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HUMANA INC - Quarter Report: 2018 March (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 1-5975
HUMANA INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
61-0647538
(State 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  ý    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  ý    No  ¨
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
ý
 
Accelerated filer
¨
 
 
 
 
 
Non-accelerated filer
¨
 
Smaller reporting company
¨
 
 
 
 
 
Emerging growth company
¨
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act.  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý
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
Outstanding at
March 31, 2018
$0.16 2/3 par value
137,682,171 shares


Table of Contents

Humana Inc.
FORM 10-Q
MARCH 31, 2018
INDEX
 
 
Page
Part I: Financial Information
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 
 
 
Certifications
 





Humana Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
March 31,
2018
 
December 31,
2017
 
(in millions, except share amounts)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
8,855

 
$
4,042

Investment securities
9,742

 
9,557

Receivables, less allowance for doubtful accounts of $87 in 2018
and $96 in 2017
1,276

 
854

Other current assets
4,059

 
2,949

Total current assets
23,932

 
17,402

Property and equipment, net
1,595

 
1,584

Long-term investment securities
2,361

 
2,745

Goodwill
3,760

 
3,281

Other long-term assets
1,805

 
2,166

Total assets
$
33,453

 
$
27,178

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Benefits payable
$
4,961

 
$
4,668

Trade accounts payable and accrued expenses
6,266

 
4,069

Book overdraft
124

 
141

Unearned revenues
3,706

 
378

Short-term debt
398

 
150

Total current liabilities
15,455

 
9,406

Long-term debt
4,772

 
4,770

Future policy benefits payable
2,842

 
2,923

Other long-term liabilities
303

 
237

Total liabilities
23,372

 
17,336

Commitments and contingencies (Note 14)

 

Stockholders’ equity:
 
 
 
Preferred stock, $1 par; 10,000,000 shares authorized; none issued

 

Common stock, $0.16 2/3 par; 300,000,000 shares authorized;
198,585,156 shares issued at March 31, 2018 and 198,572,458 shares
issued at December 31, 2017
33

 
33

Capital in excess of par value
2,626

 
2,445

Retained earnings
14,086

 
13,670

Accumulated other comprehensive (loss) income
(154
)
 
19

Treasury stock, at cost, 60,902,985 shares at March 31, 2018 and
60,893,762 shares at December 31, 2017
(6,510
)
 
(6,325
)
Total stockholders’ equity
10,081

 
9,842

Total liabilities and stockholders’ equity
$
33,453

 
$
27,178

See accompanying notes to condensed consolidated financial statements.

3


Humana Inc.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
 
Three months ended
March 31,
 
2018
 
2017
 
(in millions, except per share results)
Revenues:
 
 
 
Premiums
$
13,811

 
$
13,398

Services
327

 
253

Investment income
141

 
111

Total revenues
14,279

 
13,762

Operating expenses:
 
 
 
Benefits
11,670

 
11,326

Operating costs
1,749

 
1,553

Merger termination fee and related costs, net

 
(947
)
Depreciation and amortization
100

 
92

Total operating expenses
13,519

 
12,024

Income from operations
760

 
1,738

Interest expense
53

 
49

Income before income taxes
707

 
1,689

Provision for income taxes
216

 
574

Net income
$
491

 
$
1,115

Basic earnings per common share
$
3.56

 
$
7.54

Diluted earnings per common share
$
3.53

 
$
7.49

Dividends declared per common share
$
0.50

 
$
0.40

See accompanying notes to condensed consolidated financial statements.

4


Humana Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
Three months ended
March 31,
 
2018
 
2017
 
(in millions)
Net income
$
491

 
$
1,115

Other comprehensive (loss) income:
 
 
 
Change in gross unrealized investment
gains/losses
(203
)
 
38

Effect of income taxes
52

 
(14
)
Total change in unrealized
investment gains/losses, net of tax
(151
)
 
24

Reclassification adjustment for net
realized gains included in
investment income
(29
)
 
(26
)
Effect of income taxes
7

 
10

Total reclassification adjustment, net
of tax
(22
)
 
(16
)
Other comprehensive (loss) income, net
of tax
(173
)
 
8

Comprehensive income
$
318

 
$
1,123

See accompanying notes to condensed consolidated financial statements.

5


Humana Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
For the three months ended
March 31,
 
2018
 
2017
 
(in millions)
Cash flows from operating activities
 
 
 
Net income
$
491

 
$
1,115

Adjustments to reconcile net income to net cash provided by
operating activities:
 
 
 
Net realized capital gains
(29
)
 
(26
)
Stock-based compensation
35

 
26

Depreciation
109

 
100

Other intangible amortization
30

 
18

Provision for deferred income taxes
83

 
29

Changes in operating assets and liabilities, net of effect of
businesses acquired and dispositions:
 
 
 
Receivables
(422
)
 
(558
)
Other assets
(1,164
)
 
(415
)
Benefits payable
293

 
198

Other liabilities
885

 
542

Unearned revenues
3,328

 
3,140

Other, net
47

 
36

Net cash provided by operating activities
3,686

 
4,205

Cash flows from investing activities
 
 
 
Acquisitions, net of cash acquired
(169
)
 
(7
)
Purchases of property and equipment
(134
)
 
(122
)
Purchases of investment securities
(1,711
)
 
(1,876
)
Maturities of investment securities
217

 
284

Proceeds from sales of investment securities
1,392

 
795

Net cash used in investing activities
(405
)
 
(926
)
Cash flows from financing activities
 
 
 
Receipts from contract deposits, net
1,401

 
1,730

Proceeds from issuance of senior notes, net

 
991

Proceeds from issuance of commercial paper, net
245

 
169

Change in book overdraft
(17
)
 
(34
)
Common stock repurchases
(51
)
 
(1,574
)
Dividends paid
(57
)
 
(47
)
Proceeds from stock option exercises and other
11

 
34

Net cash provided by financing activities
1,532

 
1,269

Increase in cash and cash equivalents
4,813

 
4,548

Cash and cash equivalents at beginning of period
4,042

 
3,877

Cash and cash equivalents at end of period
$
8,855

 
$
8,425

Supplemental cash flow disclosures:
 
 
 
Interest payments
$
22

 
$
10

Income tax payments (refunds), net
$
4

 
$
(4
)
See accompanying notes to condensed consolidated financial statements.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1. BASIS OF PRESENTATION AND SIGNIFICANT EVENTS
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, 2017, that was filed with the Securities and Exchange Commission, or the SEC, on February 16, 2018. We refer to the Form 10-K as the “2017 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, future policy benefits payable, the impact of risk adjustment 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 2017 Form 10-K for information on accounting policies that we consider in preparing our 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.
Acquisition of a 40% Minority Interest in Kindred’s Homecare Business

On December 19, 2017, we announced that we entered into a definitive agreement to acquire a 40% minority interest in the Kindred at Home Division, or Kindred at Home, of Kindred Healthcare, Inc., or Kindred, for estimated cash consideration of approximately $800 million, including our share of transaction and related expenses, to facilitate a complete separation from the Long Term Acute Care and Rehabilitation businesses (the Specialty Hospital company). TPG Capital, or TPG, and Welsh, Carson, Anderson & Stowe, or WCAS, collectively, the Sponsors, along with us are jointly creating a consortium to purchase all of the outstanding and issued securities of Kindred. Immediately following the closing of that transaction, Kindred at Home and the Specialty Hospital company will be separated, with the result being that the Specialty Hospital Company will be owned by the Sponsors and Kindred at Home will be owned by a joint venture owned by the Sponsors and us. We will own 40% of Kindred at Home, with the remaining 60% owned by a new entity owned by TPG and WCAS.
At the closing of the transaction, we will enter a shareholders agreement with the Sponsors that will provide for certain rights and obligations of each party concerning the newly formed joint venture that will own Kindred at Home. The shareholders agreement with the Sponsors includes a put option under which they have the right to require us to purchase their interest in the joint venture starting at the end of year three and ending at the end of year four following the closing. Consideration upon exercise of the put option per the agreement would be valued at an exit multiple of 10.5 times the preceding twelve months earnings before interest, income taxes, depreciation and amortization, or EBITDA, subject to certain adjustments. In addition, the multiple is subject to adjustment up to 11.5 times EBITDA based on the achievement of certain pre-defined value-based outcomes tied to clinical metrics. The 11.5 times EBITDA exit multiple is comparable to the valuation of our acquired interest in Kindred at Home. Finally, we have a call option under which we have the right to require the Sponsors to sell their interest in the joint venture to Humana beginning at the end of year four and ending at the end of year five following the closing for cash consideration using the same valuation methodology applicable to the previously discussed put option consideration.


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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

The above transactions, which are anticipated to close in the summer of 2018, are subject to customary state and federal regulatory approvals, as well as other customary closing conditions. On April 5, 2018, Kindred's stockholders approved the transaction. We expect to fund the transaction through the use of parent company cash and will account for the minority investment under the equity method.
Acquisition of a 40% Minority Interest in Curo Health Services
On April 23, 2018, we, along with the same Kindred at Home sponsors, TPG and WCAS, collectively referred to as the "Consortium," entered into a definitive agreement to acquire privately held Curo Health Services, or Curo, one of the nations' leading hospice operators providing care to patients at 245 locations in 22 states. The Consortium is purchasing Curo for approximately $1.4 billion, and at the closing of the transaction, we will have a 40% minority interest. The Curo transaction, which is anticipated to close during the summer of 2018, is subject to customary state and federal regulatory approvals as well as other customary closing conditions. The Curo transaction is not conditioned upon the closing of the Consortium’s separate acquisition of Kindred at Home and is expected to occur after the closing of Kindred at Home. Upon the closing of these transactions, the Consortium intends to merge Curo with the hospice business of Kindred at Home.
Sale of Closed Block of Commercial Long-Term Care Insurance Business
On November 6, 2017, we entered into a definitive agreement to sell the stock of our wholly-owned subsidiary, KMG America Corporation, or KMG, to Continental General Insurance Company, or CGIC, a Texas-based insurance company wholly owned by HC2 Holdings, Inc., a diversified holding company. KMG’s subsidiary, Kanawha Insurance Company, or KIC, includes our closed block of non-strategic commercial long-term care insurance policies. Based on the terms of the definitive agreement we expect to record a net loss associated with the sale of KMG of approximately $350 million. The estimated loss includes a pretax loss of approximately $760 million, offset by the expected tax benefit of approximately $410 million. We will fund the transaction with approximately $203 million of parent company cash contributed into KMG, subject to customary adjustments, in addition to the transfer of approximately $150 million of statutory capital with the sale, which together should be more than offset by the estimated $410 million cash savings associated with the expected tax treatment of the sale. The KMG transaction is anticipated to close by the third quarter of 2018 subject to customary closing conditions, including South Carolina Department of Insurance approval. There can be no assurance we will obtain regulatory approvals needed to sell the business or do so under terms acceptable to us.
Workforce Optimization
During the third quarter of 2017, we initiated a voluntary early retirement program and an involuntary workforce reduction program. These programs impacted approximately 3,600 associates, or 7.8%, of our workforce in 2017. As a result, in 2017 we recorded charges of $148 million, or $0.64 per diluted common share. At December 31, 2017, $140 million was classified as a current liability, included in our condensed consolidated balance sheet in the trade accounts payable and accrued expenses line. Payments under these programs are being made upon termination during the early retirement or severance pay period. The remaining workforce optimization liability at March 31, 2018 was $94 million and is expected to be paid in 2018.
Aetna Merger
On February 16, 2017, under the terms of the Agreement and Plan of Merger, or Merger Agreement, with Aetna Inc., and certain wholly owned subsidiaries of Aetna Inc., which we collectively refer to as Aetna, we received a breakup fee of $1 billion from Aetna, which is included in our consolidated statement of income in the line captioned "Merger termination fee and related costs, net."
Revenue Recognition
Our revenues include premium and service revenues. Service revenues include administrative service fees that are recorded based upon established per member per month rates and the number of members for the month and are recognized as services are provided for the month. Additionally, service revenues include net patient service revenues that are recorded based upon established billing rates, less allowances for contractual adjustments, and are recognized

8

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

as services are provided. For more information about our revenues, refer to Note 2 to the consolidated financial statements included in our 2017 Form 10-K for information on accounting policies that we consider in preparing our consolidated financial statements. See Note 15 for disaggregation of revenue by segment and type.
At March 31, 2018, accounts receivable related to services were $162 million. For the three months ended March 31, 2018, we had no material bad-debt expense and there were no material contract assets, contract liabilities or deferred contract costs recorded on the condensed consolidated balance sheet at March 31, 2018.
For the three months ended March 31, 2018, revenue recognized from performance obligations related to prior periods (for example, due to changes in transaction price), was not material. Further revenue expected to be recognized in any future year related to remaining performance obligations was not material.
Revenue expected to be recognized in any future year related to remaining performance obligations was not material.
2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In May 2014, the Financial Accounting Standards Board, or FASB, issued new guidance that amends the accounting for revenue recognition. The amendments are intended to provide a more robust framework for addressing revenue issues, improve comparability of revenue recognition practices, and improve disclosure requirements. Insurance contracts are not included in the scope of this new guidance. Accordingly, our premiums revenue and investment income, collectively representing approximately 98% of our consolidated external revenues for the three months ended March 31, 2018, are not included in the scope of the new guidance. We adopted the new standard effective January 1, 2018, using the modified retrospective approach. As the majority of our revenues are not subject to the new guidance and the remaining revenues’ accounting treatment did not materially differ from pre-existing accounting treatment, the adoption of the new standard did not have a material impact on our consolidated results of operations, financial condition, cash flows, or related disclosures.
 
