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UnitedHealth Group 10-Q 2010 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
Form 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010 or
FOR THE TRANSITION PERIOD FROM TO Commission file number: 1-10864
UnitedHealth Group Incorporated (Exact name of registrant as specified in its charter)
(952) 936-1300 (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 þ 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨ Indicate by check mark 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 þ 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 Exchange Act). Yes ¨ No þ As of July 30, 2010, there were 1,124,267,834 shares of the registrant’s Common Stock, $.01 par value per share, issued and outstanding.
Table of ContentsTable of Contents
Table of Contents
Condensed Consolidated Balance Sheets (Unaudited)
See Notes to the Condensed Consolidated Financial Statements
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Table of ContentsCondensed Consolidated Statements of Operations (Unaudited)
See Notes to the Condensed Consolidated Financial Statements
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Table of ContentsCondensed Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
See Notes to the Condensed Consolidated Financial Statements
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Table of ContentsCondensed Consolidated Statements of Cash Flows (Unaudited)
See Notes to the Condensed Consolidated Financial Statements
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Table of ContentsNOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation, Use of Estimates and Significant Accounting Policies Basis of Presentation The accompanying Condensed Consolidated Financial Statements include the consolidated accounts of UnitedHealth Group Incorporated and its subsidiaries (the Company). The Company has eliminated intercompany balances and transactions. The year end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. Generally Accepted Accounting Principles (U.S. GAAP). In accordance with the rules and regulations of the U.S. Securities and Exchange Commission (SEC), the Company has omitted certain footnote disclosures that would substantially duplicate the disclosures contained in its annual audited Consolidated Financial Statements. As such, these Condensed Consolidated Financial Statements should be read together with the Consolidated Financial Statements and the Notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 as filed with the SEC (2009 10-K). The accompanying Condensed Consolidated Financial Statements include all normal recurring adjustments necessary to present the interim financial statements fairly. Use of Estimates These Condensed Consolidated Financial Statements include certain amounts based on the Company’s best estimates and judgments. The Company’s most significant estimates relate to medical costs, medical costs payable, revenues, goodwill, other intangible assets, investments, income taxes and contingent liabilities. These estimates require the application of complex assumptions and judgments, often because they involve matters that are inherently uncertain and will likely change in subsequent periods. The impact of any changes in estimates is included in earnings in the period in which the estimate is adjusted. Recent Accounting Standards Recently Adopted Accounting Standards. In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2010-06, “Improving Disclosures about Fair Value Measurements” (ASU 2010-06). This update amends the fair value guidance of the FASB Accounting Standards Codification (ASC) to require additional disclosures regarding (i) transfers in and out of Level 1 and Level 2 fair value measurements and (ii) activity in Level 3 fair value measurements. ASU 2010-06 also clarifies existing disclosure requirements regarding (i) the level of asset and liability disaggregation and (ii) fair value measurement inputs and valuation techniques. The new disclosures and clarifications of existing disclosures are effective for the Company’s fiscal year 2010, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which will be effective for the Company’s fiscal year 2011. The Company’s fair value disclosures, including the new disclosures effective in 2010, have been included in Note 3 of Notes to the Condensed Consolidated Financial Statements. Recently Issued Accounting Standards. In October 2009, the FASB issued ASU No. 2009-13, “Multiple-Deliverable Revenue Arrangements” (ASU 2009-13). This update removes the criterion that entities must use objective and reliable evidence of fair value in separately accounting for deliverables and provides entities with a hierarchy of evidence that must be considered when allocating arrangement consideration. The new guidance also requires entities to allocate arrangement consideration to the separate units of accounting based on the deliverables’ relative selling price. The provisions will be effective for revenue arrangements entered into or materially modified in the Company’s fiscal year 2011 and must be applied prospectively. The Company is currently evaluating the impact of the provisions of ASU 2009-13.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
The Company has determined that all other recently issued accounting standards will not have a material impact on its Condensed Consolidated Financial Statements, or do not apply to its operations. 2. Investments A summary of short-term and long-term investments is as follows:
Included in the Company’s investment portfolio were securities collateralized by sub-prime home equity lines of credit with fair values of $7 million and $9 million as of June 30, 2010 and December 31, 2009, respectively. Also included were Alt-A securities with fair values of $17 million and $19 million as of June 30, 2010 and December 31, 2009, respectively.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
The fair values of the Company’s mortgage-backed securities by credit rating and non-U.S. agency mortgage-backed securities by origination as of June 30, 2010 were as follows:
The amortized cost and fair value of available-for-sale debt securities as of June 30, 2010, by contractual maturity, were as follows:
The amortized cost and fair value of held-to-maturity debt securities as of June 30, 2010, by contractual maturity, were as follows:
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
The fair value of available-for-sale investments with gross unrealized losses by investment type and length of time that individual securities have been in a continuous unrealized loss position were as follows:
Investments classified as held-to-maturity have been excluded from the above analysis. These investments are predominantly held in U.S. government or agency obligations. Additionally, the fair values of these investments approximate their amortized cost. The unrealized losses from all securities as of June 30, 2010 were generated from approximately 460 positions out of a total of approximately 13,000 positions. The Company believes that it will collect all principal and interest due on all investments that have an amortized cost in excess of fair value. The unrealized losses on investments in state and municipal obligations and corporate obligations as of June 30, 2010 were primarily caused by interest rate increases and not by unfavorable changes in the credit ratings associated with these securities. The Company evaluates impairment at each reporting period for securities where the fair value of the investment is less than its amortized cost. The Company evaluated the underlying credit quality of the issuers and the credit ratings of the state and municipal obligations and the corporate obligations, noting neither a significant deterioration since purchase nor other factors leading to an other-than-temporary impairment (OTTI). As of June 30, 2010, the Company did not have the intent to sell any of the securities in an unrealized loss position. As of June 30, 2010, the Company’s holdings of non-U.S. agency mortgage-backed securities included $8 million of commercial mortgage loans in default. These investments were acquired in the first quarter of 2008 pursuant to an acquisition and were recorded at fair value. They represented less than 1% of the Company’s total mortgage-backed security holdings as of June 30, 2010. A portion of the Company’s investments in equity securities and venture capital funds consists of investments held in various public and nonpublic companies concentrated in the areas of health care services and related
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
information technologies. Market conditions that affect the value of health care and related technology stocks will likewise impact the value of the Company’s equity portfolio. The equity securities and venture capital funds were evaluated for severity and duration of unrealized loss, overall market volatility and other market factors. Net realized gains, before taxes, were from the following sources:
For the three and six months ended June 30, 2010 and 2009, all of the recorded OTTI charges resulted from the Company’s intent to sell certain impaired securities. 3. Fair Value Fair values of available-for-sale debt and equity securities are based on quoted market prices, where available. The Company obtains one price for each security primarily from a third-party pricing service (pricing service), which generally uses quoted or other observable inputs for the determination of fair value. The pricing service normally derives the security prices through recently reported trades for identical or similar securities, making adjustments through the reporting date based upon available observable market information. For securities not actively traded, the pricing service may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, non-binding broker quotes, benchmark yields, credit spreads, default rates and prepayment speeds. As the Company is responsible for the determination of fair value, it performs quarterly analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value. Specifically, the Company compares the prices received from the pricing service to prices reported by its custodian, its investment consultant and third-party investment advisors. Additionally, the Company compares changes in the reported market values and returns to relevant market indices to test the reasonableness of the reported prices. Based on the Company’s internal price verification procedures and review of fair value methodology documentation provided by independent pricing services, the Company has not historically adjusted the prices obtained from the pricing service. In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
The fair value hierarchy is as follows: Level 1 — Quoted (unadjusted) prices for identical assets/liabilities in active markets. Level 2 — Other observable inputs, either directly or indirectly, including:
Level 3 — Unobservable inputs that cannot be corroborated by observable market data.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
The following table presents information about the Company’s financial assets and liabilities, excluding AARP Program-related assets and liabilities, which are measured at fair value on a recurring basis, according to the valuation techniques the Company used to determine their fair values. See Note 10 of Notes to the Condensed Consolidated Financial Statements for further detail on AARP.
