Humana Inc: Form 10-Q for the period ended Jun 30, 2021

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 2020 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 18, 2021, 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.

Kindred at Home Acquisition

On April 27, 2021, we entered into a definitive agreement to acquire the remaining 60% interest in Kindred at Home, or KAH, the nation’s largest home health and hospice provider, from TPG Capital, the private equity platform of global alternative asset firm, or TPG, and Welsh, Carson, Anderson & Stowe, or WCAS, two private equity funds, or the Sponsors, for an enterprise value of $8.1 billion, which includes our existing equity value of $2.4 billion associated with our 40% minority ownership interest. KAH has locations in 40 states, providing extensive geographic coverage with approximately 65% overlap with our individual Medicare Advantage membership. The acquisition, which is expected to close in the third quarter of 2021, is subject to customary state and federal regulatory approvals. We expect to fund the approximate $5.7 billion transaction (net of our existing equity stake) through a combination of parent company cash, debt financing, and the assumption of existing KAH indebtedness. A mark to market gain on our existing 40% ownership interest, currently expected to approximate $1 billion, will be recorded upon closing of the transaction.

COVID-19

The emergence and spread of the novel coronavirus, or COVID-19, beginning in the first quarter of 2020 has impacted our business. During periods of increased incidences of COVID-19, non-essential care from a reduction in non-COVID-19 hospital admissions and lower overall healthcare system consumption decreased utilization. Likewise COVID-19 treatment and testing cost increased utilization. The significant disruption in utilization during 2020 also impacted our ability to implement clinical initiatives to manage health care costs and chronic conditions of our members, and appropriately document their risk profiles, and, as such, affecting our 2021 revenue under the risk adjustment payment model for Medicare Advantage plans.

Business Segments

We manage our business with three reportable segments: Retail, Group and Specialty, and Healthcare Services. 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 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 non-consolidating minority investment in Kindred at Home and the strategic partnership with WCAS to develop and operate senior-focused, payor-agnostic, primary care centers.

The results of each segment are measured by segment earnings, and for our Healthcare Services Segment, also include equity in net earnings from our equity method investees. 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

COVID-19 disrupted the pattern of our quarterly earnings and operating cash flows largely due to the temporary deferral of non-essential care which resulted in reductions in non-COVID-19 hospital admissions and lower overall healthcare system utilization during higher levels of COVID-19 hospital admissions. Likewise, during periods of increased incidences of COVID-19, COVID-19 treatment and testing costs increase. Similar impacts and seasonal disruptions from either higher or lower utilization are expected to persist as we respond to and recover from the COVID-19 global health crisis.

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 standalone 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.

2021 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 June 30, 2021, approximately 2,914,300 members, or 67%, of our individual Medicare Advantage members were in value-based relationships under our integrated care delivery model, as compared to 2,552,300 members, or 66%, at June 30, 2020. Medicare Advantage and dual demonstration program membership enrolled in a Humana care management program was 947,400 at June 30, 2021, an increase of 5.1% from 901,000 at June 30, 2020. These members may not be unique to each program since members have the ability to enroll in multiple programs. The increase is primarily driven by growth in Special Needs Plans, or SNP, membership, partially offset by improved predictive modeling leading to a reduction in members being managed by legacy care management programs.
• Net income was $588 million, or $4.55 per diluted common share, and $1.8 billion, or $13.75, for the three months ended June 30, 2021, and 2020, respectively. Net income was $1.4 billion, or $10.94 per diluted common share, and $2.3 billion, or $17.31 per diluted common share for the six months ended June 30, 2021, and 2020, respectively. This comparison was significantly impacted by the put/call valuation adjustments associated with certain equity method investments, the change in the fair value of publicly-traded equity securities, and transaction and integration costs associated with the pending Kindred at Home acquisition. The put/call valuation adjustments included the impact of the termination of the put/call agreement related to Kindred at Home as a result of the transaction announced on April 27, 2021. The impact of these adjustments to our consolidated income before income taxes and equity in net earnings and diluted earnings per common share was as follows for the 2021 quarter and period.

