Riverside Healthcare Association, Inc. and Subsidiaries Years Ended December 31, 2015 and 2014 With Report of Independent Auditors

Transcription

1 C ONSOLIDATED F INANCIAL S TATEMENTS AND S UPPLEMENTARY I NFORMATION Years Ended December 31, 2015 and 2014 With Report of Independent Auditors Ernst & Young LLP

2 Consolidated Financial Statements and Supplementary Information Years Ended December 31, 2015 and 2014 Contents Report of Independent Auditors...1 Consolidated Financial Statements Consolidated Balance Sheets...3 Consolidated Statements of Operations and Changes in Net Assets...4 Consolidated Statements of Cash Flows...6 Notes to Financial Statements...8 Supplementary Information Consolidating Balance Sheet...45 Consolidating Statement of Operations and Changes in Net Assets...46 Consolidating Balance Sheet with Lifelong Health Divisional Detail...48 Consolidating Statement of Operations with Lifelong Health Divisional Detail...49 Consolidating Balance Sheet with Lifelong Health Divisional Detail...50 Consolidating Statement of Operations with Lifelong Health Divisional Detail

3 Ernst & Young LLP The Edgeworth Building Suite East Cary Street Richmond, VA Tel: Fax: ey.com The Board of Directors Riverside Healthcare Association, Inc. Report on the Financial Statements Report of Independent Auditors We have audited the accompanying consolidated financial statements of Riverside Healthcare Association, Inc. (a Virginia nonprofit corporation doing business as, and hereinafter referred to as, Riverside Health System) and subsidiaries, which comprise the consolidated balance sheets as of December 31, 2015 and 2014, 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 Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in conformity with U.S. generally accepted accounting principles; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free of 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 audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of 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. 1 A member firm of Ernst & Young Global Limited

4 We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Riverside Healthcare Association, Inc. and subsidiaries at December 31, 2015 and 2014, and the consolidated results of their operations and changes in net assets, and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. Supplementary Information Our audits were conducted for the purpose of forming an opinion on the consolidated financial statements as a whole. The Consolidating Balance Sheets as of December 31, 2015 and the Consolidating Statements of Operations and Changes in Net Assets for the year ended December 31, 2015 are presented for purposes of additional analysis and are 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 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 financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States. In our opinion, the information is fairly stated, in all material respects, in relation to the financial statements as a whole. April 26, A member firm of Ernst & Young Global Limited

5 Consolidated Balance Sheets (In Thousands) Assets Current assets: Cash and cash equivalents 1,467 December $ $ 37,124 Accounts receivable, net of allowance for doubtful accounts of $53,498 in 2015 and $65,405 in , ,993 Due from third-party payors 5,360 6,653 Other receivables 14,071 14,182 Other current assets 25,007 25,861 Total current assets 202, ,813 Designated investments-bond proceeds 121,621 Designated investments 404, ,421 Land, buildings, and equipment, net 610, ,507 Other assets 50,877 49,616 Total assets $ 1,390,119 $ 1,279,357 Liabilities and net assets Current liabilities: Accounts payable $ 42,837 $ 39,132 Accrued liabilities 46,042 59,228 Borrowings under line of credit 7,415 10,484 Current portion of long-term debt and obligations under capital leases 9,261 9,346 Due to third-party payors 8,661 10,575 Other current liabilities 22,261 30,890 Total current liabilities 136, ,655 Deferred revenue 44,852 42,645 Long-term debt, less current portion 293, ,990 Obligations under capital leases, less current portion Pension and postretirement obligations 126, ,633 Other liabilities 58,907 57,104 Total liabilities 660, ,119 Net assets: Unrestricted 719, ,330 Temporarily restricted 7,942 10,888 Permanently restricted 2,273 2,347 Noncontrolling interests (370) 673 Total net assets 729, ,238 Total liabilities and net assets $ 1,390,119 $ 1,279,357 See accompanying notes

6 Consolidated Statements of Operations and Changes in Net Assets (In Thousands) Year Ended December Unrestricted revenues, gains, and other support: Net patient revenues $ 362,221 $ 320,998 Net outpatient service revenues 695, ,318 Long-term care revenues 131, ,823 Provision for bad debts (106,251) (91,548) Net patient service revenue less provision for bad debts 1,083, ,591 Other revenues 66,556 63,527 Net assets released from restrictions Total unrestricted revenues, gains, and other support 1,149,802 1,059,196 Expenses: Salaries and benefits 635, ,114 Services and other 213, ,893 Supplies 213, ,901 Depreciation and amortization 66,980 60,348 Interest 4,857 5,761 Total expenses 1,134,173 1,047,017 Operating income 15,629 12,179 Nonoperating gains and losses: Investment (loss) income, including realized and unrealized gains (losses) (10,451) 6,474 Gain (loss) from sale of assets 1,624 (3,708) Total nonoperating (losses) gains, net (8,827) 2,766 Excess of revenues, gains, and other support over expenses and losses 6,802 14,945 Noncontrolling interest 1,043 1,761 Excess of revenues, gains, and other support over expenses and losses attributable to Riverside Healthcare Association 7,845 16,706 (Continued)

