Humana Inc. & Subsidiaries v. Comm'r of Internal Revenue
| Decision Date | 26 January 1987 |
| Docket Number | 17130-82. 1,Docket No. 15292-80 |
| Citation | 88 T.C. 197,88 T.C. No. 13 |
| Parties | HUMANA INC. AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Humana Inc. and its wholly owned foreign subsidiary own all of the capital stock of a captive insurance subsidiary incorporated by the parent corporation. The parent corporation paid to the captive insurance subsidiary amounts which were treated as premiums for insurance coverage of the parent and subsidiaries. The parent allocated and charged to the subsidiaries portions of the amounts paid representing the share each bore for the hospitals each operated. The remainder represents the parent's share for the hospitals which it operated. The total sums were deducted on the consolidated income tax returns as insurance premiums. Held, the risks of loss were not shifted from petitioner and its subsidiaries and the amounts paid to the captive insurance subsidiary are not deductible as ordinary and necessary business expenses for insurance. Clougherty Packing Co. v. Commissioner, 84 T.C. 948 (1985), and Carnation Co. v. Commissioner, 71 T.C. 400 (1978), affd. 640 F.2d 1010 (9th Cir. 1981), followed and extended; Stearns-Roger Corp. v. United States, 774 F.2d 414 (10th Cir. 1985), and Mobil Oil Corp. v. United States, 8 Cl. Ct. 555 (1985), followed. L. L. Leatherman, Charles J. Lavelle, Arthur P. Hipwell, James E. Milliman, Thomas A. Brown, and Gary R. Weitkamp, for the petitioner.
Scott R. Cox and Joel V. Williamson, for the respondent.
The Commissioner determined deficiencies in income tax against petitioner for the following taxable years:
+-----------------------------------+
¦Docket No.¦TYE Aug. 31--¦Deficiency¦
+----------+-------------+----------¦
¦15292-80 ¦1976 ¦$4,615,905¦
+----------+-------------+----------¦
¦ ¦1977 ¦9,409,814 ¦
+----------+-------------+----------¦
¦17130-82 ¦1978 ¦7,723,542 ¦
+----------+-------------+----------¦
¦ ¦1979 ¦20,460,078¦
+-----------------------------------+
After concessions by the parties, one issue remains for our decision, i.e., to what extent, if any, may petitioner deduct as ordinary and necessary business expenses amounts paid to a wholly owned captive insurance company which were treated as premiums for general liability and medical malpractice insurance.
We first decided the case in Memorandum Opinion, T. C. Memo. 1985-426. Petitioner filed a motion for reconsideration of the opinion pursuant to Rule 161. 2 The Court granted the motion and withdrew the opinion.
Each of the policies provided three types of coverage: Coverage A—personal injury; Coverage B—property damage; and Coverage C— professional liability, including personal injury relating to certain professional services (i.e., malpractice). Each policy also included a ‘good samaritan endorsement‘ under which professional employees, acting outside of their capacity as employees, were covered for certain occasional professional services not rendered for their personal benefit.
Under each of the four policies, the following were considered as ‘an insured:‘
a. The named insured;
b. Any officer, hospital administrator * * *, stockholder, or member of the Board of * * * Directors or Governors of the named insured while acting for * * * the named insured.
c. Under Coverages A and B, any employee, student or volunteer worker of the named insured while acting within the scope of his duties * * *;
* * *
f. Under Coverage C, any person included in any of the employee classifications for which coverage is afforded under this policy, as indicated in Item 5 of the Declarations, while such person is acting within the scope of his duties as an employee * * *.
Pursuant to Item 5 of the Declarations, any employee of the insured was covered, including those professional employees who were licensed residents, interns, physicians, surgeons, or dentists, except that physicians, surgeons, and dentists were excluded under policy number HCI-60178. Under such policy, however, coverage was extended to independent contractors licensed as physicians and practicing in the hospital emergency room or attending to emergencies on the hospital premises. After June 1, 1979, this coverage was also provided for those insured under policy number HCI-90178. Generally, no coverage was provided for non-employee physicians, since they carried their own insurance.
