Financial Statement Analysis

Ernst & Young LLP

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

Northwestern Memorial HealthCare and Subsidiaries Years Ended August 31, 2018 and 2017 With Report of Independent Auditors

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Northwestern Memorial HealthCare and Subsidiaries

Consolidated Financial Statements

Years Ended August 31, 2018 and 2017

Contents

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

Consolidated Financial Statements

Consolidated Balance Sheets ……………………………………………………………………………………………..3 Consolidated Statements of Operations and Changes in Net Assets ………………………………………..5 Consolidated Statements of Cash Flows ………………………………………………………………………………7 Notes to Consolidated Financial Statements …………………………………………………………………………8

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Report of Independent Auditors

The Board of Directors Northwestern Memorial HealthCare

We have audited the accompanying consolidated financial statements of Northwestern Memorial HealthCare and Subsidiaries which comprise the consolidated balance sheets as of August 31, 2018 and 2017, and the related consolidated statements of operations and changes in net assets and cash flows for the years then ended, and the related notes to the consolidated financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in conformity with U.S. generally accepted accounting principles; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free of material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

A member firm of Ernst & Young Global Limited

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Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Northwestern Memorial HealthCare and Subsidiaries at August 31, 2018 and 2017, and the consolidated results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

 November 30, 2018

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Northwestern Memorial HealthCare and Subsidiaries

Consolidated Balance Sheets (In Thousands)

August 31 2018 2017 Assets Current assets:

Cash and cash equivalents $ 407,249 $ 258,463 Short-term investments 51,998 30,685 Current portion of investments, including assets limited as

to use 148,848 136,352 Patient accounts receivable, net of estimated allowances for

uncollectible accounts of $252,353 at August 31, 2018 and $223,411 at August 31, 2017 769,567 716,277

Current portion of pledges and grants receivable, net 16,107 24,561 Current portion of insurance recoverable 12,642 14,186 Inventories 71,565 64,443 Other current assets 131,284 154,752

Total current assets 1,609,260 1,399,719 Investments, including assets limited as to use, less current portion 5,980,955 5,490,526 Property and equipment, at cost:

Land 353,975 347,036 Buildings 3,970,145 3,465,273 Equipment and furniture 1,353,766 1,166,884 Construction in progress 126,535 539,340

5,804,421 5,518,533 Less accumulated depreciation 2,221,667 2,059,946 3,582,754 3,458,587 Prepaid pension cost 180,063 118,562 Pledges and grants receivable, less current portion 44,856 35,770 Insurance recoverable, less current portion 89,224 69,706 Other assets, net 175,739 153,452 Total assets $ 11,662,851 $ 10,726,322

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August 31 2018 2017 Liabilities and net assets Current liabilities:

Accounts payable $ 239,682 $ 230,588 Accrued salaries and benefits 285,043 314,163 Grants and academic support payable, current portion 33,932 38,753 Accrued expenses and other current liabilities 130,799 115,254 Due to third-party payors 545,759 434,965 Current accrued liabilities under self-insurance programs 105,659 94,256 Current maturities of long-term debt 24,571 30,239 Short-term debt 27,466 87,299

Total current liabilities 1,392,911 1,345,517 Long-term debt, less current maturities 1,394,396 1,324,776 Accrued liabilities under self-insurance programs, less

current portion 541,589 495,709 Grants and academic support payable, less current portion 76,954 79,469 Interest rate swaps 73,350 112,586 Other liabilities 150,502 143,428 Total liabilities 3,629,702 3,501,485 Net assets:

Unrestricted: Undesignated 7,364,425 6,602,984 Board-designated 242,870 229,455 Non-controlling interest in consolidated venture 626 (3,599)

Total unrestricted 7,607,921 6,828,840 Temporarily restricted 242,596 220,917 Permanently restricted 182,632 175,080 Total net assets 8,033,149 7,224,837 Total liabilities and net assets $ 11,662,851 $ 10,726,322

See accompanying notes to the consolidated financial statements.

