UPMC AUDITED CONSOLIDATED FINANCIAL STATEMENTS

Transcription

1 UPMC AUDITED CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED JUNE 30, 2011 TABLE OF CONTENTS Report of Independent Registered Public Accounting Firm Audited Consolidated Financial Statements Consolidated Balance Sheets Consolidated Statements of Operations and Changes in Net Assets Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements

2 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors UPMC Pittsburgh, Pennsylvania We have audited the accompanying consolidated balance sheets of UPMC and subsidiaries as of June 30, 2011 and 2010, and the related consolidated statements of operations and changes in net assets and cash flows for each of the two years in the period ended June 30, These financial statements are the responsibility of the UPMC and subsidiaries management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of UPMC and subsidiaries at June 30, 2011 and 2010, and the consolidated results of its operations and its cash flows for each of the two years in the period ended June 30, 2011, in conformity with U.S. generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, UPMC and subsidiaries adopted the guidance provided by Accounting Standards Codification (ASC) 805, Business Combinations, and ASC , Intangibles-Goodwill and Other, effective July 1, We also have audited, in accordance with attestation standards established by the American Institute of Certified Public Accountants and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States), UPMC and subsidiaries internal control over financial reporting as of June 30, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated September 9, 2011, expressed an unqualified opinion thereon. Pittsburgh, Pennsylvania September 9, 2011 UPMC 2011 FINANCIAL STATEMENTS 1

3 CONSOLIDATED BALANCE SHEETS June 30 ASSETS Current assets: Cash and cash equivalents $ 386,718 $ 158,067 Patient accounts receivable, net of allowance for uncollectible accounts of $94,090 in 2011 and $81,441 in , ,239 Other receivables 380, ,565 Other current assets 99,412 96,413 Total current assets 1,399,093 1,041,284 Board-designated, restricted, trusteed, and other investments 3,564,421 3,051,536 Beneficial interests in foundations 344, ,997 Property, buildings, and equipment: Land and land improvements 305, ,502 Buildings and fixed equipment 3,906,346 3,640,401 Movable equipment and internal-use software development costs 2,135,235 1,881,548 Capital leases 174, ,590 Construction in progress 236, ,388 6,758,400 6,151,429 Less allowance for depreciation (3,318,957) (2,953,004) 3,439,443 3,198,425 Other assets 376, ,810 Total assets $ 9,123,502 $ 7,918,052 LIABILITIES AND NET ASSETS Current liabilities: Accounts payable and accrued expenses $ 379,451 $ 314,806 Accrued salaries and related benefits 397, ,447 Current portion of insurance reserves 283, ,256 Current portion of long-term obligations 263, ,370 Other current liabilities 245, ,096 Total current liabilities 1,569,323 1,287,975 Long-term obligations: Revenue bonds 2,908,476 2,933,818 Notes payable and other 68,449 45,972 2,976,925 2,979,790 Pension liability 143, ,352 Long-term insurance reserves 199, ,260 Other long-term liabilities 172, ,503 Total liabilities 5,060,994 4,885,880 Net assets: Unrestricted 3,489,251 2,615,201 Restricted 573, ,971 Total net assets 4,062,508 3,032,172 Total liabilities and net assets $ 9,123,502 $ 7,918,052 See accompanying notes. UPMC 2011 FINANCIAL STATEMENTS 2

4 CONSOLIDATED STATEMENTS OF OPERATIONS AND CHANGES IN NET ASSETS Year Ended June 30 UNRESTRICTED NET ASSETS Revenues: Net patient service revenue $ 5,045,466 $ 4,424,252 Insurance enrollment revenue 3,323,550 3,042,021 Other revenue 632, ,194 Total operating revenues 9,001,045 8,046,467 Expenses: Salaries, professional fees, and employee benefits 3,258,938 2,993,634 Supplies, purchased services, and general 4,743,034 4,196,218 Depreciation and amortization 394, ,893 Provision for bad debts 198, ,690 Total operating expenses 8,595,020 7,814,435 Operating income (excluding asset impairment charge, inherent contribution-hamot affiliation and income tax expense) 406, ,032 Asset impairment charge (12,643) (14,224) Inherent contribution-hamot affiliation 60,868 Operating income 454, ,808 Income tax expense (8,429) (2,256) After-tax operating income 445, ,552 Investing and financing activities: Investment revenue 404, ,539 Interest expense (122,516) (119,909) Loss on extinguishment of debt (18) (28,270) Gain from investing and financing activities 282, ,360 Nonoperating loss (1,021) (850) Excess of revenues over expenses 726, ,062 Other changes in unrestricted net assets: Decrease (increase) in postretirement benefits liabilities 124,641 (88,819) Assets released from restriction for capital purchases 24,626 8,952 Other changes in unrestricted net assets (2,032) (10,871) Increase in unrestricted net assets 874, ,324 RESTRICTED NET ASSETS Contributions 7,365 10,806 Net realized and unrealized gains on investments 17, Assets released from restriction for operations and capital purchases (9,178) (19,200) Restricted net assets acquired 88,587 Net increase in beneficial interests in foundations 52,091 18,036 Increase in restricted net assets 156,286 10,237 Increase in net assets 1,030, ,561 Net assets, beginning of year 3,032,172 2,755,611 Net assets, end of year $ 4,062,508 $ 3,032,172 See accompanying notes. UPMC 2011 FINANCIAL STATEMENTS 3

