Edgar Filing: HUMANA INC

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2013

¨	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 or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

500 West Main Street

Louisville, Kentucky 40202

(Address of principal executive offices, including zip code)

(502) 580-1000

(Registrant’s telephone number, including area code)

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x No ¨

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

Class of Common Stock

$0.16 2/3 par value

Outstanding at

June 30, 2013

156,463,120 shares

Humana Inc.

FORM 10-Q

JUNE 30, 2013

INDEX


		Page
	Part I: Financial Information

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets at June 30, 2013 and December 31, 2012		3

	Condensed Consolidated Statements of Income for the three and six months ended June 30, 2013 and 2012		4

	Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2013 and 2012		5

	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012		6

	Notes to Condensed Consolidated Financial Statements		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		49

Item 4.	Controls and Procedures		49

	Part II: Other Information

Item 1.	Legal Proceedings		50

Item 1A.	Risk Factors		50

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		50

Item 3.	Defaults Upon Senior Securities		50

Item 4.	Mine Safety Disclosures		50

Item 5.	Other Information		50

Item 6.	Exhibits		51

	Signatures		52

	Certifications

Humana Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)


	June 30, 2013			December 31, 2012
	(in millions, except share amounts)
ASSETS
Current assets:
Cash and cash equivalents	$	1,519		$	1,306
Investment securities		7,556			8,001
Receivables, less allowance for doubtful accounts of $109 in 2013 and $94 in 2012		1,593			733
Other current assets		1,960			1,670

Total current assets		12,628			11,710

Property and equipment, net		1,133			1,098
Long-term investment securities		1,770			1,846
Goodwill		3,638			3,640
Other long-term assets		1,679			1,685

Total assets	$	20,848		$	19,979

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Benefits payable	$	4,157		$	3,779
Trade accounts payable and accrued expenses		2,174			2,042
Book overdraft		246			324
Unearned revenues		193			230

Total current liabilities		6,770			6,375
Long-term debt		2,606			2,611
Future policy benefits payable		1,810			1,858
Other long-term liabilities		327			288

Total liabilities		11,513			11,132

Commitments and contingencies
Stockholders’ equity:
Preferred stock, $1 par; 10,000,000 shares authorized; none issued		0			0
Common stock, $0.16 2/3 par; 300,000,000 shares authorized; 195,678,752 shares issued at June 30, 2013 and 194,470,820 shares issued at December 31, 2012		32			32
Capital in excess of par value		2,190			2,101
Retained earnings		8,688			7,881
Accumulated other comprehensive income		209			386
Treasury stock, at cost, 39,215,632 shares at June 30, 2013 and 36,138,955 shares at December 31, 2012		(1,784	)		(1,553	)

Total stockholders’ equity		9,335			8,847

Total liabilities and stockholders’ equity	$	20,848		$	19,979

See accompanying notes to condensed consolidated financial statements.

Humana Inc.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)


	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
	(in millions, except per share results)
Revenues:
Premiums	$	9,701	$	9,166	$	19,569	$	18,941
Services		528		434		1,053		784
Investment income		92		99		185		193

Total revenues		10,321		9,699		20,807		19,918

Operating expenses:
Benefits		8,091		7,652		16,286		16,002
Operating costs		1,461		1,384		2,907		2,767
Depreciation and amortization		80		73		160		143

Total operating expenses		9,632		9,109		19,353		18,912

Income from operations		689		590		1,454		1,006
Interest expense		35		26		70		52

Income before income taxes		654		564		1,384		954
Provision for income taxes		234		208		491		350

Net income	$	420	$	356	$	893	$	604

Basic earnings per common share	$	2.66	$	2.19	$	5.64	$	3.70

Diluted earnings per common share	$	2.63	$	2.16	$	5.58	$	3.65

Dividends declared per common share	$	0.27	$	0.26	$	0.53	$	0.51

See accompanying notes to condensed consolidated financial statements.

Humana Inc.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)


	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
	(in millions)
Net income	$	420		$	356		$	893		$	604
Other comprehensive (loss) income:
Change in gross unrealized investment gains/losses		(183	)		31			(270	)		52
Effect of income taxes		67			(11	)		99			(19	)

Total change in unrealized investment gains/losses, net of tax		(116	)		20			(171	)		33

Reclassification adjustment for net realized gains included in investment income		(6	)		(10	)		(10	)		(14	)
Effect of income taxes		2			4			4			5

Total reclassification adjustment, net of tax		(4	)		(6	)		(6	)		(9	)

Other comprehensive (loss) income, net of tax		(120	)		14			(177	)		24

Comprehensive income	$	300		$	370		$	716		$	628

See accompanying notes to condensed consolidated financial statements.

Humana Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	For the six months ended June 30,
	2013			2012
	(in millions)
Cash flows from operating activities
Net income	$	893		$	604
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized capital gains		(10	)		(14	)
Stock-based compensation		51			54
Depreciation and amortization		206			160
Benefit for deferred income taxes		(8	)		(9	)
Changes in operating assets and liabilities, net of effect of businesses acquired:
Receivables		(860	)		177
Other assets		(108	)		(250	)
Benefits payable		378			170
Other liabilities		52			51
Unearned revenues		(37	)		2,077
Other, net		28			32

Net cash provided by operating activities		585			3,052

Cash flows from investing activities
Acquisitions, net of cash acquired		(12	)		(76	)
Proceeds from sale of business		33			0
Purchases of property and equipment		(187	)		(185	)
Purchases of investment securities		(1,385	)		(1,364	)
Maturities of investment securities		549			757
Proceeds from sales of investment securities		854			529

Net cash used in investing activities		(148	)		(339	)

Cash flows from financing activities
Receipts (withdrawals) from contract deposits, net		132			152
Repayment of long-term debt		0			(36	)
Change in book overdraft		(78	)		(46	)
Common stock repurchases		(231	)		(278	)
Dividends paid		(83	)		(82	)
Excess tax benefit from stock-based compensation		0			21
Proceeds from stock option exercises and other		36			48

Net cash used in financing activities		(224	)		(221	)

Increase in cash and cash equivalents		213			2,492
Cash and cash equivalents at beginning of period		1,306			1,377

Cash and cash equivalents at end of period	$	1,519		$	3,869

Supplemental cash flow disclosures:
Interest payments	$	72		$	55
Income tax payments, net	$	511		$	293

See accompanying notes to condensed consolidated financial statements.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements are presented in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America, or GAAP, or those normally made in an Annual Report on Form 10-K. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. For further information, the reader of this Form 10-Q should refer to our Form 10-K for the year ended December 31, 2012, that was filed with the Securities and Exchange Commission, or the SEC, on February 21, 2013, as amended on April 12, 2013 to correct an error in the exhibit index. We refer to the Form 10-K, together with any amendments, as the “2012 Form 10-K” in this document. References throughout this document to “we,” “us,” “our,” “Company,” and “Humana” mean Humana Inc. and its subsidiaries.

The preparation of our condensed consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. The areas involving the most significant use of estimates are the estimation of benefits payable, the impact of risk sharing provisions related to our Medicare contracts, the valuation and related impairment recognition of investment securities, and the valuation and related impairment recognition of long-lived assets, including goodwill. These estimates are based on knowledge of current events and anticipated future events, and accordingly, actual results may ultimately differ materially from those estimates. Refer to Note 2 to the consolidated financial statements included in our 2012 Form 10-K for information on accounting policies that the Company considers in preparing its consolidated financial statements.

The financial information has been prepared in accordance with our customary accounting practices and has not been audited. In our opinion, the information presented reflects all adjustments necessary for a fair statement of interim results. All such adjustments are of a normal and recurring nature.

Business Segment Reclassifications

On January 1, 2013, we reclassified certain of our businesses to correspond with internal management reporting changes and renamed our Health and Well-Being Services segment as Healthcare Services. Our Employer Group segment now includes our health and wellness businesses, including HumanaVitality and Lifesynch’s employee assistance programs, which had historically been reported in our Healthcare Services segment. The Retail segment now includes our contract with the Centers for Medicare and Medicaid Services, or CMS, to administer the Limited Income Newly Eligible Transition, or LI-NET, program as well as our state-based Medicaid businesses, which had historically been reported in our Other Businesses category. Prior period segment financial information has been recast to conform to the 2013 presentation. See Note 13 for segment financial information.

Military Services

As described in Note 2 to the consolidated financial statements included in our 2012 Form 10-K, on April 1, 2012, we began delivering services under the current TRICARE South Region contract with the Department of Defense, or DoD, as more fully described in Note 12. We account for revenues under the current contract net of estimated healthcare costs similar to an administrative services fee only agreement. Under our previous contract, revenues were reported on a gross basis and included health care services provided to beneficiaries which were in turn reimbursed by the federal government.

2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

There are no recently issued accounting standards that apply to us or that will have a material impact on our results of operations, financial condition, or cash flows.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

3. ACQUISITIONS

On December 21, 2012, we acquired Metropolitan Health Networks, Inc., or Metropolitan, a Medical Services Organization, or MSO, that coordinates medical care for Medicare Advantage beneficiaries and Medicaid recipients, primarily in Florida. We acquired all of the outstanding shares of Metropolitan and repaid all outstanding debt of Metropolitan for a transaction value of $851 million, plus transaction expenses. The total consideration of $851 million exceeded our estimated fair value of the net tangible assets acquired by approximately $833 million, of which we allocated $263 million to other intangible assets and $570 million to goodwill. The goodwill was assigned to the Healthcare Services segment and is not deductible for tax purposes. The other intangible assets, which primarily consist of customer contracts and trade names, have a weighted average useful life of 8.4 years. The purchase price allocation of Metropolitan is preliminary, subject to completion of valuation analyses, including, for example, refining assumptions used to calculate the fair value of other intangible assets.

On October 29, 2012, we acquired a noncontrolling equity interest in MCCI Holdings, LLC, or MCCI, a privately held MSO headquartered in Miami, Florida that coordinates medical care for Medicare Advantage beneficiaries and Medicaid recipients, primarily in Florida and Texas.

The Metropolitan and MCCI transactions provide us with components of a successful integrated care delivery model that has demonstrated scalability to new markets. A substantial portion of the revenues for both Metropolitan and MCCI are derived from services provided to Humana Medicare Advantage members under capitation contracts with our health plans. In addition, Metropolitan and MCCI provide services to Medicare Advantage and Medicaid members under capitation contracts with third party health plans. Under these capitation agreements with Humana and third party health plans, Metropolitan and MCCI assume financial risk associated with these Medicare Advantage and Medicaid members.

