HUMANA INC – 10-Q – MANAGEMENT’S DISCUSSION AND ANALYSIS OF

Edgar Online, Inc.

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  The condensed consolidated financial statements of Humana Inc. in this document present the Company's financial position, results of operations and cash flows, and should be read in conjunction with the following discussion and analysis. References to "we," "us," "our," "Company," and "Humana" mean Humana Inc. and its subsidiaries. This discussion includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in filings with the SEC, in our press releases, investor presentations, and in oral statements made by or with the approval of one of our executive officers, the words or phrases like "expects," "believes," "anticipates," "intends," "likely will result," "estimates," "projects" or variations of such words and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including, among other things, information set forth in Item 1A. - Risk Factors in our 2012 Form 10-K, as modified by any changes to those risk factors included in this document and in other reports we filed subsequent to February 21, 2013, in each case incorporated by reference herein. In making these statements, we are not undertaking to address or update such forward-looking statements in future filings or communications regarding our business or results. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this document might not occur. There may also be other risks that we are unable to predict at this time. Any of these risks and uncertainties may cause actual results to differ materially from the results discussed in the forward-looking statements.  Executive Overview  General  Headquartered in Louisville, Kentucky, Humana is a leading health care company that offers a wide range of insurance products and health and wellness services that incorporate an integrated approach to lifelong well-being. By leveraging the strengths of our core businesses, we believe that we can better explore opportunities for existing and emerging adjacencies in health care that can further enhance wellness opportunities for the millions of people across the nation with whom we have relationships.  Our industry relies on two key statistics to measure performance. The benefit ratio, which is computed by taking total benefits expense as a percentage of premiums revenue, represents a statistic used to measure underwriting profitability. The operating cost ratio, which is computed by taking total operating costs as a percentage of total revenue less investment income, represents a statistic used to measure administrative spending efficiency.  

Business Segments

  On January 1, 2013, we reclassified certain of our businesses to correspond with internal management reporting changes and renamed our Health and Well-Being Services segment as Healthcare Services as further described in Note 1 to the condensed consolidated financial statements. Prior period segment financial information has been recast to conform to the 2013 presentation.  We manage our business with three reportable segments: Retail, Employer Group, and Healthcare Services. In addition, the Other Businesses category includes businesses that are not individually reportable because they do not meet the quantitative thresholds required by generally accepted accounting principles. These segments are based on a combination of the type of health plan customer and adjacent businesses centered on integrated care delivery for our health plans and other customers, as described below. These segment groupings are consistent with information used by our Chief Executive Officer to assess performance and allocate resources.  The Retail segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, marketed directly to individuals, and includes our contract with Centers for Medicare and Medicaid Services, or CMS, to administer the Limited Income Newly Eligible Transition program, or the LI-NET program, and state-based Medicaid businesses. The Employer Group segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, as well as administrative services only products, or ASO, and our health and wellness products primarily marketed to employer groups. The Healthcare Services segment includes services offered to our health                                           27 

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  plan members as well as to third parties, including provider services, pharmacy, integrated behavioral health services, and home care services. The Other Businesses category consists of our military services, primarily our TRICARE South Region contract, Puerto Rico Medicaid, and closed-block long-term care businesses.  The results of each segment are measured by income before income taxes. Transactions between reportable segments consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and behavioral health, to our Retail and Employer Group customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often utilize the same provider networks, enabling us in some instances to obtain more favorable contract terms with providers. Our segments also share indirect costs and assets. As a result, the profitability of each segment is interdependent. We allocate most operating expenses to our segments. Assets and certain corporate income and expenses are not allocated to the segments, including the portion of investment income not supporting segment operations, interest expense on corporate debt, and certain other corporate expenses. These items are managed at the corporate level. These corporate amounts are reported separately from our reportable segments and included with intersegment eliminations.  Seasonality  One of the product offerings of our Retail segment is Medicare stand-alone prescription drug plans, or PDPs, under the Medicare Part D program. These plans provide varying degrees of coverage. Our quarterly Retail segment earnings and operating cash flows are impacted by the Medicare Part D benefit design and changes in the composition of our membership. The Medicare Part D benefit design results in coverage that varies as a member's cumulative out-of-pocket costs pass through successive stages of a member's plan period which begins annually on January 1 for renewals. These plan designs generally result in us sharing a greater portion of the responsibility for total prescription drug costs in the early stages and less in the latter stages. As a result, the PDP benefit ratio generally decreases as the year progresses. In addition, the number of low-income senior members as well as year-over-year changes in the mix of membership in our stand-alone PDP products affects the quarterly benefit ratio pattern.  

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

 2013 Highlights  Consolidated   

• Our 2013 results reflect the continued implementation of our strategy to

offer our members affordable health care combined with a positive consumer

experience in growing markets. At the core of this strategy is our

integrated care delivery model, which unites quality care, high member

engagement, and sophisticated data analytics. Our approach to primary,

physician-directed care for our members aims to provide quality care that

is consistent, integrated, cost-effective, and member-focused. The model

is designed to improve health outcomes and affordability for individuals

and for the health system as a whole, while offering our members a simple,

seamless healthcare experience. We believe this strategy is positioning us

for long-term growth in both membership and earnings. At June 30, 2013,

approximately 541,400 members, or 26.7%, of our individual Medicare

Advantage membership were in risk arrangements under our integrated care

delivery model, as compared to 511,700 members at December 31, 2012 and

          502,500 members at June 30, 2012.          •   In addition, our pretax results for the three and six months ended          June 30, 2013 reflect improved operating performance across our major          business lines, including membership growth in our individual and group

Medicare Advantage products, as described below. The improved operating

performance reflects our continued focus and executional discipline

involved in key initiatives like our chronic care program, including

increased care management professional staffing and clinical assessments.

         •   Comparisons of the benefit ratios and operating cost ratios for the six

months ended June 30, 2013 and June 30, 2012 are impacted by the

transition to the current TRICARE South Region contract on April 1, 2012,

which is accounted for similar to an administrative services fee only

agreement as described in Note 2 to the consolidated financial statements

included in our 2012 Form 10-K. Our previous contract was accounted for

         similar to our fully-insured products. In addition, comparisons of the          benefit ratios for the six months ended June 30, 2013 and June 30, 2012          are impacted by the beneficial effect of a favorable settlement of          contract claims with the Department of Defense, or DoD, in the first

quarter of 2013 primarily associated with previously disclosed litigation

         settled in the second quarter of 2012.                                            28 

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• Year-over-year comparisons of diluted earnings per common share are

favorably impacted by a lower number of shares used to compute diluted

         earnings per common share primarily reflecting the impact of share          repurchases.    

• During the six months ended June 30, 2013, we repurchased 2.83 million

shares in open market transactions for $211 million and paid dividends to

          stockholders of $83 million.          •   In July 2013, we amended and restated our 5-year $1.0 billion unsecured

revolving agreement which was set to expire in November 2016 and replaced

it with a new 5-year $1.0 billion unsecured revolving agreement expiring

July 2018 as described under the section titled "Credit Agreement."

  Retail         •   On April 1, 2013, CMS issued its final Announcement of Calendar Year 2014

Medicare Advantage Benchmark Rates and Payment Policies, which we refer to

as the CMS Final Announcement. Based on the benchmark rates and payment

         policies published in the CMS Final Announcement, we estimate that our          2014 Medicare bid benchmark payment rates will decline by 2.8% in the

aggregate, including the negative impact of risk coding recalibration and

county rebasing. The 2014 bid benchmark payment rate reductions for

certain of our key markets are anticipated to be in the mid to upper

single digits, primarily due to the risk coding recalibration in 2014.

Including the health insurance industry fee associated with the Health

Care Reform Law, we anticipate we will need to address government funding

reductions of more than 4% in the aggregate in 2014. While we believe our

senior members' benefits may be adversely impacted, we believe we can

effectively design Medicare Advantage products based upon these levels of

rate reduction while continuing to remain competitive compared to both the

combination of original Medicare with a supplement policy as well as

Medicare Advantage products offered by our competitors. Nonetheless, there

can be no assurance that we will be able to successfully execute

operational and strategic initiatives that we have assumed when designing

our plan benefit offerings and premiums for 2014. Failure to execute these

         strategies may result in a material adverse effect on our results of          operations, financial position, and cash flows.    

