f t p e s 30, 2011 the cleveland clinic foundation d.b.a ......11/29/2011 page 8 1. basis of...

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

A N D O T H E R I N F O R M A T I O N

F O R T H E P E R I O D E N D E D S E P T E M B E R 3 0 , 2 0 1 1

The Cleveland Clinic Foundation d.b.a. Cleveland Clinic Health System

CLEVELAND CLINIC HEALTH SYSTEM INTERIM UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND OTHER INFORMATION FOR THE PERIOD ENDED SEPTEMBER 30, 2011

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Contents Unaudited Consolidated Financial Statements Unaudited Consolidated Balance Sheets ..................................................................................................... 1 Unaudited Consolidated Statements of Operations and Changes in Net Assets ......................................... 3 Unaudited Consolidated Statements of Cash Flows.................................................................................... 7 Notes to Unaudited Consolidated Financial Statements ............................................................................. 8

Other Information

Unaudited Consolidating Balance Sheets.................................................................................................. 17 Unaudited Consolidating Statements of Operations and Changes in Net Assets...................................... 18 Unaudited Consolidating Statements of Cash Flows ................................................................................ 22 Utilization.................................................................................................................................................. 23 Payor Mix .................................................................................................................................................. 26 Research Support....................................................................................................................................... 27 Key Ratios ................................................................................................................................................. 28 Management Discussion and Analysis of Financial Condition and Results of Operations ...................... 29

CLEVELAND CLINIC HEALTH SYSTEM INTERIM UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS FOR THE PERIOD ENDED SEPTEMBER 30, 2011

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Unaudited Consolidated Balance Sheets ($ in thousands)

September 30 December 312011 2010

AssetsCurrent assets:

Cash and cash equivalents 50,089$ 16,471$ Patient receivables, net 651,679 677,733Investments for current use 60,431 152,213Other current assets 361,566 355,561

Total current assets 1,123,765 1,201,978

Investments:Long-term investments 3,498,957 3,369,825Funds held by trustees 113,495 220,435Assets held by captive insurance subsidiary 145,410 173,757Donor restricted assets 322,117 302,566

4,079,979 4,066,583

Property, plant, and equipment, net 3,265,723 3,135,326

Other assets:Pledges receivable, net 126,851 127,627Trusts and interests in foundations 111,688 130,813Other noncurrent assets 112,507 121,431

351,046 379,871

Total assets 8,820,513$ 8,783,758$


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Unaudited Consolidated Balance Sheets (continued) ($ in thousands)

September 30 December 312011 2010

Liabilities and net assetsCurrent liabilities:

Accounts payable 260,074$ 275,262$ Compensation and amounts withheld from payroll 233,469 202,913Estimated amounts due to third-party payors 26,667 43,370Current portion of long-term debt 45,366 46,888Variable rate debt classified as current 492,765 494,300Other current liabilities 331,867 342,659

Total current liabilities 1,390,208 1,405,392

Long-term debt:Hospital revenue bonds 1,971,048 2,009,569Notes payable and capital leases 50,139 53,328

2,021,187 2,062,897

Other liabilities:Professional and general insurance liability reserves 138,931 173,180Accrued retirement benefits 475,026 510,804Other noncurrent liabilities 424,171 320,941

1,038,128 1,004,925Total liabilities 4,449,523 4,473,214

Net assets:Unrestricted 3,726,794 3,651,954Temporarily restricted 410,940 436,824Permanently restricted 233,256 221,766

Total net assets 4,370,990 4,310,544

Total liabilities and net assets 8,820,513$ 8,783,758$

See notes to unaudited consolidated financial statements.


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Unaudited Consolidated Statements of Operations and Changes in Net Assets ($ in thousands) Operations

Three months ended September 302011 2010

Unrestricted revenuesNet patient service revenue $1,415,367 $1,343,735Other 160,175 138,314 Total unrestricted revenues 1,575,542 1,482,049

ExpensesSalaries, wages, and benefits 821,875 751,476 Supplies 155,048 153,476 Pharmaceuticals 98,277 87,386 Purchased services 90,112 89,968 Administrative services 31,784 35,916 Facilities 74,805 74,862 Insurance (49,238) 675 Provision for uncollectible accounts 98,098 72,979

1,320,761 1,266,738 Operating income before interest, depreciation, and amortization expenses 254,781 215,311

Interest 23,767 22,785 Depreciation and amortization 79,817 77,913 Operating income before special charges 151,197 114,613

Special charges 15,963 - Operating income 135,234 114,613

Nonoperating gains and lossesInvestment (loss) return (221,297) 184,867 Derivative losses (93,957) (36,303) Other, net (221) 284 Net nonoperating gains and losses (315,475) 148,848 (Deficiency) excess of revenues over expenses (180,241) 263,461


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Unaudited Consolidated Statements of Operations and Changes in Net Assets (continued) ($ in thousands) Changes in Net Assets

Temporarily PermanentlyUnrestricted Restricted Restricted Total

Total net assets at July 1, 2010 3,060,886$ 426,745$ 212,536$ 3,700,167$ Excess of revenues over expenses 263,461 - - 263,461 Donated capital and assets released from restrictions for capital purposes 541 (530) - 11 Gifts and bequests - 13,063 2,342 15,405 Net investment income - 12,352 - 12,352 Net assets released from restrictions used for operations included in other unrestricted revenues - (11,460) - (11,460) Retirement benefits adjustment 7,008 - - 7,008 Net change in unrealized gains on nontrading investments 2,012 - - 2,012 Other (222) - - (222) Increase in net assets 272,800 13,425 2,342 288,567

Total net assets at September 30, 2010 3,333,686$ 440,170$ 214,878$ 3,988,734$

Total net assets at July 1, 2011 3,897,119$ 450,891$ 229,550$ 4,577,560$ Deficiency of revenues over expenses (180,241) - - (180,241) Donated capital and assets released from restrictions for capital purposes 2,400 (2,116) - 284 Gifts and bequests - (9,050) 3,702 (5,348) Net investment loss - (12,112) - (12,112) Net assets released from restrictions used for operations included in other unrestricted revenues - (17,419) - (17,419) Retirement benefits adjustment 8,439 - - 8,439 Change in interests in foundations - 746 4 750 Net change in unrealized losses on nontrading investments (1,029) - - (1,029) Other 106 - - 106 (Decrease) increase in net assets (170,325) (39,951) 3,706 (206,570)

Total net assets at September 30, 2011 3,726,794$ 410,940$ 233,256$ 4,370,990$

Net Assets



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Unaudited Consolidated Statements of Operations and Changes in Net Assets ($ in thousands) Operations

Nine Months ended September 30 2011 2010

Unrestricted revenuesNet patient service revenue 4,177,455$ 3,979,655$ Other 439,745 389,684Total unrestricted revenues 4,617,200 4,369,339

ExpensesSalaries, wages, and benefits 2,460,780 2,311,492Supplies 456,435 461,024Pharmaceuticals 280,269 254,413Purchased services 254,166 263,866Administrative services 96,141 114,361Facilities 224,263 221,170Insurance (9,136) 45,533Provision for uncollectible accounts 274,356 206,995

4,037,274 3,878,854Operating income before interest, depreciation, and amortization expenses 579,926 490,485

Interest 70,557 65,738Depreciation and amortization 255,319 236,864Operating income before special charges 254,050 187,883

Special charges 27,818 - Operating income 226,232 187,883

Nonoperating gains and lossesInvestment (loss) return (63,693) 180,880Derivative losses (110,989) (107,559)Other, net (244) 190Net nonoperating gains and losses (174,926) 73,511Excess of revenues over expenses 51,306 261,394


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Unaudited Consolidated Statements of Operations and Changes in Net Assets (continued) ($ in thousands) Changes in Net Assets

Net AssetsTemporarily Permanently

Unrestricted Restricted Restricted Total

Balances at January 1, 2010 3,037,411$ 417,457$ 205,729$ 3,660,597$ Excess of revenues over expenses 261,394 - - 261,394 Donated capital and assets released from restrictions for capital purposes 13,541 (13,309) - 232 Gifts and bequests 40,452 8,457 48,909 Transfer of net assets (1,961) 1,961 - - Net investment income - 13,970 - 13,970 Net assets released from restrictions used for operations included in other unrestricted revenues - (21,829) - (21,829) Retirement benefits adjustment 21,024 - - 21,024 Change in interests in foundations - 1,468 692 2,160 Net change in unrealized gains on nontrading investments 2,481 - - 2,481 Other (204) - - (204) Increase in net assets 296,275 22,713 9,149 328,137 Balances at September 30, 2010 3,333,686$ 440,170$ 214,878$ 3,988,734$

Balances at January 1, 2011 3,651,954$ 436,824$ 221,766$ 4,310,544$ Excess of revenues over expenses 51,306 - - 51,306 Donated capital and assets released from restrictions for capital purposes 4,761 (4,460) - 301 Gifts and bequests - 6,683 10,857 17,540 Net investment loss - (2,318) - (2,318) Net assets released from restrictions used for operations included in other unrestricted revenues - (26,723) - (26,723) Retirement benefits adjustment 25,317 - - 25,317 Change in interests in foundations - 934 633 1,567 Net change in unrealized losses on nontrading investments (6,716) - - (6,716) Other 172 - - 172 Increase (decrease) in net assets 74,840 (25,884) 11,490 60,446Balances at September 30, 2011 3,726,794$ 410,940$ 233,256$ 4,370,990$



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Unaudited Consolidated Statements of Cash Flows ($ in thousands)

Nine Months ended September 30 2011 2010

Operating activities and net nonoperating gains and lossesIncrease in net assets 60,446$ 328,137$ Adjustments to reconcile increase in net assets to net cash provided by operating activities and net nonoperating gains and losses:

Retirement benefits adjustment (25,317) (21,024) Net realized and unrealized losses (gains) on investments 115,026 (168,975) Depreciation and amortization 268,708 236,864 Provision for uncollectible accounts 274,356 206,995 Donated capital (301) (232) Restricted gifts, bequests, investment income, and other (16,789) (65,039) Accreted interest and amortization of bond premiums (519) (520) Net loss in value of derivatives 90,592 87,119 Changes in operating assets and liabilities:

Patient receivables (248,302) (204,841) Other current assets (20,034) (69,389) Other noncurrent assets 10,297 11,863 Accounts payable and other current liabilities (12,970) (15,691) Other liabilities (33,122) (25,367)

Net cash provided by operating activities and net nonoperating gains and losses 462,071 299,900

Financing activitiesPrincipal payments on long-term debt (44,386) (10,260) Change in pledges receivables, trusts and interests in foundations 33,930 (3,968) Restricted gifts, bequests, investment income, and other 16,789 65,039 Net cash provided by financing activities 6,333 50,811

Investing activitiesExpenditures for property and equipment (398,146) (327,414) Net change in cash equivalents reported in long-term investments 202,321 551,576 Purchases of investments (1,402,858) (1,489,626) Sales of investments 1,163,897 932,374 Net cash used in investing activities (434,786) (333,090)

Increase in cash and cash equivalents 33,618 17,621 Cash and cash equivalents at beginning of year 16,471 3,450

Cash and cash equivalents at end of period 50,089$ 21,071$


CLEVELAND CLINIC HEALTH SYSTEM NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS FOR THE PERIOD ENDED SEPTEMBER 30, 2011

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1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal and recurring nature. Operating results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the year ending December 31, 2011. For further information, refer to the audited financial statements and notes thereto for the year ended December 31, 2010. 2. Organization and Consolidation

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

The System is the leading provider of healthcare services in northeast Ohio. The System operates eleven hospitals with approximately 3,500 staffed beds. Ten of the hospitals are located in the Cleveland metropolitan area, anchored by the Foundation. The System operates nineteen outpatient family health centers, including eight ambulatory surgery centers, as well as a large number of physician offices, which are located throughout a seven-county area of northeast Ohio. In addition, the System operates a hospital and a clinic in Weston, Florida, health and wellness centers in West Palm Beach, Florida and Toronto, Canada, and a specialized neurological clinical center in Las Vegas, Nevada. Pursuant to agreements, the System also provides management services for Ashtabula County Medical Center, located in Ashtabula, Ohio with approximately 180 staffed beds, and in cooperation with Abu Dhabi Health Services Company, the Sheikh Khalifa Medical City, a network of healthcare facilities in Abu Dhabi, United Arab Emirates with approximately 760 staffed beds.

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

3. Accounting Pronouncements

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


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3. Accounting Pronouncements (continued)

In July 2011, the FASB issued authoritative guidance related to the presentation and disclosure of patient service revenue, provision for bad debts, and the allowance for doubtful accounts for certain health care entities. The amendments require certain health care entities to change the presentation of their statement of operations by reclassifying the provision for bad debts associated with patient service revenue from an operating expense to a deduction from patient service revenue. Additionally, those health care entities are required to provide enhanced disclosure about their policies for recognizing revenue and assessing bad debts. The amendments also require disclosures of patient service revenue by major payor source as well as qualitative and quantitative information about changes in the allowance for doubtful accounts. The guidance will become effective for the System for fiscal years and interim periods beginning after December 31, 2011, with early adoption permitted. The amendments to the presentation of the provision for bad debts related to patient service revenue in the statement of operations should be applied retrospectively to all prior periods presented. The disclosures required by the amendments should be provided for the period of adoption and subsequent reporting periods. The System is currently evaluating the new guidance and will make changes as required on or before the effective date.

4. 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. Estimates also affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

5. Reclassifications

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

6. Fair Value Measurement

The carrying values of accounts receivable and accounts payable are reasonable estimates of fair value due to the short-term nature of these financial instruments. Investments, other than alternative investments, are recorded at their fair value. The fair value of the System’s pledges receivable based on discounted cash flow analysis and adjusted for consideration of the donor’s credit was $205.0 million and $220.9 million at September 30, 2011 and December 31, 2010, respectively. The carrying amount of the System’s pledges receivable was $205.7 million and $220.5 million at September 30, 2011and December 31, 2010, respectively. The fair value of the System’s long-term debt, as estimated by discounted cash flow analyses using current borrowing rates for similar types of borrowing arrangements and adjusted for the System’s credit, was $2,640 million and $2,593 at September 30, 2011 and December 31, 2010, respectively. The carrying amount of the System’s long-term debt was $2,504 million and $2,546 at September 30, 2011 and December 31, 2010, respectively. Other noncurrent assets and liabilities have carrying values that approximate fair value.


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6. Fair Value Measurement (continued)

Fair value measurements are defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

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

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

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

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

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


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The following tables present the financial instruments measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010, based on the valuation hierarchy (in thousands):

September 30, 2011 Level 1 Level 2 Level 3 Total Assets Securities lending collateral $ 95 $ – $ – $ 95 Cash and cash equivalents 50,089 – – 50,089 Investments:

Cash and cash equivalents 173,018 15 – 173,033 Fixed income securities: U.S. treasuries 788,787 – – 788,787 U.S. government agencies – 11,662 – 11,662 U.S. corporate – 206,615 – 206,615 U.S. government agencies asset-backed – 10,789 – 10,789 Corporate asset-backed – 6,198 – 6,198 Foreign – 35,701 – 35,701 Common and preferred stocks U.S. 485,601 3,911 – 489,512 Foreign 280,797 2 – 280,799 Common collective trusts: Fixed income – 458,977 – 458,977 Equity – 463,951 – 463,951 Less securities under lending agreement (97) – – (97)

Total investments 1,728,106 1,197,821 – 2,925,927 Perpetual and charitable trusts – 66,691 – 66,691 Investments under securities lending agreement 97 – – 97 Total assets at fair value $1,778,387 $1,264,512 $ – $3,042,899

Liabilities Interest rate swaps $ – $ 177,030 $ – $ 177,030


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December 31, 2010 Level 1 Level 2 Level 3 Total Assets Securities lending collateral $ 153 $ – $ – $ 153 Cash and cash equivalents 16,471 – – 16,471 Investments:

Cash and cash equivalents 258,384 116,970 – 375,354 Fixed income securities: U.S. treasuries 692,108 – – 692,108 U.S. government agencies – 90,844 – 90,844 U.S. corporate – 258,976 – 258,976 U.S. government agencies asset-backed – 9,893 – 9,893 Corporate asset-backed – 1,334 – 1,334 Foreign – 29,189 – 29,189 Common and preferred stocks: U.S. 561,384 2,355 – 563,739 Foreign 289,101 – – 289,101 Common collective trusts: Fixed income – 453,209 – 453,209 Equity – 414,112 – 414,112 Less securities under lending agreement (154) – – (154)

Total investments 1,800,823 1,376,882 – 3,177,705 Perpetual and charitable trusts – 87,383 – 87,383 Investments under securities lending agreement 154 – – 154 Total assets at fair value $1,817,601 $1,464,265 $ – $3,281,866

Liabilities Interest rate swaps $ – $ 86,438 $ – $ 86,438

Financial instruments at September 30, 2011 and December 31, 2010, are reflected in the consolidated balance sheets as follows (in thousands):

September 30 2011

December 31 2010

Cash, cash equivalents, and investments measured at fair value $ 2,976,113 $ 3,194,330 Alternative investments accounted for under the equity method 1,214,386 1,040,937 Total cash, cash equivalents, and investments $ 4,190,499 $ 4,235,267 Perpetual and charitable trusts measured at fair value $ 66,691 $ 87,383 Interests in foundations 44,997 43,430 Trusts and interests in foundations $ 111,688 $ 130,813

See Note 7 for location of interest rate swap liabilities in the consolidated balance sheets.


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

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

The fair value of perpetual and charitable trusts in which the System receives periodic payments from the trust is determined based on the present value of expected cash flows to be received from the trust using discount rates ranging from 3.8% to 5.0%, which are based on Treasury yield curve rates. The fair value of charitable trusts in which the System is a remainder beneficiary is based on the System’s beneficial interest in the investments held in the trust, which are measured at fair value.