On July 6, 2012, we acquired SeniorBridge Family Companies, Inc., or SeniorBridge, a chronic-care provider of in-home care for seniors, expanding our existing clinical and home health capabilities and strengthening our offerings for members with complex chronic-care needs. The allocation of the purchase price resulted in goodwill of $99 million and other intangible assets of $14 million. The goodwill was assigned to the Healthcare Services segment and is not deductible for tax purposes. The other intangible assets, which primarily consist of customer contracts, trade name, and technology, have a weighted average useful life of 5.2 years.

Effective March 31, 2012, we acquired Arcadian Management Services, Inc., or Arcadian, a Medicare Advantage health maintenance organization (HMO) serving members in 15 U.S. states, increasing Medicare membership and expanding our Medicare footprint and future growth opportunities in these states. The allocation of the purchase price resulted in goodwill of $44 million and other intangible assets of $38 million. The goodwill was assigned to the Retail segment and is not deductible for tax purposes. The other intangible assets, which primarily consist of customer contracts and provider contracts, have a weighted average useful life of 9.7 years.

The results of operations and financial condition of Metropolitan, SeniorBridge, and Arcadian have been included in our condensed consolidated statements of income and condensed consolidated balance sheets from the acquisition dates. In addition, during 2013 and 2012, we acquired other health and wellness, provider, and technology related businesses which, individually or in the aggregate, have not had, and are not expected to have, a material impact on our results of operations, financial condition, or cash flows. For the year ended December 31, 2012, primarily in the fourth quarter, we recognized acquisition-related costs in connection with 2012 acquisitions of $27 million. The pro forma financial information assuming the acquisitions had occurred as of the beginning of the calendar year prior to the year of acquisition, as well as the revenues and earnings generated during the year of acquisition, were not material for disclosure purposes.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

On July 24, 2013, we announced that we had entered into a definitive agreement to acquire American Eldercare Inc., or American Eldercare, the largest provider of nursing home diversion services in the state of Florida (serving frail and elderly individuals in home and community-based settings). American Eldercare complements our core capabilities and strength in serving seniors and disabled individuals with a unique focus on individualized and integrated care, and was selected to provide Medicaid long-term care services across the entire state of Florida. The enrollment effective dates for the various regions range from August 2013 to March 2014. The transaction is subject to state regulatory approvals and is anticipated to close by the fourth quarter of 2013.

4. INVESTMENT SECURITIES

Investment securities classified as current and long-term were as follows at June 30, 2013 and December 31, 2012, respectively:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in millions)
June 30, 2013
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations	$	568	$	9	$	(6	)	$	571
Mortgage-backed securities		1,423		44		(27	)		1,440
Tax-exempt municipal securities		2,933		113		(18	)		3,028
Mortgage-backed securities:
Residential		27		1		0			28
Commercial		557		23		(7	)		573
Asset-backed securities		53		1		(1	)		53
Corporate debt securities		3,423		239		(29	)		3,633

Total debt securities	$	8,984	$	430	$	(88	)	$	9,326


December 31, 2012
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations	$	602	$	16	$	0		$	618
Mortgage-backed securities		1,519		85		(1	)		1,603
Tax-exempt municipal securities		2,890		185		(4	)		3,071
Mortgage-backed securities:
Residential		33		2		(1	)		34
Commercial		615		44		0			659
Asset-backed securities		66		2		0			68
Corporate debt securities		3,394		402		(2	)		3,794

Total debt securities	$	9,119	$	736	$	(8	)	$	9,847

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

Gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position were as follows at June 30, 2013 and December 31, 2012, respectively:


	Less than 12 months					12 months or more					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
	(in millions)
June 30, 2013
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations	$	298	$	(6	)	$	6	$	0		$	304	$	(6	)
Mortgage-backed securities		660		(26	)		17		(1	)		677		(27	)
Tax-exempt municipal securities		466		(17	)		28		(1	)		494		(18	)
Mortgage-backed securities:
Residential		2		0			2		0			4		0
Commercial		199		(7	)		0		0			199		(7	)
Asset-backed securities		36		(1	)		0		0			36		(1	)
Corporate debt securities		588		(28	)		4		(1	)		592		(29	)

Total debt securities	$	2,249	$	(85	)	$	57	$	(3	)	$	2,306	$	(88	)


December 31, 2012
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations	$	56	$	0		$	2	$	0		$	58	$	0
Mortgage-backed securities		38		0			25		(1	)		63		(1	)
Tax-exempt municipal securities		233		(3	)		27		(1	)		260		(4	)
Mortgage-backed securities:
Residential		0		0			4		(1	)		4		(1	)
Commercial		94		0			0		0			94		0
Asset-backed securities		2		0			4		0			6		0
Corporate debt securities		104		(2	)		4		0			108		(2	)

Total debt securities	$	527	$	(5	)	$	66	$	(3	)	$	593	$	(8	)

Approximately 94% of our debt securities were investment-grade quality, with a weighted average credit rating of AA- by S&P at June 30, 2013. Most of the debt securities that were below investment-grade were rated BB, the higher end of the below investment-grade rating scale. At June 30, 2013, 10% of our tax-exempt municipal securities were pre-refunded, generally with U.S. government and agency securities. Tax-exempt municipal securities that were not pre-refunded were diversified among general obligation bonds of U.S. states and local municipalities as well as special revenue bonds. General obligation bonds, which are backed by the taxing power and full faith of the issuer, accounted for 41% of the tax-exempt municipals that were not pre-refunded in the portfolio. Special revenue bonds, issued by a municipality to finance a specific public works project such as utilities, water and sewer, transportation, or education, and supported by the revenues of that project, accounted for the remaining 59% of these municipals. Our general obligation bonds are diversified across the United States with no individual state exceeding 10%. In addition, 20% of our tax-exempt securities were insured by bond insurers and had an equivalent weighted average S&P credit rating of AA- exclusive of the bond insurers’ guarantee. Our investment policy limits investments in a single issuer and requires diversification among various asset types.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

The recoverability of our non-agency residential and commercial mortgage-backed securities is supported by factors such as seniority, underlying collateral characteristics, and credit enhancements. These residential and commercial mortgage-backed securities at June 30, 2013 primarily were composed of senior tranches having high credit support, with over 99% of the collateral consisting of prime loans. The weighted average credit rating of all commercial mortgage-backed securities was AA at June 30, 2013.

The percentage of corporate securities associated with the financial services industry was 24% at June 30, 2013 and 23% at December 31, 2012.

Several European countries, including Spain, Italy, Ireland, Portugal, Cyprus, and Greece, have been subject to credit deterioration due to weakness in their economic and fiscal situations. We have no direct exposure to sovereign issuances of these six countries.

All issuers of securities we own that were trading at an unrealized loss at June 30, 2013 remain current on all contractual payments. After taking into account these and other factors previously described, we believe these unrealized losses primarily were caused by an increase in market interest rates and tighter liquidity conditions in the current markets than when the securities were purchased. At June 30, 2013, we did not intend to sell the securities with an unrealized loss position in accumulated other comprehensive income, and it is not likely that we will be required to sell these securities before recovery of their amortized cost basis. As a result, we believe that the securities with an unrealized loss were not other-than-temporarily impaired at June 30, 2013.

The detail of realized gains (losses) related to investment securities and included within investment income was as follows for the three and six months ended June 30, 2013 and 2012:


	For the three months ended June 30,						For the six months ended June 30,
	2013			2012			2013			2012
	(in millions)
Gross realized gains	$	11		$	11		$	17		$	16
Gross realized losses		(5	)		(1	)		(7	)		(2	)

Net realized capital gains	$	6		$	10		$	10		$	14

There were no material other-than-temporary impairments for the three and six months ended June 30, 2013 or 2012.

The contractual maturities of debt securities available for sale at June 30, 2013, regardless of their balance sheet classification, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


	Amortized Cost		Fair Value
	(in millions)
Due within one year	$	473	$	478
Due after one year through five years		1,833		1,899
Due after five years through ten years		2,768		2,900
Due after ten years		1,850		1,955
Mortgage and asset-backed securities		2,060		2,094

Total debt securities	$	8,984	$	9,326

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

5. FAIR VALUE

Financial Assets

The following table summarizes our fair value measurements at June 30, 2013 and December 31, 2012, respectively, for financial assets measured at fair value on a recurring basis:


			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets (Level 1)		Other Observable Inputs (Level 2)		Unobservable Inputs (Level 3)
	(in millions)
June 30, 2013
Cash equivalents	$	1,410	$	1,410	$	0	$	0
Debt securities:
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations		571		0		571		0
Mortgage-backed securities		1,440		0		1,440		0
Tax-exempt municipal securities		3,028		0		3,015		13
Mortgage-backed securities:
Residential		28		0		28		0
Commercial		573		0		573		0
Asset-backed securities		53		0		52		1
Corporate debt securities		3,633		0		3,611		22

Total debt securities		9,326		0		9,290		36

Total invested assets	$	10,736	$	1,410	$	9,290	$	36


December 31, 2012
Cash equivalents	$	1,177	$	1,177	$	0	$	0
Debt securities:
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations		618		0		618		0
Mortgage-backed securities		1,603		0		1,603		0
Tax-exempt municipal securities		3,071		0		3,058		13
Mortgage-backed securities:
Residential		34		0		34		0
Commercial		659		0		659		0
Asset-backed securities		68		0		67		1
Corporate debt securities		3,794		0		3,770		24

Total debt securities		9,847		0		9,809		38

Total invested assets	$	11,024	$	1,177	$	9,809	$	38

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

There were no material transfers between Level 1 and Level 2 during the three and six months ended June 30, 2013 or June 30, 2012.

