The consolidated financial statements of Humana Inc. in this document present the Company’s financial position, results of operations and cash flows, and should be read in conjunction with the following discussion and analysis. References to “we,” “us,” “our,” “Company,” and “Humana” mean Humana Inc. and its subsidiaries. This discussion includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this filing and in future filings with the Securities and Exchange Commission, in our press releases, investor presentations, and in oral statements made by or with the approval of one of our executive officers, the words or phrases like “expects,” “anticipates,” “intends,” “likely will result,” “estimates,” “projects” or variations of such words and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, and assumptions, including, among other things, information set forth in the “Cautionary Statements” section of this document. Because our pending acquisition has not yet occurred, these forward looking statements exclude its impact. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this document might not occur. There may also be other risks that we are unable to predict at this time. Any of these risks and uncertainties may cause actual results to differ materially from the results discussed in the forward-looking statements.
Headquartered in Louisville, Kentucky, Humana Inc. is one of the nation’s largest publicly traded health benefits companies, based on our 2003 revenues of $12.2 billion. We offer coordinated health insurance coverage and related services through a variety of traditional and Internet-based plans for employer groups, government-sponsored programs, and individuals. As of December 31, 2003, we had approximately 6.8 million members in our medical insurance programs, as well as approximately 1.7 million members in our specialty products programs. In 2003, approximately 70% of our premiums and administrative services fees resulted from members located in Florida, Illinois, Texas, Kentucky, and Ohio. During 2003, we derived approximately 42% of our premiums and administrative services fees from contracts with the federal government including two federal government contracts with the Department of Defense to provide health insurance coverage to TRICARE beneficiaries and our contracts with the Centers for Medicare and Medicaid Services, or CMS, to provide health insurance coverage for our Medicare+Choice members.
Duration is indicative of the relationship between changes in market value to changes in interest rates, providing a general indication of the sensitivity of the fair values of our debt securities to changes in interest rates. However, actual market values may differ significantly from estimates based on duration. The average duration of our debt securities was approximately 3.5 years at December 31, 2003. Based on this duration, a 1% increase in interest rates would generally decrease the fair value of our debt securities by approximately $70 million.
We recorded impairment losses of $3.2 million in 2003, $27.2 million in 2002, and $2.4 million in 2001 after an evaluation indicated that a decline in fair value below the cost basis was other than temporary.
Commercial segment premium revenues increased 12.4%, to $6.6 billion, for 2003 compared to $5.8 billion for 2002. This improvement resulted primarily from increases in per member premiums in the 12% to 14% range for 2003 on our fully insured commercial business. Additionally, our fully insured commercial medical membership increased 0.5% or 12,500 members, to 2,352,800 at December 31, 2003 compared to 2,340,300 at December 31, 2002.
The timing of payments for claims can significantly impact comparisons of our operating cash flows between years. During 2001, operating cash flows were reduced by $132.0 million as a result of our paying down unprocessed claim inventories. Since then, the level of claims inventory has stabilized. The following table presents the estimated valuation and number of unprocessed claims on hand, performance metrics we regularly review. Claims on hand represent the estimated number of provider requests for reimbursement that have been received but not yet processed.
• the introduction of new or costly treatments, including new technologies;
Our future performance depends in large part upon our management team’s ability to execute our strategy to position the company for the future. This strategy includes the growth of our Commercial segment business, introduction of new products and benefit designs, including our Smart products, the successful implementation of our e-business initiatives and the selection and adoption of new technologies. We believe that the adoption of new technologies will contribute toward a reduction in administrative costs as we more closely align our workforce with our membership. This alignment is achieved through reductions in workforce or by employing additional people in certain strategic operating areas such as sales and underwriting. Additionally, we have consolidated our service centers and their related systems as part of our operational initiatives. There can be no assurance that we will be able to successfully implement our operational and strategic initiatives that are intended to position the company for future growth. Failure to implement this strategy may result in a material adverse effect on our financial position, results of operations and cash flows.
There can be no assurance that our process of improving existing systems, developing new systems to support our operations, integrating new systems, protecting our proprietary information, and improving service levels will not be delayed or that additional systems issues will not arise in the future. Failure to adequately protect and maintain the integrity of our information systems and data may result in a material adverse effect on our financial positions, results of operations and cash flows.
Investment securities, which consist primarily of debt securities, have been categorized as available for sale and, as a result, are stated at fair value. Fair value of publicly traded debt and equity securities are based on quoted market prices. Non-traded debt securities are priced independently by a third party. Fair value of venture capital debt securities that are privately held, or where an observable quoted market price does not exist, are estimated using a variety of valuation methodologies. Such methodologies include reviewing the value ascribed to the most recent financing, comparing the security with securities of publicly traded companies in a similar line of business, and reviewing the underlying financial performance including estimating discounted cash flows. Investment securities available for current operations are classified as current assets. Investment securities available for our professional liability and long-term insurance product funding requirements, as well as statutory deposits and venture capital investments, are classified as long-term assets. Unrealized holding gains and losses, net of applicable deferred taxes, are included as a component of stockholders’ equity until realized from a sale or impairment.
