The last quarter of 2021 was a rough one for the health care sector, and naturally, carriers felt the effects: they had written beyond their budgets, and resources were stretched to their limits.

“I don't think the market has ever seen rates go that high,” says Sumit Agarwal, who works in mergers and acquisitions at Marsh, one of the world’s leading insurance brokerage firms. Demand was high and deals were closing at a record pace, which made placing deals that much more difficult. 

The strain on the system led to the reintroduction of exclusions of important factors like representations and warranties insurance which, if not included in the deal, “it’s not worth it,” Sumit says.

Prospects are looking a bit brighter for 2022: those exclusions have mostly fallen away, but the market is still recovering as prices go down and carriers try to settle rate prices and averages.

In this episode of The Professor’s Corner, we’re joined by Marsh’s Sumit Agarwal and Sam Bell who tell us more about the current climate for healthcare acquisitions, what we can expect for the year ahead, and mistakes to avoid when making deals.

Featured Guests

Name: Sumit Agarwal

What he does: Sumit is the Senior Vice President of Mergers and Acquisitions at Marsh, where he deals with transactional risk.

Organization: Marsh

Words of wisdom: “Being involved in the conversation from the start helps us overcome some challenges that may arise later in the process. And when you're looking at the eleventh hour to secure a policy, we could have gotten well ahead of it if we were brought in a lot earlier.” 

Connect: LinkedIn

Name: Sam Bell

What he does: Sam is Vice President of Marsh, where he is responsible for attracting new clients and servicing all of their commercial insurance brokerage and risk management consultation needs.

Organization: Marsh

Connect: LinkedIn

Notes From The Professor’s Corner

Top takeaways from this episode

★ The end of 2021 strained the health industry. That’s because there was record demand for healthcare deals with many being underwritten by managing general agents who had reached their maximums a lot earlier in the year than in years past. Because of those challenges, negotiations saw constraints that are no longer a problem in 2022. “There is no healthcare regulatory-related exclusion. Everyone is willing to underwrite it; it's just finding the right market to do it,” Sumit says.

★ Make sure your legal team is involved in acquisitions early on. One of the biggest mistakes Sumit and Sam see at Marsh is buyers involving their brokerage team too late in the game or hiring a third-party to speed up the due diligence process. At the very least, a full report detailing the diligence that has been done is necessary to smoothly carry out a deal. “That way, we can mark it to deal appropriately and accurately with the best carrier suited for the risk,” Sumit says.

★ Small transactions might not be worth it. For example, having a $20 or $30 million deal would allow as little as  $1 million to $5 million in limits. With the added acquisition costs and risks, the costs might not outweigh the benefits.

Episode Insights

[00:32] Meet our guests: Sam and Sumit both work with Marsh, one of the world’s leading insurance brokers and advisors.

[1:23] Looking forward: The last quarter of 2021 was a difficult one for private healthcare carriers, but things are feeling a little different this year. Sam and Sumit talk about what went wrong last year and what to expect in 2022.

[07:34] What to avoid: Sumit tells all about the biggest mistakes they’ve seen in both corporate and private equity health care acquisitions.

[11:09] Too small to succeed?: Can a deal be too small to make sense? Sumit explains which transaction sizes are worth your time.

[15:06] Special products: ‘Special product’ transactions, like underwriting the risk of PPP loan reimbursement, for example, carry specific risks, Sumit explains.

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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.

Everyone, this is Geoff Cockrell from McGuireWoods. Welcome to another of our Corner series, where we bring together deal professionals, and market presence folks in the healthcare, private equity, investing arena. Today, I'm thrilled to be joined by my good friends at Marsh, Sumit Agarwal, and Sam Bell. Both of them work in the rep and warranty insurance area, and have very specific expertise as relates to healthcare transactions in particular.

My name is Sumit Agarwal. I'm a member of Marsh's transactional risk practice. I've been a broker here, specializing in reps and warranties insurance for about a year. I was at a previous job for about two years. And prior to that, I was an M and A attorney at a large firm in New York.

And my name is Sam Bell. I'm a vice president with Marsh and my role is to find new local new business opportunities. And I utilize Sumit when it comes to all M and A transactional risk.

