Humana Inc. (HUM) Earnings Call Transcript & Summary

[Audio Gap] Humana is one of the largest Medicare companies focused on the Medicare Advantage business, but also has a large and growing Medicaid business as well as a provider business. Presenting today, we have Bruce Broussard, President and CEO; as well as Susan Diamond CFO; we also have Lisa Stoner from IR in the audience as well. So it's my pleasure to be kicking off the conference with Humana standing room only today.

Maybe just start off the Q&A with kind of the news last night. You announced officially the transition, which has been discussed for a while. But I guess why now as far as the timing of this, there's a lot going on [indiscernible] coming out.

Maybe I could do a few things there. First, just putting in context and others always questions on the selection of Jim, and then I'll talk about the timing. When the Board began the search for the succession formally, they're really looking at a few things, character traits, experience or obviously the 2 major areas. And Jim really fit both of the buckets quite well. And the character traits, what we've seen with Jim, both in the interview process and a lot of the analysis that was done with them through both the search firm and external parties that the Board hired. It was really around capacity to deal with complexity. Second thing is the ability for him to deal with details and quite extensively. And third thing is character of humility and being able to really listen. And those were really important traits as the board looked at it both from a purpose-driven organization, in addition, just the complexity of the business and also the diversity of the business. And I'll come back to that in a minute. The second thing that was intriguing with Jim's experience was around, he was -- had experience with Medicare Advantage and experienced in the provider business quite extensively. And then the third thing is he comes with a very deep strategic mindset. And so the combination -- Andy was a sitting CEO. So the combination of is character traits that really stood out and in addition to his experience, it was a differentiator for them. We had a lot of great candidates in the process. What we've seen during the last 5 months is actually that as we've seen great fellowship by the organization and his leadership skills. We've seen his ability to deal with the complexity during a time, that's really complex as a result of all the changes that have gone on in the industry. His ability to listen to the expertise in the company, especially we saw that very extensively in the bid process, which we both participated in and the ability to understand the expertise and be able to leverage the expertise of the organization. And the last thing that we've seen is his ability to really dig deep and be a really good operator. And so what the hypothesis going in, which was tested on a number of different sources prior to that coming on has actually been a great test during a very complex time. And so over the last 5 months, we've both own the bids and during that process, and they've worked together in the development of bids, and we'll obviously get into some details of that. And so we've been able to work together side by side, and it's been a very productive relationship over the last 5 months. Why now? As your part of your question, too. We're on a good breaking point. We are finalizing the bids. The bids are going to be being submitted over the coming weeks. And we're in the more of the administrative process time as opposed to any decision making. Decision making was made a number of weeks ago, which we both were part of. And as we enter into the summer time, it begins the strategic planning cycle. We have a Board meeting in October. The management team has a meeting in the middle of August that wraps around the strategic processing aspects. So it's a good break point. It's what he should own on the prospective side of the equation. The bids are done. We both have walked through that. We've had a great opportunity to see his skill sets during that period of time. And so the combination of us being able to work side-by-side during this period of time and then the beginning of the planning process, for myself and the Board, we felt that it was the right time for him to make that transition.

All right. That's great. I mean I think Jim's got a lot of the skill sets that you think about Humana's development over the next 5 or 10 years of building out of the provider base makes a lot of sense. It does feel like though the job over the next 2 or 3 years is going to be more about the repricing, which I kind of feel like the CFO has a lot to do with that side of that. So I just want to dig into kind of how you think costs have been trending? What do you think your visibility into those costs are now? I mean it does feel like everyone's had a hard time catching up to it. So has something changed? And like what's your degree of confidence as you kind of submit those bids that have just been final or being finalized now?

