# Humana Inc: Form 10-Q for the period ended Sep 30, 2019

- Company: [Humana Inc](/companies/hum.md) (CIK 49071)
- Form: 10-Q
- Filed: 2019-11-06
- Accepted by EDGAR: Nov 6, 2019, 14:57 ET
- Period: 2019-09-30
- Accession: 0000049071-19-000105
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/49071/000004907119000105/hum-20190930x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/49071/000004907119000105/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2019-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2019-07-01 to 2019-09-30 | $16.24bn | us-gaap:Revenues |
| Revenue | 9 months, 2019-01-01 to 2019-09-30 | $48.59bn | us-gaap:Revenues |
| Selling, general and administrative | 3 months, 2019-07-01 to 2019-09-30 | $1.89bn | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 9 months, 2019-01-01 to 2019-09-30 | $5.25bn | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2019-07-01 to 2019-09-30 | $868.0m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2019-01-01 to 2019-09-30 | $2.83bn | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2019-07-01 to 2019-09-30 | $62.0m | us-gaap:InterestExpense |
| Interest expense | 9 months, 2019-01-01 to 2019-09-30 | $184.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2019-07-01 to 2019-09-30 | $200.0m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 9 months, 2019-01-01 to 2019-09-30 | $684.0m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2019-07-01 to 2019-09-30 | $689.0m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2019-01-01 to 2019-09-30 | $2.19bn | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2019-07-01 to 2019-09-30 | $5.14 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 9 months, 2019-01-01 to 2019-09-30 | $16.24 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2019-07-01 to 2019-09-30 | $5.16 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 9 months, 2019-01-01 to 2019-09-30 | $16.31 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2019-07-01 to 2019-09-30 | 134,025,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 9 months, 2019-01-01 to 2019-09-30 | 135,189,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 9 months, 2019-01-01 to 2019-09-30 | $4.77bn | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2019-01-01 to 2019-09-30 | $506.0m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 9 months, 2019-01-01 to 2019-09-30 | $216.0m | us-gaap:PaymentsOfDividends |
| Share repurchases | 9 months, 2019-01-01 to 2019-09-30 | $1.01bn | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2019-09-30 | $5.53bn | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2019-09-30 | $20.32bn | us-gaap:AssetsCurrent |
| Total assets | at 2019-09-30 | $29.18bn | us-gaap:Assets |
| Current liabilities | at 2019-09-30 | $11.11bn | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2019-09-30 | $17.58bn | us-gaap:Liabilities |
| Long-term debt | at 2019-09-30 | $5.37bn | us-gaap:LongTermDebtNoncurrent |
| Current portion of debt | at 2019-09-30 | $699.0m | us-gaap:DebtCurrent |
| Shareholders' equity | at 2019-09-30 | $11.60bn | us-gaap:StockholdersEquity |
| Shares outstanding | at 2019-09-30 | 132,426,045 shares | dei:EntityCommonStockSharesOutstanding |

## Management's discussion and analysis

As filed, 69,151 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 2018 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 21, 2019, 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 depreciation and amortization, as a percentage of total revenue less investment income, represents a statistic used to measure administrative spending efficiency.

### Acquisitions and Divestitures

In the third quarter of 2018, we completed the sale of our wholly-owned subsidiary KMG to CGIC. KMG's subsidiary, KIC, included our closed block of non-strategic commercial long-term care policies. 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.

Also in the third quarter of 2018, we, along with TPG and WCAS, 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, a leading home health and hospice company, for total cash consideration of approximately $1.1 billion.

In the second quarter of 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.

In the first quarter of 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 1 and Note 3 to the condensed consolidated financial statements.

### Business Segments

We manage our business with three reportable segments: Retail, Group and Specialty, and Healthcare Services. Beginning January 1, 2018, we exited the individual commercial fully-insured medical health insurance business, as well as certain other business, and therefore no longer report separately the Individual Commercial segment and the Other Business category in the current year. Previously, the Other Business category included businesses that were not individually reportable because they did not meet the quantitative thresholds required by generally accepted accounting principles, primarily our closed-block of commercial long-term care insurance policies which were sold in 2018. The reportable 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, the Chief Operating Decision Maker, to assess performance and allocate resources.

The Retail segment consists of Medicare benefits, marketed to individuals or directly via group Medicare 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 our military services business, primarily our TRICARE T2017 East Region contract. The Healthcare Services segment includes our 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 minority investment in Kindred at Home. We reported under the category of Other Businesses those businesses that did not align with the reportable segments described above, primarily our closed-block long-term care insurance policies, which were sold in 2018.

The results of each segment are measured by segment earnings, and for our Healthcare Services Segment, also include the equity in net earnings of Kindred at Home. 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 and Group and Specialty 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.

