Ernst & Young LLP - Cleveland Clinic · 2013. 12. 20. · A member firm of Ernst & Young Global Limited Ernst & Young LLP Suite 1300 925 Euclid Avenue Cleveland, OH 44115-1476 Tel:

A U D I T E D C O N S O L I D A T E D F I N A N C I A L

S T A T E M E N T S

The Cleveland Clinic Foundation d.b.a. Cleveland Clinic Health System Years Ended December 31, 2011 and 2010 With Report of Independent Auditors

Ernst & Young LLP

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Cleveland Clinic Health System

Audited Consolidated Financial Statements

Years Ended December 31, 2011 and 2010

Contents

Report of Independent Auditors .......................................................................................................1

Audited Consolidated Financial Statements

Consolidated Balance Sheets ...........................................................................................................2 Consolidated Statements of Operations and Changes in Net Assets ...............................................4 Consolidated Statements of Cash Flows ..........................................................................................6 Notes to Consolidated Financial Statements ....................................................................................7

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Report of Independent Auditors

The Board of Directors The Cleveland Clinic Foundation

We have audited the accompanying consolidated balance sheets of The Cleveland Clinic Foundation and controlled affiliates, d.b.a. Cleveland Clinic Health System (the System), as of December 31, 2011 and 2010, and the related consolidated statements of operations and changes in net assets and cash flows for the years then ended. These financial statements are the responsibility of the System’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the System’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the System’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and 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 Cleveland Clinic Health System at December 31, 2011 and 2010, and the consolidated results of its operations, changes in net assets, and cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.

As discussed in Note 2 to the consolidated financial statements, the System changed its presentation of the provision for uncollectible accounts as a result of the adoption of Accounting Standards Update (ASU) 2011-07, Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities, effective January 1, 2010.

EY March 14, 2012

A member firm of Ernst & Young Global Limited

Ernst & Young LLP Suite 1300 925 Euclid Avenue Cleveland, OH 44115-1476 Tel: +1 216 861 5000 Fax: +1 216 583 2271 www.ey.com


Consolidated Balance Sheets(In Thousands)

December 31 2011 2010Assets Current assets:

Cash and cash equivalents 19,157$ 16,471$ Patient receivables, net of allowances for uncollectible

accounts of $152,871 in 2011 and $130,697 in 2010 656,169 677,733 Investments for current use 33,978 152,213 Other current assets 382,336 355,561

Total current assets 1,091,640 1,201,978 Investments:

Long-term investments 3,607,752 3,369,825 Funds held by trustees 132,212 220,435 Assets held by captive insurance subsidiary 173,231 173,757 Donor-restricted assets 331,449 302,566

4,244,644 4,066,583 Property, plant, and equipment, net 3,398,822 3,135,326 Other assets:

Pledges receivable, net 109,359 127,627 Trusts and interests in foundations 107,669 130,813 Other noncurrent assets 147,609 128,081 364,637 386,521

Total assets 9,099,743$ 8,790,408$

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December 31 2011 2010Liabilities and net assets Current liabilities:

Accounts payable 307,972$ 275,262$ Compensation and amounts withheld from payroll 217,102 202,913 Current portion of long-term debt 50,004 46,888 Variable rate debt classified as current 492,690 494,300 Other current liabilities 371,994 386,029

Total current liabilities 1,439,762 1,405,392 Long-term debt:

Hospital revenue bonds 2,003,220 2,009,569 Notes payable and capital leases 78,840 53,328

2,082,060 2,062,897 Other liabilities:

Professional and general insurance liability reserves 147,238 173,180 Accrued retirement benefits 639,348 510,804 Other noncurrent liabilities 430,748 327,591 1,217,334 1,011,575

Total liabilities 4,739,156 4,479,864 Net assets:

Unrestricted 3,722,758 3,651,954 Temporarily restricted 399,909 436,824 Permanently restricted 237,920 221,766

Total net assets 4,360,587 4,310,544 Total liabilities and net assets 9,099,743$ 8,790,408$ See accompanying notes.

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Consolidated Statements of Operations and Changes in Net Assets

(In Thousands)

Operations Year Ended December 31 2011 2010Unrestricted revenues Net patient service revenue 5,562,977$ 5,335,907$ Provision for uncollectible accounts (350,453) (285,778) Net patient service revenue less provision

for uncollectible accounts 5,212,524 5,050,129 Other 614,043 549,831 Total unrestricted revenues 5,826,567 5,599,960 Expenses Salaries, wages, and benefits 3,283,496 3,108,823 Supplies 622,683 621,828 Pharmaceuticals 380,634 347,225 Purchased services 367,861 357,040 Administrative services 148,144 157,249 Facilities 256,146 299,172 Insurance 4,864 58,853 5,063,828 4,950,190 Operating income before interest, depreciation,

and amortization expenses 762,739 649,770 Interest 92,706 89,486 Depreciation and amortization 335,435 309,732 Operating income before special charges 334,598 250,552 Special charges 33,403 – Operating income 301,195 250,552 Nonoperating gains and losses Investment return 62,739 368,030 Derivative losses (127,268) (57,657) Other, net (27,444) 1,101 Net nonoperating gains and losses (91,973) 311,474 Excess of revenues over expenses 209,222 562,026 (continued on next page)

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Changes in Net Assets

Temporarily PermanentlyUnrestricted Restricted Restricted Total

Balances at December 31, 2009 3,037,411$ 417,457$ 205,729$ 3,660,597$ Excess of revenues over expenses 562,026 – – 562,026 Donated capital and assets released from –

restrictions for capital purposes 21,758 (19,301) – 2,457 Gifts and bequests – 58,236 10,670 68,906 Transfer of net assets 10,126 (10,126) – – Net investment income – 25,829 – 25,829 Net assets released from restrictions used for –

operations included in other unrestricted revenues – (41,632) – (41,632) Retirement benefits adjustment 15,974 – – 15,974 Change in interests in foundations – 6,361 1,748 8,109 Change in value of perpetual trusts – – 3,619 3,619 Net change in unrealized gains on nontrading investments 5,243 – – 5,243 Other (584) – – (584) Increase in net assets 614,543 19,367 16,037 649,947

Balances at December 31, 2010 3,651,954 436,824 221,766 4,310,544 Excess of revenues over expenses 209,222 – – 209,222 Donated capital and assets released from

restrictions for capital purposes 7,982 (7,609) – 373 Gifts and bequests – 24,332 13,040 37,372 Transfer of net assets 992 (992) – – Net investment income – 5,697 – 5,697 Net assets released from restrictions used for

operations included in other unrestricted revenues – (57,428) – (57,428)Retirement benefits adjustment (143,139) – – (143,139)Change in interests in foundations – (915) 475 (440)Change in value of perpetual trusts – – 2,639 2,639 Net change in unrealized losses on nontrading investments (6,343) – – (6,343)Other 2,090 – – 2,090 Increase (decrease) in net assets 70,804 (36,915) 16,154 50,043

Balances at December 31, 2011 3,722,758$ 399,909$ 237,920$ 4,360,587$ See accompanying notes.

Net Assets

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Year Ended December 31 2011 2010 Operating activities and net nonoperating gains and losses Increase in net assets 50,043$ 649,947$ Adjustments to reconcile increase in net assets to net cash provided by

operating activities and net nonoperating gains and losses: Loss on extinguishment of debt 27,231 – Retirement benefits adjustment 143,139 (15,974) Net realized and unrealized gains on investments (3,959) (357,950) Depreciation and amortization 351,256 309,732 Provision for uncollectible accounts 350,453 285,778 Restricted gifts, bequests, investment income, and other (45,268) (106,463) Donated capital (373) (2,457) Accreted interest and amortization of bond premiums (769) (692) Net loss in value of derivatives 100,069 30,359 Changes in operating assets and liabilities:

Patient receivables (328,889) (284,691) Other current assets (35,159) (83,107) Other noncurrent assets (13,619) (17,610) Accounts payable and other current liabilities 42,664 10,654 Other liabilities (38,499) 2,298

Net cash provided by operating activities and net nonoperating gains and losses 598,320 419,824

Financing activities Proceeds from long-term borrowings 421,067 – Payments for advance refunding of long-term debt (417,784) – Principal payments on long-term debt (46,668) (13,160) Debt issuance costs (3,272) – Change in pledges receivable, trusts, and interests in foundations 49,796 (10,140) Restricted gifts, bequests, investment income, and other 45,268 106,463 Net cash provided by financing activities 48,407 83,163 Investing activities Expenditures for property and equipment (588,174) (491,816) Net change in cash equivalents reported in long-term investments 146,986 718,451 Purchases of investments (1,722,313) (2,045,232) Sales of investments 1,519,460 1,328,631 Net cash used in investing activities (644,041) (489,966) Increase in cash and cash equivalents 2,686 13,021 Cash and cash equivalents at beginning of year 16,471 3,450 Cash and cash equivalents at end of year 19,157$ 16,471$ Supplemental disclosure of noncash activityAssets acquired through capital leases 32,785$ 20,928$

See accompanying notes.


Consolidated Statements of Cash Flows(In Thousands)

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Notes to Consolidated Financial Statements

December 31, 2011 and 2010

1. Organization and Consolidation

The Cleveland Clinic Foundation (Foundation) is a nonprofit, tax-exempt, Ohio corporation organized and operated to provide medical and hospital care, medical research, and education. The accompanying consolidated financial statements include the accounts of the Foundation and its controlled affiliates, d.b.a. Cleveland Clinic Health System (System).

