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*fn*: April 26, 1977.



Burger, Brennan, Stewart, White, Marshall, Blackmun, Powell, Rehnquist, Stevens

Author: Powell

[ 430 U.S. Page 727]

 MR. JUSTICE POWELL delivered the opinion of the Court.

The question for decision is how unearned premium reserves for accident and health (A&H) insurance policies should be allocated between a primary insurer and a reinsurer for federal tax purposes. We granted certiorari in these three cases to resolve a conflict between the Circuits and the Court of Claims. 425 U.S. 990 (1976).


An insurance company is considered a life insurance company under the Internal Revenue Code if its life insurance reserves constitute more than 50% of its total reserves, IRC of 1954, § 801(a), 26 U.S.C. § 801(a),*fn1 and qualifying companies

[ 430 U.S. Page 728]

     are accorded preferential tax treatment.*fn2 A company close to the 50% line will ordinarily achieve substantial tax savings if it can increase its life insurance reserves or decrease nonlife reserves so as to come within the statutory definition.

The taxpayers here are insurance companies that assumed both life insurance risks and A&H - nonlife - risks. The dispute in these cases is over the computation for tax purposes of nonlife reserves. The taxpayers contend that by virtue of certain reinsurance agreements - or treaties, to use the term commonly accepted in the insurance industry - they have maintained nonlife reserves below the 50% level. The Government argues that the reinsurance agreements do not have that effect, that the taxpayers fail to meet the 50% test, and that accordingly they do not qualify for preferential treatment.*fn3

[ 430 U.S. Page 729]

     Specifically the dispute is over the unearned premium reserve, the basic insurance reserve in the casualty insurance business and an important component of "total reserves," as that term is defined in § 801(c).*fn4 A&H policies of the type involved here generally are written for a two- or three-year term. Since policyholders typically pay the full premium in advance, the premium is wholly "unearned" when the primary insurer initially receives it. See Rev. Rul. 61-167, 1961-2 Cum. Bull. 130, 132. The insurer's corresponding liability can be discharged in one of several ways: granting future protection by promising to pay future claims; reinsuring the risk with a solvent reinsurer; or returning a pro rata portion of the premium in the event of cancellation. Each method of discharging the liability may cost money. The insurer thus establishes on the liability side of its accounts a reserve, as a device to help assure that the company will have the assets necessary to meet its future responsibilities. See O. Dickerson, Health Insurance 604-605 (3d ed. 1968) (hereafter Dickerson). Standard accounting practice in the casualty field, made mandatory by all state regulatory authorities, calls

[ 430 U.S. Page 730]

     for reserves equal to the gross unearned portion of the premium.*fn5 A simplified example may be useful: A policyholder takes out a three-year A&H policy for a premium, paid in advance, of $360. At first the total $360 is unearned, and the insurer's books record an unearned premium reserve in the full amount of $360. At the end of the first month, one thirty-sixth of the term has elapsed, and $10 of the premium has become "earned."*fn6 The unearned premium reserve may be reduced to $350. Another $10 reduction is permitted at the end of the second month, and so on.


The reinsurance treaties at issue here assumed two basic forms.*fn7 Under the first form, Treaty I, the taxpayer served as reinsurer, and the "other party" was the primary insurer or "ceding company," in that it ceded part or all of its risk to the taxpayer. Under the second form, Treaty II, the taxpayer served as the primary insurer and ceded a portion of the business to the "other party," that party being the reinsurer. Both types of treaties provided that the other party

[ 430 U.S. Page 731]

     would hold the premium dollars derived from A&H business until such time as the premiums were earned - that is, attributable to the insurance protection provided during the portion of the policy term that already had elapsed. The other party also set up on its books the corresponding unearned premium reserve, relieving the taxpayer of that requirement. In each case, the taxpayer and the other party reported their affairs annually in this fashion to both the Internal Revenue Service and the appropriate state insurance departments. These annual statements were accepted by the state authorities without criticism. Despite this acceptance, the Government argues here that the unearned premium reserves must be allocated or attributed for tax purposes from the other parties, as identified above, to the taxpayers,*fn8 thereby disqualifying each of the taxpayers from preferential treatment.


No. 75-1221, United States v. Consumer Life Ins. Co. In 1957 Southern Discount Corp. was operating a successful consumer finance business. Its borrowers, as a means of assuring payment of their obligations in the event of death or disability, typically purchased term life insurance and term A&H insurance at the time they obtained their loans. This insurance - commonly known as credit life and credit A&H - is usually coextensive in term and coverage with the term and amount of the loan. The premiums are generally paid in full

[ 430 U.S. Page 732]

     at the commencement of coverage, the loan term ordinarily running for two or three years. Prohibited from operating in Georgia as an insurer itself, Southern served as a sales agent for American Bankers Life Insurance Co., receiving in return a sizable commission for its services.

