Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For discussion of 2017 items and year-over-year comparisons between 2018 and 2017 that are not included in this 2019 Form 10-K, refer to "Item 7. – Management Discussion and Analysis of Financial Condition and Results of Operations" found in our Form 10-K for the year ended December 31, 2018, that was filed with the Securities and Exchange Commission on February 21, 2019.

Executive Overview

General

Humana Inc., headquartered in Louisville, Kentucky, is a leading health and well-being company committed to helping our millions of medical and specialty members achieve their best health. Our successful history in care delivery and health plan administration is helping us create a new kind of integrated care with the power to improve health and well‐being and lower costs. Our efforts are leading to a better quality of life for people with Medicare, families, individuals, military service personnel, and communities at large. To accomplish that, we support physicians and other health care professionals as they work to deliver the right care in the right place for their patients, our members. Our range of clinical capabilities, resources and tools, such as in‐home care, behavioral health, pharmacy services, data analytics and wellness solutions, combine to produce a simplified experience that makes health care easier to navigate and more effective.

Our industry relies on two key statistics to measure performance. The benefit ratio, which is computed by taking total benefits expense 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, excluding Merger termination fee and related costs, net, and depreciation and amortization, as a percentage of total revenue less investment income, represents a statistic used to measure administrative spending efficiency.

Business Segments

We manage our business with three reportable segments: Retail, Group and Specialty, and Healthcare Services. Beginning January 1, 2018, we exited the individual commercial fully-insured medical health insurance business, as well as certain other business in 2018, and therefore no longer report separately the Individual Commercial segment and the Other Businesses category in the current year. Previously, the Other Businesses category included businesses that were not individually reportable because they did not meet the quantitative thresholds required by generally accepted accounting principles, primarily our closed-block of commercial long-term care insurance policies which were sold in 2018. The reportable 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, the chief operating decision maker, to assess performance and allocate resources. See Note 18 to the consolidated financial statements included in Item 8. - Financial Statements and Supplementary Data for segment financial information.

The Retail segment consists of Medicare benefits, marketed to individuals or directly via group Medicare accounts. In addition, the Retail segment also includes our contract with CMS to administer the Limited Income Newly Eligible Transition, or LI-NET, prescription drug plan program and contracts with various states to provide Medicaid, dual eligible, and Long-Term Support Services benefits, which we refer to collectively as our state-based contracts. The Group and Specialty segment consists of employer group commercial fully-insured medical and specialty health insurance benefits marketed to individuals and employer groups, including dental, vision, and other supplemental health benefits, as well as administrative services only, or ASO products. In addition, our Group and Specialty segment includes our military services business, primarily our TRICARE T2017 East Region contract. The Healthcare Services segment includes our services offered to our health plan members as well as to third parties, including pharmacy solutions, provider services, and clinical care service, such as home health and other services and capabilities to promote wellness and advance population health, including our minority investment in Kindred at Home.

The results of each segment are measured by income before income taxes and equity in net earnings from Kindred at Home, or segment earnings. Transactions between reportable segments primarily consist of sales of services rendered

by our Healthcare Services segment, primarily pharmacy, provider, and clinical care services, to our Retail and Group and Specialty segment customers. Intersegment sales and expenses are recorded at fair value and eliminated in consolidation. Members served by our segments often use 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 allocate most operating expenses to our segments. Assets and certain corporate income and expenses are not allocated to the segments, including the portion of investment income not supporting segment operations, interest expense on corporate debt, and certain other corporate expenses. These items are managed at a corporate level. These corporate amounts are reported separately from our reportable segments and are included with intersegment eliminations.

Seasonality

One of the product offerings of our Retail segment is Medicare stand-alone prescription drug plans, or PDPs, under the Medicare Part D program. 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 affects the quarterly benefit ratio pattern.

In addition, the Retail segment also experiences seasonality in the operating cost ratio as a result of costs incurred in the second half of the year associated with the Medicare marketing season.

Our Group and Specialty segment also experiences seasonality in the benefit ratio pattern. However, the effect is opposite of Medicare stand-alone PDP in the Retail segment, with the Group and Specialty segment’s benefit ratio increasing as fully-insured members progress through their annual deductible and maximum out-of-pocket expenses.

Aetna Merger

On February 16, 2017, under the terms of the Agreement and Plan of Merger, or Merger Agreement, with Aetna Inc., and certain wholly owned subsidiaries of Aetna Inc., which we collectively refer to as Aetna, we received a breakup fee of $1 billion from Aetna, which is included in our consolidated statement of income in the line captioned "Merger termination fee and related costs, net."

Acquisitions and Divestitures

In the first quarter of 2020, we acquired privately held Enclara Healthcare, or Enclara, one of the nation’s largest hospice pharmacy and benefit management providers for cash consideration of approximately $707 million, net of cash received. The purchase accounting is incomplete due to the timing of the availability of information.

Also in the first quarter of 2020, our Partners in Primary Care wholly-owned subsidiary entered into a strategic partnership with Welsh, Carson, Anderson & Stowe, or WCAS, to accelerate the expansion of our primary care model. The WCAS partnership is expected to open approximately 50 payor-agnostic, senior-focused primary care centers over 3 years beginning in 2020. Partners in Primary Care committed to the acquisition of a non-controlling interest in the approximately $600 million entity. In addition, the agreement includes a series of put and call options through which WCAS may require us to purchase their interest in the entity and, through which we may acquire WCAS’s interest over the next 5 - 10 years.

In the third quarter of 2018, we completed the sale of our wholly-owned subsidiary KMG America Corporation, or KMG, to Continental General Insurance Company, or CGIC, a Texas-based insurance company wholly owned by HC2 Holdings, Inc., a diversified holding company. KMG's subsidiary, Kanawha Insurance Company, or KIC, included our closed block of non-strategic commercial long-term care policies. Upon closing, we funded the transaction with

approximately $190 million of parent company cash contributed into KMG, subject to customary adjustments, in addition to the transfer of approximately $160 million of statutory capital with the sale.

Also in the third quarter of 2018, we, along with TPG Capital, or TPG, and WCAS (together, the "Sponsors"), completed the acquisitions of Kindred and Curo, respectively, merging Curo with the hospice business of Kindred at Home. As part of these transactions, we acquired a 40% minority interest in Kindred at Home, a leading home health and hospice company, for total cash consideration of approximately $1.1 billion.

In the second quarter of 2018, we acquired Family Physicians Group, or FPG, for cash consideration of approximately $185 million, net of cash received. FPG is one of the largest at-risk providers serving Medicare Advantage and Managed Medicaid HMO patients in Greater Orlando, Florida with a footprint that includes clinics located in Lake, Orange, Osceola and Seminole counties. The acquisition of FPG advances our strategy of helping physicians and clinicians evolve from treating health episodically to managing health holistically.

In the first quarter of 2018, we acquired the remaining equity interest in MCCI Holdings, LLC, or MCCI, a privately held management service organization headquartered in Miami, Florida, which primarily coordinates medical care for Medicare Advantage beneficiaries in Florida and Texas. The purchase price consisted primarily of $169 million cash, as well as our existing investment in MCCI and a note receivable and a revolving note with an aggregate balance of $383 million.

These transactions are more fully discussed in Note 3 and Note 4 to the consolidated financial statements.

Highlights

•

Our 2019 results reflect the continued implementation of our strategy to offer our members affordable health care combined with a positive consumer experience in growing markets. At the core of this strategy is our integrated care delivery model, which unites quality care, high member engagement, and sophisticated data analytics. Our approach to primary, physician-directed care for our members aims to provide quality care that is consistent, integrated, cost-effective, and member-focused, provided by both employed physicians and physicians with network contract arrangements. The model is designed to improve health outcomes and affordability for individuals and for the health system as a whole, while offering our members a simple, seamless healthcare experience. We believe this strategy is positioning us for long-term growth in both membership and earnings. We offer providers a continuum of opportunities to increase the integration of care and offer assistance to providers in transitioning from a fee-for-service to a value-based arrangement. These include performance bonuses, shared savings and shared risk relationships. At December 31, 2019, approximately 2,407,000 members, or 67%, of our individual Medicare Advantage members were in value-based relationships under our integrated care delivery model, as compared to 2,039,100 members, or 67%, at December 31, 2018. Medicare Advantage and dual demonstration program membership enrolled in a Humana chronic care management program was 868,800 at December 31, 2019, an increase of 21.3% from 716,000 at December 31, 2018. These members may not be unique to each program since members have the ability to enroll in multiple programs. The increase is driven by our improved process for identifying and enrolling members in the appropriate program at the right time, coupled with growth in Special Needs Plans, or SNP, membership.

•	On February 5, 2020, after the stock market closed, the Centers for Medicare and Medicaid Services (“CMS”) issued Part II of the 2021 Advance Notice of Methodological Changes for Medicare Advantage Capitation Rates and Part C and Part D Payment Policies (the “Advance Notice”). CMS has invited public comment on the Advance Notice before publishing final rates on April 6, 2020 (the “Final Notice”).

