NATIONAL COMMITTEE FOR INSURANCE TAXATION IS BASICALLY THE

ALLSTATE COMMITTEE

On January 14, 1958, a statement urging the adoption of a tax plan was presented to your committee by representatives of an organization calling itself the "National Committee for Insurance Taxation." That committee came into being about 4 years ago to serve as a front for the two Allstate Insurance Cos., which are solely owned by Sears Roebuck & Co.

Since this new organization has been and is dominated and controlled and largely financed by the two Allstate Cos., and since the proposed tax plan was first presented by the two Allstate Cos., and since, further, 1 of the 2 speakers that appeared before you recently on behalf of that organization was a high official of Allstate, we will refer to that organization hereinafter as the Allstate committee.

ALLSTATE COMMITTEE MEMBERSHIP INCLUDES HARDLY ANY MEMBERS OF NATIONALLY RECOGNIZED STOCK INSURANCE ASSOCIATIONS

It is significant, we believe, that with very few exceptions no member company of the Allstate committee is a member of the National Board of Fire Underwriters nor of the Association of Casualty & Surety Companies. These two organizations have long been recognized as the leading trade associations of purely stock insurance companies, and the members of these associations write the great bulk of the stock fire and casualty insurance business.

To the best of our knowledge, neither of these associations has indicated any desire for a change in the insurance tax laws, either for themselves or for the mutuals. And, although there are some elements in the present law that we do not like, we are not asking for any changes either.

FACTORY MUTUALS AND RECIPROCALS COVERED BY SEPARATE STATEMENTS

The mutual committee does not include the 13 companies generally referred to as factory mutuals. Their attitude with regard to their own Federal taxation has already been presented to you. Nor do we represent the interinsurance exchanges, generally called reciprocals, whose position will be presented to you later tody.

EXISTING TAX PLANS IN EFFECT SINCE 1942

For the record, may I remind you that mutual fire and casualty companies are taxed under sections 821, 822, and 823 of the Internal Revenue Code as amended. Under these sections mutuals pay taxes each and every year at regular corporate rates on taxable investment income (including realized net capital gains) provided that the tax cannot be less than 1 percent of the sum of taxable investment income and premiums, after deducting dividends to policyholders.

The tax exemption for a mutual company, found in section 501 (15) of the code, applies only to the very small companies whose total annual income from all sources (premiums, investment income, etc.) does not exceed $75,000. These very small companies, comparable to the exempt small-income individual citizens, aggregate approximately

80 percent of the total number of mutuals, but they account for less than 3 percent of the mutual premium volume.

Stock companies are taxed under sections 831 and 832 of the same code. Stock company taxes are computed on taxable profits by first combining investment income or losses, and capital gains or losses, and underwriting gains or losses (with deductions for any dividends to policyholders), and then applying regular corporate rates on the combinations, thus resulting in a tax on net profits or a tax credit carryback and carryover on net losses.

Mutual companies are not all entirely happy, by any means, because the tax floor of 1 percent on gross receipts sometimes has the effect of being a tax upon adversity. In other words, there are some years in which catastrophic losses, or even unusual losses, compel an unusually large net premium collection, either by assessment or by a reduction in dividend. At such times the imposition of this arbitrary tax on increased receipts, which are being collected solely because of unusual losses, seems to be rather harsh and inequitable. At the same time, the mutual companies as a whole realize that no system of taxation devised by man can ever be completely satisfactory.

FUNDAMENTAL DIFFERENCES BETWEEN STOCK AND MUTUAL COMPANIES

The existing law was designed to recognize the fundamental differences between stock companies and mutual companies.

A stock company has three entities: company, policyholders, and stockholders. The stockholders organize and own and operate the company primarily for the purpose of making profit for their stockholders while affording insurance protection for their policyholders. The surplus of a stock company belongs to the stockholders, and can, within limits, be paid to them as dividends.

But a mutual company has only two entities: the company itself and its policyholder members. There is no other interest to which a part of the company's surplus may be diverted. The policyholder members and the company are, to all intents and purposes, one and the same. This is a fundamental difference and affects the disposition that may be made of surplus.

