GOFFE, Judge:
The Commissioner determined deficiencies in income tax against petitioner for the following taxable years:
Docket No. TYE Aug. 31— Deficiency
15292-80 1976 $4,615,905
1977 9,409,814
17130-82 1978 7,723,542
1979 20,460,078
After concessions by the parties, one issue remains for our decision, i.e., to what extent, if any, may petitioner deduct as ordinary and necessary business expenses amounts paid to a wholly owned captive insurance company which were treated as premiums for general liability and medical malpractice insurance.
We first decided the case in a Memorandum Opinion, T.C. Memo. 1985-426. Petitioner filed a motion for reconsideration of the opinion pursuant to Rule 161.2 The Court granted the motion and withdrew the opinion.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulations of facts and attached exhibits Eire hereby incorporated by reference.
Humana Inc. was incorporated under the laws of Delaware on July 27, 1964. At all pertinent times, the stock of Humana Inc. was publicly traded on the New York Stock Exchange, and its principal place of business was in Louisville, Kentucky.
Humana Inc. is the common parent of an affiliated group of corporations that filed consolidated Federal income tax returns for the taxable years ended August 31, 1976, through August 31, 1979, inclusive, with the Internal Revenue Service Center at Memphis, Tennessee. The parent and subsidiary corporations which filed the consolidated returns will sometimes be referred to collectively as “petitioner.”
American Medicorp, Inc. (AMI), was incorporated under the laws of Delaware on January 11, 1968. It was primarily engaged in the business of operating general, acute care community hospitals offering a wide range of medical, surgical, and related services. On February 2, 1978, Humana Inc. acquired 53.4 percent of the common stock of AMI for $85.5 million and 2,849,567 shares of Humana Inc. preferred stock. On September 27, 1978, AMI merged with and into Humana Subsidiary, Inc., a wholly owned subsidiary of Humana Inc. that was incorporated for purposes of the merger. As a result of the merger, Humana Inc. became the owner of all of the outstanding common stock of AMI. The final short period taxable year of AMI ended on September 27, 1978. AMI was merged into Humana Inc. on December 21, 1978.
As of February 1978, AMI held two general liability insurance policies. The primary policy was provided by American Home Assurance Co. (American Home), and an excess layer of insurance was provided by an industry pooling arrangement known as Hospital Underwriting Group, Inc. (HUG).
As of November 1976, petitioner operated 62 hospitals in 16 States and one foreign country, containing 8,586 beds. As of 1979, principally as a result of its acquisition of AMI, petitioner operated 92 hospitals in 23 States and one foreign country, containing 16,529 beds. Petitioner currently operates 87 hospitals owned by 36 corporations.
From 1972 until August 31, 1976, Continental Insurance Co. (Continental) provided petitioner with general liability-insurance, including malpractice liability and workers’ compensation insurance. As early as 1973, however, there were signs that the availability of such coverage to hospitals was diminishing, and by the mid-1970’s, this lack of availability became severe because of the long interval between setting the premium rate, collecting the premiums, and settling claims. During the intervals, loss reserves are established by use of actuarial accounting. Errors in such loss reserves have a strong impact on capital and earnings. Due to changing rules, economic inflation, and misjudgments, insurers were adjusting their loss reserves and premiums in many lines of casualty insurance, including malpractice insurance. On May 7, 1976, Continental advised petitioner by letter that it would be unable to renew its insurance coverage when it expired on August 31, 1976.
Through the services of its insurance broker, Marsh & McLennan, Inc. (Marsh & McLennan), Humana Inc. attempted to obtain general and professional liability insurance from third-party insurers, but was unsuccessful. On June 1, 1976, Marsh & McLennan recommended that petitioner immediately take steps to establish a captive insurance company.
At the time that the Marsh & McLennan letter was received, petitioner was considering the following options:
(1) going uninsured;
(2) creating a trust fund or reserve for self- insurance;
(3) combining with other hospital companies in a 5-year insurance pooling arrangement; or
(4) establishing a captive insurance company.
