434 F.2d 115 | 5th Cir. | 1971
Lead Opinion
This case presents an important and difficult question concerning the Federal taxation of guaranteed renewable health and accident insurance companies under Subchapter L, Part I, § 801 et seq. of the Internal Revenue Code of 1954.
Plaintiff Group Life and Health Insurance Company (“Group Life”) underwrites and issues group insurance in Texas under the plan known as Blue Shield. Group Life’s parent corporation, Group Hospital Service, Inc., issues insurance in Texas under the plan known as Blue Cross. Group Life brought this income tax refund action in the District Court for the Northern District of Texas on the basis that it is entitled to be taxed as a “life insurance company” as defined by § 801(a)
The question raised is whether the District Court erred in finding that Group Life’s “Non-Cancellable, Experience Rated Medical-Surgical Insurance Policy” qualified as “guaranteed renewable life, health, and accident insurance” within § 801 (e)
To understand the argument that the issuer of Blue Shield group policies may be entitled to be taxed as a life insurance company requires an examination of the history of income taxation of insurance companies.
Since the enactment of the Revenue Act of 1921,
Defining insurance companies in terms of their reserves for tax purposes next led Congress to recognize that “noncancellable" health and accident policies ought to be treated similarly to life policies. This is so because an insurance company in issuing noncancellable health and accident policies makes provision in the early years for the increased actuarial risks in later years, and has a reserve to reflect this fact. The Revenue Act of 1942,
“Since noncancellable contracts of health and accident insurance require the accumulation of substantial reserves against increased future risks, the writing of such insurance is analogous to life insurance * * * The life insurance reserves defined in * * * [§ 201] (c) (2) [superceded by § 801(b) of the present code] as they pertain to noncancellable health and accident insurance policies are those amounts which must be reserved, in addition to unearned premiums, to provide for the additional cost of carrying such policies in later years when the insured will be older and subject to greater risk and when the cost of carrying the risk will be greater than the premiums then being received.” S.Rep. No. 1631, 77th Cong., 2d Sess. (1942-2 Cum.Bull. 504, 611-612).
To accommodate the mechanics of health and accident insurance, the casualty insurance terms of “unearned premiums” and “unpaid losses” were added to the definition of a life insurance company in essentially the same language as that of the present § 801(a) of the Code. Unearned premiums are “those amounts which shall cover the cost of carrying the insurance risk for the period for which the premiums have been paid in advance.” § 1.801-3 (e) of the Regulations. The reserve for unpaid losses “represents the present value of all benefits not yet accrued at the date of valuation, arising from disabilities already incurred * * *”
As a result of a comprehensive review of the taxation of life insurance compa
This Act added § 801(e) to the Code: “For purposes of this part, guaranteed renewable life, health, and accident insurance shall be treated in the same manner as noncancellable life, health, and accident insurance.”
The Senate Finance Committee explained that this provision was to cover “life, health, and accident policies which are not cancellable by the company but under which the insurance company reserves the right to adjust premium rates by classes, in accordance with experience under the type of policy involved.” S. Rep. No. 291, 86th Cong., 1st Sess. (1959-2 Cum.Bull. 770, 793). U.S.Code Cong. & Admin.News, p. 1606.
Group Life’s Blue Shield plan provides medical and surgical benefits for employee groups. The contracts of insurance are between Group Life and various employers, with each employee member receiving a certificate indicating coverage. The policy may not be can-celled by Group Life, but the premium rate may be adjusted periodically, based on experience by class. This rate adjustment feature is a characteristic of a “guaranteed renewable” policy rather than a “noncancellable” policy (despite Group Life’s name for the policy). The initial premium charged by Group Life was found by the District Court to remain level for two years, and the adjusted premium thereafter is to be guaranteed for at least two years.
