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United States Court of Appeals
Fifth Circuit
F I L E D
April 16, 2003
UNITED STATES COURT OF APPEALS
Charles R. Fulbruge III
Clerk
for the Fifth Circuit

NO. 02-60188

BLUE CROSS AND BLUE SHIELD OF TEXAS, INC. AND SUBSIDIARIES,
Petitioner-Appellant,
VERSUS
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.

Appeal from the Decision of the United States Tax Court

Before DeMOSS and STEWART, Circuit Judges, and FALLON,1 District Judge.
FALLON, District Judge:
Before the Court is the appeal of the Tax Court's decision against appellant Blue Cross
and Blue Shield of Texas, Inc. and Subsidiaries. The issues in this appeal require resolution of
whether certain amounts referred to as "coordination of benefits savings" ("COB savings") qualify
as "estimated salvage recoverable" such that Blue Cross can claim a special tax deduction, and, if
not, whether Blue Cross met requirements to fall under a safe harbor provision entitling it to the
1 District Judge for the Eastern District of Louisiana, sitting by designation.

deduction. The special deduction at issue allowed insurance companies to deduct ratably over a
four year period 87% of estimated salvage recoverable as calculated at the end of tax year 1989.
Blue Cross claimed the deduction for years 1992 and 1993 based on an amount of "salvage
recoverable" that consisted mostly of COB savings and, the IRS subsequently denied the
deduction after an audit. Blue Cross challenged the IRS' position denying the deduction. The Tax
Court held that both Medicare related and non-Medicare related COB savings amounts did not
qualify as estimated salvage recoverable so as to be the basis for a special deduction.
Additionally, the Tax Court held that Blue Cross did not meet the requirements to fall under the
safe harbor provision. For the reasons set forth below, we AFIIRM the decision of the Tax
Court.
BACKGROUND
From 1989 through 1993, Blue Cross and Blue Shield of Texas, Inc. (hereinafter "Blue
Cross") was a Texas corporation engaged in the business of providing health insurance and
related administrative services to individuals and groups. With regard to the group insurance
contracts issued to employers, in some cases, Blue Cross assumed accident and health insurance
risks of employees and their dependents and, in other cases, Blue Cross only provided
administrative services with no assumption of accident and health insurance risks. In addition,
from 1989 through 1993, Blue Cross was a party to contracts with the federal Health Care
Finance Administration (hereinafter "HCFA") to provide administrative services for the
processing of Medicare claims.
Blue Cross accident and health insurance policies included coordination of benefits
("COB") provisions, which are based on COB guideline regulations published by the National
2

Association of Insurance Commissioners. COB provisions apply where a person has duplicative
coverage, i.e., where the person is covered by two or more plans providing health care benefits or
services. COB provisions set forth mechanical rules for determining whether a health plan is the
primary plan or secondary plan with respect to each particular claim submitted under the plan. A
primary plan is defined as a plan whose benefits for participant's health care coverage must be
determined without consideration of the existence of any other plan. A secondary plan is defined
as one which is not a primary plan. During the years 1989 through 1993, Blue Cross operated a
COB department whose purpose was to review claims subject to coordination of benefits and to
determine whether Blue Cross was the primary plan or secondary plan with respect to each claim.
Under COB provisions, when there is overlapping coverage and a determination is made
that one plan is primary and the other secondary, the secondary insurer has two options as to how
to proceed on paying the claim. First, the secondary insurer can follow the "pay and pursue"
approach, under which the secondary insurer would pay up front the full amount of the pending
claim and then seek reimbursement from the primary insurer of the amount for which the primary
insurer is responsible. The other choice for the secondary insurer is to follow the "pursue and
pay" or "wait and pay" approach, under which the secondary insurer may wait for the primary
insurer to calculate and to make their payment on a pending claim before making the secondary
payment. Prior to and through the years in issue, Blue Cross routinely used the pursue and pay
approach, not making a secondary claim payment until it had determined the amount of the
primary payment and that the primary payment had been made by the primary plan. When Blue
Cross made a claim payment as the secondary health plan under a COB provision on Medicare
related claims, Blue Cross almost always knew that the primary portion had been paid by
3