• As discussed in the detailed Retail segment results of operations

discussion that follows, we experienced a decline in the Retail segment

benefit ratio for the six months ended June 30, 2013, with the segment's

         benefit ratio decreasing 80 basis points to 85.0%. Our Retail segment          benefit ratio for the three months ended June 30, 2013 of 84.2% was          comparable to the benefit ratio for the three months ended June 30, 2012.          •   Individual Medicare Advantage membership of 2,029,700 at June 30, 2013

         increased 102,100, or 5.3%, from 1,927,600 at December 31, 2012 and          increased 133,900 members, or 7.1%, from 1,895,800 at June 30, 2012

reflecting net membership additions for the 2013 enrollment season and new

sales to members aging-in to the Medicare program. Effective January 1,

2013, we divested approximately 12,600 members acquired with Arcadian

Management Services, Inc. in accordance with our previously disclosed

          agreement with the United States Department of Justice.          •   Medicare stand-alone PDP membership of 3,220,600 at June 30, 2013          increased 167,900 members, or 5.5%, from 3,052,700 at December 31, 2012          and increased 250,500 members, or 8.4%, from 2,970,100 at June 30, 2012

reflecting net membership additions, primarily for our Humana-Walmart plan

         offering for the 2013 enrollment season.    

• During 2012, we were successful in our bids for Medicaid business in Ohio,

Illinois, and Kentucky. Ohio and Illinois include individuals dually

eligible for both the federal Medicare program and the state-based

Medicaid program. We partnered with CareSource Management Group Company to

serve the Ohio and Kentucky individuals under a March 2012 strategic

alliance agreement. Medicaid membership in our Retail Segment at June 30,

2013 increased 18,500 members from December 31, 2012, and increased 24,100

members from June 30, 2012 primarily driven by the addition of our

recently awarded Kentucky Medicaid contract effective January 1, 2013. We

expect to begin serving members under contracts with Ohio and Illinois in

the first quarter of 2014. While we expect the dual-eligible business to

result in pretax income growth, the mix of lower margin dual-eligible

business with the higher margin Medicare Advantage business may result in

         a decline in Retail Segment margins over time.                                            29 

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• On July 24, 2013, we announced that we had entered into a definitive

agreement to acquire American Eldercare Inc., or American Eldercare, the

largest provider of nursing home diversion services in the state of

Florida (serving frail and elderly individuals in home and community-based

         settings). American Eldercare complements our core capabilities and          strength in serving seniors and disabled individuals with a unique focus          on individualized and integrated care, and was selected to provide

Medicaid long-term care services across the entire state of Florida. The

enrollment effective dates for the various regions range from August 2013

to March 2014. The transaction is subject to state regulatory approvals

and is anticipated to close by the fourth quarter of 2013.

  Employer Group Segment   

• As discussed in the detailed Employer Group segment results of operations

discussion that follows, the Employer Group segment benefit ratio

increased 70 basis points to 82.5% for the three months ended June 30,

2013. For the six months ended June 30, 2013, we experienced a decline in

the benefit ratio in the Employer Group segment, with the segment's

          benefit ratio decreasing 50 basis points to 81.0%.          •   Fully-insured group Medicare Advantage membership of 416,600 at June 30,

2013 increased 45,800 members, or 12.4%, from 370,800 at December 31, 2012

and increased 56,100 members, or 15.6%, from 360,500 at June 30, 2012

primarily due to the January 2013 addition of a new large group retirement

          account.   Healthcare Services Segment    

• On December 21, 2012, we acquired Metropolitan Health Networks, Inc., or

Metropolitan, a Medical Services Organization, or MSO, that coordinates

medical care for Medicare Advantage beneficiaries and Medicaid recipients,

         primarily in Florida. We acquired all of the outstanding shares of          Metropolitan and repaid all outstanding debt of Metropolitan for a          transaction value of $851 million, plus transaction expenses.   On October 29, 2012, we acquired a noncontrolling equity interest in MCCI Holdings, LLC, or MCCI, a privately held MSO headquartered in Miami, Florida that coordinates medical care for Medicare Advantage beneficiaries and Medicaid recipients, primarily in Florida and Texas.  The Metropolitan and MCCI transactions provide us with components of a successful integrated care delivery model that has demonstrated scalability to new markets. A substantial portion of the revenues for both Metropolitan and MCCI are derived from services provided to Humana Medicare Advantage members under capitation contracts with our health plans. In addition, Metropolitan and MCCI provide services to Medicare Advantage and Medicaid members under capitation contracts with third party health plans. Under these capitation agreements with Humana and third party health plans, Metropolitan and MCCI assume financial risk associated with these Medicare Advantage and Medicaid members.         •   On July 6, 2012, we acquired SeniorBridge Family Companies, Inc., or

         SeniorBridge, a chronic-care provider of in-home care for seniors,          expanding our existing clinical and home health capabilities and          strengthening our offerings for members with complex chronic-care needs.   Other Businesses    

• Comparisons of the benefit ratios for the six months ended June 30, 2013

and June 30, 2012 within Other Businesses are impacted by the transition

to the current TRICARE South Region contract on April 1, 2012, including a

decrease in profitability under the current contract in connection with

our bid strategy, and the beneficial effect of a favorable settlement of

contract claims with the Department of Defense, or DoD, in the first

quarter of 2013 primarily associated with previously disclosed litigation

         settled in the second quarter of 2012.    

• On June 26, 2013, the Puerto Rico Health Insurance Administration notified

us of its election not to renew our three-year Medicaid contracts for the

East, Southeast, and Southwest regions which ended June 30, 2013.

Contractual transition provisions require the continuation of insurance

coverage for beneficiaries through September 30, 2013 and an additional

period of time thereafter to process claims. During the second quarter of

2013, we recorded a loss of $31.0 million on these contracts primarily

         related to premium deficiency and employee termination costs.                                            30 

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Health Care Reform

  The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the Health Care Reform Law) enacted significant reforms to various aspects of the U.S. health insurance industry. While regulations and interpretive guidance on many provisions of the Health Care Reform Law have been issued to date by the Department of Health and Human Services, or HHS, the Department of Labor, the Treasury Department, and the National Association of Insurance Commissioners, or NAIC, there are certain provisions of the law that will require additional guidance and clarification in the form of regulations and interpretations in order to fully understand the impacts of the law on our overall business, which we expect to occur over the next several years.  Implementation dates of the Health Care Reform Law began in September 2010 and continue through 2018. The following outlines certain provisions of the Health Care Reform Law:   

• Currently Effective: Many changes are already effective and have been

implemented by the Company, including: elimination of pre-existing

condition limits for enrollees under age 19, elimination of certain annual

and lifetime caps on the dollar value of benefits, expansion of dependent

coverage to include adult children until age 26, a requirement to provide

coverage for prescribed preventive services without cost to members, new

claim appeal requirements, and the establishment of an interim high risk

program for those unable to obtain coverage due to a pre-existing

condition or health status.

   Commercial fully-insured medical plans with actual benefit ratios below certain targets (85% for large employer groups, 80% for small employer groups, and 80% for individuals, calculated in a manner prescribed by HHS) are required to rebate ratable portions of their premiums to customers annually. We began accruing for rebates in 2011, based on the manner prescribed by HHS, with rebate payments made annually each July of the following calendar year. Our benefit ratios reported herein, calculated from financial statements prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, differ from the benefit ratios calculated as prescribed by HHS under the Health Care Reform Law. The more noteworthy differences include the fact that the benefit ratio calculations prescribed by HHS are calculated separately by state and legal entity; independently for individual, small group, and large group fully-insured products; reflect actuarial adjustments where the membership levels are not large enough to create credible size; exclude some of our health insurance products; include taxes and fees as reductions of premium; and treat changes in reserves differently than GAAP.  HHS has also established, as required under the Health Care Reform Law, a federal premium rate review process, which generally applies to proposed rate increases equal to or exceeding 10%, and regulations require commercial plans to provide to the states and HHS supporting information with respect to any rate increases that are subject to the federal review process.    

