9) RELATIONSHIP WITH UNIVERSAL HEALTH REALTY INCOME TRUST AND OTHER RELATED PARTY TRANSACTIONS

Relationship with Universal Health Realty Income Trust:

At December 31, 2017, we held approximately 5.7% of the outstanding shares of Universal Health Realty Income Trust (the “Trust”). We serve as Advisor to the Trust under an annually renewable advisory agreement, which is scheduled to expire on December 31^st of each year, pursuant to the terms of which we conduct the Trust’s day-to-day affairs, provide administrative services and present investment opportunities. In December, 2017, the advisory agreement was renewed by the Trust for 2018 pursuant to the same terms in place during each of the last three years. During 2017, 2016 and 2015, the advisory fee was computed at 0.70% of the Trust’s average invested real estate assets. In addition, certain of our officers and directors are also officers and/or directors of the Trust. Management believes that it has the ability to exercise significant influence over the Trust, therefore we account for our investment in the Trust using the equity method of accounting. We earned an advisory fee from the Trust, which is included in net revenues in the accompanying consolidated statements of income, of approximately $3.6 million during 2017, $3.3 million during 2016 and $2.8 million during 2015.

Our pre-tax share of income from the Trust was $2.6 million during 2017, $1.0 million during 2016 and $1.4 million during 2015, and is included in net revenues in the accompanying consolidated statements of income for each year. Included in our share of the Trust’s income was approximately $1.7 million in 2017 related to our share of a gain recorded resulting from a property transaction, as well as insurance proceeds in excess of damaged Trust property. During 2015, our share of the Trust’s income included $500,000 related to our share of a gain on an exchange transaction recorded by the Trust. We received dividends from the Trust amounting to $2.1 million during 2017 and $2.0 million during each of 2016 and 2015.

The carrying value of our investment in the Trust was $8.2 million and $7.7 million at December 31, 2017 and 2016, respectively, and is included in other assets in the accompanying consolidated balance sheets. The market value of our investment in the Trust was $59.2 million at December 31, 2017 and $51.7 million at December 31, 2016, based on the closing price of the Trust’s stock on the respective dates.

The Trust commenced operations in 1986 by purchasing certain hospital properties from us and immediately leasing the properties back to our respective subsidiaries. Most of the leases were entered into at the time the Trust commenced operations and provided for initial terms of 13 to 15 years with up to six additional 5-year renewal terms. Each hospital lease also provided for additional or bonus rental, as discussed below. The base rents are paid monthly and the bonus rents are computed and paid on a quarterly basis, based upon a computation that compares current quarter revenue to a corresponding quarter in the base year. The leases with those subsidiaries are unconditionally guaranteed by us and are cross-defaulted with one another.

Total rent expense under the operating leases on the three hospital facilities with the Trust during 2017, 2016 and 2015 was $16.0 million, $15.9 million, and $15.6 million, respectively. Pursuant to the terms of the three hospital leases with the Trust, we have the option to renew the leases at the lease terms described above by providing notice to the Trust at least 90 days prior to the termination of the then current term. We also have the right to purchase the respective leased hospitals at the end of the lease terms or any renewal terms at their appraised fair market value as well as purchase any or all of the three leased hospital properties at the appraised fair market value upon one month’s notice should a change of control of the Trust occur. In addition, we have rights of first refusal to: (i) purchase the respective leased facilities during and for 180 days after the lease terms at the same price, terms and conditions of any third-party offer, or; (ii) renew the lease on the respective leased facility at the end of, and for 180 days after, the lease term at the same terms and conditions pursuant to any third-party offer.

The table below details the renewal options and terms for each of our three hospital facilities leased from the Trust:

Hospital Name

Type of Facility

Annual

Minimum

Rent

End of Lease Term

Renewal

Term

(years)

McAllen Medical Center

Acute Care

5,485,000

December, 2021

(a)

Wellington Regional Medical Center

Acute Care

3,030,000

December, 2021

(b)

Southwest Healthcare System, Inland Valley Campus

Acute Care

2,648,000

December, 2021

(b)

(a)	We have two 5-year renewal options at existing lease rates (through 2031).

(b)	We have two 5-year renewal options at fair market value lease rates (2022 through 2031).

In addition, certain of our subsidiaries are tenants in various medical office buildings and two free-standing emergency departments (“FEDs”) owned by the Trust or by limited liability companies in which the Trust holds 95% to 100% of the ownership interest. During the first quarter of 2015, wholly-owned subsidiaries of ours sold to and leased back from the Trust, two newly constructed FEDs located in Texas which were completed and opened during the first quarter of 2015. In conjunction with these transactions, ten-year lease agreements with six, five-year renewal options have been executed with the Trust. We have the option to purchase the properties upon the expiration of the fixed terms and each five-year renewal terms at the fair market value of the property. The aggregate construction cost/sales proceeds of these facilities was approximately $13 million, and the aggregate rent expense paid to the Trust at the commencement of the leases was approximately $900,000 annually.

Other Related Party Transactions:

In December, 2010, our Board of Directors approved the Company’s entering into supplemental life insurance plans and agreements on the lives of our chief executive officer (“CEO”) and his wife. As a result of these agreements, as amended in October, 2016, based on actuarial tables and other assumptions, during the life expectancies of the insureds, we would pay approximately $28 million in premiums, and certain trusts owned by our CEO, would pay approximately $9 million in premiums. Based on the projected premiums mentioned above, and assuming the policies remain in effect until the death of the insureds, we will be entitled to receive death benefit proceeds of no less than approximately $37 million representing the $28 million of aggregate premiums paid by us as well as the $9 million of aggregate premiums paid by the trusts. In connection with these policies, we paid approximately $1.2 million and $1.3 million in premium payments during 2017 and 2016.

In August, 2015, Marc D. Miller, our President and member of our Board of Directors, was appointed to the Board of Directors of Premier, Inc. (“Premier”), a healthcare performance improvement alliance. During 2013, we entered into a new group purchasing organization agreement (“GPO”) with Premier. In conjunction with the GPO agreement, we acquired a minority interest in Premier for a nominal amount. During the fourth quarter of 2013, in connection with the completion of an initial public offering of the stock of Premier, we received cash proceeds for the sale of a portion of our ownership interest in the GPO. Also in connection with this GPO agreement, we received shares of restricted stock of Premier which vest ratably over a seven-year period (2014 through 2020), contingent upon our continued participation and minority ownership interest in the GPO. We have elected to retain a portion of the previously vested shares of Premier, the market value of which is included in other assets on our consolidated balance sheet. Based upon the closing price of Premier’s stock on each respective date, the market value of our shares of Premier on which the restrictions have lapsed was $33 million as of December 31, 2017 and $23 million as of December 31, 2016. See Note 1 to the Consolidated Financial Statements-Business and Summary of Significant Accounting Policies, V) GPO Agreement/Minority Ownership Interest for additional disclosure related to this agreement.

In January, 2018, our Board of Directors elected a new member to fill a vacancy created by the retirement of another member. The retired Director was a member of the Executive Committee and Finance Committee of our Board of Directors, was Of Counsel to Norton Rose Fulbright US LLP, and was also the trustee of certain trusts for the benefit of our Chief Executive Officer (“CEO”) and his family. The newly elected Director, who is a Partner in Norton Rose Fulbright US LLP, will serve as a member of the Executive Committee and Finance Committee and acts as a trustee of certain trusts for the benefit of our CEO and his family. We engage Norton Rose Fulbright US LLP for a variety of legal services and the law firm also provides personal legal services to our CEO.