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CENTENE CORP – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion of our financial condition and results of operations
should be read in conjunction with our consolidated financial statements and the
related notes included elsewhere in this filing. The discussion contains
forward-looking statements that involve known and unknown risks and
uncertainties, including those set forth under Part II, Item 1A. "Risk Factors"
of this Form 10-Q.
EXECUTIVE OVERVIEW
General
We are a leading multi-national healthcare enterprise that is committed to
helping people live healthier lives. We take a local approach - with local
brands and local teams - to provide fully integrated, high-quality, and
cost-effective services to government-sponsored and commercial healthcare
programs, focusing on under-insured and uninsured individuals.
Results of operations depend on our ability to manage expenses associated with health benefits (including estimated costs incurred) and selling, general and administrative (SG&A) costs. We measure operating performance based upon two key ratios. The health benefits ratio (HBR) represents medical costs as a percentage of premium revenues, excluding premium tax and health insurer fee revenues that are separately billed, and reflects the direct relationship between the premiums received and the medical services provided. The SG&A expense ratio represents SG&A costs as a percentage of premium and service revenues, excluding premium tax and health insurer fee revenues that are separately billed. Prior to 2021, when the Affordable Care Act (ACA) health insurer fee (HIF) repeal was effected, our insurance subsidiaries were subject to the HIF. We recognized revenue for reimbursement of the HIF, including the "gross-up" to reflect the non-deductibility of the HIF. Collectively, this revenue was recorded as premium tax and health insurer fee revenue in the Consolidated Statements of Operations. For certain products, premium taxes, state assessments and the HIF were not pass-through payments and were recorded as premium revenue and premium tax expense or health insurer fee expense in the Consolidated Statements of Operations. Due to the size of the health insurer fee, one of the primary drivers of the year-over-year variances discussed throughout this section is related to the repeal of the HIF in 2021.
Magellan Acquisition
InJanuary 2021 , we announced that we entered into a definitive merger agreement to acquire Magellan Health for$95.00 per share in cash for a total enterprise value of approximately$2.2 billion . We expect the transaction to broaden and deepen our whole health capabilities and establish a leading behavioral health platform. The transaction is subject to the receipt of required state regulatory approval from one remaining state and other customary closing conditions. The transaction is not contingent upon financing. We intend to fund the acquisition primarily through our debt financing completed inJuly 2021 and cash on hand. The transaction is expected to close in the fourth quarter of 2021.
COVID-19 Trends and Uncertainties
The COVID-19 outbreak has created unique and unprecedented challenges. In 2020, we saw significant decreases in traditional utilization as stay-at-home orders were put in place, partially offset by COVID-19 treatment costs. As stay-at-home orders were lifted and vaccinations have become available in 2021, utilization has returned in varying degrees. As a result, one of the primary drivers of the year-over-year variances discussed throughout this section is related to COVID-19. In 2021, we launched several initiatives which encourage our health plan members, as well as all Americans, to receive the COVID-19 vaccine. The impact on our business in both the short-term and long-term is uncertain and difficult to predict. The outlook for the remainder of 2021 depends on future developments, including but not limited to: the length and severity of the outbreak (including new variants, which may be more contagious, more severe or less responsive to treatment or vaccines), the effectiveness of containment actions, the timing of vaccinations and achievement of herd immunity, and the timing and rate at which members return to accessing healthcare. The pandemic and these future developments have impacted and will continue to affect our membership and medical utilization. FromMarch 31, 2020 throughSeptember 30, 2021 , our Medicaid membership has increased by 2.3 million members (excluding the newNorth Carolina membership). In addition, the pandemic has and continues to have the potential to impact the administration of state and federal healthcare programs, premium rates and risk sharing mechanisms. We continue to have active dialogues with our state partners. 21 -------------------------------------------------------------------------------- Table of Contents Medical utilization continues to lack consistency and will be influenced by the intensity of additional waves of the pandemic. We will be watching external trends closely as COVID-19 costs could increase based upon macro trends. New variants and additional waves of the pandemic could create new dynamics and uncertainties around our expectations. In addition, the pandemic has had widespread economic impact, including driving interest rate decreases and lowering our investment income.
We are confident we have the team, systems, expertise and financial strength to
continue to effectively navigate this challenging pandemic landscape.
Regulatory Trends and Uncertainties
The United States government, politicians, and healthcare experts continue to discuss and debate various elements ofthe United States healthcare model. We remain focused on the promise of delivering access to high-quality, affordable healthcare to all of our members and believe we are well positioned to meet the needs of the changing healthcare landscape. We have more than three decades of experience, spanning seven presidents from both sides of the aisle, in delivering high-quality healthcare services on behalf of states and the federal government to under-insured and uninsured families, commercial organizations and military families. This expertise has allowed us to deliver cost effective services to our government sponsors and our members. While healthcare experts maintain focus on personalized healthcare technology, we continue to make strategic decisions to accelerate development of new software platforms and analytical capabilities. We continue to believe we have both the capacity and capability to successfully navigate industry changes to the benefit of our members, customers and shareholders.
For additional information regarding regulatory trends and uncertainties, see
Part II, Item 1A, "Risk Factors."
