Alinco Life Insurance Company v. United States

• Citation: 373 F.2d 336
• Decision Date: 17 February 1967
• Docket Number: No. 77-63.,77-63.
• Parties: ALINCO LIFE INSURANCE COMPANY v. The UNITED STATES.
• Court: Court of Federal Claims

373 F.2d 336 (1967)

ALINCO LIFE INSURANCE COMPANY v. The UNITED STATES.

No. 77-63.

United States Court of Claims.

February 17, 1967.

William A. Cromartie, Chicago, Ill., for plaintiff. Peter L. Wentz, Chicago, Ill., attorney of record. Edward W. Rothe, Patrick A. Heffernan, Chicago, Ill., Samuel H. Horne, of Hopkins, Sutter, Owen, Mulroy, Wentz & Davis, Washington, D. C., and John L. Carey of Oare, Thornburg, McGill & Deahl, South Bend, Ind., of counsel.

Gilbert W. Rubloff, Washington, D. C., with whom was Asst. Atty. Gen., Mitchell Rogovin, for defendant. Lyle M. Turner and Philip R. Miller, Washington, D. C., of counsel.

Before COWEN, Chief Judge, and LARAMORE, DURFEE, DAVIS, COLLINS, SKELTON and NICHOLS, Judges.

OPINION

PER CURIAM:

This case was referred to Trial Commissioner Lloyd Fletcher with directions to make findings of fact and recommendation for conclusions of law. The commissioner has done so in an opinion and report filed on March 8, 1966. Exceptions to the commissioner's findings and recommended conclusion of law were filed by the defendant and the case has been submitted to the court on oral argument of counsel and the briefs of the parties. Since the court agrees with the trial commissioner's findings, opinion and recommended conclusion of law, with modifications, it hereby adopts the same, as modified, as the basis for its judgment in this case, as hereinafter set forth. Plaintiff is therefore entitled to recover and judgment is entered for plaintiff with the amount of recovery to be determined pursuant to Rule 47(c).

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 domicil (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 policy-holder. 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 exploring possibilities 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...