
    524 F. 2d 1167
    CONSUMER LIFE INSURANCE COMPANY v. THE UNITED STATES
    [No. 463-70.
    Decided October 22, 1975]
    
      
      E. Michael Masinter, attorney of record, for plaintiff. James H. London and Hans ell, Post, Brandon <& Dorsey, of counsel.
    
      Herbert Grossman, with whom was Assistant Attorney General Scott P. Crompton, for defendant. Theodore D. Peyser, of counsel.
    Before Cowen, Chief Judge, Laramore, Senior Judge, Skelton, Nichols, Kasihwa, Ktjnzig, and Bennet, Judges.
    
   Kashiwa, Judge,

delivered the opinion of the court:

This is a single issue tax refund suit that arises out of a small loan company’s entry into the insurance business through a wholly owned subsidiary that is formed especially for that purpose. The question is whether that subsidiary, the plaintiff in this proceeding, qualified for the tax treatment accorded a “life insurance company” by §§ 801 et seq. of the Internal Bevenue Code of 1954. We hold for the plaintiff.

This case is before this court on a review of a recommended decision of Trial Judge George Willi. The court disagrees with the conclusions. A similar case, Penn Security Life Insurance Co. v. United States, ante at 594, is decided contemporaneously herewith. Issues decided therein and applicable herein are disposed of by reference to said decision; but as hereafter shown, plaintiff in this case has raised new questions based on state regulatory statutes. This decision discusses these state statutes which defendant claims are relevant.

The facts are fully detailed in the findings of fact accompanying this opinion and will be repeated herein only to the extent necessary to an understanding of the result reached.

In 1957 Southern Discount Company (Southern), a Georgia corporation, was operating a well established and successful consumer finance business. Its customer-borrowers typically purchased term life and accident and health (A & H) insurance at the time that they obtained their loans. The premium charge for the entire coverage involved was thereupon paid in full. The customers bought this protection, coextensive in both time and amount with the curtailment requirements of their borrowings, to provide a means of automatically servicing their debts to Southern in case of death or disability prior to full repayment. Georgia law prohibited Southern, as a loan company, from acting as an insurance underwriter with respect to such coverages. It was not forbidden, however, from functioning as a sales agent for insurance underwritten by a carrier duly qualified to conduct an insurance business in Georgia. American Banters Life Insurance Company (American Bankers), a Florida corporation, was such a carrier.

Until 1957 Southern acted as a commission sales agent for American Bankers in respect to life and A & H insurance issued by the latter to Southern’s borrowers. Under this arrangement, Southern received the maximum commission rate allowed by law; amounting to approximately 50 percent of the policyholder premiums. Despite the attractiveness of that return, for which it apparently had to do little more than place American Bankers’ policies with its own borrowers, Southern concluded that it could reap even greater profits from this source if it could participate as an underwriter rather than just a sales agent. It was that determination that prompted Southern to form the plaintiff as a wholly owned subsidiary.

Southern surveyed state law to locate the jurisdiction that had the most modest capitalization requirements for a licensed insurer and found that it was Arizona. Plaintiff was organized July 1, 1957 as an insurance company under an Arizona charter with an initial balance of invested capital and paid-in surplus of only $38,000. These resources were not sufficient to permit it to qualify as a direct insurer under Georgia law. It could, however, use its Arizona charter authority to operate as a reinsurer of Georgia and North Carolina coverages written by American Bankers — a duly authorized insurer in both of those states. American Bankers was willing to enter into a reinsurance treaty arrangement with plaintiff, under which it surrendered substantially all underwriting profit in return for a relatively minimal fixed fee, because it knew that if it refused, Southern would have no difficulty in replacing it with another qualified carrier. Thus, its alternative was outright exclusion from the insurance business generated by Southern’s borrowers. Thereupon, on June 28, 1957, American Bankers entered into the first of two consecutive insurance treaties (Treaty I and Treaty II, respectively) with the plaintiff.

Under Treaty I, all life and A & H policies issued by American Bankers to debtors of plaintiff’s affiliates (including the parent, Southern) on and after July 1, 1957 were to be fully reinsured with plaintiff which, as it freely concedes, thereby assumed the entire insurance risk represented by each of the policies involved; A & H as well as life. As compensation for its reinsurance function, plaintiff was to receive 87% percent (later increased to 90% percent) of all premiums collected by American Bankers from the policyholders. The timing of these payments by American Bankers to plaintiff differed, however, as between life and A & H, although the agreement required monthly remittances in each instance. As already noted, American Bankers collected all premiums in full at the inception of coverage. The Treaty stipulated that as to life policies, American Bankers was, at the end of each month, to pay plaintiff its entire share of all life premiums collected from policyholders during that month. As to A & H, however, American Bankers was to pay plaintiff only the portion of its total share of premium receipts during that month that was ratably allocable to that month’s coverage; the agreement being to pay over the remainder monthly on a pro rata basis spread over the balance of the coverage period. Thus, in respect to A & H, plaintiff never actually held any premium dollars attributable to a future period of coverage and risk exposure.

Finally, Treaty I provided for termination by either party upon thirty days written notice to the other. Termination was to be wholly prospective, the relevant clause specifying : “Upon termination by either party, this agreement shall continue to apply to all policies reinsured hereunder before such termination becomes effective.”

As required by state law, plaintiff filed annual reports of its activities under Treaty I with the insurance regulatory authorities in Arizona and Georgia. On those reports it characterized its life and A & H dealings differently. It did so by reporting both premium income and related reserves solely on the basis of actual dollar receipts for the year involved. This meant that for the life coverages it declared as- premium income- its entire percentage share of the premiums paid by policyholders during that year. Consonantly, it reported the full tabular reserve for all of such policies. As to A & H, however, it limited reported premium income to the annual aggregate of the incremental payments that had been received monthly from American Bankers. Moreover, it showed nothing on the asset side of the report representing the premiums on existing A & li policies that it was entitled under the Treaty to receive in the future. With premium income and asset balances thus restricted, plaintiff reported no reserves whatever in respect to the A & H coverages that it reinsured under Treaty I. As to those coverages, American Bankers included on its own annual reports an unearned premium reserve based on the amount of A & H premiums collected from policy holders but not yet paid over to the plaintiff. Neither the Georgia nor the Arizona regulatory authorities ever challenged or disapproved the method by which plaintiff reported its A & H reinsurance activities under Treaty I.

By 1962 plaintiff had accumulated enough earnings from operations under Treaty I to enable it to qualify as a direct insurer under Georgia and North Carolina law. It thereupon applied for and received such authority from the State of Georgia. From then on plaintiff operated as the issuing company on all life and A & H policies sold to the loan customers of Southern and its affiliates. Treaty I, in which plaintiff’s role was solely that of a reinsurer, was consequently no longer suited to its purposes. Accordingly, effective March 1, 1962, plaintiff and American Bankers entered into a new insurance treaty under which their roles were reversed; plaintiff functioning as the issuing or ceding carrier and American Bankers denominated the “reinsurer”.

Treaty II applied only to A & H insurance; plaintiff having • determined to underwrite all future life insurance by itself. The treaty provided that plaintiff, as the issuing or ceding company, would reinsure 80 percent of all future A & H policies with American Bankers. To tbat extent, plaintiff was to pay over to American Bankers on a quarterly basis all of the premiums collected from policyholders, American Bankers to return 50 percent of such amounts to the plaintiff as commissions. The Treaty contained a clause, entitled Experience Refunds, establishing a quarterly rebate due plaintiff in the amount of the total premium dollars ratably allo-cable to the expired portion of the term of policies for which such premiums had been collected, less the following deductions : (a) the amount of commissions paid plaintiff that was proportionate to the expired portion of the term of policies on which such commissions had been paid; (b) 3 percent of the earned premium dollars previously described; and (c) the sum of all claim payments made to plaintiff during the quarter by American Bankers as reinsurer. For all practical purposes, this clause served to fix American Bankers’ stake in the undertaking at a flat 3 percent of the premium dollars that it initially received from the plaintiff. Only if loss experience under the reinsured coverages exceeded 47 percent of premiums would American Bankers’ 3 percent return be encroached. Moreover, such a pattern of adverse experience would have had to persist for the ensuing twenty consecutive quarters before such an encroachment became permanent. Loss experience on A & H policies under Treaty I had ranged from 28 to 30 percent. Finally, there were no circumstances under which American Bankers’ return under Treaty II could exceed the 3 percent allotted to it therein.

On its annual reports to the state regulatory authorities covering 1962 and subsequent years, plaintiff declared no reserves relative to that portion of the A & H policies covered by the reinsurance language of Treaty II. Again, no state regulatory authority took exception to this aspect of plaintiff’s reports.