Excluding these adjustments, comparisons of our results of operations were materially impacted by the significant, temporary deferral of care in 2020 resulting from stay-at-home orders, physical distancing measures, and other restrictions implemented to reduce the spread of COVID-19, as well as the impact of COVID-19 testing and treatment costs, which on a net basis significantly and favorably impacted the 2020 quarter and period results when compared to the 2021 quarter and period results.

In addition, our results of operations for 2021 were favorably impacted by individual Medicare Advantage and state-based contract membership growth and improved operating performance in the Group and Specialty and Healthcare Services segments. Further, 2021 was also favorably impacted by the lower tax rate resulting from the termination of the non-deductible health insurance industry fee in 2021, as well as a lower number of shares used to compute dilutive earnings per common share, primarily reflecting share repurchases.

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, which was not deductible for income tax purposes and significantly increased our effective tax rate, was in effect for 2020, but was permanently repealed beginning in calendar year 2021.

It is reasonably possible that the Health Care Reform Law and related regulations, as well as other current or future legislative, judicial or regulatory changes such as the Families First Coronavirus Response Act (the "Families First Act"), the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") and other legislative or regulatory action taken in response to COVID-19 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 changes to 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 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 14 to the condensed consolidated financial statements included in this report.

Comparison of Results of Operations for 2021 and 2020

The following discussion primarily deals with our results of operations for the three months ended June 30, 2021, or the 2021 quarter, and the three months ended June 30, 2020, or the 2020 quarter, the six months ended June 30, 2021, or the 2021 period, and the six months ended June 30, 2020, or the 2020 period.

Consolidated

(dollars in millions, except per common share results)

38

(dollars in millions, except per common share results)

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

(b) Represents operating costs as a percentage of total revenues less investment income.

Premiums Revenue

Consolidated premiums increased $1.4 billion, or 7.7%, from $18.6 billion in the 2020 quarter to $20.0 billion in the 2021 quarter and increased $3.2 billion, or 8.6%, from $36.9 billion in the 2020 period to $40.1 billion in the 2021 period. These increases were primarily due to individual Medicare Advantage and state-based contracts membership growth, as well as higher per member individual Medicare Advantage premiums as a result of the improving CMS benchmark rate for 2021, net of Medicare Risk Adjustment, or MRA, headwinds resulting from COVID-19 related utilization disruption in 2020. These increases were partially offset by declining stand-alone PDP, group commercial medical, and group Medicare Advantage membership. The 2021 period was further impacted by the Medicare sequestration relief in the first quarter of 2021 that was not enacted until the second quarter of 2020.

Consolidated services revenue increased $41 million, or 9.1%, from $450 million in the 2020 quarter to $491 million in the 2021 quarter and increased $83 million, or 9.5%, from $874 million in the 2020 period to $957 million in the 2021 period. These increases were primarily due to higher revenues associated with our pharmacy and provider businesses. The 2021 period further reflects additional pharmacy revenues associated with the acquisition of Enclara which was closed during the first quarter of 2020.

Investment Income

Investment income increased $99 million, or 128.6%, from $77 million in the 2020 quarter to $176 million in the 2021 quarter primarily reflecting changes in the fair value of our common stock investments and higher realized capital gains, partially offset by lower average invested balances. Investment income increased $28 million, or 12.4%, from $226 million in the 2020 period to $254 million in the 2021 period primarily reflecting higher realized capital gains, partially offset by changes in the fair value of our common stock investments and lower average invested balances.

