Life Insurance in the Group Practice How Much and What Type Should You Purchase?

How much life insurance should your practice purchase on the lives of its doctor owners? Medical and dental groups often struggle with this, as well as what type of policy to buy and what additional riders to add on.

Individual circumstances, philosophy, and budgetary considerations enter into the decision-making process, along with a generous measure of common sense. The objective of this article is not to make you an insurance expert, but rather to give you some general guidelines to follow, from a CPA’s perspective, based on the experience of working with small to medium-sized group practices.

There are three principal reasons for purchasing life insurance. One is to provide a benefit for employees’ families in the event of a premature death. This is usually based on either some predetermined flat amount or a multiple of annual compensation, and is usually purchased as part of a group policy.

The second reason is for funding an owner buy-out. In the event of death, this would fund an unplanned expenditure that could otherwise create a financial hardship for the remaining doctor owners. The amount of insurance is usually tied to the buy-out agreement.

The third principal reason for purchasing life insurance on the doctor owners is to enable the practice to continue to meet its overhead expenditures in the event of death until a replacement can be found, which may take up to a year.
Example: Dr. G dies prematurely, and his buy-out arrangement provides for a payment of $200,000 to his family. Dr. G’s annual revenue generation was $700,000. His annual income and benefits package was approximately $300,000. This leaves about $400,000 overhead for his other four partners to carry. In addition to this, the practice has to fund approximately $50,000 in costs to recruit a new doctor. It is estimated that between cost-cutting and picking up additional patient volume, the remaining doctors can cover about $150,000 of the remaining overhead, leaving $300,000 of unabsorbed costs. The practice should be insured for the $200,000 buy-out and $300,000 of unabsorbed overhead. Insurance of $500,000 would cover these costs.

When figuring overhead costs, you should factor in other cash flow requirements, such as principal debt service and equipment expenditures.

Types of Life Insurance Policies

Life insurance comes in many different forms, but the two major categories are term life and permanent life. All other policy types are variations on these two.

Term life insurance is, in the simplest terms, pure life insurance for a specified period of time that can range from 1 to 30 years. You may pay a premium that is fixed over the period of coverage or a premium that begins very low and increases with your age. If you die during the coverage period, your beneficiary receives the death benefit. If you don’t die during the term of coverage, your beneficiary receives nothing, and your coverage simply ends.

Permanent insurance, also called cash value insurance or whole life insurance, is life insurance that is designed to have you pay a level premium throughout your life. As long as you continue to pay the premiums when due, the life insurance coverage continues throughout your life.

The premiums are much higher than term insurance because a portion of each premium pays for the actual current insurance coverage, similar to term insurance, and a portion is placed in a cash value account. This account is managed by the life insurance company. The insurance company guarantees you a minimum rate of return, and this cash value account continues to grow tax-deferred as long as the policy is in force.

You can borrow against the cash value, but unpaid policy loans will reduce the death benefit that your beneficiary will receive. If you surrender the policy before you die, i.e. cancel your coverage, you’ll be entitled to receive the cash value, minus any loans and surrender charges.

An additional feature of permanent insurance is that, if you keep the policy in force long enough, the cash-value account can grow to provide you with a return of most (if not all) premiums paid, and annual dividends paid by the insurance company can get added to the cash value account, paid out to you, or used to reduce future premiums.

Making the Choice

Your practice and owner demographics will influence your decision of whether to purchase term or permanent insurance. The following factors tend to favor term insurance:

• The insurance coverage you need is so large that the only affordable coverage is low-cost term insurance;
• The insurance coverage you need is only for a limited period of time, i.e. 10 years or less until retirement; or
• There is no requirement or desire to fund a normal retirement buy-out.

If you choose to purchase term insurance, we usually recommend you shop around for level-premium term insurance for as far out as you can, up to normal age of retirement. This makes the annual payments more affordable and predictable for budget and cash-flow purposes.

• The following factors tend to favor permanent insurance:
• Doctors are middle-aged or younger;
• The practice desires to fund part or all of the normal physician buy-out;
• The period of coverage is expected to be 20 or more years;
• You desire to take advantage of tax-deferred growth; or
• You can afford to pay higher premiums initially, in exchange for obtaining long-term insurance coverage and a return of premiums down the road.

Depending on your practice’s particular circumstances, it may make sense to buy insurance through a combination of term and permanent insurance.

Final Thoughts

Seek Professional Advice. You should only work with reputable insurance agents. These are generally recommended by your CPA, attorney, or another trusted advisor. Ask your CPA to assist you in sorting through the maze of coverages and policy types.

Beware of glitz and glitter. There are many hybrid policies that offer variable coverage, variable premiums, variable returns, and various optional riders such as disability waivers, guaranteed insurability, and conversion features. The cost of these additional options can be excessive, and you shouldn’t pay for features you don’t need. I have yet to see one of my clients actually exercise one of these options. Variable coverages, premiums, and investment returns usually confuse and leave doctors disappointed down the road. As an example, I have yet to see a ‘universal life’ policy that ever panned out as originally illustrated in the sales pitch.

Comparison shop. Don’t settle for one quote from one insurance company. Shop around and compare prices from several companies, but be sure you are comparing similar policies with similar coverages and benefits. Prices can vary substantially, depending on each company’s internal pricing strategies.

Check on the company’s financial strength. All insurance companies are rated by the major rating companies, including A.M. Best, Moody’s, and Standard & Poor’s. The ratings reflect the company’s ability to meet its obligations and are a good yardstick measurement of financial security. These ratings can be found in public libraries and on the Internet.

Re-evaluate your insurance needs. With the help of your agent and CPA, you should periodically re-evaluate your insurance needs. Your group practice situation and, accordingly, its needs will change as will insurance costs. It may be surprising, but your insurance costs may actually decrease over time.

James B. Calnan, CPA, is partner-in-charge of the Health Care Services Division of Meyers Brothers Kalicka, P.C. in Holyoke;             (413) 536-8510      .