Consolidated Financial Report and Supplementary Information September 30, 2015
Contents Independent Auditor s Report 1 2 Consolidated Financial Statements Consolidated statements of financial position 3 Consolidated statements of operations and other changes in unrestricted net assets 4 Consolidated statements of changes in total net assets 5 Consolidated statements of cash flows 6 Notes to consolidated financial statements 7 32 Supplementary Information Schedule of maximum annual debt service coverage ratio 33 Schedule for portion of business for new markets tax credit loan consolidating statement of financial position information 34 Schedule for portion of business for new markets tax credit loan consolidating statement of operations and other changes in unrestricted net assets information 35 Note to supplemental schedules 36
Independent Auditor s Report To the Board of Benevolence The Evangelical Covenant Church Chicago, Illinois To the Board of Directors Swedish Covenant Hospital Chicago, Illinois Report on the Financial Statements We have audited the accompanying consolidated financial statements of Swedish Covenant Hospital and subsidiaries (the Hospital) (an affiliate of The Evangelical Covenant Church) which comprise the consolidated statements of financial position as of September 30, 2015 and 2014, and the related consolidated statements of operations and other changes in unrestricted net assets, changes in total net assets, and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, financial statements). Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. 1
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Swedish Covenant Hospital and subsidiaries as of September 30, 2015 and 2014, and the results of their operations, their changes in net assets and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Other Matter Our audits were conducted for the purpose of forming an opinion on the financial statements as a whole. The accompanying supplementary information is presented for purposes of additional analysis and is not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information has been subjected to the auditing procedures applied in the audits of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the financial statements as a whole. Chicago, Illinois January 7, 2016 2
Consolidated Statements of Financial Position September 30, 2015 and 2014 2015 2014 Assets Current Assets Cash and cash equivalents $ 12,696 $ 30 Assets whose use is limited (Notes 1, 2, and 3) 5,585 4,259 Patient accounts receivable - net of estimated uncollectibles of $10,240 in 2015 and $7,531 in 2014 (Note 6) 35,865 31,123 Inventories 3,944 4,509 Due from third-party payors 4,266 - Other current assets 6,611 5,105 Total current assets 68,967 45,026 Assets Whose Use is Limited and Investments (Notes 1, 2, and 3) Board-designated funds 134,961 137,922 Donor restricted 17,015 18,991 SCIC restricted investments 29,524 28,237 Debt service reserve funds 9,346 9,286 Trustee-held bond project funds - 4,214 190,846 198,650 Property and Equipment (Notes 1 and 13) Land and land improvements 11,459 11,459 Buildings and building equipment 285,702 275,060 Fixed and movable equipment 175,304 170,727 Construction in progress 3,261 7,010 475,726 464,256 Less accumulated depreciation (288,735) (270,704) 186,991 193,552 Other Assets Deferred debt expense, net of accumulated amortization of $1,392 in 2015 and $1,219 in 2014 (Note 1) 2,255 2,382 Pledges receivable (Note 12) 544 994 Goodwill and other intangibles (Note 1) 870 1,946 Note receivable (Notes 4 and 9) 9,680 9,680 Insurance recoveries receivable and other assets 5,115 8,415 18,464 23,417 Total assets $ 465,268 $ 460,645 Liabilities and Net Assets Current Liabilities Accounts payable $ 12,963 $ 10,637 Accrued liabilities 40,040 31,302 Current portion of long-term debt (Note 4) 4,808 4,621 Estimated third-party payor settlements (Note 6) 17,841 17,938 Total current liabilities 75,652 64,498 Long-Term Debt, excluding current portion (Note 4) 175,937 180,698 Professional Liability (Note 13) 29,726 28,515 Fair Value of Interest Rate Swaps (Notes 3 and 4) 18,296 14,822 Asset Retirement Obligation (Note 13) 1,705 1,619 Total liabilities 301,316 290,152 Commitments and Contingencies (Note 13) Net Assets Unrestricted 141,892 149,110 Temporarily restricted (Notes 1 and 5) 3,936 3,095 Permanently restricted (Notes 1 and 5) 18,124 18,288 Total net assets 163,952 170,493 Total liabilities and net assets $ 465,268 $ 460,645 See. 3
Consolidated Statements of Operations and Other Changes in Unrestricted Net Assets Years Ended September 30, 2015 and 2014 2015 2014 Revenue: Patient service revenue, net of contractual allowances and discounts (Note 6) $ 276,874 $ 248,411 Provision for uncollectible accounts (Note 6) (11,245) (6,560) Total net patient service revenue 265,629 241,851 Public aid assessment tax revenues (Note 6) 23,304 23,244 288,933 265,095 Other revenue 27,988 19,775 Meaningful use grant revenue (Note 1) 1,066 2,139 Net assets released from restrictions, operations (Note 5) 1,333 1,104 Total revenue 319,320 288,113 Expenses: Salaries and wages 134,338 132,756 Employee benefits (Notes 1 and 8) 24,984 23,180 Professional fees 14,481 10,200 Supplies 47,495 45,263 Utilities 4,098 3,868 Repairs and maintenance 5,098 5,265 Depreciation 19,238 18,735 Insurance 11,759 8,692 Interest and amortization of financing costs, net (Note 4) 8,786 8,960 Public aid assessment tax (Note 6) 12,709 12,411 Other 29,287 