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4000 - Advisory Opinions

Insurance Coverage Provided for Funds Held Pursuant to a Doctor's Malpractice Insurance Trust

FDIC-91-92 December 2, 1991 Adrienne George, Attorney

I am writing in response to your letter of June 12, 1991 and to the letter of your colleague, ***, dated September 10, 1991. I regret that it has taken me so long to respond to your questions, but we have been receiving so many letters that we have not been able to answer them as quickly as we would like.

In your letters, you write that you represent the [Doctors Malpractice Insurance] Corporation, a California cooperative corporation (the "Corporation"), and the [Doctors Malpractice Insurance] Trust (the "Trust"). The Corporation was formed in 1981 pursuant to section 12200 et seq. of the California Corporations Code for the purpose of sponsoring an interindemnity arrangement under California Insurance Code Section 1280.7, which is known as the Trust. According to the terms of the Trust, members of the Corporation (all of whom are physicians) become signatories to the trust agreement and pool their funds in the Trust. The Trust will then pay such members' malpractice claims (and defense costs) as they occur (up to $1,000,000 per act, error or omission, but no more than $3,000,000 will be paid on behalf of a member and that member's employees during the member's particular "coverage year"). Sections 5.01, 5.02.

To fund the trust, each physician makes an initial contribution, pays quarterly fees, and may also be called upon to pay further assessments as necessary. It is intended that only the income from the initial contributions will be used to pay for malpractice claims and the trust's operating expenses; however, if the income proves insufficient, up to 10% of the initial contributions can be invaded for such purposes from time to time, provided that any such amounts are "promptly repaid" (repaid within one year). Sections 20(d), 15. Your interpretation of this provision is that, once the trustees have withdrawn 10% of the initial contributions, they must repay the initial contributions fund at least to some extent before they can invade it any more. Even then, the maximum that the trustees can withdraw from this fund is 10%. Thus, if they withdraw 7% from the fund and repay 2%, they can withdraw only another 5% from the fund. In this way, 90% of the initial contributions fund should always remain untouched. However, the fund is also used to pay refunds of initial contributions to those physicians eligible for such refunds. Section 20(b) and (c). Thus, at any one time, more than 10% of the initial contributions fund might have been invaded (and those amounts refunded would not have to be repaid).

According to the physicians' trust agreement, the trustees will refund a member's initial contribution to the trust upon that member's death, retirement or voluntary withdrawal, provided that the physician is then in full compliance with the trust agreement (e.g., has no assessments or fees outstanding), and, except in the case of death, also provided that the trust has held the initial contribution for at least ten years (that is, except in the case of death, a physician eligible for a refund will not receive it until the trust has held his initial contribution for ten years). Sections 24.01, 24.02, 24.03.

In some instances, however, the initial contribution will be forfeited. If a member is delinquent in paying assessments or quarterly fees and fails to cure this defect, he or she will cease to be a member of this plan and will lose all claim to the initial contribution. Section 24.04. Likewise, if a member fails to comply with any other provision of this agreement (other than a failure to pay assessments or fees), that member will also forfeit the initial contribution and his membership in the plan. Section 24.05. Finally, even if a member is in full compliance with the trust agreement, the trustees can terminate his membership if a majority of the members of the "professional review committee" and at least two-thirds of the board of trustees decide that his termination is "in the best interests of the Trust." Section 24.06. In this case, he can either (1) forfeit his initial contribution and receive coverage for any claims that might arise in the future for acts committed while he was a member under the agreement (known as "tail coverage"), or (2) request a refund of the initial contribution (again, presumably with the ten-year holding period requirement mentioned above), in which case his benefits under the trust agreement will cease. Id.

Given these facts, you state that the Trust holds far more than $100,000 in each of several FDIC-insured depository institutions, and you ask how an account held in the name of the Trust would be insured should its particular institution go into default.

As you know, the FDIC insures deposits according to the right and capacity in which each deposit is held, so we must first decide the right and capacity--or account category--into which the Interindemnity Agreement deposits would fall.

The Interindemnity Agreement speaks of itself as a trust, and operates like a trust, so we will treat it as a trust for insurance purposes. (The Agreement fails to meet the requirements for a joint account, nor does it qualify as a principal-agent arrangement or a mutual insurance fund.)

Having decided that the Interindemnity Agreement as a whole is a trust, we must decide whether that trust is revocable or irrevocable. Because the trust can be dissolved by the vote of three-quarters of the plan's members (at which point the trust will terminate and any remaining funds be distributed pro rata among the plan's members), the trust as a whole is revocable. Bylaws, Section 7.01.

However, the trust as a whole is comprised of two sub-trusts. One sub-trust consists of the initial contributions, one from each doctor (the principal of each contribution only), and the other sub-trust contains the doctors' assessments, the quarterly fees and the income from the initial contributions. For ease of reference, we will call the first fund the "initial contributions trust" and the second fund the "assessments trust."

But before we analyze the initial contributions trust, we must say a word about professional corporations. It is true that, if all of the physicians belonging to a professional corporation are members of the Trust, the professional corporation itself will be eligible for malpractice insurance coverage. Section 6.03. However, because it is each physician who makes the initial contribution in order to qualify as a member of the Trust, and each physician who is eligible to retrieve his or her initial contribution under certain circumstances, we will look to each doctor's interest in the Trust for purposes of determining the FDIC insurance coverage, not to the interest of any professional corporation. (It is noteworthy that, whenever any doctor in a professional corporation ceases or fails to be a Trust member, the professional corporation automatically loses its malpractice coverage--though presumably the coverage of each doctor in good standing within the professional corporation would continue.)

