*112 Decision will be entered for the petitioner.
Petitioner, chartered as a mutual insurance company, held, taxable under section 207, I. R. C. 1939, even though it had guaranty fund certificates outstanding, Citizens Fund Mutual Fire Insurance Co., 28 T. C. 1017 (decided this day), and had accumulated reasonable reserves. Order of Railway Employees, 2 T. C. 607.
*1007 Respondent determined deficiencies in petitioner's income tax for the calendar years 1946, 1948, and 1949 of $ 17,829.41, $ 27,455.25, and $ 9,807.51, respectively. By amended answer, respondent alleged that the correct deficiencies were:
| Year | Deficiency |
| 1946 | $ 24,188.45 |
| 1948 | 42,543.50 |
| 1949 | 35,625.41 |
The primary issue to be decided is whether petitioner was a mutual insurance company within the meaning of section 207 of the Internal Revenue Code of 1939. An alternative issue, raised by the amended answer and to be considered only if petitioner was not a mutual company, is whether, under section 204 of the Internal Revenue Code of 1939, petitioner may compute its reserve for unearned premiums on the full reserve basis (sometimes called the New York standard basis).
FINDINGS OF FACT.
The stipulated facts are hereby found.
Petitioner, incorporated as a mutual windstorm insurance company under the laws of Minnesota on September 7, 1929, maintained its principal office in St. *114 Paul, Minnesota. Since 1936 it has been licensed by Minnesota as a mutual fire insurance company, and has functioned under the provisions of Minnesota law applicable to mutual fire insurance companies. In each foreign State in which licensed to do business, it functioned under the provisions of law applicable to foreign mutual fire insurance companies. Petitioner's name was "Farm Owners Mutual Insurance Company" from 1946 through 1949.
Petitioner filed timely Federal income tax returns for 1946, 1948, and 1949 with the collector of internal revenue for the district of Minnesota on Form 1120 M, entitled "Mutual Insurance Company Income Tax Return."
*1008 Petitioner filed its returns on similar forms for 1942 through 1945 with that collector and paid income taxes computed under section 207 for these years. Petitioner filed with these returns a copy of its annual statement indicating the existence and amount of the guaranty fund.
Petitioner had no guaranty fund certificates outstanding prior to 1939. On November 27, 1939, petitioner's directors authorized the first issuance of guaranty fund certificates. Certificates outstanding on December 31 of each of the years 1939 through*115 1949 were:
| 1939 | $ 5,630 |
| 1940 | 7,550 |
| 1941 | 11,670 |
| 1942 | 11,760 |
| 1943 | 12,260 |
| 1944 | 116,110 |
| 1945 | $ 126,730 |
| 1946 | 155,940 |
| 1947 | 161,440 |
| 1948 | 161,440 |
| 1949 | 161,440 |
These certificates had no fixed maturity dates. Petitioner made payments ranging from $ 6,704.06 to $ 8,399.50 on the certificates outstanding in the years 1946 through 1949.
Each certificate outstanding from 1946 through 1949 was written in the following terms:
Interest 5%
Certificate of Surplus
This Certifies That the
Farm Owners Mutual Insurance Company of Saint Paul, Minnesota
IS INDEBTED TO Surplus Certificates in the amount of DOLLARS
The face amount or any part thereof and/or the interest thereon is payable to the above named holder, his heirs, assigns, executors or administrators only from earned surplus funds of the FARM OWNERS MUTUAL INSURANCE COMPANY when such payment is authorized by a recorded resolution of its Board of Directors and the approval of the Commissioner of Insurance.
THE FARM OWNERS MUTUAL INSURANCE COMPANY reserves the right to redeem this certificate at any time by paying to the holder hereof the face value of the certificate plus any accrued interest.
* * * *
At the end*116 of each of the years 1946 through 1949, the number of guaranty fund certificate holders, the approximate number of policyholders, the number of such certificate holders who were policyholders, and the percentage of the total value of guaranty fund certificates held by policyholders were: *1009
| Percentage | ||||
| Number of | Policyholders | of total | ||
| Certificate | policyholders | holding | value of | |
| Year | holders | (approximate) | certificates | guaranty |
| certificates | ||||
| held by | ||||
| policyholders | ||||
| 1946 | 82 | 13,000 | 37 | 52.7 |
| 1947 | 90 | 14,000 | 42 | 63.8 |
| 1948 | 87 | 21,000 | 41 | 66.6 |
| 1949 | 85 | 32,000 | 44 | 68.3 |
In 1949, petitioner's directors owned approximately 44 per cent of the outstanding certificates.
