Form 10-K
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2003

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                          to                         

 

Commission file number 1-5975

 


 

HUMANA INC.

(Exact name of registrant as specified in its charter)

 

Delaware   61-0647538
(State of incorporation)   (I.R.S. Employer Identification Number)
500 West Main Street    
Louisville, Kentucky   40202
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (502) 580-1000

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class


 

Name of exchange on which registered


Common stock, $0.16 2/3 par value

  New York Stock Exchange

7.25% Senior Notes, due August 2006

 

6.30% Senior Notes, due August 2018

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 


 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x    No  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of the Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in the Registrant’s definitive proxy or information statements incorporated by reference in Parts I, II and III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

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

 

The aggregate market value of voting stock held by non-affiliates of the Registrant as of June 30, 2003 was $2,290,660,754 calculated using the average price on such date of $15.11.

 

The number of shares outstanding of the Registrant’s Common Stock as of February 29, 2004 was 162,109,152.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Parts I, II and III incorporate herein by reference portions of the Registrant’s Proxy Statement filed pursuant to Regulation 14A covering the Annual Meeting of Stockholders scheduled to be held April 22, 2004.

 



Table of Contents

HUMANA INC.

 

INDEX TO ANNUAL REPORT ON FORM 10-K

For the Year Ended December 31, 2003

          Page

Part I
Item 1.    Business    3
Item 2.    Properties    18
Item 3.    Legal Proceedings    18
Item 4.    Submission of Matters to a Vote of Security Holders    21
Part II
Item 5.    Market for the Registrant’s Common Equity and Related Stockholder Matters    22
Item 6.    Selected Financial Data    23
Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    24
Item 7a.    Quantitative and Qualitative Disclosures about Market Risk    58
Item 8.    Financial Statements and Supplementary Data    59
Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    95
Item 9a.    Controls and Procedures    95
Part III
Item 10.    Directors and Executive Officers of the Registrant    96
Item 11.    Executive Compensation    98
Item 12.    Security Ownership of Certain Beneficial Owners and Management    98
Item 13.    Certain Relationships and Related Transactions    98
Item 14.    Auditor Fees and Services    98
Part IV
Item 15.    Exhibits, Financial Statement Schedules and Reports on Form 8-K    99
     Signatures and Certifications    107


Table of Contents

PART I

 

ITEM 1. BUSINESS

 

General

 

Headquartered in Louisville, Kentucky, Humana Inc. referred to throughout this document as “we,” “us,” “our,” the “Company” or “Humana,” 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. We have approximately 463,300 contracts with physicians, hospitals, dentists, and other providers to provide health care to our members. In 2003, approximately 70% of our premiums and administrative services fees resulted from members located in Florida, Illinois, Texas, Kentucky, and Ohio. We derived approximately 42% of our premiums and administrative services fees from contracts with the federal government in 2003. Under two federal government contracts with the Department of Defense, we provide health insurance coverage to the TRICARE members, accounting for approximately 20% of our total premiums and administrative services fees in 2003. Under one federal government contract with the Centers for Medicare and Medicaid Services, or CMS, we provide health insurance coverage to approximately 229,100 Medicare+Choice members in Florida, accounting for approximately 15% of our total premiums and administrative services fees in 2003.

 

We were organized as a Delaware corporation in 1964. Our principal executive offices are located at 500 West Main Street, Louisville, Kentucky 40202, and the telephone number at that address is (502) 580-1000. We file annual, quarterly, and current reports, proxy statements, and other documents with the Securities and Exchange Commission, or SEC, under the Securities Exchange Act of 1934, or the Exchange Act.

 

We have made available free of charge on or through our Internet web site (http://www.humana.com) our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Proxy Statements, and all of our other reports, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Also available on our Internet web site is information about our Board of Directors, including a determination of independence for each member, the various committees of our Board of Directors, the charters of these committees, the name(s) of the Directors designated as a financial expert under Section 11 of the Securities Act of 1933, the process for designating a lead director to act at executive sessions of the non-management Directors, the pre-approval process of non-audit services, the process by which stockholders can communicate with Directors, the process by which stockholders can make Director nominations, the Company’s Corporate Governance guidelines, the Humana Principles of Business Ethics, and the Code of Ethics for the Chief Executive Officer and Senior Financial Officers. Any waivers or amendments for Directors or Executive Officers to the Principles of Business Ethics and the Code of Ethics for the Chief Executive Officer and Senior Financial Officers will be promptly displayed on our web site. The Company will provide any of these documents in print without charge to any stockholder who makes a written request to: Joan O. Lenahan, Corporate Secretary, Humana Inc., 500 West Main Street, 27th Floor, Louisville, Kentucky 40202. Additional information about these items can be found in, and is incorporated by reference to, the Company’s Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on April 22, 2004.

 

This Annual Report on Form 10-K contains both historical and forward-looking information. See the “Cautionary Statements” section in Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations for a description of a number of factors that could adversely affect our results.

 

Business Segments

 

We manage our business with two segments: Commercial and Government. The Commercial segment consists of members enrolled in products marketed to employer groups and individuals, and includes three lines

 

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of business: fully insured medical, administrative services only, or ASO, and specialty. The Government segment consists of members enrolled in government-sponsored programs, and includes three lines of business: Medicare+Choice, Medicaid, and TRICARE. We identified our segments in accordance with the aggregation provisions of Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information which is consistent with information used by our Chief Executive Officer in managing our business. The segment information aggregates products with similar economic characteristics. These characteristics include the nature of customer groups, pricing, benefits, and underwriting requirements.

 

The results of each segment are measured by income before income taxes. We allocate all selling, general and administrative expenses, investment and other income, interest expense, and goodwill, but no other assets or liabilities, to our segments. Members served by our two segments generally utilize the same medical provider networks, enabling us to obtain more favorable contract terms with providers. Our segments also share overhead costs and assets. As a result, the profitability of each segment is interdependent.

 

Strategy

 

Our business strategy centers on increasing Commercial segment profitability while building on our existing strength in the Government segment and exploring opportunities under the recently enacted Medicare Prescription Drug, Improvement, and Modernization Act, or DIMA. Our strategy to increase Commercial segment profitability focuses on providing solutions for employers to the rising cost of health care through the use of innovative and consumer-choice product designs which are supported by service excellence and industry-leading electronic capabilities, including education, tools, and technologies provided primarily through the Internet. The intent of our Commercial segment strategy is to enable us to further penetrate high potential commercial markets and to transform the traditional experience for both employers and members in order to achieve a high degree of consumer satisfaction and loyalty.

 

Our Products

 

The following table presents our segment membership, premiums and ASO fees by product for the year ended December 31, 2003:

 

    Medical
Membership


  Specialty
Membership


  Premiums

  ASO Fees

  Total
Premiums and
ASO Fees


  Percent of Total
Premiums and
ASO Fees


 

Commercial:

                               

Fully insured:

                               

HMO

  1,028,900   —     $ 2,871,697   $ —     $ 2,871,697                   23.7 %

PPO

  1,323,900   —       3,369,109     —       3,369,109   27.9 %
   
 
 

 

 

 

Total fully insured

  2,352,800   —       6,240,806     —       6,240,806   51.6 %

Administrative services only

  712,400   —       —       122,846     122,846   1.0 %

Specialty

  —     1,668,100     320,206     —       320,206   2.7 %
   
 
 

 

 

 

Total Commercial

  3,065,200   1,668,100     6,561,012     122,846     6,683,858   55.3 %
   
 
 

 

 

 

Government:

                               

Medicare+Choice

  328,600   —       2,527,446     —       2,527,446   20.9 %

Medicaid

  468,900   —       487,100     —       487,100   4.0 %

TRICARE

  1,849,700   —       2,249,725     —       2,249,725   18.6 %

TRICARE ASO

  1,057,200   —       —       148,830     148,830   1.2 %
   
 
 

 

 

 

Total Government

  3,704,400   —       5,264,271     148,830     5,413,101   44.7 %
   
 
 

 

 

 

Total

  6,769,600   1,668,100   $ 11,825,283   $ 271,676   $ 12,096,959   100.0 %
   
 
 

 

 

 

 

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Our Products Marketed to Commercial Segment Employers and Members

 

New Generation of Products

 

We have developed a range of innovative products, styled as “Smart” products, that we believe will be a solution for employers who annually are facing double-digit premium increases driven by medical cost inflation. Our new generation of products provide more (1), choices for the individual consumer, (2), transparency of provider costs, and (3), benefit designs that engage consumers in the costs and effectiveness of health care choices. Innovative tools and technology are available to assist consumers with these decisions, including the trade-offs between higher premiums and point-of-service costs at the time consumers choose their plans, and to suggest ways in which the consumers can maximize their individual benefits at the point they use their plans. These products are sold to employers with Humana as the sole carrier, but are available on either a fully insured or self-funded basis. As of December 31, 2003, we had enrolled approximately 130,000 members into our Smart products.

 

Many of our Smart products, as well as our more traditional products, are offered to employer groups as “bundles”, where the subscribers are offered various HMO and PPO options, with various employer contribution strategies as determined by the customer.

 

HMO

 

Our health maintenance organization, or HMO, products provide prepaid health insurance coverage to our members through a network of independent primary care physicians, specialty physicians, and other health care providers who contract with the HMO to furnish such services. Primary care physicians generally include internists, family practitioners, and pediatricians. Generally, the member’s primary care physician must approve access to certain specialty physicians and other health care providers. These other health care providers include, among others, hospitals, nursing homes, home health agencies, pharmacies, mental health and substance abuse centers, diagnostic centers, optometrists, outpatient surgery centers, dentists, urgent care centers, and durable medical equipment suppliers. Because the primary care physician generally must approve access to many of these other health care providers, the HMO product is considered the most restrictive form of managed care.

 

An HMO member, typically through the member’s employer, pays a monthly fee, which generally covers, with some copayments, health care services received from or approved by the member’s primary care physician. For the year ended December 31, 2003, commercial HMO premium revenues totaled approximately $2.9 billion, or 23.7% of our total premiums and ASO fees.

 

PPO

 

Our preferred provider organization, or PPO, products, which are marketed primarily to commercial groups and individuals, include some elements of managed health care. However, they typically include more cost-sharing with the member, through copayments and annual deductibles. PPOs also are similar to traditional health insurance because they provide a member with more freedom to choose a physician or other health care provider. In a PPO, the member is encouraged, through financial incentives, to use participating health care providers, which have contracted with the PPO to provide services at favorable rates. In the event a member chooses not to use a participating health care provider, the member may be required to pay a greater portion of the provider’s fees.

 

In June 2002, we introduced HumanaOne, a major medical product marketed directly to individuals. We introduced this product in select markets where we can utilize our existing networks and distribution channels.

 

For the year ended December 31, 2003, commercial and individual PPO premium revenues totaled approximately $3.4 billion, or 27.9% of our total premiums and ASO fees.

 

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Administrative Services Only

 

We offer an administrative services only, or ASO, product to those who self-insure their employee health plans. We receive fees to provide administrative services which generally include the processing of claims, offering access to our provider networks and clinical programs, and responding to customer service inquiries from members of self-funded employers. These products may include all of the same benefit and product design characteristics of our fully insured PPO and HMO products described above, however, under ASO contracts, self-funded employers retain the risk of financing the cost of health benefits. For the year ended December 31, 2003, commercial ASO fees totaled $122.8 million, or 1.0% of our total premiums and ASO fees.

 

Specialty Products

 

We also offer various specialty products including dental, group life, and short-term disability. At December 31, 2003, we had approximately 1.7 million specialty members. For the year ended December 31, 2003, specialty product premium revenues were approximately $320.2 million, or 2.7% of our total premiums and ASO fees.

 

Our Products Marketed to Government Segment Members and Beneficiaries

 

Medicare+Choice Product

 

Medicare is a federal program that provides persons age 65 and over and some disabled persons certain hospital and medical insurance benefits, which include hospitalization benefits for up to 90 days per incident of illness plus a lifetime reserve aggregating 60 days. Each Medicare-eligible individual is entitled to receive inpatient hospital care, known as Part A care, without the payment of any premium, but is required to pay a premium to the federal government, which is adjusted annually, to be eligible for physician care and other services, known as Part B care.

 

We contract with CMS under the Medicare+Choice program to provide health insurance coverage in exchange for a fixed monthly payment per member for Medicare-eligible individuals residing in the geographic areas in which our HMOs operate. Individuals who elect to participate in Medicare+Choice programs receive additional benefits not covered by Medicare and are relieved of the obligation to pay some or all of the deductible or coinsurance amounts but are generally required to use exclusively the services provided by the HMO (subject to nominal copayments and coinsurance) and are required to pay a Part B premium to the Medicare program.

 

The Medicare+Choice product involves a contract between an HMO and CMS, pursuant to which CMS makes a fixed monthly payment to the HMO on behalf of each Medicare-eligible individual that chooses to enroll for coverage in the HMO. The fixed monthly payment, payable on the first day of a month, is determined by formula established by federal law. We sometimes receive the fixed monthly payment early due to a weekend or holiday falling on the first day of a month. Since this amount is significant, the timing of its receipt can cause a material fluctuation in our operating cash flows from period to period. We also collect additional member premiums from our members in most of our markets.

 

At December 31, 2003, we provided health insurance coverage under CMS contracts to approximately 328,600 Medicare+Choice members for which we received premium revenues of approximately $2.5 billion, or 20.9% of our total premiums and ASO fees for 2003. One such CMS contract covered approximately 229,100 members in Florida and accounted for premium revenues of approximately $1.8 billion, which represented 70.5% of our Medicare+Choice premium revenues, or 14.7% of our total premiums and ASO fees for 2003.

 

Our Medicare+Choice contracts with the federal government are renewed for a one-year term each December 31 unless terminated 90 days prior thereto. Annual increases in per member premiums from CMS have ranged from as low as approximately 2% to as high as approximately 10%, with an average of

 

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approximately 5% for the five-year period beginning January 1, 2000. Over the last several years, our Medicare+Choice membership has declined as we exited some counties. These exits were a result, in part, of lower CMS reimbursement rates.

 

In December 2003, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, or DIMA was signed into law. The legislation establishes a new Medicare private health plan program, called MedicareAdvantage, continuing the health plan options afforded under the former Medicare+Choice program while adding additional health plan options, including regional PPO options beginning in 2006. DIMA includes provisions that require the 2004 stabilization funding to be directed toward increased reimbursement for providers, increased benefits or access for members, or decreased member premiums. Including DIMA funding and changes in member premiums, we expect an 8% to 10% increase in total per member premiums in 2004 with a corresponding increase in medical costs due to increased reimbursements for providers and increased benefits for members.

 

Medicaid Product

 

Medicaid is a federal program that is state-operated to facilitate the delivery of health care services to low-income residents. Each electing state develops, through a state specific regulatory agency, a Medicaid managed care initiative that must be approved by CMS. CMS requires that Medicaid managed care plans meet federal standards and cost no more than the amount that would have been spent on a comparable fee-for-service basis. States currently either use a formal proposal process in which they review many bidders before selecting one or award individual contracts to qualified bidders who apply for entry to the program. In either case, the contractual relationship with a state generally is for a one-year period. Under these contracts, we receive a fixed monthly payment from a government agency for which we are required to provide health insurance coverage to enrolled members. Due to the increased emphasis on state health care reform and budgetary constraints, more states are utilizing a managed care product in their Medicaid programs.

 

We currently have Medicaid contracts with the Puerto Rico Health Insurance Administration through June 30, 2005, subject to each party agreeing upon annual rates. In July 2003, we signed amendments to the Puerto Rico Medicaid contracts regarding a premium rate increase for the annual period ending June 30, 2004. Our other Medicaid contracts are in Florida and Illinois, and are annual contracts. For the year ended December 31, 2003, premium revenues from our Medicaid products totaled $487.1 million, or 4.0% of our total premiums and ASO fees. At December 31, 2003, we had approximately 394,800 Medicaid members in Puerto Rico, or 84% of total Medicaid members, and 74,100 Medicaid members in Florida and Illinois, or 16% of total Medicaid members.

 

TRICARE

 

TRICARE provides health insurance coverage to the dependents of active duty military personnel and to retired military personnel and their dependents. In November 1995, the United States Department of Defense awarded us our first TRICARE contract for Regions 3 and 4 covering approximately 1.1 million eligible beneficiaries in Florida, Georgia, South Carolina, Mississippi, Alabama, Tennessee and Eastern Louisiana. On July 1, 1996, we began providing health insurance coverage to these approximately 1.1 million eligible beneficiaries.

 

On May 31, 2001, we purchased the entity responsible for administering TRICARE benefits for Regions 2 and 5 to approximately 1.2 million eligible beneficiaries in Illinois, Indiana, Kentucky, Michigan, North Carolina, Ohio, Tennessee, Virginia, Wisconsin, West Virginia and a portion of Missouri.

 

Our current TRICARE contract with the Department of Defense will be in effect until April 30, 2004 for Regions 2 and 5 and until June 30, 2004 for Regions 3 and 4. Each of the contracts is subject to a one-year renewal at the Government’s option. We believe these contracts will continue until the TRICARE transition described below.

 

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On August 21, 2003, the Department of Defense notified us that we were awarded the contract for the South Region, one of three newly-created regions under the government’s revised TRICARE Program. The current TRICARE Regions 3 and 4 will become part of the new South Region along with Region 6, which is currently administered by another contractor. The current Regions 2 and 5 will become part of the North Region, which was awarded to another contractor.

 

Pursuant to the Department of Defense’s bid process, each of the three awards was subject to protests by unsuccessful bidders of prime contracts, however, none of the protests were successful.

 

Under the Department of Defense’s current schedule for implementation of the new TRICARE contracts, Regions 2 and 5 will transition to the new North Region for the start of healthcare delivery on July 1, 2004. Regions 3 and 4 will become part of the new South Region for the start of healthcare delivery on August 1, 2004 and Region 6 will become part of our new South Region for the start of healthcare delivery on November 1, 2004. If this schedule is realized, our TRICARE membership is expected to temporarily decline to 1.5 million in July 2004, and is expected to increase to 2.8 million in November 2004. This will also result in a decline in revenues during this period.

 

In addition, retail pharmacy benefits for TRICARE beneficiaries will be administered separately under the new Department of Defense TRICARE Retail Pharmacy Program. On September 26, 2003, we were notified that we were not awarded the retail pharmacy contract and, later, that our protest of this award decision was not upheld.

 

Currently, three health benefit options are available to TRICARE beneficiaries. In addition to a traditional indemnity option, participants may enroll in an HMO-like plan with a point-of-service option or take advantage of reduced copayments by using a network of preferred providers. We have subcontracted with third parties to provide various administration and specialty services under the contracts. For the year ended December 31, 2003, TRICARE premium revenues were approximately $2.2 billion, or 18.6% of our total premiums and ASO fees.

 

At December 31, 2003, we had 1,057,200 TRICARE ASO beneficiaries for which the Department of Defense retains the risk of financing the cost of their health benefits. We obtained these beneficiaries from our acquisition of Regions 2 and 5, and by enrollment in two government programs that allow senior beneficiaries to continue in the TRICARE program even after becoming Medicare eligible, which normally is age 65. The first of these programs, called TRICARE Senior Pharmacy, became effective April 1, 2001. Under this government administrative services program, senior TRICARE beneficiaries receive certain pharmacy benefits not covered under Medicare. On October 1, 2001, the TRICARE for Life program expanded coverage to include medical benefits as well. For the year ended December 31, 2003, TRICARE administrative services fees totaled $148.8 million, or 1.2% of our total premiums and ASO fees. Once the Department of Defense’s new contracting structure is implemented, our responsibility for both of these programs will cease. The TRICARE Senior Pharmacy program is intended to become part of the previously mentioned TRICARE Retail Pharmacy Program. The TRICARE for Life program will become the TRICARE Dual-Eligible Fiscal Intermediary Contract (TDEFIC). The TDEFIC contract, for which we did not bid, was awarded to another contractor on July 25, 2003. It will become effective when the current regional contracts expire.

 

We do not believe that these TRICARE contract changes occurring during 2004 will have a material adverse effect on our financial position, results of operations, or cash flows.