Medicare. Whether an insurance company used the pursue and pay approach or the pay and
pursue approach becomes important for the calculation of "unpaid losses" and the amount of
financial reserves the company is required to maintain, which will be explained below.
When Blue Cross made a payment as the secondary health plan under a COB provision, it
calculated an amount called COB savings, which consisted of the difference between the amount
that Blue Cross would have paid if there had been no other plan in effect covering the person, and
the amount, if any, Blue Cross paid as the secondary plan. In other words, these COB savings
were amounts Blue Cross did not have to pay as a result of the COB provisions since such
amounts were paid by another health plan. COB savings could also be Medicare related, such as
when retired employees and their spouses are over the age of 65 and are covered under insurance
plans issued by health insurance companies and are also covered under Medicare. Medicare
related COB savings consist of the amount the health insurance company would be liable to pay
for medical expenses if there were no Medicare coverage less the amount the companies are
actually liable for and pay after taking into account payments to be made by Medicare. For 1989,
Blue Cross calculated a total of $243,646,504 in COB savings. Approximately 85% of the
$243,646,504 reflects Medicare related COB savings. For each of the taxable years 1989 through
1993, Blue Cross did not maintain a reserve for amounts recorded as "COB savings." The COB
savings information was used by Blue Cross' marketing department.
Blue Cross included COB savings amounts, Medicare related and non-Medicare related, in
its calculation of "unpaid losses" on its tax returns for purposes of the special deduction, by
4

treating the COB savings as "estimated salvage recoverable.2" "Unpaid losses" generally reflect
actuarially estimated amounts of medical expenses that are incurred during the year, but, that by
year end, are not paid by the health insurance companies. "Paid losses" reflect amounts of
medical expenses that are incurred during the year that health insurance companies actually pay on
claims. A health insurance loss is incurred at the time the insured received medical treatment. An
interval of time elapses before this incurred but unpaid loss is reported to the insurance company
and ultimately becomes a paid loss.
Unpaid losses are shown as a liability on Blue Cross' annual statement filed with the state
insurance regulator and are included in Blue Cross' computation of "losses incurred" for federal
income tax purposes. On annual statements filed with the state insurance regulator, insurance
companies are required to report unpaid losses representing companies' estimate of all insured
losses that have occurred on/before December 31 but which have not been paid as of that date.
Insurance companies such as Blue Cross are required by law to maintain financial reserves for
"unpaid losses" reported in their annual financial statement. If an insurance company uses the
pay and pursue method for COB savings, then the amount of reserves required for unpaid losses
is calculated based on the full, total amount of coverage on their plans, including amounts that
they will pay and be reimbursed by other insurance companies. On the other hand, if the
2 The potential problem with doing this, and where the issue is created, is that Blue Cross
used the pursue and pay method for claims that fell under COB provisions; therefore, Blue Cross
was taking into account amounts that other insurance companies were expected to pay as primary
insurer in calculating Blue Cross' unpaid losses. As will be discussed below, the Tax Court
viewed this as impermissible, because Blue Cross was claiming a salvage right to amounts that it
never expected to have to pay. The term "estimated salvage recoverable" is not defined in the
statute. Black's dictionary defines salvage in insurance as "the property saved or remaining after a
fire or other loss, sometimes retained by an insurance company that has compensated the owner
for the loss." Black's Law Dictionary, Seventh Edition (1999).
5

insurance company uses the pursue and pay approach for COB savings, then the amount of
reserves required for unpaid losses is calculated based on the portion of the claim they were
obligated to pay after the primary plan made its payment. Therefore, the companies that use the
pay and pursue approach for COB savings theoretically maintain reserves in greater amounts than
the companies that use the pursue and pay approach.
As stated earlier, Blue Cross used the pursue and pay approach and only COB savings
that resulted in actual payment or recovery by Blue Cross were used in the calculation of setting
reserves. The actuarial division of Blue Cross did not add the COB savings amounts to compute
its "unpaid losses" reported in its annual statement and had no regular use for COB savings
reports. On its annual statement for 1989, Blue Cross reported unpaid losses of $180,021,858.
In addition to being reported on annual statements and for purposes of determining
reserves, unpaid losses is an amount used to calculate "losses incurred" for federal income tax
purposes. "Losses incurred" is a deduction allowed by Section 832(c)(4) of the Internal Revenue
Code. The Code defines "losses incurred" as losses paid during the taxable year plus the increase
in unpaid losses during the year, subject to certain adjustments. Prior to 1990, the section
contained an adjustment for salvage recoverable, which required an insurance company for federal
tax purposes to reduce its deduction for "paid losses" by an estimate of anticipated recoveries
from salvage and subrogation not yet reduced to cash or cash equivalent. As to "unpaid losses,"
insurance companies had the option to take into account estimated recoveries from third party
tortfeasors and other health insurance companies. If the company elected not to reduce the
calculation of unpaid losses by estimated recoveries, the calculation was referred to as calculations
of "unpaid losses gross of estimated recoveries;" on the other hand, if the company elected to
6

