# Humana Inc: Form 10-Q for the period ended Mar 31, 2018

- Company: [Humana Inc](/companies/hum.md) (CIK 49071)
- Form: 10-Q
- Filed: 2018-05-02
- Accepted by EDGAR: May 2, 2018, 13:09 ET
- Period: 2018-03-31
- Accession: 0000049071-18-000062
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/49071/000004907118000062/hum-20180331x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/49071/000004907118000062/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2018-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2018-01-01 to 2018-03-31 | $14.28bn | us-gaap:Revenues |
| Selling, general and administrative | 3 months, 2018-01-01 to 2018-03-31 | $1.75bn | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2018-01-01 to 2018-03-31 | $760.0m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2018-01-01 to 2018-03-31 | $53.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2018-01-01 to 2018-03-31 | $216.0m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2018-01-01 to 2018-03-31 | $491.0m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2018-01-01 to 2018-03-31 | $3.53 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2018-01-01 to 2018-03-31 | $3.56 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2018-01-01 to 2018-03-31 | 138,830,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2018-01-01 to 2018-03-31 | $3.69bn | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2018-01-01 to 2018-03-31 | $134.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2018-01-01 to 2018-03-31 | $57.0m | us-gaap:PaymentsOfDividends |
| Share repurchases | 3 months, 2018-01-01 to 2018-03-31 | $51.0m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2018-03-31 | $8.86bn | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2018-03-31 | $23.93bn | us-gaap:AssetsCurrent |
| Total assets | at 2018-03-31 | $33.45bn | us-gaap:Assets |
| Current liabilities | at 2018-03-31 | $15.46bn | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2018-03-31 | $23.37bn | us-gaap:Liabilities |
| Long-term debt | at 2018-03-31 | $4.77bn | us-gaap:LongTermDebtNoncurrent |
| Short-term borrowings | at 2018-03-31 | $398.0m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2018-03-31 | $10.08bn | us-gaap:StockholdersEquity |
| Shares outstanding | at 2018-03-31 | 137,682,171 shares | dei:EntityCommonStockSharesOutstanding |

## Management's discussion and analysis

As filed, 67,844 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 2017 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 16, 2018, 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, Kentucky, is a leading health and well-being company 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.

### Aetna Merger

On February 16, 2017, under the terms of the Merger Agreement with Aetna, we received a breakup fee of $1 billion from Aetna, which is included in our consolidated statement of income in the line captioned "Merger termination fee and related costs, net."

### Acquisitions and Divestitures

On April 10, 2018, we acquired FPG for cash considerations of approximately $190 million. FPG is one of the largest at-risk providers serving Medicare Advantage and Managed Medicaid HMO patients in Greater Orlando, Florida with a footprint that includes clinics located in Lake, Orange, Osceola and Seminole counties. The acquisition of FPG advances our strategy of helping physicians and clinicians evolve from treating health episodically to managing health holistically. This acquisition is not expected to have a material impact on our results of operations, financial condition, or cash flows.

On March 1, 2018 we acquired the remaining equity interest in MCCI, a privately held management service organization headquartered in Miami, Florida, that primarily coordinates medical care for Medicare Advantage beneficiaries in Florida and Texas. The purchase price consisted primarily of $169 million cash, as well as our existing investment in MCCI and a note receivable and a revolving note with an aggregate balance of $383 million. This resulted in a preliminary purchase price allocation to goodwill of $479 million, other intangible assets of $80 million, and net tangible assets of $27 million.

On December 19, 2017, we announced that we entered into a definitive agreement to acquire a 40% minority interest in Kindred at Home for estimated cash consideration of approximately $800 million, including our share of transaction and related expenses, to facilitate a complete separation from the Long Term Acute Care and Rehabilitation businesses (the Specialty Hospital company).

On April 23, 2018, we announced that we entered into a definitive agreement to acquire a 40% minority interest in Curo, one of the nations' leading hospice operators providing care to patients at 245 locations in 22 states. Upon the closing, we intend to merge Curo with the hospice business of Kindred at Home.

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.

These transactions are more fully discussed in Note 1 and Note 3 to the condensed consolidated financial statements.

### 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 impacted approximately 3,600 associates, or 7.8%, of our workforce in 2017. As a result, we recorded charges of $148 million, or $0.64 per diluted common share. At December 31, 2017, $140 million was classified as a current liability, included in our condensed consolidated balance sheet in the trade accounts payable and accrued expenses line. Payments under these programs are being made upon termination during the early retirement or severance pay period. The remaining workforce optimization liability at March 31, 2018 was $94 million and is expected to be paid in 2018.

### Business Segments

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 T2017 East 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, such as home health and other services and capabilities to promote wellness and advance population health. The Individual Commercial segment consisted 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.