The insurance industry is regulated by the states. A particular insurance company must meet the various industry requirements of its home state, and must satisfy the requirements of all states in which it is qualified to act as an insurer. The state requirements include standards for investments, maintenance of reserves, and accounting practices. The state insurance departments supervise policy forms, agency relationships, and the general financial activities of the companies within their jurisdictions. This regulation is designed to preserve the solvency of the insurance companies for the protection of the policyholders. To implement their regulatory function, state insurance departments require companies to file annual reports. Because reports are required in all states in which a company is qualified to act as an insurer, a standard report form has been developed by the National Association of Insurance Commissioners, which is used in all fifty states. These reports disclose, among other things, the reserves being maintained by each company.

In addition to requiring annual reports, the various state insurance departments conduct regular triennial examinations of insurance companies. Where the volume of business warrants it as to a particular company, it is customary for representatives of several state insurance departments to work together on these examinations. The examinations are carried out at the offices of the company in question and may take as long as several months for large companies. Among the matters which are investigated in the course of such an examination are the reinsurance treaties to which a particular company is a party.

When a state insurance department is presented with a reinsurance agreement in existence between parties, its investigation will include a determination that each party has established adequate reserves according to its respective liabilities ¡pursuant to the terms of the reinsurance agreement.

Plaintiff was the subject of triennial examinations in 1959 and 1963 by the insurance department of Arizona. American Bankers was the subject of triennial examinations in 1960 and 1963. Participants in the 1960 examination were from the insurance departments of Florida, North Carolina, Georgia, and Texas; and participants in the 1963 examination were from the insurance departments of Florida, Georgia, Arizona, and Arkansas. The reinsurance treaties between plaintiff and American Bankers were examined in detail in the course of the aforesaid examinations. The existence of reserves for accident and health insurance held by American Bankers on the policies covered by those treaties was clear to the examiners. Also the maintenance of the reserves by American Bankers under the treaties during Period I and Period II was approved in the course of the four examinations; no requirement or even suggestion was made in the examination reports that the reserves should be otherwise maintained.

For each of the years 1958 through 1964 plaintiff computed its federal income tax liabilities and filed its returns on the premise that it was taxable as a “life insurance company” within the meaning of that term as defined by Section 801 of the Internal Revenue Code of 1954. On audit, the Revenue Service determined that plaintiff did not qualify as a life insurance company entitled to the preferential tax treatment accorded such an entity and assessed deficiencies accordingly (except for 1961 in which 'additional liability was fully expunged by other adjustments not in dispute). Plaintiff paid the assessments and upon formal disallowance of its seasonably filed claims for refund, brought this action in which the sole question for decision is that concerning plaintiff’s qualification as a life insurance company for federal tax purposes in the years 1958,1959,1960,1962,1963, and 1964.

As pertinent here, Section 801 defines a life insurance company as follows:

SEC. 801 [as amended by Sec. 2, Life Insurance Company Income Tax Act of 1959, P.L. 86-69, 73 Stat. 112]. DEFINITION OF LIFE INSURANCE COMPANY.
(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, 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)).
(c) Total Reserves Defined. — For purposes of subsection (a), the term “total reserves” means—
ill life insurance reserves,
(2) unearned premiums, and unpaid losses (whether or not ascertained), not included in life insurance reserves, and
(3) all other insurance reserves required by law.
The term “total reserves” does not include deficiency reserves (within the meaning of subsection (b) (4)).
% :Je ❖ # #

Life insurance company status, it is seen, is made to depend solely on the character and composition of an insurance company’s reserves. An insurance company merits life insurance company tax treatment if its life reserves amount to half or more of its total insurance reserves. Section 801 (c) expressly directs that total reserves, the denominator portion of the fractional test, shall include three separate categories: (1) life reserves; (2) reserves for unearned premiums and for certain unpaid losses (the latter element not being involved in this suit); and (3) all other reserves required by law.

Sections 1.801-3 (e) and 1.801-5 (b) of the Treasury Eeg-ulations on Income Tax (1962), endorsed by both parties to the present controversy, define unearned premiums and reserves required by law, respectively, as follows:

Unearned premiums. The term “unearned premiums” means those amounts which shall cover the cost of carrying the insurance risk for the period for which the premiums have been paid in advance. Such term includes all unearned premiums, whether or not required by law.
*****
Reserves required by law defined. For purposes of part I, subchapter L, chapter 1 of the Code, the term “reserves required by law” means reserves which are required either by express statutory provisions or by rules and regulations of the insurance department of á State, Territory, or the District of Columbia when promulgated in the exercise of a power conferred by statute, and which are reported in the annual statement of the company and accepted by state regulatory authorities as held for the fulfillment of the claims of policyholders or beneficiaries.

In this case there is no disagreement as to either the fact or the particular amount of plaintiff1’s life insurance reserves for each of the years in suit. Its qualification depends entirely on the question of its chargeability with reserves incident to the A & H policies to which it was a party under Treaties I and II; there being no dispute that reserves must be maintained by someone in respect to those policies. If those reserves are includable in plaintiff’s total reserves, it concededly does not pass the 50 percent test of Section 801. If, as plaintiff says, they are chargeable to American Bankers rather than to itself, it does.

To dispel the notion that it was required to maintain A & H reserves of a type comprehended by Section 801, plaintiff relies on (1) the language of the two insurance treaties under which it operated with American Bankers; (2) the testimony of a well-traveled actuarial expert, Arthur Crooks Eddy; (3) the fact that the state insurance regulatory personnel tacitly approved plaintiff’s annual report forms showing no A & H reserves; and (4) Trial Judge Fletcher’s opinion in Penn Security Life Ins. Co. v. United States (Ct. Cl. No. 109-68, decided March 2, 1973).

Plaintiff’s argument is simply that plaintiff was chargeable with no A & H unearned premium reserves because under both of the Treaties it received premium dollars only after the period of exposure to which those dollars related had expired. Accordingly, plaintiff says, since all the premiums that it received were, in point of time, already “earned” when it got them, there was no occasion for it to maintain a reserve for “unearned” premiums. Testifying as plaintiff’s expert, Mr. Eddy repeatedly opined that this feature of the Treaties, governing custpdy of prepaid premium dollars, was disposi-tive of the participants’ respective reserve obligations, i.e., that since it was American Bankers that physically held all of the A & H premium dollars allocable to the unexpired portion of the terms of the underlying policies, it was American Bankers, not plaintiff, that was obligated to carry the reserves for those policies. In this regard, his testimony was the same as it apparently had been in Penn Security, supra. In the latter case, the relevant particulars of the factual situations involved were virtually identical to those presented by Treaty I.

Defendant’s argument is that plaintiff’s total reserves in the reserve ratio must include the unearned premium reserves on the accident and health policies because those reserves must be attributed to the company ultimately liable for the insurance risks. Alternatively, if the unearned premium reserves must be required by law to be recognized, they were so required here.

Issued contemporaneously with this opinion is the per curiam decision in Penn Security Life Insurance Co. v. United States, ante at 594. That case involves life insurance company qualification and the provisions of § 801 dealing with health and accident insurance. The situation is similar to this case with that taxpayer reinsuring risks written by three unrelated insurance companies under credit life and accident and health policies on the lives and health of debtors of taxpayer’s parent which made consumer loans through subsidiaries operating finance offices. That opinion disposes of the issue under § 801(c) (2), unearned premiums, with the court concluding against attribution to plaintiff of the unearned premium reserves held by the ceding companies. We, therefore, consider the question settled. However, this leaves for determination here the § 801(c) (3) issue, insurance reserves required by law.

The defendant’s major argument in this case is that the reserves were required by law because Arizona Eevised Statutes Annotated § 20-501(5) and (9) apply in that the premiums were assets of the plaintiff because they were “in the course of collection” and tliey were “withheld by a solvent ceding insurer under a reinsurance treaty.” We interpret these sections to mean that they refer to amounts already due and unpaid. The definition of assets under § 20-501 refers to items in the possession of the taxpayer or to which the taxpayer has an enforceable claim. Without including the unearned premium in taxpayer’s assets, there can be no unearned premium reserve charged against that item. The Arizona provisions do not apply to plaintiff’s circumstances.

Turning to the liability side of the statute, defendant argues that § 20-505 requires that plaintiff establish reserves on the accident and health policies. It would appear from reading this statute that liabilities of an insurer “charged against its assets” implies that there were corresponding assets in the first place. Since there were not, this statute is inapplicable. Section 20-506A, referring to disability insurance, provides that “every insurer shall maintain an unearned premium reserve on all policies in force.” If there are two or more insurers on the same policy, they are not all meant to keep a reserve. This is how the state administrative practice operates. As long as someone has the reserve, this is. sufficient.

Under Treaty II plaintiff reinsured with American Bankers. This was authorized under Code of Georgia Annotated § 56-113. Section 56-906 (2) provides for a deduction of reinsurance from gross premiums before computing the unearned premium reserve. Arizona Revised Statutes Annotated § 20-261 and § 20-506B are similar. Defendant argues that Treaty II is a Surplus Aid contract in that since plaintiff did not reinsure its risks despite the formalities, the treaty did not qualify as authorized reinsurance and plaintiff could not take credit for the reserves. In answer to this, it can only be said that plaintiff did reinsure its risk. American Bankers was responsible for the risk and even though it only kept 3 percent of the premiums, in the event that losses had eaten into the 3 percent, this would have been American Bankers’ loss, not plaintiff’s.

