Rising healthcare industry brings stand-alone tail coverage to mind
While technology, energy and other industry sectors often capture the headlines in the financial press and in the media, health care companies are a major economic force within the U.S. economy and growing. According to The World Bank, health care spending between 2010 and 2014 accounted for nearly 18% of U.S. GDP. This number is only expected to grow in the decade ahead. While some have argued that the PPACA will slow this trend, I find little evidence that it will do so in any meaningful fashion. All of this means that health care dollars spent in the U.S. will claim an increasing portion of our GDP.
This reality has not gone unnoticed by capital markets and private equity (“P.E.”) professionals. The cash flow generated by our patient treatment market is substantial and very difficult to ignore. The attractiveness of health care as an investment or growth opportunity becomes even more compelling when it is coupled with one aspect of the PPACA, the growth in the number of patients with insurance. This simple fact means that more patients can “pay” for their care and our health care system will not be burdened with the same levels of uncompensated care as they have in the past. The dollar amount of this uncompensated care was in excess of five billion dollars in 2013. With this much capital that can be converted to “private pay” or Medicare reimbursements, you have a recipe for an attractive industry for investment.
Stories about the creation of large health systems via the infusion of massive amounts of capital are becoming more common. The creation of Steward Health Care in Boston is an excellent example of this investment trend in the industry by P.E. firms. Given the need to access capital in order to maintain cutting-edge health care, these can be real success stories. On a much smaller scale, but no less significant scale, mergers and acquisitions (“M&A”) activity in the physician space is also a growing trend. Not only is P.E. money coming into the physician industry, but larger systems are making acquisitions of physician practices across the country.
M&A transactions that involve physician practices can be complex and varied. Personalities often play a part given that physicians are not accustomed to being “employees” or involved in financial “deals.” However, with the M&A activity becoming more commonplace, the issue of medical professional liability (“MPL”) coverage inevitably comes to the fore of the discussions. The majority of MPL policies are written on a Claims-Made (“C.M.”) form. While the occurrence policy form is making a resurgence, the majority of policies are still on the C.M. form. This reality means that in the event of an M&A transaction the issue of “tail” coverage becomes a necessity. Conversely, in some cases, the question of “nose” coverage is considered. In both cases, the financial and legal implications are significant.
Unlike a “tail” policy, “nose” coverage is when a new policy is purchased with a retro date prior to the initial effective date of the policy itself. This means that incidents that occur before the beginning of the policy but for which no claim has been reported. The cost associated with adding this retroactive coverage is included in the premium of the new policy. It can be quite costly. The extra costs associated with adding “nose” coverage or the combined cost of a “tail” policy and the new policy can have a dramatic effect on the costs of the transaction. It is in these types of situations that a “stand-alone tail” can be a great solution to both seller and buyer.
WGA often recommends to its clients that they consider a stand-alone tail in order to lower the overall cost of a transaction and to eliminate uncertainty about the possibility of past liabilities impacting the profitability of a transaction. In most instances, the stand-alone tail works to the benefit of both parties.
The costs associated with a stand-alone tail policy are often 10-20% less expensive than a typical “Extended Reporting Period” (or “tail”) multiple in many medical professional liability policies. Most claims-made policies have the ERP factor clearly delineated in the policy Declarations Page. (If it is not, that is an omission that should be corrected at once.)
WGA’s Healthcare Practice can help explain the details of how this savings can be captured as a part of the M&A process. Feel free to contact us at www.WGAins.com.
About the Author
Pete Reilly is the Healthcare Practice Leader at WGA with extensive knowledge in healthcare systems, including hospitals, long-term care facilities, and medical practice groups of all sizes.