5 CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended June 30 OPERATING ACTIVITIES Increase in net assets $ 1,030,336 $ 276,561 Adjustments to reconcile increase in net assets to net cash provided by operating activities: Depreciation and amortization 394, ,893 Asset impairment charge 12,643 14,224 Inherent contribution-hamot affiliation (60,868) Net change in postretirement benefits liabilities (180,105) 88,819 Increase in beneficial interests in foundations (52,091) (18,036) Restricted contributions and investment income (24,786) (11,401) Restricted net assets acquired (88,587) Net increase in trading securities (390,922) (186,624) Changes in operating assets and liabilities 42,353 (51,883) Net cash provided by operating activities 682, ,553 INVESTING ACTIVITIES Purchase of property and equipment (net of disposals) (436,203) (355,109) Other investments (14,150) (95,097) Net decrease (increase) in investments designated as nontrading 3,943 (28,265) Cash acquired in Hamot affiliation 13,892 Net decrease in other assets 8,915 1,309 Net cash used in investing activities (423,603) (477,162) FINANCING ACTIVITIES Repayments of long-term obligations (148,393) (1,231,583) Borrowings of long-term obligations 93,350 1,176,948 Restricted contributions and investment income 24,786 11,401 Net cash used in financing activities (30,257) (43,234) Increase (decrease) in cash and cash equivalents 228,651 (18,843) Cash and cash equivalents, beginning of year 158, ,910 Cash and cash equivalents, end of year $ 386,718 $ 158,067 See accompanying notes. UPMC 2011 FINANCIAL STATEMENTS 4

6 1. ORGANIZATIONAL OVERVIEW AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES UPMC is a Pennsylvania nonprofit corporation and is exempt from federal income tax pursuant to Section 501(a) of the Internal Revenue Code ( Code ) as an organization described in Section 501(c)(3) of the Code. Headquartered in Pittsburgh, Pennsylvania, UPMC is one of the leading medical centers in the United States. UPMC is an integrated global health enterprise leveraging medical expertise, geographic reach, and financial stability in a model of care excellence that can transform health care nationally and internationally. UPMC comprises nonprofit and for-profit entities offering medical and health care related services, including health insurance products. Closely affiliated with the University of Pittsburgh ( University ) and with shared academic and research objectives, UPMC partners with the University s Schools of the Health Sciences to deliver outstanding patient care, train tomorrow s health care specialists and biomedical scientists, and conduct groundbreaking research on the causes and course of disease. The accompanying consolidated financial statements include the accounts of UPMC and its subsidiaries. The consolidated financial statements are comprised of domestic and foreign nonprofit and for-profit entities that maintain separate books and records as part of their legal incorporation. Intercompany accounts and transactions are eliminated in consolidation. Cash and Cash Equivalents Cash and cash equivalents consist primarily of cash and investments, which are so near to maturity (maturity of three months or less when purchased) that they present insignificant risk of changes in value. Net Patient Service Revenue and Accounts Receivable Net patient service revenue is reported at estimated net realizable amounts in the period in which services are provided. The majority of UPMC s services are rendered to patients under Medicare, Highmark Blue Cross Blue Shield ( Highmark ), and Medical Assistance programs. Reimbursement under these programs is based on a combination of prospectively determined rates and historical costs. Amounts received under Medicare and Medical Assistance programs are subject to review and final determination by program intermediaries or their agents. In 2011 and 2010, the percentage of net patient service revenue derived from Medicare was approximately 30%, from Highmark was approximately 26% and from Medical Assistance programs was approximately 11%. Laws and regulations governing the Medicare and Medical Assistance programs are extremely complex and subject to interpretation. Compliance with such laws and regulations are subject to government review and interpretation as well as significant regulatory action including fines, penalties, and exclusion from the Medicare and Medical Assistance programs. As a result, there is at least a reasonable possibility that the recorded estimates may change. Provisions for adjustments to net patient service revenue are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. Net patient service revenue for 2011 and 2010 was increased by approximately $4,369 and $5,152, respectively, for prior-year settlements. UPMC 2011 FINANCIAL STATEMENTS 5