In February 2016, the FASB issued new guidance related to accounting for leases which requires lessees to record
assets and liabilities reflecting the leased assets and lease obligations, respectively, while following the dual model for recognition in statements of income requiring leases to be classified as either operating or finance. Operating leases will result in straight-line expense (similar to current operating leases) while finance leases will result in a front-loaded expense pattern (similar to current capital leases). The new guidance is effective for us beginning with annual and interim periods in 2019, with earlier adoption permitted. We are in the process of reconciling the population of lease agreements and other arrangements that may contain embedded leases for purposes of adopting the new standard. While we expect to record significant leased assets and corresponding lease obligations based on our existing population of individual leases, we continue to evaluate the impact on our results of operations, financial position and cash flows.
In June 2016, the FASB issued guidance introducing a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The guidance is effective for us beginning January 1, 2020. The new current expected credit losses (CECL) model generally calls for the immediate recognition of all expected credit losses and applies to loans, accounts and trade receivables as well as other financial assets measured at amortized cost, loan commitments and off-balance sheet credit exposures, debt securities and other financial assets measured at fair value through other comprehensive income, and beneficial interests in securitized financial assets. The
new guidance replaces the current incurred loss model for measuring expected credit losses, requires expected losses
on available-for-sale debt securities to be recognized through an allowance for credit losses rather than as reductions
in the amortized cost of the securities, and provides for additional disclosure requirements. Our investment portfolio consists of available-for-sale debt securities. We are currently evaluating the impact on our results of operations, financial condition, and cash flows.
In March 2017, the FASB issued new guidance that amends the accounting for premium amortization on purchased callable debt securities by shortening the amortization period. This amended guidance requires the premium to be amortized to the earliest call date instead of maturity date. The new guidance is effective for us beginning with annual and interim periods in 2019. We do not expect adoption of this guidance will have a material impact on our results of operations, financial condition and cash flows.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

In February 2018, the FASB issued guidance which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the December 22, 2017 enactment of the Tax Cuts and Jobs Act.  The new guidance is effective for us beginning January 1, 2019, with early adoption permitted.  We early adopted this guidance in the first quarter of 2018 and it did not have a material impact on our results of operations, financial condition or cash flows.
There are no other recently issued accounting standards that apply to us or that are expected to have a material impact on our results of operations, financial condition, or cash flows.
3. ACQUISITIONS AND DIVESTITURES
On March 1, 2018 we acquired the remaining equity interest in MCCI Holdings, LLC, or MCCI, a privately held management service organization headquartered in Miami, Florida, that primarily coordinates medical care for Medicare Advantage beneficiaries in Florida and Texas. The purchase price consisted primarily of $169 million cash, as well as our existing investment in MCCI and a note receivable and a revolving note with an aggregate balance of $383 million. This resulted in a preliminary purchase price allocation to goodwill of $479 million, other intangible assets of $80 million, and net tangible assets of $27 million. The goodwill was assigned to the Retail and Healthcare Services segments. The other intangible assets, which primarily consist of customer contracts, have an estimated weighted average useful life of 8 years. Goodwill and other intangible assets are amortizable as deductible expenses for tax purposes. The purchase price allocation is preliminary, subject to completion of valuation analyses, including for example, refining assumptions used to calculate the fair value of intangible assets.
On April 10, 2018, we acquired Family Physicians Group, or FPG, for cash considerations of approximately $190 million. FPG is one of the largest at-risk providers serving Medicare Advantage and Managed Medicaid HMO patients in Greater Orlando, Florida with a footprint that includes clinics located in Lake, Orange, Osceola and Seminole counties. The acquisition of FPG advances our strategy of helping physicians and clinicians evolve from treating health episodically to managing health holistically. This acquisition is not expected to have a material impact on our results of operations, financial condition, or cash flows.
During 2018 and 2017, we acquired other health and wellness related businesses which, individually or in the aggregate, have not had a material impact on our results of operations, financial condition, or cash flows. The results of operations and financial condition of these businesses have been included in our condensed consolidated statements of income and condensed consolidated balance sheets from the respective acquisition dates. Acquisition-related costs recognized in 2018 and 2017 were not material to our results of operations. 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.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

4. INVESTMENT SECURITIES
Investment securities classified as current and long-term were as follows at March 31, 2018 and December 31, 2017, respectively:
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(in millions)
March 31, 2018
 
 
 
 
 
 
 
U.S. Treasury and other U.S. government
corporations and agencies:
 
 
 
 
 
 
 
U.S. Treasury and agency obligations
$
505

 
$
1

 
$
(5
)
 
$
501

Mortgage-backed securities
2,308

 

 
(56
)
 
2,252

Tax-exempt municipal securities
3,549

 
6

 
(61
)
 
3,494

Mortgage-backed securities:
 
 
 
 
 
 
 
Residential
24

 

 
(1
)
 
23

Commercial
580

 

 
(11
)
 
569

Asset-backed securities
554

 
1

 
(1
)
 
554

Corporate debt securities
4,693

 
131

 
(114
)
 
4,710

Total debt securities
$
12,213

 
$
139

 
$
(249
)
 
$
12,103

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
U.S. Treasury and other U.S. government
corporations and agencies:
 
 
 
 
 
 
 
U.S. Treasury and agency obligations
$
532

 
$
1

 
$
(2
)
 
$
531

Mortgage-backed securities
1,625

 
4

 
(19
)
 
1,610

Tax-exempt municipal securities
3,884

 
33

 
(28
)
 
3,889

Mortgage-backed securities:
 
 
 
 
 
 
 
Residential
26

 

 

 
26

Commercial
455

 
3

 
(2
)
 
456

Asset-backed securities
407

 
1

 

 
408

Corporate debt securities
5,175

 
244

 
(37
)
 
5,382

Total debt securities
$
12,104

 
$
286

 
$
(88
)
 
$
12,302


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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 March 31, 2018 and December 31, 2017, 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)
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and other U.S.
government corporations
and agencies:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
obligations
$
362

 
$
(2
)
 
$
129

 
$
(3
)
 
$
491

 
$
(5
)
Mortgage-backed
securities
1,489

 
(28
)
 
638

 
(28
)
 
2,127

 
(56
)
Tax-exempt municipal
securities
2,409

 
(41
)
 
621

 
(20
)
 
3,030

 
(61
)
Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
18

 

 
3

 
(1
)
 
21

 
(1
)
Commercial
451

 
(10
)
 
28

 
(1
)
 
479

 
(11
)
Asset-backed securities
162

 
(1
)
 
7

 

 
169

 
(1
)
Corporate debt securities
2,431

 
(60
)
 
761

 
(54
)
 
3,192

 
(114
)
Total debt securities
$
7,322

 
$
(142
)
 
$
2,187

 
$
(107
)
 
$
9,509

 
$
(249
)
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and other U.S.
government corporations
and agencies:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and agency
obligations
$
273

 
$
(1
)
 
$
130

 
$
(1
)
 
$
403

 
$
(2
)
Mortgage-backed
securities
581

 
(2
)
 
672

 
(17
)
 
1,253

 
(19
)
Tax-exempt municipal
securities
1,590

 
(16
)
 
661

 
(12
)
 
2,251

 
(28
)
Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Residential
20

 

 
3

 

 
23

 

Commercial
131

 
(1
)
 
28

 
(1
)
 
159

 
(2
)
Asset-backed securities
107

 

 
10

 

 
117

 

Corporate debt securities
1,297

 
(10
)
 
804

 
(27
)
 
2,101

 
(37
)
Total debt securities
$
3,999

 
$
(30
)
 
$
2,308

 
$
(58
)
 
$
6,307

 
$
(88
)
Approximately 99% of our debt securities were investment-grade quality, with a weighted average credit rating of AA by Standard & Poor's Rating Service, or S&P, at March 31, 2018. Most of the debt securities that were below investment-grade were rated BB, the higher end of the below investment-grade rating scale. Tax-exempt municipal securities were diversified among general obligation bonds of states and local municipalities in the United States as well as special revenue bonds issued by municipalities to finance specific public works projects such as utilities, water and sewer, transportation, or education. Our general obligation bonds are diversified across the United States with no individual state exceeding 9%. In addition, 2% of our tax-exempt securities were insured by bond insurers and had an

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

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.
Our unrealized losses from all securities were generated from approximately 1,410 positions out of a total of approximately 2,230 positions at March 31, 2018. All issuers of securities we own that were trading at an unrealized loss at March 31, 2018 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 in the current markets since the time the securities were purchased. At March 31, 2018, 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 March 31, 2018.
The detail of realized gains (losses) related to investment securities and included within investment income was as follows for the three months ended March 31, 2018 and 2017:
 
Three months ended
March 31,
 
2018
 
2017
 
(in millions)
Gross realized gains
$
32

 
$
27

Gross realized losses
(3
)
 
(1
)
Net realized capital gains
$
29


$
26

There were no material other-than-temporary impairments for the three months ended March 31, 2018 or 2017.
The contractual maturities of debt securities available for sale at March 31, 2018, 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
$
856

 
$
854

Due after one year through five years
2,846

 
2,803

Due after five years through ten years
2,317

 
2,247

Due after ten years
2,728

 
2,801

Mortgage and asset-backed securities
3,466

 
3,398

Total debt securities
$
12,213

 
$
12,103


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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

5. FAIR VALUE
Financial Assets
The following table summarizes our fair value measurements at March 31, 2018 and December 31, 2017, 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)
March 31, 2018
 
 
 
 
 
 
 
Cash equivalents
$
4,346

 
$
4,346

 
$

 
$

Debt securities:
 
 
 
 
 
 
 
U.S. Treasury and other U.S. government
corporations and agencies:
 
 
 
 
 
 
 
U.S. Treasury and agency obligations
501

 

 
501

 

Mortgage-backed securities
2,252

 

 
2,252

 

Tax-exempt municipal securities
3,494

 

 
3,494

 

Mortgage-backed securities:
 
 
 
 
 
 
 
Residential
23

 

 
23

 

Commercial
569

 

 
569

 

Asset-backed securities
554

 

 
554

 

Corporate debt securities
4,710

 

 
4,709

 
1

Total debt securities
12,103

 

 
12,102

 
1

Total invested assets
$
16,449

 
$
4,346

 
$
12,102

 
$
1

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
Cash equivalents
$
4,564

 
$
4,564

 
$

 
$

Debt securities:
 
 
 
 
 
 
 
U.S. Treasury and other U.S. government
corporations and agencies:
 
 
 
 
 
 
 
U.S. Treasury and agency obligations
531

 

 
531

 

Mortgage-backed securities
1,610

 

 
1,610

 

Tax-exempt municipal securities
3,889

 

 
3,889

 

Mortgage-backed securities:
 
 
 
 
 
 
 
Residential
26

 

 
26

 

Commercial
456

 

 
456

 

Asset-backed securities
408

 

 
408

 

Corporate debt securities
5,382

 

 
5,381

 
1

Total debt securities
12,302

 

 
12,301

 
1

Total invested assets
$
16,866

 
$
4,564

 
$
12,301

 
$
1


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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

There were no material transfers between Level 1 and Level 2 during the three months ended March 31, 2018 or 2017.
Financial Liabilities
Our debt is recorded at carrying value in our consolidated balance sheets. The carrying value of our senior notes debt outstanding, net of unamortized debt issuance costs, was $4,772 million at March 31, 2018 and $4,770 million at December 31, 2017. The fair value of our senior notes debt was $4,944 million at March 31, 2018 and $5,191 million at December 31, 2017. 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.
Due to the short-term nature, carrying value approximates fair value for our commercial paper borrowings. There were outstanding commercial paper borrowings of $398 million as of March 31, 2018 and $150 million as of December 31, 2017.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
As disclosed in Note 3, we acquired MCCI, FPG, and other health and wellness related businesses during 2018 and 2017. 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 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 used in the present value calculations. Other than assets acquired and liabilities assumed in these acquisitions, there were no material assets or liabilities measured at fair value on a nonrecurring basis during 2018 or 2017.
6. MEDICARE PART D
We cover prescription drug benefits in accordance with Medicare Part D under multiple contracts with the Centers for Medicare and Medicaid Services, or CMS, as described further in Note 2 to the consolidated financial statements included in our 2017 Form 10-K. The accompanying condensed consolidated balance sheets include the following amounts associated with Medicare Part D at March 31, 2018 and December 31, 2017. CMS subsidies/discounts in the table below include the reinsurance and low-income cost subsidies funded by CMS for which we assume no risk as well as brand name prescription drug discounts for Part D plan participants in the coverage gap funded by CMS and pharmaceutical manufacturers.
 
March 31, 2018
 
December 31, 2017
Risk
Corridor
Settlement
 
CMS
Subsidies/
Discounts
 
Risk
Corridor
Settlement
 
CMS
Subsidies/
Discounts
 
(in millions)
Other current assets
$
5

 
$
79

 
$
4

 
$
101

Trade accounts payable and accrued expenses
(240
)
 
(2,509
)
 
(255
)
 
(1,085
)
Net current liability
(235
)
 
(2,430
)
 
(251
)
 
(984
)
Other long-term assets
33

 

 

 

Other long-term liabilities
(78
)
 

 
(28
)
 

Net long-term liability
(45
)
 

 
(28
)
 

Total net liability
$
(280
)
 
$
(2,430
)
 
$
(279
)
 
$
(984
)

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

7. 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) established risk spreading premium stabilization programs effective January 1, 2014, including a permanent risk adjustment program and temporary risk corridor and reinsurance programs, which we collectively refer to as the 3Rs. The 3Rs, applicable to certain of our commercial medical insurance products, are further discussed in Note 2 to our 2017 Form 10-K. The temporary programs were only applicable for years 2014 through 2016. As a result of our exit from our individual commercial medical business effective January 1, 2018, the permanent risk adjustment program is currently only applicable to our commercial small group health insurance business.
On November 2, 2017, we filed suit against the United States of America in the United States Court of Federal Claims, on behalf of our health plans seeking recovery from the federal government of approximately $611 million in payments under the risk corridor premium stabilization program established under the Health Care Reform Law, for years 2014, 2015 and 2016.
 
The accompanying condensed consolidated balance sheets include the following amounts associated with the 3Rs at March 31, 2018 and December 31, 2017.
 
March 31, 2018
 
December 31, 2017
 
Risk Adjustment
Settlement
 
Reinsurance
Recoverables
 
Risk Adjustment
Settlement
 
Reinsurance
Recoverables
 
(in millions)
Prior Coverage Years
 
 
 
 
 
 
 
Premiums receivable
$
65
 
 
$

 
$
62
 
 
$

Other current assets
 
 

 
 
 
44

Trade accounts payable and
accrued expenses
(79
)
 

 
(80
)
 

Net current (liability) asset
(14
)
 

 
(18
)
 
44

Other long-term assets
 
 

 
5
 
 

Total prior coverage years' net (liability) asset
(14
)
 

 
(13
)
 
44

Current Coverage Year
 
 
 
 
 
 
 
Other long-term assets
1
 
 

 
 
 

Other long-term liabilities
(11
)
 

 
 
 

Net long-term liability
(10
)
 

 
 
 

Total 2018 coverage year net liability
(10
)
 

 
 
 

Total net (liability) asset
$
(24
)
 
$

 
$
(13
)
 
$
44

Net collections under the 3R's associated with prior coverage years were $46 million during the three months ended March 31, 2018 and were $62 million during the three months ended March 31, 2017.
In September 2018, we expect to pay the federal government $1.05 billion for our portion of the annual health insurance industry fee attributed to calendar year 2018 in accordance with the Health Care Reform Law. This fee, fixed in amount by law and apportioned to insurance carriers based on market share, is not deductible for tax purposes. Each year on January 1, except for 2017 when the fee was suspended, we record a liability for this fee in trade accounts payable and accrued expenses which we carry until the fee is paid. We record a corresponding deferred cost in other current assets in our condensed consolidated financial statements which is amortized ratably to expense over the calendar year. Amortization of the deferred cost was recorded in operating cost expense of approximately $263 million for the three months ended March 31, 2018, resulting from the amortization of the 2018 annual health insurance industry fee.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

The annual health insurance industry fee was suspended for calendar year 2017, and is also suspended for calendar year 2019.
8. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for our reportable segments for the three months ended March 31, 2018 were as follows:
 
Retail
 
Group and Specialty
 
Healthcare
Services
 
Total
 
(in millions)
Balance at January 1, 2018
$
1,059

 
$
261

 
$
1,961

 
$
3,281

Acquisitions
360

 

 
119

 
479

Balance at March 31, 2018
$
1,419

 
$
261

 
$
2,080

 
$
3,760

The following table presents details of our other intangible assets included in other long-term assets in the accompanying condensed consolidated balance sheets at March 31, 2018 and December 31, 2017.
 