Petitioner issued each certificate for cash in an amount equal to face value and established and maintained the fund represented by these certificates in accordance with the laws of Minnesota. Petitioner redeemed none of these certificates. However, some of them were transferred by the holders during the years at issue.
Petitioner maintained the certificates which were outstanding from 1946 through 1949 to provide additional protection to policyholders. *117 Petitioner's surplus to policyholders prior to the issuance of the first certificate in 1939 was at unduly low levels, both in absolute terms and relative to net premiums. During the years 1939 through 1943, the outstanding guaranty fund provided most of the surplus to policyholders.
In 1941, petitioner began to write insurance covering damage to live turkeys from fire and the elements. A severe storm in Minnesota and the Dakotas in 1940 and consequent severe losses on turkey insurance caused other insurance companies to discontinue insuring live turkeys. Petitioner had to pay heavy losses on its turkey insurance in 1943 as the result of another severe storm; its losses plus loss adjustment expenses on turkey insurance in 1943 were 157 per cent of the premiums earned. While most of the losses had been adjusted as of December 31, 1943, petitioner lacked the funds with which to make payment until it succeeded in obtaining a loan from a St. Paul bank. Subsequently it collected on its reinsurance, which resulted in petitioner's net loss being less than the net premiums for 1943.
Partially because of these losses and partially because petitioner had not been able to develop an adequate*118 surplus to policyholders since it commenced operations in 1936, petitioner lacked sufficient financial strength in the beginning of 1944 to provide adequate insurance protection to turkey growers on a large scale.
At this time turkey growers, turkey processors, and grain dealers engaged in selling feed to turkey growers were desirous of developing a mutual insurance company which would be willing to write insurance on live turkeys on a large scale, which would write such insurance at reasonable costs, and which would have a surplus to policyholders *1010 adequate to protect its members. Consequently, the National Turkey Federation, a nationwide trade association of turkey growers and processors, agreed to recommend to its members the purchase of guaranty fund certificates of petitioner in substantial amounts.
During 1944, petitioner issued additional guaranty fund certificates in the amount of $ 103,850. Such certificates were issued to strengthen petitioner's financial position in order to enable it to supply insurance on live turkeys which would otherwise not have been available at reasonable costs. Petitioner increased its guaranty fund in subsequent years for the same *119 purpose. At all times during the years at issue the guaranty fund outstanding provided surplus to policyholders which petitioner considered necessary to carry the insurance risks written by petitioner, primarily turkey insurance risks.
Petitioner's surplus, after providing for unearned premiums on the full reserve basis and exclusive of guaranty fund, increased from a $ 1,620.67 deficit in 1938 to $ 162,743.20 in 1949.
Petitioner's articles of incorporation authorized it from 1946 through 1949 to write fire and allied lines of insurance. The material parts of the articles of incorporation provided:
ARTICLE V
Sec. 1. The general management of the business of this corporation shall be vested in a Board of not less than three or more than seven Directors, each of whom shall during his term of office be a member of the Company. Such board of Directors shall be elected at the annual meetings of the Company * * *
* * * *
ARTICLE VIII
The members, or Directors, of this Company may, at any time they deem advisable, maintain, establish or create a Guaranty Fund under and pursuant to * * * Minnesota [law] * * *
* * * *
Every policyholder shall be a member entitled to vote at any annual or*120 special meeting or adjournment thereof in person or by proxy * * *
The material provisions of petitioner's bylaws in force in 1946 through 1949 provided that: The company shall hold annual meeting of members; every policyholder shall be a member of the company and entitled to vote at any annual meeting or special meeting of the company; policyholders may vote in person or by proxy; holders of guaranty fund certificates shall be entitled to one vote for each $ 10 certificate recorded in their names.
Section 66.08, Minn. Stat. Ann., permits a guaranty fund to --
be reduced or retired by vote of the policyholders of the company and the assent of the Commissioner, if the net assets of the company above its reinsurance reserve and all other claims and obligations and the amount of its *1011 guaranty fund certificates and interest thereon for two years last preceding and including the date of its last annual statement shall not be less than 50 per cent of the premiums in force.