Benefit Expense

Consolidated benefits expense increased $3.0 billion, or 21.0%, from $14.2 billion in the 2020 quarter to $17.1 billion in the 2021 quarter and increased $4.6 billion, or 15.6%, from $29.8 billion in the 2020 period to $34.4 billion in the 2021 period. The consolidated benefit ratio increased 940 basis points from 76.4% for the 2020 quarter to 85.8% for the 2021 quarter and increased 520 basis points from 80.7% for the 2020 period to 85.9% for the 2021 period. These increases reflect the significant impact of the deferral of non-essential care, net of COVID-19 treatment and testing costs and our pandemic relief efforts in 2020, amid the COVID-19 pandemic, and the termination in 2021 of the non-deductible health insurance industry fee which, along with a portion of the related tax benefit, was contemplated in the pricing and benefit design of our products. The increases were also due to the impact in 2021 associated with the competitive nature of the group Medicare Advantage business, particularly in large group accounts that were recently procured, as well as in the stand-alone PDP business. These factors were partially offset by higher favorable prior-period medical claims reserve development in 2021.

The higher favorable prior-period medical claims reserve development was primarily attributable to the reversal of actions taken in 2020, including the suspension of certain financial recovery programs for a period of time. The suspension during 2020 was intended to provide financial and administrative relief for provider facing unprecedented strain as a result of the COVID-19 pandemic. The favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 80 basis points in the 2021 quarter whereas the unfavorable prior-period medical claims reserve development increased the consolidated benefit ratio by approximately 30 basis points in the 2020 quarter. The favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 180 basis points in the 2021 period versus approximately 60 basis points in the 2020 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 $238 million, or 10.1%, from $2.4 billion in the 2020 quarter to $2.1 billion in the 2021 quarter and decreased $348 million, or 7.8%, from $4.5 billion in the 2020 period to $4.1 billion in the 2021 period. The consolidated operating cost ratio decreased 210 basis points from 12.4% for the 2020 quarter to 10.3% for the 2021 quarter and decreased 180 basis points from 11.8% for the 2020 period to 10.0% for the 2021 period. These decreases were primarily due to the termination of the non-deductible health insurance industry fee in 2021, the impact of a $150 million contribution in the 2020 quarter to the Humana Foundation to support communities served by us particularly those with social and health disparities, as well as the impact of lower COVID-19 related administrative costs in 2021 compared to 2020. Administrative costs in 2020 included costs associated with personal protective equipment, member response efforts, and the build-out of infrastructure necessary to support employees working remotely. These decreases were further impacted by scale efficiencies associated with growth in our Medicare Advantage membership and operating cost efficiencies in 2021 from previously implemented productivity initiatives. These factors were partially offset by continued strategic investments made to position us for long-term success. The non-deductible health insurance industry fee impacted the operating cost ratio by 150 basis points in the 2020 quarter and by 160 basis points in the 2020 period.

Depreciation and Amortization

Depreciation and amortization increased $25 million, or 21.0%, from $119 million in the 2020 quarter to $144 million in the 2021 quarter and increased $52 million, or 22.2%, from $234 million in the 2020 period to $286 million in the 2021 period primarily due to capital expenditures.

Interest Expense

Interest expense increased $3 million, or 3.9%, from $76 million in the 2020 quarter to $79 million in the 2021 quarter and increased $11 million, or 8.1%, from $136 million in the 2020 period to $147 million in the 2021 period.

Income Taxes

The effective income tax rate was 23.7% and 30.0% for the three months ended June 30, 2021, and 2020, respectively and was 22.7% and 31.0% for the six months ended June 30, 2021, and 2020, respectively. The decreases were primarily due to the termination of the non-deductible health insurance industry fee in 2021.

Retail Segment

41

(in millions)

(in millions)

Segment Earnings

• Retail segment earnings decreased $1.2 billion, or 58.0%, from $2.0 billion in the 2020 quarter to $836 million in the 2021 quarter and decreased $1.0 billion, or 39.0%, from $2.7 billion in the 2020 period to $1.6 billion in the 2021 period. These decreases primarily resulted from the same factors that led to the segment's higher benefit ratio, partially offset by the segment's lower operating cost ratio as more fully described below.

