Humana, Inc. v. Commissioner

KORNER, J., concurring and dissenting in part: So far as the majority opinion holds that the premiums paid to HCI by petitioner Humana Inc. (the common parent corporation) for insurance on itself may not be deducted as insurance premiums, I agree that such an outcome is controlled by our holdings in Carnation Co. v. Commissioner, 71 T.C. 400 (1978), affd. 640 F.2d 1010 (9th Cir. 1981), and Clougherty Packing Co. v. Commissioner, 84 T.C. 948 (1985), on appeal (9th Cir. 1985). I therefore concur in that portion of the opinion.

With respect to the majority’s holding that the same result obtains with respect to premiums paid by the Humana subsidiaries to HCI for comparable insurance on them and their employees, I dissent.

Neither Carnation nor Clougherty are authority for denying deductions for the amounts paid, as insurance premiums, by Humana Inc.’s subsidiaries to HCI. Said wholly owned subsidiaries of Humana Inc. Eire related to HCI as brother-sister corporations. In Carnation, we found that Three Flowers (the wholly owned offshore insurance subsidiary) was organized “to carry on the business of insurance and reinsurance of various multiple line risks including those of petitioner [Carnation] and its subsidiaries.” 71 T.C. at 402 . However, the issue of the deductibility of insurance premiums where the insurance contract is between corporations related as brother-sister was not decided. It was stipulated that for purposes of the case, all premiums were to be deemed as having been paid and deducted by Carnation. 1 In Clougherty, the wholly owned subsidiary, Lombardy’s, only business was the reinsurance of Clougherty’s workers’ compensation coverage. Clougherty was the taxpayer-petitioner. No subsidiaries of Clougherty related to Lombardy as brother-sister were involved.

In contrast with the factual situations presented in Carnation and Clougherty, the record herein shows that: (1) The wholly owned subsidiaries of Humana Inc. were insured under the subject policies; (2) the subsidiaries are related to HCI as brother-sister, not asparent-subsidiary; (3) the amounts due under the subject policies, as premiums, were billed by HCI to Humana Inc. on a monthly basis; (4) Humana Inc. paid the total amount billed by HCI on a monthly basis; (5) later, the foregoing amounts were allocated and charged back by Humana Inc. to its appropriate subsidiaries; and (6) the subsidiaries are petitioners here. 2 See sec. 1.1502-77(a), Income Tax Regs. Moreover, respondent does not contend that the existence of the said subsidiaries as separate and viable tax entities should be ignored, or that they were organized in order to unlawfully avoid the payment of tax. Respondent similarly does not contend that the subsidiaries did not engage in any business activities.

I find the majority’s holding with respect to the premiums paid by the Humana subsidiaries to HCI (the brother-sister situation) deficient in at least two important respects:

(1) The majority relies heavily upon, and quotes extensively from the joint opinion of respondent’s expert witnesses Plotkin and Stewart. A careful examination of that opinion, however, leads me to the conclusion that it gives no support to the position of the majority on the brother-sister question. As the quotations show, the thrust of the report is aimed at the parent-subsidiary question, concluding that there is no true insurance (hence no deductible premium) because there is no transfer of the risk of loss from the “insured” parent to its wholly owned subsidiary “insurer.” The reasoning apparently is that the subsidiary’s stock is shown as an asset on the parent’s balance sheet. If the parent suffers an insured loss which the subsidiary (HCI in this case) has to pay, the assets of the subsidiary insurer will be depleted by the amount of the payment. This, in turn, will reduce the value of the subsidiary’s shares as an asset of the parent (Humana), so that, in effect, the assets of the “insured” parent are bearing the loss as far as true economic impact is concerned. As the experts’ joint opinion (quoted by the majority) clearly puts it:

True insurance relieves the firm’s balance sheet of any potential impact of the financial consequences of the insured peril. For the price of the premiums, the insured rids itself of any economic stake in whether or not the loss occurs. * * * [However] as long as the firm deals with its captive, its balance sheet cannot be protected from the financial vicissitudes of the insured peril.

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CONCLUSION

So long as the firm does not transfer to another the ultimate responsibility for the financial consequences of its risks, it remains the risk bearer and faces the uncertainty of each year’s actual financial losses. The attempted placing of a firm’s risks, directly or indirectly, in its “insurance affiliates” did not accomplish a transference of risk, or constitute an insurance transaction as a matter of insurance theory or economic reality. We find our conclusion in complete accord with the clear theoretical and applied teachings of the economics, insurance theory, risk management, and captive self-insurance literatures.

Accepting, arguendo, that this is an accurate statement and is in line with our reasoning in Carnation and Clougherty, it nevertheless provides no support to the majority’s position in the brother-sister situation. Humana’s insured subsidiaries own no stock in HCI, nor vice versa. The subsidiaries’ balance sheets and net worth would in no way be affected by the payment of an insured claim by HCI. 3 It follows that when the Humana subsidiaries paid their own premiums for their own insurance, as the facts show, they shifted their risks to HCI. The rationale of Carnation and Clougherty thus does not apply, and such premiums should be allowable as deductions to the subsidiaries.

Upon what other basis can these premiums be disallowed? That is the subject of my next point of disagreement with the majority.

