Advocate Health Care Network and Subsidiaries FINANCIAL REPORT

Transcription

1 Advocate Health Care Network and Subsidiaries FINANCIAL REPORT For the First Quarter Ended March 31, 2018

2 Cautionary Statement Regarding Forward Looking Statements in this Quarterly Financial Report This Quarterly Report contains forward looking statements within the meaning of the federal securities laws. Forward looking statements are those statements that do not relate solely to historical or current fact, and can often be identified by use of words including but not limited to may, believe, will, expect, project, estimate, anticipate, plan, or continue. These forward looking statements are based on the current plans and expectations of Advocate Health Care Network and Subsidiaries ( Advocate ) that, although believed to be reasonable, are subject to a number of known and unknown uncertainties and risks inherent in the operation of health care facilities, many of which are beyond Advocate s control, that could significantly affect current plans and expectations and Advocate s future financial position and results of operations. These uncertainties and risks include, but are not limited to, the following: potential federal or state reform of health care, implementation of the Patient Protection and Affordable Care Act ( ACA ) and related rules and regulations, and any potential modifications, challenges or repeal of the ACA or any other such legislation (including, without limitation, the information regarding the ACA included under the caption Industry Risks herein); the highly competitive nature of the health care business; pressures to contain costs by managed care organizations, insurers, health care providers and Advocate s ability to negotiate acceptable terms with third party payors; changes in the Medicare and Medicaid programs that may impact reimbursements to health care providers and insurers, as well as possible additional changes in such programs; Advocate s ability to attract and retain qualified management and other personnel, including physicians, nurses and medical support personnel; liabilities and other claims asserted against Advocate (including, without limitation, the information included under the caption Laws, Regulations and Related Litigation herein;) changes in accounting standards and practices; changes in general economic conditions; future divestitures or acquisitions (including, without limitation, the information included under the caption Potential for New Corporate Affiliations herein;) changes in revenue mix or delays in receiving payments from third party payors, as has been the case in Illinois (including, without limitation, the information included under the caption Continued Pressures on and Changes to State Funded Programs herein); the availability and cost of capital to fund future expansion plans of Advocate and to provide for ongoing capital expenditure needs; changes in business strategy or development plans; Advocate s ability to implement shared services and other initiatives and realize decreases in administrative, supply and infrastructure costs; the outcome of pending and any future litigation (including, without limitation, the information included under the caption Laws, Regulations and Related Litigation herein;) the ability to achieve expected levels of patient volumes and control the costs of providing services; tax reform (including, without limitation, the information included under the caption Tax Reform herein); results of reviews of Advocate s cost reports; and increased costs from further government regulation of health care and Advocate s failure to comply, or allegations of any failure to comply, with applicable laws and regulations, including without limitation, laws, regulations, policies and procedures relating to the status of Advocate and certain of its subsidiaries as tax exempt organizations as well as its ability to comply with the requirements of Medicare and Medicaid programs. These forward looking statements speak only as of the date made. Except as required by law, Advocate has undertaken no obligation to publicly update or revise any forward looking statement contained in this Quarterly Report, whether as a result of new information, future events or otherwise. Therefore, current plans, anticipated actions and future financial position and results of operations may differ from those expressed in any forward looking statements made by or on behalf of Advocate. Investors are cautioned not to unduly rely on such forward looking statements when evaluating the information presented in this Quarterly Report.

3 Advocate Health Care Network and Subsidiaries For the First Quarter Ended March 31, 2018 C O N T E N T S Page Interim Condensed Consolidated Financial Statements for the First Quarter Ended March 31, 2018: Interim Condensed Consolidated Balance Sheets... 1 Interim Condensed Consolidated Statements of Operations and Changes in Net Assets... 3 Interim Condensed Consolidated Statements of Cash Flows... 5 Notes to Interim Condensed Consolidated Financial Statements... 6 Management Discussion and Analysis of Financial Condition and Results of Operations 24 Sources of System Net Patient Service Revenue, Utilization Statistics and Ratios Liquidity Summary... 53