### 2019 Highlights

- Our strategy offers 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, 2019, approximately 2,340,600 members, or 66%, of our individual Medicare Advantage members were in value-based relationships under our integrated care delivery model, as compared to 2,010,800 members, or 66%, at September 30, 2018. Medicare Advantage and dual demonstration program membership enrolled in a Humana chronic care management program was 882,800 at September 30, 2019, an increase of 23.8% from 713,300 at September 30, 2018. These members may not be unique to each program since members have the ability to enroll in multiple programs. The increase is driven by our improved process for identifying and enrolling members in the appropriate program at the right time, coupled with growth in Special Needs Plans, or SNP, membership.
- In October 2019, the Centers for Medicare and Medicaid Services published its updated Medicare Star Ratings for bonus year 2021. We have 3.7 million members, or 92% of our Medicare Advantage membership as of August 2019, enrolled in 18 contracts that received a 4-star rating or above. In addition, we received a 5 out of 5-star rating for our CarePlus Health Plans, Inc. contract in Florida, and received a 4.5-star rating for six Medicare Advantage contracts offered in 19 states, which cover approximately 1.2 million members. The continued improvement in our Star ratings reflects our enterprise-wide focus on driving quality and improved health outcomes.
- Net income increased $867 million from $1.3 billion in 2018 to $2.2 billion in 2019 and earnings per diluted common share increased $6.66 from $9.58 earnings per diluted common share in 2018 to $16.24 earnings per diluted common share in 2019. This comparison was primarily impacted by our Medicare Advantage business and Healthcare Services segment, as well as by previously implemented productivity initiatives that led to significant operating cost efficiencies in 2019. These impacts were partially offset by strategic investments in our integrated care delivery model, the impact of higher compensation accruals for the Annual Incentive Plan, or AIP, offered to employees across all levels of the company, lower Group and Specialty segment earnings, and the impact of workforce optimization. These changes were further favorably impacted by the suspension of the health industry insurance fee in 2019 and by a lower number of shares used to compute dilutive earnings per share, primarily reflecting share repurchases. In addition, the 2019 period was impacted by the loss on the sale of KMG recognized in 2018.
- Contributing to our Retail segment revenue growth was our individual Medicare Advantage membership, which increased 508,700 members, or 16.7%, from September 30, 2018 to September 30, 2019.
- Our operating cash flow of $4.8 billion for 2019 improved primarily from the timing of working capital changes, higher earnings, and the impact of an approximately $245 million payment related to reinsuring certain voluntary benefit and financial protection products to a third party in connection with the sale of KMG in 2018.
- On July 31, 2019, we entered into an accelerated stock repurchase agreement, the July 2019 ASR, with Citibank, N.A., or Citi, to repurchase $1 billion of our common stock. On August 2, 2019, we made a payment of $1 billion to Citi and received an initial delivery of 2.7 million shares of our common stock. We expect final settlement under the agreement to occur during the fourth quarter of 2019.
- In August 2019, we issued $500 million of 3.125% senior notes due August 15, 2029 and $500 million of 3.950% senior notes due August 15, 2049. Our net proceeds, reduced for the underwriters discount and commission and offering expenses paid as of September 30, 2019, were $987 million.
- During the third quarter of 2019, we initiated an involuntary workforce optimization program that will allow us to promote operational excellence, accelerate our strategy, fund critical initiatives and advance our growth objectives. As a result we recorded estimated charges of $46 million, or $0.26 per diluted common share, on the corporate level, included with operating costs in the condensed consolidated statements of income. We expect this liability to be primarily paid within 12 months and classified it as a current liability, included in trade accounts payable and accrued expenses.

### 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 was $14.3 billion in 2018 and was not deductible for income tax purposes, which significantly increased our effective income tax rate. A one year suspension of the health insurance industry fee, as we experienced in 2017 and are experiencing 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. The annual health insurance industry fee is scheduled to resume for calendar year 2020 under current law.

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, increases in member benefits or member eligibility criteria without corresponding increases in premium payments to us, or increases in regulation of our prescription drug benefit businesses, 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 and Group and Specialty segment customers and are described in Note 15 to the condensed consolidated financial statements included in this report.

### Comparison of Results of Operations for 2019 and 2018

The following discussion primarily deals with our results of operations for the three months ended September 30, 2019, or the 2019 quarter, the three months ended September 30, 2018, or the 2018 quarter, the nine months ended September 30, 2019, or the 2019 period, and the nine months ended September 30, 2018, or the 2018 period.

### Consolidated

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

| Revenues: Premiums: | For the three months ended September 30, 2019 | 2018 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Retail | $14,034 | $12,037 | $1,997 | 16.6% |
| Group and Specialty | 1,678 | 1,670 | 8 | 0.5% |
| Individual Commercial | — | 1 | (1) | (100.0)% |
| Other Businesses | — | 4 | (4) | (100.0)% |
| Total premiums | 15,712 | 13,712 | 2,000 | 14.6% |
| Services: |  |  |  |  |
| Retail | 4 | 1 | 3 | 300.0% |
| Group and Specialty | 200 | 215 | (15) | (7.0)% |
| Healthcare Services | 189 | 165 | 24 | 14.5% |
| Total services | 393 | 381 | 12 | 3.1% |
| Investment income | 136 | 113 | 23 | 20.4% |
| Total revenues | 16,241 | 14,206 | 2,035 | 14.3% |
| Operating expenses: |  |  |  |  |
| Benefits | 13,357 | 11,243 | 2,114 | 18.8% |
| Operating costs | 1,889 | 1,900 | (11) | (0.6)% |
| Depreciation and amortization | 127 | 102 | 25 | 24.5% |
| Total operating expenses | 15,373 | 13,245 | 2,128 | 16.1% |
| Income from operations | 868 | 961 | (93) | (9.7)% |
| Gain on sale of business | — | (4) | 4 | (100.0)% |
| Interest expense | 62 | 53 | 9 | 17.0% |
| Other (income) expense, net | (82) | 11 | (93) | (845.5)% |
| Income before income taxes and equity in net earnings | 888 | 901 | (13) | (1.4)% |
| Provision for income taxes | 200 | 266 | (66) | (24.8)% |
| Equity in net earnings of Kindred at Home | 1 | 9 | (8) | (88.9)% |
| Net income | $689 | $644 | $45 | 7.0% |
| Diluted earnings per common share | $5.14 | $4.65 | $0.49 | 10.5% |
| Benefit ratio (a) | 85.0% | 82.0% |  | 3.0% |
| Operating cost ratio (b) | 11.7% | 13.5% |  | (1.8)% |
| Effective tax rate | 22.5% | 29.1% |  | (6.6)% |