Third Quarter 2021 Highlights
Our financial performance for the third quarter of 2021 is summarized as follows: •Managed care membership of 26.5 million, an increase of 1.4 million members, or 5% year-over-year. •Total revenues of$32.4 billion , representing 11% growth year-over-year. •HBR of 88.1%, compared to 86.4% for the third quarter of 2020. •SG&A expense ratio of 8.8%, compared to 9.1% for the third quarter of 2020. •Adjusted SG&A expense ratio of 8.6%, compared to 8.9% for the third quarter of 2020. •Operating cash flows of$1.8 billion for the third quarter of 2021. •Diluted earnings per share (EPS) of$0.99 , compared to$0.97 for the third quarter of 2020. •Adjusted Diluted EPS of$1.26 , compared to$1.26 for the third quarter of 2020. A reconciliation from GAAP diluted earnings per share to Adjusted Diluted EPS is highlighted below, and additional detail is provided above under the heading "Non-GAAP Financial Presentation": Three Months Ended
2021
2020
GAAP diluted earnings per share, attributable to Centene $ 0.99$ 0.97 Amortization of acquired intangible assets 0.26
0.21
Acquisition related expenses 0.07 0.08 Other adjustments (1) (0.06) - Adjusted Diluted EPS $ 1.26$ 1.26 (1) Other adjustments include the following items for the three months endedSeptember 30, 2021 : (a) legal fees related to the legal settlement of$11 million , or$0.01 per diluted share, net of an income tax benefit of$0.01 ; (b) debt extinguishment costs of$79 million , or$0.10 per diluted share, net of an income tax benefit of$0.03 ; (c) severance costs due to a restructuring of$1 million , or$0.00 per diluted share, net of an income tax benefit of$0.00 ; (d) gain related to the acquisition of the remaining 60% interest ofCircle Health of$309 million , or$0.52 per diluted share, net of income tax expense of$0.00 ; and 22 -------------------------------------------------------------------------------- Table of Contents (e) impairment of our equity method investment in RxAdvance of$229 million , or$0.35 per diluted share, net of an income tax benefit of$0.03 .
The following items contributed to our growth over the last year:
•Apixio. InDecember 2020 , we acquiredApixio Inc. , a healthcare analytics company offering artificial intelligence technology solutions. With this transaction, we intend to continue to digitize the administration of healthcare and accelerate innovation.
•Circle Health. In
method investment in
operators of hospitals.
•Correctional. InJuly 2021 , Centurion commenced a contract with theIndiana Department of Corrections . InJuly 2020 , Centurion commenced a two-year contract with theKansas Department of Administration to provide healthcare services in theDepartment of Corrections' facilities. InApril 2020 , Centurion began providing medical services, behavioral healthcare, and substance abuse treatment within four prisons and six community corrections centers across the state ofDelaware . •Hawaii. InJuly 2021 , we began operating under two new statewide contracts inHawaii to continue administering covered services to eligible Medicaid andChildren's Health Insurance Program (CHIP) members for medically necessary medical, behavioral health, and long-term services and support and to continue administering services through the Community Care Services program in partnership with theHawaii Department of Human Services' Med-QUEST Division . •Health Insurance Marketplace. InJanuary 2021 , we expanded our offerings in theHealth Insurance Marketplace . We expanded our Marketplace product, branded Ambetter, in nearly 400 new counties across 13 existing states. In addition,Ambetter-branded Marketplace products are now offered in two new states,New Mexico andMichigan .Centers for Medicare and Medicaid Services (CMS) extended theHealth Insurance Marketplace special enrollment period untilAugust 15, 2021 , which resulted in membership growth. •Illinois. InJuly 2020 ,Meridian Health Plan of Illinois, Inc. (Meridian) began serving Medicaid members inCook County, Illinois , as a result of a member transfer agreement under which Meridian was assigned 100% ofNextLevel Health Partners, Inc.'s approximately 54,000 members who access benefits from theIllinois Department of Healthcare and Family Services' HealthChoice Illinois Program . InFebruary 2020 , we began operating inIllinois under the first phase of an expanded contract for the Medicaid Managed Care Program. The expanded contract includes children who are in need through theDepartment of Children and Family Services/Youth Care byIllinois Department of Healthcare and Family Services andFoster Care . •North Carolina. InJuly 2021 , WellCare ofNorth Carolina commenced operations under a new statewide contract inNorth Carolina providing Medicaid managed care services. In addition, we also began operating under a new contract to provide Medicaid managed care services in three regions inNorth Carolina through our provider-ledNorth Carolina joint venture,Carolina Complete Health .
•PANTHERx. In
fastest-growing specialty pharmacies in
drugs and treating rare diseases.
•TRICARE. InJanuary 2021 , we began administering the Buckley Prime Service Area Pilot in theDenver, Colorado area, which is a TRICARE pilot program for value-based payment arrangements not currently an option in the fee-for-service T2017 reimbursement model. •WellCare. OnJanuary 23, 2020 , we completed the WellCare Acquisition. The WellCare Acquisition brings a high-quality Medicare platform and further extends our robust Medicaid offerings. The WellCare Acquisition is a key part of our growth as we become one of the nation's largest sponsors of government health coverage. •In addition, revenue growth was significantly driven by Medicaid membership increases resulting from the ongoing suspension of eligibility redeterminations as well as Medicare membership growth. 23 -------------------------------------------------------------------------------- Table of Contents The growth items listed above were partially offset by the following items:
•Effective
management services program in
•Effective
contract in
•InOctober 2020 , CMS publishedMedicare Star quality ratings for the 2021 rating year. Approximately 30% of our Medicare members are in a 4 star or above plan for the 2022 bonus year compared to 46% for the 2021 bonus year. •InSeptember 2020 , ourOregon subsidiary, Trillium Community Health Plan, began operating under an expanded contract serving as a coordinated care organization for six counties in the state; however, an additional competitor was added toLane County . As a result, our membership decreased.
