Self-Insurance: Does It Ever Make Sense?

A pressing question physicians must answer these days is what to do about the cost of malpractice insurance premiums. For many physicians squeezed by Medicare and HMO cost cutting, malpractice...

A pressing question physicians must answer these days is what to do about the cost of malpractice insurance premiums. For many physicians squeezed by Medicare and HMO cost cutting, malpractice costs are devouring an ever larger share of their income. Sometimes the premiums are just too expensive to afford or insurance might be unavailable at any price. Physicians in increasing numbers are electing to “go bare”—practice without insurance—or to self-insure in some manner. While this may be necessary in some cases, it presents the obvious risk that an unfavorable judgment in a lawsuit may wipe out years of savings and hard work. Many of my clients ask whether there is an alternative to conventional insurance. Can a legal plan be developed that will hold down costs without jeopardizing personal and business assets?

I’ll answer that question by hedging my advice (like any good lawyer). Is there a legal alternative to malpractice insurance? Maybe. It depends on the circumstances. There are important business, financial, and legal issues to resolve, but the potential payoff is high enough to at least make it worth considering. In this article, we will look at the concept of self-insurance and examine the strengths and weaknesses of this option.

Goals of Self-Insurance

I once received a call from a client who was a member of a six-physician anesthesiology group. Insurance costs for the group were roughly $400,000 per year. He asked whether it would be advantageous for the group to drop coverage completely and instead establish a trust funded with the premium savings. The objective was to control litigation costs, limit settlement amounts, and hopefully distribute a surplus back to the partners every few years. He wanted to know the ramifications of this approach.

This issue is actually raised quite frequently by clients frustrated with the current insurance and practice environment. In the case of our anesthesiologist, insurance was currently available, although it was expensive and seemed excessive based on the actual dollar amount of potential liability. When insurance can be purchased, but is prohibitively costly, the cost/benefit equation must be analyzed differently than when insurance is unavailable as a practical matter. If insurance is neither available nor affordable, then certainly asset protection is the only solution. There is no other means to minimize the risk of a disastrous financial loss. When coverage can be obtained but the price is steep, the issues are more complex.

Business Problems With Self-Insurance

Dropping malpractice coverage creates a number of business problems. Even if the savings to be gained are significant, in many states the obstacles to dropping traditional coverage may make it impractical to do so.

An earlier article in this series (“Asset Protection Strategies,” MD Net Guide, March 2004) discussed the fact that many hospitals, private insurers, and other physicians may refuse to do business or practice with anyone without specified amounts of coverage. That fact alone might be reason enough for many practitioners to rule out this option. In addition, a number of states that cap non-economic damages in a malpractice suit exclude physicians with inadequate coverage from this legal protection. As the number of self-insured physicians increases, all parties involved may be forced to develop reasonable solutions to the problem and alter or modify current approaches, limitations, and business practices. Already we see examples of some hospitals and insurers approaching this new reality and agreeing to do business in the presence of reasonable financial guarantees. But certainly these business problems must be carefully considered and in many cases may present a difficult hurdle to overcome.

Legal Ramifications

Once it is decided that the plan to drop insurance coverage and establish a trust is feasible from a business standpoint, the next step would be to consider how well it works from a legal standpoint. Suppose ABC Medical Group pays $400,000 per year into a Liability Insurance Trust (LIT), and after three years there is a lawsuit naming one of the ABC members as a defendant, as well as ABC itself. How might this situation play out under the aegis of a medical trust? Here are some key points to consider:

Attack Against the LIT

The first avenue of attack by a plaintiff will be against the LIT itself. It is a source of ready, available cash and—if those funds can be reached—the plaintiff’s attorney will view it as similar to an insurance policy. He or she can attempt to drive a settlement or litigate through trial with the knowledge that he or she will be paid in the event of a favorable judgment, at least to the extent of the remaining funds in the LIT. From the defendant’s point of view, the LIT has sufficient assets to mount an appropriate legal defense, but if all of the accumulated contributions can be seized to pay for a judgment, then nothing has been accomplished by selecting this option in the first place. ABC might just as well have paid the insurance premiums.

If, on the other hand, the LIT is not vulnerable—if the funds cannot be reached by a plaintiff, even in the event of a judgment in his or her favor—the dynamic of the case and the relative leverage of the parties is completely altered. The attorney for the plaintiff would have no available source of payment for his or her claim. Under these circumstances, the administrators of the LIT are in a better position to determine the merit of the claim and possibly negotiate a reasonable settlement based on whatever standards have been established.