Petitioner rejected option (1) because it concluded that it was not strong enough to sustain the burden of catastrophic risk if it went uninsured. It rejected option (2) because, first, it felt that this option would not allow it access to commercial insurance markets for certain excess protection which it regarded as essential; second, some 40 percent of its business was under Medicare and Medicaid, and at least the former would not permit reimbursement for additions to the reserves;3 and third, it was clear that payments into such a reserve fund would not be deductible for Federal income tax purposes. Petitioner rejected option (3) because, first, it had doubts about the financial viability of its potential affiliates in such a pooling arrangement; second, one such potential affiliate owned hospitals in what were regarded as the worst States for malpractice claims; and third, it was reluctant to bind itself to such an arrangement for a 5-year period. Option (4) was considered the most attractive because it possessed none of the perceived disadvantages associated with the other options and it would provide a regulated method of insuring risks which would both isolate funds for the settlement of claims and satisfy interested lenders, mortgagees, and securities analysts. In addition, option (4) would provide access to world reinsurance and excess insurance markets.
On July 14, 1976, petitioner sought the approval of the Insurance Department of Colorado to establish a captive insurance company under Colorado law to insure against losses due to fire, general liability, medical malpractice, including hospitals, and other casualties.
On August 5, 1976, Health Care Indemnity, Inc. (HCI), was incorporated under the Colorado Corporation Act. The articles of incorporation of HCI state the following purposes for its incorporation:4
to conduct, engage in and carry on the business of making all kinds of insurance and reinsurance authorized to be made under the Colorado Captive Insurance Company Act * * * and to conduct, engage in and carry on all other activities incident to conducting such insurance and reinsurance business.
From August 20, 1976, to October 12, 1982, HCI qualified as a captive insurance company under Colorado law.
Humana Holdings, N.V. (HHNV), is a Netherlands Antilles corporation organized and incorporated on August 4, 1976. Humana Inc. purchased all of the capital stock of HHNV for $250,000, and continues to own it. The only business purpose for HHNV was to assist in the capitalization of HCI. Petitioner used the device of HHNV because it concluded that to do otherwise would have required the consolidation of HCI and Humana Inc. for tax purposes, requiring Humana Inc. to abandon its fiscal year in favor of a calendar year.
At the time of the initial capitalization of HCI, 150,000 shares of preferred stock and 250,000 shares of common stock were issued. Of these, HHNV purchased the preferred stock for $250,000 in cash, which it still owns, and Humana Inc. purchased the common stock for $750,000, paid in irrevocable letters of credit issued in favor of the Commissioner of Insurance of the State of Colorado. At all times since such capitalization, each share of common stock of HCI has been entitled to five votes, and each preferred share to one vote.
There were no agreements between HCI and Humana Inc. or its subsidiaries which would require the latter to contribute additional capital to HCI for the payment of any losses. However, on May 31, 1979, Humana Inc. contributed $1,323,000 to the capital of HCI. This represented a refund paid by HUG to Humana Inc. after AMI merged with Humana Subsidiary, Inc.
HCI issued the following policies during the taxable years in issue, identifying Humana Inc. and affiliated and subsidiary corporations, in the numbers shown, as named insureds:
Policy period _Coverage_
Policy No. From To Number of Number of corporations hospitals
1001 9/1/76 8/31/77 22 64
1003 9/1/775 9/1/78 22 59
HCI-90178 9/1/78 9/1/79 48 97
In addition, policy number HCI-60178, was effective from June 1, 1978, at which time Humana Inc. owned 53.4 percent of AMI’s common stock, until June 1, 1979. HCI replaced AMI’s primary policy with American Home, and incorporated by reference the terms of AMI’s excess coverage under its policy with HUG.
The charges for the foregoing policies accrued ratably throughout the policy periods. During the taxable years in issue, the following amounts were paid by petitioner to HCI for such policies and were deducted on the consolidated Federal income tax returns:
TYE Aug. 31-Policy No. Payments
1977 1001 6$5,703,571
1978 1003 75,865,986
1979 HCI-90178 87,582,893
HCI-60178 91,903,125
Total 21,055,575
The foregoing charges were developed by Marsh & McLen-nan pursuant to standard industry practice generally by applying to the average number of occupied beds, a composite rate developed by a rating organization known as Insurance Service Offices. The resulting amounts were billed by HCI to Humana Inc. on a monthly basis and were paid by Humana Inc. in a single payment representing the total premiums for all of the hospitals. Later, by means of an allocation formula, portions of the foregoing amounts were charged to the subsidiaries.10
Each of the policies provided three types of coverage: Coverage A — personal injury; Coverage B — property damage; and Coverage C — professional liability, including personal injury relating to certain professional services (i.e., malpractice). Each policy also included a “good Samaritan endorsement” under which professional employees, acting outside of their capacity as employees, were covered for certain occasional professional services not rendered for their personal benefit.
