1 BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 2 5901 GREEN VALLEY CIRCLE 3 CULVER CITY, CALIFORNIA 4 5 6 7 8 REPORTER'S TRANSCRIPT 9 JUNE 25, 2015 10 11 SPECIAL TAXES APPEAL HEARING 12 TRUCK INSURANCE EXCHANGE 13 NO. 240627 (STF) 'CF' 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Reported by: Kathleen Skidgel 28 CSR No. 9039 1 1 P R E S E N T 2 For the Board Jerome E. Horton of Equalization: Chairman 3 4 Sen. George Runner (Ret.) Vice Chairman 5 6 Fiona Ma, CPA Member 7 8 Diane L. Harkey Member 9 10 Joann Richmond Chief 11 Board Proceedings Division 12 13 For Board of Equalization Staff: David Levine 14 Tax Counsel IV 15 For the Department: Andrew Kwee 16 Tax Counsel 17 Stephen Smith Tax Counsel 18 19 For the Department of Insurance: Laszlo Komjathy, Jr. 20 Representative 21 David Okumura Representative 22 23 For the Claimant: Richard D. DeLaMora Attorney 24 25 ---oOo--- 26 27 28 2 1 5901 GREEN VALLEY CIRCLE 2 CULVER CITY, CALIFORNIA 3 JUNE 25, 2015 4 ---oOo--- 5 MR. HORTON: Ms. Richmond, our next matter 6 is a -- is a -- is a constitutional matter in which 7 the -- Ms. Stowers cannot participate in. 8 MS. RICHMOND: Correct. 9 MR. RUNNER: She should have to stay 'til 10 we adjourn, don't you think? That's just fair. 11 MS. STOWERS: We still have a quorum 12 here. 13 MR. RUNNER: I was just saying. 14 MS. HARKEY: Just -- just thinking. 15 MS. STOWERS: I will listen, via the 16 webcast, just in case Ms. Yee has to come back. 17 MR. RUNNER: Okay. 18 MR. HORTON: Okay. 19 MS. RICHMOND: So our next item is Item D, 20 Special Taxes Appeals Hearings. Item D1, Truck 21 Insurance Exchange. 22 Please come forward. 23 MR. HORTON: Mr. Levine, as the taxpayer 24 comes forward, would you please introduce the issues 25 in this case? 26 MR. LEVINE: Good morning, Chairman Horton, 27 Members. David Levine for the Appeals Division. 28 The issue in this insurance tax case is 3 1 whether petitioner overpaid tax by failing to claim 2 an allowable deduction for $45 million payment it 3 made pursuant to a settlement in 2000. Pursuant to 4 a lawsuit. 5 MR. HORTON: Thank you. 6 Welcome to the Board. Would you please 7 introduce yourself for the record. 8 MR. DE LA MORA: My name is Richard 9 De La Mora. I'm with Hinshaw and Culbertson, and I 10 represent Truck Insurance Exchange. 11 MR. HORTON: Welcome. You have to ten 12 minutes to make your presentation. We'd ask that 13 you commence -- be advised that we will return and 14 allow you five minutes on rebuttal. 15 MR. DE LA MORA: Thank you, Honorable 16 Chairman and Members of the Board. 17 This claim for deduction against premium 18 tax concerns $45 million that Truck Insurance 19 Company paid to settle a claim for a refund of what 20 the California Hospital Association characterized as 21 excess premium paid under a retrospective experience 22 rating plan. 23 That plan consisted of two documents: 24 The first was a standard vanilla 25 comprehensive general liability insurance policy 26 which stated the terms of coverage. 27 The second was a Premium Determination 28 Agreement which, as the title would seem to indicate 4 1 facially, involved how the company would pay first 2 advanced premium. Companies being CHA would pay to 3 Truck advance premium upfront, and also stated the 4 terms and the formula under which retrospective 5 experience rating refunds would be paid in the even 6 experience was good. 7 The CHA account was a very, very large 8 account and it expanded -- expanded over many, many 9 years. But in reality, it was no different than the 10 typical experience rating types of insurance 11 policies that are issued everyday to midsize and 12 large employers for workers compensation insurance 13 and midsize and large employers for health insurance 14 and other types of benefit programs. 15 Under all of those programs, the insured or 16 the policyholder pays an advance premium upfront 17 and, after a period of time after which all of the 18 claims are paid and the experience is in, they are 19 eligible to receive a refund of a portion of that 20 premium in the event the claims experience is good. 21 In 1989, the California Attorney General, 22 in response to an inquiry from my law partner Dick 23 Barger, then the Insurance Commissioner of the State 24 of California, opined that where such experience 25 rating refunds are paid, actually delivered to the 26 person who pays the insurance premium, that the 27 deduction against premium tax liability is required 28 and that's exactly the ruling we seek here. 5 1 We think the facts that were at issue in 2 that circumstance are no different than those at 3 issue here. 4 Truck paid $45 million to resolve an 5 experience rating refund dispute. That was excess 6 premium by definition under the terms of the policy 7 and the Premium Determination Agreement, and the 8 Department of Insurance initially -- and we believe 9 correctly -- characterized that as return premium 10 and recognized my client's entitlement to deduct 11 that from its premium tax liability. 12 That decision was rejected by the Board, 13 and we believe that was incorrect for several 14 reasons. In doing so, the Board has put forth 15 several different rationales over time. They've 16 been changing. None of them hold water. 17 The first was that the payment was made to 18 resolve a lawsuit and, therefore, is not subject to 19 characterization as return premium. 20 Lawsuits are a method to resolve disputes. 21 They do not create distinct legal rights. Let me 22 give you an example. If someone breaches a contract 23 to pay me for ben -- for my wages and I have to sue 24 to recover that money, when I recover those wages 25 pursuant to the lawsuit, I have to pay taxes on 26 those wages. Why? Because the substantive claim at 27 issue was for wages, regardless of the form in which 28 that claim is resolved. So that first rationale 6 1 just did not hold water. 2 The substantive claim here was 3 characterized by -- not by Truck, but by the 4 California Hospital Association and the District 5 Court, the Federal District Court that resolved the 6 class action that was settled her as excess premium. 7 CHA alleged that the agreement's 8 termination obligated defendants to return surplus 9 premiums to all participating hospitals over a 10 10-year period, commencing in June 1990, five years 11 after the termination date. 12 Paragraph 37 of CHA's Complaint: 13 "Defendant's have wrongfully withheld 14 from hospitals substantial unreturned 15 premiums." 16 Paragraph 76: 17 "Plaintiffs have been deprived of 18 million of dollars in unreturned premiums 19 believed to be in excess of $50 million." 20 I could go on and on because that Complaint 21 is replete with references to unreturned premiums. 22 The only issue in that lawsuit was premium and the 23 only money that Truck could have paid to settle that 24 was premium. In fact, in seeking approval of the 25 settlement itself, CHA characterized the $45 million 26 as resulting in a, quote, "reduction in premiums of 27 almost nine percent." 28 The Federal District Court agreed, holding 7 1 that -- and noting in particular that the settlement 2 payment was equal to, quote, "the exact amount of 3 unreturned premiums alleged in the Complaint." 4 The nature of the claim was for unreturned 5 premiums, and it doesn't matter if it was resolved 6 in a legal suit. 7 The second rationale given by the Board was 8 that the formula under which the return premium was 9 required to be paid under the experience rating plan 10 included an investment income component. And that's 11 true, it did. And in fact, since 1989, as a matter 12 of law under Proposition 103, a consumer protection 13 statute, every single property casualty rate in the 14 State of California must recognize and credit to the 15 policyholder investment income on reserves held. 16 Why? Because the insurance company's got the money, 17 they're earning income on it, and that should be 18 reflected in the payments that the policyholders 19 ultimately get to pay. They get to share in that. 20 So it's a -- in fact, there are -- the 21 Commissioner Garamendi at the time, 1992, adopted 22 Regulation section 2644.19 and 2644.20 which 23 specifically order all insurance companies to make 24 rates and premiums considering investment income. 25 All my client did in applying an investment 26 income credit and granting it to CHA in this case 27 under that formula was to do what the law required 28 since 1989, credit them with investment income on 8 1 reserves while held. 2 The last rationale was stated in the 3 recommendation. And the -- the recommendation 4 reaches the conclusion that for premium tax 5 purposes, interinsurance exchanges such as my client 6 can only deduct return premium. And the $45 million 7 paid to resolve CH claim was not return premium. 8 Both prongs of that conclusion are wrong. 9 First, the recommendation concludes that 10 experience rating refunds are not return premium 11 because that term is limited by law to premiums that 12 are given back to the policyholder because the 13 policy is cancelled. 14 That's based on a case, Northwestern 15 Mutual, that was decided in 1918. That case asked 16 if a dividend payable at the discretion of the Board 17 of Directors was subject to characterization as 18 return premium; and it held it was not, admittedly. 19 In doing so, the court cited and relied on 20 exclusively, noting there were no cases or no law 21 out there, they relied on the Black Law's 22 Dictionary's definition of return premium, which, at 23 that time, stated it only applied where a policy is 24 cancelled and a portion of the premium is given 25 back. 26 Well, a lot has happened since 1918. Since 27 1918, the Department of Insurance itself has 28 recognized that when you pay dividends, you're 9 1 entitled to a deduction from your gross premium for 2 premium tax purposes. 3 That decision is based on subsequent case 4 law and it is correct. In fact, the very form we 5 filled out in order to appear here today includes a 6 deduction line for -- for dividends. That didn't 7 exist in 1918 when this decision was decided and the 8 rationale of that case doesn't apply. 9 In fact, we note in our papers that 10 subsequent to that, Black's Law Dictionary's 11 definition has changed to the extent it's still 12 controlling law. It states: 13 "The amount of money given back to the 14 insured when a policy is cancelled" -- 15 that's the old standard -- "or the rate is 16 adjusted or the premiums have been 17 overpaid." 18 We are dealing with a situation here where 19 the premiums were adjusted and they were overpaid 20 based on a formula that the parties agreed to called 21 the Premium Determination Agreement. 22 That definition, as we noted in our papers, 23 has been followed by the IRS in the federal courts 24 in determining the tax liability of insurance 25 companies at the federal level. And it's also been 26 adopted, as I noted at the outset, by the California 27 Attorney General in its opinion issued to the 28 Insurance Commissioner, again, noting that where the 10 1 return premium results in reductions of the -- of 2 the premium, that the taxpayer, in this case the 3 insurance company, is entitled to keep -- it's 4 entitled to treatment as -- it's entitled to 5 deduction for tax purposes. We believe that ruling 6 should apply here. 7 The second rationale, and it's almost a 8 factual one, is that -- strike that. It's a legal 9 one, is that under the applicable statutes, my 10 client is only entitled to -- entitled to reduct 11 return premium. That's just incorrect. 12 My client is an interinsurance exchange. 13 The Legislature adopted a specific definition of 14 gross premium that applies to interinsurance 15 exchanges. While all companies can deduct return 16 premium, my client as an interinsurance exchange can 17 deduct three items from gross premium. These are 18 under R&T section 1221, and 15 -- and Insurance Code 19 section 1530. 