4 Advocate Health Care Network and Subsidiaries Interim Condensed Consolidated Balance Sheets (dollars in thousands) Unaudited Note 1 March 31, December 31, Assets Current assets: Cash and cash equivalents $ 235,425 $ 411,133 Short term investments 21,099 27,748 Assets limited as to use: Internally designated for self insurance programs 94,224 94,224 Patient accounts receivable 726, ,392 Amounts due from primary third party payors 30,471 32,301 Prepaid expenses, inventories and other current assets 312, ,369 Collateral proceeds received under securities lending program 6,110 19,577 Total current assets 1,425,712 1,626,744 Assets limited as to use: Externally designated under debt agreements, net of amounts required to meet current obligations 15,981 6,085 Internally designated for capital improvement 5,411,887 5,210,963 Internally designated for self insurance programs, less current portion 680, ,688 Externally designated for capital improvement, medical education and health care programs 62,102 64,994 Investments under securities lending program 6,038 18,975 6,176,657 5,992,705 Interests in health care and related entities 153, ,968 Reinsurance receivable 75,036 76,376 Prepaid pension expense and other noncurrent assets 270, ,277 6,675,259 6,497,326 Property and equipment at cost: Property and equipment 6,032,951 5,974,625 Less allowances for depreciation 3,045,217 2,992,201 2,987,734 2,982,424 $ 11,088,705 $ 11,106,494 Note 1: December 31, 2017 financial statement information was derived from and should be read in conjunction with the Advocate Health Care Network and Subsidiaries 2017 Audited Consolidated Financial Statements, available on the Electronic Municipal Market Access website ( See accompanying notes to interim condensed consolidated financial statements. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

5 Advocate Health Care Network and Subsidiaries Interim Condensed Consolidated Balance Sheets (continued) (dollars in thousands) Unaudited Note 1 March 31, December 31, Liabilities and net assets Current liabilities: Current portion of long term debt $ 28,926 $ 28,120 Long term debt subject to short term remarketing arrangements 91,975 91,975 Accounts payable and accrued expenses 413, ,786 Accrued salaries and employee benefits 416, ,774 Amounts due to primary third party payors 314, ,020 Current portion of accrued insurance and claims costs 104, ,593 Obligations to return collateral under securities lending program 6,110 19,577 Total current liabilities 1,376,079 1,563,845 Noncurrent liabilities: Long term debt, less current portion 1,539,106 1,527,016 Pension plan liability 4,682 4,345 Accrued insurance and claims costs, less current portion 636, ,735 Accrued losses subject to insurance recovery 75,036 76,376 Obligations under swap agreements, net of collateral posted 66,369 73,875 Other noncurrent liabilities 213, ,240 Total noncurrent liabilities 2,535,559 2,512,587 Total liabilities 3,911,638 4,076,432 Net assets: Unrestricted 7,009,527 6,860,328 Temporarily restricted 113, ,114 Permanently restricted 53,610 53,446 7,176,577 7,028,888 Non controlling interest 490 1,174 Total net assets 7,177,067 7,030,062 $ 11,088,705 $ 11,106,494 Note 1: December 31, 2017 financial statement information was derived from and should be read in conjunction with the Advocate Health Care Network and Subsidiaries 2017 Audited Consolidated Financial Statements, available on the Electronic Municipal Market Access website ( See accompanying notes to interim condensed consolidated financial statements. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

6 Advocate Health Care Network and Subsidiaries Interim Condensed Consolidated Statements of Operations and Changes in Net Assets (dollars in thousands) Unaudited For the Quarter Ended March 31, Note 1 For the Year Ended December 31, Unrestricted revenues and other support Net patient service revenue $ 1,143,551 $ 1,128,724 $ 4,515,229 Capitation revenue 320, ,495 1,317,839 Other revenue 71,219 87, ,345 1,535,695 1,535,181 6,233,413 Expenses Salaries, wages and employee benefits 789, ,691 3,141,440 Purchased services and operating supplies 352, ,213 1,414,485 Contracted medical services 142, , ,922 Other 87, , ,037 Medicaid assessment 41,352 40, ,457 Depreciation and amortization 76,123 72, ,280 Interest 14,722 14,574 58,900 1,505,007 1,488,450 5,986,521 Operating income before nonrecurring losses 30,688 46, ,892 Nonrecurring losses 7,270 1,440 42,750 Operating income 23,418 45, ,142 Nonoperating income (loss) Investment income 1, , ,236 Change in the fair value of interest rate swaps 7,505 1,511 5,748 Other nonoperating items, net 4,894 1,246 (13,812) Loss on refinancing of debt (5,971) 13, , ,201 Revenues in excess of expenses $ 37,288 $ 242,072 $ 811,343 Note 1: December 31, 2017 financial statement information was derived from and should be read in conjunction with the Advocate Health Care Network and Subsidiaries 2017 Audited Consolidated Financial Statements, available on the Electronic Municipal Market Access website ( See accompanying notes to interim condensed consolidated financial statements. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

