INDEPENDENT AUDITOR S REPORT 1 2. Statements of Financial Position 3. Statements of Activities and Changes in Unrestricted Net Assets 4

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1 SCAN Health Plan Financial Statements as of and for the Years Ended December 31, 2016 and 2015, Schedule of Expenditures of Federal Awards and Uniform Guidance Compliance Reports for the Year Ended December 31, 2016, and Independent Auditors Reports Required by Government Auditing Standards and the Uniform Guidance

2 SCAN HEALTH PLAN TABLE OF CONTENTS INDEPENDENT AUDITOR S REPORT 1 2 FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015 Statements of Financial Position 3 Statements of Activities and Changes in Unrestricted Net Assets 4 Statements of Cash Flows 5 Page Notes to Financial Statements 6 27 SCHEDULE OF EXPENDITURES OF FEDERAL AWARDS FOR THE YEAR ENDED DECEMBER 31, 2016: 28 Schedule of Expenditures of Federal Awards 29 Notes to Schedule of Expenditures of Federal Awards INDEPENDENT AUDITOR S REPORTS REQUIRED BY GOVERNMENT AUDITING STANDARDS AND THE UNIFORM GUIDANCE: 32 Independent Auditor s Report on Internal Control Over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance With Government Auditing Standards Independent Auditor s Report on Compliance for Each Major Federal Program and Report on Internal Control Over Compliance Schedule of Findings and Questioned Costs Summary Schedule of Prior Year Audit Findings 39

3 INDEPENDENT AUDITOR S REPORT Board of Directors SCAN Health Plan Long Beach, California We have audited the accompanying financial statements of SCAN Health Plan, which comprise the statements of financial position as of December 31, 2016, and the related statements of activities and changes in unrestricted net assets and cash flows for the year then ended, and the related notes to the financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

4 Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of SCAN Health Plan as of December 31, 2016, and the changes in its unrestricted net assets and its cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America. Predecessor Auditors Opinion on 2015 Financial Statements The financial statements of the Company as of and for the year ended December 31, 2015 were audited by other auditors whose report, dated April 8, 2016, expressed an unmodified opinion on those statements. Other Matters Other Information Our audit was conducted for the purpose of forming an opinion on the financial statements as a whole. The accompanying schedule of expenditures of federal awards, as required by Title 2 U.S. Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards is presented for purposes of additional analysis and is not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated, in all material respects, in relation to the financial statements as a whole. Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated April 10, 2017 on our consideration of SCAN Health Plan s internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering SCAN Health Plan s internal control over financial reporting and compliance. April 10,

5 SCAN HEALTH PLAN STATEMENTS OF FINANCIAL POSITION AS OF DECEMBER 31, 2016 AND 2015 (In thousands) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 147,956 $ 121,223 Investments 319, ,588 Premiums and other receivables net 85,219 91,831 Prepaid expenses and other current assets 1,290 1,249 Total current assets 553, ,891 PROPERTY AND EQUIPMENT Net 13,427 14,398 RESTRICTED CASH INVESTMENTS 4,504 4,060 DEPOSITS AND OTHER ASSETS 173 TOTAL ASSETS $ 571,852 $ 569,822 LIABILITIES AND UNRESTRICTED NET ASSETS CURRENT LIABILITIES: Accounts payable and accrued expenses $ 52,523 $ 42,136 Accrued payroll and related benefits 18,181 17,237 Medical claims payable 150, ,577 Unearned premiums 14,184 14,402 Total current liabilities 235, ,352 DEFERRED COMPENSATION 4,504 4,060 OTHER LIABILITIES Total liabilities 239, ,648 COMMITMENTS AND CONTINGENCIES (Note 12) UNRESTRICTED NET ASSETS 332, ,174 TOTAL LIABILITIES AND UNRESTRICTED NET ASSETS $ 571,852 $ 569,822 See notes to financial statements

