Source: RSM US LLP. PBMares is a member of RSM US Alliance.
INSIGHT ARTICLE |
Key takeaways from the summer 2020 health care industry outlook
- The health care labor market has contracted during the current recession due to a number of factors.
- COVID-19 and the demand destruction related to social distancing and deferral of nonurgent procedures are affecting health care organizations and their workforce in ways few predicted.
- Many private equity firms have significantly reduced or put on hold new deal sourcing in order to better focus on managing their current portfolios of companies through the pandemic.
- As deals do return, more transactions of distressed assets and organizations could occur along with a more complicated deal environment and lower transaction multiples.
- Telehealth continues to gain momentum as patients delay face-to-face visits due to COVID-19 concerns
Health care systems and providers have been tested in ways that just months ago may not have ever been imagined: meeting patient care needs during the COVID-19 global health crisis, managing a newly formed remote workforce, addressing a significantly affected bottom line. Health care organizations have faced these difficult times and are braced for more, hopefully better prepared during the second virus wave. Still, from challenges often come innovation and hope, and many health care systems are finding new ways to structure their organizations and care for their communities, often using digital strategies to help bridge the gaps.
The health care labor market has been tested
The health care labor market has contracted during a recession. The April report showed a loss of more than 22 million total jobs, including 1.4 million health care jobs. Most of these were ambulatory and outpatient providers (primarily dental), but 134,000 of the job losses were from acute care providers.
The May nonfarm payrolls report surprised markets with a gain of 2.5 million jobs, after the disastrous reports in March and April. Health care rebounded. Of the 1.2 million ambulatory jobs lost in April, nearly 380,000 came back in May as prohibitions on elective surgeries began lifting. However, hospitals lost an additional 26,000 jobs. Unemployment claims data suggests the current unemployed count is around 21 million.
MIDDLE MARKET INSIGHT: Our view is that we will see a slow rebound in procedure volumes, similar to the overall economy, emulating somewhat of a Nike swoosh rebound, with potential easing of volumes once backlogs and other more macroeconomic factors relating to overall employment levels.
Furloughed employees should show up as unemployed in the official payroll data. However, the concept is vague and categorization will depend on how the surveyors interpreted the respondents’ answers. Given how many health systems, providers and other health care organizations have furloughed employees, the actual reduction in health care labor employed in the United States is understated by the official data.
This reduction in employed health care labor is atypical during a recession. During the global financial crisis, the health care ecosystem actually added 600,000 jobs during a time when almost every other ecosystem was shedding them.
Of the employees who remain in health care, many are now working remotely for the first time. Health care providers have historically resisted virtual work trends. The pandemic has now required that administrative staff and many clinicians who are not directly treating COVID-19 patients work virtually. Some degree of virtual work will become part of the next normal for labor in an ecosystem that has traditionally required physical co-location of employees. COVID-19 and the demand destruction related to social distancing and prohibitions on elective surgeries are affecting health care and health care labor in ways few predicted.
When (or if) elective surgeries will fully recover
Outside of the health care industry, many people may assume the health care ecosystem would be somewhat insulated during the coronavirus pandemic, when, in fact, the industry has seen activity that would indicate quite the contrary. One of the main factors driving the precipitous drop of activity was as a result of a tweet on March 14 from U.S. Surgeon General Jerome Adams urging health care providers to forgo providing nonurgent procedures. In concert with that, many governors also made either recommendations or orders causing health care providers to delay nonurgent procedures. These announcements from government officials effectively halted a significant portion of health care providers’ volumes. Now that many of these state mandates and recommendations have been lifting, providers are starting to see patient volumes slowly returning. The question remains, however, when (or if) will these procedures fully recover? And yet as some states ease restrictions on these procedures, others are issuing executive orders to suspend procedures, as seen as recently as June 25 when Texas Governor Greg Abbott issued an executive order to do just that in four large counties in Texas.
