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UNITEDHEALTH GROUP INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read together with the accompanying Condensed Consolidated Financial Statements and Notes and with our 2013 10-K, including the Consolidated Financial Statements and Notes in Item II, Part 8, "Financial Statements" in that report. References to the terms "UnitedHealth Group," "we," "our" or "us" used throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations refer to UnitedHealth Group Incorporated and its consolidated subsidiaries. Readers are cautioned that the statements, estimates, projections or outlook contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations, including discussions regarding financial prospects, economic conditions, trends and uncertainties contained in this Item 2, may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (PSLRA). These forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the results discussed or implied in the forward-looking statements. A description of some of the risks and uncertainties is set forth in Part I, Item 1A, "Risk Factors" in our 2013 10-K and in the discussion below. EXECUTIVE OVERVIEW General UnitedHealth Group is a diversified health and well-being company dedicated to helping people live healthier lives and making health care work better. We offer a broad spectrum of products and services through two distinct platforms: UnitedHealthcare, which provides health care coverage and benefits services; and Optum, which provides information and technology-enabled health services. Further information on our business is included in Part I, Item 1, "Business" in our 2013 10-K and additional information on our segments can be found in this Item 2 and in Note 10 of Notes to the Condensed Consolidated Financial Statements in Part I, Item 1 of this report. Business Trends Our businesses participate in the U.S., Brazilian and certain other international health economies. In the United States, health care spending comprises approximately 18% of gross domestic product and has grown consistently for many years. We expect overall spending on health care to continue to grow in the future, due to inflation, medical technology and pharmaceutical advancement, regulatory requirements, demographic trends in the population and national interest in health and well-being. The rate of market growth may be affected by a variety of factors, including macro-economic conditions and regulatory changes, including enacted health care reforms in the United States, which have impacted and could further impact our results of operations. Pricing Trends. We seek to price our health care benefit products consistent with anticipated underlying medical trends, while balancing growth, margins, and competitive dynamics (such as product positioning and price competitiveness) and legislative and regulatory changes (such as cost increases for the Industry Tax provisions of Health Reform Legislation). Overall, we continue to be under pressure from ongoing market competition in commercial products and from government payment rates. The intensity of commercial pricing competition depends on local market conditions and competitive dynamics. Health plans have generally reflected the 2014 Industry Tax and Reinsurance Programs (together, ACA Fees) in their pricing. Conversely, the industry has experienced lower medical cost trends due to moderated utilization, which has impacted pricing trends. We have seen intensified competitive pricing in several local markets recently, including for small group customers in a large market for us. If these trends continue, we could see further declines in commercial, off exchange risk-based membership. Annual commercial premium rate increases are subject to federal and state review and approval procedures. While our rates and rate filings are developed using methods consistent with the standards of actuarial practice, we have experienced regulatory challenges to proposed premium rate increases in certain states, including California and New York. The Medicare Advantage rate structure is changing and funding has been cut in recent years, including in 2014, with additional reductions to take effect in 2015, as discussed below in "Regulatory Trends and Uncertainties." We are taking actions to respond to these funding reductions, but the reductions have adversely affected after-tax earnings for our Medicare business during the first three quarters of 2014, an impact that we expect will continue during the balance of 2014 and into 2015. Although we expect continued Medicaid revenue increases due to anticipated growth in our offerings, we also believe that the reimbursement rate environment creates the risk of downward pressure on Medicaid net margin percentages. We continue to work with our state customers to advocate for actuarially sound rates that are commensurate with our medical cost trends, 24-------------------------------------------------------------------------------- Table of Contents including fees and related taxes, and to take a prudent, market-sustainable posture for both new bids and maintenance of existing Medicaid contracts. Medical Cost Trends. Our medical cost trends are primarily related to unit costs, utilization and prescription drug costs. Consistent with our experience in recent years, our 2014 cost trends are largely driven by continued unit cost pressure from health care providers. Although the weak economic environment combined with our medical cost management strategies has had a favorable impact on utilization trends in recent years, the impact of Health Reform Legislation and mandates in 2014 is exerting upward pressure on medical cost trends. Driving the increases are mandated essential health benefits and limits on out-of-pocket maximums. The primary drivers of prescription drug trends continue to be unit cost pressure on brand name drugs and a shift towards expensive new specialty medications, including new hepatitis C therapies. Delivery System and Payment Modernization. The health care market is changing based on demographic shifts, new regulations, political forces and