Edgar Filing: HUMANA INC

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 1-5975

HUMANA INC.

(Exact name of registrant as specified in its charter)


Delaware		61-0647538
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

500 West Main Street

Louisville, Kentucky 40202

(Address of principal executive offices, including zip code)

(502) 580-1000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.


Class of Common Stock		Outstanding at September 30, 2011
$0.16 2/3 par value		163,503,806 shares

Humana Inc.

FORM 10-Q

SEPTEMBER 30, 2011

INDEX


Part I: Financial Information		Page

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets at September 30, 2011 and December 31, 2010		3

	Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2011 and 2010		4

	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010		5

	Notes to Condensed Consolidated Financial Statements		6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		47

Item 4.	Controls and Procedures		47

Part II: Other Information

Item 1.	Legal Proceedings		48

Item 1A.	Risk Factors		48

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		49

Item 3.	Defaults Upon Senior Securities		49

Item 4.	Removed and Reserved		49

Item 5.	Other Information		49

Item 6.	Exhibits		50

	Signatures		51

	Certifications

Humana Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)


	September 30, 2011			December 31, 2010
	(in thousands, except share amounts)
ASSETS
Current assets:
Cash and cash equivalents	$	4,019,405		$	1,673,137
Investment securities		7,864,637			6,872,767
Receivables, less allowance for doubtful accounts of $85,015 in 2011 and $51,470 in 2010:		1,036,317			959,018
Securities lending invested collateral		5,486			49,636
Other current assets		706,493			583,141

Total current assets		13,632,338			10,137,699

Property and equipment, net		850,888			815,337
Long-term investment securities		1,695,943			1,499,672
Goodwill		2,579,916			2,567,809
Other long-term assets		1,140,644			1,082,736

Total assets	$	19,899,729		$	16,103,253


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Benefits payable	$	3,868,428		$	3,469,306
Trade accounts payable and accrued expenses		2,332,638			1,624,832
Book overdraft		298,587			409,385
Securities lending payable		11,482			55,693
Unearned revenues		2,005,366			185,410

Total current liabilities		8,516,501			5,744,626
Long-term debt		1,661,552			1,668,849
Future policy benefits payable		1,580,585			1,492,855
Other long-term liabilities		283,121			272,867

Total liabilities		12,041,759			9,179,197

Commitments and contingencies
Stockholders’ equity:
Preferred stock, $1 par; 10,000,000 shares authorized; none issued		0			0
Common stock, $0.16 2/3 par; 300,000,000 shares authorized; 192,804,649 shares issued at September 30, 2011 and 190,244,741 shares issued at December 31, 2010		32,133			31,707
Capital in excess of par value		1,913,665			1,737,207
Retained earnings		6,667,005			5,529,001
Accumulated other comprehensive income		279,844			120,584
Treasury stock, at cost, 29,300,843 shares at September 30, 2011 and 21,795,051 shares at December 31, 2010		(1,034,677	)		(494,443	)

Total stockholders’ equity		7,857,970			6,924,056

Total liabilities and stockholders’ equity	$	19,899,729		$	16,103,253

See accompanying notes to condensed consolidated financial statements.

Humana Inc.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)


	Three months ended September 30,				Nine months ended September 30,
	2011		2010		2011		2010
	(in thousands, except per share results)
Revenues:
Premiums	$	8,852,536	$	8,134,645	$	26,468,203	$	24,673,259
Services		356,212		128,917		1,034,663		394,639
Investment income		91,895		87,250		272,626		252,495

Total revenues		9,300,643		8,350,812		27,775,492		25,320,393

Operating expenses:
Benefits		7,146,530		6,641,264		21,761,052		20,327,742
Operating costs		1,361,657		1,002,398		3,809,905		3,156,945
Depreciation and amortization		66,671		58,717		200,561		181,957

Total operating expenses		8,574,858		7,702,379		25,771,518		23,666,644

Income from operations		725,785		648,433		2,003,974		1,653,749
Interest expense		27,065		26,143		81,956		78,679

Income before income taxes		698,720		622,290		1,922,018		1,575,070
Provision for income taxes		253,960		229,069		701,795		583,005

Net income	$	444,760	$	393,221	$	1,220,223	$	992,065

Basic earnings per common share	$	2.71	$	2.35	$	7.34	$	5.90

Diluted earnings per common share	$	2.67	$	2.32	$	7.24	$	5.84

Dividends declared per common share	$	0.25	$	0.00	$	0.50	$	0.00

See accompanying notes to condensed consolidated financial statements.

Humana Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	For the nine months ended September 30,
	2011			2010
	(in thousands)
Cash flows from operating activities
Net income	$	1,220,223		$	992,065
Adjustments to reconcile net income to net cash provided by operating activities:
Net realized capital gains		(7,255	)		(12,286	)
Stock-based compensation		52,778			52,104
Depreciation and amortization		225,164			196,603
Provision (benefit) for deferred income taxes		12,102			(115,923	)
Changes in operating assets and liabilities, net of effect of businesses acquired:
Receivables		(77,299	)		15,592
Other assets		(205,092	)		119,728
Benefits payable		399,122			504,337
Other liabilities		391,892			520,771
Unearned revenues		1,819,931			(15,073	)
Other, net		44,414			31,253

Net cash provided by operating activities		3,875,980			2,289,171

Cash flows from investing activities
Acquisitions, net of cash acquired		(13,652	)		(10,120	)
Purchases of property and equipment		(215,926	)		(152,432	)
Purchases of investment securities		(2,667,353	)		(3,582,352	)
Maturities of investment securities		1,084,062			1,492,601
Proceeds from sales of investment securities		625,461			1,298,912
Change in securities lending collateral		44,211			88,321

Net cash used in investing activities		(1,143,197	)		(865,070	)

Cash flows from financing activities
Receipts from CMS contract deposits		2,135,321			1,319,874
Withdrawals from CMS contract deposits		(1,909,875	)		(1,117,655	)
Change in securities lending payable		(44,211	)		(88,321	)
Change in book overdraft		(110,798	)		(133,235	)
Common stock repurchases		(540,234	)		(108,170	)
Dividends paid		(41,494	)		0
Excess tax benefit from stock-based compensation		12,246			1,406
Proceeds from stock option exercises and other		112,530			11,264

Net cash used in financing activities		(386,515	)		(114,837	)

Increase in cash and cash equivalents		2,346,268			1,309,264
Cash and cash equivalents at beginning of period		1,673,137			1,613,588

Cash and cash equivalents at end of period	$	4,019,405		$	2,922,852

Supplemental cash flow disclosures:
Interest payments	$	67,894		$	66,403
Income tax payments, net	$	717,654		$	632,745

See accompanying notes to condensed consolidated financial statements.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements are presented in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the disclosures normally required by accounting principles generally accepted in the United States of America, or those normally made in an Annual Report on Form 10-K. For further information, the reader of this Form 10-Q should refer to our Form 10-K for the year ended December 31, 2010, that was filed with the Securities and Exchange Commission, or the SEC, on February 17, 2011 as retrospectively adjusted in our current report on Form 8-K filed with the SEC on October 20, 2011. We refer to the Form 10-K and Form 8-K collectively as the “2010 Form 10-K” in this document. References throughout this document to “we,” “us,” “our,” “Company,” and “Humana” mean Humana Inc. and its subsidiaries.

The preparation of our condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. The areas involving the most significant use of estimates are the estimation of benefits payable, the impact of risk sharing provisions related to our Medicare and TRICARE contracts, the valuation and related impairment recognition of investment securities, and the valuation and related impairment recognition of long-lived assets, including goodwill. These estimates are based on knowledge of current events and anticipated future events, and accordingly, actual results may ultimately differ materially from those estimates. Refer to Note 2 to the consolidated financial statements included in our 2010 Form 10-K for information on accounting policies that the Company considers in preparing its consolidated financial statements.

The financial information has been prepared in accordance with our customary accounting practices and has not been audited. In our opinion, the information presented reflects all adjustments necessary for a fair statement of interim results. All such adjustments are of a normal and recurring nature.

Realignment of Business Segments

During the first quarter of 2011, we realigned our business segments to reflect our evolving business model. We manage and report our operating results using the following segments: Retail, Employer Group, and Health and Well-Being Services. We also disclose results for Other Businesses. All respective amounts related to the segment change have been retrospectively adjusted throughout the financial statements. Our segment information is more fully described in Note 13.

As a result of changing our reportable segments, we also changed the classification of certain revenues and costs. Beginning January 1, 2011, costs of certain health and well-being services were reclassified as benefits expense including costs incurred by our wholly-owned mail order pharmacy from transactions with our members that were historically classified as selling, general and administrative (and now titled operating costs), as well as depreciation and amortization expenses. The effect of this reclassification is to account for the cost of providing these benefits to our members similarly whether the services are provided via a third party provider or internally through a stand-alone subsidiary. Likewise, co-share amounts from our members associated with our wholly-owned mail order pharmacy operations, historically classified as other revenue, are now classified as a reduction of benefits expense. The remaining items previously classified as other revenue, primarily consisting of patient service revenue associated with our Concentra Inc. subsidiary, which was acquired in December 2010, were combined with our previous administrative services fee revenue and are now classified as services revenue. Prior period amounts have been reclassified to conform to the new presentation. These adjustments had no impact on net income, cash flows or equity. Further, none of these adjustments impacted our regulated subsidiaries.

Depreciation and amortization expense associated with certain businesses in our Health and Well-Being Services segment delivering benefits to our members, primarily associated with our pharmacy operations, are now included with benefits expense. The amount of this expense was $7.9 million and $5.8 million for the three months ended September 30, 2011 and 2010, respectively. For the nine months ended September 30, 2011 and 2010, the amount of this expense was $24.6 million and $14.6 million, respectively.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In September 2011, the Financial Accounting Standards Board, or FASB, issued new guidance that will allow entities to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Previous guidance required an entity to test goodwill for impairment, on at least an annual basis, by comparing the fair value of a reporting unit with its carrying amount. If the fair value of a reporting unit is less than its carrying amount, then the second step of the test must be performed to measure the amount of the impairment loss, if any. Under the new guidance, we would not be required to calculate the fair value of a reporting unit unless we determine, based on the qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The new guidance includes a number of events and circumstances for an entity to consider in conducting the qualitative assessment. The new guidance is effective, for us, beginning with annual and interim impairment tests performed in 2012. Early adoption is permitted, including for our 2011 annual impairment test which will be performed in the fourth quarter of 2011. We are currently evaluating the new guidance.

In July 2011, the FASB issued new guidance regarding how health insurers should recognize and classify fees mandated by The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the Health Insurance Reform Legislation). The Health Insurance Reform Legislation imposes a non-deductible annual fee on health insurers for each calendar year beginning on or after January 1, 2014. The guidance requires that the liability for the fee be estimated and recorded in full once qualifying insurance coverage is provided in the applicable calendar year in which the fee is payable with a corresponding deferred cost that is amortized to expense over the calendar year that it is payable. The new guidance is effective for us when the fee is initially imposed in calendar year 2014.

