C ONSOLIDATED F INANCIAL S TATEMENTS AND S UPPLEMENTARY I NFORMATION. Saint Elizabeth Medical Center, Inc. For the Year Ended December 31, 2016

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1 C ONSOLIDATED F INANCIAL S TATEMENTS AND S UPPLEMENTARY I NFORMATION Saint Elizabeth Medical Center, Inc. For the Year Ended December 31, 2016

2 Consolidated Financial Statements and Supplementary Information For the Year Ended December 31, 2016 Contents Report of Independent Auditors Consolidated Financial Statements Consolidated Balance Sheets...1 Consolidated Statements of Operations and Changes in Net Assets...3 Consolidated Statements of Cash Flows...4 Notes to Consolidated Financial Statements...5 Supplementary Information Details of Consolidating Balance Sheets...48 Details of Consolidating Statements of Operations and Changes in Net Assets... 49

3 Independent Auditor's Report To the Board of Trustees Saint Elizabeth Medical Center, Inc. We have audited the accompanying consolidated financial statements of Saint Elizabeth Medical Center, Inc. and its subsidiaries, which comprise the consolidated balance sheet as of, and the related consolidated statements of operations and changes in net assets and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated 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 consolidated 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 consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the consolidated 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 consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinions. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Saint Elizabeth Medical Center, Inc. and its subsidiaries as of and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.

4 To the Board of Trustees Saint Elizabeth Medical Center, Inc. Other Matter Our audit was conducted for the purpose of forming an opinion on the consolidated financial statements that collectively comprise Saint Elizabeth Medical Center, Inc. and its subsidiaries' consolidated financial statements. The additional information consisting of the consolidating balance sheet and consolidating statements of operations and changes in net assets is presented for the purpose of additional analysis and is not a required part of the basic consolidated 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 consolidated financial statements. The information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the consolidated financial statements or to the basic consolidated 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 basic consolidated financial statements as a whole. April 4, 2017

5 Consolidated Balance Sheets Assets Current assets: Cash and cash equivalents 30,686 December 31 December (In Thousands) $ $ 22,029 Patient accounts receivable, net of allowance for doubtful accounts (2016 $9,648 and 2015 $8,274) 124, ,610 Inventories and supplies 25,447 22,777 Prepaid expenses and other current assets 19,820 23,976 Total current assets 200, ,392 Cash and cash equivalents-restricted (Note 1) 56,046 49,806 Assets limited as to use (Note 2) 896, ,609 Property, plant and equipment, net (Note 4) 434, ,013 Goodwill (Note 5) 17,651 13,162 Intangible assets (Note 5) 10,846 5,001 Foundation pledge receivables 2,922 3,777 Other assets 14,774 19,718 Total assets $ 1,634,632 $ 1,508,478 1

6 Consolidated Balance Sheets Liabilities and net assets Current liabilities: Accounts payable 62,087 December 31 December (In Thousands) $ $ 55,063 Accrued employee compensation 74,405 72,982 Accrued interest Accrued third-party settlements 12,286 13,173 Deferred revenue 6,641 6,563 Other current liabilities 7,768 13,304 Current portion of long-term debt (Note 6) 5,035 4,775 Total current liabilities 169, ,700 Long-term debt (Note 6) 199, ,866 Liability for self-insurance 63,989 61,631 Accrued pension liability (Note 9) 167, ,815 Fair value of interest rate swap (Note 6) 4,194 4,753 Other long-term liabilities 8,424 11,133 Total liabilities 612, ,898 Net assets: Unrestricted 1,016, ,665 Temporarily restricted 5,866 5,277 Total net assets excluding noncontrolling interest 1,022, ,942 Noncontrolling interest (497) (362) Total net assets 1,022, ,580 Total liabilities and net assets $ 1,634,632 $ 1,508,478 See accompanying notes. 2