Our Level 3 assets had a fair value of $36 million at June 30, 2013, or less than 0.4% of our total invested assets. During the three and six months ended June 30, 2013 and 2012, the changes in the fair value of the assets measured using significant unobservable inputs (Level 3) were comprised of the following:


	For the three months ended June 30,
	2013								2012
	Private Placements/ Venture Capital			Auction Rate Securities		Total			Private Placements/ Venture Capital		Auction Rate Securities		Total
	(in millions)
Balance at April 1	$	25		$	13	$	38		$	25	$	15	$	40
Total gains or losses:
Realized in earnings		0			0		0			0		0		0
Unrealized in other comprehensive income		(2	)		0		(2	)		0		0		0
Purchases		0			0		0			0		0		0
Sales		0			0		0			0		0		0
Settlements		0			0		0			0		0		0

Balance at June 30	$	23		$	13	$	36		$	25	$	15	$	40


	For the six months ended June 30,
	2013								2012
	Private Placements/ Venture Capital			Auction Rate Securities		Total			Private Placements/ Venture Capital		Auction Rate Securities			Total
	(in millions)
Balance at January 1	$	25		$	13	$	38		$	25	$	16		$	41
Total gains or losses:
Realized in earnings		0			0		0			0		0			0
Unrealized in other comprehensive income		(1	)		0		(1	)		0		0			0
Purchases		0			0		0			0		0			0
Sales		0			0		0			0		(1	)		(1	)
Settlements		(1	)		0		(1	)		0		0			0

Balance at June 30	$	23		$	13	$	36		$	25	$	15		$	40

Financial Liabilities

Our long-term debt is recorded at carrying value in our consolidated balance sheets. The carrying value of our long-term debt outstanding was $2,606 million at June 30, 2013 and $2,611 million at December 31, 2012. The fair value of our long-term debt was $2,772 million at June 30, 2013 and $2,923 million at December 31, 2012. The fair value of our long-term debt is determined based on Level 2 inputs, including quoted market prices for the same or similar debt, or if no quoted market prices are available, on the current prices estimated to be available to us for debt with similar terms and remaining maturities.

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Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

As disclosed in Note 3, we completed our acquisitions of Metropolitan, SeniorBridge, and Arcadian during 2012. The values of net tangible assets acquired and the resulting goodwill and other intangible assets were recorded at fair value using Level 3 inputs. The majority of the related tangible assets acquired and liabilities assumed were recorded at their carrying values as of the respective dates of acquisition, as their carrying values approximated their fair values due to their short-term nature. The fair values of goodwill and other intangible assets acquired in these acquisitions were internally estimated primarily based on the income approach. The income approach estimates fair value based on the present value of the cash flows that the assets are expected to generate in the future. We developed internal estimates for the expected cash flows and discount rates in the present value calculations. Other than assets acquired and liabilities assumed in these acquisitions, there were no assets or liabilities measured at fair value on a nonrecurring basis during the three and six months ended June 30, 2013 or 2012.

6. MEDICARE PART D

We cover prescription drug benefits in accordance with Medicare Part D under multiple contracts with CMS. The condensed consolidated balance sheets include the following amounts associated with Medicare Part D at June 30, 2013 and December 31, 2012. The risk corridor settlement includes amounts classified as long-term because settlement associated with the 2013 provision will exceed 12 months at June 30, 2013.


	June 30, 2013						December 31, 2012
	Risk Corridor Settlement			CMS Subsidies/ Discounts			Risk Corridor Settlement			CMS Subsidies/ Discounts
	(in millions)
Other current assets	$	37		$	758		$	37		$	635
Trade accounts payable and accrued expenses		(217	)		(344	)		(393	)		(77	)

Net current (liability) asset		(180	)		414			(356	)		558

Other long-term assets		39			0			0			0
Other long-term liabilities		(29	)		0			0			0

Net long-term asset		10			0			0			0

Total net (liability) asset	$	(170	)	$	414		$	(356	)	$	558

At December 31, 2012, the net risk corridor payable balance included a payable of $158 million related to the 2011 contract year that was paid in January 2013.

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7. GOODWILL AND OTHER INTANGIBLE ASSETS

The carrying amount of goodwill for our reportable segments has been retrospectively adjusted to conform to the 2013 segment change discussed in Note 1. Changes in the carrying amount of goodwill for our reportable segments for the six months ended June 30, 2013 were as follows:


	Retail		Employer Group		Healthcare Services			Other Businesses		Total
	(in millions)
Balance at January 1, 2013	$	857	$	205	$	2,486		$	92	$	3,640
Acquisitions		0		0		13			0		13
Dispositions		0		0		(15	)		0		(15	)

Balance at June 30, 2013	$	857	$	205	$	2,484		$	92	$	3,638

The following table presents details of our other intangible assets included in other long-term assets in the accompanying condensed consolidated balance sheets at June 30, 2013 and December 31, 2012:


	Weighted		June 30, 2013						December 31, 2012
	Average				Accumulated						Accumulated
	Life		Cost		Amortization		Net		Cost		Amortization		Net
			(in millions)
Other intangible assets:
Customer contracts/relationships		9.5 yrs	$	725	$	267	$	458	$	733	$	237	$	496
Trade names and technology		13.6 yrs		189		30		159		190		21		169
Provider contracts		15.0 yrs		51		21		30		51		19		32
Noncompetes and other		6.5 yrs		51		23		28		51		17		34

Total other intangible assets		10.4 yrs	$	1,016	$	341	$	675	$	1,025	$	294	$	731

Amortization expense for other intangible assets was approximately $28 million for the three months ended June 30, 2013 and $17 million for the three months ended June 30, 2012. For the six months ended June 30, 2013 and 2012, amortization expense for other intangible assets was approximately $56 million and $34 million, respectively. The following table presents our estimate of amortization expense for 2013 and each of the five next succeeding fiscal years:


	(in millions)
For the years ending December 31,:
2013	$	111
2014		104
2015		92
2016		86
2017		78
2018		71

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8. EARNINGS PER COMMON SHARE COMPUTATION

Detail supporting the computation of basic and diluted earnings per common share was as follows for the three and six months ended June 30, 2013 and 2012:


	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
	(dollars in millions except per common share results, number of shares in thousands)
Net income available for common stockholders	$	420	$	356	$	893	$	604

Weighted average outstanding shares of common stock used to compute basic earnings per common share		157,975		162,816		158,446		163,267
Dilutive effect of:
Employee stock options		349		572		367		727
Restricted stock		1,197		1,251		1,149		1,369

Shares used to compute diluted earnings per common share		159,521		164,639		159,962		165,363

Basic earnings per common share	$	2.66	$	2.19	$	5.64	$	3.70

Diluted earnings per common share	$	2.63	$	2.16	$	5.58	$	3.65

Number of antidilutive stock options and restricted stock excluded from computation		847		562		1,265		819

9. STOCKHOLDERS’ EQUITY

Dividends

Our Board of Directors has approved a quarterly cash dividend policy. Declaration and payment of future quarterly dividends is at the discretion of the Board and may be adjusted as business needs or market conditions change.

The following table provides details of dividend payments in 2012 and 2013 to date:


Record		Payment		Amount		Total
Date		Date		per Share		Amount
						(in millions)
	2012 payments
	12/30/2011		1/31/2012	$	0.25	$	41
	3/30/2012		4/27/2012	$	0.25	$	41
	6/29/2012		7/27/2012	$	0.26	$	42
	9/28/2012		10/26/2012	$	0.26	$	41
	2013 payments
	12/31/2012		1/25/2013	$	0.26	$	42
	3/28/2013		4/26/2013	$	0.26	$	41
	6/28/2013		7/26/2013	$	0.27	$	42

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Stock Repurchases

In April 2013, the Board of Directors replaced its previously approved share repurchase authorization of up to $1 billion (of which $557 million remained unused) with the current authorization for repurchases of up to $1 billion of our common shares exclusive of shares repurchased in connection with employee stock plans, expiring on June 30, 2015. Under the current share repurchase authorization, shares may be purchased from time to time at prevailing prices in the open market, by block purchases, or in privately-negotiated transactions, subject to certain regulatory restrictions on volume, pricing, and timing. During the six months ended June 30, 2012, we repurchased 2.73 million shares in open market transactions for $226 million at an average price of $82.78 under previously approved share repurchase authorizations. During the six months ended June 30, 2013, we repurchased 1.22 million shares in open market transactions for $82 million at an average price of $67.59 under a previously approved share repurchase authorization and we repurchased 1.61 million shares in open market transactions for $129 million at an average price of $80.06 under the current authorization. As of July 31, 2013, the remaining authorized amount under the current authorization totaled $871 million.

In connection with employee stock plans, we acquired 0.2 million shares of our common stock for $20 million and 0.6 million shares of our common stock for $52 million during the six months ended June 30, 2013 and 2012, respectively.

Accumulated Other Comprehensive Income

Accumulated other comprehensive income included net unrealized gains on our investment securities of $217 million at June 30, 2013 and $462 million at December 31, 2012. In addition, accumulated other comprehensive income included $8 million at June 30, 2013 and $76 million at December 31, 2012, for an additional liability that would exist on our closed block of long-term care policies if unrealized gains on the sale of the investments backing such products had been realized and the proceeds reinvested at then current yields. Refer to Note 17 to the consolidated financial statements in our 2012 Form 10-K for further discussion of our long-term care policies.

10. INCOME TAXES

The effective income tax rate was 35.7% for the three months ended June 30, 2013, comparable to 36.8% for the three months ended June 30, 2012. For the six months ended June 30, 2013 the effective tax rate was 35.5%, compared to 36.7% for the six months ended June 30, 2012. The tax rate for the three and six months ended June 30, 2013 reflects a change in our estimated tax liability associated with limitations on the deductibility of annual compensation in excess of $500,000 per employee as mandated by the Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the Health Care Reform Law).

11. DEBT

Credit Agreement

In July 2013, we amended and restated our 5-year $1.0 billion unsecured revolving agreement which was set to expire in November 2016 and replaced it with a new 5-year $1.0 billion unsecured revolving agreement expiring July 2018. Under the new credit agreement, at our option, we can borrow on either a competitive advance basis or a revolving credit basis. The revolving credit portion bears interest at either LIBOR plus a spread or the base rate plus a spread. The LIBOR spread, currently 110 basis points, varies depending on our credit ratings ranging from 90.0 to 150.0 basis points. We also pay an annual facility fee regardless of utilization. This facility fee, currently 15.0 basis points, may fluctuate between 10.0 and 25.0 basis points, depending upon our credit ratings. The competitive advance portion of any borrowings will bear interest at market rates prevailing at the time of borrowing on either a fixed rate or a floating rate based on LIBOR, at our option.

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The terms of the credit agreement include standard provisions related to conditions of borrowing, including a customary material adverse effect clause which could limit our ability to borrow additional funds. In addition, the credit agreement contains customary restrictive and financial covenants as well as customary events of default, including financial covenants regarding the maintenance of a minimum level of net worth of $7.1 billion at June 30, 2013 and a maximum leverage ratio of 3.0:1. We are in compliance with the financial covenants, with actual net worth of $9.3 billion and an actual leverage ratio of 0.9:1, as measured in accordance with the credit agreement as of June 30, 2013. In addition, the credit agreement includes an uncommitted $250 million incremental loan facility.

