This Preliminary Official Statement and the information contained herein are subject to completion or amendment. Under no circumstances shall this Preliminary Official Statement constitute an offer to sell or the solicitation of an offer to buy, nor shall there be any sale of these securities in any jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction. * Preliminary; subjectto change. January __,2017 agent onoraboutFebruary__, 2017. is expectedthattheBondsin definitiveformwillbeavailablefordeliverytoDTCin NewYork,Yorkoritscustodial upon fortheUnderwriterby itscounsel,Mintz,Levin,Cohn,Ferris,GlovskyandPopeo, P.C.,Boston,Massachusetts.It the ObligatedGroupbyits counsel, Ropes&GrayLLP,Boston,Massachusetts. Certain legalmatterswillbepassed Allen &SnyderLLP,Boston, Massachusetts,BondCounseltotheIssuer.Certainlegal matterswillbepasseduponfor or modificationoftheofferwithoutnotice,andto approval oftheirlegalityandcertainothermattersbyHinckley, AGREEMENT. THEISSUERHASNOTAXINGPOWER UNDERTHEACT. ARE PAYABLESOLELYFROMTHEREVENUESAND FUNDSPLEDGEDFORTHEIRPAYMENTUNDERTHE SUBDIVISION THEREOF. THE PRINCIPAL, REDEMPTION PRICE, IF ANY, AND INTEREST ON THE BONDS OF THEFAITHANDCREDITCOMMONWEALTH OFMASSACHUSETTSORANYPOLITICAL secure theNoteandPriorObligations(asdefinedherein). Master Trustee,asmorefullydescribedherein.TheMedical Centeralsohasgrantedamortgageoncertainrealestateto of December 1, 1998, as amendedand supplemented, among the Obligated Group and U.S. Bank NationalAssociation,as pledge oftheGrossReceipts(asdefinedherein)ObligatedGrouppursuanttoaMasterTrustIndenture datedas Health Ventures,Inc.(collectively,the“ObligatedGroup”)willissueanote(the“Note”)toTrusteesecured bya To securethepaymentsunderAgreement,Parent,MedicalCenter,HealthAllianceandUMass Memorial Trust Agreement dated asof February 1, 2017 (the “Agreement”), by and among the Issuer, the Institutionand Trustee. collectively withtheParentandMedicalCenter,“Institution”)inaccordanceprovisionsof Loan and UMass MemorialMedicalCenter,Inc.(the“MedicalCenter”)andHealthAllianceHospitals,(“HealthAlliance” and, including paymentstotheTrustee,foraccountofIssuerbyUMassMemorialHealthCare,Inc.(the“Parent”), as setforthinthisOfficialStatement. date onwhichinterestistobepaid. January 1andJulytotheBondownersofrecordasclosebusinessonfifteenthdaymonthpreceding the Bondowner, asmorefullydescribedherein.InterestwillbepayableonJuly1,2017andsemiannuallythereafter oneach “Trustee”). SolongasDTCoritsnominee,Cede&Co.,istheBondowner,suchpaymentswillbemadedirectly tosuch the BeneficialOwnersofBonds.See“THEBONDS-Book-Entry-OnlySystem”herein. Dated: DateofDelivery or dispositionof,theaccrualreceiptofintereston,Bonds.See“TAXEXEMPTION”herein. property taxes.BondCounselexpressesnoopinionregardinganyothertaxconsequencesrelatedtotheownership are exemptfromMassachusettspersonalincometaxesandtheBonds minimum taxableincome.Underexistinglaw,interestontheBondsandanyprofitsaleof taxes, although such interest is included in adjustedcurrent earnings when calculating corporate alternative on the Bonds is nota specific preferenceitemfor purposesof thefederalindividual or corporate alternativeminimum income forfederaltaxpurposesundertheInternalRevenueCodeof1986,asamended(the“Code”).Interest assuming, amongothermatters,compliancewithcertaincovenants,interestontheBondsisexcludedfromgross NEW ISSUE–Book-Entry-Only of DTC, receive certificatesrepresentingtheirinterestinBondspurchased.SolongasCede&Co.istheBondowner, nominee of theBondswillbemadeinbook-entryform,denominations$5,000oranymultiplethereof.Purchasers willnot Depository TrustCompany(“DTC”),NewYork,York.DTCwillactassecuritiesdepositoryfortheBonds.Purchases bonds withoutcouponsand,whenissued,willberegisteredinthenameofCede&Co.asBondownerandnominee forThe Memorial HealthCareObligatedGroupIssue,SeriesK(2017)(the“Bonds”).TheBondswillbeissuedonlyasfully-registered In The Bondsareofferedwhen,asandifissuedreceived bytheUnderwriter,subjecttopriorsale,withdrawal THE BONDSDONOTCONSTITUTEAGENERALOBLIGATION OFTHEISSUERORADEBTPLEDGE The BondsshallbespecialobligationsoftheIssuerpayablesolelyfromRevenues,asdefinedherein,Issuer, The Bondsaresubjecttoredemptionpriormaturity,includingatparincertaincircumstances, Principal ofandsemiannualinterestontheBondswillbepaidbyU.S.BankNationalAssociation,astrustee (the The MassachusettsDevelopmentFinanceAgency(the“Issuer”)isofferingits$77,650,000*RevenueBonds,UMass references herein to the Bondowners or registered owners shall mean Cede & Co., as aforesaid, and shall not mean the opinion of Hinckley, Allen& Snyder LLP, Bond Counsel, based upon an analysis of existing law and Revenue Bonds,UMassMemorialHealthCareObligatedGroupIssue PRELIMINARY OFFICIAL STATEMENT DATED JANUARY 9, 2017 MASSACHUSETTS DEVELOPMENT FINANCE AGENCY
MORGAN STANLEY Series K(2017) $77,650,000* Due: July1,asshownontheinsidecover RATINGS: See“RATINGS”herein.
$77,650,000* Massachusetts Development Finance Agency Revenue Bonds, UMass Memorial Health Care Obligated Group Issue Series K (2017)
Delivery Date: February __, 2017
Maturity Interest CUSIP (July 1) Principal Rate Price Number†
$______% Term Bonds due July 1, 20__, Price: _____%, CUSIP Number†: ______
* Preliminary; subject to change. † CUSIP is a registered trademark of the American Bankers Association. CUSIP Global Services is managed on behalf of the American Bankers Association by S&P Global Market Intelligence. Copyright © 2017 CUSIP Global Services. The CUSIP numbers listed above are being provided solely for the convenience of the Bondowners and none of the Members of the Obligated Group, the Underwriter, or the Issuer makes any representations with respect to such numbers or undertakes any responsibility for their accuracy. The CUSIP numbers may change as a result of subsequent actions including, but not limited to, complete or partial refunding or other transactions in the secondary market.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT TRANSACTIONS THAT STABILIZE OR MAINTAIN THE MARKET PRICE OF THE BONDS AT LEVELS ABOVE THOSE THAT MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. No dealer, broker, salesperson or other person has been authorized by the Issuer, the Obligated Group or the Underwriter to give information or to make representations with respect to the Bonds, other than those contained in this Official Statement, and if given or made, such other information or representations must not be relied upon as having been authorized by any of the foregoing. Certain information contained herein has been obtained from the Obligated Group, The Depository Trust Company and other sources which are believed to be reliable, but is not guaranteed as to accuracy or completeness, and is not to be construed as a representation of the Issuer. This Official Statement is submitted in connection with the sale of securities referred to herein and may not be used, in whole or in part, for any other purpose. The information and expressions of opinion herein are subject to change without notice and neither the delivery of this Official Statement nor any sale made hereunder shall, under any circumstances, create any implication that there has been no change in the affairs of the parties referred to above since the date hereof. The Underwriter has provided the following sentence for inclusion in this Official Statement. The Underwriter has reviewed the information in this Official Statement in accordance with, and as part of, its responsibility to investors under the federal securities laws as applied to the facts and circumstances of this transaction, but the Underwriter does not guarantee the accuracy or completeness of such information. The Bonds have not been registered under the Securities Act of 1933, as amended, and the Agreement has not been qualified under the Trust Indenture Act of 1939, as amended, in reliance upon exemptions contained in such acts.
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TABLE OF CONTENTS Page INTRODUCTION ...... 1
SOURCES OF PAYMENT AND SECURITY FOR THE BONDS ...... 1
THE ISSUER ...... 4
THE BONDS ...... 5
CERTAIN FINANCIAL COVENANTS ...... 8
ESTIMATED SOURCES AND USES OF FUNDS ...... 9
THE PROJECT ...... 9
PLAN OF REFUNDING ...... 10
ESTIMATED ANNUAL DEBT SERVICE REQUIREMENTS ...... 11
BONDOWNERS’ RISKS ...... 12
CONTINUING DISCLOSURE ...... 16
TAX EXEMPTION ...... 16
LEGALITY OF THE BONDS FOR INVESTMENT AND DEPOSIT ...... 18
RATINGS ...... 18
INDEPENDENT ACCOUNTANTS ...... 18
COMMONWEALTH NOT LIABLE ON THE BONDS ...... 18
UNDERWRITING ...... 19
LEGAL MATTERS ...... 19
FINANCIAL ADVISOR ...... 19
MISCELLANEOUS ...... 20 Appendix A Letter from the Obligated Group A-1 Appendix B Consolidated Financial Statements of UMass Memorial Health Care, Inc. and Affiliates for September 30, 2016 and 2015 ...... B-1 Appendix C-1 Definitions of Certain Terms ...... C-1-1 Appendix C-2 Summary of the Master Indenture ...... C-2-1 Appendix C-3 Summary of the Supplemental Master Indenture ...... C-3-1 Appendix C-4 Summary of the Loan and Trust Agreement ...... C-4-1 Appendix C-5 Summary of the Mortgage ...... C-5-1 Appendix D Proposed Form of Bond Counsel Opinion ...... D-1 Appendix E Form of Continuing Disclosure Agreement ...... E-1
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OFFICIAL STATEMENT Relating to
$77,650,000* MASSACHUSETTS DEVELOPMENT FINANCE AGENCY Revenue Bonds, UMass Memorial Health Care Obligated Group Issue Series K (2017)
INTRODUCTION
Purpose of this Official Statement This Official Statement, including the cover page and appendices hereto, sets forth certain information in connection with the issuance and sale of Massachusetts Development Finance Agency Revenue Bonds, UMass Memorial Health Care Obligated Group Issue, Series K (2017) (the “Bonds”) of the Massachusetts Development Finance Agency (the “Issuer”), a body corporate and politic and a public instrumentality of The Commonwealth of Massachusetts (the “Commonwealth”). The Issuer is authorized under Chapter 23G and, to the extent incorporated therein, Chapter 40D of the Massachusetts General Laws (said Chapters, collectively and as amended, the “Act”), and pursuant to a resolution of the Issuer adopted on December 8, 2016 (the “Resolution”) to issue the Bonds. The Bonds will be issued under a Loan and Trust Agreement dated as of February 1, 2017 (the “Agreement”) by and among the Issuer, UMass Memorial Health Care, Inc. (the “Parent”), UMass Memorial Medical Center, Inc. (the “Medical Center”) and HealthAlliance Hospitals, Inc. (“HealthAlliance” and, collectively with the Parent and the Medical Center, the “Institution”) and U.S. Bank National Association, as trustee (the “Trustee”). The definitions of certain terms used and not otherwise defined herein are contained in Appendix C-1 – “Definitions of Certain Terms.” Use of Proceeds* The proceeds from the sale of the Bonds, together with other available funds of the Institution, will be used (i) to make a deposit to the Project Fund to pay or reimburse costs of the New Part of the Project, (ii) subject to market conditions at the time of the sale of the Bonds, to refund on a current basis all or a portion of the Massachusetts Health and Educational Facilities Authority (“HEFA”) Variable Rate Demand Revenue Bonds, UMass Memorial Issue, Series E (2009) (the “Series E Bonds”) and HEFA Variable Rate Demand Revenue Bonds, UMass Memorial Issue, Series F (2009) (the “Series F Bonds” and, together with the Series E Bonds, the “Refunded Bonds”) and (iii) to pay costs of issuing the Bonds. See “THE PROJECT,” “PLAN OF REFUNDING” and “ESTIMATED SOURCES AND USES OF FUNDS” herein. SOURCES OF PAYMENT AND SECURITY FOR THE BONDS The proceeds of the Bonds will be loaned by the Issuer to the Institution pursuant to the Agreement. The Institution’s obligation to make payments under the Agreement will be secured by a note issued by the Parent, the Medical Center, UMass Memorial Health Ventures, Inc. (“Ventures”) and HealthAlliance (collectively, the “Obligated Group”) pursuant to the Master Indenture (as defined herein). The Agreement The Issuer, the Institution and the Trustee shall execute the Agreement which provides that, to the extent permitted by law, the obligation of the Institution to make payments to the Issuer and the Trustee thereunder is the joint and several, general obligation of the Parent, the Medical Center and HealthAlliance to which the full faith and credit of the Parent, the Medical Center and HealthAlliance are pledged. The Agreement also provides, among other things, that the Institution shall make payments to the Trustee equal to principal of and interest on the Bonds and certain other payments required by the Agreement. The Agreement shall remain in full force and effect until such time as all of the Bonds and the interest thereon have been fully paid or until adequate provision for such payments has been made.
* Preliminary; subject to change.
The Bonds are special obligations of the Issuer, equally and ratably secured by and payable from a pledge of and lien on, to the extent provided by the Agreement, the moneys received with respect to the Bonds by the Trustee for the account of the Issuer pursuant to the Agreement. Under the Agreement, the Issuer assigns and pledges to the Trustee in trust upon the terms of the Agreement (i) all Revenues to be received from the Institution or derived from any security provided thereunder, and (ii) all rights to receive such Revenues and the proceeds of such rights. Under the Act, to the extent authorized or permitted by law, the pledge of Revenues is valid and binding from the time when such pledge is made and the Revenues and all income and receipts earned on funds held by the Trustee for the account of the Issuer shall immediately be subject to the lien of such pledge without any physical delivery thereof or further act, and the lien of such pledge shall be valid and binding as against all parties having claims of any kind in tort, contract, or otherwise against the Issuer irrespective of whether such parties have notice thereof. The assignment and pledge by the Issuer does not include (i) the rights of the Issuer pursuant to provisions for consent, concurrence, approval or other action by the Issuer, notice to the Issuer or the filing of reports, certificates or other documents with the Issuer, or (ii) the powers of the Issuer as stated in the Agreement to enforce the provisions thereof. As additional security for its payment obligations under the Agreement, the Institution, pursuant to the Agreement, grants to the Trustee a security interest in the moneys and other investments and any proceeds thereof held in the funds established under the Agreement. The Trustee may declare all of the Bonds immediately due and payable prior to maturity at par, plus accrued interest, upon the occurrence of an Event of Default under the Agreement. See Appendix C-4 – “Summary of the Agreement” under the heading “Remedies for Events of Default.” THE BONDS DO NOT CONSTITUTE A GENERAL OBLIGATION OF THE ISSUER OR A DEBT OR PLEDGE OF THE FAITH AND CREDIT OF THE COMMONWEALTH OF MASSACHUSETTS OR ANY POLITICAL SUBDIVISION THEREOF. THE PRINCIPAL, REDEMPTION PRICE, IF ANY, AND INTEREST ON THE BONDS ARE PAYABLE SOLELY FROM THE REVENUES AND FUNDS PLEDGED FOR THEIR PAYMENT. The Master Trust Indenture To evidence the loan made to the Institution under the Agreement, the Parent, as Representative of the Obligated Group, will issue and deliver Obligation No. 14 (the “Note”) in a principal amount equal to the principal amount of the Bonds. The Note will be issued and secured under a Master Trust Indenture dated as of December 1, 1998 (the “Master Trust Indenture”) between the Parent and State Street Bank and Trust Company, predecessor to U.S. Bank National Association, as Master Trustee (the “Master Trustee”), as supplemented and amended by Supplemental Master Indenture for Obligations No. 1, No. 2, No. 3 and No. 4 dated as of December 1, 1998, Supplemental Master Indenture for Obligation No. 5 dated as of February 13, 2001, Supplemental Master Indenture for Obligation No. 6 dated as of July 12, 2005, Supplemental Master Indenture for Obligation No. 7 dated as of May 1, 2009, Supplemental Master Indenture for Obligation No. 8 dated as of May 1, 2009, Supplemental Master Indenture for Obligation No. 9 dated as of May 1, 2010 and Supplemental Master Indenture for Obligation No. 10 dated as of August 1, 2011, each among the Parent, the Medical Center and the Master Trustee, Supplemental Master Indenture for the Joinder of Additional Members of the Obligated Group dated as of March 1, 2014, Supplemental Master Indenture for Obligation No. 11 dated as of April 1, 2015, Supplemental Master Indenture for Obligation No. 12 dated as of February 1, 2016, Supplemental Master Indenture for Obligation No. 13 dated as of December 1, 2016 and Supplemental Master Indenture for Obligation No. 14 dated as of February 1, 2017 (the “Supplemental Master Indenture”), each among the Parent, the Medical Center, HealthAlliance, Ventures and the Master Trustee (the Master Trust Indenture, as supplemented and amended is referred to as the “Master Indenture”). The terms of the Note require payments from the Obligated Group that will be sufficient to provide for the timely payment of principal of and interest on the Bonds. The Obligated Group has previously issued 13 Obligations pursuant to the Master Indenture (the “Prior Obligations” and, together with the Note, the “Issued Obligations”), to secure revenue bonds issued by the Issuer or its predecessor, HEFA, and a guaranty in connection with a bond insurance policy related to one such series of bonds. Of the Prior Obligations, Obligation Nos. 4, 8, 9, 10, 11, 12 and 13 are currently Outstanding in the aggregate principal amount of $382,060,000. Obligation Nos. 8 and 11 secure the Series F Bonds and the Series E Bonds, respectively. Subject to market conditions at the time of sale of the Bonds, some or all of the Series E Bonds
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and the Series F Bonds will be refunded by the Bonds and are expected to be redeemed on or within thirty (30) days after the date the Bonds are issued. Obligation Nos. 8 and 11 will be discharged upon such redemptions to the extent that the related bond issues are fully redeemed. See “PLAN OF REFUNDING.” In 1998, the Parent, as then-sole Member of the Obligated Group, designated the Medical Center as a “Designated Member” under the Master Indenture with respect to each of the Prior Obligations issued before March 2014, when the Medical Center, HealthAlliance and Ventures became Members of the Obligated Group. The Members of the Obligated Group and all Designated Members are collectively referred to as the “Combined Group.” Accordingly, the Combined Group and the Obligated Group currently consist of the same entities. However, the Members of the Obligated Group may designate additional Designated Members from time to time. The Obligated Group covenants, to the extent permitted by law, to cause each Designated Member under the Master Indenture to pay or otherwise transfer such amounts as are necessary to duly and punctually pay the principal of and premium, if any, and interest on all Obligations or portions thereof securing indebtedness issued or secured under the Master Indenture, the proceeds of which were loaned to or otherwise made available to such Designated Member or that was otherwise issued for the benefit of such Designated Member, when and as the same become payable. Pursuant to the Master Indenture, the Issued Obligations are the joint and several obligations of each Member of the Obligated Group. No Designated Member, in such capacity, will be directly obligated to make payments with respect to any Obligation, and the Obligated Group will not be required to cause such Designated Member under the Master Indenture to make payments with respect to any future Obligation, unless the proceeds of Indebtedness issued or secured by such Obligation were loaned to or otherwise made available to such Designated Member or such Indebtedness was otherwise issued for the benefit of such Designated Member. The Master Indenture restricts the issuance of unsecured or parity debt by each Member of the Obligated Group and each Designated Member, through compliance with the Master Indenture’s limits on Long-Term and Short-Term Indebtedness. See Appendix C-2 – “Summary of the Master Indenture – Limitations on Incurrence of Additional Indebtedness.” The Master Indenture further restricts the granting of Liens on the Property of the Members of the Obligated Group and the Designated Members, but provides that any Member of the Obligated Group or any Designated Member may grant (i) Liens on its Gross Receipts to secure equally and ratably all Indenture Indebtedness issued or secured under the Master Indenture and (ii) Liens on its Property provided that such Liens constitute “Permitted Liens” under the Master Indenture. See Appendix C-1 – “Definitions of Certain Terms” and Appendix C-2 – “Summary of the Master Indenture – Limitations on Creation of Liens” and “– Pledge of Gross Receipts.” The Master Indenture does not restrict the granting of Liens by Persons who are not Members of the Obligated Group or Designated Members. See Appendix C-2 – “Summary of the Master Indenture” under the headings “Consolidation, Merger, Sale or Conveyance” and “Limitations on Creation of Liens.” The sale, lease or disposition of Property by each Member of the Combined Group is restricted by the Master Indenture. See Appendix C-2 – “Summary of the Master Indenture – Sale, Lease or Other Disposition of Property.” In addition, the merger or consolidation with and the sale or conveyance of assets by Members of the Obligated Group is also restricted under the Master Indenture. See Appendix C-2 – “Summary of the Master Indenture – Consolidation, Merger, Sale or Conveyance.” The Master Indenture permits the addition of new Members of the Obligated Group and new Designated Members. Each Member of the Obligated Group will be jointly and severally liable for all Obligations issued under the Master Indenture. See Appendix C-2 – “Summary of the Master Indenture – Membership in the Obligated Group.” The Master Indenture permits the withdrawal of Obligated Group Members, other than the Parent, and permits the Obligated Group Representative to release Persons as Designated Members. See Appendix C-2 – “Summary of the Master Indenture” under the headings “Conditions for Membership in the Obligated Group,” “Withdrawal From the Obligated Group” and “Covenants Regarding Designated Members.” In order to secure the Note and the Prior Obligations, the Members of the Obligated Group have each granted to the Master Trustee a Lien on their Gross Receipts, subject to certain Permitted Liens and certain Short- Term Indebtedness described in the Master Indenture. All of the Issued Obligations are equally and ratably secured by such Lien without priority or preference among such Issued Obligations. See Appendix C-2 – “Summary of the Master Indenture – Pledge of Gross Receipts.” See also “BONDOWNERS’ RISKS” under the headings “Enforceability of Lien on Gross Receipts” and “Enforceability of Master Trust Indenture and Agreement.” The Medical Center has granted the Master Trustee a mortgage Lien on the Memorial Campus, and all buildings, facilities and improvements thereon to secure equally and ratably all Issued Obligations, including the Note. The Medical Center is not granting a mortgage lien on the University Campus, the Hahnemann Campus or
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any other real property of the Medical Center or on the equipment, furnishings or other personal property on the Memorial Campus. See Appendix A under the heading “UMass Memorial Health Care System” for definitions and descriptions of the Memorial Campus, the University Campus and the Hahnemann Campus. The Medical Center has covenanted not to create any encumbrance on the Mortgaged Property, except that the Mortgaged Property may become subject to any of the Permitted Liens described in the Master Indenture. Upon payment and discharge of the Issued Obligations and the related bonds, or when adequate provision has been made for payment therefor as provided in the agreements providing for the issuance of such bonds, including the Agreement, the Master Trustee will release and cancel the Mortgage. See Appendix C-5 – “Summary of the Mortgage.” See “BONDOWNERS’ RISKS” under the subheadings “Status of Lien on Mortgaged Property” and “Realization of Value on the Mortgaged Property.” THE ISSUER The Issuer is authorized and empowered under the laws of Massachusetts, including the Act, to issue the Bonds for the purposes described herein and to enter into the Agreement and other agreements and instruments necessary to issue and secure the Bonds. The members of the Board of Directors and the officers of the Issuer authorized to sign documents related to bond transactions are as follows: Members of the Board of Directors Appointed Members James W. Blake, President & CEO, HarborOne Bank James E. Chisholm, Vice President for Business Development, Advantage Waypoint Karen Grasso Courtney, President, K. Courtney and Associates, Inc., and Executive Director, The Foundation for Fair Contracting of Massachusetts Grace K. Fey, CFA, Grace Fey Advisors, LLC Brian Kavoogian, Principal, Charles River Realty Advisors Lauren A. Liss, Partner, Rubin and Rudman LLP Patricia McGovern, Consultant, formerly General Counsel and Senior Vice President at Beth Israel Deaconess Medical Center (retired) Juan Carlos Morales Christopher P. Vincze, Chairman and CEO, TRC Solutions, Inc. Ex-Officio Members Chairperson, Secretary of the Executive Office of Housing and Economic Development, The Commonwealth of Massachusetts. Secretary, the Executive Office for Administration and Finance, The Commonwealth of Massachusetts, or the Secretary’s designee. Officers of the Issuer Marty Jones, President and Chief Executive Officer Simon R. Gerlin, Treasurer, Chief Financial Officer and Executive Vice President for Finance & Administration Laura L. Canter, Executive Vice President for Finance Programs Richard C.J. Henderson, Executive Vice President for Real Estate Patricia A. DeAngelis, General Counsel and Secretary Steven J. Chilton, Senior Vice President for Investment Banking (Mr. Chilton has signing authority for bond transactions only.)
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Except for the information contained herein under the caption “THE ISSUER” and “LEGAL MATTERS” the Issuer has not provided any of the information contained in this Official Statement. The Issuer is not responsible for and does not certify as to the accuracy or sufficiency of the disclosures made herein or any other information provided by the Obligated Group Members, the Underwriter or any other person. THE BONDS DO NOT CONSTITUTE A GENERAL OBLIGATION OF THE ISSUER OR A DEBT OR PLEDGE OF THE FAITH AND CREDIT OF THE COMMONWEALTH OF MASSACHUSETTS OR ANY POLITICAL SUBDIVISION THEREOF. THE PRINCIPAL, REDEMPTION PRICE, IF ANY, AND INTEREST ON THE BONDS ARE PAYABLE SOLELY FROM THE REVENUES AND FUNDS PLEDGED FOR THEIR PAYMENT UNDER THE AGREEMENT. THE ISSUER HAS NO TAXING POWER UNDER THE ACT. THE BONDS Description of the Bonds The Bonds will be dated their date of delivery and will bear interest from such date, payable on July 1, 2017 and on each January 1 and July 1 thereafter. The Bonds will mature on the dates and bear interest at the rates set forth on the inside cover page hereof. Interest on the Bonds will be calculated on the basis of a 360-day year consisting of twelve 30-day months. Subject to the provisions discussed under “Book-Entry-Only System” below, the Bonds are issuable as fully-registered bonds without coupons in the minimum denomination of $5,000 or any multiple thereof. The principal or redemption price of the Bonds will be payable at the corporate trust office of the Trustee, and interest on the Bonds will be paid by check or draft mailed to the registered owner determined as of the close of business on the record date; provided that interest is payable by wire or bank transfer within the United States to any registered owner of $1,000,000 or more in principal amount of the Bonds upon direction satisfactory to the Trustee prior to the record date. The record date is the fifteenth (15th) day of the month preceding the date on which interest is to be paid, provided that, with respect to overdue interest or interest payable on redemption of a bond other than on an interest payment date or interest on any overdue amount, the Trustee may establish a special record date that is no more than twenty (20) days before the payment date. Book-Entry-Only System The Depository Trust Company (“DTC”), New York, New York, will act as securities depository for the Bonds. The Bonds will be issued as fully-registered securities registered in the name of Cede & Co. (DTC’s partnership nominee) or such other name as may be requested by an authorized representative of DTC. One fully- registered bond certificate will be issued for each maturity of the Bonds bearing interest at the same rate in the aggregate principal amount of such maturity bearing interest at such rate, and will be deposited with DTC. DTC, the world’s largest securities depository, is a limited-purpose trust company organized under the New York Banking Law, a “banking organization” within the meaning of the New York Banking Law, a member of the Federal Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code, and a “clearing agency” registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934. DTC holds and provides asset servicing for over 3.5 million issues of U.S. and non-U.S. equity issues, corporate and municipal debt issues, and money market instruments from over 100 countries that DTC’s participants (“Direct Participants”) deposit with DTC. DTC also facilitates the post-trade settlement among Direct Participants of sales and other securities transactions in deposited securities through electronic computerized book-entry transfers and pledges between Direct Participants’ accounts. This eliminates the need for physical movement of securities certificates. Direct Participants include both U.S. and non-U.S. securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations. DTC is a wholly-owned subsidiary of The Depository Trust & Clearing Corporation (“DTCC”). DTCC is the holding company for DTC, National Securities Clearing Corporation and Fixed Income Clearing Corporation, all of which are registered clearing agencies. DTCC is owned by the users of its regulated subsidiaries. Access to the DTC system is also available to others such as both U.S. and non-U.S. securities brokers and dealers, banks, trust companies and clearing corporations that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly (“Indirect Participants”). DTC has a Standard & Poor’s rating of AA+. The DTC Rules applicable to its Participants are on file with the Securities and Exchange Commission. More information about DTC can be found at www.dtcc.com and www.dtc.org.
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Purchases of the Bonds under the DTC system must be made by or through Direct Participants, which will receive a credit for the Bonds on DTC’s records. The ownership interest of each actual purchaser of each Bond (“Beneficial Owner”) is in turn to be recorded on the Direct and Indirect Participants’ records. Beneficial Owners will not receive written confirmation from DTC of their purchase. Beneficial Owners are, however, expected to receive written confirmations providing details of the transaction, as well as periodic statements of their holdings, from the Direct or Indirect Participant through which the Beneficial Owner entered into the transaction. Transfers of ownership interests in the Bonds are to be accomplished by entries made on the books of Direct and Indirect Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in the Bonds, except in the event that use of the book-entry system for the Bonds is discontinued. To facilitate subsequent transfers, all Bonds deposited by Direct Participants with DTC are registered in the name of DTC’s partnership nominee, Cede & Co., or such other name as may be requested by an authorized representative of DTC. The deposit of Bonds with DTC and their registration in the name of Cede & Co. or such other nominee do not effect any change in beneficial ownership. DTC has no knowledge of the actual Beneficial Owners of the Bonds. DTC’s records reflect only the identity of the Direct Participants to whose accounts such Bonds are credited, which may or may not be the Beneficial Owners. The Direct and Indirect Participants will remain responsible for keeping account of their holdings on behalf of their customers. Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants, and by Direct Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time. Beneficial Owners of the Bonds may wish to take certain steps to augment transmission to them of notices of significant events with respect to the Bonds, such as redemptions, tenders, defaults, and proposed amendments to the security documents. For example, Beneficial Owners of the Bonds may wish to ascertain that the nominee holding the Bonds for their benefit has agreed to obtain and transmit notices to Beneficial Owners. In the alternative, Beneficial Owners may wish to provide their names and addresses to the registrar and request that copies of the notices be provided directly to them. Redemption notices shall be sent to DTC. If less than all of the Bonds within an issue are being redeemed, DTC’s practice is to determine by lot the amount of the interest of each Direct Participant in such issue to be redeemed. Neither DTC nor Cede & Co. (nor such other DTC nominee) will consent or vote with respect to the Bonds unless authorized by a Direct Participant in accordance with DTC’s procedures. Under its usual procedures, DTC mails an Omnibus Proxy to the issuer as soon as possible after the record date. The Omnibus Proxy assigns Cede & Co.’s consenting or voting rights to those Direct Participants to whose accounts the Bonds are credited on the record date (identified in a listing attached to the Omnibus Proxy). Principal and interest payments and redemption premium, if any, with respect to the Bonds will be made to Cede & Co., or such other nominee as may be requested by an authorized representative of DTC. DTC’s practice is to credit Direct Participants’ accounts upon DTC’s receipt of funds and corresponding detail information from the Issuer or the Trustee, on the payable date in accordance with their respective holdings shown on DTC’s records. Payments by Participants to Beneficial Owners will be governed by standing instructions and customary practices, as is the case with securities held for the accounts of customers in bearer form or registered in “street name,” and will be the responsibility of such Participant and not of DTC nor its nominee, the Issuer or the Trustee, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of principal and interest, and redemption premium, if any, to Cede & Co. (or such other nominee as may be requested by an authorized representative of DTC) is the responsibility of the Issuer or the Trustee, disbursement of such payments to Direct Participants will be the responsibility of DTC, and disbursement of such payments to the Beneficial Owners will be the responsibility of Direct and Indirect Participants. DTC may discontinue providing its services as securities depository with respect to the Bonds at any time by giving reasonable notice to the Issuer or the Trustee. Under such circumstances, in the event that a successor securities depository is not obtained, Bond certificates are required to be printed and delivered. The Issuer may decide to discontinue use of the system of book-entry-only transfers through DTC (or a successor securities depository). In that event, bond certificates will be printed and delivered. See “Certificated Bonds” below.
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THE INFORMATION IN THIS SECTION CONCERNING DTC AND DTC'S BOOK-ENTRY SYSTEM HAS BEEN OBTAINED FROM SOURCES THAT THE ISSUER BELIEVES TO BE RELIABLE, BUT NONE OF THE ISSUER, THE OBLIGATED GROUP OR THE UNDERWRITER TAKE RESPONSIBILITY FOR THE ACCURACY THEREOF. No Responsibility of Issuer, Obligated Group and Trustee. NONE OF THE ISSUER, THE OBLIGATED GROUP OR THE TRUSTEE WILL HAVE ANY RESPONSIBILITY OR OBLIGATIONS TO DIRECT PARTICIPANTS OR THE PERSONS FOR WHOM THEY ACT AS NOMINEES WITH RESPECT TO THE PAYMENTS TO OR THE PROVIDING OF NOTICE FOR DIRECT PARTICIPANTS, INDIRECT PARTICIPANTS, OR BENEFICIAL OWNERS. SO LONG AS CEDE & CO. IS THE REGISTERED OWNER OF THE BONDS, AS NOMINEE OF DTC, REFERENCES HEREIN TO THE BONDOWNERS OR REGISTERED OWNERS OF THE BONDS SHALL MEAN CEDE & CO. AND SHALL NOT MEAN THE BENEFICIAL OWNERS OF THE BONDS. Certificated Bonds. DTC may discontinue providing its services as securities depository with respect to the Bonds at any time by giving reasonable notice to the Issuer and the Trustee. In addition, the Issuer may determine that continuation of the system of book-entry transfers through DTC (or a successor securities depository) is not in the best interest of the Beneficial Owners. If, for either reason the book-entry-only system is discontinued, Bond certificates will be delivered as described in the Agreement and the Beneficial Owner, upon registration of certificates held in the Beneficial Owner’s name, will become the Bondowner. Thereafter, Bonds may be exchanged for an equal aggregate principal amount of Bonds in other authorized denominations and of the same maturity, upon surrender thereof at the principal corporate trust office of the Trustee. The transfer of any Bond may be registered on the books maintained by the Trustee for such purpose only upon assignment in form satisfactory to the Trustee. For every exchange or registration of transfer of Bonds, the Issuer and the Trustee may make a charge sufficient to reimburse them for any tax or other governmental charge required to be paid with respect to such exchange or registration of transfer, but no other charge may be made to the Bondowner for any exchange or registration of transfer of the Bonds. The Trustee will not be required to transfer or exchange any Bond during the notice period preceding any redemption if such Bond (or any part thereof) is eligible to be selected or has been selected for redemption. Redemption of the Bonds Optional Redemption of the Bonds.* The Bonds maturing after July 1, 20__ are subject to optional redemption prior to maturity, on and after _____ 1, 20__ at the option of the Issuer with the written consent of the Institution or by the written direction of the Institution to the Issuer and the Trustee, as a whole or in part at any time in such order of maturity or sinking fund installments as directed by the Institution at their principal amounts, without premium, plus accrued interest to the redemption date. Mandatory Redemption of the Bonds. The Bonds maturing on July 1, 20__ are subject to redemption from sinking fund installments at their principal amounts, without premium, plus accrued interest to the redemption date on July 1 of each of the years and in the principal amounts as follows: Principal Year Amount 20__ 20__ 20__ 20__ 20__† ______† Final maturity. Purchase of Bonds by the Institution. The Institution may purchase some or all of the Bonds of any maturity and credit them against the principal payment for such maturity or, as the case may be, any sinking fund installment for such maturity at the principal amount by delivering them to the Trustee for cancellation at least sixty (60) days before the maturity date or mandatory redemption date. In addition, whenever Bonds are called for optional or special redemption, the Institution may purchase some or all of the Bonds called for such redemption if it
* Preliminary; subject to change.
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gives written notice, as appropriate, to the Trustee and the Issuer not later than the day before the redemption date that it wishes to purchase the principal amount of Bonds specified in the notice, at a purchase price equal to the redemption price. Any such purchase of Bonds by the Institution shall not be deemed to be a payment or redemption of the Bonds or any portion thereof and such purchase shall not operate to extinguish or discharge the indebtedness evidenced by such Bonds. Special Redemption of the Bonds. The Bonds are subject to special redemption prior to maturity, in whole or in part at any time, in such order of maturity or sinking fund installment as directed by the Institution at their principal amounts, without premium, plus accrued interest to the redemption date, at the option of the Institution, in the event of damage to or destruction or taking of the Project as defined in the Agreement, which produces insurance or condemnation award proceeds allocable to the Bonds pursuant to the special redemption provisions in the Agreement. See Appendix C-4 “Summary of the Agreement” under the heading “Option to Redeem Bonds upon Casualty or Taking.” If the amount available in the Redemption Fund to redeem the Bonds at any time is less than $50,000, the Trustee may, and upon direction of the Institution shall, transfer it to the Debt Service Fund for credit against deposits otherwise required to be made therein with respect to principal instead of calling Bonds for redemption. Selection of the Bonds. If less than all of the Bonds of any maturity are to be redeemed, the portion of the Bonds to be redeemed shall be selected by the Trustee by lot or in any customary manner of selection as determined by the Trustee; provided, however, that so long as DTC or its nominee is the Bondowner, the particular portions of the Bonds to be redeemed shall be selected by lot by DTC in such manner as DTC may determine. If a Bond is of a denomination in excess of five thousand dollars ($5,000), portions of the principal amount in the amount of five thousand dollars ($5,000) or any multiple thereof may be redeemed. Notice of Redemption and Other Notices. So long as DTC or its nominee is the Bondowner, the Issuer and the Trustee will recognize DTC or its nominee as the Bondowner for all purposes, including notices and voting. Conveyance of notices and other communications by DTC to DTC Participants, by DTC Participants to Indirect Participants, and by DTC Participants and Indirect Participants to Beneficial Owners, will be governed by arrangements among them, subject to any statutory and regulatory requirements which may be in effect from time to time. The Trustee shall give notice of redemption to the Bondowners not less than twenty (20) days nor more than forty-five (45) days prior to the date fixed for redemption. Such notice of redemption may state that the proposed redemption is conditioned upon there being on deposit in the Redemption Fund on the redemption date sufficient funds to pay the full redemption price of the Bonds to be redeemed. Failure to mail notice to a particular Bondowner, or any defect in the notice to such Bondowner, shall not affect the redemption of any other Bond. So long as DTC or its nominee is the Bondowner, any failure on the part of DTC or failure on the part of a nominee of a Beneficial Owner (having received notice from a DTC Participant or otherwise) to notify the Beneficial Owner so affected shall not affect the validity of the redemption. Effect of Redemption. On the redemption date, the redemption price of each Bond to be redeemed will become due and payable; and from and after such date, notice having been properly given and amounts having been made available and set aside from such redemption in accordance with the provisions of the Agreement, notwithstanding that any Bonds called for redemption have not been surrendered, no further interest will accrue on any Bonds called for redemption. CERTAIN FINANCIAL COVENANTS Under the Master Indenture, the Obligated Group agrees, subject to any Legal Limitations, to charge and collect (and to cause its Designated Members to charge and collect) rates and charges which collectively shall, together with other available moneys, provide moneys sufficient at all times to make any payments required under the Master Indenture and to comply with the Master Indenture in all other respects, and to satisfy all other obligations of the Combined Group in a timely fashion. The Obligated Group shall, subject to Legal Limitations, charge and collect (and cause each of its Designated Members to charge and collect) rates and charges which, together with other available moneys, in each Fiscal Year will produce revenue at least sufficient to meet expenses of the Combined Group. The Obligated Group agrees, subject to Legal Limitations, to use its best efforts (and cause each of its Designated Members to use its best efforts) to maintain a Historical Debt Service Coverage Ratio of the Combined Group of at least 1.10 in each Fiscal Year. If the Historical Debt Service Coverage Ratio of the Combined Group, as
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calculated at the end of any Fiscal Year, is less than 1.10, the Obligated Group covenants to retain a Consultant to make recommendations to increase such ratio for subsequent Fiscal Years to the levels required or, if in the opinion of the Consultant the attainment of such level is impracticable, to the highest practicable level. Each Member of the Obligated Group agrees that it will (and will cause each Designated Member to), subject to Legal Limitations, substantially follow the recommendations of the Consultant or file with the Master Trustee its reasons for not following the recommendations. So long as the Obligated Group shall retain a Consultant and each Member of the Obligated Group (and Designated Member) shall follow such Consultant’s recommendations except as described above, this covenant shall be deemed to have been complied with even if the ratio for any subsequent Fiscal Year is less than 1.10 but not less than 1.00. Provided that the Historical Debt Service Coverage Ratio of the Combined Group has not been below 1.10 for the three most recent consecutive Fiscal Years, if in any Fiscal Year the Historical Debt Service Coverage Ratio of the Combined Group is less than 1.10, the Obligated Group will not be required to retain a Consultant to make such recommendations if a written report of a Consultant is filed with the Master Trustee which contains an opinion of such Consultant that (i) applicable laws and regulations have prevented the maintenance of the 1.10 ratio, (ii) the Members of the Obligated Group (and Designated Members) have generated the maximum amount of Income Available for Debt Service which in the opinion of such Consultant could reasonably have been generated given such laws and regulations during the period affected thereby and (iii) the ratio actually achieved was at least 1.00. Pursuant to the Supplemental Master Indenture, the Obligated Group agrees for so long as the Bonds are Outstanding to cause the Combined Group to maintain at all times a minimum of 60 Days Cash on Hand. Failure to achieve a minimum of 60 Days Cash on Hand as of the end of any fiscal year shall not be an event of default if the Obligated Group employs a consultant to make certain recommendations and subject to certain other conditions. See Appendix C-3 – “Summary of the Supplemental Master Indenture” under the heading “Days Cash on Hand Covenant Relating to Obligation No. 14.” This covenant, together with certain other covenants in the Master Indenture, may be waived at any time with the written consent of owners of at least a majority in aggregate principal amount of Obligations Outstanding, including the Note and the Prior Obligations. See Appendix C-2 – “Summary of the Master Indenture” under the heading “Waiver of Event of Default.” ESTIMATED SOURCES AND USES OF FUNDS The proceeds from the sale of the Bonds, rounded to the nearest dollar, and other available funds are expected to be applied as follows: Sources of Funds: Aggregate Principal Amount of the Bonds Net Original Issue Premium/Discount Total Sources of Funds:
Uses of Funds: Deposit to the Project Fund Deposit to refund the Refunded Bonds Cost of Issuance (including Underwriter’s discount)(1) Total Uses of Funds: ______(1) Costs of issuance includes Underwriter’s discount, legal costs, rating agency fees, printing costs, trustee fees, financial advisory fees and other miscellaneous fees and expenses. THE PROJECT The Existing Part of the Project The Existing Part of the Project consists of the refinancing of the projects financed and refinanced by the Refunded Bonds. See “PLAN OF REFUNDING” below. The New Part of the Project The New Part of the Project consists of the payment or reimbursement of capital costs of equipment used or to be used in connection with healthcare and related services and for various construction, improvement, renovation and equipment acquisitions on behalf of the Obligated Group. For further information regarding the Project, see Appendix A – “Letter from the Obligated Group” under the heading “The Project” and the definition of “Project” in
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Appendix C-1 – “Definitions of Certain Terms” under the heading “Definitions Pertaining to the Loan and Trust Agreement.” PLAN OF REFUNDING Subject to market conditions at the time of the sale of the Bonds, a portion of the proceeds of the Bonds, together with other available funds of the Institution, will be deposited with People’s United Bank, as trustee for the Refunded Bonds, or paid directly to the owners of the Refunded Bonds and applied to the redemption of the Refunded Bonds. The Refunded Bonds are expected to be refunded and redeemed on or within thirty (30) days after the date of issuance of the Bonds at a price of 100% of their principal amount plus accrued interest to the redemption date. The refunding is contingent upon market conditions and the delivery of the Bonds.
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ESTIMATED ANNUAL DEBT SERVICE REQUIREMENTS The following table sets forth, for each respective year ending September 30, the amounts (rounded to the nearest dollar) required to be made available by the Parent and its affiliates (including entities that are not in the Obligated Group) in such year for payment of (i) the principal of and interest on the Prior Obligations and other long-term debt (collectively, “Prior Debt”), (ii) the principal of and interest on the Bonds and (iii) the total debt service on the Bonds and the Prior Debt in such year. The Bonds Total Debt Service Debt Service on Total on the Bonds Year Prior Debt(1)(2)(3) Principal Interest Debt Service and Prior Debt
2017 $ 37,859,657 2018 44,722,806 2019 46,106,305 2020 42,998,062 2021 42,214,279 2022 39,634,737 2023 35,818,436 2024 35,585,976 2025 35,564,561 2026 35,396,209 2027 28,536,318 2028 26,015,331 2029 26,528,811 2030 23,309,550 2031 22,266,923 2032 17,148,802 2033 13,294,383 2034 3,566,152 2035 2,703,250 2036 6,708,250 2037 6,708,000 2038 6,706,200 2039 6,705,650 2040 6,705,850 2041 6,706,400 2042 6,706,750 2043 6,704,000 2044 6,708,250 2045 6,708,500 2046 6,704,250 Total $633,042,648
______(1) Assumes refunding in full of the Refunded Bonds and the discharge of the related Obligations. (2) Assumes interest rate of 3.00% for Prior Debt bearing interest at variable rates. (3) Includes long-term debt (including capitalized leases) that is not secured under the Master Indenture.
