UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 1-5975
HUMANA INC.
(Exact name of registrant as specified in its charter)
Delaware 61-0647538
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
500 West Main Street
Louisville, Kentucky 40202
(Address of principal executive offices) (Zip Code)
(502) 580-1000
(Registrants' telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months, and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO ______
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Outstanding at
Class of Common Stock April 30, 1999
$.16 2/3 par value 167,569,138 shares
1 of 24
Humana Inc.
March 31, 1999
Form 10-Q
Page of
Form 10-Q
Part I: Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for
the quarters ended March 31, 1999 and 1998 3
Condensed Consolidated Balance Sheets at March 31, 1999
and December 31, 1998 4
Condensed Consolidated Statements of Cash Flows for the
quarters ended March 31, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-20
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
Part II: Other Information
Items 1 to 6 22-24
Exhibits:
Exhibit 10 - Employment Agreement - Kenneth J. Fasola
Exhibit 12 - Ratio of Earnings to Fixed Charges
Exhibit 27 - Financial Data Schedule
2
Humana Inc.
Condensed Consolidated Statements of Operations
For the quarters ended March 31, 1999 and 1998
Unaudited
(Dollars in millions, except per share results)
1999 1998
Revenues:
Premiums $ 2,428 $ 2,352
Interest and other income 49 50
Total revenues 2,477 2,402
Operating expenses:
Medical 2,136 1,955
Selling, general and administrative 325 324
Depreciation and amortization 31 32
Total operating expenses 2,492 2,311
(Loss) income from operations (15) 91
Interest expense 10 12
(Loss) income before income taxes (25) 79
(Benefit) provision for income taxes (9) 29
Net (loss) income $ (16) $ 50
(Loss) earnings per common share $ (.10) $ .30
(Loss) earnings per common share
- assuming dilution $ (.10) $ .30
See accompanying notes.
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Humana Inc.
Condensed Consolidated Balance Sheets
Unaudited
(Dollars in millions, except per share amounts)
March 31, December 31,
1999 1998
Assets
Current assets:
Cash and cash equivalents $ 636 $ 913
Marketable securities 1,555 1,594
Premiums receivable, less allowance for
doubtful accounts $59 - March 31, 1999 and
$62 - December 31, 1998 278 276
Other 338 336
Total current assets 2,807 3,119
Long-term marketable securities 337 305
Property and equipment, net 430 433
Cost in excess of net assets acquired 1,180 1,188
Other 436 451
Total assets $ 5,190 $ 5,496
Liabilities and Stockholders' Equity
Current liabilities:
Medical and other expenses payable $ 1,513 $ 1,470
Trade accounts payable and accrued expenses 433 395
Book overdraft 197 234
Unearned premium revenues 66 294
Short-term debt 200 250
Total current liabilities 2,409 2,643
Long-term medical and other expenses payable 413 438
Long-term debt 579 573
Professional liability and other obligations 121 154
Total liabilities 3,522 3,808
Commitments and contingencies
Stockholders' equity:
Preferred stock, $1 par; authorized 10,000,000
shares; none issued
Common stock, $.16 2/3 par; authorized
300,000,000 shares; issues and outstanding
167,578,638 shares - March 31, 1999 and
167,515,362 shares - December 31, 1998 28 28
Other 1,640 1,660
Total stockholders' equity 1,668 1,688
Total liabilities and stockholders' equity $ 5,190 $ 5,496
See accompanying notes.
4
Humana Inc.
Condensed Consolidated Statements of Cash Flows
For the quarters ended March 31, 1999 and 1998
Unaudited
(Dollars in millions)
1999 1998
Net cash flows from operating activities $ (192) $ (310)
Cash flows from investing activities:
Purchases of marketable securities (167) (198)
Maturities and sales of marketable securities 169 271
Purchases of property and equipment (30) (21)
Dispositions of property and equipment 25
Other (2) 2
Net cash (used in) provided by investing activities (5) 54
Cash flows from financing activities:
Repayment of line of credit (93) (300)
Net commercial paper borrowings 49 258
Change in book overdraft (37) 52
Other 1 23
Net cash (used in) provided by financing activities (80) 33
Decrease in cash and cash equivalents (277) (223)
Cash and cash equivalents at beginning of period 913 779
Cash and cash equivalents at end of period $ 636 $ 556
Interest payments $ 10 $ 11
Income tax refunds, net $ 39
See accompanying notes.
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Humana Inc.
Notes to Condensed Consolidated Financial Statements
Unaudited
(A) Basis of Presentation
The accompanying condensed consolidated financial statements are presented in
accordance with the requirements of Form 10-Q and consequently do not include
all of the disclosures normally required by generally accepted accounting
principles or those normally made in an annual report on Form 10-K.
Accordingly, for further information, the reader of this Form 10-Q may wish
to refer to the Form 10-K of Humana Inc. (the "Company") for the year ended
December 31, 1998.
