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," "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 2011 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 24, 2012, 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 benefit expenses 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

  We manage our business with three reportable segments: Retail, Employer Group, and Health and Well-Being 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 well-being solutions for our health plans and other customers, as described below. These segment groupings are consistent with information used by our Chief Executive Officer to assess performance and allocate resources.  The Retail segment consists of Medicare 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. 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 marketed to employer groups. The Health and Well-Being Services segment includes services offered to our health plan members as well as to third parties that promote health and wellness, including primary care, pharmacy, integrated wellness, and home care services. The Other Businesses category consists of our Military services, primarily our TRICARE South Region contract, Medicaid, and closed-block long-term care businesses as well as our contract with CMS to administer the Limited Income Newly Eligible Transition program, or the LI-NET program.                                           25

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

 2012 Highlights  Consolidated   

• Our results for the three and nine months ended September 30, 2012, were

         significantly impacted by a higher benefit ratio. The consolidated benefit          ratio increased 150 basis points to 82.2% for the three months ended          September 30, 2012 and increased 150 basis points to 83.7% for the nine

months ended September 30, 2012 compared to the same periods in 2011. The

increases primarily were due to increases in the Retail segment benefit

         ratios primarily associated with our individual Medicare Advantage          products discussed in our Retail segment highlights that follow.    

• Comparisons to 2011 are impacted by benefit expenses incurred related to

the settlement of litigation associated with our Military services

business during the nine months ended September 30, 2012 and favorable

prior-year medical claims reserve development not in the ordinary course

of business that was higher in the three months ended September 30, 2012

than in the three months ended September 30, 2011 and lower in the nine

months ended September 30, 2012 than in the nine months end September 30,

          2011.          •   As announced in March 2012, we entered into a strategic alliance with

CareSource to more effectively serve Medicare and Medicaid beneficiaries -

particularly people who qualify for both the federal Medicare program and

state-based Medicaid programs. In August 2012, the Ohio Department of Job

and Family Services announced that the alliance would be serving people

who qualify for both Medicaid and Medicare in three Ohio regions as part

of the state's new Integrated Care Delivery System. On October 4, 2012, we

announced that we had been selected by the Kentucky Cabinet of Health and

Family Services to participate in its comprehensive managed Medicaid

program for Medicaid recipients residing in a 16-county region including

Louisville, Kentucky, the state's largest city.                                            26 

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  Table of Contents  Retail   

• As discussed in the detailed Retail segment results of operations

         discussion that follows, we experienced a significant increase in the          benefit ratio in the Retail segment, with the segment's benefit ratio          increasing 360 basis points to 82.3% for the three months ended

September 30, 2012 and increasing 270 basis points to 84.6% for the nine

months ended September 30, 2012. These increases primarily were due to a

planned increase in the target benefit ratio associated with positioning

for Health Insurance Reform Legislation funding changes and minimum

benefit ratio requirements and a higher individual Medicare Advantage

benefit ratio experienced on new membership than the assumptions used in

         our 2012 Medicare bids.    

• Individual Medicare Advantage membership of 1,911,800 at September 30,

2012 increased 271,500 members, or 16.6%, from 1,640,300 at December 31,

         2011 and increased 298,400 members, or 18.5%, from 1,613,400 at          September 30, 2011 primarily due to the annual enrollment period          associated with the 2012 plan year. We acquired approximately 62,600

members with <org value="ACORN:1503192772" idsrc="xmltag.org">Arcadian Management Services, Inc., or Arcadian, effective

March 31, 2012, discussed below, and 12,100 members with another          acquisition effective December 30, 2011.          •   Individual Medicare stand-alone PDP membership of 2,947,200 at

September 30, 2012 increased 406,800 members, or 16.0%, from 2,540,400 at

December 31, 2011 and increased 469,100, or 18.9%, from 2,478,100 at

September 30, 2011, primarily due to growth in our national stand-alone

Medicare Part D prescription drug plan co-branded with Wal-Mart Stores,

         Inc., the Humana Walmart-Preferred Rx Plan.    

• Effective March 31, 2012, we acquired Arcadian, a Medicare Advantage HMO

serving members in 15 U.S. states, increasing our Medicare membership by

approximately 62,600 members and expanding our Medicare footprint and

future growth opportunities. To obtain antitrust approval in connection

with the Arcadian acquisition, we entered into a consent agreement with

the United States Department of Justice that will require divestiture of

         overlapping Medicare Advantage health plan business in eight areas within          Arizona, Arkansas, Louisiana, Oklahoma, and Texas. We expect that the          divestitures, anticipated to include approximately 12,600 members, would          be effective January 1, 2013.    

• On April 2, 2012, CMS announced that it is estimating an annual payment

benchmark growth rate for Medicare of 3.07% for 2013. Together with other

         technical components of the rate change from CMS, we estimate that our          average 2013 premium rate change from CMS will be relatively flat. We

believe we can effectively design Medicare Advantage products based upon

this level of rate increase 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.

         In addition, we will continue to pursue our cost-reduction and          outcome-enhancing strategies, including care coordination and disease          management, which we believe will mitigate the adverse effects of the          rates on our Medicare Advantage members. Nonetheless, there can be no          assurance that we will be able to successfully execute operational and

strategic initiatives with respect to changes in the Medicare Advantage

program. Failure to execute these strategies may result in a material

adverse effect on our results of operations, financial position, and cash

          flows.   Employer Group Segment    

• Fully-insured group Medicare Advantage membership of 367,900 at

September 30, 2012 increased 77,300 members, or 26.6%, from 290,600 at

December 31, 2011 and increased 80,000 members, or 27.8%, from 287,900 at

September 30, 2011 primarily due to the January 2012 addition of a new          large group account.  

Health and Well-Being Services Segment

• On November 5, 2012, we announced that we had entered into a definitive

agreement to acquire Metropolitan Health Networks, Inc., or Metropolitan,

a Management Services Organization, or MSO, that coordinates medical care

for Medicare Advantage and Medicaid beneficiaries primarily in Florida.

Under the terms of the agreement, we will pay $11.25 per share in cash to

acquire all of the outstanding shares of Metropolitan and repay all

outstanding debt for an estimated transaction value of approximately $850

million plus transaction expenses. The closing of the transaction is

subject to Metropolitan shareholder approval as well as federal and state

regulatory approval and is expected to close by the end of the first

quarter of 2013. We expect to finance this transaction with a combination

of cash and debt.

