The Board of Trustees

The Detroit Medical Center

 

We have audited the accompanying consolidated balance sheets of The Detroit Medical Center and subsidiaries (The DMC) as of December 31, 2009 and 2008, and the related consolidated statements of operations and changes in net assets (deficit), and cash flows for the years then ended. These financial statements are the responsibility of The DMC’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of The DMC’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of The DMC’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Detroit Medical Center and subsidiaries at December 31, 2009 and 2008, and the consolidated results of their operations and changes in net assets (deficit), and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.

 

As discussed in Notes 9 and 10 to the consolidated financial statements, The Detroit Medical Center and subsidiaries adopted the recognition provisions of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an Amendment of FASB Statements No. 87, 88, 106 and 132(R), (codified in Accounting Standards Codification 715, Compensation—Retirement Benefits) in 2007, which changed its method of accounting for its defined benefit pension and postretirement benefit plans.

 

 

/s/ Ernst & Young LLP

 

Detroit, Michigan

May 26, 2010 except for Note 17, as to which the date is January 18, 2011.

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

 

See accompanying notes.

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

AND CHANGES IN NET ASSETS (DEFICIT)

 

 

See accompanying notes.

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See accompanying notes.

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2009

 

 

Organization

 

The Detroit Medical Center, a parent holding company, and its subsidiaries (jointly, The DMC) are major providers of health care services to residents of the Detroit metropolitan area. The DMC constitutes the academic health center of Wayne State University and works with the University to integrate clinical services, education, and research.

 

The consolidated financial statements of The DMC include The Detroit Medical Center and the corporations listed below, as well as their subsidiaries:

 

Children’s Hospital of Michigan (A)
Children’s Choice of Michigan
DMC Insurance Co., Ltd. (see Note 8)
DMC Nursing Homes, Inc.
DMC Partnership Imaging
DMC Physician Group
Detroit Receiving Hospital and University Health Center (Detroit Receiving) (A)
Harper-Hutzel Hospital (A)
HealthSource
Huron Valley-Sinai Hospital, Inc. (A)
Radius Health Care System, Inc.
Rehabilitation Institute of Michigan (A)
Southeast Michigan Physician Insurance Company
Total Linen Services (formerly Associated Hospitals Processing Facility)
Novi Regional Imaging, LLC
Sinai-Grace Hospital (A)

 

These corporations consist of both membership and stock corporations, the sole member or majority stockholder of which is The Detroit Medical Center. Such corporations are referred to herein as the subsidiaries of The DMC. The consolidated financial statements include the accounts of The Detroit Medical Center and all majority-owned subsidiaries.

 

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

 

The DMC has an investment in CareTech Corporation which is accounted for using the equity method of accounting.

 

Mission

 

The DMC is committed to improving the health of the population served by providing the highest quality health care services in a caring and efficient manner without invidious discrimination, regardless of the person’s religion, race, gender, ethnic identification, or economic status. Together with Wayne State University,

 

 

  (A) Members of The Detroit Medical Center Obligated Group (see Note 7).

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The DMC strives to be the region’s premier health care resource through a broad range of clinical services; the discovery and application of new knowledge; and the education of practitioners, teachers, and scientists.

 

As part of its public mission as the safety net health care provider in Southeast Michigan, The DMC writes off forgone charges associated with providing services to uninsured patients. This public mission support is determined by isolating the amount of bad debts originating from care to uninsured patients less any monies received by The DMC from third parties (Medicare, Medicaid, and Blue Cross) as a qualified disproportionate share hospital (DSH). The DMC also considers payments remitted to Wayne State University faculty physicians as recognition of care provided by such physicians to the uninsured population.

 

Cash and Cash Equivalents

 

The DMC considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

 

Investments

 

Investments in equity securities and debt securities are measured at fair value in the consolidated balance sheets. Donated securities are stated at fair value at the date of contribution. Investment income (including realized and unrealized gains and losses on investments, interest and dividends) are included in excess of revenue over expenses (expenses over revenue) unless the income is restricted by donor or law.