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BONDOWNERS’ RISKS Purchase of the Bonds involves risk. In order to identify risk factors and make an informed investment decision, potential investors should be thoroughly familiar with this entire Official Statement, including the Appendices hereto, in order to make a judgment as to whether the Bonds are an appropriate investment. Certain risks associated with the purchase of the Bonds are described below. Such lists of possible factors, while not setting forth all the factors which must be considered, contain some of the factors which should be considered prior to purchasing the Bonds. THE DISCUSSION OF RISK FACTORS IS NOT, AND IS NOT INTENDED TO BE, COMPREHENSIVE OR EXHAUSTIVE. Prospective purchasers of the Bonds should give careful consideration to the matters referred to in the following summary and in Appendix A – “Letter from the Obligated Group” under the heading “Bondowners’ Risks and Matters Affecting the Health Care Industry.” Such summaries should not be considered exhaustive, but rather informational only. Currently, there are no Members of the Combined Group that are not also Members of the Obligated Group. Accordingly, and for clarity, this section primarily refers to risks relating to the Obligated Group. In the event that a Designated Member is added to the Combined Group, it is expected that the risk factors described in this BONDOWNERS’ RISKS section also would apply to such Designated Member. In addition, provided no default results therefrom, a Designated Member may withdraw from the Combined Group at any time. For an explanation of the definitions of “Obligated Group,” “Designated Members” and “Combined Group” see Appendix C-1 – “Definitions of Certain Terms.” The revenue and expenses of the Obligated Group are affected by the rapidly changing health care environment. These changes are a result of the implementation of national health reform and efforts by the federal and state governments, managed care organizations (“MCOs”), private insurance companies and business coalitions to reduce and contain health care costs, including, but not limited to, the costs of inpatient and outpatient care, physician fees, capital expenditures and the costs of graduate medical education. In addition to matters discussed elsewhere in this Official Statement, the following factors may have a material effect on the operations of the Obligated Group to an extent that cannot be determined at this time. General The principal of, redemption premium, if any, and interest on the Bonds are payable solely from the amounts paid by the Institution to the Issuer under the Agreement and from amounts which may be paid to the Trustee pursuant to the Master Indenture, including moneys paid by the Obligated Group under the Note. No representation or assurance can be made that revenues will be realized by the Institution or the Obligated Group in the amounts necessary to make payments at the times and in the amounts sufficient to pay the debt service on the Bonds. Under the Master Indenture, Designated Members are not obligated to make payments with respect to any Obligations, although each Member of the Obligated Group has covenanted to cause each Designated Member as to which it exercises control to pay or transfer funds to satisfy such portion, if any, of the indebtedness secured by Obligations as was issued for the benefit of such Designated Member. No Member of the Obligated Group is obligated to exercise such control or cause payments to be made from any Designated Member that has not received the proceeds or benefit of indebtedness secured by Obligations. References to the Combined Group or Members of the Combined Group in this section entitled “BONDOWNERS’ RISKS” should not be construed to imply that any entity other than the Members of the Combined Group is directly or indirectly obligated with respect to the Obligations. Risks Affecting the Health Care Industry Generally The receipt of future revenues by the Obligated Group is subject to, among other factors, federal and state regulations and policies affecting the health care industry, the policies and practices of MCOs, private insurers and other third-party payors, and private purchasers of health care services. The effect on the Obligated Group of future changes in federal, state and private policies cannot be determined at this time. Future revenues and expenses of the Obligated Group may be affected by events and economic conditions, which may include an inability to control expenses in periods of inflation, as well as other conditions such as demand for health care services; the capability of the management of the Obligated Group; the receipt of grants and contributions; referring physicians’ and self-referred patients’ confidence in the Obligated Group; and increased use of discounted or risk-based contracts with MCOs and other payors. Other factors that may affect revenues and
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expenses include the ability of the Obligated Group to provide services required by patients; the relationship of the Obligated Group with physicians; the success of the Obligated Group’s strategic plans; the degree of cooperation among and competition with other providers in the Obligated Group’s area; changes in levels of private philanthropy; malpractice claims and other litigation; economic and demographic developments in the United States and in the service areas in which facilities of the Obligated Group are located; competition; changes in interest rates that affect investment results; and changes in rates, costs, third-party payments (including, without limitation, Medicare and Medicaid program payment) and governmental regulations concerning payment. All of the above- referenced factors could affect the Obligated Group’s ability to make payments with respect to the Bonds. See Appendix A – “Letter from the Obligated Group” under the heading “Bondowners’ Risks and Matters Affecting the Health Care Industry.” Enforceability of Lien on Gross Receipts The obligation of the Institution to make the payments required under the Agreement is secured by the Note, which in turn is secured by a security interest granted to the Master Trustee in the Gross Receipts of the Obligated Group. To the extent that Gross Receipts are derived from payments by the federal or state government under the Medicare or Medicaid program, any right of the Master Trustee to receive such payments directly during such time as the Lien on Gross Receipts remains in effect may be unenforceable. The Social Security Act and state regulations prohibit anyone other than the individual receiving care or the entity providing service from collecting Medicare and Medicaid payments directly from the federal or state government. In addition, Medicare and Medicaid receivables are subject to provisions of the Assignment of Claims Act of 1940, which restricts the ability of a secured party to collect accounts directly from government agencies. With respect to receivables and Gross Receipts not subject to the Lien in favor of the Master Trustee, the Master Trustee would occupy the position of an unsecured creditor. Counsel to the Obligated Group has not provided an opinion with regard to the enforceability of the Lien on Gross Receipts of the Obligated Group, where such Gross Receipts are derived from the Medicare and Medicaid programs. In the event of bankruptcy of a Member of the Obligated Group, transfers of property by the bankrupt entity, including the payment of debt or the transfer of any collateral, including receivables and Gross Receipts on or after the date which is 90 days (or, in some circumstances, one year) prior to the commencement of the case in bankruptcy court, may be subject to avoidance or recoupment as preferential transfers. Under certain circumstances a court may have the power to direct the use of Gross Receipts to meet expenses of the Obligated Group before paying the debt service on the Bonds. Pursuant to the Massachusetts Uniform Commercial Code, a security interest in the proceeds of Gross Receipts may not continue to be perfected if such proceeds are not paid over to the Master Trustee by the Obligated Group within 20 days of receipt. The Obligated Group is obligated to pay over such proceeds within 20 days of receipt only in the event of a failure to make required payment on the Obligations issued under the Master Indenture or on any bonds secured by any such Obligation (and, as noted above, the Lien on Gross Receipts may be released upon the fulfillment of certain conditions). If any payment is not made when due, the Members of the Obligated Group must transfer or pay over immediately to the Master Trustee any Gross Receipts with respect to which the security interest remains perfected pursuant to law. Any Gross Receipts thereafter received shall upon receipt by a Member of the Obligated Group be transferred to the Master Trustee without such Gross Receipts being commingled with other funds, in the form received (with necessary endorsements) up to an amount equal to the amount of the missed payment. The Members of the Obligated Group have granted a parity Lien on their Gross Receipts to secure the Prior Obligations. The value of the security interest in the Gross Receipts could be further diluted by the incurrence of additional indebtedness secured equally and ratably with the Bonds as to the security interest in the Gross Receipts. Status of Lien on Mortgaged Property The Issued Obligations are equally and ratably secured by a Mortgage on the Memorial Campus located in Worcester, Massachusetts, which includes the 303-bed hospital building formerly known as Memorial Hospital. None of the University Campus, Hahnemann Campus nor any other real property of the Obligated Group is subject to the Mortgage. The Medical Center will covenant not to create any encumbrance on the Mortgaged Property, except that the Mortgaged Property may become subject to any of the Permitted Liens described in the Master Indenture. The Lien of the Mortgage has not been insured under a title insurance policy. The existence of any liens
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on the Mortgaged Property having priority over the Lien created by the Mortgage may reduce the amount realized by the Master Trustee in the event of a foreclosure of the Mortgage. Realization of Value on the Mortgaged Property The Mortgaged Property is not comprised of general purpose buildings and would not generally be suitable for industrial or commercial use. Consequently, it would be difficult to find a buyer or lessee for the Mortgaged Property if it were necessary to foreclose on the Mortgaged Property. Thus, upon any default, it may not be possible to realize funds in an amount equal to the outstanding interest on and principal of the Bonds from a sale or a lease of the Mortgaged Property. Furthermore, in order to operate the Mortgaged Property as a health care facility, a purchaser of the Mortgaged Property at a foreclosure sale would under present law have to obtain a determination of need from the Massachusetts Department of Public Health and a license for the facility. The Medical Center is not granting a lien on equipment or furnishings at the Mortgaged Property. Therefore, the ability to operate the Mortgaged Property as a health care facility might be affected accordingly. In addition, under applicable federal and Massachusetts environmental statutes, in the event of any past or future releases of pollutants or contaminants on or near the Mortgaged Property, a lien superior to the Master Trustee’s Lien could attach to the Mortgaged Property to secure the costs of removing or otherwise treating such pollutants or contaminants. Such a lien would adversely affect the Master Trustee’s ability to realize sufficient amounts to pay the Issued Obligations in full. Furthermore, in determining whether to exercise any foreclosure rights with respect to the Mortgaged Property, the Master Trustee may have to take into account the potential liability of any owner of the Mortgaged Property, including an owner by foreclosure, for clean-up costs with respect to such pollutants and contaminants. No environmental assessment of the Mortgaged Property has been made prior to the issuance of the Bonds. Enforceability of Master Indenture and Agreement Under Massachusetts law, a nonprofit corporation may guarantee the debt of another corporation only if such guaranty is in furtherance of the corporate purposes of such guarantor nonprofit corporation. In addition, it is possible that the security interest granted by a Member of the Obligated Group and the obligation of a Member to make payments due, if any, under any Obligations issued under the Master Indenture, including the Note, relating to indebtedness issued for the benefit of another Member of the Obligated Group, may be declared void in an action brought by third-party creditors pursuant to the Massachusetts fraudulent conveyance statutes or may be avoided by a Member of the Obligated Group or a trustee in bankruptcy in the event of the bankruptcy of the Member of the Obligated Group from which payment is requested. An obligation may be voided under the federal Bankruptcy Code or under the Massachusetts fraudulent conveyance statute, if (a) the obligation was incurred without receipt by the obligor of “fair consideration” or “reasonably equivalent value,” and (b) the obligation renders the obligor “insolvent,” as such terms are defined under the applicable statute. Interpretation by the courts of the tests of “insolvency,” “reasonably equivalent value” and “fair consideration” has resulted in a conflicting body of case law. For example, the obligation, if any, of a Member of the Obligated Group under the Master Indenture to make all payments thereunder, including payments in respect of funds used for the benefit of the other Members of the Obligated Group, may be held to be a “transfer” which makes such Member of the Obligated Group “insolvent” in the sense that the total amount due under the Master Indenture could be considered as causing its liabilities to exceed its assets. Also, one of the Members of the Obligated Group may be deemed to have received less than “fair consideration” for such obligation because none or only a portion of the proceeds of the indebtedness are to be used to finance projects occupied or used by such Member of the Obligated Group. While the Members of the Obligated Group may benefit generally from the projects financed from the indebtedness for the other Members of the Obligated Group, the actual cash value of this benefit may be less than the obligation incurred. The rights under the Massachusetts fraudulent conveyance statutes may be asserted for a period of up to six years from the incurring of the obligations or granting of security under the Master Indenture. In addition, the assets of any Member of the Obligated Group may be held by a court to be subject to a charitable trust which prohibits payments in respect of obligations incurred by or for the benefit of others, particularly if a Member of the Obligated Group has insufficient assets remaining to carry out its own charitable functions or, under certain circumstances, if the obligations paid by such Member were issued for purposes inconsistent with or beyond the scope of the charitable purposes for which the Member of the Obligated Group was organized. The enforceability of similar master indentures has been challenged in jurisdictions outside of the
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Commonwealth. In the absence of clear legal precedent in this area, the extent to which the assets of any Member of the Obligated Group can be used to pay Obligations issued by or on behalf of others cannot be determined at this time. The Master Indenture permits Members of the Obligated Group to incur unsecured debt and debt secured on a parity with the Bonds under certain circumstances. Members of the Obligated Group, subject to restrictions set forth in the Master Indenture, may sell assets to or merge or consolidate with other Persons (whether or not then affiliated with such Member). Exercise of Remedies Under the Master Indenture “Events of Default” under the Master Indenture include the failure of the Obligated Group to make payments on any Obligation issued and Outstanding under the Master Indenture (such as the Note) and may include nonpayment related defaults under documents such as the Agreement. The Master Indenture provides that upon an “Event of Default” thereunder, the Master Trustee may in its discretion, by notice in writing to Members of the Obligated Group, declare all (but not less than all) Obligations Outstanding thereunder to be immediately due and payable and may exercise other remedies thereunder. However, the Master Trustee is not required to declare amounts under the Master Trust Indenture to be due and payable immediately unless requested to do so by the holders of at least a majority in aggregate principal amount of all Obligations then Outstanding under the Master Indenture. Consequently, upon the occurrence of an “Event of Default” under the Agreement with respect to the Bonds and an acceleration of the maturity of the Bonds, the Master Trustee is not required to accelerate the maturity of all Obligations Outstanding under the Master Indenture upon direction from the Trustee unless (i) the principal amount of the Bonds Outstanding is at least equal to a majority of the principal amount of all Obligations Outstanding under the Master Indenture, or (ii) the Trustee and all other holders of Obligations requesting such acceleration hold at least a majority of all Obligations Outstanding under the Master Indenture. The Note is cross-defaulted and secured on a parity with all other Obligations under the Master Indenture. Further, an Event of Default under the Master Indenture constitutes an Event of Default under the Agreement. See Appendix C-1 – “Definitions of Certain Terms” and Appendix C-4 – “Summary of the Certain Provisions of the Loan and Trust Agreement.” Covenant to Maintain Tax-Exempt Status of the Bonds The excludability of interest on the Bonds from the gross income of the recipients thereof for federal income tax purposes is dependent in part on the continued compliance by the Issuer and the Institution with certain covenants contained in the Agreement. These covenants relate generally to arbitrage limitations, use of bond proceeds, rebate of certain investment earnings to the federal government, and restrictions on the amount of costs of issuance financed with the proceeds of the Bonds. Failure to comply with any of these covenants may result in the inclusion of interest on the Bonds in the gross income of the recipients thereof for federal income tax purposes retroactive to the date of issuance. Considerations Relating to Additional Debt Subject to the coverage and other tests set forth therein, the Master Indenture permits the Obligated Group to incur Additional Indebtedness, including the issuing of additional bonds. Such indebtedness would increase the Obligated Group's debt service and repayment requirements and may adversely affect debt service coverage on the Bonds. Effect of Bankruptcy If any Member of the Obligated Group obtains protection under the federal Bankruptcy Code, its revenues may not be subject to the security interests created under the Master Indenture. Property acquired after the bankruptcy will not be subject to the security interests created under the Master Indenture. The member’s property, including accounts receivable and proceeds thereof, also could be used for the benefit of the member despite the security interest of the Master Trustee in such accounts receivable if the Bankruptcy Court finds that “adequate protection” of the lien holder’s interest in the property exists or is given. The commencement of a case under the federal Bankruptcy Code operates as an automatic stay of any act or proceeding to enforce a lien upon property of the affected Member of the Obligated Group. A patient care ombudsman could be appointed as an advocate for the welfare of patients. The Master Trustee may not be able to obtain relief from the automatic stay to realize upon security interests created under the Master Indenture as a result
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of concern for patient welfare or otherwise. Delay in the Master Trustee’s ability to exercise remedies against collateral could impair recovery from the collateral securing the Bonds. The commencement of a proceeding under the Bankruptcy Code also can adversely affect the business of the Obligated Group, including by increasing costs, by deterring recipients of health care services from utilizing the Members of the Obligated Group for such services and by deterring providers from remaining employed under such circumstances. In addition, if a Member of the Obligated Group were to become insolvent or if reorganization under the Bankruptcy Code were to be perceived as being in doubt, accounts receivable could become more difficult or impossible to collect. In a proceeding under the Bankruptcy Code, in particular if the indebtedness evidenced by the Bonds were to be deemed not fully secured, payments made in respect of the Bonds or other transfers of property within 90 days prior to the date of a bankruptcy case could be avoided as preferential transfers absent the presence of one of the Bankruptcy Code defenses to avoidance. To the extent avoided, the value of such payments or transfers could be recovered from the Trustee or from subsequent transferees and claims in respect of the Bonds could be disallowed pending recovery of the value of such payments or transfers. In a Chapter 11 case, the petitioner could file a plan for the adjustment of its debts which modifies the rights of creditors generally, or any class of creditors, secured or unsecured. The plan, if confirmed by the court, binds all creditors and discharges all claims held by creditors who had notice or knowledge of the bankruptcy except as set forth in the plan. No plan may be confirmed unless, among numerous other conditions, the plan is determined to be in the best interest of creditors, is feasible and either has been accepted by each class of claims impaired thereunder, or the court has found sufficient grounds to confirm the plan over the objections of a dissenting class. To accept the plan, at least two-thirds in dollar amount and more than one-half in number of the allowed claims of the class that vote with respect to the plan must accept the plan. Even if the plan is not so accepted, it may still be confirmed if the court finds that the plan is “fair and equitable” with respect to each class of non-accepting creditors impaired thereunder and does not discriminate unfairly in favor of junior creditors. With respect to secured claims of holders of the Bonds, if certain legal requirements were satisfied, a plan could alter substantive rights such as the maturity date and interest rate of the Bonds. For additional Bondowners’ Risks, see Appendix A – “Letter from the Obligated Group” under the heading “Bondowners’ Risks and Matters Affecting the Health Care Industry.” CONTINUING DISCLOSURE No financial or operating data concerning the Issuer is material to any decision to purchase, hold or sell the Bonds and the Issuer will not provide any such information. The Institution has undertaken all responsibilities for any continuing disclosure to Bondholders as described below, and the Issuer shall have no liability to the Bondholders or any other person with respect to such disclosures. The Obligated Group has covenanted for the benefit of holders and beneficial owners of the Bonds to provide certain financial information relating to the Parent and its affiliates and financial information and operating data relating to the Obligated Group following the end of each fiscal year (each an “Annual Report”) and the end of each fiscal quarter (each a “Quarterly Statement”), and to provide notices of the occurrence of certain enumerated events. The Annual Reports will be filed on behalf of the Obligated Group not later than 120 days following the end of each fiscal year and the Quarterly Statements will be filed not later than 60 days after each of the first three fiscal quarters and not later than 90 days after the end of the fourth fiscal quarter, in each case with the Municipal Securities Rulemaking Board (the “MSRB”) through its Electronic Municipal Market Access (“EMMA”) system. The event notices also will be filed on behalf of the Obligated Group with the MSRB through its EMMA system. The specific nature of the information to be contained in the Annual Reports and the Quarterly Statements or the event notices is summarized in Appendix E – “Form of Continuing Disclosure Agreement.” These covenants have been made in order to assist the Underwriter in complying with Rule 15c2-12 promulgated by the Securities and Exchange Commission. Failure to comply with these covenants is not an event of default under the Master Indenture or the Agreement. TAX EXEMPTION In the opinion of Hinckley, Allen & Snyder LLP, Bond Counsel to the Issuer (“Bond Counsel”), based upon an analysis of existing laws, regulations, rulings, and court decisions, and assuming, among other matters, compliance with certain covenants, interest on the Bonds is excluded from gross income for federal income tax
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purposes under Section 103 of the Internal Revenue Code of 1986, as amended (the “Code”). Bond Counsel is of the further opinion that interest on the Bonds is not a specific preference item for purposes of the federal individual or corporate alternative minimum taxes. However, such interest is included in adjusted current earnings when calculating corporate alternative minimum taxable income. Bond Counsel expresses no opinion regarding any other federal tax consequences arising with respect to the ownership or disposition of, or the accrual or receipt of interest on, the Bonds. The Code imposes various requirements relating to the exclusion from gross income for federal income tax purposes of interest on obligations such as the Bonds. Failure to comply with these requirements may result in interest on the Bonds being included in gross income for federal income tax purposes, possibly from the date of original issuance of the Bonds. The Issuer and the Borrower have covenanted to comply with such requirements to ensure that interest on the Bonds will not be included in federal gross income. The opinion of Bond Counsel assumes compliance with these covenants. Bond Counsel is also of the opinion that, under existing law, interest on the Bonds and any profit on the sale of the Bonds are exempt from Massachusetts personal income taxes and that the Bonds are exempt from Massachusetts personal property taxes. Bond Counsel expresses no opinion regarding any other Massachusetts tax consequences arising with respect to the Bonds. Prospective Bondowners should be aware, however, that the Bonds are included in the measure of Massachusetts estate and inheritance taxes, and the Bonds and the interest thereon are included in the measure of certain Massachusetts corporate excise and franchise taxes. Bond Counsel has not opined as to the taxability of the Bonds or the income therefrom under the laws of any state other than Massachusetts. A complete copy of the proposed form of opinion of Bond Counsel is set forth in Appendix D hereto. To the extent the issue price of any maturity of the Bonds is less than the amount to be paid at maturity of such Bonds (excluding amounts stated to be interest and payable at least annually over the term of such Bonds), the difference constitutes “original issue discount,” the accrual of which, to the extent properly allocable to each owner thereof, is treated as interest on the Bonds which is excluded from gross income for federal income tax purposes and is exempt from Massachusetts personal income taxes. For this purpose, the issue price of a particular maturity of the Bonds is the first price at which a substantial amount of such maturity of the Bonds is sold to the public (excluding bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters, placement agents or wholesalers). The original issue discount with respect to any maturity of the Bonds accrues daily over the term to maturity of such Bonds on the basis of a constant interest rate compounded semiannually (with straight-line interpolations between compounding dates). The accruing original issue discount is added to the adjusted basis of such Bonds to determine taxable gain or loss upon disposition (including sale, redemption, or payment on maturity) of such Bonds. Bondowners should consult their own tax advisors with respect to the tax consequences of ownership of Bonds with original issue discount, including the treatment of purchasers who do not purchase such Bonds in the original offering to the public at the first price at which a substantial amount of such Bonds is sold to the public. Bonds purchased, whether at original issuance or otherwise, for an amount greater than the stated principal amount to be paid at maturity of such Bonds, or, in some cases, at the earlier redemption date of such Bonds (“Premium Bonds”), will be treated as having amortizable bond premium for federal income tax purposes and Massachusetts personal income tax purposes. No deduction is allowable for the amortizable bond premium in the case of obligations, such as the Premium Bonds, the interest on which is excluded from gross income for federal income tax purposes. However, a Bondowner’s basis in a Premium Bond will be reduced by the amount of amortizable bond premium properly allocable to such Bondowner. Holders of Premium Bonds should consult their own tax advisors with respect to the proper treatment of amortizable bond premium in their particular circumstances. Prospective Bondowners should be aware that certain requirements and procedures contained or referred to in the Agreement and other relevant documents may be changed and certain actions (including, without limitation, defeasance of the Bonds) may be taken or omitted under the circumstances and subject to the terms and conditions set forth in such documents. Bond Counsel has not undertaken to determine (or to inform any person) whether any actions taken (or not taken) or events occurring (or not occurring) after the date of issuance of the Bonds may adversely affect the value of, or the tax status of interest on, the Bonds. Prospective Bondowners should be aware that from time to time legislation is or may be proposed which, if enacted into law, could result in interest on the Bonds being subject directly or indirectly to federal income taxation, or otherwise prevent Bondowners from realizing the full benefit provided under current federal tax law of the
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exclusion of interest on the Bonds from gross income. To date, no such legislation has been enacted into law. However, it is not possible to predict whether any such legislation will be enacted into law. Further, no assurance can be given that any pending or future legislation, including amendments to the Code, if enacted into law, or any proposed legislation, including amendments to the Code, or any future judicial, regulatory or administrative interpretation or development with respect to existing law, will not adversely affect the market value and marketability of, or the tax status of interest on, the Bonds. Prospective Bondowners are urged to consult their own tax advisors with respect to any such legislation, interpretation or development. Although Bond Counsel is of the opinion that interest on the Bonds is excluded from gross income for federal income tax purposes and is exempt from Massachusetts personal income taxes, the ownership or disposition of, or the accrual or receipt of interest on, the Bonds may otherwise affect a Bondowner’s federal or state tax liability. The nature and extent of these other tax consequences will depend upon the particular tax status of the Bondowner or the Bondowner’s other items of income, deduction or exclusion. Bond Counsel expresses no opinion regarding any such other tax consequences, and Bondowners should consult with their own tax advisors with respect to such consequences. LEGALITY OF THE BONDS FOR INVESTMENT AND DEPOSIT The Act provides that the Bonds are securities in which all public officers and public bodies of the Commonwealth and its political subdivisions, all Massachusetts insurance companies, trust companies, savings banks, cooperative banks, banking associations, investment companies, executors, administrators, trustees and other fiduciaries may properly and legally invest funds, including capital in their control or belonging to them. The Bonds, under the Act, are securities which may properly and legally be deposited with and received by any Commonwealth or municipal officer or any agency or political subdivision of the Commonwealth for any purpose for which the deposit of bonds or obligations of the Commonwealth is now or may hereafter be authorized by law. RATINGS S&P and Fitch Ratings (“Fitch”) have assigned ratings of “BBB+” (stable outlook) and “A-” (stable outlook), respectively, to the Bonds. Such ratings reflect only the views of such organizations and any explanation of the significance of such ratings may only be obtained from the rating agency furnishing the same. There is no assurance such ratings will continue for any given period of time or that such ratings will not be revised downward or withdrawn entirely at any time by the rating agencies. The ratings in this section are not recommendations to buy, sell or own any bonds, and such ratings may be subject to revision or withdrawal at any time by the respective rating agencies. Any downward revision or withdrawal of either or both ratings may have an adverse effect on the market price of the Bonds. Moody’s Investors Service, Inc., which has not been asked to rate the Bonds, has assigned a rating of “Baa3” (stable outlook) to certain bonds secured under the Indenture on a parity with the Bonds. INDEPENDENT ACCOUNTANTS The consolidated financial statements of UMass Memorial Health Care, Inc. and Affiliates as of September 30, 2016 and 2015 and for the years then ended, included in Appendix B of this Official Statement have been audited by PricewaterhouseCoopers LLP, independent accountants, as stated in their report appearing herein. COMMONWEALTH NOT LIABLE ON THE BONDS The Bonds are not a general obligation of the Issuer and shall not be deemed to constitute a debt or liability of the Commonwealth or any political subdivision thereof, or a pledge of the faith and credit of the Issuer or the Commonwealth or any such political subdivision, but shall be payable solely from and to the extent of the payments made by the Obligated Group pursuant to the Agreement and the Master Indenture any other funds held under the agreement for such purpose. Neither the faith and credit of the Issuer or the Commonwealth nor the taxing power of the Commonwealth or of any political subdivision thereof is pledged to the payment of the principal of or the interest on the Bonds. The Act does not in any way create a so-called moral obligation of the Commonwealth or of any political subdivision thereof to pay debt service on the Bonds in the event of default by the Obligated Group. The Issuer does not have taxing power under the Act.
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UNDERWRITING The Bonds are being purchased for reoffering by the Morgan Stanley (the “Underwriter”) pursuant to a purchase contract among the Institution, the Issuer and the Underwriter (the “Purchase Contract”). The Underwriter has agreed to purchase the Bonds at a net aggregate premium/discount of $______from the public offering prices set forth on the inside cover page hereof. The Underwriter may offer and sell the Bonds to certain dealers (including dealers depositing Bonds into investment trusts, certain of which may be sponsored or managed by the Underwriter) and others at prices lower than the public offering prices stated on the inside cover page hereof. The Purchase Contract provides that the Underwriter will purchase all the Bonds if any are purchased and provides that the Institution will indemnify the Underwriter and the Issuer and certain other parties against losses, claims, damages, and liabilities arising out of any incorrect statements of information, including the omission material facts, contained in this Official Statement and pertaining to the Obligated Group and other specified matters. The Underwriter may allow concessions from the public offering price to certain dealers, banks and others. After the initial public offering at the offering price or prices set forth on the inside cover of this Official Statement, the public offering price or prices may be varied from time to time by the Underwriter. The Underwriter has provided the following three paragraphs for inclusion in this Official Statement. The Underwriter has reviewed the information in this Official Statement in accordance with, and as part of, its responsibilities to investors under the federal securities laws as applied to the facts and circumstances of this transaction, but the Underwriter does not guarantee the accuracy or completeness of such information. The Underwriter and its affiliates are full service financial institutions engaged in various activities, which may include securities trading, commercial and investment banking, financial advisory, investment management, principal investment, hedging, financing and brokerage activities. The Underwriter and its affiliates have, from time to time, performed and may in the future perform, various investment banking services for the Issuer and/or the Obligated Group. In the ordinary course of their various business activities, the Underwriter and its affiliates may make or hold a broad array of investments and actively trade debt and equity securities (or related derivative securities, which may include default swaps) and financial instruments (including bank loans) for their own account and for the accounts of their customers and may at any time hold long and short positions in such securities and instruments. Such investment and securities activities may involve securities and instruments of the Issuer and/or the Obligated Group. The Underwriter and its affiliates may also communicate independent investment recommendations, market color or trading ideas and/or publish or express independent research views in respect of such assets, securities or instruments and may at any time hold, or recommend to clients that they should acquire, long and/or short positions in such assets, securities and instruments. Morgan Stanley, parent company of Morgan Stanley & Co. LLC, the underwriter of the Bonds, has entered into a retail distribution arrangement with its affiliate, Morgan Stanley Smith Barney LLC. As part of the distribution arrangement, Morgan Stanley & Co. LLC, may distribute municipal securities to retail investors through the financial advisor network of Morgan Stanley Smith Barney LLC. As part of this arrangement, Morgan Stanley & Co. LLC may compensate Morgan Stanley Smith Barney LLC for its selling efforts with respect to the Bonds. LEGAL MATTERS Certain legal matters incidental to the authorization and issuance of the Bonds by the Issuer are subject to the approval of Hinckley, Allen & Snyder LLP, Boston, Massachusetts, Bond Counsel, whose opinion approving the validity and tax exempt status of the Bonds will be delivered with the Bonds. A copy of the proposed form of the opinion of Bond Counsel is attached hereto as Appendix D. Certain legal matters will be passed on for the Obligated Group by its counsel, Ropes & Gray LLP, Boston, Massachusetts. Certain legal matters will be passed on for the Underwriter by its counsel, Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., Boston, Massachusetts. There is no litigation pending against the Issuer or, to the knowledge of the officers of the Issuer, threatened against the Issuer seeking to restrain or enjoin the issuance or delivery of the Bonds or in any way contesting the existence or the powers of the Issuer relating to the issuance of the Bonds. See Appendix A – “Letter from the Obligated Group” with respect to any material litigation affecting the Obligated Group. FINANCIAL ADVISOR Ponder & Co. (“Ponder”) is serving as financial advisor to the Institution in connection with the issuance of the Bonds. Ponder is not obligated to undertake, and has not undertaken, either to make an independent verification of or to assume responsibility for, the accuracy, completeness, or fairness of the information contained in this
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Official Statement. Ponder is an independent financial advisory firm and is not engaged in the business of underwriting, trading, or distributing securities. MISCELLANEOUS The Issuer has consented to the use of this Official Statement. The Issuer is responsible only for the statements contained under the caption “The Issuer” and the information pertaining to the Issuer under the caption “Legal Matters,” and the Issuer makes no representation as to the accuracy, completeness or sufficiency of any other information contained herein. Except as otherwise stated herein, neither of the Issuer nor the Underwriter makes any representations or warranties whatsoever with respect to the information contained herein. The references to the Act, the Agreement, the Master Trust Indenture, the Note, the Supplemental Master Indenture and the Continuing Disclosure Agreement are brief summaries of certain provisions thereof. Such summaries do not purport to be complete, and reference is made to the Act, the Agreement, the Master Trust Indenture, the Note, the Supplemental Master Indenture and the Continuing Disclosure Agreement for full and complete statements of such provisions. The agreements of the Issuer with the holders of the Bonds are fully set forth in the Agreement, and neither any advertisement of the Bonds nor this Official Statement is to be construed as constituting an agreement with the Bondowners. So far as any statements are made in this Official Statement involving matters of opinion, whether or not expressly so stated, they are intended merely as such and not as representations of fact. Copies of the documents mentioned in this paragraph are on file at the offices of the Issuer and of the Trustee. Information relating to DTC and the book-entry system described herein under the heading “THE BONDS - Book-Entry-Only System” has been furnished by DTC and is believed to be reliable, but none of the Issuer, the Obligated Group or the Underwriter makes any representations or warranties whatsoever with respect to such information. The Issuer has relied on the information provided by the Obligated Group contained in Appendix A – “Letter from the Obligated Group” and in Appendix B – “Consolidated Financial Statements of UMass Memorial Health Care, Inc. and Affiliates for September 30, 2016 and 2015.” Appendix B includes financial information for entities that are not Members of the Obligated Group or otherwise obligated with respect to the Bonds. While the information contained therein is believed to be reliable, the Issuer makes no representations or warranties whatsoever with respect to the information contained therein. Appendix C-1 – “Definitions of Certain Terms,” Appendix C-2 – “Summary of the Master Indenture,” Appendix C-3 – “Summary of the Supplemental Master Trust Indenture,” Appendix C-4 – “Summary of the Agreement,” and Appendix D – “Proposed Form of Bond Counsel Opinion” have been prepared by Hinckley, Allen & Snyder LLP, Bond Counsel to the Issuer. Appendix C-5 – “Summary of the Mortgage” has been prepared by Ropes & Gray LLP, counsel to the Obligated Group. Appendix E – “Form of Continuing Disclosure Agreement” has been prepared by Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., counsel to the Underwriter. All appendices are incorporated as an integral part of this Official Statement. The Institution has reviewed the portions of this Official Statement describing the Institution, the Plan of Refunding, The Project, Estimated Sources and Uses of Funds, Bondowners’ Risks, Ratings and Continuing Disclosure as it pertains to the Institution, has furnished Appendix A and Appendix B to this Official Statement, and has approved all such information for use with this Official Statement. At the closing, the Institution will certify that such portions of this Official Statement, except for any projections and opinions contained in such portions, do not contain an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made therein, in the light of the circumstances under which they are made, not misleading.
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Appendix A
Letter from the Obligated Group
APPENDIX A UMASS MEMORIAL HEALTH CARE, INC.
TABLE OF CONTENTS
OVERVIEW ...... A-1
PRINCIPAL AFFILIATES ...... A-2
UMASS MEMORIAL HEALTH CARE SYSTEM ...... A-2
STRATEGIC VISION AND CURRENT CHALLENGES ...... A-6
SYSTEM SERVICE AREA ...... A-9
SYSTEM GOVERNANCE ...... A-14
SYSTEM MANAGEMENT ...... A-15
SYSTEM UTILIZATION ...... A-17
FINANCIAL INFORMATION OF THE SYSTEM ...... A-18
MANAGEMENT’S DISCUSSION OF RECENT FINANCIAL PERFORMANCE ...... A-20
SUPPLEMENTAL FINANCIAL INFORMATION FOR THE OBLIGATED GROUP ...... A-24
SYSTEM INDEBTEDNESS ...... A-26
SOURCES OF PATIENT SERVICE REVENUE ...... A-29
SYSTEM FACILITIES ...... A-35
THE PROJECT ...... A-36
LITIGATION AND REGULATORY MATTERS ...... A-37
INSURANCE ...... A-37
HISTORY AND TRANSACTION ...... A-38
OTHER CORPORATE AFFILIATES ...... A-40
BONDOWNERS’ RISKS AND MATTERS AFFECTING THE HEALTH CARE INDUSTRY ...... A-41
APPENDIX A
January __, 2017
In connection with the issuance by the Massachusetts Development Finance Agency (the “Agency” or “MDFA”) of its Revenue Bonds, UMass Memorial Health Care System Obligated Group Issue, Series K (2017) (the “Bonds”), we are pleased to submit the following information regarding the UMass Memorial Health Care System Obligated Group (as defined herein) for inclusion in the Official Statement (the “Official Statement”).
Unless otherwise indicated, all financial, utilization, workforce, and patient service revenue data for any year refer to such data for UMass Memorial Health Care, Inc. (the “Parent”) and its affiliates (collectively, “UMass Memorial Health Care System” or the “System” or “UMMHC”) for the fiscal year ended September 30. Effective July 2014, System affiliates HealthAlliance Hospitals, Inc. (“HealthAlliance”) and UMass Memorial Health Ventures, Inc. (“Ventures”) joined the UMass Memorial Health Care System Obligated Group (the “Obligated Group”). The affiliates excluding the Obligated Group are referred to herein as the “Non-Obligated Group.” All financial and utilization references herein to the Obligated Group on a pro forma basis assume the inclusion of HealthAlliance and Ventures as of the date of their joinder to the Obligated Group. For more information regarding HealthAlliance and Ventures, see “UMASS MEMORIAL HEALTH CARE SYSTEM” herein.
AS OF THE DATE OF THIS OFFICIAL STATEMENT, THE PARENT, UMASS MEMORIAL MEDICAL CENTER, INC., HEALTHALLIANCE AND VENTURES ARE THE ONLY MEMBERS OF THE OBLIGATED GROUP, AND ARE THE ONLY CORPORATIONS WHOSE REVENUES ARE PLEDGED FOR PAYMENT OF DEBT SERVICE ON THE BONDS.
OVERVIEW
The Parent is a private, not-for-profit Massachusetts corporation formed to develop and coordinate an integrated health care delivery system. The Parent is the sole direct or indirect corporate member, stockholder, owner or partner of approximately 30 corporations, limited liability companies, or partnerships (each an “Affiliate” and collectively, the “Affiliates”), including UMass Memorial Medical Center, Inc. (the “Medical Center”), HealthAlliance, and Ventures, that provide a broad range of health care and related services to Worcester and the surrounding central Massachusetts communities. See “PRINCIPAL AFFILIATES.”
The System was formed as a result of a 1998 combination of the state-owned clinical division of the University of Massachusetts (the “University”) and a private, not-for-profit health care system controlled by Memorial Health Care, Inc. The System continues to operate subject to certain long-term transaction documents entered into in connection with the 1998 transaction (the “Transaction”). For a description of the Transaction and related transaction documents, see “HISTORY AND TRANSACTION” herein.
Each member of the Obligated Group is a Massachusetts non-profit corporation that has previously been determined by the Internal Revenue Service to be an organization described in Section 501(c)(3) of the Internal Revenue Code of 1986, as amended (the “Code”), and, therefore, is exempt from federal income tax under Section 501(a) of the Code.
On a consolidated basis as of September 30, 2016, the System had $2.28 billion in assets, generated $2.37 billion in revenue for the year then ended, and had an excess of revenue over expenses of $68.1 million for the same period. The Obligated Group had $1.84 billion in assets as of September 30, 2016, generated $1.87 billion in revenue for the year then ended, and had an excess of revenue over expenses of $81.4 million for the same period.
APPENDIX A PRINCIPAL AFFILIATES
The System encompasses a group of approximately 30 Affiliates. Certain principal Affiliates are shown on the following chart. None of the revenues or assets of any of the Affiliates, other than the members of the Obligated Group, are available for payment of the principal of, or premium or interest on, or as security for, the Bonds.
PRINCIPAL AFFILIATES OF UMASS MEMORIAL HEALTH CARE SYSTEM
UMass Memorial Health Care, Inc.
UMass Memorial UMass Memorial UMass Memorial Commonwealth UMass Memorial UMass Memorial Accountable Care Community Behavioral Professional UMass Health Ventures, Realty, Inc. Organization, Inc. Health System, Inc. Assurance Hospitals, Inc. Memorial Inc. Company, Ltd. Medical Center, Inc.
Community UMass Memorial Healthlink,Inc. Medical Group, Inc.
Central New The Clinton Marlborough England Hospital Hospital HealthAlliance, Inc. Association
HealthAlliance Members of the Obligated Group Hospitals, Inc.
UMASS MEMORIAL HEALTH CARE SYSTEM
The primary operating components of the System are set forth below.
Hospitals
The Medical Center
The Medical Center is a 779-bed acute care hospital located on four campuses that provides a full range of services, including all major specialties and subspecialties of inpatient care and ambulatory care. The Medical Center is the only hospital in central Massachusetts designated as a Level 1 trauma center by the Massachusetts Department of Public Health (“MA DPH”). The Medical Center is the System’s largest Affiliate, accounting for $1.25 billion or 54.9% of the System’s assets as of September 30, 2016 and generating $1.62 billion or 68.3% of the System’s revenues for 2016. The Parent is the sole corporate member of the Medical Center.
The Medical Center’s two principal inpatient campuses are located approximately one mile from each other: the Memorial campus at 119 Belmont Street, Worcester (the “Memorial Campus”), and the University campus at 55 Lake Avenue North, Worcester (the “University Campus”) (each a “Campus” and collectively, the “Campuses”). The Medical Center also operates an inpatient facility at the Queen Street campus located at 26 Queen Street, Worcester (the “Queen Street Campus”) and multiple outpatient facilities, including the Hahnemann campus at 281 Lincoln Street, Worcester (the “Hahnemann Campus”).
The University Campus serves as a tertiary care referral center with particular focus on advanced heart and vascular care, bone disease, neurosciences, radiation therapy, and other forms of cancer care, with a full complement of technology and support services. The University Campus also includes a comprehensive Children’s Medical Center, with specialists in all principal fields, including orthopedics, psychiatry, and surgery. The Children’s Medical Center is an institutional member of the National Association of Children’s Hospitals and Related Institutions, an association of leading pediatric programs in the United States. In addition, the University Campus has the only pediatric intensive care unit, pediatric AIDS treatment facility, cystic fibrosis center, and pediatric diabetes center in A-2 APPENDIX A central Massachusetts. The University Campus also provides advanced tertiary care unavailable at other sites in central Massachusetts, including kidney and liver transplantation, and forensic psychiatry.
The Memorial Campus provides a broad array of primary, secondary, and selected tertiary care services. It is the regional referral center for women with high-risk pregnancies, the regional intensive care center for seriously ill newborns, and a leading center for the care of orthopedic, bariatric, and cancer patients from throughout the central Massachusetts region.
The Medical Center also provides inpatient and outpatient psychiatric services at a number of locations, including a psychiatric unit with 26 licensed beds and outpatient behavioral medicine and psychiatric services on the Queen Street Campus and 27 licensed beds on the University Campus.
The Medical Center offers comprehensive emergency services with emergency departments located on both its Memorial and University Campuses available on a 24-hour basis. The University Campus Emergency Department has a 90-bed unit, which includes adult and pediatric treatment areas. The Memorial Campus Emergency Department has a 23-bed unit and also has five observation beds.
The University Campus is home to LifeFlight, New England’s first hospital-based air ambulance. This lifesaving service is available to critically ill and injured patients needing immediate transport to up-to-date lifesaving medical technology, equipment, and staff. It responds directly to accident scenes or referring hospitals for the transport of patients to appropriate tertiary care hospitals.
The Medical Center offers numerous ambulatory care programs between three main Worcester campuses and three offsite locations (Queen Street Campus provides only inpatient services). University Campus clinics include cardiology, cardiac, and vascular surgery, the comprehensive breast center, endocrinology, family medicine, gastroenterology, kidney/pancreas transplant, the lung/allergy center, the foot ankle center, neurology, oncology, orthopedics, otolaryngology, pediatrics, renal medicine, diabetes, surgery clinic, the weight center, and the wound center. Memorial Campus clinics include the community women’s care and women’s centers, gynecologic oncology, infectious disease, rheumatology, and the spine and joint center. Hahnemann Campus clinics include dermatology, family health, behavioral medicine and psychiatry, anticoagulation, the hand and upper extremity center, ophthalmology, plastic and cosmetic surgery, the tuberculosis center and sports medicine. In addition to the above, the Medical Center operates outpatient cancer services under its license at the Marlborough Hospital campus and three other health center clinics at off-site locations, including Barre Primary Care, the Plumley Village Health Center, and the Tri-River Family Health Center.
The University, Memorial, Hahnemann, and Queen Street campuses function under a single license granted to the Medical Center by the MA DPH. The Joint Commission most recently accredited the Medical Center on November 4, 2014 for a period expiring November 2017. The Medical Center is a member of the American Hospital Association (“AHA”), the Massachusetts Hospital Association (“MHA”), and participates in Vizient (formerly the University HealthSystem Consortium, “the UHC”) through the System’s membership with that organization. The Medical Center’s Continuing Medical Education Program is accredited by the Massachusetts Medical Society. The Medical Center also has a variety of departmental certifications and accreditations, including trauma and transplant.
HealthAlliance
HealthAlliance is a 122-bed not-for-profit acute care hospital that serves the communities in north central Massachusetts and southern New Hampshire. HealthAlliance has two campuses in Leominster and Fitchburg, Massachusetts (the “HealthAlliance Campuses”) that provide clinical services ranging from inpatient medical surgical and obstetric care to 24-hour emergency care, outpatient urgent care, and rehabilitation services. HealthAlliance was created in November 1994 as a result of the merger between Burbank Hospital and Leominster Hospital, Inc. and became part of the System in 1998. HealthAlliance functions under a single license granted by the MA DPH. It is accredited by The Joint Commission and is designated a primary stroke service facility by the MA DPH. HealthAlliance accounted for $213.9 million or 9.4% of the System’s assets as of September 30, 2016, generating $180 million or 7.6% of the System’s revenues for 2016. HealthAlliance is a member of the AHA, the MHA and the UHC. The Parent is the sole corporate member of UMass Memorial Community Hospitals, Inc., (“Hospitals, Inc.”), which is the sole corporate member of Central New England HealthAlliance, Inc. (“CNEHA”). CNEHA is the sole corporate member of HealthAlliance. (For a discussion of the proposed merger of Clinton Hospital into HealthAlliance see “—Clinton Hospital.”)
A-3 APPENDIX A Marlborough Hospital
Marlborough Hospital is a 79-bed community hospital located in Marlborough, Massachusetts. Marlborough Hospital was founded in 1890 and provides emergency care as well as a range of inpatient and outpatient medical, surgical and ancillary services. Marlborough Hospital is licensed by the MA DPH. In 2016, Marlborough Hospital and its affiliates had revenues of $89.1 million, an excess of revenues over expenses of $8.9 million, and, as of September 30, 2016, total assets of $84.5 million. The Joint Commission most recently accredited Marlborough Hospital on July 25, 2015 for a period expiring July 2018. It is a member of the AHA and the MHA. Hospitals, Inc. is the sole corporate member of Marlborough Hospital.
Clinton Hospital
The Clinton Hospital Association (“Clinton Hospital”) is a 41-bed community hospital located in Clinton, Massachusetts. Organized in 1889, Clinton Hospital has been a member of the System since 1998. Clinton Hospital has a 20-bed locked geriatric/medical psychiatry program and a 20-bed medical-telemetry inpatient unit. In 2016, Clinton Hospital had revenues of $26.8 million and a deficiency of revenues over expenses of $2.3 million and, as of September 30, 2016, total assets of $33.7 million. Clinton Hospital is licensed by the MA DPH. It is also designated as a primary stroke service facility by the MA DPH. Clinton Hospital is accredited by Det Norske Veritas Healthcare and holds an ISO 9001:2008 certification by the International Organization for Standardization. Clinton Hospital is a member of the AHA, the MHA, and the UHC. Hospitals, Inc. is the sole corporate member of Clinton Hospital. Subject to receipt of regulatory approvals and satisfaction of certain other conditions, it is anticipated that in fall 2017 Clinton Hospital will merge with and into HealthAlliance, with HealthAlliance as the surviving corporation.
The following table summarizes the number of licensed beds of the UMass Memorial Health Care System hospitals as of September 30, 2016:
SYSTEM LICENSED BEDS
Marlborough Clinton Medical Center* HealthAlliance* Hospital Hospital Total Medical / Surgical 446 82 47 21 596
Intensive Care / Coronary Unit/ 103 10 10 0 123 Burn Unit Obstetrics / Gynecology 65 19 0 0 84 Neonatal Intensive Care 27 0 0 0 27 Pediatric 52 11 0 0 63 Psychiatry 86 0 22 20 128 Total Licensed 779 122 79 41 1,021 Total Staffed 728 119 67 41 955 ______* Members of the Obligated Group. Source: System records.
A-4 APPENDIX A The following table summarizes the medical staff memberships for the UMass Memorial Health Care System hospitals as of September 30, 2015 and September 30, 2016:
SYSTEM MEDICAL STAFF
Designation September 30, 2015 September 30, 2016
Medical Center (Active)* 1,336 1,401 HealthAlliance (Active)* 246 244 Marlborough Hospital (Active) 135 141 Clinton Hospital (Active) 17 17 Other** 998 873
Total 2,732 2,676
Board Certified *** Medical Center 95% 92% HealthAlliance 91 95 Marlborough Hospital 99 95 Clinton Hospital 94 94 ______* Members of the Obligated Group. ** The designation “Other” includes Courtesy and Consulting Medical Staff. *** The designation “Board Certified” includes Active, Courtesy, and Consulting Medical Staff. The percentage includes only those who have achieved board certification, and does not include those who are board admissible and in the certification process. Source: System records.
Ventures
Ventures is the direct or indirect member or joint venture participant in several entities located in central Massachusetts. These entities focus on outpatient and non-acute health care services (including urgent care and rehabilitation services), specialty pharmacy and pharmacy management services, and magnetic resonance imaging. Potential future joint ventures in the planning or development stage include an ambulatory surgery center, additional urgent care sites, outpatient physical therapy, and an inpatient psychiatric hospital. UMMHC’s strategic plan contemplates using Ventures to enter into joint ventures with companies and organizations that have competencies, assets, business knowledge, and economically-viable cost structures (that UMass Memorial may not have). As such, Ventures may engage from time to time in discussions with respect to potential affiliations and joint ventures as opportunities arise. Discussions with respect to such transactions are held on an intermittent, and usually confidential, basis. Any affiliation or similar transaction would be completed in compliance with the covenants of the Master Trust Indenture between the Parent and U.S. Bank National Association, as successor master trustee to State Street Bank and Trust Company, dated as of December 1, 1998 (as amended and supplemented from time to time, the “Master Trust Indenture”). Ventures accounted for $71.0 million or 3.1% of the System’s assets as of September 30, 2016, generating $13.7 million or 0.6% of the System’s revenues for 2016.
Educational Affiliations and Programs
The Medical Center serves as the principal teaching site for medical students, residents, and fellows of the University of Massachusetts Medical School (the “Medical School”), and is the site of the Medical School’s clinical trials. There are 20 accredited residency programs, and 34 accredited and 19 other clinical fellowship programs with an aggregate of 588 residents and fellows. There are nine major participating institutions and numerous additional affiliated training sites for the residency and fellowship programs.
In addition, the Medical Center provides clinical training and affiliations for various educational purposes, serving students with various majors including: physical therapy, nursing, pharmacology, laboratory, and radiological technology, dietetic, health information management, surgical technology, respiratory and occupational therapy, social work, medicine, and health care administration. The Medical Center supports ongoing professional education for its staff through tuition reimbursement, scholarship awards, in-service education, and management training.
A-5 APPENDIX A As part of the academic affiliation between the Medical School and the Medical Center, the Medical School is the exclusive academic and medical teaching affiliate of the Medical Center. In connection with this academic affiliation, the Medical Center purchases from the Medical School certain teaching and education services required in connection with the educational activities of the Medical Center (“Medical Education Services”). The obligation to purchase Medical Education Services is determined annually and is dependent on the System’s operational performance and revenues, including supplemental payments under the Massachusetts Medicaid program (“Medicaid Supplemental Funds”) received for patient care services. The cost of these services was approximately $152.5 million in 2016, $128.1 million in 2015, and $163.8 million in 2014. For more information about the relationship between the System and University, see “HISTORY AND TRANSACTION.”
STRATEGIC VISION AND CURRENT CHALLENGES
System Strategic Plan
The Parent’s Board of Trustees has approved a strategic vision for the System, the goal of which is to become one of the best academic health systems in America by the year 2020 based on measures of patient safety, quality, cost, patient satisfaction, innovation, education, and caregiver engagement.
In support of achieving that vision, the Parent has approved a strategic plan for the System (the “Strategic Plan”) that encompasses five major strategic themes/objectives:
. Deliver exceptional quality, service, and value to patients.
. Invest in the best.
. Increase the System’s community presence.