6 SCAN HEALTH PLAN STATEMENTS OF ACTIVITIES AND CHANGES IN UNRESTRICTED NET ASSETS FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015 (In thousands) NET REVENUES: Medicare premiums $ 2,191,362 $ 2,116,317 Medi-Cal premiums 56,479 48,812 Grants and donations 3,695 3,743 Investment income 14,467 21,553 Total net revenues 2,266,003 2,190,425 OPERATING EXPENSES: Hospital, physicians, and other services 1,980,040 1,921,370 Medical administration expenses 11,172 10,320 Marketing, general, and administrative expenses 229, ,175 Depreciation and amortization 3,930 6,977 Total operating expenses 2,224,788 2,141,842 CHANGE IN UNRESTRICTED NET ASSETS FROM OPERATIONS 41,215 48,583 CHANGE IN UNREALIZED GAIN (LOSS) ON INVESTMENTS Net 3,665 (23,773) INCREASE IN UNRESTRICTED NET ASSETS BEFORE FUND TRANSFER 44,880 24,810 FUND TRANSFER TO SCAN GROUP (65,000) (75,000) DECREASE IN UNRESTRICTED NET ASSETS (20,120) (50,190) UNRESTRICTED NET ASSETS Beginning of year 352, ,364 UNRESTRICTED NET ASSETS End of year $ 332,054 $ 352,174 See notes to financial statements

7 SCAN HEALTH PLAN STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015 (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Decrease in unrestricted net assets $ (20,120) $ (50,190) Adjustments to reconcile decrease in unrestricted net assets to net cash and cash equivalents provided by operating activities: Depreciation and amortization 3,930 6,977 Net realized and unrealized (gain) loss on investments (11,899) 9,619 Fund transfer to SCAN Group 65,000 75,000 Loss on disposal of equipment Changes in operating assets and liabilities: Premiums and other receivables net 6,612 (14,668) Prepaid expenses and other current assets (41) (231) Deposits and other assets 173 (163) Accounts payable and accrued expenses 10,386 21,657 Accrued payroll and related benefits 944 7,238 Medical claims payable 10,623 2,049 Unearned premiums (218) 13,333 Deferred compensation Other liabilities (29) (255) Net cash provided by operating activities 65,827 70,804 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (2,981) (10,513) Purchase of short-term investments (168,258) (233,394) Proceeds from sales, maturities, and redemptions of short-term investments 197, ,703 Purchase of long-term investments (929) (997) Proceeds from sale of long-term investments Net cash provided by investing activities 25,906 87,437 CASH FLOWS FROM FINANCING ACTIVITIES Fund transfer to SCAN Group (65,000) (75,000) Net cash used in financing activities (65,000) (75,000) NET INCREASE IN CASH AND CASH EQUIVALENTS 26,733 83,241 CASH AND CASH EQUIVALENTS Beginning of year 121,223 37,982 CASH AND CASH EQUIVALENTS End of year $ 147,956 $ 121,223 See notes to financial statements

8 SCAN HEALTH PLAN NOTES TO FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2016 AND ORGANIZATION SCAN Health Plan (the Company ), a California nonprofit public benefit corporation, is a health maintenance organization providing comprehensive medical care and specialized social services to seniors and other Medicare eligible beneficiaries in California through the use of managed care arrangements. The Company was licensed by the state of California as a Health Care Service Plan pursuant to the Knox-Keene Act of 1975, as amended. Enrollment of participants in the Company s managed care plan began on March 1, Prior to December 31, 2007, the Company operated as a Medicare Advantage Organization (MAO) as mentioned below, with a special waiver as a Social Health Maintenance Organization under a national demonstration program administered by the Centers for Medicare and Medicaid Services (CMS), an agency of the federal government, in four counties of Southern California. The waiver expired on December 31, With the expiration of the aforementioned waiver, the Company continues to operate as a MAO. The Company receives substantially all of its revenue from CMS. In addition, the Company has a contract with the California Department of Health Care Services (DHCS) to serve dually eligible and dually enrolled beneficiaries in the Medicare and Medi-Cal programs in Riverside, San Bernardino and Los Angeles Counties and receives revenue from DHCS for this contract. Furthermore, the Company expanded its Medicare Advantage offerings to beneficiaries in Ventura, and San Diego counties in 2006 and 2007; San Joaquin County in 2009; and Contra Costa, Santa Clara, and San Francisco in 2010; Marin in 2014; Napa and Sonoma in The Company also receives grants from the state of California, local governments, and private foundations to provide in-home services for those individuals who are at risk of being institutionalized. SCAN Group is the sole corporate member of the Company. The Company is exempt from federal and California income taxes in accordance with Internal Revenue Code (IRC) Section 501(c)(3) and California Revenue and Taxation Code Section 23701(d), respectively. 2. REGULATORY REQUIREMENTS AND OPERATIONS Under the Knox-Keene Health Care Services Plan Act, the Company must comply with various rules and regulations, including certain tangible net equity requirements. In addition, the Company is subject to regulatory oversight by CMS, the California Department of Managed Health Care (the Department ), and the DHCS, among others. The Company is required to periodically file financial statements with regulatory agencies in accordance with various statutory accounting and reporting practices. At December 31, 2016 and 2015, the Company was compliant with the tangible net equity requirement of the Department, as the Company s required tangible net equity was $24.0 million and $23.2 million, respectively, as compared to actual tangible net equity of $332.1 million and $352.2 million, respectively. Restricted Cash Pursuant to requirements of the Knox-Keene Health Care Services Plan Act, $300,000 has been deposited and assigned to the Department as of December 31, 2016 and 2015, respectively. Interest income accrues to the Company