Under each of the four policies, the following were considered as “an insured:”
a. The named insured;
b. Any officer, hospital administrator * * * , stockholder, or member of the Board of * * * Directors or Governors of the named insured while acting for * * * the named insured.
c. Under Coverages A and B, any employee, student or volunteer worker of the named insured while acting within the scope of his duties * * * ;
*******
f. Under Coverage C, any person included in any of the employee classifications for which coverage is afforded under this policy, as indicated in Item 5 of the Declarations, while such person is acting within the scope of his duties as an employee * * *
Pursuant to item 5 of the Declarations, any employee of the insured was covered, including those professional employees who were licensed residents, interns, physicians, surgeons, or dentists, except that physicians, surgeons, and dentists were excluded under policy number HCI-60178. Under such policy, however, coverage was extended to independent contractors licensed as physicians and practicing in the hospital emergency room or attending to emergencies on the hospital premises. After June 1, 1979, this coverage was also provided for those insured under policy number HCI-90178. Generally, no coverage was provided for non-employee physicians, since they carried their own insurance.
Humana Inc., on forms 10-K filed with the Securities and Exchange Commission for the taxable years in issue, described the coverage provided by HCI as follows: The Insurance Subsidiary will insure the risks of the Company only, and it will only provide insurance to physicians who Eire actually employed by the Company. In such documents, “Company” is defined as Humana Inc. and its subsidiaries.
At all times pertinent in this case, payments for coverage of each of the categories described above were pEiid by petitioner: and were not charged to the employee or other individual involved.
Pursuant to policies numbered L00L, L003, and HCI-90178, the liability of HCI was limited to $2 million per occurrence under Coverages A, B, and C, $2 million in the aggregate under Coverages A and B, and $10 million in the aggregate under Coverage C.11 Pursuant to policy number HCI-60178, the liability of HCI was limited to $500,000 per occurrence and $2.4 million in the aggregate for each category of covered risks.
The insurance coverage of petitioner during the taxable years in issue also included multiple layers of excess coverage placed with third-party insurance carriers, over and above the foregoing primary layer provided by HCI.
In policies numbered 1002 and 1004, HCI also provided certain excess comprehensive general coverage to petitioner for the respective periods September 1, 1976, to August 31, 1977, and September 1, 1977, to August 31, 1978. All of the liability under these policies was reinsured by HCI with third-party reinsurance companies. The Commissioner allowed petitioner to deduct the premiums for these policies. With the exception of these policies, during the taxable years in issue HCI did not reinsure the risks of losses with other insurance companies nor did petitioner obtain policies with third-party insurers which were reinsured by or with HCI.
At all times involved in this case HCI filed separate Federal income tax returns based upon a calendar year. The returns and its books and records were maintained using the accrual method of accounting.
During the taxable years in issue, HCI had no employees other than its officers, most of whom were also officers of Humana Inc. By contract dated August 1976, Marsh & McLennan provided HCI with resident managing officers and a variety of administrative and management services, including consulting, underwriting, risk control, record-keeping, and accounting services. At all times involved in this case, Underwriters Adjusting Co. provided, by written contract, claims administration and claims service for HCI.
After concessions, the sole issue for decision is whether the following amounts are deductible as insurance premiums:
TYE Aug. 31-Amount
1977. $5,703,571
1978. 5,865,986
1979. 9,486,018
Total. 21,055,575
OPINION
We previously decided this case in Memorandum Opinion, T.C. Memo. 1985-426. Petitioner filed a motion for reconsideration, which the Court granted, and the Court withdrew the opinion.
Humana Inc. and its subsidiaries operated hospitals whose insurance coverage was canceled. Humana Inc. incorporated a captive insurance subsidiary which it jointly owned with a wholly owned foreign subsidiary. The captive insurance subsidiary purported to provide insurance coverage for Humana Inc. and its other subsidiaries. Humana Inc. paid to the captive insurance subsidiary amounts which it treated as insurance premiums. It charged portions of these amounts to its operating subsidiaries.