The System is the leading provider of healthcare services in northeast Ohio. The System operates eleven hospitals with approximately 3,400 staffed beds. Ten of the hospitals are operated in the Cleveland metropolitan area, anchored by the Foundation. The System operates nineteen outpatient Family Health Centers, including eight ambulatory surgery centers, as well as a large number of physician offices, which are located throughout a seven-county area of northeast Ohio. In addition, the System operates a hospital and a clinic in Weston, Florida, health and wellness centers in West Palm Beach, Florida and Toronto, Canada, and a specialized neurological clinical center in Las Vegas, Nevada. Pursuant to agreements, the System also provides management services for Ashtabula County Medical Center, located in Ashtabula, Ohio, with approximately 180 staffed beds, and in cooperation with Abu Dhabi Health Services Company, the Sheikh Khalifa Medical City (SKMC), a network of healthcare facilities in Abu Dhabi, United Arab Emirates with approximately 760 staffed beds.

All significant intercompany balances and transactions have been eliminated in consolidation.

2. Accounting Policies

Recent Accounting Pronouncements

In August 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2010-23 related to the measurement basis used in the disclosure of charity care. The standard requires that cost be used as the measurement basis for charity care disclosure, and the disclosure should include the direct and indirect costs of providing charity care. The standard also requires disclosure of the method used to identify or determine such costs. The standard became effective for fiscal years beginning after December 15, 2010, and should be applied retrospectively. The System adopted the provisions of this standard on January 1, 2011 and retrospectively applied the provisions to all periods presented. The adoption had no impact on previously reported excess of revenues over expenses or net assets.


Notes to Consolidated Financial Statements (continued)

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2. Accounting Policies (continued)

In August 2010, the FASB issued ASU 2010-24 on the accounting by healthcare entities for medical malpractice and similar liabilities and their related anticipated insurance recoveries. The standard clarifies that a healthcare entity should not net insurance recoveries against a related claim liability. Additionally, the amount of the claim liability should be determined without consideration of insurance recoveries. The standard became effective for interim and annual periods beginning after December 15, 2010. The System adopted the provisions of this standard on January 1, 2011. The adoption had no impact on previously reported excess of revenues over expenses or net assets.

In July 2011, the FASB issued ASU 2011-07 related to the presentation and disclosure of patient service revenue, provision for bad debts, and the allowance for uncollectible accounts. The standard requires healthcare entities that recognize significant amounts of patient service revenue at the time services are rendered even though they do not assess the patient’s ability to pay to change the presentation of their statement of operations and changes in net assets by reclassifying the provision for bad debts associated with patient service revenue from an operating expense to a deduction from patient service revenue. Additionally, those healthcare entities are required to provide enhanced disclosure about their policies for recognizing revenue and assessing bad debts. The standard also requires disclosures of patient service revenue by major payor source as well as qualitative and quantitative information about changes in the allowance for uncollectible accounts. The standard is effective for fiscal years and interim periods beginning after December 31, 2011, with early adoption permitted. The amendments to the presentation of the provision for bad debts related to patient service revenue in the statement of operations and changes in net assets are required to be applied retrospectively to all prior periods presented. The enhanced disclosures are required to be provided in the period of adoption and subsequent reporting periods. The System early adopted the provisions of this standard as of and for the year ended December 31, 2011, and retrospectively applied the presentation requirements to all periods presented. The change in presentation and additional disclosures are reflected in the System’s consolidated statements of operations and changes in net assets and in Note 3. Adoption of the new guidance had no impact on previously reported excess of revenues over expenses or net assets.



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In May 2011, the FASB issued ASU 2011-04 to amend the requirement for measuring and disclosing information about fair value that results in common principles between U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards. The amendments clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements and change particular principles and requirements for measuring or disclosing information about fair value. Principles changed include measuring fair value of financial instruments that are managed within a portfolio, application of premiums and discounts in the fair value measurement, and additional disclosures about fair value measurements. The standard will become effective for the System for annual reporting periods beginning after December 15, 2011. The System is currently evaluating the new guidance and will adopt the provisions as required upon the effective date.

Use of Estimates

The preparation of consolidated 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 consolidated financial statements. Estimates also affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Net Patient Service Revenue and Patient Receivables

Net patient service revenue is reported at the estimated net realizable amounts from patients, third-party payors, and others, including retroactive adjustments under payment agreements with third-party payors. The System has agreements with third-party payors that generally provide for payments to the System at amounts different from its established rates. For uninsured patients who do not qualify for charity care, the System recognizes revenue based on established rates, subject to certain discounts as determined by the System. An estimated provision for uncollectible accounts is recorded that results in net patient service revenue being reported at the net amount expected to be received. The System has determined, based on an assessment at the consolidated entity level, that patient service revenue is primarily recorded prior to assessing the patient’s ability to pay and as such, the entire provision for uncollectible accounts related to patient revenue is recorded as a deduction from patient service revenue in the accompanying consolidated statements of operations and changes in net assets.



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The System is paid a prospectively determined rate for the majority of inpatient acute care and outpatient, skilled nursing, and rehabilitation services provided (principally Medicare, Medicaid, and certain insurers). These rates vary according to a patient classification system that is based on clinical, diagnostic, and other factors. Medicare payments for capital are received on a prospective basis and on a cost reimbursement methodology for Medicaid. Payments are received on a prospective basis for the System’s medical education costs, subject to certain limits. The System is paid for cost reimbursable items at a tentative rate, with final settlement determined after submission of annual cost reports by the System and audits thereof by the Medicare fiscal intermediary. Provision for estimated retroactive adjustments, if any, resulting from regulatory matters or other adjustments under payment agreements are estimated in the period the related services are provided. The System recorded an increase in net patient service revenue of $1.6 million and $15.2 million in 2011 and 2010, respectively, related to changes in estimates.

Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation as well as significant regulatory action, and, in the normal course of business, the System is subject to contractual reviews and audits. As a result, there is at least a reasonable possibility that recorded estimates will change in the near term. The System believes it is in compliance with applicable laws and regulations governing the Medicare and Medicaid programs and that adequate provisions have been made for any adjustments that may result from final settlements.

Patient receivables are reduced by an allowance for uncollectible accounts. The allowance for uncollectible accounts is based upon management’s assessment of historical and expected net collections considering historical business and economic conditions, trends in healthcare coverage, major payor sources 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 modifications to the provision for uncollectible accounts to establish an appropriate allowance for uncollectible receivables. After satisfaction of amounts due from insurance, the System follows established guidelines for placing certain past-due patient balances with collection agencies, subject to the terms of certain restrictions on collection efforts as determined by the System.



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Electronic Health Record Incentive Program

The Centers for Medicare & Medicaid Services (CMS) have implemented provisions of the American Recovery and Reinvestment Act of 2009 that provide incentive payments for the meaningful use of certified electronic health record (EHR) technology. CMS has defined meaningful use as meeting certain objectives and clinical quality measures based on current and updated technology capabilities over predetermined reporting periods as established by CMS. The Medicare EHR incentive program provides annual incentive payments to eligible professionals, eligible hospitals, and critical access hospitals, as defined, that are meaningful users of certified EHR technology. The Medicaid EHR incentive program provides annual incentive payments to eligible professionals and hospitals for efforts to adopt, implement, and meaningfully use certified EHR technology. The System utilizes a grant accounting model to recognize EHR incentive revenues. The System records EHR incentive revenue ratably throughout the incentive reporting period when it is reasonably assured that it will meet the meaningful use objectives for the required reporting period and that the grants will be received. The EHR reporting period for hospitals is based on the federal fiscal year, which runs from October 1 through September 30. The System believes that the hospitals that met meaningful use objectives for the federal fiscal year ended September 30, 2011 will continue to meet these objectives for the federal fiscal year ending September 30, 2012. Therefore, for the year ended December 31, 2011, the System has accrued a portion of EHR revenues related to the federal fiscal year ending September 30, 2012. In 2011, the System recorded EHR incentive revenues of $53.5 million, comprised of $45.6 million of Medicare revenues and $7.9 million of Medicaid revenues. EHR incentive revenues are included in other unrestricted revenues in the accompanying consolidated statements of operations and changes in net assets. EHR incentive receivables from Medicare and Medicaid, which are included in other current assets, were $16.5 million and $1.8 million, respectively, at December 31, 2011.

Charity Care

The System provides care to patients who do not have the ability to pay and who qualify for charity services pursuant to established policies of the System. Charity services are defined as those for which patients have the obligation and willingness to pay but do not have the ability to do so. The System does not include charity care in net patient service revenue. The cost of charity care provided in 2011 and 2010 approximated $145 million and $150 million, respectively. The System estimated these costs by calculating a ratio of cost to gross charges and then multiplying that ratio by the gross uncompensated charges associated with providing care to charity patients.



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The System participates in the Hospital Care Assurance Program (HCAP). Ohio created HCAP to financially support those hospitals that service a disproportionate share of low-income patients unable to pay for care. HCAP funds basic, medically necessary hospital services for patients whose family income is at or below the federal poverty level, which includes Medicaid patients and patients without health insurance. The System recorded net HCAP revenues of $17.8 million and $14.0 million for the years ended December 31, 2011 and 2010, respectively, which is included in net patient service revenue in the accompanying consolidated statements of operations and changes in net assets.

International Contract Revenue Recognition

The System has management agreements with international organizations to provide consulting services for various healthcare ventures. The scope of these services ranges from managing current healthcare operations to managing the construction, training, organizational infrastructure, and operational management of future foreign healthcare entities. The management fees are received in advance and recorded as deferred revenue until the services have been provided. The System has recorded deferred revenue related to international management agreements, included in other current liabilities, of $16.2 million and $23.3 million at December 31, 2011 and 2010, respectively. Revenue related to international management agreements for 2011 and 2010 was $34.8 million and $36.1 million, respectively, and is included in other unrestricted revenues.

Cash and Cash Equivalents

The System considers all highly liquid investments with original maturities of three months or less when purchased to be cash equivalents. Cash equivalents are recorded at fair value in the consolidated balance sheets and exclude amounts included in long-term investments and investments for current use.