Enrollment

• Individual Medicare Advantage membership increased 464,400 members, or 12.0%, from June 30, 2020 to June 30, 2021, primarily due to membership additions associated with the most recent Annual Election Period, or AEP, and Open Election Period, or OEP, for Medicare beneficiaries. The membership growth was further impacted by continued enrollment resulting from special elections, age-ins, and Dual Eligible Special Need Plans, or D-SNP, members. The OEP sales period, which ran from January 1 to March 31, 2021 added approximately 36,000 members compared to the 2020 OEP that added approximately 30,000 members. Individual Medicare Advantage membership includes 532,900 D-SNP members as of June 30, 2021, a net increase of 167,600, or 45.9%, from 365,300 as of June 30, 2020.
• Group Medicare Advantage membership decreased 51,000, or 8.4%, from June 30, 2020 to June 30, 2021, primarily due to the net loss of certain large accounts in January 2021, partially offset by continued growth in small group accounts.
• Medicare stand-alone PDP membership decreased 235,300 members, or 6.1%, from June 30, 2020 to June 30, 2021, primarily due to anticipated declines as a result of the Walmart Value plan no longer being the low cost leader in 2021.
• State-based Medicaid membership increased 188,100 members, or 27.3%, from June 30, 2020 to June 30, 2021, primarily reflecting additional enrollment resulting from the economic downturn due to the COVID-19 pandemic, as well as the recently completed acquisition in Wisconsin.

Premiums Revenue

• Retail segment premiums increased $1.5 billion, or 9.1%, from $16.9 billion in the 2020 quarter to $18.5 billion in the 2021 quarter and increased $3.4 billion, or 10.2%, from $33.6 billion in the 2020 period to $37.1 billion in the 2021 period. These increases were primarily due to higher premiums as a result of individual Medicare Advantage and state-based contracts membership growth and higher per member individual Medicare Advantage premiums as a result of the improving CMS benchmark rate for 2021, net of MRA headwinds resulting from COVID-19 related utilization disruption in 2020. These favorable items were partially offset by the decline in membership in our stand-alone PDP and group Medicare Advantage offerings. The 2021 period was further impacted by the Medicare sequestration relief in the first quarter of 2021 that was not enacted until the second quarter of 2020.

Benefits Expense

• The Retail segment benefit ratio increased 870 basis points from 78.3% for the 2020 quarter to 87.0% for the 2021 quarter and increased 490 basis points from 82.4% for the 2020 period to 87.3% for the 2021 period. These increases were primarily due to the significant impact of the deferral of non-essential care, net of COVID-19 treatment and testing costs and our pandemic relief efforts in the 2020 quarter, amid the COVID-19 pandemic. These comparisons were further impacted by the termination in 2021 of the non-deductible health insurance industry fee which, along with a portion of the related tax benefit, was contemplated in the pricing and benefit design of our products, as well as the impact in 2021 associated with the competitive nature of the group Medicare Advantage business, particularly in large group accounts that were recently procured, as well as in the stand-alone PDP business. These factors were partially offset by higher favorable prior-period medical claims reserve development.
• The Retail segment's benefits expense for the 2021 quarter includes $156 million in favorable prior-period medical claims reserve development versus $33 million in unfavorable prior-period medical claims development in the 2020 quarter. For the 2021 period, the Retail segment’s benefit expense includes the beneficial effect of $619 million in favorable prior-period medical claims reserve development versus $205 million in the 2020 period. Prior-period medical claims reserve development decreased the Retail segment's benefit ratio by approximately 80 basis points in the 2021 quarter but increased the Retail segment's benefit ratio by approximately 20 basis points in the 2020 quarter. Favorable prior-period medical claims reserve

development decreased the Retail segment benefit ratio by approximately 170 basis points in the 2021 period versus approximately 60 basis points in the 2020 period.

Operating Costs

• The Retail segment operating cost ratio decreased 140 basis points from 9.7% for the 2020 quarter to 8.3% for the 2021 quarter and decreased 140 basis points from 9.4% for the 2020 period to 8.0% for the 2021 period. These decreases were primarily due to the termination of the non-deductible health insurance industry fee in 2021, lower COVID-19 related administrative costs in the 2021 quarter, as previously discussed, scale efficiencies associated with growth in our individual Medicare Advantage membership, and operating cost efficiencies in the 2021 quarter driven by previously implemented productivity initiatives. These improvements were partially offset by continued strategic investments made to position us for long-term success. The non-deductible health insurance industry fee impacted the operating cost ratio by 160 basis points in the 2020 quarter and period.

