ITEM 1. BUSINESS
GENERAL
Humana Inc. is a Delaware corporation organized in 1961. Its principal
executive offices are located at 500 West Main Street, Louisville, Kentucky
40202, and its telephone number at that address is (502) 580-1000. As used
herein, the term "the Company" includes Humana Inc. and its subsidiaries.
On March 1, 1993, the Company separated its acute-care hospital and managed
care health plan businesses into two independent publicly-held companies (the
"Spinoff"). The Spinoff was effected through the distribution to Humana
stockholders of record as of the close of business on March 1, 1993, of all of
the outstanding shares of common stock of a new hospital company, Galen Health
Care, Inc. ("Galen"). Galen was subsequently merged, through an unrelated
transaction, with a subsidiary of Columbia Healthcare Corporation (now
Columbia/HCA Healthcare Corporation) ("Columbia") and, therefore, became a
wholly-owned subsidiary of Columbia. The Company continues to operate the
managed care health plan business. In conjunction with the Spinoff, the Company
changed its fiscal year end from August 31 to December 31.
Since 1983, the Company has offered managed health care products which
integrate financing and management with the delivery of health care services
through a network of providers who share financial risk or who have incentives
to deliver cost-effective medical services. These products are marketed
primarily through health maintenance organizations ("HMOs") and preferred
provider organizations ("PPOs") that encourage, and in most HMO products
require, use of contracting providers. HMOs and PPOs also control health care
costs by various other means, including the use of utilization controls such as
pre-admission approval for hospital inpatient services and pre-authorization of
outpatient surgical procedures.
The HMO and PPO products of the Company are primarily marketed to employer
and other groups ("Commercial") and Medicare-eligible individuals. The products
marketed to Medicare-eligible individuals are either HMO products that provide
health care services which include all Medicare benefits, and in certain
circumstances, additional health care services that are not included in Medicare
benefits ("Medicare risk") or indemnity insurance policies that supplement
Medicare benefits ("Medicare supplement"). Since 1983, the growth in the
Company's HMO business has been primarily attributable to acquisitions, while
the growth in its PPO business has been exclusively from internally produced
sales.
COMMERCIAL PRODUCTS
HMOs
An HMO provides prepaid health care services to its members through primary
care and specialty physicians employed by the HMO at facilities owned by the
HMO, or through a network of independent primary care and specialty physicians
and other health care providers who contract with the HMO or the primary care
physician to furnish such services. Primary care physicians include internists,
family practitioners and pediatricians. Generally, access to specialty
physicians and other health care providers must be approved by the member's
primary care physician. These other health care providers include, among others,
hospitals, nursing homes, home health agencies, pharmacies, mental health and
substance abuse centers, diagnostic centers, optometrists, outpatient surgery
centers, dentists, urgent care centers, and durable medical equipment suppliers.
Because access to these other health care providers must be approved by the
primary care physician, the HMO product is the most restrictive form of managed
care.
At December 31, 1993, the Company owned and operated ten HMOs, which
contract with approximately 27,400 physicians (including approximately 5,900
primary care physicians) and 480 hospitals. In addition, the Company has
approximately 1,300 contracts with other providers to provide services to HMO
members. The Company also employed approximately 450 physicians in its HMOs.
An HMO member pays a monthly fee which generally covers, with minimal
co-payments, health care services received or approved by the member's primary
care physician. For the year ended December 31, 1993, Commercial HMO premium
revenues totaled approximately $1.4 billion or 43 percent of the Company's
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premium revenues of $3.1 billion. Approximately $168 million of the Company's
premium revenues for the year ended December 31, 1993, were derived from
contracts with the United States Office of Personnel Management ("OPM") under
which the Company provides health care benefits to approximately 122,700 federal
civilian employees and their dependents. Pursuant to these contracts, payments
made by OPM may be retrospectively adjusted downward by OPM if an audit
discloses that a comparable product was offered by the Company to a similarly
sized subscriber group using a rating formula which resulted in a lower premium
rate than that offered to OPM.
PPOs
PPO products include many elements of managed health care. In a PPO, the
enrollee is encouraged, through financial incentives, to use preferred health
care providers which have contracted with the PPO to provide services at
favorable rates. PPOs are also similar to traditional health insurance because
they provide an enrollee with the freedom to choose a physician or other health
care provider.
At December 31, 1993, approximately 24,300 physicians and 480 hospitals
contracted with the Company to provide services to PPO enrollees. In addition,
the Company has approximately 1,300 contracts with other providers to provide
services to PPO enrollees.