Inventories

Inventories (primarily supplies and pharmaceuticals) are stated at an average cost or the lower of cost (first-in, first-out method) or market.



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Property, Plant, and Equipment

Property, plant, and equipment purchased by the System are recorded at cost. Donated property, plant, and equipment are recorded at fair value at the date of donation. Expenditures that substantially increase the useful lives of existing assets are capitalized. Routine maintenance and repairs are expensed as incurred. Depreciation, including amortization of capital leased assets, is computed by the straight-line method using the estimated useful lives of individual assets. Buildings and building components are assigned useful lives ranging from five years to forty years. Equipment is assigned a useful life ranging from three to fifteen years. Interest cost incurred on borrowed funds during the period of construction of capital assets and interest income on unexpended project funds are capitalized as a component of the cost of acquiring those assets. The System records costs and legal obligations associated with long-lived asset retirements. Assets acquired though capital lease arrangements are excluded from the consolidated statements of cash flows.

Impairment of Long-Lived Assets

The System evaluates the recoverability of long-lived assets and the related estimated remaining lives when indicators of impairment are present. For purposes of impairment analysis, assets are grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. The System records an impairment charge or changes the useful life if events or changes in circumstances indicate that the carrying amount may not be recoverable or the useful life has changed.

Investments and Investment Income

Investments in equity securities with readily determinable fair values and all investments in debt securities are recorded at fair value in the consolidated balance sheets. Investments, excluding alternative investments, are primarily classified as trading. Investment transactions are recorded on a settlement date basis. Realized gains and losses are determined using the average cost method.



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Investments in alternative investments are primarily limited partnerships that invest in marketable securities, privately held securities, real estate, and derivative products and are reported using the equity method of accounting based on net asset value information provided by the respective partnership. Investments held by the partnerships consist of marketable securities as well as securities that do not have readily determinable values. The values of the securities held by the limited partnerships that do not have readily determinable values are determined by the general partner and are based on historical cost, appraisals, or other valuation estimates that require varying degrees of judgment. There is inherent uncertainty in such valuations, and the estimated fair values may differ from the values that would have been used had a ready market for the securities existed. Generally, the equity method investment balance of the System’s holdings in alternative investments reflects net contributions to the partnerships and the System’s share of realized and unrealized investment income and expenses. The investments may individually expose the System to securities lending, short sales, and trading in futures and forward contract options and other derivative products. The System’s risk is limited to its carrying value. Alternative investments can be divested only at specified times in accordance with terms of the partnership agreements. The financial statements of the limited partnerships are audited annually.

Return on investments, including equity method income on alternative investments, is reported as nonoperating gains and losses except for earnings on funds held by bond trustees and interest and dividends earned on assets held by the captive insurance subsidiary, which are included in other unrestricted revenues. Donor-restricted investment return on temporarily and permanently restricted investments is included in temporarily restricted net assets.

Certain of the System’s assets and liabilities are exposed to various risks, such as interest rate, market, and credit risks.

Fair Value Measurements

Fair value measurements are defined as 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.

Authoritative guidance provides an option to elect fair value as an alternative measurement for selected financial assets and liabilities not previously recorded at fair value. The System did not elect fair value accounting for any assets or liabilities that are not currently required to be measured at fair value.



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The framework for measuring fair value is comprised of a three-level hierarchy based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

• Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

• Level 2 – inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

• Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Derivatives and Hedging Activities

Derivative financial instruments, such as interest rate swaps (Note 11), are recognized as assets or liabilities in the consolidated balance sheets at fair value.

The System accounts for changes in the fair value of derivative instruments depending on whether they are designated and qualified as part of a hedging relationship and further, on the type of hedging relationship. The System has not designated any derivative instruments as hedges. Accordingly, the changes in fair value of derivative instruments are recorded in derivative losses in the consolidated statements of operations and changes in net assets.

Bond Financing Costs

Bond financing costs are amortized over the period the obligation is outstanding using the straight-line method, which approximates the interest method.



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Contributions

Unconditional donor pledges to give cash, marketable securities, and other assets are reported at fair value at the date the pledge is made to the extent estimated to be collectible by the System. Conditional donor promises to give and indications of intentions to give are not recognized until the condition is satisfied. Pledges received with donor restrictions that limit the use of the donated assets are reported as either temporarily or permanently restricted support. When a donor restriction expires, that is, when a stipulated time restriction ends or purpose restriction is accomplished, temporarily restricted net assets are transferred to unrestricted net assets and reported in the consolidated statements of operations and changes in net assets as other unrestricted revenues if the purpose relates to operations or reported as a change in unrestricted net assets if the purpose relates to capital.

Grants

Grant revenue is recognized in the period it is earned based on when the applicable project expenses are incurred and project milestones are achieved. Grant payments received in advance of related project expenses are deferred until the expenditure has been incurred and recorded as deferred revenue and included in other current liabilities. The System recorded research grant revenue, included in other unrestricted revenues, of $179.8 million and $180.2 million in 2011 and 2010, respectively.

Temporarily and Permanently Restricted Net Assets

Temporarily restricted net assets are used to differentiate resources, the use of which is restricted by donors or grantors to a specific time period or purpose, from resources on which no restrictions have been placed or that arise from the general operations of the System. Temporarily restricted gifts and bequests are recorded as an addition to temporarily restricted net assets in the period received. Permanently restricted net assets consist of amounts held in perpetuity or for terms designated by donors, including the fair value of several perpetual trusts for which the System is an income beneficiary or the beneficial interest in the fair value of underlying trust assets. Earnings on permanently restricted net assets are recorded as investment income in temporarily restricted net assets and subsequently used in accordance with the donor’s designation. Temporarily and permanently restricted net assets are primarily restricted for research, education, and strategic capital projects.



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The System returned $1.0 million and $10.1 million in 2011 and 2010, respectively, from temporarily restricted net assets to unrestricted net assets that had been transferred in prior years for the purpose of maintaining donor-restricted endowment funds at the level required by donor stipulations or law.

Excess of Revenues Over Expenses

The consolidated statements of operations and changes in net assets include excess of revenues over expenses. Changes in unrestricted net assets, which are excluded from excess of revenues over expenses, consistent with industry practice, include unrealized gains and losses on investments classified as nontrading, retirement benefits adjustments, contributions of long-lived assets (including assets acquired using grants or contributions that by donor restriction were to be used for the purpose of acquiring such assets), and transfers of net assets to maintain donor-restricted endowment funds at the level required by donor stipulations or law.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current year presentation, which had no impact on previously reported excess of revenues over expenses or net assets.

3. Net Patient Service Revenue and Patient Receivables

Net patient service revenue before the provision for uncollectible accounts by major payor source for the years ended December 31, 2011 and 2010, are as follows (in thousands):

2011 2010 Medicare $ 1,551,300 28% $ 1,561,471 29% Medicaid 196,690 4 202,556 4 Managed care and commercial 3,435,975 61 3,225,617 60 Self-pay 379,012 7 346,263 7 $ 5,562,977 100% $ 5,335,907 100%



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3. Net Patient Service Revenue and Patient Receivables (continued)

For patient receivables associated with self-pay patients, including patients with deductible and copayment balances for which third-party coverage provides for a portion of the services provided, the System records an estimated provision for uncollectible accounts in the year of service. The System has experienced an increase in the provision for uncollectible accounts as a result of high unemployment, loss of employer-sponsored insurance plans and rising patient responsibility balances. The allowance for uncollectible accounts for self-pay patients as a percentage of self-pay accounts receivable increased from 53% at December 31, 2010 to 57% at December 31, 2011. Self-pay write-offs increased $61.5 million in 2011 compared to 2010. The System does not maintain a material allowance for uncollectible accounts from third-party payors.

The System’s concentration of credit risk relating to patient receivables is limited due to the diversity of patients and payors. Patient receivables consist of amounts due from government programs, commercial insurance companies, other group insurance programs, and private pay patients. Patient receivables due from Medicare, Medicaid, and one commercial payor account for approximately 25%, 5%, and 25% at December 31, 2011, and 23%, 4%, and 23% at December 31, 2010, respectively, of the System’s total patient receivables. Revenues from the Medicare and Medicaid programs and one commercial payor account for approximately 28%, 4%, and 17% for 2011, and 29%, 4%, and 17% for 2010, respectively, of the System’s net patient service revenue. Excluding these payors, no one payor represents more than 10% of the System’s patient receivables or net patient service revenue.



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4. Cash, Cash Equivalents, and Investments

The composition of cash, cash equivalents, and investments at December 31, 2011 and 2010, is as follows (in thousands):

2011 2010 Cash and cash equivalents $ 247,525 $ 391,825 Fixed income securities:

U.S. treasuries 734,553 692,108 U.S. government agencies 12,130 90,844 U.S. corporate 202,784 258,976 U.S. government agencies asset-backed securities 9,929 9,893 Corporate asset-backed securities 5,271 1,334 Foreign 39,155 29,189 Commingled fixed income funds 437,354 453,209

Common and preferred stocks: U.S. 546,640 563,739 Foreign 313,520 289,101 Commingled equity funds 494,984 414,112

Alternative investments: Hedge funds 841,628 729,371 Private equity/venture funds 266,721 215,070 Real estate 145,585 96,496

Total cash, cash equivalents, and investments $ 4,297,779 $ 4,235,267



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4. Cash, Cash Equivalents, and Investments (continued)

Investments are primarily maintained in a master trust fund administered using a bank as trustee. The management of the majority of the System’s investments is conducted by external investment management organizations that are monitored by management and an external third-party advisor. Of these investment managers, 18 managers focus on equity investments, 9 managers focus on fixed income investments, and 81 managers focus on alternative investments. The alternative investments have separate administrators and custodian arrangements. Alternative investments also include five holdings in which the System invests directly.

