Court Opinion

ID: 4485735
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:33:56.061633+00
Date Added: 2024-06-11T14:54:07.565197
License: Public Domain

NlMS, J., concurring: I concur with the majority in both reasoning and result. However, I find it necessary to comment separately with respect to several of the concerns expressed by my colleague, Judge Goffe. In essence, Judge Goffe would have us determine that a group of affiliated corporations can never deduct premiums paid to a wholly owned captive insurer. The insurance of unrelated third parties, he concludes, is irrelevant because there is never shifting of risk from a parent and its affiliates to their wholly owned captive. Because there is no transfer of risk, the arrangement can never be considered insurance. Judge Goffe rests his conclusion on the expert testimony and reports of Dr. Plotkin and Mr. Stewart, both of whom relied not only upon insurance principles, but also upon economic theory to arrive at their conclusion that Gulf and its affiliates did not transfer their risk to Insco. Because the majority rejected the conclusions of Dr. Plotkin and Mr. Stewart with respect to the effect of the presence of unrelated insureds, Judge Goffe concludes, I believe incorrectly, that the majority “directly contradicts Dr. Plotkin’s expert report and offers absolutely no explanation for its complete disregard of it.” The majority did not completely disregard the expert reports in this case. In fact, the majority agrees with the experts with respect to their description of the necessary elements of insurance1 and their conclusion that a captive insurer represents a form of risk retention or self-insurance — when the captive insures only risks of its affiliates. The majority even quotes from the same insurance text relied upon by Dr. Plotkin for the proposition that a captive is a hybrid possessing characteristics of insurance and self-insurance. The majority disagrees, however, with Dr. Plotkin and Mr. Stewart’s ultimate conclusion that a wholly owned captive is always a risk-retention device and that the addition of third party risks does not change the relationship between the captive and its affiliates from one of risk retention to risk transfer.2  One is compelled to conclude that Judge Goffe, Dr. Plotkin, and Mr. Stewart can only reach their conclusion by adopting the economic family theory, an approach not based on insurance principles, but rather on the principle that the capital of the affiliates remains at risk, regardless of the identity of the captive’s insureds, because the affiliates and the captive are related.3 As the majority points out, we have rejected this theory in the past and we do not, despite Judge Goffe’s view to the contrary, adopt that theory here simply because the experts rely on it. Instead, the majority relies on principles of the insurance industry to distinguish between arrangements which are in essence self-insurance and arrangements which will be recognized as insurance for tax purposes. The majority recognizes that there are circumstances under which a captive should be treated as a separate corporation providing insurance to its affiliates and premiums paid by the affiliates should be deductible. I also disagree with Judge Goffe that the theory of the majority is “new and novel” and is in direct conflict with case law holding that insurance requires risk shifting and risk distribution. Gulfs principal arguments throughout its briefs are that Insco should be treated as a separate corporate entity and that the agreements entered into by Gulf, Gulf’s affiliates, and Insco are insurance, under the definition set forth in Helvering v. Le Gierse, for Which premiums paid should be deductible.4 Gulf argues that the agreements resulted in a transfer of risk because Insco was financially capable of meeting its obligations and that therefore Insco, rather than Gulf and its affiliates, bore the risk of loss. Gulf further argues that risk distribution was achieved both by the types of risks Insco insured and the parties who were insured. Gulf maintains that this should be true regardless of whether the captive insured unrelated parties. Alternatively, it contends that the insurance of unrelated third parties is relevant because— Insco’s intention coupled with its carrying through on such intention support the conclusion that Insco was providing insurance in the taxable years in issue, even for the portion of such insurance which related to risks of Gulf and its affiliates. As an example of how the insurance of unrelated third parties makes a difference, Gulf refers to O.M. 19167, which was transmitted by G.C.M. 38136 and which was withdrawn by G.C.M. 39247: O.M. 19167 considered the insurance of significant third party risks * * * to compel a conclusion that the transactions entered into by the insurance subsidiary should be considered “insurance” in such years even with respect to those transactions involving risks of companies which were related to the insurance affiliate. Furthermore, while O.M. 19167 expressed the opinion that there was not “insurance” in [earlier years] due to the fact that the percentage of third party risks that were insured in such years were minimal, -O.M. 19167 considered that such years might be viewed by a court, not “in isolation, but as the start-up phase of what will become an insurance business in the fullest sense * * * ” Respondent’s “one economic family” theory does not take account of the fact that an insurance subsidiary may intend to insure (and may in fact insure) the risks of third parties. * * * It is apparent from the above that one aspect of Gulf’s argument is that the existence of unrelated insureds should make a difference in our determination of whether the arrangements with Insco were insurance. Gulf contends that the existence of unrelated insureds is evidence that Insco is a separate insurance company. The majority, agreeing with Gulf on this point, explains further that the existence of unrelated insureds allows the Court to distinguish between arrangements which are in substance self-insurance and arrangements which are insurance. It is with respect to this point that the majority offers its reasoning that when a substantial percentage of the captive’s insureds are