•Effective
Life Counseling Program contract.
•Effective
correctional contract in
•In
divestiture of certain products in our
Medicaid and Medicare Advantage lines of business.
•We experienced a decrease in our marketplace membership driven primarily by a reduction of members in the state ofFlorida , resulting from price competition in three highly populated counties.
•Beginning in the second quarter of 2020, we experienced Medicaid state premium
rate reductions and risk corridor actions as a result of the COVID-19 pandemic.
We expect the following items to contribute to our revenue or future growth
potential:
•We expect to realize the benefit in 2021 of acquisitions, investments, and
business commenced during 2020 and 2021, as discussed above.
•InOctober 2021 , CMS published updatedMedicare Star quality ratings for the 2022 rating year. 54% of our Medicare members are in a 4 star or above plan for the 2023 bonus year, compared to approximately 30% for the 2022 bonus year. The increase is primarily due to certain disaster relief provisions in the Star quality ratings.
•In
for 2022. Our Medicare plans expect to operate in 1,575 counties across 36
states in 2022, a 26% increase in counties and three new states compared to
2021.
•In
65% interest in
•InAugust 2021 , we announced that ourNorth Carolina subsidiaries,Carolina Complete Health and WellCare ofNorth Carolina , will coordinate physical and/or other health services with Local Management Entities/Managed Care Organizations under the state's new Tailored Plans. The Tailored Plans, which are expected to launch inJuly 2022 , are integrated health plans designed for individuals with significant behavioral health needs and intellectual/developmental disabilities.
•In
Medicaid contract by the
members with quality healthcare, coordinated services, and benefits. The
contract will commence in
•InAugust 2021 , ourNevada subsidiary,SilverSummit Health plan, Inc., was awarded a contract from theNevada Department of Health and Human Services - Health Care Financing and Policy to continue providing managed care services for its Medicaid Managed Care program in bothClark andWashoe Counties. Pending regulatory approval, the contract will commence inJanuary 2022 .
•In
Corrections
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•InMay 2021 , Centurion was awarded a contract with theMissouri Department of Corrections . The contract is expected to start inNovember 2021 , subject to the court's ruling in a pending lawsuit brought by the current holder of the contract. •InJanuary 2021 , we announced that we entered into a definitive merger agreement to acquire Magellan Health for$95.00 per share in cash for a total enterprise value of approximately$2.2 billion . The transaction is subject to the receipt of required state regulatory approvals and other customary closing conditions. The transaction is expected to close in the fourth quarter of 2021.
The future growth items listed above may be partially offset by the following
items:
•We expect Medicaid eligibility redeterminations to begin in 2022.
•The anticipated and previously disclosed carve out ofCalifornia pharmacy services inJanuary 2022 in connection with the state's transition of pharmacy services from managed care to fee for service. •The anticipated carve out ofOhio pharmacy services inJuly 2022 in connection with the state's transition of pharmacy services from managed care to a single pharmacy benefit manager.
•Potential Medicaid state rate actions and risk corridor mechanisms as a result
of the COVID-19 pandemic.
MEMBERSHIP
From September 30, 2020 to September 30, 2021 , we increased our managed care
membership by 1.4 million, or 5%. The following table sets forth our membership
by line of business:
September 30, December 31, September 30,
2021 2020 2020
Traditional Medicaid (1) 13,202,500 12,055,400 11,662,100
High Acuity Medicaid (2) 1,566,000 1,554,700 1,521,700
Total Medicaid 14,768,500 13,610,100 13,183,800
Medicare PDP 4,064,400 4,469,400 4,436,400
Commercial 2,645,500 2,633,600 2,719,500
Medicare (3) 1,248,300 955,400 953,800
International 763,500 597,700 599,900
Correctional 167,600 147,200 167,200
Total at-risk membership 23,657,800 22,413,400 22,060,600
TRICARE eligibles 2,874,700 2,877,900 2,877,900
Non-risk membership 4,000 231,600 227,200
Total 26,536,500 25,522,900 25,165,700
(1) Membership includes TANF, Medicaid Expansion, CHIP,
(2) Membership includes ABD, IDD, LTSS and MMP Duals.
(3) Membership includes Medicare Advantage and Medicare Supplement.
The following table sets forth additional membership statistics, which are
included in the table above:
September 30, December 31, September 30,
2021 2020 2020
Dual-eligible (4) 1,168,400 1,066,800 974,800
Health Insurance Marketplace 2,177,000 2,131,600 2,210,800
Medicaid Expansion 2,383,500 2,181,400 2,070,500
(4) Membership includes dual-eligible ABD & LTSS and dual-eligible Medicare.