Total investment return is comprised of the following for the years ended December 31, 2011 and 2010 (in thousands):

2011 2010 Other unrestricted revenue:

Interest income and dividends $ 2,340 $ 1,784 Nonoperating gains, net:

Interest income and dividends 52,835 36,969 Net realized gains on sales of investments 90,437 73,035 Net change in unrealized (losses) gains on investments (103,751) 177,543 Equity method income on alternative investments 23,218 80,483

62,739 368,030 Other changes in net assets:

Net change in unrealized (losses) gains on nontrading investments (6,343) 5,243

Investment income on restricted investments 5,697 25,829 Total investment return $ 64,433 $ 400,886



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5. Other Current Assets and Liabilities and Other Noncurrent Assets and Liabilities

Other current and noncurrent assets at December 31, 2011 and 2010, consist of the following (in thousands):

2011 2010 Current:

Inventories $ 86,061 $ 83,797 Pledges receivable current (Note 8) 84,456 92,836 IRS FICA refund receivable 61,880 59,816 Research receivables 50,644 45,594 Prepaid expenses 27,130 25,360 Estimated amounts due from third-party payors 18,326 –Other 53,839 48,158

Total other current assets $ 382,336 $ 355,561

2011 2010 Noncurrent:

Deferred compensation plan assets $ 71,293 $ 60,845 Investments in affiliates 24,569 35,839 Unamortized bond financing costs 18,087 17,787 Other 33,660 13,610

Total other noncurrent assets $ 147,609 $ 128,081



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5. Other Current Assets and Liabilities and Other Noncurrent Assets and Liabilities (continued)

Other current and noncurrent liabilities at December 31, 2011 and 2010, consist of the following (in thousands):

2011 2010 Current:

Research deferred revenue $ 57,336 $ 55,019 Interest payable 40,138 50,159 International contracts and other deferred revenue 34,508 38,250 Employee benefit related liabilities 34,175 30,927 Current portion of professional and general

insurance liability reserves 33,978 47,249 IRS FICA refund payable 31,377 29,748 Estimated amounts due to third-party payors 38,464 43,370 Other 102,018 91,307

Total other current liabilities $ 371,994 $ 386,029

2011 2010 Noncurrent:

Interest rate swap liability (Note 11) $ 186,507 $ 86,438 Employee benefit related liabilities 113,641 101,796 Estimated amounts due to third-party payors 16,972 1,552 Gift annuity liabilities 10,901 11,053 Accrued income tax liabilities (Note 14) 9,971 12,410 Other 92,756 114,342

Total other noncurrent liabilities $ 430,748 $ 327,591 The Internal Revenue Service (IRS) made an administrative decision in 2010 to accept the position that medical residents are exempt from Federal Insurance Contributions Act (FICA) taxes under the student FICA tax exemption for periods prior to April 1, 2005, which is when new IRS tax regulations took effect that do not allow for student FICA tax exemptions for full-time medical residents. As a result of this decision, the System perfected FICA tax refund claims with the IRS that had been protected in the applicable periods. The claims include both the employer and employee portion of FICA taxes. Estimated refunds of FICA tax payments are $61.9 million and $59.8 million at December 31, 2011 and 2010, respectively, with corresponding liabilities of $31.4 million and $29.7 million at December 31, 2011 and 2010, respectively. In connection with this process, the System recorded a reduction in salaries, wages, and benefit expenses of $0.4 million and $30.1 million in 2011 and 2010, respectively.



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6. Fair Value Measurements

The carrying values of accounts receivable and accounts payable are reasonable estimates of fair value due to the short-term nature of these financial instruments. Investments, other than alternative investments, are recorded at their fair value. The fair value of the System’s pledges receivable based on discounted cash flow analysis and adjusted for consideration of the donor’s credit was $205.6 million and $220.9 million (see carrying value at Note 8) at December 31, 2011 and 2010, respectively. The fair value of the System’s long-term debt, as estimated by discounted cash flow analyses using current borrowing rates for similar types of borrowing arrangements and adjusted for the System’s credit, was $2,637 million and $2,593 million (see carrying value at Note 10) at December 31, 2011 and 2010, respectively. Other noncurrent assets and liabilities have carrying values that approximate fair value.

The following tables present the financial instruments measured at fair value on a recurring basis as of December 31, 2011 and 2010, based on the valuation hierarchy (in thousands):

December 31, 2011 Level 1 Level 2 Level 3 Total Assets Securities lending collateral $ 92 $ – $ – $ 92 Cash and investments:

Cash and cash equivalents 247,525 – – 247,525 Fixed income securities:

U.S. treasuries 734,553 – – 734,553 U.S. government agencies – 12,130 – 12,130 U.S. corporate – 202,784 – 202,784 U.S. government agencies asset-backed securities – 9,929 – 9,929 Corporate asset-backed securities – 5,271 – 5,271 Foreign – 39,155 – 39,155 Commingled fixed income funds – 437,354 – 437,354

Common and preferred stocks: U.S. 542,688 3,952 – 546,640 Foreign 313,328 192 – 313,520 Commingled equity funds – 494,984 – 494,984

Less securities under lending agreement (92) – – (92)Total cash and investments 1,838,002 1,205,751 – 3,043,753 Perpetual and charitable trusts – 64,680 – 64,680 Investments under securities lending agreement 92 – – 92 Total assets at fair value $ 1,838,186 $ 1,270,431 $ – $ 3,108,617

Liabilities Interest rate swaps $ – $ 186,507 $ – $ 186,507 Total liabilities at fair value $ – $ 186,507 $ – $ 186,507



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6. Fair Value Measurements (continued)

December 31, 2010 Level 1 Level 2 Level 3 Total Assets Securities lending collateral $ 153 $ – $ – $ 153 Cash and investments:

Cash and cash equivalents 274,855 116,970 – 391,825 Fixed income securities:

U.S. treasuries 692,108 – – 692,108 U.S. government agencies – 90,844 – 90,844 U.S. corporate – 258,976 – 258,976 U.S. government agencies asset-backed securities – 9,893 – 9,893 Corporate asset-backed securities – 1,334 – 1,334 Foreign – 29,189 – 29,189 Commingled fixed income funds – 453,209 – 453,209

Common and preferred stocks: U.S. 561,384 2,355 – 563,739 Foreign 289,101 – – 289,101 Commingled equity funds – 414,112 – 414,112

Less securities under lending agreement (154) – – (154)Total cash and investments 1,817,294 1,376,882 – 3,194,176 Perpetual and charitable trusts – 87,383 – 87,383 Investments under securities lending agreement 154 – – 154 Total assets at fair value $ 1,817,601 $ 1,464,265 $ – $ 3,281,866

Liabilities Interest rate swaps $ – $ 86,438 $ – $ 86,438 Total liabilities at fair value $ – $ 86,438 $ – $ 86,438



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Financial instruments at December 31, 2011 and 2010, are reflected in the consolidated balance sheets as follows (in thousands):

2011 2010 Cash, cash equivalents, and investments measured

at fair value (including securities under lending agreement of $92 in 2011 and $154 in 2010) $ 3,043,845 $ 3,194,330

Alternative investments accounted for under the equity method 1,253,934 1,040,937

Total cash, cash equivalents, and investments $ 4,297,779 $ 4,235,267

Perpetual and charitable trusts measured at fair value $ 64,680 $ 87,383 Interests in foundations 42,989 43,430 Trusts and interests in foundations $ 107,669 $ 130,813

See Note 11 for location of interest rate swap liabilities in the consolidated balance sheets.

The following is a description of the System’s valuation methodologies for assets and liabilities measured at fair value. Fair value for Level 1 is based upon quoted market prices. Fair value for Level 2 is determined as follows:

Investments classified as Level 2 are primarily determined using techniques that are consistent with the market approach. Valuations are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets. Inputs, which include broker/dealer quotes, reported/comparable trades, and benchmark yields, are obtained from various sources, including market participants, dealers, and brokers.

The fair value of perpetual and charitable trusts in which the System receives periodic payments from the trust is determined based on the present value of expected cash flows to be received from the trust using discount rates ranging from 3.4% to 5.0%, which are based on Treasury yield curve rates. The fair value of charitable trusts in which the System is a remainder beneficiary is based on the System’s beneficial interest in the investments held in the trust, which are measured at fair value.



1110-1302155 26


The fair value of interest rate swaps is determined based on the present value of expected future cash flows using discount rates appropriate with the risks involved. The valuations include a credit spread adjustment to market interest rate curves to appropriately reflect nonperformance risk. The credit spread adjustment is derived from other comparably rated entities’ bonds recently priced in the market.

The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the System believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

7. Property, Plant, and Equipment

Property, plant, and equipment at December 31, 2011 and 2010, consist of the following (in thousands):

2011 2010 Land and improvements $ 305,306 $ 301,454 Buildings 3,937,402 3,591,768 Leasehold improvements 31,997 31,863 Equipment 1,460,847 1,272,386 Computer hardware and software 566,850 507,272 Construction-in-progress 175,341 237,881 Leased facilities and equipment 78,473 46,180 6,556,216 5,988,804 Accumulated depreciation and amortization (3,157,394) (2,853,478) $ 3,398,822 $ 3,135,326

Included in the preceding table are unamortized computer software costs of $52.5 million and $59.1 million at December 31, 2011 and 2010, respectively. Amortization of computer software costs totaled $28.6 million and $27.5 million in 2011 and 2010, respectively.