7 Consolidated Statements of Operations and Changes in Net Assets Year Ended December 31 December (In Thousands) Patient service revenue, net of contractual provisions and discounts $ 1,180,732 $ 1,103,081 Provision for bad debts (39,477) (39,602) Net patient service revenue less provision for bad debts 1,141,255 1,063,479 Net assets released from restriction for operations Other revenue 31,657 44,998 Total revenue 1,173,639 1,109,131 Expenses: Salaries and wages 543, ,246 Employee benefits 135, ,882 Purchased services 72,581 77,977 Interest 5,835 5,892 Depreciation and amortization 67,644 63,141 Supplies 190, ,457 Other 92,459 84,340 Total expenses 1,108,385 1,058,935 Operating income 65,254 50,196 Unrestricted contributions Other gains (losses), net (Note 2) 48,529 (7,565) Excess of revenue over expenses 114,190 42,738 Excess of expenses over revenue attributable to noncontrolling interest (135) (118) Excess of revenue over expenses attributable to St. Elizabeth Medical Center, Inc. 114,325 42,856 Unrestricted net assets: Pension change other than net periodic costs (Note 9) 6,201 9,068 Other (79) (79) Net assets released from restriction for capital Increase in unrestricted net assets attributable to St. Elizabeth Medical Center, Inc. 120,990 52,121 Temporarily restricted net assets: Restricted contributions 1,859 2,435 Net assets released from restriction (1,270) (930) Increase in temporarily restricted net assets attributable to St. Elizabeth Medical Center, Inc ,505 Increase in net assets attributable to St. Elizabeth Medical Center, Inc. 121,579 53,626 Non-controlling interest: Excess of expenses over revenue attributable to noncontrolling interest (135) (118) Decrease in net assets attributable to noncontrolling interest (135) (118) Increase in net assets 121,444 53,508 Net assets at beginning of period 900, ,072 Net assets at end of period $ 1,022,024 $ 900,580 See accompanying notes. 3

8 Consolidated Statements of Cash Flows Year Ended December 31 December (In Thousands) Operating activities and gains Increase in net assets $ 121,444 $ 53,508 Adjustments to reconcile increase in net assets to net cash provided by operating activities and gains (losses): Depreciation and amortization 67,644 63,047 Amortization of bond premium/discount and issuance costs (901) 94 Provision for bad debts 39,477 39,602 Interest and dividends received on long-term investments (17,660) (16,681) Net unrealized and realized (gains) losses on long-term investments (39,524) 26,763 Change in pension other than net periodic costs (6,201) (9,068) Change in fair value of interest rate swap (559) 180 Loss on defeasance of long-term debt 12,257 Changes in operating assets and liabilities: Patient accounts receivable (49,827) (39,932) Inventory, supplies, prepaid expenses and other current assets 1,487 (6,147) Other assets 5,801 2,679 Accounts payable 7,025 (3,639) Other liabilities (25,294) 17,110 Net cash provided by operating activities and gains 115, ,516 Investing activities Change in assets limited to use, net (20,797) (45,945) Expenditures for property, plant, and equipment (78,262) (84,523) Cash restricted for property, plant, and equipment released (6,240) (45,473) Asset purchase acquisitions (17,560) (4,681) Net cash used in investing activities (122,859) (180,622) Financing activities Proceeds from long-term debt 118,493 60,000 Payments on long-term debt (102,146) (3,575) Net cash provided by financing activities 16,347 56,425 Increase in cash and cash equivalents 8,657 3,319 Cash and cash equivalents at beginning of period 22,029 18,710 Cash and cash equivalents at end of period $ 30,686 $ 22,029 See accompanying notes. 4

9 Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies Organization and Mission Saint Elizabeth Medical Center, Inc. (St. Elizabeth Healthcare or SEH) is a Kentucky Corporation founded by the Franciscan Sisters of the Poor in Sponsorship of St. Elizabeth Healthcare was transferred in 1973 to the Roman Catholic Diocese of Covington, Kentucky. St. Elizabeth Healthcare is comprised of Saint Elizabeth Hospitals and Summit Medical Group, doing business as St. Elizabeth Physicians. St. Elizabeth Healthcare has major facilities in Covington, Edgewood, Florence, Fort Thomas, Falmouth, Williamstown, and Owenton Kentucky. St. Elizabeth Healthcare s primary mission is to provide health care services to the residents of Northern Kentucky and the Cincinnati metropolitan region. All significant intercompany balances and transactions have been eliminated in consolidation. St. Elizabeth Physicians (SEP) has approximately 165 full-time equivalent primary care physicians, 117 full-time equivalent specialty physicians, and 87 advanced practice providers operating in 106 offices throughout Northern Kentucky, Ohio, and Indiana. St. Elizabeth Physicians performs most of the physician billings for St. Elizabeth Healthcare s hospital facilities. SEP Maysville Diagnostic Center (SEP MDC) is a radiological services joint venture between SEP and 15 physicians that was formed on September 4, SEP is the 51 percent majority partner of this joint venture and has a controlling interest in SEP MDC; therefore, SEP MDC is consolidated in SEP. The consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for the fair presentation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP) as of December 31, 2016 and 2015 and for the years ended. Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. 5