### 2018 Highlights

#### Consolidated

- Our consolidated pretax results of $707 million for the three months ended March 31, 2018 as compared to $1.7 billion for the three months ended March 31, 2017 were primarily impacted by the net gain associated with the terminated Merger Agreement, mainly the break-up fee, that was recorded in the three months ended March 31, 2017, and lower year-over-year pretax earnings in the Retail and Healthcare Services segments, partially offset by higher Group and Specialty segment pretax earnings. The year-over-year comparison was further impacted by the guaranty fund assessment expense to support policyholder obligations of Penn Treaty, an unaffiliated long-term care insurance company, recorded in the three months ended March 31, 2017.
- Year-over-year comparisons of diluted earnings per common share are favorably impacted by a lower number of shares used to compute earnings per commons share reflecting the impact of share repurchases and the impact of a lower tax rate for the three months ended March 31, 2018.
- Our 2018 results through March 31, 2018 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, 2018, approximately 1,959,400 members, or 64.9%, of our individual Medicare Advantage members were in value-based relationships under our integrated care delivery model, as compared to 1,901,300 members, or 66.5%, at December 31, 2017 and 1,827,600 members, or 64.4%, at March 31, 2017.

- The annual health insurance industry fee was suspended for calendar year 2017, but has resumed in 2018. Operating costs associated with the health insurer fee attributable to the three months ended March 31, 2018 was $263 million. This fee is not deductible for tax purposes, which 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.
- The 2018 quarter includes pretax income from our Individual Commercial business of $53 million, or $0.29 per diluted common share compared to $63 million, or 0.27 per diluted common share, included in the 2017 quarter.
- The 2018 quarter also includes an adjustment to provisional remeasurement of deferred taxes related to rate change from the tax reform law enacted on December 22, 2017 of $6.6 million, or $0.05 per diluted common share.
- 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. 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.
- 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, 2018, cash flow provided by operations was $3.7 billion as compared to $4.2 billion for the three months ended March 31, 2017. Our operating cash flows for the three months ended March 31, 2017 were significantly impacted by the receipt of the $1 billion Merger termination fee, net of related expenses. Our operating cash flows were also significantly impacted in both periods by the early receipt of the Medicare premium remittance for April 2018 of $3.3 billion in March 2018 and the receipt of the Medicare premium remittance for April 2017 of $3.1 billion in March 2017 because the payment dates of April 2018 and April 2017 fell on a weekend. Excluding the Merger termination fee and the timing of the Medicare premium remittances, our operating cash flows were 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 2, 2018, the Centers for Medicare and Medicaid Services (CMS) issued its announcement of 2019 Medicare Advantage Capitation Rates and Medicare Advantage and Part D Payment Policies and Final Call Letter (the Final Rate Notice). The company expects the Final Rate Notice to result in a 3% rate increase for Humana’s individual Medicare Advantage business versus CMS’ estimate for the sector of 3.5%, excluding the impact of Employer Group Waiver Plan (EGWP) funding changes, on a comparable basis. The difference between Humana and CMS projections primarily results from the geographic distribution of our members relative to the national average. In addition, the Final Rate Notice clarified that CMS has the authority to permit MA organizations to offer tailored supplemental benefits with flexibilities to target the social determinants of health as recommended by a licensed medical professional. We expect that this additional flexibility will allow us to include supplemental benefits that we believe will improve health outcomes for our members.
- On April 24, 2018, we received a Notice of Intent to be Awarded a Comprehensive Medicaid Contract under Florida’s Statewide Managed Medicaid Program in 10 of 11 regions, including the South Florida, Tampa, Jacksonville, and Orlando metro areas. The comprehensive program combines the traditional Medicaid, or TANF, and Long-Term Care programs.

#### Group and Specialty Segment

- The T2017 East Region contract is a consolidation of the former T3 North and South Regions, comprising thirty-two states and approximately six million TRICARE beneficiaries, under which delivery of health care services commenced on January 1, 2018. The T2017 East Region contract is a 5-year contract set to expire on December 31, 2022 and is subject to renewals on January 1 of each year during its term at the government's option. During 2017, we delivered services under the 5-year T3 South Region contract, which expired on December 31, 2017.

#### Healthcare Services Segment

- Medicare Advantage and dual demonstration program membership enrolled in a Humana chronic care management program was 752,400 at March 31, 2018, a decrease of 27.3% from 1,035,300 at March 31, 2017, and 5.3% from 794,900 at December 31, 2017. We have undergone an optimization process that ensures the appropriate level of member interaction with clinicians, including moving members into a monitoring program as their needs change, and graduating them out of the care management program when they no longer benefit from the services. This drives 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. The annual health insurance industry fee levied on the insurance industry is $14.3 billion in 2018 and is not deductible for income tax purposes, which significantly increases our effective income tax rate. A one year suspension in 2017 and 2019 of the health insurer fee significantly impacts our trend in key operating metrics including our operating cost and medical expense ratios, as well as our effective tax rate.

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. Although we previously participated in these exchanges by offering on-exchange individual commercial medical plans, effective January 1, 2018, we have exited our Individual Commercial medical business.

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 the Health Care Reform Law, for years 2014, 2015 and 2016.

It is reasonably possible that the Health Care Reform Law and related regulations, as well as future legislative or regulatory changes, including restrictions on our ability to manage our provider network or otherwise operate our business, or restrictions on profitability, including by comparison of our Medicare Advantage profitability to our non-Medicare Advantage business profitability and a requirement that they remain within certain ranges of each other, in the aggregate may have a material adverse effect on our results of operations (including restricting revenue, enrollment and premium growth in certain products and market segments, restricting our ability to expand into new markets, increasing our medical and operating costs, further lowering our Medicare payment rates and increasing our expenses associated with the non-deductible health insurance industry fee and other assessments); our financial position (including our ability to maintain the value of our goodwill); and our cash flows.