(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, 2019 | 2018 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Retail | $42,106 | $36,111 | $5,995 | 16.6% |
| Group and Specialty | 5,033 | 5,097 | (64) | (1.3)% |
| Individual Commercial | — | 6 | (6) | (100.0)% |
| Other Businesses | — | 22 | (22) | (100.0)% |
| Total premiums | 47,139 | 41,236 | 5,903 | 14.3% |
| Services: |  |  |  |  |
| Retail | 14 | 6 | 8 | 133.3% |
| Group and Specialty | 587 | 642 | (55) | (8.6)% |
| Healthcare Services | 502 | 438 | 64 | 14.6% |
| Other Businesses | — | 4 | (4) | (100.0)% |
| Total services | 1,103 | 1,090 | 13 | 1.2% |
| Investment income | 351 | 418 | (67) | (16.0)% |
| Total revenues | 48,593 | 42,744 | 5,849 | 13.7% |
| Operating expenses: |  |  |  |  |
| Benefits | 40,168 | 34,449 | 5,719 | 16.6% |
| Operating costs | 5,252 | 5,410 | (158) | (2.9)% |
| Depreciation and amortization | 343 | 302 | 41 | 13.6% |
| Total operating expenses | 45,763 | 40,161 | 5,602 | 13.9% |
| Income from operations | 2,830 | 2,583 | 247 | 9.6% |
| Loss on sale of business | — | 786 | (786) | (100.0)% |
| Interest expense | 184 | 159 | 25 | 15.7% |
| Other (income) expense, net | (217) | 11 | (228) | (2,072.7)% |
| Income before income taxes and equity in net earnings | 2,863 | 1,627 | 1,236 | 76.0% |
| Provision for income taxes | 684 | 308 | 376 | 122.1% |
| Equity in net earnings of Kindred at Home | 16 | 9 | 7 | 77.8% |
| Net income | $2,195 | $1,328 | $867 | 65.3% |
| Diluted earnings per common share | $16.24 | $9.58 | $6.66 | 69.5% |
| Benefit ratio (a) | 85.2% | 83.5% |  | 1.7% |
| Operating cost ratio (b) | 10.9% | 12.8% |  | (1.9)% |
| Effective tax rate | 23.8% | 18.8% |  | 5.0% |

(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 $689 million, or $5.14 per diluted common share, in the 2019 quarter compared to $644 million, or $4.65 per diluted common share, in the 2018 quarter. Net income was $2.2 billion, or $16.24 per diluted common share, in the 2019 period compared to $1.3 billion, or $9.58 per diluted common share, in the 2018 period. These increases were primarily impacted by our Medicare Advantage business and Healthcare Services segment, as well as by previously implemented productivity initiatives that led to significant operating cost efficiencies in 2019. These impacts were partially offset by strategic investments in our integrated care delivery model, the impact of higher compensation accruals for the AIP offered to employees across all levels of the company, lower Group and Specialty segment earnings, and the impact of workforce optimization. These changes were further favorably impacted by the suspension of the health industry insurance fee in 2019 and by a lower number of shares used to compute dilutive earnings per share, primarily reflecting share repurchases. In addition, the 2019 period was impacted by the loss on the sale of KMG recognized in 2018.

#### Premiums Revenue

Consolidated premiums increased $2.0 billion, or 14.6%, from the 2018 quarter to $15.7 billion for the 2019 quarter and increased $5.9 billion, or 14.3%, from the 2018 period to $47.1 billion for the 2019 period primarily due to higher premiums in the Retail segment, driven by higher premium revenues from out Medicare Advantage business resulting from membership growth and higher per member premiums. These increases were partially offset by the impact of declining stand-alone PDP membership year-over-year, as well as lower premiums in the Group and Specialty segment in the 2019 period as discussed in the detailed segment results discussion that follows.

#### Services Revenue

Consolidated services revenue increased $12 million, or 3.1%, from the 2018 quarter to $393 million for the 2019 quarter primarily due to an increase in services revenue in the Healthcare Services segment, partially offset by a decline in the Group and Specialty segment as detailed in the segment results discussion that follows. Consolidated services revenue was relatively unchanged at $1.10 billion for the 2019 period increasing $13 million, or 1.2%, from the 2018 period due to increased services revenue in the Healthcare Services segment, partially offset by a decline in the Group and Specialty segment as detailed in the segment results discussion that follows.

#### Investment Income

Investment income totaled $136 million for the 2019 quarter, increasing $23 million, or 20.4%, from $113 million for the 2018 quarter. This increase primarily reflects higher realized capital gains, higher average invested capital balances, and higher interest rates. For the 2019 period, investment income totaled $351 million, decreasing $67 million, or 16.0%, from $418 million in the 2018 period. This decrease primarily reflects lower realized capital gains and lower average invested balances, partially offset by higher interest rates.

#### Benefits Expense

Consolidated benefits expense was $13.4 billion for the 2019 quarter, an increase of $2.1 billion from the 2018 quarter. For the 2019 period, benefits expense was $40.2 billion, an increase of $5.7 billion from the 2018 period. The consolidated benefit ratio for the 2019 quarter of 85.0% increased 300 basis points from 82.0% in the 2018 quarter. The consolidated benefit ratio for the 2019 period increased 170 basis points to 85.2% from 83.5% in the 2018 period. These increases were primarily due to the suspension of the health insurance industry fee in 2019, which was contemplated in the pricing and benefit design of our products, lower favorable prior-period medical claims reserve development, an increase in the Group and Specialty benefit ratio as discussed in the detailed segment results discussion that follows, and the shift in Medicare membership mix, due to the loss of stand-alone PDP members and significant growth in Medicare Advantage members. These increases were partially offset by engaging our Medicare Advantage members in clinical programs, as well as ensuring they are appropriately documented under the CMS risk-adjustment model, and lower than expected medical costs as compared to the assumptions used in the pricing of our individual Medicare Advantage business for 2019. In addition, the 2019 quarter was significantly negatively impacted by weekday seasonality.

The favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 40 basis points in the 2019 quarter versus approximately 90 basis points in the 2018 quarter. The favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 70 basis points to 85.2% for the 2019 period compared to approximately 110 basis points to 83.5% for the 2018 period.

#### Operating Costs

Our segments incur both direct and shared indirect operating costs. We allocate the indirect costs shared by the segments primarily as a function of revenues. As a result, the profitability of each segment is interdependent.

Consolidated operating costs decreased $11 million, or 0.6%, during the 2019 quarter compared to the 2018 quarter and decreased $158 million, or 2.9%, during the 2019 period compared to the 2018 period. These decreases were primarily due to a decrease in operating costs in the Retail and the Group and Specialty segments as discussed in the detailed segment results discussion that follows.

The consolidated operating cost ratio for the 2019 quarter of 11.7% decreased 180 basis points from 13.5% in the 2018 quarter and for the 2019 period decreased 190 basis points to 10.9% from 12.8% in the 2018 period. These decreases were primarily due to the suspension of the health insurance industry fee in 2019, scale efficiencies associated with growth in our Medicare Advantage membership, and significant operating cost efficiencies in 2019 driven by previously implemented productivity initiatives. These improvements were partially offset by strategic investments in our integrated care delivery model, the impact of higher compensation expense accruals in the 2019 quarter for the AIP offered to employees across all levels, and charges associated with workforce optimization. The higher compensation accruals resulted from our continued strong performance, including customer satisfaction as measured by the net promoter score, along with higher than anticipated individual Medicare Advantage membership growth. The non-deductible health insurance industry fee impacted the operating cost ratio by 180 basis points in both the 2018 quarter and period.

#### Depreciation and Amortization

Depreciation and amortization for the 2019 quarter totaled $127 million compared to $102 million for the 2018 quarter. For the 2019 period, depreciation and amortization totaled $343 million compared to $302 million for the 2018 period. We accelerated the depreciation related to certain capitalized software of $19 million in the 2019 quarter and period.

#### Interest Expense

Interest expense for the 2019 quarter of $62 million increased $9 million, compared to $53 million for the 2018 quarter. Interest expense for the 2019 period of $184 million increased $25 million, compared to $159 million for the 2018 period. These increases were primarily due to the higher average borrowings outstanding including the impact of the borrowings under the November 2018 term loan agreement and senior notes issued in August 2019.

#### Income Taxes

The effective income tax rate was 22.5% and 23.8% for the three and nine months ended September 30, 2019, respectively, compared to 29.1% and 18.8% for the three and nine months ended September 30, 2018, respectively. These changes primarily reflect the impact of the suspension of the non-deductible health insurance industry fee in 2019 as well as the deferred tax benefit recognized in 2018 from the loss on sale of KMG. The effective income tax rate for the nine months ended September 30, 2018 reflected a $430 million deferred tax benefit, resulting from the loss on the sale of KMG attributable to its original tax basis and subsequent capital contributions to fund accumulated losses.

### Retail Segment

| Membership: Medical membership: | September 30, 2019 | 2018 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | 3,552,500 | 3,043,800 | 508,700 | 16.7% |
| Group Medicare Advantage | 523,900 | 496,800 | 27,100 | 5.5% |
| Medicare stand-alone PDP | 4,379,800 | 5,015,900 | (636,100) | (12.7)% |
| Total Retail Medicare | 8,456,200 | 8,556,500 | (100,300) | (1.2)% |
| State-based Medicaid | 469,000 | 323,800 | 145,200 | 44.8% |
| Medicare Supplement | 286,600 | 246,600 | 40,000 | 16.2% |
| Total Retail medical members | 9,211,800 | 9,126,900 | 84,900 | 0.9% |

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the three months ended September 30, 2019 | 2018 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | $10,752 | $8,912 | $1,840 | 20.6% |
| Group Medicare Advantage | 1,609 | 1,542 | 67 | 4.3% |
| Medicare stand-alone PDP | 781 | 893 | (112) | (12.5)% |
| Total Retail Medicare | 13,142 | 11,347 | 1,795 | 15.8% |
| State-based Medicaid | 742 | 561 | 181 | 32.3% |
| Medicare Supplement | 150 | 129 | 21 | 16.3% |
| Total premiums | 14,034 | 12,037 | 1,997 | 16.6% |
| Services | 4 | 1 | 3 | 300.0% |
| Total premiums and services revenue | $14,038 | $12,038 | $2,000 | 16.6% |
| **Segment earnings** | $639 | $634 | $5 | 0.8% |
| Benefit ratio | 85.9% | 83.2% |  | 2.7% |
| Operating cost ratio | 9.3% | 11.2% |  | (1.9)% |

46

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the nine months ended September 30, 2019 | 2018 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Individual Medicare Advantage | $32,254 | $26,790 | $5,464 | 20.4% |
| Group Medicare Advantage | 4,867 | 4,575 | 292 | 6.4% |
| Medicare stand-alone PDP | 2,408 | 2,703 | (295) | (10.9)% |
| Total Retail Medicare | 39,529 | 34,068 | 5,461 | 16.0% |
| State-based Medicaid | 2,143 | 1,664 | 479 | 28.8% |
| Medicare Supplement | 434 | 379 | 55 | 14.5% |
| Total premiums | 42,106 | 36,111 | 5,995 | 16.6% |
| Services | 14 | 6 | 8 | 133.3% |
| Total premiums and services revenue | $42,120 | $36,117 | $6,003 | 16.6% |
| **Segment earnings** | $1,960 | $1,394 | $566 | 40.6% |
| Benefit ratio | 86.4% | 85.4% |  | 1.0% |
| Operating cost ratio | 8.7% | 10.5% |  | (1.8)% |

#### Segment Earnings

- Retail segment earnings increased $5 million, or 0.8%, from $634 million in the 2018 quarter to $639 million in the 2019 quarter. Retail segment earnings increased $566 million, or 40.6%, from $1.4 billion in the 2018 period to $2.0 billion in the 2019 period. These increases primarily reflect the lower operating cost ratio, partially offset by the higher benefit ratio as more fully described below. As expected, the higher-than-anticipated individual Medicare Advantage membership growth during the previous Annual Election Period, or AEP, had a muted impact on the segment's earnings in the 2019 period. While new Medicare Advantage members increase revenue, on average, they have a break even impact on segment earnings in the first year as they were not previously engaged in a clinical programs or appropriately documented under the CMS risk-adjustment model, and accordingly, carry a higher benefit ratio.

