Healthcare Vertical Integration
and Internal Audit’s Role in
Strategic Transactions
September 2014
Agenda
I.
Healthcare vertical integration
II.
Internal Audit’s role in strategic transactions
Page 2
Health industry integration is not black or white
Shades of collaboration exist, although the trend is strongly to the right
Less integrated or organized systems
More integrated or organized systems
Vertical
Horizontal
Single MDs;
small groups;
single
hospitals
Independent
physician
associations,
single specialty
groups,
hospital chains
Hospital staffs
(primary care
physicians
employed by
hospitals), some
university/faculty
practices
Multispecialty
group practices
(primary carebased practices
with full
complement of
specialty
services)
Clinically
integrated
delivery systems
(multispecialty
groups with
hospitals)
Most ACOs are formed in this space
Source: www.accountablecarefacts.org
Page 3
Clinically and
financially
integrated
systems
(multispecialty
medical groups
integrated with
hospitals and
health plans)
Vertical integration has three primary objectives
Payers and health systems are increasingly willing to accept non-traditional
risks to preserve their positions in the healthcare supply chain
Objective
1. Strengthen
revenue streams
Acquirer
Target
Benefit
Risk
Health
System
Physicians
Increase referrals and
admissions
Provider productivity decline post
acquisition, inability to influence
physician decisions
Health
System
Payer
Increase patient volume and
reimbursement rates through
a restricted network and
reduction in payer margin
Financial losses due to underestimation of member utilization and
unit cost
Payer
Health System
Capture enrollment through
health system regional
presence and brand
Acquire disproportionately high-cost
members due to health system
loyalty
2. Improve control
of supply costs
Payer
Health
System,
Physicians
Improve ability to manage
population health and control
medical expense
Capital-intensive investment erodes
financial viability and flexibility
without improving health cost
management
3. Defend against
disintermediation
or exclusion
Payer
Health System
Guard against integrated
delivery systems contracting
directly with employers or
government payers as ACOs
Lose network breadth due to
reluctance of providers to participate
in network of a direct competitor
Health
System
Payer
Offset potential exclusion
from narrow networks
Lose overall managed care volume
due to commercial payers unwilling
to contract with a direct competitor
Health
System
Physicians
Avoid disproportionate
admissions to competing
health systems
Physician unwillingness to modify
referral or admission practices
Page 4
Integration activity has come in waves
Beginning in the 1980s, a surge in managed care growth fueled health
industry integration, both horizontal and vertical
Trends
1980 – 2000s
Element
-
Payers
-
-
Health Systems
-
-
Physicians
-
-
Reform
-
Reimbursement
Page 5
-
Managed care organizations grew membership and
implemented cost control techniques
Payers consolidated
Hospital networks, such as HCA, began to expand by
acquiring other hospitals
Hospitals began to form managed care networks
Health systems formed health plans
Physicians tended to operate independently from
each other
Hospitals experimented with employing physicians
Physician groups experimented with starting health
plans
No economic or political forces driving for lowering
the cost of care
Expected Clinton-era reforms failed to become a reality
Fee for service (FFS) reimbursement was the industry
standard
Observations
-
Large managed care organizations used their
leverage to negotiate lower cost provider
contracts
-
Larger health systems struggled to create
economies of scale or reduce cost
Provider-sponsored health plans initially
generated large cash flow; however,
months/years later struggled with growth and
survival
-
-
Care coordination hampered by a lack of
communication channels and incentives
Hospital-physician organizations and physician
group-owned HMOs disintegrated over time
due to poor management and diverging
interests
-
Providers were not externally incentivized to
coordinate care. Revenue could still be driven
through volume.
-
FFS created an environment where providers
and payers existed with inherent, opposing
interests
Providers were not incentivized to reduce
the cost of care
-
Vertical integration failure is common
While the benefits of integration are appealing, realization has been a
challenge for most organizations
1945: Permanente Health
Plan (later named Kaiser)
opens to the public,
providing both health
coverage and access to
hospitals
1972: Humana shifts
focus from nursing
homes to hospitals,
eventually acquiring
77 facilities
1965
1971: Rush Univ.