Humana Inc., on forms 10-K filed with the Securities and Exchange Commission for the taxable years in issue, described the coverage provided by HCI as follows: The Insurance Subsidiary will insure the risks of the Company only, and it will only provide insurance to physicians who are actually employed by the Company. In such documents, ‘Company‘ is defined as Humana Inc. and its subsidiaries.
At all times pertinent in this case, payments for coverage of each of the categories described above were paid by petitioner and were not charged to the employee or other individual involved.
Pursuant to policies numbered 1001, 1003, and HCI-90178, the liability of HCI was limited to $2 million per occurrence under Coverages A, B, and C, $2 million in the aggregate under Coverages A and B, and $10 million in the aggregate under Coverage C. 11 Pursuant to policy number HCI-60178, the liability of HCI was limited to $500,000 per occurrence and $2.4 million in the aggregate for each category of covered risks.
More importantly, under the economic family theory asserted by respondent, there seems to be no real distinction between disregarding transactions between related corporations and disregarding their separate status. However, I submit that, generally, transactions between ANY entities, related or unrelated, should be repudiated or recharacterized only if they are not legally or factually what they purport to be. The majority's reliance on financial reports to buttress its conclusion only fuels the economic family fire; it consolidates two entities for tax purposes which are not permitted to file consolidated tax returns and, without a basis for so doing, erodes the long-standing principle of Moline Properties v. Commissioner, supra.
For these reasons, I strongly believe that we should decide the issue solely on a lack of risk shifting and risk distribution basis. In this respect, there appears to be no tax avoidance scheme. The inter-corporate contractual arrangements are not determined to be shams. Indeed, a business purpose for the transactions is obvious because the entities could not obtain insurance coverage elsewhere.
If we are to abrogate the insurance transaction between these related entities, we should do so by simply saying, without more, that there is neither shifting nor distribution of risk and, consequently, no valid insurance arrangement. If we cannot say that, or must say more than that, then it seems to me that we have valid insurance transactions between separate, though related entities.
In sum, I believe that the economic family theory may conflict with fundamental principles of tax law by invoking attribution among related corporations where it has not been legislated by Congress. 3 I see no reason to give such a concept credence, as the majority is doing here. Consequently, I concur only in the result reached by the majority.
I find the majority's holding with respect to the premiums paid by the Humana subsidiaries to HCI (the brother-sister situation) deficient in at least two important respects:
1. The majority relies heavily upon, and quotes extensively from the joint opinion of respondent's expert witnesses Plotkin and Stewart. A careful examination of that opinion, however, leads me to the conclusion that it gives no support to the position of the majority on the brother-sister question. As the quotations show, the thrust of the report is aimed at the parent-subsidiary question, concluding that there is no true insurance (hence no deductible premium) because there is no transfer of the risk of loss from the ‘insured‘ parent to its wholly-owned subsidiary ‘insurer.‘ The reasoning apparently is that the subsidiary's stock is shown as an asset on the parent's balance sheet. If the parent suffers an insured loss which the subsidiary (HCI in this case) has to pay, the assets of the subsidiary insurer will be depleted by the amount of the payment. This, in turn, will reduce the value of the subsidiary's shares as an asset of the parent (Humana), so that, in effect, the assets of the ‘insured‘ parent are bearing the loss as far as true economic impact is concerned. As the experts' joint opinion (quoted by the majority) clearly puts it:
True insurance relieves the firm's balance sheet of any potential impact of the financial consequences of the insured peril. For the price of the premiums, the insured rids itself of any economic stake in whether or not the loss occurs. * * * however as long as the firm deals with its captive, its balance sheet cannot be protected from the financial vicissitudes of the insured peril.
* * *
So long as the firm does not transfer to another the ultimate responsibility for the financial consequences of its risks, it remains the risk bearer and faces the uncertainty of each year's actual financial losses. The attempted placing of a firm's risks, directly or indirectly, in its ‘insurance affiliates‘ did not accomplish a transference of risk, or constitute an insurance transaction as a matter of insurance theory or economic reality. We find our conclusion in complete accord with the clear theoretical and applied teachings of the economics, insurance theory, risk management, and captive self-insurance literatures.
Accepting, arguendo, that this is an accurate statement and is in line with our reasoning in Carnation and Clougherty, it nevertheless provides no support to the majority's position in the brother-sister situation. Humana's insured subsidiaries own no stock in...
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