# Humana Inc: Form 10-Q for the period ended Sep 30, 2018 - Company: [Humana Inc](/companies/hum.md) (CIK 49071) - Form: 10-Q - Filed: 2018-11-07 - Accepted by EDGAR: Nov 7, 2018, 16:21 ET - Period: 2018-09-30 - Accession: 0000049071-18-000123 - Inline XBRL: yes - Main document: https://www.sec.gov/Archives/edgar/data/49071/000004907118000123/hum-20180930x10q.htm - All documents and exhibits: https://www.sec.gov/Archives/edgar/data/49071/000004907118000123/ ## Figures reported in this filing Standardized XBRL line items for the period ended 2018-09-30. | Line item | Period | Value | XBRL concept | | --- | --- | ---: | --- | | Revenue | 3 months, 2018-07-01 to 2018-09-30 | $14.21bn | us-gaap:Revenues | | Revenue | 9 months, 2018-01-01 to 2018-09-30 | $42.74bn | us-gaap:Revenues | | Selling, general and administrative | 3 months, 2018-07-01 to 2018-09-30 | $1.90bn | us-gaap:SellingGeneralAndAdministrativeExpense | | Selling, general and administrative | 9 months, 2018-01-01 to 2018-09-30 | $5.41bn | us-gaap:SellingGeneralAndAdministrativeExpense | | Operating income | 3 months, 2018-07-01 to 2018-09-30 | $961.0m | us-gaap:OperatingIncomeLoss | | Operating income | 9 months, 2018-01-01 to 2018-09-30 | $2.58bn | us-gaap:OperatingIncomeLoss | | Interest expense | 3 months, 2018-07-01 to 2018-09-30 | $53.0m | us-gaap:InterestExpense | | Interest expense | 9 months, 2018-01-01 to 2018-09-30 | $159.0m | us-gaap:InterestExpense | | Income tax | 3 months, 2018-07-01 to 2018-09-30 | $266.0m | us-gaap:IncomeTaxExpenseBenefit | | Income tax | 9 months, 2018-01-01 to 2018-09-30 | $308.0m | us-gaap:IncomeTaxExpenseBenefit | | Net income | 3 months, 2018-07-01 to 2018-09-30 | $644.0m | us-gaap:NetIncomeLoss | | Net income | 9 months, 2018-01-01 to 2018-09-30 | $1.33bn | us-gaap:NetIncomeLoss | | Diluted EPS | 3 months, 2018-07-01 to 2018-09-30 | $4.65 | us-gaap:EarningsPerShareDiluted | | Diluted EPS | 9 months, 2018-01-01 to 2018-09-30 | $9.58 | us-gaap:EarningsPerShareDiluted | | Basic EPS | 3 months, 2018-07-01 to 2018-09-30 | $4.68 | us-gaap:EarningsPerShareBasic | | Basic EPS | 9 months, 2018-01-01 to 2018-09-30 | $9.64 | us-gaap:EarningsPerShareBasic | | Diluted shares (weighted) | 3 months, 2018-07-01 to 2018-09-30 | 138,678,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding | | Diluted shares (weighted) | 9 months, 2018-01-01 to 2018-09-30 | 138,695,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding | | Operating cash flow | 9 months, 2018-01-01 to 2018-09-30 | $2.51bn | us-gaap:NetCashProvidedByUsedInOperatingActivities | | Capital expenditure | 9 months, 2018-01-01 to 2018-09-30 | $436.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment | | Dividends paid | 9 months, 2018-01-01 to 2018-09-30 | $195.0m | us-gaap:PaymentsOfDividends | | Share repurchases | 9 months, 2018-01-01 to 2018-09-30 | $294.0m | us-gaap:PaymentsForRepurchaseOfCommonStock | | Cash and equivalents | at 2018-09-30 | $4.14bn | us-gaap:CashAndCashEquivalentsAtCarryingValue | | Current assets | at 2018-09-30 | $19.08bn | us-gaap:AssetsCurrent | | Total assets | at 2018-09-30 | $27.49bn | us-gaap:Assets | | Current liabilities | at 2018-09-30 | $11.32bn | us-gaap:LiabilitiesCurrent | | Total liabilities | at 2018-09-30 | $16.90bn | us-gaap:Liabilities | | Long-term debt | at 2018-09-30 | $4.77bn | us-gaap:LongTermDebtNoncurrent | | Short-term borrowings | at 2018-09-30 | $398.0m | us-gaap:ShortTermBorrowings | | Shareholders' equity | at 2018-09-30 | $10.59bn | us-gaap:StockholdersEquity | | Shares outstanding | at 2018-09-30 | 137,186,880 shares | dei:EntityCommonStockSharesOutstanding | ## Management's discussion and analysis As filed, 77,343 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 In the third quarter of 2018, we completed the sale of our wholly-owned subsidiary KMG to CGIC. Upon closing, we funded the transaction with approximately $190 million of parent company cash contributed into KMG, subject to customary adjustments, in addition to the transfer of approximately $160 million of statutory capital with the sale. On July 2, 2018 and July 11, 2018, the Consortium completed the acquisitions of Kindred and Curo, respectively, merging Curo with the hospice business of Kindred at Home. As part of these transactions, we acquired a 40% minority interest in Kindred at Home and Curo for total cash consideration of approximately $1.1 billion. Earnings from Kindred at Home are included in our consolidated statement of income in the line captioned "Equity in net earnings of Kindred at Home." On April 10, 2018, we acquired FPG for cash consideration of approximately $185 million, net of cash received. 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. 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. These transactions are more fully discussed in 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 September 30, 2018 was $29 million and is expected to be substantially 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 benefits, 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, including our investment in Kindred at Home. 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, which were sold. The results of each segment are measured by segment earnings and include the equity in net earnings of Kindred at Home for our Healthcare Services segment. 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 $1.6 billion for the nine months ended September 30, 2018 as compared to $3.5 billion for the nine months ended September 30, 2017 were primarily impacted by the loss on the sale of KMG recognized during the nine months ended September 30, 2018, lower year-over-year pretax earnings in the Retail, Healthcare Services and Individual Commercial segments, and the net gain associated with the terminated Merger Agreement, mainly the break-up fee, that was recorded in the nine months ended September 30, 2017. These items were partially offset by higher year-over-year pretax earnings in the Group and Specialty segment in the nine months ended September 30, 2018. 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 nine months ended September 30, 2017. - In connection with the sale of KMG, we recognized a pretax loss, including transaction costs, of $786 million which is reported as loss on sale of business in the accompanying condensed consolidated statements of income for the nine months ended September 30, 2018. We recorded a corresponding $430 million income tax benefit resulting from the loss. - Year-over-year comparisons of diluted earnings per common share are favorably impacted by a lower number of shares used to compute earnings per common share from share repurchases and the impact of a lower tax rate for the nine months ended September 30, 2018. - Our 2018 results through September 30, 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 September 30, 2018, approximately 2,010,800 members, or 66.1%, 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 1,877,800 members, or 65.9%, at September 30, 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 and nine months ended September 30, 2018 was $258 million and $778 million, respectively. 