Form 10-Q
Table of Contents

 

 

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, 2012

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

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

500 West Main Street

Louisville, Kentucky 40202

(Address of principal executive offices, including zip code)

(502) 580-1000

(Registrant’s 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x    No  ¨

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer    x   Accelerated filer   ¨
Non-accelerated filer    ¨     Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

 

Class of Common Stock

$0.16 2/3 par value

  

Outstanding at

June 30, 2012

161,712,439 shares

 

 

 


Table of Contents

Humana Inc.

FORM 10-Q

JUNE 30, 2012

INDEX

 

          Page  
  

Part I: Financial Information

  
Item 1.   

Financial Statements

  
  

Condensed Consolidated Balance Sheets at June 30, 2012 and December 31, 2011

     3   
  

Condensed Consolidated Statements of Income for the three and six months ended June 30, 2012 and 2011

     4   
  

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2012 and 2011

     5   
  

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2011

     6   
  

Notes to Condensed Consolidated Financial Statements

     7   
Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     25   
Item 3.   

Quantitative and Qualitative Disclosures about Market Risk

     45   
Item 4.   

Controls and Procedures

     46   

Part II: Other Information

  
Item 1.   

Legal Proceedings

     47   
Item 1A.   

Risk Factors

     47   
Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

     47   
Item 3.   

Defaults Upon Senior Securities

     47   
Item 4.   

Mine Safety Disclosures

     47   
Item 5.   

Other Information

     47   
Item 6.   

Exhibits

     48   
  

Signatures

     49   
  

Certifications

  

 

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Humana Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

     June 30,
2012
    December 31,
2011
 
     (in millions, except share amounts)  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 3,869      $ 1,377   

Investment securities

     7,882        7,743   

Receivables, less allowance for doubtful accounts of $89 in 2012 and $85 in 2011:

     898        1,034   

Other current assets

     1,422        1,027   
  

 

 

   

 

 

 

Total current assets

     14,071        11,181   
  

 

 

   

 

 

 

Property and equipment, net

     976        912   

Long-term investment securities

     1,783        1,710   

Goodwill

     2,792        2,740   

Other long-term assets

     1,233        1,165   
  

 

 

   

 

 

 

Total assets

   $ 20,855      $ 17,708   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Benefits payable

   $ 3,994      $ 3,754   

Trade accounts payable and accrued expenses

     2,081        1,783   

Book overdraft

     260        306   

Unearned revenues

     2,341        213   
  

 

 

   

 

 

 

Total current liabilities

     8,676        6,056   

Long-term debt

     1,618        1,659   

Future policy benefits payable

     1,785        1,663   

Other long-term liabilities

     321        267   
  

 

 

   

 

 

 

Total liabilities

     12,400        9,645   
  

 

 

   

 

 

 

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock, $1 par; 10,000,000 shares authorized; none issued

     0        0   

Common stock, $0.16 2/3 par; 300,000,000 shares authorized; 194,250,130 shares issued at June 30, 2012 and 193,230,310 shares issued at December 31, 2011

     32        32   

Capital in excess of par value

     2,063        1,938   

Retained earnings

     7,346        6,825   

Accumulated other comprehensive income

     327        303   

Treasury stock, at cost, 32,537,691shares at June 30, 2012 and 29,225,996 shares at December 31, 2011

     (1,313     (1,035
  

 

 

   

 

 

 

Total stockholders’ equity

     8,455        8,063   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 20,855      $ 17,708   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Humana Inc.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  
     (in millions, except per share results)  

Revenues:

           

Premiums

   $ 9,166       $ 8,849       $ 18,941       $ 17,616   

Services

     434         344         784         679   

Investment income

     99         91         193         180   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

     9,699         9,284         19,918         18,475   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating expenses:

           

Benefits

     7,652         7,269         16,002         14,614   

Operating costs

     1,384         1,193         2,767         2,449   

Depreciation and amortization

     73         68         143         134   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

     9,109         8,530         18,912         17,197   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

     590         754         1,006         1,278   

Interest expense

     26         28         52         55   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     564         726         954         1,223   

Provision for income taxes

     208         266         350         448   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 356       $ 460       $ 604       $ 775   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per common share

   $ 2.19       $ 2.76       $ 3.70       $ 4.64   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per common share

   $ 2.16       $ 2.71       $ 3.65       $ 4.57   
  

 

 

    

 

 

    

 

 

    

 

 

 

Dividends declared per common share

   $ 0.26       $ 0.25       $ 0.51       $ 0.25   
  

 

 

    

 

 

    

 

 

    

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Humana Inc.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  
     (in millions)  

Net income

   $ 356      $ 460      $ 604      $ 775   

Other comprehensive income:

        

Gross unrealized investment gain

     31        127        52        113   

Effect of income taxes

     (11     (46     (19     (41
  

 

 

   

 

 

   

 

 

   

 

 

 

Total unrealized investment gain, net of tax

     20        81        33        72   
  

 

 

   

 

 

   

 

 

   

 

 

 

Reclassification adjustment for net realized gains included in net income

     (10     (1     (14     (5

Effect of income taxes

     4        1        5        2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total reclassification adjustment, net of tax

     (6     0        (9     (3
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax

     14        81        24        69   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 370      $ 541      $ 628      $ 844   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Humana Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     For the six months ended
June 30,
 
     2012     2011  
     (in millions)  

Cash flows from operating activities

    

Net income

   $ 604      $ 775   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Net realized capital gains

     (14     (5

Stock-based compensation

     54        41   

Depreciation and amortization

     160        151   

(Benefit) provision for deferred income taxes

     (9     21   

Changes in operating assets and liabilities, net of effect of businesses acquired:

    

Receivables

     177        (587

Other assets

     (250     (175

Benefits payable

     170        484   

Other liabilities

     51        202   

Unearned revenues

     2,077        20   

Other, net

     32        30   
  

 

 

   

 

 

 

Net cash provided by operating activities

     3,052        957   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Acquisitions, net of cash acquired

     (76     (11

Purchases of property and equipment

     (185     (129

Purchases of investment securities

     (1,364     (1,902

Maturities of investment securities

     757        751   

Proceeds from sales of investment securities

     529        432   
  

 

 

   

 

 

 

Net cash used in investing activities

     (339     (859
  

 

 

   

 

 

 

Cash flows from financing activities

    

Receipts (withdrawals) from contract deposits, net

     152        188   

Repayment of long-term debt

     (36     0   

Change in book overdraft

     (46     (192

Common stock repurchases

     (278     (301

Dividends paid

     (82     0   

Excess tax benefit from stock-based compensation

     21        11   

Proceeds from stock option exercises and other

     48        91   
  

 

 

   

 

 

 

Net cash used in financing activities

     (221     (203
  

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     2,492        (105

Cash and cash equivalents at beginning of period

     1,377        1,673   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 3,869      $ 1,568   
  

 

 

   

 

 

 

Supplemental cash flow disclosures:

    

Interest payments

   $ 55      $ 57   

Income tax payments, net

   $ 293      $ 407   

See accompanying notes to condensed consolidated financial statements.

 

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Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

1. 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 accounting principles generally accepted in the United States of America, or those normally made in an Annual Report on Form 10-K. For further information, the reader of this Form 10-Q should refer to our Form 10-K for the year ended December 31, 2011, that was filed with the Securities and Exchange Commission, or the SEC, on February 24, 2012. We refer to the Form 10-K as the “2011 Form 10-K” in this document. References throughout this document to “we,” “us,” “our,” “Company,” and “Humana” mean Humana Inc. and its subsidiaries.

The preparation of our condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. The areas involving the most significant use of estimates are the estimation of benefits payable, the impact of risk sharing provisions related to our Medicare contracts, the valuation and related impairment recognition of investment securities, and the valuation and related impairment recognition of long-lived assets, including goodwill. These estimates are based on knowledge of current events and anticipated future events, and accordingly, actual results may ultimately differ materially from those estimates. Refer to Note 2 to the consolidated financial statements included in our 2011 Form 10-K for information on accounting policies that the Company considers in preparing its consolidated financial statements.

The financial information has been prepared in accordance with our customary accounting practices and has not been audited. In our opinion, the information presented reflects all adjustments necessary for a fair statement of interim results. All such adjustments are of a normal and recurring nature.

Military Services

On April 1, 2012, we began delivering services under a new TRICARE South Region contract with the Department of Defense, or DoD. Under the new contract, we provide administrative services, including offering access to our provider networks and clinical programs, claim processing, customer service, enrollment, and other services, while the federal government retains all of the risk of the cost of health benefits. Under the terms of the new TRICARE South Region contract, we do not record premiums revenue or benefit expenses in our condensed consolidated statements of income related to these health care costs and related reimbursements. Instead, we account for revenues under the new contract net of estimated health care costs similar to an administrative services fee only agreement. The new contract includes fixed administrative services fees and incentive fees and penalties. Administrative services fees are recognized as services are performed.

Our TRICARE members are served by both in-network and out-of-network providers in accordance with the new TRICARE South Region contract. We pay health care costs related to these services to the providers and are subsequently reimbursed by the DoD for such payments. We account for the payments associated with these health care costs and the related reimbursements under deposit accounting in our consolidated balance sheets and as a financing activity under receipts (withdrawals) from contract deposits in our consolidated statements of cash flows. For the three months ended June 30, 2012, health care cost payments were $515 million, exceeding reimbursements of $459 million by $56 million.

As described in Note 2 to the consolidated financial statements included in our 2011 Form 10-K, our previous TRICARE South Region contract that expired on March 31, 2012 provided a financial interest in the underlying health care cost; therefore, we reported revenues on a gross basis. We shared the risk with the federal government for the cost of health benefits in our previous contract, earning more revenue or incurring additional cost based on the variance of actual health care costs versus an annually negotiated target health care cost.

 

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Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In July 2011, the FASB issued new guidance regarding how health insurers should recognize and classify fees mandated by The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the Health Insurance Reform Legislation). The Health Insurance Reform Legislation imposes a non-deductible annual fee on health insurers for each calendar year beginning on or after January 1, 2014. The guidance requires that the liability for the fee be estimated and recorded in full once qualifying insurance coverage is provided in the applicable calendar year in which the fee is payable with a corresponding deferred cost that is amortized to expense over the calendar year that it is payable. The new guidance is effective for us when the fee is initially imposed in calendar year 2014.