There were no transfers between Levels 1 and 2 during the three and six months ended June 30, 2010.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
The following methods and assumptions were used to estimate the fair value of each class of financial instrument: Cash and Cash Equivalents. The carrying value of cash and cash equivalents approximates fair value as maturities are less than three months. Fair values of cash equivalent instruments that do not trade on a regular basis in active markets are classified as Level 2. Debt Securities. The estimated fair values of debt securities held as available-for-sale are based on quoted market prices and/or other market data for the same or comparable instruments and transactions in establishing the prices. Fair values of debt securities that do not trade on a regular basis in active markets are classified as Level 2. Equity Securities. Equity securities are held as available-for-sale investments. Fair value estimates for Level 1 and Level 2 publicly traded equity securities are based on quoted market prices and/or other market data for the same or comparable instruments and transactions in establishing the prices. The fair values of Level 3 investments in venture capital portfolios are estimated using market modeling approaches that rely heavily on management assumptions and qualitative observations. These investments totaled $155 million as of June 30, 2010. The fair values of the Company’s various venture capital investments are computed using limited quantitative and qualitative observations of activity for similar companies in the current market. The key inputs utilized in the Company’s market modeling include, as applicable, transactions for comparable companies in similar industries and having similar revenue and growth characteristics; similar preferences in the capital structure; discounted cash flows; liquidation values and milestones established at initial funding; and the assumption that the values of the Company’s venture capital investments can be inferred from these inputs. The Company’s remaining Level 3 equity securities holdings of $31 million mainly consist of preferred stock for which there is no active market. Interest Rate Swaps. Fair values of the Company’s interest rate swaps are estimated using the terms of the swaps and publicly available market yield curves. Because the swaps are unique and not actively traded, the fair values are classified as Level 2 estimates.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level 3 inputs is as follows:
There were no transfers into or from Level 3 for the three and six months ended June 30, 2010 and 2009. There were no significant fair value adjustments recorded during the three and six months ended June 30, 2010 or 2009, for non-financial assets and liabilities or financial assets and liabilities that are measured at fair value on a nonrecurring basis. These assets and liabilities are subject to fair value adjustments only in certain circumstances, such as when the Company records impairments. The table below includes fair values for certain financial instruments for which it is practicable to estimate fair value. The carrying values and fair values of these financial instruments were as follows:
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
In addition to the previously described methods and assumptions for debt and equity securities and interest rate swaps, the following are the methods and assumptions used to estimate the fair value of the other financial instruments: AARP Program-related Investments. AARP Program-related investments consist of debt and equity securities held to fund costs associated with the AARP Program (see Note 10 of Notes to the Condensed Consolidated Financial Statements). The Company elected to measure the AARP assets under management, of which the investments are a part, at fair value, pursuant to the fair value option. See the preceding discussion regarding the methods and assumptions used to estimate the fair value of debt and equity securities. Senior Unsecured Notes. The fair values of the senior unsecured notes are estimated based on third-party quoted market prices for the same or similar issues. The carrying amounts reported in the Condensed Consolidated Balance Sheets for cash and cash equivalents, accounts and other current receivables, unearned revenues, accounts payable and accrued liabilities approximate fair value because of their short-term nature. These assets and liabilities are not listed in the table above. 4. Medicare Part D Pharmacy Benefits Contract The Condensed Consolidated Balance Sheets include the following amounts associated with the Medicare Part D program:
The Catastrophic Reinsurance Subsidy and the Low-Income Member Cost Sharing Subsidy represent cost reimbursements under the Medicare Part D program. The Company is fully reimbursed by the Centers for Medicare and Medicaid Services (CMS) for costs incurred for these contract elements and, accordingly, there is no insurance risk to the Company. Amounts received for these subsidies are not reflected as premium revenues, but rather are accounted for as deposits in other policy liabilities in the Condensed Consolidated Balance Sheets. As of December 31, 2009, the amounts received for these subsidies were insufficient to cover the costs incurred for these contract elements; therefore, the Company recorded a receivable in other current receivables in the Condensed Consolidated Balance Sheets. Premiums from CMS are subject to risk-sharing provisions based on a comparison of the Company’s annual bid estimates of prescription drug costs and the actual costs incurred. Variances may result in CMS making additional payments to the Company or require the Company to remit funds to CMS subsequent to the end of the year. The Company records risk-share adjustments to premium revenue and other policy liabilities or other current receivables in the Condensed Consolidated Balance Sheets. 5. Medical Costs and Medical Costs Payable Medical costs and medical costs payable include estimates of the Company’s obligations for medical care services that have been rendered on behalf of insured consumers, but for which claims have either not yet been received or processed, and for liabilities for physician, hospital and other medical cost disputes. The Company
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
develops estimates for medical costs incurred but not reported using an actuarial process that is consistently applied, centrally controlled and automated. The actuarial models consider factors such as time from date of service to claim receipt, claim backlogs, care provider contract rate changes, medical care consumption and other medical cost trends. The Company estimates liabilities for physician, hospital and other medical cost disputes based upon an analysis of potential outcomes, assuming a combination of litigation and settlement strategies. Each period, the Company re-examines previously established medical costs payable estimates based on actual claim submissions and other changes in facts and circumstances. As the medical costs payable estimates recorded in prior periods develop, the Company adjusts the amount of the estimates and includes the changes in estimates in medical costs in the period in which the change is identified. For the three months ended June 30, 2010, there was $90 million of net favorable medical cost development related to prior fiscal years and $180 million of net favorable medical cost development related to the first quarter of 2010. For the six months ended June 30, 2010, medical costs included $580 million of net favorable medical cost development related to prior fiscal years. The favorable development for both the three and six months ended June 30, 2010 was primarily driven by changes in previous estimates related to more efficient claims handling and processing, resulting in higher completion factors and lower than expected health system utilization levels. For the three months ended June 30, 2009, there was no net medical cost development related to prior fiscal years and $30 million of net favorable medical cost development related to the first quarter of 2009. For the six months ended June 30, 2009, medical costs included $200 million of net favorable medical cost development related to prior fiscal years. No factors were individually material to the net favorable medical cost development for either the three or six months ended June 30, 2009.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
