Alinco Life Ins. Co. v. United States

                    UNITED STATES COURT OF CLAIMS

Commissioner Fletcher's opinion, as modified by the court, /*/ is as follows:

In 1953, Associates Investment Company (Associates) formed the plaintiff (Alinco) as a wholly owned subsidiary corporation and qualified it as a life insurance company under the laws of Indiana. The Government's subsequent attack on Alinco's status as a life insurance company for income tax purposes has spawned the present litigation. ¹

Summary of the Facts

The facts in this novel case are set forth at length in the findings of fact below. Here they will be summarized only to the extent necessary to explain the basis for the conclusions reached in this opinion.

Associates is one of the Nation's largest finance companies and engages for the most part in automobile financing and the making of direct personal loans. Prior to 1953, it owned or controlled a number of subsidiary corporations, one of which was Morco Insurance Agency (Morco). Due to Associates' inability under the laws of its corporate domicile (Indiana) to engage directly in the business of writing life insurance, Associates had formed Morco and qualified it as a licensed insurance agent in several states.

The importance to Associates of owning such a subsidiary was this. As a large finance company, Associates occupied an exceptionally favorable position for the solicitation and procurement through some sort of a qualified subsidiary of a substantial amount of business for life insurance companies, particularly those which engaged primarily in the writing of a specialized type of life insurance known as credit life insurance. Old Republic Life Insurance Company of Chicago, Illinois (Old Republic) was, and is, one of these specialized life insurance companies, and, as we shall see, it played an important role in the transactions which gave rise to the present controversy. Before relating those facts, however, it will be an aid to understanding if, first, credit life insurance is defined and described.

The parties have stipulated that credit life insurance is single premium term insurance on the lives of debtors, with their creditors as beneficiaries, in amounts at least sufficient to discharge their indebtednesses in case of death. Ordinarily it is sold as a part of another, and more prominent transaction, namely, a loan of money or an installment sale of tangible personal property, such as an automobile. This connection of credit life insurance to installment borrowing and purchasing has resulted in its paralleling the spectacular growth of consumer credit generally since World War II. It has been estimated that in recent years nearly 50,000,000 people in the United States are covered by some form of credit life insurance and that the total of such insurance in force is more than 40 billion dollars.

A credit life insurance policy may be written either as an individual policy issued directly to the insured debtor with his creditor named as primary beneficiary, or as a group policy issued directly to the creditor as beneficiary in which event the individual debtors of the creditor-policyholder will simply receive certificates of insurance. Two types of coverage are provided, (a) decreasing term coverage, under which the amount of the death benefit decreases during the policy term coincidentally with the decrease in the amount of the debt under the applicable installment payment schedule, and (b) level term coverage, under which the amount of the death benefit remains constant during the policy term. ²

The premium due for the entire term of the insurance must be paid at the inception of the coverage and, like some forms of group insurance, a flat rate is generally charged without inquiry as to the age, health, or medical history of the applicant. Although there were variances during the period here involved, the standard premium charge for decreasing term insurance was $ 1 per $ 100 of coverage, and for level term insurance it was $ 2 per $ 100 of coverage. Unlike most forms of casualty insurance, but like most life insurance, once the premium for credit life insurance has been paid so that the coverage has commenced, the insurance company cannot cancel the policy. Also, unlike casualty insurance, the insured has no right to cancel the policy simply to obtain a premium refund. He may, however, cause an automatic termination of the policy through some act on his part, such as prepayment of the debt, in which event he may, or may not, receive a credit or refund, dependent upon the terms of his policy.

During the period here involved, premiums on credit life insurance were computed under the same principles as were applied generally in the life insurance industry. The "net premium" (the amount designed to cover the mortality risk) was computed actuarially from established mortality tables. To the net premium was added an amount, called "loading," resulting in a total "gross premium" charged to the insured policyholder. Essentially, the amount of "loading" is the amount designed to cover the acquisition costs, other operating expenses and profits of the insurance company. ³

During the 1950's credit life insurance companies, such as Old Republic, incurred acquisition costs for their credit life business in the following ways: (1) by the payment of commissions to licensed insurance agents (generally amounting to about 50 percent of the premium), (2) by the payment to a policyholder of a "retrospective insurance rate adjustment" (generally under a group policy), and (3) by reinsurance of business with a subsidiary insurance company owned by the producer of the business. All three methods are involved here.

Associates and its subsidiaries were very important producers of credit life insurance business for Old Republic. Originally, Associates received its compensation from Old Republic for this business production by way of the first two methods mentioned above. Associates' subsidiary, Morco, had been appointed by Old Republic as one of its agents under an agreement whereby Morco received a minimum guaranteed commission of 50 percent on all credit life insurance business produced by Morco for Old Republic. Associates was also receiving retrospective rate adjustments from Old Republic on the several group policies held by Associates. These activities produced a good deal of income for the Associates' group.

In the early 1950's Old Republic found itself confronted with a worrisome development. Some of its important customers had begun to press for more commission compensation from their placing of credit life business with Old Republic, and some had even formed their own credit life insurance companies to which they shifted their credit life business. To Old Republic's management this development constituted a threat to the company's future volume of credit life insurance. However, rather than accede to the demands for larger commissions and retrospective rate adjustments, Old Republic began to suggest to its more important customers that they form their own life insurance companies, as subsidiary corporations, with which Old Republic would agree to reinsure proportionate segments of its credit life insurance. Old Republic's argument in support of its suggestion was that, in return for its customer assuming part of the risk, Old Republic could afford a more generous sharing of the premium income, the end result being "more of the pot" to its customers.

Such a suggestion was made by Old Republic to Associates in the early part of 1953. For some time Associates' management had been exploringpossibilities for entering the life insurance business, and they therefore expressed immediate interest in Old Republic's suggestion. Conferences and negotiations ensued between officials of the two companies, ⁴ and on August 3, 1953, Associates formed Alinco as a wholly-owned subsidiary and qualified it as a life insurance company under Indiana law. A reinsurance treaty was negotiated and executed between Old Republic and Alinco under the terms of which Old Republic agreed to reinsure with Alinco 18 percent of all its credit life insurance (with certain categories of risks excluded) and to pay to Alinco, as a reinsurance premium, 18 percent of the gross premiums received for such insurance. In return, Alinco agreed to reimburse Old Republic for 18 percent of the losses incurred on reinsured policies. ⁵ Accounts between Old Republic and Alinco were to be settled in monthly statements furnished by Old Republic to Alinco. The categories of insurance which were excluded from the reinsurance treaty were home mortgage policies, monthly outstanding balance group life policies, group life policies providing disability coverage, policies already reinsured with American United Life Insurance Company, and policies providing coverage on borrowers of certain named finance companies and banks, including borrowers of Associates and its subsidiaries. ⁶ The aggregate of Old Republic's credit life insurance, with the enumerated categories of risks excluded, is called herein the "Alinco Reinsurance Pool."

The Alinco-Old Republic reinsurance arrangement was typical of reinsurance arrangements generally in that Old Republic as the primary carrier handled all administrative details of the insurance including the supervision, investigation, defense against and payment of all claims, and thereafter made its claim against Alinco by way of monthly statements for Alinco's share of the losses.

Simultaneously, the prior agreements for commissions to Morco and retrospective rate adjustments to Associates had been canceled. However, Morco continued to act as Old Republic's agent in writing credit life insurance on Associates' debtors but without compensation. ⁷

From birth to liquidation, Alinco's only business consisted of reinsurance under the Old Republic-Alinco treaty. As might be expected from the fact that Old Republic handled the myriad details incident to the insurance contained in the Alinco ReinsurancePool, Alinco's operations were quite simple and inexpensive. Alinco had no office or salaried employees. An accountant employed by another subsidiary of Associates took care of Alinco's books and records, examined the monthly reports from Old Republic, deposited its monthly receipts, and prepared its annual statements to the Indiana Insurance Department with the help of information furnished him by Old Republic and Alinco's consulting actuary. On the average he was able to perform these duties in the space of approximately one day each month.

Despite the simplicity of this operation, Alinco's financial success during the period 1953 through 1959 was striking. Its net gain from operations during that period, before Federal income taxes but after paying its expenses and share of death benefits, was in excess of $ 28,500,000. See finding 21, infra.

Notwithstanding its financial success, Alinco's corporate existence was comparatively short-lived. In keeping with its management's desire to expand further into the life insurance business, Associates succeeded in acquiring control in 1957 of an operating old-line stock life insurance company, Capitol Life Insurance Company of Denver, Colorado. Originally, Associates planned to merge Alinco into Capitol, but in late 1957 or early 1958, it was learned that an Internal Revenue Agent intended to question Alinco's status as a life insurance company. Rather than burden Capitol with Alinco's potential tax problems, it was decided that Alinco should be liquidated. Thereupon, the Old Republic-Alinco reinsurance treaty was terminated as of November 30, 1959. While no business was reinsured after that date, Alinco continued to be responsible for its share of losses and premium adjustments on business previously reinsured, and Alinco was not liquidated until 1961. ⁸

The Section 269 Issue

Section 269(a) of the Internal Revenue Code of 1954 (formerly section 129(a) of the 1939 Code) provides, in pertinent part, that:

     If * * * any person or persons acquire * * * directly or

Alinco contends that section 269(a) has no relevance here and that the only issue involved is whether Alinco for the year in question (1958) met the technical requirements of section 801 of the 1954 Code defining life insurance companies. Moreover, even if section 269(a) can properly be applied to change a corporate taxpayer's status, says Alinco, the facts show that the principal purpose behind the formation of Alinco was a business purpose and not avoidance of tax. I agree with Alinco.

Few subjects in taxation have been as vexing to the courts as that of tax avoidance. There is a wealth of case material, most of it singularly unenlightening except in the context of the peculiar facts in individual cases, particularly those which "exude an odor piscatorial." Rice, Judicial Techniques in Combating Tax Avoidance, 51 Mich. L. Rev. 1021 (1953). As Randolph E. Paul once observed, the subject of tax avoidance "has virtually no philosophical pathways" and visibility is low, indeed. Paul, Restatement of Tax Avoidance, Studies in Federal Taxation, Callaghan and Co. (1937). The frustrating anarchy in the decisions is no doubt due, in part at least, to the element of subjectivity which seems inevitably to attend upon the search for a taxpayer's intention or motivation. There has resulted a rather remarkable accumulation of conveniently vague maxims, such as the substance, not the form, of a transaction must control tax incidence, ⁹ that an unreal or sham transaction must be disregarded, that what was actually done rather than what was said is the important criterion, that a taxpayer is privileged to reduce his taxes by means which the law permits, etc. See the discussion and numerous case citations in Rice, Judicial Techniques in Combating Tax Avoidance, supra, at p. 1026 et seq. "General propositions do not decide concrete cases," ¹⁰ however, and in the end the particular facts of this case must bear the responsibility for decision.

