The perils
 - and promise - 
of consolidation


The perils
 - and promise - 
of consolidation

What are the risk issues around the spate of mergers and acquisitions currently sweeping US healthcare? HRMR investigates.

In a 2013 report on the effects of hospital consolidation in the acute sector, Deloitte summed up the current trend for mergers and acquisitions (M&A) succinctly: “Consolidation in the acute sector is accelerating as hospitals seek sustainability amid increasing stress from margin pressures, regulatory compliance costs, public transparency responsibilities, operational integration in value-based delivery systems, payment reforms, and clinical improvements based on new diagnostic and therapeutic models.” 

John Lochner, captive expert and risk management consultant at Towers Watson, agrees on the fundamental driving forces behind the trend: 

“The system is somewhat strained financially. Reimbursements for some of the government programs, such as Medicare and Medicaid, are being reduced and that’s putting added pressures on hospitals and healthcare systems,” he says.

“With the passage of healthcare reform there are certain measures that essentially will require or reward scale—it’s harder to be a smaller hospital system, especially given some of the financial pressures. Things such as instituting standardised billing and adopting and implementing electronic health records require fairly significant investment and it’s hard as a small institution to be able to make that investment.”

In contrast, being part of a larger system can mean that more dollars are available. The Affordable Care Act (ACA) is also incentivizing consolidation because various healthcare providers are joining together to form Accountable Care Organizations.

Physician practices

Lochner adds that the consolidation trend is not just at the hospital level: there is also a fair amount of consolidation happening around individual physician. That has taken a couple of different forms. One is that, in general, physicians are seeking to become employees of hospitals and healthcare systems at an increasing rate, whereas in years past they might have tried to set up their own practices or join a small or medium-sized practice. 

“That trend is clearly reversed,” says Lochner. “Newer physicians who are entering the marketplace out of school are overwhelmingly electing to go down the employed route, and separately a lot of hospitals have been acquiring individual or large physician practices as well.”

The upshot of all these trends is that hospitals and healthcare systems are getting bigger. Deloitte’s analysis of hospital performance up to three years after being acquired in 2007 or 2008 suggests that the financial and operational performance for recently acquired hospitals improved post-deal more than non-acquired peers during same time period. However, most acquired hospitals’ performance stayed below that of their peers.

“National chains appear to be more successful at achieving financial value from acquisitions compared to local/regional chains,” states the report. “The quantifiable value from local/regional deals varies widely; data suggest lower performers acquired in-market demonstrate improved performance but remain lower performers compared to peer groups.”

The importance of risk management

What does the flurry of M&A activity mean for risk management? Lochner says the overarching risk is that institutions need to understand what it is they are buying, and in particular all the property and casualty risk implications of the transaction. Vital to achieving this is involving risk management in the process from the outset.

“A lot of the time what we see is that the risk management insurance professionals are not involved early on, if at all, in the acquisitions and are often invited late to the game or just left to deal with integrating the pieces once the deal is done,” he says.

“It’s vital to make certain that you understand whether the organization you are acquiring has new and different exposures and to understand the magnitude of these.”

It follows that the first challenge is to develop a sense of the risk profile of the organization you are targeting. It is important to determine whether there are any unique operations or risk issues that would merit specific risk management or risk financing treatment and to decide whether that would influence the details of the transaction.

“The second thing—which would be key in terms of understanding the risks—is trying to get a high level of understanding of the target organization’s current risk financing program, and trying to determine whether there are any material gaps in the program,” he says.

This involves asking whether there are any risks that are unknowingly uninsured or self-insured, and again trying to determine whether that would influence the deal. Second, with an eye towards the future, it is important to start to develop high level plans for how to consolidate the risk financing programs.

“Probably the greatest risk is trying to assess the target organization’s financial exposure to retained property and casualty risk,” he says. “Depending on the size of the organization, they may be retaining some meaningful amount of medical professional liability risk or even workers’ compensation risk through some sort of self-insured program—so it’s pretty key, early on, to try to obtain a pretty accurate assessment of the potential long-term liability for these self-insured exposures.”

