6 de abril de 2017

GOBiERNO DE PUERTO RICO Administración de Seguros de Salud

Han. Thomas Rivera Schatz Presidente Senado de Puerto Rico PO Box 9023431 San Juan, Puerto Rico 00902-3431

Han. Ricardo A. Rosselló Nevares Gobernador

Sra . Angela M. Avila Marrero Directora Ejecutiva ~::;:;.....-~

ESTADOS FINANCIEROS AUDITADOS PERIODO TERMINADO 30 DE JUNIO 2016

Honorable Senador Rivera Schatz:

Conforme con lo dispuesto en el Artículo VII , Sección 1 de la Ley Núm. 72 de 7 de septiembre de 1993, presentamos ante su consideración los Estados Financieros Auditados para el periodo terminado el 30 de junio de 2016 de la Administración de Seguros de Salud de PR.

Para información adicional, se puede comunicar con la Sra. Carmen Leticia Rodríguez Santiago, Directora de Finanzas y Administración al 787-474-3300, extensión 1002.

Cordialmente,

Anejo

c Carmen Leticia Rodríguez Santiago Directora de Finanzas y Administración

Maria N. Hadad Orta Directora de Oficina de Legal

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'.iECR.:. TARIA SENADO DE P.R.

~ SES Aann,stl'8Cl6n de Se uros de Salud de Puerto Rico

PO Bo x 195661 , San Juan , PR 00919-5661 Te! : 787.474 .3300 Fax : 787.474 .3348 www .as es .pr. gov

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NEXIA PUERTO RICO P.S.C. Certified Public Accountants, Tax & Business Advisor

A Member o f

NEXIA I NTERNAT I ONAL

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Puerto Rico Health lnsurance Administration (A Compone ni Unit of the Common wealth of Puerto Rico) Basic Financia[ Statements far the Years Ended }une 30, 2016 and 2015, Required Supplemental lnformation, Single Audit of Federal Financia[ Assistance for the Year Ended }une 30, 2016 and lndependent Auditors ' Report Thereon

Puerto Rico Health Insurance Administration (A Componen! Unit ofthe Commonwealth of Puerto Rico) Far the Years Ended ]une 30, 2016 and 2015

TABLE OF CONTENTS

lndependent Auditors ' Report

Management's Discussion and Analysis (Unaudited)

Basic Financia! Statements:

Statements of Net Position (Deficit)

Statements of Revenue, Expenses, and Changes in Net Position (De ficit)

Statements of Cash Flows

Notes to Financia] Statements

Required Supplementary Information:

Schedule of Expenditures of Federal Awards

Notes to Schedule of Expenditures of Federal Awards

Independe nt auditors' report on interna] control over financia] reporting and on compliance and other matters based on an audit of the financi a) statements performed in accordance with Government Auditing Standards

Independent auditors' report on compliance with requirements applicable to each major program; on interna] control over compliance; and on schedule of expenditures of federal awards required by the Uniform Guidance

Schedule of Findings and Questioned Costs

Sumrnary Schedule of Prior Audit Findings

1 - 3

4 - 12

13 - 14

15

16 - 17

18 - 35

36

37

38 - 39

40-42

43 - 45

46

NEXIA PUERTO RICO, P.S.C. Certified Public Accountants & Consultants

INDEPENDENT AUDITORS' REPORT

To the Board of Directors of the Puerto Rico Health Insurance Admi ni stration San Juan, Pue rto Rico

Report on the Financia} Statements

NEX-Í1( PUE RT O RI CO

We have audited the accompanying financ ia! statements of the Puerto Rico Health Insurance Administration (the Admini strat ion), a component unit o f the Commonwealth of Puerto Rico (the Commonwealth) , as of and far the years ended June 30 , 20 16 and 20 15, and the re lated notes to the financ ia! state ments, which collecti vely comprise the Ad ministration 's basic financ ia! state ments, as li sted in the table of contents.

Management 's Responsibility for the Financia[ Statements

Management is responsible far the preparation and fair presentat ion of these financia) statements in accordance with accounting princ ipies generally accepted in the United States of America; thi s includes the des ign, implementation, and maintenance of inte rna! control re levant to the preparation and fair presentation of financ ia! statements that are free from material misstatement, whether due to fraud or error.

Auditors' Responsibility

Our responsibi lity is to express an op m1on on these fi nancia) statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America and the standards applicable to financia! audits contained in Government Auditing Standards, issued by the Comptroller General of the United States. T hose standards require that we plan and perform the audit to obtain reasonable assurance about whether the financ ia! statements are free from material misstatement.

An audit in volves pe rforming procedures to obtain audit evidence about the amounts and disc losures in the financ ia! s tatements. The procedures selected depend on the auditor ' s j udgment, inc luding the assessment of the risks of material misstatement of the financia! statements, whether due to fraud or error. In making those risk assessments, the auditor considers interna! control relevant to the entity' s preparation and fair presentation of the financia! statements in arder to design audit procedures that are appropriate in the circumstances, but not far the purpose of expressing an opinion on the effectiveness of the entity's interna! control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of account ing polic ies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the finan cia! statements .

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

NEXIA INTER ATIONAL IS A WORLDWIDE NETWORK OF !NDEPENDENT ACCOUNT!NG AND CONSUL TlNG FIRMS

PO Box 195607 San Juan, PR 0091 9-5607

Tel.: (787) 522.0300 Fax: (787) 522-030 1

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Basis for Qualified Opinion and Note Disclosure Regarding Pensions

As di scussed in Notes 3 and 11 to the bas ic financ ia] statements, the Administration has not implernented the requirements of Statement No. 68 of the Governrnental Accounting Standards Board, Accou11ting and Financia/ Reporting fa r Pensions, an amendment of GASB Statement No. 27 (Statement 68) . Accordingly, the Admini stration has not been able to determine and account for its proportionate share of net pension liabili ty, deferred inflow of resources and deferred outflow of resources related to pension costs, and has not recognized the effect of current period changes in net pension liability, deferred outfl ow of resources and deferred inflow of resources as these relate to pens ion costs. Accounting princ ipies generally accepted in the United States of America require that pension related liability, deferred outflow of resources and deferred inflow of resources, as appl icable, be recogni zed in accordance with the parameters established by Statement No. 68, as well as the effect of current period changes of the aforementioned amounts that must be recognized in pension expense during the current period . Recognition of these arnounts would increase liabilities, increase deferred outflow of resources, increase deferred inflow of resources, increase the deficit, and change the pension expense. T he amounts by which this departure would affec t li ab ilities, deferred outflow of resources, deferred inflow of resources, deficit, and pension expenses has not been determined .

The accompanying notes to financia! statements do not disclose the information required by Statement No . 68. In our opinion, disclosure of this information is required by accounting principies generally accepted in the United States of America.

Qualified Opinion

In our opinion, except for the possible effects of the matter described above in the Basis for Qualified Opinion paragraph, the fina ncia! statements referred to above present fairly, in a li material respects, the financia! position of the Puerto Rico Health Insurance Administration as of June 30, 20 16 and 2015, and the respective changes in fin ancia! pos ition and its cash fl ows thereof for the years then ended in accordance with accounting principies generally accepted in the United States of America.

The Administration 's Ability to Continue as a Going Concern

The accompanying financ ia! statements have been prepared assurning that the Adrninistration will continue as a going concern . As shown in the financia! statements, the Administration had a negative net position of $( 131,407,267). As discussed in Note l to basic fin ancia! statements, the Administrat ion is a component unit of the Commonwealth. As of June 30, 201 6, the finan cia! condition and Iiquidity of the Commonwealth has deteriorated. Consideri ng that the Adrninistration depends significantly on appropriations from the Commonwealth, the financia! condition and liquidity of the Adrninistration could be similarly affected.

The Ad ministration is not aware of any alternate sources of funds to meet such demands, in case the Commonwealth of Puerto Rico is not able to provide the appropriati ons. Those conditions raise substantial doubt about the Adrnin istration ability to continue as a going concern . T he financia! statements do not include any adjustments that rnight result from the outcome of this uncertainty. Our opinion is not modified with respect to that matter.

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Other Matters

Required S11pple111entary Jnformation Omitted

The Administration has omitted the Schedule of the Admi nistration's Proportionate Share of the Net Pension Liability, and the Schedule of Administration's Contributions to the Employees' Pension Plan, infarmation that accounting principies generally accepted in the United States of America require to be presented to supplement the basic financia) statements. Such missing information, although not a part of the basic financi a! statements, is required by the Governmental Accounting Standards Board who considers it to be an essential part of the financia) reporting far placing the basic financia! statements in an appropriate operational, economic or historical context. Our opinion on the basic financia] statements is not affected by thi s missing infarmation.

Required S11pplementary Information

Accounting principies generally accepted in the United States of Arnerica require that the rnanagement' s discussion and analysis on pages 4 through 12 be presented to supplernent the basic financia) statements. Such infarmation , although not a part of the basic financia) statements, is required by the Governmental Accounting Standards Board, who considers it to be an essential part of financia! reporting far placing the basic financia) staternents in an appropriate operational , economic, or historical context. We have applied certain limited procedures to the required supplementary infarmation in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management's responses to our inquiries, the basic financia! statements, and other knowledge we obtained during our audit of the basic financia! statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance.

Other Reporting Required by Government Auditing Standards

In accordance with Government Auditing Standards, we have also issued our report dated November 17, 2016 on our consideration of the Administration's interna! control over financia) reporting and our tests of its compliance with certain provisions of laws, regulations, contracts and grants agreements and other matters. The purpose of that report is to describe the scope of our testing of interna! control over financia! reporting and compliance and the results of that testing and not to provide an opinion on the interna) control over financia) reporting or on compliance. That report is an integral part of an audit perfarmed in accordance with Govemmental Auditing Standards and should be considered in assessing the results of our audit.

San Juan, Puerto Rico November 17, 2016

Stamp No. E247215 was affixed to the original report. Lic. 29 1 Exp. December 1, 201 7.

3

Puerto Rico Health lnsurance Administration (A Component Vnit ofthe Commonwealth of Puerto Rico) Management 's Discussion and Analysis (Unaudited) Far the Years Ended }une 30, 2016 and 2015

This section of the fin ancia] statements is c lassified by the Governmental Accounting Standards Board (GASB) as required supple mentary information. Management of the Puerto Rico Heal th Insurance Administration (the Administration) provides this Management Discussion and Analysis for the benefit of readers of the Administration' s fin ancial statements. Along with the financia! statements and related notes, management's discussion and analysis should provide the most relevant informat ion regardi ng the financia ] condition of the Admini stration for the years ended J une 30, 2016 and 20 1 S.

Overview of the Financia} Statements

This report includes the management' s discussion and analysis, the independent auditors ' report , and the basic financia] statements and related notes to financia! state ments . The management's discussion and analysis focus on major components of the financial statements. The financial statements are designed to provide users with a broad overview of the Administration 's finance with the intention to help answer the question whether the Administration is better off or worse off financially as a result of thi s year' s acti vities . These financia! statements are prepared under the accrual basi s of accounting.

The Statements of Net Positi on (deficit) presents information on ali of the Administration's assets and Ii abilities, with the difference between the two reported as net position (deficit). Over time, increases or decreases in net position (deficit), a long with other fin ancial information, serve as indicators of the Administration's financia! position and whether it is improving or deteriorating.

T he Statements of Revenues, Expenses, and Changes in Net Pos ition (defic it) presents information showing how the Administration 's net position changed during the year. Ali changes in net position are reported as soon as the underlying event giving rise to the change occur, regardless of the timing of the cash fl ows. Therefore, revenues and expenses are reported in this statement for certain items that wi ll result in cash flows in future fiscal periods, for example, the pharmacy rebate program revenues and the claims incurred but not paid.

The Statements of Cash Flows shows how the Administration' s cash and cash equivalents increased or decreased during the year. It a lso shows how cash and cash equivalents were provided by and used in the Admini stration's operating, non-capital financing, capital and related financing, and investing acti vities. The net increase or decrease in the Administration' s cash and cash equivalents is added to the balance at the beginning of the year to arri ve at cash and cash equivalents balance at the end of the year. The Administration uses the direct method of presenting cash flows, which includes a reconciliation of operating income to net cash proivded by operating activities.