 

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The following table summarizes our total medical membership at December 31, 2003, by market and product:

 

     Commercial

   Government

  

Percent
of Total


 
     HMO

   PPO

   ASO

  

Medicare+

Choice


   Medicaid

   TRICARE

   Total

  
     (in thousands)  

Florida

   179.5    83.8    20.1    229.1    55.3    429.4    997.2    14.7 %

Illinois

   257.4    214.0    82.9    40.2    18.8    74.7    688.0    10.2  

Texas

   205.7    324.2    41.6    21.3    —      —      592.8    8.8  

Puerto Rico

   17.1    67.4    11.1    —      394.8    —      490.4    7.2  

Ohio

   157.6    61.9    136.3    —      —      73.0    428.8    6.3  

Kentucky

   34.5    202.6    116.7    —      —      67.7    421.5    6.2  

Wisconsin

   83.7    51.9    182.9    2.6    —      32.2    353.3    5.2  

Georgia

   17.4    34.6    1.8    —      —      277.0    330.8    4.9  

Virginia

   —      1.2    —      —      —      187.8    189.0    2.8  

North Carolina

   —      12.4    2.6    —      —      152.1    167.1    2.5  

Arizona

   34.3    66.6    41.0    15.5    —      —      157.4    2.3  

South Carolina

   —      3.8    0.6    —      —      133.7    138.1    2.0  

Tennessee

   —      35.8    13.1    —      —      82.1    131.0    1.9  

Michigan

   —      47.4    2.6    —      —      60.2    110.2    1.6  

Alabama

   —      —      0.2    —      —      105.8    106.0    1.6  

Indiana

   0.9    36.7    20.1    —      —      44.8    102.5    1.5  

Missouri/Kansas

   40.8    22.2    5.4    18.3    —      5.0    91.7    1.4  

Mississippi

   —      2.9    0.3    —      —      75.4    78.6    1.2  

Colorado

   —      41.5    —      —      —      —      41.5    0.6  

TRICARE ASO

   —      —      —      —      —      1,057.2    1,057.2    15.6  

Others

   —      13.0    33.1    1.6    —      48.8    96.5    1.5  
    
  
  
  
  
  
  
  

Totals

   1,028.9    1,323.9    712.4    328.6    468.9    2,906.9    6,769.6    100.0 %
    
  
  
  
  
  
  
  

 

Provider Arrangements

 

We provide our members with access to health care services through our networks of health care providers with whom we have contracted, including hospitals and other independent facilities such as outpatient surgery centers, primary care physicians, specialist physicians, dentists and providers of ancillary health care services and facilities. We have approximately 463,300 contracts with health care providers participating in our networks, which consist of approximately 294,400 physicians, 3,300 hospitals, and 165,600 ancillary providers and dentists. These ancillary services and facilities include ambulance services, medical equipment services, home health agencies, mental health providers, rehabilitation facilities, nursing homes, optical services, and pharmacies. Our membership base and the ability to influence where our members seek care generally enable us to obtain contractual discounts with providers.

 

We use a variety of techniques to provide access to effective and efficient use of health care services for our members. These techniques include the coordination of care for our members, product and benefit designs, hospital inpatient management systems, or HIMS, and enrolling members into various disease management programs. The focal point for health care services in many of our Medicare+Choice and HMO networks is the primary care physician who, under contract, provides services, and may control utilization of appropriate services, by directing or approving hospitalization and referrals to specialists and other providers. Some physicians may have arrangements under which they can earn bonuses when certain target goals relating to the provisions of quality patient care are met. Our HIMS programs use specially-trained physicians to effectively manage the entire range of an HMO member’s medical care during a hospital admission and to effectively coordinate the member’s discharge and post-discharge care. We have available a variety of disease management programs related to specific medical conditions such as congestive heart failure, coronary artery disease, prenatal

 

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and premature infant care, asthma related illness, end stage renal disease, diabetes, and breast cancer screening. We also may focus on certain rare conditions where disease management techniques benefit members in a more cost effective manner.

 

We typically contract with hospitals on either a per diem rate, which is an all-inclusive rate per day, a case rate, which is an all-inclusive rate per admission, or at a discounted charge for inpatient hospital services. Outpatient hospital services generally are contracted at a flat rate by type of service or at a discounted charge. These contracts are often multi-year agreements, with rates that are adjusted for inflation annually based on the consumer price index or other nationally recognized inflation index. Outpatient surgery centers and other ancillary providers typically are contracted at flat rates per service provided or are reimbursed based upon a nationally-recognized fee schedule such as the Medicare allowable fee schedule.

 

Our contracts with physicians typically are automatically renewed each year, unless either party gives written notice to the other party of their intent to terminate the arrangement. Most of the physicians in our PPO networks and some of our physicians in our HMO networks are reimbursed based upon a fixed fee schedule, which typically provides for reimbursement based upon a percentage of the standard Medicare allowable fee schedule.

 

Capitation

 

For 7.1% of our December 31, 2003 medical membership, we contract with hospitals and physicians to accept financial risk for a defined set of HMO membership. In transferring this risk, we prepay these providers a monthly fixed-fee per member, known as a capitation payment, to coordinate substantially all of the medical care for their capitated HMO membership, including some health benefit administrative functions and claims processing. For these capitated HMO arrangements, we generally agree to reimbursement rates that target a medical expense ratio ranging from 82% to 89%. Providers participating in hospital-based capitated HMO arrangements generally receive a monthly payment for all of the services within their system for their HMO membership. Providers participating in physician-based capitated HMO arrangements generally have subcontracted directly with hospitals and specialist physicians, and are responsible for reimbursing such hospitals and physicians for services rendered to their HMO membership.

 

For 6.4% of our December 31, 2003 medical membership, we contract with physicians under risk-sharing arrangements whereby physicians have assumed some level of risk for all or a portion of the medical costs of their HMO membership. Although these arrangements do include capitation payments for services rendered, we process substantially all of the claims under these arrangements.

 

Physicians under capitation arrangements typically have stop loss coverage so that a physician’s financial risk for any single member is limited to a maximum amount on an annual basis. We remain financially responsible for health care services to our members in the event our providers fail to provide such services.

 

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Medical membership under these various arrangements was as follows at December 31, 2003 and 2002:

 

    Commercial Segment

    Government Segment

   

Consol.

Total
Medical


 
    Fully
Insured


    ASO

    Total
Segment


    Medicare+
Choice


    Medicaid

    TRICARE

    TRICARE
ASO


    Total
Segment


   

Medical Membership:

                                                     

December 31, 2003

                                                     

Capitated HMO hospital system based

  128,000     —       128,000     38,800     13,600     —       —       52,400     180,400  

Capitated HMO physician group based

  71,700     —       71,700     5,900     220,000     —       —       225,900     297,600  

Risk-sharing

  68,000     —       68,000     157,500     204,800     —       —       362,300     430,300  

Other

  2,085,100     712,400     2,797,500     126,400     30,500     1,849,700     1,057,200     3,063,800     5,861,300  
   

 

 

 

 

 

 

 

 

Total

  2,352,800     712,400     3,065,200     328,600     468,900     1,849,700     1,057,200     3,704,400     6,769,600  
   

 

 

 

 

 

 

 

 

December 31, 2002

                                                     

Capitated HMO hospital system based

  147,400     —       147,400     47,100     11,900     —       —       59,000     206,400  

Capitated HMO physician group based

  73,900     —       73,900     10,700     292,900     —       —       303,600     377,500  

Risk-sharing

  67,700     —       67,700     160,200     164,200     —       —       324,400     392,100  

Other

  2,051,300     652,200     2,703,500     126,100     37,000     1,755,800     1,048,700     2,967,600     5,671,100  
   

 

 

 

 

 

 

 

 

Total

  2,340,300     652,200     2,992,500     344,100     506,000     1,755,800     1,048,700     3,654,600     6,647,100  
   

 

 

 

 

 

 

 

 

Medical Membership Distribution:

 

                                               

December 31, 2003

                                                     

Capitated HMO hospital system based

  5.4 %   —       4.2 %   11.8 %   2.9 %   —       —       1.4 %   2.7 %

Capitated HMO physician group based

  3.0 %   —       2.3 %   1.8 %   46.9 %   —       —       6.1 %   4.4 %

Risk-sharing

  2.9 %   —       2.2 %   47.9 %   43.7 %   —       —       9.8 %   6.4 %

All other membership

  88.7 %   100.0 %   91.3 %   38.5 %   6.5 %   100.0 %   100.0 %   82.7 %   86.5 %
   

 

 

 

 

 

 

 

 

Total

  100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %
   

 

 

 

 

 

 

 

 

December 31, 2002

                                                     

Capitated HMO hospital system based

  6.3 %   —       4.9 %   13.7 %   2.4 %   —       —       1.6 %   3.1 %

Capitated HMO physician group based

  3.2 %   —       2.5 %   3.1 %   57.9 %   —       —       8.3 %   5.7 %

Risk-sharing

  2.9 %   —       2.3 %   46.6 %   32.4 %   —       —       8.9 %   5.9 %

Other

  87.6 %   100.0 %   90.3 %   36.6 %   7.3 %   100.0 %   100.0 %   81.2 %   85.3 %
   

 

 

 

 

 

 

 

 

Total

  100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %
   

 

 

 

 

 

 

 

 

 

Capitation expense as a percentage of total medical expense was as follows for the years ended December 31, 2003, 2002 and 2001:

 

     2003

    2002

    2001

 
     (dollars in thousands)  

Medical Expenses:

                                       

Capitated HMO expense

   $ 597,244    6.0 %   $ 603,617    6.6 %   $ 546,594    6.6 %

Other medical expense

     9,282,177    94.0 %     8,534,579    93.4 %     7,733,250    93.4 %
    

  

 

  

 

  

Consolidated medical expense

   $ 9,879,421    100.0 %   $ 9,138,196    100.0 %   $ 8,279,844    100.0 %
    

  

 

  

 

  

 

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Accreditation Assessment

 

Our accreditation assessment program consists of several internal programs such as those that credential providers and those designed to meet the audit standards of federal and state agencies and external accreditation standards. We also offer quality and outcome measurement and improvement programs such as the Health Plan Employer Data Information Sets, or HEDIS, which is used by employers, government purchasers and the National Committee for Quality Assurance, or NCQA, to evaluate HMOs based on various criteria, including effectiveness of care and member satisfaction.

 

Physicians participating in our HMO networks must satisfy specific criteria, including licensing, patient access, office standards, after-hours coverage, and other factors. Most participating hospitals also meet accreditation criteria established by CMS and/or the Joint Commission on Accreditation of Healthcare Organizations, or JCAHO.

 

Recredentialing of participating providers occurs every two to three years, depending on applicable state laws. Recredentialing of participating physicians includes verification of their medical license; review of their malpractice liability claims history; review of their board certification, if applicable; and review of any complaints, including any member appeals and grievances. Committees, composed of a peer group of physicians, review the applications of physicians being considered for credentialing and recredentialing.

 

We request accreditation for certain of our HMO plans from NCQA and the American Accreditation Healthcare Commission/Utilization Review Accreditation Commission, or AAHC/URAC. Accreditation or external review by an approved organization is mandatory in the states of Florida and Kansas for licensure as an HMO. Accreditation specific to the utilization review process is also required in the state of Georgia for licensure as an HMO or PPO. Certain commercial businesses, like those impacted by United Auto Workers contracts and those where the request comes from the employer, require or prefer accredited health plans.

 

NCQA performs reviews of standards for quality improvement, credentialing, utilization management, and member rights and responsibilities. We continue to maintain accreditation in select markets through NCQA. Two markets maintain NCQA accredited status for all HMO products: Humana Health Plan of Ohio, Inc. in Cincinnati, Ohio (excellent); and Humana Health Plan, Inc., Kentucky (Commendable). Humana Health Plan, Inc. in Kansas and Missouri completed the NCQA survey process in November 2003 and awaits its decision.

 

AAHC/URAC performs reviews of standards for utilization management, and for health plan standards in quality management, credentialing, rights and responsibilities, and network management. Several markets have achieved URAC health plan accreditation for all HMO products: Humana Medical Plan, Inc. in north Florida, south Florida, central Florida (Daytona, Tampa and Orlando), and Humana Health Plan, Inc. in Kansas. The Atlanta market has URAC utilization management accreditation for HMO and PPO product lines. AAHC/URAC utilization management accreditation was received by Humana Military Healthcare Services, Inc., which administers the TRICARE program and for the Green Bay service center.

 

Some of our HMO entities are unaccredited because we sought accreditation only where regulatory requirements were in place, such as in Florida, which requires accreditation for HMO licensing, or in market areas where commercial groups use it as part of the criteria for choosing carriers. We are piloting ISO 9001:2000 certification as an alternative to accreditation. ISO is the international standards organization, which has developed an international commercial set of certifications as to quality and process, called ISO 9001:2000. At this time, the following clinical programs have received ISO registration: transplant management, centralized clinical operations providing personal nurse services, pharmacy management, and disease management.

 

Sales and Marketing

 

Individuals become members of our commercial HMOs and PPOs through their employers or other groups which typically offer employees or members a selection of health insurance products, pay for all or part of the

 

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premiums and make payroll deductions for any premiums payable by the employees. We attempt to become an employer’s or group’s exclusive source of health insurance benefits by offering a variety of HMO, PPO and specialty products that provide cost-effective quality health care coverage consistent with the needs and expectations of the employees or members. Beginning in June 2002, we also offer health insurance products to individuals.

 

We use various methods to market our commercial, Medicare+Choice and Medicaid products, including television, radio, the Internet, telemarketing, and direct mailings. At December 31, 2003, we used approximately 38,000 licensed independent brokers and agents and approximately 220 licensed employees to sell our commercial products. Many of our employer group customers are represented by insurance brokers and consultants who assist these groups in the design and purchase of health care products. We generally pay brokers a commission based on premiums, with commissions varying by market and premium volume.

 

At December 31, 2003, we employed approximately 1,280 sales representatives, who are each paid a salary and/or per member commission, to market our Medicare+Choice and Medicaid products in the continental United States. We also employed approximately 380 telemarketing representatives who assisted in the marketing of Medicare+Choice and Medicaid products by making appointments for sales representatives with prospective members.

 

Risk Management

 

Through the use of internally developed underwriting criteria, we determine the risk we are willing to assume and the amount of premium to charge for our commercial products. In most instances, employer and other groups must meet our underwriting standards in order to qualify to contract with us for coverage. Small group reform laws in some states have imposed regulations which provide for guaranteed issue of certain health insurance products and prescribe certain limitations on the variation in rates charged based upon assessment of health conditions.

 

Underwriting techniques are not employed in connection with Medicare+Choice products because CMS regulations require us to accept all eligible Medicare applicants regardless of their health or prior medical history. We also are not permitted to employ underwriting criteria for the Medicaid product, but rather we follow CMS and state requirements. In addition, with respect to our TRICARE business, we do not employ any underwriting techniques because we must accept all eligible beneficiaries who choose to participate.

 

Competition

 

The health benefits industry is highly competitive and contracts for the sale of commercial products are generally bid or renewed annually. Our competitors vary by local market and include other managed care companies, national insurance companies, and other HMOs and PPOs, including HMOs and PPOs owned by Blue Cross/Blue Shield plans. Many of our competitors have larger memberships and/or greater financial resources than our health plans in the markets in which we compete. Our ability to sell our products and to retain customers is, or may be, influenced by such factors as benefits, pricing, contract terms, number and quality of participating physicians and other providers, utilization review, claims processing, administrative efficiency, relationships with agents, quality of customer service, and accreditation results.

 

Government Regulation

 

Government regulation of health care products and services is a changing area of law that varies from jurisdiction to jurisdiction. Regulatory agencies generally have broad discretion to issue regulations and interpret and enforce laws and rules. Changes in applicable laws and regulations are continually being considered, and the interpretation of existing laws and rules also may change periodically. These regulatory revisions could affect our operations and financial results. Also, it may become increasingly difficult to control medical costs if federal

 

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Table of Contents

and state bodies continue to consider and enact significant and sometimes onerous managed care laws and regulations.

 

Enforcement of health care fraud and abuse laws has become a top priority for the nation’s law enforcement entities. The funding of such law enforcement efforts has increased dramatically in the past few years and is expected to continue. The focus of these efforts has been directed at participants in federal government health care programs such as Medicare+Choice, Medicaid, and the Federal Employee Health Benefits Program, or FEHBP. We participate extensively in these programs and have continued our stringent regulatory compliance efforts for these programs. The programs are subject to very technical rules. When combined with law enforcement intolerance for any level of noncompliance, these rules mean that compliance efforts in this area continue to be challenging.

 

We are subject to various governmental audits, investigations, and enforcement actions. These include possible government actions relating to the Employee Retirement Income Security Act, as amended, or ERISA, FEHBP, federal and state fraud and abuse laws, and other laws relating to Medicare+Choice, including adjusted community rating development, special payment status, and various other areas. Adjusted community rating development is the government-defined rating formula used to explain the Medicare+Choice benefits we offer individuals eligible for Medicare benefits based on a particular community and certain other factors. Special payment status refers to, among others, Medicare+Choice members who are institutionalized, Medicaid-eligible, or members who have contracted end-stage renal disease. The Medicare+Choice plan receives a higher payment for members who qualify for one or more of these statuses. We are currently involved in various government investigations, audits and reviews, some of which are under ERISA, and others under the authority of various states’ departments of insurance. On May 31, 2000, we entered into a five-year Corporate Integrity Agreement with the Office of the Inspector General for the Department of Health and Human Services as part of a settlement of a Medicare overpayment issue arising from an audit by the Office of the Inspector General. Although any of the pending government actions could result in assessment of damages, civil or criminal fines or penalties, and other sanctions against us, including exclusion from participation in government programs, we do not believe the results of any of these actions, individually or in the aggregate, will have a material adverse effect on our financial position, results of operations, or cash flows.

 

Of our seven licensed and active HMO subsidiaries as of February 1, 2004, five are qualified under the Federal Health Maintenance Organization Act of 1973, as amended. To obtain federal qualification, an HMO must meet certain requirements, including conformance with benefit, rating, and financial reporting standards.

 

As of February 1, 2004, Humana Medical Plan, Inc., Humana Health Plan of Texas, Inc., and Humana Health Plan, Inc. each hold CMS contracts under the Medicare+Choice program to sell Medicare HMO products in a total of seven states. In addition, Humana Insurance Company holds CMS contracts under a Medicare+Choice program to sell a private fee-for-service product in eleven states and a pilot PPO product in three counties in Florida.

 

CMS conducts audits of HMOs qualified under its Medicare+Choice program at least biannually and may perform other reviews more frequently to determine compliance with federal regulations and contractual obligations. These audits include review of the HMOs’ administration and management, including management information and data collection systems, fiscal stability, utilization management and physician incentive arrangements, health services delivery, quality assurance, marketing, enrollment and disenrollment activity, claims processing, and complaint systems.

 

CMS regulations require submission of quarterly and annual financial statements. In addition, CMS requires certain disclosures to CMS and to Medicare+Choice beneficiaries concerning operations of a health plan contracted under the Medicare+Choice program. CMS’s rules require disclosure to members upon request of information concerning financial arrangements and incentive plans between an HMO and physicians in the HMOs’ networks. These rules also require certain levels of stop-loss coverage to protect contracted physicians

 

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Table of Contents

against major losses relating to patient care, depending on the amount of financial risk they assume. The reporting of certain health care data contained in HEDIS is another important CMS disclosure requirement.

 

Our Medicaid products are regulated by the applicable state agency in the state in which we sell a Medicaid product and by the Health Insurance Administration in Puerto Rico, in conformance with federal approval of the applicable state plan, and are subject to periodic reviews by these agencies. The reviews are similar in nature to those performed by CMS.

 

Laws in the Commonwealth of Puerto Rico and each of the states in which we operate our HMOs, PPOs and other health insurance-related services regulate our operations, including the scope of benefits, rate formulas, delivery systems, utilization review procedures, quality assurance, complaint systems, enrollment requirements, claim payments, marketing and advertising. The HMO, PPO and other health insurance-related products we offer are sold under licenses issued by the applicable insurance regulators. Under state laws, our HMOs and health insurance companies are audited by state departments of insurance for financial and contractual compliance, and our HMOs are audited for compliance with health services standards by respective state departments of health. Most states’ laws require such audits to be performed at least once every three years.

 

Our licensed subsidiaries are subject to regulation under state insurance holding company and Commonwealth of Puerto Rico regulations. These regulations generally require, among other things, prior approval and/or notice of new products, rates, benefit changes, and certain material transactions, including dividend payments, purchases or sales of assets, intercompany agreements, and the filing of various financial and operational reports.

 

Certain of our subsidiaries operate in states that regulate the payment of dividends, loans, or other cash transfers to Humana Inc., our parent company, require minimum levels of equity, and limit investments to approved securities. The amount of dividends that may be paid to Humana Inc. by these subsidiaries, without prior approval by state regulatory authorities, is limited based on the entity’s level of statutory income and statutory capital and surplus. In most states, prior notification is provided before paying a dividend even if approval is not required.

