Full opinion text
MEMORANDUM AND ORDER INTRODUCTION ROGERS, District Judge. This is an action pursuant to Section 7422 of the Internal Revenue Code of 1954 (26 U.S.C.), for the recovery of federal income taxes, plus interest, paid by the plaintiff for its taxable year 1968. Over one-half million dollars are in controversy. Jurisdiction is conferred upon the Court by 28 U.S.C. § 1346(aXl). The plaintiff is a life insurance company whose claim is based upon the carryback to 1968 of a loss from operations for its taxable year 1971. Thus, while this is an action for refund of taxes and interest paid for 1968, the issues presented involve items on the plaintiff’s 1971 income tax return. The rather complicated issues presented in this case arise from two unrelated events —(1) plaintiff’s acquisition in 1971 of all the insurance business of a fraternal benefit society, the Ladies’ Society of the Brotherhood of Locomotive Firemen and Engine-men (“Society”), and (2) the plaintiff’s change in 1971 of its method of accounting for loading on deferred and uncollected premiums as a consequence of the Supreme Court’s decision in Commissioner v. Standard Life & Accident Ins. Co., 433 U.S. 148, 97 S.Ct. 2523, 53 L.Ed.2d 653 (1977). Although these two events will be discussed in detail in the Court’s findings of fact infra, a brief description of their factual backgrounds may be helpful to an understanding of the issues presented. Assumption Reinsurance Transaction The first event arises from plaintiff’s acquisition of the insurance business of the Ladies Society of the Brotherhood of Locomotive Firemen and Enginemen. Organized in 1884, the Society provided insurance benefits to its members, including funeral and life insurance benefits. Due to declining membership and the advanced age of its members, the Society began to face an “assessment spiral.” The Society solicited offers and ultimately concluded an arrangement with plaintiff whereby the premiums charged members were raised from $12 to $15 per thousand, the plaintiff assumed all liabilities under the policies, and the Society transferred to the plaintiff all of its assets which were set aside to pay benefits due under the policies. Plaintiff obtained the permission of the State Insurance Commissioner to carry securities transferred from the Society at the par value for Annual Statement purposes, though the market value of the securities had declined substantially. The par value was approximately $7,569,000; the market value was approximately $5,543,110. Plaintiff assumed liabilities which required it to establish reserves of about $7,554,519. In filing its 1971 tax return, which showed a $2,679,881 loss from operations, the plaintiff took the tangible assets into account at the $5,943,814 value, and the reserves at the claimed $7,554,519. In rejecting this tax treatment, the I.R.S. stated in a Notice of Deficiency: It is determined that you paid the Ladies’ Society of the Brotherhood of Locomotive Firemen and Enginemen $1,769,111.00 for the purchase of the insurance contracts you acquired in connection with the assumption reinsurance transaction, which amount is equal to the excess of the amount of the increase in the reserves over the net amount of assets you received from that Society. Accordingly, $1,769,111.00 is includible in your premium income in 1971 and is amortizable over the estimated life of the contracts, 10 years from July 1, 1971. The transaction between plaintiff and the Society is termed, in insurance parlance, an “assumption reinsurance transaction.” SBL is the reinsurer and the Society the reinsured. This transaction raises questions regarding how great a sum plaintiff should be deemed to have paid for the insurance business of the Society, and how plaintiff should have established reserves to cover the liabilities assumed. § 481 Adjustment — Standard Life Case For many years, life insurance companies and the I.R.S. disagreed as to the proper manner of treating unpaid deferred and uncollected premiums for income tax purposes. In Commissioner v. Standard Life & Accident Ins. Co., supra, 433 U.S. at 150-151, 97 S.Ct. at 2525, the Supreme Court pointed out: Under normal accounting rules, unpaid premiums would simply be ignored. They would not be properly accruable since the company has no legal right to collect them. Nevertheless, for the past century, insurance companies have added an amount equal to the net valuation portion of unpaid premiums to their reserves, with an offsetting addition to assets. State law uniformaly requires this treatment of unpaid premiums, as does the accounting form issued by the National Association of Insurance Commissioners (NAIC). ... In his [the Commissioner’s] view, if reserves are calculated on the fictional assumption that these premiums have been paid, the same assumption should apply to the calculation of assets and gross premium income. After viewing the arguments of the parties, the Supreme Court “split the baby”, holding that .. . the net valuation portion of unpaid premiums, but not the loading, must be included in assets and gross premium income, as well as in reserves, (emphasis added) (433 U.S. at 151, 97 S.Ct. at 2526] Between 1958 and 1970, plaintiff was required by the Internal Revenue Service to include the loading portion of unpaid premiums in its assets and gross premium income. Because of the erroneous position taken by the I.R.S., plaintiff overpaid its taxes for this time period. The parties agree that due to the Supreme Court’s decision in Standard Life, plaintiff is entitled to an adjustment in its income taxes pursuant to 26 U.S.C. § 481(a) in order to prevent duplicate reporting of income. However, the parties disagree as to the amount of the adjustment and whether plaintiff may take advantage of said adjustment in a single year, 1971, or whether the adjustment must be spread over a period of years. ISSUES PRESENTED According to the pretrial order, this case presents the following issues of law: 1. What amount is includible in plaintiff’s 1971 income as consideration received from the Society in exchange for plaintiff’s obligation to pay death benefits to the members of the Society. 2. If the amount so includible in plaintiff’s 1971 income is greater than that reported on its 1971 return, whether plaintiff is entitled to a deduction in 1971 of the excess, or whether such amount must be amortized. 3. If the amount so includible in plaintiff’s 1971 income is not greater than that reported on its 1971 return, whether a portion of plaintiff’s 1971 year-end reserve of $7,554,519 attributable to its obligations to the Society members constituted a deficiency reserve within the meaning of section 801(b)(4) of the Internal Revenue Code. 4. Whether plaintiff is entitled in 1971 to an adjustment under section 481 of the Internal Revenue Code as a result of the 1971 change in the tax treatment of its loading on deferred and uncollected premiums, and if so, in what amount. In their briefs, the parties have effectively merged issues one and two, and have discussed the legal issues presented within the context of three major questions, the first two of which relate to the transaction regarding the Society and the final of which relates to the results of the Standard Life ease: (1) Did plaintiff properly file its 1971 income tax return in reporting the consideration it received for providing benefits to members of a fraternal society? (2) Is any part of SBL’s 1971 year-end reserve for benefits provided to Society members a “deficiency reserve” within the meaning of 26 U.S.C. § 801(b)(4)? (3) How should plaintiff’s 26 U.S.C. § 481 adjustment in response to the Standard Life case be calculated? After overruling cross motions for summary judgment, the Court heard evidence on the merits of this action on May 27-29, 1980. The Court is now prepared to rule. INTRODUCTORY FINDINGS OF FACT 1. This is an action pursuant to 26 U.S.C. § 7422 for the recovery of federal income taxes of $528,017, plus interest, paid by the plaintiff, Security Benefit Life Insurance Co. for its taxable year 1968. 