7 Significant concentrations of patient accounts receivable at June 30, 2011 and 2010, include: Medicare 31% and 33%, Highmark 18% and 16%, and Medical Assistance 18% and 17%, respectively. The provision for bad debts is based upon management s assessment of historical and expected net collections considering historical business and economic conditions, trends in health care coverage, and other collection indicators. Periodically throughout the year, management assesses the adequacy of the allowance for uncollectible accounts based upon historical write-off experience by payor category. The results of this review are then used to make any modifications to the provision for bad debts to establish an appropriate allowance for uncollectible accounts. Board-Designated, Restricted, Trusteed, and Other Investments Substantially all of UPMC s investments in debt and equity securities are classified as trading. This classification requires UPMC to recognize unrealized gains and losses on substantially all of its investments in debt and equity securities as investment revenue in the consolidated statements of operations and changes in net assets. UPMC s investments in debt and equity securities that are donor-restricted assets are designated as nontrading. Unrealized gains and losses on donor-restricted assets are recorded as changes in restricted net assets in the consolidated statements of operations and changes in net assets. Gains and losses on the sales of securities are determined by the average cost method. Realized gains and losses are included in investment revenue in the consolidated statements of operations and changes in net assets. Investments in equity securities with readily determinable fair values and all investments in debt securities are measured at fair value using quoted market prices or model-driven valuations. These investments predominantly include those maintained in Master Trust Funds ( MTF ) and are summarized as nonalternative investments in Note 4. Investments in limited partnerships that invest in marketable securities (hedge funds) are reported using the equity method of accounting based on information provided by the respective partnership. The values provided by the respective partnerships are based on historical cost, appraisals, or other estimates that require varying degrees of judgment. Generally, UPMC s holdings reflect net contributions to the partnership and an allocated share of realized and unrealized investment income and expenses. The investments may individually expose UPMC to securities lending, short sales, and trading in futures and forward contract options and other derivative products. UPMC s risk is limited to its carrying value. Amounts can be divested only at specified times. The financial statements of the limited partnerships are audited annually, generally as of December 31. These investments are summarized as alternative investments in Note 4. Investments in limited partnerships that invest in nonmarketable securities (private equity) are primarily recorded at cost if the ownership percentage is less than 5% and are reported using the equity method of accounting if the ownership percentage is greater than 5%. These investments are periodically evaluated for impairment. These investments are summarized as alternative investments in Note 4. UPMC 2011 FINANCIAL STATEMENTS 6

8 Financial Instruments Cash and cash equivalents and investments recorded at fair value aggregate $2,389,485 and $1,801,142 at June 30, 2011 and 2010, respectively. The fair value of these instruments is based on market prices as estimated by financial institutions. The fair value of long-term debt at June 30, 2011 and 2010 is $3,243,383 and $3,136,038, respectively, based on market prices as estimated by financial institutions. The fair value of amounts owed to counterparties under derivative contracts at June 30, 2011 and 2010, is $17,338 and $28,162, respectively, based on pricing models that take into account the present value of estimated future cash flows. Beneficial Interests in Foundations Several of UPMC s subsidiary hospitals have foundations that, according to their bylaws, were formed for the exclusive purpose of supporting and furthering the mission of the respective hospital. The foundations are separate corporations and are not liable for the obligations of UPMC, including any claims of creditors of any UPMC entities. The net assets of certain foundations are included in the consolidated balance sheets as beneficial interests in foundations and restricted net assets because the hospitals use of these assets is at the discretion of the foundations independent board of directors. Beneficial interests in foundations of $344,344 and $273,997 and the net assets of consolidated foundations of $53,791 and $50,369 as of June 30, 2011 and 2010, respectively, are not pledged as collateral for UPMC s debt. Property, Buildings, and Equipment Property, buildings, and equipment are recorded at cost or, if donated or impaired, at fair market value at the date of receipt or impairment. Interest cost incurred on borrowed funds (net of interest earned on such funds) during the period of construction of capital assets is capitalized as a component of the cost of acquiring those assets. Costs associated with the development and installation of internal-use software are expensed or capitalized depending on whether they are incurred in the preliminary project stage, application development stage, or post-implementation stage. Depreciation is computed using the straight-line method at rates designed to amortize the assets over their estimated useful lives (predominantly ranging from 3 to 40 years) and includes amortization related to capitalized leases. Certain newly constructed buildings have estimated useful lives up to 60 years. Asset Impairment UPMC evaluates the recoverability of the carrying value of long-lived assets by reviewing long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable and adjusts the asset cost to fair value if undiscounted cash flows are less than the carrying amount of the asset. Other Assets Investments in individual entities in which UPMC has the ability to exercise significant influence but does not control, generally 20% to 50% ownership, are reported using the equity method of accounting. All other noncontrolled investments, generally less than 20% ownership, are carried at cost. Other assets include approximately $96,918 and $77,891 at June 30, 2011 and 2010, respectively, relating to investments in partnerships that provide health care, management, and other goods and services to UPMC, its affiliates, and the community at large. UPMC 2011 FINANCIAL STATEMENTS 7