Defendant then argues that even if Treaty II is operative, plaintiff would have to re-establish the reserve as an offsetting liability to the asset required under paragraph 8 of § 20-501 of the Arizona law. That section is directed primarily toward loss reimbursements for losses paid directly by the ceding company. Therefore, there is no asset belonging to plaintiff because plaintiff does not have an enforceable claim of right against American Bankers.

"We observe that the Arizona Code relating to insurance companies provided under § 20-152 for the director of insurance to certify the facts of violation of any provision to the attorney general for enjoining the violation. Wo also observe that the Georgia Code relating to insurance companies provided under § 56-214 that the Commissioner may institute legal proceedings for the enforcement of any provisions of the act. For the years in question, none of these actions were taken by either of the state officers in charge. With relation to doubtful or ambiguous statutes, it is generally accepted that in the absence of a court decision, the interpretation placed thereon by the regulatory body charged with enforcement thereof is compelling authority. Federal courts have applied this rule to state administrative interpretations or actions under state statutes. We believe that the language of the court in Salt Lake County v. Kennecott Copper Corp., 163 F. 2d 484, 489 (10th Cir. 1947) cert. denied, 333 U.S. 832, adopting a state administrative interpretation of an ambiguous state statute, is pertinent herein:

* * * Both the Supreme Court of Utah and this court are firmly committed to the familiar principle of law that in the interpretation of a doubtful or ambiguous statute, the long-continued and uniform interpretation of the administrative agency or authority charged with its administration is entitled to great weight and will not be overturned, except for cogent reasons. An administrative interpretation does not avail to overcome a statute which is so plain in its commands that it leaves nothing for construction; but ordinarily in case of doubt or ambiguity, it is entitled to great weight and will not be overthrown, except for cogent reasons. State Board of Land Commissioners v. Ririe, 56 Utah 213, 190 P. 59; Utah Hotel Co. v. Industrial Commission, 107 Utah 24, 151 P. 2d 467, 153 A.L.R. 1176; Utah Power & Light Co. v. Public Service Commission, 107 Utah 155, 152 P. 2d 542; E. C. Clsen Co. v. State Tax Commission, Utah, 168 P. 2d 324; Baze v. Scott, 10 Cir., 106 F. 2d 365; United States v. Magnolia Petroleum Co., 10 Cir., 110 F. 2d 212; Standard Surety & Casualty Co. v. State of Oklahoma, 10 Cir., 145 F. 2d 605. * * *

We believe that the Court’s language in Skidmore v. Swift & Co., 323 U.S. 134, 139-140 (1944), explains the basic reason for the rule and we deem it appropriate in the present case:

There is no statutory provision as to what, if any, deference courts should pay to the Administrator’s conclusions. And, while we have given them notice, we have had no occasion to try to prescribe their influence. The rulings of this Administrator are not reached as a result of hearing adversary proceedings in which he finds facts from evidence and reaches conclusions of law from findings of fact. They are not, of course, conclusive, even in the cases with which they directly deal, much less in those to which they apply only by analogy. They do not constitute an interpretation of the Act or a standard for judging factual situations which binds a district court’s processes, as an authoritative pronouncement of a higher court might do. But the Administrator’s policies are made in pursuance of official, duty, based upon more specialized experience and broader investigations and information than is likely to come to a judge in a particular case. They do determine the policy which will guide applications for enforcement by injunction on behalf of the Government. Good administration of the Act and good judicial administration alike require that the standards of public enforcement and those for determining private rights shall be at variance only where justified by very good reasons. The fact that the Administrator’s policies and standards are not reached by trial in adversary form does not mean that they are not entitled to respect. This Court has long given considerable and in some cases decisive weight to Treasury Decisions and to interpretative regulations of the Treasury and of other bodies that were not of adversary origin. [Emphasis supplied.]
We consider that the rulings, interpretations and onin-ions of the Administrator under this Act, while not controlling upon the courts by reason of their authority, do constitute a body of experience and informed judgment to which courts and litigants may properly resort for guidance. The weight of such a judgment in a particular case will depend upon the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control.

See New York State Department of Social Services v. Dublino, 413 U.S. 405, 420-421 (1973); NLRB v. Boeing Co., 412 U.S. 67, 74-75 (1973) ; CBS v. Democratic National Committee, 412 U.S. 94, 121 (1973); Trafficante v. Metropolitan Life Insurance Co., 409 U.S. 205, 210 (1972); Udall v. Tallman, 380 U.S. 1, 16-18 (1965); Travelers Indemnity Co. v. Wells, 316 F. 2d 770, 773 (4th Cir. 1963); Barrington Manor Apartments Corp. v. United States, 198 Ct. Cl. 298, 304, 459 F. 2d 499, 502-503 (1972); Alabama v. United States, 198 Ct. Cl. 683, 692, 461 F. 2d 1324, 1329-30, cert. denied, 409 U.S. 1023 (1972); Inter-City Truck Lines, Ltd. v. United States, 187 Ct. Cl. 290, 295, 408 F. 2d 686, 688 (1969) ; Cornman v. United States, 187 Ct. Cl. 486, 492, 409 F. 2d 230, 233, cert. denied, 396 U.S. 960 (1969); DeLano v. United States, 183 Ct. Cl. 379, 388, 393 F. 2d 517, 521 (1968); Ganse v. United States, 180 Ct. Cl. 183, 189, 376 F. 2d 900, 904 (1967); Citizen Band of Potawatomi Indians v. United States, 179 Ct. Cl. 473, 486-487, 391 F. 2d 614, 621 (1967), cert. denied, 389 U.S. 1046, 390 U.S. 957 (1968); Crawford v. United States, 179 Ct. Cl. 128, 142-143, 376 F. 2d 266, 274-275 (1967), cert. denied, 389 U.S. 1041 (1968); cf. Federal Maritime Commission v. Seatrain Lines, Inc., 411 U.S. 726, 745 (1973); Love v. Fitzharris, 460 F. 2d 382, 385 (9th Cir. 1972), vacated, 409 U.S. 1100 (1973).

Finally, with relation to the testimony of Mr. Sturtevant, who testified that the unearned premium reserve as reported by American Bankers and plaintiff was permitted “unwittingly” by the Georgia insurance authorities, we have reviewed his testimony and it does not change our interpretation of the Georgia law above expressed.

For the foregoing reasons, we hold that the plaintiff is entitled to recover.

Nichols, Judge,

dissenting:

The dissent in Penn Security Life Insurance Company v. The United States, ante at 594, is to be deemed as being applicable to this case.

FINDINGS OF FACT

History of the Controversy

1. For each of the taxable years 1958 through 1965, plaintiff filed a timely tax return and paid all taxes shown thereon to be due. The taxes paid in said years were as follows:

1958: $48,144.32
1959: $72,405.55
1960: $52,377.05
1961: $17,777.24
1962: $17,047.52
1963: $43,790.32
1964: $17,726.51

Such tax liability of plaintiff in all such years was computed in accord with Section 802 of the Internal Eevenue Code of 1954.

2. Under date of February 20, 1969, the Acting Eegional Commissioner, Internal Eevenue Service, Southeast Eegion, sent plaintiff a notice of deficiencies in federal income taxes in the aggregate amount of $233,762.75, plus interest, for the taxable years ended December 31,1958,1959,1960,1962,1963, and 1964. (Eecomputation for 1961 resulted in a refund due plaintiff.) The statement accompanying said notice of deficiency set forth the reasons for the alleged deficiencies in federal income taxes as follows:

“It is determined that for your taxable years 1958,1959, 1960, 1962, 1963 and 1964, you did not qualify as a life insurance company within the meaning of section 801 of the Internal Eevenue Code of 1954, entitling you to taxation under section 802 of the 1954 Code. Consequently, your taxable income is being computed under Section 832 of the 1954 Code. This determination is based on the following:
“(1) You did not compute or estimate your life insurance reserves on credit life contracts on the basis of a recognized Mortality Table and assumed rates of interest, as required by section 801(b) of the 1954 Code, and/or
“ (2) You did not reflect in your total reserves, defined in Section 801(c) of the 1954 Code certain unearned premiums on accident and health contracts under certain reinsurance agreements which, should have been included therein. Accordingly, when your total reserves are corrected, your life insurance reserves as reported, even if recognized as having been computed or estimated on a basis of a recognized mortality table, would not exceed 50% of your correct total reserves pursuant to section 801 (a) of the 1954 Code.”

3. On or about July 30,1969, plaintiff paid to the District Director the aggregate amount of $351,393.88 additional federal income taxes and interest thereon for the taxable years ended December 31, 1958, 1959, 1960, 1962, 1963, and 1964.

4. On or about October 14, 1969, plaintiff filed with the District Director Claims for Refund of taxes and interest in the respective amounts and for each of the taxable years as described in paragraph 3 above. On or about June 26,1970, plaintiff filed amended Claims for Refund of taxes and interest in the respective amounts and for each of the taxable years as described in paragraph 3 above.