7 Consolidated Statements of Operations and Changes in Net Assets (continued) (In Thousands) Excess of revenues, gains, and other support over expenses and losses attributable to Riverside Healthcare Association (from previous page) 7,845 Year Ended December $ $ 16,706 Change in fair value of financial instruments interest rate swap agreements (193) (3,347) Change in plan assets and benefit obligations of pension and postretirement plans 17,461 (99,299) Other 190 Change in unrestricted net assets 25,113 (85,750) Changes in temporarily restricted net assets: Restricted contributions (2,961) 954 Net assets released from permanent restrictions 4,018 Investment income 315 Other Net assets released from restrictions (59) (78) Change in temporarily restricted net assets (2,946) 5,239 Change in permanently restricted net assets: Transfer to temporarily restricted net assets (74) (4,018) Change in permanently restricted net assets (74) (4,018) Change in noncontrolling interests: Change in noncontrolling interest (1,043) (1,761) Other (244) Change in noncontrolling interests (1,043) (2,005) Change in net assets 21,050 (86,534) Net assets, beginning of year 708, ,772 Net assets, end of year $ 729,288 $ 708,238 See accompanying notes

8 Consolidated Statements of Cash Flows (In Thousands) Year Ended December Operating activities Cash received from patients and third-party payors $ 1,060,893 $ 993,812 Cash received from other operating activities 65,051 57,535 Interest and dividends received and realized (losses) gains (10,503) 6,403 Cash paid to suppliers and employees (1,061,447) (976,244) Cash paid for interest (2,046) (5,627) Net cash from operating activities 51,948 75,879 Investing activities Capital expenditures (91,218) (57,712) Proceeds from sales of capital assets 4,599 2,849 Loss on disposal of capital assets (952) Loss on abandoned capital assets (5,269) Net purchases (sales) designated investments 13,722 (21,639) Designated investment with bond proceeds (121,621) Other 547 Net cash used in investing activities (200,192) (76,502) Financing activities Proceeds from issuance of long-term debt 125,000 Net (borrowings) proceeds from use of line-of-credit (3,069) 10,484 Principal payments on long-term debt and capital leases (9,344) (13,205) Other 97 Net cash from (used in) financing activities 112,587 (2,624) Net decrease in cash and cash equivalents (35,657) (3,247) Cash and cash equivalents, beginning of year 37,124 40,371 Cash and cash equivalents, end of year $ 1,467 $ 37,

9 Consolidated Statements of Cash Flows (continued) (In Thousands) Reconciliation of change in net assets to net cash from operating activities Change in net assets 21,050 Year Ended December $ $ (86,534) Adjustments to reconcile change in net assets to net cash from operating activities: Depreciation and amortization 66,980 60,348 Provision for bad debts 106,251 91,548 (Gain) loss on sale of assets (1,624) 3,708 Change in fair value of financial instruments interest rate swap agreement 193 3,347 Change in plan assets and benefit obligations of pension and postretirement plans (17,461) 99,299 Other 9 54 Total adjustments to reconcile change in net assets to net cash from operating activities 175, ,770 Net change in operating assets and liabilities: Receivables (117,436) (100,725) Other current assets 854 (1,544) Other assets (1,261) 962 Accounts payable 3,705 (3,549) Accrued liabilities 4,275 (91,307) Due to third-party payors (1,914) 1,078 Other current liabilities (8,629) 342 Deferred revenue 2,207 (110) Other liabilities (5,251) 98,962 Net cash from operating activities $ 51,948 $ 75,879 See accompanying notes

