Humana Inc: Form 10-Q for the period ended Sep 30, 2017

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 is committed to helping our millions of medical and specialty members achieve their best health. Our successful history in care delivery and health plan administration is helping us create a new kind of integrated care with the power to improve health and well-being and lower costs. Our efforts are leading to a better quality of life for people with Medicare, families, individuals, military service personnel, and communities at large.

To accomplish that, we support physicians and other health care professionals as they work to deliver the right care in the right place for their patients, our members. Our range of clinical capabilities, resources and tools - such as in-home care, behavioral health, pharmacy services, data analytics and wellness solutions - combine to produce a simplified experience that makes health care easier to navigate and more effective.

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.

Sale of Closed Block of Commercial Long-Term Care Insurance Business

On November 6, 2017, we entered into a definitive agreement to sell the stock of our wholly-owned subsidiary, KMG America Corporation, or KMG, to Continental General Insurance Company, or CGIC, a Texas-based insurance company wholly owned by HC2 Holdings, Inc., a diversified holding company. KMG’s subsidiary, Kanawha Insurance Company, or KIC, includes our closed block of non-strategic commercial long-term care insurance policies that serves approximately 30,100 policyholders. Based on the terms of the definitive agreement we expect to record a net loss associated with the sale of KMG of approximately $400 million, or $2.75 per diluted common share. The estimated loss includes a pretax loss of approximately $900 million, offset by the expected tax benefit of approximately $500 million. We will fund the transaction with approximately $203 million of parent company cash contributed into KMG, subject to customary adjustments, in addition to the transfer of approximately $150 million of statutory capital with the sale, which together should be more than offset by the estimated $500 million cash savings associated with the expected tax treatment of the sale. The KMG transaction is anticipated to close by the third quarter of 2018 subject to customary closing conditions, including South Carolina Department of Insurance approval. There can be no assurance we will obtain regulatory approvals needed to sell the business or do so under terms acceptable to us.

Workforce Optimization

We have been committed to productivity initiatives designed to promote operational excellence, accelerate our strategy, fund critical initiatives and advance our growth objectives. During the third quarter of 2017, we initiated a voluntary early retirement program and an involuntary workforce reduction program that will allow us to achieve these objectives and position us for the future. These programs are expected to impact approximately 2,700 associates, or 5.7%, of our workforce. As a result, we recorded estimated charges of $124 million, or $0.54 per diluted common share. At October 31, 2017, we had approximately 47,200 employees. The estimated charges were recorded at the corporate level and not allocated to the segments. This charge is included with operating costs in the condensed consolidated statements of income for the three and nine month periods ended September 30, 2017. Payments under these programs are made upon termination during the early retirement or severance pay period, primarily starting as of the beginning of the first quarter of 2018. We expect this liability to be primarily paid within the next 12 months and classified it as a current liability, included in trade accounts payable and accrued expenses.

