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 June 30, 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 Number)
500 West Main Street
Louisville, Kentucky 40202
(Address of principal executive offices, including zip code)
(502) 580-1000
(Registrants' telephone number, including area code)
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 July 31, 1999
$0.16 2/3 par value 167,599,638 shares
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Humana Inc.
June 30, 1999
Form 10-Q
INDEX Page
Part I: Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Income for the quarters and
six months ended June 30, 1999 and 1998 3
Condensed Consolidated Balance Sheets at June 30, 1999 and
December 31, 1998 4
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Part II: Other Information
Item 1. Legal Proceedings 25
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
Exhibit 12 - Ratio of Earnings to Fixed Charges
Exhibit 27 - Financial Data Schedule
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Humana Inc.
Condensed Consolidated Statements of Income
For the quarters and six months ended June 30, 1999 and 1998
Unaudited
(Dollars in millions, except per share results)
Quarters Ended Six Months Ended
1999 1998 1999 1998
Revenues:
Premiums $ 2,461 $ 2,397 $ 4,889 $ 4,749
Interest and other income 44 49 93 99
Total revenues 2,505 2,446 4,982 4,848
Operating expenses:
Medical 2,094 1,995 4,230 3,950
Selling, general and
administrative 329 326 654 650
Depreciation and amortization 30 33 61 65
Total operating expenses 2,453 2,354 4,945 4,665
Income from operations 52 92 37 183
Interest expense 8 10 18 22
Income before income taxes 44 82 19 161
Provision for income taxes 16 30 7 59
Net income $ 28 $ 52 $ 12 $ 102
Basic earnings per common share $ 0.17 $ 0.31 $ 0.07 $ 0.61
Earnings per common share
- assuming dilution $ 0.17 $ 0.31 $ 0.07 $ 0.61
See accompanying notes to condensed consolidated financial statements.
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Humana Inc.
Condensed Consolidated Balance Sheets
Unaudited at June 30, 1999
(Dollars in millions, except share amounts)
June 30, December 31,
1999 1998
ASSETS
Current assets:
Cash and cash equivalents $ 542 $ 913
Marketable securities 1,504 1,594
Premiums receivable, less allowance for
doubtful accounts of $61 at June 30, 1999
and $62 at December 31, 1998 278 276
Other 364 336
Total current assets 2,688 3,119
Long-term marketable securities 285 305
Property and equipment, net 442 433
Cost in excess of net assets acquired 1,189 1,188
Other 403 451
Total assets $ 5,007 $ 5,496
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Medical and other expenses payable $ 1,394 $ 1,470
Trade accounts payable and accrued expenses 432 395
Book overdraft 210 234
Unearned premium revenues 66 294
Short-term debt 75 250
Total current liabilities 2,177 2,643
Long-term medical and other expenses payable 381 438
Long-term debt 643 573
Professional liability and other obligations 129 154
Total liabilities 3,330 3,808
Commitments and contingencies
Stockholders' equity:
Preferred stock, $1 par; authorized 10,000,000 -- --
shares; none issued.
Common stock, $0.16 2/3 par; authorized 300,000,000
shares; issued and outstanding 167,585,138
shares at June 30, 1999 and
167,515,362 shares at December 31, 1998 28 28
Capital in excess of par value 897 894
Retained earnings 765 753
Accumulated other comprehensive (loss) income (13) 13
Total stockholders' equity 1,677 1,688
Total liabilities and stockholders' equity $ 5,007 $ 5,496
See accompanying notes to condensed consolidated financial statements.
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Humana Inc.
Condensed Consolidated Statements of Cash Flows
For the six months ended June 30, 1999 and 1998
Unaudited
(Dollars in millions)
1999 1998
Net cash used in operating activities $ (279) $ (424)
Cash flows from investing activities:
Acquisition, net of cash acquired (14) --
Purchases of marketable securities (432) (550)
Maturities and sales of marketable securities 513 686
Purchases of property and equipment (46) (77)
Dispositions of property and equipment 26 9
Other (10) (25)
Net cash provided by investing activities 37 43
Cash flows from financing activities:
Repayment of line of credit (93) (300)
Net commercial paper (repayments) borrowings (12) 333
Change in book overdraft (24) 30
Other -- 31
Net cash (used in) provided by financing activities (129) 94
Decrease in cash and cash equivalents (371) (287)
Cash and cash equivalents at beginning of period 913 779
Cash and cash equivalents at end of period $ 542 $ 492
Supplemental cash flow information:
Interest payments $ 18 $ 23
Income tax (refunds) payments, net $ (35) $ 46
Details of business acquired in purchase transaction:
Fair value of net assets acquired $ 20 $ --
Cash paid for acquired business (14) --
Liabilities assumed $ 6 $ --
See accompanying notes to condensed consolidated financial statements.
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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 generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they 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. For further information, the
reader of this Form 10-Q may wish to refer to the Form 10-K of Humana Inc.
(the "Company" or "Humana") for the year ended December 31, 1998 filed with
the Securities and Exchange Commission on March 31, 1999.