Lochner says it is important to ascertain whether the target hospital has posted sufficient liabilities on its balance sheet for its retained loss obligations. If they are posting a liability, you need to ask how they go about determining that liability. 

Another issue is whether a tail liability has been posted. With self-insurance programs, most coverage is written or funded on a claims-made basis. As for the claims that will not materialise for many years later, it is important to make certain that the target acquisition organization has appropriately funded for addressing those liabilities on its balance sheet.

“Regarding claims that may arise in the future relating to medical procedures that pre-date the acquisition, you need to be pretty clear as to whether you are willing to take on those liabilities or not, and possibly should require the target institution to buy tail coverage to discharge that liability.”

A plus for risk management?

There is no doubt that there are some significant plus sides to consolidation. It presents ample opportunities for sharing best practices and a chance to improve the overall quality of the organization from a risk management perspective.

“In particular in terms of acquiring physician practices there are definitely some very strong possibilities there,” says Lochner. “Generally speaking it should allow for a closer relationship working with the physicians in terms of bringing more folks under a common risk management platform.”

He adds that a key point of the ACA is a shift to paying for services based on quality measures, and consolidation is certainly a chance to have the institution and the physician more explicitly on the same team, sharing this common aim.

“You would expect a more coordinated response and even the opportunity to jointly defend oneself against claims instead of pointing fingers at each other,” he says. “I think there’s definitely the opportunity to reduce the incidences of losses just by the fact that you will all be coordinating care more and operating under a more common risk management plan.”

Under these conditions, one can expect to see a more coordinated response should an incident occur.

Additionally, from a risk financing standpoint, as institutions have merged they have generally been able to reduce the total amount of insurance or reinsurance.

“Through economies of scale, they are able to reduce or produce some savings on the risk financing side to again help further justify the acquisition and consolidation activity.”

Antitrust concerns

There is no doubt that a significant amount of the challenges posed by M&A can be tackled by involving a risk management standpoint early in the process. This applies not just to aspects such as clinical risk management but to other board-level risk concerns.

In April 2015 ACE Group released a new white paper examining the increased risk of antitrust litigation in the healthcare market. The paper analyzes the recent growth in healthcare industry transactions and the corresponding rise in antitrust regulation and government enforcement. 

It also outlines key due diligence practices that healthcare market participants should implement to proactively address this risk and, ultimately, to avoid costly consequences.

The Evolving Threat of Antitrust Litigation in Healthcare, co-authored by Keith Lavigne, executive vice president, ACE Professional Risk, and Scott Williams, vice president, ACE Professional Risk, is the latest instalment in a series of papers developed by ACE to highlight the increased exposures faced by healthcare organizations.

“Market changes resulting from regulation will inevitably invite additional regulation and oversight. We’ve entered a new age of antitrust liability, and healthcare providers must embrace the reality that M&A activities—no matter how big or small—can carry antitrust risk,” says Lavigne. 

“As a result, healthcare providers must exercise greater due diligence in their pursuit of greater economies of scale. Heightened vigilance in managing their transactional exposures is a necessity, not an option. Failure to do so could expose them to significant risk.”

An opportunity and a challenge

Back on the front line, healthcare risk managers can face challenges and opportunities in equal measure. 

Cheryl Peaslee, president of Northern New England Society for Healthcare Risk Management and vice president, risk management for Medical Mutual, offers these concluding thoughts:

“The long-term value is probably there, if we can all get together to see how we can best manage patients and patient care and support the communities in which we live. 

“If we come together and share best practice, that will be of benefit, but at the same time it’s hard to get everybody on the same page very quickly, and there can be communication issues, expectation issues, and hand-off issues.  However, I do think consolidation is the future.”

Mergers & Acquisitions, Towers Watson, John Lochner