10 Notes to Consolidated Financial Statements December 31, Organization Riverside Healthcare Association, Inc. and subsidiaries is an organization of owned or contractually managed healthcare providers, including acute care, long-term care, physician services, home health, and associated support services located principally in Newport News, Virginia. Riverside Healthcare Association, Inc. and subsidiaries currently operate under the trade name of Riverside Health System. Riverside Health System is comprised of four major divisions. The Acute Hospital Division is composed of the following: Doctors Hospital of Williamsburg, Inc., a 40-bed acute care hospital doing business as Riverside Doctors Hospital Williamsburg Riverside, LLC, a 25-bed acute long-term care hospital doing business as Hampton Roads Specialty Hospital Rehabilitation Institute of Virginia, Inc., a 50-bed acute rehabilitation hospital doing business as Riverside Rehabilitation Institute Riverside Hospital, Inc., consisting primarily of an acute care general hospital licensed for 450 beds operating under the trade name Riverside Regional Medical Center and a 127-bed psychiatric and chemical dependence center doing business as Riverside Behavioral Health Center Riverside Middle Peninsula Hospital, Inc., a 67-bed acute care hospital doing business as Riverside Walter Reed Hospital Riverside Tappahannock Hospital, Inc., a 67-bed acute care hospital Shore Health Services, Inc., a 143-bed acute care hospital doing business as Riverside Shore Memorial Hospital

11 1. Organization (continued) The Other Acute Healthcare Division is composed of the following: MiChuMi, LLC, doing business as MDExpress, which employs 16 physicians, one nurse practitioner, and 16 physician assistants in five urgent care centers, 78.01% owned by Riverside Physician Services, Inc. Peninsula Cancer Institute, LLC, which employs 16 physicians and 6 nurse practitioners in 7 practices Riverside Physician Services, Inc., doing business as Riverside Medical Group, which employs 376 physicians, 90 nurse practitioners, 38 physician assistants, and 10 other practitioners in 111 practices The Lifelong Health and Aging Related Services Division operates 890 nursing home beds, 331 assisted living beds, and provides skilled, rehabilitation, intermediate, and home-for-adult services. The division also operates four Program of All-inclusive Care for the Elderly (PACE) Centers and manages home care and community-based services for Riverside Health System. The Lifelong Health and Aging Related Services Division is composed of the following: At Home Partners, LLC, 80% owned by Riverside Retirement Services, Inc. Center for Excellence in Aging and Lifelong Health (CEALH) Charlottesville Area Retirement Services, Inc., 51% owned by Riverside Retirement Services, Inc. Francis N. Sanders Nursing Home, Inc. Patrick Henry Hospital, Inc. Patriots Colony, Inc. Riverside Convalescent Centers, Inc. Riverside Retirement Services, Inc. 9

12 1. Organization (continued) Riverside Wellness and Fitness Centers, Inc. Sanders Common, Ltd. Shore Life Care, Inc. Tilden and Virginia Davis Support, Inc. The Healthcare Support Division is composed of the following: Newport News General and Non-Sectarian Hospital Association, Inc., a real estate holding company Peninsula Hospital Services, Inc., a laundry service company, 61% owned by Riverside Healthcare Foundation, Inc. Peninsula Radiosurgery Associates, LLC, a radiosurgery center management company Quarterpath Williamsburg, LLC RHS MedInsur, Ltd., a wholly owned captive insurance company Riverside Health System Foundation, Inc. Riverside Healthcare Association, Inc., the holding company Riverside Healthcare Foundation, Inc. Riverside Healthcare Services, Inc., which provides financial services, risk management, and management contract services to related organizations Riverside Management Services, Inc., which provides managerial and advisory services primarily to related organizations Riverside Medical Equipment Center, Inc., a physician office billing company Virginia Surgical Management, LLC, a surgery center management company 10

13 1. Organization (continued) All are hereinafter referred to collectively as the System. The System has an investment at December 31, 2015 and 2014, of approximately $1.5 million and $1.4 million, respectively, representing a 20% ownership in Newport News Town Center, LLC, a real estate development company. The System s minority-owned joint ventures are accounted for under the equity method of accounting in the accompanying consolidated financial statements. In September 2005, the System, through Riverside Hospital, Inc., formed Peninsula Radiosurgery Associates, LLC (PRA) who with the Rector and Visitors of the University of Virginia on behalf of its Medical Center (UVA) and University of Virginia Health Services Foundation (HSF) on behalf of its Department of Neurosurgery formed Riverside and University of Virginia Radiosurgery Center, LLC for the purpose of owning and leasing stereotactic head and body radiosurgery equipment and providing clinical and administrative support for the performance of stereotactic head and body radiosurgery procedures at the Hospital. The System, through Riverside Hospital, Inc., owned a 93.3% interest in PRA as of January 1, On January 31, 2014, the System acquired the remaining 6.7% ownership interest in PRA for approximately $265,000 in cash. The fair value of the total net assets as of January 31, 2014, was approximately $4.0 million. The System recorded a loss of approximately $31,000 related to its acquired interest in PRA. Basis for Consolidation The accompanying consolidated financial statements include the assets, liabilities, and net assets and operations of all of the majority-owned corporations mentioned above. All significant intercompany accounts and transactions have been eliminated in consolidation. 2. Summary of Significant Accounting Policies Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 11

