The following discussion should be read together with the accompanying
Consolidated Financial Statements and Notes to the Consolidated Financial
Statements thereto. Readers are cautioned that the statements, estimates,
projections or outlook contained in this report, including discussions regarding
financial prospects, economic conditions, trends and uncertainties contained in
this Item 7, may constitute forward-looking statements within the meaning of the
PSLRA. These forward-looking statements involve risks and uncertainties that may
cause our actual results to differ materially from the results discussed in the
forward-looking statements. A description of some of the risks and uncertainties
can be found further below in this Item 7 and in Item 1A, "Risk Factors."
EXECUTIVE OVERVIEW
General
UnitedHealth Group is a diversified health and well-being company dedicated to
helping people live healthier lives and making health care work better. We offer
a broad spectrum of products and services through two distinct platforms:
UnitedHealthcare, which provides health care coverage and benefits services; and
Optum, which provides information and technology-enabled health services.
Further information on our business is included in Item 1, "Business" and
additional information on the our segments can be found in this Item 7 and in
Note 13 to the Consolidated Financial Statements in Item 8, "Financial
Statements."
Revenues
Our revenues are primarily comprised of premiums derived from risk-based health
insurance arrangements in which the premium is typically at a fixed rate per
individual served for a one-year period, and we assume the economic risk of
funding our customers' health care benefits and related administrative costs. We
also generate revenues from fee-based services performed for customers that
self-insure the health care costs of their employees and employees' dependants.
For both risk-based and fee-based health care benefit arrangements, we provide
coordination and facilitation of medical services; transaction processing;
health care professional services; and access to contracted networks of
physicians, hospitals and other health care professionals. We also generate
service revenues from our Optum businesses relating to care management, consumer
engagement and support, distribution of benefits and services, health financial
services, operational services and support, health care information technology
and pharmacy services. Product revenues are mainly comprised of products sold by
our pharmacy benefit management business. We derive investment income primarily
from interest earned on our investments in debt securities; investment income
also includes gains or losses when investment securities are sold, or
other-than-temporarily impaired.
Pricing Trends. We seek to price our products consistent with anticipated
underlying medical trends, while balancing growth, margins, competitive
dynamics, cost increases for the industry fees and tax provisions of Health
Reform Legislation and premium rebates at the local market level. We endeavor to
sustain a commercial medical care ratio in a stable range for an equivalent mix
of business. Changes in business mix and Health Reform Legislation may impact
our premiums, medical costs and medical care ratio. Further, we continue to
expect premium rates to be under pressure through continued market competition
in commercial products and government payment rates. Aggregating
UnitedHealthcare's businesses, we expect the medical care ratio to rise over
time as we continue to grow in the senior and public markets and participate in
the health benefit exchange market in 2014.
In the commercial market segment, we expect pricing to continue to be highly
competitive in 2013. We plan to hold to our pricing disciplines and, considering
the competitive environment and persistently weak employment and new business
formation rates, we expect continued pressure on our commercial risk-based
product membership in 2013. Additionally, self-insured membership as a percent
of total commercial membership is expected to continue to increase at a modest
pace in 2013 and beyond, due in part to the emerging popularity of midsize
employers moving to self-funded arrangements.
In government programs, we are seeing continuing rate pressures, and rate
changes for some Medicaid programs are slightly negative. Unlike in prior years,
recent Medicaid reductions have generally not been mitigated by corresponding
benefit reductions or care provider fee schedule reductions by the state
sponsor. We continue to take a prudent, market-sustainable posture for both new
bids and maintenance of existing Medicaid contracts. Medicare funding is
similarly pressured; see further discussion below in "Regulatory Trends and
Uncertainties." We expect these factors to result in pressure on gross margin
percentages for our Medicare and Medicaid programs in 2013.
In 2013, UnitedHealthcare created a new affordable "Basic Plan" for Medicare
Part D consumers and reclassified its large 4 million member Medicare Part D
plan to an "Enhanced Plan" status with CMS. The change to Enhanced Plan status
changes the seasonal pattern of earnings to later in the year with no material
impact expected on full year profitability.
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Operating Costs
Medical Costs. Medical costs represent the costs of our obligations for claims
and/or benefits of our risk-based insurance arrangements. Our operating results
depend in large part on our ability to effectively estimate, price for and
manage our medical costs through underwriting criteria, product design,
negotiation of favorable care provider contracts and care coordination programs.
Controlling medical costs requires a comprehensive and integrated approach to
organize and advance the full range of interrelationships among
patients/consumers, health professionals, hospitals, pharmaceutical/technology
manufacturers and other key stakeholders.
Medical costs include estimates of our obligations for medical care services
rendered on behalf of insured consumers for which we have not yet received or
processed claims, and our estimates for physician, hospital and other medical
cost disputes. In every reporting period, our operating results include the
effects of more completely developed medical costs payable estimates associated
with previously reported periods.
Our medical care ratio, calculated as medical costs as a percentage of premium
revenues, reflects the combination of pricing, rebates, benefit designs,
consumer health care utilization and comprehensive care facilitation efforts.
Medical Cost Trends. In 2012, we managed our commercial medical cost trend to a
level under 5.5 percent. In 2013, we expect a slight increase in trend from
2012, albeit with relatively consistent unit cost and utilization trends
compared to 2012. We expect our total trend will be driven primarily by
continued unit cost pressure from health care providers as they try to
compensate for soft utilization trends and cross-subsidization pressure due to
their government reimbursement levels.
Underlying utilization trends declined significantly in 2010 and increased
modestly in 2011 and 2012. Use of outpatient services has been the primary
driver of utilization trend increase, with inpatient utilization declining. We
also experienced an increase in prescription drug costs in 2012 and expect that
trend to continue due to unit cost pressure and a trend towards expensive new
specialty drugs. As we move into 2013, we believe current utilization trends are
slightly below what we believe to be normal utilization levels. The weak
economic environment, combined with our medical cost management, has had a
favorable impact on utilization trends. We believe our alignment of progressive
benefit designs, consumer engagement, clinical management, pay-for-performance
reimbursement programs for care providers and network resources is favorably
controlling medical and pharmacy costs, enhancing affordability and quality for
our customers and members and helping to drive strong market response and
growth.
Operating Costs. Operating costs are primarily comprised of costs related to
employee compensation and benefits, agent and broker commissions, premium taxes
and assessments, professional fees, advertising and occupancy costs. We seek to
improve our operating cost ratio, calculated as operating costs as a percentage
of total revenues, for an equivalent mix of business. However, changes in
business mix, such as increases in the size of our health services businesses or
an increase in the delivery of medical services on an integrated basis may
impact our operating costs and operating cost ratio.
Other Business Trends
Our businesses participate in the U.S., Brazilian and certain other health
economies. In the U.S., health care spending comprises approximately 18% of
gross domestic product and has grown consistently for many years. We expect
overall spending on health care to continue to grow in the future, due to
inflation, medical technology and pharmaceutical advancement, regulatory
requirements, demographic trends in the population and national interest in
health and well-being. The rate of market growth may be affected by a variety of
factors, including macro-economic conditions and regulatory changes, including
in the U.S. enacted health care reforms, which could also impact our results of
operations.
Delivery System and Payment Modernization. The market is changing based on
demographic shifts, new regulations, political forces and both payer and patient
expectations. These factors are creating market pressures to change from
fee-for-service models to new delivery models focused on the holistic health of
the consumer, integrated care across care providers and pay-for-performance
payment structures. Health plans and care providers are being called upon to
work together to close gaps in care and improve the overall care for people,
improve the health of a population and reduce the cost of care. The focus on
delivery system modernization and payment reform is critical and the alignment
of incentives between key constituents remains an important theme. We have seen
increased participation in incentive-based payment models such as pay for
performance, shared savings, bundled/episode payment and Patient-Centered
Medical Home models (PCMHs). We also have seen continued development and
deployment of risk-based accountable care models designed to modernize local
delivery systems by better coordinating care, reducing the fragmentation of
treatments between multiple care providers in the current system, limiting
unnecessary hospital admissions and readmissions, focusing on preventive care,
breaking down reimbursement and treatment "silos," and improving quality and
outcomes.
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This trend is creating the need for health management services that can
coordinate care around the primary care physician and for investment in new
clinical and administrative information and management systems, providing growth
opportunities for our Optum business platform.
Government Reliance on Private Sector. The government, as a benefit sponsor, has
been increasingly relying on private sector solutions. We expect this trend to
continue as we believe the private sector provides a more flexible, better
managed, higher quality health care experience than do traditional passive
indemnity programs typically used in governmental benefit programs.
States are struggling to balance unprecedented budget pressures with increases
in their Medicaid expenditures. At the same time, many are expanding their
interest in managed care with particular emphasis on consumers who have complex
and expensive health care needs. More and more, Medicaid managed care is being
viewed as an effective method to improve quality and manage costs. Additionally,
there are more than nine million individuals eligible for both Medicare and
Medicaid. Dually eligible beneficiaries typically have complex conditions with
costs of care that are far higher than a typical Medicare or Medicaid
beneficiary. While these individuals' health needs are more complex and more
costly, they have historically been in unmanaged environments. This provides
UnitedHealthcare an opportunity to integrate Medicare and Medicaid financing to
fund efforts to optimize the health status of this frail population through
close coordination of care. As of December 31, 2012, UnitedHealthcare served
more than 250,000 members in legacy dually eligible programs through Medicare
Advantage and SNPs. In 2013, UnitedHealthcare Community & State will help
implement Ohio's MME program, one of the first in the country under the new CMS
design.
