This article is written by David B. Mandell, JD, MBA and Carole C. Foos, CPA, OJM Group.
As medical reimbursements continue to shrink and taxes increase, a popular question we receive in consults with spine specialists is, "Would owning part of a Small Insurance Company help me and my practice become more financially efficient?" If your practice currently generates over $3,000,000 of revenues and you would like to take advantage of opportunities to improve the financial success you realize from your hard work without having to see any more patients, then this article may prove to be very valuable information for you.
Small Insurance Companies (or "SMICs") are often referred to as captives, closely-held insurance companies, or a number of other names. Like any corporate structure, SMICs can be ideal tools if they are created for the right type of practice and the corporate formalities are maintained properly in a legitimate jurisdiction. The purpose of this article is to briefly describe appropriate uses, potential benefits, and approximate costs of SMICs. To better illustrate potential benefits, we offer a case study where the use of an SMIC significantly enhanced many areas of the client's comprehensive financial planning.
What is a small insurance company (SMIC)?
The SMIC we will discuss here is a properly-licensed, US-based insurance company – domiciled in one of the states that have special legislation for small insurance companies. While some advisors promote insurance arrangements in small international jurisdictions to take advantage of lower creation and maintenance costs, we think it is advisable to domicile SMICs in the U.S. As a number of states' recent captive insurance statutes allow formation for reasonable costs, we find domestic options to be financially feasible like never before.
SMIC as a risk management tool
The SMIC must always be established with a real insurance purpose. Insurance companies have been well defined in the vast array of tax laws, revenue rulings, private letter rulings, and case law. There are requirements for an insurance company to be a facility for transferring risk and protecting assets. Practitioners who specialize in this area have found ways to manage risk to maximize long term profit while reducing unnecessary risk within the insurance statutes. How risk is managed and how much risk can be insured in a captive will be answered based on your particular situation. The nice thing is that there is a great deal of flexibility in how the SMIC can benefit a client.
One specific way clients can use the SMIC is to supplement their existing insurance policies. The SMIC can insure deductibles, copayments, and excluded risks. 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. In this case, you could think of the SMIC as a tax-efficient, asset protected war chest to cover potential future losses.
Most spine surgeons are acutely aware of medical malpractice, but there are many other risks to doctors as employers and recipients of insurance (and Medicare). The SMIC can be used to protect the physician and practice from employment liability, insurance audits, Health Insurance Portability and Accountability Act (or "HIPAA") defense and a variety of other risks that will vary based on your practice size, revenue, number of employees, and other risks. This protection can be of significant value and potentially very profitable to the SMIC if you manage risk well. In some instances, the SMIC may even allow the client to reduce existing insurance, as the SMIC policy will provide additional coverage.
Some physicians choose to use an SMIC to provide flexibility in using customized policies not easily found in the commercial space. For example, you may desire a liability policy that would pay your legal fees (and allow full choice of attorney) but would not provide any benefit to creditors or claimants (what we call "Shallow Pockets" policies). This prevents the client from appearing as a "Deep Pocket" (a prime lawsuit target).
The SMIC has the flexibility to add coverage for liabilities excluded by traditional general liability policies, such as wrongful termination, harassment, or even Americans with Disabilities Act (or "ADA") violations. Given that the awards in these areas can be over $1 million per case, the SMIC can provide valuable protection here. To illustrate how the SMIC can be used, let's examine the case study of Justin and Harry.
Case Study: Justin and Harry Use SMICs
Justin and Harry are spine surgeons who are in a group (Justin) and solo (Harry) practice. Justin feels like they are paying too much for his group's medical malpractice and commercial liability insurance policies. After our firm introduced Justin and his partners to an attorney and actuary who specialize in SMICs, they 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 existing insurance premiums because they then had much higher deductibles for the 3rd party insurance policies.
Justin and his colleagues believed they could reduce his insurance premiums to commercial insurance companies, implement successful risk management programs, and reduce overall payments and costs. Ultimately, they hoped that the SMIC would help increase the profits of the practice. They were 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 SMIC reserves after five years.
Harry had a different approach. He established an SMIC 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 SMIC paid limited claims. At this point, most of the premiums are still growing as asset-protected reserves of the SMIC to be used to pay future claims. If there are very few future claims, the SMIC may become a profitable investment for Harry and his family.
Harry was also considering bringing on younger partners in to his practice. He plans on using the SMIC 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 SMIC.
SMIC: Compared to self-insuring – The "Rainy Day Fund": Because our society is litigious, many spine surgeons have been "self-insuring" against potential losses like the ones named above. These clients have simply saved funds on an after tax basis to pay any expenses that may 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 an SMIC to insure against any risks. That is because the formal payment of premiums to the SMIC may be tax-deductible to the practice. Those funds in reserve of the insurance company 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 generate very significant long term tax advantages as well. None of these benefits are found with the traditional "rainy day fund."
Avoiding land mines: It cannot be overstated – the SMIC structure must be properly created and maintained by insurance experts. 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 SMICs for clients is critical – especially the attorneys, actuaries and insurance managers who need to be involved. While using such experts and a real SMIC 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 SMIC's benefits and be 100 percent compliant.
Who can afford an SMIC? Setting up an SMIC requires particular expertise, as explained above. Thus, as might be expected, the law firms most experienced in these matters charge significant fees for both the creation and maintenance of SMICs. Set-up costs are typically $75,000+ and annual maintenance costs can be around $5,000 per month. While these fees are significant (and often fully tax-deductible), they can be shared among a number of SMIC owners. The SMIC's potential risk management, tax, practice, estate planning, and asset protection benefits often combine to make it a very attractive option for very successful spine surgeons. 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 small insurance company.
Conclusion: SMICs can be great tools for certain spine specialists
Because successful spine specialists have significant risks, are interested in better management of these risks, desire asset protection, want to build tax-favored wealth over the long-term, and might enjoy learning new ways to fund practice buy-out and estate planning opportunities, there is a good reason to spend a little time reviewing the benefits of the SMIC as an important planning tool. The authors welcome your questions. You can contact them at (877) 656-4362 or through their website www.ojmgroup.com.
SPECIAL OFFERS FOR SPINE REVIEW READERS: For a free (plus $10 S&H) hardcopy of For Doctors Only: A Guide to Working Less & Building More, please call (877) 656-4362. If you would like a free, shorter eBook version of For Doctors Only, please download our "highlights" edition at www.fordoctorsonlyhighlights.com.
David B. Mandell, JD, MBA, is an attorney and author of five national books for doctors, including FOR DOCTORS Only: A Guide to Working Less & Building More, as well a number of state books. He is a principal of the financial consulting firm OJM Group (www.ojmgroup.com), where Carole C. Foos, CPA works as a tax consultant. They can be reached at 877-656-4362 or mandell@ojmgroup.com.
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.