The Government strongly urges that Associates' only, or at least its principal, purpose in forming Alinco as a life insurance company and arranging for its reinsurance treaty with Old Republic was thereby to convert Morco's ordinary commission income and Associates' retrospective rate adjustment income into tax-free underwriting income. If this contention were factually supported, the requisite tax avoidance motive would be present to such a degree as to require a consideration of the Government's argument that section 269 may be availed of to deny a taxpayer its status acquired under other provisions of the Internal Revenue Code. However, the contention is not factually supported, and even if it were, the authorities which have considered the question in an analogous context are contrary to defendant's position here. Thus, even though the principal purpose for the formation of a Western Hemisphere Trade Corporation subsidiary was to obtain the tax benefits provided for those corporations, such motivation does not constitute tax avoidance within the meaning of the predecessor of section 269. I.T. 3757, 1945 C.B. 200. ¹¹ To the same effect, see this court's decision in A. P. Green Export Co. v. United States, 151 Ct. Cl. 628, 284 F. 2d 383 (1960) and the decision of the Tax Court in Barber-Greene Americas, Inc., 35 T.C. 365 (1960).

It seems unnecessary to elaborate the point further, since, as stated, the facts of record here will not sustain a finding of tax avoidance as the principal purpose for Alinco's formation, and hence there is nothing upon which section 269 can operate. The record is replete with business motivations of such magnitude as to make entirely subordinate any tax advantages which might be anticipated from Alinco's qualification as a life insurance company. ¹²

Thus, while Associates had been receiving commissions and retrospective premium adjustments from Old Republic prior to 1953, there were serious disadvantages to these methods of realizing a profit from the sale and processing of credit life insurance. For example, the receipt of commissions by Associates' subsidiary, Morco, on life insurance premiums was apparently in violation of Indiana insurance law, under which corporations are forbidden to act as life insurance agents. Burns Indiana Stat. Anno., Subsection 39-4601 and 39-4608. See Nichols Loan Corporation of Terre Haute v. Commissioner, 321 F. 2d 905 (7th Cir., 1963). The receipt and retention of retrospective premium adjustments were also legally dangerous because of the possibility that Associates might be considered a trustee for the individual policyholders and thus obligated to pass on the premium refund of a few dollars each year on each policy to thousands of individual customers, thus entailing considerable administrative expense as well as loss of the benefit of the premium adjustment. ¹³ Finally, there was the danger that the receipt of either commissions or retrospective premium adjustments by Associates might be considered additional compensation for the loaning of money and, therefore, in violation of state laws governing the maximum small loan rate. Thus, there were several reasons why the commission or retrospective premium adjustment methods of compensation were unsatisfactory from the lender's standpoint.

In addition, Associates desired to increase its profits from the sale of credit life insurance. Old Republic was unwilling to increase its commission rates, but it was willing to share "more of the pot" with its finance company customers provided they in turn would share the insurance risks. To accomplish this, of course, meant that Associates would have to enter the life insurance industry, a business move it had been planning for some time anyway. Since Associates could not legally do so directly, it had to form Alinco as a subsidiary and qualify it under the Indiana law applicable to life insurance companies.

Thereupon, Associates caused Alinco to enter into the reinsurance treaty with Old Republic. And, just as management had anticipated, the transaction indirectly increased Associates' profits from its production of credit life insurance business. Alinco made several million dollars more from the reinsurance treaty than Morco would have made under the previous commission agreement, and this was true irrespective of Alinco's tax status. See finding 24, infra.

This maximizing of profit, however, was not accomplished without risk. Under the commission arrangement neither Morco nor Associates bore any share whatever of the insurance risks, whereas Alinco was subjected by the treaty to very substantial life insurance risks which it was required by law to protect with reserves. ¹⁴

Throughout its brief, the Government refers to Alinco as an "ostensible" life insurance company, but it is not at all clear what is intended to be inferred by that adjective. Nowhere is the slightest suggestion made (nor could there be) that Alinco was not legally bound to its obligations under the reinsurance treaty. Rather, the Government chooses to ignore, or at most to make light of, those obligations apparently on the ground that the risks undertaken by Alinco were mostly illusory due to the fact that the average mortality cost within a $ 1 premium was in the neighborhood of 28 cents. From this it is argued that credit life insurance underwriting is a highly profitable business and that, since Old Republic's financial strength was such that it had no actuarial need to reinsure any part of its policies, the normal expectation would be a refusal by Old Republic to share with anyone its profitable premium income unless there were some clever tax scheme afoot.

However, the non sequitur is obvious when it is realized that an insurance company's decision to reinsure is not invariably based on actuarial need. In the present case, the record shows that in the early 1950's Old Republic's management became concerned over the tendency of some of its important customers to form their own insurance subsidiaries to which they fed business formerly given to Old Republic. Realizing that, if this trend continued, Old Republic would soon be out of business, its officers suggested to some of its finance company customers, including Associates, that, if they would continue to write their credit life insurance through Old Republic, then in return Old Republic would reinsure a portion of the business with an insurance subsidiary of the finance company. This enabled Old Republic not only to maintain its profits, ¹⁵ but also to pass on some of its risk. ¹⁶

There can be little doubt that Associates' management solicited and received expert advice with respect to all foreseeable tax problems involved in the Old Republic proposal. Surely they would be rightly subject to censure and discharge had they blindly committed Associates to an important change in the contractual arrangements with Old Republic without detailed consideration of the tax implications. No doubt they were impressed with the generally favorable tax treatment afforded to life insurance companies, and it must have been a factor in the ultimate decision. Yet, even a "major motive" to reduce taxes will not vitiate an otherwise valid and real business transaction. United States v. Cumberland Public Service Co., 338 U.S. 451, 455 (1950).

Here the record is entirely persuasive that the business advantages previously discussed played the leading role throughout and that, even assuming life insurance companies were taxed as ordinary corporations, Associates would nonetheless have consummated this transaction. ¹⁷

In the final analysis, and from a review of the entire proceedings in this case, it is nearly impossible to escape the impression that the Government's attack under section 269 stems, at least partially, from its conviction that Alinco is just part of a gigantic conspiracy to defraud the public. It is true that during the 1950's, credit life insurance was the subject of considerable controversy within the insurance industry itself. While there was general agreement as to the useful social function of credit life insurance, the argument was sometimes bitter over whether creditors, particularly in the fields of installment buying and small loans, were realizing exorbitant profits out of their share of allegedly excessive premium charges. See, for example, Cade, The Fundamental Issues of Consumer Credit Insurance, Insurance Law Journal, February 1955, p. 90; Mors, Consumer Installment Credit Insurance, Insurance Law Journal, May 1956, p. 299; Dunbar, Credit Insurance -- Use by Licensed Lenders, Insurance Law Journal, May 1956, p. 443; Symposium on Credit Life and Credit Health and Accident Insurance (seven papers presented at the Fifth Annual Miami Insurance Law Conference), Insurance Law Journal, June 1957, pp. 327-381; and Peters, How Should Credit Life Insurance Be Regulated, Insurance Law Journal, August 1958, p. 529.

Also, in 1955, a Subcommittee of the Senate Judiciary Committee had conducted an investigation into the credit life insurance business as it was then practiced in the State of Kansas. While recognizing the "admirable function" of credit life insurance, the Subcommittee found that some loan, finance, and credit insurance companies had been guilty of unscrupulous and abusive practices in the selling and handling of such insurance. Report of the Subcommittee on Antitrust and Monopoly Legislation, U.S. Senate, 83rd Cong., 2d Sess. ¹⁸

The foregoing studies are quite persuasive that in some areas, at least, tie-in selling of credit life insurance has been abused and exploited by unscrupulous concerns. However, except for joining most other companies in charging a premium which might be considered excessive in light of the true mortality cost, the record here does not indicate that any of the parties involved had engaged in such abusive practices. And, even if they had, it is proper to inquire what relevance such conduct would have to the resolution of a tax controversy. As the court observed in Maxwell Hardware Co. v. Commissioner, 343 F. 2d 713 (9th Cir., 1965):

     Taxation is peculiarly a matter of statutory law, and in applying

Insofar as regulation is concerned, it is of course true that Congress frequently employs a taxing statute to achieve a non-fiscal or regulatory goal. ¹⁹ Where, however, there is Congressional intent to connect a regulatory objective to a revenue raising measure, the legislative history will always disclose that intent either directly or indirectly. See United States v. Kahriger, 345 U.S. 22, 27 (1953). The legislative history of section 269 (and of its predecessor) is barren of any suggestion that Congress intended the section to have any regulatory impact whatever on industry generally, much less on the specific business here involved. ²⁰ Furthermore, Congress has made clear its desire that the insurance industry shall not be regulated by the Federal Government but by the several states. P. L. 15, 79th Cong., 59 Stat. 33 (1945), as amended, 15 U.S.C. Secs. 1011-15. See Dirlam and Stelzer, The Insurance Industry, 107 U. of Pa. L. Rev. 199 (1958). Insofar as a state regulatory function is concerned, this court has specifically held that the Internal Revenue Service may not employ the Federal tax laws in an effort to enforce its own concept of what state law should, or should not, be. See Kirtz v. United States, 157 Ct. Cl. 824, 830, 304 F. 2d 460 (1962).

In sum then, what Associates really did in this case was to give up guaranteed commissions in return for the possibility of a greater profit through the assumption of an underwriting risk. The vehicle necessary under Indiana law to accomplish this purpose was a life insurance subsidiary (Alinco). The tax advantages which may flow from being taxed as a life insurance company were undoubtedly considered in working out this transaction, but they were secondary in importance to the business purposes and Judge Learned Hand long ago reminded us that:

     Over and over again courts have said that there is nothing

The Section 801 Issue

Before coming specifically to the statutory provision involved, a short history of life insurance company taxation in this country will be useful background. Over the years, Congress, the courts, and the Treasury, in efforts to arrive at an equitable system of taxation, have wrestled intermittently with the specialized and highly technical concepts of estimation developed by the life insurance industry. ²¹ See Vickrey, Insurance Under the Federal Income Tax, 52 Yale L. Jour. 554, 575 (1943).

Prior to 1921, insurance companies had been taxed according to the same scheme as ordinary corporations. Accordingly, they were taxed not only on investment income but also upon premium income with a special deduction being allowed for the net addition to reserve funds required by law. See Mertens, Law of Federal Income Taxation, Sec. 44.01. It was soon recognized, however, that in the case of life insurance companies, the inclusion of their premium receipts in gross taxable income was "one of the faultiest parts of the income tax act." ²² Fundamentally, this was because premium receipts, in the words of the Supreme Court, "were not true income but were analogous to permanent capital investment." Helvering v. Oregon Mutual Life Ins. Co., 311 U.S. 267, 269 (1940). See, also, National Life Ins. Co. v. United States, 277 U.S. 508 (1928) and Massachusetts Mut. Life Ins. Co. v. United States, 74 Ct. Cl. 162, 56 F. 2d 897 (1932)

By the Revenue Act of 1921, Congress established special systems of taxation applicable to insurance companies alone, and with some modifications these systems have prevailed to this day. The rules thus set forth in 1921 differed somewhat dependent upon the particular type of insurance company involved.

Insofar as life insurance companies were concerned, the 1921 Act embodied the concept that premium receipts are not true income because such a large part of them must be reserved and set aside to meet future death claims. Accordingly, the Act made a life company taxable only on its investment income (interest, dividends, and rents), and premium income was excluded from the computation of its net income subject to tax. Furthermore, recognizing that interest earned on the reserved portion of premiums was an integral part of the life insurance reserve, a special deduction was allowed for a percentage of the "reserve funds required by law" (4 percent in the 1921 Act, but varied in subsequent Acts). The effect was that life insurance companies were taxed only on that portion of their income from investments which exceeded the amount of assumed interest necessary to build up their reserves for future death claims. This system is known as the "investment income" approach to the taxation of life insurance companies.