20 The first item is "all amounts returned to 21 subscribers." That's quoted from the statute. The 22 second is "all amounts credited to the accounts of 23 subscribers as savings." And the last is "return 24 premium." 25 Under the case law that I cited earlier 26 that -- actually, two cases, Industrial Indemnity 27 Insurance Exchange versus the Board, it's a 28 California Supreme Court case, and under CSAA versus 11 1 the Board, it's a Court of Appeal case. In both of 2 those cases, the courts upheld deductions from gross 3 premium for premium tax purposes for items that the 4 courts recognized were not return premium. They 5 were dividends. 6 One was a return of surplus dividend to the 7 policyholders, and one was just a general return of 8 dividends to the policyholders. In fact, the Board 9 of Equalization didn't even object to those -- those 10 deductions in those cases. So it wasn't even on the 11 table for the court to go beyond that, other than to 12 recognize that nobody was contesting the fact that 13 when you give the money back to the policyholder and 14 there are savings is deductible. 15 So we believe that in this case, at least 16 to this point, that the Board has gotten it wrong. 17 That this was, if nothing else, a refund of excess 18 premium to these policyholders and that that should 19 be recognized as a deduction. 20 Thank you. 21 MR. HORTON: Thank you very much. 22 Members, we'll now go to the Department. 23 The Department has ten minutes to make their 24 presentation. We would ask that you commence with 25 your introduction for the record. 26 MR. KWEE: Good morning, Chairman Horton 27 and Members of the Board. I'm Andrew Kwee with the 28 Board's Legal Department. And with me today is 12 1 Stephen Smith, also with the Legal Department, and 2 Laszlo Komitijay (phonetic) -- Komjathy, I'm sorry. 3 Laszlo Komjathy with the Department of Insurance, 4 and David Okumura with the Department of Insurance. 5 And Claimant is not legally entitled to 6 deduct its $45 million settlement payment to settle 7 a class action lawsuit brought pursuant to the 8 Racketeer Influenced and Corrupt Organization Act or 9 the RICO Act. 10 The RICO Act is a federal law which 11 provides federal jurisdiction in a civil cause of 12 action for damages suffered due to certain unlawful 13 acts perpetrated by an enterprise engaged in 14 racketeering activities. The RICO Act specifically 15 provides that a person injured by another person 16 engaging in an unlawful pattern of racketeering 17 activity may sue in federal court and recover 18 three-fold the damages he sustains and the cost of 19 the suit, including reasonable attorneys fees. 20 On May 3rd, 1994, Claimant was sued in a 21 federal court under this provision of the RICO Act. 22 And this is the reason that the federal court had 23 jurisdiction over this case. 24 After the federal court served by the class 25 action, six years of litigation and a bench trial, 26 Claimant settled the class action lawsuit in 2000 27 for 45 -- for a 45 dollar million -- a $45 million 28 payment, sorry. The $45 million payment included 13 1 15.8 million in attorney's fees and costs. 2 The monetary damages at issue in the 3 federal case arose from Claimant's alleged failure 4 to distribute 100 percent of the program surplus 5 remaining in Claimant's reserve account to 6 policyholders during the 12 years following 7 termination of the insurance agreements. 8 Claimant's reserve account was defined in 9 the agreement as consisting of the investment 10 earnings that's interest income, plus the 11 underwriting gain, if any. 12 Now, according to the settlement approval 13 documents filed in federal court, Claimant earned 14 $330 million in investment income. And on those 15 lines, it is necessary to point out that in the 16 federal action, Claimant contended that the amounts 17 at issue do not constitute return premium. 18 In a document submitted to federal court, 19 Claimant made the following statements -- and I'm 20 going to quote from Claimants. 21 One: 22 "Program surplus under the PDA is 23 neither premium nor return premium for 24 purposes of statutory accounting 25 principles, statutory accounting 26 requirements, or California Insurance Code 27 section 11552." 28 Next: 14 1 "The PDA is not a retrospective return 2 premium agreement." 3 And the third quote: 4 "The drafters did not intend program 5 surplus to be either a dividend in the 6 legal sense of that term or return premium 7 in the legal sense of that term." 8 And further, the Federal Court concluded 9 after a trial that -- and I'm going to quote the 10 court's language now: 11 "Accordingly, the court finds that 12 program surplus is not treated as return 13 premium. The court further finds that 14 distributions under the PDA have no affect 15 on either return -- on either premium 16 earned or earned premium." 17 Next quote -- and in reaching that 18 determination, the court also cited testimony 19 provided at trial by the hospitals. And that 20 testimony provided -- and this is a quote: 21 "We had learned enough to set the 22 premium correctly, that all of the premium 23 would be used to pay expenses, and what was 24 left over was the investment income." 25 Now, that case was settled during the 26 appeals process for $45 million. And, nevertheless, 27 despite contending that program surplus is not a 28 return premium and the federal court concluding that 15 1 it is not return premium, Claimant, after paying the 2 $45 million settlement payment, filed an amended 3 insurance tax return for calendar year 2000 and -- 4 and deducted the entire $45 million settlement 5 payments, including attorney's fees and costs, as a 6 return premium paid to -- a return premium paid to 7 policyholders. 8 Claimant now requests that that -- now 9 requests that the State issue a tax refund 10 therefore, even though Claimant never even paid a 11 reported insurance tax on this amount. 12 Now, Claimant is not entitled to a tax 13 refund for its settlement payment. Article VIII, 14 section 28 of the California Constitution imposes 15 insurance tax on the gross premiums received by an 16 insurer whereupon it's business done in this State 17 and the gross premiums tax is in lieu of any other 18 tax. As relevant here, the California Constitution 19 only authorizes a deduction from gross premiums for 20 return premiums. 21 Claimant's investment earnings do not 22 constitute a return of taxable premiums as required 23 by the Constitution because the investment earnings 24 were never subject to the gross premiums tax. The 25 California Constitution allows a deduction for 26 return of premium amounts paid by the subscriber on 27 which tax was reported and paid. Claimant did not 28 pay tax or report tax on its investment earnings; 16 1 therefore, Claimant is not legally entitled to a tax 2 refund. 3 And just for a quick clarification, back in 4 June 26 of 2006, the Department of Insurance did 5 send a letter to the Claimant and notified them that 6 they recommended that they withdraw their claim for 7 refund. So the Department of Insurance and the 8 Board staff are in agreement that a claim for refund 9 is not available in this action and have been for 10 quite some time. 11 And that's why we, staff and the Department 12 of Insurance staff, concur with the Appeals 13 Division's recommendation. 14 MR. HORTON: On rebuttal, please. 15 MR. DE LA MORA: Thank you. 16 The first statement that was made by 17 counsel was that the underlying action was a RICO 18 action and that it really had nothing to do with 19 excess premium as alleged by CHA. 20 That statement is incorrect. And, in fact, 21 it was rejected by the appeals officer who heard 22 this case who noted that while the Complaint states 23 separate -- 14 separate causes of action, it's 24 ultimately involved, quote, "a single wrong despite 25 including as many different theories for recovery 26 that the attorneys can think up," end quote. 27 The officer who heard the appeal went on to 28 state that, quote, "the basic claim for relief was 17 1 for breach of contract," end quote; specifically, 2 the Premium Determination Agreement. 3 The hearing officer further went on to note 4 that, because of this basic breach of contract, not 5 RICO claim, that the hospitals alleged that Truck 6 had caused them to, quote, "lose at least 7 $50 million in unreturned premiums," end quote. 8 So the statement that that was a RICO 9 action and a RICO settlement is just factually 10 incorrect and is contradicted by the hearing officer 11 himself. 12 Second, there was an indication that below 13 Truck argued that these were not return premiums. 14 What they did not say, and actually never cited any 15 provision of the California Insurance Code, 16 particularly 1530 as that -- as being relevant to 17 that determination at that point or Revenue and 18 Taxation Code section 12221 as being relevant to 19 that determination. They weren't. 20 It wasn't a tax case. It was a case 21 involving how much money -- let's put it in the 22 words of CHA -- how much premium that was left 23 unreturned by Truck to CHA at the conclusion of the 24 policy term. 25 That unreturned premium was alleged by CHA 26 to be $50 million, and ultimately Truck paid 27 $50 million to resolve that liability. The reason 28 Truck argued that it wasn't earned premium for 18 1 purposes of the PDA at that time was -- and there 2 was a good reason for it -- the PDA required that 3 program expenses be calculated based on a percentage 4 of premium. Therefore, when the parties drafted the 5 PDA, they didn't call it premium, they didn't call 6 it return premium, they didn't call it earned 7 premium. They called it program surplus because the 8 agreement itself required that expenses be 9 calculated as a percentage of premium. 10 So for purposes of the agreement, the 11 answer was correct, that was when the -- when 12 payments were credited back to CHA, it wasn't like a 13 dog chasing its tail, continually becoming a bigger 14 and bigger number until it was zero. When Truck 15 made payments back to CHA, for example, the 16 $5.6 million paid as -- after this lawsuit was 17 filed, it did not have to recalculate expenses and 18 then make a further payment based on the reduction 19 of expenses attributable to the program surplus 20 reduction. 21 Using as an example the $45 million here, 22 under CHA's theory at that time, which was subject 23 to that dispute, Truck would have had to make an 24 additional payment to CHA on top of the $45 million 25 if that was treated as premium for purposes of the 26 Premium Determination Agreement because its expenses 27 would have been reducible by the amount of premium 28 returned. 19 1 The parties didn't agree to that. That's 2 the issue that was on the table there. It was not a 3 tax issue and didn't involve the interpretation of 4 the statutes we're talking about here. 5 Lastly, there's some notion that somehow 6 Truck didn't pay premium taxes here and that they're 7 seeking something that they're not entitled to 8 because they never paid premium taxes. There was 9 over $650 million of premium paid by CHA to Truck 10 over the course of this agreement. That was 11 advanced premium. 12 Truck paid premium taxes on every single 13 nickel of that premium over time. The question 14 becomes is, at the end of the day when you calculate 15 the amount of the final premium due based on the 16 claims experience, the premium paid, and the 17 investment income admittedly earned on that premium 18 paid while Truck held it, is that return premium to 19 the subscriber? 20 We would submit that it is because in 21 structure, while it's very complex in this 22 agreement, it really is no different than any other 23 experience rating plan. If you do a good job on 24 your experience, if you pay more premium than you 25 should have, if you have earnings on that premium 26 that go to your credit because Prop 103 requires you 27 to take credit for those, you're entitled to money 28 back. 20 1 Truck's not in the investment business. We 2 don't sell investments, we issue insurance coverage. 