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 reported 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) First Quarter 1999 Additional Medical Claims Expense
and Tangible Asset Gain
The Company recorded $90 million ($57 million after tax, or $0.34 per diluted
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. Also, during the first quarter of 1999, the Company recorded
a $12 million ($8 million after tax, or $0.04 per diluted 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 income.
The beneficial effect related to the first quarter $50 million premium
deficiency was $12 million ($8 million after tax, or $0.05 per diluted share)
and $18 million ($12 million after tax, or $0.07 per diluted share) for the
quarter and six months ended June 30, 1999, respectively.
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Humana Inc.
Notes to Condensed Consolidated Financial Statements, continued
Unaudited
(C) Acquisition
Effective June 1, 1999, the Company reached an agreement with FPA Medical
Management, Inc. ("FPA"), its lenders and a federal bankruptcy court under
which the Company acquired the operations of 50 medical centers from FPA for
approximately $20 million. These medical centers serve approximately 121,000
Humana members. This acquisition was recorded using the purchase method of
accounting.
In July 1999, the Company reached agreements with ten provider groups to
assume operations of 21 of the 50 newly acquired medical centers in South
Florida, Tampa and Orlando to provide health care services under long-term
provider agreements with the Company. These agreements will serve
approximately 46,000 members of the Company. The Company intends to enter
into similar agreements with other providers regarding the remaining medical
centers.
(D) 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 annual contracts with various states except
for the two-year contract with the Health Insurance Administration in Puerto
Rico. Additionally, the Company's TRICARE contract is a one-year contract
renewable on July 1, 2000, for one additional year. The loss of these
contracts 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, during the first quarter of
1999, 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, arose 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 these issues 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 or results of
operations.
(E) Earnings Per Common Share
Basic earnings per common share is computed on the basis of the weighted
average number of common shares outstanding. Earnings per common share -
assuming dilution is computed on the
7
Humana Inc.
Notes to Condensed Consolidated Financial Statements, continued
Unaudited
basis of the weighted average number of common shares outstanding plus the
dilutive effect of outstanding stock options using the "treasury stock"
method.
There were no adjustments required to be made to net income for purposes of
computing basic earnings per common share and earnings per common share -
assuming dilution. Options whose exercise price is greater than the average
market price of common shares are antidilutive and, therefore, excluded from
the computation of earnings per common share - assuming dilution.
Reconciliations of the average number of common shares outstanding used in the
calculation of basic earnings per common share and earnings per common share -
assuming dilution for the quarters and six months ended June 30, 1999 and 1998
are as follows:
Quarters Ended Six Months Ended
1999 1998 1999 1998
Shares used to compute
basic earnings per
common share 167,575,863 166,600,047 167,567,646 165,728,787
Dilutive effect of common
stock options 577,524 2,517,847 907,032 2,424,889
Shares used to compute
earnings per
common share -
assuming dilution 168,153,387 169,117,894 168,474,678 168,153,676
Number of antidilutive
common stock options 8,132,781 -- 9,303,221 1,007,580
(F) Comprehensive Income (Loss)
Detail supporting the computation of comprehensive income (loss) follows for
the quarters and six months ended June 30, 1999 and 1998 (in millions):
Quarters Ended Six Months Ended
1999 1998 1999 1998
Net income $ 28 $ 52 $ 12 $ 102
Net unrealized investment
losses, net of tax (20) (6) (26) (5)
Comprehensive income (loss) $ 8 $ 46 $ (14) $ 97
(G) Long-Term Debt
The Company maintains a revolving credit agreement (the "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 June 30, 1999 were
$718 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
June 30, 1999, the Company was in compliance with these covenants. The average
interest rate on commercial paper borrowings was 5.2 percent and 5.3 percent
for the quarter and six months ended June 30, 1999, respectively.
8
Humana Inc.
Notes to Condensed Consolidated Financial Statements, continued
Unaudited
The Company intends to pay an additional $75 million of its outstanding debt
with proceeds from operating subsidiary dividends expected to be received in
the next twelve months. Borrowings under the commercial paper program, except
these planned repayments, have been classified as long-term debt based upon
management's ability and intent to refinance borrowings on a long-term basis.
(H) Segment Information
The Company markets and distributes its products to three distinct customer
groups and, therefore, reports operations in three segments: Commercial,
Public Sector and TRICARE. Results of each segment are measured based upon
premium revenues and underwriting margin (premium revenues less medical
expenses). The Company does not allocate assets or administrative costs to
the segments and, therefore, does not measure results based upon segment
assets or pretax profits.
The following table presents financial information for the Company's three
reportable segments for the quarters and six months ended June 30, 1999 and
1998 (in millions):
Quarters Ended Six Months Ended
1999 1998 1999 1998
Premium revenues:
Commercial $ 1,366 $ 1,305 $ 2,717 $ 2,595
Public Sector 893 882 1,770 1,759
TRICARE 202 210 402 395
Total for reportable segments 2,461 2,397 4,889 4,749
Non-allocated interest and other income 44 49 93 99
Total consolidated revenues $ 2,505 $ 2,446 $ 4,982 $ 4,848
Underwriting margin:
Commercial $ 219 $ 229 $ 399 $ 464
Public Sector 115 127 187 252
TRICARE 33 46 73 83
Total for reportable segments 367 402 659 799
Other, non-allocated revenue and expense:
Interest and other income 44 49 93 99
Selling, general and administrative
expenses (329) (326) (654) (650)
Depreciation and amortization (30) (33) (61) (65)
Interest expense (8) (10) (18) (22)
Total consolidated income before
income tax $ 44 $ 82 $ 19 $ 161
For the six months ended June 30, 1999, the Commercial and Public Sector
underwriting margins include $49 million and $41 million, respectively, of
additional medical claims expense recorded during the first quarter of 1999.