In June 2011, the FASB issued new guidance requiring the presentation of other comprehensive income in a statement presented with equal prominence to the other primary financial statements. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity and requires one of two alternatives for the presentation of items of net income and other comprehensive income: (1) in a single continuous statement referred to as the statement of comprehensive income, or (2) in two separate, but consecutive statements. Under either alternative, each component of net income and each component of other comprehensive income, together with totals for each, as well as total comprehensive income would need to be displayed. The new guidance is effective for us, beginning with the filing of our Form 10-Q for the three months ending March 31, 2012, with retrospective application required. Early adoption is permitted. As the new guidance only affects the presentation of other comprehensive income, it will not have a material impact on our results of operations, financial condition, or cash flows.

In May 2011, the FASB issued new guidance intended to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with accounting principles generally accepted in the United States of America and those prepared in accordance with international financial reporting standards. While the new guidance is largely consistent with existing fair value measurement principles, it expands existing disclosure requirements for fair value measurements and makes other amendments which could change how existing fair value measurement guidance is applied. The new guidance will be effective for us beginning with the filing of our Form 10-Q for the three months ending March 31, 2012. We are currently evaluating the impact of the adoption of this new guidance on our results of operations, financial condition, or cash flows.

In January 2010, the FASB issued new guidance that expanded and clarified existing disclosures about fair value measurements. Under the new guidance, we are required to disclose additional information about movements of assets among the three-tier fair value hierarchy, present separately (that is, on a gross basis) information about purchases, sales, issuances, and settlements of financial instruments in the reconciliation of fair value measurements using significant unobservable inputs (Level 3), and expand disclosures regarding the determination of fair value measurements. We adopted the new disclosure provisions during the year ended December 31, 2010, except for the gross disclosures regarding purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements which we adopted with the filing of our Form 10-Q for the three months ended March 31, 2011 as provided in Note 5.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

There are no other recently issued accounting standards that apply to us or that will have a material impact on our results of operations, financial condition, or cash flows.

3. ACQUISITIONS

On December 21, 2010, we acquired Concentra Inc., or Concentra, a health care company based in Addison, Texas, for cash consideration of $804.7 million. During the first half of 2011, we accrued and paid $3.7 million related to the final determination of working capital that existed at the acquisition date and recorded immaterial adjustments to the acquisition date fair value of Concentra’s net tangible assets acquired with a corresponding adjustment to goodwill. Through its affiliated clinicians, Concentra delivers occupational medicine, urgent care, physical therapy, and wellness services to workers and the general public through its operation of medical centers and worksite medical facilities. The Concentra acquisition provides us entry into the primary care space on a national scale, offering additional means for achieving health and wellness solutions and providing an expandable platform for growth with a management team experienced in physician asset management and alternate site care. The total consideration of $808.4 million exceeded our estimated fair value of the net tangible assets acquired by approximately $724.5 million, of which we allocated $188.0 million to other intangible assets and $536.5 million to goodwill. The goodwill was assigned to the Health and Well-Being Services segment. The other intangible assets, which primarily consist of customer relationships and trade name, have a weighted average useful life of 13.7 years. Approximately $57.9 million of the acquired goodwill is deductible for tax purposes.

The results of operations and financial condition of Concentra have been included in our consolidated statements of income and consolidated balance sheets from the acquisition date. In connection with the acquisition, we recognized approximately $14.9 million of acquisition-related costs, primarily banker and other professional fees, as operating costs in the fourth quarter of 2010. The pro forma financial information assuming the acquisition had occurred as of January 1, 2009 was not material to our results of operations.

During the third quarter of 2011, we entered into definitive agreements to acquire the California-based Medicare Advantage health maintenance organizations (HMO) Arcadian Management Services, Inc. and MD Care, Inc. These companies, on a combined basis, serve Medicare Advantage HMO members in 15 U.S. states, and offer us an opportunity to expand our Medicare footprint and grow our Medicare enrollment. The closings of these acquisitions are subject to federal and/or state regulatory approvals.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

4. INVESTMENT SECURITIES

Investment securities classified as current and long-term were as follows at September 30, 2011 and December 31, 2010, respectively:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
September 30, 2011
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations	$	859,543	$	21,656	$	(480	)	$	880,719
Mortgage-backed securities		1,711,452		91,379		(1,179	)		1,801,652
Tax-exempt municipal securities		2,617,120		112,228		(3,659	)		2,725,689
Mortgage-backed securities:
Residential		48,557		512		(1,641	)		47,428
Commercial		371,278		17,798		(1,165	)		387,911
Asset-backed securities		106,186		1,397		(130	)		107,453
Corporate debt securities		3,393,537		238,427		(27,569	)		3,604,395
Redeemable preferred stock		5,333		0		0			5,333

Total debt securities	$	9,113,006	$	483,397	$	(35,823	)	$	9,560,580

December 31, 2010
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations	$	697,816	$	14,412	$	(615	)	$	711,613
Mortgage-backed securities		1,614,569		49,783		(1,173	)		1,663,179
Tax-exempt municipal securities		2,439,659		37,294		(43,619	)		2,433,334
Mortgage-backed securities:
Residential		58,017		545		(2,675	)		55,887
Commercial		306,291		14,911		(171	)		321,031
Asset-backed securities		148,068		1,727		(44	)		149,751
Corporate debt securities		2,906,228		139,793		(13,710	)		3,032,311
Redeemable preferred stock		5,333		0		0			5,333

Total debt securities	$	8,175,981	$	258,465	$	(62,007	)	$	8,372,439

We participate in a securities lending program where we loan certain investment securities for short periods of time in exchange for collateral, consisting of cash or U.S. Government securities, initially equal to at least 102% of the fair value of the investment securities on loan. Investment securities with a fair value of $8.1 million at September 30, 2011 and $54.0 million at December 31, 2010 were on loan as of those respective dates. At September 30, 2011, all collateral from lending our investment securities was in the form of cash which has been reinvested in money market funds.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

Gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position were as follows at September 30, 2011 and December 31, 2010, respectively:


	Less than 12 months					12 months or more					Total
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses
	(in thousands)
September 30, 2011
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations	$	168,248	$	(480	)	$	0	$	0		$	168,248	$	(480	)
Mortgage-backed securities		23,462		(517	)		19,428		(662	)		42,890		(1,179	)
Tax-exempt municipal securities		140,105		(1,634	)		66,439		(2,025	)		206,544		(3,659	)
Mortgage-backed securities:
Residential		4,911		(104	)		25,560		(1,537	)		30,471		(1,641	)
Commercial		42,559		(1,165	)		0		0			42,559		(1,165	)
Asset-backed securities		18,932		(112	)		3,656		(18	)		22,588		(130	)
Corporate debt securities		681,567		(25,344	)		16,505		(2,225	)		698,072		(27,569	)

Total debt securities	$	1,079,784	$	(29,356	)	$	131,588	$	(6,467	)	$	1,211,372	$	(35,823	)


December 31, 2010
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations	$	141,766	$	(615	)	$	0	$	0		$	141,766	$	(615	)
Mortgage-backed securities		110,358		(1,054	)		5,557		(119	)		115,915		(1,173	)
Tax-exempt municipal securities		1,168,221		(33,218	)		97,809		(10,401	)		1,266,030		(43,619	)
Mortgage-backed securities:
Residential		0		0			32,671		(2,675	)		32,671		(2,675	)
Commercial		0		0			2,752		(171	)		2,752		(171	)
Asset-backed securities		17,069		(42	)		283		(2	)		17,352		(44	)
Corporate debt securities		383,677		(9,572	)		31,464		(4,138	)		415,141		(13,710	)

Total debt securities	$	1,821,091	$	(44,501	)	$	170,536	$	(17,506	)	$	1,991,627	$	(62,007	)

Approximately 96% of our debt securities were investment-grade quality at September 30, 2011, with a weighted average credit rating of AA by S&P. Most of the debt securities that were below investment-grade were rated BB, the higher end of the below investment-grade rating scale. At September 30, 2011, 12% of our tax-exempt municipal securities were pre-refunded, generally with U.S. government and agency securities, and 23% of our tax-exempt securities were insured by bond insurers and had an equivalent S&P credit rating of AA exclusive of the bond insurers’ guarantee. Our investment policy limits investments in a single issuer and requires diversification among various asset types.

The recoverability of our residential and commercial mortgage-backed securities is supported by factors such as seniority, underlying collateral characteristics and credit enhancements. Our residential and commercial mortgage-backed securities at September 30, 2011 primarily were composed of senior tranches having high credit support, with 99% of the collateral consisting of prime loans. The weighted average credit rating of all commercial mortgage-backed securities was AA at September 30, 2011.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

All issuers of securities we own that were trading at an unrealized loss at September 30, 2011 remain current on all contractual payments. After taking into account these and other factors previously described, we believe these unrealized losses primarily were caused by an increase in market interest rates and tighter liquidity conditions in the current markets than when the securities were purchased. At September 30, 2011, we did not intend to sell the securities with an unrealized loss position in accumulated other comprehensive income, and it is not likely that we will be required to sell these securities before recovery of their amortized cost basis. As a result, we believe that the securities with an unrealized loss were not other-than-temporarily impaired at September 30, 2011.

The detail of realized gains (losses) related to investment securities and included within investment income was as follows for the three and nine months ended September 30, 2011 and 2010:


	For the three months ended September 30,						For the nine months ended September 30,
	2011			2010			2011			2010
	(in thousands)
Gross realized gains	$	4,894		$	4,649		$	15,742		$	28,402
Gross realized losses		(2,748	)		(339	)		(8,487	)		(16,116	)

Net realized capital gains	$	2,146		$	4,310		$	7,255		$	12,286

There were no material other-than-temporary impairments for the three and nine months ended September 30, 2011 or 2010.

The contractual maturities of debt securities available for sale at September 30, 2011, regardless of their balance sheet classification, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


	Amortized Cost		Fair Value
	(in thousands)
Due within one year	$	513,749	$	517,127
Due after one year through five years		1,966,077		2,029,429
Due after five years through ten years		2,602,607		2,729,133
Due after ten years		1,793,100		1,940,447
Mortgage and asset-backed securities		2,237,473		2,344,444

Total debt securities	$	9,113,006	$	9,560,580

Humana Inc.