Can a LIT be established so that it is impervious to a lawsuit attack? Generally, the answer is “yes,” but that is subject to a number of important qualifications. In previous articles we have discussed the Fraudulent Transfer rules that prohibit transfers of property with the intent of defeating a creditor’s claim. In addition, it will be very important that the powers of the Trustees and administrators are properly enumerated and prescribed. In some ways the LIT itself may look similar to a traditional pension or profit-sharing trust, but rather than pay out retirement benefits, the purpose of an LIT is to determine the validity and administer the payment of claims.

Attack Against Business and Personal Assets

Although the presence of a LIT may stymie a plaintiff’s primary and preferred line of attack, other avenues remain open that must also be defended against. Without available insurance or an attractive and reachable cash fund, the financial incentive for the plaintiff is substantially diminished. Be-cause malpractice cases are typically expensive to pursue, many of the cases without significant merit may be discouraged. How-ever, in a case involving serious injury and clear liability, the plaintiff may still proceed. His or her intention is to obtain a judgment which will apply to the assets of the group as well as the personal assets of one or more physician members. The group may have valuable equipment and/or substantial accounts receivable. Certainly, the individual physician may have his or her home and savings. All of these assets may be jeopardized by a judgment. The plaintiff’s attorney may threaten to proceed against these assets if a satisfactory settlement is not reached. A good trial lawyer can create enough uncertainty and fear of loss that it raises his or her chances of negotiating a favorable settlement.

In our example of the ABC Medical Group, although the LIT is protected, the availability of the assets of the group and the individual physicians creates a weakness in the structure that the plaintiff’s attorney may be able to exploit. In order to be successful with a self-insurance strategy, group and individual assets would have to be protected as well. I’ve previously written about the techniques for protecting personal assets (also in the March 2004 MD Net Guide).

Plugging the Holes

The legal strategy for this type of self-insurance plan therefore consists of three parts:

1. Create a LIT to be funded with contributions from the members of the practice group. Since the goal is to reduce the number of claims and to control the amount of any settlement, the LIT must be drafted so that its assets are not legally reachable in the event of a judgment.

2. Protect business assets such as equipment and accounts receivable.

3. Protect personal assets such as the family home, savings, and investments.

In the event a LIT has been created and properly structured, a typical case will unfold in the following fashion. An attorney considering filing a case first investigates to determine the amount of insurance coverage. He’s informed that there is no commercial insurance and the group is self-insured and pays out claims based upon the injury and the circumstances. The most likely next move will be for the attorney to conduct a thorough investigation of the assets of the group and the individual members to determine whether it’s possible to gain an advantage in the negotiations, some threat to apply in order to obtain a settlement. If no available assets are located, if the plaintiff’s attorney determines that collection will be impossible even upon receipt of a favorable judgment, the case is likely to be dropped or settled for a minimal amount (for more background on pre-lawsuit financial investigations, see “Asset Protection and Financial Privacy,” MD Net Guide, May 2004). We can assume that an attorney will generally not proceed with a case if there are no reachable assets.

Additional Factors to Consider

It is crucial that enough money be accumulated in the LIT to cover the costs of a legal defense. If the case is not defended, the plaintiff will obtain a default judgment with any associated court orders requested. So there must be enough time and sufficient

contributions to create an adequate defense fund. A sole practitioner may use a LIT but will have to accelerate his or her contributions to make sure that potential defense costs are covered as quickly as possible.

If the attorney for the plaintiff proceeds with the case, despite the lack of reachable and available funds, and if he or she is successful at trial, assets accumulated in the future may also be subject to the judgment. Although property and savings developed prior to the case can be protected, subsequent accumulations are at least theoretically at risk.

Amounts contributed to a LIT will not be deductible for income tax purposes. Earnings on accumulated LIT assets such as interest income or dividends will be taxable when earned. If LIT assets are used to pay litigation costs or to settle claims, a deduction would be allowed at that time. Distributions of surplus funds to practice members would not be taxable.

Closing Arguments

Would I recommend a self-insurance strategy for my clients? The business problems discussed in this article will make this type of plan impractical for many physicians. Generally, practitioners who can afford to keep their insurance coverage should do so, however onerous the financial burden may seem. If insurance protection is not available or is unreasonably priced, self-insurance may provide a sensible solution to the problem. If the premium savings allow a physician to continue to provide valuable medical services, this type of planning may well be worth the thought and the effort which is required to properly implement and execute it.

A complimentary copy of the book Asset Protection for Physicians and High-Risk Business Owners (2002) by Robert J. Mintz is available from the Asset Protection Law Center or by calling 800-223-4291.