9
Humana Inc.
Notes to Condensed Consolidated Financial Statements, continued
Unaudited
(I) Impact of Recently Issued Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). In general,
SFAS No. 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. As amended by Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB Statement
No. 133", this standard is effective for the Company's financial statements
beginning January 1, 2001, with early adoption permitted. Management of the
Company anticipates that, due to its limited use of derivative instruments,
the adoption of SFAS No. 133 will not have a significant impact on the
Company's results of operations or its financial position.
(J) 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 success of the Company's profit
improvement initiatives, 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 and the Health Insurance Administration in
Puerto Rico. Such factors also include the effects of other general business
conditions, including but not limited to, compliance with debt covenants,
changes in the Company's debt rating and its ability to borrow under its
commercial paper program, 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, 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,
workers' compensation, and administrative services ("ASO") to those who
self-insure their employee health plans. In total, the Company's products are
licensed in 48 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 upon 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, 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 fourth year of its contract with the United States Department of Defense,
which is renewable on July 1, 2000, for one additional year. 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.
First Quarter 1999 Additional Medical Claims Expense and Tangible Asset Gain
The Company recorded $90 million ($57 million after tax, or $0.34 per diluted
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. Also, during the first quarter of 1999, the
Company recorded a $12 million ($8 million after tax, or $0.04 per diluted
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 income.
The beneficial effect related to the first quarter $50 million premium
deficiency was $12 million ($8 million after tax, or $0.05 per diluted share)
and $18 million ($12 million after tax, or $0.07 per diluted share) for the
quarter and six months ended June 30, 1999, respectively.
12
Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
Acquisition of Medical Centers from FPA
Effective June 1, 1999, the Company reached an agreement with FPA, its lenders
and a federal bankruptcy court under which the Company acquired the operations
of 50 medical centers from FPA for approximately $20 million. These medical
centers serve approximately 121,000 Humana members. This acquisition was
recorded using the purchase method of accounting.
In July 1999, the Company reached agreements with ten provider groups to
assume operations of 21 of the 50 newly acquired medical centers in South
Florida, Tampa and Orlando to provide health care services under long-term
provider agreements with the Company. These agreements will serve
approximately 46,000 members of the Company. The Company intends to enter into
similar agreements with other providers regarding the remaining medical
centers.
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 and six months ended
June 30, 1999 and June 30, 1998, excludes the previously described impact of
the first quarter 1999 $90 million additional medical claims expense and
tangible asset gain, but includes the beneficial effect of the premium
deficiency included therein.
Quarters Ended June 30, 1999 and 1998
Income before income taxes totaled $44 million for the quarter ended
June 30, 1999 (the "1999 quarter"), compared to $82 million for the quarter
ended June 30, 1998 (the "1998 quarter"). Net income was $28 million, or
$0.17 per diluted share, in the 1999 quarter, compared to $52 million, or
$0.31 per diluted share, in the 1998 quarter. The earnings decline is
attributable to the continuation of higher medical costs as reported in the
first quarter of 1999. The Company has implemented five profit improvement
initiatives to mitigate the effect of these higher medical cost trends. The
initiatives include pricing products commensurate with risk assumed,
rationalizing markets and products, rehabilitating the large group commercial
business, re-contracting with providers and cost management improvements
focused mainly on medical and claims cost management disciplines.
The Company's premium revenues increased 2.7 percent to $2.5 billion for the
1999 quarter, compared to $2.4 billion for the 1998 quarter. Higher premium
revenues result from increased premium yields on the Company's Commercial and
Public Sector fully insured products partially offset by a decline of fully
insured membership in these segments.
On June 30, 1999, the Company notified the Health Care Finance Administration
("HCFA") of its intent to exit 31 Medicare counties affecting approximately
46,000 members or 9.5 percent of the Company's total Medicare HMO membership.
In addition, the Company informed HCFA that it will institute Medicare benefit
reductions and premiums in the majority of its Medicare markets
beginning January 1, 2000. Also during the 1999 quarter, the Company provided
41,000 Commercial Florida individual members the required 180 day notice of
its intent to exit that business by the end of 2000. Member reductions related
to market exits, product discontinuances and premium increases will likely
result in the reduction of approximately 300,000 members during the year 2000.
13
Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
The Company's medical expense ratio for the 1999 quarter was 85.1 percent,
increasing 180 basis points from 83.3 percent for the 1998 quarter. The
increase in the medical expense ratio was primarily the result of the
Company's fully insured commercial HMO and PPO products cost trends exceeding
premium yield increases.
Offsetting the increasing medical cost trends is the continued 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 $10 million ($6 million after tax, or $0.04 per diluted
share) during the 1999 quarter.