The notes to fin ancia] statements provide additional information that is essential for a thorough understanding of the fin ancia] data presented in the financia! statements.

These statements and information represent the actual financia] condition of the Administration. Below, you will find a brief explanation of these statements and notes.

4

Puerto Rico Health Insurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Management's Discussion and Analysis ( Unaudited) Far the Years Ended ]une 30, 2016 and 2015

Financia) Highlights

For the year ended June 30, 20 16, the Administration reported an increase in net pos1t1on of approximate ly $84.7 mi Ilion, reducing its accumulated deficit to approxi mately $131 .4 mi Ilion (-39%) from $216.1 rnillion in prior year. The decrease in the accumulated deficit was primarily driven by increases in the effective reimbursement rate from the contributions from the federal government through the Puerto Rico Department of Health re lated to the Medicaid's Medica! Assistance Program (MAP) and the Children ' s Health lnsurance Program (CHIP) and inc reases in revenues from the governmental pharmacy rebate program when compared to prior year.

The condensed net position of the Administration at June 30, 2016 and 2015 is as fo llows:

Current assets Non-curren! assets

Total assets

Currenl liabilities Non-currenl liabi lities

Total liabilities

Deficit: Net investment in capital assets Deficit

Total deficit

Total Iiabilities and deficit

$

$

$

June 30, 2016

203 ,533,649 82,929,780

286 463 4?9

271,804,841 146,065,855

417 ,870,696

574,789 ( 131,982,056)

( 131.407 .267)

$ 286 463 429

$

$

$

June 30, 2015

199,955,573 142,964.428

342 920 QQJ

403, 194,449 155.838.599

559,033,048

70 1,636 (216.814,683 )

(216. 11 3.047)

$ 342 9?Q QQ J

Change In dollars Percentage

$

$

$

3,578,076 (60.034,648)

(56 456 572)

( 131,389,608) (9.772.744)

(141.162.352)

(126,847) 84,832,627

84.705,780

$ (56 456 57?)

2% (42)%

(33)%

~

(18)% (39)%

As of June 30, 2016, the Admini stration reported total assets of $286.5 million, a decrease of $56.5 million from prior year. Decrease in total assets was mainly due to collection of receivables from the Puerto Rico Department of Health and increases in the allowance for doubtful accounts re lated to governmental employers.

For the same period, total liabilities were $4 17 .9 mi Ilion, a decrease of $141.2 mi Il ion from prior year. Dec rease in total liabilities was primarily dueto the termination of the Third Party Administrator (TPA) mode l on March 31, 2015, under which liabilities related to medica! claims were accrued. As of June 30, 20 16, the Administration had approximately $3.9 million of estimated claims incurred but not reported, a reduction of approximately $72 mi Ilion when compared to June 30, 2015 .

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Puerto Rico Health Insurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Manage111ent's Discussion and Analysis (Unaudited) Far the Years Ended }une 30, 2016 and 2015

The Administration's in vestment in capital assets as of June 30, 20 16 and 20 15 amounted to $574,789 and $701 ,636, respectively, net of accumulated deprec iation. Capital assets include equip ment, furn iture, leasehold improvements, and vehic les. During the years ended June 30, 20 16 and 201 5, the Administration invested $87,568 and $284,51 7 in capital assets, respecti vely. Depreciation and amortizati on expense for the year ended J une 30, 2016 and 201 5 amounted to $2 14,4 15 and $237 ,237, respecti vely.

Beginning on April 1, 201 5, under the new managed care organization model (MCO), health care contractors assume 100 percent o f healthcare c laims risk in exchange for a Per Member Per Month (PMPM) premium, which is paid during the current service month. Therefore, the Administration is no longer required to recognize a liability for healthcare claims . As of June 30, 201 6, the Administration reduced its estimated liability for c\a ims incurred but not reported from approx imately $75.9 mill ion in year 201 5 to approximately $3.9 mi Ili on in year 20 14.

The condensed net position o f the Administration at June 30, 201 5 and 20 14 is as fol lows:

June 30, June 30, Change 2015 2014 In dollars Percentage

Currcnl assets $ 199,955,573 $ 3 14,63 1,911 $ ( 1 14,676,338) (36)% Non-curren! assets 142.964.428 109.430,8 14 33.533.614 31 %

Total assets $ 342 920 00 1 $ 424 062 725 $ C8 l 142 724) .il.91%.

Current liabili ties $ 403, 194,449 $ 447,769,372 $ (44,574,923) (10)% Non-current liabili ties 155,838 .599 206.088.689 (50.250.090) 24.4)%

Total liabilities 559.033.048 653,858.061 (94.825.013) (1 5)%

Deficit: Net investrnent in capital assets 701,636 654,356 47,280 7% Deficit (216.8 14,683) (230.449.692) 13.635.009 ~

Total deficit (2 16. 11 3,047) (229,795 .336) 13.682,289 (6)%

Total liabilities and deficit $ 342 920 00 1 $ 424 062 725 $ C8 I 142 724) .il.91%.

As of June 30, 2015 the Admini stration reported total assets of $342.9 mi Ilion, a decrease of $8 1. I million from prior year. Decrease in total assets was mainly due to collection of receivables from the Puerto Rico Department of Health, which were intransit as of June 30, 20 14.

For the same period, total liabilities reported were $559 million, a decrease of $94.8 million from prior year. Decrease in total liabilities was primarily due to the termination of the Third Party Administrator (TPA) model on March 3 1, 2015 , under which li abilities re lated to medica! cla ims expense were accrued . As of June 30, 201 5, the Administration had approximately $75.9 mill ion of estimated claims incurred but not reported under the previous TPA model, a reduction of $ 11 6.5 million when compared to June 30, 2014.

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Puerto Rico Health lnsurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Management's Discussion and Analysis (Unaudited) For the Years Ended }une 30, 2016 and 2015

The condensed changes in net position far the years ended June 30, 201 6 and 2015 is as foll ows:

Operating revenue: Contributions from Department of Health of Puerto Rico, Municipalities, employers, and

June 30, 2016

June 30, 2015

rebates $ 2,055,454, 190 $ 1,922 ,735 ,792 $ Contributions from the

Commonwealth of Puerto Rico

Total operating revenucs

Non-operat ing revenue: Interest income and legislative appropriations

Total revenucs

Operating expenses: Medica! premiums and claims General and administrative

Depreciation and amonization

Total operating expenses

Non-operating expense: Inte rest expense Impairment/loss

Total expenses

Change in net position

Net position, beginning of year, as restated

Net position, end of year

885,000 .000

2.940.454. 190

12, 190.231

2 .952.644.42 1

2,829, 171,745 26,48 1,483

2 14.415

2.855 ,867 ,643

11 ,021,993 1.049.005

2.867 .938,641

84,705,780

(216,113.047)

885.000.000

2 ,807.735,792

11 843.263

2.8 19,579.055

2,765,77 1,923 25,960,147

237.237

2,79 1.969.307

13,927,459

2 ,805.896.766

13,682,289

(229,795.336)

$ (1 31.407,267) $ (2 16. 11 3,047) $

Change In dollars Percentage

132,7 18,398

132.7 18,398

346.968

133 .065.366

63,399,822 52 1,336

(22.822)

63.898.336

(2,905,466) 1.049.005

62,041.875

7 1,023 ,49 1

13.682.289

84.705.780

7 %

o/o

5 %

3 %

5 %

2 % 2 %

(1 0)%

2 %

(2 1)% 100 o/o

2 %

519 %

(6)%

(19)%

For the year ended June 30, 2016, the Adrninistration reported operating revenues of approximately $2.9 billion, an increase of approximately $132.7 million from prior year. Increase in revenue was mainly due to increment in contributions from the Puerto Rico Department of Health related to the Medica) Assistance Program (MAP) and Children's Health Insurance Program (CHIP). For the same period, the Adrninistration reported operating expenses in the amount of approximately $2.9 bill ion, an increase of approximately $63.9 rnillion from prior year. The change was primarily due to adrninistration fees incurred as part of the phase-out of the previous TPA model.

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Puerto Rico Health lnsurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Managemen t's Discussion and Analysis (Unauditecl) For the Years Ended ]une 30, 2016 ancl 2015

The condensed changes in net position for the years ended June 30, 20 15 and 2014 is as fo llows:

Operating revcnue: Contributions from Department of Health of Puerto Rico, Municipalitics, employers, and

June 30, 2015

June 30, 2014

rebates $ 1,922,735,792 $ 1,561 ,63 1,351 $ Contributions form the

Commonwealth of Pue rto Rico

Total operating revenues

Non-operating revenue: l nterest income and legislative appropriations

T otal rcvcnues

Operat ing expenses: Medica! premiums and claims General and administrative

Depreciation and amort izat ion

Tota l opcrating expenses

Non-operating expense: Jn terest expense

T otal expenses

Change in net position

Net position, beginning of year

Net position, end of year

885,000.000

2.807 .735.792

11 .843.263

2.8 19,579.055

2,765,771,923 25,960, 147

237 .237

2,79 1.969.307

13.927.459

2.805.896.766

13,682,289

(229,795 ,336)

885.000.000

2.446,63 1.351

50.383.980

2.497.0 15.33 1

2,520,647 ,701 20,846, 176

104.642

2.541.598,51 9

14.509.503

2,556, 108.022

(59,092,691)

(170,702.645)

$ (2 16.11 3.047) $ (229,795.336) $

Change In dollars Percentage

36 1, 104,441

36 1. 104.441

(38.540.7 17)

322.563.724

245, 124 ,222 5, 113,971

132 595

250.370.788

(582.044)

249 788.744

72 ,774,980

(59 .092,691 )

13.682.289

12 %

0.32 %

7 %

(0.25)%

7 %

7 % 102 %

4 1 %

8 %

(0.04)%

0.10 %

( 1.23)%

11 o/o

15 %

For the year ended June 30, 2015, the Administration reported operating revenues of $2.8 billi on, an increase of $361 .1 million from prior year, basically due to increment in contributions from the Puerto Rico Department of Health related to MAP and CHIP.

For the same period, the Administration reported operating expenses in the amount of $2.8 billion, an increase of $250.4 million when compared to June 30, 2014. The change mostly corresponds to increases in PMPM premiums and medica! claims expenses related to the third party administration model.

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V

Puerto Rico Health lnsurance Administration (A Componen! Unit of the Commonwealth of Puerto Rico) Management's Discussion and Analysis (Unaudited) For the Years Ended ]une 30, 2016 ancl 2015

Overview

The Admin istration is a public corporation of the Common wealth of Puerto Rico (the Commonwealth), created by Act No. 72 of September 7, 1993, as amended. The Admini stration began operations on February 1, 1994 and is responsible for implementing, administering and negotiating a health insurance program, through contracts with health insurers, mental behavioral health organizations, pharmacy benefit managers, third party administrators and Medicare Advantage organizations, among others. The purpose of the Admini stration is to provide access to quality medical and hospital care to eligible Puerto Rico residents.

The Administration is the Sub-Grantee of federal funds provided by the Medicaid Program under Title XIX of the Social Security Act and Title XXI of the State Children's Health lnsurance Program (CHIP). The Single State Medicaid Agency is the Puerto Rico Department of Health (the Department of Health). Within the Department of Health , the Medicaid Program administers the eligibility program of federal and Commonwealth beneficiari es and is responsible for administering or supervising the admini stration of, and is the primary grantee of federal funds, while delegating the administration of the Puerto Rico's managed health care structure to the Administration pursuant to a Memorandum of U11derstanding.

The executi ve offices of the Administration are located at 157 1 Alda Street, Urb. Caribe, Rio Piedras, Puerto Rico 00926-27 12. The Administration 's telephone number is (787) 474-3300. Mr. Ricardo A. Rivera Cardona is the Executive Director of the Administrati o11.

