Joyce Benton, AVP, Risk Control Caroline White, Risk Control Director

CNA Hardy Annual Healthcare Conference 2017 M&A: Keys to a Successful Integration

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3 Objectives

Review current healthcare industry trends to enhance current knowledge of merger and acquisition transactions

Utilise the Enterprise Risk Management (ERM) framework to manage the merger and acquisition (M&A) integration process

Identify potential exposures and risk implications of merger and acquisition transactions for healthcare organisations

4 Definitions

Merger Two or more corporations combine into one of the existing corporations. Often, one corporation “disappears” into another corporation, as assets and liabilities are combined. Mergers are often statutory transactions. Therefore, they must abide by the laws where the merger will occur.

Acquisition A transaction in which a buyer purchases stock (for profit) or membership (not-for-profit) or assets and liabilities of a corporation.

Divestiture A transaction in which an entity chooses to sell an existing operation (in whole or in part) to another party.

Strategic Alliance

In lieu of a merger, two or more entities may form a strategic alliance, often pursued to foster similar goals, while remaining as independent organisations. Entities may wish to work together on shared services, while remaining separate entities. Some regional hospitals or “health networks” have been formed using this affiliation strategy.

Joint Venture A type of strategic alliance where two entities enter in to a legal arrangement where certain responsibilities and resources are shared through a joint venture agreement. If more than two entities are involved in creating a joint venture, it may become known as a consortium.

Due Diligence A process in which information is compiled, analysed, and reviewed to determine not only whether the transaction will achieve the entity’s strategic goal but also whether any issues or concerns must be addressed prior to a final closing of the transaction.

Source: American Society for Healthcare Risk Management, Carroll, editor. Risk Management Handbook for Healthcare Organizations, Sixth Edition

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Estimated success rate of mergers across all industries:

50% Source: Monica Oss; www.openminds.com

Types of Healthcare Consolidation and Collaboration

• Merger/acquisition: In a merger, two existing companies are combined into one company to form a new company. An acquisition involves the purchase of one organisation by another organisation, obtaining control, assets, liabilities, without the formation of a new company.

• Consolidation: Different organisations join to create a new, larger entity, thus

spreading fixed overhead costs over a larger revenue base.

• Joint operating group: Organisations share management, separate boards (also

known as, “virtual merger”).

• Shared services organisation/ Administrative services organisation: Similar to the

above, but with new and separate entity providing management services.

• Accountable care organisation: Healthcare facilities and providers join forces to

manage the care of a target population, ideally enhancing efficiency and continuity of care and optimising reimbursement.

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Competitive pressures were cited as the #1 reason for healthcare M&A activity

Source: Delloitte

Industry Trends

• Increasing margin pressure from government and commercial payers and escalating intensity of competition for healthcare funds indicate that acute care mergers and acquisitions will occur with greater frequency and complexity in the near future.

• The healthcare market is consolidating in response to a more expensive regulatory environment and new reimbursement models that favour large healthcare systems.

• Independent organisations are confronting the challenge of obtaining capital to purchase new equipment and address ageing infrastructure.

• Compliance requirements are increasing costs for healthcare organisations and providers.

7 Healthcare M&A in the U.K.

UK merger control applies to any transactions leading to a change of control over the activities (or a part of the activities) of one or more providers.

In the NHS context, the term ‘merger’ includes, among other types of transactions, those as set out in section 56 of the NHS Act 2006 as amended, ‘acquisitions’ regardless of whether any financial consideration is payable; joint ventures; the transfer of individual services or activities to another provider; and asset swaps.

8 Industry Trends in the U.S.

Hospitals In 2014, 100 mergers or acquisitions, involving 178 hospitals, took place in the U.S. hospital market. (Source: Irving Levin Associates) According to Kaufman, Hall & Associates, hospital M&A activity across the U.S. continued to rise in the first quarter of 2016 (6/9/16) The sustained increase in transaction activity demonstrates providers' continued use of mergers, acquisitions and other strategic partnerships to increase capabilities as the national healthcare system transitions toward a value-based business model. *Hospital Merger and Acquisition Activity Rises in First Quarter of 2016, According to Kaufmann Hall Analysis, June 9, 2016. Available at: http://www.kaufmanhall.com/about/news/hospital-merger-and-acquisition-activity-rises-in-first-quarter-of-2016-according-to-kaufman-hall-analysis

Ageing Services, Home Healthcare, Physicians • Approximately 300 mergers and acquisitions representing

about $26 billion were announced in the senior housing market in 2014.*

• In the long term care sector, in the Second Quarter 2016, there were 87 M&A transactions, representing 13 per cent more than in the Second Quarter 2015.*