In the Advance Notice, CMS estimates Medicare Advantage plans across the sector will, on average, experience a 0.93 percent increase in benchmark funding based on proposals included therein. As indicated by CMS, its estimate excludes the impact of fee-for-service county rebasing/repricing because the related impact is dependent upon finalization of certain data, which will be available with the publication of the Final Notice. Based on our preliminary analysis using the same factors CMS included in its estimate, the components of

which are detailed on CMS’ website, we anticipate that the proposals in the Advance Notice would result in a change to our benchmark funding relatively in line with CMS’ estimate.

Also on February 5, 2020, CMS issued a proposed rule (which we refer to as the “2021 Proposed Rule”) related to the administration of the MA and Part D programs, including, among other things, the Agency’s implementation of recent legislation removing the limitation on MA eligibility for end-stage-renal-disease, or ESRD, Medicare-eligible beneficiaries beginning in 2021, allowing for Medicare Advantage plans to offer additional supplemental benefits including telehealth, and addressing opioid recovery and treatment. The 2021 Proposed Rule also recognizes the potential opportunity to create new options for beneficiaries, including ESRD beneficiaries, and their access to care through greater flexibility around current network adequacy requirements. CMS has invited public comments to the 2021 Proposed Rule on or before April 6, 2020.

The Advance Notice and the 2021 Proposed Rule are subject to the required notice and comment period, and we cannot predict when or to what extent CMS will adopt the proposals in the Advance Notice or the 2021 Proposed Rule. We will be drawing upon our program expertise to provide CMS formal commentary on the impact of both the Advance Notice and the 2021 Proposed Rule and the related impact upon Medicare beneficiaries’ quality of care and service to our members through the MA and Part D programs.

•

Net income was $2.7 billion for 2019 compared to $1.7 billion in 2018 and earnings per diluted common share increased $7.94 from $12.16 earnings per diluted common share in 2018 to $20.10 earnings per diluted common share in 2019. This comparison was primarily impacted by higher segment earnings in our Retail and Healthcare Services segments, partially offset by lower Group and Specialty segment earnings. These changes were further favorably impacted by the put/call valuation adjustments associated with our investment in Kindred at Home and by a lower number of shares used to compute dilutive earnings per share, primarily reflecting share repurchases. In addition, year-over-year comparison to 2019 was impacted by the loss on the sale of KMG of $786 million recognized in 2018.

•	Contributing to our Retail segment revenue growth was our individual and group Medicare Advantage membership, which increased 550,700 members, or 15.5%, from 3,561,800 members at December 31, 2018 to 4,112,500 members at December 31, 2019.

•

Our operating cash flow of $5.3 billion for 2019 improved from $2.2 billion for 2018, reflecting the significant impact of increasing premiums and enrollment, as premiums generally are collected in advance of claim payments by a period of up to several months. The year-over-year comparison was further impacted by the timing of other working capital changes, higher earnings in 2019 versus 2018, and the negative impact on 2018 cash flows resulting from the funding of reinsurance transactions in connection with the sale of KMG.

•

In July 2019, the Board of Directors approved a $3.0 billion share repurchase authorization with an expiration date of June 30, 2022. We subsequently entered into an agreement with a third-party financial institution on July 31, 2019, to effect a $1.0 billion ASR program under the authorization. Under the terms of this program, which was completed in the fourth quarter of 2019, we repurchased approximately 3,376,200 shares at an average price, after a discount, of $296.19. Aside from the completion of the ASR program, we have not completed any open market stock repurchases. As of February 19, 2020, we had a remaining repurchase authorization of $2.0 billion.

•

In August 2019, we issued $500 million of 3.125% senior notes due August 15, 2029, and $500 million of 3.950% senior notes due August 15, 2049. Our net proceeds, reduced for the underwriters discount and commission and offering expenses, were $987 million. We used the net proceeds from this offering, together with available cash, to repay the $650 million outstanding amount due under our term note in August 2019, and the $400 million aggregate principal amount of our 2.625% senior notes due on its maturity date of October 1, 2019.

•	In 2019 we initiated an involuntary workforce optimization program that will allow us to promote operational excellence, accelerate our strategy, fund critical initiatives and advance our growth objectives. As a result we recorded estimated charges of $47 million, or $0.26 per diluted common share, on the corporate level, included

with operating costs in the condensed consolidated statements of income. We expect this liability to be primarily paid within 12 months.

Health Care Reform

The Health Care Reform Law enacted significant reforms to various aspects of the U.S. health insurance industry. Certain significant provisions of the Health Care Reform Law include, among others, mandated coverage requirements, mandated benefits and guarantee issuance associated with commercial medical insurance, rebates to policyholders based on minimum benefit ratios, adjustments to Medicare Advantage premiums, the establishment of federally facilitated or state-based exchanges coupled with programs designed to spread risk among insurers, and the introduction of plan designs based on set actuarial values. In addition, the Health Care Reform Law established insurance industry assessments, including an annual health insurance industry fee. The annual health insurance industry fee was suspended in 2019, but will resume for calendar year 2020, not be deductible for income tax purposes, and significantly increase our effective tax rate. In 2018, the fee levied on the health insurance industry was $14.3 billion. Under current law, the health industry fee will be permanently repealed beginning in calendar year 2021.

It is reasonably possible that the Health Care Reform Law and related regulations, as well as other current or future legislative, judicial or regulatory changes, including restrictions on our ability to manage our provider network or otherwise operate our business, or restrictions on profitability, including reviews by regulatory bodies that may compare our Medicare Advantage profitability to our non-Medicare Advantage business profitability, or compare the profitability of various products within our Medicare Advantage business, and require that they remain within certain ranges of each other, increases in member benefits or changes to member eligibility criteria without corresponding increases in premium payments to us, or increases in regulation of our prescription drug benefit businesses, 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 operating costs, further lowering our Medicare payment rates and increasing our expenses associated with assessments); our financial position (including our ability to maintain the value of our goodwill); and our 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. Transactions between reportable segments primarily consist of sales of services rendered by our Healthcare Services segment, primarily pharmacy, provider, and clinical care services, to our Retail and Group and Specialty segment customers and are described in Note 18 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data in this 2019 Form 10-K.

Comparison of Results of Operations for 2019 and 2018

Certain financial data on a consolidated basis and for our segments was as follows for the years ended December 31, 2019 and 2018:

Consolidated

										Change
		2019				2018				Dollars				Percentage
		(dollars in millions, except per common share results)
Revenues:
Premiums:
Retail		$	56,254			$	48,108			$	8,146			16.9	%
Group and Specialty		6,694				6,803				(109		)		(1.6	)%
Individual Commercial		—				8				(8		)		(100.0	)%
Other Businesses		—				22				(22		)		(100.0	)%
Total premiums		62,948				54,941				8,007				14.6	%
Services:
Retail		17				11				6				54.5	%
Group and Specialty		790				835				(45		)		(5.4	)%
Healthcare Services		632				607				25				4.1	%
Other Businesses		—				4				(4		)		(100.0	)%
Total services		1,439				1,457				(18		)		(1.2	)%
Investment income		501				514				(13		)		(2.5	)%
Total revenues		64,888				56,912				7,976				14.0	%
Operating expenses:
Benefits		53,857				45,882				7,975				17.4	%
Operating costs		7,381				7,525				(144		)		(1.9	)%
Depreciation and amortization		458				405				53				13.1	%
Total operating expenses		61,696				53,812				7,884				14.7	%
Income from operations		3,192				3,100				92				3.0	%
Loss on sale of business		—				786				(786		)		(100.0	)%
Interest expense		242				218				24				11.0	%
Other (income) expense, net		(506		)		33				(539		)		(1633.3	)%
Income before income taxes and equity in net earnings		3,456				2,063				1,393				67.5	%
Provision for income taxes		763				391				372				95.1	%
Equity in net earnings of Kindred at Home		14				11				3				27.3	%
Net income		$	2,707			$	1,683			$	1,024			60.8	%
Diluted earnings per common share		$	20.10			$	12.16			$	7.94			65.3	%
Benefit ratio (a)		85.6		%		83.5		%						2.1	%
Operating cost ratio (b)		11.5		%		13.3		%						(1.8	)%
Effective tax rate		22.0		%		18.9		%						3.1	%

(a)	Represents total benefits expense as a percentage of premiums revenue.

(b)	Represents total operating costs, excluding depreciation and amortization, as a percentage of total revenues less investment income.