During the third quarter of 1998, the Company announced its intention to close
its Puerto Rico operations upon the expiration of its Medicaid contract
because the Company did not expect to be awarded a new contract at acceptable
premium levels. The Company also established premium deficiency liabilities
based upon probable future losses under the Medicaid contract as well as
severance and lease discontinuance accruals. In May 1999, the Company reached
an agreement with the Health Insurance Administration in Puerto Rico to extend
the Medicaid contract an additional two years. As a result of the decision to
maintain a presence in Puerto Rico, the Company reversed the remaining premium
deficiency liabilities of $6 million ($4 million after tax, or $0.02 per
diluted share) as well as the severance and lease discontinuance accruals of
$2 million ($1 million after tax, or $0.01 per diluted share) during the
1999 quarter.
The administrative cost ratio improved during the 1999 quarter to 14.6 percent
from 15.0 percent in the 1998 quarter. The year-over-year improvement in the
administrative cost ratio reflects continued rationalization of staffing
levels, streamlining and centralizing the Company as well as acquisition
synergies.
Interest income totaled $40 million and $39 million for the 1999 and 1998
quarters, respectively. The increase results from realized investment gains
offset by lower investment yields. The tax equivalent yield on invested
assets approximated 8.1 percent and 9.0 percent for the 1999 and 1998
quarters, respectively. Other income declined $6 million from the 1998
quarter, due to the reduction of income from ancillary businesses the Company
sold in 1998. Interest expense declined $2 million during the 1999 quarter
as a result of lower average outstanding borrowings.
Business Segment Information for the Quarters Ended June 30, 1999 and 1998
Commercial premium revenues increased 4.7 percent for the 1999 quarter as a
result of premium yield increases of 6.9 percent on the Company's fully
insured commercial products partially offset by a decline in fully insured
membership. The Company's fully insured commercial membership declined 86,700
members from the 1998 quarter, reflecting the effects of the Company's
premium pricing discipline intended to maintain profitability.
The Commercial segment medical expense ratio for the 1999 quarter was 84.0
percent, increasing from 82.5 percent in the 1998 quarter. The medical
expense ratio increase was the result of fully insured commercial cost trends
of 10.0 percent exceeding premium yield increases of 6.9 percent. The fully
insured commercial cost trend was primarily the result of a 2.6 percent
increase in
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Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
inpatient days per thousand, a 13.0 percent increase in outpatient costs and
pharmacy costs which increased 18.8 percent. The higher pharmacy costs were
the result of increases in prescriptions per thousand of 9.3 percent and
costs per prescription of 9.2 percent. These higher medical cost trends are
attributable to growth of the Company's open access products, the effects of
the Health Insurance Portability and Accountability Act's guarantee issue
rules, the inability of certain risk-sharing providers to effectively manage
medical costs within their contractual arrangements, the lack of three tier
pharmacy product benefit contracts and generally higher medical cost trends
across the industry.
Public Sector premium revenues for the 1999 quarter increased 1.2 percent to
$893 million. A 3.0 percent Medicare HMO premium yield was offset by a
decline in membership. The Medicare HMO premium yield increase was higher
than the 2 percent statutory increase as a result of the changing geographic
mix of membership toward higher reimbursement areas. The geographic mix shift
and the reduction in Public Sector membership were the result of the closing
of the Treasure Coast and Sarasota, Florida markets. Medicare HMO membership
declined 16,200 from the 1998 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 85.6 percent for the 1998 quarter. The medical expense ratio
increase was primarily the result of ineffective risk sharing arrangements in
the Company's Medicaid products and Medicare HMO premium yield increases of
3.0 percent being insufficient to offset medical cost increases of 3.2 percent.
Increased Medicare HMO medical costs were noted in inpatient hospital rates
and pharmacy costs.
TRICARE premiums declined 3.8 percent for the 1999 quarter on declining
membership and its medical expense ratio increased to 83.7 percent during the
1999 quarter from 78.1 percent as a result of favorable contract modifications
recorded during the 1998 quarter.
Six Months Ended June 30, 1999 and 1998
Income before income taxes totaled $97 million for the six months ended
June 30, 1999 (the "1999 period"), compared to $161 million for the same
period in 1998 (the "1998 period"). Net income was $61 million, or $0.37 per
diluted share, in the 1999 period compared to $102 million, or $0.61 per
diluted share, in the 1998 period. This earnings decline was primarily a
result of medical cost increases exceeding premium yield increases, partially
offset by lower administrative spending.
The Company's premium revenues increased 2.9 percent to $4.9 billion for the
1999 period. Higher premium revenues result from increased premium yields on
the Company's Commercial and Public Sector fully insured products partially
offset by a decline of fully insured membership in these segments.
The Company's medical expense ratio increased 150 basis points to 84.7
percent during the 1999 period compared to the same period a year ago. The
higher medical expense ratio results from medical cost trend increases
exceeding premium yield increases on the Company's fully insured commercial
and Medicare HMO products. As more fully described previously, the medical
expense ratio discussion excludes the impact of the first quarter additional
$90 million medical
15
Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
claims expense. Including this item increases the 1999 period medical expense
ratio from 84.7 percent to 86.5 percent.
Offsetting the increasing medical cost trends is the continued 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 $15 million ($10 million after tax, or $0.06 per diluted
share) during the 1999 period.
