for the calendar year 2017 and operating cost efficiencies, partially offset by the estimated guaranty fund assessment expense recorded to support the policyholder obligations of Penn Treaty (an unaffiliated long-term care insurance company). The non-deductible health insurance industry fee impacted the operating cost ratio by 170 basis points in the 2016 quarter.

#### Depreciation and Amortization

Depreciation and amortization for the 2017 quarter totaled $92 million compared to $88 million for the 2016 quarter.

#### Interest Expense

Interest expense for the 2017 quarter totaled $49 million, compared to $47 million for the 2016 quarter.

#### Income Taxes

Our effective tax rate during the 2017 quarter was 34.0% compared to the effective tax rate of 49.2% in the 2016 quarter, primarily due to the 2017 temporary suspension of the non-deductible health insurance industry fee as well as previously non-deductible transaction costs that, as a result of termination of the Merger Agreement, became deductible for tax purposes and were recorded as such in the three months ended March 31, 2017.

### Retail Segment

| Membership: Medical membership: | March 31, 2017 | 2016 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | 2,839,700 | 2,807,200 | 32,500 | 1.2% |
| Group Medicare Advantage | 431,100 | 349,200 | 81,900 | 23.5% |
| Medicare stand-alone PDP | 5,199,400 | 4,834,100 | 365,300 | 7.6% |
| Total Retail Medicare | 8,470,200 | 7,990,500 | 479,700 | 6.0% |
| State-based Medicaid | 380,400 | 388,400 | (8,000) | (2.1)% |
| Medicare Supplement | 231,400 | 209,800 | 21,600 | 10.3% |
| Total Retail medical members | 9,082,000 | 8,588,700 | 493,300 | 5.7% |

40

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the three months ended March 31, 2017 | 2016 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | $8,376 | $8,027 | $349 | 4.3% |
| Group Medicare Advantage | 1,318 | 1,077 | 241 | 22.4% |
| Medicare stand-alone PDP | 941 | 1,039 | (98) | (9.4)% |
| Total Retail Medicare | 10,635 | 10,143 | 492 | 4.9% |
| State-based Medicaid | 653 | 630 | 23 | 3.7% |
| Medicare Supplement | 118 | 104 | 14 | 13.5% |
| Total premiums | 11,406 | 10,877 | 529 | 4.9% |
| Services | 2 | 1 | 1 | 100.0% |
| Total premiums and services revenue | $11,408 | $10,878 | $530 | 4.9% |
| **Income before income taxes** | $370 | $141 | $229 | 162.4% |
| Benefit ratio | 88.1% | 88.6% |  | (0.5)% |
| Operating cost ratio | 8.4% | 9.9% |  | (1.5)% |

#### Pretax Results

- Retail segment pretax income was $370 million in the 2017 quarter, an increase of $229 million, or 162.4%, compared to $141 million in the 2016 quarter, primarily driven by lower benefit and operating cost ratios.

#### Enrollment

- Individual Medicare Advantage membership increased 32,500 members, or 1.2%, from March 31, 2016 to March 31, 2017 reflecting net membership additions for Medicare beneficiaries including the effect of market and product exits in 2017. We decided certain markets and/or products were not meeting long term strategic and financial objectives. Additionally, membership was muted due to competitive actions including the uncertainty associated with the then-pending Merger transaction.
- Group Medicare Advantage membership increased 81,900, or 23.5%, from March 31, 2016 to March 31, 2017 reflecting the addition of a large account in January 2017.
- Medicare stand-alone PDP membership increased 365,300 members, or 7.6%, from March 31, 2016 to March 31, 2017 reflecting net membership additions, primarily for our Humana-Walmart plan offering, for the 2017 plan year.
- State-based Medicaid membership decreased 8,000 members, or 2.1%, from March 31, 2016 to March 31, 2017, primarily driven by lower membership associated with our Florida contracts resulting from network realignments.