Maybe just to open up the discussion a little bit, I'd be curious on your guys' thoughts on what we can expect here in 2022, given the constraints that we face in Q4 of 2021, where carriers were kind of overexposed. They'd underwritten beyond their budget generally, and healthcare specifically resources were stressed, as too many deals were on the train crack set for December of 2021. And claims history was picking up a bit, especially in healthcare transactions. And all that led to much more difficult to procure. And in some instances, just not available rep and warranty insurance for healthcare, providing services deals, things are feeling a little bit different in Q1, but Summit, maybe start with you. How is the market evolving given the tight Q4?

Yeah, thanks Jeff and thanks for having us. At the end of last year, Q3 and Q4 of 2021, rates went sky high. I don't think the market has ever seen rates go that high. And it's just a product of supply and demand deals came in at a record pace. We bound policies and deals were signing and closing out a record pace. So rates kind of matched that just again from, from capacity trade. So you have in today's market, you have a lot more MGAs, or MGUs, then you do direct underwriters. So more managing general agents that write on behalf of a syndicate. Then you do household names such as AIG and Liberty. And these guys have these MGAs have capacity restrictions. So they're allowed to underwrite a certain amount in limits on behalf of their syndicate. And they reached their maximums a lot earlier last year than, than historically.

So you've had, you had some of these MGAs that had to go out and get more capacity from their backing. People went out two. Or three times to get that. So at the end of last year, rates were matching that capacity constraint. And this year 2022, as we're ending the near end of Q1, rates have found a way down a little bit. I think people are still struggling with where the right bottom is, or average should be. So you have certain markets that are taking the lead in establishing where, where it should be and based on what we're seeing and what our group is seeing at Marsh.

I think for, for a normal deal, average rate online is about four to four and a half, probably with obviously four and a quarter being the average there. Plus, or minus just depending on the risk healthcare specifically though, it's still remains high. You're looking at five to five and a quarter where people think they should be. And just to piggyback a whole off of the constraints in Q4 and Q3 of last year, healthcare was at an, at an all time high. Most of the markets that do it were completely strapped for capacity claims at the early part of last year and early 2021 narrowed the playing field. So you only had a few markets doing it, which, which made placing a healthcare deal that much more difficult.

One, one of the other things that we saw was reintroduction of exclusions that we had not seen from kind of general billing and coding exclusions, but in my view, make the policy of questionable utility, but also other exclusions and how do the exclusions and the, and the push and pull of negotiating, negotiating those play out in kind of Q4 and then in Q1 cause those constraints kind of also show, show their head up in the exclusion arena.

Yeah, great question. And let's be real for a healthcare deal. If you don't have billing, coding, or healthcare regulation coverage for, for reps and warranties, it's not worth it. Cause that's where the real risk is. Exclusion, so you, we got those exclusions in Q4, but then again, it just begs the product, begs the question, whether reps and warranties insurance is worth it at that point on a healthcare deal. And you can come up with creative ways to get around it. You could have a separate billing and coding retention, or retention that doesn't drop. So people were getting creative at the end of last year, trying to make it work. I think those exclusions that's been fallen away this year, have a couple healthcare deals in the pipeline right now we had underwriting calls this week. There is no billing and coding exclusion. There is no healthcare regulatory related exclusion. Everyone is willing to underwrite to it. It's just finding the right market to do it and having the right diligence providers to do the work, to give the carrier's comfort that buyers doing the reckless diligence.

What are you seeing as far as carrier participation, meaning just in the raw number of them? Initially when kind of healthcare became the revenue working current for healthcare deals became available. It was a short list of carriers and then it steadily grew and grew. And then in Q4 kind of constrained again, what are you seeing by way of participants for underwriting healthcare provider services deals?

You have probably five to seven that do it. I think if you, on the record, if you ask any carrier that they'll look at any deal, but I think unofficially you have five to seven carriers that will look at healthcare deals. And I think classification of what actually constitute a healthcare deal is kind of a gray area. You have healthcare tech, which you might even have up to 10 markets to look at. Sometimes healthcare tech, the producer of the technology, or the device may not be subject to billing and coding risk. So you might have more carriers that would be willing to look at that, but true healthcare risk, or at least what I consider true healthcare risk, which would be a physician's practices, or fertility clinics or behavioral health. You're going to have five to seven that look at it and be willing to underwrite the billing and coding risk as well as healthcare regulatory risk.