During the third quarter of 1998, the Company announced its intention to
close its Puerto Rico operations upon the expiration of its Medicaid contract
because the Company did not expect to be awarded a new contract at acceptable
premium levels. The Company also established premium deficiency liabilities
based upon probable future losses under the Medicaid contract as well as
severance and lease discontinuance accruals. In May 1999, the Company reached
an agreement with the Health Insurance Administration in Puerto Rico to extend
the Medicaid contract an additional two years. As a result of the decision to
maintain a presence in Puerto Rico, the Company reversed the remaining
premium deficiency liabilities of $6 million ($4 million after tax, or $0.02
per diluted share) as well as the severance and lease discontinuance accruals
of $2 million ($1 million after tax, or $0.01 per diluted share) during the
1999 period.
The administrative cost ratio was 14.6 percent and 15.1 percent for the 1999
and 1998 periods, respectively. This improvement results from the
rationalization of staffing levels, streamlining and centralizing the Company
as well as acquisition synergies.
Interest income totaled $74 million in the 1999 period, compared to $80
million in the 1998 period. This decrease is primarily attributable to lower
investment yields. The tax equivalent yield on invested assets approximated
7.4 percent and 9.0 percent for the 1999 and 1998 periods, respectively. Other
income declined $12 million from the 1998 period, due to the reduction of
income from ancillary businesses the Company sold in 1998. Interest expense
declined $4 million during the 1999 period as a result of lower average
borrowings.
Business Segment Information for the Six Months Ended June 30, 1999 and 1998
Commercial premium revenues increased 4.7 percent for the 1999 period as a
result of fully insured premium yield increases of 6.6 percent partially
offset by a decline in fully insured membership. The Company's fully insured
commercial membership declined 87,500 members during the 1999 period, compared
to an increase of 2,100 for the same period in 1998, reflecting the effects
of the Company's premium pricing discipline intended to maintain
profitability.
The Commercial segment medical expense ratio for the 1999 period was 83.5
percent, increasing from 82.1 percent during the 1998 period. The medical
expense ratio increase was the result of fully insured commercial cost trends
of 9.1 percent exceeding premium yield increases of 6.6 percent. The fully
insured commercial cost trend was primarily the result of a 1.3 percent
increase in inpatient days per thousand, a 11.9 percent increase in outpatient
costs and pharmacy costs which increased 19.8 percent. The higher pharmacy
costs were the result of increases in prescriptions per thousand of 11.5
percent and costs per prescription of 8.2 percent. These higher
16
Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
medical cost trends are attributable to growth of the Company's open access
products, the effects of the Health Insurance Portability and Accountability
Act's guarantee issue rules, the inability of certain risk-sharing providers
to effectively manage medical costs within their contractual arrangements,
the lack of three tier pharmacy product benefit contracts and higher medical
cost trends across the industry. As more fully described previously,the
medical expense ratio discussion excludes a portion of the additional $90
million medical claims expense. Including $49 million of the additional
medical expense related to the Commercial segment results in a medical
expense ratio of 85.3 percent for the 1999 period.
Public Sector premium revenues for the 1999 period increased less than
1 percent to $1.8 billion. A 2.5 percent Medicare HMO premium yield was offset
by a decline in membership. The 2.5 Medicare HMO premium yield increase was
higher than the 2 percent statutory increase as a result of the changing
geographic mix of membership toward higher reimbursement areas. The geographic
mix shift and the reduction in Public Sector membership were the result of the
closing of the Treasure Coast and Sarasota, Florida markets. Medicare HMO
membership declined 17,200 during the period primarily from closing these
under-performing markets in Florida.
The Public Sector medical expense ratio for the 1999 period was 87.1 percent,
increasing from 85.7 percent for the 1998 period. The medical expense ratio
increase was primarily the result of ineffective risk sharing arrangements in
the Company's Medicaid products and Medicare HMO premium yield increases of
2.5 percent being insufficient to offset medical cost increases of 3.1
percent. Increased Medicare HMO medical costs were noted in inpatient hospital
rates and pharmacy costs. As more fully described previously, the medical
expense ratio discussion excludes a portion of the additional $90 million
medical claims expense. Including $41 million of the additional medical
expense related to the Public Sector segment results in a medical expense
ratio of 89.4 percent for the 1999 period.
TRICARE premiums increased 1.8 percent during the 1999 period and its medical
expense ratio increased to 81.8 percent during the 1999 period from 79.0
percent as a result of favorable contract modifications recorded during the
1998 period.
Liquidity and Capital Resources
Cash used by the Company's operations was $279 million and $424 million for
the six months ended June 30, 1999 and 1998, respectively. This net cash used
by the Company's operations during the 1999 period and the 1998 period can be
attributed to the following (in millions):
1999 1998
Cash used by operating activities $ (279) $ (424)
Timing of Medicare and TRICARE premium receipts 234 320
Workers' compensation claim payments 61 75
Pro forma cash flows provided by
(used in) operating activities $ 16 $ (29)
Pro forma cash flows from operating activities for the six months ended
June 30, 1999 was impacted by the seasonal pay down of medical claims and the
timing of provider payments and pharmacy claim processor reimbursements. Pro
forma cash flows used in operating activities for
17
Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
the six months ended June 30, 1998 was also impacted by the seasonal pay down
of medical claims as well as severance payments related to the Company's 1997
acquisitions.
