OPINION
Goffe, Judge:
The Commissioner determined deficiencies in petitioner’s Federal income tax for the taxable years ended July 29, 1978, and July 28, 1979, in the amounts of $370,944 and $628,202, respectively. The sole issue for decision is whether petitioner is entitled to deduct, as an ordinary and necessary business expense, the entire amount paid to an unrelated insurance carrier as insurance premiums for workers’ compensation coverage where the unrelated carrier reinsures 92 percent of such risk with the wholly owned captive insurance company of petitioner’s wholly owned subsidiary and cedes 92 percent of the premiums to the captive.
All of the facts were stipulated. The stipulation of facts and exhibits are incorporated by this reference. Petitioner Clougherty Packing Co. was incorporated under the laws of California on December 31, 1945. At the time of filing the petition, its principal place of business was Los Angeles, California. It filed its corporate Federal income tax returns for the taxable years ended July 29, 1978, and July 28, 1979, with the Internal Revenue Service Center in Fresno, California. The returns were not consolidated returns with its subsidiaries.
During the taxable years involved, petitioner owned all of the issued and outstanding stock of Clougherty Packing Co. of Arizona which was incorporated under the laws of Arizona on July 26, 1977. Petitioner’s Arizona subsidiary, in turn, owned all of the issued and outstanding stock of Lombardy Insurance Corp. (Lombardy). Lombardy was incorporated under the laws of Colorado on November 24, 1976, pursuant to the Colorado Captive Insurance Company Act. During the taxable years involved, Lombardy was a corporation in good standing with the Department of Insurance of the State of Colorado.
Before 1970 and continuing through the taxable years involved, petitioner employed more than 1,000 workers in California which required that petitioner obtain coverage under the California workers’ compensation laws. It was engaged in slaughtering and meat processing, and numerous workers’ compensation claims were filed against petitioner by its employees. The employees claimed that they contracted brucellosis, an industrial disease connected with meat processing. Section 3700 of the California Labor Code required employers to maintain workers’ compensation coverage by one or more insurers authorized to write compensation insurance in California, or to secure from the California Director of Industrial Relations a certificate of consent to self-insure. Prior to 1978, petitioner elected, in part, to be self-insured with respect to workers’ compensation coverage and it, therefore, secured a certificate of consent from the California Director of Industrial Relations. Liability in excess of the limited self-insurance was covered by insurance policies with insurers qualified to do business in California. The per claim limits of petitioner’s self-insurance and the California insurance carriers who carried the excess over petitioner’s self-insurance coverage from July 31, 1971, through July 30, 1977, were as follows:
Year Coverage by carrier Self-insurance in excess of self-insurance
July 31, 1971 $35,000 Employers Surplus Lines, Inc.— all in excess of $35,000
July 29, 1972 150,000 Reserve Insurance — excess of $35,000 .up to $50,0002
50,000 Employers Reinsurance — all in excess of $50,000
July 27, 173-Aug.2, 1975 35,000 Fremont Indemnity Co.— all in excess of $35,000
July 31, 1976 75,000 American Bankers Ins. Co. of Florida — all in excess of $75,000
July 30, 1977 100,000 Puritan Insurance Co.— all in excess of $100,000
In order to obtain State certification for self-insurance, petitioner was required to deliver securities to the California State Treasurer as security for potential workers’ compensation liabilities. The costs of such securities deposited with the California State Treasurer during the fiscal years ended July 31, 1971, through July 30, 1977, were as follows:
FYE— Amount
July 31, 1971. $638,269
July 29, 1972. 638,269
July 27, 1973. 638,269
Aug. 3, 1974 . 638,269
Aug. 2, 1975. 857,110
FYE— Amount
July 31, 1976. $857,110
July 30, 1977 . 857,110
Earnings from the securities inured to the benefit of petitioner while on deposit with the State.
From January 1974 to October 1976, petitioner maintained its own staff of adjusters to handle claims for workers’ compensation. After October 1976, such claims were handled by an independent insurance broker, Frank B. Hall Management Co. (Hall), a nationwide brokerage firm. During 1976, Hall prepared and submitted to petitioner a detailed report entitled "Captive Insurance Study for Clougherty Packing Co.” The report proposed that petitioner insure its liabilities for workers’ compensation directly with its own captive insurance company organized under the laws of Colorado. This proposal was not adopted on advice of petitioner’s counsel because of legal and regulatory problems under California law. Rather than establish a direct insurance captive, the. management of petitioner decided to establish a Colorado captive to reinsure some of petitioner’s risk. The management concluded that a captive insurance arrangement would reduce the cost of its liabilities for workers’ compensation coverage by: (1) Increasing investment income above the amount received on the securities deposited with the State Treasurer of California; (2) eliminating the underwriting costs paid to outside insurance carriers; and (3) receiving favorable Federal tax treatment for the captive insurance company subsidiary which treatment is available to all insurance companies.