26,675 Total expenses 312,273 296,005 Income (loss) from operations 7,047 (7,892) Nonoperating income (expense): Change in beneficial interest in investment pool (Note 2): Interest and dividend income 3,474 1,505 Realized gains on investments, net 3,487 11,924 Unrealized net losses (17,270) (5,226) Alternative investment gain, including realized gains of $2,018 2015; $2,341 2014 2,539 4,954 (7,770) 13,157 Change in fair value of swaps, net (Note 4) (3,474) (551) Other nonoperating loss (2,209) (1,899) Unrestricted contributions 34 22 (13,419) 10,729 (Deficiency) excess of revenue over expenses (6,372) 2,837 Other changes in unrestricted net assets: Transfers to permanently restricted net assets from unrestricted net assets - (294) Transfers to temporarily restricted net assets from unrestricted net assets (688) (387) Net assets released from restriction, capital - 1,215 Net assets transferred to shareholders of St. Francis IPA (158) (100) Net assets transferred to Covenant Ministries of Benevolence, net (Note 9) - (2,400) (Decrease) increase in unrestricted net assets $ (7,218) $ 871 See. 4
Consolidated Statements of Changes in Total Net Assets Years Ended September 30, 2015 and 2014 2015 2014 Unrestricted net assets (Deficiency) excess of revenue over expenses $ (6,372) $ 2,837 Transfers to permanently restricted net assets from unrestricted net assets - (294) Transfers to temporarily restricted net assets from unrestricted net assets (688) (387) Net assets released from restriction, capital - 1,215 Net assets transferred to shareholders of St. Francis IPA (158) (100) Net assets transferred to Covenant Ministries of Benevolence, net - (2,400) (Decrease) increase in unrestricted net assets (7,218) 871 Temporarily restricted net assets Contributions and pledges 1,486 2,086 Transfers from unrestricted net assets to temporarily restricted assets 688 387 Transfer to temporarily restricted net assets from permanently restricted net assets - 4 Net assets released from restrictions (Note 5) (1,333) (2,319) Increase in temporarily restricted net assets 841 158 Permanently restricted net assets Unrealized and realized (loss) gain on investments, net (164) 188 Transfer from permanently restricted net assets to temporarily restricted net assets - (4) Transfers to permanently restricted net assets from unrestricted net assets - 294 (Decrease) increase in permanently restricted net assets (164) 478 (Decrease) increase in net assets (6,541) 1,507 Net assets: Beginning of year 170,493 168,986 End of year $ 163,952 $ 170,493 See. 5
Consolidated Statements of Cash Flows Years Ended September 30, 2015 and 2014 2015 2014 Cash Flows from Operating Activities Cash received from: Patient services $ 294,788 $ 276,916 Nonpatient services 21,019 21,082 Cash paid to: Employees (134,030) (132,261) Suppliers (144,579) (137,604) Unrestricted contributions received 34 21 Unrestricted (loss) income from permanently restricted investments (164) 533 Interest paid (8,854) (8,857) Investment income received 3,474 1,505 Net cash provided by operating activities 31,688 21,335 Cash Flows from Investing Activities Capital project expenditures (13,198) (13,520) SCIC purchases of investments and cash deposits (11,506) (29,985) SCIC proceeds and maturities from the sale of investments 6,254 22,827 Net activity from beneficial interest in pooled investments (2,281) (243) Net proceed activity from trustee-held bond project fund investments 6,587 14,201 Purchase of physician practices (197) (706) Net change in other assets (61) (272) Net cash used in investing activities (14,402) (7,698) Cash Flows from Financing Activities Temporarily restricted contributions received - 1,703 Payments and funding of long-term debt (4,620) (15,426) Cash paid for net asset transfers to Covenant Ministries of Benevolence - (2,400) Net cash used in financing activities (4,620) (16,123) Net increase (decrease) in cash and cash equivalents 12,666 (2,486) Cash and cash equivalents: Beginning of year 30 2,516 End of year $ 12,696 $ 30 Supplemental schedule of noncash investing and financing activities Purchases of property and equipment in accrued liabilities $ 1,775 $ 3,569 See. 6
Note 1. Nature of Organization and Significant Accounting Policies Organization and nature of business: Swedish Covenant Hospital, a not-for-profit corporation, and subsidiaries (the Hospital) are a part of Covenant Ministries of Benevolence, which includes EMC Health, Inc., Life Center on the Green, Inc., and all Covenant Retirement Communities and extended care facilities. These institutions operate under the direction of the Board of Benevolence of The Evangelical Covenant Church (ECC). Covenant Ministries of Benevolence is the sole corporate member of the Hospital. The Hospital provides health care services to the residents of the Northwest Chicago area. The accompanying consolidated financial statements include Swedish Covenant Hospital (SCH) and its subsidiaries: Swedish Covenant Management Services, Inc. (SCMS), a taxable not-for-profit corporation; Swedish Covenant Faculty Practice Group, a not-for-profit corporation; Swedish Covenant Hospital Foundation (the Foundation), a not-for-profit corporation; and SC Insurance Company (SCIC), a not-forprofit captive insurance subsidiary. SCIC was incorporated during 2010 and is utilized by the Hospital in managing its malpractice and general liability risks beginning in January 2011. All significant intercompany accounts and transactions have been eliminated in