   In October 2012, we acquired a noncontrolling equity interest in MCCI Holdings, LLC, or MCCI, an MSO headquartered in Miami, Florida that coordinates medical care for Medicare Advantage and Medicaid beneficiaries primarily in Florida and Texas.                                           27 

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<p> The Metropolitan and MCCI transactions are expected to provide us with

proven integrated care delivery models that have demonstrated scalability

       to new markets. A substantial portion of the revenues for both        Metropolitan and MCCI are derived from services provided to defined sets        of Humana Medicare Advantage members under capitation contracts with our

health plans. Under these capitation agreements with Humana, Metropolitan

and MCCI assume financial risk associated with these Medicare Advantage

        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    

• On April 1, 2012, we began delivering services under the new TRICARE South

Region contract that the Department of Defense TRICARE Management

Activity, or TMA, awarded to us on February 25, 2011. The new 5-year South

Region contract, which expires March 31, 2017, is subject to annual

renewals on April 1 of each year during its term at the government's

option. We account for revenues under the new contract net of estimated

health care costs similar to an administrative services fee only

         agreement.   Health Insurance 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 Insurance Reform Legislation) enacted significant reforms to various aspects of the U.S. health insurance industry. While regulations and interpretive guidance on some provisions of the Health Insurance Reform Legislation have been issued to date by the Department of Health and Human Services (HHS), the Department of Labor, the Treasury Department, and the National Association of Insurance Commissioners, there are many significant provisions of the legislation that will require additional guidance and clarification in the form of regulations and interpretations in order to fully understand the impacts of the legislation on our overall business, which we expect to occur over the next several years.  

Implementation dates of the Health Insurance Reform Legislation vary from September 23, 2010 to as late as 2018. The following outlines certain provisions of the Health Insurance Reform Legislation:

• 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

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.          •   Effective January 1, 2011, minimum benefit ratios were mandated for all

         commercial fully-insured medical plans in the large group (85%), small          group (80%), and individual (80%) markets, with annual rebates to          policyholders if the actual benefit ratios, calculated in a manner          prescribed by HHS, do not meet these minimums. Certain states were

approved to apply an individual threshold lower than the 80% requirement

temporarily to avoid market disruption. We began accruing for rebates in

2011, based on the manner prescribed by HHS, with initial rebate payments

made in July 2012. 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

Insurance Reform Legislation. The more noteworthy differences include the

fact that the benefit ratio calculations prescribed by HHS are calculated

separately by state and legal entity; 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; treat changes in reserves differently than GAAP;

and classify rebate amounts as additions to incurred claims as opposed to

         adjustments to premiums for GAAP reporting.    

• Medicare Advantage payment benchmarks for 2011 were frozen at 2010 levels

         and in 2012, additional cuts to Medicare Advantage plan payments took          effect (plans receive a range of 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, in 2011 the gap in coverage for          Medicare Part D prescription drug coverage began to incrementally close.                                            28 

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• Beginning in 2014, the Health Insurance Reform Legislation 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

plans; the establishment of 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 standardized plan

designs based on set actuarial values; the establishment of a minimum

benefit ratio of 85% for Medicare plans; and insurance industry

assessments, including an annual premium-based assessment and a three-year

$25 billion commercial reinsurance fee. The annual premium-based

assessment 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 Health Insurance Reform Legislation also specifies required benefit designs, limits rating and pricing practices, encourages additional competition (including potential incentives for new market entrants) and expands eligibility for Medicaid programs. In addition, the law will significantly 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 and other health insurers, 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.  In addition, certain provisions in the Health Insurance Reform Legislation 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) are eligible for a quality bonus in their basic premium rates. Initially quality bonuses were limited to the few plans that achieved four or more stars as an overall rating, but CMS has expanded the quality bonus to three Star plans for a three year period through 2014. Recent Star Ratings issued by CMS 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, with 40% of our Medicare Advantage members in plans with an overall Star Rating of four or more stars, including one five star plan, exclusive of those recently acquired, including Arcadian. 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.  As discussed above, implementing regulations and related interpretive guidance continue to be issued on several significant provisions of the Health Insurance Reform Legislation. Congress may also withhold the funding necessary to implement the Health Insurance Reform Legislation, or may attempt to replace the legislation with amended provisions or repeal it altogether. 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 Insurance Reform Legislation could change the way we do business, potentially impacting our pricing, benefit design, product mix, geographic mix, and distribution channels. In particular, implementing regulations and related guidance are forthcoming on various aspects of the minimum benefit ratio requirement's applicability to Medicare, including aggregation, credibility thresholds, and its possible application to prescription drug plans. The response of other companies to the Health Insurance Reform Legislation and adjustments to their offerings, if any, could cause meaningful disruption in the local health care markets. Further, various health insurance reform proposals are also emerging at the state level. It is reasonably possible that the Health Insurance Reform Legislation 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 federal premium tax 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 federal premium tax 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 federal premium tax and other assessments would not have a material adverse effect on our results of operations, financial position, and cash flows.                                           29 

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  We intend for the discussion of our financial condition and results of operations that follows to assist in the understanding of our financial statements and related changes in certain key items in those financial statements from year to year, including the primary factors that accounted for those changes. Transactions between reportable segments primarily consist of sales of services rendered by our Health and Well-Being Services segment, primarily pharmacy and behavioral health services, to our Retail and Employer Group customers and are described in Note 12 to the condensed consolidated financial statements.                                           30 

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Comparison of Results of Operations for 2012 and 2011