During the years 1946 through 1949 petitioner's net assets, as so described, were in excess of 50 per cent of the premiums then in force.
During the period 1946 through 1949 no certificate holder exercised*121 more than one vote for one person at any meeting and no certificate holder ever elected or asserted the right to elect separately from policyholders any members of petitioner's directors. The number of persons present at petitioner's annual meetings from 1946 through 1949 varied from approximately 25 to 46. Some of these persons were not policyholders. During this same period one of petitioner's directors, F. W. Schwanke, was an officer and a certificate holder but he was not a policyholder.
All insurance policies, except those insuring farm property against windstorm, issued by petitioner during the years in issue, or in force at any time during such years, contained substantially the following provisions:
The maximum contingent Mutual liability of the policyholder shall be a sum equal to, and in addition to, one annual premium.
The assured is hereby notified that by virtue of his policy, he is a member of the Farm Owners Mutual Insurance Company of St. Paul, Minnesota, and that the annual meetings of said Company are to be held at its Home Office in * * * St. Paul, Minnesota, on * * *
Petitioner never assessed its policyholders.
Respondent ruled petitioner exempt from Federal*122 income tax as a mutual insurance company under the provisions of section 101 (11) of the Revenue Act of 1936 and the corresponding provisions of prior Revenue Acts on April 25, 1938. In 1945 and 1946, the Internal Revenue Service requested additional information in support of petitioner's claim for exemption. On June 22, 1946, petitioner supplied the requested information to the Internal Revenue Service by a letter which contained the following statements:
4. This company does not have capital stock but it has issued Certificates which have been used to increase the surplus available to the policyholders for the payment of losses and expenses. There are not dividends to accrue on these Certificates but an interest of 5 per cent is paid annually subject to the approval of the Board of Directors and the Commission of Insurance.
5. The owners of these Certificates of Surplus are the policyholders, agents, directors and officers of the company. At least 55 per cent of this amount outstanding is held by policyholders and agents, excluding directors and officers.
Respondent reaffirmed the income tax exemption of petitioner for taxable years prior to the effective date of the Revenue*123 Act of 1942 on the basis of the material submitted.
Petitioner made its annual statement, for each of the years in issue and for each prior year in which a guaranty fund was outstanding, to *1012 Minnesota and all other States in which it was licensed and doing business on a form approved by the National Association of Insurance Commissioners, and entitled "Mutual Fire Companies -- Association (Convention) Edition," and such annual statement showed petitioner's guaranty fund outstanding at the close of the years.
From 1946 through 1949, petitioner belonged to the Minnesota Association of Mutual Insurance Companies. This association limited its membership to mutual or cooperative insurance companies, associations, or corporations, incorporated under the Minnesota laws, or legally admitted to transact business in Minnesota. In 1948, petitioner was admitted to membership in the National Association of Mutual Insurance Companies, which limited its membership to:
Any mutual insurance company other than life which has been in continuous successful operation for a period of at least five (5) years and which has the endorsement of at least two (2) active members of this Association*124 * * *
Eight States licensed petitioner under the name of "Farm Owners Mutual Insurance Company" to write fire and allied lines of insurance in 1949; 6 States so licensed petitioner in 1948; and 2 licensed petitioner in 1946.
Petitioner's farm windstorm policies, under which assessments were collected annually to cover losses and expenses during the years at issue, contained substantially the following provision:
I agree to pay to the FARM OWNERS MUTUAL INSURANCE COMPANY * * * a survey fee of 20 cents per hundred of insurance but on no policy shall the survey fee be less than $ 3.00. I further agree to pay on the Anniversary Date of the policy of each succeeding year the assessment levied for the purpose of paying claims and expenses, and any necessary additions to the safety fund. The Directors shall fix the amount of such assessments to be charged, which may differ in amount for different parts of the territory in which the Company operates, if, in the judgment of the Directors, the hazard is greater or less than in another.