The Texas State Board of Insurance required that Group Life maintain reserves for unearned premiums and for unpaid losses for its guaranteed renewable contracts. No other reserves were required by the Board where a company had the right to adjust premium rates based on experience and by class. The Board considered Group Life’s policy to be a “guaranteed renewable health and accident policy” for purposes of Texas law. While Congress has occasionally enacted Federal tax provisions which depend on underlying state definitions and thus result in varying treatment between taxpayers of the several states,
As set forth above, the history of special taxation of life, health, and accident insurance companies arose from their need to set aside as reserves a portion of premium and investment income in the early years of a policy to cover the cost of the risk in later years when the actuarial cost will be greater. See United Benefit Life Insurance Co. v. MeCrory, 414 F.2d 928, 929-930 (8th Cir. 1969). This need to fund long-term actuarial risks was explicitly recognized as justifying the inclusion of noncancellable contracts. In providing that guaranteed renewable contracts should be treated in the same manner as noncancellable contracts, the Senate Finance Committee stated:
“Reserves with respect to such insurance will, therefore, be treated in the same manner as life insurance reserves for purposes of computing taxable investment income and gains from operations.” S.Rep. No. 291,*119 86th Cong., 1st Sess. (1959-2 Cum. Bull. 770, 793).
In light of the prior history of this area of taxation and the fact that life insurance reserves are not treated in the same manner as unearned premium and unpaid loss reserves for income tax computational purposes,
The question remains, however, whether Group Life’s policy in fact developed the additional reserves required by § 1.-801-3(d) of the Regulations. Although the parties stipulated in the District Court this question to be the sole disputed issue of fact, that Court made no finding of fact within Fed.R.Civ.P. 52(a) regarding it.
Group Life has not established the existence of the requisite reserve — a burden this taxpayer must carry to recover taxes alleged to have been erroneously collected. E. g. United States v. Anderson, 269 U.S. 422, 46 S.Ct. 131, 70 L.Ed. 347 (1926). No such reserve was reported in Group Life's annual financial statements, and Group Life’s witnesses neither established the existence of nor the need for such reserve with respect to the policy here in question. Indeed, the Government's actuary testified this type of policy would not require an additional reserve, and one of Group Life’s witnesses testified that only unearned premium and unpaid loss reserves were in fact maintained. Group Life’s statistician did not testify to the contrary, as suggested by Group Life in its brief, but rather discussed only the computation of the initial premium, not the use to which the funds were put.
We do not agree with the argument that the Commissioner of Internal Revenue may not require a group life, health, and accident insurance company to maintain the extra reserve specified by § 1.801-3(d) of the Regulations in order to qualify as a “life insurance company for Federal tax purposes” because such company is not required by the State of Texas to maintain such a reserve. Section 801(b) (2) of the Code does not limit the definitional power of
We express no opinion concerning the wisdom of denying to Group Life the benefits of life insurance company classification for income tax purposes.
Accordingly, the judgment of the District Court is reversed.
. § 801(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 noncancellable contracts of health and accident insurance, * * * ”
. §. 801(e) provides that guaranteed renewable life, health, and accident insurance shall be treated the same as noncancellable, life, health, and accident insurance.
. For a comprehensive review of the history of the income taxation of life insurance companies, see Alinco Life Insurance Co. v. United States, 373 F.2d 336, 345-349, 178 Ct.Cl. 813 (1967); Vickrey, Insurance Under the Federal Income Tax, 52 Yale L.J. 554 (1943); Mertens, Law of Federal Income Taxation, § 4401 (Zimit ed. 1964).
. Law of November 23, 1921, ch. 136, 42 Stat. 227.
. Law of October 21, 1942, eh. 619, 56 Stat. 798.
. For a more precise definition, see § 1.801-3 (g> of the Regulations.
. 26 U.S.C.A. §§ 801-820.
. The specimen policy supplied by Group Life as Stipulation Exhibit B, however, provides in Article IV. B. that “the Insurer reserves the right to change the schedule of premium rates on any policy anniversary, as applicable to the succeeding year.” “Policy anniversary” is defined in turn by Article I. J. to mean “the month and day of any subsequent year corresponding to the policy date.” The discrepancy between these provisions and the finding by the District Court remains unexplained.
. An example is the definition of legal relationships between husband and wife, especially with respect to community property versus common law treatment. See e. g., Westfall, Revitalizing the Federal Estate and Gift Taxes, 83 Harv.L. Rev. 986, 998-1000 (1970).