14 2. Summary of Significant Accounting Policies (continued) Cash and Cash Equivalents The System considers all unrestricted investments with original maturities of three months or less at the time of purchase to be cash equivalents. Accounts Receivable Accounts receivable are amounts due from patients, less allowances for uncollectible accounts and contractual discounts. The allowance for doubtful accounts is based on historical collection trends and management s judgment regarding the ability to collect specific accounts. Goodwill The System accounts for goodwill in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 350, Intangibles Goodwill and Other. As of December 31, 2015 and 2014, the balance of goodwill was $44.0 million and is included in other assets in the consolidated balance sheets. In accordance with ASC 350, the System s goodwill is not amortized but rather is tested annually for impairment. No impairment loss was recognized in 2015 and Management evaluates goodwill amounts for impairment annually during the fourth quarter, or when evidence of potential impairment exists. Inventories Inventories consist primarily of drugs and medical supplies and are stated at the lower of average cost or market and are recorded in other current assets. 12

15 2. Summary of Significant Accounting Policies (continued) Land, Buildings, and Equipment Land, buildings, and equipment are stated at cost. Depreciation is computed on the straight-line method, using the following estimated useful lives: Years Land improvements 2 25 Buildings and improvements 5 40 Fixed equipment 5 20 Major movable equipment 2 20 Land, buildings, and equipment consisted of the following: December (In Thousands) Land and improvements $ 139,001 $ 138,012 Buildings and improvements 677, ,749 Fixed equipment 38,059 39,264 Major movable equipment 374, ,400 Construction in progress 71,989 32,472 Land, buildings, and equipment 1,301,326 1,222,897 Less accumulated depreciation (690,891) (639,390) Land, buildings, and equipment, net $ 610,435 $ 583,507 As of December 31, 2015, construction in progress consisted primarily of renovations at Riverside Regional Medical Center and the new Shore Memorial Hospital, Accomack County, Virginia. At December 31, 2015, the estimated cost to complete construction in progress was approximately $86 million. 13

16 2. Summary of Significant Accounting Policies (continued) Deferred Revenue Patriots Colony, Inc. and Riverside Retirement Services, Inc. are continuing care retirement communities. Residents admitted to the facilities pay a fee at admission (advance fee) and a monthly fee to cover the cost of their care. Under the terms of the various contracts, these advance fees range from non-refundable to 95% refundable. The advance fees paid by a resident upon entering into a continuing care contract are recorded as deferred revenue from advance fees and are amortized to income using the straight-line method over the estimated remaining life expectancy of the resident, or couple. The period of amortization is adjusted annually based on the actuarially determined estimated remaining life expectancy of each individual, or joint and last survivor life expectancy of each pair of residents occupying the same unit. The refundable portion of these advance fees is repayable to the resident upon the resident vacating the unit. At December 31, 2015 and 2014, the portion of advance fees subject to refund provisions amounted to approximately $20.3 million and $18.9 million, respectively. Amounts expected to be refunded to current residents, based on the System s experience, were approximately $4.1 million and $4.7 million at December 31, 2015 and 2014, respectively, and are recorded in other current liabilities on the consolidated balance sheets. Electronic Health Record Incentive Program The American Recovery and Reimbursement Act of 2009 established incentive payments under the Medicare and Medicaid programs for certain professionals and hospitals that meaningfully use certified electronic health record technology. Payments under the program are calculated based upon estimated discharges, charity care, and other input data and are predicated upon the System s attainment of program and attestation criteria and are subject to regulatory audit. The System has opted to follow a gain contingency method, under ASC 450, Contingencies, which provides for recognition once attainment of program and attestation criteria have been achieved and amounts can be reasonably estimated. The amount of incentive payments recognized and recorded in other revenues in the consolidated statements of operations and changes in net assets is $1.6 million and $4.5 million for 2015 and 2014, respectively. 14

17 2. Summary of Significant Accounting Policies (continued) Obligation to Provide Future Services Patriots Colony, Inc. and Riverside Retirement Services, Inc. calculate the present value of the net cost of future services and the use of facilities to be provided to current residents and compare that amount with the balance of deferred revenue from advance fees. If the present value of the net cost of future services and the use of facilities exceeds the deferred revenue from advance fees, a liability is recorded with the corresponding charge to income (obligation to provide future services). No liability for the obligation to provide future services is required as of December 31, 2015 or Charity Care The System s policy is to provide medical care without regard to the patient s ability to pay for such services. Charity care is based upon a review of the patient s financial circumstances. The amounts charged to patients that qualify for charity care are excluded from net patient service revenues because the System does not pursue collection of these amounts; however, the expenses incurred in providing these services are included in the System s operating expenses. Donor-Restricted Gifts Unconditional promises to give cash and other assets are reported at fair value at the date the promise is received. The gifts 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 a stipulated time restriction ends or the purpose of the restriction is accomplished, temporarily restricted net assets are reclassified as unrestricted net assets and are reported in the consolidated statements of operations and changes in net assets as net assets released from restrictions. Donor-restricted contributions whose restrictions are met in the year of receipt are reflected as unrestricted contributions in the accompanying consolidated financial statements. 15