Summary

Net income for 2019 was $2.7 billion, or $20.10 per diluted common share, compared to $1.7 billion, or $12.16 per diluted common share, in 2018. This increase primarily was impacted by our Medicare Advantage business and Healthcare Services segment, as well as by previously implemented productivity initiatives that led to significant operating cost efficiencies in 2019. These impacts were partially offset by strategic investments in our integrated care delivery model, the impact of higher compensation accruals for the Annual Incentive Plan, or AIP, offered to employees across all levels of the company, lower Group and Specialty segment earnings, increased spending associated with the 2020 Medicare Annual Election Period, or AEP, and the impact of workforce optimization. These changes were further favorably impacted by the put/call valuation adjustments associated with our investment in Kindred at Home and by a lower number of shares used to compute dilutive earnings per share, primarily reflecting share repurchases. In addition, 2019 was impacted by the loss on the sale of KMG recognized in 2018.

Premiums Revenue

Consolidated premiums increased $8.0 billion, or 14.6%, from $54.9 billion for 2018 to $62.9 billion for 2019 primarily due to higher premiums in the Retail segment, driven by higher premium revenues from our Medicare Advantage business resulting from membership growth and higher per member premiums associated with individual Medicare Advantage. These increases were partially offset by the impact of declining stand-alone PDP membership, as well as lower premiums in the Group and Specialty segment as discussed in the detailed segment results discussion that follows.

Services Revenue

Consolidated services revenue decreased $18 million, or 1.2%, from $1.5 billion for 2018 to $1.4 billion for 2019, primarily due to a decrease in services revenue in the Group and Specialty segment, partially offset by an increase in the Healthcare Services segment as detailed in the segment results discussion that follows.

Investment Income

Investment income was $501 million for 2019, decreasing $13 million, or 2.5%, from 2018, primarily due to lower realized capital gains, partially offset by higher average invested balances and interest rates.

Benefits Expense

Consolidated benefits expense was $53.9 billion for 2019, an increase of $8.0 billion, or 17.4%, from 2018 reflecting an increase in the Retail and Group and Specialty segments benefits expense as discussed in the detailed segment results discussion that follows. As more fully described herein under the section entitled "Benefits Expense Recognition", actuarial standards require the use of assumptions based on moderately adverse experience, which generally results in favorable reserve development, or reserves that are considered redundant. We experienced favorable medical claims reserve development related to prior fiscal years of $336 million in 2019 and $503 million in 2018.

The consolidated benefit ratio for 2019 was 85.6%, an increase of 210 basis points from 2018 primarily due to the suspension of the health insurance industry fee in 2019, which was contemplated in the pricing and benefit design of our products, lower favorable prior-period medical claims reserve development, an increase in the Group and Specialty benefit ratio as discussed in the detailed segment results discussion that follows, and the shift in Medicare membership mix due to the loss of stand-alone PDP members and significant growth in Medicare Advantage members. These increases were partially offset by engaging our Medicare Advantage members in clinical programs, as well as ensuring they are appropriately documented under the CMS risk-adjustment model, and lower than expected medical costs as compared to the assumptions used in the pricing of our individual Medicare Advantage business for 2019. Favorable prior-period medical claims reserve development decreased the consolidated benefit ratio by approximately 50 basis points in 2019 and 90 basis points in 2018.

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 decreased $144 million, or 1.9%, from 2018 to $7.4 billion in 2019 reflecting a decrease in operating costs in the Retail and the Group and Specialty segments as discussed in the detailed segment results discussion that follows.

The consolidated operating cost ratio for 2019 was 11.5%, decreasing 180 basis points from 13.3% in 2018 primarily due to the suspension of the health insurance industry fee in 2019, scale efficiencies associated with growth in our Medicare Advantage membership, and significant operating cost efficiencies in 2019 driven by previously implemented productivity initiatives. These improvements were partially offset by strategic investments in our integrated care delivery model, the impact of higher compensation expense accruals in 2019 for the AIP offered to employees across all levels, increased spending associated with the Medicare AEP, and charges associated with workforce optimization. The higher compensation accruals resulted from our continued strong performance, including customer satisfaction as measured by the net promoter score, along with higher than anticipated individual Medicare Advantage membership growth. The nondeductible health insurance industry fee impacted the operating cost ratio by approximately 180 basis points in 2018.

Depreciation and Amortization

Depreciation and amortization in 2019 totaled $458 million compared to $405 million in 2018, an increase of 13.1%, primarily due to capital expenditures.

Interest Expense

Interest expense was $242 million for 2019 compared to $218 million for 2018, an increase of $24 million, or 11.0% The increase was primarily due to the higher average borrowings outstanding including the impact of the borrowings under the November 2018 term loan agreement and senior notes issued in August 2019.

Income Taxes

Our effective tax rate during 2019 was 22.0% compared to the effective tax rate of 18.9% in 2018. This change primarily reflects the impact of the suspension of the non-deductible health insurance industry fee in 2019 as well as the deferred tax benefit recognized in 2018 from the loss on sale of KMG. The effective income tax rate in 2018 reflected a $430 million deferred tax benefit, resulting from the loss on the sale of KMG attributable to its original tax basis and subsequent capital contributions to fund accumulated losses. See Note 12 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data for a complete reconciliation of the federal statutory rate to the effective tax rate.

Retail Segment

								Change
		2019			2018			Members			Percentage
Membership:
Medical membership:
Individual Medicare Advantage		3,587,200			3,064,000			523,200			17.1	%
Group Medicare Advantage		525,300			497,800			27,500			5.5	%
Medicare stand-alone PDP		4,365,200			5,004,300			(639,100	)		(12.8	)%
Total Retail Medicare		8,477,700			8,566,100			(88,400	)		(1.0	)%
State-based Medicaid		469,000			341,100			127,900			37.5	%
Medicare Supplement		298,400			254,300			44,100			17.3	%
Total Retail medical members		9,245,100			9,161,500			83,600			0.9	%

										Change
		2019				2018				Dollars				Percentage
		(in millions)
Premiums and Services Revenue:
Premiums:
Individual Medicare Advantage		$	43,128			$	35,656			$	7,472			21.0	%
Group Medicare Advantage		6,475				6,103				372				6.1	%
Medicare stand-alone PDP		3,165				3,584				(419		)		(11.7	)%
Total Retail Medicare		52,768				45,343				7,425				16.4	%
State-based Medicaid		2,898				2,255				643				28.5	%
Medicare Supplement		588				510				78				15.3	%
Total premiums		56,254				48,108				8,146				16.9	%
Services		17				11				6				54.5	%
Total premiums and services revenue		$	56,271			$	48,119			$	8,152			16.9	%
Segment earnings		$	2,235			$	1,733			$	502			29.0	%
Benefit ratio		86.4		%		85.1		%						1.3	%
Operating cost ratio		9.4		%		11.1		%						(1.7	)%

Segment Earnings

•

Retail segment earnings were $2.2 billion in 2019, an increase of $502 million, or 29.0%, compared to $1.7 billion in 2018 primarily reflecting a lower operating cost ratio, partially offset by the higher benefit ratio as more fully described below. As expected, the higher-than-anticipated individual Medicare Advantage membership growth during the previous AEP had a muted impact on the segment's earnings in 2019. While new Medicare Advantage members increase revenue, on average, they have a break even impact on segment earnings in the first year as they were not previously engaged in clinical programs or appropriately documented under the CMS risk adjustment model, and accordingly, carry a higher benefit ratio.

Enrollment

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Individual Medicare Advantage membership increased 523,200 members, or 17.1%, from 3,064,000 members as of December 31, 2018 to 3,587,200 members as of December 31, 2019, primarily due to membership additions associated with the 2019 AEP and Open Election Period, or OEP, for Medicare beneficiaries. The OEP sales period, which ran from January 1 to March 31, added approximately 43,700 members. Since the conclusion of the OEP, enrollment continued to increase due to strong sales to age-ins and those eligible for Dual Eligible Special Need Plans, or D-SNP. Individual Medicare Advantage membership includes 288,200 D-SNP members as of December 31, 2019, a net increase of 69,600, or 31.8%, from 218,600 December 31, 2018. For the full year 2020, we anticipate a net membership increase in our Individual Medicare Advantage offerings of 270,000 members to 330,000 members.

•	Group Medicare Advantage membership increased 27,500 members, or 5.5%, from 497,800 members as of December 31, 2018 to 525,300 members as of December 31, 2019, primarily due to net membership additions associated with the 2019 AEP for Medicare beneficiaries. For the full year 2020, we anticipate a net membership increase in our Group Medicare Advantage offerings of approximately 90,000 members.

•

Medicare stand-alone PDP membership decreased 639,100 members, or 12.8%, from 5,004,300 members as of December 31, 2018 to 4,365,200 members as of December 31, 2019, primarily reflecting net declines during the 2019 AEP for Medicare beneficiaries. The anticipated decline primarily was due to the competitive nature of the industry and the pricing discipline we have employed, which resulted in us no longer being the low cost plan in any market for 2019. For the full year 2020, we anticipate a net membership decline in our Medicare stand-alone PDP offerings of approximately 550,000 members.