At June 30, 2013, we had no borrowings outstanding under the previous credit agreement and we had outstanding letters of credit of $5.5 million secured under that credit agreement. No amounts have been drawn on these letters of credit. Accordingly, as of June 30, 2013, we had $994.5 million of remaining borrowing capacity under the previous credit agreement, none of which would be restricted by our financial covenant compliance requirement. We have other customary, arms-length relationships, including financial advisory and banking, with some parties to the credit agreement.

12. GUARANTEES AND CONTINGENCIES

Government Contracts

Our Medicare products, which accounted for approximately 74% of our total premiums and services revenue for the six months ended June 30, 2013, primarily consisted of products covered under the Medicare Advantage and Medicare Part D Prescription Drug Plan contracts with the federal government. These contracts are renewed generally for a calendar year term unless CMS notifies us of its decision not to renew by July 1 of the calendar year in which the contract would end, or we notify CMS of our decision not to renew by the first Monday in June of the calendar year in which the contract would end. All material contracts between Humana and CMS relating to our Medicare products have been renewed for 2014. However, our offerings of products under those contracts are subject to approval by CMS, which we expect in the fall of 2013.

CMS uses a risk-adjustment model which apportions premiums paid to Medicare Advantage plans according to health severity. The risk-adjustment model pays more for enrollees with predictably higher costs. Under this model, rates paid to Medicare Advantage plans are based on actuarially determined bids, which include a process whereby our prospective payments are based on a comparison of our beneficiaries’ risk scores, derived from medical diagnoses, to those enrolled in the government’s original Medicare program. Under the risk-adjustment methodology, all Medicare Advantage plans must collect and submit the necessary diagnosis code information from hospital inpatient, hospital outpatient, and physician providers to CMS within prescribed deadlines. The CMS risk-adjustment model uses the diagnosis data to calculate the risk-adjusted premium payment to Medicare Advantage plans, which CMS adjusts for coding pattern differences between the health plans and the government fee-for-service program. We generally rely on providers, including certain providers in our network who are our employees, to code their claim submissions with appropriate diagnoses, which we send to CMS as the basis for our payment received from CMS under the actuarial risk-adjustment model. We also rely on these providers to document appropriately all medical data, including the diagnosis data submitted with claims.

CMS is continuing to perform audits of various companies’ selected Medicare Advantage contracts related to this risk adjustment diagnosis data. We refer to these audits as Risk-Adjustment Data Validation Audits, or RADV audits. RADV audits review medical records in an attempt to validate provider medical record documentation and coding practices which influence the calculation of premium payments to Medicare Advantage plans.

On February 24, 2012, CMS released a “Notice of Final Payment Error Calculation Methodology for Part C Medicare Advantage Risk Adjustment Data Validation (RADV) Contract-Level Audits.” The payment error calculation methodology provides that, in calculating the economic impact of audit results for a Medicare Advantage contract, if any, the results of the audit sample will be extrapolated to the entire Medicare Advantage contract based

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upon a comparison to “benchmark” audit data in the government fee-for-service program. This comparison to the government program benchmark audit is necessary to determine the economic impact, if any, of audit results because the government program data set, including any attendant errors that are present in that data set, provides the basis for Medicare Advantage plans risk adjustment to payment rates. CMS already makes other adjustments to payment rates based on a comparison of coding pattern differences between Medicare Advantage plans and the government fee-for-service program data (such as for frequency of coding for certain diagnoses in Medicare Advantage plan data versus the government program data set).

The final methodology, including the first application of extrapolated audit results to determine audit settlements, is expected to be applied to the next round of RADV contract level audits to be conducted on 2011 premium payments. Selected Medicare Advantage contracts will be notified of an audit at some point after the close of the final reconciliation for the payment year being audited. The final reconciliation occurs in August of the calendar year following the payment year.

Estimated audit settlements are recorded as a reduction of premiums revenue in our consolidated statements of income, based upon available information. During 2012, we completed internal contract level audits of certain contracts based on the RADV audit methodology prescribed by CMS. Included in these internal contract level audits was an audit of our Private Fee-For-Service business which we used to represent a proxy of the benchmark audit data in the government fee-for-service program which has not yet been released. We based our accrual of estimated audit settlements for contract years 2011 (the first year that application of extrapolated audit results is applicable), 2012, and 2013 on the results of these internal contract level audits. Estimates derived from these results were not material to our results of operations, financial position, or cash flows. However, as indicated, we are awaiting additional guidance from CMS regarding the benchmark audit data in the government fee-for-service program and the identification of our specific Medicare Advantage contracts that will be selected for audit. Accordingly, we cannot determine whether such audits will have a material adverse effect on our results of operations, financial position, or cash flows.

At June 30, 2013, our military services business, which accounted for approximately 1% of our total premiums and services revenue for the six months ended June 30, 2013, primarily consisted of the TRICARE South Region contract. On April 1, 2012, we began delivering services under the new TRICARE South Region contract that the Department of Defense TRICARE Management Activity, or TMA, awarded to us on February 25, 2011. The new 5-year South Region contract, which expires March 31, 2017, is subject to annual renewals on April 1 of each year during its term at the government’s option. The TMA has exercised its option to extend the TRICARE South Region contract through March 31, 2014.

The loss of any of the contracts above or significant changes in these programs as a result of legislative or regulatory 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 results of operations, financial position, and cash flows.

Our Medicaid business, which accounted for approximately 3% of our total premiums and services revenue for the six months ended June 30, 2013, primarily consists of contracts in Puerto Rico, Florida, and Kentucky, with the vast majority in Puerto Rico. On June 26, 2013, the Puerto Rico Health Insurance Administration notified us of its election not to renew our three-year Medicaid contracts for the East, Southeast, and Southwest regions which ended June 30, 2013. Contractual transition provisions require the continuation of insurance coverage for beneficiaries through September 30, 2013 and an additional period of time thereafter to process claims. During the second quarter of 2013, we recorded a loss of $31.0 million on these contracts primarily related to premium deficiency and employee termination costs.

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Legal Proceedings and Certain Regulatory Matters

Florida Matters

On December 16, 2010, an individual filed a qui tam suit captioned United States of America ex rel. Marc Osheroff v. Humana et al. in the Southern District of Florida, against us, several of our health plan subsidiaries, and certain other companies that operate medical centers in Miami-Dade County, Florida. After the U.S. government declined to intervene, the Court ordered the complaint unsealed, and the individual plaintiff amended his complaint and served the Company on December 8, 2011. The amended complaint alleges certain civil violations by our CAC Medical Centers in Florida, including offering various amenities such as transportation and meals, to Medicare and dual eligible individuals in our community center settings. The amended complaint also alleges civil violations by our Medicare Advantage health plans in Florida, arising from the alleged activities of our CAC Medical Centers and the codefendants in the complaint. The amended complaint seeks damages and penalties on behalf of the United States under the Anti-Inducement and Anti-Kickback Statutes and the False Claims Act. On September 28, 2012, the Court dismissed, with prejudice, all causes of action that were asserted in the suit. On January 31, 2013, the Court denied a motion for reconsideration filed by the individual plaintiff. The deadline for the individual plaintiff to appeal will be set following resolution of certain motions in the district court relating to a co-defendant.

On January 6, 2012, the Civil Division of the United States Attorney’s Office for the Southern District of Florida advised us that it is seeking documents and information from us and several of our affiliates relating to several matters including the coding of medical claims by one or more South Florida medical providers, and loans to physician practices. We are responding to the information requests.

Other Lawsuits and Regulatory Matters

Our current and past business practices are subject to review or other investigations by various state insurance and health care regulatory authorities and other state and federal regulatory authorities. These authorities regularly scrutinize the business practices of health insurance and benefits companies. These reviews focus on numerous facets of our business, including claims payment practices, provider contracting, risk adjustment, competitive practices, commission payments, privacy issues, utilization management practices, and sales practices, among others. Some of these reviews have historically resulted in fines imposed on us and some have required changes to some of our practices. We continue to be subject to these reviews, which could result in additional fines or other sanctions being imposed on us or additional changes in some of our practices.

We also are involved in various other lawsuits that arise, for the most part, in the ordinary course of our business operations, certain of which may be styled as class-action lawsuits. Among other matters, this litigation may include employment matters, claims of medical malpractice, bad faith, nonacceptance or termination of providers, anticompetitive practices, improper rate setting, provider contract rate disputes, failure to disclose network discounts and various other provider arrangements, general contractual matters, intellectual property matters, and challenges to subrogation practices. A number of hospitals and other providers have also asserted that, under their network provider contracts, we are not entitled to adjust Medicare Advantage payments in connection with changes in Medicare payment systems in accordance with the Balanced Budget and Emergency Deficit Control Act of 1985, as amended (commonly referred to as “sequestration”). Those challenges could lead to arbitration or litigation. Under state guaranty assessment laws, we may be assessed (up to prescribed limits) for certain obligations to the policyholders and claimants of insolvent insurance companies that write the same line or lines of business as we do. As a government contractor, we may also be subject to qui tam litigation brought by individuals who seek to sue on behalf of the government, alleging that the government contractor submitted false claims to the government including, among other allegations, resulting from coding and review practices under the Medicare risk-adjustment model. Qui tam litigation is filed under seal to allow the government an opportunity to investigate and to decide if it wishes to intervene and assume control of the

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litigation. If the government does not intervene, the lawsuit is unsealed, and the individual may continue to prosecute the action on his or her own, on behalf of the government. We also are subject to allegations of non-performance of contractual obligations to providers, members, and others, including failure to properly pay claims, improper policy terminations, challenges to our implementation of the Medicare Part D prescription drug program and other litigation.

Personal injury claims, claims for extracontractual damages, care delivery malpractice, and claims 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.

We record accruals for such contingencies to the extent that we conclude it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. No estimate of the possible loss or range of loss in excess of amounts accrued, if any, can be made at this time regarding the matters specifically described above because of the inherently unpredictable nature of legal proceedings, which also may be exacerbated by various factors, including: (i) the damages sought in the proceedings are unsubstantiated or indeterminate; (ii) discovery is not complete; (iii) the proceeding is in its early stages; (iv) the matters present legal uncertainties; (v) there are significant facts in dispute; (vi) there are a large number of parties (including where it is uncertain how liability, if any, will be shared among multiple defendants); or (vii) there is a wide range of potential outcomes.