  The following discussion primarily deals with our results of operations for the three months ended September 30, 2012, or the 2012 quarter, the three months ended September 30, 2011, or the 2011 quarter, the nine months ended September 30, 2012, or the 2012 period, and the nine months ended September 30, 2011, or the 2011 period.  Consolidated                                                     For the three months ended                                                         September 30,                                       Change                                              2012                          2011                  Dollars           Percentage                                              (dollars in millions, except per common share results) Revenues: Premiums: Retail                                 $           6,138             $           5,399          $     739                 13.7 % Employer Group                                     2,552                         2,225                327                 14.7 % Other Businesses                                     398                         1,228               (830 )              (67.6 )%  Total premiums                                     9,088                         8,852                236                  2.7 %  Services: Retail                                                 6                             5                  1                 20.0 % Employer Group                                        88                            89                 (1 )               (1.1 )% Health and Well-Being Services                       274                           236                 38                 16.1 % Other Businesses                                      99                            26                 73                280.8 %  Total services                                       467                           356                111                 31.2 %  Investment income                                     96                            93                  3                  3.2 %  Total revenues                                     9,651                         9,301                350                  3.8 %  Operating expenses: Benefits                                           7,467                         7,147                320                  4.5 % Operating costs                                    1,408                         1,361                 47                  3.5 % Depreciation and amortization                         75                            67                  8                 11.9 %  Total operating expenses                           8,950                         8,575                375                  4.4 %  Income from operations                               701                           726                (25 )               (3.4 )% Interest expense                                      26                            27                 (1 )               (3.7 )%  Income before income taxes                           675                           699                (24 )               (3.4 )% Provision for income taxes                           249                           254                 (5 )               (2.0 )%  Net income                             $             426             $             445          $     (19 )               (4.3 )%  Diluted earnings per common share      $            2.62             $            2.67          $   (0.05 )               (1.9 )%  Benefit ratio(a)                                    82.2 %                        80.7 %                                   1.5 % Operating cost ratio(b)                             14.7 %                        14.8 %                                  (0.1 )% Effective tax rate                                  36.9 %                        36.3 %                                   0.6 %    

(a) Represents total benefit expenses as a percentage of premiums revenue.

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

    investment income.                                            31 

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   Table of Contents                                                For the nine months  ended                                                      September 30,                                    Change                                              2012                        2011               Dollars           Percentage                                            (dollars in millions, except per common share results) Revenues: Premiums: Retail                                $            18,445            $      16,100        $      2,345               14.6 % Employer Group                                      7,603                    6,668                 935               14.0 % Other Businesses                                    1,981                    3,700              (1,719 )            (46.5 )%  Total premiums                                     28,029                   26,468               1,561                5.9 %  Services: Retail                                                 17                       12                   5               41.7 % Employer Group                                        266                      269                  (3 )             (1.1 )% Health and Well-Being Services                        760                      678                  82               12.1 % Other Businesses                                      208                       76                 132              173.7 %  Total services                                      1,251                    1,035                 216               20.9 %  Investment income                                     289                      273                  16                5.9 %  Total revenues                                     29,569                   27,776               1,793                6.5 %  Operating expenses: Benefits                                           23,469                   21,761               1,708                7.8 % Operating costs                                     4,175                    3,810                 365                9.6 % Depreciation and amortization                         218                      201                  17                8.5 %  Total operating expenses                           27,862                   25,772               2,090                8.1 %  Income from operations                              1,707                    2,004                (297 )            (14.8 )% Interest expense                                       78                       82                  (4 )             (4.9 )%  Income before income taxes                          1,629                    1,922                (293 )            (15.2 )% Provision for income taxes                            599                      702                (103 )            (14.7 )%  Net income                            $             1,030            $       1,220        $       (190 )            (15.6 )%  Diluted earnings per common share     $              6.27            $        7.24        $      (0.97 )            (13.4 )%  Benefit ratio(a)                                     83.7 %                   82.2 %                                  1.5 % Operating cost ratio(b)                              14.3 %                   13.9 %                                  0.4 % Effective tax rate                                   36.8 %                   36.5 %                                  0.3 %    

(a) Represents total benefit expenses as a percentage of premiums revenue.

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

    investment income.   Summary  Net income was $426 million, or $2.62 per diluted common share, in the 2012 quarter compared to $445 million, or $2.67 per diluted common share, in the 2011 quarter. Net income was $1.0 billion, or $6.27 per diluted common share, in the 2012 period compared to $1.2 billion, or $7.24 per diluted common share, in the 2011 period. The decreases primarily were due to lower operating results in the Retail segment, partially offset by improved operating results in the Health and Well-Being Services segment. During the 2012 quarter and period, we experienced a significant increase in the Retail segment benefit ratio primarily associated with our individual Medicare Advantage products primarily due to a planned increase in the target benefit ratio associated with positioning for Health Insurance Reform Legislation funding changes and minimum benefit ratio requirements and a higher benefit ratio experienced on new membership than the assumptions used in our 2012 Medicare bids. Our diluted earnings per common share for the 2012 period included $0.18 per diluted common share for benefit expenses related to the settlement of a litigation matter associated with our Military services business. In addition,                                           32

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  our diluted earnings per common share included the beneficial impact of favorable prior-year medical claims reserve development of approximately $0.21 per diluted common share for the 2012 quarter compared to $0.13 per diluted common share for the 2011 quarter. For the 2012 period, our diluted earnings per common share included the beneficial impact of favorable prior-year medical claims reserve development of approximately $0.39 per diluted common share compared to $0.57 per diluted common share for the 2011 period.  

Premiums

  Consolidated premiums increased $236 million, or 2.7%, from the 2011 quarter to $9.1 billion for the 2012 quarter, and increased $1.6 billion, or 5.9%, from the 2011 period to $28.0 billion for the 2012 period. These increases primarily were due to increases in both Retail and Employer Group segment premiums primarily driven by higher average individual and group Medicare Advantage membership, partially offset by lower premiums for our Other Businesses due to the transition to the new TRICARE South Region contract. As discussed previously, on April 1, 2012, we began delivering services under the new TRICARE South Region contract that the TMA awarded to us on February 25, 2011. We account for revenues under the new contract net of estimated healthcare costs similar to an administrative services fee only agreement, and as such there are no premiums recognized under the new 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 increases in 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 $111 million, or 31.2%, from the 2011 quarter to $467 million for the 2012 quarter, and increased $216 million, or 20.9%, from the 2011 period to $1.3 billion for the 2012 period. These increases primarily were due to increased services revenue for our Other Businesses due to the transition to the new TRICARE South Region contract on April 1, 2012 discussed above, and an increase in services revenue in our Health and Well-Being Services segment from growth in our Concentra operations and the acquisition of SeniorBridge on July 6, 2012.  