•

State-based Medicaid membership increased 127,900 members, or 37.5%, from 341,100 members as of December 31, 2018 to 469,000 members as of December 31, 2019, primarily driven by the statewide award of a comprehensive contract under the Managed Medical Assistance, or MMA, program in Florida. Our January 31, 2020 state-based contracts membership was 608,000, representing growth of 139,000, or 30%, from December 31, 2019. This growth primarily reflects the impact of terminating the reinsurance agreement with CareSource effective January 1, 2020, which ceded all risk for our Kentucky Medicaid contract.

Premiums revenue

•	Retail segment premiums increased $8.1 billion, or 16.9%, from 2018 to 2019 period primarily due to Medicare Advantage membership growth and higher per member premiums, as well as increased state-based contracts membership. These favorable items were partially offset by the decline in membership in our stand-alone PDP offerings.

Benefits expense

•

The Retail segment benefit ratio of 86.4% for 2019 increased 130 basis points from 85.1% in 2018 primarily due to the suspension of the health insurance industry fee in 2019 which was contemplated in the pricing and benefit design of our products, lower favorable prior-period medical claims reserve development, as well as the shift in Medicare membership mix due to the loss of stand-alone PDP members and the significant growth in Medicare Advantage members. These increases were partially offset by engaging our Medicare Advantage members in clinical programs as well as ensuring they are appropriately documented under the CMS risk adjustment model, lower than expected medical costs as compared to the assumptions used in the pricing of our individual Medicare Advantage business for 2019, and the impact of a less severe flu season experienced in the first quarter of 2019 compared to that in the first quarter of 2018.

•	The Retail segment’s benefits expense for 2019 included the beneficial effect of $386 million in favorable prior-year medical claims reserve development versus $398 million in 2018. This favorable prior-year medical claims reserve development decreased the Retail segment benefit ratio by approximately 70 basis points in 2019 versus approximately 80 basis points in 2018.

Operating costs

•

The Retail segment operating cost ratio of 9.4% for 2019 decreased 170 basis points from 11.1% in 2018 primarily due to the suspension of the health insurance industry fee in 2019, as well as scale efficiencies associated with growth in our Medicare Advantage membership, and significant operating cost efficiencies in 2019 driven by previously implemented productivity initiatives. These improvements were partially offset by the strategic investments in our integrated care delivery model, the impact of higher compensation expense accruals in 2019 for the AIP as a result of our continued strong performance, and increased spending associated with the Medicare AEP.

•	The non-deductible health insurance industry fee increased the operating cost ratio by approximately 190 basis points in 2018.

Group and Specialty Segment

								Change
		2019			2018			Members			Percentage
Membership:
Medical membership:
Fully-insured commercial group		908,600			1,004,700			(96,100	)		(9.6	)%
ASO		529,200			481,900			47,300			9.8	%
Military services		5,984,300			5,928,600			55,700			0.9	%
Total group medical members		7,422,100			7,415,200			6,900			0.1	%
Specialty membership (a)		5,425,900			6,072,300			(646,400	)		(10.6	)%

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

										Change
		2019				2018				Dollars				Percentage
		(in millions)
Premiums and Services Revenue:
Premiums:
Fully-insured commercial group		$	5,123			$	5,444			$	(321	)		(5.9	)%
Specialty		1,571				1,359				212				15.6	%
Total premiums		6,694				6,803				(109		)		(1.6	)%
Services		790				835				(45		)		(5.4	)%
Total premiums and services revenue		$	7,484			$	7,638			$	(154	)		(2.0	)%
Segment earnings		$	28			$	361			$	(333	)		(92.2	)%
Benefit ratio		86.0		%		79.7		%						6.3	%
Operating cost ratio		22.0		%		23.6		%						(1.6	)%

Segment Earnings

•

Group and Specialty segment earnings were $28 million in 2019, a decrease of $333 million, or 92.2%, from $361 million in 2018 primarily due to a higher benefit ratio, along with lower military services business earnings. Earnings comparisons related to the military services business were unfavorably impacted by the receipt of certain contractual incentives and adjustments in 2018 related to the previous TRICARE contract which did not recur in 2019. These decreases were partially offset by the improvement in the operating cost ratio as more fully described below.

Enrollment

•

Fully-insured commercial group medical membership decreased 96,100 members, or 9.6% from 1,004,700 members as of December 31, 2018 primarily reflecting lower membership in small group accounts due in part to more small group accounts selecting level-funded ASO products in 2019, as well as the loss of certain large group accounts due to the competitive pricing environment. The portion of group fully-insured commercial medical membership in small group accounts was approximately 59% at December 31, 2019 and 61% at December 31, 2018.

•	Group ASO commercial medical membership increased 47,300 members, or 9.8%, from 481,900 members as of December 31, 2018 to 529,200 members as of December 31, 2019 reflecting more small group accounts selecting level-funded ASO products in 2019, partially offset by the loss of certain large group accounts as a

result of continued discipline in pricing of services for self-funded accounts amid a highly competitive environment.

•

Military services membership increased 55,700 members, or 0.9%, from 5,928,600 members as of December 31, 2018 to 5,984,300 members as of December 31, 2019. Membership includes military service members, retirees, and their families to whom we provide healthcare services under the current T2017 TRICARE East Region contract. The current contract, which covers thirty-two states, became effective on January 1, 2018.

•	Specialty membership decreased 646,400 members, or 10.6%, from 6,072,300 as of December 31, 2018 to 5,425,900 members as of December 31, 2019 primarily due to the loss of certain group accounts, including one jumbo account, offering stand-alone dental and vision products.

Premiums revenue

•

Group and Specialty segment premiums decreased $109 million, or 1.6%, from $6.8 billion in 2018 to $6.7 billion in 2019, primarily due to a decline in our fully-insured group commercial and specialty membership as well as the exit of our voluntary benefit and financial protection products in connection with the sale of KMG in 2018. These decreases were partially offset by higher stop-loss revenues related to our level-funded ASO accounts resulting from membership growth in this product and higher per member premiums across the fully-insured business.

Services revenue

•	Group and Specialty segment services revenue decreased $45 million, or 5.4%, from 2018 to 2019 primarily due to the impact of certain contractual incentives and adjustments related to the previous TRICARE contract received in 2018, which did not recur in 2019.

Benefits expense

•

The Group and Specialty segment benefit ratio increased 630 basis points from 79.7% in 2018 to 86.0% in 2019 primarily due to the impact of the continued migration of fully-insured group members to level-funded ASO products in 2019 resulting in a membership mix transformation, the suspension of the health insurance industry fee in 2019 which was contemplated in the pricing and benefit design of our products, and unfavorable prior-year medical claims reserve development driven by provider settlements. The benefit ratio was further negatively impacted by adjustments to dental network contracted rates resulting from dental network recontracting and expansion to position the business for the future.

•

The Group and Specialty segment’s benefits expense included the unfavorable effect of $50 million in prior-year medical claims reserve development in 2019 versus the beneficial effect of $46 million in favorable prior-year medical claims reserve development in 2018. This unfavorable prior-year medical claims reserve development increased the Group and Specialty segment benefit ratio by approximately 70 basis points in 2019 while the favorable prior-year medical claims reserve development decreased the Group and Specialty segment benefit ratio by approximately 70 basis points in 2018.

Operating costs

•

The Group and Specialty segment operating cost ratio of 22.0% for 2019 decreased 160 basis points from 23.6% for 2018, primarily due to the suspension of the health insurance industry fee in 2019, significant operating cost efficiencies in 2019 driven by previously implemented productivity initiatives, as well as the exit of our voluntary benefit and financial protection products in connection with the sale of KMG in 2018, which carried a higher operating cost ratio. These improvements were offset by the higher compensation expense accruals in 2019 for the AIP as a result of our continued strong consolidated performance.

•	The non-deductible health insurance industry fee increased the operating cost ratio by approximately 160 basis points in 2018.

Healthcare Services Segment

										Change
		2019				2018				Dollars				Percentage
		(in millions)
Revenues:
Services:
Clinical care services		$	140			$	176			$	(36	)		(20.5	)%
Pharmacy solutions		186				203				(17		)		(8.4	)%
Provider services		306				228				78				34.2	%
Total services revenues		632				607				25				4.1	%
Intersegment revenues:
Pharmacy solutions		22,189				20,514				1,675				8.2	%
Provider services		2,344				1,994				350				17.6	%
Clinical care services		616				662				(46		)		(6.9	)%
Total intersegment revenues		25,149				23,170				1,979				8.5	%
Total services and intersegment revenues		$	25,781			23,777				$	2,004			8.4	%
Segment earnings		$	789			$	754			$	35			4.6	%
Operating cost ratio		96.4		%		96.3		%						0.1	%

Segment Earnings

•

Healthcare Services segment earnings were $789 million in 2019, an increase of $35 million, or 4.6%, from 2018. This increase primarily was due to higher earnings from our pharmacy operations and clinical operations, and higher earnings from Kindred at Home operations. These factors were partially offset by additional investments in new clinical assets associated with our provider services business.