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5. FAIR VALUE

Financial Assets

The following table summarizes our fair value measurements at September 30, 2011 and December 31, 2010, respectively, for financial assets measured at fair value on a recurring basis:


			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
September 30, 2011
Cash equivalents	$	3,937,536	$	3,937,536	$	0	$	0
Debt securities:
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations		880,719		0		880,719		0
Mortgage-backed securities		1,801,652		0		1,801,652		0
Tax-exempt municipal securities		2,725,689		0		2,704,249		21,440
Mortgage-backed securities:
Residential		47,428		0		47,428		0
Commercial		387,911		0		387,911		0
Asset-backed securities		107,453		0		106,388		1,065
Corporate debt securities		3,604,395		0		3,579,918		24,477
Redeemable preferred stock		5,333		0		0		5,333

Total debt securities		9,560,580		0		9,508,265		52,315
Securities lending invested collateral		5,486		5,486		0		0

Total invested assets	$	13,503,602	$	3,943,022	$	9,508,265	$	52,315

December 31, 2010
Cash equivalents	$	1,606,592	$	1,606,592	$	0	$	0
Debt securities:
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations		711,613		0		711,613		0
Mortgage-backed securities		1,663,179		0		1,663,179		0
Tax-exempt municipal securities		2,433,334		0		2,381,528		51,806
Mortgage-backed securities:
Residential		55,887		0		55,887		0
Commercial		321,031		0		321,031		0
Asset-backed securities		149,751		0		148,545		1,206
Corporate debt securities		3,032,311		0		3,025,097		7,214
Redeemable preferred stock		5,333		0		0		5,333

Total debt securities		8,372,439		0		8,306,880		65,559
Securities lending invested collateral		49,636		24,639		24,997		0

Total invested assets	$	10,028,667	$	1,631,231	$	8,331,877	$	65,559

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Our Level 3 assets had a fair value of $52.3 million at September 30, 2011, or less than 0.5% of our total invested assets. During the three and nine months ended September 30, 2011 and 2010, the changes in the fair value of the assets measured using significant unobservable inputs (Level 3) were comprised of the following:


	For the three months ended September 30,
	2011									2010
	Auction Rate Securities			Private Placements/ Venture Capital			Total			Auction Rate Securities			Private Placements/ Venture Capital			Total
	(in thousands)
Beginning balance at July 1	$	21,054		$	30,529		$	51,583		$	51,473		$	14,541		$	66,014
Total gains or losses:
Realized in earnings		0			11			11			0			19			19
Unrealized in other comprehensive income		486			381			867			(54	)		(34	)		(88	)
Purchases		0			0			0			0			167			167
Sales/calls		(100	)		(46	)		(146	)		0			0			0
Settlements		0			0			0			(50	)		(30	)		(80	)

Balance at September 30	$	21,440		$	30,875		$	52,315		$	51,369		$	14,663		$	66,032


	For the nine months ended September 30,
	2011									2010
	Auction Rate Securities			Private Placements/ Venture Capital			Total			Auction Rate Securities			Private Placements/ Venture Capital			Total
	(in thousands)
Beginning balance at January 1	$	51,806		$	13,753		$	65,559		$	68,814		$	23,909		$	92,723
Total gains or losses:
Realized in earnings		16			(202	)		(186	)		16			6,214			6,230
Unrealized in other comprehensive income		2,243			996			3,239			1,314			(4,239	)		(2,925	)
Purchases		0			17,000			17,000			0			3,334			3,334
Sales/calls		(32,625	)		(672	)		(33,297	)		(2,500	)		(13,220	)		(15,720	)
Settlements		0			0			0			(16,275	)		(1,335	)		(17,610	)

Balance at September 30	$	21,440		$	30,875		$	52,315		$	51,369		$	14,663		$	66,032

There were no material transfers between Level 1 and Level 2 during the three and nine months ended September 30, 2011 or September 30, 2010.

Financial Liabilities

Our long-term debt is recorded at carrying value in our consolidated balance sheets. The carrying value of our long-term debt outstanding was $1,661.6 million at September 30, 2011 and $1,668.8 million at December 31, 2010. The fair value of our long-term debt was $1,837.5 million at September 30, 2011 and $1,746.5 million at December 31, 2010. The fair value of our long-term debt is determined based on quoted market prices for the same or similar debt, or, if no quoted market prices are available, on the current prices estimated to be available to us for debt with similar terms and remaining maturities.

Humana Inc.

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6. MEDICARE PART D

We cover prescription drug benefits in accordance with Medicare Part D under multiple contracts with the Centers for Medicare and Medicaid Services, or CMS. The condensed consolidated balance sheets include the following amounts associated with Medicare Part D as of September 30, 2011 and December 31, 2010. Amounts included below relating to the 2010 contract year for the net risk corridor payable of $380.0 million and the CMS subsidies payable of $98.3 million at September 30, 2011 are expected to be settled in the fourth quarter of 2011.


	September 30, 2011						December 31, 2010
	Risk Corridor Settlement			CMS Subsidies			Risk Corridor Settlement			CMS Subsidies
	(in thousands)
Other current assets	$	2,840		$	26,691		$	1,563		$	16,211
Trade accounts payable and accrued expenses		(623,572	)		(406,157	)		(389,203	)		(170,231	)

Net current liability	$	(620,732	)	$	(379,466	)	$	(387,640	)	$	(154,020	)

As disclosed in Note 2 to the consolidated financial statements included in our 2010 Form 10-K, reinsurance and low-income cost subsidies represent funding from CMS in connection with the Medicare Part D program for which we assume no risk. Beginning in 2011, the Health Reform Legislation mandates consumer discounts of 50% on brand name prescription drugs for Part D plan participants in the coverage gap. These discounts are funded by CMS and pharmaceutical manufacturers while we administer the application of these funds. We account for these subsidies and discounts as a deposit in our consolidated balance sheets and as a financing activity in our consolidated statements of cash flows. We do not recognize premium revenues or benefit expense for these discounts or subsidies. We have included the payable associated with the funding of these discounts with CMS subsidies in the table above.

7. GOODWILL AND OTHER INTANGIBLE ASSETS

The realignment of our business segments and corresponding change in our reportable segments, more fully described herein in Note 13, resulted in a change in the composition of our reporting units, the unit of accounting for goodwill. Accordingly, we reassigned goodwill to our reporting units as of January 1, 2011 using the relative fair value approach. Changes in the carrying amount of goodwill, by our new reportable segments, for the nine months ended September 30, 2011 were as follows:


	Retail		Employer Group		Health & Well-Being Services		Other Businesses		Total
	(in thousands)
Balance at January 1, 2011	$	592,844	$	61,990	$	1,855,522	$	57,453	$	2,567,809
Acquisitions		0		0		6,427		0		6,427
Subsequent adjustments		0		0		5,680		0		5,680

Balance at September 30, 2011	$	592,844	$	61,990	$	1,867,629	$	57,453	$	2,579,916

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The following table presents details of our other intangible assets included in other long-term assets in the accompanying condensed consolidated balance sheets at September 30, 2011 and December 31, 2010:


	Weighted Average Life		September 30, 2011						December 31, 2010
	Weighted Average Life		Cost		Accumulated Amortization		Net		Cost		Accumulated Amortization		Net
			(in thousands)
Other intangible assets:
Customer contracts/relationships		10.7 yrs	$	417,290	$	175,714	$	241,576	$	413,855	$	145,997	$	267,858
Trade names		19.6 yrs		87,400		5,713		81,687		87,400		2,268		85,132
Provider contracts		16.0 yrs		42,753		14,192		28,561		42,753		11,659		31,094
Noncompetes and other		7.4 yrs		36,940		8,094		28,846		19,475		4,085		15,390

Total other intangible assets		12.2 yrs	$	584,383	$	203,713	$	380,670	$	563,483	$	164,009	$	399,474

Amortization expense for other intangible assets was approximately $39.7 million for the nine months ended September 30, 2011 and $28.6 million for the nine months ended September 30, 2010. The following table presents our estimate of amortization expense for 2011 and each of the five next succeeding years:


	(in thousands)
For the years ending December 31,:
2011	$	53,294
2012		53,104
2013		49,849
2014		45,351
2015		40,019
2016		34,343

8. COMPREHENSIVE INCOME

The following table presents details supporting the computation of comprehensive income, net of tax, for the three and nine months ended September 30, 2011 and 2010:


	Three months ended September 30,						Nine months ended September 30,
	2011			2010			2011			2010
	(in thousands)
Net income	$	444,760		$	393,221		$	1,220,223		$	992,065
Net unrealized investment gains and other, net of tax		92,174			103,328			163,859			224,675
Reclassification adjustment for net realized gains included in net income, net of tax		(1,360	)		(2,731	)		(4,599	)		(7,785	)

Comprehensive income, net of tax	$	535,574		$	493,818		$	1,379,483		$	1,208,955

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9. EARNINGS PER COMMON SHARE COMPUTATION

Detail supporting the computation of basic and diluted earnings per common share was as follows for the three and nine months ended September 30, 2011 and 2010:


	Three months ended September 30,				Nine months ended September 30,
	2011		2010		2011		2010
	(in thousands, except per common share results)
Net income available for common stockholders	$	444,760	$	393,221	$	1,220,223	$	992,065

Weighted average outstanding shares of common stock used to compute basic earnings per common share		164,121		167,574		166,138		168,082
Dilutive effect of:
Employee stock options		895		634		962		589
Restricted stock		1,564		1,374		1,458		1,293

Shares used to compute diluted earnings per common share		166,580		169,582		168,558		169,964

Basic earnings per common share	$	2.71	$	2.35	$	7.34	$	5.90

Diluted earnings per common share	$	2.67	$	2.32	$	7.24	$	5.84

Number of antidilutive stock options and restricted stock excluded from computation		168		3,256		1,017		4,355

10. STOCKHOLDERS’ EQUITY

Dividends

In April 2011, our Board of Directors approved the initiation of a quarterly cash dividend policy. Declaration and payment of future quarterly dividends is at the discretion of the Board and may be adjusted as business needs or market conditions change.

The following table provides details of our dividend payments in 2011:


Record Date	Payment Date		Amount per Share		Total Amount
					(in millions)
6/30/2011		7/28/2011	$	0.25	$	41.5
9/30/2011		10/28/2011	$	0.25	$	40.7

In addition, in October 2011, our Board of Directors declared a cash dividend to stockholders of $0.25 per share payable on January 31, 2012 to stockholders of record on December 30, 2011.

Stock Repurchases

In April 2011, the Board of Directors replaced its previously approved share repurchase authorization of up to $250 million with a new authorization for repurchases of up to $1 billion of our common shares exclusive of shares repurchased in connection with employee stock plans. The new authorization will expire June 30, 2013. Under this share repurchase authorization, shares could be purchased from time to time at prevailing prices in the open market, by block purchases, or in privately-negotiated transactions, subject to certain regulatory restrictions on volume, pricing, and timing. During the nine months ended September 30, 2010, we repurchased 1.99 million shares in open market transactions for $100.0 million at an average price of $50.17 under the previously approved share repurchase authorization. During the nine months ended September 30, 2011, we repurchased 0.8 million shares in open market transactions for $52.6 million at an average price of $63.73 under the previously

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approved share repurchase authorization and we repurchased 5.9 million shares in open market transactions for $438.9 million at an average price of $74.01 under the new authorization. As of October 31, 2011, the remaining authorized amount under the new authorization totaled $561.3 million.