#### Enrollment

- Individual Medicare Advantage membership increased 508,700 members, or 16.7%, from September 30, 2018 to September 30, 2019, primarily due to membership additions associated with the previous AEP and Open Election Period, or OEP, for Medicare beneficiaries. The OEP sales period, which ran from January 1 to March 31, added approximately 43,700 members. Since March 31, 2019, enrollment has continued to increase due to strong sales to age-ins and those eligible for Dual Eligible Special Need Plans, or D-SNP. Individual Medicare Advantage membership includes 280,700 D-SNP members as of September 30, 2019, a net increase of 69,300, or 32.8%, from 211,400 as of September 30, 2018.
- Group Medicare Advantage membership increased 27,100, or 5.5%, from September 30, 2018 to September 30, 2019, primarily due to net membership additions associated with the previous AEP for Medicare beneficiaries.
- Medicare stand-alone PDP membership decreased 636,100 members, or 12.7%, from September 30, 2018 to September 30, 2019 reflecting net declines during the previous AEP for Medicare beneficiaries. These anticipated declines were primarily due to the competitive nature of the industry and the pricing discipline we have employed, which resulted in us no longer being the low cost plan in any market for 2019.
- State-based Medicaid membership increased 145,200 members, or 44.8%, from September 30, 2018 to September 30, 2019, primarily driven by the statewide award of a comprehensive contract under the Managed Medical Assistance, or MMA, program in Florida.

#### Premiums Revenue

- Retail segment premiums increased $2.0 billion, or 16.6%, from the 2018 quarter to the 2019 quarter and increased $6.0 billion, or 16.6%, from the 2018 period to the 2019 period primarily due to Medicare Advantage membership growth and higher per member premiums, as well as increased state-based contracts membership. These favorable items were partially offset by the decline in membership in our stand-alone PDP offerings.

#### Benefits Expense

- The Retail segment benefit ratio increased 270 basis points from 83.2% in the 2018 quarter to 85.9% in the 2019 quarter primarily due to the suspension of the health insurance industry fee in 2019 which was contemplated in the pricing and benefit design of our products, the significant unfavorable impact in the 2019 quarter of weekday seasonality, lower favorable prior-period medical claims reserve development, as well as the shift in Medicare membership mix due to the loss of stand-alone PDP members and the significant growth in Medicare Advantage members. These increases were partially offset by engaging our Medicare Advantage members in clinical programs as well as ensuring they are appropriately documented under the CMS risk-adjustment model, and lower than expected medical costs as compared to the assumptions used in the pricing of our individual Medicare Advantage business for 2019. The Retail segment benefit ratio increased 100 basis points from 85.4% in the 2018 period to 86.4% in the 2019 period, primarily reflecting the same factors that affected the 2019 quarter described above, but excluding the impact of weekday seasonality. These factors were partially offset by the impact of a less severe flu season in the 2019 period.
- The Retail segment's benefits expense for the 2019 quarter included $55 million in favorable prior-period medical claims reserve development versus $120 million in the 2018 quarter. For the 2019 period, the benefits expense includes the beneficial effect of $366 million in favorable prior-period medical claims reserve development versus $367 million in the 2018 period. Prior-period medical claims reserve development decreased the Retail segment benefit ratio by approximately 40 basis points in the 2019 quarter versus approximately 100 basis points in the 2018 quarter. Favorable prior-period medical claims reserve development decreased the Retail segment benefit ratio by approximately 90 basis points in the 2019 period versus approximately 100 basis points in the 2018 period.

#### Operating Costs

- The Retail segment operating cost ratio of 9.3% for the 2019 quarter decreased 190 basis points from 11.2% for the 2018 quarter. The Retail segment operating cost ratio of 8.7% for the 2019 period decreased 180 basis points from 10.5% for the 2018 period. These decreases primarily were due to the suspension of the health insurance industry fee in 2019, as well as scale efficiencies associated with growth in our Medicare Advantage membership, and significant operating costs efficiencies in 2019 driven by previously implemented productivity initiatives. These decreases were partially offset by the strategic investments in our integrated care delivery model and the impact of higher compensation expense accruals in 2019 for the AIP as a result of our continued strong performance. The non-deductible health insurance industry fee impacted the operating cost ratio by 190 basis points in the 2018 quarter and period.

### Group and Specialty Segment

| Membership: Medical membership: | September 30, 2019 | 2018 | Change Members | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | 927,400 | 1,029,100 | (101,700) | (9.9)% |
| ASO | 516,800 | 449,900 | 66,900 | 14.9% |
| Military services | 5,998,700 | 5,927,400 | 71,300 | 1.2% |
| Total group and specialty medical members | 7,442,900 | 7,406,400 | 36,500 | 0.5% |
| Specialty membership (a) | 5,411,400 | 6,116,300 | (704,900) | (11.5)% |

(a) Specialty products include dental, vision, voluntary benefit products and other supplemental health. 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, 2019 | 2018 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | $1,278 | $1,345 | $(67) | (5.0)% |
| Group specialty | 400 | 325 | 75 | 23.1% |
| Total premiums | 1,678 | 1,670 | 8 | 0.5% |
| Services | 200 | 215 | (15) | (7.0)% |
| Total premiums and services revenue | $1,878 | $1,885 | $(7) | (0.4)% |
| **Segment earnings** | $4 | $81 | $(77) | (95.1)% |
| Benefit ratio | 86.3% | 80.7% |  | 5.6% |
| Operating cost ratio | 21.9% | 23.6% |  | (1.7)% |