• Currently Effective with Phased-In Implementation: In 2012, additional

cuts to Medicare Advantage plan payment benchmarks began to take effect

(with plan payment benchmarks ultimately ranging from 95% in high-cost

areas to 115% in low-cost areas of Medicare fee-for-service rates), with

changes being phased-in over two to six years, depending on the level of

payment reduction in a county. In addition, since 2011 the gap in coverage

for Medicare Part D prescription drug coverage has been incrementally

closing.

   In addition, certain provisions in the Health Care Reform Law tie Medicare Advantage premiums to the achievement of certain quality performance measures (Star Ratings). Beginning in 2012, Medicare Advantage plans with an overall Star Rating of three or more stars (out of five) were eligible for a quality bonus in their basic premium rates. By law, quality bonuses were limited to the few plans that achieved four or more stars as an overall rating, but CMS, through its demonstration authority, expanded the quality bonus to three Star plans for a three year period through 2014. Star Ratings issued by CMS in October 2012 indicated that 99% of our Medicare Advantage members are now in plans that will qualify for quality bonus payments in 2014, up from 98% in 2013. Further, the percentage of our Medicare Advantage members in plans with an overall Star Rating of four or more stars, including one five star plan, increased to 40%. Plans that earn an overall Star Rating of five are immediately eligible to enroll members year round. Beginning in 2015, plans must have a Star Rating of four or higher to qualify for bonus money. Notwithstanding successful historical efforts to improve our Star Ratings and other quality measures for 2012 and 2013 and the continuation of such efforts, there can be no assurances that we will be successful in maintaining or improving our Star Ratings in future years. Accordingly, our plans may not be eligible for full level quality bonuses, which could adversely affect the benefits such plans can offer, reduce membership, and/or reduce profit margins.                                           31 

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• Effective in 2014: Beginning in 2014, the Health Care Reform Law

requires: all individual and group health plans to guarantee issuance and

renew coverage without pre-existing condition exclusions or health-status

rating adjustments; the elimination of annual limits on coverage on

certain benefits; the establishment of federally facilitated,

federal-state partnerships or state-based exchanges for individuals and

small employers (with up to 100 employees) coupled with programs designed

to spread risk among insurers; the introduction of plan designs based on

         set actuarial values; the establishment of a minimum benefit ratio of 85%          for Medicare Advantage plans; and insurance industry assessments,          including an annual health insurance industry fee and a three-year $25

billion commercial reinsurance fee. The annual health insurance industry

fee levied on the insurance industry is $8 billion in 2014 with increasing

annual amounts thereafter, growing to $14 billion by 2017, and is not

deductible for income tax purposes, which will significantly increase our

effective income tax rate in 2014. The NAIC is continuing discussions

regarding the accounting for the health insurance industry fee and may

require surplus reductions in the year preceding payment, beginning in

2014. Accordingly, in 2014 we may be required to reduce surplus for both

the 2014 and 2015 assessments. The NAIC guidance is contradictory to final

         GAAP guidance issued by the FASB in July 2011, which requires annual          accrual of the health insurance industry fee in the year in which it is          payable.   The Health Care Reform Law also specifies benefit design guidelines, limits rating and pricing practices, encourages additional competition from the establishment of two multi-state plans (one not-for-profit; one for-profit) administered through the Office of Personnel Management, and expands eligibility for Medicaid programs. In addition, the law will increase federal oversight of health plan premium rates and could adversely affect our ability to appropriately adjust health plan premiums on a timely basis. Financing for these reforms will come, in part, from material additional fees and taxes on us (as discussed above) and other health plans and individuals beginning in 2014, as well as reductions in certain levels of payments to us and other health plans under Medicare as described herein.  As discussed above, implementing regulations and related interpretive guidance continue to be issued on certain provisions of the Health Care Reform Law. Congress may also withhold the funding necessary to implement the Health Care Reform Law, or may attempt to replace the law with amended provisions. The implementation of certain provisions of Health Care Reform Law has been delayed. Given the breadth of possible changes and the uncertainties of interpretation, implementation, and timing of these changes, which we expect to occur over the next several years, the Health Care Reform Law will change the way we do business, potentially impacting our pricing, benefit design, product mix, geographic mix, and distribution channels. The response of other companies to the Health Care Reform Law and adjustments to their offerings, if any, could cause meaningful disruption in the local health care markets. It is reasonably possible that the Health Care Reform Law and related regulations, as well as future legislative changes, in the aggregate may have a material adverse effect on our results of operations, including restricting revenue, enrollment and premium growth in certain products and market segments, restricting our ability to expand into new markets, increasing our medical and operating costs, lowering our Medicare payment rates and increasing our expenses associated with the non-deductible health insurance industry fee and other assessments; our financial position, including our ability to maintain the value of our goodwill; and our cash flows. If the new non-deductible health insurance industry fee and other assessments, including a three-year commercial reinsurance fee, were imposed as enacted, and if we are unable to adjust our business model to address these new taxes and assessments, such as through the reduction of our operating costs or adjustments to premium pricing or benefit design, there can be no assurance that the non-deductible health insurance industry fee and other assessments would not have a material adverse effect on our results of operations, financial position, and cash flows.  We intend for the discussion of our financial condition and results of operations that follows to assist in the understanding of our financial statements and related changes in certain key items in those financial statements from year to year, including the primary factors that accounted for those changes. Transactions between reportable segments consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and behavioral health services, to our Retail and Employer Group customers and are described in Note 13 to the condensed consolidated financial statements.                                           32 

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Comparison of Results of Operations for 2013 and 2012

  The following discussion primarily deals with our results of operations for the three months ended June 30, 2013, or the 2013 quarter, the three months ended June 30, 2012, or the 2012 quarter, the six months ended June 30, 2013, or the 2013 period, and the six month ended June 30, 2012 or the 2012 period.  Consolidated                                                      For the three months ended                                                            June 30,                                          Change                                               2013                          2012                  Dollars           Percentage                                              (dollars in millions, except per common share results) Revenues: Premiums: Retail                                 $            6,766             $           6,390          $     376                  5.9 % Employer Group                                      2,710                         2,522                188                  7.5 % Other Businesses                                      225                           254                (29 )              (11.4 )%  Total premiums                                      9,701                         9,166                535                  5.8 %  Services: Retail                                                  2                             5                 (3 )              (60.0 )% Employer Group                                         86                            91                 (5 )               (5.5 )% Healthcare Services                                   326                           247                 79                 32.0 % Other Businesses                                      114                            91                 23                 25.3 %  Total services                                        528                           434                 94                 21.7 %  Investment income                                      92                            99                 (7 )               (7.1 )%  Total revenues                                     10,321                         9,699                622                  6.4 %  Operating expenses: Benefits                                            8,091                         7,652                439                  5.7 % Operating costs                                     1,461                         1,384                 77                  5.6 % Depreciation and amortization                          80                            73                  7                  9.6 %  Total operating expenses                            9,632                         9,109                523                  5.7 %  Income from operations                                689                           590                 99                 16.8 % Interest expense                                       35                            26                  9                 34.6 %  Income before income taxes                            654                           564                 90                 16.0 % Provision for income taxes                            234                           208                 26                 12.5 %  Net income                             $              420             $             356          $      64                 18.0 %  Diluted earnings per common share      $             2.63             $            2.16          $    0.47                 21.8 %  Benefit ratio(a)                                     83.4 %                        83.5 %                                  (0.1 )% Operating cost ratio(b)                              14.3 %                        14.4 %                                  (0.1 )% Effective tax rate                                   35.7 %                        36.8 %                                  (1.1 )%    

