InFocus: ESG in healthcare – behaviour change, measurement and implementation

Reducing environmental impact and meeting social responsibility standards are now more important than ever to society. Junior associate Will Johnson and senior partner Adam Scott of Mansfield Advisors discuss how investors are playing an influential role in driving this change in healthcare with the help of key performance metrics

ESG is here to stay

Environmental impact, Social responsibility, and ethical Governance (ESG) of companies has become increasingly important to consumers and investors over the last decade. The Global Sustainable Investment Alliance estimates over a third of assets under management in the geographies it covers qualify as ‘sustainable investment’, and many large companies (more than a third of S&P 500 companies in 2021) also mention their commitment to ‘ESG’ in marketing and reports, including those that would not traditionally be labelled as companies fitting these criteria, such as oil and gas.

Healthcare providers in Europe have been slow to adopt ESG including seeking out green financing, partly because measuring sustainability in their sector is difficult, but the pace of adoption is accelerating with real estate investors, debt providers and companies themselves increasingly including an ESG component.

Behaviour already changing

Investors can accelerate this change to better ESG compliance and are themselves coming under increasing pressure from their LPs and even debt providers to do so. High social responsibility standards like maintaining service user quality-of-life have always been important, but aside from the obvious moral obligations of care providers to deliver good care, there are also strong financial incentives. High Care Quality Commission (CQC) ratings are strongly correlated to high occupancy levels which drives profitability, and the downside reputation damage from scandals where providers fail to deliver good care is significant. For example, the ongoing Orpea elderly care homes situation in France, Castlebeck’s Winterborne View care home scandal and numerous individual facilities such as Aurora’s St Christopher’s children’s residential home closure and homes operated by Kisimul, Hesley, Cygnet, Priory and others.

Identifying the best performing assets to reduce risk and to promote improvements to sector social responsibility standards means investors need to undertake the correct due diligence. What does this look like? The quality of analysis from established expert firms has evolved over the years and is now more sophisticated; it includes targeting specific, relevant, performance indicators such as carer staffing ratios, resident average length of stay, workforce churn, facility types, staff compensation and welfare standards as well as interviews of key stakeholders such as commissioners. This all builds on available CQC quality reports, which although a good starting point are often outdated and have insufficient detail.

Measuring ESG still inaccurate

Quality of care is clearly important and relevant to both ‘S’ and ‘G’, but investors also need specific information to measure potential acquisitions on their broader ESG performance and target companies accurately.

One reason the pace of adoption has been slow in healthcare is due to the United Nations’ Sustainable Development Goal (SDG) 3, introduced to ensure healthy lives and promote well-being. It is particularly challenging to develop measurable key performance indicators (KPIs) in these areas and just 47 healthcare funds around the world (0.51% of all healthcare funds) had a greater than 50% alignment with SDG 3, according to a June 2021 report from index provider MSCI. This is compounded by other social KPI measurements under SDG 3, which are harder to measure than KPIs focused on, for instance, energy usage.

ESG rating systems are getting increasingly sophisticated, with agencies like Sustainalytics and MSCI now providing investors with information to identify companies with good ESG credentials. However, this system has been criticised (for example in The Economist special report ESG Investing published in July this year) for not fully measuring actual meaningful ESG-related qualities of companies, and therefore not providing accurate selection criteria to investors. This is demonstrated by ESG ratings for companies differing significantly between rating agencies: the Aggregate Confusion Project quantified the correlation at only approximately 60% for ESG, in comparison to the more-than 90% correlation for well-established financial credit ratings from S&P, Moody’s and Fitch. Therefore, while the introduction of ESG ratings has prompted companies to talk about ESG-related matters and make some operational changes, measuring it remains imperfect.

Implementation has been driven in Europe by investor sentiment

Implementation differs by geography. In the US investors are looking for ESG compliant healthcare opportunities, but not at the expense of the economics of the underlying transaction. In Europe, insurance companies and fund manager appear to be willing to pay a modest premium for ESG compliant assets, making their issuance both responsible and good financial sense. The difference is demonstrated by the mentions of ESG in reports by S&P 500 companies materially increasing, but taking action, in the form of specific scientific emission targets, remaining much more prevalent in the EU than the US (Figure One).

Demonstrating European investor sentiment, last year issuance came from pharma, real estate, care homes and hospitals. Swiss pharmaceutical company Novartis sold a €1.85bn sustainability-linked bond, French senior care operator Korian sold an inaugural £200m perpetual green bond and FTSE-250 healthcare real estate investment trust Assura issued a £300m sustainability bond. French hospital operator Elsan – owned by private equity firms Ardian and KKR – took a €1.6bn loan with terms linked to patient satisfaction, medical waste reduction and quality of work life of its employees. Finnish private healthcare provider Mehiläinen, owned by private equity firm CVC Capital Partners, agreed to a €1.06bn loan with the margin tied to the quality index of care services for the elderly, access to non-urgent care at Mehiläinen’s public health centres, as well as the firm’s carbon dioxide emissions. German healthcare group Fresenius and its renal care subsidiary Fresenius Medical Care each sold a €2bn sustainability-linked loan, whilst Ramsay Santé signed a €1.45bn sustainability-linked term loan and this year parent Ramsay Health Care in Australia issued a AUD1.5bn Sustainability-Linked Loan.

