Protect Your Income Against Future Downside Risk

Would you buy an insurance policy that protects your future income against reduced reimbursements, increased compliance costs, and a wide range of underinsured or uninsured lawsuit threats?

How interested would you be in this policy if the premiums were tax-deductible, the funds were invested under your direction, and the reserves were fully-refundable if you didn’t make a claim in the next 5 to 10 years?

As crazy as it sounds, high-income specialists can accomplish these goals by creating a captive insurance company (CIC). If you are a very successful physician or you work in a high liability specialty, you may want to review how a CIC could seriously improve your overall planning.

Turn threats into opportunities

There has never been more uncertainty about physicians’ future incomes than there is today.

• How will the Affordable Care Act change healthcare?

• Will the Accountable Care Organization model eliminate physicians’ abilities to profit from ancillaries?

• Will your practice be bought by private equity for millions of dollars or run out of business by the local hospital?

• Will increased recovery audit contractor (RAC) audits and insurance fraud claims make it impossible for physician-owned practices to survive the increased cost of compliance?

We don’t know the answers to these important questions, but we do know that CICs can help physicians manage financial risks, reduce taxable income by hundreds of thousands of dollars per year, and build a creditor-protected reserves account to provide finances to manage future changes.

Learn from business owners, not other physicians

The biggest mistake most physicians make is that they focus in their practices by wanting to see more and more patients, not on their practices as businesses that need to be built for profitability and sale.

For over 50 years, businesses have created their own insurance companies to more efficiently manage risk. With more than 6,000 CICs in existence, this risk management strategy can easily be called “mainstream.”

What is a captive insurance company?

A CIC is a company that is properly licensed to provide insurance coverage under the rules of a local insurance department.

For physicians, a CIC provides property and casualty insurance coverage to a medical practice, surgery center, medical products company, compound pharmacy, laboratory, real estate management company, or other business the doctor may own.

In many cases, CICs supplement existing commercial insurance policies by covering deductibles, co-payments, and policy exclusions. In other instances, CICs provide surplus lines coverage similar to what you might find at a Lloyds of London-type insurance syndicate. In other industries, companies have used CICs to insure against legislative risks and the costs of compliance for decades. Now, physicians and hospitals are following suit.

No need to go offshore for captives

Over the past 10 years, the idea of self-insurance has become so popular that 41 of the 50 states have passed captive-related legislation.

When we created our first two insurance companies for one of the world’s largest automobile companies in 1996, there was only one very active state (Vermont) working in this marketplace. Because of a perceived bias within the IRS that offshore planning is more likely to be fraudulent, there has been a spike in new company applications in domestic jurisdictions.

We are starting to see a trend of offshore captives applying to redomicile (move) to one of the 41 states to remove any unnecessary IRS scrutiny. With almost 20% of our business in 2013 dedicated to redomiciles, we found a handful of state insurance commissioners very accommodating and receptive to this business.

Are CICs worth the cost?

Many businesses are enamored by the potential to save taxes on up to $1.2 million of insurance premium per year.

However, not every business can justify such sizeable premiums. Only after a property casualty risk assessment can you truly know what risks are underinsured or uninsured and which ones are ideal for your future captive. If the assessment identifies at least $500,000 of annual premiums for a captive, then it is worth consideration. This is because the fees to create a customized insurance mechanism are not insignificant. You need legal, tax, actuarial, and insurance experience. You also want those experts to take the time to integrate the CIC into both your business structure and your personal financial goals.

The costs are also a factor. Creation fees range from $60,000 to $100,000 for customized CICs. After year one, you can expect $40,000 to $75,000 in corporate taxes, professional fees, licensing, and risk management. Lastly, you have to consider the initial capitalization required to secure your license. Most states require $250,000 of initial capitalization, but a few are lower and more flexible. The accommodations that state insurance departments are making to attract new business are always changing.

The best way physicians can use CICs

Given the current state of healthcare, physicians can go well beyond filling the gaps in their existing commercial insurance policies. Physicians can insure the loss of income from a reduction in reimbursements, loss of a key employee, loss of a contract with a hospital, expenses associated with a RAC audit or insurance fraud claim, delayed reimbursements as a result of ICD-10, and others.

CICs could also add coverage for liabilities excluded by traditional general liability policies, such as wrongful termination and harassment. Given that these awards can be in excess of $1 million, this could be a valuable coverage.

Christopher Jarvis, MBA, CFP, is a former actuary, the co-founder of the Daktori Financial Fellowship (www.daktori.com) and author of 12 financial books. Jim Cushman is a principal at Jade Risk (www.JadeRisk.com)—a captive manager who provides services to over 130 captive insurance companies worldwide. He can be reached at Jim@JadeRisk.com or (855) 523-3747.

Special Offer: For a free copy of Mr. Jarvis’ new book, The Physician’s Money Manual, please go to www.daktori.com/free-book/.