Regulatory Trends and Uncertainties
Following is a summary of management's view of the trends and uncertainties
related to some of the key provisions of the Health Reform Legislation and other
regulatory items; for additional information regarding the Health Reform
Legislation and Regulatory Trends and Uncertainties, see Item 1, "Business -
Government Regulation" and Item 1A, "Risk Factors."
Commercial Rate Increase Review. The Health Reform Legislation requires HHS to
maintain an annual review of "unreasonable" increases in premium rates for
commercial health plans. HHS established a review threshold of annual premium
rate increases generally at or above 10% and clarified that HHS review will not
supersede existing state review and approval procedures. Premium rate review
legislation (ranging from new or enhanced rate filing requirements to prior
approval requirements) has been introduced or passed in more than half of the
states as of the date of this report.
The competitive forces common in our markets do not support unjustifiable rate
increases. We have experienced and expect to continue to experience a tight,
competitive commercial pricing environment. Further, our rates and rate filings
are developed using methods consistent with the standards of actuarial
practices. We anticipate requesting rate increases above 10% in a number of
markets due to the combination of medical cost trends and the incremental costs
of health care reform. We have begun to experience greater regulatory challenges
to appropriate premium rate increases in several states, including California
and New York. Depending on the level of scrutiny by the states, there is a broad
range of potential business impacts. For example, it may become more difficult
to price our commercial risk business consistent with expected underlying cost
trends, leading to the risk of operating margin compression in the commercial
health benefits business.
Medicare Advantage Rates and Minimum Loss Ratios. Medicare Advantage pricing
benchmarks have been cut over the last several years and additional cuts were
implemented in 2012, with changes to continue to be phased in over the next one
to five years (benchmarks will ultimately range from 95% of Medicare
fee-for-service rates in high cost areas to 115% in low cost areas), depending
on the level of benchmark reduction in a county. Additionally, Congress passed
the Budget Control Act of 2011, which as amended by the American Taxpayer Relief
Act of 2012, would trigger automatic across-the-board budget cuts
(sequestration), including a reduction in outlays for Medicare starting in March
2013, absent further Congressional action. Further, beginning in 2014, Medicare
Advantage plans will be required to have a minimum medical loss ratio of 85%.
CMS has not yet issued guidance as to how this requirement will be calculated
for Medicare Advantage plans.
A significant portion of our network contracts are tied to Medicare
reimbursement levels. However, future Medicare Advantage rates may be outpaced
by underlying medical cost trends, placing continued importance on effective
medical management and ongoing improvements in administrative costs. There are a
number of annual adjustments we can and are making to our operations, which may
partially offset any impact from these rate reductions. For example, we seek to
intensify our medical and operating cost management, adjust members' benefits
and decide on a county-by-county basis in which geographies to participate.
Additionally, achieving high quality scores from CMS for improving upon certain
clinical and operational performance standards will impact future quality
bonuses that may offset these anticipated rate reductions. The expanded stars
bonus program is set to expire in 2014. In 2015, quality bonus payments will
only be paid to 4 and 5 star plans per PPACA (compared to current bonuses that
are available to certain qualifying plans rated 3 stars or higher).
Approximately 60% and 10% of our current Medicare Advantage members are enrolled
in plans that will be rated 3.5 stars or higher and 4 stars or
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higher, respectively for the 2014 payment year based on scoring released by CMS
in October 2012. Updated scores, to be released in October 2013, will determine
what portion of our Medicare Advantage membership will reside in a 4 star or 5
star plan and qualify for quality bonus payments in 2015. Although we are
dedicating substantial resources to improving our quality scores and star
ratings, if we are unable to significantly increase the level of membership in
plans with a rating of 4 stars or higher for the 2015 payment year, our 2015
results of operations and cash flows could be adversely impacted.
We also may be able to mitigate the effects of reduced funding by increasing
enrollment due, in part, to the increasing number of people eligible for
Medicare in coming years. Compared to 2011, our 2012 Medicare Advantage
membership has increased by 400,000 consumers, or 18%, including acquisitions.
Longer term, market wide decreases in the availability or relative quality of
Medicare Advantage products may increase demand for other senior health benefits
products such as our Medicare Supplement and Medicare Part D insurance
offerings.
Industry Fees and Taxes. The Health Reform Legislation includes an annual,
non-deductible insurance industry tax to be levied proportionally across the
insurance industry for risk-based products, beginning January 1, 2014. The
amount of the annual tax is $8 billion in 2014, $11.3 billion in 2015 and 2016,
$13.9 billion in 2017 and $14.3 billion in 2018. For 2019 and beyond, the amount
will be equal to the annual tax for the preceding year increased by the rate of
premium growth for the preceding year. The annual tax will be allocated based on
the ratio of an entity's net premiums written during the preceding calendar year
to the total health insurance industry's net premiums written for any U.S.
health risk-based products during the preceding calendar year, subject to
certain exceptions. This tax will first be paid and expensed in 2014; however,
because our policies are annual, we have included the tax and other Health
Reform Legislation cost factors in our 2013 rate filings relating to 2014 rate
periods and any related premium increases for 2013 policies that have coverage
into 2014 will increase the amount of premium recognized in 2013. Our effective
income tax rate will increase significantly in 2014 as a result of the
non-deductibility of these taxes.
With the introduction of state health insurance exchanges in 2014, the Health
Reform Legislation includes three programs designed to stabilize the health
insurance markets. These programs are: a transitional reinsurance program; a
temporary risk corridors program; and a permanent risk adjustment program. The
transitional reinsurance program is a temporary program which will be funded on
a per capita basis from all commercial lines of business including insured and
self-funded arrangements ($25 billion over a three-year period beginning in 2014
of which $20 billion (subject to increases based on state decisions) will fund
the state reinsurance pools and $5 billion funds the U.S. Treasury). The terms
of the specific reinsurance programs to be used in each state are not yet known.
It is our intention to pass these taxes and fees on to customers through
increases in rates and/or decreases in benefits, subject to regulatory approval.
State-Based Exchanges and Coverage Expansion. Effective in 2014, state-based
exchanges are required to be established for individuals and small employers
with enrollment processes scheduled to commence in October of 2013. We expect to
selectively respond and participate in exchanges as they are introduced to the
market. Our level of participation in state-based exchanges will be driven by
how we assess each local market's current and future prospects, including how
the exchange and its rules are set up state-by-state and, our market position
relative to others in the market. Our participation will likely evolve and
change over time as the exchange markets mature. Exchanges will create new
market dynamics that could impact our existing businesses, depending on the
ultimate member migration patterns for each market, its pace and its impact on
our established membership. For example, certain small employers may no longer
offer health benefits to their employees and larger employers may elect to
convert their benefit plans from risk-based to self-funded programs.
The Health Reform Legislation also provides for expanded Medicaid coverage
effective in January 2014. These measures remain subject to implementation at
the state level.
Individual & Small Group Market Reforms. The Health Reform Legislation includes
several provisions that will take effect on January 1, 2014 and are expected to
alter the individual and small group marketplace. Although HHS issued proposed
regulations in late 2012, these regulations are not yet final. Key provisions
include: (1) adjusted community rating requirements, which will change how
individual and small group plans are rated in many states and are expected to
result in significant adjustments in some policyholders' rates during the
transition period; (2) essential health benefit requirements, which will result
in benefit changes for many individual and small group policyholders and will
also impact rates; and (3) actuarial value requirements, which will
significantly impact benefit designs (e.g. member cost sharing requirements) and
could also significantly impact rates for some policyholders.
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RESULTS SUMMARY
For the Years Ended December 31, Increase/(Decrease) Increase/(Decrease)
(in millions, except
percentages and per
share data) 2012 2011 2010 2012 vs. 2011 2011 vs. 2010
Revenues:
Premiums $ 99,728 $ 91,983 $ 85,405 $ 7,745 8 % $ 6,578 8 %
Services 7,437 6,613 5,819 824 12 794 14
Products 2,773 2,612 2,322 161 6 290 12
Investment and other
income 680 654 609 26 4 45 7
Total revenues 110,618 101,862 94,155 8,756 9 7,707 8
Operating costs:
Medical costs 80,226 74,332 68,841 5,894 8 5,491 8
Operating costs 17,306 15,557 14,270 1,749 11 1,287 9
Cost of products sold 2,523 2,385 2,116 138 6 269 13
Depreciation and
amortization 1,309 1,124 1,064 185 16 60 6
Total operating costs 101,364 93,398 86,291 7,966 9 7,107 8
Earnings from operations 9,254 8,464 7,864 790 9 600 8
Interest expense (632 ) (505 ) (481 ) 127 25 24 5
Earnings before income
taxes 8,622 7,959 7,383 663 8 576 8
Provision for income
taxes (3,096 ) (2,817 ) (2,749 ) 279 10 68 2
Net earnings $ 5,526 $ 5,142 $ 4,634 $ 384 7 % $ 508 11 %
Diluted earnings per
share attributable to
UnitedHealth Group
common shareholders $ 5.28 $ 4.73 $ 4.10 $ 0.55 12 % $ 0.63 15 %
Medical care ratio (a) 80.4 % 80.8 % 80.6 % (0.4 )% 0.2 %
Operating cost ratio 15.6 15.3 15.2 0.3 0.1
Operating margin 8.4 8.3 8.4 0.1 (0.1 )
Tax rate 35.9 35.4 37.2 0.5 (1.8 )
Net margin 5.0 5.0 4.9 - 0.1
Return on equity (b) 18.7 % 18.9 % 18.7 % (0.2 )% 0.2 %
(a) Medical care ratio is calculated as medical costs divided by premium
revenue.
