Appendix — United States v. Consumer Life Insurance Co.
Supreme Court brief1977
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APPENDIX
IN THE
Supreme Court of the United States
OCTOBER TERM, 1976
No. 75-1221
UNITED STATES OF AMERICA,
Petitioner
—.—
CONSUMER LIFE INSURANCE COMPANY
ON WRIT OF CERTIORARI TO THE UNITED STATES
COURT OF CLAIMS
PETITION FOR A WRIT OF CERTIORARI FILED FEBRUARY 25, 1976
CERTIORARI GRANTED MAY 24, 1976
IN THE
Supreme Court of the United States
OCTOBER TERM, 1976
No. 75-1221
UNITED STATES OF AMERICA,
Petitioner
—.—
CONSUMER LIFE INSURANCE COMPANY
ON WRIT OF CERTIORARI TO THE UNITED STATES
COURT OF CLAIMS
INDEX
Page
Docket Entries of the Court of Claim 1
ß ———— —rö 5
Exhibit A, Claim for Refund — 14
Transcript of Proceedings of July 17-18, 19722 34
Testimony of Arthur Crooks Eddy ................................... 74
yr OK OO rele 159
Testimony of Hubert B. Sturtevant ..............0000...00.......... 168
Testimony of Tom Robinson 260
Testimony of Arthur Crooks Eddy (Rebuttal) —.............. 274
Plaintiff's Exhibit 2, Reinsurance agreement between Ameri-
can Bankers Life Assurance Co. and Consumer Life In-
surance Co. (June 1957), addenda and amendments .......... 292
Plaintiff's Exhibit 3, Reinsurance agreement between Con-
sumer Life Insurance Co. and American Bankers Life
Assurance Co. (April 18, 1962), addendum and amend-
——ꝛñññůñůꝛůůů ——-—„V 319
Plaintiff's Exhibit 10, Report of examination of Consumer
Life Insurance Co. as of April 30, 199292 333
Plaintiff's Exhibit 11, Report of examination of Consumer
Life Insurance Co., as of December 31, 1963 . a
ii INDEX
Plaintiff's Exhibit 18, Report of examination of American
Bankers Life Assurance Co. as of December 31, 1960
Plaintiff's Exhibit 19, Report of examination of American
Bankers Life Assurance Co., as of December 31, 1968
Plaintiff's Exhibit 20, Illustration—Reserves .......................
Plaintiff’s Exhibit 21, Illustration—1957 Agreement; A&H
r ̃é . ̃
Plaintiff’s Exhibit 22, Illustration—1959 Amendment; A&H
r .
.
Plaintiff's Exhibit 24, Illustration—Initial Effect of 1957
r èÄ r
Plaintiff’s Exhibit 25, Illustration—Initial Effect of 1962
D i a E
Plaintiff’s Exhibit 26, Illustration Consumer Life Ratio of
Premiums Written to Surplus
Plaintiff's Exhibit 27, Illustration—Comparison of Agree-
ESIC SLES 7... ce
Order Allowing Certiorari
tthe eee ee eee
1
GENERAL DOCKET
Case No. 463-70
CONSUMER LIFE INSURANCE COMPANY
v8.
THE UNITED STATES
DOCKET ENTRIES
DATE PROCEEDINGS
Dec. 30,1970 Filing fee of $10 paid by plaintiff.
Dec. 31, 1970 Court filed order referring case to Com-
missioner George Willi.
Feb. 25, 1971 Defendant’s motion for extension of time
(to April 29, 1971) to file its answer filed. Copies
(2) to atty. ALLOWED MAR. 16, 1971.
Apr. 23, 1971 Defendant’s answer to the petition filed.
Copies (13) to atty.
Apr. 26, 1971 Commissioner’s standard pretrial order
on liability filed. Copy to parties.
Jun. 7, 1971 Plaintiff's motion for extension of time
(to August 9, 1971) to comply with pretrial order
filed. Copies (2) to deft. ALLOWED JUNE 8,
1971.
Sep. 30, 1971 Defendant’s motion for leave to file out
of time a motion for extension of time filed. Copies
(2) to atty. ALLOWED OCT. 19, 1971.
Oct. 19, 1971 Defendant’s extension of time (to Novem-
ber 22, 1971) to comply with pretrial order filed.
Copies (2) to atty. ALLOWED NOV. 4, 1971.
Nov. 18, 1971 Defendant’s motion for extension of time
(to December 22, 1971) to comply with pretrial or-
der filed. Copies (2) to atty. ALLOWED DEC 6
1971.
DATE PROCEEDINGS
Mar. 23, 1973 Commissioner’s memorandum and order
under Rule 113 filed. Copy to parties.
Dec. 3, 1973 Transcript of testimony (2 volumes plus
a master index—471 pages) taken at Atlanta,
Georgia on July 17 & 18, 1973 together with plain-
tiff’s exhibits 1 thru 6, 7a-f, 8a-d, 9a-h, 10, 11, 12a-
e, 13a-c, 14, 15a-c, 16 thru 27 and defendant’s ex-
hibits 1 thru 8 filed. Notice to parties.
Dec. 3, 1973 Trial judge’s order closing proof, etc. filed.
Copy to parties.
Dec. 26, 1973 Plaintiff's motion for extension of time
(to February 6, 1974) to file requested findings, ete.
filed. Copies (2) to deft. ALLOWED DEC 28 1973.
Feb. 4, 1974 Plaintiff's requested findings of fact and
Plaintiff's brief filed. Copies (2 of each) to deft.
Mar. 5, 1974 Defendant’s motion for extension of time
(to April 20, 1974) to file requested findings, etc.
filed. Copies (2) to atty. ALLOWED MAR 6 1974.
Apr. 19, 1974 Defendant’s motion for extension of time
(to May 11, 1974) to file requested findings, etc.
filed. Copies (2) to atty. ALLOWED APR 23.
May 13, 1974 Defendant’s objections to requested find-
ings of fact, defendant’s requested findings of fact
and defendant’s brief to the trial judge filed. Copies
(2) of each to atty.
Jun. 3, 1974 Plaintiff's motion for extension of time (to
June 27, 1974) to file its reply brief, etc. filed.
Copies (2) to deft. ALLOWED JUN 4 1974.
Jun. 26, 1974 Plaintiff’s objections to defendant’s re-
quested findings of fact filed. Copies (2) to deft.
Jun. 26, 1974 Plaintiff's reply brief to the Trial Judge
filed. Copies (2) to deft.
Dec. 13, 1974 Trial judge’s opinion and findings of fact
filed. Copies to parties.
23444
ä ee ee
—
————
DATE PROCEEDIN GS
Jan. 15, 1975 Plaintiff's notice of intention to except to
commissioner's report filed. Copies (2) to deft.
Feb. 3, 1975 Plaintiff's motion for extension of time (to
March 5, 1975) to file exceptions and brief filed.
Copies (2) to deft ALLOWED FEB 4 1975.
Mar. 10, 1975 Plaintiff's exceptions to trial judge's find-
ings of fact, ete. filed. Copies (5) to deft.
Mar. 10, 1975 Plaintiff's brief accompanying exceptions
filed. Copies (5) to deft.
Mar. 12, 1975 Court entered order that this case shall
be heard en banc by the court at the June 1975 ses-
sion of the court. Copies (3) to parties.
Apr. 8, 1975 Defendant’s motion for extension of time
(to April 24, 1975) to file its brief filed. Copies (2)
to atty. ALLOWED APR 9 1975, with no further ex-
tension to be granted.
Apr. 24, 1975 Defendant's brief filed. Copies (5) to
atty.
May 6,°1975 Motion by Penn Security Life Insurance
Company to participate as amicus curiae [in the
oral argument] filed. Copy to parties. MAY 7 1975:
Motion GRANTED provided Penn Security shall not
be allowed any oral argument if the court finds, as
presently indicated by the briefs, that no new and
significant issues are raised in the oral argument in
No. 463-70.
May 19, 1975 Plaintiff’s reply brief filed. Copies (5) to
deft.
Jun. 6, 1975 Argued and submitted on the merits be-
fore Cowen, Laramore & Skelton}.
Jun. 13, 1975 Defendant’s motion for leave to advice
court of the opinion in First Railroad & Banking
Company of Georgia v. United States filed. Copies
(2) to atty. ALLOWED JUN 16 1975.
DATE PROCEEDINGS
Jul. 14, 1975 Plaintiff's motion for leave to advise the
court of a petition for rehearing, etc. filed. Copies
(2) to deft. ALLOWED JUL 25 1975.
Oct. 22, 1975 Judgment for plaintiff with the amount
of recovery to be determined pursuant to Rule 131
(e). Opinion by Judge Kashiwa. Dissenting opinion
by Judge Nichols.
Mar. 3, 1976 Notice of fil'ag, by defendant, in Supreme
Court of a petition for writ of certiorari, on Febru-
ary 25, 1976, No. 75-1221, filed.
May 27, 1976 Order of the Supreme Court, dated May
24, 1976, allowing certiorari filed. Notice to trial
judge.
May 27, 1976 Record in re certiorari forwarded to Su-
preme Court.
A ote Sata) SETHE FRR ae
D d .
5
IN THE
UNITED STATES COURT OF CLAIMS
No. 463-70
CONSUMER LIFE INSURANCE Co., PLAINTIFF,
U.
UNITED STATES OF AMERICA, DEFENDANT.
(Filed: December 30, 1970)
PETITION
Count I
1. Plaintiff herein is a stock insurance company or-
ganized and existing under the laws of the State of Ari-
zona with its executive offices located in Atlanta, Georgia.
2. This is a civil action for the recovery of income
taxes and interest erroneously overpaid and collected
under the Internal Revenue Code of 1954 (hereinafter
referred to as the Code“) and jurisdiction of this Court
is invoked pursuant to Title 28, U.S.C. § 1346 (a) (1).
3. This count of this petition is brought for the recov-
ery of the overpayment of federal income taxes and in-
terest in the amount of $86,804.47 for the taxable year
ended December 31, 1958, $120,275.60 for the taxable
year ended December 31, 1959, $82,746.88 for the taxable
year ended December 31, 1960, $461.88 for the taxable
year ended December 31, 1962, $38,479.61 for the tax-
able year ended December 31, 1963, $22,625.44 for the
taxable year ended December 31, 1964, plus interest as
allowed by law.
4. Under date of February 20, 1969, the District Di-
rector of Internal Revenue, Atlanta, Georgia (hereinafter
referred to as “District Director”) sent Plaintiff a notice
of deficiencies in federal income taxes in the aggregate
amount of $235,762.75, plus interest, for the taxable years
ended December 31, 1958, 1959, 1960, 1962, 1963 and
6
1964. The statement accompanying said notice of de-
ficiency 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 Revenue Code of 1954, en-
titling 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 (e) 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 re-
serves 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 cor-
rect total reserves pursuant to section 801 (a) of
1954 Code.”
5. 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.
6. For each of the taxable years in question, Plaintiff
filed timely federal income tax returns and paid all in-
come taxes shown due on each such return.
7. On or about October 14, 1969, Plaintiff filed with
the District Director Claims for Refund for the overpay-
ment 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
7
Claims for Refund for the overpayment of taxes and
interest in the respective amounts and for each of the
taxable years as described in paragraph 3 above. Copies
of such amended Claims for Refund are attached hereto
as Exhibit A and made a part hereof.
8. 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.
9. Plaintiff has overpaid its federal income taxes for
the taxabie years ended December 31, 1958, 1959, 1960,
1962, 1963 and 1964.
10. During each of the taxable years in question, Plain-
tiff was a “life insurance company,” as defined in Section
801(a) of the Code, and its life insurance reserves, as
defined in Section 801(b) of the Code, plus unearned
premiums, and unpaid losses (whether or noi ascer-
tained), on noncancellable life, health, or accident poli-
cies not included in life insurance reserves, comprised
more than fifty percent of its total reserves, as defined
in Section 801 (e).
11. Plaintiffs life insurance reserves were computed
or estimated on the basis of recognized mortality or
morbidity tables and assumed rates of interest, were set
aside to mature or liquidate, either by payment or rein-
surance, future unaccrued claims arising from life insur-
ance and noncancellable health and accident insurance
contracts involving, at the time with respect to which
the reserve was computed, life, health, or accident con-
tingencies, and were required by law.
12. The District Director erroneously increased Plain-
tiff's total reserves, as defined in Section 801 (e) of the
Code, by including in such total reserves the total un-
earned premiums on certain health and accident insur-
ance contracts as herein described.
13. During the taxable years ended December 31, 1958,
1959 and 1960, Plaintiff was a party to a Reinsurance
Agreement with American Bankers Life Assurance Com-
pany (hereinafter referred to as “American Bankers“),
pursuant to which Plaintiff agreed to reinsure, in the
manner described in such Reinsurance Agreement, each
8
and every life insurance policy and each and every health
and accident insurance policy written by American
Bankers in respect to debtors of Southern Discount Com-
pany, the Plaintiff’s parent company, and its subsidiaries,
which companies were primarily engaged in the business
of consumer finance. The said Reinsurance Agreement
between Plaintiff and American Bankers provided that
the liability of Plaintiff on the life insurance policies and
health and accident insurance policies shall follow the
liability of American Bankers; except that the liability
arising under the reinsurance of health and accident poli-
cies would be on a month-to-month basis only and Plain-
tiff's liability was limited solely to the amount payable
by American Bankers to Plaintiff under the terms of the
Reinsurance Agreement, which amount constituted the
monthly earned portion of the total premiums.
14. For the taxable years 1958, 1959 and i960, Plain-
tiff did not establish and maintain unearned premium
reserves with respect to such health and accident insur-
ance reinsured by Plaintiff, and pursuant to the laws of
the State of Arizona Plaintiff was not required to main-
tain the unearned premium reserves with respect to such
health and accident insurance.
15. For the taxable years 1962, 1963 and 1964, Plain-
tiff issued combined life insurance and health and acci-
dent insurance policies in certain states to debtors of
Southern Discount Company and certain of its subsid-
iaries. During such taxable years, Plaintiff was a party
to a Reinsurance Agreement with American Bankers pur-
suant to which American Bankers agreed to reinsure a
portion of such health and accident insurance written by
Plaintiff.
16. Plaintiff did not establish and maintain unearned
premium reserves with respect to that portion of the
health and accident insurance so reinsured by Plaintiff
with American Bankers, and pursuant to the laws of the
State of Arizona Plaintiff was not required to maintain
the unearned premium reserves with respect to such
health and accident insurance.
9
17. The Reinsurance Agreements between Plaintiff
and American Bankers were negotiated at arm’s length,
and the Reinsurance Agreements were entered into for
valid business purposes and had economic significance to
both parties thereto.
18. The unearned premiums with respect to the health
and accident insurance written by American Bankers for
the taxable years 1958 through 1960, and the health and
accident insurance written by Plaintiff for the taxable
years 1962 through 1964, a portion of which was rein-
sured with American Bankers, should not be included
in Plaintiff's “total reserves“ within the meaning of
Section 801(c) of the Code.
19. The District Director erroneously determined that
the Plaintiff did not qualify as a “life insurance com-
pany” within the meaning of Section 801 of the Code
and the District Director erroneously determined that the
Plaintiff was not entitled to taxation pursuant to Section
802 of the Code. The District Director erroneously deter-
mined that the Plaintiff did not compute or estimate its
life insurance reserves on the basis of recognized mor-
tality or morbidity tables and assumed rates of interest.
The District Director erroneously determined that Plain-
tiff should include in its total reserves, as defined in
Section 801(c) of the Code, unearned premiums on
health and accident insurance contracts which were the
subject of Reinsurance Agreements between Plaintiff
and American Bankers.
20. The District Director erroneously disallowed Plain-
tiff's Claims for Refund and such additional taxes and
interest paid thereon should be refunded to Plaintiff.
WHEREFORE, Plaintiff prays that it be given judg-
ment against the Defendant in the amount of $351,393.88,
plus interest as allowed by law, or such greater amount
as may be legally refundable, plus costs of this action and
such other relief as this Court may deem just and
equitable.
10
Count II
This Count sets forth an alternative claim in the event it
is held that the District Director was correct in de-
termining that Plaintiff should establish and maintain
reserves with respect to the health and accident insur-
ance which was the subject of the Reinsurance Agree-
ments between Plaintiff and American Bankers.
1.-10. Paragraphs 1 through 10 of Count I are in-
corporated in this Count II as paragraphs 1 through 10
respectively.
11.-12. Paragraphs 13 and 15 of Count I are incor-
porated in this Count II as paragraphs 11 and 12 re-
spectively.
13. Such health and accident insurance was written
in a single policy with the life insurance which was also
sold to the insureds. The policies of life insurance were
noncancellable, and the life insurance benefit was co-
terminous with the health and accident insurance bene-
fit and both benefits were combined in a single policy.