With a view to participating as an underwriter and not simply as agent in this profitable credit insurance business, Southern formed Consumer Life Insurance Co., the taxpayer here, as a wholly owned subsidiary incorporated in Arizona, the State with the lowest capital requirements for insurance companies. Although Consumer Life's low capital precluded it from serving as a primary insurer under Georgia law, it was nonetheless permitted to reinsure the business of companies admitted in Georgia.

Consumer Life therefore negotiated the first of two reinsurance treaties with American Bankers. Under Treaty I, Consumer Life served as reinsurer and American Bankers as the primary insurer or ceding company. Consumer Life assumed 100% of the risks on credit life and credit A&H business originating with Southern, agreeing to reimburse America Bankers for all losses as they were incurred. In return Consumer Life was paid a premium equivalent to 87 1/2% of the premiums received by American Bankers.*fn9 But the mode of payment differed as between life and A&H policies. With respect to life insurance policies, American Bankers each month remitted to the reinsurer - Consumer Life - the stated percentage of all life insurance premiums collected during the prior month. With respect to A&H coverage, however, American Bankers each month remitted the stated percentage of the A&H premiums earned during the prior month, the remainder to be paid on a pro rata basis over the balance of the coverage period.

Again an example might prove helpful. Assume that a

[ 430 U.S. Page 733]

     policyholder buys from American Bankers on January 1 a three-year credit life policy and a three-year credit A&H policy, paying on that date a $360 premium for each policy. On February 1, under Treaty I, American Bankers would be obligated to pay Consumer Life 87 1/2% of $360 for reinsurance of life risks. This represents the total life reinsurance premium; there would be no further payments for life reinsurance. But for A&H reinsurance, American Bankers would remit on February 1 only the stated percentage of $10, since only $10 would have been earned during the prior month. It would remit the same amount on March 1 for A&H coverage provided during February, and so on for a total of 36 months.

Treaty I permitted either party to terminate the agreement upon 30 days' notice. But termination was to be prospective; reinsurance coverage would continue on the same terms until the policy expiration date for all policies already executed. This is known as a "runoff provision."

Because it held the unearned A&H premium dollars, and also under an express provision in Treaty I, American Bankers set up an unearned premium reserve equivalent to the full value of the premiums. Meantime Consumer Life, holding no unearned premium dollars, established on its books no unearned premium reserve for A&H business.*fn10 Annual statements filed with the state regulatory authorities in Arizona and Georgia reflected this treatment of reserves, and the statements were accepted without challenge or disapproval.

By 1962 Consumer Life had accumulated sufficient surplus to qualify under Georgia law as a primary insurer. Treaty I was terminated, and Southern began placing its credit insurance business directly with Consumer Life. The parties then negotiated Treaty II, under which American Bankers served as reinsurer of the A&H policies issued by Consumer

[ 430 U.S. Page 734]

     Life.*fn11 Ultimately Consumer Life retained the lion's share of the risk, but Treaty II was set up in such a way that American Bankers held the premium dollars until they were earned. This required rather complicated contractual provisions, since Consumer Life as primary insurer did receive the A&H premium dollars initially.

Roughly described, Treaty II provided as follows: Consumer Life paid over the A&H premiums when they were received. American Bankers immediately returned 50% of this sum as a ceding commission meant to cover Consumer Life's initial expenses. Then, at the end of each quarter, American Bankers paid to Consumer Life "experience refunds" based on claims experience. If there were no claims, American Bankers would refund 47% of the total earned premiums. If there were claims (and naturally there always were), Consumer Life received 47% less the sums paid to meet claims. It is apparent that American Bankers would never retain more than 3% of the total earned premiums for the quarter. Only if claims exceeded 47% would this 3% be encroached, but even in that event Treaty II permitted American Bankers to recoup its losses by reducing the experience refund in later quarters. Actual claims experience never approached the 47% level.

Again, since American Bankers held the unearned premiums, it set up the unearned premium reserve on its books. Consumer Life, which initially had set up such a reserve at the time it received the premiums, took credit against them for the reserve held by American Bankers. Annual statements filed by both companies consistently reflected this treatment of reserves under Treaty II, and at no time did state authorities take exception.*fn12

[ 430 U.S. Page 735]

     The taxable years 1958 through 1960, and 1962 through 1964, are at issue here. For each of those years Consumer Life computed its § 801 ratio based on the reserves shown on its books and accepted by the state authorities. According to those figures, Consumer Life qualified for tax purposes as a life insurance company. The Commissioner of Internal Revenue determined, however, that the A&H reserves held by American Bankers should be attributed to Consumer Life, thereby disqualifying the latter from favorable treatment. Consumer Life paid the deficiency assessed by the Commissioner and brought suit for a refund. The Court of Claims, disagreeing with its trial judge, held for the taxpayer.