(b) Return on equity is calculated as net earnings divided by average equity.
Average equity is calculated using the equity balance at the end of the
preceding year and the equity balances at the end of the four quarters of
the year presented.
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SELECTED OPERATING PERFORMANCE AND OTHER SIGNIFICANT ITEMS
The following represents a summary of select 2012 year-over-year operating
comparisons to 2011 and other 2012 significant items.
• Consolidated revenues increased 9% and UnitedHealthcare revenues increased 8%.
• UnitedHealthcare medical enrollment grew by 6.4 million people, including
4.4 million people served in Brazil as a result of the Amil acquisition;
Medicare Part D stand-alone membership decreased by 0.6 million people.
• The consolidated medical care ratio of 80.4% decreased 40 basis points.
• Earnings from operations increased 8% at UnitedHealthcare and 14% at Optum.
• Net earnings of $5.5 billion and diluted earnings per share of $5.28
increased 7% and 12%, respectively.
• $1.1 billion in cash was held by non-regulated entities as of December 31,
2012.
• 2012 debt offerings amounted to $4 billion, including the August debt
exchange.
• Cash paid for acquisitions in 2012, net of cash assumed, totaled $6.5
billion, including the fourth quarter acquisition of approximately 65% of
the outstanding shares of Amil. We also plan to acquire an additional 25% of
Amil in the first half of 2013. See Note 6 of Notes to the Consolidated
Financial Statements included in Item 8, "Financial Statements" for further
detail on Amil.
• We repurchased 57 million shares for $3.1 billion and paid dividends of $0.8
billion.
2012 RESULTS OF OPERATIONS COMPARED TO 2011 RESULTS
Consolidated Financial Results
Revenues
Revenue increases in 2012 were driven by growth in the number of individuals
served and premium rate increases related to underlying medical cost trends in
our UnitedHealthcare businesses and growth in our Optum health service and
technology offerings.
Medical Costs
Medical costs increased in 2012 due to risk-based membership growth in our
public and senior markets businesses, unit cost inflation across all businesses
and continued moderate increases in health system use, partially offset by an
increase in favorable medical reserve development. Unit cost increases
represented the primary driver of our medical cost trend, with the largest
contributor being price increases to hospitals.
Operating Costs
The increases in our operating costs for 2012 were due to business growth,
including increases in revenues from UnitedHealthcare fee-based benefits and
Optum services, which carry comparatively higher operating costs, as well as
investments in the OptumRx pharmacy management services and UnitedHealthcare
Military & Veterans businesses.
Income Tax Rate
The increase in our effective income tax rate for 2012 was due to the favorable
resolution of various tax matters in 2011, which lowered the 2011 effective
income tax rate.
Reportable Segments
We have four reportable segments across our two business platforms,
UnitedHealthcare and Optum:
• UnitedHealthcare, which includes UnitedHealthcare Employer & Individual,
UnitedHealthcare Medicare & Retirement, UnitedHealthcare Community & State,
and UnitedHealthcare International;
• OptumHealth;
• OptumInsight; and
• OptumRx.
See Note 13 of Notes to the Consolidated Financial Statements included in Item
8, "Financial Statements" and Item 1, "Business" for a description of how each
of our reportable segments derives its revenues.
Transactions between reportable segments principally consist of sales of
pharmacy benefit products and services to UnitedHealthcare customers by OptumRx,
certain product offerings and care management and integrated care delivery
services sold to UnitedHealthcare by OptumHealth, and health information and
technology solutions, consulting and other services sold to UnitedHealthcare by
OptumInsight. These transactions are recorded at management's estimate of fair
value. Intersegment transactions are eliminated in consolidation.
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The following table presents reportable segment financial information:
For the Years Ended December 31, Increase/(Decrease) Increase/(Decrease)
(in millions, except
percentages) 2012 2011 2010 2012 vs. 2011 2011 vs. 2010
Revenues
UnitedHealthcare $ 103,419 $ 95,336 $ 88,730 $ 8,083 8 % $ 6,606 7 %
OptumHealth 8,147 6,704 4,565 1,443 22 2,139 47
OptumInsight 2,882 2,671 2,342 211 8 329 14
OptumRx 18,359 19,278 16,724 (919 ) (5 ) 2,554 15
Total Optum 29,388 28,653 23,631 735 3 5,022 21
Eliminations (22,189 ) (22,127 ) (18,206 ) 62 - 3,921 22
Consolidated revenues $ 110,618 $ 101,862 $ 94,155 $ 8,756 9 % $ 7,707 8 %
Earnings from operations
UnitedHealthcare $ 7,815 $ 7,203 $ 6,740 $ 612 8 % $ 463 7 %
OptumHealth 561 423 511 138 33 (88 ) (17 )
OptumInsight 485 381 84 104 27 297 354
OptumRx 393 457 529 (64 ) (14 ) (72 ) (14 )
Total Optum 1,439 1,261 1,124 178 14 137 12
Consolidated earnings
from operations $ 9,254 $ 8,464 $ 7,864 $ 790 9 % $ 600 8 %
Operating margin
UnitedHealthcare 7.6 % 7.6 % 7.6 % - % - %
OptumHealth 6.9 6.3 11.2 0.6 (4.9 )
OptumInsight 16.8 14.3 3.6 2.5 10.7
OptumRx 2.1 2.4 3.2 (0.3 ) (0.8 )
Total Optum 4.9 4.4 4.8 0.5 (0.4 )
Consolidated operating
margin 8.4 % 8.3 % 8.4 % 0.1 % (0.1 )%
UnitedHealthcare
The following table summarizes UnitedHealthcare revenue by business:
For the Years Ended December 31, Increase/(Decrease) Increase/(Decrease)
(in millions, except
percentages) 2012 2011 2010 2012 vs. 2011 2011 vs. 2010
UnitedHealthcare Employer & $ 46,596 $ 45,404 $ 42,550 $ 1,192 $ 2,854
Individual 3 % 7 %
UnitedHealthcare Medicare & 39,257 34,933 33,018 4,324 1,915
Retirement (a) 12 6
UnitedHealthcare Community & 16,422 14,954 13,123 1,468 1,831
State (a) 10 14
UnitedHealthcare International 1,144 45 39 1,099 nm 6 15
Total UnitedHealthcare revenue $ 103,419$ 95,336$ 88,730
$ 8,083 8 % $ 6,606 7 %
nm= not meaningful
(a) In the fourth quarter of 2012, UnitedHealthcare reclassified 75,000 dually
eligible enrollees to UnitedHealthcare Community & State from
UnitedHealthcare Medicare & Retirement to better reflect how these members
are served. Earlier periods presented have been conformed to reflect this
change.
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The following table summarizes the number of individuals served by our
UnitedHealthcare businesses, by major market segment and funding arrangement:
December 31, Increase/(Decrease) Increase/(Decrease)
(in thousands, except
percentages) 2012 2011 2010 2012 vs. 2011 2011 vs. 2010
Commercial risk-based 9,340 9,550 9,405 (210 ) (2 )% 145 2 %
Commercial fee-based 17,585 16,320 15,405 1,265 8 915 6
Total commercial 26,925 25,870 24,810 1,055 4 1,060 4
Medicare Advantage (a) 2,565 2,165 2,005 400 18 160 8
Medicaid (a) 3,830 3,600 3,385 230 6 215 6
Medicare Supplement
(Standardized) 3,180 2,935 2,770 245 8 165 6
Total public and senior 9,575 8,700 8,160 875 10 540 7
International 4,425 - - 4,425 nm - -
Total UnitedHealthcare -
medical 40,925 34,570 32,970 6,355 18 % 1,600 5 %
Supplemental Data:
Medicare Part D stand-alone 4,225 4,855 4,530 (630 ) (13 )% 325 7 %
nm= not meaningful
(a) Earlier periods presented above have been recast such that all periods
presented reflect the dually eligible enrollment change from Medicare
Advantage to Medicaid discussed above.