The term elective procedure has caused confusion among industry insiders and the general public. The term may indicate something like a cosmetic or nonmedically required surgery. Whereas many providers refrained from providing any procedure that was not urgent or that “can be delayed without undue risk to the current or future health of the patient” as stated by Governor Tim Waltz of Minnesota. Therefore, medical procedures like knee replacements and other similar procedures, which are medically necessary but not urgent, were delayed.
As the graph indicates, Google searches for the term “knee replacements” dropped to a 12-month low starting early March and continued until a modest rebound in early May. Many economists, including RSM Chief Economist Joe Brusuelas, have base case economic recoveries that look like a Nike swoosh. If so, is that what we are seeing early indications of with the data found in Google searches? Time will tell.
Our view is that we will see a slow rebound in procedure volumes, similar to the overall economy, emulating somewhat of a Nike swoosh rebound, with potential easing of volumes once backlogs and other more macroeconomic factors relating to overall employment levels. So in effect, a Nike swoosh rebound has a risk of dropping and starting over after the effect of one of these factors (i.e., the backlog) runs its course. One basis for that perspective is that health care continues to be dominated by the force that dominates other industries, and thus, the economy overall—the consumer. Consumer behavior and confidence will drive their willingness and likelihood of returning to the operating room.
JP Morgan surveyed approximately 550 individuals and what they found may not show as quick of a recovery as health care providers may have hoped for. Over a third of the respondents are planning to wait for a treatment or vaccine before undergoing a procedure. In their research, they did bifurcate those who had an elective procedure deferred and those who did not. The pie chart shows the result of the respondent’s views on rescheduling. These data points reaffirmed JP Morgan’s view that the coronavirus would have lasting impacts well beyond the second quarter of 2020.
Employment levels also directly affect our view of a recovery for health care. This is due to the obvious linkage between employment and employer-sponsored health insurance. As unemployment has grown to an estimated 20%, our concern is people will lose their employer-sponsored health insurance, and as a result, consumers will opt to forgo procedures that are not urgent in nature or simply be unable to pay their patient responsibility portion.
Merger and acquisition activity depressed, will come back changed
The marked decline in second quarter deal activity will reverse course in the next six to 12 months barring any disruptive events such as another prohibition of elective surgeries due to a second wave of COVID-19, widespread civil unrest or massive regulatory change reducing investor confidence. Deal volume in April and May of 2020 reported 63 private equity-backed acquisitions of health care providers or service organizations, down 75% year-over-year. The deal process for many of the deals that did close in Q2 had begun before the nationwide stay-at-home orders and prohibitions on elective surgeries.
Many private equity firms have significantly reduced or put on hold new deal sourcing in order to better focus on managing their current portfolios of companies through the pandemic. Strategic buyers, e.g., health systems and hospitals, have similarly put on hold or even canceled planned mergers and acquisitions. The recent cancellation of the $6 billion Beaumont and Summa merger, which had been in discussions for at least a year, is just one large example.
Health care organizations of all stripes may also be wary of (and potentially precluded from) engaging in merger and acquisition activity while simultaneously receiving federal relief funds. As health care becomes a larger political issue, the scrutiny over deals will rise.
As deals do return, we expect to see more transactions of distressed assets and organizations, a more complicated deal environment and lower transaction multiples.
We will see an increase in the number of distressed transactions. The financial markets experienced a significant shock and saw incredible trading activity in distressed debt, which surpassed levels seen during the global financial crisis. A higher volume of distressed bonds has a clear negative correlation to overall financial conditions.
More specific to health care, spreads between AA- and BBB-rated municipal bonds have increased to recent highs, with AA munis trading at a nearly 60% premium to BBB. This suggests investors are more heavily discounting underperforming health care assets.
Furthermore, COVID-19 has directly or indirectly caused at least 1,954, or 1 in 6, health care site closures, according to the Kaiser Family Foundation. This underscores the financial pressure and tough decisions health care organizations and, particularly, providers will face over the coming months. The financing environment will also be more challenging for the deals that do emerge. Pro forma adjustments will be under significantly more scrutiny than in quarters past. Both strategic and financial buyers will approach due diligence with renewed skepticism. This will also likely lead to more complex considerations, i.e., less cash and more earn outs, incentive units and other noncash proceeds.
