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Buy/Sell: Advice on Buying TPA firms

By SPBA Active Past President Fred Hunt

This is designed mainly for non-TPA entities interested in buying one or more TPA firms.  You will find it extremely candid, and I urge you not to let your own assumptions blind you to some vital factors that make the difference between profit and disaster.   The goal is not to discourage you, but to be sure that you proceed with wisdom .

LOTS OF BUYERS;  First of all, be aware that at any one time, there are at least 100 entities with the same idea of buying TPAs.  These include venture capitalists, other investors, insurance companies, medical entities, etc. etc.  Several hundred detailed proprietary studies of the TPA industry as a place to invest have been done.  Obviously, I have not had access to them, but I have gotten enough verbal summary reports to know that they have been glowing.  One used the term "golden goose" to describe the prospect of TPAs.   I and our SPBA members working hard in the very competitive and demanding  business laugh that "golden goose" is optimistic, but it is true that the TPA concept will be around as long as there is red tape.

DON'T SPOOK CLIENTS:  So you are not the first to be letting TPAs know you're looking to buy.   Consequently, don't expect to necessarily be greeted with eagerness.   TPAs are only interested in buyers they feel truly understand what the TPA business is.   The TPA business (and thus buying a TPA) is more a HUMAN relations business than just a paperwork & money-processing business.   Too many great TPA firms have crashed (along with the money spent to buy them) when a well-intentioned buyer applies "good management" techniques.   The TPA business is the business of keeping client employers/plan sponsors happy and in compliance with a myriad of laws.  TPAs have done such a good job at this that clients have gotten very spoiled with very personalized services.  Do NOT discount how attached clients are to those specialized services!!

For example, there was a great TPA firm that was bought.  The outside entity had followed my advice not to make "good management" changes for fear of spooking and losing the clients.  The TPA had had an old custom of sending to each client the list of claims submitted for the week.  The report was on blue paper, and arrived every Thursday afternoon.   A  month or so after the transfer, some clients called the TPA to say that  they were not getting "the little blue piece of paper" anymore which they used in their management meetings.  The TPA reminded the clients that they had been informed that each client now had a private website giving that and other pertinent data 24/7 updated daily.  You are probably nodding that the website service is far better, but the clients liked the blue piece of paper, and it became a spreading cancer perception that the TPA was not giving the service like "the good old days".  By renewal time of the second year, all but one client had left, and the investors were left with a very expensive empty shell.   This is a very clear dramatic example, but all too common of tampering with what the clients are used to getting.

The moral of the story in buying a TPA is that if you don't like what you see now, don't buy, because even the best-intentioned tinkering can spook the clients to leave.  The TPA business is extremely competitive, so there is always another TPA (or departing #2,3,4,5 people from the bought TPA) willing to give the clients what they want.   If you lose the clients, you've lost your investment.

Because the number of buyers who bungle has been high, a new factor has entered the scenario.  The #1 person has made his money and is contractually tied to the buying entity.  However, the #2,3,4,5 people who have to deal daily with the interaction with the clients are given no incentive to be happy with the new arrangements, even though they catch the heat from the clients who don't like the changes.  It is not uncommon for clients to now encourage the #2,3,4,and/or 5 people to split off and start a new firm to restore the customs the clients liked before.  (This is what happened in the "blue piece of paper" scenario, for example.)  So, any purchase deal is wise to make the key staff very happy, and to listen to what they say during the extended transition period.

UNDERSTAND THE CLIENTELE:  Remember that clients range from large & small corporations, city & state governmental units such as school boards, religious entities such as dioceses, and union/management joint collectively bargained trustees.  So, don't assume that TPA's clients are run-of-the-mill corporations.  TPAs tend to focus in certain types of plans & employers, such as collectively-bargained, governmental groups, or a certain size or specialty of corporations.  That makes a difference in your purchase and the way the TPA operates to serve that market.