 

As of December 31, 2003, we maintained aggregate statutory capital and surplus of $1,086.5 million in our state regulated health insurance subsidiaries. Each of these subsidiaries was in compliance with applicable statutory requirements which aggregated $640.4 million. Although the minimum required levels of equity are largely based on premium volume, product mix, and the quality of assets held, minimum requirements can vary significantly at the state level. Certain states rely on risk-based capital requirements, or RBC, to define the required levels of equity. RBC is a model developed by the National Association of Insurance Commissioners to monitor an entity’s solvency. This calculation indicates recommended minimum levels of required capital and surplus and signals regulatory measures should actual surplus fall below these recommended levels. If RBC were adopted by all states at December 31, 2003, each of our subsidiaries would be in compliance, and we would have $381.9 million of aggregate capital and surplus above any of the levels that require corrective action under RBC.

 

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.

 

Our management works proactively to ensure compliance with all governmental laws and regulations affecting our business.

 

Health Care Reform

 

There continue to be diverse legislative and regulatory initiatives at both the federal and state levels to affect aspects of the nation’s health care system.

 

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Table of Contents

Federal

 

On December 8, 2003, President Bush signed into law the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, or DIMA. DIMA makes many significant changes to the Medicare fee-for-service and Medicare+Choice programs, as well as other changes to the commercial health insurance marketplace. Most significantly, DIMA creates a prescription drug benefit for Medicare beneficiaries, establishes a new Medicare Advantage program to replace the Medicare+Choice program, and enacts health savings accounts, or HSAs, for non-Medicare eligible individuals and groups.

 

In 2004 and 2005, older Americans will be eligible to purchase a discount card. Low-income seniors also will receive an annual subsidy of $600 to further defray drug costs. Distribution of the discount cards is expected in March or April 2004. Beginning in 2006, Medicare beneficiaries will be able to sign up for a stand-alone drug plan or join a private health plan that offers drug coverage. DIMA adds a new payment methodology for private MedicareAdvantage plans in 2004. This methodology provides another basis of payment equal to 100% of Medicare fee-for-service costs and changes the 2% minimum update to include the greater of 2% or the MedicareAdvantage growth rate.

 

The legislation establishes a new Medicare private health plan program, called MedicareAdvantage, to offer regional PPO options beginning in 2006 and a continuance of HMO, Point-of-Service, PPO (those established prior to December 31, 2005), and Private-Fee-for-Service options in defined, local service areas.

 

The legislation also includes a provision establishing HSA’s, tax-advantaged savings accounts that can be used to pay for medical expenses incurred by individuals, their spouse, and their dependents.

 

The Health Insurance Portability and Accountability Act of 1996, or HIPAA, includes administrative provisions directed at simplifying electronic data interchange through standardizing transactions, establishing uniform health care provider, payer, and employer identifiers and seeking protections for confidentiality and security of patient data. Under the new HIPAA standard transactions and code sets rules, we have made significant systems enhancements and invested in new technological solutions. The compliance and enforcement date for standard transactions and code sets rules was October 16, 2003. We have continued to be in compliance with this regulation. However, as many providers indicated that they could not yet comply, CMS stated that covered entities making a good faith effort to comply with HIPAA transactions and code-set standards would be allowed to implement contingency plans to maintain their operations and cash flows. On October 15, 2003, we announced implementation of a contingency plan to accept non-compliant electronic transactions from our providers. We will continue to accept and process transactions sent in pre-HIPAA electronic formats from providers who are showing a good-faith effort until all providers and clearinghouses are capable of transmitting fully compliant standards transactions as defined in the HIPAA implementation guidelines or until CMS begins enforcement of the HIPAA Electronic Data Interchange regulations. We believe that the implementation of our contingency plans has minimized any disruptions in our business operations during this transition. However, if entities with which we do business do not ultimately comply with the HIPAA transactions and code set standards, it could result in disruptions of certain of our business operations.

 

In addition, Congress is evaluating proposals to include establishing additional protections for personal health information, tax credits for the uninsured, proposals to reduce the number of medical errors by health care providers and systems of care, and various state and federal purchasing plans to allow individuals and small employers to purchase health insurance. Many of these proposals may require additional administrative costs to ensure compliance and we are currently assessing their cost and impact on premiums for the future.

 

State

 

We continue to encounter regulation on health care claims payment practices at the state level. This legislation and possible future regulation and oversight could expose us to additional liability and penalties. Supplemental legislation includes, among other provisions, claims submission content and electronic submission.

 

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Table of Contents

We view electronic submission as a favorable development that will simplify claims interactions. A few states are considering proposals that place new limits on insurer contacts with hospitals and physicians. These proposals include provisions to expand payment disclosure, limit implementation of claims payment procedures, and extend an insurer payment liability where intermediaries fail to pay and restrict recoupment.

 

Some states are proposing the creation of small employer pooled purchasing arrangements. Although these pooled purchasing arrangements may affect the small group market, most of the proposals require these purchasing arrangements to comply with the standard small group market regulations. Similar arrangements enacted in the early 1990s had a very limited affect on the small group insurance market. A limited number of states are considering additional restrictions on the use of health status in small group rating. Mandate-free benefit plans are pending in a number of states. Some of these proposals could allow insurers more flexibility in the use of member cost sharing. There is activity in some states supporting an expansion of disclosure by hospitals, physicians and other health care providers of quality and charge data either directly to patients or to state agencies that must make it publicly available.

 

Medical malpractice reform is receiving significant attention. Pending medical malpractice reform proposals differ substantially relative to the entities covered by the reforms. Since the substance of the reforms remains under discussion and the scope of covered entities has not been resolved in most states, management is unable to predict future activity under these laws.

 

We are unable to predict how existing federal or state laws and regulations may be changed or interpreted, what additional laws or regulations affecting our businesses may be enacted or proposed, when and which of the proposed laws will be adopted or what effect any such new laws and regulations will have on our financial position, results of operations or cash flows.

 

Other

 

Captive Insurance Company

 

We bear general business risks associated with operating our Company such as professional and general liability, employee workers’ compensation, and officer and director errors and omissions risks. Professional and general liability risks may include, for example, medical malpractice claims and disputes with members regarding benefit coverage. We retain these risks through our wholly-owned, consolidated insurance subsidiary. We reduce exposure to our own general business risks by insuring levels of coverage for losses in excess of our retained limits with a number of third party insurance companies. We remain liable in the event these insurance companies are unable to pay their portion of the losses. In an effort to minimize credit risk, we insure our risks with a number of insurance companies having a long history of strong financial ratings. On January 1, 2002, and again on January 1, 2003, we reduced the amount of coverage purchased from third party insurance carriers and increased the amount of risk we retain due to substantially higher insurance rates. We provide a detail of the significant assets and liabilities related to our captive insurance subsidiary in Note 9 to the consolidated financial statements.

 

Centralized Management Services

 

We provide centralized management services to each health plan from our headquarters and service centers. These services include management information systems, product administration, financing, personnel, development, accounting, legal advice, public relations, marketing, insurance, purchasing, risk management, actuarial, underwriting, and claims processing.

 

Employees

 

As of December 31, 2003, we had approximately 13,700 employees. We have not experienced any work stoppages and believe we have good relations with our employees.

 

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Table of Contents
ITEM 2. PROPERTIES

 

We own our principal executive office, which is located in the Humana Building, 500 West Main Street, Louisville, Kentucky 40202. In addition, as of December 31, 2003, we own buildings in Louisville, Kentucky, and Green Bay, Wisconsin, and lease facilities in Cincinnati, Ohio and Puerto Rico, all of which are used for customer service, enrollment, and claims processing. During 2003, we completed the consolidation of the San Antonio, Texas, Jacksonville, Florida, and Madison, Wisconsin customer service center operations into the remaining four locations. Some of these former service center buildings have been sold or are in the process of being sold. Our Louisville and Green Bay facilities also house other corporate functions.

 

We also own or lease administrative market offices and medical centers. We no longer operate most of these medical centers but, rather, lease them to their provider operators. The following table lists the location of properties we owned or leased at December 31, 2003:

 

    

Medical

Centers


   Administrative
Offices


    
     Owned

   Leased

   Owned

   Leased

   Total

Florida

   2    39    7    50    98

Kentucky

   4    1    11    9    25

Illinois

   7    2       11    20

Texas

         4    14    18

Georgia

            14    14

Ohio

            13    13

North Carolina

            12    12

Puerto Rico

            10    10

Wisconsin

         1    8    9

Missouri/Kansas

   3    2       3    8

Virginia

            8    8

Others

   1       1    40    42
    
  
  
  
  

Total

         17            44          24    192    277
    
  
  
  
  

 

ITEM 3. LEGAL PROCEEDINGS

 

Securities Litigation

 

In late 1997, three purported class action complaints were filed in the United States District Court for the Southern District of Florida by former stockholders of Physician Corporation of America, or PCA, against PCA and certain of its former directors and officers. We acquired PCA by a merger that became effective on September 8, 1997. The three actions were consolidated into a single action entitled In re Physician Corporation of America Securities Litigation. The consolidated complaint alleged that PCA and the individual defendants knowingly or recklessly made false and misleading statements in press releases and public filings with respect to the financial and regulatory difficulties of PCA’s workers’ compensation business. The Court certified a class on May 20, 2003. On August 25, 2003, the parties entered into an agreement to settle the case for the amount of $10.2 million. On November 26, 2003, the settlement received final approval by the Court. A provision for the settlement was previously made in our financial statements during the fourth quarter of 2002. The Company had pursued insurance coverage for this matter from two insurers and has settled the matter with one of the insurers who will pursue coverage against the other insurer.

 

Managed Care Industry Purported Class Action Litigation

 

We have been involved in several purported class action lawsuits that are part of a wave of generally similar actions that target the health care payer industry and particularly target managed care companies. These include a lawsuit against us and nine of our competitors that purports to be brought on behalf of physicians who have

 

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treated our members. As a result of action by the Judicial Panel on Multidistrict Litigation (“JPML”), the case was consolidated in the United States District Court for the Southern District of Florida, and has been styled In re Managed Care Litigation.

 

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.

 

On September 26, 2002, the Court granted the plaintiffs’ request to file a second amended complaint, adding additional plaintiffs, including the Florida Medical Association, which purports to bring its action against all defendants. On October 21, 2002, the defendants moved to dismiss the second amended complaint. On December 8, 2003, the Court denied the motion.

 

Also on September 26, 2002, the Court certified a global class consisting of all medical doctors who provided services to any person insured by any defendant from August 4, 1990, to September 26, 2002. The class 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 10, 2002, the defendants asked the Court of Appeals for the Eleventh Circuit to review the class certification decision. On November 20, 2002, the Court of Appeals agreed to review the class issue. The appellate court heard oral argument on September 11, 2003, but no ruling has been issued. Discovery is ongoing, and the Court has set a trial date of September 13, 2004. Also, on January 15, 2004, the Court filed a notice with the JPML that will permit the JPML to decide whether the case should remain in Miami, Florida for trial or be separately remanded for trial to the courts in which the actions were filed prior to their transfer to and consolidation in Miami, Florida. In the case of the Company, that would be the United States District Court for the Western District of Kentucky. In the meantime, two of the defendants, Aetna Inc. and Cigna Corporation, have entered into settlement agreements which have been approved by the Court.

 

We intend to continue to defend this action vigorously.

 

Other

 

The Academy of Medicine of Cincinnati, the Butler County Medical Society, the Northern Kentucky Medical Society, and several physicians filed antitrust suits in state courts in Ohio and Kentucky against Aetna Health, Inc., Humana Health Plan of Ohio, Inc., Anthem Blue Cross Blue Shield, and United Healthcare of Ohio, Inc., alleging that the defendants violated the Ohio and Kentucky antitrust laws by conspiring to fix the reimbursement rates paid to physicians in the Greater Cincinnati and Northern Kentucky region. Each suit sought class certification, damages and injunctive relief. Plaintiffs cited no evidence that any such conspiracy existed,

 

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but based their allegations on assertions that physicians in the Greater Cincinnati region are paid less than physicians in other major cities in Ohio and Kentucky.

 

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.

 

Government Audits and Other Litigation and Proceedings

 

In July 2000, the Office of the Florida Attorney General initiated an investigation, apparently relating to some of the same matters that are involved in the managed care industry purported class action litigation described above. On September 21, 2001, the Texas Attorney General initiated a similar investigation. No actions have been filed against us by either state. These investigations are ongoing, and we have cooperated with the regulators in both states.

 

On May 31, 2000, we entered into a five-year Corporate Integrity Agreement, or CIA, with the Office of Inspector General, or OIG, of the Department of Health and Human Services. Under the CIA, we are obligated to, among other things, provide training, conduct periodic audits and make periodic reports to the OIG.

 

In addition, our business practices are subject to review by various state insurance and health care regulatory authorities and federal regulatory authorities. There has been increased scrutiny by these regulators of the managed health care companies’ business practices, including claims payment practices and utilization management practices. We have been and continue to be subject to such reviews. Some of these have resulted in fines and could require changes in some of our practices and could also result in additional fines or other sanctions.

 

We also are involved in other lawsuits that arise in the ordinary course of our business operations, including claims of medical malpractice, bad faith, nonacceptance or termination of providers, failure to disclose network discounts, and various other provider arrangements, as well as challenges to subrogation practices. We also are subject to claims relating to performance of contractual obligations to providers, members, and others, including failure to properly pay claims and challenges to the use of certain software products in processing claims. Pending state and federal legislative activity may increase our exposure for any of these types of claims.

 

In addition, several courts, including several federal appellate courts, recently have issued decisions which have the effect of eroding the scope of ERISA preemption for employer-sponsored health plans, thereby exposing us to greater liability for medical negligence claims. This includes decisions which hold that plans may be liable for medical negligence claims in some situations based solely on medical necessity decisions made in the course of adjudicating claims. In addition, some courts have issued rulings which make it easier to hold plans liable for medical negligence on the part of network providers on the theory that providers are agents of the plans and that the plans are therefore vicariously liable for the injuries to members by providers.

 

Personal injury claims and claims for extracontractual damages arising from medical benefit denials are covered by insurance from our wholly owned captive insurance subsidiary and excess carriers, except to the extent that claimants seek punitive damages, which may not be covered by insurance in certain states in which insurance coverage for punitive damages is not permitted. In addition, insurance coverage for all or certain forms of liability has become increasingly costly and may become unavailable or prohibitively expensive in the future. On January 1, 2002 and again on January 1, 2003, we reduced the amount of coverage purchased from third party insurance carriers and increased the amount of risk we retain due to substantially higher insurance rates.

 

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We do not believe that any pending or threatened legal actions against us or any pending or threatened audits or investigations by state or federal regulatory agencies will have a material adverse effect on our financial position, results of operations, or cash flows. However, the likelihood or outcome of current or future suits, like the purported class action lawsuits described above, or governmental investigations, cannot be accurately predicted with certainty. In addition, the potential for increased liability for medical negligence arising from claims adjudication, along with the increased litigation that has accompanied the negative publicity and public perception of our industry, adds to this uncertainty. Therefore, such legal actions and government audits and investigations could have a material adverse effect on our financial position, results of operations, and cash flows.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

 

a) Market Information

 

Our common stock trades on the New York Stock Exchange under the symbol HUM. The following table shows the range of high and low closing sales prices as reported on the New York Stock Exchange Composite Tape for each quarter in the years ended December 31, 2003 and 2002:

 

     High

   Low

Year Ended December 31, 2003

             

First quarter

   $ 10.71    $ 8.68

Second quarter

   $ 16.00    $ 9.09

Third quarter

   $ 18.50    $ 15.30

Fourth quarter

   $ 23.29    $ 18.42

Year Ended December 31, 2002

             

First quarter

   $ 13.60    $ 11.46

Second quarter

   $ 17.09    $ 13.57

Third quarter

   $ 15.04    $ 11.35

Fourth quarter

   $ 14.15    $ 9.87

 

b) Holders of our Capital Stock

 

As of March 1, 2004, there were approximately 6,300 holders of record of our common stock.

 

c) Dividends

 

Since February 1993, we have not declared or paid any cash dividends on our common stock. We do not presently intend to pay dividends, and we plan to retain our earnings for future operations and growth of our businesses.

 

d) Equity Compensation Plan

 

The information required by this part of Item 5 is incorporated herein by reference from our Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on April 22, 2004 appearing under the caption “Equity Compensation Plan Information” of such Proxy Statement.

 

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ITEM 6. SELECTED FINANCIAL DATA

 

     2003(a)

    2002(b)(c)

    2001

    2000

    1999(d)

 
     (in thousands, except per share results, membership and ratios)  

Summary of Operations

                                        

Revenues:

                                        

Premiums

   $ 11,825,283     $ 10,930,397     $ 9,938,961     $ 10,394,631     $ 9,958,582  

Administrative services fees

     271,676       244,396       137,090       86,298       97,940  

Investment and other income

     129,352       86,388       118,835       115,021       155,013  
    


 


 


 


 


Total revenues

     12,226,311       11,261,181       10,194,886       10,595,950       10,211,535  
    


 


 


 


 


Operating expenses:

                                        

Medical

     9,879,421       9,138,196       8,279,844       8,781,998       8,533,090  

Selling, general and administrative

     1,858,028       1,775,069       1,545,129       1,524,799       1,466,181  

Depreciation and amortization

     126,779       120,730       161,531       146,548       123,858  

Goodwill impairment and other expenses

     —         —         —         —         459,852  
    


 


 


 


 


Total operating expenses

     11,864,228       11,033,995       9,986,504       10,453,345       10,582,981  
    


 


 


 


 


Income (loss) from operations

     362,083       227,186       208,382       142,605       (371,446 )

Interest expense

     17,367       17,252       25,302       28,615       33,393  
    


 


 


 


 


Income (loss) before income taxes

     344,716       209,934       183,080       113,990       (404,839 )

Provision (benefit) for income taxes

     115,782       67,179       65,909       23,938       (22,419 )
    


 


 


 


 


Net income (loss)

   $ 228,934     $ 142,755     $ 117,171     $ 90,052     $ (382,420 )
    


 


 


 


 


Basic earnings (loss) per common share

   $ 1.44     $ 0.87     $ 0.71     $ 0.54     $ (2.28 )
    


 


 


 


 


Diluted earnings (loss) per common share

   $ 1.41     $ 0.85     $ 0.70     $ 0.54     $ (2.28 )
    


 


 


 


 


Financial Position

                                        

Cash and investments

   $ 2,927,213     $ 2,415,914     $ 2,327,139     $ 2,312,399     $ 2,785,702  

Total assets

     5,293,323       4,879,937       4,681,693       4,597,533       4,951,578  

Medical and other expenses payable

     1,272,156       1,142,131       1,086,386       1,181,027       1,756,227  

Debt

     642,638       604,913       578,489       599,952       686,213  

Stockholders’ equity

     1,835,949       1,606,474       1,507,949       1,360,421       1,268,009  

Key Financial Indicators

                                        

Medical expense ratio

     83.5 %     83.6 %     83.3 %     84.5 %     85.7 %

SG&A expense ratio

     15.4 %     15.9 %     15.3 %     14.5 %     14.6 %

Medical Membership by Segment

                                        

Commercial:

                                        

Fully insured

     2,352,800       2,340,300       2,301,300       2,545,800       3,083,600  

Administrative services only

     712,400       652,200       592,500       612,800       648,000  

Medicare supplement

     —         —         —         —         44,500  
    


 


 


 


 


Total Commercial

     3,065,200       2,992,500       2,893,800       3,158,600       3,776,100  
    


 


 


 


 


Government:

                                        

Medicare+Choice

     328,600       344,100       393,900       494,200       488,500  

Medicaid

     468,900       506,000       490,800       575,600       616,600  

TRICARE

     1,849,700       1,755,800       1,714,600       1,070,300       1,058,000  

TRICARE ASO

     1,057,200       1,048,700       942,700       —         —    
    


 


 


 


 


Total Government

     3,704,400       3,654,600       3,542,000       2,140,100       2,163,100  
    


 


 


 


 


Total Medical Membership

     6,769,600       6,647,100       6,435,800       5,298,700       5,939,200  
    


 


 


 


 


Commercial Specialty Membership

                                        

Dental

     1,147,400       1,094,600       1,123,300       1,148,100       1,146,000  

Other

     520,700       545,400       571,300       678,900       1,333,100  
    


 


 


 


 


Total specialty membership

     1,668,100       1,640,000       1,694,600       1,827,000       2,479,100  
    


 


 


 


 



(a) Includes expenses of $30.8 million pretax ($18.8 million after tax, or $0.12 per diluted share) for the writedown of building and equipment and software abandonment expenses. These expenses were partially offset by a gain of $15.2 million pretax ($10.1 million after tax, or $0.06 per diluted share) for the sale of a venture capital investment. The net impact of these items reduced pretax income by $15.6 million ($8.7 million after tax, or $0.05 per diluted share).
(b) Includes expenses of $85.6 million pretax ($58.2 million after tax, or $0.35 per diluted share) for severance and facility costs related to reducing our administrative cost structure with the elimination of three customer service centers and an enterprise-wide workforce reduction, reserves for liabilities related to a previous acquisition and the impairment in the fair value of certain private debt and equity investments.
(c) As described in Note 2 to our consolidated financial statements included herein, we adopted Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets, as of January 1, 2002. We ceased amortizing goodwill upon adopting Statement 142 on January 1, 2002. Note 5 identifies goodwill amortized in 2001 and the estimated impact on our reported net income and earnings per common share had amortization been excluded from 2001 results.
(d) Includes expenses of $584.8 million pretax ($499.3 million after tax, or $2.97 per diluted share) primarily related to goodwill impairment, losses on non-core asset sales, professional liability reserve strengthening, premium deficiency and medical reserve strengthening.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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.