We also expect the “covenant lite” debt environment of the past few years will remain in the past. As record numbers of organizations seek financing, lenders will have to compete less for deals, and thus, be less willing to bend on covenants.
Ultimately, we expect to see lower valuation multiples in the short- and medium-term. Valuation multiples are a price and they are generally guided by the forces of supply and demand like most prices. As the number of organizations seeking financing or sale (the supply) increases, and the investor demand for those assets remains relatively consistent, the price (or multiple) will decrease. We expect demand to remain consistent or decrease over the medium-term given current capital commitments to private equity funds,
and how financial and strategic buyers will generally focus on running existing operations rather than acquiring new ones.
Rapid expansion of virtual visits
Telehealth continues to gain momentum as patients delay face-to-face visits due to COVID-19 concerns. Pre-COVID-19, we saw a slow-moving trend toward virtual visits which we believed would continue to expand over the next five years. Barriers contributing to the slow growth before COVID-19 included lack of reimbursement from state and federal agencies, physicians’ willingness to embrace the use of telehealth, and patient exposure to virtual visits.
However, the recent pandemic has broken many of the barriers propelling the use of telehealth within a matter of weeks. According to Fair Health research, telehealth claim lines increased by 4,347% nationally, from 0.17% of medical claim lines in March 2019 to 7.52% in March 2020. Many health care providers have seen a huge uptick in virtual visits within the past two months. The Providence Medical Group experienced an increase from 700 visits a month to 70,000 visits a week after ramping up their telehealth platform in March.
In response to COVID-19, the Centers for Medicare & Medicaid Services has issued temporary waivers to allow for increased reimbursements related to telehealth visits. According to the CMS, “Medicare can pay for office, hospital and other visits furnished via telehealth across the country and including in patient’s places of residence.” These visits are considered the same as in-person visits and are paid at the same rate as regular, in-person visits. Before this waiver, Medicare could only pay for telehealth on a limited basis: when the person receiving the service is in a designated rural area and when they leave their home and go to a clinic, hospital or certain other types of medical facilities for the service.
CMS said that it would “extend this authority to use telecommunications for the duration of the public health emergency.” However, there has been no clarification on whether these waivers will be permanent. Regulatory agencies such as the Federal Trade Commission’s Office of Policy Planning, Bureau of Economics, Bureau of Competition and Office of the General Counsel submitted a comment to the CMS on its Interim Final Rule with Comment Period on June 2, 2020, related to the waivers. The organizations support the permanent elimination of restrictive Medicare payment requirements for telehealth. As a result of the CMS issuing relaxed guidance on reimbursements, many commercial payers have also followed suit. UnitedHealth Group provides virtual primary care physician visits with $0 copays. Humana also offers $0 copay for virtual visits and $5 copay for lab tests and prescriptions. As the pandemic begins to alleviate, we are watching closely to see if the CMS will make some of the waivers permanent. It is critical that providers continue receiving the reimbursements for telehealth services in order to maintain the momentum of the current telehealth growth.
Other trends contributing to the expansion of telehealth throughout the third quarter include the use of telehealth for virtual urgent care and emergency department visits. Cigna and Humana now offer urgent care visits through third-party platforms. In addition, telehealth behavioral health visits are also increasing as a result of COVID-19 amid the pandemic’s effects on people’s mental health. A recent survey by the Piper Sandler Company suggests 63% of consumers were likely to use telehealth for physician services and 56% for mental health.
Managing the patient experience to mirror digital retail will be critical for health care organizations to maintain a competitive advantage throughout the remainder of the year. Patients are not going to want to go back to a full facing health care experience. Research suggests an increase penetration to make telehealth a dominant substitute for primary care and urgent care triaging, according to Piper Sandler Company.
This article was written by Rick Kes, Jessika Garis, Matt Wolf and originally appeared in the 2020-07-20.
2020 RSM US LLP. All rights reserved.
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