10 1. Summary of Significant Accounting Policies (continued) Cash and Cash Equivalents Cash equivalents include investments with a maturity of three months or less when acquired or purchased, excluding amounts whose use is limited by Board designation or other arrangements under trust agreements. Cash and money market accounts are covered by the FDIC up to $250,000, mutual funds by the SPIC up to $500,000, and all treasury securities are automatically backed by the United States Government; however, the majority of St. Elizabeth Healthcare funds are not covered by these. Restricted Cash The bonds issued by St. Elizabeth Healthcare during the years ended require amounts to be set aside for the purpose of financing acquisition, construction, installation and equipping of facilities suitable for use by SEH as healthcare and health related facilities. These amounts have been classified as restricted cash on the consolidated balance sheets. Inventories Inventories consist of medical, pharmaceutical, and other supplies; quantities are determined by physical count and priced at the lower of cost or market. Cost is determined on the first-in, firstout method. Assets Limited as to Use and Investment Income Assets limited as to use consist of investments in equity securities with readily determinable fair values and all investments in debt securities are carried at fair value, as determined by quoted market sources, on the consolidated balance sheets. Hedge fund of funds, real estate funds, private equity funds, infrastructure funds, and emerging markets funds are valued at the net asset value provided by the administrator of the fund. Investment income or loss (including unrealized gains and losses on trading securities and realized gains and losses on investments, interest, and dividends) is included within excess of revenue over expenses unless the income or loss is restricted by donor or law. Substantially all investments are classified as trading securities. Fair Value Measurements St. Elizabeth Healthcare follows the provisions of Accounting Standard Codification (ASC) 820, Fair Value Measurement and Disclosure, which defines fair value as the price that would be 6

11 1. Summary of Significant Accounting Policies (continued) received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date and establishes a framework for measuring fair value. ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement; therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing an asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820 defines a three-level fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity and the reporting entity s own assumptions about market participants. The fair value hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows: Level 1 inputs utilize quoted market prices in active markets for identical assets or liabilities that St. Elizabeth Healthcare has the ability to access. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset and liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which is typically based on an entity s own assumptions, as there is little, if any, related market activity. In instances whereby the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. St. Elizabeth Healthcare s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. 7

12 1. Summary of Significant Accounting Policies (continued) In order to meet the requirements of ASC 820, St. Elizabeth Healthcare utilized three basic valuation approaches to determine fair value of its assets and liabilities required to be recorded at fair value. The first approach is the cost approach. The cost approach is generally the value a market participant would expect to replace the respective asset or liability. The second approach is the market approach. The market approach looks at what a market participant would consider an exact or similar asset or liability to that of St. Elizabeth Healthcare, including those traded on exchanges, to determine value. The third approach is the income approach. The income approach uses estimation techniques to determine the estimated future cash flows of St. Elizabeth Healthcare s respective asset or liability expected by a market participant and discounts those cash flows back to present value (more typically referred to as the cash flow approach). Derivative Instruments St. Elizabeth Healthcare has entered into certain interest rate swap arrangements in connection with its debt. Under ASC 815, Derivatives and Hedging, St. Elizabeth Healthcare records its derivative instruments as either assets or liabilities in the accompanying consolidated balance sheets at fair value. The remaining derivative balance in net assets to be amortized on previously designated hedges excluded from the excess of revenue over expenses was $1,138,000 and $1,207,000 at, respectively. The accumulated derivative asset on previously designated hedges is being amortized as a reduction to interest expense through 2033, which is when the swap agreement expires. As of, St. Elizabeth Healthcare reduced its interest expense by $69,000 each period for amortization of the accumulated derivative asset on previously designated hedges. The derivative obligation at was $4,194,000 and $4,753,000, respectively. The change in the fair market value of interest rate swaps is included within other gains (losses), net within excess of revenue over expenses. 8

13 1. Summary of Significant Accounting Policies (continued) Property, Plant, and Equipment and Depreciation Property, plant, and equipment is recorded at historical cost, or if donated, impaired, or acquired under a business combination, at fair market value at the date of receipt or determination. The assets are depreciated over their estimated useful lives using the straight-line method. Buildings, building services, and land improvements are depreciated over 3 to 40 years and equipment is depreciated over 3 to 20 years. Useful lives of assets are estimated by management in conjunction with the American Hospital Association s Estimated Useful Lives of Depreciable Hospital Assets. Unamortized Bond Issue Costs and Other Assets Debt issuance costs are recorded as a reduction in the recorded balance of outstanding debt. The costs are amortized over the term of the related debt and reported as a component of interest expense. Other Assets Other assets include investments in joint ventures and limited liability partnerships, which are accounted for on the equity method of accounting. Foundation Pledges Receivables Pledges received for unconditional promises to give are recorded as revenue in the year made by the donor. Pledges to give cash, marketable securities, and other assets are reported at fair value and discounted to present value at the date the pledge is made to the extent estimated to be collectible. Conditional donor promises to give and indications of intentions to give are not recognized until the condition is satisfied. Pledges received with donor restrictions that limit the use of the donated assets are reported as temporary restricted support until the donor restriction expires. 9