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 2018 and 2017

The following discussion primarily deals with our results of operations for the three months ended March 31, 2018, or the 2018 quarter, and the three months ended March 31, 2017, or the 2017 quarter.

### Consolidated

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

| Revenues: Premiums: | For the three months ended March 31, 2018 | 2017 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Retail | $12,068 | $11,406 | $662 | 5.8% |
| Group and Specialty | 1,739 | 1,700 | 39 | 2.3% |
| Individual Commercial | (5) | 283 | (288) | (101.8)% |
| Other Businesses | 9 | 9 | — | —% |
| Total premiums | 13,811 | 13,398 | 413 | 3.1% |
| Services: |  |  |  |  |
| Retail | 2 | 2 | — | —% |
| Group and Specialty | 219 | 161 | 58 | 36.0% |
| Healthcare Services | 104 | 88 | 16 | 18.2% |
| Other Businesses | 2 | 2 | — | —% |
| Total services | 327 | 253 | 74 | 29.2% |
| Investment income | 141 | 111 | 30 | 27.0% |
| Total revenues | 14,279 | 13,762 | 517 | 3.8% |
| Operating expenses: |  |  |  |  |
| Benefits | 11,670 | 11,326 | 344 | 3.0% |
| Operating costs | 1,749 | 1,553 | 196 | 12.6% |
| Merger termination fee and related costs, net | — | (947) | 947 | 100.0% |
| Depreciation and amortization | 100 | 92 | 8 | 8.7% |
| Total operating expenses | 13,519 | 12,024 | 1,495 | 12.4% |
| Income from operations | 760 | 1,738 | (978) | (56.3)% |
| Interest expense | 53 | 49 | 4 | 8.2% |
| Income before income taxes | 707 | 1,689 | (982) | (58.1)% |
| Provision for income taxes | 216 | 574 | (358) | (62.4)% |
| Net income | $491 | $1,115 | $(624) | (56.0)% |
| Diluted earnings per common share | $3.53 | $7.49 | $(3.96) | (52.9)% |
| Benefit ratio (a) | 84.5% | 84.5% |  | —% |
| Operating cost ratio (b) | 12.4% | 11.4% |  | 1.0% |
| Effective tax rate | 30.7% | 34.0% |  | (3.3)% |

(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 $491 million, or $3.53 per diluted common share, in the 2018 quarter compared to $1.1 billion, or $7.49 per diluted common share, in the 2017 quarter. This comparison was impacted by the Merger Agreement break-up fee, the suspension of the health insurance industry fee for calendar year 2017, the estimated guaranty fund assessment expense to support the policy holders obligations of Penn treaty, the exit of the Individual Commercial business effective January 1, 2018, and the Tax Reform Law as previously described. Excluding the impact of the items above, the year-over-year comparison primarily was due to lower earnings in the Retail and Healthcare Services segments, partially offset by higher Group and Specialty segment earnings.

#### Premiums Revenue

Consolidated premiums increased $413 million, or 3.1%, from the 2017 quarter to $13.8 billion for the 2018 quarter primarily due to higher premiums in the Retail segment, mainly resulting from our Medicare Advantage business, and the Group and Specialty segment. These items were partially offset by lower premiums resulting from the exit of the Individual Commercial business.

#### Services Revenue

Consolidated services revenue increased $74 million, or 29.2%, from the 2017 quarter to $327 million for the 2018 quarter primarily due to an increase in services revenue in the Group and Specialty segment as discussed in the detailed segment results discussion that follows.

#### Investment Income

Investment income totaled $141 million for the 2018 quarter, increasing $30 million, or 27.0% , from $111 million in the 2017 quarter primarily reflecting higher average invested balances, interest rates, and realized capital gains.

#### Benefits Expense

Consolidated benefits expense was $11.7 billion for the 2018 quarter, an increase of $344 million from the 2017 quarter, primarily due to an increase in the Retail segment benefits expense, partially offset by a decrease in the Individual Commercial and Group and Specialty segment benefits expense. We experienced favorable medical claims reserve development related to prior fiscal years of $267 million in the 2018 quarter as compared to $231 million in the 2017 quarter as discussed in the detailed segment results discussion that follows.

The consolidated benefit ratio was unchanged at 84.5% for the 2018 quarter compared to the 2017 quarter. The year-over-year comparison was favorably impacted by the reinstatement of the health insurance industry fee in 2018, which was contemplated in the pricing and benefit design of the company’s products, the seasonality and product design of our fully-insured commercial products, including an increased number of high deductible plan offerings, and higher favorable prior-period reserve development in the 2018 quarter. Favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 190 basis points in the 2018 quarter versus approximately 170 basis points in the 2017 quarter. These items were partially offset by investment of higher than initially expected individual Medicare Advantage pretax earnings in 2017 into our benefit design for its 2018 Medicare Advantage offerings, and a more severe flu season year-over-year.

#### 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 increased $196 million, or 12.6%, during the 2018 quarter compared to the 2017 quarter primarily due to an increase in operating costs in the Retail and Group and Specialty segments, partially offset by a decrease in operating costs in the Healthcare Services and Individual Commercial segments.

