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HOW PHYSICIAN-OWNED CAPTIVE INSURERS PROTECT PRACTICES

Updated: Mar 21

Captive insurance companies (or “captives”) are closely-held insurance companies owned by a corporate affiliate or subsidiary that insures the risks of its parent and/or related entities.[1] The large majority of hospital chains in the United States use captive insurers to protect against liabilities,[2] and increasingly, private medical practices are using them to manage their risks, too. However, many are still unaware of their benefits, which is not surprising considering the captive insurance industry’s historically poor job of marketing itself. Throughout the United States, medical practices use captives to cover the gaps within their commercial insurance policies caused by rising premiums, greater exclusions, and large deductibles. They can also be used to provide greater patient privacy.[3]

 

According to the American Medical Association, 31% of all physicians have been sued at some point in their careers for medical malpractices;[4] and, as every doctor knows, premiums for professional liability insurance notoriously increase on a regular basis.[5] Because captives can insure against almost all types of commercial property/casualty losses associated with a business enterprise, captives can be used not only to underwrite against some or potentially all medical malpractice losses (depending upon one’s association with hospitals which require commercially-rated ‘paper’), but they can also be used to protect a medical practice against cyber risks, loss of key person (similar to disability insurance for the practice itself), business interruption (due to some fortuity like a major weather event and resulting loss of patient visits), supply chain disruption (if the practice heavily relies upon manufactured products in its procedures), employment practices liability, product liability, license defense costs, etc. Captives can also be used to provide general excess and umbrella coverages for physicians, and they can directly access the commercial reinsurance market.   

 

Desk with medical documents and instruments

Among the various types of risks to which medical practices are exposed, the AMA recently informed its membership that most medical practices are, in fact, under-insured for cyber risks notwithstanding the increasing nature of such attacks.[6] Losses associated with cyber attacks can cripple a business. As with cyber risks, some of the aforementioned exposures may be low frequency, but they could be quite destructive to a practice’s bottom line. Captives specialize in providing insurance coverage for those types of fortuitous events. They also excel at providing more financial flexibility to organizations seeking to take greater control over their risk and claims management.

 

In conjunction with commercial medical malpractice policies that may have high deductibles, captives can also be used to finance the deductible while still keeping the primary commercial policy in place, provide greater flexibility in addressing medical malpractice claims.[7] Captives also can access the Congressionally-designated financial benefits associated with insurance coverage that are not available for traditional “self-insurance” which is, for all intents and purposes, just a savings account.  One of the key financial benefits in establishing a captive is being able to deduct the premiums paid to one’s captive as an ordinary business expense.[8] When those surplus premiums accrue, they can be invested in accordance with state captive insurance regulations. Once invested, the premium surplus can become its own revenue-generating element of the medical provider’s portfolio.

 

Ultimately, the great thing about captives is that they are bespoke to the businesses that they insure. Each medical provider knows the risks to which s/he is most exposed, and sometimes those risks are not adequately covered by commercial policy endorsements.

 

To determine whether a captive could be the right kind of tool for a practice, one needs to engage the services of a captive manager. As a critical starting point, however, and as a word of caution, it is important for every medical practice to appreciate that whatever captive manager is retained, it should focus heavily on the insurance needs of the operation. While a physician’s financial advisors and/or CFO most certainly will need to evaluate the totality of the cashflow and tax interplay of the captive, the medical practice and the captive’s beneficial owner, any mention of the tax benefits associated with captives should be purely secondary (both orally and in the marketing materials) because what drives the success (or failure) of a captive is that it is respected and operated as a regulated insurance entity, and that includes achieving the requisite risk transfer and distribution required of real insurance, and adhering to solvency and liquidity requirements mandated by the state in which it is domiciled.[9] Those who abuse the captive legislation will undoubtedly suffer the scrutiny of the Internal Revenue Service which has gone on the attack for those who treat captives merely as tax shelters.  

 

With that said, rest assured that reputable captive managers go through basic background checks by their state’s Department of Insurance. They also are affiliated with comparably approved independent actuaries, lawyers, and CPAs who specialize in insurance accounting and auditing. Captive managers, which typically charge a set-up cost and an annual management fee, work closely with their clients, their clients’ legal and financial advisors, and state regulators during the set-up process and throughout the lifespan of the captive. Forty states permit the use of captives, though the quality of regulators varies among the jurisdictions. Medical practices would want to domicile their captives in jurisdictions that are active, sophisticated, and part of larger executive and legislative branches that support the usage of captives. Top US domiciles are Vermont, Delaware, Utah, North Carolina, South Carolina, Tennessee, Arizona, Nevada, Missouri, and D.C.  

 

Unfortunately, the United States’ most populous states (California, Florida, New York, & Texas) do not have competitive captive legislation on their books so practices based in those states typically would need to look at other jurisdictions to domicile their captives and, depending upon the lines of coverage needed, possibly use the services of an admitted carrier in their home state to “front” the captive’s policies. This merely is a form of reinsurance where the admitted “fronting” carrier cedes all or the vast majority of the risks and associated premiums to the captive, but provides the commercial “paper” to meet the home state’s insurance regulations.

 

However a practice structures its captive, it would be joining a growing number of businesses that are incorporating them as essential risk management tools. According to Earnst & Young’s 2024 Global Insurance Outlook Report, captives now insure approximately 25% of all commercial property/casualty risks. Captives are no longer alternative methods of risk management. With more than $50 billion in annual premiums, they have become mainstream, and medical practices increasingly are taking advantage of their state and federally-legislated benefits. [10],[11], [12]


[1] Captive Insurance Companies, Nat’l Ass’n of Ins. Comm’rs (Jan. 31, 2024), https://content.naic.org/cipr-topics/captive-insurance-companies.

[3] How Captive Insurance Safeguards Patient Privacy, MEDICAL ECONOMICS (Oct. 31, 2023, see, https://www.medicaleconomics.com/view/how-captive-insurance-safeguards-patient-privacy-in-medical-practices.

[4] Medical Liability Reform 2024, AMERICAN MEDICAL ASSOCIATION (2024), https://www.ama-assn.org/system/files/mlr-now.pdf

[7] Keeping Medical Liability Down: How Captive Insurance and Damages Caps Could Help Control Rising Healthcare Costs, by Daniela Talmadge, JOURNAL OF CORPORATION LAW, Vol. 33, pp. 201-216 (2021).

[8] 26 U.S.C. 162, 831(a) and 831(b); see also, Protecting Americans Against Take Hikes Act of 2015, Congress enacted section 333 of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), div. Q. of Public Law 114-113, 129 Stat. 2242, 3040 (December 18, 2015).

[9] Helvering v. LeGierse, 312 U.S. 531, 539 (1941); Clougherty Packing Co. v. Comm’r, 811 F.2d 1297, 1300 (9th Cir. 1987), aff’g 84 T.C. 948 (1985); R.V.I. Guar. Co., Ltd. & Subsidiaries v. Comm’r, 145 T.C. 209, 228 (2015).

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