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Immunize Your Hospital M&A Deal With a Thorough P&C Checkup

Hospitals or healthcare systems seeking to merge with or acquire other hospitals or systems need to be mindful of the property & casualty risk implications of such transactions. The same is generally true when acquiring physician practices. The hospital due diligence team, which should include the individual in charge of the risk and insurance program, needs to review the operations of the target organization from a risk perspective, understand the high-level details of the P&C insurance program in place to address such risks and be able to assess the financial exposures related to any risks the target organization is self-insuring. Each of these is discussed below.

First, the due diligence team needs to review the operations of the organization to be acquired and the risks that emanate from such operations. The focus should be on developing a risk profile of the target organization and understanding, in particular, whether this organization has any unique operations or risk issues that would merit specific risk management or risk financing treatment, or in some way influence the details of the transaction. This review should consider not just medical professional liability risks, but environmental risks, network and privacy (cyber-liability) exposures, managed care risks, directors and officers liability, and employment practices liability exposures, among others.

Second, the team needs to obtain, at least initially, a high-level understanding of the target organization's current P&C risk financing program (e.g., insurance coverages; limits; deductibles/self-insured retentions; premiums; relationships with insurers, brokers and claim administrators; and existence of a captive insurance company or trust fund). The reasons for gathering such information are two-fold. First, one needs to determine whether there are any material gaps in the current risk financing program (e.g., risks unknowingly self-insured or underinsured) based on the results of the previous risk assessment exercise. Second, the acquiring organization can begin developing high-level plans to consolidate the risk financing programs. Consolidation can ultimately help realize the cost savings to support the merger or acquisition and upgrade the quality of protection provided to the newly merged/acquired organization.

Lastly — and, some might argue, of greatest importance — the team must assess the target organization's financial exposure to retained P&C risks, which generally become the obligation of the acquiring organization post transaction. It is important to note that most hospitals self-insure a (sometimes material) portion of their exposures to medical professional liability risks and possibly also workers compensation. These exposures are long-tail coverages, meaning it takes many years for claims to fully pay out. As such, obtaining an accurate assessment of the potential long-term liability for these retained exposures is paramount. Key issues to consider are:

  • Has the target hospital posted sufficient liabilities on its balance sheet for its retained loss and allocated loss adjustment expense obligations?

  • On what basis have these financial reserves been posted?
    • Are they based on case reserves for each claim plus a qualified actuary's projection of the hospital's incurred but not reported liability?
    • Who set the underlying case reserves? Are they adequate?
    • Are reserves based on expected value losses (or some higher confidence level) and on an undiscounted basis (i.e., not a haircut for anticipated investment income to be earned on the assets underlying the reserves)?

  • Has a "tail liability" been posted? Most medical professional liability programs, for both the self-insured and excess-insured components, are structured on a claims-made basis under which coverage applies only for incidents that occurred after an agreed date (the retroactive date), provided the claim is made during the coverage period. Under such a claims-made program, there will therefore be incidents that have occurred for which a claim has yet to be made. This is one's "tail exposure" and should be recorded as a liability on a hospital's balance sheet.

  • How will "nose" or "prior acts" coverage be handled for the acquired institution and/or the physicians? In light of the prevalence of claims-made coverage, a decision will need to be made early in the process as to how to handle the prior acts medical professional liability exposure of the acquired entity/individuals. Will the acquired entity's/individuals' retroactive dates be maintained such that the merged organization's program will respond to prior acts, or instead, will the acquired entity/individuals be required to "tail out" their exposure (i.e., buy tail coverage from their current insurer) and come into the new program on a first-year claims-made basis?

It is highly desirable for the due diligence team to work through each of the above issues to determine in advance if any of these matters could affect the terms of the deal or the very deal itself. In particular, the team will want to eliminate financial surprises up front that will work their way unfavorably through the newly merged organization’s financial statements later on.

John Lochner is a Director at Towers Watson. He can be reached by phone at (860) 843-7012 or at john.lochner@towerswatson.com.

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