American Nat. Ins. Co. v. United States

• Decision Date: 22 September 1982
• Docket Number: 193-78.,No. 336-73,336-73
• Citation: 690 F.2d 878
• Parties: AMERICAN NATIONAL INSURANCE COMPANY v. The UNITED STATES.
• Court: U.S. Claims Court

690 F.2d 878

AMERICAN NATIONAL INSURANCE COMPANY v. The UNITED STATES.

Nos. 336-73, 193-78.

United States Court of Claims.

September 22, 1982.

Vester T. Hughes, Jr., Dallas, Tex., attorney of record, for plaintiff. W. John Glancy, Dallas, Tex., David F. P. O'Connor, David L. Sinak, and Hughes & Hill, Dallas, Tex., of counsel.

Michael J. Dennis and Robert C. Markham, Washington, D. C., with whom was Asst. Atty. Gen. Glenn L. Archer, Jr., for defendant. Theodore D. Peyser, Jr., Washington, D. C., of counsel.

Before FRIEDMAN, Chief Judge, and KASHIWA and BENNETT, Judges.

ON PLAINTIFF'S MOTIONS FOR SUMMARY JUDGMENT AND FOR PARTIAL DISMISSAL AND DEFENDANT'S CROSS-MOTION FOR SUMMARY JUDGMENT

FRIEDMAN, Chief Judge:

The principal issue in this case, and the only one we discuss on the merits, is whether "experience rating refunds" that the plaintiff life insurance company was contractually obligated to pay to certain of its policyholders constituted "return premiums" or "dividends to policyholders" under the Life Insurance Company Income Tax Act of 1959, Pub.L.No.86-69, 73 Stat. 112 (codified as amended at 26 U.S.C. §§ 801-20 (1976 & Supp. IV 1980) hereinafter referred to as the "Code" and cited as I.R.C.) (the "Life Insurance Tax Act").

The significance of this distinction is that in determining a life insurance company's taxable income, the Life Insurance Tax Act limits the amount of "dividends to policyholders" but not the amount of "return premiums" that a life insurance company may deduct from its gross income. The plaintiff naturally contends that the refunds are "return premiums," and the government contends that they are "dividends to policyholders." The plaintiff has moved for summary judgment on this issue. The defendant opposes the motion on the ground that there are disputed factual issues for which a trial is required.

We hold that the experience rating refunds are return premiums, and we therefore grant the plaintiff's motion for summary judgment on this issue.

I.

The plaintiff, American National Insurance Company ("American National"), is a stock insurance company, the shares of which are publicly held.¹ For the years involved in this case (1958 through 1969), American National offered group credit life and group credit disability insurance. The insurance policies were issued through creditor organizations (such as banks) to insure loans they made against the death or disability of the debtors. American National dealt only with the credit organizations, which will be referred to as the "policyholders." The policyholder typically insured only those loans for which the debtor paid the premium.

These group policies were "Non-Participating," i.e., the policyholders were not entitled to share in American National's divisible surplus.

For many of the group policies, American National entered into experience rating refund agreements with the policyholders. The refund agreement provided a mechanism by which part of the excess premium collected for the group — the portion of the premium not required to meet the claims of the group or American National's expenses and profit connected with the group — would be returned to the policyholder.

The experience rating refund agreements provided a formula for calculating the excess premium for a given period (usually the policy year) and stated the percentage of the excess that American National was obligated to refund. The excess equalled the difference between (1) the total earned premium for the particular group policyholder during the relevant period and (2) the sum of (a) the premium loading (i.e., that part of the premium retained by the plaintiff to cover expenses and profits), (b) the claims made by the policy group during the relevant period (including claims actually paid, claims reported but not yet paid and a reserve to cover claims incurred but not yet reported ("unreported claims")), and (c) specified extraordinary claims expenses. Each agreement also specified a percentage — or schedule of percentages which generally rose with the level of premiums — of this excess to which the policyholder was entitled.

If there was no excess premium but was a deficit, American National carried the deficit over to the next year if the policy was renewed. (It is unclear whether the deficit increased the policyholder's premium for the next year or whether it merely reduced the next year's experience rating refund.) If, however, the policy was not renewed, American National absorbed the deficit.

In its federal income tax returns for the years involved, American National treated the experience rating refunds as return premiums and deducted their full amount from its gross income. The Commissioner of Internal Revenue, however, ruled that the refunds were dividends to policyholders and therefore disallowed the deduction of the portion of those payments that exceeded the maximum permissible deduction for policyholder dividends. The plaintiff paid the additional tax assessed, filed a timely claim for refund and, after the Commissioner denied the claim, filed the present suit. The petition contains 10 different claims, only three of which are involved in the present proceeding.

