UNUM Corp. v. U.S., 96-1877

• Decision Date: 09 September 1997
• Docket Number: No. 96-1877,96-1877
• Citation: 130 F.3d 501
• Parties: -8124 UNUM CORPORATION and UNUM Life Insurance Company of America, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 501

130 F.3d 501

80 A.F.T.R.2d 97-8124

UNUM CORPORATION and UNUM Life Insurance Company of America Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 96-1877.

United States Court of Appeals First Circuit.

Heard Sept. 9, 1997.

Decided Dec. 2, 1997.

William J. Kayatta, Jr., with whom Jared S. des Rosiers, Pierce Atwood, Barbara H. Furey, Barry W. Larman, Portland, ME, and UNUM Corporation and UNUM Life Insurance Company of America were on brief, for appellant.

Edward T. Perelmuter, Tax Division, Department of Justice, with whom Loretta C. Argrett, Assistant Attorney General, and David I. Pincus, Tax Division, Department of Justice, were on brief, for appellee.

Before TORRUELLA, Chief Judge, ALDRICH, Senior Circuit Judge, and LYNCH, Circuit Judge.

LYNCH, Circuit Judge.

The need to raise capital and to compete in increasingly diversified financial markets has led a number of American mutual life insurance companies to convert to being stock companies. This process, known as "demutualization," often involves a conversion of the mutual policyholders' ownership interest in the old company into ownership interest in the form of stock in the new company.

This appeal raises important questions about the proper tax treatment of one form of demutualization: whether stock and cash distributed to policyholders in exchange for their mutual ownership interests as part of a statutory demutualization constitute "policyholder dividends" under § 808 of the Internal Revenue Code. If so, the insurer may take a deduction for "policyholder dividends" under § 805(a)(3). Whether the "policyholder dividends" deduction is available has great financial consequences for the company and for the public fisc. This question involves consideration of the scope of the "policyholder dividend" under § 808, as well as the broader relationship between the general corporate tax provisions of the Code (contained in Subchapter C) and the Code's insurance tax provisions (contained in Subchapter L).

In this case, UNUM Corp. ("UNUM"), the demutualized successor to Union Mutual Life Insurance Co. ("Union Mutual"), seeks a tax refund based on a "policyholder dividends" deduction of over $652 million. This sum, which UNUM was required to distribute to its policyholders by state law, represents the value of Union Mutual's accumulated surplus. See Me.Rev.Stat. Ann. tit. 24-A, § 3477 (West 1996).

UNUM's principal argument is that the cash and stock distributed during the demutualization constitute "policyholder dividends" under the plain language of § 808(b) and thus are deductible under § 805. UNUM further argues that, beyond the statute's plain language, the legislative history and public policy behind the Code's treatment of life insurance companies support this result.

The IRS argues that general corporate tax provisions apply to insurance companies in the absence of specific provisions to the contrary in the Code's insurance tax section, and that, under those corporate tax provisions, UNUM is not entitled to any deduction for its reorganization. The IRS argues that nothing in § 808 or its legislative history indicates that Congress envisioned § 808 as encompassing capital transactions such as UNUM's demutualization. Rather, placed in proper context, § 808 is not relevant to the value-for-value exchanges for which UNUM seeks a deduction.

The district court entered judgment for the government in UNUM's suit for a refund. We affirm the judgment of the district court.

I

This appeal involves only questions of law; we exercise de novo review. Alexander v. Internal Revenue Service, 72 F.3d 938, 941 (1st Cir.1995). The parties have agreed on the facts.

A. Background

Demutualization has become increasingly common in the insurance industry. More than 200 mutual life insurance companies have demutualized since 1930. See S. Preston Ricardo, The Deductibility of Policyholder Dividends: UNUM Corp. v. United States, 50 Tax Law. 265, 265 (1996). Between 1954 and 1981, the number of mutual insurers declined from 171 to 135; during the same time, the number of stock insurers increased from 661 to 1,823. Edward X. Clinton, The Rights of Policyholders in an Insurance Demutualization, 41 Drake L.Rev. 657, 659 n. 13 (1992). Today, fewer than 80 mutual insurers have assets of over $100 million. See William B. Dunham, Jr., et al., Introduction, in Demutualization of Life Insurers, 648 PLI/Comm 9, 16 (1993). These figures suggest that mutual insurers are rapidly demutualizing, and that new insurance companies prefer the stock form at the outset.