. Build the System’s population health capabilities.
. Create an enabling culture of ownership.
The Evolving Healthcare Landscape
Management believes the business model of health care is changing rapidly in Massachusetts, driven largely by market pressures and federal and state health reform laws. These laws create incentives for health care providers to reduce the growth of health care spending by moving away from fee-for-service payment systems toward value- based payment mechanisms that link reimbursement to clinical quality and management of the cost of care. Value- based payment mechanisms include shared risk, shared savings, pay for performance, bundled pricing, episode treatment groups, and capitation. These models are intended to reward providers for keeping patients “home and healthy” and delivering care in the most cost-appropriate setting, while holding providers financially accountable for care that is of poor quality or delivered in a high cost setting. To be successful in the future, Management believes that the System must embrace the triple aim of improving the patient experience of care (including quality and satisfaction), improving the health of the populations it serves, and reducing the per capita cost of health care. In 2010, essentially all of the System’s revenue came from fee-for-service contracts. In 2016, approximately 95% came from fee-for-service contracts, and by 2020, Management anticipates that the majority of System revenue will be tied to some form of value-based payment. Consistent with this trend, in the state’s 2017 fiscal year, Massachusetts proposes to shift many providers to Medicaid payment arrangements with shared risk. Regardless of potential changes in federal or state health policy, Management believes that the trend towards value-based payments will continue and that the System should continue to work for success within these programs.
In addition to recognizing the importance of value-based payments, the Strategic Plan endorses the System’s continuing role as a health care “safety net” and tertiary care provider for the region’s sickest patients. The System’s role is likely to become more important as fewer community hospitals maintain the expensive infrastructure necessary to care for critically ill and injured patients. Over time, Management expects that tele-medicine will play an increasingly important role in all aspects of health care—from the intensive care unit (“ICU”) to home monitoring.
Other challenges Management foresees include the aging of the population and associated movement of an estimated 7,000 people per year in Massachusetts out of commercial insurance plans—which have traditionally covered the System’s costs of providing care—to programs that currently produce an operating loss for UMMHC, including Medicare and Medicare Advantage. Many of the patients who remain in commercial programs are
A-6 APPENDIX A expected to move from the classic employer-sponsored programs to the private exchanges which, thus far, have predominately sold “bronze” plans carrying high deductibles and narrow networks. These plans limit patient choice by financially penalizing members for seeking care at higher cost hospitals such as the Medical Center.
Management believes that the commoditization of low acuity acute care and elective care, coupled with the demand by younger consumers for immediate access to consumer-friendly health care services, will continue to attract new players into the health care marketplace. Companies such as CVS, Walmart, and Walgreens are already capturing a significant portion of lower acuity care that was previously seen in the doctor’s office or emergency department. It is expected that these large retailers will continue to expand their product offerings to include lab tests, imaging services, and medication infusions. Management believes that these market entrants may either become new competition or new partners for institutions such as the System.
Although presenting challenges as cited above, these changes also present UMMHC with an opportunity to deepen and broaden its mission of improving the health of the diverse communities it serves. UMMHC’s objective will be to leverage all of the assets of the System and its partners to promote the “total health” of the community.
Summary of Strategic Plan Initiatives
The Strategic Plan includes initiatives designed to respond to the shifting payment paradigm and to enhance the quality of care and healthcare outcomes for System patients. Certain key tactics included in the Strategic Plan are summarized below.
• Provide “World Class Access to World Class Doctors” through 855-UMASS-MD, the System’s online scheduling programs (ZocDoc and patient portal) and its concierge service for referring providers.
• Develop and implement entity- and department-level quality and service improvement plans.
• Expand service offerings to include easy-to-access, high value services including urgent care, non- hospital-based ambulatory surgery, and telemedicine/virtual medicine outpatient visits at a lower cost, using joint venture partnerships where appropriate to secure enhanced expertise or an improved cost profile. o The System, and its joint venture partner CareWell, have opened four urgent care centers: two in Worcester, and one in each of Northborough and Marlborough. A fifth urgent care site opened in Fitchburg in December 2016. In addition, the System has two fully-owned sites in North County that are managed by Health Alliance.
o The System has entered into a real estate agreement to develop a nine operating room ambulatory surgery center (“ASC”) through a joint venture with Shields Healthcare Group. The ASC is designed to accommodate lower acuity outpatient surgeries in a lower cost environment, emphasizing easy access and patient convenience. The project has received a Determination of Need (“DoN”) approval from MA DPH.
• Analyze service line investments and adjust annually based on clinical and academic quality and efficiency programs, profitability, and growth potential.
o As a provider of eICU services (since 2006) and Telestroke services (since 2009) in New England, the System has an opportunity to leverage its experience, which now includes 25 discrete virtual medicine programs, in an effort to become a leader in the inpatient consultation and outpatient segment of virtual medicine. The System has recently started recruiting for a leader who will unify tele-medicine efforts.
• Focus on costs of providing care. Maintaining a low cost structure allows health systems to better adapt to any future negative trends within the market place such as payor mix shift, risk contracting, and governmental reductions in revenue. Management believes the System’s cost structure is competitive within the Massachusetts marketplace, although a focus on maintaining and improving clinical costs is ongoing. Costs per discharge, adjusted to exclude direct medical education costs and physician compensation, is one metric published by the Massachusetts Center for Health Information and Analysis (“CHIA”) to assess cost structure for Massachusetts hospitals. According to CHIA’s November 2015 Hospital Profiles Report, UMMHC’s adjusted inpatient cost per discharge in 2014 was $11,743, which is 6.7% below the weighted average adjusted cost per case for all Massachusetts A-7 APPENDIX A academic medical centers. When the nine other principal Massachusetts teaching hospitals are added to the peer group, UMMHC’s adjusted inpatient cost per discharge is only 1.2% above the peer group average.
• Grow owned and affiliated community-based primary and specialty care practices.
• Become a Medicare accountable care organization (“ACO”), enhance total medical expenses (“TME”) management capabilities, and expand successful pilot programs (MyLink).
o On January 1, 2015, UMass Memorial Accountable Care Organization, Inc. (the “UMass ACO”), began participating as an ACO in the Medicare Shared Savings Program (“MSSP”) and the Medical Center began participating in the Bundled Payments for Care Improvement Initiative (“BPCI”) with shared risk bundles in spinal fusion, coronary artery bypass grafting, and total joint replacement.
• Align with payors and employers.
• Create an ACO laboratory with the Medical School.
• Enhance employee development and recognition programs.
• Partner with the Medical School to build an information technology (“IT”) system that integrates all available clinical data that is fast, dependable, and easy to use from a secure mobile platform.
To achieve the goals of the Strategic Plan, Management believes that the System must operate as an integrated delivery system, with all Affiliates adopting a “one brand, one balance sheet, one mission” philosophy, creating efficiencies through the greater consolidation and coordination of services (both clinical and administrative) of its member entities. This includes the addition of HealthAlliance and Ventures into the Obligated Group in July 2014, and the plan to merge Clinton Hospital into HealthAlliance Hospital, providing operating, clinical and care management synergies, and consolidating and reducing management overhead.
In addition, the Medical Center, for the benefit of the System, has embarked on a master facilities planning process, which is expected to include refreshing of patient care areas to enhance patient satisfaction, implementing single beds at all facilities, and updating the facilities’ infrastructure. The System is engaged in planning to identify the best use of academic medical center space appropriate to the tertiary and quaternary patient needs.
EPIC Implementation
UMMHC will accelerate the execution of the aforementioned strategies by implementing a system-wide electronic health record (“EHR”) that is designed:
• To be fast, secure and user friendly. • To encourage standardized care across the System through evidence and consensus based care pathways. • To aggregate data from across the System for quality reporting and improvement. • To be extendable to affiliated hospitals and providers in the System’s network. • To provide the System’s clinicians with all the clinical data and decision support tools necessary to make the best possible clinical decisions.
A-8 APPENDIX A The System has begun implementation of an Epic Systems Corporation EHR platform (“Epic”) for System facilities, replacing a number of separate information systems currently in place with a fully integrated IT platform designed to enable operating efficiencies, enhance provider productivity and continuum of care, as well as provide an effective and more convenient portal for patients and providers. Epic was chosen following an extensive selection process including both detailed physician and clinical staff review and feedback, and is scheduled to be implemented at the end of 2017 at all System facilities with the exception of Community Health Link.
The Epic implementation project is being led by individuals who have implemented Epic at several large academic health systems. The project is on schedule for the “Phase 1 Go-Live” on October 1, 2017, which includes the UMMHC member hospitals and the UMass Memorial Medical Group, Inc. (the “Medical Group”). The implementation will be followed by a post “Go-Live” phase, which is a period of stabilization and then optimization of the system.
Total incremental cost during the implementation process, including both capital and operating costs, is projected at approximately $270 million and $52 million, respectively. The System has secured financing of $125 million to finance a portion of the Epic project, with remaining costs funded from existing resources and operating cash. Management views the Epic project as an important strategic investment that will provide the System with a platform for continuous process and quality improvement while providing one record for primary care, specialists, and patients. Management is working proactively with Epic personnel to achieve a smooth transition. Given the possibility of cash flow interruptions during the transition period, Management has increased its current revolving loan agreement to $75 million. Management also anticipates that it may need to reduce scheduled admissions and procedures to provide additional flexibility due to potential implementation disruptions, which could result in volume decreases during the Epic implementation.
Joint Strategy with the Medical School
In addition to UMMHC’s own Strategic Plan, the System participated in a year-long joint strategic planning process with the Medical School that concluded in August 2014 with a joint strategic plan. This plan includes creating an ACO laboratory with the Medical School. For further information about the relationship between the System and the University, see “HISTORY AND TRANSACTION.”
Other Strategic Affiliations
In December 2016, UMMHC and Dana-Farber Cancer Institute, Inc. (“Dana Farber”) entered into a clinical collaboration agreement under which the cancer center at the Medical Center (the “Cancer Center”) will become a member of the Dana-Farber Cancer Care Collaborative. Under this arrangement, Dana Farber will provide certain consulting, educational, and clinical support services to the Cancer Center. The effective date of the proposed arrangement is dependent upon receipt of applicable regulatory approvals and satisfaction of certain conditions set forth in the agreement.
As part of its ongoing strategic planning, from time to time the System may receive offers from, or conduct discussions with, third parties about potential affiliations or mergers. Such discussions are held on an intermittent, and usually confidential, basis and each potential opportunity is evaluated as it arises. Any affiliation or other similar transaction would be effected in compliance with the covenants in the Master Trust Indenture.
SYSTEM SERVICE AREA
System Service Area
Massachusetts does not have a central data source that tracks outpatient volume for all hospitals, and thus the following information relates solely to inpatient volume. In 2016, approximately 57% of the System’s net patient services revenue came from outpatient services, with the remaining 43% coming from inpatient services.
For inpatient services, the System draws patients from Worcester County, Massachusetts and the surrounding communities, from other parts of The Commonwealth of Massachusetts (the “Commonwealth”), and from other states. The City of Worcester developed in the early 1900s as a center of heavy manufacturing and mechanical invention. Today, the city has evolved to include a focus on biotechnology, education, and intermodal commerce, while still retaining a significant amount of manufacturing.
A-9 APPENDIX A Prior to 2015, the System defined its service area to include the City of Worcester and 64 surrounding cities and towns. In recognition of the System’s increasing reach to patients beyond Worcester County, Management determined in 2015 that a service area incorporating all of central Massachusetts better reflected the communities served by the System and it therefore expanded the System’s total service area (the “Service Area”) to include Worcester County (excluding the town of Blackstone), the town of Orange (located in Franklin County), and 14 towns in Middlesex County. According to a 2015 estimate published by the UMass Donohue Institute, Worcester County has an estimated population of 822,696. According to the same source, the Service Area has an estimated population of 1,062,427, a 3.6% increase since 2010, compared to a 3.7% increase for the Commonwealth overall during the same time period. According to the U.S. Census Bureau’s estimates of population characteristics, the median household income for Worcester County for the 2010–2014 time period was estimated to be 3.5% lower than that of the Commonwealth, at $65,453 as compared to $67,846. The percentage of persons below the poverty level was 11.5% for Worcester County and for the Commonwealth.
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A-10 APPENDIX A The following maps illustrate the Service Area:
SERVICE AREA
The Service Area encompasses all of Worcester County, except for the town of Blackstone, plus the town of Orange in Franklin County, and 14 of the towns in Middlesex County.
A-11 APPENDIX A
SYSTEM DISCHARGES BY PATIENT ORIGIN 2012–2014
2012 2013 2014 Discharges % Discharges % Discharges %
Service Area 48,729 90% 45,429 89% 44,034 90%
Other Massachusetts 3,125 6 2,900 6 2,654 5
Other 2,456 4 2,473 5 2,075 5
Total* 54,310 100% 50,802 100% 48,763 100% ______* Discharges as collected by the Massachusetts Health Data Consortium and CHIA. Numbers used in the “System Discharges by Patient Origin” table may vary up to 1.5% from actual values due to timing differences for when the data is collected and reported. Includes all discharges except normal newborns. Source: Massachusetts Health Data Consortium 2012 and CHIA 2013–2014.
Clinical Affiliates
In addition to its primary academic affiliation with the Medical School, the Medical Center maintains clinical affiliations with the following providers:
• Berkshire Health Systems • Day Kimball Hospital • Harrington Memorial Hospital • Heywood Hospital • Holyoke Medical Center • Milford Regional Medical Center
These affiliation arrangements range from the pursuit of special projects to the provision of clinical and professional services to educational and training opportunities for various departments of the clinical affiliates.
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A-12 APPENDIX A Competition
The System accounted for 44% of all patients discharged from the Service Area in 2014, the most recent year for which data are available. Management considers Tenet Healthcare Corp. (“Tenet”), a national for-profit hospital chain represented locally by St. Vincent Hospital (“St. Vincent”) and MetroWest Medical Center (“MetroWest”), to be the System’s principal competitor located within the Service Area. St. Vincent is a 314-licensed bed acute care hospital located in Worcester, Massachusetts that opened its current inpatient facility in April 2000, and MetroWest is a 313-licensed bed acute care hospital, with two campuses, located in Framingham and Natick, Massachusetts. Both St. Vincent and MetroWest were purchased by Tenet in 2013 through its acquisition of for-profit Vanguard Health Systems. Together, the two hospitals accounted for 23% of patients discharged from the Service Area in 2014.
The following table summarizes market share information for the System and its competitors within the Service Area. For 2014, no competing hospital other than Tenet hospitals exceeded 5% of total discharges within the Service Area.
SYSTEM SERVICE AREA DISCHARGES 2012–2014
2012 2013 2014
Discharges % Discharges % Discharges %
System 48,729 45% 45,429 43% 44,034 44%
Tenet 26,681 24 25,648 25 23,296 23
Clinical Affiliates* 13,717 13 13,988 13 13,203 13
Other Hospitals 20,425 18 19,633 19 19,758 20
Total** 109,552 100% 104,698 100% 100,291 100% ______* Does not include Clinical Affiliate Day Kimball Hospital as the System does not receive Connecticut data. ** Total discharges excludes normal newborns. Source: Massachusetts Health Data Consortium 2012 and CHIA 2013–2014.
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A-13 APPENDIX A SYSTEM GOVERNANCE
The Parent and the Medical Center have identical Boards of Trustees (the “Board of Trustees”), consisting of 19 individuals, including 12 elected Trustees, four Trustees selected by the Chancellor of the Medical School with the advice and consent of the President of the University, and the Chancellor, the Chairperson of the Board, and the President/Chief Executive Officer of the Parent, ex officio, with vote. All Trustees, other than the three ex-officio Trustees, are divided into four classes, the term of one class expiring each year. At each annual meeting of the Trustees, the Trustees elect, for a term of four years, the appropriate number of successors to the class whose term is then expiring. There is also a category of Emeritus Trustees who do not have a vote and are not counted in determining presence of a quorum.
The Board of Trustees has taken steps over the last three years to broaden the membership of the Board to include expertise in so-called “Lean” techniques in healthcare, accountable care organizations, patient experience, and population health. The Board of Trustees has also established an ad hoc IT Committee, comprised of individuals with IT experience from around the country, to help guide its IT decisions and implementation.
Years of Tenure on Name Parent Board Principal Affiliation
David L. Bennett, Chairperson, 18 Principal Attorney, Bennett & Forts, P.C., Holden, MA Ex-Officio
Richard Bennett 4 President and Chief Executive Officer of Marlborough Savings Bank, Marlborough, MA
Michael Collins, M.D., Ex-Officio 9 Chancellor, University of Massachusetts Medical School, Worcester, MA
Raymond Pawlicki 1 Retired CIO for Novartis Pharmaceuticals Corp and Biogen
Edward D’Alelio 7 University of Massachusetts Foundation, Treasurer and Investment Committee Chairman, Boston, MA
Eric Dickson, M.D., Ex-Officio 3 President, CEO, UMass Memorial Health Care, Inc, Worcester, MA
Terence Flotte, M.D. 8 Dean, University of Massachusetts Medical School, Worcester, MA
Robert Finberg 4 Chair, Department of Medicine, University of Massachusetts Medical School, Worcester, MA
Elvira Guardiola, Esq. 2 Parking Administrator/Municipal Hearing Officer, City of Worcester, Worcester, MA
Paul Kangas 5 Senior Vice President, Director of Enterprise Risk, Chief Compliance Officer, TJX Companies, Inc., Framingham, MA
Peter Knox 3 Executive Vice President, Bellin Health, Green Bay, WI
Harris MacNeill 6 President, CEO and Owner of MacNeill Engineering, Marlborough, MA
Mary Ellen McNamara 6 Director, Business Transformation, Philips Health Systems North America, Andover, MA
A-14 APPENDIX A Years of Tenure on Name Parent Board Principal Affiliation O. Nsidnanya Okike, M.D. 10 Retired cardiac surgeon, UMass Memorial Medical Center, Inc., Worcester, MA
Edward Parry, III 14 Principal, Montshire Advisors
Paulette Seymour-Route, Ph.D 5 Dean Emeritus & Professor UMass Medical School, School of Nursing, Worcester, MA, Per Diem Project Manager Quality and Patient Safety, UMMHC
Richard Siegrist 3 Adjunct Professor, Harvard School of Public Health, Cambridge, MA; former CEO and Chief Innovation Officer, Press Ganey Associates, South Bend, IN
Jack M. Wilson, Ph.D 5 Distinguished Professor of Higher Education, Emerging Technologies, and Innovation, University of Massachusetts Lowell; President-Emeritus, University of Massachusetts, Boston, MA
Lynda Young, M.D. 3 Physician, Department of Pediatrics, UMass Memorial Medical Center, Inc., Worcester, MA
There are eight standing committees of the Board of Trustees: Audit, Finance, Governance, Investment and Pension, Compensation and Senior Management Evaluation, Academic Integration, Compliance, and Community Benefits. Pursuant to the Definitive Agreement and the Act (each as defined herein in “HISTORY AND TRANSACTION”), during the 99-year term of the Affiliation Agreement, the Chancellor of the Medical School serves as an ex-officio member of the Board of Trustees and is entitled to appoint four individuals to the Board of Trustees of the Medical Center. For more information, see “HISTORY AND TRANSACTION” herein.
SYSTEM MANAGEMENT
Eric W. Dickson, M.D., MHCM, age 50, was named President and Chief Executive Officer (“CEO”) of the Parent on June 25, 2013. Dr. Dickson completed his medical degree and residency training in emergency medicine at the Medical School and has a Masters Degree in Health Care Management from Harvard University. Prior to his appointment as CEO, Dr. Dickson served as President of the Medical Group, Professor and Head of the Department of Emergency Medicine at the University of Iowa Carver College of Medicine and Interim Chief Operating Officer for the University of Iowa Hospitals and Clinics. In addition to his other duties, Dr. Dickson lectures nationally on the use of “Lean” techniques in healthcare, has served as a member of the Baldrige National Quality Award Board of Examiners, and is an active faculty member for the Institute of Healthcare Improvement.
Sergio L. Melgar, age 57, was appointed Executive Vice President and Chief Financial Officer (“CFO”) of the Parent in January of 2014. For the past 24 years, Mr. Melgar has been working with health care and academic institutions. Prior to his appointment in 2014, he participated in the acquisition and subsequent integration of the health care network of Catholic University in Chile into CHRISTUS Health, a U.S. Catholic health care system serving as CFO of International Operations. For eight years, he served as the Senior Vice President for Health Affairs and CFO at the University of Kentucky overseeing all financial aspects of the clinical operations of the university hospitals and medical group, its commercial health insurance company, and its health colleges. For 10 years prior to relocating to Kentucky in 2004, Mr. Melgar served as the CFO of UCLA Health, the clinical and medical teaching arm of the University of California Los Angeles. Between 1981 and 1987, he served at Arthur Andersen & Co. and between 1987 and 1992 he served at Ernst and Young. Mr. Melgar received his B.A. in Economics from the University of California Los Angeles.
Douglas S. Brown, age 54, was appointed Senior Vice President and General Counsel for the Parent in October 2003 and in 2014 was promoted to President of Hospitals, Inc. and Chief Administrative and Legal Officer for the System. For the nine years preceding his initial appointment, Mr. Brown served in various legal and executive roles in Massachusetts state government, including service as an Assistant Attorney General; General Counsel to the Senate Committee on Ways and Means; and General Counsel, Deputy Commissioner and Acting Commissioner of the Division of Medical Assistance (the state Medicaid agency). Mr. Brown spent the first six years of his legal
A-15 APPENDIX A career at two large law firms in San Francisco and Boston. Mr. Brown received his B.A. in International Relations and J.D. from Boston University. He is a member of the Massachusetts bar.
Stephen E. Tosi, M.D., age 72, was appointed the System Chief Medical Officer and Chief Physician Executive in 2013. He was appointed Senior Vice President of the System in 2002. He also serves as President of the Medical Group. Dr. Tosi is a Director of Physician Health Services, which is a Board of Registration in Medicine-recognized organization that is designed to identify, refer to treatment and monitor the recovery of physicians with behavioral health concerns and substance abuse disorders. Dr. Tosi is the Medical Director of Commonwealth Professional Assurance Corporation, the System self-insurance trust (“CPAC”). Dr. Tosi currently serves the Medical School as Clinical Associate Professor of Urology. Dr. Tosi received his medical degree from Cornell University Medical College. His completed his surgical and urology residencies at the Dartmouth-Hitchcock Medical Center in Hanover, New Hampshire. He completed his military service as Lt. Commander in the U.S. Public Health Service, Indian Health Division, Rosebud, South Dakota.
Patrick L. Muldoon, age 62, is the President of the Medical Center. Mr. Muldoon, who was appointed President in August 2013, is responsible for all Campuses of the Medical Center. Prior to this role, Mr. Muldoon served as the President and CEO of HealthAlliance and CNEHA. He earned his undergraduate degree in Health Services Administration from Providence College and a master’s degree in Business Administration from Loyola University of Chicago. He is currently a Fellow of the American College of Health Care Executives. Mr. Muldoon recently served as the Board Chair of the MHA.
Timothy A. Tarnowski, age 58, was appointed System Senior Vice President and Chief Information Officer (“CIO”) in 2014. He joined UMMHC with experience in IT governance models, strategic planning, and the optimization of IT operations at several large academic health systems, including Indiana University Health, University of Kentucky Healthcare, and Stanford University Hospital and Clinics, where he was primarily accountable for a successful $175 million Epic implementation. Mr. Tarnowski received his B.B.A. in accounting at Cleveland State University, his M.I.M. in international finance at Thunderbird, The Garvin School of International Management, and his M.B.A. at Escuela Superior de Administración y Dirección de Empresas.
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A-16 APPENDIX A SYSTEM UTILIZATION
The following table summarizes significant utilization data for the System for the five years ended September 30, 2016.
Obligated Group Only Acute Care* 2012 2013 2014 2015 2016 2016
Average Beds Available 919 921 904 915 920 812 Discharges** 53,402 49,979 47,639 49,930 49,816 45,223 Patient Days** 259,724 256,497 248,808 259,687 259,608 234,840 Percent Occupancy 81.3% 82.8% 83.1% 84.0% 83.9% 85.3% Average Length of Stay 4.86 5.13 5.22 5.20 5.21 5.19 Case Mix Index*** 1.44 1.49 1.51 1.52 1.57 1.59 Observation Cases 12,661 14,533 15,591 13,669 14,250 11,391 Emergency Visits 225,019 218,789 215,014 215,479 222,846 182,260 Cardiac Catheterization Procedures 6,351 6,263 6,379 6,624 6,759 6,759 Lab Tests**** 16,110,904 12,807,676 9,023,294 6,976,829 7,343,279 6,709,686 Radiation Procedures 593,305 585,495 568,106 582,334 588,653 508,485 Life Flight Trips 529 472 506 471 492 492
Surgery Inpatient Surgery Cases 14,503 12,752 11,889 11,709 11,632 11,251 Outpatient Surgery Cases 23,483 24,364 25,134 25,008 24,657 22,504 Endoscopy Cases***** 29,266 28,276 28,962 30,240 32,149 28,328 Total Surgery Cases 67,252 65,392 65,985 66,957 68,438 62,083
Other Ambulatory Clinic Visits****** 717,490 723,435 738,677 727,451 743,422 743,422 Health Center Visits 100,777 109,486 106,539 109,387 112,230 112,230 Home Health Visits******* 134,368 72,209 66,670 54,758 55,436 55,436 ______* All statistics exclude information relating to Wing Memorial Hospital. ** Excludes normal newborns. *** CMS medical surgical DRG case mix, excluding Psychiatry. **** Lab Tests include outreach activity. The Lab Outreach business was sold to Quest Diagnostics division on January 2, 2013. ***** Includes statistics for the Medical Center, Health Alliance, Marlborough Hospital, and Clinton Hospital. ****** Includes statistics for only the Medical Center. ******* Home Health Visits for 2012 included the Medical Center’s Home Health and Hospice. This business was sold on September 17, 2012.
A-17 APPENDIX A Management’s Discussion of System Utilization Trends
Inpatient discharges decreased by 3,586, or 6.7%, between 2012 and 2016. Management attributes this change primarily to a statewide decline in inpatient volume and a shift to observation status for low acuity inpatients. Inpatient volume in 2016, compared to 2015, is relatively flat with a decrease of 114 discharges or 0.2%. Observation cases increased by 1,589 or 12.6% from 2012 to 2016, growing by 581 or 4.3% from 2015 to 2016 alone.
Average length of stay and case mix are also affected by the decline in inpatient discharges and shift to observation status. As low length of stay and low acuity cases move to an observation status, both inpatient metrics increase: average length of stay and case mix, based on the current population of inpatient discharges. Average length of stay has increased from 2012 to 2016 by 0.35 days or 7.2% primarily due to the shift to observation status. Case mix index has increased from 2012 to 2016 by 0.13 or 9.0%.
Lab tests have decreased significantly due to sale of the Lab Outreach program to Quest Diagnostics. Lab tests in 2012 were 16,110,904 compared to 7,343,279 in 2016, following sale of the lab outreach tests business. Radiology volume has decreased by 4,652 procedures or 0.8% based on decreased imaging volume and changes in coding and billing practices. The majority of radiology coding changes involve bundling two codes into one new code for reimbursement purposes.
Ambulatory clinic visits and health center visits have both increased from 2012 to 2016. Growth in ambulatory clinic visits for this period was 3.6%, compared to growth in health center visits of 11.4%. Inpatient surgical cases decreased by 2,871 (19.8%) from 2012 to 2016, while outpatient surgical cases (including endoscopy cases) grew by 4,057 (7.7%) for the same period.
Management believes that UMMHC’s joint venture with CareWell has contributed to increases in referrals to UMMHC entities for various specialty services that are not able to be provided at the urgent care locations. UMMHC’s Medical Group has also expanded its physician presence at affiliated hospitals, resulting in more high acuity patients being referred to the Medical Center.
FINANCIAL INFORMATION OF THE SYSTEM
The following summary statements of operations of the System for the years ended September 30, 2014, 2015, and 2016 were derived from the consolidated financial statements of the Parent and its Affiliates.
Appendix B to this Official Statement sets forth the audited consolidated balance sheets of the System as of September 30, 2016 and 2015, and the related consolidated statement of operations, changes in net assets, and cash flows for the years then ended, together with supplemental consolidating information and the report of PricewaterhouseCoopers LLP, independent auditors on the 2016 consolidated financial statements. Appendix B includes financial information for entities that are not obligated with respect to the Bonds. In 2016, the Obligated Group represented 78.7% and 80.9% of the System’s total revenues and assets, respectively.
The summary statement of operations should be read in conjunction with the complete consolidated financial statements and supplemental consolidating information of the System for 2015 and 2016, together with the related notes and the independent auditors’ report included in Appendix B. As noted above, the System contains Affiliates that are not part of the Obligated Group.
A-18 APPENDIX A SYSTEM CONSOLIDATED STATEMENTS OF OPERATIONS* (dollars in thousands)
2014 2015 2016
Unrestricted revenues, gains and other support Net patient service revenue $ 2,152,087 $ 2,173,845 $ 2,306,846 Less: Provision for bad debts (43,989) (48,863) (40,420) Net patient service revenue less provision for bad debts 2,108,098 2,124,982 2,266,426 Net assets released from restrictions used for operations 2,985 2,618 3,096 Other revenue 141,125 114,110 103,931 Total revenues, gains and other support 2,252,208 2,241,710 2,373,453 Expenses Salaries, benefits and contracted labor 1,293,021 1,298,997 1,368,449 Supplies and other expense 798,014 766,299 840,781 Depreciation and amortization 92,905 104,230 111,008 Interest 14,441 14,146 12,520 Total expenses 2,198,381 2,183,672 2,332,758 Income (loss) from operations before nonrecurring income and expenses 53,827 58,038 40,695 Gain (loss) on sale of business (9,155) 13,295 - (Expenses) expense reductions associated with sale of business 853 873 - Expenses associated with reduction in force (16,478) - - Income from operations after nonrecurring income and expenses 29,047 72,206 40,695 Nonoperating income (loss) Investment and other related income 5,490 5,608 4,446 Net realized and unrealized gain (loss) on investments 26,115 (30,815) 26,139 Actuarial change in the present value of annuities 190 (352) (369) Loss on refunding of debt - - (2,861) Total nonoperating income (loss) 31,795 (25,559) 27,355 Excess of revenues over expenses 60,842 46,647 68,050 Other changes in net assets Gain on sale from discontinued operations 1,439 - - Loss on transfer of membership interest (11,187) - - Contributions for property and equipment - 1,958 2,877 Net assets released from restrictions used for purchase of property 2,560 773 925 and equipment Pension-related changes other than net periodic benefit cost (36,398) (57,318) (93,809) Increase (decrease) in unrestricted net assets 17,256 (7,940) (21,957) Unrestricted net assets, beginning of year 761,488 778,744 770,804 Unrestricted net assets, end of year $ 778,744 $ 770,804 $ 748,847 ______* Includes entities that are not members of the Obligated Group. Source: System records.
A-19 APPENDIX A MANAGEMENT’S DISCUSSION OF RECENT FINANCIAL PERFORMANCE
The System generated an excess of revenues over expenses of $68.1 million in 2016, $46.6 million in 2015, and $60.8 million in 2014. The System reported positive operating margins before non-recurring income and expenses of $40.7 million in 2016, $58.0 million in 2015, and $53.8 million in 2014. Over the same period, the System recorded a decrease in unrestricted net assets of $22.0 million in 2016, $7.9 million in 2015, and an increase of $17.3 million in 2014.
In the early 2010s, Management recognized that revenue growth had stagnated while expenses continued to increase. Upon Dr. Dickson’s appointment at the end of 2013, Management focused on reducing costs, including the elimination of approximately 400 full-time equivalent employees (“FTEs”), disposing of certain assets not part of core operations (including the transfer of ownership of Wing Memorial Hospital to Baystate Medical Center, and selling a partial interest in Fairlawn Rehabilitation Hospital and certain real estate), closing certain units and clinical space at the Medical Center, and reducing supply chain costs. At the end of 2014, the Medical Center implemented an operational flex budgeting tool to track per-unit cost variances based on changes in patient services to better manage staffing resources based on patient mix.
In addition to aligning the cost structure, a number of initiatives were developed to grow revenue. These included improved access to System clinicians including a central appointment line, an online referral and appointment system, improvements in patient flow to reduce “boarders” in the System emergency department facilities, and enhancements to the revenue cycle, which improved cash collections and reduced accounts receivable.
The System’s revenue in the last three years has been further positively affected by a shift in payor mix. In 2014, more patients became eligible for Medicaid and other subsidized insurance plans as a result of the enrollment by individuals in affordable care plans, which decreased free care and bad debt. The System also worked actively with the Commonwealth to increase revenue for Medicaid Supplemental Funds (“MSF”) to address the growing number of Medicaid patients being treated (see “Medicaid Supplemental Funds” below).
The System has also increased its joint venture relationships as part of its Strategic Plan, particularly in ancillary outpatient services (pharmacy, lab, and diagnostic imaging). The income from joint venture investments has increased from $9.1 million in 2013 to $23.8 million in 2016.
Both the Medical Center and HealthAlliance are participants in the federal 340B Drug Pricing Program (“340B Program”). Enacted in 1992, the 340B Program requires pharmaceutical manufacturers to sell a range of prescription medications to outpatient healthcare organizations at significantly lower prices than standard formulary pricing, with discounts as high as 25–50%. Those providers, primarily remote and rural facilities or hospitals with a disproportionate share of lower-income patients, can then offer the discounted medications to qualifying patients. The financial benefit accrues when such eligible providers, including the Medical Center and HealthAlliance, acquire the drugs at lower cost but receive market competitive rates, which do not take into account the 340B discounts, for such drugs. In 2016, the Medical Center realized $30.9 million in drug cost savings and $129.2 million in contract and retail pharmacy net revenue, and Ventures’ specialty pharmacy joint venture realized $8.7 million in net revenue. Continued eligibility for and participation in the 340B Program are subject to regulatory risk, as described in “BONDOWNERS’ RISKS AND MATTERS AFFECTING THE HEALTH CARE INDUSTRY – Significant Risk Areas Summarized.”
A discussion of the System financial information is set forth below.
2016 Compared to 2015
Revenues, Gains and Other Support – Total revenues, gains and other support of the System increased from $2.24 billion to $2.37 billion for 2016, as compared to 2015. The combined net patient service revenue less provision for bad debts of the System increased by $141.4 million, from $2.12 billion to $2.27 billion for 2016, compared to the prior year period, or by 6.7%. Management attributes this growth in net patient service revenue to certain rate and volume increases and positive case-mix. The revenue growth also includes an increase in MSF of $27.4 million, an increase in the Medical Center’s outpatient specialty pharmacy of $15.1 million, as well as a decrease in the provision for bad debts of $8.4 million compared to the prior year period. For more information about MSF, see “Medicaid Supplemental Funds” below. The decrease in the provision for bad debts is primarily due to fluctuations in certain payor categories as compared to the prior year period. The System’s revenue growth was partially offset by an increase in free care expense of $19.7 million, compared to the prior year period. Compared to 2015, the following statistics increased: laboratory tests by 5.1%, observation cases by 4.3%, emergency room visits by 3.4%,
A-20 APPENDIX A case mix index by 3.3%, cardiac catheterization procedures by 2.0%, and surgeries by 1.7%. Discharges decreased by 0.2%, while patient days declined slightly from 259,687 to 259,608 or by 0.03% as compared to the prior year period. Other revenue decreased from $114.1 million to $103.9 million, or by $10.2 million (8.9%) due the System’s captive insurance company recognizing retrospective premium credit returns as well as a decrease in its realized investment gains, and a decrease in the Medical Center’s lab outreach tests and related costs following the sale of the clinical outreach and anatomic pathology outreach lab businesses to Quest Diagnostics. These decreases were partially offset by an increase in income related to the System’s investments in certain joint ventures as well as an increase in contract pharmacy arrangements.
Expenses – Total expenses of the System increased from $2.18 billion for 2015, to $2.33 billion for 2016, or by $149.1 million (6.8%). Management attributes this increase in expenses to increases in supplies and other expenses of $74.5 million, salaries, fringe benefits, and contracted labor of $69.4 million, and depreciation and amortization expenses of $6.8 million, partially offset by a decrease in interest expense of $1.6 million. The increase in supplies and other expenses is primarily due to an increase in Medical Education Services expense of $24.4 million, as well as increases in insurance claims cost recognized by the System’s captive insurance company, professional fees, pharmaceuticals, medical surgical supplies, software maintenance fees, purchased temporary services, and rentals and leases, offset by decreases in purchased services and participation payment. The increase in salaries, fringe benefits, and contracted labor is attributable to wage inflation, including a 2% bonus payment to non-union employees, an increase in FTEs, and increases in certain fringe benefits provided to the labor base. Depreciation and amortization expenses increased as a result of adjusting the estimated useful lives of certain property and equipment expected to be replaced by the new EHR and billing system. Interest expense decreased as a result of refinancing certain existing debt to obtain the benefit of lower interest rates.
Gain (loss) and expenses associated with sale of business – On January 3, 2013, the Medical Center completed the sale of its clinical outreach and anatomic pathology outreach businesses to Quest Diagnostics. The sales agreements included a transition period of 18–24 months to complete the full transition of services. The consideration received in conjunction with the sale was a combination of cash and an option to purchase an equity interest in a newly formed Quest Diagnostics subsidiary. There were no such transactions during 2016.
Non-operating Income (Expense) – During 2016, the System reported investment income of $4.4 million and net realized and unrealized gains of $26.1 million, which includes net unrealized gains of $23.2 million and net realized gains of $2.9 million. The System recorded a $2.9 million loss on refunding of debt and also recorded a $0.4 million decrease in the present value actuarial valuation of certain annuities. During 2015, the System reported investment income of $5.6 million and net realized and unrealized losses of $30.8 million, which includes net unrealized losses of $44.6 million and net realized gains of $13.8 million. The System also recorded a $0.4 million decrease in the present value actuarial valuation of certain annuities.
Other Changes in Net Assets – During 2016, the System recorded a decrease in net assets for pension related changes other than net periodic benefit cost of $93.8 million due to a lower discount rate. The System recorded $2.9 million of contributions for property and equipment a well as $0.9 million of net assets released from restrictions used for the purchase of property and equipment. During 2015, the System recorded a decrease in net assets for pension related changes other than net periodic benefit cost of $57.3 million, which was attributable to a lower discount rate and decrease in mortality. The System recorded $2.0 million of contributions for property and equipment as well as $0.8 million of net assets released from restrictions used for the purchase of property and equipment.
2015 Compared to 2014
Revenues, Gains and Other Support – Total revenues, gains and other support of the System decreased from $2.25 billion to $2.24 billion for 2015, as compared to 2014. The combined net patient service revenue less provision for bad debts of the System increased from $2.11 billion to $2.12 billion for 2015, compared to the prior year or by $16.9 million (0.8%). Management attributes this growth in net patient service revenue to certain rate and volume increases and a decrease in free care expense of $3.5 million. In addition, this growth was offset by shifts of volume between payors, a decrease in MSF of $71.4 million due to a revision in the Massachusetts Medicaid program’s methodology and adjustments for prior years, as well as an increase in the provision for bad debts of $4.9 million over the comparable prior period. For more information about MSF, see “Medicaid Supplemental Funds” below. The increase in the provision for bad debts is primarily due to fluctuations in certain payor categories as compared to the prior period. Compared to 2014, discharges increased by 4.8%, patient days increased by 3.8%, health center visits increased by 2.7%, and emergency visits increased by 0.2%. In addition, the System’s revenue increased with the transition of patients from observation status (which decreased by 11.9%) based on more appropriate coding due
A-21 APPENDIX A to clarification of the rules related to observation status. Home health visits decreased by 17.9%, and surgeries decreased by 0.8% over the same period. Other revenue decreased from $141.1 million to $114.1 million, or by $27.0 million (19.1%), due principally to a decrease in lab outreach tests provided by the Medical Center and related costs following the sale of the clinical outreach and anatomic pathology outreach lab businesses to Quest Diagnostics, as part of a two-year transition following the January 2013 sale. Other revenue also includes a prior year operating gain of $16.5 million for the partial sale of Fairlawn Rehabilitation Hospital in June 2014.
Expenses – Total expenses of the System decreased from $2.20 billion for 2014, to $2.18 billion for 2015, or by $14.7 million (0.7%). Management attributes this decrease in expenses to a decrease in supplies and other expenses of $31.7 million and interest expense of $0.3 million partially, offset by increases in depreciation and amortization expenses of $11.3 million and salaries, fringe benefits, and contracted labor of $6.0 million. The decrease in supplies and other expenses is primarily due to a decrease in Medical Education Services expenses of $35.7 million, partially offset by increases in purchased services and pharmaceuticals. The increase in salaries, fringe benefits, and contracted labor is attributable to wage inflation and increases in certain fringe benefits provided to the labor base.
Gain (loss) and expenses associated with sale of business – On January 3, 2013, the Medical Center completed the sale of a majority share of its clinical outreach and anatomic pathology outreach businesses to Quest Diagnostics. The valuation of this joint venture option was reassessed in fiscal year 2014 and was decreased by $10.2 million, offset by a $1.0 million adjustment to proceeds from sale. These two transactions combined resulted in a loss on sale of $9.2 million in 2014. Expenses associated with the sale of this business were reduced by $0.9 million in 2014. The transition of services ended in January 2015, and, as of July 1, 2015, the option to purchase an equity interest in the newly formed subsidiary was exercised. The value of the option was adjusted from a fair market value to an equity value and certain net revenues associated with the sale of business of $13.3 million were recorded and expenses were reduced by $0.9 million.
Non-operating Income (Expense) – During 2015, the System reported investment income of $5.6 million, net realized and unrealized losses on investments of $30.8 million, which includes net unrealized losses of $44.6 million and net realized gains of $13.8 million. The System also recorded a $0.4 million decrease in the present value actuarial valuation of certain annuities. During 2014, the System reported investment income of $5.5 million, net realized and unrealized gains on investments of $26.1 million, which includes net realized gains of $25.7 million and net unrealized gains of $0.4 million. The System also recorded a $0.2 million increase in the present value actuarial valuation of certain annuities.
Other Changes in Net Assets – During 2015, the System recorded a decrease in net assets for pension related changes other than net periodic benefit cost of $57.3 million. The System recorded $2.0 million of contributions for property and equipment as well as $0.8 million of net assets released from restrictions used for the purchase of property and equipment. During 2014, the System recorded a decrease in net assets for pension-related changes other than net periodic benefit cost of $36.4 million and recorded $2.6 million of net assets released from restrictions used for the purchase of property and equipment. The System recorded an $11.2 million loss on transfer of membership interest as a result of transferring the membership interest in Wing Memorial Hospital to Baystate Health as of September 1, 2014. For the 11-month period ending August 31, 2014, the System reported Wing Memorial Hospital’s excess of revenue over expenses of $1.4 million in discontinued operations in the statement of changes in net assets.
Medicaid Supplemental Funds
The System receives MSF from the Commonwealth to support its disproportionate status in providing services to patients in central Massachusetts who are insured by governmental payors. The level of funding is subject to regulatory limits and approval by both the Commonwealth and CMS on an annual basis. The System has received MSF since its formation in 1998.
During 2014, the Commonwealth increased its appropriation for the System’s MSF to $240 million from $188 million. For 2014 and subsequent years, CMS modified the process by which the allowable annual appropriation level is determined. Prior to 2014, the System’s annual appropriation was calculated based on a prospective estimate derived from an evaluation of past and projected utilization and Medicaid payment information. If funds were appropriated, the payment would be made based on the prospective estimate, regardless of whether actual activity varied from projected activity. Beginning with 2014, the MSF appropriation process has been modified to include a retrospective verification process. The System still estimates its projected utilization and Medicaid payments to produce an estimated annual request for appropriation, and the Commonwealth’s actual appropriation cannot exceed
A-22 APPENDIX A this estimated amount, but the amount is verified retrospectively and adjusted if necessary to reflect realized utilization and Medicaid payment levels.
In November 2015, CMS and the Commonwealth approved MSF for the System of $210.8 million for 2014. In addition, it was determined that certain regulatory caps had been exceeded for 2012 and 2013 by a combined $12.9 million. Medicaid supplemental payments across the country, including those made to the System, have come under increasing scrutiny by CMS in recent years, and the System expects that this scrutiny will continue. For 2015, and based on projected Medicaid payments, the System recorded $210.8 million in revenue and recognized the change in estimates for prior years.
Based on projected Medicaid payments, the System has recorded $196.0 million in revenue for 2016 and a change in estimates for prior years as outlined in the table below. (See “SOURCES OF PATIENT SERVICE REVENUE— System Sources of Gross Patient Revenue.”)
Of UMMHC’s supplemental payments, $134.1 million was received on December 30, 2016. Subsequent to that, $33.0 million was received on January 3, 2017 and $29.4 million remains outstanding.
On November 4, 2016, CMS approved the Commonwealth’s application for a new five-year waiver with CMS. That new waiver covers the period from July 2017 through June 2022, and supersedes the provisions of the remaining two years of the prior waiver. The proposed waiver permits the Commonwealth to restructure MassHealth by using ACO models and population health management, and provides for Delivery System Reform Incentive Payment (“DSRIP”) funding for certain participating institutions. (See “SOURCES OF PATIENT SERVICE REVENUE— Medicaid.”) UMMHC anticipates applying to participate as a MassHealth ACO, which participation could result in the System becoming eligible for DSRIP funding, although the amount and availability of such funding is not certain at this time. Management believes that the strategic initiatives of UMMHC will help prepare UMMHC to adapt to meet the proposed changes. (See “STRATEGIC VISION AND CURRENT CHALLENGES” for more information.)
Funding of the matching federal supplemental payments in 2017 and following years is dependent on many factors, including federal/state negotiations and future cost containment efforts. There can be no assurance that these funds or funds from other reimbursement sources will be comparable to this level of funding or sufficient to meet UMMHC’s financial needs. (See “BONDOWNERS’ RISKS AND MATTERS AFFECTING THE HEALTH CARE INDUSTRY” below.)
SYSTEM MEDICAID SUPPLEMENTAL FUNDS (dollars in thousands)
Recorded 2013 2014 2015 2016
Current Year: $176,750 $240,000 $210,786 $196,475 Adjustments for prior years 2012 (5,350) 2013 (7,574) 2014 (29,214) 2015 (471) Adjusted MSF $176,750 $240,000 $168,648 $196,004
Source: System Records.
A-23 APPENDIX A SUPPLEMENTAL FINANCIAL INFORMATION FOR THE OBLIGATED GROUP
The following charts set forth the historical coverage of annual debt service on long-term debt of the Obligated Group and pro forma System coverage of System debt. The debt service coverage ratio is based on income available for debt service during 2014, 2015, and 2016, calculated in accordance with the Master Trust Indenture.
OBLIGATED GROUP Actual Historical Debt Service Coverage (dollars in thousands)
2014 2015 2016 Excess of revenues over expenses $ 60,751 $ 80,675 $ 81,382 Income from irrevocable deposits (50) (265) (255) Unrealized (gain) loss on investments - - (16,414) Depreciation and amortization 84,594 95,826 102,073 Interest expense 14,379 13,405 11,803 Reduction in force and severance costs 14,774 - - Gain on sale of business (16,473) (14,168) - Income Available for Debt Service 157,975 175,473 178,589
Actual Debt Service* $ 43,249 $ 39,750 $ 36,276
Historical Coverage of Actual Debt Service** 3.65 4.41 4.92 Pro Forma Maximum Annual Debt Service*** 47,906 47,906 47,906 Historical Coverage of Pro Forma Maximum Annual 3.30 3.66 3.73 Debt Service*** ______* The Aggregate Debt Service Requirement, as defined in the Master Trust Indenture, including 20% of debt service on debt of Non-Obligated Group entities guaranteed by an Obligated Group member. ** Income Available for Debt Service divided by Actual Debt Service, as defined in the Master Trust Indenture. *** Preliminary subject to change. Represents the maximum annual debt service on long-term indebtedness of the Obligated Group following issuance of the Bonds, using an assumed principal amount of $77,650,000, market assumptions concerning interest rates and amortization on the Bonds, assuming the refunding of the Refunded Bonds in full, and an assumed rate of 3% on variable rate debt. Also includes debt service relating to $125 million direct purchase and capital lease indebtedness incurred subsequent to 2016. Source: Obligated Group records.
SYSTEM 2016 Pro Forma Debt Service Coverage (dollars in thousands)
2014 2015 2016 Excess of revenues over expenses $ 60,842 46,647 $ 68,050 Income from irrevocable deposits (50) (265) (255) Unrealized (gain) loss on investments - - (23,231) Depreciation and amortization 92,905 104,230 111,008 Interest expense 14,441 14,146 12,520 Reduction in force and severance costs 16,478 - - Gain on sale of business (16,473) (14,168) - Income available for debt service $ 168,143 $ 150,590 $ 168,092
Pro Forma Maximum Annual System Debt Service* $ 50,129 $ 50,129 $ 50,129
Historical Coverage of Pro Forma Maximum Annual 3.35 3.00 3.35 System Debt Service* ______* Preliminary subject to change. Includes debt of entities that are not in the Obligated Group. Represents the maximum annual debt service on long-term indebtedness of the System following issuance of the Bonds, using an assumed principal amount of $77,650,000, market assumptions concerning interest rates and amortization on the Bonds, assuming the refunding of the Refunded Bonds in full, and an assumed rate of 3% on variable rate debt. Also includes debt service relating to $125 million direct purchase and capital lease indebtedness incurred subsequent to 2016. Source: System records.