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RESULTS OF OPERATIONS The following discussion and analysis is based on our Consolidated Statements of Operations, which reflect our results of operations for the three and nine months endedSeptember 30, 2021 and 2020, prepared in accordance with generally accepted accounting principles inthe United States . Summarized comparative financial data for the three and nine months endedSeptember 30, 2021 and 2020 is as follows ($ in millions, except per share data in dollars): Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 % Change 2021 2020 % Change Premium$ 28,876 $ 26,537 9 %$ 83,436 $ 74,496 12 % Service 1,638 922 78 % 4,054 2,859 42 % Premium and service revenues 30,514 27,459 11 % 87,490 77,355 13 % Premium tax and health insurer fee 1,892 1,631 16 % 5,924 5,472 8 % Total revenues 32,406 29,090 11 % 93,414 82,827 13 % Medical costs 25,430 22,932 11 % 73,210 63,659 15 % Cost of services 1,355 861 57 % 3,510 2,519 39 % Selling, general and administrative expenses 2,684 2,507 7 % 7,324 7,146 2 % Amortization of acquired intangible assets 198 164 21 % 581 527 10 % Premium tax expense 1,965 1,389 41 % 6,129 4,737 29 % Health insurer fee expense - 376 n.m. - 1,100 n.m. Impairment 229 - n.m. 229 72 218 % Legal settlement - - n.m. 1,250 - n.m. Earnings from operations 545 861 (37) % 1,181 3,067 (61) % Investment and other income 424 95 346 % 566 375 51 % Debt extinguishment costs (79) - n.m. (125) (44) 184 % Interest expense (170) (184) (8) % (503) (551) (9) % Earnings before income tax expense 720 772 (7) % 1,119 2,847 (61) % Income tax expense 139 207 (33) % 376 1,034 (64) % Net earnings 581 565 3 % 743 1,813 (59) % Loss attributable to noncontrolling interests 3 3 - % 5 7 (29) % Net earnings attributable to Centene Corporation$ 584 $ 568 3 %$ 748 $ 1,820 (59) % Diluted earnings per common share attributable to Centene Corporation$ 0.99 $ 0.97 2 %$ 1.27 $ 3.16 (60) % n.m.: not meaningful 26
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Three Months Ended
Total Revenues
The following table sets forth supplemental revenue information for the three
months ended
2021 2020 % Change Medicaid $ 21,624 $ 19,497 11 % Commercial 4,383 4,638 (5) % Medicare (1) 3,921 3,137 25 % Medicare PDP 401 582 (31) % Other 2,077 1,236 68 % Total Revenues $ 32,406 $ 29,090 11 %
(1) Medicare includes Medicare Advantage and Medicare Supplement.
Total revenues increased 11% in the three months endedSeptember 30, 2021 over the corresponding period in 2020, due to Medicaid membership growth resulting from the ongoing suspension of eligibility redeterminations, membership growth in the Medicare business, our recent acquisitions ofPANTHERx and Circle Health and the commencement of our contracts inNorth Carolina , partially offset by the repeal of the health insurer fee.
Operating Expenses
Medical Costs
The HBR for the three months endedSeptember 30, 2021 , was 88.1%, compared to 86.4% in the same period in 2020. The HBR for the third quarter of 2020 was favorably impacted by the ACA risk corridor receivable settlement from the federal government based on theSupreme Court ruling in 2020, which impacted HBR by 130 basis points. The HBR for the third quarter of 2021 was negatively impacted by the repeal of the health insurer fee.
Cost of Services
Cost of services increased by$494 million in the three months endedSeptember 30, 2021 , compared to the corresponding period in 2020, primarily attributable to newly acquired businesses, includingPANTHERx and Circle Health , which was partially offset by the expiration of the pharmacy contract with our previously divestedIllinois health plan. The cost of service ratio for the three months endedSeptember 30, 2021 , was 82.7%, compared to 93.4% in the same period in 2020. The decrease in the cost of service ratio was driven by the acquisition of theCircle Health business, which operates at a lower cost of service ratio, and favorable results related to the shared savings programs in our physician home health business. These decreases were partially offset by PANTHERx, which operates at a higher cost of service ratio.
Selling, General & Administrative Expenses
The SG&A expense ratio was 8.8% for the third quarter of 2021, compared to 9.1% in the third quarter of 2020. The adjusted SG&A expense ratio was 8.6% for the third quarter of 2021, compared to 8.9% in the third quarter of 2020. The decreases were due to the$275 million charitable contribution commitment in the third quarter of 2020, which impacted the SG&A ratio by 100 basis points, and the leveraging of expenses over higher revenues as a result of increased Medicaid membership and the recent acquisition of PANTHERx. These impacts were partially offset by increased sales and marketing costs and the addition of theCircle Health business, which operates at a significantly higher SG&A ratio due to the nature of the business.
Health Insurer Fee Expense
As a result of the repeal of the HIF, we did not have HIF expense for the three months endedSeptember 30, 2021 , compared to$376 million in the corresponding period in 2020. 27 -------------------------------------------------------------------------------- Table of Contents Impairment During the third quarter of 2021, we recorded a$229 million non-cash impairment of our equity method investment in RxAdvance, a pharmacy benefit manager. The impairment was the result of our focus on simplification of our pharmacy operations. Specifically, during the third quarter, we made a strategic decision to transition from using the RxAdvance platform and consolidate our business on an alternative external platform.
Other Income (Expense)
The following table summarizes the components of other income (expense) for the
three months ended
2021 2020
Investment and other income $ 424 $ 95
Debt extinguishment costs (79) -
Interest expense (170) (184)
Other income (expense), net $ 175 $ (89)
Investment and other income. Investment and other income increased by
million
corresponding period in 2020, driven by a gain of
acquisition of the remaining 60% interest of
Debt extinguishment costs. InAugust 2021 , we redeemed all of our outstanding 5.375% senior notes due 2026 and all ofWellCare Health Plans, Inc.'s outstanding 5.375% senior notes due 2026, including all premiums, accrued interest and costs and expenses related and recognized a pre-tax loss on extinguishment of approximately$79 million . The loss includes the call premium and the write-off of the unamortized premium and debt issuance costs, and expenses related to the redemption. Interest expense. Interest expense decreased by$14 million in the three months endedSeptember 30, 2021 compared to the corresponding period in 2020. The decrease was driven by our senior note refinancing actions, partially offset by additional interest expense related to the Magellan financing.