Economic Factors

Medicaid Program Financing

Until March 31, 2015, the Administration paid Medicare Program costs first and the11, it requested the corresponding federal cost share to the Ce11ters for Medicaid and Medicare Services (CMS ) through the Department of Health. Until then, the Admini stration used a line of credit facility to have the required cash available to make timely Medicaid Program payme11ts to contracted healthcare organizati ons and, once the federal cost share reimbursement was received, it paid back the line of credit. The line of credit agreement was terminated and not renewed creati11g a cash shortfall. Starting 011 April 1, 2015 , the Admini stratio11 successfully negotiated with CMS a new reirnbursement protocol in which the federal cost share was available immediately after the Administratio11 submitted the federal cost share request with the condition of presenting a certification of availability of Comrnonwealth cost share to complete Medicare Program payments. In addition, the Administration and the contracted ma11aged care organizations (MCO) rnutually agreed to allow the Administratio11 to spread per month per rnember (PMPM) premium payment into four (4) weekly payments. In retum, the Administration paid the co11tracted MCO a 7% simple interest 011 unpaid monthly balances.

Background of Terminated Credit Agreements

011 March 14, 2011, the Admi11istration entered into a Credit Agreement with the Govemme11t Development Bank (GDB) in order to meet its obligations incurred prior to fiscal year 2009-2010 with healthcare contractors. As of June 30, 2016 and 2015, the principal outstanding balances amounted to $ 183,251,298 in both years and the accrued interest amounted to $ 19,713, 188 and $8,718, 111 ,

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Puerto Rico Health Insurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Management's Discussion and Analysis (Unaudited) Far the Years Ended ]une 30, 2016 and 2015

respecti vely. The Admi nistration is required to pay the principal and interest with the appropriations from Puerto Rico leg is lature. During the year ended June 30, 20 15, the Puerto Rico Office of Management and Budget (OMB) paid interest in the amount of $2,386,922, on behalf of the Administration (no interest payments were made during the year ended June 30, 201 6).

On October 18, 20 11 , the Puerto Rico Legislature approved Law Number 205. Thi s Law authorized the Administration to open a revolving li ne of credit e ither with the GDB or with a commercial bank for the sote purpose of paying health insurance premiums and health services providers. Accordingly, the GDB or afterwards, the commercial bank made credit advances to the Administration to fund premiums expenses and were reimbursed with federal funds. The amount of the line of credit was limited to and guaranteed by the amount of federal funds received by the Commonwealth from the Federal Government ' s Medicaid Program as certified by the Administration' s Board of Directors and by the Puerto Rico Medicaid Program. The Admini stration was obliged to use any federal funds reimbursement received to pay the line of cred it. The Commonwealth guaranteed an y uncovered balance of the line of credit in excess of federal funds received by making the necessary appropriations.

On July 20, 2016, the Governor of Puerto Rico signed the Law 74 which authorized the GDB to consolidate all financ ing agreements made to governmental entities which are payable with appropriations from the Puerto Rico legislature. Article 4 of such law lists a li the governmental entities wi th financia] agreements and the oulstanding principal balance and accrued interest as of December 31, 2015. The Administration is li sted with an outstanding principal balance of $ 183,25 1,298 and accrued interest of $ 14,2 15,650 as of December 3 1, 2015. As of the date of this report, the GDB has not taken any action towards conso lidation.

Background of Past and Current Healthcare Models

The Admini stration was created in 1993 to negotiate and contract for the provision of comprehensive health in surance coverage for quali fying (generally low income) Puerto Rico reside nts under the Commonwealth's "Health Reform" program. Under this system, the Commonwealth selected , through a bidding process, a prívate health insurance company for each designated region of the island and paid such insurance company the insurance premium for each eligible beneficiary within such region. The health in surance system covered the entire is land. On October 1, 201 O, the Commonwealth implemented "Mi Salud," which replaced the "Health Reform" program.

On October 14, 2014, the Board of Directors of the Administration awarded new contracts for the Government Public Health Insurance Plan (the GHP), which replaced the former "Mi Salud" plan, to fi ve prí vate insurance providers pursuant to a bidding process. The new contracts became effecti ve on April 1, 20 15. Under the new contracts, the Commonwealth public health insurance model changed from a " third-party admini strator" (TPA) model, in which the Commonwealth was ultimately responsible for the cost of the health services provided, to a "managed care organization" (MCO) model, in which the Administration pays the insurers a fi xed premium for each insured benefi ciary and the insurers are responsible for the cost of such services.

10

Puerto Rico Health lnsurance Administration (A Componen/ Unit ofthe Commonwealth of Puerto Rico) Management 's Discussion and Analysis (Unaudited) For the Years Ended }une 30, 2016 and 2015

The Adrnini stration' s change from a TPA to a MCO model has exacerbated the Adrn.inistrat ion 's liquidity need during the transition process. This heightened liquidity need is due to the TPA's phase-out period, which requires the Administration to pay-off the TPA and maintain current MCO prerniums. The MCO insurance model demands prernium payments at the beginning of each month, payable during the first fi ve days, subject to a final adj ustment by end-of-month. In order to en ure continuity of services, the Administration reached a pre liminary agree ment with the fi ve prívate insurance providers to pay-off the premiums throughout the month instead of during the firs t fi ve days of the month. As of June 30, 20 16, there was approximate ly $ 11 6 mi Ilion in unpaid c laims, inc luding the actuarially determined incurred but not reported liabi li ty for c la ims of approximately $3 .9 rnillion. ln add it ion, unpaid TPA administration fees payable under the prev ious model were approx imately $85.5 rn.i ll ion as of June 30, 20 16.

The Governor recently signed legislation that authorizes the Admini stration to borrow funds, including through the issuance of bonds, up to $400 mi Il ion in order to repay the amounts mentioned above. There is no assurance that the Adrnini stration will be able to obtain such financing. If the Adrn.inistration is unable to secure finan cing and if the Commonwealth 's fin ancia( si tuation precludes it fro m continuing to support the Commonwealth health insurance plan , the Adrninistration might be unable to fulfill its financ ia! and contractual obligations.

On June 8, 20 15, the Centers for Medicaid and Medicare Services (CMS ) confirmed that the Medicare Advantage fu nding for Puerto Ri co in 2016 will be reduced by approximately 11 %. Such reduction to the Medicare Advantage rates would impact the ability of the Medicare Advantage plans to assume the costs of covering the higher-need dual eligible population (approximately 250,000 beneficiaries) covered through the Adrn.i ni strat ion 's "Platino" program. Medicare Advantage subsidizes the costs of the "Platino" program from the rates paid th rough Medicare. Jf the Medicare Advantage plans cannot subsidi ze the costs of covering the "Platino" program, the Administration's costs for calendar year 2016 for this population woul d increase from the current $20 to $30 rn.illi on per year to $ 120 to $ 150 rnillion per year unless benefit reductions are made. However, there's no direct impact at the Adrninistrat ion level since under the new model, MCO's are paid based on a fixed contracted month ly PMPM.

Capital assets

The Adrnini stration' s investment in capita l assets as of June 30, 20 16 and 20 15 amounted to $574,789 and $70 1,636, respecti vely, net of accumulated depreciation. Capital assets include equipment, furniture, leasehold improvements, and vehicles. During the years ended June 30, 2015 and 2014, the Adrn.in istration invested $284,5 17 and $548 ,347 in capital assets, respective ly. Depreciation and amort ization expense for the years ended June 30, 20 16 and 2015 amounted to $237,237 and $ 104,462, respectively.

Currently Known Facts

Financia! Deteriora/ion ofthe Commonwealth of Puerto Rico

As d isclosed in Note 2, the financia! condition and liquidi ty of the Commonwealth has deteriorated. Considering that the Adrn.inistration depends significantly on appropriations from the Comrnonwealth, the fmancial condition and liquidity of the Adrn.inistration could be sirnilarly affected .

11

Puerto Rico Health lnsurance Administration (A Componen! Unit of the Commonwealth of Puerto Rico) Management 's Discussion and Analysis ( Unaudited) For the Years Ended }une 30, 2016 and 2015

On October 28, 20 16, the Secretary of the Treasury of the Commonwealth of Puerto Rico issued C ircular Letter Nurnber 1300-08- 17 that a li entities with deposits and other investrnent instrurnents at Government Development Bank of Puerto Rico should recogni ze an impairrnent loss equal to the unrealized or uncol lected amount of deposits at June 30, 2016, subsequent to such date, and through the issuance of the fin ancia! statements. Management performed an impairment analysis in accordance with the requirements of the Circular Letter, and decided to recognize an impairment of $ 1 million as of June 30, 2016.

Restatement of prior year financial statements

During the year ended June 30, 2016, management restated its prior year financia! statements to comply with GASB 33, Accounting and financ ia! reporting for nonexchange transactions. The adjustment consisted in the reversa! of certa in receivables from the Office of Management and Budget (OGP, for its acronym in Spanish) in the amount of $8,608, 156 representing the source of repayment of the interest payable dueto GDB for the year ended June 30, 2015.

Contacting the Administration Financial Management

This finan cia! report is des igned to provide our customers and creditors with a general overview of the Adrninistration' s finances and to dernonstrate the Adrninistration's accountability for the funds it recei ves. If you have questions about this report or need additional in forrnat ion, contact the Puerto Rico Health lnsurance Admini stration, PO Box 195661, San Juan, PR 00926-2706.

* * * * *

12

Puerto Rico Health Insurance Administration (A Componen{ Unit of the Commonwealth of Puerto Rico) Statements of Net Position (Deficit) ]une 30, 2016 and 2015

ASSETS

2016 2015

Current assets: Cash and cash equivalents, net $ 68,294, 188 $ 16,032,382 Restricted cash 1,32 1, 142 1,321, 142 Cert ificates of deposit 6 5 11 637

Total cash and certificates of deposit 69,6 15,330 23,865, 16 ]

Accounts receivabl e: Puerto Rico Department of Health 59,022,472 133,5 16,53 1 Pharmacy rebates program - net of allowance for doubtful

accounts of $928,002 in 201 6 (none in 201 5) 53,025,511 4 1,147,836 Restricted deposits 1, 100,000 Prepaid expenses 309,180 266, 116 Advance premjum 2 1,253,995 Interest receivable 307.16 1 59 929

Total current assets 203,533,649 199,955,573

Non-current assets: Accounts recei vable:

Municipalities - net of allowance for doubtful accounts of $ 15,8 13,050 in 2016 and $5 1,007 ,246 in 20 15 57,574 ,4 16 37,220,469

Other receivables - net of allowance for doubtful accounts of $744,520 in 20 16 and 20 15 4,604,488 14,433,373

Due from employers - net of allowance for doubtful accounts of $59,229,489 in 20 16 and $4,454,578 in 20 15 8,008,394 5 1,9 17,098

Capital assets - net 574,789 70 1,636 Due from MCO' s - net of allowance of $4, 11 6,4 1 O in 20 l 6 12, 167,693 17,437,857 Advance prernium 21,253,995

Total non-current assets 82,929,780 142,964,428

Total assets $ 286,463 ,429 ~ 342.920,00 l ( continued)

13

Puerto Rico Health Insurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Statements of Net Position (Deficit) ]une 30, 2016 and 2015

LIABILITIES AND DEFICIT

2016 2015 Current Iiabilities:

TPA administration fees payable $ 85,472,028 $ 108,614,607 Estimated liability far claims incurred but not reported 3,899,000 75,899,000 Premiums and claims payable 112,062,257 164,253,851 Obligation payable to Governmental Development Bank 62,000,001 41 ,333,334 Accounts payable and accrued expenses 7, 151 ,408 11 ,975 ,880 Accrued termination benefits 720,013 615,500 Accrued compensated absences 500 134 502 277

Total current liabilities 271.804,84 1 403.194 449

Non-current Iiabilities:

Obligation payable to Governmental Development Bank 121,25 1,297 141 ,9 17,964 Interest payable 19,713, 188 8,7 18, 111 Special project funds 1,321, 142 1,321 ,142 Accrued termination benefits 3,460,47 1 3,560,255 Accrued compensated absences 3 19757 321 127

Total non-current liabilities 146,065,855 l 55,838,599

Total Iiabilities 417 .870,696 559,033,048

Deficit: Net in vestment in capital assets 574,789 701,636 Deficit (l 31, 982,056) (216,8 J 4,683)

Total de ficit (131.407,267) (216.11 3,047)

Total Iiabilities and deficit $ 286,46\ 429 $ 342,920,001

See notes to financia] statements.

