ESG Reporting in Healthcare

Executive Summary

Organizations in all sectors have been utilizing Environmental, Social & Governance (ESG) Framework to communicate their social commitment and actions to stakeholders – customers, investors, government and other advocacy groups. Healthcare sector is catching up with its contribution to ESG commandments as well. Since the COVID-19 pandemic, pressure by consumers, communities, employees and the federal government has been mounting for healthcare organizations to adopt and invest in socially responsible principles and values.

The U.S. Securities and Exchange Commission is considering requiring public companies to report on their ESG commitments, with a particular focus on environmental impact. Not-for-profit hospitals are also consistently questioned by government entities about the validity of their tax-exempt status, and embedding ESG principles may help them better respond to these concerns. This article is a high level overview of the trends, reporting frameworks and investor impacts of ESG in healthcare.

ESG Reporting in Healthcare firms

The impact of ESG on healthcare firms – hospital systems (providers), pharmaceutical firms, medical device manufacturers, payers (insurance companies), pharmacies, etc. - can broadly be classified into 2 categories.

1.?????ESG’s impact on firm’s credit ratings

2.?????ESG efforts taken by healthcare firms

Both type of impacts require the creation of an ESG framework and accounting processes to measure and report them.

For now, under a lack of industry wide ESG framework, organizations have been experimenting and trying to standardize their own ESG framework that helps to –

• accurately set ESG goals
• allocate resources
• set & collect metrics
• measure & monitor progress
• report the financial impact to their consumers, investors, regulators, etc.

ESG’s impact on Credit ratings

Ratings firm S&P Global has come up with a rating framework to assess the exposure/risk of firms to ESG aspects.?

Environmental exposure:

“Extreme weather or supply disruptions can affect some manufacturers, but to date this has rarely caused credit deterioration. Pharmaceutical product, medical device, and life science product manufacturing involve hazardous substances and can produce byproducts that could harm the environment. Environmental remediation and failure to comply with regulations can be costly or cause plant shutdowns, which could affect product supply.”

Social Exposure:

In developed countries, aging populations put cost pressure on health care systems. Improving health outcomes while raising the cost effectiveness of therapies are increasingly becoming twin goals for health care companies. In some markets, including the U.S., public debate focuses on the accessibility and affordability of medicines and quality care and relatedly the transparency of prices. Increasingly, payers are advocating that health care providers and manufactures be compensated for the value they bring, to better align incentives.

We expect any potential drug pricing reform in the U.S. would only moderately burden EBITDA margins for pharmaceutical companies, because we believe the significant social benefits from the industry will lead to a balanced approach that supports continued investment in research and development (R&D) and attractive levels of returns and profitability.

We believe pharmaceutical companies that are highly innovative, invest in R&D, meaningfully improve disease treatment, are thoughtful of public opinion in developing their pricing strategies, and have a reputation for clinical excellence and regulatory compliance have more sustainable business models. In contrast, those that have a limited pipeline and rely on acquisitions, primarily develop and manufacture lifestyle drugs or raise prices significantly may face greater challenges. For many U.S. health care companies, efforts to reduce system costs will likely require many companies to evolve. This will also contribute to reimbursement risk, which already constrains ratings on providers, particularly hospitals, which deliver the most expensive of health care services. Reimbursement cuts, lower rate increases, efforts to move more volume to the lowest-cost sites of care, a greater uninsured population, and adverse shifts in payer mix can diminish the financial profile of these companies. We view adapting companies as having stronger business risks.

Medical device manufacturers and pharmaceutical manufacturers must ensure the quality and safety of their products because safety issues could be life-threatening or debilitating. The risk of litigation related to safety matters could impair credit quality.

Governance

The health care industry is highly regulated; the government is an important payer for health care services and products. There are also regulations involving safeguarding patient information, safety testing, monitoring and manufacturing quality, and marketing compliance. Noncompliance with these regulations, improper billing for services and products, aggressive marketing tactics, pricing manipulation, and failure to protect patient privacy have surfaced within the sector and can affect ratings.

McKinsey & Co expects external actions such as regulations, activist investors, consumer demand on ESG actions, etc., can impact a healthcare firm’s EBITA by 25-30%. So healthcare firms need to plan and act to prevent any adverse impact on their margins.

Source: McKinsey & Co

Not only are healthcare firms required to anticipate external demands/actions on ESG factors but should also quantify, measure and report those risks. As a risk mitigation mechanism, healthcare firms are better off taking action pro-actively to improve their ESG ratings and capture value from it. Which brings us to our next section on ESG actions taken by firms….

ESG efforts taken by healthcare firms

Under the Social category of ESG framework, healthcare firms have been designing and implementing Diversity, Equity & Inclusion (DEI) among its employees and invest and improve the Social Determinants of Health among the communities served by them.

Healthcare providers & payers alike have been formalizing their ESG commitments by setting clear goals and expectations, prioritizing them for corporate investments, creating multi-disciplinary working groups and creating transparency on the ESG framework. The transparency has been a key demand by the healthcare consumers, investors, lawmakers, donors and regulators to help decide their level of engagement with the healthcare firms. Top leadership has been providing sponsorship on ESG initiatives once ESG goals and measures are publicly disclosed. The hospital systems still seem to be lagging behind in effectively taking actions on the “E” and “G” aspects of ESG, other than sustainability initiatives. Cross-functional ESG steering committees, ESG dedicated board, etc. are some of the other leading trends.

Firms proactively taking actions on ESG stand to achieve revenue growth, cost reductions, prevent adverse regulatory actions, improve productivity and optimize shareholder returns. E.g.: Positive ESG actions can draw environmentally or socially minded consumers and investors, increasing revenue. Green initiatives can reduce operating costs.?

How can firm’s Report ESG metrics?

Many investors are demanding ESG metrics beyond what is currently available in financial statements. This is driven by regulations, a need to generate market beating financial returns, investors following UN Principles on Responsible Investing, increased awareness on impact of climate change on corporate profits, etc.

As first step, healthcare firms need to build traceability into their values streams and processes, have the right team of experts to perform due diligence and accurately quantify their ESG metrics across operations. Consistent, easily available, and easily interpreted ESG metrics are an essential requirement for any investor effort to measure the impact of capital allocation choices on the natural and social ecosystem.

Hiring the right team with knowledge in digitizing value streams, financial reporting requirements, ESG metrics, and healthcare domain can make a huge difference. Is your firm ready to take on the ESG challenge?

Please leave your thoughts below.