 

Investments in limited partnerships, such as private equity investments and hedge funds (alternative investments), are reported using the equity method of accounting based on information provided by management of the respective partnership. The investment information provided by managers of the partnerships is based on current market value, appraisals, or other estimates of fair value of investment holdings of the partnership that require varying degree of judgments. Some of the individual investments within these funds are not readily marketable; therefore their estimated value is subject to uncertainty and may differ from the value that would have been determined had a ready market for the investments existed. If no public market exists for the investments held by the partnership, the fair value is determined by the general partner taking into consideration, among other things, the cost of the securities, prices of significant placements of securities of the same issuer, and subsequent developments concerning the companies to which the securities relate. Generally, The DMC’s holdings in alternative investments reflects net contributions to the partnership and an ownership share of realized and unrealized investment income and expenses. Alternative investments have liquidity restrictions. Amounts can be divested only at specified times based on the terms of the partnership agreement.

 

Securities Lending Program

 

The DMC participates in securities lending transactions with their investment trustee, whereby a portion of its investments are loaned to selected established brokerage firms in return for cash and securities from the brokers as collateral for the investments loaned, usually on a short-term basis of 30 to 60 days. Collateral provided by brokers is maintained at levels approximating 102% of the fair value of the securities on loan and is adjusted for daily market fluctuations. The market value of collateral held for loaned securities is reported as securities lending collateral in the consolidated balance sheets. At December 31, 2009 and 2008, investment securities with an aggregate market value of $39,321,000 and $20,927,000, respectively; were

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

loaned to various brokers. In exchange, The DMC received cash collateral of $40,463,000 and $21,386,000, respectively.

 

Patient Service Revenue and Receivables

 

The majority of The DMC’s services are reimbursed under fixed price provisions of third-party payment programs (primarily Medicare, Medicaid, and Blue Cross and Blue Shield of Michigan). Under these provisions, payment rates for patient care are determined prospectively on various bases and The DMC’s revenues are limited to such amounts. Payments are also received from third parties for The DMC’s capital and medical education costs, subject to certain limits. Additionally, The DMC has entered into agreements with certain commercial insurance carriers, health maintenance organizations, and preferred provider organizations. The basis for payment under these agreements includes prospectively determined per diem rates, capitation, and discounts from established charges.

 

Net patient service revenue is reported at the estimated net realizable amounts to be received from patients, third-party payors, and others for services rendered, including estimated retroactive adjustments under reimbursement agreements with third-party payors. Retroactive adjustments are accrued on an estimated basis in the period related services are rendered and adjusted in future periods as final settlements are determined. As a result, there is at least a reasonable possibility that recorded estimates will change by a material amount in the near term. Management believes that adequate provision has been made in the consolidated financial statements for any adjustments that may result from final settlements.

 

Revenue from the Medicare and Medicaid programs each accounted for approximately 26%, 26%, and 24% of net patient service revenues during 2009, 2008, and 2007, respectively. The DMC also receives payments from the state Medicaid program related to support of the DMC’s indigent patient volume. The payments are recognized ratably as revenue over the period of support determined by the State.

 

Laws and regulations governing the Medicare and Medicaid programs are complex and subject to interpretation. Management believes that it is in compliance with all applicable laws and regulations. Compliance with such laws and regulations is subject to government review and interpretation as well as significant regulatory action including fines, penalties, and exclusion from the Medicare and Medicaid programs. In the normal course of business, The DMC has received requests for information from governmental agencies covering services provided. Management intends to fully cooperate with the governmental agencies in its request for information and believes that adequate provision has been made for any adjustments that may result from settlements.

 

The provision for bad debts is based upon management’s assessment of expected net collections and considers business and economic conditions, trends in health care coverage and other collection indicators including historical write-off experience by payor category. The results of this review are then used to make any modifications to the provision for bad debts to establish an appropriate allowance for uncollectible receivables. After receipt of amounts due from third parties, The DMC follows established guidelines for placing certain past due patient balances with collection agencies.

 

Supplies

 

Supplies represent medical supplies which are stated at the lower of cost or market. Cost is determined based on the first-in, first-out method.

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Property and Equipment

 

Property and equipment, including amounts under capital leases, are stated at cost or estimated fair value at the date of donation, and are depreciated utilizing the straight-line method over their estimated useful lives. The estimated useful lives for assets range from 3 years to 40 years.

 

An entity is required to recognize a liability for the fair value of an unconditional asset retirement obligation if the fair value of the liability can be estimated. Because there are no current plans requiring remediation giving rise to an asset retirement obligation and a settlement date has not been specified by others, management believes that sufficient information is not available to record an asset retirement obligation.