The outcome of any current or future litigation or governmental or internal investigations, including the matters described above, cannot be accurately predicted, nor can we predict any resulting penalties, fines or other sanctions that may be imposed at the discretion of federal or state regulatory authorities. Nevertheless, it is reasonably possible that any such outcome of litigation, penalties, fines or other sanctions could be substantial, and the outcome of these matters may have a material adverse effect on our results of operations, financial position, and cash flows, and may also affect our reputation.

13. SEGMENT INFORMATION

On January 1, 2013, we reclassified certain of our businesses to correspond with internal management reporting changes and renamed our Health and Well-Being Services segment as Healthcare Services. Our Employer Group segment now includes our health and wellness businesses, including HumanaVitality and Lifesynch’s employee assistance programs, which had historically been reported in our Healthcare Services segment. The Retail segment now includes our contract with CMS to administer the LI-NET program as well as our state-based Medicaid businesses, which had historically been reported in our Other Businesses category. Prior period segment financial information has been recast to conform to the 2013 presentation.

We manage our business with three reportable segments: Retail, Employer Group, and Healthcare Services. In addition, the Other Businesses category includes businesses that are not individually reportable because they do not meet the quantitative thresholds required by generally accepted accounting principles. These segments are based on a combination of the type of health plan customer and adjacent businesses centered on integrated care delivery for our health plans and other customers, as described below. These segment groupings are consistent with information used by our Chief Executive Officer to assess performance and allocate resources.

The Retail segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, marketed directly to individuals, and includes our contract with CMS to administer the LI-NET program and state-based Medicaid businesses. The Employer Group segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, as well as administrative services only, or ASO, products and our health and wellness products

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primarily marketed to employer groups. The Healthcare Services segment includes services offered to our health plan members as well as to third parties including provider services, pharmacy, integrated behavioral health services, and home care services. The Other Businesses category consists of our military services, primarily our TRICARE South Region contract, Puerto Rico Medicaid, and closed-block long-term care businesses.

Our Healthcare Services intersegment revenues primarily relate to managing prescription drug coverage for members of our other segments through Humana Pharmacy Solutions^®, or HPS, and includes the operations of RightSourceRx^®, our mail order pharmacy business. These revenues consist of the prescription price (ingredient cost plus dispensing fee), including the portion to be settled with the member (co-share) or with the government (subsidies), plus any associated administrative fees. Services revenues related to the distribution of prescriptions by third party retail pharmacies in our networks are recognized when the claim is processed and product revenues from dispensing prescriptions from our mail order pharmacies are recorded when the prescription or product is shipped. Our pharmacy operations, which are responsible for designing pharmacy benefits, including defining member co-share responsibilities, determining formulary listings, selecting and establishing prices charged by retail pharmacies, confirming member eligibility, reviewing drug utilization, and processing claims, act as a principal in the arrangement on behalf of members in our other segments. As principal, our Healthcare Services segment reports revenues on a gross basis including co-share amounts from members collected by third party retail pharmacies at the point of service.

In addition, our Healthcare Services intersegment revenues include revenues earned by certain owned providers derived from risk-based managed care agreements with our health plans. Under these agreements, the provider receives a monthly capitated fee that varies depending on the demographics and health status of the member for each member assigned to these owned providers by our health plans. The owned provider assumes the economic risk of funding the assigned members’ healthcare services and related administrative costs. Accordingly, our Healthcare Services segment reports provider services related revenues on a gross basis. Capitation fee revenue is recognized in the period in which the assigned members are entitled to receive healthcare services.

We present our consolidated results of operations from the perspective of the health plans. As a result, the cost of providing benefits to our members, whether provided via a third party provider or internally through a stand-alone subsidiary, is classified as benefits expense and excludes the portion of the cost for which the health plans do not bear responsibility, including member co-share amounts and government subsidies of $1.2 billion for the three months ended June 30, 2013 and 2012. For the six months ended June 30, 2013 and 2012, these amounts were $2.5 billion and $2.4 billion, respectively. In addition, depreciation and amortization expense associated with certain businesses in our Healthcare Services segment delivering benefits to our members, primarily associated with our provider services and pharmacy operations, are included with benefits expense. The amount of this expense was $24 million and $9 million for the three months ended June 30, 2013 and 2012, respectively. For the six months ended June 30, 2013 and 2012, the amount of this expense was $46 and $17 million, respectively. These increases primarily were due to amortization expense associated with the December 21, 2012 acquisition of Metropolitan Health Networks, Inc.

Other than those described previously, the accounting policies of each segment are the same and are described in Note 2 to the consolidated financial statements included in our 2012 Form 10-K. Transactions between reportable segments consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and behavioral health services, to our Retail and Employer Group customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often utilize the same provider networks, enabling us in some instances to obtain more favorable contract terms with providers. Our segments also share indirect costs and assets. As a result, the profitability of each segment is interdependent. We allocate most operating expenses to our segments. Assets and certain corporate income and expenses are not allocated to the segments, including the portion of investment income not supporting segment operations, interest expense on corporate debt, and certain other corporate expenses. These items are managed at a corporate level. These corporate amounts are reported separately from our reportable segments and included with intersegment eliminations in the tables presenting segment results below.

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Our segment results were as follows for the three and six months ended June 30, 2013 and 2012, respectively:


	Retail		Employer Group		Healthcare Services		Other Businesses			Eliminations/ Corporate			Consolidated
					(in millions)
Three months ended June 30, 2013
Revenues—external customers
Premiums:
Medicare Advantage	$	5,572	$	1,160	$	0	$	0		$	0		$	6,732
Medicare stand-alone PDP		785		2		0		0			0			787

Total Medicare		6,357		1,162		0		0			0			7,519

Fully-insured		285		1,273		0		0			0			1,558
Specialty		52		275		0		0			0			327
Military services		0		0		0		5			0			5
Medicaid and other		72		0		0		220			0			292

Total premiums		6,766		2,710		0		225			0			9,701

Services revenue:
Provider		0		4		313		0			0			317
ASO and other		2		82		0		114			0			198
Pharmacy		0		0		13		0			0			13

Total services revenue		2		86		326		114			0			528

Total revenues—external customers		6,768		2,796		326		339			0			10,229

Intersegment revenues
Services		0		12		2,858		0			(2,870	)		0
Products		0		0		680		0			(680	)		0

Total intersegment revenues		0		12		3,538		0			(3,550	)		0

Investment income		18		10		0		15			49			92

Total revenues		6,786		2,818		3,864		354			(3,501	)		10,321

Operating expenses:
Benefits		5,696		2,235		0		251			(91	)		8,091
Operating costs		640		429		3,697		129			(3,434	)		1,461
Depreciation and amortization		32		27		36		4			(19	)		80

Total operating expenses		6,368		2,691		3,733		384			(3,544	)		9,632

Income (loss) from operations		418		127		131		(30	)		43			689
Interest expense		0		0		0		0			35			35

Income (loss) before income taxes	$	418	$	127	$	131	$	(30	)	$	8		$	654

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited


	Retail		Employer Group		Healthcare Services		Other Businesses			Eliminations/ Corporate			Consolidated
					(in millions)
Three months ended June 30, 2012
Revenues—external customers
Premiums:
Medicare Advantage	$	5,308	$	1,011	$	0	$	0		$	0		$	6,319
Medicare stand-alone PDP		745		2		0		0			0			747

Total Medicare		6,053		1,013		0		0			0			7,066

Fully-insured		250		1,247		0		0			0			1,497
Specialty		42		262		0		0			0			304
Military services		0		0		0		44			0			44
Medicaid and other		45		0		0		210			0			255

Total premiums		6,390		2,522		0		254			0			9,166

Services revenue:
Provider		0		2		243		0			0			245
ASO and other		5		89		0		91			0			185
Pharmacy		0		0		4		0			0			4

Total services revenue		5		91		247		91			0			434

Total revenues—external customers		6,395		2,613		247		345			0			9,600

Intersegment revenues
Services		1		7		2,359		0			(2,367	)		0
Products		0		0		591		0			(591	)		0

Total intersegment revenues		1		7		2,950		0			(2,958	)		0

Investment income		20		10		0		15			54			99

Total revenues		6,416		2,630		3,197		360			(2,904	)		9,699

Operating expenses:
Benefits		5,378		2,063		0		301			(90	)		7,652
Operating costs		638		428		3,049		111			(2,842	)		1,384
Depreciation and amortization		33		22		20		4			(6	)		73

Total operating expenses		6,049		2,513		3,069		416			(2,938	)		9,109

Income (loss) from operations		367		117		128		(56	)		34			590
Interest expense		0		0		0		0			26			26

Income (loss) before income taxes	$	367	$	117	$	128	$	(56	)	$	8		$	564

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited


	Retail		Employer Group		Healthcare Services		Other Businesses		Eliminations/ Corporate			Consolidated
					(in millions)
Six months ended June 30, 2013
Revenues—external customers
Premiums:
Medicare Advantage	$	11,308	$	2,350	$	0	$	0	$	0		$	13,658
Medicare stand-alone PDP		1,546		4		0		0		0			1,550

Total Medicare		12,854		2,354		0		0		0			15,208

Fully-insured		564		2,541		0		0		0			3,105
Specialty		101		550		0		0		0			651
Military services		0		0		0		16		0			16
Medicaid and other		151		0		0		438		0			589

Total premiums		13,670		5,445		0		454		0			19,569

Services revenue:
Provider		0		8		619		0		0			627
ASO and other		4		166		0		234		0			404
Pharmacy		0		0		22		0		0			22

Total services revenue		4		174		641		234		0			1,053

Total revenues—external customers		13,674		5,619		641		688		0			20,622

Intersegment revenues
Services		0		23		5,607		0		(5,630	)		0
Products		0		0		1,334		0		(1,334	)		0

Total intersegment revenues		0		23		6,941		0		(6,964	)		0

Investment income		36		21		0		30		98			185

Total revenues		13,710		5,663		7,582		718		(6,866	)		20,807

Operating expenses:
Benefits		11,625		4,412		0		438		(189	)		16,286
Operating costs		1,253		869		7,254		244		(6,713	)		2,907
Depreciation and amortization		64		50		72		8		(34	)		160

Total operating expenses		12,942		5,331		7,326		690		(6,936	)		19,353

Income from operations		768		332		256		28		70			1,454
Interest expense		0		0		0		0		70			70