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 the 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 to the condensed consolidated financial statements included in this report 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, which we refer to collectively as 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 that 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 September 30, 2017 as compared to the three months ended September 30, 2016, were primarily impacted by the estimated charges associated with voluntary and involuntary workforce reduction programs and lower pretax earnings in the Healthcare Services segment, partially offset by year-over-year improvement in earnings for our Group and Specialty segment as well as Medicare Advantage and Individual Commercial businesses. Our consolidated pretax results for the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016, primarily reflects the net gain associated with the terminated Merger Agreement, mainly the break-up fee, along with the year-over year improvement in earnings for our Group and Specialty segment as well as Medicare Advantage and Individual Commercial businesses. These were partially offset by lower pretax earnings in the Healthcare Services segment and the recording of estimated charges associated with voluntary and involuntary workforce reduction programs during the three months ended September 30, 2017.
• 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 September 30, 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 September 30, 2017, approximately 1,877,800 members, or 65.9%, 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 1,786,100 members, or 63.1%, at September 30, 2016.
• We recorded a net gain associated with the terminated Merger Agreement, consisting primarily of the break-up fee, of approximately $947 million, or $4.33 per diluted common share during the nine months ended September 30, 2017. We recorded transaction costs in connection with the Merger of approximately $20 million, or $0.12 per diluted common share, and $81 million, or $0.49 per diluted common share, during the three and nine months ended September 30, 2016, respectively. 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.
• Year-over-year comparisons of results are also impacted by the recognition of a premium deficiency reserve for our Individual Commercial segment related to certain of our 2016 policies as discussed in the Individual Commercial segment highlights that follow. During the nine months ended September 30, 2016, we increased the premium deficiency reserve by $208 million, or $0.86 per diluted common share.
• 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 and nine months ended September 30, 2016 was $231 million and $687 million, respectively. This fee is not deductible for tax purposes, which significantly increased 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 and nine months ended September 30, 2017.
• On February 14, 2017, we announced we are exiting our Individual Commercial medical business commencing 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 will exit this business commencing January 1, 2018. The three and nine months ended September 30, 2017 includes pretax income from our Individual Commercial business of $26 million, or $0.11 per diluted common share, and $207 million, or $0.89 per diluted common share, respectively.
• 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 third quarter of 2017 we recorded estimated charges of $124 million, or $0.54 per diluted common share associated with both voluntary and involuntary workforce reduction programs that are expected to impact approximately 2,700 associates, or 5.7%, of our workforce. This charge is included with operating costs in the condensed consolidated statement of income for the three and nine month periods ended September 30, 2017.
• During the nine months ended September 30, 2017, cash flow provided by operations was $7.0 billion as compared to $4.7 billion for the nine months ended September 30, 2016. Our operating cash flows for the nine months ended September 30, 2017 were significantly impacted by the receipt of the $1 billion Merger termination fee, net of related expenses and the portion of taxes paid to date. Our operating cash flows were also significantly impacted in both periods by the early receipt of the Medicare premium remittance for October 2017 of $3.1 billion in September 2017 and the receipt of the Medicare premium remittance for October 2016 of $3.0 billion in September 2016 because the payment dates of October 2017 and October 2016 fell on a weekend. Excluding the Merger termination fee and the timing of the Medicare premium remittances, our operating cash flows were positively impacted by higher earnings and the timing of working capital items. 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.

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.

Healthcare Services Segment

• At September 30, 2017, approximately 51,500 primary care providers were in value-based relationships, an increase of 3.8% from 49,600 at September 30, 2016 and an increase of 2.2% from 50,400 at December 31, 2016. At September 30, 2017, 65.9% of our individual Medicare Advantage members were in value-based relationships compared to 63.1% at September 30, 2016 and 64.0% at December 31, 2016.
• Medicare Advantage and dual demonstration program membership enrolled in a Humana chronic care management program was 825,200 at September 30, 2017, a decrease of 21.0% from 1,044,700 at September 30, 2016, and 24.9% 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, which has resulted in 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, which ends in 2017. 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 the Trump Administration's October 12, 2017 announcement to end cost-sharing reduction benefits effective for October 2017 and beyond in all states as well as activities to repeal or replace the Health Care Reform Law, 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 insurers 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 September 30, 2017, we collected approximately $39 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 September 30, 2017, we estimate that we are entitled to collect a total of $611 million from HHS under the commercial risk corridor program for the 2014 through 2016 program years. On November 2, 2017, we filed suit against the United States of America in the United States Court of Federal Claims, on behalf of our health plans seeking recovery from the federal government of approximately $611 million in payments under the risk corridor premium stabilization program established under Health Care Reform, for years 2014, 2015 and 2016.

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 September 30, 2017, or the 2017 quarter, the three months ended September 30, 2016, or the 2016 quarter, the nine months ended September 30, 2017, or the 2017 period, and the nine months ended September 30, 2016, or the 2016 period.

Consolidated

(dollars in millions, except per common share results)

(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.