The articles of incorporation for Lombardy were filed in Colorado on November 24, 1976, but business operations did not commence until a later date. Lombardy was capitalized for $1 million, as required by the Colorado Commissioner of Insurance. Colorado statutes required a minimum capitalization of $750,000. On July 27,1977, the $1 million of capital was fully paid in, from which $750,000 was used to purchase a certificate of deposit in a Colorado bank, jointly held by Lombardy and the Colorado Division of Insurance. During September 1977, Hall proposed to petitioner’s management that Lombardy join a reinsurance underwriting group. As of September 1977, Lombardy was not yet operating and the management of petitioner rejected the group reinsurance underwriting proposal.
Petitioner and Fremont Indemnity Co. (an unrelated insurer licensed to write workers’ compensation insurance in California, hereinafter referred to as Fremont) negotiated for a captive insurance program for petitioner.
On October 25,1977, Fremont offered, in writing, to provide a captive reinsurance program for petitioner, the pertinent terms of which were as follows:
1. The cost to be 5 percent of the annual earned premium, plus premium taxes, bureau fees, and nonincidental costs.
2. The "Clougherty Captive Company” (as Fremont identified it in its offer) would assume the first $100,000 of any risk, with coverage in excess of $100,000 for any risk being furnished by Fremont.
3. All funds were to be remitted to "Clougherty’s captive” monthly, based on remittances by petitioner to Fremont, less costs and deficiencies in collateral.
On October 31, 1977, petitioner’s attorney accepted Fremont’s offer on behalf of petitioner with some "clarifications” agreed to by telephone on October 28, 1977. The name, Lombardy, was substituted for Clougherty captive. Lombardy would reinsure the first $100,000 of any risk insured with Fremont. In essence, Fremont would be assuming the risk up to $100,000 but would reinsure that risk with Lombardy. "The turn around time on money, both from Fremont to Lombardy and from Lombardy to Fremont, will be no more than five days.”
During December 1977, Hall requested the Colorado Insurance Division to perform an organizational examination of Lombardy which was accomplished and, on December 30, 1977, the Colorado Division of Insurance issued to Lombardy a certificate of authority to conduct business as a captive insurance company in the State of Colorado.
The officers and directors of Lombardy have also been officers or employees of petitioner or Hall since the organization of Lombardy and throughout the taxable years involved. During the same taxable periods, Lombardy’s sole business was the reinsurance of petitioner’s workers’ compensation coverage. Lombardy has never owned or leased any real property and the address of its principal office during the taxable years involved was the address of Hall. Lombardy had no employees but, instead, conducted its day-to-day business through employees of Hall pursuant to a management agreement between Lombardy and Hall.
During April 1978, petitioner insured its workers’ compensation coverage for 1 year with Fremont, effective January 1, 1978. Fremont notified the State of California that it had issued a valid workers’ compensation insurance policy in a form approved by the California Insurance Commissioner to petitioner for 1978 and 1979. The State of California Workers’ Compensation Insurance Rating Bureau set the premium rate for the years in question. Lombardy agreed to reinsure the first $100,000 per occurrence for all of petitioner’s risks insured by Fremont. In addition, Fremont agreed to cede (transfer) to Lombardy 92 percent of the premiums it received from petitioner. The reinsurance agreement was effective January 1, 1978, but was executed by Lombardy on February 3, 1978, and by Fremont on March 22, 1978. The Colorado Insurance Commissioner approved the premium rates and reinsurance cessions for the years involved. Under the reinsurance agreement, Lombardy was required to and did secure a $200,000 irrevocable letter of credit to be held by Fremont as security for unpaid open losses and unearned premiums. In addition,/Lombardy agreed to deposit securities with the California State Treasurer to cover demands for statutory reserves made upon Fremont by the California Department of Insurance.