5. On or about October 27, 1970, the District Director notified plaintiff that the aforesaid amended Claims for Refund for the overpayment of taxes and interest had been disallowed.

6. Plaintiff filed its Petition in this Court on December 30, 1970, for recovery of income taxes and interest paid by plaintiff with respect to its claims for its taxable years 1958, 1959,1960,1962,1963, and 1964.

7. Jurisdiction over the subject matter of this action is conferred upon this Court under Section 1346(a) (1), Title 28, United States Code.

Bade ground of Controversy

8. Plaintiff was incorporated as a stock insurance company under the Insurance Code of the State of Arizona on June 26,1957.

9. Since its incorporation, all of the outstanding stock of plaintiff has been owned by Southern Discount Company (hereinafter referred to as “Southern Discount”), which was during all years pertinent to this lawsuit a Georgia corporation licensed under the consumer finance laws of the states in which it operated, and was engaged in the consumer finance business. These state laws forbade Southern Discount from acting as an insurance company. They did, however, permit Southern Discount to act as an agent for other insurance companies.

10. Prior to the incorporation of plaintiff, Southern Discount acted as agent for various insurance companies who wrote insurance on the lives and health of Southern Discount’s borrowers.

11. Credit life and accident and health insurance is sold in connection with a loan of money or an installment sale of tangible personal property. Credit life insurance, generally defined, is term insurance on the lives of debtors, with their creditors as beneficiaries, in amounts at least sufficient to discharge their indebtedness in case of death. Sometimes the life coverage is combined with 'accident and health coverage. Such coverage pays the debtor’s monthly installments during the period within the policy term in which he is totally disabled unable to work) because of accident or sickness, provided that the disability lasts beyond a minimum or “waiting” period. Coverage may be conditioned upon the permanent as well as total disability of the debtor. When life and accident and health coverage are provided in one contract, the respective premiums are separately stated.

12. As agent in the sale of such insurance, Southern Discount was able to share in its profitability by earning a commission, the amount of which, however, was limited by state law. By causing plaintiff to be formed, Southern Discount was able to participate to a greater degree in the profitability of this business, when it was profitable, by actually engaging in the insurance underwriting function either directly or through its reinsurance.

18. The initial capital and paid-in surplus upon the incorporation of plaintiff in 1957 was $38,000.00. In 1959 plaintiff’s stated capital was increased by $175,000.00 so as to qualify plaintiff to write insurance in the State of Georgia.

14. Plaintiff’s Articles of Incorporation provide, among other powers designated therein, that the nature of the business, and objects or purposes to be transacted, promoted or carried on are:

“ (a) To insure, in its own proper and corporate name, tbe lives of persons and all insurance appertaining thereto, including, but not limiting the generality of the foregoing: term, industrial, retirement income, ordinary, modified, single premium, limited payment, group and all other types and forms of contracts of insurance upon or relating to the lives of persons in connection with the extension of credit to such persons.
(b) To reinsure all or a part of any risk, class of risks, or all of the risks of the Company with any other insurance company or companies, and to accept such reinsurance from any other insurance company or companies, as allowed by law.”

15. During all of the taxable years in issue in this case, plaintiff was licensed by the Insurance Commissioner of the State of Arizona to transact life and disability insurance business. During the taxable years in issue the Arizona Department of Insurance conducted regular examinations of plaintiff’s business activities and reports of examination were issued in 1959 and 1963.

16. American Bankers Life Assurance Company (hereinafter referred to as “American Bankers”) is an insurance company licensed to engage in the life and disability insurance business under the laws of the State of Florida.

17. Other than as a party to certain treaties described more particularly below, American Bankers was totally unrelated to plaintiff at its inception and has remained an unrelated company except for its ownership of a nominal amount of stock (approximately 2y2%) i*1 plaintiff’s parent corporation, Southern Discount, from March 15, 1962, until March 25,1969, and approximately 1% acquired in 1972 and disposed of in the following year.

18. Reinsurance is a transaction in which an insurance company (the writing company, or ceding company) transfers, at least temporarily, the responsibility for all or a portion of the claims on which it may eventually be liable under the policies it has written, to another company (the re-insurer) . The ceding company pays the reinsurer consideration for assisting the ceding company in spreading, or averaging, its liabilities or risk over time. Reinsurance may be entered into for numerous reasons, including freeing one company’s capital or surplus from restrictions imposed for reserves required, spreading risks over time, avoiding catastrophic losses, the alliance of a small, new company with an older, experienced company for business purposes, sharing profitability of the industry where business considerations require that, and avoiding fluctuations of yearly earnings.

19. During the years 1958 through 1961, plaintiff’s business consisted of reinsuring all policies of insurance against the death or disability of debtors of Southern Discount and certain of its subsidiaries, which insurance policies had been issued by American Bankers. For plaintiff to have written insurance directly, rather than to have acted as a reinsurer, plaintiff would have been required to possess total stated capital and capital surplus of some $400,000.00 at this time in the State of Georgia. Plaintiff’s intent was to act as a reinsurer, permissible with a smaller capital investment, and increase its surplus through the profitability of the business until plaintiff could qualify to write insurance directly. This method of conducting business relieved Southern Discount, plaintiff’s parent company, from the financial burden of contributing to plaintiff’s capital a large amount of cash and thereby enabled Southern Discount to utilize its available cash to produce a more attractive return through its consumer lending business.

20. This reinsurance was effected pursuant to the terms of a reinsurance treaty entered into by the parties and dated June, 1957, which agreement was amended from time to time thereafter. (This period is hereafter referred to as “Period I” and this treaty and its amendments as “Treaty I.” See paragraphs 56-58.)

21. The reinsurance treaties executed by plaintiff and American Bankers were arm’s-length agreements entered into for valid business purposes by unrelated parties.

22. American Bankers realized that if Southern Discount created a subsidiary insurance company which operated alone or under reinsurance treaties with other companies, the insurance business generated by loans on Southern Discount’s customers would be lost completely by American Bankers.

23. In 1962, plaintiff having qualified to write insurance directly in the States of North Carolina and Georgia, its primary business became the direct writing of life and accident and health insurance on the debtors of Southern Discount and certain of its subsidiaries. This business continued to be plaintiff’s primary business throughout the remainder of the years in issue (“Period II”), although plaintiff continued to reinsure certain policies under Treaty I until they expired according to their terms.

24. A certain percentage of the accident and health policies written directly by plaintiff during Period II were reinsured by American Bankers pursuant to the terms of a Beinsurance Treaty entered into between the parties on April 18, 1962. (“Treaty II.” See paragraphs 59-61.)

25. Treaty II was entered into by plaintiff and American Bankers in 1962 for valid business reasons. The cession to American Bankers, on an “as written” basis, as described below, of a majority of the credit accident and health insurance which plaintiff wrote meant that plaintiff was not required under state -law to maintain any unearned premium reserves on said insurance. Had full reserves, in the amoimt of 100% of the unearned premiums, been maintained by plaintiff with respect to said insurance, plaintiff’s earnings and the consolidated earnings and capital of Southern Discount would have been adversely affected, with consequent damage to Southern Discount’s borrowing power, which was of great import in its primary business.

26. Treaty II was an arms-length agreement between plaintiff and American Bankers. In addition to its effect on plaintiff’s reserve requirements, Treaty II permitted plaintiff to dilute the effect on its capital and surplus at any given time, of accident and health insurance claims, thus serving the traditional role of reinsurance in deferring risk and providing protection for plaintiff and its customers in the event of any catastrophic loss experience, since American Bankers’ obligations under the treaty were not limited in any way.

Qualification as a Life Insurance Oorrvpany

27. Section 801 of the Internal Bevenue Code of 1954 provides an objective test for determining whether an insur-anee company is a “life insurance company” and therefore permitted to report its income in the method prescribed by Section 802. The qualification formula may be expressed in terms of the following fraction, the quotient of which must be more than 50 percent in order for an insurance company to qualify as a life insurance company.

Qualifying reserves (numerator) -h Total reserves (denominator)
1. Tabular reserves on life, annuity, and non-eancellable acei-dent and health policies 1. Tabular reserves on life, annuity, and noncancellable accident and health policies
2. Unearned premiums on non-cancellable life, health, or accident policies not included in (1) 2. Unearned premiums not in-eluded in (1)
3. Unpaid losses on noncancel-lable life, health, or accident policies not included in (1) 3. Unpaid losses not included in (1)
4.All other insurance reserves required by law.

28. Plaintiff did not physically hold, nor did it exercise control over, those unearned premiums representing accident and health insurance reserves which the Commissioner of Internal Eevenue attributed to plaintiff for purposes of measuring plaintiff’s “total reserves.” The accident and health reserves were held by American Bankers and the investment income therefrom received by it.

