Humana 2003 Annual Report Download - page 34

Pending Acquisition
In December 2003, we reached a definitive agreement to purchase Ochsner Health Plan from Ochsner Clinic
Foundation having approximately 152,000 Commercial medical members, primarily in fully insured large group
accounts, and approximately 36,000 members in the Medicare+Choice program. This transaction, which is
subject to state regulatory approval, is expected to close in the second quarter of 2004.
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 financial statements and accompanying notes. We continuously evaluate our estimates and those
critical accounting policies related primarily to medical cost 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.
Medical Expense Recognition
Medical expenses are recognized in the period in which services are provided and include an estimate of the
cost of services which have been incurred but not yet reported, or IBNR. IBNR represents a substantial portion of
our medical and other expenses payable as follows:
December 31,
2003
Percentage of
Total
December 31,
2002
Percentage of
Total
(dollars in thousands)
IBNR .................... $1,034,858 81.3% $ 863,432 75.6%
Reported claims in process . . . 183,962 14.5% 197,722 17.3%
Pharmacy and other medical
expenses payable ......... 53,336 4.2% 80,977 7.1%
Total medical and other
expenses payable ......... $1,272,156 100.0% $1,142,131 100.0%
Estimating IBNR is complex, involves a significant amount of judgment and represents a material portion of
our medical and other expenses payable. Accordingly, it represents a critical accounting estimate. Changes in this
estimate can materially affect, either favorably or unfavorably, our results from operations and overall financial
position. For example, a 100 basis point, or 1 percent, change in the estimate of our medical and other expenses
payable at December 31, 2003, which represents approximately 40% of total liabilities, would require an
adjustment of approximately $13 million in a future period in which a revision in the estimate became known.
We develop our estimate for IBNR using actuarial methodologies and assumptions, primarily based upon
historical claim payment and claim receipt patterns, as well as historical medical cost trends. Depending on the
period for which incurred claims are estimated, we apply a different method in determining our estimate. For
periods prior to the most recent three months, the key assumption used in estimating our IBNR is that the
completion factor pattern remains consistent over a rolling 12-month period after adjusting for known changes in
claim inventory levels or known changes in claim payment processes. The completion factor is a calculation of
the percentage of claims incurred during a given period that have historically been adjudicated as of the reporting
period. For the most recent three months, the incurred claims are estimated primarily from a trend analysis based
upon per member per month claims trends developed from our historical experience in the preceding months,
adjusted for known changes in estimates of recent hospital and drug utilization data, provider contracting
changes, changes in benefit levels, product mix, and weekday seasonality.
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