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8. Pledges

Outstanding pledges receivable from various corporations, foundations, and individuals at December 31, 2011 and 2010, are as follows (in thousands):

2011 2010 Pledges due:

In less than one year $ 92,072 $ 96,185 In one to five years 87,019 77,984 In more than five years 51,081 85,306

230,172 259,475 Allowance for uncollectible pledges and discounting (36,357) (39,012)Current portion (net of allowance for uncollectible

pledges of $7.6 million in 2011 and $3.3 million in 2010) (84,456) (92,836)

$ 109,359 $ 127,627 No amounts have been reflected in the consolidated financial statements for donated services. The System pays for most services requiring specific expertise. However, many individuals volunteer their time and perform a variety of tasks that assist the System with various programs.

9. Notes Payable and Capital Leases

Notes payable and capital leases at December 31, 2011 and 2010, consist of the following (in thousands):

2011 2010 Installments and mortgage notes with interest rates

ranging from 3.0% to 6.2% $ 11,854 $ 13,588 Capital leases for facilities and equipment 62,009 33,023 City of Lakewood lease 11,566 11,965 85,429 58,576 Less current portion (6,589) (5,248) Total notes payable and capital leases $ 78,840 $ 53,328

Maturities of the installment and mortgage notes for the five years subsequent to December 31, 2011, are as follows (in thousands): 2012 – $842; 2013 – $886; 2014 – $930; 2015 – $423; and 2016 – $8,589.



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9. Notes Payable and Capital Leases (continued)

In 2011, the System entered into a capital lease with a net present value of $24.1 million for the purpose of leasing an administrative office building and related equipment. Also in 2011, the System entered into a capital lease totaling $8.5 million for the purpose of leasing a specialized cancer care facility and related equipment. In 2010, the System entered into a capital lease with a net present value of $19.7 million for the purpose of leasing an administrative office building and related equipment.

Future minimum capital lease payments, including total interest of $36.7 million, are as follows (in thousands): 2012 – $10,616; 2013 – $10,142; 2014 – $7,885; 2015 – 6,500; 2016 – $13,579; and thereafter – $49,962. Assets acquired through capital lease arrangements are included in property, plant, and equipment.

The City of Lakewood, Ohio (the City) leases real and personal property to Lakewood Hospital (Lakewood) for the purpose of operating Lakewood. In connection with executing an Amended Lease with the City, Lakewood has agreed to make additional payments to the City. The additional payments commenced in 1997 and range in annual amounts from $1.0 million to $1.2 million through 2026. The net present value of the additional payments is $11.6 million and $12.0 million at December 31, 2011 and 2010, respectively (discounted at an interest rate of 6%). In connection with the Amended Lease, Lakewood has $85.7 million of net assets, included in the System’s unrestricted net assets at December 31, 2011, available for Lakewood’s use but unavailable to other members of the System.



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10. Hospital Revenue Bonds

Hospital revenue bonds consist of the following (in thousands):

Amount Outstanding at Interest Final December 31 Rate(s) Maturity 2011 2010

Series 2011A 0.20% to 4.83% 2032 $ 195,705 $ – Series 2011B 2.94% 2031 41,120 – Series 2011C 2.73% to 4.72% 2032 170,995 – Series 2009A 5.58% 2039 306,400 306,400 Series 2009B 2.10% to 5.58% 2039 482,830 498,550 Series 2008A 3.35% to 5.55% 2043 452,340 452,340 Series 2008B Variable rate 2043 370,000 370,000 Series 2007A, Keep Memory Alive Variable rate 2037 68,600 68,600 Series 2007B, Keep Memory Alive Variable rate 2013 2,845 4,155 Series 2004B Variable rate 2039 200,000 200,000 Series 2003A 4.55% to 5.67% 2029 158,400 513,970 Series 2003C Variable rate 2035 41,905 41,905 Series 2003, Lakewood 4.40% to 4.75% 2015 13,100 15,475 Series 2002 Variable rate 2032 10,950 11,155 Series 1999B 4.65% to 5.27% 2031 – 45,010 Series 1998, Medina 5.00% 2016 6,160 6,160 2,521,350 2,533,720 Net unamortized premium 17,975 11,789 Current portion (43,415) (41,640) Long-term variable rate debt

classified as current

(492,690) (494,300) $ 2,003,220 $ 2,009,569

The System’s outstanding revenue bonds are limited obligations of various issuing authorities payable solely by the System pursuant to loan agreements between the borrowing entities and the issuing authorities. Under various financing agreements, the System must meet certain operating and financial performance covenants.



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10. Hospital Revenue Bonds (continued)

In November 2011, pursuant to certain agreements between the System and the State of Ohio (State) acting by and through the Ohio Higher Education Facility Commission, the State issued $195.7 million of fixed-rate Hospital Revenue Bonds (the Series 2011A Bonds), $41.1 million of fixed-rate Hospital Revenue Bonds (the Series 2011B Bonds), and $171.0 million of fixed-rate Hospital Revenue Bonds (the Series 2011C Bonds) for the benefit of the System. Proceeds from the sale of the Series 2011A Bonds and Series 2011C Bonds were used to refund $186.0 million and $152.3 million, respectively, of the outstanding fixed-rate Series 2003A Bonds, and proceeds from the sale of the Series 2011B Bonds were used to refund all of the outstanding fixed-rate Series 1999B Bonds. The System recorded a loss on extinguishment of debt of $27.2 million in 2011 related to this transaction, which is recorded in other nonoperating gains and losses in the consolidated statement of operations. Loss on extinguishment of debt in 2011 includes $2.3 million of previously unamortized bond financing costs related to the refunded bonds. The System capitalized $3.3 million of bond financing costs in connection with the bonds issued in 2011.

Certain of the System’s current outstanding bonds bear interest at a variable rate. During 2011 and 2010, the rates for the System’s variable rate bonds ranged from 0.01% to 0.42% (average rate 0.22%) and 0.08% to 0.48% (average rate 0.29%), respectively.

Certain variable rate revenue bonds are secured by irrevocable direct pay letters of credit and standby bond purchase agreements totaling $290.3 million at December 31, 2011. The letter-of-credit agreement for the Series 2002 Bonds requires repayment of a remarketing drawing within one year, and as such, these bonds are classified as current in the consolidated balance sheets. The letter-of-credit agreement for the Series 2007A and 2007B Bonds contains a subjective clause that, if declared by the lender, could cause immediate repayment of the bonds. As a result, these bonds are classified as current in the consolidated balance sheets.

The System provides self-liquidity on the Series 2008B and 2003C Bonds. Since the Series 2008B and 2003C Bonds are secured by self-liquidity arrangements, they are classified as current liabilities in the consolidated balance sheets.

The Lakewood Series 2003 Bonds are obligations of Lakewood pursuant to certain agreements between the City and Lakewood, whereby Lakewood has leased to the City, and the City has subleased to Lakewood, substantially all of Lakewood’s healthcare facilities.



1110-1302155 31

10. Hospital Revenue Bonds (continued)

During the term of agreements with the issuing authorities, the System is required to maintain debt service reserve funds and to make specified deposits with trustees to fund principal and interest payments when due. Also, unexpended bond proceeds are held by the trustee and released to the System for approved requisition requests for capital projects. There were no unexpended bond proceeds held by trustees at December 31, 2011. Unexpended bond proceeds held by the trustees were $192.8 million at December 31, 2010. The current portion of the funds held by trustees, which consist of amounts to fund current construction costs payable and deposits with the trustees to fund current principal and interest payments, was $105.0 million at December 31, 2010, and is included in investments for current use. There were no funds held by trustee classified as current at December 31, 2011.

The System is subject to certain restrictive covenants, including provisions relating to certain debt ratios, days cash on hand, and other matters. The System was in compliance with these covenants at December 31, 2011 and December 31, 2010, with the exception of Lakewood, which did not meet debt service coverage ratio requirements as of December 31, 2010. Noncompliance required corrective action but was not considered an event of default under the Lakewood debt agreement. Lakewood was in compliance with these covenants at December 31, 2011.

Combined current aggregate scheduled maturities, assuming the remarketing of the variable rate demand bonds, for the five years subsequent to December 31, 2011, are as follows (in thousands): 2012 – $43,415; 2013 – $42,360; 2014 – $44,510; 2015 – $48,770; and 2016 – $51,805.

Total interest paid approximated $112.7 million and $100.0 million in 2011 and 2010, respectively. Capitalized interest cost and income approximated $10.0 million and $0.3 million, respectively, in 2011 and $17.0 million and $0.7 million, respectively, in 2010.



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11. Interest Rate Swaps

The System’s objective with respect to interest rate risk is to manage the risk of rising interest rates on the System’s variable rate debt and certain variable rate operating lease payments. Consistent with its interest rate risk management objective, the System entered into various interest rate swap agreements with a total outstanding notional amount of $648.7 million and $659.7 million at December 31, 2011 and 2010, respectively. During the term of these transactions, the System pays interest at a fixed rate and receives interest at a variable rate based on the London Interbank Offered Rate (LIBOR) or the Securities Industry and Financial Markets Association Index (SIFMA). The swap agreements are not designated as hedging instruments. Net interest paid or received under the swap agreements is included in derivative losses in the consolidated statements of operations.

