San Antonio Regional Hospital and Subsidiaries Years Ended December 31, 2015 and 2014 With Report of Independent Auditors

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1 C ONSOLIDATED F INANCIAL S TATEMENTS AND S UPPLEMENTARY I NFORMATION San Antonio Regional Hospital and Subsidiaries 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 Statements of Financial Position...3 Consolidated Statements of Operations...5 Consolidated Statements of Changes in Net Assets...6 Consolidated Statements of Cash Flows...7 Notes to Consolidated Financial Statements...8 Supplementary Information Consolidating Statements of Financial Position...36 Consolidating Statements of Operations...40 Consolidating Statements of Changes in Net Assets

3 Ernst & Young LLP Suite Von Karman Avenue Irvine, CA Tel: Fax: ey.com Report of Independent Auditors The Board of Trustees San Antonio Regional Hospital and Subsidiaries We have audited the accompanying consolidated financial statements of San Antonio Regional Hospital and subsidiaries, which comprise the consolidated statements of financial position as of December 31, 2015 and 2014, and the related consolidated statements of operations, 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 from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these financial statements based on our 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 San Antonio Regional Hospital 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 over financial reporting. 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 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 San Antonio Regional Hospital and subsidiaries at December 31, 2015 and 2014, and the consolidated results of their operations, 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 accompanying consolidating financial statements are presented for purposes of additional analysis and are not a required part of the 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 audits 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 consolidated 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 consolidated financial statements as a whole. May 27, 2016 ey A member firm of Ernst & Young Global Limited

5 Consolidated Statements of Financial Position Assets Current assets: Cash and cash equivalents 7,457,814 December $ $ 23,274,736 Current portion of assets limited as to use 2,015,000 1,915,099 Marketable securities 58,329,862 48,932,520 Accounts receivable from patients, less allowances for uncollectible accounts of $10,000,000 and $25,700,000 in 2015 and 2014, respectively 42,906,107 38,712,929 Amounts due from third-party payors 5,185,932 13,928,039 Inventories of drugs and supplies 4,319,532 4,117,983 Prepaid expenses and other 7,028,405 8,586,433 Total current assets 127,242, ,467,739 Assets limited as to use, less current portion: Board-designated 169,743, ,561,285 For self-insurance program 3,696,999 3,653,427 Under debt agreements 3,680,926 20,906,841 Total assets limited as to use 177,121, ,121,553 Property and equipment, net 258,302, ,356,334 Other assets: Charitable remainder trust assets 7,461,321 8,342,353 Investments restricted by donor for capital and other purchases and to provide a permanent source of income 15,749,480 15,460,627 Deferred financing costs 1,320,698 1,373,892 Other 11,959,044 10,633,426 Total other assets 36,490,543 35,810,298 Total assets $ 599,157,398 $ 606,755,

6 Liabilities and net assets Current liabilities: Accounts payable and accrued expenses 27,173,570 December $ $ 25,452,959 Accrued compensation, related benefits, and other 18,573,056 12,617,987 Amounts payable to third-party payors 9,309,914 16,329,538 Current portion of long-term debt 2,015,000 1,915,000 Total current liabilities 57,071,540 56,315,484 Long-term liabilities: Long-term debt, less current portion 113,176, ,154,536 Self-insurance liabilities, less current portion 13,375,520 10,996,654 Pension liability and other 35,548,539 42,989,302 Liability under charitable remainder trust agreements 3,776,172 4,470,685 Other long-term liabilities 336,180 4,461,648 Total long-term liabilities 166,213, ,072,825 Total liabilities 223,284, ,388,309 Net assets: Unrestricted 354,527, ,973,547 Temporarily restricted 17,302,984 15,356,877 Permanently restricted 4,042,191 4,037,191 Total net assets 375,872, ,367,615 Total liabilities and net assets $ 599,157,398 $ 606,755,924 See accompanying notes

7 Consolidated Statements of Operations Year Ended December Unrestricted revenues, gains, and other support: Net patient service revenues $ 286,347,098 $ 305,068,498 Recoveries (provision) for uncollectible accounts 3,704,859 (19,479,404) Net patient service revenue, less provision for uncollectible accounts 290,051, ,589,094 Investment income 2,840,704 13,597,977 Premium revenue 486, ,849 Other revenue 6,264,570 6,560,465 Total unrestricted revenues, gains, and other support 299,643, ,519,385 Operating expenses: Salaries and benefits 158,626, ,057,501 Purchased services, supplies, and other 124,090, ,657,470 Depreciation and amortization 12,770,344 11,784,723 Interest 1,058, ,182 Total operating expenses 296,545, ,383,876 Excess of revenues, gains, and other support over expenses 3,097,978 24,135,509 Change in net unrealized gains on marketable securities and assets limited as to use designated as other than trading (816,743) 867,330 Change in additional minimum pension liability (727,283) (24,659,549) Increase in unrestricted net assets $ 1,553,952 $ 343,290 See accompanying notes

