Mixing MALPRACTICE insurance and investing? (captive insurance)

[Bartl007]

I just joined a practice and the malpractice carrier (red clay risk retention group inc) is a bit unique compared to most commercial carriers. http://www.totalcaptivesolutions.com/

This is my first exposure to captive insurance. https://en.wikipedia.org/wiki/Captive_insurance

Here's a WCI post that touches on the topic:

https://www.whitecoatinvestor.com/captive-insurance-companies-for-physicians/

 

Apparently the company my practice uses offers malpractice insurance (1mil/3mil) and offers the “opportunity” (actually a requirement) to purchase shares in the company as a percentage of your annual premiums (75% of annual premiums in my case). At this stage I’m unsure of what if any underlying investments exist but I am requesting more information from the company. I’ve been told that returns have been 12-15% over the last 10 years with low market correlation. I’ll believe it when I see it.

Evidently the company insures doctors with a low risk of being sued and is very selective (cherry picking) with the doctors they insure. My group has 3 doctors and this appears to be a captive that covers a number of smaller practices through the same structure.

 

Any others with experience with policies similar to this or captive insurance in general?

 

[The White Coat Investor]

When my company UMIA got bought by The Doctor's Company they had to buy us all out. In my case, that's a check for a few thousand dollars every year for 5 years. Could be a good investment, but due diligence required like any alternative untraded single business investment.

[Bartl007]

So after some further information it looks like:

-The captive insurance company is comprised of approximately 105 doctors who all are required to own shares
- the underlying investments include mostly CD ladders and blue chip stocks which are managed by an investment fiduciary (no cash value life insurance).
-The returns of 12-15% are mostly from growth of cash reserves as the premiums that are paid accumulate and the claims/settlements remain low.
-The ”investment” is a one time purchase of 75% of the annual premium which is in addition to the annual premiums paid.
- The ownership shares are a one time purchase (not recurring)
- The premium cost is approximately 5% less than the market rate for the respective speciality.
-the premiums are apparently tax deductible (but not for me since I don't itemize) and the proceeds upon withdrawal are taxed at the lower (for now) capital gains tax rate

I'm still waiting to hear back regarding a quarterly earnings report with detailed investment information but it doesn't seem unreasonable so far.


Any other red flags those with experience with captives care to share?

[Bartl007]

Just an update. I ended up buying into the captive insurance after a lengthy conversation with the head account manager for the captive and she answered all the following questions to my satisfaction. This particular captive company does have an extensive (20+yr) history which helped answer many of my questions. Here is a list of questions I asked that may help somebody in the future in the same situation.

1. Is our relationship bound by attorney client privilege? Not required, per se, but a good idea.

2. How many captives have you personally created?

3. How long have you been creating captives? Experience counts here; if they’ve done a few that are all very new, we don’t really know how they held up yet.

4. Do you have E&O or professional malpractice coverage that covers our relationship?

5. How old is the oldest captive you have created? See number three above.

6. What is the first-year, set-up cost of establishing a captive?

7. What are the recurring annual maintenance costs?

8. Are your services "turn-key" or will I need to pay outside counsel for issues like accounting and compliance? If yes, ask if they have specific resources they work with, and what their fees are as well, then qualify those resources the same way.

9. How many of your captives have been audited?

10. Of those how many have been "no change" required after the audit?

11. Does our contractual relationship include the cost of defending and responding to the audit?

12. Can you provide client/professional references?

13. How many years should I expect/plan to maintain the structure?

14. How can I collapse or wind my captive down if I need to?

15. What are the costs involved in doing so?

16. What is your normal exit strategy for captive owners?

17. What jurisdictions do you set up captives in?

18. What are the advantages of those jurisdictions over others?

19. What are all the additional risks the captive can insure me against?

[Zaphod]

How can you form a captive, or even join for something like malpractice? I've looked into them since they can be great vehicles in the right circumstances but I always come across the requirement that its for non standard insurable risks. I know hospitals do it but I think its a little different in that situation. As long as there isnt something goofy in your particular one it could be great.

[VagabondMD]

Evidently the company insures doctors with a low risk of being sued and is very selective (cherry picking) with the doctors they insure.

As an aside, I have heard sales pitches from about a dozen med mal insurance companies over the years, and they all make the same (above) claim. Classic Lake Wobegon Effect, IMO. While I expect that there are some plans that charge a fortune to insure high risk specialists who have already had some adverse activity, most conventional plans will naturally aim to limit the exposure and have had adequate reserves (premiums and investments) to cover the cost of med mal activity and losses. It's how they stay in business.

Disclosure: My group is also insured by The Doctors Company.

Okay, back to regular scheduled program.

[Hatton]

I am in a high risk specialty and have been sued so I guess I will make my money on the stock market.?