14

Puerto Rico Health lnsurance Administration (A Componen! Unit of the Commonwealth of Puerto Rico) Statements of Revenue, Expenses and Changes in Net Position. (Deficit) For the Years Ended ]une 30, 2016 an.d 2015

2016 2015 Ope rating re venue :

Contributions from: Puerto Rico Department of Health $ 1,706,685,539 $ 1,592,484,421 Commonwealth of Puerto Rico 885,000,000 885,000,000 Munic ipalities 2 14,494,151 176,772,044 Employers 4 1,864,647 42 ,11 8,244 Pharmacy rebate program 184,094, 18 J 135,308,092 Bad debt expense (91.684,328) (23,947,009)

Total operating revenue 2.940,454,190 2,807,735,792

Operating expenses : Medica( premiums and claims 2,829, 17 1,745 2,765 ,77 1,923 General and administrati ve 26,48 1,483 25 ,960, 147 Depreciation 214 415 237.237

Total operating expenses 2.855,867,643 2,791,969,307

Operating income 84 586 547 15 766 485

Non-operating revenue (expenses): Legislati ve appropriations from the

Commonwealth of Puerto Rico 7,070,000 7,259,000 Interest expense (11 ,02 1,993) ( 13,927,459) Impairment loss on deposits with the Government Development Bank (1 ,049,005)

lnterest income and others 5.1 20.23 1 4.584 263

Total non-operating revenue (expenses), net 119 233 (2,084, l 96)

Increase in net position 84,705 ,780 13,682,289

Net (deficit) at beginning of year, as restated (216, 11 3,047) (229,795,336)

Net (deficit) at end of year i {131,407 ,267) i (2 16,11 3,047)

See notes to financia! statements.

15

Puerto Rico Health Insurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Statements of Cash Flows For the Years Ended ]une 30, 2016 and 2015

2016 2015

Cash flows from operating activities: Cash receipts from contributions $ 2,870,435,876 $ 2,769,7 15,578 Cash receipts from pharmacy rebate program 17 1,288,504 122,827,75 1 Cash payments of premiums, health care organizations and

third party administrators (2,976,505,9 18) (2, 7 56,772,339) Cash payments to e mployees (4,8 13,398) ( 4,888, 158) Cash payments to vendors for goods and services (25,434,405) (58,796,797)

Net cash provided by operating activities 34 970 659 72,086,035

Cash flows from non-capital and related financing activities : Legislative appropriations from the Commonwealth

of Puerto Rico 7,070,000 7,259,000 Repayments of line of credit (82,999,274) Impairment loss on deposits with the Government

Development Bank ( 1,049,005) Purchase of capital assets (87 ,568) (284 ,567) Interest paid (26,9 16) ( 16.3 14,38 1)

Net cash provided by (used in) non-capital and related financing activities 5 906 5 11 (92,339,222)

Cash flows from investing activities: Interest col lected and others 4,872,999 13, 192,469 Redemption of certificates of deposit 6 5 11 637

Net cash provided by investing activities 11,384,636 13, 192.469

Net increase (decrease) in cash and cash equivalents 52,261,806 (7,060,7 18)

Cash and cash equi valents, at beginning of year 16,032,382 23,093, 100

Cash and cash equi valents, at end of year $ 68)294,188 $ 16)032,382 ( continued)

16

Puerto Rico Health lnsurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Statements of Cash Flows For the Years Ended ]une 30, 2016 and 2015

2016 2015

Reconciliation of operating income to net cash provided by operating activities:

Operating income $ 84,586,547 $ 15,766,485 Adjustrnents to reconcile operating incorne to net cash

provided by operating activities: Depreciation and amortization 21 4,4 15 237,237 Changes in operating assets and liabilities:

Decrease (increase) in: Certificate of deposits (1 9,774) Accounts receivable :

Puerto Rico Departrnent of Health 74,494 ,059 11 8, 188,302 Muni cipalities (20,353,947) 859,504 Pharmacy rebate program (1 1,877,675) ( 1 2,480,34 1) Other recei vables 9,828,885 (10,5 19,35 1) Due from employers 43,908,704 ( 11 ,240,577) Restricted deposits 1, 100,000 Prepaid expenses (43,064) ( 19,266,633) Due from MCO's 5,270, 164

lncrease (decrease) in : TPA administration fees payable (23, 142,579) 50,560,779 Liability fo r clairns incurred but no reported (72,000,000) ( 116,549,000) Premiurns and cl aims payable (52, 19 1,594) 74,987,805 Due to governmental agencies (7,239, 104) Accounts payable and accrued expenses (4,824,472) (l 0,51 2, 106) Accrued terminat ion benefits 4,729 (3 12,653) Accrued compensated absences (3,51 3) (374,538)

Net cash provided by operating acti vities $ 34 970 659 $ 72 086 035

SUPPLEMENTAL CASH FLOWS INFORMATION

Non-cash investing activities:

During the year ended J une 30, 2015 , the Administration retired fully depreciated equipment amounting to $932,489.

Non-cash financing activities:

During the year ended June 30, 201 5, the Puerto Rico Office of Management and Budget (OMB) paid interest on behalf of the Admini strati on amounting to $2,386,922.

See notes to financ ia! statements.

17

Puerto Rico Health Insurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Notes to Financia! Statements Far the Years Ended ]une 30, 2016 and 2015

l. REPORTING ENTITY

The Puerto Rico Health Insurance Administra/ion (the Administration) is a component unit of the Comrnonwealth of Pue rto Rico (the Commonwealth), created on September 7, 1993 by Act No. 72 (the Act), as amended, a nd commenced operations on February 1, 1994 and is considered a public corporation with ful! autonomy .

The Administration is responsible for imple menting, administering, and negotiating a health insurance syste m, through contracts w ith health insurers, me ntal health organizations, pharmacy be nefit managers, third party administrators and Medicare advantage organizations among others . T he purpose is to provide ali qualifying Puerto Rico residents access to qua lity healthcare services, including mental health, through a managed care mode l.

The Administration is the Sub-Grantee of fede ral funds provided by the Medicaid Program under T itle XIX of the Soc ia l Security Act and Title XXI of the State Chi ldren's Health lnsurance Program (CHIP). The S ingle State M edicaid Agency is the Puerto Rico Department of Health (the Department). Within the Department, the Medicaid P rogram admin isters the eligibi lity program of federal and Comrnonwealth be neficiaries and is responsible for administering or supervising the administration o f, and is the primary grantee of fede ral fund s while delegating the administrati on of the Commonwealth 's managed health care structure to the Admin istration pursuant to a Memorandum of Understanding.

A regionalization system was imple mented to establish a network of part1c1pating provider' s throughout Puerto Rico and ensure the closest possib le service to bene fi c ia ries. T he Administration pays a monthl y premium to such insurance underwriters based on a contracted premium and the number of members subscribed in the health plan. Funds to pay for such premiums are requested from the Commonwealth net of funds available for such purposes from a li other sources.

Under the provis ions of Act no. 105 of July 19, 2002, which amended Act No. 72 of 1993, the Adm.inistration was authorized to negotiate directly with health providers under a pilot program. The Administrat ion has, since then , e ntered into differe nt direct contracts to cover the insured population of different regions and municipal ities. Since November 1, 2006 through September 1, 20 l O, the Adm.inistration directly contracted providers that served approximately 190,000 pa rt icipants from the metro-north region. S ince June 30, 201 1, the Administrat ion has direct contracting projects w ith the Municipalities of Yieques and Guaynabo.

Effecti ve October 1, 20 1 O, a new integrated health care model named M i Salud was developed with the following changes :

1) Set up a standard premium per region as established by the Administration.

2) Elim.inate the referrals when the beneficiary needs the service of a specialist.

18

Puerto Rico Health lnsurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Notes to Financia/ Statements For the Years Ended ]une 30, 2016 and 2015

3) Better access to prescribed medicines without the authorization of the primary health care provider.

4) Extended hours for health care providers of basic services.

5) Te le-emergency services avail able 24 hours.

6) Integration of the physical and mental health care in one place .

7) The ri sk of the primary health provider in relat ion to medicines, emergency and preventive health care test was decreased and was transferred to the health care insurance companies .

8) Increase the coverage to include the middle c lass working force .

9) Set up a ce iling in relation to administrative expenses and gains of the health care insurance compames.

Effective October 1, 201 1, the Administration decided to expand the direct contract ing project to cover, in addition to Vieques and Guaynabo, the West, the Metro-north, the North, the San Juan, the Northeast and the Virtual Regions. These regions, previously covered by MCS Health Management Options, Inc. (MCS) under coverage for premium arrange ment were subsequently managed by Triple-S Salud, lnc. (Triple-S) as third party administrator (TPA) starting on November 1, 201 1. Under this arrangement, Triple-S received a per member per month (pmpm) for performjng administrative services and the Admi ni stration bears the risk for the provision of services to beneficiaries . In addition, the Administration implemented certain cost containment strategies to control costs. Among these strategies are establi shing a co-payment that applies far the unjustifi ed use of e mergency rooms, detect ion and control of prescription drug overuse, implementation of disease management program far respiratory cond itions, modification in provider fees and better coordination of benefits far the population having other medica! insurance.

Effective July 2013, the Admini stration announced the cancellation of Humana's contract effective September 30, 201 3. Humana admin istered three regions (East, Southeast, Southwest), with approximately 5 15,000 beneficiaries of the Mi Salud Program. On July 1, 2013, the Admini stration and Triple-S entered into an agreement pursuant to which Triple-S administered the provision of healthcare services to beneficiaries in the eight regions previously administered by MCS (fi ve regions) and Humana (remaining three regions) . Pursuant to the agreement, Triple-S acted as a third party admjnistrator and was compensated based on a per member per month admi ni strati ve fee. In contrast to the agreement with MCS and Humana, the Commonwealth has been financially respons ible and bears the risk for the provision of services to beneficiaries in the eight regions admini stered by Triple-S.

19

Puerto Rico Health lnsurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Notes to Financia[ Statements Far the Years Ended ]une 30, 2016 and 2015

On October 14, 20 14, the Board of Directors of the Administration awarded new contracts for the Government Public Health Insurance Plan (the "GHP"), which replaced the former "Mi Salud" plan , to fi ve pri vate insurance providers pursuant to a bidding process. The new contracts became effective on April l , 2015. Under the new contracts, the Commonwealth of Puerto Rico's public health insurance model changed from a "third-party administrator" (TPA) model , in which the Commonwealth was ultimately responsible for the cost of the health services provided, to a "managed care organization (MCO) model, in which the Administration wi ll pay the insurers a fixed premium for each insured benefic iary and the insurers will be responsibl e for the cost of such serv1ces.

2. GOING CONCERN CONSIDERA TION

As part of its normal operating activities, andas disclosed in Note l , the Admini stration depends significantly on appropriations from the Commonwealth. As of June 30, 2016, the Commonwealth faces significant budgetary risks and uncertainties, including liquidity risk, which is the ri sk of not having sufficient liquid financia) resources to meet their ob ligations when they become due. Because of budgetary constraints, the financia) support that the Common wealth has provided to the Administration may be affected in the near future.

As reflected in the accompanying basic fin ancia) statements, the Administration c losed its year with a net deficit o f approximately $ 131.4 mi Ilion at June 30, 2016 and $216.1 mili ion at June 30, 2015.

The revised budget for fi scal year 2016-201 7 projects that revenues will cover ali projected costs. The most relevant assumptions are as follows:

• $ 887 mili ion of revenues from legislative appropriation s

• $ 1,623 mi Ilion of revenues from federal fund s

• $ 309 mi Ilion of revenues from municipalities, rebates, and employers

• $ 4.9 mi Ilion of revenues from legislati ve appropriations to pay operational expenses

On March 14, 2011 the Administration requested a $ 186 million non-revolving line o f credit from the Government Development Bank of Puerto Rico (GDB). On that same date, a Fiscal Oversight Agreement (FOA) was subscribed between the Administration and GDB in order to provide assistance and monitoring of the Administration' s finances. The FOA authorizes GDB to assist the Administration to adopt a fi scal stabi lization plan and to take measures it deems necessary to ensure the Administration ' s financia) self-sufficiency. However, as of the date of this report, GDB has practically suspended operations and has no ability to enforce the FOA and has no resources to provide financing support.

20

Puerto Rico Health Insurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Notes to Financia! Statements For the Years Ended }une 30, 2016 and 201 5

The Fiscal Stabilization Plan includes the following measures:

• Maximization of discounts or rebates with respect to prescription drugs dispensed to

beneficiaries. • Monitoring process to ali contracted managed care organizations through information

technology and physical audits and imposition of penalties and fines for noncompliance. • Maximization of proof of petitions of federal funds through more efficient segregati on of

Commonwealth and Federal benefi ciaries.