8 Consolidated Statements of Changes in Net Assets Unrestricted net assets: Excess of revenues, gains, and other support over expenses 3,097,978 Year Ended December $ $ 24,135,509 Change in unrealized gains on marketable securities designated as other than trading (816,743) 867,330 Change in additional minimum pension liability (727,283) (24,659,549) Increase in unrestricted net assets 1,553, ,290 Temporarily restricted net assets: Contributions 2,411,737 1,415,840 Investment (loss) income (69,541) 740,254 Change in liability under charitable remainder trust agreements and other (116,980) 872,268 Net assets released from restrictions (279,109) (2,559,909) Increase in temporarily restricted net assets 1,946, ,453 Permanently restricted net assets: Contributions 5,000 Increase in permanently restricted net assets 5,000 Increase in net assets 3,505, ,743 Net assets at beginning of year 372,367, ,555,872 Net assets at end of year $ 375,872,674 $ 372,367,615 See accompanying notes

9 Consolidated Statements of Cash Flows Year Ended December Operating activities Increase in net assets $ 3,505,059 $ 811,743 Adjustments to reconcile increase in net assets to net cash provided by operating activities: Provision for uncollectible accounts (3,704,859) 19,479,404 Depreciation and amortization 12,770,344 11,784,723 Amortization of deferred financing costs 90,431 97,386 Amortization of physician income guarantees (20,724) 37,117 Change in net unrealized gains on marketable securities designated as other than trading 543,744 (867,330) Change in net unrealized (gain) loss on marketable securities designated as trading 7,080,618 (3,494,466) Change in pension liability (8,168,046) (1,306,665) Change in additional minimum pension liability 727,283 24,659,549 Loss (gain) on disposal of property and equipment 43,686 5,627 Restricted contributions (2,411,737) (1,415,840) Changes in assets and liabilities: Accounts receivable from patients (488,319) (15,963,336) Amounts due from third-party payors 1,722,483 (6,672,790) Marketable securities and assets limited as to use (17,152,990) 14,298,671 Inventories, prepaid expenses, and other current assets 1,356,479 (1,197,813) Accounts payable, accrued expenses, and other current liabilities 16,455,891 7,813,749 Self-insurance liabilities 2,378,866 (1,147,541) Other long-term assets and liabilities (6,219,228) (1,543,080) Net cash provided by operating activities 8,508,981 45,379,108 Investing activities Purchase of investments (602,253) (1,198,773) Net additions to property and equipment (24,314,740) (32,538,257) Investment in minority interest in surgicenter 94,353 33,718 Net cash used in investing activities (24,822,640) (33,703,312) Financing activities Principal payments on long-term debt (1,915,000) (1,845,000) Restricted contributions 2,411,737 1,415,840 Net cash provided by (used) in financing activities 496,737 (429,160) (Decrease) increase in cash and cash equivalents (15,816,922) 11,246,636 Cash and cash equivalents at beginning of year 23,274,736 12,028,100 Cash and cash equivalents at end of year $ 7,457,814 $ 23,274,736 Supplemental cash flow information Cash paid for interest $ 7,409,000 $ 7,494,000 See accompanying notes

10 Notes to Consolidated Financial Statements December 31, Organization and Significant Accounting Policies San Antonio Regional Hospital (SARH) is organized as a not-for-profit corporation under the laws of the state of California, and is a tax-exempt organization under the provisions of the Internal Revenue Code. SARH is the sole corporate member of the San Antonio Hospital Foundation, Inc. (SAHF), a not-for-profit, tax-exempt corporation, of Eastvale San Antonio Land Company (ESALC), a limited liability corporation, and is also the sole shareholder of Cucamonga Health Services, Inc. (CHS), a proprietary corporation. CHS is the sole corporate member of Eastvale San Antonio Building Company (ESABC), a limited liability corporation. Basis of Consolidation The consolidated financial statements of San Antonio Regional Hospital and subsidiaries (the Hospital) include the accounts of SARH, SAHF, ESALC, ESABC, and CHS. All significant intercompany transactions and balances have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Cash and Cash Equivalents The Hospital considers all highly liquid investments with original maturities when purchased of three months or less to be cash equivalents. Investments Investments in equity securities with readily determinable fair values and all investments in debt securities are measured at fair value on the consolidated statements of financial position. Certain marketable securities and assets limited as to use held at December 31, 2015 and 2014, are

