 |
Legal Matters > Captive Insurance Companies
The ABCs of CICs [Captive Insurance Companies]
For the right type of practice, with proper set-up and maintenance, our case
study shows that captive insurance companies can be a vital part of doctors'
financial plans.
By david b mandell, jd, mba and claudio a. devellis, JD, CPA
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.
What is a Captive Insurance Company (CIC)?
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.
CIC as a Risk Management Tool
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.
CIC: Compared to Self-Insuring–The “Rainy Day Fund”
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.”
Avoiding Land Mines
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.
Who Can Afford a CIC?
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.
Conclusion: CICs can be ideal for physicians
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.
END
Mr. Mandell and Mr. DeVellis can be reached at (800) 554-7233 or at
mandell@ojmgroup.com. 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.