29. Plaintiff maintained life insurance reserves with respect to life insurance reinsured pursuant to Treaty I. 'Similarly, plaintiff maintained life insurance reserves with respect to life insurance written by plaintiff during Period II.

30. Historically, life insurance reserves are maintained by an insurance company to enable the company to pay those claims which may reasonably be expected to result from the life insurance policies it has issued. The computation of life insurance reserves is based upon mortality tables which contain statistics as to average life expectancies for certain ages and sexes. By applying these statistics to the ages and sexes represented by a company’s actual policyholders, a reasonably accurate prediction of the amount necessary to meet future claims may be made. (Although the amount will vary according to the mix of policyholders for any particular company, the amount of reserves normally required was approximately 40 percent of premiums received for the policies covered by Treaty I.)

31. Traditionally, whether because accident and health insurance exposure was initially incapable of being measured statistically (although records have been maintained sufficiently by this time that a reasonable reserve requirement could probably be reached by using statistics), or perhaps because this insurance, unlike life insurance, is usually can-cellable, accident and health reserves are required to be computed in terms of how much of a premium would have to be refunded to a policy holder in the event the policy were cancelled at any particular time during its term. The reserve so maintained is referred to as the “unearned premium reserve.” This method of establishing reserves is the established method of computing reserves for health and accident insurance.

32. All credit life and credit accident and health policies issued by American Bankers and reinsured by plaintiff, and those issued by plaintiff and reinsured by American Bankers, provided for payment of the entire premium at the time of issuance. This is referred to in the industry as “single premium” payment. When a health and accident premium under such a “single premium” policy is first paid by the insured, it is wholly “unearned” in that the entire premium has been paid for coverage over the full term of the policy, which has not yet been provided. Such unearned portion is set aside on the books and records of the company as the unearned premium reserve. As the term of the policy expires with the passage of time, the premium becomes “earned” to the extent of such expiration, since that portion was paid for coverage which was provided during the expired portion of the policy.

33. An unearned premium reserve thus measures an insurance company’s reserve requirements by looking to premiums already paid by policyholders and then determining the portion of such premiums that represent payment for insurance to be provided after the reserve valuation date.

34. In the event that the policies issued by American Bankers or by plaintiff to the debtors, in Period I or II, were cancelled by some act prior to the expiration of their original terms, the refund of the unearned portion of the premiums would be made in pursuance to their terms in accordance with a prescribed formula known as the Rule of 78.

35.Under the Rule of 78 or “sum-of-the-digits” method, the unearned premium is computed by applying changing fractions each year (or month, if unearned premiums are determined monthly) to the premium paid by the insured. The numerator of the fraction changes each year (or month) to a number which corresponds to the sum of the digits of the remaining unexpired term (years or months) of the policy, and the denominator, which remains constant, is the sum of all the years’ (or months’) digits corresponding to the entire term of insurance coverage. For example, if an insured debtor paid a $300 premium for disability benefits at the inception of a three-year single premium policy, he would be entitled to a refund under the Rule of 78 of $300 (3+2+1 \ 3lj-~2+l’X^300y ^ the policy was terminated at the beginning of the first year, $ 150T{ was terminated at the beginning of the second year, and $50 (j3-j_2+íX$300^) if the policy was terminated at the beginning of the third year. 2+1 3+2+1 X$300j if the policy

36.The unearned premium reserve for accident 'and health insurance is therefore 100 percent of the 'gross accident and health premium at the outset of a policy term. It is impossible for an insurance company to maintain such a reserve unless it has other funds besides the premium in question, since other costs such as the agent’s commission and administrative expenses must also be paid from the same premium. Even with other funds the restriction on capital imposed by such a reserve requirement is severe.

37.It has become customary in the industry to structure reinsurance treaties (which serve other valid business purposes of leveling the peaks and valleys in a particular company’s liability pattern) in such a way that the larger, high-capital party to the treaty maintains the reserves required for any accident and health insurance involved. Thus the party whose capital can bear the burden of the restriction imposed by “unearned premium reserves” will physically bold those reserves and collect the investment income from them.

38. The result of plaintiff’s treaties with American Bankers was that plaintiff was not required to maintain reserves for the accident and health insurance reinsured or written directly by it, to the extent said business was subject to those treaties.

39. In Treaty I, the accident and health insurance written by American Bankers was reinsured by plaintiff on a month-to-month basis, as it became “earned.” The single premium received by American Bankers at the creation of the policy was held by American Bankers and remitted on a monthly basis, net of a 12%% retention, to plaintiff, as payment for the reinsurance being provided to American Bankers. American Bankers maintained the “unearned premium reserves” on said policies; plaintiff maintained no reserves. Plaintiff’s obligation to reimburse American Bankers for insurance claims incurred was limited in the aggregate to the amount it received from American Bankers according to the treaty.

40. Plaintiff was not required by the state regulatory agencies to establish an unearned premium reserve with respect to its reinsurance of American Bankers’ accident and health insurance policies under Treaty I because as of each payment from American Bankers to plaintiff, all such reinsurance premiums had been fully earned by plaintiff, and no portion of the reinsurance premiums received and held by plaintiff represented payment for insurance to be provided after the payment date.

41. Under Treaty II, plaintiff reinsured 80 percent (and later 65 percent) of the accident and health insurance, which it now wrote directly, with American Bankers. This reinsurance was not ceded on a month-to-month basis as earned, but all at once from the outset of the policy term. Plaintiff therefore remitted the entire premium, less commissions to agents, for the portion reinsured to American Bankers initially. American Bankers’ obligation to reimburse plaintiff for insurance claims incurred was not limited in any way. American Bankers, holding the premiums, therefore established the reserves required for such insurance. Plaintiff established no such reserves.

42. Plaintiff was not required by any state regulatory agency to establish any unearned premium reserves as to insurance ceded by it to American Bankers under Treaty II because plaintiff held no unearned premiums on such policies, but instead received credit for reserves properly established by American Bankers, which did hold those premiums.

43. The unearned premiums and corresponding reserves in question under both treaties were physically held by American Bankers, which received the investment income therefrom, and which reported said reserves for purposes of state regulation as well as taxation. Plaintiff did not obtain or use the unearned premiums reflected in the annual statements of American Bankers, nor were said unearned premiums credited, set apart, or made available to plaintiff. There was no common or direct control of American Bankers by plaintiff or vice versa.

44. There was no existing state law which would have had the effect of “attributing” to plaintiff any reserves held by American Bankers on the insurance which was the subject of Treaties I and II. As unrelated parties to arm’s-length agreements, both plaintiff and American Bankers received benefits and gave consideration for said benefits under these treaties. The unearned premiums received by American Bankers were subject to no control or other proprietary interest on the part of plaintiff.

45. Under Treaty I, plaintiff had no obligation to refund premiums paid by policyholders of American Bankers in the event of premature termination of policies issued by American Bankers, since plaintiff received such premiums only after they had been fully earned. Consequently, there was no need, either legal or practical, for plaintiff to establish an unearned premium reserve for the purpose of maintaining a fund available for the refund of premiums.

46. Under Treaty II, since American Bankers received the accident and health premiums before they were earned, and since American Bankers’ obligation to bear the cost of claims was not limited in any way, American Bankers properly maintained unearned premium reserves as to the por-' tion of such policies reinsured.

47. The treaties in question and the method of maintaining reserves pursuant thereto were not unusual in the insurance industry at this time, and are still in use. The maintenance of said reserves was proper from an actuarial and an accounting point of view. It is standard in reinsurance accounting that the company which possesses the unearned premiums is the only company required to maintain the reserves thereon, unless one of the companies is not a qualified reinsurer.'

48. The insurance industry is regulated by the states. A particular insurance company must meet the various industry requirements of its home state, and must satisfy the requirements of all states in which it is qualified to act as an insurer. The state requirements include standards for investments, maintenance of reserves, and accounting practices. The state insurance departments surpervise policy forms, agency relationships, and the general financial activities of the companies within their jurisdictions. This regulation is designed to preserve the solvency of the insurance companies for the protection of policyholders.

49. To implement their regulatory function, state insurance departments require companies to file annual reports. Because reports are required in all states in which a company is qualified to act as an insurer, a standard report form has been developed by the National Association of Insurance Commissioners, which is used in all fifty states. These reports disclose, among other things, the reserves being maintained by each company.

50. In addition to requiring annual reports, the various state insurance departments conduct regular triennial examinations of insurance companies. Where the volume of business warrants it as to a particular company, it is customary for representatives of several state insurance departments to work together on these examinations. The examinations are carried out at the offices of the company in question, and may take as long as several months for large companies. Among the matters which are investigated in the course of such an examination are the reinsurance treaties to which a particular company is a party.

51. When a state insurance department is presented with a reinsurance agreement in existence between parties, its investigation will include a determination that each party has established adequate reserves according to its respective liabilities pursuant to the terms of the reinsurance agreement.