There are no other recently issued accounting standards that apply to us or that will have a material impact on our results of operations, financial condition, or cash flows.

3. ACQUISITIONS

Effective March 31, 2012, we acquired Arcadian Management Services, Inc., or Arcadian, a Medicare Advantage health maintenance organization (HMO) serving members in 15 U.S. states, increasing Medicare membership and expanding our Medicare footprint and future growth opportunities in these areas. The preliminary allocation of the purchase price resulted in goodwill of $48 million and other intangible assets of $38 million. The goodwill was assigned to the Retail segment and is not deductible for tax purposes. The other intangible assets, which primarily consist of customer contracts and provider contracts, have a weighted average useful life of 9.7 years. The purchase price allocation is preliminary, subject to completion of valuation analyses, including, for example, refining assumptions used to calculate the fair value of other intangible assets.

On December 6, 2011, we acquired Anvita, Inc., or Anvita, a San Diego-based health care analytics company. The Anvita acquisition provides scalable analytics solutions that produce clinical insights which we expect to enhance our ability to improve the quality and lower the cost of health care for our members and customers. The preliminary allocation of the purchase price resulted in goodwill of $118 million and other intangible assets of $60 million. The goodwill was assigned to the Retail segment and is not deductible for tax purposes. The other intangible assets, which primarily consist of technology and customer contracts, have a weighted average useful life of 6.5 years. The purchase price allocation is preliminary, subject to completion of valuation analyses, including, for example, refining assumptions used to calculate the fair value of other intangible assets.

The results of operations and financial condition of Arcadian and Anvita have been included in our condensed consolidated statements of income and condensed consolidated balance sheets from the acquisition dates. Acquisition-related costs recognized in connection with these acquisitions were not material. The pro forma financial information assuming the acquisitions had occurred as of the beginning of the calendar year prior to the year of acquisition was not material to our results of operations.

On July 6, 2012, we acquired SeniorBridge Family Companies, Inc., a chronic-care provider providing in-home care for seniors, expanding our existing clinical and home health capabilities and strengthening our offerings for members with complex chronic-care needs.

 

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Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

4. INVESTMENT SECURITIES

Investment securities classified as current and long-term were as follows at June 30, 2012 and December 31, 2011, respectively:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 
     (in millions)  

June 30, 2012

          

U.S. Treasury and other U.S. government corporations and agencies:

          

U.S. Treasury and agency obligations

   $ 536       $ 17       $ 0      $ 553   

Mortgage-backed securities

     1,865         91         (1     1,955   

Tax-exempt municipal securities

     2,722         166         (2     2,886   

Mortgage-backed securities:

          

Residential

     38         1         (1     38   

Commercial

     414         34         0        448   

Asset-backed securities

     43         1         0        44   

Corporate debt securities

     3,425         325         (9     3,741   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total debt securities

   $ 9,043       $ 635       $ (13   $ 9,665   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011

          

U.S. Treasury and other U.S. government corporations and agencies:

          

U.S. Treasury and agency obligations

   $ 705       $ 20       $ 0      $ 725   

Mortgage-backed securities

     1,701         85         (2     1,784   

Tax-exempt municipal securities

     2,709         149         (2     2,856   

Mortgage-backed securities:

          

Residential

     46         0         (2     44   

Commercial

     356         25         0        381   

Asset-backed securities

     82         1         0        83   

Corporate debt securities

     3,329         262         (11     3,580   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total debt securities

   $ 8,928       $ 542       $ (17   $ 9,453   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

Gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position were as follows at June 30, 2012 and December 31, 2011, respectively:

 

     Less than 12 months     12 months or more     Total  
     Fair
Value
     Gross
Unrealized
Losses
    Fair
Value
     Gross
Unrealized
Losses
    Fair
Value
     Gross
Unrealized
Losses
 
     (in millions)  

June 30, 2012

               

U.S. Treasury and other U.S. government corporations and agencies:

               

U.S. Treasury and agency obligations

   $ 94       $ 0      $ 0       $ 0      $ 94       $ 0   

Mortgage-backed securities

     244         0        22         (1     266         (1

Tax-exempt municipal securities

     100         (1     26         (1     126         (2

Mortgage-backed securities:

               

Residential

     0         0        22         (1     22         (1

Commercial

     9         0        0         0        9         0   

Asset-backed securities

     10         0        0         0        10         0   

Corporate debt securities

     206         (9     14         0        220         (9
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total debt securities

   $ 663       $ (10   $ 84       $ (3   $ 747       $ (13
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2011

               

U.S. Treasury and other U.S. government corporations and agencies:

               

U.S. Treasury and agency obligations

   $ 117       $ 0      $ 0       $ 0      $ 117       $ 0   

Mortgage-backed securities

     67         (1     18         (1     85         (2

Tax-exempt municipal securities

     53         0        48         (2     101         (2

Mortgage-backed securities:

               

Residential

     3         0        24         (2     27         (2

Commercial

     14         0        0         0        14         0   

Asset-backed securities

     16         0        4         0        20         0   

Corporate debt securities

     355         (10     41         (1     396         (11
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total debt securities

   $ 625       $ (11   $ 135       $ (6   $ 760       $ (17
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Approximately 94% of our debt securities were investment-grade quality, with a weighted average credit rating of AA by S&P at June 30, 2012. Most of the debt securities that were below investment-grade were rated BB, the higher end of the below investment-grade rating scale. At June 30, 2012, 10% of our tax-exempt municipal securities were pre-refunded, generally with U.S. government and agency securities. Tax-exempt municipal securities that were not pre-refunded were diversified among general obligation bonds of U.S. states and local municipalities as well as special revenue bonds. General obligation bonds, which are backed by the taxing power and full faith of the issuer, accounted for 44% of the tax-exempt municipals that were not pre-refunded in the portfolio. Special revenue bonds, issued by a municipality to finance a specific public works project such as utilities, water and sewer, transportation, and education, and supported by the revenues of that project, accounted for the remaining 56% of these municipals. Our general obligation bonds are diversified across the U.S. with no individual state exceeding 11%. In addition, 22% of our tax-exempt securities were insured by bond insurers and had an equivalent weighted average S&P credit rating of AA- exclusive of the bond insurers’ guarantee. Our investment policy limits investments in a single issuer and requires diversification among various asset types.

 

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Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

The recoverability of our non-agency residential and commercial mortgage-backed securities is supported by factors such as seniority, underlying collateral characteristics and credit enhancements. These residential and commercial mortgage-backed securities at June 30, 2012 primarily were composed of senior tranches having high credit support, with 99% of the collateral consisting of prime loans. The weighted average credit rating of all commercial mortgage-backed securities was AA at June 30, 2012.

The percentage of corporate securities associated with the financial services industry was 21.9% at June 30, 2012 and 19.3% at December 31, 2011.

Several European countries, including Spain, Italy, Ireland, Portugal, and Greece, have been subject to credit deterioration due to weakness in their economic and fiscal situations. We have no direct exposure to sovereign issuances of these five countries.

All issuers of securities we own that were trading at an unrealized loss at June 30, 2012 remain current on all contractual payments. After taking into account these and other factors previously described, we believe these unrealized losses primarily were caused by an increase in market interest rates and tighter liquidity conditions in the current markets than when the securities were purchased. At June 30, 2012, we did not intend to sell the securities with an unrealized loss position in accumulated other comprehensive income, and it is not likely that we will be required to sell these securities before recovery of their amortized cost basis. As a result, we believe that the securities with an unrealized loss were not other-than-temporarily impaired at June 30, 2012.

The detail of realized gains (losses) related to investment securities and included within investment income was as follows for the three and six months ended June 30, 2012 and 2011:

 

     For the three months
ended June 30,
    For the six months
ended June 30,
 
     2012     2011     2012     2011  
     (in millions)  

Gross realized gains

   $ 11      $ 6      $ 16      $ 11   

Gross realized losses

     (1     (5     (2     (6
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized capital gains

   $ 10      $ 1      $ 14      $ 5   
  

 

 

   

 

 

   

 

 

   

 

 

 

There were no material other-than-temporary impairments for the three and six months ended June 30, 2012 or 2011.

The contractual maturities of debt securities available for sale at June 30, 2012, regardless of their balance sheet classification, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

     Amortized
Cost
     Fair
Value
 
     (in millions)  

Due within one year

   $ 374       $ 377   

Due after one year through five years

     1,844         1,917   

Due after five years through ten years

     2,754         2,968   

Due after ten years

     1,711         1,918   

Mortgage and asset-backed securities

     2,360         2,485   
  

 

 

    

 

 

 

Total debt securities

   $ 9,043       $ 9,665   
  

 

 

    

 

 

 

 

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Unaudited

 

5. FAIR VALUE

Financial Assets

The following table summarizes our fair value measurements at June 30, 2012 and December 31, 2011, respectively, for financial assets measured at fair value on a recurring basis:

 

            Fair Value Measurements Using  
     Fair
Value
     Quoted Prices in
Active Markets
(Level 1)
     Other
Observable
Inputs
(Level 2)
     Unobservable
Inputs

(Level 3)
 
     (in millions)  

June 30, 2012

           

Cash equivalents

   $ 3,646       $ 3,646       $ 0       $ 0   

Debt securities:

           

U.S. Treasury and other U.S. government corporations and agencies:

           

U.S. Treasury and agency obligations

     553         0         553         0   

Mortgage-backed securities

     1,955         0         1,955         0   

Tax-exempt municipal securities

     2,886         0         2,871         15   

Mortgage-backed securities:

           

Residential

     38         0         38         0   

Commercial

     448         0         448         0   

Asset-backed securities

     44         0         43         1   

Corporate debt securities

     3,741         0         3,717         24   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total debt securities

     9,665         0         9,625         40   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total invested assets

   $ 13,311       $ 3,646       $ 9,625       $ 40   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

           

Cash equivalents

   $ 1,205       $ 1,205       $ 0       $ 0   

Debt securities:

           

U.S. Treasury and other U.S. government corporations and agencies:

           

U.S. Treasury and agency obligations

     725         0         725         0   

Mortgage-backed securities

     1,784         0         1,784         0   

Tax-exempt municipal securities

     2,856         0         2,840         16   

Mortgage-backed securities:

           

Residential

     44         0         44         0   

Commercial

     381         0         381         0   

Asset-backed securities

     83         0         82         1   

Corporate debt securities

     3,580         0         3,556         24   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total debt securities

     9,453         0         9,412         41   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total invested assets

   $ 10,658       $ 1,205       $ 9,412       $ 41   
  

 

 

    

 

 

    

 

 

    

 

 

 

There were no material transfers between Level 1 and Level 2 during the three and six months ended June 30, 2012 or June 30, 2011.