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

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

    investment income.                                            33 

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   Table of Contents                                                  For the six months  ended                                                          June 30,                                        Change                                              2013                         2012                Dollars          Percentage                                            (dollars in millions, except per common share results) Revenues: Premiums: Retail                                $           13,670           $           12,537         $  1,133                 9.0 % Employer Group                                     5,445                        5,051              394                 7.8 % Other Businesses                                     454                        1,353             (899 )             (66.4 )%  Total premiums                                    19,569                       18,941              628                 3.3 %  Services: Retail                                                 4                           11               (7 )             (63.6 )% Employer Group                                       174                          182               (8 )              (4.4 )% Healthcare Services                                  641                          482              159                33.0 % Other Businesses                                     234                          109              125               114.7 %  Total services                                     1,053                          784              269                34.3 %  Investment income                                    185                          193               (8 )              (4.1 )%  Total revenues                                    20,807                       19,918              889                 4.5 %  Operating expenses: Benefits                                          16,286                       16,002              284                 1.8 % Operating costs                                    2,907                        2,767              140                 5.1 % Depreciation and amortization                        160                          143               17                11.9 %  Total operating expenses                          19,353                       18,912              441                 2.3 %  Income from operations                             1,454                        1,006              448                44.5 % Interest expense                                      70                           52               18                34.6 %  Income before income taxes                         1,384                          954              430                45.1 % Provision for income taxes                           491                          350              141                40.3 %  Net income                            $              893           $              604         $    289                47.8 %  Diluted earnings per common share     $             5.58           $             3.65         $   1.93                52.9 %  Benefit ratio(a)                                    83.2 %                       84.5 %                               (1.3 )% Operating cost ratio(b)                             14.1 %                       14.0 %                                0.1 % Effective tax rate                                  35.5 %                       36.7 %                               (1.2 )%    

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

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

    investment income.   Summary  Net income was $420 million, or $2.63 per diluted common share, in the 2013 quarter compared to $356 million, or $2.16 per diluted common share, in the 2012 quarter. Net income was $893 million, or $5.58 per diluted common share, in the 2013 period compared to $604 million, or $3.65 per diluted common share, in the 2012 period. The increases in net income primarily were driven by improved operating performance across most of our major business lines, including Medicare Advantage membership growth in our Retail and Employer group segments, as well as a benefit in the 2013 period from the delay in the impact of sequestration for our Medicare products. Year-over-year comparisons of diluted earnings per common share are favorably impacted by a lower number of shares used to compute diluted earnings per common share in the 2013 quarter and period primarily reflecting the impact of share repurchases. Our diluted earnings per common share for the 2013 quarter and period included expense of $0.12 per share primarily related to costs associated with the loss of our Medicaid contracts in Puerto Rico. In addition, comparisons of net income and diluted earnings per common share for the 2013 and 2012 periods are impacted by the beneficial effect of a favorable settlement of contract claims with the DoD in the first quarter of 2013 primarily associated with previously disclosed litigation settled in the second quarter of 2012.                                           34 

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Premiums

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

Services revenue

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

Investment income

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

Benefits expense

  Consolidated benefits expense was $8.1 billion for the 2013 quarter, an increase of $439 million, or 5.7%, from the 2012 quarter. For the 2013 period, consolidated benefits expense was $16.3 billion, an increase of $284 million, or 1.8%, from the 2012 period. These increases primarily were due to a year-over-year increase in Retail segment benefits expense, primarily driven by an increase in the average number of Medicare members, partially offset by a decrease in benefits expense for Other Businesses in the 2013 period primarily due to the transition to the current administrative services only TRICARE South Region contract on April 1, 2012. We do not record benefits expense under the current TRICARE South Region contract. Our previous contract was accounted for similar to our fully-insured products and as such we recorded benefits expense under the previous contract. Retail segment benefits expense increased $318 million, or 5.9%, from the 2012 quarter to the 2013 quarter, and increased $870 million, or 8.1%, from the 2012 period to the 2013 period primarily due to membership growth. As more fully described under "Benefits Expense Recognition" in Item 7 of our 2012 Form 10-K, actuarial standards require the use of assumptions based on moderately adverse experience, which generally results in favorable reserve development, or reserves that are considered redundant. We experienced favorable medical claims reserve development related to prior fiscal years of $100 million in the 2013 quarter and $40 million in the 2012 quarter. During the 2013 period, we experienced favorable medical claims reserve development related to prior fiscal years of $366 million compared to $181 million in the 2012 period. These increases in favorable medical claims reserve development primarily resulted from claims trend for prior year ultimately developing more favorably than originally expected across most of our major business lines.                                           35 

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Table of Contents

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

Operating costs

  Our segments incur both direct and shared indirect operating costs. We allocate the indirect costs shared by the segments primarily as a function of revenues. As a result, the profitability of each segment is interdependent.  Consolidated operating costs increased $77 million, or 5.6%, during the 2013 quarter compared to the 2012 quarter and increased $140 million, or 5.1%, in the 2013 period compared to the 2012 period. These increases primarily were due to an increase in operating costs in our Healthcare Services segment as a result the acquisition of Metropolitan on December 21, 2012 and SeniorBridge on July 6, 2012.  The consolidated operating cost ratio for the 2013 quarter was 14.3%, decreasing 10 basis points from the 2012 quarter primarily due to improved operating leverage in our Retail and Employer Group segments that more than offset the impact of costs associated with the loss of our Medicaid contracts in Puerto Rico. The consolidated operating cost ratio for the 2013 period was 14.1%, increasing 10 basis points from the 2012 period as the negative impact of the current TRICARE South Region contract being accounted for as an administrative services fee only arrangement beginning April 1, 2012 and costs associated with the loss of our Medicaid contracts in Puerto Rico were partially offset by improved operating leverage in our Retail and Employer Group segments.  

Depreciation and amortization

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

Interest expense

  Interest expense was $35 million for the 2013 quarter compared to $26 million for the 2012 quarter, an increase of $9 million, or 34.6%. Interest expense was $70 million for the 2013 period compared to $52 million for the 2012 period, an increase of $18 million, or 34.6%. In December 2012, we issued $600 million of 3.15% senior notes due December 1, 2022 and $400 million of 4.625% senior notes due December 1, 2042.  Income Taxes  Our effective tax rate during the 2013 quarter was 35.7% compared to the effective tax rate of 36.8% in the 2012 quarter. For the 2013 period, our effective tax rate was 35.5%, comparable to the effective tax rate of 36.7% in the 2012 period. This change is primarily due to a change in our estimated tax liability associated with limitations on the deductibility of annual compensation in excess of $500,000 per employee as mandated by the Health Care Reform Law.                                           36 

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  Table of Contents  Retail Segment                                                          June 30,                          Change                                                2013             2012           Members       Percentage Membership:  Medical membership: Individual Medicare Advantage                 2,029,700        1,895,800        133,900              7.1 % Medicare stand-alone PDP                      3,220,600        2,970,100        250,500              8.4 %  Total Retail Medicare                         5,250,300        4,865,900        384,400              7.9 % Individual commercial                           568,300          514,300         54,000             10.5 % State-based Medicaid                             70,600           46,500         24,100             51.8 %  Total Retail medical members                  5,889,200        5,426,700        462,500              8.5 %  Individual specialty membership (a)           1,011,700          906,200        105,500             11.6 %     

(a) Specialty products include dental, vision, and other supplemental health and

financial protection products. Members included in these products may not be

     unique to each product since members have the ability to enroll in multiple     products.                                                     For the three months                                                        ended                                                       June 30,                                Change                                             2013                 2012               Dollars          Percentage                                                              (in millions) Premiums and Services Revenue: Premiums: Individual Medicare Advantage            $    5,572         $         5,308        $     264                 5.0 % Medicare stand-alone PDP                        785                     745               40                 5.4 %  Total Retail Medicare                         6,357                   6,053              304                 5.0 % Individual commercial                           285                     250               35                14.0 % State-based Medicaid                             72                      45               27                60.0 % Individual specialty                             52                      42               10                23.8 %  Total premiums                                6,766                   6,390              376                 5.9 %  Services                                          2                       5               (3 )             (60.0 )% 

Total premiums and services revenue $ 6,768 $ 6,395

$     373                 5.8 %  Income before income taxes               $      418         $           367        $      51                13.9 % Benefit ratio                                  84.2 %                  84.2 %                                0.0 % Operating cost ratio                            9.5 %                  10.0 %                               (0.5 )%                                            37 