In connection with employee stock plans, we acquired 0.8 million common shares for $48.7 million and 0.2 million common shares for $8.2 million during the nine months ended September 30, 2011 and 2010, respectively.

11. INCOME TAXES

The effective income tax rate was 36.3% for the three months ended September 30, 2011 compared to 36.8% for the three months ended September 30, 2010. For the nine months ended September 30, 2011, the effective tax rate was 36.5% compared to 37.0% for the nine months ended September 30, 2010. The higher tax rate for the nine months ended September 30, 2010 primarily was due to the cumulative adjustment associated with estimating the retrospective aspect of new limitations on the deductibility of annual compensation in excess of $500,000 per employee as mandated by the Health Insurance Reform Legislation.

12. GUARANTEES AND CONTINGENCIES

Government Contracts

Our Medicare products, which accounted for approximately 65% of our total premiums and services revenue for the nine months ended September 30, 2011, primarily consisted of products covered under the Medicare Advantage and Medicare Part D Prescription Drug Plan contracts with the federal government. These contracts are renewed generally for a calendar year term unless CMS notifies us of its decision not to renew by August 1 of the calendar year in which the contract would end, or we notify CMS of our decision not to renew by the first Monday in June of the calendar year in which the contract would end. All material contracts between Humana and CMS relating to our Medicare products have been renewed for 2012, and all of our product offerings filed with CMS for 2012 have been approved.

CMS uses a risk-adjustment model which apportions premiums paid to Medicare Advantage plans according to health severity. The risk-adjustment model pays more for enrollees with predictably higher costs. Under this model, rates paid to Medicare Advantage plans are based on actuarially determined bids, which include a process whereby our prospective payments are based on a comparison of our beneficiaries’ risk scores, derived from medical diagnoses, to those enrolled in the government’s original Medicare program. Under the risk-adjustment methodology, all Medicare Advantage plans must collect and submit the necessary diagnosis code information from hospital inpatient, hospital outpatient, and physician providers to CMS within prescribed deadlines. The CMS risk-adjustment model uses this diagnosis data to calculate the risk adjusted premium payment to Medicare Advantage plans. We generally rely on providers to code their claim submissions with appropriate diagnoses, which we send to CMS as the basis for our payment received from CMS under the actuarial risk-adjustment model. We also rely on providers to appropriately document all medical data, including the diagnosis data submitted with claims.

CMS is continuing to perform audits of various companies’ selected Medicare Advantage contracts related to this risk adjustment diagnosis data. These audits are referred to herein as Risk-Adjustment Data Validation Audits, or RADV audits. RADV audits review medical record documentation in an attempt to validate provider coding practices and the presence of risk adjustment conditions which influence the calculation of premium payments to Medicare Advantage plans.

On December 21, 2010, CMS posted a description of the agency’s proposed RADV sampling and payment adjustment calculation methodology to its website, and invited public comment, noting that CMS may revise its sampling and payment error calculation methodology based upon the comments received. We believe the audit and payment adjustment methodology proposed by CMS is fundamentally flawed and actuarially unsound. In essence, in

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making the comparison referred to above, CMS relies on two interdependent sets of data to set payment rates for Medicare Advantage (MA) plans: (1) fee for service (FFS) data from the government’s original Medicare program; and (2) MA data. The proposed methodology would review medical records for only one set of data (MA data), while not performing the same exercise on the other set (FFS data). However, because these two sets of data are inextricably linked, we believe CMS must audit and validate both of them before determining the financial implications of any potential RADV audit results, in order to ensure that any resulting payment adjustment is accurate. We believe that the Social Security Act, under which the payment model was established, requires the consistent use of these data sets in determining risk-adjusted payments to MA plans. Furthermore, our payment received from CMS, as well as benefits offered and premiums charged to members, is based on bids that did not, by CMS design, include any assumption of retroactive audit payment adjustments. We believe that applying a retroactive audit adjustment after CMS acceptance of bids would improperly alter this process of establishing member benefits and premiums.

CMS has received public comments, including our comments and comments from other industry participants and the American Academy of Actuaries, which expressed concerns about the failure to appropriately compare the two sets of data. On February 3, 2011, CMS issued a statement that it was closely evaluating the comments it has received on this matter and anticipates making changes to the proposed methodology based on input it has received, although we are unable to predict the extent of changes that they may make.

To date, six Humana contracts have been selected by CMS for RADV audits for the 2007 contract year, consisting of one “pilot” audit and five “targeted” audits for Humana plans. We believe that the proposed methodology for these audits is actuarially unsound and in violation of the Social Security Act. We intend to defend that position vigorously. However, if CMS moves forward with implementation of the proposed methodology without changes to adequately address the data inconsistency issues described above, it would have a material adverse effect on our revenues derived from the Medicare Advantage program and, therefore, our results of operations, financial position, and cash flows.

Our Medicaid business, which accounted for approximately 2% of our total premiums and services revenue for the nine months ended September 30, 2011, consists of contracts in Puerto Rico and Florida, with the vast majority in Puerto Rico. Effective October 1, 2010, as amended in May 2011, the Puerto Rico Health Insurance Administration, or PRHIA, awarded us three contracts for the East, Southeast, and Southwest regions for a three year term through June 30, 2013.

The loss of any of the contracts above or significant changes in these programs as a result of legislative action, including reductions in premium payments to us, or increases in member benefits without corresponding increases in premium payments to us, may have a material adverse effect on our results of operations, financial position, and cash flows.

Our military services business, which accounted for approximately 10% of our total premiums and services revenue for the nine months ended September 30, 2011, primarily consists of the TRICARE South Region contract. The original 5-year South Region contract expired on March 31, 2009 and was extended through March 31, 2011. On October 5, 2010, we were notified that the Department of Defense, or DoD, TRICARE Management Activity, or TMA, intended to negotiate with us for an extension of our administration of the TRICARE South Region contract, and on January 6, 2011, an Amendment of Solicitation/Modification of Contract to the TRICARE South Region contract became effective. The Amendment added one additional one-year option period, Option Period IX (which runs from April 1, 2011 through March 31, 2012). The TMA exercised Option Period IX on March 17, 2011.

As required under the current contract, the target underwritten health care cost and underwriting fee amounts are negotiated separately. Any variance from the target health care cost is shared with the federal government. Accordingly, events and circumstances not contemplated in the negotiated target health care cost amount may have a material adverse effect on us. These changes may include an increase or reduction in the number of persons enrolled or eligible to enroll due to the federal government’s decision to increase or decrease U.S. military deployments. In

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the event government reimbursements were to decline from projected amounts, any failure to reduce the health care costs associated with these programs may have a material adverse effect on our results of operations, financial position, and cash flows.

In July 2009, we were notified by the DoD that we were not awarded the third generation TRICARE program contract for the South Region which had been subject to competing bids. We filed a protest with the Government Accountability Office, or GAO, in connection with the award to another bidder citing discrepancies between the award criteria and procedures prescribed in the request for proposals issued by the DoD and those that appear to have been used by the DoD in making its contractor selection. In October 2009, we learned that the GAO had upheld our protest, determining that the TMA evaluation of our proposal had unreasonably failed to fully recognize and reasonably account for the likely cost savings associated with our record of obtaining network provider discounts from our established network in the South Region. On February 25, 2011, TMA awarded the South Region contract to us. On March 7, 2011, the competing bidder filed a protest of the award with the GAO. Also on March 7, 2011, as provided in the Federal Acquisition Regulations, TMA issued a stop work order to us in connection with the award. On June 14, 2011, the GAO upheld the award of the contract to us and TMA subsequently lifted the stop work order. On June 21, 2011, the competing bidder filed a complaint in the United States Court of Federal Claims objecting to the award of the contract to us. On October 14, 2011, the Court upheld the award of the contract to us, and the competing bidder has until December 13, 2011 to appeal it to the Court of Appeals for the Federal Circuit. Ultimate disposition of the contract award is subject to the resolution of any additional actions the unsuccessful bidder may take.

Legal Proceedings and Certain Regulatory Matters

Provider Litigation

Humana Military Healthcare Services, Inc. (“Humana Military”) was named as a defendant in Sacred Heart Health System, Inc., et al. v. Humana Military Healthcare Services Inc., Case No. 3:07-cv-00062 MCR/EMT (the “Sacred Heart” Complaint), a purported class action lawsuit filed on February 5, 2007 in the U.S. District Court for the Northern District of Florida asserting contract and fraud claims against Humana Military. The Sacred Heart Complaint alleged, among other things, that, Humana Military breached its network agreements with a class of hospitals in six states, including the seven named plaintiffs, that contracted for reimbursement of outpatient services provided to beneficiaries of the DoD’s TRICARE health benefits program (“TRICARE”). The Complaint alleged that Humana Military breached its network agreements when it failed to reimburse the hospitals based on negotiated discounts for non-surgical outpatient services performed on or after October 1, 1999, and instead reimbursed them based on published CHAMPUS Maximum Allowable Charges (so-called “CMAC rates”). Humana Military denied that it breached the network agreements with the hospitals and asserted a number of defenses to these claims. The Complaint sought, among other things, the following relief for the purported class members: (i) damages as a result of the alleged breach of contract by Humana Military, (ii) taxable costs of the litigation, (iii) attorneys fees, and (iv) any other relief the court deems just and proper. Separate and apart from the class relief, named plaintiff Sacred Heart Health System Inc. requested damages and other relief for its individual claim against Humana Military for fraud in the inducement to contract. On September 25, 2008, the district court certified a class consisting of all institutional healthcare service providers in TRICARE former Regions 3 and 4 which had network agreements with Humana Military to provide outpatient non-surgical services to CHAMPUS/TRICARE beneficiaries as of November 18, 1999, excluding those network providers who contractually agreed with Humana Military to submit any such disputes with Humana Military to arbitration. On March 3, 2010, the Court of Appeals reversed the district court’s class certification order and remanded the case to the district court for further proceeding. On June 28, 2010, the plaintiffs sought leave of the district court to amend their complaint to join additional hospital plaintiffs. Humana Military filed its response to the motion on July 28, 2010. The district court granted the plaintiffs’ motion to join 33 additional hospitals on September 24, 2010. On October 27, 2010, the plaintiffs filed their Fourth Amended Complaint claiming the U.S. District Court for the Northern District of Florida has subject matter jurisdiction over the case because the allegations in the complaint raise a substantial question under federal law. The amended complaint asserts no other material changes to the allegations or relief sought by the plaintiffs. Humana Military’s Answer to the Fourth Amended Complaint was filed on November 30, 2010. We are currently involved in discovery on this matter, with trial currently scheduled for October 2012.