9 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying financial statements include the accounts of the Company and have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), including Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 958, Not-for-Profit Entities and ASC 954, Health Care Entities. FASB ASC 958 and FASB ASC 954 establish standardized external financial reporting by not-for-profit organizations and health care entities, respectively. GAAP requires not-for-profit organizations to report information regarding their financial position and activities according to three classes of net assets: Unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets, based on the existence or absence of donor-imposed restrictions. As of December 31, 2016 and 2015, the Company had no temporarily or permanently restricted net assets or contributions as there were no donor-imposed restrictions. Use of Estimates Management uses estimates and assumptions in preparing the financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities through the date of the issuance of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Receivables for Medicare risk factor adjustments in revenue recognition, reserves for health care costs, liabilities for loss contingencies, and valuation of investments are the principal areas requiring the use of estimates that require the Company to apply complex assumptions and judgments. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents primarily include highly liquid debt instruments with a remaining maturity of three months or less when purchased, as well as cash on hand and on-demand bank deposits. Investments Investments are accounted for in accordance with FASB ASC , Not-for-Profit Entities-Investments-Debt and Equity Securities. Purchases of securities are recorded at acquisition cost (including brokerage and other transaction fees). Equity securities with readily determinable fair values and all investments in debt securities are reported at fair value with realized gains included in investment income in the accompanying statements of activities and changes in unrestricted net assets. Unrealized gains and losses are included in change in unrealized gain and loss on investments, net, in the accompanying statements of activities and changes in unrestricted net assets, unless the unrealized losses are deemed to be other than temporary, in which case, the losses are recorded as realized. During the years ended December 31, 2016 and 2015, the Company did not record any realized losses for investments deemed to be other-than-temporarily impaired. Investment securities, in general, are exposed to various risks, such as interest rate, credit, and overall market volatility. Due to the level of risk associated with certain investment securities, it is reasonably possible that changes in the values of investment securities will occur in the near term and those changes could materially affect the amounts in the statements of financial position. Management reviews the Company s investments each reporting period to determine whether declines in fair value below cost are other-than-temporary. Relevant factors - 7 -

10 considered in the analysis include, but are not limited to, changes in fair value relative to market volatility, the extent and/or duration of impairment, price recovery trend, credit risk, and significant negative industry trends within the Company s total holdings. Other criteria that may indicate an other-than-temporary impairment include declarations of bankruptcy by the issuer, downgrades in credit ratings and delinquent dividends or interest payments. Upon determination that equity securities are other-than-temporarily impaired or that the Company does not have the intent and ability to hold the securities until the fair value is recovered, permanent adjustments are made to the cost basis of the investment to reflect the impairment. Adjustments are included in investment income, net. For debt securities, the Company assesses whether it has the intent to sell or will more likely than not be required to sell the security prior to recovery of the cost basis. If either condition is met, the full impairment is included in other-than-temporary impairment losses recognized in investment income, net. Otherwise, only the impairment resulting from credit deterioration is included in investment income, net. The credit component is determined by comparing the cost basis to the net present value of expected future cash flows discounted at the effective interest rate implicit in the security at the date of acquisition. Cash flow estimates for loan-backed securities are based on assumptions regarding the credit quality of the underlying collateral and prepayment timing. Cash flow estimates of corporate and other debt securities are driven by the probability of default or risk of an issuer declaring bankruptcy. US Treasury securities have no significant credit risk as these investments would not likely be settled for less than cost. Premiums and Other Receivables, Net Receivables include amounts due from thirdparty payors, such as government-sponsored health care programs (Medicare and Medi- Cal), premiums from employers, pharmacy rebates, and amounts due from members. The Company establishes an allowance for those accounts that are estimated to have credit risk (see Note 6). The Company does not believe that there is significant credit risk associated with reimbursement from government-sponsored health care programs. Policies for recording receivables relating to changes in risk adjustment factors are discussed in the revenue recognition and unearned premiums section. Property and Equipment, Net Property and equipment, net, are carried at cost less accumulated depreciation and amortization. Major betterments are capitalized while routine repairs and maintenance are expensed when incurred. Depreciation and amortization is provided on the straight-line method over the estimated useful lives of the assets as follows: Computer equipment and software Three to five years Office furniture and equipment Five years Leasehold improvements Lesser of remaining life of lease or 15 years Vehicles Five years Impairment of Long-Lived Assets Management reviews long-lived assets to be held and used in the Company s operations for impairment at least annually, or more frequently if circumstances indicate that the carrying amount of an asset may not be recoverable. If such an indicator is identified, the Company assesses by comparing the carrying amount of the asset to the sum of the undiscounted cash flows expected to result from the use of the asset and its eventual disposition. An impairment loss is recognized when the carrying - 8 -