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 significantly reduced our operating costs and effective tax rate during the three and nine months ended September 30, 2017. The annual health insurance industry fee is also, under current law, suspended for calendar year 2019. - The 2018 quarter includes pretax income from our Individual Commercial business of $5 million, or $0.03 per diluted common share compared to $26 million, or $0.11 per diluted common share, included in the 2017 quarter. The 2018 period includes pretax income from our Individual Commercial business of $76 million, or $0.42 per diluted common share compared to $207 million, or $0.89 per diluted common share, included in the 2017 period. - The 2018 period 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 $39.3 million, or $0.28 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 $4.33 per diluted common share during the nine months ended September 30, 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. #### 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). We expect the Final Rate Notice to result in a rate increase for our individual Medicare Advantage business that is slightly lower than CMS’ estimate for the sector, on a comparable basis, excluding the impact of Employer Group Waiver Plan (EGWP) funding changes and quality bonus changes. The difference between our 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 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 all 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. The new contract will phase in between December 2018 and February 2019. - In October 2018, the Centers for Medicare and Medicaid Services (CMS) published its updated Star quality ratings for bonus year 2020. We received a 5-star rating on CMS' 5-star rating system for two MA contracts offered in Florida and Tennessee. In addition, we received a 4.5-star rating for two MA contracts offered in Florida, Illinois, Kentucky, Mississippi, North Carolina, and Oregon. We have 12 contracts rated 4-star or above and 3 million members in 4-star or above rated contracts to be offered in 2019, representing 84% of our MA membership as of July 2018. The achievement of a 5-star rating for two MA contracts in Florida and Tennessee provides us the ability to market for these contracts throughout the year, creating an opportunity for increased penetration in these important geographies. #### 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 5.9 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. On October 11, 2018, we received notice from the Defense Health Agency of its intent to exercise the second option period under the East Region contract, with delivery of health care services commencing on January 1, 2019. #### Healthcare Services Segment - Medicare Advantage and dual demonstration program membership enrolled in a Humana chronic care management program was 713,300 at September 30, 2018, a decrease of 13.6% from 825,200 at September 30, 2017, and 10.3% 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. 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 of the health insurer fee, as we experienced in 2017, and under current law will experience again in 2019, 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. Our case has been stayed by the Court, pending resolution of similar cases filed by other insurers. It is reasonably possible that the Health Care Reform Law and related regulations, as well as future legislative, judicial or regulatory changes, including restrictions on our ability to manage our provider network or otherwise operate our business, or restrictions on profitability, including reviews by regulatory bodies that may compare our Medicare Advantage profitability to our non-Medicare Advantage business profitability, or compare the profitability of various products within our Medicare Advantage business, and require 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 September 30, 2018, or the 2018 quarter, the three months ended September 30, 2017, or the 2017 quarter, the nine months ended September 30, 2018, or the 2018 period, and the nine months ended September 30, 2017, or the 2017 period. ### Consolidated *(dollars in millions, except per common share results)* | Revenues: Premiums: | For the three months ended September 30, 2018 | 2017 | Change Dollars | Percentage | | --- | ---: | ---: | ---: | ---: | | Retail | $12,037 | $11,021 | $1,016 | 9.2% | | Group and Specialty | 1,670 | 1,701 | (31) | (1.8)% | | Individual Commercial | 1 | 224 | (223) | (99.6)% | | Other Businesses | 4 | 9 | (5) | (55.6)% | | Total premiums | 13,712 | 12,955 | 757 | 5.8% | | Services: | | | | | | Retail | 1 | 2 | (1) | (50.0)% | | Group and Specialty | 215 | 140 | 75 | 53.6% | | Healthcare Services | 165 | 80 | 85 | 106.3% | | Other Businesses | — | 1 | (1) | (100.0)% | | Total services | 381 | 223 | 158 | 70.9% | | Investment income | 113 | 104 | 9 | 8.7% | | Total revenues | 14,206 | 13,282 | 924 | 7.0% | | Operating expenses: | | | | | | Benefits | 11,243 | 10,642 | 601 | 5.6% | | Operating costs | 1,900 | 1,688 | 212 | 12.6% | | Depreciation and amortization | 102 | 94 | 8 | 8.5% | | Total operating expenses | 13,245 | 12,424 | 821 | 6.6% | | Income from operations | 961 | 858 | 103 | 12.0% | | Loss on sale of business | (4) | — | (4) | (100.0)% | | Interest expense | 53 | 59 | (6) | (10.2)% | | Other expense, net | 11 | — | 11 | 100.0% | | Income before income taxes and equity in net earnings | 901 | 799 | 102 | 12.8% | | Provision for income taxes | 266 | 300 | (34) | (11.3)% | | Equity in net earnings of Kindred at Home | 9 | — | 9 | 100.0% | | Net income | $644 | $499 | $145 | 29.1% | | Diluted earnings per common share | $4.65 | $3.44 | $1.21 | 35.2% | | Benefit ratio (a) | 82.0% | 82.1% | | (0.1)% | | Operating cost ratio (b) | 13.5% | 12.8% | | 0.7% | | Effective tax rate | 29.1% | 37.5% | | (8.4)% | (a) Represents benefits expense as a percentage of premiums revenue. (b) Represents operating costs as a percentage of total revenues less investment income. *(dollars in millions, except per common share results)* | Revenues: Premiums: | For the nine months ended September 30, 2018 | 2017 | Change Dollars | Percentage | | --- | ---: | ---: | ---: | ---: | | Retail | $36,111 | $33,700 | $2,411 | 7.2% | | Group and Specialty | 5,097 | 5,074 | 23 | 0.5% | | Individual Commercial | 6 | 754 | (748) | (99.2)% | | Other Businesses | 22 | 28 | (6) | (21.4)% | | Total premiums | 41,236 | 39,556 | 1,680 | 4.2% | | Services: | | | | | | Retail | 6 | 6 | — | —% | | Group and Specialty | 642 | 444 | 198 | 44.6% | | Healthcare Services | 438 | 251 | 187 | 74.5% | | Other Businesses | 4 | 5 | (1) | (20.0)% | | Total services | 1,090 | 706 | 384 | 54.4% | | Investment income | 418 | 316 | 102 | 32.3% | | Total revenues | 42,744 | 40,578 | 2,166 | 5.3% | | Operating expenses: | | | | | | Benefits | 34,449 | 32,857 | 1,592 | 4.8% | | Operating costs | 5,410 | 4,694 | 716 | 15.3% | | Merger termination fee and related costs, net | — | (947) | 947 | 100.0% | | Depreciation and amortization | 302 | 278 | 24 | 8.6% | | Total operating expenses | 40,161 | 36,882 | 3,279 | 8.9% | | Income from operations | 2,583 | 3,696 | (1,113) | (30.1)% | | Loss on sale of business | 786 | — | 786 | 100.0% | | Interest expense | 159 | 166 | (7) | (4.2)% | | Other expense, net | 11 | — | 11 | 100.0% | | Income before income taxes and equity in net earnings | 1,627 | 3,530 | (1,903) | (53.9)% | | Provision for income taxes | 308 | 1,266 | (958) | (75.7)% | | Equity in net earnings of Kindred at Home | 9 | — | 9 | 100.0% | | Net income | $1,328 | $2,264 | $(936) | (41.3)% | | Diluted earnings per common share | $9.58 | $15.44 | $(5.86) | (38.0)% | | Benefit ratio (a) | 83.5% | 83.1% | | 0.4% | | Operating cost ratio (b) | 12.8% | 11.7% | | 1.1% | | Effective tax rate | 18.8% | 35.9% | | (17.1)% | (a) Represents benefits expense as a percentage of premiums revenue. (b) Represents operating costs as a percentage of total revenues less investment income. #### Summary Net income was $644 million, or $4.65 per diluted common share, in the 2018 quarter compared to $499 million, or $3.44 per diluted common share, in the 2017 quarter. Net income was $1.3 billion, or $9.58 per diluted common share, in the 2018 period compared to $2.3 billion, or $15.44 per diluted common share, in the 2017 period. This comparison was impacted by the loss on the sale of KMG in 2018, the Merger Agreement break-up fee in 2017, the suspension of the health insurance industry fee for calendar year 2017, the exit of the Individual Commercial business effective January 1, 2018, the Tax Reform Law as previously described, and the estimated guaranty fund assessment expense to support the policy holders obligations of Penn Treaty. Year-over-year comparisons of diluted earnings per common share are also favorably impacted by a lower number of shares from share repurchases. #### Premiums Revenue Consolidated premiums increased $757 million, or 5.8%, from the 2017 quarter to $13.7 billion for the 2018 quarter and increased $1.7 billion, or 4.2%, from the 2017 period to $41.2 billion for the 2018 period primarily due to higher premiums in the Retail segment, mainly resulting from our Medicare Advantage business. These items were partially offset by lower premiums resulting from the exit of the Individual Commercial business. #### Services Revenue Consolidated services revenue increased $158 million, or 70.9%, from the 2017 quarter to $381 million for the 2018 quarter and increased $384 million, or 54.4%, from the 2017 period to $1.1 billion for the 2018 period primarily due to an increase in services revenue in the Healthcare Services and Group and Specialty segments as discussed in the detailed segment results discussion that follows. #### Investment Income Investment income totaled $113 million for the 2018 quarter, increasing $9 million, or 8.7%, from $104 million for the 2017 quarter primarily reflecting higher realized capital gains and higher interest rates, partially offset by lower average invested balances. For the 2018 period, investment income totaled $418 million, increasing $102 million, or 32.3%, from $316 million in the 2017 period primarily reflecting higher realized capital gains, average invested balances, and interest rates. #### Benefits Expense Consolidated benefits expense was $11.2 billion for the 2018 quarter, an increase of $601 million from the 2017 quarter. For the 2018 period, benefits expense was $34.4 billion, an increase of $1.6 billion from the 2017 period. These increases were primarily due to an increase in the Retail segment benefits expense, partially offset by a decrease in the Individual Commercial segment benefits expense. We experienced favorable medical claims reserve development related to prior fiscal years of $129 million in the 2018 quarter as compared to $85 million in the 2017 quarter. In the 2018 period, we experienced favorable medical claims reserve development related to prior years of $467 million as compared to $430 million in the 2017 period as discussed in the detailed segment results discussion that follows. The consolidated benefit ratio decreased 10 basis points to 82.0% for the 2018 quarter compared to 82.1% for the 2017 quarter primarily due to the positive impact on the 2018 quarter from the reinstatement of the health insurance industry fee in 2018, which was contemplated in the pricing and benefit design of our products and higher favorable prior-period reserve development. These items were partially offset by the enhanced 2018 Medicare Advantage member benefits resulting from the investment of the better than expected 2017 individual Medicare Advantage pretax earnings along with unfavorable year-over-year comparison of the Group and Specialty segment ratio as discussed in the detailed segment results discussion that follows. The consolidated benefit ratio for the 2018 period was 83.5%, a 40 basis point increase from 83.1% for the 2017 period. The year-over-year comparison for the 2018 period was favorably impacted by the exit of the Individual Commercial business effective January 1, 2018. Excluding the impact of the Individual Commercial segment, the year-over-year comparison was unfavorably impacted by the enhanced 2018 Medicare Advantage member benefits resulting from the investment of the better than expected 2017 individual Medicare Advantage pretax earnings and a more severe flu season. These items were partially offset by the reinstatement of the health insurance industry fee in 2018, which was contemplated in the pricing and benefit design of our products. The favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 90 basis points in the 2018 quarter versus approximately 70 basis points in the 2017 quarter. Favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 110 basis points in both the 2018 and the 2017 periods. #### 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 $212 million, or 12.6%, during the 2018 quarter compared to the 2017 quarter. Consolidated operating costs increased $716 