 
 
March 31, 2018
 
December 31, 2017
 
Weighted
Average
Life
 
Cost
 
Accumulated
Amortization
 
Net
 
Cost
 
Accumulated
Amortization
 
Net
 
 
 
($ in millions)
Other intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer contracts/
relationships
9.6 years
 
$
646

 
$
414

 
$
232

 
$
566

 
$
401

 
$
165

Trade names and
technology
6.5 years
 
83

 
78

 
5

 
104

 
84

 
20

Provider contracts
11.9 years
 
68

 
32

 
36

 
68

 
30

 
38

Noncompetes and
other
8.1 years
 
32

 
29

 
3

 
32

 
29

 
3

Total other intangible
assets
9.4 years
 
$
829

 
$
553

 
$
276

 
$
770

 
$
544

 
$
226

For the three months ended March 31, 2018 and 2017, amortization expense for other intangible assets was approximately $30 million and $18 million, respectively. Amortization expense for the three months ended March 31, 2018 included $12 million associated with the write-off of a trade name value reflecting the re-branding of certain provider assets. The following table presents our estimate of amortization expense for 2018 and each of the five next succeeding years:
 
(in millions)
For the years ending December 31,
 
2018
$
84

2019
63

2020
61

2021
27

2022
24

2023
16


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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

9. BENEFITS PAYABLE
On a consolidated basis, activity in benefits payable, excluding military services, was as follows for the three months ended March 31, 2018 and 2017:
 
 
For the three months ended March 31,
 
 
2018
 
2017
 
 
(in millions)
Balances, beginning of period
 
$
4,668

 
$
4,563

Less: Reinsurance recoverables
 
(70
)
 
(76
)
Balances, beginning of period, net
 
4,598

 
4,487

Incurred related to:
 
 
 
 
Current year
 
11,947

 
11,580

Prior years
 
(267
)
 
(231
)
Total incurred
 
11,680

 
11,349

Paid related to:
 
 
 
 
Current year
 
(7,775
)
 
(7,695
)
Prior years
 
(3,619
)
 
(3,451
)
Total paid
 
(11,394
)
 
(11,146
)
Reinsurance recoverable
 
77

 
71

Balances, end of period
 
$
4,961

 
$
4,761

Amounts incurred related to prior periods vary from previously estimated liabilities as the claims ultimately are settled. Negative amounts reported for incurred related to prior years result from claims being ultimately settled for amounts less than originally estimated (favorable development).
Our reserving practice is to consistently recognize the actuarial best estimate of our ultimate liability for claims. 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.
Benefits expense excluded from the previous table was as follows for the three months ended March 31, 2018 and 2017.
 
 
For the three months ended March 31,
 
 
2018
 
2017
 
 
(in millions)
Future policy benefits:
 
 
 
 
Individual Commercial
 
$
(16
)
 
$
(33
)
Other Businesses
 
6

 
10

Total future policy benefits
 
$
(10
)
 
$
(23
)





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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Incurred and Paid Claims Development
The following discussion provides information about incurred and paid claims development for our Retail, Group and Specialty, and Individual Commercial segments as of March 31, 2018 and 2017, net of reinsurance, and the total of IBNR included within the net incurred claims amounts.
Retail Segment
Activity in benefits payable for our Retail segment was as follows for the three months ended March 31, 2018 and 2017:
 
 
For the three months ended March 31,
 
 
2018
 
2017
 
 
(in millions)
Balances, beginning of period
 
$
3,963

 
$
3,507

Less: Reinsurance recoverables
 
(70
)
 
(76
)
Balances, beginning of period, net
 
3,893

 
3,431

Incurred related to:
 
 
 
 
Current year
 
10,739

 
10,255

Prior years
 
(187
)
 
(204
)
Total incurred
 
10,552

 
10,051

Paid related to:
 
 
 
 
Current year
 
(7,119
)
 
(7,014
)
Prior years
 
(3,082
)
 
(2,572
)
Total paid
 
(10,201
)
 
(9,586
)
Reinsurance recoverable
 
77

 
71

Balances, end of period
 
$
4,321

 
$
3,967

At March 31, 2018, benefits payable for our Retail segment included IBNR of approximately $2.8 billion, primarily associated with claims incurred in 2018.












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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Group and Specialty Segment
Activity in benefits payable for our Group and Specialty segment, excluding military services, was as follows for the three months ended March 31, 2018 and 2017:
 
 
For the three months ended March 31,
 
 
2018
 
2017
 
 
(in millions)
Balances, beginning of period
 
$
568

 
$
578

Incurred related to:
 
 
 
 
Current year
 
1,307

 
1,306

Prior years
 
(34
)
 
(20
)
Total incurred
 
1,273

 
1,286

Paid related to:
 
 
 
 
Current year
 
(802
)
 
(824
)
Prior years
 
(463
)
 
(493
)
Total paid
 
(1,265
)
 
(1,317
)
Balances, end of period
 
$
576

 
$
547

At March 31, 2018, benefits payable for our Group and Specialty segment included IBNR of approximately $502 million, primarily associated with claims incurred in 2018.

Individual Commercial Segment
Activity in benefits payable for our Individual Commercial segment was as follows for the three months ended March 31, 2018 and 2017:
 
 
For the three months ended March 31,
 
 
2018
 
2017
 
 
(in millions)
Balances, beginning of period
 
$
101

 
$
454

Incurred related to:
 
 
 
 
Current year
 

 
195

Prior years
 
(44
)
 
(6
)
Total incurred
 
(44
)
 
189

Paid related to:
 
 
 
 
Current year
 

 
(59
)
Prior years
 
(29
)
 
(363
)
Total paid
 
(29
)
 
(422
)
Balance, end of period
 
$
28

 
$
221


At March 31, 2018, benefits payable for our Individual Commercial segment included IBNR of approximately $19 million, associated with claims incurred in 2017 and prior.




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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Reconciliation to Consolidated

The reconciliation of the net incurred and paid claims development tables to benefits payable in the consolidated
statement of financial position is as follows:
 
Reconciliation of the Disclosure of Incurred and Paid Claims Development to Benefits Payable, net of reinsurance
 
 
 
March 31,
 
 
2018
 
Net outstanding liabilities
 
 
Retail
$
4,244

 
Group and Specialty
576

 
Individual Commercial
28

 
Other Businesses
36

 
    Benefits payable, net of reinsurance
4,884

 
 
 
 
Reinsurance recoverable on unpaid claims
 
 
Retail
77

 
     Total reinsurance recoverable on unpaid claims
77

 
 
 
 
     Total benefits payable, gross
$
4,961

10. EARNINGS PER COMMON SHARE COMPUTATION
Detail supporting the computation of basic and diluted earnings per common share was as follows for the three months ended March 31, 2018 and 2017:
 
Three months ended March 31,
 
2018
 
2017
 
(dollars in millions, except per common share results; number of shares in thousands)
Net income available for common stockholders
$
491

 
$
1,115

Weighted average outstanding shares of common stock
used to compute basic earnings per common share
137,903

 
147,824

Dilutive effect of:
 
 
 
Employee stock options
213

 
199

Restricted stock
714

 
849

Shares used to compute diluted earnings per common share
138,830

 
148,872

Basic earnings per common share
$
3.56

 
$
7.54

Diluted earnings per common share
$
3.53

 
$
7.49

Number of antidilutive stock options and restricted stock
excluded from computation
645

 
938


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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

11. STOCKHOLDERS’ EQUITY
Dividends
The following table provides details of dividend payments, excluding dividend equivalent rights for unvested stock awards, in 2017 and 2018 under our Board approved quarterly cash dividend policy:
Record
Date
 
Payment
Date
 
Amount
per Share
 
Total
Amount
 
 
 
 
 
 
(in millions)
2017 payments
 
 
 
 
 
 
1/12/2017
 
1/27/2017
 
$
0.29

 
$
43

3/31/2017
 
4/28/2017
 
$
0.40

 
$
58

6/30/2017
 
7/31/2017
 
$
0.40

 
$
58

9/29/2017
 
10/27/2017
 
$
0.40

 
$
57

2018 payments
 
 
 
 
 
 
12/29/2017
 
1/26/2018
 
$
0.40

 
$
55

3/30/2018
 
4/27/2018
 
$
0.50

 
$
69

On April 19, 2018, the Board declared a cash dividend of $0.50 per share payable on July 27, 2018, to stockholders of record on June 29, 2018.
Stock Repurchases
On December 14, 2017, our Board of Directors authorized the repurchase of up to $3.0 billion of our common shares expiring on December 31, 2020, exclusive of shares repurchased in connection with employee stock plans. Under the share repurchase authorization, shares may be purchased from time to time at prevailing prices in the open market, by block purchases, through plans designed to comply with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, or in privately-negotiated transactions, including pursuant to accelerated share repurchase agreements with investment banks, subject to certain regulatory restrictions on volume, pricing, and timing.
On December 21, 2017, we entered into an accelerated stock repurchase agreement, the December 2017 ASR, with Bank of America, N.A., or BofA, to repurchase $1.0 billion of our common stock as part of the $3.0 billion share repurchase program authorized on December 14, 2017. On December 22, 2017, we made a payment of $1.0 billion to BofA from available cash on hand and received an initial delivery of 3.28 million shares of our common stock from BofA based on the then current market price of Humana common stock. The payment to BofA was recorded as a reduction to stockholders’ equity, consisting of an $800 million increase in treasury stock, which reflects the value of the initial 3.28 million shares received upon initial settlement, and a $200 million decrease in capital in excess of par value, which reflected the value of stock held back by BofA pending final settlement of the December 2017 ASR. Upon settlement of the ASR on March 26, 2018, we received an additional 0.46 million shares as determined by the average daily volume weighted-average share price of our common stock during the term of the ASR Agreement of $267.55, bringing the total shares received under this program to 3.74 million. In addition, upon settlement we reclassified the $200 million value of stock initially held back by BofA from capital in excess of par value to treasury stock.
Our remaining repurchase authorization was approximately $2 billion as of May 1, 2018.
In connection with employee stock plans, we acquired 0.19 million common shares for $51 million and 0.35 million common shares for $74 million during the three months ended March 31, 2018 and 2017, respectively.
Treasury Stock Reissuance
We reissued 0.63 million shares of treasury stock during the three months ended March 31, 2018 at a cost of $66 million associated with restricted stock unit vestings and option exercises.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Accumulated Other Comprehensive Income
Accumulated other comprehensive income included net unrealized losses, net of tax, on our investment securities of $110 million at March 31, 2018 and net unrealized gains, net of tax, on our investment securities of $125 million at December 31, 2017. In addition, accumulated other comprehensive income included $44 million, net of tax, at March 31, 2018 and $106 million, net of tax, at December 31, 2017 for an additional liability that would exist on our closed block of long-term care insurance 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 18 to the consolidated financial statements in our 2017 Form 10-K for further discussion of our long-term care insurance policies.
12. INCOME TAXES
The effective income tax rate was 30.7% for the three months ended March 31, 2018, compared to 34.0% for the three months ended March 31, 2017 primarily due to the tax reform law enacted on December 22, 2017 (the "Tax Reform Law"), partially offset by the impact of the reinstatement of the non-deductible health insurance industry fee in 2018. The income tax rate for the three months ended March 31, 2017 included previously non-deductible transaction costs that, as a result of the termination of the Merger Agreement, became deductible for tax purposes. The Tax Reform Law reduced the statutory federal corporate income tax rate to 21 percent from 35 percent, beginning in 2018. The accounting for certain income tax effects of the Tax Reform Law is provisional. Revisions to prior estimates are recorded as additional analysis is completed using information available at each measurement date during 2018, with adjustments to the income tax provision recorded as new information becomes known. Revisions to our prior estimates for the income tax effects of the Tax Reform Law decreased our tax expense for the three months ended March 31, 2018 by $6.6 million.
13.  DEBT
The carrying value of long-term debt outstanding, net of unamortized debt issuance costs, was as follows at March 31, 2018 and December 31, 2017:
 
March 31, 2018
 
December 31, 2017
 
(in millions)
Senior notes:
 
 
 
  $400 million, 2.625% due October 1, 2019
$
399

 
$
399

  $400 million, 2.50% due December 15, 2020
397

 
397

  $400 million, 2.90% due December 15, 2022
396

 
396

  $600 million, 3.15% due December 1, 2022
596

 
595

  $600 million, 3.85% due October 1, 2024
596

 
595

  $600 million, 3.95% due March 15, 2027
595

 
594

  $250 million, 8.15% due June 15, 2038
263

 
263

  $400 million, 4.625% due December 1, 2042
396

 
396

  $750 million, 4.95% due October 1, 2044
739

 
739

  $400 million, 4.80% due March 15, 2047
395

 
396

     Total long-term debt
$
4,772

 
$
4,770

Senior Notes    

In March 2017, we issued $600 million of 3.95% senior notes due March 15, 2027 and $400 million of 4.80% senior notes due March 15, 2047. Our net proceeds, reduced for the underwriters' discount and commission and offering expenses paid as of March 31, 2017, were $991 million.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Our senior notes, which are unsecured, may be redeemed at our option at any time at 100% of the principal amount plus accrued interest and a specified make-whole amount. The 8.15% senior notes are subject to an interest rate adjustment if the debt ratings assigned to the notes are downgraded (or subsequently upgraded). In addition, our senior notes contain a change of control provision that may require us to purchase the notes under certain circumstances.
Credit Agreement
In May 2017 we amended and restated our previous 5-year $1.0 billion unsecured revolving credit agreement expiring July 2018 with a 5-year $2.0 billion unsecured revolving credit agreement which expires May 2022. Under the 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 110.0 basis points, varies depending on our credit ratings ranging from 91.0 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 9.0 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.
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 $9.5 billion at March 31, 2018 and a maximum leverage ratio of 3.0:1. We are in compliance with the financial covenants, with actual net worth of $10.1 billion and an actual leverage ratio of 1.4:1 as measured in accordance with the credit agreement as of March 31, 2018. Upon our agreement with one or more financial institutions, we may expand the aggregate commitments under the credit agreement to a maximum of $2.5 billion, through a $500.0 million incremental loan facility.
At March 31, 2018, we had no borrowings and no letters of credit outstanding under the credit agreement. Accordingly, as of March 31, 2018, we had $2.0 billion of remaining borrowing capacity (which excludes the uncommitted $500 million incremental loan facility under the 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.
Commercial Paper
We previously entered into a commercial paper program pursuant to which we may issue short-term, unsecured commercial paper notes privately placed on a discount basis through certain broker dealers. On June 15, 2017, we increased the size of the commercial paper program to permit the issuance of the commercial notes with the aggregate face or principal amount outstanding under the program at any time not to exceed $2 billion. Amounts available under the program may be borrowed, repaid and re-borrowed from time to time. The net proceeds of issuances have been and are expected to be used for general corporate purposes. The maximum principal amount outstanding at any one time during the three months ended March 31, 2018 was $442 million. There were outstanding borrowings of $398 million at March 31, 2018 and $150 million at December 31, 2017.
14. GUARANTEES AND CONTINGENCIES
Government Contracts
Our Medicare products, which accounted for approximately 81% of our total premiums and services revenue for the three months ended March 31, 2018, 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 May 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. Our bids for the 2019 calendar year are due by June 4, 2018.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