• In the Third Quarter 2016, almost one-fourth of all healthcare M&A transactions involved long term care.*

• In 2015, there were 22 publically announced physician group acquisitions.*

• Medicare home health organisations experienced 91 transactions in 2014. (Source: The Braff Group in www.seniorhousingnews.com)

*Source: Levin & Associates at http://healthcare.levinassociates.com/

9 Recent U.S. Healthcare M&A Transactions

2nd Quarter 2016 (Number of Deals)

1st Quarter 2016 (Number of Deals)

Change From Previous Quarter

Behavioural Health 17 8 +113%

Home Health and Hospice 12 18 -33%

Hospitals 22 27 -19%

Labs, MRI and Dialysis 11 8 +38%

Long-term Care 87 83 +5%

Managed Care 5 8 -38%

Physician Medical Groups 27 19 +42%

Rehabilitation 7 10 -30%

Other 51 40 +28%

Services Subtotal 239 221 +8%

Technology Subtotal 157 137 +15%

GRAND TOTAL 396 358 +11%

10 Factors Influencing Increasing M&A

• Financial stability and profitable growth gaining economies of scale, market share gains, and administrative efficiencies.

• Competitive pressures for securing referral streams, expanding geography and

enlarging population health and care management opportunities.

• Complementing and enhancing scope of services, including service line integration,

unified branding and clinical standardisation.

• Centralising primary care infrastructure and securing specialist services.

• Healthcare reform and accountable care trend, emphasising value-based metrics

and the need for new technology and capital investment.

• Enhance operational efficiencies.

• Acquire greater price leverage with private insurers.

11 Factors Influencing Increasing Ageing Services M&A

• Demographics: Ageing Baby Boomers stretching as far as the eye can see … leading to perpetually bullish investors.

• Major capital in the market, including large real estate investment trusts (REITs), both

public and private ($27 billion in aging services REIT acquisitions since 2000).

• Motivated sellers, due to rising valuations.

• Economies of scale and administrative efficiency.

• Industry momentum toward continuum of care/ageing in place capabilities and

away from freestanding facilities.

• Healthcare reform and accountable care trend, emphasising value-based metrics

and the need for new technology and capital investment.

• Strategy to fill vacant leadership positions, especially for smaller and more remote

facilities.

12 To Merge or Not to Merge?

• What are the options? Is there a simpler, less costly or less risky means to grow and compete?

• Why us? What makes this organization attractive to others?

• Why them? What are the proposed partner’s (or partners’) strengths, marketing niches, challenges?

• Why together? Do the parts fit well, including organizational values and practices?

• Is it doable? Can management, boards, brands and staff become one?

Before pursuing the M&A initiative, leadership should ask the following questions:

13 Related Risks

In August 2015, a survey by Healthcare Risk Management Review (HRMR)¹ revealed that 83 percent of risk managers believe the current trend for consolidation will affect patient safety (i.e., reluctance to share data; management evaluates bottom line productivity rather than quality and safety outcomes; employees attention focused on other issues during the M&A).* Potential exposures may include:

• Management of acquired business and clinical units. • Increased risk of patient harm due to substandard quality of care. • High staff turnover. • Noncompliance with laws and regulatory requirements. • Loss of reimbursement. • Difficulties in investigating and resolving claims.

*Risk managers say hospital consolidation affects patient safety. Healthcare Risk Management Review (HRMR). June 18, 2015. http://www.hrmronline.com/news/risk-managers-say-hospital-consolidation-affects-patient-safety-878

14 Snapshot of a Health System’s M & A and Risk Management Issues

M&A Background: • This was a Health System’s (HS) first venture into M&A activity. Since inception, the

HS has been a stand-alone, one hospital system with regional medical centers. Per conversation with the risk manager, the merger was driven by need to expand revenue and market share and to provide resources and tertiary services to residents in another part of the state. After three years of discussion and a subsequent due diligence process, the merger was finalized.

• Lessons learned and risks identified

– Involvement of risk management early in the process – Recognition of corporate and organizational culture differences – Focus on operations during the due diligence and integration process – Awareness of unanticipated discoveries – Assessment of high risk services

15 Sample CNA Healthcare Risk Control Publications

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16 Risk Management’s Role Post-Merger

• Focus on patient safety and quality issues during the transition.

• Anticipate and mitigate transition-related risks.

• Advocate for constructive change and continuous quality improvement.

• Translate risk reduction aspirations into formal policies and procedures.

• Maintain organisational continuity in an ever-shifting legal and clinical environment.