3 Truck pays clai -- it gives money back to the 4 policyholder in three forms: Dividends, claims, or 5 excess premium payments. 6 This was not a claim payment; everybody 7 concedes that. It was either -- frankly, this is 8 what the court held down below, the district court. 9 It was either a dividend, a return premium payment, 10 or something in between. 11 It doesn't matter. Under 1530 of the 12 Insurance Code which applies to interinsurance 13 exchanges, all forms of monies returned to 14 subscribers under their policies, with the exception 15 of claim payments, are subject to deduction for 16 premium tax purposes. 17 Our position is supported by the law and 18 frankly the uncontroverted facts here, and we ask 19 that it be adopted by the Board. 20 MR. HORTON: Thank you. 21 Discussion, Members? 22 Member Runner? 23 MR. RUNNER: Okay. I think that's on. 24 Yeah. 25 Let me -- let me just start with the, um -- 26 the first -- the $5 million -- $5,000,623 settlement 27 payment. That was deducted or seen as a return of 28 premium, correct? 21 1 MR. KWEE: My understanding is that they 2 deducted it. They claimed they deducted it, but 3 that was never picked up by Department of Insurance; 4 that's why it's not before us today. 5 This -- this amount, settlement payment, is 6 what was picked up and we -- we caught that. But 7 the other 230 dollar million -- $230 million in 8 deductions were not picked up. So we -- we -- 9 MR. RUNNER: So you believe that, for 10 instance, this -- this other payment that was made 11 in this account or in -- to this -- to -- to the 12 hospital association was just missed? 13 MR. KWEE: That's correct. But to the 14 extent that there were any premiums, they have 15 already exceeded the amount of any return premium 16 deduction available by their $230 million deduction 17 already claimed and received. 18 MR. RUNNER: Okay. Let me ask the taxpayer 19 representative there, is that your opinion in 20 regards to $5 million? 21 MR. DE LA MORA: No, it's incorrect -- 22 well, it is my opinion with respect to the 23 $5 million, yes. 24 MR. RUNNER: Uh-huh. 25 MR. DE LA MORA: Truck did claim that as a 26 deduction against its gross premium for premium tax 27 purposes. It was accepted. And it -- it was 28 properly treated, we believe. 22 1 I would also note that, yes, it is correct, 2 when prior credits were given before the policy 3 terminated against basically how large their 4 premiums would be, that was recognized as a 5 deduction. The treatment Truck is asking for here 6 as to this $45 million is the exact same treatment 7 that has been afforded to these payments since -- 8 since the agreement went into effect. 9 MR. RUNNER: Let me just ask, too, I mean 10 there was some comment in regards to the Department 11 of Insurance and BOE is on the same page here. 12 What -- what happened to the letter that -- 13 But we didn't start out there, right? I 14 mean the Department of Insurance wrote a letter on 15 March 29th, 2005 -- 16 MR. KWEE: Maybe the Department of 17 Insurance -- their attorney, Laszlo Komjathy, is 18 here. 19 MR. RUNNER: -- indicating that based on 20 their review it found that Claimant should be 21 refunded and the refund should be granted? 22 MR. KOMJATHY, JR.: The, uh -- the initial 23 review as -- was limited to what documents were 24 received by -- from the taxpayer. And based upon 25 that limited number of documents, a determination -- 26 initial determination was made. And that was the 27 basis of the letter. 28 Subsequently, State Board reviewed it and 23 1 said, wait, there's more to it. And at that point 2 the Department -- the Departments went back and 3 started looking at the records related to the 4 filings and the court proceedings that had -- that 5 resulted in this $45 million claim. 6 And during that, that's when they 7 discovered that the testimony by -- the testimony 8 given in that proceeding was that it was never the 9 intent of the hospitals to get any premium back. It 10 was solely going to be interest -- they only wanted 11 the additional interest income earned. 12 Truckers (verbatim) pointed out that, yes, 13 there was no earned -- they did not intend to have 14 any earned income. This was not one of these pro -- 15 was not one of these programs, as counsel calls it. 16 This was a otherwise program because they were 17 trying to capture investment income only. 18 They even noted in the trial they didn't 19 want any earned income coming back in income because 20 they would have to then recalculate and come up with 21 some way to reimburse Medi-Cal and other programs. 22 Because if it wasn't -- if it was premium coming 23 back, then they should -- there should be a credit 24 going back further. 25 The hospitals wanted only to have income 26 that is generated from the investments being 27 returned. 28 After reviewing all this and including the 24 1 findings of the court, because the court was very 2 much impressed by counsel -- hospital's witnesses 3 who testified that we didn't want earned income 4 back. This -- we were looking for investment income 5 only. And further, that they found that there was 6 no basis for this being one of these programs where 7 you're looking -- you're getting back premium. 8 For those reasons, after reviewing it all 9 then, the analysis -- subsequent analysis made, it 10 was a determination made that it was the initial 11 analysis was incorrect and in fact that there is no 12 premium returned. 13 MR. RUNNER: Okay. From the taxpayer's 14 point of view, did they have the materials they 15 should have had in order to make the full decision 16 correctly? 17 MR. DE LA MORA: Yes. In fact, thank 18 you -- thank you, your Honor. 19 If you'd look at the letter March 29, 2005 20 that the Department submitted in which case it 21 recommended approval of the refund request because 22 it was returned premium, they attach at page 2 a 23 list of the many documents they received and 24 reviewed in making that determination. They 25 included the policies; financial statements 26 concerning the amounts of unreturned premium 27 refunded by the policies; the settlement and 28 agreement and release that we're talking about under 25 1 which the $50 million was paid by Truck here; the 2 Proposed Order re: Notice of Settlement of Class 3 Action dated June 20 as issued by the California 4 Hospital Association; Defendant's post trial 5 submission of annotated proposed findings in fact 6 and conclusions of law as issued. And the case is 7 filed in the United States District Court. 8 So we would submit that, first of all, the 9 statement that the Department did not have 10 information is just factually incorrect to begin 11 with. And second of all, that they had plenty of 12 information to make a determination and the 13 determination was that this should be treated as a 14 reduction of gross premium, just like all the other 15 prior payments had been treated. 16 If I may also, sir, respond to the -- the 17 point made about what CHA may have intended from its 18 own personal business perspective? If that's okay 19 with you, sir? 20 MR. RUNNER: Actually, I think I'm -- I 21 just need that one. 22 Let me ask, go back to this. In the 23 settlement agreement, there's a statement in there 24 that says the stated -- statements sum -- it 25 represents a significant portion of the Plaintiff's 26 overall claims. Notably this sum is the exact 27 amount of unreturned premiums alleged in the 28 Complaint. 26 1 That makes it sound like it's a return of 2 premium to me. 3 MR. KOMJATHY, JR.: Oh, I agree. It does 4 make it sound like. But you have to remember, these 5 are submissions for the purposes of having the court 6 approve a settlement. 7 The trial, the underlying trial, during 8 that trial it wasn't -- yes, they were -- the 9 hospital was claiming it was premium. Trucking -- 10 Truck was always saying, no, it wasn't premium. It 11 wasn't related to earned premium, it was investment 12 income. 13 And the reasons why they did that, I don't 14 have. You know, I was not there at the trial. 15 Counsel was talking about what they meant at the 16 trial, but I wasn't there and he wasn't there 17 either. 18 The point is, is that it was investment 19 income. There was no premium being returned. The 20 amount, yes, it was the same amount. Because that's 21 the basis. They were saying that, oh, Truck from 22 the very beginning was withholding premium that 23 should be returned to us. And that was -- and then 24 they incorporate the RICO Act to get in front of the 25 federal court, and there's other allegations. The 26 cases never went to the trial to the end. 27 MR. RUNNER: Right. 28 MR. KOMJATHY, JR.: But there was a trial 27 1 regarding the question of whether or not this was 2 premium. And the court found that everything -- all 3 the evidence submitted, that it was not -- the money 4 in question was not earned premium. 5 MR. RUNNER: Okay. Let me ask the 6 representative then, why -- why should we -- why 7 should I be compelled to respond to your argument 8 during trial versus what it says is the agreement in 9 the settlement? 10 MR. DE LA MORA: Preliminarily, let me just 11 note that factually the statement you read, sir, was 12 not the statement of CHA. It was a statement of the 13 Federal District Court judge and his order. 14 MR. RUNNER: That is correct, yes. 15 MR. DE LA MORA: Proving the -- 16 MR. RUNNER: That was not C -- 17 MR. DE LA MORA: Proving the settlement. 18 MR. RUNNER: Right. That was the court 19 saying that. 20 MR. DE LA MORA: That was the Court's 21 characterization. 22 MR. RUNNER: Right. 23 MR. DE LA MORA: The reason that -- that 24 you should is that they are two different questions. 25 What the parties intended for purposes of their 26 agreement and the amount of money that Truck would 27 be entitled to keep as an administrative expense is 28 irrelevant to the question of how you treat this 28 1 payment, whether it's subject to characterization as 2 a dividend or subject to characterization as return 3 premium, or something in between as the superior -- 4 as the trial court said. It just doesn't matter. 5 The question is, How do you treat that 6 payment then for premium tax purposes? And in this 7 case, we believe that under the relevant statute, 8 for my client, which is an interinsurance exchange 9 and a unique entity, the Legislature has held that 10 whenever sums are returned to subscribers, which is 11 what the policyholder is technically called here, 12 that that is subject to a deduction. A recognition 13 of the unique structure, but different types of 14 monies go back and forth. 15 So dividends are deductible. Return 16 premiums are deductible, and any sum that has the 17 net effect of reducing the cost of insurance due to 18 the subscriber is deductible. 19 MR. RUNNER: Okay, thank you. 20 MR. HORTON: Member Harkey. 21 MS. HARKEY: I'm not so sure I'm ready, but 22 let me just try here. 23 Okay. Explain to me if I'm correct on 24 this. This is for the, uh -- the taxpayer. 25 CHA filed the lawsuit. And they filed it 26 as a withholding of premium so they could file a 27 RICO suit. 28 MR. DE LA MORA: I don't know why CHA filed 29 1 the lawsuit. All I know is what they alleged. And 2 what they alleged was that we had unlawfully 3 withheld return premium due to them under the policy 4 and the Premium Determination Agreement in the 5 amount of $50 million. They alleged, as the appeal 6 officer who heard the case, many, many, causes of 7 action. 8 The Complaint -- and we've given it to 9 you -- is very, very thick. But the core complaint 10 remains that Truck withheld $50 million of 11 unreturned premium. 12 MS. HARKEY: I -- I understand. I 13 understand, but that's how they got federal -- 14 MR. DE LA MORA: It got to federal court 15 because -- 16 MS. HARKEY: -- jurisdiction -- 17 MR. DE LA MORA: Yes. 18 MS. HARKEY: -- because of their original 19 claim. 