14. The reserves with respect to such health and acci-
dent insurance would be includable in the computation
of Plaintiff's “life insurance reserves“ in that such
amounts were computed or estimated on the basis of
recognized mortality or morbidity tables and assumed
rates of interest, and were set aside to mature or liqui-
date future unaccrued claims arising from life insur-
ance, annuity and noncancellable health and accident in-
surance contracts (including life insurance contracts com-
bined with noncancellable health and accident insurance)
involving, at the time with respect to which the reserve is
computed, life, health, or accident contingencies.
15. Such health and accident insurance was noncan-
cellable and the unearned premium reserve established
with respect to such noncancellable health and accident
insurance would be includable in the computation of
unearned premiums, and unpaid losses (whether or not
ascertained) on noncancellable life, health or accident
policies not included in life insurance reserves, as de-
scribed in Section 801 (a) (2) of the Code.
11
16. The District Director my ag = determined a
Plaintiff did not qualify as a “life insurance comp
within the meaning of Section 801 of the Code, and the
District Director erroneously determined that Plaintiff
was not entitled to taxation under Section 802 of the
Code.
17. The District Director erroneously disallowed Plain-
tiff's Claims for Refund and such additional taxes and
interest paid thereon should be refunded to Plaintiff.
WHEREFORE, Plaintiff prays that it be given judg-
ment against the Defendant in the amount of $351,393.88,
plus interest as allowed by law, or such greater amount
as may be legally refundable, plus costs of this action
and such other relief as this Court may deem just and
uitable.
1 Count III
This Count sets forth an alternative claim in the event it
is held that the District Director was correct in de-
termining that Plaintiff should establish and maintain
reserves with respect to the health and accident in-
surance which was the subject of the Reinsurance
Agreements between Plaintiff and American Bankers,
and in the event it is held that such reserves do not
qualify as “life insurance reserves.”
1.-10. Paragraphs 1 through 10 of Count I are incor-
porated in this Count III as paragraphs 1 through 10 re-
spectively. f
11.12. Paragraphs 13 and 15 of Count I are incor-
porated in this Count III as paragraphs 11 and 12 re-
spectively.
13. The Reinsurance Agreement that was in effect
between Plaintiff and American Bankers for the taxable
years 1958, 1959 and 1960, provided for monthly pre-
mium payments from American Bankers to Plaintiff. Any
excess premium payments over the amount of monthly
premiums required to be remitted pursuant to the terms
of the contract would be premiums paid in advance of
the due date. Such premiums paid in advance would not
12
be unearned premiums and would not be included in the
computation of the amount of “total reserves” as defined
in Section 801 (e) of the Code.
14. Plaintiff's total reserves, as defined in Section
801 (e) of the Code, would not include any amounts re-
lating to advance premiums, and Plaintiff's life insur-
ance reserves plus unearned premiums and unpaid losses
on noncancellable life, health or accident policies would
comprise more than fifty percent of Plaintiff’s total
reserves.
15. The Reinsurance Agreement that was in effect
between Plaintiff and American Bankers for the taxable
years 1962, 1963 and 1964, provided for Plaintiff to remit
to American Bankers a percentage of the single premium
for each policy reinsured with American Bankers at the
end of the quarter with respect to which such premiums
were collected. Any premiums not remitted to American
Bankers in accordance with the terms of the Reinsurance
Agreements would constitute a liability from Plaintiff to
American Bankers and not unearned premiums.
16. Plaintiff’s total reserves, as defined in Section
801(c) of the Code, would not include any amounts relat-
ing to premiums which were not remitted to American
Bankers in accordance with the terms of the Reinsurance
Agreements, and the Plaintiff’s life insurance reserves
plus unearned premiums and unpaid losses on noncan-
cellable life, health or accident policies would comprise
more than fifty percent of Plaintiff’s total reserves.
17. In computing the amount of “total reserves” as
defined in Section 801 (e) of the Code, the District Direc-
tor erred in determining the cost of carrying the insur-
ance risk.
18. The District Director erred in failing to include in
the calculation of unearned premiums and unpaid losses,
as defined in Section 801 (a) (2) of the Code, the amount
of unpaid losses on noncancellable life insurance con-
tracts.
19. The District Director erroneously determined that
Plaintiff did not qualify as a “life insurance company”
within the meaning of Section 801 of the Code, and the
District Director erroneously determined that the Plain-
13
tiff was not entitled to taxation under Section 802 of
the Code. '
20. The District Director erroneously disallowed Plain-
tiff’s Claims for Refund and such additional taxes and
interest paid thereon should be refunded to Plaintiff.
WHEREFORE, Plaintiff prays that it be given judg-
ment against the Defendant in the amount of $351,393.88,
plus interest as allowed by law, or such greater amount
as may be legally refundable, plus costs of this action
and such other relief as this Court may deem just and
equitable.
E. Michael Masinter
Attorney for Plaintiff
Hansell, Post, Brandon & Dorsey
3300 First National Bank Tower
Atlanta, Georgia 30303
(404) 522-3558
Of Counsel.
Hansell, Post, Brandon & Dorsey
3300 First National Bank Tower
Atlanta, Georgia 30303
Plaintiff’s Post Office Address:
Consumer Life Insurance Co.
919 West Peachtree Street, N. E.
Atlanta, Georgia 50309
14
15
ur A Dan
Aegerter unter. Aren rut: lie eIND
form 843 — Stomp rem 843 Director's Stamp
rev. Nev 1968) Date nove 2 3 —
The teure Revenue Service wil Indic ote ln the 22 The internal Reveave Service will indicate in the block below the hind of cipim filed, ond AB in, where required,
DOD Refund of Taxes egen. Erroneously, or Excessively Collected. LD Refund of Taxes ere. Erroneousty, or Eacessivety Collected.
CC Refund of Amourt Psid for Stamps Unused, or Used in Error or txcess. D Ratund of Amount Paid for Stamps Unused, or Used in Error or Excess,
LD Abatement of Tay: Assessed (not applicable to income, estate or taxes), Q Abstement of Tax Assessed (not applicable to incame, estate or gift u.
Please Type or Print Mainly ~ Please Type or Print Itainty
Dame of taxpayer or purchase of stamps ‘Teams of taxpoyer or purchoser 4 clamps
~CONSUMER LUVE INSURANCE CO, —__ CONSUMER LIFE INSURANCE CO,
Humber ond street City or town, Stata, and — Humber pnd street City oF town, State, ond Zi’ code
—212 West Peachtree Street, N. E Atlanta a 30309 . — 30309
Fill in appli iLems— Use attachments if necessary — ——
. Your cle security number — we — Emploper idenuncoten number Of aay) mimes os Te ee . Empteyer identincation umber OF eny),
. 58 -0825266 252 —
—1—— N where „. Name and eddress shown on re NG. (rem above . 1 — 1
Phoenix, Arizona Phoenix, Arizona
© Perted—it for tax reporied on sanual bool prenare tepereta term fer N Pee r
. } ag 198, wD Income Tax and Interest — — Tex and Interest
© Amount of assessment payment & Amount of esecerment ot peyment
P uly 30, 1969 |_July 30, 1969 _ _
186,804.47 ——— iS hasan Go be sbeted Quel apgeahia to income, &>
Dots stamee were purchased — . ̃ ̃ —— — Sate cigs ware purtaoesd tom Gove | © Ament — —— . —-H Desens, oe
— 1s E .
Tar.. thai this cise should be slowed fer the following sssseua: Tr Wee cictmont believes Ghet this —2—ä— ———
Plus interest allowed by law, Pius intefest allowed by law.
** Amount from Line 9 below 53, 683.33
Interest assessed through 6-27-69 ’ 1 % Amount from Line 9 below TT, 249.06
Total to g. and i, above r Interest assessed to 6-27-69
Total to g. and 1. above .
COMPUTATION OF INCOME TAX REFUND income Tax COMPUTATION OF INCOME TAX REFUND
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8 Net overpayment (enter in item | above) . ila i i ee a oS . 683,33 9% 2 Dr. —————— ———
Under penatties of perjury, | declere ~ Ueder peostties of perjury. | deciare that | this claim, ch accompanying schedules and statements,
asinine Sa pooh , 2 — 2 — and to the best of my hacutedge and baiiet it — Wa
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Dyed June 25, 19.70 — 25, __ __ 9.70.
— SCL ce On REVERSE tom 643 Gun tem — e m OF REVERNE tom 043 On 1
16
17
EXHIBIT 4
AMENDED Cc FOR REFUND
term 043 Otrector) Stamp
an * Claim —
— .
The Interns! Revenue Service wl indicate in the bieck below the Lind of cisim Bled, sad Sl in, where required.
(DD Refund of Taxes ea. Erroneously, or Excessivety Collected.
Q Refund of Amount Paid for Stamps Unused, or Used in Error or Excess,
DL Abatement of Tax /ssessed (not applicable to income, estate or g N taxes).
Please Type or Print F ay
J. c
CONSUMER LIFE IN INSURANCE CO,
— ons eben City or own, State, ond ZIP code
919 West. Peachtree Street, N. E. Allanta, Georgia 30309
Fill in applicable itemis—vse attachments if necessary
— ‘al Sead — eas Bb Employer cenuficaton number Of any)
i 58 -082526
© loterns! Revrove Service office where re | ¢. Name and
turn Gl ony) was filed DD shown om et Af Gerad from above
Phoenix, Arizona
. Period—t! fo” tex repurted on saavel basis, prepare separate form for each taxable year t. King of tox
30» December 31 Income Tax and Interest
Oates of payment
3 82,746.88 July 30, 1969
N Dete stamps were purchased trom Geverm | L Amount
— to de refunced Of income tax, .
3
* The claimant believes isi Uris Claim should be allowed for the following reasone: — attached
Plus interest allowed by law.
err A
SAE FOR KErUND
tem 843 a —— —
a. Claim
*.
1 — from Line 9 below 55, 276.15
terest assessed through 6-27-69 27, 470.73
Total to g. and 1. above $82, 746.88
(COMPUTATION OF INCOME TAX REFUND Income Tax ;
nn „„ b . 6925 5„„5„„„%„%?ö „„ „ „ „1 „
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© Net overpayment (enter n Rem I Sers „ „„ „„ „„ „ „ „ „ 8 76. 89
Under penalties of periury, | declare that | have
and to the best of my knowledge and belief it is
:
3
LP po
— — SEK rc õο⁰ẽ⁰mw ON ACYERSE form Ai (tev. 11-48
The Internal Revenue Service will indicote in the biech below the hind of e ond G1 in, where required.
oD Retund of Taxes We catty, Erroneousty, or Cxcessively Collected.
OD Refund of Amount nid tor Stamps Unused, or Used in Error or Excess.
(D Adetement of Tax Arsessed (not applicable to income, estate or git taxes).
Please Type or Print F ainty
Meme of taspayer er purchaser @ stomps
CONS JMER LIFE NS. RANCE CO,
Mu mbe: ond street ; City or own, State, ond ZIP code
919 West Peachtree Street, N. E. Atlanta, Georgia 30309
Fill in applicaui2 items—use attachments if necessary
0. Your social security Wite’s n at return d. Leere, identucation number Of any)
ii | 3 889823288
bee Revenve Service office where re | 6. .. „% shown on return, # eee (rom sbove
tem Gi ony) wes fies
Phoenix, Arizona
egy ee el „%
From January } 19.82. December 31 12. 2 Income Tax and Inte rest
Oates o
(B Amount — 2 payment
9 461.88 July 30, 1969 a
Dee ei were purchased rem 1 — 1 to be sbeted „
. 2 U below) tote, er m taxes)
$ 461. 88* 4
El Tee clement believes thet @ 0 otsim shew
„„ See statement attached.
Plus interest allowed by Jaw.
Amount from Line 9 below 335.43
Interest assessed through 6-27-69 741.2
Total to g. and 1. above
COMPUTATION OF INCOME TAX REFUND Income Tax
A Tex withheld . ec cece stece eee eosseeeeer ees „ „„ „ —
A Ceumsted un pfl %%% „„ „„ „„ „„
3 Tax paid with original return . 9ůũõü»ëꝛ %% „ „1 ey 21
4 Ary edditional Income be ell 335.43
& Total tax pod (edd lines 1-4) . “oe % 0 „% % % % % % ee „% „% „% „„ „„ „„ „ „66 1382.25
6 Less: Yourcomputationofcorrecttax. g „„ „„ LL
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8 Amount previously refunded. 2 sw ee eee ee ee eee ee ee eee
@ Net overpayment (enter in tem | above) . Nr .
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— Revenue Service — tn the both below the Rind of chain Med, ond GH tn, —
DOD Refund of Taxes Mecatty, Erroneously, or Excessively Collected.
O Refund of Anount Psid for Stamps Unused, or Used in Ervor or Exenes.
"[]) Abstement of Tax Assessed (not applicabte te income, estate or gif taxes).
— Please Type or Print Pi: indy . 1
DS.
r LIFE INSUBANCE COQ. __
West Peachtree Street, N. k. Atlanta, Georgia 30309
g Fill in — attachments lt necessary
. Your secie! security number Wes t ©. Ch een
. E j i 58 -0825266
1 %% ord trem steve
@ interns! Rewenve Service office where re 4. Mame „„ shown on return,
% Suen OF ony) wos ied ,
‘Phoenix, Arizona
— for tex reported on snmual Bevis, geupere saperate Sore —— ͤ Feat om
© Amount — Oates of payment ; a
3,479. 61 1 July 30, 1938
„ ae oe — —
38, 479. 61* s
T cistnent believes Shot this chim shoud tat ‘
. thet this be shared tor the resented Bee attached
Plus interest allowed by law.
Amount from Line 9 below 20, 218, 23
Interest assessed through 6-37-89 9, 261.38
Total to g. and 1. above $ 38,479.61
ne COMPUTATION OF INCOME TAX REFUND — Tex
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Penatties of perjury. | deciere thet | heve
ond to the best of my knowledge and belie! it is
19
AMENDED CLAIM FOR REFUND,
oo Claim
22 Service *
Me internet U indinate in the bloch balew the hind of claim Sled, oad GE in, whore required,
DOD Refund of Taxes Mandy, Erroneously, or Excessively Collected.
D Refund of Amowat eld for Stamps Unused, or Used in Error or Cena.
LD) Abetoment of Tax / seessed (not applicable to income, estate or g it taxes
—ñ̃ —¾
2 . —
CONSUMER LIFE INSURANCE CO,
ond street Ghy or town, Stata, ond Ti? code
i
8
K
a fia Went Peachirse Street. M.———[_Atlanta. Gaorgia_s0309
. in — ettochenents ¥ soceoneny ; ‘
3 — om xe „˙,
© laternal Revenue eee office where re . Meme end oddrese shown on retyrn, if diferent trem sbove
turn Gf ony) was filed
Phoenix, Arizona
© Pertod—Z8 tor ton reported on snnusl beols, propere separate form ter coch isaable year Kind of ten”
; Income Tax and Interest
© Amount of sssesoment Dotes of payment
9 22, 625.44 E July 30, 1969
2 ese quechqees Gam Gove — tJ J de NN
422.628, 44. $
rr rr See statement attached.
Plus interest allowéd by law.
Amount from Line 9 below 17, 999.95
Interest assessed through 6-27-69 4,625.49
Total to g. andi, above 22, 625.44
COMPUTATION OF “INCOME TAX REFUND income Tax
STex wth wcrc „ „„ „„ „„ cess „ „ —
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B Tax poid eee eee e sfodbdaial
4 Any sdditionat Income tun o's see eee „„ „„ 4 :
© Tots tox ped (add lines (9 6.46
© Less: Yourcomputationofcomecttat. «se eee ees eee eee „„
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Under penalties of perjury, | declare thet | have examined this ciaim, including
mmm ,
—. . tom 643 d, 9
oe
20
EXHIBIT A
CLAIM FOR REFUND
Consumer Life Insurance Co. (hereinafter referred to
as “Taxpayer’’) is a stock insurance company organized
and existing under the laws of the State of Arizona. Tax-
payer is engaged in the life insurance and health and ac-
cident insurance business. Taxpayer’s home office is lo-
cated at 222 North Central Avenue, Suite 904, Phoenix,
Arizona, 85004, and Taxpayer’s executive offices are lo-
cated at 919 West Peachtree Street, N. W., Atlanta,
Georgia, 30309. For the period involved in this Claim
for Refund, Taxpayer filed its Federal income tax re-
turns with the District Director of Internal Revenue,
Phoenix, Arizona.
Taxpayer is a “life insurance company” as defined in
Section 801 (a) of the Internal Revenue Code of 1954
(the Code“). Section 801(a) of the Code defines a life
insurance company as follows:
“For purposes of this subtitle, the term ‘life in-
surance company’ means an insurance company which
is engaged in the business of issuing life insurance
and annuity contracts (either separately or com-
bined with health and accident insurance), or non-
cancellable contracts of health and accident insur-
ance, 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 sub-
section (c)).”
Section 801(c) of the Code states that:
the term ‘total reserves’ means
(1) life insurance reserves,
(2) unearned premiums, and unpaid losses
(whether or not ascertained), not included in
life insurance reserves, and
21:
(3) all other reserves required by law.”
