Health Care Rep and Warranty Insurance: New Solutions for Private Equity Buyers and Sellers

Foley & Lardner LLP

Whether in an auction or proprietary transaction, risk allocation has typically been a function of indemnities tied to reps and warranties and the type of supporting credit. Holdbacks, earnouts, escrows, baskets and caps and their varied combinations are part of deal making “market” studies and the inevitable negotiation of who bears what risk and how. Health care deals have unique difficulties given that in transactions where Medicare or Medicaid reimbursement is at stake, laws of typical successor liability are not in play. For example, many times buyers assume existing provider agreements even in asset deals to assure payment continuity and shore up working capital; in turn they seek indemnification from sellers for post-close recoupment risk.

Historically, rep and warranty insurance to cover regulatory risk has been expensive (read high deductible, premium), time consuming and riddled with coverage exceptions. However underwriters are beginning to fill this void at lower limits and/or where billing is based on simpler models (e.g. capitation) or single provider line of businesses (e.g. compare academic medical centers). Typically either sellers obtain such insurance to benefit buyers (or cover their own indemnity to allow distribution of proceeds) or buyers obtain coverage to obtain an advantage in auctions (to void an escrow request for example).

New underwriting is beginning to appear in the market which provides for coverages for defense costs, overbilling, penalties, Stark and AKS violations, albeit at lower overall coverage levels (e.g. below 15M) with due diligence costs that can range from 50k to 100k and premiums in the 2% range for a 10M policy. Ideally, a well-established business that produces external audits, a history of low claim denial/recoupment and a capitated, bundled or other risk based payment methodology can successfully place such a policy. Conversely, given the fact that buyers in auctions will not be familiar with the target initially, will be disinclined to spend resources until it is given exclusivity, a problem for buyers will be how to coordinate its own due diligence with the need of an underwriter for its own independent research, which may include independent billing audits.

More likely may be sellers who seek to backstop their own indemnity (or tender the policy to buyers) when an auction is initially announced which will allow PE firms to distribute more total proceeds notwithstanding indemnity exposure.

For sure some technical issues will remain in any case including:

  1. assessing if any conditions of the policy will deny payment based on lack of or improper disclosure;
  2. coordinating the policy terms with the definitive document (e.g deductibles/baskets; carve-outs; non-coverage for criminal acts, punitives, consequentials etc..);
  3. and timing issues needed to get underwriters comfortable with the risk (i.e. only after considerable effort may a party know if insurance on reasonable term is available).

In the end, rep and warranty insurance for health care deals will not replace corporate guaranties, escrows and holdbacks but will be part of the risk management toolkit and work in tandem with some of these traditional features to allocate risk. What is promising is that the insurance industry is now more focused on providing solutions in this area that will be better in some cases than others but should in any case be considered by sellers and buyers in their strategic exit and purchase planning.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Foley & Lardner LLP

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