1. Q: Is there a buying & merger frenzy? Is the industry consolidating into a few large firms?
A: There is always some buying & selling, though it tends to go in waves. There are some factors to remember. It is NOT like other industries.
>>>First of all, TPAs almost never put out "for sale" signs, because a main value of the TPA is customer retention, and if the word gets out that the company is for sale, some clients may get spooked and be susceptible to be lured away.
>>>Second, the BIGGEST driver of selling in the TPA industry is what I call "the biological clock". For example: The owner is 55 to 60, and knows that there is normally a 3-5 year carryover transition period he will be expected to stay. So if the owner wants to retire 3-5 years hence, he starts to very quietly feel around about buyers now.
>>>Third, sometimes the urge to sell is really just the urge to change or grow. So, there have been situations in which a firm that was rumored to be available ends up buying the suitors who sought to buy it.
>>>Fourth, There are new TPAs formed or evolving from the woodwork at a rate about equal with the number of firms who are absorbed in mergers. (Many HMOs, insurers, hospitals and others are diversifying by forming or buying TPAs.) So the total number of member TPA firms is pretty steady at about 400 firms (which is actually growth, since when TPAs merge with other TPAs, the new parent is a bigger player).
>>>Fifth, there is not a correlation between size of TPA and quality of work. There are some superb boutique firms and in every size category. Some of the reasons for dynamic and not-so-successful are discussed below.
2. Q: Do most mergers & acquisitions prove successful & profitable?
A: Unfortunately, the rate of unhappiness & failure (sometimes total destruction of the bought company and loss of the investment in 1-3 years) is about equal to the divorce rate in the U.S. (50%, I understand). The reason for failure in 90% of the cases is buyers' folly or bull-headedness. Memorize and keep reminding yourself: "TPAs are like butterflies. If you touch their wings, they will not fly anymore." What that means is that textbook "good management" and "business model" techniques tend to poison the client base of a TPA incredibly fast. So, if you don't like the TPA exactly as you see it today, don't assume that when you apply your magic touch it will blossom. It won't. It will usually die in 1-3 years.
The reason is that TPAs pamper their clients with all sorts of personalized services, and the customs/services (which may seem odd to anyone else) have usually evolved from the relationship the way the clients want it. So, even the best "improvements" are resented as diminished service. For example, a major top-notch TPA was bought by a large outside entity, which instituted various efficiencies and "improvements". One such was to make a report about weekly claims per-employer available to the client 24/7 online, instead of the old system of a report on blue paper each Thursday. The new system was clearly better, but the loss of the "little blue piece of paper" led to a client revolt. They urged the #2,3,4,and 5 people to bail out and start their own TPA to restore the desired customs. Within months, the old firm had no clients left, and the buyer had nothing but a multi-multi million dollar loss to show.
So, unless you want to see your investment evaporate (and be the one to blame for it), be sure that you like what you see, and kill your temptation to tinker. It should be noted that buy-outs where the buyer has faithfully kept hands-off and given maximum flexibility have been extremely successful. So, the fate of the investment is up to the buyer (and self-restraint thereof not to tinker, even if the improvement idea seems very good).
3. Q: What is the price formula or trend for buying TPAs?
A: No such thing, and ignore any reports you hear. The reason is that each deal is custom-designed...often with big factors based on the role or performance of the selling CEO. For instance, one TPA sold a tiny TPA for $6 million (which led every other TPA to mentally assume that their TPA would be several multiples of $6 million). However, the unpublished factor was that the young seller was virtually an indentured servant for the next decade or more. So, to try to track trends will only lead you into trouble.
There is a very rough rule of thumb method to gauge at least a starting discussion range. Plot two swaths on a graph. First, plot what would be between 300% and 700% times net. (What's included in net?, you ask. With a range of 3 to 7, it doesn't matter much, and TPAs use different accounting allotments.) Second, plot what would be 100% to 150% of gross income. Hopefully, those two plot areas will converge in some range, and that's at least a general discussion start....from which all the other factors such as if the seller is going to stay around can be negotiated. Some deals also build in a factor based on future performance...mainly as an incentive to keep the old owner's incentive. So, a sale price might be much higher…with adjustment if business tanks after the sale. So, you can see that reported prices & statistics are misleading snapshots.
Some frequent myths & misperceptions:
>>>Myth: "The goal is to become the nationwide dominant "McDonalds of TPAs"
Response: Get in line behind about 500 others who have had that idea...and changed their mind or failed. As noted elsewhere, the secret of success of the TPA business is personalization personalization personalization. So, if a client has even the slightest feeling that he is being treated in cookie-cutter fashion, he'll leave.
>>>Myth: "We can increase profits by outsourcing the backroom work to some off-site very cheap labor force."
Response: While it is possible in this era of computers & internet, it is doomed for the same reason as the response to the prior question. When an employer CEO has a worker with a question about the status of his claim, he wants to be on the phone and talking first-hand to a person who is handling it. Also, claims processors are the first line of government compliance for many laws, so intimate familiarity and interaction with other parts of the TPA firm are virtually essential to obey the laws with efficiency, Penalties (including jail time) for even unknowing goofs on benefits laws are made to be crippling. If even top attorneys get muddled in this field, do you and the client want to be relying on the low-cost off-site workers?
>>Myth: "The TPAs are a 'golden goose' business to be in."
Response: There have been dozens of independent detailed studies of the TPA industry and future prospects thereof. Almost all have talked to me, and I mince no words about the good, the bad, and the ugly of the business. In any case, they have uniformly come out with recommendations to their clients that the TPA is a "golden goose" (a term once used in such a report). That is flattering in once sense, and true in the respect that TPAs are in the business of red tape, and red tape will do nothing but grow. Even dramatic changes to the health coverage system would leave many duties for TPAs to perform for clients. (Think of the CPA tax-preparation industry as a good parallel. The more taxes are "simplified" and "reformed", the more customers need to rely on professional tax preparers.) However, there are some reality checks to the "golden goose" image. First of all, the TPA business is not a high profit margin business, and sometimes even a loss-leader. (I hear ranges of 3-5%, but also 10-15%….the difference probably being that each TPA has a different accounting method and business-cost attribution model. Meanwhile there is an ERISA-based custom of having TPA fees be low enough to pass a test of common-sense fiduciary duty by the client....and the TPA busines is EXTREMELY competitive. So, no one should be under the illusion that TPA is a get-rich-quick scheme.
Let me end with the three important reminders which tend to slip the mind of the over-eager.
(1). Every number or statistic related to TPAs, benefits, insurance, medicine...and just about everything else...has a built-in 1,000% distortion factor...not because people are lying, but because even the most basic vocabulary terms have vastly different uses. So, for your credibility & sanity, view any numbers or studies purely as snapshots of the one incident in the context and vocabulary of those who asked the questions and the understanding at that moment of the persons who gave answers. A 1,000% different numerical answer is probably just as attainable.
(2). If you are thinking of buying a TPA, remember "A TPA is like a butterfly. If you touch its wings, it can not fly any more." If you intend to tinker and bring "improvements" to a system that has been hued by the wants of the customer, prepare for an expensive crash landing.
(3). Remember the quantity and source of the laws & requirements that apply. There are a few thousand, and influence even the most trivial clerical functions of a TPA and plan. They can bring very severe penalties. They span multiple areas of legal discipline (tax law, labor law, health law, etc.) TPA work is NOT synonymous with insurance laws and customs. ERISA self-funding and the all-important ERISA fiduciary responsibility to follow (and occasionally enforce on your own client) is a very different and very demanding responsibility. (See the pieces on the website describing ERISA fiduciary.)