Originally Published at Captive Insurance Times Magazine, May 2013 (scroll to page 20)
Life is filled with risks. Every day, you take risks in your business. Some of these risks are calculated on your part; after all, you must take on these risks in order to make a profit in your business. Other risks may not be so well known to you, or they may not be at the forefront of your mind on a regular basis. As much as you may carry insurance on the truck used to make deliveries in your business, you may not carry similar insurance on the computer used to track your deliveries. There may even be some risks that you know about but are simply too expensive for you to insure.
Unfortunately, unless you pay an insurance company a premium to insure your business against all of these risks, there is no tax benefit to self-insurance. Most businesses, whether it be a medical practice, surgery centre, advertising firm, or any number of other companies unknowingly self-insure a great part of their risks from daily business activities. Self-insurance, whether funded out of company reserves or personal after-tax savings, is not tax-deductible. To compound the issue, smaller deductibles are expensive, can contain complicated qualifiers, and are not tax-beneficial. The solution for many is a captive insurance company. Properly structured, self-insurance through the use of a captive insurance company can create substantial tax deductions, resulting in tremendous tax savings.
Captive insurance produces material tax savings that help you to save real dollars in your business. Furthermore, captive insurance helps businesses to combat inadequate insurance and excessively high premiums. Yet, most business owners have no idea what captive insurance is, much less how to use it to their advantage.
Captive insurance is a strategy whereby your business purchases insurance coverage from an insurance company that you own and control, i.e., a “captive” insurance company. The premiums paid by your business are tax deductible. Meanwhile, the premiums that your captive collects are tax-free. You read that correctly: The premiums collected by your captive insurance company are tax-free.
Every year, throughout the US, medical profes- sionals suffer losses in their businesses that are not covered by insurance. An interruption in business due to an outside cause such as a hurricane or significant regulatory change can inflict costly damage to your practice. Just as well, you may stand to lose substantial revenue due to malfunctioning equipment or an action taken by a government agency against your practice. Doctors everywhere have to worry about the ever-increasing costs of litigation defense arising from the explosion of tort litigation and runaway juries handing out verdicts in malpractice cases as if money grows on trees.
Fortunately, there is insurance available to cover most of these cases. Unfortunately, the cost of insurance can be very expensive or practically unattainable for doctors in many states. Even those who can afford the insurance often find that it does not protect them or their business from many common forms of business losses.
Some doctors choose to combat the high cost of liability insurance by reducing coverage or ‘going bare’ and not purchasing any insurance at all. By doing so, these physicians are knowingly taking on increased risk to their financial wellbeing. Perhaps they believe that they will not be sued, and that they are very good at managing their liabilities.
"Your business pays premiums to your captive in return for insurance covering the potential liabilities and risks of your business. If all goes well, and there are no claims at the end of the year, your captive gets to recognise those premiums as pure profit."
Surprisingly enough, a growing trend amongst physicians is to simply choose not to insure themselves. As absurd as that may seem to some of us, there is some method to this madness. Insurance statistics prove this out: approximately 80 percent of all insurance claims are made by fewer than 20 percent of all insureds. In other words, most doctors never have a claim, but they are paying for the claims of others by purchasing insurance.
Those doctors who are not buying insurance have, in many cases, simply figured out the dirty little secret of insurance. If everything goes well, and there is no claim at the end of the year, the entire premium paid to the insurance company for that year becomes pure profit for the insurance company. Of course, the insurance company will incur a number of losses from other doctors, but the insurance company is not in this game to provide a public service; it is here to make a profit.
By offering liability insurance to doctors, the insurance company is publicly advertising that it thinks it can make a profit on such insurance. This is because, on the whole, the majority of doctors will not have any claims, and the insurance company actuaries have figured this out.
When you buy liability insurance from the insurance company, the insurance company is making an investment in you. The insurance company is betting its own money that you will not have a claim, and that those valuable premium dollars you paid to buy the policy will become pure profit for the insurance company.
In order to capture these profits for yourself, you should best understand how likely it is that you will incur a loss in your own business. Are you the type of physician who carefully manages his risk exposure and liabilities? If you can answer yes to this question, then captive insurance may allow you to capture those insurance company profits for yourself.
Captive insurance is a simple concept. Working with a lawyer experienced in captive insurance and a captive management services provider, you incorporate your very own insurance company. We refer to this insurance company as a captive because it is owned and controlled by you. Also, unlike insurance companies that sell insurance to the general public, your captive only sells insurance to you and businesses that are affiliated with you.
Your business pays premiums to your captive in return for insurance covering the potential liabilities and risks of your business. If all goes well, and there are no claims at the end of the year, your captive gets to recognise those premiums as pure profit.
I’ve recently authored the book, The Physician’s Guide to Captive Insurance Companies, to reflect the fact that a growing number of doctors throughout the US are implementing captive insurance as an integral part of their business and estate plans. As more and more doctors are getting burned by the high cost of liability insurance, and are seeing premium dollars wasted when no claims are made, an increasing percentage of these same doctors are choosing to instead insure themselves through their own captives, keeping those profits for themselves.
The focus of the book is on the benefits to your business from captive insurance. The benefits gleaned from captive insurance begin and end with the availability of completely customised insurance coverage for your business. However, in addition to learning how your very own captive insurance company enables you to capture insurance premium dollars as profits, the book also walks you through the many ways your own captive insurance company can help you to better protect your business from an asset protection standpoint. Every year, thousands of doctors are named as defendants in litigation, ranging from professional liability and malpractice claims to personal tort lawsuits, divorce proceedings, and business disputes.
If you are like most doctors or business owners for that matter, the money you earn in your business goes into a bank or brokerage account titled in your own name, or in the name of a conventional trust set up by a neighborhood estate planning lawyer. Unfortunately, as many doctors can painfully attest, that money is unprotected and can be taken from you by plaintiffs’ lawyers. If your money instead flows into a captive insurance company, you stand a better chance of protecting your wealth.
It is extremely important to note that the insurance we are discussing is real insurance. Moreover, the type of company that we refer to as a captive insurance company is, in fact, a licensed insurance company owned by you. Your captive is licensed, regulated, managed, and maintained just like any other insurance company out there. Probably the only difference between your captive and every other insurance company out there is this: since you are the shareholder, you profit from the captive’s performance.
There are also important financial and tax aspects of captive insurance. Tax benefits do not, in and of themselves, justify the use of captive insurance. Nevertheless, a properly structured and valid captive insurance arrangement offers some useful tax benefits, including the ability to exempt up to $1.2 million of business income from federal income tax every year.
Captive insurance, however, is not a tax panacea. The tax benefits must be weighed against the tax cost of liquidating the captive or taking out periodic dividends. Depending on your time horizon, a captive insurance plan may not offer tax benefits. However, with careful planning, one can accumulate significant tax-mitigated wealth through the use of a captive insurance company.