Income Tax Expense
For the three months endedSeptember 30, 2021 , we recorded income tax expense of$139 million on pre-tax earnings of$720 million , or an effective tax rate of 19.3%. The effective tax rate for the third quarter of 2021 reflects the non-taxable gain related to the acquisition of the remaining 60% interest ofCircle Health and the repeal of the health insurer fee beginning in 2021. For the third quarter of 2021, our effective tax rate on adjusted earnings was 24.5%. For the three months endedSeptember 30, 2020 , we recorded income tax expense of$207 million on pre-tax earnings of$772 million , or an effective tax rate of 26.8%, which reflects a favorable tax settlement, offset by the reinstatement of the health insurer fee in 2020.
Segment Results
The following table summarizes our consolidated operating results by segment for
the three months ended
2021 2020 % Change Total Revenues Managed Care$ 30,889 $ 28,016 10 % Specialty Services 4,727 3,774 25 % Eliminations (3,210) (2,700) (19) % Consolidated Total$ 32,406 $ 29,090 11 % Earnings from Operations Managed Care$ 699 $ 888 (21) % Specialty Services (154) (27) (470) % Consolidated Total$ 545 $ 861 (37) % 28
-------------------------------------------------------------------------------- Table of Contents Managed Care Total revenues increased 10% in the three months endedSeptember 30, 2021 , compared to the corresponding period in 2020, due to Medicaid membership growth resulting from the ongoing suspension of eligibility redeterminations, membership growth in the Medicare business, the commencement of our contracts inNorth Carolina , and our recent acquisition ofCircle Health , partially offset by the repeal of the health insurer fee. Earnings from operations decreased$189 million between years. In 2020, earnings from operations benefited from the favorable impact of the ACA risk corridor receivable settlement from the federal government, partially offset by the$275 million charitable contribution commitment in the third quarter of 2020. Earnings from operations in 2021 was negatively impacted by higher COVID testing and treatment costs and the repeal of the health insurer fee in 2021, partially offset by strong membership growth.
Specialty Services
Total revenues increased 25% in the three months endedSeptember 30, 2021 , compared to the corresponding period in 2020, resulting primarily from newly acquired businesses, including PANTHERx, increased services associated with membership growth in the Managed Care segment, and newly awarded contracts in our correctional business, partially offset by the expiration of the pharmacy contract with our previously divestedIllinois health plan. Earnings from operations decreased$127 million in the three months endedSeptember 30, 2021 , compared to the corresponding period in 2020, primarily due to the impairment of our equity method investment in RxAdvance, a pharmacy benefit manager, partially offset by favorable results related to the shared savings programs in our physician home health business.
Nine Months Ended
2020
Total Revenues
The following table sets forth supplemental revenue information for the nine
months ended
2021 2020 % Change Medicaid $ 62,612 $ 55,466 13 % Commercial 12,391 12,893 (4) % Medicare (1) 11,631 8,892 31 % Medicare PDP 1,494 1,856 (20) % Other 5,286 3,720 42 % Total Revenues $ 93,414 $ 82,827 13 %
(1) Medicare includes Medicare Advantage and Medicare Supplement.
Total revenues increased 13% in the nine months endedSeptember 30, 2021 over the corresponding period in 2020 primarily due to Medicaid membership growth resulting from the ongoing suspension of eligibility redeterminations, membership growth in the Medicare business, a full nine months of WellCare revenues, our recent acquisitions ofPANTHERx and Circle Health , and the commencement of our contracts inNorth Carolina , partially offset by the repeal of the health insurer fee. During the nine months endedSeptember 30, 2021 , we received premium rate adjustments, which yielded a net 2% composite change across all of our markets. Operating Expenses Medical Costs The HBR for the nine months endedSeptember 30, 2021 was 87.7%, compared to 85.5% in the same period in 2020. The HBR for 2020 was favorably impacted the ACA risk corridor settlement from the federal government based on aSupreme Court ruling in 2020, which impacted HBR by 50 basis points. The 2021 HBR was negatively impacted by higher utilization in the Marketplace business in 2021, the repeal of the health insurer fee, and higher COVID testing and treatment costs. Marketplace utilization in 2021 included pent-up demand resulting from previously deferred services during the pandemic. 29 -------------------------------------------------------------------------------- Table of Contents Cost of Services Cost of services increased by$991 million in the nine months endedSeptember 30, 2021 , compared to the corresponding period in 2020, primarily attributable to newly acquired businesses, includingPANTHERx and Circle Health , which was partially offset by the expiration of the pharmacy contract with our previously divestedIllinois health plan. The cost of service ratio for the nine months endedSeptember 30, 2021 , was 86.6%, compared to 88.1% in the same period in 2020. The decrease in the cost of service ratio was driven by the acquisition of theCircle Health business, which operates at a lower cost of service ratio, and favorable results related to the shared savings programs in our physician home health business. These decreases were partially offset by PANTHERx, which operates at a higher cost of service ratio.