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Northwestern Memorial HealthCare and Subsidiaries

Consolidated Statements of Operations and Changes in Net Assets (In Thousands)

Year Ended August 31 2018 2017 Revenue Net patient service revenue $ 5,053,132 $ 4,749,433 Provision for uncollectible accounts 175,516 202,047 Net patient service revenue after provision for uncollectible

accounts 4,877,616 4,547,386 Rental and other revenue 313,757 256,362 Net assets released from donor restrictions and federal and state 35,290 27,248 Total revenue 5,226,663 4,830,996 Expenses Salaries 2,126,172 1,969,531 Employee benefits 317,874 297,842 Supplies 1,000,194 877,030 Purchased services 552,525 538,642 Depreciation and amortization 310,948 287,149 Insurance 112,834 104,578 Rent and utilities 100,814 91,307 Repairs and maintenance 101,960 88,331 Interest 41,027 44,106 Illinois Hospital Assessment 110,339 103,362 Other 180,926 127,949 Total expenses 4,955,613 4,529,827 Operating income 271,050 301,169 Nonoperating gains (losses) Investment return 490,971 655,269 Change in fair value of interest rate swaps 31,353 37,521 Loss on extinguishment of long term debt (23,990) (216) Grants and academic support provided (34,307) (20,172) Other 9,846 9,291 Total nonoperating gains, net 473,873 681,693 Excess of revenue over expenses 744,923 982,862 Net gain (loss) attributable to non-controlling interest

in subsidiaries 775 (703) Excess of revenue over expenses attributable to NMHC

and Subsidiaries $ 744,148 $ 983,565

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Northwestern Memorial HealthCare and Subsidiaries

Consolidated Statements of Operations and Changes in Net Assets (continued) (In Thousands)

Year Ended August 31 2018 2017

Total Controlling Non-

controlling Total Controlling Non-

controlling Unrestricted net assets Excess (deficiency) of revenue over expenses $ 744,923 $ 744,148 $ 775 $ 982,862 $ 983,565 $ (703) Net assets released from restrictions used for

property and equipment 7,672 7,672 – 6,279 6,279 – Postretirement-benefit-related changes other than

net periodic 33,863 33,863 – 64,884 64,884 – Distribution to non-controlling interest (1,243) – (1,243) (785) – (785) Other (6,134) (10,827) 4,693 (313) (446) 133 Increase (decrease) in unrestricted net assets 779,081 774,856 4,225 1,052,927 1,054,282 (1,355) Temporarily restricted net assets Contributions 49,373 49,373 – 44,892 44,892 – Investment return 15,389 15,389 – 14,051 14,051 – Net assets released from restrictions used for:

Operating expenses, charity care, research and education (32,208) (32,208) – (34,859) (34,859) –

Property and equipment additions (7,672) (7,672) – (6,279) (6,279) – Change in fair value of split-interest agreements 411 411 – 147 147 – Other (3,614) (3,614) – (8,804) (8,804) – Increase in temporarily restricted net assets 21,679 21,679 – 9,148 9,148 – Permanently restricted net assets Contributions 6,403 6,403 – 5,609 5,609 – Change in fair value of split-interest agreements 525 525 – 775 775 – Other 624 624 – 6,785 6,785 – Increase in permanently restricted net assets 7,552 7,552 – 13,169 13,169 – Change in net assets 808,312 804,087 4,225 1,075,244 1,076,599 (1,355) Net assets, beginning of period 7,224,837 7,228,436 (3,599) 6,149,593 6,151,837 (2,244) Net assets, end of period $ 8,033,149 $ 8,032,523 $ 626 $ 7,224,837 $ 7,228,436 $ (3,599)

See accompanying notes to consolidated financial statements.

