Penn Sec. Life Ins. Co. v. United States

• Citation: 524 F.2d 1155
• Decision Date: 22 October 1975
• Docket Number: No. 109-68.,109-68.
• Parties: PENN SECURITY LIFE INSURANCE COMPANY v. The UNITED STATES.
• Court: Court of Federal Claims

524 F.2d 1155

PENN SECURITY LIFE INSURANCE COMPANY v. The UNITED STATES.

No. 109-68.

United States Court of Claims.

October 22, 1975.

John B. Jones, Jr., Washington, D. C., for plaintiff; Owen T. Armstrong, St. Louis, Mo., attorney of record. Lowenhaupt, Chasnoff, Freeman, Holland & Mellitz, St. Louis, Mo., Robert A. Kagan, New York City, John T. Sapienza, Andrew W. Singer and Covington & Burling, Washington, D. C., of counsel.

Herbert Grossman, Washington, D. C., with whom was Asst. Atty. Gen. Scott P. Crampton, for defendant. Gilbert E. Andrews and Roger A. Schwartz, New York City, of counsel.

Before COWEN, Chief Judge, and DAVIS, NICHOLS, SKELTON, KASHIWA, KUNZIG and BENNETT, Judges.

PER CURIAM:^*

Section 801(a) of the Internal Revenue Code, as amended, defines a life insurance company in the following language:

(a) Life Insurance Company Defined.—For purposes of this subtitle, the term "life insurance company" means an insurance company which is engaged in the business of issuing life insurance and annuity contracts (either separately or combined with health and accident insurance), or non-cancellable contracts of health and accident insurance, if—

(1) its life insurance reserves (as defined in subsection (b)), plus

(2) unearned premiums, and unpaid losses (whether or not ascertained), on noncancellable life, health, or accident policies not included in life insurance reserves, comprise more than 50 percent of its total reserves (as defined in subsection (c)).¹

In Alinco Life Insurance Company v. United States, 373 F.2d 336, 178 Ct.Cl. 813 (1967), the court addressed its attention to the question of whether an insurance company specializing in the reinsuring of credit life insurance could qualify as a life insurance company under Section 801, and held that it could, provided it met the 50 percent test. As might have been easily predicted, the question of life insurance company qualification is now back before the court with emphasis, however, on those provisions of Section 801 dealing, not with life insurance, but with health and accident insurance. In applying Section 801 to this case, we appreciate that the statute was not "written for ordinary folk * * *" It is addressed to technical specialists (i. e., actuaries) and hence, its provisions "must be read by judges with the minds of the specialists." Frankfurter, Some Reflections on the Reading of Statutes, 47 Col.L.Rev. 527, 536 (1947).

On balance, we have concluded that plaintiff-taxpayer has the better of the argument and qualifies as a life insurance company so that it is entitled to recover. To explain why requires, first of all, a description of the taxpayer's method of conducting its insurance business during the years in issue, namely, the calendar years 1963, 1964, and 1965.

In those years, plaintiff's business consisted primarily of reinsuring risks written by three unrelated insurance companies under credit life, accident and health policies on the lives and health of debtors of plaintiff's parent, Aetna Finance Company (Aetna). Aetna was engaged in the business of making consumer loans through subsidiaries operating over 200 finance company offices in approximately 25 states.

In connection with such loan transactions, it was commonplace for Aetna's borrowers to apply for and receive credit life insurance policies (or group insurance certificates), including health and accident benefits, from one of three insurance companies, namely, Old Republic Life Insurance Company (Old Republic), Pilot Life Insurance Company (Pilot), and National Fidelity Life Insurance Company (National Fidelity). Hereafter, these companies are frequently referred to as "the ceding companies," and plaintiff had separate disability reinsurance treaties in force with each of them during the years involved.

Under the life insurance provisions of these policies, the insurer was required to pay the creditor any outstanding balance of the debt in the event of the insured debtor's death. The health and accident provisions called for the insurer to pay debt installments falling due while the insured was totally disabled and unable to work. The terms of the policies (or group certificates) were coextensive with the contractual term of the related indebtedness, usually two to three years.