The consolidated operating cost ratio for the 2018 quarter of 12.4% increased 100 basis points from the 2017 quarter primarily due to the reinstatement of the health insurance industry fee in 2018, and long-term sustainability investments in the 2018 quarter as a result of the Tax Reform Law. Our long-term sustainability investments include investments in our associate workforce, primarily the establishment of an annual incentive program for a broader range of employees, together with additional investments in the communities of our members, technology and our integrated delivery model. These items were partially offset by the favorable impact of significant operating cost efficiencies in the 2018 quarter driven by productivity initiatives implemented in 2017, the impact of the guaranty fund assessment expense to support policy holder obligations of Penn Treaty in the 2017 quarter, and the exit of the Individual Commercial business effective January 1, 2018. The non-deductible health insurance industry fee impacted the operating cost ratio by 190 basis points in the 2018 quarter.

#### Depreciation and Amortization

Depreciation and amortization for the 2018 quarter totaled $100 million compared to $92 million for the 2017 quarter.

#### Interest Expense

Interest expense for the 2018 quarter totaled $53 million, compared to $49 million for the 2017 quarter.

#### Income Taxes

Our effective tax rate during the 2018 quarter was 30.7% compared to the effective tax rate of 34.0% for the 2017 quarter, primarily due to the Tax Reform Law primarily due to the Tax Reform Law, partially offset by the impact of the reinstatement of the non-deductible health insurance industry fee in 2018. The income tax rate for the three months ended March 31, 2017 included previously non-deductible transaction costs that, as a result of the termination of the Merger Agreement, became deductible for tax purposes. The Tax Reform Law reduced the statutory federal corporate income tax rate to 21 percent from 35 percent, beginning in 2018. The accounting for certain income tax effects of the Tax Reform Law is provisional. Revisions to prior estimates are recorded as additional analysis is completed using information available at each measurement date during 2018, with adjustments to the income tax provision recorded as new information becomes known. Revisions to our prior estimates for the income tax effects of the Tax Reform Law decreased our tax expense for the three months ended March 31, 2018 by $6.6 million.

### Retail Segment

| Membership: Medical membership: | March 31, 2018 | 2017 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | 3,018,500 | 2,839,700 | 178,800 | 6.3% |
| Group Medicare Advantage | 492,700 | 431,100 | 61,600 | 14.3% |
| Medicare stand-alone PDP | 5,042,100 | 5,199,400 | (157,300) | (3.0)% |
| Total Retail Medicare | 8,553,300 | 8,470,200 | 83,100 | 1.0% |
| State-based Medicaid | 336,000 | 380,400 | (44,400) | (11.7)% |
| Medicare Supplement | 238,700 | 231,400 | 7,300 | 3.2% |
| Total Retail medical members | 9,128,000 | 9,082,000 | 46,000 | 0.5% |

40

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the three months ended March 31, 2018 | 2017 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | $8,970 | $8,376 | $594 | 7.1% |
| Group Medicare Advantage | 1,524 | 1,318 | 206 | 15.6% |
| Medicare stand-alone PDP | 896 | 941 | (45) | (4.8)% |
| Total Retail Medicare | 11,390 | 10,635 | 755 | 7.1% |
| State-based Medicaid | 553 | 653 | (100) | (15.3)% |
| Medicare Supplement | 125 | 118 | 7 | 5.9% |
| Total premiums | 12,068 | 11,406 | 662 | 5.8% |
| Services | 2 | 2 | — | —% |
| Total premiums and services revenue | $12,070 | $11,408 | $662 | 5.8% |
| **Income before income taxes** | $267 | $370 | $(103) | (27.8)% |
| Benefit ratio | 87.4% | 88.1% |  | (0.7)% |
| Operating cost ratio | 10.1% | 8.4% |  | 1.7% |

#### Pretax Results

- Retail segment pretax income was $267 million in the 2018 quarter, a decrease of $103 million, or 27.8%, compared to $370 million in the 2017 quarter, primarily due to the result of investment in benefit design for 2018 Medicare Advantage offerings further discussed below, investments made in the 2018 quarter as a result of the Tax Reform Law as previously described, lower favorable prior-period reserve development, and a more severe flu season year-over-year. These items were partially offset by the significant operating cost efficiencies further discussed below.

#### Enrollment

- Individual Medicare Advantage membership increased 178,800 members, or 6.3%, from March 31, 2017 to March 31, 2018, primarily due to membership additions associated with the most recent Annual Election Period, or AEP, for Medicare beneficiaries.
- Group Medicare Advantage membership increased 61,600, or 14.3%, from March 31, 2017 to March 31, 2018 , primarily due to increased sales to our existing group accounts during the most recent AEP for Medicare beneficiaries.
- Medicare stand-alone PDP membership decreased 157,300 members, or 3.0%, from March 31, 2017 to March 31, 2018 reflecting net declines during the most recent AEP for Medicare beneficiaries.These declines primarily resulted from the previously disclosed loss of auto assigned members in Florida and South Carolina due to pricing over CMS low income benchmark and continued membership declines in our Enhanced Plan. In addition, growth in our co-branded Walmart plan was significantly lower than historic levels due to the introduction of additional low-priced competitor offerings in many regions.
- State-based Medicaid membership decreased 44,400 members, or 11.7%, from March 31, 2017 to March 31, 2018, primarily driven by the previously disclosed decision to not participate in Illinois' Integrated Program Medicaid contract, along with lower membership associated with our Florida contract due to overall strengthening economic conditions.