• Timely accounts receivables reconciliation and collections process .

3. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a. Basis of Accounting

The financia! statements are presented on the accrual basis of accounting in conformity with accounting principies generally accepted in the United States of America. Under this method, revenues are recognized when earned, regardless of when received, and expenses when incurred, regardless of when paid.

b. Basis of presentation

The financia! statements are presented as an enterprise fu nd and conform to the provisions of Governmental Accounting Standards Board Statement No. 34 (GASB No. 34), Basic Financia! Statements - and Management 's Discussion and Analysis - for State and Local Governments. GASB No. 34, as amended, establi shes standards for externa! financia] reporting for ali state and local governmental entities, which includes a Statement of Net Position, a Statement of Revenues, Expenses, and Changes in Net Position, and a Statement of Cash Flows.

As further explained on Note 11 , the Employees Retirement System of the Commonwealth of Puerto Rico did not provide the Administration the information needed to adopt GASB Statement No. 68, Accounting and Financia! Reporting for Pensions - an amendment of GASB Statement No. 27 (GASB 68) . Accordingly, these financia! statements do not contain any adjustments, disclosures or required supplementary information established by GASB 68 .

c. Recently adopted accounting standards

The Governmental Accounting Standards Board issued the GASB Statement No. 72, Fair Value Measurement and Application with effectiveness for the year 20 16. This Statement addresses accounting and financi a! reporting issues related to fair value measurements, provides guidance determining a fair value measurement for financia! reporting purposes and for applying fair value to certain investments and disclosures related to fair value measurements . This Statement requires a government to use valuation techniques that are

2 1

Puerto Rico Health lnsurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Notes to Financia! Statements Far the Years Ended ]une 30, 2016 and 2015

appropriate under the circumstances and for which sufficient data are available to measure fair value. This Statement establishes a hierarchy of inputs to valuation techniques used to measu re fair value. That hierarchy has three levels . Level 1 inputs are quoted prices (unadj usted) in active markets for identical assets or liabilities. Leve( 2 inputs are inputs-other than quoted prices-included within Level I that are observable for the asset or liability, either directly or indirectly. Finally, Level 3 inputs are unobservable inputs, such as management's assumption of the default rate among underl ying mortgages of a mortgage-backed security.

Adoption of GASB No.72 did not have a sign ificant impact in the Administration's financia! sattements.

d. Cash, cash equivalents, and restricted cash

The Administration considers ali highl y liquid investments with maturities of three months or less to be cash equivalents.

Restricted cash if for use in the Intelligent Card program for benefi ciaries and the balance shown is the remainder of the funds established for said purposes.

e. Allowance f or doubtful accounts

The allowance for doubtful accounts is an amount that management believes will be adequate to absorb possible losses on existing accounts receivable that may become uncollectible based on evaluations of collectability of accounts receivable and prior credi t loss experience. Because of uncertainties inherent in the estimation process, management's estímate of credit losses in the existing accounts receivable and related allowance may change in the future.

f Contributions from the Commonwealth of Puerto Rico

Contributions received from the Commonwealth of Puerto Rico represent appropnat10ns to cover the local share to meet federal funds matching requirements and funds for the payment of health insurance premiums and administrative expenses.

g. Contributions from the Puerto Rico Department of Health

Contributions received from the Puerto Rico Department of Health represent payments to the Administration by the Medicaid Program which consist of a determined monthly amount of the funds allocated to Puerto Rico under Tile XIX of the Social Security Act and State Plan. In order to comply with the match of federal funds, the Administration is assigned funds from the Commonwealth. The Medicaid Program is the recipient of CHIPS and Prescription Drugs funds which are in whole transfered to the Administration for health care services for the eiioible

b

population of these funds.

22

Puerto Rico Health lnsurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Notes to Financia! Statements For the Years Ended ]une 30, 2016 and 2015

h. Contributions from Mu.nicipalities

Contributions from Municipalities represent the budgetary appropnat10ns of the municipal governments for direct health services in areas covered by the government health plan. The charges made by the Administration are based on established percentages applied to the corresponding Municipalities' operational budget for the lesser of current year or fi scal year 2003-2004 as set forth in Act No. 72 of September 7 , 1993 , as amended. These contributions are withheld by the Municipal Revenue Col lection Center from money ass igned to the municipalities and remitted to the Administration on a monthly basis. In April 2016, the supreme court of the Common wealth of Puerto Rico resolved in favor of municipalities and CRIM stating that the budget base year should be 2003-2004 in stead of 2004-2005.

i. Use of estimates

The process of preparing financia! statements in conformity with accounting principies generally accepted in the Un ited States of America requires the use of estimates and assumptions regarding certain types of assets, liabilities, revenues and expenses. Such estimates primari ly related to un settled transactions and events as of the date of the financ ia! statements. Accordingly, upon settlement, actual results may differ from those estimates.

j . Revenue recognition

The Administration di stinguishes operating revenue from non-operating revenue. Revenue assoc iated to Contributions from the Puerto Rico Department of Health, the Commowealth of Puerto Rico, Municipa lities, Employers, and Pharmacy Rebate Programs are recorded as operating revenue. Re venue associated with legislative appropriations from the Commonwealth of Puerto Rico and interest are recorded as non-operating revenue.

k. Capital assets

Capital assets are stated at cost. Donated property is reported at their estimated fair value at the date received. When assets are retired or otherwise disposed of, the cost and accumulated depreciation or amortization are removed from the accounts, and any resulting gain or loss is recorded in the operations for the period.

Expenditures for repairs and maintenance that do not extend the use ful lives of the assets are charged to operations in the year incurred.

l. lmpairment of Capital Assets

A capital asset generally should be considered impaired if both (a) the decline in service utility of the capital asset is large in magnitude and (b) the event or change in circumstance is outside the normal life cycle of the capital asset. No impairment charges were recorded during the years ended June 30, 2016 and 2015 .

23

Puerto Rico Health lnsurance Administration (A Componen! Unit of the Commonwealth of Puerto Rico) Notes to Financial Statements Far the Years Ended ]une 30, 2016 and 2015

m. Depreciation and amortization

Depreciation is provided over the estimated useful Jife of each class of depreciable asset and is computed using the straight-line method. The depreciable lives are: 3-10 years far equipment, computer and software; 3-5 years far vehicles; 5 years far leasehold improvements and 2-10 years far furniture and others .

n. Compensated absences

The employees of the Administration earn thirty (30) days of vacation and eighteen ( 18) days of sick leave annually. Vacation time accumulated is fully vested to the employees from the first day of work. In the event of resignation, an empl oyee is reimbursed far accumulated vacation days up to the max imum all owed . Separation of employ ment prior to the use of ali or part of the sick leave terminates ali rights far compensation except that, in the event of retirement, an employee is reimbursed far accumulated sick leave days up to the maximum allowed of ninety (90) days after 1 O years of services.

The employees have the right to accumulate the excess of s ixty (60) days in vacation and ninety (90) days in sick leave until December 31 of each year. The excess should be paid to the employee befare March 3 1 of the fallow ing year.

Compensated absences are accrued when incurred usin g the pay or salary rates in effect at the date of balance sheet.

o. Risk management

The Adrninistration is exposed to various risks of loss from torts, theft of, damage to, and destruction of assets, errors and omi ssions, employee injuries and illnesses, natural d isasters, and other losses. Commercial insurance coverage is obtained far potential claims aris ing from such matters.

The commercial insurance coverage is negotiated by the Department of Treasury of the Commonwealth of Puerto Rico and the cost is bi lled to the Administration.

p. Pharmacy rebate program

The Adrninistration established a governmental pharmacy rebate program which consists of agreements negotiated far the purpose of obtaining pharmaceutical rebates and discounts with respect to the utilization of certain prescription branded drugs dispensed to beneficiates. The Adrninistration contracted a prívate entity far the implementation and pharmacy rebate program implementation and adrnin istration. The Administration retains 100% of the income deri ved from this program based on a Puerto Rico Department of Justice Ruling.

24

Puerto Rico Health lnsurance Administration (A Componen{ Unit of the Commonwealth of Puerto Rico) Notes to Financia/ Statements For the Years Ended }une 30, 2016 and 2015

q. Accounting for pension costs

As disclosed in Note 11 to the basic financia) statements, the Admini stration was not able to implement the requirements of Statement No. 68 of the Governmental Accounting Standards Board, Accounting and Financia! Reporting for Pension, and amendment of GASB Statement No 27., (GASB 68) . The Administration' s inability to imple ment the requirements of GASB 68 resu lted from the unavailability of the required information that was expected to be provided by The Employee Retirement System of the Commonwealth of Puerto Rico and its Instrumentali ties (ERS), a pension trust fund of the Commonwealth, which is not under the Administration' s management and control. Therefore, as of the date of thi s report, it is unknown when the required information will be provided to enable the Administration to imple ment the requirements GASB 68 and, therefore, the Administration is not able to determi ne the possible impact on its basic financial statements. This si tuation resulted in the issuance of a qualified opinion from our externa] auditors .

r. Estimated liability for claims incurred but not reported

Represents the estimated da llar amount of med ical claims incurred but unpaid to providers based on experience and accumulated statistical data under the Government Health Program. The estimates of medica) claims incurred but not reported (IBNR) and other medical expense payments are developed by an independent actuary using assumptions based upan payment patterns for medica), pharmacy and dental cl aims, inflation of medica) costs, historical developments and other relevant factors. Claims liabilities are based on estimates and, while management believes that the amounts are adequate, the ultimate Jiability may be in excess of or less than the amounts provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed, and any adjustments are refl ected in the statement of revenue, expenses and changes in net position for the current year.

Starting on April 1, 20 15, under the new MCO model , the Administration pays the insurers a fixed per month per member (PMPM) premium for each insured beneficiary and the insurers are respons ible for claims liabilities and related medica( cost associated to such services.

s. Medica[ cost recognition

Up to March 31, 2015, significan ti y ali medica] costs were the risk of the Admini stration. Medica] costs included claims payments, capitation payments, and other costs incurred to provide health care to beneficiaries as well as estimates of future payments for health care provided prior to the clase of the year. Capitation payments represented monthly prepaid fees disbursed to participating primary care physicians and other providers who were responsible for providing health care to beneficiaries. Risks related to catastrophic or high risk conditions were assumed by the administration.

Starting on April 1, 2015, under the new MCO model, the Administration pays the insurers a fixed PMPM premium for each insured beneficiary and the insurers are responsible for claims liabilities and related medica) cost associated to such services .

25

Puerto Rico Health lnsurance Administration (A Componen! Unit of the Commonwealth of Puerto Rico) Notes to Financia! Statements Far the Years Ended ]une 30, 2016 and 2015

4. CASH AND CASH EQUIV ALENTS

The Administration' s cash and cash equi valents as of June 30, 2016 consisted of the following :

Deposit Impairment Book Balance loss Balance

Cash deposited in commercial banks $ 68,896,33 1 $ $ 68,896,331

Deposits accounts with the Government Development Bank for Puerto Rico 1,768,004 ( 1,049,005) 7 18 999

Total cash and cash equivalents $ :zo 664 335 $ ( 1 042 005) $ 62 615 330

Jmpairment Loss on Deposits with Governmental Development Bank

As explained in Note 2, the Commonwealth and the GDB face significant uncertainties, includ ing liquidity risks, which is the ri sk of not having sufficient liquid financia! resources to meet tbeir obligations when they come due.

Pursuant to recently enacted legislation, the Governor of the Conunonwealth has ordered the suspension of loan disbursements by GDB, imposed restrictions on the withdrawal and transfer of deposits from GDB, and imposed a moratorium on debt obligations of GDB, among other meas u res.