52. Plaintiff was the subject of triennial examinations in 1959 and 1963 by the insurance department of Arizona.

53. American Bankers was the subject of triennial examinations in 1960 and 1963. Participants in the 1960 examination were from the insurance departments of Florida, North Carolina, Georgia, and Texas; and participants in the 1963 examination were from the insurance departments of Florida, Georgia, Arizona, and Arkansas.

54. The reinsurance treaties between plaintiff and American Bankers were examined in detail in the course of the aforesaid examinations. The existence of reserves for accident and health insurance held by American Bankers on the policies covered by those treaties was clear to the examiners. Also the maintenance of the reserves by American Bankers under the treaties during Period I and Period II was approved in the course of the four examinations; no requirement or even suggestion was made in the examination reports that the reserves should be otherwise maintained.

55. There is no federal law pertaining to the matters of regulation which constitute the responsibility of the various states as described above.

56. Insofar as pertinent to this litigation, Treaty I read as follows:

AETICLE I
American Bankers agrees to cede to Consumer Life and Consumer Life agrees to accept reinsurance to the extent set forth below:
One Hundred Per Cent (100%) of each and every Life policy and each and every Health and Accident policy (herein called “Life policies” and “Health and Accident policies”) issued by American Bankers in. respect to debtors of Consumer Life and its subsidiary and affiliated corporations. The liability of Consumer Life under said Life and Health and Accident policies shall follow the _ liability of American Bankers except that the liability of Consumer Life arising under its reinsurance of said Health and Accident policies is on a month to month basis only and is limited solely to such amounts as shall become payable by Consumer Life under the provisions of Article V prior to the termination of this agreement.
ARTICLE II
This agreement applies to all said policies issued by American Bankers on or after the 1st day of July, 1957.
ARTICLE III
American Bankers shall furnish Consumer Life on or before the 20th day of July, 1957 and on or before the 20th day of each month thereafter, a statement showing the following information on transactions of the preceding month:
A. On all Life policies the statement will show:
(1) The amount of premiums collected;
(2) The amount of premiums returned on account of cancellation or other reason; and
(3) The amount of losses paid.
. B. On all Health and Accident policies the statement will show:
(1) The amount of premiums collected;
(2) The amount of premiums returned on account of cancellation or other reason;
( 3) The amount of losses paid;
(4) The amount of losses reported and unpaid and the estimated amount of losses incurred and unreported at the end of the preceding month; and
(5) The amount of premiums earned.
For the purpose of computing premiums earned during any month on Health and Accident policies under this Article III, the sum of the premiums collected on policies written during the month less any premium returned because of cancellation or other reason during the month, shall be added to the unearned premium reserve at the beginning of the month on policies then in force, and from the total sum so obtained shall be subtracted the unearned premium reserve at the end of the month on policies in force at that time.
For the purpose of computing losses, losses reported and unpaid and losses incurred and unreported, the allocated loss expense shall be added to the amount of loss claims. In tins connection the allocated loss expense shall be all claim expenses over and above the usual claim expenses incurred in the routine handling of a claim in the ordinary course of business, it being the intent of the parties hereto to include such expenses as the hiring of a special investigator, unusual travel expense in connection with the handling of a claim, attorney’s fees arising from a claim and other expenses not incurred in the usual and ordinary course of handling a claim.
ARTICLE IV
In addition to the monthly statement set forth in Article III, American Bankers agrees to furnish Consumer Life on or before the 20th day of January each year and from time to time as may be requested by Consumer Life, but in no event more often than monthly, a statement containing the following information 'as at the end of the month preceding the statement:
A. The amount of reserve on all life policies then in force;
B. The amount of losses on Life policies reported and unpaid and the estimated amount of losses incurred but unreported;
C. The amounts of insurance on all Life policies;
D. Such other information as may be required to complete annual statements or other statements as required by law.
Consumer Life shall, at all reasonable times during this agreement, have full and free access to all books, records and files of American Bankers’ office with respect to the business covered by this agreement.
ARTICLE V
In consideration of the reinsurance as set forth in Article I, the American Bankers agrees to pay monthly to Consumer Life, based on the statement set forth in Article III for the preceding month, and payable at the same time: (1) Eighty-seven and One-half Per Cent (871^%) of the premiums collected less any premiums returned on all Life policies, and (2) Eighty-seven and One-half Per Cent (8714%) of the premiums earned on all Health and Accident policies.
Conswmer Life agrees to reimburse American Bankers before the 30th day of the month after such statement is submitted, for all losses actually paid during the preceding month on Life policies and all losses actually paid during the preceding month on Health and Accident policies plus any increase or less any decrease during said month in the amount of Health and Accident losses reported and unpaid and incurred and unreported.
ARTICLE VI
American Bankers shall maintain all unearned premiums, loss and other reserves as may be required by law against all Health and Accident policies. Consumer Life shall maintain policy and other reserves as may be required by law on all Life policies.
ARTICLE VII
American Bankers agrees to pay all state, county, or city taxes which may be or become due in connection with the insurance sold or premiums collected on policies reinsured under this agreement.
ARTICLE VIII
American Bankers has furnished to Comumer Life and Comumer Life has acknowledged having received from American Bankers specimen forms upon which all said policies covered hereby are currently written. American Bankers reserves the right to make changes in such forms from time to time, but shall promptly notify Comuzmer Life of all such changes.
ARTICLE IX
The supervision 'and payment of all claims on policies covered by this agreement shall be handled by American Bankers and the decision of American Bankers in settling, rejecting or defending such claims shall be binding on Comumer Life.
ARTICLE X
In the event of the insolvency of the American Bankers, all reinsurance shall be payable directly to the liquidator, receiver or statutory successor of said American Bankers, without diminution because of the insolvency of American Bankers.
In the event of insolvency of American Bankers, the liquidator, receiver or statutory successor shall give Comumer Life written notice of the pendency of a claim on the policy reinsured within a reasonable time after such claim is filed in the insolvency proceeding. During the pendency of any such claim, Consumer Life may investigate such claim and interpose in the name of American Bankers (its liquidator, receiver or statutory successor,) but at its own expense, in the proceeding where such claims are to be adjudicated, any defense or defenses which Consumer Life may deem available to American Bankers or its liquidator, receiver or statutory successor.
ARTICLE XI
All disputes and differences between the two contracting parties upon which an amicable understanding cannot be reached are to be decided by arbitration and the arbitrators, who shall regard this agreement from the standpoint of practical business and equity rather than from that of the strict law, are empowered to determine as to the interpretation of the agreement obligation.
The court of arbitrators which is to be held in the city of Miami, Florida, shall consist of three arbitrators who must be officers of life insurance companies other than the two parties of this agreement. One of the arbitrators is to be appointed by American Bankers, the second by Consumer Life and the third is to be selected by these two representatives before the beginning of the arbitration. Should one of the parties decline to appoint an arbitrator or should the two arbitrators be unable to agree upon the choice of a third, the appointment shall be left to the president of the American Life Convention.
The arbitrators are not bound by any rules of law. They shall decide by a majority of votes and from their written decision there can be no appeal. The cost of arbitration, including the fees of the arbitrators, shall be borne by the losing party unless the arbitrators shall decide otherwise.
ARTICLE XII
This agreement constitutes the entire contract between the parties and may not be altered, modified or in any ways amended except by an instrument in writing duly executed by the proper official of both parties.
ARTICLE XIII
This agreement may be terminated by either party effective on the last day of any month upon at least thirty (30) days written notice of the other party.
Upon termination by either party, this agreement shall continue to apply to all policies reinsured hereunder before such termination becomes effective.
IN WITNESS WHEREOF, the parties hereto have caused this instrument to be signed and sealed by their duly authorized officers on this 28 day of June, 1957.

57. By amendments effective November 1,1957 and April 1, 1958, American Bankers’ retained share of the total premiums received annually in excess of $200,000 was reduced from 12y2 percent, as provided in Article V of Treaty I, finding 56, supra, to 9 y2 percent.

58. Treaty I was further amended May 28, 1958, effective as of July 1, 1957, to revise the extent of plaintiff’s interim liability as the reinsurer of American Bankers’ exposure under the A & H coverages subject to the Treaty. At all times, however, plaintiff reinsured the entire risk represented by those coverages, the only change being in the timing of its loss indemnity payments to American Bankers. At the time of this amendment plaintiff had accumulated a surplus fund of $130,000 from A & H premium receipts out of which to meet its reinsurance obligations which were averaging approximately $3,000 per month.