Sure. So obviously, the industry experienced higher-than-expected trend throughout 2023. And at year-end, we saw that further sequential uptick in the first -- fourth quarter. There was some varying commentary at the time about whether that would persist into '24. We obviously had a point of view that it would and have always believed that the majority of what we were seeing was an industry issue versus anything Humana specific. And that while the commentary might have been different going into the first of the year, we did feel like over time, it would likely converge I think we've begun to see some of that, obviously, with some of the commentary CBS has come out with. I think United, while they had some MLR pressure, they had a change disruption, which made it more difficult. So we'll see how that comes to mature over the second quarter. As we've evaluated our own results, as we said on our first quarter call, we were pleased to see that we have seen some positivity in the first quarter. There is always some lack of visibility in the first quarter as it respects things that are relying on paid claims. That's typically inpatient unit cost and non-inpatient trends. We acknowledge it to change disruption impacted that somewhat and made it a little bit more challenging than normal times. But this is always something that -- an uncertainty we do at this time of the year and going to the bids. As we did evaluate the first quarter though, and when we do have good visibility into MRA, and we did see some slight positivity in our final submissions for 2022 dates of service and initial '23. So that was positive. We have good visibility into inpatient admissions. That was certainly something that we were anxious to monitor given the 2 midnight rule as many uptick we saw in the fourth quarter, there was a lot of questions about how we -- what assumptions we made about the impact of those changes was what's on the fourth quarter of pull forward or not. At the time, we believe that it wasn't. It was likely some incremental pressure, which we baked into guidance. As we've evaluated the first quarter -- as we said on our first quarter call, initially, we did see some higher admission levels, which we did believe was primarily related to greater impact from those changes initially than we expected. But we saw improvement over each week as our clinicians, and we think provider clinicians became accustomed to the new rules and tested each other's interpretation. As we said, March was actually slightly favorable such that the first quarter in total was pretty much on plan. For the month of April, initially, we did see a little bit of an uptick in the first few weeks of April, but then that has since moderated so that the back part of April and then into the first part of May is in line with expectations. So we feel good about that. We did see some early indications of positive unit costs, and that we think makes sense given some of the shift that we are seeing from what used to come in as an observation is now coming in as an inpatient. Those tend to be short stay, lower severity. So the early indicators do suggest that there is some tailwind hopefully there that we'll continue to see mature. We didn't let that flow through the first quarter results. As we said, given the change disruption and the assumptions we had to make there, we did want to make sure that we gave those claims time to fully mature before we let anything flow through. So for the quarter, as we said, we did our normal process. We then made an explicit adjustment for the claims we felt were missing because of the change disruption. Had we stopped here, we would have seen some favorability, but we went ahead and booked some incremental claims, such that MLR came in line with expectations. Since that time, we do have the benefit of April paid claims. We did see some further positive prior year development primarily for the fourth quarter, although we did see positive development for all quarters stating back to 2023. So again, positive, and we are hopeful that, that will continue and suggest that the baseline that we jumped off of proved a bit conservative. In terms of things we're watching, I would say dental is something that we feel like we have less visibility, too. Dental providers were more impacted by changes than others, and we did see higher cost than '23. So that's certainly something we want to see. And then obviously, the non-inpatient. Early indicators, we're not concerned about anything we're seeing. We just acknowledge that it have the visibility we would like to feel more confident. So we'll just let watch those claims develop through the second quarter.

Okay. So just to make sure I got a few of those things. So you're saying that since you reported Q1, you've got more visibility on Q4. And that Q4, higher elevation that you thought might be permanent, you're starting to say, well, the base is looking a little bit lower than what you planned?

Yes. We saw -- and we always anticipate positive development into the next year just because of our reserving practices. When we speak about favorability, it means it was more positive than we had anticipated. So as we said on our first call, we saw positive development primarily for third quarter. We mentioned that if we just let things run it would have suggested positive development for fourth quarter as well. I didn't let that run through the first quarter because of the change now that those claims have further matured an additional month we did see some incremental positivity. Again, all quarters in '23, but mostly in the fourth quarter.

Just to make sure I understand your April and May comments. You're saying, April, at the beginning started that high, then moderated back to expectations at the end of April and into May?

Yes.

[indiscernible] this admission data that you're talking about.

[indiscernible] yes. Impatient admissions.