Income before income taxes	$	768	$	332	$	256	$	28	$	0		$	1,384

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited


	Retail		Employer Group		Healthcare Services		Other Businesses			Eliminations/ Corporate			Consolidated
					(in millions)
Six months ended June 30, 2012
Revenues—external customers
Premiums:
Medicare Advantage	$	10,401	$	2,036	$	0	$	0		$	0		$	12,437
Medicare stand-alone PDP		1,471		4		0		0			0			1,475

Total Medicare		11,872		2,040		0		0			0			13,912

Fully-insured		494		2,489		0		0			0			2,983
Specialty		80		522		0		0			0			602
Military services		0		0		0		937			0			937
Medicaid and other		91		0		0		416			0			507

Total premiums		12,537		5,051		0		1,353			0			18,941

Services revenue:
Provider		0		4		474		0			0			478
ASO and other		11		178		0		109			0			298
Pharmacy		0		0		8		0			0			8

Total services revenue		11		182		482		109			0			784

Total revenues—external customers		12,548		5,233		482		1,462			0			19,725

Intersegment revenues
Services		1		17		4,824		0			(4,842	)		0
Products		0		0		1,175		0			(1,175	)		0

Total intersegment revenues		1		17		5,999		0			(6,017	)		0

Investment income		39		20		0		29			105			193

Total revenues		12,588		5,270		6,481		1,491			(5,912	)		19,918

Operating expenses:
Benefits		10,755		4,116		0		1,317			(186	)		16,002
Operating costs		1,275		864		6,189		217			(5,778	)		2,767
Depreciation and amortization		63		44		39		8			(11	)		143

Total operating expenses		12,093		5,024		6,228		1,542			(5,975	)		18,912

Income (loss) from operations		495		246		253		(51	)		63			1,006
Interest expense		0		0		0		0			52			52

Income (loss) before income taxes	$	495	$	246	$	253	$	(51	)	$	11		$	954

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The condensed 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 filings with the SEC, 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,” “believes,” “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 Item 1A. – Risk Factors in our 2012 Form 10-K, as modified by any changes to those risk factors included in this document and in other reports we filed subsequent to February 21, 2013, in each case incorporated by reference herein. In making these statements, we are not undertaking to address or update such forward-looking statements in future filings or communications regarding our business or results. 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.

Executive Overview

General

Headquartered in Louisville, Kentucky, Humana is a leading health care company that offers a wide range of insurance products and health and wellness services that incorporate an integrated approach to lifelong well-being. By leveraging the strengths of our core businesses, we believe that we can better explore opportunities for existing and emerging adjacencies in health care that can further enhance wellness opportunities for the millions of people across the nation with whom we have relationships.

Our industry relies on two key statistics to measure performance. The benefit ratio, which is computed by taking total benefits expense as a percentage of premiums revenue, represents a statistic used to measure underwriting profitability. The operating cost ratio, which is computed by taking total operating costs as a percentage of total revenue less investment income, represents a statistic used to measure administrative spending efficiency.

Business Segments

On January 1, 2013, we reclassified certain of our businesses to correspond with internal management reporting changes and renamed our Health and Well-Being Services segment as Healthcare Services as further described in Note 1 to the condensed consolidated financial statements. Prior period segment financial information has been recast to conform to the 2013 presentation.

The Retail segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, marketed directly to individuals, and includes our contract with Centers for Medicare and Medicaid Services, or CMS, to administer the Limited Income Newly Eligible Transition program, or the LI-NET program, and state-based Medicaid businesses. The Employer Group segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, as well as administrative services only products, or ASO, and our health and wellness products primarily marketed to employer groups. The Healthcare Services segment includes services offered to our health

plan members as well as to third parties, including provider services, pharmacy, integrated behavioral health services, and home care services. The Other Businesses category consists of our military services, primarily our TRICARE South Region contract, Puerto Rico Medicaid, and closed-block long-term care businesses.

The results of each segment are measured by income before income taxes. Transactions between reportable segments consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and behavioral health, to our Retail and Employer Group customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often utilize the same provider networks, enabling us in some instances to obtain more favorable contract terms with providers. Our segments also share indirect costs and assets. As a result, the profitability of each segment is interdependent. We allocate most operating expenses to our segments. Assets and certain corporate income and expenses are not allocated to the segments, including the portion of investment income not supporting segment operations, interest expense on corporate debt, and certain other corporate expenses. These items are managed at the corporate level. These corporate amounts are reported separately from our reportable segments and included with intersegment eliminations.

Seasonality

One of the product offerings of our Retail segment is Medicare stand-alone prescription drug plans, or PDPs, under the Medicare Part D program. These plans provide varying degrees of coverage. Our quarterly Retail segment earnings and operating cash flows are impacted by the Medicare Part D benefit design and changes in the composition of our membership. The Medicare Part D benefit design results in coverage that varies as a member’s cumulative out-of-pocket costs pass through successive stages of a member’s plan period which begins annually on January 1 for renewals. These plan designs generally result in us sharing a greater portion of the responsibility for total prescription drug costs in the early stages and less in the latter stages. As a result, the PDP benefit ratio generally decreases as the year progresses. In addition, the number of low-income senior members as well as year-over-year changes in the mix of membership in our stand-alone PDP products affects the quarterly benefit ratio pattern.

Our Employer Group segment also experiences seasonality in the benefit ratio pattern. However, the effect is opposite of the Retail segment, with the Employer Group’s benefit ratio increasing as fully-insured members progress through their annual deductible and maximum out-of-pocket expenses.

2013 Highlights

Consolidated

•

Our 2013 results reflect the continued implementation of our strategy to offer our members affordable health care combined with a positive consumer experience in growing markets. At the core of this strategy is our integrated care delivery model, which unites quality care, high member engagement, and sophisticated data analytics. Our approach to primary, physician-directed care for our members aims to provide quality care that is consistent, integrated, cost-effective, and member-focused. The model is designed to improve health outcomes and affordability for individuals and for the health system as a whole, while offering our members a simple, seamless healthcare experience. We believe this strategy is positioning us for long-term growth in both membership and earnings. At June 30, 2013, approximately 541,400 members, or 26.7%, of our individual Medicare Advantage membership were in risk arrangements under our integrated care delivery model, as compared to 511,700 members at December 31, 2012 and 502,500 members at June 30, 2012.

•

In addition, our pretax results for the three and six months ended June 30, 2013 reflect improved operating performance across our major business lines, including membership growth in our individual and group Medicare Advantage products, as described below. The improved operating performance reflects our continued focus and executional discipline involved in key initiatives like our chronic care program, including increased care management professional staffing and clinical assessments.

•

Comparisons of the benefit ratios and operating cost ratios for the six months ended June 30, 2013 and June 30, 2012 are impacted by the transition to the current TRICARE South Region contract on April 1, 2012, which is accounted for similar to an administrative services fee only agreement as described in Note 2 to the consolidated financial statements included in our 2012 Form 10-K. Our previous contract was accounted for similar to our fully-insured products. In addition, comparisons of the benefit ratios for the six months ended June 30, 2013 and June 30, 2012 are impacted by the beneficial effect of a favorable settlement of contract claims with the Department of Defense, or DoD, in the first quarter of 2013 primarily associated with previously disclosed litigation settled in the second quarter of 2012.

•

Year-over-year comparisons of diluted earnings per common share are favorably impacted by a lower number of shares used to compute diluted earnings per common share primarily reflecting the impact of share repurchases.

•

During the six months ended June 30, 2013, we repurchased 2.83 million shares in open market transactions for $211 million and paid dividends to stockholders of $83 million.

•

Retail

•

On April 1, 2013, CMS issued its final Announcement of Calendar Year 2014 Medicare Advantage Benchmark Rates and Payment Policies, which we refer to as the CMS Final Announcement. Based on the benchmark rates and payment policies published in the CMS Final Announcement, we estimate that our 2014 Medicare bid benchmark payment rates will decline by 2.8% in the aggregate, including the negative impact of risk coding recalibration and county rebasing. The 2014 bid benchmark payment rate reductions for certain of our key markets are anticipated to be in the mid to upper single digits, primarily due to the risk coding recalibration in 2014. Including the health insurance industry fee associated with the Health Care Reform Law, we anticipate we will need to address government funding reductions of more than 4% in the aggregate in 2014. While we believe our senior members’ benefits may be adversely impacted, we believe we can effectively design Medicare Advantage products based upon these levels of rate reduction while continuing to remain competitive compared to both the combination of original Medicare with a supplement policy as well as Medicare Advantage products offered by our competitors. Nonetheless, there can be no assurance that we will be able to successfully execute operational and strategic initiatives that we have assumed when designing our plan benefit offerings and premiums for 2014. Failure to execute these strategies may result in a material adverse effect on our results of operations, financial position, and cash flows.

•

As discussed in the detailed Retail segment results of operations discussion that follows, we experienced a decline in the Retail segment benefit ratio for the six months ended June 30, 2013, with the segment’s benefit ratio decreasing 80 basis points to 85.0%. Our Retail segment benefit ratio for the three months ended June 30, 2013 of 84.2% was comparable to the benefit ratio for the three months ended June 30, 2012.

•

Individual Medicare Advantage membership of 2,029,700 at June 30, 2013 increased 102,100, or 5.3%, from 1,927,600 at December 31, 2012 and increased 133,900 members, or 7.1%, from 1,895,800 at June 30, 2012 reflecting net membership additions for the 2013 enrollment season and new sales to members aging-in to the Medicare program. Effective January 1, 2013, we divested approximately 12,600 members acquired with Arcadian Management Services, Inc. in accordance with our previously disclosed agreement with the United States Department of Justice.

•

Medicare stand-alone PDP membership of 3,220,600 at June 30, 2013 increased 167,900 members, or 5.5%, from 3,052,700 at December 31, 2012 and increased 250,500 members, or 8.4%, from 2,970,100 at June 30, 2012 reflecting net membership additions, primarily for our Humana-Walmart plan offering for the 2013 enrollment season.

•

During 2012, we were successful in our bids for Medicaid business in Ohio, Illinois, and Kentucky. Ohio and Illinois include individuals dually eligible for both the federal Medicare program and the state-based Medicaid program. We partnered with CareSource Management Group Company to serve the Ohio and Kentucky individuals under a March 2012 strategic alliance agreement. Medicaid membership in our Retail Segment at June 30, 2013 increased 18,500 members from December 31, 2012, and increased 24,100 members from June 30, 2012 primarily driven by the addition of our recently awarded Kentucky Medicaid contract effective January 1, 2013. We expect to begin serving members under contracts with Ohio and Illinois in the first quarter of 2014. While we expect the dual-eligible business to result in pretax income growth, the mix of lower margin dual-eligible business with the higher margin Medicare Advantage business may result in a decline in Retail Segment margins over time.