million, or 15.3%, during the 2018 period compared to the 2017 period 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 13.5% increased 70 basis points from the 2017 quarter. The consolidated operating cost ratio for the 2018 period increased 110 basis points to 12.8% from 11.7% in the 2017 period. These increases primarily were due to the reinstatement of the health insurance industry fee in 2018, and long-term sustainability investments in the 2018 quarter and period as a result of the Tax Reform Law. Our long-term sustainability investments include the continuation of 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 to drive more affordable healthcare and better clinical outcomes, and an increase in incentive compensation costs under the expanded program noted above, resulting from the continued strong performance. The ratio was further impacted by the growth in our military services business, which carries a higher operating ratio than our other products, due to the previously disclosed transition to the TRICARE East Region contract effective January 1, 2018. These items were partially offset by the favorable impact of significant operating cost efficiencies in the 2018 quarter and period driven by productivity initiatives implemented in 2017, the impact of the charges recorded in the 2017 quarter associated with the voluntary and involuntary workforce reduction program, and the favorable year-over-year comparison of the impact of the guaranty fund assessment expense to support policy holder obligations of Penn Treaty in the 2017 period, as well as the exit of the Individual Commercial business, which carried a higher operating cost ratio than our other products, effective January 1, 2018. The non-deductible health insurance industry fee impacted the operating cost ratio by 180 basis points in both the 2018 quarter and 2018 period. #### Depreciation and Amortization Depreciation and amortization for the 2018 quarter totaled $102 million compared to $94 million for the 2017 quarter. For the 2018 period, depreciation and amortization totaled $302 million compared to $278 million for the 2017 period. #### Interest Expense Interest expense for the 2018 quarter totaled $53 million, compared to $59 million for the 2017 quarter, and totaled $159 million for the 2018 period compared to $166 million for the 2017 period. #### Income Taxes For the 2018 period our effective tax rate was 18.8% compared to the effective tax rate of 35.9% for the 2017 period. These decreases are primarily due to the tax benefit of $430 million resulting from the sale of KMG as well as the Tax Reform Law previously discussed, partially offset by the impact of the reinstatement of the non-deductible health insurance industry fee in 2018. The income tax rate for the nine months ended September 30, 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 nine months ended September 30, 2018 by $39.3 million. ### Retail Segment | Membership: Medical membership: | September 30, 2018 | 2017 | Change Members | Percentage | | --- | ---: | ---: | ---: | ---: | | Individual Medicare Advantage | 3,043,800 | 2,849,400 | 194,400 | 6.8% | | Group Medicare Advantage | 496,800 | 438,400 | 58,400 | 13.3% | | Medicare stand-alone PDP | 5,015,900 | 5,290,900 | (275,000) | (5.2)% | | Total Retail Medicare | 8,556,500 | 8,578,700 | (22,200) | (0.3)% | | State-based Medicaid | 323,800 | 363,400 | (39,600) | (10.9)% | | Medicare Supplement | 246,600 | 234,900 | 11,700 | 5.0% | | Total Retail medical members | 9,126,900 | 9,177,000 | (50,100) | (0.5)% | *(in millions)* | Premiums and Services Revenue: Premiums: | For the three months ended September 30, 2018 | 2017 | Change Dollars | Percentage | | --- | ---: | ---: | ---: | ---: | | Individual Medicare Advantage | $8,912 | $8,077 | $835 | 10.3% | | Group Medicare Advantage | 1,542 | 1,272 | 270 | 21.2% | | Medicare stand-alone PDP | 893 | 921 | (28) | (3.0)% | | Total Retail Medicare | 11,347 | 10,270 | 1,077 | 10.5% | | State-based Medicaid | 561 | 630 | (69) | (11.0)% | | Medicare Supplement | 129 | 121 | 8 | 6.6% | | Total premiums | 12,037 | 11,021 | 1,016 | 9.2% | | Services | 1 | 2 | (1) | (50.0)% | | Total premiums and services revenue | $12,038 | $11,023 | $1,015 | 9.2% | | **Segment earnings** | $634 | $610 | $24 | 3.9% | | Benefit ratio | 83.2% | 84.3% | | (1.1)% | | Operating cost ratio | 11.2% | 9.8% | | 1.4% | 48 *(in millions)* | Premiums and Services Revenue: Premiums: | For the nine months ended September 30, 2018 | 2017 | Change Dollars | Percentage | | --- | ---: | ---: | ---: | ---: | | Individual Medicare Advantage | $26,790 | $24,735 | $2,055 | 8.3% | | Group Medicare Advantage | 4,575 | 3,867 | 708 | 18.3% | | Medicare stand-alone PDP | 2,703 | 2,787 | (84) | (3.0)% | | Total Retail Medicare | 34,068 | 31,389 | 2,679 | 8.5% | | State-based Medicaid | 1,664 | 1,954 | (290) | (14.8)% | | Medicare Supplement | 379 | 357 | 22 | 6.2% | | Total premiums | 36,111 | 33,700 | 2,411 | 7.2% | | Services | 6 | 6 | — | —% | | Total premiums and services revenue | $36,117 | $33,706 | $2,411 | 7.2% | | **Segment earnings** | $1,394 | $1,587 | $(193) | (12.2)% | | Benefit ratio | 85.4% | 86.1% | | (0.7)% | | Operating cost ratio | 10.5% | 8.9% | | 1.6% | #### Segment Earnings - Retail segment earnings increased $24 million, or 3.9%, from $610 million in the 2017 quarter to $634 million in the 2018 quarter primarily due the year-over-year improvement in the segment's benefit ratio, partially offset by the segment's higher operating ratio. Retail segment earnings decreased $193 million, or 12.2%, from $1.6 billion in the 2017 period to $1.4 billion in the 2018 period primarily due to a higher operating cost ratio, partially offset by an improving benefit ratio. #### Enrollment - Individual Medicare Advantage membership increased 194,400 members, or 6.8%, from September 30, 2017 to September 30, 2018, primarily due to membership additions associated with last year's Annual Election Period, or AEP, for Medicare beneficiaries. - Group Medicare Advantage membership increased 58,400, or 13.3%, from September 30, 2017 to September 30, 2018, primarily due to increased sales to our existing group accounts during last year's AEP for Medicare beneficiaries. - Medicare stand-alone PDP membership decreased 275,000 members, or 5.2%, from September 30, 2017 to September 30, 2018 reflecting net declines during last year's 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 historical levels due to the introduction of additional low-priced competitor offerings in many regions. - State-based Medicaid membership decreased 39,600 members, or 10.9%, from September 30, 2017 to September 30, 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 Medicaid contract