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Northwestern Memorial HealthCare and Subsidiaries

Consolidated Statements of Cash Flows (In Thousands)

Year Ended August 31 2018 2017 Operating activities Change in net assets $ 808,312 $ 1,075,244 Adjustments to reconcile change in net assets to net cash provided by

operating activities: Postretirement benefit-related changes other than net periodic

pension cost (33,863) (64,884) Change in fair value of interest rate swaps (31,353) (37,521) Loss on extinguishment of long-term debt 23,990 216 Net unrestricted realized investment return and net change in

unrestricted and restricted unrealized investment gains/losses (492,730) (657,573) Restricted contributions, change in fair value of split interest

agreements, and realized investment return (70,342) (63,170) Depreciation and amortization 310,948 287,149 Provision for uncollectible accounts 175,516 202,047 Changes in operating assets and liabilities:

Patient accounts receivable (228,806) (318,552) Due to third-party payors 115,152 29,161 Grants and academic support payable (7,336) (31,468) Other operating assets and liabilities (58,669) (38,764)

Net cash provided by operating activities 510,819 381,885 Investing activities Purchase of investments (2,028,729) (2,501,222) Sale of investments 1,791,936 2,456,759 Net unrestricted realized investment return 205,285 194,902 Capital expenditures, net (432,084) (512,804) Net cash used in investing activities (463,592) (362,365) Financing activities Proceeds from line of credit – 45,000 Proceeds from commercial paper – 87,299 Proceeds from issuance of long-term debt 790,240 – Payments of commercial paper (59,833) – Payments of line of credit – (104,750) Payments of long-term debt (699,190) (69,939) Restricted contributions, change in fair value of split interest agreements,

and realized investment return 70,342 63,170 Net cash provided by financing activities 101,559 20,780 Net increase in cash and cash equivalents 148,786 40,300 Cash and cash equivalents, beginning of period 258,463 218,163 Cash and cash equivalents, end of the period $ 407,249 $ 258,463

See accompanying notes to consolidated financial statements.

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Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (In Thousands)

August 31, 2018

1. Organization and Summary of Significant Accounting Policies

Northwestern Memorial HealthCare (NMHC) is the parent of an integrated nonprofit health care organization, anchored by Northwestern Memorial Hospital (NMH) and Northwestern Medical Group (NMG), that provides health care services to communities in northern Illinois. NMHC partners with Northwestern University’s Feinberg School of Medicine (FSM) to form an academic medical center, branded as Northwestern Medicine, that is shaping the future of medicine through outstanding patient care, research and training of resident physicians.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of NMHC and its subsidiaries (collectively referred to herein as Northwestern Memorial). All significant intercompany transactions and balances have been eliminated in consolidation.

Charity Care and Community Benefit

Northwestern Memorial provides care to patients regardless of their ability to pay. Northwestern Memorial developed a Free and Discounted Care Policy (the Policy) for both the uninsured and the underinsured. Under the Policy, patients are offered discounts of up to 100% of charges on a sliding scale, which is based on income as a percentage of the federal poverty level guidelines (up to 600%). The Policy also contains provisions that are responsive to those patients subject to catastrophic health care expenses and uninsured patients not covered by the provisions above. Since Northwestern Memorial does not pursue collection of these amounts, they are not reported as Net patient service revenue, and the cost of providing such care is recognized within operating expenses.

Northwestern Memorial estimates the direct and indirect costs of providing charity care by applying a cost to gross charges ratio to the gross uncompensated charges associated with providing charity care to patients. The cost of providing charity care was $67,146 and $61,258 for the years ended August 31, 2018 and 2017, respectively. Northwestern Memorial also received certain funds of $392 and $342 for the years ended August 31, 2018 and 2017, respectively, to offset or subsidize charity care services provided. These funds are primarily received from investment return on free care endowment funds. In the Annual Non Profit Hospital Community Benefits Plan Report filed with the Illinois Attorney General for the year ended August 31, 2017, Northwestern Memorial reported total community benefit of $831,862 (unaudited), including unreimbursed cost of charity care of $65,761 (unaudited), which is calculated using a different

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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1. Organization and Summary of Significant Accounting Policies (continued)

methodology than that used for the consolidated financial statements. Management is currently collecting the information needed to file the 2018 report; however, it does not expect a material change from prior year.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents include highly liquid short-term investments with maturities of 90 days or less from the date of purchase.