18 2. Summary of Significant Accounting Policies (continued) Derivatives Policy The System manages its exposure to interest rate volatility through use of interest rate swap contracts. This contract qualifies as a derivative financial instrument. In accordance with the provisions of FASB ASC , Health Care Entities Derivatives and Hedging, the System applies the provisions of FASB ASC 815, Derivatives and Hedging, in the same manner as forprofit enterprises. That is, the gain or loss items related to derivative instruments that affect a forprofit enterprise s income from continuing operations under ASC 815 similarly affect the System s performance indicator, and the gain or loss items that are excluded from a for-profit enterprise s income from continuing operations similarly are excluded from the System s performance indicator. The System s performance indicator is referred to as excess of revenues, gains, and other support over expenses and losses. The net amount that becomes due or payable under the contracts is recognized currently in operating income. The System recognizes the derivative instrument at its estimated fair value at each balance sheet date and the gains and losses in its consolidated statements of operations and changes in net assets. Under ASC , to exclude the change in fair value from operating income, the derivative instrument must not only be related to a specific bond issue, but also be a statistically correlated hedge of the current interest cash flow on the bonds. The fair value of the System s interest rate swap agreements liability increased by approximately $193,000 in 2015 and increased by approximately $3.3 million in These changes have been included as separate changes in net assets in the consolidated statements of operations and changes in net assets. As of December 31, 2015 and 2014, the fair value of the interest rate swap agreements liability was $11.1 million and $10.9 million, respectively, and is included in the other long-term liabilities. The total notional amounts of the System s interest rate swap agreements as of December 31, 2015 and 2014, were $53.8 million and $55.5 million, respectively. Temporarily and Permanently Restricted Net Assets Temporarily restricted net assets are those whose use by the System has been limited by donors to a specific time period or purpose. When a donor restriction expires, temporarily restricted net assets are released and reclassified as unrestricted net assets. Permanently restricted net assets have been restricted by donors to be maintained by the System in perpetuity. 16

19 2. Summary of Significant Accounting Policies (continued) Income Taxes Riverside Healthcare Association, Inc. has received a group exemption letter from the Internal Revenue Service (IRS) recognizing each of its wholly owned subsidiaries, except for Riverside Medical Equipment Center, Inc., Newport News General and Non-Sectarian Hospital Association, Inc., Shore Health Services, Inc., Shore Life Care, Inc., and Tilden and Virginia Davis Support, Inc., stating they are exempt from income taxes pursuant to Section 501(c)(3) of the Internal Revenue Code (IRC), except for unrelated business income. Newport News General and Non-Sectarian Hospital Association, Inc. has retained its determination letter from the IRS stating it is exempt from income taxes pursuant to IRC Section 501(c)(2). Shore Health Services, Inc., Shore Life Care, Inc., and Tilden and Virginia Davis Support, Inc. have retained their determination letters stating they are exempt from income taxes pursuant to IRC Section 501(c)(3). No provision for income taxes was required for the years ended December 31, 2015 or Functional Expenses The System provides general healthcare services to residents within its geographical location. Expenses related to providing these services are as follows: Year Ended December (In Thousands) Healthcare services $ 866,543 $ 797,592 Education, fund-raising, and other services 50,590 48,020 General and administrative 217, ,405 $ 1,134,173 $ 1,047,017 17

20 2. Summary of Significant Accounting Policies (continued) Mission Statement and Nonoperating Gains and Losses The System s primary mission is to provide the highest quality care based on the medical needs of the citizens of the surrounding communities. Only those 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 the System s primary mission are considered to be nonoperating. Nonoperating gains and losses include earnings on investments and gains and losses resulting from unusual or infrequent transactions. Reclassifications Certain prior year balances have been reclassified to be consistent with the current year presentation. Recent Accounting Pronouncements In May 2014, the FASB issued Accounting Standards Update (ASU) , Revenue from Contracts with Customers, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance, and requires significantly expanded disclosures about revenue recognition. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance is effective for the System as of January 1, Early adoption is not permitted. The System is currently evaluating the impact on the consolidated financial statements and the options of adopting using either a full retrospective or a modified approach. In August 2014, the FASB issued ASU , Presentation of Financial Statements Going Concern (Subtopic ): Disclosure of Uncertainties about an Entity s Ability to Continue as a Going Concern. This ASU is intended to define management s responsibility to evaluate whether there is substantial doubt about an organization s ability to continue as a going concern and to provide related footnote disclosures. The amendments in this ASU are effective for reporting periods beginning after December 15, 2016, with early adoption permitted. The System is currently evaluating the impact on the consolidated financial statements. 18