Commercial risk-based membership decreased in 2012 due to a competitive market
environment, conversions to fee-based products by large public sector clients
that we retained and other decreases in the public sector. In fee-based
commercial products, the increase was due to a number of new business awards and
strong customer retention. Medicare Advantage increased due to strengthened
execution in product design, marketing and local engagement, which drove sales
growth, combined with the addition of 185,000 Medicare Advantage members from
2012 acquisitions. Medicaid growth was due to a combination of winning new state
accounts and growth within existing state customers, partially offset by a
fourth quarter market withdrawal from one product in a specific region,
affecting 175,000 beneficiaries. Medicare Supplement growth was due to strong
retention and new sales. In our Medicare Part D stand-alone business, membership
decreased primarily as a result of the first quarter 2012 loss of approximately
470,000 auto-assigned low-income subsidy Medicare Part D beneficiaries, due to
pricing benchmarks for the government-subsidized low income Medicare Part D
market coming in below our bids in a number of regions. International represents
commercial membership in Brazil added as a result of the Amil acquisition in
2012.
UnitedHealthcare's revenue growth in 2012 was primarily due to growth in the
number of individuals served, commercial premium rate increases related to
expected increases in underlying medical cost trends and the impact of lower
premium rebates.
UnitedHealthcare's earnings from operations for 2012 increased compared to the
prior year primarily due to the factors that increased revenues combined with an
improvement in the medical care ratio driven by effective management of medical
costs and increased favorable medical reserve development. The favorable
development for 2012 was driven by lower than expected health system utilization
levels and increased efficiency in claims handling and processing.
In March 2012, UnitedHealthcare Military & Veterans was awarded the TRICARE West
Region Managed Care Support Contract. The contract, for health care operations,
includes a transition period and five one-year renewals at the government's
option. The first year of operations is anticipated to begin April 1, 2013. The
base administrative services contract is expected to generate a total of $1.4
billion in revenues over the five years.
Optum. Total revenues increased in 2012 due to business growth and 2011
acquisitions at OptumHealth, partially offset by a reduction in pharmacy service
revenues related to reduced levels of UnitedHealthcare Part D prescription drug
membership and related prescription volumes.
Optum's earnings from operations and operating margin for 2012 increased
compared to 2011 due to improvements in operating cost structure stemming from
advances in business simplification, integration and overall efficiency and
revenue growth in higher margin products.
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The results by segment were as follows:
OptumHealth
Revenue increases at OptumHealth for 2012 were primarily due to market
expansion, including growth related to 2011 acquisitions in integrated care
delivery, and strong overall business growth.
Earnings from operations for 2012 and operating margins increased compared to
2011 primarily due to gains in operating efficiency and cost management as well
as increases in earnings from integrated care operations.
OptumInsight
Revenues at OptumInsight for 2012 increased primarily due to the impact of
growth in compliance services for care providers and payment integrity offerings
for commercial payers, which was partially offset by the June 2011 divestiture
of the clinical trials services business.
The increases in earnings from operations and operating margins for 2012 reflect
an improved mix of services and advances in operating efficiency and cost
management.
OptumRx
The decreases in OptumRx revenues in 2012 were due to the reduction in
UnitedHealthcare Medicare Part D plan participants. Intersegment revenues
eliminated in consolidation were $15.6 billion for 2012 and $16.7 billion for
2011.
OptumRx earnings from operations and operating margins for 2012 decreased
primarily due to decreased prescription volume in the Medicare Part D business
and investments to support growth initiatives, which were partially offset by
earnings contributions from specialty pharmacy growth and greater use of generic
medications.
Over the course of 2013, we will consolidate and manage our commercial pharmacy
benefit programs from Express Scripts' subsidiary, Medco Health Solutions, Inc.
As a result of this transition, OptumRx expects to add approximately12 million
members throughout 2013.
2011 RESULTS OF OPERATIONS COMPARED TO 2010 RESULTS
Consolidated Financial Results
Revenues
The increases in revenues for 2011 were driven by strong organic growth in the
number of individuals served in our UnitedHealthcare businesses, commercial
premium rate increases reflecting underlying medical cost trends and revenue
growth across all Optum businesses.
Medical Costs
Medical costs for 2011 increased due to risk-based membership growth in our
commercial and public and senior markets businesses and continued increases in
the cost per service paid for health system use, and a modest increase in health
system utilization, mainly in outpatient and physician office settings.
For each period, our operating results include the effects of revisions in
medical cost estimates related to prior periods. Changes in medical cost
estimates related to prior periods, resulting from more complete claim
information identified in the current period, are included in total medical
costs reported for the current period. For 2011 and 2010 there was $720 million
and $800 million, respectively, of net favorable medical cost development
related to prior fiscal years. The favorable development in both periods was
primarily driven by continued improvements in claims submission timeliness,
which resulted in higher completion factors and lower than expected health
system utilization levels. The favorable development in 2010 also benefited from
a reduction in reserves needed for disputed claims from care providers; and
favorable resolution of certain state-based assessments.
Operating Costs
The increase in our operating costs for 2011 was due to business growth,
including an increased mix of Optum and UnitedHealthcare fee-based and service
revenues, which have higher operating costs, and increased spending related to
reform readiness and compliance. These factors were partially offset by overall
operating cost management and the increase in 2010 operating costs due to the
goodwill impairment and charges for a business line disposition of certain
i3-branded clinical trial service businesses.
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Income Tax Rate
The effective income tax rate for 2011 decreased compared to the prior year due
to favorable resolution of various historical tax matters in the current year as
well as a higher effective income tax rate in 2010, due to the cumulative
implementation of certain changes under the Health Reform Legislation.
Reportable Segments
UnitedHealthcare
UnitedHealthcare's revenue growth for 2011 was due to growth in the number of
individuals served across our businesses and commercial premium rate increases
reflecting expected underlying medical cost trends.
UnitedHealthcare's earnings from operations for 2011 increased compared to the
prior year as revenue growth and improvements in the operating cost ratio more
than offset increased compliance costs and an increase to the medical care
ratio, which was primarily due to the initiation of premium rebate obligations
in 2011, and lower favorable reserve development levels.
Optum. Total revenue for these businesses increased in 2011 due to business
growth and acquisitions at OptumHealth and OptumInsight and growth in customers
served through pharmaceutical benefit management programs at OptumRx.
Optum's operating margin for 2011 was down compared to 2010. The decrease was
due to changes in business mix within Optum's businesses and realignment of
certain internal business arrangements.
The results by segment were as follows:
OptumHealth
Increased revenues at OptumHealth for 2011 were primarily due to expansions in
service offerings through acquisitions in clinical services, as well as growth
in consumer and population health management offerings.
Earnings from operations for 2011 and operating margin decreased compared to
2010. The decreases reflect the impact from internal business and service
arrangement realignments and the mix effect of growth and expansion in newer
businesses such as clinical services.
OptumInsight
Increased revenues at OptumInsight for 2011 were due to the impact of organic
growth and the full-year impact of 2010 acquisitions, which were partially
offset by the divestiture of the clinical trials services business in June 2011.
The increases in earnings from operations and operating margins for 2011 reflect
an increased mix of higher margin services in 2011 as well as the effect on 2010
earnings from operations and operating margin of the goodwill impairment and
charges for a business line disposition of certain i3-branded clinical trial
service businesses.
OptumRx
The increase in OptumRx revenues for 2011 was due to increased prescription
volumes, primarily due to growth in customers served through Medicare Part D
prescription drug plans by our UnitedHealthcare Medicare & Retirement business,
and a favorable mix of higher revenue specialty drug prescriptions. Intersegment
revenues eliminated in consolidation were $16.7 billion and $14.4 billion for
2011 and 2010, respectively.
OptumRx earnings from operations and operating margins for 2011 decreased as the
mix of lower margin specialty pharmaceuticals and Medicaid business and
investments to support growth initiatives including the in-sourcing of our
commercial pharmacy benefit programs more than offset the earnings contribution
from higher revenues and greater use of generic medications.
LIQUIDITY, FINANCIAL CONDITION AND CAPITAL RESOURCES
Liquidity
Introduction
We manage our liquidity and financial position in the context of our overall
business strategy. We continually forecast and manage our cash, investments,
working capital balances and capital structure to meet the short- and long-term
obligations of our businesses while seeking to maintain liquidity and financial
flexibility. Cash flows generated from operating activities are principally from
earnings before non-cash expenses.
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Our regulated subsidiaries generate significant cash flows from operations and
are subject to financial regulations and standards in their respective
jurisdictions. These standards, among other things, require these subsidiaries
to maintain specified levels of statutory capital, as defined by each
jurisdiction, and restrict the timing and amount of dividends and other
distributions that may be paid to their parent companies. In the United States,
most of these regulations and standards are generally consistent with model
regulations established by the NAIC. Except in the case of extraordinary
dividends, these standards generally permit dividends to be paid from statutory
unassigned surplus of the regulated subsidiary and are limited based on the
regulated subsidiary's level of statutory net income and statutory capital and
surplus. These dividends are referred to as "ordinary dividends" and generally
can be paid without prior regulatory approval. If the dividend, together with
other dividends paid within the preceding twelve months, exceeds a specified
statutory limit or is paid from sources other than earned surplus, the entire
dividend is generally considered an "extraordinary dividend" and must receive
prior regulatory approval. In 2012, based on the 2011 statutory net income and
statutory capital and surplus levels, the maximum amount of ordinary dividends
which could be paid by our U.S. regulated subsidiaries to their parent companies
was $4.6 billion.
In 2012, our regulated subsidiaries paid their parent companies dividends of
$4.9 billion, including $1.2 billion of extraordinary dividends. In 2011, our
regulated subsidiaries paid their parent companies dividends of $4.5 billion,
including $1.1 billion of extraordinary dividends.