CMS uses a risk-adjustment model which adjusts premiums paid to Medicare Advantage, or MA, plans according to health status of covered members. The risk-adjustment model, which CMS implemented pursuant to the Balanced Budget Act of 1997 (BBA) and the Benefits Improvement and Protection Act of 2000 (BIPA), generally pays more where a plan's membership has higher expected costs. Under this model, rates paid to MA plans are based on actuarially determined bids, which include a process whereby our prospective payments are based on our estimated cost of providing standard Medicare-covered benefits to an enrollee with a "national average risk profile." That baseline payment amount is adjusted to reflect the health status of our enrolled membership. Under the risk-adjustment methodology, all MA 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 MA 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. In addition, we conduct medical record reviews as part of our data and payment accuracy compliance efforts, to more accurately reflect diagnosis conditions under the risk adjustment model. These compliance efforts include the internal contract level audits described in more detail below, as well as ordinary course reviews of our internal business processes.
CMS is phasing-in the process of calculating risk scores using diagnoses data from the Risk Adjustment Processing System, or RAPS, to diagnoses data from the Encounter Data System, or EDS. The RAPS process requires MA plans to apply a filter logic based on CMS guidelines and only submit claims that satisfy those guidelines. For submissions through EDS, CMS requires MA plans to submit all the encounter data and CMS will apply the risk adjustment filtering logic to determine the risk scores. For 2017, 25% of the risk score was calculated from claims data submitted through EDS. CMS has revised the pace of the phase-in and, for 2018 and 2019, 15% and 25%, respectively, of the risk score will be calculated from claims data submitted through EDS. The phase-in from RAPS to EDS could result in different risk scores from each dataset as a result of plan processing issues, CMS processing issues, or filtering logic differences between RAPS and EDS, and could have a material adverse effect on our results of operations, financial position, or cash flows.

CMS is continuing to perform audits of various companies’ selected MA 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 MA plans.
In 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 an MA contract, if any, the results of the RADV audit sample will be extrapolated to the entire MA contract after a comparison of the audit results to a similar audit of Medicare FFS (we refer to the process of accounting for errors in FFS claims as the "FFS Adjuster"). This comparison of RADV audit results to the FFS error rate is necessary to determine the economic impact, if any, of RADV audit results because the government used the Medicare FFS program data set, including any attendant errors that are present in that data set, to estimate the costs of various health status conditions and to set the resulting adjustments to MA plans’ payment rates. CMS already makes other adjustments to payment rates based on a comparison of coding pattern differences between MA plans and Medicare FFS data (such as for frequency of coding for certain diagnoses in MA plan data versus the Medicare FFS program dataset).
The final RADV extrapolation methodology, including the first application of extrapolated audit results to determine audit settlements, is expected to be applied to RADV contract level audits conducted for contract year 2011 and subsequent years. CMS is currently conducting RADV contract level audits for contract years 2011, 2012, and 2013 in which two, five and five of our Medicare Advantage plans are being audited, respectively. Per CMS guidance, selected MA contracts will be notified of an audit at some point after the close of the final reconciliation for the payment year being audited.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Estimated audit settlements are recorded as a reduction of premiums revenue in our consolidated statements of income, based upon available information. We perform internal contract level audits based on the RADV audit methodology prescribed by CMS. Included in these internal contract level audits is an audit of our Private Fee-For Service business which we used to represent a proxy of the FFS Adjuster which has not yet been released. We based our accrual of estimated audit settlements for each contract year on the results of these internal contract level audits and update our estimates as each audit is completed. Estimates derived from these results were not material to our results of operations, financial position, or cash flows. We report the results of these internal contract level audits to CMS, including identified overpayments, if any. However, as indicated, we are awaiting additional guidance from CMS regarding the FFS Adjuster. Accordingly, we cannot determine whether such RADV audits will have a material adverse effect on our results of operations, financial position, or cash flows.
In addition, as part of our internal compliance efforts, we routinely perform ordinary course reviews of our internal business processes related to, among other things, our risk coding and data submissions in connection with the risk adjustment model. These reviews may also result in the identification of errors and the submission of corrections to CMS, that may, either individually or in the aggregate, be material. As such, the result of these reviews may have a material adverse effect on our results of operations, financial position, or cash flows.
In addition, CMS' comments in formalized guidance regarding “overpayments” to MA plans appear to be inconsistent with CMS' prior RADV audit guidance. These statements, contained in the preamble to CMS’ final rule release regarding Medicare Advantage and Part D prescription drug benefit program regulations for Contract Year 2015, appear to equate each Medicare Advantage risk adjustment data error with an “overpayment” without reconciliation to the principles underlying the FFS Adjuster referenced above. We will continue to work with CMS to ensure that MA plans are paid accurately and that payment model principles are in accordance with the requirements of the Social Security Act, which, if not implemented correctly could have a material adverse effect on our results of operations, financial position, or cash flows.
At March 31, 2018, our military services business, which accounted for approximately 1% of our total premiums and services revenue for the three months ended March 31, 2018, primarily consisted of the T2017 TRICARE East Region contract. The T2017 East Region contract is a consolidation of the former T3 North and South Regions, comprising thirty-two states and approximately six million TRICARE beneficiaries, under which delivery of health care services commenced on January 1, 2018. The T2017 East Region contract is a 5-year contract set to expire on December 31, 2022 and is subject to renewals on January 1 of each year during its term at the government's option.
Our state-based Medicaid business accounted for approximately 4% of our total premiums and services revenue for the three months ended March 31, 2018. In addition to our state-based Temporary Assistance for Needy Families, or TANF, Medicaid contracts in Florida and Kentucky, we have contracts in Florida for Long Term Support Services (LTSS), and in Illinois for stand-alone dual eligible demonstration programs serving individuals dually eligible for both the federal Medicare program and the applicable state-based Medicaid program.
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, regulatory restrictions on profitability, including by comparison of our Medicare Advantage profitability to our non-Medicare Advantage business profitability and a requirement that they remain within certain ranges of each other, 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.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Legal Proceedings and Certain Regulatory Matters
As previously disclosed, the Civil Division of the United States Department of Justice provided us with an information request in December 2014, concerning our Medicare Part C risk adjustment practices. The request relates to our oversight and submission of risk adjustment data generated by providers in our Medicare Advantage network, as well as to our business and compliance practices related to risk adjustment data generated by our providers and by us, including medical record reviews conducted as part of our data and payment accuracy compliance efforts, the use of health and well-being assessments, and our fraud detection efforts. We believe that this request for information is in connection with a wider review of Medicare Risk Adjustment generally that includes a number of Medicare Advantage plans, providers and vendors. We continue to cooperate with and voluntarily respond to the information requests from the Department of Justice. These matters are expected to result in additional qui tam litigation.
As previously disclosed, on January 19, 2016, an individual filed a qui tam suit captioned United States of America ex rel. Steven Scott v. Humana, Inc., in United States District Court, Central District of California, Western Division. The complaint alleges certain civil violations by us in connection with the actuarial equivalence of the plan benefits under Humana’s Basic PDP plan, a prescription drug plan offered by us under Medicare Part D. The action seeks damages and penalties on behalf of the United States under the False Claims Act. The court ordered the qui tam action unsealed on September 13, 2017, so that the relator could proceed, following notice from the U.S. Government that it was not intervening at that time. On January 29, 2018, the suit was transferred to the United States District Court, Western District of Kentucky, Louisville Division. We take seriously our obligations to comply with applicable CMS requirements and actuarial standards of practice, and we are vigorously defending against these allegations.
On November 2, 2017, we filed suit against the United States of America in the United States Court of Federal Claims, on behalf of our health plans seeking recovery from the federal government of approximately $611 million in payments under the risk corridor premium stabilization program established under Health Care Reform, for years 2014, 2015 and 2016.  We have not recognized revenue, nor have we recorded a receivable, for any amount due from the federal government for unpaid risk corridor payments as of March 31, 2018.  We have fully recognized all liabilities due to the federal government that we have incurred under the risk corridor program, and have paid all amounts due to the federal government as required. There is no assurance that we will prevail in the lawsuit.
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, health care delivery and benefits companies. These reviews focus on numerous facets of our business, including claims payment practices, statutory capital requirements, provider contracting, risk adjustment, competitive practices, commission payments, privacy issues, utilization management practices, pharmacy benefits, access to care, 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 and payment disputes, including disputes over reimbursement rates required by statute, general contractual matters, intellectual property matters, and challenges to subrogation practices. For example, a number of hospitals and other providers have asserted that, under their network provider contracts, we are not entitled to reduce Medicare Advantage payments to these providers in connection with changes in Medicare payment systems and in accordance with the Balanced Budget and Emergency Deficit Control Act of 1985, as amended (commonly referred to as “sequestration”). Those challenges have led and could lead to arbitration demands or other litigation. Also, under state guaranty assessment laws, including those related to state cooperative failures in the industry, 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.


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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

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, those 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 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 other 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.
A limited number of the claims asserted against us are subject to insurance coverage. Personal injury claims, claims for extra contractual 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 the contingencies discussed in the sections above 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 judgments, penalties, fines or other sanctions that may be imposed at the discretion of federal or state regulatory authorities or as a result of actions by third parties. Nevertheless, it is reasonably possible that any such outcome of litigation, judgments, 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.
15. SEGMENT INFORMATION
We manage our business with four reportable segments: Retail, Group and Specialty, Healthcare Services and Individual Commercial. 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 well-being solutions 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 benefits, marketed to individuals or directly via group accounts. In addition, the Retail segment also includes our contract with CMS to administer the Limited Income Newly Eligible Transition, or LI-NET, prescription drug plan program and contracts with various states to provide Medicaid, dual eligible, and Long-Term Support Services benefits, which we refer to collectively as our state-based contracts. The Group and Specialty segment consists of employer group commercial fully-insured medical and specialty health insurance benefits marketed to individuals and employer groups, including dental, vision, and other supplemental health and voluntary insurance benefits and financial protection products, as well as administrative services only, or ASO products. In addition, our Group and Specialty segment includes military services business, primarily our TRICARE T2017 East Region contract. The Healthcare Services segment includes services offered to our health plan members as well as to third parties, including pharmacy solutions, provider services, and clinical care service, such as home health and other services and capabilities to promote wellness and advance population health. The Individual Commercial segment consisted of our individual commercial fully-insured medical health insurance benefits. We report under the category of Other Businesses those businesses that do not align with the reportable segments described above, primarily our closed-block long-term care insurance policies.

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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

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 Humana Pharmacy, Inc., 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, contracting with 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 and non-risk-based managed care agreements with our health plans. Under risk based 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. Under non risk-based agreements, our health plans retain the economic risk of funding the assigned members' healthcare services. Our Healthcare Services segment reports provider services revenues associated with risk-based agreements on a gross basis, whereby capitation fee revenue is recognized in the period in which the assigned members are entitled to receive healthcare services. Provider services revenues associated with non-risk-based agreements are presented net of associated healthcare costs.
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 $2.9 billion and $3.0 billion for the three months ended March 31, 2018 and 2017, 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 $39 million and $26 million for the three months ended March 31, 2018 and 2017, respectively.
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 2017 Form 10-K. Transactions between reportable segments primarily consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and clinical care services, to our Retail, Group and Specialty, and Individual Commercial segment customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often use 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 are included with intersegment eliminations in the tables presenting segment results below.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Our segment results were as follows for the three months ended March 31, 2018 and 2017:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Retail
 
Group and Specialty
 
Healthcare
Services
 
Individual Commercial
 
Other
Businesses
 
Eliminations/
Corporate
 
Consolidated
 
(in millions)
Three months ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
Revenues - external customers
 
 
 
 
 
 
 
 
 
 
 
 
Premiums:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individual Medicare Advantage
$
8,970

 
$

 
$

 
$

 
$

 
$

 
$
8,970

Group Medicare Advantage
1,524

 

 

 

 

 

 
1,524

Medicare stand-alone PDP
896

 

 

 

 

 

 
896

Total Medicare
11,390

 

 

 

 

 

 
11,390

Fully-insured
125

 
1,392

 

 
(5
)
 

 

 
1,512

Specialty

 
347

 

 

 

 

 
347

Medicaid and other
553

 

 

 

 
9

 

 
562

Total premiums
12,068

 
1,739

 

 
(5
)
 
9

 

 
13,811

Services revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
Provider

 

 
65

 

 

 

 
65

ASO and other
2

 
219

 

 

 
2

 

 
223

Pharmacy

 

 
39

 

 

 

 
39

Total services revenue
2

 
219

 
104

 

 
2

 

 
327

Total revenues - external customers
12,070

 
1,958

 
104

 
(5
)
 
11

 

 
14,138

Intersegment revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Services

 
5

 
4,018

 

 

 
(4,023
)
 

Products

 

 
1,535

 

 

 
(1,535
)
 

Total intersegment revenues

 
5

 
5,553

 

 

 
(5,558
)
 

Investment income
37

 
7

 
6

 

 
35

 
56

 
141

Total revenues
12,107

 
1,970

 
5,663

 
(5
)
 
46

 
(5,502
)
 
14,279

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Benefits
10,552

 
1,273

 

 
(60
)
 
26

 
(121
)
 
11,670

Operating costs
1,222

 
463

 
5,441

 
2

 
2

 
(5,381
)
 
1,749

Depreciation and amortization
66

 
23

 
49

 

 

 
(38
)
 
100

Total operating expenses
11,840

 
1,759

 
5,490

 
(58
)
 
28

 
(5,540
)
 
13,519

Income from operations
267

 
211

 
173

 
53

 
18

 
38

 
760

Interest expense

 

 

 

 

 
53

 
53

Income (loss) before income taxes
$
267

 
$
211

 
$
173

 
$
53

 
$
18

 
$
(15
)
 
$
707


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Humana Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

 
Retail
 
Group and Specialty
 
Healthcare
Services
 
Individual Commercial
 
Other
Businesses
 
Eliminations/
Corporate
 
Consolidated
 
(in millions)
Three months ended March 31, 2017
 
 
 