As a result of the reductions in liquidity experienced subsequent to J une 30, 2014, GDB took a number of liquidity enhancing and conservation measures, and explored the sale of assets and other alternati ves to address its liquidity needs. In light of GDB' s significant debt service obligations during the year 20 16, these measures, however, are not expected to be sufficient to maintain GDB ' s operati ons in the ordinary course absent the completion of a capital market transaction, a restructuring of GDB 's debt, and the payment by the Commonwealth of debt service on GDB' s public sector loans payable from annual appropriations. As a result of the non-payment by the Commonwealth of the appropriation to GDB and GDB ' s inability to restructure its debt in light of the broader fiscal crisis faced by the Commonwealth, GDB was not in a positi on to pay principal on its debt obli gati ons due on May 1, 2016 and continue operations in the ordinary course. In April 2016, the Governor imposed on GDB, emergency operational restrictions and debt moratorium desc ribed below. The GDB has continued to pay interest on its debt obligations.

Due to the conditions and events described above, GDB's management be lieves substantial doubt exists as the GDB ' s abi lity to continue as a going concern .

On October 18, 2016, the Secre tary of the Treasury of the Commonwealth of Puerto Rico issued its Circular Letter 1300-08-17 confirming that there is substantial doubt that GDB may be able to continue operating as a going concem , and that GDB is currently without financia! liquidity. Based on this information, the Secretary recommended to ali component units and other entities with deposits at GDB to evaluate the possibility of recogni zing an impairment loss as of June 30, 2016, for amounts held at GDB.

26

Puerto Rico Health Insurance Administration (A Componen! Unit of the Commonwealth of Puerto Rico) Notes to Financia! Statements Far the Years Ended ]une 30, 2016 and 2015

As a result of the above matters, the Administration recognized an impairment loss on deposits held with GDB of approximately $ 1 milli on. The remaining balance of approximately $7 19 thousand relates to federal funds and are expected to be returned to the Administration.

S. CUSTODIAL CREDIT RISK - DEPOSITS

Custodi a! credit risk is the risk that, in an event of a bank failure, the Admin istration deposits might not be recovered. The Commonwealth requires that public funds deposited in commercial banks must be fully collaterali zed for the amount deposited in excess of federal depository insurance coverage. Ali securities pledged as collate ral are held by the Secretary of the Treasury of the Commonwealth. Deposits at the Government Development Bank of Puerto Rico are uninsured and uncollateralized as this entity is a component unit of the Commonwealth of Puerto Rico and therefore, is exempt from compliance wi th the collateralization requirement.

For the year ended June 30, 2016 and 2015 , the custodia! risk of the administration amounted to $ 1.8 mi Ilion and $9.3 million, respectively, which is the bank balance of cash and cash equivalents deposited at the Government Development Bank for Puerto Rico. These deposits are exempt from the collateral requirement established by the Commonwealth.

6. ACCOUNTS RECEIVABLE

Accounts receivable and the a ll owance for doubtful accounts as of June 30, 2016 and 2015 consist of the followin g:

Puerto Rico Department of Health Municipalities Pharmacy rebate program Other receivables Due from employers

Allowance for doubtful accounts

Account receivable, net

$

$

2016

59,022,472 73,387,466 53,953,5 13

5,349,008 67 ,237,883

258,950,342 (76,715,061)

)8223528)

2015

$ 133,5 16,531 98,705,767 41 , 147,836 32,675,679 56,371,676

362,417,489 (66,684,396)

$ 295 133 093

A llowance for doubtful accounts is di vided in four parts. The first part of the reserve is re lated to municipalities amounting to approximately $ 15.8 million and $5 1 million for 2016 and 2015, respectively. The second part is related to governmental agencies for employer's contributions for the medica! health plan amounting to approximately $59.2 million and $4.5 million for 2016 and 2015, respectively . The third part relates to other receivables amounting to $744 thousand in 2016 and 2015, while the fourth part relates to the pharmacy rebate program of approximately $923,000 in 2016 (none in 20 15).

27

Puerto Rico Health Insurance Administration (A Componen! Unit of the Commonwealth of Puerto Rico) Notes to Financia[ Statements Far the Years Ended ]une 30, 2016 and 2015

7. CAPITAL ASSETS

8.

The activities of the capital assets accou nts for the years ended June 30, 2016 and 2015 were as foll ows:

June 30 2016 Beginning Ending

Balance Additions Retirements Balance

Equipment, computer and software $ 1,220,647 $ 80,674 $ $ 1,301,321 Furniture and others 259,585 6,044 265,629 Vehicles 94,652 850 95 ,502 Leasehold impro vements 33,1 23 33,123

1,608,007 87,568 1,695,575 Accumulated depreciation (906,371) (214,41 5) (1,120,786)

Capital assets, net $ 70) 636 $ ( )26 847) $ $ 574 789

June 30, 2015 Beginning Ending

Balance Additions Retirements Balance

Equipment, computer and software $ 1,762,8 19 $ 25 1,394 $ (793,566) $ 1,220,647 Vehicles 94,652 94,652 Leasehold improvements 108,468 33, 123 ( 108,468) 33, 123 Furniture and others 290,040 (30,455) 259,585

2,255,979 284,517 (932,489) 1,608,007 Accumul ated depreciation (1,601,623) (237,237) 932,489 (906,371)

Capital assets, net $ 654 356 $ 47 280 $ $ 70) 636

DUE FROM MCO'S

The Administration contracted the services of a public accounting firm to carry out an interna! audit of the payment system under the previous TPA model. The sample selected for testing revealed that the Administration made duplicate payments and also paid premiums for deceased persons to the insurance entities in charge of the administration of the health care program in Puerto Rico (Mi Salud). The amount overpaid was determined by subtracting the deceased listing provided by "Registro Demografico" (by its Spanish name) from the participants list provided by the Department of Health which was used to calculate the premiums and administration fees paid to the insurance entities.

28

Puerto Rico Health lnsurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Notes to Financia[ Statements Far the Years Ended ]une 30, 2016 and 2015

As a result of the audit, the Administration filed a claim to one of the insurance companies representing 37% of the total overpayment. As of the date of this report, various validation procedures have been sati sfactori ly perfarmed over the underlying data, but other allegations brought by the counterparty challenging sorne contractual aspects of the contract remain unresolved. The Admin istration bel ieves that has conclusive evidence to overcome counterparty allegations and recover a substanti al amount of the claim. As of June 30, 2016, an allowance far doubtful account of $4, 116,4 1 O was established.

Also, as of the date of this report, no others claims have been filed again st the other insurance entities.

9. OBLIGA TION WITH GOVERNMENT DEVELOPMENT BANK

On March 14, 20 11, the Administration entered into a Credit Agreement with the GDB in arder to pay its obligations to healthcare insurers incurred prior to fiscal year 2009-2010. The aggregate principal amount of the non-revo lving line of credit was $ 186,000,000 and is payable in nine payments of $20,666,667 each due on March 14 of the years 2015 through 2023.

lnterests are accrued at a fluctuating annual rate of interest equal to the greater of (i) 1.5% over prime rate, and ( ii ) 6%. As of June 30, 201 6 and 201 5, the outstanding principal balance amounted to $ 183,25 1,298 and the accrued interest amounted to $19,713 ,188 and $8,7 18,111 , respectively. The principal and interest is payable with appropriati ons from the Legislature of Puerto Rico pursuant to Act No. 173.

This credit agreement expired on March 3 1, 20 15. During the year 201 5, the Puerto Rico Office of Management and budget (OMB) paid interest amounting to $2,386,922 on behalf of the Administration . No payments were made by OMB during the year 2016. OMB did not appropriate any funds to pay the principal of thi s Credit Agreement.

On July 20, 2016, the Governor of Puerto Rico signed the Law 74 which authorized the GDB to consolidate ali financing agreements made to governmental entities which are payable with appropriations from the legislature. Article 4 of such law lists ali the governmental entities with financia! agreements and the outstanding principal balance and accrued interest as of December 3 1, 201 5. The Administration is listed with an outstanding principal balance of $ 183,251,298 and accrued interest of $ 14,2 15,650 as of December 31, 2015. As of the date of this report, the GDB has not taken any action towards this act.

10. LIABILITY FOR CLAIMS INCURRED BUT NOT REPORTEO

The liability far claims incurred but not reported is based on historical claims experience data, assumptions, and projections as to future e vents, including claims frequency, persistency and inflationary trends determined by an independent actuaria] study. The assumptions u sed in estimating and establishing the liability are reviewed annually based on curre nt circumstances and trends. The actuaria) study considered the experience of the Administration from the date Triple-S

29

Puerto Rico Health Insurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Notes to Financia! Statements Far the Years Ended }une 30, 2016 and 2015

began administering Mi Salud Program on November 1, 2011 to March 31 , 2016, date in whcih the Administration change to the MCO model. Any resulting adju stments are considered to be a change in an accounting estimate and accounted for as an increase (decrease) to current period expenses.

The liability for both, reported and unreported claims totaled $3,899,000 and $75,899,000 at June 30, 2016 and 20 15, respectively, and includes estimates of future payments of c laims and claims adjustments expenses .

As of June 30, 20 16 and 2015, total claims liabilities activity reported was as follows:

2016

C laims li ability at beginning of period : $ 240, 152,851 $ lncurred claims 92, 191,469 Less: paid claims (210,632,430)

C laims payable at end of period $ 121 1 11 820 $

These are presented in the accompanyng statements of net position as foll ows:

C laims payable $ Estimated liability for claims incurred but not reported

112,062,257 $ 3 899 000

2015

28 1,714,046 1,762,646,626

( 1,804,207,82 1)

240 152 851

164,253,85 1 75 899 000

$ 115261251 $ 240152851

11. RETIREMENT SYSTEM

Defined benefit pension plan

The Employees' Retirement System of the Govemment of the Commonwealth of Puerto Rico (the Retirement Syste m), created pursuant to Act No. 447 of May 15, 1951, as amended, is a cost­sharing multiple-employer defined benefit pension plan sponsored by, and reported as a component unit of the Commonwealth. All regular employees of the Administration hired befare January l , 2000 and less than fifty-fi ve (55) years of age at the date of employment became members of the Retirement System as a condition to their employment. No benefits are payable if the participant receives a refund of his/her accumulated contributions.

The Reti rement System provides retire ment, death and disability benefits pursuant to legislation enacted by the Commonwealth ' s legis lature. Retire ment benefits depend u pon age at retirement and the number of years of creditable service. Benefits vest after ten (1 O) years of plan participation. Disability benefits are available to me mbers for occupational and non-occupational disability benefits.

30

Puerto Rico Health Jnsurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Notes to Financia/ Statements Far the Years Ended ]une 30, 2016 and 2015

Members who have attained at least fifty-fi ve (55) years of age and have completed at least twenty-five (25) years of creditable service or members who have attained fifty-eight (58) years of age and have completed at least ten ( 10) years of creditable service, are entitled to an annual benefit, payable monthly for life. The amount of the annuity shall be 1.5% of the average compensation, as defined , multiplied by the number of years of creditable service up to twenty (20) years, plus 2% of the average compensation, as defined, mu ltiplied by the number of years of creditable service in excess of twenty (20) years. In no case will the annuity be less than $400 per month .

Part icipants who have completed at least thirty (30) years of creditable service are entitled to receive the merit Annuity. Partic ipants who have not attained fifty-five (55) years of age will receive 65% of the average compensation, as defined ; otherwise they will receive 75% of the average compensation.

Commonwealth legislation requires employees hired on or befare March 31, 1990 to contribute 5 .775% for the first $550 of their monthly gross salary and 8.275% for the excess over $550 of monthly gross salary. Employees hired on or after April 1, 1990 are required to contribute 8.275% of their monthly salary. The Admini stration is required by the same statute to contribute 11.52% of the partic ipants' gross-salary.

Defined Contribution Plan

The Legislature of the Commonwealth enacted Act no. 305 on September 24 , 1999, which amends Act No . 447, to establish, among others, a defined contribution savings plan program (the Program) to be administered by the Retirement System. All regul ar employees hired for the first time on or after January l , 2000 and former employees who participated in the defined benefit pe nsion plan, received a refund of their contribution and are rehired on or after January 1, 2000, become members of the Program as a condition to their e mployment. In addition, employees who at December 3 1, 1999 were partic ipants of the defined benefit pension plan, had the option, up to March 3 1, 2000, to irrevocably transfer their prior contributions to the defined benefit pension plan plus interest thereon to the Program.

Act no. 305 requires employees to contribute 8.275% of their monthly gross salary to the Program. Employees may elect to increase their contribution up to 10% of their monthly gross salary. Employee contributions are credited to his/her indi vidual account established under the Program. Partic ipants have three options to invest the ir contributions to the Program. lnvestment income is credited to the participant account serru-annually.