 

Overview

 

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.

 

We manage our business with two segments: Commercial and Government. The Commercial segment consists of members enrolled in products marketed to employer groups and individuals, and includes three lines of business: fully insured medical, administrative services only, or ASO, and specialty. The Government segment consists of members enrolled in government-sponsored programs, and includes three lines of business: Medicare+Choice, Medicaid, and TRICARE. Our Government segment has produced consistent profits and relatively stable margins for many years. Our business strategy largely revolves around increasing our Commercial segment profitability while building on our existing strength in the Government segment.

 

Our strategy to increase Commercial segment profitability focuses on providing solutions for employers to the rising cost of health care through the use of innovative and consumer-choice product designs which are supported by service excellence and industry-leading electronic capabilities, including education, tools and technologies provided primarily through the Internet. To that end, we have developed an innovative suite of products styled as “Smart” products. We believe that these Smart products offer the best solution for many employers to the problem of fast rising health care costs for their employees. Although enrollment in our Smart products is a relatively modest 130,000 members at December 31, 2003, we believe that substantial growth in these products, which may be competitively priced to produce higher margins, is the key for our continuing improvement in the Commercial segment. January 2004 sales were approximately 70,000 in our Smart products.

 

Other important elements which impact our Commercial segment profitability are the competitive pricing environment and market conditions. With respect to pricing, there is the balancing act between sustaining or

 

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increasing underwriting margins versus achieving enrollment growth. With respect to market conditions, there is the impact of economies of scale on administrative overhead. As a result of the decline in popularity of tightly managed HMOs and intensive utilization review procedures, medical costs become increasingly comparable among the larger competitors, with product design and consumer involvement then becoming the more important drivers of medical services consumption. As a result, administrative expense efficiency is becoming a primary driver of commercial margin sustainability. In line with that philosophy, we continue to reduce our administrative expense structure, realize administrative expense savings through technology tools, and look at acquisition opportunities that align with our geographic presence and Commercial strategy.

 

In December 2003, we announced that we had reached a definitive agreement with the Ochsner Clinic Foundation of New Orleans, Louisiana to acquire Ochsner Health Plan. We believe that this acquisition will enhance our presence in the Southern United States, an area growing in population and commercial activity. In addition to creating a new Humana market in New Orleans, the Ochsner Health Plan acquisition is expected to facilitate sales opportunities in our existing Houston market and is anticipated to make us more attractive to national accounts.

 

In our Government segment, there were two significant developments in 2003. First, in August 2003, our subsidiary, Humana Military Healthcare Services, or HMHS, was awarded the Department of Defense’s TRICARE contract to support healthcare delivery to active duty and retired service members and their families in the South Region beginning in 2004. The South Region is one of the three regions in the United States as defined by the Department of Defense’s new contract alignment. Under the terms of the award, HMHS will be the Managed Care Support Contractor serving approximately 2.8 million TRICARE beneficiaries in Tennessee, South Carolina, Georgia, Alabama, Mississippi, Florida, Arkansas, Louisiana, Oklahoma and Texas. Most importantly, procurement of the South Region contract positions us to continue our TRICARE operating margins consistent with the levels we have enjoyed since beginning the TRICARE program in July 1996.

 

Second, in December 2003 President Bush signed Medicare modernization legislation that provides stabilization funding for the Medicare+Choice program and may provide longer-term opportunities for Humana, including the potential to (1), expand the Company’s current Medicare+Choice market presence, (2), become a MedicareAdvantage Regional PPO, (3), add an Interim Drug Discount Card, and (4), become a Prescription Drug Standalone Plan. We are evaluating these potential opportunities and anticipate completing our analysis during 2004. We believe the new Medicare legislation demonstrates the federal government’s financial commitment to the private payor program and the commitment to providing health benefits and options to seniors, which should translate to stable, if not increasing, participation from Humana in this sector.

 

During 2003, our revenue increased by almost $1 billion to $12.2 billion versus $11.3 billion the previous year. 80% of the revenue increase was derived from our Commercial segment, primarily a result of underwriting our premiums commensurate with underlying medical cost inflation. The leveraging of this increase in underwriting dollars in excess of administrative and overhead expenses was the primary driver of the increase in our commercial and consolidated pretax profits. During the second quarter of 2003, we completed a transition from seven service centers to four, which has resulted in continuing administrative efficiencies.

 

Cash flows from operations generated $413.1 million during 2003, $44.1 million of which was used to purchase 3.7 million shares of our common stock at an average price of $12.03 per share. We invested $101.3 million on capital expenditures during 2003.

 

We intend for the discussion of our financial condition and results of operations that follows to assist in the understanding of our financial statements and related changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain critical accounting principles and estimates impact our financial statements.

 

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Pending Acquisition

 

In December 2003, we reached a definitive agreement to purchase Ochsner Health Plan from Ochsner Clinic Foundation having approximately 152,000 Commercial medical members, primarily in fully insured large group accounts, and approximately 36,000 members in the Medicare+Choice program. This transaction, which is subject to state regulatory approval, is expected to close in the second quarter of 2004.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements and accompanying notes, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements and accompanying notes requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We continuously evaluate our estimates and those critical accounting policies related primarily to medical cost and revenue recognition as well as accounting for impairments related to our investment securities, goodwill, and long-lived assets. These estimates are based on knowledge of current events and anticipated future events, and accordingly, actual results ultimately may differ from those estimates. We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements.

 

Medical Expense Recognition

 

Medical expenses are recognized in the period in which services are provided and include an estimate of the cost of services which have been incurred but not yet reported, or IBNR. IBNR represents a substantial portion of our medical and other expenses payable as follows:

 

     December 31,
2003


   Percentage of
Total


    December 31,
2002


   Percentage of
Total


 
     (dollars in thousands)  

IBNR

   $ 1,034,858                81.3 %   $ 863,432                75.6 %

Reported claims in process

     183,962    14.5 %     197,722    17.3 %

Pharmacy and other medical expenses payable

     53,336    4.2 %     80,977    7.1 %
    

  

 

  

Total medical and other expenses payable

   $ 1,272,156    100.0 %   $ 1,142,131    100.0 %
    

  

 

  

 

Estimating IBNR is complex, involves a significant amount of judgment and represents a material portion of our medical and other expenses payable. Accordingly, it represents a critical accounting estimate. Changes in this estimate can materially affect, either favorably or unfavorably, our results from operations and overall financial position. For example, a 100 basis point, or 1 percent, change in the estimate of our medical and other expenses payable at December 31, 2003, which represents approximately 40% of total liabilities, would require an adjustment of approximately $13 million in a future period in which a revision in the estimate became known.

 

We develop our estimate for IBNR using actuarial methodologies and assumptions, primarily based upon historical claim payment and claim receipt patterns, as well as historical medical cost trends. Depending on the period for which incurred claims are estimated, we apply a different method in determining our estimate. For periods prior to the most recent three months, the key assumption used in estimating our IBNR is that the completion factor pattern remains consistent over a rolling 12-month period after adjusting for known changes in claim inventory levels or known changes in claim payment processes. The completion factor is a calculation of the percentage of claims incurred during a given period that have historically been adjudicated as of the reporting period. For the most recent three months, the incurred claims are estimated primarily from a trend analysis based upon per member per month claims trends developed from our historical experience in the preceding months, adjusted for known changes in estimates of recent hospital and drug utilization data, provider contracting changes, changes in benefit levels, product mix, and weekday seasonality.

 

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The completion factor method is used for the months of incurred claims prior to the most recent three months because the historical percentage of claims processed for those months is at a level sufficient to produce a consistently reliable result. Conversely, for the most recent three months of incurred claims, the volume of claims processed historically is not at a level sufficient to produce a reliable result, which therefore requires us to examine historical trend patterns as the primary method of evaluation.

 

Medical cost trends potentially are more volatile than other segments of the economy. The drivers of medical cost trends include increases in the utilization of hospital and physician services, prescription drugs, and new medical technologies, as well as the inflationary effect on the cost per unit of each of these expense components. Other external factors such as government-mandated benefits or other regulatory changes, catastrophes, and epidemics also may impact medical cost trends. Additionally, as we realign our commercial strategy, we continue to reduce the level of traditional utilization management functions such as pre-authorization of services, monitoring of inpatient admissions, and requirements for physician referrals. Other internal factors such as system conversions and claims processing interruptions also may impact our ability to accurately predict estimates of historical completion factors or medical cost trends. All of these factors are considered in estimating IBNR and in estimating the per member per month claims trend for purposes of determining the reserve for the most recent three months. Each of these factors requires significant judgment by management.

 

The completion and claims per member per month trend factors are the most significant factors impacting the IBNR estimate. The following table illustrates the sensitivity of these factors and the estimated potential impact on our operating results caused by changes in these factors based on December 31, 2003 data:

 

Completion Factor (a):


    Claims Trend Factor (b):

 

(Decrease)
Increase
in Factor


   Increase
(Decrease) in
Medical and
Other Expenses
Payable


    (Decrease)
Increase
in Factor


    Increase
(Decrease) in
Medical and
Other Expenses
Payable


 
(dollars in thousands)  

(3%)

   $ 136,000     (3 %)   $ (59,000 )

(2%)

   $ 88,000     (2 %)   $ (41,000 )

(1%)

   $ 43,000     (1 %)   $ (22,000 )

1%

   $ (40,000 )   1 %   $ 14,000  

2%

   $ (79,000 )   2 %   $ 33,000  

3%

   $ (116,000 )   3 %   $ 51,000  

(a) Reflects estimated potential changes in medical and other expenses payable caused by changes in completion factors for incurred months prior to the most recent three months.
(b) Reflects estimated potential changes in medical and other expenses payable caused by changes in annualized claims trend used for the estimation of per member per month incurred claims for the most recent three months.

 

Most medical claims are paid within a few months of the member receiving service from a physician or other health care provider. As a result, these liabilities generally are described as having a “short-tail”, which causes less than 2% of our medical and other expenses payable as of the end of any given period to be outstanding for more than 12 months. As such, we expect that substantially all of the 2003 estimate of medical and other expenses payable will be known and paid during 2004.

 

Our reserving practice is to consistently recognize the actuarial best point estimate within a level of confidence required by actuarial standards. Actuarial standards of practice generally require a level of confidence such that the liabilities established for IBNR have a greater probability of being adequate versus being insufficient, or such that the liabilities established for IBNR are sufficient to cover obligations under an assumption of moderately adverse conditions. Adverse conditions are situations in which the actual claims are

 

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expected to be higher than the otherwise estimated value of such claims at the time of the estimate. Therefore, in many situations, the claim amounts ultimately settled will be less than the estimate that satisfies the actuarial standards of practice.

 

IBNR established in connection with our TRICARE contracts is typically more difficult to estimate than with our other operations, as a result of having more variables which impact the estimate. Such variables include continual changes in the number of eligible beneficiaries, changes in the utilization of military treatment facilities and changes in levels of benefits versus the original contract provisions. Many of these variables are impacted significantly by an increase or decrease in military activity involving the United States armed forces.

 

Our TRICARE contracts contain risk-sharing provisions with the Department of Defense and with subcontractors, which effectively limit profits and losses when actual claim experience varies from the medical claim amounts included in our annual bids. Additionally, other factors impacting medical claims expenses such as changes in the number of eligible beneficiaries and changes in the level of usage of military treatment facilities result in equitable revenue adjustments through the change order and bid price adjustment process. As a result of the above contract provisions, the impact of changes in estimates for prior year TRICARE medical claims payable on our results of operations is reduced substantially, whether positive or negative.

 

The following table provides a reconciliation of changes in medical and other expenses payable for the years ended December 31, 2003, 2002 and 2001:

 

     2003

    2002

    2001

 
     (in thousands)  

Balances at January 1

   $ 1,142,131     $ 1,086,386     $ 1,181,027  

Acquisitions

     —         —         85,052  

Incurred related to:

                        

Current year

     9,955,491       9,125,915       8,303,256  

Prior years

     (76,070 )     12,281       (23,412 )
    


 


 


Total incurred

     9,879,421       9,138,196       8,279,844  
    


 


 


Paid related to:

                        

Current year

     (8,710,393 )     (8,002,610 )     (7,291,541 )

Prior years

     (1,039,003 )     (1,079,841 )     (1,167,996 )
    


 


 


Total paid

     (9,749,396 )     (9,082,451 )     (8,459,537 )
    


 


 


Balances at December 31

   $ 1,272,156     $ 1,142,131     $ 1,086,386  
    


 


 


 

Amounts incurred related to prior years vary from previously estimated liabilities as the claims are ultimately settled. Negative amounts reported for incurred related to prior years result from claims being ultimately settled for amounts less than originally estimated (favorable development). Positive amounts reported for incurred related to prior years result from claims ultimately being settled for amounts greater than originally estimated (unfavorable development).

 

As summarized in the previous table, claim reserve balances at December 31, 2000 ultimately settled during 2001 for $23.4 million less than the amounts originally estimated, representing 0.3% of medical claim expenses recorded in 2000. During 2002, claim reserve balances at December 31, 2001 ultimately settled for $12.3 million more than the amounts originally estimated, representing 0.1% of medical claim expenses recorded in 2001. This $35.7 million increase in the amounts incurred related to prior years was substantially all attributable to our TRICARE operations and resulted primarily from enhanced benefits enacted for TRICARE beneficiaries as a result of Congressional legislation, the impact of which was not fully determinable at December 31, 2001. As these additional medical expenses were recognized during 2002, we also recognized and received commensurate revenues from the Department of Defense as a result of change orders and bid price adjustments, or BPAs.

 

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During 2003, claim reserve balances at December 31, 2002 ultimately settled for $76.1 million less than the amounts originally recorded, representing 0.8% of medical claim expenses recorded in 2002. This $88.4 million decline in the amounts incurred related to prior years consists of $68.3 million attributable to our TRICARE operations with the remaining $20.1 million primarily resulting from fourth quarter 2002 utilization in our commercial medical products ultimately being lower than originally estimated. The $68.3 million increase in TRICARE incurred related to prior years resulted from establishing the reserves resulting from the enhanced benefits for TRICARE beneficiaries as discussed above as well as lower than originally estimated utilization of medical services by TRICARE beneficiaries in the second half of 2002.

 

Revenue Recognition

 

We generally establish one-year contracts with commercial employer groups, subject to cancellation by the employer group’s 30-day written notice. Our contracts with federal or state governments are generally multi-year contracts subject to annual renewal provisions with the exception of our Medicare+Choice contracts with the federal government which renew annually. Our commercial contracts establish rates on a per member basis for each month of coverage. Except for TRICARE contracts discussed in the following section, our government contracts also establish monthly rates per member but may have additional amounts due to us based on items such as age, working status, or specific health issues of the member.

 

Premium revenues and ASO fees are estimated by multiplying the membership covered under the various contracts by the contractual rates. In addition, we adjust revenues for, estimated changes in an employer’s enrollment and customers that ultimately may fail to pay. Enrollment changes not yet reported by an employer group, an individual, or the government, also known as retroactive membership adjustments, are based on historical trends. We monitor the collectibility of specific accounts, the aging of receivables, as well as prevailing and anticipated economic conditions, and reflect any required adjustments in the current period’s revenue.

 

We bill and collect premium and ASO fee remittances from employer groups, the federal and state governments, and individual Medicare+Choice members monthly. Premium and ASO fee receivables are presented net of allowances for estimated uncollectible accounts and retroactive membership adjustments. Premiums and ASO fees received prior to the period members are entitled to receive services are recorded as unearned revenues.

 

TRICARE Revenues

 

Base premium revenues as originally specified in our TRICARE contracts are recognized ratably throughout each contract year as eligible beneficiaries are entitled to receive services. TRICARE revenues also include amounts recoverable from the federal government as a result of BPAs and change orders.

 

Under our TRICARE contracts, we retain the financial risk of contractual discounts in the provider networks, same-store utilization of services, and administrative overhead. However, the federal government retains the financial risk associated with changes in usage levels at military treatment facilities, or MTFs, changes in the number of persons eligible for TRICARE benefits, and medical unit cost inflation. BPAs are utilized to retroactively adjust premium revenues for the impact of the items for which the federal government retains risk. We work closely with the federal government to obtain and review eligibility and MTF workload data, and to quantify and negotiate amounts recoverable or payable under our contractual BPA requirements. We record revenues applicable to BPAs when these amounts are determinable and the collectibility is reasonably assured. Because final settlement of BPAs occurs only at specified intervals, typically in excess of 6 months after the end of a contract year for our largest regions, cumulative amounts receivable or payable under BPAs may be outstanding in excess of a year. Amounts receivable or payable within a year are classified as premiums receivable or trade accounts payable and accrued expenses, respectively, in our consolidated balance sheets. Amounts receivable or payable for longer than one year are classified as other long-term assets or other long-term liabilities, respectively. The increase in activity and deployments surrounding military conflicts in the Middle East has significantly impacted BPA activity in recent years.

 

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TRICARE change orders occur when we perform services or incur costs under the directive of the federal government that were not originally specified in our contracts. Under federal regulations we are entitled to an equitable adjustment to the contract price, which results in additional premium revenues. Examples of items that have necessitated substantial change orders in recent years include congressionally legislated increases in the level of benefits for TRICARE beneficiaries and the administration of new government programs such as TRICARE for Life and TRICARE Senior Pharmacy. Like BPAs, we record revenue applicable to change orders when these amounts are determinable and the collectibility is reasonably assured. Unlike BPAs, where settlement only occurs at specified intervals, change orders may be negotiated and settled at any time throughout the year.

 

Total TRICARE premium and ASO fee receivables were as follows at December 31, 2003 and 2002:

 

     2003

    2002

 
     (in thousands)  

TRICARE premiums receivable:

                

Base receivable

   $ 254,688     $ 190,339  

Bid price adjustments (BPAs)

     92,875       104,044  

Change orders

     7,073       1,400  
    


 


Subtotal

     354,636       295,783  

Less: long-term portion of BPAs

     (38,794 )     (86,471 )
    


 


Total TRICARE premiums receivable

   $ 315,842     $ 209,312  
    


 


TRICARE ASO fees receivable:

                

Base receivable

   $ —       $ 7,205  

Change orders

     11,968       56,230  
    


 


Total TRICARE ASO fees receivable

   $ 11,968     $ 63,435  
    


 


 

Our TRICARE contracts also contain risk-sharing provisions with the federal government to minimize any losses and limit any profits in the event that medical costs for which we are at risk differ from the levels targeted in our contracts. Amounts receivable from the federal government under such risk-sharing provisions are included in the BPA receivable above, while amounts payable to the federal government under these provisions of approximately $17.3 million at December 31, 2003 are included in medical and other expenses payable in our consolidated balance sheets.

 

Investment Securities

 

Investment securities totaled $1,995.8 million, or 38% of total assets at December 31, 2003. Debt securities totaled $1,960.6 million, or 98% of our total investment portfolio. More than 94% of our debt securities were of investment-grade quality, with an average credit rating of AA by Standard & Poor’s at December 31, 2003. Most of the debt securities that are below investment grade are rated at the higher end (B or better) of the non-investment grade spectrum. Our investment policy limits investments in a single issuer and requires diversification among various asset types.