Script Volume

•	Humana Pharmacy Solutions® script volumes for the Retail and Group and Specialty segment membership increased to approximately 456 million in 2019, up 3.6% versus scripts of approximately 440 million in 2018. The increase primarily reflects growth associated with higher Medicare Advantage and state-based contracts membership, partially offset by the decline in stand-alone PDP membership.

Services revenue

•	Services revenue increased $25 million, or 4.1%, from 2018 to $632 million for 2019 primarily due to revenue growth from our provider services business.

Intersegment revenues

•

Intersegment revenues increased $1.98 billion, or 8.5%, from 2018 to $25 billion for 2019 primarily due to strong Medicare Advantage membership growth, partially offset by the loss of intersegment revenues associated with the decline in stand-alone PDP membership. Intersegment revenues in 2019 were further impacted by higher revenues associated with our provider services business reflecting the previously disclosed acquisitions of MCCI and FPG.

Operating costs

•	The Healthcare Services segment operating cost ratio of 96.4% for 2019 was relatively unchanged from 96.3% for 2018.

Liquidity

Historically, our primary sources of cash have included receipts of premiums, services revenue, and investment and other income, as well as proceeds from the sale or maturity of our investment securities, and borrowings. Our primary uses of cash historically have included disbursements for claims payments, operating costs, interest on borrowings, taxes, purchases of investment securities, acquisitions, capital expenditures, repayments on borrowings, dividends, and share repurchases. Because premiums generally are collected in advance of claim payments by a period of up to several months, our business normally should produce positive cash flows during periods of increasing premiums and enrollment. Conversely, cash flows would be negatively impacted during periods of decreasing premiums and enrollment. From period to period, our cash flows may also be affected by the timing of working capital items including premiums receivable, benefits payable, and other receivables and payables. Our cash flows are impacted by the timing of payments to and receipts from CMS associated with Medicare Part D subsidies for which we do not assume risk. The use of cash flows may be limited by regulatory requirements of state departments of insurance (or comparable state regulators) which require, among other items, that our regulated subsidiaries maintain minimum levels of capital and seek approval before paying dividends from the subsidiaries to the parent. Our use of cash flows derived from our non-insurance subsidiaries, such as in our Healthcare Services segment, is generally not restricted by state departments of insurance (or comparable state regulators).

For additional information on our liquidity risk, please refer to Item 1A. – Risk Factors in this 2019 Form 10-K.

Cash and cash equivalents increased to $4.1 billion at December 31, 2019 from $2.3 billion at December 31, 2018. The change in cash and cash equivalents for the years ended December 31, 2019, 2018 and 2017 is summarized as follows:

	2019				2018				2017
	(in millions)
Net cash provided by operating activities	$	5,284			$	2,173			$	4,051
Net cash used in investing activities	(1,278		)		(3,087		)		(2,941		)
Net cash used in financing activities	(2,295		)		(785		)		(945		)
Increase (decrease) in cash and cash equivalents	$	1,711			$	(1,699	)		$	165

Cash Flow from Operating Activities

The change in operating cash flows over the three year period primarily results from the corresponding change in the timing of working capital items, earnings, and enrollment activity as discussed below. The increase in operating cash flows in 2019 reflect the significant impacts of increasing premiums and enrollment, as premiums generally are collected in advance of claim payments by a period of up to several months, higher earnings, the timing of other working capital items, and the impact of an approximately $245 million payment related to reinsuring certain voluntary benefit and financial protection products to a third party in connection with the sale of KMG in 2018.

The decrease in operating cash flows in 2018 primarily was due to the receipt of the merger termination fee in 2017, net of related expenses and taxes paid, funding the reinsurance of certain voluntary benefit and financial protection products to a third party in connection with the sale of KMG in 2018 and the timing of working capital items.

The most significant drivers of changes in our working capital are typically the timing of payments of benefits expense and receipts for premiums. We illustrate these changes with the following summaries of benefits payable and receivables.

The detail of benefits payable was as follows at December 31, 2019, 2018 and 2017:

													Change
	2019				2018				2017				2019				2018
	(in millions)
IBNR (1)	$	4,150			$	3,361			$	3,154			$	789			$	207
Reported claims in process (2)	628				617				614				11				3
Other benefits payable (3)	1,226				884				900				342				(16		)
Total benefits payable	$	6,004			$	4,862			$	4,668			1,142				194
Payables from disposition																	58
Change in benefits payable per cash flow statement resulting in cash from operations													$	1,142			$	252

(1)

IBNR represents an estimate of benefits payable for claims incurred but not reported (IBNR) at the balance sheet date and includes unprocessed claim inventories. The level of IBNR is primarily impacted by membership levels, medical claim trends and the receipt cycle time, which represents the length of time between when a claim is initially incurred and when the claim form is received and processed (i.e. a shorter time span results in a lower IBNR). IBNR includes unprocessed claims inventories.

(2)	Reported claims in process represents the estimated valuation of processed claims that are in the post claim adjudication process, which consists of administrative functions such as audit and check batching and handling, as well as amounts owed to our pharmacy benefit administrator which fluctuate due to bi-weekly payments and the month-end cutoff.

(3)	Other benefits payable include amounts owed to providers under capitated and risk sharing arrangements.

The increase in benefits payable in 2019 and 2018 was primarily due to an increase in IBNR, mainly as a result of Medicare Advantage membership growth. In addition, 2019 was impacted by an increase in the amounts owed to providers under capitated and risk sharing arrangements.

The detail of total net receivables was as follows at December 31, 2019, 2018 and 2017:

													Change
	2019				2018				2017				2019				2018
	(in millions)
Medicare	$	835			$	836			$	511			$	(1	)		$	325
Commercial and other	162				135				273				27				(138		)
Military services	128				123				166				5				(43		)
Allowance for doubtful accounts	(69		)		(79		)		(96		)		10				17
Total net receivables	$	1,056			$	1,015			$	854			41				161
Reconciliation to cash flow statement:
Change in receivables from acquisition													(12		)		—
Change in receivables disposed from sale of business													3				3
Change in receivables per cash flow statement resulting in cash used by operations													$	32			$	164

Medicare receivables are impacted by changes in revenue associated with individual and group Medicare membership changes as well as the timing of accruals and related collections associated with the CMS risk-adjustment model.

The decrease in commercial and other receivables in 2018 as compared to 2017, was due primarily to a decrease in our receivable associated with the commercial risk adjustment provision of the Health Care Reform Law. This decrease corresponds with our exit from the Individual Commercial business.

Military services receivables at December 31, 2019, 2018, and 2017 primarily consist of administrative services only fees owed from the federal government for administrative services provided under our TRICARE contracts. The 2017 balance also includes transition-in receivables under our T2017 East Region contract collected in 2018.

Many provisions of the Health Care Reform Law became effective in 2014, including the non-deductible health insurance industry fee. The annual health insurance industry fee was suspended for the calendar year 2017, but resumed in calendar year 2018.The annual health insurance industry fee was again suspended in 2019, but will resume for calendar year 2020, not be deductible for income tax purposes, and significantly increase our effective tax rate. Under current law, the health industry fee will be permanently repealed beginning in calendar year 2021. We paid the federal government annual health insurance industry fees of $1.04 billion in 2018.

In addition to the timing of payments of benefits expense, receipts for premiums and services revenues, and amounts due under the health insurance industry fee provisions of the Health Care Reform Law, other items impacting operating cash flows include income tax payments and the timing of payroll cycles.

Cash Flow from Investing Activities

Our ongoing capital expenditures primarily relate to our information technology initiatives, support of services in our provider services operations including medical and administrative facility improvements necessary for activities such as the provision of care to members, claims processing, billing and collections, wellness solutions, care coordination, regulatory compliance and customer service. Total capital expenditures, excluding acquisitions, were $736 million in 2019, $612 million in 2018, and $524 million in 2017.

In 2018, we completed the sale of our wholly-owned subsidiary KMG to CGIC. Upon closing, we funded the transaction with approximately $190 million of parent company cash contributed into KMG, subject to customary adjustments, in addition to the transfer of approximately $160 million of statutory capital with the sale. Total cash and cash equivalents, including parent company funding, disposed at the time of sale, was $805 million. See Note 3 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data

During 2018 we paid cash consideration of approximately $1.1 billion to acquire a 40% minority interest in Kindred at Home, $169 million to acquire the remaining interest in MCCI, and $185 million to acquire all of FPG, as discussed in Notes 3 and 4 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

We reinvested a portion of our operating cash flows in investment securities, primarily investment-grade fixed income securities, totaling $542 million, $221 million, and $2.4 billion, during 2019, 2018 and 2017 respectively.