11 1. Organization and Significant Accounting Policies (continued) designated as other than trading and certain marketable securities are designated as trading. The Hospital outsources the management of certain investment portfolios to third-party investment managers. Third-party investment management fees were $669,000 and $604,000, in 2015 and 2014, respectively. For these portfolios, the Hospital holds its investment managers accountable to achieve certain benchmarks with respect to return on investments, and limits the amount of its investment portfolio that can be invested in certain types of assets. The Hospital classifies investments controlled and managed by the Hospital as other than trading. The Hospital classifies the investments for which the management is outsourced to professional investment advisors as trading. Investment income (including realized gains and losses on investments, interest, and dividends) is included in excess of unrestricted revenues, gains, and other support over expenses unless the income is restricted by donor or law. Unrealized gains and losses on investments designated as other than trading are excluded from the excess of unrestricted revenues, gains, and other support over expenses. Realized and unrealized gains and losses on trading securities are included in investment income. Assets Limited as to Use Assets limited as to use include board-designated assets for replacement and acquisitions of property and equipment, self-insurance trust funds for payment of medical malpractice claims, and assets held by a trustee under bond indentures. Trustee-held assets include construction project, principal repayment, and interest payment funds. The current portion of assets limited as to use includes amounts that will be used to pay the current portion of the principal and interest on the bonds. Operating Income The Hospital considers the performance indicator to be the excess of revenues over expenses. Net Patient Service Revenue Net patient service revenue is 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 adjusted in future periods as final settlements are determined. Revenues from the Medicare and Medi-Cal programs accounted for approximately 16% and 5%, respectively, of the Hospital s net patient service

12 1. Organization and Significant Accounting Policies (continued) revenue for the year ended December 31, Revenues from the Medicare and Medi-Cal programs accounted for approximately 19% and 2%, respectively, of the Hospital s net patient service revenue for the year ended December 31, Laws and regulations governing the Medicare and Medi-Cal programs are complex and subject to interpretation. The Hospital believes that it is in compliance with all applicable laws and regulations and is not aware of any pending or threatened investigations involving allegations of potential wrongdoing. While no such regulatory inquiries have been made, compliance with such laws and regulations can be subject to future government review and interpretation as well as significant regulatory action, including fines, penalties, and exclusion from the Medicare and Medi-Cal programs. The Hospital has agreements with government third-party payors that provide for payments to the Hospital at amounts different from its established rates. A summary of the payment arrangements with major government third-party payors follows: Medicare. Inpatient acute care and most outpatient services rendered to Medicare program beneficiaries are paid at prospectively determined rates per discharge or visit. These rates vary according to patient classification systems that are based on clinical, diagnostic, and other factors. The Hospital is reimbursed for cost reimbursable items at a tentative rate with final settlement determined after submission of annual cost reports by the Hospital and audits thereof by the Medicare fiscal intermediary. Medi-Cal. From May 2001 through September 2008, inpatient services rendered to Medi-Cal program beneficiaries were reimbursed based on a cost-based reimbursement methodology. The Hospital was reimbursed at a tentative rate with final settlement determined after audit by the fiscal intermediary. Effective October 1, 2008, the state of California reduced the Hospital s Medi-Cal reimbursement (AB 1183) by approximately 50% as part of the state s budget reduction initiatives. The Hospital joined other similarly situated hospitals in a group lawsuit to overturn the reimbursement reduction. Based on a subsequent administrative settlement, there is an open period of January 1, 2011 through April 12, 2011, where AB 1183 will still apply if the group lawsuit is not successful. The Hospital has reserved $1,469,000 for the associated reimbursement reduction associated with AB From April 13, 2011 through June 30, 2013, the Hospital s Medi-Cal reimbursement methodology reverted to back to cost-based. As of July 1, 2013, the Hospital s Medi-Cal reimbursement methodology has changed to prospectively determined rates per discharge (APR-DRG) similar to the Medicare methodology. Outpatient services are reimbursed based on predetermined rates

