Owning a Small Insurance Company
When properly created, small insurance companies can offer additional asset protection for practices.
Ophthalmologists and medical practice executives often look for ways to protect their practices from potential claims and to reduce risks and taxes. When your practice grows and begins to generate more than $3,000,000 in revenue, you should plan to take advantage of opportunities to improve and protect the financial success you realize from your hard work without having to increase patient volume.
Small insurance companies (SMICs) are often referred to as captive or closely-held insurance companies. Like any corporate structure, SMICs can be ideal tools if they are created for the right type of practice and if the corporate formalities are maintained properly in a legitimate jurisdiction. The purpose of this article is to briefly describe the appropriate uses, potential benefits, and approximate costs of SMICs. To better illustrate potential benefits, we offer two case studies in which the use of SMICs significantly enhanced areas of the clients’ comprehensive financial planning.
WHAT IS A SMIC?
The SMICs we will discuss here are properly licensed, US-based insurance companies, domiciled in one of the states that have special legislation for SMICs. Although some advisers promote domiciling 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 United States. A number of states have recently enacted captive insurance statutes that allow formation for reasonable costs, and therefore we find domestic options to be financially feasible.
A 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 depend on particular situations. The nice thing is that there is a great deal of flexibility in how a SMIC can benefit a client.
Ophthalmologists can use SMICs to supplement existing insurance policies. The SMIC can insure deductibles, copayments, and risks excluded from other policies. This “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 doctors are acutely aware of medical malpractice, but there are many other risks to doctors as employers and as recipients of insurance and Medicare payments. The SMIC can be used to protect the doctor and practice from employment liability, insurance audits, HIPAA defense, and a variety of other risks that will vary based on factors such as a practice’s size, revenue, and number of employees. This protection can be of significant value and can potentially be very profitable to the SMIC if risk is managed well. In some instances, the SMIC may even allow the client to reduce existing insurance, as the SMIC policy will provide additional coverage.
Some doctors choose to use a SMIC to provide the flexibility to create customized policies not easily found in the commercial marketplace. 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. This prevents the physician from appearing to be a lucrative lawsuit target.
The SMIC has the flexibility to add coverage for liabilities excluded by traditional general liability policies, such as wrongful termination or harassment. Given that awards in these areas can be more than $1 million per case, a SMIC can provide valuable protection. To illustrate how the SMIC can be used, read the sidebar Caroline and Harry Use SMICs.
Caroline and Harry Use SMICs
THE RAINY DAY FUND
Because our society has become so litigious, many doctors have been self-insuring against potential losses such as 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 is realized. Although having a rainy day fund may prove wise, in some situations a retina doctor with a rainy day fund may be wiser to use a SMIC to insure against risks because the formal payment of premiums to the SMIC may be tax-deductible to the practice. Funds in reserve with the insurance company can enjoy the highest levels of asset protection, be structured to layer into a practice exit strategy, and generate significant long-term tax advantages. None of these benefits are found with a rainy day fund.
STICK TO THE EXPERTS
It cannot be overstated: A SMIC must be properly created and maintained by insurance experts. If not, all risk management, asset protection, practice, and tax benefits may be lost. For these reasons, using professionals who have expertise in establishing SMICs for clients is crucial, and special attention should be paid to the attorneys, actuaries, and insurance managers whose involvement is needed. Although hiring such experts to create a formal SMIC structure may be more expensive than employing a hastily made alternative, this is one area in which doing it right is the only way to enjoy the SMIC’s benefits while staying entirely compliant with current statutes.
WHO CAN AFFORD A SMIC?
Setting up a SMIC requires particular expertise, and the law firms most experienced in these matters charge significant fees for both the creation and maintenance of SMICs. Setup costs typically start at $75,000, and maintenance costs can total approximately $5,000 per month. Although these fees are significant, they can be shared among a number of SMIC owners. The potential risk management, tax, practice, estate planning, and asset protection benefits of a SMIC often combine to make it an attractive option for successful ophthalmologists. Creating a SMIC with the help of a financial advisor is an excellent way to maximize the benefits of working with a financial professional. n
For a free hard copy of For Doctors Only: A Guide to Working Less & Building More, call 1-877-656-4362. Or visit ojmbookstore.com and enter promotional code NEWRET24 for a free e-book download of For Doctors Only or the shorter For Doctors Only Highlights for your Kindle or iPad.
David B. Mandell, JD, MBA
• principal, OJM Group; author, For Doctors Only: A Guide to Working Less & Building More
• 1-877-656-4362; email@example.com
Carole C. Foos, CPA
• principal and lead tax consultant, OJM Group