Cash Flow from Financing Activities

Our financing cash flows are significantly impacted by the timing of claims payments and the related receipts from CMS associated with Medicare Part D claim subsidies for which we do not assume risk. Monthly prospective payments from CMS for reinsurance and low-income cost subsidies are based on assumptions submitted with our annual bid. Settlement of the reinsurance and low-income cost subsidies is based on a reconciliation made approximately 9 months after the close of each calendar year. Claims payments were $560 million higher than receipts from CMS associated with Medicare Part D claim subsidies for which we do not assume risk during 2019 and $653 million higher during 2018. Receipts from CMS associated with Medicare Part D claims subsidies for which we do not assume risk were $1.9 billion higher than claims payments during 2017. Our net payable for CMS subsidies and brand name prescription drug discounts was $229 million at December 31, 2019 compared to a net payable of $331 million at December 31, 2018.

Under our administrative services only TRICARE contract, health care cost payments for which we do not assume risk exceeded reimbursements from the federal government by $63 million in 2019 and reimbursements from the federal

government exceeded health care cost payments for which we do not assume risk by $38 million in 2018 and $11 million in 2017.

Claims payments associated with cost sharing provisions of the Health Care Reform Law for which we do not assume risk were $25 million in 2018. Claims payments associated with cost sharing provisions of the Health Care Reform Law for which we do not assume risk were higher than reimbursements from HHS by $44 million in 2017.

We repurchased common shares for $1.07 billion, $1.09 billion and $3.37 billion in 2019, 2018 and 2017 under share repurchase plans authorized by the Board of Directors and in connection with employee stock plans.

As discussed further below, we paid dividends to stockholders of $291 million in 2019, $265 million in 2018, and $220 million in 2017.

We entered into a commercial paper program in October 2014. Net repayments of commercial paper were $360 million in 2019 and the maximum principal amount outstanding at any one time during 2019 was $801 million. Net proceeds from the issuance of commercial paper were $485 million in 2018 and the maximum principal amount outstanding at any one time during 2018 was $923 million. Net repayments of commercial paper were $153 million in 2017 and the maximum principal amount outstanding at any one time during 2017 was $500 million.

In November 2018, we entered into a $1.0 billion term note agreement with a bank at a variable rate of interest due within one year. For a detailed discussion of our debt please refer to Note 13 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

In August 2019, we issued $500 million of 3.125% senior notes due August 15, 2029 and $500 million of 3.950% senior notes due August 15, 2049. Our net proceeds, reduced for the underwriters' discount and commission and offering expenses paid were $987 million. We used the net proceeds from this offering, together with available cash, to repay the $650 million outstanding amount due under our term note in August 2019, and the $400 million aggregate principal amount of our 2.625% senior notes due on maturity at October 1, 2019. In December 2017, we issued $400 million of 2.50% senior notes due December 15, 2020 and $400 million of 2.90% senior notes due December 15, 2022. Our net proceeds, reduced for the underwriters' discount and commission and offering expenses paid as of December 31, 2017, were $794 million. We used the net proceeds, together with available cash, to fund the redemption of our $300 million aggregate principal amount of 6.30% senior notes maturing in August 2018 and our $500 million aggregate principal amount of 7.20% senior notes maturing in June 2018 at 100% of the principal amount plus applicable premium for early redemption and accrued and unpaid interest to the redemption date, for cash totaling approximately $829 million.

The remainder of the cash used in or provided by financing activities in 2019, 2018, and 2017 primarily resulted from proceeds from stock option exercises and the change in book overdraft.

Future Sources and Uses of Liquidity

Dividends

For a detailed discussion of dividends to stockholders, please refer to Note 16 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

Stock Repurchases

For a detailed discussion of stock repurchases, please refer to Note 16 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

Debt

In February 2020, we entered into a new $1 billion term loan commitment with a bank that allows for up to three draws with the initial draw at a minimum of $300 million that matures 1 year after the first draw, subject to a 1 year extension. Following any initial draw, any unused commitments in excess of $300 million expire on June 30, 2020,

with the remaining commitments of up to $300 million available until September 30, 2020. If the initial draw has not been made by June 30, 2020, then all commitments expire on June 30, 2020. The facility fee, interest rate and financial covenants are consistent with those of our revolving credit agreement. There is no prepayment penalty.

For a detailed discussion of our debt, including our senior notes, credit agreement and commercial paper program, please refer to Note 13 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

Acquisitions and Divestiture

For a detailed discussion of our acquisitions and divestitures, please refer to Notes 3 and 4 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data

Liquidity Requirements

We believe our cash balances, investment securities, operating cash flows, and funds available under our credit agreement and our commercial paper program or from other public or private financing sources, taken together, provide adequate resources to fund ongoing operating and regulatory requirements, acquisitions, future expansion opportunities, and capital expenditures for at least the next twelve months, as well as to refinance or repay debt, and repurchase shares.

Adverse changes in our credit rating may increase the rate of interest we pay and may impact the amount of credit available to us in the future. Our investment-grade credit rating at December 31, 2019 was BBB+ according to Standard & Poor’s Rating Services, or S&P, and Baa3 according to Moody’s Investors Services, Inc., or Moody’s. A downgrade by S&P to BB+ or by Moody’s to Ba1 triggers an interest rate increase of 25 basis points with respect to $250 million of our senior notes. Successive one notch downgrades increase the interest rate an additional 25 basis points, or annual interest expense by $1 million, up to a maximum 100 basis points, or annual interest expense by $3 million.

In addition, we operate as a holding company in a highly regulated industry. Humana Inc., our parent company, is dependent upon dividends and administrative expense reimbursements from our subsidiaries, most of which are subject to regulatory restrictions. We continue to maintain significant levels of aggregate excess statutory capital and surplus in our state-regulated operating subsidiaries. Cash, cash equivalents, and short-term investments at the parent company increased to $1.4 billion at December 31, 2019 from $578 million at December 31, 2018. This increase primarily reflects insurance subsidiaries dividends, non-insurance subsidiaries' profits and net proceeds from debt issuance, partially offset by common stock repurchases, insurance subsidiaries' capital contributions, repayment of debt and capital expenditures. Our use of operating cash derived from our non-insurance subsidiaries, such as our Healthcare Services segment, is generally not restricted by Departments of Insurance (or comparable state regulatory agencies). Our regulated insurance subsidiaries paid dividends to the parent of $1.8 billion in 2019, $2.3 billion in 2018, and $1.4 billion in 2017. Refer to our parent company financial statements and accompanying notes in Schedule I - Parent Company Financial Information. The amount of ordinary dividends that may be paid to our parent company in 2020 is approximately $1 billion, in the aggregate. Actual dividends paid may vary due to consideration of excess statutory capital and surplus and expected future surplus requirements related to, for example, premium volume and product mix.

Regulatory Requirements

For a detailed discussion of our regulatory requirements, including aggregate statutory capital and surplus as well as dividends paid from the subsidiaries to the parent, please refer to Note 16 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

Contractual Obligations

We are contractually obligated to make payments for years subsequent to December 31, 2019 as follows:

		Payments Due by Period
		Total				Less than 1 Year				1-3 Years				3-5 Years				More than 5 Years
		(in millions)
Debt		$	5,700			$	700			$	1,000			$	600			$	3,400
Interest (1)		3,348				226				418				349				2,355
Operating leases (2)		501				133				215				83				70
Purchase obligations (3)		2,503				922				1,136				346				99
Future policy benefits payable and other long-term liabilities (4)		478				26				226				65				161
Total		$	12,530			$	2,007			$	2,995			$	1,443			$	6,085

(1)	Interest includes the estimated contractual interest payments under our debt agreements.

(2)

We lease facilities, computer hardware, and other furniture and equipment under long-term operating leases that are noncancelable and expire on various dates through 2046 . We sublease facilities or partial facilities to third party tenants for space not used in our operations which partially mitigates our operating lease commitments. See also Note 10 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

(3)

Purchase obligations include agreements to purchase services, primarily information technology related services, or to make improvements to real estate, in each case that are enforceable and legally binding on us and that specify all significant terms, including: fixed or minimum levels of service to be purchased; fixed, minimum or variable price provisions; and the appropriate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty.

(4)

Includes future policy benefits payable ceded to third parties through 100% coinsurance agreements as more fully described in Note 19 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data. We expect the assuming reinsurance carriers to fund these obligations and reflected these amounts as reinsurance recoverables included in other long-term assets on our consolidated balance sheet. Amounts payable in less than one year are included in trade accounts payable and accrued expenses in the consolidated balance sheet.

Off-Balance Sheet Arrangements

As of December 31, 2019, we were not involved in any special purpose entity, or SPE, transactions. For a detailed discussion of off-balance sheet arrangements, please refer to Note 17 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

Guarantees and Indemnifications

For a detailed discussion of our guarantees and indemnifications, please refer to Note 17 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

Government Contracts

For a detailed discussion of our government contracts, including our Medicare, Military, and Medicaid contracts, please refer to Note 17 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements and accompanying notes, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements and accompanying notes requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We continuously evaluate our estimates and those critical accounting policies primarily related to benefits expense and revenue recognition as well as accounting for impairments related to our investment securities, goodwill, and long-lived assets. These estimates are based on knowledge of current events and anticipated future events and, accordingly, actual results ultimately may differ from those estimates. We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements.

