Asset-protection Strategies for Physicians
Developments Involving Malpractice Insurance
The availability and cost of malpractice insurance is the primary professional issue facing physicians. As the cost of medical malpractice insurance has skyrocketed, many physicians have sought to control costs by reducing their policy limits to the minimum required for medical staff membership (commonly, $1 million per incident and $3 million annual aggregate) or by shifting to less expensive carriers. This latter approach can backfire when the new carrier is downgraded by a rating service to a point below that which satisfies hospital medical staff requirements, or when the malpractice insurance carrier ceases operations entirely or is seized by state regulators. For example, the state seizure of the PIE Mutual Insurance Co. in Ohio in 1997 left many Ohio physicians with only the state guarantee fund amount of $300,000 to deal with any claim.
The increasing unavailability of "occurrence" medical malpractice insurance has caused many physicians to obtain "claims-made" insurance. This presents issues involving "tail" insurance upon the termination of coverage. The prospect of a "tail" premium equal to two times (or even more) the annual premium has forced many physicians into early retirement or into employment with large group practices or hospital-related entities. The prospect of going "bare" has become all too real for physicians who were insured with non-standard carriers whose "tail" insurance continues only for a certain number of years, unlike traditional "tail" coverage, which continues until the policy limits are exhausted.
It could be argued that the concern with respect to the threat posed by a medical malpractice plaintiff is exaggerated. While I am not aware of any published data on instances in which physicians have had to use personal funds to resolve malpractice claims, our firm's experience is that this is very rare. In the 40 years that we have represented physicians and physician groups, we have encountered only six instances in which physicians had to use personal funds. Four cases involved very low levels of insurance, and two cases involved no insurance at all. The total amount paid in all six cases was less than $300,000.
That personal payments seem to be rare is probably the result of a variety of factors. In an era of higher policy limits, "umbrella coverage" or separate policy limits for the physician's employer, there are simply more insurance dollars available. The typical "shotgun" approach common in medical malpractice litigation assured that there would be multiple defendants, many with "deep pockets" who could be persuaded to contribute to a settlement. In addition, malpractice plaintiffs and their attorneys have generally not evidenced interest in pursuing physicians' personal assets except in unusual circumstances. Of course, to some extent this lack of interest may also have been attributable to the fact that many physicians had engaged in asset-protection planning, thereby rendering themselves essentially judgment-proof to any but the most determined judgment creditor.
The future may be different. Lower insurance policy limits, the impact of state law tort reform, and the possibility that hospitals, already strapped for funds, may be less likely to contribute to settlements in cases involving physician malpractice, may affect the dynamics of resolving medical malpractice claims.
On the other hand, those same state law tort reforms, and particularly the limitations on non-economic damages, may over time reduce the incidence of large medical malpractice verdicts. The outcome of future court challenges will determine this impact.
The Risk of Non-malpractice Claims
Although physicians are naturally inclined to view an asset-protection strategy in the context of a medical malpractice claim, in our experience physicians have paid or lost money far more often as the result of the following:
- uninsured or underinsured casualty losses;
- ill-advised investments;
- personal guarantees of business obligations;
- alimony and property payments that could have been minimized with a pre-nuptial agreement;
- uninsured sexual harassment claims;
- estate taxes caused by inadequate estate planning;
- victimization by fraud;
- liability for breach of fiduciary duty (e.g., ERISA claims, director or officer liability); and
- indemnification obligations.
Any asset-protection strategy that does not address these risks is short-sighted.
The Components of an Asset-protection Strategy
A comprehensive asset-protection strategy for a physician should include several components. Some of these are set forth below. They would, of course, be in addition to common-sense liability avoidance (e.g., use good judgment: Do not permit underage drinking in your house, recognize changing times—what may have been viewed in the past simply as obnoxious behavior in the operating room is now actionable sexual harassment, meet your fiduciary obligations—serving on a hospital or other board of directors is more than an honor, it is a responsibility that entails numerous risks, etc.).
