Consider captive insurance plan to protect your practice

Key Points

Although it may not be for everyone, in today's economic climate, many medical practices are using "captive" insurance arrangements to stay competitive, reduce expenses, and, in some cases, reap tax savings. A captive insures the risks of a practice, an affliated group of practices, businesses, and even organizations, and it collects premiums and pays the claims more commonly handled by insurance companies.

When a captive insurance program is created, control of premium payments and management of those funds according to the group's own investment strategy is feasible; this setup makes maximizing the yield on the portfolio commensurate with the risk involved. Maturities also can be structured to meet the cash flow requirements of group members.

Industry associations or captive subsidiaries in a multicorporate structure are able to band together for group funding, which will be discussed in this article. Consolidation of coverage and centralization of administrative support are cost-effective strategies in an increasingly competitive world. And tax savings are possible, thanks to the unique tax rules for insurance entities.

LOOKING BACK AND AHEAD

Modern captives began in Bermuda in the early 1960s, and captive insurance was formalized in the late 1970s, with a medical malpractice captive for Harvard University. In recent years, the growth of captive insurance and related risk transfer mechanisms has boomed, driven relentlessly by businesses seeking to better manage insurance needs, including cost, coverage, service, and capacity.

The market for alternative risks, including captives, is very large, far exceeding $100 billion of annual insurance premiums. It is estimated that more than 6,000 captives exist today, with more being formed each week. Insurance industry trends indicate that many practices will, out of necessity, implement a captive or alternative risk strategy over the next few years.

A PRIVATE LETTER RULING

In fact, recently, a practice, operating as a limited liability company, together with a number of other practices, proposed to form a "Risk Retention Group" (RRG).

The group would issue insurance policies for (1) medical malpractice liability coverage for active physicians and practices that are underserved by the commercial professional malpractice insurance market, and (2) "tail" or extended reporting endorsement coverage for retired physicians and practices.

The practices plan to form a RRG with each initial member owning an equal share in the proposed insurance entity. As the core operations grow and expand, additional entities are expected to join the membership and attain a prorata share of the RRG's ownership. The RRG will be registered, admitted, and regulated by its state department of insurance and licensed as an association captive insurance company.

Based on the carefully tailored facts presented, the Internal Revenue Service (IRS) issued a Private Letter Ruling (PLR), in essence, pre-approving the proposed RRG. The IRS concluded that amounts paid by the medical practice to the RRG for medical malpractice liability insurance can be treated as "insurance premiums," to the extent that such premiums are for current year coverage.

Of course, the RRG will issue policies with standard lines of liability up to a fixed amount per claim and an annual aggregate to physicians providing medical services under the relevant practice's contract. The RRG will retain the risk for part of each claim and buy reinsurance for the balance.

The RRG will be managed internally and it will maintain all responsibility for underwriting, policy service, claims and risk management, financial management and reporting, and reinsurance procurement and administration.

Most importantly, at least to the IRS, premiums for both medical professional liability coverage and any extended reporting (or "tail") coverage will be determined at arms-length. A risk management and actuarial consulting firm will develop premium rates, by state, for RRG risks. Underwritten physicians will be rated according to a scoring system based on training, loss history, and other underwriting factors.