Humana Inc. 's ( HUM ) second-quarter 2014 operating earnings came in at $2.19 per share, in line with the Zacks Consensus Estimate. Moreover, results compared unfavorably with $2.63 per share earned in the year-ago quarter.
The year-over-year decline was due to the investments in healthcare exchanges and state-based contracts, along with an increase in specialty drug costs related to a new treatment of Hepatitis C. Moreover, the last comparable quarter included pre-tax expenses associated with Humana's exit from the Puerto Rico Medicaid business in Sep 30, 2013.
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Revenues at Humana for the reported quarter climbed 18.4% year over year to $12.2 billion. Higher medical membership in the Retail segment and Medicare Advantage membership in the Employer Group segment led to an increase in premiums and services revenues that mainly drove overall revenues in the reported quarter.
Revenues also surpassed the Zacks Consensus Estimate of $11.9 billion. However, Humana's investment income remained flat year over year at $92 million.
Humana's consolidated benefit ratio, which reflects the percentage of benefit expenses in premium revenues, decreased 30 basis points (bps) year over year to 83.1%. This improvement was attributable to Humana's exit from the Puerto Rico Medicaid business in Sep 2013, partially offset by a decline in Retail and Employer Group benefit ratios.
Humana's consolidated operating cost ratio, which reflects the percentage of operating costs in total revenue less investment income, rose 80 bps year over year to 15.1%. The increase primarily resulted from a rise in ratios in the Retail and Employer Group.
Quarterly Results by Segment
Retail Segment: The segment's pre-tax income declined 21.3% year over year to $329 million due to higher benefit and operating cost ratio.
Reported premiums and services revenues increased 27.2% to $8.6 billion in the reported quarter. The upside primarily reflects a 16.2% year-over-year increase in individual Medicare Advantage membership and higher membership associated with healthcare exchanges.
The benefit ratio was 84.7%, deteriorating from 84.2% in the prior-year quarter. This deterioration stemmed from a decline in favorable prior-year medical claims reserve development, increase in specialty drug costs associated with the treatment of Hepatitis C and an increase in benefit ratios related to the new members from healthcare exchange offerings.
Operating cost ratio deteriorated 190 bps to 11.4% in the reported quarter. This deterioration stemmed mainly from marketing and distribution expenses for Medicare Advantage members, investment spending for healthcare exchanges and new state-based contracts, and non-deductible health insurance industry fee as per the healthcare reform.
Employer Group: This segment of Humana incurred pre-tax income of $89 million, comparing unfavorably with $134 million in the year-ago period. This decline came from a rise in the benefit and operating cost ratio in the segment.
The benefit ratio was 83.4%, up 90 bps year over year, reflecting a decline in the favorable prior-year medical claims reserve development and an increase in the specialty prescription drug costs. Operating cost ratio increased 90 bps to 16.0% due to the effect of the non-deductible health insurance industry fee and other fees, and an increase in the percentage of small group commercial group business with a higher operating cost ratio than large group business.
Meanwhile, reported premiums and services revenues increased 9.2% to $3.1 billion, primarily on the back of an increase in average group Medicare Advantage membership.
Healthcare Services: Pre-tax income for the segment rose to $206 million from $124 million in the second quarter of 2013. The upside was attributable to higher revenues and profits from the pharmacy solutions business and the home-based services businesses of Humana.
Revenues at this segment also rose 27% year over year to $4.97 billion, mainly on improvement in the pharmacy solutions and home-based services businesses. Growth in the pharmacy solutions business also improved the operating cost ratio by 80 bps year over year to 95.1% in the reported quarter.
Other Business: The other business segment reported a pre-tax income of $17 million, comparing favorably with a pre-tax loss of $30 million in the year-ago quarter. The improvement was largely attributable to the absence of expenses related to the loss of the Medicaid contracts in Puerto Rico.
Humana's operating cash outflow was $200 million in the second quarter of 2014 against a cash inflow of $173 million in the second quarter of 2013. Receivables that were recorded in the reported quarter associated with the premium stabilization programs and lower net income mainly led to the downside.
As of Jun 30, 2014, cash, cash equivalents and investment securities of Humana were $9.2 billion, lower than $10.94 billion as of Dec 31, 2013. The decline was owing to the funding of the working capital requirements associated with the PartD reinsurance subsidies and an increase in receivables related to the premium stabilization programs.
The debt-to-capital ratio of Humana as of Jun 30, 2014 was 20.6%, representing a 120 bps improvement from 21.8% as of Dec 31, 2013. The improvement was due to higher capitalization related to earnings in the second quarter of 2014.
Share Repurchase Update
In Apr 2014, the board of directors of Humana replaced the previous $1 billion share repurchase authorization with a new $1 billion program. The previous authorization had shares worth $569 million remaining to be repurchased. The new program is scheduled to expire on Jun 30, 2016.
During the second quarter of 2014, Humana spent $101 million to buy back 0.8 million shares. Currently, the company is left with shares worth approximately $899 million under this program.
Humana reiterated its earnings per share (EPS) guidance for 2014 in the range of $7.25 to $7.75 on revenues of $47 billion to $49 billion. This is on expectations of a consistently strong performance by the existing operations of Humana, higher-than-expected specialty drug costs for Hepatitis C treatment, increase in planned investments in clinical initiatives and a decline in investment spending and start-up costs for the healthcare exchange business. The guidance lies below the Zacks Consensus Estimate of $7.86 for 2014. Additionally, operating cost ratio is expected to be in the range of 15.4%-16%.
Zacks Rank and Other HMOs
Humana currently carries a Zacks Rank #2 (Buy). Among other health maintenance organizations (HMOs), WellPoint Inc. ( WLP ) and Aetna Inc. ( AET ) outperformed the Zacks Consensus Estimate in second-quarter 2014. Another company in the same sector, Molina Healthcare Inc. ( MOH ), is scheduled to release second-quarter 2014 earnings today after the market closes. While Molina Healthcare sports a Zacks Rank #1 (Strong Buy), Aetna has a Zacks Rank #2 (Buy).
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