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On March 2, 2009, in a case styled Southeast Georgia Regional Medical Center, et al. v. Humana Military Healthcare Services, Inc., the named plaintiffs filed an arbitration demand, seeking relief on the same grounds as the plaintiffs in the Sacred Heart litigation. The arbitration plaintiffs originally sought certification of a class consisting of all institutional healthcare service providers that had contracts with Humana Military to provide outpatient non-surgical services and whose agreements provided for dispute resolution through arbitration. Humana Military submitted its response to the demand for arbitration on May 1, 2009. The plaintiffs have subsequently withdrawn their motion for class certification. On June 18, 2010, plaintiffs submitted their amended arbitration complaint. Humana Military’s answer to the complaint was submitted on July 9, 2010. An arbitration trial was held from September 26, 2011 to October 7, 2011, and the parties are waiting for a decision.

Humana intends to defend each of these actions vigorously.

Internal Investigation

With the assistance of outside counsel, we are conducting an ongoing internal investigation related to certain aspects of our Florida subsidiary operations, and have voluntarily self-reported the existence of this investigation to CMS, the U.S. Department of Justice and the Florida Agency for Health Care Administration. Matters under review include, without limitation, the relationships between certain of our Florida-based employees and providers in our Medicaid and/or Medicare networks, practices related to the financial support of non-profit or provider access centers for Medicaid enrollment and related enrollment processes, and loans to or other financial support of physician practices. We have reported to the regulatory authorities noted above on the progress of our investigation to date, and intend to continue to discuss with these authorities our factual findings as well as any remedial actions we have taken or may take.

Other Lawsuits and Regulatory Matters

Our current and past business practices are subject to review or other investigations by various state insurance and health care regulatory authorities and other state and federal regulatory authorities. These authorities regularly scrutinize the business practices of health insurance and benefits companies. These reviews focus on numerous facets of our business, including claims payment practices, provider contracting, competitive practices, commission payments, privacy issues, utilization management practices, and sales practices, among others. Some of these reviews have historically resulted in fines imposed on us and some have required changes to some of our practices. We continue to be subject to these reviews, which could result in additional fines or other sanctions being imposed on us or additional changes in some of our practices.

On September 10, 2009, the Office of Inspector General, or OIG, of the United States Department of Health and Human Services issued subpoenas to us and our subsidiary, Humana Pharmacy, Inc., seeking documents related to our Medicare Part D prescription plans and the operation of RightSourceRx^®, our mail order pharmacy in Phoenix, Arizona. In July 2010, the government informed us that no additional materials will be sought pursuant to the subpoenas.

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We also are involved in various other lawsuits that arise, for the most part, in the ordinary course of our business operations, including employment litigation, claims of medical malpractice, bad faith, nonacceptance or termination of providers, anticompetitive practices, improper rate setting, failure to disclose network discounts and various other provider arrangements, general contractual matters, intellectual property matters, and challenges to subrogation practices, certain of which may be styled as class-action lawsuits. We also are subject to claims relating to performance of contractual obligations to providers, members, and others, including failure to properly pay claims, improper policy terminations, challenges to our implementation of the Medicare Part D prescription drug program and other litigation. Under state guaranty assessment laws, we may be assessed (up to prescribed limits) for certain obligations to the policyholders and claimants of insolvent insurance companies that write the same line or lines of business as we do.

Personal injury claims and claims for extracontractual damages arising from medical benefit denials are covered by insurance from our wholly owned captive insurance subsidiary and excess carriers, except to the extent that claimants seek punitive damages, which may not be covered by insurance in certain states in which insurance coverage for punitive damages is not permitted. In addition, insurance coverage for all or certain forms of liability has become increasingly costly and may become unavailable or prohibitively expensive in the future.

We record accruals for such contingencies to the extent that we conclude it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. No estimate of the possible loss or range of loss in excess of amounts accrued, if any, can be made at this time regarding the matters specifically described above because the inherently unpredictable nature of legal proceedings may be exacerbated by various factors, including: (i) the damages sought in the proceedings are unsubstantiated or indeterminate; (ii) discovery is not complete; (iii) the proceeding is in its early stages; (iv) the matters present legal uncertainties; (v) there are significant facts in dispute; (vi) there are a large number of parties (including where it is uncertain how liability, if any, will be shared among multiple defendants); or (vii) there is a wide range of potential outcomes.

The outcome of any current or future litigation or governmental or internal investigations, including the matters described above, cannot be accurately predicted, nor can we predict any resulting penalties, fines or other sanctions that may be imposed at the discretion of federal or state regulatory authorities. Nevertheless, it is reasonably possible that any such penalties, fines or other sanctions could be substantial, and the outcome of these matters may have a material adverse effect on our results of operations, financial position, and cash flows and may affect our reputation.

13. SEGMENT INFORMATION

During the first quarter of 2011, we realigned our business segments to reflect our evolving business model. As a result, we reassessed and changed our operating and reportable segments in the first quarter of 2011 to reflect management’s new view of the business and to align our external financial reporting with our new operating and internal financial reporting model. Historical segment information has been retrospectively adjusted to reflect the effect of this change. Our new reportable segments and the basis for determining those segments are discussed below.

We currently manage our business with three reportable segments: Retail, Employer Group, and Health and Well-Being Services. In addition, we include businesses that are not individually reportable because they do not meet the quantitative thresholds in an Other Businesses category. These segments are based on a combination of the type of health plan customer and adjacent businesses centered on well-being solutions for our health plans and other customers, as described below. These segment groupings are consistent with information used by our Chief Executive Officer to assess performance and allocate resources.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

to individuals. The Employer Group segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, as well as administrative services only products marketed to employer groups. The Health and Well-Being Services segment includes services offered to our health plan members as well as to third parties that promote health and wellness, including primary care, pharmacy, integrated wellness, and home care services. The Other Businesses category consists of our Military services, primarily our TRICARE South region contract, Medicaid, and closed-block long-term care businesses as well as our contract with CMS to administer the Limited Income Newly Eligible Transition (LI-NET) program.

Our Health and Well-Being Services intersegment revenues primarily relate to managing prescription drug coverage for members of our other segments through Humana Pharmacy Solutions^®, or HPS, and includes the operations of RightSourceRx^®, our mail order pharmacy business. These revenues consist of the prescription price (ingredient cost plus dispensing fee), including the portion to be settled with the member (co-share) or with the government (subsidies), plus any associated administrative fees. Service revenues related to the distribution of prescriptions by third party retail pharmacies in our networks are recognized when the claim is processed. Product revenues from dispensing prescriptions from our mail order pharmacies are recorded when the prescription or product is shipped. Our pharmacy operations, which are responsible for designing pharmacy benefits, including defining member co-share responsibilities, determining formulary listings, selecting and establishing prices charged by retail pharmacies, confirming member eligibility, reviewing drug utilization, and processing claims, act as a principal in the arrangement on behalf of members in our other segments. As principal, our Health and Well-Being Services segment reports revenues on a gross basis including co-share amounts from members collected by third party retail pharmacies at the point of service.

We present our consolidated results of operations from the perspective of the health plans. As a result, the cost of providing benefits to our members, whether provided via a third party provider or internally through a stand-alone subsidiary, is classified as benefits expense and excludes the portion of the cost for which the health plans do not bear responsibility, including member co-share amounts and government subsidies of $1.1 billion and $0.9 billion for the three months ended September 30, 2011 and 2010, respectively. For the nine months ended September 30, 2011 and 2010, these amounts were $3.1 billion and $2.6 billion, respectively.

Other than those described previously, the accounting policies of each segment are the same and are described in Note 2 to the consolidated financial statements included in our 2010 Form 10-K. Transactions between reportable segments consist of sales of services rendered by our Health and Well-Being Services segment, primarily pharmacy and behavioral health services, to our Retail and Employer Group customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often utilize the same provider networks, enabling us in some instances to obtain more favorable contract terms with providers. Our segments also share indirect costs and assets. As a result, the profitability of each segment is interdependent. We do not report total assets by segment since this is not a metric used to assess performance and allocate resources. We allocate most operating expenses to our segments. Certain corporate income and expenses are not allocated to the segments, including investment income not supporting segment operations, interest expense on corporate debt, and certain other corporate expenses. These items are managed at the corporate level. These corporate amounts are reported separately from our reportable segments and included with intersegment eliminations in the tables presenting segment results below.

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited

Our segment results were as follows for the three and nine months ended September 30, 2011 and 2010, respectively:


	Retail		Employer Group		Health and Well-Being Services		Other Businesses		Eliminations/ Corporate			Consolidated
	(in thousands)
Three months ended September 30, 2011
Revenues - external customers
Premiums:
Medicare Advantage	$	4,566,087	$	802,957	$	0	$	0	$	0		$	5,369,044
Medicare stand-alone PDP		578,786		1,910		0		42,524		0			623,220

Total Medicare		5,144,873		804,867		0		42,524		0			5,992,264

Fully-insured		221,632		1,185,285		0		0		0			1,406,917
Specialty		33,149		235,050		0		0		0			268,199
Military services		0		0		0		943,984		0			943,984
Medicaid and other		0		0		0		241,172		0			241,172

Total premiums		5,399,654		2,225,202		0		1,227,680		0			8,852,536

Services revenue:
Provider		0		0		233,608		0		0			233,608
ASO and other		4,597		88,699		0		26,444		0			119,740
Pharmacy		0		0		2,864		0		0			2,864

Total services revenue		4,597		88,699		236,472		26,444		0			356,212

Total revenues - external customers		5,404,251		2,313,901		236,472		1,254,124		0			9,208,748

Intersegment revenues
Services		0		3,715		2,129,915		0		(2,133,630	)		0
Products		0		0		461,213		0		(461,213	)		0

Total intersegment revenues		0		3,715		2,591,128		0		(2,594,843	)		0

Investment income		19,023		11,879		0		14,324		46,669			91,895

Total revenues		5,423,274		2,329,495		2,827,600		1,268,448		(2,548,174	)		9,300,643

Operating expenses:
Benefits		4,249,209		1,856,934		0		1,116,702		(76,315	)		7,146,530
Operating costs		602,878		405,853		2,723,334		121,574		(2,491,982	)		1,361,657
Depreciation and amortization		29,738		20,851		20,701		2,450		(7,069	)		66,671

Total operating expenses		4,881,825		2,283,638		2,744,035		1,240,726		(2,575,366	)		8,574,858

Income from operations		541,449		45,857		83,565		27,722		27,192			725,785
Interest expense		0		0		0		0		27,065			27,065

Income before income taxes	$	541,449	$	45,857	$	83,565	$	27,722	$	127		$	698,720

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited


	Retail		Employer Group		Health and Well-Being Services		Other Businesses		Eliminations/ Corporate			Consolidated
	(in thousands)
Three months ended September 30, 2010
Revenues - external customers
Premiums:
Medicare Advantage	$	4,075,532	$	723,378	$	0	$	0	$	0		$	4,798,910
Medicare stand-alone PDP		504,929		1,153		0		73,501		0			579,583