7 Advocate Health Care Network and Subsidiaries Interim Condensed Consolidated Statements of Operations and Changes in Net Assets (continued) (dollars in thousands) Unaudited For the Quarter Ended March 31, Note 1 For the Year Ended December 31, Unrestricted net assets Revenues in excess of expenses $ 37,288 $ 242,072 $ 811,343 Contributions received from a supporting foundation and grants used for capital purposes 1,703 1,661 6,450 Post retirement benefit plan adustments 77,773 Alternative investment cummulative fair value adjustment 110,214 Other (6) 95 Increase in unrestricted net assets 149, , ,566 Temporarily restricted net assets Contributions for medical education programs, capital purchases, and other purposes 2,233 2,413 17,001 Realized gains (losses) on investments 962 (274) 3,586 Unrealized (losses) gains on investments (1,334) 3,212 7,239 Net assets released from restrictions and used for operations, for capital purposes, for medical education programs and other purposes (3,535) (3,629) (21,726) (Decrease) increase in temporarily restricted net assets (1,674) 1,722 6,100 Permanently restricted net assets Contributions for medical education programs, capital purchases and other purposes Increase in permanently restricted net assets Increase in net assets 147, , ,137 Change in non controlling interest (684) (1,045) (324) Net assets at beginning of period 7,030,062 6,128,249 6,128,249 Net assets at end of period $ 7,177,067 $ 6,372,865 $ 7,030,062 Note 1: December 31, 2017 financial statement information was derived from and should be read in conjunction with the Advocate Health Care Network and Subsidiaries 2017 Audited Consolidated Financial Statements, available on the Electronic Municipal Market Access website ( See accompanying notes to interim condensed consolidated financial statements. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

8 Advocate Health Care Network and Subsidiaries Interim Condensed Consolidated Statements of Cash Flows (dollars in thousands) Unaudited For the Quarter Ended March 31, Note 1 For the Year Ended December 31, Operating activities Increase in net assets $ 147,005 $ 244,616 $ 901,813 Adjustments to reconcile (decrease) increase in net assets to net cash (used in) provided by operating activities: Depreciation, amortization and accretion 74,818 70, ,932 Deferred income taxes 338 (823) Losses (gains) on disposal of property and equipment 482 (665) 20,390 Loss on refinancing of debt 5,971 Change in fair value of interest rate swaps (7,505) (1,511) (5,748) Postretirement benefit plan adjustments (77,773) Restricted contributions and gains on investments, net of assets released from restrictions used for operations (1,832) (1,968) (15,276) Change in operating assets and liabilities: Trading securities (167,601) (98,902) (457,919) Patient accounts receivable 20,422 6,669 (65,381) Amounts due to/from primary third party payors (2,426) 20,915 (8,094) Accounts payable, accrued salaries, employee benefits, accrued expenses and other noncurrent liabilities (156,624) (191,358) (69,946) Other assets (16,915) (109,824) 55,370 Accrued insurance and claims costs 19,121 22,215 (44,393) Net cash (used in) provided by operating activities (91,055) (38,523) 527,123 Investing activities Purchases of property and equipment (79,644) (87,266) (343,626) Proceeds from sale of property and equipment 39 4,855 7,063 Cash and investments acquired in the acquistion of Advocate Physician Partners 157, ,286 Net sales and purchases of investments designated as nontrading (9,896) (17,840) (32) Other 3,618 (9,168) (90,321) Net cash (used in) provided by investing activities (85,883) 47,867 (269,630) Financing activities Payment of long term debt (795) (542) (140,894) Proceeds from issuance of long term debt 115,000 Proceeds from restricted contributions and gains on investments 2,025 5,462 28,297 Other (351) Net cash provided by (used in) financing activities 1,230 4,920 2,052 (Decrease) increase in cash and cash equivalents (175,708) 14, ,545 Cash and cash equivalents at beginning of period 411, , ,588 Cash and cash equivalents at end of period $ 235,425 $ 165,852 $ 411,133 Note 1: December 31, 2017 financial statement information was derived from and should be read in conjunction with the Advocate Health Care Network and Subsidiaries 2017 Audited Consolidated Financial Statements, available on the Electronic Municipal Market Access website ( See accompanying notes to interim condensed consolidated financial statements. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