Group and Specialty Segment

(a) Specialty products include dental, vision, 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)

44

(in millions)

Segment Earnings

• Group and Specialty segment earnings decreased $247 million, or 86.1%, from $287 million in the 2020 quarter to $40 million in the 2021 quarter and decreased $178 million, or 45.4%, from $392 million in the 2020 period to $214 million in the 2021 period. These decreases were primarily due the same factors that led to the segment's higher benefit ratio.

Enrollment

• Fully-insured commercial group medical membership decreased 114,700 members, or 14.0%, from June 30, 2020 to June 30, 2021 reflecting lower small group quoting activity and sales attributable to depressed economic activity from the COVID-19 pandemic, partially offset by higher retention of existing customers, particularly in larger groups. The portion of group fully-insured commercial medical membership in small group accounts was approximately 52% at June 30, 2021 and 57% at June 30, 2020.
• Group ASO commercial medical membership decreased 8,400 members, or 1.7%, from June 30, 2020 to June 30, 2021. Small group membership comprised 45% of group ASO medical membership at June 30, 2021 and 45% at June 30, 2020. The membership change reflects intensified competition for small group accounts, partially offset by strong retention among large group accounts.
• Military services membership increased 5,200 members, or 0.1%, from June 30, 2020 to June 30, 2021. Membership includes military service members, retirees, and their families to whom we are providing healthcare services under the current TRICARE East Region contract.
• Specialty membership decreased 17,400 members, or 0.3%, from June 30, 2020 to June 30, 2021 due primarily to the loss of dental and vision groups cross-sold with medical, as reflected in the loss of group fully-insured commercial medical membership described above, as well as the loss of certain groups with stand-alone dental and vision. The decrease also reflects the impact of the economic downturn driven by the COVID-19 pandemic.

Premiums Revenue

• Group and Specialty segment premiums decreased $123 million, or 7.5%, from $1.6 billion in the 2020 quarter to $1.5 billion in the 2021 quarter and decreased $248 million, or 7.5%, from $3.3 billion in the 2020 period to $3.0 billion in the 2021 period. These decreases were primarily due to the decline in our fully-insured group commercial membership, partially offset by higher per member premiums across the fully-insured commercial business.

Services Revenue

• Group and Specialty segment services revenue increased $2 million, or 1.0%, from $192 million in the 2020 quarter to $194 million in the 2021 quarter and decreased $3 million, or 0.8%, from $387 million in the 2020 period to $384 million in the 2021 period.

Benefits Expense

• The Group and Specialty segment benefit ratio increased 1,560 basis points from 67.0% in the 2020 quarter to 82.6% in the 2021 quarter and increased 550 basis points from 73.1% in the 2020 period to 78.6% in the 2021 period. These increases were primarily due to the significant impact of the deferral of non-essential care, net of COVID-19 treatment and testing costs and our pandemic relief efforts in the 2020 quarter, amid the COVID-19 pandemic, and the termination in 2021 of the non-deductible health insurance industry fee in which, along with a portion of the related tax benefit, was contemplated in the pricing and benefit design of our products. These increases were partially offset by higher favorable prior-period medical claims reserve development, as well as deliberate pricing and benefit design efforts to increase profitability and position the commercial business for long-term success.
• The Group and Specialty segment's benefits expense included $8 million in favorable prior-period medical claims reserve development in the 2021 quarter versus $16 million in unfavorable prior-period medical claims reserve development in the 2020 quarter. This prior-period medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 50 basis points in the 2021 quarter but increased the Group Specialty segment benefit ratio by approximately 100 basis points in the 2020 quarter. The Group and Specialty segment's benefits expense included the effect of a favorable prior-period medical claims reserve development of $100 million in the 2021 period versus $30 million in the 2020 period. The favorable prior period medical claims reserve development for the 2021 period decreased the Group and Specialty segment benefit ratio by approximately 330 basis points and 90 basis points in the 2020 period.