Our non-regulated businesses also generate cash flows from operations for
general corporate use. Cash flows generated by these entities, combined with
dividends from our regulated entities and financing through the issuance of long
term debt as well as issuance of commercial paper or drawings under our
committed credit facility, further strengthen our operating and financial
flexibility. We use these cash flows to expand our businesses through
acquisitions, reinvest in our businesses through capital expenditures, repay
debt, and return capital to our shareholders through shareholder dividends
and/or repurchases of our common stock, depending on market conditions.
Summary of our Major Sources and Uses of Cash
For the Years Ended December 31, Increase/(Decrease) Increase/(Decrease)
(in millions) 2012 2011 2010 2012 vs. 2011 2011 vs. 2010
Sources of cash:
Cash provided by operating activities $ 7,155$ 6,968$ 6,273 $
187 $ 695
Proceeds from issuances of long-term
debt and commercial paper, net of
repayments 4,567 346 94 4,221 252
Proceeds from common stock issuances 1,078 381 272 697 109
Net proceeds from customer funds
administered - 37 974 (37 ) (937 )
Other - 391 20 (391 ) 371
Total sources of cash 12,800 8,123 7,633
Uses of cash:
Cash paid for acquisitions, net of cash
assumed and dispositions (6,280 ) (1,459 ) (2,304 ) (4,821 ) 845
Common stock repurchases (3,084 ) (2,994 ) (2,517 ) (90 ) (477 )
Purchases of investments, net of sales
and maturities (1,299 ) (1,695 ) (2,157 ) 396 462
Purchases of property, equipment and
capitalized software, net of
dispositions (1,070 ) (1,018 ) (878 ) (52 ) (140 )
Cash dividends paid (820 ) (651 ) (449 ) (169 ) (202 )
Net cash paid for customer funds
administered (324 ) - - (324 ) -
Acquisition of noncontrolling interest
shares (319 ) - - (319 ) -
Other (627 ) - (5 ) (627 ) 5
Total uses of cash (13,823 ) (7,817 ) (8,310 )
Net (decrease) increase in cash $ (1,023 ) $ 306 $ (677 ) $ (1,329 ) $ 983
2012 Cash Flows Compared to 2011 Cash Flows
Cash flows from operating activities for 2012 increased $187 million, or 3% from
2011 due to increased net income and related tax accruals, which were partially
offset by the payment in 2012 of 2011 premium rebate obligations as 2012 was the
first year rebate payments were made under the Health Reform Legislation.
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Cash flows used for investing activities increased $4.5 billion, or 107%,
primarily due to increased investments in acquisitions in 2012. See Note 6 of
Notes to the Consolidated Financial Statements included in Item 8, "Financial
Statements" for further information on 2012 acquisitions.
Cash flows from financing activities increased $3.0 billion primarily due to
increases in long-term debt, commercial paper and common stock issuances,
partially offset by increases in cash paid for customer funds related to Part D
and increased shareholder dividend payments. The increases in long-term debt,
commercial paper and common stock issuances were primarily related to the Amil
acquisition.
2011 Cash Flows Compared to 2010 Cash Flows
Cash flows from operating activities increased $695 million, or 11%, from 2010.
The increase was primarily driven by growth in net earnings and changes in
various working capital accounts, which were partially offset by a reduction in
unearned revenues due to the early receipt of certain 2011 state Medicaid
premium payments in 2010, which increased 2010 cash from operating activities.
Cash flows used for investing activities decreased $1.2 billion, or 22%,
primarily due to relatively lower investments in acquisitions in 2011 and a
decrease in net purchases of investments.
Cash flows used for financing activities increased $879 million, or 55%,
primarily due to increased share repurchases and cash dividends in 2011,
partially offset by an increase in net borrowings.
Financial Condition
As of December 31, 2012, our cash, cash equivalent and available-for-sale
investment balances of $28.3 billion included $8.4 billion of cash and cash
equivalents (of which $1.1 billion was held by non-regulated entities),
$19.2 billion of debt securities and $677 million of investments in equity
securities and venture capital funds. Given the significant portion of our
portfolio held in cash equivalents, we do not anticipate fluctuations in the
aggregate fair value of our financial assets to have a material impact on our
liquidity or capital position. The use of different market assumptions or
valuation methodologies, especially those used in valuing our $241 million of
available-for-sale Level 3 securities (those securities priced using significant
unobservable inputs), may have an effect on the estimated fair value amounts of
our investments. Due to the subjective nature of these assumptions, the
estimates may not be indicative of the actual exit price if we had sold the
investment at the measurement date. Other sources of liquidity, primarily from
operating cash flows and our commercial paper program, which is supported by our
bank credit facilities, reduce the need to sell investments during adverse
market conditions. See Note 4 of Notes to the Consolidated Financial Statements
included in Item 8, "Financial Statements" for further detail of our fair value
measurements.
Our cash equivalent and investment portfolio had a weighted-average duration of
2.1 years and a weighted-average credit rating of "AA" as of December 31, 2012.
Included in the debt securities balance was $1.9 billion of state and municipal
obligations that are guaranteed by a number of third parties. Due to the high
underlying credit ratings of the issuers, the weighted-average credit rating of
these securities with and without the guarantee was "AA" as of December 31,
2012. We do not have any significant exposure to any single guarantor (neither
indirect through the guarantees, nor direct through investment in the
guarantor). When multiple credit ratings are available for an individual
security, the average of the available ratings is used to determine the
weighted-average credit rating.
Capital Resources and Uses of Liquidity
In addition to cash flow from operations and cash and cash equivalent balances
available for general corporate use, our capital resources and uses of liquidity
are as follows:
Commercial Paper. We maintain a commercial paper borrowing program, which
facilitates the private placement of unsecured debt through third-party
broker-dealers. The commercial paper program is supported by the bank credit
facilities described below. As of December 31, 2012, we had $1.6 billion of
commercial paper outstanding at a weighted-average annual interest rate of 0.3%.
Bank Credit Facilities. We have $3.0 billion five-year and $1.0 billion 364-day
revolving bank credit facilities with 21 banks, which mature in November 2017
and November 2013, respectively. These facilities provide liquidity support for
our $4.0 billion commercial paper program and are available for general
corporate purposes. There were no amounts outstanding under these facilities as
of December 31, 2012. The interest rates on borrowings are variable depending on
term and are calculated based on the LIBOR plus a credit spread based on our
senior unsecured credit ratings. As of December 31, 2012, the annual interest
rates on these facilities, had they been drawn, would have ranged from 1.0% to
1.3%.
Our bank credit facilities contain various covenants, including requiring us to
maintain a debt to debt-plus-equity ratio of not more than 50%. Our debt to
debt-plus-equity ratio, calculated as the sum of debt divided by the sum of debt
and shareholders'
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equity, which reasonably approximates the actual covenant ratio, was 35.0% as of
December 31, 2012. We were in compliance with our debt covenants as
of December 31, 2012.
Long-term debt. Periodically, we access capital markets and issue long-term debt
for general corporate purposes, for example, to meet our working capital
requirements, to refinance debt, to finance acquisitions or for share
repurchases.
In connection with the Amil acquisition, we assumed variable rate debt
denominated in Brazilian Reais, Amil's functional currency. The total Brazilian
Real denominated long-term debt outstanding at December 31, 2012 was $611
million, and had an aggregate weighted average interest rate of approximately
9%. For more detail on the Amil debt see Note 8 of Notes to the Consolidated
Financial Statements included in Item 8, "Financial Statements."
In October 2012, we issued $2.5 billion in senior unsecured notes, which
included: $625 million of 0.850% fixed-rate notes due October 2015, $625 million
of 1.400% fixed-rate notes due October 2017, $625 million of 2.750% fixed-rate
notes due February 2023 and $625 million of 3.950% fixed-rate notes due October
2042.
In August 2012, we completed an exchange of $1.1 billion of our zero coupon
senior unsecured notes due November 2022 for $0.5 billion additional issuance of
our 2.875% notes due in March 2022, $0.1 billion additional issuance of our
4.375% notes due March 2042 and $0.1 billion in cash. The transaction was
undertaken to increase financial flexibility and reduce interest expense.
In March 2012, we issued $1.0 billion in senior unsecured notes. The issuance
included $600 million of 2.875% fixed-rate notes due March 2022 and $400 million
of 4.375% fixed-rate notes due March 2042.
Credit Ratings. Our credit ratings at December 31, 2012 were as follows:
Moody's Standard & Poor's Fitch A.M. Best
Ratings Outlook Ratings Outlook Ratings Outlook Ratings Outlook
Senior unsecured debt A3 Negative A Stable A- Stable bbb+ Stable
Commercial paper P-2 n/a A-1 n/a F1 n/a AMB-2 n/a
The availability of financing in the form of debt or equity is influenced by
many factors, including our profitability, operating cash flows, debt levels,
credit ratings, debt covenants and other contractual restrictions, regulatory
requirements and economic and market conditions. For example, a significant
downgrade in our credit ratings or conditions in the capital markets may
increase the cost of borrowing for us or limit our access to capital. We have
adopted strategies and actions toward maintaining financial flexibility to
mitigate the impact of such factors on our ability to raise capital.