2. Jurisdiction is conferred upon this Court by 28 U.S.C. § 1346(a)(1). 3. Plaintiff’s claim is based upon the carryback to 1968 of a loss of operations from its taxable year 1971. Thus, while this is an action for refund of taxes and interest paid for the year 1968, the issues presented involve items on plaintiff’s 1971 income tax return. 4. Plaintiff Security Benefit is, and at all times relevant was, a corporation organized and existing under the laws of the State of Kansas as a mutual life insurance company, engaged in the business of writing various forms of life insurance, annuities and accident and health insurance. 5. The plaintiff is, and at all times relevant was, a life insurance company as defined by 26 U.S.C. § 801(a), and was therefore subject to the Internal Revenue Code’s provisions regarding taxation of life insurance companies, 26 U.S.C. §§ 801-820. 6. Plaintiff is also, and was at all times relevant, subject to regulation by the Kansas Insurance Department. 7. Plaintiff timely filed its 1968 Federal income tax return, reporting a liability thereon of $718,450. Plaintiff paid this amount, but upon audit the Internal Revenue Service determined the correct tax to be $697,509, and refunded to plaintiff the $20,941 overpayment. 8. Plaintiff timely filed its 1971 Federal ■ income tax return, reporting taxable investment income of $1,937,096, and a loss from operations of $2,679,881. 9. In July, 1972, plaintiff timely filed a Form 1139 — an Application for Tentative Refund from Carryback, wherein the 1971 operations loss of $2,679,881 was treated as an operations loss carryback to 1968, resulting in a tax refund of $465,174 for the year 1968. 10. Plaintiff’s 1971 tax return was examined by the I.R.S., and an April 22, 1974 report determined that plaintiff’s allowable 1971 operations loss was $918,971, rather than the $2,679,881 claimed by plaintiff. The report also determined that this reduction in plaintiff’s claimed 1971 operations loss resulted in (a) a reduction of the 1971 loss carryback to 1968, (b) an increase in plaintiff’s 1968 tax liability to $528,017, rather than the $232,335 reported, and (c) a 1968 tax deficiency of $295,682. 11. On January 27, 1975, plaintiff and the I.R.S. timely entered into a Form 872-A Agreement, Special Consent Fixing Period of Limitation Upon Assessment of Income Tax, extending the statute of limitations for assessments that could result from adjustments to plaintiff’s 1971 Federal income tax return. 12. Plaintiff received a Statutory Notice of Deficiency from the I.R.S. proposing a 1968 tax deficiency of $295,682 on the basis that plaintiff understated income it received in 1971 from the Ladies’ Society of the Brotherhood of Locomotive Firemen and Enginemen. 13. Plaintiff paid the 1968 tax deficiency and the attributable interest. 14. On December 23, 1976, plaintiff Security Benefit timely filed a claim for refund (Form 1120X) for 1968, seeking a recovery of tax in the amount of $528,017, together with assessed interest and statutory interest. 15. By examination report dated March 24, 1977, the I.R.S. (a) increased plaintiff’s 1971 loss from operations from $918,971, as previously determined to $1,053,082, (b) increased plaintiff’s 1971 operations loss carryback to 1968 by $134,111, and (c) decreased plaintiff’s 1968 dividend deduction by $134,111 from $1,450,905 to $1,316,794. These adjustments, which reflect an I.R.S. concession on an issue not here in dispute, did not affect plaintiff’s 1968 tax liability. 16. In this action, plaintiff claims that the 1971 loss from operations was greater than the $2,679,881 reported on its 1971 return, and, as stated above, seeks a refund of the entire $528,017 paid for the year 1968, plus interest. INTRODUCTORY LEGAL DISCUSSION Before reaching the three major issues of the case, we deem it appropriate to briefly discuss a few facets of the income taxation of insurance companies. The Supreme Court has referred to the pertinent laws and regulations as “the complex portion of the Internal Revenue Code concerning life insurance companies.” Commissioner v. Standard Life & Accident Insurance Co., supra, 433 U.S. at 149, 97 S.Ct. at 2524. Although much of what we outline in this section will be repeated below, a brief overview of the law, including lengthy quotations from two clear and helpful opinions, should assist an understanding of the complicated legal issues involved. As a life insurance company, plaintiff SBL is taxable under 26 U.S.C. §§ 801-820, which codify the Life Insurance Income Tax Act of 1959. “[L]ife insurance company taxable income” is defined in 26 U.S.C. § 802(b) as the sum of— (1) the taxable investment income (as defined in 26 U.S.C. § 804) or, if smaller, the gain from operations (as defined in section 809), (2) if the gain from operations exceeds the taxable investment income, an amount equal to 50 percent of such excess, plus (3) the amount subtracted from the policy-holders surplus account for the taxable year, as determined under section 815. The third subsection of § 802(b) is not applicable to a mutual company such as plaintiff. Life insurance companies are taxed in a three phase system, about which quite a bit of expert testimony was presented at trial. In Reserve Life Ins. Co. v. United States, 45 A.F.T.R.2d 80-893 (Ct.C1.1980), the court explained: Phase I imposes a tax at the full corporate rate on the lesser of: (1) the insurance company’s taxable investment income (i. e., the portion of the net investment income actually earned which exceeds the amount of investment income needed to meet future policy obligations to policyholders); or (2) the company’s gain from operations (i. e., the excess of income over expenses). If the company’s gain from operations is greater than the company’s taxable investment income, the company pays a full corporate tax on the taxable investment income and also pays, as phase II, a full corporate tax on one-half of the amount by which the gain from operations exceeds the taxable investment income. In a situation where the company’s gain from operations exceeds the taxable investment income, the one-half of the difference that escapes phase II taxation is put in a special account and accumulated on the tax records. If the company decides later on to use this money, it is then taxed at the full corporate rate as phase III. The first two major issues in this case involve an assumption reinsurance transaction whereby SBL, the reinsurer, assumed liability on policies originally issued by the Society, the reinsured. The background concepts necessary to evaluation of an assumption reinsurance transaction were broadly sketched in the following passage from Mutual Savings Life Ins. Co. v. United States, 488 F.2d 1142, 1143-1144 (5th Cir. 1974): As premiums on policies are received by a life insurance