Two issues are presented for our decision:
(1) Are the sums paid to HCI by Humana Inc. on its own behalf deductible as ordinary and necessary business expenses for insurance premiums, and
(2) Are the sums charged by Humana Inc. to the operating subsidiaries deductible on the consolidated income tax returns as ordinary and necessary business expenses for insurance premiums.
For convenience, the first issue may be described as the “parent-subsidiary” issue and the second issue may be described as the “brother-sister” issue. These represent the relationships between the entity which purports to be the insured and the captive insurance subsidiary which purports to be the insurer.
We have previously decided the parent-subsidiary issue in Carnation Co. v. Commissioner, 71 T.C. 400 (1978), affd. 640 F.2d 1010 (9th Cir. 1981), and Clougherty Packing Co. v. Commissioner, 84 T.C. 948 (1985), on appeal (9th Cir., Dec. 13, 1985). Our decision in Carnation has been followed in disallowing the deductions in Beech Aircraft Corp. v. United States, 797 F.2d 920 (10th Cir. 1986); Stearns-Roger Corp. v. United States, 774 F.2d 414 (10th Cir. 1985); and Mobil Oil Corp. v. United States, 8 Cl. Ct. 555 (1985). Carnation was applied, but with a different result, in Crawford Fitting Co. v. United States, 606 F. Supp. 136 (N.D. Ohio 1985). Our decision in Clougherty has been followed in Anesthesia Service Medical Group v. Commissioner, 85 T.C. 1031 (1985), on appeal (9th Cir., May 14, 1986), Stearns-Roger, and Mobil. Accordingly, we decide the parent-subsidiary issue in favor of respondent under the authority of Carnation and Clougherty, and it is unnecessary to restate our analysis.
Petitioner also contends that even if the subject payments failed to constitute deductible insurance premiums, they are nonetheless deductible under section 162 “because they are ‘ordinary and necessary’ business expenses ‘paid or incurred’ during the taxable years” in issue. In Clougherty, we answered this argument by holding that in disallowing the payments as insurance premiums, we reclassified them as nondeductible. 84 T.C. at 960. The Claims Court in Mobil followed this approach. 8 Cl. Ct. at 567.
Payments to a captive insurance company are equivalent to additions to a reserve for losses. Stearns-Roger Corp. v. United States, supra at 415; Mobil Oil Corp. v. United States, supra at 567. It has long been recognized that sums set aside as an insurance reserve are not deductible. Steere Tank Lines, Inc. v. United States, 577 F.2d 279, 280 (5th Cir. 1978), cert. denied 440 U.S. 946 (1979); Spring Canyon Coal v. Commissioner, 43 F.2d 78 (10th Cir. 1930), cert. denied 284 U.S. 654 (1931). If the payments to HCI are not deductible as insurance premiums, they are not deductible at all.
In addition, petitioner argues for deductibility of portions of the amounts paid by Humana Inc. to HCI. It contends that the expense of providing insurance to certain employees, officers, directors, and contractors covered under the policies in issue should be deductible. As to this argument, petitioner cites no authority to support its apparent contention that the risks, whether arising from purely corporate acts or acts of specific corporate employees, were other than the risks fully retained within the meaning of Carnation and Clougherty. Indeed, we believe that it would be difficult to find any such persuasive authority where, as here, the coverage of certain employees, officers, and others was clearly an integral part of the protection of the parent corporation. In this regard, on its forms 10-K filed by Humana Inc. with the Securities and Exchange Commission for the taxable years in issue, it described the coverage provided by HCI as follows: The Insurance Subsidiary will insure the risks of the Company only, and it will only provide insurance to physicians who are actually employed by the Company. In such documents, “Company” is defined as Humana Inc. and its subsidiaries.
We turn now to the brother-sister issue, which is an issue of first impression in this Court. It has, however, been decided in favor of the Government in Stearns-Roger and Mobil. Those cases extended the rationale of Carnation and Clougherty to the brother-sister factual pattern. We likewise extend the rationale to the brother-sister factual pattern of the instant case. We emphasize that our holding is based upon the factual pattern presented in this case. We recognize that corporate factual patterns may differ. See Crawford Fitting Co. v. United States, supra. In addition, other factors may be present, e.g., reinsurance agreements, guarantees, etc.