Operating Costs

• The Group and Specialty segment operating cost ratio increased 10 basis points from 23.8% for the 2020 quarter to 23.9% for the 2021 quarter primarily reflecting the continued strategic investments made to position us for long-term success. The impact of the strategic investments was partially offset by the termination of the non-deductible health insurance industry fee in 2021, lower COVID-19 related administrative costs in 2021, as previously discussed, and operating cost efficiencies driven by previously implemented productivity initiatives. The Group and Specialty segment operating cost ratio was unchanged from 23.4% for the 2020 period. The non-deductible health insurance industry fee impacted the operating cost ratio by 130 basis points in the 2020 quarter and period.

Healthcare Services Segment

(in millions)

(in millions)

Segment Earnings

• Healthcare Services segment earnings decreased $6 million, or 1.9%, from $317 million in the 2020 quarter to $311 million in the 2021 quarter resulting from the same factors that led to the segment's increased operating cost ratio in the 2021 quarter, partially offset by higher earnings from equity method investments. Healthcare Services segment earnings increased $13 million, or 2.3%, from $567 million in the 2020 period

to $580 million in the 2021 period primarily due to improved operating performance in the provider business, as well as higher earnings from equity method investments.

Script Volume

• Humana Pharmacy Solutions script volumes on an adjusted 30-day equivalent basis increased to approximately 129 million in the 2021 quarter, up 11.2%, versus scripts of approximately 116 million in the 2020 quarter. For the 2021 period, script volumes increased to approximately 255 million, up 7.8%, versus scripts of approximately 236 million in the 2020 period. These increases were primarily due to higher individual Medicare Advantage and state-based contracts membership, partially offset by the decline in stand-alone PDP and group Medicare Advantage membership and the impact of early prescription refills in the second quarter of 2020 as members prepared for extended supply needs in response to COVID-19 restrictions.

Services Revenues

• Services revenues increased $33 million, or 13.1%, from $252 million in the 2020 quarter to $285 million in the 2021 quarter and increased $79 million, or 16.6%, from $477 million in the 2020 period to $556 million in the 2021 period. These increases were primarily due to higher revenues associated with our pharmacy and provider businesses. The 2021 period further reflects additional pharmacy revenues associated with the acquisition of Enclara which was closed during the first quarter of 2020.

Intersegment Revenues

• Intersegment revenues increased $549 million, or 8.2%, from $6.69 billion in the 2020 quarter to $7.24 billion in the 2021 quarter and increased $615 million, or 4.5%, from $13.5 billion in the 2020 period to $14.2 billion in the 2021 period. These increases were primarily due to individual Medicare Advantage and state-based contracts membership growth, as well as higher revenues associated with our provider business. These increases were partially offset by the loss of intersegment revenues associated with the decline in stand-alone PDP and group Medicare Advantage membership as previously discussed and the impact of increased pharmacy revenues in the 2020 quarter as a result of allowing early prescription refills to permit our members to prepare for extended supply needs due to COVID-19 restrictions.

Operating Costs

• The Healthcare Services segment operating cost ratio increased 70 basis points from 95.1% for the 2020 quarter to 95.8% for the 2021 quarter and increased 30 basis points from 95.6% for the 2020 period to 95.9% for the 2021 period. These increases reflect increased administrative costs in the pharmacy operations as a result of incremental spend to accelerate growth within the business, additional shipping costs incurred in pharmacy operations to ensure members' timely receipt of prescriptions, and increased utilization levels in our provider business in 2021 compared to depressed levels in 2020 amid the COVID-19 pandemic. These increases were partially offset by the impact on the 2020 ratios associated with COVID-19 administrative related costs, including expenses associated with additional safety measures taken for our pharmacy, provider, and clinical teams who continued to provide services to members throughout the crisis, as well as operational improvement in our provider services business, largely related to Conviva, along with operating cost efficiencies driven by previously implemented productivity initiatives in 2021. The 2021 period was further impacted by pharmacy labor-related overtime costs due to weather disruptions occurring in the first quarter of 2021.