reduce the calculation of unpaid losses by estimated recoveries, the calculation was referred to as
"unpaid losses net of estimated recoveries."
In 1990, the section was amended to require all health insurance companies to reduce their
paid and unpaid losses included in "losses incurred" by estimated recoveries of salvage�in other
words, to calculate unpaid losses net of estimated recoveries.3 For those insurance companies
that had not reduced their unpaid losses by estimated recovery of salvage in the years prior to
1990, the amendment constituted a change in the method of accounting that required reporting of
additional income. Because of this effect, Congress granted a one time special deduction,
forgiving 87% of this income and requiring the remaining 13% to be included in income ratably
over four years. For companies that prior to 1990 had reported unpaid losses net of estimated
recoveries, Congress granted a similar special deduction equaling 87% of the amount of
"estimated salvage recoverable" that the companies had taken into account during 1989, to be
deducted ratably over four years beginning with 1990.
In light of the change in the tax law, the Treasury Department issued official guidance on
implementing the new tax law, and also provided a safe harbor provision. Under the
implementing regulation, a tax payer claiming the special deduction was required to "establish to
the satisfaction of the district director that the deduction represents only the discounted amount of
non-admitted salvage recoverable that was actually taken into account by the taxpayer in
computing losses incurred for" the last taxable year beginning January 1, 1990. Under the
regulations, a taxpayer would be deemed to have taken salvage recoverable into account only if
3 The amendment can be found in �11305(a) of the Omnibus Budget Reconciliation Act of
1990 (1990 OBRA), Pub. L. No. 101-508, 104 Stat. 1388-452.
7

the taxpayer filed a statement by September 16, 1991 with the insurance regulatory authority of
the taxpayer's state of domicile disclosing the extent to which losses incurred for each line of
business reported on the 1989 annual statement were reduced by estimated salvage recoverable.
Moreover, in a proposed form of the regulation, a safe harbor provision was included which
provided that if the requirements were followed, a deduction would not be adjusted in the absence
of fraud. However, when the regulation was finalized, the "absence of fraud" language was
changed to provide that amounts reported as "bona fide" estimated salvage recoverable would not
be adjusted, if all other requirements were met.
Blue Cross, prior to 1990, calculated unpaid losses using the net calculation, that is, they
reduced their unpaid losses by estimated recoveries and, therefore, they claimed the special
deduction for tax years 1990 through 1993. Blue Cross calculated that under the special
deduction rule, a total of $70,950,582 reflected Blue Cross' estimated salvage recoverable relating
to unpaid losses for its last taxable year beginning before January 1, 1990. Blue Cross multiplied
the total $70,950,582 by 87% and by a discount factor of approximately four percent, to produce
a figure of $59,352,862, or $14,838,215, for each of the years 1990 through 1993 as its special
deduction.
In September of 1991, Blue Cross sent a disclosure letter to the Texas Department of
Insurance, which stated the following:
As you are aware, in reporti ng to your department [Blue
Cross] has always followed actuarially accepted and certified practices
for determining and reporting its losses incurred and its incurred
unpaid claim reserves. In OBRA 1990, Congress granted a special
one time deduction to insurance carriers who report losses incurred as
we do. IRS regulations provide that a notification filed with your
office will establish the amount of this allowable tax deduction.
8

The sole purpose of this letter is to notify you that we have
determined our special tax deduction to be 87% of $74,780,518
discounted at 96.1538% for recoveries related to our losses incurred
deduction prior to 1990 and reported in the 1989 annual statement.
OUR REPORTING TO YOU HAS NOT CHANGED AND
WILL NOT CHANGE IN ANY RESPECT FROM THE ACCEPTED
METHODS AND APPROACHES WE HAVE ALWAYS USED. Our
incurred unpaid claim reserves will continue to be determined using
the same methods, include the same actuarial certifications as always
and continue to be in full compliance with established methods and
practices approved and routinely examined by your department.