 

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.

 

Our investment securities are 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 vendor. Fair value of venture capital debt securities that are privately

 

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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. 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.

 

Gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2003, included the following:

 

     Less than 12 months

    12 months or more

    Total

 
    

Fair

Value


   Unrealized
Losses


   

Fair

Value


   Unrealized
Losses


   

Fair

Value


   Unrealized
Losses


 
     (in thousands)  

U.S. Government obligations

   $ 251,218    $ (2,125 )   $ —      $ —       $ 251,218    $ (2,125 )

Tax exempt municipal securities

     90,705      (1,566 )     21,979      (494 )     112,684      (2,060 )

Corporate and other securities

     121,184      (3,674 )     714      (4 )     121,898      (3,678 )

Mortgage-backed securities

     47,060      (1,295 )     —        —         47,060      (1,295 )

Redeemable preferred stocks

     —        —         21,348      (734 )     21,348      (734 )
    

  


 

  


 

  


Debt securities

     510,167      (8,660 )     44,041      (1,232 )     554,208      (9,892 )

Equity securities

     —        —         7,162      (285 )     7,162      (285 )
    

  


 

  


 

  


Long-term investment securities

   $ 510,167    $ (8,660 )   $ 51,203    $ (1,517 )   $ 561,370    $ (10,177 )
    

  


 

  


 

  


 

We regularly evaluate our investment securities for impairment. We consider factors affecting the investee, factors affecting the industry the investee operates within, and general debt and equity market trends. We consider the length of time an investment’s fair value has been below carrying value, the near term prospects for recovery to carrying value and our intent and ability to hold the investment until maturity or market recovery is realized. If and when a determination is made that a decline in fair value below the cost basis is other than temporary, the related investment is written down to its estimated fair value through earnings. The risks inherent in assessing the impairment of an investment include the risk that market factors may differ from our expectations; facts and circumstances factored into our assessment may change with the passage of time; or we may decide to subsequently sell the investment. The determination of whether a decline in the value of an investment is other than temporary requires us to exercise significant diligence and judgment. The discovery of new information and the passage of time can significantly change these judgments. The status of the general economic environment and significant changes in the national securities markets influence the determination of fair value and the assessment of investment impairment.

 

Unrealized losses at December 31, 2003 resulted from 96 positions. Less than 3% of the carrying value of our consolidated investment securities have been in an unrealized loss position greater than one year. The unrealized losses at December 31, 2003 generally can be attributed to changes in interest rates. All securities trading at an unrealized loss remain current on all contractual payments and we believe it is probable that we will be able to collect all amounts due according to the contractual terms of the debt securities. After taking into account these and other factors, including our ability and intent to hold these securities until recovery or maturity, we determined the unrealized losses on these investment securities were temporary.

 

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.

 

Goodwill and Long-lived Asset

 

At December 31, 2003, goodwill and other long-lived assets represented 23% of total assets and 65% of total stockholders’ equity.

 

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In accordance with the adoption of an accounting standard on January 1, 2002, as discussed in Note 2 to the consolidated financial statements, goodwill is no longer amortized but must be tested at least annually for impairment at a level of reporting referred to as the reporting unit and more frequently if adverse events or changes in circumstances indicate that the asset may be impaired. A reporting unit is one level below our Commercial and Government segments. The Commercial segment’s two reporting units consist of fully and self-insured medical and specialty. The Government segment’s three reporting units consist of Medicare+Choice, TRICARE and Medicaid. Goodwill was assigned to the reporting unit that was expected to benefit from a specific acquisition. If goodwill was expected to benefit multiple reporting units, we allocated goodwill in connection with our transitional impairment test as of January 1, 2002 based upon the reporting units’ relative fair value. This process resulted in the allocation of $633.2 million of goodwill to the Commercial segment and $143.7 million of goodwill to the Government segment.

 

Our strategy, long-range business plan, and annual planning process supports our goodwill impairment tests. These tests are based primarily on an evaluation of future discounted cash flows under several scenarios. We used a range of discount rates that correspond to our weighted-average cost of capital. Key assumptions including changes in membership, premium yields, medical cost trends and certain government contract extensions are consistent with those utilized in our long-range business plan and annual planning process. If these assumptions differ from actual, the estimates underlying our goodwill impairment tests could be adversely affected.

 

Long-lived assets consist of property and equipment and other intangible assets. These assets are depreciated or amortized over their estimated useful life, and are subject to impairment reviews. We periodically review long-lived assets whenever adverse events or changes in circumstances indicate the carrying value of the asset may not be recoverable. In assessing recoverability, we must make assumptions regarding estimated future cash flows and other factors to determine if an impairment loss may exist, and, if so, estimate fair value. We also must estimate and make assumptions regarding the useful life we assign to our long-lived assets. If these estimates or their related assumptions change in the future, we may be required to record impairment losses or change the useful life, including accelerating depreciation for these assets. We recognized losses due to impairment and accelerated depreciation from changes in estimated useful life of $30.8 million in 2003, $2.4 million in 2002 and none in 2001. See Note 4 to the consolidated financial statements.

 

Recently Issued Accounting Pronouncements

 

On December 17, 2003, the Staff of the Securities and Exchange Commission (“SEC” or the “Staff”) issued Staff Accounting Bulletin No. 104, Revenue Recognition, or SAB 104, which supercedes Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, or SAB 101. SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superceded as a result of the issuance of EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s Revenue Recognition in Financial Statements Frequently Asked Questions and Answers, or the FAQ, issued with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition. Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The provisions of SAB 104 do not have an impact on our current revenue recognition policies.

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB 51, or FIN 46. The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (variable interest entities, or VIEs) and how to determine when and which business enterprise should consolidate the VIE (the primary beneficiary). In December 2003, the FASB issued FIN 46-R, Consolidation of Variable Interest Entities—an interpretation of ARB 51 (revised December 2003), which replaces FIN 46. FIN 46-R incorporates certain modifications to FIN 46 adopted by the FASB subsequent to the issuance of FIN 46, including modifications to the scope of FIN 46. Additionally, FIN 46-R incorporates much of the guidance previously issued in the form of FASB Staff Positions.

 

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For all special purpose entities (“SPEs”) created prior to February 1, 2003, public entities must apply either the provisions of FIN 46 or early adopt the provisions of FIN 46-R at the end of the first interim or annual reporting period ending after December 15, 2003. If a public entity applies FIN 46 for such period, the provisions of FIN 46-R must be applied as of the end of the first interim or annual reporting period ending after March 15, 2004. For all non-SPEs created prior to February 1, 2003, public entities will be required to adopt FIN 46-R at the end of the first interim or annual reporting period ending after March 15, 2004. For all entities (regardless of whether the entity is an SPE) that were created subsequent to January 31, 2003, public entities were already required to apply the provisions of FIN 46, and should continue doing so unless they elect to early adopt the provisions of FIN 46-R as of the first interim or annual reporting period ending after December 15, 2003. If they do not elect to early adopt FIN 46-R, public entities would be required to apply FIN 46-R to those post-January 31, 2003 entities as of the end of the first interim or annual reporting period ending after March 15, 2004.

 

As part of our ongoing business, we do not participate or knowingly seek to participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or SPEs, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2003, we are not involved in any SPE transactions. The adoption of FIN 46 or FIN 46-R is not expected to have a material impact on our financial position, results of operations or cash flows.

 

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Comparison of Results of Operations for 2003 and 2002

 

Certain financial data for our two segments was as follows for the years ended December 31, 2003 and 2002:

 

                 Change

 
     2003

    2002

    Dollars

    Percentage

 
     (in thousands, except ratios)  

Premium revenues:

                              

Fully insured

   $ 6,240,806     $ 5,499,033     $ 741,773             13.5  %

Specialty

     320,206       337,295       (17,089 )   (5.1 )%
    


 


 


 

Total Commercial

     6,561,012       5,836,328       724,684     12.4  %
    


 


 


 

Medicare+Choice

     2,527,446       2,629,597       (102,151 )   (3.9 )%

TRICARE

     2,249,725       2,001,474       248,251     12.4  %

Medicaid

     487,100       462,998       24,102     5.2  %
    


 


 


 

Total Government

     5,264,271       5,094,069       170,202     3.3  %
    


 


 


 

Total

   $ 11,825,283     $ 10,930,397     $ 894,886     8.2  %
    


 


 


 

Administrative services fees:

                              

Commercial

   $ 122,846     $ 103,203     $ 19,643     19.0  %

Government

     148,830       141,193       7,637     5.4  %
    


 


 


 

Total

   $ 271,676     $ 244,396     $ 27,280     11.2  %
    


 


 


 

Income (loss) before income taxes:

                              

Commercial

   $ 121,010     $ (15,174 )   $ 136,184     897.5  %

Government

     223,706       225,108       (1,402 )   (0.6 )%
    


 


 


 

Total

   $ 344,716     $ 209,934     $ 134,782     64.2  %
    


 


 


 

Medical expense ratios:

                              

Commercial

     82.9 %     83.5 %           (0.6 )

Government

     84.3 %     83.8 %           0.5  
    


 


         

Total

     83.5 %     83.6 %           (0.1 )
    


 


         

SG&A expense ratios:

                              

Commercial

     16.9 %     18.0 %           (1.1 )

Government

     13.4 %     13.5 %           (0.1 )
    


 


         

Total

     15.4 %     15.9 %           (0.5 )
    


 


         

 

Medical membership was as follows at December 31, 2003 and 2002:

 

    
  
   Change

 
     2003

   2002

   Members

    Percentage

 

Commercial segment medical members:

                      

Fully insured

   2,352,800    2,340,300    12,500             0.5  %

ASO

   712,400    652,200    60,200     9.2  %
    
  
  

 

Total Commercial

   3,065,200    2,992,500    72,700     2.4  %
    
  
  

 

Government segment medical members:

                      

Medicare+Choice

   328,600    344,100    (15,500 )   (4.5  )%

Medicaid

   468,900    506,000    (37,100 )   (7.3  )%

TRICARE

   1,849,700    1,755,800    93,900     5.3  %

TRICARE ASO

   1,057,200    1,048,700    8,500     0.8  %
    
  
  

 

Total Government

   3,704,400    3,654,600    49,800     1.4  %
    
  
  

 

Total medical membership

   6,769,600    6,647,100    122,500     1.8  %
    
  
  

 

 

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Overview

 

Net income was $228.9 million, or $1.41 per diluted share, in 2003 compared to net income of $142.8 million, or $0.85 per diluted share, in 2002. The increase in earnings resulted primarily from significant improvement in operating earnings for the Commercial segment and a decrease in expenses for asset impairments and other unusual items.

 

Premium Revenues and Medical Membership

 

Premium revenues increased 8.2%, to $11.8 billion, for 2003 compared to $10.9 billion for 2002. Higher premium revenues resulted primarily from increases in fully insured commercial per member premiums and an increase in TRICARE premiums. Items impacting per member premiums include changes in premium and government reimbursement rates, as well as changes in geographic mix of membership, the mix of product offerings, and the mix of benefit plans selected by our membership.

 

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.

 

We anticipate 2004 Commercial fully insured per member premiums will increase approximately 8% to 10%. This reduction in the rate of increase in Commercial fully insured per member premiums is expected to occur as a result of a changing mix of business, reductions in the level of benefits purchased by our customers, and a more competitive pricing environment. The change in the mix of business, which is expected to result from growth in our individual products and changes in the products purchased by our large group customers, and reductions in the level of benefit purchased will result in a commensurate reduction in medical cost trends. We expect Commercial fully insured and ASO medical membership to achieve a combined increase for all of 2004 of between 6% and 9%, with most of the growth occurring in the ASO business.

 

Government segment premium revenues increased 3.3%, to $5.3 billion, for 2003 compared to $5.1 billion for 2002. This increase primarily was attributable to our TRICARE business, partially offset by a reduction in our Medicare+Choice membership. Rates were increased upon annual renewal of our base TRICARE contract and led to an increase in TRICARE premium revenues of $248.3 million, or 12.4%, compared to 2002. Medicare+Choice membership was 328,600 at December 31, 2003 compared to 344,100 at December 31, 2002, a decline of 15,500 members, or 4.5%. This decline resulted as we exited several counties in some of our markets effective January 1, 2003 and general attrition in certain markets as a result of annual changes to benefit designs. Per member premiums increased in the 4% to 6% range for 2003. Due to DIMA, we are expecting a return to growth, with MedicareAdvantage membership increasing to approximately 340,000 to 360,000 members by the end of 2004 and increases in per member premiums in the range of 8% to 10%.

 

Administrative Services Fees

 

Administrative services fees for 2003 were $271.7 million, an increase of $27.3 million from $244.4 million for 2002. For the Commercial segment, administrative services fees increased $19.6 million, or 19.0%, to $122.8 million. This increase corresponds to the higher level of ASO membership at December 31, 2003, which was 712,400 members, compared to 652,200 members at December 31, 2002 and also reflects an increase in the average fees received per member. Administrative services fees for the Government segment increased $7.6 million when comparing 2003 to 2002. This increase resulted from contractual adjustments related to TRICARE for Life, a program for seniors in which we provide medical benefit administrative services.

 

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Investment and Other Income

 

Investment and other income totaled $129.4 million in 2003, an increase of $43.0 million from $86.4 million in 2002. This increase resulted primarily from an increase in net realized capital gains due to a $15.2 million gain from the sale of a venture capital investment and lower investment impairment losses, a result of an improving market. We recorded investment impairment losses of $3.2 million in 2003 compared to $27.2 million in 2002. Higher average invested balances offset lower interest rates. The average yield on investment securities was 3.5% in 2003, declining from 4.6% in 2002.

 

Medical Expense

 

Total medical expenses as a percentage of premium revenues, or medical expense ratio (MER), for 2003 were 83.5%, decreasing 10 basis points from 83.6% for 2002.

 

The Commercial segment medical expense ratio for 2003 was 82.9%, decreasing 60 basis points from 83.5% for 2002. The improvement in the MER primarily resulted from per member premium rate increases in excess of medical cost trends for our large group customers and the attrition of groups with higher medical expense ratios. We expect the Commercial segment MER to increase between 100 to 130 basis points in 2004 primarily due to competitive pricing pressures and the pass through of increased administrative expense efficiencies to customers in the form of lower rates.

 

The Government segment medical expense ratio for 2003 was 84.3%, increasing 50 basis points from 83.8% for 2002. This increase primarily was attributable to TRICARE as a result of having a higher level of BPA activity in the prior year.

 

SG&A Expense

 

Total selling, general and administrative, or SG&A, expenses as a percentage of premium revenues and administrative services fees, or SG&A expense ratio, decreased 50 basis points in 2003 primarily because of a decrease in severance and related employee benefit costs of $29.0 million, the absence of 2002 expenses of $30.1 million associated with a contingent contractual provider dispute and other items, offset by an increase in building impairments of $14.8 million.

 

Increased operating efficiency led to the consolidation of seven service centers into four and an enterprise-wide workforce reduction affecting administrative expenses in both 2003 and 2002 by recording expenses for severance and related employee benefit costs and building impairments. Severance and related employee benefit costs, more fully described in Note 10 to the consolidated financial statements, amounted to $11.2 million in 2003 and $40.2 million in 2002. The 2002 severance amount primarily related to the service center consolidation. Building impairments, more fully described in Note 4 to the consolidated financial statements, amounted to $17.2 million in 2003 and $2.4 million in 2002.

 

During 2002, we recorded $30.1 million of administrative expenses for a contingent contractual provider dispute and other items associated with our 1997 acquisition of Physician Corporation of America, or PCA. The $30.1 million of expenses in 2002 resulted from three issues. First, on January 28, 2003, we settled a dispute with a provider for $8.3 million primarily regarding old claims of PCA subsidiaries dating prior to Humana’s 1997 acquisition. Second, during the fourth quarter of 2002, as a December 2, 2002 trial date approached, efforts intensified to reach settlement of an old PCA shareholder dispute for periods prior to Humana’s 1997 acquisition of PCA. As a result, we accrued $15.7 million because the loss was probable and the amount could be reasonably estimated. We reversed $1.8 million of this reserve when the final settlement was paid during the third quarter of 2003. Third, in connection with an agreement reached in November 2002, we partially wrote-off a note receivable of $6.1 million from the purchaser of our workers’ compensation business which was sold in 2000. The agreement with the purchaser resulted when a significant customer contract was terminated in the fourth quarter of 2002. We acquired the workers’ compensation business in connection with the 1997 PCA acquisition.

 

 

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The Commercial and Government segments’ SG&A expense ratios likewise were impacted by the same items described previously. Operational efficiencies gained from completing the consolidation of the service centers and workforce reductions, as well as increases in premiums in excess of inflationary trends on administrative expenses, are expected to decrease the Commercial segment’s SG&A expense ratio to a range of 15.5% to 16.5% and the Government segment’s SG&A expense ratio to a range of 11.0% to 12.0% in 2004.

 

Depreciation and amortization was $126.8 million in 2003, an increase of $6.1 million, or 5.0%, from $120.7 million in 2002. The increase results from accelerated depreciation of software in 2003 of $13.5 million, as more fully described in Note 4 to the consolidated financial statements, partially offset by lower amortization related to other intangible assets as costs associated with the government contract acquired with the TRICARE 2 and 5 transaction became fully amortized in the second quarter of 2003.

 

Interest Expense

 

Interest expense was $17.4 million in 2003, an increase of $0.1 million from $17.3 million in 2002. This increase primarily resulted from higher average outstanding debt due to the issuance of $300 million senior notes in August 2003 offset by lower interest rates.

 

Income Taxes

 

Our effective tax rate in 2003 of 33.6% increased 1.6% compared to the 32% effective tax rate in 2002. The increase in the effective tax rate primarily resulted from a lower proportion of tax-exempt investment income to pretax income. During 2002, the Internal Revenue Service completed their audit of all open years prior to 2000 which resulted in a favorable adjustment to the estimated accrual for income taxes of approximately $32.6 million. This was offset by an increase of approximately $24.5 million in the capital loss valuation allowance after we reevaluated probable capital gain realization in the allowable carryforward period based upon our capital gain experience beginning in 2000 and consideration of alternative tax planning strategies. See Note 7 to the consolidated financial statements for a complete reconciliation to the federal statutory rate.

 

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Comparison of Results of Operations for 2002 and 2001

 

Certain financial data for our two segments was as follows for the years ended December 31, 2002 and 2001:

 

                 Change

 
     2002

    2001

    Dollars

    Percentage

 
     (in thousands, except ratios)        

Premium revenues:

                              

Fully insured

   $ 5,499,033     $ 4,941,888     $ 557,145             11.3 %

Specialty

     337,295       304,714       32,581     10.7 %
    


 


 


 

Total Commercial

     5,836,328       5,246,602       589,726     11.2 %
    


 


 


 

Medicare+Choice

     2,629,597       2,909,478       (279,881 )   (9.6 )%

TRICARE

     2,001,474       1,341,557       659,917     49.2 %

Medicaid

     462,998       441,324       21,674     4.9 %
    


 


 


 

Total Government

     5,094,069       4,692,359       401,710     8.6 %
    


 


 


 

Total

   $ 10,930,397     $ 9,938,961     $ 991,436     10.0 %
    


 


 


 

Administrative services fees:

                              

Commercial

   $ 103,203     $ 84,204     $ 18,999     22.6 %

Government

     141,193       52,886       88,307     167.0 %
    


 


 


 

Total

   $ 244,396     $ 137,090     $ 107,306     78.3 %
    


 


 


 

Income (loss) before income taxes:

                              

Commercial

   $ (15,174 )   $ (2,013 )   $ (13,161 )   653.8 %

Government

     225,108       185,093       40,015     21.6 %
    


 


 


 

Total

   $ 209,934     $ 183,080     $ 26,854     14.7 %
    


 


 


 

Medical expense ratios:

                              

Commercial

     83.5 %     83.1 %           0.4  

Government

     83.8 %     83.6 %           0.2  
    


 


         

Total

     83.6 %     83.3 %           0.3  
    


 


         

SG&A expense ratios:

                              

Commercial

     18.0 %     17.6 %           0.4  

Government

     13.5 %     12.8 %           0.7  
    


 


         

Total

     15.9 %     15.3 %           0.6  
    


 


         

 

Medical membership was as follows at December 31, 2002 and 2001:

 

               Change

 
     2002

   2001

   Members

    Percentage

 

Commercial segment medical members:

                      

Fully insured

   2,340,300    2,301,300    39,000             1.7 %

ASO

   652,200    592,500    59,700     10.1 %
    
  
  

 

Total Commercial

   2,992,500    2,893,800    98,700     3.4 %
    
  
  

 

Government segment medical members:

                      

Medicare+Choice

   344,100    393,900    (49,800 )   (12.6 )%

Medicaid

   506,000    490,800    15,200     3.1 %

TRICARE

   1,755,800    1,714,600    41,200     2.4 %

TRICARE ASO

   1,048,700    942,700    106,000     11.2 %
    
  
  

 

Total Government

   3,654,600    3,542,000    112,600     3.2 %
    
  
  

 

Total medical membership

   6,647,100    6,435,800    211,300     3.3 %
    
  
  

 

 

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Overview

 

Net income was $142.8 million, or $0.85 per diluted share, in 2002 compared to net income of $117.2 million, or $0.70 per diluted share, in 2001. The increase in earnings primarily resulted from premium revenues increasing more than operating costs in both our Commercial and Government segments and the non-amortization of goodwill partially offset by expenses for asset impairments and other unusual items.