•

Employer Group Segment

•

As discussed in the detailed Employer Group segment results of operations discussion that follows, the Employer Group segment benefit ratio increased 70 basis points to 82.5% for the three months ended June 30, 2013. For the six months ended June 30, 2013, we experienced a decline in the benefit ratio in the Employer Group segment, with the segment’s benefit ratio decreasing 50 basis points to 81.0%.

•

Fully-insured group Medicare Advantage membership of 416,600 at June 30, 2013 increased 45,800 members, or 12.4%, from 370,800 at December 31, 2012 and increased 56,100 members, or 15.6%, from 360,500 at June 30, 2012 primarily due to the January 2013 addition of a new large group retirement account.

Healthcare Services Segment

•

Other Businesses

•

Comparisons of the benefit ratios for the six months ended June 30, 2013 and June 30, 2012 within Other Businesses are impacted by the transition to the current TRICARE South Region contract on April 1, 2012, including a decrease in profitability under the current contract in connection with our bid strategy, and the beneficial effect of a favorable settlement of contract claims with the Department of Defense, or DoD, in the first quarter of 2013 primarily associated with previously disclosed litigation settled in the second quarter of 2012.

•

On June 26, 2013, the Puerto Rico Health Insurance Administration notified us of its election not to renew our three-year Medicaid contracts for the East, Southeast, and Southwest regions which ended June 30, 2013. Contractual transition provisions require the continuation of insurance coverage for beneficiaries through September 30, 2013 and an additional period of time thereafter to process claims. During the second quarter of 2013, we recorded a loss of $31.0 million on these contracts primarily related to premium deficiency and employee termination costs.

Health Care Reform

The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the Health Care Reform Law) enacted significant reforms to various aspects of the U.S. health insurance industry. While regulations and interpretive guidance on many provisions of the Health Care Reform Law have been issued to date by the Department of Health and Human Services, or HHS, the Department of Labor, the Treasury Department, and the National Association of Insurance Commissioners, or NAIC, there are certain provisions of the law that will require additional guidance and clarification in the form of regulations and interpretations in order to fully understand the impacts of the law on our overall business, which we expect to occur over the next several years.

Implementation dates of the Health Care Reform Law began in September 2010 and continue through 2018. The following outlines certain provisions of the Health Care Reform Law:

•

Currently Effective: Many changes are already effective and have been implemented by the Company, including: elimination of pre-existing condition limits for enrollees under age 19, elimination of certain annual and lifetime caps on the dollar value of benefits, expansion of dependent coverage to include adult children until age 26, a requirement to provide coverage for prescribed preventive services without cost to members, new claim appeal requirements, and the establishment of an interim high risk program for those unable to obtain coverage due to a pre-existing condition or health status.

Commercial fully-insured medical plans with actual benefit ratios below certain targets (85% for large employer groups, 80% for small employer groups, and 80% for individuals, calculated in a manner prescribed by HHS) are required to rebate ratable portions of their premiums to customers annually. We began accruing for rebates in 2011, based on the manner prescribed by HHS, with rebate payments made annually each July of the following calendar year. Our benefit ratios reported herein, calculated from financial statements prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, differ from the benefit ratios calculated as prescribed by HHS under the Health Care Reform Law. The more noteworthy differences include the fact that the benefit ratio calculations prescribed by HHS are calculated separately by state and legal entity; independently for individual, small group, and large group fully-insured products; reflect actuarial adjustments where the membership levels are not large enough to create credible size; exclude some of our health insurance products; include taxes and fees as reductions of premium; and treat changes in reserves differently than GAAP.

HHS has also established, as required under the Health Care Reform Law, a federal premium rate review process, which generally applies to proposed rate increases equal to or exceeding 10%, and regulations require commercial plans to provide to the states and HHS supporting information with respect to any rate increases that are subject to the federal review process.

•

Currently Effective with Phased-In Implementation: In 2012, additional cuts to Medicare Advantage plan payment benchmarks began to take effect (with plan payment benchmarks ultimately ranging from 95% in high-cost areas to 115% in low-cost areas of Medicare fee-for-service rates), with changes being phased-in over two to six years, depending on the level of payment reduction in a county. In addition, since 2011 the gap in coverage for Medicare Part D prescription drug coverage has been incrementally closing.

In addition, certain provisions in the Health Care Reform Law tie Medicare Advantage premiums to the achievement of certain quality performance measures (Star Ratings). Beginning in 2012, Medicare Advantage plans with an overall Star Rating of three or more stars (out of five) were eligible for a quality bonus in their basic premium rates. By law, quality bonuses were limited to the few plans that achieved four or more stars as an overall rating, but CMS, through its demonstration authority, expanded the quality bonus to three Star plans for a three year period through 2014. Star Ratings issued by CMS in October 2012 indicated that 99% of our Medicare Advantage members are now in plans that will qualify for quality bonus payments in 2014, up from 98% in 2013. Further, the percentage of our Medicare Advantage members in plans with an overall Star Rating of four or more stars, including one five star plan, increased to 40%. Plans that earn an overall Star Rating of five are immediately eligible to enroll members year round. Beginning in 2015, plans must have a Star Rating of four or higher to qualify for bonus money. Notwithstanding successful historical efforts to improve our Star Ratings and other quality measures for 2012 and 2013 and the continuation of such efforts, there can be no assurances that we will be successful in maintaining or improving our Star Ratings in future years. Accordingly, our plans may not be eligible for full level quality bonuses, which could adversely affect the benefits such plans can offer, reduce membership, and/or reduce profit margins.

•

Effective in 2014: Beginning in 2014, the Health Care Reform Law requires: all individual and group health plans to guarantee issuance and renew coverage without pre-existing condition exclusions or health-status rating adjustments; the elimination of annual limits on coverage on certain benefits; the establishment of federally facilitated, federal-state partnerships or state-based exchanges for individuals and small employers (with up to 100 employees) coupled with programs designed to spread risk among insurers; the introduction of plan designs based on set actuarial values; the establishment of a minimum benefit ratio of 85% for Medicare Advantage plans; and insurance industry assessments, including an annual health insurance industry fee and a three-year $25 billion commercial reinsurance fee. The annual health insurance industry fee levied on the insurance industry is $8 billion in 2014 with increasing annual amounts thereafter, growing to $14 billion by 2017, and is not deductible for income tax purposes, which will significantly increase our effective income tax rate in 2014. The NAIC is continuing discussions regarding the accounting for the health insurance industry fee and may require surplus reductions in the year preceding payment, beginning in 2014. Accordingly, in 2014 we may be required to reduce surplus for both the 2014 and 2015 assessments. The NAIC guidance is contradictory to final GAAP guidance issued by the FASB in July 2011, which requires annual accrual of the health insurance industry fee in the year in which it is payable.

The Health Care Reform Law also specifies benefit design guidelines, limits rating and pricing practices, encourages additional competition from the establishment of two multi-state plans (one not-for-profit; one for-profit) administered through the Office of Personnel Management, and expands eligibility for Medicaid programs. In addition, the law will increase federal oversight of health plan premium rates and could adversely affect our ability to appropriately adjust health plan premiums on a timely basis. Financing for these reforms will come, in part, from material additional fees and taxes on us (as discussed above) and other health plans and individuals beginning in 2014, as well as reductions in certain levels of payments to us and other health plans under Medicare as described herein.

As discussed above, implementing regulations and related interpretive guidance continue to be issued on certain provisions of the Health Care Reform Law. Congress may also withhold the funding necessary to implement the Health Care Reform Law, or may attempt to replace the law with amended provisions. The implementation of certain provisions of Health Care Reform Law has been delayed. Given the breadth of possible changes and the uncertainties of interpretation, implementation, and timing of these changes, which we expect to occur over the next several years, the Health Care Reform Law will change the way we do business, potentially impacting our pricing, benefit design, product mix, geographic mix, and distribution channels. The response of other companies to the Health Care Reform Law and adjustments to their offerings, if any, could cause meaningful disruption in the local health care markets. It is reasonably possible that the Health Care Reform Law and related regulations, as well as future legislative changes, in the aggregate may have a material adverse effect on our results of operations, including restricting revenue, enrollment and premium growth in certain products and market segments, restricting our ability to expand into new markets, increasing our medical and operating costs, lowering our Medicare payment rates and increasing our expenses associated with the non-deductible health insurance industry fee and other assessments; our financial position, including our ability to maintain the value of our goodwill; and our cash flows. If the new non-deductible health insurance industry fee and other assessments, including a three-year commercial reinsurance fee, were imposed as enacted, and if we are unable to adjust our business model to address these new taxes and assessments, such as through the reduction of our operating costs or adjustments to premium pricing or benefit design, there can be no assurance that the non-deductible health insurance industry fee and other assessments would not have a material adverse effect on our results of operations, financial position, and cash flows.

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, including the primary factors that accounted for those changes. Transactions between reportable segments consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and behavioral health services, to our Retail and Employer Group customers and are described in Note 13 to the condensed consolidated financial statements.

Comparison of Results of Operations for 2013 and 2012

The following discussion primarily deals with our results of operations for the three months ended June 30, 2013, or the 2013 quarter, the three months ended June 30, 2012, or the 2012 quarter, the six months ended June 30, 2013, or the 2013 period, and the six month ended June 30, 2012 or the 2012 period.

Consolidated


	For the three months ended June 30,						Change
	2013			2012			Dollars			Percentage
	(dollars in millions, except per common share results)
Revenues:
Premiums:
Retail	$	6,766		$	6,390		$	376			5.9	%
Employer Group		2,710			2,522			188			7.5	%
Other Businesses		225			254			(29	)		(11.4	)%

Total premiums		9,701			9,166			535			5.8	%

Services:
Retail		2			5			(3	)		(60.0	)%
Employer Group		86			91			(5	)		(5.5	)%
Healthcare Services		326			247			79			32.0	%
Other Businesses		114			91			23			25.3	%

Total services		528			434			94			21.7	%

Investment income		92			99			(7	)		(7.1	)%

Total revenues		10,321			9,699			622			6.4	%

Operating expenses:
Benefits		8,091			7,652			439			5.7	%
Operating costs		1,461			1,384			77			5.6	%
Depreciation and amortization		80			73			7			9.6	%

Total operating expenses		9,632			9,109			523			5.7	%

Income from operations		689			590			99			16.8	%
Interest expense		35			26			9			34.6	%

Income before income taxes		654			564			90			16.0	%
Provision for income taxes		234			208			26			12.5	%

Net income	$	420		$	356		$	64			18.0	%

Diluted earnings per common share	$	2.63		$	2.16		$	0.47			21.8	%

Benefit ratio^(a)		83.4	%		83.5	%					(0.1	)%
Operating cost ratio^(b)		14.3	%		14.4	%					(0.1	)%
Effective tax rate		35.7	%		36.8	%					(1.1	)%

(a)	Represents total benefits expense as a percentage of premiums revenue.

