Not to be lost in the maelstrom of debate over the Affordable Care Act (ACA; commonly known as Obamacare), is the reality that the law took effect October 1. Various provisions and penalties come into effect through the next few years, but private equity firms stand to benefit from the new law from the outset.
Nancy-Ann DeParle has a uniquely comprehensive perspective on the ACA and its implications for private equity. She left the industry in 2009 to become director of White Office of Healthcare Reform, then deputy chief of staff for policy. Having had a role in the creation of ACA, she has returned to the corporate world as partner with Consonance Capital Partners, a private-equity firm focused exclusively on investing in the US healthcare industry.
DeParle observes two facets of ACA on the private equity segment, one for the management firms themselves, and second for their portfolio companies. DeParle is excited that for all the change ACA actually plays to the strengths of private equity managers. “They are the perfect people to take advantage of this initiative because they are so analytical. The transparency on costs and the new ability to understand cost differentials is exactly the type of thing private equity managers thrive on.”
She notes that one provision of the new law requires employers to state on each worker’s W-2 form exactly how much is being paid for coverage. “I have had friends and colleagues across the private equity industry tell me that they are now paying much closer attention to their healthcare costs than they used to. This industry is very savvy about information like that.”
Broadly speaking, DeParle says large firms that are already providing healthcare coverage should pay less over time. That goes for private equity shops themselves as well as most of their larger portfolio companies. “Big firms have been paying a hidden tax to cover uninsured Americans, and that burden should be reduced as those people are covered.” She notes, however, that some large firms, particularly in retail and restaurants, have not tended to provide coverage. “Those firms will have some new obligations,” DeParle adds.
Taking a second look at portfolio companies, DeParle says that private fund managers will have new metrics for judging profitability. “Those with demonstrable value to their programs, and with a strong business model will have an advantage.” She adds that the new emphasis on consumers will bring healthcare into line with the rest of the US economy. “Also less spending on healthcare by private equity firms means more money to invest in portfolio companies. Less spending on healthcare by portfolio companies means more money to invest in the business or to return to ownership.”
THE YOUNG AND THE RESTLESS
Any discussion of the ACA needs to start with the original goals of the legislation, says Pam Hendrickson, chief operating officer of The Riverside Company. “Broadly speaking the goals were universal coverage and bending the cost curve, which most people would agree are good goals. But there is a math problem. The program as a whole needs healthy people to participate.”
That is a math problem, Hendrickson explains because a healthy 27-year-old male would pay about $320 a month for basic coverage under one of the state insurance exchanges. “But how many young healthy men are going to spend even that on health insurance that they may not think they need? Especially if the fine for not having coverage is only $95 a year. That penalty ratchets up over time, and by 2016 will be $165 or 2.5 percent of income, whichever is greater.”
If large numbers of healthy people do not participate, “that becomes a humongous problem,” says Hendrickson. “If the risk pool is out of whack, the costs get wildly expensive.” Riverside is a global private-equity firm focused on investing in growing enterprises valued at up to $250 million. The firm’s global portfolio includes more than 75 companies.
On a more hopeful note, Hendrickson observes that the other goal of ACA, to bend the cost curve, is already happening. “In many states we are seeing health-care cost increases of about 4-5 percent a year, which seems like a lot, compared to base inflation or interest rates, but is significantly below the 11-12 percent increases that we saw in recent years.”
Hendrickson stresses that the current slowing of the rate of increase cannot be directly credited to ACA, which only took effect October 1. But it can be attributed in part to some adumbration from ACA, as well as market responses to the soaring costs of coverage. “Here at our own company we created a pooled program that reined in some of the rate of increase through simple economies of scale, but also through teaching people how to use the system more effectively and efficiently.”
DUE DILIGENCE REFORM
Specific to private equity, Hendrickson’s judgment is that at least for this year and next, ACA will not affect many firms directly. She says most GPs, even small ones, tend to offer fairly good benefit packages, including health insurance. “Over time, if there were a shop that did not offer coverage, the fees and penalties could start to add up, but I don’t think that is going to be a major concern for a lot of private equity firms.”