20 MR. DE LA MORA: It would -- the RICO claim 21 was a federal rope. I don't think there was 22 diversity issue there at all. 23 MS. HARKEY: Okay. Okay. So then the 24 court found that it was investment income, the 25 dollars were actually investment income. And your 26 contention is it's investment income, and that's 27 also because of the type of business that the sums 28 returned to -- that the sums returned to subscribers 30 1 are deductible. 2 MR. DE LA MORA: We don't contend -- 3 MS. HARKEY: Doesn't matter if it's 4 investment income or whatever. It was returned to 5 subscribers because of the nature of your insurance 6 exchange or whatever it is. 7 MR. DE LA MORA: Yes, it includes a 8 formula. And the formula includes premium as a 9 starting point; it includes investment income on 10 the -- on the revenue side. And on the -- the 11 expense side, it includes administrative expenses. 12 And it includes claims costs. And you just 13 basically run the formula, and you come up with the 14 number. 15 I would note that CHA, at paragraph 28 of 16 their Complaint, specifically said, quote, "The 17 program's salient feature is the calculation of 18 primary layer premiums, retroactively based on the 19 loss experienced of all participants." 20 MS. HARKEY: Right. 21 MR. DE LA MORA: Again, that's not us. 22 That's how they characterized it. I understand they 23 may have had concerns about making refunds to 24 Medi-Cal or whatever, but those weren't what the 25 agreement provided and they're irrelevant to this. 26 MS. HARKEY: In essence, they didn't want 27 to do that type -- that -- that type of work. This 28 was a class action. And basically somebody wanted 31 1 to pay off, the attorneys wanted to be paid and they 2 just -- I mean, that's the way it is. That's what 3 class action is. 4 So -- 5 MR. DE LA MORA: Attorneys like to be paid; 6 I will stipulate. 7 MS. HARKEY: Yeah, they like to be paid. 8 And in class actions, they usually get the bi -- the 9 larger chunk, but that is just the nature of the 10 litigation. 11 The primary point is that, under the code 12 that you cited -- and I'm not an insurance expert, 13 nor am I a legal expert -- but under the code that 14 you cited that the sums -- sums are returned to 15 subscribers are deductible, and that's kind of where 16 you're basing your case. It doesn't matter how the 17 litigation was filed. 18 MR. DE LA MORA: Correct. 19 MS. HARKEY: Okay. For the Department. 20 You claim that there were no premium paid. The 21 Appellant is claiming that there were premiums paid. 22 There were 650 million advance premiums paid. And 23 that they paid taxes on those -- not the premiums. 24 They didn't pay taxes, but they're saying there was 25 650 million advance premiums for which they paid 26 taxes on. 27 I'll throw it out to whoever wants to 28 respond to that. 32 1 MR. KWEE: Yeah. And if I may clarify. So 2 we have the distinction between the premiums and the 3 investment earnings on those premiums. And the way 4 we're looking at it is basically to say that 5 investment earnings are deductible as a savings or a 6 credit within section 1530 is really to put -- 7 putting the cart before the horse because before 8 asserting entitlement to a refund for tax paid, the 9 first question is whether Claimant didn't pay any 10 tax on the amount upon which a refund is claimed. 11 And the answer to this question is no. And the 12 Supreme Court actually opined on this issue -- 13 MS. HARKEY: Okay. Let me stop you before 14 you go on because you're going to lose me. 15 So the reason you're saying that taxes were 16 not paid is because there's investment income. 17 You're not saying they didn't pay taxes on the 18 premiums. So you're saying it's because investment 19 income they didn't pay taxes on it. 20 But if, in fact, this were a return of -- 21 of premium, then you wouldn't have that argument. 22 MR. KWEE: Right. And the key word there 23 is "return" because the investment earnings aren't 24 paid, they're not returned. And the Supreme Court 25 has actually opined on this issue. And the Supreme 26 Court included that investment earnings cannot 27 legally be deducted from gross premiums in 28 Northwestern Mutual Life Insurance Co. 33 1 And the Supreme Court stated investment 2 earnings and other sources of income aside from 3 premiums are not deductible because, quote, "They do 4 not represent, as to each member of the institution, 5 the excess of premiums over the cost of insurance 6 which he has actually paid." The key word being 7 "paid." 8 MS. HARKEY: Okay. Now let me go back to 9 the taxpayer's rep. 10 So you're citing, though, is it a 11 California Insurance Regulation? You said -- you 12 said it was a Constitution or in our Constitution 13 section VIII, that you -- that everything has to go 14 back to the -- 15 MR. DE LA MORA: Yes. 16 MS. HARKEY: I -- I missed -- I got a lot 17 of numbers here, but I want to be sure I'm -- 18 MR. DE LA MORA: Yes. Let me just cite -- 19 MS. HARKEY: Cite -- cite which one -- 20 which -- which code you're citing. 21 MR. DE LA MORA: Insurance Code section 22 1861.05, which was passed as part of Proposition 103 23 provides that as a matter of law, in making premium 24 and charging insurance rates, insurance companies 25 must give consideration to the investment income 26 they earn while they're holding premiums. That's 27 number one. 28 Number two, to implement that, then 34 1 Insurance Commissioner John Garamendi implemented 2 regulations that said insurance companies have to 3 figure out what their investment return is, multiply 4 that investment return by the amount of money they 5 hold to pay claims, which came from the 6 policyholders, and have to, in developing their 7 rates, basically credit that amount back to 8 policyholders. 9 What's the net effect, policyholders pay 10 less premium because insurance companies are, as a 11 matter of law, required to recognize that. 12 MS. HARKEY: So, okay. 13 MR. DE LA MORA: This contract's no 14 different. 15 MS. HARKEY: Okay. So what you're saying 16 then is the investment income is already calculated 17 into the premiums. 18 MR. DE LA MORA: In fact, the formula that 19 we're talking about here includes a premium -- the 20 premium is calculated under a formula that includes 21 investment income as a factor. 22 MS. HARKEY: So they're -- 23 MR. DE LA MORA: We concede that. 24 MS. HARKEY: The -- the premiums are 25 decreased by the amount of the investment income. 26 And had the investment income not been there, it 27 would all be premium. 28 MR. DE LA MORA: Absolutely. Which is why 35 1 the law requires that the company recognize that. 2 And why, frankly, CHA negotiated for that, that when 3 you calculated the return premium at the end of the 4 day, they would get a piece of the investment income 5 over time. 6 I don't want anybody to leave, also, with 7 the impression that the company has paid out more 8 in -- just claiming more in premium tax credits than 9 they actually paid in premium taxes. It's the 10 $650 million swamps anything that's been claimed to 11 date. They're still -- they've still paid a lot 12 more. 13 MS. HARKEY: Thank you. That -- that 14 clarifies. Thank you. 15 I'm sorry. Did you want to respond? 16 MR. KOMJATHY, JR.: I just want to respond 17 on one thing. They keep talking about Prop 103 and 18 how this is -- and the discussion of it. 19 One, my understanding, this is all related 20 to premiums and policies written prior and concluded 21 before Prop 103 was even in effect. So I'm not sure 22 that this is even germane to our discussion here as 23 to on these particular policies that were issued 24 prior to Prop 103 and which were completed prior to 25 Prop 103 and were in a runoff, would be 26 applicable -- would be somehow -- 27 MS. HARKEY: Okay. But if they were 28 covered under Prop 103, you would agree with him? 36 1 MR. KOMJATHY, JR.: Well -- 2 MS. HARKEY: And we wouldn't be here, or -- 3 MR. KOMJATHY, JR.: I'm not sure because on 4 Prop 103 it's more it has to do with rate 5 regulation -- 6 MS. HARKEY: Okay. 7 MR. KOMJATHY, JR.: -- not on what is 8 premium tax, what is taxable as premium. It's all 9 about how are we going to determine what's an 10 appropriate reasonable rate -- 11 MS. HARKEY: Right. 12 MR. KOMJATHY, JR.: -- for tax -- for -- 13 MS. HARKEY: Right. And it should be -- it 14 should be -- 15 MR. KOMJATHY, JR.: That should be put into 16 the calculation. 17 MS. HARKEY: The premium less any 18 investment income so that it's all in the same. 19 So, this is pre Prop 103? 20 MR. DE LA MORA: It is, but the formula 21 that we used is exactly what Proposition 103 22 requires. And my point is that the inclusion of an 23 investment income component in credit to the 24 policyholder doesn't magically convert an insurance 25 policy into an investment contract. It's still an 26 insurance policy, and the amount you're paid is 27 still insurance premium even though there's an 28 investment component -- 37 1 MS. HARKEY: Right. 2 MR. DE LA MORA: -- used to determine that 3 premium. 4 MS. HARKEY: I have that. But -- okay. 5 Thank you. 6 MR. HORTON: Member Ma. 7 MS. MA: Okay. First off, I'd love to see 8 a copy of that letter from the Department of 9 Insurance. And it's relating to the first payment, 10 right, the $5.6 million -- 11 MR. DE LA MORA: I don't have -- 12 MS. MA: -- that was accepted? 13 MR. DE LA MORA: I don't have a copy of the 14 letter where the Department does that. It would 15 have just been included on our company's typical 16 premium tax return. 17 I would note that the Department has 18 stipulated that that, in fact, occurred today, so 19 it's not really an issue in dispute. 20 MS. MA: Okay. And so the 5.623 million is 21 in the same -- for the same purpose as the 22 45 million. 23 MR. DE LA MORA: The exact same purpose. 24 MS. MA: The underlying costs. 25 MR. DE LA MORA: It was paid after the 26 policy terminated and while the litigation was 27 pending, it was paid. And, in fact, it's referenced 28 by the court as being part of the settlement payment 38 1 even though it was voluntarily paid by Truck. And 2 we -- Truck did take a deduction for that. They 3 just, frankly, screwed up when they didn't take a 4 deduction for the 45 until 2003. 5 MS. MA: Okay. 6 So, to Appeals, I do have a question about 7 the Northwestern Mutual case. 8 MR. LEVINE: I thought I'd just be able to 9 sit here and get a good view, but -- 10 MS. MA: Okay. So, in that case, the 11 definition of return premiums, what is the 12 definition of return premiums? 13 MR. LEVINE: It's a return of the actual 14 premium, and it's for where the -- if a contract is 15 voided or if it's issued by mistake or if there's 16 fraud involved, and there may be another -- another 17 thing. It's not just as stated in the brief. 18 The D&R never says it's only for a voided 19 contract. It's for contracts that are issued by 20 mistake, which is why the D&R also explains why 21 certain price errors we would accept as a return 22 premium when they're refunded. 23 But basically, it's a refund of the actual 24 premium for the stated reasons, not a refund of 25 something else, like earnings, which are -- 26 I have a different view than Mr. De La Mora 27 about the business of an insurance company. All 28 insurance companies are financial companies because 39 1 they're earning money on their premiums. That's 2 part of the deal. That's part of the business of 3 insurance because they're building their -- their 4 inventory of money so they can pay claims, make 5 money, pay their costs. 6 So under the Constitution, all earnings for 7 investments are exempt. They're exempt from use 8 tax, they're exempt from most taxes except real 9 estate and a couple others. And that's why the 10 premium -- the deduction for return premiums is 11 limited to premiums. It's limited to the tax paid 12 premiums. If you refund the tax paid premiums, you 13 get to take a deduction against your next year's 14 taxable premiums. 