The preparation of the Company's condensed consolidated financial statements
in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect (a) the reported
amounts of assets and liabilities, (b) disclosure of contingent assets and
liabilities at the date of the financial statements and (c) reported amounts
of revenues and expenditures during the reporting period. Actual results
could differ from those estimates.
The financial information has been prepared in accordance with the Company's
customary accounting practices and has not been audited. In the opinion of
management, the information presented reflects all adjustments necessary for
a fair statement of interim results. All such adjustments are of a normal
and recurring nature.
(B) Additional Medical Claims Expense and Tangible Asset Gain
The Company recorded $90 million ($57 million after tax, or $.34 per share)
in additional medical claims expense during the first quarter of 1999.
Included in this expense were approximately $50 million related to a
provision for probable future losses (premium deficiencies), $35 million to
strengthen medical claims payable and $5 million for a payment to Columbia/HCA
Healthcare Corporation ("Columbia/HCA") to resolve certain contractual issues.
The premium deficiency was the result of management's regular assessment of
the profitability of its contracts for providing health care services to its
members. Contributing to the premium deficiency was the impact from a
March 31, 1999, Columbia/HCA contract for hospital services in certain Florida
markets, as well as increasing medical costs in markets where the Company had
been sharing medical cost risk with providers. The $35 million medical
claims payable strengthening resulted from higher than expected medical cost
trends in the Company's preferred provider organization ("PPO") products and
Medicare business identified by the Company's analysis of February and
March, 1999, claims payments, concluded in April 1999. Partially offsetting
these additional medical costs was a $5 million ($3 million after tax, or
$.02 per share) favorable claim liability development in the Company's
run-off workers' compensation business. Also during the first quarter of
1999, the Company recorded a $12 million ($8 million after tax, or $.04 per
share) gain on the sale of a tangible asset which has been included in
interest and other income in the accompanying condensed consolidated
statements of operations.
6
Humana Inc.
Notes to Condensed Consolidated Financial Statements, continued
Unaudited
(C) Contingencies
The Company's Medicare HMO contracts with the federal government are renewed
for a one-year term each December 31 unless terminated 90 days prior thereto.
Legislative proposals are being considered which may revise the Medicare
program's current support of the use of managed health care for Medicare
beneficiaries and future reimbursement rates thereunder. Management is
unable to predict the outcome of these proposals or the impact they may have
on the Company's financial position, results of operations or cash flows.
The Company's Medicaid contracts are generally annual contracts with various
states except for the two-year contract with the Commonwealth of Puerto Rico.
The Company previously announced its intention to close this market when the
contract expired on April 30, 1999, because it did not expect to be able to
renew the contract under favorable terms. The Company is currently in
discussion with the Puerto Rico Health Insurance Administration regarding
maintaining its presence in Puerto Rico at premium rates which would allow a
reasonable margin. Although an agreement has not been reached, the Company
is continuing to provide services for its Puerto Rico members under the
existing agreement. Additionally, the Company's TRICARE contract is a
one-year contract renewable annually for up to two additional years. The
loss of these contracts (other than the contract in Puerto Rico) or
significant changes in these programs as a result of legislative action,
including reductions in payments or increases in benefits without
corresponding increases in payments, would have a material adverse effect on
the revenues, profitability and business prospects of the Company. In
addition, the Company continually contracts and seeks to renew contracts
with providers at rates designed to ensure adequate profitability. To the
extent the Company is unable to obtain such rates, its financial position,
results of operations and cash flows could be adversely impacted.
The Company reached an agreement in principle with the United States Justice
Department and the Department of Health and Human Services on a settlement
relating to Medicare premium overpayments. The settlement, totaling $15
million, arises out of the erroneous designation of certain Medicare
enrollees as eligible for Medicaid, resulting in higher payments to the
Company by the federal government related in large part to the years 1991
and 1992. The Company had established adequate liabilities for the
resolution of this issue and, therefore, the settlement did not have a
material impact on the Company's financial position or its results of
operations.
During the ordinary course of business, the Company is subject to pending
and threatened legal actions and audits by the agencies that regulate the
Company. Management of the Company does not believe that any of these
actions will have a material adverse effect on the Company's financial
position, results of operations or cash flows.
7
Humana Inc.
Notes to Condensed Consolidated Financial Statements, continued
Unaudited
(D) Earnings Per Common Share
Detail supporting the computation of earnings or loss per common share
follows:
Dollars in millions, except per share results
Net (Loss) Per Share
Quarter Ended March 31, 1999 Income Shares Results
Loss per common share $ (16) 167,559,428 $ (.10)
Effect of dilutive stock options -
Loss per common share - assuming dilution $ (16) 167,559,428 $ (.10)
Quarter Ended March 31, 1998
Earnings per common share $ 50 164,857,526 $ .30
Effect of dilutive stock options 2,331,930
Earnings per common share -
assuming dilution $ 50 167,189,456 $ .30
For the quarter ended March 31, 1999, all outstanding options to purchase
shares of 10,473,660 were excluded from the computation given the Company's
net loss for the quarter. Options to purchase 2,015,160 shares for the
quarter ended March 31, 1998 were excluded in the computation of earnings per
common share-assuming dilution because the options' exercise prices were
greater than the average market price of the common shares.