6. Commercial Paper and Long-Term Debt Commercial paper and long-term debt consisted of the following:
Commercial Paper and Bank Credit Facility Commercial paper consists of senior unsecured debt sold on a discount basis with maturities up to 270 days. As of June 30, 2010, the Company’s outstanding commercial paper had interest rates ranging from 0.4% to 0.5%. The Company has a $2.5 billion five-year revolving bank credit facility with 23 banks, which matures in May 2012. This facility supports the Company’s commercial paper program and is available for general corporate purposes. There were no amounts outstanding under this facility as of June 30, 2010. The interest rate is variable based on term and amount and is calculated based on the London Interbank Offered Rate (LIBOR) plus a spread. As of June 30, 2010, the annual interest rate on this facility, had it been drawn, would have ranged from 0.5% to 1.0%.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
Debt Covenants The Company’s bank credit facility contains various covenants, the most restrictive of which requires the Company to maintain a debt-to-total-capital ratio, calculated as the sum of commercial paper and debt divided by the sum of commercial paper, debt and shareholders’ equity, below 50%. The Company was in compliance with its debt covenants as of June 30, 2010. Debt Tender In the first quarter of 2010, the Company completed cash tender offers for $775 million in aggregate principal of certain of its outstanding fixed-rate notes to improve the matching of interest rate exposure related to its floating rate assets and liabilities on its balance sheet. Interest Rate Swap Contracts During the first half of 2010, the Company entered into interest rate swap contracts to convert a portion of its interest rate exposure from fixed rates to floating rates to more closely align interest expense with interest income received on its cash equivalent and investment balances. The floating rates are benchmarked to LIBOR. The swaps are designated as fair value hedges of fixed-rate debt. Since the specific terms and notional amounts of the swaps match those of the debt being hedged, they were assumed to be highly effective hedges and all changes in fair value of the swaps were recorded on the Condensed Consolidated Balance Sheets with no net impact recorded in the Condensed Consolidated Statements of Operations. The following table summarizes the location and fair value of fair value hedges on the Company’s Condensed Consolidated Balance Sheets as of June 30, 2010:
The following table provides a summary of the effect of changes in fair value of fair value hedges on the Company’s Condensed Consolidated Statements of Operations:
7. Income Taxes The Company’s income tax rate for both the three and six months ended June 30, 2010 was 37.0%. The Company’s income tax rate for the three and six months ended June 30, 2009 was 34.0% and 35.1%,
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
respectively. The increase in the effective income tax rate resulted primarily from limitations on the future deductibility of certain compensation related to the Patient Protection and Affordable Care Act, as modified by the Health Care and Education Reconciliation Act of 2010 (Health Reform Legislation), which was signed into law during the first quarter of 2010, as well as a benefit in the 2009 tax rate from the resolution of various historical federal and state income tax matters. 8. Shareholders’ Equity Share Repurchase Program Under its Board of Directors’ authorization, the Company maintains a share repurchase program. The objectives of the share repurchase program are to optimize the Company’s capital structure and cost of capital, thereby improving returns to shareholders, as well as to offset the dilutive impact of share-based awards. Repurchases may be made from time to time at prevailing prices in the open market, subject to certain Board restrictions. In February 2010, the Board renewed and increased the Company’s share repurchase program, and authorized the Company to repurchase up to 120 million shares of its common stock. During the six months ended June 30, 2010, the Company repurchased 39 million shares at an average price of approximately $32 per share and an aggregate cost of $1.2 billion. As of June 30, 2010, the Company had Board authorization to purchase up to an additional 85 million shares of its common stock. Dividends In May 2010, the Company’s Board of Directors increased the Company’s cash dividend to shareholders and moved the Company to a quarterly dividend payment cycle. The first quarterly dividend of $0.125 per share was paid on June 21, 2010 to shareholders of record on June 7, 2010. 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. Prior to May 2010 the Company’s policy had been to pay an annual dividend, the most recent of which was $0.03 per share paid on April 20, 2010 to shareholders of record on April 6, 2010. 9. Share-Based Compensation As of June 30, 2010, the Company had 56.5 million shares available for future grants of share-based awards under its share-based compensation plan, including, but not limited to, incentive or non-qualified stock options, stock-settled stock appreciation rights (SARs), and up to 12.5 million of awards in restricted stock and restricted stock units (collectively, restricted shares). The Company’s outstanding share-based awards consist mainly of non-qualified stock options, SARs and restricted shares.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
Stock Options and SARs Stock options and SARs generally vest ratably over four to six years and may be exercised up to 10 years from the date of grant. Stock option and SAR activity for the six months ended June 30, 2010 is summarized in the table below:
To determine compensation expense related to the Company’s stock options and SARs, the fair value of each award is estimated on the date of grant using an option-pricing model. For purposes of estimating the fair value of the Company’s employee stock option and SAR grants, the Company uses a binomial model. The principal assumptions the Company used in applying the option-pricing models were as follows:
