Before You Buy an Elder Care Facility, Do Your Workers’ Comp Due Diligence
Posted in: Commercial Insurance
If you’re in the elder care or nursing home industry, you’re likely aware of the movement happening across your industry. Mergers and acquisitions are more and more prevalent, and when they occur, one of the biggest mistakes buyers make is not doing their due diligence on the newly acquired business.
What gets overlooked? Buyers often fail to carefully consider a facility’s loss history and experience modification for their workers comp insurance. This misstep comes with costly consequences — and can cause buyers to miss the impact that a seller’s past loss history will have on the buyers premium for the next three or four years (depending on the state).
If you’re thinking about acquiring a nursing home, continuing care retirement community or assisted living company, understand that your success as a new operator hinges on the business’ loss history and experience modification. Why? Put simply, both can dramatically affect the workers’ compensation insurance premium you end up paying when you take over the business. And a high premium, in turn, can make a major dent in your bottom line.
In an earlier blog post about workers’ compensation in the elder care industry, I talked briefly about why loss history and experience modification require far more attention than they usually receive. Here, I explore these issues in more depth and explain what you, as a buyer, can do to protect yourself from landing a bad deal.
Loss History and Experience Modification: What They Mean, Why They Matter
A loss history delineates all of the workers’ comp claims submitted over a designated period of time, including claims paid by the insurance company and the amount expected to be paid in the future. Insurance companies analyze loss history as a significant part of the underwriting process and consider it a key element to determining a facility’s premium. Nearly always, those facilities with higher amounts of loss pay higher premiums.
Underwriters also base workers’ comp premiums on a company’s experience modification, a numerical rating calculated based on loss history among other factors and assigned by a governing body. Experience modification is also known as “mod” or “e-mod” in the insurance world. Mods are calculated only when a company meets the eligibility requirements established by that particular state, which can greatly vary. So, not every company will have a mod.
The entity creating the mod varies by state. In the majority of the states, the mod is calculated and maintained by the National Council on Compensation Insurance (NCCI). Elsewhere, it’s regulated by an independent board or bureau, or by the state’s own experience rating plan. Insurance companies use both the loss history and the mod rate, if available, to gauge past injuries and potential risk to predict future losses and calculate workers’ comp premiums.
As a buyer, you may not realize it, but when you acquire an existing elder care company, you inherit that company’s loss history and, if one exists, its experience mod. Even if your own losses are minimal and you’re doing everything you can to lower the risk of additional losses at your new facilities, you still end up paying the higher premium, and will continue to do so as long as your loss history is factored into the mod. In most states, this means three full years.
Making matters worse, the responsibility of managing the seller’s claims after the closing often remains with the previous owner, who may have little-to-no incentive to manage them well. If and when the previous owner mismanages the claims, you may find that the cost of the claims increase, which ultimately results in a higher premium — at no fault of your own.
How Can Buyers Protect Themselves?
As a buyer, you can do a number of things to avoid getting stuck with a high premium, or new facilities that cost far more to run than you anticipated.
- Realize that loss history and experience modification will affect your premium.
Insurance companies base their pro forma on past costs of workers’ comp claims, and use what they learn about a company’s past to make future projections. If you acquire an elder care business with a poor workers’ comp record, in most cases, you will inherit that record and those higher premiums, usually for three years. I know an elder care operator, for instance, who bought a number of facilities but didn’t look closely enough at loss history as part of the due diligence. They ended up having to pay an unexpectedly large workers comp premium and their bottom line took a hard hit.
- Demand the loss history from the seller.
As a buyer, it’s your job to ask the seller to hand over the loss history. Yet the majority of buyers don’t know this, and sellers certainly aren’t going to offer it. Many sellers will give you a song and dance or resort to some other stalling tactic — but hold firm in your demand that the seller hand it over. As we tell our clients, it’s your right, as a buyer, to see the complete record of all currently valued workers’ comp claims, past and present, and to scrutinize it to avoid any surprises down the road. Underwriters always want to see the current year, in addition to the past four years, so make sure you receive records for the past five years.
- Evaluate the loss history and mod sooner rather than later.
Don’t wait until you’ve already submitted your purchase offer to look at the loss history and mod. The value of the business is based, in part, on the number and severity of workers’ comp claims, so an early evaluation may give you leverage for negotiating the terms of the purchase agreement. It will also give you insight on the morale of the employees who work at the company’s facilities, along with the systems, policies, and procedures (or lack thereof) in place.
- Understand how experience mods are calculated.
When you evaluate an experience mod, keep in mind that the mod reflects the entire company, not just one facility. Also know that mods compare the claim experience of an employer relative to other employers within the same industry group. In this sense, they help buyers gauge how an organization stacks up among similar operations. A mod factor of 1.0 represents the average loss history for that industry, while a modification of greater than 1.0 indicates the loss history is worse than average. Likewise, a mod of less than 1.0 signifies that the organization is outperforming its industry group. How does the mod affect premium? The experience rating has a direct impact on premium. For instance, a mod of 1.15 results in an additional premium of 15 percent.
Realize, however, that you can’t just look at the number. You have to dig deeper. Why? Experience mods do not reflect the most recent losses. They are based on three years (for NCCI states, that is) of loss experience, but they exclude the current policy year because the modification is calculated during the term of the current policy. For example, a policy that renews on January 1, 2015, will generally have an experience rating based on the loss experience from the policy years of 2011, 2012, and 2013. For the renewal on January 1, 2016, the oldest policy year (2011) will drop off the mod calculation, and 2014 will be added. This results in the new experience period of 2012, 2013, and 2014.
What, then, does this mean for you as a buyer? It means that a seller’s mismanagement of more recent claims may not show up on the mod, and that you need to look closely not only at the current mod but also at the loss experience over the past two years. Only then can you project future expenses and make an accurate value assessment of the business you’re considering purchasing.
- Work with an expert who understands the nuances.
Evaluating experience mods and loss histories can get complicated. For instance, every injury affects the mod for three years, whether it’s a medical-only claim or an indemnity claim. And although the frequency and severity of losses factor into the mod, the frequency of claims “weigh” more, resulting in a higher mod score.You want to work with a partner who understands the intricacies of how experience mods work — and how they differ by state. So don’t risk a higher premium on your newly acquired facility. Make sure you enter the deal fully informed of what you can expect in future years as a result of the facility’s experience and loss history, and work with a team that can make that happen.
At PSA, the experts in our Healthcare Risk Solutions team work with potential buyers of elder care companies to evaluate loss histories, mods, and other risk factors so they can make sound purchasing decisions. To learn how we can help you, reach out to me at cmorsberger@psafinancial.com.
