In part I, I outlined a number of strategies for protecting your practiceï¿½s assets. In this section of the series on protecting your assets, Iï¿½ll cover what you need to know about captive insurance companies.
In part I, I outlined a number of strategies for protecting your practice’s assets. In this section of the series on protecting your assets, I’ll cover what you need to know about captive insurance companies.
Captive Insurance Companies: The Ultimate Practice Tools
Many physicians will build their wealth primarily through their professional practice. Typically, the practice is not only the vehicle that allows the client to use leverage, but also the vehicle which creates the bulk of the client’s annual income and long-term wealth accumulation.
Given this fundamental importance, it is essential that doctors do everything possible to protect the practice and maximize its leverage potential. The best tool for achieving such protection and leverage is the captive insurance company (CIC). In this article, we will discuss what a CIC is, what benefits it offers, and how physicians can use it to maximize the benefits they get from their practice planning.
We stress the importance of using tools that have multiple benefits. By using these tools, physicians can compound their leverage and achieve a number of planning goals more efficiently than if they tried to reach their goals one at a time. Of all the tools discussed in this series, the CIC can be the most efficient. For clients who own successful businesses or professional practices, the CIC often becomes the cornerstone of the ascent to a desired level of affluence. This is because the CIC affords the following benefits:
• Superior risk management for the practice
• Reduction in the practice’s insurance expenses to third-party insurers
• The ability to capture profits on insurance policies
• Highest levels of asset protection for CIC assets
• Superior income tax treatment for CIC income (when the CIC is properly structured and maintained)
• Significant estate planning benefits (when the CIC is properly integrated with estate planning tools)
• Creation of a potential buy-out mechanism for older owners of the practice upon retirement
The CIC we will discuss here is a fully-licensed insurance company domiciled either in one of the states that has special legislation for small captive companies or in an offshore jurisdiction that has similar captive legislation. Whenever a CIC is established offshore, it is critical that the CIC be compliant with all U.S. tax rules and must be handled by captive managers, tax attorneys, or CPAs experienced in these matters.
CIS is a Risk Management Tool
The CIC must always be established with a real insurance purpose; that is, it must be formed as a facility for transferring risk and protecting assets. The transaction must make economic sense. Beyond this general rule, there is a great deal of flexibility in how the CIC can benefit its owner(s).
First, clients can use the CIC to supplement their existing insurance policies. 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. As physicians, you should be concerned with all types of lawsuits—from medical malpractice to practice risks to employment liability—and this protection can be significant. Further, the CIC may even allow the client to reduce existing insurance, as the CIC policy will step in to provide additional coverage if needed.
Using one’s own CIC gives the client flexibility in using customized policies which one would not easily find when using large third-party insurers. For example, many clients would like a liability policy that would pay the client’s legal fees (and allow full choice of attorney), but would not be available to pay creditors or claimants. This prevents the client from appearing as a “deep pocket”—a prime lawsuit target. Avoiding this appearance is a necessary asset protection strategy in today’s highly-litigious society.
In addition, the CIC has the flexibility to add coverage for liabilities excluded by traditional general liability policies, such as wrongful termination, harassment, or even ADA violations. Given that the awards in these areas can be over $1 million per case, physicians should understand the value of the CIC for this benefit alone.
Benefits of having a CIC
CIC compared with self-insuring—the “rainy day” fund. Because our society has become so litigious, many physicians have been “self-insuring” against potential losses like the ones named above. These clients have simply saved up funds to be used to pay any expenses that may arise from a risk. This is the proverbial “rainy day fund.” While a rainy day fund may prove wise, the client would be better off using a CIC to insure against any risks. This is because premiums paid to the CIC enjoy the highest levels of asset protection, can be structured to grow outside the taxable estate, can be structured to layer into a practice exit strategy, and can enjoy tax advantages as well. None of these benefits are found with the “rainy day fund.”
Avoiding land mines. The CIC structure must be properly created and maintained. 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 CICs for clients is critical. It is especially important that the right attorneys and insurance managers are involved. While using such experts and a real CIC structure may be more expensive than some of the cheaper alternatives being touted on the web or at fly-by-night seminars, this is one area where “doing it right” is the only way to enjoy the CIC’s benefits and be 100% compliant with federal and local laws and regulations.
Who can afford a CIC? Setting up a CIC requires particular expertise. As you might expect, the professionals most experienced in these matters charge significant fees for both the creation and maintenance of CICs. Set-up costs are typically around $100,000, and annual maintenance costs another $50,000 per year. While these fees are significant (and often fully tax-deductible), the CIC’s potential risk management, tax, practice, estate planning, and asset protection benefits often combine to make it a very attractive option for very successful physicians. 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 captive insurance company.
Physicians face various financial threats that range from operational problems to exit strategy challenges and from lawsuit threats to increasing operational costs. Astute physicians not only want to mitigate these risks, but also want to do so in an efficient manner. For these reasons, physicians who own very successful practices use captive insurance companies (CICs). A CIC can be a valuable tool in addressing many of a physician’s planning challenges at one time. Once you read part 3 of the article on all of the available planning options, you will have a greater understanding and appreciation of the value of a CIC.
Darrell Aviss is managing director of SwissGuard International, GmbH, an independent financial consulting firm based in Zurich, Switzerland. The firm offers Swiss annuities to American investors through Swiss insurance companies established to meet the private investment and financial protection needs of international clients. Mr. Aviss welcomes questions or comments at 800-796-7496 or visit www.swiss-annuity.com.