Patient Accounts Receivable

Patient accounts receivable are stated at net realizable value. Northwestern Memorial maintains allowances for uncollectible accounts and for estimated losses resulting from a payor’s inability to make payments on accounts. Northwestern Memorial estimates the allowance for uncollectible accounts based on management’s assessment of historical and expected net collections, considering historical and current business and economic conditions, trends in health care coverage, and other collection indicators. Patient accounts receivable are charged to the provision for uncollectible accounts when they are deemed uncollectible.

Assets Limited as to Use

Assets limited as to use consist primarily of investments designated for certain medical education and health care programs. The particular Northwestern Memorial corporation that controls these investments makes such designations and may, at its discretion, subsequently use them for other purposes. In addition, assets limited as to use include investments held by trustees under debt agreements and for self-insurance and collateral related to interest rate swaps.

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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1. Organization and Summary of Significant Accounting Policies (continued)

Investments

Investments in equity securities with readily determinable fair values and all investments in debt securities are reported at fair value based on quoted market prices. Unless in pension plan assets, alternative investments are reported using the equity method. Alternative investments can include common collective trusts, commingled funds, 103-12 entities and other limited partnership interests in hedge funds, private equity, venture capital and real estate funds. Alternative investments in the pension plan are reported at fair value based on net asset value (NAV) per share or equivalent.

Derivative Instruments

Derivative instruments, specifically interest rate swaps, are recorded in the accompanying consolidated balance sheets at fair value. The change in the fair value of derivative instruments is recorded in Nonoperating gains (losses).

Inventories

Inventories, consisting primarily of pharmaceuticals and other medical supplies, are stated at the lower of cost on the first-in, first-out method or fair value.

Property and Equipment

Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets. Generally, buildings and building service equipment have a composite life of approximately 40 years and equipment and furniture have useful lives of 3-20 years. Interest incurred on borrowed funds during the period of construction of capital assets is capitalized as a component of the cost of acquiring those assets.

Other Intangible Assets

Intangible assets are stated at fair value at time of purchase and are amortized using the straight line method over the estimated life based on terms of the underlying agreement giving rise to the intangible.

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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1. Organization and Summary of Significant Accounting Policies (continued)

Asset Impairment

Northwestern Memorial considers whether indicators of impairment are present and performs the necessary tests to determine if the carrying value of an asset is appropriate. Impairment write downs are recognized in operating income at the time the impairment is identified. There were no impairments of long-lived assets in 2018 or 2017.

Deferred Charges

Deferred finance charges and bond discounts or premiums are amortized or accreted using the effective interest method or the bonds outstanding method, which approximates the effective interest method, over the life of the related debt.

Net Assets

Resources are classified for reporting purposes as unrestricted, temporarily restricted and permanently restricted, according to the absence or existence of donor-imposed restrictions. In addition unrestricted net assets are further classified as general unrestricted or board-designated unrestricted. Board-designated net assets are unrestricted net assets that have been set aside by the Board for specific purposes. Temporarily restricted net assets are those assets, including contributions and accumulated investment returns, whose use has been limited by donors for a specific purpose or time period. Permanently restricted net assets are those for which donors require the principal of the gifts to be maintained in perpetuity to provide a permanent source of income.

Any changes in donor restrictions that change the net asset category of previously recorded contributions are recorded as Other in the accompanying consolidated statements of operations and changes in net assets in the period communicated by the donor.

Net Patient Service Revenue

Northwestern Memorial has agreements with third-party payors that provide for payments to Northwestern Memorial at amounts different from its established rates. Payment arrangements include prospectively determined rates per admission or visit, reimbursed costs, discounted charges and per diem rates. Net patient service revenue is reported at the estimated net amount due

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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1. Organization and Summary of Significant Accounting Policies (continued)

from patients and third-party payors for services rendered, including estimated adjustments under reimbursement agreements with third-party payors, certain of which are subject to audit by administering agencies. These adjustments are accrued on an estimated basis and are adjusted, as needed, in future periods.

