Unlocking value in health plan M&A
Sometimes the deals don’t deliver
The pace of consolidation among commercial health plans is increasing. From a low point in the recession year of 2009, the number of merger and acquisition (M&A) transactions in the sector has increased annually and is approaching pre-recession levels. But executives who contemplate mergers and acquisitions should take note: the evidence of recent years suggests that unlocking financial value from such deals can be a 50-50 proposition at best.
Our analysis of 44 transactions between 2006 and 2012 points to a startling conclusion: fewer than half actually led to sustained improvements in comparative market value three years after the deal closed. Notably, the majority of these sought geographical expansion, revenue diversification, or increased presence in the Medicare and Medicaid markets as their rationale, but a financial justification (i.e. value creation) is often an accompanying long-term goal.
Is unlocking financial value the most important barometer of whether a transaction met expectations when viewed in retrospect? After all, M&A activity among health plans is often justified by a wide range of motivations – enrollment growth, improved service to members, access to new markets, diversification of service offerings, global expansion, and others. The fact is that value creation – improving operating margins, enhancing the balance sheet, and providing shareholder value – is one of the most commonly used way investors, industry experts, and parties to the transaction assess the effectiveness of the deal. Our analysis suggests many fall short.
What’s ahead for M&A activity?
M&A in the health insurance industry is cyclical. Its pace varies with market and industry economic conditions and regulatory changes. After a decline in the late 2000s, the health insurance industry has seen a recent increase in M&A activity (Figure 1). This trend is anticipated to continue, fueled by legislative, economic, and strategic drivers that are prompting some health plans to turn to consolidation as a way to improve economies of scale and remain competitive. Whether for growth or survival, the health insurance industry is becoming increasingly concentrated, as some players expand vertically, some pursue new market segments through horizontal acquisitions, and others are absorbed and disappear. Many U.S. commercial health plans are small, with fewer than 250,000 members.1 Nine percent of U.S. plans qualify as “large” with more than a million lives covered. However, the health plan market is fairly concentrated: The 10 largest plans account for about 56 percent of the 218 million lives insured in the U.S.2 At least until the next economic downturn, health plan M&A is likely to remain active because of the supply of target plans – in addition to sustained pressures and continued opportunities.
Pressures on small plans may drive some toward acquisition by larger counterparts. These pressures include the rollout of federal health reform, adoption of ICD-10, and other regulatory changes. Market shifts, increased competition, cost pressures, the need for new capital, declining operating margins, and falling per capita reimbursements may also drive more consolidation.
Larger plans are likely to increase their M&A activity for strategic purposes – to increase enrollment in targeted geographies at home or abroad, or in niches such as military health or Medicaid – but the advantages of scale are not infinite. At what point might the health plan industry become too concentrated and then faced with attendant disadvantages of lack of competition and consumer choice and the potential for monopolistic behavior?
Given increased regulation via the Affordable Care Act and shifting enrollment from group to individual products, it is our surmise that combinations of plans to achieve scale and sustainability are likely to accelerate. The risks and challenges for health plans point to the potential for plans to pursue an aggressive growth and innovation strategy buoyed by effective M&A efforts that achieve value. Deals per se are not the goal; deals that produce long-term sustainable value will likely be the difference to winners in the “new normal.”
Figure 1. Number of announced health plan-related M&A transactions
0 10 20 30 40 60 50 Number of T ransactions Year 2006 2007 2008 2009 2010 2011 N=49 N=40 N=29 N=29 N=36 N=21
Deals among health plans are likely to increase in coming years as the full impact of compliance with the Affordable Care Act is felt. Health exchanges, limits on medical loss ratios and premium increases, requirements about what’s covered in essential health benefits in each state, and other requirements of the law mean the “new normal” for health plans is tougher sledding. At the same time, the “new normal” can be a growth opportunity for health plans: increased individual and small-group enrollment through the health exchanges, expansion of Medicaid enrollment and implementation of “managed Medicaid” in many states, growth in the retail health plan market, and the transition from defined benefits to defined contribution plans by employers represent the potential for significant upside for organizations equipped with core competencies and acceptable scale to provide value.
Growth potential does not lead directly to value. In each case, a decision was made that the deal carried enough promise to make the arduous process worthwhile. Why didn’t more of them provide better financial results? Why wasn’t the anticipated value unlocked?
The most likely answer: M&A can be a complex, multi-stage process, not a single event (Figure 2). And all too often, the terms of the transaction (e.g., valuation) fail to adequately or correctly integrate the key elements of operational performance that lead to long-term value. In Deloitte’s experience with these transactions, the M&A process is integral to the outcome: it should be systematic, forward looking, operationally astute, and data driven. At the end of the day, it’s about leaders of both organizations willing to share a goal and assume risk.
