Humana Inc. : Managing in a Changing Industry

Humana Inc. : Managing in a Changing Industry

Case Brief

Statement of main issue: Humana Inc. and David Jones were facing several key decisions that will have tremendous implications on the firm. Following with certain changes of health care policy and emerging trends in the U.S. health care industry, the prospect of Humana's health plan segment was bright, while the outlook of its hospitals business was bleak. Jones and Humana's management were triggered to restructure the firm so a long-term profitability could be achieved. Jones' options include modifying the integrated strategy of the day, selling hospital assets, doing a leveraged buyout, repurchasing stock, or undertaking a spinoff. Adding to the complexity of his decision, Jones must make sure his proposal will be favorable to shareholders.

Scenario and Financial Analysis Humana could dig itself a deeper hole if no restructure will undertake at a firm level. Although the integrated strategy worked well initially, Humana could not maintain and outperform the industry like Kaiser Permanente did. Unlike Kaiser who mainly employed its own physicians and only treated enrollees in Kaiser health plans, Humana hospitals also accepted patients not enrolled in its health plans. Its hospitals' sources of revenue are mainly from Medicare (26% of the revenue) and other payers (payers not registered in Humana's health plans accounted for 61% of the revenue). Humana's integrated strategy certainly created a fundamental flaw to its overall profitability. Some physicians complained that Humana charged higher services rates on other insurance plans, and they had no incentive to send their patients to Humana hospitals. Also,

Humana hospitals gain profit by expecting more patient days, which hurt health plans' profit in turn. Humana had a high medical loss ration at 85.9% in June,1992. A restructure at Humana is therefore impending.

The option of modifying the integrated strategy by adopting a new price structure for hospital services would not resolve the problem; rather, lower charges on hospital services would further pressure Humana, as it already faced a loss on Medicare patients and an increased operating costs. Also, it would be difficult for Humana to afford the $584 million Medicare recapture cost if it wants to dispose the firm's hospitals assets. Similarly, with a restriction on maintained assets of $523 million, it would be a burden to Humana to carry out a leveraged buyout.

A spinoff strategy should resolve Humana's problem and create extra value to the firm. As analyzed in exhibit 1, a multiples valuation is conducted and Humana's integrated market capitalization before spinoff is estimated at $ 3416.75 million. With a spinoff, its health plans' market capitalization is estimated at $254.8 million and hospitals' market