#### Premiums Revenue

- Retail segment premiums increased $662 million, or 5.8%, from the 2017 quarter to the 2018 quarter primarily due to individual and group Medicare Advantage membership growth in the most recent AEP as well as increased per-member premiums for certain products within the segment, partially offset by declines in the stand-alone PDP and state-based contracts revenues resulting from membership declines discussed above. Average group and individual Medicare Advantage membership increased 7.4% for the 2018 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 70 basis points from 88.1% in the 2017 quarter to 87.4% in the 2018 quarter, primarily due to the reinstatement of the health insurance industry fee in 2018 which was contemplated in the pricing and benefit design of our products. This was partially offset by the unfavorable impact from investment of higher than initially expected individual Medicare Advantage pretax earnings in 2017 into our benefit design for our 2018 Medicare Advantage offerings, lower favorable prior-period reserve development, and a more severe flu season year-over-year.
- The Retail segment’s benefits expense for the 2018 quarter included $187 million in favorable prior-period medical claims reserve development versus $204 million in the 2017 quarter. Prior-period medical claims reserve development decreased the Retail segment benefit ratio by approximately 150 basis points in the 2018 quarter versus approximately 180 basis points in the 2017 quarter.

#### Operating Costs

- The Retail segment operating cost ratio of 10.1% for the 2018 quarter increased 170 basis points from 8.4% for the 2017 quarter. The year-over-year comparison was negatively impacted by the reinstatement of the health insurance industry fee in 2018, and investments made in the 2018 quarter as a result of the Tax Reform Law. These items were partially offset by significant operating cost efficiencies in the 2018 quarter driven by productivity initiatives implemented in 2017. The non-deductible health insurance industry fee impacted the operating cost ratio by 190 basis points in the 2018 quarter.

### Group and Specialty Segment

| Membership: Medical membership: | March 31, 2018 | 2017 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | 1,075,100 | 1,119,400 | (44,300) | (4.0)% |
| ASO | 452,600 | 447,000 | 5,600 | 1.3% |
| Military services | 5,931,100 | 3,082,800 | 2,848,300 | 92.4% |
| Total group and specialty medical members | 7,458,800 | 4,649,200 | 2,809,600 | 60.4% |
| Specialty membership (a) | 6,738,900 | 6,921,800 | (182,900) | (2.6)% |

(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)*

| Premiums and Services Revenue: Premiums: | For the three months ended March 31, 2017 | 2016 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | $1,392 | $1,378 | $14 | 1.0% |
| Group specialty | 347 | 322 | 25 | 7.8% |
| Total premiums | 1,739 | 1,700 | 39 | 2.3% |
| Services | 219 | 161 | 58 | 36.0% |
| Total premiums and services revenue | $1,958 | $1,861 | $97 | 5.2% |
| **Income before income taxes** | $211 | $171 | $40 | 23.4% |
| Benefit ratio | 73.2% | 75.6% |  | (2.4)% |
| Operating cost ratio | 23.6% | 21.4% |  | 2.2% |

#### Pretax Results

- Group and Specialty segment pretax income was $211 million in the 2018 quarter, an increase of $40 million or 23.4%, from $171 million in the 2017 quarter, primarily due to higher pretax earnings from our fully insured commercial medical business.

#### Enrollment

- Fully-insured commercial group medical membership decreased 44,300 members, or 4.0%, from March 31, 2017 to March 31, 2018 reflecting lower membership in small group accounts due in part to more small group accounts continuing to select level funded ASO products in 2018.
- Group ASO commercial medical membership increased 5,600 members, or 1.3%, from March 31, 2017 to March 31, 2018 reflecting more small group accounts selecting level-funded ASO products in 2018, partially offset by 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.
- Military services membership increased 2,848,300 members, or 92.4%, from March 31, 2017 to March 31, 2018 primarily due to our transition to providing healthcare services to military service members, retirees, and their families under the new T2017 East Region contract covering 32 states, which became effective January 1, 2018.
- Specialty membership decreased 182,900 members, or 2.6%, from March 31, 2017 to March 31, 2018 primarily due to the losses of some large group accounts offering stand-alone dental and vision products, partially offset by an increase in individual dental and vision membership.

#### Premiums Revenue

- Group and Specialty segment premiums increased $39 million, or 2.3%, from the 2017 quarter to $1.7 billion for the 2018 quarter primarily reflecting higher stop-loss premiums related to our small group level funded accounts, and higher per-member premiums across most lines of business in the segment, partially offset by declines in average group fully-insured and ASO commercial medical membership.

#### Services Revenue

- Group and Specialty segment services revenue increased $58 million, or 36.0%, from the 2017 quarter to $219 million for the 2018 quarter as a result of the transition to the TRICARE T2017 East Region contract on January 1, 2018.

#### Benefits Expense

- The Group and Specialty segment benefit ratio decreased 240 basis points from 75.6% in the 2017 quarter to 73.2% in the 2018 quarter primarily due to the impact of the reinstatement of the health insurance industry fee in 2018 which was contemplated in the pricing of our products, the seasonality and product design of our fully-insured commercial products, including increased number of high deductible plan offerings, and higher favorable prior-period reserve development.
- The Group and Specialty segment's benefits expense included $34 million in favorable prior-period medical claims reserve development in the 2018 quarter and $20 million in the 2017 quarter. This favorable prior-period medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 200 basis points in the 2018 quarter and 120 basis points in the 2017 quarter.