 

Other Noncurrent Assets

 

Other noncurrent assets include deferred debt issuance costs which are amortized ratably over the terms of the related debt issues using a method that approximates the interest method. Goodwill and the intangible assets are amortized by the straight-line method over a ten-year period (see Note 2).

 

Temporarily and Permanently Restricted Net Assets

 

Temporarily restricted net assets are those whose use has been limited by donors to a specific purpose, such as capital additions or research. When a donor restriction is satisfied, such as through expenditure for the restricted purpose, temporarily restricted net assets are reclassified as net assets released from restrictions for either operating purposes or for long-lived assets and are included in unrestricted revenues and other support, or as an other increase in unrestricted net assets, respectively. Pledges are recorded as increases in temporarily restricted net assets when the pledge is made.

 

Permanently restricted net assets have been restricted by the donors to be maintained by The DMC in perpetuity, the income therefrom to be used in accordance with any restrictions by the donor.

 

Excess of Revenue Over Expenses

 

The statement of operations and changes in net assets (deficit) includes the excess of revenue over expenses (expenses over revenue). Changes in unrestricted net assets which are excluded from the excess of revenue over expenses (expenses over revenue), consistent with industry practice, include changes in the pension and postretirement benefit liability and net assets released from restrictions for the purchase of long-lived assets.

 

Charity Care

 

The DMC provides health care services free of charge or at reduced rates to individuals who meet certain eligibility criteria, based on published Income Poverty Guidelines. As these amounts were initially billed at the time of service, charity care provided by The DMC of approximately $80,853,000, $91,111,000, and $95,278,000 for the years ended December 31, 2009, 2008, and 2007, respectively, have been included in the provision for uncollectible accounts on the statement of operations.

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Impairment of Long-Lived Assets

 

In accordance with ASC 360, Accounting for the Impairment of Long-Lived Assets, The DMC performs an evaluation of impairment losses on long-lived assets used in operations when events and circumstances indicate that long-lived assets might be impaired. If the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets, an impairment charge is recorded and the amount of the impairment is determined based on the fair market value of the asset. During 2009, the DMC recognized an impairment charge of $1,254,000 in the statement of operations related to a facility that is no longer being used by The DMC.

 

Use of Estimates

 

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

 

Income Taxes

 

The Detroit Medical Center, each of its hospital subsidiaries and certain of its other subsidiaries are nonprofit corporations, exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code. Radius Health Care System, Inc. is a for-profit corporation, which has net operating loss carryforwards that are available to offset its future taxable income. The DMC uses the liability method of accounting for income taxes under which deferred taxes are determined based on the differences between financial statement and tax bases of assets and liabilities, using current tax rates. The DMC has recorded a valuation allowance equal to the deferred tax asset associated with the net operating loss carryforwards, as such amounts are not considered recoverable.

 

Reclassifications

 

Certain reclassifications were made to the 2008 and 2007 consolidated financial statements to conform to the 2009 presentation. The reclassifications included (1) a reclassification in 2008 of $18,330,000 in third party allowances from net accounts receivable to the estimated third party settlement liability, (2) the reclassification in 2008 of $13,125,000 from prepaid expenses and other to other non-current assets related to the excess insurance receivable and (3) the reclassification in 2008 and 2007 of the change in investments, except for the unrealized gain/loss, from operating activities to financing activities on the statement of cash flows. These reclassifications had no impact on the change in net assets previously reported.

 

New Accounting Standards

 

In December 2008, the Financial Standards Accounting Board (FASB) issued authoritative guidance regarding employers’ disclosures about postretirement benefit plan assets. This guidance requires more detailed disclosures about the fair value measurements of employers’ plan assets including: (a) investment policies and strategies; (b) major categories of plan assets; (c) information about valuation techniques and inputs to those

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

techniques, including the fair value hierarchy classifications of the major categories of plan assets; (d) the effects of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets; and (e) significant concentrations of risk within plan assets. The disclosure requirements are effective for fiscal years ending after December 15, 2009, and the provisions are not required for earlier periods presented for comparative purposes. The DMC adopted this guidance for the year ended December 31, 2009. Adoption of the new guidance had no impact on the consolidated financial results.

 

Effective July 1, 2009, Financial Accounting Standard Board (FASB) SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting principles (GAAP)—a replacement of FASB Statement No. 162 (ASC) became the single official source of authoritative, nongovernmental source for generally accepted accounting principles. The historical GAAP hierarchy was eliminated and the ASC became the only level of authoritative GAAP. All other literature became non-authoritative. ASC is effective for financial statements issued for interim and annual periods ending after September 15, 2009. As ASC was not intended to change or alter existing GAAP, it did not have any impact on the financial position, results of operations or cash flows of The DMC.