both payer and patient expectations. Health plans and care providers are being called upon to work together to close gaps in care and enhance overall care for people, improve the health of populations and reduce costs. Delivery system modernization and payment reform are critical and the alignment of incentives between key constituents remains an important theme. We are increasingly rewarding care providers for delivering improvements in quality and cost-efficiency. As of September 30, 2014, we served nearly 3 million people through the most progressive of these arrangements, including full-risk, shared-risk and bundled episode-of-care payment approaches. As of September 30, 2014, our contracts with value based spending total nearly $35 billion annually, up significantly from recent years. This trend is creating needs for health management services that can coordinate care around the primary care physician, including new primary care channels, and for investments in new clinical and administrative information and management systems, which we believe will provide growth opportunities for our Optum business platform. Regulatory Trends and Uncertainties Following is a summary of management's view of the trends and uncertainties related to some of the key provisions of Health Reform Legislation and other regulatory items. For additional information regarding Health Reform Legislation and regulatory trends and uncertainties, see Part I, Item 1 "Business - Government Regulation" and Item 1A, "Risk Factors" in our 2013 10-K. Medicare Advantage Rates and Minimum Loss Ratios. Medicare Advantage rates have been cut over the last several years, including in 2014, with additional funding reductions to be phased-in through 2017 as a result of (a) changes to CMS Medicare Advantage benchmark rates; (b) Health Reform Legislation; and (c) the Budget Control Act of 2011, as amended by the American Taxpayer Relief Act of 2012, which reduced Medicare Advantage and Medicare Part D payments, beginning April 1, 2013 (Sequestration). The CMS final notice of 2015 Medicare Advantage benchmark rates and payment policies includes additional significant reductions for 2015. These industry level reductions, including the impact of the Industry Tax described below, are expected to result in revenue reductions and incremental assessments totaling more than 6% of revenue in 2014 and more than an additional 3% in 2015, against a typical industry forward medical cost trend of 3%. The impact of these cuts to our Medicare Advantage revenues is partially mitigated by reductions in provider reimbursements for those care providers with rates indexed to Medicare Advantage revenues or Medicare fee-for-service reimbursement rates. Compared to 2013, and prior to any efforts to mitigate these funding reductions, we estimate that the net impact of these reductions and the Industry Tax on our full-year 2014 consolidated net earnings will be more than $1.3 billion. These factors affected our plan benefit designs, market participation, growth prospects and earnings for our Medicare Advantage plans in 2014. Although, since the beginning of 2014, Medicare Advantage and Medicare Part D plans have been required to have minimum medical loss ratios (MLRs) of 85%, the minimum MLR standard has not had a material impact on our consolidated financial results. Health Reform Legislation directed HHS to establish a program to reward high-quality Medicare Advantage plans beginning in 2012. Our Medicare Advantage rates are currently enhanced by CMS quality bonuses in certain counties based on our local plans' star ratings. The level of star ratings from CMS, based upon specified clinical and operational performance standards, will impact future quality bonuses. In addition, star ratings affect the amount of savings a plan has to generate to offer supplemental benefits, which ultimately may affect the plan's membership and revenue. The current expanded star bonus program that pays bonuses to qualifying plans rated 3 stars or higher expires after 2014. In 2015, quality bonus payments will be paid only to 4 and 5 star plans. For the 2015 payment year, we expect more than 37% of our Medicare Advantage members to be enrolled in plans that will be rated 4 stars or higher. We currently expect a similar percentage of members to be enrolled in such plans for the 2016 payment year. We are dedicating substantial resources to advance our quality scores and star ratings to strengthen our local market programs and further improve our performance for the 2017 and 2018 payment years. The ongoing reductions to Medicare Advantage funding place continued importance on effective medical management and ongoing improvements in administrative efficiency. There are a number of adjustments we have made to partially offset these 25-------------------------------------------------------------------------------- Table of Contents rate reductions. These adjustments will impact the majority of the seniors we serve through Medicare Advantage. For example, we seek to intensify our medical and operating cost management, make changes to the size and composition of our care provider networks, adjust members' benefits, implement or increase member premiums over and above the monthly payments we receive from the government, and decide on a county-by-county basis where we will offer Medicare Advantage plans. The depth of the underfunding of these benefits caused us to exit certain plans and market areas for 2014. In other markets, we may experience a reduction in membership in the plans with the greatest changes to premiums and benefits, but we expect stable or growing membership in our strongest markets. In the longer term, we also may be able to mitigate some of the effects of reduced funding by increasing enrollment due, in part, to the increasing number of people eligible for Medicare in coming years. As Medicare Advantage reimbursement changes, other products may become relatively more attractive to Medicare beneficiaries increasing the demand for other senior health benefits products such as our market-leading Medicare Supplement and stand-alone Medicare Part D insurance