#### Operating Costs

- The Group and Specialty segment operating cost ratio of 23.6% for the 2018 quarter increased 220 basis points from 21.4% for the 2017 quarter primarily due to the reinstatement of the health insurance industry fee in 2018, growth in our military services business, which carries a higher operating cost ratio than other products within the segment, as a result of the transition to the TRICARE T2017 East Region contract, and investments made in the 2018 quarter as a result of the Tax Reform Law as previously described. These items were partially offset by significant operating cost efficiencies in the 2018 quarter driven by productivity initiatives implemented in 2017. The non-deductible health insurance industry fee impacted the operating cost ratio by 160 basis points in the 2018 quarter.

### Healthcare Services Segment

*(in millions)*

| Revenues: Services: | For the three months ended March 31, 2018 | 2017 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Clinical care services | $44 | $50 | $(6) | (12.0)% |
| Pharmacy solutions | 39 | 18 | 21 | 116.7% |
| Provider services | 21 | 20 | 1 | 5.0% |
| Total services revenues | 104 | 88 | 16 | 18.2% |
| Intersegment revenues: |  |  |  |  |
| Pharmacy solutions | 4,995 | 5,141 | (146) | (2.8)% |
| Provider services | 378 | 418 | (40) | (9.6)% |
| Clinical care services | 180 | 303 | (123) | (40.6)% |
| Total intersegment revenues | 5,553 | 5,862 | (309) | (5.3)% |
| Total services and intersegment revenues | $5,657 | $5,950 | $(293) | (4.9)% |
| **Income before income taxes** | $173 | $244 | $(71) | (29.1)% |
| Operating cost ratio | 96.2% | 95.5% |  | 0.7% |

#### Pretax Results

- Healthcare Services segment pretax income of $173 million for the 2018 quarter decreased $71 million, or 29.1%, from $244 million in the 2017 quarter primarily due to the impact of the optimization process associated with our chronic care management programs, as well as the investments made in the 2018 quarter as a result of the Tax Reform Law as previously described.

#### Script Volume

- Humana Pharmacy Solutions script volumes on an adjusted 30-day equivalent basis increased to approximately 108 million in the 2018 quarter, up 0.9%, versus scripts of approximately 107 million in the 2017 quarter. This increase primarily reflected growth associated with higher individual Medicare Advantage membership for the 2018 quarter compared to the 2017 quarter, partially offset by the decline in stand-alone PDP and Individual Commercial membership.

#### Services Revenues

- Services revenues increased $16 million, or 18.2%, from the 2017 quarter to $104 million for the 2018 quarter primarily due to service revenue growth from our pharmacy solutions business.

#### Intersegment Revenues

- Intersegment revenues decreased $309 million, or 5.3%, from the 2017 quarter to $5.6 billion for the 2018 quarter primarily due to the loss of intersegment revenues associated with our exit from the Individual commercial business, and a decline in pharmacy solutions revenue year-over-year primarily due to lower stand-alone PDP membership as a result of the previously disclosed loss of auto assigned members in Florida and South Carolina resulting from pricing over the CMS low income benchmark and continued membership declines in our Enhanced product. In addition, the year-over-year comparison was impacted by the result of the optimization process associated with our chronic care management programs previously discussed, and lower revenue in our provider services business reflecting Medicare rates year-over-year in geographies where

our provider assets are primarily located. These declines were partially offset by Medicare Advantage membership growth in the 2018 quarter.

#### Operating Costs

- The Healthcare Services segment operating cost ratio of 96.2% for the 2018 quarter increased 70 basis points from 95.5% for the 2017 quarter primarily due to the timing of the optimization process associated with our chronic conditions management programs and the long-term sustainability investments in the 2018 quarter as a result of the Tax Reform Law. With the optimization of our chronic care management programs, operating cost reductions may lag the associated reduction in revenue, negatively impacting the operating cost ratio. These items were partially offset by significant operating cost efficiencies in the 2018 quarter driven by productivity initiatives implemented in 2017.

### Individual Commercial Segment

- Individual Commercial segment pretax income of $53 million for the 2018 quarter decreased $10 million from the 2017 quarter. The pretax income in the 2018 quarter primarily reflects the impact of favorable prior-period reserve development.

### Liquidity

Historically, our primary sources of cash have included receipts of premiums, services revenue, and investment and other income, as well as proceeds from the sale or maturity of our investment securities, borrowings, and proceeds from sales of businesses. Our primary uses of cash historically have included disbursements for claims payments, operating costs, interest on borrowings, taxes, purchases of investment securities, acquisitions, capital expenditures, repayments on borrowings, dividends, and share repurchases. Because premiums generally are collected in advance of claim payments by a period of up to several months, our business normally should produce positive cash flows during periods of increasing premiums and enrollment. Conversely, cash flows would be negatively impacted during periods of decreasing premiums and enrollment. From period to period, our cash flows may also be affected by the timing of working capital items including premiums receivable, benefits payable, and other receivables and payables. Our cash flows are impacted by the timing of payments to and receipts from CMS associated with Medicare Part D subsidies for which we do not assume risk. The use of 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 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 have impacted 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, 2018, net collections under the 3Rs associated with prior coverage years were $46 million compared to $62 million during the three months ended March 31, 2017. The remaining net payable balance associated with the 3Rs was approximately $24 million at March 31, 2018, including $14 million related to prior coverage years, compared to a net receivable of $31 million at December 31, 2017. The remaining net payable balance is primarily related to our Individual Commercial medical business which we exited effective January 1, 2018. 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 the Health Care Reform Law, for years 2014, 2015 and 2016. There is no assurance, however, that we will prevail in this lawsuit.

