Sears, Roebuck & Co. v. Comm'r of Internal Revenue
| Decision Date | 24 January 1991 |
| Docket Number | Docket No. 2165-89. |
| Parties | SEARS, ROEBUCK AND CO. AND AFFILIATED CORPORATIONS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
P is the parent of three wholly owned insurance company subsidiaries, S1, S2, and S3. S1 was a casualty and liability insurer and issued policies to P. P's premium payments to S1 represented .25 of 1 percent of the total premiums earned by S1. S1 conducted business with P in the same manner as it did with unrelated insureds; insurance contracts were written, premiums transferred, and losses paid. On consolidated returns, S1 deducted reserves based on premiums received from P.
S2 and S3 insured lenders against losses on mortgage loans. S2 and S3 did not pay a loss until the insured lender acquired title to the mortgaged property and filed a claim for loss. S2 and S3 estimated unpaid loss reserves based on loans in default, loans in the process of foreclosure, and loans that resulted in the conveyance of property to an insured lender. S2 and S3 reported those amounts as losses incurred under sec, 832(b)(5), I.R.C. as amended.
HELD: The arrangement between P and S1 is insurance and will not be recharacterized and treated as self-insurance. HELD FURTHER: S2 and S3 did not incur a loss under sec. 832(b)(5) until the insured lender acquired title to the mortgaged property. Frederic W. Hickman, Patrick A. Heffernan, Michael M. Conway, Michael A. Clark, Richard Bromley, Paul S. Caselton, Bradford L. Ferguson, Burton H. Litwin, and Michael R. Schlessinger, for the petitioner.
Beth L. Williams, Teri A. Frank, Charles W. Maurer, Jr., and Christopher J. Faiferlick, for the respondent.
Respondent determined deficiencies in petitioner's Federal income taxes as follows:
+--------------------------------------+
¦FYE ¦Deficiency ¦
+-------------------------+------------¦
¦Jan. 31, 1981 ¦$35,539,844 ¦
+-------------------------+------------¦
¦Dec. 31, 1981 (11 months)¦7,706,252 ¦
+-------------------------+------------¦
¦Dec. 31, 1982 ¦9,137,694 ¦
+--------------------------------------+
After concessions, the issues for decision are (1) whether certain payments by Sears, Roebuck and Co. to its wholly owned subsidiary, Allstate Insurance Company, are insurance premiums for tax purposes and (2) whether subsidiaries of Allstate Insurance Company engaged in the mortgage guaranty insurance business may base estimated unpaid losses, deductible under section 832(c)(4), on defaults in payment by borrowers prior to foreclosure on the mortgaged properties. Alternative issues raised by the parties are not reached because of our disposition of these two issues. All section references are to the Internal Revenue Code, as amended and in effect for the years in issue. All Rule references are to this Court's Rules of Practice and Procedure.
The two issues set forth above were sequentially tried and separately briefed by the parties. Certain principles, particularly those argued by petitioner, relate to the overall scheme of insurance company taxation. The first issue, referred to in this opinion as the “insurance premiums issue,” has been the subject of numerous prior opinions of this Court and of other courts; in other cases, however, the issue has been described as a “captive” insurance issue. The second issue, referred to as the “mortgage guaranty insurance” issue, has not previously been decided.
Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. It is simply not possible to reproduce all of the findings requested by the parties. Similarly, we cannot address in our opinion every argument set out in approximately 1400 (typewritten) pages of briefs of the parties. Despite the importance of these issues, we believe that they may be distilled to the essence of the differences between the parties and resolved concisely, if not comprehensively.
Sears, Roebuck and Co. (Sears or petitioner) is the parent of an affiliated group of corporations filing consolidated returns for the years in issue. Sears is a publicly held corporation, and its stock is traded on the New York, Midwest, and Pacific stock exchanges. During the years in issue, Sears was the world's largest retailer, operating more than 400 warehouses and catalogue distribution centers and 830 retail stores. Sears was exposed to a wide variety of risks, including risk of damage or destruction of its stores, warehouses, vehicles, or other properties; work-related injuries to its employees; and injuries to customers or third parties on Sears premises or by a Sears product or vehicle.