Therefore, from the foregoing statutory definitions,
the qualification of an insurance company as a “life in-
surance company” depends upon a qualification fraction
in which the numerator is the company’s life insurance
reserves plus its unearned premiums and unpaid losses
on non-cancellable life, health or accident policies not in-
‘ cluded in life insurance reserves, and the denominator is
the insurance company’s total reserves as defined in Sec-
tion 801 (e) of the Code.
Transactions From 1957 to 1962
All of the outstanding stock of Taxpayer is owned by
Southern Discount Company, a Georgia corporation.
When Taxpayer commenced the insurance business in
1957, Taxpayer entered into a Reinsurance Agreement
with American Bankers Life Assurance Company of
Miami, Florida, (hereinafter referred to as “American
Bankers”) pursuant to which Taxpayer agreed to rein-
sure each and every life insurance policy and each and
every health and accident insurance policy written by
American Bankers in respect to debtors of Southern Dis-
count Company and subsidiaries of Southern Discount
Company, which companies were engaged primarily in
the business of consumer finance. The Reinsurance Agree-
ment provided that the liability of Taxpayer on the life
insurance policies and the health and accident insurance
policies shall follow the liability of American Bankers,
except that the liability of Taxpayer arising under its
reinsurance of health and accident policies would be on
a month-to-month basis only. Such monthly liability of
Taxpayer was further limited solely to the amount pay-
able by American Bankers to Taxpayer under the terms
of the contract, which amount, in effect, was the monthly
earned portion of the total premiums. Thus, pursuant
to the terms of the Reinsurance Agreement, Taxpayer’s
maximum amount of potential liability on the health and
accident policies during any one month was limited
solely to the amount of premiums earned on all such
health and accident insurance covered by the Reinsur-
ance Agreement.* In consideration for this reinsurance,
Taxpayer was paid a percentage of the monthly earned
premium, initially 8742 percent, and increasing in later
years to 9014 percent.
The Reinsurance Agreement between American Bank-
ers and Taxpayer was amended by subsequent agree-
ments between the parties, generally for the purpose of
modifying the percentage of reinsurance premium paid
by American Bankers to Taxpayer. The amendment of
May 28, 1958, specifically provided that the liability of
Taxpayer on health and accident insurance policies shall
be on a month-to-month basis only, and such liability
was to be limited to such amounts payable by American
Bankers to Taxpayer under the terms of the Reinsurance
Agreement.
The Reinsurance Agreement specifically provided that
American Bankers was to maintain all unearned premi-
ums, loss, and other reserves as may be required by law
against the health and accident insurance policies. There-
fore, American Bankers established and maintained the
unearned premium reserve with respect to the health and
accident insurance written by American Bankers and
reinsured on a month-to-month basis by Taxpayer. Since
the Reinsurance Agreement provided that American
Bankers was to pay to Taxpayer only the earned portion
of the health and accident premiums, American Bankers
retained in its possession the unearned portion of the
* An insurance company writing health and accident insurance
will usually have received the premium during the year which will
not have been entirely earned at the end of the year. A reserve must
be established at the end of the year to reflect the liability arising
therefrom. The same principle applies for premiums which will not
have been earned at the end of a month, and accordingly a reserve
must be established at the end of each month to reflect the future
liability arising from health and accident insurance written during
the month. Unearn premium reserves are not based on recognized
mortality or morbidity tables, but on the period for which the
premium is paid. Therefore, the amount of the reserve established
at the end of any period should be the pro rata portion of the
premiums or unearned premiums at the end of the period. See gen-
erally R. Denney, A. Rua & R. Schoen, Federal Income Taxation of
Insurance Companies § 5.5 and § 5.14 (2d ed. 1966).
23
premiums, and American Bankers established and main-
tained the unearned premium reserve required by State
law to cover the liability for future claims arising under
the health and accident insurance policies. At no time
did Taxpayer receive the unearned premiums nor main-
tain the unearned premium reserve, and pursuant to the
laws of the State of Arizona, Taxpayer was not required
to maintain the unearned premium reserve with respect
to such health and accident insurance so reinsured. Fur-
thermore, in all of its reports filed annually with the
Department of Insurance of the State of Arizona, Tax-
payer never established or maintained an unearned pre-
mium reserve for such health and accident reinsurance.
Also, the Department of Insurance of the State of Ari-
zona, in its regular examination of Taxpayer’s financial
condition, never required or sought to require Taxpayer
to maintain the unearned premium reserve with respect
to the health and accident insurance so reinsured.
Transactions Commencing with 1962
In 1962, Taxpayer began writing directly life insur-
ance policies and health and accident insurance policies
with respect to the debtors of Southern Discount Com-
pany and its subsidiaries doing business in Georgia.
With respect to this insurance, Taxpayer determined not
to bear the insurance risk fully, but to reinsure a portion
of the insurance risk with American Bankers. Accord-
ingly, on April 18, 1962, Taxpayer entered into another
Reinsurance Agreement with American Bankers with
respect to the health and accident insurance written
directly by Taxpayer on debtors of Southern Discount
Company and its subsidiaries in the State of Georgia.
Pursuant to this Reinsurance Agreement, American
Bankers reinsured eighty percent of the health and acci-
dent insurance written by Taxpayer. The Reinsurance
Agreement provided that the liability of American Bank-
ers with respect to such health and accident insurance
would arise immediately. For this reinsurance, Taxpayer
paid American Bankers a percentage of the premiums
paid on the policies.
24
-In addition, American Bankers agreed to pay Tax-
payer an experience refund based upon a formula set
forth in the Reinsurance Agreement, pursuant to which,
Taxpayer would be entitled to share in the profit from
such health and accident insurance in the event the in-
surance reinsured by American Bankers was profitable.
Such experience refund agreements were customary in
the reinsurance industry, and were normal provisions in
reinsurance agreements with American Bankers, and
other companies engaged in the reinsurance business.
There were other Reinsurance Agreements between Tax-
payer and American Bankers with substantially identical
provisions to cover subsidiaries of Southern Discount
Company located in states other than Georgia.
The Reinsurance Agreements between Taxpayer and
American Bankers were negotiated at arm’s length, and
there was no relationship between Taxpayer or Southern
Discount Company and American Bankers during the
period covered by this Claim for Refund, and thereafter,
except as described herein, and except for a nominal
amount of stock (approximately 212%) of Southern Dis-
count Company owned by American Bankers for the
period March 15, 1962, through March 25, 1969.
On July 1, 1963, Taxpayer entered into an agreement
with Life Insurance Company of North Carolina, pur-
suant to which Life Insurance Company of North Caro-
lina reinsured with Taxpayer insurance written with
respect to debtors of certain subsidiaries of Southern
Discount Company engaged in the consumer finance busi-
ness in North Carolina. Pursuant to this Reinsurance
Agreement, one hundred percent. of the life insurance
and one hundred percent. of the health and accident in-
surance was reinsured with Taxpayer, except, however,
Life Insurance Company of North Carolina maintained
a reserve of forty percent. of the cumulative total of
premiums written with which to meet claims.
With respect to insurance written by Taxpayer, Tax-
payer was required by law to maintain all reserves on
such insurance, except that Taxpayer was not required
under the laws of the State of Arizona to maintain the
unearned premium reserve with respect to that portion
——— SS ©
25.
of the health and accident insurance reinsured with
American Bankers. To the contrary, the Reinsurance
Agreement provided that American Bankers was required
to maintain all reserves on such portion of the health
and accident insurance so reinsured. Taxpayer did not
include such reserves in its reports filed with the Depart-
ment of Insurance of the State of Arizona; and the De-
partment of Insurance, in its examination of Taxpayer’s
financial condition, did not require Taxpayer to establish
or maintain a reserve with respect to the health and acci-
dent insurance reinsured with American Bankers.
In determining the fraction described in Section 801
of the Code for years prior to 1962, Taxpayer was re-
quired to maintain reserves only with respect to the life
insurance reinsured by Taxpayer, and no reserves were
required to be established or maintained with respect to
the health and accident insurance reinsured by Taxpayer,
since Taxpayer only reinsured health and accident insur-
ance on a month-to-month basis, and its liability was
limited by the terms of the Reinsurance Agreement.
Therefore, the amount of life insurance reserves consti-
tutes the numerator, and, likewise, the amount of life
insurance reserves constitutes the denominator, or the
figure representing total reserves. Hence, Taxpayer
clearly qualifies as a “life insurance company” pursuant
to the definition contained in Section 801 of the Code
for such period.
With respect to 1962, 1963 and 1964, when Taxpayer
was writing life insurance and health and accident in-
surance directly, Taxpayer only reinsured a portion of
the health and accident insurance with American Bank-
ers, and Taxpayer did not reinsure any of its life insur-
ance. Therefore, in this computation, the numerator
would constitute all of the life insurance reserves, and
the denominator, or the figure representing total reserves,
would include the life insurance reserves plus the un-
earned premium reserve with respect to the portion of
the health and accident insurance that was not reinsured
by Taxpayer. Since this fraction results in life insur-
ance reserves constituting more than fifty percent. of
Taxpayer’s total reserves, Taxpayer clearly qualifies as
26
a “life insurance company” as defined in Section 801 of
the Code for such years.
The District Director of Internal Revenue erroneously
determined that, for the taxable years of 1958, 1959,
1960, 1962, 1963 and 1964, Taxpayer did not qualify as
a “life insurance company” within the meaning of Sec-
tion 801 of the Code, and the District Director errone-
ously determined that Taxpayer was not entitled to
taxation under Section 802 of the Code. Furthermore,
the District Director erroneously determined that the
Taxpayer did not compute or estimate its life insurance
reserves on credit life contracts on the basis of a recog-
nized mortality table and assumed rates of interest as
required by Section 801(b) of the Code; and the District
Director erroneously determined the Taxpayer did not
reflect in its total reserves certain unearned premiums
on health and accident contracts under certain Reinsur-
ance Agreements. During the years 1957 through 1960,
the District Director erroneously added to the total re-
serves of Taxpayer the total unearned premium reserves
on all health and accident insurance written by Ameri-
can Bankers and reinsured by Taxpayer. During the
years 1963 and 1964, the District Director erroneously
determined that Taxpayer’s total reserves should include
that portion of the unearned premium reserve with re
spect to the percentage of health and accident insurance
reinsured by the Taxpayer with American Bankers.
The Reinsurance Agreements between Taxpayer and
American Bankers were valid, bona fide contractual
agreements between the parties thereto, and such con-
tracts had business and economic significance to both
Taxpayer and American Bankers. Taxpayer entered into
such reinsurance agreements for valid business purposes.
One of the primary business purposes of the Reinsurance
Agreements was to enable Taxpayer to indirectly insure
the debtors of Southern Discount Company. During the
years prior to 1962, Taxpayer was not qualified to en-
gage in insurance business directly in those states in
which Southern Discount Company conducted business,
and therefore, in order to insure debtors of Southern
Discount Company, Taxpayer had to enter into Reinsur-
—
27
ance Agreements with an insurance company that was
qualified to write insurance in those states in which
Southern Discount Company conducted business. Also,
taxpayer entered into such reinsurance agreements in
order to qualify as a “life insurance company” as defined
in the Internal Revenue Code. Such a purpose of rein-
suring health and accident insurance, or failing to accept
reinsurance on the health and accident insurance, except
on a month-to-month basis in order to qualify for taxa-
tion as a “life insurance company“, is a proper purpose,
since Taxpayer is entitled to arrange its business affairs
in such a manner as to minimize its tax liability, and to
derive the maximum business advantages from the taxing
laws. Taxpayer acknowledges that this was one of the
business reasons for entering into the reinsurance agree-
ments. Since the reinsurance agreements were valid and
binding contracts between the parties, the reinsurance
transactions in all respects had significant economic and
business effects on both parties to the agreements, and
accordingly, Taxpayer should not be required to establish
or maintain any reserves with respect to the health and
accident insurance that was reinsured as described here-
in.
In the alternative, if the District Director is correct in
determining that Taxpayer should establish and main-
tain reserves with respect to the percentage of health
and accident insurance reinsured by Taxpayer with
American Bankers, such reserves should qualify and be
treated as “life insurance reserves” as defined in Section
801 of the Code. Such health and accident insurance
was written on the same policy forms and was combined
with the life insurance which was also sold to the in-
sureds. The policies of life insurance were noncancelisile
and the life insurance was coterminous with the health
and accident insurance. Such health and accident insur-
ance was for an average term of approximately 18 months
and was noncancellable by the Taxpayer. Such noncan-
cellable health and accident insurance should be included
in the computation of unearned premiums, and unpaid
losses (whether or not ascertained), on noncancellable
life, health or accident policies not included in life insur-
ance reserves as described in Section 801 (a) (a) of the
Code; and the life insurance reserves plus unearned pre-
miums and unpaid losses on noncancellable life, health
and accident policies would comprise more than 50 per
cent of Taxpayer’s total reserves.
Further, in the alternative, if the District Director is
correct in determining that Taxpayer should establish
and maintain reserves with respect to the percentage of
health and accident insurance reinsured by Taxpayer
with American Bankers prior to 1962, the District Di-
rector erred in computing the amount of such reserves.
In computing “total reserves,” as defined in Section 801
(e), there should not be included therein any premiums
paid in advance. The reinsurance agreement between
Taxpayer and American Bankers provided for monthly
premium payments from American Bankers to Taxpayer
and the unearned premium reserves claimed to exist by
the District Director can exist only where there are sin-
gle premium payments. However, single premiums paid
under a monthly premium contract would clearly pay
premiums in advance of the due date, thereby creating
advance premiums and not unearned premiums as claimed
by the District Director; therefore, even if there were
single premium payments from American Bankers to
Taxpayer, rather than monthly premium payments, the
total reserves computed pursuant to Section 801 (e) would
not include the amount relating to advance premiums.
Therefore, for such period Taxpayer would qualify as a
‘life insurance company” since the computation of “total
reserves” should exclude the advance premiums, and the
life insurance reserves plus unearned premiums and un-
paid losses on noneancellable life, health or accident poli-
cies would comprise more than 50 percent of Taxpayer's
total reserves.
With respect to years, subseqeunt to 1961, Taxpayer,
in accordance with its Reinsurance Agreement with
American Bankers, remitted to American Bankers a per-
centage of the single premium for each policy reinsured
with American Bankers at the end of the quarter with
respect to which such premiums were collected. Had Tax-
payer withheld any portion of such single premiums due
29
to American Bankers, which would have at least been
necessary to have created unearned premiums on the
percentage of insurance reinsured as is claimed by the
District Director, Taxpayer would have been in violation
of its agreement to pay American Bankers single pre-
miums. If such amounts had been withheld they would
not in fact have constituted unearned premiums but
would have been a liability of Taxpayer to American
Bankers since American Bankers by contract was the
insurer of the risks represented by the percentage of
reinsurance and American Bankers was obligated to pay
claims arising from such risks and consequently required
by iaw to maintain the unearned premiums for such
risks. Thus, for the taxable years subsequent to 1961
Taxpayer’s life insurance reserves plus unearned pre-
miums and unpaid losses on noncancellable life, health
or accident policies would comprise more than 50 percent
of Taxpayer’s total reserves.
Further, in the alternative, if the District Director is
correct in determining that Taxpayer should establish
and maintain reserves with respect to the percentage of
health and accident insurance reinsured by Taxpayer
with American Bankers for years subsequent to 1961,
Taxpayer would, nevertheless, qualify as a “life insur-
ance company” as defined in Section 801(a) of the Code.
In computing the amount of “total reserves” the amount
attributable to such health and accident insurance re-
serves would be the cost of carrying the insurance risk
(see Reg. § 801-3(e)), and when such amount represent-
ing the cost of carrying the insurance risk is included
in the computation of “total reserves,” Taxpayer would
qualify as a “life insurance company” for years after
1961, since its life insurance reserves plus unearned pre-
miums and unpaid losses on noncancellable life, health
and accident policies comprise more than 50 percent of
Taxpayer’s total reserves.
Further, in the alternative, if the District Director is
correct in determining that Taxpayer should establish
and maintain reserves with respect to the percentage of
health and accident insurance reinsured by Taxpayer
with American Bankers, the District Director, neverthe-
30
less, erroneously calculated the numerator of the fraction
expressed in Section 801 (a) of the Code by failing to
include in the calculation of the numerator the unpaid
losses on noncancellable life insurance contracts. Tax-
payer recognizes that it is proper to include such unpaid
losses in the calculation of the denominator, total re-
serves, as the District Director has recognized in his
computations, but such amount must also be included in
the calculation of the numerator. (IRC 1954, § 801(a)
(2).) In computing both the numerator and denominator
the statute clearly provides that there must be included
the amount representing unpaid losses on noncancellable
life insurance contracts.
The life insurance reserves established by Taxpayer
during the period in question were computed or estimated
on the basis of recognized mortality or morbidity tables
and assumed rates of interest. Such life insurance re-
serves constituted amounts set aside to mature or liqui-
date future unaccrued claims arising from life insurance
contracts, and such reserves were required by law.