During 1946 petitioner was a member or subscriber to the predominant rating bureau of 2 States in which it was qualified to do business; in 1948, 5 States; *125 and in 1949, 6 States. Insurance-rating bureaus are regulated by State statutes and are under supervision of a State officer. These bureaus promulgate rates for various types of insurance, including fire and extended coverage. Insurance companies may qualify in the various States to write insurance at rates which deviate from the rate promulgated by the rating bureaus. Petitioner wrote fire and extended coverage insurance at rates below the rates promulgated by the insurance-rating bureaus in the States in which it was licensed to do business. Petitioner wrote crop-hail insurance at the full rate promulgated by the rating bureaus. Petitioner promulgated its own turkey insurance rates, establishing what is known as an independent rate filing in that class of coverage. It wrote inland marine insurance at the rates of the Transportation Insurance Rating *1013 Bureau. Petitioner paid dividends of $ 12,053.39, $ 19,481.67, $ 22,966.31, and $ 13,147.08 to its policyholders on turkey insurance in the years 1946 through 1949, respectively. No other dividends were paid during these years.
The following table gives figures for petitioner's turkey insurance business for 1946 through*126 1949.
| Net premiums | Number of | Maximum | Maximum | |
| Year | received on | turkey poults | liability per | amount of |
| turkeys | insured | turkey | reinsurer's | |
| liability | ||||
| 1946 | $ 249,749 | 4,577,214 | $ 3.00 | $ 200,000 |
| 1947 | 241,437 | 4,538,242 | 3.50 | 200,000 |
| 1948 | 234,942 | 3,590,412 | 3.50 and 4.50 | 179,521 |
| 1949 | 492,907 | 7,542,801 | 3.50 and 4.50 | 340,000 |
Through the writing of insurance at substantial deviations under the rating bureau rates used by the standard stock companies, through the payment of dividends to policyholders, and through the establishment of low independent rates, petitioner during the years at issue furnished insurance to its policyholders substantially at cost after the payment of all losses and expenses, the establishment of the necessary reserves for insurance outstanding, and the retention of reasonable surplus to meet losses more severe than are normally anticipated and to provide for conflagration and catastrophe hazards.
The following chart shows the increase in petitioner's surplus due to operations from 1945 through 1949:
| 1945 | 1946 | 1947 | |
| Total gains (or losses) from underwriting | |||
| and investments | $ 87,515.87 | $ 106,384.76 | $ 28,535.66 |
| Less: | |||
| Dividends declared to policyholders | 26,113.65 | 29,695.87 | 8.78 |
| Interest on guaranty fund | 6,837.39 | 8,002.38 | |
| Federal income taxes incurred | 2,957.42 | 4,322.00 | 5,244.03 |
| Total deductions | 29,071.07 | 40,855.26 | 13,255.19 |
| Increase in surplus from operations of | |||
| business (no guaranty fund included) | 58,444.80 | 65,529.50 | 15,280.47 |
| 1948 | 1949 | |
| Total gains (or losses) from underwriting | ||
| and investments | $ 131,124.74 | $ 144,793.90 |
| Less: | ||
| Dividends declared to policyholders | 11,782.97 | 54,982.60 |
| Interest on guaranty fund | 8,071.50 | 8,072.00 |
| Federal income taxes incurred | 6,405.07 | 11,740.77 |
| Total deductions | 26,259.54 | 74,795.37 |
| Increase in surplus from operations of | ||
| business (no guaranty fund included) | 104,865.20 | 69,998.53 |
Minnesota examined petitioner as of December 31, 1946. The examiner stated in his resort to the Minnesota commissioner of insurance on February 24, 1947, that:
The Company, as a general writing mutual insurance company, may insure against loss or damage to any or all kinds of business set forth in * * * Minnesota [law] * * *
* * * *
The Company maintains a complete record of premiums in force by line and year of expiration. From these records, a recapitulation of premiums in force was taken, and the proper unearned factors applied. The above amount represents 50% of the regular reserve and 100% of advance premiums. This is *1014 permitted under the Minnesota statutes for mutual companies issuing an assessable policy.
The Minnesota commissioner of insurance*128 approved and accepted this report.