A-24 APPENDIX A In the Master Trust Indenture, the Obligated Group has agreed to maintain not less than 60 Days Cash on Hand at the end of each fiscal year. The following chart sets forth the actual Days Cash on Hand as of 2014, 2015, and 2016. There can be no assurance that Days Cash on Hand for future fiscal years will be maintained at the historical levels shown, and failure to achieve and maintain the 60 Days Cash on Hand ratio would not constitute a default under the Master Trust Indenture if the Obligated Group employs a consultant to make certain recommendations and subject to certain other conditions. See Appendix C-3 – “Summary of the Supplemental Master Indenture – Days Cash on Hand Covenant Relating to Obligation No. 14.”
OBLIGATED GROUP Cash and Investments (dollars in thousands)
2014 2015 2016 Unrestricted cash, cash equivalents and marketable $ 468,998 $ 495,460 $ 577,510 securities Amounts held in escrow* - - 45,863 Total Cash 468,998 495,460 623,373
Operating expenses, as defined** $ 1,447,656 $ 1,435,797 $ 1,562,328
Days Cash on Hand 118.2 126.0 146.0 ______* Includes but not limited to principal and interest payments and certain project construction funds held in escrow. ** Operating expenses exclude depreciation, interest and unusual items including MES provided by the University. Source: Obligated Group records.
Liquidity
The Obligated Group’s cash, cash equivalents, and marketable securities as outlined above increased by $127.9 million from 2015 to 2016. The increase in cash was primarily attributable to (1) receipts of MSF payments of $174.2 million attributable to fiscal year 2014 and receipts of $171.9 million attributable to fiscal year 2015, (2) receipt of $61.2 million of construction funds from Series I financing, offset by draw downs of $15.7 million received as unrestricted cash, (3) receipts from operations, particularly from Medicare, Medicaid, Fallon Community Health Plan (“Fallon”), and the Commonwealth’s Health Safety Net Fund (the “Fund”), (4) rebates received from specific vendors, (5) utilization of $55.0 million under a revolving loan, and (6) transfers from Non-Obligated Group participating entities, primarily to fund the fiscal year 2015 and 2014 Medical Education Services (“MES”) commitment to the Medical School. The increase in cash was partially offset by expenditures related to (1) scheduled payments on long-term debt, notes payable, and capital leases, (2) pension contributions of $55.0 million, (3) purchases of property and equipment of $174.8 million, and (4) certain payments to the Medical School consisting of MES payments and payments for shared services and rental payments. The market value of investments increased by $19.0 million during the 12 months ended September 30, 2016. As of September 30, 2016, the Obligated Group had approximately $623.4 million (146 days) of cash on hand.
2016 Compared to 2015
For the Obligated Group, the excess of revenue over expenses, after adding back depreciation and amortization expense of $102.1 million, provided $183.5 million in cash in 2016. In addition, cash was provided during 2016 due to a $4.9 million increase in accounts payable, accrued expenses, and accrued compensation as well as a decrease of $15.9 million in net patient accounts receivable due to cash collection.
2015 Compared to 2014
For the Obligated Group, the excess of revenue over expenses, after adding back depreciation and amortization expense of $95.8 million, provided $176.5 million in cash in 2015. In addition, cash was provided during 2015 due to a $4.7 million increase in accounts payable, accrued expenses, and accrued compensation as well as a decrease of $3.5 million in net patient accounts receivable due to cash collections.
A-25 APPENDIX A Financial Information by Principal Affiliate
The following table presents total unrestricted revenue and other support and the excess (deficiency) of revenue over expenses of the System for 2016 and total assets as of September 30, 2016. The negative values associated with CPAC represent the exclusion of the results of operations of CPAC, a subsidiary of the Parent, from the Obligated Group to the Non-Obligated Group, consistent with the Master Trust Indenture.
SYSTEM SUMMARIZED FISCAL YEAR 2016 FINANCIAL INFORMATION BY PRINCIPAL AFFILIATES* (dollars in millions)
Excess (Deficiency) of Revenue % of Total % of Over Revenues Total assets Total Expenses
Medical Center $ 1,621.5 68.3% $ 1,250.1 54.9% $ 47.6 Parent and Affiliate 206.4 8.7% 558.5 24.5% 18.0 CPAC** (18.0) (0.8%) (160.2) (7.0%) (6.6) Health Alliance Hospital, Inc. 180.0 7.6% 213.9 9.4% 8.2 Health Ventures 13.7 0.6% 71.0 3.1% 14.2 Eliminations*** (134.9) (5.7%) (91.8) (4.0%) - Subtotal Obligated Group 1,868.7 78.7% 1,841.5 80.9% 81.4
Central New England Health Alliance, Inc. and 9.9 0.4% 11.9 0.5% 0.7 Affiliates CPAC 18.0 0.7% 160.2 7.0% 6.6 The Clinton Hospital Association 26.8 1.1% 33.7 1.5% (2.3) Community HealthLink, Inc. 70.7 3.0% 20.9 0.9% 0.1 Marlborough Hospital and Affiliates 89.1 3.8% 84.5 3.7% 8.9 Medical Group 502.5 21.2% 210.8 9.3% (28.7) Additional Affiliates 19.7 0.8% 41.0 1.8% 1.4 Eliminations**** (0.9) (0.0%) (0.7) (0.0%) - Subtotal Non-Obligated Group 735.9 31.0% 562.2 24.7% (13.3)
Eliminations and Consolidating Entries***** (231.1) (9.7%) (128.1) (5.6%) -
Total $ 2,373.5 100.0% $ 2,275.6 100.0% $ 68.1 ______* Includes entities that are not members of the Obligated Group. ** Represents the exclusion of the results of operations of CPAC, a subsidiary of the Parent, from the Obligated Group to the Non-Obligated Group, consistent with the Master Trust Indenture. *** Eliminations representing transactions between the Parent (excluding CPAC), the Medical Center, HealthAlliance and Ventures. **** Eliminations representing transactions among the Non-Obligated Group. ***** Eliminations representing transactions between the Obligated Group and Non-Obligated Group. Source: System records.
For summary descriptions of each hospital entity and certain Affiliates, see “PRINCIPAL AFFILIATES” and “OTHER CORPORATE AFFILIATES.” In addition, significant assets and liabilities relating to the Group Practice (as defined below) and the insurance trust fund established by the University to provide coverage for the Teaching Hospital (as defined below), the Group Practice, and certain others (the “Self-Insurance Trust” or the “Trust”) were assumed by the Parent or the Affiliates in connection with the Transaction.
SYSTEM INDEBTEDNESS
Outstanding long-term indebtedness of the System as of September 30, 2016, and as of September 30, 2015 is presented in the audited consolidated financial statements and consolidating supplemental schedules set forth in Appendix B to this Official Statement. As of September 30, 2016 and 2015, the System’s aggregate long-term debt amounted to $442.0 million and $426.7 million, respectively. As of September 30, 2016 and 2015, the Obligated Group’s aggregate long-term debt amounted to $423.3 million and $406.9 million, respectively. Overall debt A-26 APPENDIX A includes MDFA revenue bonds, lines of credit, master leases and subleases, and other notes payable as well as capital lease obligations.
On February 2, 2016, MDFA issued its Revenue Bonds, UMass Memorial Series I in the amount of $168,785,000 to reimburse capital costs for various construction, improvement, renovation, and equipment acquisitions on behalf of the Obligated Group, to refinance all of the Massachusetts Health and Educational Facilities Authority (“MHEFA”) Revenue Bonds, UMass Memorial Issue, Series A (1998), MHEFA Revenue Bonds, UMass Memorial Issue, Series D (2005), and to finance certain costs of issuance. As a result of this transaction, the Obligated Group reported a loss on refunding of debt of $2.9 million.
On June 29, 2016, the Obligated Group increased its commercial line of credit from $50.0 million to $75.0 million. The line is unsecured and expires June 28, 2017. The amount outstanding under the line as of September 30, 2016 was $55.0 million.
Subsequent to September 30, 2016, the Obligated Group obtained $125 million in financing for the Epic project, consisting of a $75.0 million MDFA tax-exempt capital lease and the $50.0 million MDFA Revenue Bond, UMass Memorial Series J (2016).
Subject to regulatory approvals and other factors, the Obligated Group expects to borrow up to an additional $60 million by the end of calendar year 2017 for capital projects at HealthAlliance and the Medical Center.
For further discussions related to the System’s Outstanding Indebtedness, see footnote 8 to the audited consolidated financial statements and consolidated supplemental schedules as set forth in Appendix B to this Official Statement.
SYSTEM WORKFORCE
The System is the largest employer in Worcester County, with a workforce as of September 30, 2016 of 15,613 employees (10,605 FTEs) and 1,740 per diem employees, including 3,377 registered nurses and 111 licensed practical nurses.
As of September 30, 2016, the Medical Group employed 1,044 physicians (984 FTEs) and 258 Nurse Practitioners/Physicians Assistants (212 FTEs), all included in the above totals for the System. The employed physicians of the Medical Group were the attending physicians responsible for approximately 85.0% of the Medical Center’s discharges in 2016. For more information about the Medical Group, see “OTHER CORPORATE AFFILIATES.”
The Medical Center employees are represented for purposes of collective bargaining by five labor organizations: State Healthcare and Research Employees (“SHARE”) (2,189 employees or 1,900 FTEs); United Food and Commercial Workers (“UFCW”) (890 employees or 822 FTEs); Massachusetts Nurses Association (“MNA”) (2,353 employees or 1,135 FTEs); National Association of Government Employees (“NAGE”) (88 employees or 51 FTEs); and the UMass Memorial Public Safety Union (20 employees or 17 FTEs). As of September 30, 2016, the turnover rate for the nurses at the Medical Center (Worcester operations) was approximately 7.6%, and the vacancy rate for the nurses was 7%.
HealthAlliance employees are represented for purposes of collective bargaining by three labor organizations: MNA (354 employees or 256 FTEs); Service Employees International Union (“SEIU”) (87 employees or 71 FTEs); and Security, Police, and Fire Professionals of America (“SPFPA”) (32 employees or 17 FTEs). As of September 30, 2016, the turnover rate for the nurses at HealthAlliance was 6.5%, and the vacancy rate for the nurses was 7%.
Clinton Hospital employees are represented for purposes of collective bargaining by two labor organizations: MNA (75 employees or 40 FTEs); and SEIU (two employees or two FTEs). As of September 30, 2016, the turnover rate for the nurses at Clinton Hospital was 9.1%, and the vacancy rate for the nurses was 14%.
Marlborough Hospital employees are represented for purposes of collective bargaining by two labor organizations: MNA (205 employees or 103 FTEs); and SEIU (one employee or one FTE). As of September 30, 2016, the turnover rate for the nurses at Marlborough Hospital was 19.9%, and the vacancy rate for the nurses was 12%.
Community Healthlink, Inc. (“Community Healthlink”) employees are represented for purposes of collective bargaining by SEIU (636 employees or 540 FTEs). As of September 30, 2016, the turnover rate for the nurses at
A-27 APPENDIX A Community Healthlink was 23%, and the vacancy rate for the nurses was 19%. For more information about Community Healthlink, see “OTHER CORPORATE AFFILIATES.”
The following grid provides the status of each Collective Bargaining Agreement for the System:
# of UNION Members Contract Expiration MNA-University 1,384 4/6/2018 (Massachusetts Nurses Association) 6/10/2018 MNA-Memorial/Hahnemann 969
SHARE 2,189 9/30/2018 (State Healthcare and Research Employees) UFCW 854 (United Food and Commercial Workers) 6/10/2017 UFCW-Skilled 36 10/31/2017 (United Food and Commercial Workers) NAGE
(National Association of Government 88 6/30/2017 Employees) UMass Memorial Public Safety Union 20 6/15/2017 (Memorial Police) MNA-Clinton 75 12/31/2016 (Currently in negotiations) (Massachusetts Nurses Association) 1199 SEIU – Clinton 2 12/31/2016 (Currently in negotiations) (LPN) MNA-Marlborough 205 11/14/2017 (Massachusetts Nurses Association) SEIU – Marlborough 1 9/30/2017 (LPN) MNA-HealthAlliance Burbank 24 8/21/2017 (Massachusetts Nurses Association) MNA-HealthAlliance Leominster 306 7/21/2017 (Massachusetts Nurses Association) MNA-HealthAlliance Home, Health & Hospice 24 3/31/2017 (Massachusetts Nurses Association) 1199 SEIU – Burbank 76 2/28/2018 1199 SEIU – LPN 5 9/30/2017 1199 SEIU – HHH 6 9/30/2017 SPFPA – HealthAlliance 32 9/30/2016 (Currently in negotiations) (Security)
Management believes that the relationship between the System and its employees is a professional and productive one. For a discussion of workforce shortages and their potential effect, see “BONDOWNERS’ RISKS AND MATTERS AFFECTING THE HEALTH CARE INDUSTRY—Business Relationships and Other Business Matters—Labor Relations and Collective Bargaining.”
A-28 APPENDIX A SYSTEM PENSION AND RETIREMENT BENEFITS
The Parent and its Affiliates sponsor defined contribution pension plans covering substantially all employees who have met age and service requirements. Contributions to the plans are based on specific percentages of annual compensation and/or employee contributions. Pension expense related to the defined contribution plan was approximately $26.7 million and $25.2 million for the years ending September 30, 2016 and 2015, respectively.
In addition, the Parent sponsors the UMass Memorial Health Care, Inc. Master Pension Trust in which the participating plans, both noncontributory defined benefit plans, are the UMass Memorial Health Care, Inc. Pension Plan and the Marlborough Hospital Retirement Plan. The benefits under these plans are based primarily on years of service and employees’ compensation. As of September 30, 2016, the projected benefit obligation of the plans exceeded the fair value of plan assets, resulting in a liability in the amount of $246.6 million, reflected within accrued pension and postretirement benefit obligations on the consolidated balance sheet. Interest rate levels and the financial performance of the investments of the pension plans can have a material impact on this liability. The Parent has developed a funding policy for these defined benefit plans requiring contributions at least equal to the minimum amount required under the law. Contributions in the amount of $56.2 million (see “SUPPLEMENTAL FINANCIAL INFORMATION FOR THE OBLIGATED GROUP—Liquidity”) and $106.2 million were made for the years ending 2016 and 2015, respectively. System Management anticipates contributing $1.2 million to the plans during 2017.
Also, the UMass Memorial Health Care Pension Restoration Benefit Plan, established for key employees specifically designated as participants, is funded at time of benefit payment and has a projected benefit obligation, as of September 30, 2016, of $5.3 million. Contributions in the amount of $2.9 million and $1.2 million were made for the years ending 2016 and 2015, respectively. System Management anticipates contributing $0.6 million to the plan during 2017.
The Parent provides postretirement medical benefits to certain of its employees. Medical benefits are funded from the general assets of the Parent on a current basis. The plan pays a portion of health insurance costs for eligible participants. As of September 30, 2016, liabilities of $6.4 million and $36.1 million pertaining to this benefit arrangement are contained within other current liabilities and accrued pension and postretirement benefit obligations, respectively, on the consolidated balance sheet.
For additional information on the Parent’s retirement plans and postretirement medical benefits plan, see footnote 4 of the audited consolidated financial statements and consolidated supplemental schedules as set forth in Appendix B to this Official Statement, which refers to plans of the System, including entities that are members of the Obligated Group.
SOURCES OF PATIENT SERVICE REVENUE
The System maintains agreements with the United States Department of Health and Human Services (“DHHS”) under the Medicare program, the Commonwealth under the Medicaid program, Blue Cross and Blue Shield of Massachusetts, Inc. (“BCBSMA”), and certain other managed care programs that govern payment to the hospitals for services rendered to patients covered by these programs. Net patient service revenue is recorded after deductions for charity care, bad debts and other discounts and contractual allowances.
While the method of payment varies substantially from one payor category to another and even within certain payor categories, the System, in common with the broader hospital industry, generally is paid per diem or per diagnosis while physician groups are generally fee based.
The following table reflects the distribution of gross patient service revenue for the System by payor source and by inpatient and outpatient designation for the five fiscal years ended September 30, 2016. This information is based on patient classification at the time of discharge billing.
A-29 APPENDIX A SYSTEM SOURCES OF GROSS PATIENT SERVICE REVENUE*
Fiscal Year Ended September 30 Obligated Group Only – SOURCE 2014 2015 2016 2016 Medicare 26.3% 26.5% 27.2% 27.0% Medicare Managed Care 9.5 9.6 9.9 10.4 Medicaid 10.7 10.9 10.2 11.0 Medicaid Managed Care 9.8 10.7 12.0 12.8 Private Pay 41.8 40.6 39.3 37.5 Other 1.9 1.7 1.4 1.3 TOTAL 100.0 100.0 100.0 100.0 Inpatient 41.7 43.0 42.8 44.0 Outpatient 58.3 57.0 57.2 56.0 TOTAL 100.0% 100.0% 100.0% 100.0%
* Excludes Community HealthLink and, therefore, is not presented on a consolidated basis. Source: System records.
Medicare
Medicare is a federal health care program created by Title XVIII of the Social Security Act. Medicare covers both hospital and physician services for eligible individuals who are elderly, disabled, or subject to certain chronic conditions. Medicare generally pays acute care hospitals for most general medical/surgical services provided to eligible inpatients under a prospective payment system (“PPS”) known as inpatient PPS (“IPPS”). Under the IPPS, hospitals receive a predetermined payment amount for each Medicare discharge. This IPPS payment is a standard national amount based on the diagnostic related group (“DRG”) for the discharge subject to a geographic adjustment that takes into account wage differentials. DRGs classify treatments for illnesses according to the estimated costs of hospital resources necessary to furnish care for each patient’s principal diagnosis and establish a payment amount for that diagnosis treatment group. Hospitals are thus at financial risk for providing services to a patient at an actual cost greater than the applicable DRG payment.
DRG rates are updated annually by the hospital market-basket percentage increase, which is the measure of the inflation experienced by hospitals in purchasing the goods and services they need to provide inpatient services. The update is established by statute. Historically, the percentage increases to the DRG rates have often been lower than the percentage increases in the costs of goods and services purchased by hospitals.
A hospital’s receipt of the full annual market basket increase is contingent upon its submission of certain quality of care data. Quality data is currently collected on an array of quality measures related to heart attack, heart failure, pneumonia, surgical care, mortality, readmissions, hospital-acquired conditions, participation in systematic clinical database registries, and patient satisfaction. Some of this data is reported by hospitals to CMS and some is calculated using information from Medicare claims data. Hospitals must report specific quality measures for inpatient services and satisfy a certain data validation threshold in order to receive the full market basket percentage increase. Beginning with federal fiscal year (“FFY”) 2015, hospitals that do not successfully participate in the quality reporting program and do not submit the required quality data are subject to a one-fourth reduction of the market basket update (previously, these hospitals received a two percentage point reduction). The law also required that the update for any hospital that is not a meaningful EHR user be reduced by one-quarter of the market basket update in FFY 2015, requires a one-half of the market basket update in FFY 2016, and will require a three-quarters of the market basket update in FFY 2017 and later years. In 2016, the Medical Center received the full market basket update since it met the reporting requirements and met stage 1 meaningful use.
Teaching hospitals such as the Medical Center receive additional payments to cover the direct and indirect costs of graduate medical education. Direct medical graduate education costs (“DGME”) are reimbursed under a prospective methodology based on a hospital-specific approved amount per resident. Medicare also makes additional payments to PPS teaching hospitals for the indirect medical education (“IME”) costs attributable to their approved graduate
A-30 APPENDIX A medical education programs. The IME payment is an additional yearly payment calculated as a percentage add-on to the inpatient DRG payment. The payment is based on a formula that incorporates the hospital’s ratio of residents to beds in use and total IPPS revenue.
DGME and IME payments are subject to certain limitations, including a cap on a hospital’s reimbursable residents based on the number of residents in a base year. Congress has repeatedly sought to limit DGME payments. For example, the Medicare Prescription Drug, Improvement and Modernization Act contained provisions for the reduction of resident caps in hospitals with resident counts below the cap and redistribution of those resident slots to other hospitals, particularly rural hospitals. CMS also has sought to limit DGME and IME payments. In August 2001, CMS amended its IME regulation to provide that hospitals may not include residents in the IME computation to the extent that the residents are engaged exclusively in research and not in patient care activities. In 2016, the System received GME payments in the amount of $80.0 million.
Hospitals receive additional payments for other costs. In certain circumstances, CMS makes an additional payment for new services and technologies if the estimated charges for the new service or technology exceed the DRG payment by a threshold amount and the new service or technology is a substantial clinical improvement relative to technologies previously available. Hospitals also receive additional payments, known as outlier payments, for cases for which costs exceed the IPPS payment amount plus an additional fixed dollar threshold amount.
In addition, Medicare makes additional payments to hospitals that serve large numbers of low-income patients. However, beginning in 2014, hospitals receiving supplemental disproportionate share hospital (“DSH”) payments from Medicare (i.e., those hospitals that care for a disproportionate share of low-income patients) receive 25% of the amount they previously would have received under the former statutory formula for Medicare DSH. A portion of the remaining 75% will be paid to Medicare DSH hospitals based on their share of uninsured low-income days. In 2016, the System received DSH payments of $19.3 million. There is no assurance that these payments, considered together with the DRG payment, will be sufficient to cover the actual cost of providing hospital services or that these payments will continue at their current levels.
Hospitals also receive an additional per discharge payment based on a federal rate (with certain adjustments) to reimburse hospitals for capital costs. There are add-on amounts to this payment for certain types of hospitals and for certain costs. In addition to a geographic adjustment factor, there are increases to hospitals located in large urban areas (urban add-on payment). The capital payment rate is further increased for hospitals serving a disproportionately large number of low-income patients and for the indirect medical education costs incurred by teaching hospitals. Updates to the capital IPPS are not established by statute. Instead, capital rates are updated annually by CMS based on its calculation of the change in prices associated with capital-related costs as measured by the capital input price index and adjusted by other policy factors. The capital IPPS market-basket update for 2016 is 0.8%.
Beginning with 2012, IPPS payments also include adjustments based on quality of care in order to encourage high quality care. Under the Hospital Value-Based Purchasing Program, a portion of hospitals’ Medicare payments for inpatient acute care is linked to performance on quality measures such as whether a patient received an antibiotic before surgery and how well doctors and nurses communicate with patients. Under the Hospital Readmissions Reduction Program, Medicare payments are reduced for hospitals with excess readmissions. Under the Hospital- Acquired Condition Reduction Program, Medicare payments are reduced for some hospitals that rank in the worst 25% performing quartile with respect to hospital-acquired conditions.
Most hospital outpatient services are reimbursed on the basis of an outpatient PPS methodology (“OPPS”). Payments under the OPPS are based upon ambulatory payment classification (“APC”) groups. An APC group includes various clinically similar services with a single rate for all services in the group. APC rates are subject to a geographic adjustment that takes into account wage differentials. APCs are also adjusted annually based on the hospital market-basket index. There can be no assurance that the hospital OPPS rate considered with all applicable adjustments will be sufficient to cover the actual costs of outpatient hospital services.
CMS is implementing several changes to the APC payment system, including rule changes designed to move the OPPS toward making payments for larger packages of items and services rather than making separate payments for each individual service. In calendar year 2015, CMS implemented an APC payment policy that makes a single payment for all related or adjunctive hospital items and services provided to a patient receiving certain primary procedures that are either largely device-dependent, such as insertion of a pacemaker, or that represent single session services with multiple components, such as intraocular telescope implementation.
A-31 APPENDIX A In future years, the federal government may take additional actions affecting Medicare coverage that may affect payments or reimbursement for services to the Obligated Group. The ACA has had and continues to have a significant impact on coverage and reimbursement. Future health reform or actions to implement, modify or repeal the ACA could have both positive and negative effects on the nation’s hospitals and other health care providers, including the System. Subsequent budget control legislation may also affect payment for services of the Affiliates. The Budget Control Act of 2011 includes provisions to reduce the federal deficit. The Budget Control Act, as amended, resulted in the imposition of 2% reductions in Medicare payments to providers beginning in 2013. More recent legislation extends reductions through 2024. See “BONDOWNERS’ RISKS—Health Care Environment.”
The ACA includes a number of provisions that encourage the creation of new health care delivery programs for Medicare beneficiaries, such as patient-centered medical homes that will feature interdisciplinary professional teams to support primary care practices, and the MSSP, under which ACOs composed of groups of providers will be held accountable for the quality, cost and overall care of Medicare beneficiaries attributed to the ACO and will share in the cost savings they achieve for the Medicare program.
On January 1, 2015, the UMass ACO joined the MSSP on a shared savings basis only, with no downside risk. For the 2015 performance year, no savings were realized. On April 1, 2015, the Medical Center joined BPCI Model 2 for the Major Joint Replacement Lower Extremity bundle. The BPCI program rewards providers that have actual expenditures that are lower than the targets set by CMS. On July 1, 2015, the Coronary Artery Bypass Graft Surgery bundle was added, and on October 1, 2015, the Cervical Spinal Fusion and Spinal Fusion (non-cervical) bundles were added. During 2016, $843,000 was received as a result of positive results for the first three quarters of the bundle program.
Medicaid
Under Title XIX of the Social Security Act, the federal government provides matching funds to the Commonwealth for expenditures made under Medicaid. The Massachusetts Executive Office of Health and Human Services (“EOHHS”) Office of Medicaid administers the Massachusetts Medicaid program, also known as “MassHealth.”
Hospitals receive payments for MassHealth members in a number of different ways. Medicaid rates for acute hospitals for MassHealth members not enrolled in a Medicaid Managed Care Organization (“MCO”) are set by annual contracts between the hospitals and EOHHS. For MassHealth members enrolled in Medicaid MCOs, hospitals receive payments according to their contracts with MCOs or according to the terms of the MCO contracts with EOHHS.
For services provided to MassHealth members not enrolled in a Medicaid MCO, MassHealth’s payment for acute inpatient admissions is based upon an Adjudicated Payment Amount per Discharge (“APAD”). The APAD reimburses hospitals a DRG payment that is specific to each case based on APR-DRG assignment. The APAD is derived from the 2012 statewide average hospital cost per admission, standardized for case mix differences and area wage variation. An efficiency standard is determined by capping hospital costs, weighted by MassHealth discharges, at the 65% level of costs. The statewide average is adjusted for inflation and outliers. MassHealth also provides an outlier adjustment that provides an additional payment for unusually high-cost cases that are not fairly represented in the grouping methodology. The fixed cost threshold for which an inpatient case will qualify for an outlier payment is $24,000. The percent cost that will be paid above the APR-DRG payment and outlier threshold is 80%.
Capital payments are paid on an APR-DRG case mix adjusted per-discharge basis, and are efficiency-adjusted. Capital costs are based on each hospital’s 2012 Massachusetts Division of Health Care Finance and Policy 403 Cost Report, updated for the hospital’s case mix index and inflation to the current year.
In addition to the APR-DRG, EOHHS pays for certain inpatient services on a per diem basis. Psychiatric services delivered in Department of Mental Health-licensed psychiatric beds of acute hospitals are paid an all-inclusive statewide psychiatric per diem rate and acute hospitals are paid a rehabilitation per diem for services delivered in rehabilitation units. Services delivered to individuals who transfer between hospitals or between certain settings within a hospital are paid adjusted per diem rates.
For MassHealth acute outpatient hospital services, the PAPE methodology provides a hospital-specific episodic rate for most services. The hospital-specific PAPE is based on an outpatient statewide standard payment (see below) adjusted for hospital-specific case mix. Certain services, including laboratory services are carved out of the PAPE calculation and payment. Laboratory and other carve-out services are paid for in accordance with the applicable
A-32 APPENDIX A EOHHS fee schedules. In 2017, MassHealth intends to implement a new outpatient payment method using ambulatory payment groups (APGs) similar to Medicare’s methodology.
Calculation of the outpatient statewide standard payment is based on MassHealth payments for outpatient services in hospital rate year 2014, as adjusted by (1) including outlier payments, (2) excluding payments for laboratory services, and (3) bundling services received on the same day. The result of this calculation is adjusted for inflation to obtain the outpatient statewide standard factor for hospital rate year 2016. The hospital-specific PAPE is determined by multiplying the outpatient statewide standard by each hospital’s case mix index calculated by EOHHS.
Hospitals may be reimbursed under MassHealth for physician services provided by hospital-based physicians. This reimbursement is the lower of the physician fee schedule established by EOHHS, the hospital’s usual and customary charge, or 100 percent of the hospital’s actual charge submitted.
MassHealth also has a Pay-for-Performance program, which provides a method for quality scoring and converting quality scores to payments that are contingent upon hospital adherence to quality standards and achievement of performance thresholds and benchmarks in accordance with Massachusetts statute.
A portion of the Massachusetts Medicaid program operates as a demonstration program under what is referred to as an 1115 Waiver that encompasses waivers of certain federal Medicaid requirements. Originally approved in 1995, this demonstration program was effective through June 30, 2014. After several short-term extensions, CMS signed an extension in October 2014 retroactive to July 1, 2014 and through June 30, 2019. This program mandates that many Medicaid beneficiaries must enroll in Medicaid MCOs. EOHHS has contracted with MCOs to provide health care services to Medicaid beneficiaries who enroll in Medicaid managed care.
Under the ACA, Medicaid DSH allotments to each state will be reduced beginning in FFY 2018, based on a methodology to be determined by DHHS, accounting for statewide reductions in uninsured and uncompensated care. The Commonwealth continues to consider and implement initiatives to reform the delivery of care through MassHealth and payment for that care. Health care providers that participate in such initiatives may receive preferential reimbursement. In 2016, the System received $5.9 million in Medicaid DSH payments.
The System also receives MSF. See “MANAGEMENT’S DISCUSSION OF RECENT FINANCIAL PERFORMANCE—Medicaid Supplemental Funds.” The failure to maintain the current level of expected MSF to the System in future years could have a material adverse effect on the System. The Commonwealth’s provision of MSF is dependent on many factors, and there can be no assurance that future funding levels will be sufficient to meet the System’s financial needs.
Also under the ACA, states have the option to expand the Medicaid program to all individuals under 133% of the federal poverty level and will receive enhanced federal assistance for expenditures for the newly eligible. Massachusetts has elected to expand its Medicaid program, resulting in the shift to MassHealth of certain portions of populations that had been covered under the 1115 Waiver, which included the former state-subsidized Commonwealth Care program as well as the Fund. Given the coverage expansions already accomplished in Massachusetts through state health reform, Massachusetts will be eligible for more limited, phased-in assistance until 2020, at which point Massachusetts will receive the same federal match percentage as other states for this population. This was a source of additional federal funding to the Commonwealth beginning in 2014. Medicaid eligibility for children cannot be reduced until after 2019, which, while it could contribute to budget pressures, will also ensure continued coverage for many patients.
Chapter 224 of the Acts of 2012 (“Chapter 224”) directed the Massachusetts Medicaid Office to pay for health care based on alternative payment methodologies for at least 25% of its enrollees beginning July 1, 2013 and increasing to at least 80% by July 1, 2015. Alternative payment methodologies may include bundled payments, global payments, shared savings and other innovative methods of paying for health care services. Chapter 224 also directs MassHealth to amend its MCO contracts to implement this project.
UMMHC joined MassHealth’s new Primary Care Payment Reform Program (“PCPR”) on March 1, 2014, with seven of its primary care sites participating. The PCPR program includes a capitated payment rate for primary care services, quality payments if certain criteria are met and shared savings or losses on total medical expenditures for included services. The PCPR program ran through December 31, 2016. UMMHC received quality payments for both 2014 and 2015, but the MassHealth program has not completed the shared savings calculations for 2015 and full results for 2015 are unknown at this time.
A-33 APPENDIX A Chapter 224 provides that, beginning July 1, 2014, other Massachusetts public payors, should, to the extent feasible, implement alternative payment methodologies. In addition, EOHHS is instructed to seek a federal waiver to permit Medicaid to participate in alternative payment methodologies. A significant percentage of the commercially insured population in Massachusetts is already covered by such payment methodologies, such as through the BCBSMA AQC. Alternative approaches being considered by MassHealth include a shared risk ACO or a joint venture type arrangement (see also “STRATEGIC VISION AND CURRENT CHALLENGES”).
Free Care and Uncompensated Care
The Fund, now administered by MassHealth, is intended to maintain a health care safety net by reimbursing hospitals and community health centers for a portion of the cost of reimbursable services provided to low-income, uninsured or underinsured residents of the Commonwealth. The Fund pays hospitals on a fee-for-service basis for eligible services provided to eligible low-income patients. It uses Medicare pricing data and the most recent version of the Medicare DRG values to calculate inpatient medical pricing, and includes adjustments for items such as high- cost outliers, transfer cases, special pay post-acute DRGs, partially eligible stays and participation in the Acute Hospital Inpatient Quality Reporting program. Any significant changes to the Fund or in regulations governing the eligibility and payment on free care claims may have an adverse impact on the Obligated Group.
Commercial Insurance and Managed Care Programs
Commercial payors negotiate contracts directly with hospitals, physician groups and physician-hospital organizations. Under these contracts, commercial payors make payments either directly, on behalf of self-funded employer accounts, health benefit plans, or other entities, primarily on the basis of established or discounted charges for covered services. Patients carrying the coverage are generally responsible to the hospitals providing services for certain co-payments and deductibles.
MCOs, including health maintenance organizations (“HMOs”) and preferred provider organizations (“PPOs”), are organizations that provide insurance coverage through a network of health care providers to members for a fixed monthly premium or provide administrative services to self-funded employers. To control costs, these organizations typically contract with hospitals and other providers, review medical services for medical necessity, and channel patients to contracted providers of health care services.
Under the traditional fee-for-service method of health care delivery, hospitals, physicians, and other providers are compensated on a per-service basis. MCOs may contract with providers to provide health care services under a fee- for-service payment methodology or under a budgeted per member per month (“PMPM”) methodology. Under the fee-for-service payment methodology, providers are generally compensated on a per-service basis. A portion of the annual payment rate change may be contingent upon the provider meeting certain utilization or other performance goals. Under a budgeted PMPM payment arrangement, the provider bears some or all of the risk if the cost of services provided exceeds the amount of the budgeted PMPM payments. This payment methodology creates an incentive to control utilization of services.
The System has contracts with all the major MCOs in the region including, but not limited to, BCBSMA, Harvard Pilgrim Health Care (“HPHC”), Tufts Health Plan (“Tufts”), and Fallon. The BCBSMA AQC is a four-year, shared risk-based agreement, effective 2013–2016, with quality measures that mitigate risk. Services are paid on a fee-for- service basis but settled based upon the year-end results against a PMPM budget. The PMPM budget is adjusted for severity and network trends and includes a limit on downside risk. Similarly, the System’s contracts with HPHC and Tufts each include limits on downside risk. The other payor contracts are fee-for-service with inpatient services under these contracts based on negotiated DRGs, per diems or case rates and may include additional payments that are based on various performance measures. Payments for outpatient services are on the basis of fee schedules or discounted charges. The System has contracts with HPHC through December 31, 2019, with Fallon through December 31, 2017 and with Tufts through December 31, 2017.
A-34 APPENDIX A The managed care plans referring the highest volume of inpatients to the System for 2014-2016 are summarized in the following table:
SYSTEM DISCHARGES BY PAYOR
Payor 2014 2015 2016 Blue Cross – HMO 6.2% 5.5% 5.4% Blue Cross – PPO and Other 5.7 5.4 5.4 Blue Cross – Senior 2.4 2.7 2.3 Harvard Pilgrim Health Care 4.3 4.2 4.3 Fallon Community Health Plan 7.9 7.7 2.7 Tufts Associated Health Plan 5.3 5.6 4.6 Other Managed Care 22.9 22.2 27.4 Subtotal 54.7 53.3 52.1 Non-Managed Care 45.3 46.7 47.9 Total 100.0% 100.0% 100.0% Source: System records.
Total managed care contracts accounted for approximately 52.1% of discharges at the System for 2016. The System is a participating provider in Medicare managed care products offered by certain major MCOs.
SYSTEM FACILITIES
The principal facilities of the Medical Center are located at the University, Memorial, Hahnemann, and Queen Street campuses, all located in Worcester, Massachusetts. The facilities located at the University Campus consist of approximately 1,123,000 square feet of space owned by the University and used by the Medical Center pursuant to a 99-year occupancy agreement that terminates in 2097, which space was principally constructed in 1975. See “HISTORY AND TRANSACTION—Description of the Transaction.” In 2006, a significant expansion to the University Campus of 296,000 square feet (included in the above number) was completed and known as the “Lakeside Expansion.” This project included a significant expansion of the University Campus Emergency Department facilities, along with construction of 10 new operating rooms, 66 treatment rooms, 16 new ICU beds, and a reconfiguration of ambulance and Life Flight access, including a new helipad. Shell space in the original project has since been fitted out to accommodate 16 additional ICU beds plus 18 Step-Down and Medical/Surgical beds. In 2010, the Medical Center moved several outpatient services—Heart & Vascular, Oncology, Muscular- skeletal, and Diabetes—into approximately 141,000 square feet of a new ambulatory care center on the University Campus. Also in 2010, the Medical School built the approximately 260,000 square foot ambulatory building, of which the Medical Center leased approximately 75%.
The facilities located at the Memorial Campus consist of approximately 728,000 square feet, with a significant renovation of inpatient facilities completed in 1996. There are 753 licensed inpatient beds on the Memorial and University Campuses. The Hahnemann Campus is used for outpatient services and ambulatory surgery and consists of approximately 264,000 square feet. Various renovation projects have occurred at the Memorial and Hahnemann Campuses since 1996. The Medical Center also operates a 26-bed inpatient Psychiatric Treatment and Recovery Center at the Queen Street Campus. The Medical Center operates in nine off-site locations in approximately 58,000 square feet of various outpatient ambulatory services ranging from Radiology, Endoscopy, and Primary Care and Specialty Care services. The Medical Center also owns and operates four medical office locations in approximately 46,000 square feet with primary and specialty care services.
The principal facilities of HealthAlliance are located on two campuses in Leominster and Fitchburg, Massachusetts. The current facility located on the Leominster campus consists of one main campus building of approximately 420,000 square feet; the facility at the Fitchburg (the former site of Burbank Hospital) campus is approximately 160,000 square feet. Also on the Leominster campus, HealthAlliance owns and operates two medical office buildings of approximately 90,000 square feet combined, occupied by primary care and specialty physician practices. In addition, HealthAlliance operates an urgent care center in approximately 5,700 square feet of leased space.
A-35 APPENDIX A The principal facilities of Marlborough Hospital are located on one campus in Marlborough, Massachusetts. The current facilities consist of one main campus building of approximately 167,000 square feet. In 2013, a 13,000 square foot cancer center addition was built, which houses an outpatient clinic and infusion services and Linear Accelerator (“LINAC”) services. In addition, there are two off-site clinical office locations of approximately 22,750 square feet, collectively, for endoscopy, physical therapy, and women’s health services. Marlborough Hospital also owns and operates a 12,000 square foot ambulatory building on the campus that is occupied by physician practices.
The principal facilities of Clinton Hospital are located on one campus in Clinton, Massachusetts. The current facilities consist of two buildings of approximately 102,000 square feet, collectively, of inpatient and outpatient services. In 2012, a new 14,000 square foot 24-hour emergency department was constructed with an additional 14,000 square foot of second floor shell space for future growth. Clinton Hospital also owns and operates a 7,500 square foot medical office suite on the campus.
The principal operations of Community Healthlink are located in Worcester, Massachusetts in nine facilities totaling 275,552 square feet and include outpatient clinics, counseling offices, and administrative space. There are also program sites located in Leominster, Fitchburg, Clinton, and Gardner totaling 39,300 square feet. In addition, Community Healthlink operates approximately 48 residential sites within the community totaling an additional 87,238 square feet. For more information about Community Healthlink, see “OTHER CORPORATE AFFILIATES.”
The Medical Group facilities occupy 254,000 square feet of leased space in various communities throughout the Service Area (71 locations). For more information about the Medical Group, see “OTHER CORPORATE AFFILIATES.”
In addition to the above facilities, the System leases approximately 318,000 square feet of general office space occupied by corporate functions.
The System has expended approximately $453 million on capital projects over the five fiscal years ended September 30, 2016, and anticipates future capital renovation, equipment, and improvement projects in the next few years. Management expects to fund such future expenditures, including IT expenditures through operating revenues, development funds and, depending upon the System’s financial performance and market conditions, tax-exempt financing.
For a discussion of efforts by the City of Worcester to promote “voluntary” payments by nonprofit corporations in lieu of real estate taxes, see “BONDOWNERS’ RISKS AND MATTERS AFFECTING THE HEALTH CARE INDUSTRY—Tax-Exempt Status and Other Tax Matters—Real Property Tax Exemption.”
THE PROJECT
The New Part of the Project (as defined in Appendix C-1 to this Official Statement) consists of the payment or reimbursement of capital costs of equipment used or to be used in connection with healthcare and related services and for various construction, improvement, renovation and equipment acquisitions on behalf of the Obligated Group. These projects include the following: (1) at the University Campus: (a) upgrades, renovations, furnishing and equipping to accommodate office relocations from hospital building/professional/medical staff administrative offices to non-clinical office space, (b) miscellaneous upgrades, renovations, furnishing and equipping at the University Campus, (c) pathways, upgrades to waiting rooms and staff break rooms, which will include new finishes and furnishings; (2) at the Memorial Campus: (a) infrastructure, replacement of HVAC, sanitary and water piping distribution systems, (b) pathways, public corridor and atrium development, which project connects two primary patient and visitor entry points, (c) acquisition, renovation and installation of an emergency power and combined heat and power system, (d) miscellaneous upgrades, renovations, furnishing and equipping at the Memorial Campus, and (3) West 1, 2 & 3 inpatient rooms refresh and refurbishment to update and standardize West patient rooms and employee work spaces. Most of the projects noted above relate to facility improvements aimed at patient and employee safety and comfort, patient satisfaction, and employee and patient flow.
A-36 APPENDIX A LITIGATION AND REGULATORY MATTERS
The members of the Obligated Group are involved from time to time as both plaintiffs and defendants in a variety of litigation matters and reviews and investigations by government agencies. Management considers such litigation and regulatory matters to be a routine part of health care operations.
CMS Notice of Disallowance/Request for Information – Following a 2009 audit report by the Office of Audit Services of the Office of Inspector General (the “OIG”) of DHHS, under which the Commonwealth’s Medicaid program returned approximately $1.5 million in federal financial participation (“FFP”) to CMS regarding supplemental Medicaid payments to the Medical Center from fiscal years 2000 through and including 2005, CMS informed the Commonwealth on February 7, 2011, of its intention to disallow $25.5 million in FFP for the same supplemental payments made to the Medical Center for a subset of the same time period (2000 through 2003). The stated reason for the disallowance was that the Commonwealth had not complied with the time limit for claiming payment for Medicaid expenditures. The Commonwealth filed a request for reconsideration of the disallowance. On April 13, 2012, CMS issued a letter to the Commonwealth affirming the disallowance except with respect to $8.1 million for supplemental payments for fiscal year 2003, which CMS acknowledges were claimed timely. Management worked with the Commonwealth to file an appeal to the DHHS Departmental Appeals Board (the “DAB”) on June 12, 2012. After the Commonwealth filed its brief with the DAB, CMS submitted its brief in May 2013 and asked the DAB to increase the disallowance of the federal share from $17.0 million to $21.0 million due to an earlier CMS calculation error. The Medical Center intervened in the matter and contested the proposed increase in the disallowance. A hearing on the appeal was held on June 18, 2013.
On September 30, 2013, the DAB issued its decision reversing the CMS disallowance of approximately $21.5 million in FFP based on a finding that the claim for FFP had been timely, and sustaining the disallowance of approximately $4.25 million in FFP based on the OIG’s audit report finding that the relevant expenditures were not authorized by the Commonwealth plan. The Commonwealth’s Medicaid agency has not recouped any funds from the System as a result of the disallowance or, as noted above, for the prior return of funds related to the OIG audit report, although it is expected that such a recoupment will be asserted. The Medical Center has sufficient reserves to reimburse the Commonwealth for the amount sustained by the decision.
Wrongful Termination Suit – A former executive of a pharmacy joint venture between Ventures and Shields Health Solutions, LLC (“Shields”) filed suit in Massachusetts Federal District Court on April 1, 2016. The suit was filed against a number of parties, including two limited liability companies: UMass Memorial Shields Pharmacy, LLC and Shields Specialty Pharmacy Holdings, LLC. The case is a wrongful termination action seeking damages for lost wages and equity. The case is in the initial pleadings phase. Although there can be no assurance as to the outcome of this matter, management does not believe it will have a material adverse effect on its consolidated financial statements.
The ultimate effect, if any, of the matters described above on the System or the Obligated Group cannot currently be determined. Adverse resolution of any of the above matters could have a material adverse effect on the Obligated Group.
INSURANCE
The Parent and certain of its Affiliates are self-insured for certain professional and general liability, health insurance, and workers’ compensation benefit programs, and several other smaller lines of insurance or deductibles. In addition, a range of commercial insurance coverage is in place for certain exposures that are not self-insured, along with commercial excess insurance over the self-insured programs.
The University’s Self-Insurance Trust (the “Trust”) was established effective July 1, 1985 as an irrevocable self- insurance trust. The Trust was established to provide professional liability, University Campus premises liability and physicians’ and surgeons’ liability coverage on an occurrence basis for incidents arising subsequent to June 30, 1985 for the Teaching Hospital and the Group Practice (each defined below under “HISTORY AND TRANSACTION”). In addition, the Trust provided coverage for interns and residents working off-site.
At the time of the Transaction, the University transferred substantially all of the assets and liabilities of the Trust to the Parent. On April 1, 1999, CPAC, a captive insurance company, was incorporated in Grand Cayman, British West Indies. The Parent is the sole shareholder of CPAC, which provides insurance for the Parent’s Self Insurance Program. A-37 APPENDIX A CPAC provides professional malpractice coverage of $5 million per incident with a $10 million annual aggregate to employees (including residents) and physicians of the Medical Center and the Medical Group and other Affiliates, and general liability coverage for System premises. The Parent purchases reinsurance of $50 million over the primary CPAC program. Effective October 1, 2002, CPAC also began to fund the workers compensation liability at statutory limits for the Medical Center and the Medical Group, with excess insurance currently purchased on a commercial basis for claims exceeding a $750,000 self-insured retention. Effective October 1, 2003, all of the Affiliates were brought into the CPAC program and share in the same aggregate coverage levels for professional and general liability and workers compensation. In addition to the above, CPAC also insures a quota share layer in the medical stop-loss program of $50,000 excess of the System $500,000 self-insured retention. Amounts in excess of the CPAC layer are commercially reinsured to unlimited. Other lines of insurance or deductibles self-insured through CPAC include Claim Handling E&O, Directors & Officers deductible, HIV Indemnity, Employed Lawyers Gap coverage, and the Managed Care E&O deductible.
Other types of insurance coverage, purchased commercially, include directors and officers and employment practices liability, fiduciary liability, network security and privacy liability, firearms liability, property and business interruption, aviation and helipad, travel accident, crime, motor vehicle/ambulance, and an umbrella policy with limits of $5 million over the automobile, ambulance, and employer liability lines of coverage.
HISTORY AND TRANSACTION
Formation of the Parent
The Parent was formed in 1997 as a result of the combination of the acute care hospital and related activities of two Worcester-based health care systems: (1) the state-owned Clinical Division of the University, which included a 337- bed teaching hospital (the “Teaching Hospital”), a 559-member physician group practice (the “Group Practice”), and a number of affiliated health care providers and support organizations (collectively, “UMMC”) and (2) a private, not-for-profit health care system controlled by Memorial Health Care, Inc. (the “Memorial Parent”), the parent corporation of Memorial Hospital, Inc. (“Memorial Hospital”), a 324-bed acute care hospital, and its affiliated entities, including a 115-member physician group practice (such combination is referred to herein collectively as the “Transaction”).
The University is a public institution of higher education of the Commonwealth. Prior to the Transaction, the University operated the Teaching Hospital and the Group Practice. The Teaching Hospital opened in 1976 and had its origins in the 1965 selection of Worcester as the site of the University’s new Medical School, which graduates over 100 medical students each year (117 for the academic year 2015). The University gradually expanded the scope of activities of the Teaching Hospital, and in 1981, the Teaching Hospital became a Level I trauma center.
In 1991, the former Worcester City Hospital site was acquired by the Worcester City Campus Corporation (“WCCC”), a corporation authorized by the Massachusetts Legislature to hold the Worcester City Hospital property and develop an integrated health care delivery system supporting the missions of the University. WCCC thereafter continued its expansion of the UMMC-affiliated network, which included acquiring controlling interests in Clinton Hospital, a 41-bed hospital located in Clinton, Massachusetts, and Marlborough Hospital, a 79-licensed bed hospital located in Marlborough, Massachusetts.