 
 
 
 
 
 
 
Revenues - external customers
 
 
 
 
 
 
 
 
 
 
 
 
Premiums:
 
 
 
 
 
 
 
 
 
 
 
 
 
Individual Medicare Advantage
$
8,376

 
$

 
$

 
$

 
$

 
$

 
$
8,376

Group Medicare Advantage
1,318

 

 

 

 

 

 
1,318

Medicare stand-alone PDP
941

 

 

 

 

 

 
941

Total Medicare
10,635

 

 

 

 

 

 
10,635

Fully-insured
118

 
1,378

 

 
283

 

 

 
1,779

Specialty

 
322

 

 

 

 

 
322

Medicaid and other
653

 

 

 

 
9

 

 
662

Total premiums
11,406

 
1,700

 

 
283

 
9

 

 
13,398

Services revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
Provider

 

 
70

 

 

 

 
70

ASO and other
2

 
161

 

 

 
2

 

 
165

Pharmacy

 

 
18

 

 

 

 
18

Total services revenue
2

 
161

 
88

 

 
2

 

 
253

Total revenues - external customers
11,408

 
1,861

 
88

 
283

 
11

 

 
13,651

Intersegment revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Services

 
5

 
4,310

 

 

 
(4,315
)
 

Products

 

 
1,552

 

 

 
(1,552
)
 

Total intersegment revenues

 
5

 
5,862

 

 

 
(5,867
)
 

Investment income
25

 
11

 
8

 
1

 
21

 
45

 
111

Total revenues
11,433

 
1,877

 
5,958

 
284

 
32

 
(5,822
)
 
13,762

Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Benefits
10,051

 
1,286

 

 
156

 
29

 
(196
)
 
11,326

Operating costs
954

 
399

 
5,680

 
62

 
4

 
(5,546
)
 
1,553

Merger termination fee and related costs, net

 

 

 

 

 
(947
)
 
(947
)
Depreciation and amortization
58

 
21

 
34

 
3

 

 
(24
)
 
92

Total operating expenses
11,063

 
1,706

 
5,714

 
221

 
33

 
(6,713
)
 
12,024

Income (loss) from operations
370

 
171

 
244

 
63

 
(1
)
 
891

 
1,738

Interest expense

 

 

 

 

 
49

 
49

Income (loss) before income taxes
$
370

 
$
171

 
$
244

 
$
63

 
$
(1
)
 
$
842

 
$
1,689


31

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Humana Inc.
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 Securities and Exchange Commission, or 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 “believes,” “expects,” “anticipates,” “intends,” “likely will result,” “estimates,” “projects” or variations of such words and similar expressions are intended to identify such forward–looking statements. These forward–looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including, among other things, information set forth in Item 1A. – Risk Factors in our 2017 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 16, 2018, 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
Humana Inc., headquartered in Louisville, Kentucky, is a leading health and well-being company committed to
helping our millions of medical and specialty members achieve their best health. Our successful history in care delivery and health plan administration is helping us create a new kind of integrated care with the power to improve health and well being and lower costs. Our efforts are leading to a better quality of life for people with Medicare, families, individuals, military service personnel, and communities at large. To accomplish that, we support physicians and other health care professionals as they work to deliver the right care in the right place for their patients, our members. Our range of clinical capabilities, resources and tools, such as in home care, behavioral health, pharmacy services, data analytics and wellness solutions, combine to produce a simplified experience that makes health care easier to navigate and more effective.
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, excluding Merger termination fee and related costs, net, and depreciation and amortization, as a percentage of total revenue less investment income, represents a statistic used to measure administrative spending efficiency.
Aetna Merger
On February 16, 2017, under the terms of the Merger Agreement with Aetna, we received a breakup fee of $1 billion from Aetna, which is included in our consolidated statement of income in the line captioned "Merger termination fee and related costs, net."
Acquisitions and Divestitures
On April 10, 2018, we acquired FPG for cash considerations of approximately $190 million. FPG is one of the largest at-risk providers serving Medicare Advantage and Managed Medicaid HMO patients in Greater Orlando, Florida with a footprint that includes clinics located in Lake, Orange, Osceola and Seminole counties. The acquisition of FPG advances our strategy of helping physicians and clinicians evolve from treating health episodically to managing health holistically. This acquisition is not expected to have a material impact on our results of operations, financial condition, or cash flows.
On March 1, 2018 we acquired the remaining equity interest in MCCI, a privately held management service organization headquartered in Miami, Florida, that primarily coordinates medical care for Medicare Advantage beneficiaries in Florida and Texas. The purchase price consisted primarily of $169 million cash, as well as our existing

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investment in MCCI and a note receivable and a revolving note with an aggregate balance of $383 million. This resulted in a preliminary purchase price allocation to goodwill of $479 million, other intangible assets of $80 million, and net tangible assets of $27 million.
On December 19, 2017, we announced that we entered into a definitive agreement to acquire a 40% minority interest in Kindred at Home for estimated cash consideration of approximately $800 million, including our share of transaction and related expenses, to facilitate a complete separation from the Long Term Acute Care and Rehabilitation businesses (the Specialty Hospital company).    
On April 23, 2018, we announced that we entered into a definitive agreement to acquire a 40% minority interest in Curo, one of the nations' leading hospice operators providing care to patients at 245 locations in 22 states. Upon the closing, we intend to merge Curo with the hospice business of Kindred at Home.
On November 6, 2017, we entered into a definitive agreement to sell the stock of our wholly-owned subsidiary, KMG America Corporation, or KMG, to Continental General Insurance Company, or CGIC, a Texas-based insurance company wholly owned by HC2 Holdings, Inc., a diversified holding company. KMG’s subsidiary, Kanawha Insurance Company, or KIC, includes our closed block of non-strategic commercial long-term care insurance policies.
These transactions are more fully discussed in Note 1 and Note 3 to the condensed consolidated financial statements.

Workforce Optimization
We have been committed to productivity initiatives designed to promote operational excellence, accelerate our strategy, fund critical initiatives and advance our growth objectives. During the third quarter of 2017, we initiated a voluntary early retirement program and an involuntary workforce reduction program that will allow us to achieve these objectives and position us for the future. These programs impacted approximately 3,600 associates, or 7.8%, of our workforce in 2017. As a result, we recorded charges of $148 million, or $0.64 per diluted common share. At December 31, 2017, $140 million was classified as a current liability, included in our condensed consolidated balance sheet in the trade accounts payable and accrued expenses line. Payments under these programs are being made upon termination during the early retirement or severance pay period. The remaining workforce optimization liability at March 31, 2018 was $94 million and is expected to be paid in 2018.
Business Segments
We manage our business with four reportable segments: Retail, Group and Specialty, Healthcare Services and Individual Commercial. 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 well-being solutions 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 benefits, marketed to individuals or directly via group accounts. In addition, the Retail segment also includes our contract with CMS to administer the Limited Income Newly Eligible Transition, or LI-NET, prescription drug plan program and contracts with various states to provide Medicaid, dual eligible, and Long-Term Support Services benefits, which we refer to collectively as our state-based contracts. The Group and Specialty segment consists of employer group commercial fully-insured medical and specialty health insurance benefits marketed to individuals and employer groups, including dental, vision, and other supplemental health and voluntary insurance benefits and financial protection products, as well as administrative services only, or ASO products. In addition, our Group and Specialty segment includes military services business, primarily our TRICARE T2017 East Region contract. The Healthcare Services segment includes services offered to our health plan members as well as to third parties, including pharmacy solutions, provider services, and clinical care service, such as home health and other services and capabilities to promote wellness and advance population health. The Individual Commercial segment consisted of our individual commercial fully-insured medical health insurance benefits. We report under the category of Other Businesses those businesses that do not align with the reportable segments described above, primarily our closed-block long-term care insurance policies.

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The results of each segment are measured by income before income taxes. Transactions between reportable segments primarily consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and clinical care services, to our Retail, Group and Specialty, and Individual Commercial segment customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often use 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 are 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. 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.
In addition, the Retail segment also experiences seasonality in the operating cost ratio as a result of costs incurred in the second half of the year associated with the Medicare marketing season.
Our Group and Specialty segment also experiences seasonality in the benefit ratio pattern. However, the effect is opposite of Medicare stand-alone PDP in the Retail segment, with the Group and Specialty segment’s benefit ratio increasing as fully-insured members progress through their annual deductible and maximum out-of-pocket expenses.
2018 Highlights
Consolidated
Our consolidated pretax results of $707 million for the three months ended March 31, 2018 as compared to $1.7 billion for the three months ended March 31, 2017 were primarily impacted by the net gain associated with the terminated Merger Agreement, mainly the break-up fee, that was recorded in the three months ended March 31, 2017, and lower year-over-year pretax earnings in the Retail and Healthcare Services segments, partially offset by higher Group and Specialty segment pretax earnings. The year-over-year comparison was further impacted by the guaranty fund assessment expense to support policyholder obligations of Penn Treaty, an unaffiliated long-term care insurance company, recorded in the three months ended March 31, 2017.
Year-over-year comparisons of diluted earnings per common share are favorably impacted by a lower number of shares used to compute earnings per commons share reflecting the impact of share repurchases and the impact of a lower tax rate for the three months ended March 31, 2018.
Our 2018 results through March 31, 2018 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, provided by both employed physicians and physicians with network contract arrangements. 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

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growth in both membership and earnings. We offer providers a continuum of opportunities to increase the integration of care and offer assistance to providers in transitioning from a fee-for-service to a value-based arrangement. These include performance bonuses, shared savings and shared risk relationships. At March 31, 2018, approximately 1,959,400 members, or 64.9%, of our individual Medicare Advantage members were in value-based relationships under our integrated care delivery model, as compared to 1,901,300 members, or 66.5%, at December 31, 2017 and 1,827,600 members, or 64.4%, at March 31, 2017.
The annual health insurance industry fee was suspended for calendar year 2017, but has resumed in 2018. Operating costs associated with the health insurer fee attributable to the three months ended March 31, 2018 was $263 million. This fee is not deductible for tax purposes, which increases our effective income tax rate. The one-year suspension in 2017 of the health insurer fee has significantly reduced our operating costs and effective tax rate during the three months ended March 31, 2017.
The 2018 quarter includes pretax income from our Individual Commercial business of $53 million, or $0.29 per diluted common share compared to $63 million, or 0.27 per diluted common share, included in the 2017 quarter.
The 2018 quarter also includes an adjustment to provisional remeasurement of deferred taxes related to rate change from the tax reform law enacted on December 22, 2017 of $6.6 million, or $0.05 per diluted common share.
We recorded a net gain associated with the terminated Merger Agreement, consisting primarily of the break-up fee, of approximately $947 million, or $4.26 per diluted common share during the three months ended March 31, 2017. Certain costs associated with the Merger were previously not deductible for tax purposes, but became deductible, and were recorded as such in the three months ended March 31, 2017 as a result of the termination of the Merger Agreement.
On March 1, 2017, a court ordered the liquidation of Penn Treaty (an unaffiliated long-term care insurance company), which triggered assessments from state guaranty associations that resulted in our recording a $54 million, or $0.23 per diluted common share, estimate in operating costs in the three months ended March 31, 2017.
During the three months ended March 31, 2018, cash flow provided by operations was $3.7 billion as compared to $4.2 billion for the three months ended March 31, 2017. Our operating cash flows for the three months ended March 31, 2017 were significantly impacted by the receipt of the $1 billion Merger termination fee, net of related expenses. Our operating cash flows were also significantly impacted in both periods by the early receipt of the Medicare premium remittance for April 2018 of $3.3 billion in March 2018 and the receipt of the Medicare premium remittance for April 2017 of $3.1 billion in March 2017 because the payment dates of April 2018 and April 2017 fell on a weekend. Excluding the Merger termination fee and the timing of the Medicare premium remittances, our operating cash flows were impacted by higher earnings and the timing of working capital items. See further discussion under the section titled "Liquidity" in this report.
Retail
On April 2, 2018, the Centers for Medicare and Medicaid Services (CMS) issued its announcement of 2019 Medicare Advantage Capitation Rates and Medicare Advantage and Part D Payment Policies and Final Call Letter (the Final Rate Notice). The company expects the Final Rate Notice to result in a 3% rate increase for Humana’s individual Medicare Advantage business versus CMS’ estimate for the sector of 3.5%, excluding the impact of Employer Group Waiver Plan (EGWP) funding changes, on a comparable basis. The difference between Humana and CMS projections primarily results from the geographic distribution of our members relative to the national average. In addition, the Final Rate Notice clarified that CMS has the authority to permit MA organizations to offer tailored supplemental benefits with flexibilities to target the social determinants of health as recommended by a licensed medical professional. We expect that this additional flexibility will allow us to include supplemental benefits that we believe will improve health outcomes for our members.

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On April 24, 2018, we received a Notice of Intent to be Awarded a Comprehensive Medicaid Contract under Florida’s Statewide Managed Medicaid Program in 10 of 11 regions, including the South Florida, Tampa, Jacksonville, and Orlando metro areas. The comprehensive program combines the traditional Medicaid, or TANF, and Long-Term Care programs.
Group and Specialty Segment
The T2017 East Region contract is a consolidation of the former T3 North and South Regions, comprising thirty-two states and approximately six million TRICARE beneficiaries, under which delivery of health care services commenced on January 1, 2018. The T2017 East Region contract is a 5-year contract set to expire on December 31, 2022 and is subject to renewals on January 1 of each year during its term at the government's option. During 2017, we delivered services under the 5-year T3 South Region contract, which expired on December 31, 2017.
Healthcare Services Segment
Medicare Advantage and dual demonstration program membership enrolled in a Humana chronic care management program was 752,400 at March 31, 2018, a decrease of 27.3% from 1,035,300 at March 31, 2017, and 5.3% from 794,900 at December 31, 2017. We have undergone an optimization process that ensures the appropriate level of member interaction with clinicians, including moving members into a monitoring program as their needs change, and graduating them out of the care management program when they no longer benefit from the services. This drives quality outcomes, which has resulted in reduced segment earnings but higher returns on investment.
Health Care Reform
The Health Care Reform Law enacted significant reforms to various aspects of the U.S. health insurance industry. Certain significant provisions of the Health Care Reform Law include, among others, mandated coverage requirements, mandated benefits and guarantee issuance associated with commercial medical insurance, rebates to policyholders based on minimum benefit ratios, adjustments to Medicare Advantage premiums, the establishment of federally-facilitated or state-based exchanges coupled with programs designed to spread risk among insurers, and the introduction of plan designs based on set actuarial values. In addition, the Health Care Reform Law established insurance industry assessments, including an annual health insurance industry fee and a three-year $25 billion industry wide commercial reinsurance fee. The annual health insurance industry fee levied on the insurance industry is $14.3 billion in 2018 and is not deductible for income tax purposes, which significantly increases our effective income tax rate. A one year suspension in 2017 and 2019 of the health insurer fee significantly impacts our trend in key operating metrics including our operating cost and medical expense ratios, as well as our effective tax rate.
As noted above, the Health Care Reform Law required the establishment of health insurance exchanges for individuals and small employers to purchase health insurance that became effective January 1, 2014, with an annual open enrollment period. Although we previously participated in these exchanges by offering on-exchange individual commercial medical plans, effective January 1, 2018, we have exited our Individual Commercial medical business.
On November 2, 2017, we filed suit against the United States of America in the United States Court of Federal Claims, on behalf of our health plans seeking recovery from the federal government of approximately $611 million in payments under the risk corridor premium stabilization program established under the Health Care Reform Law, for years 2014, 2015 and 2016.
It is reasonably possible that the Health Care Reform Law and related regulations, as well as future legislative or regulatory changes, including restrictions on our ability to manage our provider network or otherwise operate our business, or restrictions on profitability, including by comparison of our Medicare Advantage profitability to our non-Medicare Advantage business profitability and a requirement that they remain within certain ranges of each other, 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, further lowering our Medicare payment rates and increasing our expenses

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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.
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 primarily consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and clinical care services, to our Retail, Group and Specialty, and Individual Commercial segment customers and are described in Note 15 to the condensed consolidated financial statements included in this report.

