5 Things Humana Inc. Management Wants You to Know

Interested in owning insurers based on improving results tied to the launch of the Affordable Care Act? Remember that not all insurers benefit equally from reform.

Some insures, like WellPoint, are more exposed to exchanges, and others, like Molina Health, benefit most from Medicaid expansion. At Humana Inc (NYSE: HUM  ) , it's Medicare plans that move the needle.

Medicare accounts for more than 75% of Humana's revenue, but exchanges and Medicaid only represent about 5% and 1.5% of sales, respectively.

That's an important take-away for investors, but it's not the only thing investors should know about Humana. Here are five quotes from Humana's second quarter conference call that investors should keep in mind when considering Humana's shares.

1. Ageing boomers are supporting growth
Roughly 10,000 baby boomers are turning 65 every day through 2029 and many of these boomers will embrace Medicare Advantage plans sold by Humana. Humana's Medicare Advantage plans replace traditional, or original, Medicare, often providing seniors with more comprehensive care, including drug benefits. That appeal appears to be resonating given this C-suite comment during Humana's second quarter earnings conference call.

"Medicare membership has grown significantly this year. While we also anticipate net growth for individual Medicare in 2015," said Bruce Broussard, president and CEO.

Membership in Humana's individual Medicare Advantage plans grew 16.4%, or 333,300 members to 2.36 million people in the past year. That helped lift Humana's revenue from Medicare members from $7.5 billion a year ago to $8.8 billion in the second quarter.

2. Reviewing strategic alternatives
Humana provides health care insurance to more than 13.6 million people and one of the largest line items for member cost of care is prescription medicine. As a result, Humana runs its own pharmacy benefit manager, or PBM.

That PBM negotiates lower drug prices for Humana, promotes the use of generic drugs, and helps reduce hospitalizations due to patient's failing to take their drugs as prescribed.

The PBM also works with non-Humana health care payers, such as self-insured companies, to help reduce their drug costs. While Humana's PBM is big, it's far from the biggest PBM (CVS Caremark and Express Scripts are far larger). Since drug prices are sky-rocketing, scale is becoming increasingly important to inking cut-rate prices with drugmakers. As a result, Humana appears willing to consider various alternatives for its PBM business.

"A thorough and rigorous analysis of our PBM is under way, which includes a strategic and financial review," according to Broussard.

3. Picking up the pace
Although it's Medicare that drives revenue and profit at Humana, the company is benefiting on the margin from membership growth tied to the Affordable Care Act's exchanges.

Humana's participation in exchanges allowed its individual commercial membership to jump 122% year-to-date to 1.1 million people. 

"Our health care exchange membership also grew substantially during the second quarter given the influx of applications late in the first quarter," said Broussard.

That influx of new members helped lift Humana's fully insured revenue from $1.6 billion a year ago to $2.2 billion in the second quarter.

4. Keeping a lid on costs

"The majority of our ACA membership was effective in the second quarter and the very early drug claims data indicate that those members are on average younger and healthier than those that enrolled in the first quarter," said Humana senior Vice President and CFO Brian Kane.

That's great news for shareholders given that fear over medical care costs has served as a lid on shares in the past.

So far, that fear hasn't materialized. During the first six months of 2014, Humana's medical loss ratio, or the amount of premiums the company has spent on member health care, has stayed pretty much in check versus a year ago. The ratio in its retail segment, which includes the exchanges, has remained unchanged at 85%.

5. Conviction to reward investors
At a bit shy of 1%, Humana's shares don't offer shareholders a very large dividend yield, but that could change in the future.

The company continues to actively buy back shares, spending $101 million last quarter to repurchase over 805,000 shares. And during the company's conference call, management indicated that it would consider its capital allocation strategy carefully given that clarity into capital needs has improved over the past two quarters.

"With regard to capital allocation, over the coming months, we are committed to taking a fresh look at our financial leverage, capital allocation and return policies. We will evaluate increasing the amount of capital we return to shareholders beyond what we have historically done while considering the needs and opportunities of our business," said Kane.

Since Humana's cash dividend payout ratio, a measure of how much of the company's operating cash (after preferred dividends and capex) is used to pay common dividends is lower than competitors UnitedHealth Group and WellPoint, there could be room for a boost.

HUM Cash Dividend Payout Ratio (Annual) Chart

HUM Cash Dividend Payout Ratio (Annual) data by YCharts

Fool-worthy final thoughts
Despite Humana's membership and revenue growth, the company continues to forecast earnings per share of just $7.25-$7.75 this year. If it delivers at the low end of that guidance it would represent a decline from the $7.73 the company earned in 2013.

That said, an older, longer-living America will continue to offer Medicare growth opportunities and management has indicated that pricing for plans offered through exchanges next year could make the exchange business break-even in 2015. If that's true, a larger membership base could allow for earnings growth in the future.

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