As frequent speakers to physicians on asset protection and advanced planning, we are often asked about captive insurance companies (CICs). Certainly, CICs can be ideal tools if they are created for the right type of practice and are established and maintained properly. In this article, we will examine the benefits and costs of CICs and then demonstrate a case study of two doctors who use CICs to significantly enhance many areas of his comprehensive financial planning.
The CIC we will discuss here is a fully-licensed insurance company - domiciled either in one of the states that has special legislation for small captive companies or in an offshore jurisdiction which has similar captive legislation. Whenever a CIC is established offshore, it is critical that the CIC be compliant with all US tax rules and handled by captive managers, tax attorneys, or CPAs experienced in these matters.
The CIC must always be established with a real insurance purpose - that is, as a facility for transferring risk and protecting assets. The transaction must make economic sense. Beyond this general rule, there is a great deal of flexibility in how the CIC can benefit a client.
First, clients can use the CIC to supplement their existing insurance policies. Such "excess" protection gives the client the security of knowing that the company and its owners will not be wiped out by a lawsuit award in excess of traditional coverage limits. As doctors, you should be concerned with all types of lawsuits - from medical malpractice to practice risks to employment liability - and this protection can be significant. Further, the CIC may even allow the client to reduce existing insurance, as the CIC policy will step in to provide additional coverage, if needed.
Also, using one’s own CIC gives the client flexibility in using customized policies which one would not easily find when using large third-party insurers. For example, many clients would like a liability policy that would pay the client’s legal fees (and allow full choice of attorney), but would not be available to pay creditors or claimants (what we call "Shallow Pockets" policies). This prevents the client from appearing as a "Deep Pocket" (a prime lawsuit target) - avoiding this appearance is a necessary asset protection strategy today.
In addition, the CIC has the flexibility to add coverage for liabilities excluded by traditional general liability policies, such as wrongful termination, harassment, or even ADA violations. Given that the awards in these areas can be over $1 million per case, doctors should understand the value of the CIC for this benefit alone. Let’s see how two such clients used a CIC by looking at the Case Study of Justin and Harry.
Case Study: Justin and Harry Use CICs
Justin and Harry are doctors who each own successful practices and surgery centers. Justin feels like he is paying too much for his group’s medical malpractice and commercial liability insurance policies. After our firm introduced Justin to an attorney and actuary who specialize in CICs, he created one to issue policies that cover the least significant, most common medical malpractice and commercial liability claims (under $100,000 per occurrence). This significantly reduced his existing insurance premiums because he then had much higher deductibles for his 3rd party insurance policies.
Justin believed he could reduce his insurance premiums to commercial insurance companies, implement successful risk management programs, reduce the claims of the center, and reduce his overall payments and costs. Ultimately, he hoped that the CIC would help him increase the profits of the center. He was right. While a significant portion of the $1.5 million in total payments was paid out to cover claims, there was still over $1 million in his CIC reserves after five years. Justin also had the CIC owned by a Trust for his family, so he was able to build the wealth created by the CIC out of his taxable estate.
Harry had a different approach. He established a CIC to insure lesser risks that were not covered under commercial insurance. These policies included Medicare fraud defense, HIPAA litigation expense, and malpractice defense policies (which is available only to pay for the company’s legal fees, but not to pay claimants). After five years, Harry’s CIC did not pay any claims. At this point, the premiums are still growing as reserves of the CIC to be used to pay future claims.
Harry was also considering bringing on younger partners into his practice. He plans on using the CIC as part of an exit strategy for his practice as well, with each new partner responsible for paying some of his buyout from both the practice and the CIC.
Because our society has become so litigious, many doctors have been "self-insuring" against potential losses like the ones named above. These clients have simply saved funds - which will be used to pay any expenses that arise if a risk comes to fruition. This is the proverbial "rainy day fund." While a rainy day fund may prove wise, the client would be better off using a CIC to insure against any risks. That is because - as discussed above - once the premiums are paid to the CIC, the funds enjoy the highest levels of asset protection (+4/+5), can be structured to grow outside the taxable estate, can be structured to layer into a practice exit strategy, and can enjoy extreme income tax advantages as well. None of these benefits are found with the "rainy day fund."
As previously mentioned, the CIC structure must be properly created and maintained. If not, all risk management, asset protection, estate, practice and tax benefits may be lost. For these reasons, using professionals who have expertise in establishing CICs for clients is critical - especially the attorneys and insurance managers involved. While using such experts and a real CIC structure may be more expensive than some of the cheaper alternatives being touted on the internet or at fly-by-night seminars, this is one area where "doing it right" is the only way to enjoy the CIC’s benefits and be 100% compliant.
Setting up a CIC requires particular expertise, as explained above. As might be expected, the professionals most experienced in these matters charge significant fees for both the creation and maintenance of CICs. Set-up costs are typically around $100,000 and annual maintenance costs another $50,000 per year. While these fees are significant (and often fully tax-deductible), the CIC’s potential risk management, tax, practice, estate planning, and asset protection benefits often combine to make it a very attractive option for very successful doctors. There is no better way for successful practice owners to leverage their advisors than to work with them to create such a flexible and efficient planning tool as a captive insurance company.
Because successful doctors have significant risks to insure against, are interested in asset protection, in building tax-favored wealth over the long-term, and in finding practice buy-out and estate planning opportunities, they have many reasons to be interested in utilizing CICs as important planning tools. The interest level in the CIC is even more pronounced with high-liability and high income specialists. If you are a very successful physician or you work in a high liability specialty, you should review how a CIC could seriously improve your overall planning.
Mr. Mandell and Mr. DeVellis can be reached at (800) 554-7233 or at [email protected] For a free audio CD that further discusses this and other personal and practice strategies for doctors, please call (800) 554-7233 or visit www.ojmgroup.com.