The CEOs of TPA's clients tend to be protective and paternalistic in the nice sense of the word.  It is important for any buyer to understand this, and not think that all employers have the same mindset.   The majority of TPA clients tend to be in the range of 75-5,000 workers.  This means that the employer tends to know or have contact with the workers in some way...the parking lot, in the grocery story, PTA, in church, etc.  So, these employers both care about the workers...and they don't want to face some worker (or local news stories) angry about their benefits.   So, benefit decisions and decision-making is very different from in a mega or bureaucratic organization.  Also, because most TPAs administer self-funded plans the client contact or involved party is often the CEO, CFO, COO or senior official.

PRICE RANGE FOR TPAs:  Beware looking for price trends or comparables.  The reason is that every TPA and every deal is unique.  There are a dozen or more major factors that skew the price.  Why is the seller selling?  What is the buyer actually buying?  Is the price up front or over time?  Does the over-time portion tie to some level of profit or growth?  What are the conditions on the selling owner?  (For example, a 3-5 year transition is normal in order to keep clients calm and comfortable with "the new people".  Sometimes the sales price is not only the purchase, but also the payment and possible bonus for that continuing period of time.)  Does the TPA feel that the buyer will blunder and destroy the firm in a year or two (as described above)?  Is it the sale of assets or the firm and its operations & liabilities?  So, price comparisons will probably give more problems than guidance.

As a vague starting point for discussion, there are two measures sometimes used.  One is 100-150% of gross annual income of the firm.  The other is 3-7% of the net income of the firm.  Since many TPA firms have complex organizational arrangements and several sources of income, you might legitimately ask what to count in "gross" and "net".   The solution for this exercise is to plot a band defined by a curve of the highest and lowest possible interpretations of "net" and "gross".  Hopefully, the two broad plotted bands will cross, and that gives a hypothetical starting point for negotiation and consideration of all the other factors.

KNOW THE INDUSTRY:   When you say "TPA", do you know what you mean?  First of all, since there is no set definition, there are many entities who like to use the name on occasion.  "TPAs" tend to fall into four broad categories.  The terms I use are my own, not official.

(1).  There are about 350 of what I call "comprehensive-service TPAs".   It is not to say that all do every service for every type of client plan, but within their market niche, they are pretty much one-stop-shopping to get the direct and additional services.  SPBA's membership is composed of the comprehensive-service TPAs, and probably 95% of such TPAs are members of SPBA. 

(2).  There are about 1,000 "TPAs" who provide TPA services for only one or a few services or products, such as dental, vision, 401k, etc. 

(3).  There are uncounted entities who do a tiny bit of TPA work as a sideline.  They show up in some legal listings, such as those derived from the 5500 forms, but they are like the law firm that used to be on our floor, which handled a few small retiree plans for a legal client.  So, these are law firms, CPA firms, insurance agents, etc., not really a "TPA".

(4).  There are a couple thousand of what I call "TPAs of convenience".  They like to add TPA to their professional resume, and may not even know they aren't real TPAs.  These may be data processing firms, consultants, accountants, insurance companies, etc.  When they call me, they often brag that they are the biggest, best, fastest, etc.  When they are finished bragging, I bring up some government compliance duty or liability of  TPAs, and I either get an ignorant silence, or they scramble to tell me that they aren't really a TPA, "no, we're not TPAs!"

So, if you're thinking of buying into the TPA business, know what you're seeking and to whom you're talking.   Most of the media and commercial listings of TPAs include many of the entities in category 2,3 &4.  If your goal, like most buyers, is the comprehensive service TPA, then the best resource is the SPBA TPA Directory.  The good news about this resource is that it lists every SPBA member TPA, along with a contact person.  More importantly, there is a handy chart for each firm with about 25 indicators of  the types of clients & geographic regions served, types of services, and a realistic size indicator of  how big a player the entity is.  It means that you can target the types of TPAs you're seeking, and can sound informed when talking to them.  (As noted in the first paragraph, they are fed up with uninformed solicitations to buy.)