For the reasons hereinabove stated, the District Direc-
tor erroneously determined a deficiency in Taxpayer’s
income tax as a result of such determination and as a
result of the erroneous re-computation and adjustments
made to the Taxpayer’s reserves.
is
(Number and Title Omitted.)
(Filed: April 23, 1971)
ANSWER
The defendant, the United States of America, by its
attorneys, in answer to the petition filed herein, denies
each and every allegation of the petition, except to the
extent specifically admitted below:
COUNT I
1. Defendant admits the allegations contained in para-
graph 1.
2. Defendant denies any income taxes and interest
were erroneously overpaid and collected; defendant ad-
mits the remaining allegations contained in paragraph 2.
3. Defendant denies there has been any overpayment
of federal income taxes and interest; defendant admits
the remaining allegations contained in paragraph 3.
4. Defendant admits the allegations contained in para-
graph 4 except to state that the notice of deficiencies
was sent to the plaintiff by the Acting Regional Commis-
sioner, Internal Revenue Service, Southeast Region, and
that the deficiencies in federal income taxes were in the
aggregate of $233,762.75, not $235,762.75 as alleged.
5. Defendant admits the plaintiff paid $351,393.88 but
states that the Internal Revenue Service’s Certificate of
Assessments and Payments (Form 4340) for the taxable
years ended December 31, 1958, 1959, 1960, 1962, 1963
and 1964 shows the payment date thereof to be August
1, 1969.
6. Defendant admits the allegations contained in para-
graph 6.
7. Defendant admits the allegations contained in para-
graph 7 except to state that the Internal Revenue Serv-
ice receipt date stamped on each of the plaintiff's original
Claims for Refund shows they were filed on October 21,
1969, not October 14, 1969 as alleged.
32
8. Defendant admits the allegations contained in para-
graph 8.
9-12. Defendant denies the allegations contained in
paragraphs 9 through 12.
13. Defendant is presently unable to obtain knowledge
or information sufficient to form a belief as to the truth
of the allegations contained in paragraph 13 except ad-
mits that “During the taxable years ended December 31,
1958, 1959 and 1960, Plaintiff was a party to a Rein-
surance Agreement with American Bankers Life Assur-
ance Company * .“
14. Defendant denies the allegations contained in
paragraph 14.
15. Defendant is presently unable to obtain knowledge
or information sufficient to form a belief as to the truth
of the allegations contained in paragraph 15.
16-20. Defendant denies the allegations contained in
paragraphs 16 through 20.
COUNT II
1-10. Defendant realleges its answers to paragraphs
1 through 10 as stated above.
11-12. Defendant realleges its answers to paragraphs
13 and 15 as stated above.
13-17. Defendant denies the allegations contained in
paragraphs 13 through 17.
COUNT III
1-10. Defendant realleges its answers to paragraphs
1 through 10 as stated above.
11-12. Defendant realleges its answers to paragraphs
13 and 15 above.
13-20. Defendant denies the allegations contained in
paragraphs 13 through 20.
8
WHEREFORE, defendant prays that the petition be
dismissed with costs against the plaintiff.
Respectfully submitted,
/s/ Johnnie M. Walters
JOHNNIE M. WALTERS
Assistant Attorney General
/s/ Mark Segal
MARK SEGAL
Attorney
April 16, 1971
g
[1]
(Number and Title Omitted)
( Filed: )
TRANSCRIPT OF PROCEEDINGS
LOCATION OF HEARING:
UNITED STATES COURT OF CLAIMS
ATLANTA, GEORGIA
DATE:
July 17, 1973
BEFORE:
THE HONORABLE GEORGE WILLY
APPEARANCES:
ROGER A. SCHWARZ
HERBERT GROSSMAN
for the Defendant
E. MICHAEL MASINTER
JAMES H. LANDON
for the Plaintiff
[23] TESTIMONY FOR PLAINTIFF
Pursuant to the order of reference by the Honorable,
the United States Court of Claims, in the above entited
cause, testimony on behalf of the Plaintiff was taken
as follows:
THE COURT: Do you solemnly swear that the testi-
mony you are about to give will be the truth, the whole
truth, and nothing but the truth, so help you God?
THE WITNESS: I do.
THE COURT: Be seated.
THE REPORTER: Would you state your name and
24] address for the record, please?
85
THE WITNESS: John William Born, 1110 Kingston
Drive, Northeast Atlanta, Georgia.
THE REPORTER: And, how do you spell your last
name?
THE WITNESS: B-o-r-n.
JOHN WILLIAM BORN,
itn roduced on behalf of the Plaintiff, having first
* —— by said Commissioner, was examined
and in answer to interrogatories, testified as follows:
DI * EXAMINATION
BY MR. LANDON:
Q Mr. Born, would you tell us by whom you are
presently employed?
A Southern Discount Company.
Q Is Southern your only employer?
A That's right.
Q Do you hold positions with any other companies?
A Yes, with various subsidiary companies owned by
Southern Discount.
Q How long have you been employed by Southern
Discount group?
A Since March the 2nd, of 1959.
Q What is your position with the Plaintiff?
A I’m financial vice president, and secretary and
[25] treasurer.
And, how long have you held that position with
Consumer Life Insurance Company?
A Since, about 1965.
Q Can you tell me, and tell the Court, what is the
nature of your responsibilities as the secretary-treasurer
and financial vice president?
A I supervise the overall administrative functions of
the company, namely record keeping, and filing reports
of all sort—of all types.
36
Q Among those reports are you familiar with the tax
returns of the company?
Q Yes, I am.
And, with the annual statem i
submitted by the company? eta co
ry Ves.
Do you hold professional i
. I p degrees or certificates,
A Yes, I do.
And, what are those?
A I’m a CPA, and also a member of the Bar.
Q Thank you. Can you tell us please the relationship
of credit insurance in general to the business of Southern
Discount Company, the parent of Consumer Life Insur-
ance Company?
1261 A Southern Discount is licensed under the State
Small Loan Laws to make small loans, and these statutes
authorize the companies to sell credit life and accident
health, and also fire insurance, as an agent for insurance
companies.
Q Prior to the formation of Consumer Life, how did
Southern Discount arrange for credit insurance for its
customers?
A They were represented by American Bankers as
agent, and prior to that some other companies.
Q But, Southern Discount Company was the agent?
A That's right. Or some other subsidiary companies.
ey 1 ay. authorization to sell insurance,
—that is limi insurance incident t ‘
outstanding credit risks, or a
THE WITNESS: That's right, yes.
BY MR. LANDON: (Resuming)
Did Southern Discount receive commissions for act-
ing as agent on those sales of insurance?
A Yes, it did.
Q How were those commissions determined?
A _They were generally regulated by the states, North
Carolina limits the commission to 40 percent, Georgia
to advance commission of 50 percent, and then depending
87
upon [27] the profitability of the business, an additional
commission could be earned of up to 15 percent.
Q What motivated Southern Discount to consider
forming Consumer Life Insurance Company at this time?
A To increase its earnings, and—out of the insur-
ance, which is sold.
Q How could those earnings be increased by forming
an insurance company subsidiary?
A Well, by making within the company the profit
that was earned by the insurance company, over and
above the commissions paid to the agent.
Can you explain what that profit might be, in
other words we might take a hypothetical transaction, of
not—not considering any of our re-insurance questions,
just for an insurer, how does an insuring company make
money—assume that it is paid $100.00 in premium, what
happens to that?
A If you assume $100.00 in premium, the agent’s
commission would be $50.00 or 50 percent, the loss ratio
depending upon whether it is life, or accident-health,
could vary from as low as 10 to 15 percent, or as high
as 30 or 40 percent. So, that if you were to take the
commission expense of $50.00, and add for example a
$20.00 loss ratio, for claims, that would leave $30.00 to
—to the insurance company to cover its overhead, pre-
mium, taxes and profitabil- [28] ity.
Q And, would anything else come out of that $30.00?
You mentioned a contingent commission, would that—
A Assuming—based on a loss ration of 20 percent,
the company would pay an additional contingent com-
mission of up to 15 percent.
Q Right, then, whatever was left after that would
be the profitability to an insurance company?
A That's correct.
THE COURT: Before you were getting the commis-
sion income as a practical matter, weren’t you? You
didn’t have anybody selling this insurance, the—the lend-
er sold it didn’t he, when he loaned the money?
THE WITNESS: That’s correct, prior to the forma-
tion of the company, the finance company officers were
38
agents for American Bankers, and received a commission
—insurance.
THE COURT: Well, they had been getting this all
along, and they didn’t improve their earnings?
THE WITNESS: Not as it relates—
THE COURT: Not in that respect—
THE WITNESS: No, not as it relates to the com-
mission, they would not improve it by formation of a
company.
29] THE COURT: Right.
BY MR. LANDON: (Resuming)
Q The improved earnings though came from what?
A The profitability of the life insurance company
operation, as such.
Q Thank you. Can you tell us as opposed to the in-
surance company, how a re-insurance company makes
money?
A The re-insurer normally re-insures through a con-
tract or a relationship with another insurance company,
who is authorized to write business in a particular state,
where the re-insurer may not be, and with the general
plan being that the re-insurer receives certain premiums
in order to insure the risk, and bears the losses, related
to those premiums.
For example, you might have a—a treaty that would
call for such as in the case of the treaty between Con-
sumer and American Bankers, Consumer Life would
receive 87142% of the premiums. American Bankers
would retain 1212%, pay the premium taxes and their
overhead. With Consumer paying the losses, and com-
missions if any out of the 87½ %, and retaining what
additional profit might be available.
Q So, then, would it be correct to say that it is the
same sort of profitability that an insurance company
130] has, it is just that if you are not qualified as an
insurance company, the way that you do it is to be a
re-insurance company?
A You cannot normally get through a reinsurance
contract 100 percent of the premiums, you can get 87 to
90, sometimes higher, percent of the premiums.
39
THE COURT: When you say you, you are speaking
of the re-insurer?
THE WITNESS: That’s correct, sir.
BY MR. LANDON: (Resuming)
What exactly is re-insurance?
7 Re-insurance is a contract that is entered into be-
tween insurance companies, the result of which is to
spread the risk over a—a period of years. It is normally
done to—as a capital consideration, and in the case of
Consumer, the re-insurance contract was—was a con-
sideration to permit them to increase its earnings through
this arrangement.
Q Why did Southern Discount create a subsidiary
which acted as a re-insurer, rather than as a direct
insurer?
A Because of capital requirements, the re-insurer,
Consumer, could be formed for approximately $38,000.00
capital, and get into the business via the re-insurance
arrangement, to form a company to write directly. It
[31] would have required approximately $400.00 capital
—$400,000.00 capital to do so in Georgia, at the time.
Q But the re-insurer was not required to meet that
capital requirement?
A That's correct.
THE COURT: From the standpoint of the insurance
—what you might call insurance function, what if any-
thing is different in the nature of a re-insurer, on the
one hand, and an insurer on the other hand?
THE WITNESS: The primary difference would be
that the re-insurer does not issue the policies under its
THE COURT: But that’s mechanical, isn’t it?
THE COURT: I’m saying, from—in the context of
insurance function, that is to say, I suppose what—ah—
assumption of risk, is there any institutional or intrinsic
difference between an insurer on the one hand, and a
re-insurer on the other hand?
40
THE WITNESS: The only difference would be that
the re-insurer joins another company, in the carrying out
of the functions of an insurance business. And,—it was
just a means whereby the companies share in the profits,
and also the risk.
THE COURT: But, would it be fair to say that [32]
—that assumption of risk is the basic hallmark of the
two—
THE WITNESS: Yes, sir.
THE COURT: Enterprises, that they have in com-
mon?
THE WITNESS: Yes, sir, that’s right.
BY MR. LANDON: (Resuming)
Q Mr. Born, I want to show you now certain of the
Plaintiff's Exhibits that we have identified previously,
and would like for you to comment on each one of them,
just describe what it is. Plaintiff's Exhibit #27
A This is the re- insurance treaty between American
Bankers and Consumer Life Insurance Company, dated
in 1957, which was the first re-insurance agreement.
Q I show you Plaintiff's Exhibit #3?
A This is the re- insurance treaty between Consumer
Life Insurance and American Bankers Insurance Com-
pany, dated in 1962, which covered business ceded to
American Bankers by Consumers.
Q Plaintiff's Exhibit #4?
A This is a re-insurance treaty between the Life In-
surance Company of North Carolina, and Consumer Life
Insurance Company. This treaty arose out of the fact
that Southern Discount Company purchased, I believe it
was three or four branch offices in North Carolina, and
through [33] this arrangement Southern through Con-
sumer was able to get an additional income over and
above the limited commission that was payable by North
Carolina, or that North Carolina allowed, into the busi-
ness that was in force, and sold by the Insurance Com-
pany of North Carolina at the time, this amounted to
approximately 7% percent additional income.
41
Plaintiff's Exhibit number 5—
MR. SCHWARZ: Off the record for a moment, please
I didn’t hear the last —
(Whereupon, the Reporter played back part of the
tape. )
BY MR. LANDON: (Resuming)
Plaintiff's Exhibit #5?
2 This is the insurance treaty between Consumer
Life Insurance Company, and American Bankers, and
it covered business ceded to American Bankers, under
insurance be Ad op aan
Plaintiff's
2 This is a reinsurance treaty between Consumer
Life Insurance Company and American Bankers, ye
which Consumer ceded to American Bankers the -
ness written in the State of Florida.
Q Thank you. I show you Plaintiff's Exhibit 16, can
you describe what these Exhibits constitute? )
[34] A These were the re-insurance ceded siatements
that Consumer received from American Bankers, under
—1957 re-insurance treaty.
Can you state what is chown on the face of this?
A Yes, the—under the treaty, American Bankers was
t remit to Consumer on the life—credit life ousiness,
the premiums writien, and there is a calculation showing
the session of the credit life business, showing that Con-
sumer received 90% percent, which is for the year Janu-
ary, 1959, and under this particular Code, received 901%
reent of the written premium, and Consumer reim-
— American Bankers with the losses paid to that
period, and shows the reserve set aside for incurred, but
unreported claims, which—with the balance being paid
to Consumer. This was a net 7 but it included
i the losses, on a net 8.
1 you — hl — 17, and ask you to
comment solely on this Exhibit
A This oy re-insurance assumed statement, showing
that American Bankers, assumes risk under the 1962
agreement. This showed that—a summarization of the
42
premiums assumed by them, the computations of un-
earned and earned premiums, and the amount re-insured
by Consumer as shown as 80 percent, with a resulting
computation showing on a quarterly basis the experi-
enced refund, due Consumer for 135 that particular
period.
Q To turn your attention now to the re-insurance
treaty that we first examined there, the re-insurance
treaty dated 1957, how were the credit life insurance—
not the credit accident and health premiums, physically
handled under that—under that re-insurance treaty?
A They were ceded by American Bankers to Con-
Sumer on an as written basis, less their retention.
Q As re-insurer then, to what extent was Consumer
A Liable for ail of the life claims.
Q Did the method of re-insuring credit accident and
health insurance differ from the method of re-insuring
credit life, insofar as the transfer of the premium pay-
ments went?
A Yes. On the credit accident and health insurance,
the premiums were ceded to Consumer on an as-earned
basis
Q What does as earned mean?
health premium or insurance premiums generally, the
policy is written,—the policy might be written for 15 or
or sum of the digits’ method.
Q Were—why was there a difference in the way that
these two, the life
insured, one as written, one as earned?
economic loss in going into the business, based on the
capitalization of the company, which was originally some
00. The re-insurance of the accident
on an as earned pais was considered aecesary to pro
tect the capital of the company, and to ena
tinue to qualify to re-insure the life business. 8
Q Did this method of re- insurance affeet —
appearance of the company in any way or the eapi
i the company?
1 — the financial statement of ne — 4
would not reflect reserves for accident and hea
i it would only reflect elaims for one month. 2
* Did it affect the consolidated net income a :
or net capital picture for Southern Discount in gen —
A Ah—of course the—Southern’s overall ineome —
increased by reason of having formed the life insur
2 2822 insurance agreement, which we have
AL and the re- insurance of credit aceident —
health on an as earned basis, affeet that — — —
consolidated capital picture yA — Discoun
4 11 — the A&H on an as
written, the income would have been decreased, . *
@ You mentioned the term economic loss, an —
I believe that you would have had to have retain 4
serves [38] in the total amount of the premiums written,
4a
had you re-insured as written, what exactly would have
caused the economic loss that you referred to?
A The requirement that Consumer set up 100 percent
of the unearned premium.
Where does the loss come in with that? In other
words how much does Consumer receive—how much does
it reserve?
A Well, under the treaty—originally it only received
874 percent of the premium, and it would have been
required to set up the full 100 percent of unearned in
the reserve.
Q And, under the treaty, where—where was the 12%
percent retained?