 

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Our Level 3 assets had a fair value of $40 million at June 30, 2012, or less than 0.5% of our total invested assets. During the three and six months ended June 30, 2012 and 2011, the changes in the fair value of the assets measured using significant unobservable inputs (Level 3) were comprised of the following:

 

     For the three months ended June 30,  
     2012      2011  
     Private
Placements/
Venture
Capital
     Auction
Rate
Securities
     Total      Private
Placements/
Venture
Capital
     Auction
Rate
Securities
    Total  
     (in millions)  

Beginning balance at April 1

   $ 25       $ 15       $ 40       $ 14       $ 51      $ 65   

Total gains or losses:

                

Realized in earnings

     0         0         0         0         0        0   

Unrealized in other comprehensive income

     0         0         0         0         2        2   

Purchases

     0         0         0         17         0        17   

Sales

     0         0         0         0         (33     (33

Settlements

     0         0         0         0         1        1   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Balance at June 30

   $ 25       $ 15       $ 40       $ 31       $ 21      $ 52   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

     For the six months ended June 30,  
     2012     2011  
     Private
Placements/
Venture
Capital
     Auction
Rate
Securities
    Total     Private
Placements/
Venture
Capital
     Auction
Rate
Securities
    Total  
     (in millions)  

Beginning balance at January 1

   $ 25       $ 16      $ 41      $ 14       $ 52      $ 66   

Total gains or losses:

              

Realized in earnings

     0         0        0        0         0        0   

Unrealized in other comprehensive income

     0         0        0        0         2        2   

Purchases

     0         0        0        17         0        17   

Sales

     0         (1     (1     0         (33     (33

Settlements

     0         0        0        0         0        0   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Balance at June 30

   $ 25       $ 15      $ 40      $ 31       $ 21      $ 52   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Financial Liabilities

Our long-term debt, recorded at carrying value in our consolidated balance sheets, was $1,618 million at June 30, 2012 and $1,659 million at December 31, 2011. The fair value of our long-term debt was $1,867 million at June 30, 2012 and $1,834 million at December 31, 2011. The fair value of our long-term debt is determined based on Level 2 inputs including quoted market prices for the same or similar debt, or, if no quoted market prices are available, on the current prices estimated to be available to us for debt with similar terms and remaining maturities.

 

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6. MEDICARE PART D

We cover prescription drug benefits in accordance with Medicare Part D under multiple contracts with the Centers for Medicare and Medicaid Services, or CMS. The condensed consolidated balance sheets include the following amounts associated with Medicare Part D as of June 30, 2012 and December 31, 2011. The risk corridor settlement includes amounts classified as long-term because settlement associated with the 2012 provision will exceed 12 months as of June 30, 2012.

 

     June 30, 2012     December 31, 2011  
     Risk
Corridor
Settlement
    CMS
Subsidies
    Risk
Corridor
Settlement
    CMS
Subsidies
 
     (in millions)  

Other current assets

   $ 37      $ 437      $ 2      $ 363   

Trade accounts payable and accrued expenses

     (328     (428     (331     (139
  

 

 

   

 

 

   

 

 

   

 

 

 

Net current (liability) asset

     (291     9        (329     224   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other long-term assets

     8        0        0        0   

Other long-term liabilities

     (50     0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net long-term liability

     (42     0        0        0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net (liability) asset

   $ (333   $ 9      $ (329   $ 224   
  

 

 

   

 

 

   

 

 

   

 

 

 

7. GOODWILL AND OTHER INTANGIBLE ASSETS

Changes in the carrying amount of goodwill for our reportable segments for the six months ended June 30, 2012 were as follows:

 

     Retail      Employer
Group
     Health &
Well-Being
Services
     Other
Businesses
     Total  
     (in millions)  

Balance at January 1, 2012

   $ 754       $ 62       $ 1,867       $ 57       $ 2,740   

Acquisitions

     43         0         9         0         52   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance at June 30, 2012

   $ 797       $ 62       $ 1,876       $ 57       $ 2,792   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents details of our other intangible assets included in other long-term assets in the accompanying condensed consolidated balance sheets at June 30, 2012 and December 31, 2011:

 

     Weighted
Average
Life
     June 30, 2012      December 31, 2011  
        Cost      Accumulated
Amortization
     Net      Cost      Accumulated
Amortization
     Net  
     (in millions)  

Other intangible assets:

                    

Customer contracts/relationships

     10.5 yrs       $ 459       $ 204       $ 255       $ 429       $ 182       $ 247   

Trade names and technology

     15.0 yrs         136         12         124         135         6         129   

Provider contracts

     15.1 yrs         51         17         34         44         15         29   

Noncompetes and other

     7.1 yrs         41         14         27         40         10         30   
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total other intangible assets

     11.6 yrs       $ 687       $ 247       $ 440       $ 648       $ 213       $ 435   
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Unaudited

 

Amortization expense for other intangible assets was approximately $34 million for the six months ended June 30, 2012 and $26 million for the six months ended June 30, 2011. The following table presents our estimate of amortization expense for 2012 and each of the five next succeeding years:

 

     (in millions)  

For the years ending December 31,:

  

2012

   $ 68   

2013

     64   

2014

     59   

2015

     53   

2016

     47   

2017

     39   

8. EARNINGS PER COMMON SHARE COMPUTATION

Detail supporting the computation of basic and diluted earnings per common share was as follows for the three and six months ended June 30, 2012 and 2011:

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  
     (dollars in millions except per common share results,
number of shares in thousands)
 

Net income available for common stockholders

   $ 356       $ 460       $ 604       $ 775   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average outstanding shares of common stock used to compute basic earnings per common share

     162,816         167,021         163,267         167,146   

Dilutive effect of:

           

Employee stock options

     572         1,073         727         996   

Restricted stock

     1,251         1,466         1,369         1,405   
  

 

 

    

 

 

    

 

 

    

 

 

 

Shares used to compute diluted earnings per common share

     164,639         169,560         165,363         169,547   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic earnings per common share

   $ 2.19       $ 2.76       $ 3.70       $ 4.64   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted earnings per common share

   $ 2.16       $ 2.71       $ 3.65       $ 4.57   
  

 

 

    

 

 

    

 

 

    

 

 

 

Number of antidilutive stock options and restricted stock excluded from computation

     562         139         819         1,441   

 

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Unaudited

 

9. STOCKHOLDERS’ EQUITY

Dividends

In April 2011, our Board of Directors approved the initiation of a quarterly cash dividend policy. Declaration and payment of future quarterly dividends is at the discretion of the Board and may be adjusted as business needs or market conditions change.

The following table provides details of our dividend payments in 2012:

 

Record Date     Payment
Date
    Amount
per Share
    Total
Amount
 
                  (in millions)  
  12/30/2011        1/31/2012      $ 0.25      $ 41   
  3/30/2012        4/27/2012      $ 0.25      $ 41   
  6/29/2012        7/27/2012      $ 0.26      $ 42   

Stock Repurchases

In April 2012, the Board of Directors replaced its previously approved share repurchase authorization of up to $1 billion with a new authorization for repurchases of up to $1 billion of our common shares exclusive of shares repurchased in connection with employee stock plans, expiring on June 30, 2014. Under this share repurchase authorization, shares could be purchased from time to time at prevailing prices in the open market, by block purchases, or in privately-negotiated transactions, subject to certain regulatory restrictions on volume, pricing, and timing. During the six months ended June 30, 2011, we repurchased 3.37 million shares in open market transactions for $253 million at an average price of $74.89 under previously approved share repurchase authorizations. During the six months ended June 30, 2012, we repurchased 1.15 million shares in open market transactions for $100 million at an average price of $86.95 under a previously approved share repurchase authorization and we repurchased 1.58 million shares in open market transactions for $126 million at an average price of $79.94 under the new authorization. As of July 31, 2012, the remaining authorized amount under the new authorization totaled $874 million.

In connection with employee stock plans, we acquired 0.6 million common shares for $52 million and 0.7 million common shares for $48 million during the six months ended June 30, 2012 and 2011, respectively.

10. INCOME TAXES

The effective income tax rate was 36.8% for the three months ended June 30, 2012, compared to 36.6% for the three months ended June 30, 2011. For the six months ended June 30, 2012 the effective tax rate was 36.7%, compared to 36.6% for the six months ended June 30, 2011.

11. GUARANTEES AND CONTINGENCIES

Government Contracts

Our Medicare products, which accounted for approximately 71% of our total premiums and services revenue for the six months ended June 30, 2012, primarily consisted of products covered under the Medicare Advantage and Medicare Part D Prescription Drug Plan contracts with the federal government. These contracts are renewed generally for a calendar year term unless CMS notifies us of its decision not to renew by August 1 of the calendar year in which the contract would end, or we notify CMS of our decision not to renew by the first Monday in June of the calendar year in which the contract would end. All material contracts between Humana and CMS relating to our Medicare products have been renewed for 2013. However, our offerings of products under those contracts are subject to approval by CMS, which we expect in the Fall of 2012.