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  Table of Contents                                                 For the six months                                                       ended                                                      June 30,                               Change                                            2013                2012              Dollars          Percentage                                                            (in millions) Premiums and Services Revenue: Premiums: Individual Medicare Advantage            $  11,308$        10,401$    907                 8.7 % Medicare stand-alone PDP                     1,546                  1,471              75                 5.1 %  Total Retail Medicare                       12,854                 11,872             982                 8.3 % Individual commercial                          564                    494              70                14.2 % State-based Medicaid                           151                     91              60                65.9 % Individual specialty                           101                     80              21                26.3 %  Total premiums                              13,670                 12,537           1,133                 9.0 %  Services                                         4                     11              (7 )             (63.6 )% 

Total premiums and services revenue $ 13,674$ 12,548

$  1,126                 9.0 %  Income before income taxes               $     768        $           495        $    273                55.2 % Benefit ratio                                 85.0 %                 85.8 %                              (0.8 )% Operating cost ratio                           9.2 %                 10.2 %                              (1.0 )%   Pretax Results   

• Retail segment pretax income was $418 million in the 2013 quarter, an

increase of $51 million, or 13.9%, compared to the 2012 quarter. Retail

segment pretax income was $768 million in the 2013 period, an increase of

$273 million, or 55.2%, compared to the 2012 period. These increases

reflect improved operating performance over the prior year and were

primarily driven by membership growth as well as a decrease in the

operating cost ratio as favorable outcomes from clinical initiatives were

generally offset by related investment spending, as described below. In

         addition, the increase in the 2013 period reflects a decline in the          benefit ratio also described below.   Enrollment    

• Individual Medicare Advantage membership increased 133,900 members, or

7.1%, from June 30, 2012 to June 30, 2013 reflecting net membership

additions for the 2013 enrollment season and new sales to members aging-in

to the Medicare program. Effective January 1, 2013, we divested

approximately 12,600 members acquired with Arcadian Management Services,

Inc. in accordance with our previously disclosed agreement with the United

          States Department of Justice.          •   Medicare stand-alone PDP membership increased 250,500 members, or 8.4%,

from June 30, 2012 to June 30, 2013 reflecting net membership additions,

primarily for our Humana-Walmart plan offering, for the 2013 enrollment

         season.    

• Individual commercial medical membership increased 54,000 members, or

10.5%, from June 30, 2012 to June 30, 2013 primarily driven by favorable

         member retention and new sales.    

• State-based Medicaid membership increased 24,100 members, or 51.8%, from

June 30, 2012 to June 30, 2013, primarily driven by the addition of our

recently awarded Kentucky Medicaid contract effective January 1, 2013 as

         discussed previously.    

• Individual specialty membership increased 105,500 members, or 11.6%, from

June 30, 2012 to June 30, 2013 primarily driven by increased membership in

dental and vision offerings.

  Premiums         •   Retail segment premiums increased $376 million, or 5.9%, from the 2012

quarter to the 2013 quarter and increased $1.1 billion, or 9.0%, from the

2012 period to the 2013 period primarily due to a 7.0% and 8.2% increase

in average individual Medicare Advantage membership in the 2013 quarter

and period, respectively. Individual Medicare Advantage per member

premiums decreased approximately 1.9% in the 2013 quarter compared to the

2012 quarter, and increased approximately 0.5% in the 2013 period compared

to the 2012 period, primarily reflecting the impact of sequestration which

         became effective on April 1, 2013.                                            38 

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   Table of Contents  Benefits expense         •   The Retail segment benefit ratio of 84.2% in the 2013 quarter was          comparable to that of the 2012 quarter as year-over-year timing          differences primarily associated with clinical investment spending and

weekday seasonality (the number of business days in the period) generally

offset the impact of favorable outcomes associated with clinical programs

         and higher prior-year medical claims reserve development. The Retail          segment benefit ratio decreased 80 basis points from 85.8% in the 2012          period to 85.0% in the 2013 period primarily due to a decline in the          benefit ratios associated with our individual Medicare Advantage and

Medicare stand-alone PDP products primarily driven by higher favorable

         prior-year medical claims reserve development in the 2013 period than in          the 2012 period. The Retail segment's benefits expense for the 2013          quarter included the beneficial effect of $72 million in favorable          prior-year medical claims reserve development versus $24 million in the          2012 quarter. For the 2013 period, the Retail segment's benefits expense

included the beneficial effect of $265 million in favorable prior-year

medical claims reserve development versus $140 million in the 2012 period.

These increases in favorable prior-year medical claims reserve development

primarily were driven by claims trend for prior year ultimately developing

more favorably than originally expected. This favorable prior-year medical

claims reserve development decreased the Retail segment benefit ratio by

approximately 110 basis points in the 2013 quarter versus approximately 40

basis points in the 2012 quarter, and by approximately 190 basis points in

the 2013 period versus approximately 110 basis points in the 2012 period.

   Operating costs    

• The Retail segment operating cost ratio of 9.5% for the 2013 quarter

decreased 50 basis points from the 2012 quarter. The Retail segment

operating cost ratio of 9.2% for the 2013 period decreased 100 basis

points from 2012 period. These decreases reflect scale efficiencies

associated with servicing higher year-over-year membership together with

our continued focus on operating cost efficiencies.

   Employer Group Segment                                                        June 30,                           Change                                              2013             2012           Members         Percentage Membership: Medical membership: Fully-insured commercial group              1,196,100        1,196,900           (800 )             (0.1 )% ASO                                         1,199,600        1,228,800        (29,200 )             (2.4 )%  Group Medicare Advantage                      416,600          360,500         56,100               15.6 % Medicare Advantage ASO                              0           27,900        (27,900 )           (100.0 )%  Total group Medicare Advantage                416,600          388,400         28,200                7.3 %  Group Medicare stand-alone PDP                  3,700            4,400           (700 )            (15.9 )%  Total group Medicare                          420,300          392,800         27,500                7.0 %  Total group medical members                 2,816,000        2,818,500         (2,500 )             (0.1 )%  Group specialty membership (a)              7,256,800        6,957,800        299,000                4.3 %     

(a) Specialty products include dental, vision, and other supplemental health and

financial protection products. Members included in these products may not be

unique to each product since members have the ability to enroll in multiple

    products.                                            39 

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  Table of Contents                                               For the three months ended                                                        June 30,                                  Change                                              2013                   2012               Dollars         Percentage                                                                 (in millions) Premiums and Services Revenue: Premiums: Fully-insured commercial group           $      1,273          $         1,247        $      26                2.1 %  Group Medicare Advantage                        1,160                    1,011              149               14.7 % Group Medicare stand-alone PDP                      2                        2                0                  0 %  Total group Medicare                            1,162                    1,013              149               14.7 % Group specialty                                   275                      262               13                5.0 %  Total premiums                                  2,710                    2,522              188                7.5 %  Services                                           86                       91               (5 )             (5.5 )%  Total premiums and services revenue      $      2,796          $         2,613        $     183                7.0 %  Income before income taxes               $        127          $           117        $      10                8.5 % Benefit ratio                                    82.5 %                   81.8 %                               0.7 % Operating cost ratio                             15.3 %                   16.3 %                              (1.0 )%                                                 For the six months  ended                                                        June 30,                                  Change                                              2013                   2012               Dollars         Percentage                                                                 (in 

millions)

 Premiums and Services Revenue: Premiums: Fully-insured commercial group           $      2,541          $         2,489        $      52                2.1 %  Group Medicare Advantage                        2,350                    2,036              314               15.4 % Group Medicare stand-alone PDP                      4                        4                0                  0 %  Total group Medicare                            2,354                    2,040              314               15.4 % Group specialty                                   550                      522               28                5.4 %  Total premiums                                  5,445                    5,051              394                7.8 %  Services                                          174                      182               (8 )             (4.4 )%  Total premiums and services revenue      $      5,619          $         5,233        $     386                7.4 %  Income before income taxes               $        332          $           246        $      86               35.0 % Benefit ratio                                    81.0 %                   81.5 %                              (0.5 )% Operating cost ratio                             15.4 %                   16.5 %                              (1.1 )%   Pretax Results   

• Employer Group segment pretax income increased $10 million, or 8.5%, to

$127 million in the 2013 quarter, and increased $86 million, or 35.0%, to

$332 million in the 2013 period reflecting improved operating performance

over the prior year. This improvement primarily was due to group Medicare

Advantage membership growth and a lower operating cost ratio, as described

          below. In addition, the 2013 period reflects a lower benefit ratio, also          described below.                                            40 

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  Table of Contents  Enrollment   

• Fully-insured commercial group medical membership of 1,196,100 remained

relatively unchanged from June 30, 2012 to June 30, 2013 as an increase in

small group business membership was generally offset by lower membership

          in large group accounts.          •   Fully-insured group Medicare Advantage membership increased 56,100          members, or 15.6%, from June 30, 2012 to June 30, 2013 primarily due to          the January 2013 addition of a new large group retirement account.    

