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or 15 years ago, it was a lower rate than the same premium would be now because 15 years ago it looked reasonable that we could make more interest than we make now.

Where you would lose, and the only place you would lose, is that in the case of death or your retirement and endowment we could not give you as much income after your policy expires as we would have otherwise. That is the point. That was usually the case, sir, where a certain rate was guaranteed but when we made extra we gave extra, what was called excess interest. Of course the principal thing is protection; that is the first thing. If you die, your widow always gets the savings but the income from it is less because we cannot earn as much on $1,000 for her, and neither can you, as we could 20 years ago.

Mr. MARTIN. Now the differences of opinion expressed and to be expressed before the committee today as indicated in your statement have more to do with the distribution of the tax between the different types of companies?

Mr. ADAMS. Mr. Schmuck, representing Acacia, will speak for himself. He will be against what I argued here on this averaging basis. He thinks stock companies can be treated differently than mutuals. I have given the best argument I knew how and have said that he represents the only company in the United States that asks a competitive damage for the mutuals. The Metropolitan does not, the Prudential does not, New York Life does not.

Mr. MARTIN. You are not in disagreement as to the Government's total tax?

Mr. ADAMS. That is right.

Mr. Martin. It is only in the distribution between the different types of companies?

Mr. ADAMS. That is right. And Mr. Jenkins' very good friend and my very good friend, John Lloyd, represents the only other company. He said to me, "Claris, we are good friends, we get on different sides of more questions." I said, "John, that is not because I am a mule," and he knows what I am talking about.

Mr. Martin. You are largely in agreement, are you not, that if we should increase the taxes paid by insurance companies that would come out of the policyholders? There is no disagreement there?

Mr. ADAMS. No, sir.

The CHAIRMAN. We thank you, Mr. Adams, for your appearance before the committee.

Mr. Adams. Thank you very much, gentlemen.

The CHAIRMAN. Mr. Lloyd K. Crippen, vice president and actuary, and Edward J. Schmuck, general counsel, Acacia Mutual Life Insurance Co., Washington, D. C. Will you give your name and address to the reporter and the capacity in which you appear?

STATEMENT OF EDWARD J. SCHMUCK, GENERAL COUNSEL, AND

LLOYD K. CRIPPEN, VICE PRESIDENT AND ACTUARY, ACACIA MUTUAL LIFE INSURANCE CO., WASHINGTON, D. C.

Mr. SCHMUCK. My name is Edward J. Schmuck. I am general

. counsel of the Acacia Mutual Life Insurance Co., Washington, D.C I am accompanied by Mr. Lloyd K. Crippen, vice president and actuary of the company.

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Mr. JENKINS. Mr. Chairman, I should like to say at this point that Mr. John Lloyd, vice president of the Cincinnati Life Insurance Co., could not be here today. I should like permission for him to place a statement in the record following the remarks of this present witness,

The CHAIRMAN. Without objection that may be done.

Mr. Schmuck. Acacia Mutual Life Insurance Co. appreciates the opportunity to be represented and to have its views heard by your committee in your consideration of the income taxation of lifeinsurance companies. Acacia is a mutual life-insurance company holding a charter granted by special act of the Congress of the United States. It is composed of 202,000 policyholders with total insurance in force of more than a billion dollars and assets of $228 million.

Since the extended hearings before your committee on the stop-gap legislation (H. R. 371, 81st Cong., later absorbed into the 1950 Revenue Act), which established a special tax formula for life-insurance companies for the taxable years 1949 and 1950, and the hearings on the Treasury proposals in February 1950 for permanent legislation covering life-insurance company taxation, we have continued our study of that problem. World conditions in recent months have turned our attention increasingly to the needs of the Government for added revenue.

With respect to the taxation of life-insurance companies, we are renewing the recommendations we made to your committee last year that,

1. Mutual life-insurance companies should be taxed directly on their full free investment income, on a company-by-company basis without averaging or any other artificial formula.

2. Consideration should be given to some form of total netincome basis for taxing stock life insurance companies. We are firmly convinced that these recommendations are sound and fair and will eliminate the gross inequities of the industry-wide averaging formula constituting the unique, unsound, and unfair method of taxing life-insurance companies. In addition, our studies show clearly that had our proposals been adopted by the Congress in 1950, tax revenues, currently and in the foreseeable future, would have been substantially greater for the Government than under either the method laid down in the stop-gap legislation or the 1942 formula which will become effective again unless the Congress acts upon the expiration of the stop-gap formula.