On audit for tax years 1992 and 1993, the Commissioner of Internal Revenue disallowed
each of Blue Cross' claimed $14,838,215 special deductions. Approximately 94% of the total
$70,950,582 claimed by Blue Cross as estimated salvage recoverable reflected COB savings.
Approximately 85% of the COB savings amount reflected Medicare related COB savings. Only
approximately 3% of the $70,950,582 claimed by Blue Cross as estimated salvage recoverable
reflected amounts that Blue Cross actually paid and then recovered from tortfeasors and from
other insurance companies.4 Blue Cross challenged the Commissioner's denial of the deduction in
the United States Tax Court. The Tax Court held that Blue Cross' COB savings, both those that
were Medicare related and non-Medicare related, did not constitute estimated salvage recoverable
for purposes of the special deduction. Additionally, the Tax Court held that Blue Cross did not
qualify for safe harbor relief because its disclosure letter did not meet the regulatory requirements.
Blue Cross timely appealed to this Court the Tax Court's holdings regarding whether the COB
4 Six percent of the total deduction is no longer at issue. The Tax Court approved 3% of
the $70,950,582 that Blue Cross calculated as its total estimated salvage recoverable reflected
amounts Blue Cross actually paid and then recovered from third party tortfeasors and other health
insurance companies. The Tax Court found that Blue Cross also conceded that 3% of the amount
claimed did not represent genuine salvage recoverable. The remaining amount in dispute is the
94% of the total estimated salvage recoverable, which represents COB savings.
9

savings constitute salvage recoverable and whether Blue Cross qualified for safe harbor relief.
DISCUSSION
A. Standard of Review:
The standard of review in this case is de novo for conclusions of law and clear error for
factual findings. Compaq Computer Corp. & Subsidiaries v. Comm'r. of Internal Revenue, 277
F.3d 778, 780 (5th Cir. 2001).
B. Did the Tax Court err in holding that Blue Cross could not treat amounts described as COB
savings that it did not expect to pay as "estimated salvage recoverable" for purposes of the
special deduction provided in 1990 OBRA, including amounts related to Medicare COB
savings?
According to the Tax Court, the authority it reviewed suggested that to qualify as
estimated salvage recoverable for purposes of the special deduction rule, there must exist an
expectation of actual payment. Because Blue Cross used the pursue and pay approach before
making secondary payments under COB provisions, the Tax Court held that Blue Cross' COB
savings did not qualify as estimated salvage recoverable and were not allowable under the special
deduction rule. Blue Cross did not expect to pay amounts reflected as COB savings under the
pursue and pay approach; rather, they only expected to pay the portion they were obligated to pay
as a secondary plan. On the other hand, the Tax Court reasoned that when an insurer uses the pay
and pursue approach, there exists expectation of actual payment of amounts that may later be
COB savings because they are properly payable by another plan, in which case the COB savings
would qualify as estimated salvage recoverable.
As to medicare related COB savings, the Tax Court held that these savings also did not
qualify as salvage recoverable for purposes of the special deduction because of an exclusion in
10

Blue Cross' policies, which it interpreted as excluding coverage for medical expenses and claims
that were covered "under the Workers' Compensation law, or any other present or future laws
enacted by the Legislature of any state, or by the Congress of the United States [such as
Medicare]." Considering this provision, the Tax Court concluded that Medicare related benefits
were excluded from coverage under Blue Cross' health insurance plans, and, therefore, without
contractual liability and without payment of Medicare covered benefits, Blue Cross' Medicare
related COB savings did not constitute estimated salvage recoverable.
Blue Cross argues that the Tax Court erroneously defined "estimated salvage recoverable"
to require an expectation of actual payment. According to Blue Cross, both Medicare and non-
Medicare related COB savings constitute estimated salvage recoverable because Blue Cross was
liable for the full amount of incurred claims and, therefore, had a right of salvage for amounts that
would be covered by primary insurers, despite the fact that they used the pursue and pay
approach to the COB savings. Blue Cross maintains that from the time a person insured by Blue
Cross incurred medical expenses, until such time as the primary health plan paid in whole or in
part, Blue Cross remained liable to the insured for the full amount of covered expenses even
though Blue Cross was "secondary" for COB purposes.5
5 As support for this concept of dual liability, Blue Cross points to the fact that the Texas
Department of Insurance allowed health insurers to report its unpaid losses in the full amount,
"gross" of COB recoverable. Blue Cross also relies on a Texas state law, the Life, Accident,
Health & Hospital Service Insurance Guaranty Association Act, which provides that where an
insolvent primary health insurer had a contractual obligation that was also the contractual
obligation of a solvent secondary health insurer, no guaranty association benefits would be
provided until the insured first exhausted his rights against the solvent secondary health insurer.
According to Blue Cross, the law presumed the existence of a duplicative contractual obligation
to the insured on the part of both health insurers until such time as the liability was extinguished
by payment of one or the other. Last, Blue Cross refers to Texas and Louisiana state court cases
that it asserts have recognized that both health plans remain primarily liable to the insured even
11

