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Individuals and corporations pay premiums to insurers for different purposes, in the court’s view. Individuals acquire insurance coverage to protect their wealth and future income or to provide income replacement or a substitute for bequests to their heirs. Corporations, such as Sears,
acquire insurance to spread the cost of casualties more evenly over time and to benefit from an insurance company’s expertise and ability to provide highly specialized insurance-related services. Corporations buy “loss-evaluation and loss-administration services, at which insurers have a
comparative advantage, more than they buy loss distribution.”
The court was satisfied that the transaction had sufficient characteristics of insurance to preclude a recharacterization. It increased Allstate’s insurance pool, which reduced Allstate’s ratio of expected to actual losses. It allocated the administrative work on claims to Allstate employees, who had a “comparative advantage” at those tasks. The court stated that the transaction placed, Sears’s risks in a larger pool, performing one of the standard insurance functions in a way that a captive does not.
More: Allstate furnishes Sears with the same hedging and administration services it furnishes to all other customers.
It establishes reserves, pays state taxes, participates in state risk-sharing pools (for insolvent insurers), and so on, just as it would if Sears were an unrelated company. Although Sears could deduct its premiums paid to Allstate because the underlying transaction qualified as insurance, the deduction was offset on Sears’s consolidated return as premium income of Allstate. Significantly,
however, Allstate could deduct reserves established when Sears incurred a covered loss because the coverage qualified as insurance. This tax treatment reflects the underlying economics because Allstate could deduct reserve increases that it had to establish when Sears incurred a loss covered by Allstate.