(E) Comprehensive Income or Loss
Comprehensive loss totaled $22 million for the quarter ended March 31, 1999
and was comprised of net loss of $16 million and net unrealized investment
losses of $6 million. Comprehensive income totaled $51 million for the
quarter ended March 31, 1998 and was comprised of net income of $50 million
and net unrealized investment gains of $1 million.
(F) Long-Term Debt
The Company maintains a revolving credit agreement ("Credit Agreement")
which provides liquidity under a line of credit of up to $1.5 billion. The
Company also maintains a commercial paper program and issues debt securities
thereunder. Commercial paper borrowings outstanding at March 31, 1999, were
$779 million and are backed by the Credit Agreement. The Credit Agreement
contains usual and customary covenants including, but not limited to,
financial tests for interest coverage and leverage ratios. As of
March 31, 1999, the Company was in compliance with these covenants. The
average interest rate on commercial paper borrowings was 5.5 percent for the
quarter ended March 31, 1999.
8
Humana Inc.
Notes to Condensed Consolidated Financial Statements, continued
Unaudited
The Company intends to pay an additional $200 million of its outstanding debt
with proceeds from operating subsidiary dividends expected to be received
during 1999. Borrowings under the commercial paper program, except the
planned 1999 payments, have been classified as long-term debt based on
management's ability and intent to refinance borrowings on a long-term basis.
(G) Segment Information
The segment results for the quarters ended March 31, 1999 and 1998 are as
follows:
Dollars in millions 1999 1998
Premium revenues:
Commercial $ 1,351 $ 1,290
Public sector 877 877
TRICARE 200 185
Total for reportable segments 2,428 2,352
Non-allocated revenues - interest and other income 49 50
Total consolidated revenues $ 2,477 $ 2,402
Underwriting margin:
Commercial $ 180 $ 235
Public sector 72 125
TRICARE 40 37
Total for reportable segments 292 397
Other, non-allocated revenues and expenses:
Interest and other income 49 50
Selling, general and administrative (325) (324)
Depreciation and amortization (31) (32)
Interest expense (10) (12)
Total consolidated (loss) income before income taxes $ (25) $ 79
Commercial and Public Sector underwriting margin include $49 million and
$41 million of additional medical claims expense recorded during the quarter
ended March 31, 1999, respectively.
9
Humana Inc.
Notes to Condensed Consolidated Financial Statements, continued
Unaudited
(H) Impact of Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). In general,
SFAS 133 requires that all derivatives be recognized as either assets or
liabilities in the balance sheet at their fair value, and sets forth the
manner in which gains or losses thereon are to be recorded. The treatment
of such gains or losses is dependent upon the type of exposure, if any, for
which the derivative is designated as a hedge. This statement is effective
for periods beginning after June 15, 1999. Management of the Company
anticipates that, due to its limited use of derivative instruments, the
adoption of SFAS 133 will not have a significant effect on the Company's
results of operations or its financial position.
(I) Reclassifications
Certain reclassifications have been made to the prior year's condensed
consolidated financial statements to conform with the current year
presentation.
10
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
This discussion and analysis contains both historical and forward-looking
information. The forward-looking statements may be significantly impacted by
risks and uncertainties, and are made pursuant to the safe harbor provisions
of the Private Securities Litigation Reform Act of 1995. There can be no
assurance that anticipated future results will be achieved because actual
results may differ materially from those projected in the forward-looking
statements. Readers are cautioned that a number of factors, which are
described herein and in the Company's Annual Report on Form 10-K for the
year ended December 31, 1998, could adversely affect the Company's ability
to obtain these results. These include the effects of either federal or
state health care reform or other legislation, changes in the Medicare
reimbursement system, medical and pharmacy cost trends, the ability of health
care providers (including physician practice management companies) to comply
with current contract terms, renewal of the Company's Medicare contracts with
the federal government, renewal of the Company's contract with the federal
government to administer the TRICARE program and renewal of the Company's
Medicaid contracts with various state governments. Such factors also
include the effects of other general business conditions, including but not
limited to, the Company's ability to integrate its acquisitions, the
Company's ability to appropriately address the "Year 2000" computer system
issue, government regulation, competition, premium rate and yield changes,
retrospective premium adjustments relating to federal government contracts,
changes in commercial and Medicare HMO membership, operating subsidiary
capital requirements, the effect of provider contract rate negotiations,
compliance with debt covenants, general economic conditions and the
retention of key employees. In addition, past financial performance is
not necessarily a reliable indicator of future performance and investors
should not use historical performance to anticipate results or future
period trends.