14 1. Summary of Significant Accounting Policies (continued) Goodwill and Intangible Assets Identifiable intangible assets subject to amortization consist primarily of exclusivity and noncompetition agreements. Amortization of the intangible assets is calculated using the straight-line method over estimated lives of the exclusivity and non-compete agreements ranging from one to twenty years. Amortization expense was $1,746,000 and $1,275,000 for the years ended December 31, 2016 and 2015, respectively, and is included in depreciation and amortization expense. St. Elizabeth Healthcare annually performs an evaluation of goodwill for impairment considering qualitative and quantitative factors. There are no indicators that an impairment loss should be recognized in Malpractice and General Liability Contingencies St. Elizabeth Healthcare maintains a policy of self-insuring its professional liability risks for individual losses up to specified amounts per claim. In addition, the self-insurance plan has specified annual aggregate limits. St. Elizabeth Healthcare carries insurance coverage for incidents that would exceed coverages specified by the self-insurance program. Because of the nature of its operations, St. Elizabeth Healthcare is, at all times, subject to pending and threatened legal actions, which arise in the normal course of its activities. Malpractice and general liability claims for incidents that may give rise to litigation have been asserted against St. Elizabeth Healthcare by various claimants. The claims are in various stages of processing and some may ultimately be brought to trial. There are also known incidents that have occurred through December 31, 2016 that may result in the assertion of additional claims. There may be other claims from unreported incidents arising from services provided to patients; however, because the annual excess insurance policy covers only claims that have been asserted and incidents reported to the insurance carrier, these unknown incidents are not yet covered by excess insurance. The liability for medical malpractice at includes estimated amounts for claims and related legal expenses for these unreported incidents. At, St. Elizabeth Healthcare s management recorded its best estimate of these contingent losses based upon recommendations of professional actuaries. Recorded malpractice and general liability self-insurance liabilities, discounted at 1.10 percent, are adequate in management s opinion. As the actuarially determined accrual for professional and general liability is an estimate, the possibility exists that the estimate could be revised by a material amount. 10

15 1. Summary of Significant Accounting Policies (continued) St. Elizabeth Healthcare established a trust for the purpose of malpractice and general liability selfinsurance liability, setting aside assets based on actuarial funding recommendations; this amount is included in assets limited as to use. St. Elizabeth Healthcare is also self-insured for workers compensation, unemployment compensation, and employee medical insurance coverage. At, St. Elizabeth Healthcare s management recorded its best estimates of known and incurred, but not reported claims for losses as determinable based on recommendations of professional actuaries. Recorded self-insured liabilities are adequate in management s opinion. Temporarily Restricted Assets Temporarily restricted assets are those whose use by St. Elizabeth Healthcare has been limited by donors to a specific time period or purpose. Some of the larger restricted assets are for the Clinical Research Institute, heart and vascular care, cancer care, women s wellness, hospice, and Vision (an associate led campaign to give back to their community and fellow associates in crisis). These funds are to cover facilities, equipment, research, education, supplies, and other specified expense. Net Patient Accounts and Net Patient Service Revenue Net patient accounts are reduced by an allowance for doubtful receivables based upon the historical collection experience of St. Elizabeth Healthcare adjusted for current environmental risks and trends for each major payor source. Amounts recognized are subject to adjustment upon review by third-party payors. Significant provision is made for self-pay patient accounts in the period of service based on past collection experience. Net patient service revenue is reported at the estimated net realizable amounts from patients, thirdparty payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Settlements are recorded on an estimated basis in the period the related services are rendered and adjusted in future periods based upon additional information, filed cost reports, interim settlements, and final settlements. St. Elizabeth Healthcare recognizes patient service revenue at the time services are rendered even though they do not assess the patient s ability to pay. As a result, the provision for bad debts and charity care is presented as a deduction from patient service revenue (net of contractual provisions and discounts). For uninsured and underinsured patients that do not qualify for charity care, St. Elizabeth Healthcare recognizes revenue when services are provided. Based on historical experience, a significant portion of St. Elizabeth Healthcare s uninsured and 11