Casualty insurance companies, on the other hand, were taxed on their underwriting income, as well as their investment income. This meant that premiums were included in gross income, although a deduction was allowed for the net increase in unearned premiums during the year. Furthermore, in determining "underwriting income," a deduction was allowed for "losses incurred," which meant losses paid during the year plus the net increase in "unpaid losses" outstanding at the end of the year. Revenue Act of 1921, c. 136, 42 Stat. 227, Section 246(b) (5) & (6).

Since life companies were taxed differently from casualty companies, it became necessary to define what constituted a life insurance company and the following definition was adopted in section 242 of the Act:

     when used in this title the term "life insurance company" means

     Some companies mix with their life business accident and health

By 1940, court decisions had established that, insofar as the qualification formula was concerned, accident and health reserves maintained with respect to policies providing combined life, accident and health coverage, were considered to be the same as life reserves. Therefore, once a company, by reason of the reserve test, had qualified as a life company, it could obtain a deduction for the statutory assumed interest on all of its technical insurance reserves (as opposed to its ordinary liability reserves) whether pertaining to life policies or to accident and health policies. See, for example, Helvering v. Oregon Mut. Life Ins. Co., supra, and Commissioner v. Monarch Life Ins. Co., 114 F. 2d 314 (1st Cir., 1940). Not long after these decisions, the Congress commenced its consideration of the Revenue Act of 1942 in the course of which the existing definition of life insurance companies was reviewed, particularly with respect to that part of the definition dealing with health and accident insurance.

The result was a revision of the definition to accommodate the difference between cancellable and noncancellable health and accident policies. In contrast to the casualty aspects of cancellable health and accident policies, it was recognized that the writing of such insurance in noncancellable form bore a close analogy to life insurance. ²⁴ Said the Senate Committee on Finance:

     Technical changes are made to distinguish in a clearer manner the

     an insurance company which is engaged in the business of issuing

Insofar as the issues in this case are concerned, the 1942 definition of a life insurance company, together with its qualification formula, has remained unchanged. The definitional section enacted in 1942 became known as section 201(b) of the 1939 Code which, in turn, became section 801 of the 1954 Code with no change in substance. See Mertens, Law of Federal Income Taxation, Sec. 44.18. Likewise, although the Life Insurance Company Income Tax Act of 1959 ²⁶ made some dramatic changes in the concept of life insurance company taxation, ²⁷ it made no changes in the definition of "life insurance company" or of "life insurance reserves" which have any relevance to this case. Therefore, the above described considerations which gave rise to the 1942 definition are all relevant to a determination of Alinco's qualification under the present section 801 of the 1954 Code, as amended. Insofar as pertinent here, section 801 reads as follows:

     (a) Life Insurance Company Defined. -- For purposes of

     The term "insurance company" means a company whose primary and

It is true, as defendant argues, that Alinco reinsured only with one primary carrier from which Alinco received business because that carrier in turn received business from Alinco's parent, that the primary carrier handled all the administrative details of the insurance, and that Alinco's operation was therefore an extremely simple one with very little general operating expense. But it is in the nature of any reinsurance arrangement that the reinsurer's operation will tend to be a simple one since the primary carrier typically does all the work. The important fact from the standpoint of a reinsurer, such as Alinco, is the assumption of risks funded by reserves. This Alinco clearly did, and that is all the statute and regulations require. The principal question, therefore, is not whether Alinco was an insurance company but whether it was a life insurance company under the technical qualification formula contained in section 801.

The parties are in full agreement that the qualification formula in section 801 may be expressed in terms of the following fraction, the quotient of which must be more than 50 percent in order for an insurance company to qualify as a life insurance company:

         Qualifying reserves          /          Total reserves

In my opinion, Alinco is clearly correct in its basic contention. Its only insurance reserve was its tabular life insurance reserve computed on the basis of the Commissioner's 1941 Standard Ordinary Mortality Table (a recognized table), with a two percent assumed rate of interest which reserve was set aside to pay future claims arising from the life insurance contracts issued by Old Republic and reinsured by Alinco. ²⁹ Since Alinco's life insurance reserve goes into both the numerator and the denominator of the qualifying fraction, and since there were no other reserves to go into either the numerator or the denominator, Alinco's qualifying reserves, of course, were 100 percent of its total reserves.

Defendant insists, however, that credit life insurance (the only type of insurance reinsured by Alinco) is a creature apart. While agreeing that it resembles life insurance in that it is payable on death, defendant argues that it more closely resembles casualty insurance in that a flat premium rate is charged regardless of age or medical history. ³⁰ Therefore, the argument goes, even though the casualty term "unearned premium" may have no application to ordinary life insurance, it does have application to credit life insurance and is well understood in that industry. Consequently, in applying the section 801 qualification formula to Alinco, it is necessary, says defendant, to go to the records of the primary carrier (Old Republic) and construct therefrom the "unearned premiums" in the Alinco Reinsurance Pool by a simple mathematical proration of the original gross premium according to how much of the policy term had elapsed at the time of valuation. ³¹ The record in this case simply will not sustain defendant's position.

In the first place, there was general consensus among the experts who testified at the trial that credit life insurance is properly defined as specialized single premium term life insurance. Indeed, it was so stipulated by the parties in pretrial proceedings. It is well known, of course, that life insurance policies take many forms ranging all the way from a simple term life policy to exceedingly complicated life policies with a myriad of fringe benefits. But throughout all such contracts the one thing that distinguishes life insurance from casualty insurance is the ultimate eventuality insured against, namely death. ³² This is the only risk insured against by credit life insurance, and it is therefore properly defined as life insurance.

In the second place, in its efforts to apply the "unearned premiums" concept to credit life insurance, defendant would have the court ignore the entire legislative history behind the inclusion of the term in what is now section 801. As demonstrated above, when in 1942 Congress first added the term to the definition section for life insurance companies, it had in mind solely a revision of the formula to include as qualifying reserves "unearned premiums" and "unpaid losses" on noncancellable health and accident policies which, historically, were treated in the industry as casualty-type coverage. There is nothing to indicate that, by the addition of those terms, Congress meant to imply that there are any such things either as "unearned premiums" or "unearned premium reserves" with respect to life insurance policies such as those reinsured by Alinco.

The testimony of Alinco's expert actuary, Arthur C. Eddy, is entirely persuasive that these technical terms refer primarily to casualty-type insurance and are rather meaningless in pure life insurance. For example, if a life insurance actuary were to hear the term "unearned premiums," in his mind he would simply equate it to the tabular life insurance reserves. ³³ This is because what the unearned premiums reserve is to the casualty insurance company, the tabular life insurance reserve is to the life insurance company. As was observed long ago in Travelers Equitable Insurance Co., 22 B.T.A. 784, 789 (1931):

     We think it clear that the term "unearned premiums" has a fixed

     If a statute is written for ordinary folk, it would be arbitrary

Defendant contends, however, that the foregoing principles are inapplicable to credit life insurance and, in support of the contention, points to the fact that in some of the group policies in the Alinco Reinsurance Pool, Old Republic itself had provided for termination of the policy "upon repossession of the collateral, in which event the unearned premium shall be credited to the account of the debtor." ³⁴ [Emphasis supplied.] This is proof, says defendant, that in a credit life context the term "unearned premium" does have significance. This is no doubt true. Indeed, the record discloses that, particularly in recent years, some credit life insurance companies have elected, as permitted by local law, to use an unearned premium reserve instead of a tabular reserve. See findings 33 and 34, infra. This is done with the idea of providing for instances where their credit life policies, or state statutes, require a refund or credit of part of the prepaid premium to the creditor -policyholder or debtor in the event of termination of the insurance coverage prior to the scheduled maturity date of the indebtedness.

However, the important point to remember here is that neither Old Republic nor Alinco elected to reserve on an unearned premium basis but, in fact, maintained their reserves on the traditional tabular basis. So long as credit life insurance is life insurance and, therefore, not required to be reserved on an unearned gross premium basis (like accident and health insurance), the mere fact that sometimes a refund of premium is given or required cannot serve to change the proper reserve basis from tabular to unearned premium either for insurance accounting purposes or for the purpose of the statutory qualification formula. ³⁵

Furthermore, in computing Alinco's qualification ratio, defendant compounded its error. The "unearned premiums" which it used in developing the denominator of the fraction were unearned gross premiums. That this was erroneous, even under defendant's theory, is shown by the following definition contained in section 1.801-3(e) of the Treasury Regulations:

     (E) Unearned premiums. The term "unearned premiums" means those

The basic fallacy underlying defendant's position on this aspect of the case is even demonstrated by its own illustration. It concludes its brief to the commissioner as follows:

     If a borrower who paid $ 2 for a two-year level term credit life

Finally, one can accept arguendo all of defendant's theories with respect to the existence of unearned premiums and unpaid losses in the case of credit life insurance, and Alinco must still prevail. This is because any such "unearned premiums" or "unpaid losses" were maintained by Alinco on noncancellable life insurance policies. As such, they go into the numerator as well as the denominator of the qualifying fraction, and Alinco's percentage thus remains at 100.

It is clear from the legislative history discussed above that the phrase "noncancellable life, health, or accident policies" was intended to refer only to health and accident coverage. This is in accord with the understanding of the insurance industry, for the record is clear that there is no such thing as a cancellable life insurance policy and that the cancellable-noncancellable distinction has significance only in an accident and health insurance context. That the Treasury Department itself shares that understanding is illustrated by section 1.801-3(c) of the Regulations reading, in pertinent part:

     (c) Noncancellable life, health, or accident insurance policy.

The fact remains that no such policies were contained in the Alinco Reinsurance Pool. Those credit life policies were not cancellable at the option of either the insurer or the insured during the term for which they were written. Since the term of a credit life insurance policy in the Pool was usually made coextensive with the contractual term of the related indebtedness, it was possible for the life insurance coverage to terminate prior to the term for which the policy was originally written, as, for example, if the debt was paid prior to its maturity date. The possibility that such prepayment might occur, however, could hardly be considered a right of cancellation since in such event the insurance coverage was terminated by the policy itself. Such termination is not, therefore, the result of the exercise of any right of cancellation granted by the policy to either the insurer or insured. It is true that the master group policies in the Alinco Reinsurance Pool were specifically made cancellable at the option of either the insurer or the creditor-policyholder upon proper notice, but such cancellation could only be effected with respect to future debtors who would otherwise have come under such master policy. These policies did not give the insurer or the creditor-policyholder the right to cancel the credit life insurance coverage already in existence prior to cancellation. ³⁸

Furthermore, with the exception of the clause in group decreasing term policy Number RP 387, which provides that the insurance will be terminated "upon repossession of the collateral, in which event the unearned premium shall be credited to the account of the debtor," none of the policies in the Pool contained provisions requiring the insurer to refund or credit any part of the prepaid premium to the creditor -policyholder or to the debtor upon termination of the coverage prior to the original maturity date of the indebtedness. In fact, it will be noted that group decreasing term policy Number RP 134 provides that "No refund shall be made by the Company by reason of the prepayment of any loan."

Thus, even if Alinco can be said to have had "unearned premiums" and "unpaid losses" under the literal interpretation given those phrases by defendant, they were on "noncancellable" life insurance policies and, therefore, they should be included in the numerator as well as the denominator of the qualifying fraction. When this is done, it is admitted that Alinco's reserve-ratio is 100 percent and hence it clearly qualifies as a life insurance company under section 801.