15 MS. MA: Right. Okay. So the three that 16 you cited -- cancellations, otherwise voided, 17 mistakes or fraud -- are they classified as 18 unearned? 19 MR. LEVINE: Yes, unearned. 20 MS. MA: Unearned return premiums. 21 And is there another part of this 22 definition that says, "And which the company is 23 fully bound to return," under that case? 24 MR. LEVINE: I believe that that's the way 25 it's worded. 26 MS. MA: And what does that mean, "fully 27 bound to return"? 28 MR. LEVINE: I don't think we've really had 40 1 to test that. 2 If you cancel a three-year policy after two 3 years and the insurance company is bound to return 4 that third year's premium, then it's a return 5 premium. 6 If the insurance company could have given 7 you a good driver discount but didn't and discovers 8 it could have and they do, I suppose it could be 9 arguable whether they're bound to. But they refund 10 the money and the Department of Insurance is going 11 to accept that as a return premium. We certainly 12 would regard that as bound to return, bound to be 13 returned. 14 It's anything that's not earned that they 15 discover they should have refunded of the tax paid 16 premium. 17 MS. MA: So -- so the two amounts that they 18 received, the 5.6 million and the $45 million 19 payment, were they earned or unearned? 20 MR. LEVINE: I don't think that the record 21 establishes that any portion of that was from the 22 premium. 23 Was it earned? Again, it was a settlement 24 and the D&R kind of takes the best case scenario to 25 address each issue without resolving issues that 26 would be required if we were to have concluded that 27 some refund was allowable. So it doesn't address 28 every permutation. 41 1 So I don't necessarily think 45 million was 2 all for a breach of contract under the PDA because 3 it was a combined lawsuit even though the core of it 4 was the failure to refund. 5 Taking the best case, I'd say the 6 45 million was a refund -- a payment under the -- 7 required by the contract. But the question is, is 8 what was it a payment of? And the contract -- 9 I don't think you want me to give you a 10 long description of how premiums might be applied, 11 but they received 650 in premiums on which they pay 12 tax and they used a lot of those premiums to pay 13 claims. 14 I'm not sure what's normally the case, 15 whether they pay premiums -- use premiums to pay 16 claims before investment. But if -- if they were 17 using premiums to pay claims before they touched the 18 investment, and every year put the investment in an 19 investment -- an account that was earning 20 investment, earning interest or other money on the 21 investment and paying the premiums until it was 22 exhausted and then they made a payment back of the 23 excess investment, that would not be a return 24 premium because the premium has been exhausted. 25 If they had returned the actual premium and 26 traced it to the premium, we would have granted, but 27 they didn't. They've claimed, well, okay then use a 28 prorate. Because if you compare the total amount of 42 1 money that was available, which was the premiums and 2 the investment, and compare it to what we refunded, 3 then it would be 72 percent. So give us 72 percent 4 at least. 5 So that's the type of approach they've 6 taken. And we've said, well, you've got to trace it 7 to the premium. And we discussed that during the 8 appeals conference, trace it to the premium, which 9 was not done. 10 MS. MA: Okay. So -- so your opinion is 11 that some of it could be return premium based on 12 policyholders overpaying, and some of it is for 13 something else. 14 MR. LEVINE: Do I think in this case? No, 15 I don't. Do I think that's possible? Yes. 16 I don't think that the record here shows 17 that that was the case here. This money was 18 investment and that was the -- the court's decision. 19 The court decided the case in phases. And the first 20 phase, which I think was the only phase that was 21 actually tried, the court found that the record 22 showed that the parties, when they were negotiating 23 this deal, did not intend it to be premiums that 24 were being paid back. It was something in between, 25 something sui generis, and that was argued during 26 the appeals conference. 27 This is something different. This was a 28 unique contract. It wasn't like a classic 43 1 retrospective premium. It was something different 2 that they negotiated something unique and that we'd 3 never see it again. And that was discussed at the 4 conference, that we would never see this type of 5 situation again. It's unique. 6 And -- and that goes to the -- the talking 7 about it, the Complaint, that it was premiums, as 8 Mr. De La Mora says, it doesn't matter what they 9 called it; it matters what it is. 10 I think we'd all call this, if we were just 11 talking back and forth, we'd all call it premiums. 12 So would I. It's just easier. It's -- it's what 13 you would call it, but we need to decide what it is 14 for insurance tax purposes and that's something 15 different. 16 So it doesn't matter what they called it 17 during -- in the Complaint and what the judge said 18 at the end when he's resolving the settlement, which 19 is something completely different, as you probably 20 figured out. 21 MS. MA: Okay. So for insurance purposes, 22 insurance tax purposes, what are they allowed -- 23 what is a taxpayer allowed to deduct? 24 MR. LEVINE: Returned premiums and inter -- 25 contrary to implication in the briefs and the 26 argument, we never said in the D&R that they 27 can't -- that 1530, Insurance Code 1530 doesn't 28 apply. 44 1 This was an interinsurance exchange. And 2 the definition of gross premiums for interinsurance 3 exchanges, they have a special definition which 4 takes into account certain savings returned to 5 customers, which are very specific and discussed in 6 the D&R. 7 So if they had returned savings of 8 premium -- from premiums, that would be deductible 9 or return premiums. So if they traced this to 10 premiums and it was under the contract -- 11 MS. MA: Okay. 12 MR. LEVINE: -- it would be deductible. 13 MS. MA: And so you're saying that the 14 amounts were not traced back to premiums paid or any 15 of the earnings from the policyholders? 16 MR. LEVINE: Right. 17 MS. MA: And that's something else. 18 MR. LEVINE: Right. There's also the 19 complications of the lawsuit and what is that -- 20 that payment? Is it all for breach of contract or 21 is it for something else? 22 But if we assume it was an entire -- 23 entirely -- should have been paid without regard to 24 the lawsuit, the lawsuit shouldn't have been 25 necessary, that's what they should have paid, it 26 would have been deductible to the extent they could 27 trace it back to the premiums, tax paid premiums, 28 not the exempt investment income. 45 1 MS. MA: Okay. So then you also mentioned 2 $650 million that they've paid on, paid the gross 3 income tax on over the years. 4 MR. LEVINE: Correct. 5 MS. MA: So they have paid the tax on the 6 gross incomes. 7 MR. LEVINE: On the gross premiums. 8 MS. MA: On the gross premiums. 9 MR. LEVINE: They paid the insurance gross 10 premiums tax on their gross premiums. There's no 11 dispute -- 12 MS. MA: Right. 13 MR. LEVINE: -- about that. 14 MS. MA: And they can only get a deduction 15 on any of the gross premiums that they've paid tax 16 on. So they've paid tax on everything. 17 MR. LEVINE: Correct. 18 MS. MA: And now it's just trying to trace 19 back what the refund was for, or what the payment 20 was for, that 45 million, but not -- but we're not 21 talking about the other 5.6. 22 MR. LEVINE: Well, to the extent that 23 they've -- if there was any premiums that were 24 refunded, they took deductions. 25 When you look at the Northwest case and the 26 Mutual case, you have to -- the court took a 27 legalistic approach on payments of dividends and a 28 practical approach on crediting dividends against 46 1 premiums. So if you never have to pay it, it isn't 2 taxable. So if they have a cash payment -- so we 3 have that aspect. 4 When -- during the policy years, they were 5 required to make this credit and they deduct it from 6 the premium. It never became part of the premium. 7 They didn't pay tax on it. No argument about that. 8 After the policy ended in '89 and they 9 started having to make these payments that weren't 10 credits because there was no premiums coming in, 11 they -- my understanding is they had 230 million 12 that they paid and they took deductions for those. 13 So $236 million with the payment during the lawsuit, 14 that they took deductions of return premiums that 15 the Department of Insurance did not pick up in their 16 review of the returns. 17 So if there were any premiums that were 18 actually returned, that 236 million surely would 19 have used them up. And that's part of the reason 20 why we concluded that, even looking at it best case, 21 there's no tax paid premium that would have been 22 left to be refunded. Everything else was just the 23 investment earnings. 24 MS. MA: Is there a statute of limitations 25 for filing? 26 MR. LEVINE: Not -- 27 MS. MA: Why -- 28 MR. LEVINE: They -- there is, but they 47 1 made it. They -- they -- if this $45 million 2 deductible -- was deductible, it should have been 3 deducted on the 2000 return that was due, I think, 4 in April 2001. I think the claim was filed in 2003. 5 It's a four-year statute of limitation. So this has 6 been a long process, but the claim is valid for the 7 45 million. As far as -- 8 MS. MA: But they couldn't open up -- 9 MR. LEVINE: No. The 230 -- 10 MS. MA: The other -- another claim for the 11 5.6? 12 MR. LEVINE: No. Right or -- 13 MS. MA: So that's why they just -- 14 MR. LEVINE: Right or wrong, it's only 15 relevant to the extent of this "Did they use up 16 premiums or not?" 17 But no, the Department -- they -- no 18 further claims can be filed and no further 19 assessments can be issued. 20 MS. MA: Okay. I'm good for now. 21 MR. HORTON: Further discussion? 22 Member Runner. 23 MR. RUNNER: Yeah, let me -- I -- I'm 24 assuming that probably the taxpayer representative 25 might have a little different view on some of those 26 issues? 27 MR. DE LA MORA: Yes. In fact I -- I 28 wanted to respond to several of those points. 48 1 MR. RUNNER: Please do. 2 MR. DE LA MORA: You started with the quote 3 from Northwestern Mutual, and you asked, "Doesn't it 4 extend to monies that the company is bound to pay 5 back?" 6 And in fact in this case the company was 7 bound to pay back those monies because there was a 8 contract that required them to do so. That's number 9 one. 10 Number two, there was much discussion about 11 whether -- again, whether this is return premium. 12 And our view is it doesn't matter if it's return 13 premium, so long as it's either money paid back or 14 savings to the subscriber because of the special 15 statute that applies admittedly to interinsurance 16 exchanges. 17 So it is correct, as Mr. Levine pointed 18 out, that in the court below, when they were having 19 this fight, the court said, look, somewhere between 20 return premium and dividends this sui generis item 21 exists. It doesn't matter at the end of the day 22 because both types, return premiums and dividends, 23 are deductible from gross premium. How do we know 24 that? The Department of Insurance's own form, the 25 top line deduction is "Take out your dividends 26 before you calculate your gross premiums." 27 It's also the deductibility of dividends 28 and funds that are just returned to subscribers for 49 1 interinsurance exchanges as affirmed by the two 2 cases we cited, Industrial Indemnity Insurance 3 Exchange; that was a refund of distributable 4 surplus. Nobody tried to call it a return premium. 5 It was just this, again, a sui generis item that was 6 returned by an exchange of the subscribers. That 7 was found deductible to the extent actually given to 8 the subscribers. And CSAA, the second case, was a 9 case involving a dividend. 