 

Premium Revenues and Medical Membership

 

Premium revenues increased 10.0%, to $10.9 billion, for 2002 compared to $9.9 billion for 2001. Higher premium revenues resulted primarily from significant increases in fully insured commercial per member premiums and an increase in TRICARE premiums. Items impacting per member premiums include changes in premium and government reimbursement rates, as well as changes in geographic mix of membership, the mix of product offerings, and the mix of benefit plans selected by our membership.

 

Commercial segment premium revenues increased 11.2%, to $5.8 billion, for 2002 compared to $5.2 billion for 2001. This increase primarily resulted from increases in fully insured commercial per member premiums in the 12% to 14% range for 2002. Additionally, our fully insured commercial medical membership increased 1.7% or 39,000 members, to 2,340,300 at December 31, 2002 compared to 2,301,300 at December 31, 2001.

 

Government segment premium revenues increased 8.5%, to $5.1 billion, for 2002 compared to $4.7 billion for 2001. This increase was primarily attributable to our TRICARE business, partially offset by a reduction in our Medicare+Choice membership.

 

TRICARE premium revenues were $2.0 billion, an increase of $660 million or 49.2% compared to 2001. $334 million of the increase in TRICARE premium revenues is attributable to the acquisition of TRICARE Regions 2 and 5 on May 31, 2001, with the remainder of the increase attributable to the annual increase in our contractually determined base revenues and increases in premium revenues recorded as a result of bid price adjustments, or BPAs, and change orders.

 

Increasing premium revenues recorded in connection with BPAs resulted from an increase in the number of eligible TRICARE beneficiaries and a decrease in the use of military treatment facilities, or MTFs, by TRICARE beneficiaries. The number of TRICARE beneficiaries increased in 2002 as a result of the events of September 11, 2001, the subsequent build-up of military personnel to support military operations in Afghanistan, and the continuing build-up of military personnel surrounding other international tensions. A decline in the usage of MTFs occurred for some periods after September 11, 2001 when certain MTFs were restricted by the Department of Defense resulting in a greater use of our provider network by retired military personnel and the dependents of both active duty and retired military personnel. Increasing premium revenues recorded in connection with change orders primarily resulted from expanded benefits for TRICARE beneficiaries as mandated by Congress which includes, among other items, a reduction of the beneficiary out-of-pocket maximum cost and the elimination of certain copayments.

 

Collectively, all of these actions resulted in higher medical expenses during 2002. Since these actions were not originally specified in our contracts, we were entitled to equitable revenue adjustments via the change order and BPA process. We recognized revenues related to these adjustments when the settlement amount became determinable and the collectibility was reasonably assured.

 

Medicare+Choice premium revenues were $2.6 billion in 2002, a decrease of 9.6% from $2.9 billion in 2001. Medicare+Choice membership was 344,100 at December 31, 2002, compared to 393,900 at December 31, 2001, a decline of 49,800 members, or 12.6%. Medicare+Choice per member premiums increased 5.6% in 2002. The decrease in membership was due to our exit of various counties on January 1, 2002, as well as attrition in certain markets as a result of annual changes to benefit designs.

 

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Administrative Services Fees

 

Administrative services fees for 2002 were $244.4 million, an increase of $107.3 million from $137.1 million for 2001. For the Commercial segment, administrative services fees increased $19.0 million, or 22.6%, to $103.2 million. This increase corresponds to the higher level of ASO membership at December 31, 2002, which was 652,200 members, compared to 592,500 members at December 31, 2001 and also reflects an increase in the average fees received per member. Administrative services fees for the Government segment increased $88.3 million when comparing 2002 to 2001. The TRICARE Regions 2 and 5 acquisition accounted for $51 million of this increase, with the remainder attributable to the implementation of the TRICARE for Life benefits program effective October 1, 2001. TRICARE for Life is a program for seniors where we provide medical benefit administrative services.

 

Investment and Other Income

 

Investment and other income totaled $86.4 million in 2002, a decrease of $32.4 million from $118.8 million in 2001. Net realized losses of $10.1 million in 2002 compared to net realized gains of $13.9 million in 2001. Net realized losses in 2002 included impairment losses of $27.2 million primarily related to privately held venture capital investment securities after an evaluation indicated that a decline in fair value below the cost basis was other than temporary. Lower interest rates also decreased investment income $10.9 million in 2002 compared to 2001. The average yield on investment securities was 4.6% in 2002, declining from 5.1% in 2001.

 

Medical Expense

 

The medical expense ratio for 2002 was 83.6%, increasing 30 basis points from 83.3% in 2001.

 

The Commercial segment medical expense ratio for 2002 was 83.5%, increasing 40 basis points from 83.1% in 2001. This increase primarily was due to the shift in the mix of our fully insured commercial medical membership to a heavier concentration of larger group sizes. Large group commercial membership represented approximately 65% of our fully insured commercial membership at December 31, 2002 compared to 62% at December 31, 2001. Large group membership traditionally experiences a higher medical expense ratio and a lower selling, general and administrative expense ratio than does our small group membership.

 

The Government segment medical expense ratio for 2002 was 83.8%, increasing 20 basis points from 83.6% in 2001. This increase primarily was attributable to TRICARE. As discussed previously, TRICARE medical expense increased due to expanded benefits for TRICARE beneficiaries mandated by Congress, an increase in eligible beneficiaries, and an increase in the use of Humana’s provider network rather than MTFs. Since these actions were not originally specified in our contracts or were for items that the Department of Defense retains financial risk, we were entitled to equitable revenue adjustments through the change order and BPA processes. These higher medical expenses combined with the associated higher premium revenues resulted in an overall increase in the Government medical expense ratio.

 

SG&A Expense

 

The SG&A expense ratio for 2002 was 15.9%, increasing 60 basis points from 15.3% for 2001. This increase primarily resulted from an increase in severance and related employee benefit expenses of $36.0 million, long-lived asset impairments of $2.4 million, and the establishment of reserves for a contingent contractual provider dispute and other items associated with our 1997 acquisition of Physician Corporation of America, or PCA of $30.1 million.

 

The Commercial segment’s SG&A expense ratio was 18.0% for 2002, increasing 40 basis points from 2001 of 17.6%. This increase was the result of the items discussed above.

 

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The Government segment’s SG&A expense ratio was 13.5% for 2002, increasing 70 basis points compared to 12.8% in 2001. This increase resulted from the items discussed above and a change in the mix of revenues. A higher proportion of revenues was generated from administrative services fees, primarily from the TRICARE Regions 2 and 5 acquisition and the implementation of the TRICARE for Life benefit programs effective October 1, 2001. ASO business carries a much higher SG&A ratio than fully insured business.

 

Depreciation and amortization was $120.7 million in 2002, a decrease of $40.8 million, or 25.3%, from $161.5 million in 2001. As discussed in Note 2 to the consolidated financial statements, we ceased amortizing goodwill on January 1, 2002 in accordance with adopting a new accounting standard. This decreased goodwill amortization by $55 million. On a comparable basis, depreciation and amortization was $106.5 million in 2001, excluding goodwill amortization expense. The $14.2 million increase in 2002 compared to 2001, as adjusted, resulted from capital expenditures primarily related to our technology initiatives and a full year of amortization of other intangible assets related to the acquisition of TRICARE Regions 2 and 5 on May 31, 2001.

 

Interest Expense

 

Interest expense was $17.3 million in 2002, a decrease of $8.0 million from $25.3 million in 2001. This decrease primarily resulted from lower interest rates.

 

Income Taxes

 

Our effective tax rate in 2002 of 32% decreased 4% compared to the 36% effective tax rate in 2001. The lower effective tax rate in 2002 primarily resulted from the cessation of non-deductible goodwill amortization on January 1, 2002, partially offset by higher state income taxes and a lower proportion of tax-exempt investment income to pretax income. In addition, during 2002, the Internal Revenue Service completed their audit of all open years prior to 2000, which resulted in a favorable adjustment to the estimated accrual for income taxes of approximately $32.6 million. This was offset by an increase of approximately $24.5 million in the capital loss valuation allowance after we reevaluated probable capital gain realization in the allowable carryforward period based upon our capital gain experience beginning in 2000 and consideration of alternative tax planning strategies. See Note 7 to the consolidated financial statements for a complete reconciliation to the federal statutory rate.

 

Liquidity

 

Our consolidated liquidity continued to strengthen in 2003, with cash and cash equivalents increasing to $931.4 million at December 31, 2003 from $721.4 million at December 31, 2002. Because we operate as a holding company, our parent company is dependent upon dividends and administrative expense reimbursements from our subsidiaries, most of which are subject to regulatory restrictions. Our parent company liquidity also improved during 2003. Cash, cash equivalents and short-term investments at our parent company amounted to $399.4 million at December 31, 2003, increasing $212.4 million from $187.0 million at December 31, 2002. The primary source for the increase in cash and cash equivalents has been the increase in our net income.

 

The change in cash and cash equivalents for the years ended December 31, 2003, 2002 and 2001 is summarized as follows:

 

     2003

    2002

    2001

 
     (in thousands)  

Net cash provided by operating activities

   $ 413,140     $ 321,408     $ 148,958  

Net cash used in investing activities

     (373,163 )     (128,157 )     (118,807 )

Net cash provided by (used in) financing activities

     170,070       (123,314 )     (36,293 )
    


 


 


Increase (decrease) in cash and cash equivalents

   $ 210,047     $ 69,937     $ (6,142 )
    


 


 


 

 

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The primary drivers of operating cash flow in our business are premium collections and medical claim payments. Because premiums generally are collected in advance of claims payments by a period up to several months in many instances, our business should normally produce strong cash flows during a period of increasing enrollment. Conversely, cash flows would be negatively impacted during a period of shrinking enrollment, as was the case for us during 2001. The exception to this general rule is the collection of TRICARE BPAs and change orders, which may occur up to six months after the end of a contract year. Other activities that impact our cash flows are the collection of ASO fees and investment income and the payment of operating expenses, interest expense and taxes.

 

During 2003, our operating cash flows were not substantially impacted by a change in the timing of premium and ASO fee collections or medical claim payments, as both amounts generally increased with inflation and membership growth. However, during 2002, our operating cash flows were negatively impacted by slower cash collections of premium and ASO fee receivables when TRICARE receivables increased by $174 million as detailed in the following table:

 

     December 31,

    Change

 
     2003

    2002

    2001

    2003

    2002

 
     (in thousands)  

TRICARE:

                                        

Base receivable

   $ 266,656     $ 197,544     $ 166,763     $ 69,112     $ 30,781  

Bid price adjustments (BPAs)

     92,875       104,044       —         (11,169 )     104,044  

Change orders

     7,073       57,630       18,423       (50,557 )     39,207  
    


 


 


 


 


       366,604       359,218       185,186       7,386       174,032  

Less: long-term portion of BPAs

     (38,794 )     (86,471 )     —         47,677       (86,471 )
    


 


 


 


 


TRICARE subtotal

     327,810       272,747       185,186       55,063       87,561  

Commercial and other

     178,577       146,882       148,784       31,695       (1,902 )

Allowance for doubtful accounts

     (40,400 )     (30,178 )     (38,539 )     (10,222 )     8,361  
    


 


 


 


 


Total net receivables

   $ 465,987     $ 389,451     $ 295,431     $ 76,536     $ 94,020  
    


 


 


 


 


 

TRICARE base receivables, which are collected monthly in the ordinary course of business, increased in 2003 as rates under our base TRICARE contract increased upon the annual renewal of the contracts for Regions 3 and 4 and Regions 2 and 5. Total TRICARE receivables significantly increased from 2001 to 2002 primarily due to change orders and BPAs due to an increase in activity and deployments surrounding military conflicts in the Middle East.

 

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.

 

     Estimated
Valuation


   Claims on
Hand


   Number of
Days Claims
On-hand


     (dollars in thousands)

December 31, 2000

   $ 257,400    1,157,900    11.0

December 31, 2001

   $ 125,400    518,100    5.0

December 31, 2002

   $ 92,300    424,200    4.5

December 31, 2003

   $ 109,700    443,000    4.9

 

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Medical and other expenses payable increased during 2003 and 2002 due primarily to medical claims inflation and increases in membership. The timing of claim payments did not significantly impact 2003 or 2002 cash flows from operations. The detail of medical and other expenses payable was as follows at December 31, 2003, 2002, and 2001:

 

                    Change

 
     2003

   2002

   2001

   2003

    2002

 
     (in thousands)  

IBNR(1)

   $ 1,034,858    $ 863,432    $ 802,574    $ 171,426     $ 60,858  

Unprocessed claim inventories(2)

     109,700      92,300      125,400      17,400       (33,100 )

Processed claim inventories(3)

     74,262      105,422      102,622      (31,160 )     2,800  

Payable to pharmacy benefit administrator and other(4)

     53,336      80,977      55,790      (27,641 )     25,187  
    

  

  

  


 


Total medical and other expenses payable

   $ 1,272,156    $ 1,142,131    $ 1,086,386    $ 130,025     $ 55,745  
    

  

  

  


 



(1) IBNR represents an estimate of medical expenses payable for claims incurred but not reported (IBNR) at the balance sheet date. The level of IBNR is primarily impacted by membership levels, medical claim trends and the receipt cycle time, which represents the length of time between when a claim is initially incurred and when the claim form is received (i.e. a shorter time span results in a lower IBNR).
(2) Unprocessed claim inventories represent the estimated valuation of claims received but not yet fully processed. Further detail regarding unprocessed claim inventories is provided below.
(3) Processed claim inventories represent the estimated valuation of processed claims that are in the post claim adjudication process, which consists of administrative functions such as audit and check batching and handling.
(4) The balance due to our pharmacy benefit administrator fluctuates due to bi-weekly payments and the month-end cutoff and other medical expenses payable.

 

The timing of Medicare+Choice premium receipts may significantly impact our cash flows from operations in a particular period as the Medicare+Choice premium receipt is payable to us on the first day of each month. When the first day of a month falls on a weekend or holiday, we receive this payment at the end of the previous month. Since this amount is significant, the timing of its receipt can cause a material fluctuation in our operating cash flows from period to period. The Medicare+Choice premium receipts for January 2004 of $211.9 million and for January 2003 of $205.8 million were received early in December 2003 and December 2002, respectively, because January 1 is a holiday. This timing accounts for a significant portion of the unearned revenues balance on our consolidated balance sheets at December 31, 2003 and 2002.

 

Cash Flow from Investing Activities

 

During 2003, we reinvested a portion of our operating cash flows in investment securities, primarily short-duration fixed income securities, totaling $283.1 million. During 2003, 2002 and 2001, we also made capital expenditures as discussed below.

 

Cash Flow from Financing Activities

 

During 2003, we converted our short-term commercial paper debt to long-term borrowings and repurchased common shares as discussed below. The cash used in financing activities in 2002 resulted primarily from common share repurchases while the use of cash in 2001 resulted from reductions in borrowings.

 

Capital Expenditures

 

Our ongoing capital expenditures primarily relate to our technology initiatives and administrative facilities necessary for activities such as claims processing, billing and collections, medical utilization review, and customer service. Total capital expenditures, excluding acquisitions, were $101.3 million in 2003, $112.1 million

 

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in 2002, and $115.5 million in 2001. Excluding acquisitions, we expect our total capital expenditures in 2004 to be approximately $100 million, most of which will be used for our technology initiatives and improvement of administrative facilities.

 

Stock Repurchase Plan

 

For the year ended December 31, 2003, we acquired 3.7 million of our common shares at an aggregate cost of $44.1 million, or an average of $12.03 per share. Of these shares, 1.4 million were acquired in connection with employee stock plans at an aggregate cost of $23.3 million, or an average of $16.27 per share, and the remaining 2.3 million shares were acquired in open market transactions at an aggregate cost of $20.8 million, or an average of $9.31 per share. In July 2003, the Board of Directors authorized an additional use of up to $100 million for the repurchase of our common shares exclusive of shares repurchased in connection with employee stock plans. The shares may be purchased from time to time at prevailing prices in the open market or in privately negotiated transactions. As of February 24, 2004, $94.2 million of the July 2003 authorization remains available for share repurchases.

 

Debt

 

Short-term and long-term debt outstanding was as follows at December 31, 2003 and 2002:

 

     2003

   2002

     (in thousands)

Short-term debt:

             

Conduit commercial paper financing program

   $ —      $ 265,000
    

  

Long-term debt:

             

6.30% senior, unsecured notes due 2018, net of unamortized discount of $838 at December 31, 2003

   $ 299,162    $ —  

7.25% senior, unsecured notes due 2006, net of unamortized discount of $376 at December 31, 2003 and $521 at December 31, 2002

     299,624      299,479

Fair value of interest rate swap agreements

     12,754      34,889

Deferred gain from interest rate swap exchange

     26,175      —  
    

  

Total senior notes

     637,715      334,368

Other long-term borrowings

     4,923      5,545
    

  

Total long-term debt

   $ 642,638    $ 339,913
    

  

 

Senior Notes

 

In order to term-out our short-term debt and take advantage of historically low interest rates, we issued $300 million 6.30% senior notes due August 1, 2018 on August 5, 2003. Our net proceeds, reduced for the cost of the offering, were approximately $295.8 million. The net proceeds were used for general corporate purposes, including the funding of our short term cash needs.

 

In order to hedge the risk of changes in the fair value of our $300 million 6.30% senior notes and our $300 million 7.25% senior notes attributable to fluctuations in interest rates, we entered into interest rate swap agreements. Interest rate swap agreements, which are considered derivatives, are contracts that exchange interest payments on a specified principal amount, or notional amount, for a specified period. The interest rate swap agreements have the same critical terms as our 6.30% senior notes and our 7.25% senior notes. Changes in the fair value of the 6.30% or 7.25% senior notes and the swap agreements due to changing interest rates are assumed to offset each other completely, resulting in no impact to earnings from hedge ineffectiveness. Our swap agreements are recognized in our consolidated balance sheet at fair value with an equal and offsetting adjustment to the carrying value of our senior notes. The fair value of our interest rate swap agreements are estimated based

 

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on quoted market prices of comparable agreements, and reflect the amounts we would receive (or pay) to terminate the agreements at the reporting date.

 

Our interest rate swap agreements exchange the fixed interest rate under our 6.30% and 7.25% senior notes for a variable interest rate. At December 31, 2003, the variable interest rate was 2.03% for the 6.30% senior notes and 6.26% for the 7.25% senior notes. The $300 million swap agreements for the 6.30% senior notes mature on August 1, 2018, and the $300 million swap agreements for the 7.25% senior notes mature on August 1, 2006, and each has the same critical terms as the related senior notes.

 

In June 2003, we recorded a deferred gain and received proceeds of $31.6 million in exchange for new swap agreements discussed above related to our 7.25% senior notes. The corresponding deferred swap gain of $31.6 million is being amortized to reduce interest expense over the remaining term of the 7.25% senior notes. The carrying value of our 7.25% senior notes has been increased $26.2 million by the remaining deferred swap gain balance at December 31, 2003.

 

At December 31, 2003, the $12.8 million fair value of our swap agreements is included in other long-term assets. Likewise, the carrying value of our senior notes has been increased $12.8 million to reflect its fair value. The counterparties to our swap agreements are major financial institutions with which we also have other financial relationships.