#### Premiums Revenue

- Retail segment premiums increased $529 million, or 4.9%, from the 2016 quarter to the 2017 quarter primarily due to group and individual Medicare Advantage membership growth and increased per-member premiums for the individual Medicare Advantage and state-based contract businesses. Average group and individual Medicare Advantage membership increased 3.8% for the 2017 quarter. 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.

#### Benefits Expense

- The Retail segment benefit ratio decreased 50 basis points from 88.6% in the 2016 quarter to 88.1% in the 2017 quarter, primarily due to the planned exits from certain Medicare Advantage markets that carried a higher benefit ratio than other markets as well as the seasonal impact of leap day in the 2016 quarter versus none in the 2017 quarter. These favorable items were partially offset by lower prior period development, margin compression associated with the competitive environment in the group Medicare Advantage business, and the impact of the temporary suspension of the health insurance industry fee for calendar year 2017 which was contemplated in the pricing and benefit design of our products.
- The Retail segment’s benefits expense for the 2017 quarter included $204 million in favorable prior-period medical claims reserve development versus $218 million in favorable prior-prior period medical claims reserve development in the 2016 quarter. The decline in prior period development is due to unfavorable year-over-year comparisons for our Medicare business. Prior-period medical claims reserve development decreased the Retail segment benefit ratio by approximately 180 basis points in the 2017 quarter versus approximately 200 basis points in the 2016 quarter.

#### Operating Costs

- The Retail segment operating cost ratio of 8.4% for the 2017 quarter decreased 150 basis points from 9.9% for the 2016 quarter due to the temporary suspension of the health insurance industry fee for calendar year 2017. The non-deductible health insurance industry fee impacted the operating cost ratio by 170 basis points in the 2016 quarter.

### Group and Specialty Segment

| Membership: Medical membership: | March 31, 2017 | 2016 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | 1,119,400 | 1,136,400 | (17,000) | (1.5)% |
| ASO | 447,000 | 579,400 | (132,400) | (22.9)% |
| Military services | 3,082,800 | 3,076,800 | 6,000 | 0.2% |
| Total group and specialty medical members | 4,649,200 | 4,792,600 | (143,400) | (3.0)% |
| Specialty membership (a) | 6,921,800 | 7,045,100 | (123,300) | (1.8)% |

(a) Specialty products include dental, vision, voluntary benefit products 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.

42

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the three months ended March 31, 2017 | 2016 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | $1,378 | $1,337 | $41 | 3.1% |
| Group specialty | 322 | 318 | 4 | 1.3% |
| Military services | — | 5 | (5) | (100.0)% |
| Total premiums | 1,700 | 1,660 | 40 | 2.4% |
| Services | 161 | 177 | (16) | (9.0)% |
| Total premiums and services revenue | $1,861 | $1,837 | $24 | 1.3% |
| **Income before income taxes** | $171 | $172 | $(1) | (0.6)% |
| Benefit ratio | 75.6% | 73.6% |  | 2.0% |
| Operating cost ratio | 21.4% | 23.5% |  | (2.1)% |

#### Pretax Results

- Group and Specialty segment pretax income was $171 million in the 2017 quarter, a decrease of $1 million or 0.6%, from $172 million in the 2016 quarter. The decline was primarily due to an increase in the benefit ratio, largely offset by the improvement in the operating cost ratio.

#### Enrollment

- Fully-insured commercial group medical membership decreased 17,000 members, or 1.5%, from March 31, 2016 to March 31, 2017 reflecting lower membership in small group accounts due in part to certain small group accounts moving from fully insured to ASO products.
- Group ASO commercial medical membership decreased 132,400 members, or 22.9%, from March 31, 2016 to March 31, 2017 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, partially offset by certain small group accounts moving from fully-insured to ASO products.
- Specialty membership decreased 123,300 members, or 1.8%, from March 31, 2016 to March 31, 2017 primarily due to the loss of certain group fully-insured commercial medical and ASO accounts that also had specialty coverage.

#### Premiums Revenue

- Group and Specialty segment premiums increased $40 million, or 2.4% from the 2016 quarter to $1.7 billion for the 2017 quarter primarily due to an increase in fully-insured commercial medical per-member premiums, partially offset by a decline in average fully-insured commercial medical membership.