• Effective January 1, 2013 we lost our sole group Medicare Advantage ASO

         account which had 27,900 members at June 30, 2012.    

• Group ASO commercial medical membership decreased 29,200 members, or 2.4%,

from June 30, 2012 to June 30, 2013 primarily due to continued pricing

          discipline in a highly competitive environment for self-funded accounts.          •   Group specialty membership increased 299,000 members, or 4.3%, from

June 30, 2012 to June 30, 2013 primarily due to increased cross-selling of

our specialty products to our medical membership and growth in stand-alone

specialty product sales.

  Premiums         •   Employer Group segment premiums increased $188 million, or 7.5%, from the

2012 quarter to the 2013 quarter, and increased $394 million, or 7.8%,

from the 2012 period to the 2013 period primarily due to higher average

group Medicare Advantage medical membership.

  Benefits expense   

• The Employer Group segment benefit ratio increased 70 basis points from

         81.8% in the 2012 quarter to 82.5% in the 2013 quarter primarily due to          growth in our group Medicare Advantage products which generally carry a

higher benefit ratio than our fully-insured commercial group products,

         partially offset by higher favorable prior-year medical claims reserve          development. In addition, unfavorable timing differences for weekday

seasonality for the 2013 quarter versus the 2012 quarter negatively

         impacted the benefit ratio comparison year-over-year. The Employer Group          segment benefit ratio decreased 50 basis points from 81.5% in the 2012

period to 81.0% in the 2013 period primarily due to higher favorable

prior-year medical claims reserve development in the 2013 period than in

the 2012 period, partially offset by growth in our group Medicare

Advantage products as described above. The Employer Group segment's

benefits expense for the 2013 quarter included the beneficial effect of

$27 million in favorable prior-year medical claims reserve development

versus $12 million in the 2012 quarter. For the 2013 period, the Employer

         Group segment's benefits expense included the beneficial effect of $103          million in favorable prior-year medical claims reserve development versus

$27 million in the 2012 period. These increases in favorable prior-year

medical claims reserve development primarily were driven by claims trend

for prior year ultimately developing more favorably than originally

expected. This favorable prior-year medical claims reserve development

decreased the Employer Group segment benefit ratio by approximately 100

basis points in the 2013 quarter versus approximately 50 basis points in

the 2012 quarter, and by approximately 190 basis points in the 2013 period

versus approximately 50 basis points in the 2012 period.

  Operating costs   

• The Employer Group segment operating cost ratio of 15.3% for the 2013

quarter decreased 100 basis points from the 2012 quarter. For the 2013

period, the Employer Group segment operating cost ratio of 15.4% decreased

110 basis points from the 2012 period. These decreases primarily reflect

continued savings as a result of our operating cost reduction initiatives

and growth in our group Medicare Advantage products which generally carry

         a lower operating cost ratio than our fully-insured commercial group          products.                                            41 

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   Table of Contents  Healthcare Services Segment                                                For the three months ended                                                      June 30,                                  Change                                            2013                   2012              Dollars          Percentage                                                               (in millions) Revenues: Services: Provider services                      $        290          $           243        $     47                19.3 % Home care services                               23                        0              23               100.0 % Pharmacy solutions                               13                        4               9               225.0 %  Total services revenues                         326                      247              79                32.0 %  Intersegment revenues: Pharmacy solutions                            3,212                    2,829             383                13.5 % Provider services                               223                       49             174               355.1 % Home care services                               72                       42              30                71.4 % Integrated behavioral health services                                         31                       30               1                 3.3 %  Total intersegment revenues                   3,538                    2,950             588                19.9 %  Total services and intersegment revenues                               $      3,864          $         3,197        $    667                20.9 %  Income before income taxes             $        131          $           128        $      3                 2.3 % Operating cost ratio                           95.7 %                   95.4 %                               0.3 %                                               For the six months  ended                                                      June 30,                                  Change                                            2013                   2012              Dollars          Percentage                                                               (in millions) Revenues: Services: Provider services                      $        572          $           474        $     98                20.7 % Home care services                               46                        0              46               100.0 % Pharmacy solutions                               22                        8              14               175.0 % Integrated behavioral health services                                          1                        0               1               100.0 %  Total services revenues                         641                      482             159                33.0 %  Intersegment revenues: Pharmacy solutions                            6,297                    5,758             539                 9.4 % Provider services                               450                       99             351               354.5 % Home care services                              132                       78              54                69.2 % Integrated behavioral health services                                         62                       64              (2 )              (3.1 )%  Total intersegment revenues                   6,941                    5,999             942                15.7 %  Total services and intersegment revenues                               $      7,582          $         6,481        $  1,101                17.0 %  Income before income taxes             $        256          $           253        $      3                 1.2 % Operating cost ratio                           95.7 %                   95.5 %                               0.2 %   Pretax results   

• Healthcare Services segment pretax income of $131 million for the 2013

quarter increased $3 million from the 2012 quarter. For the 2013 period,

Healthcare Services segment pretax income of $256 million increased $3

million from the 2012 period. Revenue growth and the pretax income

contribution from the acquisition of Metropolitan and our home care

services business were generally offset by previously-planned investment

         spending associated with the integration and build-out of provider          practices and chronic care centers.                                            42 

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  Table of Contents  Script Volume   

• Script volumes for the Retail and Employer Group segment membership

         increased to approximately 68 million in the 2013 quarter, up 15% versus          scripts of approximately 59 million in the 2012 quarter. For the 2013          period, script volumes for the Retail and Employer Group segment          membership increased to approximately 134 million, up 15% versus scripts

of approximately 117 million in the 2012 period. The year-over-year

increase primarily reflects growth associated with higher average medical

membership for the 2013 quarter and period than in the 2012 quarter and

          period.   Services revenue    

• Services revenue increased $79 million, or 32.0%, from the 2012 quarter to</p>

$326 million for the 2013 quarter and increased $159 million, or 33.0%

from the 2012 period to $641 million for the 2013 period. These increases

are primarily due to the acquisitions of Metropolitan and SeniorBridge as

well as growth in our provider services operations.

  Intersegment revenues   

• Intersegment revenues increased $588 million, or 19.9%, from the 2012

quarter to $3.5 billion for the 2013 quarter and increased $942 million,

or 15.7%, from the 2012 period to $6.9 billion for the 2013 period. These

increases are primarily due to growth in our pharmacy solutions business

as it serves our growing membership, particularly Medicare stand-alone

PDP, and the acquisition of Metropolitan in the fourth quarter of 2012.

   Operating costs    

• The Healthcare Services segment operating cost ratio of 95.7% for the 2013

quarter was relatively unchanged from 95.4% for the 2012 quarter. The

segment's operating cost ratio of 95.7% for the 2013 period was relatively

unchanged from 95.5% for the 2012 period.