16 1. Summary of Significant Accounting Policies (continued) underinsured patients will be unable or unwilling to pay for the services provided. Thus, St. Elizabeth Healthcare records a significant provision for bad debts related to uninsured and underinsured patients in the period the services are provided. Patient service revenue, net of contractual allowances and discounts (but before the provision for bad debts), recognized for the years ended, respectively, by major payor source, is as follows: (In Thousands) Medicare $ 394,261 $ 361,186 Medicaid 159, ,754 Anthem Blue Cross 289, ,222 Humana 53,816 53,244 United Health Care 148, ,729 Other insurance and workers compensation 103, ,319 Self-pay 30,538 26,627 Patient service revenue (net of contractual provisions and discounts) 1,180,732 1,103,081 Provision for bad debts (39,477) (39,602) Net patient service revenue less provision for bad debts $ 1,141,255 $1,063,479 Charity Care St. Elizabeth Healthcare provides care, without charge or at amounts less than its established rates, to patients who meet certain criteria under its charity care policy. Amounts determined to qualify as charity care are not reported as net patient service revenue. The cost to St. Elizabeth Healthcare to provide charity care was approximately $9,220,000 and $7,774,000 for the years ended, respectively. The cost to St. Elizabeth Healthcare to provide charity care was determined through application of the ratio of patient costs to charges, per Schedule H of Form 990 filed with the Internal Revenue Service, to current-year charity care charges included as a deduction from gross patient revenue. The Affordable Care Act (ACA) was passed to provide Americans better access to health care coverage. A major component of increasing access to coverage was new federal funding for 12

17 1. Summary of Significant Accounting Policies (continued) states to expand their Medicaid eligibility to 138 percent of the Federal Poverty Level. Previously these patients qualified under the Kentucky State Indigent Program and were included in St. Elizabeth Healthcare s charity care program. As a result of Kentucky choosing to participate in the Medicaid expansion program, charity care has been lower in 2016 and 2015 and the number of patients eligible for Medicaid has increased. The percent of Medicaid net revenue to total net revenue was 14 percent in both 2016 and Federal law requires that state Medicaid programs make Disproportionate Share Hospital (DSH) payments to qualifying hospitals that serve a large number of Medicaid and uninsured individuals. Uninsured individuals qualified under the Kentucky DSH/Indigent program are reported under hospital charity. St. Elizabeth Healthcare recognized $12,615,000 and $12,551,000 for the years ended, respectively, which were recognized as an offset to charity deductions. St. Elizabeth Healthcare also paid provider tax to the State in the amounts of $12,549,000 and $12,551,000 for the years ended, respectively, and recorded these amounts to other operating expense. Kentucky uses these taxes to draw matching DSH funds from the federal government. Revenue and Expenses St. Elizabeth Healthcare s mission is to meet the health care needs of its local market area through a broad range of general and specialized health care services including inpatient acute care, outpatient services, and other health care services. Activities directly associated with the furtherance of this purpose are considered to be operating activities. Other activities that result in gains or losses unrelated to St. Elizabeth Healthcare s primary mission are considered to be nonoperating and are reported in other gains and losses, consisting primarily of investment income and contributions. Approximately 75 percent and 73 percent of St. Elizabeth Healthcare s expenses relate to health care services for the years ended, respectively. 13

18 1. Summary of Significant Accounting Policies (continued) Tax Status No provision has been made for income taxes since St. Elizabeth Healthcare is exempt from federal income taxes under Internal Revenue Code Section 501(c)(3) and is classified as other than a private foundation by the Internal Revenue Service. Management has analyzed the tax positions taken by St. Elizabeth Healthcare and has concluded that as of December 31, 2016, there are no uncertain positions taken or expected to be taken that would require recognition of a liability or disclosure in the financial statements. St. Elizabeth Healthcare is not currently under examination by the Internal Revenue Service or any state or local tax authorities. St. Elizabeth Healthcare s federal tax returns for the year ended prior to December 31, 2013 and prior years are no longer subject to examination as the statute of limitations has expired for those years. Contributions Contributions are recorded at fair value in the period received or pledged. Donor-restricted contributions are reported as temporarily restricted support if they are received with donor stipulations that limit the use of the donated assets. When a donor restriction expires, that is, when the purpose or time restriction is accomplished, temporarily restricted net assets are reclassified as unrestricted net assets and reported in the consolidated statements of operations and changes in net assets. Donor-restricted contributions whose restrictions are met within the same year as received are accounted for as unrestricted contributions. Consolidated Statements of Operations and Changes in Net Assets For purposes of presentation, transactions deemed by management to be ongoing, major, or central to the provision of health care services are reported as revenue and expenses. Other activities that result in gains or losses unrelated to St. Elizabeth Healthcare s primary mission are considered to be non-operating and are reported in other income, consisting primarily of investment income and contributions. Changes in unrestricted net assets that are excluded from the excess of revenue over expenses, consistent with industry practice, include contributions of long-lived assets, changes in plan assets and benefit obligations of the pension plans, amortization of previously hedged interest rate swaps, and the write-off of the unamortized balance on previously hedged interest rate swaps. 14

