Humana Inc.’s ( HUM - Analyst Report ) second-quarter 2012 operating earnings per share came in at $2.19, lagging the Zacks Consensus Estimate of $2.23 as well as the year-ago earnings of $2.59 per share.

The earnings decline was attributable to lower pre-tax income in the company’s Retail segment, which were partially offset by higher year-over-year earnings in the Humana’s Employer Group and Health and Well-Being Services business segments.

The operating earnings exclude expenses of about 18 cents per share related to a litigation settlement in the reported quarter and the positive impact of 15 cents and 12 cents per share in the first quarter of 2012 and the prior-year quarter, respectively, related to favorable development of prior-period medical claims reserves.

On a reported basis, Humana earned $356 million or $2.16 per share in the quarter, against $460 million or $2.71 per share in the prior-year quarter.

Consolidated revenues for the reported quarter climbed 4.0% year over year to $9.70 billion but lagged the Zacks Consensus Estimate of $9.85 billion. Revenues from premium and administrative services also increased 4.0% year over year to $9.60 billion.

Meanwhile, total medical membership increased 8.5% year over year to 11.94 million at the end of June 2012, while the total specialty membership at the end of the reported quarter rose 7.0% to 7.86 million.

Humana reported benefit expenses of $7.65 billion, up 5.3% year over year, while operating costs climbed 16.0% year over year to $1.38 billion. Alongside, depreciation and amortization expenses spiked 7.4% year over year to $73 million.

Consolidated benefit ratio, which reflects the percentage of benefit expenses in premium revenues, increased by 140 basis points to 83.5% from 82.1% in the prior-year quarter, mainly buoyed by a hike in the benefit ratio of the Retail and Employer Group segments.

The consolidated operating cost ratio, which reflects the percentage of operating costs in total revenues less investment income, increased to 14.4% from 13.0% in the prior-year quarter, primarily as a result of the adverse impact of the accounting changes for the company’s new South Region TRICARE contract.

Segment Results

Retail Segment: The retail segment includes Medicare Advantage and prescription drug plans, and individual health insurance business lines.

The segment’s pre-tax income plummeted to $367 million from $503 million in the prior-year quarter, on the heels of increased benefit and operating cost ratios.

Reported premiums and services revenue increased 16% to $6.28 billion in the reported quarter. The upside primarily resulted from 18% year-over-year growth in individual Medicare Advantage membership.

The benefit ratio was 84.1% as compared with 81.4% in the prior-year quarter. Operating cost ratio also increased 90 basis points (bps) to 10.0% in the reported quarter.

Employer Group: The employer group includes employer group coverage and group Medicare Advantage and prescription drug plans.

The segment reported pre-tax income of $114 million in the reported quarter compared to $108 million in the prior-year quarter. Meanwhile, reported premiums and services revenue increased 13% to $2.62 billion, primarily on the back of higher group Medicare Advantage membership.

The benefit ratio was 82.2% versus 81.2% in the prior-year quarter, whereas the reported operating cost ratio was 15.9%, down 90 bps from 16.8% in the year-ago quarter.

Health and Well-Being Services: Health and well-being services include pharmacy solutions, primary care services, home care services and integrated wellness services.

Pre-tax income for the segment increased substantially to $131 million from $88 million in the prior-year quarter, due to growth in the company’s pharmacy solutions business.

Reported services revenue also increased to $3.22 billion from $2.73 billion in the year-ago quarter, primarily based on the growth in the Medicare Advantage enrollment and increased utilization in the company’s mail-order pharmacy business. However, operating cost ratio decreased 80 bps to 95.2% in the reported quarter.

Financial Update

Cash flow from operations was $706 million in the quarter under review, surging from $161 million in the year-ago quarter, mainly due to changes in working capital. Humana exited the quarter with cash and cash equivalents of $3.87 billion and long-term debt of $1.62 billion.

Share Repurchase and Dividend Update

During the second quarter of 2012, Humana repurchased 1.58 million shares at an average price of $79.94 per share. As of June 30, 2012, the company had $874 million outstanding under its share repurchase program, which will expire in June 30, 2014.

On July 27, 2012, Humana paid a cash dividend of 26 cents per share to shareholders of record as of June 29, 2012.

Outlook

Humana slashed its 2012 earnings forecast to a range of $6.90–7.10 per share from its earlier forecast of $7.55–7.75 per share, mainly due to higher-than-expected benefit ratio for new Medicare Advantage policyholders as well as higher utilization rates for new and existing policyholders in the reported quarter.

The company also declared its third-quarter EPS guidance of $2.00–2.10. The guidance excludes the impact of future share repurchases.

Consolidated revenue for 2012 is expected to be in the range of $39.0–39.5 billion. Additionally, cash flow from operations is projected between $1.6–1.8 billion, while capital expenditure is anticipated to be around $375 million.

Peer Take

UnitedHealth Group Inc. ( UNH - Analyst Report ) , a rival of Humana, declared its second-quarter 2012 earnings of $1.27 per share, up 9% over the year-ago quarter.

Another peer, CIGNA Corp. ( CI - Analyst Report ) , will announce its second-quarter 2012 financial results before the market opens on August 2, 2012.

Zacks Rank

Currently, the shares of Humana carry a Zacks #3 Rank, implying a short-term Hold rating.