Contributions

Unrestricted gifts, other than long-lived assets, are included within other in Nonoperating gains (losses) in the accompanying consolidated statements of operations and changes in net assets. Unrestricted gifts of long-lived assets, such as land, buildings or equipment, are recorded at fair value as an increase in unrestricted net assets. Contributions are reported as either temporarily or permanently restricted net assets if they are received with donor restrictions. When a donor restriction expires, that is, when a stipulated time restriction ends or purpose restriction is accomplished, Temporarily restricted net assets are reclassified as unrestricted net assets and reported in the accompanying consolidated statements of operations and changes in net assets as net assets released from restrictions.

Unconditional promises to give cash or other assets are reported as pledges receivable and contributions within the appropriate net asset category. An allowance for uncollectible pledges receivable is estimated based on historical experience and other collection indicators. Pledges receivable with payment terms extending beyond one year are discounted using market rates of return reflecting the terms and credit of the pledges at the time a pledge is made.

Northwestern Memorial is a beneficiary of several split-interest agreements, primarily perpetual trusts held by others, and recognizes its interest in these perpetual trusts as temporarily or permanently restricted net assets based on its percentage of the fair value of the trusts’ assets.

Nonoperating Gains (Losses)

Nonoperating gains (losses) consist primarily of investment returns (including realized and unrealized gains and losses, changes in Northwestern Memorial’s equity interest in alternative investments, interest and dividends), contributions of unrestricted net assets in excess of consideration paid (where applicable), unrestricted contributions received, grants and academic support provided to external organizations, net assets released from restrictions and used for grants and academic support, changes in fair value of interest rate swaps and loss on extinguishment of debt.

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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1. Organization and Summary of Significant Accounting Policies (continued)

Excess of Revenue Over Expenses

The accompanying consolidated statements of operations and changes in net assets include the Excess of revenue over expenses. Changes in unrestricted net assets, which are excluded from the Excess of revenue over expenses, consist primarily of contributions of long-lived assets (including assets acquired using contributions, which, by donor restriction, are to be used for the purposes of acquiring such assets), transfers between net asset categories based on changes in donor restrictions and Postretirement benefit-related changes other than net periodic pension cost.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 converged and replaced existing revenue recognition guidance, including industry-specific guidance, and requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. An entity should disclose sufficient information to enable the financial statement users to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU 2015-14, which defers the effective date to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. This ASU allows two alternative methods for application, either retrospectively to each reporting period presented or a modified retrospective approach with a cumulative effect adjustment to net assets at the date of initial application. Northwestern Memorial expects to use the modified retrospective approach. Northwestern Memorial expects substantially all of its current provision for uncollectible accounts to qualify as a price concession under the new guidance and, therefore, be netted along with charity care and contractual discounts in Net patient service revenue. Northwestern Memorial expects expanded disclosures to also be made. Although the adoption of ASU 2014-09 will have an impact on the amounts presented in certain categories of the consolidated statements of operations and changes in net assets, it is not expected to materially impact Northwestern Memorial’s consolidated financial statements

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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1. Organization and Summary of Significant Accounting Policies (continued)

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which will require lessees to put most leases on their balance sheets but recognize expenses on their income statements in a manner similar to existing accounting standards. The guidance also eliminates current real estate- specific provisions for all entities. This new guidance is effective for the fiscal years and interim periods within those fiscal years beginning after December 15, 2018, with early adoption permitted. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. Full retrospective application is prohibited. Northwestern Memorial is currently evaluating the impact this guidance will have on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. ASU 2016-14 will change certain financial statement requirements for not-for-profit (NFP) entities in the scope of Topic 958 in an effort to make the information more meaningful to users and make reporting less complex. NFP entities will no longer be required to distinguish between resources with temporary and permanent restrictions on the face of the financial statements. Additionally, NFP entities will be required to present expenses by their natural and functional classification and present investment returns net of external and direct internal investment expenses. This new guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. This guidance is to be applied retrospectively and early adoption is permitted. Northwestern Memorial is currently evaluating the impact this guidance will have on its consolidated financial statements