No. 75-1260, First Railroad & Banking Co. of Georgia v. United States. The relevant taxable entity in this case is First of Georgia Life Insurance Co., a subsidiary of the petitioner First Railroad Banking Co. of Georgia. Georgia Life was party to a Treaty II type agreement,*fn13 reinsuring its A&H policies with an insurance company, another subsidiary of First Railroad.*fn14 On the basis of the reserves carried on its books and approved by state authorities, Georgia Life qualified

[ 430 U.S. Page 736]

     as a life insurance company for the years at issue here, 1961-1964. Consequently First Railroad excluded Georgia Life's income from its consolidated return, pursuant to § 1504 (b)(2) of the Code. The Commissioner determined that Georgia Life did not qualify for life insurance company status or exclusion from the consolidated return, and so assessed a deficiency. First Railroad paid and sued for a refund. It prevailed in the District Court, but the Court of Appeals for the Fifth Circuit reversed, relying heavily on Economy Finance Corp. v. United States, 501 F.2d 466 (CA7 1974), cert. denied, 420 U.S. 947, rehearing denied, 421 U.S. 922 (1975), motion for leave to file second petition for rehearing pending, No. 74-701.


No. 75-1285, United States v. Penn Security Life Ins. Co. Penn Security Life Insurance Co., a Missouri corporation, is, like Consumer Life, a subsidiary of a finance company. Under three separate Treaty I type agreements, it reinsured the life and A&H policies of three unrelated insurers during the years in question, 1963-1965. The other companies reported the unearned premium reserves, and the Missouri authorities approved this treatment. Because one of the three treaties did not contain a runoff provision like that present in Consumer Life, the Government conceded that the reserves held by that particular ceding company should not be attributed to the taxpayer. But the other two treaties were similar in all relevant respects to Treaty I in Consumer Life. After paying the deficiencies assessed by the Commissioner, Penn Security sued for a refund in the Court of Claims. Both the trial judge and the full Court of Claims ruled for the taxpayer.


The Government commences its argument by suggesting that these reinsurance agreements were sham transactions

[ 430 U.S. Page 737]

     without economic substance and therefore should not be recognized for tax purposes. See, e.g., Gregory v. Helvering, 293 U.S. 465, 470 (1935); Knetsch v. United States, 364 U.S. 361 (1960). We do not think this is an accurate characterization.

Both taxpayers who were parties to Treaty I agreements entered into them only after arm's-length negotiation with unrelated companies. The ceding companies gave up a large portion of premiums, but in return they had recourse against the taxpayers for 100% of claims. The ceding companies were not just doing the taxpayers a favor by holding premiums until earned. This delayed payment permitted the ceding companies to invest the dollars, and under the treaties they kept all resulting investment income. Nor were they mere "paymasters," as the Government contends, for indemnity reinsurance of this type does not relieve the ceding company of its responsibility to policyholders. Had the taxpayers become insolvent, the insurer still would have been obligated to meet claims.*fn15

Treaty II also served most of the basic business purposes commonly claimed for reinsurance treaties. See W. Hammond, Insurance Accounting Fire & Casualty 86 (2d ed. 1965); Dickerson, 563-564. It reduced the heavy burden on the taxpayer's surplus caused by the practice of computing casualty reserves on the basis of gross unearned premiums even though the insurer may have paid out substantial sums in commissions and expenses at the commencement of coverage. By reducing this drain on surplus, the

[ 430 U.S. Page 738]

     taxpayer was able to expand its business, resulting in a broader statistical base that permitted more accurate loss predictions.*fn16 Through Treaty II each taxpayer associated itself with a reinsurance company more experienced in the field. Moreover, under Treaty II the taxpayers were shielded against a period of catastrophic losses. Even though the reinsurer would eventually recapture any such deep losses, it would be of substantial benefit to the ceding company to spread those payments out over a period of months or years. Both courts

[ 430 U.S. Page 739]

     below that passed on Treaty II agreements found expressly that the treaties served valid and substantial nontax purposes.*fn17 Tax considerations well may have had a good deal to do with the specific terms of the treaties, but even a "major motive" to reduce taxes will not vitiate an otherwise substantial transaction. United States v. Cumberland Pub. Serv. Co., 338 U.S. 451, 455 (1950).*fn18