Petitioner, in support of its motion for reconsideration argues that in the Mobil case it has support for holding that the risk was shifted among the subsidiaries. We disagree. Mobil involved not only the deductibility of payments from the parent and the subsidiaries to the captive insurance subsidiary but also whether the payments from the subsidiaries to the captive insurance subsidiary resulted in constructive dividends to the parent. The Claims Court held that the arrangement did not cause the risk of loss to be shifted and the payments were, therefore, not deductible as insurance premiums. It also held that the payments did not result in constructive dividends to the parent. 8 Cl. Ct. at 568.
Petitioner relies upon the portion of the Claims Court opinion concerning constructive dividends in which the Court describes the business purposes involved. The business purpose for the payments is not relevant in deciding the deductibility of the payments as insurance premiums because the payments have been reclassified as nondeductible additions to a reserve for losses.
This is the first case on captive insurance arrangements in which expert testimony has been presented to this Court. Carnation was decided on the parties’ motions for summary judgment and Clougherty was fully stipulated. In the instant case, three expert witnesses testified and the Court received written reports of their opinions. Dr. Irving Pfeffer testified for petitioner and Dr. Irving Plotkin and Mr. Richard Edward Stewart testified on behalf of respondent. Dr. Plotkin testified in the Stearns-Roger, Beech Aircraft, and Mobil cases cited above. Dr. Pfeffer and Mr. Stewart did not testify in any of the previously decided cases.
The opinion of Dr. Pfeffer provides little reasoning and is not very convincing. It simply concludes that the arrangements between Humana Inc., its operating subsidiaries, and HCI constitute insurance. Furthermore, it is contrary to the cases cited above.
Dr. Plotkin and Mr. Stewart prepared a joint opinion. Their opinion is consistent with our decisions in Carnation and Clougherty and contains very persuasive reasoning. The analysis portion of the Plotkin-Stewart expert report is as follows:
Analysis
This case presents the question of whether payments made by a corporation to its wholly owned subsidiary in exchange for formal contracts of “insurance” constitute deductible premiums for federal income tax purposes. The respondent has taken the position that such transactions are not deductible since they are devoid of any risk transfer (also referred to as risk shifting), an element which he believes to be critical to the definition of insurance for federal income tax purposes.
The respondent has requested us to analyze whether or not the various transactions between and among Humana, AMI, HCI, and * * * , labeled “insurance” by the petitioner, can actually be considered “insurance” from the standpoint of how the insurance and economic professions view them.
Commercial insurance is a mechanism for transferring the financial uncertainty arising from pure risks faced by one firm to another in exchange for an insurance premium. Such financial uncertainty is caused by the possibility of certain types of occurrences that may have only adverse financial consequences. A corporation such as Humana that places its risks in a captive insurance company that it owns, either directly or through a parent corporation, subsidiary, or a fronting company, is not relieving itself of this financial uncertainty. The reason for this is simply that such corporation, through its ownership position, still holds the benefits and burdens of retaining the financial consequences of its own risks. It has a dollar for dollar economic interest in the result of any “insured” peril.
A term frequently used for the act of insuring is underwriting. An essential element of the concept of underwriting is the transference of uncertainty from one firm to another, generally from the one whose activities naturally give rise to the uncertainty to one whose investors are in the business of accepting such uncertainty for the potential profit they can earn thereby.
Thus, insurers, and the interests that own them, are risk takers. They assume the financial consequences of the risks for others in return for a premium payment. * * *
The essential element of an insurance transaction from the standpoint of the insured (e.g., Humana and its hospital network), is that no matter what insured perils occur, the financial consequences are known in advance. Thus the insured, for the price of its premium, is protected from such financial consequences, within the limits of its policy. 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.
To have a true transfer of risk, another risk-bearer must replace the insured. To speak of a transfer of risk to a fund or reserve established by the insured is merely to describe “self-insurance”. A captive insurance subsidiary, such as HCI, represents a recognized form of risk retention or “self-insurance”. Many scholars have noted that the very term, “self-insurance”, is a misnomer, since there cannot be any insurance without risk transfer.