Accordingly, in my opinion, Alinco is entitled to the refund claimed, the exact amount of which should be determined pursuant to Rule 47(c).

Findings of Fact

Dramatis Personae

1. The plaintiff, Alinco Life Insurance Company, (Alinco) was incorporated on August 3, 1953, under the Insurance Code of the State of Indiana, with paid-in capital of $ 300,000, all of which was subscribed for by and issued to Associates Investment Company. Alinco's corporate purposes, as set forth in its Articles of Incorporation and never amended, were:

     (a) To insure the lives of persons and to make every insurance

Since 1961, Alinco has been completely liquidated, but retains its corporate existence under the laws of the State of Indiana and has the capacity to maintain this suit.

2. Associates Investment Company (Associates) was incorporated under the Indiana General Corporation Act. It and its subsidiary companies have over 300 offices throughout the United States. It is one of the Nation's largest finance companies. The Associates group engages in automobile financing and makes direct personal loans. In addition, Associates owns all the stock of the following companies: Emmco Insurance Company (Emmco), organized in 1936 primarily to write fire and casualty insurance on automobiles financed by the Associates group; Alinco Life Insurance Company, the plaintiff here; Capitol Life Insurance Company (Capitol) an old-line stock insurance company organized in 1904 and acquired by Associates in 1957; and Morco Insurance Agency (Morco), a licensed insurance agent incorporated in 4 different states. Under Indiana law, Associates could not engage in the business of writing life insurance nor could it act as a commission agent for the sale of life insurance.

3. Old Republic Life Insurance Company (Old Republic), an Illinois corporation, is a life insurance company writing various forms of life, accident, and health insurance in all 50 states, Canada, and Puerto Rico. Old Republic has about 3,900 shareholders and about 3.5 billion dollars of insurance in force. It was one of the first life insurance companies to specialize in writing credit life insurance, and this kind of insurance accounts for the bulk of its business. Old Republic is not affiliated with Associates. Old Republic has always filed its Federal income tax returns as a life insurance company on Form 1120L and its status as a life insurance company, for income tax purposes, has not been questioned.

Credit Life Insurance and Reinsurance: Description, History, and Function

4. Credit life insurance, generally defined, is single premium term insurance on the lives of debtors, with their creditors as beneficiaries, in amounts at least sufficient to discharge their indebtednesses in case of death. It was first written in the United States by the Morris Plan Insurance Society during World War I. At that time it was considered a rather unorthodox type of life insurance coverage and was not widely held. The real growth of credit life insurance began after World War II and paralleled the growth of consumer credit. Today, most consumer credit is covered by such life insurance. Accordingly, it is estimated that about 50,000,000 people in the United States are covered by some form of credit life insurance, and the total of such insurance in force is more than 40 billion dollars. Sometimes the life coverage is combined with accident and health coverage, although no such combined policies are involved in this case.

5. Credit life insurance is sold usually as a part of another, and more prominent transaction, namely, a loan of money or an installment sale of tangible personal property. Its primary function is to provide a sure, quick, and uncomplicated means for liquidating the balance due on the loan or installment sale in the event of the death of the borrower or purchaser whose family is thus relieved from the burden of the deceased's indebtedness. Accordingly, in the words of the Subcommittee on Antitrust and Monopoly Legislation of the Senate Judiciary Committee, credit life insurance "like all other forms of insurance, when not abused * * * performs a most admirable function." ¹

6. Credit life insurance is written in two different ways: (1) under an individual insurance policy issued directly to the insured debtor, or (2) under a group policy, in which case the beneficiary-creditor is the policyholder and the individual insured debtor simply receives a certificate of insurance. It is generally written for a term which is coextensive with the contractual term of the related indebtedness. Occasionally the term is as long as five years, but it averages two to three years in most instances.

7. Two types of life insurance coverage are provided by credit life insurance, namely: (1) decreasing term coverage (also called declining balance insurance), under which the amount of the death benefit decreases during the policy term, coincidentally with the decrease in the amount of the debt under the applicable installment payment schedule, and (2) level term coverage, under which the amount of the death benefit remains constant during the policy term (a type of coverage particularly suitable where the debt is not payable in regular installments, but, for example, in a lump sum).

8. Under a standard credit life insurance policy, the creditor is the primary beneficiary to the extent of the unpaid balance of the indebtedness account at the time of the insured debtor's death. If, because of prepayment or some other reason, the amount of the death benefit payable under the policy should happen to exceed the balance due on the account, the insured's designated secondary beneficiary receives the excess.

9. The premium due for the entire term of the credit life insurance coverage is paid in a lump sum at the inception of the coverage. Although there was no absolute pattern, dependent upon whether the policy was group or individual, during the 1950's, the premiums generally charged by Old Republic and other insurance companies for declining balance credit life insurance ranged from approximately 50 cents to one dollar per $ 100 of coverage per year. For the less prevalent level term policies in which the amount of insurance coverage remains constant during the full period of the loan, the usual premium charge was about two dollars per $ 100 of coverage per year. Like some forms of group insurance, but unlike ordinary whole life or term insurance, a flat rate for credit life insurance is charged, and an inquiry is generally not made as to the age, health, or medical history of the applicant.

10. Essentially, credit life insurance is simply a specialized form of term life insurance written for a specific purpose as described in finding 5, supra. Unlike insurance, such as fire, public liability, and similar types of casualty insurance, a credit life insurance contract ordinarily cannot be canceled during the term for which it is written by either the insurance company or by the insured. Under the typical level term policy, there is no right on the part of either party to cancel the coverage prior to the original maturity date of the underlying indebtedness. Under a typical decreasing term policy, however, the coverage decreases with the repayment of the debt and will terminate automatically on the earliest to occur of the following events: repayment of the debt, default of the debt with or without repossession of the collateral, or the original scheduled maturity of the debt. In situations where the insured debtor has refinanced his indebtedness and purchased a new credit life insurance policy to cover the new debt, it is a common practice for the insurance company to makean appropriate adjustment in the amount of the premium on the new policy reflecting the unexpired term of the old policy, which has the effect of a partial premium refund under the old policy.

In group credit life insurance policies, it is customary to include a provision providing for cancellation of the policy by either the insurer or the creditor-policyholder as to persons becoming debtors of the policyholder after the effective date of notice of cancellation. It is further provided, however, that such cancellation cannot affect the insurance in force under the policy at the time of cancellation.

11. The premium charge for a life insurance contract is computed so as to cover all the contingencies the insurance company is likely to meet, and these contingencies are generally grouped into three elements, namely, mortality, interest, profit and expenses. Mortality refers to that part of the premium which provides for the occurrence of the risk insured against, while the second element takes into account the assumed interest to be earned by the company. The third element primarily covers profit and the costs incident to management of the company, such as salaries, rents, commissions, taxes, and other costs of doing business. In arriving at a premium charge, the first and second step is the computation of what is called a "net premium" which takes into account only the mortality and interest elements. To the net premium is then added an amount called "loading" which is calculated to provide for profit and expenses. The resulting premium is called the "gross premium" which is the premium charge to the policyholder.

The computation of credit life insurance premiums is based upon the foregoing principles. The record in this case shows that the net premium for credit life insurance was computed actuarially from established mortality tables, and during the 1950's the mortality cost of such insurance ranged between 28 cents and 38 cents per one hundred dollars of coverage per year. In arriving at the gross premium, it is obvious that there is more room for flexibility or the exercise of judgment as to the needed or desired amount of loading for expenses and profit. This accounts for the fact that gross premiums for credit life insurance might vary from 50 cents to one dollar per one hundred dollars of coverage on declining balance insurance. There is room for competition in the credit life insurance industry through decreasing the amount of loading and thus decreasing the gross premium charge. However, due to the method by which credit life insurance is sold, a unique situation has been observed by persons knowledgeable in the industry. Since the premium for credit life insurance is generally paid by the borrower, and since the lender's remuneration is generally a percentage thereof, the higher the gross premium, the greater will be the profit to the lender who procures the policy. Therefore, some lenders (or sellers) in seeking to increase their remuneration for the procurement of such insurance tend to place their business with the insurance company that charges the highest gross premium. An experienced lender (or seller) can generally foresee that, since the borrower's (or purchaser's) interest lies in the consummation of the primary transaction of loan (or installment sale), he is not likely to go out "shopping" elsewhere for a lower premium rate assuming he is interested in acquiring any credit life insurance at all. Thus, it is reasonable to anticipate that, in most instances, a borrower desiring to cover his loan with credit life insurance will consummate the entire transaction with his creditor in preference to making independent analysis or comparison of credit life premiums available elsewhere. This situation is sometimes referred to as "reverse competition" and is one of the factors leading to the contention by some persons that premium overcharging is a common abuse in the selling of credit life insurance.

12. During the 1950's there were three basic methods by which insurance companies which wrote credit life insurance (including Old Republic) incurred acquisition costs with respect to credit life business:

(a) The first method was through the payment of commissions to duly licensed insurance agents. During the 1950's such commissions paid to insurance agents for the placing of credit life insurance were ordinarily 40 to 50 percent of the gross premium. In many states, however, finance and small loan companies such as Associates, which are common sources for credit life business, were prohibited by law from being licensed as insurance agents. It was not uncommon, therefore, that such companies would form subsidiary corporations and qualify them to act as insurance agents. In the present case, this was done by Associates in forming Morco, even though, at least in Indiana, this also was of doubtful legality so far as life insurance was concerned.

(b) A second method was through the payment to the policyholder of a retrospective insurance rate adjustment. This method was used frequently in the case of group credit life insurance. Under this method the insurance company received the entire premium from the producer of the business. The insurance company used the premium to pay the mortality cost, kept an agreed percentage of the premium to cover its administrative costs and profit, and refunded the remainder of the premium to the group policyholder, i.e., the lender or seller. If the net premium correctly reflected the risk assumed by the insurance company, the loading in the gross premium was sufficient for the lender or seller to receive a retrospective rate adjustment. A number of states have enacted statutes which expressly forbid the retention by a policyholder of a group credit insurance policy of such retrospective rate adjustments where the insured debtors have paid all of the premiums.

(c) The third method used was that of reinsurance. Under this method, the creditor (lender or seller) would form an insurance company subsidiary and qualify it to do business as an insurance company under the laws of at least the domiciliary state. The creditor would then enter into an agreement with the particular insurance company for which the creditor was procuring life insurance business under which agreement the primary insurer would agree to reinsure a portion of the business so obtained (or some other equivalent business) with the creditor's insurance company subsidiary. If the net premiums on such reinsured business were properly computed by the primary insurer, and if there were no unusual or abnormal loss experiences on the reinsured business, the creditor's insurance company could expect to receive a profit on its portion of the gross premiums covering policies reinsured with it.

In insurance terminology, the contract between the primary insurer and the reinsurer is generally referred to as a "reinsurance treaty." There are both actuarial and financial reasons for reinsurance which must be considered by the management of any primary insurer in deciding whether to reinsure a portion of its business. ²

The actuarial reasons for reinsuring are generally said to be two -fold, i.e., (1) a need or desire to spread the risks undertaken by the primary insurer, ³ and (2) a need or desire by the primary insurer to "protect" its surplus.