19 1. Summary of Significant Accounting Policies (continued) Recently Issued Accounting Pronouncements The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No , Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for- Profit Entities in August, ASU requires significant changes to the financial reporting model of organizations who follow FASB not-for-profit rules, including moving from three classes of net assets down to two classes, net assets with donor restrictions and net assets without donor restrictions. The ASU will also require changes in the way certain information is aggregated and reported by SEH, including required disclosures about the liquidity and availability of resources. The new standard is effective for SEH s year ending December 31, 2018 and thereafter and must be applied on a retrospective basis. Management does not expect that this standard will have a significant impact on the financial statements. In February 2016, the Financial Accounting Standards Board issued ASU , Leases, which will supersede the current lease requirements in ASC 840. The ASU requires lessees to recognize a right of use asset and related lease liability for all leases, with a limited exception for short-term leases. Leases will be classified as either finance or operating, with the classification affecting the pattern of expense recognition in the statement of operations. Currently, leases are classified as either capital or operating, with only capital leases recognized on the balance sheet. The reporting of lease related expenses in the statements of operations and cash flows will be generally consistent with the current guidance. The new lease footnote guidance will be effective for SEH s year ending December 31, 2019 and will be applied using a modified retrospective transition method to the beginning of the earliest period presented. Management expects that this new standard will significantly increase short and long-term assets and liabilities upon adoption. The effect on the results of operations is not expected to be significant. During May 2014, the Financial Accounting Standards Board released Accounting Standards Update (ASU) , Revenue from Contracts with Customers (Topic 606). The amendments in the ASU clarify the principles for recognizing revenue and develop a common revenue standard for U.S. GAAP that removes inconsistencies and weaknesses in revenue requirements, provides a more robust framework for addressing revenue issues, improves comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets, provides more useful information to users of financial statements through improved disclosure requirements, and simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer. SEH will be required to adopt and implement this accounting update as of and for the year ending December 31, Management does not expect that this standard will have a significant impact on the calculation of net patient revenue. 15

20 2. Assets Limited as to Use Saint Elizabeth Medical Center, Inc. The following is a description of the aggregate carrying amount of assets limited as to use by major type of investment carried at fair value for the different investment groupings: December 31, December 31, (In Thousands) Money market funds $ 6,860 $ 9,658 U.S. government obligations 47,494 62,424 Asset-backed securities 60,232 52,326 Corporate bonds 62,179 58,561 Municipal bonds 9,106 6,928 Foreign bonds 6,418 9,254 Government-backed securities 11,301 10,416 Federal agency bonds 493 3,955 Common stock 107,197 96,225 Mutual funds: Large cap value 68,879 50,074 Large cap core All cap core 24,104 22,448 Mid cap core 35,622 32,026 International large cap 71,670 66,077 International small cap 23,449 21,979 International emerging markets 24,147 14,492 Fixed income 54,665 50,275 Hedge fund of funds 133, ,812 Real estate funds 110,135 87,098 Emerging markets fund 39,229 34,565 Total assets limited as to use $ 896,590 $ 818,609 Assets limited as to use: Internally and board-designated for capital needs $ 835,889 $ 759,329 Designated for self-insurance needs 60,701 59,280 Total assets limited as to use $ 896,590 $ 818,609 16

21 2. Assets Limited as to Use (continued) Other gains (losses), net is comprised of the following for the years ended December 31: (In Thousands) Realized gains on sales of investments, net $ 541 $ 10,236 Interest and dividend income, net 17,660 16,681 Change in unrealized gains (losses) on investments, net 38,983 (36,999) Total investment income (loss) 57,184 (10,082) Change in fair market value of interest rate swap 559 (180) Loss on advance refunding of debt (12,257) - Other 3,043 2,697 $ 48,529 $ (7,565) 3. Assets and Liabilities Measured at Fair Value The carrying value of the hedge fund of funds, real estate funds, private equity funds, infrastructure funds, and emerging markets funds (alternative investments) is based on valuations provided by the administrators of the specific financial instruments. The underlying investments in these financial instruments may include marketable debt and equity securities, commodities, foreign currencies, derivatives, real estate and private equity investments. The underlying investments themselves are subject to various risks including market, credit, liquidity, and foreign exchange risk. St. Elizabeth Healthcare believes the carrying amount of these financial instruments in the consolidated balance sheets is a reasonable estimate of ownership interest. Since these financial instruments are not readily marketable, the estimated carrying value is subject to uncertainty and may differ from the value that would have been used had a market for such financial instruments existed. The change in the carrying value of the alternative investments is included in the other gains (losses), net within excess of revenue over expenses. Cash and Cash Equivalents and Assets Limited as to Use St. Elizabeth Healthcare s cash and cash equivalents and assets limited as to use, except for alternative investments, which are recorded at the net asset value provided by the administrator of the fund, are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of transparency. The types of instruments based on quoted market prices in active markets include common stock, mutual funds, and money market securities (cash 17