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

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

7. Interest Rate Swaps

The System’s objective with respect to interest rate risk is to manage the risk of rising interest rates on the System’s variable-rate debt and certain variable-rate operating lease payments. Consistent with its interest rate risk management objective, the System entered into various interest rate swap agreements with a total outstanding notional amount of $648.8 million and $659.7 million at September 30, 2011 and December 31, 2010, respectively. During the term of these transactions, the System pays interest at a fixed-rate and receives interest at a variable-rate based on the London Interbank Offered Rate (LIBOR) or the Securities Industry and Financial Markets Association Index (SIFMA). The swap agreements are not designated as hedging instruments. Net interest paid or received under the swap agreements is included in derivative gains (losses) on the consolidated statements of operations.


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7. Interest Rate Swaps (continued)

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

Notional Amount at Expiration September 30 December 31

Swap Type Date System Pays System Receives 2011 2010

Fixed 2013 5.90% 100% of LIBOR $ 2,845 $ 4,155 Fixed 2016 5.28% 100% of SIFMA 18,700 21,880 Fixed 2021 3.21% 68% of LIBOR 40,430 41,765 Fixed 2024 3.42% 68% of LIBOR 30,100 30,500 Fixed 2027 3.56% 68% of LIBOR 146,293 149,485 Fixed 2028 5.12% 100% of LIBOR 43,425 44,220 Fixed 2028 3.51% 68% of LIBOR 33,215 33,705 Fixed 2030 5.07% 100% of LIBOR 62,500 62,500 Fixed 2030 5.06% 100% of LIBOR 62,500 62,500 Fixed 2032 4.32% 79% of LIBOR 2,704 2,741 Fixed 2032 4.33% 70% of LIBOR 5,408 5,483 Fixed 2032 3.78% 70% of LIBOR 2,704 2,741 Fixed 2036 4.90% 100% of LIBOR 50,000 50,000 Fixed 2036 4.90% 100% of LIBOR 79,375 79,375 Fixed 2037 4.62% 100% of SIFMA 68,600 68,600

$ 648,799 $ 659,650 The following table summarizes the location and amounts of the values for the System’s interest rate swap agreements (in thousands):

Liability Derivatives September 30, 2011 December 31, 2010 Derivatives not designated as hedging instruments

Balance Sheet Location Fair Value

Balance Sheet Location Fair Value

Interest rate swap agreements Other noncurrent liabilities $ 177,030

Other noncurrent liabilities $ 86,438


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7. Interest Rate Swaps (continued)

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

Quarter ended Nine months ended Derivatives not designated Location of

September 30 September 30

as hedging instruments Loss Recognized 2011 2010 2011 2010 Interest rate swap agreements Derivative losses ($93,957) ($36,303) ($110,989) ($107,559)

The System has used various derivative contracts in connection with certain prior obligations and investments. Although minimum credit ratings are required for counterparties, this does not eliminate the risk that a counterparty may fail to honor its obligations. Derivative contracts are subject to periodic “mark-to-market” valuations. A derivative contract may, at any time, have a positive or negative value to the System. In the event that the negative value reached certain thresholds established in the derivative contracts, the System is required to post collateral, which could adversely affect its liquidity. At September 30, 2011 and December 31, 2010, the System posted $109.6 million and $33.9 million, respectively, of collateral that is included in funds held by trustee in the consolidated balance sheets. In addition, if the System were to choose to terminate a derivative contract or if a derivative contract were terminated pursuant to an event of default or a termination event as described in the derivative contract, the System could be required to pay a termination payment to the counterparty. 8. Pensions and Other Postretirement Benefits

The System has two defined benefit pension plans, including the CCHS Retirement Plan, which cover substantially all of the System’s employees. The benefits provided are based on age, years of service and compensation. The System’s policy is to fund at least the minimum amounts required by the Employee Retirement Income Security Act.

The CCHS Retirement Plan ceased benefit accruals as of December 31, 2009 for all employees, except those participating in a union, employed at Medina Hospital, or on long-term disability. Benefit accruals ceased as of December 31, 2010 for all Medina Hospital employees.

The System sponsors two noncontributory defined contribution plans, including the Cleveland Clinic Investment Pension Plan (IPP). The IPP covers substantially all of the System’s employees. The System’s contribution for the IPP is based upon a percentage of employee compensation and years of service. The System also sponsors a noncontributory, defined contribution plan, which covers certain of its employees. The System’s contribution to the plan is based upon a percentage of employee compensation, as defined, determined according to age.

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


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8. Pensions and Other Postretirement Benefits (continued)

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

2011 2010 2011 2010Amounts related to defined benefit pension plans:

Service cost 288$ 696$ 863$ 2,089$ Interest cost 18,764 18,224 56,293 54,672 Expected return on assets (19,291) (19,663) (57,872) (58,991) Net amortization and deferral 7,961 6,049 23,882 18,146

Total defined benefit pension plans 7,722 5,306 23,166 15,916 Defined contribution plans 39,568 37,550 123,909 115,727

47,290$ 42,856$ 147,075$ 131,643$

Quarter Ended September 30 Nine Months Ended September 30

As of September 30, 2011, the System has made contributions of $38.7 million to the defined benefit pension plans. The System expects to make additional contributions of $9.0 million to the defined benefit pension plans for the remainder of 2011.

9. Special Charges

In 2011, the System incurred and recorded special charges of $27.8 million related to exit and disposal costs associated with the closing of Huron Hospital (Huron). Special charges include $13.4 million of accelerated depreciation expense resulting from the closing of the Huron facilities. In August 2011, the System ceased inpatient, emergency and trauma services at Huron. Outpatient services remained available at Huron until the opening of a new community health center in October 2011, which is located adjacent to the Huron campus. Services previously provided at Huron have been migrated to other System hospitals and to the new community health center.

10. Subsequent Events

The System evaluated events and transactions occurring subsequent to September 30, 2011 through November 29, 2011, the date the financial statements were issued. During this period, there were no subsequent events requiring recognition in the consolidated financial statements. Additionally, there were no nonrecognized subsequent events requiring disclosure, except that in November 2011, pursuant to certain agreements between the System and the State of Ohio (State) acting by and through the Ohio Higher Education Facility Commission, the State issued $195.7 million of fixed-rate Hospital Revenue Bonds (the Series 2011A Bonds), $41.1 million of fixed-rate Hospital Revenue Bonds (the Series 2011B Bonds), and $171.0 million of fixed-rate Hospital Revenue Bonds (the Series 2011C Bonds) for the benefit of the System. Proceeds from the sale of the Series 2011A Bonds and Series 2011C Bonds were used to refund $186.0 million and $152.3 million, respectively, of the outstanding fixed-rate Series 2003A Bonds, and proceeds from the sale of the Series 2011B Bonds were used to refund all of the outstanding fixed-rate Series 1999B Bonds.

CLEVELAND CLINIC HEALTH SYSTEM OTHER INFORMATION FOR THE PERIOD ENDED SEPTEMBER 30, 2011

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Unaudited Consolidating Balance Sheets ($ in thousands)

September 30, 2011Consolidating Consolidating

Obligated Non-Obligated Adjustments & Obligated Non-Obligated Adjustments &Group Group Eliminations Consolidated Group Group Eliminations Consolidated

AssetsCurrent assets:

Cash and cash equivalents -$ 50,089$ -$ 50,089$ -$ 16,471$ -$ 16,471$ Patient receivables, net 607,297 57,771 (13,389) 651,679 629,357 58,830 (10,454) 677,733 Due from affiliates 6,358 33,217 (39,575) - 51,707 9 (51,716) - Investments for current use 13,182 47,249 - 60,431 104,964 47,249 - 152,213 Other current assets 328,182 34,929 (1,545) 361,566 328,335 27,960 (734) 355,561

Total current assets 955,019 223,255 (54,509) 1,123,765 1,114,363 150,519 (62,904) 1,201,978

Investments:Long-term investments 3,285,312 213,645 - 3,498,957 3,119,056 250,769 - 3,369,825 Funds held by trustees 108,064 5,431 - 113,495 215,861 4,574 - 220,435 Assets held by captive insurance subsidiary - 145,410 - 145,410 - 173,757 - 173,757 Donor restricted assets 307,359 14,758 - 322,117 292,484 10,082 - 302,566

3,700,735 379,244 - 4,079,979 3,627,401 439,182 - 4,066,583

Property, plant, and equipment, net 2,825,534 440,189 - 3,265,723 2,693,850 441,476 - 3,135,326

Other assets:Pledges receivable, net 117,276 9,575 - 126,851 114,651 12,976 - 127,627 Trusts and beneficial interests in foundations 79,095 32,593 - 111,688 99,786 31,027 - 130,813 Other noncurrent assets 113,101 2,176 (2,770) 112,507 120,477 6,724 (5,770) 121,431

309,472 44,344 (2,770) 351,046 334,914 50,727 (5,770) 379,871

Total assets 7,790,760$ 1,087,032$ (57,279)$ 8,820,513$ $7,770,528 $1,081,904 ($68,674) $8,783,758

September 30, 2011Consolidating Consolidating


Liabilities and net assetsCurrent liabilities:

Accounts payable 230,656$ 29,641$ (223)$ 260,074$ 242,996$ 33,000$ (734)$ 275,262$ Compensation and amounts withheld from payroll 215,634 17,835 - 233,469 184,232 18,681 - 202,913 Estimated amounts due to third-party payors 21,873 4,794 - 26,667 37,662 5,708 - 43,370 Current portion of long-term debt 40,355 5,011 - 45,366 41,729 5,159 - 46,888 Variable rate debt classified as current 422,705 70,060 - 492,765 422,855 71,445 - 494,300 Due to affiliates 16,749 6,500 (23,249) - - 51,716 (51,716) - Other current liabilities 264,592 80,695 (13,420) 331,867 267,784 85,329 (10,454) 342,659

Total current liabilities 1,212,564 214,536 (36,892) 1,390,208 1,197,258 271,038 (62,904) 1,405,392 Long-term debt:

Hospital revenue bonds 1,954,690 16,358 - 1,971,048 1,990,582 18,987 - 2,009,569 Notes payable and capital leases 38,078 12,061 - 50,139 46,375 11,953 (5,000) 53,328

1,992,768 28,419 - 2,021,187 2,036,957 30,940 (5,000) 2,062,897

Other liabilities:Professional and general insurance liability reserves 57,177 81,754 - 138,931 72,059 101,121 - 173,180 Accrued retirement benefits 475,024 2 - 475,026 510,804 - - 510,804 Other noncurrent liabilities 420,523 21,265 (17,617) 424,171 316,459 4,482 - 320,941

952,724 103,021 (17,617) 1,038,128 899,322 105,603 - 1,004,925 Total liabilities 4,158,056 345,976 (54,509) 4,449,523 4,133,537 407,581 (67,904) 4,473,214

Net assets:Unrestricted 3,047,057 682,507 (2,770) 3,726,794 3,035,937 616,787 (770) 3,651,954 Temporarily restricted 375,085 35,855 - 410,940 401,349 35,475 - 436,824 Permanently restricted 210,562 22,694 - 233,256 199,705 22,061 - 221,766

Total net assets 3,632,704 741,056 (2,770) 4,370,990 3,636,991 674,323 (770) 4,310,544

Total liabilities and net assets 7,790,760$ 1,087,032$ (57,279)$ 8,820,513$ $7,770,528 $1,081,904 ($68,674) $8,783,758

December 31, 2010

December 31, 2010


Please refer to Management’s Discussion and Analysis for a listing of the hospitals in the obligated group.


11/29/2011 Page 18

Unaudited Consolidating Statements of Operations and Changes in Net Assets ($ in thousands) Operations

Consolidating ConsolidatingObligated Non-Obligated Adjustments & Obligated Non-Obligated Adjustments &

Group Group Eliminations Consolidated Group Group Eliminations Consolidated

Unrestricted revenuesNet patient service revenue 1,305,256$ 150,911$ (40,800)$ 1,415,367$ 1,233,076$ 142,667$ (32,008)$ 1,343,735$ Other 131,159 53,396 (24,380) 160,175 110,152 53,953 (25,791) 138,314 Total unrestricted revenues 1,436,415 204,307 (65,180) 1,575,542 1,343,228 196,620 (57,799) 1,482,049

ExpensesSalaries, wages, and benefits 770,459 89,583 (38,167) 821,875 694,986 85,892 (29,402) 751,476 Supplies 132,180 23,006 (138) 155,048 131,214 22,584 (322) 153,476 Pharmaceuticals 92,278 5,999 - 98,277 81,275 6,111 - 87,386 Purchased services 82,675 10,533 (3,096) 90,112 83,424 9,811 (3,267) 89,968 Administrative services 18,897 18,613 (5,726) 31,784 27,390 13,908 (5,382) 35,916 Facilities 63,085 13,082 (1,362) 74,805 63,319 12,759 (1,216) 74,862 Insurance 3,407 (35,954) (16,691) (49,238) 12,775 6,110 (18,210) 675 Provision for uncollectible accounts 85,546 12,552 - 98,098 61,484 11,495 - 72,979

1,248,527 137,414 (65,180) 1,320,761 1,155,867 168,670 (57,799) 1,266,738

Operating income before interest, depreciation, and amortization expenses 187,888 66,893 - 254,781 187,361 27,950 - 215,311

Interest 23,060 707 - 23,767 21,985 800 - 22,785 Depreciation and amortization 72,152 7,665 - 79,817 69,414 8,499 - 77,913 Operating income before special charges 92,676 58,521 - 151,197 95,962 18,651 - 114,613

Special charges 15,963 - - 15,963 - - - - Operating income 76,713 58,521 - 135,234 95,962 18,651 - 114,613

Nonoperating gains and lossesInvestment (loss) return (206,282) (15,015) - (221,297) 173,171 11,696 - 184,867 Derivative losses (93,150) (807) - (93,957) (32,539) (3,764) - (36,303) Other, net (208) (13) - (221) 306 (22) - 284 Net nonoperating gains and losses (299,640) (15,835) - (315,475) 140,938 7,910 - 148,848 (Deficiency) excess of revenues over expenses (222,927) 42,686 - (180,241) 236,900 26,561 - 263,461

Three Months Ended September 30, 2010Three Months Ended September 30, 2011


11/29/2011 Page 19

Unaudited Consolidating Statements of Operations and Changes in Net Assets (continued) ($ in thousands) Changes in Net Assets

ConsolidatingObligated Non-Obligated Adjustments &

Group Group Eliminations Consolidated

Total net assets at July 1, 2010 3,023,436 678,851 (2,120) 3,700,167 Excess of revenues over expenses 236,900 26,561 - 263,461 Donated capital, excluding assets released from restrictions for capital purposes 11 - - 11 Restricted gifts and bequests 15,278 127 - 15,405 Restricted net investment income 11,835 517 - 12,352 Net assets released from restrictions used for operations included in other unrestricted revenues (9,019) (2,441) - (11,460) Contributions from (to) affiliates - 437 (437) - Retirement benefits adjustment 7,008 - - 7,008 Net change in unrealized gains on nontrading investments 2,012 - - 2,012 Other (222) - - (222) Increase (decrease) in total net assets 263,803 25,201 (437) 288,567

Total net assets at September 30, 2010 3,287,239 704,052 (2,557) 3,988,734

(3,001,735) (660,982) 2,120 (3,660,597) Total net assets at July 1, 2011 3,880,559 699,771 (2,770) 4,577,560

(Deficiency) excess of revenues over expenses (222,927) 42,686 - (180,241) Donated capital, excluding assets released from restrictions for capital purposes 284 - - 284 Restricted gifts and bequests (3,804) (1,544) - (5,348) Restricted net investment loss (11,865) (247) - (12,112) Net assets released from restrictions used for operations included in other unrestricted revenues (16,923) (496) - (17,419) Retirement benefits adjustment 8,439 - - 8,439 Change in restricted net assets related to interests in foundations - 750 - 750 Net change in unrealized losses on nontrading investments (1,029) - - (1,029) Other (30) 136 - 106 (Decrease) increase in total net assets (247,855) 41,285 - (206,570)

Total net assets at September 30, 2011 3,632,704 741,056 (2,770) 4,370,990

See notes to unaudited consolidated financial statements. Please refer to Management’s Discussion and Analysis for a listing of the hospitals in the obligated group.