13 1. Organization and Significant Accounting Policies (continued) The administrative procedures related to the cost reimbursement programs in effect generally preclude final determination of amounts due the Hospital until cost reports are audited or otherwise reviewed and settled with the applicable administrative agencies. Normal estimation differences between final settlements and amounts accrued in previous years are reported as adjustments of the current year s net patient service revenue. In the opinion of management, adequate provision has been made for adjustments, if any, that might result from subsequent review. The Hospital revised prior period settlement estimates after completing and filing its cost reports, resulting in a (decrease) increase of $(174,000) and $557,000 to net patient service revenues in 2015 and 2014, respectively. Net Patient Accounts Receivable The Hospital s primary concentration of credit risk is patient accounts receivable, which consist of amounts owed by various governmental agencies, insurance companies, and private patients. The Hospital manages the receivables by regularly reviewing its patient accounts and contracts and by providing appropriate allowances for uncollectible amounts. These allowances are estimated based upon historical payments, negotiated contracts, and governmental reimbursements. The Hospital had a change in estimate of the allowance due to the prior year recoveries. The Hospital s allowance for doubtful accounts for self-pay patients was 35% and 83% of self-pay accounts receivable at December 31, 2015 and 2014, respectively. Adjustments and changes in estimates are recorded in the period in which they are determined. Significant concentrations of gross patient accounts receivable are as follows: December Medicare 9% 7% Medi-Cal Due to the inherent variability in this area of patient receivable collections, there is at least a reasonable possibility that recorded estimates may change by a material amount in the near term

14 1. Organization and Significant Accounting Policies (continued) Allowances for Uncollectible Accounts Patient service revenue is reduced by the provision for uncollectible accounts, and accounts receivable are reduced by an allowance for uncollectible accounts. These amounts are based on management s assessment of historical and expected net collections for each major payor source, considering business and economic conditions, trends in health care coverage, and other collection indicators. Management regularly reviews data about these major payor sources of revenue in evaluating the sufficiency of the allowance for uncollectible accounts. On the basis of historical experience, a significant portion of the Hospital s uninsured patients will be unable or unwilling to pay for the services provided. Thus, the Hospital records a provision for uncollectible accounts in the period services are provided to self-pay patients, including both uninsured patients and patients with deductible and copayment balances due for which third-party coverage exists for a portion of their balance. For receivables associated with patients who have third-party coverage, the Hospital analyzes contractually due amounts and updates its estimated allowance for uncollectible accounts and provision for uncollectible accounts, if necessary. Accounts receivable are written off after collection efforts have been followed, in accordance with the Hospital s policies. A summary of the Hospital s allowance for uncollectible accounts activity is as follows: December Allowance for uncollectible accounts beginning balance $ 25,700,000 $ 23,500,000 Provision for uncollectible accounts (3,704,859) 19,479,404 Bad debt write-offs, net of recoveries (11,995,141) (17,279,404) Allowance for uncollectible accounts ending balance $ 10,000,000 $ 25,700,000 The Hospital serves certain patients whose medical care costs are not paid at established rates. These patients include those sponsored under government programs such as Medicare and Medi-Cal, those sponsored under private contractual agreements, charity patients, and other uninsured patients who have a limited ability to pay. Patient service revenue is reported at the estimated net realizable amounts for services rendered. The Hospital recognizes patient service revenue associated with patients who have third-party payor coverage on the basis of contractual

15 1. Organization and Significant Accounting Policies (continued) rates for the services rendered. For uninsured patients that do not qualify for charity care, net revenue is recognized based on a range between the Hospital s uninsured patient discount rate and total charges further reduced by the Hospital s estimated bad debt and charity provision. Patient service revenues, net of contractual allowances and discounts and before the provision for uncollectible accounts, recognized from major payor sources are as follows: December % 2014 % Medicare $ 46,718,255 16% $ 56,907,012 19% Medi-Cal 12,928, ,232,114 2 Managed care 204,075, ,272, Self-pay and other 22,625, ,657, Patient service revenues before: Provision for uncollectible accounts 286,347, % 305,068, % Provision for uncollectible accounts 3,704,859 (19,479,404) Net patient service revenues $ 290,051,957 $ 285,589,094 Property and Equipment Property and equipment are reported on the basis of cost. Donated items are recorded based on fair market value at the date of donation, which value is subsequently considered as the cost basis. Ordinary maintenance and repairs are expensed as incurred. Depreciation is computed using the straight-line method at rates calculated to amortize the cost of the assets over their estimated useful lives ranging from 3 to 30 years. Amortization of leasehold improvements is computed under the straight-line method over the lesser of the useful life of the related asset or the term of the related leases. Costs incurred to develop internal-use software during the application development stage are capitalized and recorded at cost. Application development stage costs generally include costs associated with internal-use software configuration, coding, installation, and testing. Costs of significant upgrades and enhancements that result in additional functionality also are capitalized,