That said, it is possible to view the initial contributions trust as either revocable or irrevocable.

The initial contributions trust may be seen as revocable because each doctor can revoke the trust, at least as to him, and in some cases, retrieve his initial contribution. However, the interest he holds in his initial contribution is marred by defeating contingencies--he may forfeit his initial contribution if he has been delinquent in paying his fees or assessments, or if he has violated any other terms of the interindemnity agreement. When a revocable trust has defeating contingencies, the beneficiaries' interests so affected will be added together for insurance purposes and insured as if they were the individually-owned funds of the settlors. For instance, where a husband and wife establish a trust to benefit their three children but the trust has defeating contingencies, assuming that there was no indication that the husband and wife had contributed different amounts to the trust, half of the trust funds would be insured as if they were the individually-owned funds of the wife, and the other half would be insured as if they were the individually-owned funds of the husband. Our case, however, is slightly different. With the [Doctors Malpractice Insurance] Trust, each settlor puts a different amount of money in trust for himself (and for any other beneficiary that he might name), and these sums are to be kept distinct in terms of their ownership. For example, Dr. Smith has a right to retrieve his own initial contribution but not that of Dr. Jones; Dr. Smith's beneficiary would be eligible to receive Dr. Smith's initial contribution upon that doctor's death, but would not receive the initial contribution of Dr. Jones. In this case, the FDIC would insure the interest of each physician in his initial contribution as if it were his individually-owned funds. This means that the interest of each doctor in the initial contributions trust at the time of the bank's default would be added together with any other individually-owned funds which that doctor holds at the same bank, and that entire amount would be insured for a maximum of $100,000. Please note that, if a doctor already holds $100,000 in her own name at the same institution, her interest in the trust would be uninsured. And because this trust can be invaded to a maximum of 10%, a particular doctor's interest in the trust when the bank defaults may be less than her original contribution. Section 20(b) and (c). Also, in order to be eligible for this insurance coverage, each trust account must indicate, by its title, that it involves a trust--for instance, a permissible title in this case would be "[Doctors Malpractice Insurance] Trust--Initial Contributions Sub-Trust Account." Further, the trustees must comply with the recordkeeping requirements of 12 C.F.R. § 330.4, so that the interest of each doctor in the account is readily apparent.

On the other hand, one might regard the initial contributions trust as irrevocable. After all, while any one doctor can withdraw from the initial contributions trust, it would take three-quarters of the members to dissolve the trust completely. Further, once a doctor makes her initial contribution to the trust, the trust terms operate as written and she can do nothing to change them. Thus, as to each doctor, the initial contributions trust is irrevocable. But, in this case, each doctor would have a retained interest in her initial contribution, on the condition that she not forfeit it as described above. According to our regulation on irrevocable trusts, when a settlor retains an interest in her irrevocable trust, that interest does not qualify as a "trust interest" but is insured as if it were the individually-owned funds of the settlor. 12 C.F.R. § 330.11(c)(1). This is true even when the retained interest is contingent, as in this case. Thus, the result for insurance purposes is the same, whether the initial contributions trust is regarded as revocable or irrevocable. Here, too, the title must indicate that the account involves a trust--a permissible title would be "[Doctors Malpractice Insurance] Trust--Initial Contributions Sub-Trust Account"--and the trustees must also comply with the recordkeeping requirements of 12 C.F.R. § 330.4.

The assessments trust is irrevocable, since once a physician's check is deposited in this trust, the doctor loses control over how it will be used. It may be used, someday, to pay for a malpractice claim against him; on the other hand, it may go to pay a malpractice claim for a physician he does not even know. For this reason, each doctor's interest in the assessments trust is contingent. According to our rule on irrevocable trusts, all contingent interests in an irrevocable trust are added together, and that entire amount is insured for up to $100,000. 12 C.F.R. § 330.11(b). Here again, the title must indicate that the amount involves a trust, as in " Trust--Assessments Sub-Trust Account," but in this case, the recordkeeping requirements of 12 C.F.R. § 330.4 would not be necessary (because no one doctor has an ascertainable interest in the assessments trust).

The next question we must ask is, would the FDIC permit an allocation of funds between the initial contributions sub-trust and the assessments sub-trust at any one bank? For example, let us assume that 2% of the total trust funds belong to the initial contributions sub-trust and 98% of the funds belong to the assessments sub-trust. Would it be possible, at any one bank, for the trustees to allocate, say, 50% of the trust funds in that bank to the initial contributions sub-trust and the other 50% of the trust funds to the assessments sub-trust? The answer to this question is yes, provided that the trustees can prove through their recordkeeping that their identification of each part of the trust as an initial contribution or assessment (or some other part of the trust) is correct.

Even though the trustees can hold a large portion of initial contribution funds at the same insured depository institution (due to the pass-through insurance coverage afforded them), still only $100,000 in assessment funds can be held at each such institution. Thus, to prevent some funds from being uninsured, the trustees must monitor each assessments sub-trust account at any one insured depository institution to ensure that it does not exceed $100,000.

I hope that this information will prove useful to you. If I can be of any further help, I can be reached at (202) 898-3859.

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