Accordingly, a firm cannot insure itself. This does not mean, however, that a firm cannot or should not choose to retain the financial uncertainty of the hazards it faces, nor attempt to predict and minimize the financial consequences of its risks. Whether its portfolio of risks is large or small, there is always uncertainty concerning what will be the actual financial consequences of the events that may occur during some future time period. In fact, the larger the collection of risks, the greater is the uncertainty concerning the actual result. The only way a firm can relieve itself but only of the financial uncertainty is by entering into a contract whereby some other firm will assume that uncertainty. * * *
A firm placing its risks in a captive insurance company in which it holds a sole or predominant[12] ownership position, is not relieving itself of financial uncertainty. It is, through its ownership, retaining the burdens and benefits of assuming the financial responsibility of its own risks. This concept has been recognized by scholars for at least twenty years:
“It is apparent that the nature of the captive-insurance device involves not only the element of insurance through ‘transfer’ of risks, but also the notion of self-insurance since the ‘owners’ of the risks insured therein are the ‘owners’ of the insurer. The fortunes of the two entities are interlocked to the extent that the risks insured in the captive are not reinsured. In this sense, captive insuring can be considered a risk-retention device similar to self-insurance. In fact, if self-insurance involves the conduct of risk managment ‘according to all the sound principles and practices employed by insurance companies’ it might be argued that captive insuring is the epitome of the self-insurance device * * * (Robert S. Goshay, ‘Captive Insurance Companies,’ Risk Management, Ch. VI, Richard D. Irwin, Inc., Homewood, Illinois, 1964, pp. 80-121, at p. 85.)”
* * * the recognition and description of captive insurance as a form of risk retention and self-insurance permeates the theoretical and applied insurance and accounting literature. * * *
When a firm actually obtains insurance, the firm’s financial costs associated with the insured peril are independent of whether or not the peril actually comes to pass, or the extent of the financial damage caused by the peril. Its costs, in fact, are equal to the insurance premium and known in advance with certainty. Just the opposite obtains with any form of self-insurance, be it on the corporation’s books or through the books of the firm’s captive insurance subsidiary. The actual costs are a direct, dollar-for-dollar function of what perils in fact come to pass and what their financial consequences turn out to be.
* * * * * * *
A question that perplexes some when initially confronted with the captive insurance area is whether or not respondent has chosen to treat, either directly or indirectly, two separate legal entities as one single economic unit. One’s first impression might be that, since a parent corporation can deal at arm’s-length with a subsidiary in other areas besides insurance and have such transactions respected by respondent, “insurance premiums” paid to a captive should not be treated any differently. The answer to this paradox lies in the unique nature of insurance transactions relative to other types of parent/subsidiary transactions.
True insurance relieves the firm’s balance sheet of any potential impact of the financial consequences of the insured peril. For the price of the premiums, the insured rids itself of any economic stake in whether or not the loss occurs. * * * [However] as long as the firm deals with its captive, its balance sheet cannot be protected from the financial vicissitudes of the insured peril.[13]
On the other hand, if a parent sold its subsidiary a hotel, it is true that the ultimate fate of that hotel will be reflected on the balance sheet. However, whether or not the transferred property could accurately, for tax and other purposes, be described as a hotel is not a function of whether or not the parent’s balance sheet reflects the ultimate fate of the property. This, however, is precisely opposite from the case of insurance. A transaction can be fairly described as insurance if, and only if, the parent’s balance sheet is immunized from the financial consequences of the insured peril. * * *
It is well recognized that insurance premiums are accorded unique and favorable treatment within the Internal Revenue Code. The same is true for other specific economic activities, such as the depletion allowance accorded to oil wells. We believe that if company A sold company B a farm but in the contract described it as an oil well, company B would not be eligible for depletion allowances.
* :f: 4! jjc # *
CONCLUSION
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” did not accomplish a transference of risk, or constitute an insurance transaction as a matter of insurance theory or 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.
In Beech Aircraft, the District Court commented favorably on the testimony of Dr. Plotkin, found it to be relevant, and overruled the taxpayer’s objections to the testimony.14 No court has refused to accept the testimony of Dr. Plotkin on captive insurance.