 

In December 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARE No. 51 (SFAS 160) (codified in ASC 810, Consolidation), which requires enhanced reporting of the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. SFAS 160 is effective for fiscal years beginning on or after September 15, 2009. The DMC does not believe the effect that the adoption of SFAS 160 will have on its consolidated financial statements will be significant.

 

In May 2009, the FASB issued authoritative guidance intended to improve the financial accounting and reporting for not-for-profit mergers and acquisitions and intangible assets. The guidance is effective for mergers that occur during reporting periods beginning on or after December 15, 2009 and for acquisitions that take place during fiscal years that begin on or after December 15, 2009. The DMC will apply this guidance to any future business combinations.

 

In May 2009, the FASB issued Statement of Financial Accounting Standards No. 165, Subsequent Events (FAS 165) (codified in ASC 855, Subsequent Events). ASC 855 establishes general standards of accounting for and disclosure of subsequent events, which are events that occur after the balance sheet date but before the financial statements are issued or available to be issued. In addition, certain events subsequent to the balance sheet date may require recognition in the financial statements as of the balance sheet date under the requirements of ASC 855. The DMC adopted the provisions of ASC 855 as of December 31, 2009 and evaluated the impact of subsequent events through May 26, 2010, representing the date on which the consolidated financial statements were available to be issued. No recognized or non-recognized subsequent events were identified for recognition or disclosure in the consolidated balance sheet or the accompanying notes to the consolidated financial statements, except for the matters discussed in Notes 13 and 17.

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

 

 

 

Net patient service revenue consists of the following:

 

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Net patient accounts receivable consists of the following:

 

 

The DMC grants credit without collateral to its patients, most of whom are local residents and are insured under third-party payor agreements. Significant concentrations of accounts receivable at December 31, 2009 and 2008, include net amounts due from Medicare (18% and 22%), Medicaid (20% and 14%), Blue Cross (10% and 13%), and other payors, (52% and 51%), respectively.

 

 

The components of cash, cash equivalents, and investments are summarized as follows:

 

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Investment return is summarized as follows:

 

 

Investment return on board-designated funds for capital improvements is included in other nonoperating income. All other investment return, which is not restricted by explicit donor stipulations, is included in other revenue, except for unrealized gains/losses which are included as a component of the performance indicator in the statement of operations. Equity earnings (loss) on limited partnerships of $155,000, $(7,373,000), and $2,862,000 is included in the realized gain (loss) amount for the years ended December 31, 2009, 2008, and 2007, respectively.

 

The DMC invests in various financial instruments which are publicly traded. Financial instruments are exposed to various risks such as interest rate, market and credit risks. Due to the level of risk associated with certain investment securities, it is at least reasonably possible that changes in the value of investments will occur in the near term, and that such changes could materially affect the amounts reported in the statement of operations and changes in net assets (deficit).

 

 

The carrying value of cash and cash equivalents, accounts receivable and accounts payable are reasonable estimates of fair value due to the short-term nature of these financial instruments. Investments, other than alternative investments, are recorded at fair value. At December 31, 2009 and 2008, the carrying value and fair value of The DMC’s long-term debt, (excluding capital leases), as estimated by discounted cash flow analyses using the current borrowing rate for similar types of borrowing arrangements and adjusted for credit risk of The DMC was $492,383,000 and $431,557,000 at December 31, 2009, respectively; and $505,826,000 and $364,128,000 at December 31, 2008, respectively (see Note 7). Other noncurrent assets and liabilities have carrying values that approximate fair value.

 

ASC 820 emphasizes that fair value is a market based measurement, not an entity-specific measurement Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

 

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs utilize other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based upon inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Management’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

Investments are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of transparency. The types of instruments based on quoted market prices in active markets include most agency securities, active listed equities and most money market securities. Such instruments are generally classified within Level 1 of the fair market value hierarchy. The DMC does not adjust the quoted price for such investments.

 

The types of instruments valued based on quoted prices that are not active, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include most investment-grade and high yield corporate bonds, U.S. government and mortgage securities. Such instruments are generally classified within Level 2 of the fair market value hierarchy.