[Bartl007]

I am far from an expert and welcome anyone with detailed knowledge or experience with captive malpractice insurance to chime in.


If you poke around on the website above (first link posted) it answers some questions about how the captive is structured and how reinsurance is used to cover losses beyond the cash reserves.


“The captive company, not its members or officers, is liable for the risks of a claim. The captive partners with top-rated reinsurance companies to help minimize risk and exposure, while allowing the captive to assume as much risk as possible. “

These are heavily regulated entities and audits are commonplace. (Our captive just completed an audit with a few minor corrections required) They are required by law to have actuarial calculations done to insure that appropriate cash reserves and reinsurance is being held to cover any potential losses.

-Rex
I suppose I could get coverage from another company but have chosen to continue being covered by the captive for the time being. If I choose to drop coverage or leave the group, I am able to get my investment back plus any return (taxed at capital gains rates)

Yes it is true that most of the "return" on the investment is from surplus of premiums collected from the members (insured docs). Instead of having a few million dollars sitting under a mattress, the captive has the funds invested in relatively low yield vehicles to not be eaten up by inflation (similar to a cash balance plan that has to meet actuarial testing).

Nobody is getting rich with this captive model, but for some specialties that have high yearly premiums, at least all that money isn't flushed down the toilet and you still maintain coverage in the event of a suit. You may get a nice check upon retiring or leaving the group.


-Vagabond
I agree completely about appealing to doctors superiority complexes and was quite sceptical at first. After over an hour on the phone with the captive manager, it was at least apparent that I wasn't sending a check to Burnie Madoff.

[Hatton]

I really do not know a thing about a captive insurer.  I just know that if you are sued you want a malpractice carrier that has a reputation for being a tough negotiator with plaintiff firms and not one who will just settle.  You also need to know that that your carrier has access to the very best defense attorneys. If your speciality is never sued then why even have insurance.

[Zaphod]

The whole point of these captives aside from the tax benefits, is in regards to malpractice since your premiums which are not insignificant for most, arent just gone forever, you get a return on them. You can set up all kinds of ways to recoup that, they are very flexible. Better than nothing I suppose, but you do have to pay attention to your other risks of course.

[Bartl007]

-hatton
I agree that the best malpractice companies will fight against suits and are willing to go to court (not settle). That is part of the reason our practice made the switch to the captive carrier we use now. The other Malpractice carrier used by a large majority of physicians in my state (proassurance) has a well known history of settling cases and writing checks to plaintiffs.


Every specialty gets sued at some point. The likelihood of a suit is directly correlated to the premiums you pay.


-rex
What I would do with the money otherwise would be give it to the insurance company= gone forever


My particular captive management company has been doing this for 20+ years and currently manages 5 separate physician captives. The list of questions posted above helped with some of the due diligence involved in making sure you're not getting involved in a captive that may have to be “wound down” or dissolved in the near future due to a variety of factors that have to be considered.


Again, nobody is getting rich off of this arrangement, but our captive doesn't have a big building in New York, advertising budget, sales force to employ, etc. Maybe I wasn't clear above, but the sources of revenue that a traditional insurance company has (mostly premiums paid) are what makes up the majority of the ~12% “return” mentioned above. (The investments in blue chip stocks and CD's are merely an inflation hedge and not a primary source of revenue) I have reviewed the quarterly earnings report for our captive and as a shareholder am invited to the yearly shareholders meeting held in the state of our domicile. I probably won't go, but the option is always there.


There is no dishonesty involved, but like any reader of this board I approach claims of “12% return on investment” with a healthy dose of scepticism.


Premiums are paid yearly by the members of the captive whether the market is up or down, hence the low correlation with the market. Unlike a traditional investment, you are not allowed to contribute more than 75% of your yearly premium in my instance. (Some captives managed by the company we use have a 98% limit). In other words, you can't just invest as much money as you want and get 12% return. Again this is a one time purchase and not a recurring investment. But if your malpractice premiums are 50k/year for some of the more expensive specialties with a traditional malpractice company:


You can get potentially 5% off of your yearly premium = 47.5k yearly premium (every captive can set their premiums however they want it, but ours is 5% less than the market rate for any given specialty).


Then if you earn a conservative 10% (less than the historic return quoted above) return over a 30 year career with an initial investment of 75% of your 47.5k yearly premium = $35,625(this is the check you write to purchase shares in the captive insurance company)


You get a check for $621,635 upon your retirement and withdrawing your shares in the captive. ( taxed at capital gains rates)


This check along with the $2500 per year savings of your premiums is better than a kick in the teeth, but nobody is buying an island to retire to with their proceeds.


And of course the numbers above are a best case scenario with a specialty with very high yearly premiums (I'm so glad I didn't choose to go into obgyn)

[Zaphod]

A captive wont generate much return off investments initially, but it can become a problem after several years as there is some cap on amounts made off investments (not terrible you would just distribute them).

