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Morningstar | Humana Produces Strong Membership Growth as Profits Are Pressured in Quarter

Humana reported strong membership growth in its third quarter, and impressively, it was able to keep its medical costs in check. We find this a positive development, especially given the firm’s significant skew toward Medicare membership. However, higher operating expenses provided material headwinds as the firm made operating investments to enhance its efficiency. The reinstatement of the health insurer tax did affect the trajectory of these two metrics. Nevertheless, we believe it’s imperative that Humana keep its centralized costs in check, given the high cost of its Medicare cohort and the fluctuation of its medical loss ratio. After factoring in these latest developments, we are reiterating our $215 fair value estimate and no-moat rating for the managed-care organization.

The combination of Humana's exit from the public exchange market and solid underwriting held the firm’s medical loss ratio steady compared with the year-ago period. However, the adjusted operating cost ratio (centralized costs as a percentage of operating revenue) increased by 170 basis points and weighed on profits. Positively, premium and total operating revenue increased for the quarter and were accompanied by a significant increase in membership. We believe the firm continues to benefit from higher-deductible plans, which kept utilization at a lower rate. We find this development highly positive and believe it reflects good underwriting and sales execution. However, the increase in centralized costs is a negative, and we would like to see this trend reverse over the coming quarters. Given the long-term uncertainty that will dominate the health insurance space over the next several years and the firm’s concentration in the lower-profit Medicare Part C market, controlling nonmedical expenses will be essential for Humana in producing long-term economic profits.