The Company's subsidiaries operate in states that require minimum 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' ability 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.
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 June 30, 1999 were
$718 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
June 30, 1999, the Company was in compliance with these covenants. The
average interest rate on commercial paper borrowings was 5.2 percent and 5.3
percent for the quarter and the six months ended June 30, 1999, respectively.
The Company intends to pay an additional $75 million of its outstanding debt
with the proceeds from operating subsidiary dividends expected to be received
in the next twelve months. Borrowings under the commercial paper program,
except these planned repayments, 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 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.
The Company's ongoing capital expenditures are primarily attributable 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 for the
remainder of 1999 will approximate $40 million to $45 million for the
expansion and improvement of these items.
The Company's Year 2000 or Y2K Readiness Disclosure Statement
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
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
18
Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
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.
The Company's application systems are largely developed and maintained
in-house by a staff of 400 application programmers who are versed in the
utilization of state-of-the-art technology. All application systems are fully
integrated and automatically pass data through various system processes. The
Company's primary data center and the majority of its programming and support
staff are located at the Company's corporate offices in Louisville, Kentucky.
In order to create the necessary internal focus surrounding the Year 2000
problem the Company has established a centralized Year 2000 Program
Management Office (PMO) which is charged with overall coordination of
enterprise wide Y2K initiatives and regular progress reporting to the
Company's senior management.
The Company's Year 2000 initiatives are focused on four key areas of
operation:
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 heating and air
conditioning systems.
The Company commenced its assessment of Year 2000 exposures in early 1996. In
December 1998, the Company was 100 percent complete with the remediation of
its core business systems. As of June 30, 1999, the Company had remediated
98 percent of its business application systems. The remediated systems are
currently operating in the company's production environment utilizing the
updated Year 2000 logic. The Company's plan is to have all production
applications fully remediated during the fourth 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 during the fourth 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 $26.7 million. Project to date costs total $23.9 million,
including $2.1 million during the quarter ended June 30, 1999. Year 2000
expenses are projected to represent approximately 6 percent of the Information
Systems budget during 1999. Year 2000 costs are expensed as incurred and
funded through operating cash flows.
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. In order to mitigate these risks the Company has
chosen to develop business continuity and contingency plans. These plans
19
Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
would be enacted if the Company's Year 2000 project is not completed in an
accurate or timely manner, or if third party constituents have failures due
to the millennium change. The Company has identified six major functional
areas encompassing 22 operational subdivisions that require contingency plan
development. 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 are inclusive of alternate operating procedures, were finalized during
the second quarter of 1999 and are anticipated to be implemented during the
fourth 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 recognizes that it does not control third
party systems. The Company continues to work with its third parties to verify
their readiness; however, at this juncture the Company has not received
assurances that all third parties and/or their key interfaces will be
converted in a timely manner. If these organizations do not accomplish their
Year 2000 initiatives in a timely manner and/or fail to properly implement
appropriate contingency plans, Year 2000 failures may result. These failures
could potentially 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 issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). In general, SFAS
No. 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. As amended by Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB Statement
No. 133", this standard is effective for the Company's financial statements
beginning January 1, 2001, with early adoption permitted. Management of the
Company anticipates that, due to its limited use of derivative instruments,
the adoption of SFAS No. 133 will not have a significant impact on the
Company's results of operations or its financial position.
20
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 3,174,000 3,260,700
September 30 3,235,800
December 31 3,261,500
Administrative services members at:
March 31 617,900 682,200
June 30 636,700 693,400
September 30 673,900
December 31 646,200
Total Commercial members at:
March 31 3,789,600 3,931,800
June 30 3,810,700 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 30 484,800 501,000
September 30 502,800
December 31 502,000
Medicaid and other members at:
March 31 704,300 696,800
June 30 707,200 692,000
September 30 696,500
December 31 700,400
Total Public Sector members at:
March 31 1,185,000 1,192,600
June 30 1,192,000 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 1,064,600 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 6,067,300 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 2,837,600 2,477,800
September 30 2,597,800
December 31 2,633,300
21
Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
Supplemental Consolidated Statement of Quarterly Operations (Unaudited)
(Dollars in millions, except per share results)
1999
First (a) Second Total
Revenues:
Premiums by segment:
Commercial $ 1,351 $ 1,366 $ 2,717
Public Sector 877 893 1,770
TRICARE 200 202 402
Total premiums 2,428 2,461 4,889
Interest and other income 49 44 93
Total revenues 2,477 2,505 4,982
Operating expenses:
Medical 2,136 2,094 4,230
Selling, general and administrative 325 329 654
Depreciation and amortization 31 30 61
Total operating expenses 2,492 2,453 4,945
Income (loss) from operations (15) 52 37
Interest expense 10 8 18
Income (loss) before income taxes (25) 44 19
Provision (benefit) for income taxes (9) 16 7
Net income (loss) $ (16) $ 28 $ 12
Basic earnings (loss) per common share $ (0.10) $ 0.17 $ 0.07
Earnings (loss) per common share -
assuming dilution $ (0.10) $ 0.17 $ 0.07
Medical expense ratio 88.0% 85.1% 86.5%
Administrative cost ratio 14.7% 14.6% 14.6%
(a) Includes first quarter 1999 additional medical claims expense of $90
million ($57 million after tax, or $0.34 per diluted share) and a $12 million
($8 million after tax, or $0.04 per diluted share) gain on the sale of a
tangible asset.