Introduction
The Company is a health services company that facilitates the delivery of
health care services through networks of providers to its approximately 6.1
million medical members. The Company's products are marketed primarily
through health maintenance organizations ("HMOs") and preferred provider
organizations ("PPOs") that encourage or require the use of contracted
providers. HMOs and PPOs control health care costs by various means,
including pre-admission approval for hospital inpatient services,
pre-authorization of outpatient surgical procedures, and risk-sharing
arrangements with providers. These providers may share medical cost risk or
have other incentives to deliver quality medical services in a cost-effective
manner. The Company also offers various specialty products to employers,
including dental, group life and workers' compensation, and administrative
services ("ASO") to those who self-insure their employee health plans. In
total, the Company's products are licensed in 47 states, the District of
Columbia and Puerto Rico, with approximately 21 percent of its membership in
the state of Florida.
The Company markets and distributes its products to three distinct customer
groups and, therefore, reports operations in three business segments.
Results of each segment are measured based on premium revenues and
underwriting margin (premium revenues less medical expenses). The
11
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
Company does not allocate assets or administrative costs to the segments and,
therefore, does not measure results based on segment assets or pretax profits.
Members from all three segments generally utilize the same medical provider
networks, enabling the Company to obtain more favorable contract terms with
providers. As a result, the profitability of each segment is somewhat
interdependent. In the Commercial segment, the Company markets and
distributes its fully-insured HMO, PPO, and specialty and its ASO products
to large group employers (over 100 employees) and small group employers.
Premium revenue pricing to large group employers has historically been
more competitive than that to small group employers, resulting in less
favorable underwriting margins for large groups. In the Public Sector
segment, the Company markets and distributes its Medicare and Medicaid
products to individuals eligible for these government-sponsored programs.
The Medicare HMO product provides health care services that include all
Medicare benefits and, in certain circumstances, additional services. The
Company's third segment is TRICARE. In this segment, the Company facilitates
health care services for the dependents of active military personnel and
retired military personnel and their dependents located in the Southeastern
United States. The Company is in the third year of its contract with the
United States Department of Defense, which is renewable annually for up to
two additional years. As encouraged by government regulation, TRICARE is
managed by a separate management team and is more autonomous than the
Company's Commercial and Public Sector segments, which generally share sales,
marketing, customer service, medical management and claims processing
functions of the Company.
Additional Medical Claims Expense and Tangible Asset Gain
The Company recorded $90 million ($57 million after tax, or $.34 per share)
in additional medical claims expense during the first quarter of 1999.
Included in this expense were approximately $50 million related to a
provision for probable future losses (premium deficiencies), $35 million to
strengthen medical claims payable and $5 million for a payment to
Columbia/HCA to resolve certain contractual issues. The premium deficiency
was the result of management's regular assessment of the profitability of its
contracts for providing health care services to its members. Contributing to
the premium deficiency was the impact from a March 31, 1999, Columbia/HCA
contract for hospital services in certain Florida markets, as well as
increasing medical costs in markets where the Company had been sharing
medical cost risk with providers. The $35 million medical claims payable
strengthening resulted from higher than expected medical cost trends in the
Company's PPO products and Medicare business identified by the Company's
analysis of February and March, 1999, claims payments, concluded in April 1999.
Partially offsetting these additional medical costs was a $5 million
($3 million after tax, or $.02 per share) favorable claim liability
development in the Company's run-off workers' compensation business. Also
during the first quarter of 1999, the Company recorded a $12 million
($8 million after tax, or $.04 per share) gain on the sale of a tangible
asset which has been included in interest and other income in the
accompanying condensed consolidated statements of operations.
12
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
Comparison of Results of Operations
In order to enhance comparability, and to present an estimated baseline
against which historical and prospective periods should be measured, the
following discussion comparing results for the quarters ended March 31, 1999,
and March 31, 1998, excludes the impact of the $90 million additional medical
claims expense and a tangible asset gain discussed previously, but includes
the beneficial effect of the premium deficiency included therein and the
$5 million run-off workers' compensation reserve adjustment. The beneficial
effect from the premium deficiency for the quarter ended March 31, 1999, was
approximately $6 million ($4 million after tax, or $.02 per share).
Income before income taxes totaled $53 million for the quarter ended
March 31, 1999 (the "1999 quarter"), compared to $79 million for the quarter
ended March 31, 1998 (the "1998 quarter"). Net income was $33 million or
$.20 per share in the 1999 quarter, compared to $50 million or $.30 per share
in the 1998 quarter. The decrease in earnings was primarily the result of
medical cost increases exceeding the related premium increases for the
Company's commercial and Medicare lines of business and lower realized
investment gains and other income. Partially offsetting these items was
lower administrative cost spending.