Other Businesses

  Pretax loss for our Other Businesses of $30 million for the 2013 quarter declined $26 million from a pretax loss of $56 million for the 2012 quarter. The pretax loss in the 2013 quarter primarily was due to costs associated with the loss of our Medicaid contracts in Puerto Rico described previously. The pretax loss in the 2012 quarter primarily was due to costs incurred in connection with a litigation settlement associated with our military services business. Pretax income for our Other Businesses of $28 million for the 2013 period increased $79 million compared to a loss of $51 million for the 2012 period. The 2013 period includes the beneficial effect of a favorable settlement of contract claims with the DoD primarily associated with the litigation settled in the 2012 period as described above.  Liquidity  Our primary sources of cash include receipts of premiums, services revenues, and investment and other income, as well as proceeds from the sale or maturity of our investment securities and borrowings. Our primary uses of cash include disbursements for claims payments, operating costs, interest on borrowings, taxes, purchases of investment securities, acquisitions, capital expenditures, repayments on borrowings, dividends, and share repurchases. Because premiums generally are collected in advance of claim payments by a period of up to several months, our business normally should produce positive cash flows during periods of increasing premiums and enrollment. Conversely, cash flows would be negatively impacted during periods of decreasing premiums and enrollment. From period to period, our cash flows may also be affected by the timing of working capital items. The use of operating cash flows may be limited by regulatory requirements which require, among other items, that our regulated subsidiaries maintain minimum levels of capital and seek approval before paying dividends from the subsidiaries to the parent.  

For additional information on our liquidity risk, please refer to the section entitled "Risk Factors" in our 2012 Form 10-K.

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Cash and cash equivalents increased to $1.5 billion at June, 2013 from $1.3 billion at December 31, 2012. The change in cash and cash equivalents for the six months ended June 30, 2013 and 2012 is summarized as follows:

                                                           2013        2012                                                           (in millions)            Net cash provided by operating activities   $  585$ 3,052            Net cash used in investing activities         (148 )       (339 )            Net cash provided by financing activities     (224 )       (221 )             Increase in cash and cash equivalents       $  213$ 2,492

Cash Flow from Operating Activities

  Our operating cash flows for the 2012 period were significantly impacted by the early receipt of the Medicare premium remittance for July 2012 of $2.1 billion in June 2012 because the payment date of July 1, 2012 fell on a weekend. Generally, when the first day of a month falls on a weekend or holiday, with the exception of January 1 (New Year's Day), we receive this payment at the end of the previous month. Therefore, the 2012 period included seven monthly Medicare payments compared to only six monthly Medicare payments during the 2013 period. This also resulted in an increase to unearned revenues in our condensed consolidated balance sheet at June 30, 2012.  

Excluding the impact from the timing of the Medicare premium receipt, the decrease in operating cash flows from the 2012 period to the 2013 period primarily results from the timing of working capital items, partially offset by higher earnings.

  Comparisons of our operating cash flows also are impacted by other changes in our working capital. The most significant drivers of changes in our working capital are typically the timing of payments of benefits expense and receipts for premiums. We illustrate these changes with the following summaries of benefits payable and receivables.  The detail of benefits payable was as follows at June 30, 2013 and December 31, 2012:                                                                                       2013           2012                                              June 30,        December 31,         Period         Period                                                2013              2012             Change         Change                                                                    (in millions) IBNR (1)                                    $    2,767$       2,552$    215$   385 Reported claims in process (2)                     483                 315            168            146 Other benefits payable (3)                         907                 912             (5 )         (291 )  Total benefits payable                      $    4,157$       3,779            378            240  Reconciliation to cash flow statement: Payables from acquisition                                                               0            (70 )  Change in benefits payable per cash flow statement resulting in cash from operations                                                                       $    378$   170

(1) IBNR represents an estimate of benefits payable for claims incurred but not

reported (IBNR) at the balance sheet date. The level of IBNR is primarily

impacted by membership levels, medical claim trends and the receipt cycle

time, which represents the length of time between when a claim is initially

incurred and when the claim form is received (i.e. a shorter time span

results in a lower IBNR).

(2) Reported claims in process represents the estimated valuation of processed

    claims that are in the post claim adjudication process, which consists of     administrative functions such as audit and check batching and handling, as

well as amounts owed to our pharmacy benefit administrator which fluctuate

due to bi-weekly payments and the month-end cutoff.

(3) Other benefits payable include amounts owed to providers under capitated and

risk sharing arrangements.

The increase in benefits payable from December 31, 2012 to June 30, 2013 primarily was due to an increase in IBNR, primarily as a result of Medicare Advantage membership growth, and an increase in the amount of processed but unpaid claims, including amounts due to our pharmacy benefit administrator which fluctuate due to month-end

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  cutoff. The increase in benefits payable from December 31, 2011 to June 30, 2012 primarily was due to the same factors resulting in the increase in benefits payable from December 31, 2012 to June 30, 2013 described above, as well as a $262 million decrease in the Military services benefits payable due to the run-out of claims under the previous TRICARE South Region contract that expired on March 31, 2012. Under the current contract effective April 1, 2012, the federal government retains the risk of the cost of health benefits and related benefit obligation.  The detail of total net receivables was as follows at June 30, 2013 and December 31, 2012:                                                                                        2013          2012                                               June 30,        December 31,         Period        Period                                                 2013              2012             Change        Change                                                                     (in millions) Medicare                                     $    1,208       $         422       $    786$   140 Healthcare services and other                       388                 346             42            28 Military services                                   106                  59             47          (300 ) Allowance for doubtful accounts                    (109 )               (94 

) (15 ) (4 )

  Total net receivables                        $    1,593       $         733            860          (136 )  Reconciliation to cash flow statement: Receivables from acquisition                                                             0           (41 )  Change in receivables per cash flow statement resulting in cash from operations                                                                        $    860$  (177 )Medicare receivables are impacted by the timing of accruals and related collections associated with the CMS risk-adjustment model. The increase in Medicare receivables at June 30, 2013 reflects an increase in Medicare risk-adjustment revenue receivable. In the 2012 period, we received the mid-year Medicare risk-adjustment payment early in June 2012 due to the early receipt of the July 2012 CMS payment as discussed previously, reducing our receivable balance. This early receipt impacts the comparison of the 2013 period change in Medicare receivables of $786 million to the 2012 period change of $140 million in the table above. In connection with our July 2013 payment from CMS, we collected $494 million associated with the mid-year Medicare risk-adjustment payment.  Military services receivables at June 30, 2013 and December 31, 2012 consist of administrative services only fees owed from the federal government for administrative services provided under our current TRICARE South Region contract and final settlement balances due under our previous TRICARE South Region contract that expired on March 31, 2012. The $300 million decrease in Military services receivables from December 31, 2011 to June 30, 2012 primarily resulted from the transition to our current TRICARE South Region contract. As disclosed previously, we account for our current TRICARE South Region contract similar to an administrative services fee only agreement. As such, beginning April 1, 2012, payments of the federal government's claims and related reimbursements for the current TRICARE South Region contract are classified with receipts (withdrawals) from contract deposits as a financing item in our consolidated statements of cash flows.  In addition to the timing of receipts for premiums and services revenues and payments of benefits expense, other working capital items impacting operating cash flows primarily resulted from the timing of payments for the Medicare Part D risk corridor provisions of our contracts with CMS and changes in the timing of the collection of pharmacy rebates.  

Cash Flow from Investing Activities

  Our ongoing capital expenditures primarily relate to our information technology initiatives, support of services in our provider services operations including medical and administrative facility improvements necessary for activities such as the provision of care to members, claims processing, billing and collections, wellness solutions, care coordination, regulatory compliance and customer service. Total capital expenditures, excluding acquisitions, were $187 million in the 2013 period and $185 million in the 2012 period. Excluding acquisitions, we expect total capital expenditures in 2013 in a range of approximately $425 million to $450 million.  

Cash consideration paid for acquisitions, net of cash acquired, of $76 million in the 2012 period primarily relates to the acquisition of Arcadian.

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Cash Flow from Financing Activities

  Receipts from CMS associated with Medicare Part D claim subsidies for which we do not assume risk were $144 million higher than claims payments during the 2013 period and $208 million higher than claims payments during the 2012 period. Under our current administrative services only TRICARE South Region contract that began April 1, 2012, health care cost payments for which we do not assume risk exceeded reimbursements from the federal government by $12 million during the 2013 period and $56 million during the 2012 period.  We repurchased 2.83 million shares of our common stock for $211 million in the 2013 period and 2.73 million shares of our common stock for $226 million in the 2012 period under share repurchase plans authorized by the Board of Directors. We also acquired shares of our common stock in connection with employee stock plans for an aggregate cost of $20 million in the 2013 period and $52 million in the 2012 period.  