22
Humana Inc.
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations, continued
Supplemental Consolidated Statement of Quarterly Operations (Unaudited)
(Dollars in millions, except per share results)
1998
First Second Third(a)(b) Fourth Total
Revenues:
Premiums by segment:
Commercial $1,290 $1,305 $1,325 $1,337 $5,257
Public Sector 877 882 891 890 3,540
TRICARE 185 210 205 200 800
Total premiums 2,352 2,397 2,421 2,427 9,597
Interest and other income 50 49 43 42 184
Total revenues 2,402 2,446 2,464 2,469 9,781
Operating expenses:
Medical 1,955 1,995 2,081 2,010 8,041
Selling, general and
administrative 324 326 351 327 1,328
Depreciation and amortization 32 33 32 31 128
Asset write-downs and other
special charges -- -- 34 -- 34
Total operating expenses 2,311 2,354 2,498 2,368 9,531
Income (loss) from operations 91 92 (34) 101 250
Interest expense 12 10 13 12 47
Income (loss) before income taxes 79 82 (47) 89 203
Provision (benefit) for
income taxes 29 30 (17) 32 74
Net income (loss) $ 50 $ 52 $ (30) $ 57 $ 129
Basic earnings (loss) per
common share $ 0.30 $ 0.31 $(0.18) $ 0.34 $0.77
Earnings (loss) per common
share - assuming dilution $ 0.30 $ 0.31 $(0.18) $ 0.34 $0.77
Medical expense ratio 83.1% 83.3% 85.9% 82.8% 83.8%
Administrative cost ratio 15.2% 15.0% 15.8% 14.7% 15.2%
(a) Includes charges associated with certain market closures, merger
dissolution costs and losses on disposal of non-strategic assets of $34
million ($22 million after tax, or $0.13 per diluted share).
(b) Includes premium deficiencies of $46 million ($29 million after tax, or
$0.17 per diluted share), a one-time incentive for non-officer employees of
$16 million ($10 million after tax, or $0.06 per diluted share) and other
costs of $36 million ($23 million after tax, or $0.14 per diluted share).
23
Humana Inc.
Item 3: Quantitative and Qualitative 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.
24
Humana Inc.
Part II: Other Information
Item 1: Legal Proceedings
Since June 22, 1999, five related, purported class action complaints entitled
(1) Alan Freeberg v. Gregory H. Wolf, et al., Civ. Act. No. 3:99CV-398-S, (2)
Robert Norman v. Humana Inc., et al., Civ. Act. No. 3:99CV-415-H, (3) Marc
Berger v. Humana Inc., et al., Civ. Act. No. 3:99CV-454-H, (4) Don Bailey v.
Humana Inc., et al., Civ. Act. No. 3:99CV-484-H, and (5) Karen Rubin v.
Gregory H. Wolf, et al., Civ. Act. No. 3:99CV-498-S, were filed in the United
States District Court for the Western District of Kentucky at Louisville, by
purported stockholders of the Company against the Company and certain of its
current and former directors and officers. The five complaints contain the
same or substantially similar allegations; namely, that the Company and the
individual defendants knowingly or recklessly made false or misleading
statements in press releases and public filings concerning the Company's
financial condition, primarily with respect to the impact of the negotiations
over renewal of the Company's contract with Columbia/HCA. The allegations in
all five complaints are premised on alleged violations of Section 10(b) of
the Securities Exchange Act of 1934 (the "1934 Act") and SEC Rule 10b-5, and
Section 20(a) of the 1934 Act. All five complaints seek certification of a
class of stockholders who purchased shares of Humana common stock starting
either (in three complaints) on October 31, 1998 or (in two complaints) on
February 9, 1999 and ending (in all five complaints) on April 8, 1999, and
all seek money damages in unspecified amounts, plus (in certain of the
complaints) pre-judgment and post-judgment interest, and costs and expenses
including attorney and expert fees. The Company believes the allegations in
the above complaints are without merit and intends to pursue the defense of
the actions vigorously.
A class action lawsuit styled Mary Forsyth, et al v. Humana Inc., et al,
Case #CV-5-89-249-PMP (L.R.L.), was filed on March 29, 1989, in the United
States District Court for the District of Nevada involving claims
arising out of the method of calculation of coinsurance for Nevada insureds
prior to 1988, and an antitrust claim. The District Court granted the
Company's motion for summary judgment on most of the claims on July 22, 1993.
The District Court granted summary judgment in favor of plaintiffs on
the claim under the Employee Retirement Income Security Act ("ERISA").