(2) The majority in this case for the first time extends the rationale of Carnation and Clougherty to the brother-sister situation. In addition, the majority cites and relies upon Stearns-Roger Corp. v. United States, 774 F.2d 414 (10th Cir. 1985), and Mobile Oil Corp. v. United States, 8 Cl. Ct. 555 (1985). See also Beech Aircraft Corp. v. United States, 797 F.2d 920 (10th Cir. 1986). A reading of these cases shows that each of them, either explicitly or implicitly, has adopted the “economic family” concept advanced by respondent in Rev. Rul. 77-316, 1977- 2 C.B. 53 , where it is said:

there is no economic shifting or distributing of risks of loss with respect to the risks carried or retained by the wholly owned * * * subsidiaries * * * [T]he insuring parent corporation and its domestic subsidiaries, and the wholly owned “insurance” subsidiary, through separate corporate entities, represent one economic family with the result that those who bear the ultimate economic burden of loss are the same persons who suffer the loss. To the extent that the risks of loss are not retained in their entirety by * * * or reinsured with * * * insurance companies that are unrelated to the economic family of insureds, there is no risk-shifting or risk-distributing, and no insurance, the premiums for which are deductible under section 162 of the Code.

Thus, the amounts paid by the [parents], and their domestic subsidiaries, and retained by [the insurance subsidiaries], respectively, are not deductible under section 162 of the Code as “ordinary and necessary expenses paid or incurred during the taxable year.” Because such amounts remain within the economic family and under the practical control of the respective parent in each situation, there has been no amount “paid or incurred.” * * *

In spite of its citation of, and reliance upon the above cases, the majority in the instant case (as in Carnation and Clougherty) again purports to refuse to accept respondent’s economic family argument. Instead, the majority passes over the substantial issues which are raised with the airy statement that “we hold that it is more appropriate to examine all the facts to decide whether or to what extent there has been a shifting of the risk from one entity to the captive insurance company.”

I find the majority’s attempted distinction here to be disingenuous and entirely unconvincing. What facts are there which support the conclusion here that there was no shifting of risk from the Humana subsidiaries to HCI? The subsidiaries, who paid their own premiums for their own insurance, had no ownership in HCI, the insurer, nor did HCI have any ownership in them. If we are to recognize HCI and the hospital subsidiaries as valid separate business entities, conducting active legitimate businesses, and devoid of sham — neither respondent nor the majority herein says to the contrary — then how can we say that there was no shifting of risk from the hospital-subsidiaries/sisters to the insurer/brother (HCI), without violating the time-honored rule that each taxpayer is a separate entity for tax purposes? Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943); Burnet v. Commonwealth Imp. Co., 287 U.S. 415 (1932). The only way it can be done is to ignore the separate entities of Humana, its hospital subsidiaries, and HCI, to call them all one “economic family” and to say that what happens to one happens to all of them. On the facts of the brother-sister situation presented here, I think that is what the majority is doing, and it ought to say so forthrightly. I would still disagree with such a position, but at least it would have the virtue of candor. Other than “economic family,” I can think of no theory on which the result here can be rationalized, and the majority has not articulated any.

This Court has never adopted respondent’s economic family theory, 4 and has expressed — justifiably—its concern regarding the adoption of such theory and its application to other areas of the tax law. 5 The theory of Helvering v. LeGierse, 312 U.S. 531 (1941), may have been adequate to sustain the holdings in Carnation and Clougherty, where only a parent and its insurance subsidiary were involved. It cannot be stretched to cover the instant brother-sister situation, where there was nothing — equity ownership or otherwise — to offset the shifting of risk from the hospital subsidiaries to HCI. If the majority is to accomplish the fell deed here, “a decent respect to the opinions of mankind requires that they should declare the causes which impel them” 6 to such a result.

Shields, Clapp, Swift, Gerber, Wright, and Wells, JJ., agree with this concurring and dissenting opinion. Carnation and its subsidiary corporations that were required to file Federal income tax returns each filed separate Federal income tax returns rather than a consolidated return.

As stated in the majority’s findings of fact, supra, Humana Inc. and its domestic subsidiaries filed consolidated Federal income tax returns for the years in issue. Respondent conceded that HCI was not a member of the affiliated group of corporations of which Humana Inc. was the common parent. HCI was not able to and did not file its income tax returns on a consolidated basis with Humana Inc. and its subsidiaries. Secs. 1501, 1504(a), 1504(b). HCI filed separate returns for all the pertinent years.

The majority, at note 13 of the majority opinion, states that Humana Inc. (the common parent), filed consolidated balance sheets for all of its subsidiaries (including HCI) for financial reporting purposes. The effect, says the majority, is that the assets of HCI were included in the consolidated statements. I question whether this would be proper for tax reporting purposés, where HCI was not and could not be a member of the consolidated returns which were filed. See my note 2, supra.

The majority further states that even if HCI was not properly includable in Humana’s consolidated balance sheet for tax reporting purposes, nevertheless Humana would reflect its investment in HCI’s stock under the “equity” method. Ergo, if HCI pays an insured claim against one of its brother/sister subsidiaries, its assets, and therefore the assets of Humana parent will decrease, and therefore Humana parent is the one who truly bears the loss. Consistent with this reasoning, is respondent prepared to allow a deduction to Humana parent when HCI pays an insured claim against one of the brother/sister hospital subsidiaries?

See Carnation Co. v. Commissioner, 71 T.C. 400, 409-410 (1978); Clougherty Packing Co. v. Commissioner, 84 T.C. 948, 956, 957, 959 (1985).

Clougherty Packing Co. v. Commissioner, 84 T.C. at 959 (majority opinion); 962-964 (Hamblen, J., concurring); 964 (Jacobs, J., concurring).

T. Jefferson, The Declaration of Independence (1776).