Okay. And the higher April, is that just you think the calendar for March into April or...

We think some of it might be seasonality, like the east of when the Easter holidays fall. It could be some of that people coming back from Spring Break and catching up. So again, early March high but then moderate in the back half and then early May is in line again.

And then if you said a lot, so -- and I'm writing in here. So on the dental side, you said the dental visibility was more impacted by change in other providers? Do you have visibility now are you still saying that's still an area where it's not...

Yes. Obviously, we don't have the same visibility we typically would because they were more impacted by change. And so we're having to make some assumptions based on the claims that have come in. That's just one area knowing that it was a point of pressure in 2023 is something we'll want to continue to evaluate. We did make some benefit changes for demo in '24 so again something music knowledge will need to see how that continues to develop along with the non-inpatient was obviously an area that we saw increasing trends over the year where we have less visibility [indiscernible].

But as Susan mentioned, in the bid process, we have not taken these into account the April trends when [indiscernible] had in the prior period development.

Okay. And so it's still not 100% clear what you guys are saying about 2025 margins. You guys indicated that you're focused on margins, you're willing to exit calender years as you're willing to exit plans and stand new plans next to them. And -- so you're focused on margins more than membership. But it sounds like it's a 3-year repricing or 4 year repricing [indiscernible] I just -- clarify that. But it sounded like that maybe 2025 would be the smallest year incremental margin improvement. Is that the right way to think about it, that there'll be more improvement in '26 and '27 than there would be in '25, but just because of the rate update?

Yes. So as we gave our initial commentary back from the preliminary [indiscernible] notice or even before that. We anticipated a flat rate notice. As we've said, ultimately, it proved to be negative. And for us, it was about a negative 160 basis points. So when you consider the rate notice, the implementation of another 1/3 of V28, the trend that we're experiencing as well as the impacts of the IRA, all of those things combined. If you add them all up, are pushing up against TBC on average in terms of the benefit changes, you would need to make just to keep margins flat year-over-year. Now that doesn't mean you can't drive margin improvement. But on the average, you're pushing up that threshold. So not as much room as we had hoped to take additional pricing solely for the purpose of margin expansion. So as we think about the decisions for '25 bids, as we have said, we do intend to exit some counties. When we thought about the framework of how we make those decisions, a primary input was the profitability of the plan. But also looking how mature is the plan? How long has it been in market, what's the membership composition? Is the membership credible? Has it been unprofitable for more than 1 year? Do we understand the underlying drivers? Is there a solution to that, whether it's contracting stars or some other lever? And based on all of that, if we felt like the path to profitability was too long, then we've decided to exit or if because of the TBC thresholds and limitations inherently in TBC, if we felt it was going to only have a product that was not very desirable by consumers, we would exit and then we can reintroduce and optimize it without the constraints of TBC. So we do intend cheap exit plans. That is a source of margin improvement because by and large, those plant exits are planes that are unprofitable. And so obviously, we'll go from losing money to not losing money. Then across the rest of the portfolio, still focused again, you can think of it as margin improvement across the board for planes that are not at our target margins. So we will be looking to make larger benefit changes on those planes that are not achieving our targeted margins. We do have many plans that do achieve targeted margins. Those are going to be ones where we're going to be very mindful of are we willing to take less than the maximum of TBC against those planes because even with less than the maximum, they're still profitable, we want those plans to retain membership and grow. So we'll be looking to balance against all of that to maximize sort of enterprise earnings. So while we will improve margins across the board for the plans that will remain on an absolute earnings basis, you'll see that improvement, but then we are expecting a loss of some membership as a result of the benefit changes. We are anticipating that we will have a negative net growth for 2025. We've said probably a few hundred thousand that will be very dependent on what the competitive landscape looks like and what changes people actually make. We would say that the loss of membership is primarily related to those plan exits as we think about it and then all others we're assuming closer to flat. But acknowledge there's a wider range of potential variation for '25, just given the uncertainty of what absolute level of changes others might make and then the discrete changes and how those ultimately resonate with consumers. So we could see additional membership loss, but at the same time, we could see membership growth. I think all of us have reiterated, we do believe the industry will grow. I think you've heard many of us say, though, we expect to shrink. So who's going to grow and all of that, I think we're all probably being somewhat cautious just because there's so much that we're doing that hasn't been done in the industry before and just need more visibility before we can refine our estimates.