16 1. Organization and Significant Accounting Policies (continued) whereas costs incurred for maintenance and minor upgrades and enhancements are expensed as incurred. Capitalized costs are amortized using the straight-line method over three to five years once the software is ready for its intended use. Total capitalized internal-use software costs were approximately $18,056,000 as of December 31, 2015, and $17,227,000 as of December 31, 2014, and amortization expense recorded for such internal-use software was approximately $3,072,000 and $2,735,000 for the years ended December 31, 2015 and 2014, respectively. Inventories Inventories of drugs and supplies are stated at cost (first-in, first-out method), which is not in excess of market. Deferred Financing Costs Deferred financing costs are being amortized over the period in which the related debt is outstanding. Charity Care The Hospital provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Because the Hospital does not pursue collection of amounts determined to qualify as charity care, they are not reported as net patient service revenue. The Hospital uses a patient cost of care to patient charge ratio to approximate its direct and indirect costs of providing charity care. This ratio is applied to the specific charges forgone for services and supplies furnished under the Hospital s charity care policy. The Hospital determined that its direct and indirect costs of providing charity care were approximately $4,788,000 and $2,428,000 for the years ended December 31, 2015 and 2014, respectively. Concentrations of Credit Risk Financial instruments that potentially subject the Hospital to concentrations of credit risk consist primarily of cash and cash equivalents, assets limited to use, marketable securities, and accounts receivable. The majority of the investment portfolio is managed by professional investment managers within the guidelines established by the Board of Trustees, which, as a matter of policy, limit the amounts that may be invested in any one issuer. With the exception of the Medicare and Medi-Cal programs, concentrations of credit risk with respect to accounts receivable are limited due to the large number of payors comprising the Hospital s patient base

17 1. Organization and Significant Accounting Policies (continued) Donor-Restricted Gifts Gifts restricted as to use are received by the Foundation and recorded at fair value. The gifts are reported as either temporarily or permanently 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 purpose restriction is accomplished, temporarily restricted net assets are reclassified as unrestricted net assets and reported on the consolidated statements of operations as net assets released from restrictions. Split-Interest Agreements Split-interest agreements, which are a component of donations and bequests pledged, are arrangements in which a donor enters into a trust or other arrangements under which the benefits of such arrangements are distributed to a designated beneficiary or beneficiaries over the trust s term or agreement s term. The Hospital has received contributions under charitable remainder trust arrangements whereby the Hospital serves as trustee. The contributions are recognized in the period in which the trust is established. The assets are recorded at fair value when received and the liability to the designated beneficiary is recorded at the present value of the estimated future payments to be distributed over the expected life of the beneficiary, using a discount rate that reflects current market conditions. The fair value of split-interest agreements is $1,039,000 and $1,440,000 at December 31, 2015 and 2014, respectively, and is recorded within the charitable remainder trust. The present value of the related liabilities is $3,776,000 and $4,471,000 at December 31, 2015 and 2014, respectively, and is recorded within the liability under the charitable remainder trust agreements. The Organization is a beneficiary of assets contributed by donors under unconditional, irrevocable agreements held by independent trustees or other fiscal agents. Assets have been included at fair value in the accompanying consolidated financial statements. Self-Insurance Liabilities The Hospital is self-insured for certain employee health care claims. The Hospital accrues health care claims, including management s estimates of incurred but not reported claims, based on the Hospital s claims experience. Amounts accrued totaled $865,000 and $950,000 at December 31, 2015 and 2014, respectively

18 1. Organization and Significant Accounting Policies (continued) The Hospital is self-insured for workers compensation benefits. Amounts accrued totaled $4,402,000 and $3,891,000 at December 31, 2015 and 2014, respectively, representing the undiscounted cost of workers compensation losses, including an estimate for losses incurred but not reported. The estimate was prepared by an actuary. The Hospital is a full participant in the California Self-Insurers Security Fund as an alternative to providing a letter of credit to assure the state of California that it will be able to meet its self-insured obligations. The Hospital purchases medical malpractice insurance coverage from a captive insurance company (the Captive) (see Note 7) on a claims-made basis of up to $5,000,000 per occurrence in excess of the $50,000 per claim self-insured limit. In 2015 and 2014, the Hospital recorded the gross malpractice liability at $13,432,000 and $10,771,000, respectively, offset by a malpractice insurance receivable of $8,718,000 and $7,664,000, respectively, resulting in a net liability of $4,714,000 and $3,107,000, respectively. These liabilities represent the undiscounted cost of medical malpractice losses not covered by insurance, including an estimate for losses incurred but not reported. Commercial insurance has been obtained for losses up to $30,000,000 in excess of the Captive s coverage limits. The current portion of self-insured claims accrual, representing the cost expected to be paid in the following year, is included in accounts payable and accrued expenses. Amounts expected to be paid beyond one year from December 31 are included in self-insurance liabilities. Income Taxes The principal operations of the Hospital are exempt from taxation pursuant to Internal Revenue Code Section 501(c)(3) and the related state provisions. Accounting Standards Codification (ASC) 740, Income Taxes, clarifies the accounting for income taxes by prescribing a minimum recognition threshold that a tax position is required to meet before being recognized in the financial statements. ASC 740 also provides guidance on derecognition, measurement, classification, interest and penalties, disclosure, and transition. The guidance is applicable to pass-through entities and tax-exempt organizations. No significant tax liability for tax benefits, interest, or penalties was accrued at December 31, 2015 or The Hospital currently files Form 990 (informational return of organizations exempt from income taxes) and Form 990-T (business income tax return for an exempt organization) in the U.S. federal jurisdiction and the state of California for each tax-exempt organization as appropriate. The statute of limitations for the years 2012 through 2014 remains open to examination by the major U.S. taxing jurisdictions to which the Hospital is subject

19 1. Organization and Significant Accounting Policies (continued) Temporarily and Permanently Restricted Net Assets Temporarily restricted net assets are those whose use by the Hospital has been limited by donors to a specific time period or purpose. Permanently restricted net assets have been restricted by donors to be maintained by the Hospital in perpetuity. When a donor restriction expires, that is, when a stipulated time restriction ends or a restricted purpose is accomplished, temporarily restricted net assets used in operations are reclassified as unrestricted net assets and reported on the consolidated statements of operations as net assets released from restrictions. Donor-restricted contributions whose restrictions are met within the same year as received are reflected as unrestricted contributions on the consolidated statements of operations. Recent Accounting Pronouncements In August 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No , Presentation of Financial Statements Going Concern (Subtopic ): Disclosure of Uncertainties about an Entity s Ability to Continue as a Going Concern, which will require management to evaluate whether there is a substantial doubt about the entity s ability to continue as a going concern and, if so, to disclose this in its financial statements. The new standard will become effective for the Hospital for the period ending December 31, 2015, and allows for early adoption. The guidance became effective for the Hospital on January 1, 2015, and it did not have a material impact on its consolidated financial statements. In May 2014, the FASB issued ASU , Revenue from Contracts with Customers (Topic 606), to clarify the principles for recognizing revenue and to improve financial reporting by creating common revenue recognition guidance for U.S. generally accepted accounting principles and International Financial Reporting Standards. The core principles of the guidance in ASU is that an entity should recognize 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 and services. Management is evaluating the potential impact of this guidance, which will be effective in

20 1. Organization and Significant Accounting Policies (continued) In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Leases. The guidance requires that lessees will be required to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. The ASU also will require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative information. The standard will take effect for the Hospital for fiscal years beginning after December 15, The Hospital is still evaluating the impact of ASU No Fair Value of Financial Instruments Marketable securities and assets limited as to use are stated at fair value on the consolidated statements of financial position. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal or most advantageous market for the asset or liability at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the Hospital utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: Level 1 Pricing inputs into the determination of fair value are generally observable inputs, such as quoted prices in active markets on identical assets or liabilities. Financial assets in Level 1 include listed equities. Level 2 Pricing inputs are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 Pricing inputs are generally unobservable and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require management s judgment or estimation of assumptions that market participants would use in pricing the assets or liabilities. The fair values are therefore determined using factors that involve considerable judgment and interpretations, including, but not limited to, private and public comparables, third-party appraisals, discounted cash flow models, and fund manager estimates

21 1. Organization and Significant Accounting Policies (continued) Assets and liabilities measured at fair value are based on one or more of three valuation techniques noted in the tables below. a. Market approach: Prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. b. Cost approach: Amount that would be required to replace the service capacity of an asset (replacement cost). c. Income approach: Techniques to convert future amounts to a single present amount based on market expectations (including present value techniques, option-pricing, and excess earnings models). The following table provides the method used to fair value certain assets and liabilities as of December 31, Only assets and liabilities measured at fair value are shown in the three-tier fair value hierarchy. Fair Value at December 31, 2015 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Valuation Technique (a,b,c) Cash and cash equivalents $ 28,855,559 $ 28,855,559 $ $ a Debt securities: U.S. Government and agency 26,168,583 26,168,583 a Corporate 150,788, ,788,045 a Municipal 11,718,874 11,718,874 a Common stock 43,146,057 43,146,057 a Liabilities: Charitable remainder trust liabilities $ 3,776,172 $ $ $ 3,776,172 a,c

22 1. Organization and Significant Accounting Policies (continued) The following table provides the method used to fair value certain assets and liabilities as of December 31, Only assets and liabilities measured at fair value are shown in the three-tier fair value hierarchy. Fair Value at December 31, 2014 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Valuation Technique (a,b,c) Cash and cash equivalents $ 34,564,087 $ 34,564,087 $ $ a Debt securities: U.S. Government and agency 50,939,625 50,939,625 a Corporate 123,748, ,748,057 a Municipal 12,132,640 12,132,640 a Common stock 44,594,025 44,594,025 a Interest receivable 1,793,718 1,793,718 a Liabilities: Charitable remainder trust liabilities $ 4,470,685 $ $ $ 4,470,685 a,c The table below sets forth a summary of changes in fair value of the Level 3 liabilities: Year Ended December Balance, beginning of year $ 4,470,685 $ 5,957,636 Payments, settlements, and other, net (577,533) (2,359,219) Change in present value (116,980) 872,268 Balance, end of year $ 3,776,172 $ 4,470,

23 1. Organization and Significant Accounting Policies (continued) Long-Term Debt The fair value of the Hospital s long-term debt is estimated based on current market rates for debt of the same risk and maturities (see Note 4). Charitable Remainder Trusts Contributions of charitable remainder trusts (CRTs) for which the Hospital is the trustee are recorded at the current fair value of the assets received, less a liability for the present value of the expected future payments to be made to the beneficiaries, utilizing a discount rate of 6%. Changes in CRT balances are reported in the consolidated statements of changes in net assets. Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of Long-lived assets to be held and used are reviewed for events or changes in circumstances which indicate that their carrying value may not be recoverable. There were no abandonment or impairment losses recognized in 2015 or Capitalized Interest Interest, related to the facility replacement project, is capitalized during construction. Interest on the Hospital s Revenue Certificate of Participation, 2012 Series Revenue Bonds, net of investment income earned on unused bond proceeds, were capitalized in the amount of $6,494,919 and $6,584,316 for the years ended December 31, 2015 and 2014, respectively

24 2. Property and Equipment The Hospital is in the process of a construction project to expand capacity. While the project will not replace the existing hospital, the 179,000-square-foot addition will add a new 52-bed emergency department and 92-bed patient tower. Property and equipment consist of the following at December 31: Buildings and improvements $ 152,988,949 $ 141,947,859 Equipment 162,183, ,697,898 Land improvements 10,855,355 10,855,355 Leasehold improvements 4,068,032 2,297, ,095, ,798,973 Less accumulated depreciation and amortization 249,563, ,662,520 80,531,756 74,136,453 Construction-in-progress 162,827, ,276,202 Land 14,943,679 14,943,679 $ 258,302,748 $ 238,356, Investments Investments in marketable securities, assets limited as to use, CRT assets, and investments restricted for the acquisition of property and equipment and to provide a permanent source of income are stated at fair value

25 3. Investments (continued) The investments are classified as follows on the accompanying consolidated statements of financial position: Year Ended December Assets limited as to use (current) $ 2,015,000 $ 1,915,099 Marketable securities (current) 58,329,862 48,932,520 Assets limited as to use (long term) 177,121, ,121,553 Charitable remainder trust (long term) 7,461,321 8,342,353 Investments restricted by donor for capital purchases and to provide a permanent source of income (long term) 15,749,480 15,460,627 $ 260,677,118 $ 267,772,152 Investment income includes the following: Year Ended December Interest and dividend income $ 7,235,575 $ 7,165,584 Unrealized (losses) gains designated as trading, net (7,080,620) 3,494,466 Realized gains 2,685,749 2,937,927 $ 2,840,704 $ 13,597,977 Management continually reviews its investment portfolio and evaluates whether declines in the fair value of securities designated as other than trading should be considered other than temporary. Factored into this evaluation are the general market conditions, the issuer s financial condition and near-term prospects, conditions in the issuer s industry, the recommendation of advisors, and the length of time and extent to which the market value has been less than cost

26 4. Long-Term Debt Long-term debt, excluding original issue discount, consists of the following: December Certificates of Participation, 2011 Series: Principal is payable annually in varying amounts ranging from $2,015,000 to $8,800,000 due through January Interest is payable semiannually at rates ranging from 4.00% to 6.50% $ 115,191,773 $ 117,069,536 Less current portion (2,015,000) (1,915,000) $ 113,176,773 $ 115,154,536 Maturities of long-term debt, excluding original issue discount, as of December 31, 2015, are as follows: Fiscal year: 2016 $ 2,015, ,115, ,220, ,330, ,460,000 Thereafter 106,300,000 $ 117,440,000 Pursuant to the terms of the Hospital Revenue Certificates of Participation indentures, the Hospital is required to maintain funds on deposit with a trustee to pay principal and interest and to maintain certain financial and debt service ratios. As of December 31, 2015, the Hospital was in compliance with these financial covenants. The carrying value of tax-exempt debt was $115,191,773, which is net of the discount of $2,248,227 at December 31, The fair value of tax-exempt debt, based on current market rates for debt of the same risk and maturities, was estimated at $134,758,605 (Level 2) at December 31, Debt issuance costs of $1,900,000 were incurred in connection with the debt offering in Debt issuance costs are being amortized over the respective commitment periods. Amounts amortized to interest expense totaled $53,194 and $97,386 at December 31, 2015 and 2014, respectively