 

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CMS uses a risk-adjustment model which apportions premiums paid to Medicare Advantage plans according to health severity. The risk-adjustment model pays more for enrollees with predictably higher costs. Under this model, rates paid to Medicare Advantage plans are based on actuarially determined bids, which include a process whereby our prospective payments are based on a comparison of our beneficiaries’ risk scores, derived from medical diagnoses, to those enrolled in the government’s original Medicare program. Under the risk-adjustment methodology, all Medicare Advantage plans must collect and submit the necessary diagnosis code information from hospital inpatient, hospital outpatient, and physician providers to CMS within prescribed deadlines. The CMS risk-adjustment model uses the diagnosis data to calculate the risk-adjusted premium payment to Medicare Advantage plans. We generally rely on providers to code their claim submissions with appropriate diagnoses, which we send to CMS as the basis for our payment received from CMS under the actuarial risk-adjustment model. We also rely on providers to document appropriately all medical data, including the diagnosis data submitted with claims.

CMS is continuing to perform audits of various companies’ selected Medicare Advantage contracts related to this risk adjustment diagnosis data. We refer to these audits as Risk-Adjustment Data Validation Audits, or RADV audits. RADV audits review medical record documentation in an attempt to validate provider coding practices and the presence of risk adjustment conditions which influence the calculation of premium payments to Medicare Advantage plans.

On February 24, 2012, CMS released a “Notice of Final Payment Error Calculation Methodology for Part C Medicare Advantage Risk Adjustment Data Validation (RADV) Contract-Level Audits.” The payment error calculation methodology provides that, in calculating the economic impact of audit results for a Medicare Advantage contract, if any, the results of the audit sample will be extrapolated to the entire Medicare Advantage contract based upon a comparison to “benchmark” audit data in the government fee-for-service program. This comparison to the government program benchmark audit is necessary to determine the economic impact, if any, of audit results because the government program data set provides the basis for Medicare Advantage plans risk adjustment to payment rates.

The final methodology, including the first application of extrapolated audit results to determine audit settlements, will be applied to the next round of RADV contract level audits to be conducted on 2011 premium payments. Medicare Advantage contracts will be selected for audit after the close of the final reconciliation for the payment year being audited. The final reconciliation occurs in August of the calendar year following the payment year.

Estimated audit settlements, if any, are recorded as a reduction of premium revenue in our condensed consolidated statements of income, based upon available information. However, we are awaiting additional guidance from CMS regarding the benchmark audit data in the government fee-for-service program and the identification of our specific Medicare Advantage contracts that will be selected for audit. Accordingly, we cannot determine whether such audits will have a material adverse effect on our results of operations, financial position, or cash flows.

At June 30, 2012, our Military services business, which accounted for approximately 5% of our total premiums and services revenue for the six months ended June 30, 2012, primarily consisted of the TRICARE South Region contract. On April 1, 2012, we began delivering services under the new TRICARE South Region contract that the Department of Defense TRICARE Management Activity, or TMA, awarded to us on February 25, 2011. The new 5-year South Region contract, which expires March 31, 2017, is subject to annual renewals on April 1 of each year during its term at the government’s option.

 

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Unaudited

 

Our Medicaid business, which accounted for approximately 2% of our total premiums and services revenue for the six months ended June 30, 2012, consists of contracts in Puerto Rico and Florida, with the vast majority in Puerto Rico. Effective October 1, 2010, as amended in May 2011, the Puerto Rico Health Insurance Administration, or PRHIA, awarded us contracts for the East, Southeast, and Southwest regions for a three-year term through June 30, 2013.

The loss of any of the contracts above or significant changes in these programs as a result of legislative action, including reductions in premium payments to us, or increases in member benefits without corresponding increases in premium payments to us, may have a material adverse effect on our results of operations, financial position, and cash flows.

Legal Proceedings and Certain Regulatory Matters

Provider Litigation

As previously disclosed, Humana Military Healthcare Services, Inc. (“Humana Military”) was named as a defendant in Sacred Heart Health System, Inc., et al. v. Humana Military Healthcare Services Inc., Case No. 3:07-cv-00062 MCR/EMT (the “Sacred Heart” Complaint). During the three months ended June 30, 2012, following a mediated negotiation, Humana Military reached settlement agreements with all of the plaintiffs in the Sacred Heart Complaint, and the court has dismissed, with prejudice, all causes of action, claims and counterclaims that were asserted by the plaintiffs and Humana Military in the case. As a result, we incurred additional benefit expenses of approximately $46 million during the three months ended June 30, 2012.

Florida Matters

As previously disclosed, with the assistance of outside counsel, we are conducting an ongoing internal investigation related to certain aspects of our Florida subsidiary operations. We have voluntarily self-reported the existence of this investigation to CMS, the U.S. Department of Justice, and the Florida Agency for Health Care Administration. Matters under review include, without limitation, the relationships between certain of our Florida-based employees and providers in our Medicaid and/or Medicare networks, practices related to the financial support of non-profit or provider access centers for Medicaid enrollment and related enrollment processes, and loans to or other financial support of physician practices. We have reported to these regulatory authorities on the progress of our investigation to date, and intend to continue to discuss with these authorities our factual findings as well as any remedial actions we have taken or may take. We also may face litigation or further government inquiry regarding certain aspects of the Medicare and Medicaid operations of certain of our Florida subsidiaries.

On December 16, 2010, an individual filed a qui tam suit captioned United States of America ex rel. Marc Osheroff v. Humana et al. in the Southern District of Florida, against us, several of our health plan subsidiaries, and certain other companies that operate medical centers in Miami-Dade County, Florida. After the U.S. government declined to intervene, the Court ordered the complaint unsealed, and the individual plaintiff amended his complaint and served the Company on December 8, 2011. The amended complaint alleges certain civil violations by our CAC Medical Centers in Florida, including offering various amenities such as transportation and meals, to Medicare and dual eligible individuals in our community center settings. The amended complaint also alleges civil violations by our Medicare Advantage health plans in Florida, arising from the alleged activities of our CAC Medical Centers and the codefendants in the complaint. The amended complaint seeks damages and penalties on behalf of the United States under the Anti-Inducement and Anti-Kickback Statutes and the False Claims Act. We have filed motions to dismiss on behalf of Humana and our subsidiaries.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

On January 6, 2012, the Civil Division of the United States Attorney’s Office for the Southern District of Florida advised our legal counsel that it is seeking documents and information from us and several of our affiliates relating to several matters including the coding of medical claims by one or more South Florida medical providers, and loans to physician practices.

Other Lawsuits and Regulatory Matters

Our current and past business practices are subject to review or other investigations by various state insurance and health care regulatory authorities and other state and federal regulatory authorities. These authorities regularly scrutinize the business practices of health insurance and benefits companies. These reviews focus on numerous facets of our business, including claims payment practices, provider contracting, competitive practices, commission payments, privacy issues, utilization management practices, and sales practices, among others. Some of these reviews have historically resulted in fines imposed on us and some have required changes to some of our practices. We continue to be subject to these reviews, which could result in additional fines or other sanctions being imposed on us or additional changes in some of our practices.

We also are involved in various other lawsuits that arise, for the most part, in the ordinary course of our business operations, certain of which may be styled as class-action lawsuits. Among other matters, this litigation may include employment matters, claims of medical malpractice, bad faith, nonacceptance or termination of providers, anticompetitive practices, improper rate setting, failure to disclose network discounts and various other provider arrangements, general contractual matters, intellectual property matters, and challenges to subrogation practices. Under state guaranty assessment laws, we may be assessed (up to prescribed limits) for certain obligations to the policyholders and claimants of insolvent insurance companies that write the same line or lines of business as we do. As a government contractor, we may also be subject to qui tam litigation brought by individuals who seek to sue on behalf of the government, alleging that the government contractor submitted false claims to the government. Qui tam litigation is filed under seal to allow the government an opportunity to investigate and to decide if it wishes to intervene and assume control of the litigation. If the government does not intervene, the lawsuit is unsealed, and the individual may continue to prosecute the action on his or her own. We also are subject to allegations of non-performance of contractual obligations to providers, members, and others, including failure to properly pay claims, improper policy terminations, challenges to our implementation of the Medicare Part D prescription drug program and other litigation.

Personal injury claims and claims for extracontractual damages arising from medical benefit denials are covered by insurance from our wholly owned captive insurance subsidiary and excess carriers, except to the extent that claimants seek punitive damages, which may not be covered by insurance in certain states in which insurance coverage for punitive damages is not permitted. In addition, insurance coverage for all or certain forms of liability has become increasingly costly and may become unavailable or prohibitively expensive in the future.

We record accruals for such contingencies to the extent that we conclude it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. No estimate of the possible loss or range of loss in excess of amounts accrued, if any, can be made at this time regarding the matters specifically described above because of the inherently unpredictable nature of legal proceedings which also may be exacerbated by various factors, including: (i) the damages sought in the proceedings are unsubstantiated or indeterminate; (ii) discovery is not complete; (iii) the proceeding is in its early stages; (iv) the matters present legal uncertainties; (v) there are significant facts in dispute; (vi) there are a large number of parties (including where it is uncertain how liability, if any, will be shared among multiple defendants); or (vii) there is a wide range of potential outcomes.

The outcome of any current or future litigation or governmental or internal investigations, including the matters described above, cannot be accurately predicted, nor can we predict any resulting penalties, fines or other sanctions that may be imposed at the discretion of federal or state regulatory authorities. Nevertheless, it is reasonably possible that any such penalties, fines or other sanctions could be substantial, and the outcome of these matters may have a material adverse effect on our results of operations, financial position, and cash flows, and may also affect our reputation.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

12. SEGMENT INFORMATION

We manage our business with three reportable segments: Retail, Employer Group, and Health and Well-Being Services. In addition, the Other Businesses category includes businesses that are not individually reportable because they do not meet the quantitative thresholds required by generally accepted accounting principles. These segments are based on a combination of the type of health plan customer and adjacent businesses centered on well-being solutions for our health plans and other customers, as described below. These segment groupings are consistent with information used by our Chief Executive Officer to assess performance and allocate resources.

The Retail segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, marketed directly to individuals. The Employer Group segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, as well as administrative services only products marketed to employer groups. The Health and Well-Being Services segment includes services offered to our health plan members as well as to third parties that promote health and wellness, including primary care, pharmacy, integrated wellness, and home care services. The Other Businesses category consists of our Military services, primarily our TRICARE South Region contract, Medicaid, and closed-block long-term care businesses as well as our contract with CMS to administer the Limited Income Newly Eligible Transition program, or the LI-NET program.