The Company's premium revenues grew $76 million or 3 percent from the 1998
quarter. Combined commercial and Medicare premium yield resulted in a 4
percent increase which was partially offset by a decline in membership in
both lines of business. Commercial premium yields increased 6.3 percent
while Medicare HMO premium yields increased 2.1 percent. The Company's
fully-insured commercial membership declined 89,800 members during the 1999
quarter, reflecting the effects of the Company's premium pricing discipline
intended to maintain profitability. Medicare HMO membership declined 21,300
during the 1999 quarter, the result of closing the Treasure Coast and
Sarasota, Florida, markets. For the remainder of 1999, commercial membership
is expected to increase 3 percent to 5 percent, while Medicare membership is
expected to be flat to slightly down. Medicaid membership was about flat with
year-end. The Company is currently in discussions with the Puerto Rico
Health Insurance Administration regarding maintaining its presence in
Puerto Rico at premium rates which would allow a reasonable margin. Although
a new contract has not been renegotiated, the Company has agreed to continue
to provide services to its members under the existing agreement.
The Company's medical expense ratio for the 1999 quarter was 84.3 percent,
increasing from 83.1 percent from the same period in 1998. The higher
medical expense ratio was the result of medical cost trends exceeding
premium yield increases in the Company's commercial and Medicare lines of
business. Commercial cost trends of 8.3 percent primarily result from higher
hospital outpatient and pharmacy costs which have increased 11 percent and
21 percent, respectively. Increased inpatient hospital cost per day and
increased pharmacy costs have caused a 3.1 percent increase in Medicare
medical costs. Also contributing to the medical expense ratio increase was
the inability of certain capitated risk-sharing providers to manage medical
costs within their contractual obligations.
13
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
As a result, the higher actual claim costs incurred by these risk-sharing
providers has been recognized as expense by the Company rather than the
capitated contract amount. There can be no assurance that the medical cost
trends will not continue to increase.
Partially offsetting the increasing medical cost trends is a favorable claim
liability development in the Company's run-off workers' compensation business
acquired in connection with its acquisition of Physician Corporation of
America ("PCA") in 1997. After evaluating the workers' compensation claim
liabilities against claim payments and file closings, the Company reduced
these liabilities by $5 million ($3 million after tax, or $.02 per share)
during the quarter.
As more fully described previously, the medical expense ratio discussion
excludes the impact of the additional $90 million medical claims expense.
Including this item increases the 1999 quarter medical expense ratio from
84.3 percent to 88.0 percent.
During the 1999 quarter, the Company's administrative cost ratio improved to
14.7 percent from 15.2 percent in the 1998 quarter. This year-over-year
improvement in the administrative cost ratio reflects efforts to streamline
the organization, as well as synergy savings from the acquisition of PCA and
ChoiceCare Corporation in 1997.
Interest income totaled $34 million and $41 million for the 1999 and 1998
quarters, respectively. The decrease is primarily attributable to realized
investment gains included in the 1998 quarter. The tax equivalent yield on
invested assets approximated 6.7 percent and 8.5 percent for the 1999 and
1998 quarters, respectively.
Business Segment Information
Commercial premium revenues increased 4.7 percent for the 1999 quarter as a
result of premium yield increases of 6.3 percent partially offset by a 89,800
decline in fully-insured membership. The membership decline was the result
of the Company's commitment to price its commercial products commensurate
with the underlying risk. The Commercial segment medical expense ratio for
the 1999 quarter was 83.0 percent, increasing from 81.8 percent in the 1998
quarter. The medical expense ratio increase was the result of premium yield
increases being insufficient to offset medical cost trend increases.
Increased medical costs were noted in hospital outpatient and pharmacy costs.
As more fully discussed previously, the medical expense ratio discussion
excludes a portion of the $90 million additional medical claims expense.
Including $49 million of the additional medical expense related to the
Commercial segment results in a medical expense ratio of 86.7 percent for the
1999 quarter.
Public Sector premium revenues for the 1999 quarter were generally flat with
the 1998 quarter. A 2.1 percent Medicare HMO premium yield increase was
offset by a decline in membership. The premium yield increase was slightly
higher than the 2 percent statutory increase as a result of the
14
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
changing geographic mix of membership toward higher reimbursement areas.
This change was due in large part to closing the Treasure Coast and Sarasota,
Florida, markets. Medicare HMO membership declined 21,300 during the quarter
primarily from closing these under-performing markets in Florida. The Public
Sector medical expense ratio for the 1999 quarter was 87.1 percent,
increasing from 85.7 percent for the 1998 quarter. The medical expense ratio
increase was primarily the result of Medicare HMO premium yield increases
being insufficient to offset medical cost trend increases. Increased medical
costs were noted in inpatient hospital rates and pharmacy costs. As more
fully discussed previously, the medical expense ratio discussion excludes a
portion of the $90 million additional medical claims expense. Including $41
million of the additional medical expense related to the Public Sector
segment results in a medical expense ratio of 91.8 percent for the 1999
quarter.