Share Repurchase Program. Under our Board of Directors' authorization, we
maintain a share repurchase program. Repurchases may be made from time to time
in open market purchases or other types of transactions (including prepaid or
structured share repurchase programs), subject to certain Board restrictions. In
June 2012, our Board renewed and expanded our share repurchase program with an
authorization to repurchase up to 110 million shares of our common stock. As of
December 31, 2012, we had Board authorization to purchase up to an additional 85
million shares of our common stock. For details of our 2012 share repurchases,
see Note 10 of Notes to the Consolidated Financial Statements included in Item
8, "Financial Statements."
Dividends. In June 2012, our Board of Directors increased our cash dividend to
shareholders to an annual dividend rate of $0.85 per share, paid quarterly.
Since May 2011, we had paid an annual dividend of $0.65 per share, paid
quarterly. Declaration and payment of future quarterly dividends is at the
discretion of the Board and may be adjusted as business needs or market
conditions change. For details of our dividend payments, see Note 10 of Notes to
the Consolidated Financial Statements included in Item 8, "Financial
Statements."
Amil Tender Offer. During the fourth quarter of 2012, we purchased approximately
65% of the outstanding shares of Amil for $3.5 billion. We expect to acquire an
additional 25% ownership interest during the first half of 2013 through a tender
offer for Amil's publicly traded shares. The tender offer price will be at the
same price paid to Amil's controlling shareholders, adjusted for statutory
interest under Brazilian law from the date of payment to the controlling
shareholders to the date of payment to the tendering minority shareholders.
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CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table summarizes future obligations due by period as of
December 31, 2012, under our various contractual obligations and commitments:
(in millions) 2013 2014 to 2015 2016 to 2017 Thereafter Total
Debt (a) $ 3,413 $ 3,271 $ 3,384 $ 16,769 $ 26,837
Operating leases 380 676 510 556 2,122
Purchase obligations (b) 137 184 7 - 328
Future policy benefits (c) 135 256 265 1,923 2,579
Unrecognized tax benefits
(d) 11 - - 60 71
Other liabilities recorded
on the Consolidated Balance
Sheet (e) 89 18 6 1,511 1,624
Other obligations (f) 50 144 60 43 297
Redeemable noncontrolling
interests (g) 1,393 182 546 - 2,121
Total contractual
obligations $ 5,608 $ 4,731 $ 4,778 $ 20,862 $ 35,979
(a) Includes interest coupon payments and maturities at par or put values. For
variable rate debt, the rates in effect at December 31, 2012 were used to
calculate the interest coupon payments. The table also assumes amounts are
outstanding through their contractual term. See Note 8 of Notes to the
Consolidated Financial Statements included in Item 8, "Financial Statements"
for more detail.
(b) Includes fixed or minimum commitments under existing purchase obligations
for goods and services, including agreements that are cancelable with the
payment of an early termination penalty. Excludes agreements that are
cancelable without penalty and excludes liabilities to the extent recorded
in our Consolidated Balance Sheets as of December 31, 2012.
(c) Future policy benefits represent account balances that accrue to the benefit
of the policyholders, excluding surrender charges, for universal life and
investment annuity products and for long-duration health policies sold to individuals for which some of the premium received in the earlier years is
intended to pay benefits to be incurred in future years. See Note 2 of Notes
to the Consolidated Financial Statements included in Item 8, "Financial
Statements" for more detail.
(d) As the timing of future settlements is uncertain, the long-term portion has
been classified as "Thereafter."
(e) Includes obligations associated with contingent consideration and other
payments related to business acquisitions, certain employee benefit
programs, charitable contributions related to the PacifiCare acquisition and
various other long-term liabilities. Due to uncertainty regarding payment
timing, obligations for employee benefit programs, charitable contributions
and other liabilities have been classified as "Thereafter."
(f) Includes remaining capital commitments for venture capital funds and other
funding commitments.
(g) Includes commitments to purchase the remaining publicly traded Amil shares
as well as the put/call for the shares owned by Amil's remaining non-public
shareholders. See Note 6 of Notes to the Consolidated Financial Statements
included in Item 8, "Financial Statements" for more detail.
We do not have other significant contractual obligations or commitments that
require cash resources; however, we continually evaluate opportunities to expand
our operations. This includes internal development of new products, programs and
technology applications, and may include acquisitions.
OFF-BALANCE SHEET ARRANGEMENTS
As of December 31, 2012, we were not involved in any off-balance sheet
arrangements (as that phrase is defined by SEC rules applicable to this report)
which have or are reasonably likely to have a material adverse effect on our
financial condition, results of operations or liquidity.
RECENTLY ISSUED ACCOUNTING STANDARDS
We have determined that there have been no recently issued, but not yet adopted,
accounting standards that will have a material impact on our Consolidated
Financial Statements.
CRITICAL ACCOUNTING ESTIMATES
Critical accounting estimates are those estimates that require management to
make challenging, subjective or complex judgments, often because they must
estimate the effects of matters that are inherently uncertain and may change in
subsequent
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periods. Critical accounting estimates involve judgments and uncertainties that
are sufficiently sensitive and may result in materially different results under
different assumptions and conditions.
Medical Costs Payable
Each reporting period, we estimate our obligations for medical care services
that have been rendered on behalf of insured consumers but for which claims have
either not yet been received or processed and for liabilities for physician,
hospital and other medical cost disputes. We develop estimates for medical care
services incurred but not reported using an actuarial process that is
consistently applied, centrally controlled and automated. The actuarial models
consider factors such as time from date of service to claim receipt, claim
processing backlogs, seasonal variances in medical care consumption, health care
professional contract rate changes, medical care utilization and other medical
cost trends, membership volume and demographics, the introduction of new
technologies, benefit plan changes, and business mix changes related to
products, customers and geography. Depending on the health care professional and
type of service, the typical billing lag for services can be up to 90 days from
the date of service. Substantially all claims related to medical care services
are known and settled within nine to twelve months from the date of service. As
of December 31, 2012, our days outstanding in medical payables was 49 days.
Each period, we re-examine previously established medical costs payable
estimates based on actual claim submissions and other changes in facts and
circumstances. As more complete claim information becomes available, we adjust
the amount of the estimates and include the changes in estimates in medical
costs in the period in which the change is identified. In every reporting
period, our operating results include the effects of more completely developed
medical costs payable estimates associated with previously reported periods. If
the revised estimate of prior period medical costs is less than the previous
estimate, we will decrease reported medical costs in the current period
(favorable development). If the revised estimate of prior period medical costs
is more than the previous estimate, we will increase reported medical costs in
the current period (unfavorable development). Medical costs in 2012, 2011, and
2010 included favorable medical cost development related to prior years of $860
million, $720 million and $800 million, respectively.
In developing our medical costs payable estimates, we apply different estimation
methods depending on the month for which incurred claims are being estimated.
For example, we actuarially calculate completion factors using an analysis of
claim adjudication patterns over the most recent 36-month period. A completion
factor is an actuarial estimate, based upon historical experience and analysis
of current trends, of the percentage of incurred claims during a given period
that have been adjudicated by us at the date of estimation. For months prior to
the most recent three months, we apply the completion factors to actual claims
adjudicated-to-date to estimate the expected amount of ultimate incurred claims
for those months. For the most recent three months, we estimate claim costs
incurred primarily by applying observed medical cost trend factors to the
average per member per month (PMPM) medical costs incurred in prior months for
which more complete claim data is available, supplemented by a review of
near-term completion factors. This approach is consistently applied from period
to period.
Completion Factors. Completion factors are the most significant factors we use
in developing our medical costs payable estimates for older periods, generally
periods prior to the most recent three months. The completion factor includes
judgments in relation to claim submissions such as the time from date of service
to claim receipt, claim inventory levels and claim processing backlogs as well
as other factors. If actual claims submission rates from providers (which can be
influenced by a number of factors including provider mix and electronic versus
manual submissions) or our claim processing patterns are different than
estimated, our reserves may be significantly impacted.
The following table illustrates the sensitivity of these factors and the
estimated potential impact on our medical costs payable estimates for those
periods as of December 31, 2012:
Completion Factors Increase (Decrease)
Increase (Decrease) in Factors In Medical Costs Payable
(in millions)
(0.75)% $ 261
(0.50) 173
(0.25) 87
0.25 (86 )
0.50 (172 )
0.75 (257 )
Medical cost PMPM trend factors. Medical cost PMPM trend factors are significant
factors we use in developing our medical costs payable estimates for the most
recent three months. Medical cost trend factors are developed through a
comprehensive analysis of claims incurred in prior months, provider contracting
and expected unit costs, benefit design, and by reviewing a
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broad set of health care utilization indicators including, but not limited to,
pharmacy utilization trends, inpatient hospital census data and incidence data
from the National Centers for Disease Control. We also consider macroeconomic
variables such as gross-domestic product growth, employment and disposable
income. A large number of factors can cause the medical cost trend to vary from
our estimates including: our ability and practices to manage medical costs,
changes in level and mix of services utilized, mix of benefits offered including
the impact of co-pays and deductibles, changes in medical practices,
catastrophes and epidemics.
