In conclusion, I believe that, wherever possible, reasonable legislative steps should be taken to remove inequities and to encourage private foreign trade and investment. I respectfully submit that H. R. 6248 and H. R. 7247 would not only remove a sever inequity on some United States taxpayers operating abroad, but would tend to promote private foreign economic expansion and, thereby, further the aims of our foreign policy and the economic interests of our Nation. The CHAIRMAN. Our next witness is Mr. Larry J. Desmond. Mr. Desmond, come forward and identify yourself for the record by giving us your name, address, and the capacity in which you appear. STATEMENT OF LARRY J. DESMOND, IN BEHALF OF THE RECIPROCAL INTERINSURERS FEDERAL TAX COMMITTEE, WASHINGTON, D. C. Mr. DESMOND. Mr. Chairman, gentlemen of the committee, my name is L. J. Desmond. I am comptroller of the Union Automobile Indemnity Association of Bloomington, Ill. I appear here today as the representative of the Reciprocal Interinsurers Federal Tax Committee, an association of reciprocal exchanges. A list of the membership appears in appendix III. The CHAIRMAN. The Chair observes that you have with you at the witness table our former colleague from the State of Illinois, Mr. Barnes. Mr. DESMOND. Yes, sir; that is true. The CHAIRMAN. He is accompanying you in the presentation of this testimony. Mr. Desmond, would it be possible for you to conclude your remarks within the 15 minutes allotted to you, sir? Mr. DESMOND. Within 15 or 18 minutes, I am sure, if that is agreeable. The CHAIRMAN. All right, sir. You are recognized. Mr. DESMOND. The presentation of the National Committee for Insurance Taxation, made several weeks ago, is misleading and inaccurate. The national committee, headed by the Allstate Insurance Co., wanted you to believe that all three types of fire and casualty insurers are the same, and that reciprocals do not bear their fair share of the tax burden. These conclusions are wrong. The real facts are these: 1. Reciprocals operate for the benefit of subscribers, not stockholders. 2. Reciprocals refund substantial savings to their subscribers. 3. Reciprocals do not receive a competitive advantage from the Federal tax laws. 4. The reciprocal premium dollar does pay a full and fair share of the tax burden. NATIONAL COMMITTEE FALLACIES Many of the inaccuracies and misleading comparisons made by the national committee have been pointed out to you today by other witnesses. There is no need to repeat them. We wish to concentrate on the basic fallacy underlying the national committee's presentation, that reciprocal insurance and stock insurance are identical. With your permission, we propose to show that they are not. This distinction was ably presented by Floyd E. Jacobs, general counsel for the American Reciprocal Association, in 1942. After ex tensive hearings and thoughtful consideration, Congress devised a tax formula for all segments of the fire- and casualty-insurance field. Fifteen years of experience justify the continuation of that formula. HOW RECIPROCAL INSURANCE STARTED The concept of reciprocal insurance was formed in 1881 in New York City by six dry-goods merchants. Dissatisfied with the cost and the quality of fire insurance then available to them and unable to bear their losses individually through self-insurance, they adopted the idea of sharing the risk by private contract rather than through a corporate insurer. Each agreed to indemnify the others in the event of a fire loss and thus secured for himself protection in an amount five times his maximum personal cost. This new insurance concept worked out well. Good insurance at minimum cost resulted. The idea grew and other exchanges were formed to provide insurance in the fire and casualty field. History has demonstrated that reciprocal exchanges tend to specialize in restricted occupations, groups or areas. For example, of the member companies of this committee: 2 insure only members of the Armed Forces; 5 insure only companies in the lumber industry; 2 insure only companies in the canning industry; 2 insure only retail druggists; 2 insure only bottlers, brewers, dairies, bakeries, and creameries; 1 insures only coal-mining interests; 1 insures only retail store interests; 1 insures only truckers and motor carriers; 1 insures only franchised automobile dealers; 4 insure only automobile club members in a single State; 1 insures only automobile club members in 2 States; 1 insures only automobile club members in 3 States. As an illustration of why this happens, 1 or 2 lumber yards or mills or canneries would be an unusual hazard for a general insurer. Perhaps they may even find difficulty getting insurance. Where many or most of such companies can unite in their own reciprocal exchange, a better spread of the risk and more efficient underwriting brings a lower cost. In addition to these 23 exchanges above, 12 others do business in 5 States or less, and another 5 have a net annual premium volume of less than $500,000. Basically, then, most reciprocals do not appeal to the same broad market as do stock companies. WHAT IT IS A reciprocal exchange is a group of persons commonly called subscribers who exchange contracts of insurance on the reciprocal plan through an attorney-in-fact. The subscribers are not a company nor a corporation but are and always remain individuals in concept and in fact. Each is an insured and an insurer to the others. The contract they exchange, through the attorney-in-fact, is the means of bringing this interinsurance about. Subscribers at the exchange are seeking sound insurance protection at minimum cost. They are not seeking profits either for themselves or for the reciprocal exchange. Each year the individual subscriber places on deposit with the attorney-in-fact a stated sum of money. It is not a premium in the sense used by