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 2020 Form 10-K and Item 1A of Part II of this document.

Cash and cash equivalents decreased to approximately $3.4 billion at June 30, 2021 from $4.7 billion at December 31, 2020. The change in cash and cash equivalents for the six months ended June 30, 2021 and 2020 is summarized as follows:

(in millions)

Cash Flow from Operating Activities

Cash flows used in operations of $477 million in the 2021 period decreased $4.0 billion from cash flows provided by operations of $3.5 billion in the 2020 period primarily due to the negative impact of working capital items and lower earnings in the 2021 period compared to the 2020 period. Our 2021 period operating cash flows were significantly impacted by changes to working capital levels, primarily as a result of prior year disruptions caused by COVID-19. These impacts include paying down claims inventory and capitation for provider surplus amounts earned in 2020 as well as additional provider support. Further, quarterly tax payment estimates typically paid in the 2020 period were deferred to the third quarter of 2020 due to COVID-19.

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 June 30, 2021 and December 31, 2020:

(in millions)

(1) IBNR represents an estimate of benefits payable for claims incurred but not reported (IBNR) at the balance sheet date and includes unprocessed claim inventories. The level of IBNR is primarily impacted by membership levels, medical claim trends and the receipt cycle time, which represents the length of time between when a claim is initially incurred and when the claim form is received and processed (i.e. a shorter time span results in a lower IBNR).

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

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

The increase in benefits payable in 2021 was primarily due to an increase in reported claims in process and higher IBNR, partially offset by reduction in capitation accruals. Higher reported claims in process was a function of month-end cutoff. IBNR increased primarily as a result of individual Medicare Advantage membership growth partially offset by paying down claim inventories. The 2020 period was significantly impacted by higher capitation accruals as significantly lower utilization caused by COVID-19 resulted in higher surplus accruals to providers.

The detail of total net receivables was as follows at June 30, 2021 and December 31, 2020:

(in millions)

The changes in Medicare receivables for both the 2021 period and the 2020 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. We received the 2021 $1.3 billion mid-year settlement in July 2021.

Cash Flow from Investing Activities

During 2021, we acquired various health and wellness related businesses for cash consideration of approximately $325 million, net of cash received.

During 2020, we acquired privately held Enclara Healthcare for cash consideration of approximately $709 million, net of cash received.

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 $619 million in the 2021 period and $418 million in the 2020 period.

Net purchases of investment securities were $1.3 billion and $1.7 billion in the 2021 and 2020 period, respectively.

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 claim payments by $1.2 billion and $412 million in the 2021 and 2020 period, respectively.

Under our administrative services only TRICARE contracts, health care costs payments for which we do not assume risk exceeded reimbursements from the federal government by $2 million and $23 million in the 2021 and 2020 period, respectively.

Net proceeds from the issuance of commercial paper were $508 million in the 2021 period and $21 million in the 2020 period. The maximum principal amount outstanding at any one time during the 2021 period was $1.3 billion.

In March 2020, we issued $600 million of 4.500% senior notes due April 1, 2025 and $500 million of 4.875% senior notes due April 1, 2030. Our net proceeds, reduced for the underwriters' discount and commission and offering expenses paid as of June 30, 2020 were $1,088 million.

We acquired common shares in connection with employee stock plans for an aggregate cost of $33 million in the 2021 period and $25 million in the 2020 period.

We paid dividends to stockholders of $173 million during the 2021 period and $156 million during the 2020 period.

In March 2020, we drew $1 billion on our existing term loan commitment, which was repaid in November 2020.

The remainder of the cash used in or provided by financing activities in 2021 and 2020 primarily resulted from proceeds from stock option exercises and the change in book overdraft.

