The healthcare sector faced several challenges in 2022, including interest rate hikes and concerns over the US economy. This led to fewer megadeals and a decrease in forward-looking EV/EBITDA multiples for healthcare organizations, but we observed some interesting developments that may have been driven by the COVID-19 pandemic.
After a record-setting year in 2021, healthcare M&A activity in the US saw a slight decrease in 2022 which can be attributed to the overall slowdown in M&A activity in the country. The trends we witnessed through our own data was also reflected in the wider market, for example, the data provided by PitchBook. According to our analysis, the number of public and private healthcare and healthcare-adjacent transactions utilizing representations and warranties insurance (RWI) has dropped by approximately 34% from approximately 1,000 submissions in 2021 to approximately 660 submissions in 2022.
Despite headwinds several areas have remained active over the last 12 months. For example, the home health and elder care sector submissions (including hospices) are seeing strong interest and it is reflected in transaction volume/value, indicating continued interest in alternative care models. Even though the total number of such transactions in 2022 was lower 1 the total deal value remained close to 2021.2
Continuing the trend from 2021, transaction activity also remains strong in the rehabilitation, pain management, and behavioral care (including substance use disorder treatment) sectors. In the past two years, we observed strong numbers with approximately 60 RWI submissions in 2021 (approximately $17Bn in TEV) and 40 submissions in 2022 (approximately $7Bn). This may indicate both the increased focus by financial sponsors on this sector as demand for such services remains high and also insurers being more comfortable with the threat of regulatory enforcement within the sector. We expect those numbers to increase as more healthcare systems look to add at-home healthcare to their services list. Furthermore, the pandemic-driven adoption of telehealth continues to be a trend, with more targets across all sectors adding such capabilities. At the same time, sectors in which transaction activity was predicted to get hot remained relatively slow, such as hospital transactions and healthcare staffing businesses.
Cyber breaches cause for concern
On the coverage side, with the growth of cloud data storage and the wide use of electronic health records, potential liability arising out of healthcare organizations’ failure to protect personal health information or cyber breaches remains a major concern. As reported in The State of Ransomware 2022 by Sophos, ransomware attacks on healthcare organizations almost doubled year over year, making the healthcare sector the most affected industry, with the total cost of recovery also being one of the highest. The report states that a majority of healthcare organizations (69%) polled experienced or were targeted by a ransomware attack in 2022. Given the heightening competitiveness among healthcare reps and warranties insurers, we saw the RWI market shifting from excluding cyber breaches or providing coverage specifically excess and no broader than underlying cyber insurance to providing broader coverage and being excess underlying cyber insurance. It is too soon to see how this will play out in a claims scenario. Cyber risks are best approached on a case-by-case basis where coverage may be provided if insurers can get comfortable with the level of maturity of cybersecurity programs and underlying cyber insurance, especially when the latter also covers ransomware attacks.
Enforcement trends
While the cyber security environment for healthcare organizations may have worsened in 2022, some other concerns associated with such organizations may have been overblown. For example, there is a spike in government enforcement actions against substance use disorder clinics for various violations, including Medicare fraud and abuse. However, on a case-by-case basis, it is possible that a reasonably-sized organization, with sufficient compliance resources, would reduce fraud and abuse concerns over a “mom and pop” target.
Similarly, it seems that the wave of litigation involving opioid product manufacturers and large pharmacy providers is not targeting substance use disorder clinics yet to any large degree. At the same time, with the new voluntary guidance on opioids issued by the Centers for Disease Control and Prevention in November 2022 we may see an uptick in opioids prescriptions, and we will continue to closely watch this industry for any short- or long-term effects.
Furthermore, an increasing number of RWI markets are comfortable with Medicare hospice cap exposure as such matters are usually well documented, and annual reports are required by the Center of Medicare and Medicaid Services. If a hospice target has fundamental compliance problems or acknowledges cap liabilities, coverage can be limited in underwriting, including limited by location.
Looking ahead
We continue to keep an eye on these and other market developments, including the increasing scrutiny of PE healthcare M&A transactions, the growth of telehealth and digital health companies, and the increasing focus on value-based care and alternative care models. With the COVID-19 Public Health Emergency (PHE) set to expire, providers and manufacturers will need to ensure that they are able to comply with pre-pandemic regulations and are not reliant on any waiver or relaxation of regulations having been granted during the PHE, which will be ending over various timelines in the near to mid-term.
As we look at the remainder of 2023, we expect healthcare M&A to remain active leading to a continuous strong outlook for healthcare RWI, albeit with lower deal values, more platform add-on and carve-outs transactions. As we continue to generate claims data, Liberty GTS is in great position to provide more meaningful coverage for healthcare transactions and better tailor our coverage to buyer’s needs, in a sustainable way.