In insurance company accounting, the term "unearned premiums" or "unearned premium reserve" reflects the liability of the company for premiums collected but not yet earned. The unearned premium reserve of stock companies under the laws of all the States, and that of mutual companies under the laws of many States, must be computed on the full reserve basis. In computing the reserve on that basis, there must be allocated to it so much of the net premiums written on each policy in force at the end of the year as the length of the term which the policy will continue after the end of the year bears to the total term of the policy. For the purposes of this computation it is generally assumed that the term of each policy begins on July 1 of the year in which it actually begins. The following schedule reflects unearned premium reserves on the full reserve basis:
| Unearned premium | |
| Policies | reserve -- fraction |
| in force | of net premiums |
| December 31 | in force |
| 1 year or less | 1/2 |
| 2-year policies: | |
| First year | 3/4 |
| Second Year | 1/4 |
| 3-year policies: | |
| First year | 5/6 |
| Second year | 3/6 |
| Third year | 1/6 |
| 4-year policies: | |
| First year | 7/8 |
| Second year | 5/8 |
| Third year | 3/8 |
| Fourth year | 1/8 |
| 5-year policies: | |
| First year | 9/10 |
| Second year | 7/10 |
| Third year | 5/10 |
| Fourth year | 3/10 |
| Fifth year | 1/10 |
| Over 5 years | Pro rata |
| Advance premiums | 100 per cent |
*129 The laws of Minnesota permit mutual fire insurance companies issuing policies with contingent assessment liability to compute the unearned premium reserve as an amount equal to one-half of that computed on the full reserve basis. In its annual statements filed with the Minnesota commissioner of insurance and with its Federal income tax returns, petitioner computed its unearned premium reserves on the Minnesota mutual basis.
Petitioner had an unearned premium reserve, computed on the Minnesota mutual basis, as of December 31 for the years 1945 through 1949 as follows:
| 1945 | $ 25,949.88 |
| 1946 | 44,837.80 |
| 1947 | 66,432.20 |
| 1948 | 108,358.30 |
| 1949 | 176,858.23 |
*1015 Petitioner had an unearned reserve, computed on a full reserve basis, as of December 31 for the years 1945 through 1949 as follows:
| 1945 | $ 48,389.86 |
| 1946 | 84,012.11 |
| 1947 | 132,773.03 |
| 1948 | 214,405.05 |
| 1949 | 350,846.80 |
Petitioner's total surplus to policyholders rose from $ 216,830.88 in 1945 to $ 498,171.77 in 1949. This increase in surplus reflects $ 34,710 which is attributable to the issuance of guaranty certificates and not to business operations.
From its organization until the close of 1949, petitioner*130 wrote total net premiums of $ 3,487,997.42, and it paid a total of $ 72,492.04 in dividends to policyholders and a total of $ 39,839.20 in interest on guaranty fund certificates.
A "paid-in guaranty fund" is a fund created by advances to the company of sums of money in consideration of the company's assumption of an obligation to pay an agreed rate of return until the principal is repaid, all payments by the company, both of the annual return and of the principal sum advanced, to be made from surplus only.
Fire and marine companies are generally classified under the following headings: (a) Stock companies; (b) mutual companies; (c) Lloyd's organizations; and (d) reciprocal or inter-insurance exchanges. The insurance industry classifies as mutual companies those companies which have paid-in guaranty funds, including those companies, such as petitioner, incorporated in jurisdictions the statutory law of which expressly authorizes the holders of guaranty fund certificates to exercise voting rights.
Petitioner was during the years in issue a mutual insurance company.
OPINION.
This proceeding is in all respects similar to Citizens Fund Mutual Fire Insurance Co., 28 T. C. 1017.*131 In addition to the question of guaranty fund certificates decided in Citizens Fund Mutual Fire Insurance Co., supra, respondent in both cases makes a contention, the scope of which we find something less than clear. Whether it is intended merely as a makeweight to the "guaranty fund" argument or as a separate contention, we are unable to discern. In neither aspect, however, do we find it persuasive.
In order to assure a fair statement of respondent's position, we quote in the margin excerpts from his brief, which should be self-explanatory. 1*1016 These arguments appear to us to amount to no more than the statement that since mutual companies and stock companies have certain similarities, under the law of Minnesota and most other States in which petitioner has qualified to carry on business, there can be no such thing as a mutual company as distinguished from a stock company. Reduced to its lowest terms, this contention would seem to be that since both stock and mutual companies are in the insurance business, and hence that many legal requirements as to one resemble the other, the similarities outweigh the differences and only the similarities*132 will be respected. To refute this proposition it seems to us necessary only to state it.