company, state insurance laws require a portion of the premiums to be set aside as reserves for the payment of claims. Premium receipts must be reported as income, but to avoid taxing the company on that portion of the premium receipts allocated to reserve requirements, the Act provides that amounts by which reserves are increased may be deducted from current operating income. Concomitantly, when a policy is paid on the death of the insured so that reserves are decreased and the reserved assets are freed for the company’s general use, the amount of decrease must be reported as income for tax purposes. In addition to basic transactions in which an insurance company issues a life insurance policy to an individual, collects premiums, sets' aside in reserves a portion of each premium during the life of the policy holder, and then pays the face of the policy upon the insured’s death permitting a reduction in reserve requirements, insurance companies reinsure themselves. In such reinsurance transactions, one company transfers a policy to another company, the “reinsurer,” which then is entitled to receive the insurance premiums as paid, maintains appropriate statutory reserves, and pays the death benefits when the policyholder dies. Usually large numbers of policies are involved and often they have been in force for a period of time so that substantial amounts of reserves are being held against the policies at the time of the transfer. The Reinsured. In reinsurance transactions, the company which assigns the policies, the “reinsured,” can legally reduce its reserves by the amount required to be held in reserve on the assigned policies, but this amount must be reported as income. If any consideration is paid by the reinsured to the reinsurer for assumption of the policy liabilities, the reinsured is entitled to deduct this amount from income. In some cases, the reinsured may receive consideration from the reinsuring company, and such consideration must then be included as income. The Reinsurer. On the other hand, the reinsurer, upon acquiring the policies, must commensurately increase its required reserves, but may immediately deduct this amount from income. Any consideration received from the reinsured must be reported by the reinsurer as income. But if the reinsurer has paid consideration for the policies, the payment cannot immediately be deducted, but must be amortized over the estimated life of the contracts. When the reinsurer receives consideration in the exact amount of the required reserves, these payments obviously offset each other. The reinsured company reports as income the amount by which its reserves may now be reduced, but deducts the identical amount which it has paid to the reinsurer. The reinsuring company reports as income the amount paid it by the reinsured, but deducts from income the same amount by which its reserves have been increased. The third issue in the case involves an understanding of the Supreme Court’s decision in Commissioner v. Standard Life & Accident Ins. Co., supra. To comprehend the issues involved, one must have a passing familiarity with a number of life insurance terms and basic concepts. These were discussed in relatively clear terms in Reserve Life Ins. Co. v. United States, supra, 45 A.F.T.R.2d at 80-893 to 80-895: A life insurance contract is a contract under which the insurance company agrees with a person to assume certain risks related to life and death. The insurance company charges the policyholder annually and agreed price, known as the “gross premium,” for assuming and carrying the risks involved in the policy. The gross premium is composed of two parts, i. e., the “net valuation premium” and the “loading.” The “net valuation premium” on a particular policy means the amount of money that, using the mortality table and the interest rate assumed for the policy, will be sufficient to provide for the payment of the benefits promised in the policy. The net valuation premium is added to the policy reserve each year in order that the company may be able to satisfy future claims under the policy and to provide current policy benefits. The “loading” portion is the part of the gross premium from which the company’s deductible expenses (e. g., overhead, salesmen’s commissions state taxes, etc.) are paid. The loading represents the difference between the gross premium and the net valuation premium. Although premiums on ordinary life insurance are typically calculated and quoted on an annual basis, policyholders often pay premiums on an installment plan (e. g., semiannually, quarterly, or monthly). “Deferred premiums” are installments which remain to be paid after the end of the insurance company’s tax year on December 31 and before the next annual renewal dates (i. e., the anniversary dates) of the respective policies. “Uncollected premiums” are premiums which, at the close of December 31 each year, are already due but have not been paid, and which relate to insurance policies that are still in effect under grace-period provisions. The term “unpaid premiums” is sometimes used in the life insurance industry to include both deferred premiums and uncollected premiums. There is no obligation — contractual or otherwise — on the part of the policyholders to pay to the insurance company either deferred or uncollected premiums. If, however, a policyholder does not pay a premium in conformity with the provisions of the policy, the policy lapses upon the expiration of a grace period. Life insurance “reserves” are not trust funds or particular assets in escrow. They are merely statements of liability reflecting a life insurance company’s benefit obligations to its policyholders. The reserve simply operates as a charge on so much of an insurance company’s assets as must be maintained in order for the company to be able to meet its future commitments under the policies it has issued. In the United States, reserves are computed on a net premium basis. The three basic elements affecting a life insurance reserve are: (1) the mortality tables utilized; (2) the interest rate utilized; and (3) the valuation method utilized. The mortality tables are usually prescribed, and the interest rate is usually regulated, by state law. With respect to the third element, i. e., the valuation method, there are two basic valuation methods used by insurance companies: (1) “the net level premium” method; and (2) a “preliminary term” method. If the mortality table and assumed rate of interest are the same, the basic difference between the net level premium method and a preliminary term method is in the uniformity of the net valuation premiums under the net level method for all policy years, including the first. The net level premium method assumes uniform net valuation premiums for all years throughout the premium-paying period of an insurance policy. On the other hand, a preliminary term method assumes a smaller net valuation premium in the policy’s first year of existence when the company’s expenses in connection with the policy are greater — than in all subsequent policy years, in which larger and uniform net valuation premiums are assumed. The first-year net valuation premium assumed by a preliminary term method is less than — and the net valuation premiums in the second and subsequent years are greater than — the uniform net valuation premiums assumed by the net level premium method. A gross deferred or uncollected premium is equal to the net valuation portion