In addition to these actuarial reasons, there are many financial reasons which may induce an insurance company to reinsure part of its business. Some of these reasons are (1) the lowering of administrative unit costs which will ordinarily result by the ability of the primary insurer to increase its business volume following reinsurance, (2) a temporary financial weakness of the primary insurer, (3) "fronting" by the primary insurer so as to allow the reinsurer an entry into states where the primary insurer was duly licensed but where the reinsurer was not licensed, (4) as a means of obtaining profits from insurance written in foreign countries which have blocked currency, and (5) a competitive need to please or satisfy important customers who own or control their own insurance companies. Also, reinsurance may be required by law, such as in the Federal Employees Group Life Insurance Program.

In the typical situation of an insurer writing credit life insurance there exists a large number of small, homogeneous risks. No one death of an insured borrower is likely to cause a great financial loss to the primary insurer which wrote the coverage. Therefore, the most common actuarial reason for reinsurance, i.e., a spreading of the risk, normally does not exist in the credit life insurance business, although the actuarial reason of protecting the surplus might well exist. However, as set forth above, there are many reasons other than actuarial ones why a primary insurer might desire to reinsure a portion of its business.

In any event, the question of whether an insurance company should reinsure a portion of its business in any particular case is a decision for management which will ordinarily be made only after due consideration has been given to both actuarial and financial reasons.

The Business Arrangements Between Old Republic, Associates, and Morco Prior to Alinco's Formation

13. Beginning in 1948, Old Republic issued master credit life and credit accident and health policies to Associates. Between 1948 and 1951, eight separate policies were issued. Four other policies were issued in August 1953 and, at least, eight others were issued thereafter. The first life insurance policy between Old Republic and Associates provided that OldRepublic would insure the lives of borrowers from Associates (and its subsidiaries) who were between the ages of 18 and 65. Although the policies issued by Old Republic to Associates varied in many respects, in none of the policies issued prior to 1959 was the premium rate charged borrowers less than one dollar per $ 100 of insurance per year. In fact, the one -dollar rate was charged by Old Republic on approximately 75 to 80 percent of its total declining balance credit life insurance.

14. During the period prior to August 1953, Old Republic and Associates' subsidiary, Morco, had entered into Life Insurance Agency Agreements whereby Old Republic appointed Morco as its representative for the purpose of soliciting insurance on the lives of debtors of Associates or its subsidiaries. ⁴ A typical agreement provided as follows:

* * * *

     The Agent [Morco] shall receive as his full and complete

From the foregoing, it is clear that, prior to the formation of Alinco, Old Republic had a minimum obligation to pay Morco at least a 50 percent commission on all credit life insurance business produced by Morco for Old Republic. In addition, Associates was receiving during this period from Old Republic so-called "retrospective insurance rate adjustments." ⁵ This was a lucrative facet of the overall business from which the Associates' group made a good deal of money.

Alinco's History

15. Shortly after World War II (about 1946 or 1947), Associates' top management made studies from which it was decided that there was money to be made in the life insurance business and that such business would be a natural one for Associates because of its multitude of customers. Associates began looking for a life insurance company that was qualified to do business in the various states and that could be acquired for a reasonable price. It turned out that such companies were not easy to find. During this time, Associates' founder and chairman of its board of directors became ill and lost interest in expanding into new fields, so that little progress was made in furthering Associates' interest in getting into the life insurance business for the next several years. After that chairman died, in 1951, and under the leadership of a new chairman, it was decided, in 1952, to go forward with expansion into the life insurance field.

16. About this time, Old Republic knew that a number of finance companies were forming their own life insurance companies and were taking credit life insurance business away from Old Republic by insuring their own customers. With a view to protecting its existing business and obtaining new business, Old Republic suggested to some of these finance companies that Old Republic, which was qualified to do business in all states, should "front" for their insurance subsidiaries, retaining a portion of the premium for its services. In addition, Old Republic was experiencing increasing pressures from some of its finance company customers who, in the words of a high ranking official of Old Republic, wanted "more and more of the pot." By this statement he meant that they wanted higher commissions because they thought their business production for Old Republic was better than anyone else's. To offset such pressures, Old Republic's officials would suggest to the customer that he form his own insurance company to which Old Republic would cede business by reinsurance in return for the customer using the experienced services of Old Republic as primary carrier. In this way, by assuming a portion of the insurance risk, the customer might stand to get "more of the pot" provided losses were not unduly high. Apparently, Associates was such a customer, for on January 16, 1953, the president of Old Republic wrote the president of Associates, as follows:

     During the past few months there have been certain developments

17. Nonetheless, the record shows that, during the negotiations, it was made clear to Associates that Old Republic was willing to reinsure some of its life insurance business with an Associates' life insurance subsidiary, provided that in return Old Republic would continue to receive other credit life insurance business from Associates and its subsidiaries. This plan of reinsurance appealed to Associates because it would enable Associates to get a life insurance subsidiary into operation and thus gain the required underwriting experience in the life insurance business needed to qualify for admission as a life underwriter in other states. Associates also felt that it stood to earn substantial insurance underwriting profits, assuming the loss experience was favorable. The new subsidiary would thus provide a vehicle by which Associates could realize its management's long-standing desire to expand into the life insurance field, although management did not even then intend that a single life insurance subsidiary would constitute its only entry into the life insurance business. Furthermore, the formation of such a life insurance subsidiary would enable Associates to eliminate the practice of receiving commissions from Old Republic, through Morco, for providing life insurance to its customers, which may have been in violation of Indiana law and which some thought might be considered extra profit earned in connection with the making of a loan and, therefore, in excess of the maximum rate which could be charged under the state laws then in effect with respect to small loan companies. Consequently, Associates' management decided to go through with the plan, and, as previously stated, on August 3, 1953, Associates formed Alinco as its wholly-owned subsidiary and qualified it to do business as a life insurance company under the laws of the State of Indiana.

18. Effective August 3, 1953, Alinco and Old Republic consummated their prior negotiations ⁶ by entering into a quota share reinsurance treaty, under which Old Republic agreed to reinsure with Alinco 18 percent of all its credit life insurance (with certain categories of risks excluded) and to pay to Alinco, as a reinsurance premium, 18 percent of the gross premiums received for such insurance. In return, Alinco agreed to reimburse Old Republic for 18 percent of the losses incurred on reinsured policies. Accounts between Old Republic and Alinco were to be settled in monthly statements furnished by Old Republic to Alinco. The categories of insurance which were excluded from the reinsurance treaty were home mortgage policies, monthly outstanding balance group life policies, group life policies providing disability coverage, policies already reinsured with American United Life Insurance Company, and policies providing coverage on borrowers of certain named finance companies and banks, including borrowers of Associates and its subsidiaries. ⁷ The aggregate of Old Republic's credit life insurance, with the enumerated categories of risks excluded, is sometimes called herein the "Alinco Reinsurance Pool," of which Alinco reinsured the percentage specified in the quota share reinsurance treaty.

The Alinco-Old Republic reinsurance arrangement was typical of reinsurance arrangements generally in that Old Republic as the primary carrier handled all administrative details of the insurance including the supervision, investigation, defense against and payment of all claims, and thereafter made a claim against Alinco by way of the monthly statements for Alinco's share of the losses. Although neither the reinsurance treaty nor the record here indicates specifically which company bore the ultimate burden of the administrative expenses and acquisition costs, it is a fair inference that such costs and expenses were considered in negotiating Alinco's percentage of reinsurance under the treaty.

19. Also, effective August 3, 1953, Morco and Old Republic canceled their then existing life insurance agency agreements and entered into a new life insurance agency agreement whereby Old Republic appointed Morco as its representative for the purpose of soliciting insurance on the lives of creditors of Associates and its subsidiaries. See footnote 4, supra. There was no provision in this life insurance agency agreement whereby Morco would receive compensation for its services. However, this agreement did provide:

     On or before the twentieth day of the month, the Agent [Morco]

After August 3, 1953, however, Morco and/or Associates continued, as before, to receive commissions and retrospective insurance rate adjustments from Old Republic on credit accident and health coverages written by Old Republic on borrowers from Associates.

Also, around August 3, 1953, four new master policies were issued between Old Republic and Associates. At least two of these policies provided that Old Republic would insure the lives of debtors of Associates with the specified premium being 8 1/3 cents per month for each one hundred dollars of initial coverage, which Old Republic's Senior Vice-President recognized as the "normal dollar rate."

20. The Old Republic-Alinco reinsurance treaty of August 3, 1953, was amended several times, each amendment increasing Alinco's quota share of the Alinco Reinsurance Pool, and altering somewhat the Pool's composition. The first amendment, effective July 1, 1954, increased Alinco's quota share to 27.5 percent; the second, effective July 1, 1955, increased Alinco's quota share to 58.5 percent; the third, effective May 1, 1957, increased Alinco's quota share to 65 percent, and the fourth amendment, effective June 1, 1958, increased Alinco's quota share to 75 percent.

The Old Republic-Alinco reinsurance treaty and the amendments thereto were the result of bargaining and negotiation between representatives of Old Republic and representatives of Associates. In such negotiations Associates attempted to secure for Alinco the greatest possible amount of reinsurance from Old Republic based upon the amount of credit life insurance business which Associates or its subsidiaries were placing with Old Republic. Presumably, out of self -interest, Old Republic's efforts in the negotiations would be to keep the amount of reinsurance it ceded to Alinco as small as possible consistent with its desire to retain Associates as an important producer of credit life insurance business for Old Republic.

Alinco's Operations

21. From 1953 until 1961, Alinco's only business consisted of reinsurance under the Old Republic-Alinco reinsurance treaty, as amended. The following chart prepared from Alinco's annual statements sets forth in tabular form a summarization of the operating results of Alinco. It shows for each year from 1953 through 1961, the total premiums received on reinsurance assumed, the net investment income, the total death benefits paid, the total general insurance expenses, the net gain (or loss) from operations before Federal income taxes, the Federal income tax due according to Form 1120L as filed by Alinco, and the dividends, some of which were liquidating dividends, paid by Alinco to Associates, its only stockholder:

                            Premiums

22. The large dollar volume of business described above was produced by an extremely simple and inexpensive operation at least insofar as Alinco was concerned. Alinco never had an office of its own nor did it ever pay any amount of rent. When, in 1958, an Internal Revenue Agent asked to be taken to the offices of Alinco, he was taken to the offices of Emmco, where Alinco's books and records were kept.

Alinco never had a salaried employee. Instead, one of Emmco's accountants was designated assistant treasurer of Alinco. He was given the responsibility for maintaining its books and records and preparing its annual statements (with the advice and assistance of Old Republic and Alinco's consulting actuary) to be filed with the Indiana Insurance Department on the forms prescribed by the National Association of Insurance Commissioners. In addition, he received Old Republic's monthly report to Alinco, (see finding 23, infra) together with a check for the net amount due Alinco from Old Republic under the reinsurance treaty, which check he deposited in Alinco's bank account. He attended to the recording of all accounting data in Alinco's books which comprised simply a ledger, general journal, and cash receipts and disbursements journal. He prepared monthly trial balances and statements of surplus, acted as secretary for Alinco's investment committee, and conferred on occasion with State and Federal officials interested in Alinco's operations. Generally speaking, he was able to perform these duties in the space of approximately one day per month.