Moving beyond kind of evolution from Q4 to Q1. Are there any trends in rapid work insurance, that stuff as relates to healthcare deals that you're watching, or think that we could be expecting?

I think it's more so just finding the right opportunity for, for reps and warranties insurance. You have some of these smaller deals that generally speaking reps and warranties may, or may not be economically practical.

Another topic that might be interesting to have your perspective on would be where do you see private equity funds, or buyers, or sellers to that matter? Where do you see them make mistakes, or challenges where they could you thinking about best practices that might avoid some of those challenges and mistakes?

Yeah, you have, as far as Mark is concerned, we're, we're split pretty evenly 50-50, and it's been the case for 2020 and 2021 where 50% of our clients are, are corporate and the other 50 are private equity. And the biggest challenge we face is not being involved early enough. And that's more so, so we can set expectations. I think some of these buyers, they like the business risk. They want to move quickly. They kind of hire this, the suite of third party diligent providers and look at everything and then they want a policy. Unfortunately for these underwriters, they want to know what diligence was done. And sometimes buyers like, hey, I think, I think this, this business is great. There's no issues with it. Why don't you want to underwrite the policy? The biggest challenge that we face is just having these buyers memorialize the diligence that they're doing when it comes to legal, you're doing a full suite of diligence as far as legal matters are concerned.

If their target is unaudited, most carriers require full scope by side quality earnings report from a reputable third party advisor. Same thing with tax work, regulatory insurance. So the biggest challenge we face is just lining up expectations with third party diligence providers, providing written reports and making sure that carriers have what they need to underwrite the deal. And even with some of these corporate clients, they have a lot of internal advisors that do work. And there's no problem with that. As long as they write a one, or two page summary and it could be in word, it doesn't have to be on any sort of fancy template, but just saying, hey, this is what we looked at. This is what we found. And just giving the carrier comfort that when, when a rep says X, Y, Z, that the, that the buyer has done the requisite diligence to confirm that seller company's rep is actually true.

Right? We, we, on the legal side, we approach it from the perspective of, especially when the buyer is wanting to move quickly. That the most important thing we can do is by the time we get to that underwriting call, there aren't open things floating around that if there are any kind of gray area topics that we have fully vetted. Kind of our answer on those topics and be ready to discuss why that was the correct call and that there's a clean understanding of where on the risk spectrum that resides and just kind of fronting issues. Those calls go a lot better and you have fewer tail issues if you can be ready for them on the front end, but it is a pretty substantial list to be sure.

Yeah, a hundred percent. And, and when you have a client that comes in and says, hey, we're looking at this target. We'd love to be brought in initially. And whether it falls apart, or not, it's one thing, but just kind of setting expectations that way we can market to deal appropriately and accurately with the best carrier suited for the risk. There's certain, there's certain carriers out there that won't touch a deal with unaudited financials. And there's no reason to approach those markets on a given deal, or there's carriers out there that will like smaller deals, or specific sector deals. So being involved in the conversation from the start helps us overcome some of these challenges that may, may arise later in the process. And when you're looking at the 11th hour to secure policy, we could have gotten well ahead of it if we were brought in a lot earlier.

As far as kind of by the transactions that are being underwritten, there was a time when you had to have transactions of a certain kind, but that was kept dipping down and down and down to where kind of pre Q4, we were finding policies being available for deals that might be only a 30 million dollar enterprise value where you're buying say 5 million dollars of coverage. I had questions about some of the utility on, in that arena. How do you think about kind of the bottom end of size for both availability and where, where the line, where it stops making sense?

