Highly regulated and prone to litigation, health care companies are considered risky purchases. So much so that, for a long time, the insurance market refused to provide coverage for deals in the industry.

But health care is also one of the most active parts of the economy for mergers and acquisitions. The frenzy of activity since the end of the Great Recession has been such that underwriters are now offering representations and warranties insurance for most M&A deals in the sector.

R&W protects buyers from future liabilities that can emerge from a company they have purchased. With the overall M&A market on a roll, players such as private equity companies and others have increasingly opted to use the coverage to facilitate deals. The health care industry, where transactions have ballooned in recent years, has lately caught up with the trend.

Consultancy Kaufman Hall estimated that there were 115 health care M&A deals in 2017, amounting to $63.2 billion in transacted revenues. In 2016, the numbers were 102 and $31.3 billion, respectively, and the party continues to go on.

Aaron Zeid, vice president, Gallagher — Chicago

Preliminary reports compiled by The New York Times and Thompson Reuters indicate that health care M&A transactions amounted to $315.7 billion in the first half of 2018, compared to $154.9 billion in the same period of 2017.

The number of deals where participants employ R&W insurance as a tool to facilitate an agreement is on the rise as well, according to insurers and brokers.

“Every week we see an increase in the number of health care deals that come across our desk,” said Joseph Laws, the head of M&A Insurance at XL Catlin.

With good reason. The purchase of a hospital, specialized clinic or pharmaceutical company entails a degree of risk that has derailed many a deal in the past. Acquired companies may face litigation due to past malpractices by its medical staff. Anti-kickback regulation that forbids employees to make referrals to services or products, a common practice, has been severely enforced by the authorities. Payments from government programs such as Medicare and Medicaid are often the targets of overbilling or even fraud that can result in expensive future charges on buyers.

“Health care exposures are a combination of statutory penalties and prosecutorial discretion,” explained Kris Kemp, an M&A expert at the Bass, Berry & Sims law office in Nashville.

The Department of Justice reported that, in the fiscal year to September 2017, it recovered $2.4 billion in settlements and judgments related to fraud in the health care sector. The list of potential liabilities that can generate enforcement actions is a long one, and sometimes due diligence teams are not able to spot them among the avalanche of regulatory, financial and compliance documentation involved in a deal.

“The health care sector encompasses a broad range of risks but generally the internal and external risk factors it faces mean that the likeliness of the claims is much higher in health care services than in other businesses.” — James Swan, head of Americas, Liberty Mutual Global Transaction Solutions

It is not surprising then that insurers and brokers have reported a significant spike of interest for R&W policies. And finally, availability is catching up with demand.

“Demand has always been there, but heavily regulated industries, such as health care and financial institutions, have been more challenging for R&W underwriters due to the severe fines and penalties that can quickly add up for a target’s non-compliance with rules and regulations,” said Aaron Zeid, a vice president at Gallagher in Chicago.

“More recently, some markets have brought in health care specialists to help underwrite these deals, and at least six are aggressively seeking new business in the space.”

But health care companies should be ready to pay more dearly for their coverages than M&A participants in other sectors of the economy. Navine Aggarwal, the head of M&A Insurance at Ethos, estimated that, while R&W insurance rates amount to between 2.5 percent and 3 percent of the limit purchased for deals in manufacturing, they will be usually 0.5 percent higher for health care companies.

It also varies by health care subsector. Laser eye clinics do not involve government payments and tend to pay lower premiums. At highly regulated hospitals, however, premiums can get as high as 4 percent of the limits acquired.

James Swan, head of Americas, Liberty Mutual Global Transaction Solutions

“The health care sector encompasses a broad range of risks but generally the internal and external risk factors it faces mean that the likeliness of the claims is much higher in health care services than in other businesses,” said James Swan, head of Americas, Liberty Mutual Global Transaction Solutions. “So R&W rates can be variable based on risk factors, although rates have fallen significantly in recent years.”

Carriers remain reluctant to venture into some high-risk subsectors, such as pain management clinics, which have come under government scrutiny due to the current opioid crisis. Pharmaceutical manufacturing can also meet resistance from underwriters, as companies are exposed to too many compliance and filing risks as well as class-action suits and latent litigation that is hard to spot with due diligence. Durable medical equipment, outpatient clinics and assisted living facilities are other examples of sectors that insurers still find hard to swallow.

Concerns With R&W Coverage for Health Care

In most other parts of the health care industry, however, a widening range of potential liabilities are being taken on by R&W insurers, although some exclusions remain. Some may balk, for instance, at the idea of taking Medicare and Medicaid billing risks, which are linked to the possibility that the targeted companies have overcharged the government for treatments provided under those programs.

“Some health care providers have been known to overbill insurance,” Aggarwal said. “It can result in claims on their insurance policies for overbilling, and there has been much enforcement action from the government within certain areas of the health care sector.”

Underwriters are also paying attention to patient data privacy. They will want to see the underlying cyber coverages and data protection policies in place at the targeted company before they agree to underwrite a deal.

“Depending on the nature of the risk, it can be possible to provide the buyer with coverage for breaches of warranties given by the seller caused by prior violations such as HIPAA, subject to receipt of a recent IT security assessment and appropriate underlining cyber security coverage,” Swan said. “We also expect clean due diligence from the buyers’ lawyers on the target’s data privacy policies, notification procedures and audit practices.”

Medicare and Medicaid billing and HIPAA violations are risks that give carriers the most pause, said Kemp. “And those risks represent a large portion of the issues a buyer will be concerned about.”

Therefore risk managers and compliance professionals from both buyers and sellers have their hands full helping transactions succeed.

“R&W insurance isn’t designed to be a substitute for appropriate due diligence,” Swan said. “As underwriters, we look to see that the buyer has conducted reasonable diligence of the deal.”

He noted that the list of documents that insurers will be particularly keen to check include contracts signed with providers and partners, which can reveal the risk of infringements of anti-kickback rules. &