(dollars in millions, except per common share results)

(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 $499 million, or $3.44 per diluted common share, in the 2017 quarter compared to $450 million, or $2.98 per diluted common share, in the 2016 quarter. The 2017 quarter includes net income from our Individual Commercial segment of $0.11 per diluted common share, as well as $0.55 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. These were offset by $0.54 per diluted common share in estimated charges associated with both voluntary and involuntary workforce reduction programs. Net income was $2.3 billion, or $15.44 per diluted common share, in the 2017 period compared to $1.0 billion, or $6.73 per diluted common share, in the 2016 period. The 2017 period includes a net gain associated with the terminated Merger Agreement consisting primarily of the break-up fee representing $4.33 per diluted common share. In addition, the 2017 period includes net income from our Individual Commercial segment of $0.89 per diluted common share, as well as $1.60 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. These were offset by $0.54 per diluted common share in estimated charges associated with both voluntary and involuntary workforce reduction programs, 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. Excluding the impact of the items above, the increase in the 2017 quarter and the 2017 period 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 $416 million, or 3.1%, from the 2016 quarter to $13.0 billion for the 2017 quarter and decreased $905 million, or 2.2%, from the 2016 period to $39.6 billion for the 2017 period. These decreases are 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 $4 million, or 1.8%, from the 2016 quarter to $223 million for the 2017 quarter and decreased $43 million, or 5.7%, from the 2016 period to $706 million for the 2017 period. These decreases are 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 $104 million for the 2017 quarter, increasing $8 million, or 8.3%, from $96 million for the 2016 quarter. For the 2017 period, investment income totaled $316 million, increasing $25 million, or 8.6% , from $291 million in the 2016 period. These increases primarily reflect higher average invested balances and interest rates, partially offset by lower realized capital gains.

Benefits Expense

Consolidated benefits expense was $10.6 billion for the 2017 quarter, a decrease of $258 million from the 2016 quarter. For the 2017 period, benefits expense was $32.9 billion, a decrease of $949 million from the 2016 period. These decreases are 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 $85 million in the 2017 quarter as compared to $90 million in the 2016 quarter. In the 2017 period, we experienced favorable medical claims reserve development related to prior fiscal years of $430 million as compared to $525 million in the 2016 period as discussed in the detailed segment results discussion that follows.

The consolidated benefit ratio increased 60 basis points to 82.1% for the 2017 quarter compared to 81.5% for the 2016 quarter primarily due to the increase in the Retail segment benefit ratio, partially offset by decreases in the Group and Specialty and Individual Commercial segment benefit ratios as discussed in the segment results of operation discussion that follows. The consolidated benefit ratio for the 2017 period was 83.1%, a 50 basis point decrease from 83.6% for the 2016 period, primarily due to the decrease in the Individual Commercial segment benefit ratio, partially offset by the increase in the Retail and Group and Specialty segment benefit 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 70 basis points in each of the 2017 quarter and the 2016 quarter. Favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 110 basis points in the 2017 period versus approximately 130 basis points in the 2016 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 $51 million, or 2.9%, 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, and lower Individual Commercial membership, partially offset by the estimated charges associated with both voluntary and involuntary workforce reduction programs recorded during the 2017 quarter. Consolidated operating costs decreased $478 million, or 9.2%, during the 2017 period compared to the 2016 period primarily due to the temporary suspension of the health insurance industry fee for the calendar year 2017, and lower Individual Commercial membership, partially offset by the estimated charges associated with both voluntary and involuntary workforce reduction programs as well as 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 12.8% was unchanged from the 2016 quarter. The year-over-year comparison was favorably impacted by the temporary suspension of the health insurance industry fee for the calendar year 2017, offset by the loss of scale efficiency from market exits in the 2017 period associated with the Individual Commercial product, the estimated charges associated with both voluntary and involuntary workforce reduction programs recorded in the 2017 quarter, and the increase in employee compensation costs resulting from the continued strong performance. The consolidated operating cost ratio for the 2017 period decreased 90 basis points to 11.7% from 12.6% in the 2016 period primarily due to the temporary suspension of the health insurance industry fee for the calendar year 2017 as well as operating cost efficiencies, partially offset by the loss of scale efficiency from market exits in the 2017 period associated with the Individual Commercial product, the estimated charges associated with both voluntary and involuntary workforce reduction programs recorded in the 2017 quarter, as well as the impact of 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 both the 2016 quarter and 2016 period.

