Health care industry outlook
Volume 7, Spring 2021
As the global vaccination rollout continues and communities and businesses recover, the health care industry has much to weigh the remainder of this year, and as we all look toward a more normalized future. From current legislative and funding considerations and the expansion and impact of digital health, to assessing a deal-making environment ripe with opportunity—but also wrought with challenges—there’s much for health care providers to address as 2021 churns on.
- Despite the broadening of the eligibility requirements, some health systems may still be unable to access PPP funds because they will be unable to demonstrate financial need.
- Even with positive operating margins, health systems experienced double-digit declines in patient volumes across the board.
- Congress will continue to evaluate surprise billing and health care mergers and acquisitions, specifically private equity’s involvement in such deal-making.
- The fragmented nature of the health care ecosystem, accommodative rate environment, investor demand for health care and digital disruption shaped by the response to the pandemic will continue to drive deal flow.
Legislative impact on the industry
From a legislative perspective the past 12 months have been quite a ride. The Coronavirus Aid, Relief, and Economic Security (CARES) Act has certainly provided significant funding and liquidity for many health care providers. The Consolidation Appropriation Act (CAA), 2021, which was passed late in 2020, provided for a few changes in the requirements related to some of the CARES Act funding received through the Provider Relief Funding; however, it also introduced the first of potentially many pieces of legislation regarding surprise billing.
In March 2021 we also saw the new administration’s efforts regarding stimulus pass in the form of the American Rescue Plan Act (ARP). ARP provided two areas of interest for the health care community. The first was $8.5 billion earmarked for rural health care, and the second was a change to the eligibility requirements for the Paycheck Protection Program. The change to the PPP loan eligibility was for certain non-profit organizations to allow for those organizations to evaluate their employee count on a “per physical location” perspective.
As a result of the changes in the PPP we do expect many larger health care organizations to evaluate this program. Many nonprofit health systems were not previously allowed to utilize this program because their employee head count was significantly higher than 500 employees, whereas now on a per-physical-location perspective many of those health systems could potentially apply for a specific hospital or specific physical location.
Despite the broadening of the eligibility requirements, some health systems may still be unable to access the PPP funds because they will be unable to demonstrate the financial need required to access the funds. However, as shown, we expect many health systems may be able to demonstrate need based on their financial results. According to data from over 900 hospitals accumulated by Kaufman Hall, most hospitals reflected declining operating margins early in 2021 despite provider relief funding and other CARES Act aid.
As Americans become vaccinated and society returns toward normalcy, we expect Congress to continue to evaluate surprise billing and health care mergers and acquisitions, specifically private equity’s involvement in such deal-making. This is an issue that garnered bipartisan support pre-pandemic. Part of the CAA addressed surprise billing for (generally) emergent services. Likely next steps include legislation or perhaps administrative actions taken to reduce the patient burden for ambulatory or other nonemergent services. How that burden will be distributed between payors and providers is the multibillion-dollar question.
The government’s focus on health care mergers and acquisitions and particularly private equity’s role in transactions is also returning to pre-pandemic levels.
The government’s focus on health care mergers and acquisitions and particularly private equity’s role in transactions is also returning to pre-pandemic levels. In March we saw the House Ways and Means Oversight Committee hold a hearing on private equity’s role in health care transactions. The dialogue of the hearing itself offers little insight into any future legislative or administrative action, but the fact that a health care committee of jurisdiction held such a hearing suggests we are moving toward a post-COVID-19 regulatory environment that will likely seek to address perceived issues in health care M&A.
Show me the money
As indicated in the previous section, relief funds have been partially distributed to health care organizations. However, with the pandemic still affecting hospital operations in a significant way, when will the remaining funds be distributed, and furthermore, why the delay?
Two Wall Street Journal reporters, Stephanie Armour and Melanie Evans, reported that the Biden administration is focused on ongoing distributions to cover the cost of treating uninsured patients and is reviewing the program to ensure guidelines for additional funding comply with laws and regulations. The reporters indicated that many hospitals say the relief allocated by Congress to date is not enough to cover the financial hit from COVID-19, with Moody’s Investors Service analysts projecting that the impact of the pandemic coupled with a challenged economy will continue to drive down hospital revenues. Hospital groups believe that the lack of a secretary in charge of the U.S. Department of Health and Human Services may have added delays in payment, according to Armour and Evans.
Our evaluation of the data related to how COVID-19 has affected hospital operations financially indicates that the results are mixed. There is one consistent theme, however, and that is that telemedicine or telehealth has had a profound impact on the delivery of care. Through December 2020, telehealth claims are up 2,817% over December 2019.
The following chart illustrates the top five telehealth diagnosis codes for 2020.
