Drawing on Morgan Stanley’s investment banking and investment consulting experience guiding healthcare systems through transactions, we examine how retirement plans can influence valuations and other aspects of negotiations. We also examine ways management teams of hospital systems can prepare for decisions related to retirement plans that will arise during the diligence process and beyond.
How Retirement Plans Influence Healthcare Acquisitions
The healthcare industry is experiencing a wave of consolidation activity, particularly among large hospital systems that are looking to manage rising costs and expand their reach across markets and throughout the continuum of care.
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Preparing for a transaction involves evaluating a host of complex strategic and financial considerations—and understanding how the acquisition target’s and acquirer’s retirement plans fit together should be part of this analysis.
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Description
54%
of healthcare industry CEOs say they plan to make at least one acquisition in the next three years.1
250+
hospital mergers as of since January 2020.2
41%
In 2022, 41% of physicians worked in a facility owned at least partially by a hospital or health system, up from 29% in 2012.3
Why Healthcare Systems Are Consolidating
The desire for organizations to expand their footprint, broaden their services and provide better care to more patients are key drivers of M&A activity in healthcare. Local hospitals may be seeking to access the resources and infrastructure that come from being part of a larger system, while a prospective acquirer may look to increase its presence and influence across the regions it serves. More specifically, some of the top underlying reasons for consolidation include:
- Achieve economies of scale to combat rising expenses by sharing or centralizing resources, technology, facilities and other operational components
- Gain more leverage with payors by strengthening their negotiating power
- Influence policy makers to help achieve favorable policies at the local, state and federal levels
- Expand across the continuum of care to provide patients a more unified experience and enhance the system’s ability to drive better patient outcomes and more efficient value-based care
- Join other mission-based facilities to grow a network of like-minded caregivers in a state or region
- Attract talent by offering doctors, nurses and other staff access to better resources, technology and training
- Avoid being the last mover to not miss out on strategic opportunities to strengthen the system’s competitive position
What Happens to an Acquiree’s Retirement Plan in an Acquisition?
How a healthcare organization handles a newly acquired retirement plan can have significant implications on its balance sheet and benefits program. The balance sheet considerations are particularly important when the acquisition target has a defined benefit (DB) plan, and the decisions will largely hinge on the plan’s funded status and overall health. The most common ways that healthcare systems address an acquired retirement plan include:
Take Over the Plan
Some acquirers choose to assume the role of sponsor of the acquiree’s plan alongside its own, particularly if the target organization will be operated as a distinct business line. While it can be more costly and cumbersome to run two plans, there may be less initial administrative burden and newly transferred employees will maintain consistent coverage. However, the acquirer may also choose to close or freeze the plan, which could be an undesirable outcome for participants.
Merge the Plan
Acquiring organizations may choose to fold a new plan into their own plan. Though this may result in some changes in the plan’s administrative terms, this often can be done relatively quickly, saves on long-term operating costs, and typically offers participants continuity in benefits and vesting status when joining the new plan. But, like a plan takeover, an open acquired plan could be closed or frozen by the acquirer, producing a potentially adverse outcome for employees.
Terminate the Plan
If the acquiring company determines that maintaining or merging the acquired plan is too financially or administratively burdensome, the acquirer may choose to terminate the plan. In the case of a DB plan, this would entail providing participants with a lump sum offering and potentially require a sale of the assets and liabilities to an insurance company.
Selling a Plan to an Insurance Company
In some cases when the acquiring company chooses to terminate the acquired plan, they may choose to sell the assets and liabilities to an insurance company. This approach frees the acquirer from its longer-term obligations of providing monthly distributions to pensioners and eliminates the ongoing administrative costs of operating a pension plan, including Pension Benefit Guaranty Corporation (PBGC) premiums and fees for actuarial service providers.
However, the acquirer may pay a sizable premium to the insurance company to offload the plan. Additionally, if the plan was significantly underfunded, the path to selling to an insurance company could require a sizable contribution. The plan sponsor should also carefully consider the investment strategy leading into these transitions to limit the volatility of the plan’s funded status (ratio of assets to liabilities).
How Retirement Plans Factor Into an Acquisition—and How Both Sides Can be Prepared
Defined Benefit Plans
If the acquisition target has a DB plan, the acquirer will begin analyzing the plan early in the due diligence process. As the buy-side investment bankers assess the plan’s potential impact on the deal, they typically consult with various stakeholders and experts such as the plan’s administrator, the organization’s actuary and a retirement plan consultant.
The acquiring healthcare organization should be well-informed about all details of the DB plan to gauge the potential impact on the acquisition, and the funded status is central to this analysis. Typically, an underfunded plan gets moved to the top of the issues list for further review, but one that is significantly underfunded has the potential to derail negotiations.
On the other hand, a plan with a funding surplus may be an even more attractive target to an acquiring firm. In certain instances, an acquiree may be able to leverage an over- or fully funded plan as a negotiation tool toward a more favorable purchase price. In either case, a well-funded plan on the part of the acquiree will alleviate one potential concern for the acquiring firm.
The acquiree should be ready to give a full picture of their DB plan’s health by telling the story behind the numbers. The acquiree’s management team and bankers need to do the up-front work enabling them to highlight the investment strategies, risk management practices, actuarial considerations or other factors that have led to the plan’s current status and, importantly, in the case of under-funded plans, describe how those factors are putting the plan on a trajectory toward better health.
Defined Contribution Plans
Compared to DB plans, defined contribution (DC) plans typically don’t have as significant an impact on deal negotiations in healthcare. Nevertheless, gathering information about the target’s DC plan will be an important part of the diligence process.
Because employees of the acquisition target often will be moved into the acquirer’s existing DC plan, the acquirer must consider how its contribution levels, investment options and fees, financial wellness offerings and other existing plan features compare with what the target’s employees currently have.
It is also important for acquirers to understand the demographics of the target’s employee base and evaluate whether the plan’s features and participant engagement strategies need to be adjusted for the new, expanded workforce.
In addition to offering guidance on incorporating retirement plans, consultants provide post-merger operational support for DC plans. The retirement consultant can promote a seamless transition by working with record keepers, evaluating vesting schedules and sharing best practices on contributions and other activities. A qualified consultant can also draw upon their experience to help ensure a robust and consistent fiduciary governance process is executed throughout potential service provider transitions and participant integrations.
To learn more about the trends affecting M&A activity in the healthcare sector and guidance on how an organization’s retirement plans can influence deal negotiations, please contact your Morgan Stanley representative.
Disclosures
1Source: PwC's 27th Annual Global CEO Survey, January 15, 2024.
2Source: Morgan Stanley; data as of May 2024.
3Source: KFF.org, Ten Things to Know About Consolidation in Health Care Provider Markets, April 19, 2024.
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