Risk-free interest rates are based on U.S. Treasury yields in effect at the time of grant. Expected volatilities are based on the historical volatility of the Company’s common stock and the implied volatility from exchange-traded options on the Company’s common stock. The Company uses historical data to estimate option and SAR exercises and forfeitures within the valuation model. The expected lives of options and SARs granted represents the period of time that the awards granted are expected to be outstanding based on historical exercise patterns. The weighted-average grant date fair value of stock options and SARs granted during the three and six months ended June 30, 2010 was approximately $10 per share and $13 per share, respectively. The weighted-average grant date fair value of stock options and SARs granted during both the three and six months ended June 30, 2009 was approximately $10 per share. The total intrinsic value of stock options and SARs exercised during the three and six months ended June 30, 2010 was $9 million and $62 million, respectively. The total intrinsic value of stock options and SARs exercised during the three and six months ended June 30, 2009 was $8 million and $215 million, respectively.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
Restricted Shares Restricted shares generally vest ratably over two to five years. Compensation expense related to restricted shares is based on the share price on date of grant. Restricted share activity for the six months ended June 30, 2010 is summarized in the table below:
The weighted-average grant date fair value of restricted shares granted during the three and six months ended June 30, 2010 was approximately $29 per share and $33 per share, respectively. The weighted-average grant date fair value of restricted shares granted during the three and six months ended June 30, 2009 was approximately $28 per share and $29 per share, respectively. The total fair value of restricted shares vested during the three and six months ended June 30, 2010 was $41 million and $85 million, respectively. The total fair value of restricted shares vested during the three and six months ended June 30, 2009 was $45 million and $54 million, respectively. Share-Based Compensation Recognition The Company recognizes compensation expense for share-based awards, including stock options, SARs and restricted shares, on a straight-line basis over the related service period (generally the vesting period) of the award, or to an employee’s eligible retirement date under the award agreement, if earlier. For the three and six months ended June 30, 2010, the Company recognized compensation expense related to its share-based compensation plans of $67 million ($65 million net of tax effects) and $167 million ($152 million net of tax effects), respectively. For the three and six months ended June 30, 2009, the Company recognized compensation expense related to its share-based compensation plans of $85 million ($58 million net of tax effects) and $180 million ($121 million net of tax effects), respectively. Share-based compensation expense is recognized in operating costs in the Company’s Condensed Consolidated Statements of Operations. As of June 30, 2010, there was $567 million of total unrecognized compensation cost related to share awards that is expected to be recognized over a weighted-average period of 1.4 years. For the three and six months ended June 30, 2010, the income tax benefit realized from share-based award exercises was $16 million and $44 million, respectively. For the three and six months ended June 30, 2009, the income tax benefit realized from share-based award exercises was $16 million and $69 million, respectively. As further discussed in Note 8 of Notes to the Condensed Consolidated Financial Statements, the Company maintains a share repurchase program. The objectives of the share repurchase program are to optimize the Company’s capital structure, cost of capital and return to shareholders, as well as to offset the dilutive impact of shares issued for share-based award exercises.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
10. AARP The Company provides health insurance products and services to members of AARP under a Supplemental Health Insurance Program (the Program), and separate Medicare Advantage and Medicare Part D arrangements. The products and services under the Program include supplemental Medicare benefits (AARP Medicare Supplement Insurance), hospital indemnity insurance, including insurance for individuals between 50 to 64 years of age, and other related products. Under the Program, the Company is compensated for transaction processing and other services, as well as for assuming underwriting risk. The Company is also engaged in product development activities to complement the insurance offerings. The Company’s agreement with AARP on the Program provides for the maintenance of the Rate Stabilization Fund (RSF) that is held by the Company on behalf of policyholders. Underwriting gains or losses related to the AARP Medicare Supplement Insurance business are directly recorded as an increase or decrease to the RSF. The primary components of the underwriting results are premium revenue, medical costs, investment income, administrative expenses, member service expenses, marketing expenses and premium taxes. Underwriting gains and losses are recorded as an increase or decrease to the RSF and accrue to the overall benefit of the AARP policyholders, unless cumulative net losses were to exceed the balance in the RSF. To the extent underwriting losses exceed the balance in the RSF, losses would be borne by the Company. Deficits may be recovered by underwriting gains in future periods of the contract. To date, the Company has not been required to fund any underwriting deficits. The RSF balance is reported in other policy liabilities in the Condensed Consolidated Balance Sheets and changes in the RSF are reported in medical costs in the Condensed Consolidated Statement of Operations. The Company believes the RSF balance as of June 30, 2010 is sufficient to cover potential future underwriting and other risks and liabilities associated with the contract. The effects of changes in balance sheet amounts associated with the Program also accrue to the overall benefit of the AARP policyholders through the RSF balance. Accordingly, the Company excludes the effect of such changes in its Condensed Consolidated Statements of Cash Flows. Under the Company’s agreement with AARP, the Company separately manages the assets that support the Program. These assets are held at fair value in the Condensed Consolidated Balance Sheets as assets under management. These assets are invested at the Company’s discretion, within investment guidelines approved by the Program, and are used to pay costs associated with the Program. The Company does not guarantee any rates of investment return on these investments and upon any transfer of the Program to another entity, the Company would transfer cash in an amount equal to the fair value of these investments at the date of transfer. Interest earnings and realized investment gains and losses on these assets accrue to the overall benefit of the AARP policyholders through the RSF and, thus, are not included in the Company’s earnings. The Company elected to measure the entirety of the AARP assets under management at fair value, pursuant to the fair value option.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
The following AARP Program-related assets and liabilities were included in the Company’s Condensed Consolidated Balance Sheets:
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The fair value of cash, cash equivalents and investments associated with the Program, reflected as assets under management, and the fair value of other assets and other liabilities were classified in accordance with the fair value hierarchy as discussed in Note 3 of Notes to the Condensed Consolidated Financial Statements and were as follows:
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11. Comprehensive Income The table below presents comprehensive income, defined as changes in the equity of the Company’s business excluding changes resulting from investments by and distributions to its shareholders.