Benefits Expense Recognition

Benefits expense is recognized in the period in which services are provided and includes an estimate of the cost of services which have been incurred but not yet reported, or IBNR. IBNR represents a substantial portion of our benefits payable as follows:

	December 31, 2019				Percentage of Total			December 31, 2018				Percentage of Total
	(dollars in millions)
IBNR	$	4,150			69.1	%		$	3,361			69.1	%
Reported claims in process	628				10.5	%		617				12.7	%
Other benefits payable	1,226				20.4	%		884				18.2	%
Total benefits payable	$	6,004			100.0	%		$	4,862			100.0	%

Our reserving practice is to consistently recognize the actuarial best point estimate within a level of confidence required by actuarial standards. For further discussion of our reserving methodology, including our use of completion and claims per member per month trend factors to estimate IBNR, refer to Note 2 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

The completion and claims per member per month trend factors are the most significant factors impacting the IBNR estimate. The portion of IBNR estimated using completion factors for claims incurred prior to the most recent two months is generally less variable than the portion of IBNR estimated using trend factors. The following table illustrates the sensitivity of these factors assuming moderately adverse experience and the estimated potential impact on our operating results caused by reasonably likely changes in these factors based on December 31, 2019 data:

Completion Factor (a):				Claims Trend Factor (b):
Factor Change (c)		Decrease in Benefits Payable		Factor Change (c)		Decrease in Benefits Payable
(dollars in millions)
0.70%		$(308)		(3.00)%		$(270)
0.60%		$(264)		(2.75)%		$(248)
0.50%		$(220)		(2.50)%		$(225)
0.40%		$(176)		(2.25)%		$(203)
0.30%		$(132)		(2.00)%		$(180)
0.20%		$(88)		(1.75)%		$(158)
0.10%		$(44)		(1.50)%		$(135)

(a)	Reflects estimated potential changes in benefits payable at December 31, 2019 caused by changes in completion factors for incurred months prior to the most recent two months.

(b)	Reflects estimated potential changes in benefits payable at December 31, 2019 caused by changes in annualized claims trend used for the estimation of per member per month incurred claims for the most recent two months.

(c)	The factor change indicated represents the percentage point change.

The following table provides a historical perspective regarding the accrual and payment of our benefits payable, excluding military services. Components of the total incurred claims for each year include amounts accrued for current year estimated benefits expense as well as adjustments to prior year estimated accruals. Refer to Note 11 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data for Retail and Group and Specialty segment tables including information about incurred and paid claims development as of December 31, 2019, net of reinsurance, as well as cumulative claim frequency and the total of IBNR included within the net incurred claims amounts.

		2019				2018				2017
		(in millions)
Balances at January 1		$	4,862			$	4,668			$	4,563
Less: Reinsurance recoverables		(95		)		(70		)		(76		)
Balances at January 1, net		4,767				4,598				4,487
Incurred related to:
Current year		54,193				46,385				44,001
Prior years		(336		)		(503		)		(483		)
Total incurred		53,857				45,882				43,518
Paid related to:
Current year		(48,421		)		(41,736		)		(39,496		)
Prior years		(4,267		)		(3,977		)		(3,911		)
Total paid		(52,688		)		(45,713		)		(43,407		)
Reinsurance recoverable		68				95				70
Balances at December 31		$	6,004			$	4,862			$	4,668

The following table summarizes the changes in estimate for incurred claims related to prior years attributable to our key assumptions. As previously described, our key assumptions consist of trend and completion factors estimated using an assumption of moderately adverse conditions. The amounts below represent the difference between our original estimates and the actual benefits expense ultimately incurred as determined from subsequent claim payments.

	Favorable Development by Changes in Key Assumptions
	2019							2018							2017
	Amount				Factor Change (a)			Amount				Factor Change (a)			Amount				Factor Change (a)
	(dollars in millions)
Trend factors	$	(233	)		(3.1	)%		$	(229	)		(3.3	)%		$	(279	)		(2.7	)%
Completion factors	(103		)		(0.3	)%		(274		)		(0.8	)%		(204		)		(0.7	)%
Total	$	(336	)					$	(503	)					$	(483	)

(a)	The factor change indicated represents the percentage point change.

As previously discussed, our reserving practice is to consistently recognize the actuarial best estimate of our ultimate liability for claims. Actuarial standards require the use of assumptions based on moderately adverse experience, which generally results in favorable reserve development, or reserves that are considered redundant. We experienced favorable medical claims reserve development related to prior fiscal years of $336 million in 2019, $503 million in 2018, and $483 million in 2017. The table below details our favorable medical claims reserve development related to prior fiscal years by segment for 2019, 2018, and 2017.

	(Favorable) Unfavorable Medical Claims Reserve Development												Change
	2019				2018				2017				2019				2018
	(in millions)
Retail Segment	$	(386	)		$	(398	)		$	(386	)		$	12			$	(12	)
Group and Specialty Segment	50				(46		)		(40		)		96				(6		)
Individual Commercial Segment	—				(57		)		(56		)		57				(1		)
Other Businesses	—				(2		)		(1		)		2				(1		)
Total	$	(336	)		$	(503	)		$	(483	)		$	167			$	(20	)

The favorable medical claims reserve development for 2019, 2018, and 2017 primarily reflects the consistent application of trend and completion factors estimated using an assumption of moderately adverse conditions. Our favorable development for each of the years presented above is discussed further in Note 11 to the consolidated financial statements included in Item 8. – Financial Statements and Supplementary Data.

We continually adjust our historical trend and completion factor experience with our knowledge of recent events that may impact current trends and completion factors when establishing our reserves. Because our reserving practice is to consistently recognize the actuarial best point estimate using an assumption of moderately adverse conditions as required by actuarial standards, there is a reasonable possibility that variances between actual trend and completion factors and those assumed in our December 31, 2019 estimates would fall towards the middle of the ranges previously presented in our sensitivity table.

There was no benefit expense excluded from the previous table for the years ended December 31, 2019 and 2018. Benefits expense reduced by $22 million associated with future policy benefits for the year ended December 31, 2017 was excluded from the previous table.

Revenue Recognition

We generally establish one-year commercial membership contracts with employer groups, subject to cancellation by the employer group on 30-day written notice. Our Medicare contracts with CMS renew annually. Our military services contracts with the federal government and certain contracts with various state Medicaid programs generally are multi-year contracts subject to annual renewal provisions.

We receive monthly premiums from the federal government and various states according to government specified payment rates and various contractual terms. We bill and collect premium from employer groups and members in our Medicare and other individual products monthly. Changes in premium revenues resulting from the periodic changes in risk-adjustment scores derived from medical diagnoses for our membership are estimated by projecting the ultimate annual premium and recognized ratably during the year with adjustments each period to reflect changes in the ultimate premium.

Premiums revenue is estimated by multiplying the membership covered under the various contracts by the contractual rates. Premiums revenue is recognized as income in the period members are entitled to receive services, and is net of estimated uncollectible amounts, retroactive membership adjustments, and adjustments to recognize rebates under the minimum benefit ratios required under the Health Care Reform Law. We estimate policyholder rebates by projecting calendar year minimum benefit ratios for the small group and large group markets, as defined by the Health Care Reform Law using a methodology prescribed by HHS, separately by state and legal entity. Medicare Advantage products are also subject to minimum benefit ratio requirements under the Health Care Reform Law. Estimated calendar year rebates recognized ratably during the year are revised each period to reflect current experience. Retroactive membership adjustments result from enrollment changes not yet processed, or not yet reported by an employer group or the government. We routinely monitor the collectability of specific accounts, the aging of receivables, historical retroactivity trends, estimated rebates, as well as prevailing and anticipated economic conditions, and reflect any required adjustments in current operations. Premiums received prior to the service period are recorded as unearned revenues.

Medicare Risk-Adjustment Provisions

CMS utilizes a risk-adjustment model which apportions premiums paid to Medicare Advantage, or MA, plans according to health severity. The risk-adjustment model, which CMS implemented pursuant to the Balanced Budget Act of 1997(BBA) and the Benefits Improvement and Protection Act of 2000 (BIPA), generally pays more for enrollees with predictably higher costs. Under the risk-adjustment methodology, all MA 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 MA plans. Rates paid to MA plans are established under an actuarial bid model, including a process that bases our payments on a comparison of our beneficiaries’ risk scores, derived from medical diagnoses, to those enrolled in the government’s Medicare FFS program. We generally rely on providers, including certain providers in our network who are our employees, 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 phasing-in the process of calculating risk scores using diagnoses data from the Risk Adjustment Processing System, or RAPS, to diagnoses data from the Encounter Data System, or EDS. The RAPS process requires MA plans to apply a filter logic based on CMS guidelines and only submit diagnoses that satisfy those guidelines. For submissions through EDS, CMS requires MA plans to submit all the encounter data and CMS will apply the risk adjustment filtering logic to determine the risk scores. For 2019, 25% of the risk score was calculated from claims data submitted through EDS. CMS will increase that percentage to 50% in 2020 and has proposed to increase that percentage to 75% in 2021. The phase-in from RAPS to EDS could result in different risk scores from each dataset as a result of plan processing issues, CMS processing issues, or filtering logic differences between RAPS and EDS, and could have a material adverse effect on our results of operations, financial position, or cash flows. We estimate risk-adjustment revenues based on medical diagnoses for our membership. The risk-adjustment model, including CMS changes to the submission process, is more fully described in Item 1. – Business under the section titled “Individual Medicare,” and in Item 1A. - Risk Factors.