The following table illustrates the sensitivity of these factors and the
estimated potential impact on our medical costs payable estimates for the most
recent three months as of December 31, 2012:
Medical Costs PMPM Trend Increase (Decrease)
Increase (Decrease) in Factors In Medical Costs Payable
(in millions)
3% $ 505
2 337
1 168
(1) (168 )
(2) (337 )
(3) (505 )
The analyses above include outcomes that are considered reasonably likely based
on our historical experience estimating liabilities for incurred but not
reported benefit claims.
Our estimate of medical costs payable represents management's best estimate of
our liability for unpaid medical costs as of December 31, 2012, developed using
consistently applied actuarial methods. Management believes the amount of
medical costs payable is reasonable and adequate to cover our liability for
unpaid claims as of December 31, 2012; however, actual claim payments may differ
from established estimates as discussed above. Assuming a hypothetical 1%
difference between our December 31, 2012 estimates of medical costs payable and
actual medical costs payable, excluding AARP Medicare Supplement Insurance and
any potential offsetting impact from premium rebates, 2012 net earnings would
have increased or decreased by $62 million.
Revenues
Revenues are principally derived from health care insurance premiums. We
recognize premium revenues in the period eligible individuals are entitled to
receive health care services. Customers are typically billed monthly at a
contracted rate per eligible person multiplied by the total number of people
eligible to receive services, as recorded in our records.
Effective in 2011, U.S. commercial health plans with medical loss ratios on
fully insured products, as calculated under the definitions in the Health Reform
Legislation, that fall below certain targets are required to rebate ratable
portions of their premiums to their customers annually. Premium revenues are
recognized based on the estimated premiums earned net of projected rebates
because we are able to reasonably estimate the ultimate premiums of these
contracts. Each period, we estimate premium rebates based on the expected
financial performance of the applicable contracts within each defined
aggregation set (e.g., by state, group size and licensed subsidiary). The most
significant factors in estimating the financial performance are current and
future premiums and medical claim experience, effective tax rates and expected
changes in business mix. The estimated ultimate premium is revised each period
to reflect current and projected experience.
Our Medicare Advantage and Part D premium revenues are subject to periodic
adjustment under CMS' risk adjustment payment methodology. The CMS risk
adjustment model provides higher per member payments for enrollees diagnosed
with certain conditions and lower payments for enrollees who are healthier. We
and health care providers collect, capture, and submit available diagnosis data
to CMS within prescribed deadlines. CMS uses submitted diagnosis codes,
demographic information, and special statuses to determine the risk score for
most Medicare Advantage beneficiaries. CMS also retroactively adjusts risk
scores during the year based on additional data. We estimate risk adjustment
revenues based upon the data submitted and expected to be submitted to CMS. As a
result of the variability of factors that determine such estimations, the actual
amount of CMS' retroactive payments could be materially more or less than our
estimates. This may result in favorable or unfavorable adjustments to our
Medicare premium revenue and, accordingly, our profitability. Risk adjustment
data for certain of our plans is subject to review by the government, including
audit by regulators. See Note 12 of Notes to the Consolidated Financial
Statements included in Item 8, "Financial Statements" for additional information
regarding these audits.
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Goodwill and Intangible Assets
Goodwill. Goodwill represents the amount of the purchase price in excess of the
fair values assigned to the underlying identifiable net assets of acquired
businesses. Goodwill is not amortized, but is subject to an annual impairment
test. Tests are performed more frequently if events occur or circumstances
change that would more likely than not reduce the fair value of the reporting
unit below its carrying amount.
To determine whether goodwill is impaired, we perform a multi-step impairment
test. First, we can elect to perform a qualitative assessment of each reporting
unit to determine whether facts and circumstances support a determination that
their fair values are greater than their carrying values. If the qualitative
analysis is not conclusive, or if we elect to proceed directly with quantitative
testing, we will then measure the fair values of the reporting units and compare
them to their aggregate carrying values, including goodwill. If the fair value
is less than the carrying value of the reporting unit, then the implied value of
goodwill would be calculated and compared to the carrying amount of goodwill to
determine whether goodwill is impaired.
We estimate the fair values of our reporting units using discounted cash flows,
which include assumptions about a wide variety of internal and external factors.
Significant assumptions used in the impairment analysis include financial
projections of free cash flow (including significant assumptions about
operations, capital requirements and income taxes), long-term growth rates for
determining terminal value beyond the discretely forecasted periods, and
discount rates. For each reporting unit, comparative market multiples are used
to corroborate the results of our discounted cash flow test.
Forecasts and long-term growth rates used for our reporting units are consistent
with, and use inputs from, our internal long-term business plan and strategy.
Key assumptions used in these forecasts include:
• Revenue trends. Key drivers for each reporting unit are determined and
assessed. Significant factors include: membership growth, medical trends,
and the impact and expectations of regulatory environments. Additional
macro-economic assumptions around unemployment, GDP growth, interest rates,
and inflation are also evaluated and incorporated.
• Medical cost trends. See further discussion of medical costs trends within
Medical Costs above. Similar factors are considered in estimating our
long-term medical trends at the reporting unit level.
• Operating productivity. We forecast expected operating cost levels based on
historical levels and expectations of future operating cost productivity
initiatives.
• Capital levels. The capital structure and requirements for each business is
considered.
Although we believe that the financial projections used are reasonable and
appropriate for all of our reporting units, due to the long-term nature of the
forecasts there is significant uncertainty inherent in those projections. That
uncertainty is increased by the impact of health care reforms as discussed in
Item 1, "Business - Government Regulation". For additional discussions regarding
how the enactment or implementation of health care reforms and how other factors
could affect our business and the related long-term forecasts, see Item 1A,
"Risk Factors" in Part I and "Regulatory Trends and Uncertainties" above.
Discount rates are determined for each reporting unit and include consideration
of the implied risk inherent in their forecasts. This risk is evaluated using
comparisons to market information such as peer company weighted average costs of
capital and peer company stock prices in the form of revenue and earnings
multiples. Beyond our selection of the most appropriate risk-free rates and
equity risk premiums, our most significant estimates in the discount rate
determinations involve our adjustments to the peer company weighted average
costs of capital that reflect reporting unit-specific factors. Such adjustments
include the addition of size premiums and company-specific risk premiums
intended to compensate for apparent forecast risk. We have not made any
adjustments to decrease a discount rate below the calculated peer company
weighted average cost of capital for any reporting unit. Company-specific
adjustments to discount rates are subjective and thus are difficult to measure
with certainty.
The passage of time and the availability of additional information regarding
areas of uncertainty in regards to the reporting units' operations could cause
these assumptions to change in the future.
We elected to bypass the optional qualitative reporting unit fair value
assessment and completed our annual quantitative tests for goodwill impairment
as of January 1, 2013. All of our reporting units had fair values substantially
in excess of their carrying values, thus we concluded that there was no need for
any impairment of our goodwill balances as of December 31, 2012.
Intangible assets. Separately-identifiable intangible assets are acquired in
business combinations and are assets that represent future expected benefits but
lack physical substance (e.g., membership lists, customer contracts, trademarks
and technology). Our intangible assets are initially recorded at their fair
values. Finite-lived intangible assets are amortized over their expected useful
lives, while indefinite-lived intangible assets are evaluated for impairment on
at least an annual basis. Both finite-lived and indefinite-lived intangible
assets are evaluated for impairment between annual periods if an event occurs or
circumstances change that may indicate impairment. Our most significant
intangible assets are customer-related intangibles, which represent 77% of our
total intangible asset balance of $4.7 billion.
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Customer-related intangible assets acquired in business combinations are
typically valued using an income approach based on discounted future cash flows
attributable to customers that exist as of the date of acquisition. The most
significant assumptions used in the valuation of customer-related assets
include: projected revenue and earnings growth, retention rate, perpetuity
growth rate and discount rate. These initial valuations and the embedded
assumptions contain uncertainty to the extent that those assumptions and
estimates may ultimately differ from actual results (e.g., customer turnover may
be higher or lower than the assumed retention rate suggested).
Our finite-lived intangible assets are subject to impairment tests when events
or circumstances indicate that an asset's (or asset group's) carrying value may
exceed its estimated fair value. Consideration is given on a quarterly basis to
a number of potential impairment indicators including: changes in the use of the
assets, changes in legal or other business factors that could affect value,
experienced or expected operating cash-flow deterioration or losses, adverse
changes in customer populations, adverse competitive or technological advances
that could impact value, and other factors. Following the identification of any
potential impairment indicators, we would calculate the estimated fair value of
a finite-lived intangible asset (or asset group) using the undiscounted cash
flows that are expected to result from the use of the asset or related group of
assets. If it is determined that an impairment exists, the amount by which the
carrying value exceeds its estimated fair value would be recorded as an
impairment.
Our indefinite-lived intangible assets are tested for impairment on an annual
basis, or more frequently if impairment indicators exist. To determine if an
indefinite-lived intangible asset is impaired, we assess qualitative factors to
determine whether the existence of events and circumstances indicate that it is
more likely than not that the indefinite-lived intangible asset's carrying value
exceeds its fair value. If, after assessing the totality of events and
circumstances, we conclude that it is not more likely than not that the
indefinite-lived intangible asset's carrying value exceeds its fair value, no
impairment exists and no further testing is performed. If we conclude otherwise,
we would perform a quantitative analysis by comparing its estimated fair value
to its carrying value. If the carrying value exceeds its estimated fair value,
an impairment would be recorded for the amount by which the carrying value
exceeds its estimated fair value.