• Create synergies to merge organisational cultures.

• Support and guide the integration process utilising an Enterprise (Organisation-wide) Risk Management approach.

17 Keys to Success

The increasing wave of M&A activity creates not only new efficiencies but also a wide range of challenges associated with integrating very different facilities into a unified whole.

Across industries, most agree that post-merger integration is the single most important factor contributing to success. (Advisory Board Company, “Best in class Integration of Newly Acquired Entities,” 2013.)

While M&A activity is increasing, 2012 data demonstrated that few hospitals mergers in the U.S. actually achieved their original goals. According to the study, few deals improve quality of care. (Robert Wood Johnson Foundation, “The Impact of Hospital Consolidation,” 2012)

M&A activity should be reviewed and analysed through the lens of the Enterprise Risk Management (ERM) framework. Utilising the ERM framework will enhance strategic decision-making by showing the connection between risk and the total value and future prospects of the enterprise.

18 Enterprise Risk Management

• A framework of activities that helps an organisation identify and manage risk holistically by considering all forms of risk across the organisation.

• Used in UK’s NHS for many years, as Organisational or Integrated Risk Management

• An integrated approach to risk management that connects silos so that the organisation understands all risks that it must confront and enables the organisation to become more strategic in addressing such risks.

• A process supporting the concept that risks do not exist or behave in “isolation” but can be identified, grouped and catalogued in risk domains.

Operational Processes

Human Capital

Finance

Hazard

Strategic

Technology

Legal/ Regulatory

Clinical

Property and Assets

Resident Safety

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Risks associated with the focus and direction of the organisation. Post- merger M&A actions associated with strategic risks: • Identify enterprise risks in the due

diligence process and integrate these risks into a post-merger strategy.

• Develop and implement a post-merger integration plan, including cultural alignment of component operations to ensure consistency of mission, vision and values.

• Assign an individual to lead the post-merger integration process, with the support of governing board, senior management, key stakeholders, subject matter experts and frontline staff.

• Establish communication goals and communicate integration-related objectives.

Strategic Risks

Financial

Hazard

Human Capital

Strategic

Legal/ Regulatory

Clinical

Technology

Operational

Patient Safety

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Risks associated with inadequate or failed or internal processes or systems that affect business operations. Post- merger M&A actions associated with operational risks: • Integrate policies and procedures across

the new entity in alignment with post-merger strategy.

• Implement risk, quality and patient safety management programs on a system-wide basis.

• Establish a peer review process and system-wide procedure for credentialing, privileging and reappointment of medical staff and advanced practice providers.

• Initiate a system-wide, non-punitive incident reporting system that incorporates data analysis.

• Address diversity issues within the new entity, including language barriers, cultural variation and degree of health literacy.

Operational Risks

Financial

Hazard

Human Capital

Strategic

Legal/ Regulatory

Clinical

Technology

Operational

Patient Safety

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Risks associated with delivery of care to residents, patients and other healthcare customers. Post- merger M&A actions associated with clinical risks: • Establish multidisciplinary committees to

oversee perinatal, emergency, surgical and invasive procedure, mental health and radiological/diagnostic/interventional services

• Implement a consistent approach to handoff communication that has been developed, articulated and implemented across the combined healthcare system.

• Develop a consistent process for monitoring, investigating and reporting hospital-acquired conditions.

• Establish a process to analyse and address healthcare-associated infection trends and patterns.

Clinical Risks

Financial

Hazard

Human Capital

Strategic

Legal/ Regulatory

Clinical

Technology

Operational

Patient Safety

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Risks associated with the organisation’s workforce. Post-merger M&A actions associated with human capital risks:

• Develop a plan to manage staff

transitions during the consolidation, encompassing such issues as hiring, talent management, staff reductions, retirements and turnover.

• Implement human resources policies and procedures on a system-wide basis to ensure compliance with applicable regulatory requirements.

• Develop a system-wide process to hold individuals accountable for their actions and performance.

• Utilise employee surveys to assess staff morale and degree of cultural integration.

• Implement a staff orientation programme that addresses system-wide clinical practice standards and human resources policies.

Human Capital Risks

Financial

Hazard

Human Capital

Strategic

Legal/ Regulatory

Clinical

Technology

Operational

Patient Safety

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Risks associated with the failure to identify, manage and monitor government mandates on a local, regional or national level (state or federal in the U.S.). Post-merger M&A actions associated with legal/regulatory risks: • Implement a unified compliance program

at all facilities.

• Determine that all facilities have been found to be in good standing following state, regulatory and accreditation inspections, and any plans of correction have been addressed.