TRICARE premiums increased 8.1 percent for the 1999 quarter on stable
membership due to contract modifications. TRICARE's medical expense ratio
did not change significantly from the 1998 quarter.
Liquidity
During the 1999 quarter, $192 million was used in the Company's operating
activities, compared to $310 million being used in operations in the 1998
quarter. This net cash used in operations during the 1999 and 1998 quarters
can be attributed to the following:
1999 1998
Cash used in operating activities $ (192) $ (310)
Timing of Medicare premium receipts 234 235
Workers' compensation claim payments 28 30
Paydown of medical claim backlogs
related to acquired companies 50
Severance payments related to acquired companies 25
Pro forma operating cash flows $ 70 $ 30
The Company's subsidiaries operate in states which require certain levels of
equity and regulate the payment of dividends to the parent company. As a
result, the Company's ability to use operating subsidiaries' cash flows is
restricted to the extent of the subsidiaries' abilities to obtain regulatory
approval to pay dividends.
The National Association of Insurance Commissioners has recommended that
states adopt a risk-based capital ("RBC") formula for companies established
as HMO entities. The RBC provisions may require new minimum capital and
surplus levels for some of the Company's HMO subsidiaries. The Company does
not expect that the RBC provisions will have a material impact on its
financial position, results of operations or cash flows.
15
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
The Company maintains a revolving credit agreement ("Credit Agreement") which
provides liquidity under a line of credit of up to $1.5 billion. The Company
also maintains a commercial paper program and issues debt securities
thereunder. Commercial paper borrowings outstanding at March 31, 1999, were
$779 million and are backed by the Credit Agreement. The Credit Agreement
contains usual and customary covenants including, but not limited to,
financial tests for interest coverage and leverage ratios. As of
March 31, 1999, the Company was in compliance with these covenants.
The average interest rate on commercial paper borrowings was 5.5 percent for
the quarter ended March 31, 1999.
The Company intends to pay an additional $200 million of its outstanding debt
with the proceeds from operating subsidiary dividends expected to be received
during 1999. Borrowings under the commercial paper program, except the
planned 1999 payments, have been classified as long-term debt based on
management's ability and intent to refinance borrowings on a long-term basis.
Management believes that existing working capital, future operating cash
flows and funds available under the existing revolving Credit Agreement and
commercial paper program are sufficient to meet future liquidity needs.
Management also believes the aforementioned sources of funds are adequate to
allow the Company to fund capital requirements.
Capital Resources
The Company's ongoing capital expenditures relate primarily to administrative
facilities and related information systems necessary for activities such as
claims processing, billing and collections, medical utilization review and
customer service. Planned capital spending in 1999 will approximate $80 to
$90 million for the expansion and improvement of these items.
The Company's Y2K Readiness Disclosure Statement
The Company operates one of the largest managed care data centers in the
nation. The primary computing facility is located in Louisville, Kentucky.
The Company's application systems are largely developed and maintained
in-house by a staff of 400 application programmers who are versed in the use
of state-of-the-art technology. All application systems are fully integrated
and automatically pass data through various system processes. The
information systems support marketing, sales, underwriting, contract
administration, billing, financial, and other administrative functions as
well as customer service, authorization and referral management, concurrent
review, physician capitation and claims administration, provider management,
quality management and utilization review.
The Year 2000 issue is the result of two potential malfunctions that may have
an impact on the Company's systems and equipment. The first potential
malfunction is the result of computers being programmed to use two rather
than four digits to define the applicable year. The second potential
16
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
malfunction arises where embedded microchips and micro-controllers have been
designed using two rather than four digits to define the applicable year. As
a result, certain of the Company's date-sensitive computer programs, building
infrastructure components and medical devices, may recognize a date using
"00" as the year 1900 rather than the year 2000. If uncorrected, the problem
may result in computer system and program failures or equipment malfunctions
that could result in a disruption of business operations (such as the payment
of medical claims, premium billing and collection, and membership enrollment
verification).
Humana's Information Systems organization operates in a centralized manner.
The Company's data center and the majority of its programming and support
staff are located at its corporate offices in Louisville, Kentucky. A Year
2000 project management office is in place to oversee the progress made in
the assessment and correction of the Company's Year 2000 exposures.
In general, the Company's Year 2000 project consists of four phases -
assessment, remediation, validation, and implementation - and is categorized
into the following four components:
Information Technology (IT) - software essential for day-to-day operations
including both internally developed software and third party software which
interfaces therewith.
IT Infrastructure - mainframe, network, telecommunications interfaces and
self-contained operating systems.