12. Segment Financial Information The Company has four reporting segments:
The following is a description of the types of products and services from which each of the Company’s reporting segments derives its revenues:
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
Transactions between reporting segments principally consist of sales of pharmacy benefit products and services to Health Benefits customers by Prescription Solutions, certain product offerings sold to Health Benefits customers by OptumHealth, and consulting and other services sold to Health Benefits by Ingenix. These transactions are recorded at management’s estimate of fair value. Intersegment transactions are eliminated in consolidation. The following table presents reporting segment financial information:
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
13. Commitments and Contingencies Legal Matters Because of the nature of its businesses, the Company is frequently made party to a variety of legal actions and regulatory inquiries related to, among other things, the design and management of its service offerings. The Company records liabilities for its estimates of probable costs resulting from these matters where appropriate. These matters include, but are not limited to, claims relating to health care benefits coverage, medical malpractice actions, contract disputes and claims related to certain business practices. Litigation Matters MDL Litigation. Beginning in 1999, a series of class action lawsuits were filed against the Company by health care providers alleging various claims relating to the Company’s reimbursement practices, including alleged
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
violations of the Racketeer Influenced Corrupt Organization Act (RICO) and state prompt payment laws and breach of contract claims. Many of these lawsuits were consolidated in a multi-district litigation in the United States District Court for the Southern District Court of Florida (MDL). In the lead MDL lawsuit, the court certified a class of health care providers for certain of the RICO claims. In 2006, the trial court dismissed all of the claims against the Company in the lead MDL lawsuit, and the Eleventh Circuit Court of Appeals later affirmed that dismissal, leaving eleven related lawsuits that had been stayed during the litigation of the lead MDL lawsuit. In August 2008, the trial court, applying its rulings in the lead MDL lawsuit, dismissed seven of these lawsuits (the seven lawsuits). The trial court also dismissed all but one claim in an eighth lawsuit, and ordered the final claim to arbitration. In December 2008, at the plaintiffs’ request, the trial court dismissed without prejudice one of the three remaining lawsuits. The court also denied the plaintiffs’ request to remand the remaining two lawsuits to state court and a federal magistrate judge recommended dismissal of those suits. In April 2009, the plaintiffs in these last two suits filed amended class action complaints alleging breach of contract, but those amended complaints were subsequently dismissed without prejudice. In July 2010, the Eleventh Circuit reversed the trial court’s dismissal of the seven lawsuits and remanded those cases to the trial court for further proceedings. In addition, the Company is party to a number of arbitrations in various jurisdictions involving claims similar to those alleged in the seven lawsuits. The Company is vigorously defending against the remaining claims in these cases. AMA Litigation. On March 15, 2000, a group of plaintiffs including the American Medical Association (AMA) filed a lawsuit against the Company in state court in New York, which was removed to federal court. The complaint and subsequent amended complaints asserted antitrust claims and claims based on the Employee Retirement Income Security Act of 1974, as amended (ERISA), as well as breach of contract and the implied covenant of good faith and fair dealing, deceptive acts and practices, and trade libel in connection with the calculation of reasonable and customary reimbursement rates for non-network health care providers by the Company’s affiliates. On January 14, 2009, after almost nine years of litigation and many rulings from the court on various motions, the parties announced an agreement to settle the lawsuit, along with a similar case filed in 2008 in federal court in New Jersey. Under the terms of the proposed settlement, the Company and its affiliated entities will be released from claims relating to their out-of-network reimbursement policies from March 15, 1994 through the date of final court approval of the settlement. The Company will pay a total of $350 million to fund the settlement for health plan members and out-of-network providers in connection with out-of-network procedures performed since March 15, 1994. The agreement contains no admission of wrongdoing. The proposed settlement is subject to final court approval. In addition, the Company has the right to terminate the settlement if a certain number of class members elect to opt-out of the settlement. The court granted preliminary approval of the proposed settlement over the objections of certain plaintiffs’ counsel on December 1, 2009, and a final approval hearing following notice to members of the class is scheduled for September 2010. Other lawsuits in various jurisdictions relating to the calculation of reasonable and customary reimbursement rates for non-network health care providers remain pending against a number of health insurers, including the Company. California Claims Processing Matter. As previously disclosed, in 2007, the California Department of Insurance (CDI) examined the Company’s PacifiCare health insurance plan in California. The examination findings related to the timeliness and accuracy of claims processing, interest payments, provider contract implementation, provider dispute resolution and other related matters. On January 25, 2008, the CDI issued an Order to Show Cause to PacifiCare Life and Health Insurance Company, a subsidiary of the Company, alleging violations of certain insurance statutes and regulations in connection with the CDI’s examination findings. On June 3, 2009, the Company filed a Notice of Defense to the Order to Show Cause denying all material allegations and asserting certain defenses. The matter has been the subject of an administrative hearing before a California administrative law judge (ALJ) since December 2009. CDI has recently amended its Order to Show Cause, alleging a significant
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
number of additional violations, also relating to claims processing. After the ALJ issues a ruling at the conclusion of the administrative proceeding, the California Insurance Commissioner may accept, reject or modify the ALJ’s ruling, issue his own decision, and impose a fine or penalty. The Commissioner’s decision is subject to challenge in court. Historical Stock Option Practices. In 2006, a consolidated shareholder derivative action, captioned In re UnitedHealth Group Incorporated Shareholder Derivative Litigation was filed against certain of the Company’s current and former officers and directors in the United States District Court for the District of Minnesota. The consolidated amended complaint was brought on behalf of the Company by several pension funds and other shareholders and named certain of the Company’s current and former officers and directors as defendants, as well as the Company as a nominal defendant. The consolidated amended complaint generally alleged that the defendants breached their fiduciary duties to the Company, were unjustly enriched and violated the securities laws in connection with the Company’s historical stock option practices. On June 26, 2006, the Company’s Board of Directors created a Special Litigation Committee under Minnesota Statute 302A.241, consisting of two former Minnesota Supreme Court Justices, with the power to investigate the claims raised in the derivative actions and shareholder demands and determine whether the Company’s rights and remedies should be pursued. A consolidated derivative action, captioned In re UnitedHealth Group Incorporated Derivative Litigation, was also filed in Hennepin County District Court, State of Minnesota. The action was brought by two individual shareholders and named certain of the Company’s current and former officers and directors as defendants, as well as the Company as a nominal defendant. On December 6, 2007, the Special Litigation Committee concluded its review of claims relating to the Company’s historical stock option practices and published a report. The Special Litigation Committee reached settlement agreements on behalf of the Company with its former Chairman and Chief Executive Officer William W. McGuire, M.D., former General Counsel David J. Lubben and former director William G. Spears. In addition, the Special Litigation Committee concluded that all claims against all named defendants in the derivative actions, including current and former Company officers and directors, should be dismissed. Each settlement agreement is conditioned upon dismissal of claims in the derivative actions and resolution of any appeals. Following notice to shareholders, the federal court granted the parties’ motion for final approval of the proposed settlements on July 1, 2009, and entered final judgment dismissing the federal case with prejudice on July 2, 2009. The state court granted the parties’ motion for final approval of the proposed settlements and dismissed the state case with prejudice on May 14, 2009, and entered final judgment on July 17, 2009. The federal and state courts also awarded plaintiffs’ counsel fees and expenses of $30 million and $6 million, respectively, which have been paid by the Company. A shareholder has filed an appeal with the U.S. Court of Appeals for the Eighth Circuit challenging only the federal plaintiffs’ counsel’s fee award. Federal plaintiffs’ counsel is contesting the appeal. As previously disclosed, the Company also received inquiries from a number of federal and state regulators from 2006 through 2008 regarding its historical stock option practices. Many of those inquiries have been closed, resolved or inactive since 2008. The Company may be subject to additional litigation or other proceedings or actions arising out of the Company’s historical stock option practices and the related restatement of its historical Consolidated Financial Statements. Litigation and any potential regulatory proceeding or action may be time consuming, expensive and distracting from the conduct of the Company’s business. The adverse resolution of any specific lawsuit or any potential regulatory proceeding or action could have a material adverse effect on the Company’s business, financial condition and results of operations.
