Humana Earnings Review

Humana Inc. (HUM), which last month lowered its estimates for 2008, reported a 13% gain in first quarter earnings, beating analysts' estimates by two cents per share, Bloomberg reports in a very comprehensive story. One reason HUM beat estimates is that its income tax rate fell to 35.3%. HUM closed Monday at $46.38, up 3.34% on the day.

In its earnings announcement, Humana said:

Humana Inc. (NYSE: HUM) today reported financial results for the quarter ended March 31, 2008 (1Q08) including diluted earnings per common share [EPS] of $0.47, ahead of management's previous guidance for EPS of $0.44 to $0.46, primarily due to a lower-than-anticipated effective tax rate. The company earned $0.42 per share for the quarter ended March 31, 2007 (1Q07). The company also announced that it had raised its EPS projection for the year ending December 31, 2008 to a range of $4.10 to $4.35 to reflect a lower diluted share count and effective tax rate for the full year.

"Our Medicare Advantage and Commercial progress was particularly strong in the first quarter," said Michael B. McCallister, the company's president and chief executive officer. "Our first quarter earnings, and our success in achieving targeted Medicare Advantage membership gains year to date, give us confidence that we'll continue to see solid improvement in all non-Prescription Drug Plan [PDP] lines of business through 2008 and beyond. We expect to return our stand-alone PDPs to profitability in 2009."

Revenues - 1Q08 consolidated revenues rose 12% to $6.96 billion from $6.20 billion in 1Q07, with total premium and administrative services fees also up 12% compared to the prior year's quarter. This year-over-year increase was primarily driven by higher average Medicare Advantage membership in 1Q08 versus 1Q07.

Benefit expenses - The 1Q08 consolidated benefits ratio (benefit expenses as a percent of premium revenues) of 86.7% was 10 basis points lower than the 1Q07 benefit ratio of 86.8%, the combined result of a 70 basis point increase in the Government Segment benefits ratio and a 260 basis point decline in the Commercial Segment benefits ratio.

Selling, general, & administrative (SG&A) expenses - The 1Q08 consolidated SG&A expense ratio (SG&A expenses as a percent of premiums, administrative services fees and other revenue) increased 40 basis points to 13.8% for 1Q08 from 13.4% in 1Q07. The year-over-year increase was primarily the result of the acquisition of two specialty products companies in the fourth quarter of 2007.

In the three months ended March 31, Humana had 170.6 million shares outstanding that it used in computing diluted EPS, up from 169 million a year ago. The company's medical costs have been stable. Jim Murray, COO, told analysts during its conference call that HUM has seen its medical spend rate stay flat or even decline, and, "We don't see any piece of that accelerating in any way, shape or form." McCallister said he sees hospitals giving pretty much the same prices to all carriers because they don't have any incentives to favor one over another. This means, he told analysts, that the insurers will have to compete on some other basis than their ability to get a better price from a provider.

In his prepared remarks to securities analysts during their conference call, McCallister said:

In our Commercial segment we anticipate extending our record of steady pre-tax earnings growth this year. We have the best balanced membership portfolio in our history and benefit expense trends are in check.

Pricing discipline is strong, and as the bar chart shows, our 2007 acquisitions of KMG and CompBenefits have broadened our capabilities in the voluntary benefits dental and vision markets consistent with employers' growing desire for benefit providers who offer full-service solutions. At the same time, medical membership within the Commercial segment continues to show steady but targeted growth. In fact, we're raising our expectation for total Commercial medical membership growth to between 90,000 and 120,000 members in 2008 driven by individual and small group sales and retention improvement.

McCallister said he doesn't think Congress can cut payments and benefits to Medicare Advantage enrollees, which it is considering doing so it save money and avert scheduled July 1 payment cuts to physicians. Congress is hearing from Medicare beneficiaries who don't want their benefits cut, he said. He then described the disease management and other services Humana's Medicare Advantage beneficiaries receive that enrollees in Medicare's standard program don't get. Clearly, Humana is concerned. It will continue to target a 5% profit margin on its Medicare business.

Long term, Humana is developing ways to move Medicare Advantage patients into PPOs, which it believes will replace private fee-for-service plans. Humana also is working on improving ways to better manage and coordinate care for Medicare beneficiaries, "because we have to find cost savings."

Humana said it has a strong financial incentive to grow its small group and individual businesses, because as they account for a bigger share of the company's business, its medical expense ratios become more profitable. That is, they fall.

Humana's small group business is growing with the growth in the number of small businesses, and at the same time, the company is growing its individual business as more small businesses drop health benefits and throw employees into the individual market, McCallister said.

Humana is strong in both markets and is prepared to grow both markets. In the individual markets, Humana has done some things to make it easier for brokers to do business with the company, and it has created a "differentiated value proposition rather than allowing ourselves to become commoditized, and we recognize that there's some price that folks will leave. But we've tried to keep our pricing relatively close to the competition, but recognizing and really pushing some of the other value that we bring."

Humana thinks it can gain some market share in the individual markets over some of the Blue Cross plans "that have been in this business for a long period of time and haven't done a lot of the things that we've done."

Humana told analysts that this year's flu season cost it $25 million to $30 million more than last year, and, it said, "it's well within the normal range of variation that we experience from quarter to quarter, and it doesn't change our outlook for the full year."

Humana's daily chart is here. Click on the chart for hourly, daily, weekly and point and figure charts.

Full disclosure: I have no positions in HUM or any other insurers.