Total Medicare		4,580,461		724,531		0		73,501		0			5,378,493

Fully-insured		189,503		1,275,945		0		0		0			1,465,448
Specialty		21,663		216,814		0		0		0			238,477
Military services		0		0		0		873,588		0			873,588
Medicaid and other		0		0		0		178,639		0			178,639

Total premiums		4,791,627		2,217,290		0		1,125,728		0			8,134,645

Services revenue:
Provider		0		0		3,815		0		0			3,815
ASO and other		3,116		94,884		0		27,102		0			125,102
Pharmacy		0		0		0		0		0			0

Total services revenue		3,116		94,884		3,815		27,102		0			128,917

Total revenues - external customers		4,794,743		2,312,174		3,815		1,152,830		0			8,263,562

Intersegment revenues
Services		0		3,224		1,843,235		0		(1,846,459	)		0
Products		0		0		342,777		0		(342,777	)		0

Total intersegment revenues		0		3,224		2,186,012		0		(2,189,236	)		0

Investment income		21,265		11,165		0		11,482		43,338			87,250

Total revenues		4,816,008		2,326,563		2,189,827		1,164,312		(2,145,898	)		8,350,812

Operating expenses:
Benefits		3,879,424		1,818,752		0		1,021,082		(77,994	)		6,641,264
Operating costs		461,038		407,117		2,106,079		118,551		(2,090,387	)		1,002,398
Depreciation and amortization		27,625		21,704		8,211		2,664		(1,487	)		58,717

Total operating expenses		4,368,087		2,247,573		2,114,290		1,142,297		(2,169,868	)		7,702,379

Income from operations		447,921		78,990		75,537		22,015		23,970			648,433
Interest expense		0		0		0		0		26,143			26,143

Income (loss) before income taxes	$	447,921	$	78,990	$	75,537	$	22,015	$	(2,173	)	$	622,290

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited


	Retail		Employer Group		Health and Well-Being Services		Other Businesses		Eliminations/ Corporate			Consolidated
	(in thousands)
Nine months ended September 30, 2011
Revenues - external customers
Premiums:
Medicare Advantage	$	13,645,876	$	2,364,306	$	0	$	0	$	0		$	16,010,182
Medicare stand-alone PDP		1,737,603		5,638		0		195,604		0			1,938,845

Total Medicare		15,383,479		2,369,944		0		195,604		0			17,949,027

Fully-insured		628,811		3,600,476		0		0		0			4,229,287
Specialty		88,504		697,934		0		0		0			786,438
Military services		0		0		0		2,801,999		0			2,801,999
Medicaid and other		0		0		0		701,452		0			701,452

Total premiums		16,100,794		6,668,354		0		3,699,055		0			26,468,203

Services revenue:
Provider		0		0		671,055		0		0			671,055
ASO and other		11,364		267,902		0		76,659		0			355,925
Pharmacy		0		0		7,683		0		0			7,683

Total services revenue		11,364		267,902		678,738		76,659		0			1,034,663

Total revenues - external customers		16,112,158		6,936,256		678,738		3,775,714		0			27,502,866

Intersegment revenues
Services		0		10,313		6,324,992		0		(6,335,305	)		0
Products		0		0		1,329,722		0		(1,329,722	)		0

Total intersegment revenues		0		10,313		7,654,714		0		(7,665,027	)		0

Investment income		56,968		35,287		0		39,999		140,372			272,626

Total revenues		16,169,126		6,981,856		8,333,452		3,815,713		(7,524,655	)		27,775,492

Operating expenses:
Benefits		13,193,598		5,408,049		0		3,375,461		(216,056	)		21,761,052
Operating costs		1,625,423		1,216,685		8,004,784		351,145		(7,388,132	)		3,809,905
Depreciation and amortization		88,598		64,101		60,927		6,802		(19,867	)		200,561

Total operating expenses		14,907,619		6,688,835		8,065,711		3,733,408		(7,624,055	)		25,771,518

Income from operations		1,261,507		293,021		267,741		82,305		99,400			2,003,974
Interest expense		0		0		0		0		81,956			81,956

Income before income taxes	$	1,261,507	$	293,021	$	267,741	$	82,305	$	17,444		$	1,922,018

Humana Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Unaudited


	Retail		Employer Group		Health and Well-Being Services		Other Businesses		Eliminations/ Corporate			Consolidated
	(in thousands)
Nine months ended September 30, 2010
Revenues - external customers
Premiums:
Medicare Advantage	$	12,241,366	$	2,259,733	$	0	$	0	$	0		$	14,501,099
Medicare stand-alone PDP		1,512,738		3,443		0		342,649		0			1,858,830

Total Medicare		13,754,104		2,263,176		0		342,649		0			16,359,929

Fully-insured		551,581		3,904,705		0		0		0			4,456,286
Specialty		58,853		663,055		0		0		0			721,908
Military services		0		0		0		2,603,950		0			2,603,950
Medicaid and other		0		0		0		531,186		0			531,186

Total premiums		14,364,538		6,830,936		0		3,477,785		0			24,673,259

Services revenue:
Provider		0		0		9,869		0		0			9,869
ASO and other		8,457		294,241		0		82,072		0			384,770
Pharmacy		0		0		0		0		0			0

Total services revenue		8,457		294,241		9,869		82,072		0			394,639

Total revenues - external customers		14,372,995		7,125,177		9,869		3,559,857		0			25,067,898

Intersegment revenues
Services		0		9,892		5,674,965		0		(5,684,857	)		0
Products		0		0		936,673		0		(936,673	)		0

Total intersegment revenues		0		9,892		6,611,638		0		(6,621,530	)		0

Investment income		62,002		32,412		0		31,363		126,718			252,495

Total revenues		14,434,997		7,167,481		6,621,507		3,591,220		(6,494,812	)		25,320,393

Operating expenses:
Benefits		11,796,751		5,586,593		0		3,125,564		(181,166	)		20,327,742
Operating costs		1,512,779		1,250,446		6,427,167		348,611		(6,382,058	)		3,156,945
Depreciation and amortization		86,826		70,219		19,703		8,684		(3,475	)		181,957

Total operating expenses		13,396,356		6,907,258		6,446,870		3,482,859		(6,566,699	)		23,666,644

Income from operations		1,038,641		260,223		174,637		108,361		71,887			1,653,749
Interest expense		0		0		0		0		78,679			78,679

Income (loss) before income taxes	$	1,038,641	$	260,223	$	174,637	$	108,361	$	(6,792	)	$	1,575,070

Retail segment operating costs for the nine months ended September 30, 2010 include $147.5 million for the write-down of deferred acquisition costs associated with our individual commercial medical policies as discussed more fully in Note 18 to the consolidated financial statements included in our 2010 Form 10-K.

Humana Inc.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The condensed consolidated financial statements of Humana Inc. in this document present the Company’s financial position, results of operations and cash flows, and should be read in conjunction with the following discussion and analysis. References to “we,” “us,” “our,” “Company,” and “Humana” mean Humana Inc. and its subsidiaries. This discussion includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in filings with the SEC, in our press releases, investor presentations, and in oral statements made by or with the approval of one of our executive officers, the words or phrases like “expects,” “anticipates,” “intends,” “likely will result,” “estimates,” “projects” or variations of such words and similar expressions are intended to identify such forward–looking statements. These forward–looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including, among other things, information set forth in Item 1A. – Risk Factors in our 2010 Form 10-K, as modified by any changes to those risk factors included in this document and in other reports we filed subsequent to February 17, 2011, in each case incorporated by reference herein. In making these statements, we are not undertaking to address or update these factors in future filings or communications regarding our business or results. In light of these risks, uncertainties and assumptions, the forward–looking events discussed in this document might not occur. There may also be other risks that we are unable to predict at this time. Any of these risks and uncertainties may cause actual results to differ materially from the results discussed in the forward–looking statements.

Executive Overview

General

Headquartered in Louisville, Kentucky, Humana is a leading health care company that offers a wide range of insurance products and health and wellness services that incorporate an integrated approach to lifelong well-being. By leveraging the strengths of our core businesses, we believe that we can better explore opportunities for existing and emerging adjacencies in health care that can further enhance wellness opportunities for the millions of people across the nation with whom we have relationships.

Our industry relies on two key statistics to measure performance. The benefit ratio, which is computed by taking total benefit expenses as a percentage of premiums revenue, represents a statistic used to measure underwriting profitability. The operating cost ratio, which is computed by taking total operating costs as a percentage of total revenue less investment income, represents a statistic used to measure administrative spending efficiency.

2011 Business Segment Realignment

Business Segments

We currently manage our business with three reportable segments: Retail, Employer Group, and Health and Well-Being Services. In addition, we include other businesses that are not reportable because they do not meet the quantitative thresholds required by generally accepted accounting principles in an Other Businesses category. These segments are based on a combination of the type of health plan customer and adjacent businesses centered on well-being solutions for our health plans and other customers, as described below. These segment groupings are consistent with information used by our Chief Executive Officer to assess performance and allocate resources.

The Retail segment consists of Medicare and commercial fully-insured medical and specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, marketed directly to individuals. The Employer Group segment consists of Medicare and commercial fully-insured medical and

specialty health insurance benefits, including dental, vision, and other supplemental health and financial protection products, as well as administrative services only products marketed to employer groups. The Health and Well-Being Services segment includes services offered to our health plan members as well as to third parties that promote health and wellness, including primary care, pharmacy, integrated wellness, and home care services. The Other Businesses category consists of our Military services, primarily our TRICARE South Region contract, Medicaid, and closed-block long-term care businesses as well as our contract with CMS to administer the LI-NET program.

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

Seasonality

Our Retail segment offers Medicare stand-alone prescription drug plans, or PDPs, under the Medicare Part D program. These plans provide varying degrees of coverage. Our quarterly Retail segment earnings and operating cash flows are impacted by the Medicare Part D benefit design and changes in the composition of our membership. The Medicare Part D benefit design results in coverage that varies as a member’s cumulative out-of-pocket costs pass through successive stages of a member’s plan period which begins annually on January 1 for renewals. These plan designs generally result in us sharing a greater portion of the responsibility for total prescription drug costs in the early stages and less in the latter stages. As a result, the PDP benefit ratio generally decreases as the year progresses. In addition, the number of low-income senior members as well as year-over-year changes in the mix of membership in our stand-alone PDP products affect the quarterly benefit ratio pattern.

2011 Highlights

Consolidated

•

We experienced favorable prior-period medical claims reserve development of approximately $34 million, or $0.13 per diluted common share, for the three months ended September 30, 2011 as compared to $84 million, or $0.31 per diluted common share, for the three months ended September 30, 2010. For the nine months ended September 30, 2011, we experienced favorable prior-period development of approximately $151 million, or $0.57 per diluted common share, compared to $194 million, or $0.72 per diluted common share, for the nine months ended September 30, 2010.