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Table of ContentsUNITEDHEALTH GROUP NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued) (Unaudited)
Government Regulation The Company’s business is regulated at federal, state, local and international levels. The laws and rules governing the Company’s business and interpretations of those laws and rules are subject to frequent change. Broad latitude is given to the agencies administering those regulations. Further, the Company must obtain and maintain regulatory approvals to market and sell many of its products. The Company has been and is currently involved in various governmental investigations, audits and reviews. These include routine, regular and special investigations, audits and reviews by CMS, state insurance and health and welfare departments, state attorneys general, the Office of the Inspector General, the Office of Personnel Management, the Office of Civil Rights, U.S. Congressional committees, the U.S. Department of Justice, U.S. Attorneys, the SEC, the IRS, the U.S. Department of Labor, the Federal Deposit Insurance Corporation and other governmental authorities. Examples of audits include a review by the U.S. Department of Labor of the Company’s administration of applicable customer employee benefit plans with respect to ERISA compliance and audits of the Company’s Medicare health plans to validate the coding practices of and supporting documentation maintained by its care providers. Such government actions can result in assessment of damages, civil or criminal fines or penalties, or other sanctions, including loss of licensure or exclusion from participation in government programs and could have a material adverse effect on the Company’s financial results. The coding audits may result in prospective and retrospective adjustments to payments made to health plans pursuant to CMS Medicare contracts. During the first quarter of 2010, the Health Reform Legislation was signed into law. The Health Reform Legislation, and existing or future laws and rules, could force the Company to change how it does business, restrict revenue and enrollment growth in certain products and market segments, restrict premium growth rates for certain products and market segments, increase its medical and administrative costs and capital requirements, expose it to an increased risk of liability (including increasing its liability in federal and state courts for coverage determinations and contract interpretation) or put it at risk for loss of business. In addition, the Company’s operating results, financial position, including its ability to maintain the value of its goodwill, and cash flows could be materially adversely affected by such changes.
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The following discussion should be read together with the accompanying Condensed Consolidated Financial Statements and Notes. References to the terms “we,” “our” or “us” used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations refer to UnitedHealth Group Incorporated and its subsidiaries. EXECUTIVE OVERVIEW General UnitedHealth Group is a diversified health and well-being company, serving more than 75 million individuals worldwide. Our focus is on improving the overall health and well-being of the people we serve and their communities and enhancing the performance of the health system. We work with health care professionals and other key partners to expand access to high quality health care. We help people get the care they need at an affordable cost; support the physician/patient relationship; and empower people with the information, guidance and tools they need to make personal health choices and decisions. Through our diversified family of businesses, we leverage core competencies in advanced technology-based transactional capabilities; health care data, knowledge and information; and health care resource organization and care facilitation to make health care work better. These core competencies are focused in two market areas, health benefits and health services. Health benefits are offered in the individual and employer markets and the public and senior markets through our UnitedHealthcare, Ovations and AmeriChoice businesses. Health services are provided to the participants in the health system itself, ranging from employers and health plans to physicians and life sciences companies through our OptumHealth, Ingenix and Prescription Solutions businesses. In aggregate, these businesses have more than two dozen distinct business units that address specific end markets. Each of these business units focuses on the key goals in health and well-being: access, affordability, quality and simplicity as they apply to their specific market. Revenues Our revenues are primarily comprised of premiums derived from risk-based health insurance arrangements in which the premium is fixed, typically for a one-year period, and we assume the economic risk of funding our customers’ health care benefits and related administrative costs. We also generate revenues from fee-based services performed for customers that self-insure the health care costs of their employees and employees’ dependants. For both risk-based and fee-based health care benefit arrangements, we provide coordination and facilitation of medical services; transaction processing; health care professional services; and access to contracted networks of physicians, hospitals and other health care professionals. We also generate service revenues from Ingenix health intelligence and contract research businesses. Product revenues are mainly comprised of products sold by our Prescription Solutions pharmacy benefit management business and sales of Ingenix publishing and software products. We derive investment income primarily from interest earned on our investments in debt securities. Our investment income also includes gains or losses when the securities are sold, or other-than-temporarily impaired. Operating Costs Medical Costs. Our operating results depend in large part on our ability to effectively estimate, price for and manage our medical costs through underwriting criteria, product design, negotiation of favorable care provider contracts and medical management programs. Controlling medical costs requires a comprehensive and integrated approach to organize and advance the full range of interrelationships among patients/consumers, health professionals, hospitals, pharmaceutical/technology manufacturers and other key stakeholders.
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Table of ContentsMedical costs include estimates of our obligations for medical care services rendered on behalf of insured consumers for which we neither have received nor processed claims, and our estimates for physician, hospital and other medical cost disputes. In every reporting period, our operating results include the effects of more completely developed medical costs payable estimates associated with previously reported periods. Our medical care ratio, calculated as medical costs as a percentage of premium revenues, reflects the combination of pricing, benefit designs, consumer health care utilization and comprehensive care facilitation efforts. We seek to sustain a stable medical care ratio for an equivalent mix of business, however, changes in business mix, such as expanding participation in comparatively higher medical care ratio government-sponsored public sector programs and recently enacted Health Reform Legislation, may impact our medical costs and medical care ratio. Operating Costs. Operating costs are primarily comprised of costs related to employee compensation and benefits, agent and broker commissions, premium taxes and assessments, professional fees, advertising and occupancy costs. We seek to improve our operating cost ratio, calculated as operating costs as a percentage of total revenues, for an equivalent mix of business, however, changes in business mix, such as increases in the size of our health services businesses, and recently enacted Health Reform Legislation, may impact our operating costs and operating cost ratio. Cash Flows We generate cash primarily from premiums, service and product revenues and investment income, as well as proceeds from the sale or maturity of our investments. Our primary uses of cash are for payments of medical claims, purchases of investments, common stock repurchases, acquisitions, dividends to shareholders and payments on debt. For more information on our cash flows, see “Liquidity” below. Business Trends Our businesses participate in the U.S. health economy, which comprises approximately 17% of U.S. gross domestic product and which has grown consistently for many years. We expect overall spending on health care in the U.S. to continue to rise in the future, due to inflation, technology and pharmaceutical advancement, regulatory requirements, demographic trends in the U.S. population and national interest in health and well-being. The rate of market growth may be affected by a variety of factors, including macro-economic conditions and enacted health care reforms, which could also impact our results of operations. Health Care Reforms. In the first quarter of 2010, the Patient Protection and Affordable Care Act and a reconciliation measure, the Health Care and Education Reconciliation Act of 2010, which we refer to together as the Health Reform Legislation, were signed into law. The Health Reform Legislation enhances access to coverage and modifies aspects of the commercial insurance market, as well as the Medicaid and Medicare programs, CHIP and other aspects of the health care system. Provisions of the Health Reform Legislation become effective at various dates over the next several years. The Department of Health and Human Services (HHS), the Department of Labor and the Treasury Department have issued interim final regulations on a few aspects of Health Reform Legislation, but we await final rules and interim guidance on other key aspects of the legislation. Due to the complexity of the Health Reform Legislation, including yet to be promulgated implementing regulations, lack of interpretive guidance and gradual implementation, the impact of the Health Reform Legislation is not yet fully known. While we anticipate the Health Reform Legislation will open new opportunities for business growth, we have focused the description of this legislation and its impacts principally on the risks it introduces or heightens for our existing businesses.
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Table of ContentsThe following outlines certain provisions of the Health Reform Legislation that will take effect in 2010 through 2014: Effective 2010: Expansion of dependent coverage to include adult children until age 26; elimination of certain annual and lifetime caps on the dollar value of certain essential health benefits (yet to be fully defined); elimination of pre-existing condition limits for enrollees under 19; prohibitions on certain policy rescissions; development of an annual rate review process for commercial health plans; cost sharing obligations for out of network emergency services; a requirement to provide coverage for preventative services without cost to members (for grandfathered plans); and establishment of an interim state level high risk program for those unable to obtain coverage due to pre-existing condition or health status. These Health Reform Legislation changes are expected to increase medical cost trends and affect our underwriting policies in the individual and group commercial markets. We have implemented certain policies contemplated by the Health Reform Legislation, including ending our limited use of policy rescissions (subject to limited exceptions) and extending existing dependent coverage to include adult children until age 26. Effective 2011: Establishment of minimum medical cost ratios for all commercial fully insured health plans in the large employer group, small employer group and individual markets (85% for large employer groups, 80% for small employer groups and 80% for individuals); the individual market medical cost ratio is subject to adjustment by HHS if HHS determines that the requirement is disruptive to the market. Beginning in 2011, companies with medical cost ratios below these targets will be required to rebate premiums to their customers annually. HHS has not yet promulgated rules addressing several important aspects of this requirement, including: the appropriate measurement and application of these ratios, such as defining which expenses should be classified as medical and which should be classified as non-medical for purposes of the calculation; which taxes, fees and assessments may be excluded from premium calculations; the definition of large and small groups; whether these calculations should be prepared by companies at the national level or on some type of disaggregated basis; and how often and to which period this test should be applied. Depending on the results of the calculation, there is a broad range of potential rebate and other business impacts in the near term and there could be meaningful disruption in local health care markets if companies decide to adjust their offerings in response to these requirements. For example, companies could elect to change pricing, modify product features or benefits, adjust their mix of business or even exit segments of the market. Companies could also seek to adjust their operating costs to support reduced premiums by making changes to their distribution arrangements or decreasing spending on non-medical product features and services. Given the breadth of possible changes, the lack of definitive guidance from the National Association of Insurance Commissioners (NAIC) or HHS and the potential for meaningful market disruption in 2011 and 2012, we are not able to fully project the impact these medical cost ratios will have on our market share, revenues and results of operations. However, in the individual market (which represents less than 5% of our annual consolidated revenues and operating earnings), the minimum medical cost ratio, if not adjusted by HHS, will require changes to our pricing, product offerings and approach. We have begun making changes to reduce our product distribution costs in the individual market in response to this legislation. These changes could impact future growth in these products. Other market participants could also implement changes to their business practices in response to this legislation, which could positively or negatively impact our growth and market share. Effective 2011: Mandating consumer discounts of 50% on prescription drugs for Part D plan participants in the coverage gap. This statutory reduction in drug prices for seniors in the coverage gap may cause people who may have had difficulty affording their medications to increase their pharmaceutical usage. The change in pricing could also have secondary effects, such as changing the mix of brand name and generic drug usage. Companies may seek to capture the costs of these changes in Part D prescription drug plan bids to CMS for 2011, likely causing plan costs to increase meaningfully. We have appropriately incorporated the anticipated impact of these changes in our 2011 bids.
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Table of ContentsEffective 2011/2012: Reduction in Medicare Advantage rates. As part of the Health Reform Legislation, Medicare Advantage payment benchmarks for 2011 were frozen at 2010 levels. Separately, CMS implemented a reduction in Medicare Advantage reimbursements of 1.6% for 2011. We expect the 2011 rates will be outpaced by medical trends, placing continued importance on effective medical management and ongoing improvements in administrative costs. Beginning in 2012, additional cuts to Medicare Advantage plans will take effect (plans will ultimately receive 95% of Medicare fee-for-service rates in high cost areas to 115% in low cost areas), with changes being phased-in over two to six years, depending on the level of payment reduction in a county. There are a number of annual adjustments we can make to our operations, which may partially offset any impact from these rate reductions. For example, we can adjust members’ benefits, decide on a county-by-county basis which geographies to participate in and seek to intensify our medical and operating cost management. Additionally, achieving high quality scores from CMS for improving upon certain clinical and operational performance standards will impact future quality bonuses. Quality bonuses may further offset these anticipated rate reductions as CMS star rating bonuses are phased in over three years beginning in 2012. Market wide decreases in the availability of Medicare Advantage products and in the quality of benefits beyond base Medicare may increase demand for other senior health benefits products such as Medicare Part D and Medicare Supplement insurance. Effective 2013: Limitation on the deductibility of executive compensation under Section 162(m) of the Internal Revenue Code for insurance providers if at least 25% of the insurance provider’s gross premium income from health business is derived from health insurance plans that meet the minimum creditable coverage requirements. This provision is effective beginning in 2013 with respect to services performed after 2009. For a discussion of the 2010 impact of this provision on our consolidated results, see “2010 Results of Operations Compared to 2009 Results – Income Tax Rate” below. Effective 2013/2014: Increase in payments in fee-for-service and managed care for primary care services provided by primary care doctors (family medicine, general internal medicine or pediatric medicine) to 100% of the Medicare payment rates for 2013 and 2014 and provides 100% federal financing for the difference in rates based on rates applicable on July 1, 2009. The increase in Medicaid rates to primary care doctors are expected to increase cost trends for Medicaid Managed Care plans, but the increase should be fully offset by federal funding for the temporary increase. Effective 2014: Annual insurance industry assessment ($8 billion levied on the insurance industry in 2014 with increasing annual amounts thereafter), which is not deductible for income tax purposes; expansion of Medicaid eligibility for all individuals and families with incomes up to 133% of the federal poverty level (states can early adopt the expansion without increased federal funding until 2014); states receive full federal matching in 2014 through 2016; all individual and group health plans must offer coverage on a guaranteed issued and guaranteed renewal basis during annual open enrollment and cannot apply pre-existing condition exclusions or health status rating adjustments; elimination of annual limits on essential benefits coverage on certain plans; establishment of state-based exchanges for individuals and small employers (with up to 100 employees) as well as certain CHIP eligibles; introduction of standardized plan designs based on set actuarial values to increase comparability of competing products on the exchanges; and establishment of minimum medical cost ratio of 85% for Medicare Advantage plans. Due to the lack of enabling regulations and guidance, we are not able to project the impact these reform provisions will have on our revenues, results of operations and cash flows. Given the breadth of possible changes resulting from the Health Reform Legislation and from implementing regulations that have not yet been drafted, the Health Reform Legislation and the related regulations could change how we do business, restrict revenue and enrollment growth in certain products and market segments,
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Table of Contentsrestrict premium growth rates for certain products and market segments, increase our medical and administrative costs, expose us to an increased risk of liability (including increasing our liability in federal and state courts for coverage determinations and contract interpretation) or put us at risk for loss of business. In addition, our results of operations, financial position, including our ability to maintain the value of our goodwill, and cash flows could be materially adversely affected by such changes. We operate a diversified set of health care focused businesses, and our business model has been intentionally designed to address a multitude of market sectors. For example, in addition to the potential impacts on our businesses described above, we also anticipate that the Health Reform Legislation will further increase attention on the need for health care cost containment and improvements in quality, as well as in prevention, wellness and disease management. We believe demand for many of our service offerings, such as consulting services, data management, information technology and infrastructure construction, disease management programs and wellness programs will continue to grow. Therefore, we could see simultaneous increases and decreases in demand for our various products and services. For additional information regarding our risks related to health care reforms, see “Item 1A. Risk Factors” in Part II of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 (March 2010 10-Q). Adverse Economic Conditions. The current U.S. recessionary economic environment has impacted demand for some of our products and services. For example, decreases in employment have reduced the number of workers and dependants offered health care benefits by our employer customers, putting pressure on top line growth for our UnitedHealthcare and OptumHealth businesses. This workplace attrition will continue to impact UnitedHealthcare’s commercial risk and fee-based membership throughout 2010, and this is expected to continue until national employment stabilizes. In contrast, our AmeriChoice business is experiencing growth in its state Medicaid offerings as employment rates fall. If the recessionary economic environment continues for a prolonged period, federal and state governments may decrease funding for various health care government programs in which we participate and/or impose new or higher levels of taxes or assessments. Our revenues are also impacted by U.S. monetary and fiscal policy. In response to recessionary conditions, the U.S. Federal Reserve has maintained the target federal funds rate at a range of zero to 25 basis points. In general, we believe that economic recessions could impact our revenue growth rate and our operating profitability. We also believe that government funding pressure, coupled with recessionary economic conditions, will impact the financial positions of hospitals, physicians and other care providers and could therefore increase medical cost trends experienced by our businesses. For additional discussions regarding how the adverse economic conditions could affect our business, see “Item 1A. Risk Factors” in Part I of our 2009 10-K. Mental Health Parity and Addiction Equity Act. The Paul Wellstone-Pete Domenici Mental Health Parity and Addiction Equity Act 2008 (Mental Health Parity Act) became effective for plan years beginning on or after October 3, 2009 and requires that financial requirements and treatment limitations applicable to mental health or substance abuse benefits be no more restrictive than those imposed on medical and surgical benefits. The Mental Health Parity Act does not require plans to offer mental health or substance abuse benefits. The Federal Mental Health Parity Act Interim Final Regulations were released in February 2010 with an effective date as early as July 1, 2010 for some plans. Based on our current interpretations of the regulatory changes, we expect to see some impacts to risk-based behavioral health benefit costs beginning in 2011. Based on our customer renewal cycle, we believe the impact on our 2010 results of operations will not be material. We anticipate pricing actions in 2011 will mitigate or partially mitigate the impact of revised regulations on our margins.
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Table of ContentsRESULTS SUMMARY
2010 RESULTS OF OPERATIONS COMPARED TO 2009 RESULTS Consolidated Financial Results Revenues The increases in revenues for the three and six months ended June 30, 2010 were primarily due to strong organic growth in risk-based benefit offerings in our public and senior markets businesses. Growth in customers served by our health services businesses, particularly through pharmaceutical benefit management programs, increasing revenues from public sector programs and health care technology software and services also contributed to our revenue growth. Medical Costs Medical costs for the three and six months ended June 30, 2010 increased primarily due to growth in our public and senior markets risk-based businesses and medical cost inflation, which were partially offset by overall net favorable development of prior period medical costs and decreases in commercial membership. For each period, our operating results include the effects of revisions in medical cost estimates related to prior periods. Changes in medical cost estimates related to prior periods, resulting from more complete claim information identified in the current period, are included in total medical costs reported for the current period.
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Table of ContentsFor the three months ended June 30, 2010, there was $90 million of net favorable medical cost development related to prior fiscal years and $180 million of net favorable medical cost development related to the first quarter of 2010. For the six months ended June 30, 2010, medical costs included $580 million of net favorable medical cost development related to prior fiscal years. The favorable development for both the three and six months ended June 30, 2010 was primarily driven by changes in previous estimates related to more efficient claims handling and processing, resulting in higher completion factors and lower than expected health system utilization levels. For the three months ended June 30, 2009, there was no net medical cost development related to prior fiscal years and $30 million of net favorable medical cost development related to the first quarter of 2009. For the six months ended June 30, 2009, medical costs included $200 million of net favorable medical cost development related to prior fiscal years. Operating Costs Operating costs for the three and six months ended June 30, 2010 increased due to acquired and organic business growth and the absorption of new business development and start-up costs. Income Tax Rate The increases for both the three and six months ended June 30, 2010 in our effective income tax rate as compared to the comparable periods in 2009 resulted from limitations on the future deductibility of certain compensation related to the Health Reform Legislation, which was signed into law during the first quarter of 2010, as well as a benefit in the 2009 tax rate from the resolution of various historical federal and state income tax matters. Reporting Segments We have four reporting segments:
See Note 12 of Notes to the Condensed Consolidated Financial Statements for a description of the types and services from which each of these reporting segments derives its revenues. Transactions between reporting segments principally consist of sales of pharmacy benefit products and services to Health Benefits customers by Prescription Solutions, certain product offerings sold to Health Benefits customers by OptumHealth, and consulting and other services sold to Health Benefits by Ingenix. These transactions are recorded at management’s estimate of fair value. Intersegment transactions are eliminated in consolidation.
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Table of ContentsThe following summarizes the operating results of our reporting segments:
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