Oregon’s Insurance Commissioner Laura Cali – without hesitation and after receiving no public comments – has approved a merger between PacificSource Health Plan and Legacy Health that could dramatically shake up the marketplace – with the hospital system and insurer expected to take on the heavy hitters – Providence Health & Services and Kaiser Permanente – who have an integrated healthcare system and can control not only the cost and quality of healthcare from the ground up – but also have a stronghold among physicians. Oregon Health & Science University is building a similar system – without direct ownership – having captured Portland Adventist Medical Center and Tuality Healthcare, along with smaller hospitals in rural Oregon.
Now that this merger is official, onlookers will no doubt keep their eyes poised on Regence BlueCross BlueShield, which is the state’s largest insurer and could inevitably d fall prey to higher costs from both hospitals and physicians since it has no ownership rights.
In her order, Cali said the proposed acquisition will infuse $247.5 million in new capital to PacificSource, without significantly altering operations. She also found there was no apparent inequity or unfairness to its policyholders. With the merger, Legacy is now an equal partner of PacificSource, owning a 50 percent interest in the insurer.
The Lund Report Broke This Story
Last October, The Lund Report received confidential information about the proposed acquisition. In those documents, officials at both companies mapped out their concerns and considerations in a fast-changing healthcare marketplace.
Here’s a look back at what we uncovered:
Summer 2014: Legacy’s Strategic Plans
In mid-2014, leaders at Legacy Health had developed a new “strategic plan framework,” a set of documents outlining how they wanted their network of hospitals and clinics to succeed in a world of “care transformation.” In a July 2014 presentation labeled “Excerpts from Strategic Planning and Deep Dive Discussion,” Legacy developed a to-do list that it labeled “an evolving list based on market opportunities. Among the items on the list:
- Expand regional relationships.
- Reconfigure care management and population health functions across the continuum.
- Develop population health analytics.
Legacy had hired Evolent Health, a consulting business that specializes in helping health organizations adapt to a changing policy and economic world, which in the July 2014
presentation outlined strategic challenges that the hospital chain faced. Much came down to “value-based care” – the Affordable Care Act model in which doctors and other health providers are paid based on results, not tests and procedures. The focus under this model is on “population health,” or working to keep people healthy, rather than treating them only after they become ill.
To summarize Evolent’s assessment of Legacy’s challenges: In the greater Portland metro area, where Legacy and its physicians largely operate, the health insurance market is fragmented, making it hard for providers to negotiate value-based reimbursement programs. The insurance sector’s market fragmentation also limits Legacy’s ability to grow through payer partnerships alone. The consulting group also determined that Legacy’s brand “as a provider of the community and for the community” would be essential to a successful effort to prepare for a world of value-based care payments. And Evolent believed that the “presence of smaller, regional plans may present a plan joint venture or acquisition opportunity. In short: With the existing Portland metro insurance marketplace making it hard for Legacy to develop a working approach to value-based care, Evolent suggested that the company enter that marketplace itself.
Legacy Examines Insurance Landscape
Legacy officials began to consider Evolent’s recommendation, though they kept their talks top secret, not even reporting full details of their consideration to the Legacy board.
In a meeting document titled “Strategic Collaboration Committee At-Risk Strategy Development,” dated Oct. 28, 2014, Legacy set a goal of entering the insurance market by Jan. 1, 2016. Officials saw two options for getting there: Either start a health plan from scratch, or partner with an existing health plan via a joint venture. Either way: “pursue at least 50% ownership in a health plan.” Board members would learn some details that November, the document says.
Officials at Legacy’s Oct. 28, 2014, meeting seem to have felt a sense of urgency. A slide from a Power Point presentation, which was peppered with images, when extra symbols are removed and a few punctuation points are added, reads: “The time has come to chart Legacy’s future. The market is moving, change is inevitable. And (the) window of opportunity is limited. Good news is, Legacy has a solid foundation to build on.”
Legacy’s Strategic Collaboration Committee decided at this October 2014 meeting that they would need one or two subject-matter experts to help them explore the process of creating a health insurance company.
Then Evolent Health presented its assessment of health insurance partners for Legacy to review. Regence was deemed a poor fit because of challenging negotiations to date, and because it was “unlikely to be open to an exclusive relationship in the Portland area.” Moda’s statewide alliance with OHSU raised concerns, as did worries about the financial health of Moda.
Health Net could be hard to negotiate with because its parent company is in California. National health insurance companies are uninterested in partnering with local and regional companies.
That left three contenders that tied for “best fit” in Evolent’s first-round review: PacificSource, Samaritan Health Plan and CareOregon.
A closer review of those three options ruled out Samaritan because of its small size – only 39,000 members – as well as limited financial performance, and ruled out CareOregon, which is focused on Medicaid, not commercial health plans. “PacificSource is the most attractive option for partnership, but alignment with Legacy vision is unknown,” Evolent wrote. PacificSource covers 277,000 people across four states, including 34,000 in Legacy’s footprint, and is financially sound, the consultants noted. They also noted that there were no guarantees that a partnership would work out: “PS’s vision for value care and interest in Legacy exclusivity unknown.”
