Growth in the health benefits market can be tough. Not only do you have to contend with rising medical costs, but also you have to deal with major competitors such as UnitedHealth (NYSE:UNH), Aetna (NYSE:AET), and CIGNA (NYSE:CI). Sometimes, then, above-average growth requires above-average risk, and it's possible that that's the approach being taken today by Humana (NYSE:HUM).
It certainly doesn't seem that there was any real shortage of growth in the third quarter. Humana's revenue rose 20% to more than $3.8 billion, and there were good enrollment trends in the Medicare business. Two items, though, blur earnings comparisons in this quarter -- a class action legal settlement and Katrina-related expenses. With those expenses included, earnings per share came in at $0.30, but that number jumps to $0.60 without them and would have handily beaten the average estimate for the quarter.
Below the headline numbers, there wasn't much that was terribly different about this quarter. The government business segment (Medicare, Medicaid, and TRICARE) showed good revenue and membership trends, and pre-tax income would have been up significantly (about 40%) were it not for including the litigation and hurricane expenses. Humana's medical loss ratio did increase, though, and that's something to keep an eye on.
In the commercial business, revenue declined along with ongoing "attrition" in membership. I suppose attrition sounds better than "losing members," right? While this segment's pre-tax loss was largely a function of the aforementioned hurricane and litigation expenses, even adding those back leads to year-on-year profit decline. Here too, the medical expense ratio worsened from last year.
It seems pretty clear to me that Humana is making aggressive moves to grow its membership and revenue in the short term. The company put in very aggressive bids for Medicare Part D and as a result was successful across the board. Now, that will mean improved membership numbers, growing revenue, and perhaps some positive operating leverage. But the low bids come with a risk: If Humana did in fact make those bids too aggressive, they could be facing some underwriting risk in the years to come.
I can appreciate Humana's interest in growing its Medicare business, especially as the current No. 1 player in Medicare, PacifiCare (NYSE:PHS), is being bought out by UnitedHealth. And it is certainly possible that these aggressive Part D bids will in time lead to capturing even more business from members. Still, investors should realize that this growth won't be coming without some risks -- risks that could bite into earnings down the road.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