There was no agreement or understanding between petitioner, its wholly owned subsidiary in Arizona, Hall, or Fremont that petitioner would indemnify Fremont, that it would pay additional capital into Lombardy, or that it would take any steps, direct or indirect, to assure that Lombardy would perform its obligations under its reinsurance agreement with Fremont. The premium paid by petitioner to Fremont was set by the Workers’ Compensation Insurance Rating Bureau of the State of California; the rates for reinsurance cessions from Fremont to Lombardy were negotiated between Fremont and Lombardy, but had to be approved by the Insurance Commissioner for the State of Colorado.
Following the effective date of the insurance and reinsurance arrangement, January 1, 1978, petitioner was no longer required to deposit securities with the State Treasurer of California to cover workers’ compensation claims arising after January 1,1978. Subsequent to being informed that petitioner was no longer self-insured, the State of California audited the self-insurance reserves of petitioner and demanded an increase in the amount of securities on deposit for pre-1978 claims. Later, the reserves on deposit with the State of California were reduced as petitioner’s pre-1978 liabilities were settled and paid. The values of the securities on deposit for the taxable years ended July 29, 1978, and July 28, 1979, were $1,489,644 and $1,120,303, respectively.
During the taxable years ended July 29, 1978, and July 28, 1979, petitioner accrued and deducted as premiums for workers’ compensation insurance $840,000 and $1,457,500, respectively. During the taxable years ended July 29, 1978, and July 28,1979, Fremont paid to Lombardy $772,900 and $1,340,000,3 respectively, as reinsurance premiums.
The Commissioner, in the statutory notice of deficiency, disallowed that portion of petitioner’s deductions for premiums on workers’ compensation insurance which represented the "reinsurance premiums” paid by Fremont to Lombardy in the amounts of $772,800 and $1,340,900 for the taxable years ended July 29, 1978, and July 28, 1979, respectively.
The first captive insurance company case submitted to this Court was Carnation Co. v. Commissioner, 71 T.C. 400 (1978), affd. 640 F.2d 1010 (9th Cir. 1981). An appeal in the instant case would also be to the Court of Appeals for the Ninth Circuit. Carnation Co. v. Commissioner, supra, was submitted to the Court upon cross motions for summary judgment and the instant case was submitted fully stipulated.
Carnation and an unrelated insurance company, American Home Assurance Co. (American Home) entered into an insurance agreement, and American Home simultaneously reinsured 90 percent of Carnation’s risk with Carnation’s wholly owned Bermuda subsidiary, Three Flowers Assurance Co. (Three Flowers). We held that Carnation was not entitled to deduct as insurance premiums 90 percent of its payments to American Home. We based our holding upon Helvering v. Le Gierse, 312 U.S. 531 (1941).
Le Gierse involved the exclusion from the gross estate of a portion of the insurance proceeds payable to decedent’s daughter. Shortly before her death, the decedent purchased from an unrelated insurance company a single premium life insurance policy, naming her daughter as beneficiary. The decedent simultaneously purchased a single premium lifetime annuity payable to herself from the same unrelated insurance company. The insurance company agreed to issue the life insurance policy only upon the condition that petitioner simultaneously purchase the annuity. The Court held that the life insurance and annuity transaction were not separate and distinct transactions and should be considered together. It reasoned that "annuity and insurance are opposites; in this combination the one neutralizes the risk customarily inherent in the other. From the company’s viewpoint, insurance looks to longevity, annuity to transiency.” 312 U.S. at 541. The Court went on to hold that the combination of agreements did not represent a shifting of the risk of loss inherent in insurance; therefore, the proceeds received by the daughter did not represent an amount receivable as insurance.
We applied Le Gierse to the facts in Carnation as follows:
By entering into the agreements in issue, Carnation attempted to shift its risk of property loss due to fire, lightning, vandalism, malicious mischief, sprinkler leakage, flood, and earthquake shock. The agreements attempted ultimately to shift 90 percent of the risk to Three Flowers and 10 percent of the risk to American Home. In the event of a covered casualty, the loss suffered hy Carnation ultimately would be borne 90 percent by Three Flowers and 10 percent by American Home. The agreement to purchase additional shares of Three Flowers by Carnation bound Carnation to an investment risk that was directly tied to the loss payment fortunes of Three Flowers, which in turn were wholly contingent upon the amount of property loss suffered by Carnation. The agreement by Three Flowers to "reinsure” Carnation’s risks and the agreement by Carnation to capitalize Three Flowers up to $3 million on demand counteracted each other. Taken together, these two agreements are void of insurance risk. As was stated by the Court in Le Gierse, "in this combination the one neutralizes the risk customarily inherent in the other.” 312 U.S. at 541. [71 T.C. at 409.]