Selling, General & Administrative Expenses
The SG&A expense ratio for the nine months endedSeptember 30, 2021 was 8.4%, compared to 9.2% for the corresponding period in 2020. The adjusted SG&A expense ratio for the nine months endedSeptember 30, 2021 was 8.1%, compared to 8.7% for the nine months endedSeptember 30, 2020 . The 2020 ratios were negatively impacted by the$275 million charitable contribution commitment to our foundation in the third quarter of 2020. The 2021 ratios benefited from the leveraging of expenses over higher revenues as a result of increased Medicaid membership and recent acquisitions. These were partially offset by increased sales and marketing costs, primarily due to the Marketplace special enrollment period, and the addition ofCircle Health , which operates at a higher SG&A ratio, due to the nature of the business. The SG&A expense ratio also benefited from lower acquisition related costs.
Health Insurer Fee Expense
As a result of the repeal of the HIF, we did not have HIF expense for the nine months endedSeptember 30, 2021 , compared to$1.1 billion in the corresponding period in 2020. Impairment During the third quarter of 2021, we recorded a$229 million non-cash impairment of our equity method investment in RxAdvance, a pharmacy benefit manager. The impairment was the result of the our focus on simplification of our pharmacy operations. Specifically, during the third quarter, we made a strategic decision to transition from using the RxAdvance platform and consolidate our business on an alternative external platform. During the first quarter of 2020, we recorded$72 million of a non-cash impairment of our third-party care management software business. Legal Settlement During the second quarter of 2021, we recorded a legal settlement reserve estimate of$1.25 billion (inclusive of theArkansas ,Illinois ,Mississippi andOhio settlements) related to services provided byEnvolve , our pharmacy benefits manager subsidiary, essentially during 2017 and 2018.
Other Income (Expense)
The following table summarizes the components of other income (expense) for the
nine months ended
2021 2020
Investment and other income $ 566 $ 375
Debt extinguishment costs (125) (44)
Interest expense (503) (551)
Other income (expense), net $ (62) $ (220)
Investment and other income. Investment and other income increased by $191
million in the nine months ended September 30, 2021 compared to the
corresponding period in 2020. The increase was driven by a gain related to the
acquisition of the remaining 60% interest of Circle Health of $309 million ,
partially offset by a $62 million reduction to the gain due to the finalization
of the working capital adjustment related to the divestiture of certain products
of our Illinois health plan recorded in the nine months ended September 30,
2021 , compared to the previously reported $104 million gain recorded in the nine
months ended September 30, 2020 . The increase was also partially offset by lower
interest rates.
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Debt extinguishment costs. In August 2021 , we redeemed all of our outstanding
5.375% senior notes due 2026 and all of WellCare Health Plans, Inc.'s ,
outstanding 5.375% senior notes due 2026, and recognized a pre-tax loss on
extinguishment of approximately $79 million . The loss includes the call premium
and the write-off of the unamortized premium and debt issuance costs.
In February 2021 , we tendered or redeemed all of our outstanding $2.2 billion
4.75% Senior Notes, due 2025 and recognized a pre-tax loss on extinguishment of
approximately $46 million . The loss includes the call premium and the write-off
of unamortized premium and debt issuance costs.
In February 2020 , we redeemed all of our outstanding $1.0 billion 6.125% Senior
Notes, due February 15, 2024 (the 2024 Notes) and recognized a pre-tax loss on
extinguishment of approximately $44 million . The loss includes the call premium,
the write-off of unamortized debt issuance costs and the loss on the termination
of the $1.0 billion interest rate swap associated with the 2024 Notes.
Interest expense. Interest expense decreased by $48 million in the nine months
ended September 30, 2021 , compared to the corresponding period in 2020, driven
by our senior note refinancing actions.
Income Tax Expense
For the nine months endedSeptember 30, 2021 , we recorded income tax expense of$376 million on pre-tax earnings of$1.1 billion , or an effective tax rate of 33.6%. The effective tax rate for the nine months endedSeptember 30, 2021 reflects the partial non-deductibility of the legal settlement reserve and the repeal of the health insurer fee beginning in 2021. For the nine months endedSeptember 30, 2021 , our effective tax rate on adjusted earnings was 25.4%. For the nine months endedSeptember 30, 2020 , we recorded income tax expense of$1.0 billion on pre-tax earnings of$2.8 billion , or an effective tax rate of 36.3%, which reflects the reinstatement of the health insurer fee in 2020, the non-deductibility of certain acquisition related expenses, and the tax impact associated with theIllinois divestiture.
Segment Results
The following table summarizes our consolidated operating results by segment for
the nine months ended
2021 2020 % Change Total Revenues Managed Care$ 89,082 $ 79,577 12 % Specialty Services 13,553 11,203 21 % Eliminations (9,221) (7,953) (16) % Consolidated Total$ 93,414 $ 82,827 13 % Earnings from Operations Managed Care$ 1,240 $ 3,014 (59) % Specialty Services (59) 53 (211) % Consolidated Total$ 1,181 $ 3,067 (61) % Managed Care Total revenues increased 12% in the nine months endedSeptember 30, 2021 , compared to the corresponding period in 2020, primarily due to Medicaid membership growth resulting from the ongoing suspension of eligibility redeterminations, membership growth in the Medicare business, a full nine months of WellCare revenues, the commencement of our contracts inNorth Carolina , and our recent acquisition ofCircle Health , partially offset by the repeal of the health insurer fee. Earnings from operations decreased$1.8 billion between years primarily due to a legal settlement reserve estimate of$1.25 billion related to services provided byEnvolve , higher utilization in the Marketplace business in 2021, the repeal of the health insurer fee in 2021 and an unfavorable 2020 risk adjustment in 2021. These decreases were partially offset by lower acquisition related expenses and a full nine months of WellCare results.