Adequate Insurance Coverage. Regardless of what other strategies might be considered, liability insurance would always be recommended as the primary component. Considerations in making decisions with respect to insurance would include the strength of the carrier and its commitment to remaining in the physician's market, the amount of insurance coverage and, least importantly, the premium cost.
A physician's asset-protection strategy should include reviewing the adequacy of all insurance policies including life, disability, office overhead, automobile, homeowner's, umbrella coverage and employment practices (to cover the increasingly common incidence of discrimination and sexual-harassment claims). For a physician, an insurance review would include insurance coverage maintained by, or contractual indemnification provided by, the physician's employer or by other third parties (e.g., hospitals, nursing homes) for which the physician provides services. Often, those services do not constitute the "practice of medicine" and are not covered by the physician's malpractice insurance. Identifying insurance gaps can be the most valuable asset-protection service an attorney can provide.
The Transfer of Ownership of Assets Within a Family. A common asset-protection strategy for physicians has been to gift assets to a non-physician spouse or to children. While this strategy continues to be effective, given the ever-higher incidence of both husband and wife being physicians, interspousal gifts may not solve the problem.
Poorly thought-out gifting programs can create federal estate tax problems. As the unified credit amount under federal estate tax law increases (to $1.5 million per individual for deaths occurring in 2004), an overly aggressive gifting program can result in unnecessary federal estate taxes if, for example, it leaves the donor spouse with a taxable estate short of the unified credit amount and if the donor spouse predeceases the donee spouse. No major gifting program should be undertaken without it being coordinated with proper estate planning. That being said, transferring assets (e.g., a personal residence) to the non-physician spouse often achieves both asset-protection and estate-planning goals.
Building Up Value in Exempt Assets. State law exemptions permitted by the Bankruptcy Code should be considered as part of any asset-protection strategy. This is particularly true given the fact that two of the largest components of many physicians' estates (life insurance and a personal residence) are treated with degrees of exempt status under various state law. That being said, estate-planning issues involving, for example, the form of ownership of real estate (e.g., estate tax issues, probate avoidance) should generally be considered before asset-protection issues.
Family Limited Partnerships and Limited-liability Companies. Family limited partnerships or limited-liability companies can offer significant asset protection in that, if properly structured, on an ongoing basis the creditor of a partner or member could only receive a charging order against the individual's interest in the partnership or LLC. Typically these entities are attractive to physicians more as vehicles through which family property can be better managed or controlled, or through which ownership interests in property can be gifted to other family members at a discounted value so as to minimize federal gift tax complications.
Such entities can also be a much more convenient way of transferring interest in real estate than by transferring percentage fee interests with complications associated with mortgages, deed filings and title insurance.
Asset-protection Trusts. Asset-protection trusts have been suggested to physicians for many years as a means whereby the physician can retain an ownership interest in assets while at the same time place the assets outside of the claims of creditors. In the past, they were formed in places such as Liechtenstein or the Isle of Man. The costs associated with setting these trusts up, the inconvenience and the general feeling of lack of adequate control over the assets contributed to making them unattractive to most physicians.
Despite the widespread adoption of state law tort reform, physicians continue to be greatly concerned with asset-protection issues.
The laws of a number of states (at my last count, Delaware, Alaska, Nevada, Rhode Island, Utah and Missouri) now offer asset-protection trusts that are an exception to the self-settled discretionary trust rule under which the trust corpus would otherwise be subject to the claim of the settlor's creditors.
In forming such a trust, certain matters involving the establishment and ongoing operation of the trust need to be considered. Typically, the trustee must be domiciled in the state that offers the asset-protection trust. As a practical matter, this is not a problem in that many large banks have formed trust companies in the above listed states.
These trusts can provide substantial retained powers for the settlor, such as the right to receive trust income, the right to receive principal under an ascertainable standard, the power to veto trust distributions, special powers of appointment and the right to remove a trustee or advisor.