due to overall strengthening economic conditions. #### Premiums Revenue - Retail segment premiums increased $1.0 billion, or 9.2%, from the 2017 quarter to the 2018 quarter and increased $2.4 billion, or 7.2%, from the 2017 period to the 2018 period primarily due to individual and group Medicare Advantage membership growth in last year's AEP as well as increased per-member premiums for certain products within the segment, partially offset by declines in the state-based contracts and stand-alone PDP revenues resulting from membership declines discussed above. Average group and individual Medicare Advantage membership increased 7.6% for the 2018 quarter and 7.5% for the 2018 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 decreased 110 basis points from 84.3% in the 2017 quarter to 83.2% 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 and higher prior-period reserve development. These items were partially offset by the unfavorable impact from the enhanced 2018 Medicare Advantage member benefits resulting from the investment of the better than expected 2017 individual Medicare Advantage segment earnings. The Retail segment decreased 70 basis points from 86.1% in the 2017 period to 85.4% in the 2018 period due to the same factors impacting the quarter comparison, excluding the impact of the favorable prior-period reserve development. The 2018 period was also impacted by a more severe flu season. - The Retail segment’s benefits expense for the 2018 quarter included $120 million in favorable prior-period medical claims reserve development versus $52 million in the 2017 quarter. For the 2018 period, the Retail segment’s benefit expense include the beneficial effect of $367 million in favorable prior-period reserve development versus $339 million in the 2017 period. Prior-period medical claims reserve development decreased the Retail segment benefit ratio by approximately 100 basis points in the 2018 quarter versus approximately 50 basis points in the 2017 quarter. Favorable prior-period reserve development decreased the Retail segment benefit ratio by approximately 100 basis points in both the 2018 period and the 2017 period. #### Operating Costs - The Retail segment operating cost ratio of 11.2% for the 2018 quarter increased 140 basis points from 9.8% for the 2017 quarter. The Retail segment operating cost ratio of 10.5% for the 2018 period increased 160 basis points from 8.9% for the 2017 period. The year-over-year comparison was negatively impacted by the reinstatement of the health insurance industry fee in 2018, strategic investments made in the 2018 quarter as a result of the Tax Reform Law, and an increase in incentive compensation costs under the expanded program noted previously, resulting from continued strong performance by the company. These items were partially offset by significant operating cost efficiencies in the 2018 quarter and period driven by productivity initiatives implemented in 2017. The non-deductible health insurance industry fee impacted the operating cost ratio by 190 basis points in both the 2018 quarter and the 2018 period. ### Group and Specialty Segment | Membership: Medical membership: | September 30, 2018 | 2017 | Change Members | Percentage | | --- | ---: | ---: | ---: | ---: | | Fully-insured commercial group | 1,029,100 | 1,098,800 | (69,700) | (6.3)% | | ASO | 449,900 | 445,700 | 4,200 | 0.9% | | Military services | 5,927,400 | 3,099,000 | 2,828,400 | 91.3% | | Total group and specialty medical members | 7,406,400 | 4,643,500 | 2,762,900 | 59.5% | | Specialty membership (a) | 6,116,300 | 6,934,000 | (817,700) | (11.8)% | (a) Specialty products include dental, vision, voluntary benefit products and other supplemental health and financial protection products. Members included in these products may not be unique to each product since members have the ability to enroll in multiple products. *(in millions)* | Premiums and Services Revenue: Premiums: | For the three months ended September 30, 2018 | 2017 | Change Dollars | Percentage | | --- | ---: | ---: | ---: | ---: | | Fully-insured commercial group | $1,345 | $1,370 | $(25) | (1.8)% | | Group specialty | 325 | 331 | (6) | (1.8)% | | Total premiums | 1,670 | 1,701 | (31) | (1.8)% | | Services | 215 | 140 | 75 | 53.6% | | Total premiums and services revenue | $1,885 | $1,841 | $44 | 2.4% | | **Segment earnings** | $81 | $93 | $(12) | (12.9)% | | Benefit ratio | 80.7% | 79.6% | | 1.1% | | Operating cost ratio | 23.6% | 20.9% | | 2.7% | 51 *(in millions)* | Premiums and Services Revenue: Premiums: | For the nine months ended September 30, 2018 | 2017 | Change Dollars | Percentage | | --- | ---: | ---: | ---: | ---: | | Fully-insured commercial group | $4,083 | $4,098 | $(15) | (0.4)% | | Group specialty | 1,014 | 976 | 38 | 3.9% | | Total premiums | 5,097 | 5,074 | 23 | 0.5% | | Services | 642 | 444 | 198 | 44.6% | | Total premiums and services revenue | $5,739 | $5,518 | $221 | 4.0% | | **Segment earnings** | $372 | $365 | $7 | 1.9% | | Benefit ratio | 78.0% | 77.9% | | 0.1% | | Operating cost ratio | 23.6% | 21.3% | | 2.3% | #### Segment Earnings - Group and Specialty segment earnings decreased $12 million, or 12.9%, from $93 million in the 2017 quarter to $81 million in the 2018 quarter primarily reflecting the impact of the segment's higher benefit ratio, partially offset by higher pretax earnings associated with our military services business, which was favorably impacted by the timing of certain contractual incentives and adjustments. Group and Specialty segment earnings increased $7 million, or 1.9%, from $365 million in the 2017 period to $372 million in the 2018 period primarily reflecting higher pretax earnings associated with our group ASO commercial medical business, as well as higher year-over-year earnings in our military services business, which was favorably impacted by the timing of certain contractual incentives and adjustments. These increases were partially offset by slightly higher segment benefit ratio. #### Enrollment - Fully-insured commercial group medical membership decreased 69,700 members, or 6.3%, from September 30, 2017 to September 30, 2018 primarily reflecting lower membership in small group accounts due in part to more small group accounts selecting level-funded ASO products in 2018. The portion of group fully-insured commercial medical membership in small group accounts (2-99 sized employer groups) was approximately 62 percent at September 30, 2018 and 64 percent at September 30, 2017. - Group ASO commercial medical membership increased 4,200 members, or 0.9%, from September 30, 2017 to September 30, 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 2,828,400 members, or 91.3%, from September 30, 2017 to September 30, 