9 Note A Basis of Presentation Advocate Health Care Network and Subsidiaries Notes to Interim Condensed Consolidated Financial Statements As of and for the First Quarter Ended March 31, 2018 (dollars shown in tables are in thousands except as noted) The accompanying Interim Condensed Consolidated Financial Statements for the first quarters ended March 31, 2018 and 2017 have been prepared in accordance with accounting principles generally accepted in the United States applied on a basis substantially consistent with that of the 2017 audited consolidated financial statements of Advocate Health Care Network and Subsidiaries ( Advocate ). In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The interim condensed consolidated financial statements do not include all the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. Operating results for the quarter ended March 31, 2018 are not necessarily indicative of the results that may be experienced during the year ending December 31, Note B Accounting Pronouncements In March 2017, the Financial Accounting Standards Board ( FASB ) issued guidance that is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, related to the presentation of net periodic pension cost and net periodic postretirement benefit costs. Advocate elected to early adopt this standard effective January 1, This new guidance requires that the service cost component be reported in the same line item as compensation costs arising from services rendered by the pertinent employees during the period. The other components of net pension and postretirement benefit costs are required to be presented separately from the service cost component and outside a subtotal of income from operations. Advocate has evaluated the effect of this guidance on the Interim Condensed Consolidated Statements and has determined that this guidance will reduce operating income but will have no effect on revenues in excess of expenses on the Consolidated Statements of Operations and Changes in Net Assets. This guidance will not have an effect on the measurement of pension cost nor presentation of prepaid pension expense or pension plan liabilities in the Consolidated Balance Sheets. Advocate used the practical expedient and used the amounts disclosed in the retirement plans note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. The other components of net pension and postretirement benefit costs reclassified from salaries, wages and employee benefits to other nonoperating items, net was $4.0 million for the quarter ended March 31, 2017 and $15.6 million for the year ended December 31, In November 2016, the FASB issued guidance related to the statement of cash flows. The guidance will require restricted cash and restricted cash equivalents to be included with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown on the statement of cash flows. This guidance is effective for the fiscal years, and interim periods within those fiscal years, beginning after December 15, The Interim Condensed Consolidated Financial Statements were prepared on April 13,

10 In August 2016, the FASB issued guidance related to the presentation of financial statements of not forprofit entities. The guidance will require net assets to be categorized either as net assets with donor restrictions or net assets without donor restrictions rather than the currently required three classes of net assets. The guidance also requires additional quantitative and qualitative disclosures and disclosure of expenses by their natural and functional classifications. This guidance is effective for fiscal years beginning after December 15, 2017 but for interim periods beginning after December 15, Advocate is evaluating the effect this guidance will have on its consolidated financial statements; however, the guidance is not expected to have an effect on revenues in excess of expenses on the Consolidated Statements of Operations and Changes in Net Assets. In February 2016, the FASB issued guidance related to lease accounting. The guidance will require leases that are classified as operating leases under current guidance to be recognized on the balance sheet as lease assets and liabilities by lessees. This new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, Advocate is evaluating the effect this guidance will have on its consolidated financial statements. In January 2016, the FASB issued guidance requiring financial instruments accounted for on the equity method to be measured at fair value, with changes in fair value recognized in net income. This new guidance is effective for fiscal years and interim periods within those fiscal years beginning after December 15, As of January 1, 2018, Advocate elected to measure its investments in private equity limited partnerships, previously carried at cost, at fair value. Advocate recorded a cumulative effect adjustment of $110.2 million as an increase in unrestricted net assets due to this election in January On January 1, 2018, Advocate adopted the new revenue recognition accounting standard issued in May 2014 by the FASB. The guidance outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. 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 also requires expanded disclosures regarding Advocate s revenue recognition policies and significant judgements used in the determination of net revenue. Advocate applied the full retrospective approach to all contracts when adopting the guidance. As a result, the amounts which were previously classified as the provision for uncollectible accounts $72.1 and $237.3 million at March 31, 2017 and December 21, 2017, respectively, in the condensed consolidated statements of operations and changes in net assets are now reflected as implicit price concessions and are therefore included as a reduction to net patient service revenue in the condensed consolidated statements of operation and changes in net assets. With the adoption of this guidance, changes in credit issues not assessed at the date of service are recognized as other expenses on the condensed consolidated statement of operations and changes in net assets. Prior to the adoption of this guidance, the provision for uncollectible accounts had been presented consistent with the previous revenue recognition standard which required it to be presented separately as a component of net operating revenue. Additionally, with the adoption of this standard, the allowance for doubtful accounts of approximately $ and $216.6 million at March 31, 2017 and December 31, 2017, respectively, is presented as a component of net patient accounts receivable. Other than these changes in presentation on the condensed consolidated statement of operations and changes in net assets and condensed consolidated balance sheet, the adoption of this guidance did not have a material impact on the consolidated results of operations for the three months ended March 31, The Interim Condensed Consolidated Financial Statements were prepared on April 13,