59. Treaty II is recited in toto. It read as follows:

ARTICLE I
Basis of Reinsurance
1. On and after the effective date hereof, the Ceding Company’s liability under Credit Accident and Sickness policies issued directly by the Ceding Company on the policy forms specified in Schedule A, attached hereto, shall be reinsured automatically to the degree and in the manner hereinafter specified.
2. The reinsurance liability of American Bankers during 1962 shall be 80% of each policy issued by the Ceding Company; thereafter, with respect to new business, such reinsurance liability may be reduced at the option of the ceding company at the beginning of each subsequent calendar year.
3. Reinsurance hereunder shall apply and be subject to all benefits and limitations included in policies issued by the Ceding Company and subject to reinsurance hereunder.
ARTICLE II
Mode of Cession
1. Reinsurance of Credit Accident and Sickness insurance issued or renewed by the Ceding Company on and after the effective date of this Agreement shall be effected by the Ceding Company’s mailing- to American Bankers a reinsurance cession on a form of which a sample is attached hereto and marked Schedule B, not later than the twentieth day following the last day of the calendar quarter covered by the reinsurance cession. The liability of American Bankers shall:
(a) commence as of the effective dates of the reinsurance premiums, and
_(b) continue only for the period covered by the reinsurance premiums.
% In no event shall the reinsurance be in force and binding unless the policy issued by the Ceding Company to the insured is in force.
ARTICLE III
Reinsurance Premiums
1. The reinsurance premiums to be paid the American Bankers by the Ceding Company shall be the premiums charged the insured by the Ceding Company during the calendar quarter for the coverage reinsured.
2. The American Bankers will pay to the Ceding Company a commission of 50% of reinsurance premiums received, as specified in this Article, on reinsurance hereunder.
ARTICLE IV
Oversights
1. American Bankers shall be bound as the Ceding Company is bound, and it is expressly understood and agreed that if non-payment of premiums within the time specified or failure to comply with the terms of this Agreement is shown to be unintentional and the result of misunderstanding or oversight on the part of either the Ceding Company or American Bankers, both the Ceding Company and American Bankers shall be restored to the positions they would have occupied had no such error or oversight occurred.
ARTICLE V
Payment of Claims
1. At the end of each calendar quarter American Bankers shall reimburse the Ceding Company for American Bankers share of all claim payments made by the Ceding Company during the calendar quarter on policies reinsured hereunder.
2. It is hereby understood and agreed that the American Bankers shall be liable only for claims incurred on or after the effective date hereof.
ARTICLE VI
Experience Befwnds
1. Reinsurance ceded hereunder shall be eligible for an Experience Refund. The Experience Refund for a given calendar quarter shall be computed as follows:
Experience Refund = (P-Co-E-Cl)
where P=earned reinsurance premiums during the calendar quarters as determined by American Bankers.
Co=earned reinsurance commissions during the calendar quarter as determined by American Bankers.
E=an expense, profit, and contingency charge equal to .03P.
Cl=incurred reinsurance claims during the calendar quarter as determined by American Bankers.
2. If P-Co-E-Cl is negative for a given calendar quarter such negative amount will.be treated as an addition to the incurred claims in calculating the Experience Refund for the following calendar quarters.
ARTICLE VII
Taxes, Assessments and Expenses
Neither party hereto shall be liable to the other for taxes, assessments, or any expenses resulting from reinsurance hereunder. The Ceding Company shall furnish the American Bankers with all necessary information so that American Bankers will not be required to perform any office work other than the regular bookkeeping entries made in connection with reinsurance accounting.
ARTICLE VIII
Inspection of Records
American Bankers shall have the right at any reasonable time to inspect at the office of the Ceding Company all books and documents relating to the reinsurance under this Agreement.
ARTICLE IX
Insolvency
1. In the event of insolvency of the Ceding Company, all reinsurance in force shall be payable to its liquidator or receiver without diminution because of the insolvency of the Ceding Company by any court of competent jurisdiction or any justice or judge thereof, or by any receiver or liquidator having 'authority to determine and allow such claims. It is understood, however, that in the event of the insolvency of the Ceding Company, the liquidator, receiver or statutory successor of the Ceding Company shall give written notice of the pend-ency of a claim against the Ceding Company on the policy reinsured with [in] a reasonable time after such claim is filed in the insolvency proceedings and that during the pendency of such claim the American Bankers may investigate such claim and interpose, at its own expense, in the proceedings where such claim is to be adjudicated any defense or defenses which it may deem available to the Ceding Company or its liquidators or receiver or statutory successor.
2. The expense thus incurred by American Bankers shall be chargeable against the Ceding Company as part of the expense of liquidation to the extent of a proportionate share of the benefit which may accrue to the Ceding Company solely as a result of the defense undertaken by American Bankers.
ARTICLE X
Settlement of Claims
1. American Bankers shall be liable to the Ceding Company for the benefits covered by reinsurance hereunder to the same extent as the Ceding Company is liable to the insured for such benefits and all reinsurance shall be subject to the terms and conditions of the particular form of policy under which the Ceding Company shall be liable.
2. It is hereby understood and agreed that the American Bankers shall be liable only for claims incurred on or after the effective date hereof.
3. Whenever a claim is made under a policy of the Ceding Company, which has been reinsured hereunder, it shall be taken and considered by American Bankers to be a claim for the amount of reinsurance on such risk and American Bankers shall abide the issue as it shall be settled by the Ceding Company and shall pay the amount of reinsurance covered by the policy of reinsurance when the Ceding Company shall settle with the Claimant.
4. Any suit or claim may be contested or compromised on the part of the Ceding Company and in case of a reduction of the claim made upon the Ceding Company, American Bankers and the Ceding Company shall participate in such reduction in the ratio that each company’s net liability bore to the total net liability prior to the reduction of the claim. Any unusual expenses incurred by the Ceding Company in defending or investigating any claims or taking up or rescinding any policy reinsured hereunder aside from routine investigations and other expenses incidental to the settlement of claims shall be shared in the same proportion.
5. In every case of loss, copies of proofs obtained by the Ceding Company shall likewise be taken as sufficient by American Bankers and copies thereof, together with a statement showing the amount paid on such claim by the Ceding Company shall be furnished to American Bankers before payment shall be demanded of it.
ARTICLE XI
Arbitration
1. All disputes and differences between the two contracting parties upon which an amicable understanding cannot be reached are to be decided by arbitration and the arbitrators, who shall regard this treaty from the standpoint of practical business and equity rather than from that of the strict law, are empowered to determine as to the interpretation of the treaty obligation.
2. The court of arbitrators which is to be held in the City of Miami, Florida, shall consist of three arbitrators who must be officers of life insurance companies other than the two parties of this Agreement. One of the arbitrators is to be appointed by the Ceding Company, the second by American Bankers and the third is to be selected by those two representatives before the beginning of the arbitration. Should one of the parties decline to appoint an arbitrator or should the two arbitrators be unable to agree upon the choice of a third, the appointment shall be left to the counsel for the Consumer Credit Insurors Association.
3. The arbitrators are not bound by any rules of law. They shall decide by a majority of votes and from their written decision there can be no appeal. The cost of arbitration, including the fees of the arbitrators, shall be borne by the losing party unless the arbitrators shall decide otherwise. • ■
ARTICLE Nil
Parties to Agreement
This is an agreement solely between the Ceding Company and American Bankers. The acceptance of reinsurance hereunder shall not create any right or legal relation whatever between American Bankers and the insured or the beneficiary under any policy of the Ceding Company which may be reinsured hereunder.
ARTICLE XIII
Duration
1. This agreement shall be effective as of the 1st day of March 1962, and may be terminated as of the end of any calendar quarter by either party giving to the other not less than 30 days’ written notice.
2. Upon termination, as provided in this Article, the Ceding Company shall, within 30 days of the termination date, supply American Bankers with the informa» tion necessary to calculate the final experience refund as of the termination date. Payment of (a) the final experience refund, (b) the unearned premium reserve held by American Bankers less unearned commissions thereon, and (c) payment of the claim reserve held by American Bankers.

60. On December 2,1964, effective October 1, 1964, plaintiff and American Bankers executed the following amendment to Treaty II:

ADDENDUM TO REINSURANCE AGREEMENT
THIS AGREEMENT, made this 2nd day of December, 1964, and effective the 1st day of October, 1964, by and between CONSUMER LIFE INSURANCE COMPANY OF PHOENIX, ARIZONA, hereinafter designated as “Ceding Company” and AMERICAN BANKERS LIFE ASSURANCE COMPANY OF FLORIDA, a corporation duly organized and existing under and by virtue of the laws of the State of Florida and having its executive office in the City of Miami, and State of Florida, hereinafter designated as “Company”.
WITNESSETH:
WHEREAS, the Company and the Ceding Company entered into a Reinsurance Agreement on the 1st day of March, 1962; and
WHEREAS, the parties are mutually desirous of amending said Agreement as hereinafter set forth.
NOW, THEREFORE, IT IS MUTUALLY UNDERSTOOD AND AGREED AS FOLLOWS:
1. The terms and conditions of said Reinsurance Agreement are incorporated within the terms of this Agreement.
2. Article I, Paragraph (2) is hereby amended to read: The reinsurance liability of American Bankers shall be 65% of each policy issued by the Ceding Company ; thereafter, with respect to new business, such reinsurance liability may be reduced at the option of the Ceding Company at the beginning of each subsequent calendar year.
3. All other conditions are to remain the same.