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Comparison of Results of Operations for 2018 and 2017
The following discussion primarily deals with our results of operations for the three months ended March 31, 2018, or the 2018 quarter, and the three months ended March 31, 2017, or the 2017 quarter.
Consolidated
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the three months ended
March 31,
 
Change
 
2018
 
2017
 
Dollars
 
Percentage
 
(dollars in millions, except per common share results)
 
 
Revenues:
 
 
 
 
 
 
 
Premiums:
 
 
 
 
 
 
 
Retail
$
12,068

 
$
11,406

 
$
662

 
5.8
 %
Group and Specialty
1,739

 
1,700

 
39

 
2.3
 %
Individual Commercial
(5
)
 
283

 
(288
)
 
(101.8
)%
Other Businesses
9

 
9

 

 
 %
Total premiums
13,811

 
13,398

 
413

 
3.1
 %
Services:
 
 
 
 
 
 
 
Retail
2

 
2

 

 
 %
Group and Specialty
219

 
161

 
58

 
36.0
 %
Healthcare Services
104

 
88

 
16

 
18.2
 %
Other Businesses
2

 
2

 

 
 %
Total services
327

 
253

 
74

 
29.2
 %
Investment income
141

 
111

 
30

 
27.0
 %
Total revenues
14,279

 
13,762

 
517

 
3.8
 %
Operating expenses:
 
 
 
 
 
 
 
Benefits
11,670

 
11,326

 
344

 
3.0
 %
Operating costs
1,749

 
1,553

 
196

 
12.6
 %
  Merger termination fee and related costs, net

 
(947
)
 
947

 
100.0
 %
Depreciation and amortization
100

 
92

 
8

 
8.7
 %
Total operating expenses
13,519

 
12,024

 
1,495

 
12.4
 %
Income from operations
760

 
1,738

 
(978
)
 
(56.3
)%
Interest expense
53

 
49

 
4

 
8.2
 %
Income before income taxes
707

 
1,689

 
(982
)
 
(58.1
)%
Provision for income taxes
216

 
574

 
(358
)
 
(62.4
)%
Net income
$
491

 
$
1,115

 
$
(624
)
 
(56.0
)%
Diluted earnings per common share
$
3.53

 
$
7.49

 
$
(3.96
)
 
(52.9
)%
Benefit ratio (a)
84.5
%
 
84.5
%
 
 
 
 %
Operating cost ratio (b)
12.4
%
 
11.4
%
 
 
 
1.0
 %
Effective tax rate
30.7
%
 
34.0
%
 
 
 
(3.3
)%
(a)
Represents total benefits expense as a percentage of premiums revenue.
(b)
Represents total operating costs, excluding Merger termination fee and related costs, net, and depreciation and amortization, as a percentage of total revenues less investment income.

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Summary
Net income was $491 million, or $3.53 per diluted common share, in the 2018 quarter compared to $1.1 billion, or $7.49 per diluted common share, in the 2017 quarter. This comparison was impacted by the Merger Agreement break-up fee, the suspension of the health insurance industry fee for calendar year 2017, the estimated guaranty fund assessment expense to support the policy holders obligations of Penn treaty, the exit of the Individual Commercial business effective January 1, 2018, and the Tax Reform Law as previously described. Excluding the impact of the items above, the year-over-year comparison primarily was due to lower earnings in the Retail and Healthcare Services segments, partially offset by higher Group and Specialty segment earnings.
Premiums Revenue
Consolidated premiums increased $413 million, or 3.1%, from the 2017 quarter to $13.8 billion for the 2018 quarter primarily due to higher premiums in the Retail segment, mainly resulting from our Medicare Advantage business, and the Group and Specialty segment. These items were partially offset by lower premiums resulting from the exit of the Individual Commercial business.
Services Revenue
Consolidated services revenue increased $74 million, or 29.2%, from the 2017 quarter to $327 million for the 2018 quarter primarily due to an increase in services revenue in the Group and Specialty segment as discussed in the detailed segment results discussion that follows.
Investment Income
Investment income totaled $141 million for the 2018 quarter, increasing $30 million, or 27.0% , from $111 million in the 2017 quarter primarily reflecting higher average invested balances, interest rates, and realized capital gains.
Benefits Expense
Consolidated benefits expense was $11.7 billion for the 2018 quarter, an increase of $344 million from the 2017 quarter, primarily due to an increase in the Retail segment benefits expense, partially offset by a decrease in the Individual Commercial and Group and Specialty segment benefits expense. We experienced favorable medical claims reserve development related to prior fiscal years of $267 million in the 2018 quarter as compared to $231 million in the 2017 quarter as discussed in the detailed segment results discussion that follows.
The consolidated benefit ratio was unchanged at 84.5% for the 2018 quarter compared to the 2017 quarter. The year-over-year comparison was favorably impacted by the reinstatement of the health insurance industry fee in 2018, which was contemplated in the pricing and benefit design of the company’s products, the seasonality and product design of our fully-insured commercial products, including an increased number of high deductible plan offerings, and higher favorable prior-period reserve development in the 2018 quarter. Favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 190 basis points in the 2018 quarter versus approximately 170 basis points in the 2017 quarter. These items were partially offset by investment of higher than initially expected individual Medicare Advantage pretax earnings in 2017 into our benefit design for its 2018 Medicare Advantage offerings, and a more severe flu season year-over-year.
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 $196 million, or 12.6%, during the 2018 quarter compared to the 2017 quarter primarily due to an increase in operating costs in the Retail and Group and Specialty segments, partially offset by a decrease in operating costs in the Healthcare Services and Individual Commercial segments.
The consolidated operating cost ratio for the 2018 quarter of 12.4% increased 100 basis points from the 2017 quarter primarily due to the reinstatement of the health insurance industry fee in 2018, and long-term sustainability

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investments in the 2018 quarter as a result of the Tax Reform Law. Our long-term sustainability investments include investments in our associate workforce, primarily the establishment of an annual incentive program for a broader range of employees, together with additional investments in the communities of our members, technology and our integrated delivery model. These items were partially offset by the favorable impact of significant operating cost efficiencies in the 2018 quarter driven by productivity initiatives implemented in 2017, the impact of the guaranty fund assessment expense to support policy holder obligations of Penn Treaty in the 2017 quarter, and the exit of the Individual Commercial business effective January 1, 2018. The non-deductible health insurance industry fee impacted the operating cost ratio by 190 basis points in the 2018 quarter.
Depreciation and Amortization
Depreciation and amortization for the 2018 quarter totaled $100 million compared to $92 million for the 2017 quarter.
Interest Expense
Interest expense for the 2018 quarter totaled $53 million, compared to $49 million for the 2017 quarter.
Income Taxes
Our effective tax rate during the 2018 quarter was 30.7% compared to the effective tax rate of 34.0% for the 2017 quarter, primarily due to the Tax Reform Law primarily due to the Tax Reform Law, partially offset by the impact of the reinstatement of the non-deductible health insurance industry fee in 2018. The income tax rate for the three months ended March 31, 2017 included previously non-deductible transaction costs that, as a result of the termination of the Merger Agreement, became deductible for tax purposes. The Tax Reform Law reduced the statutory federal corporate income tax rate to 21 percent from 35 percent, beginning in 2018. The accounting for certain income tax effects of the Tax Reform Law is provisional. Revisions to prior estimates are recorded as additional analysis is completed using information available at each measurement date during 2018, with adjustments to the income tax provision recorded as new information becomes known. Revisions to our prior estimates for the income tax effects of the Tax Reform Law decreased our tax expense for the three months ended March 31, 2018 by $6.6 million.
Retail Segment
 
March 31,
 
Change
 
2018
 
2017
 
Members
 
Percentage
Membership:
 
 
 
 
 
 
 
Medical membership:
 
 
 
 
 
 
 
Individual Medicare Advantage
3,018,500

 
2,839,700

 
178,800

 
6.3
 %
Group Medicare Advantage
492,700

 
431,100

 
61,600

 
14.3
 %
Medicare stand-alone PDP
5,042,100

 
5,199,400

 
(157,300
)
 
(3.0
)%
Total Retail Medicare
8,553,300

 
8,470,200

 
83,100

 
1.0
 %
State-based Medicaid
336,000

 
380,400

 
(44,400
)
 
(11.7
)%
Medicare Supplement
238,700

 
231,400

 
7,300

 
3.2
 %
Total Retail medical members
9,128,000

 
9,082,000

 
46,000

 
0.5
 %
 
 
 
 
 
 
 
 

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For the three months ended
March 31,
 
Change
 
2018
 
2017
 
Dollars
 
Percentage
 
(in millions)
 
 
Premiums and Services Revenue:
 
 
 
 
 
 
 
Premiums:
 
 
 
 
 
 
 
Individual Medicare Advantage
$
8,970

 
$
8,376

 
$
594

 
7.1
 %
Group Medicare Advantage
1,524

 
1,318

 
206

 
15.6
 %
Medicare stand-alone PDP
896

 
941

 
(45
)
 
(4.8
)%
Total Retail Medicare
11,390

 
10,635

 
755

 
7.1
 %
State-based Medicaid
553

 
653

 
(100
)
 
(15.3
)%
Medicare Supplement
125

 
118

 
7

 
5.9
 %
Total premiums
12,068

 
11,406

 
662

 
5.8
 %
Services
2

 
2

 

 
 %
Total premiums and services revenue
$
12,070

 
$
11,408

 
$
662

 
5.8
 %
Income before income taxes
$
267

 
$
370

 
$
(103
)
 
(27.8
)%
Benefit ratio
87.4
%
 
88.1
%
 
 
 
(0.7
)%
Operating cost ratio
10.1
%
 
8.4
%
 
 
 
1.7
 %
Pretax Results
Retail segment pretax income was $267 million in the 2018 quarter, a decrease of $103 million, or 27.8%, compared to $370 million in the 2017 quarter, primarily due to the result of investment in benefit design for 2018 Medicare Advantage offerings further discussed below, investments made in the 2018 quarter as a result of the Tax Reform Law as previously described, lower favorable prior-period reserve development, and a more severe flu season year-over-year. These items were partially offset by the significant operating cost efficiencies further discussed below.
Enrollment
Individual Medicare Advantage membership increased 178,800 members, or 6.3%, from March 31, 2017 to March 31, 2018, primarily due to membership additions associated with the most recent Annual Election Period, or AEP, for Medicare beneficiaries.
Group Medicare Advantage membership increased 61,600, or 14.3%, from March 31, 2017 to March 31, 2018 , primarily due to increased sales to our existing group accounts during the most recent AEP for Medicare beneficiaries.
Medicare stand-alone PDP membership decreased 157,300 members, or 3.0%, from March 31, 2017 to March 31, 2018 reflecting net declines during the most recent AEP for Medicare beneficiaries.These declines primarily resulted from the previously disclosed loss of auto assigned members in Florida and South Carolina due to pricing over CMS low income benchmark and continued membership declines in our Enhanced Plan. In addition, growth in our co-branded Walmart plan was significantly lower than historic levels due to the introduction of additional low-priced competitor offerings in many regions.
State-based Medicaid membership decreased 44,400 members, or 11.7%, from March 31, 2017 to March 31, 2018, primarily driven by the previously disclosed decision to not participate in Illinois' Integrated Program Medicaid contract, along with lower membership associated with our Florida contract due to overall strengthening economic conditions.



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Premiums Revenue
Retail segment premiums increased $662 million, or 5.8%, from the 2017 quarter to the 2018 quarter primarily due to individual and group Medicare Advantage membership growth in the most recent AEP as well as increased per-member premiums for certain products within the segment, partially offset by declines in the stand-alone PDP and state-based contracts revenues resulting from membership declines discussed above. Average group and individual Medicare Advantage membership increased 7.4% for the 2018 quarter. 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.
Benefits Expense
The Retail segment benefit ratio decreased 70 basis points from 88.1% in the 2017 quarter to 87.4% in the 2018 quarter, primarily due to the reinstatement of the health insurance industry fee in 2018 which was contemplated in the pricing and benefit design of our products. This was partially offset by the unfavorable impact from investment of higher than initially expected individual Medicare Advantage pretax earnings in 2017 into our benefit design for our 2018 Medicare Advantage offerings, lower favorable prior-period reserve development, and a more severe flu season year-over-year.
The Retail segment’s benefits expense for the 2018 quarter included $187 million in favorable prior-period medical claims reserve development versus $204 million in the 2017 quarter. Prior-period medical claims reserve development decreased the Retail segment benefit ratio by approximately 150 basis points in the 2018 quarter versus approximately 180 basis points in the 2017 quarter.
Operating Costs
The Retail segment operating cost ratio of 10.1% for the 2018 quarter increased 170 basis points from 8.4% for the 2017 quarter. The year-over-year comparison was negatively impacted by the reinstatement of the health insurance industry fee in 2018, and investments made in the 2018 quarter as a result of the Tax Reform Law. These items were partially offset by significant operating cost efficiencies in the 2018 quarter driven by productivity initiatives implemented in 2017. The non-deductible health insurance industry fee impacted the operating cost ratio by 190 basis points in the 2018 quarter.











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Group and Specialty Segment
 
March 31,
 
Change
 
2018
 
2017
 
Members
 
Percentage
Membership:
 
 
 
 
 
 
 
Medical membership:
 
 
 
 
 
 
 
Fully-insured commercial group
1,075,100

 
1,119,400

 
(44,300
)
 
(4.0
)%
ASO
452,600

 
447,000

 
5,600

 
1.3
 %
Military services
5,931,100

 
3,082,800


2,848,300


92.4
 %
Total group and specialty medical members
7,458,800

 
4,649,200

 
2,809,600

 
60.4
 %
Specialty membership (a)
6,738,900

 
6,921,800

 
(182,900
)
 
(2.6
)%
(a)
Specialty products include dental, vision, voluntary benefit products and other supplemental health and financial protection products. Members included in these products may not be unique to each product since members have the ability to enroll in multiple products.
 