11/29/2011 Page 20

Unaudited Consolidating Statements of Operations and Changes in Net Assets ($ in thousands) Operations

Consolidating ConsolidatingObligated Non-Obligated Adjustments & Obligated Non-Obligated Adjustments &

Group Group Eliminations Consolidated Group Group Eliminations Consolidated

Unrestricted revenuesNet patient service revenue 3,850,804$ 448,536$ (121,885)$ 4,177,455$ 3,643,983$ 424,587$ (88,915)$ 3,979,655$ Other 350,212 163,019 (73,486) 439,745 303,414 162,409 (76,139) 389,684 Total unrestricted revenues 4,201,016 611,555 (195,371) 4,617,200 3,947,397 586,996 (165,054) 4,369,339

ExpensesSalaries, wages, and benefits 2,312,088 262,932 (114,240) 2,460,780 2,129,631 263,313 (81,452) 2,311,492 Supplies 389,391 67,903 (859) 456,435 397,955 63,746 (677) 461,024 Pharmaceuticals 262,253 18,016 - 280,269 236,239 18,174 - 254,413 Purchased services 233,018 29,910 (8,762) 254,166 241,729 31,478 (9,341) 263,866 Administrative services 55,332 57,879 (17,070) 96,141 83,586 46,506 (15,731) 114,361 Facilities 191,455 37,174 (4,366) 224,263 187,935 36,458 (3,223) 221,170 Insurance 37,535 3,403 (50,074) (9,136) 51,917 48,246 (54,630) 45,533 Provision for uncollectible accounts 235,907 38,449 - 274,356 174,417 32,578 - 206,995

3,716,979 515,666 (195,371) 4,037,274 3,503,409 540,499 (165,054) 3,878,854

Operating income before interest, depreciation, and amortization expenses 484,037 95,889 - 579,926 443,988 46,497 - 490,485

Interest 68,480 2,077 - 70,557 63,635 2,103 - 65,738 Depreciation and amortization 231,354 23,965 - 255,319 210,923 25,941 - 236,864 Operating income before special charges 184,203 69,847 - 254,050 169,430 18,453 - 187,883

Special charges 27,818 - - 27,818 - - - - Operating income 156,385 69,847 - 226,232 169,430 18,453 - 187,883

Nonoperating gains and lossesInvestment (loss) return (60,041) (3,652) - (63,693) 164,640 16,240 - 180,880 Derivative losses (108,558) (2,431) - (110,989) (98,700) (8,859) - (107,559) Other, net (201) (43) - (244) 290 (100) - 190 Net nonoperating gains and losses (168,800) (6,126) - (174,926) 66,230 7,281 - 73,511 (Deficiency) excess of revenues over expenses (12,415) 63,721 - 51,306 235,660 25,734 - 261,394

Nine Months Ended September 30, 2011 Nine Months Ended September 30, 2010


11/29/2011 Page 21

Unaudited Consolidating Statements of Operations and Changes in Net Assets (continued) ($ in thousands) Changes in Net Assets

ConsolidatingObligated Non-Obligated Adjustments &

Group Group Eliminations Consolidated

Total net assets at January 1, 2010 3,001,735$ 660,982$ (2,120)$ 3,660,597$ Excess of revenues over expenses 235,660 25,734 - 261,394 Donated capital, excluding assets released from restrictions for capital purposes 212 20 - 232 Restricted gifts and bequests 42,323 6,586 - 48,909 Restricted net investment income 13,315 655 - 13,970 Net assets released from restrictions used for operations included in other unrestricted revenues (18,801) (3,028) - (21,829) Contributions (to) from affiliates (10,506) 10,943 (437) - Retirement benefits adjustment 21,024 - - 21,024 Change in restricted net assets related to interest in foundations - 2,160 - 2,160 Net change in unrealized gains on nontrading investments 2,481 - - 2,481 Other (204) - - (204) Increase (decrease) in total net assets 285,504 43,070 (437) 328,137

Total net assets at September 30, 2010 3,287,239$ 704,052$ (2,557)$ 3,988,734$

Total net assets at January 1, 2011 3,636,991$ 674,323$ (770)$ 4,310,544$ (Deficiency) excess of revenues over expenses (12,415) 63,721 - 51,306 Donated capital, excluding assets released from restrictions for capital purposes 301 - - 301 Restricted gifts and bequests 16,652 888 - 17,540 Restricted net investment (loss) income (2,564) 246 - (2,318) Net assets released from restrictions used for operations included in other unrestricted revenues (25,220) (1,503) - (26,723) Transfers from (to) affiliates 322 1,678 (2,000) - Retirement benefits adjustment 25,317 - - 25,317 Change in restricted net assets related to interests in foundations - 1,567 - 1,567 Net change in unrealized losses on nontrading investments (6,716) - - (6,716) Other 36 136 - 172 (Decrease) increase in total net assets (4,287) 66,733 (2,000) 60,446

Total net assets at September 30, 2011 3,632,704$ 741,056$ (2,770)$ 4,370,990$



11/29/2011 Page 22

Unaudited Consolidating Statements of Cash Flows ($ in thousands)

Nine Months Ended September 30, 2011 Nine Months Ended September 30, 2010Consolidating Consolidating


Operating activities and net nonoperating gains and losses(Decrease) increase in total net assets (4,287)$ 66,733$ (2,000)$ 60,446$ 285,504$ 43,070$ (437)$ 328,137$ Adjustments to reconcile increase (decrease) in netassets to net cash provided by (used in) operating activities and net nonoperating gains and losses: Retirement benefits adjustment (25,317) - - (25,317) (21,024) - - (21,024) Net realized and unrealized losses (gains) on investments 109,195 5,831 - 115,026 (153,840) (15,135) - (168,975) Depreciation and amortization 244,743 23,965 - 268,708 210,923 25,941 - 236,864 Provision for uncollectible accounts 235,907 38,449 - 274,356 174,417 32,578 - 206,995 Donated capital (301) - - (301) (212) (20) - (232) Restricted gifts, bequests, investment income, and other (14,088) (2,701) - (16,789) (55,638) (9,401) - (65,039) Transfers (from) to affiliates (322) (1,678) 2,000 - 10,506 (10,943) 437 - Accreted interest and amortization of bond premiums (400) (119) - (519) (401) (119) - (520) Net loss in value of derivatives 90,592 - - 90,592 80,671 6,448 - 87,119 Changes in operating assets and liabilities: Patient receivables (213,847) (37,390) 2,935 (248,302) (178,125) (25,466) (1,250) (204,841) Other current assets 33,271 (41,975) (11,330) (20,034) (8,387) (37,442) (23,560) (69,389) Other noncurrent assets 8,810 4,487 (3,000) 10,297 10,822 608 433 11,863 Accounts payable and other current liabilities 14,355 (53,337) 26,012 (12,970) 15,270 (74,992) 44,031 (15,691) Other liabilities (12,923) (2,582) (17,617) (33,122) (25,540) 19,390 (19,217) (25,367) Net cash provided by (used in) operating activities and net nonoperating gains and losses 465,388 (317) (3,000) 462,071 344,946 (45,483) 437 299,900

Financing activitiesPrincipal payments on long-term debt (45,213) (4,173) 5,000 (44,386) (6,283) (3,977) - (10,260) Change in pledges receivable, trusts and interests - in foundations 30,297 3,633 - 33,930 (952) (3,016) - (3,968) Restricted gifts, bequests, investment income, and other 14,088 2,701 - 16,789 55,638 9,401 - 65,039 Net cash (used in) provided by financing activities (828) 2,161 5,000 6,333 48,403 2,408 - 50,811

Investing activitiesExpenditures for property and equipment (374,135) (24,011) - (398,146) (302,058) (25,356) - (327,414) Net change in cash equivalents reported in long-term investments 175,907 26,414 - 202,321 451,349 100,227 - 551,576 Purchases of investments (1,304,982) (97,876) - (1,402,858) (1,329,757) (159,869) - (1,489,626) Sales of investments 1,038,328 125,569 - 1,163,897 797,623 134,751 - 932,374 Transfers from (to) affiliates 322 1,678 (2,000) - (10,506) 10,943 (437) - Net cash (used in) provided by investing activities (464,560) 31,774 (2,000) (434,786) (393,349) 60,696 (437) (333,090)

Increase in cash and cash equivalents - 33,618 - 33,618 - 17,621 - 17,621 Cash and cash equivalents at beginning of year - 16,471 - 16,471 - 3,450 - 3,450

Cash and cash equivalents at end of year -$ 50,089$ -$ 50,089$ -$ 21,071$ -$ 21,071$



11/29/2011 Page 23

Utilization The following table provides selected utilization statistics for the obligated group: TOTAL OBLIGATED GROUP

Year Ended December 31 YTD September 302008 2009 2010 2010 2011

Total Staffed Beds 3,115 3,039 3,139 3,081 3,004

Percent Occupancy 74.4% 73.5% 71.2% 71.8% 67.9%

Inpatient Admissions Acute 129,597 130,429 129,737 97,797 94,448 Post-acute 13,880 12,951 11,861 8,866 8,761 Total 143,477 143,380 141,598 106,663 103,209

Patient Days Acute 696,329 699,265 696,239 522,631 508,025 Post-acute 125,151 119,545 94,317 71,276 67,173 Total 821,480 818,810 790,556 593,907 575,198

Surgical Facility Cases Inpatient 51,573 53,008 52,250 39,499 37,557 Outpatient 102,581 107,572 107,132 80,652 79,049 Total 154,154 160,580 159,382 120,151 116,606

Emergency Room Visits 329,071 346,936 345,912 261,885 263,013 Please refer to Management’s Discussion and Analysis for a listing of the hospitals in the obligated group.


11/29/2011 Page 24

Utilization (continued) The following table provides selected utilization statistics for The Cleveland Clinic Foundation:

THE FOUNDATIONYear Ended December 31 YTD September 30

2008 2009 2010 2010 2011Total Staffed Beds 1,202 1,214 1,239 1,248 1,261


Inpatient Admissions Acute 48,229 52,164 52,881 39,929 39,263 Post-acute 2,123 1,786 529 407 618 Total 50,352 53,950 53,410 40,336 39,881

Patient Days: Acute 311,248 339,155 345,857 258,366 251,338 Post-acute 21,876 18,821 3,006 2,448 4,826 Total 333,124 357,976 348,863 260,814 256,164

Average Length of Stay Acute 6.41 6.41 6.55 6.52 6.42 Post-acute 10.00 10.30 5.27 5.42 7.53


Emergency Room Visits 51,628 56,227 54,138 41,496 42,650

Outpatient Evaluation and Management Visits 1,790,230 1,923,913 2,032,041 1,528,750 1,750,983

Acute Medicare Case Mix Index 2.37 2.51 2.52 2.49 2.54

Total Acute Patient Case Mix Index 2.23 2.31 2.33 2.31 2.35 Please refer to Management’s Discussion and Analysis for a listing of the hospitals in the obligated group.


11/29/2011 Page 25

Utilization (continued) The following table provides selected utilization statistics for the Ohio community hospitals that are members of the obligated group: COMMUNITY HOSPITALS


Total Staffed Beds 1,913 1,825 1,900 1,833 1,743


Inpatient Admissions Acute 81,368 78,265 76,856 57,868 55,185 Post-acute 11,757 11,165 11,332 8,459 8,143 Total 93,125 89,430 88,188 66,327 63,328

Patient Days Acute 385,081 360,110 350,382 264,265 256,687 Post-acute 103,275 100,724 91,311 68,828 62,347 Total 488,356 460,834 441,693 333,093 319,034


Emergency Room Visits 277,443 290,709 291,774 220,389 220,363 Please refer to Management’s Discussion and Analysis for a listing of the hospitals in the obligated group.


11/29/2011 Page 26

Payor Mix The following table shows payor mix as a percentage of gross patient service revenue for the obligated group as a whole: OBLIGATED GROUPBased on Gross Patient Service Revenue


Payor

Managed Care and Commerical 47% 46% 44% 45% 44%

Medicare 41% 41% 42% 41% 42%

Medicaid 7% 8% 8% 8% 8%

Self-Pay & Other 5% 5% 6% 6% 6%

Total 100% 100% 100% 100% 100% Please refer to Management’s Discussion and Analysis for a listing of the hospitals in the obligated group.


11/29/2011 Page 27

Research Support ($ in thousands) The Clinic funds the annual cost of research from external sources, such as federal grants and contracts and contributions restricted for research, and internal sources such as contributions, endowment earnings and revenue from operations. The following table summarizes the sources of research support for the Clinic:

2008 2009 2010 2010 2011External Grants EarnedFederal Sources $100,221 $100,952 $104,947 $76,661 $84,029Non-Federal Sources 84,262 96,598 81,349 60,361 50,312

Total 184,483 197,550 186,296 137,022 134,341

Internal Support 68,914 71,408 61,374 46,752 50,140

Total Sources of Support $253,397 $268,958 $247,670 $183,774 $184,481

Year Ended December 31 YTD September 30


11/29/2011 Page 28

Key Ratios The following table provides selected key ratios for the System as a whole:

2008 2009 2010 2010 2011

Liquidity ratiosDays of cash on hand 183 224 245 235 251 Days of revenue in accounts receivable 47 52 49 49 46

Coverage ratiosCash to debt (%) 106.9 111.5 130.0 122.7 138.7 Maximum annual debt service coverage (x) 3.0 4.3 4.8 4.4 5.5 Interest expense coverage (x) 6.2 10.1 9.1 8.4 9.7 Debt to cash flow (x) 6.6 4.0 3.6 4.0 3.1

Leverage ratioDebt to capitalization (%) 49.4 46.1 41.6 43.9 40.7

Profitability ratiosOperating margin (%) 4.7 6.4 4.3 4.3 4.9 Operating cash flow margin (%) 10.8 13.3 11.0 11.2 12.6 Excess margin (%) (9.2) 12.1 9.1 5.9 1.2 Return on assets (%) (5.9) 8.9 6.4 4.1 0.8

NOTES:Coverage and liquidity ratios are calculated using a 12-month rolling income statement.

YTD September 30Year Ended December 31

CLEVELAND CLINIC HEALTH SYSTEM MANAGEMENT’S DISCUSSION AND ANALYSIS FOR THE PERIOD ENDED SEPTEMBER 30, 2011

11/29/2011 Page 29

OVERVIEW The Cleveland Clinic Health System (System) is a world-renowned provider of healthcare services. In 2010, the System attracted patients from across the United States and from 126 other countries. The System is the leading provider of healthcare services in northeast Ohio. The System operates eleven hospitals with approximately 3,500 staffed beds. Ten hospitals are located in the Cleveland metropolitan area, anchored by The Cleveland Clinic Foundation (Clinic). The System operates nineteen outpatient Family Health Centers, including eight ambulatory surgery centers, as well as a large number of physician offices, which are located throughout a seven-county area of northeast Ohio. In addition, the System operates a hospital and a clinic in Weston, Florida, health and wellness centers in West Palm Beach, Florida and Toronto, Canada, and a specialized neurological clinical center in Las Vegas, Nevada. Pursuant to agreements, the System also provides management services for Ashtabula County Medical Center, located in Ashtabula, Ohio, with approximately 180 staffed beds, and in cooperation with Abu Dhabi Health Services Company, the Sheikh Khalifa Medical City (SKMC), a network of healthcare facilities in Abu Dhabi, United Arab Emirates with approximately 760 staffed beds.

CLEVELAND CLINIC HEALTH SYSTEM NORTHEAST OHIO SERVICE AREA AND FACILITIES


11/29/2011 Page 30

OVERVIEW (continued) The following table sets forth the number of staffed beds for the hospitals currently operated by the obligated group as well as the other entities in the System as of September 30, 2011:

Staffed Beds

OBLIGATEDCleveland Clinic 1,261Euclid Hospital 231Fairview Hospital 402Hillcrest Hospital 462Lutheran Hospital 182Marymount Hospital 256South Pointe Hospital 210

3,004NON-OBLIGATED

Children’s Hospital, Shaker 25Lakewood Hospital 250Medina Hospital 110Weston Hospital 155

540

HEALTH SYSTEM 3,544

SIGNIFICANT DEVELOPMENTS Expansion and Improvement Projects Due to the anticipated long-term growth in the demand for services and the desire to continually upgrade medical technology, the System is investing in facilities and equipment to better serve its patients. In October 2011, the System opened the Cleveland Clinic Stephanie Tubbs Jones Health Center in East Cleveland, Ohio at a cost of $25 million. The three-story 50,000-square foot community health center offers a variety of outpatient services, including primary and specialty care, specialized care for women and children, behavioral health & substance abuse services, as well as prevention, wellness and health education programs. The community health center emphasizes chronic disease management with a focus on diabetes, hypertension and kidney failure.


11/29/2011 Page 31

SIGNIFICANT DEVELOPMENTS (continued) In July 2011, the System opened the Twinsburg Family Health and Surgery Center in Twinsburg, Ohio at a cost of $96 million. The four-story 190,000 square foot facility offers advanced specialty and primary care, an outpatient surgery center, infusion suite for chemotherapy, full scale imaging center and a retail pharmacy. The facility is also the first family health center in the System to offer a 24-hour emergency department with a helipad. The family health center builds on the established network of System facilities in the Cleveland area and allows the System to better serve patients in Cleveland’s growing southeastern suburban communities.

In June 2011, the System completed a $9.5 million construction project to expand ambulatory surgical capabilities at the Wooster Family Health Center. The expansion adds 15,000 square feet to the existing facility and includes three operating rooms, numerous pre-surgical preparation and post-surgical recovery rooms, and an enhanced reception and waiting area for patients and visitors. The System also has the following expansion projects in progress:

Radiology Master Plan - This multi-year, multi-phase renovation and construction plan is aimed at fulfilling the growth needs of the Department of Radiology within the Imaging Institute. The project will consolidate and centralize magnetic resonant (MR) services in the Glickman Tower. The project also includes the renovation of vacated molecular functional imaging space into a patient preparation and recovery department. Additionally, the plan allows for a new outpatient entrance to the Department of Radiology and enhanced patient waiting and changing areas. Phase 1A of the project, the Interventional MR Surgical Suite, began in 2009 and was completed in 2010. The Suite combines high-field MR imaging with a surgical suite, which allows surgeons to take advantage of MR imaging in real time during surgical procedures. Phase 1B, the consolidation of MR services in the Glickman Tower, began in the fourth quarter 2010 and was completed in July 2011. Phase 2, the consolidation of CT services, is currently in the design phase, and construction is expected to begin in the first quarter of 2012. The project is expected to have a total of five phases.

Laboratory Upgrade & Expansion - In July 2010, construction began on a new 135,000-square foot building on the Clinic’s main campus to house the Pathology and Laboratory Medicine Institute. The new facility is expected to be completed in the fourth quarter of 2011 with activation and lab relocation completed by first quarter 2012. In addition to the construction project, the System is currently upgrading its laboratory technology to provide state of the art clinical services to the System hospitals in connection with detecting, diagnosing and treating diseases. The cost of the technology upgrades and construction is approximately $122 million.