#### Services Revenue

- Group and Specialty segment services revenue decreased $16 million, or 9.0%, from the 2016 quarter to $161 million for the 2017 quarter primarily due to a decline in revenue in our group ASO commercial medical business mainly due to membership declines.

#### Benefits Expense

- The Group and Specialty segment benefit ratio increased 200 basis points from 73.6% in the 2016 quarter to 75.6% in the 2017 quarter primarily due to the impact of lower favorable prior-period medical claims reserve

development in the 2017 quarter, the impact of the temporary suspension of the health insurance industry fee for calendar year 2017 which was contemplated in the pricing of our products, as well as an increased proportion of small group members in community rated plans that carry a higher benefit ratio.

- The Group and Specialty segment’s benefits expense included $20 million in favorable prior-period medical claims reserve development in the 2017 quarter and $41 million in the 2016 quarter. This favorable prior-period medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 120 basis points in the 2017 quarter and 250 basis points in the 2016 quarter.

#### Operating Costs

- The Group and Specialty segment operating cost ratio of 21.4% for the 2017 quarter decreased 210 basis points from 23.5% for the 2016 quarter primarily due to the temporary suspension of the health insurance industry fee for calendar year 2017 and operating cost efficiencies. The non-deductible health insurance industry fee impacted the operating cost ratio by 150 basis points in the 2016 quarter.

### Healthcare Services Segment

*(in millions)*

| Revenues: Services: | For the three months ended March 31, 2017 | 2016 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Clinical care services | $50 | $52 | $(2) | (3.8)% |
| Provider services | 20 | 20 | 0 | —% |
| Pharmacy solutions | 18 | 7 | 11 | 157.1% |
| Total services revenues | 88 | 79 | 9 | 11.4% |
| Intersegment revenues: |  |  |  |  |
| Pharmacy solutions | 5,141 | 5,407 | (266) | (4.9)% |
| Provider services | 418 | 418 | — | —% |
| Clinical care services | 303 | 319 | (16) | (5.0)% |
| Total intersegment revenues | 5,862 | 6,144 | (282) | (4.6)% |
| Total services and intersegment revenues | $5,950 | $6,223 | $(273) | (4.4)% |
| **Income before income taxes** | $244 | $252 | $(8) | (3.2)% |
| Operating cost ratio | 95.5% | 95.5% |  | —% |

#### Pretax Results

- Healthcare Services segment pretax income of $244 million for the 2017 quarter decreased slightly by $8 million, or 3.2% from $252 million in the 2016 quarter reflecting the impact of the optimization process associated with our chronic condition management programs. The reduction in pharmacy solutions intersegment revenues was offset by a similar reduction in operating costs associated with the pharmacy solutions business.

#### Script Volume

- Humana Pharmacy Solutions® script volumes for Retail, Group and Specialty, and Individual Commercial segment membership increased to approximately 107 million in the 2017 quarter, up 2.9%, versus scripts of approximately 104 million in the 2016 quarter primarily reflecting growth associated with higher average Retail segment Medicare membership for the 2017 quarter compared to the 2016 quarter.

#### Services Revenues

- Services revenues increased $9 million, or 11.4%, from the 2016 quarter to $88 million for the 2017 quarter primarily due to service revenue growth from our pharmacy solutions business.

#### Intersegment Revenues

- Intersegment revenues decreased $282 million, or 4.6%, from the 2016 quarter to $5.9 billion for the 2017 quarter primarily due to our pharmacy solutions business as well as the impact of the optimization process associated with our chronic conditions management programs discussed previously. Our pharmacy solutions business revenues were impacted by improvements in net pharmacy costs driven by our pharmacy benefit manager and an increase in the generic dispensing rate. These items were partially offset by higher year-over-year script volume from growth in our Medicare Advantage and stand-alone PDP membership. Our generic dispensing rate improved to 91.1% during the 2017 quarter compared to 90.1% during the 2016 quarter. The higher generic dispensing rate reduced revenues (and operating costs) for our pharmacy solutions business as generic drugs are generally priced lower than branded drugs.