21 2. Summary of Significant Accounting Policies (continued) In May 2015, the FASB issued Accounting Standards Update (ASU) , Disclosures for Investments in Certain Entities that Calculate Net Asset Value per share (or its equivalent). ASU removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value (NAV) per share practical expedient and limits the disclosure requirements. ASU is effective for annual and interim periods beginning after December 15, The System is currently evaluating the impact on the consolidated financial statements. In April 2015 the FASB issued ASU , Interest imputation of interest. ASU provides that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ASU is effective for annual periods beginning after December 15, 2015 for public business entities, with early adoption permitted. The System is currently evaluating the impact on the consolidated financial statements. In February 2016, the FASB issued ASU , Leases, intended to improve financial reporting about leasing transactions. The new lease standard requires lessees to put most leases on their balance sheets but recognize expenses on their income statements in a manner similar to today s accounting. The guidance also eliminates today s real estate-specific provisions and changes the sale and leaseback accounting model for all entities. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The guidance could have broad implications for entities finances and operations. The standard is effective for System as of December 31, Early adoption is permitted. The System is currently in the preliminary planning stages of evaluating the impact of adoption of the new lease standard on its consolidated financial statements. 3. Net Patient Service Revenues Net patient service revenues are reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and are adjusted in future periods as final settlements are determined. The System has agreements with certain third-party payors that provide for reimbursement at amounts different from their established rates. The difference between the reimbursement and the standard billing rate results in contractual adjustments, which are deducted from patient service revenues, resulting in net patient service revenues. 19

22 3. Net Patient Service Revenues (continued) Patient accounts receivable are reduced by an allowance for uncollectible accounts. In evaluating the collectability of accounts receivable, the System analyzes its past history and identifies trends for each of its major payor sources of revenue to estimate the appropriate allowance for uncollectible accounts and provision for bad debts. Management regularly reviews data about these major payor sources of revenue in evaluating the sufficiency of the allowance for uncollectible accounts. For receivables associated with services provided to patients who have third-party coverage, the System analyzes contractually due amounts and provides an allowance for uncollectible accounts and a provision for bad debts, if necessary. For receivables associated with self-pay patients (which include both patients without insurance and patients with deductible and co-payment balances due for which third-party coverage exists for part of the bill), the System records a provision for bad debts in the period of service on the basis of its past experience. The difference between standard rates (or the discounted rates if negotiated) and the amounts actually collected after all reasonable collection efforts have been exhausted is charged off against the allowance for uncollectible amounts. Patient service revenue, net of contractual allowances and discounts and after the provision for bad debts, is recognized from these major payer sources for the years ended December 31, 2015 and 2014, as follows (in thousands): Gross patient revenue $ 2,798,862 $ 2,581,773 Deductions: Medicare, Medicaid, and other allowances and discounts (1,517,118) (1,395,190) Charity care (92,306) (99,444) Net patient service revenue 1,189,438 1,087,139 Less: provision for bad debts (106,251) (91,548) Total $ 1,083,187 $ 995,591 20

23 3. Net Patient Service Revenues (continued) The System s payor mix of major third-party payors, based on percentages of gross patient service revenue, was as follows: Year Ended December Medicare (including Medicare Advantage) 48% 48% Medicaid (including Medicaid Health Maintenance Organization (HMO)) 9 9 Blue Cross (including Blue Cross HMO) Commercial and other insured Self-pay % 100% Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near term. Adjustments to revenue estimates related to prior periods resulted in increases in net patient service revenue of $7.2 million and $3.1 million, for the years ended December 31, 2015 and 2014, respectively. A summary of the basis of hospital reimbursement from major third-party payors is as follows: Acute Care Medicare Inpatient services and capital costs related to Medicare program beneficiaries are paid at prospectively determined rates per discharge. These rates vary according to a patient classification system that is based on clinical, diagnostic, and other factors. Substantially all Medicare outpatient services are paid at prospectively determined rates, which vary according to services rendered. Other outpatient services related to Medicare beneficiaries are paid based on a cost reimbursement methodology. The System s Medicare cost reports have been final-settled by the intermediary through December 31, There are several Medicare Advantage Programs in the System s service area. Inpatient acute care services are reimbursed at prospectively determined rates per discharge based upon the Medicare inpatient patient classification system. Outpatient services are reimbursed at prospectively determined rates based upon the Medicare Outpatient Prospective Payment System. 21