Our Health and Well-Being Services intersegment revenues primarily relate to managing prescription drug coverage for members of our other segments through Humana Pharmacy Solutions®, or HPS, and includes the operations of RightSourceRx®, our mail order pharmacy business. These revenues consist of the prescription price (ingredient cost plus dispensing fee), including the portion to be settled with the member (co-share) or with the government (subsidies), plus any associated administrative fees. Services revenues related to the distribution of prescriptions by third party retail pharmacies in our networks are recognized when the claim is processed and product revenues from dispensing prescriptions from our mail order pharmacies are recorded when the prescription or product is shipped. Our pharmacy operations, which are responsible for designing pharmacy benefits, including defining member co-share responsibilities, determining formulary listings, selecting and establishing prices charged by retail pharmacies, confirming member eligibility, reviewing drug utilization, and processing claims, act as a principal in the arrangement on behalf of members in our other segments. As principal, our Health and Well-Being Services segment reports revenues on a gross basis including co-share amounts from members collected by third party retail pharmacies at the point of service.

We present our consolidated results of operations from the perspective of the health plans. As a result, the cost of providing benefits to our members, whether provided via a third party provider or internally through a stand-alone subsidiary, is classified as benefits expense and excludes the portion of the cost for which the health plans do not bear responsibility, including member co-share amounts and government subsidies of $1.2 billion and $1.0 billion for the three months ended June 30, 2012 and 2011, respectively. For the six months ended June 30, 2012 and 2011, these amounts were $2.4 billion and $2.0 billion, respectively. In addition, depreciation and amortization expense associated with certain businesses in our Health and Well-Being Services segment delivering benefits to our members, primarily associated with our pharmacy operations, are included with benefits expense. The amount of this expense was $9 million and $7 million for the three months ended June 30, 2012 and 2011, respectively. For each of the six months ended June 30, 2012 and 2011, the amount of this expense was $17 million.

Other than those described previously, the accounting policies of each segment are the same and are described in Note 2 to the consolidated financial statements included in our 2011 Form 10-K. Transactions between reportable segments consist of sales of services rendered by our Health and Well-Being Services segment, primarily pharmacy and behavioral health services, to our Retail and Employer Group customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often utilize the same provider networks, enabling us in some instances to obtain more favorable contract terms with providers. Our segments also share indirect costs and assets. As a result, the profitability of each segment is interdependent. We

 

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Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

allocate most operating expenses to our segments. Assets and certain corporate income and expenses are not allocated to the segments, including the portion of investment income not supporting segment operations, interest expense on corporate debt, and certain other corporate expenses. These items are managed at a corporate level. These corporate amounts are reported separately from our reportable segments and included with intersegment eliminations in the tables presenting segment results below.

Our segment results were as follows for the three and six months ended June 30, 2012 and 2011:

 

     Retail      Employer
Group
     Health and
Well-Being
Services
     Other
Businesses
    Eliminations/
Corporate
    Consolidated  
     (in millions)  

Three months ended June 30, 2012

               

Revenues—external customers

               

Premiums:

               

Medicare Advantage

   $ 5,308       $ 1,011       $ 0       $ 0      $ 0      $ 6,319   

Medicare stand-alone PDP

     672         2         0         73        0        747   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total Medicare

     5,980         1,013         0         73        0        7,066   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Fully-insured

     250         1,247         0         0        0        1,497   

Specialty

     42         262         0         0        0        304   

Military services

     0         0         0         44        0        44   

Medicaid and other

     0         0         0         255        0        255   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total premiums

     6,272         2,522         0         372        0        9,166   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Services revenue:

               

Provider

     0         0         245         0        0        245   

ASO and other

     5         89         0         91        0        185   

Pharmacy

     0         0         4         0        0        4   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total services revenue

     5         89         249         91        0        434   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total revenues—external customers

     6,277         2,611         249         463        0        9,600   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Intersegment revenues

               

Services

     1         4         2,377         0        (2,382     0   

Products

     0         0         591         0        (591     0   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total intersegment revenues

     1         4         2,968         0        (2,973     0   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Investment income

     20         10         0         15        54        99   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total revenues

     6,298         2,625         3,217         478        (2,919     9,699   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Operating expenses:

               

Benefits

     5,273         2,074         0         406        (101     7,652   

Operating costs

     625         417         3,064         123        (2,845     1,384   

Depreciation and amortization

     33         20         22         4        (6     73   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total operating expenses

     5,931         2,511         3,086         533        (2,952     9,109   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     367         114         131         (55     33        590   

Interest expense

     0         0         0         0        26        26   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

   $ 367       $ 114       $ 131       $ (55   $ 7      $ 564   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Benefit expenses for the three months ended June 30, 2012 included favorable prior-year medical claims reserve development not in the ordinary course of business of an estimated $24 million in our Retail segment, $12 million in our Employer Group segment, and $4 million for our Other Businesses. In addition, benefit expenses for our Other Businesses for the three months ended June 30, 2012 included expense of approximately $46 million for a litigation settlement associated with our Military services business.

 

21


Table of Contents

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

     Retail      Employer
Group
     Health and
Well-Being
Services
     Other
Businesses
     Eliminations/
Corporate
    Consolidated  
     (in millions)  

Three months ended June 30, 2011

                

Revenues—external customers

                

Premiums:

                

Medicare Advantage

   $ 4,555       $ 764       $ 0       $ 0       $ 0      $ 5,319   

Medicare stand-alone PDP

     601         2         0         77         0        680   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total Medicare

     5,156         766         0         77         0        5,999   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Fully-insured

     206         1,217         0         0         0        1,423   

Specialty

     30         233         0         0         0        263   

Military services

     0         0         0         935         0        935   

Medicaid and other

     0         0         0         229         0        229   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total premiums

     5,392         2,216         0         1,241         0        8,849   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Services revenue:

                

Provider

     0         0         222         0         0        222   

ASO and other

     4         87         0         28         0        119   

Pharmacy

     0         0         3         0         0        3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total services revenue

     4         87         225         28         0        344   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total revenues—external customers

     5,396         2,303         225         1,269         0        9,193   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Intersegment revenues

                

Services

     0         3         2,074         0         (2,077     0   

Products

     0         0         434         0         (434     0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total intersegment revenues

     0         3         2,508         0         (2,511     0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Investment income

     19         12         0         13         47        91   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total revenues

     5,415         2,318         2,733         1,282         (2,464     9,284   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Operating expenses:

                

Benefits

     4,390         1,800         0         1,149         (70     7,269   

Operating costs

     490         387         2,625         111         (2,420     1,193   

Depreciation and amortization

     32         23         20         3         (10     68   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total operating expenses

     4,912         2,210         2,645         1,263         (2,500     8,530   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Income from operations

     503         108         88         19         36        754   

Interest expense

     0         0         0         0         28        28   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Income before income taxes

   $ 503       $ 108       $ 88       $ 19       $ 8      $ 726   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Benefit expenses for the three months ended June 30, 2011 included favorable prior-year medical claims reserve development not in the ordinary course of business of an estimated $32 million in our Retail segment and $9 million for our Other Businesses, partially offset by unfavorable prior-year medical claims reserve development of approximately $8 million in our Employer Group segment.

 

22


Table of Contents

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

     Retail      Employer
Group
     Health and
Well-Being
Services
     Other
Businesses
    Eliminations/
Corporate
    Consolidated  
     (in millions)  

Six months ended June 30, 2012

               

Revenues—external customers

               

Premiums:

               

Medicare Advantage

   $ 10,401       $ 2,036       $ 0       $ 0      $ 0      $ 12,437   

Medicare stand-alone PDP

     1,332         4         0         139        0        1,475   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total Medicare

     11,733         2,040         0         139        0        13,912   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Fully-insured

     494         2,489         0         0        0        2,983   

Specialty

     80         522         0         0        0        602   

Military services

     0         0         0         937        0        937   

Medicaid and other

     0         0         0         507        0        507   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total premiums

     12,307         5,051         0         1,583        0        18,941   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Services revenue:

               

Provider

     0         0         478         0        0        478   

ASO and other

     11         178         0         109        0        298   

Pharmacy

     0         0         8         0        0        8   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total services revenue

     11         178         486         109        0        784   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total revenues—external customers

     12,318         5,229         486         1,692        0        19,725   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Intersegment revenues

               

Services

     1         8         4,863         0        (4,872     0   

Products

     0         0         1,175         0        (1,175     0   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total intersegment revenues

     1         8         6,038         0        (6,047     0   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Investment income

     39         20         0         29        105        193   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total revenues

     12,358         5,257         6,524         1,721        (5,942     19,918   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Operating expenses:

               

Benefits

     10,560         4,138         0         1,512        (208     16,002   

Operating costs

     1,253         844         6,218         239        (5,787     2,767   

Depreciation and amortization

     63         40         43         8        (11     143   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total operating expenses

     11,876         5,022         6,261         1,759        (6,006     18,912   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     482         235         263         (38     64        1,006   

Interest expense

     0         0         0         0        52        52   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

   $ 482       $ 235       $ 263       $ (38   $ 12      $ 954   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Benefit expenses for the six months ended June 30, 2012 included favorable prior-year medical claims reserve development not in the ordinary course of business of approximately $57 million in our Retail segment and $9 million for our Other Businesses, partially offset by unfavorable prior-year medical claims reserve development of approximately $18 million in our Employer Group segment. In addition, benefit expenses for our Other Businesses for the six months ended June 30, 2012 included expense of approximately $46 million for a litigation settlement associated with our Military services business.