#### Operating Costs

- The Healthcare Services segment operating cost ratio was unchanged from the 2016 quarter to the 2017 quarter.

### Individual Commercial Segment

- As announced on February 14, 2017, we are exiting our individual commercial medical business January 1, 2018.
- Individual Commercial segment pretax income of $63 million for the 2017 quarter increased $75 million from the 2016 quarter, reflecting the exit of certain markets in 2017, per-member premium increases, and the effect of the 2016 premium deficiency reserve recognized in the fourth quarter of 2015.
- Individual commercial medical membership decreased 674,700 members, or 77.0%, from March 31, 2016 to March 31, 2017 reflecting the decline in the number of counties we offered on-exchange coverage and the discontinuance of all off-exchange products.
- The benefit ratio for the Individual Commercial segment was 55.1% for the 2017 quarter, a significant decrease from 81.6% for the 2016 quarter. The year-over-year decrease primarily resulted from planned exits from certain markets that carried a higher benefit ratio than other markets, per-member premium increases, and the effect of the 2016 premium deficiency reserve recognized in the fourth quarter of 2015.
- The operating cost ratio for the Individual Commercial segment was 21.9% in the 2017 quarter, an increase of 300 basis points from 18.9% in the 2016 quarter, primarily due to reduced leverage from market exits in 2017 partially offset by the temporary suspension of the health insurance industry fee for calendar year 2017.

### Liquidity

Our primary sources of cash include 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 include 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 three months ended March 31, 2017, net collections under the 3Rs associated with prior coverage years were $62 million compared to $219 million during the three months ended March 31, 2016. Net collections for the three months ended March 31, 2016 included an advance payment for a portion of the 2015 reinsurance amount. The remaining net receivable balance associated with the 3Rs was approximately $394 million at March 31, 2017, including $403 million related to prior coverage years, compared to $456 million at December 31, 2016, neither of which includes any risk corridor receivable. Amounts associated with prior coverage years of $403 million is expected to be collected during the third quarter of 2017. 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 2016 Form 10-K.

Cash and cash equivalents increased to approximately $8.4 billion at March 31, 2017 from $3.9 billion at December 31, 2016. The change in cash and cash equivalents for the three months ended March 31, 2017 and 2016 is summarized as follows:

*(in millions)*

|  | 2017 | 2016 |
| --- | ---: | ---: |
| Net cash provided by operating activities | $4,205 | $502 |
| Net cash used in investing activities | (926) | (428) |
| Net cash provided by financing activities | 1,269 | 156 |
| Increase in cash and cash equivalents | $4,548 | $230 |

### Cash Flow from Operating Activities

Our operating cash flows for the 2017 quarter were significantly impacted by the early receipt of the Medicare premium remittance for April 2017 of $3.1 billion in March 2017 because the payment date of April 1, 2017 fell on a weekend. Generally, when the first day of a month falls on a weekend or holiday, with the exception of January 1 (New Year’s Day), we receive this payment at the end of the previous month. This also resulted in an increase to unearned revenues in our condensed consolidated balance sheet at March 31, 2017.Our operating cash flows were also significantly impacted by the $1 billion receipt of the Merger termination fee. Excluding the timing of the Medicare premium remittance and the Merger termination fee, our operating cash flows were negatively impacted by the timing of working capital items partially offset by higher earnings.

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 March 31, 2017 and December 31, 2016:

*(in millions)*

|  | March 31, 2017 | December 31, 2016 | 2017 Quarter Change | 2016 Quarter Change |
| --- | ---: | ---: | ---: | ---: |
| IBNR (1) | $3,397 | $3,422 | $(25) | $(107) |
| Reported claims in process (2) | 588 | 654 | (66) | 130 |
| Premium deficiency reserve (3) | — | — | — | 13 |
| Other benefits payable (4) | 776 | 487 | 289 | 102 |
| Total benefits payable | $4,761 | $4,563 | $198 | $138 |

(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, 2016 to March 31, 2017 primarily was due to an increase in the amounts owed to providers under the capitated and risk sharing arrangements. This was partially offset by a decrease in the amount of processed but unpaid claims, which fluctuate due to month-end cutoff as well as a decrease in IBNR primarily driven by declines in individual commercial medical membership in the 2017 quarter, partially offset by an increase in group Medicare Advantage membership. The increase in benefits payable from December 31, 2015 to March 31, 2016 largely was due to an increase in IBNR. IBNR increased primarily as a result of individual Medicare Advantage membership growth.