In March 2017, the FASB issued ASU 2017-07, Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which changes the presentation of periodic benefit cost components. Under ASU 2017-07, service costs will continue to be presented within operating expenses but amortization of prior service credits and other components of net periodic benefit cost in Nonoperating gains (losses) in the consolidated statements of operation and changes in net assets. Northwestern Memorial has evaluated the effect of this guidance on the consolidated financial statements and has determined that this guidance will reduce operating income but will have no effect on revenues in excess of expenses. This guidance will not have an effect on the measurement of pension cost nor presentation of prepaid pension expense or pension plan liabilities on the consolidated balance sheets. ASU 2017-07 is effective for annual reporting periods beginning after December 15, 2017.

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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1. Organization and Summary of Significant Accounting Policies (continued)

In June 2018, the FASB issued ASU 2018-08, Not-for-Profit Entities (Topic 958) – Clarifying the Scope and Accounting Guidance for Contributions Received and Contributions Made. ASU 2018-08 provides a more robust framework to determine when a transaction should be accounted for as a contribution or as an exchange transaction and provides additional guidance about how to determine whether a contribution is conditional. This ASU is effective for annual periods beginning after June 15, 2018, including interim periods therein, and will be applied on a modified prospective basis. Northwestern Memorial is currently evaluating the impact this guidance will have on its consolidated financial statements.

2. Net Patient Service Revenue

Northwestern Memorial recognizes net patient service revenue associated with services provided to patients who have third-party payment coverage with Medicare, Medicaid, Blue Cross, other managed care programs and other third-party payors on the basis of the contractual rates for the services rendered at the time services are provided. Payment arrangements with those payors include prospectively determined rates per admission or visit, reimbursed costs, discounted charges and per diem rates. Reported costs and/or services provided under certain of the arrangements are subject to retroactive audit and adjustment. Net patient service revenue increased by $7,176 and $33,843 in 2018 and 2017, respectively, as a result of changes in estimates due to settlements of prior fiscal years’ cost reports and the disposition of other payor audits and settlements. Changes in Medicare and Medicaid programs and reduction in funding levels could have an adverse effect on Northwestern Memorial.

Northwestern Memorial also provides care to self-pay patients. Under its Free and Discounted Care Policy, Northwestern Memorial provides medically necessary care to patients in its community with inadequate financial resources at discounts of up to 100% of charges using a sliding scale that is based on patient household income as a percentage (up to 600%) of the federal poverty level guidelines. The Policy also contains a catastrophic financial assistance provision that limits a patient’s total financial responsibility to Northwestern Memorial. Since Northwestern Memorial does not pursue collection of these amounts, they are not reported as net patient service revenue. The Policy has not changed in fiscal year 2018 or 2017. Northwestern Memorial implemented presumptive eligibility screening procedures for free care in fiscal year 2014. Northwestern Memorial recognizes net patient service revenue on services provided to these patients at the discounted rate at the time services are rendered.

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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2. Net Patient Service Revenue (continued)

Net patient service revenue, net of contractual allowances and discounts, is reduced by the provision for uncollectible accounts, and net patient accounts receivable are reduced by an allowance for uncollectible accounts. These amounts are based primarily on management’s assessment of historical and expected write-offs and net collections, along with the aging status for each major payor source. Management regularly reviews data about these major payor sources of revenue in evaluating the sufficiency of the estimated allowances for uncollectible accounts. Based on historical experience, a portion of Northwestern Memorial’s self-pay patients who do not qualify for charity care will be unable or unwilling to pay for the services provided. Thus, a provision is recorded for uncollectible accounts in the period services are provided related to these patients. After all reasonable collection efforts have been exhausted in accordance with Northwestern Memorial’s policies, accounts receivable are written off and charged against the estimated allowances for uncollectible accounts.