Third party business partners and intermediaries - entities on which the
Company relies for transmission and receipt of claims, and encounter,
membership and payment information, including federal and state governmental
agencies such as the Health Care Financing Administration.
Non-IT Infrastructure - telecommunications equipment, elevators, public
safety equipment (i.e., security and fire), medical equipment and HVAC
systems.
The Company commenced the assessment of its Year 2000 exposures in 1996.
Remediation efforts of internally developed software and third party software
applications are almost fully complete. As of March 31, 1999, the Company
had remediated 95% of its core systems identified in the assessment. These
systems are currently operating in the production environment using the
updated Year 2000 logic. The Company's plan is to have all production
applications fully remediated by the end of the third quarter of 1999.
In addition, the Company is in the process of contacting vendors, third party
business partners and intermediaries in an effort to ascertain their Year
2000 readiness. The Company anticipates completing, in all material respects,
its Year 2000 project by the end of the third quarter of 1999. The Company's
efforts are currently progressing on plan.
The Year 2000 project is currently estimated to have a minimum total cost of
approximately $26 million. Project to date costs total $21.7 million,
including $4.1 million during the quarter ended
17
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
March 31, 1999. Year 2000 expenses are projected to represent less than
6 percent of the Information Systems budget during 1999. Year 2000 costs are
expensed as incurred and funded through operating cash flow.
The extent and magnitude of the Year 2000 project, as it will affect the
Company both before and for some period after January 1, 2000, are difficult
to predict or quantify. As part of the Company's Year 2000 readiness, it has
undertaken the development of business continuity and contingency plans.
These plans will be in place to mitigate issues that arise in the event that
the Year 2000 project is not completed in an accurate or timely manner, or
third party constituents have failures due to the millennium change. The
Company has identified six major functional areas, covering 22 operational
subdivisions, that will require contingency plans. The six major functional
areas are: providers, service centers, suppliers and vendors, customers and
brokers, banking and finance, and legal services. The Company's business
continuity and contingency planning efforts, which encompasses alternate
operating procedures, are anticipated to be complete by the end of the third
quarter of 1999.
While the Company presently believes that the timely completion of its
Year 2000 project will limit exposure so that the Year 2000 will not pose
material operational problems, the Company does not control third party
systems. Although the Company is contacting third parties, the Company has
not received assurances that all third parties and/or their interfaces will
be converted in a timely manner. Additionally, if Year 2000 modifications or
upgrades are not accomplished in a timely manner or proper contingency plans
are not implemented, Year 2000 failures which may result could have a
material adverse impact on the Company's results of operations or its
financial position.
The costs of the Year 2000 project and the date on which the Company plans to
complete Year 2000 modifications are based on management's best estimates,
considering assumptions of future events including the continued availability
of certain resources and other factors. There can be no guarantee that these
estimates will be achieved and actual results could differ materially from
plan. Specific factors that might cause such material differences include,
but are not limited to, the availability and cost of personnel trained in
this area, the ability to locate and correct all relevant computer codes, and
the ability of the Company's significant suppliers, customers and others with
which it conducts business, including federal and state governmental agencies,
to identify and resolve their own Year 2000 issues.
Impact of Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). In general,
SFAS 133 requires that all derivatives be recognized as either assets or
liabilities in the balance sheet at their fair value, and sets forth the
manner in which gains or losses thereon are to be recorded. The treatment of
such gains or losses is dependent upon the type of
18
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
exposure, if any, for which the derivative is designated as a hedge. This
statement is effective for periods beginning after June 15, 1999. Management
of the Company anticipates that, due to its limited use of derivative
instruments, the adoption of SFAS 133 will not have a significant effect on
the Company's results of operations or its financial position.
19
Humana Inc.
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
Quarterly Membership 1999 1998
Commercial:
Fully-insured members at:
March 31 3,171,700 3,249,600
June 30 3,260,700
September 30 3,235,800
December 31 3,261,500
Administrative services members at:
March 31 617,900 682,200
June 30 693,400
September 30 673,900
December 31 646,200
Total Commercial members at:
March 31 3,789,600 3,931,800
June 30 3,954,100
September 30 3,909,700
December 31 3,907,700
Pubic Sector:
Medicare HMO members at:
March 31 480,700 495,800
June 30 501,000
September 30 502,800
December 31 502,000
Medicaid and other members at:
March 31 704,300 696,800
June 30 692,000
September 30 696,500
December 31 700,400
Total Public Sector members at:
March 31 1,185,000 1,192,600
June 30 1,193,000
September 30 1,199,300
December 31 1,202,400
TRICARE:
TRICARE eligible members at:
March 31 1,085,700 1,103,500
June 30 1,096,300
September 30 1,090,400
December 31 1,085,700
Total medical members at:
March 31 6,060,300 6,227,900
June 30 6,243,400
September 30 6,199,400
December 31 6,195,800
Specialty members at:
March 31 2,771,900 2,647,800
June 30 2,477,800
September 30 2,597,800
December 31 2,633,300
20
Humana Inc.