9 Goodwill Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to the fair value of assets acquired and liabilities assumed. As of June 30, 2011, goodwill of $119,445 is recorded in UPMC s consolidated balance sheets as other assets. Goodwill is reviewed annually for impairment, or more frequently if events or circumstances indicate that the carrying value of an asset may not be recoverable. The impairment test for goodwill requires a comparison of the fair value of each reporting unit that has goodwill associated with its operations with its carrying amount, including goodwill. The impairment analysis includes estimating the fair market value of each of the reporting units which have goodwill associated with their operations using discounted cash flow and multiples of cash earnings valuation techniques, plus valuation comparisons to recent public sale transactions of similar businesses, if any. These valuation methods require UPMC to make estimates and assumptions regarding future operating results, cash flows, changes in working capital and capital expenditures, profitability, and the cost of capital. Although UPMC believes that the estimates and assumptions used are reasonable, actual results could differ from those estimates and assumptions. Health Insurance Revenue and Costs UPMC s insurance subsidiaries (collectively, Health Plans ) provide health care services on a prepaid basis under various contracts. The Health Plans provide medical services to subscribing participants under agreements that provide for capitated payments based on the number of subscribing enrollees, regardless of the medical services actually performed. Insurance enrollment revenues are recognized as income in the period in which enrollees are entitled to receive health care services. Enrollment revenue includes approximately 77% for the years ended June 30, 2011 and 2010, from Medicare and Medical Assistance. Health care costs were approximately $3,061,590 and $2,784,838, of which $771,654 and $758,732 were eliminated in consolidation representing medical services performed by other UPMC entities for the years ended June 30, 2011 and 2010, respectively. Such costs are included in supplies, purchased services, and general expenses. These costs include estimates of payments to be made on claims reported as of the balance sheet date and estimates of health care services rendered but not reported to the Health Plans. Such estimates include the cost of services that will continue to be rendered after the balance sheet date when the Health Plans are obligated to remit payment for such services in accordance with contract provisions or regulatory requirements. Current accrued insurance reserves include approximately $203,647 and $222,790 at June 30, 2011 and 2010, respectively, relating to estimates of claims payable for health care services. Unrestricted net assets required to meet statutory requirements of the Health Plans were $212,229 and $204,678 at June 30, 2011 and 2010, respectively. UPMC 2011 FINANCIAL STATEMENTS 8

10 Derivatives UPMC uses derivative financial instruments ( derivatives ) to modify the interest rates and manage risks associated with its asset allocation and outstanding debt. UPMC records derivatives as assets or liabilities in the consolidated balance sheets at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. UPMC has entered into interest rate swap agreements to convert a portion of fixed rate debt to a variable interest rate. UPMC also entered into interest rate swap agreements that convert a portion of its variable rate debt to a fixed interest rate. None of UPMC s swaps outstanding as of June 30, 2011 and 2010, are designated as hedging instruments and as such, changes in fair value are recognized in investing and financing activities as investment revenue in the consolidated statements of operations and changes in net assets. UPMC has also entered into equityrelated derivatives to manage the asset allocation in its investment portfolio. Under the equity index swap agreements UPMC pays a fixed income-like return in order to receive an equity-like return. The notional amount of these swaps is based upon UPMC s target asset allocation. Restricted Net Assets Unconditional promises to give cash and other assets are reported at fair value as of the date the promise is received. Conditional promises to give are reported at fair value at the date the condition is met. Contributions are reported as restricted if they are received with donor stipulations that limit the use of the donated assets. Restricted net assets include $184,547 and $157,464 of permanently restricted net assets held in perpetuity at June 30, 2011 and 2010, respectively. The remainder of restricted net assets is temporarily restricted and primarily represents beneficial interests in foundations that support research and other health care programs. Temporarily restricted net assets are limited by donors and the foundations to a specific time period or purpose. Temporarily restricted net assets are reclassified to unrestricted net assets and included in the consolidated statements of operations and changes in net assets as other revenue or assets released from restriction for capital purchases when the restriction is met. Nonoperating Loss Nonoperating loss includes costs not directly associated with patient care, related patient services, or other activities unrelated to the core operations of UPMC s business. Excess of Revenues Over Expenses The consolidated statements of operations and changes in net assets include excess of revenues over expenses as a performance indicator. Excess of revenues over expenses includes all changes in unrestricted net assets except for contributions and distributions from foundations for the purchase of property and equipment, adjustments for pension liability, dis operations, and the cumulative effect of changes in accounting principles. UPMC 2011 FINANCIAL STATEMENTS 9

11 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 and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain reclassifications were made to the 2010 accompanying financial statements to conform to the 2011 presentation. These reclassifications had no impact on the changes in net assets or excess of expenses over revenues previously reported. New Accounting Pronouncements Effective July 1, 2010, UPMC adopted the guidance provided by Accounting Standards Codification ( ASC ) 805, Business Combinations, with additional guidance unique to not-for-profit entities in ASC and guidance specific to health care entities in ASC The new accounting literature provides not-for-profit organizations with specific guidance on accounting for mergers and acquisitions, including determining whether a combination between two or more not-for-profit entities is a merger or an acquisition, how to account for each and the disclosures that should be made. Beginning on July 1, 2010, UPMC applied the transition provisions of the guidance in ASC , Intangibles-Goodwill and Other, which requires UPMC to cease amortization of previously recognized goodwill and to test goodwill for impairment annually or more frequently if events or circumstances indicate that the carrying value of an asset may not be recoverable. UPMC completed a transitional goodwill impairment test measured as of July 1, 2010 and the annual goodwill impairment test measured as of April 30, No adjustments to the carrying value of UPMC s previously recognized goodwill were recorded during the year ended June 30, Effective July 1, 2010, UPMC early adopted the guidance provided by ASC , Measuring Charity Care for Disclosure, which requires UPMC to use cost as the basis for charity care disclosure purposes and that cost be identified as the direct and indirect costs of providing the charity care. In July 2011, the Financial Accounting Standards Board ( FASB ) issued new guidance, Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts. The guidance requires certain health care entities to present the bad debt expense associated with patient service revenue as a deduction from patient service revenue (net of contractual allowances and discounts) rather than an operating expense. The guidance is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2011, with early adoption permitted. UPMC 2011 FINANCIAL STATEMENTS 10