offerings. Industry Tax and Premium Stabilization Programs. Health Reform Legislation includes an Industry Tax levied proportionally across the health insurance industry for risk-based products, which began January 1, 2014. The industry-wide amount of the annual tax is $8 billion in 2014, $11.3 billion in 2015 and 2016, $13.9 billion in 2017 and $14.3 billion in 2018. For 2019 and beyond, the amount will equal the annual tax for the preceding year increased by the rate of premium growth for the preceding year. With the introduction of state health insurance exchanges and other significant market reforms in the individual and small group markets in 2014, Health Reform Legislation includes three programs designed to stabilize the health insurance markets. These programs encompass: a Reinsurance Program; a temporary risk corridors program; and a permanent risk adjustment program. The Reinsurance Program is a temporary program that will be funded on a per capita basis from all commercial lines of business including insured and self-funded arrangements. The total three year amount of $25 billion for the Reinsurance Program will be allocated as follows: $20 billion, subject to increases based on state decisions, to fund the reinsurance pool and $5 billion to fund the U.S. Treasury. While funding for the Reinsurance Program will come from all commercial lines of business, only market reform compliant individual business will be eligible for reinsurance recoveries. In September 2014, we paid $1.3 billion for our share of the Industry Tax, which we began expensing ratably throughout the year on January 1, 2014. Because this tax is not deductible, we estimate a significant increase of approximately 500 basis points (bps) in our 2014 effective income tax rate. We estimate that the full-year 2014 expense from tax deductible contributions to the Reinsurance Program will be approximately $0.5 billion in 2014, payable in 2015. We do not expect material payments or receipts related to the temporary risk corridors program, permanent risk adjustment program or reinsurance recoveries in 2014. To the extent possible, we include the reform fees and related tax impacts in our pricing, which is expected to result in approximately $1.5 billion of additional annual premiums in 2014. Since the ACA Fees are included in operating costs, we expect our medical care ratio to decrease in 2014 compared to historical results; the cost of these fees is factored in, however, when calculating minimum MLR rebates. For detail on the Industry Tax and Premium Stabilization Programs, see Note 1 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report. Exchanges and Coverage Expansion. Across markets, we and our competitors are adapting product, network and marketing strategies to anticipate new or expanding distribution channels including public exchanges, private exchanges and off exchange purchasing. Effective in 2014, states have either created their own public exchange, entered a partnership exchange or relied on the federally facilitated exchange for individuals and small employers. The exchanges have created new market dynamics that have impacted and could further impact our existing businesses, depending on the ultimate member migration patterns for each market, the pace of migration in the market and the impact of the migration on our established membership. For example, over time certain employers may no longer offer health benefits to their employees and some employers purchasing full-risk products could convert to self-funded programs. Conversely, in private exchanges, some employers may convert from self-funded programs to full-risk products. Our level of participation in public exchanges is determined on a state-by-state basis. Each state is evaluated based on factors such as growth opportunities, our current local presence, our competitive positioning, our ability to honor our commitments to our local customers and consumers, and the regulatory environment. In 2014, we are participating in 13 exchanges, including four individual and nine small group exchanges. In 2015, we plan to participate in nearly two dozen individual exchanges and in 12 small group exchanges. Health Reform Legislation, as interpreted by the U.S. Supreme Court, also provides for optional expanded Medicaid coverage that became effective in January 2014. We participate in programs in 24 states and the District of Columbia, and of these, 12 states opted to expand Medicaid for 2014. The Congressional Budget Office forecasts that 12 million people will obtain coverage through Medicaid by the end of 2016, and we endeavor to build market share serving the needs of these beneficiaries and their state sponsors. 26-------------------------------------------------------------------------------- Table of Contents Individual and Small Group Market Reforms. Health Reform Legislation includes several provisions, for most individual and small group plans with plan years that began on January 1, 2014, that have altered the individual and small group marketplace, including, among other matters: (a) adjusted community rating requirements, which change how individual and small group plans are priced in many states; (b) essential health benefit requirements that result in benefit changes for many individual and small group policyholders; (c) actuarial value requirements, which significantly impact benefit designs in the individual market, such as member cost sharing requirements; and (d) guaranteed issue requirements that obligate carriers to provide coverage to any qualified group or individual. These changes resulted in significant benefit design and pricing changes for a substantial portion of the fully insured individual and small group markets and a reduction in the number of states in which we offer policies to new individual customers. Additionally, states were granted the authority to allow eligible individuals and small businesses to renew non-ACA compliant plans, in some cases through October 2017. RESULTS SUMMARY The following table summarizes our consolidated results of operations and other financial information: (in millions, Nine Months