Everyone understands the reason for frequent school fire and tornado drills as well as the importance of conducting a life boat drill before the ship even leaves port. Planning ahead for what to do in the event of an emergency can save lives as well as property.
When it comes to asset protection, however, many physicians make only one plan—medical liability coverage—even though other circumstances are more likely to result in significant financial losses. For example, an automobile accident, an injury at home or work, or the break-up of a practice or marriage can result in significant legal costs and the loss of assets.
Those who have experienced these hardships may feel as though laws are stacked against them. When it comes to medical liability, for example, in states with joint and several liability, a defendant who is found only partially responsible for an injury may end up having to pay the full amount if the other defendants are unable to pay. But at least the defendant has insurance coverage. No such protection can be applied to the division of assets and the costs of divorce. Consequently, physicians should use a portfolio of strategies in considering the best way to protect hard-earned assets.
Liability insurance coverages
Insurance is one way to mitigate exposure to catastrophic losses. Medical liability insurance has long been regarded as a primary means of protecting assets from negligence lawsuits. However, when premiums are excessive in comparison to the limits of coverage, physicians may “go bare.” Some states’ statutory requirements may offset the need for medical liability coverage. For example, in Florida, physicians must be able to cover a $250,000 statutory minimum in the case of an adverse judgment or risk losing their medical licenses. They can address this requirement by establishing an escrow account or an irrevocable line of credit, or by having the financial means to cover such a judgment.
However, even with medical liability insurance, physicians are at risk for judgments in excess of their policy’s limits. In the event of a $1 million judgment, for example, a $250,000 policy means the physician would still be liable for the additional $750,000. The only way to keep the plaintiff’s attorney at bay is proper asset protection.
One of the real benefits of malpractice insurance is that the insurance company pays for legal expenses and thus will fight to protect itself from loss. Although attorneys may offer malpractice defense insurance, they may be focused on a quick settlement rather than incur the cost of a protracted legal battle in which they have nothing at stake.
General liability can occur as a result of motor vehicle accidents when the physician or a member of his or her family was driving. Again, if damages exceed policy limits, this liability may have an impact. This also applies to homeowners and business liability insurance in case of slips and falls or other injuries in those venues. Fortunately, umbrella liability policies are relatively affordable and should be an essential component of asset protection.
For most people, their largest asset is their home. In some states, the homestead exemption protects this asset from liability claims. The strength of this exemption varies by state. Some states have an unlimited exemption—but even this is not a perfect asset protection strategy because the exemption expires as soon as the house is sold. Neither is it safe to rely on home ownership by joint tenants with a spouse, due to the potential of divorce or the spouse’s death. It seems best not to put your complete nest egg into your nest.
For the most part, IRS-qualified plans are protected. This includes all pension plans, 401k/403b plans, individual retirement accounts (IRAs), health savings accounts, and Section 529 college savings plans. Because these plans grow tax-deferred (or tax-free in the case of a Roth IRA), most financial planners recommend “paying yourself first” and contributing the maximum annual contribution as early as possible each year. The asset protection benefit is a bonus. However, qualified plans have annual contribution limits.
Similarly, the cash surrender value of whole or variable life insurance and annuities is also generally exempt from liability claims and grows tax deferred. These policies (modified endowment contracts) can be overfunded but only up to IRS-specified annual limits based on the value of the death benefit.
If the physician must pay a large verdict, for example, he or she could borrow from the cash value of a life insurance plan for living expenses. The insured can repay the loan during his or her lifetime, or the amount owed would be subtracted from the death benefit, when payable. Because estate planning may involve using a similar technique, asset protection and estate planning should be coordinated.
A partial or total disability can certainly affect a physician’s assets. Someone who is unable to work for an extended period of time may have to liquidate assets to make ends meet. Disability insurance can minimize that risk. The policy must stipulate the physicians own occupation and specialty to ensure partial disability coverage. Although the amount of insurance available may be limited, when premiums are paid in after-tax dollars, disability payments are nontaxable.
Because a practice is often named in a malpractice lawsuit as the employer of a sued physician, judgments can be levied against the practice just as they can against the physician. A practice’s most valuable asset is usually its accounts receivable (A/R). Fortunately, protecting this asset and maintaining the practice’s financial flexibility can be done by obtaining a business line of credit from a bank.
The practice’s A/R serves as collateral and the bank becomes the first lien holder of record. If a suit is filed, the practice can use incoming A/R to pay office expenses as well as the bank loan. New charges can be billed under the name of a new practice entity, leaving no exposed A/R.
From an asset protection standpoint, practice ownership of assets such as an office building or imaging equipment is risky. It is safer to either lease these from third parties or own them through other entities and lease them to the practice.
Many corporate structures can be used to protect practice-related and personal assets. A limited liability company, for example, is a hybrid entity that combines the limited liability of a corporation with the flow-through income taxation of a partnership. A more complex version—a family limited liability partnership—can also be used to protect business and personal assets.
Under this structure, two distinct corporate entities—a general partner and a limited partner—are established. The general partner determines the amount and timing of partnership distributions but holds virtually no assets. The limited partner owns virtually all of the assets but does not control them. Thus, a judgment against the limited partner cannot be enforced because the limited partner cannot opt to use assets to pay the creditor.
This type of entity can hold virtually any asset, including medical real estate or equipment leased back to the practice, ambulatory surgical center shares, personal real estate investments, or stocks and bonds.
Many types of trusts can be used for asset protection. A trust is a legal entity into which the physician gifts assets to be protected. Because the physician no longer owns the asset, a creditor can no longer claim it. Trusts are complex documents and require experienced legal counsel to establish. A general rule is that the more irrevocable the trust, the more likely that asset will remain protected. The drawback of an irrevocable trust is that the physician loses the chance to reconsider and reclaim the gifted assets.
Although circumstances beyond a physician’s control may put assets at risk, a variety of asset protection techniques can be used. Because no single strategy is both perfect and unlimited, and none is immune to nullification by new legislation or judicial rulings, using multiple strategies makes sense. With asset protection in place, a physician can help limit losses and keep assets from being completely claimed by others.
Kevin Shrock, MD, a member of the AAOS Medical Liability Committee, is president of Fort Lauderdale Ortho and Sports Medicine, LLC, and Shrock Orthopedic Research, LLC.