 
 
 
 
 
 
 
 
For the three months ended
March 31,
 
Change
 
2017
 
2016
 
Dollars
 
Percentage
 
(in millions)
 
 
Premiums and Services Revenue:
 
 
 
 
 
 
 
Premiums:
 
 
 
 
 
 
 
Fully-insured commercial group
$
1,392

 
$
1,378

 
$
14

 
1.0
 %
Group specialty
347

 
322

 
25

 
7.8
 %
Total premiums
1,739

 
1,700

 
39

 
2.3
 %
Services
219

 
161

 
58

 
36.0
 %
Total premiums and services revenue
$
1,958

 
$
1,861

 
$
97

 
5.2
 %
Income before income taxes
$
211

 
$
171

 
$
40

 
23.4
 %
Benefit ratio
73.2
%
 
75.6
%
 
 
 
(2.4
)%
Operating cost ratio
23.6
%
 
21.4
%
 
 
 
2.2
 %
Pretax Results
Group and Specialty segment pretax income was $211 million in the 2018 quarter, an increase of $40 million or 23.4%, from $171 million in the 2017 quarter, primarily due to higher pretax earnings from our fully insured commercial medical business.
Enrollment
Fully-insured commercial group medical membership decreased 44,300 members, or 4.0%, from March 31, 2017 to March 31, 2018 reflecting lower membership in small group accounts due in part to more small group accounts continuing to select level funded ASO products in 2018.
Group ASO commercial medical membership increased 5,600 members, or 1.3%, from March 31, 2017 to March 31, 2018 reflecting more small group accounts selecting level-funded ASO products in 2018, partially offset by the loss of certain large group accounts as a result of continued discipline in pricing of services for self-funded accounts amid a highly competitive environment.

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Military services membership increased 2,848,300 members, or 92.4%, from March 31, 2017 to March 31, 2018 primarily due to our transition to providing healthcare services to military service members, retirees, and their families under the new T2017 East Region contract covering 32 states, which became effective January 1, 2018.
Specialty membership decreased 182,900 members, or 2.6%, from March 31, 2017 to March 31, 2018 primarily due to the losses of some large group accounts offering stand-alone dental and vision products, partially offset by an increase in individual dental and vision membership.
Premiums Revenue
Group and Specialty segment premiums increased $39 million, or 2.3%, from the 2017 quarter to $1.7 billion for the 2018 quarter primarily reflecting higher stop-loss premiums related to our small group level funded accounts, and higher per-member premiums across most lines of business in the segment, partially offset by declines in average group fully-insured and ASO commercial medical membership.
Services Revenue
Group and Specialty segment services revenue increased $58 million, or 36.0%, from the 2017 quarter to $219 million for the 2018 quarter as a result of the transition to the TRICARE T2017 East Region contract on January 1, 2018.
Benefits Expense
The Group and Specialty segment benefit ratio decreased 240 basis points from 75.6% in the 2017 quarter to 73.2% in the 2018 quarter primarily due to the impact of the reinstatement of the health insurance industry fee in 2018 which was contemplated in the pricing of our products, the seasonality and product design of our fully-insured commercial products, including increased number of high deductible plan offerings, and higher favorable prior-period reserve development.
The Group and Specialty segment's benefits expense included $34 million in favorable prior-period medical claims reserve development in the 2018 quarter and $20 million in the 2017 quarter. This favorable prior-period medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 200 basis points in the 2018 quarter and 120 basis points in the 2017 quarter.
Operating Costs
The Group and Specialty segment operating cost ratio of 23.6% for the 2018 quarter increased 220 basis points from 21.4% for the 2017 quarter primarily due to the reinstatement of the health insurance industry fee in 2018, growth in our military services business, which carries a higher operating cost ratio than other products within the segment, as a result of the transition to the TRICARE T2017 East Region contract, and investments made in the 2018 quarter as a result of the Tax Reform Law as previously described. These items were partially offset by significant operating cost efficiencies in the 2018 quarter driven by productivity initiatives implemented in 2017. The non-deductible health insurance industry fee impacted the operating cost ratio by 160 basis points in the 2018 quarter.

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Healthcare Services Segment
 
 
 
 
 
 
 
 
 
For the three months ended
March 31,
 
Change
 
2018
 
2017
 
Dollars
 
Percentage
 
(in millions)
 
 
Revenues:
 
 
 
 
 
 
 
Services:
 
 
 
 
 
 
 
Clinical care services
$
44

 
$
50

 
$
(6
)
 
(12.0
)%
Pharmacy solutions
39

 
18

 
21

 
116.7
 %
Provider services
21

 
20

 
1

 
5.0
 %
Total services revenues
104

 
88

 
16

 
18.2
 %
Intersegment revenues:
 
 


 
 
 
 
Pharmacy solutions
4,995

 
5,141

 
(146
)
 
(2.8
)%
Provider services
378

 
418

 
(40
)
 
(9.6
)%
Clinical care services
180

 
303

 
(123
)
 
(40.6
)%
Total intersegment revenues
5,553

 
5,862

 
(309
)
 
(5.3
)%
Total services and intersegment revenues
$
5,657

 
$
5,950

 
$
(293
)
 
(4.9
)%
Income before income taxes
$
173

 
$
244

 
$
(71
)
 
(29.1
)%
Operating cost ratio
96.2
%
 
95.5
%
 
 
 
0.7
 %
Pretax Results
Healthcare Services segment pretax income of $173 million for the 2018 quarter decreased $71 million, or 29.1%, from $244 million in the 2017 quarter primarily due to the impact of the optimization process associated with our chronic care management programs, as well as the investments made in the 2018 quarter as a result of the Tax Reform Law as previously described.
Script Volume
Humana Pharmacy Solutions script volumes on an adjusted 30-day equivalent basis increased to approximately 108 million in the 2018 quarter, up 0.9%, versus scripts of approximately 107 million in the 2017 quarter. This increase primarily reflected growth associated with higher individual Medicare Advantage membership for the 2018 quarter compared to the 2017 quarter, partially offset by the decline in stand-alone PDP and Individual Commercial membership.
Services Revenues
Services revenues increased $16 million, or 18.2%, from the 2017 quarter to $104 million for the 2018 quarter primarily due to service revenue growth from our pharmacy solutions business.
Intersegment Revenues
Intersegment revenues decreased $309 million, or 5.3%, from the 2017 quarter to $5.6 billion for the 2018 quarter primarily due to the loss of intersegment revenues associated with our exit from the Individual commercial business, and a decline in pharmacy solutions revenue year-over-year primarily due to lower stand-alone PDP membership as a result of the previously disclosed loss of auto assigned members in Florida and South Carolina resulting from pricing over the CMS low income benchmark and continued membership declines in our Enhanced product. In addition, the year-over-year comparison was impacted by the result of the optimization process associated with our chronic care management programs previously discussed, and lower revenue in our provider services business reflecting Medicare rates year-over-year in geographies where

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our provider assets are primarily located. These declines were partially offset by Medicare Advantage membership growth in the 2018 quarter.
Operating Costs
The Healthcare Services segment operating cost ratio of 96.2% for the 2018 quarter increased 70 basis points from 95.5% for the 2017 quarter primarily due to the timing of the optimization process associated with our chronic conditions management programs and the long-term sustainability investments in the 2018 quarter as a result of the Tax Reform Law. With the optimization of our chronic care management programs, operating cost reductions may lag the associated reduction in revenue, negatively impacting the operating cost ratio. These items were partially offset by significant operating cost efficiencies in the 2018 quarter driven by productivity initiatives implemented in 2017.
Individual Commercial Segment
Individual Commercial segment pretax income of $53 million for the 2018 quarter decreased $10 million from the 2017 quarter. The pretax income in the 2018 quarter primarily reflects the impact of favorable prior-period reserve development.
Liquidity
Historically, our primary sources of cash have included receipts of premiums, services revenue, and investment and other income, as well as proceeds from the sale or maturity of our investment securities, borrowings, and proceeds from sales of businesses. Our primary uses of cash historically have included disbursements for claims payments, operating costs, interest on borrowings, taxes, purchases of investment securities, acquisitions, capital expenditures, repayments on borrowings, dividends, and share repurchases. Because premiums generally are collected in advance of claim payments by a period of up to several months, our business normally should produce positive cash flows during periods of increasing premiums and enrollment. Conversely, cash flows would be negatively impacted during periods of decreasing premiums and enrollment. From period to period, our cash flows may also be affected by the timing of working capital items including premiums receivable, benefits payable, and other receivables and payables. Our cash flows are impacted by the timing of payments to and receipts from CMS associated with Medicare Part D subsidies for which we do not assume risk. The use of cash flows may be limited by regulatory requirements of state departments of insurance (or comparable state regulators) which require, among other items, that our regulated subsidiaries maintain minimum levels of capital and seek approval before paying dividends from the subsidiaries to the parent. Our use of cash flows derived from our non-insurance subsidiaries, such as in our Healthcare Services segment, is generally not restricted by state departments of insurance (or comparable state regulators).
The effect of the commercial risk adjustment, risk corridor, and reinsurance provisions of the Health Care Reform Law have impacted the timing of our operating cash flows, as we build receivables for each coverage year that are expected to be collected in subsequent coverage years. During the three months ended March 31, 2018, net collections under the 3Rs associated with prior coverage years were $46 million compared to $62 million during the three months ended March 31, 2017. The remaining net payable balance associated with the 3Rs was approximately $24 million at March 31, 2018, including $14 million related to prior coverage years, compared to a net receivable of $31 million at December 31, 2017. The remaining net payable balance is primarily related to our Individual Commercial medical business which we exited effective January 1, 2018. On November 2, 2017, we filed suit against the United States of America in the United States Court of Federal Claims, on behalf of our health plans seeking recovery from the federal government of approximately $611 million in payments under the risk corridor premium stabilization program established under the Health Care Reform Law, for years 2014, 2015 and 2016. There is no assurance, however, that we will prevail in this lawsuit.
For additional information on our liquidity risk, please refer to the section entitled “Risk Factors” in our 2017 Form 10-K.

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Cash and cash equivalents increased to approximately $8.9 billion at March 31, 2018 from $4.0 billion at December 31, 2017. The change in cash and cash equivalents for the three months ended March 31, 2018 and 2017 is summarized as follows:
 
Three Months Ended
 
2018
 
2017
 
(in millions)
Net cash provided by operating activities
$
3,686

 
$
4,205

Net cash used in investing activities
(405
)
 
(926
)
Net cash provided by financing activities
1,532

 
1,269

Increase in cash and cash equivalents
$
4,813

 
$
4,548

Cash Flow from Operating Activities
Our operating cash flows for the 2018 quarter and 2017 quarter were significantly impacted in both periods by the early receipt of the Medicare premium remittances of $3.3 billion in March 2018 and $3.1 billion in March 2017 because the payment dates of April 2018 and April 2017 fell on a weekend. Generally, when the first day of a month falls on a weekend or holiday, with the exception of January 1 (New Year's Day), we receive this payment at the end of the previous month. This also resulted in an increase to unearned revenues in our condensed consolidated balance sheet at March 31, 2018. Our operating cash flows for the 2017 quarter were also significantly impacted by the receipt of the $1 billion Merger Agreement break-up fee. Excluding the Merger termination fee and the timing of the Medicare premium remittances, our operating cash flows were impacted by higher earnings and the timing of working capital items.
The most significant drivers of changes in our working capital are typically the timing of payments of benefits expense and receipts for premiums. We illustrate these changes with the following summaries of benefits payable and receivables.
The detail of benefits payable was as follows at March 31, 2018 and December 31, 2017:
 
March 31, 2018
 
December 31, 2017
 
2018
Quarter
Change
 
2017
Quarter
Change
 
(in millions)
IBNR (1)
$
3,360

 
$
3,154

 
$
206

 
$
(25
)
Reported claims in process (2)
718

 
614

 
104

 
(66
)
Other benefits payable (3)
883

 
900

 
(17
)
 
289

Total benefits payable
$
4,961

 
$
4,668

 
$
293

 
$
198

(1)
IBNR represents an estimate of benefits payable for claims incurred but not reported (IBNR) at the balance sheet date and includes unprocessed claim inventories. The level of IBNR is primarily impacted by membership levels, medical claim trends and the receipt cycle time, which represents the length of time between when a claim is initially incurred and when the claim form is received and processed (i.e. a shorter time span results in a lower IBNR). IBNR includes unprocessed claims inventories.
(2)
Reported claims in process represents the estimated valuation of processed claims that are in the post claim adjudication process, which consists of administrative functions such as audit and check batching and handling, as well as amounts owed to our pharmacy benefit administrator which fluctuate due to bi-weekly payments and the month-end cutoff.
(3)
Other benefits payable primarily include amounts owed to providers under capitated and risk sharing arrangements.
The increase in benefits payable from December 31, 2017 to March 31, 2018 primarily was due to an increase in IBNR, primarily as a result of Medicare Advantage membership growth as well as an increase in the amount of processed

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but unpaid claims, which fluctuate due to month-end cutoff. The increase in benefits payable from December 31, 2016 to March 31, 2017 primarily was due to an increase in the amounts owed to providers under the capitated and risk sharing arrangements. This was partially offset by a decrease in the amount of processed but unpaid claims, which fluctuate due to month-end cutoff as well as a decrease in IBNR primarily driven by declines in individual commercial medical membership in the 2017 quarter, partially offset by an increase in group Medicare Advantage membership.
The detail of total net receivables was as follows at March 31, 2018 and December 31, 2017:
 
March 31, 2018
 
December 31, 2017
 
2018
Quarter
Change
 
2017
Quarter
Change
 
(in millions)
Medicare
$
968

 
$
511

 
$
457

 
$
467

Commercial and other
246

 
273

 
(27
)
 
64

Military services
149

 
166

 
(17
)
 
22

Allowance for doubtful accounts
(87
)
 
(96
)
 
9

 
5

Total net receivables
$
1,276

 
$
854

 
$
422

 
$
558

The changes in Medicare receivables for both the 2018 quarter and the 2017 quarter reflect the typical pattern caused by the timing of accruals and related collections associated with the CMS risk-adjustment model. Significant collections occur with the mid-year and final settlements with CMS in the second and third quarter.
Cash Flow from Investing Activities
We reinvested a portion of our operating cash flows in investment securities, primarily investment-grade fixed income securities, totaling $102 million in the 2018 quarter and $797 million in the 2017 quarter.
On March 1, 2018 we acquired the remaining equity interest in MCCI, a privately held management service organization headquartered in Miami, Florida, that primarily coordinates medical care for Medicare Advantage beneficiaries in Florida and Texas. The purchase price included, in part, cash consideration of $169 million, as discussed in Note 3 to the condensed consolidated financial statements.