Two U.S. District courts have followed the rationale of Carnation to reach the same result, Stearns-Roger Corp., Inc. v. United States, 577 F. Supp. 833 (D. Colo. 1984), and Beech Aircraft Corp. v. United States, an unreported case (D. Kan. 1984, 54 AFTR 2d 84-6173, 84-2 USTC par. 9803). One U.S. District Court applied the rationale of Carnation, but reached a contrary result on factual distinctions. Crawford Fitting Co. v. United States, 606 Fed. Supp. 136 (N.D. Ohio 1985).
Respondent, in the instant case, urges us to adopt a concept referred to as "economic family.” It is apparent from the opinions in Stearns-Roger and Beech Aircraft that expert witnesses testified for the Government in support of its "economic family” theory. We have no such evidence in the case before us and we find it unnecessary to embrace such a concept because we conclude that the instant case can be decided within the parameters of Carnation.
Petitioner, in the instant case, bases its position upon the following arguments: (1) Disallowance of the premiums violates the recognition of legitimate business transactions between separate entities who are members of an affiliated group; (2) other risk shifting among members of an affiliated group is recognized for tax purposes; and (3) our opinion in Carnation is either wrong or the facts in Carnation are distinguishable from the facts before us in this case. We will discuss these points in inverse order.
We cannot agree that our opinion in Carnation was incorrect. The decision was affirmed and the rationale of Carnation has been applied by three separate District Courts. Carnation has not been criticized by any other courts. We continue to adhere to such rationale and have been shown nothing to convince us that Carnation was incorrect or should not be followed.
We likewise hold that the operative facts in the instant case are indistinguishable from the facts in Carnation. Petitioner relies heavily upon the fact that it paid in $1 million of capital to Lombardy and had no arrangement to indemnify Fremont for losses. For this fact to be critical, the comparable facts of the funding of the captive in Carnation must be critical. They are not. The rationale of Carnation is that there was no shifting of 90 percent of the parent’s risk of loss. Without quoting at length from our opinion in Carnation, suffice it to say that the agreement of Carnation to provide additional capital to Three Flowers was only one of the several factors upon which we concluded there was not the requisite shifting of risk to constitute insurance for purposes of deducting insurance premiums. The financial viability of the captive insurance subsidiary is not controlling. The test continues to be whether, considering all of the facts, the risk of loss was shifted away from the taxpayer who seeks to deduct insurance premiums.
The interdependence of all of the agreements is relevant here as the Supreme Court held that it was in Le Gierse (see discussion on page 955 supra) and as we held that it was in Carnation, see quote at page 955 supra. The execution dates certainly confirm their interdependence as demonstrated below:
Feb. 3, 1978.Lombardy executed reinsurance agreement with Fremont effective Jan. 1, 1978
Mar. 22, 1978.Fremont executed reinsurance agreement
which Lombardy executed on Feb. 3, 1978 Apr. 24, 1978.Fremont issued insurance policy to petitioner covering the period from Jan. 1, 1978, to Jan. 1, 1979, effective Jan. 1, 1978
1978.Fremont notified the Division of Self Insurance of the State of California that it had issued a valid workers’ compensation insurance policy to petitioner for the years 1978 and 1979
Jan. 24, 1979.The insurance policy issued by Fremont to petitioner is renewed for 1 year, effective Jan. 1, 1979
Petitioner argues that other shifts of risk among members of an affiliated group are recognized for tax purposes. That is true. Indeed, that is one of the reasons we are reluctant to embrace the "economic family” concept urged by respondent, because such a concept cannot be reconciled with types of transactions between related entities other than insurance.
Shifting of risk in transactions other than insurance are simply not relevant here. We are concerned only with the deductibility of insurance premiums. The cost of insurance is represented by the insurance premium. Accordingly, to deduct insurance premiums it is essential to decide whether the relationship giving rise to the payment constitutes insurance.4.
The limit of our inquiry is the deductibility of premiums paid for insurance coverage. We pointed out in Carnation at page 413 of 71 T.C. that we did not see how Le Gierse has any application beyond insurance premiums. Our holding in Carnation and our holding here is likewise limited to the deduction for insurance premiums. It has long been decided that a taxpayer cannot deduct as insurance premiums amounts set aside in its own possession to compensate itself for perils which are generally the subject of insurance. In Pan-American Hide Co. v. Commissioner, 1 B.T.A. 1249, 1250 (1925), the deduction was disallowed because the law did not permit a taxpayer to deduct as an expense an amount it feared may some day be called upon to spend. The law has not changed. Even if the taxpayer cannot obtain insurance to cover the peril, the amount set aside as self-insurance is not deductible. L.A. Thompson Scenic Railway v. Commissioner, 2 B.T.A. 664 (1925).