A captive is more like owning a business, an insurance business like Berkshire Hathaway. They make their money by using premiums, aka the "float" to provide themselves with leverage. There are also several other decent reasons for doing a captive. Its not right for everyone, but in the right situation can be very lucrative and of course the opposite is also true.

I was interested in doing one and read a couple of the books some years ago, but its not something I can realistically do as a sole proprietor. Its more of a tax code anomaly than some wild product, and I'd think of it as a business with all the inherent risks and rewards.

[Bartl007]

-rex


I think you may be misunderstanding the source of the “returns”. They really have nothing to do with the CD ladders and stocks held by the captive. They are from the yearly premiums collected from the members. I'm not sure how else to explain it. Perhaps zaphods posts are a better way of phrasing it.


I think it would be interesting to compare a mutual malpractice company with a well run captive insurance company. There may not be enough of a difference in total cost when dividends from the mutual insurance company are paid out compared to the complexity of forming a captive.


I welcome anyone who has compared both to educate the forum on the differences. May be a decent idea for a WCI pro/con blog post.


I try to keep an open mind about most things and if we end up finding a mutual malpractice insurance company that saves us money over the course of time compared to our current captive insurance company, I'm all about jumping ship.


What is your yearly dividend from your mutual malpractice carrier as a percentage of your annual premiums?


Are your annual premiums at the market rate for your state and specialty? Higher or lower?


I'm neither happy nor sad about my current carrier. It's a business expense just like any other. If I can reduce that expense, that lowers my overhead and helps run my business more efficiently. I'm constantly looking for ways to reduce expenses (while maintaining quality) that affect the bottom line and I welcome any suggestions.

[Hatton]

Bartl007 wrote:

-hatton
I agree that the best malpractice companies will fight against suits and are willing to go to court (not settle). That is part of the reason our practice made the switch to the captive carrier we use now. The other Malpractice carrier used by a large majority of physicians in my state (proassurance) has a well known history of settling cases and writing checks to plaintiffs.

Every specialty gets sued at some point. The likelihood of a suit is directly correlated to the premiums you pay.

-rex
What I would do with the money otherwise would be give it to the insurance company= gone forever

My particular captive management company has been doing this for 20+ years and currently manages 5 separate physician captives. The list of questions posted above helped with some of the due diligence involved in making sure you’re not getting involved in a captive that may have to be “wound down” or dissolved in the near future due to a variety of factors that have to be considered.

Again, nobody is getting rich off of this arrangement, but our captive doesn’t have a big building in New York, advertising budget, sales force to employ, etc. Maybe I wasn’t clear above, but the sources of revenue that a traditional insurance company has (mostly premiums paid) are what makes up the majority of the ~12% “return” mentioned above. (The investments in blue chip stocks and CD’s are merely an inflation hedge and not a primary source of revenue) I have reviewed the quarterly earnings report for our captive and as a shareholder am invited to the yearly shareholders meeting held in the state of our domicile. I probably won’t go, but the option is always there.

There is no dishonesty involved, but like any reader of this board I approach claims of “12% return on investment” with a healthy dose of scepticism.

Premiums are paid yearly by the members of the captive whether the market is up or down, hence the low correlation with the market. Unlike a traditional investment, you are not allowed to contribute more than 75% of your yearly premium in my instance. (Some captives managed by the company we use have a 98% limit). In other words, you can’t just invest as much money as you want and get 12% return. Again this is a one time purchase and not a recurring investment. But if your malpractice premiums are 50k/year for some of the more expensive specialties with a traditional malpractice company:

You can get potentially 5% off of your yearly premium = 47.5k yearly premium (every captive can set their premiums however they want it, but ours is 5% less than the market rate for any given specialty).

Then if you earn a conservative 10% (less than the historic return quoted above) return over a 30 year career with an initial investment of 75% of your 47.5k yearly premium = $35,625(this is the check you write to purchase shares in the captive insurance company)

You get a check for $621,635 upon your retirement and withdrawing your shares in the captive. ( taxed at capital gains rates)

This check along with the $2500 per year savings of your premiums is better than a kick in the teeth, but nobody is buying an island to retire to with their proceeds.

And of course the numbers above are a best case scenario with a specialty with very high yearly premiums (I’m so glad I didn’t choose to go into obgyn)

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Bartl007 I must disagree with you about proassurance. I sit on a committee for them that helps to decide which cases get defended and which get settled.  I am OB/gyn and have been through the process.  They aggressively defend doctors.  Sometimes they defend stuff I think should be settled.  I would keep malpractice costs as a business expense and invest in stocks.  I have been with this carrier when it was a mutual company too.

[Bartl007]

Thanks for the ”inside” info on proassurance. I trust your opinion over mine (based on word of mouth) and stand corrected.