The following table summarizes the System’s interest rate swap agreements (in thousands):

Swap Expiration System Notional Amount at December 31Type Date Pays System Receives 2011 2010

Fixed 2013 5.90% 100% of LIBOR $ 2,845 $ 4,155 Fixed 2016 5.28% 100% of SIFMA 18,700 21,880 Fixed 2021 3.21% 68% of LIBOR 40,430 41,765 Fixed 2024 3.42% 68% of LIBOR 30,100 30,500 Fixed 2027 3.56% 68% of LIBOR 146,293 149,485 Fixed 2028 5.12% 100% of LIBOR 43,425 44,220 Fixed 2028 3.51% 68% of LIBOR 33,215 33,705 Fixed 2030 5.07% 100% of LIBOR 62,500 62,500 Fixed 2030 5.06% 100% of LIBOR 62,500 62,500 Fixed 2032 4.32% 79% of LIBOR 2,690 2,741 Fixed 2032 4.33% 70% of LIBOR 5,380 5,483 Fixed 2032 3.78% 70% of LIBOR 2,690 2,741 Fixed 2036 4.90% 100% of LIBOR 50,000 50,000 Fixed 2036 4.90% 100% of LIBOR 79,375 79,375 Fixed 2037 4.62% 100% of SIFMA 68,600 68,600

$ 648,743 $ 659,650



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11. Interest Rate Swaps (continued)

The following table summarizes the location and fair value for the System’s interest rate swap agreements (in thousands):

Derivatives Liability December 31, 2011 December 31, 2010

Balance Sheet

Location Fair ValueBalance Sheet

Location Fair ValueDerivatives not designated as

hedging instruments Interest rate swap agreements Other noncurrent

liabilities $ 186,507 Other noncurrent liabilities $ 86,438

The following table summarizes the location and amounts of derivative losses on the System’s interest rate swap agreements (in thousands):

Year Ended December 31 Location of Loss Recognized 2011 2010 Derivatives not designated as

hedging instruments Interest rate swap agreements Derivative losses $ (127,268) $ (57,657)

The System has used various derivative contracts in connection with certain prior obligations and investments. Although minimum credit ratings are required for counterparties, this does not eliminate the risk that a counterparty may fail to honor its obligations. Derivative contracts are subject to periodic “mark-to-market” valuations. A derivative contract may, at any time, have a positive or negative value to the System. In the event that the negative value reaches certain thresholds established in the derivative contracts, the System is required to post collateral, which could adversely affect its liquidity. At December 31, 2011 and 2010, the System posted $118.5 million and $33.9 million, respectively, of collateral with counterparties that is included in funds held by trustees in the accompanying consolidated balance sheets. In addition, if the System were to choose to terminate a derivative contract or if a derivative contract were terminated pursuant to an event of default or a termination event as described in the derivative contract, the System could be required to pay a termination payment to the counterparty.



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12. Professional and General Liability Insurance

The System manages its professional and general liability insurance program through a captive insurance arrangement.

In the ordinary course of business, professional and general liability claims have been asserted against the System by various claimants. These claims are in various stages of processing or, in certain instances, are in litigation. In addition, there are known incidents, and there also may be unknown incidents, which may result in the assertion of additional claims. The System has accrued its best estimate of both asserted and unasserted claims based on actuarially determined amounts. These estimates are subject to the effects of trends in loss severity and frequency, and ultimate settlement of professional and general liability claims may vary significantly from the estimated amounts.

The System’s professional and general liabilities of $181.2 million and $220.4 million at December 31, 2011 and 2010, respectively, are recorded as noncurrent and current liabilities and include discounted estimates of the ultimate costs for both asserted claims and unasserted claims. Asserted claims were discounted at 2.50% and 3.75% at December 31, 2011 and 2010, respectively. Unasserted claims were discounted at 4.00% and 3.75% at December 31, 2011 and 2010, respectively. Through the captive insurance subsidiary, the System has set aside investments of $207.2 million ($34.0 million included in investments for current use) and $220.9 million ($47.2 million included in investments for current use) at December 31, 2011 and 2010, respectively, of which $31.9 million and $30.5 million at December 31, 2011 and 2010, respectively, are restricted in accordance with a reinsurance trust agreement to meet reinsurance requirements in the State of Florida.



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12. Professional and General Liability Insurance (continued)

Activity in the professional and liability reserves is summarized as follows (in thousands):

2011 2010 Balance at beginning of year $ 220,429 $ 214,568 Incurred related to:

Current period 53,901 67,744 Prior period (42,645) (15,726)

Total incurred 11,256 52,018 Paid related to:

Current period 2,813 1,548 Prior period 32,801 45,917

Total paid 35,614 47,465 (24,358) 4,553 (Decrease) increase in unasserted claims (16,416) 1,685 Increase (decrease) in reinsurance recoverable 1,561 (377) Balance at end of year $ 181,216 $ 220,429

The foregoing reconciliation shows $42.6 million and $15.7 million of favorable development in 2011 and 2010, respectively, due to changes in the actuarial estimates as a result of lower claim activity, closed claims, and settlement amounts lower than expected due to risk management initiatives and the impact of a series of tort reforms passed by the Ohio General Assembly beginning in 2003. The System utilizes a combination of actual and industry statistics to estimate loss and loss adjustment expense reserves.



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13. Pensions and Other Postretirement Benefits

The System has two defined benefit pension plans, including the CCHS Retirement Plan, which cover substantially all of the System’s employees. The benefits provided are based on age, years of service, and compensation. The System’s policy is to fund at least the minimum amounts required by the Employee Retirement Income Security Act. The CCHS Retirement Plan ceased benefit accruals as of December 31, 2009 for all employees, except those participating in a union, employed at Medina Hospital, or on long-term disability. The System also maintains a nonqualified defined benefit supplemental retirement plan (SRP), which covers certain of its employees.

The CCHS Retirement Plan ceased benefit accruals as of December 31, 2010 for all Medina Hospital employees. As a result of this amendment, the System recorded a curtailment charge of $0.2 million for the year ended December 31, 2010, which is included in salaries, wages, and benefits in the accompanying consolidated statements of operations and changes in net assets.

In 2011, the CCHS Retirement Plan extended a lump-sum option for certain legacy benefits that did not previously qualify for this option. As a result of this amendment, the System recorded a credit of $6.7 million for the year ended December 31, 2011, which is included in retirement benefits adjustment in the accompanying consolidated statements of operations and changes in net assets.

The System implemented a new noncontributory, defined contribution plan effective January 1, 2010, which covers substantially all of the System’s employees. The System’s contribution for the plan is based upon a percentage of employee compensation and years of service. The System also sponsors an additional noncontributory, defined contribution plan, which covers certain of its employees. The System’s contribution to the plan is based upon a percentage of employee compensation, as defined, determined according to age.

The System sponsors several contributory, defined contribution plans, which cover substantially all employees. The System’s contributions to the contributory plans, if required, are determined based on employee contributions.

The System provides healthcare benefits upon retirement for substantially all of its employees. The System’s healthcare plans generally provide for cost sharing, in the form of employee and retiree contributions, deductibles, and coinsurance. The System’s policy is to fund the annual cost of healthcare benefits from the general assets of the System. The estimated cost of these postretirement benefits is actuarially determined and accrued over the employees’ service periods.



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13. Pensions and Other Postretirement Benefits (continued)

The System committed to change certain provisions in its postretirement health benefit plan in 2010. Changes to the plan, which will be implemented beginning in 2012 and will impact certain participants in the plan, include changes to minimum eligibility requirements, increases to monthly participant contributions, and reductions in the number of contribution tiers. As a result of these amendments, the System recorded a credit of $15.8 million for the year ended December 31, 2010, which is included in retirement benefits adjustment in the accompanying consolidated statements of operations and changes in net assets.

The System committed to change certain additional provisions in its postretirement health benefit plan in 2011. Changes to the plan, which will be implemented beginning in 2012 and will impact certain participants in the plan, include increases in deductibles, co-pays and out-of-pocket maximums. In addition, coverage has been extended to Florida caregivers effective January 1, 2012. As a result of these amendments, the System recorded a credit of $3.4 million for the year ended December 31, 2011, which is included in retirement benefits adjustment in the accompanying consolidated statements of operations and changes in net assets.

The System expects to make contributions of $128.1 million to the defined benefit pension plans in 2012. Pension benefit payments over the next ten years are estimated as follows: 2012 – $71.5 million; 2013 – $77.1 million; 2014 – $79.7 million; 2015 – $82.7 million; 2016 – $89.2 million; and in the aggregate for the five years thereafter – $487.5 million.

The System expects to make contributions of $4.5 million to other postretirement benefit plans in 2012. Other postretirement benefit payments over the next ten years, net of the average annual Medicare Part D subsidy of approximately $5.7 million, are estimated as follows: 2012 –$4.5 million; 2013 – $5.0 million; 2014 – $5.8 million; 2015 – $6.3 million; 2016 – $6.8 million; and in the aggregate for the five years thereafter – $36.1 million.

No plan assets are expected to be returned to the employer during 2012.

The System is required to recognize the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligations) of its postretirement benefit plans in the consolidated balance sheets, with a corresponding adjustment to unrestricted net assets. The amounts recorded in unrestricted net assets will be subsequently recognized as net periodic pension cost pursuant to the System’s accounting policy for amortizing such amounts.



1110-1302155 38


Included in unrestricted net assets at December 31, 2011 and 2010, are the following amounts that have not yet been recognized in net periodic pension cost (in thousands):

Defined Benefit Pension Plans

Other Postretirement Benefits

2011 2010 2011 2010

Unrecognized actuarial losses $ 620,543 $ 478,821 $ 56,008 $ 44,936 Unrecognized prior service

(credit) cost (6,716) 28 4,171 7,082 Total $ 613,827 $ 478,849 $ 60,179 $ 52,018

Actuarial losses are amortized as a component of net periodic pension cost only if the losses exceed 10% of the greater of the projected benefit obligation or the fair value of plan assets. Unrecognized prior service costs are amortized on a straight-line basis over the estimated life of the plan participants. In 2012, the System is expected to amortize $46.1 million of unrecognized actuarial losses and $1.7 million of unrecognized prior service credits in net periodic pension costs.