Intangible assets were not impaired in 2012.
Investments
As of December 31, 2012, we had investments with a carrying value of $21
billion, primarily held in marketable debt securities. Our investments are
principally classified as available-for-sale and are recorded at fair value. We
exclude gross unrealized gains and losses on available-for-sale investments from
earnings and report net unrealized gains or losses, net of income tax effects,
as a separate component in shareholders' equity. We continually monitor the
difference between the cost and fair value of our investments. As of
December 31, 2012, our investments had gross unrealized gains of $825 million
and gross unrealized losses of $9 million.
For debt securities, if we intend to either sell or determine that we will be
more likely than not be required to sell the security before recovery of the
entire amortized cost basis or maturity of the security, we recognize the entire
impairment in earnings. If we do not intend to sell the debt security and we
determine that we will not be more likely than not be required to sell the debt
security but we do not expect to recover the entire amortized cost basis, the
impairment is bifurcated into the amount attributed to the credit loss, which is
recognized in earnings, and all other causes, which are recognized in other
comprehensive income.
For equity securities, we recognize impairments in other comprehensive income if
we expect to hold the equity security until fair value increases to at least the
equity security's cost basis and we expect that increase in fair value to occur
in a reasonably forecasted period. If we intend to sell the equity security or
if we believe that recovery of fair value to cost will not occur in the near
term, we recognize the impairment in our income statement.
The most significant judgments and estimates related to investments are related
to determination of their fair values and the other-than-temporary impairment
assessment.
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Fair values. Fair values of available-for-sale debt and equity securities are
based on quoted market prices, where available. We obtain one price for each
security primarily from a third-party pricing service (pricing service), which
generally uses quoted or other observable inputs for the determination of fair
value. The pricing service normally derives the security prices through recently
reported trades for identical or similar securities, making adjustments through
the reporting date based upon available observable market information. For
securities not actively traded, the pricing service may use quoted market prices
of comparable instruments or discounted cash flow analyses, incorporating inputs
that are currently observable in the markets for similar securities. Inputs that
are often used in the valuation methodologies include, but are not limited to,
benchmark yields, credit spreads, default rates and prepayment speeds, and
non-binding broker quotes. As we are responsible for the determination of fair
value, we perform quarterly analyses on the prices received from the pricing
service to determine whether the prices are reasonable estimates of fair value.
Specifically, we compare:
• the prices received from the pricing service to prices reported by a
secondary pricing service, its custodian, its investment consultant and/or
third-party investment advisors; and
• changes in the reported market values and returns to relevant market indices
and our expectations to test the reasonableness of the reported prices.
Based on our internal price verification procedures and our review of the fair
value methodology documentation provided by independent pricing service, we have
not historically adjusted the prices obtained from the pricing service.
Other-than-temporary impairment assessment. Individual securities with fair
values lower than costs are reviewed for impairment considering the following
factors: our intent to sell the security or the likelihood that we will be
required to sell the security before recovery of the entire amortized cost, the
length of time and extent of impairment and the financial condition and
near-term prospects of the issuer as well as specific events or circumstances
that may influence the operations of the issuer. Other factors included in the
assessment include the type and nature of the securities and liquidity. Given
the nature of our portfolio, primarily investment grade securities, historical
impairments were largely market related (e.g., interest rate fluctuations, etc.)
as opposed to credit related. We do not expect that trend to change in the near
term. Our large cash holdings reduce the risk that we will be required to sell a
security. However, our intent to sell a security may change from period to
period if facts and circumstances change.
We believe we will collect the principal and interest due on our debt securities
with an amortized cost in excess of fair value. The unrealized losses of $9
million and $32 million at December 31, 2012 and 2011, respectively, were
primarily caused by market interest rate increases and not by unfavorable
changes in the credit standing. We manage our investment portfolio to limit our
exposure to any one issuer or market sector, and largely limit our investments
to U.S. government and agency securities; state and municipal securities;
mortgage-backed securities; and corporate debt obligations, substantially all of
investment-grade quality. Securities downgraded below policy minimums after
purchase will be disposed of in accordance with our investment policy. Total
other-than-temporary impairments during 2012, 2011 and 2010 were $6 million, $12
million and $23 million, respectively. Our cash equivalent and investment
portfolio had a weighted-average duration of 2.1 years and a weighted-average
credit rating of "AA" as of December 31, 2012. We have minimal securities
collateralized by sub-prime or Alt-A securities, and a minimal amount of
commercial mortgage loans in default.
The judgments and estimates related to fair value and other-than-temporary
impairment may ultimately prove to be inaccurate due to many factors including:
circumstances may change over time, industry sector and market factors may
differ from expectations and estimates or we may ultimately sell a security we
previously intended to hold. Our assessment of the financial condition and
near-term prospects of the issuer may ultimately prove to be inaccurate as time
passes and new information becomes available including current facts and
circumstances changing, or as unknown or estimated unlikely trends develop.
As discussed further in Item 7A "Quantitative and Qualitative Disclosures About
Market Risk" a 1% increase in market interest rates has the effect of decreasing
the fair value of our investment portfolio by $656 million.
Income Taxes
Our provision for income taxes, deferred tax assets and liabilities, and
uncertain tax positions reflect our assessment of estimated future taxes to be
paid on items in the consolidated financial statements.
Deferred income taxes arise from temporary differences between financial
reporting and tax reporting bases of assets and liabilities, as well as net
operating loss and tax credit carryforwards for tax purposes. We have
established a valuation allowance against certain deferred tax assets based on
the weight of available evidence (both positive and negative) for which it is
more-likely-than-not that some portion, or all, of the deferred tax asset will
not be realized.
An uncertain tax position is recognized when it is more likely than not that the
position will be sustained upon examination, including resolutions of any
related appeals or litigation processes, based on the technical merits. We
prepare and file tax returns based on our interpretation of tax laws and
regulations and record estimates based on these judgments and interpretations.
In the normal course of business, our tax returns are subject to examination by
various taxing authorities. Such
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examinations may result in future tax and interest assessments by these taxing
authorities. Inherent uncertainties exist in estimates of tax positions due to
changes in tax law resulting from legislation, regulation and/or as concluded
through the various jurisdictions' tax court systems.
The significant assumptions and estimates described above are important
contributors to our ultimate effective tax rate in each year. A hypothetical
increase or decrease in our effective tax rate by 1% on our 2012 earnings before
income taxes would have caused the provision for income taxes and net earnings
to change by $86 million.
Contingent Liabilities
Because of the nature of our businesses, we are routinely involved in various
disputes, legal proceedings and governmental audits and investigations. We
record liabilities for our estimates of the probable costs resulting from these
matters where appropriate. Our estimates are developed in consultation with
legal counsel, if appropriate, and are based upon an analysis of potential
results, assuming a combination of litigation and settlement strategies and
considering our insurance coverage, if any, for such matters.
Estimates of costs resulting from legal and regulatory matters involving us are
inherently difficult to predict, particularly where the matters: involve
indeterminate claims for monetary damages or may involve fines, penalties or
punitive damages; present novel legal theories or represent a shift in
regulatory policy; involve a large number of claimants or regulatory bodies; are
in the early stages of the proceedings; or could result in a change in business
practices. Accordingly, in many cases, we are unable to estimate the losses or
ranges of losses for those matters where there is a reasonable possibility or it
is probable that a loss may be incurred. Similarly, the assessment of the
likelihood of assertion of unasserted claims involves significant judgment.
Given this inherent uncertainty, it is possible that future results of
operations for any particular quarterly or annual period could be materially
affected by changes in our estimates or assumptions. We evaluate our related
disclosures each reporting period. See Note 12 of Notes to the Consolidated
Financial Statements included in Item 8, "Financial Statements" for discussion
of specific legal proceedings including an assessment of whether a reasonable
estimate of the losses or range of loss could be determined.
LEGAL MATTERS
A description of our legal proceedings is included in Note 12 of Notes to the
Consolidated Financial Statements included in Item 8 "Financial Statements."
CONCENTRATIONS OF CREDIT RISK
Investments in financial instruments such as marketable securities and accounts
receivable may subject us to concentrations of credit risk. Our investments in
marketable securities are managed under an investment policy authorized by our
Board of Directors. This policy limits the amounts that may be invested in any
one issuer and generally limits our investments to U.S. government and agency
securities, state and municipal securities and corporate debt obligations that
are investment grade. Concentrations of credit risk with respect to accounts
receivable are limited due to the large number of employer groups and other
customers that constitute our client base. As of December 31, 2012, we had an
aggregate $1.9 billion reinsurance receivable resulting from the sale of our
Golden Rule Financial Corporation life and annuity business in 2005. We
regularly evaluate the financial condition of the reinsurer and only record the
reinsurance receivable to the extent that the amounts are deemed probable of
recovery. As of December 31, 2012, the reinsurer was rated by A.M. Best as "A+."
As of December 31, 2012, there were no other significant concentrations of
credit risk.