. See e. g., § 805(c). of the Code; Rev. Rui. 70-460, 1970 Int.Rev.Bull.No.36 at 8. See generally United States v. Atlas life Insurance Co., 381 U.S. 233, 85 S.Ct. 1379, 14 L.Ed.2d 358 (1965); Western National Life Insurance Co. of Texas v. Commissioner of Internal Revenue, 5 Cir., 1970, 432 F.2d 298 [No. 28569, Sept. 30, 1970)].
. The REX formula is the revised rating formula used by Group Life to adjust the premiums on the basis of experience. The following description of its mechanics is taken from the Stipulation of the parties filed in the District Court:
“The Rex formula is a formula whereby the experience of each group (referred to as ‘group experience’) is combined with the experience of all, groups subject to this formula (referred to as ‘community experience’). The community experience is the combined experience of all groups rated under the Rex Formula for the past twelve months, and for the years involved herein was 83%. The relative weight of each group’s experience to the community experience is based on the individual group’s combined income for the preceding three years (referred to as ‘credibility factor’). The Rex Formula is applied as follows:
A. Each group’s cumulative three year premium income is determined and that amount is then used to determine the relative weight to be given to the group’s experience by application of the following credibility table:
CREDIBILITY TABLE
CUMULATIVE INCOME FOR EXPERIENCE LAST THREE YEARS GROUP RECOGNITION COMMUNITY
0 — 3,999 20% 80%
4.000— 5,999 30% 70%
6.000— 8,999 40% 60%
9.000— 12,999 50% 50%
13.000— 17,999 60% 40%
18.000— 23,999 70% 30%
24.000— 30,000 80% 20%
31.000— up 90% 10%
For example, a group with a total three year premium of $7,000.00 would use 40% of its group experience and 60% of the community experience in determining the increase or decrease in the premium rate.
B. The next step is to determine the experience factor for each group. This is computed by dividing the total claims paid by the total premium income for the past three years.
For example, a group having premium income of $7,000.00 and claims of $6,500.00 a year over a three years period has a group experience of 93%, ($6,-500.00 4- $7,000.00).
C. The next step is to combine the group’s own experience factor with the community experience factor in accordance with the credibility table as follows:
(1) i Multiply the group’s credibility factor times the group’s experience factor. For example, a group having 40% credibility factor and a 93% experience factor has a resulting factor of 37.2%, (40% X 93%).
(2) Multiply the community’s credibility factor times the community’s experience*120 factor. A community credibility factor of 60 times the community experience of 83% gives a resulting factor of 49.8% (60% X 83%).
(3) The group factor, 37.2%, is added to the community factor, 49.8%, and the result, 87.0%, is the adjusted three year ratio.
D. Reference is then made to the Rate Adjustment Table to determine whether the premium rate for the next policy year will remain the same, will be increased, or will be decreased. The rate adjustment table is as follows:
RATE ADJUSTMENT TABLE
ADJUSTED RATIO RATE ADJUSTMENT
Up to 59.9% - 15%
60% to 69.9% — 10%
70% to 82.9% 0%
83% to 90.9% + 8%
91% to 94.9% + 12%
95% to 98.9% + 16%
99% and up + 20%
For example, a group with a total adjusted three year ratio of 87% will have an increase in premiums of 8% over the previous year.
. Group Life, unlike the United States, did not request the District Court to re
. This Court stated in Western National Life Insurance Co. of Texas v. Commissioner of Internal Revenue, 432 F.2d 298, 302 (1970), that “very few phases of corporate or personal income taxation [have] been attended with as much difficulty as the devising of a fair basis for taxing insurance companies.”
Rehearing
ON PETITION FOR REHEARING AND PETITION FOR REHEARING EN BANC
The Petition for Rehearing is denied and no member of this panel nor Judge in regular active service on the Court having requested that the Court be polled on rehearing en banc, (Rule 35 Federal Rules of Appellate Procedure; Local Fifth Circuit Rule 12) the Petition for Rehearing En Banc is denied.