of the deferred or uncollected premium plus the loading portion thereof. The components of each gross deferred or uncollected premium (i. e., the net valuation premium and the loading), as reported in the company’s Annual Statement, necessarily differ, depending upon whether the Annual Statement reserve is computed under a preliminary term method or under the net level premium method. Utilization (with the same assumed interest and mortality factors) of a preliminary term method, rather than the net level premium method, in computing Annual Statement reserves would result in a smaller net valuation premium and increased loading only for the first year of each life insurance policy, and would result in larger net valuation premiums and reduced loading for all but the first year of each life insurance policy. Because a life insurance company’s “mix” of business is usually such that first-year premiums tend to be dominant over renewal premiums, the preliminary term method of valuing reserves (which maximizes the loading portion and minimizes the net valuation portion of first-year gross premiums) generally has income tax advantages over the net level premium method. This is especially true with respect to deferred and uncollected first-year premiums, since the Supreme Court determined in Commissioner v. Life & Accident Insurance Co., supra, 433 U.S. at 151 [97 S.Ct. at 2525], that only the net valuation portions — and not the loading portions — of unpaid premiums are required to be included in a life insurance company’s assets and gross premium income, as well as in its reserves, for the purpose of computing the company’s federal income tax liability. With the background statement of facts and the preliminary discussion of the legal concepts now set forth, we turn to a discussion of the three major issues presented by this case. ISSUE NUMBER ONE: DID PLAINTIFF PROPERLY REPORT THE CONSIDERATION IT RECEIVED FOR PROVIDING BENEFITS TO MEMBERS OF A FRATERNAL ORGANIZATION, IN FILING ITS 1971 INCOME TAX RETURN? FINDINGS OF FACT 1. The Ladies Society of the Brotherhood of Locomotive Firemen and Engine-men is a fraternal benefit society which provided insurance benefits to its members. These benefits consisted of life insurance benefits and funeral benefits. The premiums charged by the Society in 1971 were $12 per year per $1,000 of life insurance benefits. The funeral benefits constituted less than two percent of the total insurance program. 2. Under the Society’s constitution, members who were under the age of 50 could apply for life insurance benefits of $200 or $500, and members who were under the age of 45 could apply for life insurance benefits of $1,000. Approximately 70% of the Society’s members were age 37 or less when they commenced insurance coverage and more than 96% were age 46 or less. 3. The only assets held by the Society in 1970 for the payment of insurance benefits were those in its insurance funds. The only source of funds for the assets maintained as part of the insurance funds were the assessments from the Society members, plus income earned thereon. 4. The insurance funds were the Society’s only reserves for meeting its insurance liabilities. The Society did not estimate or compute reserves on the traditional basis of mortality tables and assumed rates of interest. 5. No state insurance department exercised regulatory jurisdiction over the Society’s insurance activities. 6. As of July 1, 1971, the assets in the Society’s insurance funds consisted of cash, bonds, and real estate interests. The bonds were considered to be high quality, but had substantially decreased in market value from the time they were purchased by the Society. As of July 1, 1971, the par value of the bonds was $7,569,000 and the fair market value was $5,543,110. 7. The par value of the bonds closely approximated the purchase price paid for such bonds by the society. The par value also approximated an amount equal to the accumulation of past assessments, plus interest, less claims, expenses, and small amounts transferred to other accounts. 8. In December of 1967, Nelson and Warren, a firm of consulting actuaries, analyzed the Society’s insurance fund. The analysis revealed that since 1960 claims had been continuously increasing while total assessments had been continuously decreasing. In spite of this trend, it was concluded that the fund was financially sound and that the $12 assessments, plus the assets in the insurance fund, would be adequate to cover operating expenses and pay death benefits. The study noted, however, that the fund showed some symptoms of an “assessment spiral” and that if the trends became more unfavorable the Society should take remedial action. 9. The trend toward an assessment spiral continued. So, in 1970, the Society’s officers decided to look for acceptable insurance for its members as a substitute for the Society’s benefits. 10. Plaintiff received a July 7, 1970 letter from Marian Roger, grand president of the Society, in which she asked if the plaintiff would be interested in providing this coverage. The letter informed plaintiff that the business was solvent and in good financial condition. 11. Robert E. Jacoby, SBL’s vice-president in charge of reinsurance, had the responsibility to determine if it would be advisable for the plaintiff to acquire this business. By letter dated July 27, 1970, Mr. Jacoby responded to Mrs. Roger’s letter, telling her that the plaintiff was interested in exploring the matter further, but that more information was needed. 12. Jacoby began gathering information for his actuaries to determine what annual premiums would be required so that the premiums, together with the assets to be transferred from the Society, would be adequate to meet death claims. One of the actuaries, Steve Cooper, concluded that a $12 premium would produce a “surplus strain,” whereas age-banded premiums of $12, $15, and $18 would produce a “surplus gain.” Other research indicated that approximately 75% of the insured members of the Society were between 50 and 80 years old. 13. On September 3, 1970, Jacoby wrote Mrs. Koger to make a tentative offer. One of the terms of the proposed offer was that the assessment rates would be increased from a straight $12 per thousand to age-banded rates of $12, $15, and $18. 14. This offer was made contingent on State approval for valuation of the insurance fund bonds at par because there would be a substantial surplus strain if the bonds were carried on the Annual Statement at a transfer date fair market value. Jacoby sent a letter to the Kansas Insurance Commissioner in which he indicated that plaintiff would be willing to assume the Society’s liabilities if permitted to carry the bonds to be received from the Society at par rather than at fair market value for Annual Statement purposes. 15. The Society rejected the concept of age-banded premiums, apparently because of the heavier burden it placed on older members. Further negotiations occurred, and it was agreed that a straight premium of $15 per $1,000 of life insurance benefits and $30 per $1,000 of funeral benefits would be appropriate. On December 21, 1970, Jacoby sent a copy of a proposed agreement to the Kansas Commissioner of Insurance. Tentative approval was given by the Commissioner on January 5, 1971, and on February 3, 1971, permission was given to plaintiff to carry the securities to be received from the Society at par. 16. In February, 1971, each insured member of the Society was sent an explanation of the proposed agreement and a ballot upon which to vote acceptance or nonacceptance. The agreement was accepted. 