Specialty Services
Total revenues increased 21% in the nine months endedSeptember 30, 2021 , compared to the corresponding period in 2020, resulting primarily from newly acquired businesses, including PANTHERx, and increased services associated with membership 31 -------------------------------------------------------------------------------- Table of Contents growth in the Managed Care segment, partially offset by the expiration of the pharmacy contract with our previously divestedIllinois health plan. Earnings from operations decreased$112 million in the nine months endedSeptember 30, 2021 , compared to the corresponding period in 2020, primarily due to the impairment of our equity method investment in RxAdvance, a pharmacy benefit manager, partially offset by favorable results related to the shared savings programs in our physician home health business. Earnings from operations in 2020 was negatively affected by the previously discussed$72 million impairment related to our third-party care management software business. LIQUIDITY AND CAPITAL RESOURCES
Shown below is a condensed schedule of cash flows used in the discussion of
liquidity and capital resources ($ in millions).
Nine
Months Ended
2021 2020
Net cash provided by operating activities $ 3,530 $ 2,522
Net cash used in investing activities (2,442) (2,700)
Net cash provided by financing activities 1,597 383
Effect of exchange rate changes on cash and cash equivalents (8) 8
Net increase in cash, cash equivalents, and restricted cash and
cash equivalents $ 2,677 $ 213
Cash Flows Provided by Operating Activities
Normal operations are funded primarily through operating cash flows and borrowings under our revolving credit facility. Operating activities provided cash of$3.5 billion in the nine months endedSeptember 30, 2021 compared to providing cash of$2.5 billion in the comparable period in 2020. Cash flows provided by operations in 2021 was primarily driven by net earnings before the legal settlement reserve, the majority of which is expected to be paid in future periods, an increase in state risk sharing mechanism payables, partially offset by risk adjustment and minimum MLR payments for theHealth Insurance Marketplace 2020 plan year. Cash flows provided by operations in 2020 were due to net earnings, an increase in medical claims liabilities from growth and expansions, and an increase in other long-term liabilities related to minimum MLR payables and a delay in tax payments related to the COVID-19 extensions to payment deadlines. This was partially offset by an increase in premium and related receivables due to the timing of payments for pharmacy rebates and HIF reimbursement and a decrease in accounts payable and accrued expenses related to risk adjustment and minimum MLR payments. Cash flows from operations in each year can be impacted by the timing of payments we receive from our states. As we have seen historically, states may prepay the following month premium payment, which we record as unearned revenue, or they may delay our premium payment, which we record as a receivable. We typically receive capitation payments monthly; however, the states in which we operate may decide to adjust their payment schedules, which could positively or negatively impact our reported cash flows from operating activities in any given period.
Cash Flows Used in Investing Activities
Investing activities used cash of$2.4 billion in the nine months endedSeptember 30, 2021 , and$2.7 billion in the comparable period in 2020. Cash flows used in investing activities in 2021 primarily consisted of the net additions to the investment portfolio of our regulated subsidiaries (including transfers from cash and cash equivalents to long-term investments), acquisition and divestiture activity primarily related to the acquisition of the remaining 60% interest ofCircle Health for$705 million and capital expenditures.
Cash flows used in investing activities in 2020 primarily consisted of our
acquisition of WellCare, partially offset by divestiture proceeds.
We spent$662 million and$663 million in the nine months endedSeptember 30, 2021 and 2020, respectively, on capital expenditures for system enhancements, computer hardware and software, and corporate headquarters expansions.
As of
fixed-income securities with an average duration of 3.6 years. We had
unregulated cash and investments of
to
represents cash and cash equivalents held by unregulated entities, including
32 -------------------------------------------------------------------------------- Table of Contents$1.8 billion of cash raised for the anticipated closing of the Magellan Acquisition. Unregulated cash was reduced by pharmacy payments made in early October in the normal course of business.