*133 A good deal of evidence was introduced tending to show that petitioner's premiums were larger than its costs, particularly in the new venture of insuring turkey raisers, with the consequence that a surplus for contingencies and losses was created and from time to time increased. We take it that respondent is urging that this failure to sell insurance at cost, or at least to redistribute the surplus currently to its policyholders, prevents it from being a mutual insurance company. Basically this contention contradicts his principal argument. Petitioner is shown to have required the funds represented by the guaranty fund certificates to create a sufficient reserve to provide to its policyholders reasonable protection against loss. The certificates cannot safely be retired until this protection is available from other sources. But when what would otherwise be a lack of reserves is sought to be remedied by the gradual accumulation of a book surplus, respondent objects that insurance is not being sold at cost.
*1017 However that may be, the contention was made and answered in Order of Railway Employees, 2 T.C. 607">2 T. C. 607, 615, where we said:
"an insurance*134 company, acting bona fide, has the right to retain * * * an amount sufficient to insure the security of its policyholders in the future as well as the present, and to cover any contingencies that may arise or may be fairly anticipated." 29 American Jurisprudence, par. 64. * * * The members, and they alone, are entitled to all dividends, whether resulting from current operations or paid upon dissolution and whether they are true dividends or only excess premiums paid.
As in Order of Railway Employees, supra, petitioner's officers testified at length as to the reasons for maintaining reserves, particularly with respect to the turkey insurance. Petitioner's situation and their conclusions from it, which are more fully set forth in our findings, appear to us to be reasonable and certainly to eliminate any possibility that in this case we could conclude that petitioner's failure to distribute larger dividends was due to bad faith on the part of its officers. It may be that we should here reiterate a warning expressed in Order of Railway Employees, supra, at 616:
We do not intimate that Congress intended to allow a mutual *135 insurance company to accumulate and hold, throughout its existence, all of the excess of premiums over cost. It clearly belongs to the policyholders and should be returned to them. Respondent's argument, based upon the testimony of petitioner's actuary, is not wholly without substance. It may be, if the facts demonstrate that a company organized as a mutual has ceased to operate as one, that the privilege of returning its income as a mutual may be denied. As we view the evidence and the stipulated facts in this proceeding, however, a finding that petitioner had ceased to be a true mutual would not be justified.
Under these circumstances and on this record, we cannot approve respondent's determination that in the years in question petitioner was not a mutual insurance company.
Decision will be entered for the petitioner.
Footnotes
1. * * * There are a number of statutes in the law of the State of Minnesota that can apply to both types of companies. See sections 66.04, 66.09, 60.29, and chapter 65, Minn. Stat. Anno. The provisions of chapter 65 of Minn. Stat. Anno., which chapter is entitled "Fire Insurance Companies," relate to a great extent to both stock and mutual fire insurance companies. States other than Minnesota have similar statutes. Anno. Laws of Mass., chapter 175, section 99; Mich. Stat. Anno., chapter 242, section 24.422.
A mutual insurance company may write the same type of insurance and may be required to maintain the same reserve that a stock insurance company has to maintain. Sections 66.04, 66.09, Minn. Stat. Anno. Both stock and mutual fire insurance companies use the same standard type of fire insurance policy in the State of Minnesota. Section 65.01, Minn. Stat. Anno.; Tr. 106.
Respondent admits that there are some differences in the laws relating to the formation and operations of stock and mutual fire insurance companies, but submits that these differences are few and of an inconsequential nature. * * * There is a difference in the method of incorporating a mutual insurance company and a stock insurance company * * * A mutual company must inform its policyholders in their policies in regard to the time and place of the annual meeting. If the policyholder is contingently liable for an assessment equal to the amount of one annual premium, a provision to this effect must be included in the policy. However, assessments rarely are made. Also, a mutual insurance company can issue a nonassessable policy if it meets certain conditions. See section 66.04, Minn. Stat. Anno. * * *
* * * *
Petitioner's requested finding of fact No. 1 also states that in each foreign state in which the petitioner was licensed to do business, it operated under the provisions of law applicable to foreign mutual insurance companies of this kind. If the provisions of these laws are analyzed, it will be learned that in many instances the provisions of law that apply to foreign mutual insurance companies are the same laws that apply to the domestic stock insurance companies incorporated in those states.↩