In a mutual company, only the policyholder has a beneficial interest in the surplus and the surplus serves only as a protective fund for him. A policyholder's dividend is the return to the policyholder, out of surplus, of the unused and unneeded portion of his own money.

It is only natural that the stock companies are taxed on a profitincome basis, because they are owned by third-party stockholders and engaged legitimately in business with the hope of making and distributing profits.

The larger their net profits, the larger their taxes. The smaller their net profits, the smaller their taxes. Gains or losses from one branch of business, such as underwriting, may be offset against gains or losses in another branch, such as investments. A stock insurance company may be able to do a tremendous volume of business in some particular year and yet experience such heavy losses that the year ends up without any net profits and sometimes with net losses. In such cases, stock companies are not chargeable with any income tax, and should not be. Where they have net losses, those losses can be carried back against past operations or carried over as credits against future

operations and sometimes both backward and forward-just as is the case with other profitmaking business corporations.

In the case of mutual insurance companies, the only revenue that can ever be properly classified as taxable income is the net investment income derived from investment of the funds that the company has in hand. On these funds, that is, entire net investment income, ever since 1942 every mutual fire and casualty insurance company in the United States, with the sole exception of the very small companies whose gross receipts do not exceed $75,000 per year, has paid not less than the full corporate Federal income tax, each and every year, regardless of whether underwriting results have been favorable or otherwise.

Whenever this full corporate rate taxation on the entire net investment income of a mutual does not equal at least 1 percent of its entire gross receipts (less only refunds and refund-dividends to policyholders), then this 1 percent tax floor is applicable.

Mutual fire and casualty insurance companies stand unique, in this respect, among all taxpayers of the United States, because they are the only class of taxpayers, either personal or corporate, having a definite tax floor operating on them each and every year.

MUTUALS HAVE PAID, AND ARE PAYING, SUBSTANTIAL TAXES UNDER EXISTING TAX LAWS

Under these established tax laws and plans, which have been in effect over since 1942, mutual fire and casualty insurance companies have paid substantial Federal income taxes. These mutual taxes ranged steadily upward from a little less than $6 million ($5,859,000) in 1943 up to more than $29 million ($29,049,000) in 1954, and they aggregate a grand total of more than $227 million ($227,588,000) in the 14-year tax period of 1943 to 1956.

ALLSTATE COMMITTEE QUOTATIONS REFER TO CONDITIONS PRIOR TO 1942 TAX REVISION

The Allstate committee statement quotes liberally and frequently from the 1942 hearings before the Committee on Ways and Means and from some statements and recommendations made by the Treasury at that time. It is significant, however, that they could not quote any statements from authoritative sources except those issued 16 years ago, prior to the enactment of the 1942 Revenue Act, which set up the existing system of separate taxation for stock and mutual fire and casualty insurance companies.

This existing system has proven so satisfactory and fair that with the sole exception of the Allstate committee,no nationally organized industry group is complaining about the mutual insurance tax status.

THE ALLSTATE COMMITTEE'S TAX PLAN PROPOSAL

Although the Allstate committee argues that stocks and mutuals should all be taxed under the identical statute and identical plan, it carefully avoided recommending the taxation of all companies either on the stock plan or on the mutual plan. Instead, the Allstate committee proposed a tax plan substantially the same as that which the Allstate insurance companies first proposed nearly 5 years ago.

Reduced to its simplest terms, the Allstate committee proposal calls for all fire and casualty insurance companies-stock, mutual, and reciprocal-to be taxed on the following basis:

(a) Exclude from income-tax calculations all underwriting profits or losses.

(b) Levy a tax at regular corporate rates on net taxable investment income and net realized capital gains.

(c) Impose a tax of 1 percent on net premiums written, less $150,000 premiums and less dividends to policyholders.

The records reveal that the two Allstate companies, in marked contrast to most of their principal stock competitors, usually have large net profits from their underwriting or insurance operations and comparatively small taxable investment income.

