Understanding Hospital Consolidation Exposures:
The Risks of the Eater...the Risks of the Eaten
Speaking specifically about what happens to captive insurance companies in this age of hospital system consolidations, acquisitions, mergers, and fire sales...there are some rules of thumb to follow.
These are pretty simple rules, and generally need less lawyer supervision than one would think. (Not that any lawyer would agree with that conclusion.)
So if your system is being acquired, is merging with another system, or you’re the victim of that fire sale noted above...keep these rules in mind.
Rule #1...Understand How Tail Works
With few exceptions in all claims-made environments, captives neither accrue for nor fund tail exposure. It resides on the parent hospital’s/system’s books. Remember, nobody expects a hospital to go out of business, so the idea of actually cashing in a hospital’s tail accrual used to fall within the realm of fantasy. Alas, no more. The accounting rules are clear relative to how tail may be accrued...but make no mistake, your view of what your tail is worth (what’s been accrued on your books) may differ from what the acquiring organization thinks it’s worth. Identify the issue early and deal with it. Your tail accrual is your true IBNR and is significantly different than what shows up as “IBNR” on your captive’s unaudited financials, which may simply be a misnomer for case reserve development.
Rule #2...Understand What Tail Covers
Again, remember that nobody starts a health care system with the idea that it’s going to be sold. We have clients with tail accruals that go back more than 35 years, and where the ebb and flow of that accrual doesn’t vary by more than 3% or 4% per year. Hospital system executives spend time every few years adding or deleting boxes to the corporate organizational chart. Your tail accrual is designed to cover the medical professional and many times general liability true IBNR exposure in claims-made environments for your organizational chart in its entirety. Unless your actuary has specifically excluded entities on your organizational chart as part of the IBNR calculation...then all of your org chart entities are covered, when tail is invoked, regardless of the degree of PL or GL risk. But, even more important than that, auditors are particular about verifying tail accrual on a global basis, and unless you have an auditor's opinion that the tail accrual excludes certain parts of your org chart, and therefore you have an unfunded exposure, then you have reasonable proof that your tail accrual applies to all of the entities described in your organizational chart and in your audited financials.
Rule #3...Understand How the Reinsurance Rules of the Game May Change
Most facultative and treaty reinsurance programs are specific about a change in ownership causing immediate termination of the reinsurance agreement. This issue is all that it implies...which is to say a major issue. This is more than observing the rules of the game relative to pulling claim triggers under the so-called “seven deadly sins”...this is making sure that you use best efforts to avoid legacy liability attaching post-acquisition because of a failure to exercise due diligence in the claims reporting process.
Rule #4...Understand How the Definitions May Change
I’ve never seen two captive-issued insurance policies look exactly alike. One of the reasons our firm has formed captives for almost 25 years is to enable insureds, primarily health care providers, to tailor the insuring agreements and conditions in their policies to their own specific needs. When two captives merge or a captive is acquired, you’re more than apt to have not only differing policy language with respect to conditions and insuring agreements, but also vastly different exclusion language. Stuff covered under one policy may not be covered under another. It is important to negotiate these differences in advance, so that no legacy liability remains for either organization.
Rule #5...Understand That No Two Case Reserves Are Alike
As I write this, fortunes are being made by service providers creating and, in fact, inciting disagreements between buyers and sellers over the issue of the ultimate value of individual case reserves. What would be, under normal circumstances, a professional “agreement to disagree” among what are otherwise two reasonable, intelligent, and fair-minded risk managers...become a bloodletting at case reserve valuation time. No amount of historical evidence or precedent with regard to how a risk manager has handled claims in the past will amount to a hill of beans if someone thinks that that shoulder dystocia is only worth $750,000 and the acquiring system’s risk manager has been advised that it’s really worth $1.4 million, and where that advice has been rendered by someone with little experience in that jurisdiction with that type of claim. Because so much of the disagreement between actuaries in the merger/acquisition arena is caused by serious disagreements among risk managers in the value of large case reserves, this becomes important if we’re trying to figure out how much claims-made case development reserve can or cannot be used. Assume the worst. If you’re the one being eaten, your reserves will always be woefully inadequate, so be prepared for no amount of historical claims settlement evidence to make any difference. Plan accordingly.
Rule #6...Understand What Happens to Directors and Officers Liability
While this is a more global issue in the case of the Eater and the Eaten...it has particular relevance with captive insurance companies. Most single-parent and many industrial insured captives do not purchase insurance company Errors and Omissions insurance. Of course, Directors and Officers liability insurance extended by the major D&O insurers to the system as a whole, inclusive of the subsidiary captive operation, excludes claims from insurance company operations. When you are a going concern, just as in the tail issue, you can sail along blithely without thinking too much about this. But when you get into the realm of who’s having who for dinner, the actions of the officers and directors of the captive insurer become important relative to such issues as the early termination of service providers, the handling of reinsurance termination, decisions made relative to the investment portfolio, and, in general, the amount of diligence exercised by the board over policy language and captive governance. This is a mine field.
Rule #7...Understand When an Employee Thinks He or She Is Not
With the intense physician acquisition efforts underway everywhere by hospital systems, we haven’t had enough time go by for physicians to change their “mindset” about the fact that they are no longer in private practice and are employees of a hospital. The good news for them is that they don’t pay for their professional liability insurance anymore. The bad news for risk managers is that these physicians still think they are in private practice and can ask many questions about how their coverage pertains and does not, about prior acts issues related to private practice exposures, about what they can and can’t do outside of their employment contract...well, you know the drill. The problem lies in acquisition/merger. Risk managers need to understand that Murphy’s Law will reign. A couple of days after the acquisition, a prior acts claim involving an employed physician who was in private practice, and where the captive granted prior acts coverage upon employment, will suddenly emerge and create legacy liability. We all know that nobody thinks about this stuff, except when it happens...and as we go through a process now where in some cases our client is the Eater...and some cases the Eaten...it is important to pay attention to the prior acts commitments made upon physician acquisition for the years immediately preceding the acquisition of the whole system.
These are just seven of the simple rules...there are three times that number that are perhaps more complicated and deserve your equal attention. Contact us if you’d like to learn more.
The Risks of the Eaten
The Risks of the Eater
...really means "System du Jour"