 

23


Table of Contents

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

 

     Retail      Employer
Group
     Health and
Well-Being
Services
     Other
Businesses
     Eliminations/
Corporate
    Consolidated  
     (in millions)  

Six months ended June 30, 2011

                

Revenues—external customers

                

Premiums:

                

Medicare Advantage

   $ 9,080       $ 1,560       $ 0       $ 0       $ 0      $ 10,640   

Medicare stand-alone PDP

     1,158         4         0         153         0        1,315   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total Medicare

     10,238         1,564         0         153         0        11,955   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Fully-insured

     407         2,416         0         0         0        2,823   

Specialty

     56         463         0         0         0        519   

Military services

     0         0         0         1,858         0        1,858   

Medicaid and other

     0         0         0         461         0        461   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total premiums

     10,701         4,443         0         2,472         0        17,616   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Services revenue:

                

Provider

     0         0         437         0         0        437   

ASO and other

     7         180         0         50         0        237   

Pharmacy

     0         0         5         0         0        5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total services revenue

     7         180         442         50         0        679   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total revenues—external customers

     10,708         4,623         442         2,522         0        18,295   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Intersegment revenues

                

Services

     0         6         4,195         0         (4,201     0   

Products

     0         0         869         0         (869     0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total intersegment revenues

     0         6         5,064         0         (5,070     0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Investment income

     38         24         0         25         93        180   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total revenues

     10,746         4,653         5,506         2,547         (4,977     18,475   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Operating expenses:

                

Benefits

     8,944         3,552         0         2,258         (140     14,614   

Operating costs

     1,023         811         5,281         230         (4,896     2,449   

Depreciation and amortization

     59         43         40         5         (13     134   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total operating expenses

     10,026         4,406         5,321         2,493         (5,049     17,197   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Income from operations

     720         247         185         54         72        1,278   

Interest expense

     0         0         0         0         55        55   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Income before income taxes

   $ 720       $ 247       $ 185       $ 54       $ 17      $ 1,223   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Benefit expenses for the six months ended June 30, 2011 included favorable prior-year medical claims reserve development not in the ordinary course of business of approximately $72 million in our Retail segment, $33 million in our Employer Group segment, and $12 million for our Other Businesses.

 

24


Table of Contents

Humana Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The condensed consolidated financial statements of Humana Inc. in this document present the Company’s financial position, results of operations and cash flows, and should be read in conjunction with the following discussion and analysis. References to “we,” “us,” “our,” “Company,” and “Humana” mean Humana Inc. and its subsidiaries. This discussion includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in filings with the SEC, in our press releases, investor presentations, and in oral statements made by or with the approval of one of our executive officers, the words or phrases like “expects,” “anticipates,” “intends,” “likely will result,” “estimates,” “projects” or variations of such words and similar expressions are intended to identify such forward–looking statements. These forward–looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including, among other things, information set forth in Item 1A. – Risk Factors in our 2011 Form 10-K, as modified by any changes to those risk factors included in this document and in other reports we filed subsequent to February 24, 2012, in each case incorporated by reference herein. In making these statements, we are not undertaking to address or update such forward-looking statements in future filings or communications regarding our business or results. In light of these risks, uncertainties and assumptions, the forward–looking events discussed in this document might not occur. There may also be other risks that we are unable to predict at this time. Any of these risks and uncertainties may cause actual results to differ materially from the results discussed in the forward–looking statements.

Executive Overview

General

Headquartered in Louisville, Kentucky, Humana is a leading health care company that offers a wide range of insurance products and health and wellness services that incorporate an integrated approach to lifelong well-being. By leveraging the strengths of our core businesses, we believe that we can better explore opportunities for existing and emerging adjacencies in health care that can further enhance wellness opportunities for the millions of people across the nation with whom we have relationships.

Our industry relies on two key statistics to measure performance. The benefit ratio, which is computed by taking total benefit expenses as a percentage of premiums revenue, represents a statistic used to measure underwriting profitability. The operating cost ratio, which is computed by taking total operating costs as a percentage of total revenue less investment income, represents a statistic used to measure administrative spending efficiency.

Business Segments

We manage our business with three reportable segments: Retail, Employer Group, and Health and Well-Being Services. In addition, the Other Businesses category includes businesses that are not individually reportable because they do not meet the quantitative thresholds required by generally accepted accounting principles. These segments are based on a combination of the type of health plan customer and adjacent businesses centered on well-being solutions for our health plans and other customers, as described below. These segment groupings are consistent with information used by our Chief Executive Officer to assess performance and allocate resources.

The Retail segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, marketed directly to individuals. The Employer Group segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, as well as administrative services only products marketed to employer groups. The Health and Well-Being Services segment includes services offered to our health plan members as well as to third parties that promote health and wellness, including primary care, pharmacy, integrated wellness, and home care services. The Other Businesses category consists of our Military services, primarily our TRICARE South Region contract, Medicaid, and closed-block long-term care businesses as well as our contract with CMS to administer the Limited Income Newly Eligible Transition program, or the LI-NET program.

 

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The results of each segment are measured by income before income taxes. Transactions between reportable segments consist of sales of services rendered by our Health and Well-Being Services segment, primarily pharmacy and behavioral health services, to our Retail and Employer Group customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often utilize the same provider networks, enabling us in some instances to obtain more favorable contract terms with providers. Our segments also share indirect costs and assets. As a result, the profitability of each segment is interdependent. We allocate most operating expenses to our segments. Assets and certain corporate income and expenses are not allocated to the segments, including the portion of investment income not supporting segment operations, interest expense on corporate debt, and certain other corporate expenses. These items are managed at the corporate level. These corporate amounts are reported separately from our reportable segments and included with intersegment eliminations.

Seasonality

One of the product offerings of our Retail segment is Medicare stand-alone prescription drug plans, or PDPs, under the Medicare Part D program. These plans provide varying degrees of coverage. Our quarterly Retail segment earnings and operating cash flows are impacted by the Medicare Part D benefit design and changes in the composition of our membership. The Medicare Part D benefit design results in coverage that varies as a member’s cumulative out-of-pocket costs pass through successive stages of a member’s plan period which begins annually on January 1 for renewals. These plan designs generally result in us sharing a greater portion of the responsibility for total prescription drug costs in the early stages and less in the latter stages. As a result, the PDP benefit ratio generally decreases as the year progresses. In addition, the number of low-income senior members as well as year-over-year changes in the mix of membership in our stand-alone PDP products affects the quarterly benefit ratio pattern.

Our Employer Group segment also experiences seasonality in the benefit ratio pattern. However, the effect is opposite of the Retail segment, with the Employer Group’s benefit ratio increasing as fully-insured members progress through their annual deductible and maximum out-of-pocket expenses.

2012 Highlights

Consolidated

 

   

Our results for the three and six months ended June 30, 2012, were significantly impacted by a higher benefit ratio. The consolidated benefit ratio increased 140 basis points to 83.5% for the three months ended June 30, 2012 and increased 150 basis points to 84.5% for the six months ended June 30, 2012 compared to the same periods in 2011. The increases primarily were due to increases in the Retail segment benefit ratios primarily associated with our individual Medicare Advantage products discussed in our Retail segment highlights that follow.

 

   

Comparisons to 2011 are impacted by benefit expenses incurred related to the settlement of litigation associated with our Military services business during the three months ended June 30, 2012 and favorable prior-year medical claims reserve development not in the ordinary course of business that was higher in the three months ended June 30, 2012 than in the three months ended June 30, 2011 and lower in the six months ended June 30, 2012 than in the six months end June 30, 2011.

 

   

In April 2012, our Board of Directors replaced its previously approved share repurchase authorization of up to $1 billion of our common shares (of which $461 million remained as of April 30, 2012) with a new authorization for repurchases of up to $1 billion of our common shares, such authorization to expire on June 30, 2014. As of July 31, 2012, the remaining authorized amount under the new authorization totaled $874 million.

Retail

 

   

As discussed in the detailed Retail segment results of operations discussion that follows, we experienced a significant increase in the benefit ratio in the Retail segment, with the segment’s benefit ratio increasing 270 basis points to 84.1% for the three months ended June 30, 2012 and increasing 220 basis points to 85.8% for the six months ended June 30, 2012. These increases primarily were due to a planned increase in the target benefit ratio associated with positioning for Health Insurance Reform Legislation funding changes and minimum benefit ratio requirements and a higher individual Medicare Advantage benefit ratio experienced on new membership than the assumptions used in our 2012 Medicare bids.

 

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Individual Medicare Advantage membership of 1,895,800 at June 30, 2012 increased 255,500 members, or 15.6%, from 1,640,300 at December 31, 2011 and increased 293,300 members, or 18.3%, from 1,602,500 at June 30, 2011 primarily due to the annual enrollment period associated with the 2012 plan year. We acquired approximately 62,600 members with Arcadian Management Services, Inc., or Arcadian, effective March 31, 2012, discussed below, and 12,100 members with another acquisition effective December 30, 2011.

 

   

Individual Medicare stand-alone PDP membership of 2,896,800 at June 30, 2012 increased 356,400 members, or 14.0%, from 2,540,400 at December 31, 2011 and increased 488,100, or 20.3%, from 2,408,700 at June 30, 2011, primarily due to growth in our national stand-alone Medicare Part D prescription drug plan co-branded with Wal-Mart Stores, Inc., the Humana Walmart-Preferred Rx Plan.

 

   

Effective March 31, 2012, we acquired Arcadian, a Medicare Advantage HMO serving members in 15 U.S. states, increasing our Medicare membership by approximately 62,600 members and expanding our Medicare footprint and future growth opportunities. To obtain antitrust approval in connection with the Arcadian acquisition, we entered into a consent agreement with the United States Department of Justice that will require divestiture of overlapping Medicare Advantage health plan business in eight areas within Arizona, Arkansas, Louisiana, Oklahoma, and Texas. We expect that the divestitures, anticipated to include approximately 12,600 members, would be effective January 1, 2013.

 

   

On April 2, 2012, CMS announced that payment rates will increase on average 3.07% for 2013. We believe we can effectively design Medicare Advantage products based upon this level of rate increase while continuing to remain competitive compared to both the combination of original Medicare with a supplement policy as well as Medicare Advantage products offered by our competitors. In addition, we will continue to pursue our cost-reduction and outcome-enhancing strategies, including care coordination and disease management, which we believe will mitigate the adverse effects of the rates on our Medicare Advantage members. Nonetheless, there can be no assurance that we will be able to successfully execute operational and strategic initiatives with respect to changes in the Medicare Advantage program. Failure to execute these strategies may result in a material adverse effect on our results of operations, financial position, and cash flows.