Changes in plan assets and benefit obligations recognized in unrestricted net assets during 2011 and 2010 included an increase in net assets as follows (in thousands):

Defined Benefit Pension Plans

Other Postretirement Benefits

2011 2010 2011 2010 Current year actuarial loss $ (173,555) $ (23,883) $ (13,490) $ (4,207)Amortization of actuarial loss 31,833 24,154 2,418 2,168 Current year prior service credit 6,737 220 3,414 15,813 Amortization of prior service

cost (credit) 7 39 (503) 1,670 Total $ (134,978) $ 530 $ (8,161) $ 15,444



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The following table sets forth the funded status of the System’s postretirement benefit plans and the amounts recognized in the System’s December 31, 2011 and 2010 consolidated balance sheets (in thousands):

Defined Benefit Other Postretirement Pension Plans Benefits 2011 2010 2011 2010 Change in projected benefit obligation:

Projected benefit obligation at beginning of year $ 1,334,450 $ 1,262,035 $ 113,766 $ 126,389

Service cost (credit) 1,150 2,784 1,374 (2,961)Curtailment – (6,608) – – Interest cost 75,058 72,896 6,694 7,622 Actuarial loss 88,689 54,450 13,491 4,206 Participant contributions – – 4,837 3,866 Plan amendments (6,736) (58) (3,414) (15,813)Benefits paid (54,897) (51,049) (10,914) (11,037)Federal subsidy – – 1,302 1,277 Early retiree reinsurance program receipts – – – 217

Projected benefit obligation at end of year 1,437,714 1,334,450 127,136 113,766

Change in plan assets: Fair value of plan assets at beginning of year 928,557 799,489 – – Actual return on plan assets (7,704) 102,613 – – Participant contributions – – 4,837 3,866 System contributions 49,341 77,504 6,077 7,171 Benefits paid (54,897) (51,049) (10,914) (11,037)

Fair value of plan assets at end of year 915,297 928,557 – – Accrued retirement benefits $ (522,417) $ (405,893) $ (127,136) $ (113,766) Current liabilities $ (5,709) $ (5,029) $ (4,496) $ (3,826)Noncurrent liabilities (516,708) (400,864) (122,640) (109,940)Net liability recognized in balance sheets $ (522,417) $ (405,893) $ (127,136) $ (113,766)

The accumulated benefit obligation for all defined benefit pension plans was $1,417.4 million at December 31, 2011 and $1,312.3 million at December 31, 2010.



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The components of net periodic benefit cost are as follows (in thousands):

Defined Benefit Other Postretirement Pension Plans Benefits 2011 2010 2011 2010 Components of net periodic

benefit cost:

Service cost (credit) $ 1,150 $ 2,784 $ 1,374 $ (2,961)Interest cost 75,058 72,896 6,694 7,622 Expected return on plan assets (77,161) (78,654) – – Amortization of unrecognized

actuarial net loss 31,833 24,154 2,418 2,168 Amortization of unrecognized

prior service cost (credit) 7 39 (503) 1,670 Curtailments – 161 – –

Net periodic benefit cost 30,887 21,380 9,983 8,499 Defined contribution plans 160,481 149,479 – – Total included in operations $ 191,368 $ 170,859 $ 9,983 $ 8,499

Weighted-average assumptions used to determine pension and postretirement benefit obligations and net periodic benefit cost are as follows:

Defined Benefit Other Postretirement Pension Plans Benefits 2011 2010 2011 2010 Weighted-average assumptions:

Discount rates: Used for benefit obligations 5.19% 5.76% 5.38% 5.90% Used for net periodic benefit cost 5.76% 5.90% 5.90% 6.25%

Expected rate of return on plan assets 8.00% 8.00% – – Rate of compensation increase:

Used for benefit obligations 3.00% 3.00% – – Used for net periodic benefit cost 3.00% 3.00% – –



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The System uses a direct cost approach to estimate its postretirement benefit obligation for healthcare services provided by the System (internally provided services). Healthcare services provided by non-System entities (externally provided services) are based on the System’s historical cost experience. The annual assumed healthcare cost trend rate for internally provided services is 7.00% and is assumed to decrease by approximately 0.50% per year to an ultimate rate of 4.50% in 2017. The healthcare cost trend rate for externally provided services is 8.00% and is assumed to decrease by approximately 0.50% per year to an ultimate rate of 5.50% in 2017 and thereafter. A one-percentage-point increase or decrease in the healthcare cost trend rate would have increased or decreased the December 31, 2011 service and interest costs in total by $2.1 million and $1.6 million, respectively, and the December 31, 2010 service and interest costs in total by $2.5 million and $1.8 million, respectively.

The System’s weighted-average asset allocation of pension plan assets at December 31, 2011 and 2010, by asset category, are as follows:

Percentage of Plan Assets at December 31 2011 2010 Asset category Interest-bearing cash 2.8% 6.7% Fixed income securities 22.1 25.1 Common and preferred stocks 55.2 53.2 Alternative investments 19.9 15.0 Total 100.0% 100.0%

The System’s investment strategy for its pension assets balances the liquidity needs of the pension plans with the long-term return goals necessary to satisfy future pension obligations. The target allocation ranges of the investment pool to various asset classes include equity investments (45% to 65% target), fixed income investments (20% to 50% target), alternative investments (10% to 30% target) and cash and cash equivalents (0% to 10% target) and are designed to diversify the portfolio in a way that achieves an efficient trade-off between long-term return and risk while providing adequate liquidity to meet near-term expenses and obligations.



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The System’s pension portfolio return assumption of 8.0% is based on the targeted assumed rate of return through a diversified portfolio designed to mitigate short-term return volatility and achieve an efficient trade-off between return and risk. Expected returns and risk for each asset class are formed using a global capital asset pricing model framework in which the expected return is the compensation earned from taking risk. Forward-looking adjustments are made to expected return, volatility, and correlation estimates as well. Additionally, constraints such as permissible asset classes, portfolio guidelines, and liquidity considerations are included in the model.

The following tables present the financial instruments in the System’s defined benefit pension plans measured at fair value on a recurring basis as of December 31, 2011 and 2010, based on the valuation hierarchy (in thousands):

December 31, 2011 Level 1 Level 2 Level 3 Total Assets Cash and investments:

Cash and cash equivalents $ 25,485 $ 9 $ – $ 25,494 Fixed income securities:

U.S. treasuries 73,733 – – 73,733 U.S. government agencies – 10,301 – 10,301 U.S. corporate 47,436 32,858 – 80,294 Foreign – 5,895 – 5,895 Commingled fixed income funds – 32,236 – 32,236

Common and preferred stocks: U.S. 214,722 545 – 215,267 Foreign 111,903 – – 111,903 Commingled equity funds – 178,304 – 178,304

Hedge funds – – 157,107 157,107 Private equity – – 24,763 24,763 Less securities under lending agreement (506) (2) – (508)

Total cash and investments 472,773 260,146 181,870 914,789 Investments under securities lending agreement 506 2 – 508 Total assets at fair value $ 473,279 $ 260,148 $ 181,870 $ 915,297



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December 31, 2010 Level 1 Level 2 Level 3 Total Assets Cash and investments:

Cash and cash equivalents $ 61,722 $ 9 $ – $ 61,731 Fixed income securities:

U.S. treasuries 77,393 – – 77,393 U.S. government agencies – 12,449 – 12,449 U.S. corporate 46,923 40,423 – 87,346 Foreign – 5,431 – 5,431 Commingled fixed income funds – 51,013 – 51,013

Common and preferred stocks: U.S. 211,970 127 – 212,097 Foreign 108,736 – – 108,736 Commingled equity funds – 173,059 – 173,059

Hedge funds – – 120,658 120,658 Private equity – – 18,644 18,644 Less securities under lending agreement (927) (10) – (937)

Total cash and investments 505,817 282,501 139,302 927,620 Investments under securities lending agreement 927 10 – 937 Total assets at fair value $ 506,744 $ 282,511 $ 139,302 $ 928,557

Level 3 Rollforward Hedge Private Funds Equity Total Fair value as of December 31, 2009 $ 57,766 $ 12,688 $ 70,454

Unrealized gains, net 6,956 1,779 8,735 Purchases 70,600 5,320 75,920 Sales and redemptions (14,664) (1,143) (15,807)

Fair value as of December 31, 2010 120,658 18,644 139,302 Unrealized gains, net 1,257 1,622 2,879 Purchases 47,900 7,348 55,248 Sales and redemptions (12,708) (2,851) (15,559)

Fair value as of December 31, 2011 $ 157,107 $ 24,763 $ 181,870 Fair value methodologies for Level 1 and Level 2 are consistent with the inputs described in Note 6. Fair value for Level 3 represents the System’s ownership interest in the net asset value of the respective partnership as a practical expedient to measure fair value.



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Fixed income securities include debt obligations of the U.S. government and various agencies, U.S. corporations, and other fixed income instruments such as mortgage-backed and asset-backed securities. The composition of these securities represents an expected return and risk profile that is commensurate with broadly defined fixed income indexes such as the Barclays Capital U.S. Aggregate Index. Additionally, investments include commingled fixed-income funds that may also invest opportunistically in mortgage-backed and asset-backed securities as well as non-U.S. and high-yield debt instruments.

Common and preferred stocks include investments of publicly traded common stocks of both U.S. and international corporations, the majority of which represent actively traded and liquid securities that are traded on many of the world’s major exchanges and include large-, mid-, and small-capitalization securities. The composition of these securities represents an expected return and risk profile that is commensurate with broadly defined equity indexes such as the Russell 3000 Index and the Morgan Stanley Capital International (MSCI) All Country World ex-U.S. Index. Included in Level 2 are equity investments that reside in commingled equity funds whose underlying assets may include publicly traded equity securities.

Alternative investments include hedge funds that are meant to provide equity-like returns with fixed-income-like levels of risk. Included in this category are investments that are well diversified across various strategies and may consist of absolute return funds, long/short funds, and other opportunistic funds. The underlying investments in such funds may include publicly traded and privately held equity and debt instruments issued by U.S. and international corporations as well as various derivatives based on these securities. Private equity investments make up a smaller portion of the alternative investments and generally consist of limited partnerships formed to invest in equity and debt investments in operating companies that are not publicly traded. Investment strategies in this category may include buyouts, distressed debt, and venture capital.