Cash Flows Provided by Financing Activities
Financing activities provided cash of$1.6 billion in the nine months endedSeptember 30, 2021 , compared to providing cash of$383 million in the comparable period in 2020. Financing activities in 2021 were driven by costs associated with our debt refinancing, offset by increased borrowings. InJuly 2021 , we issued$1.8 billion 2.45% Senior Notes due 2028 (the 2028 Notes). We intend to use the net proceeds from the offering of the 2028 Notes to finance a portion of the cash consideration payable in connection with our previously announced acquisition of Magellan Health Inc. and to pay related fees and expenses. If the Magellan Acquisition is not completed, we expect to use the net proceeds of the offering for debt repayment and general corporate purposes. 2020 net financing activities were due to increased borrowings, partially offset by common stock repurchases. Liquidity Metrics InFebruary 2021 , our Board of Directors approved an increase in our Company's existing share repurchase program. With the increase, we are authorized to repurchase up to$1.0 billion worth of shares of our common stock, inclusive of the previously approved stock repurchase program. From time to time, we raise capital through the issuance of debt in the form of senior notes. As ofSeptember 30, 2021 , we had an aggregate principal amount of$16.0 billion of senior notes issued and outstanding. The indentures governing our various maturities of senior notes contain restrictive covenants. As ofSeptember 30, 2021 , we were in compliance with all covenants. We also have a$200 million non-recourse construction loan to fund the expansion of our corporate headquarters. Refer to Note 6. Debt for further information regarding the issuance and redemption of senior notes as well as detail related to our construction loan. The credit agreement underlying our Company's revolving credit facility and term loan facility contains customary covenants as well as financial covenants including a minimum fixed charge coverage ratio and a maximum debt-to-EBITDA ratio. Our maximum debt-to-EBITDA ratio under the credit agreement may not exceed 4.0 to 1.0. As ofSeptember 30, 2021 , we had$150 million of borrowings outstanding under our revolving credit facility,$2.2 billion of borrowings under our term loan facility, and we were in compliance with all covenants. As ofSeptember 30, 2021 , there were no limitations on the availability of our revolving credit facility as a result of the debt-to-EBITDA ratio. We had outstanding letters of credit of$126 million as ofSeptember 30, 2021 , which were not part of our revolving credit facility. The letters of credit bore weighted interest of 0.6% as ofSeptember 30, 2021 . In addition, we had outstanding surety bonds of$1.2 billion as ofSeptember 30, 2021 . AtSeptember 30, 2021 , we had working capital, defined as current assets less current liabilities, of$3.0 billion , compared to$1.8 billion atDecember 31, 2020 . We manage our short-term and long-term investments with the goal of ensuring that a sufficient portion is held in investments that are highly liquid and can be sold to fund short-term requirements as needed.
At
by the sum of total debt and total equity, was 41.5%, compared to 39.3% at
capital ratio was 41.2% as of
others, of our leverage and financial flexibility.
2021 Expectations
During the remainder of 2021, we expect to receive net dividends from our insurance subsidiaries of approximately$235 million and spend approximately$220 million in additional capital expenditures primarily associated with system enhancements and market and corporate headquarters expansions. These amounts are expected to be funded by unregulated cash flow generation in 2021 and borrowings on our revolving credit facility and construction loan. From time to time we may elect to raise additional funds for these and other purposes, either through issuance of debt or equity, the sale of investment securities or otherwise, as appropriate. In addition, we may strategically pursue refinancing or redemption opportunities to extend maturities and/or improve terms of our indebtedness if we believe such opportunities are favorable to us. 33 -------------------------------------------------------------------------------- Table of Contents Our lease obligations were significantly impacted due to the acquisition ofCircle Health , which closed in the third quarter of 2021. For additional information regarding these contractual obligations, refer to Note 7. Leases, included in Part I, Item 1. "Notes to the Consolidated Financial Statements" of this filing. Based on our operating plan, we expect that our available cash, cash equivalents and investments, cash from our operations and cash available under our revolving credit facility will be sufficient to finance our general operations and capital expenditures for at least 12 months from the date of this filing. While we are currently in a strong liquidity position and believe we have adequate access to capital, we may elect to increase borrowings under our revolving credit facility. 34
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REGULATORY CAPITAL AND DIVIDEND RESTRICTIONS Our operations are conducted through our subsidiaries. As managed care organizations, most of our subsidiaries are subject to state regulations and other requirements that, among other things, require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing, payment and amount of dividends and other distributions that may be paid to us. Generally, the amount of dividend distributions that may be paid by a regulated subsidiary without prior approval by state regulatory authorities is limited based on the entity's level of statutory net income and statutory capital and surplus. Our regulated subsidiaries are required to maintain minimum capital requirements prescribed by various regulatory authorities in each of the states in which we operate. During the nine months endedSeptember 30, 2021 , we received$1.3 billion of net dividends from our regulated subsidiaries. For our subsidiaries that file with theNational Association of Insurance Commissioners (NAIC), the aggregate risk-based capital (RBC) level as ofDecember 31, 2020 , which was the most recent date for which reporting was required, was in excess of 350% of the Authorized Control Level. We intend to continue to maintain an aggregate RBC level in excess of 350% of the Authorized Control Level during 2021. Under the California Knox-Keene Health Care Service Plan Act of 1975, as amended (Knox -Keene ), certain of ourCalifornia subsidiaries must comply with tangible net equity (TNE) requirements. Under these Knox-Keene TNE requirements, actual net worth less certain unsecured receivables and intangible assets must be more than the greater of (i) a fixed minimum amount, (ii) a minimum amount based on premiums or (iii) a minimum amount based on healthcare expenditures, excluding capitated amounts. Under the New York StateDepartment of Health Codes, Rules and Regulations Title 10, Part 98, ourNew York subsidiary must comply with contingent reserve requirements. Under these requirements, net worth based upon admitted assets must equal or exceed a minimum amount based on annual net premium income.
The NAIC has adopted rules which set minimum RBC requirements for insurance
companies, managed care organizations and other entities bearing risk for
healthcare coverage. As of
compliance with the RBC requirements enacted in those states.
As a result of the above requirements and other regulatory requirements, certain
of our subsidiaries are subject to restrictions on their ability to make
dividend payments, loans or other transfers of cash to their parent companies.
Such restrictions, unless amended or waived or unless regulatory approval is
granted, limit the use of any cash generated by these subsidiaries to pay our
obligations. The maximum amount of dividends that can be paid by our insurance
company subsidiaries without prior approval of the applicable state insurance
departments is subject to restrictions relating to statutory surplus, statutory
income and unassigned surplus.
35
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