With mergers and acquisitions (M&As), it is critical that the medical professional liability insurance program be properly accounted for. Unpaid losses and loss adjustment expenses associated with the program can be a significant item on a balance sheet. There can be both substantial benefits and dangers associated with M&As that are important for management to consider in the preliminary stages of the M&A process. Milliman’s Richard Frese and Andy Hoffman provide perspective in this article.
This article was published in the February 2017 issue of Inside Medical Liability.
In this report, Milliman consultants Jeremy Kent and Ed Morgan discuss some of the challenges in valuing insurance companies under the Solvency II framework. The authors also propose a possible valuation methodology to meet the needs of potential investors with a certain perspective in mergers and acquisitions transactions. While under Solvency II a number of factors may influence distributable profits, the authors believe that the most important drivers, particularly in the medium to long term, will be the required level of Solvency II capital and the own funds available and eligible to cover it.
Insurers have many important considerations to discuss early on when contemplating purchase or sale of a company. Valuation and business strategy should be primary considerations, but solvency and financial statement impacts can derail otherwise sound transactions. It’s important to consider a wide range of issues for any such transaction, including current accounting and regulatory requirements, goodwill, intangible assets, and an accurate and well-founded estimate of earnings. Milliman consultants David Kirk and Janri Theron provide perspective in this article.
Healthcare organizations pursuing a merger and acquisition (M&A) transaction should seek an actuarial analysis to estimate their medical malpractice (medmal) exposure. When seeking guidance from an actuary, executives need to consider several details that go into estimates, such as loss-development assessments, frequency and severity trends, and the accuracy of utilization data. Milliman actuary Richard Frese discusses these three details in his recent HFM magazine article entitled “Actuarial considerations of medical malpractice evaluations in M&As.” Here’s an excerpt:
A Loss-Development Assessment
An actuary applies mathematical models to estimate unknown losses or future losses based on prior history. Unknown losses are referred to as incurred but not reported (IBNR) losses. IBNR losses include claims that have not yet been reported, further loss development on known claims, claims that will reopen, and claims that may be in the pipeline but have not yet reached the status of a full suit. The sum of the known case reserves and the IBNR equals the liability on the balance sheet. The actuary tries to use as much of the hospital’s or health system’s history as is credible in developing a loss-development analysis. When there is not full credibility, an actuary blends in an industry standard or may use only this standard. When assessing future loss development, the actuary makes judgments. Even a slight variation in one of the actuary’s selections can have a significant impact on a loss estimate, particularly the tail factor, which explains the longer development of a tail factor in medical malpractice. Loss development will vary significantly between jurisdictions. Healthcare leaders should try to understand the actuaries’ thought processes and challenge the actuaries when the analysis does not line up with their assumptions. In an M&A transaction, it may be appropriate for an acquiring organization to assume the loss development of the acquired entity will follow the loss development of the acquirer. In this instance, leaders for the entity being acquired should be asked to value the reserves and payments so that the methodologies are consistent. Management may also request a scenario that assumes loss development of the acquired entity follows its own historical pattern. Loss control also becomes a question during an M&A transaction. The acquired organization may lose the motivation to engage in safe practice and defend claims. If the acquired entity has claims-made coverage, the acquirer may require that all claims be reported to the current insurance program.
Frequency and Severity Trends
The costs of claims usually rise over time, but the rate at which they occur can vary. When forecasting losses, actuaries examine both frequency and severity trends. Trends may be estimated based on the hospital’s or health system’s own data, if credible, or may need to be supplemented with industry information. A change in trends will affect future loss estimates. Considering that pro forma financial statements may require a projection of the next three years, it is important that the trends examined be appropriate so that the funding is adequate, not deficient or excessive. An actuary also may apply a trend for exposure when projecting future losses (commonly measured in occupied-bed equivalents), but such a projection often is based exclusively on the hospital’s or health system’s own growth or decrease in utilization and/or physicians.
Accuracy of Utilization Data
An actuary assumes that losses are proportional to the hospital’s or health system’s utilization—as measured by the number of inpatients beds, procedures, and physicians, for example. An organization’s leaders should ensure that metrics are detailed and accurately represent the operations of the hospital or health system. Some data may reflect increases over time, while other data may illustrate reductions that have occurred, so it is important to capture all available statistics. The definition of utilization metrics may vary by hospital. An organization’s leaders should discuss with the actuary what constitutes a record of each metric. This conversation is critical because an actuary will convert the statistics into occupied-bed equivalents and will need to ensure the proper weight or conversion factor is applied. In addition, some actuaries apply an industry cost per occupied bed to the number of occupied beds to arrive at an estimate of losses. This estimation will be skewed if the bed conversion factors that are applied are incorrect.
In this short film, Milliman consultants from across the globe address the challenges facing multinational insurers and investment banks looking to engage in cross-border mergers and acquisitions (M&A) transactions. Topics discussed include cultural and language differences, regulatory variance and complexity, local market considerations, and the importance of an unbiased, experienced actuarial valuation.