Rev. Rul. 55-693

Advice has been requested as to the taxability of an amount transferred from a mutual insurance company to a casualty insurance company for the purpose of reinsuring liability risks for catastrophe losses.

X casualty company, a stock fire insurance company taxable under section 831 of the Internal Revenue Code of 1954, entered into a reinsurance agreement with Y mutual insurance company, a mutual insurance company having no reinsurance protection or protection against catastrophe losses, whereby Y transferred the sum of 500 x dollars, representing a portion of its reserve for unearned premiums, to X as a `catastrophe loss reserve.' This `reserve' is to be kept intact by X for catastrophe insurance losses of Y except for the portion which X may earn into its underwriting income each year. Under the terms of the agreement, 80 percent of the premiums received thereafter by Y will be paid in consideration for such reinsurance and X will reinsure 100 percent of Y's liability on insurance risks either issued or to be issued.

Section 832(b) of the 1954 Code, defining taxable income in the case of insurance companies other than life or mutual insurance companies, provides, in part, as follows:

(3) UNDERWRITING INCOME.-The term `underwriting income' means the premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred.

(4) PREMIUMS EARNED.-The term `premiums earned on insurance contracts during the taxable year' means an amount computed as follows:

(A) From the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance.

(B) To the result so obtained, add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year.

The word `premium,' which has been defined as the consideration paid for a contract of insurance, is the proper term to use in designating the sum which one insurance company pays to another on its reinsurance contract. Hoosier Casualty Co. v. Commissioner , 32 Fed.(2d) 940, certiorari denied, 280 U.S. 581. Accordingly, the `catastrophe loss reserve' also represents in the instant case the `premium' paid by Y to X for reinsurance. The words `unearned premiums' as used above must be given their commonly accepted meaning. Compare Helvering v. Edythe LeGierse et al. , 312 U.S. 531, Ct. D. 1491, C.B. 1941-1, 430. `Unearned premiums' may be defined as that portion which the company has not yet had time to earn or, more precisely, that portion paid by the policyholder which must be returned on cancellation of the policy, and which is in direct proportion to the unexpired time which the policy is to run. Huebner, Property Insurance, (1929 edition), Chapter XVI, 217; Early, Jr. v. Lawyers Title Insurance Corporation , 132 Fed.(2d) 42; Massachusetts Protective Association, Inc. , v. United States , 114 Fed.(2d) 304, Ct. D. 1483, C.B. 1941-1, 383; Aetna Insurance Co. et al. v. Hyde , decided by the Supreme Court of Missouri, May 21, 1926, 285 S.W. 65. Therefore, in the instant case, until the transferred reserve composed of unearned premiums has been earned by X through the lapse of time, it may be considered as `unearned' within the meaning of section 832(b)(4) of the 1954 Code.

Accordingly, it is held that the amount transferred under a reinsurance agreement to X casualty company from Y mutual insurance company for reinsurance of Y's insured liability risks represents a premium for the reinsurance undertaken by X , and that portion of the premium which remains unearned at the end of the taxable year is deductible as an `unearned premium' under section 832(b)(4) of the 1954 Code