Whether or not these were sham transactions, however, the Government would attribute the contested unearned premium reserves to the taxpayers because it finds in § 801(c)(2) a rule that "insurance reserves follow the insurance risk." Brief for United States 34. This assertion, which forms the heart of the Government's case, is based on the following reasoning. Section 801 provides a convenient test for determining whether a company qualifies for favorable tax treatment as a life insurance company, a test determined wholly by the ratio of life reserves to total reserves. Reserves, under accepted accounting and actuarial standards, represent liabilities. Although often carelessly referred to as "reserve funds," or as being available to meet policyholder claims, reserves are not assets; they are entered on the liability side of the balance sheet. Under standard practice they are mathematically equivalent to the gross unearned premium dollars already

[ 430 U.S. Page 740]

     paid in, but conceptually the reserve - a liability - is distinct from the cash asset. This much of the argument is indisputably sound.

The Government continues: Since a reserve is a liability, it is simply an advance indicator of the final liability for the payment of claims. The company that finally will be responsible for paying claims - the one that bears the ultimate risk - should therefore be the one considered as having the reserves. In each of these cases, the Government argues, it was the taxpayer that assumed the ultimate risk. The other companies were merely paymasters holding on to the premium dollars until earned in return for a negligible percentage of the gross premiums.


We may assume for present purposes that the taxpayers did take on all substantial risks under the treaties.*fn19 And in the broadest sense reserves are, of course, set up because of future risks. Cf. Helvering v. Le Gierse, 312 U.S. 531, 539 (1941). The question before us, however, is not whether the Government's position is sustainable as a matter of abstract logic.*fn20 Rather it is whether Congress intended a "reserves follow the risk" rule to govern determinations under § 801.

[ 430 U.S. Page 741]

     There is no suggestion in the plain language of the section that this is the case. See nn. 1 and 4, supra. If anything, the language is a substantial obstacle to accepting the Government's position. The word "risk" does not occur. Moreover, in § 801(c)(2) Congress used the phrase "unearned premiums" rather than "unearned premium reserve." The Government argues that, taken in context, "unearned premiums" must be regarded as referring to reserves - to the liability account for unearned premium reserves and not the asset represented by the premium dollars. We agree that the reference is to reserves, but still the use of the truncated phrase suggests that Congress intended a mechanical application of the concept. In other words, this phrase suggests that in Congress' view unearned premium reserves always would be found in the same place as the unearned premiums themselves. If so, reserves would follow mechanically the premium dollars, as taxpayers contend, and would not necessarily follow the risk.

[ 430 U.S. Page 742]


The rather sparse legislative history furnishes no better support for the Government's position. Under the early Revenue Acts, all insurance companies were taxes on the same basis as other corporations. Both investment income and premium or underwriting income were included in gross income, although there was a special deduction for additions to reserves. See, e.g., Revenue Act of 1918, § 234(a)(10), 40 Stat. 1079.

By 1921 Congress became persuaded that this treatment did not accurately reflect the nature of the life insurance enterprise, since life insurance is often a form of savings for policyholders, similar in some respects to a bank deposit. See Hearings on H.R. 8245 before the Senate Committee on Finance, 67th Cong., 1st Sess., 83 (1921) (testimony of Dr. T. S. Adams, Tax Adviser to Treasury Department). Under this view, premium receipts "were not true income [to the life insurance company] but were analogous to permanent capital investment." Helvering v. Oregon Mutual Life Ins. Co., 311 U.S. 267, 269 (1940). The 1921 Act therefore provided, for the first time, that life insurance companies would be taxed on investment income alone and not on premium receipts. Revenue Act of 1921, §§ 242-245, 42 Stat. 261. The same rationale did not apply to other forms of insurance, and Congress continued to tax insurance companies other than life on both underwriting and investment income. §§ 246-247.

The 1921 Act was thus built on the assumption that important differences between life and nonlife insurance called for markedly different tax treatment. Strict adherence to this policy rationale would dictate that any company insuring both types of risks be required to segregate its life and nonlife business so that appropriate tax rules could be applied to each. Congress considered this possibility but chose instead

[ 430 U.S. Page 743]

     a more convenient rule of thumb,*fn21 the 50% reserve ratio test.*fn22 The Treasury official primarily responsible for the 1921 Act explained: S

"Some companies mix with their life business accident and health insurance. It is not practicable for all companies to disassociate those businesses so that we have assumed that if this accident and health business was more than 50 per cent of their business, as measured by their reserves, it could not be treated as a life insurance company. On the other hand, if their accident and health insurance were incidental and represented less than 50 per cent of their business we treated them as a life insurance company." 1921 Hearings, supra, 85 (testimony of Dr. T. S. Adams).I

This passage constitutes the only significant reference to the test in the 1921 deliberations.