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SIGNIFICANT DEVELOPMENTS (continued) Avon Family Health Center – Construction began in November 2009 on a new $92 million family health center in Avon, Ohio that will be called the Richard E. Jacobs Health Center. The four-story 180,000 square foot facility will offer primary care services and more than 30 specialty services. It will also house a large physical therapy area, an ambulatory surgery center, full scale imaging services, a pharmacy and a 24-hour emergency department with a helipad. The new facility is expected to be opened in December 2011 and will replace the current Avon Family Health Center and Westlake Family Health Center. Fairview Hospital Renovation & Expansion – In the first quarter of 2011, officials from Fairview Hospital and the Clinic broke ground on a $76 million construction project that includes replacement, renovation and expansion of Fairview’s emergency department (ED) and intensive care unit (ICU). The project includes 135,000 square feet of new building space on a site currently used for parking plus 25,000 square feet of renovated space. The new unit will ultimately include 52 ED beds, 26 ICU beds in private rooms, 12 renovated medical-surgical beds and new parking areas. The project is also designed to create a more attractive facility and a welcoming experience for patients and visitors. The first phase of the project, a parking deck adding 200 parking spaces, was completed in April 2011. The entire project is expected to be completed by the first quarter of 2013.

Marymount Hospital Surgical Replacement & Expansion – This $45 million construction project includes replacement and expansion of Marymount’s surgical suites and perioperative facilities. The project includes 43,000 square feet of new building space and 29,000 square feet of renovated space. Construction began in November 2010 and is expected to be completed in the second quarter of 2013. Lakewood Hospital Strategic Plan – Lakewood Hospital is currently implementing a strategic plan called Vision for Tomorrow. The plan encompasses a variety of changes to Lakewood Hospital to enhance patient care and respond to the changing needs of Cleveland’s western suburbs. As part of the Vision for Tomorrow plan, certain services at Fairview and Lakewood hospitals have been realigned. In June 2010 both inpatient pediatric and trauma services transitioned from Lakewood to Fairview with the support of the Lakewood City Council. The transitions facilitated the expansion of acute rehabilitation and older adult behavioral services at Lakewood. In the first quarter of 2011, Lakewood Hospital opened a newly-expanded 35-bed inpatient acute rehabilitation unit. Acute rehabilitation services at Fairview Hospital have been transitioned to Lakewood Hospital, and the new unit will be the hub of rehabilitation services for the System on the west side of Cleveland. In addition to traditional therapy, the center offers additional services such as horticulture, art, music, relaxation training, cooking classes and pet therapy. The continued effectiveness of the Vision for Tomorrow plan as a long-term strategy is being reviewed in light of economic developments that have occurred since the approval of the plan.


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SIGNIFICANT DEVELOPMENTS (continued)

Data Center – In 2010, the System began construction of a new data center in Brecksville, Ohio. The Brecksville data center will support the System’s information technology systems and will replace the System’s current data center in Cleveland. The new data center will enable the System to continue rapid adoption of strategic IT systems to improve patient experience, increase operational excellence and accommodate future growth of the System. Construction is expected to be completed in December 2011, and installation of servers and migration of data from the existing data center is expected to continue into late 2012.

Huron Hospital In June 2011, the System announced its intention to close Huron Hospital within 90 days. The decision to close Huron Hospital was carefully made after extensive analysis and evaluation by the System. Huron Hospital had been adversely impacted by a decrease in patient volume, population decline in the hospital’s community, and a trend toward outpatient instead of inpatient care. The System believes the new Cleveland Clinic Stephanie Tubbs Jones Health Center (STJ Health Center) in East Cleveland will better meet the needs of patients in the community. Inpatient, emergency and trauma services at Huron Hospital were discontinued on August 22, but outpatient services remained available at Huron Hospital until the opening of the STJ Health Center on October 3, 2011. Patients who need transportation for services other than those provided at the new STJ Health Center are able to access round-trip shuttle services from the Huron campus to the Clinic, Euclid, South Pointe and Hillcrest Hospitals. When the System announced the decision to close Huron Hospital, the Clinic worked with the City of East Cleveland to ease the impact of the closure on that community. Although not legally required to do so, the Clinic entered into an agreement with the City of East Cleveland that provides for financial support for the city based on lost payroll tax revenue over a five-year period. The Clinic will raze the Huron Hospital building and donate a majority of the property to the City of East Cleveland. Despite attempts to continue discussions with the City of Cleveland about area-wide emergency and trauma services following the closure of Huron Hospital, the City of Cleveland filed a lawsuit on June 29, 2011 in federal district court against the Clinic seeking to prevent the Clinic from closing emergency and trauma services at Huron Hospital. The Clinic promptly filed a motion to dismiss and believes that the City of Cleveland’s lawsuit is meritless. The City of Cleveland subsequently filed a motion for a temporary restraining order to prevent the closing of these services. On August 15, 2011, the federal district court denied that motion, and on September 9, 2011, the court granted the Clinic’s motion to dismiss the complaint. On October 6, 2011, the City of Cleveland appealed the court’s decision to dismiss the complaint. The appeal is still pending, and the Clinic strongly believes it will prevail. The appeal has had no affect on the closure and demolition of Huron Hospital, which is proceeding on schedule.


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SIGNIFICANT DEVELOPMENTS (continued) Financing Developments In November 2011, pursuant to certain agreements between the System and the State of Ohio (State) acting by and through the Ohio Higher Education Facility Commission, the State issued $195.7 million of fixed-rate Hospital Revenue Bonds (the Series 2011A Bonds), $41.1 million of fixed-rate Hospital Revenue Bonds (the Series 2011B Bonds), and $171.0 million of fixed-rate Hospital Revenue Bonds (the Series 2011C Bonds) for the benefit of the System. Proceeds from the sale of the Series 2011A Bonds and Series 2011C Bonds were used to refund $186.0 million and $152.3 million, respectively, of the outstanding fixed-rate Series 2003A Bonds, and proceeds from the sale of the Series 2011B Bonds were used to refund all of the outstanding fixed-rate Series 1999B Bonds. The Series 2011A Bonds and Series 2011C Bonds were assigned ratings of Aa2 and AA- by Moody’s Investor Services (Moody’s) and Standard & Poor’s (S&P), respectively. The Series 2011B Bonds are direct placement bonds, which were not rated by Moody’s or S&P. At the time the Series 2011A Bonds and Series 2011C Bonds were rated, Moody’s affirmed the Aa2 rating on the System’s obligated group outstanding debt and maintained their stable outlook. Moody’s cites various factors to support this rating and outlook, including a leading market position in northeast Ohio and strong patient demand, exceptional fundraising abilities, good operating margins, and strong unrestricted investment position. In its report, Moody’s stated the System’s national and international clinical reputation and wide patient draw support future growth and compensate for stagnant population trends in the Cleveland area. S&P also affirmed its AA- rating on the System’s obligated group outstanding debt and maintained their stable outlook. The System’s worldwide reputation for clinical excellence, unique national and global business position, and very strong operational management and financial profile contributed to the assigned rating and outlook. S&P also cites the System as being well positioned for health reform and the challenges stemming from an uncertain reimbursement environment. Challenges to the current rating include a slowing economy in northeast Ohio and the System’s debt leverage relative to the rating category. In August, Moody’s downgraded its bond rating for Lakewood Hospital Association (Lakewood), a non-obligated group affiliate of the System, from A3 to Baa2, and maintained its negative outlook at the lower rating level. The rating change impacts $13 million of Series 2003 Bonds issued through the City of Lakewood, Ohio. Moody’s report cites continued significant declines in admissions, large and escalating operating losses, and significant decreases in unrestricted cash as the basis for the downgrade. The negative rating outlook is driven by challenges in reversing volume losses and improving operating performance as well as concerns that Lakewood’s cash will continue to decline. The report indicates that Lakewood’s current credit profile suggests a lower credit rating, but its strong and integrated relationship within the System is factored into the current rating. The System continues to assess Lakewood’s challenges and identify opportunities for improvement.


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SIGNIFICANT DEVELOPMENTS (continued) Affiliations In the first quarter of 2011, the Clinic formed an Innovation Alliance with MedStar Health, a nine-hospital system that serves the Maryland and Washington, DC areas. Pursuant to the Innovation Alliance, MedStar Institute for Innovations will outsource to Cleveland Clinic Innovations, the commercialization arm of the Clinic, its technology and commercialization work. The immediate goal of the Alliance is for MedStar to utilize the Clinic’s comprehensive technology and commercialization experience to allow MedStar to turn their medical ideas into marketable inventions and commercial ventures. The integration of capabilities between the two organizations will be focused on development and rapid deployment of new technologies. Cleveland Clinic Innovations promotes scientific, clinical and administrative creativity throughout the Clinic and seeks commercial application of that creativity. Specifically, it helps to grow the Clinic’s innovative capacity, mentors inventors, creates spin-off companies, licenses technology, secures resources, and establishes strategic collaborations with corporate partners. Since 2000, 35 companies have been spun-off from the Clinic, with Cleveland Clinic Innovations transacting more than 260 technology licenses, filing 1,600 patents, and acting on more than 1,600 new inventions. In 2010, Cleveland Clinic Innovations opened a new 50,000 square foot Global Cardiovascular Innovation Center on the Clinic’s main campus, which is home to its operations as well as an incubator facility for 20 other companies. Also, Cleveland Clinic Innovations produced the widely noted Cleveland Clinic “Top 10 Medical Innovations” and launched a project to profile the innovation and commercialization functions at the top 100 health care institutions. In the first quarter of 2011, Intelect Medical, Inc., a Clinic spin-off company, was sold to Boston Scientific Corporation for $78 million. The Clinic’s share of the sale was $12.8 million, which was recorded as an equity investment in 2010. Intelect Medical is developing advanced neuromodulation technologies for deep brain stimulation therapy, which when combined with other Boston Scientific technologies is expected to improve the outcome for patients with neurological disorders and disabilities. Intelect Medical was incorporated in 2005 based on intellectual property developed at the Cleveland Clinic Center for Neurological Restoration and its Lerner Research Department of Biomedical Engineering. In the second quarter of 2011, the Clinic formed a collaboration with InnoCentive, an open innovation and crowdsourcing company that collaborates with organizations to solve problems by connecting them to the world’s largest and most diverse community of innovators. Managed by the Clinic’s Lerner Research Institute, the Cleveland Clinic Medical Innovation Pavilion went live in July on InnoCentive’s website presenting a series of challenges designed to advance patient care and biomedical research.


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SIGNIFICANT DEVELOPMENTS (continued) In the third quarter of 2011, the Clinic established heart-care affiliation partnerships with Novant Health’s Presbyterian Hospital and Forsyth Medical Center, both located in North Carolina. The affiliation with the two Novant hospitals is the first to include all aspects of cardiac care. The affiliation gives the Clinic the chance to extend the Cleveland Clinic reputation and brand while offering an opportunity to improve the quality of cardiac care at the two hospitals through access to and implementation of the Clinic’s nationally-recognized practices and protocols. In October of 2011, the Clinic signed a Memorandum of Understanding with Ohio University and its Heritage College of Osteopathic Medicine. The intent is to explore an academic collaboration that will expand both osteopathic medical and health sciences education at South Pointe Hospital and potentially other facilities within the System. Appointments Robert E. Rich has been elected Chair of the Board of Directors and the Board of Trustees, succeeding A. Malachi Mixon, III, who retired at the end of 2010. Mr. Rich joined the Board of Trustees in 2002 and the Board of Directors in 2005, serving as Vice Chair of the Board since June 2010. Mr. Rich is also the Chairman of Rich Products Corporation, a family-owned frozen foods manufacturer in Buffalo, New York. Rich Products operates in over 100 countries with sales revenue of more than $2.9 billion. Mr. Mixon served as a Trustee since 1990 and was elected Chair of the Board of Trustees in 1997. He served on the Board of Directors since 1992 and as the Chair from 2003 until his retirement. He was elected Chair Emeritus upon his retirement from the Board of Directors. Joseph M. Scaminace, Chair, President and CEO of the Cleveland-based OM Group, Inc replaced Mr. Rich as the Board of Directors’ Vice Chair. Mr. Scaminace joined the Board of Trustees in 1996 and the Board of Directors in 2000. The System has made several appointments to the hospital leadership team at Cleveland Clinic Abu Dhabi (CCAD). Marc Harrison, MD, has been appointed as the new Chief Executive Officer (CEO) of CCAD. Dr. Harrison joined the staff of Cleveland Clinic Children’s Hospital in 1999, serving as Medical Director of the pediatric ICU and Chairman of the Department of Pediatric Critical Care, and has most recently served as the Chief Medical Operations Officer of the Clinic. Tomislav Mihaljevic, MD has been appointed as the new Chief of Staff of CCAD. Dr. Mihaljevic will be replacing Dr. Robert Lorenz who has fulfilled his three year commitment to CCAD and will be returning to the System to continue his clinical practice. Other senior leadership appointed to CCAD include Calum Laurie, recruited from Australia, appointed as the new Chief Financial Officer, and Barbara Flinn, appointed as the new Chief Human Resources Officer. CCAD is expected to open at the end of 2013 as a full-service hospital.


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SIGNIFICANT DEVELOPMENTS (continued) Robert Wyllie, MD, has been appointed as Chief Medical Operations Officer of the Clinic to succeed Dr. Harrison. In this role, Dr. Wyllie will oversee Medical and Clinical Operations to best position Cleveland Clinic as an integrated delivery network that focuses on its patient-centered system of care. Dr. Wyllie joined the Clinic in 1981, and most recently served as Institute Chair of the Children’s Hospital and Pediatric Institute. Scott Knoer, PharmD, has been appointed Chief Pharmacy Officer for the Clinic. Mr. Knoer most recently served as the Director of Pharmacy at the University of Minnesota, where he was deeply involved in system integration, refreshing the pharmacy practice model, and support of safety, quality, patient experience and operational excellence. As the Clinic’s Chief Pharmacy Officer, Mr. Knoer will be responsible for the continued integration of the Clinic’s inpatient and outpatient pharmacy activities to achieve the best possible outcomes. David Levin, MD, has been appointed as Chief Medical Information Officer of the Clinic. In this role, Dr. Levin will lead teams responsible for the development and optimization of clinical information systems and their use in clinical settings to improve safety, quality and efficiency. Dr. Levin most recently served as Vice President of Medical Informatics for Sentara Healthcare in Virginia. Awards & Recognition The Cleveland Clinic was ranked as the fourth best hospital in the United States by U.S. News and World Report in its 2011-2012 edition of “America’s Best Hospitals.” This is the twenty-first consecutive year the Clinic was ranked sixth or better. In addition, the Clinic’s Heart and Vascular Institute, located on the Clinic’s main campus, was recognized as the best cardiology and heart surgery program in the United States, an honor the Clinic has received annually since 1994. The report also ranked twelve other Clinic medical specialties among the nation’s Top 10: digestive disorders (2), urology (2), kidney disorders (2), rheumatology (3), respiratory disorders (3), orthopaedics (4), gynecology (4), diabetes & endocrinology (5), neurology and neurosurgery (6), ear, nose & throat (8), and cancer (9). Cleveland Clinic Children’s Hospital ranked as one of the top pediatric hospitals in the country. The Children’s Hospital earned national rankings in 10 medical specialties including cancer, cardiology & heart surgery, diabetes & endocrinology, gastroenterology, neonatology, nephrology, neurology & neurosurgery, orthopaedics, pulmonology, and urology. The neurology & neurosurgery program ranked first in Ohio for the fourth consecutive year and seventh nationally. The publication also evaluated hospitals by metropolitan area. Only hospitals scoring in the top 25 percent among their peers in at least one of 16 medical specialties were included in the metropolitan area ranking. The Clinic was ranked as the best hospital in the Cleveland metropolitan area. The report also ranked eight other System hospitals among the top 17: Fairview Hospital (4), Hillcrest Hospital and South Pointe Hospital (tied for 5), Huron Hospital (9), Euclid Hospital, Lakewood Hospital, and Marymount Hospital (tied for 12), and Lutheran Hospital (16). Cleveland Clinic Florida ranked second of eighteen hospitals in the Miami-Fort Lauderdale metro area.


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SIGNIFICANT DEVELOPMENTS (continued) The Clinic was named an Energy Star Partner of the Year by the U.S. Environmental Protection Agency and the U.S. Department of Energy. The Energy Star program promotes energy efficiency practices that protect the environment through intelligent product design practices. The Clinic established the Office for a Healthy Environment in 2007 to expand and oversee environmental initiatives. These initiatives include implementation of a comprehensive recycling program throughout the System, development of new waste tracking tools and other environmental stewardship programs. The Clinic was named a member of the Environmental Leadership Circle by Practice Greenhealth, a national membership organization for healthcare facilities committed to environmentally responsible operations. This award recognizes healthcare facilities that set high standards for environmental practices in health care. To be considered for this prestigious award, facilities must meet the criteria for the mercury-free award, recycle at least 25% of their total waste stream, have implemented other innovative pollution prevention programs and be leaders in their community. Practice Greenhealth also recognized the System with 21 other honors for its main campus, family health centers and community hospitals. The Global Cardiovascular Innovation Center (GCIC) on the Clinic’s main campus has been awarded Leadership in Energy and Environmental Design (LEED) gold certification for its environmentally-responsible design and efficient operating systems. LEED is a third-party certification program and the nationally accepted benchmark for design, construction and operation of environmentally responsible and energy-efficient buildings. In addition to GCIC, the System has three LEED silver certified buildings located on the main campus and in Florida. The Heart Failure Intensive Care Unit (ICU) on the Clinic’s main campus has received the Beacon Award for Critical Care Excellence from the American Association of Critical Nursing (AACN). The Beacon Award was created by the AACN in 2003 to challenge acute and critical care nurses to improve inpatient care. The Beacon Award recognizes adult critical care, adult progressive care and pediatric critical care units that achieve high quality outcomes. There are an estimated 6,000 ICUs in the U.S, with approximately 240 receiving this award. Of the honorees, only four ICUs in Ohio were honored this year. The Clinic’s intestinal rehabilitation and transplant program recently received Centers for Medicare and Medicaid certification. This accreditation is only granted to transplant programs that meet strict volume and quality criteria. With the newly certified intestinal transplant program, Cleveland Clinic Transplant Center becomes one of the largest and most comprehensive transplant centers in the country and is able to offer all solid organ transplants along with composite tissue transplants. In the third quarter, Fairview Hospital was certified as a Primary Stroke Center by the Joint Commission and recognized as a leader in stroke care. The Joint Commission is an independent, not-for-profit organization and one of the leading standards-setting and accrediting bodies in health care. The System offers six Primary Stroke Centers including the Clinic (recertified in second quarter 2011), Fairview, Euclid, Hillcrest, Lakewood, and Marymount hospitals.