Investment Income

  Investment income totaled $96 million for the 2012 quarter, an increase of $3 million from the 2011 quarter. For the 2012 period, investment income totaled $289 million, an increase of $16 million, or 5.9%, from the 2011 period. These increases primarily reflect capital gains realized in the 2012 quarter and period.  

Benefit Expenses

  Consolidated benefit expenses were $7.5 billion for the 2012 quarter, an increase of $320 million, or 4.5%, from the 2011 quarter. For the 2012 period, consolidated benefit expenses were $23.5 billion, an increase of $1.7 billion, or 7.8%, from the 2011 period. These increases primarily were due to an $800 million, or 18.8%, increase in Retail segment benefit expenses from the 2011 quarter to the 2012 quarter, and a $2.4 billion, or 18.3%, increase in Retail segment benefit expenses from the 2011 period to the 2012 period, primarily driven by an increase in the average number of individual Medicare members. These increases were partially offset by a decrease in benefit expenses for Other Businesses primarily due to the transition to the new administrative services only TRICARE South Region contract on April 1, 2012. We do not record benefit expenses under the new contract.  The consolidated benefit ratio for the 2012 quarter was 82.2%, a 150 basis point increase from the 2011 quarter. The consolidated benefit ratio for the 2012 period was 83.7%, a 150 basis point increase from the 2011 period. These increases primarily were due to increases in both the Retail and Employer Group segments benefit ratios as described further in our segment results discussion that follows. Year-over-year quarterly comparisons of the consolidated benefit ratio were favorably impacted by 20 basis points and year-over-year period comparisons were favorably impacted by 30 basis points due to the continued growth of our Health & Well-Being Services segment and the related savings realized on a consolidated basis from providing these services directly to our members at fair market value rather than through a third party.                                           33

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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 $47 million, or 3.5%, during the 2012 quarter compared to the 2011 quarter, and increased $365 million, or 9.6%, during the 2012 period compared to the 2011 period. The increases primarily were due to an increase in operating costs in our Retail Segment as a result of Medicare Advantage growth.  The consolidated operating cost ratio for the 2012 quarter was 14.7%, improving 10 basis points from the 2011 quarter primarily reflecting substantially improved operating leverage nearly offset by the impact of the new TRICARE South Region contract being accounted for as an administrative services fee only arrangement. For the 2012 period the consolidated operating cost ratio was 14.3%, increasing 40 basis points from the 2011 period as the negative impact of the new TRICARE South Region contract being accounted for as an administrative services fee only arrangement was partially offset by improved operating leverage.  

Depreciation and Amortization

  Depreciation and amortization for the 2012 quarter totaled $75 million, an increase of $8 million, or 11.9%, from the 2011 quarter. For the 2012 period, depreciation and amortization of $218 million increased $17 million, or 8.5%, from the 2011 period. These increases primarily were due to increased amortization expense in the 2012 quarter and period as a result of the acquisitions of Anvita in the fourth quarter of 2011, Arcadian in the first quarter of 2012, and other health and wellness businesses during 2012.  

Interest Expense

  Interest expense was $26 million for the 2012 quarter compared to $27 million for the 2011 quarter. Interest expense was $78 million for the 2012 period compared to $82 million for the 2011 period. In March 2012, we repaid $36 million of junior subordinated debt that carried a higher interest rate than our senior notes.  Income Taxes 

Our effective tax rate during the 2012 quarter was 36.9%, comparable to the effective tax rate of 36.3% in the 2011 quarter. For the 2012 period, our effective tax rate was 36.8%, comparable to the effective tax rate of 36.5% in the 2011 period.

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  Table of Contents  Retail Segment                                                       September 30,                        Change                                                2012             2011           Members       Percentage Membership:  Medical membership: Individual Medicare Advantage                 1,911,800        1,613,400        298,400             18.5 % Individual Medicare stand-alone PDP           2,947,200        2,478,100        469,100             18.9 %  Total individual Medicare                     4,859,000        4,091,500        767,500             18.8 % Individual commercial                           518,600          480,700         37,900              7.9 %  Total individual medical members              5,377,600        4,572,200        805,400             17.6 %  Individual specialty membership (a)             940,800          755,600        185,200             24.5 %     

(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                                                   September 30,                              Change                                            2012                 2011              Dollars          Percentage                                                             (in millions) Premiums and Services Revenue: Premiums: Individual Medicare Advantage           $     5,203        $         4,566        $    637                14.0 % Individual Medicare stand-alone PDP             635                    579              56                 9.7 %  Total individual Medicare                     5,838                  5,145             693                13.5 % Individual commercial                           255                    221              34                15.4 % Individual specialty                             45                     33              12                36.4 %  Total premiums                                6,138                  5,399             739                13.7 %  Services                                          6                      5               1                20.0 % 

Total premiums and services revenue $ 6,144 $ 5,404

       $    740                13.7 %  Income before income taxes              $       424        $           541        $   (117 )             (21.6 )% Benefit ratio                                  82.3 %                 78.7 %                               3.6 % Operating cost ratio                           10.7 %                 11.2 %                              (0.5 )%                                                 For the nine months                                                       ended                                                   September 30,                              Change                                            2012                 2011              Dollars          Percentage                                                             (in millions) Premiums and Services Revenue: Premiums: Individual Medicare Advantage           $    15,604        $        13,646        $  1,958                14.3 % Individual Medicare stand-alone PDP           1,967                  1,737             230                13.2 %  Total individual Medicare                    17,571                 15,383           2,188                14.2 % Individual commercial                           749                    628             121                19.3 % Individual specialty                            125                     89              36                40.4 %  Total premiums                               18,445                 16,100           2,345                14.6 %  Services                                         17                     12               5                41.7 % 

Total premiums and services revenue $ 18,462 $ 16,112

       $  2,350                14.6 %  Income before income taxes              $       906        $         1,261        $   (355 )             (28.2 )% Benefit ratio                                  84.6 %                 81.9 %                               2.7 % Operating cost ratio                           10.3 %                 10.1 %                               0.2 %                                            35 

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  Table of Contents  Pretax Results   

