Oxford Life Ins. Co. v. U.S., 84-2835

• Decision Date: 30 May 1986
• Docket Number: No. 84-2835,84-2835
• Citation: 790 F.2d 1370
• Parties: -5092, 86-1 USTC P 9449 OXFORD LIFE INSURANCE COMPANY, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1370

790 F.2d 1370

58 A.F.T.R.2d 86-5092, 86-1 USTC P 9449

OXFORD LIFE INSURANCE COMPANY, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 84-2835.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Oct. 10, 1985.

Decided May 30, 1986.

Theodore R. Groom, Groom & Nordberg, Washington, D.C., for plaintiff-appellant.

Michael L. Paup, U.S. Dept. of Justice, and Gary R. Allen, Atty., Washington, D.C., for defendant-appellee.

Appeal from the United States District Court for the District of Arizona.

Before SKOPIL, FLETCHER and WIGGINS, Circuit Judges.

WIGGINS, Circuit Judge:

Oxford Life Insurance Company (Oxford) appeals the district court's dismissal of Oxford's suit for the refund of federal income taxes paid in 1973 and grant of summary judgment for the government on Oxford's erroneous refund counterclaim for 1974. See 574 F.Supp. 1417 (D.Ariz.1983). Oxford sought to recover federal income taxes paid in connection with an assumption reinsurance transaction in which it acquired a block of 10,000 life insurance policies from another insurance company. We affirm the district court's decision in part, reverse in part, and remand for a determination of the length of the amortization period.

This appeal involves the tax consequences of an assumption reinsurance transaction. In an assumption reinsurance transaction, one insurance company, the ceding company or reinsured, transfers certain of its policies to another insurance company, the assuming company or reinsurer. The assuming company steps into the ceding company's shoes--it assumes the statutory reserve liability on the policies; it gains entitlement to all future premiums; and it becomes directly liable to the policy holders. Beneficial Life Insurance Co. v. Commissioner, 79 T.C. 627, 636 (1982). All life insurance companies are required by state insurance laws to set aside minimum life insurance reserves on their policies. These reserves are estimates of the present value of future benefit payments to policy holders. Accordingly, after a reinsurance transaction, the assuming company establishes reserves on its books to cover the newly-acquired policies, and the ceding company decreases its annual statement reserves by the amount of reserves previously maintained on the transferred policies.

FACTS

In 1973, Oxford, an Arizona corporation, entered into an assumption reinsurance agreement with Pioneer Insurance Company (Pioneer), a Nebraska corporation, to acquire a block of insurance business, consisting of approximately 10,000 twenty-payment whole life policies written by Pioneer with a face value of $58,672,232.00. Under the agreement, Pioneer, the ceding or reinsured company, agreed to pay Oxford, the assuming company or reinsurer, a reinsurance premium for the policies Oxford was assuming. The reinsurance premium consisted of (1) the amount of reserves that Oxford would have to establish on its books as required by state law for the transferred policies ($3,952,531), and (2) other liabilities assumed by Oxford on the policies ($262,400.23), for a total reinsurance premium of $4,214,931.23. In turn, Oxford agreed to pay Pioneer a reinsurance commission of $2,500,000 to be netted against the reinsurance premium Oxford was to be paid. Because the agreement provided for transfer only of the net sum On its 1973 federal income tax return, Oxford reported as income the $1,714,913.23 tangible property, or net amount, that it had received from Pioneer. Against this income, Oxford deducted both the liabilities it had assumed from Pioneer and the reserves it was required to set aside to cover the transferred Pioneer policies. Oxford also elected to recompute its reserves on a net level premium basis pursuant to 26 U.S.C. Sec. 818(c) (1970), thereby increasing its deduction for the newly-established reserves from $3,952,531 to $5,101,677. Thus, Oxford was able to report a $3.7 million loss on the reinsurance transaction.

of the two obligations, Oxford received from Pioneer the 10,000 policies and tangible assets worth $1,714,931.23.

On audit by the IRS, Oxford was issued deficiency notices for the tax years 1973 and 1974, and Oxford paid the assessments in full. Oxford filed claims for refunds for both 1973 and 1974, but the IRS granted a refund only for the 1974 tax year. On October 26, 1981, Oxford filed an amended complaint in district court seeking refund of its 1973 income taxes. The government counterclaimed for repayment of Oxford's 1974 income tax refund. On cross-motions for partial summary judgment, the district court granted the government's motion as to the 1973 tax year, finding that (1) Oxford must also include the intangible value of the policies in income; (2) the cost of acquiring the policies from Pioneer must be amortized over the life of the policies, and is not currently deductible; and (3) if the reserves were revalued under section 818(c), Oxford's income and assets should be correspondingly adjusted. After the government moved for summary judgment on the remaining issues, the court dismissed Oxford's refund suit for 1973 and granted the judgment for the government on its counterclaim for 1974.

