Practice Economics
Is Payout Insurance Necessary?
In many instances, this insurance is expensive and illogical.

BY MARK E. KROPIEWNICKI, J.D., LL.M.

Many ophthalmology groups indiscriminately follow the advice of insurance agents and buy life and/or disability buyout insurance on each group member to provide proceeds for unexpected payouts. While it's somewhat emotionally comforting to know that the loss of a partner will result in little or no cash outlay by the group, this approach is both expensive and illogical. In this month's article, I'll explain why this is so.

DISSECTING THE INSURANCE FALLACY

Let's take an oversimplified example of two ophthalmologist-shareholders of a professional corporation in which the only asset is $400,000 of accounts receivable -- the product of the two doctors' own work. If the corporation buys $200,000 of life insurance on each of them to provide the funds to buy either member out upon death, it appears on the surface that the payment of a nominal premium will allow each member to be treated properly.

However this isn't as logical as it may seem. Each doctor actually pays for his own insurance premium by forsaking the income that the professional corporation must use to pay both premiums. This shortchanges the deceased member because he has both paid for the $200,000 of insurance and also worked hard enough to realize $200,000 on the accounts receivable. The life insurance, in effect, obscures the true economic worth of his practice.

The doctors would be better served by simply personally buying their own insurance policies with no connection to their professional corporation or to their payout arrangements. In such a case, upon a doctor's death, his beneficiary would receive both the $200,000 life insurance proceeds and the $200,000 accounts receivable payout.

The same objection applies to disability buyout insurance. While the insurance industry has created a special "disability buyout policy," the policy tends to be even more expensive than life insurance and thus isn't often used.

Any arrangement for paying out a group member must, of course, be affordable and appropriate within the ongoing group's likely finances, regardless of any insurance protection. The group members should look to the group and its actual financial attributes and values in deciding on a fair payout arrangement. If that's done, then insurance shouldn't be a major factor in structuring the group's payout arrangements.

ILLUSTRATION: PETER TILL

WHEN INSURANCE MAKES SENSE

Some risk-averse practices will still prefer obtaining insurance, particularly on the life of a key partner. If a key member's drawing power is so great, and if the other doctors are unsure that they can continue to maintain the group's volume in the event of that partner's death, then insurance may be justified. The group usually purchases the insurance policy, and the premiums are charged to the other doctors, since the purpose of such insurance is to provide them with a special element of protection.

This is known as key person insurance. Such life and/or disability buyout insurance may also be useful to a group fearing an inability to cope financially with a sudden, catastrophic loss of any highly productive member. A sudden death may render the ongoing doctors unable to meet patient care demands; and this may continue for months until the necessary replacement doctor can be recruited and hired. As above, key person insurance to cover this risk should be payable to the corporation and not be part of any payout arrangement.

SET THE PAYOUT FIRST

Payouts need to be fair and appropriate in all events regardless of the circumstances of a specific doctor's production. The payout should be established first without regard to insurance. Only then should the group decide whether insurance is desirable as protection.

Mark E. Kropiewnicki, J.D., LL.M., is a principal consultant with The Health Care Group, Inc., and a principal and president of Health Care Law Associates, P.C., in Plymouth Meeting, Pa. He regularly advises physicians and practices on their contracting matters and business law obligations. He can be reached at (800) 473-0032.