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SIGNIFICANT DEVELOPMENTS (continued) SKMC received re-accreditation by the Joint Commission International for the three year period from April 2011 through April 2014. The accreditation noted exceptional areas of quality, infection control, patient & family rights, and leadership. Cleveland Clinic Florida and Fairview Hospital were recognized as national winners in the Thomson Reuters 100 Top Hospitals National Benchmark study. Cleveland Clinic Florida was recognized in the Medium Community Hospital category and Fairview Hospital was recognized in the Teaching Hospital category. The study evaluated more than 2,900 short-term, acute care, non-federal U.S. hospitals in ten areas: mortality, medical complications, patient safety, average length of stay, expenses, profitability, patient satisfaction, adherence to clinical standards of care and post-discharge mortality and readmission rates for acute myocardial infarction, heart failure and pneumonia. It is the fourth time that both hospitals have been named a top 100 hospital by Thomson Reuters. The Clinic was ranked among the most trusted nonprofit organizations in America, according to results of the Harris Interactive EquiTrend annual brand equity poll. Harris Interactive, a global market research firm, conducted the survey online among more than 25,000 U.S. consumers earlier this year. The poll measured more than 1,200 brands across 53 different categories, including 87 nonprofit brands. The Clinic published its second report in May in fulfillment of its support of the United Nations Global Compact, the world’s largest voluntary corporate citizenship initiative. In 2008, the Clinic became the first healthcare provider in the world to sign the UN Global Compact. By signing, organizations voluntarily take responsibility for the impact of their activities on customers, suppliers, employees, communities, and other stakeholders, as well as the environment through sustainability and ethical business practices. The report provides data on the Clinic’s compliance with ten universal principles that the UN Global Compact asks companies to support. The Clinic was ranked as one of the country’s top five hospital systems by Diversity Inc., a national publication known for its “Top 50 Companies for Diversity”. The four areas measured include CEO commitment, human capital, corporate and organizational communications, and supplier diversity. The Clinic was recognized for its strong CEO commitment and strong supplier diversity program. The System has a diversity and inclusion department dedicated to providing strategic leadership for creating an inclusive organizational culture of patients, employees, business partners and the community. Initiatives focus on workforce demographics, education, pipeline development, economic development, economic initiatives/supplier diversity and cultural competency learning. The Cleveland Clinic’s Shape up and Go! Program received a 2011 Healthy Living Innovation Award in the Healthy Workplace (Large employer) category from the U.S. Department of Health and Human Services. This award highlights innovative health promotion projects that have demonstrated a significant impact on the health of the community.


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SIGNIFICANT DEVELOPMENTS (continued) In October, the Clinic hosted more than 1,000 attendees, including senior executives, investors, entrepreneurs and clinicians, at its ninth annual Medical Innovation Summit. This year’s summit titled “Cardiovascular Technologies, State of the Heart” included presentations and discussions on the latest breakthroughs in cardiovascular care and consideration of the challenges and opportunities of innovation in healthcare during a time of unprecedented change in medicine. Other conference topics included the most pressing cardiovascular care challenges, 2012 election and its impact on innovation, and investing in healthcare information technology. During the summit, the “Top 10 Medical Innovations for 2012” were announced. A panel of physicians and researchers from the Clinic selected devices and therapies for the list based on four criteria: significant potential for short-term clinical impact, high probability of success, ability and timing to market and sufficient data to support the nomination. Included in the Top 10 were catheter-based renal denervation to control resistant hypertension, CT scans for early detection of lung cancer, and concussion management systems for athletes. The Clinic’s police department has earned international accreditation from the Commission on Accreditation for Law Enforcement Agencies. The Clinic is only the second hospital in the country to earn this honor. This accreditation is considered the “gold standard” of requirements for law enforcement agencies worldwide and aims to improve the delivery of public safety services by maintaining standards developed by public safety practitioners that cover a range of up-to-date public safety initiatives. The Clinic’s Protective Services department also earned the number one spot in the Hospital/Medical Center category in Security Magazine’s “Security 500 Report”, an annual ranking of efficiency that benchmarks the security programs of five hundred organizations. The rankings covered nineteen different sectors with the Clinic being ranked first among sixty-six hospitals/medical centers.


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STRATEGIC INITIATIVES Cross-functional teams from across the System have identified strategic initiatives designed to ensure the System is well positioned for the future, including how to serve its communities in the most efficient manner possible. These initiatives, which are designed to achieve operational effectiveness and strategic positioning for the System, are aligned across four strategic themes, including value, growth, knowledge and citizenship. Value initiatives are focused on increasing the quality of healthcare while effectively managing the costs of providing healthcare with the goal of improving efficiency and patient experience. Growth initiatives are focused on core and non-core growth and integration that benefit the largest number of patients by cultivating new markets, products and services. Knowledge initiatives involve active support of research and innovation to discover new knowledge, and support of education to train medical professionals. Citizenship initiatives are designed to positively impact the health and wellness of the citizens in the communities served by the System. The following describes a few of the System’s initiatives: Physician Integration Since the Clinic’s beginnings in 1921, physicians have held the central role in the Clinic’s multidisciplinary healthcare delivery model. In 2010, the System focused on expanding this model to its community hospitals through three component programs: Institute Staff Model, Cleveland Clinic Quality Alliance, and Community Physician Partnership. The programs are designed to create a practice environment aligned around physician collaboration and common quality and practice standards. The Institute Staff Model focuses on fully integrating Clinic-employed physicians who practice in one or more of the System’s community hospitals into the Institute related to their specialty area. In addition, the model invites independent physicians to become employed as staff physicians. Staff physicians participate in the Institute-based processes designed to promote consistent and constantly improving healthcare. The Cleveland Clinic Community Physician Partnership (CPP) is the largest physician led organization in Northeast Ohio. It was established over 12 years ago to support independent physicians in their efforts to provide efficient, high quality patient care in a private practice setting. The CPP enables community physicians to decide whether to participate in certain managed care contracts that may also include the Clinic and its physicians, while still maintaining their private practices. The CPP expedites contract participation through a messenger model and provides administrative support with enrollment and credentialing processes for managed care health plans. The CPP also provides access to vendor-sponsored discounts for physician practice-associated goods and services, including office supplies, financial services and group professional liability coverage.


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STRATEGIC INITIATIVES (continued) The Quality Alliance is an important program within CPP that is offered to independent physicians. It was launched in 2010, to provide a mechanism through which independent physicians and employed Cleveland Clinic physicians can collaborate around quality and value. The goals of the Quality Alliance are to develop a network, led by its physician members that will improve quality and consistency of care, reduce costs and increase efficiency. By practicing in accordance with evidence-based clinical protocols and gaining performance feedback, physicians in the Quality Alliance will document and provide higher-quality and more efficient care. Recognizing this value, Medical Mutual of Ohio (MMO) signed an innovative agreement with CPP in June 2011, to implement evidence-based protocols and report quality outcomes. System Integration The System Integration Initiative involves coordinated efforts among clinical, operational, and administrative teams to allow the System to work as a single, integrated enterprise. The initiative includes aligning services across System facilities to provide an integrated system of care. In January, the System designated the Clinic, Euclid Hospital and Lakewood Hospital to serve as specialty centers for acute rehabilitation services. These three units are distributed across Northeast Ohio and centrally coordinated to provide high-quality, innovative rehabilitation services. In June, the System transitioned obstetrics deliveries at Marymount Hospital to Hillcrest and Fairview Hospitals. The transition consolidates obstetric delivery services for the System at four community hospitals in Northeast Ohio, including Fairview, Hillcrest, Lakewood and Medina Hospitals. In August, the System announced plans to move adult psychiatric and gero-pysch beds from South Pointe Hospital to Marymount Hospital. Construction has begun at Marymount and the change in service will be effective January 1, 2012. The transition expands psychiatric services already provided at Marymount Hospital. The System is currently in the midst of a five-year project to align revenue cycle support services and processes to support patients as they progress through their continuum of care. The Enterprise Administrative Patient Management (EAPM) project will consolidate thirteen different technology systems used for scheduling appointments, admissions and billings into one technology platform with the goal of improving patient experience. EAPM will cost approximately $134 million and will be implemented in phases beginning in the first quarter of 2012 with full implementation scheduled to be completed by 2014. Reducing the number of systems will improve patient service and employee efficiency.


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STRATEGIC INITIATIVES (continued) In 2009, the Clinic created the Cleveland Clinic Contact Center, a dedicated facility designed to standardize access for patients to schedule appointments with Clinic staff physicians. The process will be identical across Clinic institutes, and will create an integrated work environment that will allow patients to schedule appointments in multiple departments and institutes at different locations within the Clinic’s integrated system. The Contact Center is currently scheduling for ten institutes and is expected to be fully operational by the end of 2013. Enterprise Risk Management In 2010 the Clinic began a multi-phase enterprise risk management (ERM) initiative to develop a more formal systematic approach to the identification, assessment, prioritization, and reporting of risks. The process is closely linked with the System’s strategic and annual planning. The ultimate objective is to create an enterprise-wide risk management model that contains sustainable reporting and monitoring processes and embeds risk management into the Clinic culture, in order to more effectively mitigate risks. The Clinic established an ERM Steering Committee and engaged a consulting firm to assist in this project. The ERM Steering Committee has completed the risk identification phase creating a Clinic risk profile that categorizes individual risks based on their level of impact on its ability to meet its strategic objectives. In this phase, risks have been identified as top risks, which are further separated into sub-risks and mapped to established Clinic strategic initiatives. A formal governance structure has been established with work teams formed to perform extensive risk assessments and mitigation analysis. This is expected to be an on-going process. Financial Reporting In 2007, the Clinic began an initiative to evaluate its internal control environment and to create efficiencies in the System’s financial reporting processes. The initiative is based upon concepts established in the Sarbanes-Oxley Act of 2002 (SOX), even though the System is not subject to the provisions of SOX. The goals of the initiative are to ensure the integrity and reliability of financial information, strengthen internal control in the reporting process, reduce the risk of fraud and improve efficiencies in the financial reporting process. The initiative reviews all aspects of the financial reporting process, identifies potential risks and ensures that they have been mitigated utilizing a management self-assessment process. As a result of this initiative, management completed a certification of its internal controls over financial reporting as part of the issuance of its consolidated financial results for 2010, which is the second year the certification process was completed. More than 130 members of management, including top leadership, were involved in this certification. The Clinic is one of the first not-for-profit hospitals to issue a management report on the effectiveness of internal controls over financial reporting, a move that further increases the transparency of the organization. Management updates the certification on a quarterly basis. There were no changes in the internal control over financial reporting during the nine months ended September 30, 2011 that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting for the System.


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COMMUNITY BENEFIT AND ECONOMIC IMPACT Community Benefit As a charitable, tax-exempt healthcare organization, the System’s mission includes addressing health service needs and providing benefits to the communities it serves. The System must satisfy a community benefit standard to maintain its tax-exempt status. To measure the cost of the benefits the System provides to the community, the System uses the Catholic Health Association (CHA) community benefit model. The CHA model is the standard in community benefit reporting and is the basis for the standard adopted by the IRS for use in its Form 990, the information return required to be filed with the IRS by exempt organizations. In 2010, the System provided $537.4 million in benefits to the community.

Cleveland Clinic Health System* Breakdown of Total Community Benefit (2010)

$537.4 Million

* Includes all health system operations in Ohio and Florida. Florida represents approximately 3 percent

of total community benefit ** Net of HCAP benefit of $14 million Charity Care: Charity care represents the cost of providing free or discounted medically necessary care to patients unable to pay some or all of their bills. The System’s charity care policy provides free or discounted care to patients whose incomes are up to 400 percent of the federal poverty level. The charity care policy applies to both hospital care and services provided by the System’s employed physicians.


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COMMUNITY BENEFIT AND ECONOMIC IMPACT (continued) Medicaid Shortfall: The System is a leading provider of Medicaid services in Ohio. The Medicaid Program provides healthcare coverage for low-income families and individuals and is funded by both the state and federal governments. Medicaid shortfall represents the difference between the costs of providing care to Medicaid beneficiaries and the reimbursement received by the System. Subsidized Health Services: Subsidized health services yield low or negative margins but these programs are needed in the community. Subsidized health services within the System include pediatric programs, psychiatric/behavioral health programs, obstetrical services, chronic disease management and outpatient clinics. Outreach Programs: The System is actively engaged in a broad array of community outreach programs, including numerous initiatives designed to serve vulnerable and at-risk populations in the community. The System’s outreach programs include free health screenings, clinical services and wellness education. Outreach programs typically fall into three categories: community health services, cash and in-kind donations and community building. A few of the System’s community outreach initiatives are highlighted below:

• Health fairs provided thousands of people with free screenings for diabetes, cholesterol, heart disease, and prostate and other cancers. The Minority Men’s Health Fair, Universal Sisters, WomanKind and dozens of community health fairs highlighted the efforts of hundreds of System employees for preventative care.

• The Clinic’s Pathology & Laboratory Medicine Institute donated services to Cleveland area

safety-net providers The Free Clinic and Care Alliance.

• The Clinic’s Office of Civic Education Initiatives supports the region’s K-12 schools and offers a multifaceted approach to promote education, ranging from student internships and mentoring to in-kind and financial contributions.

Education: The System provides a wide range of high-quality medical education, including accredited training programs for residents, physicians, nurses and other allied health professionals. With more than 1,000 interns, residents and fellows, the System maintains one of the largest graduate medical education programs in the nation. At the postgraduate level, the System’s Center of Continuing Education has developed one of the largest and most diverse continuing medical education programs in the world. The System also operates Cleveland Clinic Lerner College of Medicine of Case Western Reserve University, dedicated to the teaching of physician-scientists. Allied health professionals are also recognized as important members of the healthcare team. In 2010, there were more than 1,400 students/rotations in 55 allied health education programs at System hospitals and facilities.


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COMMUNITY BENEFIT AND ECONOMIC IMPACT (continued) Research: In 2010, the System’s total expenditures on research activities were $194.3 million, partially offset by $133.5 million in grants and other funding, yielding a net community benefit of $60.8 million. From a community benefit perspective, medical research includes basic, clinical and community health research, as well as studies on healthcare delivery. Community benefits include research activities supported by government and foundation sources; corporate and other grants are excluded from community benefits. The System uses internal funding to cover shortfalls in outside resources for research. Economic Impact According to a 2010 Economic and Fiscal Impact Report released in 2011, the System is the largest employer in Northeast Ohio and the second largest employer in the State of Ohio with more than 41,000 employees. In 2009 the System generated $10.5 billion of the total economic activity in Ohio ($10.4 billion on a regional level), and has directly and indirectly supported more than 81,000 jobs generating approximately $4.0 billion in wages and earnings. The System’s economic activity was accountable for $663 million in total state and local taxes. System-supported households spent $2.3 billion on goods and services. Locally, the System’s economic activity within an eight-county region accounts for approximately eight percent of the total gross regional product. As a major part of the region’s growing healthcare industry, the System has contributed to the strengthening of Ohio’s economy for the past 90 years by sustaining and growing a strong workforce. In just the past decade, the System has spent $2.6 billion building 10 million square feet of new facilities and currently has more than $335 million of new facilities under construction. The System’s 2010 Economic and Fiscal Impact Report is the result of an economic analysis completed by the Cleveland-based Silverlode Consulting Corp. The report was commissioned in 2010 and uses 2009 data, the most current data available at that time. The report was completed in part using the IMPLAN® economic impact model, which is used by more than 1,000 public and private institutions to estimate economic and fiscal impacts. HEALTH INFORMATION TECHNOLOGY The Clinic has been a national leader in the innovative application of health information technology (HIT) systems. Through the development and application of HIT systems, the System is focusing on providing more cost effective healthcare and improving patient safety. HIT systems have received particular attention recently as part of the HITECH Act, a part of the American Recovery and Reinvestment Act of 2009 (Recovery Act).


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HEALTH INFORMATION TECHNOLOGY (continued) The Centers for Medicare & Medicaid Services (CMS) have recently implemented provisions of the Recovery Act that provide incentive payments for the meaningful use of certified electronic health record (EHR) technology. CMS has defined meaningful use in a three phase format with current criteria based on available technology capabilities and provider practice experience. The definition is expected to expand and become more robust in future years based on anticipated technologies and capabilities development. The Medicare EHR incentive program will provide incentive payments to eligible professionals, eligible hospitals, and critical access hospitals, as defined, that are meaningful users of certified EHR technology. In order to qualify for an incentive payment, eligible providers need to demonstrate meaningful use of the certified EHR by entering certain objectives and clinical quality measures and attesting that they have successfully demonstrated meaningful use via the CMS’ web-based Medicare EHR Incentive Program System. The Medicaid EHR incentive program will provide incentive payments to eligible professionals and hospitals for efforts to adopt, implement, and meaningfully use certified EHR technology. Providers are required to attest to the EHR requirements on the state’s Medicaid Provider Incentive Program. As of October 6, 2011, the System has successfully attested six hospitals and approximately 700 providers with Medicare and has attested nine hospitals with Medicaid. The attestation process will continue throughout the remainder of 2011 and in future years as required by the incentive program. The Clinic continues to implement improvements to its HIT systems including several components that can be accessed through its website. These components include:

• An electronic medical record system composed of an integrated suite of software modules that virtually align physical locations, physician expertise and nursing and care team skills into a single, coordinated group practice.