Prior to the Transaction, Memorial Hospital had separately existed as a private, not-for-profit hospital in the Worcester area since 1871. Memorial Hospital operated two main campuses, the Memorial Hospital (which provided acute care services) and the Hahnemann Campus (which offered sub-acute and ambulatory care), and also provided various satellite services.
Description of the Transaction
Following execution of an agreement setting forth the principal terms of the proposed transaction, the University, WCCC, and the Memorial Parent obtained legislative approval for the transaction in November of 1997 as a result of the passage of Chapter 163 of the Acts of 1997 (the “Act”). Following enactment of the Act, various conforming changes were made to finalize the terms of the transaction, resulting in the execution of the Amended and Restated Definitive Agreement among the University, WCCC, the Memorial Parent, the Parent, and the Medical Center dated as of March 31, 1998 (the “Definitive Agreement”).
Pursuant to the Definitive Agreement and the Act, effective March 31, 1998, the Memorial Parent merged with and into, the Parent, a new Massachusetts not-for-profit corporation named UMass Memorial Health Care, Inc., and A-38 APPENDIX A Memorial Hospital merged with and into, the Medical Center, a new Massachusetts not-for-profit corporation named UMass Memorial Medical Center, Inc. Simultaneously, substantially all of the assets and liabilities of the clinical activities of UMMC were transferred to and assumed by the Parent or the Medical Center and one or more entities under the control of the Parent. Substantially all of the assets and liabilities and all of the affiliates of WCCC were transferred to the direct or indirect control of the Parent.
Other principal terms of the arrangement among the University, WCCC, and the Parent and/or its Affiliates are set forth in a series of documents contemplated by or executed simultaneously with the Definitive Agreement. These include the following documents (which, together with the Definitive Agreement, are collectively referred to herein as the “Transaction Agreements”):
• An Occupancy and Shared Services Agreement (the “Occupancy Agreement”), pursuant to which the Medical Center is granted the right to occupy certain portions of the University’s Campus used principally by the Teaching Hospital for the clinical activities of UMMC and under which the University and the Medical Center agree to designated responsibility for various capital and operating expenses relating to the occupied premises;
• An Academic Affiliation and Support Agreement (the “Affiliation Agreement”), pursuant to which the Medical Center and Parent agree to make certain payments to the University, described further below;
• A License Agreement, pursuant to which the Parent and its Affiliates are entitled to use the name “UMass” under certain circumstances; and
• One or more agreements relating to the leasing of certain employees by the University to the Medical Center or its Affiliates pursuant to which the Medical Center agrees to indemnify the University for substantially all liabilities relating to such leased employees.
The Transaction Agreements and the Act contemplate a long-term, 99-year affiliation among the Parent, the Parent’s Affiliates, and the University. The Transaction includes a series of arrangements set forth in detail in the Transaction Agreements, as subsequently amended. Certain principal components of the Transaction are as follows:
• Pursuant to the 99-year Affiliation Agreement, the Medical Center retains its historic role as the principal teaching hospital for the Medical School student training programs and remains the principal site for clinical trials for the University’s research endeavors.
• Pursuant to the 99-year Occupancy Agreement, the Obligated Group is granted the right to use portions of the University’s Campus required for the operation of the former Teaching Hospital and other clinical activities. The Medical Center is obligated to maintain, update, and replace the portion of the facilities occupied by the Medical Center and to return the facilities to the University at the end of the Occupancy Agreement.
• So long as the University continues to operate the Medical School with substantial numbers of students and amounts of research funding, the Obligated Group is jointly and severally obligated to pay to the University an annual fee of $12 million plus an annual inflation adjustment, in total $18.7 million as of September 30, 2016, and a percent of the net combined operating income of the System (with certain exclusions for new affiliates located outside of Worcester County and other exceptions) based on a graduated formula designed to yield up to 20% of net combined operating income if the Medical Center and its Affiliates produce substantial net operating income without regard to certain negotiated items (the “Base Payment”). This amount may be reduced under certain conditions if the Medical School’s ongoing programs and research activities substantially decrease. For a discussion of prior year payments, see footnote 14 to the audited consolidated financial statements and consolidating supplemental schedules as set forth in Appendix B to this Official Statement.
• In the event the University were ever to cease to operate a medical school with substantial numbers of students and amounts of research funding during the 99-year term of the Occupancy Agreement and the Affiliation Agreement, the obligation to make the Base Payment will be converted into a rental payment at the then fair market value of the used premises, subject to certain adjustments. A-39 APPENDIX A OTHER CORPORATE AFFILIATES
None of the entities listed below is a member of the Obligated Group.
CNEHA and its Affiliates
Hospitals, Inc. is the sole corporate member of CNEHA, and CNEHA is the sole corporate member of HealthAlliance.
Other affiliates of CNEHA include HealthAlliance Realty Corp., which owns three medical office buildings, and HealthAlliance Home Health and Hospice, Inc., which operates a home health care agency. In 2016, CNEHA and Affiliates (excluding HealthAlliance) had revenues of $9.9 million and an excess of revenues over expenses of $0.7 million and, as of September 30, 2016, total assets of $11.9 million.
CPAC
On April 1, 1999, CPAC was incorporated as an insurance company in Grand Cayman, British West Indies. The Parent is the sole shareholder and member of CPAC and annually appoints its Board of Directors. CPAC provides insurance for the Obligated Group. See also “INSURANCE.” As of September 30, 2016, CPAC held assets of $160.2 million and had actuarially estimated liabilities of $126.1 million, calculated at the expected level, discounted by 2.0% for both professional and general liability and workers compensation, expected valuation of liability, and includes malpractice, general liability, workers compensation, medical stop-loss, HIV indemnity, employed lawyers, and Directors & Officers (D&O), and Managed Care Errors and Omissions (E&O) deductible liabilities.
Community Healthlink
Effective June 30, 1998, UMass Memorial Behavioral Health Systems, Inc., of which the Parent is sole corporate member, became the sole corporate member of Community Healthlink. Community Healthlink provides community mental health, substance abuse, homeless and rehabilitation services for adults, children and families in central Massachusetts. In 2016, Community Healthlink had revenues of $70.7 million, an excess of revenues over expenses of $0.1 million and, as of September 30, 2016, total assets of $20.9 million.
UMass Memorial Medical Group, Inc.
The Medical Group is an Affiliate of the Parent and is the principal provider of physician services to the System. The Medical Group consists of approximately 1,044 physicians (984 FTEs) who provide primary care and specialty services at 71 sites or offices located in 23 municipalities in and around Worcester, Massachusetts. In 2016, the Medical Group had revenues of $502.5 million, a deficiency of revenues over expenses of $28.7 million, and, as of September 30, 2016, total assets of $210.8 million.
Additional Corporate Affiliates
Except as noted below, the Parent is also a direct or indirect corporate member, stockholder, owner, or partner of the following Affiliates which, in the aggregate, accounted for approximately 0.8% of the revenues generated by the System during 2016. These affiliates include:
− The UMass ACO was formed effective January 1, 2015 to participate in the MSSP. An ACO is a group of physicians, hospitals, and other health care providers who provide coordinated care to their patients. Coordinated care helps ensure that patients, especially the chronically ill, receive the right care at the right time and in the right setting to avoid unnecessary duplication of services. Effective January 1, 2016, the UMass ACO includes six hospitals, four federally qualified health centers, 28 physician groups, and 26 individual physicians. The hospitals include the Medical Center, the HealthAlliance Campuses, Marlborough Hospital, Clinton Hospital, Holyoke Medical Center, and Sturdy Memorial Hospital. The physician groups include four large physician groups, including the Medical Group, Sturdy Memorial Associates, Inc., Wachusett Emergency Physicians, P.C., and Western Mass Physician Associates, Inc., along with a number of smaller groups and individual physicians. The federally qualified health centers include the Edward M. Kennedy Community Health Center, Inc., Community Health Connections, Inc., Community Healthlink, and the Family Health Center of Worcester, Inc. A-40 APPENDIX A − UMass Memorial Realty, Inc., which owns and leases real property.
− Yarock Memorial Housing, Inc., whose primary purpose is to receive and administer funds exclusively for civic and charitable proposes and to provide dwelling accommodations and related facilities for health, social, recreational, and educational use of the disabled and indigent.
− UMass Memorial Investment Partnership, LLP, which manages pooled investments for participating System entities.
In addition, the following Affiliates serve principally as holding companies for Affiliates: UMass Memorial Behavioral Health System, Inc. and UMass Memorial Community Hospitals, Inc. Members of the System also participate in joint ventures relating to diagnostic imaging services, philanthropy, investment management, physician-hospital joint contracting, and other health related activities.
BONDOWNERS’ RISKS AND MATTERS AFFECTING THE HEALTH CARE INDUSTRY
In addition to the risks set forth in the forepart of this Official Statement, the following factors, among others, constitute risks with respect to the Bonds. The ability of the Obligated Group to pay amounts due with respect to the Bonds is subject to significant risks relating to the health care industry generally and, more specifically, to the enforceability of the Master Trust Indenture against the Obligated Group.
In General
Future revenues and expenses of the Obligated Group will be affected by events and conditions relating generally to, among other things, demand for the services of the System, the ability of the System to provide the services required by patients, physicians’ relationships with the System, reimbursement rates under agreements with third-party payors as well as the Medicare and Medicaid programs, research grant funding, management capabilities, the correctness of the design and success of the System’s strategic plans, the degree of cooperation among and competition with other hospitals in the System’s area, changes in private philanthropy, malpractice claims and other litigation, economic developments in the Service Area, the System’s ability to control expenses and maintain relationships with HMOs, sponsors of research, and other managed health care organizations and third-party payors, rates, costs, third-party reimbursement, legislation and government regulation. Although the System reasonably expects to generate sufficient revenues in the future to cover its expenses, third-party payments, regulation and unanticipated events and circumstances may occur that cause variations from this expectation, and the variations may be material.
Accordingly, there can be no assurance that the financial condition of the Obligated Group and/or utilization of the System’s facilities will not be adversely affected, and there can be no guarantee that there will be sufficient revenues to make payments with respect to the Bonds. The following general factors, among others, could affect the level of revenues to the System or its financial condition or otherwise result in risks for Bondowners in addition to the risks set forth in the Official Statement under “Bondowners’ Risks.”
Significant Risk Areas Summarized
Certain of the primary risks associated with the operations of the members of the Obligated Group are briefly summarized in general terms below and are explained in greater detail in subsequent sections. The occurrence of one or more of these risks could have a material adverse effect on the financial condition and results of operations of the System and, in turn, the ability of the Obligated Group to make payments under the Master Trust Indenture and of principal of and interest on the Bonds.
General Economic Conditions, Bad Debt, Indigent Care and Investment Performance – Health care providers are affected by the economic environment in which they operate. To the extent that employers reduce their workforces or budgets for employee health care coverage or private and public insurers seek to reduce payments to health care providers or curb utilization of health care services, health care providers may experience decreases in insured patient volume and reductions in payments for services. In addition, to the extent that state, county or city governments are unable to provide a safety net of medical services, pressure is applied to local health care providers to increase free care. Furthermore, economic downturns, increased employee health insurance cost share obligations, and lower funding of Medicare and state Medicaid and other state health care programs may increase the number of patients who are unable to pay for their medical and hospital services. These conditions may give rise to increases in A-41 APPENDIX A health care providers’ uncollectible accounts, or “bad debt,” and, consequently, to reductions in operating income. Declines in investment portfolio values may reduce or eliminate non-operating revenues. Losses in pension and benefit funds may result in increased funding requirements. Potential failure of lenders, insurers or vendors may negatively affect the results of operations and the overall financial condition of health care providers. Philanthropic support may also decrease or be delayed. For a discussion of these risks with regard to the System, see “FINANCIAL INFORMATION OF THE SYSTEM.”
Dependence on Medicaid Supplemental Funds – The System depends materially on MSF. The Commonwealth’s provision of Medicaid Supplemental Funds is dependent on many factors, including federal/state negotiations and future cost containment efforts. There can be no assurance that future funds will be comparable to the current level of funding or sufficient to meet the System’s financial needs. Future delays or reductions in state supplemental funding could have a materially adverse effect on the System.
Dependence on 340B Drug Pricing – Hospitals such as the Medical Center that serve a high percentage of low- income patients are eligible for reduced pricing on drugs. This program contributed materially to the Medical Center’s operating income in 2016. Any reduction in eligibility for, or changes to, the 340B program generally could have a materially adverse effect on the System.
Nonprofit Health Care Environment – The significant tax benefits received by nonprofit, tax-exempt hospitals may cause the business practices of such hospitals to be subject to scrutiny of public officials and the press, and to legal challenges of the ongoing qualification of such organizations for tax-exempt status. Practices that have been examined, criticized, or challenged have included pricing practices, billing and collection practices, charitable care, and executive compensation. Challenges to entitlement to exemption of property from real property taxation have succeeded from time to time. Multiple governmental authorities, including state attorneys general, the Internal Revenue Service (“IRS”), the United States Congress and state legislatures have held hearings and carried out audits regarding the conduct of tax-exempt organizations, including tax-exempt hospitals. These efforts will likely continue in the future. Citizen organizations, such as labor unions and patient advocates, have also focused public attention on the activities of tax-exempt hospitals and raised questions about their practices. Proposals to increase the regulatory requirements for nonprofit hospitals’ retention of tax-exempt status, such as by establishing a minimum level of charity care, have also been introduced repeatedly in Congress. Significant changes in the obligations of nonprofit, tax-exempt hospitals, and challenges to or loss of the tax-exempt status of non-profit hospitals generally or the members of the Obligated Group in particular could have a material adverse effect on the System.
Federal Health Care Reform – The ACA includes numerous provisions affecting the delivery of health care services, the financing of health care costs, payments to health care providers, and the legal obligations of health insurers, providers, employers, and consumers. These provisions are slated to take effect at specified times over approximately the next decade, and, therefore, the full consequences of the ACA on the health care industry are still being realized. In addition, it is possible that changes in administration and policy resulting from the recent U.S. presidential election could result in additional proposals and/or changes to the ACA, including the potential repeal of all or parts of that law. In addition, the uncertainties regarding the implementation of the ACA create unpredictability for the strategic and business planning efforts of health care providers, which in itself creates risk. See “HEALTH CARE ENVIRONMENT” below.
Rate Pressure from Insurers and Purchasers – Certain health care markets, including central Massachusetts, are strongly affected by large health insurers and, in some cases, by major purchasers of health services. In those areas, health insurers may have significant influence over the rates, utilization and competition of hospitals and other health care providers. Rate pressure imposed by health insurers or other major purchasers, including managed care payors, may have a material adverse impact on health care providers, particularly if major purchasers put increasing pressure on payors to restrain rate increases. Business failures by health insurers also could have a material adverse impact on contracted hospitals and other health care providers in the form of payment shortfalls or delay, and continuing obligations to care for managed care patients without receiving payment. In addition, disputes with non- contracted payors may result in an inability to collect billed charges from these payors.
Capital Needs vs. Capital Capacity – Hospital and other health care operations are capital intensive. Regulation, technology and expectations of physicians and patients require constant and often significant capital investment. Total capital needs may exceed capital capacity.
Reliance on Medicare – Inpatient hospitals rely to a high degree on payment from the federal Medicare program. Recent changes in the underlying law and regulations, as well as in payment policy and timing, create uncertainty and could have a material adverse impact on hospitals’ payment stream from Medicare. With health care and A-42 APPENDIX A hospital spending reported to be increasing faster than the rate of general inflation, Congress or CMS is expected to take action in the future to decrease or restrain Medicare outlays for hospitals.
Medicare Trust Funds – Two trust funds are maintained as part of the Medicare Program. Hospital Insurance (“HI”) or Medicare Part A, helps to pay for hospital, home health, skilled nursing facility, and hospice care for the aged and disabled and is financed primarily by payroll taxes paid by workers and employers. The Medicare Board of Trustees’ annual report to Congress in June 2016 indicated that the HI Trust Fund is not financed adequately and is projected to be exhausted in 2028, two years earlier than in the prior year report. The other trust fund and various other components of the Medicare Program also have significant funding challenges. The trustees recommended that Congress and the executive branch work closely together with a sense of urgency to address the depletion of the HI Trust Fund and the projected growth in hospital and other expenditures. Accordingly, it is likely that statutory and regulatory attempts to contain increases in Medicare costs will continue in the future.
State Medicaid Programs – State Medicaid programs constitute an important payor source for many hospitals, but these programs often pay hospitals and other health care providers at levels that are substantially below the actual cost of the care provided. As Medicaid is partially funded by states, the financial condition of such states is likely to result in lower funding levels or payment delays. This could have a material adverse impact on hospitals and other health care providers.
Increasing Consumer Choice – Hospitals and other health care providers face increased pressure to be transparent and provide information about cost and quality of services, which may lead to a loss of business as consumers and others make choices about where to receive health care services based upon reports about cost and quality.
Costs and Restrictions from Governmental Regulation – Nearly every aspect of hospital operations and health care delivery is regulated, in some cases by multiple agencies of government. The level and complexity of regulation and compliance audits appear to be increasing, imposing greater operational limitations, enforcement and liability risks, and significant and sometimes unanticipated costs.
Government “Fraud” Enforcement – “Fraud” in government funded health care programs is a significant concern of federal and state regulatory agencies overseeing health care programs and is one of the federal government’s prime law enforcement priorities. The federal government and, to a lesser degree, state governments impose a wide variety of extraordinarily complex and technical requirements intended to prevent over-utilization based on economic inducements, misallocation of expenses, overcharging and other forms of “fraud” in the Medicare and Medicaid programs, as well as other state and federally-funded health care programs. This body of regulation affects a broad spectrum of hospital and other health care provider commercial activity, including billing, accounting, recordkeeping, medical staff oversight, physician contracting and recruiting, cost allocation, clinical trials, discounts, and other functions and transactions.
Violations and alleged violations may be deliberate, but also frequently occur in circumstances where management is unaware of the conduct in question, as a result of mistake, or where the individual participants do not know that their conduct is in violation of law. Violations may occur and be prosecuted in circumstances that do not have the traditional elements of fraud, and enforcement actions may extend to conduct that occurred in the past. Violations may carry significant sanctions. The government periodically conducts widespread investigations covering categories of services or certain accounting or billing practices.
Violations and Sanctions – The government or private “whistleblowers” often pursue aggressive investigative and enforcement actions. The government has a wide array of civil, criminal, monetary and other penalties, including the suspension of essential hospital and other health care provider payments from the Medicare or Medicaid programs, or exclusion from those programs. Aggressive investigation tactics, negative publicity and threatened penalties can be, and often are, used to force health care providers to enter into monetary settlements in exchange for releases of liability for past conduct, as well as agreements imposing prospective restrictions or mandated compliance requirements on health care providers. Such negotiated settlement terms may have a materially adverse impact on hospital and other health care provider operations, financial condition, results of operations and reputation. Multi- million dollar fines and settlements for alleged intentional misconduct, fraud or false claims are not uncommon in the health care industry. These risks are generally uninsured. Government enforcement and private whistleblower suits may increase in the hospital and health care sector. Many large hospital and other health care provider systems are likely to be adversely affected.
Personnel Shortage – From time to time, shortages of physicians and nursing and other technical personnel occur, which may have its primary impact on hospitals and health care systems. Various studies have predicted that A-43 APPENDIX A physician and nurse shortages will become more acute over time, as practitioners retire and patient volume exceeds the growth in new professionals. Shortages of other professional and technical staff such as pharmacists, therapists, laboratory technicians and others may occur. Hospital operations, patient and physician satisfaction, financial condition and future growth could be negatively affected by personnel shortages, resulting in a material adverse impact on hospitals and health care systems.
Technical and Clinical Developments – New clinical techniques and technology, as well as new pharmaceutical and genetic developments and products, may alter the course of medical diagnoses and treatments in ways that are currently unanticipated, and that may dramatically change medical and hospital care. These could result in higher health care costs, reductions in patient populations, lower utilization of hospital service and new sources of competition for hospitals.
Proliferation of Competition – Hospitals face competition from specialty providers of care and ambulatory care facilities. This competition may cause hospitals to lose essential inpatient or outpatient market share. Competition may be focused on services or payor classifications where hospitals realize their highest margins, thus negatively affecting programs that are economically important to hospitals. Specialty hospitals may attract specialists as investors and may seek to treat only profitable classifications of patients, leaving full-service hospitals with higher acuity and lower paying patient populations. These new sources of competition may have a material adverse impact on hospitals, particularly where principal physician admitters may curtail their use of a hospital service in favor of a competitor’s facilities.
Labor Costs and Disruption – The delivery of health care services is labor intensive. Labor costs, including salary, benefits and other liabilities associated with the workforce, have a significant impact on hospital and health care provider operations and financial condition. Hospital and health care employees are increasingly organized in collective bargaining units and may be involved in work actions of various kinds, including work stoppages and strikes. Overall costs of the hospital workforce and turnover are high. Pressure to recruit, train and retain qualified employees is expected to accelerate. These factors may materially increase hospital costs of operation. Workforce disruption may negatively affect hospital revenues and reputation.
Pension and Benefit Funds – As large employers, hospitals and health care providers may incur significant expenses to fund pension and benefit plans for employees and former employees, and to fund required workers’ compensation benefits. Plans are often underfunded, or may become underfunded and funding obligations in some cases may be erratic or unanticipated and may require significant commitments of available cash needed for other purposes.
Medical Liability Litigation and Insurance – Medical liability litigation is subject to public policy determinations and legal and procedural rules that may be altered from time to time, with the result that the frequency and cost of such litigation, and resultant liabilities, may increase in the future. Health systems may be affected by negative financial and liability impacts on physicians. Costs of insurance, including self-insurance, may increase dramatically.
Construction Risks – Construction projects are subject to a variety of risks, including but not limited to delays in issuance of required building permits or other necessary approvals or permits, including environmental approvals, strikes, shortages of materials and labor, and adverse weather conditions. Such events could delay project completion and use. Cost overruns may occur due to change orders, delays in the construction schedule, scarcity of building materials and labor, and other factors. Cost overruns could cause the costs of any project to exceed available funds.
Facility Damage – Hospitals and health care providers are highly dependent on the condition and functionality of their physical facilities. Damage from earthquakes, floods, fires, other natural causes, deliberate acts of destruction, or various facilities system failures may have a material adverse impact on operations, financial conditions and results of operations.
Impact of Market Turmoil and General Economic Factors
The disruption of the credit and financial markets since 2008 resulted in volatility in the securities markets, significant losses in investment portfolios, increased business failures and consumer and business bankruptcies. In response to this disruption of the credit and financial markets, federal legislation was enacted, including the Recovery Act and the Dodd-Frank Act (defined below).
A-44 APPENDIX A In February 2009, the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”) was enacted and included several provisions intended to provide financial relief to the health care sector by providing approximately $150 billion in new funds. The funds were used to, among other things, provide a temporary increase in Federal payments to fund state Medicaid programs and provided subsidies to the recently unemployed for health insurance premium costs. The Recovery Act and resulting regulations established a framework for the implementation of a nationally-based health IT program. For more information regarding this program, see “—REGULATORY ENVIRONMENT—The HITECH Act” below.
In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted in an effort to stabilize the credit and financial markets. Regulatory action is being considered by various federal agencies and the Federal Reserve Board and foreign governments which are intended to increase the regulation of financial institutions and domestic and global credit and securities markets. The effects of these legislative, regulatory and other governmental actions, including the Dodd-Frank Act, upon the System and, in particular upon its access to capital markets and its investment portfolios, cannot be predicted.
Nonprofit Health Care Environment
Each member of the Obligated Group is a nonprofit corporation, exempt from federal income taxation as an organization described in Section 501(c)(3) of the Code. As a nonprofit, tax-exempt organization, each member of the Obligated Group is subject to federal, state and local laws, regulations, rulings and court decisions relating to its organization and operation, including its operation for charitable purposes. At the same time, the System conducts large-scale, complex business transactions and is a major employer in the central Massachusetts area. There can often be a tension between the rules designed to regulate a wide range of charitable organizations and the day-to-day operations of a complex health care organization.
The operations and practices of nonprofit, tax-exempt hospitals are routinely challenged or criticized for inconsistency or inadequate compliance with the regulatory requirements for, and societal expectations of, nonprofit, tax-exempt organizations. These challenges are broader than concerns about compliance with federal and state statutes and regulations, such as Medicare and Medicaid compliance, and instead in many cases are examinations of core business practices of the health care organizations. Areas that have come under examination include pricing practices, billing and collection practices, charitable care, methods of providing and reporting community benefit, executive compensation, exemption of property from real property taxation, private use of facilities financed with tax-exempt bonds and others. These challenges and questions have come from a variety of sources, including state attorneys general, the IRS, labor unions, Congress, state legislatures, and patients, and in a variety of forums, including hearings, audits and litigation. The challenges and examinations, and any resulting legislation, regulations, judgments or penalties, could have a material adverse effect on the System. These challenges or examinations include the following, among others:
Congressional Hearings – Senate and House committees have conducted several nationwide investigations of hospital billing and collection practices and prices charged to uninsured patients and have considered reforms to the nonprofit sector, including proposed reform in the area of tax-exempt health care organizations, as part of health care reform generally. See “—IRS Examination of Compensation Practices,” “—IRS Community Benefit Initiative” and “—Challenges to Real Property Tax Exemption” below.
IRS Bond Examinations – IRS officials have indicated that more resources will be invested in audits of tax-exempt bonds in the charitable organization sector with specific review of private use. A schedule to the Form 990 return (Schedule K) is intended to address what the IRS believes is significant noncompliance with recordkeeping and record retention requirements. Schedule K also requires tax-exempt organizations to report on the investment and use of bond proceeds to address IRS concerns regarding compliance with arbitrage rebate requirements and the private use of bond-financed facilities.
IRS Examination of Compensation Practices – In 2004, the IRS began a new program to measure compliance by tax-exempt organizations with requirements that they not pay excessive compensation and benefits to their officers and other insiders. In 2009, the IRS issued its Hospital Compliance Project Final Report (the “IRS Final Report”) that examined tax-exempt hospitals’ practices and procedures with regard to compensation and benefits paid to their officers and other defined “insiders.” The IRS Final Report indicates that the IRS will continue to heavily scrutinize executive compensation arrangements, practices and procedures of tax-exempt hospitals and other tax-exempt organizations and, in certain circumstances, may conduct further investigations or impose fines on tax-exempt organizations.
A-45 APPENDIX A IRS Community Benefit Initiative – The IRS has undertaken a community benefit initiative directed at hospitals. An IRS report on this initiative determined that a lack of uniformity in definitions of community benefit used by reporting hospitals, including those regarding uncompensated care and various types of community benefit, make it difficult for the IRS to assess whether any particular hospital is in compliance with current law. Form 990 includes Schedule H, which hospitals and health systems must use to report their community benefit activities, including the cost of providing charity care and other tax-exemption related information. Proposals have also been made within Congressional committees to codify the requirements for hospitals’ tax-exempt status, including requirements to conduct a regular community needs analysis and to provide minimum levels of charity care.
ACA Requirements for Tax-Exempt Status – As part of the ACA, Congress enacted Section 501(r) of the Code which imposes additional requirements for hospitals and other designated health care organizations to be treated as tax- exempt organizations. Under these rules, in order to maintain their tax-exempt status hospitals must establish and publicize written financial assistance policies, conduct community health needs assessments at least once every three years and describe in their annual tax returns how they are addressing the needs identified in such assessments. See “HEALTH CARE ENVIRONMENT—Tax Exemption Requirements” below.
Challenges to Real Property Tax Exemption – Recently, the real property tax exemptions afforded to certain nonprofit health care providers by state and local taxing authorities have been challenged on the grounds that the health care providers were not engaged in sufficient charitable activities as to warrant exemption from taxation as a charitable institution. For example, the Illinois Supreme Court upheld a decision relating to a local taxing authority’s decision to deny a request for property tax exemption for a nonprofit hospital on the basis that the hospital had not proven with clear and convincing evidence that it was operating within a charitable purpose under applicable Illinois law. Additionally, similar challenges have been based on a variety of grounds, including allegations of aggressive billing and collection practices and excessive financial margins. Several of these disputes have been determined in favor of the taxing authorities or have resulted in settlements. See “TAX-EXEMPT STATUS AND OTHER TAX MATTERS—Real Property Tax Exemption” below.
Indigent Care – Tax-exempt health care providers often treat large numbers of indigent patients who are unable to pay in full for their medical care. Typically, urban, inner-city hospitals and other health care providers may treat significant numbers of indigents. These hospitals and health care providers may be susceptible to economic and political changes that could increase the number of indigents or their responsibility for caring for this population. General economic conditions affect the number of employed individuals who have health coverage and the ability of patients to pay for their care. Similarly, changes in governmental policy, which may result in coverage exclusions under local, county, state and federal health care programs (including Medicare and Medicaid) may increase the frequency and net cost of indigent treatment by such hospitals and other providers. It also is possible that future legislation could require that tax-exempt hospitals and other providers maintain minimum levels of indigent care as a condition to federal income tax exemption or exemption from certain state or local taxes.
Class Actions – Nonprofit hospitals and health systems have long been subject to a wide variety of litigation risks, including liability for care outcomes, employer liability, property and premises liability, and peer review litigation with physicians, among others. In recent years, consumer class action litigation has emerged as a potentially significant source of litigation liability for nonprofit hospitals and health systems. These class action suits have most recently focused on hospital billing and collections practices and breaches of privacy, and they may be used for a variety of currently unanticipated causes of action. Since the subject matter of class action suits may involve uninsured risks, and since such actions often involve alleged large classes of plaintiffs, they may have material adverse consequences on hospitals and health systems in the future. See “—BUSINESS RELATIONSHIPS AND OTHER BUSINESS MATTERS—Wage and Hour Class Actions and Litigation” and “—BUSINESS RELATIONSHIPS AND OTHER BUSINESS MATTERS—Other Class Actions” below.
The foregoing are some examples of the challenges and examinations facing nonprofit health care organizations. They are indicative of a greater scrutiny of the billing, collection and other business practices of these organizations and may indicate an increasingly difficult operating environment for health care organizations, including the members of the Obligated Group. The challenges and examinations, and any resulting legislation, regulations, judgments, or penalties, could have a material adverse effect on hospitals and health care providers, including the System, and, in turn, its ability to make payments under the Master Trust Indenture and the Bonds.
Health Care Environment
The ACA has been subject to opposition in the political and judicial arenas, and President-Elect Donald Trump and republican members of Congress have vowed to renew repeal efforts in 2017. A number of Congressional proposals A-46 APPENDIX A have already been advanced for repealing the ACA. If a full repeal proves impractical, legislators may instead dismantle portions of the ACA through various legislative efforts (including replacement or amendment) and funding measures. The effect of any major modification or repeal of the ACA on the financial conditions of the members of the Obligated Group cannot be predicted with certainty, but could be materially adverse.
Additionally, many of the reductions in reimbursement to health care providers included in the ACA have yet to take full effect, and the increased health care coverages contemplated under the ACA has not yet been realized. The practical consequences of the ACA and its potential repeal, as well as of other future federal and state actions to cut costs and change the health care delivery system, cannot be foreseen.
Some of the specific provisions of the ACA that may affect the System’s operations, financial performance or financial condition are described below.
Market Basket Reductions – Generally, Medicare payment rates to hospitals are adjusted annually based on a “market basket” of estimated cost increases. The ACA provides for several types of adjustments (positive and negative) in the market basket. For federal fiscal year 2017, the net market basket adjustment for general acute care hospitals is approximately 0.95%.
Hospital Acquired Conditions Penalty – Beginning in FFY 2015, Medicare inpatient payments to hospitals that are in the top quartile nationally for frequency of certain “hospital-acquired conditions” will be reduced by 1% for all discharges for the applicable FFY. In addition, the ACA provides that, as of July 1, 2011, CMS will no longer provide federal funding to states for any amounts expended by providers in treating so-called provider-preventable conditions. The Massachusetts Executive Office of Health and Human Services also issued regulations effective for dates of service on or after July 1, 2012 denying Medicaid payment for costs associated with provider preventable conditions, which include those identified as Health Care Acquired Conditions and Other Provider Preventable Conditions as defined in federal regulations. Notably, the MA DPH promulgated regulations prohibiting health care facilities from charging or seeking reimbursement for services provided as a result of a “serious reportable event” when a preventability analysis determines that the event was preventable. The conditions included under these MA DPH regulations are far more extensive than those included in the Medicare “hospital-acquired conditions.”
Readmission Rate Penalty – The ACA required CMS to reduce Medicare inpatient payments to hospitals with excess readmission rates for certain medical conditions, beginning on October 1, 2012. For FFY 2016, a hospital’s payments can be reduced by a maximum of 3%. In addition, the ACA allows for expansion of the conditions measured for readmission rate penalties beginning in FFY 2015.
DSH Funding – Beginning in FFY 2017, hospitals receiving supplemental DSH payments from Medicare (i.e., those hospitals that care for a disproportionate share of Medicare beneficiaries) are slated to have their DSH payments reduced by potentially 75% (offset however, by the reduced levels of uninsured requiring services). The base 25% will be supplemented by additional payments based on the volume of uninsured and uncompensated care provided by each such hospital, and is anticipated to be partially offset by a higher proportion of covered patients as other provisions of the ACA go into effect. Separately, beginning in FFY 2017, Medicaid DSH allotments to each state also will be reduced based on a methodology that takes into account statewide reductions in uninsured and uncompensated care.
Tax Exemption Requirements – The ACA also contains new requirements for tax-exempt hospitals. Under the ACA, each tax-exempt hospital facility is required to (i) conduct a community health needs assessment at least every three years and adopt an implementation strategy to meet the identified community needs, (ii) adopt, implement and widely publicize a written financial assistance policy and a policy to provide emergency medical treatment without discrimination, (iii) limit charges to individuals who qualify for financial assistance under such tax-exempt hospital’s financial assistance policy to no more than the amounts generally billed to individuals who have insurance covering such care and refrain from using “gross charges” when billing such individuals, and (iv) refrain from taking extraordinary collection actions without first making reasonable efforts to determine whether the individual is eligible for assistance under such tax-exempt hospital’s financial assistance policy. In addition, the Treasury Department is required to review information about each tax-exempt hospital’s community benefit activities at least once every three years, as well as to submit an annual report to Congress with information regarding the levels of charity care, bad debt expenses, unreimbursed costs of government programs, and costs incurred by tax-exempt hospitals for community benefit activities. The periodic reviews and reports to Congress regarding the community benefits provided by 501(c)(3) hospitals may increase the likelihood that Congress will require such hospitals to provide a minimum level of charity care in order to retain tax-exempt status and may increase IRS scrutiny of particular 501(c)(3) hospital organizations. A-47 APPENDIX A Patient Service Revenues
Medicare Program – Medicare is the federal health insurance system under which hospitals are paid for services provided to eligible elderly and disabled persons. Medicare is administered by CMS, which delegates to the states the process for certifying hospitals to which CMS will make payment. In order to achieve and maintain Medicare certification, hospitals must meet CMS’s “Conditions of Participation” on an ongoing basis, as determined by the states and The Joint Commission. The requirements for Medicare certification are subject to change, and, therefore, it may be necessary for hospitals to effect changes from time to time in their facilities, equipment, personnel, billing, policies and services. As the population ages, more people will become eligible for the Medicare program. Current projections indicate that demographic changes and continuation of current cost trends will exert significant and negative forces on the overall federal budget.
Hospital Inpatient Reimbursement – Hospitals are generally paid for inpatient services provided to Medicare beneficiaries based on established categories of treatments or conditions known as DRGs. See “SOURCES OF PATIENT SERVICE REVENUE—Medicare.” The actual cost of care, including capital costs, may be more or less than the DRG rate. DRG payments include a labor-related share and a non-labor related share. The labor-related share is adjusted by the wage index applicable to the area where the hospital is located. In 2016, changes in the area wage index resulted in material reductions in Medicare reimbursement to Massachusetts hospitals, including the System hospitals. Future changes to the area wage index may result in increases or decreases in reimbursement. In addition, DRG rates are subject to other adjustments by CMS and are subject to federal budget considerations. There is no guarantee that DRG rates, as they change from time to time, will cover actual costs of providing services to Medicare patients.
Hospital Outpatient Reimbursement – Hospitals are generally paid for outpatient services provided to Medicare beneficiaries based on established categories of treatments or conditions known as APCs. The actual cost of care, including capital costs, may be more or less than the reimbursements. There is no guarantee that APC rates, as they change from time to time, will cover actual costs of providing services to Medicare patients.
Physician Payments – Medicare pays for physician services using a national fee schedule. The fee schedule establishes payment amounts for all physician services rendered to Medicare patients, including services of provider-based physicians, and is subject to annual updates. On April 16, 2015, President Obama signed into law MACRA. MACRA repeals the sustainable growth rate formula for calculating updates to Medicare payment rates to physicians and establishes an alternative set of annual updates. In addition, the act introduces a new merit-based incentive payment system and puts in place processes for developing, evaluating, and adopting alternative payment models. It is unclear how these changes may affect the System.
Other Medicare Service Payments – Medicare payment for skilled nursing services, psychiatric services, inpatient rehabilitation services, general outpatient services and home health services are based on regulatory formulas or pre- determined rates. There is no guarantee that these rates, as they may change from time to time, will be adequate to cover the actual cost of providing these services to Medicare patients.
Reimbursement of Hospital Capital Costs – Hospital capital costs apportioned to Medicare patient use (including depreciation and interest) are paid by Medicare exclusively on the basis of a standard federal rate (based upon average national costs of capital), subject to limited adjustments specific to the hospital. There can be no assurance that future capital-related payments will be sufficient to cover the actual capital-related costs of facilities applicable to Medicare patient stays or will provide flexibility for hospitals to meet changing capital needs.
Medical Education Payments – Medicare currently pays for a portion of the costs of medical education at hospitals that have teaching programs. These payments are vulnerable to reduction or elimination. The direct and indirect medical education reimbursement programs have repeatedly emerged as targets in the legislative efforts to reduce the federal budget deficit.
Medicaid Program – Medicaid is a program of medical assistance, funded jointly by the federal government and the states, for certain needy individuals and their dependents. Under Medicaid, the federal government provides limited funding to states that have medical assistance programs that meet federal standards. Attempts to balance or reduce federal and state budgets will likely negatively affect Medicaid and other state health care program spending.
Historically Medicaid has reimbursed at rates below the cost of care. Therefore, increases in the overall proportion of Medicaid patients pose a risk. It is uncertain to what extent this risk may be mitigated if the increased Medicaid utilization replaces previously uncompensated patients. A-48 APPENDIX A Certain states selectively contract with general acute care hospitals to provide services to participants in the Medicaid program of the state and may not provide payment to hospitals that do not have such a contract. Payment under the contracts may not cover the cost of providing services or may be reduced by the states. Reductions in payments by state Medicaid programs or loss of such contracts could materially adversely affect the financial condition of the System.
Medicare and Medicaid Audits – Hospitals that participate in the Medicare and Medicaid programs are subject from time to time to audits and other investigations relating to various aspects of their operations and billing practices, as well as to retroactive audit adjustments with respect to reimbursements claimed under these programs. Medicare and Medicaid regulations also provide for withholding reimbursement payments in certain circumstances. New billing rules and reporting requirements for which there is no clear guidance from CMS or state Medicaid agencies could result in claims submissions being considered inaccurate. The penalties for violations may include an obligation to refund money to the Medicare or Medicaid program, payment of criminal or civil fines and, for serious or repeated violations, exclusion from participation in federal health programs.
Authorized by HIPAA (as defined below), the Medicare Integrity Program (“MIP”) was established to deter fraud and abuse in the Medicare program. Funded separately from the general administrative contractor program, MIP allows CMS to enter into contracts with outside entities and insure the “integrity” of the Medicare program. These outside entities, Medicare zone program integrity contractors (“ZPICs”) are contracted by CMS to review claims and medical charts, both on a prepayment and post-payment basis, conduct cost report audits and identify cases of suspected fraud. ZPICs have the authority to deny and recover payments as well as to refer cases to the OIG. CMS is also planning to enable ZPICs to compile claims data from multiple sources in order to analyze the complete claims histories of Medicare beneficiaries for inconsistencies.
CMS also enlists recovery audit contractors (“RACs”) to conduct periodic annual audits of Medicare payments to search for potentially improper Medicare payments from prior years that were not detected through CMS’s routine program integrity efforts. The RACs are private contractors, paid on a contingency fee basis, and use their own software and review processes. Although required to identify both overpayments and underpayments, RACs have in practice collected significantly more in overpayments from health care providers in proportion to the underpayments to the providers. Under the ACA, recovery audits were expanded to include Medicaid by requiring states to contract with RACs to conduct those audits.
In addition, CMS has instituted a Medicaid Integrity Program, modeled on MIP. Medicaid Integrity Program contractors assist state Medicaid agencies by analyzing Medicaid claims data to identify high-risk areas and potential vulnerabilities and conducting post-payment field audits and desk reviews audits of Medicaid provider payments.
Audits may result in reduced reimbursement or repayment obligations related to past alleged overpayments and may also delay Medicare or Medicaid payments to health care providers pending resolution of the appeals process. The ACA explicitly gives DHHS the authority to suspend Medicare and Medicaid payments to a health care provider or supplier during a pending investigation of fraud. The ACA also amended certain provisions of the False Claims Act (“FCA”) (as defined below) to include retention of overpayments as a violation. It also added provisions respecting the timing of the obligation to identify, report and reimburse overpayments. See “—REGULATORY ENVIRONMENT—False Claims Act” below. The effect of these changes on existing programs and systems of the System cannot be predicted.
Disproportionate Share Hospitals – The federal Medicare and state Medicaid programs each provide additional payment to “disproportionate share hospitals” (or “DSHs”), which are hospitals that serve a disproportionate share of certain low-income patients. The Medical Center, HealthAlliance, Marlborough Hospital, and Clinton Hospital qualify as DSHs. See also “—HEALTH CARE ENVIRONMENT—DSH Funding” above. There can be no assurance that payments to the System will continue to qualify for DSH status.
State and Local Budgets – The Commonwealth has incurred financial challenges, including erosion of general fund tax revenues, falling real estate values, slowing economic growth, and higher unemployment, each of which may continue to worsen or resist improvement over the coming years.
The financial challenges facing the Commonwealth may negatively affect hospitals in a number of ways, including elimination or reduction of health care safety net programs (causing a greater number of indigent, uninsured or underinsured patients) and reductions in Medicaid reimbursement rates. The financial challenges may also result in a greater number of indigent, uninsured or underinsured patients who are unable to pay for their care or gain access to A-49 APPENDIX A primary care facilities, a greater number of individuals who qualify for Medicaid and reductions in Medicaid reimbursement rates.
On July 8, 2016, the Governor signed into law the budget for state fiscal year 2017, which begins July 1, 2016. The Governor’s budget includes a new $250 million assessment to be levied on the Commonwealth’s acute care hospitals, including the Medical Center and HealthAlliance. The additional $250 million assessment will be deposited into a newly created “MassHealth Delivery System Reform Trust.” The budget will offset this $250 million assessment by increasing MassHealth reimbursement rates to acute care hospitals, as a group, by $250 million, but there are no assurances that any individual hospital’s rate increase offset would cover its share of the $250 million assessment.
Health Plans and Managed Care – Most private health insurance coverage is provided by various types of “managed care” plans, including HMOs and PPOs that generally use discounts and other economic incentives to reduce or limit the cost and utilization of health care services. Medicare and Medicaid also purchase hospital care using managed care options. Payments to hospitals from managed care plans typically are lower than those received from traditional indemnity or commercial insurers.
In many markets, managed care plans have replaced indemnity insurance as the primary source of non-governmental payment for hospital services, and hospitals must be capable of attracting and maintaining managed care business, often on a regional basis. Regional coverage and aggressive pricing may be required. However, it is also essential that contracting hospitals be able to provide the contracted services without significant operating losses, which may require multiple forms of cost containment.
Many HMOs and PPOs currently pay providers on a negotiated fee-for-service basis or, for institutional care, on a fixed rate per day of care, which, in each case, usually is discounted from the usual and customary charges for the care provided. As a result, the discounts offered to HMOs and PPOs may result in payment to a provider that is less than its actual cost. Additionally, the volume of patients directed to a provider may vary significantly from projections, and changes in the utilization may be dramatic and unexpected, thus jeopardizing the provider’s ability to manage this component of revenue and cost.
Some HMOs employ a “capitation” payment method under which hospitals are paid a predetermined periodic rate for each enrollee in the HMO who is “assigned” or otherwise directed to receive care at a particular hospital. The hospital may assume financial risk for the cost and scope of institutional care given. If payment is insufficient to meet the hospital’s actual costs of care, or if utilization by enrollees materially exceeds projections, the financial condition of the hospital could erode rapidly and significantly.
Often, HMO contracts are enforceable for a stated term, regardless of hospital losses and may require hospitals to care for enrollees for a certain time period, regardless of whether the HMO is able to pay the hospital. Members of the Obligated Group from time to time have disputes with HMOs, PPOs and other managed care payors concerning payment and contract interpretation issues. Such disputes may result in mediation, arbitration or litigation. Management expects that these types of issues ultimately will be resolved.
Defined broadly, for the fiscal year ended September 30, 2016, managed care contracts constituted approximately 52.1% of discharges at the System, but there is no assurance that the System will maintain managed care contracts or obtain other similar contracts in the future. See “SOURCES OF PATIENT SERVICE REVENUE.”
Failure to maintain contracts could have the effect of reducing the System’s market share and net patient services revenues. Conversely, participation may result in lower net income to the System if it is unable to contain adequately its costs. Thus, managed care poses one of the most significant business risks (and opportunities) the System faces.
Negative Rankings Based on Clinical Outcomes, Cost, Quality, Patient Satisfaction and Other Performance Measures – Health plans, Medicare, Medicaid, employers, trade groups and other purchasers of health services, private standard-setting organizations and accrediting agencies increasingly are using statistical and other measures in efforts to characterize, publicize, compare, rank and change the quality, safety and cost of health care services provided by hospitals and health care providers. Published rankings such as “score cards,” “pay for performance” and other financial and non-financial incentive programs are being introduced to affect the reputation and revenue of hospitals, the members of their medical staffs and other providers and to influence the behavior of consumers and providers such as the System. Currently prevalent are measures of quality based on clinical outcomes of patient care, reduction in costs, patient satisfaction and investment in health IT. Measures of performance set by others that A-50 APPENDIX A characterize a hospital or a health care provider negatively may adversely affect its reputation and financial condition.
Massachusetts Cost Control Initiatives
In 2012, the Massachusetts legislature enacted Chapter 224 in an effort to control the rate of increase of public and private health care costs in the Commonwealth. Chapter 224 created two new state agencies, the Health Policy Commission (the “HPC”) and CHIA, each with a variety of duties and powers. Among other things, CHIA is mandated to calculate and monitor per capita TME in the Commonwealth, and to monitor the relative prices paid by health insurers to hospitals and large medical groups. The HPC will compare the growth in TME to the rate of the growth of the Massachusetts economy. If the growth in medical expenditures exceeds the rate of growth of the economy, the HPC will hold public hearings, and may require certain high cost health care providers to develop and execute “performance improvement plans” in order to moderate the growth of health care expenditures. The HPC has the authority to license and regulate “accountable care organizations” in Massachusetts and those regulations could have a material impact on the financial performance of Massachusetts hospitals. Chapter 224 also empowers the Commonwealth’s Division of Insurance to oversee the financial solvency of health care providers that enter into risk contracts with health insurers or with government agencies. Chapter 224 has a variety of other provisions increasing state government’s ability to monitor and regulate the health care system and to increase its financial transparency.
The Massachusetts Attorney General has engaged in a variety of initiatives intended to restrain the growth of health care costs in the Commonwealth and has published reports critical of the contracting practices of large health care systems and health insurers. The new HPC, acting in concert with other state agencies and officials, may put pressure on health insurers and health care providers to restrain the growth of health care costs, especially if the growth in TME exceeds the growth rate of the state economy. Various legislative proposals are filed in the legislature each year to further regulate the health care system and some of these proposals could, if enacted, have an adverse impact on Massachusetts hospitals.
Regulatory Environment
“Fraud” and “False Claims” – Health care “fraud and abuse” laws have been enacted at the federal and state levels to regulate broadly the provision of services to government program beneficiaries and the methods and requirements for submitting claims for services rendered to the beneficiaries. Under these laws, hospitals and others can be penalized for a wide variety of conduct, including: submitting claims for services that are not provided; billing in a manner that does not comply with government requirements or includes inaccurate billing information; billing for services deemed to be medically unnecessary; or billing accompanied by an illegal inducement to utilize or refrain from utilizing a service or product.
Federal and state governments have a broad range of criminal, civil and administrative sanctions available to penalize and remediate health care fraud, including the exclusion of a hospital from participation in the Medicare/Medicaid programs, civil monetary penalties, and suspension of Medicare/Medicaid payments. Fraud and abuse cases may be prosecuted by one or more government entities and private individuals, and more than one of the available sanctions may be, and often are, imposed for each violation.
