Humana Inc. (HUM) Earnings Call Transcript & Summary

Joining us today. It's my pleasure to be introducing Humana. Humana is one of the largest providers of Medicare Advantage health insurance in the country, but it also has a commercial and growing Medicaid business as well as a Pharmacy and provider services business. Presenting today, we have Susan Diamond, the CFO of the company. We also have Lisa Stoner from the Investor Relations in the audience as well.

But a couple of questions to start off. I don't know if anyone has any questions. By all means, you can bring them up. But at the beginning of the year, we had a situation where Bruce came out and kind of talked about the 4.5% to 5% margin target for the company. And I think he created a little bit of confusion. He wasn't sure whether the company is trying to back off of that? Or it really seems like you're trying to reposition how we should think about margins for the company moving away from a Medicare margin to an enterprise margin. Can you just maybe expand a little bit about what the message there is?

Yes, sure, happy to. So as you mentioned, so we have, for a long time, had a well-established sort of individual MA margin target of 4.5% to 5%, which has always been sort of viewed as a long-term margin opportunity. And we've been saying that for many years. And at the time that we introduced that target, Medicare and individual Medicare was largely sort of the generator of the earnings for the enterprise. So it was sort of a proxy for enterprise margins at the time. What I think you've heard Bruce and myself trying to do in introducing some of the commentary is just acknowledge that as the company has grown and evolved since then, we have an ever-growing Healthcare Services business in addition to some of the other services that we support the Medicare Advantage membership with across the enterprise. So an example of that is our specialty business, which supports all of the dental, hearing and vision benefits that embedded in our MA offerings. And so as we've grown the benefit -- and enrich the benefits that we provide to our Medicare beneficiaries and scale some of our Healthcare Services capabilities, the largest today, of which is the Pharmacy business, where we deliver industry-leading mail order penetration, we're just acknowledging that while the individual health plan margin is certainly important and is a core driver of earnings for the enterprise, as we continue to grow and scale our other capabilities, they will provide more and more contribution to the enterprise earnings profile of Humana. And we think sort of demonstrating progress against our ability to expand those offerings demonstrate that we're able to get more of our members using those capabilities and then creating visibility to the margin that, that creates for the enterprise will be important and increasingly a topic of conversation. So what Bruce was really trying to do is start to convey that as you think about the opportunity for Humana, we should certainly continue to strive to deliver against that long-term individual MA growth target, which continues to be the goal, but also then talk about the success we're having expanding the use of our services across the enterprise and create some visibility to what the margin potential of that additional utilization looks like. And in our Investor Day last June, we began to share a view of what that potentially could look like and provided a chart that showed if you had a health plan member utilizing every other capability across Humana, what does that aggregate margin profile look like? And what we demonstrated was the margin opportunity is about 2 to 4x the health plan margin alone if those numbers were, in fact, using all other services. And that's really just meant to convey that there is a much greater opportunity for us long term as we continue to scale those businesses. Primary care is certainly one of the largest contributors, and that continues to be where we are focused in expanding access to our primary care capabilities and then driving more panel membership growth into that so we can start to benefit from that. When we come out in the fall at our Investor Day, which we announced would be September 15, we do intend to create a lot more visibility to our forward-looking expectations for our Healthcare Services businesses, particularly Primary Care in the home to give you a better sense of the earnings contribution you can expect over time as those businesses continue to grow and scale and how we think about penetration of those assets. So certainly, more to come on that. But really, the commentary is meant to just reinforce the potential that we have within Humana across our capabilities beyond just the health plan membership, which we knowledge continues to be important, but we'll have other things that we'll -- you'll be hearing us talk more and more about as we -- as they begin to become more material to the enterprise.

Yes, that's a great answer, I guess, because you're basically saying we're not backing away 4.5% to 5% on the health plan side, we're just saying that a broader number is the right way to think about it. And that, that butter number is probably been north of 4.5% to 5%.

Right. When you think about -- if you took a health plan member and looked at their aggregate enterprise contribution that you should expect it to be north of 4.5% to 5% if they're using other services.

Okay. Great. And then how do you think about -- you've had years where you were focused on top line growth. This year, you're more focused on margins. How do you think about balancing those 2 at the end of the day?

Sure. So the way we've always thought about it is, first and foremost, we are working to deliver against our long-term EPS growth target of 11% to 15%. So that's always the primary goal. Within any given year, based on the opportunity and the dynamics that we're dealing with, we may over-index to more on membership growth versus more on margin. For 2022, we did consciously choose to over-index a little bit more to margin. And that was really just recognizing that given the challenges that COVID had introduced for us, particularly in 2021 and all the uncertainty we were facing, we had taken a different approach to guidance than some of our competitors that made it sound different, continue to have to talk about certain uncertainties that created some frustration, I think, within the investor base and continued sort of overhang in terms of the performance that we could expect. So our objective going into pricing for 2022, recognizing when we submitted our bids, a year ago, there was still a lot of open questions around the uptake rate of the vaccine, how successful it would be. Would we continue to see new variants that would evade the vaccine. There continued to be a lot of uncertainty. And so to the degree possible, we wanted to try to eliminate that overhang going into '22 and so opted to take a more conservative approach to pricing. When we did that, we knew it would come at some expensive membership growth at the time based on the information analysis we completed. We thought we'd see an impact of about $100,000 in terms of Medicare growth. We thought that was a reasonable trade-off in order to ensure that we can sort of preserve confidence in terms of the earnings contribution in '22. As we got into the fall and started seeing the results of AEP come in, we did recognize and understood that we were going to see a bigger impact from that more conservative pricing approach than we had initially anticipated. And obviously, in January came out with our revised membership growth number. I think had we anticipated that level of impact this time last year, I think you probably would have seen us try to take some additional actions to negate some of that. But unfortunately, this time last year when we chose to be a little bit more conservative, some other competitors were choosing to invest incrementally. And so at the end of the day, we found ourselves in a position where we were more disadvantaged from a product value standpoint than we had anticipated, which then made us more susceptible to disenrollment activity this last AEP, which is reflected in our growth. So I think for 2023, we always knew we'd have to create some capacity to invest. Obviously, with the results of growth this year, we recognized it was going to be a larger investment than we had originally thought. That is what led us to focus very intently on the $1 billion value creation goal that we announced on our fourth quarter call. We have been working on that for some time. When we came out with our revised membership guidance, we heard pretty clearly from investors that they understood that we knew how to get back to growth. We've done it before. The question was, is that going to come at the expense of your EPS growth target. So one of the reasons we came out very publicly with the value of the goal was to start to sort of rebuild that confidence and credibility that we were creating the capacity that would allow us to make the needed investment and return to industry-leading growth not at the expense of margin, and that we could confidently do both. So we're pleased with the progress we've made so far. I think our teams are happy with the capacity we've created within the company for us to invest in product and are feeling good about how we think we'll be positioned for '23. Obviously, we'll have to see when the landscape data comes out in the fall, are we positioned as we thought? We are confident we'll make significant progress in terms of additional Medicare growth. Whether we get all the way back to industry-leading within 1 year or not, we'll have to see in the fall based on decisions others make. But based on the choices we're making, we are very confident that we will demonstrate a minimally significant progress.

And so as far as the issue for the shortfall this year, it sounds like you're largely viewing it as a situation of you were conservative when others were still being aggressive. You also mentioned in the past, it brokered -- brokers ensuring -- like if you think about the rationale, is it mostly the benefits? Or is it 60-40? How do you think about the issues that cost and then how do you fix those issues?

Sure. We primarily view it as a product value issue in this since it is disadvantaged. We have been clear publicly that we do use some of the call center brokers to a greater degree than some of our peers do or at least have historically. We have historically seen slightly higher churn in that space. It was a little bit elevated this year, even beyond that. And because of our -- a larger percentage of our book coming from that channel when we found ourselves disadvantaged, we were more susceptible to that higher disenrollment. Had our product positioning bid been stronger than we would have argued that, that would have been somewhat muted. So at the end of the day, it's a little bit circular, but ultimately, the core challenge was the product positioning. It was somewhat exacerbated by our reliance on that channel where you do see tend to see a higher disenrollment rate. But the core issue we view is product positioning. So again, that's what we've been focused on primarily to get addressed for '23. Although having said that, we've acknowledged that we are not satisfied with the quality of sales and retention that we're seeing out of that channel. And so we've been working with them. And this isn't new, we've been working with them in the last couple of years to make improvements, both in terms of sort of the sales cycle and training and processes that they employ, getting them to be more focused on retention, which frankly, given the way their business model works, they're equally incentivized to address as well. So we've been working with them on training and other changes to their processes. And then in addition to looking at compensation levers, in the way we incentivize the agency and also how they incentivize their individual agents to focus more on the quality of sales and retention versus just sheer sales volume.