• Retail segment pretax income was $424 million in the 2012 quarter, a

decrease of $117 million, or 21.6%, compared to $541 million in the 2011

quarter primarily due to an increase in the benefit ratio partially offset

by improvement in the operating cost ratio. Retail segment pretax income

was $906 million in the 2012 period, a decrease of $355 million, or 28.2%,

         compared to $1.3 billion in the 2011 period primarily driven by          year-over-year increases in both the benefit ratio and operating cost          ratio for the 2012 period.   Enrollment    

• Individual Medicare Advantage membership increased 298,400 members, or

18.5%, from September 30, 2011 to September 30, 2012 primarily due to the

annual enrollment period associated with the 2012 plan year as well as

age-in enrollment throughout the year. We acquired approximately 62,600

members with Arcadian effective March 31, 2012 and 12,100 members with

another acquisition effective December 30, 2011. As discussed previously,

we expect to divest approximately 12,600 members acquired with Arcadian

effective January 1, 2013 in accordance with our agreement with the United

          States Department of Justice.          •   Individual Medicare stand-alone PDP membership increased 469,100 members,

or 18.9%, from September 30, 2011 to September 30, 2012 primarily from

growth in our low-price-point Humana Walmart-Preferred Rx Plan offering.

• Individual commercial medical membership increased 37,900 members, or

         7.9%, from September 30, 2011 to September 30, 2012.    

• Individual specialty membership increased 185,200 members, or 24.5%, from

September 30, 2011 to September 30, 2012 primarily driven by increased

sales in dental offerings.

  Premiums         •   Retail segment premiums increased $739 million, or 13.7%, from the 2011

quarter to the 2012 quarter and increased $2.3 billion, or 14.6%, from the

2011 period to the 2012 period. The increases primarily were due to an

18.4% and 17.3% increase for the 2012 quarter and period, respectively, in

average individual Medicare Advantage membership compared to the 2011

quarter and period. Individual Medicare Advantage per member premiums

decreased approximately 4% and 3% in the 2012 quarter and period,

respectively, compared to the 2011 quarter and period primarily driven by

         a higher percentage of members that aged-in that generally carry a lower          risk score than other members and accordingly a lower premium per member

as well as lower per member premiums for members acquired in connection

with the Arcadian acquisition effective March 31, 2012. In addition,

individual Medicare stand-alone PDP premiums revenue increased $56

million, or 9.7%, from the 2011 quarter to the 2012 quarter and increased

$230 million, or 13.2%, from the 2011 period to the 2012 period. These          increases primarily were due to a 19.3% and 20.7% increase for the 2012

quarter and period, respectively, in average individual PDP membership

compared to the 2011 quarter and period.

  Benefit expenses   

• The Retail segment benefit ratio increased 360 basis points from 78.7% in

the 2011 quarter to 82.3% in the 2012 quarter. The Retail segment benefit

ratio increased 270 basis points from 81.9% in the 2011 period to 84.6% in

the 2012 period. During the 2012 quarter and period, we experienced a

significant increase in the benefit ratio for our individual Medicare

         Advantage products primarily due to a planned increase in the target          benefit ratio associated with positioning for Health Insurance Reform

Legislation funding changes and minimum benefit ratio requirements, a

higher benefit ratio experienced on new membership than the assumptions

used in our 2012 Medicare bids, and increased outpatient utilization for

both new and existing members. In addition, the 2012 period reflects a

year-over-year increase in clinicians and other health care quality

<pre> expenditures given our continuing growth in membership.

• The Retail segment's benefit expenses included the beneficial effect of an

estimated $38 million in favorable prior-year medical claims reserve

development in the 2012 quarter and $32 million in the 2011 quarter.

Favorable reserve development decreased the Retail segment benefit ratio

by approximately 60 basis points in both the 2012 and 2011 quarters. For

the 2012 period, the Retail segment's benefit expenses included the

beneficial effect of an estimated $95 million in favorable prior-year

         medical claims reserve development versus $104 million in the 2011 period.          Favorable reserve development decreased the Retail segment benefit ratio

by approximately 50 basis points in the 2012 period and 70 basis points in

         the 2011 period.                                            36 

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  Table of Contents  Operating costs   

• The Retail segment operating cost ratio of 10.7% for the 2012 quarter

improved 50 basis points from 11.2% for the 2011 quarter primarily as a

result of scale efficiencies associated with servicing higher

year-over-year membership in every line of Retail business together with

our continued focus on operating cost efficiencies. The Retail segment

operating cost ratio of 10.3% for the 2012 period increased 20 basis

points from 10.1% for the 2011 period primarily reflecting higher

          year-over-year clinical, provider, and technological infrastructure          spending.   Employer Group Segment                                            September 30,                      Change                                     2012            2011          Members       Percentage Membership: Medical membership: Fully-insured commercial group     1,204,500       1,181,300        23,200              2.0 % ASO                                1,231,100       1,287,000       (55,900 )           (4.3 )%  Group Medicare Advantage             367,900         287,900        80,000             27.8 % Medicare Advantage ASO                27,800          27,600           200              0.7 % 

Total group Medicare Advantage 395,700 315,500 80,200

            25.4 %  Group Medicare stand-alone PDP         4,400           4,200           200              4.8 %  Total group Medicare                 400,100         319,700        80,400             25.1 %  Total group medical members        2,835,700       2,788,000        47,700              1.7 % 

Group specialty membership (a) 7,088,600 6,419,300 669,300

           10.4 %     

(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.                                            37 

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  Table of Contents                                               For the three months ended                                                      September 30,                               Change                                              2012                   2011               Dollars         Percentage                                                                 (in millions) Premiums and Services Revenue: Premiums: Fully-insured commercial group           $      1,256          $         1,185        $      71                6.0 %  Group Medicare Advantage                        1,023                      803              220               27.4 % Group Medicare stand-alone PDP                      2                        2                0                0.0 %  Total group Medicare                            1,025                      805              220               27.3 % Group specialty                                   271                      235               36               15.3 %  Total premiums                                  2,552                    2,225              327               14.7 %  Services                                           88                       89               (1 )             (1.1 )%  Total premiums and services revenue      $      2,640          $         2,314        $     326               14.1 %  Income before income taxes               $         43          $            46        $      (3 )             (6.5 )% Benefit ratio                                    85.3 %                   83.5 %                               1.8 % Operating cost ratio                             15.6 %                   17.5 %                              (1.9 )%                                                    For the nine months ended                                                      September 30,                               Change                                              2012                   2011               Dollars         Percentage                                                                 (in 

millions)