consolidation. Swedish Covenant Surgery Center (SCSC) was formed to provide cost-efficient, ambulatory surgical care to patients residing in the Chicagoland area. SCSC commenced operations in July 2012. In August 2013, SCH became the sole shareholder of SCSC, and SCSC is consolidated in the financial statements as of that date. During fiscal year 2014, SCSC was dissolved and all assets have been transferred to the Hospital. The Hospital owns 50% of Swedish Covenant Managed Care Alliance, Inc., its physician hospital organization (PHO). Managed Health Care Associates, Ltd., an unrelated third party, owns the other 50% of the PHO. The purpose of the PHO is to manage the Hospital s Medicare and other health maintenance organization members. The Hospital s investment in the PHO is accounted for using the equity method. Income from the PHO totaled $1,252 and $957 in fiscal year 2015 and 2014, respectively, and is reported in net patient service revenue in the consolidated statements of operations and other changes in unrestricted net assets. The Hospital owns seven Class C units of CyberKnife Cancer Institute of Chicago, LLC (CKCI) and sixteen Class C units of CK Property Development, LCC (CKP). CKCI was formed to provide costefficient, highly specialized cancer care to patients residing in the Chicagoland area. CKP is a supporting real estate joint venture for CKCI. Additionally, the Hospital entered into a CK Program Lease and Services agreement. All activities for CKCI and CKP commenced operations in fiscal year 2012. The Hospital s investments in CKCI and CKP are accounted for using the equity method. The Hospital owns one class B share of Upper Midwest Consolidated Services Center, LLC (UMCSC) for the purposes of pooling the Hospital s supply purchases with VHA Sponsored Patrons. This one share represents less than 5% of the total shares outstanding. The Hospital s investment in UMCSC is accounted for under the cost method. 7
Note 1. Nature of Organization and Significant Accounting Policies (Continued) The Hospital made an initial investment of $30 in Accountable Care Chicago, LLC (ACC), to serve as an Accountable Care Entity (ACE) in accordance with the criteria set forth in the Illinois Department of Healthcare and Family Services (IDHFS) Solicitation for Accountable Care Entities. ACC was formed to develop a collaborative provider network that will be capable of providing the full range of health care services required by IDHFS across the care continuum, including having sufficient data analytics and a health information technology infrastructure to facilitate the coordination of care for the population and communities served. The Hospital s investment in the ACE is accounted for using the equity method. On July 15, 2015, Molina Healthcare of Illinois, Inc. entered into an asset purchase agreement with ACC (d/b/a MyCare Chicago) to acquire certain assets of the Medicaid business of ACC. The Hospital s investments in PHO, UMCSC, CKCI, CKP, and ACC totaled $97 and $146 at September 30, 2015 and 2014, respectively, and are reported in other long-term assets in the consolidated statements of financial position. During fiscal years 2015 and 2014, the Hospital acquired several physician practices for cash of $197 and $706, respectively, in order to meet the primary service area s community needs for access to health care. Independent appraisals of the practices were obtained prior to negotiating the terms of the acquisition price. The excess of acquisition costs over the fair value of net assets acquired has been recorded as goodwill. At September 30, 2015 and 2014, the amount of goodwill recorded is $750 and $1,312, respectively. During fiscal year 2015, goodwill was impaired by $562. At September 30, 2015 and 2014, the amount of intangible assets with finite lives is $120 and $634, respectively, net of accumulated amortization of $1,706 and $1,066, respectively. Intangible assets with finite lives are amortized over their useful lives, which is three years. Significant accounting policies are as follows: Use of estimates: Management has made estimates and assumptions that affect the reported amounts of certain assets, liabilities, revenue, and expenses. Actual results could differ from those estimates. The use of estimates and assumptions in the preparation of the accompanying financial statements is primarily related to the determination of the net patient accounts receivable, settlements with third-party payors, and the accrual for self-insurance liabilities. Due to uncertainties inherent in the estimation and assumption process, it is at least reasonably possible that changes in these estimates and assumptions in the near-term would be material to the financial statements. Income taxes: The Hospital is a not-for-profit organization under the laws of Illinois. The Internal Revenue Service has determined that the Hospital is a not-for-profit organization described in Section 501(c)(3) of the Internal Revenue Code (the Code) and is exempt from federal income taxes on related income pursuant to Section 501(a) of the Code. Accordingly, the Hospital has not provided for income taxes in the accompanying financial statements. For SCMS, deferred taxes are provided on a liability method, whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. SCMS had approximately $75,466 and $63,262 at September 30, 2015 and 2014, respectively, of net operating loss carryforwards; $0 and $0 expired in fiscal 2015 and 2014, respectively. SCMS has recorded a full valuation allowance against the related deferred tax asset due to the uncertainty associated with its realizability. 8