22 3. Assets and Liabilities Measured at Fair Value (continued) and cash equivalents). Such instruments are generally classified within Level 1 of the fair value hierarchy. St. Elizabeth Healthcare does not adjust the quoted price for such instruments. The types of instruments valued based on quoted prices that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most U.S. government obligations, preferred stock, investment-grade and high-yield corporate bonds, foreign bonds, and asset-backed securities. Fair values are primarily obtained from third-party pricing services for identical or comparable assets or liabilities. Such instruments are generally classified within Level 2 of the fair value hierarchy. Primarily all of St. Elizabeth Healthcare s marketable debt securities, including asset-backed obligations, are actively traded and the recorded fair value reflects current market conditions; however, due to the volatility in the investment market, there is at least a reasonable possibility that recorded investment values may change by a material amount in the near term. The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level of input that is significant to the fair value measurement in its entirety. 18

23 3. Assets and Liabilities Measured at Fair Value (continued) Following is the summary of the inputs and valuation techniques as of December 31, 2016 and 2015 used for valuing Level 2 financial instruments: Financial Instrument Input Valuation Technique Corporate and foreign bonds Broker/dealer Market Government obligations Broker/dealer Market Federal agency bonds Broker/dealer Market Municipal bonds Broker/dealer Market Government-backed securities Broker/dealer Market/income Asset-backed securities Broker/dealer Market/income Common Collective Trust Broker/dealer Market Interest Rate Swap Agreements St. Elizabeth Healthcare participates in interest rate swap agreements to manage its exposures to fluctuations in interest rates and overall long-term debt portfolio. The interest rate swap agreements are contracts between St. Elizabeth Healthcare and third parties (counterparties) that provide for economic payments between parties based on changes in notional amounts and defined interest rates. The risk of the interest swap agreements is estimated and managed on an ongoing basis by St. Elizabeth Healthcare. St. Elizabeth Healthcare s interest rate swap agreements are not traded on an exchange. The valuation of the interest rate swap agreements is determined using widely accepted valuation techniques, including a discounted cash flow analysis on the expected cash flows of each interest rate swap agreement. The discounted cash flow analysis reflects the contractual terms of the interest rate swap agreements, including the period to maturity and uses observed market-based inputs, including interest rate curves and implied volatilities. Valuation adjustments are required to be considered in the determination of fair value. This includes amounts to reflect counterparty credit quality and liquidity risk. To comply with the provisions of ASC 820, St. Elizabeth Healthcare incorporated a credit valuation adjustment to appropriately reflect nonperformance risk in the fair value measurements. Although St. Elizabeth Healthcare has determined that certain of the inputs used to value its interest rate swap agreements fall within Level 2 of the fair value hierarchy, certain inputs and the credit valuation adjustment associated with the interest rate swap agreements utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by St. Elizabeth Healthcare or the counterparties. As a result, St. Elizabeth Healthcare has determined that its interest rate swap agreements in their entirety are classified in Level 3 of the fair value hierarchy. 19

24 3. Assets and Liabilities Measured at Fair Value (continued) The following table summarizes St. Elizabeth Healthcare s assets and liabilities measured at fair value on a recurring basis as of December 31, 2016, aggregated by the level in the fair value hierarchy within which those measurements are measured: Fair Value at December 31, 2016 Fair Value Measurement Using Quoted Prices in Active Markets for Identical Assets and Liabilities (Level 1) (In Thousands) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Assets limited as to use Money market funds $ 6,860 $ 6,860 $ $ U.S. government obligations 47,494 47,494 Asset-backed securities 60,232 60,232 Corporate bonds 62,179 62,179 Municipal bonds 9,106 9,106 Foreign bonds 6,418 6,418 Government-backed securities 11,301 11,301 Federal agency bonds Common stock 107, ,197 Mutual funds: Large cap value 68,879 68,879 Large cap core All cap core 24,104 24,104 Mid cap core 35,622 35,622 International large cap 71,670 71,670 International small cap 23,449 23,449 International emerging markets 24,147 24,147 Fixed income 54,665 54,665 Assets measured at fair value levels $ 613,833 $ 416,610 $ 197,223 $ Hedge fund of funds 133,393 Real estate funds 110,135 Emerging markets fund 39,229 Total assets limited as to use $ 896,590 $ 416,610 $ 197,223 $ Fair value of interest rate swaps $ 4,194 $ $ $ 4,194 Total liabilities at fair value $ 4,194 $ $ $ 4,194 20