The big catch, Hendrickson reckons, is going to be among a firm’s portfolio companies. “By 2015 as mandates and penalties become stiffer, there is going to be a serious due-diligence challenge to all private equity firms as they buy and sell companies. Those firms will also be subject to the ACA mandates and penalties, and as owners private equity firms will have to figure the cost of coverage, and compliance, or not, into their calculations.”
Hendrickson is confident that over a few years, GPs’ due diligence will get sorted on the important calculations and numbers to watch, and those will join standard metrics like EBITDA in the summary sheet of any potential transaction. “At this point none of this is well thought out, but it may be over time.”
If ACA is broadly successful, health-care costs and insurance rates will decline over time, benefiting employers and employees, Hendrickson says. “If it is not successful, prices will rise for everyone, even private equity firms and other employers offering private coverage. That is because if ACA cannot support itself, then surcharges could be placed on private coverage. The funding for ACA has to come from somewhere.”
Either scenario is years over the horizon, however, and in the near-term Hendrickson urges GPs to double down on their due diligence for every transaction. Some of that burden can be borne by the portfolio company itself, as well as the counterparty. But it behooves private equity shops to double check, if only for their own protection.
From that point it should be easier for GPs to negotiate a master benefit policy, says Richard Wald, director and national practice leader in the employer healthcare consulting group at Deloitte. “Private equity firms know their tax status, and their healthcare status will be very similar. In relation to portfolio companies and extending benefits, it all comes down to the master control group.”
Taking another perspective, healthcare coverage may offer a reason for a private equity firm to revisit its status as implementation of Obamacare takes place over the coming years. “There are many different reasons that a private equity shop may want to structure itself in one way or another,” Wald explains. “To this point that has primarily been a tax-driven decision. But that status can be changed if there is a significant cost benefit to be gained.”
He suggests that just as small groups are assigned to review investment opportunities and also for tax implications of every transaction, now fund managers have a similar incentive for reviewing the status of their firm as well as portfolio companies. After all, unlocking hidden value is a hallmark of buyout artists.
Underscoring the theme of cost transparency and control, Wald says surveys by his firm indicate as many as half the business executives in the country admit their firms do not have a holistic healthcare coverage strategy. He suggests that affects every aspect of operations, from continuing employee costs to future liabilities that have to be figured into mergers and acquisitions.
“As an investment opportunity for private equity firms, ACA is a great deal,” says David Bowen, global director of health care practice at advisory firm Hill & Knowlton. “Any thing that has a meaningful effect on a large segment of the economy is always an investment opportunity. But the effects on management of private equity firms is much more subtle.”
Looking broadly at private equity firms without regard to size or how they are constituted, Bowen expects that the initial effects of the October 1 opening of state exchanges, and the January 1, 2014 mandates, “are likely to only have a minimal immediate impact. Some companies may have to make some changes, but until we see how efficient and effective the many provisions of the new law are, it will be at least a little while until the changes are felt through the PE sector.”
Bowen suggests that unless there is some obvious and immediate benefit to a firm to make some significant change in the near term, GPs should probably just keep steady on with whatever health coverage they have in place. “Even for private equity firms with fewer than 50 employees, most of those are already offering some type of plan or program,” he says. “There should not be an additional burden, at least not yet.”
Bowen is most excited that if ACA fulfills its promise, and the state insurance exchanges do work, they will liberate many entrepreneurs to step out on their own. “Don’t forget the original reason for employers to offer health care was during World War II there were wage and price freezes,” Bowden relates. “Employers could not give raises, but they sought and received a ruling that ‘fringe benefits’ as they were called at the time, were not wages and could be offered and enhanced.”
Under the law of unintended consequences, health coverage has become as much of a tether as a benefit. “Everyone knows people who are staying in a job only for the coverage,” says Bowen.
“That inhibits entrepreneurship and growth. If exchanges do indeed prove manageable, maybe that will free people to move to smaller firms or even out on their own.” Given the strong independent and entrepreneurial spirit in private equity, that sector could see a blossoming of new shops and specialized shops once partners and managers at all levels are not tied by their benefits to a given firm.