Note 1. Nature of Organization and Significant Accounting Policies (Continued) The Hospital and its not-for-profit subsidiaries each file Form 990 (Return of Organization Exempt from Income Tax), and the for-profit subsidiary files Form 1120 (U.S. Corporation Income Tax Return) annually. When these returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would ultimately be sustained. Examples of tax positions common to health systems include such matters as the obligated group, the nature, characterization and taxability of joint venture income and various positions relative to potential sources of unrelated business income (UBI). UBI is reported on Internal Revenue Service Form 990-T, as appropriate. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes that it is more likely than not that the tax position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions are not offset or aggregated with other positions. Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely to be realized on settlement with the applicable taxing authority. The portion of the benefits reflected as a liability for unrecognized tax benefits in the accompanying consolidated statements of financial position along with any associated interest and penalties that would be payable to the taxing authorities upon examination. At September 30, 2015 and 2014, there were no unrecognized tax benefits identified or recorded as liabilities. The Forms 990, Forms 990-T and Forms 1120 filed by the Hospital are subject to examination for up to three years from the extended due date of each return. These returns are no longer subject to examination for tax years ended before September 30, 2012. Basis of presentation: The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) as recommended by the Audit and Accounting Guide for Health Care Entities (the Guide) published by the American Institute of Certified Public Accountants. (Deficiency) excess of revenue over expenses: The consolidated statements of operations and other changes in unrestricted net assets show the (deficiency) excess of revenue over expenses for the Hospital. Changes in unrestricted net assets that are excluded from (deficiency) excess of revenue over expenses, consistent with industry practice, include net assets released from restrictions for capital purposes and net assets transferred to related organizations. Cash and cash equivalents: Cash and cash equivalents consist principally of undesignated and unrestricted cash accounts, money market demand deposits, and commercial paper with maturities at date of purchase of three months or less. Assets whose use is limited: Board-designated assets are invested in a combined investment fund that aggregates investments of all Covenant Ministries of Benevolence institutions. While these funds are held and invested by Covenant Ministries of Benevolence, the Hospital retains the benefits of ownership of its proportional interest in the combined investment fund. Ownership interests in the combined investment fund are reported as beneficial interest in investment pool in the accompanying financial statements. Trustee-held bond project funds and bond sinking funds are invested in qualified investments in accordance with the respective bond or loan agreements. Assets whose use is limited are classified as trading securities and are carried at fair value. See Note 3 for descriptions of the methods of determining fair value. 9
Note 1. Nature of Organization and Significant Accounting Policies (Continued) Assets whose use is limited in the amount of $5,585 and $4,259 are classified as current as of September 30, 2015 and 2014, respectively, which includes bond and interest sinking fund money expected to be used to pay principal and interest payments to bond holders during the upcoming fiscal year. Realized gains and losses from sales of investments and unrealized gains and losses on investments are determined using the average cost method. Interest, dividends, and realized and unrealized gains and losses are recorded as nonoperating revenue. Inventories: Inventories are stated at the lower of cost or market value. Property and equipment: Property and equipment are recorded at cost and are depreciated on the straight-line method over the estimated useful lives of the assets. Estimated useful lives of the assets are: Land improvements Buildings and building equipment Fixed and movable equipment 5 20 years 10 40 years 3 20 years The Hospital continually evaluates whether circumstances have occurred that would indicate the remaining estimated useful lives of long-lived assets may warrant revision or that the remaining balance of such assets may not be recoverable. No such impairments have been recorded as of September 30, 2015 and 2014. Deferred debt expense and debt discount: All expenses relating to the procurement of debt, including underwriting fees, have been deferred and are amortized over the maturities of the bonds. However, in the case of variable rate revenue bonds, amounts deferred are expensed if it is concluded that a failed remarketing has occurred or is probable to occur. Original debt discounts are amortized over the maturities of the related bonds. Temporarily restricted net assets: Temporarily restricted net assets are those whose use has been limited by donors to a specific time period or purpose. Permanently