Under its reinsurance treaties with the ceding companies, plaintiff agreed to reinsure 100 percent of the liability of each ceding company with respect to disability benefits included in credit life policies issued to Aetna and its borrowers. These treaties provided for payment of reinsurance premiums to plaintiff on a monthly earned premium basis; i. e., a reinsurance premium was payable each month with respect to reinsurance coverage provided during the previous month based on a percentage of premiums "earned" on covered policies during that month.

All of the credit insurance policies issued by the ceding companies called for payment of insurance premiums (both a life insurance premium and, where applicable, a disability premium) at the inception of the policy term. When a disability premium is first received under such a policy, it is wholly "unearned" in the sense that the entire premium is attributable to the unexpired portion of the policy. As the term of the policy expires each month, a proportionate part of the premium becomes "earned"; i. e., attributable to insurance protection provided during that month.

Thus, to use plaintiff's illustration, if a ceding company received a $360 disability premium on January 1, 1963, with respect to a policy providing insurance coverage for 36 months, one-thirty-sixth of this premium (or $10) would be considered "earned" during the month of January and each succeeding month. The "unearned" premium would be $350 at the end of January, $340 at the end of February, and so on. Under its disability reinsurance treaties, plaintiff was entitled to a monthly reinsurance premium equal to a percentage of the $10 "earned" premium for reinsurance coverage actually provided each month. The ceding companies retained all unearned premiums on policies covered under the disability reinsurance treaties and established an unearned premium reserve in the amount of such unearned premiums for the benefit of their policy holders in accordance with the applicable restrictions of state law and in satisfaction of the reserve requirements of the various states in which they did business.

Since plaintiff received no unearned premiums from the ceding companies, it was not required to establish an unearned premium reserve by the State of Missouri. No actuary or state regulatory authority required plaintiff to establish an unearned premium reserve under its disability reinsurance treaties with the ceding companies, since plaintiff never received premiums thereunder for insurance to be provided in the future or premiums which it might otherwise be required to refund.

Approximately two-thirds of the unearned premium reserves held by the ceding companies represented unearned "loading" charges made to cover profits and sales and office expenses. The remaining one-third of such unearned premium reserves represented unearned net premiums charged to policyholders to cover the expected cost of providing disability insurance benefits; this portion alone (known in the industry as the morbidity element) reflected the amount that the companies were actuarially required to hold in order to pay disability claims as they matured. Unearned loading charges are held as part of unearned premium reserves because the casualty insurance industry has traditionally determined its reserve requirements with regard to the full amount of premiums that would have to be refunded if all policies in force were simultaneously canceled instead of reserving only for the cost of carrying the insurance risk (the unearned net premiums) as in life insurance.

As insureds grow older, the mortality or morbidity costs increase and when an accident and health policy is written for a long term of years, the guaranteed level premium charged will not be sufficient to provide benefits after the insured reaches a specified age. In those instances, a reserve, in addition to the pro rata gross unearned premium reserve, is set up out of current premiums to provide for the excess of future benefits over future premiums. No such reserves were created by the three insurers with regard to the credit accident and health policies reinsured with taxpayer, presumably because such policies were relatively short-term.

In addition to its reinsurance treaties with the ceding companies during the years in issue, plaintiff also issued its own group annuity policy on December 22, 1965 (Group Annuity Contract No. 101) to the St. Louis Union Trust Company as trustee of Pension Fund No. 6 of the International Telephone Retirement Plan for Salaried Employees, which contract has remained outstanding and in effect to the present time. Plaintiff received securities valued at $5,929,057.24 for the purchase of single premium annuities under Group Annuity Contract No. 101 on or about December 22, 1965. Prior to this transaction, no group annuity or individual annuity contracts had been purchased by any trustee of any pension fund under the International Telephone Retirement Plan for Salaried Employees on the lives of the individuals covered under Group Annuity Contract No. 101.

Plaintiff maintained a reserve of $6,072,004 on December 31, 1965, with respect to its liabilities under Group Annuity Contract No. 101 on that date. Such reserve was computed on the basis of a recognized mortality table (1959 G.A.) and an assumed rate of interest (3½%), and was set aside to mature or liquidate future unaccrued claims arising under Group Annuity Contract No. 101.

On April 4, 1968, plaintiff filed a petition with this court seeking a refund of income taxes for the years in issue on the grounds, inter alia, that it was entitled to deduct accrued...