•

In April 2011, our Board of Directors approved the initiation of a quarterly cash dividend policy and we subsequently paid a cash dividend of $0.25 per share to stockholders of record on each of June 30, 2011 and September 30, 2011.

•

In addition, in April 2011, the Board of Directors replaced its previously approved share repurchase authorization of up to $250 million with a new authorization for repurchases of up to $1 billion. The new authorization will expire June 30, 2013. As of October 31, 2011, the remaining authorized amount under the new authorization totaled $561.3 million.

•

Our year-to-date comparisons are impacted by the $147.5 million write-down of deferred acquisition costs associated with our individual commercial medical policies during the nine months ended September 30, 2010 as discussed more fully in Note 18 to the consolidated financial statements included in our 2010 Form 10-K.

Retail

•

On April 4, 2011, CMS announced that Medicare Advantage payment rates will increase on average 0.4% sector-wide in 2012. We believe we effectively designed Medicare Advantage products based upon this level of rate increase while continuing to remain competitive compared to both the combination of original Medicare with a supplement policy as well as other Medicare Advantage competitors within our industry. In addition, we will continue to pursue our cost-reduction and outcome-enhancing strategies, including care coordination and disease management, which we believe will mitigate the adverse effects of the rates on our Medicare Advantage members. Nonetheless, there can be no assurance that we will be able to successfully execute operational and strategic initiatives with respect to changes in the Medicare Advantage program. Failure to execute these strategies may result in a material adverse effect on our results of operations, financial position, and cash flows.

•

Individual Medicare Advantage membership of 1,613,400 at September 30, 2011 increased 152,700 members, or 10.5%, from 1,460,700 at December 31, 2010 and increased 151,200, or 10.3%, from 1,462,200 at September 30, 2010 primarily due to a successful enrollment season associated with the 2011 plan year.

•

Individual Medicare stand-alone PDP membership of 2,478,100 at September 30, 2011 increased 807,800 members, or 48.4%, from 1,670,300 at December 31, 2010 and increased 789,900, or 46.8%, from 1,688,200 at September 30, 2010, primarily due to sales of our new lowest premium national stand-alone Medicare Part D prescription drug plan co-branded with Wal-Mart Stores, Inc., the Humana Walmart-Preferred Rx Plan, that we began offering for the 2011 plan year.

•

Our year-to-date Retail segment comparisons are impacted by the $147.5 million write-down of deferred acquisition costs associated with our individual commercial medical policies during the nine months ended September 30, 2010 as discussed above.

•

During the third quarter of 2011, we entered into definitive agreements to acquire the California-based Medicare Advantage health maintenance organizations (HMO) Arcadian Management Services, Inc. and MD Care, Inc. These companies, on a combined basis, serve approximately 79,000 Medicare Advantage HMO members in 15 U.S. states, and offer us an opportunity to expand our Medicare footprint and grow our Medicare enrollment. The closings of these acquisitions are subject to federal and/or state regulatory approvals.

Other Businesses

•

As more fully discussed in Note 12 to the condensed consolidated financial statements, on February 25, 2011, the TMA awarded the TRICARE South Region contract to us. On March 7, 2011, the competing bidder filed a protest of the award with the GAO. Also on March 7, 2011, as provided in the Federal Acquisition Regulations, TMA issued a stop work order to us in connection with the award. On June 14, 2011, the GAO upheld the award of the contract to us and TMA subsequently lifted the stop work order. On June 21, 2011, the competing bidder filed a complaint in the United States Court of Federal Claims objecting to the award of the contract to us. On October 14, 2011, the Court upheld the award of the contract to us, and the competing bidder has until December 13, 2011 to appeal it in the Court of Appeals for the Federal Circuit. As a result of the award of the TRICARE South Region contract to us, we no longer expect a goodwill impairment to occur during the second half of 2011. Ultimate disposition of the contract award is, however, subject to the resolution of any additional actions the unsuccessful bidder may take.

Health Insurance Reform

In March 2010, the President signed into law The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the Health Insurance Reform Legislation) which enact significant reforms to various aspects of the U.S. health insurance industry. While regulations and interpretive guidance on some provisions of the Health Insurance Reform Legislation have been issued to date by the Department of Health and Human Services (HHS), the Department of Labor, the Treasury Department, and the National Association of Insurance Commissioners, there are many significant provisions of the legislation that will require additional guidance and clarification in the form of regulations and interpretations in order to fully understand the impacts of the legislation on our overall business, which we expect to occur over the next several years.

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

•

Changes effective for plan years beginning on or after September 23, 2010 included: elimination of pre-existing condition limits for enrollees under age 19, elimination of certain annual and lifetime caps on the dollar value of benefits, expansion of dependent coverage to include adult children until age 26, a requirement to provide coverage for preventive services without cost to members, new claim appeal requirements, and the establishment of an interim high risk program for those unable to obtain coverage due to a pre-existing condition or health status.

•

Effective January 1, 2011, minimum benefit ratios were mandated for all commercial fully-insured medical plans in the large group (85%), small group (80%), and individual (80%) markets, with annual rebates to policyholders if the actual benefit ratios, calculated in a manner prescribed by HHS, do not meet these minimums. Beginning in 2011, we accrued for rebates, based on the manner prescribed by HHS, with initial rebate payments to be made in mid-2012. Our benefit ratios reported herein, calculated from financial statements prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, differ from the benefit ratios calculated as prescribed by HHS under the Health Insurance Reform Legislation. The more noteworthy differences include the fact that the benefit ratio calculations prescribed by HHS are calculated separately by state and legal entity; reflect actuarial adjustments where the membership levels are not large enough to create credible size; exclude some of our health insurance products; include taxes and fees as reductions of premium; treat changes in reserves differently than GAAP; and classify rebate amounts as additions to incurred claims as opposed to adjustments to premiums for GAAP reporting.

•

Medicare Advantage payment benchmarks for 2011 were frozen at 2010 levels and beginning in 2012, additional cuts to Medicare Advantage plan payments will begin to take effect (plans will receive a range of 95% in high-cost areas to 115% in low-cost areas of Medicare fee-for-service rates), with changes being phased-in over two to six years, depending on the level of payment reduction in a county. In addition, beginning in 2011, the gap in coverage for Medicare Part D prescription drug coverage has begun to incrementally close.

•

Beginning in 2014, the Health Insurance Reform Legislation requires: all individual and group health plans to guarantee issuance and renew coverage without pre-existing condition exclusions or health-status rating adjustments; the elimination of annual limits on coverage on certain plans; the establishment of state-based exchanges for individuals and small employers (with up to 100 employees); the introduction of standardized plan designs based on set actuarial values; the establishment of a minimum benefit ratio of 85% for Medicare Advantage plans; and insurance industry assessments, including an annual premium-based assessment ($8 billion levied on the insurance industry in 2014 with increasing annual amounts thereafter), which is not deductible for income tax purposes.

The Health Insurance Reform Legislation also specifies required benefit designs, limits rating and pricing practices, encourages additional competition (including potential incentives for new market entrants) and expands eligibility for Medicaid programs. In addition, the law will significantly increase federal oversight of health plan premium rates and could adversely affect our ability to appropriately adjust health plan premiums on a timely basis. Financing for these reforms will come, in part, from material additional fees and taxes on us and other health insurers, health plans and individuals beginning in 2014, as well as reductions in certain levels of payments to us and other health plans under Medicare as described above.

In addition, certain provisions in the Health Insurance Reform Legislation tie Medicare Advantage premiums to the achievement of certain quality performance measures (Star Ratings). Beginning in 2012, Medicare Advantage plans with an overall Star Rating of three or more stars (out of five) will be eligible for a quality bonus in their basic premium rates. Initially quality bonuses were limited to the few plans that achieved four or more stars as an overall rating, but CMS has expanded the quality bonus to three Star plans for a three year period through 2014.

Notwithstanding successful efforts to improve our Star Ratings and other quality measures for 2012 and 2013 and the continuation of such efforts, there can be no assurances that we will be successful in maintaining or improving our Star Ratings in future years. Accordingly, our plans may not be eligible for full level quality bonuses, which could adversely affect the benefits such plans can offer, reduce membership and/or reduce profit margins.

As discussed above, implementing regulations and related interpretive guidance continue to be issued on several significant provisions of the Health Insurance Reform Legislation, and certain aspects of the Health Insurance Reform Legislation are also being challenged in federal court, seeking to limit the scope of or have all or portions of the Health Insurance Reform Legislation declared unconstitutional. Judicial proceedings are subject to appeal and could last for an extended period of time, and we cannot predict the results of any of these proceedings. Congress may also withhold the funding necessary to implement the Health Insurance Reform Legislation, or may attempt to replace the legislation with amended provisions or repeal it altogether. Given the breadth of possible changes and the uncertainties of interpretation, implementation, and timing of these changes, which we expect to occur over the next several years, the Health Insurance Reform Legislation could change the way we do business, potentially impacting our pricing, benefit design, product mix, geographic mix, and distribution channels. The response of other companies to the Health Insurance Reform Legislation and adjustments to their offerings, if any, could cause meaningful disruption in the local health care markets. Further, various health insurance reform proposals are also emerging at the state level. It is reasonably possible that the Health Insurance Reform Legislation and related regulations, as well as future legislative changes, in the aggregate may have a material adverse effect on our results of operations, including restricting revenue, enrollment and premium growth in certain products and market segments, restricting our ability to expand into new markets, increasing our medical and administrative costs, lowering our Medicare payment rates and increasing our expenses associated with the non-deductible federal premium tax and other assessments; our financial position, including our ability to maintain the value of our goodwill; and our cash flows. If the new non-deductible federal premium tax is imposed as enacted, and if we are unable to adjust our business model to address this new tax, there can be no assurance that the non-deductible federal premium tax would not have a material adverse effect on our results of operations, financial position, and cash flows.

We intend for the discussion of our financial condition and results of operations that follows to assist in the understanding of our financial statements and related changes in certain key items in those financial statements from year to year, including the primary factors that accounted for those changes.

Comparison of Results of Operations for 2011 and 2010

The following discussion primarily deals with our results of operations for the three months ended September 30, 2011, or the 2011 quarter, the three months ended September 30, 2010, or the 2010 quarter, the nine months ended September 30, 2011, or the 2011 period, and the nine months ended September 30, 2010, or the 2010 period.