 Premiums and Services Revenue: Premiums: Fully-insured commercial group           $      3,745          $         3,601        $     144                4.0 %  Group Medicare Advantage                        3,059                    2,363              696               29.5 % Group Medicare stand-alone PDP                      6                        6                0                0.0 %  Total group Medicare                            3,065                    2,369              696               29.4 % Group specialty                                   793                      698               95               13.6 %  Total premiums                                  7,603                    6,668              935               14.0 %  Services                                          266                      269               (3 )             (1.1 )%  Total premiums and services revenue      $      7,869          $         6,937        $     932               13.4 %  Income before income taxes               $        278          $           293        $     (15 )             (5.1 )% Benefit ratio                                    83.1 %                   81.1 %                               2.0 % Operating cost ratio                             16.0 %                   17.5 %                              (1.5 )%   Pretax Results   

• Employer Group segment pretax income decreased $3 million, or 6.5%, from

the 2011 quarter to $43 million in the 2012 quarter. Employer Group

segment pretax income was $278 million in the 2012 period, a decrease of

$15 million, or 5.1%, compared to $293 million in the 2011 period. These

decreases primarily reflect an increase in the benefit ratio partially

         offset by improvement in the operating cost ratio as described below.                                            38 

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  Table of Contents  Enrollment   

• Fully-insured commercial group medical membership increased 23,200

members, or 2.0%, from September 30, 2011 to September 30, 2012 primarily

due to growth in small group membership partially offset by declines in

          large group business.          •   Fully-insured group Medicare Advantage membership increased 80,000

members, or 27.8%, from September 30, 2011 to September 30, 2012 primarily

         due to the January 2012 addition of a new large group account.    

• Group ASO commercial medical membership decreased 55,900 members, or 4.3%,

from September 30, 2011 to September 30, 2012 primarily due to continued

pricing discipline in a highly competitive environment for self-funded

          accounts.          •   Group specialty membership increased 669,300 members, or 10.4%, from

September 30, 2011 to September 30, 2012 primarily due to continued

         cross-selling of our specialty products to our medical membership and          growth in stand-alone specialty product sales.   Premiums    

• Employer Group segment premiums increased $327 million, or 14.7%, from the

         2011 quarter to $2.6 billion for the 2012 quarter and increased $935          million, or 14.0%, from the 2011 period to $7.6 billion for the 2012          period primarily due to higher average group Medicare Advantage

membership. In addition, the 2012 period included the beneficial effect of

approximately $25 million associated with updating estimates regarding

calculations of 2011 premium rebates payable associated with minimum

benefit ratios required under the Health Insurance Reform Legislation.

         This change in estimate was attributable to the refinement of the          state-level calculations based on the run out of claims during 2012.   Benefit expenses    

• The Employer Group segment benefit ratio increased 180 basis points from

83.5% in the 2011 quarter to 85.3% in the 2012 quarter. The Employer Group

segment benefit ratio increased 200 basis points from 81.1% in the 2011

period to 83.1% in the 2012 period. Excluding the impact of prior-year

medical claims reserve development discussed below, these increases were

         primarily due to higher membership in our group Medicare Advantage          products which generally carry a higher benefit ratio than our          fully-insured commercial group products. In addition, the benefit ratio          for the 2012 period included the beneficial effect of a reduction in          prior-year premium rebate estimates discussed above.    

• The Employer Group segment's benefit expenses included the beneficial

effect of an estimated $14 million and $9 million in favorable prior-year

medical claims reserve development in the 2012 quarter and 2011 quarter,

respectively. Favorable development decreased the Employer Group segment

benefit ratio by approximately 60 basis points in the 2012 quarter

compared to 40 in the 2011 quarter. The Employer Group segment's benefit

         expenses included the negative impact of an estimated $4 million in          unfavorable prior-year medical claims reserve development in the 2012

period and the beneficial effect of an estimated $42 million in favorable

prior-year medical claims reserve development in the 2011 period. The

unfavorable development increased the Employer Group segment benefit ratio

by approximately 10 basis points in the 2012 period. Favorable development

decreased the Employer Group segment benefit ratio by approximately 60

basis points in the 2011 period.

  Operating costs         •   The Employer Group segment operating cost ratio of 15.6% for the 2012          quarter improved 190 basis points from 17.5% for the 2011 quarter. The          Employer Group segment operating cost ratio of 16.0% for the 2012 period

improved 150 basis points from 17.5% for the 2011 period. These decreases

primarily reflect growth in our group Medicare Advantage products which

generally carry a lower operating cost ratio than our fully-insured

         commercial group products and continued savings as a result of our          operating cost reduction initiatives.                                            39 

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Health and Well-Being Services Segment

                                                For the three months ended                                                    September 30,                              Change                                            2012                   2011              Dollars         Percentage                                                               (in millions) Revenues: Services: Primary care services                  $        248          $           230        $     18                7.8 % Integrated wellness services                      4                        3               1               33.3 % Pharmacy solutions                                3                        3               0                0.0 % Home care services                               19                        0              19              100.0 %  Total services revenues                         274                      236              38               16.1 %  Intersegment revenues: Pharmacy solutions                            2,767                    2,481             286               11.5 % Primary care services                            63                       47              16               34.0 % Integrated wellness services                     53                       42              11               26.2 % Home care services                               43                       21              22              104.8 %  Total intersegment revenues                   2,926                    2,591             335               12.9 %  Total services and intersegment revenues                               $      3,200          $         2,827        $    373               13.2 %  Income before income taxes             $        148          $            83        $     65               78.3 % Operating cost ratio                           94.6 %                   96.3 %                             (1.7 )%                                               For the nine months ended                                                    September 30,                              Change                                            2012                   2011              Dollars         Percentage                                                               (in millions) Revenues: Services: Primary care services                  $        722          $           662        $     60                9.1 % Integrated wellness services                      8                        8               0                0.0 % Pharmacy solutions                               11                        8               3               37.5 % Home care services                               19                        0              19              100.0 %  Total services revenues                         760                      678              82               12.1 %  Intersegment revenues: Pharmacy solutions                            8,525                    7,339           1,186               16.2 % Primary care services                           162                      135              27               20.0 % Integrated wellness services                    156                      126              30               23.8 % Home care services                              121                       55              66              120.0 %  Total intersegment revenues                   8,964                    7,655           1,309               17.1 %  Total services and intersegment revenues                               $      9,724          $         8,333        $  1,391               16.7 %  Income before income taxes             $        411          $           268        $    143               53.4 % Operating cost ratio                           95.1 %                   96.1 %            60               (1.0 )%                                            40 