Allstate Insurance Company (Allstate), a wholly owned subsidiary of Sears, was incorporated in 1931 under the Illinois Insurance Code as an Illinois insurance corporation. Allstate Enterprises (Enterprises) was also a wholly owned subsidiary of Sears and engaged in the business of providing financial services. By 1945, Allstate was licensed in 40 states, insured more than 1 percent of the passenger automobiles in the United States, and was the 20th largest automobile insurer (measured by premium volume) in the United States.
Sears first purchased insurance from Allstate in 1945. During the years in issue, Allstate insured approximately 10 to 15 percent of Sears' total insurable risks. Allstate earned premiums in excess of $5 billion during 1980, 1981, and 1982 on all of its lines of insurance. The total premiums for policies issued to Sears by Allstate represented approximately .25 of 1 percent of the total premiums earned by Allstate from all insureds on all lines of businesses for the years in issue. In other words, the total premiums for Allstate's policies with unrelated policyholders represented approximately 99.75 percent of Allstate's total premiums earned during the years in issue.
Historically and through the years in issue, Allstate was formed and operated as an insurance company, regulated by State insurance laws and taxable as an insurance company under the Internal Revenue Code. Policies issued to Sears by Allstate, described in detail below, are comparable in all material respects to policies issued to unrelated insureds. All of the policies issued to Sears by Allstate in issue in this case were properly executed agreements authorized by appropriate officers of each company. Changes in policy terms during the period of the policies were reflected in properly executed endorsements. With respect to the execution, modification, performance, and renewal of all of the policies in issue, Allstate and Sears observed formalities similar to those followed with respect to Allstate insurance policies with third-party customers unrelated by ownership to Allstate or to Sears and its subsidiaries. Allstate was not formed or operated for the purpose of providing self- insurance to Sears.
The property and liability insurance operations of Allstate during the years in issue ranked Allstate second among United States property and liability insurers, measured by the volume of premiums, with capital and surplus in excess of $2,371,000,000, assets in excess of $8,054,000,000, more than 39,000 employees, and more than 18,965,000 policyholders. During the years in issue, Allstate serviced its personal lines from its corporate headquarters, as well as from field offices at 2,500 locations, of which 1,270 were located in Sears stores. Allstate's national accounts, involving large commercial accounts, were serviced by the same network of field and regional offices but underwritten solely from its corporate headquarters.
During the years in issue, Allstate had approximately 40,000 employees who may be categorized as follows:
+----------------------------------------------------------+
¦Category ¦1/30/80 ¦12/31/82 ¦
+-------------------------------------+---------+----------¦
¦Full-time agents ¦10,200 ¦11,700 ¦
+-------------------------------------+---------+----------¦
¦Claims service, underwriting & policy¦ ¦ ¦
+-------------------------------------+---------+----------¦
¦service, investment, management, ¦ ¦ ¦
+-------------------------------------+---------+----------¦
¦administrative, and miscellaneous ¦29,000 ¦29,200 ¦
+-------------------------------------+---------+----------¦
¦Total ¦39,200 ¦40,900 ¦
+----------------------------------------------------------+
The A.M. Best Company (Best) rates the financial condition of property and casualty insurance companies each year. The premiums and loss statistics reviewed by Best, as reflected in the Best insurance reports, included those premiums and losses attributable to the transactions in issue between Sears and Allstate and between Enterprises and Allstate. Best gave Allstate its highest rating, an A+, for the years in issue.
Insurance exists as a mechanism for individuals and business firms to deal with the economic consequences of pure risks. Risk is present when the outcome of an event is uncertain or unknown. A pure risk is one in which the event can produce either a loss or a neutral outcome; there is no possibility of profit. Examples of pure risks are exposures to fires, windstorms, motor vehicle accidents, and liability lawsuits. In contrast to pure risks, speculative risks can produce either a profit or a loss. Insurance requires a reduction, not a complete elimination, of the insured's risk. Insureds always have the residual risk of insurance company insolvency.
An insurance premium generally consists of three basic components. One portion of the premium is intended to cover expected losses. The expected loss is the average amount the insurer would expect to pay in...
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