10 So we know there's lots of different things 11 that are entitled to deduction besides those -- 12 the -- the return premium item. And, again, by 13 focusing solely on the return premium argument, the 14 Departments are ignoring that fact. 15 Lastly, there was an indication that -- and 16 it's factually incorrect to say that the company 17 collected $650 million and deducted $230 million, 18 and then there was an additional five and now we're 19 seeking 45. That's just factually incorrect. 20 While the policy was in effect prior to 21 1989, all the credits that were due under the 22 Premium Determination Agreement were applied to 23 reduce future premiums. So they were netted out. 24 So instead of paying a dollar for your premium, you 25 would only pay 90 cents for that premium if you were 26 the policyholder in this case. 27 So the $650 million that Truck recognized 28 is a hard number. $650 million because it takes 50 1 into account all those credits, that's what Truck 2 paid tax on. Truck has not received premium credits 3 to that extent. 4 Second, the $5.6 million is different 5 because that was paid after the policy terminated 6 and was actually money that Truck paid as a refund 7 of program surplus or excess premium, however you 8 characterize it. What it was required to be paid 9 under the Premium Determination Agreement, Truck 10 actually wrote a check for that amount, delivered it 11 to CHA and claimed a deduction against its gross 12 premiums. That is a hard number, as is the 13 $45 million. The rest were just credits against 14 future premiums, and so they were -- there was no 15 separate line item deduction taken for those. 16 Lastly, there's -- again, we -- we keep 17 getting hung up on this, that somehow Truck has got 18 to show you that the money that was paid to these 19 folks, the $45 million came from premium as opposed 20 to investment income on the premium earned. 21 You know, money's fungible. And I don't 22 know about your bank account or my bank account. 23 But my checking account, I write a check, I don't 24 know whether that check came from my investment 25 earnings. I don't know whether the money I paid 26 came from my salary. I don't know where it came 27 from. 28 What matters -- my expense reports, I don't 51 1 know where it came from. What matters is I've had 2 to pay out money to that person and it's because of 3 the essential characteristic of money which is 4 fungible. It goes into the general accounts. 5 They're asking Truck to perform an 6 impossible task, trace the dollars that were paid 7 back, the hard dollars paid back to CHA to 8 investment income, 200-and-some-odd-million dollars 9 earned over the course of the agreement, or premium, 10 $650 million over the course of the agreement. It's 11 just impossible to do because money's fungible. 12 What we did do, and we don't think it's 13 correct because, for the many reasons stated, we did 14 give you a breakdown of 72 percent of this money was 15 attributable to premium. If you just want to have 16 a -- you know, take a meat cleaver to it and say 17 "Well, fine, we'll treat it all -- we'll just do an 18 even distribution," that's at the most fair you're 19 going to be because of the character of money. So 20 we did that as well. 21 The last thing I would note that there's an 22 Insurance Code provision, section 1420. And we 23 talked a lot about savings and whether or not Truck 24 is even entitled at all to claim a deduction for 25 savings to the extent they were paid to the 26 policyholder -- everybody admits the policyholders 27 got money back here -- whether Truck can take the 28 deduction because some piece of it is attributable 52 1 to investment income. 2 Well, section 1420 says that when an 3 insurance exchange pays savings, which is the exact 4 same term that we're allowed to disallow under the 5 Insurance Code 1530 and Revenue and Taxation Code, 6 they are payable, quote, "irrespective of the 7 source," end quote. In other words, they can come 8 from investment income or whatever, it does not 9 matter. We're not assigned with a duty to trace it 10 to any particular source. 11 So, again, even if you take the 12 Department's position, you know, at its word which 13 is it's sui generis somewhere between dividends and 14 somewhere between return premium, and maybe it 15 includes investment income, it just doesn't matter 16 because the legal standards that apply to my client, 17 which is unique, are different. 18 Thank you. 19 MR. RUNNER: Let me just follow up on a 20 couple -- I guess I'm trying to figure out in kind 21 of its simplest form. 22 You -- you -- you've got an insurance 23 company and you've got a hospital association. They 24 go into a contract for some insurance coverage. In 25 that contract it says that under certain -- under a 26 certain amount of time there will be certain 27 returns. The hospital association all of a sudden 28 feels like the contract was not honored and, 53 1 therefore, they did not get all their returns. And 2 then they've got to go down this path to try to 3 recover from the insurance company what they believe 4 is their return on their premium. 5 Okay. If indeed the insurance company 6 would have just agreed to the numbers or -- or came 7 to the same place the insurance -- the hospital 8 association came with, this $45 million would have 9 been correctly deductible for them, correct, if it 10 was during -- held during the time without the court 11 case? It would have been returned to premium. 12 MR. SMITH: I don't think so. 13 MR. KOMJATHY, JR.: I don't think so. 14 MR. RUNNER: Oh. 15 MR. KOMJATHY, JR.: The reason why is that 16 this isn't the return of premium. Again, you're 17 referring to premium. 18 He talks about it as being it's everything 19 fungible. However, the contract that was entered 20 into between the hospital and Truck -- 21 MR. RUNNER: Right. 22 MR. KOMJATHY, JR.: -- they wanted it not 23 to be any premium coming back to 'em. So they 24 didn't want earned premium coming back to 'em. 25 Truck understood this and they formed this contract 26 on that basis. And one of the documents that -- 27 MR. RUNNER: So hold on, let me get -- let 28 me go back to the taxpayer then. 54 1 How would -- if indeed, um -- how would you 2 have felt -- or I guess at this point I'm trying to 3 get -- see how to get through this question. 4 How would you characterize what you -- 5 what -- what Truck would have paid if -- to avoid 6 any dispute and it going to court? 7 MR. DE LA MORA: You know, I'm not sure I 8 could have given all the different arguments I've 9 heard from the Board at this point. But -- but what 10 I would have simply said was for premium tax 11 purposes, this shall be treated as return premium. 12 However, for all other purposes, including 13 calculation of expenses, it shall not be considered 14 premium. And perhaps that would have avoided this 15 whole dispute. But that's -- that's where we are. 16 I -- I -- again, we don't think it matters, 17 for an exchange, how you characterize it. It's 18 stipulated among every single person sitting here 19 that Truck gave $45 million to the CHA -- 20 MR. RUNNER: Uh-huh. 21 MR. DE LA MORA: -- to settle CHA's claim 22 for excess premiums under the Premium Determination 23 Agreement. That's stipulated. 24 MR. RUNNER: Okay. Let -- that's good. 25 I'll use that -- let me use that word then. 26 MR. DE LA MORA: Then it gets 27 complicated. 28 MR. RUNNER: Let me -- let me use that 55 1 word. It was excess premium. It was to much 2 premium that was being charged. 3 So let me just say, if the amount of 4 premium was indeed not excess, I guess, at that 5 point and it was determined it would be the right 6 amount of premium, then they would have been able 7 then to deduct it correctly. 8 MR. KOMJATHY, JR.: If in fact it was -- 9 MR. RUNNER: Okay. 10 MR. KOMJATHY, JR.: -- premium. 11 MR. RUNNER: Okay. So then there's 12 dispute. Goes to court. 13 Was there -- was there language that could 14 have been preserved in order to help Truck if the -- 15 if the -- if the lawsuit was worded differently or 16 if the -- that would have preserved this amount of 17 money that was going back to -- to the hospital 18 association, to allow them to have this deduction, 19 in your opinion? 20 MR. KOMJATHY, JR.: Unfortunately, I 21 didn't -- you know, I didn't -- I'm not involved in 22 the underlying -- 23 MR. RUNNER: Yeah. 24 MR. KOMJATHY, JR.: -- when they were 25 negotiating the contract. 26 MR. RUNNER: Right. 27 MR. KOMJATHY, JR.: But what I do know from 28 the testimony that was given in the trial, they did 56 1 not want any earned premium back. It is only 2 investment income. 3 And, in fact, counsel -- one of their 4 counsel for Truck during the -- when they were doing 5 these findings of facts in the federal court trial, 6 their counsel put out and in the Defendant's 7 proposed annotated findings and conclusions they 8 made a point in saying in their view the program 9 surplus under the PDA is neither premium nor return 10 premium for purposes of statutory accounting 11 principles, statutory accounting requirements, or 12 California Insurance Code section 11552. 13 MR. RUNNER: And whose statement is this? 14 I'm sorry. 15 MR. KOMJATHY, JR.: This is one of the 16 counsel for Truck during the trial -- after the 17 initial trial and the court was doing their 18 initial -- their findings of fact -- 19 MR. RUNNER: Mm-hmm. 20 MR. KOMJATHY, JR.: -- and conclusions of 21 law. 22 Since I wasn't there, but I presume that 23 the court released the proposed findings of facts 24 and so counsel had an opportunity to annotate it and 25 explain why they think what is correct or incorrect 26 in the findings. And this was submitted as part of 27 their record. And that was Truck's attorney making 28 that statement. Not this particular attorney. 57 1 MR. RUNNER: Right. 2 MR. KOMJATHY, JR.: But during that trial, 3 they were saying, "Ah, this is not premium and not 4 return premium," which is the program surplus. 5 The issue was, is how much -- I think the 6 hospital, they're looking at, "We think we didn't 7 get enough money back under the contract." 8 MR. RUNNER: Right. 9 MR. KOMJATHY, JR.: Okay. We don't -- we 10 want back investment. We want our investment income 11 because that's what they talked about -- 12 MR. RUNNER: Mm-hmm. 13 MR. KOMJATHY, JR.: -- is that we're 14 interested in that for various purposes. This is 15 the way we want it. As they say, it was a very 16 unique contract. 17 So, they are -- they're saying, okay, how 18 can we get into federal court because we think we 19 have extra leverage with the RICO. 20 MR. RUNNER: Right. 21 MR. KOMJATHY, JR.: We now recategorize, 22 ten years later, after the contract was incepted 23 that oh, no, we were really trying to get -- this is 24 all earned premium that we were entitled to get back 25 and they did not give it back to us. 26 During the trial it comes out, and the 27 court finally determines, is that this was not -- 28 this is not premium. This is not a question -- 58 1 earned premium is what it was and they found that it 2 was not one of these retro policies. And they also 3 bought into the idea that it wasn't earned premium 4 that they're entitled to get back. 5 MR. RUNNER: Okay. Let me go right here. 6 MR. KWEE: May -- if I may just make a 7 quick clarification because there's a lot of 8 emphasis on the title of Premium Determination 9 Agreement. And just to clarify, this agreement did 10 deal with premiums coming in, but what we're looking 11 at here was a specific piece of the agreement; and 12 that is, what happens after termination of the 13 agreement. 14 So the agreement -- we have this Premium 15 Determination Agreement. Then we had the 16 termination of their policy. Then we had five years 17 lapse. And then we started to have the return of 18 the excess investment income. And we're only 19 looking at that specific portion of the agreement 20 which dealt with how to refund that specific count 21 which was the program surplus. 