The bad news is that the SPBA Directory costs $495 (send check for $495 make out to and sent to SPBA at 2 Wisconsin Circle, #670, Chevy Chase, MD 20815, and it goes to you via Priority Mail the day the check arrives).   So, it is only for people seriously looking. 

NO "FOR SALE" LIST OF TPAs:  Since the value of any TPA is client loyalty, the "don't spook the clients" rule discussed before means that TPAs almost never openly say they are for sale.  In fact, the sale process is more like dating.  Just as you never know when you will bump into the perfect mate, many a sale or merger has evolved from a chance conversation, especially when one TPA buys another.  TPAs don't want the word leaking that they are selling, because then other TPAs will approach their clients like a going-out-of-business sale.  So, the SPBA Directory becomes the most efficient tool to narrow the search.

UNDERSTAND WHAT A TPA DOES:  Just blindly processing claims and cranking out checks (as many data processing firms could do) is a tiny fraction of what a TPA "does".   About 90% of what TPAs do is impacted by extensive government compliance rules for the TPA, plan, and/or employer.   The penalties can be very harsh, even for items that were unknown or out of control of the TPA, plan, or employer.   The rules cover several different areas of law and there are hundreds of new issues every year. So, even lawyers with outstanding experience in one arena may give erroneous advice in other areas and trigger huge penalties.  TPAs certainly do not practice law or give legal advice, but SPBA and its members  have a long candid face-to-face relationship with the people who shape and interpret the laws for the government.  There is also much sharing among SPBA members of hints & experiences.  So, SPBA is usually able to point out the problem areas and report what the officials are saying.   Some buyers of TPAs tend to discount the government compliance role, in part because it is usually woven like second-nature into all the functions of the TPA firm.

Government compliance, seeing cost-effectiveness in medical providers, arranging the adjunct services many plans need, and all within the very strict selfless ERISA fiduciary format is extremely important.  Government enforcement is unpredictable and erratic, but when it hits, it comes with a wallop.  ERISA is a rare law that can be prosecuted as civil and/or criminal (jail time) offense.

UNDERSTAND THE CASH-FLOW OF TPAs:  Don invest in a TPA expecting to make X% of profit every year.  First of all, the TPA business is so competitive that  profit margins are quite low.  Second, net income is not consistent, because costs of implementing some new government compliance requirement can be very expensive before the clients are willing to be charged for it.  Also, occasionally, some large competing source of business (such as insurance companies or HMOs) lower their prices below market in order to build up their numbers.  They can't sustain such losses, and TPAs often get the client back, seeking the personalized service, but there has been a dent in the TPA's income in the meantime.

SUMMARY:  As promised at the start, this is brutally candid, but is intended to be constructive.  We are as anxious to have good "marriages" between TPAs and buyers as you are.   When things go badly, you lose money, but we suffer the embarrassment of a broken TPA.  So, please read and heed the advice carefully,  It is culled from almost 30 years of involvement in the process.  Don't buy a TPA with the intention of changing it.  What you see as a quirk may be a key to client retention.  Also, after the purchase, listen carefully to the thoughts, reports, and advice of the professional TPA staff.  They are as eager for the firm to remain successful as you are, and they are the ones feeling the pulse of the clients.    Buyers who have followed this management strategy have been very successful.

P.S. – Hearing this advice, many potential buyers say they understand and would like to attend SPBA meetings in order to watch, learn, and get to know TPAs.  That is not an option.  SPBA meetings are open only to member TPAs and Stop-Loss Service Providers.  SPBA meetings are very intense sessions on the nitty-gritty issues the members are facing.  There are no opportunities for mixing or being a sponsor.   Most importantly, TPAs view SPBA meetings like a family gathering, so if someone "just happens" to appear in the same town or hotel, it has the same effect as if someone came to your family gathering to give a sales pitch.  It kills goodwill.  So, the best way to succeed is carefully read and understand this  explanation, get an SPBA Directory in order to study possible candidates, and then start talking in the tone of a possible business partner (not as someone planning to buy and change things).