49

*(in millions)*

| Premiums and Services Revenue: Premiums: | For the nine months ended September 30, 2019 | 2018 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Fully-insured commercial group | $3,873 | $4,083 | $(210) | (5.1)% |
| Group specialty | 1,160 | 1,014 | 146 | 14.4% |
| Total premiums | 5,033 | 5,097 | (64) | (1.3)% |
| Services | 587 | 642 | (55) | (8.6)% |
| Total premiums and services revenue | $5,620 | $5,739 | $(119) | (2.1)% |
| **Segment earnings** | $174 | $372 | $(198) | (53.2)% |
| Benefit ratio | 83.0% | 78.0% |  | 5.0% |
| Operating cost ratio | 21.9% | 23.6% |  | (1.7)% |

#### Segment Earnings

- Group and Specialty segment earnings decreased $77 million, or 95.1%, from $81 million in the 2018 quarter to $4 million in the 2019 quarter. Group and Specialty segment earnings decreased $198 million, or 53.2%, from $372 million in the 2018 period to $174 million in the 2019 period. These decreases were primarily due to a higher benefit ratio, along with lower military services business earnings. Earnings comparisons related to the military services business were unfavorably impacted by the receipt of certain contractual incentives and adjustments in 2018 related to the previous TRICARE contract which did not recur in 2019. These decreases were partially offset by the improvement in the operating cost ratio as more fully described below.

#### Enrollment

- Fully-insured commercial group medical membership decreased 101,700 members, or 9.9%, from September 30, 2018 to September 30, 2019 primarily reflecting lower membership in small group accounts due in part to more small group accounts selecting level-funded ASO products in 2019, as well as the loss of certain large group accounts due to the competitive pricing environment. The portion of group fully-insured commercial medical membership in small group accounts was approximately 60% at September 30, 2019 and 62% at September 30, 2018.
- Group ASO commercial medical membership increased 66,900 members, or 14.9%, from September 30, 2018 to September 30, 2019 reflecting more small group accounts selecting level-funded ASO products in 2019, 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 71,300 members, or 1.2%, from September 30, 2018 to September 30, 2019. Membership includes military service members, retirees, and their families to whom the company provides healthcare services under the current T2017 TRICARE East Region contract. The current contract, which covers 32 states, became effective on January 1, 2018.
- Specialty membership decreased 704,900 members, or 11.5%, from September 30, 2018 to September 30, 2019 primarily due to the loss of certain group accounts, including one jumbo account, offering stand-alone dental and vision products.

#### Premiums Revenue

- Group and Specialty segment premiums were relatively unchanged increasing $8 million, or 0.5%, from the 2018 quarter to $1.7 billion for the 2019 quarter. Group and Specialty segment premiums decreased $64 million, or 1.3%, from the 2018 period to $5.0 billion for the 2019 period, primarily due to a decline in our fully-insured group commercial and specialty membership. This decrease was partially offset by higher stop-loss revenues related to our level-funded ASO accounts resulting from membership growth in this product, higher per member premiums across the fully-insured business, and lower unfavorable commercial risk adjustment, or CRA, payable estimate in 2019 as compared to 2018, which resulted in higher small group fully-insured commercial revenues. The 2019 period was further negatively impacted by the exit of our voluntary benefit and financial protection products in connection with the sale of KMG in 2018.

#### Services Revenue

- Group and Specialty segment services revenue decreased $15 million, or 7.0%, from the 2018 quarter to $200 million for the 2019 quarter and decreased $55 million, or 8.6%, from the 2018 period to $587 million for the 2019 period primarily due to the impact of certain contractual incentives and adjustments related to the previous TRICARE contract received in 2018, which did not recur in 2019.

#### Benefits Expense

- The Group and Specialty segment benefit ratio increased 560 basis points from 80.7% in the 2018 quarter to 86.3% in the 2019 quarter. The Group and Specialty segment benefit ratio increased 500 basis points from 78.0% in the 2018 period to 83.0% in the 2019 period. These increases primarily were due to the significant unfavorable impact in the 2019 quarter of weekday seasonality, the suspension of the health insurance industry fee in 2019 which was contemplated in the pricing and benefit design of our products, as well as the meaningful impact of the continued migration of fully-insured group members to level-funded ASO products in 2019 resulting in a membership mix transformation. In addition, the impact of adjustments to dental network contracted rates resulting from dental network re-contracting and expansion to position the business for the future, and lower prior-period medical claims reserve development unfavorably impacted the 2019 quarter and period ratio. These items were partially offset by the smaller unfavorable premium adjustment in 2019 as compared to 2018 related to our CRA accrual associated with the ACA-compliant business as a result of the release of CMS's final 2018 CRA data.
- The Group and Specialty segment's benefits expense included $1 million in favorable prior-period medical claims reserve development in the 2019 quarter versus $7 million in the 2018 quarter. This favorable prior-period medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 10 basis points in the 2019 quarter and approximately 40 basis points in the 2018 quarter. The Group and Specialty segment's benefits expense included the effect of an unfavorable prior-period medical claims reserve development of $35 million in the 2019 period versus favorable prior-period medical claims reserve development of $41 million in the 2018 period. The unfavorable prior-period medical claims reserve development for the 2019 period increased the Group and Specialty segment benefit ratio by approximately 70 basis points and the favorable prior-period medical claims reserve development for the 2018 period decreased the Group and Specialty segment benefit ratio 80 basis points.