61. On December 29, 1964, effective December 31, 1964, plaintiff and American Bankers executed the following further amendment to Treaty II:

AMENDMENT TO Reinsurance Agreement between Consumer Life Insurance Company of Phoenix, Arizona, and American Bankers Life Assurance Company of Florida, of Miami, Florida, dated April 18, 1962.
Article VI of above mentioned Reinsurance Agreement is hereby amended to read as follows:
ARTICLE VI
Experience Refunds
1. Reinsurance ceded hereunder shall be eligible for an Experience Refund. The Experience Refund for a given calendar quarter shall be computed as follows:
Experience Eefund = (P-Co-E-Cl-N)
where P=earned reinsurance premiums during the calendar quarter as determined by American Bankers.
Co=earned reinsurance commissions during the calendar quarter as determined by American Bankers.
E=an expense, profit, and contingency charge equal to .03P.
Cl — incurred reinsurance claims during the calendar quarter as determined by American Bankers.
N=negative carry-forward from prior quarter.
2. If a negative amount is obtained from the calculation of the Experience Eefund for a given calendar quarter, such negative amount will be carried forward in calculating the Experience Eefund for the following calendar quarter, provided, however, that any un-amortized balance of such negative carry-forward will be dropped from the refund calculation after 20 quarters. The “first-in, first-out” principle will apply to the un-amortization of two or more negative carry-forwards arising from the experience of different calendar quarters.
IN WITNESS WHEEEOF the parties hereto have caused this Amendment to be executed in duplicate this 29th day of December, 1964, and to be effective for calculating the Experience Eefund due for the calendar quarter ending December 31,1964.

ULTIMATE CONCLUSION OP FACT

62. Unearned premiums and the corresponding reserves held pursuant to Treaty I are not includable in planitiff’s “total reserves” for purposes of Internal Eevenue Code Section 801.

63. Unearned premiums and the corresponding reserves held pursuant to Treaty II are not includable in plaintiff’s “total reserves” for purposes of Internal Eevenue Code Section 801.

64. Plaintiff qualified as a life insurance company for purposes of Section 801 because its life insurance reserves exceeded 50 percent of its total reserves, as that term is defined in Section 801(c), as shown by plaintiff’s income tax returns for the years 1958, 1959, 1960, 1962, 1963, and 1964.

CONCLUSION 03? LAW

Upon the foregoing opinion and findings of fact, which are made a part thereof, the court concludes as a matter of law that plaintiff is entitled to recover; and judgment is entered to that effect, with the determination of the amount of recovery to be made in further proceedings under Hule 131(c). 
      
       The last-mentioned category has been traditionally and centrally implicated in the federal taxation of insurance companies. See Brown v. Helvering, 291 U.S. 193, 201 (1934), and eases cited therein.
     
      
       § 20-501. "Assets” defined
      
      “In any determination of the financial condition of an insurer, there shall be allowed as assets only such assets as are owned by the insurer and which consist of:
      “1. Cash in the possession of the Insurer, or in transit under its control, and including the true balance of any deposit in a solvent bank or trust company.
      * » * » *
      “5. Premiums in the course of collection, other than for life insurance, not more than three months past due, less commissions payable thereon. The foregoing limitation shall not apply to premiums payable directly or indirectly by tha United States or by any of its instrumentalities.
      “6. Installment premiums other than life insurance premiums, in accordance with regulations prescribed by the director consistent with practice formulated or adopted by the national association of insurance commissioners.
      “7. Notes and like written obligations not past due, taken for premiums other than life insurance premiums, on policies permitted to be issued on such basis, to the extent of the unearned premium reserves carried thereon.
      “8. The full amount of reinsurance recoverable by a ceding insurer from a solvent reinsurer and which reinsurance is authorised under § 20-261.
      “9. Amounts receivable by an assuming insurer representing funds withheld by a solvent ceding insurer under a reinsurance treaty.
      “10. Deposits or equities recoverable from underwriting associations, syndicates and reinsurance funds, or from any suspended banking institution, to the extent deemed by the director available for the payment of losses and claims and at values to be determined by him.
      “11. All assets, whether or not consistent with the provisions of this section, as may be allowed pursuant to the annual statement form approved by the national association of insurance commissioners for the kinds of insurance to be reported upon therein.
      “12. Other assets, not inconsistent with the provisions of this section, deemed by the director to be available for the payment of losses and claims, at values to be determined by him.”
      • * * • *
     
      
       § 26-506. Liabilities
      
      “In any determination of the financial condition of an insurer, capital stock and liabilities to be charged against its assets shall include:
      *****
      “3. With reference to life and disability insurance and annuity contracts:
      *****
      “(b) Reserves for disability benefits, for both active and disabled lives,
      *****
      “(d) Any additional reserves which may be required by the director consistent with practice formulated or approved by the national association of insurance commissioners, on account of such insurance.
      “4. With reference to insurance other than specified in paragraph 3 of this section, and other than title insurance, the amount of reserves equal to the unearned portions of the gross premiums charged on policies in force, computed in accordance with this article.”
     
      
       § 20-506. Unearned premium, reserve
      
      “A. With reference to insurance against loss or damage to property, except as provided in § 20-507, and -with reference to all general casualty insurance, disability insurance, except as provided in § § 20-508 and 20-510, and surety insurance, every insurer shall maintain an unearned premium reserve on all policies in force.”
     
      
       § 56 — 113. Authorised reinsurance. — “(1) An insurer .shall reinsure its risks, or any part thereof, only in solvent insurers having surplus to policy holders or trusteed funds on deposit in the United States for the benefit of their policyholders not less in amount than the paid-in capital required under this Title of a domestic stock insurer authorized to transact like kinds of insurance.
      “(2) An insurer shall so reinsure in such alien insurers only as either (a) are authorized to transact insurance in at least one state of the United States, or (b) have in the United States a duly authorized attorney-in-fact to accept service of legal process against the insurer as to any liability which might arise on account of such reinsurance, or (e) may be approved by the Commissioner. In the event reinsurance is placed which is not in compliance with the foregoing provisions, the ceding insurer shall not be allowed credit for such reinsurance either as an asset or deduction from liability, nor may it increase any amounts it is authorized to have at risk because of such reinsurance.
      “(3) No credit shall be allowed, as an asset or as a deduction from liability, to any ceding insurer for reinsurance nor increase the amount it is authorized to have at risk unless the reinsurance is in insurers either authorized to do business in this State, or which have been approved by written order of the Department filed in its office and which order has not been subsequently disapproved; Provided, however, that sueh credit shall be allowed for reinsurance ceded to unauthorized alien assuming insurers, if such insurers have maintained in the United States for not less than 10 years immediately preceding such reinsurance a trust fund of not less than $50,000,000 available for the purpose of protecting policyholders in the United States. Nor shall such credit be allowed unless the reinsurance is payable by the assuming insurer on the basis of the liability of the ceding insurer under the contracts reinsured without diminution because of the insolvency of the ceding insurer.
      * * * * *
      “(5) Notwithstanding the provisions of this Code, full credit shall be allowed a ceding insurer, as an asset or as a deduction from liability, for all reinsurance which may be in effect or which may be hereafter effected under any contract or reinsurance in effect on the 31st day of December 1959, and any continuations or renewals of such contract of reinsurance. Provided, however, that no new insurance risk shall be ceded after two years from the effective date of this Title unless such reinsurance contract meets all the standards set forth in this Title.”
     
      
       § 56-906
      “(2) The Commissioner may require that such reserves shall be equal to the unearned portions of the gross premiums in force after deducting reinsurance in solvent insurers as computed on each respective risk from the policy’s date of issue. If the Commissioner does not so require, the portions of the gross premium in force, less reinsurance in solvent insurers to be held as a premium reserve, shall be computed according to the following table:”
      * * * * *
     
      
      
         § 20-261. Authorized reinsurance
      
      “A. An insurer shall reinsure its risks, or any part thereof, only in solvent insurers having surplus to policyholders not less in amount than the paid-in capital required under this title of a domestic stock insurer, other than a limited stock insurer, authorized to transact like kinds of insurance. A domestic limited stock life insurer may accept reinsurance of the risks of other such limited stock insurers and of domestic benefit insurers.
      “B. An insurer shall so reinsure in such alien insurers only as either are
      authorized to transact insurance in at least one state of the United States, or have in the United States a duly authorized attomey-in-fact to accept service of legal process against the insurer as to any liability which might arise on account of such reinsurance.
      “C. No credit shall be allowed, as an asset or as a deduction from liability, to any ceding insurer for reinsurance unless the reinsurance is payable by the assuming insurer on the basis of the liability of the ceding insurer under the contracts reinsured without diminution because of the insolvency of the ceding insurer nor unless under the reinsurance contract the liability for such reinsurance is assumed by the assuming insurer or insurers as of the same effective date.”
      *****
     
      
       § 20-506
      “B. The director may require that such reserves be equal to the unearned portions of the gross premiums in force after deducting reinsurance in solvent insurers as computed on each respective risk from the policy’s date of issue. If the director does not so require, the portions of the gross premiums in force, less reinsurance in solvent insurers to be held as a premium reserve, shall be computed according to the following table
      *****
     