Figure 2. The M&A Lifecycle
Merger Strategy Development Target Screening and Identification Preliminary Due Diligence Synergy and Value Driver Quantification Negotiation of Letter of Intent Implementation and Transaction Closing Preparation Closing and Execution of Implementation Plan Implementation Planning Financial Modeling Definitive Due Diligence Negotiation of Final Transaction
Due Diligence Integration Divestiture
Our view: the quest for long-term value
These findings do not necessarily invalidate the intention of building value through M&A. When the point-of-transaction specifics point toward an opportunity to generate returns, the potential is real. But in our experience, that potential can dissipate without an effective formula for the set-up, the transaction, and the post-deal integration of people, workflows, infrastructure, and focus around a well-constructed and widely understood strategy.
Appropriately, much attention is given to the deal: terms and conditions, termination rights, and transition planning during due diligence pre-closing. Whether in the position of buyer or seller, the flurry of activity around the deal should be intense and meticulous. M&A activity takes place across a complex lifecycle. Many of the factors that determine whether a deal creates or dissipates value happen long before or after the excitement of closing day. Some are integral to the process of negotiating and executing a deal. Some are organizational, such as executive capabilities, cultural factors, IT system compatibility, board support, and shareholder activism. Still others are external (Figure 3).
But all too often, the intensity around completing the deal masks appropriate attention to what happens after closing. Unlocking the anticipated value a deal was predicated on requires functional competencies – from sales and marketing, tax, and Sarbanes-Oxley compliance to finance, facilities, talent, and information technology. If there is a formula for creating value through M&A, it is to trust nothing to chance. The study: the data tell the story
The 44 health plan acquisitions Deloitte examined occurred between 2006 and 2012 and involved 11 different publicly traded acquirers whose performance metrics were available to the public. For each transaction, a series of key indicators was analyzed to give insights into the financial performance of transactions over time.
The key measure of the study was a comparison of price per share of the acquiring company compared against a health care payor industry index3 tracking price per share covering the same time period. Except for transactions too recent for study over the entire three-year period, the measurements were taken from the time of announcement, one year later, and three years later for each transaction. For this reason, the base number of plans under study varies from one time period to the next.
Figure 3.
• Market shifts • Health reform • Regulatory scrutiny • Rising capital needs • Margin pressure • Increased competition • Geographical overlap External value challenges include: Pre-close value determinants include: • M&A strategy • Target screening • Due diligence • Valuation • Merger agreements Post-close value determinants include: • Implementation planning • Implementation execution • Cultural integration
In addition to measuring stock-price changes, further analyses were completed to create a more thorough understanding of the impact of M&A on the industry. Three additional indicators were tracked over the study time period (2006 to 2012) for the acquiring plans: revenue, earnings per share (EPS), and medical loss ratios (MLR). These three indicators were analyzed at time of announcement, one year later, and three years later. Qualitative analysis was also completed by reviewing the analyst notes at the time period before the merger and the time period after the merger to identify any changes in analyst ratings.
In sum, an uneven picture presents:
• For slightly more than half of the acquiring plans, price per share outpaced the health care payor index at announcement and one year later. By the three-year mark, fewer than four in 10 had a higher growth in price per share compared to the industry index growth. • All but one of the acquiring plans showed an increase in
revenue in the wake of a deal, and most also improved their EPS. Changes in MLR one and three years after an acquisition were negligible.
• Changes in analyst ratings for acquirers were few, and where ratings did change, three times as many fell as improved.
Results: Was value created? Measuring changes in price per share
In order to measure valuation changes, we conducted analysis on changes in price per share among the acquiring health plans in our study sample. Time of announcement valuation changes were measured in absolute terms, while one-year and three-year valuation changes were measured as deviations from a health care payor index.
At the time of announcement, 55 percent of deals (24 of 44 deals analyzed) showed an immediate increase in price per share while 36 percent (16 of 44 deals analyzed) saw an immediate decrease, and 9 percent (four of 44 deals analyzed) did not change. Among plans whose value increased, median growth was 1 percent, and the greatest individual gain was 11 percent. Even though gainers outnumbered losers, the median change in value among all acquiring plans was a gain of only one-tenth of 1 percent. One year post-merger, 55 percent (18 of 33 deals analyzed) of acquiring plans had increased their value compared to the industry index, but the results varied widely, from a 66 percent gain to a 78 percent loss (Figure 4). The median outcome after one year was a 2 percent loss in value.