other types of insurers, but is a deposit. The subscriber in turn receives a guaranty of indemnity in the event of loss. All losses incurred by the individuals and the operating expenses incident thereto are paid out of the sum of the deposits. Part of the deposits is also set aside for reserves or as policyholders' surplus for use in the case of unusually heavy losses. The balance is refunded to the subscriber as savings. No matter how the total deposit may be temporarily divided or what name may be temporarily given, each deposit is held in the account of the individual subscriber. The excess of premiums over losses and expenses in a stock corporation belongs to the corporation. That is not true in a reciprocal exchange. An exchange is legally incapable of owning such excess, but must hold it for the accounts of its individual subscribers. It is not a profit in any sense of the word. It is still the same money that the subscriber originally deposited. His interest in unused deposits cannot be dissipated by the declaration of stockholders' dividends, since there are no stockholders. All savings accrue only to the benefit of the subscriber in the form of returned deposits, a reduction in future deposits, or as added reserves against abnormal losses. It must be clearly understood that the unused deposits are the subscriber's own funds. They never belong to anyone else. It is obvious that the reciprocal interinsuring operation must be approached differently, taxwise, than an insuring operation designed to make a profit. The intent of Congress through the years has been to give full recognition to the nonprofit motivation of reciprocal interinsurance. THE ROLE OF THE ATTORNEY IN FACT (See appendix II for typical insurance code provisions.) In a reciprocal exchange the attorney in fact serves as its manager, acting as the common agent of all the subscribers. He provides the administrative services which are vital to the operation of the reciprocal exchange. These services include the exchange of contracts, the collection and safeguarding of the funds, the maintenance of the subscribers' accounts, the settlement of losses, the inspection of risks, and the compliance with all applicable insurance regulations. All attorneys in fact are not compensated in the same manner. The compensation arrangement is fixed by a contract between the subscribers and the attorney. Some receive a fixed percentage of the premium deposits and pay most operating expenses; others receive a smaller percentage and absorb none of the expenses; still others serve without percentage compensation. What is of significance to your committee is that where compensation is received, the attorney in fact pays and always has paid an income tax. RATE OF GROWTH The national committee implies that the rate of growth of reciprocals is phenomenal and far outstrips the growth of stock companies. That contention is simply not true. The following list shows the percentage of the industry's total net premiums written by reciprocals during the past 5 years: The reciprocals' share has varied less than one-tenth of 1 percent during this period. The figure for 1956 is the same as it was in 1952. The drawing on the next page shows the rate of growth in dollars. It illustrates that the entire insurance industry has grown tremendously and the reciprocals have done no more than retain a fair share. (The drawing referred to is as follows.) Mr. DESMOND. This drawing is composed of two panels. In the left panel we show the reciprocal and stock volume in 1942, and in the final panel we show the reciprocal and stock premiums for 1956. I think it is quite apparent from this drawing that the stock company has grown quite tremendously, over $5 million; where the reciprocals have grown it has only been proportional. Another indicator is that the number of reciprocals has not increased significantly since 1943, while there has been a substantial increase in the number of stock companies. You will note in this tabulation that the number of reciprocals has increased only by 10 since 1943: Reciprocals have been operated at tremendous savings in costs to their subscribers. They have been paid 64 percent of what remained after payment of losses and expenses, for the years 1943 through 1956. In 1955 they were paid $36,480,000 or 71 percent, and in 1956 they received $37,791,000, or 100 percent of what was left. Obviously, there is no unreasonable retention of the subscriber's money by the reciprocal industry. (See tables A and B of appendix I.) Those subscribers who deduct their original premium deposits as a business expense naturally pay tax on any return of savings. The substantial amount of savings returned to subscribers points up very vividly the difference between stock companies and reciprocals. During this same period the stock companies were paying nearly $2 billion to stockholders in the form of profits. And yet the national committee contends that there is no basic difference. RETENTION OF SURPLUS Insurance at cost does not mean that reciprocals must return every cent above absolute cost to the subscriber. Insurance at cost includes a sufficient amount to provide a safety factor, with no profit paid to third-party stockholders. In an insurance operation, the premium is necessarily greater than the expected cost of insurance. Part of the excess is used as a surplus fund out of which extraordinary losses can be met. In fact, reciprocals like other insurers are required by the laws of each State to maintain a surplus fund for the protection of policyholders. To distribute all of a reciprocal's surplus each year would place in jeopardy every existing policy. No prudent person would be inclined to insure at an exchange which had so improvidently conducted its affairs that it retained only enough to meet current liabilities, leav 20675-58-pt. 3—57 |