For the year ended December 31, 1993, premium revenues from Commercial PPOs
totaled $357 million or 11 percent of the Company's premium revenues of $3.1
billion.
MEDICARE PRODUCTS
Medicare is a federal program that provides persons age 65 and over and
some disabled persons certain hospital and medical insurance benefits, which
include hospitalization benefits for up to 90 days per incident of illness plus
a lifetime reserve aggregating 60 days. Each Medicare eligible individual is
entitled to receive inpatient hospital care (Part A) without the payment of any
premium, but is required to pay a premium to the federal government, which is
annually adjusted, to be eligible for physician and other services (Part B).
Even though participating in both Part A and Part B of Medicare,
beneficiaries are still required to pay certain deductible and co-insurance
amounts. They may, if they choose, supplement their Medicare coverage by
purchasing policies which pay these deductibles and co-insurance amounts. Many
of these policies also cover other services (such as prescription drugs) which
are not included in Medicare coverage. These policies are known as Medicare
supplement policies.
Certain managed care companies which operate HMOs contract with the federal
government's Health Care Financing Administration ("HCFA") to provide medical
benefits to Medicare-eligible individuals residing in the geographic areas in
which their HMOs operate in exchange for a fixed monthly payment from HCFA per
enrollee. Individuals who elect to participate in these Medicare risk programs
are relieved of the obligation to pay some or all of the deductible or
co-insurance amounts but are required to use exclusively the services provided
by the HMO. Other than the Part B premium paid by the enrollee to the Medicare
program, the enrollee does not pay the HMO a premium for these services except
where the benefits provided by the HMO exceed the benefits provided by the
Medicare program.
Medicare Risk
As discussed above, a Medicare risk product involves a contract between an
HMO and HCFA pursuant to which HCFA makes a fixed monthly payment to the HMO on
behalf of each Medicare-eligible individual who chooses to enroll for coverage
by the HMO. Enrollment may be terminated by the member upon 30 days' notice. The
fixed monthly payment is determined and adjusted annually by HCFA, and takes
into account, among other things, the cost of providing medical care in the
geographic area where the member resides.
The Company markets a variety of Medicare risk HMO products. All of these
products provide an enrolled individual with all of the benefits covered by the
Medicare program but relieve the enrolled individual of the obligation to pay
deductibles and co-insurance that would otherwise apply. Some of these products
also
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provide additional benefits not covered by Medicare, such as vision and dental
care services and prescription drugs.
Where competitive conditions permit, the Company also charges a premium to
members (in addition to the payment from HCFA) for some of the Medicare risk
products. At December 31, 1993, approximately 73,300 members in nine markets
were paying premiums which totaled $51 million for the year ended December 31,
1993.
The Company provides Medicare risk services under seven contracts with HCFA
("HCFA Contracts") in 10 markets. At December 31, 1993, HCFA Contracts covered
approximately 270,800 Medicare risk members for which the Company received HCFA
revenues of approximately $1.2 billion or 40 percent of the Company's premium
revenues for the year ended December 31, 1993, of $3.1 billion. At December 31,
1993, one such HCFA Contract covered approximately 210,000 members in Florida.
For the year ended December 31, 1993, this Florida HCFA Contract accounted for
$1 billion or 80 percent of the Company's HCFA revenues of approximately $1.2
billion or 32 percent of the Company's total premium revenues. Each HCFA
Contract is renewed each December 31 unless HCFA or the Company terminates it
upon at least 90 days' notice prior thereto. Management believes termination of
the HCFA Contract covering the members in Florida would have a material adverse
effect on the Company's revenues, profitability and business prospects.
Moreover, changes in the Medicare risk program, such as reduction in payments by
HCFA or mandated increases in benefits without corresponding increases in
payments, could also have a material adverse effect on the Company's revenues,
profitability and business prospects.
Effective January 1, 1994, payments under the Company's HCFA Contracts
increased by an average of approximately 3 percent. Although annual increases
have varied significantly, increases have averaged approximately 7 percent over
the last five years, including the increase of January 1994.
Medicare Supplement
The Company's Medicare supplement product is an insurance policy which pays
for hospital deductibles, co-payments and co-insurance for which the Medicare
program participant is responsible.
Under the terms of existing Medicare supplement policies, the Company may
not reduce or cancel the benefits contracted for by policyholders. These
policies are annually renewable by the insured at the Company's prevailing
rates, which may increase subject to approval by appropriate state insurance
regulators.