For receivables associated with self-pay patients, Northwestern Memorial records estimated allowances for uncollectible accounts in the period of service on the basis of past experience. These adjustments are accrued on an estimated basis and are adjusted as needed in future periods.

Net patient service revenue (including patient co pays and deductibles), net of contractual allowances and discounts (but before the provision for uncollectible accounts) by primary payor source was as follows for the years ended August 31:

2018 2017 Third-party payors $ 4,960,402 $ 4,643,685 Patients 92,730 105,748 $ 5,053,132 $ 4,749,433

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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2. Net Patient Service Revenue (continued)

Northwestern Memorial grants credit without collateral to its patients, most of whom are local residents and are insured under third-party payor agreements. Patient accounts receivable, by major primary payor source, including patient co-pays and deductibles before deducting estimated allowances for uncollectible accounts, were as follows at August 31:

2018 2017 Medicare 18% 14% Medicaid 11 11 Blue Cross 22 16 Other managed care 25 32 Other third-party payors 7 8 Patients 17 19 100% 100%

The estimated allowance for uncollectible accounts was $252,353 and $223,411, or 25.1% and 24.3% of the related patient accounts receivable, net of contractual adjustments as of August 31, 2018 and August 31, 2017, respectively. The significant variance was caused primarily due to the aging of outstanding accounts receivable.

3. Illinois Hospital Assessment Program

In December 2008, the Illinois Hospital Assessment Program was approved by the Federal Centers for Medicare and Medicaid Services (CMS) for the period from July 1, 2008 through June 30, 2013. In July 2012, this program was extended to December 31, 2014, as part of the Save Medicaid Access and Resources Together (SMART) Act. In June 2014, this program was extended to June 30, 2018 as part of the Omnibus Medicaid Bill Senate Bill 741. In October 2013, the Enhanced Illinois Hospital Assessment Program as authorized under Illinois Public Act 97-688 was approved by CMS retroactive to June 10, 2012. Together, these two programs are referred to herein as (HAP). Under HAP, the state receives additional federal Medicaid funds for the State’s healthcare system, administered by the Illinois Department of Healthcare and Family Services. HAP includes payments to NMHC hospitals from the state and assessments against NMHC hospitals, which are paid to the state in the same year.

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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3. Illinois Hospital Assessment Program (continued)

In June 2014, Omnibus Medicaid Bill Senate Bill 741 authorized a new supplemental program (Access Program) to cover new Medicaid beneficiaries under the Affordable Care Act (ACA), which was approved by CMS in January 2015. In May 2016, the State of Illinois passed HB 4678 (Expanded Access Program) which implemented a framework to increase ACA access funds to Illinois hospitals. The new ACA access funds are attributable to the ACA adults enrolled in managed care products. In September 2016, the Illinois Department of Family and Healthcare Services submitted its certification of the new Medicaid managed care organization rates to CMS. After agreements between managed care organizations and providers were executed, payments for this new program and an adjustment to the assessments began in November 2016 and were retroactive to January 1, 2016.

HAP and the Expanded Access Program ended on June 30, 2018. In June 2018, the Illinois General Assembly approved SB 1773, which was signed by the Governor and is now Illinois Public Law 100-581; the law as amended redesigns both programs. CMS approved the new program on June 20, 2018. Supplemental payments for the new HAP program began in July 2018 and are reflected below. In addition to the supplemental payments, the new HAP program provides for increased Illinois Medicaid and Illinois Medicaid Managed Care inpatient rates.

A summary of the amounts recognized for the HAP and Access programs is as follows:

2018 2017 Net patient service revenue:

HAP $ 123,455 $ 112,813 Access program 15,843 20,418 Expanded access program 20,393 42,557

159,691 175,788 Illinois hospital assessment 110,339 103,362 Net excess of HAP and ACA revenue over Illinois

assessment $ 49,352 $ 72,426 The Expanded Access Program Revenue and Illinois Hospital Assessment expense for the twelve months ended August 31, 2017 include retroactive portions from January 1, 2016 through August 31, 2016 of $16,728 and $2,004, respectively.