23. From this record it is obvious that the major reason for the simplicity of Alinco's operations was the fact that Old Republic, as the primary carrier, handled through its own staff all the administrative details attendant upon the insurance contained in the Alinco Reinsurance Pool, including the investigation and payment of claims. This is a typical reinsurance arrangement whereby the primary carrier handles all such administrative details and then furnishes the reinsurer a monthly statement showing the reinsurer its share of new business written offset by its share of losses paid. A typical monthly statement from Old Republic to Alinco during the year in issue was as follows:

         ALINCO LIFE INSURANCE COMPANY REPORT DUE FEBRUARY 1958

24. During the period 1955 ⁸ through 1959, Old Republic received from Associates and its subsidiaries the following amounts of "net premiums" ⁹ on credit life insurance policies written on the lives of borrowers of Associates:

 1955                                     $ 6,169,943.78

The benefits accruing to Old Republic from the reinsurance arrangement were less tangible. Considering the adequacy of Old Republic's reserves and unassigned surplus during the 1950's, together with the nature of the risks which it insured, the usual actuarial reason for reinsurance, namely, the spreading of risk, would not have been of major concern to Old Republic's management. However, the financial reasons for Old Republic to enter into the reinsurance arrangement were substantial. It thereby relieved itself of an onerous commission obligation. Furthermore, the reinsurance arrangement reasonably assured Old Republic that it would retain the business and good will of one of its important customers.

That the reinsurance method of defraying insurance acquisition costs, as opposed to the commission method, was gaining in popularity during the 1950's is shown by the annual statements filed by Old Republic with the State of Illinois Insurance Department. During the 1950's there was considerable growth in the life insurance ceded to reinsurers by Old Republic. In the year 1952, for example, Old Republic received life insurance premiums in the amount of $ 12.1 million (health and accident premiums were $ .6 million). It paid $ 6.5 million as commissions and $ 2.7 million in death benefits, In that year the total face value amount of life insurance ceded to reinsurers by Old Republic was less than $ 22,000. By the year 1958 the pattern had changed. While life insurance premiums received by Old Republic again were $ 12.1 million (accident and health premiums $ 1.1 million), it paid only $ 1.7 million as commissions. However, the total face value amount of life insurance which it ceded to reinsurers had grown to over $ 24.5 million.

25. As noted earlier in finding 17, supra, Associates' management never intended that Alinco would constitute the sole entry of Associates into the life insurance business. ¹⁰ In 1957, following considerable search and investigation, Associates succeeded in acquiring control of Capitol Life Insurance Company (Capitol). This company had its home office in Denver, Colorado, where it employed between 25 and 50 people. Capitol was an operating old -line stock life insurance company which had been organized in 1904 and which was qualified to do business throughout most of the country. As soon as Capitol could be "digested" and proper management installed at its home office, Associates planned to merge Alinco into Capitol. When, however, Associates learned late in 1957 or early in 1958 that an Internal Revenue Agent intended to question Alinco's status as a life insurance company under the Internal Revenue Code, the merger plan was abandoned, and it was decided that Alinco should be liquidated. Obviously, it would have been unwise for Associates to bequeath Alinco's potential tax problems to Capitol.

In contemplation of Alinco's liquidation and dissolution, the reinsurance treaty with Old Republic was terminated as of November 30, 1959, and no business was reinsured after that date. However, Alinco, continued to be responsible for its share of losses and premium adjustments on business reinsured prior to that date.

26. The Indiana Insurance Department conducted four complete examinations of Alinco's operations: one for the period from July 21, 1953 to December 31, 1954; one for the period from January 1, 1955 through December 31, 1957; one for the period from January 1, 1958 through December 31, 1960; and one for the period from January 1, 1961 through December 31, 1963. In each case, Alinco was found to have complied with all applicable Indiana laws.

Alinco's Qualification as a Life Insurance Company Under Section 801 of the Internal Revenue Code

The Nature of the Alinco Reinsurance Pool.

27. The Alinco Reinsurance Pool was composed of typical credit life insurance policies. Some were level term and some were decreasing term; some were individual policies and some were group policies with individual certificates of insurance; but all were written with various financial institutions as the primary beneficiaries, and all were advance single premium policies. Generally, the Alinco Reinsurance Pool represented a fair cross section of Old Republic's credit life insurance business, although it was not completely representative because the borrowers of many significant creditors were excluded. The following table shows the makeup of the Pool and Alinco's quota share thereof for 1958, the year at issue:

                             Total insurance

     Group Decreasing Term Policy Number RP 134

Furthermore, with the exception of the clause in group decreasing term policy Number RP 387, which provides that the insurance will be terminated "upon repossession of the collateral, in which event the unearned premium shall be credited to the account of the debtor," none of the policies in the Pool contained provisions requiring the insurer to refund or credit any part of the prepaid premium to the creditor -policyholder or tothe debtor upon termination of the coverage prior to the original maturity date of the indebtedness. In fact, it will be noted that group decreasing term policy Number RP 134 provides that "No refund shall be made by the Company by reason of the prepayment of any loan."

However, while not required by the terms of the policies, in the case of refinancing coupled with the purchase of new credit life insurance coverage, Old Republic followed the practice of terminating the original coverage upon the insured's request and reducing the premium for the new coverage by the unexpired portion of the premium on the original policy.

Insurance Reserves

30. The insurance business is strictly regulated by the states. For example, the state insurance departments supervise policy forms, agency relationships, investments, accounting practices, reserves, and the general financial responsibility of insurance companies.

31. A life insurance reserve is the excess, as of any particular date, of the present value of future death claims over the present value of future premiums with respect to life insurance policies in force, both determined according to appropriate mortality tables and assuming a certain rate of interest. The purpose of a life insurance reserve is to determine that amount, as of the valuation date, which, together with anticipated future premiums and investment income, will be sufficient to pay anticipated death claims on the life insurance in force, as such claims mature.

32. The mortality tables and assumed rates of interest used in computing a life insurance reserve are specified in the insurance contracts, subject to certain minimum standards imposed by state regulatory authorities. The mortality tables used are those which are based on statistical studies made by actuaries since about 1785 and which are recognized by the actuarial societies and by the National Association of Insurance Commissioners.

33. A life insurance reserve computed as described above is commonly called a tabular reserve because it is computed on the basis of a mortality table. This is to be contrasted with an unearned premium reserve, which simply represents the unexpired portion of premiums received for policies in force, on a pro rata basis, and which historically has been used in reserving for casualty and accident and health policies. The historical reason for this distinction is that life insurance is not cancellable during the term for which the premium is paid and the entire premium is considered earned when received; on the other hand, casualty insurance (and accident and health insurance, when it was developed in the late 19th Century) has traditionally given the insured the right of cancellation at any time, coupled with the right to obtain a refund of a portion of the premium paid. For these reasons, all of the states require that life insurance must be reserved on a tabular basis, (except that in the case of credit life insurance, at the election of the insurance company, an unearned premium reserve sometimes may also be used,) ¹² and that casualty and accident and health insurance must be reserved on an unearned premium basis.

34. Although the unearned premium reserve historically has been associated only with casualty and accident and health insurance and not with life insurance, some insurance companies selling credit life insurance have elected to use an unearned premium reserve in order to provide for instances where their credit life policies required a refund or credit of part of the prepaid premium to the creditor-policyholder or debtor in the event of termination of the insurance coverage prior to the scheduled maturity date of the indebtedness. ¹³ In general, this type of policy appears to have been a relatively recent development in the credit life insurance industry. As a result of criticism arising from the abuses by some companies engaged in this business, it became increasingly common in the late 1950's to find newly enacted state laws (modeled mostly on the NAIC "Model Bill") requiring a refund or credit to be made to the debtor where the credit life coverage was terminated prior to its original maturity date.

Old Republic's and Alinco's Insurance Reserves

35. As required by state law, the policies themselves, and sound actuarial practice, Old Republic maintained tabular reserves for its life insurance policies (including credit life) and unearned premium reserves for its accident and health policies. ¹⁴ Its credit life insurance reserve as of each December 31 (the close of the accounting year for all insurance companies) was computed by first determining, through statistical sampling, the average age of all insureds and the average remaining term with respect to all decreasing and level term policies in force and by then applying the Commissioners' 1941 Standard Ordinary Mortality Table with an assumed two percent interest rate, to arrive at a factor which, when applied to the amount of insurance in force, produced the amount of the life insurance reserve. The Commissioners' 1941 Standard Ordinary Mortality Table is a recognized mortality table, approved by the National Association of Insurance Commissioners and is required both by law and by Old Republic's policy terms.

36. Under the reinsurance treaty, Alinco was required to maintain such reserves as might be found necessary by experience, but in no event less than $ 2.64 per $ 1,000 of reinsurance in force under the treaty, since 2.64 was the reserve factor used by Old Republic in computing its own reserves. Alinco's reserves with respect to the reinsurance assumed from Old Republic were valued by J. Huell Briscoe & Associates, independent actuarial consultants, who adopted the same method used by Old Republic. However, when the resulting factor turned out to be slightly less than 2.64, the minimum factor provided in the reinsurance treaty (the Old Republic factor) was used because the actuary considered that the Alinco Reinsurance Pool was sufficiently representative of Old Republic's business to make the use of the same reserve factor proper. The following table shows Alinco's life insurance reserves as of dates pertinent to this case:

                                               Alinco's life

37. As previously stated, for each of the years 1953 through 1961, as required by the Indiana Insurance Code, Alinco filed with the Insurance Department of the State of Indiana an annual statement on the form prescribed by the National Association of Insurance Commissioners. The data and statements contained in these annual statements were taken from (and accurately reflect) Alinco's books and records, which were properly maintained and were audited by Arthur Andersen & Company, independent public accountants, every 6 months. Some of this data was furnished to Alinco by Old Republic and Alinco's actuary. Neither the annual statements nor Alinco's books and records reflected any "unearned premiums" or reserves for the refund of "unearned premiums."

38. Old Republic's method of reserving for credit life insurance and the amounts of reserves maintained pursuant to that method were consistently approved by the State of Illinois, which examined Old Republic's reserves each year and issued a certificate of valuation evidencing compliance with state law. Also, Old Republic sought and obtained the Illinois Insurance Department's approval of its reinsurance treaty with Alinco. This was necessary so that Old Republic could take credit, in its annual statements, for the life insurance reserves maintained by Alinco with respect to its quota share of the Alinco Reinsurance Pool. In determining the life insurance reserves which Old Republic was required to maintain, the State of Illinois gave Old Republic credit for the life insurance reserves maintained by Alinco with respect to the reinsured risks.

39. Each year, the Indiana Insurance Department accepted Alinco's life insurance reserve and, as required by law, Alinco maintained on deposit with the Indiana Insurance Department securities having a value, according to the National Association of Insurance Commissioners' published list of valuations, at least equal to the amount of such reserve as of the preceding December 31.

40. The following table shows Alinco's year-end liability for claims arising out of the risks reinsured under the Old Republic reinsurance treaty:

      Date          Due and         Incurred but         Total

41. Defendant's exhibit No. 10 in evidence is a schedule prepared by the Actuarial and Insurance Tax Branch of the Internal Revenue Service in an effort to determine the qualification of Alinco as a life insurance company under the "more than 50 percent of its total reserves" test set forth in section 801(a) of the Internal Revenue Code. This schedule was prepared "on the assumption that all policies reinsured with Alinco were not 'noncancellable'." Defendant's Requested Finding of Fact No. 77. It has been found above, however, that all of the policies in the Alinco Reinsurance Pool were noncancellable in that neither Alinco, Old Republic, nor the policyholders could terminate their coverage at their option during the term for which the policies were written except (in the case of certain group policies) with respect to debtors to be insured in the future (see findings 28 and 29, supra). Therefore, since defendant's schedule was based upon an erroneous assumption, it is treated here as irrelevant and will not be reproduced in these findings.