• Assign an individual to monitor the contract and agreement management process across all sites.

• Review all marketing materials by legal counsel, risk management staff and senior leadership.

Legal / Regulatory Risks

Financial

Hazard

Human Capital

Strategic

Legal/ Regulatory

Clinical

Technology

Operational

Patient Safety

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Risks associated with decisions that affect the financial sustainability of the organisation. Post-merger M&A actions associated with financial risks: • Centralise insurance purchasing to

ensure that the system as a whole has adequate lines of insurance and limits of coverage.

• Develop a system-wide claims management programme.

• Create a strategy for investing in information technology, addressing both software and hardware.

• Implement a plan to identify potential economies of scale.

• Identify internal barriers or challenges in achieving financial risk management goals.

Financial Risks

Financial

Hazard

Human Capital

Strategic

Legal/ Regulatory

Clinical

Technology

Operational

Patient Safety

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Risks associated with the use of machines, hardware, equipment, devices and tools, including clinical and operational techniques, systems and methods of organisation. Post-merger M&A actions associated with technology risks: • Institute a system-wide comprehensive

information technology plan.

• Assess IT systems across the enterprise with respect to effectiveness, interface readiness and security.

• Develop a system-wide policy regarding mobile device security and confidentiality, including guidelines on encrypting information.

• Develop a system-wide security and privacy policy covering all employees and vendors.

• Evaluate electronic health record issues on a system-wide basis.

Technology Risks

Financial

Hazard

Human Capital

Strategic

Legal/ Regulatory

Clinical

Technology

Operational

Patient Safety

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Risks associated with asset depreciation, as well as natural and man-made disasters and events that may damage facilities and/or disrupt operations. Post-merger M&A actions associated with hazard risks: • Institute a multidisciplinary environment of

care/safety (Health and Safety) committee to discuss emergent and critical issues.

• Develop system-wide and facility-specific emergency preparedness and business continuity plans.

• Develop and implement system-wide written life safety, biomedical and general equipment, utility and security management programs.

Hazard Risks

Financial

Hazard

Human Capital

Strategic

Legal/ Regulatory

Clinical

Technology

Operational

Patient Safety

27 Three Key Phases of M&A

Planning Implementation Evaluation and monitoring

• Begin integration planning far in advance of deal closure.

• Immediately identify a dedicated integration leader.

• Assemble a distinct integration team.

• Use early wins to establish credibility and build momentum.

• Prioritise issues regarding IT integration.

• Emphasise the benefits of integration.

• Establish baseline targets in the beginning.

• Instill accountability through defined scorekeeping.

• Create clear pathways to readjust the integration plan.

• Memorialise learning processes to inform future integration.

28 Integration Factors Considered Most Critical to M&A Success

• Integrating systems and processes – 4.1 • Integrating people and culture – 3.5 • Negotiating and appropriate valuation – 3.1 • Performing rigorous due diligence – 2.2 • Planning a clear M&A strategy – 2.1 (Rated by importance on a 5 point scale) http://mergermarketgroup.com/wp-content/uploads/2013/10/TheStorytellers_Report_TheMissingChapter-FINAL_LR.pdf

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Basic risk management questions to ask

Healthcare Integration

• Are all exposures assessed – e.g., clinical, property, fiscal, employer’s liability, business interruption, and cyber liability, among others?

• Have leadership teams met to discuss key issues in depth – and if current executives and board members leave, have other individuals been identified to serve in those roles?

• Is a combined strategy established and implemented, considering account synergies, potential market fluctuations and enterprise liabilities?

• Are both the benefits and risks of “bigness” considered – e.g., increased efficiency, centralised control and potentially enhanced compliance … versus potentially decreased flexibility, community connection and responsiveness?

• Is there a special team in place to support the merger process (including the performance of due diligence), and is this team representative of the merging entities and interdisciplinary?

• Has the other organisation’s culture been evaluated prior to purchase to ensure compatibility?

• Is there a post-merger communication plan aimed at current and prospective residents/families, staff, local providers/facilities and the community at large?

• Are the intangibles fully considered, e.g., reputation and brand, morale, safety and quality awareness, two-way communication, accountability, compassion, respect?

30 Interactive Session

• M & A Group Exercise

– In groups of 4-5 people, work through the case study and assignment.

– Appoint a group’s spokesperson to present to the large group.

31 CNA Healthcare Resources

• Risk Control – CNA Risk Control – http://www.cna.com – Select “Look for Resources to Manage and Reduce Risk”, then select

Healthcare for more resources.

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Questions