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  Table of Contents  Pretax results   

• Health and Well-Being Services segment pretax income increased $65 million,

     or 78.3%, from the 2011 quarter to $148 million for the 2012 quarter and      increased $143 million, or 53.4%, from the 2011 period to $411 million for

the 2012 period. These increases primarily were due to growth in our pharmacy

solutions business, including higher utilization of our mail-order pharmacy

      by our members.   Script Volume   

• Script volumes for the Retail and Employer Group segment membership increased

to approximately 60 million in the 2012 quarter, up approximately 15% versus

scripts of approximately 52 million in the 2011 quarter. For the 2012 period,

script volumes for the Retail and Employer Group segment membership increased

to approximately 177 million, up approximately 15% versus scripts of

approximately 153 million in the 2011 period. The year-over-year increase

primarily reflects growth associated with higher average medical membership

     together with an increase in mail order penetration for our medical      membership for the 2012 quarter and period than in the 2011 quarter and      period.   Services revenue    

• Services revenue increased $38 million, or 16.1%, from the 2011 quarter to

$274 million for the 2012 quarter and increased $82 million, or 12.1% from

the 2011 period to $760 million for the 2012 period. These increases

primarily reflect growth in our Concentra operations and the acquisition of

SeniorBridge in July 2012.

  Intersegment revenues   

• Intersegment revenues increased $335 million, or 12.9%, from the 2011 quarter

to $2.9 billion for the 2012 quarter and increased $1.3 billion, or 17.1%,

from the 2011 period to $9.0 billion for the 2012 period. These increases

were primarily due to growth in our pharmacy solutions business, including

our mail-order pharmacy, as it serves our growing membership, particularly

Medicare stand-alone PDP.

  Operating costs   

• The Health and Well-Being Services segment operating cost ratio of 94.6% for

the 2012 quarter improved 170 basis points from 96.3% for the 2011 quarter.

The segment's operating cost ratio of 95.1% for the 2012 period improved 100

basis points from 96.1% for the 2011 period. These decreases primarily

reflect scale efficiencies associated with growth in our pharmacy solutions

business, including higher script volumes in our mail-order pharmacy

     business.   Other Businesses  Pretax income for our Other Businesses of $50 million for the 2012 quarter compares to pretax income of $29 million for the 2011 quarter primarily due to higher revenues associated with risk sharing arrangements under our previous TRICARE South Region contract. For the 2012 period, pretax income of $12 million for our Other Businesses compares to $83 million for the 2011 period primarily due to costs in connection with a litigation settlement associated with our Military services business.  

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 this report and in our 2011 Form 10-K.

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  Cash and cash equivalents was $1.4 billion at September 30, 2012 equivalent to the balance at December 31, 2011. The change in cash and cash equivalents for the nine months ended September 30, 2012 and 2011 is summarized as follows:                                                              2012          2011                                                              (in millions)

Net cash provided by operating activities $ 1,718$ 3,876

       Net cash used in investing activities                 (753 )      

(1,143 )

      Net cash used in financing activities                 (979 )       

(387 )

(Decrease) increase in cash and cash equivalents $ (14 ) $ 2,346

Cash Flow from Operating Activities

  Our operating cash flows for the 2011 period were significantly impacted by the early receipt of the Medicare premium remittance for October 2011 of $1,796 million in September 2011 because the payment date of October 1, 2011 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 2011 period included ten monthly Medicare payments compared to only nine monthly Medicare payments during the 2012 period.  

Excluding the impact from the timing of the Medicare premium receipt, the decrease in operating cash flows from the 2011 period to the 2012 period primarily results from lower earnings and the timing of working capital items.

  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 benefit expenses 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 September 30, 2012 and December 31, 2011:                                                                                        2012            2011                                           September 30,        December 31,        Period          Period                                               2012                 2011            Change          Change                                                                    (in millions) IBNR (1)                                 $         2,610       $       2,056       $   554        $     80 Reported claims in process (2)                       466                 376            90             194 Military services benefits payable (3)                                                   15                 339          (324 )           121 Other benefits payable (4)                           867                 983          (116 )             4  Total benefits payable                   $         3,958       $       3,754           204             399  Reconciliation to cash flow statement: Payables from acquisition                                                              (73 )             0  Change in benefits payable per cash flow statement resulting in cash from operations                                                                    $   131        $    399     

(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) Military services benefits payable primarily represents the run-out of the

claims liability associated with our previous TRICARE South Region contract

that expired on March 31, 2012. A corresponding receivable for reimbursement

by the federal government is included in the Military services receivable in

the receivables table that follows.

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

    risk sharing arrangements.                                            42 

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  The increase in benefits payable from December 31, 2011 to September 30, 2012 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 which fluctuate due to month-end cutoff. These increases were partially offset by a $324 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 as well as a decrease in amounts owed to providers under capitated and risk sharing arrangements. Under the new TRICARE South Region contract effective April 1, 2012, the federal government retains the risk of the cost of health benefits and related benefit obligation as further described in Note 1 to the condensed consolidated financial statements. The increase in benefits payable from December 31, 2010 to September 30, 2011 primarily was due to an increase in amounts due to our pharmacy benefit administrator which fluctuate due to month-end cutoff, an increase in Military services benefits payable, and an increase in IBNR as a result of Medicare Advantage membership growth.  The detail of total net receivables was as follows at September 30, 2012 and December 31, 2011:                                                                                           2012            2011                                            September 30,         December 31,         Period          Period                                                2012                  2011             Change          Change                                                                      (in millions) Medicare                                  $           290        $         336        $   (46 )      $    (32 ) Commercial and other                                  397                  315             82              37 Military services                                      49                  468           (419 )           106 Allowance for doubtful accounts                       (94 )                (85 )           (9 )           (34 )  Total net receivables                     $           642        $       1,034           (392 )            77  Reconciliation to cash flow statement: Receivables from acquisition                                                              (44 )             0  Change in receivables per cash flow statement resulting in cash from operations                                                                            $  (436 )      $     77   

Medicare receivables are impacted by the timing of accruals and related collections associated with the CMS risk-adjustment model.