Three years post-merger, only 39 percent (nine of the 23 deals analyzed) had increased in value more than the industry had over the same period. The median value was positive – an increase 2 percent greater than the industry average – but after three years, the range of outcomes had shifted downward compared to year one, ranging from a 42 percent gain to a 93 percent loss (Figure 4).
Figure 4. Change in price per share vs. health plan index at one and three years following merger announcement
-100% -100% 50% 0% 50% -78% -93% 42% 66% 2% -2%
Low end of range Median High end of range
100%
100%
Three years post-announcement (n=23 deals) One year post-announcement (n=33 deals)
Additional analyses: impact on revenue, EPS, and medical loss ratios
One year following a merger, 91 percent (30 of 33 deals analyzed) of the acquiring plans had increased their revenue. The median change overall was a 15 percent increase. Over the same one-year post-merger period, 79 percent of plans increased EPS while 21 percent saw it fall, with a 26 percent average increase overall. At the third-year time point, 100 percent of the plans under study (23 deals) had increased revenue (by 49 percent on average) and 83 percent of plans had increased EPS (by 40 percent on average).
Over the entire period 2006 to 2012, without respect to when individual acquisitions took place, the plans under study did see revenue increase an average of 40 percent. Similarly, the plans studied showed an average increase in EPS of 98 percent from 2006 to 2012. While to some degree changes in revenue growth and share price earnings may be attributable to the merger, other contributing factors are likely to impact revenue growth and price, and only an indirect relationship between the merger and revenue trends can be posited.
Improvement in MLR might indicate better operating efficiency in the wake of a merger, but plans that acquired other plans did not experience significant changes in this metric. After one year, the average MLR change was a half-percent decrease, with the range being from an 8.5 half-percent decrease to a 7.8 percent increase. After three years, the average change was a half-percent increase, with the range being from a 3.7 percent decline to a 7.9 percent increase. Results: top and bottom performers
Do the extreme performers among post-merger plans tell a different story from the averages? Perhaps the greatest lesson they teach is how the paths forward from an acquisition can diverge.
After one year, the top three shareholder value-enhancing transactions during the study period experienced share-price growth that exceeded the sector index by 66 percent, 65 percent, and 51 percent, respectively. Three years post-merger, three different merged plans were at the top of the value list, and they were still ahead of the health care payor index (Figure 5).
Figure 5. Top three and bottom three performing deals (measured by change in price per share vs. health plan index)
-60% -40% -20% 0% 20% 40% 60% 80% 66% -23% -31% 65% 51% 42% 27% 26% -38% -43%
100% At one year post-merger At three years post-merger
Top three performing deals Top three performing deals
The performances of transactions at the other end of the scale were not as effective when compared against the industry index, though the acquiring plans still had growth in share price. One year after their respective announcements, three merged plans lagged behind the sector index. However, the share prices in each case actually rose – by $9.08, $1.67, and $1.79, respectively. At the three-year mark, the three lowest-performing transactions had fallen 38 percent, 43 percent, and 93 percent behind the market index in share price. Whether one considers the average across health plan mergers or focuses on the highest- and lowest-performing transactions, the value created by a merger can vary widely as soon as one year post-merger, and this continues to be seen three years post-merger.
Analysis: synergy in health plan M&A compared to other industries
The absence of sustained value creation among some health plan M&A transactions is not necessarily unique. Other industries face the same challenges. In separate Deloitte research that examined examples from a variety of sectors, 70 percent of transactions did not reach their defined synergy targets.4 Though the units of measurement are not identical, that outcome is not too far from the health plan result of 61 percent of deals that did not lead to growth ahead of the industry index.
A more direct comparison between the M&A experience of health plans and the way M&A affects organizations in other industries is the way post-merger value changes compared to changes in the Dow Jones Industrial Average. At the one-year mark, 58 percent of health plan M&A deals had created more value than the change in the Dow Jones over the same period. But three years post-merger, only 43 percent created more value change than the Dow Jones.
It’s our view that there can be a place in health plan M&A where science gives way to art. In Deloitte’s experience, the value that comes from health plan consolidation derives from several targeted areas, including combining administrative functions, making the most of pharmacy and network pricing in the health plan space, careful planning and execution of the combination of provider networks, and pharmacy contracts that can yield potential gains.
And the health insurance industry is a people business: Elimination of redundant functions and roles, headcount, and outsourcing opportunities offer an opportunity for substantial value creation upside without compromising market momentum and strategy implementation. But often these efforts are limited to deal-related one-time changes rather than dynamic shrinking of fixed costs associated with high-quality workforce integration and performance. Benefits design and performance-based compensation play a huge role in value creation post-deal and are sometimes the biggest challenge in unlocking value, especially when cultures vary or middle manager political clashes emerge and compromise performance.
It could be an oversimplification to say implementation and integration are among the only places where merged plans gain or lose value. For example, a change in geographical footprint certainly can alter market access and generate business growth. Deals can also generate value spikes on the strength of news coverage and investor enthusiasm. But as the share-price data suggests, many of those increases can be fleeting.
The bottom line: go big or get out … but don’t let the value slip away
Going big is likely to be necessary, but going big without unlocking value after the deal is consummated is likely to be a disaster for many parties. Clearly, going big is a trend across the entire health care industry. Consider: in 2012, the ten largest health plans in the U.S. had a combined market share of 56 percent5 – up from 48 percent in 2000.6 And in 2010, 59 percent of acute hospitals were in hospital systems, up from 52 percent in 2000.7 Our study suggests health plans deals often fail to unlock value. They can disappoint their investors, employees, and partners, and may fail to live up to the expectations upon which the deal was contemplated at the outset of discussions.
Deals are important, but going big is no sure bet for unlocking value. It’s our experience that optimal value can be achieved as the result of relentless, ongoing pursuit of operational synergies involving people, processes and technologies, and strategic execution of a growth strategy in a focused, disciplined process. These combine to potentially maximize value creation and are foundational to effective M&A for commercial health plans.
Unlocking value in health plan M&A is about the process of doing things well after the deal is done by anticipating each step before the deal is signed. Only then is it possible to unlock value and meet expectations
Optimal value may be achieved through ongoing pursuit of operational synergies, technologies, and strategic execution of a growth strategy.
Contact information
To learn more about the Deloitte Center for Health Solutions, its projects and events, please visit www.deloitte.com/ centerforhealthsolutions. To learn more about the paper and it’s contents contact a listed author. To learn more about Deloitte’s related health care services contact a contributor. Deloitte Center for Health Solutions 1001 G Street N.W. Suite 1200 Washington, DC 20001 Phone 202-220-2177 Fax 202-220-2178 Email healthsolutions@deloitte.com Web www.deloitte.com/centerforhealthsolutions Follow @DeloitteHealth at www.twitter.com Contacts
To begin a discussion or for further information on Deloitte life sciences and health care M&A or corporate finance related offerings.
M&A Consulting Services Brian Flanigan Principal Deloitte Consulting LLP bflanigan@deloitte.com Mark Hopkins Principal Deloitte Consulting LLP mahopkins@deloitte.com Ollie McCoy Principal Deloitte Consulting LLP omccoy@deloitte.com
M&A Transaction Services Philip Pfrang
Partner
Deloitte & Touche LLP ppfrang@deloitte.com Todd Pierro
Partner
Deloitte & Touche LLP tpierro@deloitte.com Kyle Woitel Partner Deloitte Tax LLP kwoitel@deloitte.com James Gorayeb Senior Manager Deloitte & Touche LLP jgorayeb@deloitte.com
Deloitte Corporate Finance LLC Hector G. Calzada, Jr.
Managing Director
Deloitte Corporate Finance LLC hcalzada@deloitte.com Simon Gisby
Managing Director
Deloitte Corporate Finance LLC sgisby@deloitte.com
Researchers
Sheryl Coughlin, PhD, MHA Head of Research
Deloitte Center for Health Solutions Deloitte LLP
scoughlin@deloitte.com Leslie Korenda, MPH Research Manager
Deloitte Center for Health Solutions Deloitte LLP
lkorenda@deloitte.com
Authors
Paul H. Keckley, PhD Executive Director
Deloitte Center for Health Solutions Deloitte LLP pkeckley@deloitte.com Brian Flanigan Principal Deloitte Consulting LLP bflanigan@deloitte.com Mark Hopkins Principal Deloitte Consulting LLP mahopkins@deloitte.com Ollie McCoy Principal Deloitte Consulting LLP omccoy@deloitte.com Acknowledgements
We wish to thank Jennifer Bohn, Katrina Drake Hudson, Lynn Sherry, Liza Benner, Elizabeth Stanley, Amy Coffey, Larisa Layug, Brian Schmidt, David Betts, Jimmy Peterson, Jaya Agarwal, Abhijit Khuperkar, Ryan Carter and the many others who contributed their ideas and insights to this project.
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The Deloitte Center for Health Solutions is the health services research arm of Deloitte LLP. Our goal is to inform all stakeholders in the health care system about emerging trends, challenges, and opportunities using rigorous research. Through our research, roundtables, and other forms of This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.