Depreciation and Amortization

Depreciation and amortization for the 2017 quarter totaled $94 million compared to $86 million for the 2016 quarter. For the 2017 period, depreciation and amortization totaled $278 million compared to $263 million for the 2016 period.

Interest Expense

Interest expense for the 2017 quarter totaled $59 million, compared to $47 million for the 2016 quarter, and totaled $166 million for the 2017 period compared to $141 million for the 2016 period. The increase was due to the issuance of $1 billion of senior notes in March 2017.

Income Taxes

Our effective tax rate during the 2017 quarter was 37.5% compared to the effective tax rate of 50.1% in the 2016 quarter. For the 2017 period our effective tax rate was 35.9% compared to the effective tax rate of 50.2% for the 2016 period. These decreases are 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

(in millions)

48

(in millions)

Pretax Results

• Retail segment pretax income of $610 million in the 2017 quarter was relatively unchanged from $608 million in the 2016 quarter, reflecting the year-over-year improvement in the operating cost ratio being substantially offset by the increase in the benefit ratio. Retail segment pretax income increased $324 million, or 25.7%, to $1.6 billion in the 2017 period from $1.3 billion in the 2016 period, primarily due to the year-over-year improvement in earnings for our Medicare Advantage business.

Enrollment

• Individual Medicare Advantage membership increased 17,700 members, or 0.6%, from September 30, 2016 to September 30, 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 growth was muted due to competitive actions including the uncertainty associated with the then-pending Merger transaction during last year's Annual Election Period.
• Group Medicare Advantage membership increased 84,500, or 23.9%, from September 30, 2016 to September 30, 2017 reflecting the addition of a large account in January 2017.
• Medicare stand-alone PDP membership increased 377,500 members, or 7.7%, from September 30, 2016 to September 30, 2017 reflecting net membership additions, primarily for our Humana-Walmart plan offering, for the 2017 plan year.
• State-based Medicaid membership decreased 26,700 members, or 6.8%, from September 30, 2016 to September 30, 2017, primarily driven by lower membership associated with our Florida contracts resulting from network realignments.

Premiums Revenue

• Retail segment premiums increased $212 million, or 2.0%, from the 2016 quarter to the 2017 quarter and increased $1.1 billion, or 3.3%, from the 2016 period to the 2017 period. These increases primarily were due to Medicare Advantage membership growth and increased per-member premiums for certain businesses within the segment. Average group and individual Medicare Advantage membership increased 3.2% for the 2017

quarter and 3.5% for the 2017 period. 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 increased 70 basis points from 83.6% in the 2016 quarter to 84.3% in the 2017 quarter, and increased 30 basis points from 85.8% in the 2016 period to 86.1% in the 2017 period. These increases primarily were due to 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, margin compression associated with the competitive environment in the group Medicare Advantage business and lower favorable prior-period medical claims reserve development. These increases were partially offset by the impact of planned exits from certain Medicare Advantage markets that carried a higher benefit ratio than other markets as well as lower than expected medical costs as compared to the assumptions used in the pricing of our individual Medicare Advantage business.
• The Retail segment’s benefits expense for the 2017 quarter included $52 million in favorable prior-period medical claims reserve development versus $80 million in favorable prior-period medical claims reserve development in the 2016 quarter. For the 2017 period, the Retail segment's benefit expense includes the beneficial effect of $339 million in favorable prior-period reserve development versus $379 million in the 2016 period. Prior-period medical claims reserve development decreased the Retail segment benefit ratio by approximately 50 basis points in the 2017 quarter versus approximately 70 basis points in the 2016 quarter. Favorable prior-period reserve development decreased the benefit ratio by approximately 100 basis points in the 2017 period versus approximately 120 basis points in the 2016 period.