Since the Allstate committe plan would eliminate all taxation of underwriting profits (which usually constitute the great bulk of the profits of the two Allstate companies) and substitute a 1-percent (sales tax) premium tax (which sales tax Allstate suggested be passed on to the policyholders) it is obvious that the Allstate committee plan's principal effect would not be tax equality, but rather a tremendous tax reduction for the two Allstate companies and a few others at the expense of the mutuals, reciprocals, and many stock companies.

EFFECT OF PROPOSED 1-PERCENT SALES TAX ON INSURANCE COMPANIES GENERALLY

The Allstate committee argued that the sales-tax portion of its proposal would not be a burden upon fire and casualty companies because it should be passed on to policyholders in the rates. Total premium volume of the fire and casualty business for 1956 was $11,131,847,483. Thus, the added burden to policyholders under the proposal could be at least $111,318,000 per year.

We have serious doubts that such a pass-on of a sales tax as a substitute for an income tax would be permitted under State insurance regulation. Furthermore, there are many large business firms which. because of their very size, are self-insured. A still larger number are on the border between self-insuring and placing their risk in insurance companies.

State premium taxes, which average about 2 percent, plus the Allstate proposed 1-percent sales tax, if included in rates, would certainly drive many of these borderline companies into self-insurance. This is particularly true in the field of group insurance and workmen's compensation. To the extent that these large business firms turn to self-insurance, the premium volume of the insurance companies and hence the tax revenue to be derived from insurance companies by the Treasury would be reduced.

EFFECT OF ALLSTATE COMMITTEE PLAN ON STOCK COMPANIES

Some stock companies, especially the two Allstate companies, as shown hereinafter, would be benefited by the proposed plan. But many stock companies, including some of the principal competitors of the two Allstate companies, would suffer heavy increases in their tax burden.

And all stock companies would lose the right they now have to offset underwriting losses against investment income.

I wish I had the time to give you some figures just taken from Best's. You know the Best's reports. They are "the Bible" of the insurance industry. These figures show that the underwriting losses in 1957 are staggering on some individual stock companies running up to millions of dollars. If these stock companies could not offset these underwriting losses against investment income, that would be very unfair to those companies.

At the current 52 percent corporate tax rates, a stock fire or casualty company earning underwriting gains of 2 percent per dollar of premium collected would pay just about the same under the Allstate committee proposal as under the present stock tax formula.

But a stock company earning less than 2 percent on net premiums written would be penalized by the proposal. This penalty would be more pronounced in the case of stock companies with underwriting losses, such as have been so common during 1956 and 1957. Under existing law, the underwriting loss may be subtracted from investment income and the tax paid on the net difference. This would not be possible under the Allstate committee proposal.

In effect, such a company would be subject to the tax at corporate rates on its investment transactions, plus 1 per cent of net premiums, less policyholder dividends, in a year of underwriting loss when such a tax would be most burdensome.

The opposite would be true of a company making in excess of 2 percent underwriting gain per dollar of net premium written. Here the 1 percent tax on net premiums discharges the tax obligation on underwriting gains regardless of how large these may be in proportion to net premiums written.

Hence, it may be said accurately that the Allstate committee proposal would give its greatest advantages to those companies, like the two Allstate companies, with the highest rate of underwriting gain. In short, the proposal is contrary to the basic principle of a net income tax: namely, ability to pay.

EFFECT OF ALLSTATE COMMITTEE PROPOSAL ON MUTUAL COMPANIES AND MUTUAL POLICYHOLDERS

The mutual tax would be almost doubled. As admitted by the Allstate committee statement and tabulations, the tax burden on mutual companies (and consequently on mutual policyholders) for the 1943-56 period would have increased from $227,588,000 to $400,309,000.

EFFECT ON THE TWO ALLSTATE COMPANIES

The Allstate committee statement and tables disclosed that if its proposal had been in effect in 1943-56, the net tax decrease to stock companies as a whole would have aggregated $54,250,000. But they did not disclose the fact that the two Allstate companies, writing less than 2 percent of the total stock company business, would have realized more than half of that net total tax decrease.

As shown by the table below, we estimate that the tax decrease for the two Allstate companies would have amounted to about $28,600,000. This would have been nearly 53 percent of the total tax decrease of all stock companies combined.