It is undisputed that the definition of insurance means the shifting of risk and that the insurance premium is the cost of providing for the shifting of risk. See Steere Tank Lines, Inc. v. United States, 577 F.2d 279 (5th Cir. 1978). The insurance premium is the measure by which unrelated parties calculate the cost of the risk being assumed by the insurance company. The agreement by which Lombardy was to receive from Fremont 92 percent of the premiums which petitioner paid to Fremont, the unrelated party, measured that portion of the total risk of Fremont assumed by Lombardy, petitioner’s captive insurance company. The question is, therefore, whether this 92 percent of the premiums paid by petitioner is, in reality, insurance premiums. Under the definition of insurance, such payments do not constitute insurance premiums unless they are paid to shift risk away from the taxpayer who seeks to deduct them. This portion of the amounts paid to Fremont which were ceded to Lombardy must constitute insurance premiums to be deductible. They are not insurance premiums unless they pay for a shift away from petitioner of 92 percent of petitioner’s risk of loss.
When petitioner sustains losses covered by its workers’ compensation insurance, 92 percent is sustained by Lombardy. Accordingly, because petitioner, through its wholly owned Arizona corporation, owns all of Lombardy, it has not shifted the risk of sustaining such losses to unrelated parties in exchange for insurance premiums because the premiums were paid to the wholly owned subsidiary of its wholly owned subsidiary. We reiterate that it is unnecessary to use the term "economic family” in resolving the issue because it might foster a theory which would be extended to other areas of the tax law.5 We hasten to point out, nevertheless, that parents and wholly owned subsidiaries are involved in Carnation and here. We express no opinion, however, as to situations where the taxpayer does not completely own the subsidiary.
We found in Carnation, as we find here, that to the extent the risk was not shifted, insurance does not exist and the payments to that extent are not insurance premiums. The measure of the risk shifted is the percentage of the premium not ceded. This is nothing more than a recharacterization of the payments which petitioner seeks to deduct as insurance premiums.
Petitioner argues that our holding in Carnation disregards the separate nature of the corporate entities involved, citing Moline Properties v. Commissioner, 319 U.S. 436 (1943). Such an argument is contrary to what we said at page 408 of 71 T.C.:
The foregoing analysis of Le Gierse reveals that the Court considered together two related agreements between unrelated parties. The Court’s opinion is not premised on its disregarding the separateness of the parties to the agreements. We conclude that the application of Le Gierse to the facts of the instant case will be equally valid whether or not Three Flowers and Carnation are separate entities for tax purposes. [Emphasis added.]
We reaffirm the quotation from Carnation that if the holding of Le Gierse applies, it applies regardless of whether or not Carnation and Three Flowers were considered separate entities for tax purposes.
It has been 6 years since we decided Carnation. The separate entity argument was argued and disposed of in Beech Aircraft Corp. v. United States, supra, and Crawford Fitting Co. v. United States, supra. The taxpayers continue to argue the theory in undecided cases which have been submitted to us. We, therefore, deem it appropriate to explain in more detail why we conclude that the separate nature of the corporate entities has not been disregarded in applying Le Gierse.
There are numerous situations in the tax law, both statutory and case law, where the separate nature of the entity is not disregarded but the transaction, as cast between the related parties, is reclassified to represent something else, e.g., reasonable compensation or dividend, loans or contributions to capital, loans or dividends, deposits or payments, or other recharacterization such as permitted under section 482, Internal Revenue Code of 1954, as amended. We have done nothing more in Carnation and here but to reclassify, as nondeductible, portions of the payments which the taxpayers deducted as insurance premiums but which were received by the taxpayer’s captive insurance subsidiaries.
The only insurance business which Lombardy had was that of petitioner. We expressly decline to decide in this case how the result might be affected, if at all, if the captive insurance company had insurance business from unrelated customers.
We, therefore, under the authority of Carnation, sustain respondent’s determination in denying 92 percent of petitioner’s deductions for insurance premiums on its workers’ compensation insurance. To reflect an alternative deduction which respondent does not dispute,
Decision will be entered under Rule 155.
Reviewed by the Court.
Dawson, Fay, Simpson, Sterrett, Chabot, Parker, and Cohen, JJ., agree with the majority opinion. Nims, J., did not participate in the consideration of this case.