DISCUSSION

The three issues involved in this case arise under the Life Insurance Company Income Tax Act of 1959, Pub.L. No. 86-69, 73 Stat. 112, as set forth in sections 801 through 820 of Title 26. The crucial issue is whether a reinsurer such as Oxford must include in income under 26 U.S.C. Sec. 809(c) (1970) an amount equal to the reserve liability assumed on the transferred policies. If we find Oxford is required to include this amount in income, we must then determine whether the excess of the reserve liability over the tangible consideration received by Oxford is currently deductible or represents the cost of acquiring an asset and is therefore amortized over the useful life of that asset. Finally, we must decide what effect a revaluation of reserves under 26 U.S.C. Sec. 818(c) (1970) has on the amount included in income. As these issues present legal questions, this court's review is de novo. First Charter Financial Corp. v. United States, 669 F.2d 1342, 1345 (9th Cir.1982).

A. OXFORD'S INCOME

When determining gain or loss from operations, a life insurance company is required under section 809(c)(1) to include in income consideration received "in respect of assuming liabilities under contracts not issued by the taxpayer." On its 1973 tax return, Oxford included in income under section 809(c)(1) only the $1.7 million in net tangible assets it received from Pioneer. Oxford also deducted under section 809(d)(2) the reserves it was required to establish on the policies and the other liabilities assumed, resulting in at least a $2.5 million loss. ¹

The government does not contest the deductions but contends that Oxford must include in its income an additional amount of consideration received from Pioneer for assuming the liabilities on the policies. This additional consideration is the intangible value of the policies as represented by the excess of the reserves over the tangible assets actually received by Oxford. Oxford alleges that its income should be limited to the net tangible assets it received which gave Oxford an immediate and absolute We find that the reinsurer's income in an assumption reinsurance transaction under section 809(c) includes the intangible value of the block of insurance policies acquired. Beneficial Life Insurance Co. v. Commissioner, 79 T.C. 627, 637-40, 651 (1982); Kentucky Central Life Insurance Co. v. Commissioner, 57 T.C. 482, 497-500 (1972); Treas.Reg. Sec. 1.817-4(d)(2)(iii). As the district court noted, in substance, Pioneer paid Oxford an amount of tangible consideration equal to the reserves required on the reinsured policies, and, in return, Oxford paid Pioneer a purchase price for the transferred policies equal to the difference between the reserves and the value of the tangible assets actually received. 574 F.Supp. at 1426. See Beneficial Life, 79 T.C. at 639. To hold differently would enable Oxford, in accepting the long-term nature of the transaction as to reporting gains but not as to reporting expenses, to claim an artificial tax loss, when in fact Oxford has acquired a block of valuable policies with the right to their future income. ²

right to income. Oxford contends that its income should not include the value of the block of policies because there is no assurance that Oxford will receive future premium payments from the policy holders.

Oxford gained more than new liabilities in the transaction; in addition to the tangible assets from Pioneer, it acquired valuable life insurance policies. Under general principles of tax law, the value of properties exchanged in an arm's length transaction is presumed to be equal. United States v. Davis, 370 U.S. 65, 72, 82 S.Ct. 1190, 1194, 8 L.Ed.2d 335 (1962); Kentucky Central, 57 T.C. at 496. Where a taxpayer acquires all the assets of another in a transaction, the amount of liability assumed is treated as part of the cost of acquiring the tangible and intangible assets received. Commissioner v. Tufts, 461 U.S. 300, 306, 313, 103 S.Ct. 1826, 1830, 1834, 75 L.Ed.2d 863 (1983); Crane v. Commissioner, 331 U.S. 1, 14, 67 S.Ct. 1047, 1054-55, 91 L.Ed. 1301 (1947).

Moreover, Oxford's contention that it should be allowed to recognize a start-up loss on the assumed policies in the same manner as direct insurers is inapt. Oxford's position is not analogous to a direct insurer which sells individual policies through agents and is responsible for high first-year costs, including commissions, medical reports, and operating expenses. While Congress may have recognized that small direct insurers initially face high losses when placing new policies on the company books, the reinsurer of insurance is in a different position. Kentucky Central, 57 T.C. at 499. In one transaction, Oxford acquired 10,000 new life insurance...