Ended except percentages Three Months Ended September 30, Increase/(Decrease) September 30, Increase/(Decrease) and per share data) 2014 2013 2014 vs. 2013 2014 2013 2014 vs. 2013 Revenues: Premiums $ 28,972 $ 27,356 $ 1,616 6 % $ 85,927 $ 81,850 $ 4,077 5 % Services 2,535 2,280 255 11 7,386 6,636 750 11 Products 1,080 825 255 31 3,115 2,325 790 34 Investment and other income 172 163 9 6 613 561 52 9 Total revenues 32,759 30,624 2,135 7 97,041 91,372 5,669 6 Operating costs: Medical costs 23,092 22,044 1,048 5 69,823 66,786 3,037 5 Operating costs 5,436 4,869 567 12 15,836 14,308 1,528 11 Cost of products sold 955 731 224 31 2,776 2,082 694 33 Depreciation and amortization 373 349 24 7 1,097 1,025 72 7 Total operating costs 29,856 27,993 1,863 7 89,532 84,201 5,331 6 Earnings from operations 2,903 2,631 272 10 7,509 7,171 338 5 Interest expense (152 ) (178 ) (26 ) (15 ) (467 ) (532 ) (65 ) (12 ) Earnings before income taxes 2,751 2,453 298 12 7,042 6,639 403 6 Provision for income taxes (1,149 ) (883 ) 266 30 (2,933 ) (2,393 ) 540 23 Net earnings 1,602 1,570 32 2 4,109 4,246 (137 ) (3 ) Earnings attributable to noncontrolling interests - - - nm - (48 ) (48 ) nm Net earnings attributable to UnitedHealth Group common shareholders $ 1,602 $ 1,570 $ 32 2 % $ 4,109 $ 4,198 $ (89 ) (2 )% Diluted earnings per share attributable to UnitedHealth Group common shareholders $ 1.63 $ 1.53 $ 0.10 7 % $ 4.15 $ 4.09 $ 0.06 1 % Medical care ratio (a) 79.7 % 80.6 % (0.9 )% 81.3 % 81.6 % (0.3 )% Operating cost ratio 16.6 15.9 0.7 16.3 15.7 0.6 Operating margin 8.9 8.6 0.3 7.7 7.8 (0.1 ) Tax rate 41.8 36.0 5.8 41.7 36.0 5.7 Net earnings margin 4.9 5.1 (0.2 ) 4.2 4.6 (0.4 ) Return on equity (b) 19.6 % 19.8 % (0.2 )% 16.8 % 17.7 % (0.9 )% nm= not meaningful (a) Medical care ratio is calculated as medical costs divided by premium revenue. (b) Return on equity is calculated as annualized net earnings divided by average equity. Average equity is calculated using the equity balance at the end of the preceding year and the equity balances at the end of each of the quarters in the periods presented. 27-------------------------------------------------------------------------------- Table of Contents SELECTED OPERATING PERFORMANCE AND OTHER SIGNIFICANT ITEMS The following represents a summary of select third quarter 2014 year-over-year operating comparisons to 2013 and other 2014 significant items. • Consolidated revenues increased by 7%, Optum revenues grew 21% and UnitedHealthcare revenues increased 6%. • ACA Fees have favorably affected our 2014 medical care ratio (110 bps), and unfavorably impacted our operating cost ratio (120 bps) and effective income tax rate (5%). • Earnings from operations increased by 10%, including an increase of 27% at Optum and 5% at UnitedHealthcare. • Earnings per share to UnitedHealth Group shareholders increased 7% to $1.63 and included the negative year-over-year per share impact of $0.25 in ACA Fees, ACA Medicare rate cuts and other ACA impacts. • As of September 30, 2014, there was $1.0 billion of cash available for general corporate use and year-to-date 2014 cash flows from operations were $5.6 billion. 2014 RESULTS OF OPERATIONS COMPARED TO 2013 RESULTS Consolidated Financial Results Revenues The increases in revenues during the three and nine months ended September 30, 2014 were primarily driven by growth in the number of individuals served in our public and senior markets businesses and pharmacy services growth at Optum. Medical Costs and Medical Care Ratio Medical costs during the three and nine months ended September 30, 2014 increased due to risk-based membership growth in our public and senior markets businesses. The impact of billing the ACA Fees decreased the medical care ratio for the three and nine months ended September 30, 2014 compared to 2013. The nine month medical care ratio decrease was partially offset by the impact of lower levels of favorable medical cost reserve development. Operating Cost Ratio The increase in our operating cost ratio during the three and nine months ended September 30, 2014 was due to the introduction of ACA Fees and specific investments in Optum growth platforms, partially offset by productivity and operating performance gains. Income Tax Rate The increase in our income tax rate resulted primarily from the nondeductible Industry Tax. See Note 1 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1, and "Industry Tax and Premium Stabilization Programs" in the "Executive Overview" above for more information on ACA Fees. 28-------------------------------------------------------------------------------- Table of Contents Reportable Segments Prior period segment financial information has been recast to conform to the 2014 presentation. See Notes 1 and 10 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report for more information on our segments. The following table presents a summary of the reportable segment financial information: Three Months Ended September 30, Increase/(Decrease) Nine Months Ended September 30, Increase/(Decrease) (in millions, except percentages) 2014 2013 2014 vs. 2013 2014 2013 2014 vs. 2013 Revenues UnitedHealthcare $ 30,039 $ 28,384 $ 1,655 6 % $ 89,364 $ 84,939 $ 4,425 5 % OptumHealth 2,849 2,494 355 14 8,015 7,347 668 9 OptumInsight 1,250 1,202 48 4 3,740 3,536 204 6 OptumRx 8,011 6,295 1,716 27 23,469 17,138 6,331 37 Optum eliminations (124 ) (118 ) 6 5 (354 ) (341 ) 13 4 Optum 11,986 9,873 2,113 21 34,870 27,680 7,190 26 Eliminations (9,266 ) (7,633 ) 1,633 21 (27,193 ) (21,247 ) 5,946 28 Consolidated revenues $ 32,759 $ 30,624 $ 2,135 7 % $ 97,041 $ 91,372 $ 5,669 6 % Earnings from operations UnitedHealthcare $ 2,038 $ 1,950 $ 88 5 % $ 5,266 $ 5,357 $ (91 ) (2 )% OptumHealth 314 271 43 16 749 707 42 6 OptumInsight 225 212 13 6 635 650 (15 ) (2 ) OptumRx 326 198 128 65 859 457 402 88 Optum 865 681 184 27 2,243 1,814 429 24 Consolidated earnings from operations $ 2,903 $ 2,631 $ 272 10 % $ 7,509 $ 7,171 $ 338 5 % Operating margin UnitedHealthcare 6.8 % 6.9 % (0.1 )% 5.9 % 6.3 % (0.4 )% OptumHealth 11.0 10.9 0.1 9.3 9.6 (0.3 ) OptumInsight 18.0 17.6 0.4 17.0 18.4 (1.4 ) OptumRx 4.1 3.1 1.0 3.7 2.7 1.0 