With regard to Medicare related COB savings, Blue Cross argues that it was liable for
such claims under the "other coverage" provision of its insurance contracts. According to Blue
Cross, "other coverage" includes "any governmental program existing by statutory authority"
under which the insured is entitled to medical benefits, except Medicaid. Blue Cross policies
provided that when Blue Cross was the secondary carrier to the insured's "other coverage" "the
benefits of the other coverage shall be deducted from the [medical expenses] for which any benefit
is provided under [this contract] . . . and [Blue Cross] will pay the remainder of the charges for
such items." Under these provisions, Blue Cross claims it coordinated benefits with Medicare as
it would with any other health plan, and Blue Cross' liability to an insured retiree would only be
extinguished to the extent Medicare actually paid benefits. Blue Cross would be obligated to pay
the remainder of the covered expenses.
Blue Cross argues that the Tax Court's reliance on an exclusionary provision in the
policies is misplaced. The exclusionary provision the Tax Court relied on excluded coverage for
"any [medical] services or supplies for which benefits are, or could upon proper claim be,
provided under the Workers' Compensation law, or any other present or future laws enacted by
the Legislature of any state, or by the Congress of the United States. . . ." Blue Cross argues that
if the Tax Court's extreme interpretation of this provision as excluding all liability of Blue Cross
for Medicare covered claims is accepted, the effect would be that Blue Cross was charging
millions of dollars per year to insureds who were also covered under Medicare in return for no
though COB rules make those health plans primary or secondary with respect to each other.
(citing Caraway v. Royale Airlines, Inc., 559 So. 2d 954 (La. Ct. App. 2d Cir. 1990) rev'd in part
on other grounds, 579 So. 2d 424 (La. 1991) and Texas Prop. & Cas. Ins. Guar. Assoc. v.
Southwest Aggregates, Inc., 982 S.W.2d 600, 606 (Tex. Ct. App. 1998)).
12

coverage, and all payments that Blue Cross had previously made on Medicare related claims were
just out of its kindness and generosity because Blue Cross was not obligated to pay anything.
Aside from the nonsensical implications resulting from such an interpretation of the exclusion,
Blue Cross argues that even if the provisions concerning "other coverage" and this exclusion were
viewed as ambiguous, Texas state law would apply and construe the contract in favor of coverage
for these Medicare related claims.6
Furthermore, Blue Cross asserts that the term "salvage" means tangible and intangible
property, including tort subrogation and rights against any third party who may be liable for the
insured's loss. To support its argument that pursue and pay COB savings qualify as salvage
recoverable, Blue Cross reasons that there are two ways for the insurer to have the benefit of the
insured's claim against a third party: the third party can either pay the insurer or pay the insured.
In the former case, the insurer takes over and pursues the insured's claim against the third party; in
the latter case, the insurer lets the insured keep the claim against the third party. It is Blue Cross'
position that either way, the benefit to the insurer is the same and falls within the concept of
salvage for tax purposes. In support of this theory, Blue Cross cites the appellee's expert witness,
Professor Brockett, who testified that property is salvage whether or not the insurer takes
possession of tangible property. Blue Cross argues that this concept should also apply to
intangible property in the form of a claim for money.
In opposition to Blue Cross' arguments, Appellee asserts that the COB savings do not
constitute estimated salvage recoverable because they were not reasonable estimates of recovery
6 In its reply brief, as an additional basis for its argument that the Tax Court erroneously
relied on the exclusion, Blue Cross argues that the exclusion excluded coverage only for
workplace injuries.
13