 

The following tables summarize The DMC’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2009 and 2008, aggregated by the level in the fair value hierarchy defined above:

 

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

 

 

On May 7, 2007, The DMC and GE Capital executed an amended and restated credit agreement. Under the amended terms of the credit agreement, The DMC has liquidity available of up to $60,000,000 based on eligible accounts receivable which is determined based on net accounts receivable which are less than 120 days old reduced by third-party advances and allowances for doubtful accounts. The DMC has the ability to increase the available liquidity up to $80,000,000 based on eligible accounts receivable. The credit agreement, which expires June 30, 2010, is secured by eligible accounts receivable. Under the terms of the credit agreement, The DMC is required to have days in accounts receivable less than 97 days, for the preceding three month period, maintain liquidity of $50,000,000 at all times and average liquidity of $65,000,000 for the preceding three month period, and maintain a rolling fixed charge coverage ratio of no less than 1.10 any time the month end liquidity is less than $120,000,000. Interest on borrowings can either be fixed or floating subject to monthly adjustments (the interest rate at December 31, 2009 was 1.48%). In addition, The DMC is charged an unused facility fee equal to .25% of the unused liquidity facility. At December 31, 2009 and 2008, the balance outstanding on the line of credit was $20,753,000 and $3,476,000, respectively. The available balance on the line of credit at December 31, 2009 and 2008 was $54,036,000 and $71,313,000, respectively.

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

 

Long-term debt and capital leases consist of the following:

 

 

The Detroit Medical Center and its hospital subsidiaries are members of The Detroit Medical Center Obligated Group, which was created under a Master Indenture and Security Agreement. In addition, The Detroit Medical Center and its hospital subsidiaries became part of Sinai Hospital Obligated Group, which was created under a separate Master Indenture, which also became known as The Detroit Medical Center Obligated Group subsequent to the 1997 acquisition of Sinai Hospital by The DMC. Collectively these Master Indentures are referred to as “Master Indentures.” The Master Indentures provide that each member of the Obligated Group is jointly and severally liable for obligations issued thereunder. The Detroit Medical Center serves as Obligated Group Agent.

 

The MSHFA bonds are tax-exempt revenue bonds secured by obligations issued under the Master Indenture, which the Obligated Group must repay under loan agreements with MSHFA. The bonds mature in annual amounts through 2028, ranging in the aggregate from $13,155,000 in 2010 to $37,585,000 in 2028.

 

During the term of the agreements with MSHFA, The DMC is required to maintain debt service reserve funds and make specified deposits with trustees to fund principal and interest payments when due. Also, unexpended bond proceeds are held by the trustee and released to The DMC for approved capital projects. At December 31, 2009 and 2008, unexpended bond proceeds were $3,805,000.

 

Interest paid was $30,994,000, $32,346,000, and $33,506,000 in 2009, 2008, and 2007, respectively. In addition, The DMC capitalized interest of $174,000 in 2008.

 

The cost and accumulated depreciation for assets under capital lease were $64,001,000 and $41,462,000 at December 31, 2009, and $60,873,000 and $33,091,000 at December 31, 2008.

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Future maturities of long-term debt and future minimum payments under capital leases are summarized as follows:

 

 

Rent expense incurred under operating noncancellable leases for the years ended December 31, 2009, 2008, and 2007 was $17,634,000, $16,118,000, and $17,111,000, respectively. The DMC has noncancellable lease commitments at December 31, 2009, as follows (in thousands):

 

 

 

The Detroit Medical Center has established an offshore captive insurance company to provide professional and general liability coverage to The Detroit Medical Center, its hospital subsidiaries, certain medical staff members, and other affiliates. A portion of the risk of loss from professional liability claims is retained by some of the subsidiaries. Through March 31, 2004, The DMC acquired excess professional liability and general liability coverage from a captive insurance company in which it held a minority interest. Effective April 1, 2004, The DMC purchased the excess coverage from the offshore captive owned by The DMC, which in turn reinsured a portion of the losses through commercial insurance companies.

 

The DMC and its affiliates have accrued their best estimate of the ultimate cost of losses payable by the captive insurance company and the retained portion of losses under other insurance arrangements. These estimates include an amount for claims incurred but not reported.

 

Accrued professional liability losses are recorded at their estimated present value based on discount rates, which average approximately 5% in 2009 and 2008. At December 31, 2009 and 2008 The DMC has recorded a receivable for excess insurance recoverable of $13,247,000 and $13,125,000, respectively, which is included in other long term assets. Professional liability expense for the years ending December 31, 2009, 2008, and 2007, was $28,140,000, $29,022,000, and $25,108,000, respectively.