In succeeding years controversy developed over the preferential treatment enjoyed by life insurance companies. There were claims that they were not carrying their fair share of the tax burden. There were charges that stock companies were favored over mutuals, or vice versa. There was

[ 430 U.S. Page 744]

     a nagging question over just how to compute a proper deduction for additions to reserves. Congress tried a host of different formulas to ameliorate these problems. See H.R. Rep. No. 34, 86th Cong., 1st Sess., 2-7 (1959); S. Rep. No. 291, 86th Cong., 1st Sess., 3-11 (1959); Alinco Life Ins. Co. v. United States, 178 Ct. Cl. 813, 831-837, 373 F.2d 336, 345-349 (1967). But throughout these years the 50% test was not significantly changed.*fn23

In 1959 Congress passed legislation that finally established a permanent tax structure for life insurance companies. Life Insurance Company Income Tax Act of 1959, 73 Stat. 112. For the first time since 1921, not only investment income but also a portion of underwriting income was made subject to taxation.*fn24 But even as Congress was rewriting the substantive provisions for taxing life insurance companies, it did not, despite occasional calls for change,*fn25 make any relevant alterations in § 801. Moreover, the few references to that provision

[ 430 U.S. Page 745]

     in the committee reports shed little light on the issue presented here.*fn26 They contain no explicit or implicit support for a rule that reserves follow the risk.


More important than anything that appears in hearings, reports, or debates is a provision added in 1959, § 820, concerning modified coinsurance contracts between life insurance companies.*fn27 This section, although designed to deal with a

[ 430 U.S. Page 746]

     problem different from the one presented here, is simply unintelligible if Congress thought that § 801 embodied an unvarying rule that reserves follow the risk.

A conventional coinsurance contract is a particular form of indemnity reinsurance.*fn28 The reinsurer agrees to reimburse the ceding company for a stated portion of obligations arising out of the covered policies. In return, the reinsurer receives a similar portion of all premiums received by the insurer, less a ceding commission to cover the insurer's overhead. The reinsurer sets up the appropriate reserve for its proportion of the obligation and, as is customary, the ceding company takes

[ 430 U.S. Page 747]

     credit against its reserves for the portion of the risks reinsured.

A modified coinsurance contract is a further variation in this esoteric area of insurance. As explained before the Senate Finance Committee, a modified form of coinsurance developed because some major reinsurers were not licensed to do business in New York, and New York did not permit a ceding company to take credit against its reserves for business reinsured with unlicensed companies. Hearings on H.R. 4245 before the Senate Committee on Finance, 86th Cong., 1st Sess., 608 (1959) (statement of Henry F. Rood). Denial of credit places the ceding company in an undesirable position. It has depleted its assets by paying to the reinsurer the latter's portion of premiums, but its liability account for reserves remains unchanged. Few companies would accept the resulting drain on surplus, and unlicensed reinsurers wishing to retain New York business began offering a modified form of coinsurance contract. Obligations would be shared as before, but the ceding company, which must in any event maintain 100% of the reserves, would be permitted to retain and invest the assets backing the reserves. As consideration for this right of retention, modified coinsurance contracts require the ceding company to pay to the reinsurer, under a complicated formula, the investment income on the reinsurer's portion of the investments backing the reserve. See id., at 609; E. Wightman, Life Insurance Statements and Accounts 150-151 (1952); D. McGill, Life Insurance 435-440 (rev. ed. 1967).

The 1959 legislation, as it passed the House, contained no special treatment for these modified contracts. The income involved therefore would have been taxed twice, once as investment income to the ceding company and then as underwriting income to the reinsurer.*fn29 The Senate thought this double taxation inequitable, and therefore added § 820, to which the House agreed. That section provides that for tax

[ 430 U.S. Page 748]

     purposes modified coinsurance contracts shall be treated the same as conventional coinsurance contracts, if the contracting parties consent to such treatment. For consenting companies Congress not only provided that gross investment income shall be treated as if it were received directly (in appropriate share) by the reinsurer, § 820(c)(1), but also expressly declared that the reserves "shall be treated as a part of the reserves of the reinsurer and not of the reinsured." § 820(c)(3).