Laws governing fraud and abuse may apply to a hospital and to nearly all individuals and entities with which a hospital does business. Fraud investigations, settlements, prosecutions and related publicity can have a material adverse effect on hospitals. See “—Enforcement Activity” below. Major elements of these often highly technical laws and regulations are generally summarized below.
The Secretary of DHHS may exclude a provider’s participation in Medicare and Medicaid, as well as suspend payments to a provider pending an investigation or prosecution of a credible allegation of fraud against the provider.
False Claims Act – The federal FCA makes it illegal to submit or present a false, fictitious or fraudulent claim for payment or approval for payment for which the federal government provides, or reimburses at least some portion of, the requested money or property. Pursuant to the ACA, failure to report and return to a federal health care program a known overpayment within 60 days of having identified the overpayment or, for cost-reporting entities, the date (if later) on which a hospital cost report is due can give rise to an FCA claim. FCA investigations and cases have become common in the health care field and may cover a range of activity from intentionally inflated billings, to highly technical billing infractions, to allegations of inadequate care. Violation or alleged violation of the FCA most often results in settlements that require multi-million dollar payments and compliance agreements. The FCA also A-51 APPENDIX A permits individuals to initiate civil actions on behalf of the government in lawsuits called “qui tam” actions. Qui tam plaintiffs, or “whistleblowers,” can share in the damages recovered by the government or recover independently if the government does not participate. The FCA has become one of the government’s primary weapons against health care fraud. FCA violations or alleged violations could lead to settlements, fines, exclusion or reputation damage that could have a material adverse impact on a hospital.
Anti-Kickback Law. – The federal “Anti-Kickback Law” is a criminal statute that prohibits anyone from soliciting, receiving, offering or paying any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, in return for a referral (or to induce a referral) for any item or service that is paid by any federal or state health care program. The Anti-Kickback Law applies to many common health care transactions between persons and entities with which a hospital does business, including hospital-physician joint ventures, medical director agreements, physician recruitment agreements, physician office leases and other transactions. The ACA amended the Anti-Kickback Law to provide that a claim that includes items or services resulting from a violation of the Anti-Kickback Law now constitutes a false or fraudulent claim for purposes of the FCA.
Violation or alleged violation of the Anti-Kickback Law most often results in settlements that require multi-million dollar payments and mandatory compliance agreements that typically include costly audit requirements. The Anti- Kickback Law can be prosecuted either criminally or civilly. Violation is a felony, subject to a fine of up to $25,000 for each act (which may be each item or each bill sent to a federal program), imprisonment and exclusion from the Medicare and Medicaid programs. In addition, civil monetary penalties of $10,000 per item or service in noncompliance (which may be each item or each bill sent to a federal program) or an “assessment” of three times the amount claimed may be imposed. The IRS has taken the position that hospitals which are in violation of Anti- Kickback Law may also be subject to revocation of their tax-exempt status.
Stark Referral Law – The federal “Stark” statute prohibits the referral by a physician of Medicare and Medicaid patients for certain designated health services (including inpatient and outpatient hospital services, clinical laboratory services, and radiation and other imaging services) to entities with which the referring physician has a direct or indirect financial relationship. It also prohibits a hospital furnishing the designated services from billing Medicare, or any other payor or individual, for services performed pursuant to a prohibited referral. The government does not need to prove that the entity knew that the referral was prohibited to establish a Stark violation. If certain substantive and technical requirements are not met, many ordinary business practices and economically desirable arrangements between hospitals and physicians will likely constitute “financial relationships” within the meaning of the Stark statute, thus triggering the prohibition on referrals and billing. Most providers of designated health services with physician relationships have some exposure to liability under the Stark statute.
Medicare may deny payment for all services related to a prohibited referral, and a hospital that has billed for prohibited services is obligated to notify and refund the amounts collected from the Medicare program. For example, if an office lease between a hospital and a large group of heart surgeons is found to violate Stark, the hospital could be obligated to repay CMS for the payments received from Medicare for all of the heart surgeries performed by all of the physicians in the group for the duration of the lease; a potentially significant amount. The government may also seek substantial civil monetary penalties, and in some cases, a hospital may be liable for fines up to three times the amount of any monetary penalty, and be excluded from the Medicare and Medicaid programs. Potential repayments to CMS, settlements, fines or exclusion for a Stark violation or alleged violation could have a material adverse impact on a hospital.
Civil Monetary Penalties Law – The federal Civil Monetary Penalties Law (“CMPL”) provides for administrative sanctions, including civil money penalties and treble damages, against health care providers for a broad range of billing and other financial abuses. For example, a health care provider is liable under the CMPL if it knowingly presents, or causes to be presented, improper claims for reimbursement under Medicare, Medicaid, and other federal health care programs or if it gives benefits or other inducements to Medicare or Medicaid beneficiaries that the provider knows or should know are likely to induce the beneficiaries to choose the provider for their care. In addition, a hospital that participates in arrangements under which a physician is paid to limit or reduce medically necessary services to Medicare fee-for-service beneficiaries would be subject to CMPL penalties. The ACA added new exceptions to the CMPL permitting, among other things, arrangements that promote access to care and pose a low risk of harm to patients and the federal health care programs.
Health care providers may be found liable under the CMPL even when they did not have actual knowledge of the impropriety of their action. It is sufficient to knowingly undertake the action. Ignorance of the CMPL is no defense. The imposition of civil money penalties on a health care provider could have a material adverse impact on the provider’s financial condition. A-52 APPENDIX A State “Fraud” and “False Claims” Laws – Hospital providers in the Commonwealth also are subject to Massachusetts state laws related to false claims (similar to the FCA or that are generally applicable false claims laws), anti-kickback (similar to the federal Anti-Kickback Law or that are generally applicable anti-kickback or fraud laws), and physician referral (similar to Stark). These prohibitions, although similar in public policy and scope to the federal laws, have not in all instances been avidly enforced to date. However, in the future they could pose the possibility of a material adverse impact on a hospital for the same reasons as the federal statutes. See “—False Claims Act,” “—Anti-Kickback Law” and “—Stark Referral Law” above.
Antitrust – Antitrust liability may arise in a wide variety of circumstances, including medical staff privilege disputes, payor contracting, physician relations, joint ventures, merger, affiliation and acquisition activities, certain pricing or salary setting activities, as well as other areas of activity. The application of the federal and state antitrust laws to health care is evolving (especially as the ACA is implemented), and therefore not always clear. Currently, the most common areas of potential liability are joint action among providers with respect to payor contracting and medical staff credentialing disputes. From time to time, the System is or may be involved with all of these types of activities, and the System cannot predict when or to what extent liability, if any, may arise. Liability in any of these or other trade regulation areas may be substantial, depending upon the facts and circumstances of each case.
Violation of the antitrust laws could result in criminal and/or civil enforcement proceedings by federal and state agencies, as well as actions by private litigants. In certain actions, private litigants may be entitled to treble damages, and in others, governmental entities may be able to assess substantial monetary fines.
HIPAA – The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) adds additional criminal sanctions for health care fraud and applies to all health care benefit programs, whether public or private. HIPAA also provides for punishment of a health care provider for knowingly and willfully embezzling, stealing, converting or intentionally misapplying any money, funds, or other assets of a health care benefit program. A health care provider convicted of health care fraud could be subject to mandatory exclusion from Medicare.
HIPAA also addresses the confidentiality of individuals’ health information. Disclosure of certain broadly defined “protected health information” is prohibited unless expressly permitted under the provisions of HIPAA and applicable regulations or authorized by the patient. HIPAA’s confidentiality provisions extend not only to patient medical records, but also to a wide variety of health care clinical and financial settings where patient privacy restrictions often impose new communication, operational, accounting and billing restrictions. These add costs and create potentially unanticipated sources of legal liability.
HIPAA imposes civil monetary penalties for violations and criminal penalties for knowingly obtaining or using individually identifiable health information. The penalties range from $50,000 to $250,000 and/or imprisonment for up to 10 years if the information was obtained or used with the intent to sell, transfer or use for commercial advantage, personal gain or malicious harm.
The Recovery Act includes broad, sweeping changes to the HIPAA provisions regarding confidentiality of patient medical records. In general, the Recovery Act increases penalties for violations of patient medical record confidentiality and strengthens enforcement and oversight.
The HITECH Act – Provisions in the Health Information Technology for Economic and Clinical Health Act (the “HITECH Act”), enacted as part of the Recovery Act, increase the maximum civil monetary penalties for violations of HIPAA and grant enforcement authority of HIPAA to state attorneys general. The HITECH Act also (i) extends the reach of HIPAA beyond “covered entities,” (ii) imposes a breach notification requirement on HIPAA covered entities, (iii) limits certain uses and disclosures of individually identifiable health information, and (iv) restricts covered entities’ marketing communications.
The HITECH Act also established programs under Medicare and Medicaid to provide incentive payments for demonstrating the “meaningful use” of certified EHR technology. Health care providers demonstrate their meaningful use of EHR technology by meeting objectives specified by CMS for using health IT and by reporting on specified clinical quality measures. Beginning in 2015, hospitals and physicians who have not satisfied the performance and reporting criteria for demonstrating meaningful use had their Medicare payments significantly reduced.
Security Breaches and Unauthorized Releases of Personal Information – Federal, State and local authorities are increasingly focused on the importance of protecting the confidentiality of individuals’ personal information, including patient health information. Many states have enacted laws requiring businesses to notify individuals of A-53 APPENDIX A security breaches that result in the unauthorized release of personal information. In some states, notification requirements may be triggered even where information has not been used or disclosed, but rather has been inappropriately accessed. State consumer protection laws may also provide the basis for legal action for privacy and security breaches and frequently, unlike HIPAA, authorize a private right of action. In particular, the public nature of security breaches exposes health organizations to increased risk of individual or class action lawsuits from patients or other affected persons, in addition to government enforcement. Failure to comply with restrictions on patient privacy or to maintain robust information security safeguards, including taking steps to ensure that contractors who have access to sensitive patient information maintain the confidentiality of such information, could consequently damage a health care provider’s reputation and materially adversely affect business operations.
Specifically, Massachusetts has state laws relating to the privacy and security of personal information. The so-called Data Breach Notification Law requires businesses to notify the Massachusetts Attorney General’s Office (the “AGO”), the Director of Consumer Affairs and Business Regulation, and the affected individual in the event of a data breach. Businesses, including hospitals, must implement and document compliance with certain security standards such as vendor contracting provisions and encryption of portable devices. The AGO may bring an action under the unfair trade practices statute for violation of the Data Breach Notification Law. Additionally, the so-called Data Disposal Law requires businesses, including hospitals, to employ certain safeguards when disposing of or destroying personal information. The penalties for violation of the Data Disposal Law include a maximum of $5,000 per instance of improper disposal.
International Classification of Diseases, 10th Revision Coding System – In 2009, CMS published the final rule adopting the International Classification of Disease, 10th Revision coding system (“ICD-10”). ICD-10 provides a common approach to the classification of diseases and other health problems, allowing the United States to align with other nations to better share medical information, diagnosis, and treatment codes. In order to implement the ICD-10, staff will need to be retrained, processes redesigned, and computer applications modified as the current available codes and digit size will dramatically increase. Additionally, there is a potential for temporary coding and payment backlog, as well as potential increases in claims errors. Products and services will be developed by outside software vendors, clearinghouses and third-party billing companies to support and enable timely, complete and successful implementation of ICD-10. Health care organizations were required to implement ICD-10 no later than October 1, 2015. The System has met the October 1, 2015 deadline for ICD-10 implementation.
Exclusions from Medicare or Medicaid Participation – The government may exclude a hospital from Medicare/Medicaid program participation if it is convicted of a criminal offense relating to the delivery of any item or service reimbursed under Medicare or a state health care program, any criminal offense relating to patient neglect or abuse in connection with the delivery of health care, fraud against any federal, state or locally financed health care program or an offense relating to the illegal manufacture, distribution, prescription, or dispensing of a controlled substance. The government also may exclude individuals or entities under certain other circumstances, such as an unrelated conviction of fraud, or other financial misconduct relating either to the delivery of health care in general or to participation in a federal, state or local government program. Exclusion from the Medicare/Medicaid program means that a hospital would be decertified and no program payments could be made. Any hospital exclusion could be a materially adverse event. In addition, exclusion of hospital employees may be another source of potential liability for hospitals or health systems.
Enforcement Affecting Academic Research – In addition to increasing enforcement of laws governing payment and reimbursement, the federal government has also stepped up enforcement of laws and regulations governing the conduct of clinical trials at hospitals. DHHS elevated and strengthened its Office of Human Research Protection, one of the agencies with responsibility for monitoring federally funded research. In addition, the National Institutes of Health (“NIH”) significantly increased the number of facility inspections that these agencies perform. The Food and Drug Administration (“FDA”) also has authority over the conduct of clinical trials performed in hospitals when these trials are conducted on behalf of sponsors seeking FDA approval to market the drug or device that is the subject of the research. Moreover, the OIG has included several enforcement initiatives related to reimbursement for experimental drugs and devices (including kickback concerns) and has issued compliance program guidance directed at recipients of extramural research awards from the NIH and other agencies of the U.S. Public Health Service. These agencies’ enforcement powers range from substantial fines and penalties to exclusion of researchers and suspension or termination of entire research programs, and errors in billing of the Medicare program for care provided to patients enrolled in clinical trials that is not eligible for Medicare reimbursement can subject hospitals to sanctions as well as repayment obligations.
A-54 APPENDIX A Administrative Enforcement – Administrative regulations may require less proof of a violation than do criminal laws, and, thus, health care providers may have a higher risk of imposition of monetary penalties as a result of administrative enforcement actions.
Compliance with Conditions of Participation – CMS, in its role of monitoring participating providers’ compliance with conditions of participation in the Medicare program, may determine that a provider is not in compliance with its conditions of participation. In that event, a notice of termination of participation may be issued or other sanctions potentially could be imposed.
EMTALA – The Emergency Medical Treatment and Active Labor Act (“EMTALA”) is a federal civil statute that requires hospitals to treat or conduct a medical screening for emergency conditions and to stabilize a patient’s emergency medical condition before releasing, discharging or transferring the patient. A hospital that violates EMTALA is subject to civil penalties of up to $50,000 per offense and exclusion from the Medicare and Medicaid programs. In addition, the hospital may be liable for any claim by an individual who has suffered harm as a result of a violation.
Licensing, Surveys, Investigations and Audits – Health facilities are subject to numerous legal, regulatory, professional and private licensing, certification and accreditation requirements. These include, but are not limited to, requirements of state licensing agencies and The Joint Commission. Renewal and continuation of certain of these licenses, certifications and accreditations are based on inspections or other reviews generally conducted in the normal course of business of health facilities. Loss of, or limitations imposed on, hospital licenses or accreditations could reduce hospital utilization or revenues, or a hospital’s ability to operate all or a portion of its facilities.
Environmental Laws and Regulations – Health facilities are subject to a wide variety of federal, state and local environmental and occupational health and safety laws and regulations. These include, but are not limited to: air and water quality control requirements; waste management requirements; specific regulatory requirements applicable to asbestos and radioactive substances; requirements for providing notice to employees and members of the public about hazardous materials handled by or located at the hospital; and requirements for training employees in the proper handling and management of hazardous materials and wastes.
Health facilities may be subject to requirements related to investigating and remedying hazardous substances located on their property, including substances that may have migrated off the property. Typical hospital operations include the handling, use, storage, transportation, disposal and discharge of hazardous, infectious, toxic, radioactive, flammable and other hazardous materials, wastes, pollutants and contaminants. As such, hospital operations are particularly susceptible to the practical, financial and legal risks associated with the environmental laws and regulations. Such risks may result in damage to individuals, property or the environment; may interrupt operations and increase their cost; may result in legal liability, damages, injunctions or fines; and may result in investigations, administrative proceedings, civil litigation, criminal prosecution, penalties or other governmental agency actions; and may not be covered by insurance.
Enforcement Activity – Enforcement activity against health care providers has increased, and enforcement authorities have adopted aggressive approaches. In the current regulatory climate, it is anticipated that many hospitals and physician groups will be subject to an audit, investigation, or other enforcement action regarding the health care fraud laws mentioned above.
Enforcement authorities are often in a position to compel settlements by providers charged with or being investigated for false claims violations by withholding or threatening to withhold Medicare, Medicaid and similar payments or to recover higher damages, assessments or penalties by instituting criminal action. In addition, the cost of defending such an action, the time and management attention consumed, and the facts of a case may dictate settlement. Therefore, regardless of the merits of a particular case, a hospital could experience materially adverse settlement costs, as well as materially adverse costs associated with implementation of any settlement agreement. Prolonged and publicized investigations could be damaging to the reputation and business of a hospital, regardless of outcome.
Certain acts or transactions may result in violation or alleged violation of a number of the federal health care fraud laws described above, and corresponding penalties or settlement amounts often are compounded. Generally these risks are not covered by insurance. Enforcement actions may involve multiple hospitals or other facilities in a health system, as the government often extends enforcement actions regarding health care fraud to other entities in the same organization. As a result, Medicare fraud related risks identified as being materially adverse to a hospital could have materially adverse consequences to a health system taken as a whole. A-55 APPENDIX A Determination of Need Requirements
The Massachusetts DoN Program, requires an acute care hospital to obtain the approval of MA DPH before (i) undertaking a “substantial capital expenditure” in excess of a specified dollar threshold, (ii) making a substantial change in services defined, in part, as offering, expanding, or converting to certain innovative services or new technologies designated by MA DPH, including, but not limited to, cardiac catheterization, open heart surgery, magnetic resonance imaging, free standing ambulatory surgery, and positron emission tomography (PET), or (iii) adding, expanding, or converting to services which may be provided by a facility that is not an acute care hospital. The capital expenditure threshold is adjusted annually. From October 1, 2016 through September 30, 2017, the capital expenditure threshold is $18,065,167. If a provider fails to obtain required approvals, such provider will be subject to sanctions that may include, without limitation, civil fines and injunctions to restrain or prevent violations of the DoN law. As a result of these sanctions, Medicare and Medicaid certification could be affected. The DoN Program may limit or delay a provider’s ability to respond to competitive initiatives or implement a provider’s strategic plan.
Management of the System is aware of no proceeding or investigation in which a violation of the DoN law of Massachusetts by the System is alleged or suspected by any governmental agency.
Business Relationships and Other Business Matters
Affiliation, Merger, Acquisition and Divestiture – As part of its ongoing planning and property management functions, the members of the Obligated Group review the use, compatibility and financial viability of many of their operations, and from time to time, may pursue changes in the use, or disposition, of their facilities. Likewise, any Member of the Obligated Group may receive offers from, or conduct discussions with, third parties about the potential acquisition of operations or properties that may become part of one or more of the members of the Obligated Group in the future, or about the potential sale of some of the operations and properties of the members of the Obligated Group. Discussions with respect to affiliation, merger, acquisition, disposition, or change of use, including those that may affect the members of the Obligated Group, are held on an intermittent, and usually confidential, basis. As a result, it is possible that the assets currently owned by the members of the Obligated Group may change from time to time, subject to the provisions in the financing documents that apply to merger, sale, disposition or purchase of assets. The members of the Obligated Group evaluate affiliation opportunities as they arise. Any affiliation or other similar transaction would be completed in compliance with the covenants in the Master Trust Indenture.
Integrated Delivery Systems – Health facilities and health care systems often own, control or have affiliations with physician groups and independent practice associations. Generally, the sponsoring health care facility or health care system is the primary capital and funding source for the alliances and may have an ongoing financial commitment to provide growth capital and support operating deficits. As separate operating units, integrated physician practices and medical foundations sometimes operate at a loss and require subsidy from the related hospital or health system.
These types of alliances are likely to become increasingly important to the success of hospitals in the future as a result of changes to the health care delivery and reimbursement systems that are intended to restrain the rate of increases of health care costs, encourage coordinated care, promote collective provider accountability and improve clinical outcomes. The ACA authorizes several alternative payment programs for Medicare that promotes, reward or necessitate integration among hospitals, physicians and other providers.
Whether these programs will achieve their objectives and be expanded or mandated as conditions of Medicare participation cannot be predicted. However, Congress and CMS have clearly emphasized continuing the trend away from the fee-for-service reimbursement model, which began in the 1980s with the introduction of the prospective payment system for inpatient care, and toward an episode-based payment model that rewards use of evidence-based protocols, quality and satisfaction in patient outcomes, efficiency in using resources, and the ability to measure and report clinical performance. This shift is likely to favor integrated delivery systems, which may be better able than stand-alone providers to realize efficiencies, coordinate services across the continuum of patient care, track performance and monitor and control patient outcomes. Changes to the reimbursement methods and payment requirements of Medicare, which is the dominant purchaser of medical services, are likely to prompt equivalent changes in the commercial sector, because commercial payors frequently follow Medicare’s lead in adopting payment policies.
While payment trends may stimulate the growth of integrated delivery systems, these systems carry with them the potential for legal or regulatory risks. Many of the risks discussed in “—Regulatory Environment” above, may be A-56 APPENDIX A heightened in an integrated delivery system. The foregoing laws were not designed to accommodate coordinated action among hospitals, physicians and other health care providers to set standards, reduce costs and share savings, among other things. Although CMS and the agencies that enforce these laws are expected to institute new regulatory exceptions, safe harbors or waivers that will enable providers to participate in payment reform programs, there can be no assurance that the regulations will be forthcoming or that any regulations or guidance issued will sufficiently clarify the scope of permissible activity. State law prohibitions, such as the bar on the corporate practice of medicine, or state law requirements, such as insurance laws regarding licensure and minimum financial reserve holdings of risk-bearing organizations, may also introduce complexity, risk and additional costs in organizing and operating integrated delivery systems. Tax-exempt hospitals also face the risk in affiliating with for-profit entities that the IRS will determine that compensation practices or business arrangements result in private benefit or private use or generate unrelated business income for the hospitals.
In addition, integrated delivery systems present business challenges and risks. Inability to attract or retain participating physicians may negatively affect managed care, contracting and utilization. The technological and administrative infrastructure necessary both to develop and operate integrated delivery systems and to implement new payment arrangements in response to changes in Medicare and other payor reimbursement is costly. Hospitals may not achieve savings sufficient to offset the substantial costs of creating and maintaining this infrastructure.
Physician Medical Staff – The primary relationship between a hospital and physicians who practice in it is through the hospital’s organized medical staff. Medical staff bylaws, rules and policies establish the criteria and procedures by which a physician may have his or her privileges or membership curtailed, denied or revoked. Physicians who are denied medical staff membership or certain clinical privileges or who have such membership or privileges curtailed or revoked often file legal actions against hospitals and medical staffs. Such actions may include a wide variety of claims, some of which could result in substantial uninsured damages to a hospital. In addition, failure of the hospital governing body to adequately oversee the conduct of its medical staff may result in hospital liability to third parties.
Physician Supply – Sufficient community-based physician supply is important to hospitals. CMS annually reviews overall physician reimbursement formulas for Medicare and Medicaid. Changes to physician compensation under these programs could lead to physicians ceasing to accept Medicare or Medicaid patients. Regional differences in reimbursement by commercial and governmental payors, along with variations in the costs of living, may cause physicians to avoid locating their practices in communities with low reimbursement or high living costs. Hospitals may be required to invest additional resources in recruiting and retaining physicians, or may be compelled to affiliate with, and provide support to, physicians in order to continue serving the growing population base and maintain market share.
Competition Among Health Care Providers – Increased competition from a wide variety of sources, including specialty hospitals, other hospitals and health care systems, HMOs, inpatient and outpatient health care facilities, long-term care and skilled nursing services facilities, clinics, physicians and others, may adversely affect the utilization and revenues of hospitals. Existing and potential competitors may not be subject to various restrictions applicable to hospitals, and competition, in the future, may arise from new sources not currently anticipated or prevalent.
Specialty facilities or ventures that attract an important segment of an existing hospital’s admitting specialists and services that generate significant revenue may be particularly damaging. For example, some large hospitals may have significant dependence on heart surgery or orthopedic programs producing revenue streams that cover significant fixed overhead costs. If a significant component of such a hospital’s heart surgeons or orthopedists develop their own specialty hospital or surgery center (alone or in conjunction with a growing number of specialty hospital operators and promoters), taking with them their patient base, the hospital could experience a rapid and dramatic decline in net revenues that is not proportionate to the number of patient admissions or patient days lost. It is also possible that the competing specialty entity, as a for-profit venture, would not accept indigent patients or other payors and government programs, leaving low-pay patient populations in the full-service hospital. In certain cases, such an event could be materially adverse to the hospital. A variety of proposals has been advanced recently to permanently prohibit such investments. Nonetheless, specialty hospitals continue to represent a significant competitive challenge for full-service hospitals.
Freestanding ambulatory surgery centers may attract away significant commercial outpatient services traditionally performed at hospitals. Commercial outpatient services, currently among the most profitable for hospitals, may be lost to competitors who can provide these services in an alternative, less costly setting. Full-service hospitals rely upon the revenues generated from commercial outpatient services to fund other less profitable services, and the decline of such business may result in a decline in operating income. Competing ambulatory surgery centers, more A-57 APPENDIX A likely a for-profit business, may not accept indigent patients or low paying programs and would leave these populations to receive services in the full-service hospital setting. Consequently, hospitals are vulnerable to competition from ambulatory surgery centers.
Additionally, scientific and technological advances, new procedures, drugs and appliances, preventive medicine and outpatient health care delivery may reduce utilization and revenues of hospitals in the future or otherwise lead to new avenues of competition. In some cases, hospital investment in facilities and equipment for capital-intensive services may be lost as a result of rapid changes in diagnosis, treatment or clinical practice brought about by new technology or new pharmacology.
Action by Purchasers of Hospital Services and Consumers – Major purchasers of hospital services could take action to restrain hospital charges or charge increases. As a result of increased public scrutiny, it is also possible that the pricing strategies of hospitals may be perceived negatively by consumers, and hospitals may be forced to reduce fees for their services. Decreased utilization could result, and hospitals’ revenues may be negatively affected. In addition, consumers and groups on behalf of consumers are increasing pressure on hospitals and health care providers to be transparent and provide information about cost and quality of services that may affect future consumer choices about where to receive health care services.
Ballot Initiatives and Legislation: Nursing and Other Workforce Shortages; Operating Margins; Health Insurance Payments – Periodically, organizations or interest groups involved in or focused on the delivery of healthcare in the Commonwealth seek to address issues of concern through public ballot initiatives. In recent years, ballot initiatives have been introduced by organizations including the MNA and SEIU.
In 2014, the MNA initiated a statewide ballot initiative requiring minimum nurse to patient staffing ratios. Although the statewide ballot question did not reach the November 2014 ballot, in June 2014, the Massachusetts legislature passed and the Governor signed into law legislation that dictates nurse staffing levels in intensive care units in all Massachusetts hospitals. The law mandated that, effective on September 28, 2014, in all intensive care units the patient assignment for the registered nurse shall be 1:1 or 1:2 depending on the stability of the patient. The HPC has promulgated regulations governing the implementation and operation of this staffing ratio including the formulation of an acuity tool and a method of reporting to the public on staffing compliance in hospital intensive care units, as well as in neonatal and pediatric intensive care units, burn units and coronary care units. The costs of implementation of the HPC’s regulations cannot yet be fully ascertained.
There can be no assurance that the MNA, the SEIU or other organizations will not continue to initiate ballot initiatives or engage in other legislative activities that may adversely affect hospital operations, patient and physician satisfaction, financial condition, results of operations and future growth.
Labor Relations and Collective Bargaining – Hospitals are large employers with a wide diversity of employees. Increasingly, employees of hospitals are becoming unionized, and many hospitals have collective bargaining agreements with one or more labor organizations. Employees who are subject to collective bargaining agreements may include essential nursing and technical personnel, as well as food service, maintenance and other trade personnel. Renegotiation of such agreements upon expiration may result in significant cost increases to hospitals. Employee strikes or other adverse labor actions may have an adverse impact on operations, revenue and hospital reputation. For information concerning collective bargaining activities among System employees, see “SYSTEM WORKFORCE.”
Wage and Hour Class Actions and Litigation – Federal law and many states impose standards related to worker classification, eligibility and payment for overtime, liability for providing rest periods and similar requirements. Large employers with complex workforces, such as hospitals, are susceptible to actual and alleged violations of these standards. In recent years there has been a proliferation of lawsuits over these “wage and hour” issues, often in the form of large, sometimes multi-state, class actions. For large employers, such as hospitals, such class actions can involve multi-million dollar claims, judgments and settlements. A major class action decided or settled adversely to the System could have a material adverse impact on its financial condition and results of operations.
Other Class Actions – Nonprofit hospitals and health systems have long been subject to a wide variety of litigation risks, including liability for care outcomes, employer liability, property and premises liability, and peer review litigation with physicians, among others. In recent years, consumer class action litigation has emerged as a potentially significant source of litigation liability for nonprofit hospitals and health systems. These class action suits have most recently focused on hospital billing and collections practices, and they may be used for a variety of currently unanticipated causes of action. Since the subject matter of class action suits may involve uninsured risks, A-58 APPENDIX A and since such actions often involve alleged large classes of plaintiffs, they may have material adverse consequences on nonprofit hospitals and health systems in the future.
Health Care Worker Classification – Health care providers, like all businesses, are required to withhold income taxes from amounts paid to employees. If the employer fails to withhold the tax, the employer becomes liable for payment of the tax imposed on the employee. On the other hand, businesses are not required to withhold federal taxes from amounts paid to a worker classified as an independent contractor. The IRS has established criteria for determining whether a worker is an employee or an independent contractor for tax purposes. If the IRS were to reclassify a significant number of hospital independent contractors (e.g., physician medical directors) as employees, back taxes and penalties could be material.
Staffing – From time to time, the health care industry suffers from a scarcity of nursing personnel, respiratory therapists, pharmacists and other trained health care technicians. In addition, aging medical staffs and difficulties in recruiting individuals to the medical profession are predicted to result in physician shortages. A significant factor underlying this trend includes a decrease in the number of persons entering those professions. This is expected to intensify in the future, aggravating the general shortage and increasing the likelihood of hospital-specific shortages. Competition for physicians and other health care professionals, coupled with increased recruiting and retention costs may increase hospital operating costs, possibly significantly. This trend could have a material adverse impact on the financial conditions and results of operations of hospitals. This scarcity may further be intensified if utilization of health care services increases as a consequence of the ACA’s expansion of the number of insured consumers.
Professional Liability Claims and General Liability Insurance – In recent years, the number of professional and general liability suits and the dollar amounts of damage recoveries have increased in health care nationwide, resulting in substantial increases in malpractice insurance premiums, higher deductibles and generally less coverage. Professional liability and other actions alleging wrongful conduct and seeking punitive damages are often filed against health care providers. Insurance does not provide coverage for judgments for punitive damages.
Beginning in 2008, CMS refused to reimburse hospitals for medical costs arising from certain “never events,” which include specific preventable medical errors. Certain private insurers and HMOs followed suit. The occurrence of “never events” is more likely to be publicized and may negatively affect a hospital’s reputation, reducing future utilization and potentially increasing the possibility of liability claims.
Litigation also arises from the corporate and business activities of hospitals, from a hospital’s status as an employer or as a result of medical staff or provider network peer review or the denial of medical staff or provider network privileges. As with professional liability, many of these risks are covered by insurance, but some are not. For example, some antitrust claims or business disputes are not covered by insurance or other sources and may, in whole or in part, be a liability of the System if determined or settled adversely.
Information Technology – The ability to adequately price and bill health care services and to accurately report financial results depends on the integrity of the data stored within information systems, as well as the operability of such systems. An ongoing commitment of significant resources is required to maintain, protect and enhance existing information systems and to develop new systems to keep pace with continuing changes in information processing technology, evolving systems and regulatory standards. There can be no assurance that efforts to upgrade and expand information systems capabilities, protect and enhance these systems, and develop new systems to keep pace with continuing changes in information processing technology will be successful or that additional systems issues will not arise in the future. For a discussion of the Epic implementation and associated risks, see “STRATEGIC VISION AND CURRENT CHALLENGES—EPIC Implementation.”
Electronic media are also increasingly being used in clinical operations, including the conversion from paper to EHR, computerization of order entry functions and the implementation of clinical decision-support software. The reliance on IT for these purposes imposes new expectations on physicians and other workforce members to be adept in using and managing electronic systems. It also introduces risks related to patient safety, and to the privacy, accessibility and preservation of health information. See “—Regulatory Environment—HIPAA” above. Technology malfunctions or failure to understand and use information systems properly could result in the dissemination of or reliance on inaccurate information, as well as in disputes with patients, physicians and other health care professionals. Health information systems may also be subject to different or higher standards or greater regulation than other IT or the paper-based systems previously used by health care providers, which may increase the cost, complexity and risks of operations. All of these risks may have adverse consequences on hospitals and health care providers.
A-59 APPENDIX A Cybersecurity Risks – Despite the implementation of network security measures by the System, its IT systems may be vulnerable to breaches, hacker attacks, computer viruses, physical or electronic break-ins and other similar events or issues. Such events or issues could lead to the inadvertent disclosure of protected health information or other confidential information or could have an adverse effect on the ability of the System to provide health care services.
Tax-Exempt Status and Other Tax Matters
Maintenance of the Tax-Exempt Status of Benefiting Affiliates – The maintenance of each Member of the Obligated Group’s status as an organization described in Section 501(c)(3) of the Code is contingent on compliance with general rules promulgated in the Code and related regulations regarding the organization and operation of tax- exempt entities, including their operation for charitable and other permissible purposes and their avoidance of transactions that may cause their earnings or assets to inure to the benefit of private individuals. As these general principles were developed primarily for public charities that do not conduct large-scale technical operations and business activities, they often do not adequately address the myriad operations and transactions entered into by a modern health care organization. Although traditional activities of health care providers, such as medical office building leases, have been the subject of interpretations by the IRS in the form of Private Letter Rulings, many activities or categories of activities have not been fully addressed in any official opinion, interpretation or policy of the IRS.
The ACA also contains certain requirements for tax-exempt hospitals. Under the ACA, each tax-exempt hospital facility is required to (i) conduct a community health needs assessment at least every three years and adopt an implementation strategy to meet the identified community needs, (ii) adopt, implement and widely publicize a written financial assistance policy and a policy to provide emergency medical treatment without discrimination, (iii) limit charges to individuals who qualify for financial assistance under the tax-exempt hospital’s financial assistance policy to no more than the amounts generally billed to individuals who have insurance covering that care and refrain from using “gross charges” when billing those individuals, and (iv) refrain from taking extraordinary collection actions without first making reasonable efforts to determine whether the individual is eligible for assistance under the tax-exempt hospital’s financial assistance policy. In addition, the Treasury Department is required to review information about each tax-exempt hospital’s community benefit activities at least once every three years, as well as to submit an annual report to Congress with information regarding the levels of charity care, bad debt expenses, unreimbursed costs of government programs, and costs incurred by tax-exempt hospitals for community benefit activities. The periodic reviews and reports to Congress regarding the community benefits provided by 501(c)(3) hospitals may increase the likelihood that Congress will require hospitals to provide a minimum level of charity care in order to retain tax-exempt status and may increase IRS scrutiny of particular 501(c)(3) hospital organizations.
The System participates in a variety of transactions with physicians either directly or indirectly. Management believes that the transactions to which the System is a party are consistent with the requirements of the Code as to tax-exempt status, but, as noted above, there is uncertainty as to the state of the law.
If the IRS were to find that a Member of the Obligated Group has participated in activities in violation of certain regulations or rulings, the tax-exempt status of that Member of the Obligated Group could be jeopardized. Although the IRS has not frequently revoked the 501(c)(3) tax-exempt status of nonprofit health care corporations, it could do so in the future. Loss of tax-exempt status by a Member of the Obligated Group potentially could result in loss of tax exemption of tax-exempt debt issued for the benefit of the System and defaults in covenants regarding the Bonds and other obligations likely would be triggered. Loss of tax-exempt status also could result in substantial tax liabilities on the System’s income. For these reasons, loss of tax-exempt status of a Member of the Obligated Group could have a material adverse effect on the financial condition of the System.
In some cases, the IRS has imposed substantial monetary penalties on tax-exempt hospitals in lieu of revoking their tax-exempt status. In those cases, the IRS and the tax-exempt hospitals entered into settlement agreements requiring the hospital to make substantial payments to the IRS.
In lieu of revocation of tax-exempt status, the IRS may impose penalty excise taxes on certain “excess benefit transactions” involving 501(c)(3) organizations and “disqualified persons.” An excess benefit transaction is one in which a disqualified person or entity receives more than fair market value from the exempt organization, pays the exempt organization less than fair market value for property or services, or shares the net revenues of the tax-exempt entity. A disqualified person is a person (an individual or an entity) who is in a position to exercise substantial influence over the affairs of the exempt organization during the five years preceding an excess benefit transaction. The statute imposes excise taxes on the disqualified person and any “organization manager” who knowingly participates in an excess benefit transaction. These rules do not penalize the exempt organization itself, so there A-60 APPENDIX A would be no direct impact on the System if an excess benefit transaction were subject to IRS enforcement, pursuant to these “intermediate sanctions” rules.
Real Property Tax Exemption – State, county and local taxing authorities undertake audits and reviews of the operations of tax-exempt health care providers with respect to their real property tax exemptions. In some cases, particularly where authorities are dissatisfied with the level of charitable activity provided by a nonprofit organization, the real property tax-exempt status of the health care providers has been questioned. The City of Worcester has recently promoted “voluntary” agreements with nonprofit entities to make payments in lieu of taxes (“PILOTs”). The majority of the System’s real property is currently treated as exempt from real property taxation. Although the System’s real property tax exemptions with respect to its core hospital facilities have not, to the knowledge of Management, been the subject of a request for any PILOT agreement, there can be no assurance concerning this issue. In addition, an audit could lead to a challenge that could adversely affect the System’s real property tax exemptions.
It is not possible to predict the scope or effect of future legislative or regulatory actions with respect to taxation of nonprofit corporations. There can be no assurance that future changes in the laws and regulations of state or local governments will not materially adversely affect the financial condition of the System by requiring payment of income, local property or other taxes. See also “—Nonprofit Health Care Environment—IRS Community Benefit Initiative” and “—Challenges to Real Property Tax Exemption” above.
Maintenance of Tax-Exempt Status of Interest on the Bonds – The Code imposes a number of requirements that must be satisfied for interest on state and local obligations, such as the Bonds, to be excludable from gross income for federal income tax purposes. These requirements include limitations on the use of bond proceeds, limitations on the investment earnings of bond proceeds prior to expenditure, a requirement that certain investment earnings on bond proceeds be paid periodically to the United States Treasury, and a requirement that issuers file an information report with the IRS. The System has covenanted in certain of the documents referred to herein that it will comply with such requirements. Future failure by the System to comply with the requirements stated in the Code and related regulations, rulings, and policies may result in the treatment of interest on the Bonds as taxable, retroactively to the date of issuance.
Limitations on Contractual and Other Arrangements Imposed by the Internal Revenue Code – As a tax-exempt organization, each Member of the Obligated Group is limited with respect to its use of practice income guarantees, reduced rent on medical office space, low interest loans, joint venture programs and other means of recruiting and retaining physicians. Uncertainty in this area has been reduced somewhat by the issuance by the IRS of guidelines on permissible physician recruitment practices. The IRS scrutinizes a broad variety of contractual relationships commonly entered into by hospitals and has issued a detailed audit guide suggesting that field agents scrutinize numerous activities of the hospitals in an effort to determine whether any action should be taken with respect to limitations on or revocation of their tax-exempt status or assessment of additional tax. Any suspension, limitation, or revocation of a Member of the Obligated Group’s tax-exempt status or assessment of significant tax liability would have a materially adverse effect on the System.
Other Risk Factors
Investments – The System has significant holdings in a broad range of investments. Market fluctuations may affect the value of those investments and those fluctuations may be and historically have been at times material.
Other Future Risks – In the future, the following factors, among others, may adversely affect the operations of health care providers, including the System, or the market value of health care revenue bonds, including the Bonds, to an extent that cannot be determined at this time:
• Adoption of legislation or implementation of regulations that would modify national or state health programs or that would establish national, statewide or otherwise regulated rates applicable to hospitals and other health care providers;
• Reduced demand for the services of the System that might result from decreases in population or loss of market share to competitors;
• Bankruptcy of an indemnity/commercial insurer, managed care plan or other payor;
A-61 APPENDIX A • Efforts by insurers and governmental agencies to limit the cost of hospital services, to reduce the number of hospital beds and to reduce the utilization of hospital facilities by such means such as improved occupational health and safety and outpatient care, or comparable regulations or attempts by third-party payors to control or restrict the operations of certain health care facilities;
• Cost and availability of any insurance, such as professional liability, fire, automobile and general comprehensive liability coverages, which health care facilities of a similar size and type generally carry;
• The occurrence of a natural or man-made disaster, a pandemic or an epidemic that could damage Obligated Group’s facilities, interrupt utility service to such facilities, result in an abnormally high demand for health care services or otherwise impair the System’s operations and the generation of revenues from such facilities. The System’s facilities are covered by general property insurance in an amount that Management considers generally sufficient to provide for the replacement of such facilities in the event of most natural disasters; and
• Limitations on the availability of, and increased compensation necessary to secure and retain, nursing, technical and other professional personnel.
******
The information contained here is submitted for inclusion in the Official Statement relating to the Bonds.
Respectfully submitted,
OBLIGATED GROUP:
UMASS MEMORIAL HEALTH CARE, INC. UMASS MEMORIAL MEDICAL CENTER, INC. HEALTHALLIANCE HOSPITALS, INC. UMASS MEMORIAL HEALTH VENTURES, INC.
By: ______Eric W. Dickson, M.D. President and Chief Executive Officer
By: ______Sergio L. Melgar Executive Vice President and Chief Financial Officer
A-62
Appendix B
Consolidated Financial Statements of UMass Memorial Health Care, Inc. and Affiliates
[THIS PAGE INTENTIONALLY LEFT BLANK] APPENDIX B
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Consolidated Balance Sheets ...... 3
Consolidated Statements of Operations ...... 4
Consolidated Statements of Changes in Net Assets ...... 5
Consolidated Statements of Cash Flows ...... 6
Notes to Consolidated Financial Statements ...... 7-53
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APPENDIX B
Report of Independent Auditors
To the Board of Trustees of UMass Memorial Healthcare, Inc.
We have audited the accompanying consolidated financial statements of UMass Memorial Health Care, Inc. and Affiliates (the “System) which comprise the consolidated balance sheets as of September 30, 2016 and 2015 and the related consolidated statements of operations, changes in net assets, and cash flows for the years then ended.
Management's Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the System's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the System's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of UMass Memorial Health Care, Inc. and Affiliates as of September 30, 2016 and 2015, and the results of their operations, changes in their net assets, and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America.
PricewaterhouseCoopers LLP, 101 Seaport Boulevard, Suite 500, Boston, MA 02210 T: (617) 530 5000, F: (617) 530 5001, www.pwc.com/us APPENDIX B
Other Matter
Our audit was conducted for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The consolidating information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the consolidated financial statements. The consolidating information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the consolidated financial statements or to the consolidated financial statements themselves and other additional procedures, in accordance with auditing standards generally accepted in the United States of America. In our opinion, the consolidating information is fairly stated, in all material respects, in relation to the consolidated financial statements taken as a whole. The consolidating information is presented for purposes of additional analysis of the consolidated financial statements rather than to present the financial position, results of operations, changes in net assets and cash flows of the individual entities and is not a required part of the consolidated financial statements. Accordingly, we do not express an opinion on the financial position, results of operations, changes in net assets and cash flows of the individual entities.
December 16, 2016
PricewaterhouseCoopers LLP, 101 Seaport Boulevard, Suite 500, Boston, MA 02210 T: (617) 530 5000, F: (617) 530 5001, www.pwc.com/us APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV &RQVROLGDWHG%DODQFH6KHHWV 6HSWHPEHUDQG
(in thousands of dollars)
$VVHWV Current assets Cash and cash equivalents $ 231,027 $ 162,456 Short-term investments 32,118 31,792 Current portion of assets whose use is limited 9,553 8,700 Patient accounts receivable, net of allowance for doubtful accounts of $50,834 in 2016 and $55,445 in 2015 222,524 237,658 Inventories 33,630 29,135 Prepaid expenses and other current assets 32,752 30,488 Estimated settlements receivable from third-party payers 196,882 353,793 Total current assets 758,486 854,022 Assets whose use is limited Funds held in escrow under bond indenture agreements, net of current portion 47,189 12,103 Restricted investments 88,118 88,195 Captive insurance company investments 157,518 164,440 Total assets whose use is limited 292,825 264,738 Long-term investments 441,610 404,945 Property and equipment, net 688,390 594,222 Beneficial interest in trusts 7,719 7,991 Other assets 86,572 73,115 Total assets $ 2,275,602 $ 2,199,033 /LDELOLWLHVDQG1HW$VVHWV Current liabilities Accounts payable and accrued expenses $ 153,067 $ 145,288 Accrued compensation 145,546 142,335 Estimated settlements payable to third-party payers 27,594 21,593 Debt, current 79,380 87,698 Due to the University of Massachusetts 144,547 166,220 Total current liabilities 550,134 563,134 Estimated settlements payable to third-party payers, net of current portion 44,446 39,845 Other noncurrent liabilities 23,793 23,429 Accrued pension and postretirement benefit obligations 287,876 205,127 Estimated self-insurance costs 159,939 165,372 Debt, net of current portion 362,658 334,416 Total liabilities 1,428,846 1,331,323 Commitments and contingencies Net assets Unrestricted 748,847 770,804 Temporarily restricted 43,180 42,537 Permanently restricted 54,729 54,369 Total net assets 846,756 867,710 Total liabilities and net assets $ 2,275,602 $ 2,199,033
The accompanying notes are an integral part of these consolidated financial statements.