17. The agreement was executed on May 1, 1971, and was approved by the Commissioner of Insurance on May 19, 1971. 18. The agreement was effective as of July 1, 1971. On that date, the premium was raised from $12 to $15 per thousand dollars of coverage. Plaintiff issued assumption certificates to the Society members which provided that the insurance benefits were not subject to cancellation except for nonpayment of premiums. 19. Also on July 1, 1971, the Society transferred to plaintiff cash in the amount of $70,436.67, real property with a fair market value of $330,267.35, and securities with a total fair market value of $5,543,110, for a total of $5,943,814. The par value of the securities was $7,487,380. When the securities are valued at par, the total amount of assets transferred was $7,888,084.02. The Society did not transfer, nor did it agree to transfer, any other assets to plaintiff. The assets transferred constituted almost all of the Society’s assets. 20. Plaintiff did not agree to pay a commission or bonus for the insurance business it acquired from the Society. 21. In the negotiations, the parties did not place a value on the insurance business or contracts which plaintiff acquired. If such business or contracts had an ascertainable value, it was not taken into account as consideration by the parties to the transaction. 22. Jacoby and Cooper both anticipated that the acquisition of this block of business from the Society would be profitable for the plaintiff in the long run. 23. Mean reserves of $7,554,519 attributable to plaintiff’s liabilities to the members of the Society were included as part of an $11,236,157 amount reported by plaintiff in its 1971 Annual Statement as reserves for life policies and contracts. 24. The $7,554,519 mean reserve included in plaintiff’s 1971 Annual Statement was computed using the 1958 C.S.O. table, a recognized mortality table within the meaning of 26 U.S.C. § 801(b)(lXA), and a Zxh% assumed rate of interest. This reserve was reported as part of plaintiff’s overall reserve on its 1971 income tax return. 25. The $7,554,519 reserve was a reserve set aside by plaintiff to satisfy future unac-crued claims arising from life insurance’ contracts involving life contingencies. Such reserve was required by law. 26. In computing the reserve, the company actuary, Cooper, did not have information regarding the initial issue dates of the certificates or policies to the members of the Society or the ages of the members at the date of issue. 27. In computing the initial reserve component of the Annual Statement reserve, the company actuary in effect determined the present value of future benefits as of July 1, 1971, using the 1958 C.S.O. table and an assumed rate of interest of 3V2 % and then reduced this amount by the present value of annual net premiums of $15 per thousand to be received subsequent to July 1, 1971 for each contract where an insured had an attained age of 38 and a lesser annual net premium where an insured had not attained the age of 38. 28. An annual net premium of $15 per thousand of insurance in force or less was a reasonable assumption, according to expert testimony. The $15 annual net premium yielded an initial reserve which was a close approximation of, although less than, the carrying value of the assets transferred by the Society. Further, if the mean reserve were computed on the basis of precise data now known using the mortality table and interest assumptions used by plaintiff, the reserve would have closely approximated the mean reserve calculated by plaintiff, and it would have qualified as a life insurance reserve under the provisions of Sub-chapter L. 29. To minimize surplus strain, plaintiff estimated the reserve using the least conservative assumptions available under Kansas law. Actuary Cooper utilized 3V2% as the interest rate — the maximum allowed by Kansas law. Had a lesser interest rate been assumed, the reserve calculated would have been even larger. 30. Actuaries are permitted discretion by State insurance authorities in the assumptions they can make in estimating or computing reserves. In its examination of the company, the Kansas Insurance Department did not dispute the propriety of any of the standards adopted or any of the assumptions made by plaintiff in reporting the transaction with the Society. 31. An assumption reinsurance transaction is an arrangement whereby an insurance company, referred to as the reinsurer or the reinsuring company, becomes solely liable on contracts which it did not issue. In effect, a reinsurer steps into the shoes of a ceding or reinsured company and is substituted for such company where thereby is relieved from its liability. The agreement between plaintiff and the Society was an assumption reinsurance transaction. 32. Where a reinsurer in an assumption reinsurance transaction becomes solely liable to policyholders on a block of contracts transferred to it, it generally receives consideration from the ceding company (the reinsured) for its assumption of the latter company’s liabilities. 33. The reinsurer computes its reserves on the assumed contracts by reference to the ceding company’s issue dates and the age at issue rather than the attained age of the individuals insured. 34. Sometimes the reinsurer may agree to pay a certain amount to the ceding company as a commission, or as reimbursement for unrecovered expenses that such company may have incurred in placing the business on the books or as the value of the insurance in force assumed by the reinsurer. Where each company in an assumption reinsurance transaction agrees to make a payment to the other, the company with the greater obligation may pay the other a net amount rather than have an exchange of checks by the transacting parties. While only one payment is made, each of the contracting parties has agreed to make a payment to the other in this type of “netting transaction.” 35. The agreement between plaintiff and the Society was not a “netting transaction.” DISCUSSION OF LAW (A) Introduction Following its transaction with the Society, plaintiff reported as income arising out of the transaction a total of $5,943,814. This figure is the total of cash ($70,436.67), real property ($330,267.35) and securities ($5,543,110 market exchange value) received. It is defendant’s view that plaintiff should have reported, as compensation received in the transaction, $7,554,519 — an amount equal to the reserves it established. The difference of opinion between the parties as to what amount should have been reported as income on plaintiff’s 1971 tax return arises from a difference of opinion as to the definition of “compensation” in 26 U.S.C. § 809(cXl). The parties agree that when, as in the transaction between plaintiff and the Society, a reinsurer assumes the insurance obligations of another entity, it must report as income all “consideration” which it received from the reinsured. § 809(c)(1) states that the following shall be taken into account in determining gain or loss from operations: The gross amount of premiums and other consideration (including advance premiums, deposits, fees, assessments, and consideration in respect of assuming liabilities under contracts not issued by the taxpayer) on insurance and annuity contracts (including contracts