11 amount is not recoverable. The Company measures the impairment as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Management did not record any impairment of its long-lived assets during the years ended December 31, 2016 or Performance Indicator The Company considers the change in unrestricted net assets from operations to be the Company s performance indicator. Change in unrestricted net assets from operations includes all changes in unrestricted net assets and excludes changes in unrealized loss on investments, net and fund transfers. Revenue Recognition and Unearned Premiums Generally, MAO s membership contracts with CMS, where individuals are subject to an annual election period after which members are locked into the contract and can only dis-enroll in limited circumstances. Dually eligible individuals with full or partial Medicaid benefits, however, are granted a special election period to enroll or dis-enroll at any time during the calendar year. Employer group retiree plan membership contracts are renewed on an annual basis. Certain optional membership contracts are on a monthly basis, subject to cancellation by the individual upon 30 days written notice. Under each of these types of membership contracts, revenues are recognized based on the estimated number of eligible members per month multiplied by the contracted monthly capitation rate. Medicare revenue streams are adjusted for member health status. Revenue is recorded in the month in which eligible members are entitled to health care services. Premiums received prior to the month earned are reported as unearned premiums in the financial statements. In addition to premiums paid by CMS, Medicare subscribers pay a fixed monthly premium to the Company for the plan year. Premium revenues are recognized ratably over the period in which eligible subscribers are entitled to receive covered benefits. Member premiums received prior to the month earned are reported as unearned premiums in the financial statements. The Company has an arrangement with CMS for certain Medicare products, whereby periodic changes in its risk factor adjustment scores for hierarchical condition category codes result in changes to health plan services premium revenues. CMS uses a riskadjustment model to determine the premium amount it pays for each member. The CMS risk-adjustment model apportions premiums paid to all MAO plans according to health severity and certain demographic factors. The CMS risk-adjustment model provides higher per member payments for enrollees diagnosed with certain conditions and lower payments for enrollees who are healthier. Under this risk-adjustment methodology, all MAO health plans must capture, collect, and submit certain necessary diagnosis code information from encounter data obtained from inpatient and ambulatory treatment settings to CMS within prescribed deadlines. The Company estimates risk adjustment revenues based upon the diagnosis data submitted and expected to be submitted to CMS. Risk adjustment data is subject to review by the government, including audit by regulators. Based on the Company s evaluation of estimated settlements for CMS risk factor adjustment scores, the Company recorded a receivable of $5.2 million at December 31, 2016, and is included within premiums and other receivables, net. The Company recorded a payable to CMS of $27.2 million at December 31, 2015, and is included in accounts payable and accrued expenses. Because the recorded revenue is based on the best estimate at the time, the actual payment received from CMS for risk adjustment reimbursement settlements could differ significantly from the amounts initially recognized in the financial statements. A portion of the receivable or payable for estimated settlements for CMS risk factor adjustment scores results in a related capitation expense - 9 -