For additional information on our liquidity risk, please refer to the section entitled “Risk Factors” in our 2017 Form 10-K.

Cash and cash equivalents increased to approximately $8.9 billion at March 31, 2018 from $4.0 billion at December 31, 2017. The change in cash and cash equivalents for the three months ended March 31, 2018 and 2017 is summarized as follows:

*(in millions)*

|  | Three Months Ended 2018 | 2017 |
| --- | ---: | ---: |
| Net cash provided by operating activities | $3,686 | $4,205 |
| Net cash used in investing activities | (405) | (926) |
| Net cash provided by financing activities | 1,532 | 1,269 |
| Increase in cash and cash equivalents | $4,813 | $4,548 |

### Cash Flow from Operating Activities

Our operating cash flows for the 2018 quarter and 2017 quarter were significantly impacted in both periods by the early receipt of the Medicare premium remittances of $3.3 billion in March 2018 and $3.1 billion in March 2017 because the payment dates of April 2018 and April 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, 2018. Our operating cash flows for the 2017 quarter were also significantly impacted by the receipt of the $1 billion Merger Agreement break-up fee. Excluding the Merger termination fee and the timing of the Medicare premium remittances, our operating cash flows were 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 March 31, 2018 and December 31, 2017:

*(in millions)*

|  | March 31, 2018 | December 31, 2017 | 2018 Quarter Change | 2017 Quarter Change |
| --- | ---: | ---: | ---: | ---: |
| IBNR (1) | $3,360 | $3,154 | $206 | $(25) |
| Reported claims in process (2) | 718 | 614 | 104 | (66) |
| Other benefits payable (3) | 883 | 900 | (17) | 289 |
| Total benefits payable | $4,961 | $4,668 | $293 | $198 |

(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). IBNR includes unprocessed claims inventories.

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

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

The increase in benefits payable from December 31, 2017 to March 31, 2018 primarily was due to an increase in IBNR, primarily as a result of Medicare Advantage membership growth as well as an increase in the amount of processed but unpaid claims, which fluctuate due to month-end cutoff. 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 detail of total net receivables was as follows at March 31, 2018 and December 31, 2017:

*(in millions)*

|  | March 31, 2018 | December 31, 2017 | 2018 Quarter Change | 2017 Quarter Change |
| --- | ---: | ---: | ---: | ---: |
| Medicare | $968 | $511 | $457 | $467 |
| Commercial and other | 246 | 273 | (27) | 64 |
| Military services | 149 | 166 | (17) | 22 |
| Allowance for doubtful accounts | (87) | (96) | 9 | 5 |
| Total net receivables | $1,276 | $854 | $422 | $558 |

The changes in Medicare receivables for both the 2018 quarter and the 2017 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 the second and third quarter.

### Cash Flow from Investing Activities

We reinvested a portion of our operating cash flows in investment securities, primarily investment-grade fixed income securities, totaling $102 million in the 2018 quarter and $797 million in the 2017 quarter.

On March 1, 2018 we acquired the remaining equity interest in MCCI, a privately held management service organization headquartered in Miami, Florida, that primarily coordinates medical care for Medicare Advantage beneficiaries in Florida and Texas. The purchase price included, in part, cash consideration of $169 million, as discussed in Note 3 to the condensed consolidated financial statements.

Our ongoing capital expenditures primarily relate to our information technology initiatives, support of services in our provider services operations including medical and administrative facility improvements necessary for activities such as the provision of care to members, claims processing, billing and collections, wellness solutions, care coordination, regulatory compliance and customer service. Total capital expenditures, excluding acquisitions, were $134 million in the 2018 quarter and $122 million in the 2017 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 $1.4 billion during the 2018 quarter and higher than claims payments by $1.7 billion during the 2017 quarter.

Under our administrative services only TRICARE contracts, health care cost payments for which we do not assume risk exceeded reimbursements from the federal government by $28 million in the 2018 quarter. In the 2017 quarter, reimbursements from the federal government exceeded health care cost payments for which we do not assume risk by $9 million.

Claims payments associated with cost sharing provisions of the Health Care Reform Law for which we do not assume risk were $16 million higher than reimbursements from HHS during the 2018 quarter and $3 million higher than reimbursements from HHS during the 2017 quarter.

On March 26, 2018 we completed the final settlement of our accelerated stock repurchase with no additional share repurchases under the current stock repurchase authorization during the 2018 quarter. We also acquired common shares in connection with employee stock plans for an aggregate cost of $51 million in the 2018 quarter and $74 million in the 2017 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 paid as of March 31, 2017, were $991 million.