Under a modified coinsurance contract the reinsurer bears the risk on its share of the obligations. Thus, if § 801 mandates that reserves follow the risk, the reinsurer could not escape being considered as holding its share of the reserve. Section 820(c)(3), providing for attribution of the reserves to the reinsurer, would be an elaborate redundancy. And although § 820 (a)(2) specifies that attribution under § 820 is optional, requiring the consent of the parties, the parties would in fact have no option at all. Plainly § 820 is incompatible with a view that § 801 embodies a rule that reserves follow the risk.*fn30

[ 430 U.S. Page 749]

     The Commissioner himself, interpreting § 801 in light of § 820, has implicitly acknowledged that reserves do not follow the risk. Rev. Rul. 70-508, 1970-2 Cum. Bull. 136. Advice was requested by the parties to a modified coinsurance contract who had not elected the special treatment available under § 820. The ceding company had carried the life insurance reserves on its books, although the reinsurer bore the ultimate risk. The ceding company wanted to know whether it could count those reserves in its ratio for purposes of § 801. Relying on § 801(b) and the Treasury Regulations implementing it, the Commissioner ruled that it could. A "reserves follow the risk" rule would have dictated precisely the opposite result.


Section 820 affords an unmistakable indication that § 801 does not impose the "reserves follow the risk" rule. Instead, Congress intended to rely on customary accounting and actuarial practices, leaving, as § 820 makes evident, broad discretion to the parties to a reinsurance agreement to negotiate their own terms. This does not open the door to widespread abuse. "Congress was aware of the extensive, continuing supervision of the insurance industry by the states. It is obvious that subjecting the reserves to the scrutiny of the state regulatory agencies is an additional safeguard against overreaching by the companies." Mutual Benefit Life Ins. Co. v. Commissioner, 488 F.2d 1101, 1108 (CA3 1973), cert. denied, 419 U.S. 882 (1974). See Lamana-Panno-Fallo Industrial Ins. Co. v. Commissioner, 127 F.2d 56, 58-59 (CA5 1942); Alinco Life Ins. Co. v. United States, 178 Ct. Cl., at 831, 373 F.2d, at 345. See also Prudential Ins. Co. v. Benjamin, 328 U.S. 408, 429-433 (1946); 15 U.S.C. § 1011 (McCarran-Ferguson Act). In presenting the 1959 legislation to the full House, members of the committee that drafted the bill were careful to underscore the continuing primacy of state

[ 430 U.S. Page 750]

     regulation, with specific reference to the question of reserves.*fn31

In two of the cases before us the courts below expressly found that the reserves were held in accordance with accepted actuarial and accounting standards,*fn32 while the third court did not address the issue. In all three, it was found that no state insurance department required any change in the way the taxpayers computed and reported their reserves.*fn33 Since the taxpayers neither held the unearned premium dollars nor set up the corresponding unearned premium reserves, and since that treatment was in accord with customary practice as policed by the state regulatory authorities, we hold that § 801(c)(2) does not permit attribution to the taxpayers of the reserves held by the other parties to the reinsurance treaties.*fn34


The Government argues that even if attribution of reserves is not required under § 801(c)(2), attribution is required

[ 430 U.S. Page 751]

     under § 801(c)(3), counting in total reserves "all other insurance reserves required by law." See n. 4, supra. Under state statutory law, the Government suggests, these taxpayers were required to set up and maintain the full unearned premium reserves.

Our attention is drawn to no statute in any of the affected States that expressly requires this result. Instead the Government returns to its main theme and asserts, in essence, that certain general state statutory provisions embody the doctrine that reserves follow the risk.*fn35 We would find it difficult to infer such a doctrine from the statutory provisions relied on by the Government even if there were no other indications to the contrary. But other indications are compelling. The insurance departments of the affected States consistently accepted annual reports showing reserves held as the taxpayers claim they should be.*fn36 It is well established

[ 430 U.S. Page 752]

     that the consistent construction of a statute "by the agency charged with its enforcement is entitled to great deference by the courts." NLRB v. Boeing Co., 412 U.S. 67, 75 (1973). See Trafficante v. Metropolitan Life Ins. Co., 409 U.S. 205, 210 (1972); Udall v. Tallman, 380 U.S. 1, 16-18 (1965); Skidmore v. Swift & Co., 323 U.S. 134, 139-140 (1944). This is no less the rule when federal courts are interpreting state law administered by state regulatory officials,*fn37 at least where, as here, there is no reason to think that the state courts would construe the statute differently. We find no basis for holding that taxpayers were required by law, within the meaning of § 801(c)(3), to maintain the disputed unearned premium reserves.*fn38

[ 430 U.S. Page 753]


For the reasons stated, we hold for the taxpayers. The judgments in Nos. 75-1221 and 75-1285 are affirmed. The judgment in No. 75-1260 is reversed, and the case is remanded for further proceedings consistent with this opinion.

It is so ordered.

MR. JUSTICE WHITE, with whom MR. JUSTICE MARSHALL joins, dissenting.

The Court today makes it possible for insurance companies doing almost no life insurance business to qualify for major tax advantages Congress meant to give only to companies doing mostly life insurance business. I cannot join in the creation of this truckhole in the law of insurance taxation.