On appeal, the Court of Appeals for the Ninth Circuit reinstated certain
claims, including the claim under the Racketeer Influenced and Corrupt
Organizations Act ("RICO") on behalf of a class of insureds who paid
coinsurance at Humana hospitals (the "Co-Payer Class"), and the antitrust
claim. The Ninth Circuit also ruled that the damages in the Co-Payer Class'
RICO claim, before any trebling, were correctly limited to the amount of
overpayment of the coinsurance, which totaled approximately $1.6 million
plus interest. On August 18, 1997, the Company filed a Petition for Writ
of Certiorari in the United States Supreme Court requesting the Supreme Court
to reverse the part of the Ninth Circuit ruling reinstating the RICO claim
of the Co-Payer Class. In January, 1999, the Supreme Court ruled that the
plaintiffs could pursue their RICO claim. The Company requested summary
judgment in the District Court on the reinstated antitrust claim on
October 6, 1997, and upon reconsideration, the motion was granted. On October
1, 1997, the plaintiffs filed a motion in the District Court for leave to
file a Fifth Amended Complaint reasserting an ERISA claim and adding new RICO
and antitrust claims. The Company opposed the motion, and the motion was
denied. The trial on the remaining RICO and antitrust claims was
scheduled to begin on October 6, 1999. The parties have entered into a
settlement agreement resolving all outstanding claims. The terms are subject
to the approval of the District Court. The parties have submitted the
settlement agreement to the District Court for preliminary approval.
The settlement is not expected to have a material adverse effect on the
Company's financial position or results of operations.
25
Humana Inc.
Part II: Other Information, continued
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 and 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.
On May 5, 1999, plaintiffs moved for certification of the purported class.
On June 28, 1999, defendants moved for summary judgment and filed papers
opposing the motion for class certification. Both motions are currently
pending. 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.
On April 22, 1993, an alleged stockholder of the Company filed a purported
shareholder derivative action in the Court of Chancery of the State of
Delaware, County of New Castle, styled Lewis v. Austen, et al, Civil Action
No. 12937. The action was purportedly brought on behalf of the Company and
Galen Health Care, Inc. ("Galen") against all of the directors of both
companies at the time Galen was spun off from the Company alleging, among
other things, that the defendants had improperly amended the Company's
existing stock option plans to bifurcate their existing options to allow
employees of each company to receive options in the stock of the other
company. The challenged amendment to the plan was approved by the Company's
stockholders at the 1993 Annual Meeting of Stockholders. The defendants filed
a motion to dismiss the Case in October 1995. A hearing on this motion was
held on January 26, 1999. On June 2, 1999, the court rendered its decision
granting defendants' motion, thereby dismissing the case.
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 to the extent that claimants seek punitive damages,
which may not be covered by insurance if awarded. 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.
26
Humana Inc.
Part II: Other Information, continued
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.
Item 2: Changes in Securities
None.
Item 3: Defaults Upon Senior Securities
None.
Item 4: Submission of Matters to a Vote of Security Holders
None.
Item 5: Other Information
None.
Item 6: Exhibits and Reports on Form 8-K
(a) Exhibit Index
Exhibit 12 Statement re: Computation of Ratio of Earnings to
Fixed Charges, filed herewith.
Exhibit 27 Financial Data Schedule (filed electronically)
(b) During the quarter ended June 30, 1999, and as of the filing date,
Humana Inc. filed the following report on Form 8-K:
* On August 3, 1999, the Company filed a report on Form 8-K
regarding the resignation of Gregory H. Wolf as President and
Chief Executive Officer of the Company and the appointment of
David A. Jones as interim Chief Executive Officer.
27
Humana Inc.
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.
(Registrant)
Date: August 16, 1999 By: /s/ James E. Murray
James E. Murray
Chief Financial Officer
(Principal Accounting Officer)
Date: August 16, 1999 By: /s/ Kathleen Pellegrino
Kathleen Pellegrino
Vice President and
Acting General Counsel
28
Exhibit 12
Humana Inc.
Ratio of Earnings to Fixed Charges
For the quarters and six months ended June 30, 1999 and 1998
Unaudited
(Dollars in millions)
Quarters Ended Six Months Ended
1999 1998 1999 (a) 1998
Earnings:
Income before income taxes $ 44 $ 82 $ 19 $ 161
Fixed charges 11 13 24 28
$ 55 $ 95 $ 43 $ 189
Fixed charges:
Interest charged to expense $ 8 $ 10 $ 18 $ 22
One-third of rent expense 3 3 6 6
$ 11 $ 13 $ 24 $ 28
Ratio of earnings to fixed charges 4.9 7.6 1.8 6.8
The one-third of rent expense included in fixed charges is that proportion
deemed representative of the interest portion.
(a) Exclusive of the first quarter 1999 additional medical claims expense of
$90 million ($57 million after tax, or $0.34 per diluted share) and a $12
million ($8 million after tax, or $0.04 per diluted share) gain on the sale of
a tangible asset, the ratio of earnings to fixed charges for the six months
ended June 30, 1999 would have been 5.0.
5
1,000,000
6-MOS
DEC-31-1999
JAN-01-1999
JUN-30-1999
542
1,504
339
61
4
2,688
828
386
5,007
2,177
718
0
0
28
1,649
5,007
4,889
4,982
4,230
4,945
0
0
18
19
7
12
0
0
0
12
0.07
0.07
