Did you have a Magic 8 Ball when you were younger? In case you weren’t as cool as I was, let me tell you how it worked. You would ask a question, shake the Magic 8 Ball, and flip it over to read a randomly generated answer. A standard Magic 8 Ball has 20 possible answers, including 10 affirmative answers, 5 non-committal answers, and 5 negative answers. It was created to be a gimmick or paper weight for adults, but it ended up being a craze for youngsters like myself. I’ll never forgive it for telling me “Don’t count on it” when I asked it if my dream prom date would say yes.
Private equity firms have kicked the tires on Medical insurance portfolio programs before. For many, the end result was “Outlook not so good.” Despite your personal experience with this question, in the next 12-18 months, I am confident that you will reach out to a broker and ask if market appetite has changed. Rising Medical insurance costs and the evolving needs of your portfolio companies will compel you to make the ask.
Any broker that understands the private equity space will tell you that “Signs point to yes” because the market has never been more prepared to make this work. You will save money, simplify a challenging process, give you more control over ESG initiatives, and, with the right broker, improve the lives of your portfolio company employees. I am sure that “You may rely on it” since there is no downside to taking this to the feasibility study stage to see what’s possible in 2021.
If you consult your Magic 8 Ball, it will tell you “Without a doubt,” or “As I see it, yes” because I firmly believe that in 3-5 years every private equity firm will implement a group purchasing program in one form or another.
The following nine reasons could compel you to do it:
1. Medical insurers are clamoring for portfolio program business. Understanding the opportunities and nuances of portfolio companies is a relatively new phenomenon at insurance companies. It wasn’t that long ago that a private equity transaction would concern an underwriter due to all of the unknown that comes with it.
New owners? What are they like?
Rapid growth? No thank you!
Eventual liquidity event? You mean they are going to do this again?
You want us to get it done and then ask our questions? No way! Send your submission through the usual channels!
Today, Medical insurers in particular employ teams of people to craft a portfolio program offering that cannot be beat. These insurers have big goals, and they will do what it takes to win your business.
One way that they do this is by viewing ten, 200 employee groups as one, 2,000 employee group (even though they are each insured separately). A 2,000 employee group receives more robust services and transparent claims data, which makes it easier to deploy resources that drive down cost over the long term.
These insurers also understand that they save a lot of money by limiting their acquisition cost. A private equity firm will likely always own ~10 companies, and the insurer will retain the companies once they are sold because the plans are fully portable. You might not own the company 10 years later, but they will likely still be an insured of that Medical carrier.
2. Medical costs will continue to trend upward. Medical insurance is usually the 2nd or 3rd largest expense at your portfolio companies, and the upward cost trend has obviously been a problem for a long time. There are no signs of this trend improving.
3. COVID-19’s impact on Medical cost is still looming. There are many potential ramifications of COVID-19 to the Medical insurance marketplace that haven’t materialized yet. For instance, patients have avoided hospitals for routine and elective procedures, which could cause them all to flood the market at once thus overwhelming the system.
Patients have likely held back on preventive health measures and testing that would logically prevent more serious and costly issues in the future. It’s impossible to tell which of these factors will have the greatest impact, but we know that it’s coming and it will drive up cost.
4. Your company’s Medical insurance spend will be as low as possible in a group purchasing arrangement. We modeled the kind of financial impact a Medical portfolio program can have, which includes the following metrics:
- The fund includes 10 portfolio companies.
- At initial transaction close, every company will have 100 EE’s.
- There will be a 10% increase in EE count every year resulting in ~145EE’s at the end of year five.
- Employees contribute 30% of the Medical premium.
- At exit, each company is sold at an EBITDA multiple of 14.3x.
In 2021, a company with 100 EE’s will spend approximately $1.5M / year for Medical insurance. Accounting for headcount growth (10% / year) and pricing trend of 7% the total cost could be ~$2.9M after the 4th renewal. The net cost to the Company after employee contributions will be approximately $2M annually. A 92% increase in cost from the first year.
If that same company entered a portfolio program arrangement shortly after close, the total cost after the 4th renewal could be approximately $2.4M with a net cost after employee contributions of ~$1.8M. This represents a premium reduction of approximately ~$250,000 in year 5, and $675,000 over the course of the 5-year hold period. Your company will need to sell a lot of t-shirts, see a lot of patients, or sign a lot of SaaS contracts to make up for $675,000 of increased expense.
Assuming a 14.3x EBITDA multiple at exit, the value of that company increased almost $3.4M. Replicate this across 10 exits, and you have created ~$34M of value across your fund.
It’s important to note that as a result of this arrangement, each employee at your companies will average an extra $700 / year in their paycheck in year 5, and over $2,250 over the course of 5 years.
Approximately $67M of value can be created across 10 companies using these same metrics if all of the companies start with 200 EE’s at close.
5. Medical providers will consolidate and increase their leverage. Many medical providers have struggled since COVID-19 began, so we expect an uptick in consolidation. That’s good for you if you have a healthcare fund, but fewer providers means that they will have more leverage when negotiating rates with Medical insurers.
6. You will get access to claims data irrespective of the funding arrangement. Across your portfolio, some of your companies might be fully insured, level funded, or self-insured. Currently, only the self-insured companies have access to the kind of claims data that allows them to make decisions that improve the health of their employee population.
Medical carriers do not share detailed claims data when a plan is fully insured or level funded. They will tell you that your plan is running at 95% ($.95 in claims for every $1 in premium that your group paid) but they won’t tell you if the $.95 went to knee / hip replacements or heart attacks.
How can you possibly know where to spend your wellness budget if you don’t know the general health of your workforce? You are shooting in the dark without claims data. A portfolio program will get you the type of claims data that is only reserved for self-insured groups.
7. The employees at your portfolio companies will have a better member experience. They will receive better service, access to improved technology, and more money in their paycheck (they pay a portion of the premium, too.) This is the type of good news that you want to send to your employees.
8. New elements of ESG will be under your control. You are under increased pressure to reference non-financial reporting results that impact the companies that you invest in. Through a portfolio program, you can determine which initiatives require attention, and offer things that each company could have a hard time getting on their own, such as:
- DE&I training
- Personal financial wellness initiatives
- Mental health support
- College search help
- Legal assistance
- Standardized leave policies
With one phone call to your broker, you can take immediate action and implement a portfolio wide offering that will improve the lives of the employees at your companies.
9. You will receive more meaningful due diligence results. During due diligence you likely will learn that the 2nd or 3rd largest expense at the Target will go down shortly after close. You will also be able to share this news with the employees at the Target. Wouldn’t that be a breath of fresh air.
By creating an Employee Benefits portfolio program, you have a tremendous opportunity to make a meaningful impact at your portfolio companies (Outlook good). Administratively, you can lighten the load for your management teams while improving the technology and offering to the participating employees (Without a doubt). Financially, the amount that employees contribute to the cost will go down, one of the top expenses at your companies will be reduced, and a meaningful positive impact on EBITDA will result thus improving returns to you and your LP’s (It is certain).