supplementary thereto); less return premiums, and premiums and other consideration arising out of reinsurance ceded. Except in the case of amounts of premiums or other consideration returned to another life insurance company in respect of reinsurance ceded, amounts returned where the amount is not fixed in the contract but depends on the experience of the company or the discretion of the management shall not be included in return premiums, (emphasis added) The difference of opinion as to what constitutes “consideration”, in turn, arises from a dispute as to whether this transaction is governed by the I.R.S. regulations in effect in 1971, or by those same regulations as amended in 1976. Plaintiff argues that the transaction should be controlled by the regulations which were in effect in 1971. Defendant argues that the regulations were amended in 1976 to correct previous errors and that the corrected regulations should control. Plaintiff contends, and defendant does not dispute, that SBL’s 1971 tax return was completed in conformity with the regulations in effect at that time. § 1.817-4(d)(l) of the 1971 regulations provided, generally, that assumption reinsurance “shall be subject to the provisions of sections 806(a) [governing certain changes in reserves and assets] and 809 and the regulations thereunder.” More specifically, § 1.817 — 4(d)(2)(ii) read as follows in 1971: In connection with an assumption reinsurance (as defined in paragraph (a)(7)(ii) of § 8.809-5) transaction, a reinsurer shall in any taxable year beginning after December 31, 1957— (a) Treat the consideration received from the reinsured in any such taxable year as an item of gross amount under section 809(c)(1), and (b) Treat any amount paid to the rein-sured, to the extent - such amount meets the requirements of section 162, as a deferred expense under section 809(dX12) and amortize such amount over the reasonably estimated life (as defined in subdivision (iii) of this subparagraph) of the contracts reinsured, irrespective of the taxable year in which such amount was paid to the reinsurer. The 1971 version of § 1.817-4(d)(3) contained four examples to provide guidance to taxpayers attempting to discover the income tax consequences of their reinsurance transactions. Example (1) is virtually indistinguishable from the case at hand: Example (1). On June 30, 1959, X, a life insurance company, reinsured a portion of its insurance contracts with Y, a life insurance company, under an agreement whereby Y agreed to assume and become solely liable under the contracts reinsured. The reserves on the contracts reinsured by X were $100,000. Under the reinsurance agreement, X agreed to pay Y a consideration of $75,000 in cash for assuming such contracts. Assuming no other insurance transactions by X or Y during the taxable year, and assuming that X and Y compute the reserves on the contracts reinsured on the same basis, X has income of $100,000 under section 809(c)(2) as a result of this net decrease in its reserves and a deduction of $75,000 under section 809(d)(7) for the amount of the consideration paid to Y for assuming these contracts. Y has income of $75,000 under section 809(c)(1) as a result of the consideration received from X and a deduction of $100,000 under section 809(d)(2) for the net increase in its reserves. If the Society and SBL were substituted for X and Y, respectively, and the figures relevant to the transaction in this case were also substituted, Example (1) would read as follows: On July 1, 1971, Society, a fraternal organization providing life insurance benefits to its members, reinsured its insurance contracts with SBL, a life insurance company, under an agreement whereby SBL agreed to assume and become solely liable under the contracts reinsured. The reserves on the contracts reinsured by Society were $7,554,519. Under the reinsurance agreement, Society agreed to pay SBL a consideration of $5,543,110 in cash and other tangible property for assuming such contracts. Assuming no other insurance transactions by Society or SBL during the taxable year, and assuming that Society and SBL compute the reserves on the contracts reinsured on the same basis, Society has income of $7,554,519 under section 809(c)(2) as a result of this net decrease in its reserves and a deduction of $5,543,110 under section 809(dX7) for the amount of the consideration paid to SBL for assuming these contracts. SBL has income of $5,543,110 under section 809(c)(1) as a result of the consideration received from Society and a deduction of $7,554,159 under section 809(d)(2) for the net increase in its reserves. Plaintiff computed its 1971 income tax in conformity with Example (1). This computation was also consistent with Example (4) of the 1971 regulations [which is now Example (5) of the 1976 regulations]: On August 1, 1960, R, a life insurance company, reinsured all of its insurance policies with S, a life insurance company, under an agreement whereby S agreed to assume and become solely liable under the contracts reinsured. The reserves on the contracts reinsured by R were $3,000,-000. Under the reinsurance agreement, R agreed to pay S a consideration of $3,000,000 in stocks and bonds for assuming such contracts. Assuming no other insurance transactions by R or S during the taxable year, that R and S compute the reserves on the contracts reinsured on the same basis, and that R has a recognized gain (after the application of the limitation of section 817(b)(1)) of $20,000 due to appreciation in value of the assets transferred, the results to each company are as follows: INCOME Company R (reinsured) Net decrease in reserves (sec. 809(dX2)) ......$3,000,000 Capital gain as limited by see. 817(d)(1) to be taxed separately under sec. 802(a)(2) ....... 20,000 Company S (reinsurer) Consideration received by S in respect of assuming liabilities under contracts issued by R (sec. 809(cXD......$3,000,000 DEDUCTIONS Company R (reinsured) Consideration paid by R to S in respect of S's assuming liabilities under contracts issued by R (sec. 809(dX7)) . .$3,000,000 Company S (reinsurer) Net increase in reserves (sec. 809(d)(2)).....$3,000,000 SBL points out that § 1.817-4(d)(3) and Example (1) were applied in a manner completely consistent with SBL’s 1971 return in Mutual Savings Life Ins. Co. v. United States, 488 F.2d 1142 (5th Cir. 1974), a case worthy of some discussion. Mutual Savings was a tax refund suit involving a life insurance company’s acquisition of two blocks of life insurance policies from other insurance companies in reinsurance transactions. The two reinsured companies involved were Georgia Life and Health Insurance Company and the Life Insurance Company of Florida. In the Georgia Life transaction, as here, the rein-sured paid consideration to the taxpayer in an amount less than the required reserves. In Florida Life transaction, the taxpayer not only received no payment from the rein-sured, but actually paid a substantial sum to it for the policies. The heart of the lawsuit was the meaning of the phrase “consideration received from the reinsured” in § 1.817-4(dX2)(ii). Mutual Savings argued that the phrase encompassed only tangible assets labeled by the parties as consideration. The Government argued, as here, that the total consideration included not only tangible assets transferred but also the intangible value of the insurance contracts themselves. The Government’s position was rejected, and Mutual Savings prevailed