Captive insurance Companies — The Ultimate Practice Tools
Many Doctors will build their wealth primarily through their professional practice. Typically, the practice is not only the vehicle that allows the client to use Leverage, but also the vehicle which creates the bulk of the client’s annual income and long-term wealth accumulation. Given this fundamental importance, it is essential that Doctors do everything possible to protect the practice and maximize its Leverage potential. The best tool for achieving such protection and Leverage is the one we will discuss in this chapter—the captive insurance company (CIC). In this chapter, we will discuss what a CIC is, what benefits it offers, and how Doctors can use it to maximize the benefits they get from their practice planning.
Early in the book, we stressed the importance of using tools that have multiple benefits. By using tools that offer multiple benefits, Doctors can compound their Leverage and achieve a number of planning goals more efficiently than if they tried to reach their goals one at a time. Of all the tools discussed in this book, the CIC can be the most efficient. For clients who own successful businesses or professional practices, the CIC often becomes the cornerstone of the ascent to a desired level of affluence. This is because the CIC affords the following benefits:
· Superior risk management for the practice.
· Reduction in the practice’s insurance expenses to third-party insurers.
· The ability to capture profits on insurance policies.
· Highest levels (+4 and +5) of asset protection for CIC assets.
· Superior income tax treatment for CIC income (when the CIC is properly structured and maintained).
· Significant estate planning benefits (when the CIC is properly integrated with estate planning tools).
· Creation of a potential buy-out mechanism for older owners of the practice upon retirement.
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 must be 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 its owner(s).
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.
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 in today’s highly-litigious society.
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 hired them to create a CIC to issue policies that cover the least significant, most common medical malpractice and commercial liability claims (under $100,000 per occurrence). These self-insured policies significantly reduced his existing insurance premiums because he then had much higher deductibles for his third-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 total 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 created the CIC owned by a Trust for his family. This way 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 are 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 is also considering bringing 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.
The purpose of the case study is to demonstrate that clients can purchase policies from their CIC that are similar to policies offered by traditional third-party insurers or can purchase less common policies. In either case, CIC owners have an opportunity to enjoy powerful asset protection, tax, retirement, and estate planning advantages from using a CIC. In essence, the question for the client becomes:
If you are going to use insurance to protect against risk, why give away the potential profits, asset protection, and tax and estate planning benefits when you do not have to?
Let’s more closely examine a few of the benefits of having a 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 up funds to be used to pay any expenses that may arise from a risk. 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. This is because premiums paid to the CIC 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 tax advantages as well. None of these benefits are found with the “rainy day fund.”
Avoiding Land Mines
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. It is especially important that the right attorneys and insurance managers are 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 with Federal and local laws and regulations.
Doctors face various financial threats that range from operational problems to exit strategy challenges and from lawsuit threats to increasing operational costs. Astute Doctors not only want to mitigate these risks, but to do so in an efficient manner. For these reasons, Doctors who own very successful practices use captive insurance companies (CICs). A CIC can be a valuable tool in addressing many of a Doctor’s planning challenges at one time. In fact, perhaps no other tool described in this book can impact a client’s overall wealth protection and long-term accumulation as much as a CIC. Once you read the rest of the book and understand all of the available planning options, you will have a greater understanding and appreciation of the value of a CIC.