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Activity in reserves for professional liability is summarized as follows:

 

 

The changes in the provision for incurred claims for the prior year have been adjusted to reflect the changes in estimates of the ultimate settlement costs of such losses. The favorable development which occurred during 2009 and 2008 relates to a reduction in claim frequency and severity.

 

 

The DMC maintains a defined contribution retirement plan for employees. The DMC contributes a fixed percentage of employee salaries to the plan and also matches contributions made by employees to the defined contribution plan during the year. During 2008, The DMC changed the matching contribution from a two-to-one match to a three-to-one or a four-to-one match based on years of service. Total expense under the plan was $22,502,000, $21,059,000, and $12,902,000 for the year ended December 31, 2009, 2008, and 2007, respectively.

 

The DMC also has a noncontributory defined benefit retirement plan covering substantially all of the employees of The Detroit Medical Center and its subsidiaries hired prior to June 1, 2003. The benefits under the defined benefit plan are based in general on years of service and final average earnings.

 

In 2003, The DMC announced that benefits provided under the defined benefit retirement plan would be frozen effective June 1, 2003. Management elected to freeze the pension benefits to reduce the expected increase in pension expense subsequent to 2003. In 2007, The DMC recognized a curtailment gain and reduction in the accumulated benefit obligation of $2,159,000 related to a change in the amount of benefits for a collective bargaining unit.

 

The DMC’s funding policy for the defined benefit plan is, in general, to fund an amount based on the recommendation of consulting actuaries that is in compliance with the requirements of the Employee Retirement Income Security Act of 1974.

 

THE DETROIT MEDICAL CENTER AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

On December 31, 2007, The DMC adopted the recognition provisions of FASB Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (FAS 158) (codified in ASC 715, Compensation - Retirement Benefits), which required The DMC to recognize the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligations) of the pension plan in the December 31, 2007 consolidated balance sheet, with a corresponding adjustment to unrestricted net assets. The adjustment to unrestricted net assets at adoption represents the net unrecognized actuarial losses which were previously netted against The Detroit Medical Center’s funded status in the consolidated balance sheets. Further, actuarial gains and losses that arise in subsequent periods and are not recognized as net periodic pension cost in the same periods will be recognized as a component of unrestricted net assets. These amounts will be subsequently recognized as a component of net periodic pension cost on the same basis as the amounts recognized in unrestricted net assets upon the adoption of ASC 715.

 

The incremental effects of adopting the provisions of ASC 715 for the defined benefit retirement plan on the consolidated balance sheet at December 31, 2007 are presented in the following table. The adoption of ASC 715 had no effect on The DMC’s excess of revenue over expenses for the year ended December 31, 2007, and it will not affect the operating results in future periods.

 

 

The following table provides a reconciliation of the changes in the defined benefit plan’s benefit obligation and fair value of assets for the years ended December 31, 2009 and 2008, and a statement of the funded status as of December 31, 2009 and 2008.

 

 

The accumulated benefit obligation for the defined benefit plans was $867,821,000 and $833,871,000 at December 31, 2009 and 2008, respectively.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Included in unrestricted net assets at December 31, 2009 and 2008, are unrecognized actuarial losses of $233,273,000 and $327,093,000, respectively that have not yet been recognized in net periodic pension cost. The actuarial loss included in unrestricted net assets and expected to be recognized in net periodic pension cost during fiscal year ending December 31, 2010, is $18,709,000.

 

The following is a summary of the changes in plan assets and benefit obligation recognized in unrestricted net assets:

 

 

A summary of the components of net pension expense is as follows:

 

 

The assumptions used to determine the plan benefit obligation are as follows:

 

 

The assumptions used to determine the net periodic benefit cost are as follows:

 

 

To develop the expected long-term rate of return on assets assumption, The DMC considered the current level of expected returns on risk-free investments (primarily government bonds), the historical level of

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

the risk premium associated with the other asset classes in which the portfolio is invested, and the expectations for future returns of each asset class. The expected return for each asset class was then weighted based on the target asset allocation to develop the expected long-term rate of return on assets assumption for the portfolio.