State legislatures have facilitated this demutualization process by passing statutes permitting such conversions. Presently, at least forty-one states have specific statutes that provide for demutualization of mutual life insurers. Alexander M. Dye, Distributing Consideration to Policyholders, in Demutualization of Life Insurers, 648 PLI/Comm 75, 78 (1993). Only Hawaii and Idaho expressly prohibit direct mutual to stock conversion, although they still permit demutualization through the alternate method of bulk reinsurance conversion. See Clinton, supra, at 673 n. 116. Every state, including those that lack specific demutualization statutes, permits at least some form of demutualization. See id.

There are three usual types of mutual to stock conversions: a statutory conversion whereby the insurer directly converts its form of business, merger with a stock insurer, and bulk reinsurance of the mutual company's policies. See id. at 660-61. This case only concerns the first type of conversion: a statutory conversion, in which a mutual company alters its organizational form to become a stock insurer by redistributing all the mutual policyholder's ownership interest in the mutual insurer into shares of stock in a new stock corporation. "This type of reorganization may properly be regarded as a reorganization of the company because the policyholders are exchanging membership in the mutual for shares in the new corporation." Id. at 660.

By demutualizing, mutual insurers can obtain certain advantages available to stock insurers. Stock corporations are better able to raise capital because they may sell stock on the equity markets. See id. at 666-671. Stock companies can more easily diversify their operations by creating upstream holding companies which can own subsidiaries engaged in other businesses. See id. at 671-72. They can also create incentives for superior management performance through stock option plans. See id. at 672-74. Mutual insurers can only raise capital by retaining earnings or charging excess premiums, and are generally subject to comprehensive regulation by state authorities. These limitations can hinder their ability to grow and diversify. See id. at 666.

Much is at stake in this process. Mutual insurance companies have historically lagged behind stock insurers in growth of assets and capital. Demutualization and subsequent stock sales may improve a mutual insurer's capital position and competitive standing with other insurers and financial institutions. Mutual insurers naturally want to contend in the increasingly competitive and deregulated financial services markets. Many mutual insurers regard demutualization as an important step toward bolstering their financial strength and flexibility.

B. Facts

Union Mutual, based in Maine, was organized as a mutual insurance company in 1848. Union Mutual's business was selling various types of insurance and annuity products. As a mutual company, Union Mutual had no stock and was owned by its participating policyholders. ¹ Policyholders contributed to Union Mutual's surplus by paying premiums that exceeded the actuarial cost of their policy coverage.

In 1984, Union Mutual's management decided to reorganize the company as a stock insurer. The management decided that the company would gain four principal business advantages from this conversion: an increased ability to raise capital, greater flexibility to diversify into new markets, an increased accountability for company performance by management, and an enhanced ability to attract and retain key personnel.

Under Maine law, Union Mutual was not permitted to implement its conversion plan until the plan was approved by the Maine Superintendent of Insurance. See Me.Rev.Stat. Ann. tit. 24-A, § 3477 (West 1996). Maine law imposes several conditions that a demutualization plan must satisfy in order to receive approval by the Superintendent. These include, inter alia, (1) that the company pay policyholders a "fair and equitable" amount for their ownership interests in the company, (2) that the "equity share" of each policyholder be determined under a fair and reasonable formula based upon the insurer's entire surplus as stated in a financial statement filed with the Superintendent, (3) that the conversion plan give each member of the demutualizing insurer a preemptive right to acquire his or her proportionate part of the proposed capital stock of the new stock company, (4) that the plan provide for payment to each member of his or her entire equity share in the insurer, with the payment to be made in cash or stock of the stock company, and (5) that policyholders entitled to receive stock or cash include all policyholders within three years prior to the date the plan was submitted for approval to the Superintendent. See id.

On December 14, 1984, Union Mutual submitted a plan of recapitalization and conversion to the Superintendent. Union Mutual amended the plan several times in response to rulings by the Superintendent. On July 11, 1986, Union Mutual submitted its fourth and final amended plan, which was approved by the Superintendent on August 8, 1986.

The approved plan of conversion may be generally described as follows. A holding company was formed to own all the stock of the new stock company. Those who were "eligible policyholders" ² transferred their "membership interests" in Union...