#### Operating Costs

- The Group and Specialty segment operating cost ratio of 21.9% for the 2019 quarter decreased 170 basis points from 23.6% for the 2018 quarter. For the 2019 period, the Group and Specialty segment operating cost ratio of 21.9% decreased 170 basis points from 23.6% for the 2018 period. These decreases primarily were due to the suspension of the health insurance industry fee in 2019, as well as significant operating cost efficiencies in the 2019 quarter driven by previously implemented productivity initiatives. These improvements were offset by the higher compensation expense accruals in 2019 for the AIP as a result of our continued strong performance. The 2019 period was further impacted by the exit of our voluntary benefit and financial protection products in connection with the sale of KMG in 2018, which carried a higher operating cost ratio. The non-

deductible health insurance industry fee impacted the operating cost ratio by 160 basis points in the 2018 quarter and period.

### Healthcare Services Segment

*(in millions)*

| Revenues: Services: | For the three months ended September 30, 2019 | 2018 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Provider services | $104 | $70 | $34 | 48.6% |
| Pharmacy solutions | 53 | 52 | 1 | 1.9% |
| Clinical care services | 32 | 43 | (11) | (25.6)% |
| Total services revenues | 189 | 165 | 24 | 14.5% |
| Intersegment revenues: |  |  |  |  |
| Pharmacy solutions | 5,673 | 5,092 | 581 | 11.4% |
| Provider services | 591 | 537 | 54 | 10.1% |
| Clinical care services | 149 | 161 | (12) | (7.5)% |
| Total intersegment revenues | 6,413 | 5,790 | 623 | 10.8% |
| Total services and intersegment revenues | $6,602 | $5,955 | $647 | 10.9% |
| **Segment earnings** | $212 | $215 | $(3) | (1.4)% |
| Operating cost ratio | 96.2% | 96.1% |  | 0.1% |

*(in millions)*

| Revenues: Services: | For the nine months ended September 30, 2019 | 2018 | Change Dollars | Percentage |
| --- | ---: | ---: | ---: | ---: |
| Provider services | $265 | $158 | $107 | 67.7% |
| Pharmacy solutions | 134 | 148 | (14) | (9.5)% |
| Clinical care services | 103 | 132 | (29) | (22.0)% |
| Total services revenues | 502 | 438 | 64 | 14.6% |
| Intersegment revenues: |  |  |  |  |
| Pharmacy solutions | 16,335 | 15,181 | 1,154 | 7.6% |
| Provider services | 1,792 | 1,456 | 336 | 23.1% |
| Clinical care services | 457 | 511 | (54) | (10.6)% |
| Total intersegment revenues | 18,584 | 17,148 | 1,436 | 8.4% |
| Total services and intersegment revenues | $19,086 | $17,586 | $1,500 | 8.5% |
| **Segment earnings** | $611 | $594 | $17 | 2.9% |
| Operating cost ratio | 96.3% | 96.2% |  | 0.1% |

#### Segment Earnings

- Healthcare Services segment earnings of $212 million for the 2019 quarter was relatively unchanged, decreasing $3 million, or 1.4%, from $215 million in the 2018 quarter. The decrease primarily resulted from

additional investments in clinical assets associated with our provider services business and slightly lower earnings from Kindred at Home operations. These declines were partially offset by higher earnings from our pharmacy operations and the improvement in core operating results from the provider services business year over year. For the 2019 period, the Healthcare Services segment earnings of $611 million increased $17 million, or 2.9%, from $594 million in the 2018 period. This increase was primarily due to higher earnings from our pharmacy and clinical care services operations and 2019 earnings from Kindred at Home operations. These factors were partially offset by additional investments in new clinical assets associated with our provider services business.

#### Script Volume

- Humana Pharmacy Solutions script volumes on an adjusted 30-day equivalent basis increased to approximately 116 million in the 2019 quarter, up 5.5%, versus scripts of approximately 110 million in the 2018 quarter. For the 2019 period, script volumes increased to approximately 339 million, up 3.4%, versus scripts of approximately 328 million in the 2018 period. These increases primarily reflect growth associated with higher individual Medicare Advantage membership, partially offset by the decline in stand-alone PDP membership.

#### Services Revenues

- Services revenues increased $24 million, or 14.5%, from the 2018 quarter to $189 million for the 2019 quarter and increased $64 million, or 14.6%, from the 2018 period to $502 million for the 2019 period primarily due to revenue growth from our provider services business.

#### Intersegment Revenues

- Intersegment revenues increased $623 million, or 10.8%, from the 2018 quarter to $6.4 billion for the 2019 quarter and increased $1.4 billion, or 8.4%, from the 2018 period to $18.6 billion for the 2019 period. These increases primarily were due to strong Medicare Advantage membership growth, partially offset by the loss of intersegment revenues associated with the decline in stand-alone PDP membership. The 2019 period was further impacted by higher revenues associated with our provider services business reflecting the previously disclosed acquisition of MCCI and FPG.

#### Operating Costs

- The Healthcare Services segment operating cost ratio of 96.2% and 96.3% for the 2019 quarter and period, respectively, were relatively unchanged from 96.1% and 96.2% in the 2018 quarter and period, respectively.

### 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, and borrowings. 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 2018 Form 10-K.

Cash and cash equivalents increased to approximately $5.5 billion at September 30, 2019 from $2.3 billion at December 31, 2018. The change in cash and cash equivalents for the nine months ended September 30, 2019 and 2018 is summarized as follows:

*(in millions)*

|  | Nine Months Ended 2019 | 2018 |
| --- | ---: | ---: |
| Net cash provided by operating activities | $4,772 | $2,506 |
| Net cash used in investing activities | (477) | (2,640) |
| Net cash (used in) provided by financing activities | (1,111) | 234 |
| Increase in cash and cash equivalents | $3,184 | $100 |

### Cash Flow from Operating Activities

Our operating cash flow for the 2019 period reflects the significant impact of increasing premiums and enrollment, as premiums generally are collected in advance of claim payments by a period of up to several months. Our operating cash flow for the 2019 period further improved from the 2018 period from the timing of working capital changes, higher earnings, and the impact of an approximately $245 million payment related to reinsuring certain voluntary benefit and financial protection products to a third party in connection with the sale of KMG in 2018.

