Captive Insurance Can Bring Windfall to Physicians

July 11, 2016

Captive insurance companies allow physicians to pool their malpractice premiums, so that any risk is distributed across the group.

Depending on specialty and geographic area, malpractice insurance can add significant costs to running a medical practice. According to the Physicians Practice 2015 Physician Compensation Survey, the mean annual expense for malpractice coverage in a nonsurgical or obstetric specialty, was $9,697. For an obstetric or surgical specialty, this jumps to $102,678. It's no wonder then that physicians are willing to advocate for tort reform and also seek alternative ways to protect their practices and assets from lawsuits.

Recently, Physicians Practice associate editor Erica Sprey spoke with Philip Garrett Panitz, a tax attorney based in Westlake Village, Calif., a suburb of Los Angeles, in a two-part interview. Panitz is certified by the California Bar Association as a tax specialist and represents clients in confrontations with the IRS and other taxing agencies. He has also become an expert in an area called captive insurance, which is a vehicle that allows physicians to establish their own malpractice insurance companies.

Below is part one of the interview.

Erica Sprey: Can you tell me what captive insurance is?

Philip Panitz: Obviously professionals have very high insurance premiums, particularly doctors … for malpractice insurance, etc. And captive insurance has come on the scene as a potential alternative. And what it is, you create your own insurance company. You create this insurance company and you pay premiums to your own insurance company. That is sort of the overview, [a] simplistic way of looking at it. So rather than pay a private insurance company very high premiums, you are paying your own company premiums. And the advantage of that, of course, is that ultimately, if you don't have the claims and you retire as a physician, you get to dissolve your own insurance company and those premiums will come back to you. So that's one of the major advantages of captive insurance.

ES: Is this a single individual who does this or do you need to be part of a group?

PP: Well, the way it actually works, a physician or a group of physicians, contribute premiums to their captive insurance company. In order to qualify under the rules of insurance and also to pass IRS muster, the insurance company has to be legitimate. What does that mean? There has to be two elements to it: a shifting of the risk and a distribution of the risk. That's what insurance is. So let me explain those in a little more detail. So when you shift risk you take it away from one party and putting it on another party.

So for example, in traditional mode, you pay a premium to the insurance company and the insurance company has the risk. You no longer have the risk of loss. When you transfer the risk to your own insurance company, at that point there is a risk shift, but it could be argued that as those assets are yours, or could eventually be yours again, you are not really shifting the risk because you still have it. So there has to be some additional risk shift. So when you ask me if there are other [physicians] involved, the way this is set up is … there is a business model of a re-insurance company that takes that risk away from your captive insurance company and pays the insurance into that re-insurance company. So your captive insurance company, if you are a doctor, you are paying premiums into your captive insurance and then there is a transfer of that risk once again to this re-insurance company. That re-insurance company has many captives that are paying it premiums, and therefore there is a distribution of the risk, because now there are a pool of doctors that have their own insurance companies that are paying premiums into this re-insurer. That creates the distribution of the risk between all those doctors.

Let's say there are a 100 captive insurance companies that are paying premiums into the re-insurer. Maybe there are some claims for doctors from malpractice, [so] that re-insurer has to pay out those claims. Now the risk has really shifted because your doctor who has created his captive insurance company is only getting hit for a small piece of that risk. And most of the premiums that he's paid are still in that captive insurance company. There's less risk exposure because that risk has been distributed out to all those captive insurance companies that are in that pool of insurance. That's the way the industry works.

ES: What are the benefits of creating a captive insurance company?

PP: There are a number of benefits. The first benefit is that the actual payment of the premium into [a physician's] own captive insurance company is tax deductible, as it would be as a business expense, [like] you were paying for Prudential or the Hartford. It's a business expense, you are paying it, it's tax deductible. The second benefit, which you don't have in the traditional insurance sense, is that eventually when the physician retires, those premiums that he's paid into his own captive, and some of which is transferred into a re-insurer, whatever is left in that captive insurance (or gets paid back to that captive insurance when premiums are not used for malpractice claims) eventually are liquidated back to the doctor when he retires. So you get a lot of this money back.

What happens to the money when it is sitting in the captive insurance? It's not just sitting there, it's actually being invested. Since this is a legitimate insurance company, it has very strict requirements as to what it can invest in; very conservative type investments. But that money is being invested, ultimately, to the doctor's benefit. So when he does liquidate his captive insurance company, let's say when he retires his practice, all that has grown inside his captive insurance company. So he does gets that back.