restricted net assets: Permanently restricted net assets are those whose use is limited by donor stipulations that neither expire by the passage of time, nor can be fulfilled or otherwise removed. Investment income generated from permanently restricted assets, however, can be used to support hospital-sponsored activities. Losses on investments that reduce permanently restricted net assets below their original donor gift fair value reduce unrestricted net assets by means of a transfer from unrestricted net assets to permanently restricted net assets. Subsequent investment gains that restore the fair value of the investments to the original donor gift fair value increase unrestricted net assets by means of a transfer from permanently restricted net assets. Net patient service revenue: Net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under certain reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period the related services are rendered and adjusted in future periods as final settlements are determined. Total net patient service revenue also includes public aid assessment tax revenues (see Note 6). Other operating revenue: Other operating revenue includes revenue from the Hospital s parking garage, cafeteria and outpatient pharmacies, rental revenue from physician offices, and other patientrelated revenue. Such revenue is recognized when services are provided. 10
Note 1. Nature of Organization and Significant Accounting Policies (Continued) Medicare and Medicaid Electronic Health Records (EHR) Incentive Programs: The American Recovery and Reinvestment Act of 2009 provides for Medicare and Medicaid Incentive Programs beginning in Federal fiscal year 2011 for eligible acute care hospitals that are meaningful users of certified EHR technology, as defined by the Federal Register. The Hospital has implemented certified EHR technology that has enabled it to demonstrate its meaningful use and to qualify for the incentive programs. The initial incentive payments received for both the Medicare and Medicaid EHR incentive programs are estimates based upon data from prior year s cost reports. The final settlements will be determined after the submission of the current annual cost reports and subsequent audits by the fiscal intermediary. The Hospital s compliance with the meaningful use criteria is also subject to audit by the Federal government. The EHR Incentive Programs are expected to continue through September 30, 2017, and the incentive payments will be calculated annually. The Hospital accounts for EHR incentive funds using the grant accounting model. Under this model, the Hospital records EHR incentive revenue when it is reasonably assured that it will meet the meaningful use criteria for the required reporting period and that the grant will be received. The Hospital has recorded $872 and $1,658 of Medicare EHR incentive for the years ended September 30, 2015 and 2014, respectively, and $194 and $481 of Medicaid EHR incentive for the years ended September 30, 2015 and 2014, respectively, reported as meaningful use grant revenue in the accompanying consolidated statements of operations and other changes in unrestricted net assets. Contributions: Unrestricted contributions are included in contributions at the date of the gift. Restricted contributions received with donor stipulations that limit the use of the donated assets are reported as either temporarily or permanently restricted. Charity care: The Hospital provides care to patients who meet certain criteria under its charity care policy, in compliance with state law, without charge or at amounts less than its established rates. Accordingly, normal charges for these services are not recorded as revenue. See Note 7 for the estimated costs of the charity care. Self-insured employee health care costs: The Hospital self-insures a significant portion of its employee health care costs, and limits its exposure through purchased stop-loss coverage. The Hospital accrues estimated incurred but not paid employee health costs based on analysis of historical payment lag patterns for such claims. During the year ended September 30, 2014, the Hospital implemented an Employer Provider Option (EPO) in which employees may elect coverage where a majority of their health care is provided by the Hospital and a network of Hospital-affiliated providers. Under the EPO, the thirdparty administrator (an insurance company) pays claims for services provided by the Hospital to the Hospital s employees at rates that approximate rates paid by the third-party administrator to other Chicago-area hospitals. The Hospital records patient service revenue for such services at the amount paid by the third-party administrator, with an equal amount recorded as employee benefits expense. For the years ended September 30, 2015 and 2014, the patient service revenue recognized for services provided by the Hospital to its employees approximated $5,965 and $4,094, respectively. Derivative financial instruments: The Hospital has entered into interest rate swap agreements in order to reduce the Hospital s exposure to variations in interest rates related to the Hospital s floating rate for long-term borrowings (see Note 4). Hedge accounting is not applied. The swap agreements are recorded in the consolidated statements of financial position at their fair values and changes in the fair values of the swap agreements are recorded in nonoperating income (expense). If debt is extinguished prior to its contractual maturity, the Hospital may conclude to either terminate the interest rate swap agreement or, if deemed economically disadvantageous to terminate, continue to operate under the agreement despite the extinguishment of the related debt. The determination of fair value includes the consideration of any credit valuation adjustments necessary, giving consideration to the creditworthiness of the respective counterparties or the Hospital, as appropriate. 11