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 817,700 members, or 11.8%, from September 30, 2017 to September 30, 2018 primarily due to reinsuring a portion of our voluntary benefits and financial protection products membership to a third party in connection with the previously disclosed sale of KMG, as well as the losses of some large group accounts offering stand-alone dental and vision products. These decreases were partially offset by an increase in individual dental and vision membership. #### Premiums Revenue - Group and Specialty segment premiums decreased $31 million, or 1.8%, from the 2017 quarter to $1.7 billion for the 2018 quarter primarily due to reinsuring our voluntary benefits and financial protection products to a third party in connection with the previously disclosed sale of KMG, and declines in average group fully-insured commercial medical membership, partially offset by higher stop-loss premiums related to our small group level funded ASO accounts and higher per-member premiums across most lines of business in the segment. Group and Specialty segment premiums increased $23 million, or 0.5%, from the 2017 period to $5.1 billion for the 2018 period primarily due to 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 commercial medical membership as well as reinsuring our voluntary benefits and financial protection products to a third party in connection with the previously disclosed sale of KMG. #### Services Revenue - Group and Specialty segment services revenue increased $75 million, or 53.6%, from the 2017 quarter to $215 million for the 2018 quarter and increased $198 million, or 44.6%, from the 2017 period to $642 million for the 2018 period as a result of the transition to the TRICARE T2017 East Region contract on January 1, 2018, along with the favorable impact of the timing of certain contractual incentives and adjustments. #### Benefits Expense - The Group and Specialty segment benefit ratio increased 110 basis points from 79.6% in the 2017 quarter to 80.7% in the 2018 quarter primarily due to retroactive contractual rate adjustments, membership mix, including the continued migration of healthier groups to level funded ASO products in 2018, the unfavorable impact of seasonality on our fully-insured medical claims, as well as lower favorable prior-period reserve development. These factors were partially offset by the reinstatement of the health insurance industry fee in 2018 which was contemplated in the pricing of our products. The Group and Specialty segment benefit ratio increased 10 basis points from 77.9% in the 2017 period to 78.0% in the 2018 period primarily due the same factors in the year-over-year quarter comparison as well as the impact of lower premiums resulting from the adjustment of our commercial risk adjustment, or CRA, accrual related to the Affordable Care Act, or ACA, compliant business resulting from the release of the CMS's final 2017 CRA data. - The Group and Specialty segment's benefits expense included $7 million in the 2018 quarter in favorable prior-period medical claims reserve development versus $13 million in the 2017 quarter. This favorable prior-period medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 40 basis points in the 2018 quarter and 80 basis points in the 2017 quarter. The Group and Specialty segment's benefits expense included the beneficial effect of a favorable prior-period medical claims reserve development of $41 million in the 2018 period versus $44 million in the 2017 period. This favorable prior-period medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 80 basis points in the 2018 period and 90 basis points in the 2017 period. #### Operating Costs - The Group and Specialty segment operating cost ratio of 23.6% for the 2018 quarter increased 270 basis points from 20.9% for the 2017 quarter. For the 2018 period, the Group and Specialty segment operating cost ratio of 23.6% increased 230 basis points from 21.3% for the 2017 period. These increases primarily were 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, investments made in the 2018 quarter as a result of the Tax Reform Law as previously described, and an increase in incentive compensation costs under the expanded program noted previously, resulting from the continued strong performance by the company. These items were partially offset by significant operating cost efficiencies driven by productivity initiatives implemented in 2017. The non-deductible health insurance industry fee impacted the operating cost ratio by 160 basis points in both the 2018 quarter and the 2018 period. ### Healthcare Services Segment *(in millions)* | Revenues: Services: | For the three months ended September 30, 2018 | 2017 | Change Dollars | Percentage | | --- | ---: | ---: | ---: | ---: | | Provider services | $70 | $21 | $49 | 233.3% | | Pharmacy solutions | 52 | 20 | 32 | 160.0% | | Clinical care services | 43 | 39 | 4 | 10.3% | | Total services revenues | 165 | 80 | 85 | 106.3% | | Intersegment revenues: | | | | | | Pharmacy solutions | 5,092 | 5,246 | (154) | (2.9)% | | Provider services | 537 | 392 | 145 | 37.0% | | Clinical care services | 161 | 273 | (112) | (41.0)% | | Total intersegment revenues | 5,790 | 5,911 | (121) | (2.0)% | | Total services and intersegment revenues | $5,955 | $5,991 | $(36) | (0.6)% | | **Segment earnings** | $215 | $240 | $(25) | (10.4)% | | Operating cost ratio | 96.1% | 95.6% | | 0.5% | *(in millions)* | Revenues: Services: | For the nine months ended September 30, 2018 | 2017 | Change Dollars | Percentage | | --- | ---: | ---: | ---: | ---: | | Provider services | $158 | $58 | $100 | 172.4% | | Pharmacy solutions | 148 | 58 | 90 | 155.2% | | Clinical care services | 132 | 135 | (3) | (2.2)% | | Total services revenues | 438 | 251 | 187 | 74.5% | | Intersegment revenues: | | | | | | Pharmacy solutions | 15,181 | 15,581 | (400) | (2.6)% | | Provider services | 1,456 | 1,207 | 249 | 20.6% | | Clinical care services | 511 | 876 | (365) | (41.7)% | | Total intersegment revenues | 17,148 | 17,664 | (516) | (2.9)% | | Total services and intersegment revenues | $17,586 | $17,915 | $(329) | (1.8)% | | **Segment earnings** | $594 | $754 | $(160) | (21.2)% | | Operating cost ratio | 96.2% | 95.4% | | 0.8% | #### Segment Earnings - Healthcare Services segment earnings of $215 million for the 2018 quarter decreased $25 million, or 10.4%, from $240 million in the 2017 quarter. For the 2018 period, the Healthcare Services segment earnings of $594 million decreased $160 million, or 21.2%, from $754 million in the 2017 period. These decreases primarily were 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 and period as a result of the Tax Reform Law as previously described, partially offset by the