12 and a receivable or payable from or to physician provider groups. The change in the Company s estimate for the risk adjustment revenues related to prior years and recorded in the years ended December 31, 2016 and 2015, was an increase to Medicare premiums of $10.4 million and $7.4 million, respectively. Net of capitation, the change in unrestricted net assets for the year ended December 31, 2016, and December 31, 2015, was an increase of $1.3 million and $2.0 million, respectively, which did not have a material impact on the Company s operating results or financial condition. Hospital, Physicians, and Other Services Health care costs for all physician services and a majority of hospital services are provided under capitated contractual agreements and are recorded in the period when members are entitled to services. For shared risk providers, the Company establishes the risk-pool fund and records claim payments based on the contracted division of financial responsibility. Providers bear the level of financial risk specified in their respective contractual agreements if mutually agreed-upon hospital utilization goals are not achieved. The Company is exposed to the possible risk that Delegated Administrators (DA) under a capitated contract may be unable to meet their financial obligations. The liability for certain delegated claims may be transferred to the Company in the event of DA insolvency or termination of a DA agreement. To manage this risk, the Company monitors the financial status of the DA network via analysis of the DA s quarterly financial statements, annual audited financial statements, and by conducting on-site audits. The Company has the contractual right to withhold a portion of capitation otherwise payable to the DA in the event that a DA becomes insolvent or terminates an agreement. This withhold is held in reserve by the Company to cover any potential transfer of delegated liabilities and was $2.4 million and $2.0 million at December 31, 2016 and 2015, respectively, and is included in medical claims payable in the accompanying statements of financial position. The Company also accepts hospital risk through contractual agreements based upon negotiated fee schedules as opposed to a fixed capitation. The cost of health care services is recognized in the period in which services are provided and includes an estimate of the cost of services that have been incurred but not yet reported (IBNR). The Company estimates IBNR using standard actuarial methodologies based upon historical data, including the period between the rendered date of service and the date claims are received and paid, denied claim activity, expected medical cost inflation, seasonality patterns, and changes in membership. The estimated service costs are determined on an accrual basis and adjusted in future periods as required. Any adjustments to the prior-period estimates are included in the current period. Such estimates are subject to the effect of changes in the regulatory environment and economic conditions. Given the inherent variability of such estimates, the actual liability could differ significantly from the amounts provided. The Company assesses the profitability of its Medicare and Medi-Cal contracts for providing health care services when operating results or forecasts indicate probable future losses. The Company establishes a premium deficiency liability in current operations to the extent that the sum of expected future costs, claim adjustment expenses, and maintenance costs exceeds related future premiums under contract. For purposes of determining premium deficiencies, contracts are grouped in a manner consistent with its method of acquiring, servicing, and measuring the profitability of such contracts. Premium deficiencies, if any, are recognized in the period the loss is determined and are classified as hospital, physicians, and other services expenses. Losses recognized as a premium deficiency result in reduction to expenses in subsequent periods, as operating losses under these contracts are charged to the liability previously established. The Company had no premium deficiency reserves as of December 31, 2016 and

13 While the ultimate amount of claims and losses paid is dependent on future developments, the Company believes the liability for medical claims payable, shared risk settlements, and other reserves included in medical claims payable in the statements of financial position are adequate to cover such costs. Medical Administration Expenses Medical administration expenses include care management for Medicare and Medi-Cal members who meet specified criteria, care coordination, disease management, and quality improvement. These expenses are recognized when incurred. Deferred Compensation The Company maintains various nonqualified retirement plans that cover certain key executives. The Company records the compensation expense related to these plans as they are earned. Contingencies The Company has regulatory matters outstanding, as discussed further in Note 12. Periodically, the Company reviews the status of all significant outstanding matters to assess the potential financial exposure. When (i) it is probable that an asset has been impaired or a liability has been incurred and (ii) the amount of the loss can be reasonably estimated, the estimated loss is recorded in the financial statements. The Company provides disclosure in the notes to the financial statements for loss contingencies that do not meet both these conditions if there is a reasonable possibility that a loss may have been incurred that would be material to the financial statements. Significant judgment is required to determine the probability that a liability has been incurred and whether such liability is reasonably estimable. Accruals made are based on the best information available at the time, which can be highly subjective. The final outcome of these matters could differ significantly from the amounts included in the accompanying financial statements. Income Taxes The Company is recognized as a tax-exempt entity under IRC Section 501(c)(3) and California Revenue Code Section 23701(d). Under FASB ASC 740, Income Taxes, the Company is required to recognize a liability for each uncertain tax position at the amount estimated to be required to settle the issues. As of December 31, 2016 and 2015, there were no liabilities recorded for uncertain tax positions. The federal income tax return has a three-year statute of limitation and the California return has a four-year statute of limitation, from the latter of a) the due date of the return or b) the date the return is filed. During this time period the income tax returns could be subject to examination. The federal income tax returns are subject to examination from 2013 through 2015 and state income tax returns are subject to examination from 2012 through Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents, restricted cash, premiums and other receivables, accounts payable and accrued expenses, and medical claims payable at December 31, 2016 and 2015, approximate fair value because of the relatively short-term nature of these instruments. Fair value for investments in debt and equity securities is generally based upon quoted market prices. Where quoted market prices were not readily available, fair values were estimated using valuation methodologies based on available and observable market information