22 So, just the title of the agreement isn't 23 necessarily relevant to what we're looking at here 24 which is how to -- how to -- not return, but how to 25 pay off the investment earnings that were generated 26 through the program premium amounts. 27 And here we have the testimony that the 28 whole purpose of this agreement was to basically use 59 1 premium to pay for the losses which was tax 2 advantageous for them, and then get back the 3 investment interest because that was the best way 4 that would work for them. And that's why we're here 5 today. 6 MR. RUNNER: Let me go back to the taxpayer 7 real quick on that issue in regards to, again, the 8 issue of the -- the investment credit versus the 9 issue of the earned premium. 10 MR. DE LA MORA: If you look in the 11 Complaint that CHA filed, if you look in the 12 documents that the district court issued, Judge 13 Straub, not once do they mention investment income. 14 What we continually hear -- in fact, the PDA doesn't 15 even talk about returning investment income; it 16 talks about returning program surplus. What we keep 17 hearing today is -- 18 MR. RUNNER: Let me -- and just for the 19 sake of the discussion, and program surplus then -- 20 MR. DE LA MORA: Is defined by a formula 21 which includes -- 22 MR. RUNNER: Which includes -- which would 23 be? 24 MR. DE LA MORA: Which includes premium, 25 investment income, less claims paid and 26 administrative expenses. 27 MR. RUNNER: Which is deductible. 28 MR. RUNNER: Which is deductible. 60 1 MR. RUNNER: Okay. 2 MR. DE LA MORA: The entire discussion of 3 investment income and desire relates to the 4 testimony of one California Hospital Association 5 executive. So what? That doesn't bind us. That 6 testimony made by that executive in the course of 7 litigation concerning what the term premium means 8 for purposes of calculating administrative expenses 9 tells us nothing about what's going on here today. 10 But what the judge actually ruled at the end of the 11 day was that the settlement represents, quote, "the 12 exact amount of unreturned premiums alleged in the 13 Complaint," end quote. 14 And he didn't just stop there. The judge 15 went on to order that when it came time to 16 distribute that $45 million to the CH pol -- CHA 17 policyholders, how did he do it? In direct 18 proportion to the amount of premium they paid. 19 So every decision that that judge made was 20 by reference to premium, not by reference to 21 investment income. The Premium Determination 22 Agreement doesn't talk about investment income. 23 But, again, under the statutes we've cited, even if 24 it did for interinsurance exchanges, that wouldn't 25 matter because savings are payable from any source. 26 So, this discussion is -- again, I'm a 27 little just shocked that it comes based on the 28 testimony of one CHA executive primarily, but that's 61 1 where we are at this point in time. 2 This is not a complex transaction. You pay 3 premium in. If your claims history is good, you get 4 money back. That's your refund. You, as a 5 policyholder, look at that and say my cost of 6 insurance, my premium, is the amount I paid in less 7 the amount I got back. That's what -- that's what 8 this case is ultimately about on the easiest to 9 understand level. We get wrapped around -- 10 MR. RUNNER: Why -- why isn't this just 11 about the fact that they believe that they overpaid 12 their premium? 13 MR. KWEE: And that's also because the 14 Supreme Court also had said that Insurance Code 15 1530, which is the one he was referring -- Claimant 16 is referring to, is the Supreme Court said that must 17 be harmonized with the California Constitution. And 18 it -- and the Supreme Court explained that to render 19 any amounts paid by -- paid by the subscribers as 20 a -- to render any portion of that amount as 21 nontaxable, it should appear that such portion of 22 the sums paid was in effect not a part of the 23 necessary premium or stated amount paid. 24 So, again -- and going back to the statute, 25 it uses the word return, so that's why -- because 26 the Supreme Court and because the Insurance Codes 27 both used -- used the word "return," there has to be 28 some component that this amount was first taxed and 62 1 is later being returned, because otherwise you'd be 2 claiming a deduction for amounts which could 3 potentially exceed even the amount that you ever 4 paid tax on, on the premium. 5 MR. RUNNER: One quick thing. Again, part 6 of the issue of this settlement for approval, 7 there's language in there that says, "The actual 8 distribution of each hospital will be based upon the 9 ration of premium paid by the hospital to the total 10 premium paid." 11 That sounds like a pretty direct 12 correlation then to the issue going back to 13 premium. 14 MR. KWEE: Yes, but that account consisted 15 primarily of investment earnings. 16 MR. RUNNER: But it's going back for the 17 amount of premium that they overpaid. 18 MR. KWEE: And I believe the reason for 19 that is because, for example, you have 626 -- I 20 believe, 626 hospitals and then each one is putting 21 money in at a random amount and to determine how 22 much investment earnings they're entitled to, you 23 have to come up with some allocation relative to how 24 much they paid. But this is amount is what 25 investment earnings were generated. It's not about 26 what they were paid. So then they're just basically 27 returning the investment earnings. They're paying 28 investment earnings, but the investment earnings 63 1 does not make it premium, basically. 2 MR. RUNNER: Okay. And you would dispute 3 the issue of investment earnings versus the other 4 language? 5 MR. DE LA MORA: I -- I've disputed it, 6 yes. 7 MR. RUNNER: Okay. Thank you. 8 MR. HORTON: Member Harkey. 9 MS. HARKEY: Okay. Let me just explain 10 that the circle I am having trouble squaring is 11 section 1530 of the Insurance Code states that for 12 the purposes of section 12221 of the Revenue and Tax 13 Code, the term "gross premiums" as applied to 14 reciprocal or interinsurance exchanges includes all 15 sums paid by subscribers in the state by reason of 16 the insurance exchange, whether termed premium 17 deposit, membership fee or otherwise after deducting 18 there from premium deposit returns or cancellations 19 and all amounts returned to subscribers credited to 20 their account in savings. 21 It's then followed up by Insurance Code 22 1420. It's -- it defines "savings" as the savings 23 or credits may be returned to the subscribers 24 irrespective of the source for which said savings or 25 credits accrue whenever such returns do not 26 constitute an impairment of the assets or reserves 27 required to be maintained. 28 So the plain language of that section seems 64 1 to eliminate the argument that investment earnings 2 can't be considered savings for purpose of excluding 3 returns. 4 I've -- I've got -- I've just got a problem 5 because I think we're looking at -- we're looking at 6 the Constitution to be sure that the premiums were 7 paid. And since it's older, the premiums we have 8 to -- or not the premiums -- the taxes were paid. 9 And since this is 1989 and there on, you know, if 10 the taxes weren't paid, then we'd be having more 11 issue with this company. So I have to assume that 12 those taxes were paid on the premiums. 13 Okay. So, then -- so that takes care of 14 that issue because they'd have been wiped out or out 15 of business long before that. 16 So then we've got section 1530 and section 17 1420 which kind of indicate it really doesn't matter 18 what they're returning because they're an 19 interinsurance exchange. 20 MR. KWEE: Right. And 1420 does use the 21 word "return." And I guess we were looking at that 22 in context of the Supreme Court case, which had 23 stated that investment earnings were not eligible 24 for a deduction and later -- and that was the -- the 25 Northwestern Mutual. 26 MS. HARKEY: Yeah, but this is an 27 interinsurance exchange -- 28 MR. KWEE: Right. 65 1 MS. HARKEY: -- that is -- it doesn't 2 matter where they get their money from. That's 3 section 1530 says it's to be treated just like a 4 premium. 5 MR. KWEE: And the Industrial Indemnity 6 case, the Supreme Court also stated that 1530 has to 7 be harmonized with the California Constitution. 8 MS. HARKEY: Yeah, and you said the 9 California Constitution required the payment of the 10 taxes on the premiums in order to be refunded. So 11 we got rid of that because they did pay, or else 12 they'd have been in jail, locked up or gone, long 13 gone before -- before we sit here today, if they 14 hadn't paid for 1989 and going forward. 15 So that's kind of a moot issue. I believe 16 that they paid, otherwise we -- you know, you 17 wouldn't be sitting here. They wouldn't be in 18 business, from 1989. 19 So it is section 1530 we're looking at and 20 section 1420, because the Constitution's been -- 21 that's where -- that circle's been squared. So it's 22 just these two that, I can't -- I can't agree with 23 you on because these two sections of the Insurance 24 Code seem to -- seem to be very, very clear that it 25 really doesn't matter as to what they're returning. 26 And the -- the argument that the taxpayer is making 27 with regard to what the judge actually ruled or said 28 seems to -- I mean it's -- it's nice to hear, but I 66 1 think these two Insurance Code kind of trump. 2 Unless they really didn't pay -- if they didn't pay 3 taxes on the premiums in 1989 and going forward. 4 Thank you. 5 MR. HORTON: Mr. Levine. 6 MR. LEVINE: Did you want -- want me to 7 answer one of those general questions? 8 MR. HORTON: Yes. 9 MR. LEVINE: I will point out that 10 Mr. De La Mora is talking about advanced premiums as 11 if there's something different here. 12 Every insurance policy I've ever paid for 13 was an advance payment of premiums. This is just a 14 payment to premiums. All premiums are paid in 15 advance of the insurance company assuming the risk. 16 As far as the savings, I think I agree with 17 you. The problem is that you have to look at how 18 that fits into context of the Insurance Code. And 19 those savings are discretionary savings returned to 20 the inter -- to the subscribers of the 21 interinsurance exchange. That's what 1420 says, 22 when they make a determination that it doesn't 23 impair the integrity of the insurance. 24 MS. HARKEY: The reserves. 25 MR. LEVINE: This is -- this payment was a 26 payment that Claimant is arguing was made because it 27 was required by contract. If it was required by 28 contract, it was required to be paid whether it 67 1 impaired the integrity of the funds of the 2 interinsurance exchange or not. They don't -- you 3 don't have a right to withhold payment that you're 4 required to make on a breach of -- under a contract 5 because it might impair your -- your funds. You 6 might withhold it and risk a lawsuit. But -- 7 MS. HARKEY: So what you're saying is 8 you're adding another dimension to this that it -- 9 it may have been part of their reserves? 10 MR. LEVINE: No. What I'm saying is that, 11 based on Claimant's argument that this was a payment 12 required by the contract, they need to show it 13 qualified for the return premium deduction and not 14 the savings provision, which is a provision that the 15 court has said cannot be required by a subscriber. 16 A subscriber can't sue the interinsurance 17 exchange and mandate that it make a refund of 18 savings. That's what the Lee decision says. 19 So, the 1420 requires a discretionary 20 decision by persons in authority in the 21 interinsurance exchange, that it can afford to make 22 the payment. So it's a discretionary decision to 23 make a payment. And if such a payment is made, I 24 think it probably is deductible from gross premiums. 