The detail of total net receivables was as follows at March 31, 2017 and December 31, 2016:

*(in millions)*

|  | March 31, 2017 | December 31, 2016 | 2017 Quarter Change | 2016 Quarter Change |
| --- | ---: | ---: | ---: | ---: |
| Medicare | $1,254 | $787 | $467 | $592 |
| Commercial and other | 643 | 579 | 64 | (13) |
| Military services | 54 | 32 | 22 | 11 |
| Allowance for doubtful accounts | (113) | (118) | 5 | (14) |
| Total net receivables | $1,838 | $1,280 | $558 | $576 |

The changes in Medicare receivables for both the 2017 quarter and the 2016 quarter 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 mid-year and final settlements with CMS in August and October, respectively.

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. During the 2017 quarter, we received net collections of $62 million for the commercial 3Rs associated with prior coverage years as compared to net collections of $219 million in the 2016 quarter. The net receivable balance associated with the 3Rs was approximately $394 million at March 31, 2017 and $456 million at December 31, 2016, including certain amounts recorded in receivables in the table above. In 2017, we will not pay the federal government for the annual health insurance industry fee due to the temporary one year suspension as compared to our payment of $916 million in the third quarter of 2016. 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 $797 million in the 2017 quarter and $303 million in the 2016 quarter.

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 $122 million in the 2017 quarter and $125 million in the 2016 quarter.

### 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 $1.7 billion during the 2017 quarter and higher than claims payments by $315 million during the 2016 quarter. The 2017 quarter included the impact of the early receipt for April remittance from CMS. Our net payable for CMS subsidies and brand name prescription drug discounts was $851 million at March 31, 2017 compared to a net receivable of $1.7 billion at March 31, 2016 and $873 million at December 31, 2016. Refer to Note 6 to the condensed consolidated financial statements included in this report.

Under our administrative services only TRICARE South Region contract, reimbursements from the federal government exceeded health care cost payments for which we do not assume risk by $9 million in the 2017 quarter. In the 2016 quarter, health care cost payments for which we do not assume risk exceeded reimbursements from the federal government by $19 million.

Claims payments associated with cost sharing provisions of the Health Care Reform Law for which we do not assume risk were $3 million higher than reimbursements from HHS during the 2017 quarter and $22 million lower than reimbursements from HHS during the 2016 quarter.

We repurchased 5.83 million shares for $1.2 billion in the 2017 quarter, which excludes another $300 million of stock held back pending final settlement of an accelerated stock repurchase plan, 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 quarter due to the restrictions of the Merger Agreement. We also acquired common shares in connection with employee stock plans for an aggregate cost of $74 million in the 2017 quarter and $71 million in the 2016 quarter.

In March 2017, we issued $600 million of 3.95% senior notes due March 15, 2027 and $400 million of 4.80% senior notes due March 15, 2047. Our net proceeds, reduced for the underwriters' discount and commission and offering expenses, were $991 million. We intend to use the net proceeds for general corporate purposes.

Net proceeds from the issuance of commercial paper were $169 million in the 2017 quarter. There were no net proceeds from the issuance of commercial paper in the 2016 quarter. The maximum principal amount outstanding at any one time during the 2017 quarter was $500 million.

We paid dividends to stockholders of $47 million during both the 2017 and 2016 quarters, as discussed further below.

### Future Sources and Uses of Liquidity

### Dividends

For a detailed discussion of dividends to stockholders, please refer to Note 11 to the condensed consolidated financial statements.