Employer Group Segment

 

   

Fully-insured group Medicare Advantage membership of 360,500 at June 30, 2012 increased 69,900 members, or 24.1%, from 290,600 at December 31, 2011 and increased 78,500 members, or 27.8%, from 282,000 at June 30, 2011 primarily due to the January 2012 addition of a new large group account.

Health and Well-Being Services Segment

 

   

On July 6, 2012, we acquired SeniorBridge Family Companies, Inc., a chronic-care provider providing in-home care for seniors, expanding our existing clinical and home health capabilities and strengthening our offerings for members with complex chronic-care needs.

Other Businesses

 

   

On April 1, 2012, we began delivering services under the new TRICARE South Region contract that the Department of Defense TRICARE Management Activity, or TMA, awarded to us on February 25, 2011. The new 5-year South Region contract, which expires March 31, 2017, is subject to annual renewals on April 1 of each year during its term at the government’s option. We account for revenues under the new contract net of estimated health care costs similar to an administrative services fee only agreement.

 

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Health Insurance Reform

In June 2012, the U.S. Supreme Court upheld the constitutionality of various aspects of The Patient Protection and Affordable Care Act. Together with The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the Health Insurance Reform Legislation), significant reforms to various aspects of the U.S. health insurance industry were enacted. While regulations and interpretive guidance on some provisions of the Health Insurance Reform Legislation have been issued to date by the Department of Health and Human Services (HHS), the Department of Labor, the Treasury Department, and the National Association of Insurance Commissioners, there are many significant provisions of the legislation that will require additional guidance and clarification in the form of regulations and interpretations in order to fully understand the impacts of the legislation on our overall business, which we expect to occur over the next several years.

Implementation dates of the Health Insurance Reform Legislation vary from September 23, 2010 to as late as 2018. The following outlines certain provisions of the Health Insurance Reform Legislation:

 

   

Many changes are already effective and have been implemented by the Company, including: elimination of pre-existing condition limits for enrollees under age 19, elimination of certain annual and lifetime caps on the dollar value of benefits, expansion of dependent coverage to include adult children until age 26, a requirement to provide coverage for preventive services without cost to members, new claim appeal requirements, and the establishment of an interim high risk program for those unable to obtain coverage due to a pre-existing condition or health status.

 

   

Effective January 1, 2011, minimum benefit ratios were mandated for all commercial fully-insured medical plans in the large group (85%), small group (80%), and individual (80%) markets, with annual rebates to policyholders if the actual benefit ratios, calculated in a manner prescribed by HHS, do not meet these minimums. Certain states were approved to apply an individual threshold lower than the 80% requirement temporarily to avoid market disruption. We began accruing for rebates in 2011, based on the manner prescribed by HHS, with initial rebate payments made in July 2012. Our benefit ratios reported herein, calculated from financial statements prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, differ from the benefit ratios calculated as prescribed by HHS under the Health Insurance Reform Legislation. The more noteworthy differences include the fact that the benefit ratio calculations prescribed by HHS are calculated separately by state and legal entity; reflect actuarial adjustments where the membership levels are not large enough to create credible size; exclude some of our health insurance products; include taxes and fees as reductions of premium; treat changes in reserves differently than GAAP; and classify rebate amounts as additions to incurred claims as opposed to adjustments to premiums for GAAP reporting.

 

   

Medicare Advantage payment benchmarks for 2011 were frozen at 2010 levels and in 2012, additional cuts to Medicare Advantage plan payments took effect (plans receive a range of 95% in high-cost areas to 115% in low-cost areas of Medicare fee-for-service rates), with changes being phased-in over two to six years, depending on the level of payment reduction in a county. In addition, in 2011 the gap in coverage for Medicare Part D prescription drug coverage began to incrementally close.

 

   

Beginning in 2014, the Health Insurance Reform Legislation requires: all individual and group health plans to guarantee issuance and renew coverage without pre-existing condition exclusions or health-status rating adjustments; the elimination of annual limits on coverage on certain plans; the establishment of state-based exchanges for individuals and small employers (with up to 100 employees) coupled with programs designed to spread risk among insurers; the introduction of standardized plan designs based on set actuarial values; the establishment of a minimum benefit ratio of 85% for Medicare plans; and insurance industry assessments, including an annual premium-based assessment and a three-year $25 billion commercial reinsurance fee. The annual premium-based assessment levied on the insurance industry is $8 billion in 2014 with increasing annual amounts thereafter, growing to $14 billion by 2017, and is not deductible for income tax purposes, which will significantly increase our effective income tax rate in 2014. In December 2011, the National Association of Insurance Commissioners, or NAIC, issued proposed guidance indicating the insurance industry premium-based assessment may require accrual and associated subsidiary funding consideration in 2013 instead of 2014. This proposed NAIC guidance is contradictory to final GAAP guidance issued by the Financial Accounting Standards Board, or FASB, in July 2011, which requires accrual of the insurance industry premium-based assessment beginning in 2014, the year in which it is payable. Refer to Recently Issued Accounting Pronouncements in Note 2 to the condensed consolidated financial statements. In June 2012, the NAIC’s Statutory Accounting Principles, or SAP, Working Group deferred issuing guidance that would have required accrual and associated subsidiary funding consideration related to the insurance industry premium-based assessment beginning in 2013.

 

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The Health Insurance Reform Legislation also specifies required benefit designs, limits rating and pricing practices, encourages additional competition (including potential incentives for new market entrants) and expands eligibility for Medicaid programs. In addition, the law will significantly increase federal oversight of health plan premium rates and could adversely affect our ability to appropriately adjust health plan premiums on a timely basis. Financing for these reforms will come, in part, from material additional fees and taxes on us and other health insurers, health plans and individuals beginning in 2014, as well as reductions in certain levels of payments to us and other health plans under Medicare as described herein.

In addition, certain provisions in the Health Insurance Reform Legislation tie Medicare Advantage premiums to the achievement of certain quality performance measures (Star Ratings). Beginning in 2012, Medicare Advantage plans with an overall Star Rating of three or more stars (out of five) are eligible for a quality bonus in their basic premium rates. Initially quality bonuses were limited to the few plans that achieved four or more stars as an overall rating, but CMS has expanded the quality bonus to three Star plans for a three year period through 2014. Recent Star Ratings issued by CMS indicated that 98% of our Medicare Advantage members are now in plans that will qualify for quality bonus payments in 2013, exclusive of those recently acquired, including Arcadian. Notwithstanding successful historical efforts to improve our Star Ratings and other quality measures for 2012 and 2013 and the continuation of such efforts, there can be no assurances that we will be successful in maintaining or improving our Star Ratings in future years. Accordingly, our plans may not be eligible for full level quality bonuses, which could adversely affect the benefits such plans can offer, reduce membership, and/or reduce profit margins.

As discussed above, implementing regulations and related interpretive guidance continue to be issued on several significant provisions of the Health Insurance Reform Legislation. Congress may also withhold the funding necessary to implement the Health Insurance Reform Legislation, or may attempt to replace the legislation with amended provisions or repeal it altogether. Given the breadth of possible changes and the uncertainties of interpretation, implementation, and timing of these changes, which we expect to occur over the next several years, the Health Insurance Reform Legislation could change the way we do business, potentially impacting our pricing, benefit design, product mix, geographic mix, and distribution channels. In particular, implementing regulations and related guidance are forthcoming on various aspects of the minimum benefit ratio requirement’s applicability to Medicare, including aggregation, credibility thresholds, and its possible application to prescription drug plans. The response of other companies to the Health Insurance Reform Legislation and adjustments to their offerings, if any, could cause meaningful disruption in the local health care markets. Further, various health insurance reform proposals are also emerging at the state level. It is reasonably possible that the Health Insurance Reform Legislation and related regulations, as well as future legislative changes, in the aggregate may have a material adverse effect on our results of operations, including restricting revenue, enrollment and premium growth in certain products and market segments, restricting our ability to expand into new markets, increasing our medical and operating costs, lowering our Medicare payment rates and increasing our expenses associated with the non-deductible federal premium tax and other assessments; our financial position, including our ability to maintain the value of our goodwill; and our cash flows. If the new non-deductible federal premium tax and other assessments, including a three-year commercial reinsurance fee, were imposed as enacted, and if we are unable to adjust our business model to address these new taxes and assessments, such as through the reduction of our operating costs or inclusion in premium pricing, there can be no assurance that the non-deductible federal premium tax and other assessments would not have a material adverse effect on our results of operations, financial position, and cash flows.

We intend for the discussion of our financial condition and results of operations that follows to assist in the understanding of our financial statements and related changes in certain key items in those financial statements from year to year, including the primary factors that accounted for those changes. Transactions between reportable segments consist of sales of services rendered by our Health and Well-Being Services segment, primarily pharmacy and behavioral health services, to our Retail and Employer Group customers and are described in Note 12 to the condensed consolidated financial statements.

 

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Comparison of Results of Operations for 2012 and 2011

The following discussion primarily deals with our results of operations for the three months ended June 30, 2012, or the 2012 quarter, the three months ended June 30, 2011, or the 2011 quarter, the six months ended June 30, 2012, or the 2012 period, and the six months ended June 30, 2011, or the 2011 period.