Our ongoing capital expenditures primarily relate to our information technology initiatives, support of services in our provider services operations including medical and administrative facility improvements necessary for activities such as the provision of care to members, claims processing, billing and collections, wellness solutions, care coordination, regulatory compliance and customer service. Total capital expenditures, excluding acquisitions, were $134 million in the 2018 quarter and $122 million in the 2017 quarter.

Cash Flow from Financing Activities
Receipts from CMS associated with Medicare Part D claim subsidies for which we do not assume risk were higher than claims payments by $1.4 billion during the 2018 quarter and higher than claims payments by $1.7 billion during the 2017 quarter.
Under our administrative services only TRICARE contracts, health care cost payments for which we do not assume risk exceeded reimbursements from the federal government by $28 million in the 2018 quarter. In the 2017 quarter, reimbursements from the federal government exceeded health care cost payments for which we do not assume risk by $9 million.
Claims payments associated with cost sharing provisions of the Health Care Reform Law for which we do not assume risk were $16 million higher than reimbursements from HHS during the 2018 quarter and $3 million higher than reimbursements from HHS during the 2017 quarter.

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On March 26, 2018 we completed the final settlement of our accelerated stock repurchase with no additional share repurchases under the current stock repurchase authorization during the 2018 quarter. We also acquired common shares in connection with employee stock plans for an aggregate cost of $51 million in the 2018 quarter and $74 million in the 2017 quarter.
In March 2017, we issued $600 million of 3.95% senior notes due March 15, 2027 and $400 million of 4.80% senior notes due March 15, 2047. Our net proceeds, reduced for the underwriters' discount and commission and offering expenses paid as of March 31, 2017, were $991 million.
Net proceeds from the issuance of commercial paper were $245 million in the 2018 quarter and $169 million in the 2017 quarter. The maximum principal amount outstanding at any one time during the 2018 quarter was $442 million.
We paid dividends to stockholders of $57 million during the 2018 quarter and $47 million during the 2017 quarter.
Future Sources and Uses of Liquidity
Dividends
For a detailed discussion of dividends to stockholders, please refer to Note 11 to the condensed consolidated financial statements.
Stock Repurchases
For a detailed discussion of stock repurchases, please refer to Note 11 to the condensed consolidated financial statements.
Debt
For a detailed discussion of our debt, including our senior notes, credit agreement and commercial paper program, please refer to Note 13 to the condensed consolidated financial statements.
Acquisitions and Divestitures
On April 10, 2018, we acquired FPG for cash considerations of approximately $190 million. FPG is one of the largest at-risk providers serving Medicare Advantage and Managed Medicaid HMO patients in Greater Orlando, Florida with a footprint that includes clinics located in Lake, Orange, Osceola and Seminole counties. The acquisition of FPG advances our strategy of helping physicians and clinicians evolve from treating health episodically to managing health holistically. This acquisition is not expected to have a material impact on our results of operations, financial condition, or cash flows.
On March 1, 2018 we acquired the remaining equity interest in MCCI, a privately held management service organization headquartered in Miami, Florida, that primarily coordinates medical care for Medicare Advantage beneficiaries in Florida and Texas. The purchase price consisted primarily of $169 million cash, as well as our existing investment in MCCI and a note receivable and a revolving note with an aggregate balance of $383 million. This resulted in a preliminary purchase price allocation to goodwill of $479 million, other intangible assets of $80 million, and net tangible assets of $27 million.
On December 19, 2017, we announced that we entered into a definitive agreement to acquire a 40% minority interest in Kindred at Home for estimated cash consideration of approximately $800 million, including our share of transaction and related expenses, to facilitate a complete separation from the Long Term Acute Care and Rehabilitation businesses (the Specialty Hospital company). TPG and WCAS, collectively, the Sponsors, along with us are jointly creating a consortium to purchase all of the outstanding and issued securities of Kindred. The Kindred transaction, which is anticipated to close in the summer of 2018, is subject to customary state and federal regulatory approvals, as well as other customary closing conditions. On April 5, 2018, Kindred's stockholders approved the transaction. We expect to fund the transaction through the use of parent company cash and will account for the minority investment under the equity method.

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On April 23, 2018, we, along with the same Kindred at Home Sponsors, TPG and WCAS entered into a definitive agreement to acquire privately held Curo, one of the nations' leading hospice operators providing care to patients at 245 locations in 22 states. The Consortium is purchasing Curo for approximately $1.4 billion, and at the closing of the transaction, we will have a 40% minority interest. The Curo transaction, which is anticipated to close during the summer of 2018, is subject to customary state and federal regulatory approvals as well as other customary closing conditions.

On November 6, 2017, we entered into a definitive agreement to sell the stock of our wholly-owned subsidiary, KMG, to CGIC, a Texas-based insurance company wholly owned by HC2 Holdings, Inc., a diversified holding company. KMG’s subsidiary, KIC, includes our closed block of non-strategic commercial long-term care insurance policies. We will fund the transaction with approximately $203 million of parent company cash contributed into KMG, subject to customary adjustments, in addition to the transfer of approximately $150 million of statutory capital with the sale. The KMG transaction is anticipated to close by the third quarter of 2018 subject to customary closing conditions, including South Carolina Department of Insurance approval. There can be no assurance we will obtain regulatory approvals needed to sell the business or do so under terms acceptable to us.
Liquidity Requirements
We believe our cash balances, investment securities, operating cash flows, and funds available under our credit agreement and our commercial paper program or from other public or private financing sources, taken together, provide adequate resources to fund ongoing operating and regulatory requirements, acquisitions, future expansion opportunities, and capital expenditures for at least the next twelve months, as well as to refinance or repay debt, and repurchase shares.
Adverse changes in our credit rating may increase the rate of interest we pay and may impact the amount of credit available to us in the future. Our investment-grade credit rating at March 31, 2018 was BBB+ according to Standard & Poor’s Rating Services, or S&P, and Baa3 according to Moody’s Investors Services, Inc., or Moody’s. A downgrade by S&P to BB+ or by Moody’s to Ba1 triggers an interest rate increase of 25 basis points with respect to $250 million of our senior notes. Successive one notch downgrades increase the interest rate an additional 25 basis points, or annual interest expense by less than $1 million, up to a maximum 100 basis points, or annual interest expense by $3 million.
In addition, we operate as a holding company in a highly regulated industry. Humana Inc., our parent company, is dependent upon dividends and administrative expense reimbursements from our subsidiaries, most of which are subject to regulatory restrictions. We continue to maintain significant levels of aggregate excess statutory capital and surplus in our state-regulated operating subsidiaries. Cash, cash equivalents, and short-term investments at the parent company were $567 million at March 31, 2018 compared to $688 million at December 31, 2017. This decrease primarily reflects the impact of capital contributions into a subsidiary to fund Medicare growth, as well as the acquisition of the remaining equity interest in MCCI for $169 million cash, dividends and capital expenditures partially offset by cash generated by our non-insurance subsidiaries and net proceeds from the issuance of commercial paper. Our use of operating cash derived from our non-insurance subsidiaries, such as our Healthcare Services segment, is generally not restricted by departments of insurance (or comparable state regulator).
In September 2018, we expect to pay the federal government $1.05 billion for our portion of the annual health insurance industry fee attributed to calendar year 2018 in accordance with the Health Care Reform Law. This fee is not deductible for tax purposes. Each year on January 1, except for 2017, we record a liability for this fee in trade accounts payable and accrued expenses which we carry until the fee is paid. We record a corresponding deferred cost in other current assets in our condensed consolidated financial statements which is amortized ratably to expense over the calendar year. Amortization of the deferred cost resulted in operating cost expense of approximately $263 million for the three months ended March 31, 2018 resulting from the amortization of the 2018 annual health insurance industry fee. The annual health insurance industry fee was suspended for calendar year 2017, and is also suspended for calendar year 2019.
Regulatory Requirements
Certain of our subsidiaries operate in states that regulate the payment of dividends, loans, or other cash transfers to Humana Inc., our parent company, and require minimum levels of equity as well as limit investments to approved securities. The amount of dividends that may be paid to Humana Inc. by these subsidiaries, without prior approval by

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state regulatory authorities, or ordinary dividends, is limited based on the entity’s level of statutory income and statutory capital and surplus. In most states, prior notification is provided before paying a dividend even if approval is not required.
Although minimum required levels of equity are largely based on premium volume, product mix, and the quality of assets held, minimum requirements vary significantly at the state level. Based on the most recently filed statutory financial statements as of December 31, 2017, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $8.0 billion, which exceeded aggregate minimum regulatory requirements of $4.8 billion. Subsidiary dividends are subject to state regulatory approval, the amount and timing of which could be reduced or delayed. Excluding Puerto Rico subsidiaries, the amount of ordinary dividends that may be paid to our parent company in 2018 is approximately $1.1 billion in the aggregate. This compares to dividends that were paid to our parent company in 2017 of approximately $1.4 billion. Actual dividends paid may vary due to consideration of excess statutory capital and surplus and expected future surplus requirements related to, for example, premium volume and product mix.



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Item 3.    Quantitative and Qualitative Disclosures about Market Risk
Our earnings and financial position are exposed to financial market risk, including those resulting from changes in interest rates.
Interest rate risk also represents a market risk factor affecting our consolidated financial position due to our significant investment portfolio, consisting primarily of fixed maturity securities of investment-grade quality with a weighted average S&P credit rating of AA at March 31, 2018. Our net unrealized position decreased $308 million from a net unrealized gain position of $198 million at December 31, 2017 to a net unrealized loss position of $110 million at March 31, 2018. At March 31, 2018, we had gross unrealized losses of $249 million on our investment portfolio primarily due to an increase in market interest rates since the time the securities were purchased. There were no material other-than-temporary impairments during the three months ended March 31, 2018. While we believe that these impairments are temporary and we currently do not have the intent to sell such securities, given the current market conditions and the significant judgments involved, there is a continuing risk that future declines in fair value may occur and material realized losses from sales or other-than-temporary impairments may be recorded in future periods.
Duration is the time-weighted average of the present value of the bond portfolio’s cash flow. Duration is indicative of the relationship between changes in fair value and changes in interest rates, providing a general indication of the sensitivity of the fair values of our fixed maturity securities to changes in interest rates. However, actual fair values may differ significantly from estimates based on duration. The average duration of our investment portfolio, including cash and cash equivalents, was approximately 4.0 years as of March 31, 2018 and approximately 4.1 years as of December 31, 2017. Based on the duration, including cash equivalents, a 1% increase in interest rates would generally decrease the fair value of our securities by approximately $650 million at March 31, 2018.
Item 4.    Controls and Procedures
Under the supervision and with the participation of our Chief Executive Officer, or CEO, our Chief Financial Officer, or CFO, and our Principal Accounting Officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures for the quarter ended March 31, 2018.
Based on our evaluation, our CEO, CFO, and our Principal Accounting Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information the Company is required to disclose in its reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, including, without limitation, ensuring that such information is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


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Part II. Other Information
Item 1.     Legal Proceedings
For a description of the legal proceedings pending against us and certain other pending or threatened litigation, investigations, or other matters, see “Legal Proceedings and Certain Regulatory Matters” in Note 14 to the condensed consolidated financial statements beginning on page 27 of this Form 10-Q.
Item 1A.    Risk Factors
There have been no changes to the risk factors included in our 2017 Form 10-K.
Item 2:
Unregistered Sales of Equity Securities and Use of Proceeds
(a)
None.
(b)
N/A
(c)
The following table provides information about our purchases of equity securities that are registered by us pursuant to Section 12 of the Securities Exchange Act of 1934, as amended, during the three months ended March 31, 2018:
Period
Total Number
of Shares
Purchased (1)(2)
 
Average
Price Paid
per Share (3)
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs (1)(2)
 
Dollar Value of
Shares that May
Yet Be Purchased
Under the Plans
or Programs (1)
January 2018

 
$

 

 
$
2,000,000,000

February 2018

 

 

 
2,000,000,000

March 2018
453,323

 

 
453,323

 
2,000,000,000

Total
453,323

 
$

 
453,323

 
 
(1)
On December 14, 2017, our Board of Directors authorized the repurchase of up to $3.0 billion of our common shares expiring on December 31, 2020, exclusive of shares repurchased in connection with employee stock plans. On December 21, 2017, we entered into an accelerated stock repurchase agreement, the December 2017 ASR, with Bank of America, N.A., or BofA, to repurchase $1.0 billion of our common stock as part of the $3.0 billion share repurchase program authorized on December 14, 2017. On March 26, 2018 we completed the final settlement of our accelerated stock repurchase. Our remaining repurchase authorization was approximately $2 billion as of May 1, 2018.
(2)
Includes 0.46 million shares received in March 2018 upon settlement of an accelerated repurchase program for which no cash was paid during the period and excludes 0.19 million shares repurchased in connection with employee stock plans.
(3)
Excludes the impact of the 0.46 million shares received in March 2018 upon settlement of an accelerated repurchase program which were determined by the average daily volume weighted-average share price of our common stock during the term of the ASR Agreement of $267.55.
Item 3:
Defaults Upon Senior Securities
None.
Item 4:
Mine Safety Disclosures
Not applicable.

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Item 5:
Other Information
None.
Item 6:
Exhibits
3(i)
Restated Certificate of Incorporation of Humana Inc. filed with the Secretary of State of Delaware on November 9, 1989, as restated to incorporate the amendment of January 9, 1992, and the correction of March 23, 1992 (incorporated herein by reference to Exhibit 4(i) to Humana Inc.’s Post-Effective Amendment No. 1 to the Registration Statement on Form S-8 (Reg. No. 33-49305) filed February 2, 1994).
3(ii)By-Laws of Humana Inc., as amended on December 14, 2017 (incorporated herein by reference to Exhibit 3(b) to Humana Inc.’s Current Report on Form 8-K, filed December 14, 2017).
12Computation of ratio of earnings to fixed charges.
31.1Principal Executive Officer certification pursuant to Section 302 of Sarbanes–Oxley Act of 2002.
31.2Principal Financial Officer certification pursuant to Section 302 of Sarbanes–Oxley Act of 2002.
32Principal Executive Officer and Principal Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101
The following materials from Humana Inc.'s Quarterly Report on Form 10-Q formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets at March 31, 2018 and December 31, 2017; (ii) the Condensed Consolidated Statements of Income for the three months ended March 31, 2018 and 2017; (iii) the Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2018 and 2017; (iv) the Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017; and (v) Notes to Condensed Consolidated Financial Statements.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
HUMANA INC.
 
 
(Registrant)
 
 
 
 
Date:
May 2, 2018
By:
/s/ CYNTHIA H. ZIPPERLE
 
 
 
Cynthia H. Zipperle
 
 
 
Senior Vice President, Chief Accounting Officer and Controller (Principal Accounting Officer)
 
 
 
 

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