When preparing a private equity-backed investment, it’s likely that something called a “representation and warranty” insurance policy, or “reps and warranty,” will be discussed. These policies help to minimize exposure in corporate transactions.

In healthcare deals, two types of exclusions can be requested by the reps and warranty insurer: general exclusions and specific exclusions. General exclusions arise before the due diligence process, while specific exclusions are a result of things uncovered in the due diligence process. 

The end of 2021 showed a significant increase in general exclusions for coding and billing, which left companies exposed to risk from the False Claims Act. This trend started shifting around in early 2022, but is still something that should be examined by counsel. 

When specific exclusions are proposed by an insurer, it’s important for counsel to narrow the scope of the exclusion so that the deal can have the most comprehensive reps and warranty coverage possible. 

In this episode of The Professor’s Corner, host Geoff Cockrell brings on a fellow McGuireWoods partner, Trey Andrews, to discuss how to navigate both general and specific exclusions when purchasing a reps and warranty policy. 

With experienced attorneys like Geoff and Trey, it’s much easier to have the leverage needed with reps and warranty insurers, establishing rapport and developing trust in their extensive private equity experience. 

Featured Guest

Name: Trey Andrews

What he does: As a Partner at McGuireWoods, Trey is a member of the healthcare transactions team. He focuses on private equity-backed healthcare acquisitions. 

Organization: McGuireWoods

Words of wisdom: “At McGuireWoods, we do a substantial amount of these healthcare private equity-backed transactions, where quite a few [of those deals] have reps and warranty policies put in place. I think that gives us the benefit of having colleagues to go to who really understand how this issue has been dealt with by others.”

Connect: LinkedIn 

Notes From the Professor’s Corner

Top takeaways from this episode

★ General exclusions for billing and coding can have a far reach. Billing and coding are how healthcare organizations generate income. When that function is excluded in a reps and warranty policy, it can be very risky. For example, exposing the client to litigation from a False Claims Act. It’s more common to see these exclusions in home health and hospice providers who generate a large volume of claims. 

★ Specific exclusions are born out of the due diligence process. An insurer might discover something too risky for them to cover while reviewing a company’s due diligence. Healthcare organizations often operate in gray-area decision-making, so it’s important for counsel to explain how something that seems risky on the surface is part of the nature of the industry. 

★ There are 3 steps to negotiate exclusions in a reps and warranty policy. Trey recommends communicating openly with the carrier regarding gray areas, working to minimize the scope of exclusions by demonstrating an understanding of the industry, and giving the carrier a sense of how other players in the market have viewed the same risk.

Episode Insights

[00:47] General vs. specific exclusions: Geoff runs down the basics of general and specific exclusions in reps and warranty policies.

[02:00] Billing and coding exclusions: Trey explains how the False Claims Act potentially exposes companies with billing and coding exclusions in their policies. 

[04:44] Q4 2021 to Q1 2022: Geoff and Trey go over some of the trends that have been quickly changing in the reps and warranty market. 

[07:26] Know your stuff on billing and coding: Be thorough in examining the client’s billing and coding through chart audits. 

[11:10] What to disclose to the insurance carrier: There are times when a company is operating in a gray area within healthcare law and while it’s not necessarily a deal-breaker, it’s important to disclose that in the diligence memorandum and discuss it with the carrier.

[14:36] 3 steps for fewer exclusions: Trey breaks down exactly how he negotiates with insurance carriers to minimize exclusions.

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is the Professor's Corner, a McGuireWoods series, exploring business and legal issues prevalent in today's private equity industry. Tune in with McGuireWoods's partner, Geoff Cockrell, as he and specialists share real world insight to help enhance your knowledge.

Thank you for joining another episode of our Corner series. This is Geoff Cockrell from McGuireWoods. In our Corner series, we addressed a number of deal dynamics that affect healthcare private equity investing. And this episode I'm going to be joined by my partner, Trey Andrews, who sits in our healthcare group. And we're going to be talking about some of the more specific nuances surrounding exclusions to a rep and warranty insurance policy in the context of healthcare provider services transactions. And just to set the table a little bit for this discussion, we're going to be separating out the distinction between a general exclusion and a specific exclusion. A general exclusion to a rep and warranty insurance policy is an exclusion that applies obviously generally, but it's made without reference to specific due diligence findings. It comes in at the very outset of underwriting, whereas a specific exclusion usually arises in connection with an issue that has arisen during the underwriting process or the diligence process.

And specifically in the context of healthcare provider services transaction. The first exclusion we want to talk about is a general exclusion for billing and coding. Several years ago, when rep and warranty insurance policies were just becoming more popular, it was pretty customary for those policies to include a general exclusion for all billing and coding issues. Trey, maybe you could weigh in and then we'll talk about how the industry has evolved, but what do you think the impact of a general billing and coding exclusion is on the efficacy of coverage in a rep and warranty insurance context?