Moreover, even if the defendant's underlying assumption were correct, the schedule is based upon several factual estimates which the record now shows were erroneous. For example, the figures in the schedule as to original gross premiums charged on the policies contained in the Pool were rough estimates supplied at defendant's request by the comptroller of Old Republic. Since Old Republic's records are kept and its annual statements prepared on a mortality reserve basis, rather than on an unearned premium reserve basis, it was not required to, and did not, keep accounting records as to the original gross premiums on its insurance in force. Hence, the only reliable sources for the actual original gross premiums charged by Old Republic on the thousands of insurance policies involved were the policies themselves, claims, and refunds. However, to extract this information from those original records would have involved data processing at a cost of over $ 100,000. Rather thanundergo such expense, the defendant asked Old Republic's comptroller to furnish his best estimate of the average gross premiums allocable to the Alinco Reinsurance Pool. He endeavored to do so, but in his calculations for the year at issue he assumed that the premium rate charged by Old Republic on all its decreasing term insurance was the maximum rate of $ 1 per $ 100 of coverage. However, testimony at the trial showed that the comptroller erred in using this maximum rate to arrive at his estimate of original gross premiums. Old Republic's Senior Vice -President testified that not more than 75 percent of the policies issued in 1958 bore the maximum premium rate. The comptroller's error, therefore, produced an overstatement of the original gross premiums as shown in the defendant's schedule with a resulting distortion of the computed ratio.

Furthermore, in computing the ratio for the years 1960 and 1961, the defendant erroneously assumed the existence of "unearned premiums" even at a time when the policies involved should have reached their maturity dates so that all premiums were then fully "earned". ¹⁵ This erroneous assumption also distorted the computed ratio.

Counsel for Alinco have countered defendant's schedule with a rebuttal computation of their own which purports to rectify the foregoing errors. ¹⁶ However, Alinco's schedule is likewise not reproduced herein because it, too, appears to contain an erroneous assumption. In computing an estimate of unearned gross premiums on level term insurance, for the year 1958, counsel assumed that Old Republic's comptroller had used a maximum rate of $ 2 per $ 100 of coverage just as he had done with the maximum $ 1 rate for decreasing term insurance. In his testimony the comptroller did indicate that he had used a maximum rate of $ 2. However, an examination of his underlying work papers reveals that he, in fact, arrived at an average rate somewhere between $ 1 and $ 2.14 per $ 100 of coverage.

Because of the inaccuracies described, it would seem improper to include either schedule in these findings of fact even if the schedules were otherwise relevant. Simply by way of comparison, however, it may be noted that the computations made resulted in the following ratios of Alinco's life insurance reserves to its total reserves for the years indicated:

                        Defendant's                Alinco's

History of This Controversy

42. For each taxable year, 1953 through 1961, plaintiff filed timely Federal corporate income tax returns, computing its taxable income and tax as a life insurance company, in accordance with section 201 of the Internal Revenue Code of 1939 or section 802 of the Internal Revenue Code of 1954, whichever was applicable. For the year 1958, the tax shown to be due was $ 1,347,023.69, which amount was paid.

43. Plaintiff's 1960 and 1961 tax returns showed operations losses of $ 784,037.55 and $ 337,954.02, respectively, on the basis of which plaintiff applied for and received tentative adjustments for operations loss carryback deductions in the year 1958 and, consequently, refunds totaling $ 291,717.81, plus interest, for the year 1958.

44. Subsequently, on December 26, 1962, the Internal Revenue Service determined a deficiency of $ 1,952,623.05 in plaintiff's 1958 income tax. The asserted deficiency was based primarily upon (a) a determination that plaintiff did not qualify as a life insurance company for tax purposes, under section 801(a) of the Internal Revenue Code of 1954, but rather was taxable as an ordinary corporation under section 11 of the Code; (b) a determination that plaintiff was not entitled to the $ 25,000 surtax exemption provided for in section 11(c) of the Code; and (c) a determination that plaintiff has established neither the amount of, nor its entitlement to, a net operating loss or an operations loss deduction in the year 1958 by reason of the carryback of losses incurred in the years 1960 and 1961.

45. On January 15, 1963, plaintiff paid to defendant the amount of the deficiency asserted for the year 1958 ($ 1,952,623.05), together with statutory interest in the amount of $ 412,413.60, for a total of $ 2,365,036.65. On January 16, 1963, plaintiff filed with the District Director, Internal Revenue Service, at Indianapolis, Indiana, a claim for refund of the amount paid on January 15, 1963, and that claim for refund was disallowed on February 12, 1963. This suit was timely filed thereafter.

Ultimate Findings of Fact

46. A number of purposes motivated the management of Associates in its decision to form Alinco Life Insurance Company as a subsidiary of Associates. The principal purposes for Alinco's formation were business purposes, the most important being (a) to expand Associates' activities into the life insurance industry by way of a subsidiary insurance corporation, thus gaining experience in dealing with the specialized concepts of that regulated industry preliminary to further expansion therein, and (b) to obtain more profits from the large production by Associates and its subsidiaries of credit life insurance business than had been experienced by them under a commission method of doubtful legality. In thus planning the formation of a life insurance company, Associates received both legal and accounting advice with respect to the special tax treatment afforded such companies by the Internal Revenue Code, and such advice was given serious consideration by Associates' management. However, the record clearly warrants the inference that Alinco, or a similar company, would have been formed by Associates in the early 1950's even if life insurance companies were taxed on the same basis as ordinary corporations. Tax avoidance was not the principal purpose for the formation of Alinco by Associates.

47. During the years 1958, 1960, and 1961 Alinco was a life insurance company engaged solely in the business of reinsuring life insurance contracts, and its life insurance reserves comprised more than 50 percent of its total reserves. This was true even if Alinco be deemed to have had unearned premiums and unpaid losses because such unearned premiums and unpaid losses, if any, were on noncancellable life insurance policies and hence were included in its life insurance reserves.

Conclusion of Law

Upon the foregoing findings of fact and opinion, which are adopted by the court and made a part of the judgment herein, the court concludes as a matter of law that plaintiff is entitled to recover, and judgment is entered to that effect with the determination of the amount of recovery to be reserved for further proceedings under Rule 47(c) in accordance with this opinion.

In accordance with the opinion of the court, a memorandum report of the commissioner and a stipulation of the parties, it was ordered on April 21, 1967, that judgment for the plaintiff be entered for $ 2,360,716.69, together with interest thereon as provided by law from January 15, 1963.

¹ The present case involves only Alinco's claim for refund of Federal income taxes and statutory interest thereon amounting to $ 2,365,036.65 for the calendar year 1958, the years 1960 and 1961 being also involved because of net operating loss carrybacks from those years. However, litigation is pending in the Tax Court of the United States with respect to the tax liabilities of Alinco for the years 1953 through 1957 and of Associates for the years 1953 through 1959.

² Obviously, level term is particularly suitable in cases of loans repayable in a lump sum rather than by regular installments.

³ Obviously, there is room for competition in the life insurance industry through decreasing the amount of "loading" and thus decreasing the gross premium charge. However, due to the method by which credit life insurance is sold, a unique situation has been observed by persons knowledgeable in the industry. Since the premium for credit life insurance is generally paid by the borrower, and since the lender's remnueration is generally a percentage thereof, the higher the gross premium, the greater will be the profit to the lender who procures the policy. Therefore, some lenders (or sellers) in seeking to increase their remuneration for the procurement of such insurance tend to place their business with the insurance company that charges the highest gross premium. An experienced lender (or seller) can generally foresee that, since the borrower's (or purchaser's) interest lies in the consummation of the primary transaction of loan (or installment sale), he is not likely to go out "shopping" elsewhere for a lower premium rate assuming he is interested in acquiring any credit life insurance at all. Thus, it is reasonable to anticipate that, in most instances, a borrower desiring to cover his loan with credit life insurance will consummate the entire transaction with his creditor in preference to making any independent analysis or comparison of credit life premiums available elsewhere. This situation is sometimes referred to as "reverse competition" and is one of the factors leading to the contention by some persons that premium overcharging is a common abuse in the selling of credit life insurance.

⁴ If written memorandum regarding these negotiations were ever prepared by officials of either company, such writings have since been either lost or destroyed.

⁵ The treaty was later amended on four occasions to increase Alinco's quota share. By June 1, 1958, Alinco's share had been increased to 75 percent.

⁶ This exclusion from the reinsurance treaty of credit life policies produced by Associates, along with all other matters relating to the formation and operation of Alinco, was the result of careful planning by Associates' operating personnel and tax advisors.

⁷ This was true only with respect to credit life insurance. Morco continued to receive commissions from Old Republic on the writing of credit accident and health policies.

⁸ However, it has continued to retain its corporate status under Indiana law so that it has the capacity to maintain this suit.

⁹ Once described by Judge Learned Hand as "anodynes for the pains of reasoning." Commissioner v. Sansome, 60 F. 2d 931, 933 (2d Cir., 1932).

¹⁰ Holmes, J. dissenting in Lochner v. New York, 198 U.S. 45, 76 (1905).

¹¹ The failure here to follow this analogous administrative ruling brings to mind the critical observation of a well-known tax lawyer and commentator: "If the Treasury is to behave in a responsible and mature manner, it should not say one thing in administration and then say precisely the opposite in litigation." Eisenstein, A Critical View of the Treasury, 15 N.Y.U. Inst. on Fed. Taxation 21, 24 (1957).

¹² Counsel for plaintiff point to the fact that in planning the formation of a life insurance subsidiary, it cannot safely be assumed that taxation as a life insurance company will necessarily be beneficial. As will appear below, between 1921 and 1958, premium income was not an item of gross income to life insurance companies, but neither were their underwriting losses deductible from their investment income. Hence, it was possible that a newly formed life insurance company whose initial underwriting expenses were substantial might be forced to pay tax on its investment income despite larger underwriting losses. See statement of Edward J. Schmuck, Esquire, then General Counsel of Acacia Mutual Life Insurance Company, Hearings Before Senate Finance Committee, 86th Cong., 1st Sess., on H.R. 4245, March 3, 1959, at p. 196.

¹³ That this was a real threat is indicated by the fact that a number of states had regulations prohibiting the holder of a group credit life insurance master policy from retaining any refunded premiums where the borrowers had themselves paid the original premiums. See, for example, No. Car. Ins. Code, Sec. 58-44.7.

¹⁴ As of December 31, 1958, Alinco's reinsurance risk under its quota share of the policies in force in the Alinco Reinsurance Pool was $ 959,704,957. See finding 27, infra.

¹⁵ There was also a substantial advantage to Old Republic in maintaining or increasing its volume by retaining Associates' business despite the fact that the reinsurance premium paid to Alinco was the same percentage of the original gross premium as the reinsured risk. This is because the volume helped Old Republic to lower its unit cost on processing and thus contributed to its profit.

¹⁶ Although Old Republic had no pressing actuarial need to spread its risk, the possibility of unusual losses arising from disasters or war conditions was not de minimus. Defendant's expert witness, who had long experience with credit life insurance, testified as to some examples of such unusual losses which had adversely affected his company during his professional career.