11 Because Advocate s performance obligations relate to contracts with a duration of less than one year, Advocate has elected to apply the optional exemption provided in the guidance and, therefore, is not required to disclose the aggregate amount of the transaction price allocated to performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period. The unsatisfied or partially unsatisfied performance obligations referred to above are primarily related to inpatient acute care services at the end of the reporting period. The performance obligations for these contracts are generally completed when the patients are discharged, which generally occurs within days or weeks of the end of the reporting period. As provided for under the guidance, Advocate does not adjust the promised amount of consideration from patients and third party payers for the effects of a significant financing component due to Advocate s expectation that the period between the time the service is provided to a patient and the time that the patient or a third party payer pays for that service will be one year or less. However, Advocate does, in certain instances, enter into payment agreements with patients that allow payments in excess of one year. For those cases, the financing component is not deemed to be significant to the contract. Advocate does not incur significant incremental costs in obtaining contracts with patients. As permitted in the guidance, any costs which are incurred, are expensed in the period of occurrence, as the amortization period of any asset that Advocate would have recognized is one year or less in duration. Note C Reclassifications in the Condensed Consolidated Financial Statements Certain reclassifications were made to the 2017 interim condensed consolidated financial statements and footnotes to conform to the classifications used in There was no impact on previously reported 2017 net assets or revenues in excess of expenses. Note D Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and amounts disclosed in the notes to the financial statements at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Although estimates are considered to be fairly stated at the time made, actual results could differ materially from those estimates. Advocate considers critical accounting policies to be those that require the more significant judgments and estimates in the preparation of its financial statements, including, but not limited to, the following: recognition of patient service revenue, which includes, explicit and implicit price concessions, third party payor settlements, contracted medical service expense recognition and reserves for incurred but not reported claims; accounting for asset impairment or disposal of long lived assets; reserves for losses and expenses related to health care professional, general and other self insured liability risks; accounting for swap valuations; and pension plan actuarial assumptions. Management relies on historical experience and on other assumptions believed to be reasonable under the circumstances in making its judgments and estimates. Although estimates are considered to be reasonable at the time made, actual results could differ materially from those estimates. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

12 Changes in estimates that relate to prior years third party payment arrangements resulted in no effect to net patient service revenue and an increase of $0.1 million for the quarters ended March 31, 2018 and 2017, respectively; and $2.4 million decrease for the year ended December 31, Note E Revenue and Patient Accounts Receivable Net patient service revenue is reported at the amount that reflects the consideration to which Advocate expects to be entitled in exchange for providing patient care. These amounts are due from patients, third party payors (including health insurers and government programs), and others and includes variable consideration for retroactive revenue adjustments due to settlement of audits, reviews, and investigations. Generally, Advocate bills the patients and third party payors several days after the services are performed and/or the patient is discharged from the facility. Revenue is recognized as performance obligations are satisfied. Performance obligations are determined based on the nature of the services that Advocate provides. Revenue for performance obligations is recognized over time based on actual charges incurred in relation to total expected (or actual) charges. Performance obligations satisfied over time relate to patients receiving health care services. Advocate measures the performance obligation from admission into the hospital (inpatient) or check in (outpatient) to the point when it is no longer required to provide services to that patient, which is generally at the time of discharge (in patient) or check out (out patient). Advocate believes that this method provides a faithful depiction of the transfer of services over the term of the performance obligation based on the inputs needed to satisfy the obligation. Advocate uses a portfolio approach to account for categories of patient contracts as a collective group rather than recognizing revenue on an individual contract basis. The portfolios consist of major payor classes for inpatient revenue and major payor classes and types of services provided for outpatient revenue. Based on historical collection trends and other analyses, Advocate believes that revenue recognized by utilizing the portfolio approach approximates the revenue that would have been recognized if an individual contract approach were used. Advocate determines the transaction price, which involves significant estimates and judgement, based on standard charges for goods and services provided, reduced by explicit and implicit price concessions, including adjustments to contractual arrangements with third party payors, discounts provided to uninsured and underinsured patients in accordance with Advocate s financial assistance policy, and/or implicit price concessions based on this historical collection experience of patients. Advocate determines the transaction price associated with services provided to patients who have third party payor coverage based on the reimbursement terms outlined in contractual agreements, Advocate s discount policies and historical experience. For uninsured and under insured patients who do not qualify for charity care, Advocate determines the transaction price associated with services on the basis of charges reduced by implicit price concessions. Implicit price concessions included in the estimate of the transaction price are based on Advocate s historical collection experience for applicable patient portfolios. Patients who meet Advocate s criteria for free care charity are provided care without charge; such amounts are not reported as revenue. Subsequent changes to the estimate of the transaction price are generally recorded as adjustments to net patient service revenue in the period of the change. Settlements with third party payers for retroactive adjustments due to audits, reviews or investigations are considered variable consideration and are included in the determination of the estimated transaction price for providing patient care using the most likely outcome method. These settlements are estimated based on the terms of the payment agreements with the payer, correspondence from the payer and Advocate s historical The Interim Condensed Consolidated Financial Statements were prepared on April 13,