Optum 7.2 6.9 0.3 6.4 6.6 (0.2 ) Consolidated operating margin 8.9 % 8.6 % 0.3 % 7.7 % 7.8 % (0.1 )% UnitedHealthcare The following table summarizes UnitedHealthcare revenue by business: Three Months Ended Nine Months Ended September 30, Increase/(Decrease) September 30, Increase/(Decrease) (in millions, except percentages) 2014 2013 2014 vs. 2013 2014 2013 2014 vs. 2013 UnitedHealthcare Employer & Individual $ 10,610 $ 11,230 $ (620 ) (6 )% $ 32,296 $ 33,424 $ (1,128 ) (3 )% UnitedHealthcare Medicare & Retirement 11,477 11,042 435 4 34,764 33,275 1,489 4 UnitedHealthcare Community & State 6,131 4,581 1,550 34 17,069 13,501 3,568 26 UnitedHealthcare International 1,821 1,531 290 19 5,235 4,739 496 10 Total UnitedHealthcare revenue $ 30,039 $ 28,384 $ 1,655 6 % $ 89,364 $ 84,939 $ 4,425 5 % 29-------------------------------------------------------------------------------- Table of Contents The following table summarizes the number of individuals served by our UnitedHealthcare businesses, by major market segment and funding arrangement: September 30, Increase/(Decrease) (in thousands, except percentages) 2014 2013 2014 vs. 2013 Commercial risk-based 7,545 8,130 (585 ) (7 )% Commercial fee-based 18,300 19,060 (760 ) (4 ) Commercial fee-based TRICARE 2,910 2,930 (20 ) (1 ) Total commercial 28,755 30,120 (1,365 ) (5 ) Medicare Advantage 2,995 2,970 25 1 Medicaid 4,920 3,955 965 24 Medicare Supplement (Standardized) 3,715 3,415 300 9 Total public and senior 11,630 10,340 1,290 12 International 4,550 4,815 (265 ) (6 ) Total UnitedHealthcare - medical 44,935 45,275 (340 ) (1 )% Supplemental Data: Medicare Part D stand-alone 5,155 4,895 260 5 % The decrease in commercial risk-based enrollment was a result of disciplined pricing in a continued competitive environment and a decrease in individual policy customers due in part to customers moving to public exchanges. The decrease in number of people served under commercial fee-based arrangements was primarily due to the loss of a large state employer account. Medicare Advantage participation increased year-over-year despite the significant funding reductions, which caused us to exit certain markets in January 2014, reduce product offerings, adjust networks and reduce benefits for 2014. Nearly 60% of the Medicaid growth was driven by Medicaid expansion under the ACA with the remaining growth from the combination of states launching new programs to complement established programs and market approaches and growth in those traditional programs. Medicare Supplement growth reflected strong customer retention and new sales. The number of people served internationally decreased year-over-year primarily due to price increases in Brazil in response to the increasing costs of mandated health care benefits. In our Medicare Part D stand-alone business, the number of people served increased primarily as a result of new product introductions and strong customer retention in the market. UnitedHealthcare's revenue growth during the three and nine months ended September 30, 2014 was due to growth in the number of individuals served in our public and senior markets businesses, revenues to recover ACA Fees and commercial price increases reflecting underlying medical cost trends, partially offset by decreased commercial risk-based enrollment and a reduced level of Medicare Advantage funding. UnitedHealthcare's operating earnings for the three and nine months ended September 30, 2014 were pressured year-over-year by ACA Fees, Medicare Advantage funding reductions and increased spending on specialty medications to treat hepatitis C. Offsetting these factors were public and senior growth, reduced levels of per-member inpatient hospital utilization and revenue true-ups. For the nine month period, operating earnings were also impacted by reduced levels of favorable medical cost reserve development compared to 2013. Optum Total revenues increased for the three and nine months ended September 30, 2014 primarily due to pharmacy growth at OptumRx and growth at OptumHealth. The increases in Optum's earnings from operations for the three and nine months ended September 30, 2014 were driven by earnings growth at OptumRx and OptumHealth. Optum's operating margin improved for the three months ended September 30, 2014 primarily as a result of enhanced margin performance at OptumRx. The operating margin declined for the nine months ended September 30, 2014 due to the increased mix of comparatively lower margin pharmacy services in Optum's overall business and investments to develop future growth opportunities, particularly at OptumHealth and OptumInsight. The results by segment were as follows: OptumHealth Revenue increased at OptumHealth for the three and nine months ended September 30, 2014 primarily due to expansion and growth in integrated care delivery services. 30-------------------------------------------------------------------------------- Table of Contents Earnings from operations for the three and nine months ended September 30, 2014 increased primarily due to revenue growth and cost efficiencies, offset in part by investments to develop future growth opportunities. The operating margin for the nine months ended September 30, 2014 decreased slightly due to investments for future growth. OptumInsight Revenue at OptumInsight for the three and nine months ended September 30, 2014 increased primarily due to the growth in Optum360 revenue management and government exchange services, partially offset by a reduction in hospital compliance services. Earnings from operations and operating margins for the three and nine months ended September 30, 2014 reflected changes in product mix and investments for future growth. OptumRx Increased OptumRx revenue for the three and nine months ended September 30, 2014 was due to growth in people served in UnitedHealthcare's public and senior markets, the insourcing of UnitedHealthcare's commercial pharmacy benefit programs, growth from external clients as well as an increase in specialty pharmaceutical revenues. Earnings from operations and operating margins for the three and nine months ended September 30, 2014 increased primarily due to