In our two previous discussions we introduced the general concept of a captive insurance company (captive) as well as specific qualifying questions to help doctors pick a good captive administrator. This week we examine some key issues that can help determine if your specific medical practice is at the point where a captive may create a benefit. Like most legal and financial strategies it is more important to determine if it is a fit for you and your specific needs, numbers, and fact pattern as it is to determine if it is "a good idea" in general.
1. Do we have risk that legitimately needs additional coverage? The core concept is that of a liability insurance company. As such, the determination that your practice has substantial and recurring risk that requires high cost, third-party insurance is the first step and the justifiable core business purpose of the endeavor. In most cases captive providers will examine both existing identified risks and coverage and will include additional issues that would benefit the practice and its owners. Common examples include key man insurance, directors and officer’s coverage, various health benefits, errors and omissions, gaps, and countless other sources of risk that must be addressed with any competent asset protection plan.
2. Are we willing and able to pay for the costs of set up and administration every year? A captive is a real, living breathing insurance company subject to all insurance company regulations. This requires specialized skill and knowledge to set up and run it in a way that is compliant with both insurance regulations and stringent IRS guidelines. Costs for captive creation of the size and complexity appropriate for most medical practices range from $20,000 for a "segregated cell" captive to over $100,000 and recurring annual fees can easily equal that based on the provider. That’s in addition to the annual contribution of $500,000+ most entry-level captive owners make in premium payments.
3. Are we most motivated by risk planning or tax savings? Of course we all want both, but most experts in this area agree that that primary motivator should be the ability to more cost effectively manage your existing risk coverage and any gaps, not a tax savings. In fact, attorney Jay Adkisson, a nationally known Newport Beach, Calif., attorney and expert on captive insurance who literally "wrote the book" on captives (Adkisson’s "Captive Insurance Companies") suggested an addition to the list of qualifying questions to ask a captive promoter I provided last week; “If a client told you that the only reason that they really needed the captive for was to save taxes, will you form the captive? If they say 'yes' to that, run."
Adkisson further explained that when captives are designed and marketed specifically for tax savings they often fail the essential business purpose tests established by the IRS, especially when they are too aggressive about the large premiums and overly aggressive risk provisions they include. Specific examples of this kind of "sham" insurance include types of risk not reasonable, customary or necessary in your business and location, (Adkisson mentioned tidal wave insurance in the Midwest as a specific example) as well as paying premiums far above any commercially reasonable rate corresponding to the costs of the insurance, which negates any reasonable economic purpose according to the IRS.
This list is by no means complete, but provides a good start to understanding the basic qualifications and reasonable expectations you should have in mind when determining the fit of a captive for you medical business. Next week, we will conclude our look at captives with answers to some frequently asked questions including basic qualifiers on "cell captives" for those who can’t make annual contributions of $500,000 or more and further advice form Jay Adkisson on the best captive jurisdictions.
Find out more about Ike Devji and our other Practice Notes bloggers.