13 settlement activity, including an assessment to ensure that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the retroactive adjustment is subsequently resolved. Estimated settlements are adjusted in future periods as new information becomes available or as years are settled or are no longer subject to such audits, reviews and investigations. For the three months ended March 31, 2018, changes in Advocate s estimates of implicit price concessions, discounts and contractual adjustments or other reductions to expected payments for performance obligations in prior years were not significant. Currently, Illinois utilizes supplemental reimbursement programs to supplement reimbursement to providers to offset a portion of the cost of providing care to Medicaid and indigent patients. These programs are designed with input from the Centers for Medicare & Medicaid Services and are funded with a combination of state and federal resources including assessments levied on the providers. Under these supplemental programs, Advocate recognizes revenue and related expenses in the period in which amounts are estimable and collection is reasonably assured. Reimbursement under these programs is reflected in net patient service revenue and the assessment is reflected in other expense on the condensed consolidated statement of operations and changes in net assets. Advocate has determined that the nature, amount, timing and uncertainty of revenue and cash flows are affected by the payors, the lines of business that render services to patients and the timing of when revenue is recognized and billed. The composition of net patient service revenue by payor is as follows: For the Quarter Ended March 31, For the Year Ended December 31, Medicare and Medicare Managed Care $ 386,148 $ 371,111 $ 1,558,033 Medicaid and Medicaid Managed Care 176, , ,723 Blue Cross 284, , ,420 Managed Care 230, ,734 1,018,714 Self Pay 17,082 14,364 51,395 Other 49,300 46, ,944 $ 1,143,551 $ 1,128,724 $ 4,515,229 Deductibles, copayments and coinsurance under third party payment programs which are the patient s responsibility are included within the primary payor category in the table above. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

14 The composition of net patient service revenue based on Advocate s main business lines are as follow: For the Quarter Ended March 31, For the Year Ended December 31, Hospital $ 955,536 $ 960,033 $ 3,805,964 Physician Services 143, , ,629 Home health, hospice, home care products 23,152 27,330 89,127 Other 21,011 21,476 68,509 $ 1,143,551 $ 1,128,724 $ 4,515,229 Capitation Revenue Advocate has agreements with various managed care organizations under which Advocate provides or arranges for medical care to members of the organizations in return for a monthly payment per member. Revenue is earned each month as a result of agreeing to provide or arrange for their medical care. Other Revenue Other revenue is recognized at an amount that reflects the consideration to which Advocate expects to be entitled in exchange for providing goods and services. The amounts recognized reflect consideration due from customers, third party payers, and others. Primary categories of other revenue include income from joint ventures, grant revenue, cafeteria revenue, rent and lease revenue and other. Patient Accounts Receivable Advocate s patient accounts receivable are reported at the amount that reflects the consideration to which Advocate expects to be entitled in exchange for providing patient care. In certain instances, Advocate does receive payment in advance of the services provided and would consider these amounts to represent contract liabilities. Contract liabilities at March 31, 2018 and 2017 and December 31, 2017 were not significant. The revenue related to patient accounts receivable are reported at net realizable value based on certain assumptions. For third party payors including Medicare, Medicaid, Blue Cross and Managed Care, the net realizable value is based on the estimated contractual reimbursement percentage, which is based on current contract prices or historical paid claims data by payor. For self pay, which includes patients who are uninsured and the patient responsibility portion for patients with insurance, and other accounts receivable the net realizable value is determined using estimates of historical collection experience including an analysis by aging category. These estimates are adjusted for expected recoveries and any anticipated changes in trends including significant changes in payor mix, shared revenue cycle operations, economic conditions or trends in federal and state governmental healthcare coverage. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

15 Note F Investments Substantially all investments and assets limited as to use are classified as trading. Investments in debt and equity securities with readily determinable fair values are measured at fair value using quoted market prices. Investments in limited partnerships that invest in marketable securities and derivative products ( hedge funds ) are reported using the equity method of accounting based on information provided by the respective partnership. Prior to January 1, 2018, investments in private equity limited partnerships with ownership percentages over 5% were recorded on the equity method of accounting, while those with ownership percentages of 5% or less were recorded using the cost method of accounting. As of January 1, 2018, Advocate elected to measure its investments in private equity limited partnerships, previously carried at cost, at fair value. Advocate recorded as a change in unrestricted net assets a cumulative effect adjustment of $110.2 million due to this election. Therefore, as of January 1, 2018, investments in private equity limited partnerships with ownership percentages over 5% were recorded on the equity method of accounting, while those with ownership percentages of 5% or less were recorded at fair value. For private equity investments previously carried at cost, Advocate regularly compared the net asset value ( NAV ), which is a proxy for the fair value, to the recorded cost of these investments for potential other than temporary impairment. The cost of these investments was $610.5 million and the NAV of these, based on estimates determined by the investments manager, was $719.6 million at December 31, For the quarter ended March 31, 2017, Advocate identified and recorded $0.0 million and $2.6 million for the year ended December 31, 2017 of impairment losses that are included in investment income in the interim condensed consolidated statements of operations and changes in net assets. Receivables and payables for investment trades not settled are presented with prepaid expenses, inventories and other current assets and accounts payable and accrued expenses. Unsettled sales resulted in receivables due from brokers of $51.5 million and $29.5 million at March 31, 2018 and December 31, 2017, respectively. Unsettled purchases resulted in payables of $103.4 million and $76.8 million at March 31, 2018 and December 31, 2017, respectively. Investment income or loss (including realized gains and losses, interest, dividends, changes in equity of limited partnerships and unrealized gains and losses) is included in investment income unless the income or loss is restricted by donor or law or is related to assets designated for self insurance programs. Investment income on self insurance trust funds is reported in other revenue. Gains and losses that are restricted by donor or law are reported as a change in temporarily restricted net assets. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

16 Investment returns for assets limited as to use, cash and cash equivalents and short term investments are comprised of the following: For the Quarter Ended March 31, For the Year Ended December 31, Interest and dividend income $ 6,906 $ 13,434 $ 51,142 Equity income from alternative investments 14,749 54, ,441 Net realized gains (losses) 31,185 (12,822) 103,030 Net unrealized (losses) gains (42,210) 150, ,319 $ 10,630 $ 205,797 $ 678,932 Investment returns are included in the consolidated statements of operation and changes in net assets as follows: For the Quarter Ended March 31, For the Year Ended December 31, Other revenue $ 9,531 $ 8,835 $ 46,871 Investment income 1, , ,236 Temporarily resticted net assets realized and change in unrealized (losses) gains (372) 2,938 10,825 $ 10,630 $ 205,797 $ 678,932 Investments in hedge funds totaled $2,149.1 million and $1,958.8 million at March 31, 2018 and December 31, 2017, respectively. Investments in private equity limited partnerships totaled $982.4 million and $826.3 million at March 31, 2018 and December 31, 2017, respectively. At March 31, 2018, Advocate had commitments to fund, including recallable distributions, an additional $870.5 million to private equity limited partnerships over approximately the next seven years. Note G Fair Value Measurements Advocate accounts for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value is observable in the market. Advocate categorizes each fair value measurement in one of three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are: Level 1: Level 2: Level 3: Quoted prices in active markets for identified assets or liabilities. Inputs, other than the quoted process in active markets that are observable either directly or indirectly. Unobservable inputs in which there is little or no market data, which then requires the reporting entity to develop its own assumptions about what market participants would use in pricing the asset or liability. The following section describes the valuation methodologies Advocate uses to measure financial assets and liabilities at fair value. In general, where applicable, Advocate uses quoted prices in active markets for identical assets and liabilities to determine fair value. This pricing methodology applies to Level 1 investments The Interim Condensed Consolidated Financial Statements were prepared on April 13,

17 such as domestic and international equities, United States Treasuries, exchange traded funds, and agency securities. If quoted prices in active markets for identical assets and liabilities are not available to determine fair value, then quoted prices for similar assets and liabilities or inputs other than quoted prices that are observable either directly or indirectly are used. These investments are included in Level 2 and consist primarily of corporate notes and bonds, foreign government bonds, mortgage backed securities, commercial paper and certain agency securities. The fair value for the obligations under swap agreements included in Level 2 is estimated using industry standard valuation models. These models project future cash flows and discount the future amounts to a present value using market based observable inputs, including interest rate curves. The fair values of the obligation under swap agreements include adjustments related to Advocate s credit risk. Advocate s investments are exposed to various kinds and levels of risk. Equity securities and equity funds expose Advocate to market risk, performance risk and liquidity risk for both domestic and international investments. Market risk is the risk associated with major movements of the equity markets. Performance risk is that risk associated with a company s operating performance. Fixed income securities and fixed income mutual funds expose Advocate to interest rate risk, credit risk and liquidity risk. As interest rates change, the value of many fixed income securities is affected, including those with fixed interest rates. Credit risk is the risk that the obligor of the security will not fulfill its obligations. Liquidity risk is affected by the willingness of market participants to buy and sell particular securities. Liquidity risk tends to be higher for equities related to small capitalization companies and certain alternative investments. Due to the volatility in the capital markets, there is a reasonable possibility of subsequent changes in fair value resulting in additional gains and losses in the near term. In the normal course of operations and within established investment policy guidelines, Advocate may enter into various exchange traded and over the counter derivative contracts for trading purposes, including futures, options and forward contracts. These instruments are used primarily to maintain Advocate s strategic asset allocation, adjust the portfolio duration, modify term structure exposure, change sector exposure and arbitrage market inefficiencies. These instruments require Advocate to deposit cash collateral with the broker or custodian. At March 31, 2018 and December 31, 2017, the collateral provided was $11.7 million and $11.3 million, respectively. At March 31, 2018 and December 31, 2017, the notional value of the derivatives in long positions was $94.0 million and $160.1 million, respectively, and those in a short position was $(25.9) million and $(2.9) million, respectively. By using derivative financial instruments, Advocate exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contracts. When the fair value of a derivative contract is positive, the counterparty owes Advocate, which creates credit risk for Advocate. When the fair value of a derivative contract is negative, Advocate owes the counterparty, and therefore, it does not possess credit risk. Advocate minimizes the credit risk in derivative instruments by entering into transactions that may require the counterparty to post collateral for the benefit of Advocate based on the credit rating of the counterparty and the fair value of the derivative contract. Market risk is the adverse effect on the value of a financial instrument that results from a change in the underlying reference security. The market risk associated with market changes is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. The Interim Condensed Consolidated Financial Statements were prepared on April 13,

18 The carrying values of cash and cash equivalents, accounts receivable and payable, accrued expenses and short term borrowings are reasonable estimates of their fair values due to the short term nature of these financial instruments. The following are assets and liabilities measured at fair value on a recurring basis at March 31, 2018: Fair Value Measurements at Reporting Date Using Quoted Prices in Active Significant Other Significant Markets for Identical Observable Unobservable Assets Inputs Inputs Description March 31, 2018 (Level 1) (Level 2) (Level 3) Assets Cash and short term investments $ 364,922 $ 295,208 $ 69,714 $ Corporate Bonds and other debt securities 360, ,207 United States goverment obligations 419, ,468 Bond and other debt security mutual funds 435, , ,206 Non government fixed income obligations 24,495 24,495 Equity securities 930, ,530 Equity funds 860, , ,618 Assets at net asset value: Hedge funds 2,149,127 Private equity limited parnternships 982,362 Total investments $ 6,527,405 Collateral proceeds received under securities lending program $ 6,110 $ 6,110 Liabilities Derivatives: Obligations under interest rate swap agreements, net $ (66,369) $ (66,369) Obligations to return capital under securities lending program $ (6,110) $ (6,110) The Interim Condensed Consolidated Financial Statements were prepared on April 13,

19 The following are assets and liabilities measured at fair value on a recurring basis at December 31, 2017: Fair Value Measurements at Reporting Date Using Quoted Prices in Active Significant Other Significant Markets for Identical Observable Unobservable Assets Inputs Inputs Description December 31, 2017 (Level 1) (Level 2) (Level 3) Assets Cash and short term investments $ 753,399 $ 685,370 $ 68,029 $ Corporate Bonds and other debt securities 347, ,290 United States goverment obligations 378, ,051 Bond and other debt security mutual funds 430,581 99, ,607 Non government fixed income obligations 21,145 21,145 Equity securities 962, ,123 Equity funds 848,155 92, ,703 Assets at net asset value: Hedge funds 1,958,788 Private equity limited parnternships 826,278 Total investments $ 6,525,810 Collateral proceeds received under securities lending program $ 19,577 $ 19,577 Liabilities Derivatives: Obligations under interest rate swap agreements, net $ (73,875) $ (73,875) Obligations to return capital under securities lending program $ (19,577) $ (19,577) Note H Long Term Debt Advocate s outstanding bonds are secured by obligations issued under the Amended and Restated Master Trust Indenture dated as of September 1, 2011, with Advocate Health Care Network, Advocate Health and Hospitals Corporation ( AHHC ), Advocate Condell Medical Center ( ACMC ), Advocate Sherman Hospital ( ASH ) and Advocate North Side Health Network ( ANS ) (the Obligated Group ) and U.S. Bank National Association, as master trustee (the Advocate Master Indenture ). Under the terms of the bond indentures and other arrangements, various amounts are to be on deposit with trustees, and certain specified payments are required for bond redemption and interest payments. The Advocate Master Indenture and other debt agreements, including bank credit agreements, also place restrictions on Advocate and require Advocate to maintain certain financial ratios. Advocate s unsecured variable rate revenue bonds at March 31, 2018, Series 2008C 3B of $22.0 million and Series 2011B of $70.0 million, while subject to a long term amortization period, may be put to Advocate at the option of the bondholders on certain remarketing dates. To the extent that bondholders may, under the terms of the debt, put their bonds within a maximum of twelve months after March 31, 2017, the principal amount of such bonds has been classified as a current obligation in the accompanying condensed consolidated balance sheets. Management believes the likelihood of a material amount of bonds being put to Advocate is The Interim Condensed Consolidated Financial Statements were prepared on April 13,