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Business Advisor
Physicians, Cover Thy Assets
Benjamin Renzo
Publish Date: October 1, 2008

Each year malpractice insurance becomes more expensive and less effective at protecting physicians' assets, their practices and the surgery centers where they operate. While most physicians carry malpractice liability insurance that covers $1 million per incident and $3 million for multiple claims in the same year, the average jury verdict award increased from $3.1 million in 2000 to $4 million in 2006, say published reports.

That means that if a physician is hit with a jury verdict, the amount of the judgment is likely to be more than the physician's malpractice insurance coverage. When this happens, the court will look at the physician's business and personal assets to settle the debt. One of the primary assets a judgment creditor will go after is the accounts receivable of the physician's practice or the surgery center where the physician is an investor.

Equity stripping lets you guard what's yours
Depending on the state where the physician practices, he can protect his accounts receivable — cash owed to him that generates no interest — by creating an accounts receivable financing plan known as equity stripping.

Don't confuse accounts receivable financing with factoring — when a business sells its accounts receivable at a discount to a financial firm. However, like factoring, equity stripping does take advantage of the fact that most medical practices don't collect on all their accounts receivable. When planning this strategy, it's important to work with a financial planner, a tax specialist, an attorney and a bank that are familiar with accounts receivable financing.

Here's how it works. The practice takes out a "lifetime loan" from a bank using its accounts receivable and other assets — such as equipment and real estate — as collateral. The lender files a UCC-1 lien against the practice's assets. Such a lien establishes that the lender will be the first creditor in line in the event of bankruptcy or a judgment against the physician. In the case of a malpractice judgment with a properly structured financing program in place, the judgment creditor will have to pay off the lender before collecting the accounts receivable or other practice assets.

Next, the physician buys a high cash-value indexed annuity or universal life insurance policy for the amount of the loan. The typical cash surrender value of the life insurance policy should be between 70 percent and 105 percent of the initial premium payment. A suitable indexed universal life insurance policy should generate a minimum guaranteed annual return of about 2.5 percent, with a potential for a 5-percent to 10-percent return. The physician uses the proceeds from the loan to pay for the policy, usually in equal increments over five years. During the five years, he'll need to put the unused loan proceeds in a savings or premium deposit account in his name.

Upon retirement, the physician cashes in the policy and pays off the loan. After several years, the value of the policy is likely to be the same or of greater value than the outstanding loan. The insurance agent shouldn't charge him a fee for the life insurance policy because the insurance carrier will pay him a commission.

Choosing the right bank is important because terms and rates can vary. Some banks aren't familiar with loans for accounts receivable financing, while others offer high fees for short-term loans. Beware of short-term loans with adjustable rates. The loan rate should be 1.0 percent to 1.75 percent above the one-year London Interbank Offered Rate (LIBOR). (The one-year LIBOR rate in mid-August was 3.22 percent.) The lender should waive any pre-payment penalties and shouldn't charge origination fees. Annual interest charges should be the only fee associated with the loan.

With this arrangement, the practice's assets are linked to the loan, giving priority to the lender if creditors go after the physician. At the same time, the universal life insurance policy, worth at least as much as the assets, may be protected from creditors. Because the receivables of the practice are tied up in the loan, this strategy helps deter frivolous malpractice lawsuits and encourages settlement negotiation. During their discovery process, the patient's attorneys will learn that there is no "low-hanging fruit" — accessible assets — to go after in court.

Safety for everyone
Malpractice lawsuits aren't going away. Neither are accounts receivables. Why not protect the money owed to you with an accounts receivable financing strategy? In a group practice or ASC investment, you can use AR financing as a low-cost perk for recruiting and retaining physicians. For group practices or ASCs with several investors, you'll need to establish and carve out the AR generated by each physician. Then each physician takes out a loan based on his share of the AR.

Pitfalls of Equity Stripping

  • Sometimes it may be difficult to secure a loan at an interest rate lower than the rate of the return from the universal life insurance policy. However, some physicians feel that an unfavorable rate is worth paying in order to protect the practice's or surgery center's assets.
  • Equity stripping may not work if a physician is in the process of being sued by a patient.
  • Finally, the physician needs to meet with tax advisors to consider the tax consequences of this strategy.

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