Okay. So if I understood the way that you were originally providing guidance before you saw the rate update coming worse than you thought, you were assuming the rate would be somewhat below trend, maybe 100 basis points on below what you can manage trend to and that with benefit cuts, you could get $8 of earnings growth. The rate came in worse and that's going to make it less margin improvement this year than you were hoping for. So is the right way to think about it that in 2026. If rates are centered you can manage trend, you could actually still grow $8 in earnings in out years. Is that what you need? What kind of rate environment do you need to show the improvement?

So if you think about what we're navigating in '26, you have obviously the higher trend they're all catching that wasn't in '24 pricing fully and then you have the IRA, which is a bit unique. So when you think about '26, we will have another year of V28. We will not have the same impact from the IRA and then we want at the same level of trend to deal with. So in theory, even with a similar rate notice, you will have more headroom to then take benefit actions for the purposes of margin. . Now our hope is that rates are actually better than we experienced this year just given CMS' point of view and the incorporation of that negative restatement amount. If these trends develop as we all anticipate, then in theory, that should come back when they reassess the trend within their core sort of rate book change. But even in the absence of that, you'll have more headroom just because you won't have to absorb IRI and some of the higher turn. And then as you get to '27, you don't have right V28s fully phased in, so again, even more headroom. So assuming a reasonable rate environment that's reflective of trend and assuming a competitive environment where people are pricing to trend then yes you should have ample room in '26 and then even further in '27 to get back to those longer-term margins, which we had said we think will minimally be 3% across the industry.

Okay. And that 3% number, I think I guess I asked the question on a call, but it was a bit lower than what the other companies are talking about. I mean like I guess, may come say, 3% to 5% or 4% to 5% and so you're just saying 3%-plus. How do you think about 3% is the number? And why focus on the low end of what are the people seem to be talking about?

Yes. And so when we talk about individual MA margins, we do not include investment income. We allocate that at a segment level, not line of business. So our 3%, you can think of, I'd say, roughly 100 basis points to that. So it really puts us at the lower end of what some of our peers are saying in terms of long-term margin. When we set our commitments back in 2022, as you think about the plan that underlie that very compelling earnings and EPS growth trajectory, it relied on an individual end margin that was closer to 3%, 3.5%. We did not assume that you had to get to 4% to 4.5% in order to deliver that. And our view has always been in this environment where there still is an opportunity for really strong top line growth through increased in the eligibles and penetration of MA not to mention the yield that you get in this environment, if you wanted to grow membership at the industry rate, we felt like it would be very difficult to do that and extract more than, say, 3% to 3.5% margin near term. Over time, that could certainly change and as membership growth moderates a bit, you might see margins creep up. We think at least in the midterm as there's still very strong top line opportunity that we think balancing margin and the opportunity for membership growth that sort of maximizing that aggregate value that you can create, 3% to 3.5% is more reasonable in terms of what you can expect and minimally necessary, just given sort of capital requirement in the business, the risk that we're taking that minimally, we think the industry will demand that is a minimum margin.

And you're thinking that with the normal rate environment or [indiscernible] kind of think should happen over the next couple of years, 2027 is a good year or we've heard other companies say, 3 to 4 years, like is it...

Yes. I mean we're starting -- as we've acknowledged from our [indiscernible] is roughly breakeven. I know some others are sitting at a negative margin. So might have a little bit more room to do. Some others have different TBC thresholds. So given our sort of TBC environment, we would say again, in a more reasonable rate environment, reflective of a trend and if the competitive environment is all pricing to that, then in theory, by '27, there should be room that you can do that.