Operating Costs

• The Retail segment operating cost ratio of 9.8% for the 2017 quarter decreased 80 basis points from 10.6% for the 2016 quarter. The Retail segment operating cost ratio of 8.9% for the 2017 period decreased 120 basis points from 10.1% for the 2016 period. These decreases primarily were due to the temporary suspension of the health insurance industry fee for calendar year 2017, partially offset by the increase in employee compensation costs resulting from the continued strong performance. The non-deductible health insurance industry fee impacted the operating cost ratio by 170 basis points in each of the 2016 quarter and the 2016 period.

Group and Specialty Segment

(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.

(in millions)

51

(in millions)

Pretax Results

• Group and Specialty segment pretax income was $93 million in the 2017 quarter, an increase of $56 million, or 151.4%, from $37 million in the 2016 quarter. This increase primarily reflects the impact of higher pretax earnings associated with our fully-insured commercial medical products. The Group and Specialty segment pretax income was $365 million in the 2017 period, an increase of $32 million from $333 million in the 2016 period. The increase primarily reflects the impact of higher pretax earnings associated with our fully-insured commercial medical products, partially offset by the impact of the timing of revenues under our TRICARE contract primarily relating to medical cost trend incentives and amounts for additional services requested under the contract.

Enrollment

• Fully-insured commercial group medical membership decreased 32,700 members, or 2.9%, from September 30, 2016 to September 30, 2017 reflecting lower membership in small group accounts due in part to more small group accounts selecting ASO products in 2017.
• Group ASO commercial medical membership decreased 124,600 members, or 21.8%, from September 30, 2016 to September 30, 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 more small group accounts selecting ASO products in 2017.
• Specialty membership decreased 21,200 members, or 0.3%, from September 30, 2016 to September 30, 2017 primarily due to declines in other supplemental benefits membership, as well as a decline in dental ASO membership due to terminations of several large group accounts. Other supplemental benefits include life, disability, and fixed benefit products including cancer and critical illness policies.

Premiums Revenue

• Group and Specialty segment premiums increased $31 million, or 1.9%, from the 2016 quarter to $1.7 billion for the 2017 quarter and increased $61 million, or 1.2%, from the 2016 period to $5.1 billion for the 2017 period. These increases primarily were due to an increase in group fully-insured commercial medical per-member premiums, partially offset by a decline in average group fully-insured commercial medical membership.

Services Revenue

• Group and Specialty segment services revenue was relatively unchanged for the 2017 quarter, decreasing $7 million, or 4.8%, from the 2016 quarter. The Group and Specialty segment service revenue decreased $56 million, or 11.2%, from the 2016 period to $444 million for the 2017 period, primarily due to a decline in revenue in our group ASO commercial medical business mainly due to membership declines as well as due to the timing of revenue under our TRICARE contract.

Benefits Expense

• The Group and Specialty segment benefit ratio decreased 140 basis points from 81.0% in the 2016 quarter to 79.6% in the 2017 quarter primarily reflecting favorable utilization in the fully-insured commercial medical business and higher favorable prior-period medical claims reserve development, partially offset by 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. The Group and Specialty segment benefit ratio increased 60 basis points from 77.3% in the 2016 period to 77.9% in the 2017 period primarily due to 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, partially offset by lower utilization for the fully-insured commercial medical business in the 2017 period.
• The Group and Specialty segment benefits expense included $13 million in favorable prior-period medical claims reserve development in the 2017 quarter versus favorable prior-period medical claims reserve development of $3 million in the 2016 quarter. This favorable prior-period medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 80 basis points in the 2017 quarter and decreased the benefit ratio by 20 basis points in the 2016 quarter. The Group and Specialty segment’s benefits expense included the beneficial effect of a favorable prior-period medical claims reserve development of $44 million in the 2017 period versus $41 million in the 2016 period. This favorable prior-period medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 90 basis points in the 2017 period and 80 basis points in the 2016 period.