in the action. Regarding the transaction with Georgia Life, as indicated above, the reinsured obtained policies for which the legally required reserves exceeded the tangible assets received from the reinsured: In the first transaction, taxpayer acquired from Georgia Life and Health Insurance Company life insurance policies for which the legal required reserves were $1,047,142. Taxpayer received from Georgia Life $682,990 in tangible assets. Mutual Life was required to increase its reserves by $1,047,142, which is $364,152 in excess of the value of the tangible assets received. The District Court held that Mutual was entitled to deduct $1,047,142 for the increase in its life insurance reserves and was required to report as income the $682,990 consideration received from Georgia Life. The net effect, therefore, was to allow the taxpayer a $364,152 excess of deductions over reported income on the transaction. The Government contends that the “difference between the obligations assumed ($1,047,142) and the tangible assets received ($682,990) represents the payment ($364,152) taxpayer made to Georgia Life for the privilege of taking over this block of business” and that this payment may only be amortized over the useful life of the contracts. [488 F.2d at 1145] A comparison between the facts of this case and the specifics of the Georgia Life transaction in Mutual Savings indicates near identity. The Government’s position regarding the taxability of the transaction is also the same. In Mutual Savings, the court quoted Example (1) from § 1.817-4(d)(3) and utilized it as a basis for rejecting the Government’s view, stating: The Government contends that this example does not properly reflect the law in that the phrase “consideration received from the reinsured,” Treasury Regulations, supra, applies not only to tangible assets paid to the taxpayer by the rein-sured, but also to the intangible asset value of the acquired life insurance policies. In this example, however, only the tangible consideration transferred between the parties is shown to be considered. A taxpayer has the right to rely upon the Government’s Regulations and their published illustrations. Treasury Regulations having the force and effect of law are binding on tax officials, as well as taxpayers. See Pacific Nat’l Bank of Seattle v. Comm'r of Internal Revenue, 91 F.2d 103 (9th Cir. 1937). As stated by the trial court in its decision from the bench, “the Government cannot just abandon example 1 of the regulations and direct it into some type of obscurity oblivion as if it never existed, whereas the parties do and can fit in that direct pattern. Until the regulation is changed, the Government is obligated to follow it.” We find no error in the District Court’s decision regarding the Georgia Life transaction. [488 F.2d at 1145-1146] The Florida Life transaction in the Mutual Savings case was not so directly analogous factually; nonetheless, the court’s discussion of its tax treatment, which stressed that only tangible transfers are taken into consideration in determining compensation, is worthy of note. To repeat, if the regulations extant in 1971 as interpreted in Example (1) and as applied in Mutual Savings control our decision in this case, plaintiff properly filed its 1971 tax return. Although the Government’s position was completely rejected in Mutual Savings, it was generally accepted in a similar case decided about the same time, Kentucky Central Life Ins. Co. v. C. I. R, 57 T.C. 482 (1972). In Kentucky Central, the taxpayer was the reinsurer which assumed the liability on a block of policies known as the Skyland policies originally issued by the re-insured, Guaranty Savings Life Insurance Company. Under the reinsurance agreement, the purchase price was $1,800,000. Of this, $1,650,000 was for the Skyland policies, their agreed value as gauged by the present value of the future profits to be derived from the policies involved. Rather than pay the $1,650,000 to Guaranty, Kentucky Central was given a credit by Guaranty in the overall transaction. In reporting its compensation, Kentucky Central listed as consideration the tangible assets it had received, but not the $1,650,000 credit. The court viewed the basic issue as whether an amount equivalent to the value of the insurance business received by petitioner in the assumption reinsurance transaction with Guaranty should be included in premium income within the purview of § 809(c)(1) in determining gain from operations. The taxpayer claimed the only consideration it received was $310,398.11 in premium income. The I.R.S. claimed that the taxpayer had assumed reserves of $1,960,398.11 and received in return consideration in the same amount. The difference between the two figures was the $1,650,000 value placed on the insurance business reinsured and received by the taxpayer from Guaranty by the terms of the agreement. The court noted that, assuming a bona fide arm’s-length transaction, it was reasonable to believe that each party had received consideration equal to the value it bestowed upon the other. The court felt that had the transaction been handled without the use of credits, on a strictly cash basis, the taxpayer would have paid Guaranty $1,800,000 cash in return for the tangible assets and insurance contracts purchased and also for the required reserves previously accumulated from premiums. In holding for the government, the court stated: As the sale worked out, taxpayer succeeded in making the purchase of the Skyland business without having to transfer any sizable amounts of cash or other assets as consideration for its new acquisitions. Additionally, Kentucky Central has attempted to avail itself of the deduction created by section 809(d)(2), for increasing its reserves as part of the sale, without recognizing, coincidently, the consideration it received from Guaranty in the form of credits for the reserves. Should petitioner’s argument prevail, we would, in effect, be allowing it a current loss deduction for $1,650,000 of the purchase price it indirectly paid Guaranty. Such could not have been the intendment of section 809 when enacted by Congress. Although the court found little assistance in the legislative history of the relevant congressional acts, it found the taxpayer’s position inconsistent with its view of congressional intent: To allow petitioner the benefit of the section 809(d)(2) deduction for the increase in its reserves necessitated by the sale transaction, without also imputing premium income to it under section 809(c)(1) for the credit it received on the purchase price of the Skyland business, would produce a gross distortion in taxpayer’s income, a windfall tax benefit, which is not in keeping with the purpose of subchapter L. Furthermore, this Court has previously dealt with the assumption of liabilities in an insurance setting and imputed income to petitioner from a reinsurance agreement. International Life Insurance Co., 51 T.C. 765 (1969). Although that case may be distinguishable from the instant case on its facts, the basic rationale of the decision is nevertheless applicable. Therefore, we are firmly convinced that Congress intended the phrase, “and consideration in respect of assuming liabilities under contracts not issued by the taxpayer,” in section 809(cXl) to serve as a catchall for transactions such as the one here. In Kentucky Central, the taxpayer placed reliance upon Example (1) of § 1.187-4(d)(3). Unlike