14 Recently Adopted Accounting Pronouncements In April 2014, the FASB issued Accounting Standards Update (ASU) No , Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The amendments in this update change the criteria for reporting discontinued operations, which includes a component of an entity or a group of components of an entity, a business, or nonprofit activity. The revised definition of a discontinued operation includes those disposals of components of an entity or group of components of an entity representing a strategic shift that has (or will have) a major effect on an entity s operations and financial results. ASU No also eliminates the current requirement in US GAAP to assess continuing cash flows and continuing involvement with the disposal group. A disposal meeting the new definition is required to be reported in discontinued operations when the component of an entity or group of components of an entity meets the held for sale criteria, is actually disposed of by sale, or is disposed of through means other than a sale. The amendments require an entity to present the assets and liabilities of a disposal group that includes discontinued operations separately in the asset and liability sections of the balance sheet, for both current and prior periods. ASU No does not change the presentation guidance for the statement of activities and changes in unrestricted net assets. ASU No requires additional disclosures about discontinued operations. The new standard applies prospectively, for both public and private entities, to annual periods ending after December 15, 2016, and to annual and interim periods thereafter. As early adoption is permitted, the Company has elected to early adopt ASU No The adoption of this guidance did not have a material impact on the Company s financial statements. In August 2014, the FASB issued ASU No , Disclosure of Uncertainties About an Entity s Ability to Continue as a Going Concern. The standard requires management to perform interim and annual assessments of an entity s ability to continue as a going concern within one year of the date the financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity s ability to continue as a going concern. ASU No applies to all entities and is effective for annual and interim reporting periods ending after December 15, 2016, with early adoption permitted. The adoption of this guidance was effective as of the beginning of the Company s 2016 fiscal year and did not impact the Company s financial statements. Recently Issued Accounting Pronouncements In May 2014, the FASB issued ASU No , Revenue from Contracts with Customers. The core principle of ASU No is built on the contract between a vendor and a customer for the provision of goods and services, and attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, the standard requires five basic steps: (i) Identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. Nonpublic entities will apply the new standard for annual periods beginning after December 15, 2018, and interim periods within annual reporting periods beginning after December 15, Three basic transition methods are available full retrospective, retrospective with certain practical expedients, and a cumulative effect approach. Under the third alternative, an entity would apply the new revenue standard only to contracts that are incomplete under legacy US GAAP at the date of initial application (e.g., October 1, 2018) and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings

15 That is, prior years would not be restated and additional disclosures would be required to enable users of the financial statements to understand the impact of adopting the new standard in the current year compared to prior years that are presented under legacy US GAAP. Early adoption is permitted. The Company is currently evaluating the effect of this guidance on its statements of activities and changes in unrestricted net assets and financial position. In May 2015, the FASB issued ASU No , Financial Services Insurance (Topic 944): Disclosures about Short-Duration Contracts. The main objective of ASU No is to enhance disclosures about the liability for unpaid claims and claim adjustment expenses, specifically the development of claims, the frequency and severity of claims, and expanded disclosures about reserves that are discounted. ASU No also requires insurance entities, such as the Company, to disclose information about significant changes in methodologies and assumptions used to calculate the liability for unpaid claims and claim adjustment expenses, including reasons for the change and effects on the financial statements. For nonpublic entities, the amendments in ASU No are effective for annual reporting periods beginning after December 15, 2016, and interim reporting periods within annual reporting periods beginning after December 15, Early adoption is permitted. The Company is currently evaluating the effect of this guidance on its statements of activities and changes in unrestricted net assets and financial position. In January 2016, the FASB issued ASU No , Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee). The amendments in this Update also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition the amendments in this update eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities and the requirement for to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities. For nonpublic business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact of this statement on its financial statements. In February 2016, the FASB issued ASU No , Leases. The new standard establishes a right of use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the consolidated financial statements, with certain practical expedients available. While the Company is still evaluating the impact of the pending adoption of the new standard on its consolidated financial statements, the Company expects that upon adoption it will recognize ROU assets and lease liabilities and that the amounts could be material