A That was retained by American Bankers.
Q As to the credit life insurance, which was re-
insured under the 1957 treaty, what reserves were main-
tained by Consumer Life and what reserves were con-
tained by American Bankers?
A Consumer on the credit life, since it re- insured the
business on a written basis, maintained the total required
reserve, which was a reserve estimated, based on mor-
tality tables at approximately 40 percent of the unearned
premiums.
Q Those reserves therefore, are different from [39]
the sorts of reserves required to be retained for accident
and health insurance?
A That's correct.
Q Ah—who under this same treaty—the 1957 treaty,
as it was amended, maintained the accident and health
insurance reserves?
A American Bankers, I assume it was their contrac-
tual obligation to do so under the treaty—Consumer—
MR. SCHWARZ: I object to that answer, the con-
tract not only speaks for itself, but doesn’t have those
terms in it, I don’t think.
BY MR. LANDON: (Resuming)
Q All right. Did Consumer Life Insurance maintain
any reserves as to the accident and health insurance,
re-insured under the 1957 treaty?
A No, it did not—no it did not.
45
Q Are you aware of whether American Bankers
maintained any reserves as to those premiums?
A Yes, I have been told that they did, yes.
Q Were you ever required by any—by any regula-
tory agency, or anyone else to maintain reserves as to
that insurance which you re-insured?
A No. ,
Q The accident—no?
A No. aN See
[40] @Q How were these various reserve liabilities re-
flected on Consumer Life’s annual statements in its tux
returns for the credit life and for the accident and
?
ery same as—as they were reflected in the annual
statements,—the reserves—for the life insurance was
reflected as a liability. The reserves under the periods
1957, 1958 through 1961, the company did not have an
accident and health reserve.
Q Is Consumer regulated by law?
A Yes, it is. ;
Q What regulation does exist for Consumer in the
various states in which it operates?
A The home state, being Arizona, regulates Con-
sumer as to certain financial statement figures, invest-
ments, as to what generally the—sets up the rules and
regulations for the conduct of an insurance company
operation. When you get admitted into a state to write
direct business, then you are subject to regulations by
that state as to policy forms, but primarily the home
state law, as I understand it governs the financial state-
ment practices, and establishment of reserves, and—
So, as to the reserve requirements of Consumer
Life, which state law were you concerned with?
A Generally, the reserves were determined by the
[41] actuary, but based on my understanding, the—the
law of the State of Arizona was the—the law that we
were concerned with maintaining the reserves under.
Q Did Consumer Life comply with those reserve re-
quirements of the State of Arizona?
A Yes.
Q Was Consumer Life ever examined by the Insur-
—_ ** of the State of Arizona?
es.
Q_ How often did that occur under in the years in
which we are concerned, 1957 through 1964?
A It was examined—the period ending December 31,
1959, and then the period ended December 31, 1963.
Normally these examinations are conducted every three
years, but we went from 1959 to 1963 for some reason
without one.
Q That was in—who determi -
1 rmined when they were ex
A Well, as I recall, I requested the the December,
1963 examination, because we contemplated naking ap-
plication to do business in other states, and this is gen-
* 8 requirement for that.
as—in either of those examinations, was Con-
— 5 — * maintaining the — which you
ave just described to us, ever challenged or di
A Not to my knowledge. —s
[42] Q Would you have knowledge of such a challenge
or *
Ves.
Q What is the nature of that examination by the
Insurance Department of the State of Arizona? What
do they in fact physically do?
A They conduct a general audit of the assets and
liabilities of the company.
Q During period I you stated I believe, that your
annual statement reflected reserves for the credit life
insuranee, is that correct?
A Yes.
Q Then, you stated—or what did you state concern-
ing your annual statements as far as reflecting any re-
serves for credit accident and health insurance?
; A Under the first treaty, where Consumer was a re-
insurer, on the accident and health on an earned basis,
there was no reserves maintained.
Q Why did Consumer and American Bankers enter
a different re-insurance treaty in 1962?
A Ah—Consumer had—had been admitted to—as a
direct writer, and the—really it is a part of my analy-
sis of the—of the operation. We went to another com-
pany and got proposals to find out just what—what the
net cost of the profitability of the business [43] could
be to Consumer, so that the re-insurance treaty, in 1957
would not be applicable to the company as a direct
writer. We didn’t feel that we could carry the full risk,
so that that gave rise to a re-insurance treaty, and—
because of the fact that as you build the accident and
health business, you—you have to set up the full un-
earned premium, and pay the commission on it, it creates
a loss, so that based on my analysis of the business, we
determined to continue the re-insurance treaty in force
to execute a re-insurance treaty to cover the direct busi-
ness being written. This was in early 1962.
THE COURT: Excuse me, before you move into this
current era, referring now to the prior period, in which,
as I understand it, Consumer was functioning as a—a
re-insurer with American Bankers, operating as ceding
carrier, for both credit life and A&H, correct?
THE WITNESS: Yes, sir.
THE COURT: All right. Now, recognizing that in
the two categories the—the—the nature of the risk haz-
ards are different, nonetheless, if you examine the risk
assumed by the ceding carrier on the one hand, in your
credit life, and on the other the A&H, and then look at
the extent to which Consumer as the re-insurer in each
instance relieved American Bankers of the risk to which
it had exposed itself with the policy holder, do you follow
[44] what I am saying so far?
THE WITNESS: Yes, as to the credit life, yes.
THE COURT: All right. Did—or was there any
difference in the degree of risk to the insured that Con-
sumer assumed as a re-insurer in the case of A&H as
there was in the case of credit life, or put otherwise,
did Consumer assume any lesser portion of the risk as
a whole in the case of A&H than it did credit life?
THE WITNESS: No, the contract stipulated that the
re-insurer would assume 100 percent of the risk.
THE COURT: In each instance?
48
THE WITNESS: In each instance. But, that the
contract was amended in 1958, to limit Consumer’s lia-
bility to the earned premiums on a month to month
basis, which meant that Consumer as an operating com-
pany would not be liable to re-imburse American Bank-
ers, the ceding company, except to the extent of earned
premiums on the accident and health.
THE COURT: From 1958 forward?
THE WITNESS: That’s right.
THE COURT: Proceed.
BY MR. LANDON: (Resuming)
Q You have stated that Consumer Life and American
Bankers based on your investigation of the business and
the decision to qualify as a direct writer, then entered
into [45] a second re-insurance treaty in 1962. What
was the effect of that treaty as to the credit life written
by Consumer Life?
A Consumer retained all of the—the credit life in-
surance, the risk, the whole operation, the American
Bankers did not re-insure any of the credit life business.
Q And, what was the effect of that treaty on re-
insurance of credit accident and health insurance?
A We- Consumer ceded to American Bankers 80 per-
cent of the risk on aceiden“ and health.
Q did this re-insurance on an 80 percent basis, have
an effect—were the terms of the treaty intended to have
an effect on Consumer’s capital structure?
A Yes, because without the re-insurance, we would
have had to build the reserve plus pay the commission
to the finance companies, resulting in a—a—an opera-
— decrease in earnings, and thereby decreasing capi-
tal.
Q As to the 80 percent of the credit accident and
health insurance, which was ceded by Consumer Life to
American Bankers, did Consumer Life maintain any un-
earned premium reserve?
A Ah—not as to the 80 percent. Consumer did main-
tain and carry the reserve on 20 percent, which was
retained.
49
Who maintained the reserves on the 80 percent?
46] A American Bankers.
Q On whose annual statements were those reserves
reflected?
A On American Bankers.
Q Did any state regulatory body ever require Con-
sumer to maintain those reserves or indicate that those
reserves were being incorrectly maintained by American
Bankers, rather than by Consumer?
A No.
(Pause.)
MR. LANDON: That concludes our examination.
THE COURT: We'll have a ten minute recess.
(Whereupon, the hearing in the above case was re-
cessed at 10:29 as described above. )
THE COURT: Very well, before cross I would like
to inquire of the parties whether they discriminate or
distinguish at all between the—the situation presented
by the Plaintiff’s re-insurance of A&H up to this point
in time in 1958, at which I understood the witness to
state that its liability as a re-insurer by treaty amend-
ment became limited to its premium receipts as con-
trasted with the situation obtaining there before, which
I understood it, it was on the entire risk.
MR. MASINTER: If Your Honor, please, we do not
distinguish, because we have treated that all along [47]
as merely a clarifying amendment, more like clearing
up a typographical error.
THE COURT: Do you mean that you are contending
that as a matter of law, as it were, that—that Consum-
er’s liability as a re-insurer was at all times limited to
its premium receipt, so that the—
MR. MASINTER: Well, that’s—that’s—
THE COURT: 1958 action then, in your view was
simply declaratory of the existing arrangement?
MR. MASINTER: For the original re-insurance con-
tract of re-insured accident and health, on an as earned
basis. Now, the clarifying amendment merely sets forth
in the words what it meant by an as earned basis.
THE COURT: But didn’t the witness indicate that
there was a reduction in risk exposure to the Plaintiff
as a re-insurer by virtue of this 1958 amendment. I
thought that he told me that prior thereto in both the
credit life and the A&H, Consumer as the reinsurer
assumed the entire risk. That is to say the entire risk
that the ceding—that American Bankers assumed vis a
vis its insured.
Then I thought he went on to say, that in the case of
A&H. by virtue of a treaty amendment, in 1958, its risk
assumption was narrowed in that it was subject to a
ceiling amount. That ceiling being its premium receipis,
or maybe I misunderstood him.
[48] MR. MASINTER: Well, I think that is what he
said, but—ah—what he did not go further to say, is that
really the parties treated it from the very outset in the
same manner as they did after the 1958 amendment, and
actually I think the amendment was the early part of
1959.
There was no difference in the treatment, no differ-
ence in the forwarding of premiums, no—no intent dif-
ference—the intent was there all along from the very
outset, and I don’t think that there was any difference.
I think that he was just trying to pinpoint the date.
But you might—
THE COURT: Excuse me, you say the intent, by
that you mean the intent that Consumer’s not assume
the risk without limitation? That it was never intended
that it assume the entire risk incurred or shouldered by
American Bankers as the ceding carrier.
MR. MASINTER: I think that that is correct, Your
Honor. I think that the contract is clear that the intent
was that the re-insurer, Consumer, only re-insured the
A&H business on an as earned basis from the very out-
set. And, as earned means, as I understand the insur-
ance actuarial and accounting principles, on a month
to month basis. And, all that the 1958 or 1959 amend-
ment did was to say, that the liability of Consumer will
be on an as earned or month to [49] month basis, and
that’s really all it was from the very beginning.
51
So, I don’t—I don’t take the amendment to have any
substantive or risk shifting difference. I think that that
was the way it was intended to be from the very outset,
but this really just clarifies it.
THE COURT: Well, in ary event, can I correctly
assume that the amendment ia question is in the record
as a part of Plaintiff's 2?
MR. MASINTER: Yes, sir, it is, and—and if I
might—
THE COURT: Well, that’s fine. You all may cover
it any way you see fit, I just thought at the outset that
I would like to know whether there was a contention
that there was any difference, and you have answered
that in your view there is no difference.
MR. MASINTER: There has—there has never been
any contention by us or by the Government that it should
be treated any differently, and really it has just been
assumed that this was just a clarifying type of amend-
ment, which set forth the intent of the parties from the
very outset, of—
THE COURT: All right.
MR. MASINTER: Of the agreement, and had no sub-
stantive effect. And, his answer I think would stand [50]
really from the very beginning of the contractual ar-
rangement between Consumer and American Bankers.
THE COURT: All right, proceed, Mr. Schwarz.
MR. SCHWARZ: Your Honor, we do intend to pur-
sue the—these terms in the agreement on cross examina-
tion. I think that that may clarify your question some-
what more.
CROSS EXAMINATION
BY MR. SCHWARZ:
Q Mr. Born, would you agree that under both of the
insurance treaties that were the subject of your direct
examination, all losses that were ultimately paid to an
insured, were paid out of funds which would otherwise
have been earned by Consumer under the treaties, and
not by American Bankers?
A Well, they were all paid out of the premiums.
52
And, if those premiurms—if the losses were not
paid because they were not incured, that is because the
loss did not arise, would the money that would other-
wise have been used to pay those losses be earned by
Consumers under both treaties?
A Ah—yes, because, I suppose the premiums—the
source for the payment of the losses—as risk.
Could you—I think that I understand your answer,
but I believe you summarized it a little too quickly, [51]
could you be a little clearer?
A The premiums—generally, the revenue is a source
to pay the losses with. Now, under the first contract,
the premiums were generated through American Bank-
ers, so that the losses were transferred to Consumer
through the—through the first re-insurance treaty. Under
the second contract the policies were written by Con-
sumer, with a portion of the loss being transferred to
American Bankers by the treaty.
Q Now, there was experience refund provision under
the second treaty, is that right?
A That's correct.
Q Was the fact of that experience refund provision
such that any portion of that total amount subject to the
refund, which was not used to pay losses, would be re-
turned to Consumer?
A Ah—yes—
Q Asan experience refund?
A As an experience refund.
Q Is it correct, that under the second treaty then,
American Bankers stood to earn a three percent flat fee
under the agreement, and regardless of the loss experi-
ence, it could not earn more or less than three percent?
A Well, American Bankers stood to earn the three
[52] —the three percent, plus the investment income on
the reserve funds, which they held.
Q You are referring to the income on a portion of
the premium which was temporarily transferred to
American Bankers?
A That's correct, right.
53
Q And, that was the same portion that was subject
to the experience refund back to Consumer in the event
of a favorable policy experience?
A In the event of a favorable loss ratio, yes.
Q Is it your understanding that as a technical matter
under the insurance law, the direct writer is the only
company as between it and a re-insurer, which has a
liability to the insured, and that a re-insurer is techni-
cally liable only to the direct writer?
A That's correct generally.
Q But is it the effect of both of these treaties that
Consumer whether it was the re-insurer under the first
treaty or the ceding company, that is the direct writer
under the second treaty, was the one that retained the
ultimate liability for any claims that were paid to the
policy holder?
THE COURT: What-does ultimate mean?
MR. SCHWARZ: I’m using ultimate to distinguish
between the liability that the direct writer has to pay
[53] the claim to the insured, and the liability of some
other company, which may be incurred under a treaty
to pay the direct writer for the claim which it has paid
the insured under the policy.
THE WITNESS: I’m not sure that—that I under-
stand your question fully.
BY MR. SCHWARZ: (Resuming)
Q Let me make it a little simpler. Under the first
treaty, American Bankers was the direct writer, and
Consumer was the re-insurer?
A Yes.
Q When American Bankers entered into a policy with
an insured, it became obliged to pay claims that were
incurred by the insured?
A Yes.
Q Under the re-insurance agreement, the direct
writer knew that any claims which it paid to the insured
would be repayed to it by Consumer as part of the re-
insurance agreement, isn’t that correct?
54
A Yes, I think that it provided that the—the risk
of the re-insurer would follow the risk of the ceding
company under the policy.
And, it was
THE COURT: Well, excuse me, Mr. Born, is it your
understanding that that obtained from 1957 on until
54] era II, as you have called it here, where they re-
versed their roles?
THE WITNESS: Yes, sir.
THE COURT: So, that was unaffected by this 1958
amendment that you mentioned earlier?
THE WITNESS: As to the—the language—
THE COURT: A&H.
THE WITNESS: —in the contract called for one
hundred percent of the risk to be insured—reinsured by
Consumer, and that the liability of the reinsured would
follow the liability of the ceding company to the insurer.
THE COURT: And, that never changed by virtue of
this 1958 treaty amendment that you mentioned earlier?
THE WITNESS: No, only as to the point in time,
as to which when there would be a settlement of this
liability between the companies.
THE COURT: But, in terms of risk assumption and
exposure apart from the settlement or when or where
or how, there was never a change in that?
THE WITNESS: That’s right, it was one hundred
percent by reason of the contract, yes.
THE COURT: I see. Proceed.
BY MR.SCHWARZ: (Resuming)
Q Based on the answer that you have just given, Mr.
Born, isn’t it correct that the term as earned which
[55] you used in description of the accident and health
reinsurance treaties refers to the method by which
payments were made between the ceding company,
American Bankers, and the re-insurer, rather than !
terms of any modification of the ultimate liability of the
re-insurer, Consumer, for the payments which American
Bankers paid?
A I would look at it on the basis that—under the
re-insurance contract as an obligation for Consumer to
55
re-imburse American Bankers for losses, but the first
contract called for that liability to be limited to the
earned premiums on a month to month basis.
Did that term that you are referring to in any
way practically limit the liability—the ultimate liability
of Consumer for all claims regardless of how high they
were?
A Well,—
Q I believe that you stated, did you not, to—in an-
swer to Commissioner Willy’s question that one hundred
percent of the liability of American Bankers under
ae Oe Te ee Consumer, is that cor-
rect
A That's right.
Right, and the payment provision
MR. MASINTER: Your Honor, I would suggest that
you allow him to answer one question at a time. I think
that he has gotten about three questions involved there.
[56] MR. nt ey! - just gave an answer
to a question, an ere is one er question pending.
THE COURT: Proceed.
BY MR. SCHWARZ: (Resuming)
Q Now, let’s clarify what is meant by the term as
earned under the reinsurance treaty—the first reinsur-
ance treaty. Each month American Bankers would re-
ceive all the premiums written by Southern Discount
during the previous month, isn’t that correct?
A That's correct,
7 = the accident and health policies?
es.
Q Okay. Now, each month, losses would be incurred
* A outstanding policies, is that correct?
es.
Q Under the terms of the treaty, is it your under-
standing that in order to determine how much money
would transferred from American Bankers to the
reinsurer, you would compute first the figure called
— earned, is that correct?
56
Q This is part of the computation, I’m not trying
to take the whole thing—
A Yes, that was a part of it.
Q All right. Now, premiums earned would you say
[57] was effectively a fraction of the total premiums
received which equalled one month’s coverage out of the
total number of months over which the policies were
issued?
A Well, the premiums earned in any one month
would be the computation of the earned amount on all of
the policies in force. It wouldn’t have necessarily any-
thing to do with the business written in a particular—a
current month or a preceding month, but a number of
months.
Q Okay. So that with respect to the policies written,
the previous month, a fraction of the premiums earned
on those would be remitted, as well as a fraction of the
premiums earned on all other policies earned outstand-
ing as of that time?
A That's right.
Q Now, from that figure of premiums earned, Ameri-
can Bankers would subtract the losses paid during the
month?
A That's right.
Q And, would remit the balance to Consumer?
A This is on the accident and health, yes.
Q Was there any—was there ever any month in
which the total of the losses paid for the month ex-
ceeded the premiums which Consumer was to earn?
A I don’t know that I could say positively yes or
[58] no. The business was profitable. So, that in most
of the months there would have been a positive cash
flow to Consumer.
Q And, is it your understanding that, whether or
not such an event actually occurred—
A Ido not know that it did.
Q All right. If it had, is it your understanding
that under the treaty Consumer would have sent a check
to American Bankers for the excess, so that it would
discharge its one hundred percent liability for any
claims which American Bankers had incurred?
57
A No, it would have been carried over against fu-
ture periods.
THE COURT: But it would have been in any event
an obligation of Consumer to American Bankers?
THE WITNESS: That’s correct, yes.
BY MR. SCHWARZ: (Resuming)
Q You mentioned that one of the purposes for en-
tering into the first reinsurance treaty was to permit
Consumer to grow in its early years without having
the kind of loss position that would occur if it were the
direct writer, do you recall that testimony?
A Yes.
Q I would like to ask you a couple of questions to
clarify just what this meant. You were given an [59]
example, I believe, where $100.00 in premiums were re-
ceived, and $50.00 in commissions were initially paid
out, and I believe that the example referred to $20.00
in losses, leaving $30.00 of which a potential 15 per-
cent contingent commission might be paid under a re-
insurance agreement.
Now, let’s assume no reinsurance for a moment. If
the direct writer received $100.00 in premiums, its first
obligation would be to set up an unearned premium re-
serve of $100.00, isn’t that correct initially?
A Initially.
Q Initially. At the same time it would be obliged
to pay $50.00 in commissions at the outset, is that correct?
A That's right.
Q All right. That's the normal practice in insur-
ance, and in this type of eredit insurance?
A Yes, generally.
Q Now, if an annual statement were prepared as
of that date, let’s say that all of this took place in
December of the year, and an annual statement is then
prepared, is it correct that the surplus would have been
invaded by 50 in this example because you would be
required to set up a gross unearned prernium reserve of
$100.00, you would have paid out $50.00 of the $100.00
in premiums that you received, leaving $50.00 that would
have to reduce surplus?
160] A That's right.
Q And, if that is all that happened, the company
would be in a deficit position, assuming that it had no
other surplus?
A Yes.
Q Okay. And, is that what you meant when you
said that unless Consumer arranged its business under
a reinsurance agreement, whereby it was the reinsurer,
it could not have grown the way it did?
A That was an example in Consumer’s case by rea-
son of the design on the part of the company to build
the capital of the company in order ultimately to become
qualified in other companies. Consumer did not pay
that advance commission in the early years. So, that
the effect on consumer would have been only to the ex-
tent of the—the money retained by American Bankers,
which was 12% percent.
Q Well, then if Consumer had become the direct
writer, and had not paid any commission, and also be-
cause it did not have reinsurance, would not have had to
pay that reinsurance commission, then where would the
deficit position come in that you referred to?
A Well, Consumer would have had some $400,000.00
in capital in order to become a direct writer. This the
company did not have. The company was formed with
$38,000.00 [61] capital.
Q So that—the reason for setting up is not so much
the deficit position, but the fact that the capital re-
quirement in—in Georgia, or the states where it was
— to do this business, was much higher than another
state
A In Arizona, yes.
Q And, you waived the profitability of entering into
a reinsurance agreement, and having to pay a 12%
percent commission against what it would have cost to
accumulate the necessary additional capital, and I assume
decided on the course that you took, is that correct?
A This is—this is what I understand. Remember,
I indicated that I joined the company in 1959. So, that
Consumer had—was in operations under the reinsurance
treaty at the time that I came with the compény, but
59
is my understanding as to the reasons the method,
plan of operation to go into the insurance company
an Arizona company, was because of the small capi-
tal requirement, and it was done quite generally in the
industry as I understand.
THE COURT: And, what did you understand the
basis for the $400,000.00 capital requirement was, or
would have been, had you gone the alternate route?
THE WITNESS: Well, the insurance laws of—of
[62] states vary as to the amount of capitalization that
is required for a company to write insurance policies
in that state. For example, Georgia I believe is 200
200; North Carolina now requires us to have $600,000.00
in capital, and $600,000.00 in surplus. So, that with
the—in order to write the business in certain states,
where Southern was located, Southern would have had
to have had an additional capitalization to have written
business directly in the State of Georgia. So, this is
the reason the reinsurance company approach was used
in order to get into the life insurance business.
BY MR. SCHWARZ: (Resuming)
Q In what year did American Bankers begin to
pay commissions to Southern Discount under the first
treaty?
A I believe that it was 1959.
Q Do you recall approximately how much those com-
missions ran as a percentage of premiums?
A I believe that they were 20 percent.
Q Until that period began, was it correct that Con-
sumers was earning the money which was later paid to
Southern Discount as commissions?
A Well, Consumer was—was earning—was receiving
the—the life insurance premium, less the American
Bankers retention, and setting up the reserves, and earn-
ing this [63] —the profit on the life business over the
lives of the policies.
Q I’m not talking now in terms of the timing of the
earnings, but in overall effect, whether this was what
happened?
this
the
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60
A The end result was that yes, Consumer realized
these earnings.
Q Now, once American Bankers began to pay com-
missions to Southern Discount, was it then in a position
whereby it set up a gross unearned premium reserve
of 100 percent of the premiums received, paid out 20
percent commission at the outset, and with respect just
to those transactions, would have also been in a deficit
position—
A Except that I believe that the contracts were
amended to permit a pass through of that commission
expense to Consumer.
Q How did that work?
A The contracts were amended to show that—that
Consumer did in effect reimburse American Bankers
for the—for the 20 percent commission.
Q Well, in a normal reinsurance treaty, the rein-
surer will assume the liability for commissions as well
as for the payment of claims, isn’t that correct?
A Yes, um-huh.
Q If $100.00 in premiums are received by a ceding
[64] company, and under a typical agreement, 97 per-
cent of the premiums received will—will be the rein-
surance premium, and let’s say that the ceding company
or the direct writer pays over that 97 to the reinsurer,
from which commissions are then taken out, and claims
ultimately paid, the direct writer will still set up an
unearned premium reserve of $100.00, will it not, and
then offset that by reinsurance premiums paid?
A Yes, um-huh.
Q Under the first treaty, the parties agreed that
unearned premium reserves would be maintained by
direct writer—I withdraw that statement. Would you
look at Article 6 of Plaintiff’s Exhibit 2, please, and
tell me your understanding of its import?
(Pause.)
A Yes, I think that it stipulates who was to main-
tain the—the reserves.
Q Is it your understanding—
A Required by law.
61
Q Is it your understanding that Article 6 states
that the—that American Bankers—it is your understand-
ing that all this Article 6 says, is that American Bankers
shall maintain any reserves required by—by law?
A On the accident and health business.
Q Do you understand this to reflecting an agreement
[65] of the parties that it was American Bankers that
would maintain the unearned premium reserve rather
than Consumer on that business?
A Ah—I think that you would look to the contract
to determine that—the way that I read that it states
that American Bankers shall maintain the unearned
premiums, the loss and other reserves required by law.
Q Well, if the law states who is to maintain the re-
serve, then wouldn’t it be superfluous in this contract to
say that the parties shall obey the law?
A Well,—except that—
Q What I am getting at, Mr. Born, couldn’t the
parties agree here, within your understanding of the
—of the discretion allowed to companies, which enter into
reinsurance agreement, that one company or the other
might maintain the unearned premium reserve as part
of their overall agreement?
MR. MASINTER: I object to the question, I think
that the contract speaks for itself. This would be pure
speculation and conjecture on h‘s part as to what a
contract could or might say.
MR. SCHWARZ: I’m not—vwell,—
THE COURT: Well, I thought that he was asking
him about practice. This is—he told us that he is a
lawyer. The question—would seem to me, relate to his
[66] regular functions with, employment functions with
the Plaintiff. I—I think that he would be competent to
—if he—if he
MR. MASINTER: If he knows.
THE COURT: Exactly, if he's short on an under-
standing, he can so indicate.
THE WITNESS: Well, I’m not sure that I’m an
expert on reinsurance. But, companies quite often re-
insure policy risks for financial reasons, and the terms
of the contracts—the contracts that I have seen, and
have discussed with other people who have companies
similar to ours, and insurance companies can by con-
tract transfer their risk with the purpose generally to
spread their risk over a longer period of time for—for
capital reasons. Companies quite often in maybe De-
cember determine that maybe their capital is going
to be impaired, and if they do not do something they
might stand the chance of losing their license in a par-
ticular state, so that they would enter into a reinsurance
arrangement to transfer this liability to another com-
pany.
THE COURT: And, that is what we understand, Mr.
Born, but unless I misunderstand, all of that goes to
the function of—of reinsurance arrangement as a means
of transferring risk, and distributing risk, and all the
rest of it. But, I thought that what he was talking
about [67] was whether you had any impression either
way that once a reinsurance arrangement was in force,
so that the risk matters that you have just told us
about have been redistributed in accordance with the
parties wishes, then at that point is it your thought
that the parties are free to determine and decide among
themselves as to which of the respective risks they will
maintain requisite reserves, are they free to do that,
are they free to—ah—if you are the ceding carrier, and
I’m the reinsurer, do you have an impression as to
whether we are free, assuming that our reinsurer is
going to take 80 percent of the loss, or 100 percent of
the loss in this instance, is it your thought that, insofar
as regulatory requirements are concerned, we would be
left free to determine among ourselves who is going to
maintain these reserves, assuming of course, that however
we do it, we will wind up in the aggregate with a—
with a total reserving of the risk exposure?
THE WITNESS: Well, I could perhaps answer that
this way. It is my understanding that the regulatory—
the regulatory authorities would require the—the reserves
to follow the premiums. If you have the premiums, then
you required by law to set up the reserves.
THE COURT: I see.
63
THE WITNESS: If you do not have the premiums,
[68] then you—under the state laws, you would not be—
now as a matter of—
THE COURT: I see, so it is your impression that
reserve obligation follows premiums rather than reserve
obligations following risk assumption, in the event that
the two differed, the determinative would be premium
receipt?
THE WITNESS: That’s my understanding, yes.
THE COURT: Isee. Right.
BY MR. SCHWARZ: (Resuming)
Do you know what unauthorized reinsurance is?
A Generally, it would be a company that is not
authorized to reinsure, a contract company as a direct
writer having a contract with an unauthorized—a com-
pany that is not authorized by law, not approved by the
state regulatory authority as a reinsurer.
Q Could that reinsurer still be a competent, liquid
company, but for any number of reasons might not be an
authorized reinsurer in some particular state?
A This is entirely possible.
Q If a company entered into a reinsurance agreement
with an unauthorized reinsurer, and remitted the rein-
surance premium to the reinsurer, he—the insurance
regulatory authority or the direct writer might still
require it to maintain the unearned premium reserve
if the reinsurer [69] was not authorized, isn’t that cor-
rect from your understanding?
MR. MASINTER: If Your Honor please, I object to
the question, and I don’t think that it has anything to
do with this case, and—
THE COURT: I—I’m inclined to—ah—agree that at
least I don’t understand affirmatively what it has to do
with the case. What does it have to do with what he
is testifying about, Mr. Schwarz?
MR. SCHWARZ: Your Honor, he made a statement
as to his understanding concerning where the unearned
premium reserve would have to be set up, that is—
64
THE COURT: He said that the reserve obligation
followed premium payments or receipts, is that what
you mean?
MR. SCHWARZ: Les, and I am pursuing that prin-
cipal which he stated, in terms of one situation, one where
the reinsurance premium is transferred to a reinsurer,
but where that reinsurer is unauthorized to do business
in the state in which the ceding company is domiciled.
That is a very common situation, and I’m asking him
as to how he—what his understanding of the reserve
reserve requirement would be in that situation, and my
specific question was, isn’t it your understanding that
in that situation, the ceding company would still be
required to show the [70] unearned premium reserve
even though the premiums had been transferred to the
reinsurer.
THE COURT: If you have an understanding, the—
THE WITNESS: Well, I do not really have a basis
to answer, because I think that that would be a question
of determination of whether or not the ceding company
could take the reserve, it would depend upon the ex-
amining authority in the particular state. But, follow-
ing the same statement, the unauthorized reinsurer hav-
ing received the premiums would be required to carry
the reserve, I assume. This is—
BY MR. SCHWARZ: (Resuming)
Q Would it be in the discretion of the regulatory
authority in the ceding state to require it or not as it
saw fit?
A Ah—I think under general regulations, the insur-
ance commissioners have a certain authority to regulate
the companies, and they generally review its contracts
from a standpoint of financial soundness of the company
for the benefit of protection to policy holders, and under
certain circumstances, for many reasons, perhaps a par-
ticular state insurance commissioner could require a par-
ticular company to also carry those reserves, this—this
I’m not certain of.
[71] THE COURT: I think that you are getting close
to trying to push the witness into an expert status, Mr.
65
Schwarz, so—there are going to be experts, as I under-
stand it.
MR. SCHWARZ: I’m going to move on, Your Honor.
BY MR. SCHWARZ: (Resuming)
Q Would you state again the reasons Consumer had
for entering into the second treaty?
A The second treaty came about because we—we
had become licensed in Georgia, and later in North Caro-
lina, and had made application for the State of Florida.
The reasons that the reinsurance treaty was continued
was because of the—the financial analysis which I made
as to the effect on Consumer and on the company from
its consolidated income standpoint, that if we wrote this
business without continuing the insurance, there were
considerations of the net profit, and also considerations
of income taxes involved, related to the company.
So, that my overall analysis was that if we began to
pick up all of the life business, and all of the accident
and health, without a reinsurance company, it would
cost us in terms of consolidating net income, consider-
able money, which I did not want to reflect because of
the large volume of borrowings that Southern Discount
Company regularly made.
721 From a financial standpoint, it was my responsi-
bility to plan the affairs of the company so that from
an accounting standpoint the—well, I didn’t feel that
I was called on—upon to arrange or not arrange the
reinsurance, whch would have resulted in a reduced profit-
ability in financial statements thereby limiting the amount
of funds that we could borrow.
Q You would agree that you were entitled to arrange
your affairs so as to make as much money as you could?
A Yes.
Q And, that if tax considerations contributed to that,
you were also entitled to take those into consideration?
A Yes.
Am I correct that you still intended to continue
the assumption of 100 percent of the liability that arose
under the policies that were issued, as between you and
American Bankers, and that it was just a question of
rearranging the financial affairs of the company so as to
maximize the profitability of doing that?
A That was the result, yes.
Q Is it correct that even as you entered into the
second treaty, the first treaty remained in operation with
respect to policies that were in force at the time of
entering into the second treaty?
[73] A Yes, it did.
And that that treaty remained in force until all
the policies that were in force at the time of the second
treaty had expired in their normal course, is that right?
A Yes.
(Pause.)
MR. SCHWARZ: Your Honor, if I may just have
one minute, I think that I—
(Pause.)
BY MR. SCHWARZ: (Resuming)
Q I just have one more question, Mr. Born. Under
the first treaty, is it your understanding that if—that
if American Bankers had become insolvent, the rein-
surer would still be obliged to pay claims that arose
under the policies?
A Yes.
Q If the unearned premiums were being held by
American Bankers, where would the reinsurer get the
funds to pay those claims?
A Well, you would have had the accountability for
the unearned premiums. If American Bankers was in-
solvent, the—on the life business, there is no question
but what Consumer had the funds and was liable. But
on the accident and health, Consumer’s liability was lim-
itted to the monthly earned premium.
74] So, that had American Bankers become insolvent,
I would assume that as losses were incurred, that Con-
sumer would under the reinsurance treaty been required
to pay those losses, which would have had the same
effect really of spreading the losses out over the expira-
tion date of the policies.
67
Q To Consumer’s—
. 3 I assume that, yes, Consumer would have been
iable.
Q I see. There was no limit to Consumer’s liability
under those provisions, is that your understanding?
A I think that that is right, yes.
MR. SCHWARZ: I have no further questions, Your
Honor.
THE COURT: Redirect.
REDIRECT EXAMINATION
BY MR. LANDON:
Mr. Born, let me ask you one question solely. The
counsel for the Defendant referred to a three percent
guaranteed commission, which was paid, was that in fact
a guaranteed three percent commission at the time of
the treaty being written?
A That was an agreed rate.
Q Was there any way that that three percent [75]
could have varied based on the loss ratios, the loss
profitability that in fact occurred?
A No, we might have tried to negotiate it lower, but
insofar—insofar as the—contract it would remain the
same.
Q The three percent figure, right, had the money been
there, had losses increased to an extent that they would
have exceeded 97 percent for some reason with the com-
missions, and so forth, would that three percent have
been affected by that fact?
A Well, I think that American Bankers would have
been liable for 80 percent of the risk, and could con-
ceivably under those circumstances, it could have wiped
out their three percent, yes.
A And, that would be in effect to some degree in
addition to the capital reasons, which you gave for mak-
ing the determination under the second treaty—
A Yes.
Q And, other consideration would have in fact re-
sulted in some risk sharing to that extent, were—had
68
those events occurred, which apparently they did not
during that time?
A That’s right.
MR. LANDON: Thank you.
THE COURT: May I ask for my own edification,
[76] are you contending that Consumers loss liability
as a reinsurer of these risks was to any extent affected
or reduced or limited by the amount of premium dol-
lars that it got at any one time?
MR. LANDON: Your Honor, I am not one to inter-
pret the exact words of that contract. Mr. Born men-
tioned the 1959 amendment, which stated that it was
limited. I think that the—
THE COURT: Well,—but I am putting that to one
side. Now, I would just like to be clear about what—
about what you are contending here, because frankly,
I—he is a very knowledgeable witness, and he seems to
be completely forthright, but I feel that I am with him,
I’m following everything, and then he’ll make a remark
like he did here just a minute ago, well, yes, up to the
extent of the premiums they got. And, then, I think to
myself, well, apparently I didn’t understand him.
Now, can’t you tell me what you’re contending, as to
this risk liability, is it affected by the amount of premium
dollars that Consumer receives as a reinsurer, as dis-
tinguished from a contractual covenants assigning or
apportioning risk, as such, and not premium dollars?
MR. LANDON: Ah—I think—what I gather your
understanding is is the correct—and as Mr. Born ex-
plained, the distinctions were as to the settlement, the
[77] times of payment, and that sort of thing, but did
not affect the—
THE COURT: Fine.
MR. LANDON: That is my understanding.
THE COT'RT: Now, what I meant is, just a minute
ago when counsel was asking him about—well, suppose
American Bankers went broke, became insolvent, would
Consumer not have to come up with any risks incurred,
or losses experienced, and then I thought he said yes,
up to the amount of the premiums they had gotten.
69
Well, that set me back again. Now, as I understand
it, if you disregard when they have to make this pay-
ment, and just focus on whether they have to make
good these risks, there is no question but what Consumer
as a reinsurer in A&H and credit life had to come up
with 100 percent of the risk exposure, is that right,
Mr. Born?
THE WITNESS: That’s correct, yes, sir.
THE COURT: At some time or another?
THE WITNESS: That’s right.
THE COURT: Okay. |
MR. LANDON: That concludes my redirect exami-
nation.
THE COURT: All right, anything further?
RECROSS EXAMINATION
BY [78] MR. SCHWARZ:
Q I just want to pursue that point one short step
further, regarding the three percent figure under the
second treaty, three percent commission that American
Bankers was to receive. Isn’t it correct, Mr. Born, that
that three percent was a fraction of the reinsurance
premium that was payable to American Bankers, and
not a fraction of all premiums received by Consumer as
the direct writer?
A It was a fraction of the earned reinsurance pre-
miums being 80 percent of the—of 100 percent of the
premiums, three percent of that figure.
Q If in any month the loss experience with regard
to the portion that was reinsured with American Bank-
ers exceeded the earned premium, isn’t it your under-
standing that that negative balance would be carried
forward to the next month?
A Yes.
Q So, that American Bankers would still get its three
percent out of that premium, even if that loss total was
greater than the premium earned?
A In a particular month. But his—the example was,
that if you had a 97 percent loss ratio, then you would
70
at that point—American Bankers would begin to lose
that three percent.
[79] Q Would you explain—well, if in any month
the losses were—in any month the losses would have to
be 97 percent of what in order for American Bankers
to lose that three percent?
A Well, American Bankers received 80 percent of
the premiums, so, insofar as American Bankers are
concerned, the loss ratio—it really wouldn’t have made
any difference rather it was 97 percent of 80 percent of
the premiums, or 97 percent of 100 percent of the pre-
miums, because the amount that American Bankers was
to reimburse Consumer was—was 80 percent, so the
minute 80 percent of the losses payable by American
Bankers exceeded the 97 percent of 80 percent of the
earned, then American Bankers would have had a loss.
Q II thought that we had clarified this, but your
answer suggests that we haven’t, and I think that it
ought to be clarified at this point. I hand you Exhibit
number 3, Mr. Born, and ask you to summarize your
understanding of Article 6 of that Exhibit, which is
headed experience refunds?
A The experience refund to Consumer Life Insur-
ance Company would have been the earned reinsurance
premiums less a reimbursement of the earned reinsur-
ance commissions, less three percent expense profit.
Q Now, that is the three percent that we are [80]
talking about here, is that correct?
A That's it. And, less incurred reinsurance claims
during the calendar quarter.
Now, would you read paragraph 2 of Article 6,
first, and then tell us your understanding of it?
A And, if the foregoing formula is negative for a
given calendar quarter, such negative amount will be
treated as an addition to incurred claims in calculating
the experience refund for the following calendar quarters.
Q Is it your understanding that under that provision,
in any one month, whether that result is positive or
negative, American Bankers will get its three percent,
and the only month—I end my question there, isn’t it
correct that first the three percent due to American Bank-
71
ere comes out, and then everything else is subtracted,
and if there is a negative result it is carried forward to
the next month. So, that the only time that Consumer—
that American Bankers could ever lose anything would
be at some termination point if there is still an excess,
and the treaty doesn’t say what would happen under
those circumstances, does it?
A There is an amendment to it, that says that that
will be dropped after 20 quarters.
Q So, that the negative figure would have to be car-
mer „ 20 — rs . order for it—
it would not charged against this—
against this refund.
Q All right.
A American Bankers would have had it.
Q Wouldn’t you say that as a practical matter, it
was virtually impossible that the experience under this
treaty would ever produce a loss of that three percent
even for one quarter to American Bankers?
i
Q In setting the three percent figure that Consumer
agreed to pay American Bankers under this agreement,
would you say that the possibility of—of the amount that
was going to be paid to Ameriean Bankers being actually
pay claims was an extremely minor eonsidera-
1
:
:
4
8
g
:
:
:
:
72
correct? Because the negative figure would be carried
forward indefinitely?
A Well, you would have to accumulate the results
of the formula computation. If you got into a high-loss
ratio, with the last factor being negative, more than
off-setting the earned premiums, then I could I could
see a condition not in Consumer’s case because of the
volume of business involved, but I could see a certain
circumstance under which American Bankers would have
a loss situation, and would lose that three percent.
Q But, you are saying that at the time that this
treaty was negotiated, in view of the experience that
Consumer had thus far under the eariier treaty, within
the industry, there was not that—
A That's right. The loss ratio of the type of business
was—was well known to both parties.
MR. SCHWARZ: I have no further questions, Your
Honor.
[83] THE COURT: Anything further, Mr. Masinter?
FURTHER REDIRECT EXAMINATION
BY MR. LANDON:
LI ask him to repeat—Mr. Born, didn’t you say that
this sort of contract was customary in the industry, and
that this was a competitive rate that was used?
A Yes.
And, the point being that I think that counsel was
raising, was whether or not this was—this possibility of
loss based on an extremely high loss ratio, was an in-
ducement to the contract, it was nonetheless a fact, a
possibility did exist regardless of its remoteness, or
whatever was that what your statement was?
A Yes.
MR. LANDON: That’s all the questions.
THE COURT: Was this American Bankers outfit a
total stranger to both Southern Discount and Consumers
in the terms of any ownership attributes?
THE WITNESS: Ah—I guess that the two compa-
nies had done business over a number of years.
73
Southern had acted as agents for American Bankers
prior to the formation of Consumer Life. American
Bankers at one time had a small interest in Southern
stock, but that was later disposed of. So, that in terms
of the [84] negotiations between the companies, Ameri-
can Bankers was an independent company at all times,
with Southern having no incident of ownership in
yo as such.
URT: Or vice versa after the liquiuation of
the stock to which you just referred? 10
THE WITNESS: That's right.
MR. SCHWARZ: Your Honor, may I just ask one
question or two about that stock interest, which I forgot
to ask on my examination?
FURTHER RECROSS EXAMINATION
BY MR. SCHWARZ:
Q Is it correct, Mr. Born, that the—that American
Bankers owned 21% percent of the stock of Southern Dis-
count 9 1962 until March 25, 1969, and
approximately an itional 1 percent ired in 1972,
which it held until February ‘of 1973?
A Yes, it is.
Q March 15, 1972 was about a month before the sec-
ond treaty, is that your understanding? The second
treaty was—
A That’s—I’m sure that that is correct.
Q Was the—was the stock acquisition acquired in
connection with the renegotiation of the treaty arrange-
ments between the two parties?
A No.
[85] Q What were the loss ratios under the first
treaty, what range did they actually cover, do you recall?
A Do you mean as to life or accident and health?
Q As to life and accident and health.
A The loss ratios on the life, and this would be
based on—I guess an accumulation of the figures over
the period from 1957 until on in through 1963 or 1964,
would have been in the range of 23 to 24 percent of—
give or take two or three percent, and based on—
74
Q Of the premium charged? a
A Based on an earned premium basis. On the acci-
dent and health, the approximate loss ratio would have
been in the area of 30—30 percent approximately—28
to 30 percent.
Q Is that approximately the ratios that were experi-
enced before these contracts were entered into in 1957?
A I have no information on what the loss ratios were
prior to that time.
MR. SCHWARZ: No further questions.
THE COURT: Mr. Masinter?
MR. LANDON: No further questions, Your Honor.
THE COURT: Thank you, sir, you may be excused.
(Witness excused. )
[86] MR. MASINTER: Your Honor, we are ready for
our next witness, it might help if you would give some
idea as to what time you want to reeess for lunch?
THE COURT: Whatever your pleasure is. It makes
little difference to me, around noon or anytime there-
after that you get to, you might begin with him, and
when you get to a point that you feel is convenient or
that you want to regroup, or for any other purpose,
why just indicate that you would like to recess.
MR. MASINTER: All right, fine. A. C. Eddy, Jr.
will be our next witness.
THE COURT: Raise your right hand. Do you sol-
emnly swear that the testimony you are about to give
will be the truth, the whole truth, and nothing but the
truth, so help you God?
THE WITNESS: I do.
THE COURT: Be seated.
THE REPORTER: Please state your name and ad-
dress for the record.
THE WITNESS: My name is Arthur Crooks Eddy.
THE REPORTER: Would you spell it please?
THE WITNIESS: Arthur, A-r-t-h-u-r, Crooks,
C-r-o-o-k-s, Eddy, E-d-d-y.
THE REPORTER: And your address, please.
THE WITNESS: 3167 Linden, L-i-n-d-e-n, Road,
Rocky River, Ohio, 44116.
75
187 THE REPORTER: Thank you.
ARTHUR CROOKS EDDY, a witness produced on
behalf of the Plaintiff, having first been duly sworn by
said commissioner, was examined and, in answer to inter-
rogatories, testified as follows:
DIRECT EXAMINATION
BY MR. MASINTER:
Q Mr. Eddy, what is your present occupation?
A I'm a consulting actuary.
Q How long have you been engaged in that nature
of work?
A In being an actuary, I’ve worked for approxi-
mately 25 years, and consulting work for about 13 or
14 years.
Q Would you please describe the nature of the services
that you perform as a consulting actuary?
A Well, the ser ices are three general categories.
One are advisory services in the area of life insurance
company management problems, life insurance company
administrative problems, accounting, taxation and tax
paying, or in „* processing, rate making, reserve cal-
culations, annual statement work, things of that nature.
MR. SCHWARZ: Your Honor, in the interest of time,
we * stipulate to Mr. Eddy’s qualifications as an
expe
MR. MASINTER: Okay, thank you.
[88] THE COURT: Well, excuse me, I guess I would
a yt | - 1 an expert on what?
. : I was getting to that, Your Hono
THE COURT: Al “a sash eaaae
: INTER: I was going to go into some
tions also about his background as 4 — le
indicated that he performed some services with respect
te the income taxes and accounting type matters.
BY MR. MASINTER: (Resuming)
Q Does an actuary perform accounting work also?
A Yes, for life insurance companies to the extent that
76
life insurance accounting is somewhat penerally—dif-
ferent from general accounting, and differs from the
AICPA’s interpretation of general accepted accounting
principals as far as their annual statement of reporting.
It involves the type of bookkeeping which the actuaries
refer to as an incomplete system of double entry book-
keeping, and that has to do with how a company’s
develop and account for—on their statements, their major
liabilities, namely their policy reserves. And, calcula-
tions of policy reserves involve life contingency mathe-
matics, which are generally the type of mathematics—
well, specifically the type of mathematics which actuaries
are compelled [89] to learn and to understand.
So, that particular function in life insurance compa-
nies is generally delegated to actuaries to perform. And,
this frequently encompasses the assistance in or the com-
pletion of their annual statements, and also tax returns.
Q In order to become a member of your professional
association or society, do you have to study accounting or
take specific examinations in accounting?
A Yes, an actuary does have to have passed exami-
nations in his subjects.
MR. MASINTER: We will submit, Your Honor, that
the stipulation as to Mr. Eddy’s expertise runs to his
qualification as an actuary, and also his qualification as
to accounting matters, insofar as they relate to insur-
ance company, examinations, and the types of things that
Mr. Eddy just testified to.
THE COURT: I see. Is that understood by the
Government?
MR. SCHWARZ: That’s satisfactory.
THE COURT: All right, that will be so stipulated.
BY MR. MASINTER: (Resuming)
Q Mr. Eddy, would you describe briefly the general
method of regulation of insurance companies that is in
effect [90] in the United States?
A Well, insurance companies are for the most part
regulated by several insurance departments; the insur-
ance laws and regulations of the various states in the
United States.
The extent of federal regulations is very minimal and
generally is restricted to federal income taxation.
Are these regulatory requirements uniform or con-
sistent in any way?
A The—the insurance statutes of most states are
quite similar, and especially with respect to things such
as policy and contract liabilities and reserves, and this
is mostly through the efforts of the National Association
of Insurance Commissioners, which has been in existence
for many decades, and through their concerted efforts,
and their various committees and sub-committees, they
have developed various guidelines, which led to very much
uniformity, as far as legislation and as far as rules and
regulations promulgated by the insurance departments
of the several states.
And, there are differences, of course, and no two states
will be precisely the same in all respects, insofar as their
regulations. But, there is a thread of uniformity in
many of the important areas.
1911 Q How do the states conduct examinations of
insurance companies?
A The—the Commissioners have divided the United
States into several districts, encompassing states,—ad-
jacent states, in these various—and these are called
zones, and the—
Q What are they called?
Zones.
Q Zones.
_A And, the insurance companies domiciled in a par-
ticular zone are generally examined by representatives
from the insurance departments, comprising the states
of that zone. And, ihe chief examiner is generally an
examiner from a state that the company is domiciled in.
Frequently states who have a major interest or a large
number of policy holders in a company outside its zone,
may still be represented in an examination.
But, generally speaking the examinations are per-
formed within the zone, by the zone states or representa-
tives from the zone states.
Q Well, let's take for example a company that may
be doing business or contacts with eight or ten states,
and suppose the eight or ten states lie in two different
78
geographical zones, how would an examination come about,
who would appoint the examiner?
[92] A Well, the—the selection of examiners for an
examination depend first of all on the influence that
the chief—in the home state examiner—and the chief
examiner, and availability of those other examiners who
would be free to help an examination, and who are also
interested in a given company. And, then, also, the con-
sideration of the volume of insvrance business in a
given state would have some influence on that state’s
interest in participating in the examination.