As we shall show later in this statement, taxes paid by the lifeinsurance companies for the year 1949, if levied in accordance with our recommendations, would have aggregated approximately $124,000,000. The amount actually paid under the stop-gap legislation aggregated approximately 42.5 million dollars.

The history of Federal legislation affecting life-insurance companies indicates a keen appreciation by the Congress of the social and econorric value of encouraging the American people to make individual and independent provision for themselves and their dependents against the hazards of death and old age through the medium of life insurance and retirement benefit policies. We are confident, therefore, that your committee will keep before it in your deliberations that amendment of the tax law affecting life-insurance companies should not impair the ability of individuals to acquire and maintain adequate lifeinsurance protection.

Our approach to the problem of establishing a fair and proper method of taxing life-insurance-company income, proceeds from the three basic principles which we have always considered fundamental to any tax law affecting the life-insurance business. These principles are as follows:

1. The life-insurance industry as a whole should pay income taxes in an aggregate amount which is fair to the industry as a whole and to the Government.

2. There should be a fair and equitable distribution of the aggregate income tax among the individual life-insurance companies comprising the industry.

3. The tax basis or formula should give recognition to the statutory and contractual obligation of each individual company for adding interest to its policy reserves.

Approximately 68 percent of the life insurance in force in this country has been issued by mutual life-insurance companies. These companies are a form of cooperative enterprise owned by the policyholders and from which, therefore, no individual proprietary interest derives any personal profit. The policyholders are the mutual lifeinsurance companies and all rights and privileges of these companies belong to the policyholders. The management of these companies are in effect trustees for their policyholders.

The premiums paid by the policyholders of a mutual life insurance company are actually a deposit with the management of the company to cover the individual policyholder's share of the mortality funds, the legal reserve to support policy obligations, and the operating expenses. As a cooperative enterprise, a mutual life-insurance company might reasonably contend that it should not be subjected to an income tax. However, it is not now, and never has been our position that mutual life-insurance companies should be exempt from income taxation.

Since 1921 life-insurance companies have been taxed on the basis of their net investment income interest, dividends, and rents, less investment expenses) less a deduction for interest required to maintain policy reserves and, also, a deduction for other miscellaneous interest obligations. The income which mutual life insurance companies earn by the investment of both their legal reserves and their surplus funds is their only real income. To the extent that investment income is not needed to satisfy contractual and statutory requirements to policyholders it is in our opinion properly subject to an income-tax levy consistent with the basic principles set forth above.

The remaining 32 percent, a substantial portion of the life insurance in this country, has been issued by stock life-insurance companies. These companies are organized, as are any other privately owned business corporations, for the personal profit that their stockholders may derive from the sale of life insurance and retirement benefit contracts to the public.

The sources of the profits of stock life-insurance companies are the premiums paid by the policyholders in excess of the cost of the insurance protection they receive and the investment income in excess of reserve requirements. The profits paid to the stockholders in the form of cash dividends or allocated to them in the form of stock dividends are business profits in every sense of the word. The surplus accumulations also belong to tbe stockholders.

It is obvious, therefore, that there are real and fundamental differences between the mutual life insurance companies which are cooperative enterprises and the stock life insurance companies which are private profit enterprises. In a mutual company there is no individual proprietary interest; in a stock company the proprietary interest of the stockholders is paramount. In a mutual company funds available for dividends are paid only to policyholders; in a stock company, similar dividends may be paid to policyholders on policies providing for such participation, but beyond that, all funds available for dividend distribution are private profits to the stockholders. In a mutual company the surplus funds are accumulated for the benefit of its policyholders; in a stock company the surplus funds are the property of the stockholders as in any other privately owned business corporation. In a mutual company, both premium deposits and investment income are applied solely and exclusively to the benefit of the policyholders who compose the company; in a stock company premium deposits and investment income are applied first, to satisfy the contredtual and statutory obligations to policyholders, second, to dividends or refunds to the policyholders under participating policies, if any, and where the policies so provide, and third, the remainder to the private profit of the stockholders.

