APP, which employed physicians and contracted them out to emergency rooms across the nation, had been struggling for months. Over the summer, it seemed to have found a solution, striking a deal to sell itself to SCP Health, but that arrangement fell through.

As it prepared to wind down, APP said it would transfer its contracts to competitors and hospitals. Two weeks later the company was closed for good.

Employees took to Reddit, blasting the supposed profiteering of investment firms: “Private equity doesn't care about us — milk dried up and now time for slaughter,” one user wrote, apparently not appreciating that APP’s equity value had just been wiped out.

Another former employee, who joined APP because of its above-market pay, told 9fin: “If they had told us they were going to close their doors, people would have left a long time ago.”

What hastened APP’s meltdown was a piece of government legislation called the No Surprises Act. The company was caught in the crossfire: even though it didn’t engage in the practices this new law was intended to curtail, its business model was fundamentally altered by it.

Oops

The private equity firm Brown Brothers Harriman Capital Partners acquired APP in 2016, and then loaded it with debt to fund an acquisition spree. This debt-funded roll-up model worked for a good few years, until the Covid pandemic rocked the healthcare sector.

In 2021, the company struggled to refinance its debt in the leveraged loan markets. Then came the final blow: the No Surprises Act, which came into effect in early 2022.

Designed to shield patients from unexpectedly high medical costs (known as ‘surprise’ or ‘balance’ billing), the NSA has accelerated the day of reckoning for many debt-laden healthcare providers, which were already grappling with rising interest rates, wage inflation, and a slow recovery in patient volume after the pandemic. Envision Healthcare and Air Methods, for example, both cited the legislation when they filed for bankruptcy this year.

With backing from both major political parties, the legislation is designed to crack down on the practice of billing patients directly for the balance that is left over when insurers underpay or outright deny to cover the cost of care provided by out-of-network doctors at in-network facilities.

While APP didn’t directly engage in balance billing, the legislation led health insurance companies to adopt less favorable payment terms in general, which then significantly impacted the company’s revenue.

“The regulatory implementation of the NSA was problematic, effectively shifting the balance of power in payment disputes too far in the favor of insurance companies,” wrote APP’s chief restructuring officer John DiDonato in court papers.

A similar dynamic is playing out across the healthcare industry, especially among physician staffing, radiology, anesthesia and air ambulance operators that were heavily dependent on their ability to bill patients directly.

“For a lot of the smaller healthcare groups, it’s very tough for them to stay solvent with these very low payments as insurers kick away payments,” said Jeffrey Davis, health policy director at McDermott+Consulting, a consulting and lobbying firm.

Can’t get paid

Businesses like APP have low margins and are heavily dependent on juicier payments from private insurers to offset lower reimbursement rates from government insurance schemes (typically, healthcare providers break even on Medicare claims and lose money on Medicaid).

But since the NSA came into effect, many of these providers find themselves locked in protracted legal battles to get paid for these more lucrative claims.

“Insurers have flooded the arbitration process by underpaying on the front end,” said Patrick Velliky, vice president of government affairs at Envision. “So we have no other recourse but to pursue arbitration.”

The volume of such disputes has far exceeded the expectations of Federal agencies, creating a huge backlog of claims. So far, firms such as Radiology Partners, TeamHealth and Envision say they are winning the vast majority of these disputes — but insurers are slow to pay up, according to sources.

Close to 60% of the arbitration awards that Envision has won are currently unpaid and past due, said Velliky. The company said in court filings that its largest payor (an insurer) has slashed its reimbursements by nearly 60% over the past five years, reducing revenue by more than $400m.

Similar pressures were among the factors that pushed Air Methods, a helicopter ambulance provider, into bankruptcy in October. The company is expected to hand control to a group of lenders, wiping out the equity stake of its sponsor American Securities.

Rising stress

Once upon a time, firms like Envision and Air Methods were seen as stable and attractive businesses for private equity firms. By loading up on debt to acquire smaller competitors, they could grow scale and this gain negotiating power with insurance companies.

Similarly, credit investors bought into this strategy for years, bankrolling these firms in the debt markets. Now, the rising cost of borrowing alone makes this strategy far less appealing than it was in the zero interest rate era; add the NSA on top, and it’s a doozy.

“Now there’s a capped growth profile and margins are being squeezed,” said a credit investor familiar with the sector. “It's less attractive from a sponsor standpoint and makes it more challenging for debt investors.”

A spate of upcoming debt maturities will put some riskier credits to the test.

Global Medical Response has begun talks with lenders ahead of a roughly $4.5bn debt wall in 2025, as 9fin reported earlier this month. The KKR-backed company generates the bulk of its transport revenue from less profitable services paid by Medicare and Medicaid, and less than 5% of its annual sales from out-of-network providers, according to analysts at S&P.

Meanwhile, Radiology Partners (which we mentioned earlier) is exploring its options as it faces more than $2bn in near-term debt maturities. The medical imaging provider has been grappling with tightening liquidity as the NSA delays expected payments from insurers.

The healthcare sector represents 21% of the distressed bond and loan universes, and will likely remain a large contributor to distressed activity in 2024, according to research published by JP Morgan earlier this month.

Pendulum swing

People within the industry are hesitant to forecast exactly when this slump might end, but a series of recent legal rulings is providing some hope that reimbursement dynamics could eventually change.

Four lawsuits have been filed in Texas against the NSA’s guidelines on the arbitration process, and healthcare providers have won in every one of these cases. That has reinforced an increasingly popular view that arbitration may not be the most economically sensible route for insurance companies going forward.

“Many insurers that go through arbitration have to pay more than they would have if they had contracted the service providers [directly],” said a credit analyst. “At some point, there will be a reversal of kicking the providers out of network.”

Some healthcare investors are playing the long game, betting that financially weaker companies will cede market share to stronger ones. TeamHealth and Radiology Partners have both been able to pick up hospital contracts from struggling competitors, sources noted.

That’s a far cry from the dreams that these companies — and their private equity sponsors — were selling before the NSA came into effect, but it might just be enough.

“It may still not be an attractive neighborhood to be in,” a portfolio manager said. “But the ones that survive can pick up the volume and keep their margins more insulated.”