 

The DMC’s pension plan weighted-average asset allocations by asset category are as follows:

 

 

The plan assets are invested in separately managed portfolios using investment management firms. The plans’ objective for all asset categories is to maximize total return without assuming undue risk exposure. The plan maintains a well-diversified asset allocation that best meets these objectives. Plan assets are largely comprised of equity securities, which include companies with all market capitalization sizes in addition to international and convertible securities. Cash and cash equivalents are comprised of money market funds. Debt securities include domestic and foreign government obligations, corporate bonds, and mortgage backed securities. Alternative investments include investments in limited partnerships.

 

Investments in derivative securities are not permitted for the sole purpose of speculating on the direction of market interest rates. Included in this prohibition are leveraging, shorting, swaps, futures, options, forwards, and similar strategies.

 

In each investment account, investment managers are responsible to monitor and react to economic indicators, such as GDP, CPI, and the Federal Monetary Policy, that may affect the performance of their account. The performance of all managers and the aggregate asset allocation are formally reviewed on a quarterly basis, with a rebalancing of the asset allocation occurring at least once a year. The current asset allocation objective is to maintain a certain percentage with each class allowing for a 10% deviation from the target.

 

The following table summarizes the Company’s pension assets measured at fair value on a recurring basis as of December 31, 2009, aggregated by the level in the fair value hierarchy within which those measurements are determined as disclosed in Note 5. Fair value methodologies for Level 1 and Level 2 are

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

consistent with the inputs described in Note 5. Fair value for Level 3 represents the DMC’s ownership interest in the net asset value of the respective partnership, which approximates fair value.

 

 

 

Expected cash flows for the defined benefit retirement plan are as follows:

 

 

The expected employer contributions above represent amounts to be paid to the trust and the benefit payment amounts above represent total benefits expected to be paid from the trust.

 

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Certain DMC hospitals sponsor defined benefit health care plans for retirees who meet eligibility requirements, and one hospital has committed to continue postretirement health care benefits to certain union employees meeting certain age and service requirements. Additionally, two hospitals provide postretirement life insurance benefits to eligible employees and retirees. The plans are frozen and no new employees are eligible to participate.

 

On December 8, 2003, the Prescription Drug, Improvement and Modernization Act of 2003 (the Act) was signed into law. The Act introduces a prescription drug benefit under Medicare as well as a federal subsidy to certain sponsors of postretirement health care benefit plans that provide a prescription drug benefit to their enrollees that is at least actuarially equivalent to Medicare Part D. The DMC’s estimate of its postretirement obligation, net periodic postretirement benefit cost, and the corresponding disclosures include the effect of the Act.

 

On December 31, 2007, DMC adopted the recognition provisions of FASB Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (FAS 158) (codified in ASC 715, Compensation—Retirement Benefits), which required The DMC to recognize the funded status (i.e., the difference between the fair value of plan assets and the accumulated benefit obligations) of its postretirement benefit plan in the December 31, 2007 consolidated balance sheet, with a corresponding adjustment to unrestricted net assets. The adjustment to unrestricted net assets at adoption represents the net unrecognized actuarial losses and unrecognized prior service costs, which were previously netted against The DMC funded status in the consolidated balance sheets. These amounts will be subsequently recognized as net periodic postretirement benefit cost pursuant to The DMC historical accounting policy for amortizing such amounts. Further, actuarial gains and losses that arise in subsequent periods and are not recognized as net periodic postretirement benefit plan cost in the same periods will be recognized as a component of unrestricted net assets. These amounts will be subsequently recognized as a component of net periodic postretirement benefit cost on the same basis as the amounts recognized in unrestricted net assets at adoption of ASC 715.

 

The incremental effects of adopting the provisions of ASC 715 for the postretirement benefit plan on the consolidated balance sheet at December 31, 2007 are presented in the following table. The adoption of ASC 715 had no effect on The DMC excess of revenue over expenses for the year ended December 31, 2007, or for any prior period presented, and it will not affect the operating results in future periods.

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The following table presents the amounts recognized for all the plans in the consolidated financial statements:

 

 

Included in unrestricted net assets are the following amounts that have not yet been recognized in postretirement benefit cost:

 

 

The prior service cost and actuarial losses included in unrestricted net assets and expected to be recognized in net periodic pension cost during 2010 are $56 and $63, respectively.

 

Changes in plan assets and benefit obligation recognized in unrestricted net assets during 2009 and 2008 include:

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Net periodic postretirement benefit cost includes the following components: