Factory Mutual Taxation May 22, 1961 with constantly growing business and deposits, have been an important factor in taking care of the problem. Therefore, having in mind that the average Factory Mutual risk is very large and that under the statutes of most States where they are licensed they may not expose themselves on a single risk to a loss of in excess of 10% of their surplus and voluntary reserves, they must have these large deposits to augment their resources so as to be able to provide adequate protection to those who need it. If they were to require a premium deposit of approximately the cost of insurance, or 6 cents, their underwriting capacity would be reduced sharply to a little less than 50% of what it is at present. A review of the foregoing will indicate that the Factory Mutual Companies do not charge premiums as such, but they do require that a policyholder at the inception of his policy deposit with the Company a substantial sum of money out of which the real premium or cost of insurance will be deducted at the expiration of termination of the policy, It is obvious that under such a method of operation the premium income of the company in any year is the amount which it has absorbed from the premium deposits in force. It is possible for the accountants to determine through the application of a rather simple formula to the premium deposits in force the accrual from the premium deposits which should be considered as earned in any given calendar year. EARNED PREMIUM FORMULA IN NAIC STATEMENT INACCURATE The argument in favor of using the National Association of Insurance Commissioners' Convention Form of Annual Statement without modification as the basis of calculating earned premium of companies operating on a premium deposit basis ignores the facts. The Factory Mutuals have repeatedly pointed out to the State Insurance Commissioners that the present form of Convention Statement, which was intended for stock companies and those mutual companies using stock company rating procedures, presents an entirely erroneous picture when applied to such companies as the Factory Mutuals who operate on the basis of a premium deposit. However, the Commissioners have felt that they would not be justified in preparing a separate form of statement for the Factory Mutual Companies because of the comparatively small size of the group. It is recognized by all impartial authorities, such as Best & Company, that there is no relationship between the Factory Mutual so-called statutory earned premiums, as shown in the Annual Statement, and the actual absorbed premiums of these companies. Many of our states have formally recognized this 70510 0-61-pt. 3-19 Factory Mutual Taxation May 22, 1961 fact by special tax provisions in their law or formal opinions of their Attorneys General. We are attaching hereto as Exhibit "B" a Table showing the actual absorbed premiums of Factory Mutual Companies as compared to the so-called Statutory Earned Premiums for the period from 1942 to 1959, inclusive. This Table illustrates the differences between the two methods of calculation and the fact that there is no uniform relationship between them. The statutory method always penalizes the companies in a period of rapid growth, since it starts with the premium deposits written. The method of calculating earned premium which we have proposed is one which is easily subject to audit by the Collectors of Internal Revenue, and in the calculation of the taxes to be paid by the Factory Mutual Companies there would be no difficulty in its determination. CONTROL OF TAX LIABILITY In discussions with representatives of the Treasury, the point has been made that the basis suggested would put the Factory Mutual Companies in a position to control their taxes by controlling the amount of net premium collected. This point was stated in a Treasury memorandum discussing the Boggs-Baker Bills as follows: "Consequently, there is a real possibility that as The whole point of this argument is that if the amount absorbed by the Factory Mutual Companies from the premium deposits in their hands, plus the investment income, is just barely sufficient to cover the losses and expenses of the companies, there will be no tax upon them. The Treasury apparently contemplates that in good years, with low losses and expenses, absorptions will be reduced so that income corresponds to outgo. In any such year the company can, of course, add nothing whatever to its reserves. In years in which very heavy catastrophe losses are experienced, the companies have found it necessary to actually draw upon surplus in order to pay losses and expenses, the total of absorbed premiums and investment income being insufficient for the purpose. They must, therefore, build up surplus in good years, Factory Mutual Taxation May 22, 1961 The argu whether such additions to surplus are taxed or not. ment, in essence, states that if any company is willing to operate without profit or at a loss it need pay no income tax, This is generally true of any business corporation. No company has to operate at a profit so as to be able to pay an income tax, but a corporation that fails to more than break even will not stay in business long. From a business standpoint, however, in view of the need of the Factory Mutual Companies to continue to increase surplus in order to handle the insurance needs of American industry in the future, it is obvious that the companies would be stultifying themselves if they adopted any such policy. Tax savings would be made at the expense of ability to function, which would be the depth of stupidity. The stock insurance companies, who have been taxed on the basis here proposed for the Factory Mutuals, have made underwriting gains whenever they could. They regard the present period of underwriting losses with undisguised horror, despite the savings they have made in income tax as compared to more profitable years. CONCLUSION The problem of the Factory Mutuals and the indicated solution were stated in very few words by Roy E. Moor, Professor of Economics, Williams College, in the paper he presented before the Ways & Means Committee in December 1959. Mr. Moor said: "Factory Mutuals are presently taxed under the same sections as mutual non-life insurance companies generally. However, because of the relatively large investment income derived from the more sizable premiums, these companies are always taxed on the net investment income alternative. This appears to be a clear-cut instance in which an inequity exists because the companies are not taxed like other corporations. As with all insurance companies, Factory Mutuals should have all of their income included in the tax base and then be able to deduct all business expenses, both investment costs and insurance costs. The perpetual treatment does not seem applicable since the premiums are in fact used to meet expenses. In essence, the dollars that are used have no labels." Factory Mutual Taxation May 22, 1961 The tax treatment of the companies operating on the premium deposit plan proposed in the bill introduced by Congressman Ikard at this session of Congress would put them on the same basis of taxation as stock insurers with a modification in the method of determining their premium income to take into account the premium deposit method of operation which is unique in the insurance field. The record indicates that tax relief for these Companies is long overdue. Eighteen years ago assurances were given that if the 1942 legislation was found inequitable in its results the necessary corrective steps would be taken by Congress. The bill for this purpose introduced at this session of Congress should be enacted. 87TH CONGRESS 18T SESSION H. R. 4311 IN THE HOUSE OF REPRESENTATIVES FEBRUARY 15, 1961 Mr. IKARD of Texas introduced the following bill; which was referred to the Committee on Ways and Means A BILL To establish an equitable basis for application of the Federal income tax to mutual fire insurance companies which operate on the basis of perpetual policies or premium deposits. 1 Be it enacted by the Senate and House of Representa2 tives of the United States of America in Congress assembled, 3 That section 831 (a) of the Internal Revenue Code of 1954 4 (imposing a tax on certain mutual marine and fire insurance 5 companies and on stock insurance companies which are not 6 life insurance companies) is amended to read as follows: "(a) IMPOSITION OF TAX.-Taxes computed as pro 7 8 vided in section 11 shall be imposed for each taxable year on 9 the taxable income of |