3 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV &RQVROLGDWHG6WDWHPHQWVRI2SHUDWLRQV (in thousands of dollars) 8QUHVWULFWHGUHYHQXHVJDLQVDQGRWKHUVXSSRUW Net patient service revenue $ 2,306,846 $ 2,173,845 Less: Provision for bad debts (40,420) (48,863) Net patient service revenue less provision for bad debts 2,266,426 2,124,982 Net assets released from restrictions used for operations 3,096 2,618 Other revenue 103,931 114,110 Total revenues, gains and other support 2,373,453 2,241,710 ([SHQVHV Salaries, benefits and contracted labor 1,368,449 1,298,997 Supplies and other expense 840,781 766,299 Depreciation and amortization 111,008 104,230 Interest 12,520 14,146 Total expenses 2,332,758 2,183,672 Income from operations before nonrecurring income and expenses 40,695 58,038 Gain on sale of business - 13,295 Expense reductions associated with sale of business - 873 Income from operations after nonrecurring income and expenses 40,695 72,206 Nonoperating income (loss) Investment and other related income 4,446 5,608 Net realized and unrealized gain (loss) on investments 26,139 (30,815) Actuarial change in the present value of annuities (369) (352) Loss on refunding of debt (2,861) - Total nonoperating income (loss) 27,355 (25,559) Excess of revenues over expenses 68,050 46,647 Other changes in net assets Contributions for property and equipment 2,877 1,958 Net assets released from restrictions used for purchase of property and equipment 925 773 Pension-related changes other than net periodic cost (93,809) (57,318) Decrease in unrestricted net assets (21,957) (7,940) Unrestricted net assets, beginning of year 770,804 778,744 Unrestricted net assets, end of year $ 748,847 $ 770,804 The accompanying notes are an integral part of these consolidated financial statements. 4 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV &RQVROLGDWHG6WDWHPHQWVRI&KDQJHVLQ1HW$VVHWV 7HPSRUDULO\ 3HUPDQHQWO\ (in thousands of dollars) 8QUHVWULFWHG 5HVWULFWHG 5HVWULFWHG 7RWDO 1HWDVVHWV6HSWHPEHU $ 778,744 $ 47,906 $ 52,134 $ 878,784 Excess of revenues over expenses 46,647 - - 46,647 Contributions - 685 2,879 3,564 Investment and other related income - 1,143 - 1,143 Net assets released from restrictions Used for purchase of property and equipment 773 (773) - - Used for operations - (2,618) - (2,618) Net realized gain on sale of investments - 2,762 - 2,762 Contributions for property and equipment 1,958 - - 1,958 Change in unrealized gains and losses on investments - (6,568) - (6,568) Change in beneficial interest in trusts and other - - (644) (644) Pension-related changes other than net periodic cost (57,318) - - (57,318) Total increase (decrease) in net assets (7,940) (5,369) 2,235 (11,074) 1HWDVVHWV6HSWHPEHU 770,804 42,537 54,369 867,710 Excess of revenues over expenses 68,050 - - 68,050 Contributions - 2,608 50 2,658 Investment and other related income - 466 - 466 Net assets released from restrictions Used for purchase of property and equipment 925 (925) - - Used for operations - (3,096) - (3,096) Net realized gain on sale of investments - 234 - 234 Contributions for property and equipment 2,877 - - 2,877 Change in unrealized gains and losses on investments - 1,356 - 1,356 Change in beneficial interest in trusts and other - - 310 310 Pension-related changes other than net periodic cost (93,809) - - (93,809) Total increase (decrease) in net assets (21,957) 643 360 (20,954) 1HWDVVHWV6HSWHPEHU $ 748,847 $ 43,180 $ 54,729 $ 846,756 The accompanying notes are an integral part of these consolidated financial statements. 5 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV &RQVROLGDWHG6WDWHPHQWVRI&DVK)ORZV (in thousands of dollars) &DVKIORZVIURPRSHUDWLQJDFWLYLWLHV Change in net assets $ (20,954) $ (11,074) Adjustments to reconcile change in net assets to net cash provided by (used in) operating activities Net unrealized (gain) loss on investments (24,587) 51,221 Depreciation and amortization 111,008 104,230 Accretion on asset retirement obligation 507 510 Provision for bad debts 39,934 48,241 Undistributed earnings of affiliates (22,497) - Net loss not yet recognized in net periodic pension cost 93,809 57,318 Actuarial change in the present value of annuities 369 352 Net realized gain on sale of investments (5,825) (26,882) Net loss on refunding of debt 2,861 - Restricted contributions (2,610) (3,541) Gain on sale of business, net of expense reductions - (14,168) Loss on disposal of assets 532 161 Change in beneficial interest in trusts (310) 644 Distributions from equity method investees 13,748 - (Decrease) increase in cash resulting from a change in Patient accounts receivable (25,286) (45,373) Inventories, prepaid expenses and other current assets (6,276) 4,289 Contributions receivable (48) (23) Accounts payable, accrued expenses and accrued compensation (1,779) (3,261) Estimated settlements with third-party payers 167,513 (135,802) Due to the University of Massachusetts (21,691) 99,179 Other noncurrent assets and liabilities (60) 112 Accrued pension and postretirement benefit obligations (10,882) (59,988) Estimated self-insurance costs (5,433) (6,583) Net cash provided by operating activities 282,043 59,562 &DVKIORZVIURPLQYHVWLQJDFWLYLWLHV Purchases of property and equipment (193,676) (58,899) Contributions to joint ventures (4,578) - Purchases of investments (607,927) (462,517) Proceeds from sales and maturities of investments 560,822 469,236 Net cash used in investing activities (245,359) (52,180) &DVKIORZVIURPILQDQFLQJDFWLYLWLHV Proceeds from restricted contributions 2,585 662 Proceeds from restricted contributions of securities 25 - Cash received on contributions receivable for long-term purposes 325 482 Cash received for beneficial interest agreements 582 9,919 Payments on annuity obligation (562) (562) Payments on long-term debt and capital lease obligations (88,487) (54,906) Proceeds from borrowings on debt 117,419 77,795 Net cash provided by financing activities 31,887 33,390 Net increase in cash and cash equivalents 68,571 40,772 Cash and cash equivalents, beginning of year 162,456 121,684 Cash and cash equivalents, end of year $ 231,027 $ 162,456 The accompanying notes are an integral part of these consolidated financial statements. 6 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG 'HVFULSWLRQRIWKH2UJDQL]DWLRQ UMass Memorial Health Care, Inc. (“UMass Memorial”), a Massachusetts not-for-profit corporation, was formed in 1998 pursuant to state legislation to develop and coordinate an integrated health care delivery system. UMass Memorial was established through the combination of Memorial Health Care, Inc., the University of Massachusetts (the “University”) Medical School Teaching Hospital Trust Fund, the University of Massachusetts Clinical Services Division (“Clinical Services Division”) and the assets from the University’s Worcester City Campus Corporation (“WCCC”) d/b/a UMass Health System and their affiliates. The combination is referred to herein as the “Merger.” UMass Memorial is the direct or indirect member, stockholder, owner, or partner of a number of corporations, limited liability companies, and partnerships (the “Affiliates”) that provide a broad range of health care and related services to Worcester and the surrounding central Massachusetts communities. The accompanying consolidated financial statements include: +RVSLWDOV UMass Memorial Medical Center, Inc. (the “Medical Center”) operates a 779-bed acute care hospital located on two principal campuses and provides a full range of services, including all major specialties and subspecialties of inpatient care and ambulatory care. UMass Memorial Community Hospitals, Inc. (“Hospitals, Inc.”), a subsidiary of UMass Memorial, is the sole corporate member of Central New England HealthAlliance, Inc. (“CNEHA”). CNEHA is the parent organization of HealthAlliance Hospitals, Inc. (“HAH”), which operates a general acute-care hospital facility on two campuses in Leominster and Fitchburg, Massachusetts, with a total of 122 beds. Hospitals, Inc. is the sole corporate member of Marlborough Hospital, a 79-bed community hospital located in Marlborough, Massachusetts and Clinton Hospital Association (“Clinton Hospital”), a 41- bed community hospital located in Clinton, Massachusetts. HAH and Clinton Hospital have executed an Agreement of Merger pursuant to which Clinton Hospital will be merged into HAH, leaving HAH as the surviving corporation and Clinton Hospital as a satellite campus under HAH’s hospital license. This merger will not occur prior to all regulatory approvals and is anticipated to occur on October 1, 2017 by filing Articles of Merger with the Massachusetts Secretary of State. 3K\VLFLDQ3UDFWLFHV UMass Memorial Medical Group, Inc. (the “Medical Group”) is an UMass Memorial subsidiary that resulted from the merger of the Medical Group, UMass Community Physicians, Inc., and UMass Memorial Community Physician Group, Inc. The Medical Group is the principal provider of physician services to the System. The Medical Group consists of approximately 1,100 physicians who provide primary care and specialty services to Worcester and the surrounding central Massachusetts communities. 7 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG 9HQWXUHV UMass Memorial Health Ventures, Inc. (“Ventures”) is the direct or indirect member or joint venture participant in several entities located in Central Massachusetts. These entities focus on outpatient and non-acute health care services including urgent care and rehabilitation services, specialty pharmacy and pharmacy management services and magnetic imaging. 2WKHU3URYLGHUV UMass Memorial and its affiliates also operate a number of related health care businesses and support organizations. 6XPPDU\RI6LJQLILFDQW$FFRXQWLQJ3ROLFLHV 5HSRUWLQJ(QWLW\ The accompanying financial statements include the accounts of UMass Memorial and all of its majority-owned and controlled affiliates (the “System”). Intercompany accounts and transactions have been eliminated in preparing the consolidated financial statements. The assets of any one of the members of the consolidated group may not be available to meet the obligations of other affiliates in the group. UMass Memorial, the Medical Center, Ventures and HAH are referred to herein as the “Obligated Group”. 8VHRI(VWLPDWHV The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenue and expenses during the reporting period. The System’s significant estimates include the allowance for doubtful patient accounts receivable, estimated contractual allowances and settlements due from and to third-party payers, valuation of its investments, estimated useful lives, asset retirement obligations, estimated professional liability costs, pension and benefit obligations and other reserves for self-insured claims. Actual results could differ from those estimates. 5HYHQXH5HFRJQLWLRQ Net patient service revenue is reported at the estimated net realizable amounts from patients, third- party payers and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payers. Under the terms of various agreements, regulations, and statutes, certain elements of third-party reimbursement are subject to negotiation, audit and/or final determination by the third-party payers. As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near term. Differences between preliminary estimates of net patient service revenue and final third-party settlements are included in net patient service revenue in the year in which the settlement or change in estimate occurs. Changes in prior year estimates, excluding the impact of Special Medicaid Payments, increased net patient service revenue by approximately $15,246,000 in 2016 and $21,478,000 in 2015. Net patient service revenue, before the provision for bad debts for the years ended September 30, 2016 and 2015 is comprised of third-party payer revenue of $2,277,535,000 and $2,155,598,000 and self-pay revenue of $29,311,000 and $18,247,000, respectively. 8 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG A portion of estimated settlements with third-party payers has been classified as long-term since such amounts, by their nature or by virtue of regulation or legislation, will not be paid within one year. 2WKHU5HYHQXH In fiscal years 2016 and 2015, the System received incentive payments relating to Electronic Health Records (“EHR") of $3,070,000 and $4,276,000, respectively, as part of the American Recovery and Reinvestment Act of 2009 (“ARRA”). The provisions of the ARRA allow for incentive payments to eligible hospitals and providers that implement and meaningfully use EHR technology by 2014. Incentive payments are contingent upon meeting certain data capture and data sharing capabilities accompanied by additional requirements for meeting increased clinical quality measures. Management believes all contingencies have been met and therefore these incentives have been recorded within Other Revenue in the consolidated statements of operations. 'RQRU5HVWULFWHG*LIWV Unconditional promises to give that are expected to be collected within one year are recorded at estimated net realizable value and are included in prepaid expenses and other current assets. Unconditional promises to give that are expected to be collected in future years are recorded at the present value of their estimated future cash flows in other assets. The discount on those amounts is computed using the interest rate applicable to the year in which the promises are received. Amortization of the discount is included in contribution revenue. Unconditional promises to give are reported at fair value at the date the promise is received. Conditional promises to give are reported at fair value at the date the conditions have been satisfied. The gifts are reported as either temporarily or permanently restricted contribution revenue if they are received with donor stipulations that limit the use of the donated assets. When a donor restriction expires, that is, when a stipulated time restriction ends or purpose restriction is accomplished, temporarily restricted net assets are reclassified to unrestricted net assets and reported in the statement of operations as net assets released from restrictions. ,QYHVWPHQWDQG2WKHU5HODWHG,QFRPH The System evaluates the fair values provided by its investment managers and assesses the valuation methods and assumptions used in determining their fair value. Those estimated fair values may differ significantly from the values that would have been used had a readily determinable market for these investments existed and the differences could be material. UMass Memorial and its affiliates have the ability to liquidate their investments periodically in accordance with the provisions of the respective fund agreements. Investments, in general, are exposed to various risks, such as interest rate, credit and overall market volatility. As such, it is reasonably possible that changes in the values of investments will occur in the near term and that such changes could materially affect the amounts reported in the consolidated balance sheets and statements of operations. Investment related income, as well as realized and unrealized gains and losses on investments, are recorded within excess of revenues over expenses unless the income or loss is restricted by donor or law. Realized gains and losses are determined by use of average cost. Unrealized gains and losses reflect the period-to-period changes in the fair value of investments. 7HVWLQJ)LQDQFLDO$VVHWVIRU,PSDLUPHQW The System conducts an annual assessment to determine whether it is more likely than not that the fair value of each of its intangible assets are less than their respective carrying values. If there are 9 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG any such indications present, the System is required to make a formal estimate of the recoverable amount. This assessment did not have a material impact on the consolidated financial statements. ,QFRPH7D[HV The System follows a two-step approach for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. The substantial majority of UMass Memorial and its affiliate entities are recognized by the Internal Revenue Service as tax-exempt under Section 501(c)(3) of the Internal Revenue Code. Accordingly, these entities will not incur any liability for federal income taxes except for tax on unrelated business income. Certain affiliates are taxable entities. The measurement of the amounts recorded as a provision for income taxes based upon the aforementioned approach was $301,000 and $94,500 for the years ended September 30, 2016 and 2015, respectively, and is recorded as part of supplies and other expense in the accompanying consolidated statements of operations. The System does not believe it has any significant uncertain tax positions. ([FHVVRI5HYHQXHV2YHU([SHQVHV The consolidated statements of operations and changes in net assets include excess of revenues over expenses, the performance indicator. Changes in unrestricted net assets that are excluded from excess of revenues over expenses include contributions of property and equipment (including assets acquired using contributions which, by donor restrictions, were used for the purposes of acquiring such assets), and pension-related changes other than net periodic cost. &DVKDQG&DVK(TXLYDOHQWV Cash and cash equivalents include investments in certificates of deposit and highly liquid debt instruments with maturities of three months or less at the date of purchase, excluding amounts classified as assets whose use is limited and long-term investments. $OORZDQFHIRU'RXEWIXO$FFRXQWV Patient accounts receivable are reduced by an allowance for doubtful accounts. In evaluating the collectability of patient accounts receivable, the System analyzes its past history and identifies trends for each of its major categories of revenue (inpatient, outpatient and professional) to estimate the appropriate allowance for doubtful accounts and provision for bad debts. Management regularly reviews data about these major categories of revenue in evaluating the sufficiency of the allowance for doubtful accounts. Throughout the year, the System, after all reasonable collection efforts have been exhausted, will write off the difference between the standard rates (or discounted rates if negotiated) and the amounts actually collected against the allowance for doubtful accounts. In addition to the review of the categories of revenue, management monitors the write offs against established allowances as of a point in time to determine the appropriateness of the underlying assumptions used in estimating the allowance for doubtful accounts. Patient accounts receivable is presented net of an allowance for doubtful accounts of $50,834,000 and $55,445,000 as of September 30, 2016 and 2015, respectively, in the consolidated balance sheets. Management attributes this change in the allowance for doubtful accounts due to a decrease in accounts receivable and improvement in the aging where more current accounts are reflected in the current year. Bad debt expense for nonpatient related accounts receivable is reflected in operating expense on the statements of operations. Patient related bad debt expense is reflected as a reduction in patient service revenue in the statements of operations. ,QYHQWRULHV Supplies and other inventories are stated at the lower of cost (based upon the first-in, first-out method) or market. 10 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG $VVHWV:KRVH8VHLV/LPLWHG Assets whose use is limited include assets held by trustees under indenture and malpractice agreements and restricted contributions from donors pooled for investment purposes. ,PSDLUPHQWRI3URSHUW\DQG(TXLSPHQW Property and equipment to be held and used are reviewed for impairment whenever circumstances indicate that the carrying amount of an asset may not be recoverable. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less cost to dispose. )DLU9DOXHRI)LQDQFLDO,QVWUXPHQWV The carrying amounts of UMass Memorial and its affiliates’ financial instruments, as reported in the accompanying consolidated balance sheets, other than long-term debt, are at, or approximates their fair value. 3URSHUW\DQG(TXLSPHQW Property and equipment are recorded at cost (Note 6) or, if received by gift or donation, at fair value at the date of the gift. Depreciation is recorded over the estimated useful lives of each class of depreciable assets utilizing the straight-line method. Useful lives are determined based upon guidelines established by the American Hospital Association and range from 3 to 40 years. Land improvements 3-25 years Building and building improvements 5-40 years Major movable and fixed equipment 3-20 years Expenditures for maintenance, repairs and renewals are charged to expense as incurred, whereas major betterments are capitalized as additions to property and equipment. Equipment under capital lease obligations is amortized utilizing the straight-line method over the shorter period of the lease term or the estimated useful life of the equipment. Such amortization is recorded in depreciation and amortization expense. Interest cost incurred on borrowed funds during the period of construction of capital assets is capitalized as a component of the cost of acquiring those assets. Gifts of property or equipment are reported as unrestricted support and are excluded from excess of revenues over expenses unless explicit donor stipulations specify how the donated assets must be used. Gifts of property and equipment with explicit restrictions that specify how the assets are to be used and gifts of cash or other assets that must be used to acquire property and equipment are reported as restricted support. Absent explicit donor stipulations about how long the property and equipment must be maintained, expirations of donor restrictions are reported and such assets are reclassified from temporarily restricted to unrestricted when the donated or acquired property and equipment are placed in service. $VVHW5HWLUHPHQW2EOLJDWLRQ An asset retirement obligation (“ARO”) is a legal obligation associated with the retirement of property and equipment. These liabilities are initially recorded at fair value and the related asset retirement costs are capitalized by increasing the carrying amount of the related assets by the same amount. Asset retirement costs are subsequently depreciated over the useful lives of the related assets. Subsequent to initial recognition, the System records period-to-period changes in the ARO liability resulting from the passage of time and revisions to either the timing or the amount of the original estimate of undiscounted cash flows. 11 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG ,QYHVWPHQWV$FFRXQWHGIRU8QGHUWKH(TXLW\0HWKRG The System accounts for investments in entities that are not under its direct control but has the ability to exercise significant influence over the operating and financial policies of the investee under the equity method. Equity method investments are recorded at original cost and are adjusted periodically to recognize the applicable proportionate share of the investees’ net income or losses after the date of investment, increases for additional contributions made, decreases for dividends or distributions received, and any impairment losses resulting from adjustments to net realizable value (Note 7). UMass Memorial and certain affiliates participate in joint ventures with 50% or less ownership, and accounts for the investments in the unconsolidated affiliates as equity investments. 'HEW,VVXDQFH&RVWVDQG2ULJLQDO,VVXH'LVFRXQWRU3UHPLXP Debt issuance costs and any original issue discount or premium are amortized over the period the related obligation is outstanding using the effective interest method or straight line, which approximates the effective interest method. 6SOLW,QWHUHVW$JUHHPHQW UMass Memorial holds and administers an irrevocable charitable gift annuity recorded within other noncurrent liabilities. The contributed assets related to the annuity contract are recorded at fair value as part of investments. Contribution revenue is recognized as of the date that all donor conditions are met and a liability is recorded for the present value of the future estimated payments to the donor and/or other beneficiaries. The liability is adjusted during the term of the annuity contract consistent with the changes in the value of the assets and actuarial assumptions. 3HQVLRQ3RVWUHWLUHPHQWDQG3RVWHPSOR\PHQW%HQHILW3ODQV The System recognizes the funded status of each defined pension, retiree health care and postemployment benefit plans. (VWLPDWHG3URIHVVLRQDO/LDELOLW\&RVWV Estimated professional liability costs consist of estimated liabilities for medical or general liability claims which have been reported, as well as a provision for claims incurred but not reported. It is UMass Memorial and its affiliates’ policy to provide for such claims, to the extent self-insured, on a discounted basis. 6HOI,QVXUDQFH UMass Memorial and certain of its affiliates are self-insured for certain professional liability (Note 12), general liability, health insurance, and workers’ compensation benefit claims, all of which are funded and insured through the Commonwealth Professional Assurance Company, Ltd. (“CPAC”), a wholly-owned subsidiary of UMass Memorial, except for health insurance which is self-funded. Estimated losses and claims are accrued as incurred. UMass Memorial and its affiliates have provided for the cost of claims incurred during the current period, as well as estimates of the liability for claims incurred but not yet reported. 7HPSRUDULO\DQG3HUPDQHQWO\5HVWULFWHG1HW$VVHWV Temporarily restricted net assets are those whose use by UMass Memorial and its affiliates has been limited by donors to a specific time period or purpose. Permanently restricted net assets have been restricted by donors to be maintained by UMass Memorial and its affiliates in perpetuity. UMass Memorial and its affiliates have interpreted Massachusetts’ Uniform Prudent Management of Institutional Funds Act (“UPMIFA”), as requiring realized and unrealized gains on permanently restricted net assets to be retained as temporarily restricted net assets until appropriated by the 12 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Board and expended. UPMIFA allows the Board to appropriate an amount of the net appreciation as is prudent considering UMass Memorial and its affiliates’ long-term and short-term needs, present and anticipated financial requirements, expected total return on its investments, price-level trends and general economic conditions. Amounts appropriated by the Board for expenditure during the years ended September 30, 2016 and 2015 amounted to $719,000 and $1,063,000, respectively. These amounts are recorded as net assets released from restrictions. 5HFHQW$FFRXQWLQJ3URQRXQFHPHQWV In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09 - Revenue from Contracts with Customers at the conclusion of a joint effort with the International Accounting Standards Board to create common revenue recognition guidance for United States GAAP and international accounting standards. This framework ensures that entities appropriately reflect the consideration to which they expect to be entitled in exchange for goods and services, by allocating transaction price to identified performance obligations, and recognizing that revenue as performance obligations are satisfied. Qualitative and quantitative disclosures will be required to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The standard is effective for fiscal years beginning after December 15, 2017 or fiscal year 2019 for the System. The System is evaluating the impact this will have on the consolidated financial statements. In April 2015, the FASB issued ASU 2015-03 - Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs, which requires all costs incurred to issue debt to be presented in the balance sheet as a direct deduction from the carrying value of the associated debt liability. The System has decided to early adopt the guidance and change its reporting on debt issuance costs. Accordingly, certain amounts within the 2015 consolidated financial statements have been reclassified to conform to the 2016 presentation. Previously reported debt issuance costs in other noncurrent assets of $4,633,000 have been reclassified as a reduction of long-term debt. In May 2015, the FASB issued ASU 2015-07, Disclosures for Certain Entities That Calculate Net Asset Value (“NAV”) per Share (or its Equivalent), which removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using net asset value per share as the practical expedient. This guidance is effective in fiscal year 2017; however, early adoption is permitted. The System is evaluating the impact of the new guidance on the consolidated financial statements. In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which address certain aspects of recognition, measurement, presentation and disclosure of financial instruments. This guidance allows an entity to choose, investment-by-investment, to report an equity investment that neither has a readily determinable fair value, nor qualifies for the practical expedient for fair value estimation using NAV, at its cost minus impairment (if any), plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issue. Impairment of such investments must be assessed qualitatively at each reporting period. Entities must disclose their financial assets and liabilities by measurement category and form of asset either on the face of the balance sheet or in the accompanying notes. The ASU is effective for annual reporting periods beginning after December 15, 2018 or fiscal year 2020 for the System. As of September 30, 2016, the provision to eliminate the requirement to disclose the fair value of debt has been early adopted by the System in fiscal 2016. The System is currently evaluating the impact of the other aspects of the new guidance on the consolidated financial statements. 13 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG In February 2016, the FASB issued ASU 2016-02, Leases, which, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its consolidated balance sheets. The guidance also expands the required quantitative and qualitative disclosures surrounding leases. The ASU is effective for fiscal years beginning after December 15, 2018, or fiscal year 2020 for the System. Early adoption is permitted. The System is evaluating the impact of the new guidance on the consolidated financial statements. In August 2016, the FASB issued ASU 2016-14, Presentation of Financial Statements for Not-for- Profit Entities, which makes targeted changes to the not-for-profit financial reporting model. Under the new ASU, the existing three-category classification of net assets will be replaced with a simplified model that combines temporarily restricted and permanently restricted into a single category called “net assets with donor restrictions.” The guidance for classifying deficiencies in endowment funds has also been simplified and clarified. New disclosures will highlight restrictions on the use of resources that make otherwise liquid assets unavailable for meeting near-term financial requirements. The ASU also imposes several new requirements related to reporting expenses, including providing information about expenses by their natural classification. The ASU is effective for fiscal years beginning after December 15, 2017 or fiscal year 2019 for the System and early adoption is permitted. The System is evaluating the impact of the new guidance on the consolidated financial statements. 5HFODVVLILFDWLRQV Certain 2015 amounts have been reclassified to conform to the current year presentation. 6XSSOHPHQWDO'LVFORVXUHVRI&DVK)ORZ,QIRUPDWLRQ Cash paid for interest, net of capitalized interest of $2,320,000 and $1,146,000, was $11,976,000 and $14,278,000 for the years ended September 30, 2016 and 2015, respectively. Noncash investing and financing activities: (in thousands of dollars) Property and equipment included in accounts payable and due to the University of Massachusetts $ 31,417 $ 19,731 Property and equipment financed with/by capital lease obligation - 304 During fiscal year 2016, the Medical Center refunded Series A and Series D with proceeds from Series I (Note 8), the noncash items related to this transaction for the year ended September 30 were as follows: (in thousands of dollars) Payments on long-term debt $ 140,110 Proceeds from borrowings (131,807) Sales and maturities of investments (11,586) Other noncurrent assets 911 Net assets surrendered $ (2,372) Liabilities incurred $ (489) 14 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG During fiscal year 2015, the Medical Center exercised its option to purchase an 18.9% equity ownership in the newly formed joint venture Quest Diagnostics Massachusetts, LLC. (“Quest Diagnostics”) (Note 7) Upon exercising the option, noncash items related to the assets received and liabilities incurred for the year ended September 30 were as follows: (in thousands of dollars) Prepaid expenses and other current assets $ (6,164) Property and equipment (323) Other assets 31,633 Note payable (11,849) Net assets received $ 13,297 Liabilities incurred $ 1,196 &KDULW\&DUHDQG&RPPXQLW\%HQHILW3URJUDPV &KDULW\&DUH UMass Memorial and its affiliates provide services to patients regardless of their ability to pay. Certain uninsured and underinsured patients qualify for care without charge or care at reduced rates based on established policies of UMass Memorial and its affiliates. Patient eligibility under such policies is based on income using the federal poverty guideline levels or financial hardship if medical expenses to gross income meet predefined levels. Charges foregone under these policies are not reported as net patient service revenue. Management estimates that the cost associated with the charity care provided by UMass Memorial and its affiliates was approximately $36,743,000 and $30,117,000 for the years ended September 30, 2016 and 2015, respectively. Such costs have been estimated based on the ratio of expenses to established patient service revenue charges. Massachusetts law provides coverage for healthcare services via the Health Safety Net (“HSN”). During 2016 and 2015, the System received reimbursement from the Commonwealth of Massachusetts (the ”Commonwealth”) in the amounts of $10,293,000 and $6,277,000, respectively, from this program. In addition to providing direct patient charity care, UMass Memorial and its affiliates make other significant contributions to the community. UMass Memorial and its affiliates file annual Community Benefit Reports with the Commonwealth, pursuant to State Attorney General guidelines, which provides an overview of the major community programs it supports. &RPPXQLW\%HQHILW3URJUDPV UMass Memorial has a strong history of working closely with many stakeholders and supporting programs that address health disparities to improve the health and quality of life in Central Massachusetts through its community benefits programs. Building on the World Health Organization (“WHO”) definition of health as a “state of complete physical, mental, and social well-being, and not merely the absence of disease”, UMass Memorial and its affiliates, like WHO, understand that there are a host of social determinant factors that impact the ability to achieve optimal health. In adopting this broad definition of health, UMass Memorial charges themselves with the duty of improving access to care and responding to those socio-cultural and economic barriers that 15 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG negatively impact the health and well-being of individuals and the community. As a not-for-profit hospital, UMass Memorial and its affiliates are required to conduct a Community Health Needs Assessment (“CHA”) every three years. The CHA utilizes quantitative and qualitative data to identify and develop strategies to address the needs of the medically-underserved in each hospital’s respective services area. Working in collaboration with local health departments, neighborhood residents, community-based organizations, city and state officials, advocacy groups, schools, coalitions, faith-based organizations and other stakeholders, UMass Memorial and its affiliates are involved in community benefits activities that target long-term solutions while addressing the root causes of disease. 7KH&RPPXQLW\%HQHILW6WUDWHJLF,PSOHPHQWDWLRQ3ODQ UMass Memorial and its affiliates’ Community Benefit Strategic Implementation Plans align with the priorities identified by the CHA and Community Health Improvement Plans (“CHIP”) developed in collaboration with local Departments of Public Health in each of their respective areas. UMass Memorial and its affiliates have implemented programs and initiatives to address the identified needs of medically underserved patients as well as other priorities and strategies outlined in the CHIP. Target populations include: Underinsured/uninsured Populations living in poverty Children and youth at risk Ethnic and linguistic minorities Residents of targeted low-income neighborhoods Elders. A partial listing of the UMass Memorial Community Benefits programs and efforts include the following: The UMass Memorial Asthma Home Visiting Intervention Pilot in Bell Hill was expanded under the Prevention and Wellness Trust Fund grant award, which allowed the City of Worcester to develop a city-wide, comprehensive model including a total of 11 partners. Partners include: two community health centers, the Worcester Public Schools, the Worcester Head Start Program, Worcester Community Legal Aid, the City of Worcester Division of Public Health and Office of Healthy Homes. This community/clinical linkage model is being implemented to address high rates of pediatric asthma in the City of Worcester utilizing community health workers. Working in collaboration with Clark University, UMass Memorial established an Academic Health Department to support the CHIP and strengthen the City of Worcester Public Health Infrastructure. A Care Mobile program provides medical and dental services to vulnerable populations in 11 neighborhood sites and preventive dental services to 20 schools. These programs address the high incidence of dental caries due to a lack of fluoridation in the City of Worcester’s water supply. Programs and collaborative efforts that improve access to care (e.g. support of oral health initiatives, outreach and support to immigrant/refugee communities, capacity building at community health centers). 16 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Support programs that promote positive development for at-risk youth as a way to address substance abuse, tobacco, mental health and violence prevention through advocacy, public health-related policy initiatives, social norms campaigns, and onsite mental health services at youth-serving organizations. Developed a Hot-spotting Task Force with the University to identify needs of super-users; developed a partnership with Worcester Community Legal Aid to address the social/economic factors impacting vulnerable populations. Development of a community-clinical linkage program with the Trauma Department to reduce falls among the elderly population. Obesity/healthy weight efforts (e.g. access to physical activity, food insecurity, community gardens, veggie mobile and cooking/nutrition education). Programs that promote health and address health disparities (substance abuse and mental health (e.g. increasing awareness and access to services for youth, participation in a hoarding task force, fall prevention and health education for seniors)). Coalition building efforts and partnerships that engage local residents and community stakeholders in identifying and planning solutions to address community needs (e.g. development of CHA). Workforce development/jobs for inner-city youth. In partnership with community groups, each affiliate hospital is addressing identified needs and striving to improve the health and well-being needs of the residents of Central New England. 7KLUG3DUW\5HLPEXUVHPHQWDQG8QFRPSHQVDWHG&DUH UMass Memorial and its affiliates have agreements with third-party payers that provide for payments at amounts different from their established rates. A summary of payment arrangements with major third-party payers follows: 0HGLFDUH Acute care hospitals are subject to a federal prospective payment system for most Medicare inpatient hospital services and for certain outpatient services. Under this arrangement, Medicare pays a prospectively determined per discharge or per visit rate for nonphysician services. These rates vary according to the severity based Diagnosis Related Group (“DRG”) or Ambulatory Payment Classification (“APC”) of each patient. Certain transplant services and medical education costs related to Medicare beneficiaries are paid based on a cost-reimbursement methodology, subject to certain limits. Hospitals are reimbursed for cost-reimbursable items at a tentative rate, with final settlement determined after submission of annual cost reports and audits thereof by the Medicare fiscal intermediary. Certain other outpatient services are reimbursed according to fee screens. 2WKHU3D\HU$UUDQJHPHQWV The System’s acute care hospitals have entered into other payment arrangements with BlueCross BlueShield of Massachusetts (“Blue Cross”), the Massachusetts Executive Office of Health and Human Services (“EOHHS”), certain commercial insurance carriers, Health Maintenance 17 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Organizations (“HMO”), and preferred provider organizations. The basis for payment under these agreements includes prospectively determined rates per discharge and per day, discounts from established charges and fee screens. Certain arrangements also include quality and performance initiatives that may result in additional payments if quality measures are achieved. 5LVN$UUDQJHPHQW During 2016, the System’s acute care hospitals and Medical Group entered its fourth year in a risk arrangement with Blue Cross covering HMO members comprising of fully and self insured accounts. This agreement is referred to as the Alternative Quality Contract (“AQC”) and is effective for four years. 6SHFLDO0HGLFDLG3D\PHQWV During 2016 and 2015, the Division of Medical Assistance revised certain UMass Memorial’s affiliates’ standard Medicaid rates for unreimbursed charges related to providing services to patients eligible for medical assistance under Title XIX or to low-income patients (“Special Medicaid Payments”). Special Medicaid Payments totaling $196,004,000 in 2016 and $168,649,000 in 2015, respectively, were recognized as net patient service revenue in the accompanying consolidated financial statements. The Special Medicaid Payment of $168,649,000 in 2015 reflects $210,786,000 in services related to 2015 and a change in prior year estimates that decreased net patient service revenue by approximately $42,137,000. Special Medicaid Payments of $196,475,000 and $352,649,000 were recorded as a receivable as of September 30, 2016 and 2015, respectively. The outstanding 2015 Special Medicaid Payment after the change in prior year estimates of $182,316,000 was received in June 2016. The outstanding 2014 Special Medicaid Payment after the change in prior year estimates of $182,787,000 was received in November 2015. Differences between preliminary estimates and final settlements are included in net patient service revenue in the year the change in estimate occurs. Estimated settlements payable to third-party payers includes $12,925,000 of 2015 recoupments payable to the Commonwealth as of September, 30, 2016. +HDOWK6DIHW\1HW The Commonwealth operates a program called the HSN. The program, which became effective October 1, 2007, is designed to reimburse hospitals for a portion of the uncompensated care provided to patients subject to certain eligibility rules. Hospitals are required to contribute to the HSN trust fund and are assessed a fee based upon estimates of the statewide cost of uncompensated care. The System has recorded its gross obligation to the HSN, net of reimbursement received as part of its net patient service revenue in the accompanying consolidated financial statements. $FFRXQWDEOH&DUH2UJDQL]DWLRQ UMass Memorial commenced operations of an Accountable Care Organization (“ACO”) beginning January 1, 2015 and joined the voluntary Medicare Savings Program that was established under the Affordable Care Act. The program rewards ACOs that lower their growth in health care costs while meeting performance standards on quality. $VVHWV:KRVH8VHLV/LPLWHGDQG,QYHVWPHQWV UMass Memorial and certain of its affiliates have combined the management of certain of their investments in the UMass Memorial Investment Partnership, LLP (the “Partnership”). Each of the participating affiliates reports its proportionate share of the Partnership’s investments in its financial statements. Pooled investment income and gains and losses of the Partnership are allocated to 18 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG the participating affiliates based on their respective units in the Partnership. Investments held within the Partnership totaled approximately $481,662,000 and $453,171,000 as of September 30, 2016 and 2015, respectively. Investments, including those held within the Partnership, consist of the following at September 30: (in thousands of dollars) Mutual funds and common collective trusts $ 321,969 $ 288,813 Bonds and notes 150,647 109,179 Hedge funds 138,670 152,863 Cash and cash equivalents 74,999 79,708 Common stocks 55,888 50,435 Private equity funds 29,988 25,523 Other investments 3,945 3,654 Subtotal 776,106 710,175 Beneficial interest in trusts 7,719 7,991 Other assets 4,070 3,956 $ 787,895 $ 722,122 Such amounts are reported in the consolidated balance sheets at September 30 as follows: (in thousands of dollars) Short-term investments $ 32,118 $ 31,792 Current portion of assets whose use is limited 9,553 8,700 Assets whose use is limited Funds held in escrow under bond indenture agreements Debt service funds 13 13 Debt service reserve funds 1,313 12,090 Project funds 45,863 - 47,189 12,103 Restricted investments 88,118 88,195 Captive insurance company investments 157,518 164,440 Long-term investments 441,610 404,945 Subtotal 776,106 710,175 Beneficial interest in trusts 7,719 7,991 Other assets 4,070 3,956 $ 787,895 $ 722,122 Funds held in escrow under bond indenture agreements include the debt service funds for payments of principal and interest, and project funds for property and equipment acquisitions. Included in total investments as of September 30, 2016 and 2015, were pending sales of $1,773,000 and $1,652,000 and purchases of $1,433,000 and $1,909,000, respectively. 19 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG The composition of investment return for the years ended September 30 was as follows: (in thousands of dollars) Interest, dividend and other related income Other operating revenue $ 1,938 $ 4,116 Nonoperating revenue 4,446 5,608 Temporarily restricted 466 1,143 Net realized gains on sale of investments Other operating revenue 2,683 10,282 Nonoperating revenue 2,908 13,838 Temporarily restricted 234 2,762 Change in net unrealized gains (losses) on investments Nonoperating revenue 23,231 (44,653) Temporarily restricted 1,356 (6,568) Permanently restricted 310 (644) Total investment return $ 37,572 $ (14,116) UMass Memorial and its affiliates report investments at fair value. Fair value is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value: Level 1 - Observable inputs such as quoted prices for identical assets and liabilities in active markets; Level 2 - Valuations using observable inputs other than Level 1 prices such as quoted prices in active markets for similar assets and liabilities; quoted prices for identical or similar assets or liabilities in markets that are not active; broker or dealer quotations; or inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and Level 3 - Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. The fair value hierarchy also requires UMass Memorial and its affiliates to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The fair value hierarchy does not attempt to measure the quality of the investments. Management believes that the investment values are fairly stated. UMass Memorial and its affiliates primarily use market values as provided by the custodian along with consideration of the prices as provided by the investment managers. These market values are set with reference to market activity for highly liquid assets such as U.S. Treasury and agency securities and agency residential mortgage-backed securities, and matrix pricing for other asset classes, such as commercial mortgage and other asset-backed securities. Values for corporate bonds, convertible bonds and municipal bonds may be determined using discounted cash flow 20 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG pricing models considering adjustments for spreads and prepayments for the instruments. Prices for fixed income securities may also be priced using dealer quotes. Management has ongoing procedures in place to evaluate and monitor new and ongoing third party valuations including regular communication with investment advisors, monthly and quarterly performance benchmarking, and the review of partnership financial statements. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Investments may be classified as Level 2 when market information (including observable net asset values) is available, yet the investment is not traded in an active market. Market information, including observable net asset values, subscription and redemption activity, if applicable, and the length of time until the investment will become redeemable are considered when determining the proper categorization of the investment’s fair value measurement within the fair valuation hierarchy. Investments that have observable market inputs (such as net asset values) and UMass Memorial has the ability to redeem at the measurement date are classified in the fair value hierarchy as Level 2. Investments that have unobservable inputs or for which UMass Memorial does not have the ability to redeem at the measurement date are classified in the fair value hierarchy as Level 3. The following fair value hierarchy table presents information about the System’s financial assets measured at fair value on a recurring basis based upon the lowest level of significant input to the valuations as of September 30, 2016 and 2015. 6HSWHPEHU (in thousands of dollars) /HYHO /HYHO /HYHO 7RWDO )LQDQFLDODVVHWV Investments Mutual funds and common collective trusts$ 190,132 $ 131,837 $ - $ 321,969 Bonds and notes 18,692 131,955 - 150,647 Hedge funds - 30,514 108,156 138,670 Cash and cash equivalents 74,999 - - 74,999 Common stocks 55,888 - - 55,888 Private equity funds - - 29,988 29,988 Other investments 1,634 194 2,117 3,945 Total investments at fair value 341,345 294,500 140,261 776,106 Beneficial interest in trusts - - 7,719 7,719 Other assets 4,070 - - 4,070 Total financial assets at fair value $ 345,415 $ 294,500 $ 147,980 $ 787,895 21 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG 6HSWHPEHU (in thousands of dollars) /HYHO /HYHO /HYHO 7RWDO )LQDQFLDODVVHWV Investments Mutual funds and common collective trusts$ 174,321 $ 114,492 $ - $ 288,813 Bonds and notes 20,266 88,913 - 109,179 Hedge funds - 40,284 112,579 152,863 Cash and cash equivalents 79,708 - - 79,708 Common stocks 50,435 - - 50,435 Private equity funds - - 25,523 25,523 Other investments 823 1,624 1,207 3,654 Total investments at fair value 325,553 245,313 139,309 710,175 Beneficial interest in trusts - - 7,991 7,991 Other assets 3,956 - - 3,956 Total financial assets at fair value $ 329,509 $ 245,313 $ 147,300 $ 722,122 The availability of observable market data is monitored to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions on model- based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, the transfer is reported at the beginning of the reporting period. For the year ended September 30, 2015, there was one transfer of $1,207,000 from Level 1 to Level 3. The following table presents the activity for the year for all assets categorized as Level 3 for the years ended September 30, 2016 and 2015: 3ULYDWH %HQHILFLDO (TXLW\ +HGJH 2WKHU ,QWHUHVW (in thousands of dollars) )XQGV )XQGV ,QYHVWPHQWV LQ7UXVWV 7RWDO )DLU9DOXH6HSWHPEHU $ 25,523 $ 112,579 $ 1,207 $ 7,991 $ 147,300 Realized gains (losses) (3,005) 1,067 - - (1,938) Unrealized gains (losses) 1,909 (407) (56) 308 1,754 Purchases 5,561 - 966 - 6,527 Sales - (5,083) - - (5,083) Cash received from beneficial interest in trusts - - - (580) (580) )DLU9DOXH6HSWHPEHU $ 29,988 $ 108,156 $ 2,117 $ 7,719 $ 147,980 3ULYDWH %HQHILFLDO (TXLW\ +HGJH 2WKHU ,QWHUHVW (in thousands of dollars) )XQGV )XQGV ,QYHVWPHQWV LQ7UXVWV 7RWDO )DLU9DOXH6HSWHPEHU $ 5,309 $ 111,111 $ - $ 15,675 $ 132,095 Realized gains (losses) (1,467) 3,869 - - 2,402 Unrealized gains (losses) (26) (6,172) - - (6,198) Purchases 21,707 12,014 - - 33,721 Sales - (8,243) - - (8,243) Transfers into Level 3 1,207 1,207 Cash received from beneficial interest in trusts - - - (7,060) (7,060) Change in value of beneficial interest in trusts - - - (624) (624) )DLU9DOXH6HSWHPEHU $ 25,523 $ 112,579 $ 1,207 $ 7,991 $ 147,300 22 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG The System uses NAV to determine the fair value of its investments which (a) do not have a readily determinable fair market value and (b) prepare their financial statements consistent with the measurement principles of an investment company or have the attributes of an investment company. The following table summarizes the key provisions for the System’s alternative investments as of September 30, 2016 and 2015: (in thousands of dollars) /HYHO )DLU RI 5HGHPSWLRQ 5HGHPSWLRQ ,QYHVWPHQW 6WUDWHJ\ 9DOXH )XQGV 7HUPV 5HVWULFWLRQV Common collective trust To track the performance of the $ 35,881 1 2 business days. None. Russell 3000 Index. Common collective trust Capital growth through investment 22,970 1 5 business days. The redemption of Units is subject to certain in a professionally managed portfolio restrictions and limitations set forth in the of international securities. Trust Agreement (Suspension of Subscriptions, Redemptions and Valuations). Common collective trust Fixed income securities. 16,487 1 Daily. None. Common collective trust Asset diversification by investing 28,431 1 1 business day. None. in equity assets, diversifying strategies and fixed income. Common collective trust Total return. 17,790 1 Daily. None. Hedge Fund Multi-strategy equities, commodities, 30,514 2 May withdraw all or any Payments for withdrawals will be made no currencies and fixed income part of its distributable later than 30 business days after the effective securities. amount the first day of any date of withdrawal. A reasonable reserve for the fiscal period (first business Partner's share of any future expenses or day of the month) with 14 definite or contingent liabilities of the Partnership days advance written that have not been taken into account will be held notice. until the next occurring audit. APPENDIX B 23 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG (in thousands of dollars) /HYHO )DLU RI 5HGHPSWLRQ 5HGHPSWLRQ ,QYHVWPHQW 6WUDWHJ\ 9DOXH )XQGV 7HUPV 5HVWULFWLRQV Common collective trust Capital growth through investment $ 19,849 1 5 business days. The redemption of Units is subject to certain in a professionally managed portfolio restrictions and limitations set forth in the of international securities. Trust Agreement (Suspension of Subscriptions, Redemptions and Valuations). Common collective trust To track the performance of the 24,307 1 2 business days. None. Russell 3000 Index. Common collective trust Fixed income securities. 19,114 1 Daily. None. Hedge Fund Multi-strategy equities, commodities, 29,877 2 May withdraw all or any Payments for withdrawals will be made no currencies and fixed income part of its distributable later than 30 business days after the effective securities. amount the first day of any date of withdrawal. A reasonable reserve for the fiscal period (first business Partner's share of any future expenses or day of the month) with 14 definite or contingent liabilities of the Partnership days advance written that have not been taken into account will be held notice. until the next occurring audit. Hedge Fund Senior secured debt, loans, notes, bonds. 10,407 1 Monthly liquidity with 30 None. days written notice. Mutual Fund Growth. 5,437 1 Weekly. None. 24 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG (in thousands of dollars) /HYHO $PRXQWRI 7LPLQJWR 5HGHPSWLRQ )DLU RI 5HPDLQLQJ 8QIXQGHG 'UDZ 5HGHPSWLRQ 5HGHPSWLRQ 5HVWULFWLRQVLQ ,QYHVWPHQW 6WUDWHJ\ 9DOXH )XQGV /LIH &RPPLWPHQWV &RPPLWPHQWV 7HUPV 5HVWULFWLRQV 3ODFHDW Hedge Fund Arbitrage, hedged equity $ 42,458 2 None. $ - None. December 31 or Redemptions are permitted on Lock up and special situations. on calendar quarter December 31 or on calendar quarter provisions set to expire associated with investment associated with investment date on December 31, 2016, date applicable to each subject to 100 days written notice, March 31, 2017, and class of shares each after a lock-up period of 1 or 3 years. September 30, 2017. with 100 days notice. If members do not redeem shares at end of lock-up, they will be subject to a new lock-up period of 1 or 3 years applicable to each class of shares. Hedge Fund Investment in securities 19,603 1 None. - None. 45 days written notice Class B Shares may not be None. and other investments required for redemption. redeemed until shares held to achieve above-average for a continuous period of at capital growth. least 12 months. Thereafter, redeemable as of December 31 of each year on 45 days written notice. Hedge Fund Private investments in 12,563 1 None. - None. Any calendar quarter on 95 days written notice. None. funds and hedge funds. or after the 12th month of initial investment. Hedge Fund Various investments 12,388 1 None. - None. 45 days written notice Annually, on December 31. None. strategies to provide superior required for redemption. risk-adjusted returns while preserving capital. Hedge Fund Arbitrage, distressed 11,995 3 None. - None. Redemptions are Quarterly only if there has None. investments, long/short valued one month after the been a tender offer by equity and fixed income. repurchase request the fund. (the "Valuation Date") and generally paid one month after Valuation Date contingent on Fund liquidation constraints. Hedge Fund Event Driven Strategy in 9,008 1 None. - None. Redemptions are valued As of the first calendar None. stressed and distressed at a per share price based quarter-end occurring segments of corporate on the Net Asset Value of immediately after the end of credit market. series with 90 days written the 11th month following the notice. date of issuance. APPENDIX B 25 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG /HYHO FRQWLQXHG $PRXQWRI 7LPLQJWR 5HGHPSWLRQ )DLU RI 5HPDLQLQJ 8QIXQGHG 'UDZ 5HGHPSWLRQ 5HGHPSWLRQ 5HVWULFWLRQVLQ ,QYHVWPHQW 6WUDWHJ\ 9DOXH )XQGV /LIH &RPPLWPHQWV &RPPLWPHQWV 7HUPV 5HVWULFWLRQV 3ODFHDW Hedge Fund Multi-strategy. 141 3 None. - None. Currently liquidating Distribution made as Redemptions are positions. positions are liquidated. in process. Other asset Closely held stock. 