Thanks Geoff. Yeah, billing and coding exclusions. They can tend to have in a healthcare provider services transaction more of a farther reaching effect that can really gut the benefit of the policy. Right? When you think about a healthcare transaction, particularly one where there's federal healthcare program dollars at stake and at risk. One of your primary risk areas is the False Claims Act. And the False Claims Act really goes towards false and fraudulent claims that are submitted to the government for reimbursement, which in turn, if an insurer through your indemnification structure, if you're using rep and warranty insurance, isn't actually going to cover billing and coding, which can get to very real risk under the False Claims Act. If you can put a policy in place that may not give you adequate coverage to address risk under the False Claims Act.

That's exactly right. In the context of a healthcare provider services company, the risk profile of a False Claims Act exposure, the headline numbers can be enormous in connection with the size of the business. And that's why some investors have anxiety about investing in healthcare in the first place. But navigating that risk is a significant portion of it. And if you have that front end exclusion for billing and coding to trace point, it's unclear how much value you're getting from the policy in the first place.

While that is true, the industry has evolved in over the last couple years, we were seeing consistently policies being underwritten that did not have that general exclusion, which made rep and warranty insurance, a viable option in a healthcare provider services transaction. What I will add is that in Q4, when the rep and warranty insurance market came close to not seizing up as not the right word, but becoming almost unavailable just from the demands of market activity, will we saw one of the ways that underwriters at carriers would kind of navigate the supply demand of rep and warranty insurance was to reintroduce that general billing and coding exclusion, which knocked it out as a viable product in a lot of transactions.

And so one of the things we're seeing or trying to evaluate now, as we come into Q1 is as the insurance market has loosened up after the white hot Q4, how is that playing out with the carriers as relates to billing and coding exclusions? And Trey, what's been your experience that you've seen in the market as to whether or not we can expect to see the billing and coding exclusion more widely introduced?

I think that's right. Q4 definitely changed things from allowing carriers to really reintroduce the broad base billion coding exclusion from a policy. I think in Q1, we've seen a shift back to, it maybe used more in a more targeted sense and provider types where the insurers have seen greater risk, your hospice companies, your home health companies, your provider types, where they're really the transaction it's created greater exposure because just the quantity of bills and maybe the insurers have also seen and taken some hits in that environment. So I've definitely seen a shift back towards where we were prior to Q4, but I don't think it's gone completely away where we're still dealing with broad based billing and coding exclusions from policies in certain provider types right now.

The pinch in Q4 kind of had two components. One was just like the physical ability to underwrite and process those policies to issue them. They were just resource constraints to even pull it off, whether you're talking legal resources, internal underwriter resources at the carrier, they were just resource constraints that made it very difficult in Q4 that has gotten better in Q1. But the second issue that is still present to some extent is that many carriers, as we talked to them, felt like their tonal kind of underwritten risk had gotten outsized in favor of health care provider services. And there was a desire to rebalance that a little bit, and that to some extent is continuing in Q1.

So even if the broad based billing and coding exclusion is not specifically a part of the policy, it's enough in the ether that private equity funds and folks seeking to procure a policy should have those conversations upfront and they may need to navigate whether or not that broad exclusion is going to be present and the drivers on that to trace point might be the sub-sector that's involved. It also might be relational with the underwriter or the broker, obviously folks that buy of insurance, you get a little bit preferential treatment in that process. But the learning on that is to look at it early, because it could be a significant item.

And Geoff, I think on top of that is the relationship with the insurer, the preferential treatment for how much there are definitely insurers that they are much more accustomed to healthcare deals. And so they may not take that broad swapping view of we are excluding all billing and coding.

But also in addition to running that down early on in the transaction, to understand the type of policy and the coverage you're going to be able to put in place showing that insurer the amount of work you've done to really vet the billing and coding of the provider type by doing your chart audit, making sure sample sizes are the right amount by pressing on and making sure that what's under the hood at the provider type for billing and coding can help remove any angst from the insurer to help them understand, "Okay. While in general, there may be risk in billing and coding just by nature of it's a human process running these codes through and claims, this target may not have the same level of risk as we would see across the entire industry, just by nature of you have pressure tested as your adequate way."

I've definitely seen some carriers get more comfortable when there are instances where they may exclude billing and coding, being able to walk that back and appreciate and value what the sponsor is doing to fully understand risk from a billing and coding perspective.

Turning a little bit to specific exclusions, Trey, maybe give a walkthrough of how those arise in connection with the carriers underwriting process.

Sure. Specific exclusions and healthcare. They really come out of the diligence process that the legal team is running down by doing corporate and regulatory diligence in the deal, right? As your regulatory diligence unfolds, there's certain risks that are going to come around. They may be more theoretical risks. And then there are going to be actual known quantifiable risks that you can put a number on where there's a risk. Really the exclusions are from better specific in a rep and warranty deal. They're driven from that diligence process that are specific to the target that is subject to the transaction.

I would note that there can be different types of things that arise. Your diligence might uncover an instance where it's pretty clear that the target has done something that was problematic. The exact kind of ramifications of that event or activity may be difficult to put your finger on exactly, but it's pretty clear that something was done that was probably not the right thing. I would put that in one bucket, another bucket, which makes for a lot more interesting discussions with the carrier is an instance where the target has been operating in a gray zone, or they were making a close call.