Operating Costs

• The Group and Specialty segment operating cost ratio of 20.9% for the 2017 quarter decreased 220 basis points from 23.1% for the 2016 quarter. For the 2017 period, the Group and Specialty segment operating cost ratio of 21.3% decreased 180 basis points from 23.1% for the 2016 period. These decreases primarily were due to the temporary suspension of the health insurance industry fee for calendar year 2017 as well as operating cost efficiencies, partially offset by an increase in employee compensation costs resulting from the continued strong performance. The non-deductible health insurance industry fee impacted the operating cost ratio by 150 basis points in both the 2016 quarter and period.

Healthcare Services Segment

(in millions)

(in millions)

Pretax Results

• Healthcare Services segment pretax income of $240 million for the 2017 quarter decreased by $57 million, or 19.2%, from $297 million in the 2016 quarter. For the 2017 period, the Healthcare Services segment pretax income of $754 million decreased $74 million, or 8.9%, from $828 million in the 2016 period. These decreases primarily were due to the impact of the optimization process associated with our chronic care management

programs and increases in the operating cost ratio for both the 2017 quarter and period, as well as pressures in our provider services business reflecting lower Medicare rates year-over-year in geographies where our provider assets are primarily located for the 2017 period. The reductions in pharmacy solutions intersegment revenues were offset by similar reductions in operating costs associated with the pharmacy solutions business.

Script Volume

• Humana Pharmacy Solutions script volumes on an adjusted 30-day equivalent basis for Retail, Group and Specialty, and Individual Commercial segment membership increased to approximately 108 million in the 2017 quarter, up 1.2%, versus scripts of approximately 107 million in the 2016 quarter. For the 2017 period, script volumes for Retail, Group and Specialty, and Individual Commercial segment membership increased to approximately 323 million, up 2.1%, versus scripts of approximately 316 million in the 2016 period. These increases primarily reflected growth associated with higher Medicare membership for the 2017 quarter and 2017 period compared to the 2016 quarter and 2016 period, partially offset by the decline in Individual Commercial membership.

Services Revenues

• Services revenues increased $3 million, or 3.9%, from the 2016 quarter to $80 million for the 2017 quarter and increased $14 million, or 5.9%, from the 2016 period to $251 million for the 2017 period primarily due to service revenue growth from our pharmacy solutions business.

Intersegment Revenues

• Intersegment revenues decreased $410 million, or 6.5%, from the 2016 quarter to $5.9 billion for the 2017 quarter and decreased $1.0 billion, or 5.4%, from the 2016 period to $17.7 billion for the 2017 period primarily due to our pharmacy solutions business as well as the result of the optimization process associated with our chronic care management programs discussed previously, as well as ongoing pressures in our provider services business reflecting lower Medicare rates year-over-year in geographies where our provider assets are primarily located. 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, partially offset by the impact of lower Individual Commercial membership. Our generic dispensing rate improved to 91.2% and 91.3% during the 2017 quarter and 2017 period, respectively, compared to 90.4% and 90.3% during the 2016 quarter and 2016 period, respectively. 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 of 95.6% for the 2017 quarter increased 70 basis points from 94.9% for the 2016 quarter primarily due to the timing of the optimization process associated with our chronic conditions management programs and the increase in employee compensation costs resulting from the continued strong performance. As we optimize our chronic care management programs, operating cost reductions may lag the associated reduction in revenue, negatively impacting the operating cost ratio. For the 2017 period, the Healthcare Services segment operating cost ratio was relatively unchanged from the 2016 period.