Commonly, the state statutes authorizing these trusts do not immediately insulate assets from creditor claims and also exempt certain claims. For example, under Delaware law,1 future creditors have a "tail" period after the transfer to the trust. Exempt claims include those such as a spouse with claims for alimony or child support and certain tort claimants whose claims precede the funding of the trust.2
Notwithstanding these limitations, asset-protection trusts will likely become an increasingly common asset-protection strategy for physicians and non-physicians alike.
Retirement Plan Assets. In our experience, a typical physician's most valuable single financial asset is his or her qualified retirement plan account or rollover IRA. The most common asset-protection-related questions that we receive from our physician clients are these:
- Are my qualified retirement plan assets protected from the claims of creditors?
- If I roll my qualified plan assets into an IRA, will they still be protected?
ERISA prevents a creditor from executing on assets in an ERISA-qualified retirement plan to satisfy a judgment against the plan participant or beneficiary.3 Thus, answering the first question necessitates determining whether the plan in question is an "ERISA plan." Generally speaking, pension plans, profit-sharing plans and 401(k) plans, which are tax-qualified under §401(a) of the Internal Revenue Code, would be considered "ERISA-qualified plans." However, uncertainty can arise in situations in which the plan loses its tax-qualified status due to operational or document deficiencies, or where the sole participant in the plan is the owner or spouse of the owner of the business.4 These uncertainties can be reduced by including a non-owner (other than the owner's spouse) as a plan participant, by careful plan administration and by obtaining IRS determination letters, even upon the termination of the plan.
Answering the second question involves an analysis of state law. IRAs are not "ERISA plans" and are not insulated from the claims of creditors by ERISA. State exemption laws provide varying levels of protection for IRAs, some providing full exemption5 with others providing an exemption to the extent necessary for the support of the IRA beneficiary and the beneficiary's dependents.6 A useful web site on the subject of state law exemptions is www.leimbergservices.com.
Some uncertainty on the subject of protection for IRAs was caused by a 2002 decision of the Sixth Circuit Court of Appeals in Lamkins v. Golden,7 which held that Michigan's IRA exemption statute did not protect a participant's interest in a SEP-IRA because it was an employer-sponsored plan. It appears that bankruptcy courts in the Sixth Circuit have subsequently declined to apply the result in Lamkins to non-employer-sponsored IRAs.8 As a result, our counsel to clients in states such as Ohio is that assets in an IRA should enjoy the same level of asset-protection as assets in an ERISA plan. However, this area of law continues to be somewhat unsettled, and there could be more unexpected decisions such as Lamkins.
Avoidance of Indemnification Obligations. Physicians who provide independent contractor or similar services (whether clinical or administrative in nature) to other medical providers, institutions or facilities (e.g., hospitals, surgery centers) are regularly presented written service agreements that contain various indemnifications, hold-harmless clauses or defense obligations. Such indemnification obligations would typically not be covered by a physician's liability insurance, at least to the extent that the indemnification obligation exceeded what would be imposed on the physician under the facts of a particular case by operation of common law indemnification principles.
Defense obligations raise similar problems in that generally there is no defense obligation under common law principles.
A physician should not agree to these types of obligations without first obtaining the written approval from his or her liability insurance carrier or carriers. While indemnification provisions often give rise to difficult negotiations, in our experience the other medical provider will generally agree to modify its demand in the face of a refusal by the physician's insurance company to recognize the indemnification, defense or hold-harmless obligation.
Despite the widespread adoption of state law tort reform, physicians continue to be greatly concerned with asset-protection issues. In addressing this concern, two factors must be kept in mind. First, the malpractice plaintiff is far from the only potential threat, and, indeed, is not the most likely threat to the financial well-being of a physician. Secondly, an asset-protection strategy should be integrated into an overall financial and estate planning program.