It's not a clean conclusion that they were violative of healthcare law, but they've made choices that are on a spectrum. And in that context, the diligence memorandum that has produced made kind of talk about those things. And in fact, the transaction agreement may have some specific treatment, maybe a specific indemnity that relates to that item, but it's also not clear that there's a point blank breach of the representation. And in that context, Trey, can you describe how those discussions go with the carriers underwriting process and how do you kind of limit the exclusion to a scope or get it omitted outright? How do those discussions go?

It's really an education moment with the carrier and the carriers attorneys that are working with you. It is a matter of being able to show them when you think you're landing in that gray zone, that the purpose of highlighting the risk spectrum that you mentioned Geoff is that you're weighing in to the clients so that they can help make a risk based decision for business model. But that doesn't necessarily mean that's going to translate into risk the insurer is actually going to be taking on just because you're flagging that risk. I think the first step is obviously characterizing the risk appropriately in the diligence memorandum so that it's not conveyed or seen to be in a risk that is actually out there that may just be more of a type of process that could be improved upon. The second point is, you're going to get your time with the carrier to answer questions.

And I think in that moment, that's your time to be able to help the care understand how you're viewing the risk. And I like to do a few things to do that really is establishing my credibility and that I do this routinely, and I've seen this regularly in the industry, right?

It helps that carrier appreciate that the person looking at the risk is actually the individual that also knows the risk they're looking at and can really give them a read on the market of it. I think you have to explain to them your thought process of how while maybe it may be gray, what are the things that have helped you get comfortable with that risk that you can also give them to lean on so that as they're analyzing risk from their perspective? And then it goes down to a matter of just helping them become comfortable with you and the target in general, and then the risk spectrum of the entire deal, the greater amount of understanding you can show in the provider type and in the target and how you have run through your process, the greater comfort that care is going to have in potentially working with you on removing exclusion in that instance.

That's exactly right. And that goes to the broader diligence process, kind of establishing to kind of our satisfaction and then the carrier satisfaction that the target is not a sloppy company, not a company that takes regulatory compliance lightly or approaches it cavalierly, but does approach it carefully, but is in the business of making calls in a market where elements of gray zone decision making is unavoidable. That goes a long way towards establishing that credibility that you're talking about.

And it lays the groundwork for either having the scope of an exclusion, very narrowly tailored to what has specifically been identified as opposed to either a broader statement in general, or a statement that goes beyond what was the specific instances that have been uncovered and can really help you in other instances, avoid that exclusion entirely. It is definitely a process where we as council need to know exactly the trace point, what we're doing and have the ability to navigate that sequence with the underwriter, but also to trace point, if you navigate it can carefully, thoughtfully transparently, you can often land at a situation where you are not undermining the significance and worth of the policy that is being purchased and are really just limiting out of the policy specific things that are deemed to be violative of the reps and warranties at the time that the policy is being written.

So Trey, let's say that you've kind of navigated that process and you are going to have a specific exclusion. So once you're in that area, how do you go about kind of process wise and conceptually, how do you go about chipping away at the scope of that exclusion? Which is a significant part of this process?

Yeah, I think that there's a few things you can do. First of all, open communication with the carrier to help understand why they're viewing a risk that you may not have viewed in the same light, right? They may have different experiences that really drive into why they're thinking this should be an exclusion. If you can get that background that can help you respond to their point. The entire process of trying to chip away the exclusion is to help them get comfortable with your analysis of where the risk is. And so I always start by getting their point of view, right? It doesn't help if I'm just chasing something down, trying to respond if I don't have an understanding of why they're thinking the way they're doing. The next step in the piece of the puzzle is if they're looking for additional information, obviously hunt it down.

You're working with your sellers council almost as a team at that point, because it's going to benefit the seller equally as much as it's going to the buyer to have a strong of a policy in place. So the fellow should really be helping you respond to questions and help provide additional information to the insurer to get them the information they need that may get them that comfort. And then the last point I would make is being able to give them a market read for how other carriers have viewed risk in a similar sense, right? At McGuireWoods, we do a substantial amount of these healthcare private equity back transactions, where quite a few have rep and warranty policies that are put in place.

And I think that gives us that benefit of having colleagues to go to really understand how this issue and maybe a specific issue has been dealt with by others, so that we can frame that up for the carrier in the same way so that they know that they're not getting outside of market as well, or shifting the market in ways that others may not. I think those are really the three tactics I would take. And hopefully with a combination of all three of them, you can, the ultimate goal is to remove the exclusion outright. The kind of the secondary goal is to have that exclusion as tailored as narrowly as possible so that the policy still provides broad based coverage in all of the other areas that you're hoping to narrow the exclusion from.

Super helpful. I think we'll leave it at that for today. Trey, you are quite the pro in this, and there's very few I'd want to have in the trenches in this more than you. And thank you everyone for joining us. This is another episode of our Corner series. There'll be more to come. Thanks a lot.

Thank you for joining us on this installment of the Professor's Corner. To learn more about today's discussion, please email host Geoff Cockrell at gcockrell@mcguirewoods.com. We look forward to hearing from you.

This series was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this series, you acknowledge that McGuireWoods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in this installment. The views, information or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state, and should not be construed as an offer to make or consider any investment or course of action.