growth in scale that resulted in greater productivity and better absorption of our fixed costs, and improved performance in both drug purchasing and mail fulfillment. LIQUIDITY, FINANCIAL CONDITION AND CAPITAL RESOURCES Liquidity Introduction We manage our liquidity and financial position in the context of our overall business strategy. We continually forecast and manage our cash, investments, working capital balances and capital structure to meet the short-term and long-term obligations of our businesses while seeking to maintain liquidity and financial flexibility. Cash flows generated from operating activities are principally from earnings before noncash expenses. Our regulated subsidiaries generate significant cash flows from operations and are subject to financial regulations and standards in their respective jurisdictions. These standards, among other things, require these subsidiaries to maintain specified levels of statutory capital, as defined by each jurisdiction, and restrict the timing and amount of dividends and other distributions that may be paid to their parent companies. In the United States, most of these regulations and standards are generally consistent with model regulations established by the National Association of Insurance Commissioners. Except in the case of extraordinary dividends, these standards generally permit dividends to be paid from statutory unassigned surplus of the regulated subsidiary and are limited based on the regulated subsidiary's level of statutory net income and statutory capital and surplus. These dividends are referred to as "ordinary dividends" and generally may be paid without prior regulatory approval. If the dividend, together with other dividends paid within the preceding twelve months, exceeds a specified statutory limit or is paid from sources other than earned surplus, the entire dividend is generally considered an "extraordinary dividend" and must receive prior regulatory approval. For the nine months ended September 30, 2014, our U.S. regulated subsidiaries paid their parent companies dividends of $3.8 billion, and we had approximately $1.3 billion in ordinary dividend capacity remaining. For the twelve months ended December 31, 2013, our regulated subsidiaries paid their parent companies dividends of $3.2 billion. Our nonregulated businesses also generate cash flows from operations that are available for general corporate use. Cash flows generated by these entities, combined with dividends from our regulated entities and financing through the issuance of long-term debt as well as issuance of commercial paper or the ability to draw under our committed credit facilities, further strengthen our operating and financial flexibility. We use these cash flows to expand our businesses through acquisitions, reinvest in our businesses through capital expenditures, repay debt, and return capital to our shareholders through shareholder dividends and/or repurchases of our common stock, depending on market conditions. 31-------------------------------------------------------------------------------- Table of Contents Summary of our Major Sources and Uses of Cash and Cash Equivalents Nine Months Ended September 30, Increase/(Decrease) (in millions) 2014 2013 2014 vs. 2013 Sources of cash: Cash provided by operating activities $ 5,622 $ 5,923 $ (301 ) Sales and maturities of investments, net of purchases 253 - 253 Customer funds administered - 308 (308 ) Proceeds from common stock issuances 400 538 (138 ) Issuances of long-term debt and commercial paper, net of repayments 543 146 397 Other - 45 (45 ) Total sources of cash 6,818 6,960 Uses of cash: Common stock repurchases (3,024 ) (2,348 ) (676 ) Purchases of property, equipment and capitalized software, net (1,121 ) (840 ) (281 ) Cash dividends paid (1,004 ) (777 ) (227 ) Cash paid for acquisitions and noncontrolling interest shares, net of cash assumed (851 ) (1,804 ) 953 Purchases of investments, net of sales and maturities - (1,148 ) 1,148 Customer funds administered (440 ) - (440 ) Other (424 ) (76 ) (348 ) Total uses of cash (6,864 ) (6,993 ) Effect of exchange rate changes on cash and cash equivalents 3 (87 ) 90 Net decrease in cash and cash equivalents $ (43 ) $ (120 ) $ 77 2014 Cash Flows Compared to 2013 Cash Flows Cash flows provided by operating activities in 2014 decreased primarily due to the September payment of the $1.3 billion Industry Tax ahead of related fourth quarter customer collections and an increase in government receivables. These decreases were partially offset by an increased level of accounts payable and other liabilities from the collection of Reinsurance Program fees in advance of remittance in 2015, and an increase in accrued income taxes. Other significant changes in sources or uses of cash year-over-year included: (a) a change in investment activity from net purchases in 2013 to net sales in 2014; (b) decreased spending on acquisitions and noncontrolling interest shares; (c) an increase in Part D subsidy receivables causing a change in customer funds administered; and (d) increased repurchases of common stock. Financial Condition As of September 30, 2014, our cash, cash equivalent and available-for-sale investment balances of $28.0 billion included $7.2 billion of cash and cash equivalents (of which $1.0 billion was available for general corporate use), $19.2 billion of debt securities and $1.6 billion of investments in equity securities consisting of investments in non-U.S. dollar fixed-income funds; employee savings plan related investments; venture capital funds; and dividend paying stocks. Given the significant portion of our portfolio held in cash equivalents, we do not anticipate fluctuations in the aggregate fair value of our financial assets to have a material impact on our liquidity or capital position. The use of different market assumptions or valuation methodologies, especially those used in valuing our $367 million of available-for-sale Level 3 securities (those securities priced using significant unobservable inputs), may have an effect on the estimated fair values of our investments. Due to the subjective nature of these assumptions, the estimates may not be indicative of the actual exit price if we had sold the investment at the measurement date. Other sources of liquidity, primarily from operating cash flows and our commercial paper program, which is supported by our bank credit facilities, reduce the need to sell investments during adverse market conditions. See Note 3 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report for further detail concerning our fair value measurements. Our available-for-sale debt portfolio had a weighted-average duration of 3.4 years and a weighted-average credit rating of "AA" as of September 30, 2014. When multiple credit ratings are available for an individual security, the average of the available ratings is used to determine the weighted-average credit rating. 