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14. Income Taxes

The Foundation and most of its controlled affiliates are tax-exempt organizations as described in Section 501(c)(3) of the Internal Revenue Code. These organizations are subject to income tax on any income from unrelated business activities. The System also owns or controls certain taxable affiliates.

The System files income tax returns in the U.S. federal jurisdiction and in various state and foreign jurisdictions. With few exceptions, the System is no longer subject to U.S. federal, state, and local or non-U.S. income tax examinations by tax authorities for years before 2008.

At December 31, 2011 and 2010, the liability for uncertainty in income taxes was $10.0 million and $12.4 million, respectively. The System does not expect a significant increase or decrease in unrecognized tax benefits within the next 12 months. The System recognizes interest and penalties accrued related to the liability for unrecognized tax benefits in the consolidated statements of operations and changes in net assets.

At December 31, 2011 and 2010, the System has net operating losses available for federal income tax purposes of $108.0 million and $115.0 million, respectively, of which $103.7 million and $110.7 million, respectively, represent net operating loss carryforwards. These losses expire in varying amounts from 2012 through 2031. A valuation allowance has been recorded for the full amount of the deferred tax asset related to the net operating loss carryforwards due to the uncertainty regarding their use. The System has $4.3 million of net operating losses available for carryback at December 31, 2011 and 2010, for which a deferred tax asset has been recorded.



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15. Commitments and Contingent Liabilities

The System leases various equipment and facilities under operating lease arrangements. Total rental expense in 2011 and 2010 was $72.2 million and $73.3 million, respectively. Minimum operating lease payments over the next five years are as follows (in millions): 2012 – $47.0; 2013 – $37.7; 2014 – $31.3; 2015 – $27.5; and 2016 – $26.7.

Included in the System’s operating lease payments are the following off-balance-sheet financing agreements:

In 2003, the System entered into an operating lease agreement totaling $32.0 million for the purpose of leasing a genetics and stem cell research building (Stem Cell Building Lease). Under the terms of the Stem Cell Building Lease, the System began to lease the facility upon the issuance of the certificate of occupancy in December 2004 and is required to lease the facility for 29 years. At December 31, 2011, total remaining minimum operating lease payments were $30.1 million.

In 2006, the System entered into an operating lease agreement totaling $156.9 million for the purpose of leasing a parking garage and service center building (Service Center Lease). Under the terms of the Service Center Lease, the System began to lease the facility upon issuance of a certificate of occupancy in October 2008 and is required to lease the facility for 21 years with an option (by the System) to extend the lease an additional 5 years. At December 31, 2011, total remaining minimum operating lease payments were $150.1 million.

In 2007, the System entered into two operating lease agreements totaling $80.3 million to lease an office complex comprised of four office buildings and a day care center facility, totaling approximately 707,000 square feet. The System will lease the facilities for 22 years. The System is subsequently leasing two of the office buildings and the day care center (total of 403,000 square feet) to a tenant through June 30, 2017, with the tenant having the option to extend the lease for an additional five years. At December 31, 2011, total remaining minimum operating lease payments were $76.6 million.

At December 31, 2011, the System has commitments for construction and other related capital contracts of $209.9 million and letters of credit of $0.5 million. Guarantees of mortgage loans made by banks to certain staff members are $8.7 million at December 31, 2011. In addition, the System has remaining commitments to invest approximately $235.7 million in alternative and direct investments at December 31, 2011. The largest commitment at December 31, 2011, to any one alternative strategy manager is $20.0 million. These investments are expected to occur over the next three to five years. No amounts have been recorded in the accompanying consolidated balance sheets for these commitments and guarantees.



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15. Commitments and Contingent Liabilities (continued)

In the fourth quarter of 2011, the System recorded a reduction in a loss contingency liability of $40.6 million that had been accrued in prior years. The adjustment was based on updated information that resulted in favorable development of the liability.

16. Endowment

The System’s endowment consists of approximately 244 individual donor-restricted funds established for a variety of purposes. Net assets associated with endowment funds are classified and reported based on donor-imposed restrictions.

Interpretation of Relevant Law

In 2009, the Uniform Prudent Management of Institutional Funds Act (UPMIFA) was enacted to update and replace Ohio’s previous law, the Uniform Management of Institutional Funds Act. The System has interpreted UPMIFA as requiring the preservation of the fair value of the original gift as of the gift date of the donor-restricted endowment funds, absent explicit donor stipulations to the contrary. As a result of this interpretation, the System classifies as permanently restricted net assets (1) the original value of gifts donated to the permanent endowment, (2) the original value of subsequent gifts to the permanent endowment, and (3) accumulations to the permanent endowment made in accordance with the direction of the applicable donor gift instrument at the time the accumulation is added to the fund. The remaining portion of the donor-restricted endowment fund that is not classified in permanently restricted net assets is classified as temporarily restricted net assets until those amounts are appropriated for expenditure by the System in a manner consistent with the standard for expenditure prescribed by UPMIFA. In accordance with UPMIFA, the System considers the following factors in making a determination to appropriate or accumulate donor-restricted endowment funds:

1. The duration and preservation of the fund. 2. The purposes of the System and the donor-restricted endowment fund. 3. General economic conditions. 4. The possible effect of inflation and deflation. 5. The expected total return from income and the appreciation of investments. 6. Other resources of the System. 7. The investment policies of the System.



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16. Endowment (continued)

Funds With Deficiencies

From time to time, the fair value of assets associated with individual donor-restricted endowment funds may fall below the level that the donor requires the System to retain as a fund of perpetual duration. Deficiencies of this nature that are reported in unrestricted net assets were $7.3 million and $8.3 million as of December 31, 2011 and 2010, respectively.

Return Objectives and Risk Parameters

The System has adopted investment and spending policies for endowment assets that attempt to provide a predictable stream of funding to programs supported by its endowment while seeking to maintain the purchasing power of the endowment assets. Endowment assets include those assets of donor-restricted funds that the organization must hold in perpetuity. Under this policy, the endowment assets are invested in a highly diversified portfolio of U.S. and non-U.S. publicly traded equities, alternative investments, and fixed income securities structured to achieve an optimal balance between return and risk. The System expects its endowment funds, over time, to provide an average rate of return of approximately 7.5% annually. Actual returns in any given year may vary from this amount.

Strategies Employed for Achieving Objectives

To satisfy its long-term rate-of-return objectives, the System relies on a total return strategy in which investment returns are achieved through both capital appreciation (realized and unrealized) and current yield (interest and dividends). The System targets a diversified asset allocation to achieve its long-term return objective within prudent risk constraints.

Spending Policy and How the Investment Objectives Relate to Spending Policy

The System has a policy of appropriating for distribution each year up to 5% of its endowment fund’s average fair value over the prior three years through the calendar year-end preceding the fiscal year in which the distribution is planned. In establishing this policy, the System considered the long-term expected return on its endowment. Accordingly, over the long term, the System expects the current spending policy to allow its endowment to grow at an average of 2.5% annually. This is consistent with the System’s objective to maintain the purchasing power of the endowment assets held in perpetuity or for a specified term as well as to provide additional real growth through new gifts and investment return.



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16. Endowment (continued)

Changes in Endowment Net Assets (in thousands)

Temporarily Restricted

Permanently Restricted Total

Endowment net (deficit) assets,

January 1, 2010 $ (15,741) $ 162,976 $ 147,235 Investment return 3,129 – 3,129 Net appreciation 13,714 – 13,714 Contributions – 12,502 12,502 Appropriation of endowment

assets for expenditure (3,039) – (3,039)Endowment net (deficit) assets,

December 31, 2010 (1,937) 175,478 173,541 Investment return 2,662 – 2,662 Net appreciation 682 – 682 Contributions – 13,247 13,247 Appropriation of endowment

assets for expenditure (2,108) – (2,108)Endowment net (deficit) assets,

December 31, 2011 $ (701) $ 188,725 $ 188,024 17. Functional Expenses

The System provides healthcare services and education and performs research. Expenses related to these functions were as follows (in thousands):

2011 2010 Healthcare services $ 4,385,782 $ 4,233,457 Research 207,075 203,855 Medical education 242,028 234,965 General and administrative 622,714 610,559 Non-healthcare services 67,773 66,572 $ 5,525,372 $ 5,349,408



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18. Special Charges

In 2011, the System incurred and recorded special charges of $33.4 million related to exit and disposal costs associated with the closing of Huron Hospital (Huron). Special charges include $15.8 million of accelerated depreciation expense, $7.5 million related to a pledge liability recorded by the System in connection with the closing of Huron, $4.0 million in employee termination benefit costs, $0.9 million in insurance costs, and $5.2 million in various costs incurred in 2011 associated with maintaining the vacant facility and transferring the equipment to other System hospitals. The System paid $2.9 million of the employee termination benefit costs in 2011. Also in 2011, the System opened a new community health center located adjacent to the Huron campus. Services previously provided at Huron have been migrated to other System hospitals and to the new community health center. Therefore, the closure of Huron is not considered a discontinued operation.

19. Subsequent Events

The System evaluated events and transactions occurring subsequent to December 31, 2011 through March 14, 2012, the date the consolidated financial statements were issued. During this period, there were no subsequent events requiring recognition in the consolidated financial statements, and there were no nonrecognized subsequent events requiring disclosure.

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Ernst & Young LLP - Cleveland Clinic · 2013. 12. 20. · A member firm of Ernst & Young Global Limited Ernst & Young LLP Suite 1300 925 Euclid Avenue Cleveland, OH 44115-1476 Tel: