What Every Physician Owned Hospital Needs to Know About Captive Insurance B Y : T H E S T R A U S S L A W F I R M, L L C P E T E R J. S T R A U S S, J. D., L L. M.
The Strauss Law Firm Peter Strauss is the Managing Member of The Strauss Law Firm, LLC: o Focus on estate and tax planning, asset protection, international business, and captive insurance solutions Mr. Strauss regularly speaks at professional society meetings, including: American Institute of Certified Public Accountants (AICPA), Hawaii Tax Institute (HTI), American Association of Orthopaedic Executives (AAOE), and National Advisors Trust Company He has authored three books on captive insurance planning: Captive Insurance Companies for the Small Business Owner The Definitive Guide to Captive Insurance Companies The Physician s Guide to Captive Insurance Companies Mr. Strauss is a graduate of the New England School of Law, and holds an LL.M. in Estate Planning from the University of Miami.
$260,767
Q&A Q: How do we save $260,767 for physician-owned hospitals? A: By implementing a captive insurance company. Q: What is a captive insurance company? A: A captive is an insurance company established to provide a broad range of risk management capabilities to affiliated companies.
Q&A Q: Why should you establish a captive insurance company? A: To address issues we are all facing: Rising Costs of Insurance Decreased Scope of Coverage Rising Tax Rates Increased Opportunity for Litigation
A Captive Provides You with the Following: Comprehensive & Customizable Insurance Coverage Minimizing Income Tax Burden Increasing Cash Flow Reducing Exposure to Lawsuits Retain Control
Again, a captive is your own insurance company. By owning your own insurance company, policies can be designed to provide customized and comprehensive coverage for risk related to your business. Q: What kinds of risk are we talking about?
Types of Risk Health Property Insured Auto Malpractice General Liability
Types of Risk Loss of Use of Surgery Center Computer Data Restoration LOI Due to Reputational Damage Self- Insured Inability to Practice Cost of Clean Up
Tax Benefits Premium payments made to a captive insurance company are 100% tax deductible to your underlying business. Sec. 831(b): Premiums received by captive insurance companies are tax exempt up to $1.2 million per year. Bottom Line: With a properly structured captive, self-insurance through a captive insurance company can create substantial tax deductions, resulting in tremendous tax savings.
Client Example- Nationwide Medical Center Coverage Limit Premium Policy Aggregate Deductible and Limit No Agg Limit 0 Loss of Income due to Reputational Damage 1,250,000 189,399 Administrative Actions 1,250,000 41,399 Loss of Income and Cost of Clean Up (Contamination/Infection) 1,250,000 81,344 LOI/Extra Expense- Loss of Use of Surgery Center 1,250,000 81,344 Computer Data Restoration and Loss of Revenue 1,250,000 81,344 Business Interruption- Outside Causes 1,250,000 145,353 Employment Practices Liability 1,250,000 37,203 Legal Expense 1,250,000 49,604 Tax Audit Expense 250,000 19,842 Wrongful Acts 1,250,000 49,604 Inability to Practice (Loss of Revenue and Extra Expense) 1,250,000 164,478 TOTAL: 11 Coverages $12,750,000 $940,913
Year 1 Year 2 Year 3 Year 4 Year 5 Year 10 Captive Insurance Company Annual Premium 940,913 940,913 940,913 940,913 940,913 940,913 Set-Up Fee 65,000 3,500 3,500 3,500 3,500 3,500 Captive Manager s Retainer 25,000 10,000 10,000 10,000 10,000 10,000 Manager s Premium Charge 10% 10% 10% 10% 10% 10% Total Costs 184,091.30 107,591.30 107,591.30 107,591.30 107,591.30 107,591.30 Costs as % of Premium 19.57% 11.43% 11.43% 11.43% 11.43% 11.43% Beginning of Year Acct. Value 0 801,815 1,727,126 2,702,894 3,731,871 9,782,156 Investment Base 756,821.70 1,635,137 2,560,448 3,536,216 4,565,192 10,615,478 Income & Gains 52,977.519 114,460 179,231 247,535 319,563 743,083 Corporate Tax 7,984 22,471 36,785 51,880 67,799 161,396 End of Year Acct Value 801,815 1,727,126 2,702,894 3,731,871 4,816,957 11,197,165 After-Tax Account Taxable Proceeds 940,913 940,913 940,913 940,913 940,913 940,913 Income/Employment Tax Burden 45% 45% 45% 45% 45% 45% Tax on Proceeds 423,411 423,411 423,411 423,411 423,411 423,411 Beginning of Year Acct. Value 517,520 1,058,551 1,624,217 2,215,621 2,883,934 6,373,988 Tax on Income & Gains 12,679 12,679 39,793 54,283 69,431 156,163 End of Year Acct. Value 541,048 1,106,715 1,698,119 2,316,432 2,962,878 6,664,004 Captive Advantage Pre-Liquidation Tax Benefit 260,767 620,767 1,004,775 1,415,439 1,854,079 4,533,161
$260,767
Relevant Facts Captives have been prevalent in the US for over half of a century. More than 30 states and 35 countries currently serve as domiciles for captive insurance companies. Over 90% of Fortune 500 companies utilize a captive insurance company. The IRS provides specific Internal Revenue Code Sections and Revenue Rulings that serve as safe harbors for small business owners; the result of which is a market that exceeds $200 billion in annual insurance premiums.
Relevant Facts Cont. Hurricane Katrina vs. Hurricane Isaac: Business Interruption Insurance Smarter Insurance Companies Mandatory Evacuations 40% of businesses do not reopen after a disaster.
A Little Recap Captive insurance companies are real insurance companies owned and operated by high net-worth business owners. Premiums are tax deductible to the business. Premiums collected are tax exempt to the captive insurance company. Captive insurance companies have been around for over half a century. There is a specific IRC section validating the utilization.
Traditional Insurance Coverage Big Insurance Co. $$ Property Malpractice General Liability Auto Health Business Owner Never see this money again!
Self-Insured Coverage = More Extensive Coverage + Tax Benefits Reputational Damage Business Owner s Captive Insurance Co. Loss of Key Customer Litigation Defense Supply Chain Interruption Business Owner Employment Practices IRS Sec. 831(b): Premiums received by captive insurance companies are tax exempt up to $1.2 million per year.
Nuts and Bolts Establishing a Captive Feasibility, Formation, Function Domicile International v. Domestic Management Selection, Duties, Services, Costs Captive Ownership Individuals, LLCs, Partnerships, Corporations, Trusts, etc. Reinsurance
Insurance Benefits Summary Captives will allow you to procure new and more comprehensive insurance coverage. Captives will allow you to insure non-traditional or selfinsured risks typically not purchased on the commercial insurance market due to the expensive nature of the coverage. Captives will allow you to more thoroughly insure a multitude of risks.
Asset Protection Benefits Assets in a captive are not exposed to creditors. Assets in a captive are only available to pay the claims approved by the captive company and its owners. Captive insurance companies can be owned inside an Asset Protection Trust. Captives allow the use of customized policies that are often too pricey or unavailable through large insurers, allowing greater flexibility and reduced exposure. Using a captive, monies can be transferred as a business expense into an independently operating, fully licensed captive insurance company. Any lawsuit, claim, divorce, tax or other action against the business owner, the business, or the assets is completely separate from the captive. Thus, investments held and owned by the captive are fully protected against litigation.
Estate Planning Benefits Business owners can transfer ownership at time of capitalization of the captive (i.e. to a Trust or LLC). Example: Assume that a business created a captive and premiums are set at $650,000 per year. The business owner has three children and gifts the capitalization to a dynasty trust for their benefit. The trust now owns the captive insurance company of which the children are the direct beneficiaries and not a single penny of the business owner s lifetime exclusion is used. Example Continued: Assume that the insurance company operated for 10 years and assets grew at 7% per year. Let s also assume that taxes, claims and operating expenses totaled 10% per year. After 10 years, the insurance company would have in excess of $7.6 million, of which the entire amount would be outside of the estate of the business owner and excluded from estate taxes.
$358,634
Client Example- Southeastern Surgery Center Coverage Limit Premium Policy Aggregate Deductible and Limit 750,000 0 Reputational Damage 750,000 140,962 Administrative Actions 750,000 86,143 Computer Data Restoration and Loss of Income 750,000 61,671 Wrongful Acts 750,000 77,528 Work Stoppage 750,000 25,842 Loss of Key Employee (1, AggLtd) 750,000 56,728 Loss of Key Employee (2, AggLtd) 500,000 41,907 Business Interruption- Loss of Work Premise 750,000 77,528 Cost of Clean-Up 750,000 86,434 Legal Expenses 750,000 40,804 Tax Audit Defense Expense 250,000 21,536 Computer Data Restoration and Loss of Income 750,000 83,117 Wrongful Acts 750,000 105,996 Loss of Key Supplier 750,000 27,689 Business Interruption- Loss of Work Premise 750,000 4,846 Reputational Damage 750,000 183,345 Legal Expenses 750,000 51,006 Tax Audit Defense Expense 250,000 26,920 Total: 18 coverages, after 2 subjected to 750,000 aggregate limit) $11,750,000 $1,200,000
Year 1 Year 2 Year 3 Year 4 Year 5 Year 10 Captive Insurance Company Annual Premium 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 Set-Up Fee 65,000 3,500 3,500 3,500 3,500 3,500 Captive Manager s Retainer 25,000 10,000 10,000 10,000 10,000 10,000 Manager s Premium Charge 10% 10% 10% 10% 10% 10% Total Costs 210,000 133,500 133,500 133,500 133,500 133,500 Costs as % of Premium 17.5% 11.13% 11.13% 11.13% 11.13% 11.13% Beginning of Year Acct. Value 0 1,048,664 2,233,329 3,482,593 4,799,980 12,546,093 Investment Base 990,000 2,115,164 3,299,829 4,549,093 5,866,480 13,612,593 Income & Gains 69,300 148,061 230,988 318,437 410,654 952,881 Corporate Tax 10,636 29,897 48,223 67,549 87,929 207,762 End of Year Acct Value 1,048,664 2,233,329 3,482,593 4,799,980 6,189,205 14,357,712 After-Tax Account Taxable Proceeds 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000 Income/Employment Tax Burden 45% 45% 45% 45% 45% 45% Tax on Proceeds 540,000 540,000 540,000 540,000 540,000 540,000 Beginning of Year Acct. Value 660,000 1,350,030 2,071,456 2,825,708 3,614,277 8,129,110 Tax on Income & Gains 46,200 148,061 145,002 197,800 252,999 569,038 End of Year Acct. Value 690,030 1,411,456 2,165,708 2,954,277 3,778,727 8,498,985 Captive Advantage Pre-Liquidation Tax Benefit 358,634 821,872 1,316,886 1,845,703 2,410,478 5,858,728
$358,634
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Contact Information Peter J. Strauss, J.D., LL.M. Address: 10 Hospital Center Common, Suite 400 Hilton Head Island, SC 29926 Phone: (843) 681-4190 Fax: (843) 681-4191 Email: pstrauss@thestrausslawfirm.com Website: www.thestrausslawfirm.com The information contained herein was obtained from sources considered reliable. Their accuracy cannot be guaranteed. The opinions expressed are solely those of the presenters and do not constitute legal advice nor reflect opinions from any other source.