We feel that a clear understanding of these fundamental differences between the two types of companies operating in the life-insurance business is important to a sound evaluation of the possible appropriate bases for the income taxation of life-insurance companies.

It is our opinion that, at least for mutual life insurance companies, free investment income is the proper base of taxable income. By free investment income we mean the amount which is arrived at by deducting from net investment income interest, dividends, and rents, less investment expenses) the amount of interest required to maintain contractual and statutory policy reserves and the miscellaneous interest obligations to policyholders and their beneficiaries.

The only funds regularly received by a mutual life insurance company other than its investment income are premium deposits. Neither the whole nor any part of the gross premium deposited with the company constitutes income. The entire amount of the premium is a deposit made by the policyholder with the company from which, as indicated above, the company applies whatever amount is necessary to cover the pro rata share of payments to policyholders and beneficiaries, to maintain legal reserves and to pay operating expenses. In addition, in those companies in which the investment income may be insufficient to meet the amount of guaranteed interest which must be added to the legal reserves to fulfill contractual and statutory requirements, the deficit must either be made up from surplus or a portion of the gross premium will have to be used for that purpose.

The gross premium generally exceeds the exact amount needed for these policyholder and operating requirements. In a mutual company, this excess of the premium deposit, together with free investment income, if any, in part is refunded to the policyholder in the form of dividends and in part is allocated to the surplus account maintained for the added security of the policyholders. Since the surplus account is maintained for the sole benefit of the policyholders, with no individual proprietary interest entitled to any part thereof, it is apparent that any excess from the gross premium which is placed in this account

retains its nature as a deposit by the policyholder with the company and does not constitute income to the company.

For these reasons, we submit that in theory and in fact free investment income is the only amount received by a mutual life insurance company which is properly subject to income taxation.

It is, and consistently has been, our opinion that in fairness to the Government, all free investment income should be subjected to normal corporate income taxation. As a matter of fact, however, since the investment income approach was adopted in 1921, the tax has never been imposed on the full free investment income of the life insurance companies, either taken as a whole or taken individually.

This has resulted because the reserve interest deduction permitted by the Government ever since 1921 has always been calculated at an arbitrary flat rate for each company regardless of the substantial differences among companies with respect to their actual reserve interest requirements. Under the income-tax laws in existence prior to 1942, the Government provided that each and every company should use the same rate of interest in calculating its deduction for interest required to maintain policy reserve funds, disregarding the wide variations there were among the companies as to the rate required in accordance with their actual statutory and contractual obligations. (From 1921 through 1931 the rate was 4 percent; from 1932 through 1941 the rate, with a minor variation, was 3% percent.)

In the 1942 amendments of the Revenue Code, Congress took account of the fact that because of the defects in prior laws many companies, including most large companies, were paying no tax even though they had actual free investment income. Acacia, in its appearance before the Ways and Means Committee in that year, urged the imposition of a tax on a basis giving full recognition to the reserve interest requirements of the individual companies but avoiding the use of any arbitrary basis for determining such a deduction. In the law finally adopted in 1942, recognition was given in principle to the statutory and contractual requirements of the company for adding interest to its policy reserves. Again, however, the deduction gave only partial recognition to the actual reserve interest requirements of the companies and set up another arbitrary and artificial method for computing the deduction at the same rate for all companies. The result again was a failure to tax the actual and full free investment income of all the companies and again the formula operated inequitably in the distribution of the tax among all of the companies comprising the life-insurance industry.

Primarily because of the continuing trend toward a lower rate of earnings on investments, the total taxable income of the life insurance industry reduced rapidly, with the final result that for the taxable years 1947 and 1948, the total net investment income of the lifeinsurance industry was less than the amount of deduction permitted according to the arbitrary 1942 formula for the interest required to maintain reserves and for other policy obligations. The individual companies had enough free investment income in these 2 years to have produced a total of approximately $58,000,000 of taxes for these years, if the tax had been imposed at the regular corporate tax rates upon the actual free investment income of each individual life-insurance company. Nevertheless under the 1942 formula then in effect, the Government actually received no taxes for these years on the lifeinsurance business of the companies.

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