In an article published by Modern Healthcare on March 25, 2021, Alex Kacik and Tara Bannow reported that some of the largest health systems in the country experienced an increase in profits during 2020 despite the challenges brought on by the pandemic. Several factors contributed to this trend including: patients that did receive care tended to be higher acuity, which drew more revenue; hospitals tended to have a higher proportion of commercially insured patients, were better at cutting expenses, or both; hospitals received benefits from the government like the 20% Medicare add-on payment for COVID-19 patients; there was a moratorium on Medicare rate cuts related to sequestration; and the ability to defer taxes. The reporters acknowledged that while it appears that larger hospitals are doing well given their larger financial and competitive resources, smaller health systems may not have had the same experience.
Health systems experienced double-digit declines in patient volumes across the board. Kaufman Hall conducted a survey of 900 hospitals across the country and provided the following volume statistics in their March report.
February was another challenging month for hospitals that continue to deal with declining patient volumes following January’s record-high COVID-19 hospitalizations. February expenses rose while margins, volumes and total revenues all fell below levels seen in February 2020. The report highlights that the median operating EBITDA margin was 4.1% without CARES and 5.4% with CARES. Other key operating margin trends from the report include the following.
As if dealing with a global pandemic isn’t enough, “federal records released as part of the 9th annual Hospital Readmissions Reduction Program audit show that nearly half of all hospitals will be penalized because of their high patient readmission rates,” according to a report by Christian Worstell with Medicare Advantage.com. He reports that 2,545 hospitals will receive lower Medicare payments for one full year due to their poor performance.
And from a workforce perspective, according to the U.S. Bureau of Labor Statistics Data (bls.gov), unemployment in the health care and social assistance industry is at 3.6% for February 2021. The industry experienced flat unemployment trends going into 2020, and while the pandemic-related restrictions affected all industries, employment increased at a steady rate during 2021 for health care.
In analyzing the data, it is clear that health systems across the country have experienced some form of financial impact, some feeling it more than others. Data suggests that there is still a financial need—a “show me the money” moment—as health systems continue to fight COVID-19. The pandemic has forever changed the way health care systems do business and the delivery of care in the communities they serve. Leadership needs to continue to be agile, resilient and creative; additional funding can help support their efforts.
The pandemic has forever changed the way health care systems do business and the delivery of care in the communities they serve.
High transaction volume will continue through 2021
Q4 2020 and Q1 2021 were among the busiest periods in health care deal-making ever. We expect that the fragmented nature of the health care ecosystem, accommodative rate environment, investor demand for health care and digital disruption wrought by the response to the pandemic will continue to drive deal flow.
2020 saw 895 health care service deals, according to Pitchbook data, which made it the busiest year for health care services deals since at least 2002 (reliable data prior to 2002 is unavailable). 2019 and 2018, the previous high, saw 810 and 826 deals, respectively. That 2020 was a record year is remarkable given the dearth of deal flow experienced in Q2 as strategic players and financial investors focused on managing existing operations and we all adjusted to a virtual deal-making environment. Q4 2020 saw 334 deals, which represents an increase of 127 deals over Q4 of 2019 and underscores the demand for health care deal-making post-COVID-19.
The accommodative interest rate environment will persist for some time, further fueling health care deal fervor. Lower rates better enable investors and buyers, particularly financial buyers like private equity firms, to close deals. According to IBISWorld research, the health care sector remains highly fragmented across most subsectors; for example no one health system accounts for over 5% of that subsector’s revenue.
Investor interest in health care remains elevated. Bloomberg reports over $150 billion in dry powder committed to private equity funds focused on health care. Public markets are also active, particularly special purpose acquisition companies, or SPACs.
SPACs are not a new financing vehicle. They have, however, garnered favor in the past 18 months as ways for private companies to quickly go public and for a broader set of investors to participate in the traditional initial public offering upside that has usually been reserved for the largest institutional investors and investment banks. Few sectors have seen as much SPAC interest as health care.
More capital has been raised and deployed for health care SPACs in Q1 2021 than was raised and deployed in all of 2020. Significant health care deals include Clover Health, Multiplan and SOC Telemed. In total, health care SPACs have yet to deploy $14.6 billion. It is important to note that SPACs are not required to disclaim the industry in which they plan to purchase one or more private companies. However, many do list potential target industries, or their likely targets can be deduced based on the management team’s resume.
April has brought a slowdown in SPAC IPO activity and an SEC warning that some special purpose acquisition companies may have improperly accounted for warrants issued or sold to their investors.
We will continue to see robust activity in divestitures, mergers, acquisitions, joint ventures, capital raises and deals of all shapes and sizes through 2021.
It’s little wonder why so much capital is flowing into health care. The pandemic pulled forward digital disruption in health care by at least five to 10 years. Patients have long wanted the option of digital and virtual care.
The digital health and telemedicine genie is out of the bottle now. Leading legacy health care organizations are rapidly positioning themselves for a future we previously thought was years away. We will continue to see robust activity in divestitures, mergers, acquisitions, joint ventures, capital raises and deals of all shapes and sizes through 2021.