### Stock Repurchases

For a detailed discussion of stock repurchases, please refer to Note 11 to the condensed consolidated financial statements.

### Debt

For a detailed discussion of our debt, including our senior notes, credit agreement and commercial paper program, please refer to Note 13 to the condensed consolidated financial statements.

### 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 March 31, 2017 was BBB+ according to Standard & Poor’s Rating Services, or S&P, and Baa3 according to Moody’s Investors Services, Inc., or Moody’s. A downgrade by S&P to BB+ or by Moody’s to Ba1 triggers an interest rate increase of 25 basis points with respect to $750 million of our senior notes. Successive one notch downgrades increase the interest rate an additional 25 basis points, or annual interest expense by $2 million, up to a maximum 100 basis points, or annual interest expense by $8 million.

In addition, we operate as a holding company in a highly regulated industry. Humana Inc., our parent company, is dependent upon dividends and administrative expense reimbursements from our subsidiaries, most of which are subject to regulatory restrictions. We continue to maintain significant levels of aggregate excess statutory capital and surplus in our state-regulated operating subsidiaries. Cash, cash equivalents, and short-term investments at the parent company were $1.7 billion at March 31, 2017 compared to $2.0 billion at December 31, 2016. This decrease reflects the payment of $1.5 billion for our accelerated share repurchase program in March 2017 and the capital contribution of $535 million to our long-term care subsidiary, as described below. These items were partially offset by the receipt of the Merger termination fee net of related expenses and net proceeds associated with the issuance of senior notes in March 2017. 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).

Our parent company funded a subsidiary capital contribution of approximately $535 million in the first quarter of 2017 for reserve strengthening associated with our closed block of long-term care insurance policies.

The annual health insurance industry fee has been suspended for calendar year 2017, but is scheduled to resume in calendar year 2018. In September 2016, we paid the federal government $916 million for our portion of the annual health insurance industry fee attributed to calendar year 2016 in accordance with the Health Care Reform Law. This fee is not deductible for tax purposes. Each year on January 1, except for 2017, we record a liability for this fee in trade accounts payable and accrued expenses which we carry until the fee is paid. We record a corresponding deferred cost in other current assets in our condensed consolidated financial statements which is amortized ratably to expense over the calendar year. Amortization of the deferred cost resulted in operating cost expense of approximately $227 million for the three months ended March 31, 2016 resulting from the amortization of the 2016 annual health insurance industry fee.

### Regulatory Requirements

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

Although minimum required levels of equity are largely based on premium volume, product mix, and the quality of assets held, minimum requirements vary significantly at the state level. Based on the most recently filed statutory financial statements as of December 31, 2016, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $7.7 billion, which exceeded aggregate minimum regulatory requirements of $4.8 billion. Subsidiary dividends are subject to state regulatory approval, the amount and timing of which could be reduced or delayed. Excluding Puerto Rico subsidiaries, the amount of ordinary dividends that may be paid to our parent company in 2017 is approximately $850 million in the aggregate. This compares to dividends that were paid to our parent company in 2016 of approximately $763 million. 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, 2,084 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 March 31, 2017. Our net unrealized position increased $21 million from a net unrealized loss position of $28 million at December 31, 2016 to a net unrealized loss position of $7 million at March 31, 2017. At March 31, 2017, we had gross unrealized losses of $165 million on our investment portfolio primarily due to an increase in market interest rates since the time the securities were purchased. There were no material other-than-temporary impairments during the three months ended March 31, 2017. 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 3.4 years as of March 31, 2017 and approximately 4.4 years as of December 31, 2016. Based on the duration, including cash equivalents, a 1% increase in interest rates would generally decrease the fair value of our securities by approximately $640 million at March 31, 2017.

## Controls and procedures

As filed, 1,293 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 March 31, 2017.

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 March 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Filed May 3, 2017.
Source: SEC EDGAR, the filing index for accession 0000049071-17-000102. Last ingested by Listed: Nov 6, 2026, 14:15 ET. No prices; not investment advice.