16 4. MEDICARE PART D The Company is a plan sponsor offering Medicare Part D prescription drug insurance coverage under a contract with CMS. The Company s Medicare Part D benefit design includes both the basic Medicare Part D benefit (the Defined Standard Benefit ) and a supplemental benefit. For the basic Medicare Part D benefit, the Company is responsible for approximately 75% of each Medicare beneficiary s drug costs up to an initial annual coverage limit of $3,310 per member. The supplemental benefit, for which the Company receives no Medicare Part D reimbursement, generally (i) fills each member s annual coverage gap between $3,310 and approximately $7,515 with generic drug coverage and (ii) reduces the member s deductible/copay/coinsurance below the levels specified by the Defined Standard Benefit. Under the Medicare Part D program, there are seven separate elements of payment received by the Company during the plan year. These payment elements are as follows: CMS Premium CMS pays a fixed monthly premium per member to the Company for the entire plan year, risk-adjusted based on an individual member s health. Member Premium Certain members pay a fixed monthly premium to the Company for the entire plan year in addition to the CMS premium. Low-Income Premium Subsidy For qualifying low-income members, CMS will reimburse the Company, on the member s behalf, some or all of the member s monthly premiums depending on the member s income level in relation to the federal poverty level. Catastrophic Reinsurance Subsidy CMS will reimburse the Company a prospective cost reimbursement amount monthly of approximately 80% of the costs incurred by individual members in excess of the individual annual out-of-pocket maximum of $4,850 and $4,700 for 2016 and 2015, respectively. Subsequent to the end of the plan year, a settlement payment is made between CMS and the Company based on actual claims experience. The Company s catastrophic reinsurance subsidy balance as of December 31, 2016, was a net payable to CMS of $14.9 million, and is included in medical claims payable. The Company s catastrophic reinsurance subsidy balance as of December 31, 2015, was a net receivable from CMS of $12.2 million and is included in premiums and other receivables, net. Low-Income Member Cost-Sharing Subsidy (LICS) For qualifying low-income members, CMS will reimburse the Company, on the member s behalf, some or all of a member s cost-sharing amounts, such as deductibles and coinsurance, depending on the member s income level in relation to the Federal Poverty Level. CMS pays the Company a prospective LICS amount monthly. The Company administers and pays the subsidized portion of the claims on behalf of CMS, and a settlement payment is made between CMS and the Company based on actual claims experience, subsequent to the end of the plan year. The Company s LICS balance as of December 31, 2016, was a net payable to CMS of $2.0 million and is included in medical claims payable, net. The Company s LICS balance as of December 31, 2015, was a net receivable from CMS of $1.0 million and is included in premiums and other receivables, net

17 Coverage Gap Discount Program (CGDP) Effective January 1, 2011, CMS provides discounts of 50% on brand name prescription drugs to applicable Medicare beneficiaries in the coverage gap. Subsequent to the end of the plan year, a settlement payment is made between CMS and the Company based on actual discount amounts made available to each Medicare Part D member. The Company s CGDP balance as of December 31, 2016 and 2015, was a net payable to CMS of $4.7 million and $2.8 million, respectively, and is included in medical claims payable. CMS Risk Share If the Defined Standard Benefit cost of any Medicare Part D plan varies more than 5% above or below the level estimated in the original bid submitted by the Company and approved by CMS, there is a risk-share settlement with CMS that is settled subsequent to the end of the plan year. The Company s cost experience under the Defined Standard Benefit was lower than the bid which resulted in a risk-share payable to CMS. Settlement of the total amount payable occurs approximately nine months after the end of the contract year. The Company s riskshare balance as of December 31, 2016 and 2015, was a net payable to CMS of $10.8 million and $12.1 million, respectively, and is included in unearned premiums. The CMS premium, the member premium, and the low-income premium subsidy represent payments for the Company s insurance risk coverage under the Medicare Part D program and, therefore, are recorded in Medicare premium revenues in the statements of activities and changes in unrestricted net assets for the years ended December 31, 2016 and Premium revenues are recognized ratably over the period in which eligible individuals are entitled to receive prescription drug benefits. Premium payments received in advance of the applicable service period are recorded as unearned premiums. The risk share adjustment, if any, is recorded as an adjustment to premium revenues and other receivables or liabilities. Pharmacy benefit costs and general administrative costs, under the contract where the Company has assumed insurance risk, are expensed as incurred and are recognized in hospital, physicians, and other services or marketing, general, and administrative expenses, respectively, in the statements of activities and changes in unrestricted net assets. The catastrophic reinsurance subsidy, LICS, and CGDP represent cost reimbursements under the Medicare Part D program. The Company is fully reimbursed by CMS for costs incurred for these contract elements, and accordingly, there is no insurance risk to the Company