Medical Center opens
Anchor HMO
2011: Highmark
acquires West Penn
Allegheny Health
System
1990: Cigna acquires majority ownership of
Lovelace Health Systems
1992: Humana spins off 77
hospitals as Galen Health
Care to focus exclusively on
insurance
1969: Harvard Community Health
Plan opens as a PSHP
1986: HealthWest
(later UniHealth)
launches
CareAmerica
1980: Geisenger
Medical Center starts
the Geisenger Health
System (a PSHP)
2011: UnitedHealth
Group acquires 2,300
physician Monarch
Healthcare
1998: UPMC launches
UPMC Health Plan
1986: Allegheny Health,
Education, and
Research Foundation
(AHERF) begins
integration efforts,
purchasing physician
organizations and
hospitals
1998:
AHERF files
for
bankruptcy
1994: Promina Health
founded by Piedmont
Healthcare
2013: Kaiser sells
Ohio health plan
to Catholic Health
Partners (Health
Innovations Ohio)
2010
2001:
UniHealth
divests its
medical and
insurance
practices
1993: Sutter
Health opens
Omni Healthcare
Plan
1984: Sentara opens
Optima HMO Health
Plan
Traditional fee for service dominated the market
2000: Rush University
Medical Center sells
Anchor HMO to
WellPoint
1995
1980
1947: Group Health Cooperative opens
in Seattle Washington as a PSHP
Page 6
2002: Piedmont separates from Promina Health,
exiting the health plan market
1983: Intermountain Healthcare creates
SelectHealth, a non-profit health plan
2012: Sutter
Health
launches Sutter
Health Plus
2011: Humana acquires
300 clinic Concentra
Health
2014: North Shore LIJ
opens CareConnect
2002: Cigna sells Lovelace to
Ardent Health Services
1999: Sutter Health
sells Omni Healthcare
to BCBSCA
Rise of managed care organizations and new reimbursement
methodologies (e.g., DRGs, per diems, case rates, carve outs)
2014: Piedmont
Healthcare and Wellstar
Health System start
Piedmont Wellstar Plan
Passage of the
Affordable Care Act
Vertical integration is fraught with risk
Endeavors have failed for myriad reasons, but at the core is typically an
under-estimation of the risks to be managed
Developing
organizational
capabilities too far
in advance of
market demand
Optimistic
assumptions
regarding
willingness of
business partners
to make
concessions
Insufficient
capability to
execute core new
functions (e.g., pricing,
reserving, practice
management)
Inability to
effectively
coordinate care
across the
integrated delivery
system
Page 7
Strategic,
Financial
and
Operational
Risk
Inadequate
physician
alignment,
particularly within
primary care
Not clearly
defining each
entity’s role
within the system
Limiting financial
wherewithal by
taking on too
much at once
Paying for
productivity gains
that do not align with
the acquired entity’s
new incentives
The next wave is upon us
Regulatory and market changes are prompting both defensive and
opportunistic integration moves
Trends
2010-2014
Element
-
Payers
-
Health Systems
-
Physicians
Renewed focused on acquisition/merger activity to
increase scale
Rapid EHR adoption driven by financial and care
coordination incentives
Payments increasingly tied to quality metrics
Increasing acceptance of risk through ACOs
-
Rapid movement towards health system employment
Physician group consolidation
Primary care shortage
Broader acceptance of evidence-based medicine,
standards of practice and clinical pathways
-
ACO and patient centered medical home development
Health Insurance Exchanges provide new forum for
individual and small group market competition
Increasing public acceptance of cost control techniques
(e.g., narrow networks, Medicare Shared Savings
Services Program)
Reform
-
Reimbursement
-
Page 8
Slower membership growth due to escalating premiums
Reduced ability to limit risk through underwriting; forced
to manage risk once “in house”
New regulations and taxes negatively impact profitability
Selective vertical integration through medical group or
facility acquisition, or partnerships with health systems
Value-based reimbursement models
Shared reward systems (e.g., MSSP)
Compliance contingent reimbursement (Meaningful Use,
Medicare STARS Program)
Observations
-
-
-
-
-
Pressured to effectively manage medical expense
Working towards ACO-like payment methodologies
(rewarding quality and care coordination)
Increasing member engagement
Positioning for inclusion in narrow payer networks
and alternative contract arrangements
Focused on clinical/operational excellence
Patient demand for price transparency
Technological advancement opening new
communication channels for providers and patients
Improved ability to coordinate care and control
costs
Gradual movement towards transparency of
outcomes
Health Insurance Exchanges increasing patient
volume will likely challenge primary care capacity
Quality programs are necessary core capabilities
Transparency in quality measurements is increasing
consumer driven health care
Increased provider risk acceptance
Payer and provider incentive alignment
Risk-based payer revenue
Integration is being initiated from all directions
Health systems and payers are both testing new positions along the supply
chain
►
Provider sponsored health plans
–
–
–
►
Health plan hospital/provider acquisitions
–
–
–
►
Sutter Health Plus (Sutter Health)
CareConnect (North Shore Long Island Jewish)
Piedmont Wellstar Health Plans (Piedmont and Wellstar Health Systems)
West Penn Allegheny (Highmark)
Concentra clinics (Humana)
Diagnostic Clinic Medical Group (Florida Blue)
Accountable Care Organizations (ACOs)
–
–
–
–
Page 9
More than 500 Medicare and Commercial ACOs have formed since 2010
Most are hospital or health system led
More than 10 million members are enrolled in commercial ACOs
Major, national health insurers have announced intentions to significantly
increase their volume of ACO contracts
Where to begin?