12 2. SIGNIFICANT TRANSACTIONS On February 1, 2011, UPMC, Hamot Medical Center ( Hamot ) and the Hamot Health Foundation ( Foundation ) executed an Integration and Affiliation Agreement (the Agreement ) providing for an affiliation between UPMC and Hamot. On the date of the affiliation, the articles of incorporation and bylaws of Hamot were amended such that UPMC became the sole corporate member of Hamot. As a result of the affiliation, UPMC acquired $406,664 of total assets, consisting primarily of property, plant and equipment and investments, and assumed $255,631 of Hamot s liabilities consisting primarily of long-term debt obligations. Hamot is a multi-institutional nonprofit health system that includes hospitals and a network of other health care providers servicing the city of Erie and a larger multi-county area in northwestern Pennsylvania, western New York and northeastern Ohio. The transaction is intended to preserve and enhance the mission of Hamot and to enhance Hamot s ability to provide high-quality health services to the Erie community. Pursuant to the Agreement, UPMC will provide Hamot with a total investment of $300,000 over a 10-year period that will support expansion and enhancement of medical services for the communities that Hamot serves. On the date of the affiliation, UPMC established a $100,000 fund on Hamot s balance sheet (the Hamot Fund ) which is dedicated solely for the support of Hamot and is controlled solely by Hamot s board of directors. Over a 10-year period, $50,000 from the Hamot Fund, along with an additional $200,000 committed by UPMC from other sources including UPMC Hamot s cash flows, is to be spent for the enhancement of facilities and services at Hamot. Such amounts will be expended pursuant to plans and budgets approved by the Hamot board of directors and UPMC. The remaining $50,000 of the Hamot Fund may be expended as directed by Hamot s board of directors following such 10-year period, but without any requirement that it be expended on a specific schedule. UPMC applied the business combination accounting guidance in ASC as described above in Note 1 to account for the transaction. The guidance primarily characterizes business combinations between not-for-profit entities as nonreciprocal transfers of assets resulting in the contribution of the acquiree s net assets to the acquirer. ASC prescribes that the acquirer recognize an excess of the acquisition date unrestricted net assets acquired over the fair value of the consideration transferred as a separate credit in its statements of operations and changes in net assets as of the acquisition date. Accordingly, UPMC recognized contribution income related to the unrestricted net assets acquired in the transaction of $60,868 in its statements of operations and changes in net assets for the year ended June 30, UPMC recorded an increase in restricted net assets of $88,587 in its statements of operations and changes in net assets for the year ended June 30, In December 2010, the Department of Public Welfare ( DPW ) received approval from the Centers for Medicare and Medicaid Services ( CMS ) for the Pennsylvania state plan amendments pursuant to Pennsylvania Act 49 of 2010 that, among other things, established a new inpatient hospital fee-for-service payment system (using APR-DRG), established enhanced hospital payments through the state s Medical Assistance managed care program and secured additional matching Medicaid funds through the establishment of the Quality Care Assessment. In February 2011, the DPW received the approvals necessary from CMS on the final technical language for the DPW contracts with managed care organizations. The Hospital and Healthcare Association of Pennsylvania issued hospital-specific impacts of the Medical Assistance payment modernization for fiscal year UPMC recorded an operating income impact of $57,226 in its consolidated statements of operations and changes in net assets for the year ended June 30, UPMC 2011 FINANCIAL STATEMENTS 11

