Kentucky Cent. Life Ins. Co. v. Commissioner, 57 T. C. 482 (1972)

In an assumption reinsurance transaction, the consideration received by the reinsurer for assuming liabilities under non-issued contracts must be included in premium income for tax purposes.

Summary

Kentucky Central Life Insurance Company acquired Guaranty’s Skyland division business through an assumption reinsurance agreement, agreeing to assume all liabilities under the ceded insurance contracts. The agreed purchase price was $1,800,000, allocated between tangible assets and the insurance business, with the latter valued at $1,650,000. The payment was offset by the reserves Kentucky Central assumed. The IRS argued that the $1,650,000 should be included in Kentucky Central’s premium income under IRC § 809(c)(1). The Tax Court agreed, holding that this amount was consideration for assuming liabilities and should be amortized over the average life of the reinsured policies, rejecting the notion that any part of the payment was for goodwill.

Facts

In 1961, Kentucky Central Life Insurance Company entered into an agreement with Guaranty Savings Life Insurance Company to acquire Guaranty’s Skyland division business. The agreement included the transfer of insurance policies, real estate, and office equipment. The purchase price was set at $1,800,000, with $145,000 allocated to real estate, $5,000 to office equipment, and $1,650,000 to the insurance business. Kentucky Central agreed to assume all liabilities under the insurance contracts, and the payment was offset by the reserves required for these contracts, which totaled $1,974,494. 11. Guaranty paid the excess of $88,456. 42 to Kentucky Central. Kentucky Central reported $310,398. 11 as premium income from the transaction but did not include the $1,650,000 value of the insurance business in its income.

Procedural History

The IRS issued a notice of deficiency, asserting that Kentucky Central understated its premium income by $1,650,000 under IRC § 809(c)(1). Kentucky Central contested this, leading to a trial before the United States Tax Court. The court’s decision was issued on January 11, 1972.

Issue(s)

1. Whether the $1,650,000 value of the insurance business received by Kentucky Central should be included in its premium income under IRC § 809(c)(1)?
2. Whether any portion of the $1,650,000 should be allocated to goodwill and thus not amortizable?
3. If the $1,650,000 is amortizable, over what period should it be amortized?

Holding

1. Yes, because the $1,650,000 represents consideration received by Kentucky Central for assuming liabilities under contracts not issued by it, as per IRC § 809(c)(1).
2. No, because there was no evidence that goodwill was considered in the transaction, and the value of the insurance business was based on expected future profits.
3. The $1,650,000 should be amortized over the average life of the reinsured policies, with industrial life policies amortized over 6 years and ordinary life policies over 9 years.

Court’s Reasoning

The court reasoned that the $1,650,000 value of the insurance business was consideration for Kentucky Central’s assumption of liabilities, aligning with the intent of IRC § 809(c)(1). The court rejected Kentucky Central’s argument that the reserves offset the purchase price without generating income, as this would distort income and contravene the purpose of the tax code. The court found no evidence of goodwill being part of the transaction, as the parties did not discuss or consider it, and the value was based on future profits. The court also determined that amortization should be based on the average life of the policies, as calculating the life of each policy individually would be impractical and would unfairly benefit Kentucky Central by allowing hindsight. The court adopted the IRS’s allocation of the $1,650,000 among the different types of policies, as there was no evidence to the contrary.

Practical Implications

This decision clarifies that in assumption reinsurance transactions, the value of the insurance business transferred must be included in the reinsurer’s premium income under IRC § 809(c)(1). It establishes that such amounts can be amortized over the average life of the reinsured policies, providing a clear method for calculating amortization periods. The ruling also underscores the importance of distinguishing between the value of the insurance business and goodwill, requiring clear evidence for any goodwill allocation. This case impacts how life insurance companies structure and report assumption reinsurance transactions, ensuring that the tax treatment reflects the economic realities of the transaction. Subsequent cases and IRS guidance have relied on this decision when addressing similar tax issues in the insurance industry.