Note 1. Nature of Organization and Significant Accounting Policies (Continued) Recent accounting pronouncements: In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either a full retrospective or retrospective with cumulative effect transition method. Early adoption is permitted for fiscal years beginning after December 15, 2016. The updated standard will be effective for the Hospital s fiscal year 2019 consolidated financial statements. The Hospital has not yet selected a transition method and is currently evaluating the effect that the updated standard will have on the financial statements. In May 2015, the FASB issued ASU 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). ASU 2015-07 removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient, and also removes the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. During the year ended September 30, 2015, the Hospital elected to early adopt the provisions of ASU 2015-07, including retrospective application for the year ended September 30, 2014. The adoption of ASU 2015-07 resulted in the removal of certain investments valued using the net asset value per share practical expedient, formerly assessed as Level 2, from the fair value hierarchy disclosed in Note 3. Subsequent events: The Hospital recognizes, in the financial statements, the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the consolidated statements of financial position, including the estimates inherent in the process of preparing the financial statements. The Hospital does not recognize subsequent events that provide evidence about conditions that did not exist at the date of the consolidated statement of financial position, but arose after the date of the consolidated statements of financial position, but before the financial statements are issued. For these purposes, the Hospital has evaluated events occurring subsequent to the date of the consolidated statement of financial position through January 7, 2016, the date the financial statements were issued. The Hospital has not evaluated events occurring after January 7, 2016, in these financial statements. Reclassifications: Certain prior-year amounts have been reclassified to conform to the current-year presentation, with no effect on excess of revenues over expenses and net assets. Note 2. Assets Whose Use is Limited Assets whose use is limited include assets classified in the following six categories: Board-Designated Funds Assets set aside by the Board of Directors (Board) for debt repayment, benevolent care, capital replacement, and certain future construction and capital projects over which the Board retains control and, which at its discretion, may use subsequently for other purposes. Such funds are not expected to be used in the next year. Debt Service Reserve Funds Assets held by trustees under the terms of the master indenture agreement, set aside to meet the maximum annual interest expense, principal payments, and sinking fund requirements during the term of the bond. Trustee-Held Bond Project Funds Assets held by bond trustees under the terms of the master indenture agreement for certain construction projects. Trustee-Held Bond-Sinking Funds Assets held by bond trustees under the terms of the master indenture agreement for either bond principal or bond interest payments. SCIC Restricted Investments Assets held by SCIC for the Department of Arizona Insurance Regulations of capitalization and for the purposes of paying malpractice liability and general insurance claims. 12
Note 2. Assets Whose Use is Limited (Continued) Donor-Restricted Funds Assets restricted by donors to be maintained by the Foundation in perpetuity. Most board-designated assets are invested in a combined investment fund that aggregates investments of all Covenant Ministries of Benevolence institutions. While these funds are held and invested by Covenant Ministries of Benevolence, the Hospital retains the benefits of ownership of its proportional interest in the combined investment fund. Assets whose use is limited, at fair value, as of September 30, 2015 and 2014, consisted of the following: 2015 2014 Board-designated funds: Funded depreciation $ 81,463 $ 82,941 Long-term investment 53,498 54,981 134,961 137,922 Donor-restricted funds 17,015 18,991 SCIC restricted investments 29,733 29,363 Trustee-held funds, debt service reserve funds 9,346 9,286 Trustee-held funds, bond project funds - 4,214 Trustee-held funds, bond-sinking funds 5,376 3,133 Total 196,431 202,909 Less current portion (5,585) (4,259) Assets whose use is limited, long-term $ 190,847 $ 198,650 The Hospital s assets whose use is limited, at fair value, as of September 30, 2015 and 2014, consisted of the following: 2015 2014 Interest in Covenant Ministries of Benevolence combined investment fund $ 124,027 $ 126,308 Alternative investment funds: Hedge funds 3,056 3,024 Cash and money market accounts 6,550 9,350 Equity securities 48,864 51,652 Fixed income securities 13,934 12,575 $ 196,431 $ 202,909 13