The Adrrunistration is required by Act No. 305 to contribute 10.275% of the participant' s gross salary. The Retirement System will use these contributions to increase its asset leve! and reduce the unfunded status of the defined benefit pension plan.

31

Puerto Rico Health Insurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Notes to Financial Statements Far the Years Erided ]une 30, 2016 and 2015

Upon retirement, the balance in the participant's account will be used to purchase an annuity contract, which will provide for monthly benefits during the participant's li fe and 50% of such monthly benefit to the participant 's spouse in case of the partic ipant's death. Participants with a balance of $ 10,000 or less at retirement wi ll receive a lump-sum payment. In case of death, the balance in the participant's account will be paid in a lump sum to his/her beneficiaries. Participants have the option of a lump sum or purchas ing an annuity contract in case of permanent disability.

Total employee contributions to the above mentioned plans during the year ended June 30, 2016 and 2015, amounted to approxi mately $521,994, and 401,391 respectively.

Furthermore, on April 4, 2013 the Governor of Puerto Rico signed into Law Act No. 3 of 2013 which represents a comprehensive reform of the Employee Retirement System (ERS). Act No. 3 beca me effecti ve on J uly 1, 20 13 and amends the provisions of the diffe rent structures under the ERS, including, but not limited, the following:

• For active participants of the contributory defined benefits program under Act No. 447 of

1951 and Act No. 1 of 1990, ali retirement benefits accrued through June 30, 2013 will be

frozen, and thereafter, ali future benefits will accrue under the defined contribution formula

used far System 2000 participants, and will be paid at retirement through a lifet ime annuity.

• Increases the minimum pension for current retirees from $400 to $500 per month.

• The retirement age far Act No. 447 participants will be gradually increased from age 58 to

61. • The retirement age far current System 2000 participants is increased gradually from age 60

to 65 . • Eliminates the "merit annuity" availab le to participants who joined the ERS prior to April 1,

1990. • The retirement age far new employees is increased to age 67, except for new state and

municipal police officers, firefighters, and custody officers, which will be age 58. • The employee contribution rate will increase from 8.275% to 10%.

• Far System 2000 participants, the reti rement benefits will no longer be paid as a lump sum

distribution, instead, they will be paid through a lifetime annuity.

• E liminates or reduces various retirement benefits previously granted by spec ial laws,

including Christmas and summer bonuses. The Christmas bonus payable to current retirees

is reduced from $600 to $200 and is e liminated far future retirees. The summer bonus will be e liminated .

• - Disability benefits will be e lirninated and substituted far a mandatory disability insurance policy.

• Survivor benefits will be notified.

Additional information on the Retirement System is provided in its stand-alone basic financia( statements, a copy of which can be obtained from the retirement System Administration, PO Box 42003, San Juan, PR 00949.

32

Puerto Rico Health lnsurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Notes to Financia! Statements For the Years Ended ]une 30, 2016 and 2015

Statement No. 68 of the Governmental Accounting Standards Board, Accounting and Financia! Reporting fo r Pensions - an amendment of GASB Statement No. 27 (GASB 68) became effective for the year ended June 30, 2015. This Statement repl aces the requirements of Statement No. 27, Accounting for Pensions by Sta te and Local Governmental Employers, as well as the requirements of Statement No. 50, Pension Disclosures, as they relate to pensions that are provided through pension plans administered as trusts or equi valent arrangements that meet certain criteria as is the case of the Employees Retirement Syste m (ERS) .

As of the date of the re lease of thi s report , the ERS has not pro vided the Administration with the required information to imple ment the requirements of GASB 68 for the years ended June 30, 2016 and 2015. Therefo re, the accompanying financia! statements do not have any adjustments that will be necessary for the Administration to account for its proportionate share of the net pension liability, deferred inflow of resources and deferred outflow of resources in the statements of net position as of June 30, 20 16 and 20 15, as well as the effect in the recorded pension expense in the state ments revenue, expenses and changes in net position for the years ended June 30, 20 16 and 2015. Also, additi onal disclosures required by GASB 68 as well as required supplementary information have been omitted from these basic financia! statements.

12. EARL Y TERMINA TION BENEFITS

On Jul y 2, 201 O, the Corrunonwealth enacted Act No. 70 to establish a program that provides benefits for early retirement or economic incentives for voluntary employment termination to eligible employees, as defined, including employees of the Administration. Act No. 70 established that earl y retirement benefits will be provided to elig ible e mployees that have completed between 15 to 29 years of creditable services and will consist of biweekly benefits ranging from 37.5% to 50% of each employee's salary, as defined. In this early re tirement bene fit program, the Administration will pay the employer contributions to the Retirement System and the corresponding pension until the employee complies with the age requirements and 30 years of creditable services applicable to the Retirement System. Economic incentives are available to eligible employees that qualify for retirement benefits. Economic incentives consist of a payment ranging from one to six months of salary. Additionally, eligible empl oyees that choose to participate in this program, other than those qualifying for retirement benefits, are eligible to recei ve health plan coverage for up to 12 months in a health plan selected by management of the Commonwealth of Puerto Rico.

At June 30, 2016 and 201 5, unpaid long-term benefits granted on this program were discounted 3%. Total accrued terminations benefits as of June 30, 2016 and 2015 amounted to $4, 180,484 and $4, 175,755, respecti vely.

13. RESTATEMENT OF PRIOR YEAR FINANCIAL STATEMENTS

During the year ended June 30, 2016, management restated its prior year financia! statements to comply with GASB 33, Accounting and financia[ reporting fo r nonexchange transactions. The adjustment consisted in the reversa] of certain receivables from the Office of Management and Budget (OGP, for its acronym in spanish) in the amount of $8,608,156 representing the source of repayment of the interest payable due to GDB for the year ended June 30, 20 15.

33

V

Puerto Rico Health lnsurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Notes to Financia! Statements Far the Years Ended ]une 30, 2016 and 2015

The e ffect of this restatement in the 2015 financia) statements is as follows:

Net deficit, beginning balance as previously reported Restatement - e lirnination of receivable

Net deficit, beginning balance as restated

14. COMMITMENT ANO CONTINGENCIES

Commitments

$ (207 ,504,89 1) (8,608, 156)

$ (2 )6 113 047)

On July 1, 20 14, the Adrninistration signed a tease agreement for fi ve years commencing on Jul y 1, 2014 through June 30, 2019 with an automatic extension for another fi ve years from July 1, 20 19 through June 30, 2024. The lease agreement has a cancellation penalty of $950,000 if the tease is not renewed at the end of the fi ve-year tenn . Rent expense for the years ended June 30, 2016 and 2015 amounted to $377 ,475 and $463,744, respecti vely.

Total future mínimum lease payments on this operating lease as of June 30, 20 16, is as foll ows:

Contingencies

Year ending June 30,

201 7 2018 2019

Amount

$ 422,004 419,179 4 14 116

$ 1 255 299

The Administrat ion is defendant and/or co-defendant in legal proceedings pertaining to matters incidental to the performance of its operations. With respect to the pending and threatened litigations, the Administration, in consultation with legal counsel, has advised that at this stage of the proceedings they cannot offer an opinion as to the probable outcome. Accordingly, management does not consider necessary making any provi sion in its books for these cases and intends to contest them vigorously.

The Administration has been requested to repay the Puerto Rico Treasury Department approximately $ 103 million representing additional transfers of money from the central government during the fiscal years 2001 -2003. After consultation with externa! legal counsel, the Administration is of the opinion that the money does not have to be repaid and believes that the likelihood of an unfavorable outcome is remote. Therefore, no reserve has been recorded in the Adrninistration financia! statements.

34

Puerto Rico Health Insurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Notes to Financia/ Statements Far the Years Ended ]une 30, 2016 and 2015

Federal grants

The Administration receives as a sub-grantee financia! assistance from the federal government corresponding to Medicaid Program passed through the Puerto Rico Department of Health , the grantee. Federal grants are subject to financia! and compliance audits by grantor agencies in order to determine the Administration' s compli ance with the regulations and conditions of such grants. It is management ' s opinion that no additional material unrecorded liabilities wi ll arise from audits previously performed or to be performed.

15. RECLASSIFICA TIONS

Certain prior year' s amounts have been re'classified to conform to the current year presentation.

16. SUBSEQUENT EVENTS

The Administration has evaluated ali events subsequent to the financia! statement date of June 30, 2016 through November 17, 20 16, which is the date these financi a! statements were available to be issued. The subsequent events disclosed are principally those which management believes are of sufficient public interest for disclosure.

On July 20, 20 J 6, the Governor of Puerto Rico signed the Law 74 which authorized the GDB to consolidate ali financing agreements made to governmental entities which are payable with appropriations from the Puerto Rico legi slature. Artic le 4 of such law lists ali the governmental enti ties with financia! agreements and the outstanding principal balance and accrued interest as of December 3 1, 20 15. The Administration is listed with an outstanding principal balance of $183,25 J ,298 and accrued interest of $ 14,2 15,650 as of December 3 1, 2015 .

On October 18, 2016, the Secretary of the Treasury of the Commonwealth of Puerto Rico issued its C ircu lar Letter 1300-08-1.7 confirming that there is substantial doubt that GDB may be able to continue operating as a going concern, and that GDB is currently without financia! liquidity. Based on thi s information, the Secretary recommended to ali component units and other entities with deposits at GDB to evaluate the possibility of recognizing an impairment loss as of June 30, 2016, for amounts he ld at GDB. As a result, the Administration recognized an impairment loss on deposits held with GDB of approximately $1 million.

* * * * *

35

V

Puerto Rico Health Insurance Administra/ion (A Component Unit of the Commonwealth of Puerto Rico) Schedule of Expenditures of Federal Awards For the Year Ended }une 30, 2016

Federal Grantor / Pass-Through Grantor / Program or Cluster Title

U.S. Department of Health and Human Services

Major Programs: Passed through the Puerto Ri co Department of Health

Medica! Assistance Program (Medicaid; T itle XIX) Children Health lnsurance Prograrn (CHIP) ARRA - HIT Incentive Payrnents ARRA - HIT Administrative Irnplementation Payrnents

Total Expenditures

See notes to Schedule of Expenditures of Federal Awards.

36

Federal CFDA Number Expenditures

93.778 $ 1,532, 176,791 93 .767 161 ,154,373 93 .778 10,521,339 93.778 1,878 ,928

$ 1 105131 431

Puerto Rico Health lnsurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Notes to Schedule of Expenditures of Federal Awards Far the Year Ended }une 30, 2016

l. BASIS OF PRESENTATION

The accompanying schedu le of expenditures of federal awards includes the federal grant activity of the Puerto Rico Health lnsurance Admjnistration and is presented on the accrual bas is of accounting. The informat ion in this schedule is presented in accordance with the OMB Uniform Guidance .

2. PASS-THROUGH ENTITY IDENTIFYING NUMBER

State or Local government redistribution of federal awards to the Adrrunistration , known as "pass­through awards", should be treated by the Adrrunistration as though they were received directly from the federal government. Uniform Guidance requ ires the schedule to include the name of the pass-through entity and the identifying number assigned to the pass-through entity for the federal awards received.

* * * * *

37

NEXIA PUERTO RICO, P.S.C. Certified Public Accountants & Consultants NEXI~

PUERTO RICO

INDEPENDENT AUDITORS' REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND ON COMPLIANCE AND OTHER MATTERS BASED ON AN AUDIT OF THE FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE WITH GOVERNMENT AUDITING STANDARDS

To the Board of Directors of Puerto Rico Health lnsurance Administration

We have audited , in accordance with the auditing standards generally accepted in the United States of America and the standards applicable to financia! audits contained in Government Auditing Standards issued by the Comptroller General of the United States, the financia! statements of the governmental activities of Puerto Rico Health lnsurance Administration (the Administration), as of and for the year ended June 30, 20 16, and the related notes to the fin ancia! statements , which co llecti vely comprise the Administration' s basic fin anc ia! statements and have issued our report thereon dated November 17, 2016.