on amounts that Blue Cross anticipated it would have to pay. Rather, according to Blue Cross'
financial reporting director, the COB savings were amounts that they expected the other insurance
company to pay. Additionally, Blue Cross' actuary stated that he established the company's loss
reserve net of COB savings because there was no anticipated liability of the company for those
payments by other companies. Specifically with regard to Medicare related COB savings,
Appellee argues that Blue Cross always knew the amount that Medicare had paid before it
calculated COB savings and, therefore, had no expectation that it would have to pay amounts
Medicare already paid.
In addition, Appellee asserts that the Tax Court's interpretation of salvage recoverable is
correct because it is consistent with industry usage. In particular, Professor Brockett testified that
the general insurance industry would not view COB savings as salvage and subrogation because
the key to recovery, salvage, and subrogation is payment. According to Appellee, even Blue
Cross' expert agreed that gross reserves are based on an estimation of the amount that a company
expects to pay out and that a secondary insurer would not have a recovery for COB savings
because it would not be paying those amounts.
As the Tax Court noted, limited authority exists to explain estimated salvage recoverable.
The term "estimated salvage recoverable"is not defined in the Tax Code. The term appears in
section 832 of the Internal Revenue Code, 26 U.S.C. � 832(5)(a), which outlines the procedure to
calculate "losses incurred," a deduction for federal income tax purposes. In explaining how to
calculate "losses incurred," the Code provides the following:
The term "losses incurred" means losses incurred during the taxable
year o n insurance contracts computed as follows (i) To losses paid
during the taxable year, deduct salvage and reinsurance recovered
14

during the taxable year. (ii) To the result so obtained, add all unpaid
losses on life insurance contracts plus all discounted unpaid losses . .
. outstanding at the end of the taxable year and deduct all unpaid
losses on life insurance contracts plus all discounted unpaid losses
outstanding at the end of the preceding taxable year. (iii) To the
results so obtained, add estimated salvage recoverable and reinsurance
recoverable as of the end of the preceding taxable year and deduct
estimated salvage recoverable and reinsurance recoverable as of the
end of the taxable year.
Under this statute, estimated salvage recoverable is one component used in the calculation to
determine the appropriate amount of the deduction for losses incurred. Prior to 1990, Section
832 required only paid losses to be reduced by salvage recoverable. However, in 1990 Congress
amended section 832 by �11305(a) of the Omnibus Budget Reconciliation Act of 1990 ("1990
OBRA")7, now requiring that both paid and unpaid losses be reduced by estimated salvage
recoverable, whether or not the salvage is treated as an asset for statutory accounting purposes.
In other words, prior to 1990, salvage recoverable was only used to calculate paid losses for the
"losses incurred" determination; after 1990, salvage recoverable is used to calculate paid and
unpaid losses for the "losses incurred" determination. Because "estimated salvage recoverable" is
a subpart of paid and unpaid losses, definitions and interpretations of paid and unpaid losses are
instructive on the scope of "estimated salvage recoverable," as well as explanations of the concept
of salvage in general. In fact, such definitions and interpretations are the only sources for
determining what "estimated salvage recoverable" means, and whether it should include COB
savings under a pursue and pay approach.
"Salvage" in the insurance context is "the property saved or remaining after a fire or other
loss, sometimes retained by an insurance company that has compensated the owner for the loss."
7 Pub. L. No. 101-508, 104 Stat. 1388-452.
15

Black's Law Dictionary, Seventh Edition (1999). (Emphasis added). The United States Supreme
Court described the general concept of salvage in the following way: "From the very nature of the
contract of insurance as a contract of indemnity, the insurer, when he has paid to the assured the
amount of indemnity agreed on between them, is entitled by way of salvage, to the benefit of
anything that may be received, either from the remnants of the goods, or from damages paid by
third persons for the same loss." Phoenix Ins. Co. v. Erie & Western Transp. Co., 117 U.S. 312,
321 (1886). (Emphasis added).8
Specifically in the context of paid losses, courts have considered the terms salvage and
salvage recoverable in cases decided prior to the 1990 amendment. One court explained that
"when an insurance company pays a claim, it ordinarily has a right of salvage under the insurance
policy." Allstate Fire Ins. Co. v. United States, No. 381-73, 1980 WL 4713, *7 (Ct. Cl. Mar. 14,
1980). Another case pointed out that "salvage includes all tangible property and subrogation
claims acquired by an insurance company after indemnifying its insured under contracts of
insurance." Continental Ins. Co. v. United States, 474 F.2d 661, 664 (Ct. Cl. 1973). In
Continental, the Court explained that in calculating paid losses, salvage in the course of
liquidation, consisting of all property, real or personal, and tangible or intangible, shall be taken
into account to the extent of the value thereof at the end of the taxable year as determine from a
fair and reasonable estimate based upon either the facts of each case or the company's experience
8 See also Van Schaick v. Comm'r. of Internal Revenue, 32 B.T.A. 736, 741 (U.S. Bd.
Tax App. 1935) (agreeing that term salvage as used in the law of insurance is the proceeds
received by the insurer (1) after paying total loss or amount of valuation in a valued policy, out of
the property, the subject matter of the insurance contract; or (2) after paying total or partial loss,
out of the claim that passes to the insurer by virtue of the right of subrogation and not as an
incident to the property in the subject matter of the insurance contract .)
16