Note 3. Fair Value Measurements Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Hospital uses various methods including market, income and cost approaches. Based on these approaches, the Hospital often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Hospital utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Hospital is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories: The hierarchy is measured in three levels based on the reliability of inputs: Level 1: Valuations are based on quoted prices in active markets for identical assets or liabilities that the Hospital has the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments. Level 2: Valuations are not based on quoted prices for identical assets or liabilities, but rather are based on significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Fair values are primarily obtained from third-party pricing services for comparable assets or liabilities. Level 3: Valuations are derived from other valuation methodologies and incorporate certain assumptions and projections that are not observable in the market and require significant professional judgment in determining the fair value assigned to such assets or liabilities. Management s estimates of the fair values of the alternative investments in hedge funds, limited partnerships, and private equity funds are based on net asset value information provided by the fund managers or general partners, which in turn, is based on the most recent information available to the fund manager for the underlying investments. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls, is based on the lowest level input that is significant to the fair value measurement in its entirety. Investment Securities The Hospital invests in a pooled fund (combined investment fund, or CIF) maintained by Covenant Ministries of Benevolence (CMB). The CMB pooled fund is comprised of various types of investments including: mutual funds, equity and debt securities, and alternative investments. The Hospital owns an interest in CMB s pooled fund; the Hospital does not own or have any interest in the underlying investments. As an investor in the pooled fund, the Hospital has the ability to withdraw up to $105,000 from its account with 30 days notice or less. Additionally, 90 days notice may be required for the Hospital to withdraw in excess of $105,000, up to the full balance, from its account. As a practical expedient, the fair value of the Hospital s interest in the CMB pooled fund is estimated based on the net asset value of the CIF reported by CMB. The Hospital reports investments in equity securities with readily determinable fair values and all investments in debt securities at fair value. Fair value of equity securities is determined primarily on the basis of quoted market prices. The Hospital s shares in mutual funds are stated at fair value based on quoted market prices, which represents the net asset value of shares held by the Hospital at year-end. The fair value of investments in fixed income securities, which primarily includes investments in corporate and other bonds, is primarily determined using techniques that are consistent with the market approach. 14
Note 3. Fair Value Measurements (Continued) Alternative Investments The fair value of alternative investments is $3,056 and $3,024 at September 30, 2015 and 2014, respectively. As of September 30, 2015 and 2014, these investments were invested in a fund of hedge funds with quarterly liquidity requiring one day notice for redemption. As a practical expedient, alternative investments with no market activity are valued using the net asset values reported by the investment funds, which in turn are based on the most recent information available to the fund manager for the underlying investments. Significant observable inputs include benchmark yields, reported trades, observable broker/dealer quotes, and issuer spreads. Investments in alternative investment funds consist of domestic equity, international equity, hedge funds, private equity, international real estate, puts and calls, and mortgages. In the case of large cap equity, small cap equity, international equity and hedge funds, the holdings are in offshore corporations that are valued monthly. The underlying fund holdings are primarily exchange traded, readily marketable securities both equities and bonds. A small percentage of holdings are in private investments and derivatives. All hedged equity, international hedged equity and absolute return has pricing policies that depend on outside pricing services to validate their pricing. Interest in Irrevocable Trusts Interest in irrevocable trusts is recorded as the Hospital s percentage of the fair value of the trusts net assets. Interest Rate Swaps The fair value of the interest rate swap agreements was determined using an industry standard valuation model, which is based on a market approach. 15