Yeah, I think when you talk about a 20, or 30 million dollar deal, you're, you're at minimum limit to just three to five million, you can get, there are programs out there from some carriers to get limits as low as one million, but the economics start to make less sense. Are you doing full scope, two of these, assuming that a deal that small is going to have an unaudited target? Are you hiring a law firm to do full scope diligence? The economics on a deal that size stop to make sense, or you start to question whether it makes sense and do you just go back to a traditional escrow? Cause then the escrow at that point might be just as monetary, just not much higher than the cost of the policy, as well as yeah, these carriers and us brokers we put, we put the buy side through the ringer in terms of there's this whole separate work stream that you have to focus on.

And we're obviously here to facilitate that, but you're focusing on the deal. Everyone's kind of rushing to get it done. And then you have this whole separate reps and warranties insurance process to go through it. At the end of last year, I think anything less than 10 million limits was very difficult to get done. And it just simply came down to the economics of an opportunity cost. It's going to take just as much time, if not more time, to do a policy of three to five million in limits, then it would be to do 20, 25 million in limits. And obviously the economics on a 25 million dollar deal make much more sense from a time perspective. But I think that's leveled out, I have plenty of deals in the pipeline that are 5 million in limits, but I also have just as many that are 30, 40, 50 million limits.

Yep. One of the interesting evolutions that I'm seeing on the small acquisition and especially in [technical 00:13:31] provider services business, which has as its growth model, doing a whole series of small acquisitions, I agree that the economics of the cost of the policy and the work streams stop making sense. But the challenge is that the risk allocates and structure to a seller of a RWI deal is so compelling rather than having say 10, or more percent in escrow and exposure that might be more than that. Having their exposure curtailed down to a really small percent, say a half, or maybe three quarters of a percent is super attractive to the sellers. And I'm having more buyers that are doing serial transactions and feel like they are kind of diversifying their risk on their own. Considering kind of self underwriting the insurance policy meaning offer the seller the same RWI type risk allocation.

So they're limited to say a very small escrow of a half, or three quarters of a percent. And then having that be the end of the line. With the buyer basically underwriting that with the theory being that the carriers, when they kind of figure out their premiums, they really are pricing that risk plus some money for himself. And if you're spreading that risk through serial transactions on your own, is it worth considering just self-insuring for that? But still delivering the same treatment to the seller. That's been an interesting development and we'll see if that lands, or not. One last topic is what are you seeing by way of kind of special product, products to deal with a known issue that is say somewhere on the risk spectrum that was going to probably garner a specific exclusion from the general policy. Are you seeing kind of higher risk, more expensive products evolving?

Yeah, I mean, tax has been around for a long time and it's not a fairly difficult risk to underwrite. If you have a tax opinion, [Mo 00:15:38] shop, Mark included, we have a very robust, reputable tax team that does these risks. The rates are significantly higher. And then we also have a contingent liability practice. We have a, we have a group in house that does that as well. And they'll look at litigation risks, or any sort of specific risk that, hey, this is known. Would you be willing to underwrite it? Those are around the rates, again are high it begs a question, whether it's worth it, or not. But again, that comes down to a risk allocation business decision, but those are coming. They weren't around, they haven't been around for a very long time, but we see those often do they get placed often, not as much as reps and warranties obviously, but those specialty products are there.

I think they're here to stay. It's just a matter of finding the right stop to understand it. And a good example of this was PPP loans about a year ago, where two, or three thoughts came out and said, hey, we'll underwrite the risk in the event that you don't get your PPP loan reimbursed. I think the government ended up making it very easy to get that reimbursed and that product didn't really do too many. And I think the folks that tried to underwrite it only did one, or two policies at most. It was just a, it was evolving. People didn't know what the playing field would be, but those, the market doesn't really good job of seeing what's latest and greatest trying to find creative solutions for clients, especially reps and warranties insurance didn't cover PPP loan, or Cares Act related matter. So the market adjusted trying to find a specialty product to help address that concern.

Yeah. As a M and A practitioner, the rep and warranty insurance product has really transformed the M and A process in ways that make it way easier to get deals done. And you, it's also helped in kind of avoiding so many of the most tedious lawyer fights over district allocation is out of market. No you're out of market. No you're out of market. It short circuits a lot of those things, which is a lot better, but it's been a good evolution and it will continue to evolve. I'm sure Sumit and Sam, I really appreciate you guys joining us for this episode. Your insights are always a lot of help. And thank you again.

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 in 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.