27 5. Commitments and Contingencies Guarantee The Hospital provides physician recruitment agreements to certain physicians who agree to relocate to its communities to fill a need in the Hospital s service areas and commit to remain in practice there. Under these agreements, the Hospital makes loans available to the physicians consisting of advances for amounts in excess of the earnings of their practice, up to the amount stipulated in the agreement. The assistance periods range from 12 to 24 months. Such payments are recoverable from the physicians if they do not fulfill their commitment period to the regional, which is typically double the assistance period. The carrying amount of the asset and liability (the future payments the Hospital expects to make under the guarantees) for the Hospital s obligations under these guarantees is approximately $407,000 and $336,000, respectively, as of December 31, 2015, and $230,000 and $180,000, respectively, as of December 31, 2014, and is reflected in other assets and other long-term liabilities on the accompanying consolidated statements of financial position. The advances made pursuant to these agreements are earned by the physicians as they fulfill their commitment period to the regional; otherwise, any remaining amounts are payable back to the Hospital. Leases The Hospital leases certain buildings and equipment under various non-cancelable operating leases expiring in various years. Certain of these leases have renewal options providing for additional lease periods. Future minimum payments by year for these obligations consisted of the following as of December 31, 2015: 2016 $ 710, , , , ,137 Thereafter 257,516 $ 1,816,373 Total rental expense amounted to $3,014,000 and $3,358,000 in 2015 and 2014, respectively

28 5. Commitments and Contingencies (continued) Technology Systems The Hospital has entered into various agreements to license software and to remotely host information technology systems. The estimated future licensing and remote hosting obligations are as follows: Legal 2016 $ 5,988, ,223, ,039, ,935, ,783,811 Thereafter 3,755,419 $ 25,726,959 The Hospital is a defendant in various legal actions arising from the normal conduct of business. The Hospital believes that the ultimate resolution of the various proceedings will not have a material adverse effect upon the consolidated financial position, results of operations, changes in net assets, or cash flows of the Hospital. 6. Retirement Plans Defined Contribution Plan All newly hired employees are eligible to participate in a defined contribution retirement plan. The Hospital makes a matching contribution of 50% of participant contributions up to 5% of their eligible compensation. The Hospital may make an additional discretionary contribution to the plan of 2.5% to 4.5% of the participant s eligible compensation, based on years of service. Effective June 1, 2012, employees hired on or before December 31, 2005, who were previously participants in the defined benefit plan are eligible to receive an enhanced discretionary contribution. The Hospital makes contributions to the plan of 2.5% to 10.2% of the participant s eligible compensation, based on years of service. Contributions for the defined contribution plan totaled $6,414,000 and $6,504,000 for the years ended December 31, 2015 and 2014, respectively

29 6. Retirement Plans (continued) Defined Benefit Plan The Hospital has a non-contributory defined benefit pension plan covering eligible employees who work at least 1,000 hours per year and have completed one year of continuous full-time service. The benefits are based on years of service and the employee s compensation. Benefits vest after five years of service or on the attainment of age 65. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. The Hospital closed the defined benefit pension plan effective for new employees hired after December 31, Effective June 1, 2012, the Hospital s Board approved freezing the defined benefit pension plan, at which point plan participants no longer accrue additional benefits related to credited service or subsequent pay increases. The defined benefit pension plan is available to all employees hired on or before December 31, In addition to providing pension benefits, the Hospital provides certain health care benefits for retired employees who elect to continue coverage under the Hospital Health Care Plan. Substantially all of the Hospital s employees who retire at age 62 (with 10 or more years of service) or age 59-1/2 (with 30 or more years of service) are eligible for these benefits until they reach age 65. The following table sets forth the changes in benefit obligations, changes in plan assets, and components of the net periodic benefit cost for both the pension plan and the postretirement health care benefit plan: Pension Benefits December 31 Other Benefits December Change in projected benefit obligations: Projected benefit obligation at beginning of year $ 161,641,381 $ 135,764,921 $ 4,320,273 $ 3,484,542 Service cost 250, ,338 Interest cost 6,589,494 6,560, , ,548 Actuarial (gains) losses (8,802,911) 30,495, , ,442 Participant contributions 150, ,280 Benefits paid (11,361,891) (11,179,837) (733,713) (563,877) Projected benefit obligation at end of year $ 148,066,073 $ 161,641,381 $ 5,144,903 $ 4,320,