24 3. Net Patient Service Revenues (continued) Medicaid Inpatient services are reimbursed at prospectively determined operating rates and tentative, cost-based capital and education rates per discharge, with final settlement of capital and education costs determined after submission of annual cost reports by the System and audits thereof by the Medicaid fiscal intermediary. Outpatient services are reimbursed at prospective determined rates. The System s Medicaid cost reports have been final-settled by the intermediary through December 31, There are several Medicaid managed programs in the System s service area. Inpatient acute care services are reimbursed at prospectively determined rate. Outpatient services are reimbursed at either a percentage of charges or prospectively determined rates. Blue Cross For Blue Cross HMO subscribers, inpatient acute care services are reimbursed on prospectively determined rates per discharge, and outpatient services are reimbursed according to a fee schedule. For Blue Cross Preferred Provider Organization (PPO) subscribers, inpatient acute care services are reimbursed on a discharge basis, and outpatient services are reimbursed based upon a fee schedule. For other Blue Cross subscribers, inpatient acute care and outpatient services are reimbursed based upon a percentage of charges. Commercial and Other Insured Each hospital also has payment agreements with certain commercial insurance carriers, HMOs, and PPOs. The basis for payment to the System under these agreements is primarily a discount from established charges. Long-Term Care and Other Approximately 76% and 74%, respectively, of long-term care services were provided to Medicaid and Medicare patients in 2015 and Skilled nursing services provided under the Medicare program are reimbursed based upon a case-mix and geographically adjusted prospective payment. In the first half of 2014, Medicaid nursing home services were reimbursed using a prospective rate based on defined allowable costs of services rather than on the basis of standard billing rates. Effective July 1, 2014, Medicaid payment methodology began a four-year transition blending a facility s historical price-based rate with patient-specific case-mix rate, with an add-on for facility-specific capital. The Long-Term Care Division Medicaid cost reports have been final-settled by the intermediary through December 31,

25 3. Net Patient Service Revenues (continued) Net patient service revenues for Riverside Medical Group (RMG) are included in net outpatient service revenues in the accompanying consolidated statements of operations and changes in net assets. These services are reimbursed based on established fee schedules for Medicare and Medicaid, negotiated fee schedules for Anthem and commercial payors, and capitated rates for HMOs. For the years ended December 31, 2015 and 2014, total net patient service revenues for RMG totaled approximately $188.1 million and $181.9 million, respectively. Regulatory Environment National and state healthcare-related legislation has been and is expected to continue to be introduced in the U.S. Congress and the Commonwealth of Virginia Legislature. Such legislation has addressed benefits provided, insurance coverage, and provider reimbursement and will result in reductions in Medicare and Medicaid spending over the next several years. The healthcare industry is subject to numerous laws and regulations of federal, state, and local governments. These laws and regulations include, but are not necessarily limited to, matters such as licensure, accreditation, government healthcare program participation requirements, reimbursement for patient services, and Medicare and Medicaid fraud and abuse. Government activity has increased with respect to investigations and allegations concerning possible violations of fraud and abuse statutes and regulations by healthcare providers. Violations of these laws and regulations could result in expulsion from government healthcare programs, together with the imposition of significant fines and penalties, as well as significant repayments for patient services previously billed. Management is not aware of any material, noncompliance with fraud and abuse-related rules or other applicable government laws and regulations. While no material regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation, as well as regulatory action unknown or unasserted at this time. 23

26 4. Community Benefit Expense The following summary estimates the System s estimated cost of providing services to the indigent and benefits to the broader community: Year Ended December (In Thousands) Benefits for the indigent: Unreimbursed cost of charity $ 31,999 $ 31,664 Bad debt expense 106,251 91,548 Unreimbursed costs of Medicaid program 11,177 14,075 Total quantifiable benefits for the indigent, at cost 149, ,287 Benefits for the broader community: Education and research programs 10,757 10,427 Other community benefits 3,975 4,635 Total quantifiable benefits for the broader community 14,732 15,062 Total quantifiable community benefits, at cost $ 164,159 $ 152,349 The System accepts all patients regardless of their ability to pay. Benefits for the indigent include services provided to persons who cannot afford healthcare because of inadequate resources or who are uninsured. This includes traditional charity care at the estimated cost and the costs of treating Medicaid beneficiaries in excess of government payments. Distinguishing uncollected patient revenue between charity and bad debt requires full consideration of both the financial and nonfinancial circumstances of the patient, which are not always available to the organization. Therefore, both traditional charity care and bad debt are included as a component of benefits for the indigent. Benefits for the broader community include services provided to other needy individuals who may not qualify as indigent, but need special services and support. Examples include the elderly, substance abusers, victims of child abuse, and the disabled. Benefits for the broader community also include the cost of health promotion and education, health clinics and screenings, and the unreimbursed cost of medical training. The costs for these services have been estimated using multiple costing methodologies, including the application of cost-to-charge ratios, internal cost accounting estimates, Medicare allowable costs, and, where possible, the amount provided as support to the community group or building activity. 24