  Military services receivables at December 31, 2011 primarily consisted of estimated claims owed from the federal government for health care services provided to beneficiaries and underwriting fees under our previous TRICARE South Region contract that expired on March 31, 2012. The $419 million decrease in Military services receivables from December 31, 2011 to September 30, 2012 primarily resulted from the transition to our new TRICARE South Region contract which we account for similar to an administrative services fee only agreement. As such, beginning April 1, 2012, payments of the federal government's claims and related reimbursements are classified with receipts (withdrawals) from contract deposits as a financing item in our condensed consolidated statements of cash flows. Military services receivables at September 30, 2012 primarily consist of administrative services only fees owed from the federal government for administrative services provided under our new TRICARE South Region contract.  In addition to the timing of receipts for premiums and services fees and payments of benefit expenses, 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, changes in the timing of the collection of pharmacy rebates, and the timing of payments for premium rebates associated with minimum benefit ratios required under the Health Insurance Reform Legislation.  

Cash Flow from Investing Activities

  We reinvested a portion of our operating cash flows in investment securities, primarily investment-grade fixed income securities, totaling $161 million in the 2012 period and $913 million in the 2011 period. Our ongoing capital expenditures primarily relate to our information technology initiatives, support of services in our Concentra and other medical facilities and administrative facilities necessary for activities such as the provision of care to members, claims processing, billing and collections, wellness solutions, care coordination, regulatory compliance and                                           43

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  customer service. Total capital expenditures, excluding acquisitions, were $304 million in the 2012 period and $216 million in the 2011 period reflecting increased spending associated with growth in our primary care services and pharmacy businesses in our Health and Well-Being Services segment. Excluding acquisitions, we expect total capital expenditures in 2012 of approximately $400 million, comparable to $346 million for the full year 2011. Cash consideration paid for acquisitions, net of cash acquired, of $288 million in the 2012 period primarily relates to the acquisitions of Arcadian in March 2012, SeniorBridge during the 2012 quarter, and other health and wellness related businesses.  

Cash Flow from Financing Activities

  Receipts from CMS associated with Medicare Part D claim subsidies for which we do not assume risk were $282 million lower than claims payments during the 2012 period and $225 million higher than claim payments during the 2011 period. Under our new 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 $65 million during the 2012 period.  

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

  We repurchased 6.25 million shares for $460 million during the 2012 period compared to 6.76 million shares for $492 million during the 2011 period under share repurchase plans authorized by the Board of Directors. We also acquired 0.6 million common shares in connection with employee stock plans for an aggregate cost of $53 million during the 2012 period compared to 0.8 million common shares for an aggregate cost of $49 million in the 2011 period.  During the 2012 period, we paid dividends to stockholders of $124 million as discussed further below. We paid dividends to stockholders of $41 million during the 2011 period.  

The remainder of the cash used in or provided by financing activities in the 2012 and 2011 periods primarily resulted from proceeds from stock option exercises.

Future Sources and Uses of Liquidity

Dividends

  In April 2011, our Board of Directors approved the initiation of 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 our dividend payments in 2012:

                  Record         Payment          Amount            Total                Date             Date         per Share          Amount                                                              (in millions)                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   In October 2012, the Board of Directors declared a cash dividend of $0.26 per share payable on January 25, 2013 to stockholders of record as of the close of business on December 31, 2012.  

Stock Repurchase Authorization

  In April 2012, the Board of Directors replaced its previously approved share repurchase authorization of up to $1 billion with a new authorization for repurchases of up to $1 billion of our common shares exclusive of shares repurchased in connection with employee stock plans. The new authorization will expire June 30, 2014. Under this 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. As of October 31, 2012, the remaining authorized amount under the new authorization totaled $640 million.                                           44 

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Senior Notes

  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) and contain a change of control provision that may require us to purchase the notes under certain circumstances. All four 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 November 2011, we amended and restated our 3-year $1.0 billion unsecured revolving credit agreement which was set to expire in December 2013 and replaced it with a 5-year $1.0 billion unsecured revolving agreement expiring November 2016. 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 120 basis points, varies depending on our credit ratings ranging from 87.5 to 147.5 basis points. We also pay an annual facility fee regardless of utilization. This facility fee, currently 17.5 basis points, may fluctuate between 12.5 and 27.5 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 new 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 new 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 $6.5 billion at September 30, 2012 and a maximum leverage ratio of 3.0:1. We are in compliance with the financial covenants, with actual net worth of $8.7 billion and actual leverage ratio of 0.7:1, as measured in accordance with the new credit agreement as of September 30, 2012. In addition, the new credit agreement includes an uncommitted $250 million incremental loan facility.  At September 30, 2012, we had no borrowings outstanding under the new credit agreement. We have outstanding letters of credit of $5 million secured under the new credit agreement. No amounts have been drawn on these letters of credit. Accordingly, as of September 30, 2012, we had $995 million of remaining borrowing capacity under the new 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 called, 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.  

Adverse changes in our credit rating may increase the rate of interest we pay and may impact the amount of credit available to us in the future. Our investment-grade credit rating at September 30, 2012 was BBB according to Standard & Poor's Rating Services, or S&P, and Baa3 according to Moody's Investors Services, Inc., or Moody's. A

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  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.  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 $522 million at September 30, 2012 compared to $494 million at December 31, 2011.  

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, is limited based on the entity's level of statutory income and statutory capital and surplus. In most states, prior notification is provided before paying a dividend even if approval is not required.  Although minimum required levels of equity are largely based on premium volume, product mix, and the quality of assets held, minimum requirements can vary significantly at the state level. Based on the most recently filed statutory financial statements as of June 30, 2012, our state regulated subsidiaries had aggregate statutory capital and surplus of approximately $4.2 billion, which exceeded aggregate minimum regulatory requirements. The amount of dividends that were paid to our parent company in the 2012 period were approximately $1.2 billion, an increase of $163 million compared to dividends that were paid for the full year 2011 of approximately $1.1 billion. 

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