unrelated, risk transfer is present and will be recognized because the risks of the affiliated group are transferred to the unrelated insureds through the captive’s premium pool. Contrary to Judge Goffe’s conclusion, the majority does not blur the distinction between the concepts of shifting of risk and distribution of risk. The majority requires that both be present. The majority simply recognizes that both may be present when the captive insures a substantial percentage of unrelated insureds and when the law of large numbers operates so that the premiums are reasonably calculated to cover losses. The majority’s reasoning is not unlike that set forth in G.C.M. 38316, which was cited by Gulf on brief: In short, while it is settled that for an “offshore captive’’ to be truly an insurer it must serve to shift and distribute risks outside of the corporate group in a substantive way, we must look to both policyholders and shareholders to determine if the requisite risk shifting and distribution is present. Under insurance theory, risks are shifted and distributed not through the capital structure of the company, but rather through the premiums (and resulting surplus and investment income) paid by the policyholders. Thus, we believe that, although there may be no ownership of an insurer outside of an affiliated group, we must still look to the percentage of nonaffiliated policyholders that the “captive” has, and/or the relative dollar value of premiums paid by nonaffiliated policyholders to determine the presence or absence of insurance. With regard to the instant case, your memorandum suggests that although risk is distributed by the presence of nonaffiliated policyholders, the element of risk shifting is absent, because the parent is shifting its insurable risk to an “insurance” company for which the parent provided the basic capitalization. Looking to the capital structure of the subsidiary alone to determine whether risks are shifted from the insured to the insurer, however, ignores a basic premise of the insurance business, that in a normal insurance situation risk shifting and distributing is accomplished through the premium-based underwriting operation. In other words, claims are paid by a solvent insurer not from paid in capital, but rather from premium income, investment income, and surplus. See D. Gregg and V. Lucas, Life and Health Insurance Handbook 140 (3d ed. 1973) and S. Huebner and R. Black, Life Insurance 6 (9th ed. 1976), both of which discuss the relationship of insurance benefits and premiums in the context of life insurance; 1 W. Freedman, Richards on the Law of Insurance 2, 83 (1952). Therefore, we believe that when, as in the instant case, risks have been distributed to other policy holders then it necessarily follows that the risk has also been shifted to those other policy holders. Thus, because in this case the other policyholders are not members of the affiliated group, there has been a shifting and distributing of risks outside the group, through the medium of the “captive” insurance company which, although largely owned by the parent, receives (at least in the latter two years) approximately half of the money from which it will pay claims from unrelated parties. [Emphasis added.] Because Gulfs primary argument was that Insco should be treated as a separate corporation providing insurance it did not go to great lengths to argue that the unrelated insureds made the difference between an arrangement that lacked risk transfer and one that did not. However, it is apparent that Gulf did present and argue, albeit as an alternative, this theory. For the foregoing reasons I respectfully disagree with Judge Goffe’s conclusions. Whitaker, Kórner, Hamblen, Swift, Jacobs, Gerber, Wright, Parr, and Williams, JJ., agree with this concurring opinion.   For example, Dr. Plotkin’s report provides: “The essential element of an insurance transaction from the standpoint of the insured firm, is that no matter what insured perils occur, the financial consequences are known in advance. Thus, the insured, for the price of the premium, is protected, within the limits of its policy, from such financial consequences and from having to worry about and provide for them. By reason of its contract, the insured is indemnified against loss from a defined hazard or risk. In essence, the premium represents the substitution of a small, but certain “loss,” for a potentially large and uncertain loss. It provides piece [sic] of mind and the ability to devote all of one’s financial resources to other concerns and objectives.” These basic principles are identical to those set forth by the majority.    Dr. Plotkin specifically concludes that by accepting third-party risks, the captive and its owners accept the uncertainty inherent in the third parties’ risks in addition to those inherent in their own risks.    Dr. Plotkin concluded: “So long as the firm does not transfer to another the ultimate responsibility for the financial consequences of its risks, it remains the risk bearer and faces the uncertainty of each year’s actual financial losses. The attempted placing of a firm’s risks, directly or indirectly, in its “insurance affiliates” does not accomplish a transference of risk, or constitute an insurance transaction as a matter of insurance theory or practice or as a matter of economic reality. We find our conclusion in complete accord with the clear theoretical and applied teachings of the economics, insurance theory, risk management, and captive self-insurance literatures and the documented practices of corporate risk managers.” Mr. Stewart concluded: “what it all comes down to is whether there was transfej^of. financial risk. There was not. The reason is that Gulf owns Insco.”    Alternatively, Gulf argued that the agreements should be treated as insurance regardless of the presence of risk transfer, “When one considers the large number of risks to which Gulf and its affiliates were subject, the pooling of these diverse independent risks in a single corporate entity such as Insco achieves risk distribution which, standing alone, should result in a determination that “insurance” existed. * * *” Gulf did not pursue this argument because we held in Carnation Co. that there cannot be insurance without transfer of risk.