THE COURT: Mr. Masinter, maybe I misunderstand
the definition of an actuary, but his stipulated expertise
is as an actuary, and one versed in insurance accounting
principals, now does all this business about regulatory
practice, and what not fall under one or the other or
both of those umbrellas, and if so which?
MR. MASINTER: Well, I think both, Your Honor.
I think that the actuary is the—the only perculiarly quali-
fied to respond to all of these matters that relate to in-
surance companies, certainly a lawyer is not, I’ll tell you
that.
THE COURT: Well, maybe I—right, well, maybe I
misunderstand what an actuary—I always thought that
an actuary was a fellow who told him what risks you
were going to assume, and he was supposed to tell you
how much you would have to lay away to defend that,
and I didn’t [93] know he had anything to do with
regulations.
MR. MASINTER: I would suggest that it might be
appropriate for Mr. Eddy to—to describe for the Court
exactly the functions that an actuary does.
THE COURT: All right.
MR. MASINTER: I think that that would be ap-
propriate.
THE WITNESS: Well, it might be a little difficult
for me to mention all the various things that one is
required or called upon to do, in the actuary profession.
But, they do encompass dealing with insurance depart-
ments, both in determining or developing policy forms,
the policy contracts themselves, reinsurance contracts.
79.
Then the question of reserve caleulations, and cer-
tification of reserves, as a consulting actuary, one fre-
quently represents insurance departments in the cer-
tification of reserves, as a representative of the insur-
ance department, which is a role that I have performed
on occasions.
We also are required to be familiar with the valuation
requirements, and the reporting requirements of the
states in which our companies are operating.
MR. MASINTER: Does that—sufficiently—
THE COURT: III think that I understand [94] his
exposure, I—I just don’t want you to be mislead—
frankly it would seem to me that if you all—now maybe
this is not going to occur, but if you all got into some
controversy—some viable controversy about what a par-
ticular jurisdiction required, I don’t think that this
man, and his thoughts on that subject would be par-
ticularly probative to me as opposed to going to what
I would consider the horse’s mouth, that is someone
competent to speak for the jurisdiction in question.
Now, maybe you all don’t—you know, aren’t going to
encounter that kind of—of thing, but I don’t see where
he is—well, he spoke about reserves for example. I
can understand where he could—would have expertise in
matters of reserve computation, and—ah—derivation or
the like, but I don’t understand that he would have
expertise in something that went to the question of
the prescription of a reserve, or why something of that
sort would be required and if required the extent to
which it is required, and all of those kinds of things.
MR. SCHWARZ: Your Honor, I—
THE COURT: But, you may not have any problem
along those lines.
MR. SCHWARZ: In terms of what we have stipu-
lated to, I think that it might be appropriate for me to
make one statement in that regard.
1951 THE COURT: All right.
MR. SCHWARZ: Mr. Eddy, has had a great deal of
experience in connection with the filing of annual state-
ments, and from that experience he would know what
— —
some insurance department accepted in a certain case, and
what it didn’t accept in certain cases within the realm
of his experience.
I would not object to—to his stating the results of
his experience in that regard for whatever it is worth.
THE COURT: Well, all right. All right, but in that
capacity, he would be speaking as a fact witness, as I
understand it, and not an expert. Isn’t that right? I
just want to be sure that you are not mislead.
MR. MASINTER: Well, if Your Honor, please. I
think that, that the capacity of an actuary as an expert
in matters relating to insurance company regulations
does go to the question of—of the requirements for re-
serves, the—the respective regulatory requirements of the
various states in which their clients do business. I
think that this is quite properly the subject matter of a
consulting actuary, and one who is an expert in his
field.
THE COURT: Well, all right.
MR. SCHWARZ: Your Honor, I limited my—my
stipulation—I would like to limit my stipulation to [96]
that kind of testimony, and the reason that I stated it
the way I did was because if questions were posed saying
what would the insurance departments do or would they
permit thus and so, I don’t think that Mr. Eddy is
qualified to say what Arizona would do or what another
state would do. He could say that as an expert having
covered a lot of audits of this type, he had known that
it has been done. To that extent an argument, an argu-
ment can be made that that was the policy at the time.
But to say that in this situation which he is not
familiar with, based on his understanding that their
policy is this or that, I don’t think that he is qualified
to testify to that.
THE COURT: I think maybe that’s a decent exam-
ple of the kind of thing that I would have in mind,
Mr. Masinter. If for example, it were germane as to
what Podunk required with regard to particular insur-
ance, his opinion in the matter, as against a man who
~is—works as the chief administrator of—of Podunk’s
program in this particular, why I would
81
MR. MASINTER: I have no difference as to that,
Your Honor.
THE COURT: All right, fine.
MR. MASINTER: I think that Mr. Eddy is quali-
fied to testify as to his general experience in [97] mat-
ters of this nature. As to precisely what the State of
Florida, and the State of Arizona, and the State of
Georgia did in this particular instance is clearly a mat-
ter of record. It is reflected in the annual statements,
and in the reports of examination conducted by the
various insurance departments.
THE COURT: All right. So he is going to talk
about what you might call generally industry practice.
MR. MASINTER: General industry—
THE COURT: As he understands it?
MR. MASINTER: That’s correct.
THE COURT: All right.
BY MR. MASINTER: ( Resuming)
Q Mr. Eddy, let me ask you this, in what states do
your clients conduct business, at the present, and over
the past ten years, what states generally have you been
familiar with?
A Well, most of the contiguous United States—the
states of the United States. And, I don’t know of any
offhand that I didn’t deal with. But I can’t be abso-
lutely certain right at the moment.
Q When you deal with the regulatory authorities,
what type of matters do you become involved with, and
what is the general nature of your experience and ex-
pertise in dealing with the regulatory authorities?
[98] A Well, the most common encounters are dealing
with the policy forms, the reinsurance forms, reserve
certifications, valuation reports, and on company ex-
aminations, and consultation with examiners at various
companies while on examination about various details to
be handled or reported in their own reports—their ex-
amination reports.
Q What is a reserve certification on valuation?
A Well, the—various insurance companies have their
reserves certified by the home state, and when they are
operating in more than one state—under one state’s
jurisdiction, they generally are required to get a certifi-
cation of the reserves which they report in their annual
report, certified by the insurance department of their
home state, as to its sufficiency and accuracy, and this is
then submitted with their filings to the other states in
which they are operating or licensed.
Another type of certification is the one required by a
number of states, within the last few years, and a
growing trend, in that the insurance departments of
the several states are now requiring a certification of
reserves to be performed by independent actuaries for the
companies domiciled in their own state, which is a
second type of certification.
Q Tell us how that type of certification comes [99]
about, and what role an actuary would play?
A Well, it’s—it’s a growing problem in the insurance
industry, and I presume, to—to be able to accept the
reserve reported by the 1800 odd companies without
some assurances that they have been—the reserves them-
selves have been examined by someone qualified. And,
this—there maybe six or eight states now—maybe ten
states who in order to satisfy themselves that this exam-
ination has in fact been done, they are requiring an inde-
pendent certification, someone not on the cor. Hany's staff.
Q Is this the type of work you might do?
A Yes, I have done that type of work.
Q In what states have you performed this type of
certification?
* Ah—Ohio, South Carolina, New Hampshire, I’m
not sure what others at this moment.
Q But more than just one or two?
A Oz, yes, right.
Q Do the state insurance departments accept gen-
erally the certification performed by an independent
actuary, or do they perform their own examination
report?
A Well, to the extent—this is a new requirement,
you understand, for independent certifications, that is
Q So actually you have worked for an insuran
department as well? N
A I have, yes, sir.
Q So, it might be possible for any insurance de-
partment in any state in the United States to come hire
you, A. — you would perform independent work
or them
A Well, they do—do hire independent consultants, I’
1 8 es eg
Mr. Eddy, would you tell us if you are general
familiar with what is meant by credit life 1
and credit accident and health insurance, would you
describe that for us?
his disability.
And, the benefits provided by the general type [101]
credit insurance contract is to pay the amount of the
unpaid indebtedness on death to the creditor, if there
is any excess payment that is id to th j
of the debtor. 7 a
And, in the case of the accident and sickness bene-
84
Q Would you describe for us generally how the credit
insurance grew and developed in the United States?
A Yes, sir. Credit insurance was by most standards
practically non-existent at the end of World War II. In
fact in 1945 there was some $400,000,000.00 of credit
insurance in force in the United States life companies
covering about 2,000,000 people.
By the end of 1971, that had grown to be more than
$114,000,000,000.00; covering some 99,000,000 people.
Now, this insurance grew, and that information you
can find in the life insurance fact book, which is pub-
lished by the Institute of Life Insurance. I’m quoting
from the 1972 publication. The 1973 publication would
have more up to date figures than that.
[102] Now, this business grew, power in growth, the
growth in consumer financing, which I’m sure that
most people in business realize, gots its fresh start and
impetus after World War II also.
I don’t know—have I answered your question?
Q Would you tell us the main companies that were
involved in this industry in the early development and
throughout the development of it?
A Well, in the earlier days of credit insurance, the
pioneering companies were companies such as American
Bankers, companies like Old Republic out of Chicago,
American National out in Texas, Pilot Life Insurance
Company, a former employer of mine, and a number of
other fairly large companies, with substantial diversity of
products—insurance products.
But, these companies were the ones who really initiated
the credit insurance programs. And, they recognized the
saleability of credit insurance, and developed the prod-
ucts as the consumer financing grew.
In the early days of credit insurance, the insurance
was really sold by these companies, the policy forms were
theirs, and they simply used the finance institutions, the
loan offices, or an individual in the loan offices, or the
banks, in the case that the banks were involved in credit
insurance, as their agents. And, they [103] paid gen-
erally they paid a commission to the financing institu-
tion through those individuals.
85
And, they were then the only insurance company in-
volved in the operation. It wasn’t too long after the
beginning of the large great growth of credit insurance
though that insurance companies or the financial insti-
tutions such as Southern Discount here recognized that
they were not getting all of the profits from the opera-
tion, and that they in fact were the economic powers
that generated the—the insurance opportunities—the in-
surance sale opportunities.
And, as a matter of fact, and something easily sub-
stantiated, there was a great growth in small limited
capital insurance companies organized during that period
of time, starting in the late 1940’s, going into the 1950’s,
in the State of Arizona.
For example, currently there are about 350 life com-
panies in Arizona, most of which are of the Consumer
variety, domiciled there, out of 1800 companies in the
United States. In fact the insurance in force in Arizona
represents maybe about something less than one percent
of the insurance in force in the country, and that is total
insurance, all types. And, yet 19 percent of the insurance
companies are domiciled in the State of Arizona.
[104] And, it was due to the fact that this economic
power generating credit insurance sales, was translated
into ownership of insurance companies by these economic
powers. And, they started off with the limited amount
of capital that was required. Arizona required actually
$37,500.00 of capital and surplus to start a life insur-
ance company, $25,000.00 in capital, and $12,500.00 in
surplus.
And, for the most part, companies like American
Bankers—the companies that were the pioneers in the
credit insurance business were faced with either coop-
erating with and helping create these small captive com-
panies or else lose the business completely, because many
of these financial institutions were quite capable of
establishing insurance companies to sell their own in-
surance,
But, American Bankers as an example of the pio-
neers, they started these operations or assisted in the
start of them, by offering the policy forms, and doing
the administrative work, as they always had done, and
yet in order to allow the companies—these financial
institutions to participate in the life insurance earnings
of the life insurance portion, then they passed on what-
ever part of the business they were required to under
the competitive pressures of the other pioneers, to keep as
much of the earning’s capacity of the insurance as was
[105] possible.
In this case they were passing on the insurance pro-
gram to Consumer with an 12½ percent charge for
their function, which included the policy forms, and the
administrative work, and of course for their profits,—
their earnings.
Q In your experience, then, this was a fairly widely
accepted and common type of practice for finance com-
panies and institutions to form their own—
A Right—well, having worked with Pilot, which was
one of these companies pioneering, they had dozens of
this similar situations, and of course as an actuary with
that company, it was one of my jobs to be—connected
with that program, and working with that program, and
then also in the consulting work, most of these com-
panies did require consulting actuaries to do—to help
complete their annual statements for one thing, and
other matters too.
MR. MASINTER: If Your Honor please, I think
that this might be a good opportunity to stop for
lunch, and because we are ready to get into another
subject, and we would like to set up a little projectory
of a chart, and we would like tc have Mr. Eddy de-
scribe, and this micht be a good time to do that.
THE COURT: Very well, we'll recess and reconvene
106] at 1:30.
MR. LANDON: Have you any preference, Your
Honor, for where that screen should go?
THE COURT: Well, no, wherever, you—you might
put it over there somewhere.
(Whereupon, the hearing in the above was recessed
at 12:10 p.m., as described above.)
87
[107] AFTERNOON SESSION
THE COURT: Will you resume the stand, Mr. Eddy?
I remind you that you remain under the oath adminis-
tered at the outset of your testimony?
BY MR. MASINTER: (Resuming)
Yes, my experience in that is that at the outset
of these large number of companies that were formed in
the State of Arizona with 37,500 capital generally were
companies that were established by business enterprises
which had their business interest, main interest and
issuing company which would in turn cede reinsurance
to them as a reinsurer and that in fact is what happened
in most of these—well, in essentially all of the cases
> I've had experience with and they number quite
a few.
Q Why couldn’t they have become quali i
a | * directly? om th Sole
ell, as an example, for Consumer, for the
have been able to have written directly in their al in
88
territory which I believe to have been the State of
Georgia and maybe the southeast, they would have had
to have had a company licensed, either domiciled and
licensed or licensed in the southeast or in that territory.
Well, in those days the requirements of all the states in
the southeast were substantially greater than the capital
requirements, were substantially greater than the capital
requirements of Arizona, and there was a question and
it was with quite a number of these companies that I
have had the opportunity to work for one way or an-
other, it was generally their interest to minimize their
capital invested in this business. For one thing, the
capital and surplus of a life insurance company, even
these limited [109] capital companies in Arizona and
their policy reserves—or the assets representing their
policy reserves are limited as to what investments they
may be placed in, limited to fixed dollar type investments
generally which carry with them substantial guarantees
of principal, relatively speaking with quite relatively low
rate of eturn. I think Mr. Born said earlier this morn-
ing that Southern Discount, and my experience is true of
all these finance companies that I had worked with, they
were in the business of borrowing money in order to
relend it and they were paying pretty high interest
charges for the money they borrowed and in fact, dur-
ing that period of time, it is my recollection and belief
that they were paying seven or eight percent as sort of
the minimum to borrow money to put in the finance
business.
Well, it would have been right foolish for them to have
taken that money or much of it to invest in capital and
surplus of a stock life insurance company which had
limited return and they would in fact be losing the dif-
ference between what they had to pay to borrow money
and the amount of return you could get on that type of
investment permitted to life insurance companies.
Now, I think those are the several reasons or at least
a couple reasons why they went to Arizona and why they
had limited capital. Another thing to consider [110] and
certainly was considered by a number of clients that
I’ve worked for was the fact that although the consumer
89
finance companies were the agency for us for selling thi
* *
business, they really didn't have generally mashing —
that sort of thing, but it was a service that was bei
performed, but mainly my opinion was that the —
sumer finance business, generally speaking was inter-
ested in going in insurance business for this credit in-
surance and for the additional profits it might get by
being in that business, other than just as an agency, and
that the reinsurance route was in part sold to them by
the more established pioneering companies who and I
know a number of the gentlemen who were in those
companies at that time who were really concerned about
trying to keep as much of the credit insurance profits
or income as they could, so this was sort of a joint
venture and joint interest for them to help establish
such limited capital companies because they kept them
in 91 picture for a longer period of time.
n your experience, what would be the av
rate of return during the years in question on 23
ser ves invested by insurance companies?
(111) A Well, quite generally actuaries were assum-
ing that for purposes of calculation, premium calcula-
tion premium rates for other types of insurance four
four and one-half percent average return.
Q So that if companies that earned higher rate of
return, it would be—what you’re saying is that it would
be foolish to go from a higher rate of return to four
four and a half percent rate of return.
A Right, because that’s just another part of the
question, of capitalization considerations and one being
you don’t have to have as much money and two, if you
222 — A — at on ee of loss of higher return
oney than that’s an addition i i i
— Gee al capital consideration
How are credit life insurance policies an
H policies issued, master policies — . —
or groups, generally speaking?
90
A Well, credit insurance is issued both as directly
individual policies, issued directly to the individual from
the company that’s issuing it, the insurance company
and also it’s issued through a group contract between
the insurance company and the creditor with certificates
being issued to the individual debtors. Now, at this time
in the United States about ten percent of the volume by
number of lives and the amount of insurance in force, is
on the [112] individual basis and about 90 percent is in
force on the group basis.
Q Turning your attention now, Mr. Eddy, to the con-
cept of reserves could y
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