Consolidated

 

     For the three months ended
June 30,
    Change  
     2012     2011     Dollars     Percentage  
     (dollars in millions, except per common share results)        

Revenues:

        

Premiums:

        

Retail

   $ 6,272      $ 5,392      $ 880        16.3 

Employer Group

     2,522        2,216        306        13.8 

Other Businesses

     372        1,241        (869     (70.0 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total premiums

     9,166        8,849        317        3.6 
  

 

 

   

 

 

   

 

 

   

 

 

 

Services:

        

Retail

     5        4        1        25.0 

Employer Group

     89        87        2        2.3 

Health and Well-Being Services

     249        225        24        10.7 

Other Businesses

     91        28        63        225.0 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total services

     434        344        90        26.2 
  

 

 

   

 

 

   

 

 

   

 

 

 

Investment income

     99        91        8        8.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     9,699        9,284        415        4.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Benefits

     7,652        7,269        383        5.3

Operating costs

     1,384        1,193        191        16.0 

Depreciation and amortization

     73        68        5        7.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     9,109        8,530        579        6.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     590        754        (164     (21.8 )% 

Interest expense

     26        28        (2     (7.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     564        726        (162     (22.3 )% 

Provision for income taxes

     208        266        (58     (21.8 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 356      $ 460      $ (104     (22.6 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

   $ 2.16      $ 2.71      $ (0.55     (20.3 )% 

Benefit ratio(a)

     83.5      82.1        1.4

Operating cost ratio(b)

     14.4      13.0        1.4

Effective tax rate

     36.8      36.6        0.2

 

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

 

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     For the six months  ended
June 30,
    Change  
     2012     2011     Dollars     Percentage  
     (dollars in millions, except per common share results)        

Revenues:

        

Premiums:

        

Retail

   $ 12,307      $ 10,701      $ 1,606        15.0 

Employer Group

     5,051        4,443        608        13.7 

Other Businesses

     1,583        2,472        (889     (36.0 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total premiums

     18,941        17,616        1,325        7.5 
  

 

 

   

 

 

   

 

 

   

 

 

 

Services:

        

Retail

     11        7        4        57.1 

Employer Group

     178        180        (2     (1.1 )% 

Health and Well-Being Services

     486        442        44        10.0 

Other Businesses

     109        50        59        118.0 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total services

     784        679        105        15.5 
  

 

 

   

 

 

   

 

 

   

 

 

 

Investment income

     193        180        13        7.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     19,918        18,475        1,443        7.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Benefits

     16,002        14,614        1,388        9.5

Operating costs

     2,767        2,449        318        13.0 

Depreciation and amortization

     143        134        9        6.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     18,912        17,197        1,715        10.0 
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     1,006        1,278        (272     (21.3 )% 

Interest expense

     52        55        (3     (5.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     954        1,223        (269     (22.0 )% 

Provision for income taxes

     350        448        (98     (21.9 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 604      $ 775      $ (171     (22.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

   $ 3.65      $ 4.57      $ (0.92     (20.1 )% 

Benefit ratio(a)

     84.5     83.0       1.5

Operating cost ratio(b)

     14.0     13.4       0.6

Effective tax rate

     36.7     36.6       0.1

 

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

Summary

Net income was $356 million, or $2.16 per diluted common share, in the 2012 quarter compared to $460 million, or $2.71 per diluted common share, in the 2011 quarter. Net income was $604 million, or $3.65 per diluted common share, in the 2012 period compared to $775 million, or $4.57 per diluted common share, in the 2011 period. The decreases primarily were due to lower operating results in the Retail segment as well as Other Businesses, partially offset by improved operating results in the Health and Well-Being Services segment. During the 2012 quarter and period, we experienced a significant increase in the Retail segment benefit ratio primarily associated with our individual Medicare Advantage products primarily due to a planned increase in the target benefit ratio associated with positioning for Health Insurance Reform Legislation funding changes and minimum benefit ratio requirements and a higher benefit ratio experienced on new membership than the assumptions used in our 2012 Medicare bids. Our diluted earnings per common share for the 2012 quarter and period included $0.18 per diluted common share for benefit expenses related to the settlement of a litigation matter associated with our Military

 

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services business. In addition, our diluted earnings per common share included the beneficial impact of favorable prior-year medical claims reserve development of approximately $0.15 per diluted common share for the 2012 quarter compared to $0.12 per diluted common share for the 2011 quarter. For the 2012 period, our diluted earnings per common share included the beneficial impact of favorable prior-year medical claims reserve development of approximately $0.18 per diluted common share compared to $0.44 per diluted common share for the 2011 period.

Premiums

Consolidated premiums increased $317 million, or 3.6%, from the 2011 quarter to $9.2 billion for the 2012 quarter, and increased $1.3 billion, or 7.5%, from the 2011 period to $18.9 billion for the 2012 period. These increases primarily were due to increases in both Retail and Employer Group segment premiums primarily driven by higher average individual and group Medicare Advantage membership, partially offset by lower premiums for our Other Businesses due to the transition to the new TRICARE South Region contract. As discussed previously, on April 1, 2012, we began delivering services under the new TRICARE South Region contract that the TMA awarded to us on February 25, 2011. We account for revenues under the new contract net of estimated healthcare costs similar to an administrative services fee only agreement, and as such there are no premiums recognized under the new contract. Average membership is calculated by summing the ending membership for each month in a period and dividing the result by the number of months in a period. Premiums revenue reflects changes in membership and increases in average per member premiums. Items impacting average per member premiums include changes in premium rates as well as changes in the geographic mix of membership, the mix of product offerings, and the mix of benefit plans selected by our membership.

Services Revenue

Consolidated services revenue increased $90 million, or 26.2%, from the 2011 quarter to $434 million for the 2012 quarter, and increased $105 million, or 15.5%, from the 2011 period to $784 million for the 2012 period. These increases primarily were due to increased services revenue for our Other Businesses due to the transition to the new TRICARE South Region contract on April 1, 2012 discussed above, and an increase in primary care services revenue in our Health and Well-Being Services segment from growth in our Concentra operations.

Investment Income

Investment income totaled $99 million for the 2012 quarter, an increase of $8 million from the 2011 quarter. For the 2012 period, investment income totaled $193 million, an increase of $13 million, or 7.2%, from the 2011 period. These increases primarily reflect capital gains realized in the 2012 quarter and period.

Benefit Expenses

Consolidated benefit expenses were $7.7 billion for the 2012 quarter, an increase of $383 million, or 5.3%, from the 2011 quarter. For the 2012 period, consolidated benefit expenses were $16.0 billion, an increase of $1.4 billion, or 9.5%, from the 2011 period. These increases primarily were due to an $883 million, or 20.1%, increase in Retail segment benefit expenses from the 2011 quarter to the 2012 quarter, and a $1.6 billion, or 18.1%, increase in Retail segment benefit expenses from the 2011 period to the 2012 period, primarily driven by an increase in the average number of individual Medicare members. These increases were partially offset by a decrease in benefit expenses for Other Businesses primarily due to the transition to the new administrative services only TRICARE South Region contract on April 1, 2012. We do not record benefit expenses under the new contract.

The consolidated benefit ratio for the 2012 quarter was 83.5%, a 140 basis point increase from the 2011 quarter. The consolidated benefit ratio for the 2012 period was 84.5%, a 150 basis point increase from the 2011 period. These increases primarily were due to increases in both the Retail and Employer Group segments benefit ratios as described further in our segment results discussion that follows. Year-over-year quarter and period comparisons of the consolidated benefit ratio were favorably impacted by 30 basis points due to the continued growth of our Health & Well-Being segment and the related savings realized on a consolidated basis from providing these services directly to our members at fair market value rather than through a third party.

Operating Costs

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

 

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Consolidated operating costs increased $191 million, or 16.0%, during the 2012 quarter compared to the 2011 quarter, and increased $318 million, or 13.0%, during the 2012 period compared to the 2011 period. The increases primarily were due to an increase in operating costs in our Retail Segment as a result of Medicare Advantage growth.

The consolidated operating cost ratio for the 2012 quarter was 14.4%, increasing 140 basis points from the 2011 quarter. For the 2012 period the consolidated operating cost ratio was 14.0%, increasing 60 basis points from the 2011 period. These increases primarily reflect the impact of the new TRICARE South Region contract being accounted for as an administrative services fee only arrangement.

Depreciation and Amortization

Depreciation and amortization for the 2012 quarter totaled $73 million, an increase of $5 million, or 7.4%, from the 2011 quarter. For the 2012 period, depreciation and amortization of $143 million increased $9 million, or 6.7%, from the 2011 period. These increases primarily were due to increased amortization expense in the 2012 quarter and period as a result of the acquisitions of Anvita in the fourth quarter of 2011 and Arcadian in the first quarter of 2012.

Interest Expense

Interest expense was $26 million for the 2012 quarter compared to $28 million for the 2011 quarter. Interest expense was $52 million for the 2012 period compared to $55 million for the 2011 period. In March 2012, we repaid $36 million of junior subordinated debt that carried a higher interest rate than our senior notes.

Income Taxes

Our effective tax rate during the 2012 quarter was 36.8%, comparable to the effective tax rate of 36.6% in the 2011 quarter. For the 2012 period, our effective tax rate was 36.7%, comparable to the effective tax rate of 36.6% in the 2011 period.

 

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Retail Segment

 

     June 30,      Change  
     2012      2011      Members      Percentage  

Membership:

           

Medical membership:

           

Individual Medicare Advantage

     1,895,800         1,602,500         293,300         18.3

Individual Medicare stand-alone PDP

     2,896,800         2,408,700         488,100         20.3
  

 

 

    

 

 

    

 

 

    

 

 

 

Total individual Medicare

     4,792,600         4,011,200         781,400         19.5

Individual commercial

     514,300         456,600         57,700         12.6
  

 

 

    

 

 

    

 

 

    

 

 

 

Total individual medical members

     5,306,900         4,467,800         839,100         18.8
  

 

 

    

 

 

    

 

 

    

 

 

 

Individual specialty membership (a)

     906,200         680,500         225,700         33.2
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(a) Specialty products include dental, vision, and other supplemental health and financial protection products. Members included in these products may not be unique to each product since members have the ability to enroll in multiple products.

 

     For the three months ended
June 30,
    Change  
     2012     2011     Dollars     Percentage  
           (in millions)              

Premiums and Services Revenue:

        

Premiums:

        

Individual Medicare Advantage

   $ 5,308      $ 4,555      $ 753        16.5

Individual Medicare stand-alone PDP

     672        601        71        11.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Total individual Medicare

     5,980        5,156        824        16.0

Individual commercial

     250        206        44        21.4

Individual specialty

     42        30        12        40.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total premiums

     6,272        5,392        880        16.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Services

     5        4        1        25.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total premiums and services revenue

   $ 6,277      $ 5,396      $ 881        16.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

   $ 367      $ 503      $ (136     (27.0 )% 

Benefit ratio

     84.1     81.4   </