Learning From the Past
An undated document headlined “Lessons Learned By Provider Owned Health Plans From The 1990s” shows that Legacy took a look to the past when deciding on its future steps. In this document, Legacy noted that Oregon provider-owned health plans in the 1990s struggled for a number of reasons: their provider networks were too small and geographically limited, did not grow large enough to manage the risks that they took on, did not have strong underwriting systems, and struggled to meet capital requirements.
The document concluded that a PacificSource and Legacy partnership could overcome those challenges through the many physicians and other providers involved in the Legacy Health Partners network, plus
PacificSource’s underwriting experience and its own network of providers, and Legacy’s strong balance sheet. However, it also noted that provider reimbursement rates, a historic challenge, could again be an issue – and said “creation of a well functioning Population Health Services function is critical.”
Studying a Potential Partner
Between October 2014 and May 2015, Legacy and its consultants learned everything they could about PacificSource, though conversations were kept top secret. On May 19, 2015, Legacy presented a document on the implications of such a partnership with each page marked “Strictly Confidential.”
This document, prepared by HealthScape Advisors, shows that by May 2015 Legacy had ruled out the possibility of starting a new health plan from scratch by itself, though it was still considering launching a health plan if it could find an infrastructure partner. Legacy was also considering partnering with an existing health plan to create a new health venture.
“Current market trends are driving providers towards health plan ownership,” HealthScape wrote. The Affordable Care Act has created a more complex healthcare marketplace in some ways, but it has also “removed traditional barriers to entry and changed the value equation to benefit provider-plan partnerships,” it said. Just as Legacy is facing pressure to move to value-
based care, insurance companies are now being pressured to better diagnose and document the risk of members, because of limits on using underwriting to set rates, HealthScape wrote.
As Legacy considered a partnership, the hospital chain looked into the insurance company’s financial situation, and determined that the insurer was financially sound, with risk-based capital levels notably above typical target levels, at 475 percent, or roughly $400 million. Legacy also noted that the Affordable Care Act has created “significant risk and uncertainty for health plans.”
HealthScape also outlined a partnership between Legacy Health and PacificSource, though a new separate entity, owned half by each entity. By keeping the new company a separate legal entity “Legacy’s risk is limited to the amount of money it decides to invest in NewCo,” HealthScape wrote.
Legacy was aware of risks of a Portland metro area with this partner, however, the document says. With only 15,000 members in the Portland metro areas, a small number of sick members could significantly impact a plan’s financial performance. Including its membership across the rest of Oregon, Idaho and Montana, however, results in less financial risk, the May 2015 document says. Ultimately, it concludes, the risks of inaction are greater than the risks of action.
PacificSource Agrees to Talk
On June 24, 2015, Legacy Health and PacificSource signed a mutual exclusivity agreement. “The parties have been discussing the possibility of a transaction (the ‘Potential Transaction’) in which Legacy or its nonprofit affiliate would acquire a 50% membership interest in PacificSource,” the document reads.
The document notes that during negotiations Legacy is requiring PacificSource to stop any partnership talks with other health companies, and PacificSource demanded a similar commitment from Legacy. “The conversation is in early stages and there is definitive agreement in place,” the mutual exclusivity agreement states. Formal conversations between the two companies were now under way. Earlier, PacificSource turned down an opportunity to form a partnership with Providence Health Plans after its physicians balked, fearing a loss of autonomy.
Valuation of PacificSource
Three weeks later, PacificSource and Legacy were talking to Alton Health Advisors, which they sought to hire to prepare a valuation that would guide their venture together. “As you explained to me, Legacy is proposing to acquire a significant financial interest in PHP (probably at least 40%) through a cash investment in PHP,” read a letter from Alton dated July 16, 2015. That appears to reflect a slight misunderstanding of the 50-50 joint venture that PacificSource and Legacy were discussing, but not a misunderstanding that would affect the valuation process. “Valuation” is the part-science, part-art practice of determining the financial value of a company.
In September 2015, Alton Health Advisors delivered its valuation report on PacificSource, which was developed after allowing both Legacy and the health insurer to weigh in on an earlier draft. Alton wrote that it worked through multiple methods– doing a comparable companies analysis,
comparable transactions analysis, and discounted cash-flow analysis – to arrive at a range of business enterprise values. Alton then adjusted for PacificSource’s capital and debt levels to arrive at an estimated equity value of between $271 million and $343 million.
Among the factors contributing to that estimate, Alton noted, was PacificSource’s financial forecasts through 2018, which predict significant growth. Next week, The Lund Report will look more closely at those forecasts as we examine what may come next for a PacificSource-Legacy partnership.
Documents obtained by The Lund Report outline Legacy’s strategic thinking, but say far less about PacificSource. But officials at the insurance company must have seen opportunity in Legacy’s proposal, because by September 23, 2015, the two organizations were reviewing draft vision statements. Up for discussion as a possible start to the vision statement: “Together, Legacy and PacificSource will create a market leading integrated health plan that will become the affiliation partner of choice in the Portland metro region and all areas served.”
Together, the two aimed to combine their strengths develop integrated care models in order to deliver higher-quality care at lower costs, and to develop healthcare products that both employers and individual consumers would find attractive. HealthScape Advisors wrote that partnering would allow Legacy to advance its shift to value-based payments, and would establish an integrated care model that PacificSource could then adapt in other markets. Harnessing data and technology tools would play a central role.
Diane can be reached at [email protected].