Beginning in the fourth quarter of 2002, we began participation in a securities lending program where we loan certain investment securities for short periods of time in exchange for collateral, consisting of cash or U.S. Government securities, equal to at least 102% of the fair value of the investment securities on loan. As of
At December 31, 2003, we had no direct or indirect (conduit) commercial paper borrowings outstanding.
We have defined contribution retirement and savings plans covering eligible employees. Our contribution to these plans is based on various percentages of compensation, and in some instances, on the amount of our employees’ contributions to the plans. The cost of these plans amounted to approximately $37.9 million in 2003, $34.8 million in 2002, and $30.2 million in 2001, all of which was funded currently to the extent it currently was deductible for federal income tax purposes. Based on the year end closing stock price of $22.85, approximately 25% of the retirement and savings plan’s assets were invested in our common stock representing less than 5% of the shares outstanding as of December 31, 2003. The Company match is invested in the Humana common stock fund. However, a participant may reinvest any funds, including the Company match, in any other plan investment option at any time.
Compensation expense related to variable-based stock option awards and to modifications to fixed-based stock option awards was not material for 2003, 2002, and 2001. The effects on net income and earnings per share if we had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to our fixed-based stock option awards is included in Note 2.
One TRICARE subsidiary under the Regions 3 and 4 contract with the Department of Defense is required to maintain current assets at least equivalent to its current liabilities. We were in compliance with this requirement at December 31, 2003.
The plaintiffs assert that we and other defendants improperly paid providers’ claims and “downcoded” their claims by paying lesser amounts than they submitted. The complaint alleges, among other things, multiple violations under the Racketeer Influenced and Corrupt Organizations Act, or RICO, as well as various breaches of contract and violations of regulations governing the timeliness of claim payments. We moved to dismiss the complaint on September 8, 2000, and the other defendants filed similar motions thereafter. On March 2, 2001, the Court dismissed certain of the plaintiffs’ claims pursuant to the defendants’ several motions to dismiss. However, the Court allowed the plaintiffs to attempt to correct the deficiencies in their complaint with an amended pleading with respect to all of the allegations except a claim under the federal Medicare regulations, which was dismissed with prejudice. The Court also left undisturbed the plaintiffs’ claims for breach of contract. On March 26, 2001, the plaintiffs filed their amended complaint, which, among other things, added four state or county medical associations as additional plaintiffs. Two of those, the Denton County Medical Society and the Texas Medical Association, purport to bring their actions against us, as well as against several other defendant companies. The Medical Association of Georgia and the California Medical Association purport to bring their actions against various other defendant companies. The associations seek injunctive relief only. The defendants filed a motion to dismiss the amended complaint on April 30, 2001.
includes two subclasses. A national subclass consists of medical doctors who provided services to any person insured by a defendant when the doctor has a claim against such defendant and is not required to arbitrate that claim. A California subclass consists of medical doctors who provided services to any person insured in California by any defendant when the doctor was not bound to arbitrate the claim.
On October 23, 2003, we entered into a settlement agreement with the plaintiffs that specified an increase in future reimbursement we pay to a class consisting of physicians in a 12-county area in Southern Ohio and Northern Kentucky over the next three years. We agreed to increase the reimbursement, in the aggregate, subject to certain contingencies, that will increase the amounts paid for physician services over the amounts paid in 2003 as follows: $20 million in 2004, an additional $15 million in 2005 and an additional $10 million in 2006. The agreement also provides for a committee to monitor our contracting practices for the period 2007 through 2010, with reporting to us if any anticompetitive behavior is believed to have occurred. The agreement was approved by the courts on December 30, 2003.
On May 31, 2001, we acquired the outstanding shares of common stock of a newly-formed Anthem Health Insurance Company subsidiary responsible for administering TRICARE benefits in Regions 2 and 5 for $43.5 million in cash, net of direct transaction costs. We accounted for this acquisition under the purchase method of accounting and accordingly, our consolidated results of operations include the results of the acquired business from the date of acquisition. We allocated the purchase price to net tangible and other intangible assets based upon fair value. Any remaining value not assigned to net tangible or other intangible assets was then allocated to goodwill. Other intangible assets of $11.8 million relate to the acquired government contract and were amortized over the contract’s life assuming no extension, or approximately 2 years. Goodwill recorded in
connection with the acquisition was $32.9 million. Unaudited pro forma results of operations information have not been presented because the effect of the acquisition was not significant to our results of operations or financial position.