the court in Mutual Savings, the court in Kentucky Central rejected example one as controlling: Because in the example no amount was included in the reinsurer’s income for the value of the insurance business transferred, petitioner claims no amount should be included in its income for the value of the business it received in this transaction. We are not impressed with the argument for two reasons. In the first place, we are not concerned with the value of the insurance business ceded per se. We are concerned with an amount equivalent to the value of the business, but only because that is the amount taxpayer failed to report as income. Another reason we are unpersuaded by petitioner’s analogy is that the example in the regulations does not give enough of the relevant facts and is thus misleading. The example leaves us uninformed as to what value was placed on the reinsured business and whether the reserves for the policies were transferred in the transaction. It seems logical to assume the only reason the reinsured would pay the reinsurer the $75,000 in cash would be to establish the required reserves for the policies ceded, but we will not make such an assumption on the facts as presented in the example. Furthermore, the result reached by the example and the preceding regulations can be read to support respondent’s position if we decide that section 809(c)(1) consideration includes credits given a re-insurer for liabilities it assumes in a reinsurance transaction. For these reasons, we hold that petitioner received $1,650,000 additional consideration which is taxable to it as premium income under section 809(c)(1), from its reinsurance of Guaranty’s Skyland division business. In light of the conflict in the Kentucky Central and Mutual Savings cases, and no doubt upset that its position was rejected in the latter case, the I.R.S. set about to amend the pertinent regulations. Regulation § 1.817-4(d)(2), as amended in 1976, now reads as follows: (iii) . .. where the reinsured transfers to the reinsurer in connection with the assumption reinsurance transaction a net amount which is less than the increase in the reinsurer’s reserves resulting from the transaction, the reinsurer shall be treated as— (A) Having received from the rein-sured consideration in an amount equal to the net amount of the increase in the reinsurer’s reserves resulting from the transaction, and (B) Having paid the reinsured an amount for the purchase of the contracts equal to the excess of the amount of such increase in the reinsurer’s reserves over the net amount received from the rein-sured. Accompanying the new regulations is a modified version of Example (1) which now provides: Example (1). On June 30, 1959, X a life insurance company reinsured a portion of its insurance contracts with Y, a life insurance company, under an agreement whereby Y agreed to assume and to become solely liable under the contracts re-insured. The reserves on the contracts reinsured by X were $100,000. Under the reinsurance agreement X agreed to pay Y $100,000 for assuming such contracts and Y agreed to pay X $17,000 for the right to receive future premium payments under this block of contracts. Rather than exchange payments of money, X agreed to pay a net amount of $83,000 in cash. Assuming that the reasonably estimated life of the contracts reinsured is 17 years, that there are no other insurance transactions by X or Y during the taxable year, and assuming that X and Y compute the reserves on the contracts reinsured on the same basis, X has income of $100,000 under section 809(c)(2) as a result of the net decrease in its reserves. X has a net deduction of $83,000 ($100,000 - $17,000) under section 809(d)(7). For the taxable year 1959, Y has income of $100,000 under section 809(c)(1) as a result of the consideration received from X and a deduction of $100,000 under section 809(d)(2) for the net increase in reserves and $1,000 ($17,000 divided by 17, the reasonably estimated life of the contracts reinsured), under section 809(d)(12). The remaining $16,000 shall be amortized over the next 16 succeeding taxable years (16 X $1,000 = $16,000) under section 809(d)(12) at the rate of $1,000 for each such taxable year, (emphasis added) A new Example (3) was also issued which apparently illustrates the application of subdivision (2)(iii): Example (3). The facts are the same as in Example (1), except that the reinsurance agreement does not specifically provide that X agreed to pay Y $100,000 for assuming the contracts reinsured and Y agreed to pay X $17,000 for the right to receive future premium payments under such contracts. Instead, X agreed to pay Y a net amount of $83,000 in cash for assuming such contracts. Nevertheless, Y is treated as having received from X consideration equal to $100,000, the amount of the increase in Y’s reserves, and as having paid $17,000 ($100,000 less $83,000) for the purchase of such contracts. Therefore, for the taxable year 1959, Y has income of $100,000 under section 809(cXl). Y also has a deduction of $100,000 under section 809(d)(2) for the net increase in its reserves and an amortization deduction under section 809(dX12) of $1,000 ($17,000 divided by 17, the reasonably estimated life of the contracts reinsured). The remaining $16,000 shall be amortized by Y over the next 16 succeeding years. For 1959, X has income of the reasonably estimated life of the contracts $100,000 under section 809(c)(2) as a result of the net decrease in its reserves and a deduction of $83,000 under section 809(d)(7) for the net amount of consideration paid to Y for assuming the contracts reinsured, (emphasis added) It may be noted for purposes of future discussion that new Example (1) pertains to a transaction in which there is an explicit “netting” arrangement, whereas new Example (3) involves the imputation of income in the absence of such an explicit agreement. Before discussing the real substance and application of the 1976 regulations, we must discuss their relevance to the case at hand. Plaintiff SBL argues that this case is controlled by the 1971 regulations, and that it would be unfair to retroactively apply the 1976 regulations. Defendant, on the other hand, argues that the 1976 regulations are retroactive in effect and do govern the filing of plaintiff’s 1971 tax return. (B) Retroactivity of the 1976 Regulations The parties recognize that the I.R.S. has broad power to promulgate rules and regulations with retroactive application. A presumption of retroactivity arises from 26 U.S.C. § 7805(b) which provides: The Secretary or his delegate may prescribe the extent, if any, to which any ruling or regulation, relating to the internal revenue laws, shall be applied without retroactive effect. The background for this statute was described in some detail in Wisconsin Nipple & Fabricating Corp. v. C.I.R., 581 F.2d 1235, 1237-1238 (7th Cir. 1978): The explanation for the presumption in favor of retroactivity implied by this statutory language lies in the declaratory theory of jurisprudence on which the statute is predicated. The predecessor of § 7805(b), enacted in 1921, was in response to a proposal the Secretary of the Treasury had made in 1919. The provision was sought because administrative rulings were viewed as merely declaring what the statute had meant all along, and therefore necessarily retroactive, and it was thought the Secretary or his delegate should have power to grant relief from retroactivity in