Insurance Freedom

August 11, 2009
Rick Jaye

,
Karl Huish

Captive insurance companies can reduce insurance costs, save taxes, protect assets, and transfer business value and family wealth to future generations. Legal changes in the last five years may make this one of the most advantageous times to form one.

Many successful doctors in private practice have discovered the potential benefits of forming captive insurance companies, also known as “captives.” Captives may be one of the best business planning tools for business owners, as they can reduce insurance costs, save taxes, protect assets, and transfer business value and family wealth to future generations. Legal changes in the last five years may make this one of the most advantageous times to form a captive.

A captive is an insurance company (often small) that covers the insurance risks of an affiliate. For example, a group of doctors can form and own a captive to insure against medical malpractice risks, or even risks unrelated to medical malpractice, such as the loss of a key employee, wrongful termination, or the loss of electronic medical records or medical license. Captives can be formed in the United States or a foreign jurisdiction. A business owner in Arizona for example, can form a captive in a non-Arizona jurisdiction, and still have all of the captive benefits.

Captives Put Doctors Back in Control

In many areas of the country, medical malpractice insurance is a legitimate crisis because of high costs and the lack of control allowed to the insured. However, a captive allows physician groups (with typically at least $750,000 in aggregate medical malpractice insurance premiums) to write medical malpractice insurance to shareholders or other doctors. This puts the physicians in control, allowing them to respond to claims, hire attorneys and make settlements on their terms. Better still, if the claims are low, the insurance reserves in the captive can be paid out to the physicians upon retirement (or sooner).

Commercial insurance is typically priced at a 50 percent loss ratio, which means that only 50 cents of every dollar in premiums is expected to be paid out in claims. The insurance company uses the other 50 percent for overhead and profit. Alternatively, captives may allow business owners to retain a portion of their premiums. For example, a group of physicians can form a captive and pay $1 million in total malpractice premiums to the captive. If the group has average claims, each member can keep the extra $500,000 per year inside his or her captive, and as the physicians retire, they can cash out their stock in the captive — an impressive $5 million after just 10 years, not counting investment income. In addition, reinsurance can be obtained for catastrophic risks.

Captives Create Tax Savings

Captives are also attractive because the IRS provides favorable tax treatment for insurance companies. Exemptions are allowed for small insurance companies receiving up to $1.2 million per year, and larger insurance companies can take current deductions for estimated future losses. Both provisions make owning an insurance company an attractive investment. For example, a business owner or company paying $1 million in premiums to a captive will receive a business deduction for the insurance payment, but the captive will not pay tax on the payment. This can result in $400,000 or greater of annual income-tax savings alone.

Captives Protect Assets Against LitigationCaptives may be the best asset protection tool available to business owners. Assets in a captive are not reachable by creditors and attorneys, and are only available to pay valid claims—claims approved by the captive company. A captive also allows the use of customized policies that are often too pricey or unavailable through large insurers. Many physicians would like a malpractice policy that would pay legal fees and allow full choice of attorney, but could not be used to pay creditors or claimants, preventing the physician from appearing as a “deep pocket.” Most large insurers do not provide this type of policy.

Captives Offer Many BenefitsIf you are a doctor and have insurance premiums for current business coverage in amounts exceeding $250,000 per year, risks that are uninsured or self-insured, and business income of $1 million per year, you may want to explore how a captive may potentially help improve risk management, reduce taxes and protect assets.

Captives are specialized risk and business management tools and require special management expertise. The captive structure must be properly created and maintained by specialists in the field. If it is not, the insurance, asset protection and tax benefits may be lost.

Rick A. Jaye serves as Chief Financial Strategist of Advanced Equities Asset Management, an affiliate of First Allied Securities. Mr. Jaye serves on the Board of Directors of Doctors Bank, LLC, a bank holding company in Manhattan Beach, CA. He is a registered investment advisor representative and holds a life, health, and variable insurance license.

Karl Huish is President & CEO of Tribeca Strategic Advisors, an attorney licensed with the state of Arizona, and a Certified Financial Planner.

Laws and regulations, including any compensation or investor protection arrangement, may vary from state to state. The information in this article is provided as a guide and is not intended to be legal and/or taxation advice. You are strongly recommended to seek your own legal and taxation advice from suitably qualified professional advisors.