Home / Personal Finance / Consider a captive insurance company

Consider a captive insurance company

By David B. Mandell, JD, MBA & Richard J. DiPasquale, CLU

As frequent speakers at medical conferences, there is no topic about which we get more interest than captive insurance companies (CICs) and how physicians can use them. This has been especially true in the last few years, as medical malpractice insurance premiums have soared. Certainly, CICs can be ideal tools, if established and maintained properly, and if suited to the individual doctor’s or group’s economic need. In this article, we will examine the benefits and costs of CICs and explain the beneficial legal changes that occurred in the last year.

The CIC we will address here is a legitimate insurance company, licensed to write insurance in the U.S., but typically based in an offshore jurisdiction, such as Bermuda or the British Virgin Islands. Most CICs are established in these countries because of their favorable insurance laws and tax treatment, although the funds in the CICs can be maintained and managed in the U.S. In fact, these offshore CICs have grown to number over 4,000 companies, writing an estimated US$60 billion in premium per year, or more than a third of the total commercial insurance market in the United States. While Fortune 500 companies have long used CICs to protect assets and gain tax advantages, it is only in the last decade that individuals, business owners and professionals have begun to take advantage of them as well.

The physician/group’s CIC may be used to insure all, or portions of, the medical practice’s significant risks, such as malpractice or high liability non-malpractice risks like wrongful termination sexual harassment, or loss of electronic medical records (see following discussion of CIC as asset protector). Alternatively, the CIC might be used to insure relatively low liability risks like the loss of licensure. Regardless of the type of risk, like most insurance, the CIC will transfer most of its risk to another re-insurer. Thus, the CIC can be structured to have as much or as little economic risk as the physician chooses, while allowing the significant tax benefits described below.

CIC As An Asset Protection Tool

The CIC has a number of asset protection advantages. First, physicians can use the CIC to supplement (or in some, cases, even replace) their existing malpractice policy. Such supplemental malpractice protection may allow the physician to (1) have a larger deductible from their traditional carrier or (2) lower limits from their traditional carrier. Either strategy will save the doctor significantly in out of pocket premium costs each year.

Further, the physician could use the CIC to provide additional coverage beyond the traditional limits. As physicians see more and more outstanding jury awards in medical malpractice cases, this protection can be significant.

Also, using one’s own CIC gives the physician flexibility in using customized policies which one would not get using large third party insurers. For example, many physicians would like a malpractice policy that would pay the doctor’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 physician from appearing as a “Deep Pocket” – a necessary asset protection strategy today.

Finally, the physician’s CIC has the flexibility to add coverage for liabilities ignored by traditional malpractice policies, such as wrongful hiring/firing, economic losses from the practice, or even HCFA or HIPAA violations. Given that the awards in these areas can be over $1 million per case, physicians would be well-advised to use the CIC for this alone.

Although physicians can sometimes purchase policies like the ones described above from traditional third party insurers, they would not enjoy the powerful tax advantages described above. In essence, the question for the doctor becomes: If you are going to use insurance to protect your assets, why give away the potential profits to the insurance company, when you could own the company yourself? Let’s examine this more closely.

Annual Deductions & Superior Asset Protection

Because our society has become so litigious in recent years, many physicians have been “self-insuring” against potential losses like the ones named above. These doctors have simply saved funds – which will be used to pay any lawsuit expenses which arise. While this planning may prove wise, the doctor would be better off using a CIC to insure against such risk. That is because premiums paid to the CIC can be fully tax deductible, while amounts saved to “self-insure” are not. The CIC in other words, may allow doctors to get a full deduction each year – protecting against the same risks they previously “self-insured” against.

Moreover, when the physician “self-insures,” the funds stay in his/her name, or the name of the practice. Thus, they are available to any lawsuit claimants, creditors, divorce proceeding, bankruptcy trustees, etc. who may attack the doctor’s assets. Simply put, there is no asset protection tool shielding the “self-insured” funds. Conversely, using the CIC, the physician has transferred such funds to an independent operating, fully-licensed insurance company. Any lawsuit, claim, divorce, tax or other action against the physician or his/her practice is completely separate from the CIC. Thus, the funds in the CIC are ideally asset-protected against any litigation risks of the physician.

No Loss Of Control

When investigating the merits of a CIC, many physicians are concerned with losing control of the funds paid to the CIC. While the physicians’ concerns are certainly justified, the proper CIC structure allows for complete control by the physician. There is no need for the physician to trust any other person or entity with their assets – a drawback of some of the other asset protection structures we use as planning professionals, such as irrevocable trusts. Further, while the CIC may be established outside the U.S. to keep administrative costs low (although certain U.S. states can also be used), the CIC funds can remain in the U.S., in American stocks, mutual funds, money management accounts, etc.

Legislative Changes Make CICs Even More Viable

In 2004, President Bush signed into law the Pension Funding Equity Act of 2004 (H.R. 3108). Although the bulk of the provisions of this act related to pension funding requirements and issues relating to employee retirement plans, several provisions were included which impacted CICs formed under tax sections 501(c)(15) and 831(b).

While the details of the new legislation are beyond the scope of this article, in general, the changes clarified and simplified the eligibility standards for small CICs. For example, CICs now formed under 831(b) no longer have a minimum premium requirement, when before the minimum was $351,000. This allows the 831(b) company to be a viable alternative for profitable medical practices looking for risk management, asset protection and tax benefits when its revenues are less than $3 million per year – this was not the case before. Because the 831(b) company is much easier to form than a 501(c)(15) company, such a change is a significant one.

Even more positive than the specifics of the legislation is that we now have conservative, clear guidance from Congress on what a CIC formed under these tax sections can be and what it cannot be. No longer can the abuse of a few taxpayers taint the legitimate tax, risk management, and asset protection benefits of such structures for clients who use the CIC for its intended purpose. This has been our position all along, and now we have specific legislation on point.

Given the recent environment where the IRS has systematically eliminated many tax-beneficial strategies, such clear guidance from Congress and the President (to whom the IRS reports) shows us that CIC, when done right, are a legitimate solution that is here to stay.

CIC Costs and Landmines

Setting up a CIC requires particular expertise. Thus, 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 $50,000 and annual maintenance costs another $25,000, although CICs can often be established for a group of physicians (where all funds are segregated for each doctor) for about $15,000 per doctor. While these fees are significant, given the CIC’s potential tax and asset protection benefits, they are viable options for many physicians and/or groups practicing in high-income high-liability specialties.

The CIC structure must be properly created and maintained. If not, not only may all asset protection and tax benefits be lost, but the doctor may suffer serious tax penalties as well. For these reasons, using professionals who have expertise in establishing CICs for physicians is critical – especially the accountants and attorneys 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 stay out of trouble with the IRS.

Because they have both significant and minor risks to insure against, because they generally have high income tax liabilities, and because they are interested in building asset-protected wealth over the long-term, CICs are important planning tools for all types of doctors. This match of problem and solution is even more pronounced with high-liability specialists. In short, CICs should be considered as an integral part of the doctor’s business planning strategies.

David B. Mandell, JD, MBA is an attorney, lecturer, and author of Wealth Protection, MD. He is also a co-founder of The Wealth Protection Alliance (WPA) – a nationwide network of independent financial advisory firms. Richard J. DiPasquale, CLU, ChFC is a Principal of the Wealth Creation and Protection Alliance, which is a charter member of the WPA.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.