32-------------------------------------------------------------------------------- Table of Contents Capital Resources and Uses of Liquidity In addition to cash flows from operations and cash and cash equivalent balances available for general corporate use, our capital resources and uses of liquidity are as follows: Commercial Paper and Bank Credit Facilities. Our bank credit facilities provide liquidity support for our commercial paper borrowing program, which facilitates the private placement of unsecured debt through third-party broker-dealers, and are available for general corporate purposes. For more information on our commercial paper and bank credit facilities, see Note 6 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report. Our bank credit facilities contain various covenants, including covenants requiring us to maintain a debt to debt-plus-equity ratio of not more than 50%. Our debt to debt-plus-equity ratio, calculated as the sum of debt divided by the sum of debt and shareholders' equity, which reasonably approximates the actual covenant ratio, was 34.9% as of September 30, 2014. Long-term Debt. Periodically, we access capital markets and issue long-term debt for general corporate purposes, for example, to meet our working capital requirements, to refinance debt, to finance acquisitions or for share repurchases. Credit Ratings. Our credit ratings as of September 30, 2014 were as follows: Moody's Standard & Poor's Fitch A.M. Best Ratings Outlook Ratings Outlook Ratings Outlook Ratings Outlook Senior unsecured debt A3 Stable A Positive A- Stable bbb+ Stable Commercial paper P-2 n/a A-1 n/a F1 n/a AMB-2 n/a The availability of financing in the form of debt or equity is influenced by many factors, including our profitability, operating cash flows, debt levels, credit ratings, debt covenants and other contractual restrictions, regulatory requirements and economic and market conditions. For example, a significant downgrade in our credit ratings or adverse conditions in the capital markets may increase the cost of borrowing for us or limit our access to capital. Share Repurchase Program. In June 2014, our Board renewed our share repurchase program with an authorization to repurchase up to 100 million shares of our common stock. As of September 30, 2014, we had Board authorization to purchase up to an additional 82 million shares of our common stock. For more information on our share repurchase program, see Note 7 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report. Dividends. In June 2014, our Board of Directors increased our quarterly cash dividend to shareholders to an annual dividend rate of $1.50 per share. For more information on our dividend, see Note 7 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report. CONTRACTUAL OBLIGATIONS AND COMMITMENTS A summary of future obligations under our various contractual obligations and commitments as of December 31, 2013 was disclosed in our 2013 10-K. During the nine months ended September 30, 2014, there were no material changes to this previously disclosed information outside the ordinary course of business. However, we continually evaluate opportunities to expand our operations, including through internal development of new products, programs and technology applications and acquisitions. RECENTLY ISSUED ACCOUNTING STANDARDS In May 2014, the Financial Accounting Standards Board issued ASU No. 2014-09 "Revenue from Contracts with Customers (Topic 606)." ASU 2014-09 will supersede existing revenue recognition standards with a single model unless those contracts are within the scope of other standards (e.g., an insurance entity's insurance contracts). The revenue recognition principle in ASU 2014-09 is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, new and enhanced disclosures will be required. Companies can adopt the new standard using either the full retrospective approach, a modified retrospective approach with practical expedients, or a cumulative effect upon adoption approach. ASU 2014-09 will become effective for annual and interim reporting periods beginning after December 15, 2016. Early adoption is not permitted. We are currently evaluating the effect of the new revenue recognition guidance. We have determined that there have been no other recently issued, but not yet adopted, accounting standards that will have a material impact on our Condensed Consolidated Financial Statements. 33-------------------------------------------------------------------------------- Table of Contents CRITICAL ACCOUNTING ESTIMATES In preparing these Condensed Consolidated Financial Statements, we are required to make judgments, assumptions and estimates, which we believe are reasonable and prudent based on the available facts and circumstances. These judgments, assumptions and estimates affect certain of our revenues and expenses and their related balance sheet accounts and disclosure of our contingent liabilities. We base our assumptions and estimates primarily on historical experience and factor in known and projected trends. On an ongoing basis, we re-evaluate our selection of assumptions and the method of calculating our estimates. Actual results, however, may materially differ from our calculated estimates and this difference would be reported in our current operations. Our critical accounting estimates include medical costs payable, revenues, goodwill