 

Credit Agreements

 

We maintain two unsecured revolving credit agreements consisting of a $265 million, 4-year revolving credit agreement and a $265 million, 364-day revolving credit agreement with a one-year term-out option. A one-year term-out option converts the outstanding borrowings, if any, under the credit agreement to a one-year term loan upon expiration. The 4-year revolving credit agreement expires in October 2005. In October 2003, we renewed the 364-day revolving credit agreement which expires in October 2004, unless extended.

 

There were no balances outstanding under either agreement at December 31, 2003 or 2002. Under these agreements, at our option, we can borrow on either a competitive advance basis or a revolving credit basis. The revolving credit portion of both agreements bears interest at either a fixed rate or floating rate based on LIBOR plus a spread. The spread, which varies depending on our credit ratings, ranges from 80 to 125 basis points for our 4-year agreement, and 85 to 137.5 basis points for our 364-day agreement. We also pay an annual facility fee regardless of utilization. This facility fee, currently 25 basis points, may fluctuate between 15 and 50 basis points, depending upon our credit ratings. The competitive advance portion of any borrowings under either credit agreement will bear interest at market rates prevailing at the time of borrowing on either a fixed rate or a floating rate basis, at our option.

 

These credit agreements, and the agreement relating to the conduit commercial paper program described below, contain customary restrictive and financial covenants as well as customary events of default, including financial covenants regarding the maintenance of net worth, minimum interest coverage, and maximum leverage ratios. At December 31, 2003, we were in compliance with all applicable financial covenant requirements. The terms of each of these credit agreements also include standard provisions related to conditions of borrowing, including a customary material adverse effect clause which could limit our ability to borrow. We have not experienced a material adverse effect and we know of no circumstances or events which would be reasonably likely to result in a material adverse effect. We do not believe the material adverse effect clause poses a material funding risk to Humana in the future.

 

Commercial Paper Programs

 

We maintain indirect access to the commercial paper market through our conduit commercial paper financing program. Under this program, a third party issues commercial paper and loans the proceeds of those issuances to us so that the interest and principal payments on the loans match those on the underlying commercial

 

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paper. The $265 million, 364-day revolving credit agreement supports the conduit commercial paper financing program of up to $265 million.

 

We also maintain and may issue short-term debt securities under a commercial paper program when market conditions allow. The program is backed by our credit agreements described above. Under the terms of our credit agreements, aggregate borrowings under both the credit agreements and commercial paper program cannot exceed $530 million.

 

At December 31, 2003, we had no direct or indirect (conduit) commercial paper borrowings outstanding.

 

Other Borrowings

 

Other borrowings of $4.9 million at December 31, 2003 and $5.5 million at December 31, 2002 represent financing for the renovation of a building, bear interest at 2% per annum, are collateralized by the building, and are payable in various installments through 2014.

 

Shelf Registration

 

On April 1, 2003, our universal shelf registration became effective with the Securities and Exchange Commission. This allows us to register debt or equity securities, from time to time, with the amount, price and terms to be determined at the time of the sale. After the issuance of our $300 million, 6.30% senior notes in August 2003, we have up to $300 million remaining from a total of $600 million under the universal shelf registration. The universal shelf registration allows us to use the net proceeds from any future sales of our securities for our operations and for other general corporate purposes, including repayment or refinancing of borrowings, working capital, capital expenditures, investments, acquisitions, or the repurchase of our outstanding securities.

 

Contractual Obligations

 

We are contractually obligated to make payments for years subsequent to December 31, 2003 as follows:

 

     Payments Due by Period

     Total

   Less than
1 Year


   1–3 Years

   3–5 Years

   More than
5 Years


     (in thousands)

Debt(1)

   $ 642,638    $ 635    $ 327,163    $ 1,080    $ 313,760

Operating leases(2)

     257,222      63,392      93,070      54,969      45,791

Purchase and other obligations(3)

     48,983      24,344      18,235      4,651      1,753
    

  

  

  

  

Total

   $ 948,843    $ 88,371    $ 438,468    $ 60,700    $ 361,304
    

  

  

  

  


(1) Debt payments could be accelerated upon violation of debt covenants. We believe the likelihood of a debt covenant violation is remote.
(2) We lease facilities, computer hardware, and other equipment under long-term operating leases that are noncancelable and expire on various dates through 2017. We sublease facilities or partial facilities to third party tenants for space not used in our operations which partially mitigates our operating lease commitments. An operating lease is a type of off-balance sheet arrangement. Assuming we acquired the asset, rather than leased, we would have recognized a liability for the financing of these assets. See also Note 13 to the consolidated financial statements.
(3) Purchase and other obligations include agreements to purchase services, primarily information technology related services, or to make improvements to real estate that are enforceable and legally binding on us and that specify all significant terms, including: fixed or minimum levels of service to be purchased; fixed, minimum or variable price provisions; and the appropriate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty.

 

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Off-Balance Sheet Arrangements

 

Our 5-year and 7-year airplane operating leases provide for a residual value payment of no more than $9.2 million at the end of the lease terms, which expire December 29, 2004 for the 5-year lease and January 1, 2010 for the 7-year lease. We have the right to exercise a purchase option with respect to the leased airplanes or the airplanes can be sold to a third party. If we decide not to exercise our purchase option at the end of the lease, we must pay the lessor a maximum amount of $4.4 million related to the 5-year lease and $4.8 million related to the 7-year lease. The amount will be reduced by the net sales proceeds of the airplanes to a third party. After considering the current fair value of the airplanes, we recorded a $1.5 million provision during 2003 for the exposure from the residual value guarantee. During 2003, we terminated two 5-year airplane leases early. The impact of these transactions was not material.

 

Indemnifications and Guarantees

 

Through indemnity agreements approved by the state regulatory authorities, certain of our regulated subsidiaries generally are guaranteed by Humana Inc., our parent company, in the event of insolvency for (1), member coverage for which premium payment has been made prior to insolvency; (2), benefits for members then hospitalized until discharged; and (3), payment to providers for services rendered prior to insolvency. Our parent also has guaranteed the obligations of our TRICARE subsidiaries.

 

In the ordinary course of business, we enter into contractual arrangements under which we may agree to indemnify a third party to such arrangement from any losses incurred relating to the services they perform on behalf of us, or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have been immaterial.

 

Other Liquidity Factors

 

Our investment-grade credit rating at December 31, 2003 was Baa3 according to Moody’s Investors Services, Inc., or Moody’s, and BBB, according to Standard & Poor’s Corporation, or S&P. A downgrade to Ba2 or lower by Moody’s and BB or lower by S&P would give the counterparties of three of our interest rate swap agreements with a $300 million notional amount, the right, but not the obligation, to cancel the interest rate swap agreement. If cancelled, we would pay or receive an amount based on the fair market value of the swap agreement. Assuming these swap agreements had been cancelled on December 31, 2003, we would have received $8.7 million. Other than the swap agreements, adverse changes in our credit ratings will not create, increase, or accelerate any liabilities. Adverse changes in our credit rating will increase the rate of interest we pay and may impact the amount of credit available to us in the future.

 

Related Parties

 

No related party transactions had a material effect on our financial position, results of operations, or cash flows. Certain immaterial related party transactions are discussed in our Proxy Statement for the meeting to be held April 22, 2004—see “Certain Transactions with Management and Others.”

 

Regulatory Requirements

 

Certain of our subsidiaries operate in states that regulate the payment of dividends, loans, or other cash transfers to Humana Inc., our parent company, require minimum levels of equity as well as limit investments to approved securities. The amount of dividends that may be paid to Humana Inc. by these subsidiaries, without prior approval by state regulatory authorities, is limited based on the entity’s level of statutory income and statutory capital and surplus. In most states, prior notification is provided before paying a dividend even if approval is not required.

 

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As of December 31, 2003, we maintained aggregate statutory capital and surplus of $1,086.5 million in our state regulated health insurance subsidiaries. Each of these subsidiaries was in compliance with applicable statutory requirements which aggregated $640.4 million. Although the minimum required levels of equity are largely based on premium volume, product mix, and the quality of assets held, minimum requirements can vary significantly at the state level. Certain states rely on risk-based capital requirements, or RBC, to define the required levels of equity. RBC is a model developed by the National Association of Insurance Commissioners to monitor an entity’s solvency. This calculation indicates recommended minimum levels of required capital and surplus and signals regulatory measures should actual surplus fall below these recommended levels. If RBC were adopted by all states at December 31, 2003, each of our subsidiaries would be in compliance and we would have $381.9 million of aggregate capital and surplus above any of the levels that require corrective action under RBC.

 

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.

 

Future Liquidity Needs

 

Because of the items discussed in this Liquidity section, we believe that funds from future operating cash flows and funds available under our credit agreements and commercial paper program are sufficient to meet short and intermediate-term liquidity needs. We also believe these sources of funds are adequate to allow us to fund selected expansion opportunities, as well as to fund capital requirements.

 

Market Risk-Sensitive Financial Instruments and Positions

 

The level of our pretax earnings is subject to risk due to changes in investment income from our fixed income portfolio which is partially offset by both our debt position and the short-term duration of the fixed income investment portfolio.

 

We evaluated the impact on our investment income and debt expense resulting from a hypothetical change in interest rates of 100, 200 and 300 basis points over the next twelve-month period, as reflected in the following table. The modeling technique used to calculate the pro forma net change in pretax earnings considered the cash flows related to fixed income investments and debt, which are subject to interest rate changes during a prospective twelve-month period. This evaluation measures parallel shifts in interest rates and may not account for certain unpredictable events that may effect interest income, including, among others, unexpected changes of cash flow into and out of the portfolio, shifts in the asset mix between tax and tax-exempt securities, and spread changes specific to various investment categories. In the past ten years, changes in 3 month LIBOR rates during the year have exceeded 300 basis points twice, have not changed between 200 and 300 basis points, have changed between 100 and 200 basis points once and have changed by less than 100 basis points seven times. LIBOR was 1.15% at December 31, 2003. Our model assumed the maximum possible reduction in LIBOR could not exceed 115 basis points.

 

     Increase (decrease) in pretax
earnings given an interest rate
decrease of X basis points


    Increase (decrease) in pretax
earnings given an interest rate
increase of X basis points


 
     (300)

    (200)

    (100)

    100

    200

    300

 
     (in thousands)        

2003

                                                

Fixed income portfolio

   $ (13,105 )   $ (11,977 )   $ (9,757 )   $ 9,169     $ 18,068     $ 26,844  

Debt

     5,567       5,567       5,567       (5,567 )     (11,134 )     (16,700 )
    


 


 


 


 


 


Total

   $ (7,538 )   $ (6,410 )   $ (4,190 )   $ 3,602     $ 6,934     $ 10,144  
    


 


 


 


 


 


2002

                                                

Fixed income portfolio

   $ (21,793 )   $ (15,708 )   $ (8,848 )   $ 9,229     $ 17,253     $ 24,876  

Debt

     4,019       4,019       4,019       (4,019 )     (8,038 )     (12,057 )
    


 


 


 


 


 


Total

   $ (17,774 )   $ (11,689 )   $ (4,829 )   $ 5,210     $ 9,215     $ 12,819  
    


 


 


 


 


 


 

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Government Contracts

 

Our MedicareAdvantage contracts with the federal government are renewed for a one-year term each December 31 unless notice of termination is received at least 90 days prior thereto. In December 2003, the Medicare Prescription Drug, Improvement, and Modernization Act, or DIMA, was signed into law. DIMA includes provisions that require the 2004 stabilization funding to be directed toward increased reimbursement for providers, increased benefits or access for members, or decreased member premiums. We believe DIMA will open new opportunities for us. However, we do not believe that the benefit to our 2004 financial position, results of operations, or cash flows will be material.

 

Our current TRICARE contract with the Department of Defense will be in effect until April 30, 2004 for Regions 2 and 5 and until June 30, 2004 for Regions 3 and 4. Each of the contracts is subject to a one-year renewal at the Government’s option. We believe these contracts will continue until the TRICARE transition described below.

 

On August 21, 2003, the Department of Defense notified us that we were awarded the contract for the South Region, one of three newly-created regions under the government’s revised TRICARE Program. The current TRICARE Regions 3 and 4 will become part of the new South Region along with Region 6, which is currently administered by another contractor. The current Regions 2 and 5 will become part of the North Region, which was awarded to another contractor.

 

Pursuant to the Department of Defense’s bid process, each of the three awards was subject to protests by unsuccessful bidders of prime contracts, however, none of the protests were successful.

 

Under the Department of Defense’s current schedule for implementation of the new TRICARE contracts, Regions 2 and 5 will transition to the new North Region for the start of healthcare delivery on July 1, 2004. Regions 3 and 4 will become part of the new South Region for the start of healthcare delivery on August 1, 2004 and Region 6 will become part of our new South Region for the start of healthcare delivery on November 1, 2004. If this schedule is realized, our TRICARE membership is expected to temporarily decline to 1.5 million in July 2004, and is expected to increase to 2.8 million in November 2004. This will also result in a decline in revenues during this period.

 

In addition, retail pharmacy benefits for TRICARE beneficiaries will be administered separately under the new Department of Defense TRICARE Retail Pharmacy Program. On September 26, 2003, we were notified that we were not awarded the retail pharmacy contract and, later, that our protest of this award decision was not upheld.

 

We currently have Medicaid contracts with the Puerto Rico Health Insurance Administration through June 30, 2005, subject to each party agreeing upon annual rates. In July 2003, we signed amendments to the Puerto Rico Medicaid contracts regarding a premium rate increase for the annual period ending June 30, 2004. Our other Medicaid contracts are in Florida and Illinois, and are annual contracts. As of December 31, 2003, Puerto Rico accounted for approximately 84% of our total Medicaid membership.

 

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

 

Legal Proceedings

 

We are party to a variety of legal actions in the ordinary course of business, including employment matters, breach of contract actions, tort claims, and shareholder suits involving alleged securities fraud. A description of material legal actions in which we are currently involved is included under “Legal Proceedings” of Item 3 in

 

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Part 1. We cannot predict the outcome of these suits with certainty, and we are incurring expenses in defense of these matters. In addition, recent court decisions and legislative activity may increase our exposure for any of these types of claims. Therefore, these legal actions could have a material adverse effect on our financial position, results of operations and cash flows.

 

Cautionary Statements

 

This document includes both historical and forward-looking statements. The forward-looking statements are made within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of complying with these safe harbor provisions. We have based these forward-looking statements on our current expectations and projections about future events, trends and uncertainties. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including, among other things, the information discussed below. In making these statements, we are not undertaking to address or update each factor in future filings or communications regarding our business or results. Our business is highly complicated, regulated and competitive with many different factors affecting results.

 

If the premiums we charge are insufficient to cover the cost of health care services delivered to our members, or if our estimates of medical claim reserves based upon our estimates of future medical claims are inadequate, our profitability could decline.

 

We use a significant portion of our revenues to pay the costs of health care services delivered to our members. These costs include claims payments, capitation payments, allocations of some centralized expenses and various other costs incurred to provide health insurance coverage to our members. These costs also include estimates of future payments to hospitals and others for medical care provided to our members. Generally, premiums in the health care business are fixed for one-year periods. Accordingly, costs we incur in excess of our medical cost projections generally are not recovered in the contract year through higher premiums. We estimate the costs of our future medical claims and other expenses using actuarial methods and assumptions based upon claim payment patterns, medical inflation, historical developments, including claim inventory levels and claim receipt patterns, and other relevant factors. We also record medical claims reserves for future payments. We continually review estimates of future payments relating to medical claims costs for services incurred in the current and prior periods and make necessary adjustments to our reserves. However, increases in the use or cost of services by our members, competition, government regulations and many other factors may and often do cause actual health care costs to exceed what was estimated and reflected in premiums.

 

These factors may include:

 

  increased use of medical facilities and services, including prescription drugs;

 

  increased cost of such services;

 

  the Company’s membership mix;

 

  termination of capitation arrangements resulting in the transfer of membership to fee-for-service arrangements;

 

  changes or reductions of our utilization management functions such as preauthorization of services, concurrent review or requirements for physician referrals;

 

  catastrophes, including acts of terrorism or epidemics;

 

  the introduction of new or costly treatments, including new technologies;

 

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  medical cost inflation; and

 

  new government mandated benefits or other regulatory changes.

 

Failure to adequately price our products or estimate sufficient medical claim reserves may result in a material adverse effect on our financial position, results of operations and cash flows.

 

If we do not design and price our products properly and competitively, our membership and profitability could decline.

 

We are in a highly competitive industry. Many of our competitors are more established in the health care industry and have a larger market share and greater financial resources than we do in some markets. In addition, other companies may enter our markets in the future, including emerging competitors in the MedicareAdvantage program, in e-commerce insurance or benefit programs and in consumer-directed health plans. Contracts for the sale of commercial products are generally bid upon or renewed annually. While health plans compete on the basis of many factors, including service and the quality and depth of provider networks, we expect that price will continue to be a significant basis of competition. In addition to the challenge of controlling health care costs, we face competitive pressure to contain premium prices.

 

Premium increases, introduction of new product designs, and our relationship with our providers in various markets, among other issues, could affect our membership levels. Other actions that could affect membership levels include the possible exit of or entrance to MedicareAdvantage or Commercial markets. If we do not compete effectively in our markets, if we set rates too high or too low in highly competitive markets to keep or increase our market share, if membership does not increase as we expect, or if it declines, or if we lose accounts with favorable medical cost experience while retaining or increasing membership in accounts with unfavorable medical cost experience, our business and results of operations could be materially adversely affected.

 

If we fail to effectively implement our operational and strategic initiatives, our business could be materially adversely affected.

 

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.

 

If we fail to properly maintain the integrity of our data, or to strategically implement new information systems, or to protect our proprietary rights to our systems, our business could be materially adversely affected.

 

Our business depends significantly on effective information systems and the integrity and timeliness of the data we use to run our business. Our business strategy involves providing members and providers with easy to use products that leverage our information to meet their needs. Our ability to adequately price our products and services, provide effective and efficient service to our customers, and to timely and accurately report our financial results depends significantly on the integrity of the data in our information systems. As a result of our past and on-going acquisition activities, we have acquired additional systems. We have been taking steps to

 

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reduce the number of systems we operate, have upgraded and expanded our information systems capabilities, and are gradually migrating existing business to fewer systems. If the information we rely upon to run our businesses was found to be inaccurate or unreliable or if we fail to maintain effectively our information systems and data integrity, we could have operational disruptions, have problems in determining medical cost estimates and establishing appropriate pricing, have customer and physician and other health care provider disputes, have regulatory problems, have increases in operating expenses, lose existing customers, have difficulty in attracting new customers, or suffer other adverse consequences. Our information systems require an ongoing commitment of significant resources to maintain, protect and enhance existing systems and develop new systems to keep pace with continuing changes in information processing technology, evolving industry and regulatory standards, and changing customer preferences.

 

We depend on independent third parties for significant portions of our systems-related support, equipment, facilities, and certain data, including data center operations, data network, voice communication services and pharmacy data processing. This dependence makes our operations vulnerable to such third parties’ failure to perform adequately under the contract, due to internal or external factors. Due to continued consolidation in the industry, there are a limited number of service organizations with the size, scale and capabilities to effectively provide certain of these services, especially with regard to pharmacy benefits processing and management. However, we believe that other organizations could provide similar services on comparable terms. A change in service providers, however, could result in a decline in service quality and effectiveness or less favorable contract terms which could adversely affect our operating results.

 

We rely on our agreements with customers, confidentiality agreements with employees, and our trade secrets and copyrights to protect our proprietary rights. These legal protections and precautions may not prevent misappropriation of our proprietary information. In addition, substantial litigation regarding intellectual property rights exists in the software industry. We expect software products to be increasingly subject to third-party infringement claims as the number of products and competitors in this area grows.

 

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.

 

If we fail to manage prescription drug costs successfully, our financial results could suffer.

 

In general, prescription drug costs have been rising over the past few years. These increases are due to the introduction of new drugs costing significantly more than existing drugs, direct to consumer advertising by the pharmaceutical industry that creates consumer demand for particular brand-name drugs, and members seeking medications to address lifestyle changes. In order to control prescription drug costs, we have implemented multi-tiered copayment benefit designs for prescription drugs, including our four-tiered copayment benefit design, Rx4 and an Rx allowance program. We are also evaluating other multi-tiered designs. We cannot assure that these efforts will be successful in controlling costs. Failure to control these costs could have a material adverse effect on our financial position, results of operations and cash flows.

 

We are involved in various legal actions, which, if resolved unfavorably to us, could result in substantial monetary damages.

 

We are a party to a variety of legal actions that affect our business, including employment and employment discrimination-related suits, employee benefit claims, breach of contract actions, and tort claims.