Congress has chosen to give life insurance companies extremely favorable federal income tax treatment. The reason for this preferential tax treatment is the nature of life insurance risks. They are long-term risks that increase over the period of coverage and that will ultimately require the payment of a claim. Companies that assume life insurance risks therefore must accumulate substantial reserve funds to meet future claims; these reserve funds are invested, and a large portion of the investment income is then added to the funds already accumulated. In recognition of the special

[ 430 U.S. Page 754]

     characteristics of life insurance risks, Congress has allowed a substantial portion of life insurance company income to escape taxation.*fn1

Other types of insurance, such as the accident and health (A&H) coverage provided by the taxpayers in these cases, do not involve the assumption of long-term risks that inevitably will require the payment of benefits at some point in the relatively distant future. Consequently, Congress has provided for taxation of such nonlife insurance companies in much the same manner as any other corporation. See Internal Revenue Code of 1954, §§ 831, 832, 26 U.S.C. §§ 831, 832. Many companies mix nonlife insurance business with their life insurance business, and Congress has decided to tax such "mixed" enterprises according to whether the majority of the company's business is life or nonlife: S

"[I]f this accident and health business was more than 50 per cent of their business, as measured by their reserves, it could not be treated as a life insurance company. On the other hand, if their accident and health insurance were incidental and represented less than 50 per cent of their business we treated them as a life insurance company." Hearings on H.R. 8245 before the Senate Committee on Finance, 67th Cong., 1st Sess., 85 (1921) (testimony of Dr. T. S. Adams, Tax Adviser to the Treasury Department), also quoted ante, at 743.I

[ 430 U.S. Page 755]

     In order to measure the proportion of life insurance business done by an insurance company, Congress used the fraction of total insurance reserves consisting of life insurance reserves, as defined by § 801. The purpose of this reserve-ratio test is, of course, to determine whether a majority of an insurance company's business is life insurance.*fn2

More than 50% of the business of the taxpayer insurance companies for the taxable years in question here was nonlife rather than life insurance business, as measured by the reserves accumulated to cover all life and nonlife risks assumed by the taxpayers.*fn3 The taxpayers sought to obtain preferential treatment as life insurance companies under § 801 by arranging with other companies to hold the necessary reserves for the taxpayers. I agree with the majority that these arrangements had economic substance in that the companies holding the reserves performed two additional

[ 430 U.S. Page 756]

     functions for the taxpayers: a clearinghouse function, collecting premiums and paying out claims, and a financing function, lending the difference between the reserves established for the policy and the premiums, less selling expenses, received from the policyholder. See ante, at 737-738, and n. 16; Economy Finance Corp. v. United States, 501 F.2d 466, 477-478 (CA7 1974), cert. denied, 420 U.S. 947, rehearing denied, 421 U.S. 922 (1975), motion for leave to file second petition for rehearing pending, No. 74-701. But I cannot agree that these arrangements enable the taxpayers to qualify for tax savings Congress intended to give only to insurance companies whose predominant business is the assumption of insurance risks.


The majority holds that the taxpayers may obtain these tax savings despite the predominantly nonlife character of their insurance business, "[s]ince the taxpayers neither held the unearned [A&H] premium dollars nor set up the corresponding unearned premium reserves, and since that treatment was in accord with customary practice as policed by the state regulatory authorities...." Ante, at 750. This rule would permit an A&H insurance company to qualify for preferential treatment as a life insurance company by selling a few life policies and then arranging, by means similar to those employed here, for a third party to hold the A&H premiums and the corresponding reserves. Under the majority's rule, these reserves held by the third party to cover risks assumed by the A&H company would not be attributed to that company; its total reserves for purposes of § 801 would consist almost entirely of whatever life insurance reserves it held; and the company would satisfy the reserve-ratio test.*fn4 I

[ 430 U.S. Page 757]

     cannot believe that Congress intended to allow an insurance company to shelter its nonlife insurance income from taxation merely by assuming an incidental amount of life insurance risks and engaging another company to hold its reserves through arrangements with the requisite economic substance and state regulatory approval to satisfy the standard announced by the majority today.

The language of § 801 and its accompanying regulations does not require such a result. Section 801(a) provides that any insurance company may qualify as a life insurance company "if its life insurance reserves... comprise more than 50 percent of its total reserves..." (emphasis added); § 801(c)(2) includes "unearned premiums" in the definition

[ 430 U.S. Page 758]

     of "total reserves" for purposes of § 801(a). It is clear that, as required by Treasury Regulations, unearned premium reserves were set up to "cover the cost of carrying the [A&H] insurance risk for the period for which the premiums have been paid in advance," Treas. Reg. § 1.801-3(e) (1972), and that these reserves "have been actually held during the taxable year[s"] at issue here. § 1.801-5(a)(3) (1960). The question is whether the A&H reserves set up to cover risks assumed by each taxpayer are considered to be "its" reserves even though they are in the physical possession and under the nominal control of another company.