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

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4. Investments and Other Financial Instruments

The composition of investments, including assets limited as to use, and cash and cash equivalents and short-term investments, at August 31 is as follows:

2018 2017 Measured at fair value:

Cash and short-term investments $ 502,382 $ 321,507 Mutual funds 262,719 228,599 Corporate bonds 305,081 312,980 U.S. government and agency issues 258,970 268,858 Equity securities 222,356 220,543 Other fixed income 23,926 13,393

1,575,434 1,365,880 Measured at net asset value as practical expedient:

Common collective trusts and commingled funds 765,371 685,948 Interest in 103-12 investment entities 297,217 291,304

1,062,588 977,252 Accounted for under the equity method:

Alternative investments 3,951,028 3,572,894 $ 6,589,050 $ 5,916,026

Investments, including assets limited as to use, and cash and cash equivalents and short-term investments, consist of the following at August 31:

2018 2017 Assets limited as to use:

Trustee-held funds $ 651 $ 67,082 Self-insurance programs 627,438 579,780 Board-designated funds 190,188 181,417

Total assets limited as to use 818,277 828,279 Donor-restricted funds 360,442 337,025 Unrestricted, undesignated funds 4,951,084 4,461,574 Total investments, excluding short-term investments 6,129,803 5,626,878

Other financial instruments: Cash and cash equivalents and short-term investments 459,247 289,148

$ 6,589,050 $ 5,916,026

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

1809-2875972 20

4. Investments and Other Financial Instruments (continued)

The composition and presentation of investment returns are as follows for the years ended August 31:

2018 2017 Interest and dividend income $ 27,373 $ 25,135 Investment expenses (4,683) (5,613) Realized gains on alternative investments, net 98,365 123,759 Realized gains on other investments, net 97,782 62,870 Net change in unrealized gains on alternative investments 246,963 348,167 Net change in unrealized gains on other investments 40,872 115,062 Change in value of joint ventures 77 497 $ 506,749 $ 669,877 Reported as:

Rental and other revenue $ 389 $ 557 Nonoperating investment return 490,971 655,269 Temporarily restricted – investment return 15,389 14,051

$ 506,749 $ 669,877 Northwestern Memorial’s investments measured at fair value include mutual funds; common equities; corporate and U.S. government debt issues; state, municipal and foreign government debt issues; commingled funds; common collective trusts; and 103-12 entities.

Commingled investments, common collective trusts and 103-12 entities are commingled funds formed from the pooling of investments under common management. Unlike a mutual fund, these investments are not registered investment companies and, therefore, are exempt from registering with the Securities and Exchange Commission.

The investment strategy for the mutual funds, commingled funds, common collective trusts and 103-12 entities involves maximizing the overall long-term return by investing in a wide variety of assets, including domestic large cap equities, domestic small cap equities, international developed equities, blended equities, (i.e., a mix of domestic and international equities), natural resources and private investment limited partnerships (LPs).

Northwestern Memorial HealthCare and Subsidiaries

Notes to Consolidated Financial Statements (continued) (In Thousands)

1809-2875972 21

4. Investments and Other Financial Instruments (continued)

Northwestern Memorial’s non-pension plan investments measured under the equity method of accounting include absolute return hedge funds, equity long/short hedge funds, real estate, natural resources and LPs, collectively referred to as alternative investments. Alternative investments in the pension plan assets are measured at fair value.

Absolute return hedge funds include funds with the ability to opportunistically allocate capital among several strategies. Generally, these funds diversify across strategies in an effort to deliver consistently positive returns regardless of the movement within global markets, exhibit relatively low volatility and are redeemable quarterly with a 60-day notice period. Equity long/short hedge funds include hedge funds that invest both long and short in U.S. and international equities. These funds typically focus on diversifying or hedging across particular sectors, regions or market capitalizations and are generally redeemable quarterly with a 60-day notice period. Absolute return and equity long/short managers are redeemable quarterly or annually with a 45- to 90-day notice period.