Avoiding the mistakes of the past begins with an assessment of the factors
that drive success and failure
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Gate 1
Gate 2
Gate 3
Gate 4
Objectives and risk
identification
Capability assessment
Build versus buy
analysis
Business case
development
Clarify strategic intent
and desired
competitive position
within market context
Identify licensure
requirements
Perform high-level
capability analysis
–
Patient services
and network
coverage
–
Financial risk
management
–
Payer or provider
operations
Identify risks and
potential mitigation
actions
Page 10
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Identify the core
capabilities required to
effectively manage
population health to
create a positive return
on investment
Determine the level of
capability maturity
needed to successfully
compete in the targeted
market
Identify the capability
gaps to be addressed
before launching new
product or services
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Evaluate the feasibility
and level of effort
required to develop
required capabilities in
house
Assess the opportunity
and associated risks of
partnership
arrangements
Determine the costs and
advantages of acquiring
existing capability
providers
Conduct initial due
diligence on acquisition
targets
Develop a
recommended approach
to obtaining each
capability
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Determine availability
and cost of capital
Determine start up
costs, to include
capability investments,
capital requirements,
talent acquisition and
marketing
Forecast cash inflows
driven by patient and
premium revenue and
investment income
Estimate cash outflows
based on the timing and
magnitude of claims
payments, operating
expenses, interest
payments and taxes
Determine NPV and/or
ROI of the health plan
investment
Agenda
I.
Healthcare vertical integration
II.
Internal Audit’s role in strategic transactions
Page 11
Background
Strategic transactions like mergers and acquisitions (M&A) and
divestitures remain some of the most risk-heavy initiatives that any
organization can undertake.
The proactive involvement of Internal Audit (IA) before, during and
after the merger, acquisition or divestiture can help management
identify issues and opportunities related to the transaction that might
not otherwise be addressed.
Acting as an advisor to the program management team, IA is ideally
positioned to assess and monitor program management activities,
review controls and provide key insights while maintaining
independence and objectivity.
Page 12
How IA can help during strategic transactions
►
Provide increased visibility into key risks related to strategic transaction
changes (e.g., Finance, IT, HR, Operational risks)
►
Reinforce that risks and controls are the responsibility of management
►
Identify gaps in the integration or separation project management plan
►
Suggest opportunities for synergies that would boost the acquisition’s return
on investment (ROI) or actions to increase separation-related cost savings
►
Highlight the impact that the acquisition and its integration, or the divestiture,
may have on other parts of the business
►
Identify potential gaps in the internal control structure
►
Support management’s prioritization of transition and organizational readiness
risks
Page 13
Role of IA during M&A
►
There are four key areas where IA can play a crucial role in an organization’s
M&A lifecycle:
Throughout the M&A process, IA should form a part of the program
management team so that it can assess and monitor activities and
provide key insights. IA can also audit program management activities
to highlight process gaps and areas of future improvements.
Page 14
Role of IA during M&A: Strategy
Page 15
Role of IA during M&A: Due diligence
Page 16
Role of IA during M&A: Deal approval and close
Page 17
Role of IA during M&A: Integration
Page 18
The role of IA during divestitures
►
There are four key areas where IA can play a role in the divestiture lifecycle:
Leading practice calls for IA to be embedded as part of the program
management team and be involved throughout the divestiture life
cycle.
Page 19
The role of IA during divestitures: Strategy
Page 20
The role of IA during divestitures: Due diligence
Page 21
The role of IA during divestitures: Deal approval and close
Page 22
The role of IA during divestitures: Separation
Page 23
Key benefits
IA provides a critical perspective to strategic transaction deals that many
executives may not consider. Without that perspective — right from the start
— the organization could find out far too late that the price was not right, or
that it has to spend a significant amount of money to fix issues that IA could
have identified and helped the organization avoid
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Strategically, IA can determine an organization’s readiness for the
transaction
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During due diligence, IA can alert the organization to potential risk,
control or regulatory issues that would cause the organization to overpay
or undervalue
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Prior to deal close, IA can help prevent deal value leakage
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Post-transaction, IA’s involvement can lead to organizational efficiencies
and strengthened control monitoring
Page 24
For further information
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See the full “Internal Audit’s role during the strategic
transactions life cycle” report
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For further GRC thought leadership, please refer to
our Insights on governance, risk and compliance
series on:
www.ey.com/GRCinsights
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Please contact:
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Page 25
Sean Lueck, EY Healthcare Advisory (904-505-6572)
Wally Ward, EY Healthcare Advisory (704-331-1907)