Net proceeds from the issuance of commercial paper were $245 million in the 2018 quarter and $169 million in the 2017 quarter. The maximum principal amount outstanding at any one time during the 2018 quarter was $442 million.

We paid dividends to stockholders of $57 million during the 2018 quarter and $47 million during the 2017 quarter.

### 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.

### Acquisitions and Divestitures

On April 10, 2018, we acquired FPG for cash considerations of approximately $190 million. FPG is one of the largest at-risk providers serving Medicare Advantage and Managed Medicaid HMO patients in Greater Orlando, Florida with a footprint that includes clinics located in Lake, Orange, Osceola and Seminole counties. The acquisition of FPG advances our strategy of helping physicians and clinicians evolve from treating health episodically to managing health holistically. This acquisition is not expected to have a material impact on our results of operations, financial condition, or cash flows.

On March 1, 2018 we acquired the remaining equity interest in MCCI, a privately held management service organization headquartered in Miami, Florida, that primarily coordinates medical care for Medicare Advantage beneficiaries in Florida and Texas. The purchase price consisted primarily of $169 million cash, as well as our existing investment in MCCI and a note receivable and a revolving note with an aggregate balance of $383 million. This resulted in a preliminary purchase price allocation to goodwill of $479 million, other intangible assets of $80 million, and net tangible assets of $27 million.

On December 19, 2017, we announced that we entered into a definitive agreement to acquire a 40% minority interest in Kindred at Home for estimated cash consideration of approximately $800 million, including our share of transaction and related expenses, to facilitate a complete separation from the Long Term Acute Care and Rehabilitation businesses (the Specialty Hospital company). TPG and WCAS, collectively, the Sponsors, along with us are jointly creating a consortium to purchase all of the outstanding and issued securities of Kindred. The Kindred transaction, which is anticipated to close in the summer of 2018, is subject to customary state and federal regulatory approvals, as well as other customary closing conditions. On April 5, 2018, Kindred's stockholders approved the transaction. We expect to fund the transaction through the use of parent company cash and will account for the minority investment under the equity method.

On April 23, 2018, we, along with the same Kindred at Home Sponsors, TPG and WCAS entered into a definitive agreement to acquire privately held Curo, one of the nations' leading hospice operators providing care to patients at 245 locations in 22 states. The Consortium is purchasing Curo for approximately $1.4 billion, and at the closing of the transaction, we will have a 40% minority interest. The Curo transaction, which is anticipated to close during the summer of 2018, is subject to customary state and federal regulatory approvals as well as other customary closing conditions.

On November 6, 2017, we entered into a definitive agreement to sell the stock of our wholly-owned subsidiary, KMG, to CGIC, a Texas-based insurance company wholly owned by HC2 Holdings, Inc., a diversified holding company. KMG’s subsidiary, 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. 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.

### 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, 2018 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 $250 million of our senior notes. Successive one notch downgrades increase the interest rate an additional 25 basis points, or annual interest expense by less than $1 million, up to a maximum 100 basis points, or annual interest expense by $3 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 $567 million at March 31, 2018 compared to $688 million at December 31, 2017. This decrease primarily reflects the impact of capital contributions into a subsidiary to fund Medicare growth, as well as the acquisition of the remaining equity interest in MCCI for $169 million cash, dividends and capital expenditures partially offset by cash generated by our non-insurance subsidiaries and net proceeds from the issuance of commercial paper. 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).

In September 2018, we expect to pay the federal government $1.05 billion for our portion of the annual health insurance industry fee attributed to calendar year 2018 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 $263 million for the three months ended March 31, 2018 resulting from the amortization of the 2018 annual health insurance industry fee. The annual health insurance industry fee was suspended for calendar year 2017, and is also suspended for calendar year 2019.

### 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.

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, 2017, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $8.0 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 2018 is approximately $1.1 billion in the aggregate. This compares to dividends that were paid to our parent company in 2017 of approximately $1.4 billion. 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, 2,088 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, 2018. Our net unrealized position decreased $308 million from a net unrealized gain position of $198 million at December 31, 2017 to a net unrealized loss position of $110 million at March 31, 2018. At March 31, 2018, we had gross unrealized losses of $249 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, 2018. While we believe that these impairments are temporary and we currently do not have the intent to sell such securities, given the current market conditions and the significant judgments involved, there is a continuing risk that future declines in fair value may occur and material realized losses from sales or other-than-temporary impairments may be recorded in future periods.

Duration is the time-weighted average of the present value of the bond portfolio’s cash flow. Duration is indicative of the relationship between changes in fair value and changes in interest rates, providing a general indication of the sensitivity of the fair values of our fixed maturity securities to changes in interest rates. However, actual fair values may differ significantly from estimates based on duration. The average duration of our investment portfolio, including cash and cash equivalents, was approximately 4.0 years as of March 31, 2018 and approximately 4.1 years as of December 31, 2017. Based on the duration, including cash equivalents, a 1% increase in interest rates would generally decrease the fair value of our securities by approximately $650 million at March 31, 2018.

## 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, 2018.

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, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Filed May 2, 2018.
Source: SEC EDGAR, the filing index for accession 0000049071-18-000062. Last ingested by Listed: Nov 12, 2026, 20:28 ET. No prices; not investment advice.