Asset-protection Strategies for Physicians

Journal Issue

Oct 2003

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New professionals are more acutely aware of liability risks and the exposure of
personal assets to the claims of creditors than physicians. Historically, their
concern has focused largely on malpractice-related claims. Given the publicity
of large malpractice verdicts and the incessant amount of malpractice-related
attorney advertising, this concern is understandable. However, malpractice
liability is hardly the only financial risk that physicians face.

<h3>Developments Involving Malpractice Insurance</h3>

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.

<h3>The Risk of Non-malpractice Claims</h3>

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:

<ul>
<li>uninsured or underinsured casualty losses;

</li><li>ill-advised investments;
</li><li>personal guarantees of business obligations;
</li><li>alimony and property payments that could have been minimized with a pre-nuptial
agreement;
</li><li>uninsured sexual harassment claims;
</li><li> estate taxes caused by inadequate estate planning;
</li><li> victimization by fraud;
</li><li> liability for breach of fiduciary duty (e.g., ERISA claims, director or officer liability); and
</li><li>indemnification obligations.
</li></ul>

Any asset-protection strategy that does not address these risks is short-sighted.

<h3>The Components of an Asset-protection Strategy</h3>

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.

<blockquote><blockquote>
<hr>
<big><center>
Despite the widespread adoption of state law tort reform, physicians continue to be
greatly concerned with asset-protection issues.
</center></big>
<hr>
</blockquote></blockquote>

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,<a href="#1" name="1a">1</a> 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.<a href="#2" name="2a">2</a>

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:

<ul>
<li>Are my qualified retirement plan assets protected from the claims of creditors?
</li><li>If I roll my qualified plan assets into an IRA, will they still be protected?
</li></ul>

ERISA
prevents a creditor from executing on assets in an ERISA-qualified retirement
plan to satisfy a judgment against the plan participant or beneficiary.<a href="#3" name="3a">3</a> 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.<a href="#4" name="4a">4</a> 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 exemption<a href="#5" name="5a">5</a> with others providing an exemption to the extent
necessary for the support of the IRA beneficiary and the beneficiary's
dependents.<a href="#6" name="6a">6</a> A useful web site on the subject of state law exemptions is <a href="http://www.leimbergservices.com">www.leimbergservices.com</a>.

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,<a href="#7" name="7a">7</a> 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.<a href="#8" name="8a">8</a> 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.

<h3>Conclusion</h3>

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.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=D…. Code Ann. Title 12, §3572(b)</a>. <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=D…. Code Ann. Title 12, §3573</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
U.S.C. §1056</a> (d)(i); <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… v. Shumate, 112 S.Ct. 2242 (1992)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
v. Paul Revere Life Ins. Co., 205 F.3d. 296 (6th Cir 2000)</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> See, e.g., Ohio Revised Code
§2329.66(A)(10)(c). <a href="#5a">Return to article</a>

<a name="6">6</a> See, e.g., Wisconsin Statute §815.18 (3)
(j). <a href="#6a">Return to article</a>

<a name="7">7</a> 2002 U.S. App. Lexis 900; 2002-1 U.S. Tax Cas. (CCH) P. 50, 216; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… E.B.C. 1587 (Issued Jan. 17, 2002)</a>. <a href="#7a">Return to article</a>

<a name="8">8</a> See, e.g., <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Fixel, 286 B.R. 638 (Bankr. N.D. Ohio 2002)</a>; <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…
re Buzza, 287 B.R. 417 (Bankr. S.D. Ohio 2002)</a>. <a href="#8a">Return to article</a>

Journal Authors

John T. Mulligan

Journal Date

Wednesday, October 1, 2003 - 12:00

Bankruptcy Rule

2003