• A secure, on-line health management tool that connects patients to portions of their personalized health information.

• A secure, on-line system that allows physicians in private practice to become clinically integrated with the Clinic to treat their patients.

Certain of these services are currently provided by the System’s community hospitals, and the remaining services are currently being implemented. Seven of the System’s community hospitals and the Weston Hospital have fully implemented these services. Medina Hospital will implement these services in early 2012.


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HEALTH INFORMATION TECHNOLOGY (continued) The Clinic recently collaborated with The MetroHealth System, a public health system located in Cuyahoga County, Ohio to link their emergency departments’ electronic medical records (EMRs). This pilot project is the first towards connecting EMRs throughout both health systems. After proper patient authorization, the health systems have shared patient data electronically in approximately 200 cases. It is believed to have improved patient care by immediately providing more complete medical histories, eliminating the need for unnecessary diagnostic tests and allowing for faster and more accurate diagnosis. Sharing of EMRs is possible because both the Clinic and MetroHealth have an EMR system through Epic Corporation. Epic has created a program, the CareEverywhere network that allows the health systems to share records through proper patient authorization. Through this program, the Clinic and MetroHealth now have access to a network of 330 hospitals and clinics nationwide. CONFLICT OF INTEREST The System maintains policies that require internal reporting of outside financial and fiduciary interests to ensure that potential conflicts of interests do not inappropriately influence research, patient care, education, business or professional decision making. In connection with these policies, the System developed the Innovation Management and Conflict of Interest Program, which is designed to promote innovation while at the same time reducing, eliminating or managing real or perceived bias either due to System personnel consulting with pharmaceutical, medical device and diagnostic companies (industry) or the commercialization efforts undertaken by the System to develop discoveries and make them accessible to patients. The System is committed to a process that maintains integrity in innovation and places the interests of our patients first. A number of efforts related to this program are in progress or were recently completed:

• An initiative to bring transparency to the System’s relationships with industry was implemented in late 2008, in which the specific types of interactions that individual physicians and scientists have with industry were disclosed on publicly-accessible web pages on the System’s internet site. Information can be accessed by patients that describes the training, type of practice and accomplishments of a specific doctor or scientist, as well as the names of companies with which the doctor has financial or fiduciary relations as an inventor, consultant, speaker or board member. These disclosures were recently updated. The System is believed to be the first academic medical center in the country to make these interactions public. Many other academic medical centers have followed the System’s lead by providing similar disclosures.

• A committee is drafting new policies for the System pertaining to conflicts of interest in clinical

practice and education.


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CONFLICT OF INTEREST (continued)

• The Innovation Management and Conflict of Interest Committee of the System has established processes with cross-membership and seamless interactions and communications with the Board of Directors’ Conflict of Interest and Managing Innovations Committee.

• The Cleveland Clinic Innovators' Charitable Fund is being established to receive royalty

payments for System-developed devices that are purchased by the System. These royalties will be distributed to external charities.

INDUSTRY OUTLOOK In January 2011, Moody’s Investor Service (Moody’s) maintained its outlook for the U.S. not-for-profit healthcare sector as negative. Moody’s cites various factors to support its outlook. Slow economic recovery continues to have significant ramifications for the sector. High unemployment and the resulting loss of employer-sponsored insurance plans continue to drive lower patient volumes. In addition, revenue growth is expected to become increasingly difficult as hospitals face lower reimbursement rates from nearly all payors. Medicare is making no adjustment to reimbursement rates in federal fiscal years 2011 and 2012 due to presumed overpayments in prior years. Hospitals are also expected to face more repayments back to Medicare as a result of the expansion of Recovery Audit Contractors (RAC) reviews. State budget gaps along with the expected expiration of federal stimulus funding in 2011 put Medicaid rates at risk. Maintaining positive operating performance is further challenged as management teams have already made significant expense reductions; finding additional reductions will be difficult. Despite partial recovery in equity and credit markets, Moody’s expects hospitals to continue to face risks related to their debt structures and liquidity requirements. Although many hospitals took advantage of recent improvements in the debt capital markets, a significant dollar amount of standby bond purchase agreements and letters of credit are due for renewal in 2011 and 2012. In addition to challenges with debt structures, liquidity needs are likely to remain high due to increased capital spending, pension funding requirements, potential swap collateral requirements and new opportunities for physician employment and practice acquisitions. Finally, the rebound of the investment market, implementation of provider fees and ongoing trends towards mergers and acquisitions are cited as factors that have the ability to mitigate the challenges the sector faces.


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INDUSTRY OUTLOOK (continued) In January 2011, Standard & Poor’s (S&P) maintained its stable outlook for the U.S. not-for-profit health care sector. S&P cites the gradual economic recovery, cost containment and significant efforts to improve economies of scale, product and process standardization as factors supporting its outlook. The shift to more conservative balance sheet management two years ago is also cited for the outlook maintenance. Since the credit crisis of 2008-2009, many hospitals have shifted their debt from variable-rate structures to fixed-rate structures or short-term bank loans. Although fixed-rate debt is generally more expensive, its stability with its predictability of interest appears to appeal to many organizations. Despite the stable outlook, S&P cautions about the sector’s ability to sustain its progress. Like Moody’s, S&P points to declining inpatient volumes along with declining reimbursement rates as factors that will continue to put pressure on revenues. Expense management and consolidation strategies will help hospitals face short-term problems; however, these strategies will have limited effectiveness in the long-term unless the broader business model also changes. Healthcare reform continues to be a controversial issue as legal challenges to the legislation continue to abound and management teams attempt to prioritize their readiness strategies. Despite the controversy, S&P believes that many of the factors leading to reform such as growing uninsured and underinsured population, decline in employer-sponsored insurance plans, and the rising cost of insurance premiums remain and that no major actions will be taken in 2011 to derail healthcare reform. In August, Moody’s released its report of fiscal year 2010 medians for U.S. not-for-profit hospitals. Moody’s medians are based on audit results of 417 organizations. While the medians indicate revenue growth in 2010, the rate of growth was 4.0%, a 2.2% decline from 2009 and the lowest revenue growth rate in more than a decade. The report cites Medicare cuts resulting from the federal deficit as well as lower rate increases from commercial payers as they face their own increased regulatory requirements under federal reform as the primary reasons driving the lower revenue growth rates. Expense growth rates also declined in 2010, mainly due to aggressive cost control measures, resulting in margins that were relatively flat compared to 2009. With a more modest revenue growth rate, stable operating performance reflected in the median margins was driven by good expense controls. However, achieving further expense reductions may be more difficult going forward. Revenue growth is also challenged by a slightly negative median admissions growth rate, while several outpatient indicators showed declining growth rates. The report indicates that lower reimbursement rates, higher levels in uncompensated care, and declining median volume growth rates combined with an uncertain economy will continue to put pressure on the sector. Moody’s did note an increase in cash on hand due to rebound of the investment markets, increased cash flow generation, reduced capital spending and a reduction in median accounts receivable. In August, Standard & Poor’s released its report of U.S. Not-For-Profit Health Care System Fiscal 2010 Median Ratios. The median ratios are based on 2010 audited financial statements of 143 health care systems. The results show a broad improvement across most medians and rating levels, including gains in unrestricted liquidity and overall cash flow. Median operating margins were generally stable, and positive rating actions outpaced negative ratings actions for 2010. The report cites that the median trends and recent ratings actions support the near-term outlook for the sector, although the uncertainty of health care reform and related operating pressures make the medium- to long-term outlook more challenging.


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INDUSTRY OUTLOOK (continued) In a Moody’s Special Comment Report dated May 10, 2011, the rating agency discussed its view of how hospitals and health systems can better position themselves for healthcare reform. Moody’ believes that achieving positive financial performance and greater accountability for quality patient outcomes at lower costs are keys to success during the era of health care reform. Effective tools include information technology, physician alignment and effective management and governance. However, the report indicates that achieving these quality and cost goals can be challenging, especially in an environment of declining reimbursement, non-standardized measurements, growing competition, and the potential for new risk-sharing arrangements. The System continues to be impacted by industry challenges that put pressure on the System’s financial performance. Management is focused on the recruitment and retention of qualified staff in many clinical areas, particularly nursing, in order to meet the demands of patient activity. These efforts pressure the System’s salary cost structure, as well as employee benefit costs. Pharmaceutical costs and medical supply costs continue to create challenges to the cost structure. Increases in pharmaceutical costs are driven by utilization and price increases. Medical supply costs are primarily driven by utilization and price of implants. For both pharmaceuticals and medical supplies, a sizeable percentage of the cost increase flows through to increases in payments from payors; however, the balance cannot be passed through to payors. Additionally, the healthcare industry is subject to significant regulation by federal, state, and local governmental agencies and independent organizations and accrediting bodies, changes in technology and treatment modes, competition and changes in third-party reimbursement programs. The decline in the population of the Greater Cleveland area as noted in the 2010 census creates challenges among hospitals to attract the fewer available patients. Furthermore, although the System maintains a diversified investment portfolio, the System’s investments are subject to the inherent risk and volatility associated with global financial markets. The System continuously monitors the environment in which it operates and is engaged in various strategic initiatives to address its cost structure and reimbursement challenges.


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PATIENT VOLUMES The following table summarizes patient volumes for the System:

For the quarter ended For the nine months endedSeptember 30 September 30

2011 2010 Variance % 2011 2010 Variance %

Inpatient admissionsAcute admissions 36,298 38,483 -2,185 -5.7% 112,185 115,512 -3,327 -2.9%Post-acute admissions 3,294 3,433 -139 -4.0% 10,372 10,221 151 1.5%

39,592 41,916 -2,324 -5.5% 122,557 125,733 -3,176 -2.5%

Patient DaysAcute patient days 189,145 197,468 -8,323 -4.2% 581,147 593,759 -12,612 -2.1%Post-acute patient days 28,135 29,221 -1,086 -3.7% 88,121 89,329 -1,208 -1.4%

217,280 226,689 -9,409 -4.2% 669,268 683,088 -13,820 -2.0%

Surgical casesInpatient 14,601 15,530 -929 -6.0% 45,064 46,642 -1,578 -3.4%Outpatient 31,816 31,992 -176 -0.6% 95,524 97,707 -2,183 -2.2%

46,417 47,522 -1,105 -2.3% 140,588 144,349 -3,761 -2.6%

ER visits 111,583 113,245 -1,662 -1.5% 331,434 330,212 1,222 0.4%

Clinic Outpatient Evaluation and Management Visits 584,641 522,276 62,365 11.9% 1,750,983 1,528,750 222,233 14.5%

Overall, the System experienced a decrease in acute admissions in the third quarter and the first nine months of 2011, compared to the same periods in 2010. The 3% decrease in acute admissions for the first nine months of 2011 was driven by a 2% decrease at the Clinic, a 4% decrease at the community hospitals, and a 1% decrease at the Florida facilities. Excluding Huron Hospital, acute admissions for the first nine months of 2011 decreased 1% for the System and collectively for the community hospitals, compared to the prior year. Approximately 25% of acute admissions at the Clinic are transfer admissions, which are patients transferred from other hospitals or healthcare providers. Transfer admissions at the Clinic decreased 2% for the first nine months of 2011, compared to the same period in 2010. Excluding the Florida facilities, the System experienced a 3% decrease in acute admissions. In contrast, according to data from the Center for Health Affairs, acute discharges in northeast Ohio remained flat for the first nine months of 2011, compared to the same period in 2010. The Clinic has addressed capacity constraints over the last few years with the opening of the Miller Family Pavilion in late 2008. Occupancy at the Clinic has averaged 81% over the last two years, down from 86% in years 2008 and prior. The increased capacity has benefited patients by providing broader access to services and more efficient bed management, which resulted in patients bedded in on-service units and the capacity to allow further growth of the Cleveland Clinic Critical Care Transport Program.


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PATIENT VOLUMES (continued) Total surgical cases for the System decreased 2% in the third quarter and 3% the first nine months of 2011, compared to the same periods in 2010. The decrease in the first nine months was driven by a 6% decrease at the community hospitals, while the Clinic experienced a 1% increase and Florida experienced flat surgical cases. Excluding Huron Hospital, the community hospitals collectively reported a 5% decrease, with individual hospitals ranging from 2% to 13%. Inpatient surgical cases for the System decreased 3% in the first nine months of 2011, compared to the same period in 2010, due to decreases of 4% at the Clinic and 3% at the community hospitals. During the same time period, outpatient surgical cases for the System decreased 2% primarily due to an 8% decrease experienced collectively at the community hospitals. The Clinic and Florida facilities experienced an increase in outpatient surgical cases of 4% and 1%, respectively, in the first nine months of 2011, compared to the same period in 2010. Outpatient evaluation and management visits (E&M visits) at the Clinic increased 8% and 15% in the third quarter and the first nine months of 2011, respectively, compared to the same periods last year. The increase is primarily due to the physician integration initiative that has increased the number of Clinic-employed physicians that provide services in the System’s community hospitals. Excluding the activity related to these physicians, E&M visits increased 4% and 7% for the third quarter and first nine months of 2011, respectively, compared to the same periods in 2010. The following table summarizes selected information for Northeast Ohio hospitals:

Northeast Ohio Hospital Statistics

Nine months ended September 30 Market Share2011 2010 Variance % 2011 2010

Acute dischargesSystem hospitals (1) 107,797 111,127 -3,330 -3.0% 46% 48%Other hospitals (2) 125,656 122,560 3,096 2.5% 54% 52%

233,453 233,687 -234 -0.1% 100% 100%

Total surgical casesSystem hospitals (1) 132,144 137,102 -4,958 -3.6% 54% 55%Other hospitals (2) 110,889 112,574 -1,685 -1.5% 46% 45%

243,033 249,676 -6,643 -2.7% 100% 100%

Source: The Center for Health Affairs Volume Statistics(1) System hospitals excludes Florida facilities and includes Ashtabula County Medical Center.

(2) Other hospitals includes all other hospitals in northeast Ohio reported by the Center for Health Affairs that are not included in System hospitals.


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LIQUIDITY

Cash and Investments The System’s objectives for its investment portfolio are to target returns over the long-term that exceed the System’s capital costs so as to optimize its asset/liability mix and preserve and enhance its strong financial structure. The asset allocation of the portfolio is broadly diversified across global equity and global fixed income asset classes and alternative investment strategies, and is designed to maximize the probability of achieving the long-term investment objectives at an appropriate level of risk while maintaining a level of liquidity to meet the needs of ongoing portfolio management. This allocation is formalized into a strategic policy benchmark that guides the management of the portfolio and provides a standard to use in evaluating the portfolio’s performance. Investments are primarily maintained in a master trust fund administered using a bank as trustee. The management of the majority of the System’s investments is conducted by external investment management organizations that are monitored by management and a third-party external advisor. The System has established formal investment policies that support the System’s investment objectives and provides an appropriate balance between return and risk.

The following table sets forth the allocation of the System’s cash and investments at September 30, 2011 and December 31, 2010:

Cash and Investments (Dollars in thousands)

Cash and cash equivalents 223,122 5% 391,825 9% Fixed income securities 1,059,752 26% 1,082,344 26% Marketable equity securities 770,311 18% 852,840 20% Common collective trusts 922,928 22% 867,321 20% Alternative investments 1,214,386 29% 1,040,937 25%Total cash and investments 4,190,499 100% 4,235,267 100%Less restricted investments* (641,453) (848,971)

Unrestricted cash and investments 3,549,046$ 3,386,296$

Days cash on hand 251 245

*Restricted investments include funds held by trustees, assets held by captiveinsurance subsidiary and donor restricted assets.

December 31, 2010September 30, 2011

At September 30, 2011, total cash and investments for the System (including restricted investments) were $4.190 billion, a decrease of $45 million from $4.235 billion at December 31, 2010. Cash inflows consist of cash provided by operating activities net of related investment income of $347.0 million, and a net increase in restricted gifts and income of $50.7 million. Cash inflows were offset by capital expenditures of $398.1 million and scheduled principal payments on debt of $44.4 million.


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LIQUIDITY (continued) The System invests in alternative investments to increase the portfolio’s diversification. Alternative investments are primarily limited partnerships that invest in marketable securities, privately held securities, real estate, and derivative products and are reported using the equity method of accounting based on information provided by the respective partnership. Alternative investments at September 30, 2011 and December 31, 2010 consist of the following:

Alternative Investments (Dollars in thousands)

Hedge funds 818,704$ 67% 729,371$ 70% Private equity 213,266 18% 177,786 17% Real estate 140,909 12% 96,496 9% Venture capital 41,507 3% 37,284 4%Total alternative investments 1,214,386$ 100% 1,040,937 100%

December 31, 2010September 30, 2011

Alternative investments have varying degrees of liquidity provisions, and are generally less liquid than the traditional equity and fixed income classes of investments. Over time, investors may earn a premium return in exchange for this lack of liquidity. Hedge funds typically contain redeemable interests and offer the most liquidity of the alternative investment classes. These investment funds permit holders periodic opportunities to redeem interests at frequencies that can range from daily to annually, subject to lock-up provisions that are generally imposed upon initial investment in the fund. It is common, however, that a small portion (5-10%) of withdrawal proceeds are held back from distribution pending the fund’s annual audit, which can be up to a year away. Private equity, real estate, and venture capital funds typically have non-redeemable partnership interests. Due to the inherent illiquidity of the underlying investments, the funds generally contain lock-up provisions that prohibit redemptions during the fund’s life. Distributions from the funds are received as the underlying investments in the fund are liquidated. These investments have an initial subscription period, under which commitments are made to contribute a specified amount of capital as called for by the general partner of the fund. The System periodically reviews unfunded commitments to ensure adequate liquidity exists to fulfill anticipated contributions to alternative investments. Included in the System’s cash and investments are investments held by the System’s captive insurance company. These investments totaled $192.7 million as of September30, 2011, with an asset mix of 17% cash and short-term investments, 30% fixed-income securities, 41% common collective trusts and 12% alternative investments. The asset mix reflects the need for liquidity within the captive and the objective to maintain stable returns utilizing a lower tolerance for risk and volatility consistent with insurance regulatory requirements. The assets are invested using many of the same investment managers used in the System’s long-term investment portfolio.