2,117 - None. - No commitment. No restriction. No restriction. None. Private Equity Diversification through 10,603 1 None. - None. 60 days written notice Initial lock-up period of 24 months Redemption special investments. required for redemption. during which withdrawals are restrictions permitted but are subject to a have not been met. penalty and capped. Private Equity Diversification through 7,426 1 None. - None. Written notice before September Annually. Holding period requirement farm land investments. 30th after holding period. has been met. Private Equity Diversification through 3,984 1 9 to 8 years. 6,436 None. Redemptions are not Closed-end fund with no Not redeemable. real estate investments. permitted. redemptions. Private Equity Structured debt products. 2,585 2 None. 1,800 None. None. None. None. Private Equity Senior secured lending 2,286 1 None. 2,444 None. Redemptions are not Redemptions are not Capital will be and other investment permitted. permitted. distributed to investors products to generate attractive as investments risk-adjusted returns. are liquidated. Private Equity Global private equity. 1,787 3 3 to 5 years. 520 Term of agreement. Redemptions are not Amount, timing and form of distributions Not redeemable. permitted. determined by the fund. Private Equity Debt financing. 1,317 1 None. - None. Redemptions are not Redemptions are not Periodic distributions permitted. permitted. will be made to return capital and achieve a predetermined preferred return. $ 140,261 22 $ 11,200 26 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG (in thousands of dollars) /HYHO $PRXQWRI 7LPLQJWR 5HGHPSWLRQ )DLU RI 5HPDLQLQJ 8QIXQGHG 'UDZ 5HGHPSWLRQ 5HGHPSWLRQ 5HVWULFWLRQVLQ ,QYHVWPHQW 6WUDWHJ\ 9DOXH )XQGV /LIH &RPPLWPHQWV &RPPLWPHQWV 7HUPV 5HVWULFWLRQV 3ODFHDW Hedge Fund Arbitrage, distressed $ 16,778 3 None. $ - None. Redemptions are Quarterly only if there has Redemption investments, long/short valued one month after the been a tender offer by restrictions equity and fixed income. repurchase request the fund. have been met (the "Valuation Date") and at year end. generally paid one month after Valuation Date contingent on Fund liquidation constraints. Hedge Fund Arbitrage, hedged equity 42,245 2 None. - None. December 31 or Redemptions are permitted on Lock up and special situations. on calendar quarter December 31 or on calendar quarter provisions reset associated with investment associated with investment date December 31, 2013 date applicable to each subject to 100 days written notice, through class of shares each after a lock-up period of 1 or 3 years. December 31, 2015. with 100 days notice. If members do not redeem shares at end of lock-up, they will be subject to a new lock-up period of 1 or 3 years applicable to each class of shares. Hedge Fund Private investments in 12,600 1 None. - None. Any calendar quarter on 95 days written notice. Redemption restrictions funds and hedge funds. or after the 12th month have been met of initial investment. at year end. Hedge Fund Multi-strategy. 255 4 None. - None. Currently liquidating Distribution made as Redemptions are positions. positions are liquidated. in process. Hedge Fund Event Driven Strategy in 9,718 1 None. - None. Redemptions are valued As of the first calendar Redemption stressed and distressed at a per share price based quarter-end occurring restrictions segments of corporate on the Net Asset Value of immediately after the end of have been met credit market. series with 90 days written the 11th month following the at year end. notice. date of issuance. Hedge Fund Investment in securities 18,851 1 None. - None. 45 days written notice Class B Shares may not be Redemption and other investments required for redemption. redeemed until shares held restrictions to achieve above-average for a continuous period of at have not capital growth. least 12 months. Thereafter, been met. redeemable as of December 31 of each year on 45 days written notice. Hedge Fund Various investments 12,132 1 None. - None. 45 days written notice Annually, on December 31. Redemption strategies to provide superior required for redemption. restrictions risk-adjusted returns while have not been met. preserving capital. APPENDIX B Other asset Closely held stock. 1,207 - None. - No commitment. No restriction. No restriction. None. 27 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG (in thousands of dollars) /HYHO FRQWLQXHG $PRXQWRI 7LPLQJWR 5HGHPSWLRQ )DLU RI 5HPDLQLQJ 8QIXQGHG 'UDZ 5HGHPSWLRQ 5HGHPSWLRQ 5HVWULFWLRQVLQ ,QYHVWPHQW 6WUDWHJ\ 9DOXH )XQGV /LIH &RPPLWPHQWV &RPPLWPHQWV 7HUPV 5HVWULFWLRQV 3ODFHDW Private Equity Global private equity. 2,200 3 3 to 5 years. 809 Term of agreement. Restricted. Amount, timing and form of distributions Not redeemable. determined by the fund. Private Equity Structured debt products. 2,529 1 None. - None. None. None. None. Private Equity Debt financing. 2,208 1 None. - None. Redemptions are not Redemptions are not Periodic distributions permitted. permitted. will be made to return capital and achieve a predetermined preferred return. Private Equity Senior secured lending 1,375 1 None. 3,830 None. Redemptions are not Redemptions are not Capital will be and other investment permitted. permitted. distributed to investors products to generate attractive as investments risk-adjusted returns. are liquidated. Private Equity Diversification through 7,174 1 None. - None. Written notice before September Annually. Holding period requirement farm land investments. 30th after holding period. has not been met. Private Equity Diversification through 432 1 None. 9,568 None. Not applicable. Closed-end fund with no Not redeemable. real estate investments. redemptions. Private Equity Diversification through 9,605 1 None. - None. 60 days written notice Initial lock-up period of 24 months Redemption special investments. required for redemption. during which withdrawals are restrictions permitted but are subject to a have not been met. penalty and capped. $ 139,309 22 $ 14,207 28 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG 9DOXDWLRQ7HFKQLTXHV Valuation techniques maximize the use of relevant observable inputs and minimize the use of unobservable inputs. The following is a description of the valuation methodologies used for assets measured at fair value on a recurring basis. The fair value of investments is determined in accordance with the current fair value guidance and as described below. NAV would not be used as a practical expedient for fair value when it is determined to be probable that the investment would sell for an amount different than the reported net asset value. In such situations, management would estimate the fair value of the investment in good faith based on the available information and will update the fair value methodology if a significant event occurs which has the potential of impacting the ultimate value of the investment. Cash Equivalents – The carrying value of cash equivalents approximates fair value as maturities are less than three months and/or include money market funds that are based on quoted prices and are actively traded. Mutual Funds and Common Stocks – The fair values of mutual funds and common stocks are based on quoted market prices or net assets value. These mutual funds are required to publish the NAV and to transfer at that price. The mutual funds held by UMass Memorial and its affiliates are deemed to be actively traded. The fair value of domestic and international equity securities are principally based on quoted market prices that are traded in an active market. Common Collective Trusts – The fair value of common collective trusts are based on the NAV of the fund, representing the fair value of the underlying investments, which are generally securities traded on an active market. The NAV is used as a practical expedient to estimate fair value. Such investments are classified as Level 2 when UMass Memorial and its affiliates has the ability to redeem the investment in the fund at the NAV (or its equivalent) at the measurement date or within the near term and there are no other potential liquidity restrictions. Private Equity and Hedge Funds – The estimated fair values of these investments for which no quoted market prices are readily available, are determined based upon the information provided by the fund managers. Such information is generally based on the NAV of the fund, which is used as a practical expedient to estimate fair value. UMass Memorial and its affiliates have classified certain of its investments reported at NAV as Level 2 because it has the ability to redeem its investments in the fund at the NAV per share (or its equivalent) at the measurement date or within the near term and there are no other potential liquidity restrictions. Funds categorized within Level 3 may be subject to a minimum holding period or lockup may not be able to redeem at the measurement date or within 90 days thereof, can be subject to redemption notice periods in excess of 90 days, or have the ability to limit the aggregate amount of shareholder redemptions. Investment gains, losses, and expenses are allocated to the investors based on the ownership percentage as described in the respective partnership or hedge fund agreements. Bonds and Notes – Certain bonds are valued at the closing price reported in the active market in which the bond is traded. Other bonds are valued based on yields currently available on comparable securities of issuers with similar credit ratings. When quoted prices are not available for identical or similar bonds, the bond is valued under a discounted cash flow approach that maximizes observable inputs, such as current yields of similar instruments, but includes adjustments for certain risks that may not be observable, such as credit and liquidity risks. 29 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Beneficial Interest in Trusts – The estimated fair values of UMass Memorial and its affiliates beneficial interest in trusts are determined based upon information provided by the trustees. Such information is generally based on the pro rata interest in the net assets of the underlying investments. The assets held in trust consist primarily of cash equivalents and marketable securities. The fair values of the perpetual trusts are measured using the fair value of the assets contributed to the trusts. The preceding methods may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although UMass Memorial and its affiliates believes its valuation methods or assumptions 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 fair value measurement at the reporting date. There have been no changes in the methodologies used at September 30, 2016 and 2015. 3URSHUW\DQG(TXLSPHQW Property and equipment consist of the following at September 30: (in thousands of dollars) Land and land improvements $ 21,883 $ 21,764 Buildings and building improvements 852,918 874,124 Major movable and fixed equipment 753,526 753,708 1,628,327 1,649,596 Less: Accumulated depreciation and amortization 1,105,305 1,103,602 523,022 545,994 Construction in progress 165,368 48,228 Property and equipment, net $ 688,390 $ 594,222 Depreciation expense (excluding amortization of capital lease assets (Note 9)) amounted to approximately $110,096,000 and $103,202,000 for the years ended September 30, 2016 and 2015, respectively. In connection with the Merger, the University transferred to UMass Memorial substantially all of the assets of the Clinical Services Division, except to the extent that the assets were shared by the University. With respect to such shared assets, the University and UMass Memorial have entered into a 99-year occupancy and shared services agreement (the “Occupancy Agreement”) under which the University has granted UMass Memorial the right to use such assets for the term of the agreement. UMass Memorial has agreed to maintain and be responsible for 50% of the capital costs under this agreement (Note 14). The Occupancy Agreement provides that if the University ceases operations as a medical school, UMass Memorial and the University will enter into a lease at the then fair value of the related space, adjusted to give effect to any improvements subsequent to the Merger and the debt assumed by UMass Memorial at the date of the Merger. UMass Memorial recorded its interest in the assets covered by the Occupancy Agreement utilizing the original cost and related accumulated depreciation, as reflected on the consolidated balance 30 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG sheets of the Clinical Services Division on the date of the Merger. The net book value of the assets covered by the Occupancy Agreement at the date of the Merger was approximately $56,000,000. On July 20, 2015, management executed a contract obligation for the purchase and implementation of a System-wide, fully integrated Electronic Medical Record (“EMR”) and billing system (Note 12). The implementation is expected to be completed during fiscal year 2017. As a result of the pending implementation, the estimated useful lives of certain Medical Center assets expected to be replaced by the EMR were adjusted to reflect the new system’s implementation date. As of September 30, 2015, the amount of depreciation incurred was $7,496,000. Certain other Medical Center ongoing projects were discontinued and expensed. For the years ended September 30, 2016 and 2015, the amount of discontinued and expensed projects was $1,524,000 and $1,644,000, respectively. (TXLW\0HWKRG,QYHVWPHQWV UMass Memorial and certain of its affiliates have investments in joint ventures accounted for under the equity method reported as other assets in the consolidated balance sheets. Amounts related to these investments were $77,102,000 and $63,228,000 for the years ended September 30, 2016 and 2015, respectively. Joint venture income (loss) associated with these investments is reported as other revenue in the consolidated statements of operations and amounted to $23,753,000 and $14,247,000, for the years ended September 30, 2016 and 2015, respectively. On January 3, 2013, certain assets and the operations of the clinical and anatomic laboratory outreach businesses owned by the Medical Center were sold to Quest Diagnostics. The sales agreements included a transitional period of 18-24 months to complete the full transition of service. The consideration received in conjunction with the sale was a combination of cash and an option to purchase an equity interest in a newly formed Quest Diagnostics subsidiary. Effective July 1, 2015, the Medical Center exercised its sales agreement option to purchase an equity interest in a Quest Diagnostics subsidiary. This transaction resulted in an 18.9% ownership in the subsidiary and a gain on the option exercise of $13,620,000, offset by a $325,000 adjustment to proceeds from sale related to Ventures. These two transactions combined resulted in a gain on sale of $13,295,000 in 2015. Expenses associated with the sale of this business were reduced by $873,000 in 2015. Of the total System joint venture investments, Quest Diagnostics amounts to $61,725,000 and $54,092,000 as of September 30, 2016 and 2015, respectively, and had joint venture income of $7,633,000 and $561,000 as of September 30, 2016 and 2015, respectively. The joint venture investments made distributions of $13,748,000 and $13,612,000 for the years September 30, 2016 and 2015, respectively. 31 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG 'HEW Debt consists of the following at September 30: ,QWHUHVW 5DWHDW 6HSWHPEHU )LQDO (in thousands of dollars) 0DWXULW\ Massachusetts Health and Educational Facilities Authority ("MHEFA") Revenue Bonds UMass Memorial, Series A $ - $ 33,275 UMass Memorial Variable Rate, Series B 1.75% 2023 11,200 12,500 UMass Memorial, Series D - 107,450 UMass Memorial Variable Rate, Series E 1.35% 2035 25,725 26,525 UMass Memorial Variable Rate, Series F 1.26% 2035 25,725 26,525 UMass Memorial, Series G 4.25%-5.0% 2022 32,770 37,595 Massachusetts Development Finance Agency ("MDFA") Revenue Bonds UMass Memorial, Series H 4.0%-5.5% 2031 67,855 74,145 UMass Memorial, Series I 4.0%-5.0% 2046 168,785 - Marlborough Hospital Variable Rate, Series A 2.47% 2034 7,973 8,217 Revolving loan 1.11% 2017 55,000 50,000 Master leases and subleases, and other notes payable 0%-5.26% 2017-2044 25,628 48,464 Capital lease obligations (Note 9) 573 872 Total debt 421,234 425,568 Add: Net unamortized original issue premium 26,100 1,179 Less: Debt issuance costs (5,296) (4,633) Less: Current portion (79,380) (87,698) Debt, net of current portion $ 362,658 $ 334,416 5HYHQXH%RQGVDQG1RWHV3D\DEOH UMass Memorial and certain of its affiliates are obligated under various MDFA revenue bonds and notes payable covered by a Master Trust Indenture (“MTI”). The MTI, dated as of December 1, 1998 and subsequently supplemented, includes UMass Memorial and other Members of the Obligated Group. The Master Trustee defines the terms and conditions upon which Obligations will be issued, authenticated, delivered and accepted as well as setting forth certain economic covenants. Under the terms of the loan agreements, the obligations are collateralized by property and equipment and gross receipts, as defined. The terms of the mortgage and trust agreements also require the establishment of certain reserve funds that are held by trustees (Note 5). The bonds require periodic interest and principal payments to these funds held in trust that are proportionate to the annual interest and principal payments or sinking fund installments. The revenue bonds are generally redeemable prior to maturity at premiums ranging up to 4%. ,VVXDQFHRI'HEW UMass Memorial, Series E – These bonds were issued in 2009 directly to a financial institution with an initial tender date of May, 2012. In January 2012, the Obligated Group (Note 2) entered into an agreement with the same financial institution to remarket these bonds under a new Index Floating Rate Mode effective through April, 2015. On April 1, 2015, UMass Memorial and the financial institution refinanced with a five year mandatory purchase date of April 1, 2020. The principal amortization schedule remains as it had existed before and the interest rate is variable. UMass 32 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Memorial entered into a new Continuing Covenant Agreement (“CCA”) with the financial institution with economic covenants that are similar to the MTI. UMass Memorial, Series F – These bonds were issued in 2009 directly to a financial institution with an initial tender date of May, 2014. UMass Memorial also entered into a CCA with the financial institution at the time the bonds were originally issued. The CCA included covenants related to debt service coverage, days cash on hand and maintaining certain investment credit ratings. In February 2014, the Obligated Group entered into an agreement with the same financial institution to extend the tender date to May 2016. In addition, the CCA was amended to redefine the calculation for debt service coverage and the credit rating covenant. On May 21, 2015, UMass Memorial and the same financial institution amended the Series F loan agreement to extend the mandatory purchase date to May 22, 2018; the amendment also provides for two additional one year extensions of the tender date (effectively to May 22, 2020) absent an event of default. The principal amortization schedule remains as it had existed before and the interest rate is variable. UMass Memorial and the financial institution also amended the CCA with economic covenants that are similar to the MTI and deleted the credit rating covenant. Quest Diagnostics – On July 1, 2015, the Medical Center exercised its option to purchase an 18.9% equity ownership in Quest Diagnostics. Upon exercising this option, and to retain its 18.9% ownership, an additional $11,849,000 capital contribution was incurred as a note payable to the newly formed joint venture subsidiary (Note 7). The interest rate was 0.45% and the note payable was paid in full on December 30, 2015. Marlborough Hospital Series A – In November 2014, Marlborough Hospital entered into an agreement with a commercial bank to amend its Series A bond payable to extend its initial tender date of November 24, 2014 to November 24, 2019. UMass Memorial, Series I – On February 2, 2016, the Obligated Group entered into an agreement with MDFA to issue MDFA Revenue Bonds, UMass Memorial Series I in the amount of $168,785,000. The proceeds from the sale will be used to reimburse capital costs of equipment used or to be used in connection with healthcare and related services and for various construction, improvement, renovation, and equipment acquisitions on behalf of the Obligated Group, refund all of MHEFA Revenue Bonds, UMass Memorial Issue, Series A (1998), MHEFA Revenue Bonds, UMass Memorial Issue, Series D (2005), and certain debt issuance costs. As a result of this transaction, the Obligated Group reported a loss on refunding of debt of $2,861,000. 7D[([HPSW)LQDQFH'HEW Subsequent to September 30, 2016, the Obligated Group entered into two agreements. In both agreements, the acquired equipment collateralizes the borrowings and the economic covenants are consistent to the existing CCA. 33 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Finance Lease – On December 7, 2016, the Obligated Group entered into a tax exempt finance lease agreement with MDFA and a bank. The proceeds received from the lease of $75,000,000, will be used to provide funding for the purchase and implementation of the EMR (Note 12). Principal payments begin twelve months after closing. Interest accrues at a fixed rate of 2.04% and is payable in 120 monthly installments. Annual principal payments for the next five years and thereafter are as follows at September 30, 2016: (in thousands of dollars) 2017 $ - 2018 5,737 2019 7,787 2020 7,948 2021 8,112 Thereafter 45,416 Total $ 75,000 Non-Bank Qualified Bonds – In addition to the finance lease, the Obligated Group entered into a variable rate direct purchase agreement with the same bank on December 7, 2016. Proceeds from the agreement, up to $50,000,000, are to be used to provide funding for the purchase and implementation of the EMR (Note 12). Principal payments begin twelve months after closing. Interest is based on 70% of the one month LIBOR rate plus an applicable margin rate. Interest payments will be at least 1.63% of the outstanding balance and payable in 156 monthly payments. 5HYROYLQJ/RDQ$JUHHPHQW On June 30, 2015, the Obligated Group entered into a $50,000,000 unsecured revolving loan agreement with a financial institution. The loan agreement expired June 29, 2016. There was no amount outstanding under this agreement at September 30, 2016. On June 29, 2016, the Obligated Group and the same financial institution amended the unsecured revolving loan agreement to increase the commitment from $50,000,000 to $75,000,000, to extend the agreement to June 28, 2017, and to modify certain aspects of the agreement regarding interest rates and certain required provisions. The interest rate is based on LIBOR plus 0.55%. The interest rate at the close of business on September 30, 2016 was 1.11%. The amount outstanding under this agreement at September 30, 2016 was $55,000,000. 'HEW&RYHQDQWV UMass Memorial and its affiliates’ debt agreements contain limitations on additional indebtedness, mergers, and other covenants, including required debt service coverage ratios. In addition, the Obligated Group is required to maintain a specified amount of cash and unrestricted investments. Several of the debt agreements limit the transfer of assets outside of the Obligated Group. Accordingly, the assets of an affiliate included in the consolidated financial statements may not be available to meet the obligations of other affiliates. 34 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG 3ULQFLSDO3D\PHQWVDQG6LQNLQJ)XQG5HTXLUHPHQWV Annual principal payments and sinking fund requirements on debt for the next five years and thereafter are as follows at September 30, 2016 (excluding the principal payments for tax exempt finance debt issued after September 30, 2016) : (in thousands of dollars) 2017 $ 78,223 2018 21,227 2019 20,416 2020 18,222 2021 18,381 Thereafter 264,765 Total debt $ 421,234 ,QWHUHVW3DLG Total interest paid during 2016 and 2015 was approximately $14,296,000 and $15,424,000, respectively. Interest capitalized as a component of the cost of assets constructed was approximately $2,320,000 and $1,146,000 in 2016 and 2015, respectively. /HDVHV UMass Memorial and its affiliates lease certain office and clinical equipment under leases with terms exceeding one year. Rent expense under operating leases was approximately $27,117,000 and $27,706,000 for the years ended September 30, 2016 and 2015, respectively. The following assets under capital leases are included in property and equipment (excluding assets covered under the Occupancy Agreement) at September 30: (in thousands of dollars) Property and equipment $ 18,934 $ 18,957 Less: Accumulated amortization 17,430 16,199 Net unamortized balance $ 1,504 $ 2,758 Amortization expense of assets recorded under capital leases of approximately $565,000 and $671,000 in 2016 and 2015, respectively, and is included in depreciation and amortization expense. 35 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Future minimum lease payments under noncancelable capital leases and operating leases consisted of the following at September 30, 2016: &DSLWDO 2SHUDWLQJ (in thousands of dollars) /HDVHV /HDVHV 2017 $ 269 $ 25,437 2018 177 24,276 2019 44 21,778 2020 44 20,216 2021 44 17,927 Thereafter 9 100,229 Total minimum lease payments 587$ 209,863 Less: Amounts representing interest 14 Present value of net minimum lease payments $ 573 Minimum payments have not been reduced by minimum sublease rentals of $1,938,000 due in the future under noncancelable subleases. 7HPSRUDULO\DQG3HUPDQHQWO\5HVWULFWHG1HW$VVHWV Temporarily restricted net assets, including accumulated net realized and unrealized gains on permanently restricted net assets that are available for Board appropriation in accordance with Massachusetts law, are available for the following purposes at September 30: (in thousands of dollars) Health care services $ 28,109 $ 26,434 Research 8,782 8,951 Medical education 3,047 3,027 Charity care 2,178 2,358 Buildings and equipment 1,064 1,767 $ 43,180 $ 42,537 36 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Permanently restricted net assets are restricted for the following at September 30: (in thousands of dollars) Investments to be held in perpetuity, the income from which is expendable to support health care services or other purposes designated by the donor $ 47,010 $ 46,378 Beneficial interest in trusts 7,719 7,991 $ 54,729 $ 54,369 3OHGJHV Pledges consist of unconditional promises to give in the future. Pledges are reported at their present value, net of allowances and discounts, at discount rates ranging from 0.59% to 1.14% and 0.37% to 2.06% at September 30, 2016 and 2015, respectively. At September 30, 2016 and 2015, pledges are expected to be received according to the following schedule: (in thousands of dollars) In one year or less $ 275 $ 461 Between one year and five years 96 203 Total 371 664 Less: Discount to present value (8) (33) Less: Allowance for doubtful pledges (31) (69) Pledges receivable, net $ 332 $ 562 (QGRZPHQW The System’s endowment consists of approximately 118 individual funds established for a variety of purposes. Net assets associated with endowment funds are classified and reported based on the existence or absence of donor-imposed restrictions. The System has interpreted UPMIFA as requiring the preservation of the original gift as of the gift date absent explicit donor stipulations to the contrary. As a result, the System classifies as permanently restricted net assets, (a) the original value of gifts donated to the permanent endowment, (b) the original value of subsequent gifts to the permanent endowment and (c) 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 Board of Trustees in a manner consistent with the standard of prudence prescribed by Massachusetts UPMIFA. In accordance with Massachusetts UPMIFA, the System and the Board of Trustees considers the following factors in making a determination to appropriate or accumulate endowment funds: The duration and preservation of the fund The purposes of the System and the donor restricted endowment fund 37 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG General economic conditions The possible effect of inflation and deflation The expected total return from income and the appreciation of investments Other resources of the System The investment policies of the System. Endowment net asset composition by fund as of September 30 is as follows: 6HSWHPEHU (in thousands of dollars) 7HPSRUDULO\ 3HUPDQHQWO\ 5HVWULFWHG 5HVWULFWHG 7RWDO Donor restricted endowment funds Income restricted $ 10,641 $ 28,217 $ 38,858 Income unrestricted 13,542 26,512 40,054 $ 24,183 $ 54,729 $ 78,912 6HSWHPEHU (in thousands of dollars) 7HPSRUDULO\ 3HUPDQHQWO\ 5HVWULFWHG 5HVWULFWHG 7RWDO Donor restricted endowment funds Income restricted $ 6,852 $ 25,890 $ 32,742 Income unrestricted 12,787 28,479 41,266 $ 19,639 $ 54,369 $ 74,008 38 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Changes in endowment net assets for the year ended September 30 are as follows: 6HSWHPEHU (in thousands of dollars) 7HPSRUDULO\ 3HUPDQHQWO\ 5HVWULFWHG 5HVWULFWHG 7RWDO Endowment net assets, beginning of year $ 19,639 $ 54,369 $ 74,008 Investment return Investment and other related income 666 - 666 Net appreciation (realized and unrealized) 1,407 - 1,407 Net investment return 2,073 - 2,073 Transfer into endowment 3,640 - 3,640 Gifts - 50 50 Appropriation of endowment assets for expenditure (1,169) - (1,169) Change in beneficial interest in trusts and other - 310 310 Endowment net assets, end of year $ 24,183 $ 54,729 $ 78,912 6HSWHPEHU (in thousands of dollars) 7HPSRUDULO\ 3HUPDQHQWO\ 5HVWULFWHG 5HVWULFWHG 7RWDO Endowment net assets, beginning of year $ 21,451 $ 52,134 $ 73,585 Investment return Investment and other related income 717 - 717 Net depreciation (realized and unrealized) (1,690) - (1,690) Net investment return (973) - (973) Gifts - 2,879 2,879 Appropriation of endowment assets for expenditure (839) - (839) Change in beneficial interest in trusts and other - (644) (644) Endowment net assets, end of year $ 19,639 $ 54,369 $ 74,008 The primary long-term management objective for the System’s endowment funds is to maintain the permanent nature of each endowment fund, while providing a predictable, stable, and constant stream of earnings. Consistent with that objective, the primary investment goal is to earn an average annual return equal to or greater than an assumed 5% annual spending policy rate for the endowment funds plus the rate of inflation, net of all fees, including investment management and related fees and expenses, over the long-term. The endowment funds are invested in the Partnership to diversify exposure and minimize risk consistent with System investment policy. 39 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG %HQHILW3ODQV UMass Memorial and its affiliates sponsor several noncontributory defined contribution plans and defined benefit pension plans covering substantially all employees who have met age and service requirements. 'HILQHG&RQWULEXWLRQ5HWLUHPHQW3ODQV UMass Memorial and its affiliates make annual contributions to their defined contribution plans based on specific percentages of annual compensation and/or employee contributions. Pension expense related to these defined contribution plans was approximately $26,666,000 and $25,162,000 for the years ended September 30, 2016 and 2015, respectively. 'HILQHG%HQHILW5HWLUHPHQW3ODQV The benefits under the defined benefit plans are based primarily on years of service and employees’ compensation. The funding policy is to make contributions to the plans at least equal to the minimum amount required by law. Plan assets consist principally of mutual funds, bonds and notes and common stock. In addition, UMass Memorial and its affiliates sponsor certain postretirement medical plans. )XQGHG6WDWXV The funded status of UMass Memorial and affiliates plans are recognized as liabilities. Unrecognized actuarial losses and prior service costs previously recorded as charges to net assets are “recycled” out of net assets as components of net periodic credit. The amounts in unrestricted net assets as of September 30, 2016 and 2015 that are not yet recognized as a component of net periodic credit are as follows: 6HSWHPEHU 3RVWUHWLUHPHQW (in thousands of dollars) 3HQVLRQ %HQHILWV 7RWDO Net prior service credit $ 58,662 $ - $ 58,662 Net actuarial loss (442,870) (9,030) (451,900) 6HSWHPEHU 3RVWUHWLUHPHQW (in thousands of dollars) 3HQVLRQ %HQHILWV 7RWDO Net prior service credit $ 66,177 $ - $ 66,177 Net actuarial loss (361,148) (4,458) (365,606) 40 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Changes in plan assets and benefit obligations recognized in unrestricted net assets during 2016 and 2015 include: (in thousands of dollars) Current year actuarial net loss $ (107,284) $ (71,131) Amortization of prior actuarial net loss 20,990 21,325 Amortization of prior service credit (7,515) (7,512) $ (93,809) $ (57,318) The amounts in unrestricted net assets as of September 30, 2016 that are expected to be recognized as a component of net periodic credit during fiscal 2017 are as follows: 3RVWUHWLUHPHQW (in thousands of dollars) 3HQVLRQ %HQHILWV 7RWDO Net prior service credit $ (7,519) $ - $ (7,519) Net actuarial loss 26,351 501 26,852 The following tables provide a reconciliation of benefit obligations, plan assets and the funded status of UMass Memorial and its affiliates’ defined benefit plans and the related amounts that are recognized in the accompanying consolidated balance sheets at September 30: 3HQVLRQ%HQHILWV (in thousands of dollars) Accumulated benefit obligation $ 1,108,974 $ 932,632 Change in projected benefit obligation Projected benefit obligation $ 917,143 $ 873,106 Service cost 41,888 40,391 Interest cost 42,618 38,301 Actuarial loss 117,849 14,719 Benefits paid (43,046) (47,110) Expenses paid (3,774) (2,264) Projected benefit obligation $ 1,072,678 $ 917,143 Change in plan assets Fair value of plan assets 746,324 699,856 Actual return on plan assets 67,537 (11,573) Employer contributions 59,070 107,415 Benefits paid (43,046) (47,110) Expenses paid (3,774) (2,264) Fair value of plan assets 826,111 746,324 Underfunded status, end of year $ 246,567 $ 170,819 41 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG The amounts recognized in the consolidated balance sheets for the defined benefit plans on a combined basis as of September 30 were as follows: (in thousands of dollars) Amounts recognized as liabilities in the consolidated balance sheet consist of the following Accounts payable and accrued expenses $ 630 $ 801 Accrued pension and postretirement obligations 245,937 170,018 $ 246,567 $ 170,819 UMass Memorial and its affiliates’ used the following assumptions in determining its September 30 projected benefit obligation amounts: Discount rate 3.47-3.69% 4.50-4.81% Rate of compensation increase 5.55-2.05% 5.95-2.45% (based on age and position classification) UMass Memorial updated the mortality table used to value annuities to reflect longer anticipated life expectancies. During 2015, the change in the mortality assumption increased the liability of the UMass Memorial Health Care Pension Plan by $28,800,000. The following is a summary of the allocation and target allocation of the plan assets by asset category for the benefit plans as of: 6HSWHPEHU $OORFDWLRQ 7DUJHW Mutual funds and common collective trusts 43 % 44 % Bonds and notes 22 % 26 % Common stocks 13 % 13 % Cash investments 9 % 0 % Private equity funds 8 % 12 % Hedge funds 5 % 5 % 6HSWHPEHU $OORFDWLRQ 7DUJHW Mutual funds and common collective trusts 44 % 40 % Bonds and notes 21 % 22 % Common stocks 14 % 20 % Hedge funds 11 % 5 % Cash investments 6 % 0 % Private equity funds 4 % 13 % 42 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG The following table presents the assets of the defined benefit plans as of September 30, 2016 and 2015, measured at fair value on a recurring basis using the fair value hierarchy described in Note 5. Included in the asset totals of $826,111,000 and $746,324,000 as of September 30, 2016 and 2015, were pending sales of $2,714,000 and $1,467,000 and purchases of $2,092,000 and $2,020,000, respectively: 6HSWHPEHU (in thousands of dollars) /HYHO /HYHO /HYHO 7RWDO Mutual funds and common collective trusts $ 204,170 $ 162,744 $ - $ 366,914 Bonds and notes 38,812 138,848 - 177,660 Common stocks 104,967 - - 104,967 Hedge funds - 19,869 19,224 39,093 Cash investments 72,060 - - 72,060 Private equity funds - - 65,417 65,417 Total investments at fair value $ 420,009 $ 321,461 $ 84,641 $ 826,111 6HSWHPEHU (in thousands of dollars) /HYHO /HYHO /HYHO 7RWDO Mutual funds and common collective trusts $ 175,442 $ 143,027 $ - $ 318,469 Bonds and notes 21,285 137,128 - 158,413 Common stocks 107,477 - - 107,477 Hedge funds - 48,164 33,582 81,746 Cash investments 46,986 - - 46,986 Private equity funds - - 33,233 33,233 Total investments at fair value $ 351,190 $ 328,319 $ 66,815 $ 746,324 43 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG The following table presents the activity for the year for all assets categorized as Level 3 for the years ended September 30, 2016 and 2015: 3ULYDWH (TXLW\ +HGJH 6HSWHPEHU (in thousands of dollars) )XQGV )XQGV )DLUYDOXH2FWREHU $ 33,233 $ 33,582 $ 66,815 Realized gains (losses) (3,947) 129 (3,818) Unrealized gains (losses) 2,456 (2,901) (445) Purchases 33,675 5,001 38,676 Sales - (16,587) (16,587) )DLUYDOXH6HSWHPEHU $ 65,417 $ 19,224 $ 84,641 3ULYDWH (TXLW\ +HGJH 6HSWHPEHU (in thousands of dollars) )XQGV )XQGV )DLUYDOXH2FWREHU $ 17,214 $ 37,215 $ 54,429 Realized gains (losses) (2,941) 6,246 3,305 Unrealized gains (losses) 1,252 (5,570) (4,318) Purchases 17,708 33,000 50,708 Sales - (37,309) (37,309) )DLUYDOXH6HSWHPEHU $ 33,233 $ 33,582 $ 66,815 UMass Memorial and its affiliates’ investment strategy is to utilize broadly diversified passive vehicles where appropriate, with an investment mix and risk profile consistent with pension liabilities. Periodic studies are undertaken to determine the asset mix that will meet pension obligations at a reasonable cost to UMass Memorial and which are consistent with the fiduciary requirements of pension regulations. In selecting the expected long-term rate of return on assets, UMass Memorial and its affiliates’ considered the average rate of earnings expected on the funds invested or to be invested to provide for the benefits of these plans. This included considering the trusts’ asset allocation and the expected returns likely to be earned over the life of the plan. This basis is consistent with the prior year. UMass Memorial and its affiliates expect to contribute approximately $1,841,000 to their defined benefit pension plans during the year ended September 30, 2017. 44 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG (VWLPDWHG)XWXUH%HQHILW3D\PHQWV The following benefit payments, which reflect expected future service, are expected to be paid during the period ended September 30: (in thousands of dollars) 2017 $ 57,296 2018 61,040 2019 66,008 2020 70,382 2021 74,863 2022 through 2026 410,782 The following are the components of net periodic cost for UMass Memorial and its affiliates’ defined benefit plans: (in thousands of dollars) Net periodic cost Service cost $ 41,888 $ 40,391 Interest cost 42,618 38,301 Expected return on plan assets (52,232) (47,474) Net amortization 12,297 13,436 Net periodic cost $ 44,571 $ 44,654 Assumptions used in determining net periodic cost of the defined benefit plans were: Discount rate 4.50-4.81% 4.27-4.47% Rate of compensation increase 5.95-2.44% 5.60-2.10% (based on age and position classification) Expected return on plan assets 7.00 % 7.00 % 80DVV0HPRULDO3RVWUHWLUHPHQW0HGLFDO%HQHILWV UMass Memorial and its affiliates provide postretirement medical benefits to certain of its employees. Benefits are funded from the general assets of the System on a current basis. Such plans pay a portion of health insurance costs for eligible participants. 45 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG Presented below is financial information related to the postretirement medical plans for the years ended September 30: 3RVWUHWLUHPHQW 0HGLFDO%HQHILWV (in thousands of dollars) Change in accumulated postretirement benefit obligation Accumulated postretirement benefit obligation $ 36,229 $ 37,273 Service cost 155 246 Interest cost 1,732 1,658 Actuarial loss (gain) 4,739 (2,636) Benefits paid (376) (312) Accumulated postretirement benefit obligation 42,479 36,229 Change in plan assets Employer contributions 376 312 Benefits paid (376) (312) Fair value of plan assets - - Underfunded status, end of year $ 42,479 $ 36,229 The amounts recognized in the consolidated balance sheets for the post-retirement benefit plans as of September 30 were as follows: (in thousands of dollars) Amounts recognized as liabilities in the consolidated balance sheet consist of the following Accounts payable and accrued expenses $ 425 $ 450 Accrued pension and postretirement obligations 42,054 35,779 $ 42,479 $ 36,229 UMass Memorial and its affiliates’ used the following assumptions in determining its September 30 projected benefit obligation amounts: Discount rate 3.69 % 4.81 % Current year health care cost trend rate 6.50 % 7.00 % Ultimate year health care cost trend rate 5.00 % 5.00 % UMass Memorial and its affiliates expect to contribute approximately $433,000 to its postretirement benefit plans during the year ended September 30, 2017. 46 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG (VWLPDWHG)XWXUH%HQHILW3D\PHQWV The following benefit payments related to the postretirement benefit plan are expected to be paid during the periods ended September 30: (in thousands of dollars) 2017 $ 459 2018 544 2019 666 2020 789 2021 915 2022 through 2026 6,327 (VWLPDWHG0HGLFDUH3DUW'6XEVLGLHV The following Medicare Part D subsidies related to the postretirement benefit plan are expected to be received during the periods ended September 30: (in thousands of dollars) 2017 $ 26 2018 29 2019 34 2020 40 2021 48 2022 through 2026 414 The assumed health care cost trend rate used in measuring the postretirement medical benefit obligation was 6.50% in 2016, declining gradually to 5.00% by 2019 and remaining level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement benefit plan. A one-percentage-point change in the assumed health care cost trend rates would have the following effects: 3HUFHQWDJH 3HUFHQWDJH 3RLQW 3RLQW (in thousands of dollars) ,QFUHDVH 'HFUHDVH Effect on total of service and interest cost $ 2,337 $ (1,538) Effect on postretirement benefit obligation 10,400 (7,980) 47 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG The following are the components of net periodic cost for UMass Memorial and its affiliates’ postretirement medical plan: (in thousands of dollars) Net periodic cost Service cost $ 155 $ 246 Interest cost 1,732 1,658 Net amortization 168 377 Net periodic cost $ 2,055 $ 2,281 Assumptions used in determining net periodic cost of the postretirement medical plan were: Discount rate 4.81 % 4.47 % Current year health care cost trend rate 6.50 % 7.00 % Ultimate year health care cost trend rate 5.00 % 5.00 % &RPPLWPHQWVDQG&RQWLQJHQFLHV 6HOI,QVXUDQFH CPAC is a wholly-owned captive insurance company incorporated and based in the Cayman Islands for the purpose of providing professional and general liability, workers’ compensation insurance and several other smaller lines of insurance or deductibles, including medical stop-loss insurance. Estimated malpractice costs, as calculated by CPAC’s consulting actuaries, consist of specific reserves to cover the estimated liability resulting from medical or general liability incidents, as well as potential claims which have been reported and a provision for claims incurred but not reported. Estimated malpractice liabilities are based on claims reported, historical experience and industry trends. These liabilities include estimates of future trends in loss severity and frequency and other factors that could vary as the claims are ultimately settled. Although it is not possible to measure the degree of variability inherent in such estimates, management believes the reserves for claims are adequate. These estimates are periodically reviewed and necessary adjustments are recorded in the year the need for such adjustments becomes known. Management is unaware of any claims that would cause the final expense for medical malpractice risks to vary materially from the amounts provided. CPAC estimates that the expected claims liabilities at September 30, 2016 and 2015, on an undiscounted basis, are approximately $154,000,000 and $171,000,000, respectively, assuming losses are limited to $5,000,000 for professional liability and $3,000,000 for general liability per individual claim, respectively. These amounts are then discounted at 2%, as of September 30, 2016 and 2015, over an estimated payout period of 12 years. 48 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG ([FHVV/LDELOLW\&RYHUDJH UMass Memorial and its affiliates have excess liability coverage of $50,000,000 for malpractice losses in excess of $5,000,000 per individual claim and for annual aggregate malpractice losses in excess of $60,000,000 on a claims-made basis. The existence of this reinsurance coverage does not relieve UMass Memorial and its affiliates of its primary obligation with respect to losses incurred. UMass Memorial and its affiliates would be liable for claims ceded to reinsurers in the event such reinsurers were unable to meet their obligations. UMass Memorial records the gross exposure of claim liabilities and a corresponding receivable for insurance recoveries when such circumstances are present. 6XUHW\%RQG UMass Memorial and its affiliates have surety bonds in the aggregate amount of $19,450,000 related to two workers’ compensation self-insurance programs. (OHFWURQLF0HGLFDO5HFRUGDQG%LOOLQJ6\VWHP On July 20, 2015, management executed a license and support agreement for the development, licensing and implementation of a System wide, fully integrated EMR and billing system. The implementation is expected to be completed during fiscal year 2017. The design and implementation costs are expected to be funded through ongoing operations, current financial resources and additional financing. The software license and implementation fees will be paid in sixty monthly installments of $463,000, which includes interest at the 1-month LIBOR plus 2%. In connection with the implementation, the estimated useful lives of assets expected to be replaced by the EMR, has been adjusted to reflect the new system’s implementation date. See Note 6 for further discussion on related property and equipment. 2WKHU&RQWLQJHQFLHV UMass Memorial and its affiliates are parties to various legal proceedings and potential claims arising in the ordinary course of business. In addition, the health care industry as a whole is subject to numerous laws and regulations of federal, state and local governments. Compliance with these laws and regulations can be subject to future government review and interpretation, as well as regulatory actions unknown or unasserted at the time. Recently, government activity has increased with respect to investigations and allegations concerning possible violations by health care providers of regulations. These could result in the imposition of significant fines and penalties, as well as significant repayments of previously billed and collected revenues from patient services. Management believes that the System and its affiliates are in compliance with current laws and regulations and does not believe that these matters will have a material adverse effect on its consolidated financial statements. Centers for Medicare and Medicaid Services (“CMS”) Notice of Disallowance/Request for Information - Following a 2009 audit report by the Office of Audit Services of the Office of Inspector General of the United States Health and Human Services (the “OIG”), under which the Commonwealth Medicaid Program returned approximately $1,500,000 in federal financial participation (“FFP”) to the CMS regarding supplemental Medicaid payments to the Medical Center from fiscal years 2000 through and including 2005, CMS informed the Commonwealth on February 7, 2011, of its intention to disallow $25,500,000 in FFP for the same supplemental payments made to UMass Memorial for a subset of the same time period (2000 through 2003). The stated reason for the disallowance was that the Commonwealth had not complied with the time limit for claiming payment for Medicaid expenditures. The Commonwealth filed a request for reconsideration of the disallowance. On April 13, 2012, CMS issued a letter to the Commonwealth affirming the disallowance except with respect to $8,100,000 for supplemental payments for fiscal year 2003 which CMS acknowledged were claimed timely. Management worked with the Commonwealth to 49 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG file an appeal to the Department of Health and Human Services Departmental Appeals Board (the “DAB”) on June 12, 2012. After the Commonwealth filed its brief with the DAB, CMS submitted its brief in May 2013 and asked the DAB to increase the disallowance of the federal share from $17,000,000 to $21,000,000 due to an earlier CMS calculation error. UMass Memorial intervened in the matter and contested the proposed increase in the disallowance. A hearing on the appeal was held on June 18, 2013. On September 30, 2013, the DAB issued its decision reversing the CMS disallowance of approximately $21,500,000 in FFP based on a finding that the claim for FFP had been timely and sustaining the disallowance of approximately $4,250,000 in FFP based on the OIG’s audit report finding that the relevant expenditures were not authorized by the Commonwealth plan. The Commonwealth Medicaid Agency has not recouped any funds from UMass Memorial as a result of the disallowance or, as noted above, for the prior return of funds related to the OIG audit report, although it is expected that such a recoupment will be asserted. The Medical Center has sufficient reserves to reimburse the Commonwealth for the amount sustained by the decision. Wrongful Termination Suit – A former executive of a pharmacy joint venture between Ventures and Shields Health Solutions, LLC (“Shields”) filed suit in Massachusetts Federal District Court on April 1, 2016. The suit was filed against a number of parties, including two limited liability companies: UMass Memorial Shields Pharmacy, LLC and Shields Specialty Pharmacy Holdings, LLC. The case is a wrongful termination action seeking damages for lost wages and equity. The case is in the initial pleadings phase. Although there can be no assurance as to the outcome of this matter, management does not believe it will have a material adverse effect on its consolidated financial statements. &RQFHQWUDWLRQRI&UHGLW5LVN Financial instruments that potentially subject UMass Memorial and its affiliates to concentrations of credit risk are patient and other accounts receivable, cash equivalents and investments. UMass Memorial and its affiliates generally invest available cash in certificates of deposit and repurchase agreements with various banks, commercial paper of domestic companies with high credit ratings and securities backed by the United States government. UMass Memorial and its affiliates grant credit without collateral to their patients, many of whom are local residents and are insured under third-party payer agreements. Net patient accounts receivable consist of the following at September 30: Commercial insurance and HMOs 40 % 40 % Medicaid 21 % 21 % Patients 17 % 18 % Medicare 16 % 16 % Other 6 % 5 % 100 % 100 % 50 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG 7UDQVDFWLRQVZLWKWKH8QLYHUVLW\ In connection with the Merger discussed in Note 1, UMass Memorial entered into several agreements with the University (the “Definitive Agreement”), including: The Obligated Group was granted the right to occupy certain portions of the University’s Worcester, Massachusetts campus (the “Occupancy and Shared Services Agreement”). The University and the Medical Center agreed to share responsibility for various capital and operating expenses related to the occupied premises (Note 6). UMass Memorial and its affiliates agreed to make certain payments to the University including: (1) an annual fee of $12,000,000 (plus an inflation adjustment), which totaled approximately $18,688,000 and $18,661,000 for the years ended September 30, 2016 and 2015, respectively, so long as the University continues to operate a medical school with substantial numbers of students and amounts of research funding, and (2) a percent of the net combined operating income of UMass Memorial and its affiliates (with certain exceptions) based on an agreed-upon formula (“Participation Payment”, the participation payment may be adjusted under certain conditions if the University’s ongoing programs and research activities substantially decrease). UMass Memorial incurred expense of approximately $2,043,000 and $3,841,000 for the years ended September 30, 2016 and 2015, respectively, pursuant to the agreed-upon formula. The System contracts University employees for medical residency, physician and other services. The cost of these contracted employees is reported as salaries, benefits and contracted labor in the accompanying consolidated financial statements. Total payroll expense related to these employees for the years ended September 30, 2016 and 2015 was $68,792,000 and $65,424,000, respectively. The cost incurred for fringe benefits related to these employees for the years ended September 30, 2016 and 2015 was approximately $13,946,000 and $13,575,000, respectively. Subsequent to the Merger, the University and UMass Memorial agreed to amend certain aspects of the Definitive Agreement as follows: The Medical Center agreed to segregate a portion of its unrestricted net assets, totaling approximately $15,500,000 at September 30, 2001, to be designated as Department Education Funds (the “Ed Funds”). During 2002, the Medical Center transferred the balance of the Ed Funds to the Medical Group and the Medical Group segregated these funds within its unrestricted net assets. The balance of the Ed Funds at September 30, 2016 is approximately $42,000,000. These funds have been frozen, until such time as the Chancellor of the University (the “Chancellor”) and the Chief Executive Officer of UMass Memorial (the “CEO”) mutually agree to release any and all of these funds. In September of 2011, the Medical Group established Academic Investment Funds (the “AIF”) at the University. The Medical Group has transferred $4,400,000 and $6,600,000 in 2016 and 2015, respectively, to the AIF. UMass Memorial has also committed to fund $4,575,000 to the AIF. These amounts have been recorded as expense in the accompanying consolidated statements of operations. In fiscal year 2017, the Medical Group anticipates funding the AIF by approximately $6,600,000. The use of the AIF is controlled jointly by the Chancellor and the CEO. In addition, the Chancellor and the CEO jointly approve the annual operating budgets of each clinical department in the Medical Group. 51 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG The following significant transactions with the University have been recorded in income from operations: 3XUFKDVHG6HUYLFHV The Obligated Group reimburse and are reimbursed by the University for certain common services purchased and provided. The net services purchased by the Obligated Group amounted to $20,340,000 and $20,397,000 for 2016 and 2015, respectively. 5HQWDQGUHODWHGH[SHQVHV The Obligated Group has a 99-year office building lease through 2097 with the University, which requires UMass Memorial and affiliates to make annual rental payments (Note 9). In addition to the rental component, the agreement requires the UMass Memorial and affiliates to pay certain expenses related to the leased building. UMass Memorial also has three building leases with the University’s WCCC. During the years ended September 30, 2016 and 2015, expenses paid by the UMass Memorial to the WCCC amounted to approximately $8,791,000 and $8,675,000, respectively. 0HGLFDO(GXFDWLRQ6HUYLFHV As part of the academic affiliation between the University and the Medical Center and pursuant to the enabling legislation creating UMass Memorial, the University is the exclusive academic and medical teaching affiliate of the Medical Center. In connection with this affiliation, the Medical Center and other UMass Memorial affiliates compensate the University for the costs of teaching and education services and support the University contributes to the delivery of medical care by the Medical Center and other UMass Memorial affiliates. The cost of these services was approximately $152,483,000 and $128,074,000 for 2016 and 2015, respectively. The cost for these services is recorded as supplies and other expense. Certain of the amounts due to and from the University are subject to settlement between the System and the University. Management has recorded its best estimate of the amounts due to and from the University. Differences between current estimates of such assets and liabilities and final settlements are included in operations in the year in which the settlement or change in estimate occurs. Management does not expect such differences to be material to the consolidated balance sheets, results of operations, or cash flows of the System. 'XHWRWKH8QLYHUVLW\ The amounts due to the University at September 30 consisted of the following: (in thousands of dollars) Medical education services and participation payment $ 87,768 $ 146,229 Accrued compensation and benefits 36,096 11,162 Accounts payable - net of accounts receivable 19,366 7,252 Other 1,317 1,577 Total due to the University, net $ 144,547 $ 166,220 52 APPENDIX B 80DVV0HPRULDO+HDOWK&DUH,QFDQG$IILOLDWHV 1RWHVWR&RQVROLGDWHG)LQDQFLDO6WDWHPHQWV 6HSWHPEHUDQG )XQFWLRQDO([SHQVHV UMass Memorial and its affiliates provide general health care services to residents within its geographic location. Expenses related to providing these services are as follows for the years ended September 30: (in thousands of dollars) Health care services $ 1,901,611 $ 1,802,980 General and administrative 431,147 380,692 $ 2,332,758 $ 2,183,672 6XEVHTXHQW(YHQWV The System recognizes in the consolidated financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the consolidated balance sheets. The System does not recognize subsequent events that provide evidence about conditions that did not exist at the date of the consolidated balance sheets but arose after the consolidated balance sheets date but before the consolidated financial statements are issued. For these purposes, UMass Memorial has evaluated events occurring subsequent to the consolidated balance sheets date through December 16, 2016, the date the consolidated financial statements were issued. Other than the tax exempt finance debt disclosed in Note 8, there are no other subsequent events that required recognition or disclosure in the consolidated financial statements. 53 APPENDIX B