Humana (HUM)

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See all Bulls Reasons Bulls: Reasons To Buy Rising health care costs mean more Americans want insurance 0% agree Rising health care costs mean more Americans want insurance Positive Trends: Healthcare costs have been rising and will only continue to rise as the population ages. Americans will want to insure themselves from the most extreme of these costs, meaning Humana is well positioned to take advantage. Moreover, since Humana has a long track... read more View or Edit Reason 0 votes 0% agree Organic growth drives profits 0% agree Organic growth drives profits Organic growth is good: Humana nearly doubled its membership between 2005 and 2006 by leveraging Medicare Part D. The company expanded by offering a new product, rather than by acquiring rivals or slashing prices. This growth route leads to higher profitability in the long run. View or Edit Reason 0 votes 0% agree Recent acquisition of CompBenefits is a step in the right direction 0% agree Recent acquisition of CompBenefits is a step in the right direction Heading in the right direction: Although Humana has been slow to diversify its offerings, its recent acquisition of CompBenefits is a step in the right direction and a signal of its willingness to head towards bundling. View or Edit Reason 0 votes 0% agree See all Bears Reasons Bears: Reasons To Sell "Despite growth, no profits" 0% agree "Despite growth, no profits" Despite growth, no profits: Humana had a banner year in 2006, but despite this, its profit margins declined. To an extent, taking on new customers requires lowering prices. But the rise in the MCR is worrisome, because it signals that the new Medicare Part D customers may never be... read more View or Edit Reason 0 votes 0% agree Despite growth, no profits 0% agree Despite growth, no profits Despite growth, no profits: Humana had a banner year in 2006, but despite this, its profit margins declined. To an extent, taking on new customers requires lowering prices. But the rise in the MCR is worrisome, because it signals that the new Medicare Part D customers may never be... read more View or Edit Reason 0 votes 0% agree Problems in the credit market 0% agree Problems in the credit market Problems in the credit market: The subprime meltdown will have a negative impact on Humana's bottom line, as it makes bonds harder to buy because of concerns about ratings reliability. Moreover if the Fed cut interest rates, then net investment income will decline. View or Edit Reason 0 votes 0% agree Send the authors a comment or suggestion Be the first to make a suggestion See All Suggestions

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Humana (HUM) is a health insurance company which generated $21.4 billion in total revenue in 2006, with $487 million in net income. Historically, about half of Humana's beneficiaries have participated in government sponsored programs, including the state- and federally- funded Medicare, the federally funded Medicaid Advantage, and TRICARE, a program for armed services personnel. Humana's longstanding relationship with the government is beginning to pay high dividends, as it has capitalized on Medicare Part D's prescription drug coverage by enrolling over 3 million seniors in new benefits programs. Enrollment in government programs now accounts for 70% of all of Humana's membership.

In addition to standard health insurance, Humana sells dental products, and has recently acquired a company selling vision and other dental insurance products. Still, the product line is not terribly diversified; it is largely concentrated in the government programs. This ignores the trend towards diversification that other insurance companies like Aetna have been quick to exploit.

As an insurer, Humana is in the business of risk and cannot avoid it. Key risk areas include the possibilities of government regulation of insurance and expanding national insurance. While Humana does benefit from government expenditure on health insurance, that relationship will last only as long as the government continues working with the private sector. Insurers also face risk from interest rate fluctuations, because their income is in part derived from investment.

[edit] Business Overview

Humana’s business is based on managing health risk for beneficiaries. As a health insurer, Humana agrees to pay for a percentage of its customers' medical expenses in exchange for a fee, called the premium. These medical expenses include hospitalizations in case of emergency as well as more routine costs like prescription drugs. The vast majority of Humana’s income comes from the premiums it charges customers; the remainder comes from investments made on this income (more on this below) and from a handful of other services, such as call-in pharmacies.

[edit] Investing the Premium

Most insurers offer clients a premium based on the expected cost of caring for them, plus a markup for administrative costs and profit. An insurance company can actually turn a profit even if the cost of administration and insurance claims exceeds the premiums it collects. It does so by investing income on the float: between the time when a client pays a premium and the time when the client needs payment for his or her medical expenses, Humana invests the premium in stocks and bonds.

[edit] Key Statistics

There are two key statistics that measure an insurer's performance:

• Administrative Cost Ratio (ACR): The ACR is the ratio of administrative and sales expenses to the total income from premiums. In 2006, administrative and sales expenses amounted to 14.3% of income from premiums, so the ACR was 14.3%.

• Medical Loss Ratio (MLR): The MLR is the ratio of medical expenses to income from premiums. In 2006, this was 84.0%.

Adding the two up, we see that without any investment, Humana would earn 1.7% profit on its premiums alone. Nevertheless, Humana does take advantage of the float, and it earned about 1.4% net interest income on the premiums, bringing its total profit margin to around 3% (ignoring taxes and other revenue sources). Income from investment can determine profitability, so Humana and other insurers can be sensitive to changes in the interest rate and to fluctuations in the bond market.

[edit] High Enrollment in Government Programs

Thousands of individuals. Humana's enrollment mix. Source: Company reports

$MM. Humana's revenue mix in government programs. Source: Company reports

Over the last several years, the majority of Humana's enrollees have been in state- or federal-government-sponsored programs. As seen in the top figure, historically, members of these programs have constituted some 50-55% of Humana's membership; however, that number has recently jumped to 70%. Humana currently offers four government-sponsored programs:

• Medicaid, which is available to low-income individuals and others with certain chronic diseases. Medicaid is funded by both state and federal governments.

• TRICARE, an insurance program for members of the armed forces and their spouses and beneficiaries.

• Medicare Advantage, the entitlement program available to all senior citizens and funded by the federal government.

• Medicare Part D (MCPDP), the Medicare prescription drug benefit program that began in early 2006.

The bottom figure demonstrates that the majority of Humana's revenue from government programs originates with Medicare. It also suggests that the growth in government sponsored membership came from the introduction of Medicare Part D and growth in Medicare Advantage. Revenues in these divisions both grew strongly while the other programs experienced no growth at all.

[edit] Operating Metrics

The following table displays some of the key statistics for Humana since 2005.

Source: Company Reports

The table indicates considerable growth in enrollment and premiums since 2005, without any deterioration in profit margins. The table does not tell the whole story, however, because this growth occurred almost exclusively in government segments; the commercial segment in 2006 was actually not profitable, even counting investment income.

Source: Company Reports

Humana's profit margin declined from 2005 to 2006 in both segments, despite rising overall. Falling margins in each sector brought down margins overall, but the increased concentration in the government segment that brough them up, with the second effect outweighing the first. The government sector's declining profit margin is not necessarily ominous, since it accompanied rapid organic growth: Humana grew by taking on new clients, rather than via mergers or acquisitions, which are costly.

[edit] Trends and Forces

[edit] Ignoring Consolidation?

As more businesses plan to obtain dental, vision, and health insurance from a single provider, consolidation has been growing in the health insurance industry. In 2002, the four largest health insurance providers held only a combined 13% share of the U.S. market; by 2005, those same companies now controlled 22% of the market. This increased concentration of revenues at the top of the ladder comes from the bundling of various insurance products--bundling increases a company's revenue without driving up sales costs.

Humana has not capitalized on this consolidation trend. While the company provides dental insurance to 1.1 million beneficiaries and has some 0.5 million other enrollees in non-health programs, Humana has not historically had significant operations in vision or behavioral health programs, making effective health-related bundling nearly impossible. However, in June 2007, Humana announced plans to buy the dental and vision benefits provider CompBenefits--a step in the right direction.

It is difficult to quantify just how much extra revenue Humana has forfeited by its slow bundling uptake. However, a comparison with bundled-insurance leader Aetna shows Humana with a relatively high MLR (84% in 2006), while Aetna's MLR is much stronger and lower (75% in 2006). While other differences between the two companies surely contribute to this 10% gap, it is safe to assume that bundling has a significant positive effect on lowering the ratio of medical costs to premiums paid.

[edit] Humana Capitalizes on Government Health Care

An aging population will require more medical care. Source: US Census

National health insurance has become a hot topic on the legislative agenda. While the national insurance plan is currently quite limited, restricting participation to lower-income residents (Medicaid) and senior citizens (Medicare), a national insurance program for children is now under congressional consideration. If passed, it would greatly expand the coverage offered by S-chip, the insurance program sponsored by both the state and federal governments. States have also begun to offer their own universal health care plans, with Massachusetts and California leading the way. If these plans become more widely implemented, they could increase competition for Humana and for other insurance companies. But the federal subsidies also present another possible risk; because of the looming budget deficit, funding may not always exist for Medicare. If the government were to cut the program, Humana would lose a huge share of its enrollment and its revenue. Medicare funding seems safe for the moment, though, since the Democrats, who have historically been more keen to promote programs like Medicare, currently control both houses of Congress.

Nonetheless, Medicare spending is expensive--at $230 billion, it was one of the federal government's greatest expenses in 2006. This is because the elderly require substantially more medical care than younger people, often at a higher cost, and the U.S. population is aging at a considerable rate. This has two potential effects for Aetna. A population with greater health care needs requires additional insurance: age drives demand. But to the extent that people already insured face rising health care costs, medical losses rise in response to population aging.

The national plans under consideration usually call for the government to provide insurance. But Medicare Part D, effective January 1, 2006, enables all Medicare-eligible senior citizens to purchase medication with the help of subsidies from the federal government. Whereas the competition inherent in national insurance is bad for Humana's bottom lines, government subsidies boost profitability, so Medicare Part D is good news for the company. Of 40 million eligible seniors, some 6.5 million have already signed up for the program and some 3 million of these are registered with Humana, which was well-positioned to capitalize on the new program because of its past involvement with government healthcare.