with similar cases. Id. at 666-67. These cases suggest that salvage recoverable, at least in the
context of paid losses, includes amounts the company reasonably expects that it will recover after
it has paid a claim.
In the context of unpaid losses, courts have not considered the meaning or scope of
"estimated salvage recoverable." However, Income Tax Regulation 1.832-4 directly addresses
the calculation of "unpaid losses" for the purpose of determining losses incurred, and estimated
salvage recoverable is a part of that calculation. Regulation 1.832-4 provides the following:
In computing "losses incurred" the determination of unpaid losses at
the close of each year must represent actual unpaid losses as nearly as
it is possible to ascert ain them. Every insurance company to which
this section applies must be prepared to establish to the satisfaction of
the district director that the part of the deduction for "losses
incurred"which represents unpaid losses at the close of the taxable
year comprises only actual unpaid losses . . . . These losses must be
stated in amounts which, based upon the facts in each case and the
company's experience with similar cases, represent a fair and
reasonable estimate of the amount the company will be required to
pay. Amounts included in, or added to, the estimates of unpaid losses
which, in the opinion of the district director, are in excess of a fair and
reasonable estimate will be disallowed as a deduction . . . . Estimates
of salvage recoverable must be based on the facts of each case and the
company's experience with similar cases.
Although this regulation does not expressly define salvage recoverable, salvage recoverable is a
subpart used to determine unpaid losses and, therefore, the scope of the term salvage recoverable
must be interpreted in accordance with the rules applicable to unpaid losses. The Tax Court
considered the above detailed sources to determine what constitutes estimated salvage
recoverable. Such limited authority is all that is available to determine the meaning of the term.
Blue Cross criticizes the Tax Court's emphasis on the phrase "will be required to pay" in
the regulation regarding losses incurred and argues that the phrase was erroneously relied on as
17

the basis for the Tax Court's holding that COB savings under the pursue and pay approach do not
constitute estimated salvage recoverable. According to Blue Cross, a Technical Advice
Memorandum issued by the IRS eight months after the Tax Court's decision clarifies that the
phrase "will be required to pay" refers to the requirement that taxpayers base their estimates of
unpaid losses on actual losses, not losses that might occur in the future. On the other hand, the
Appellee points to another Technical Advice Memorandum that it contends supports its position
and addresses the issue directly, providing that treasury regulations prohibit setting up unpaid
losses on pursue and pay savings. However, according to the Internal Revenue Code, 26 U.S.C.
� 6110, such technical advice memorandum may not be used or cited as precedent.
Despite Blue Cross' arguments, under the limited authority available regarding the
meaning and scope of the term, the Tax Court correctly held that COB savings under the pursue
and pay approach do not constitute estimated salvage recoverable. Applying the rule regarding
unpaid losses to determine the scope of estimated salvage recoverable leads to the conclusion that
estimated salvage recoverable must consist of amounts the company expects to recover from
amounts that it will pay or has paid, based on the company's experience and the facts of the case.9
If the company uses the pursue and pay approach for COB savings, then the company does not
expect to actually pay the portion of the claim covered by the primary plan. Based on its
experience and the facts of the case, the insurer cannot include that amount as unpaid losses
9 As one author explained, "estimated salvage recoverable includes all anticipated
recoveries on account of salvage . . ." citing Treasury Regulation 1.832-4 discussing the losses
incurred calculation. MARTIN WEINSTEIN, ET AL., MERTEN'S LAW OF FED. INCOME TAXATION
�44:11(2003) (Emphasis added). Blue Cross cannot anticipate a recovery when it only anticipates
paying the portion of the claim it is responsible for as secondary insurer. However, if Blue Cross
used the pay and pursue approach, Blue Cross would anticipate recovery on claims it paid in full
when it was only responsible as a secondary insurer.
18