and intangible assets, investments, income taxes and contingent liabilities. For a detailed description of our critical accounting estimates, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our 2013 10-K. For a detailed discussion of our significant accounting policies, see Note 2 of Notes to the Consolidated Financial Statements in Item II, Part 8, "Financial Statements" in our 2013 10-K and Note 1 of Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this report. FORWARD-LOOKING STATEMENTS The statements, estimates, projections, guidance or outlook contained in this report include "forward-looking" statements within the meaning of the PSLRA. These statements are intended to take advantage of the "safe harbor" provisions of the PSLRA. Generally, the words "believe," "expect," "intend," "estimate," "anticipate," "forecast," "plan," "project," "should" and similar expressions identify forward-looking statements, which generally are not historical in nature. These statements may contain information about financial prospects, economic conditions and trends and involve risks and uncertainties. We caution that actual results could differ materially from those that management expects, depending on the outcome of certain factors. Some factors that could cause results to differ materially from results discussed or implied in the forward-looking statements include: our ability to effectively estimate, price for and manage our medical costs, including the impact of any new coverage requirements; the potential impact that new laws or regulations, or changes in existing laws or regulations, or their enforcement or application could have on our results of operations, financial position and cash flows, including as a result of increases in medical, administrative, technology or other costs or decreases in enrollment resulting from U.S., Brazilian and other jurisdictions' regulations affecting the health care industry; the impact of any potential assessments for insolvent payers under state guaranty fund laws; the impact of the Patient Protection and Affordable Care Act, which could materially and adversely affect our results of operations, financial position and cash flows through reduced revenues, increased costs, new taxes and expanded liability, or require changes to the ways in which we conduct business or put us at risk for loss of business; potential reductions in revenue or delays to cash flows received under Medicare, Medicaid and TRICARE programs, including sequestration and potential effects of a prolonged U.S. government shutdown or debt ceiling constraints; uncertainties regarding changes in Medicare, including potential changes in risk adjustment data validation audit and payment adjustment methodology; failure to comply with privacy and data security regulations; regulatory and other risks and uncertainties associated with the pharmacy benefits management industry; competitive pressures, which could affect our ability to maintain or increase our market share; the impact of challenges to our public sector contract awards; our ability to execute contracts on competitive terms with physicians, hospitals and other service professionals; increases in costs and other liabilities associated with increased litigation, government investigations, audits or reviews; failure to manage successfully our strategic alliances or complete or receive anticipated benefits of acquisitions and other strategic transactions, including the Amil acquisition; the impact of fluctuations in foreign currency exchange rates on our reported shareholders' equity and results of operations; potential downgrades in our credit ratings; our ability to attract, retain and provide support to a network of independent producers (i.e., brokers and agents) and consultants; the potential impact of adverse economic conditions on our revenues (including decreases in enrollment resulting from increases in the unemployment rate and commercial attrition) and results of operations; the performance of our investment portfolio; possible impairment of the value of our goodwill and intangible assets in connection with dispositions or if estimated future results do not adequately support goodwill and intangible assets recorded for our existing businesses or the businesses that we acquire; increases in health care costs resulting from large-scale medical emergencies; failure to maintain effective and efficient information systems or if our technology products otherwise do not operate as intended; misappropriation of our proprietary technology; failure to protect against cyber-attacks or other privacy or data security incidents; our ability to obtain sufficient funds from our regulated subsidiaries or the debt or capital markets to fund our obligations, to maintain our debt to total capital ratio at targeted levels, to maintain our quarterly dividend payment cycle or to continue repurchasing shares of our common stock; and failure to achieve targeted operating cost productivity improvements, including savings resulting from technology enhancement and administrative modernization. This list of important factors is not intended to be exhaustive. We discuss certain of these matters more fully, as well as certain risk factors that may affect our business operations, financial condition and results of operations, in our other periodic and 34-------------------------------------------------------------------------------- Table of Contents current filings with the SEC, including our 2013 10-K. Any or all forward-looking statements we make may turn out to be wrong, and can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. By their nature, forward-looking statements are not guarantees of future performance or results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Actual future results may vary materially from expectations expressed or implied in this report or any of our prior communications. You should not place undue reliance on forward-looking statements, which speak only as of the date they are made. We do not undertake to update or revise any forward-looking statements, except as required by applicable securities laws. |