Interna[ Control Over Financia[ Reporting

In planning and performing our audit on the financia! statements, we considered Administration' s interna! control over financia! reporting ( interna! control ) to determine the audit procedures that are appropriate in the circumstances for the purpose of expressing our opinion on the fin ancia! statements, but not for the purpose of expressing an opinion on the e ffecti veness of the Admini strati on' s interna! contro l. Accordingly, we do not express an opinion on the effectiveness of Administration's interna! control.

A def iciency in interna! control exi sts when the design or operation of a control does not allow management or e mployees, in the normal course of performing their assigned functions, to prevent, or detect and correct, mi sstatement on a timely basis. A material weakness is a deficiency, ora combination of defi ciencies, in interna! control , such that there is a reasonable possibility that a material misstatement of the entity' s fin ancia! statements will no be prevented, or detected and corrected on a timely basis. A significant deficiency is a deficiency, or a combination of defic iencies, in interna! control that is less severe than a material weakness, yet importan! enough to merit attention by those charged with go vernance .

Our considerati~n of interna! control was for the limüed purpose described in the preceding paragraph and was not des1gned to identify ali deficiencies in interna! control that might be material weaknesses or significant de ficiencies. Given these limitations, during our audit we did not identify any deficiencies in interna! control that we consider to be material weaknesses. However, material weaknesses may ex ist that have not been identified.

NEX IA INTERNA TIONAL IS A WORLDWJDE NETWORK OF lNDEPENDENT ACCOUNTING AND CONSULTING F!RMS

PO Box 195607 San Juan. PR 00919-5607

Tel.: (787) 522.0300 Fax: (787) 522-0301

Compliance and Other Matters

As pan of obtai11i11g reasonable assurance about whether the Admi11istration's fi11a11c ial stateme11ts are free from material misstatement, we performed tests of its compliance with certa in provisions of laws, regulations, contracts a11d grant agreeme11 ts, noncomplia11ce with which cou ld have a direct and material effect 011 the determination of financial statement arnou11ts. However, providing a11 opi11ion 011 cornpliance with those provisions was not an objective of our audit, and accordingly, we do not express such an opinion. T he results of our tests di sclosed no insta11ces of noncornpli ance or other rnatter that are required to be reported under Governme11t Auditing Standards.

Purpose of this Report

The purpose of this report is solely to describe the scope of our testing of interna! control and compliance and the resul t of that testing, and not to provide an opinion on the effectiveness of the entity's's interna! control or on cornpliance. This reporl is an integral pa11 of an audit perforrned in accorda11ce with Government Auditing Standards in considering Administratio11 's interna! control and cornpliance. Accordingly, this communication is not suitable for any other purpose.

San Juan, Puerto Rico November 17, 2016

Stamp No. E2472 16 was aflixcd 10 the o rig inal reporl. Lic. 291 Exp. Decembcr 1, 2017.

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NEXIA PUERTO RICO, P.S.C. Certified Public Accountants & Consultants NEX-I'A

P UE RTO RI C O

INDEPENDENT AUDITORS' REPORT ON COMPLIANCE WITH REQUIREMENTS APPLICABLE TO EACH MAJOR PROGRAM; ON INTERNAL CONTROL OVER COMPLIANCE; ANO ON SCHEDULE OF EXPENDITURES OF FEDERAL A WARDS REQUIRED BY THE UNIFORM GUIDE

To the Board of Directors of Puerto Rico Health Insurance Administration

Report on Cornpliance for Each Major Federal Program

We have audited the Puerto Rico Health Insurance Administration 's compliance with the types of compliance requirements described in the OMB Compli ance Supplement that could have a direct and material effect on each of the Admi nistration' s major federal programs for the year ended June 30, 20 16. The Administration' s major federal programs are identified in the summary of auditor's results section of the acco rnpanying schedule of findings and questi oned cost.

Management's Responsibility

Managernent is responsible for compliance with federal statutes, regulations, and the terrns and conditions of its federal awards applicable to its federal programs.

A uditor's Responsibility

Our respons ibility is to express an opinion on cornpl iance for each of the Administration' s major federal programs based on our audit of the types of compliance requirements referred to above. We conducted our audit of compliance in accordance w ith auditing standards generally accepted in the United States of Arnerica; the standards applicable to financia! audits contained in Government Auditing Standards, issued by the Comptroller General of the United States; and the audit requirements of Title 2 U.S . Code of Federal Regulations Part 200, Uniform Administrative Requirements, Cost Principies, and Audit Requirements for Federal Awards (Uni form Guidance). Those standards and the Uni form Guidance require that we plan and perform the audit to obtain reasonable assurance about whether noncompliance with the types of compliance requirements referred to above that could have a direct and material effect on a major federal program occurred . An audit includes examining, on a test basis, evidence about the Administration' s compliance with those requirements and performing such other procedures as we considered necessary in the circurnstances .

We believe that our audit provides a reasonable basis for our opinion on compliance for each major federal program. However, our audit does not provide a legal determination of the Administration ' s compliance.

NEXIA INTERNA TIONAL IS A WORLDWI DE NETWORK OF INDEPENDENT ACCOUNTING AND CONSULTING FIRMS

PO Box 195607 San Juan. PR 00919-5607

Tel.: (787) 522.0300 Fax: (787) 522-0301

Opinion 0 11 Each Major Federal Program

In our op inion, Puerto Rico Health Insurance Administration complied , in ali material respects, with the types of compliance requirements referred to above that cou ld have a direct and material effect on each of its major federal programs for the year ended June 30, 20 16.

Report on Interna/ Control over Compliance

Management of the Administration is responsible for establishing and maintaining effective interna! control over compliance with the types of compliance requirements referred to above. In planning and performing our audit of compliance, we considered the Administration' s interna! control o ver compliance with the type of requirements that could have a direct and material effect on each major federal program to determine the auditing procedures that are appropriate in the circumstances for the purpose of expressing our opinion on compliance for each rnajor fereal program and to test and report on interna! control over compliance in accordance with Uniform Guidance, but not for the purpose of express ing an opinion on the e ffecti veness of interna! control over compliance. Accordingly, we do not express an opinion on the effecti veness of the Administration's interna! control over compliance.

A deficiency in interna! control over compliance ex ists when the design or operation of a control over compliance does not a llow management or empl oyees, in the normal course of performing their assigned functions, to prevent, or detect and correct, noncompliance with a type of compliance requirement of a federal program on a timely basis. A material weakness in interna! control over compliance is a deficiency, or combination of deficiencies, in interna! control over compli ance, such that there is a reasonable possibility that material noncompliance with a type of compliance requirement of a federal program wi ll not be prevented, or detected and corrected, on a timely basis. A significan! deficiency in interna! control over compliance is a deficiency, or a combination of deficiencies, in interna! control over compliance with a type of compliance requirement of a federal program that is less severe than a material weakness in interna! control over compliance, yet important enough to merit attention by those charged with governance.

Our consideration of interna! control over compliance was for the limited purpose described in the first paragraph of this section and was not designed to identi fy ali defi ciencies in interna! control over compliance that might be materia l weaknesses or s ignificant deficiencies. We did not identify any defic iencies in interna! control over compliance that we consider to be material weaknesses . However, material weaknesses may exist that have not been identified.

The purpose of this report on interna] control over compliance is solely to describe the scope of our testing of interna! control over compliance and the results of that testing based on the requirements of Uniform Guidance. Accordingly, this report is not suitable for any other purpose.

Report on Schedule of Expenditures of Federal Awards Required by the Uniform Guidance

We have audited the financia! state ments of the Puerto Rico Health Insurance Administration as of and for the year ended June 30, 2016, and have issued our report thereon dated November 17, 2016, which contained a qualified opinion on those financia! statements . Our audit was conducted for the purpose of forming an opinion on the financia! state ments as a whole. The accompanying schedule of expenditures of federal awards is presented for purposes of additional analysis as required by the Uniform Guidance and is not a required part of the financia! statements . Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financia! statements.

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The in formation has been subjected to the auditing procedures applied in the audit of the financ ia! statements and certain additional procedures, including comparing and reconciling such informat ion directly to the underlying accounting and other records used to prepare the financia) statements orto the fi nancia! statements themselves, and other add itional procedures in accordance with auditing standards generall y accepted in the United States of Ameri ca. In our opinion, the schedule of expenditures of federal awards is fairl y stated in ali material respects in relation to the financia) statements as a whole.

San Juan , Puerto Rico November 17, 2016

Stamp No. E24 7217 was affi xed to the original repon. Lic. 291 Exp. December l. 20 17.

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Puerto Rico Health lnsurance Administration (A Component Unit of the Commonwealth of Puerto Rico) Schedule of Findings and Questioned Costs For the Year Encled }une 30, 2016

Section 1 - Summary of Auditors' Results

Financial Statements T ype of auditors' report issued Interna) control over financing reporting:

1. Material weakness identified? 2. Significant deficiencies that are not considered to be materia l weakness 3. Noncompliance material to financia! statement noted?

Federal awards Interna) control over majar programs:

1. Material weaknesses identified? 2. Significant defic iencies that are not considered to be material weakness? 3. T ype of auditors' report i sued on compliance for maj ar program? 4. Any audit findings di sclosed that are required to be reported in accordance with

FR § 200.5 l 6(a)

Identification of majar programs:

Name of Federal Program or Cluster

Medica( Assistance Program (Medicaid; T itle 1XI) ARRA - HIT Incentive Payments ARRA - HIT Administrati ve Implementation Payments Children' s Health Insurance Program (CHIP)

CFDA Number(s)

93.778 93.778 93.778 93.767

Dallar threshold used to distinguish between Type A and T ype B programs:

Auditee qualified as a low-risk auditee?

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Qualified

No No No

No No

Unmodified

Yes

$ 4,948,277

No

Puerto Rico Health lnsurance Administration (A Component Unit ofthe Commonwealth of Puerto Rico) Schedule of Findings and Questioned Costs Far the Year Ended ]une 30, 2016

SECTION 2-FINANCIAL STATEMENTS FINDINGS

There are no significant deficiencies or other findings for the period ended June 30, 2016.

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Puerto Rico Health Insurance Administration (A Componen! Unit of the Commonwealth of Puerto Rico) Schedule of Findings and Questioned Costs For the Fiscal Year Ended }une 30, 2016

SECTION 3 - FINDINGS AS REOUIRED BY UNIFORM GUIDANCE

Finding 2016-01- Business Continuity

Condition A disaster recovery plan to recover and protect a business information technol ogy infrastructure in the event of unforeseen interruptions has been implemented but not tested.

Criteria 45 CFR 164.308 "Administrati ve safeguards", section (7) (i) "Contingency plan", establi sh (and impleme nt as needed) policies and procedures for responding to an emergency or other occurrence (for example, fire, vandalism, system failure, and natural disaster) that damages systems that contain electronic protected health information.

Effect Critica! business functions may not be resumed in a timely and efficient manner 111 case that an emergency or disaster renders the information technology infrastructure inoperati ve.

Questioned costs Non e

Cause The administration has not tested its disaster recovery plan for fu nctionality.

Recommendation T he administration should test its Business Continuity Plan to ensure that operations may be resumed promply after a real emergency event. In order to provide full assurance that the alternate processing fac ility will work e ffectively, the plan must be tested by simulating ali procedures to be performed during a real emergency. Procedures should include manual processing of transactions to ensure continuity of operations until computer processing is restored. These manual procedures should also be sirnulated on a periodic basis to assure that ali current e rnployees are full y trained to perform their duties in case of a disaster, or in any case of prolonged system unavailabi lity. Procedures should be developed to periodically test the plan by simulating an emergency and to perform any necessary updates for changing business conditions and computer environments on a regular basis.

Management Response The Administration is in the process of obtaining qualified bidders from a request for proposal (RFP) process for testing its Business Continuity Plan (Plan). Once proposals are received, they will be evaluated for compliance with the specific proposal and Plan requirements. From the selected organizati ons that meet the requirements set forth in the RFP, one will be selected to perform such test. Winning proposal will be submitted to the Office of Finance and Administrat ion for budgeting purposes.

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Puerto Rico Health Jnsurance Administration (A Componen! Unit of the Commonwealth of Puerto Rico) Summary Schedule of Prior Year Findings and Questioned Costs For the Year Ended ]une 30, 2016

Finding Reference Number Finding Description

2015-01 Data Collection Form 2015-02 Business Continuity

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Questioned Cost

None None

Finding Current Status

Resolved Uncorrected