13 In March 2010, the Internal Revenue Service ( IRS ) published an administrative determination to accept the position that medical residents are exempt from Federal Insurance Contributions Act ( FICA ) taxes based on the student exception for services provided during tax periods prior to April 1, 2005, which is when new IRS regulations took effect. UPMC previously remitted such taxes for medical residents and filed protective claims related to the student exception incorporating both the employer and employee portion of the FICA taxes remitted between January 1996 and March As of June 30, 2011, UPMC has recorded a receivable of $71,112, representing both the employer and employee portion of the expected FICA tax refund, in other receivables. UPMC recorded a credit of $22,110 to salaries, professional fees and employee benefits and $9,746 in investment revenue, related to the employer portion of the FICA tax refund and accrued interest in its statements of operations and changes in net assets for the year ended June 30, The claims remain subject to review by the IRS prior to remittance of the refund to UPMC. On October 31, 2001, UPMC entered into an Integration and Affiliation Agreement ( Children s Agreement ) with Children s Hospital of Pittsburgh ( Children s ) and Children s Hospital Foundation ( Children s Foundation ) whereby UPMC became the sole corporate member of Children s. The Children s Agreement, as amended and supplemented, included UPMC s commitment to pay the costs of constructing a new hospital and pediatric research facility for Children s ( New Children s Facilities ) up to a total of $621,800. The New Children s Facilities opened during the year ended June 30, The Children s Foundation agreed to fund $96,800 toward the total cost of the construction project. As of June 30, 2011, the remaining commitment of the Children s Foundation toward the funding of the New Children s Facilities is approximately $36,630. Payment of the additional funding commitment is to be received no later than five years from the completion of construction. The Children s Foundation also agreed to provide annual financial support for a minimum of 20 years (beginning in 2001) for pediatric care, research, and/or education computed at 5% of the rolling average of the corpus (defined as the value of all of the Foundation s assets less any funds held by the Foundation where the donor has directed a different spending provision). In advance of the fiscal year, the Children s Foundation computes the rolling average of the prior calendar year to determine the 5% payment for the upcoming fiscal year. The amount of support for 2011 and 2010 was $13,116 and $14,738, respectively. 3. CHARITY CARE UPMC s patient acceptance policy is based on its mission and its community service responsibilities. Accordingly, UPMC accepts patients in immediate need of care, regardless of their ability to pay. UPMC does not pursue collection of amounts determined to qualify as charity care based on established policies of UPMC. These policies define charity care as those services for which no payment is due for all or a portion of the patient s bill from the patient. For financial reporting purposes, charity care is excluded from net patient service revenue. The amount of charity care provided, determined on the basis of cost, was $96,523 and $91,297 for the years ended June 30, 2011 and 2010, respectively. UPMC estimates the cost of providing charity care using the ratio of average patient care cost to gross charges, and then applying that ratio to the gross uncompensated charges associated with providing charity care. UPMC 2011 FINANCIAL STATEMENTS 12

14 4. CASH AND INVESTMENTS Following is a summary of cash and investments included in the consolidated balance sheets: June 30 Internally designated: Funded depreciation $ 12,231 $ 10,945 Employee benefit and workers compensation self-insurance programs 47,850 21,328 Professional and general liability insurance program 302, ,513 Health insurance programs 448, , , ,502 Externally designated: Trusteed assets for capital and debt service payments 16, ,545 Donor-restricted assets 213, , , ,267 Other long-term investments 2,523,719 2,064,767 Board-designated, trusteed, and other investments 3,564,421 3,051,536 Cash and cash equivalents 386, ,067 $ 3,951,139 $ 3,209,603 Following is a summary of the composition of cash and investments. The table below shows all of UPMC s investments including nonalternative investments measured at fair value and alternative investments using either the cost or equity method of accounting. June 30 Cash and cash equivalents $ 386,718 $ 158,067 Nonalternative investments: Fixed income 980, ,986 Domestic equity 339, ,219 International equity 601, ,930 Public real estate 41,485 28,164 Commodities 40,107 29,776 2,002,767 1,643,075 Alternative investments: Long/short equity 386, ,277 Absolute return 209, ,947 Private equity 730, ,862 Private real estate 129, ,196 Natural resources 106, ,179 1,561,654 1,408,461 $ 3,951,139 $ 3,209,603 UPMC 2011 FINANCIAL STATEMENTS 13

15 Investments are primarily maintained in MTF and administered using a bank as trustee. As of June 30, 2011, 143 external investment managers handled the investment of cash and investments. Of these firms, 17 manage equity investments, 9 manage fixed income investments, and 117 manage alternative investment strategies including hedge funds and private equity limited partnerships. The largest allocation to any alternative investment is $40,064. Certain managers use various equity and interest rate derivatives. These instruments are subject to various risks similar to nonderivative financial instruments including market, credit, liquidity, operational, and foreign exchange risk. As of June 30, 2011 and 2010, UPMC had remaining commitments to invest approximately $509,905 and $588,885, respectively, in private equity limited partnerships at various times and amounts, at the discretion of the investment managers, over the next ten years. As of June 30, 2011 and 2010, respectively, UPMC had total investments recorded at cost of $850,551 and $791,184. These investments include private equity limited partnerships recorded at cost, as well as assets recorded as other assets in the consolidated balance sheets. Investment return from cash and investments is comprised of the following for the years ended June 30, 2011 and 2010, respectively: Year Ended June 30 Interest income $ 42,507 $ 23,221 Dividend income 27,571 15,528 Net realized gains on sales of securities 172,918 86, , ,415 Unrealized investment gains 190, ,011 Impairment losses on limited partnerships (19,700) (39,326) Net losses on direct investments (426) Derivative contracts mark to market 12,454 69, , ,235 Total investment gain 426, ,650 Traditional investment manager and trustee fees (22,184) (18,111) Investment revenue $ 404,549 $ 290,539 UPMC 2011 FINANCIAL STATEMENTS 14