The Regulations explicitly answer this question in the affirmative for life insurance reserves: S

"[Life insurance] reserves held by the company with respect to the net value of risks reinsured in other solvent companies... shall be deducted from the company's life insurance reserves. I For example, if an ordinary life policy with a reserve of $100 is reinsured in another solvent company on a yearly renewable term basis, and the reserve on such yearly renewable term policy is $10, the reinsured company shall include $90 ($100 minus $10) in determining its life insurance reserves." § 1.801-4(a)(3) (1972). (Emphasis added.)I

Accord, § 1.801-4(d)(5). Thus, for purposes of the reserve-ratio test of § 801, life insurance reserves are attributable to the company assuming the risk under a reinsurance agreement. The same attribution rule should be used in calculating the denominator of the reserve ratio (life plus nonlife reserves) as for the numerator (life reserves); as the majority recognizes, ante, at 748 n. 30, there is no reason not to adopt a consistent approach to allocation of both life and nonlife reserves in determining life insurance company status.

The rule that life and nonlife reserves are attributable to the risk bearer reflects the familiar principles of cases such as Lucas v. Earl, 281 U.S. 111 (1930), where income earned by

[ 430 U.S. Page 759]

     a taxpayer was attributed to him notwithstanding a contractual arrangement under which the income was paid over to a third party. In that case, the salary derived from the taxpayer's business activity was treated as "his" income even though he did not receive or hold it. Similarly, the reserves applicable to the A&H insurance business of each of the taxpayers here should be treated as "its" reserves. Cf. Commissioner v. Hansen, 360 U.S. 446 (1959).*fn5


The majority insists nonetheless that these predominantly nonlife insurance companies be given preferential tax treatment intended only for predominantly life insurance companies. To reach this result, the majority relies, not on the language or legislative history of the § 801 reserve-ratio test, but on § 820 of the Code, which was added nearly 40 years after the reserve-ratio test was adopted and which gives life insurance companies the choice of whether to have reserves

[ 430 U.S. Page 760]

     under certain "modified coinsurance contracts" attributed to the reinsurer who bears the risk or to the reinsured who holds the reserves under the contract. See ante, at 745-748. The majority finds this section at once "redundan[t]" and "incompatible" with the Commissioner's interpretation of § 801. Ante, at 748. What the majority overlooks is that § 820 applies only to companies that have already qualified as life insurance companies by virtue of § 801; it prescribes, not how those companies qualify for life insurance company status, but rather how they are to be taxed once they have qualified for such status - specifically, how they can avoid double taxation on investment income received by the reinsurer but paid over to the reinsured pursuant to the particular type of reinsurance contract defined in § 820(b). The option to attribute reserves for these contracts either to the reinsurer or the reinsured is given only to life insurance companies which qualify under § 801, see § 820(b)(1), and is expressly made inapplicable "for purposes of section 801" in determining whether they so qualify, § 820(a)(1).

The majority notes that § 820(a)(1) denies insurance companies the choice of how to allocate their modified coinsurance contract reserves for purposes of the § 801 reserve-ratio test, but interprets this exception to § 820 to "[mean] that for purposes of § 801 the reserves are invariably treated as held by the ceding company...." Ante, at 748 n. 30. This "explanation" simply assumes the conclusion that the majority is attempting to justify: What the parties to these cases are arguing about is whether for § 801 purposes reserves are invariably attributable to the company holding them rather than to the company bearing the risks that the reserves were set up to cover. Mandatory attribution to the risk bearer under § 801 is just as consistent with the inapplicability of the § 820 option as is mandatory attribution to the holder of those reserves, and is more consistent with the attribution rule prescribed by the Regulations for life insurance reserves. See

[ 430 U.S. Page 761]

     supra, at 758. Moreover, the definition of nonlife reserves under §§ 801(c)(2) and (3) is explicitly made applicable only "[f]or purposes of [the] subsection [801] (a)" reserve-ratio test. The attribution rule at issue in these cases thus does not apply to the § 820 rules for taxing the income of life insurance companies from modified coinsurance contracts (or to the taxation of any other insurance income). In short, the majority's conclusion that § 820 "affords an unmistakable indication" of congressional intent with respect to attribution of reserves under § 801, ante, at 749, is refuted by the language of the Code itself.*fn6

For the reasons stated, I respectfully dissent.

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