25 It's a different calculation because it comes up 26 above the line rather than below the line, and -- 27 MS. HARKEY: Yeah, we're kind of getting 28 into the weeds. But what I'm saying is that then 68 1 section 1530 -- 2 MR. LEVINE: -- doesn't apply here. 3 MS. HARKEY: It has to apply here. Were 4 they not an interinsurance exchange? 5 MR. LEVINE: Yes, they definitely were. 6 MS. HARKEY: Okay. 7 MR. LEVINE: The question is whether -- 8 MS. HARKEY: Then it has to apply here. I 9 don't see how it doesn't. 10 MR. LEVINE: Well, it does apply to any 11 savings that this interinsurance exchange gives to 12 its members under the requirements of the Insurance 13 Code. And Insurance Code 1420 requires a 14 discretionary decision. 15 MS. HARKEY: Okay. So what -- what amount 16 would you ace out, other than a hundred percent, as 17 not being part what they could return? I mean, do 18 you have a number? 19 MR. LEVINE: Zero. They did not make any 20 discretionary decision. They are saying that they 21 made this payment because the contract required it. 22 And I agree that's the only theory besides the 23 other -- 24 MS. HARKEY: They -- they made -- they made 25 a discretionary decision to settle at this amount, 26 and that's a settlement. That's not a -- that's not 27 a -- it's -- it's not a -- it was not a -- a -- a 28 normal course of business, but it was still a 69 1 discretionary decision to settle at the amount. And 2 so the amount be that CHA didn't want return of 3 premium to be stated in the document simply because 4 if they returned a premium then CHA would have to 5 figure out how to return all of the money back to 6 Medicare, Medi-Cal and others, I think was probably 7 the reason. It got too complex that way. 8 And so, I'm just -- I'm having trouble 9 because Insurance Code 1530 states that it really 10 doesn't matter what it is. And as long as they paid 11 the taxes on the premium, that -- that squares the 12 circle for the court referring it to -- to the 13 California Constitution. So then we're just down to 14 the Insurance Codes. And I think we're getting 15 really lost in this because it's -- it's -- it's the 16 Insurance Codes. 17 So I'm -- I'm through. But I appreciate 18 your explanation, but I'm just trying to dig in 19 here. If we had some lesser amount that we could 20 carve out, but I don't know how we'd do that at this 21 point. 22 Yes? 23 MR. DE LA MORA: If I may -- 24 MS. HARKEY: Sure. 25 MR. DE LA MORA: -- just follow on, on 26 that. 27 Again, when we were talking about the 28 Northwestern case earlier, there was a notation in 70 1 that case that something is return premium if you're 2 compelled to repay it under your contract. So we've 3 argued, frankly, we were compelled to make this 4 payment under the contract and, therefore, it's 5 return premium. 6 But at the end of the day, our core 7 argument remains section 1530 and 1420, which is the 8 form of the payment just doesn't matter as long as 9 it's savings to the subscriber. And savings are 10 payable regardless of source. 11 So I -- I think that you've perceived the 12 argument correctly, although we also believe it's 13 return premium frankly. But under any way you slice 14 this -- and it's almost like whack-a-mole; we're 15 constantly responding to different characterizations 16 of what we've done to fit a legal framework. But 17 the reality is, however you slice this, premium was 18 taken in, premium refunds were paid back, we're 19 entitled to deduct that. 20 MS. HARKEY: Thank you. 21 MR. HORTON: Member Ma. 22 MS. MA: I have a question. So, how much 23 of the $45 million was actually returned to 24 subscribers versus litigation costs? 25 MR. DE LA MORA: We submitted an additional 26 brief, and I just -- it's in the record. I don't 27 know the exact number. 28 But effectively, after Farmers was out of 71 1 the case, the subscribers received all but, I 2 believe, $13 million or thereabouts. But the 3 numbers are actually in the record. We're not even 4 being given credit for that piece, but let me just 5 say this about that. 6 The settlement agreement provides that CHA 7 is responsible for its own attorney's fees. That's 8 just the standard American rule of law. Unless you 9 have a contractual or to statutory right to have 10 your attorney's fees paid by the other party, the 11 money you spend pursuing your legal claim -- in this 12 case a legal claim for $50 million of unreturned 13 premium is your own responsibility. 14 So we would argue that the fees and costs 15 that they expended to recover this money is their 16 own deal and does not result in a reduction of our 17 entitlement to claim a refund for the money we paid 18 back in response to their claim for unreturned 19 premium. 20 MS. MA: Okay. Maybe to the Department. 21 How much actually got -- went back to the 22 subscribers? 23 MR. KWEE: Just to clarify, 15.8 million 24 was deducted and paid for attorney's fees and costs. 25 And that was -- and that was before any amount was 26 re -- was paid to the subscribers pursuant to the 27 class action account. 28 And I'd also like to clarify that the RICO 72 1 Act would have statutorily imposed the attorneys 2 fees and costs on the Claimants. And, in addition, 3 we have the Industrial Indemnity case. And in the 4 that case the Supreme Court had found that a five 5 percent compensation paid to an attorney in fact -- 6 it was not a savings or -- it was not a savings, 7 dividend or credit because basically that amount 8 went to the attorney and the subscriber didn't 9 actually get any portion of that amount. So it 10 couldn't have been really a savings or a credit to 11 him because he didn't even -- he didn't even receive 12 it. 13 MR. DE LA MORA: May I -- 14 MS. MA: Okay. So that was a long -- a 15 long response. And as I understand, the RICO Act 16 didn't really apply in the end anyway. So just how 17 much went to the subscriber? 18 MR. KWEE: Basically the $45 million, less 19 the 15.8 million in attorney's fees and costs. 20 MR. RUNNER: That's 15.8. 21 MS. MA: Less 15 what? 22 MR. KWEE: 15.8 million in attorney's fees 23 and costs. I'm rounding. 24 MR. RUNNER: I have 12 point (inaudible) -- 25 MR. DE LA MORA: It sounds about right. 26 Again, it's in the record. We gave you the orders. 27 I would just note, in terms of the fees and 28 costs, the court did not find that Truck was 73 1 responsible for any attorney's fees. In fact, it 2 approved a settlement agreement that said CHA was 3 responsible for its own attorney's fees. 4 So you're correct, there was no RICO 5 finding and there was no finding that Truck was 6 responsible to pay any attorney's fees. 7 MS. MA: Right. Right, but I understand. 8 I mean, if we're talking about filing an amended 9 return or a return in general under the Insurance 10 Code -- I'm not an expert either, so please, you 11 know, correct me if I'm wrong. A company reports 12 gross premiums. They're allowed a deduction for 13 dividends and allowed a deduction for premiums 14 returned to subscribers. 15 Is that my understanding, or is it -- 16 because this is a settlement. So it's technically 17 not -- it wasn't done willingly, voluntarily, you 18 know, timely, by the taxpayer's back. Because 19 otherwise we wouldn't be here, right? If they had 20 paid $45 million back, I mean they would have been 21 entitled to the deduc -- the deduction on the tax 22 return. 23 But now because it's a settlement, I kind 24 of see it a little bit differently. I don't know 25 how much is a return premium. Which, if we're going 26 just based on the raw numbers, $45 million less 15.8 27 actually did go back to the return -- return back to 28 the taxpayers. Therefore, kind of in my mind, that 74 1 would be the amount that they would be allowed a 2 deduction for on their amended return. But am I 3 wrong? 4 MR. LEVINE: About -- I don't want to speak 5 for the Department's returns. They're not the way I 6 would design them. 7 MS. MA: Okay. Maybe I can ask them. 8 Sorry. 9 Department of Insurance. 10 MR. KOMJATHY, JR.: Yes. 11 MS. MA: They're filing an amended return. 12 MR. KOMJATHY, JR.: Yes. 13 MS. MA: So now they're filing an amended 14 return for what they deem is returned premiums, 15 excess premiums paid by policyholders that they owe 16 to the policyholders that they actually gave them. 17 Would it be reasonable to allow them the 18 deduction for the $45 million settlement that they 19 received, less the 15.8 attorney's fees that they 20 had to incur, and the remainder is, what, 21 $30 million is actually what they returned to the 22 policyholders, which is what they can claim a 23 deduction for on their insurance gross premiums tax 24 return. 25 MS. HARKEY: In a normal circumstance. 26 MS. MA: In a normal circumstance. 27 MR. KOMJATHY, JR.: Under the assumption 28 that it is in fact return premium, I would have to 75 1 agree with you. But it was never categorized as 2 returned premium by the parties to the contract, 3 underlying the contract and for the policies that 4 were purchased. 5 They could have all the time -- from the 6 very beginning they had the ability to track 7 payments out of the premium box and the money that 8 was put aside each year as to the investment income. 9 MS. MA: I get it, but -- 10 MR. KOMJATHY, JR.: But here if it -- 11 MS. MA: But they returned the premiums. 12 MR. KOMJATHY, JR.: It's if returned -- 13 MS. MA: They returned it. 14 MR. KOMJATHY, JR.: If it's returned 15 premium, if it is in fact returned premium, they 16 would be entitled to the deduction. 17 MS. MA: Okay. 18 MR. HORTON: Further discussion, Members? 19 Member Runner? 20 Hearing none, is there a motion? 21 MR. RUNNER: I would move -- 22 Oh, actually, let me just -- before I make 23 a motion, I'd like to clarify. 24 I have in the settlement a number of 12 25 thousand -- 12,655,000 and some change. What 26 number -- and then we went to fifteen eight in 27 costs. 28 MR. DE LA MORA: Counsel's including costs 76 1 as well in that. 2 MR. KWEE: That's correct, attorney's fees 3 and costs. 4 MR. RUNNER: Attorneys and costs. Okay. 5 Then my motion would be to find for the 6 taxpayer net of the tax -- of the attorney fees and 7 costs. 8 MS. HARKEY: I will second. 9 MR. HORTON: There's a motion on the floor, 10 second by Member Harkey. 11 Discussion, Members? 12 Ms. Richmond, please call the roll. 13 MS. RICHMOND: Mr. Horton. 14 MR. HORTON: No. 15 MS. RICHMOND: Ms. Harkey. 16 MS. HARKEY: Aye. 17 MS. RICHMOND: Mr. Runner. 18 MR. RUNNER: Aye. 19 MS. RICHMOND: Ms. Ma. 20 MS. MA: Aye. 21 MS. RICHMOND: Motion carries. 22 MR. HORTON: Thank -- 23 MR. RUNNER: One quick discussion on this. 24 Is this a -- is this a Section 40 case? 25 MR. LEVINE: Yes, it is. 26 MR. RUNNER: I'd like at least the option, 27 when this comes back to us, to review this in 28 regards to a formal decision. 77 1 MR. LEVINE: Okay. 2 MR. RUNNER: Thank you. 3 MR. LEVINE: This is supposed -- supposedly 4 unique. We're never going to see it again. 5 MR. RUNNER: Yeah, okay. You guys can tell 6 us that when you bring it back. 7 MR. LEVINE: I only know what I've been 8 told. 9 MR. RUNNER: You can tell us that when you 10 get back, then we won't need to. 11 MR. DE LA MORA: Thank you, Mr. Chairman. 12 Thank you, Board. 13 MR. HORTON: Thank you very much for 14 appearing before us. The Board will send you a 15 written report of our decision. 16 ---oOo--- 17 18 19 20 21 22 23 24 25 26 27 28 78 1 REPORTER'S CERTIFICATE 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, KATHLEEN SKIDGEL, Hearing Reporter for 8 the California State Board of Equalization certify 9 that on June 25, 2015 I recorded verbatim, in 10 shorthand, to the best of my ability, the 11 proceedings in the above-entitled hearing; that I 12 transcribed the shorthand writing into typewriting; 13 and that the preceding pages 1 through 78 constitute 14 a complete and accurate transcription of the 15 shorthand writing. 16 17 Dated: July 21, 2015 18 19 20 ____________________________ 21 KATHLEEN SKIDGEL, CSR #9039 22 Hearing Reporter 23 24 25 26 27 28 79