Individual Commercial Segment

• As announced on February 14, 2017, we are exiting our Individual Commercial medical business commencing January 1, 2018.
• Individual Commercial segment pretax income of $26 million for the 2017 quarter increased $24 million from the 2016 quarter, primarily due to the exit of certain markets in 2017, and per-member premium increases. For the 2017 period, the Individual Commercial segment pretax income of $207 million increased $442 million from the 2016 period, primarily due to the same factors impacting the quarter in addition to the $208 million increase in the premium deficiency reserve recorded in the second quarter of 2016 related to certain of our 2016 policies.
• Individual commercial medical membership decreased 583,400 members, or 80.3%, from September 30, 2016 to September 30, 2017 reflecting the decline in the number of counties we offered on-exchange coverage and the discontinuance of offering off-exchange products.
• The benefit ratio for the Individual Commercial segment was 65.6% and 51.6% for the 2017 quarter and 2017 period, respectively, a significant decrease from 82.4% and 90.9% for the 2016 quarter and 2016 period, respectively. The year-over-year declines primarily resulted from the impact from planned exits in 2017 in certain markets that carried a higher benefit ratio, and per-member premium increases. The 2017 period was also impacted by the effect of the $208 million increase in the 2016 premium deficiency reserve recorded in the second quarter of 2016 related to certain of our 2016 policies.
• The operating cost ratio for the Individual Commercial segment was 21.9% in the 2017 quarter, an increase of 560 basis points from 16.3% in the 2016 quarter. The Individual Commercial segment operating cost ratio of 20.0% for the 2017 period increased 340 basis points from 16.6% in the 2016 period. These increases are primarily due to the loss of scale efficiency 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 nine months ended September 30, 2017, net collections under the 3Rs associated with prior coverage years were $307 million compared to $319 million during the nine months ended September 30, 2016. The remaining net receivable balance associated with the 3Rs was approximately $173 million at September 30, 2017, including $171 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 $171 million are expected to be collected during the fourth quarter of 2017 and first quarter of 2018. The remaining net receivable balance is primarily related to our Individual Commercial medical business which we are exiting commencing January 1, 2018. 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 $9.9 billion at September 30, 2017 from $3.9 billion at December 31, 2016. The change in cash and cash equivalents for the nine months ended September 30, 2017 and 2016 is summarized as follows:

(in millions)

Cash Flow from Operating Activities

Our operating cash flows for the 2017 period were significantly impacted by the receipt of the $1 billion Merger break-up fee, net of related expenses and the portion of taxes paid to date, and by the early receipt of the Medicare premium remittance for October 2017 of $3.1 billion in September 2017, as well as for October 2016 of $3.0 billion in September 2016, because the payment dates of October 1, 2017 and October 1, 2016 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 September 30, 2017. Excluding the Merger termination fee and the timing of the Medicare premium remittances, our operating cash flows were positively impacted by higher earnings and the timing of working capital items.

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 September 30, 2017 and December 31, 2016:

(in millions)

(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 September 30, 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 IBNR primarily driven by declines in individual commercial medical membership in the 2017 period, partially offset by an increase in group Medicare Advantage membership. The increase in benefits payable from December 31, 2015 to September 30, 2016 largely 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.

The detail of total net receivables was as follows at September 30, 2017 and December 31, 2016:

(in millions)

The changes in Medicare receivables for both the 2017 period and the 2016 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 mid-year and final settlements with CMS in the third quarter.

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 period, we received net collections of $307 million for the commercial 3Rs associated with prior coverage years as compared to net collections of $319 million in the 2016 period. The net receivable balance associated with the 3Rs was approximately $173 million at September 30, 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 $1.4 billion in the 2017 period and $132 million in the 2016 period.

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 $376 million in the 2017 period and $395 million in the 2016 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 $1.9 billion during the 2017 period and higher than claims payments by $404 million during the 2016 period. Our net payable for CMS subsidies and brand name prescription drug discounts was $1.1 billion at September 30, 2017 compared to a net receivable of $1.6 billion at September 30, 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 $22 million in the 2017 period and by $8 million in the 2016 period.