impact of Kindred at Home. #### Script Volume - Humana Pharmacy Solutions script volumes on an adjusted 30-day equivalent basis increased to approximately 110 million in the 2018 quarter, up 1.6%, versus scripts of approximately 108 million in the 2017 quarter. For the 2018 period, script volumes increased to approximately 328 million, up 1.5%, versus scripts of approximately 323 million in the 2017 period. These increases primarily reflected growth associated with higher individual Medicare Advantage membership, partially offset by the decline in stand-alone PDP and Individual Commercial membership. #### Services Revenues - Services revenues increased $85 million, or 106.3%, from the 2017 quarter to $165 million for the 2018 quarter and increased $187 million, or 74.5%, from the 2017 period to $438 million for the 2018 period primarily due to service revenue growth from our provider services and pharmacy solutions businesses. #### Intersegment Revenues - Intersegment revenues decreased $121 million, or 2.0%, from the 2017 quarter to $5.8 billion for the 2018 quarter and decreased $516 million, or 2.9%, from the 2017 period to $17.1 billion for the 2018 period primarily due to the loss of intersegment revenues associated with our exit from the Individual commercial business, a decline in pharmacy solutions revenue year-over-year primarily due to lower stand-alone PDP membership, the result of improving the effectiveness of our chronic care management programs previously discussed, and the impact to our provider services business of the lower 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 both the 2018 quarter and period, as well as higher intersegment revenues associated with our provider services business reflecting our previously disclosed acquisition of MCCI Holdings, LLC. #### Operating Costs - The Healthcare Services segment operating cost ratio of 96.1% for the 2018 quarter increased 50 basis points from 95.6% for the 2017 quarter and increased 80 basis points from 95.4% for the 2017 period to 96.2% for the 2018 period primarily due to the lag in operating cost reduction associated with improving the effectiveness of our chronic conditions management programs, as compared to the timing of reduction in revenue, the long-term sustainability investments in the 2018 quarter and period as a result of the Tax Reform Law, and an increase in incentive compensation costs under the expanded program noted previously, resulting from continued strong performance by the company. These items were partially offset by significant operating cost efficiencies in the 2018 quarter and period driven by productivity initiatives implemented in 2017. ### Individual Commercial Segment - Individual Commercial segment earnings of $5 million for the 2018 quarter decreased $21 million from the 2017 quarter and decreased $131 million from the 2017 period. The segment earnings in the 2018 quarter and period 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). 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 $4.1 billion at September 30, 2018 from $4.0 billion at December 31, 2017. The change in cash and cash equivalents for the nine months ended September 30, 2018 and 2017 is summarized as follows: *(in millions)* | | Nine Months Ended 2018 | 2017 | | --- | ---: | ---: | | Net cash provided by operating activities | $2,506 | $6,962 | | Net cash used in investing activities | (2,640) | (1,776) | | Net cash provided by financing activities | 234 | 802 | | Increase in cash and cash equivalents | $100 | $5,988 | ### Cash Flow from Operating Activities Our operating cash flows for the 2017 period were significantly impacted by the early receipt of the Medicare premium remittances of $3.1 billion in September 2017 because the payment date of October 1, 2017 fell on a weekend. Generally, when the first day of a month falls on a weekend or holiday, with the exception of January 1 (New Year's Day), we receive this payment at the end of the previous month. Our operating cash flows for the 2018 period were negatively impacted by approximately $245 million related to reinsuring certain voluntary benefit and financial protection products to a third party in connection with the sale of KMG. Our operating cash flows for the 2017 period were also significantly impacted by the receipt of the $1 billion Merger Agreement break-up fee. Excluding the effects of the reinsurance transactions, Merger termination fee and the timing of the Medicare premium remittances, our operating cash flows were primarily impacted by earnings and the timing of working capital items, including the timing of Medicare risk adjustment payments. 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, 2018 and December 31, 2017: *(in millions)* | | September 30, 2018 | December 31, 2017 | 2018 Period Change | 2017 Period Change | | --- | ---: | ---: | ---: | ---: | | IBNR (1) | $3,299 | $3,154 | $145 | $(114) | | Reported claims in process (2) | 783 | 614 | 169 | 44 | | Other benefits payable (3) | 938 | 900 | 38 | 466 | | Total benefits payable | $5,020 | $4,668 | $352 | $396 | | Payables from divestiture | | | 58 | — | | Change in benefits payable per cash flow statement resulting in cash from operations | | | $410 | $396 | (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 September 30, 2018 primarily was due to an increase in the amount of processed but unpaid claims, which fluctuate due to month-end cutoff as well as an increase in IBNR, primarily as a result of Medicare Advantage membership growth. 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 detail of total net receivables was as follows at September 30, 2018 and December 31, 2017: *(in millions)* | | September 30, 2018 | December 31, 2017 | 2018 Period Change | 2017 Period Change | | --- | ---: | ---: | ---: | ---: | | Medicare | $744 | $511 | $233 | $(293) | | Commercial and other | 292 | 273 | 19 | (138) | | Military services | 118 | 166 | (48) | 44 | | Allowance for doubtful accounts | (92) | (96) | 4 | 29 | | Total net receivables | $1,062 | $854 | $208 | $(358) | | Reconciliation to cash flow statement: | | | | | | Disposition of receivables from sale of business | | | 3 | — | | Change in receivables per cash flow statement resulting in cash from operations | | | $211 | $(358) | The changes in Medicare receivables for both the 2018 period and the 2017 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 second and third quarter. ### Cash Flow from Investing Activities In the third quarter of 2018, we completed the sale of our wholly-owned subsidiary KMG to CGIC. Upon closing, we funded the transaction with approximately $190 million of parent company cash contributed into KMG, subject to customary adjustments, in addition to the