(b)	Represents total operating costs as a percentage of total revenues less investment income.


	For the six months ended June 30,						Change
	2013			2012			Dollars			Percentage
	(dollars in millions, except per common share results)
Revenues:
Premiums:
Retail	$	13,670		$	12,537		$	1,133			9.0	%
Employer Group		5,445			5,051			394			7.8	%
Other Businesses		454			1,353			(899	)		(66.4	)%

Total premiums		19,569			18,941			628			3.3	%

Services:
Retail		4			11			(7	)		(63.6	)%
Employer Group		174			182			(8	)		(4.4	)%
Healthcare Services		641			482			159			33.0	%
Other Businesses		234			109			125			114.7	%

Total services		1,053			784			269			34.3	%

Investment income		185			193			(8	)		(4.1	)%

Total revenues		20,807			19,918			889			4.5	%

Operating expenses:
Benefits		16,286			16,002			284			1.8	%
Operating costs		2,907			2,767			140			5.1	%
Depreciation and amortization		160			143			17			11.9	%

Total operating expenses		19,353			18,912			441			2.3	%

Income from operations		1,454			1,006			448			44.5	%
Interest expense		70			52			18			34.6	%

Income before income taxes		1,384			954			430			45.1	%
Provision for income taxes		491			350			141			40.3	%

Net income	$	893		$	604		$	289			47.8	%

Diluted earnings per common share	$	5.58		$	3.65		$	1.93			52.9	%

Benefit ratio^(a)		83.2	%		84.5	%					(1.3	)%
Operating cost ratio^(b)		14.1	%		14.0	%					0.1	%
Effective tax rate		35.5	%		36.7	%					(1.2	)%

(a)	Represents total benefits expense as a percentage of premiums revenue.

(b)	Represents total operating costs as a percentage of total revenues less investment income.

Summary

Net income was $420 million, or $2.63 per diluted common share, in the 2013 quarter compared to $356 million, or $2.16 per diluted common share, in the 2012 quarter. Net income was $893 million, or $5.58 per diluted common share, in the 2013 period compared to $604 million, or $3.65 per diluted common share, in the 2012 period. The increases in net income primarily were driven by improved operating performance across most of our major business lines, including Medicare Advantage membership growth in our Retail and Employer group segments, as well as a benefit in the 2013 period from the delay in the impact of sequestration for our Medicare products. Year-over-year comparisons of diluted earnings per common share are favorably impacted by a lower number of shares used to compute diluted earnings per common share in the 2013 quarter and period primarily reflecting the impact of share repurchases. Our diluted earnings per common share for the 2013 quarter and period included expense of $0.12 per share primarily related to costs associated with the loss of our Medicaid contracts in Puerto Rico. In addition, comparisons of net income and diluted earnings per common share for the 2013 and 2012 periods are impacted by the beneficial effect of a favorable settlement of contract claims with the DoD in the first quarter of 2013 primarily associated with previously disclosed litigation settled in the second quarter of 2012.

Premiums

Consolidated premiums increased $535 million, or 5.8%, from the 2012 quarter to $9.7 billion for the 2013 quarter, and increased $628 million, or 3.3%, from the 2012 period to $19.6 billion for the 2013 period. These increases primarily were due to increases in both Retail and Employer Group segment premiums mainly driven by higher average individual and group Medicare Advantage membership, partially offset by the impact of sequestration which became effective April 1, 2013 and lower premiums for our Other Businesses due to the transition to the current TRICARE South Region contract. As discussed in Note 2 to the consolidated financial statements included in our 2012 Form 10-K, on April 1, 2012, we began delivering services under the current TRICARE South Region contract that the TMA awarded to us on February 25, 2011. We account for revenues under the current contract net of estimated healthcare costs similar to an administrative services fee only agreement, and as such there are no premiums recognized under the current contract. Our previous contract was accounted for similar to our fully-insured products and as such we recognized premiums under the previous contract. Average membership is calculated by summing the ending membership for each month in a period and dividing the result by the number of months in a period. Premiums revenue reflects changes in membership and average per member premiums. Items impacting average per member premiums include changes in premium rates as well as changes in the geographic mix of membership, the mix of product offerings, and the mix of benefit plans selected by our membership.

Services revenue

Consolidated services revenue increased $94 million, or 21.7%, from the 2012 quarter to $528 million for the 2013 quarter and increased $269 million, or 34.3%, from the 2012 period to $1.1 billion for the 2013 period. These increases primarily were due to an increase in services revenue in our Healthcare Services segment and an increase in services revenue for our Other Businesses due to the transition to the current TRICARE South Region contract on April 1, 2012. The increases in services revenue in our Healthcare Services segment primarily resulted from the acquisition of Metropolitan Health Networks, Inc., or Metropolitan, on December 21, 2012 and SeniorBridge Family Companies, Inc., or SeniorBridge, on July 6, 2012, and growth in our Concentra operations.

Investment income

Investment income totaled $92 million for the 2013 quarter compared to $99 million for the 2012 quarter and was $185 million for the 2013 period compared to $193 million for the 2012 period as higher average invested balances were more than offset by lower interest rates and lower realized capital gains year-over-year.

Benefits expense

Consolidated benefits expense was $8.1 billion for the 2013 quarter, an increase of $439 million, or 5.7%, from the 2012 quarter. For the 2013 period, consolidated benefits expense was $16.3 billion, an increase of $284 million, or 1.8%, from the 2012 period. These increases primarily were due to a year-over-year increase in Retail segment benefits expense, primarily driven by an increase in the average number of Medicare members, partially offset by a decrease in benefits expense for Other Businesses in the 2013 period primarily due to the transition to the current administrative services only TRICARE South Region contract on April 1, 2012. We do not record benefits expense under the current TRICARE South Region contract. Our previous contract was accounted for similar to our fully-insured products and as such we recorded benefits expense under the previous contract. Retail segment benefits expense increased $318 million, or 5.9%, from the 2012 quarter to the 2013 quarter, and increased $870 million, or 8.1%, from the 2012 period to the 2013 period primarily due to membership growth. As more fully described under “Benefits Expense Recognition” in Item 7 of our 2012 Form 10-K, actuarial standards require the use of assumptions based on moderately adverse experience, which generally results in favorable reserve development, or reserves that are considered redundant. We experienced favorable medical claims reserve development related to prior fiscal years of $100 million in the 2013 quarter and $40 million in the 2012 quarter. During the 2013 period, we experienced favorable medical claims reserve development related to prior fiscal years of $366 million compared to $181 million in the 2012 period. These increases in favorable medical claims reserve development primarily resulted from claims trend for prior year ultimately developing more favorably than originally expected across most of our major business lines.

The consolidated benefit ratio for the 2013 quarter was 83.4%, a 10 basis point decrease from the 2012 quarter. The consolidated benefit ratio for the 2013 period was 83.2%, a 130 basis point decrease from the 2012 period primarily due to decreases in both the Retail and Employer Group segments benefit ratios in the 2013 period as described further in our segment results discussion that follows, as well as the beneficial effect in the 2013 period of a favorable settlement of contract claims with the DoD primarily associated with previously disclosed litigation settled in the second quarter of 2012. The increase in favorable prior-year medical claims reserve development of $60 million from the 2012 quarter to the 2013 quarter and $185 million from the 2012 period to the 2013 period positively impacted year-over-year comparisons of the benefit ratio.

Operating costs

Our segments incur both direct and shared indirect operating costs. We allocate the indirect costs shared by the segments primarily as a function of revenues. As a result, the profitability of each segment is interdependent.

Consolidated operating costs increased $77 million, or 5.6%, during the 2013 quarter compared to the 2012 quarter and increased $140 million, or 5.1%, in the 2013 period compared to the 2012 period. These increases primarily were due to an increase in operating costs in our Healthcare Services segment as a result the acquisition of Metropolitan on December 21, 2012 and SeniorBridge on July 6, 2012.

The consolidated operating cost ratio for the 2013 quarter was 14.3%, decreasing 10 basis points from the 2012 quarter primarily due to improved operating leverage in our Retail and Employer Group segments that more than offset the impact of costs associated with the loss of our Medicaid contracts in Puerto Rico. The consolidated operating cost ratio for the 2013 period was 14.1%, increasing 10 basis points from the 2012 period as the negative impact of the current TRICARE South Region contract being accounted for as an administrative services fee only arrangement beginning April 1, 2012 and costs associated with the loss of our Medicaid contracts in Puerto Rico were partially offset by improved operating leverage in our Retail and Employer Group segments.

Depreciation and amortization

Depreciation and amortization for the 2013 quarter totaled $80 million, an increase of $7 million, or 9.6%, from the 2012 quarter. For the 2013 period, depreciation and amortization of $160 million increased $17 million, or 11.9%, from the 2012 period. These increases are primarily due to capital expenditures and depreciation and amortization associated with 2012 acquisitions.

Interest expense

Interest expense was $35 million for the 2013 quarter compared to $26 million for the 2012 quarter, an increase of $9 million, or 34.6%. Interest expense was $70 million for the 2013 period compared to $52 million for the 2012 period, an increase of $18 million, or 34.6%. In December 2012, we issued $600 million of 3.15% senior notes due December 1, 2022 and $400 million of 4.625% senior notes due December 1, 2042.

Income Taxes

Our effective tax rate during the 2013 quarter was 35.7% compared to the effective tax rate of 36.8% in the 2012 quarter. For the 2013 period, our effective tax rate was 35.5%, comparable to the effective tax rate of 36.7% in the 2012 period. This change is primarily due to a change in our estimated tax liability associated with limitations on the deductibility of annual compensation in excess of $500,000 per employee as mandated by the Health Care Reform Law.

Retail Segment

June 30,

Change

2013

2012

Members

Percentage

Membership:

Medical membership:

Individual Medicare Advantage

2,029,700

1,895,800

133,900

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company