 

We, together with some of our competitors in the health benefits business are defendants in a number of purported class action lawsuits. These include an action against us and nine of our competitors that purports to

 

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be brought on behalf of health care providers. This suit alleges breaches of federal statutes, including ERISA and RICO.

 

In addition, because of the nature of the health care business, we are subject to a variety of legal actions relating to our business operations, including the design, management and offering of products and services. These include and could include in the future:

 

  claims relating to the methodologies for calculating premiums;

 

  claims relating to the denial of health care benefits;

 

  challenges to the use of some software products used in administering claims;

 

  medical malpractice actions based on our medical necessity decisions or brought against us on the theory that we are liable for our providers’ alleged malpractice;

 

  allegations of anti-competitive and unfair business activities;

 

  provider disputes over compensation and termination of provider contracts;

 

  disputes related to self-funded business, including actions alleging claim administration errors;

 

  claims related to the failure to disclose some business practices; and

 

  claims relating to customer audits and contract performance.

 

In some cases, substantial non-economic or punitive damages as well as treble damages under the federal False Claims Act, RICO and other statutes may be sought. While we currently have insurance coverage for some of these potential liabilities, other potential liabilities may not be covered by insurance, insurers may dispute coverage or the amount of insurance may not be enough to cover the damages awarded. Additionally, the cost of business insurance coverage has increased significantly. As a result, we have increased the amount of risk that we self-insure, particularly with respect to matters incidental to our business. We believe that we are adequately insured for claims in excess of our self-insurance. However, some types of damages, like punitive damages, may not be covered by insurance, particularly in those jurisdictions in which coverage of punitive damages is prohibited. Insurance coverage for all or some forms of liability may become unavailable or prohibitively expensive in the future.

 

A description of material legal actions in which we are currently involved is included under “Legal Proceedings” of Item 3 in Part I. We cannot predict the outcome of these suits with certainty, and we are incurring expenses in the defense of these matters. In addition, recent court decisions, including some that erode protections under the Employee Retirement Income Security Act, or ERISA, and legislative activity may increase our exposure for any of these types of claims. Therefore, these legal actions could have a material adverse effect on our financial position, results of operations and cash flows.

 

As a government contractor, we are exposed to additional risks that could adversely affect our business or our willingness to participate in government health care programs.

 

A significant portion of our revenues relates to federal, state and local government health care coverage programs, including the TRICARE, Medicare+Choice, and Medicaid programs. These programs involve various risks, including:

 

  the possibility of reduced or insufficient government reimbursement in the future;

 

 

the possibility that we will not be able to extend or renew any of the contracts relating to these programs. These contracts also are generally subject to frequent change, including changes that may reduce the number of persons enrolled or eligible to enroll, reduce the revenue we receive or increase

 

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our administrative or health care costs under those programs. Our current TRICARE contract with the Department of Defense will be in effect until April 30, 2004 for Regions 2 and 5 and until June 30, 2004 for Regions 3 and 4. Each of the contracts is subject to a one-year renewal at the Government’s option. We believe these contracts will continue until the TRICARE transition described below. On August 21, 2003, the Department of Defense notified us that we were awarded the contract for the South Region, one of three newly-created regions under the government’s revised TRICARE Program. The current TRICARE Regions 3 and 4 will become part of the new South Region along with Region 6, which is currently administered by another contractor. The current Regions 2 and 5 will become part of the North Region, which was awarded to another contractor. Pursuant to the Department of Defense’s bid process, each of the three awards was subject to protests by unsuccessful bidders of prime contracts, however, none of the protests were successful.

 

  under the Department of Defense’s current schedule for implementation of the new TRICARE contracts, Regions 2 and 5 will transition to the new North Region for the start of healthcare delivery on July 1, 2004. Regions 3 and 4 will become part of the new South Region for the start of healthcare delivery on August 1, 2004 and Region 6 will become part of our new South Region for the start of healthcare delivery on November 1, 2004. If this schedule is realized, our TRICARE membership is expected to temporarily decline to 1.5 million in July 2004, and is expected to increase to 2.8 million in November 2004. This will also result in a decline in revenues during this period.

 

  in the event government reimbursement were to decline from projected amounts, our failure to reduce the health care costs associated with these programs could have a material adverse effect on our business. Changes to these government programs in the future may also affect our ability or willingness to participate in these programs. Other than as described herein, the loss of our current or future TRICARE contracts, would have a material adverse effect on our financial position, results of operations and cash flows;

 

  at December 31, 2003, under one of our contracts with the Centers for Medicare and Medicaid Services, or CMS, we provided health insurance coverage to approximately 229,100 members in Florida. This contract accounted for approximately 15% of our total premiums and ASO fees for the twelve months ended December 31, 2003. The loss of this and other CMS contracts or significant changes in the MedicareAdvantage program as a result of legislative action, including reductions in payments to us or increases in benefits to members without corresponding increases in payments, may have a material adverse effect on our financial condition, results of operations and cash flows;

 

  in December 2003, The Medicare Prescription Drug, Improvement and Modernization Act, or DIMA, was signed into law. DIMA includes provisions that require the 2004 stabilization funding to be directed toward increased reimbursement for providers, increased benefits or access for members or decreased member premiums. We believe DIMA will open new opportunities for us. However, DIMA may intensify competition in the seniors’ health services market. We do not believe that the benefit to our 2004 financial position, results of operations or cash flows will be material;

 

  higher comparative medical costs;

 

  government regulatory and reporting requirements;

 

  higher marketing and advertising costs per member as a result of marketing to individuals as opposed to groups; and

 

  the possibility of temporary or permanent suspension from participating in government health care programs, including Medicare and Medicaid, if we are convicted of fraud or other criminal conduct in the performance of a health care program or if there is an adverse decision against us under the federal False Claims Act.

 

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Our industry is currently subject to substantial government regulation, which, along with possible increased governmental regulation or legislative reform, increases our costs of doing business and could adversely affect our profitability.

 

The health care industry in general, and health insurance, particularly health maintenance organizations, or HMOs, and preferred provider organizations, or PPOs, are subject to substantial federal and state government regulation, including:

 

  regulation relating to minimum net worth;

 

  licensing requirements;

 

  approval of policy language and benefits;

 

  mandated benefits and processes;

 

  provider compensation arrangements;

 

  member disclosure;

 

  approval of acquisitions;

 

  approval of entry, withdrawal or re-entry into a state or market;

 

  premium rates; and

 

  periodic examinations by state and federal agencies.

 

State regulations require our licensed, operating subsidiaries to maintain minimum net worth requirements and restrict some investment activities. Additionally, those regulations restrict the ability of our subsidiaries to make dividend payments, loans, loan repayments or other payments to us.

 

In recent years, significant federal and state legislation affecting our business has been enacted. State and federal governmental authorities are continually considering changes to laws and regulations applicable to us and are currently considering regulations relating to:

 

  mandatory benefits and products;

 

  rules tightening time periods in which claims must be paid;

 

  medical malpractice reform;

 

  defining medical necessity;

 

  health insurance access;

 

  provider compensation and contract language;

 

  disclosure of provider fee schedules and other data impacting payments to providers;

 

  product flexibility and use of innovative technology;

 

  disclosure of provider quality information;

 

  health plan liability to members who fail to receive appropriate care;

 

  disclosure and composition of physician networks;

 

  formation of regional/national association health plans for small employers;

 

  physicians’ ability to collectively negotiate contract terms with carriers, including fees; and

 

  mental health parity.

 

All of these proposals could apply to us.

 

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There can be no assurance that we will be able to continue to obtain or maintain required governmental approvals or licenses or that legislative or regulatory changes will not have a material adverse effect on our business. Delays in obtaining or failure to obtain or maintain required approvals could adversely affect our revenue or the number of our members, increase costs or adversely affect our ability to bring new products to market as forecasted.

 

The National Association of Insurance Commissioners, or NAIC, has adopted risk-based capital requirements, also known as RBC, which is subject to state-by-state adoption and to the extent implemented, sets minimum capitalization requirements for insurance and HMO companies. The NAIC recommendations for life insurance companies were adopted in all states and the prescribed calculation for HMOs has been adopted in most states in which we operate. The HMO rules may increase the minimum capital required for some of our subsidiaries.

 

The Health Insurance Portability and Accountability Act of 1996, or HIPAA, includes administrative provisions directed at simplifying electronic data interchange through standardizing transactions, establishing uniform health care provider, payer, and employer identifiers and seeking protections for confidentiality and security of patient data. Under the new HIPAA standard transactions and code sets rules, we have made significant systems enhancements and invest in new technological solutions. The compliance and enforcement date for standard transactions and code sets rules was October 16, 2003. We have continued to be in compliance with this regulation. However, as many providers indicated that they could not yet comply, CMS stated that covered entities making a good faith effort to comply with HIPAA transactions and code-set standards would be allowed to implement contingency plans to maintain their operations and cash flows. On October 15, 2003, we announced implementation of a contingency plan to accept non-compliant electronic transactions from our providers. We will continue to accept and process transactions sent in pre-HIPAA electronic formats from providers who are showing a good-faith effort until all providers and clearinghouses are capable of transmitting fully compliant standards transactions as defined in the HIPAA implementation guidelines or until CMS begins enforcement of the HIPAA Electronic Data Interchange regulations. Management believes that the implementation of our contingency plans has minimized any disruptions in our business operations during this transition. However, if entities with which we do business do not ultimately comply with the HIPAA transactions and code set standards, it could result in disruptions of certain of our business operations.

 

Additionally, under the new HIPAA privacy rules, which became effective on April 14, 2003, we must now comply with a variety of requirements concerning the use and disclosure of individuals’ protected health information, establish rigorous internal procedures to protect health information and enter into business associate contracts with those companies to whom protected health information is disclosed. Regulations issued in February 2003 set standards for the security of electronic health information requiring compliance by April 21, 2005. Violations of these rules will subject us to significant penalties. Compliance with HIPAA regulations requires significant systems enhancements, training and administrative effort. The final rules do not provide for complete federal preemption of state laws, but rather preempt all inconsistent state laws unless the state law is more stringent. HIPAA could also expose us to additional liability for violations by our business associates.

 

Another area receiving increased focus is the time in which various laws require the payment of health care claims. Many states already have legislation in place covering payment of claims within a specific number of days. However, due to provider groups advocating for laws or regulations establishing even stricter standards, procedures and penalties, we expect additional regulatory scrutiny and supplemental legislation with respect to claims payment practices. The provider-sponsored bills are characterized by stiff penalties for late payment, including high interest rates payable to providers and costly fines levied by state insurance departments and attorneys general. This legislation and possible future regulation and oversight could expose our Company to additional liability and penalties.

 

We are also subject to various governmental audits and investigations. These can include audits and investigations by state attorneys general, CMS, the Office of the Inspector General of Health and Human

 

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Services, the Office of Personnel Management, the Department of Justice, the Department of Labor, and state Departments of Insurance and Departments of Health. These activities could result in the loss of licensure or the right to participate in various programs, or the imposition of fines, penalties and other sanctions. In addition, disclosure of any adverse investigation or audit results or sanctions could negatively affect our reputation in various markets and make it more difficult for us to sell our products and services.

 

If we fail to maintain satisfactory relationships with the providers of care to our members, our business could be adversely affected.

 

We contract with physicians, hospitals and other providers to deliver health care to our members. Our products encourage or require our customers to use these contracted providers. These providers may share medical cost risk with us or have financial incentives to deliver quality medical services in a cost-effective manner.

 

In any particular market, providers could refuse to contract with us, demand higher payments, or take other actions that could result in higher health care costs for us, less desirable products for customers and members or difficulty meeting regulatory or accreditation requirements. In some markets, some providers, particularly hospitals, physician/hospital organizations or multi-specialty physician groups, may have significant market positions and negotiating power. In addition, physician or practice management companies, which aggregate physician practices for administrative efficiency and marketing leverage, may, in some cases, compete directly with us. If these providers refuse to contract with us, use their market position to negotiate favorable contracts or place us at a competitive disadvantage, our ability to market products or to be profitable in those areas could be adversely affected.

 

In some situations, we have contracts with individual or groups of primary care physicians for an actuarially determined, fixed, per-member-per-month fee under which physicians are paid an amount to provide all required medical services to our members (i.e. capitation). The inability of providers to properly manage costs under these capitation arrangements can result in the financial instability of these providers and the termination of their relationship with us. In addition, payment or other disputes between a primary care provider and specialists with whom the primary care provider contracts can result in a disruption in the provision of services to our members or a reduction in the services available to our members. The financial instability or failure of a primary care provider to pay other providers for services rendered could lead those other providers to demand payment from us, even though we have made our regular fixed payments to the primary provider. There can be no assurance that providers with whom we contract will properly manage the costs of services, maintain financial solvency or avoid disputes with other providers. Any of these events could have an adverse effect on the provision of services to our members and our operations.

 

Our ability to obtain funds from our subsidiaries is restricted.

 

Because we operate as a holding company, we are dependent upon dividends and administrative expense reimbursements from our subsidiaries to fund the obligations of Humana Inc., the parent company. These subsidiaries generally are regulated by states’ Departments of Insurance. In most states, we are required to seek prior approval by these state regulatory authorities before we transfer money or pay dividends from these subsidiaries that exceed specified amounts, or, in some states, any amount. In addition, we normally notify the state Departments of Insurance prior to making payments that do not require approval. We are also required by law to maintain specific prescribed minimum amounts of capital in these subsidiaries. One TRICARE subsidiary under the Regions 3 and 4 contract with the Department of Defense is required to maintain assets at least equivalent to its current liabilities.

 

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Increased litigation and negative publicity could increase our cost of doing business.

 

The health benefits industry continues to receive significant negative publicity reflecting the public perception of the industry. This publicity and perception have been accompanied by increased litigation, including some large jury awards, legislative activity, regulation and governmental review of industry practices. These factors may adversely affect our ability to market our products or services, may require us to change our products or services, may increase the regulatory burdens under which we operate and may require us to pay large judgments or fines. Any combination of these factors could further increase our cost of doing business and adversely affect our financial position, results of operations and cash flows.

 

ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The information required by this Item appears in Management’s Discussion and Analysis of Financial Condition and Results of Operations – Item 7 herein, under the caption “Market Risk-Sensitive Financial Instruments and Positions.”

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Humana Inc.

 

CONSOLIDATED BALANCE SHEETS

 

     December 31,

 
     2003

    2002

 
     (in thousands, except share
amounts)
 
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 931,404     $ 721,357  

Investment securities

     1,676,642       1,395,068  

Receivables, less allowance for doubtful accounts of $40,400 in 2003 and $30,178 in 2002

                

Premiums

     452,404       321,135  

Administrative services fees

     13,583       68,316  

Other

     247,298       250,857  
    


 


Total current assets

     3,321,331       2,756,733  
    


 


Property and equipment, net

     416,472       459,842  

Other assets:

                

Long-term investment securities

     319,167       299,489  

Goodwill

     776,874       776,874  

Other

     459,479       586,999  
    


 


Total other assets

     1,555,520       1,663,362  
    


 


Total assets

   $ 5,293,323     $ 4,879,937  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

Current liabilities:

                

Medical and other expenses payable

   $ 1,272,156     $ 1,142,131  

Trade accounts payable and accrued expenses

     440,340       552,689  

Book overdraft

     219,054       94,882  

Unearned revenues

     333,071       335,757  

Short-term debt

     —         265,000  
    


 


Total current liabilities

     2,264,621       2,390,459  

Long-term debt

     642,638       339,913  

Other long-term liabilities

     550,115       543,091  
    


 


Total liabilities

     3,457,374       3,273,463  
    


 


Commitments and contingencies

                

Stockholders’ equity:

                

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

     —         —    

Common stock, $0.16 2/3 par; 300,000,000 shares authorized; 173,909,127 shares issued in 2003 and 171,334,893 shares issued in 2002

     28,984       28,556  

Capital in excess of par value

     974,975       931,089  

Retained earnings

     949,811       720,877  

Accumulated other comprehensive income

     16,909       22,455  

Unearned stock compensation

     (754 )     (6,516 )

Treasury stock, at cost, 12,018,281 shares in 2003 and 8,362,537 shares in 2002

     (133,976 )     (89,987 )
    


 


Total stockholders’ equity

     1,835,949       1,606,474  
    


 


Total liabilities and stockholders’ equity

   $ 5,293,323     $ 4,879,937  
    


 


 

The accompanying notes are an integral part of the consolidated financial statements.

 

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Humana Inc.

 

CONSOLIDATED STATEMENTS OF INCOME

 

     For the year ended December 31,

     2003

   2002

   2001

     (in thousands, except per share results)

Revenues:

                    

Premiums

   $ 11,825,283    $ 10,930,397    $ 9,938,961

Administrative services fees

     271,676      244,396      137,090

Investment and other income

     129,352      86,388      118,835
    

  

  

Total revenues

     12,226,311      11,261,181      10,194,886
    

  

  

Operating expenses:

                    

Medical

     9,879,421      9,138,196      8,279,844

Selling, general and administrative

     1,858,028      1,775,069      1,545,129

Depreciation and amortization

     126,779      120,730      161,531
    

  

  

Total operating expenses

     11,864,228      11,033,995      9,986,504
    

  

  

Income from operations

     362,083      227,186      208,382

Interest expense

     17,367      17,252      25,302
    

  

  

Income before income taxes

     344,716      209,934      183,080

Provision for income taxes

     115,782      67,179      65,909
    

  

  

Net income

   $ 228,934    $ 142,755    $ 117,171
    

  

  

Basic earnings per common share

   $ 1.44    $ 0.87    $ 0.71
    

  

  

Diluted earnings per common share

   $ 1.41    $ 0.85    $ 0.70
    

  

  

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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Humana Inc.

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

 

    Common Stock

    Capital In
Excess of
Par Value


    Retained
Earnings


  Accumulated
Other
Comprehensive
Income (Loss)


   

Unearned

Stock
Compensation


    Treasury
Stock


    Total
Stockholders’
Equity


 
    Issued
Shares


    Amount

             
    (in thousands)  

Balances, January 1, 2001

  170,889     $ 28,482     $ 922,621     $ 460,951   $ (8,509 )   $ (29,177 )   $ (13,947 )   $ 1,360,421  

Comprehensive income:

                                                           

Net income

  —         —         —         117,171     —         —         —         117,171  

Other comprehensive income:

                                                           

Net unrealized investment gains, net of $12,847 tax

  —         —         —         —       20,179       —         —         20,179  
                                                       


Comprehensive income

                                                        137,350  

Common stock repurchases

  —         —         —         —       —         —         (1,867 )     (1,867 )

Restricted stock grants (forfeitures), net

  (433 )     (72 )     (1,699 )     —       —         815       956       —    

Restricted stock amortization

  —         —         —         —       —         9,492       —         9,492  

Restricted stock market value adjustment

  —         —         (988 )     —       —         988       —         —    

Stock option exercises

  237       39       1,776       —       —         —         (81 )     1,734  

Stock option tax benefit

  —         —         261       —       —         —         —         261  

Other stock compensation

  —         —         468       —       —         —         90       558  
   

 


 


 

 


 


 


 


Balances, December 31, 2001

  170,693       28,449       922,439       578,122     11,670       (17,882 )     (14,849 )     1,507,949  

Comprehensive income:

                                                           

Net income

  —         —         —         142,755     —         —         —         142,755  

Other comprehensive income:

                                                           

Net unrealized investment gains, net of $6,465 tax

  —         —         —         —       10,785       —         —         10,785  
                                                       


Comprehensive income

                                                        153,540  

Common stock repurchases

  —         —         —         —       —         —         (74,035 )     (74,035 )

Restricted stock forfeitures

  (331 )     (55 )     (2,317 )     —       —         2,372               —    

Restricted stock amortization

  —         —         —         —       —         8,994       —         8,994  

Stock option exercises

  973       162       8,370       —       —         —         (1,206 )     7,326  

Stock option tax benefit

  —         —         2,204       —       —         —         —         2,204  

Other stock compensation

  —         —         393       —       —         —         103       496  
   

 


 


 

 


 


 


 


Balances, December 31, 2002

  171,335       28,556       931,089       720,877     22,455       (6,516 )     (89,987 )     1,606,474  

Comprehensive income:

                                                           

Net income

  —         —         —         228,934     —         —         —         228,934  

Other comprehensive loss:

                                                           

Net unrealized investment losses, net of ($3,531) tax

  —         —         —         —       (5,546 )     —         —         (5,546 )
                                                       


Comprehensive income