Consolidated


	For the three months ended September 30,						Change
	2011			2010			Dollars			Percentage
	(dollars in thousands)
Revenues:
Premiums:
Retail	$	5,399,654		$	4,791,627		$	608,027			12.7	%
Employer Group		2,225,202			2,217,290			7,912			0.4	%
Other Businesses		1,227,680			1,125,728			101,952			9.1	%

Total premiums		8,852,536			8,134,645			717,891			8.8	%

Services:
Retail		4,597			3,116			1,481			47.5	%
Employer Group		88,699			94,884			(6,185	)		(6.5	)%
Health and Well-Being Services		236,472			3,815			232,657			nm
Other Businesses		26,444			27,102			(658	)		(2.4	)%

Total services		356,212			128,917			227,295			176.3	%

Investment income		91,895			87,250			4,645			5.3	%

Total revenues		9,300,643			8,350,812			949,831			11.4	%

Operating expenses:
Benefits		7,146,530			6,641,264			505,266			7.6	%
Operating costs		1,361,657			1,002,398			359,259			35.8	%
Depreciation and amortization		66,671			58,717			7,954			13.5	%

Total operating expenses		8,574,858			7,702,379			872,479			11.3	%

Income from operations		725,785			648,433			77,352			11.9	%
Interest expense		27,065			26,143			922			3.5	%

Income before income taxes		698,720			622,290			76,430			12.3	%
Provision for income taxes		253,960			229,069			24,891			10.9	%

Net income	$	444,760		$	393,221		$	51,539			13.1	%

Diluted earnings per common share	$	2.67		$	2.32		$	0.35			15.1	%
Benefit ratio(a)		80.7	%		81.6	%					(0.9	)%
Operating cost ratio(b)		14.8	%		12.1	%					2.7	%
Effective tax rate		36.3	%		36.8	%					(0.5	)%


	For the nine months ended September 30,						Change
	2011			2010			Dollars			Percentage
	(dollars in thousands)
Revenues:
Premiums:
Retail	$	16,100,794		$	14,364,538		$	1,736,256			12.1	%
Employer Group		6,668,354			6,830,936			(162,582	)		(2.4	)%
Other Businesses		3,699,055			3,477,785			221,270			6.4	%

Total premiums		26,468,203			24,673,259			1,794,944			7.3	%

Services:
Retail		11,364			8,457			2,907			34.4	%
Employer Group		267,902			294,241			(26,339	)		(9.0	)%
Health and Well-Being Services		678,738			9,869			668,869			nm
Other Businesses		76,659			82,072			(5,413	)		(6.6	)%

Total services		1,034,663			394,639			640,024			162.2	%

Investment income		272,626			252,495			20,131			8.0	%

Total revenues		27,775,492			25,320,393			2,455,099			9.7	%

Operating expenses:
Benefits		21,761,052			20,327,742			1,433,310			7.1	%
Operating costs		3,809,905			3,156,945			652,960			20.7	%
Depreciation and amortization		200,561			181,957			18,604			10.2	%

Total operating expenses		25,771,518			23,666,644			2,104,874			8.9	%

Income from operations		2,003,974			1,653,749			350,225			21.2	%
Interest expense		81,956			78,679			3,277			4.2	%

Income before income taxes		1,922,018			1,575,070			346,948			22.0	%
Provision for income taxes		701,795			583,005			118,790			20.4	%

Net income	$	1,220,223		$	992,065		$	228,158			23.0	%

Diluted earnings per common share	$	7.24		$	5.84		$	1.40			24.0	%
Benefit ratio(a)		82.2	%		82.4	%					(0.2	)%
Operating cost ratio(b)		13.9	%		12.6	%					1.3	%
Effective tax rate		36.5	%		37.0	%					(0.5	)%

(a)	Represents total benefit expenses as a percentage of premium revenues.

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

nm – not meaningful

Summary

Net income was $444.8 million, or $2.67 per diluted common share, in the 2011 quarter compared to $393.2 million, or $2.32 per diluted common share, in the 2010 quarter. Net income was $1.2 billion, or $7.24 per diluted common share, in the 2011 period compared to $992.1 million, or $5.84 per diluted common share, in the 2010 period. The increases during the 2011 quarter and period primarily were due to improved operating performance in the Retail and Health and Well-Being Services segments. Our diluted earnings per common share include the beneficial impact of favorable prior-period medical claims reserve development of approximately $0.13 per diluted common share for the 2011 quarter compared to $0.31 per diluted common share for the 2010 quarter and $0.57 per diluted common share for the 2011 period compared to $0.72 per diluted common share for the 2010 period. Net income for the 2010 period also included the negative impact of a $147.5 million ($0.55 per diluted common share) write-down of deferred acquisition costs associated with our individual commercial medical policies in our Retail Segment.

Premiums

Consolidated premiums increased $717.9 million, or 8.8%, from the 2010 quarter to $8.9 billion for the 2011 quarter, and increased $1.8 billion, or 7.3%, from the 2010 period to $26.5 billion for the 2011 period. The increases primarily were due to a $608.0 million, or 12.7%, and $1.7 billion, or 12.1%, year-over-year increase in Retail segment premiums for the 2011 quarter and period, respectively, partially offset by a decline in Employer Group segment premiums in the 2011 period. The increase in Retail segment premiums primarily resulted from higher average individual Medicare Advantage membership. The decrease in Employer Group segment premiums primarily resulted from lower average fully-insured commercial group medical membership. Average membership is calculated by summing the ending membership for each month in a period and dividing the result by the number of months in a period.

Services Revenue

Consolidated services revenue increased $227.3 million from the 2010 quarter to $356.2 million for the 2011 quarter. For the 2011 period, services revenue was $1.0 billion, an increase of $640.0 million, or 162.2%, compared to the 2010 period. The increases during the 2011 quarter and period were primarily the result of the increase in primary care services revenue in our Health and Well-Being Services segment, primarily as a result of the acquisition of Concentra on December 21, 2010.

Investment Income

Investment income totaled $91.9 million for the 2011 quarter, an increase of $4.6 million from the 2010 quarter, primarily due to higher interest rates. For the 2011 period, investment income totaled $272.6 million, an increase of $20.1 million from the 2010 period primarily reflecting higher interest rates as well as higher average invested balances as a result of the reinvestment of operating cash flow.

Benefit Expenses

Consolidated benefit expenses were $7.1 billion for the 2011 quarter, an increase of $505.3 million, or 7.6%, from the 2010 quarter. For the 2011 period, consolidated benefit expenses increased by $1.4 billion, or 7.1%, from the 2010 period to $21.8 billion. The increases were primarily due to a $369.8 million, or 9.5%, and $1.4 billion, or 11.8%, year-over-year increase in Retail segment benefit expenses in the 2011 quarter and period, respectively, primarily driven by an increase in the average number of Medicare members.

The consolidated benefit ratio was 80.7% for the 2011 quarter, decreasing 90 basis points from the 2010 period, and 82.2% for the 2011 period, decreasing 20 basis points from the comparable 2010 period primarily driven by a decline in the Retail segment benefit ratio, particularly for our individual Medicare Advantage products, partially offset by lower favorable prior-period medical claims reserve development in the 2011 quarter and period than in the 2010 quarter and period on a consolidated basis.

Operating Costs

Our segments incur both direct and shared indirect operating costs. We allocate the indirect costs shared by the segments primarily as a function of revenues. As a result, the profitability of each segment is interdependent.

Consolidated operating costs increased $359.3 million, or 35.8%, during the 2011 quarter compared to the 2010 quarter. For the 2011 period, consolidated operating costs increased $653.0 million, or 20.7%, compared to the 2010 period. The increases primarily were due to an increase in operating costs in our Health and Well-Being Segment as a result of the acquisition of Concentra on December 21, 2010, as well as an increase in operating costs in our Retail segment as a result of increased expenses associated with the Medicare sales season for 2012 offerings which began a month earlier than in the prior year. The 2010 period includes $147.5 million of operating costs for the write-down of deferred acquisition costs associated with our individual commercial medical policies in our Retail Segment.

The consolidated operating cost ratio for the 2011 quarter was 14.8%, an increase of 270 basis points from the 2010 quarter. For the 2011 period, the consolidated operating cost ratio was 13.9%, a 130 basis point increase from the 2010 period. The $147.5 million write-down of deferred acquisition costs in the 2010 period increased the operating cost ratio 60 basis points for the 2010 period. Excluding the impact of the write-down of deferred acquisition costs in 2010, the increases primarily reflect the greater percentage of our revenues derived from Concentra, acquired December 21, 2010, in our Health and Well-Being Services segment, which carries a higher operating cost ratio on external revenues than our other business segments, as well as an increase in the Retail segment operating cost ratio.

Depreciation and Amortization

Depreciation and amortization for the 2011 quarter totaled $66.7 million, an increase of $8.0 million, or 13.5%, from the 2010 quarter. Depreciation and amortization for the 2011 period totaled $200.6 million, an increase of $18.6 million or 10.2% from the 2010 period. The increases primarily reflect depreciation and amortization expense associated with our Concentra operations, acquired on December 21, 2010.

Interest Expense

Interest expense was $27.1 million for the 2011 quarter, increasing $0.9 million, or 3.5% from the 2010 quarter, and $82.0 million for the 2011 period, increasing $3.3 million, or 4.2%, from the 2010 period.

Income Taxes

Our effective tax rate during the 2011 quarter was 36.3% compared to the effective tax rate of 36.8% in the 2010 quarter. The effective tax rate for the 2011 period of 36.5% declined from 37.0% for the 2010 period. The higher tax rate for the 2010 period primarily was due to the cumulative adjustment associated with estimating the retrospective aspect of new limitations on the deductibility of annual compensation in excess of $500,000 per employee as mandated by the Health Insurance Reform Legislation.

Retail Segment

		$0,000,000		$0,000,000		$0,000,000		$0,000,000
	September 30,				Change
	2011		2010		Members		Percentage
Membership:
Medical membership:
Individual Medicare Advantage		1,613,400		1,462,200		151,200		10.3	%
Individual Medicare stand-alone PDP		2,478,100		1,688,200		789,900		46.8	%

Total individual Medicare		4,091,500		3,150,400		941,100		29.9	%
Individual commercial		480,700		412,700		68,000		16.5	%

Total medical members		4,572,200		3,563,100		1,009,100		28.3	%

Individual specialty membership(a)		755,600		487,000		268,600		55.2	%

(a)	Specialty products include dental, vision, and other supplemental health and financial protection products. Members included in these products may not be unique to each product since members have the ability to enroll in multiple products.


	For the three months ended September 30,				Change
	2011		2010		Dollars		Percentage
	(in thousands)
Premiums and Services Revenue:
Premiums:
Individual Medicare Advantage	$	4,566,087	$	4,075,532	$	490,555		12.0	%
Individual Medicare stand-alone PDP		578,786		504,929		73,857		14.6	%

Total individual Medicare		5,144,873		4,580,461		564,412		12.3	%
Individual commercial		221,632		189,503		32,129		17.0	%
Individual specialty		33,149		21,663		11,486		53.0	%

Total premiums		5,399,654		4,791,627		608,027		12.7	%

Services		4,597		3,116		1,481		47.5	%

Total premiums and services revenue	$	5,404,251	$	4,794,743	$	609,508		12.7	%

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company