Provided By Andy Parker, CFA, CFP®, Senior Financial Advisor at Larson Financial Group
One of the unfortunate realities of practicing medicine is that most doctors will be the target of a lawsuit at some point during their career. In fact, a study published by the New England Journal of Medicine found that a staggering 99% of physicians in high-risk specialties will be sued by the age of 65.1 Medical malpractice insurance is essential and, depending on specialty and geographic location, can be one of the more substantial costs associated with operating a medical practice.
One alternative risk strategy available to medical groups is to form a captive insurance company. Through this process, the medical group(s) establishes its own insurance company to provide medical malpractice insurance. For certain specialties in high-risk states, this can be a very cost-effective solution. It can reduce malpractice premiums drastically while protecting some of the practice’s assets at the same time.
What is a Captive Insurance Company?
Captive insurance companies (CICs) are properly registered and capitalized insurance companies owned by one or more individuals. Their sole purpose is insuring the company that owns it, hence the name captive. They are subject to all the regulations and reporting requirements of the state they are formed in, and therefore must be run with a high degree of compliance and disclosure.2 However, it’s important not to confuse CICs with Risk Retention Groups (RRGs), which are held to an even greater degree of oversight and scrutiny.
Doctors have very high insurance premiums. Instead of paying these coverage premiums to a private insurer with built-in company costs such as overhead, commissions, advertising, etc., you could pay these premiums into a company that you own with the flexibility to either reserve or re-invest those premiums in a tax-advantaged way for the profit of the insurance company. Essentially you’re turning an expense into an asset.3
You’ll still want to purchase medical malpractice insurance from a commercial carrier, albeit one that offers high-deductible plans with substantial discounts. Your CIC exists to insure the deductible of that policy. The ultimate goal is to be properly insured while maintaining control of premiums as much as possible. In some cases, captives are used to provide supplemental coverage on risks not covered in traditional liability policies such as data breach or employee lawsuits.2
Potential Benefits of CICs
Captive insurance can help stabilize risk management costs by insuring risks that are currently uninsurable or insurable only at a prohibitive cost. It allows you the flexibility to determine premiums based on the group’s loss experience instead of the experience of a comparable peer group where loss ratios could be much higher.4
If you’re able to manage and avoid risks while limiting your claim history, you may soon find yourself sitting on a surplus of reserve funds that are asset protected. Early on, you’ll want to keep this money very liquid in case a claim needs to be paid. As time goes by, you can put these surplus funds to work with an investment strategy that fits your group’s goals and objectives.
If you’re lucky enough to avoid any claims before retiring from your career in medicine, you can use this money as a supplemental retirement income. Not only will you be improving the practice’s bottom line by reducing insurance expenses, but there are potential tax advantages as well if you follow proper guidelines. In addition to deducting the premiums as an expense to your business, any future distribution of profits from the captive you own would be taxed at the more favorable capital gains rate. Taxation should not be the primary justification for the creation of a captive insurance arrangement, and realizing these benefits requires the management of specialized tax and legal counsel.5
Potential Risks of CICs
A captive insurance arrangement is not an ideal fit for every medical practice. Generally speaking, a practice would need to generate a gross operating income of at least $300,000 per year in order to justify the cost of establishing and maintaining a CIC. However, if your practice has several benefit-eligible employees and a high profit margin, it could be a prudent move to explore the viability of adding a captive.
Founding a CIC is a complex financial undertaking, and the fees to create a formal insurance mechanism can be hefty. It should not be undertaken without a competent team of professionals in the legal, tax and actuarial disciplines with extensive experience in this type of insurance. Importantly, these experts must take the time to integrate the captive into both the existing business structure and into the owners’ personal financial goals. The cost may be $50,000-$100,000 to create the CIC and $40,000-$80,000 annually to maintain it.5 It will also require the buy-in and contributions of your partners and other key stakeholders in the practice to be economically viable.
If used appropriately, many physicians and physician-owned practices can benefit from implementing this unique financial solution. Besides shifting risks from the practice partners onto the CIC, all assets in contained within the CIC carry the maximum rating of protection against creditors. No matter how careful you are, many events can transpire that could financially cripple a medical practice. But if you can successfully avoid these claims, you’ll have reduced the cost of third-party insurance while possibly increasing your liability coverage at the same time.
- Anupam B. Jena, M.D.,Ph.D., Seth Seabury, Ph.D., Darius Lakdawalla, Ph.D., and Amitabh Chandra, Ph.D. “Malpractice Risk According to Specialty” (August 18, 2011). http://www.nejm.org/doi/full/10.1056/NEJMsa1012370#t=article
- Ike Devji, JD “A Physician’s Guide to Captive Insurance Companies” (July 17, 2012). http://www.physicianspractice.com/blog/physicians-guide-captive-insurance-companies
- Erica Sprey “Captive Insurance Can Bring Windfall to Physicians” (July 11, 2016). http://www.diagnosticimaging.com/blog/captive-insurance-can-bring-windfall-physicians
- Mark E. Battersby “Consider Captive Insurance Plan to Protect Your Practice” (May 25, 2011). http://medicaleconomics.modernmedicine.com/medical-economics/news/modernmedicine/modern-medicine-feature-articles/consider-captive-insurance-pl?page=full
- John Henry Dreyfuss “Captive Insurance Company Can Help Your Practice Earn More, Keep More, and Maintain Greater Control of Assets” (May 28, 2015). http://www.mdalert.com/article/aptive-insurance-company-can-help-your-practice-earn-more-keep-more-and-maintain-greater-control-of-assets
Advisory Services offered through Larson Financial Group, LLC, a Registered Investment Advisor. Securities offered through Larson Financial Securities, LLC, Member FINRA/SIPC. Medical Malpractice Insurance offered through Larson Financial Brokerage, LLC.
Medical Malpractice Insurance is a complicated issue and cannot be fully covered within the context of this article. This article should not be construed as legal advice. Please contact a qualified attorney and/or insurance carrier with knowledge about your specific needs.
Larson Financial Group, LLC, Larson Financial Securities, LLC and their representatives do not provide legal advice or services. Please consult the appropriate professional regarding your legal needs.