At December 31, 1993, the Company provided Medicare supplement benefits to
approximately 153,600 members. Premium revenues derived from this product for
the year ended December 31, 1993, totaled $132 million.
PROVIDER ARRANGEMENTS
The Company's HMOs contract with individual or groups of primary care
physicians, generally for an actuarially determined, fixed, per-member-per-month
fee called a "capitation" payment. These contracts typically obligate primary
care physicians to provide or arrange for the provision of all covered health
care services to HMO members, including health care services provided by
specialty physicians and other health care providers. The capitation payment
does not vary with the nature or extent of health care services arranged for or
provided to the member and is generally designed to shift all or part of the
HMO's financial risk to the primary care physician. However, the degree to which
the Company shifts its risk varies by provider. The Company remains financially
responsible for the provision of or payment for such health care services if a
primary care physician fails to perform his or her obligations under the
contract. The Company also employs 450 physicians in markets where it operates
staff model HMOs. The Company is directly responsible for all health care
services provided by these employed physicians. In order to control costs,
improve quality and create comprehensive networks, the Company also contracts
with medical specialists and other providers to which a primary care physician
may refer a member. Typically, payments by the Company to these specialists and
other providers reduce the ultimate payment that otherwise would be made to a
primary care physician.
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The Company's HMOs and PPOs contract for hospital services generally under
a per diem payment arrangement for inpatient hospital services and a discounted
fee-for-service payment arrangement for outpatient services. The Company's PPOs
contract on a per diem or discounted basis with other health care providers.
Many of the physicians who contract with the Company's HMOs also contract
with its PPOs to provide services to enrollees at discounted fees. In addition,
in a number of markets the Company's PPOs contract with physicians who have not
contracted with its HMOs.
Physician participation in the Company's HMOs and PPOs is conditioned upon
meeting its HMOs' and PPOs' requirements concerning the physician's professional
qualifications.
Effective with the consummation of the Spinoff, the Company entered into a
three-year operating agreement with Galen whereby the Company will use the
services of Galen's hospitals guaranteeing certain minimum utilization levels.
The rate increases charged for such services are defined under the terms of the
agreement. Commercial rate increases are limited to the lesser of the increase
in the hospital Consumer Price Index or the Company's premium rate increases,
less 1 percent. The Medicare risk rate increases are equal to the percentage
adjustment in HCFA's market specific hospital payment rate to the Company.
During the year ended December 31, 1993, 16 percent of the Company's total
medical costs were incurred in Galen's hospitals.
MARKETING
Individuals become members of the Company's Commercial HMOs and PPOs
through their employer or other groups which typically offer employees or
members a selection of health care products, pay for all or part of the premiums
and make payroll deductions for any premiums payable by the employees. The
Company attempts to become an employer's or group's exclusive source of health
care benefits by offering HMO and PPO products that provide cost-effective
quality care consistent with the health care needs and expectations of the
employees or members.
The Company uses various methods to market its Commercial and Medicare
products, including television, radio, telemarketing and mailings. At December
31, 1993, the Company used approximately 2,000 independent licensed brokers and
agents and 160 licensed employees to sell its Commercial products. Many employer
groups are represented by insurance brokers and consultants who assist these
groups in the design and purchase of health care products. The Company generally
pays brokers a commission based on premiums, with commissions varying by market
and premium volume. At December 31, 1993, approximately 260 independent licensed
brokers and 430 employed sales representatives, who are each paid a salary
and/or per member commission, marketed the Company's Medicare products.
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The following table lists the Company's Commercial, Medicare risk and
Medicare supplement membership at December 31, 1993, by market and product:
MEMBERS
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COMMERCIAL
--------------------- MEDICARE MEDICARE
MARKET PPO HMO RISK SUPPLEMENT TOTAL
---------------------- ------- ------- -------- ---------- ---------
Chicago, IL 25,900 266,900 23,700 100 316,600
Corpus Christi, TX 11,200 21,400 5,200 3,900 41,700
Daytona, FL 4,100 15,800 18,000 3,500 41,400
Kansas City, MO 3,000 84,900 6,700 5,100 99,700
Las Vegas, NV 7,600 14,100 4,600 26,300
Lexington, KY 38,400 35,400 7,600 81,400
Louisville, KY 15,300 177,300 2,600 28,000 223,200
Orlando, FL 7,400 30,700 22,300 3,700 64,100
Phoenix, AZ 2,900 19,700 12,400 3,900 38,900
San Antonio, TX 28,700 60,600 10,200 5,600 105,100
South Florida, FL(1) 53,900 152,200 107,600 3,300 317,000
Tampa, FL 15,100 66,300 62,100 6,100 149,600
Others 14,500 40,700 78,200 133,400
------- ------- -------- ---------- ---------
TOTAL 228,000 986,000 270,800 153,600 1,638,400
------- ------- -------- ---------- ---------
------- ------- -------- ---------- ---------
(1) Includes Dade, Broward and Palm Beach counties.
The Company acquired an HMO in Washington, D.C., with approximately 125,000
members for $55 million on February 28, 1994.
The Company's 25 largest group contracts at December 31, 1993, accounted
for approximately 33 percent of total Commercial membership. No one group
contract accounted for as much as 5 percent of the Company's Commercial product
premium revenues; however, certain employer groups accounted for a significant
percentage of Commercial insurance premiums in some markets. The loss of one or
more of these contracts in a particular market could have a material adverse
effect on the Company's operations in that market.
CONTROL OF HEALTH CARE COSTS
The focal point for cost control in the Company's HMOs is the primary care
physician, whether employed or under contract, who provides services and
controls utilization of services by directing or approving hospitalization and
referrals to specialists and other health care providers. Cost control in the
Company's PPOs is achieved through obtaining discounts from participating health
care providers. With respect to both HMO and PPO products, cost control is
further achieved through use of a utilization review system managed by the
Company designed to reduce unnecessary hospital admissions and lengths of stay
and unnecessary or inappropriate medical procedures.
New technologies (which typically require substantial expenditures),
inflation, increasing hospital costs and numerous other external factors may
adversely affect the ability of the Company to control health care costs in the
future.
RISK MANAGEMENT
Through the use of internally developed underwriting criteria, the Company
determines the risk it is willing to assume and the amount of premium to charge
for its Commercial products. Employer and other groups must meet the Company's
underwriting standards in order to qualify to contract with the Company for
coverage. Underwriting techniques are not employed in connection with Medicare
risk HMO products
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because of HCFA regulations that require the Company to accept all eligible
Medicare applicants regardless of their health or prior medical history.
COMPETITION
The health care benefit industry is highly competitive and contracts for
the sale of Commercial products are generally bid or renewed annually. The
Company's competitors vary by local market and include Blue Cross/Blue Shield
(including HMOs and PPOs owned by Blue Cross/Blue Shield plans), national
insurance companies and other HMOs and PPOs. Many of the Company's competitors
have larger enrollments in local markets or greater financial resources. The
Company's ability to sell its products and to retain customers is influenced by
such factors as benefits, pricing, contract terms, number and quality of
participating physicians and other health care providers, utilization review,
claims processing and administrative efficiency.
GOVERNMENT REGULATION
Of the Company's 13 licensed HMO subsidiaries, six are qualified under the
Federal Health Maintenance Organization Act of 1973, as amended. Four of these
six subsidiaries are parties to HCFA Contracts to provide Medicare risk HMO
products in 10 markets.
An HMO which is federally qualified may require employers with more than 25
employees that offer health insurance benefits to include federally qualified
HMO products as an option available to their employees. To obtain federal
qualification, an HMO must meet certain requirements, including conformance with
financial criteria, a standard method of rate setting, a comprehensive benefit
package, and prohibition of medical underwriting of individuals. In certain
markets, and for certain products, the Company operates HMOs that are not
federally qualified because this provides greater flexibility with respect to
product design and pricing than is possible for federally qualified HMOs.
HCFA audits Medicare risk HMOs at least biannually and may perform other
reviews more frequently to determine compliance with federal regulations and
contractual obligations. These audits include review of the HMOs' administration
and management (including management information and data collection systems),
fiscal stability, utilization management and incentive arrangements, health
services delivery, quality assurance, marketing, enrollment activity, claims
processing and complaint systems. HCFA regulations require quarterly and annual
submission of financial statements and restrict the number of Medicare risk
enrollees to no more than the HMO's Commercial enrollment in a specified service
area. HCFA regulations also require independent review of medical records and
quality of care, review and approval by HCFA of all advertising, marketing and
communication materials, and independent review of all denied claims and service
complaints which are not resolved in favor of a member.
Laws in each of the states in which the Company operates its HMOs and PPOs
regulate its operations, including the scope of benefits, rate formula, delivery
systems, utilization review procedures, quality assurance, enrollment
requirements, claim payments, marketing and advertising. The PPO products
offered by the Company are sold under insurance licenses issued by the
applicable state insurance regulators. The Company's HMOs and PPOs are required
to be in compliance with certain minimum capital requirements. These
requirements must be satisfied by investing in approved investments that
generally cannot be used for other purposes. Under state laws, the Company's
HMOs and PPOs are audited by state departments of insurance for financial and
contractual compliance, and its HMOs are audited for compliance with health
services standards by respective state departments of health.
Management believes that the Company is in substantial compliance with all
governmental laws and regulations affecting its business.
NATIONAL HEALTH CARE REFORM
Congress is in the process of evaluating a number of legislative proposals
that would effect major changes in the United States health care system. Among
the proposals under consideration are government imposed cost controls, measures
to increase the availability of group health insurance coverage to employees,
and the
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creation of statewide health alliances that would cover individuals and families
not enrolled in large employer health plans. Legislative reform is not
anticipated before the latter part of 1994 and implementation of any reform
package could take several additional years. In general, managed care is being
considered as a means by which health care costs may be reduced. Although
management believes the Company is well positioned to take advantage of the
opportunities which will be afforded by national health care reform, it is not
possible to predict the final form these proposals will take or the affect these
proposals may have on the Company's operations.
STATE HEALTH CARE REFORM
During 1993, the State of Florida adopted health care reform legislation
which, among other things, established a mechanism through which small employers
and self-employed individuals may acquire health care coverage through state
chartered non-profit entities known as Community Health Purchasing Alliances
(CHPAs). It is intended the CHPAs will also be used to acquire insurance for
state employees and Medicaid beneficiaries in the future. The legislation
divides the state into 11 geographic areas and establishes a separate CHPA in
each area. Humana intends to offer products in each of these geographic areas.
In order to sell health care coverage to CHPA membership, an entity must
register as an Accountable Health Partnership (AHP). An AHP may be either an
insurer or an HMO and must specify in which geographic areas it wishes to offer
its product. There are other requirements relating to organization, grievance
procedures, terminations and product offerings for AHPs. Applicable Company HMOs
and PPOs are in the process of registering as AHPs.
Certain other states in which the Company operates are also actively
pursuing health care reform; however, at this time it is not possible to predict
the ultimate impact on the Company's operations.
OTHER RELATED PRODUCTS
The Company offers administrative services to employers who self-insure
their employee health benefits. At December 31, 1993, the Company provided
claims processing, utilization review and other administrative services to 40
self-insured employer groups, for approximately 63,700 employees and employee
dependents. For the year ended December 31, 1993, revenues from these services
totaled approximately $5 million.
The Company operates a prescription drug management service which
administers drug benefit programs for various HMOs and PPOs, including those of
the Company. For the year ended December 31, 1993, prescription drug management
service revenues from third-party customers totaled approximately $3 million.
On June 30, 1993, the Company acquired the operations of a dental services
company which provides dental products to employer groups, HMOs and PPOs,
including those of the Company. Since the acquisition, dental service revenues
from third-party customers totaled approximately $2 million.
On March 3, 1994, the Company acquired a minority interest in a mental
health HMO, which will provide services to the Company's members in certain
markets as well as to third-party customers.
OTHER BUSINESSES
Hospital
The Company operates a 170-bed hospital in Lexington, Kentucky, which was
contributed to the Company by Galen in connection with the Spinoff. The hospital
provides care primarily to members of the Company's managed care plans in
Lexington. The Company is currently reviewing alternatives for the ultimate sale
or third-party management of the hospital.
Captive Insurance Company
The Company insures substantially all professional liability risks through
a wholly-owned subsidiary (the "Captive Subsidiary") which was incorporated in
January 1993 in the State of Vermont. Previous to the Captive Subsidiary
beginning operations in February 1993, professional liability risks were insured
by a
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subsidiary of Galen. In connection with the Spinoff, the Captive Subsidiary and
the Galen subsidiary entered into a loss portfolio reinsurance agreement whereby
the Captive Subsidiary will indemnify the Galen subsidiary, subject to aggregate
limits, against all liabilities incurred by the Galen subsidiary related to the
professional liability risks of the Company prior to September 1, 1993.
Centralized Management Services
Centralized management services are provided to each health plan from the
Company's headquarters. These services include management information systems,
financing, personnel, development, accounting, legal advice, public relations,
marketing, insurance, purchasing, risk management, actuarial, underwriting and
claims processing.
EMPLOYEES
As of December 31, 1993, the Company and its subsidiaries had approximately
8,800 full-time employees.
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