25 3. Assets and Liabilities Measured at Fair Value (continued) The following table summarizes St. Elizabeth Healthcare s assets and liabilities measured at fair value on a recurring basis as of December 31, 2015, aggregated by the level in the fair value hierarchy within which those measurements are measured: Fair Value at December 31, 2015 Fair Value Measurement Using Quoted Prices in Active Markets for Identical Assets and Liabilities (Level 1) (In Thousands) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Assets limited as to use Money market funds $ 9,658 $ 9,658 $ $ U.S. government obligations 62,424 62,424 Asset-backed securities 52,326 52,326 Corporate bonds 58,561 58,561 Municipal bonds 6,928 6,928 Foreign bonds 9,254 9,254 Government-backed securities 10,416 10,416 Federal agency bonds 3,955 3,955 Common stock 96,225 96,225 Mutual funds: Large cap value 50,074 50,074 Large cap core All cap core 22,448 22,448 Mid cap core 32,026 32,026 International large cap 66,077 66,077 International small cap 21,979 21,979 International emerging markets 14,492 14,492 Fixed income 50,275 50,275 Assets measured at fair value levels $ 567,134 $ 363,270 $ 203,864 $ Hedge fund of funds 129,812 Real estate funds 87,098 Emerging markets fund 34,565 Total assets limited as to use $ 818,609 $ 363,270 $ 203,864 $ Fair value of interest rate swaps $ 4,753 $ $ $ 4,753 Total liabilities at fair value $ 4,753 $ $ $ 4,753 21

26 3. Assets and Liabilities Measured at Fair Value (continued) St. Elizabeth Healthcare s policy is to recognize transfers between levels of the fair value hierarchy as of the end of the reporting period. The fair value of the emerging markets fund at December 31, 2015 was estimated based on the underlying assets within the fund, which fell within Level 2 of the fair value hierarchy. In 2016, the value of the emerging markets fund was valued based on the net asset value per share of the investment company that holds this investment. The method that St. Elizabeth used to value the emerging markets fund was changed due to new information obtained in As a result of this change, the fair value tables in 2016 and 2015 were updated. The methods described above may produce a fair value that may not be indicative of net realizable value or reflective of future fair value. Furthermore, while St. Elizabeth Healthcare believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the consolidated balance sheets date. The following table is a rollforward of the consolidated balance sheets amounts for financial instrument liabilities classified by St. Elizabeth Healthcare within Level 3 of the fair value hierarchy defined above: Fair Value Measurement Using Significant Unobservable Inputs (Level 3) Interest Rate Swaps (In Thousands) Balance at January 1 $ (4,753) $ (4,573) Change in fair market value of interest rate swaps 559 (180) Balance at December 31 $ (4,194) $ (4,753) 22

27 3. Assets and Liabilities Measured at Fair Value (continued) Investments in Entities that Calculate Net Asset Value Per Share The following description of funds is applicable to funds included in the assets limited as to use and/or the funds included in retirement plan assets in Note 9. Hedge Fund of Funds The hedge fund of funds investment is comprised of shares in the William Blair Marble Place TE Fund, L.P. (William Blair), the AQR GRP EL Offshore Fund, Ltd (AQR), and the Evanston Capital Management Weatherlow Fund I L.P. (Evanston) as of ; the Magnitude International (Magnitude) was a new investment for the year ended December 31, The fair value of the investments in this class has been estimated using the net asset value of the investments. William Blair Marble Place TE The William Blair partnership operates as a fund of funds, which is a vehicle that pursues its investment objective by investing in other investment companies. Through its investment in the hedge funds, the partnership is invested, indirectly, primarily in debt obligations, preferred stock, common stocks, warrants, futures, forward and option contracts on currencies, metals, financial instruments, stock indices, energy and agricultural commodities, and other derivative securities, many of which are likely to be speculative in character. There were no unfunded commitments at December 31, 2016 or In March 2016, the St. Elizabeth Healthcare Investment Committee voted to terminate its partnership with William Blair and redeem one hundred percent of its investment. Subsequent to this, the partnership voted to close the fund. The redemption is being disbursed to St. Elizabeth Healthcare according to terms agreed upon by all William Blair partners pursuant to the closing of the fund. As of December 31, 2016, disbursements of percent of St. Elizabeth Healthcare s shares had been processed by William Blair; the remaining percent will be disbursed in two installments in 2017, with the final installment being disbursed upon completion of William Blair s 2016 audited financial statements and is anticipated to be received by May, AQR GRP EL Offshore Fund, Ltd. AQR operates a diversified set of global risks covering equities, government bonds, and commodities. These include exposure to global developed and emerging stocks, global inflation 23