II.

A. From 1921 until the Life Insurance Tax Act, life insurance companies were taxed only on their excess or "free" investment income (i.e., the insurance company's earnings from investment above those allocated to policyholders under statutory provisions) but not on their underwriting income (i.e., earnings on premiums in excess of claims and expenses related to the policies in a given year). See generally Commissioner v. Standard Life & Accident Insurance Co., 433 U.S. 148, 152-54, 97 S.Ct. 2523, 2526-2527, 53 L.Ed.2d 653 (1977); Alinco Life Insurance Co. v. United States, 178 Ct.Cl. 813, 373 F.2d 336 (1967); 8 J. MERTENS, THE LAW OF FEDERAL INCOME TAXATION § 44A.01 (1978) hereinafter cited as MERTENS' LAW OF INCOME TAXATION.

In the Life Insurance Tax Act, Congress subjected to taxation all the income of life insurance companies. It did so by dividing total income into three phases and taxing those phases under complicated formulae. See generally I.R.C. § 802(b); H.R.REP.NO.34, 86th Cong., 1st Sess. 1-17 (1959); S.REP.NO.291, 86th Cong., 1st Sess. 13-29 (1959), U.S.Code Cong. & Admin.News 1959, p. 1575; 8 MERTENS' LAW OF INCOME TAXATION, supra, at § 44A.01.

Phase I consists of the company's free investment income (as calculated under sections 804 through 806 of the Code), or its total income from all operations (as calculated under sections 809 through 812 of the Code) if less than free investment income. I.R.C. § 802(b)(1). (If income from operations is less than free investment income, the company pays tax only under phase I, and phases II and III are inapplicable.) Phase II consists of one-half of the difference between income from operations (if larger than free investment income) and free investment income. Id. at § 802(b)(2). The difference between the gain from operations and free investment income was thought by Congress to be roughly equivalent to underwriting gain. See, e.g., H.R.REP.NO.34, supra, at 3, 13; S.REP.NO.291, supra, at 6. Phase II thus taxes one-half of the taxpayer's underwriting income. The remainder of underwriting income is taxed under phase III when it is distributed to stockholders. I.R.C. § 802(b)(3). (Phase III is not relevant to our decision and will not be discussed further.)

B. Gain or loss from total operations is calculated under sections 809 through 812 of the Code. Gross gain is the sum of three income items: the insurance company's share of all investment income, its gross receipts from its insurance business (i.e., premiums, decreases in reserves and miscellaneous items) and, after 1961, its net capital gain. I.R.C. §§ 809(b) & (c); see 8 MERTENS' LAW OF INCOME TAXATION, supra, at § 44A.09. Section 809(d) lists a number of deductions, including dividends to policyholders, that reduce this gross amount. See also 8 MERTENS' LAW OF INCOME TAXATION, supra, at § 44A.10.

The major component of gross receipts, which itself is one of the three items of gross gain from operations, is premiums on insurance and annuity contracts. Section 809(c)(1) of the Code defines the premiums that must be included in gross receipts as gross premiums less, inter alia, "return premiums." There are no explicit limitations on the amount by which return premiums may reduce gross premiums.

"Dividends to policyholders," on the other hand, are deducted from gross operations income under section 809(d)(3). The policyholder dividend deduction consists of the dividends paid (or rate credits made) and changes in the size of any reserves held by the taxpayer for dividends payable. I.R.C. § 811(b).

Section 809(f) of the Code, however, limits the deduction of policyholder dividends. The amount of policyholder dividends that may be deducted from gross operations income cannot exceed the amount by which gross operations income, unreduced by dividends to policyholders (or the deductions under sections 809(d)(5) and (6)), exceeds free investment income, plus $250,000. In other words, while dividends to policyholders may be deducted in full against phase II or underwriting income, they may reduce phase I or free investment income by not more than $250,000.

Insofar as this case is concerned, the only difference between characterizing an amount returned to a policyholder as a return premium or as a dividend is the extent to which the amount may reduce free investment (phase I) income. Regardless of the characterization, amounts returned to policyholders may reduce a taxpayer's phase II, or underwriting, income without limitation. Only return premiums, however, may be deducted in full and without limitation against phase I income.

III.

A. The amounts returned by life insurance companies to their policyholders are either "return premiums" under section 809(c)(1) of the Code or ...