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LIQUIDITY (continued) Also included in the System’s cash and investments are $126.7 million of funds held by trustees. Bond funds held by trustees totaled $5.5 million, comprised of debt service reserve funds of $4.6 million, and funded principal and interest accounts of $0.9 million. Debt service reserve funds relate to bond series associated with hospitals that are not part of the obligated group. Funds held by trustees also include $121.2 million of posted collateral. Collateral is comprised of $11.6 million related to a futures and options program within the System’s investment portfolio and $109.6 million related to the System’s derivative contracts. The derivative contracts require that collateral be posted when the market value of a contract in a liability position exceeds a certain threshold. The collateral is returned as the liability is reduced. Investment objectives of funds held by the trustees are designed to preserve principal by investing in highly liquid cash or fixed-income investments. At September 30, 2011, the asset mix of funds held by trustees was 11% cash and short-term investments and 89% fixed-income securities. Below is a comparison of the allocation of the System’s cash and investments in total and excluding the investments held by the captive insurance company and funds held by trustees:

Cash and Investments (Dollars in thousands)

Cash and cash equivalents 223,122 5% 176,525 5%Fixed income securities 1,059,752 26% 889,531 23%Marketable equity securities 770,311 18% 769,339 20%Common collective trusts 922,928 22% 843,969 22%Alternative investments 1,214,386 29% 1,191,799 30%

Total cash and investments 4,190,499$ 100% 3,871,163$ 100%

September 30, 2011

System TotalExcluding Captive Assets and

Funds Held by Trustees


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

Total investment return for the System is comprised of the following:

Investment Return (Dollars in thousands)

2011 2010 2011 2010

Other unrestricted revenue:Interest income and dividends 512$ 461$ 1,897$ 1,395$

Nonoperating (losses) gains, net:Interest income and dividends 10,863 8,149 38,353 25,434 Net realized gains on sales of investments 21,446 12,166 69,912 33,228 Net change in unrealized (losses) gains on investments (236,743) 159,966 (182,578) 105,313 Equity method (loss) income on alternative investments (16,863) 4,586 10,620 16,905

(221,297) 184,867 (63,693) 180,880 Other changes in net assets:

Net change in unrealized (losses) gains on nontrading (1,029) 2,012 (6,716) 2,481 Investment (loss) income on restricted investments (12,112) 12,352 (2,318) 13,970

Total investment (loss) return (233,926)$ 199,692$ (70,830)$ 198,726$

For the quarterended September 30

For the nine monthsended September 30


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LIQUIDITY (continued) Long-term Debt At September 30, 2011, outstanding hospital revenue bonds for the System totaled $2.493 billion, of which $1.799 billion (72%) is related to fixed-rate bonds and $694 million (28%) is related to variable-rate bonds. The System utilizes various interest rate swap derivative contracts to manage the risk of increased debt service resulting from rising market interest rates on variable-rate bonds and certain variable-rate operating lease payments. Using an interest rate benchmark, these contracts convert variable-rate debt to a fixed-rate, which further reduces the System’s exposure to variable interest rates. The derivative contracts can be unwound by the System at any time, whereas the counterparty has the option to unwind the derivative contracts only upon an event of default as defined in the contracts. Approximately $282 million of the variable-rate bonds are secured by irrevocable direct pay letters of credit or standby bond purchase agreements. Bonds supported by letters of credit that expire within one year or contain a subjective clause which, if declared by the lender, could cause immediate repayment of the bonds are classified as current liabilities. The remaining $412 million variable-rate bonds are supported by the System’s self-liquidity program. Bonds supported by self-liquidity include $100 million remarketed in daily mode and $312 million remarketed in commercial paper mode. Commercial paper bonds are structured with various term dates so that no more than $50 million of bonds mature within a five-day period. Bonds supported by self-liquidity are classified as current liabilities. Combined current aggregate scheduled principal payments by calendar year, assuming the remarketing of the variable-rate bonds are as follows (in thousands): 2011 – $41,640; 2012 – $40,560; 2013 – $42,470; and 2014 – $44,637; and 2015 – $48,905. The System has paid $40.7 million of scheduled principal payments in 2011.


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LIQUIDITY (continued) Outstanding hospital revenue bonds for the System as of September 30, 2011 and December 31, 2010 consist of the following:

Hospital Revenue Bonds(Dollars in thousands)

Series Beneficiary TypeFinal

MaturitySeptember 30

2011December 31

20102009A CCHS Obligated Group Fixed 2039 306,400$ 306,400$ 2009B CCHS Obligated Group Fixed 2039 482,830 498,550 2008A CCHS Obligated Group Fixed 2043 452,340 452,340 2008B CCHS Obligated Group Variable 2043 370,000 370,000 2007A Keep Memory Alive Variable 2037 68,600 68,600 2007B Keep Memory Alive Variable 2013 2,845 4,155 2004B CCHS Obligated Group Variable 2039 200,000 200,000 2003A CCHS Obligated Group Fixed 2032 496,735 513,970 2003C CCHS Obligated Group Variable 2035 41,905 41,905 2003 Lakewood Hospital Fixed 2015 13,100 15,475 2002 CCHS Obligated Group Variable 2032 11,005 11,155 1999B CCHS Obligated Group Fixed 2031 41,120 45,010 1998 Medina Hospital Fixed 2016 6,160 6,160

2,493,040$ 2,533,720$

In November 2011, fixed-rate hospital revenue bonds were issued for the benefit of the System. These bonds were used to refund a portion of the Series 2003A bonds and all of the Series 1999B bonds. For a complete description of the bonds issued in 2011, refer to “Significant Developments – Financing Developments.” BOND COVENANTS The System is subject to certain restrictive covenants, including provisions relating to certain debt ratios, days cash on hand and other matters. The obligated group was in compliance with these covenants at September 30, 2011. Lakewood Hospital Association (Lakewood), a non-obligated affiliate of the System, was not in compliance with the debt service coverage covenant as of December 31, 2010 as it relates to the Series 2003 Lakewood bonds. Non-compliance requires corrective action but is not considered an event of default under the debt agreement. Lakewood is implementing corrective action in accordance with the provisions of the Lakewood debt agreement.


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BOND COVENANTS (continued) The following table presents certain key ratios for the obligated group and the associated covenant requirement:

September 30 December 312011 2010 Covenant

Actual Actual RequirementDays cash on hand 251 248 >100Debt to capitalization ratio 45% 45% <60%Maximum annual debt service coverage 4.72x 4.40x >1.25x

(Obligated Group Only)Key Ratios

BOND RATINGS The obligated group’s outstanding bonds have been assigned ratings of Aa2 (stable outlook) and AA- (stable outlook) by Moody’s and S&P, respectively. These ratings were affirmed in October 2011. The following table lists the various bond rating categories for Moody’s and S&P:

Bond Ratings

Rating categoryMoody's S&P Definition

Stongest Aaa AAA PrimeAa AA High grade/high qualityA A Upper medium grade

Baa BBB Lower medium gradeBa BB Non-investment grade/speculativeB B Highly speculative

Caa/Ca CCC Extremely speculativeWeakest C D Default or bankruptcy

Cleveland Clinic Aa2 AA-

Within each rating category are the following modifiers:Moody's ratings: 1 indicates higher end, 2 indicates mid-range, 3 indicates lower endS&P ratings: + indicates higher end, - indicates lower end

Healthcare organizations generally do not achieve a rating of Aaa or AAA from Moody’s or S&P, respectively, due to the nature of the healthcare industry. Based on recent ratings summary reports obtained from Moody’s and S&P, no healthcare organizations were rated in the prime category.


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CONSOLIDATED RESULTS OF OPERATIONS For the Quarters Ended September 30, 2011 and 2010 Operating income for the System was $135.2 million in the third quarter of 2011, resulting in an operating margin of 8.6% as compared to operating income of $114.6 million and an operating margin of 7.7% in the third quarter of 2010. The higher operating income for the third quarter of 2011 resulted from increases in other unrestricted revenues related to the electronic health record (EHR) incentive program (see Health Information Technology section for a description of the EHR incentive program) and a reduction in malpractice insurance and strategic consulting expenses. Operating income for the quarter was higher despite increases in salaries and benefits and provision for uncollectible accounts. The System also recorded special charges in the third quarter of 2011 related to the closing of Huron Hospital (see Significant Developments – Huron Hospital for more information on the closing of Huron Hospital). Nonoperating losses for the System were $315.5 million in the third quarter of 2011 compared to nonoperating gains of $148.8 million in the third quarter of 2010. The decrease from the prior year is primarily a result of losses from investments that were attributable to the overall decline in the financial markets. Overall, the System reported a deficiency of revenues over expenses of $180.2 million in the third quarter of 2011 compared to an excess of revenue over expenses of $263.5 million in the third quarter of 2010. The System’s net patient service revenue increased $71.6 million (5.3%) in the third quarter of 2011, compared to the same period in 2010. Inpatient admissions decreased 5.5% compared to the prior year, although the impact to patient service revenue was mitigated by an increase in outpatient evaluation and management visits at the Clinic of 11.9% in the third quarter of 2011 compared to the same period in 2010. In addition to outpatient volumes, increases in revenue also resulted from rate increases on the System’s managed care contracts and price increases that became effective in 2011. Self-pay revenue for the System remained flat at 5.8% of total gross patient revenue for the third quarter of 2011 compared to the same period in 2010. Other unrestricted revenues increased $21.9 million (15.8%) in the third quarter of 2011, compared to the same period in 2010. Other unrestricted revenues include $18.5 million of revenue recorded in the third quarter of 2011 related to the EHR incentive program as well as $12.5 million from the distribution of a remainder trust, a $2.4 million increase in international management fee contract revenue, and a $0.7 million increase in outpatient pharmacy revenue. These increases were offset by a decrease in unrestricted gifts. Total expenses increased $72.9 million (5.3%) in the third quarter of 2011, compared to the same period in 2010. The increase was largely driven by increases in salaries and benefits, provision for uncollectible accounts, and special charges associated with the closing of Huron Hospital, offset by decreases in malpractice insurance and strategic consulting expenses.


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CONSOLIDATED RESULTS OF OPERATIONS (continued) Salaries and benefits increased $70.4 million (9.4%) in the third quarter of 2011, compared to the same period in 2010. Salaries, excluding benefits, increased $32.4 million (5.0%), due to annual salary adjustments awarded in the second quarter of 2011 (averaging 2-3% across the System). Average full-time equivalent employees remained relatively consistent in the third quarter of 2011, compared to the same period in 2010. Additional increases in salaries and wages include a 13.6% increase in overtime and premium pay and a 12.5% increase in agency personnel costs. The System utilizes agency personnel as temporary support to supplement the employed physicians and nurses as well as to contend with issues in the healthcare industry related to recruitment and retention of qualified staff. Employee benefit costs increased $38.0 million (37.0%) primarily due to an increase in FICA expense of $29.7 million. In 2010, the System recorded an accrual of $28.7 million for refunds of FICA tax payments made in prior years related to medical residents based on an administrative decision by the Internal Revenue Service to accept the position that medical residents are exempt from FICA taxes for certain prior years. Other increases in benefit costs include an increase in retirement benefit costs of $4.3 million and an increase in employee and retiree healthcare costs of $1.8 million, including costs of various health and wellness programs offered to participants in the employee health plan. Supply and pharmaceutical expenses increased $12.5 million (5.2%) in the third quarter of 2011, compared to the same period in 2010 due to an increase in pharmaceutical costs of $10.9 million and an increase in medical supplies of $1.0 million. Pharmaceutical costs increased primarily due to higher costs and increased utilization in the outpatient pharmacies. The System changed its employee health benefit to encourage utilization of the System’s retail pharmacies instead of third party retail pharmacies, which has resulted in an increase in pharmaceutical costs. To address the challenge of rising supply costs in the healthcare industry, management is engaged in a supply chain management program to identify and implement supply chain savings through renegotiation, product standardization and improvements in procurement to payment processes. This program is expected to yield a full year effect savings of over $100 million annually for the System. Purchased services increased $0.1 million (0.2%) in the third quarter of 2011, compared to the same period in 2010. The State of Ohio increased the state franchise fee charged to hospitals effective July 1, 2011. The state franchise fee is an assessment implemented by the state in 2009 charged to hospitals based on a percentage of costs that is used to fund the state Medicaid program. The increase in the state franchise fee resulted in a $6.5 million increase to purchased services expense in the third quarter of 2011, compared to the same period in 2010. However, the increase in the state franchise fee for the System is offset by an increase in supplemental payments from Medicaid, which are recorded in net patient revenues. The increase in purchased services in the third quarter was offset by a reduction in expenses related to uncertain tax liabilities and software maintenance expenses. Administrative services decreased $4.1 million (11.5%) in the third quarter of 2011, compared to the same period in 2010. The decrease primarily relates to the timing of consulting expenses. The System has various strategic initiative projects directed at reducing costs.


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CONSOLIDATED RESULTS OF OPERATIONS (continued) Insurance expense decreased $49.9 million in the third quarter of 2011, compared to the same period in 2010. The System recorded a reduction in malpractice expense of $15.8 million and $69.3 million in the third quarter of 2010 and 2011, respectively, based on actuarial analysis of outstanding claims liabilities related to current and prior year claims. Over the last few years, the System has undertaken numerous initiatives to manage its medical malpractice insurance expense that resulted in reducing the number of claims and lawsuits and associated costs. These initiatives include hiring additional staff devoted to clinical risk management, promoting patient safety to prevent untoward events, and expanding education programs geared to enhance quality throughout the organization. The System has also taken, where appropriate, a more proactive approach to expedite the settlement of claims, which has reduced claim expenses and has resulted in more favorable settlements. Provision for uncollectible accounts increased $25.1 million (34.4%) in the third quarter of 2011, compared to the same period in 2010. The System has experienced an increase in provision for uncollectible accounts over the last few years as a result of high unemployment and loss of employer-sponsored insurance plans. Additionally, employers have shifted a greater portion of the cost of care to employees to manage health benefit costs resulting in rising patient responsibility balances that are more difficult to collect. The provision for uncollectible accounts in 2011 includes a higher level of expense related to these patients. Management continues to monitor the ongoing effects of the economy and resulting impact on the System and is focused on strategic initiatives to improve patient access and manage expenses throughout the System. Interest expense increased $1.0 million (4.3%) in the third quarter of 2011, compared to the same period in 2010. Various capital projects financed with System bonds were completed and placed into service in 2010. As a result, the related interest that was previously capitalized during the period of construction is now being recorded as expense. Additionally, the System entered into new capital leases in the fourth quarter of 2010. Depreciation and amortization expenses increased $1.9 million (2.4%) in the third quarter of 2011, compared to the same period in 2010. The increase in depreciation and amortization is primarily due to property, plant and equipment acquired throughout 2010 that is being depreciated in 2011, including significant construction projects completed and placed into service. Special charges increased $16.0 million in the third quarter of 2011, compared to the same period in 2010. These charges represent exit and disposal costs associated with the closing of Huron Hospital. Special charges include $10.0 million of accelerated depreciation expense resulting from the closing of the Huron facilities.


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CONSOLIDATED RESULTS OF OPERATIONS (continued) Gains and losses from nonoperating activities are recorded below operating income in the statement of operations. These items resulted in a net loss to the System of $315.5 million in the third quarter of 2011 compared to a net gain of $148.8 million in the third quarter of 2010. The net change of $464.3 million resulted primarily from a $406.2 million decrease in earnings on the System’s investment portfolio and a $57.7 million unfavorable variance in derivative gains and losses. Derivative gains and losses result from changes in the interest rate benchmark associated with the System’s interest rate swap contracts and include net interest paid or received under the swap agreements. The System’s investment portfolio was adversely impacted by a broad sell-off in the global equity markets in the third quarter of 2011 caused by deteriorating economic conditions and a decline in investor confidence. The System’s long-term investment portfolio reported investment losses of 6.3% for the third quarter of 2011, compared to investment losses of 6.2% for the portfolio’s benchmark. The System’s long-term investment portfolio reported investment gains of 6.8% in the third quarter of 2010.

For the Nine Months Ended September 30, 2011 and 2010 Operating income for the System was $226.2 million for the first nine months of 2011, resulting in an operating margin of 4.9% as compared to operating income of $187.9 million and an operating margin of 4.3% for the first nine months of 2010. The higher operating income in 2011 resulted from increases in other unrestricted revenues related to the EHR incentive program and a reduction in malpractice insurance and strategic consulting expenses. Operating income for the first nine months of 2011 was higher despite increases in salaries and benefits and provision for uncollectible accounts. The System also recorded special charges in 2011 related to the closing of Huron Hospital. Nonoperating losses for the System were $174.9 million for the first nine months of 2011 compared to nonoperating gains of $73.5 million for the same period in 2010. The decrease from the prior year is primarily a result of losses from investments that were attributable to the overall decline in financial markets. Overall, the System reported an excess of revenues over expenses of $51.3 million for the first nine months of 2011 compared to $261.4 million for the same period in 2010. The System’s net patient service revenue increased $197.8 million (5.0%) in the first nine months of 2011, compared to the same period in 2010. Inpatient admissions were down 2.5% compared to the prior year, although the impact to patient service revenue was mitigated by an increase in outpatient evaluation and management visits at the Clinic of 14.5% in the first nine months of 2011 compared to the same period in 2010. In addition to outpatient volumes, increases in revenue also resulted from rate increases on the System’s managed care contracts and price increases that became effective in 2011. The System has experienced an increase in self-pay patients primarily as a result of high unemployment and loss of employer-sponsored insurance plans. Self-pay revenue for the System was 5.8% of total gross patient revenue in 2011 compared to 5.7% in 2010. The increase in self-pay revenue has negatively impacted operating performance and continues to challenge the revenue realization of the System. Over the last few years, the System has initiated cross-regional and local revenue management projects designed to improve patient care access throughout the System. In connection with this initiative, management has renewed efforts to improve the front-end financial clearance process to assist patients with COBRA eligible benefits who are seeking care.