16 In managing the UPMC investment strategy, an important consideration is to ensure sufficient liquidity. While UPMC s relationships with its external investment managers vary in terms of exit provisions, a percentage of the agreements allow ready access to underlying assets which are generally liquid and marketable. Investment liquidity as of June 30, 2011, is shown below: Liquidity Cash and Cash Nonalternative Alternative Availability Equivalents Investments Investments Total Within three days $ 386,718 $ 1,900,233 $ 40,008 $ 2,326,959 Within 30 days 102, ,534 Within 60 days 66,559 66,559 Within 90 days 146, ,824 More than 90 days 1,308,263 1,308,263 Total $ 386,718 $ 2,002,767 $ 1,561,654 $ 3,951, CREDIT ARRANGEMENTS UPMC has a revolving line and letter of credit facility (the Revolving Facility ) with an available line of $300,000 and an option to increase the aggregate commitment by $100,000 for a total available line of $400,000. The Revolving Facility expires on June 15, The Revolving Facility is used to manage cash flow during the year and to provide for a consolidated method of issuing various letters of credit for certain business units. A note to secure UPMC s repayment obligation with respect to the Revolving Facility was issued under the 2007 UPMC Master Trust Indenture ( 2007 UPMC MTI ) and is secured by a pledge of and security interest in the gross revenues of UPMC parent corporation, UPMC Presbyterian Shadyside, Magee-Womens Hospital of UPMC, UPMC Passavant and UPMC St. Margaret as members of the obligated group under the 2007 UPMC MTI. Advances may be variable rate based on the prime rate or the Federal Funds effective rates, or advances may be fixed on the date of the advance based on the British Bankers Association Interest Settlement Rate and the reserve requirement on Eurocurrency liabilities. No borrowings were outstanding under the Revolving Facility as of June 30, 2011 and As of June 30, 2011, UPMC has issued $88,236 of letters of credit under the Revolving Facility. These letters of credit predominantly support the capital requirements of certain insurance subsidiaries and the self-insured workers compensation liability. As of June 30, 2011, there was $211,764 available under the Revolving Facility. In addition to the Revolving Facility described above, UPMC has a revolving credit facility with an available line of 18,000 ($25,902) that is used to support the working capital needs of UPMC Beacon. This line was fully drawn at June 30, UPMC 2011 FINANCIAL STATEMENTS 15

17 6. LONG-TERM OBLIGATIONS AND INTEREST RATE SWAPS Long-term obligations consist of the following: June 30 Fixed rate revenue bonds $ 2,003,341 $ 2,014,562 Variable rate revenue bonds 805, ,618 Capital leases and other 382, ,426 Par value of long-term obligations 3,191,280 3,060,606 Net premium and other 49,433 58,554 3,240,713 3,119,160 Less current portion (263,788) (139,370) Total long-term obligations $ 2,976,925 $ 2,979,790 Revenue instruments outstanding represent funds borrowed by the UPMC parent corporation and various subsidiaries pursuant to loan agreements and lease and sublease financing arrangements with governmental authorities. The bonds were used for the purchase, construction, and renovation of hospital facilities, certain buildings and equipment, as well as the extinguishment of debt. Capital leases and other consists primarily of capital leases that are secured by certain equipment and properties. The fixed rate revenue instruments bear interest at fixed coupon rates ranging from 2.50% to 6.00% in 2011 and The average interest cost for the variable rate instruments was 0.96% and 0.70% during fiscal years 2011 and 2010, respectively. Revenue instruments have varying principal payments and final maturities from 2015 through Certain revenue bonds are secured by bond insurance ($233,526 and $184,701 in 2011 and 2010, respectively). Reimbursement agreements ($255,890 and $230,000 in 2011 and 2010, respectively) provide loans to UPMC in the amount necessary to purchase the variable rate demand revenue bonds if not remarketed. The agreements have expiration and repayment dates beyond June 30, Revenue instruments in the aggregate amount of debt outstanding of $2,784,428 and $2,772,424 as of June 30, 2011 and 2010, respectively, are issued under the 1995 UPMC MTI. Included in this amount are instruments totaling $2,615,388 and $2,590,222 as of June 30, 2011 and 2010, respectively, which are also secured under the 2007 UPMC MTI. The instruments are secured by a pledge of and security interest in gross revenues of each of the respective MTI obligated groups. Certain amounts borrowed under the 1995 UPMC MTI are loaned to certain subsidiary corporations pursuant to loan and contribution agreements and require the transfer of subsidiary funds to the parent corporation in the event of failure to satisfy the UPMC parent corporation liquidity covenant. UPMC 2011 FINANCIAL STATEMENTS 16