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, 2019 and December 31, 2018:

*(in millions)*

|  | September 30, 2019 | December 31, 2018 | 2019 Period Change | 2018 Period Change |
| --- | ---: | ---: | ---: | ---: |
| IBNR (1) | $4,017 | $3,361 | $656 | $145 |
| Reported claims in process (2) | 1,084 | 617 | 467 | 169 |
| Other benefits payable (3) | 1,119 | 884 | 235 | 38 |
| Total benefits payable | $6,220 | $4,862 | $1,358 | $352 |
| Payables from divestiture |  |  | — | 58 |
| Change in benefits payable per cash flow statement resulting in cash from operations |  |  | $1,358 | $410 |

(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, 2018 to September 30, 2019 and from December 31, 2017 to September 30, 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, 2018 to September 30, 2019 was also impacted by an increase in the amounts owed to providers under the capitated and risk sharing arrangements.

The detail of total net receivables was as follows at September 30, 2019 and December 31, 2018:

*(in millions)*

|  | September 30, 2019 | December 31, 2018 | 2019 Period Change | 2018 Period Change |
| --- | ---: | ---: | ---: | ---: |
| Medicare | $638 | $836 | $(198) | $233 |
| Commercial and other | 152 | 135 | 17 | 19 |
| Military services | 131 | 123 | 8 | (48) |
| Allowance for doubtful accounts | (73) | (79) | 6 | 4 |
| Total net receivables | $848 | $1,015 | $(167) | $208 |
| Reconciliation to cash flow statement: |  |  |  |  |
| Receivables from acquisition of business |  |  | (12) | 3 |
| Change in receivables per cash flow statement resulting in cash from operations |  |  | $(179) | $211 |

The changes in Medicare receivables for both the 2019 period and the 2018 period reflects 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

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 $506 million in the 2019 period and $436 million in the 2018 period.

Net proceeds from investment securities sales and maturities in the 2019 period were $29 million and $50 million in the 2018 period.

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.

Also, in the third quarter of 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.

During the 2018 period, we acquired the remaining equity interest in MCCI and acquired FPG for cash consideration of $169 million and $185 million, respectively, as discussed in Note 3 to the condensed consolidated financial statements.

### 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 $113 million in the 2019 period and $436 million in the 2018 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 $102 million in the 2019 period and by $33 million in the 2018 period.

In August 2019, we issued $500 million of 3.125% senior notes due August 15, 2029 and $500 million of 3.950% senior notes due August 15, 2049. Our net proceeds, reduced for the underwriters' discount and commission and offering expenses paid as of September 30, 2019 were $987 million.We used the net proceeds from this offering, together with available cash, to repay the $650 million outstanding amount due under our term note in August 2019, and the $400 million aggregate principal amount of our 2.625% senior notes due on its maturity date of October 1, 2019.

On July 31, 2019, we entered into an accelerated stock repurchase agreement, the July 2019 ASR, with Citibank, N.A., or Citi, to repurchase $1 billion of our common stock. On August 2, 2019, we made a payment of $1 billion to Citi and received an initial delivery of 2.7 million shares of our common stock. See Note 11 to our condensed consolidated financial statements. We expect final settlement under the agreement to occur during the fourth quarter of 2019.

Under a share repurchase plan authorized by the Board of Directors, we repurchased 0.68 million shares during the 2018 period for $224 million. There were no other share repurchases under share repurchase plans authorized by the Board of Directors in the 2019 period with the exception of the July 2019 ASR. We also acquired common shares in connection with employee stock plans for an aggregate cost of $10 million in the 2019 period and $70 million in the 2018 period.

Net repayments of commercial paper were $358 million in the 2019 period and net proceeds from the issuance of commercial paper were $240 million in the 2018 period. The maximum principal amount outstanding at any one time during the 2019 quarter was $670 million.

We paid dividends to stockholders of $216 million during the 2019 period and $195 million during the 2018 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

During the 2018 period, we completed the acquisitions of MCCI and FPG for total cash consideration of $354 million. 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, 2019 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 $1.7 billion at September 30, 2019 compared to $578 million at December 31, 2018. 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 subsidiary earnings, borrowings under senior notes, and other working capital changes. These increases were partially offset by the net repayment of commercial paper borrowings, repayment of short term debt and senior notes, share repurchases, capital expenditures, subsidiaries capital contributions, and cash dividends to shareholders. 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. If the dividend, together with other dividends paid within the preceding twelve months, exceeds a specified statutory limit or is paid from sources other than earned surplus, it is generally considered an extraordinary dividend requiring prior regulatory approval. 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, 2019, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $7.6 billion, which exceeded aggregate minimum regulatory requirements of $5.7 billion. The amount of dividends paid to our parent company was approximately $1.4 billion during the nine months ended September 30, 2019 compared to $1.9 billion during the nine months ended September 30, 2018. 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, 2,227 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, 2019. Our net unrealized position increased $447 million from a net unrealized loss position of $204 million at December 31, 2018 to a net unrealized gain position of $243 million at September 30, 2019. At September 30, 2019, we had gross unrealized losses of $10 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, 2019. 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 2.3 years as of September 30, 2019 and approximately 2.9 years as of December 31, 2018. 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, 2019.

## 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, 2019.

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, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Filed Nov 6, 2019.
Source: SEC EDGAR, the filing index for accession 0000049071-19-000105. Last ingested by Listed: Nov 6, 2026, 14:15 ET. No prices; not investment advice.