[edit] Championing Generic Drugs

Prescription drugs expenses are one of the largest outlays that Humana makes on its clients' behalf, and prescription drug costs have been rising rapidly. Between 1995 and 2005, prescription drug costs increased by an average of 12%, while other medical costs increased by just 5-6%. UNH saves money when its clients purchase generic drugs instead of brand name drugs. The differences between generic and brand name drugs can be staggering: Costco Wholesale (COST) sells Prozac and Zocor for over $140, while their generic equivalents cost only $5 each.

In terms of a larger debate about the availability of quality health care in the U.S., there has been growing pressure on pharmaceutical companies to lower prescription drug prices by either cutting prices or granting generic licenses. This issue is often brought up in political discourse, with many politicians pushing for prescription drug reforms. Humana stands to benefit from these activists' success in achieving their goal of lower drug prices; whether through pharmaceutical companies' cost cutting or an increase in the availability of generics, Humana would see its outlays for patients' medications decrease, boosting profits.

[edit] Competition

The following table compares Aetna to three other leading health insurers across various measures of performance and profitability. In addition to MLR and ACR, it presents two other important statistics:

• Investment Ratio: The ratio of investment income to revenue is the investment ratio. It reflects the contribution of investment to an insurer's profit margin.

• Implied operating margin: The implied profit margin is equal to what the operating margin would be if investment income, premiums, and fees were the only source of revenue, and medical losses, benefits, and administration costs were the only expenses. (It is equal to the 100% plus the investment ratio, less the ACR and MLR.)

In reality other factors also influence profitability, especially legal fees. The investment ratio is equal to net investment income divided by revenue from premiums and fees.In reality other factors also influence profitability, especially legal fees. In April, 2007, Humana had to pay Oklahoma $500,000 because it was employing unlicensed agents.

Note that for Cigna and UnitedHealth Group, the data refer only to medical insurance, not other products. Source: Company Reports.

By implied operating margin, Humana ranks near the bottom of the pack: it is even with UnitedHealth Group, and well behind Cigna and Aetna. But whereas UnitedHealth Group is an industry leader with relatively high revenues, Humana is a smaller company. Looking a bit more closely, we see that, while Humana has the lowest ACR of the group, it has by far the highest MLR, and this is the source of its low operating margin. A high MLR is usually a sign of lax pricing discipline, as enrollees are taken on and charged too little for their health expenses. A low ACR, on the other hand, can indicate efficiency in administration or sales.

 Humana

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	Select All  |  Select None Companies Aetna (AET) AMERIGROUP (AGP) Centene (CNC) Coventry Health Care (CVH) I-TRAX (DMX) Health Net (HNT) Healthspring (HS) Metropolitan Health Networks (MDF) Magellan Health Services (MGLN) MOLINA HEALTHCARE (MOH) Sierra Health Services (SIE) Wellcare Group (WCG) UnitedHealth Group (UNH) WellPoint Health Networks (WLP) Humana (HUM) CIGNA Corporation (CI) UNIVERSAL AMERICAN CORP (UAM) Cancel

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Company	Data From	Premiums from Medicare	Net Investment Income	Revenue	Premiums from Medicaid	Revenue by Geography - United States	Net Income Margin
Aetna (AET)	2007	$2.6B[1]	$1.15B[2]	$27.6B[3]	$245M[1]	$27.6B[3]	7%[3]
CIGNA Corporation (CI)	2007	$675M[4]	$1.11B[5]	$17.6B[5]	Add	$17.6B[5]	6%[5]
Coventry Health Care (CVH)	2007	$2.87B[6]	Add	$9.88B[7]	$1.11B[6]	$9.88B[7]	6%[7]
Humana (HUM)	2007	$14.8B[8]	$314M[9]	$25.3B[9]	$556M[8]	$25.3B[9]	3%[9]
UnitedHealth Group (UNH)	2007	$26B[10]	$1.14B[11]	$75.4B[12]	$6.58B[10]	Add	6%[12]

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[edit] References

1. ↑ ^{1.0 1.1} AET,2007,EXBT-13,Item-na,Page-5
2. ↑ AET,2007,EXBT-13,Item-na,Page-41
3. ↑ ^{3.0 3.1 3.2} AET,2007,EXBT-13,Item-na,Page-40
4. ↑ CI,2007,10-K,Item-7,Page-48
5. ↑ ^{5.0 5.1 5.2 5.3} CI,2007,10-K,Item-6,Page-38
6. ↑ ^{6.0 6.1} CVH,2007,10-K,Item-7,Page-48
7. ↑ ^{7.0 7.1 7.2} CVH,2007,10-K,Item-8,Page-47
8. ↑ ^{8.0 8.1} HUM,2007,10-K,Item-7,Page-35
9. ↑ ^{9.0 9.1 9.2 9.3} HUM,2007,10-K,Item-6,Page-30
10. ↑ ^{10.0 10.1} UNH,2007,10-K,Item-7,Page-20
11. ↑ UNH,2007,10-K,Item-8,Page-51
12. ↑ ^{12.0 12.1} UNH,2007,10-K,Item-6,Page-19