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CONSOLIDATED RESULTS OF OPERATIONS (continued) Other unrestricted revenues increased $50.1 million (12.8%) in the first nine months of 2011, compared to the same period in 2010. Increases in other unrestricted revenues include $30.7 million of revenue recorded in 2011 related to the EHR incentive program, a $6.2 million increase in gifts and assets released from restriction primarily related to a $12.5 million distribution from a remainder trust, a $5.2 million increase in international management fee contract revenue, and a $3.3 million increase in outpatient pharmacy revenue. Total expenses increased $209.5 million (5.0%) in the first nine months of 2011 compared to the same period in 2010. The increase was largely driven by an increase in salaries and benefits expense, provision for uncollectible accounts, depreciation expense, and special charges associated with the closing of Huron Hospital. The increases were offset by a decrease in malpractice insurance and strategic consulting expenses. Salaries and benefits increased $149.3 million (6.5%) in the first nine months of 2011, compared to the same period in 2010. Salaries, excluding benefits, increased $91.1 million (4.7%) in the first nine months of 2011 due to annual salary adjustments awarded in the second quarter of 2011 (averaging 2-3% across the System). Average full-time equivalent employees remained relatively consistent in the first nine months of 2011, compared to the same period in 2010. Additional increases in salaries and wages include a 10.5% increase in overtime and premium pay and a 9.5% increase in agency personnel costs. The System utilizes agency personnel as temporary support to supplement the employed physicians and nurses as well as to contend with issues in the healthcare industry related to recruitment and retention of qualified staff. Employee benefit costs increased $58.2 million (15.3%) primarily due to an increase in FICA expense of $32.9 million. In 2010, the System recorded an accrual of $28.7 million for refunds of FICA tax payments made in prior years related to medical residents based on an administrative decision by the Internal Revenue Service to accept the position that medical residents are exempt from FICA taxes for certain prior years. Other increases in benefit costs include an increase in retirement benefit costs of $15.1 million and an increase in employee and retiree healthcare costs of $4.4 million, including costs of various health and wellness programs offered to participants in the employee health plan. Supply and pharmaceutical expenses increased $21.3 million (3.0%) in the first nine months of 2011, compared to the same period in 2010. Pharmaceutical costs increased $25.9 million primarily due to higher costs and increased utilization in the outpatient pharmacies and the oncology department. The System changed its employee health benefit to encourage utilization of the System’s retail pharmacies instead of third party retail pharmacies, which has resulted in an increase in pharmaceutical costs. These costs were offset by a decrease in medical supplies of $8.2 million mainly due to a decrease in implant expense experienced in the cardiology, neurology, and orthopaedic departments. To address the challenge of rising supply costs in the healthcare industry, management is engaged in a supply chain management program to identify and implement supply chain savings through renegotiation, product standardization and improvements in procurement to payment processes. This program is expected to yield a full year effect savings of over $100 million annually for the System.


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CONSOLIDATED RESULTS OF OPERATIONS (continued) Purchased services decreased $9.7 million (3.7%) in the first nine months of 2011, compared to the same period in 2010. The decrease was primarily due to a reduction in uncertain tax liabilities and a decrease in printing and transcription services. Administrative services decreased $18.2 million (15.9%) in the first nine months of 2011, compared to the same period in 2010. The decrease primarily relates to the timing of consulting expenses. The System has various strategic initiative projects directed at reducing costs. Facilities expense increased $3.1 million (1.4%) in the first nine months of 2011, compared to the same period in 2010. The increase is primarily due to an increase in maintenance contracts of $3.6 million. Insurance expense decreased $54.7 million in the first nine months of 2011, compared to the same period in 2010. The System recorded a reduction in malpractice expense of $15.8 million and $69.3 million in the third quarter of 2010 and 2011, respectively, based on actuarial analysis of outstanding claims liabilities related to current and prior year claims. Over the last few years, the System has undertaken numerous initiatives to manage its medical malpractice insurance expense that resulted in reducing the number of claims and lawsuits and associated costs. These initiatives include hiring additional staff devoted to clinical risk management, promoting patient safety to prevent untoward events, and expanding education programs geared to enhance quality throughout the organization. The System has also taken, where appropriate, a more proactive approach to expedite the settlement of claims, which has reduced claim expenses and has resulted in more favorable settlements. Provision for uncollectible accounts increased $67.4 million (32.5%) in the first nine months of 2011, compared to the same period in 2010. The System has experienced an increase in provision for uncollectible accounts over the last few years as a result of high unemployment and loss of employer-sponsored insurance plans. Additionally, employers have shifted a greater portion of the cost of care to employees to manage health benefit costs resulting in rising patient responsibility balances that are more difficult to collect. The provision for uncollectible accounts in 2011 includes a higher level of expense related to these patients. Management continues to monitor the ongoing effects of the economy and resulting impact on the System and is focused on strategic initiatives to improve patient access and manage expenses throughout the System. Interest expense increased $4.8 million (7.3%) in the first nine months of 2011, compared to the same period in 2010. Various capital projects financed with System bonds were completed and placed into service in 2010. As a result, the related interest that was previously capitalized during the period of construction is now being recorded as expense. Additionally, the System entered into new capital leases in the fourth quarter of 2010. Depreciation and amortization expenses increased $18.5 million (7.8%) in the first nine months of 2011, compared to the same period in 2010. The increase in depreciation and amortization is primarily due to property, plant and equipment acquired throughout 2010 that is being depreciated in 2011, including significant construction projects completed and placed into service. Additionally, the System recorded a $4.5 million adjustment in 2011 to reduce the value of property held for sale in Florida.


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CONSOLIDATED RESULTS OF OPERATIONS (continued) Special charges increased $27.8 million in the first nine months of 2011, compared to the same period in 2010. These charges represent exit and disposal costs associated with the closing of Huron Hospital. Special charges include $13.4 million of accelerated depreciation expense resulting from the closing of the Huron facilities. Gains and losses from nonoperating activities are recorded below operating income in the statements of operations. These items resulted in a net loss to the System of $174.9 million in the first nine months of 2011 compared to a net gain of $73.5 million in the first nine months of 2010. The net change of $248.4 million resulted primarily from a $244.6 million unfavorable variance in earnings on the System’s investment portfolio and a $3.4 million unfavorable variance in derivative gains and losses. Derivative gains and losses result from changes in the interest rate benchmark associated with the System’s interest rate swap contracts and include net interest paid or received under the swap agreements. The System’s investment portfolio was adversely impacted by a broad sell-off in the global equity markets in the third quarter of 2011 caused by deteriorating economic conditions and a decline in investor confidence. The System’s long-term investment portfolio reported investment losses of 2.4% in the first nine months of 2011, compared to a benchmark of investment losses of 2.8%. In comparison, broad global equity markets have declined over 12% year-to-date illustrating the diversification that exists within the Health System's investment portfolio. The System’s long-term investment portfolio reported investment gains of 6.6% in the first nine months of 2010.

BALANCE SHEET – SEPTEMBER 30, 2011 COMPARED TO DECEMBER 31, 2010

Patient accounts receivable, net of allowances for uncollectible accounts, decreased $26.1 million (3.8%) from December 31, 2010 to September 30, 2011. The decrease in accounts receivable has resulted from lower inpatient admissions and surgical volumes combined with strong cash collections that have reduced days revenue outstanding from 49 days at December 31, 2010 to 46 days at September 30, 2011. The decrease has been offset by increases in patient revenues resulting from rate increases on the System’s managed care contracts and price increases that became effective in 2011. Additionally, the System has experienced an increase in patient responsibility accounts receivable. Patient responsibility accounts, which represents the portion of services that is not paid by a patient’s insurance company, have increased as a result of employers shifting a greater portion of the cost of care to employees, generally in the form of co-pays and deductibles. The System records estimated allowances that result in patient accounts receivable being reported at the net amount expected to be received. Investments for current use decreased $91.8 million (60.3%) from December 31, 2010 to September 30, 2011 primarily due to payments of principal and interest due on bonds. Other current assets increased $6.0 million (1.7%) from December 31, 2010 to September 30, 2011. The increase in other current assets is primarily a result of an increase in receivables related to international management contracts of $9.9 million and an increase in prepaid insurance and other expenses of $7.8 million offset by a decrease in current pledge receivables of $14.0 million.


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BALANCE SHEET – SEPTEMBER 30, 2011 COMPARED TO DECEMBER 31, 2010 (continued) Unrestricted investments increased $129.1 million (3.8%) from December 31, 2010 to September 30, 2011. The increase in unrestricted investments is primarily from positive cash flows from operations and a $50.0 million dividend received from the System’s captive insurance company offset by negative market returns on the System's long-term investment portfolio. Funds held by trustees decreased $106.9 million (48.5%) from December 31, 2010 to September 30, 2011. Bond fund activity resulted in a net decrease to funds held by trustee of $185.5 million, primarily due to bond draws to reimburse the System for capital project expenditures. This was offset by an increase in the collateral posted with the counterparty on the System’s derivative contracts of $75.6 million. Assets held by the System’s captive insurance subsidiary decreased $28.3 million (16.3%) from December 31, 2010 to September 30, 2011. The decrease in the captive insurance assets is primarily related to a $50.0 million dividend paid by the captive to the Clinic in 2011. The decrease is offset by insurance premiums received in excess of reimbursement payments for claims previously settled and paid by other System entities. Donor restricted assets increased $19.6 million (6.5%) from December 31, 2010 to September 30, 2011. The increase in donor restricted assets is primarily from receipt of donor restricted gifts in excess of expenditures from restricted funds and investment losses on restricted investments. Net property, plant and equipment increased $130.4 million (4.2%) from December 31, 2010 to September 30, 2011. In the first nine months of 2011, the System had expenditures for property, plant and equipment of $398.1 million. These additions were offset by a $256.5 million increase in accumulated depreciation. Capital expenditures in 2011 for major construction projects, including amounts paid on retainage liabilities recorded at December 31, 2010, include $51.3 million for the new data center project, $43.6 million for the Laboratory Upgrade and Expansion project, $41.1 million for the Twinsburg Family Health Center project, $39.4 million for the Avon Family Health Center project, $17.9 million for the EAPM revenue cycle project, $14.1 million for Hillcrest renovations, $10.8 million for the new Stephanie Tubbs Jones Health Center, $10.7 million for the Marymount Hospital Surgical Replacement and Expansion project, $7.8 million for the Fairview Hospital Renovation and Expansion project, $6.7 million for the Radiology Master Plan, and $4.7 million for the Wooster Ambulatory Service Center project. The Wooster renovation and Twinsburg Family Health Center were completed in 2011. Other noncurrent assets decreased $28.8 million (7.6%) from December 31, 2010 to September 30, 2011. The decrease was primarily due to the sale of the System’s equity interest in a CCF innovations spin-off company that had been recorded on the equity method at December 31, 2010 for $12.8 million and the receipt of a $12.5 million distribution from a charitable remainder trust. Accounts payable decreased $15.2 million (5.5%) from December 31, 2010 to September 30, 2011. The decrease is principally attributable to the timing of payment processing.


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BALANCE SHEET – SEPTEMBER 30, 2011 COMPARED TO DECEMBER 31, 2010 (continued)

Compensation and amounts withheld from payroll increased $30.6 million (15.1%) from December 31, 2010 to September 30, 2011. The change is primarily attributable to the timing of payroll and growth in salaries and employee benefit accruals. Estimated amounts due to third-party payors decreased $16.7 million (38.5%) from December 31, 2010 to September 30, 2011. The decrease is primarily related to EHR incentive program accruals that have reduced third-party liabilities by $7.7 million and the reversal of $12.0 million of estimated liabilities related to managed care contractual matters. Current portion of long-term debt decreased $1.5 million (3.2%) from December 31, 2010 to September 30, 2011. The decrease was due to payment of regularly scheduled principal payments of $44.4 million offset by reclassifications of debt from long-term to current. Other current liabilities decreased $10.8 million (3.1%) from December 31, 2010 to September 30, 2011. The decrease is primarily attributable to a reduction in accrued interest payable of $25.0 million related to the timing of interest payments on the System’s fixed-rate bonds. This decrease was offset by increases in the State franchise fee liability of $7.2 million and an increase in costs associated with the closing of Huron Hospital of $2.0 million. Hospital revenue bonds decreased $38.5 million (1.9%) from December 31, 2010 to September 30, 2011 due to the reclassification of scheduled principal payments from noncurrent to current. Professional and general insurance liability reserves decreased $34.2 million (19.8%) from December 31, 2010 to September 30, 2011 primarily due to a $69.3 million adjustment to decrease the overall malpractice liability based on updated actuarial analysis of outstanding claim liabilities related to current and prior year claims. The adjustment has been offset by an increase in the liability resulting from insurance premium funding accruals to the System’s captive insurance subsidiary in excess of claims paid. Accrued retirement benefits decreased $35.8 million (7.0%) from December 31, 2010 to September 30, 2011 primarily due to $38.7 million of cash contributions to the defined benefit pension plans. Total other noncurrent liabilities increased $103.2 million (32.2%) from December 31, 2010 to September 30, 2011. Increases include $90.6 million in derivative liabilities associated with changes in the fair value of the System’s interest rate swap contracts, $4.9 million of costs associated with the closing of Huron Hospital, and $3.6 million of deferred operating lease payments. The deferred operating lease payments represent the amount of lease payments calculated on a straight-line basis in excess of actual lease payments.


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BALANCE SHEET – SEPTEMBER 30, 2011 COMPARED TO DECEMBER 31, 2010 (continued)

Total net assets increased $60.4 million (1.4%) from December 31, 2010 to September 30, 2011. Unrestricted net assets increased $74.8 million (2.0%) comprised primarily of an excess of revenues over expenses of $51.3 million, $4.8 million of donated capital and assets released from restrictions for capital purposes, and $25.3 million to record amortization of prior service costs and actuarial losses related to the System’s retirement benefits offset by $6.7 million in unrealized losses on nontrading investments. Restricted net assets decreased $14.4 million (2.2%) comprised primarily of $2.3 million of net investment loss and $31.2 million of assets released from restriction offset by $17.5 million of restricted gifts.

SUBSEQUENT EVENTS – ONE MONTH PERIOD ENDED OCTOBER 31, 2011

In November 2011, fixed-rate hospital revenue bonds were issued for the benefit of the System. These bonds were used to refund a portion of the outstanding Series 2003A bonds and all of the outstanding Series 1999B bonds. For a complete description of the bonds issued in 2011, refer to “Significant Developments – Financing Developments.” In connection with the issuance of the Series 2011C Bonds, the System provided additional disclosure in the offering circular regarding financial results through October 31, 2011. The Health System experienced operating income of $10.4 million for the one month ended October 31, 2011. Operating income was $236.6 million through October year-to-date, which was above plan and the prior year. The positive operating income resulted from expense management, favorable development of claims in the Health System's malpractice insurance program and revenue associated with the electronic health record incentive program. The Health System experienced non-operating gains of $139.3 million for the one month ended October 31, 2011, comprised primarily of gains on investments of $122.8 million and increases in the value of the Health System's derivative contracts of $16.4 million. The Health System's investment portfolio has experienced estimated returns of +1.8% through October year-to-date, compared to an estimated portfolio benchmark of +1.5%. In comparison, broad global equity markets have declined over 4% year-to-date illustrating the diversification that exists within the Health System's investment portfolio. Total net assets increased $151.8 million from September, 30, 2011 to October 31, 2011. Unrestricted net assets increased $153.0 million primarily due to operating income and non-operating gains as described in the preceding paragraphs. Unrestricted net assets also increased $2.8 million for amortization of prior service costs and actuarial losses associated with the Health System's retirement benefit plans. Restricted net assets decreased $1.2 million primarily due to assets released from restriction for operations in excess of new gifts and investment income on restricted investments.


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FORWARD-LOOKING STATEMENTS Forward-looking statements contained in this report and other written reports and oral statements are made based on known events and circumstances at the time of release, and as such, are subject in the future to unforeseen uncertainties and risks. All statements regarding future performance, events or developments are forward-looking statements. It is possible that the System’s future performance may differ materially from current expectations depending on economic conditions within the healthcare industry and other factors. Among other factors that might affect future performance are: Changes to the Medicare and Medicaid reimbursement systems resulting in reductions in payments;

Legislative reforms or actions that reduce the payment for, and/or utilization of, health care services, such as the Patient Protection and Affordable Care Act passed into law earlier this year;

Adjustments resulting from Medicare and Medicaid reimbursement audits, including audits initiated by the Medicare Recovery Audit Contractor program;

Increased competition in the areas served by the System;

The ability of the System to access capital for the funding of capital projects;

Availability of malpractice insurance at reasonable rates, if at all;

The System’s ability to recruit and retain professionals;

General economic and business conditions, internationally, nationally and regionally, including the impact of financial market conditions and volatility and increases in the number of self-pay patients;

The declining population in the Greater Cleveland area;

Impact of federal laws on tax-exempt organizations and state law relating to exemption from real estate taxes;

Management, utilization and increases in the cost of medical drugs and devices as technological advancement progresses without concurrent increases in federal reimbursement; and

Changes in accounting standards or practices.

The System undertakes no obligation to update or publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this report.

f t p e s 30, 2011 the cleveland clinic foundation d.b.a ......11/29/2011 page 8 1. basis of...

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