In that $1 billion, I know you said that some of it -- it sounds like a smaller portion would be going to grow in the services business. But that -- but the majority of the $1 billion, is that going into benefits? Or is it going into commissions and advertising? Or how do we think about that?

Yes. So I would say we haven't obviously given specifics some of that for competitive reasons, but you can certainly think about the $1 billion of capacity that we're creating, the majority of it being directed towards the Medicare business. Some of that will be made available for other strategic priorities, including expansion of, say, the value of aged home health model is one example. But you can think of the majority being directed to the Medicare business. And then the majority of the dollars that are going to Medicare being directed to product, but then also some used for marketing and distribution investment as well. We would like to reduce our reliance on the third-party channel over time. In order to do that we need to create the capacity to invest more near term in distribution and marketing in particular. And so that will require, again, some capacity. One of the things we'll look at this year, we had some admin favorability in the first quarter. We argue that a lot of that is timing in nature. But if we do get additional savings from our $1 billion value creation goal in terms of as we get things implemented, that does create some additional favorability this year. That would be one thing we would look at to say, can we accelerate some of the investments that we'd like to make in our proprietary, distribution as well as the marketing investments that will allow us to maybe accelerate some of that migration. But that won't be a dramatic pivot. We think the third-party call centers have room to improve, but will continue to be a meaningful part of the distribution landscape long term. So we'll continue to work with them, but we would like to see some incremental progress creating a little bit more balance across our distribution channels.

And so when you think about that gap that happened this year, are you thinking that you're going to close that -- be able to close that gap next year? Or is there still kind of a delta between where you were historically and where you're going to be?

I would say we'll see in the fall. But we obviously have done a lot of work. We had a favorable rate notice for 2023. While that's great, it does make it a little bit more difficult to anticipate what competitors might do with those funds, depending on what they were -- sort of enterprise portfolio and priorities look like, how they might use that to further invest in Medicare product versus other strategic priorities. So we've certainly gone through our own thinking about what that might be. I would say that we are going into our '23 bids trying to position ourselves to get to close that value proposition gap. Some competitors, who we would argue, have unsustainable levels of investment currently have been pretty clear publicly that they intend to orient a little bit more to margin next year, exactly how that looks and what changes they make, again, is something we'll have to see. But based on our work, we are working very hard to position ourselves to get back to close that value proposition gap, to get back to industry-leading growth. We'll just have to see ultimately what competitors do. And do we find there are any remaining gaps at a local level or certain sort of product demographic. We'll have to take a look. But our goal is to get back -- get as close to industry leading growth, if not get there in 1 year. We just recognize it would be impossible to predict. And so we have the benefit of seeing what the competitors do.

And when you think about that shortfall or share loss, do you feel like it is those smaller companies who are pricing below cost that are the bigger issue? Or is it the more established players that you've always been competing with that have been more of the issue?

Sure, it's a combination. Obviously, some of the smaller players have more significant impact in a local geography, they tend to be more concentrated. And so certainly, in those markets, we'll see disproportionate impact. So we certainly would expect to see maybe a greater opportunity in some of those markets this year if they do, in fact, sort of pull back on their investment level or even just maintain at a time when we're investing. So we're certainly being thoughtful about those opportunities. But I would say, even more broadly, even say in the dual space, that's been a source of disproportionate growth for us the last couple of years and largely we and United sort of garner the lion's share in that space. And it continues to be a strong growth opportunity. So that is certainly something we're still growing nicely this year, just not as much as we had previously. So that certainly will be an area where we will look to invest in order to sort of reestablish our leading position there. And so that -- we'll have to see what United ultimately does in terms of what investments they make as well. But we are considering what's the current sort of offering set, how do we sort of compete against that and not just match it, but then look for new ways to differentiate within duals and other consumer segments in order to disproportionately grow and drive that industry average growth that we're looking for.

Okay. And then when we think about this year, you guys provided $1 -- or gave guidance that there's $1 of COVID in here. And then Q1 started off well, and you said that the $1 is still there. I mean how exactly should we think about that dynamic? Does that mean that you didn't see that $0.25 of COVID in Q1 and now there's a $1 still in Q2, 3, 4? Or the $0.25 are now built into Q1? How do we think about that?

Sure. So it's a little bit complicated for us. The way we baked it into guidance, we weren't going to try to predict exactly when we might have a surge. And we just said, look, the $1 is embedded, you can think of it sort of $0.25 a quarter is what we can tolerate. As we saw the first quarter emerge, as we've said, we saw positivity from an inpatient utilization standpoint. January was actually negative just because of the high rate of COVID that we saw. Ultimately, Omicron proved to produce the highest level of absolute hospitalizations that we had seen since the start of the pandemic. But what was unique is the rate at which it then subsequently declined. Historically, on the way up a curve and on the way back down, we have seen pretty just like a one-to-one offset in the Medicare business, where for every one additional COVID admission, you'd see on reduced non-COVID and on the way back down, the opposite. What we saw this time is we saw the offset going up. But as we came back down, the rate of rebound in non-COVID admissions did not keep pace with the rate at which COVID decline. And we think partly, that was due to just the rate at which it declined, which we hadn't seen. And maybe hospitals weren't sort of getting ahead of that in terms of scheduling procedures and some other things and ultimately expect that to get back to sort of more normal levels. But so far, throughout the first quarter, we continue to see lower inpatient utilization, COVID and non-COVID, than we expected. We are seeing some higher unit costs as a result of that. We're seeing, again, the proportion of hospitalizations that are COVID, and we've described it as incidental COVID. Because of the PAT, hospitals will get an additional 20% reimbursement for any COVID-positive patient, whether they're being admitted for COVID or not. And because of the transmissibility of Omicron, we did see a higher percentage of our admissions have this incidental COVID diagnosis, which triggered a higher unit cost. So we have assumed that, that will continue in the first quarter as we've allowed for a higher level of unit cost that offset some of that inpatient utilization favorability. And then on the non-inpatient side, we have yet -- we don't yet have full visibility into that emerging data. We don't have the same real-time information from authorization data. So it takes a little bit longer for those claims to complete. For the first quarter, we have assumed that they will come in consistent with plan. We'll have to see if that proves to be true. Historically, if we've seen depression in patient, we've typically seen it in non-inpatient as well. But for now, we have not assumed that to be the case. So what you can think of in the first quarter is that our actual Medicare results assume that we sort of experienced that $0.25 headwind because we've effectively reserved consistent with plan, and the plan included the $0.25. Our hope is that, that will prove to be conservative. And over the course of the year, we'll see positive sort of current year development where that would unwind. As we've talked about our full year guidance, however, we have acknowledged that at this point in time, we don't have any reason to believe that we will need the COVID contingency based on what we saw in the first quarter. There's still a long way to go to see what's the absolute level of COVID we continue to see through the year. Does the PHE get extended, which will trigger that higher unit cost reimbursement rate and just where it is baseline trend ultimately normalize. We also suspect there's some sort of capacity constraint in the current results just given the labor challenges in the market. And so the pace at which some of those alleviate is something that, again, we'll have to watch longer term to see where this utilization ultimately come in. But for now, we would say right now, we don't have any reason to believe we'll need the COVID contingency, but we've maintained it in our guide. We've always said we'll be conservative in letting that out, and we'll want to see through the second quarter just how the emerging trends come through and whether we have any reason to believe that, that will be necessary. But right now, you can consider our guide as continuing to maintain the full dollar.

Okay. Excellent. I guess as we think about trend going on. So we say there's $1 of COVID in there. Does that mean that there's an expectation of a spike in Q3 or 4 again? Or how do we think about that?

Again, we are -- we have decided it's not fruitful to try to predict what COVID might do. You can try, and then you'll just be proven wrong. So we -- and again, historically is that when we've had surges, it's actually been a net positive, at least in the Medicare business, where you tend to see more than a full offset. We acknowledge the longer COVID goes on that may not continue to be the case, especially if it's an overall lower level and the surge has become less intense, then we might see behavior changes in the provider population as well as patients in terms of what they're comfortable doing. So we, going into '22, though, have said we are not going to anticipate that we will continue to see below baseline utilization. So our core estimates for '22 assume that we will run at baseline given where we booked at the first quarter, we've arguably taken it slightly above baseline for the $0.25. And our full guide we've maintained the ability to cover $1, should it emerge. And so you can think of it as our expectation is -- well it's baseline trend and then slightly above that consistent with the $1 of COVID headwind. But we haven't tried to predict it in terms of exactly when that might occur.

And how do you think about -- there's been some articles about hospital companies trying to push through significant pricing because they are seeing labor constraints as you mentioned before. How do you think about your ability to pass on those rate increases to your customers? And is there -- I don't ever remember seeing a company miss on unit costs. Usually, it's a trend in utilization or acuity maybe that caused the misses, but is there actual risk of a unit cost miss for the industry?

Yes. I would say for Humana in particular, just given the proportionate share of our Medicare business versus commercial, our contracts are largely tied to Medicare reversion rates. And so it's not something that we're individually negotiating with the hospital systems. I would say so far -- we actually checked with the team earlier this week. We are not seeing any elevated levels of outreach from hospital systems asking to open up contracts or revisit sort of their reimbursement rates. And I do think, again, because we peg everything to the CMS reimbursement rates largely, we're somewhat insulated from entry here, sort of negotiation pressure. Ultimately, we'll have to see what CMS does with the inpatient reimbursement rates in the fall. That is fairly defined in terms of the methodology of how that's calculated. So we have visibility to that. They also share some early sort of estimates of what's inflation -- what are their estimates of inflation over that period of time. So we're relying on that as we think about pricing. I think we'll probably take a little bit more conservative approach to that as we think about recognizing there is a couple of months here between when we file bids and they ultimately finalize rates. But we would argue that the way that calculation works, we don't anticipate significant increases beyond what they've already estimated for inpatient reimbursement for 2023. Longer term, we'll have to see how that plays out. But arguably, if CMS were -- if it was systemic and long term and CMS ultimately baked it in, arguably that gets into our reimbursement rates over time. And so again, it mitigates the pressure. On the commercial side, certainly, there's going to be some opportunity where hospitals might come forward and want to renegotiate. We tend -- our commercial and Medicare contracts tend to be single -- they're combined. And so you can't open up one without the other. And then also, they tend to be multiyear contracts. And so there's not a ton of flexibility that the systems have to do that in a shorter window. I think there are some service categories. Home health is one example, where as an industry, MA tends to contract at rates below Medicare fee-for-service. I do think, as we see the rates come out in the fall for home health, if they're views insufficient in this environment, I can see that being a space where we might see more pressure from home health agencies to revisit reimbursement if they find that it's insufficient, particularly relative to the fee-for-service business. And might cause them to prioritize Medicare fee-for-service patients over ours, which would be not an ideal outcome. And so I think we need to work with them to make sure that our patients maintain access care.

That's probably a good time to pivot because the home health dynamic is interesting because to your point, Medicare Advantage pays less than fee-for-service as for home health and yet you thought it was a good idea to buy a home health provider. So it seems like you don't see value, but then you do see value. So can you talk a little bit about why home health is a good service to get into and how we should think about rates?

Sure. So as you said, we didn't buy Kindred because we love Medicare fee-for-service home health. Our interest in Kindred specifically was a belief that more care could and should and would be delivered in the home. And that patients would both want more care delivered in the home, and it would be possible to deliver more care in the home and that, that's a better site of service for many services. And what we found is in some of the barriers to doing that at scale historically has been a lack of access to a nationally scaled home health labor force. The industry is fairly fragmented. And so even though Kindred is the largest home health agency, it still has, call it, mid- to single-digit sort of market share. So it can be very difficult to scale home-based care delivery models in the absence of having access to a nationally scaled platform. So that was one of the reasons that we were interested in buying Kindred. Our belief was, given the patient profile that they tend to serve, which tends to be a more complex comorbid patient, who is 5 times more likely to be hospitalized because of the cities that they're navigating. We have had a strong belief that there is a significant opportunity to deliver home health in a more comprehensive way, and we'll holistically identify and address the needs of the patient. And we have found through various programs that when you get into the home and you better understand sort of the barriers to health for that individual, whether it's social determinants, they're isolated, they can't drive, they don't have transportation, food and security, et cetera, you have a much better opportunity to identify that if you get into the home. And then we can connect in to all the resources that can address that. So our motivation has always been to bring a value-based payment model and clinical model to home health. And you heard us talk about on the last call, we are in the process of expanding that capability, which we acquired through One Home last year. They currently provide home health DME and infusion services under a value-based model in Florida and Texas, and we are looking to expand that significantly. We are launching some additional markets later this year. We'll have about 15% of our members covered under that model by year-end. And then the expectation is about 50% of our members within 5 years. And Initially, we'll launch the sort of core model, which gets after managing home health, DME and infusion spend and eliminating some of the waste that goes on in that fee-for-service model today. But then we'll quickly follow with enhanced clinical models that really get after reducing readmissions, reducing other post-acute care by delivering better and more comprehensively addressing the needs of the patient. That could be lack of engaged primary care. And so if we have a patient who is continuing to cycle through the ER and facility settings because they don't have good primary care, we can connect them to a center while a physician is an example or a heal physician. If it's an exacerbation for an acute issue, we can bring in a service like dispatch and keep them in the home, which then should reduce ultimately another readmission and then which oftentimes, in this population, leads to a post-acute stay. So our belief is that if you bring a total cost of care mindset to home health, that you can drive significant value to the health plan in terms of savings on total cost of care, while also driving additional penetration into Kindred and benefiting from that margin while also creating a level of margin at the sort of convener level, which One Home will serve in that role. And so significant opportunity for the enterprise, and we'll again share some more visibility on what that looks like near and longer term at our Investor Day in September.

Okay. And then the other big services piece that you're investing in is in the physician side of things. You guys have been trying to balance short-term investment losses versus long-term opportunities. So I guess, how are you doing that? And how should we think about the financial attractiveness of the way you're investing in that business?

Sure. And earlier this year and late last year, we worked hard to really understand sort of investor sentiment around this because there is a trade-off. In order to scale de novo clinics, there is a J-curve associated with that, where if you're building a new center and so you can reach panel density, you're going to sustain operating losses off of that center. And so that can create some earnings dilution or pressure depending on the level of ambition you have around scaling those assets. So based on the rate at which we would like to scale those assets, we had to make a decision around are we going to do that on balance sheet, which might create some earnings pressure, short term or take it off balance sheet like we did with our Welsh Carson partnership these last couple of years, which can insulate us from that dilution. Ultimately, obviously, we're going to provide a return to that partner, but that was sort of the trade-off choices we were working with. Based on sort of -- as we did the analysis and the rate of ambition that we have for scaling that asset and then some of the investors. And we ultimately decided that the best path forward was to continue to look for off-balance sheet partnerships that would allow us to continue to scale at the rate we would like, while minimizing any earning solution. So we have committed to finding a strategy that will allow us to continue to expand and not impact our ability to deliver on the 11% to 15% long-term EPS growth target that we have and allow us to deliver on both. We will expect to have something to announce in the next couple of -- in terms of what that go-forward partnership would look like. We think that based on the success we had in the initial partnership with Welsh Carson and the proof points that we've been able to demonstrate in terms of our ability to deliver against the assumptions that support that J curve that we can negotiate more favorable terms for this next set of clinics than we did initially just based on the strength of what we've done so far. And we feel good about the terms that we've been able to sort of negotiate that it's a reasonable sort of return for the capital that a partner would put up. And we've tried to be creative about the duration that we use the capital, sort of what we use the capital for to try to again sort of minimize the ultimate return that we'll have to pay for the use of outside capital.

And when you think about bringing these things back on balance sheet, are these things going to be profitable at that point? Or you bring it back when they're breakeven? Or...

Yes. So the intent is that we would -- there's a quick call structure associated with these arrangements where then it gives us the ability to bring those assets back on balance sheet at a point in which they would then be contributing to earnings and not represent a dilution to earnings. And then we'll have to see. But given the current thinking, as we get through this next sort of couple of years with off-balance sheet financing, at that point in time, the earnings contribution from the cohorts that have come back on, hopefully, will allow us to then potentially self-fund going forward, which does -- see again at that time based on the opportunity and further pace of advancement, whether that's something we continue to do off-balance sheet or can self-fund through the earnings of the business.

All right. Great. I think that's all we have time for. Thank you very much.

Great. Absolutely. Thanks for having me.