During the 2013 period, we paid dividends to stockholders of $83 million compared to $82 million in the 2012 period as discussed further below.

In March 2012, we repaid, without penalty, junior subordinated long-term debt of $36 million.

Future Sources and Uses of Liquidity

Dividends

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

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

                Record            Payment          Amount            Total              Date                Date         per Share          Amount                                                               (in millions)              2012 payments              12/30/2011         1/31/2012     $     0.25     $            41              3/30/2012          4/27/2012     $     0.25     $            41              6/29/2012          7/27/2012     $     0.26     $            42              9/28/2012         10/26/2012     $     0.26     $            41               2013 payments              12/31/2012         1/25/2013     $     0.26     $            42              3/28/2013          4/26/2013     $     0.26     $            41              6/28/2013          7/26/2013     $     0.27     $            42   Stock Repurchases  In April 2013, the Board of Directors replaced its previously approved share repurchase authorization of up to $1 billion (of which $557 million remained unused) with the current authorization for repurchases of up to $1 billion of our common shares exclusive of shares repurchased in connection with employee stock plans, expiring on June 30, 2015. Under the current share repurchase authorization, shares may be purchased from time to time at prevailing prices in the open market, by block purchases, or in privately-negotiated transactions, subject to certain regulatory restrictions on volume, pricing, and timing. During the 2012 period, we repurchased 2.73 million shares in open market transactions for $226 million at an average price of $82.78 under previously approved share repurchase authorizations. During the 2013 period, we repurchased 1.22 million shares in open market transactions for $82 million at an average price of $67.59 under a previously approved share repurchase authorization and we repurchased 1.61 million shares in open market transactions for $129 million at an average price of $80.06 under the current authorization. As of July 31, 2013, the remaining authorized amount under the current authorization totaled $871 million.                                           46 

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

Senior Notes

  In December 2012, we issued $600 million of 3.15% senior notes due December 1, 2022 and $400 million of 4.625% senior notes due December 1, 2042. Our net proceeds, reduced for the discount and cost of the offering, were $990 million. We used the proceeds from the offering primarily to finance the acquisition of Metropolitan, including the retirement of Metropolitan's indebtedness, and to pay related fees and expenses. We previously issued $500 million of 6.45% senior notes due June 1, 2016, $500 million of 7.20% senior notes due June 15, 2018, $300 million of 6.30% senior notes due August 1, 2018, and $250 million of 8.15% senior notes due June 15, 2038. The 7.20% and 8.15% senior notes are subject to an interest rate adjustment if the debt ratings assigned to the notes are downgraded (or subsequently upgraded). In addition, our 7.20%, 8.15%, 3.15%, and 4.625% senior notes contain a change of control provision that may require us to purchase the notes under certain circumstances. All six series of our senior notes, which are unsecured, may be redeemed at our option at any time at 100% of the principal amount plus accrued interest and a specified make-whole amount.  

Credit Agreement

  In July 2013, we amended and restated our 5-year $1.0 billion unsecured revolving agreement which was set to expire in November 2016 and replaced it with a new 5-year $1.0 billion unsecured revolving agreement expiring July 2018. Under the new credit agreement, at our option, we can borrow on either a competitive advance basis or a revolving credit basis. The revolving credit portion bears interest at either LIBOR plus a spread or the base rate plus a spread. The LIBOR spread, currently 110 basis points, varies depending on our credit ratings ranging from 90.0 to 150.0 basis points. We also pay an annual facility fee regardless of utilization. This facility fee, currently 15.0 basis points, may fluctuate between 10.0 and 25.0 basis points, depending upon our credit ratings. The competitive advance portion of any borrowings will bear interest at market rates prevailing at the time of borrowing on either a fixed rate or a floating rate based on LIBOR, at our option.  The terms of the credit agreement include standard provisions related to conditions of borrowing, including a customary material adverse effect clause which could limit our ability to borrow additional funds. In addition, the credit agreement contains customary restrictive and financial covenants as well as customary events of default, including financial covenants regarding the maintenance of a minimum level of net worth of $7.1 billion at June 30, 2013 and a maximum leverage ratio of 3.0:1. We are in compliance with the financial covenants, with actual net worth of $9.3 billion and an actual leverage ratio of 0.9:1, as measured in accordance with the credit agreement as of June 30, 2013. In addition, the credit agreement includes an uncommitted $250 million incremental loan facility.  At June 30, 2013, we had no borrowings outstanding under the previous credit agreement and we had outstanding letters of credit of $5.5 million secured under that credit agreement. No amounts have been drawn on these letters of credit. Accordingly, as of June 30, 2013, we had $994.5 million of remaining borrowing capacity under the previous credit agreement, none of which would be restricted by our financial covenant compliance requirement. We have other customary, arms-length relationships, including financial advisory and banking, with some parties to the credit agreement.  

Other Long-Term Borrowings

In March 2012, we repaid, without penalty, junior subordinated debt of $36 million. Prior to repayment, the junior subordinated debt bore a fixed annual interest rate of 8.02% payable quarterly until 2012, and then payable at a floating rate based on LIBOR plus 310 basis points.

Liquidity Requirements

  We believe our cash balances, investment securities, operating cash flows, and funds available under our credit agreement or from other public or private financing sources, taken together, provide adequate resources to fund ongoing operating and regulatory requirements, acquisitions, future expansion opportunities, and capital expenditures for at least the next twelve months, as well as to refinance or repay debt, and repurchase shares.                                           47

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  Adverse changes in our credit rating may increase the rate of interest we pay and may impact the amount of credit available to us in the future. A downgrade by S&P to BB+ or by Moody's to Ba1 triggers an interest rate increase of 25 basis points with respect to $750 million of our senior notes. Successive one notch downgrades increase the interest rate an additional 25 basis points, or annual interest expense by $2 million, up to a maximum 100 basis points, or annual interest expense by $8 million. Our investment-grade credit rating at June 30, 2013 was BBB according to Standard & Poor's Rating Services, or S&P, and Baa3 according to Moody's Investors Services, Inc., or Moody's. On July 17, 2013, S&P raised our investment-grade credit rating to BBB+.  In addition, we operate as a holding company in a highly regulated industry. Humana Inc., our parent company, is dependent upon dividends and administrative expense reimbursements from our subsidiaries, most of which are subject to regulatory restrictions. We continue to maintain significant levels of aggregate excess statutory capital and surplus in our state-regulated operating subsidiaries. Cash, cash equivalents, and short-term investments at the parent company were $883 million at June 30, 2013 compared to $346 million at December 31, 2012. As described above in the section titled "Health Care Reform," the NAIC is continuing discussions regarding the accounting for the health insurance industry fee required by the Health Care Reform Law and may require surplus reductions in the year preceding payment, beginning in 2014. Accordingly, in 2014 we may be required to reduce surplus for both the 2014 and 2015 assessments. The NAIC guidance is contradictory to final GAAP guidance issued by the FASB in July 2011, which requires annual accrual of the health insurance industry fee in the year in which it is payable.  

Regulatory Requirements

  Certain of our subsidiaries operate in states that regulate the payment of dividends, loans, or other cash transfers to Humana Inc., our parent company, and require minimum levels of equity as well as limit investments to approved securities. The amount of dividends that may be paid to Humana Inc. by these subsidiaries, without prior approval by state regulatory authorities, or ordinary dividends, is limited based on the entity's level of statutory income and statutory capital and surplus. In most states, prior notification is provided before paying a dividend even if approval is not required. Actual dividends paid may vary due to consideration of excess statutory capital and surplus and expected future surplus requirements related to, for example, premium volume and product mix.  Although minimum required levels of equity are largely based on premium volume, product mix, and the quality of assets held, minimum requirements vary significantly at the state level. Based on the most recently filed statutory financial statements as of March 31, 2013, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $5.6 billion, which exceeded aggregate minimum regulatory requirements of $3.2 billion. The amount of dividends that were paid to our parent company in the 2013 period was approximately $967 million, a decrease of approximately $230 million compared to dividends that were paid for the full year 2012 of approximately $1.2 billion. The year-over-year decline primarily is a result of higher surplus requirements associated with premium growth.                                           48

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