transfer of approximately $160 million of statutory capital with the sale. Total cash and cash equivalents, including parent company funding, disposed at September 30, 2018, was $805 million. See Note 3 to our condensed consolidated financial statements. During July 2018 we paid cash consideration of approximately $1.1 billion as part of the Consortium's investment in Kindred, which includes both the Kindred at Home Division and Curo Health Services businesses. Net proceeds from investment securities sales in the 2018 period of $50 million primarily reflects actions associated with the sale of KMG described previously. In the 2017 period, we reinvested a portion of our operating cash flows in investment securities, primarily investment-grade fixed income securities, totaling $1.4 billion. On March 1, 2018 we acquired the remaining equity interest in MCCI. The purchase price included, in part, cash consideration of $169 million, as discussed in Note 3 to the condensed consolidated financial statements. On April 10, 2018, we acquired Family Physicians Group, or FPG, for cash consideration of approximately $185 million. 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 $436 million in the 2018 period and $376 million in the 2017 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 $436 million during the 2018 period and higher than claims payments by $1.9 billion during the 2017 period. 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 $33 million in the 2018 period. In the 2017 period, reimbursements from the federal government exceeded health care cost payments for which we do not assume risk by $22 million. Claims payments associated with cost sharing provisions of the Health Care Reform Law for which we do not assume risk were $25 million higher than reimbursements from HHS during the 2018 period and $41 million higher than reimbursements from HHS during the 2017 period. On March 26, 2018 we completed the final settlement of our accelerated stock repurchase along with 0.68 million additional share repurchases under the current stock repurchase authorization during the 2018 period for $224 million. We also acquired common shares in connection with employee stock plans for an aggregate cost of $70 million in the 2018 period and $79 million in the 2017 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. Net proceeds from the issuance of commercial paper were $240 million in the 2018 period. Repayments of commercial paper were $153 million in the 2017 period. The maximum principal amount outstanding at any one time during the 2018 period was $442 million. We paid dividends to stockholders of $195 million during the 2018 period and $162 million during the 2017 period. ### 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 In the third quarter of 2018, we completed the sale of our wholly-owned subsidiary KMG to CGIC. Upon closing, we funded the transaction with approximately $190 million of parent company cash contributed into KMG, subject to customary adjustments, in addition to the transfer of approximately $160 million of statutory capital with the sale. Total cash and cash equivalents, including parent company funding required disposed at September 30, 2018, was $805 million. See Note 3 to our condensed consolidated financial statements. During the 2018 period, we completed the acquisition of MCCI and FPG for total cash consideration of $354 million. During July 2018 we paid cash consideration of approximately $1.1 billion as part of the Consortium's investment in Kindred, which includes both the Kindred at Home Division and Curo Health Services businesses. For a detailed discussion of these transactions, please refer to Note 3 to the condensed consolidated financial statements. ### Liquidity Requirements We believe our cash balances, investment securities, operating cash flows, and funds available under our credit agreement and our commercial paper program or from other public or private financing sources, taken together, provide adequate resources to fund ongoing operating and regulatory requirements, acquisitions, future expansion opportunities, and capital expenditures for at least the next twelve months, as well as to refinance or repay debt, and repurchase shares. Adverse changes in our credit rating may increase the rate of interest we pay and may impact the amount of credit available to us in the future. Our investment-grade credit rating at September 30, 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 $1.0 billion at September 30, 2018 compared to $688 million at December 31, 2017. This increase primarily was due to insurance subsidiary dividends in excess of capital contributions from our parent company as well as operating cash derived from our non-insurance subsidiaries during the 2018 period. These items were partially offset by the completion of the Kindred at Home acquisition, as well as the acquisitions of MCCI and FPG, dividends and capital expenditures. 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). ### 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 June 30, 2018, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $6.6 billion, which exceeded aggregate minimum regulatory requirements of $5.3 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 $1.9 billion during the nine months ended September 30, 2018 compared to $1.4 billion during the nine months ended September 30, 2017. Actual dividends paid may vary year over year 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, 2,229 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 September 30, 2018. Our net unrealized position decreased $467 million from a net unrealized gain position of $198 million at December 31, 2017 to a net unrealized loss position of $269 million at September 30, 2018. At September 30, 2018, we had gross unrealized losses of $273 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, 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 2.4 years as of September 30, 2018 and approximately 4.1 years as of December 31, 2017. The decline in the average duration is reflective of the longer duration securities associated with the sale of KMG. Based on the duration, including cash equivalents, a 1% increase in interest rates would generally decrease the fair value of our securities by approximately $356 million at September 30, 2018. ## Controls and procedures As filed, 1,301 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 September 30, 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 September 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Filed Nov 7, 2018. Source: SEC EDGAR, the filing index for accession 0000049071-18-000123. Last ingested by Listed: Nov 6, 2026, 14:15 ET. No prices; not investment advice.