27 5. Designated Investments The System s investments consist of marketable securities designated by the Board of Directors for plant replacement and expansion and debt service as well as investments in joint ventures. The System s investments designated by the Board of Directors for plant replacement and expansion and debt service are carried at fair value determined in accordance with the provisions of FASB ASC 820, Fair Value Measurement. The System s investments in joint ventures are accounted for under the equity method of accounting. The System has designated its marketable securities as trading securities and recognizes investment income or loss (including realized and unrealized gains and losses on investments, interest, and dividends) in excess of revenues, gains, and other support over expenses and losses, unless the income or loss is restricted by donor or by law. The estimated values of the System s designated investments are as follows: December 31, 2015 December 31, 2014 Fair Market Fair Market Cost Value Cost Value (In Thousands) Cash and short-term investments $ 3,334 $ 3,334 $ 3,291 $ 3,291 Money market mutual funds 2,765 2,765 19,011 19,011 Bond mutual fund 154, , , ,029 International bond mutual fund 24,759 24,167 11,812 12,131 Common trust fund 62,337 68,498 65,814 77,520 Marketable equity securities 34,141 39,523 33,907 42,869 Foreign equity securities 11,802 13,487 10,775 12,711 U.S. government bonds and notes 3,148 3,106 5,271 5,303 Mortgage-backed securities 5,856 5,835 3,512 3,539 Corporate bonds and notes 20,745 20,475 18,582 18,811 Total investments 323, , , ,215 Alternative investments 51,217 55,918 48,094 54,345 Investment in joint ventures 18,064 18,064 15,692 15,692 Other investments Total designated investments $ 392,736 $ 404,699 $ 390,577 $ 418,421 Cash and cash equivalents $ 121,621 $ 121,621 $ $ Total designated investments bond proceeds $ 121,621 $ 121,621 $ $ 25

28 5. Designated Investments (continued) The fair market values of the System s designated investments, excluding certain alternative investments, investments in joint ventures, and other investments, were determined by year-end closing prices reported in the listings of the applicable major exchanges. The System also holds limited partnership interests in alternative investment funds, in addition to the joint venture investments described in Note 1, all of which are accounted for under the equity method. Investment (loss) income consists of the following: Year Ended December (In Thousands) Interest and dividends $ 6,107 $ 6,838 Investment (loss) income from equity method investments (980) 1,988 Realized losses, net (2,084) (3,380) Unrealized (losses) gains on trading securities, net (13,494) 1,028 Investment (loss) income $ (10,451) $ 6,474 Marketable equity and debt securities and other investments are carried at fair value based on quoted market prices. Realized gains and losses on the sale of investments are determined based on the cost of specific investments sold. 6. Fair Value of Financial Instruments The System s financial instruments include cash and cash equivalents, receivables, designated investments, accounts payable, accrued liabilities, and long-term debt. With the exception of long-term debt, the carrying amounts of these instruments approximate their fair values because of the short maturity or frequent repricing of these instruments. 26

29 6. Fair Value of Financial Instruments (continued) The System s investments in marketable securities are carried at fair value, based on quoted market prices or other observable inputs. The fair value of the System s long-term debt is estimated based on quoted market prices for the same or similar issues or on the current rates offered to the System for debt of the same remaining maturities. The fair value of the System s debt at December 31, 2015 and 2014, was approximately $280 million and $166 million, respectively. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (i.e., the exit price) in an orderly transaction between market participants at the measurement date. 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 the asset or liability. In determining fair value, the System uses the market approach. The market approach utilizes prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Level 1 and Level 2 of the hierarchy) and the reporting entity s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). The fair value levels are as follows: Level 1 Inputs utilize unadjusted quoted prices in active markets for identical assets or liabilities that the System has the ability to access at the measurement date. Level 2 Inputs are inputs other than quoted prices included in Level 1 that are observable for the assets or liabilities, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the assets or liabilities (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 assets or liabilities, which are typically based on an entity s own assumptions, as there is little, if any, related market activity. 27