This change in market activity is also being reflected in reporting with most large international real estate managers including Welltower, Ventas, NorthWest Healthcare and Medical Properties Trust featuring extensive ESG policies in quarterly performance reports and on websites. Assura has publicly committed to targeting net zero for new primary care real estate and LNT Group now builds net zero care homes with heat pumps, solar panels and design features to maximise the quality of care and minimise the environmental impact.

Rising energy costs and inflation: an additional incentive for implementation

The direct financial pressures for reducing energy usage are also stronger than ever in the ongoing crisis. With such rapid price increases occurring, many fund managers will be paying greater attention to asset energy costs for the first time.

We are all by now painfully familiar with the forecasts for the remainder of 2022 and 2023, with the per-kWh prices for Electricity and Gas expected to increase from 21p and 4p respectively in 2021 to 52p and 15p in Q1 2023, according to DBEIS projections (with 2022 averages of 32p and 9p). The implications of these increases are meaningful. We estimate a typical private hospital will experience 2% EBITDAR margin reduction at the forecast 2023 prices, from a base performance of around 20%, arising from a £500-600,000 energy bill for a typical 40 bed private hospital, an excess spend of over £350,000 (see Figure Two).

While the full impact of price increases will be delayed for winter 2022/23 by recently announced price caps outlined in the Energy Bill Relief Scheme in the UK (and equivalents elsewhere), the impact will be felt eventually. A 2% reduction in EBITDAR margin impacts the rent cover for landlords, the interest cover for lenders and the returns to shareholders. Therefore, building net zero, ESG compliant assets makes even more commercial sense, but more importantly investors should ask themselves what initiatives are available to improve the energy efficiency of their existing hospitals or homes, what are the up-front capex requirements, and what are the payback periods?

Making ‘green’ upgrades to facilities now represents a means to improve mid-to-short-term profitability as payback periods have been significantly shortened, on top of long-term risk protection. Most healthcare infrastructure was constructed pre-2000 (over 60% of the NHS estate according to the Naylor report), meaning there is significant scope to benefit from retrofits that are now attractive investments. For example, the payback period on upgrading old 32W fluorescent lighting to 17W LEDs is now only a few months and upgrading 100mm loft insulation to 270mm would pay for itself in only five years (less than two for a non-insulated building) compared to ten or more in the past. Even high-capex solar panel installation is an attractive long-term cost-saving solution, paying back initial investment in less than three years at originally forecast 2022 prices (Figure Three).

If prices do return to more ‘normal’ rates by 2024, removing the financial incentives for upgrades, then government legislation is also increasing pressure on property owners to be more environmentally friendly. A December 2020 BEIS White Paper suggests EPC ratings of at least B will be required for commercial buildings by 2030, as part of the government’s aim to reach carbon neutrality. Currently, most healthcare facilities are rated D or worse and only the most modern facilities are achieving EPC ratings of B, for example Spire’s Manchester and Nottingham hospitals, both built in 2017. Action will therefore be required for most of the existing infrastructure.

Investors should seriously consider making eco-upgrades across their portfolios to improve ESG credentials, for both short-to-medium term financial benefits and futureproofing against government policy. There are examples of major healthcare real estate players already taking action: Welltower has committed to full LED bulb replacement across their retirement home portfolio, and PHP has devised targets to reach net zero in current asset operations by 2023 and in their new developments by 2025. While the current energy crisis may turn out to be transitory, we anticipate ‘E’-related risks associated with future turmoil in the energy markets to firmly remain on the minds of investment committees for years to come, creating additional pressure to improve environmental impact performance across the sector. Once made, these investments should mean healthcare facilities will no longer be relative laggards in environmental issues and will catch up with other sectors, while retaining their relative leadership on social impact and governance concerns.


Two key themes emerge. First, care quality matters more than ever and is correlated to higher returns. Service user quality of life remains centre-stage when assessing healthcare facilities for investment, with inferior quality infrastructure or operators failing to meet service standards continuing to expose investors to reputational risk.

Secondly, broader ESG considerations aside from care quality are also increasingly important although less easy to measure. Meaningful practical ‘green’ initiatives are moving up the list of priorities for asset managers and operators owing to stronger financial incentives and a newfound realisation of potential future business risks associated with ignoring them. However, today North America and Europe differ. In the US, ESG compliance is often mentioned but remains more of a ‘nice to have’, not a ‘must have’. In contrast, in Europe there appears to be a better sector ESG performance driven by legislation and investor requirements leading to better pricing for ESG compliant assets.