18 The various indebtedness agreements contain restrictive covenants, the most significant of which are the maintenance of minimum debt service coverage and liquidity ratios, and restrictions as to the incurrence of additional indebtedness and transfers of assets. Aggregate maturities of long-term obligations for the next five years, assuming remarketing of UPMC s variable rate debt, are as follows: 2012 $ 263, , , , ,052 Interest paid, net of amounts capitalized, on all obligations was $131,990 and $131,883 during the years ended June 30, 2011 and 2010, respectively. Capitalized interest of $2,964 and $2,625 was recorded in 2011 and 2010, respectively. UPMC uses derivatives to manage its exposure on its debt instruments and its asset allocation. By using derivatives to manage these risks, UPMC exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivatives. When the fair value of a derivative is positive, the counterparty owes UPMC, which creates credit risk for UPMC. When the fair value of a derivative is negative, UPMC owes the counterparty and, therefore, it does not incur credit risk. UPMC minimizes the credit risk in derivatives by entering into transactions that require the counterparty to post collateral for the benefit of UPMC based on the credit rating of the counterparty and the fair value of the derivative. If UPMC has a derivative in a liability position, UPMC s credit is a risk and FAS 157 fair market values could be adjusted downward. Market risk is the effect on the value of a financial instrument that results from a change in interest rates. The market risk associated with interest rate changes is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken. Management also mitigates risk through periodic reviews of derivative positions in the context of UPMC s total blended cost of capital. UPMC maintains interest rate swap programs on a variety of its revenue bonds in order to manage its interest rate risk. To meet this objective and to take advantage of low interest rates, UPMC entered into various interest rate swap agreements to manage interest rate risk. The notional amount under each interest rate swap agreement is reduced over the term of the respective agreement to correspond with reductions in various outstanding bond series. During the term of these agreements, the floating to fixed rate swaps convert variable rate debt to a fixed rate and the basis swaps convert the interest rate on underlying LIBOR-based bonds to the Securities Industry and Financial Markets Association Municipal Swap Index ( SIFMA Index ). Under the basis swaps, UPMC pays a rate equal to the SIFMA Index, an index of seven-day, high-grade, tax-exempt variable rate demand obligations. The SIFMA Index rates ranged from 0.11% to 0.34% (weighted-average rate of 0.26%) in 2011 and from 0.15% to 0.43% (weighted-average rate of 0.28%) in UPMC 2011 FINANCIAL STATEMENTS 17

19 The following table summarizes UPMC s interest rate swap agreements: Notional Amount at Maturity UPMC UPMC June 30 Swap Date Pays Receives Floating to fixed % 68% one-month $ 141,030 $ 147,005 LIBOR Basis 2021 SIFMA Index 67% three-month 53,905 53,905 LIBOR plus.2077% Basis 2037 SIFMA Index 67% three-month 46,095 46,095 LIBOR plus.3217% $ 241,030 $ 247,005 After giving effect to the above derivative transactions, UPMC s variable rate debt was approximately 21% and 20% of the total debt outstanding as of June 30, 2011 and 2010, respectively. The following table summarizes UPMC s equity swap agreements: Notional Amount at Maturity UPMC UPMC June 30 Date Pays Receives 2011 Three Month LIBOR S&P 500 $ 75,000 $ 50,000 plus.0600% Total Return Index 2012 Three Month LIBOR MSCI EAFE 50,001 - minus.2500% Daily Total Return Three Month LIBOR S&P ,000 - plus.1700% Total Return Index $ 150,001 $ 50,000 1 The MSCI EAFE Index is a free-float adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US and Canada. The fair value of UPMC s derivative instruments at June 30, 2011 and 2010, is classified in the consolidated balance sheets as follows: June 30 Other assets $ 2,962 $ Long-term obligations (17,338) (27,578) $ (14,376) $ (27,578) UPMC 2011 FINANCIAL STATEMENTS 18

20 The effects of changes in the fair value of the derivative instruments on the consolidated statements of operations and changes in net assets for the years ended June 30, 2011 and 2010, are as follows: Classification of Gain Recognized in Excess of Amount of Gain Recognized in Type of Derivative Revenues Over Expenses Excess of Revenues Over Expenses Interest rate contracts Investment revenue $ 4,188 $ 76,158 Equity index contracts Investment revenue 9,014 (6,445) $ 13,202 $ 69,713 UPMC s derivatives contain provisions that require UPMC s debt to maintain an investment grade credit rating from certain major credit rating agencies. If UPMC s debt were to fall below investment grade, it would be in violation of these provisions, and the counterparties to the derivatives could request payment or demand immediate and ongoing full overnight collateralization on derivatives in net liability positions. The aggregate fair value of all derivatives with creditrisk-related contingent features that are in a liability position at June 30, 2011 and 2010, is $16,942 and $21,129, respectively, for which UPMC has posted no collateral. If the credit-risk-related contingent features underlying these derivatives were triggered to the fullest extent on June 30, 2011, UPMC would be required to post an additional $19,424 of collateral to its counterparties. Pursuant to master netting arrangements, UPMC offsets the fair value of amounts recognized for derivatives, including the right to reclaim or obligation to return cash collateral from/to counterparties. 7. FAIR VALUE MEASUREMENTS As of June 30, 2011, UPMC held certain assets that are required to be measured at fair value on a recurring basis. These include cash and cash equivalents and certain board-designated, restricted, trusteed, and other investments and derivatives. UPMC s alternative investments are measured using either the cost or equity method of accounting and are therefore excluded from the fair value hierarchy table presented herein. The valuation techniques used to measure fair value are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs are generally unsupported by market activity. The three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value, include: Level 1 Quoted prices for identical assets or liabilities in active markets. Level 2 Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-driven valuations whose inputs are observable or whose significant value drivers are observable. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. UPMC 2011 FINANCIAL STATEMENTS 19