Note 3. Fair Value Measurements (Continued) Fair value of financial instruments carried at fair value: Categories of assets and liabilities measured at fair value on a recurring basis during the year ended September 30, 2015, using unadjusted quoted prices in active markets for identical assets (Level 1); significant other observable inputs (Level 2); and significant unobservable inputs (Level 3), are as follows: Fair Value as of September 30, 2015 Quoted Prices in Significant Investments Active Other Significant Valued Identical Observable Unobservable Using the Assets Inputs Inputs Practical Description Total (Level 1) (Level 2) (Level 3) Expedient Interest in CMB combined investment fund $ 124,027 $ - $ - $ - $ 124,027 Alternative investment funds: Hedge funds 3,056 - - - 3,056 Equities securities: Mutual funds: Domestic small cap 1,796 1,796 - - - Domestic mid cap 3,217 3,217 - - - Domestic large cap 7,135 7,135 - - - Domestic real estate 3,516 3,516 - - - International large cap 10,678 10,678 - - - Domestic bond 11,353 11,353 - - - International bond 9,439 9,439 - - - Common stock: Energy 1,730 1,730 - - - Fixed income securities: U.S. government obligations 2,189 391 1,798 - - Municipal bonds 146 45 101 - - Federal agency mortgage-backed securities 1,839 1,585 254 - - Collateralized mortgage obligations and asset-backed securities 804 255 549 - - Corporate and other obligations 8,956 6,347 2,609 - - 189,881 $ 57,487 $ 5,311 $ - $ 127,083 Cash and money market accounts 6,550 Total $ 196,431 Interest in irrevocable trusts $ 782 $ - $ - $ 782 $ - Derivatives - interest rate swaps (Note 4) $ (18,296) $ - $ (18,296) $ - $ - 16
Note 3. Fair Value Measurements (Continued) Categories of assets and liabilities measured at fair value on a recurring basis during the year ended September 30, 2014, are as follows: Fair Value as of September 30, 2014 Quoted Prices in Significant Investments Active Other Significant Valued Identical Observable Unobservable Using the Assets Inputs Inputs Practical Description Total (Level 1) (Level 2) (Level 3) Expedient Interest in CMB combined investment fund $ 126,308 $ - $ - $ - $ 126,308 Alternative investment funds: Hedge funds 3,024 - - - 3,024 Equities securities: Mutual funds: Domestic small cap 1,314 1,314 - - - Domestic mid cap 4,302 4,302 - - - Domestic large cap 5,750 5,750 - - - Domestic real estate 4,954 4,954 - - - International large cap 10,204 10,204 - - - Domestic bond 14,095 14,095 - - - International bond 8,729 8,729 - - - Common stock: Healthcare 3 3 - - - Energy 2,301 2,301 - - - Fixed income securities: U.S. government obligations 388 388 - - - Municipal bonds 59 59 - - - Federal agency mortgage-backed securities 2,495 2,033 462 - - Collateralized mortgage obligations and asset-backed securities 2,128 547 1,581 - - Corporate and other obligations 7,505 5,966 1,539 - - 193,559 $ 60,645 $ 3,582 $ - $ 129,332 Cash and money market accounts 9,350 Total $ 202,909 Interest in irrevocable trusts $ 783 $ - $ - $ 783 $ - Derivatives - interest rate swaps (Note 4) $ (14,822) $ - $ (14,822) $ - $ - 17
Note 3. Fair Value Measurements (Continued) A reconciliation of the beginning and ending balances for the assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the years ended September 30, 2015 and 2014, is as follows: Interest in Irrevocable Trusts Balance, October 1, 2013 $ 797 Unrealized losses (14) Balance, September 30, 2014 783 Unrealized losses (1) Balance, September 30, 2015 $ 782 For the year ended September 30, 2015, the application of valuation techniques applied to similar assets has been consistent. The Hospital assesses levels of the investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that caused the transfer. The Hospital invests a significant amount of funds in the CIF. In the event that CMB does not fulfill its obligations, the Hospital may be exposed to risk. The risk of default depends on the creditworthiness of the counterparty to those transactions. CMB attempts to minimize credit risk by monitoring the creditworthiness of counterparties. 18
Note 3. Fair Value Measurements (Continued) As of September 30, 2015 and 2014, the investments underlying the Hospital s proportionate interest in the CMB combined investment fund were categorized as follows: 2015 2014 Percentage Percentage of Total of Total Pooled Fund Pooled Fund CIF Hierarchy Level 1 Equity securities Domestic equity (a) 22 % 29 % International equity (b) 4 2 Fixed income securities Bonds 29 25 Alternative investments Domestic equity (a) - 1 Hedge funds (c) - 1 International equity (b) - - Derivatives (d) 1 - Other 1 2 Total Level 1 investments 57 % 60 % CIF Hierarchy Level 2 Equity securities Domestic equity (a) - % 4 % Fixed income securities Bonds 9 9 Alternative investments Domestic equity (a) 6 International equity (b) 7 8 Derivatives (d) - - Other 2 - Total Level 2 investments 24 % 21 % CIF Hierarchy Level 3 Alternative investments Domestic equity (a) 3 % 4 % Hedge funds (c) 10 8 Private equity (d) 4 5 International real estate - - Mortgages 2 2 Total Level 3 investments 19 % 19 % Total CIF investments 100 % 100 % (a) This category includes one hedge fund that is designed to protect the market value of designated equity holdings from losses attributable to the declines in the equity market. (b) This category includes three private investment funds that primarily invest in equity securities of companies ordinarily located in any country other than the United States and Canada. (c) This category includes six hedge funds that pursue a number of investment strategies. The fair market value recorded reflects the amount expected to be received as the fund liquidates. One fund is in a 1 year lock up period and another fund is in a 2 year lock up period. (d) This category includes six private equity funds that invest in a diversified portfolio of venture capital, buyout, and special situations partnerships and other limited liability vehicles. The unfunded commitment of $15,772 will be funded by all the institutions within the combined investment fund. The Hospital s portion of the unfunded commitment is not currently determinable. 19