Item 3. Quantitative and Qaulitative Disclosures about Market Risk
Since the date of the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1998, no material changes have occurred in the
Company's exposure to market risk associated with the Company's investments
in market risk sensitive financial instruments, as set forth in the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in such Form 10-K.
21
Humana Inc.
Part II: Other Information
Item 1: Legal Proceedings
Between November 19, 1997 and December 11, 1997, three related, purported
class action complaints entitled (i) Medhat Reiser v. PCA, et al, Civil
Action No. 97-3678 (S.D. Fla.)(Middlebrooks, J.), (ii) Janice Wells and
Stewart Colton v. PCA, et al, Civil Action No. 97-3832 (King, J.), and
(iii) David Applestein v. PCA, et al, Civil Action No. 97-4030 (Nesbitt, J.),
were filed in the United States District Court for the Southern District of
Florida by purported former stockholders of Physician Corporation of
America ("PCA") against PCA and certain of its former directors and officers.
By order entered February 13, 1998, the three actions were consolidated into
a single action entitled In re Physician Corporation of America Securities
Litigation, Civil Action No. 97-3678 (S.D. Fla.)(Middlebrooks, J.). The
Reiser, Wells and Applestein complaints contain the same or substantially
similar allegations; namely, that PCA and the individual defendants
knowingly or recklessly made false and misleading statements in press
releases and public filings with respect to the financial and regulatory
difficulties of PCA's workers' compensation business. Count I of all three
complaints is premised on alleged violations of Section 10(b) of the
Securities Exchange Act of 1934 (the "1934 Act") and SEC Rule 10b-5, and
Count II on alleged violations of Section 20(a) of the 1934 Act. All
three complaints seek certification of a class of stockholders who
purchased shares of PCA common stock from May 1996 through March 1997, as
well as money damages plus prejudgment interest in an unspecified amount,
and costs and expenses including attorneys fees. On February 19, 1999,
the U.S. District Court denied PCA's motion to dismiss. This matter has
been set for trial beginning January, 2001. The Company believes that
the allegations in the above complaints are without merit and intends to
pursue the defense of the consolidated action vigorously.
Damages for claims for personal injuries and medical benefit denials are
usual in the Company's business. Personal injury claims are covered by
insurance from the Company's wholly-owned captive insurance subsidiary and
excess carriers, except punitive damages generally are not paid where claims
are settled and generally are awarded only where a court determines there has
been a willful act or omission to act.
Government regulators conduct reviews from time to time to audit compliance
with government regulations and statutes, and those reviews may result in
fines or other payments.
Management does not believe that any pending and threatened legal actions and
audits by agencies that regulate the Company will have a material adverse
effect on the Company's financial position, results of operations or cash
flows.
Items 2 - 3:
None.
22
Humana Inc.
Part II: Other Information, continued
Item 4: Submission of Matters to a Vote of Security Holders
(a) The regular annual meeting of stockholders of Humana Inc. was held in
Louisville, Kentucky on May 6, 1999, for the purpose of electing the
Board of Directors.
(b) Proxies for the meeting were solicited pursuant to Section 14(a) of the
Securities Exchange Act of 1934 and there was no solicitation in
opposition to management's solicitations. All of management's nominees
for directors were elected.
(c) One proposal was submitted to a vote of security holders as follows:
(1) The stockholders approved the election of the following persons as
directors of the Company:
Name For Withheld
K. Frank Austen, M.D. 136,398,798 14,868,526
Michael E. Gellert 136,391,376 14,875,948
John R. Hall 136,394,172 14,873,152
David A. Jones 136,431,940 14,835,384
David A. Jones, Jr. 136,430,260 14,837,064
Irwin Lerner 136,393,668 14,873,656
W. Ann Reynolds, Ph.D. 136,437,727 14,829,597
Gregory H. Wolf 136,400,536 14,866,788
Item 5:
None.
Item 6: Exhibits and Report on Form 8-K
(a) Exhibits:
Exhibit 10 - Employment Agreement - Kenneth J. Fasola dated
March 29, 1999, filed herewith.
Exhibit 12 - Statement re: Computation of Ratio of Earnings to Fixed
Charges, filed herewith.
Exhibit 27 - Financial Data Schedule
(b) On April 8, 1999, the Company filed a report on Form 8-K regarding its
intention to record $90 million additional medical claims expense
during the first quarter, as discussed in both Items 1 and 2 of this
Form 10-Q.
23
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HUMANA INC.
Date: May 17, 1999 /s/ James E. Murray
James E. Murray
Chief Financial Officer
(Principal Accounting Officer)
Date: May 17, 1999 /s/ Kathleen Pellegrino
Kathleen Pellegrino
Vice President and
Associate General Counsel
24