¹⁷ The Government points skeptically at the fact that Alinco reinsured only credit life insurance whereas Associates, through Morco, was producing for Old Republic both credit life and credit accident and health insurance. No important conclusions flow from this fact. At the time involved, credit accident and health insurance was not as important as credit life insurance. Furthermore, Indiana law did not prohibit the payment of commissions to a corporate agency (such as Morco) on accident and health insurance, as it did on life insurance, so there was no necessity to change the existing commission setup to eliminate accident and health insurance. Also, it simplified accounting and regulatory problems to reinsure only credit life insurance.

¹⁸ The National Association of Insurance Commissioners was likewise investigating the abuses connected with the selling of credit life insurance and formulated a "Proposed Model Bill" for the regulation of the writing of both credit life and credit health and accident insurance. Among other things, the Model Bill restricted the amount of insurance to the amount of the indebtedness, restricted the term of the insurance to the maturity date of the indebtedness, made mandatory a refund (or credit) of premium in case of refinancing, and limited the amount of compensation which could be paid to the procurer of the insurance. Commencing in the late 1950's, the Model Bill, or similar legislation, has been enacted by a number of state legislatures. See Peters, How Should Credit Life Insurance Be Regulated, supra, pp. 531-533, and finding 34, infra.

¹⁹ For example, the first act of the first Congress in 1789 imposed customs duties for revenue and for "the encouragement and protection of manufacturers." Act of July 4, 1789, 1 Stat. 24, Chapter 2. See, also, Chapter 39, "Regulatory Taxes," 1954 Code, and Blough, The Federal Taxing Process, Prentice-Hall, Inc., 1952, pp. 409-426.

²⁰ For an authoritative discussion of the legislative history and the factors which led to the enactment of section 269's predecessor, see Rudick, Acquisitions to Avoid Income or Excess Profits Tax: Section 129 of the Internal Revenue Code, 58 Harv. L. Rev. 196 (1944). The Senate and House Committee Reports are reproduced in 1944 C. B. 901 et seq.

²¹ Curiously by today's standards, life insurance was once regarded as a "blasphemous attempt to estimate man at a price." See Oppenheimer, Proceeds of Life Insurance Policies Under the Federal Estate Tax, 43 Harv. L. Rev. 724 (1930). Cf. the Supreme Court's more enlightened approach in Burnet v. Wells, 289 U.S. 670, 681 (1933).

²² Dr. T. S. Adams, then Tax Advisor to the Treasury Department, so advised the Senate Finance Committee. Senate Hearings on H.R. 8245, 67th Cong., 1st Sess., p. 83 (1921).

²³ Hearings before the Senate Committee on Finance, 67th Cong., 1st Sess., on H.R. 8245, p. 85 (1921).

²⁴ The analogy had been previously noted by the First Circuit Court of Appeals in Massachusetts Protective Ass'n v. United States, 114 F. 2d 304, 311 (1st Cir., 1940).

²⁵ A full discussion of these reserves is contained in Commissioner v. Monarch Life Ins. Co., supra, at pp. 320-323.

²⁶ P.L. 86-69, 86th Cong., 1st Sess., approved June 25, 1959, applicable retroactively to taxable years beginning after December 31, 1957.

²⁷ Probably the most significant change was a modification of the "investment income" approach. In general, the 1959 Act combined a tax on investment income with a tax on one-half of underwriting income and provided for a tax on the remainder of the underwriting income as and when distributed to stockholders. For a full description, see Mertens, supra, Sec. 44A.01, et seq.

²⁸ "Tabular" reserves, as the name suggests, are simply the reserves for future unaccrued claims on life, annuity, and noncancellable accident and health policies which are computed "on the basis of recognized mortality or mobidity tables and assumed rates of interest." See section 801(b)(1), supra.

²⁹ Alinco's life insurance reserve was accepted by the Indiana Insurance Department and, also, by the Illinois Insurance Department as a part of Old Republic's reserves. The method of computing these reserves is described below in findings 35 through 38. Under the reinsurance treaty, Alinco was required to maintain such reserves as might be found necessary by experience, but in no event less than $ 2.64 per $ 1,000 of reinsurance in force under the treaty, since that was the reserve factor used by Old Republic in computing its own reserves.

³⁰Cf. Commissioner v. Noel Estate, 380 U.S. 678 (1965) where one of the principal questions was whether the proceeds of flight accident insurance (which, of course, is issued at a flat premium rate regardless of age or medical condition) were includible as life insurance in decedent's gross estate for estate tax purposes despite the casualty nature of such insurance. The Supreme Court accepted the Government's position that such insurance was includible in the taxable estate because it was "on the life of the decedent." Sec. 2042, 1954 Code.

³¹ The Government's request for this data confounded Old Republic's personnel. Since Old Republic maintained its life insurance reserves on a tabular basis, it kept its accounting records on the same basis. Therefore, the information desired by the Government as to premiums and unexpired terms was available only from original sources, such as the policies themselves. To extract the accurate data from those sources involved a cost of over $ 100,000 which neither Old Republic nor the Government was willing to bear. In an effort to accommodate the Government, but with an appropriate caveat, Old Republic's comptroller furnished some rough estimates from which the Internal Revenue Service erected a schedule that turned out to be largely hypothetical. See finding 41, infra. At this point, no doubt, the Government shared the view of Professor Spencer L. Kimball that "* * * a curious thing about the insurance business -- a business that necessarily deals statistically with great masses of information -- is the large amount of relevant and useful information that is not accessible." Book Review, 63 Mich. L. Rev. 1509 (June 1965).

³² This is not to say, of course, that some casualty insurance does not insure against death. The point is that it also insures against many other evitable hazards, such as fire, theft, etc., whereas life insurance, particularly term life insurance, has the sole function of protecting against death. See Nash, Federal Taxation of Life Insurance Companies, Matthew Bender & Co. (1965), Secs. 2.03, 2.04.

³³ In this connection it is instructive to refer to the classic textbook on life insurance, Huebner and Black, Life Insurance, Appleton-Century-Crofts, 5th Edition (1958). When the reader examines the index for "unearned premium," he is simply referred to the chapter dealing with life insurance reserves. And, as might be expected from Mr. Eddy's testimony, nowhere in the chapter does the term "unearned premiums" even appear. Further, see p. 6 of the text where it is stated that in life insurance the "unearned premium is called the policy reserve." Perhaps this concept had its genesis in the holding of Lord Mansfield long ago that, once the risk has attached under a contract of insurance, the premium has been earned, and no part thereof is returnable absent an agreement to the contrary. Tyrie v. Fletcher, Cowp. 666, 668. The rule thus laid down seems never to have been questioned. See Mailhoit v. Metropolitan Life Ins. Co., 87 Me. 374, 32 Atl. 989 (1895). This has been the law in Alinco's domiciliary state for many years. Continental Life Ins. Co. v. Houser, 111 Ind. 266, 12 N.E. 479 (1887) and Metropolitan Life Ins. Co. v. McCormick, 19 Ind. App. 49, 49 N.E. 44 (1898).

³⁴ The record does not show what portion of the total Pool was made up of such group policies, nor was any effort made by defendant to segregate them in its computation of Alinco's qualification ratio.

³⁵ At most, the refund possibility is a contingent liability for which some reserve in addition to the mortality reserve should be established. And defendant's expert witness testified that today the commonest method of reserving for credit life insurance is to add to the mortality reserve "a little loading" to cover the refund contingency.

³⁶ On defendant's computation for the year in issue, using gross unearned premiums, Alinco failed to meet the reserve -ratio test by only nine-tenths of one percent. See finding 41, infra.

³⁷ In the case of noncancellable or guaranteed renewable accident and health insurance, something must be added to the unearned premium for anticipated future premium deficiencies. However, no comparable additional reserve is required in the case of life insurance (whether term or level premium) because the factor for future premium deficiencies is an integral part of the actuarial tables on the basis of which the mortality reserve is computed.

³⁸ Insofar as the individual credit life policies in the Pool are concerned, their provisions disclose no event or condition which would serve to terminate the policy other than death of the insured or the expiration of the original term stated therein.

² Since reinsurance must necessarily result in the sharing of its profits, if any, from the reinsured business, it may be logically concluded that the primary insurer's management will give very serious consideration to any decision to reinsure part of its business.

³ For example, if the normal size of risks insured by a given company was $ 10,000, but it decided to underwrite a large risk of $ 250,000, the company would be likely to reinsure some portion of that large risk in order to avoid the hazard of an extraordinary loss which would not be averaged out by the other risks insured.

⁴ This agency appointment appears to have been in violation of Indiana law which, since 1935, has prohibited corporations from acting as agents for life insurance companies. Sec. 39-4608 Burns Indiana Stat. Anno.

⁵ Although the record is not completely clear in this respect, the retrospective insurance rate adjustment appears to relate primarily to group insurance. (See finding 12(b) supra.) In any event, the record shows that Associates, which held several group policies issued by Old Republic, reported retrospective insurance rate adjustments in its 1953 income tax return amounting to $ 3,477,429.12.

⁶ As stated in finding 16 above, if written memoranda regarding these negotiations were ever prepared by officials of either company, such writings have since been either lost or destroyed.

⁷ This exclusion from the reinsurance treaty of credit life policies produced by Associates, along with all other matters relating to the formation and operation of Alinco, was the result of careful planning by Associates' operating personnel and tax advisors.

⁸ By the time of trial, the data for the earlier years was no longer available.

⁹ The term "net premiums" is not used here in the technical sense as defined in finding 11, supra. Old Republic's comptroller, who assembled these figures, testified that he meant the term in the sense of gross premiums "after refund." The record is not clear as to what he meant by "after refund," although it may be inferred that he had reference to that portion of premiums refunded upon an early termination of a policy by an act of the insured. In any event, it is clear from the contractual arrangements described in finding 19, supra, that no commissions had been deducted by Associates or its subsidiaries prior to remitting the premiums listed in this finding.

¹⁰ Consideration was even given to the acquisition of an insurance company engaged in the writing of credit accident and health insurance, but the plans in this regard were never consummated.

¹¹ The analysis contained in this finding relates primarily to the group credit life policies in the Pool. Insofar as the individual credit life policies in the Pool are concerned, their provisions disclose no event or condition which would serve to terminate the policy other than death of the insured or the expiration of the original term stated therein.

¹² In this regard, the following appears in the credit life insurance exhibit in the 1959 and 1960 annual statements filed by Old Republic with the State of Illinois: "Is reserve liability calculated on an unearned gross premium basis? No If not, explain basis used. Mortality Tables."

¹³ An example of such a policy is in evidence. It is a group policy written by Capitol on debtors of Associates effective January 1, 1960, providing in part as follows:

     The insurance with respect to any individual insured Debtor shall

¹⁴ Commencing in 1959, Old Republic apparently also could have elected to use an unearned premium reserve for its credit life insurance in force, if it so desired. See footnote 12, supra.

¹⁵ This condition of maturity came about because of the termination of the Alinco-Old Republic reinsurance treaty as of November 30, 1959.

¹⁶ Counsel prepared the rebuttal schedule solely for the purpose of showing that Alinco actually met the statutory percentage requirement even on the assumption that the policies were cancellable, and that, therefore, "unearned premiums" existed with respect to the Alinco Reinsurance Pool. They do not agree, of course, that the assumption is correct. To the contrary, they contend that all such computations (including their own) are irrelevant because, as a matter of law, Alinco had no "unearned premiums" or "unpaid losses" and that all policies in the Pool were "noncancellable."