Dr. Plotkin testified in both of the brother-sister cases. The District Court, in Stearns-Roger, adopted the analysis of Dr. Plotkin. The Claims Court, in Mobil, based upon the opinion of Dr. Plotkin, concluded that the risk of loss was always with the parent corporation and was not shifted away from the parent by reason of payments among the brother-sister subsidiaries. The Claims Court commented upon the testimony of Dr. Plotkin as follows:
Dr. Irvin Plotkin, * * * was qualified as an expert in the economics of insurance. Dr. Plotkin testified that Mobil did not actually purchase insurance as the term is defined in the field of economics. Essentially, Dr. Plotkin testified that a wholly-owned subsidiary cannot insure its parent because there is no risk transference. The risk of loss remains within the economic unit. As a shareholder of a wholly-owned insurance affiliate, the parent company bears the risks of the subsidiary, suffers from losses sustained by the subsidiary, and benefits from gains realized by the subsidiary. * * * [8 Cl. Ct. at 563.]
Mr. Stewart, in his testimony in the instant case, agreed with Dr. Plotkin as to the shifting of risk. Mr. Stewart has imposing credentials, among them he was superintendent of insurance for the State of New York from 1967 through 1970. From a pragmatic standpoint he perceived no difference between the payments at issue and self insurance.
The joint opinion of Dr. Plotkin and Mr. Stewart proceeds from the proposition that there must be a transfer or shifting of risk for the transactions to represent insurance. This conforms to “hornbook law” 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. Stearns-Roger Corp. v. United States, 774 F.2d at 416; Carnation Co. v. Commissioner, 640 F.2d at 1013; Mobil Oil Corp. v. Commissioner, 8 Cl. Ct. at 566; Clougherty Packing Co. v. Commissioner, 84 T.C. at 958; Pan-American Hide Co. v. Commissioner, 1 B.T.A. 1249, 1250 (1925). Thus, a taxpayer cannot deduct as insurance premiums amounts which it sets aside as a reserve to cover future casualties.
If we decline to extend our holdings in Carnation and Clougherty to the brother-sister factual pattern, we would exalt form over substance and permit a taxpayer to circumvent our holdings by simple corporate structural changes. Assume that Corporation A incorporates a wholly owned captive insurance company, Corporation B, which insures the risks of A. Under our holdings in Carnation and Clougherty, A could not deduct the premiums it pays to B.
Let us alter the corporate structures to the brother-sister factual pattern. The shareholders of Corporation A exchange their stock for the stock of Corporation B, which was incorporated for the sole purpose of holding the stock of A. A is now the wholly owned subsidiary of B. A continues to be the operating corporation. B then incorporates a wholly owned captive insurance company, Corporation C. Corporation C insures the risks of Corporation A, the operating company. Corporations A and C are brother-sister corporations of a common parent, Corporation B.
If we do not extend the holdings of Carnation and Clougherty to the brother-sister factual pattern, the payments from Corporation A to Corporation C would be deductible as insurance premiums. Such a holding, of course, would be contrary to the decisions of the 10th Circuit in Stearns-Roger and the Claims Court in Mobil, both of whom relied upon our decisions in Carnation and Clougherty.
Respondent again argues that we should adopt his “economic family” concept which he articulated in Rev. Rul. 77-316, 1977-2 C.B. 53. We declined to adopt that concept in Carnation Co. v. Commissioner, 71 T.C. at 413, and also declined to adopt it in Clougherty Packing Co. v. Commissioner, 84 T.C. at 956. We again decline to adopt that concept because it does not tell all of the story. As we have seen from Crawford Fitting an “economic family” may exist which results in the shifting of risk. Instead of applying a broad approach such as “economic family” to captive insurance, we hold that it is more appropriate to examine all of the facts to decide whether or to what extent there has been a shifting of the risk from one entity to the captive insurance company.
We conclude that there was not the necessary shifting of risk from the operating subsidiaries of Humana Inc. to HCI and, therefore, the amounts charged by Humana Inc. to its subsidiaries did not constitute insurance. Accordingly, the amounts paid to HCI are not deductible as ordinary and necessary business expenses.
Decisions will be entered under Rule 155.
Reviewed by the Court.
Sterrett, Simpson, Chabot, Nims, Parker, Whitaker, Hamblen, Cohen, Jacobs, Parr, and Williams, JJ., agree with the majority opinion.