Claims payments associated with cost sharing provisions of the Health Care Reform Law for which we do not assume risk were $41 million higher than reimbursements from HHS during the 2017 period and $62 million higher than reimbursements from HHS during the 2016 period.

Under a share repurchase plan authorized by the Board of Directors, we repurchased 7.63 million shares for $1.7 billion in the 2017 period, including $1.5 billion under the February 2017 accelerated stock repurchase plan. 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 $79 million in the 2017 period and $75 million in the 2016 period.

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 paid as of March 31, 2017, were $991 million. We intend to use the net proceeds for general corporate purposes.

Net repayments of commercial paper were $153 million in the 2017 period and $1 million in the 2016 period. The maximum principal amount outstanding at any one time during the 2017 period was $500 million.

We paid dividends to stockholders of $162 million during the 2017 period and $133 million during the 2016 period, 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.

Divestitures

On November 6, 2017, we entered into a definitive agreement to sell the stock of our wholly-owned subsidiary, KMG America Corporation, or KMG, to Continental General Insurance Company, or CGIC, a Texas-based insurance company wholly owned by HC2 Holdings, Inc., a diversified holding company. KMG’s subsidiary, Kanawha Insurance Company, or KIC, includes our closed block of non-strategic commercial long-term care insurance policies. We will fund the transaction with approximately $203 million of parent company cash contributed into KMG, subject to customary adjustments, in addition to the transfer of approximately $150 million of statutory capital with the sale.

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 September 30, 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 $2.3 billion at September 30, 2017 compared to $2.0 billion at December 31, 2016. This increase primarily reflects the receipt of $1.4 billion of subsidiary dividends, the receipt of the Merger termination fee, net of related expenses, and the net proceeds associated with the issuance of senior notes in March 2017, partially offset by the payment of $1.7 billion for our share repurchase program, the capital contribution of $535 million to our long-term care subsidiary, as described below, dividends, capital expenditures and other insignificant items. 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 $231 million and $687 million for the three and nine months ended September 30, 2016, respectively, 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 June 30, 2017, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $7.3 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. The amount of dividends paid to our parent company was approximately $1.4 billion during the nine months ended September 30, 2017 compared to $663 million during the nine months ended September 30, 2016.

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 September 30, 2017. Our net unrealized position increased $198 million from a net unrealized loss position of $28 million at December 31, 2016 to a net unrealized gain position of $170 million at September 30, 2017. At September 30, 2017, we had gross unrealized losses of $82 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 nine months ended September 30, 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 September 30, 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 $700 million at September 30, 2017.

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 September 30, 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 September 30, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

There have been no changes to the risk factors included in our 2016 Form 10-K, other than as follows:

The divestiture of our subsidiary, KMG America Corporation, is subject to various closing conditions, including various regulatory approvals and customary closing conditions, as well as other uncertainties, and there can be no assurances as to whether and when it may be completed.

On November 6, 2017, we entered into a definitive agreement to sell the stock of our wholly-owned subsidiary, KMG America Corporation, or KMG, to Continental General Insurance Company, or CGIC, a Texas-based insurance company wholly owned by HC2 Holdings, Inc., a diversified holding company. KMG’s subsidiary, Kanawha Insurance Company, or KIC, includes our closed block of non-strategic commercial long-term care insurance policies that serves approximately 30,100 policyholders. Consummation of the divestiture involves certain risks, including, among other things, the timing to consummate the divestiture, the risk that a condition to closing of the divestiture may not be satisfied, the risk that required regulatory approvals for the divestiture are not obtained, are delayed or are subject to conditions that are not anticipated, the risk that we may not recognize all or a portion of the expected tax benefits from the divestiture, and the risk of indemnification exposure under the contractual agreements to effect the divestiture.