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MEDICARE UPDATES

As previously announced, the net market basket increase for October 2012 was 1.8%, which consisted of a market basket increase of 2.5% minus a productivity adjustment of 0.7%. We estimate that the impact of this 1.8% funding increase will provide us with additional Medicare revenue of approximately US$6.0 million per annum. However, as previously indicated, the Special U.S. Joint Select Committee on Deficit Reduction, also known as the "Super Committee", failed to make a recommendation to reduce government spending by January 15, 2012 and the long-term care industry was facing automatic Medicare funding reductions of 2% effective January 2, 2013, as a result of sequestration. These cuts have been delayed until March 1, 2013, by the signing into law of the American Taxpayer Relief Act of 2012 (ATRA), and will become automatic unless new legislation is passed. A 2% funding reduction is estimated to reduce our Medicare revenue by approximately US$6.7 million per annum.

Effective October 2012, the Centers for Medicare & Medicaid Services (CMS) established a requirement for pre-approval by a physician of claims over US$3,700 for physical and speech therapy and a similar pre-approval process for claims over US$3,700 for occupational therapy. Approval or denial of therapy services beyond these caps is determined on an individual basis and, therefore, the impact cannot be precisely determined. During the 2012 fourth quarter, we recorded negative revenue adjustments of US$1.0 million for denials of therapy services over the cap. The ATRA has extended these therapy cap requirements until December 31, 2013. The impact of these therapy caps may be mitigated to a certain extent by reductions in staffing and, in some cases, residents paying privately for these services.

In addition, the ATRA has delayed, until January 1, 2014, a 27% reduction of Medicare Part B rates previously scheduled to have commenced on January 1, 2013. The impact of the 27% Part B rate reduction on our therapy revenue was estimated to be US$11 million per annum. We continue to dialogue with policymakers about the impact of the Part B fee reduction and therapy caps on access to care and quality of life for our residents.

PROVISION FOR SELF-INSURED LIABILITIES

The results of our independent actuarial review conducted at year end did not necessitate a further strengthening of reserves for our pre-2012 claims in the 2012 fourth quarter. For the year ended December 31, 2012, we have made provisions for self-insured liabilities of $40.8 million (US$40.8 million), of which $16.6 million (US$16.6 million) related to the strengthening of our prior years' reserves. In comparison, for the 2011 year, our provision for self-insured liabilities was $65.3 million (US$66.0 million), of which $42.8 million (US$43.3 million) related to prior years' reserves. The strengthening of our prior years' reserves was primarily attributable to claims in the State of Kentucky and settlement of certain pre-2012 claims in other states. Excluding prior years' reserve adjustments, our provision for self-insured liabilities was US$24.2 million in 2012 compared to US$22.7 million in 2011. Our claims experience in Kentucky has accounted for more than 50% of our provision for self-insured liabilities over the past two years. We had anticipated that following our exit from that state in mid-2012, our provision for self-insured liabilities would be reduced by approximately US$12 million per annum. However, an increase in claims in other states has offset this anticipated reduction.