18 5. INVESTMENTS Investments are recorded at fair value and consist of the following as of December 31, 2016 and 2015 (in thousands): As of December 31, Investments current: US government and agency obligations $ 57,584 $ 40,285 Corporate bonds 48,557 52,521 Corporate equity securities 25,583 44,961 Mortgage-backed securities 100,020 82,027 Asset-backed securities 19,634 42,641 Mutual funds 57,460 64,050 Commingled funds 10,318 10,103 Total investments current 319, ,588 Investments long term mutual funds 4,504 4,060 Total $ 323,660 $ 340,648 At December 31, 2016 and 2015, mutual funds are primarily invested in domestic and foreign equity securities and commingled funds are invested in foreign equity securities. Investments internally restricted for use in the Company s various nonqualified deferred retirement plans amounted to $4.5 million and $4.0 million at December 31, 2016 and 2015, respectively, and are included in long term investments in the accompanying statements of financial position. The composition of investment income includes the following for the years ended December 31, 2016 and 2015 (in thousands): For the years ended December 31, Interest $ 5,206 $ 5,951 Dividends 2,034 2,665 Realized gains net 8,247 14,154 Investment management fee (1,020) (1,217) $ 14,467 $ 21,

19 The following tables show the unrealized losses and fair value of the Company s investments at December 31, 2016 and 2015, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position. Unrealized losses on investments as of December 31, 2016, are as follows (in thousands): Unrealized Losses Unrealized Losses Less Than 12 Months 12 Months or Greater Total Unrealized Unrealized Unrealized Fair Value Value Fair Value Value Fair Value Value US government and agency obligations $ 28,125 $ (517) $ 2,599 $ (11) $ 30,724 $ (528) Corporate bonds 18,256 (173) 2,445 (25) 20,701 (198) Corporate equity securities 2,969 (256) 329 (69) 3,298 (325) Mortgage-backed securities 35,188 (346) 26,543 (559) 61,731 (905) Asset-backed securities 5,547 (19) 1,217 (19) 6,764 (38) Mutual funds 6,506 (190) 19,111 (1,370) 25,617 (1,560) Total investments $ 96,591 $ (1,501) $ 52,244 $ (2,053) $ 148,835 $ (3,554) Unrealized losses on investments as of December 31, 2015, are as follows (in thousands): Unrealized Losses Unrealized Losses Less Than 12 Months 12 Months or Greater Total Unrealized Unrealized Unrealized Fair Value Value Fair Value Value Fair Value Value US government and agency obligations $ 37,401 $ (124) $ - $ - $ 37,401 $ (124) Corporate bonds 34,379 (408) 6,767 (194) 41,146 (602) Corporate equity securities 11,927 (1,358) 1,843 (613) 13,770 (1,971) Mortgage-backed securities 39,212 (248) 14,526 (336) 53,738 (584) Asset-backed securities 25,765 (148) 9,460 (312) 35,225 (460) Mutual funds 12,903 (1,428) 13,082 (4,491) 25,985 (5,919) Total investments $ 161,587 $ (3,714) $ 45,678 $ (5,946) $ 207,265 $ (9,660) The unrealized losses on the Company s investments are considered temporary in nature. For fixed income securities, the change in market value has resulted from fluctuating interest rates, rather than a deterioration of the credit worthiness of the issuers. The equity securities are subject to short term fluctuations of the stock market. Given the equity portfolio s longer term horizon and its well diversified nature, we believe these losses are temporary as well. Approximately 46% and 61% of the Company s fair value of investments were in a loss position at December 31, 2016 and 2015, respectively