Investment Securities

Investment securities totaled $11.4 billion, or 39% of total assets at December 31, 2019, and $10.4 billion, or 41% of total assets at December 31, 2018. The investment portfolio was primarily comprised of debt securities, detailed below, at December 31, 2019 and entirely at December 31, 2018. The fair value of debt securities were as follows at December 31, 2019 and 2018:

		12/31/2019				Percentage of Total			12/31/2018				Percentage of Total
		(dollars in millions)
U.S. Treasury and other U.S. government corporations and agencies:
U.S. Treasury and agency obligations		$	354			3.1	%		$	417			4.0	%
Mortgage-backed securities		3,710				32.6	%		2,544				24.4	%
Tax-exempt municipal securities		1,463				12.9	%		2,771				26.5	%
Mortgage-backed securities:
Residential		—				—	%		55				0.5	%
Commercial		804				7.1	%		523				5.0	%
Asset-backed securities		1,093				9.6	%		985				9.4	%
Corporate debt securities		3,947				34.7	%		3,142				30.2	%
Total debt securities		$	11,371			100.0	%		$	10,437			100.0	%

Approximately 96% of our debt securities were investment-grade quality, with a weighted average credit rating of AA by S&P at December 31, 2019. Most of the debt securities that were below investment-grade were rated BB, the higher end of the below investment-grade rating scale. Tax-exempt municipal securities were diversified among general obligation bonds of states and local municipalities in the United States as well as special revenue bonds issued by municipalities to finance specific public works projects such as utilities, water and sewer, transportation, or education. Our general obligation bonds are diversified across the United States with no individual state exceeding 1% of our total debt securities. Our investment policy limits investments in a single issuer and requires diversification among various asset types.

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 December 31, 2019:

		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 millions)
	December 31, 2019
	U.S. Treasury and other U.S. government corporations and agencies:
	U.S. Treasury and agency obligations	$	48			$	—			$	23			$	—			$	71			$	—
	Mortgage-backed securities	315				(1		)		204				(2		)		519				(3		)
	Tax-exempt municipal securities	58				—				75				—				133				—
	Mortgage-backed securities:
	Residential	—				—				—				—				—				—
	Commercial	118				—				36				—				154				—
	Asset-backed securities	20				—				607				(3		)		627				(3		)
	Corporate debt securities	589				(2		)		155				—				744				(2		)
	Total debt securities	$	1,148			$	(3	)		$	1,100			$	(5	)		$	2,248			$	(8	)

Under the other-than-temporary impairment model for debt securities held, we recognize an impairment loss in income in an amount equal to the full difference between the amortized cost basis and the fair value when we have the intent to sell the debt security or it is more likely than not we will be required to sell the debt security before recovery of our amortized cost basis. However, if we do not intend to sell the debt security, we evaluate the expected cash flows to be received as compared to amortized cost and determine if a credit loss has occurred. In the event of a credit loss, only the amount of the impairment associated with the credit loss is recognized currently in income with the remainder of the loss recognized in other comprehensive income.

When we do not intend to sell a security in an unrealized loss position, potential other-than-temporary impairment is considered using a variety of factors, including the length of time and extent to which the fair value has been less than cost; adverse conditions specifically related to the industry, geographic area or financial condition of the issuer or underlying collateral of a security; payment structure of the security; changes in credit rating of the security by the rating agencies; the volatility of the fair value changes; and changes in fair value of the security after the balance sheet date. For debt securities, we take into account expectations of relevant market and economic data. For example, with respect to mortgage and asset-backed securities, such data includes underlying loan level data and structural features such as seniority and other forms of credit enhancements. A decline in fair value is considered other-than-temporary when we do not expect to recover the entire amortized cost basis of the security. We estimate the amount of the credit loss component of a debt security as the difference between the amortized cost and the present value of the expected cash flows of the security. The present value is determined using the best estimate of future cash flows discounted at the implicit interest rate at the date of purchase. The risks inherent in assessing the impairment of an investment include the risk that market factors may differ from our expectations, facts and circumstances factored into our assessment may change with the passage of time, or we may decide to subsequently sell the investment. The determination of whether a decline in the value of an investment is other than temporary requires us to exercise significant diligence and judgment. The discovery of new information and the passage of time can significantly change these judgments. The status of the general economic environment and significant changes in the national securities markets influence the determination of fair value and the assessment of investment impairment. There is a continuing risk that declines in fair value may occur and additional material realized losses from sales or other-than-temporary impairments may be recorded in future periods.

All issuers of securities we own that were trading at an unrealized loss at December 31, 2019 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 in the current markets since the time the securities were purchased. At December 31, 2019, 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 December 31, 2019. There were no material other-than-temporary impairments in 2019, 2018, or 2017.

Goodwill and Long-lived Assets

At December 31, 2019, goodwill and other long-lived assets represented 21% of total assets and 50% of total stockholders’ equity, compared to 23% and 58%, respectively, at December 31, 2018.

We are required to test at least annually for impairment at a level of reporting referred to as the reporting unit, and more frequently if adverse events or changes in circumstances indicate that the asset may be impaired. A reporting unit either is our operating segments or one level below the operating segments, referred to as a component, which comprise our reportable segments. A component is considered a reporting unit if the component constitutes a business for which discrete financial information is available that is regularly reviewed by management. We are required to aggregate the components of an operating segment into one reporting unit if they have similar economic characteristics. Goodwill is assigned to the reporting unit that is expected to benefit from a specific acquisition.

We use the one-step process to review goodwill for impairment to determine both the existence and amount of goodwill impairment, if any. Our strategy, long-range business plan, and annual planning process support our goodwill impairment tests. These tests are performed, at a minimum, annually in the fourth quarter, and are based on an evaluation of future discounted cash flows. We rely on this discounted cash flow analysis to determine fair value. However outcomes from the discounted cash flow analysis are compared to other market approach valuation methodologies for reasonableness. We use discount rates that correspond to a market-based weighted-average cost of capital and terminal growth rates that correspond to long-term growth prospects, consistent with the long-term inflation rate. Key assumptions in our cash flow projections, including changes in membership, premium yields, medical and operating cost trends, and certain government contract extensions, are consistent with those utilized in our long-range business plan and annual planning process. If these assumptions differ from actual, including the impact of the Health Care Reform Law or changes in Government rates, the estimates underlying our goodwill impairment tests could be adversely affected. Goodwill impairment tests completed in each of the last three years did not result in an impairment loss. The fair value of our reporting units with significant goodwill exceeded carrying amounts by a substantial margin. A 100 basis point increase in the discount rate would not have a significant impact on the amount of margin for any of our reporting units with significant goodwill, with the exception of our clinical and provider reporting units in our Healthcare Services segment. Our clinical and provider reporting units primarily provide services to our Retail members. A significant increase in the discount rate, decrease in the long-term growth rate, or substantial reductions in our underlying cash flow assumptions, including revenue growth rates, medical and operating cost trends, and projected operating income, could have a negative impact on the estimated fair value of these reporting units. The clinical reporting unit had a fair value of $544 million which exceeded its carrying value of $533 million by $11 million or 2%. If the discount rate increased 100 basis points, then the clinical reporting unit would incur an impairment loss of approximately $62 million. The provider reporting unit had a fair value of $2.3 billion which exceeded its carrying value of $1.3 billion by $1.0 billion or 78%. The provider reporting unit estimate of fair value relies on multiple assumptions regarding the underlying long-term cash flows, any one of which may be significantly impacted by future changes in estimates and may negatively impact fair value. The clinical and provider reporting units account for $524 million and $761 million, respectively, of goodwill. Impairment tests completed for 2019, 2018, and 2017 did not result in an impairment loss.

Long-lived assets consist of property and equipment and other finite-lived intangible assets. These assets are depreciated or amortized over their estimated useful life, and are subject to impairment reviews. We periodically review long-lived assets whenever adverse events or changes in circumstances indicate the carrying value of the asset may not be recoverable. In assessing recoverability, we must make assumptions regarding estimated future cash flows and other factors to determine if an impairment loss may exist, and, if so, estimate fair value. We also must estimate and make assumptions regarding the useful life we assign to our long-lived assets. If these estimates or their related assumptions

change in the future, we may be required to record impairment losses or change the useful life, including accelerating depreciation or amortization for these assets. There were no material impairment losses in the last three years.