Future Sources and Uses of Liquidity

Dividends

For a detailed discussion of dividends to stockholders, please refer to Note 10 to the condensed consolidated financial statements.

Stock Repurchases

For a detailed discussion of stock repurchases, please refer to Note 10 to the condensed consolidated financial statements.

Debt

For a detailed discussion of our debt, including our senior notes, credit agreements, commercial paper program, and other short-term borrowings, please refer to Note 12 to the condensed consolidated financial statements.

Kindred at Home Acquisition

On April 27, 2021, we entered into a definitive agreement to acquire the remaining 60% interest in KAH, the nation’s largest home health and hospice provider, from TPG and WCAS, two private equity funds, or the Sponsors, for an enterprise value of $8.1 billion, which includes our existing equity value of $2.4 billion associated with our 40% minority ownership interest. KAH has locations in 40 states, providing extensive geographic coverage with approximately 65% overlap with our individual Medicare Advantage membership. The acquisition, which is expected to close in the third quarter of 2021, is subject to customary state and federal regulatory approvals. We expect to fund the approximate $5.7 billion transaction (net of our existing equity stake) through a combination of parent company cash and debt financing.

In April 2021, we entered into a commitment letter with Goldman Sachs Bank USA, or Goldman Sachs, pursuant to which, and subject to the terms and conditions set forth therein, Goldman Sachs committed to lend us up to $3.5 billion under a new senior unsecured 364-day bridge loan facility, or Bridge Loan. If we enter into the Bridge Loan, the proceeds of the Bridge Loan will be used to finance a portion of the cash consideration payable for the KAH transaction. The outstanding Bridge Loan commitments under the commitment letter were reduced to $3.0 billion in connection with the effectiveness of the delayed draw term loan credit agreement described below.

In May 2021, we entered into a $500 million unsecured delayed draw term loan credit agreement. If we draw on the delayed term loan, the proceeds will be used to finance a portion of the cash consideration payable for the KAH transaction.

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 June 30, 2021 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 $1.3 billion at June 30, 2021 compared to $772 million at December 31, 2020. This increase primarily was due to dividends received from regulated subsidiaries, earnings in non-regulated Healthcare Services subsidiaries, and the issuance of commercial paper, partially offset by acquisitions, capital expenditures, cash dividends to shareholders, and capital contributions to certain subsidiaries. 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 regulators).

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 March 31, 2021, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $10.0 billion, which exceeded aggregate minimum regulatory requirements of $7.2 billion. The amount of ordinary dividends paid to our parent company was approximately $1.3 billion during the six months ended June 30, 2021 compared to $360 million during the six months ended June 30, 2020. The amount, timing and mix of ordinary and extraordinary dividend payments will vary due to state regulatory requirements, the level of excess statutory capital and surplus and expected future surplus requirements related to, for example, premium volume and product mix.

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 June 30, 2021. Our net unrealized position decreased $247 million from a net unrealized gain position of $514 million at December 31, 2020 to a net unrealized gain position of $267 million at June 30, 2021. At June 30, 2021, we had gross unrealized losses of $87 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 credit allowances during the six months ended June 30, 2021. While we believe that these securities in an unrealized loss will recover in value over time 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 credit allowances may be recorded in future periods.

Duration is the time-weighted average of the present value of the bond portfolio’s cash flow. Duration is indicative of the relationship between changes in fair value and changes in interest rates, providing a general indication of the sensitivity of the fair values of our fixed maturity securities to changes in interest rates. However, actual fair values may differ significantly from estimates based on duration. The average duration of our investment portfolio, including cash and cash equivalents, was approximately 3.6 years as of June 30, 2021 and approximately 3.0 years as of December 31, 2020. The increase in the average duration is reflective of the decreased holdings of cash and cash equivalents, along with other portfolio management activities. Based on the duration, including cash equivalents, a 1% increase in interest rates would generally decrease the fair value of our securities by approximately $619 million at June 30, 2021.

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 June 30, 2021.

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 June 30, 2021 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.