because its experience and expectation is that the primary plan will pay that portion, and the
insurer who is a secondary plan will only pay the amount left over after payment by the primary
insurer. On the other hand, when an insurer uses the pay and pursue approach to COB savings, it
expects to and does pay the full amount of the claim and, therefore, has expectation based on its
experience and the facts of the case that it will recover by salvage a particular amount that the
primary plan is responsible to pay. An estimated amount of unpaid losses is not a fair and
reasonable estimate of amounts it will be required to pay if it includes amounts that the company,
based on its experience and the facts of the case, expects are amounts that will be paid by another
health plan and the secondary plan has no basis to recover. Such is the case when an insurer uses
the pursue and pay approach to COB savings.
Blue Cross' argument that its dual liability gives it a salvage right ignores the standard set
forth for unpaid losses discussed above. Even if Blue Cross is potentially liable for the full
amount, the full amount of the claim would not be a fair and reasonable estimate of its unpaid
losses, because based on Blue Cross' experience of using the pursue and pay approach and the
facts of the case, Blue Cross expects that it will only have to pay the amount left over after
payment by the primary plan. The standard mentioned for determining unpaid losses is not all
potential amounts that the company may be liable to pay, but rather amounts that the company, in
its experience and facts of the case, will be required to pay. Again, because estimated savage
recoverable is a subpart used to determine unpaid losses, it must follow the same standard. This
leads to the conclusion that estimated salvage recoverable must only include salvage that the
company, based on its experience and facts of the case, expects to recover. When an insurer uses
the pursue and pay approach to COB savings, it does not expect to recover the amount of the
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claim paid by the primary plan and, therefore, it cannot constitute estimated salvage recoverable.
In conclusion, the authority explaining/defining salvage, estimated salvage recoverable in
the context of paid losses, and the regulation regarding unpaid losses all support the Tax Court's
holding that estimated salvage recoverable does not include COB savings under the pursue and
pay approach because there is no expectation of payment of the full amount and, accordingly, no
corresponding salvage right. The fact that some of the COB savings were Medicare related does
not change the outcome- even if Blue Cross provided coverage for such claims, the Medicare
related claims were handled in the same way as other claims with regard to the pursue and pay
approach. Consequently, Blue Cross similarly had no expectation of paying amounts covered by
Medicare as a primary plan, but would only pay the remainder of the claim after payment by
Medicare in accordance with its "other coverage" provisions. Thus, no estimated salvage
recoverable existed with regard to the Medicare related COB savings for the same reasons as non-
Medicare related COB savings. A determination of whether Blue Cross' policies excluded all
claims covered by Medicare or just amounts paid by Medicare is not necessary, but such a finding
would only add support to the conclusion that Medicare related COB savings do not constitute
estimated salvage recoverable.
C. Did the Tax Court err in holding that Blue Cross failed to qualify for the safe harbor
provision and, thus, was not entitled to the special deduction?
Even though the COB savings did not constitute estimated salvage recoverable, the safe
harbor provision may nevertheless entitle Blue Cross to the deduction if its argument on the safe
harbor provision is accepted. As will be explained further below, Blue Cross argues that it is
entitled to the deduction under the safe harbor provision even if COB savings do not qualify as
20

estimated salvage recoverable because Blue Cross was in good faith and acted without fraud in
claiming the deduction.
In light of the change in the tax law by 1990 OBRA, the Treasury Department issued
official guidance in March 1991 on implementing the new tax law, which included a safe harbor
provision. Proposed Treasury Regulation 1.832-4(e) required a tax payer claiming the special
deduction to "establish to the satisfaction of the district director that the deduction represents only
the discounted amount of non-admitted salvage recoverable that was actually taken into account
by the taxpayer in computing losses incurred for . . ." the last taxable year beginning January 1,
1990. The proposed regulation also provided that this requirement is deemed to be met if the
taxpayer files with the appropriate state regulatory authority, on or before July 15, 1991, a
statement disclosing the extent to which non-admitted salvage recoverable was taken into account
in computing losses paid or unpaid losses in the underwriting and investment exhibit of its 1989
annual statement.
While the proposed regulation was pending, the IRS issued IRS Announcement 91-106,
which extended the date for filing the disclosure statement. Revenue Procedure 91-48 provided
that for purposes of the safe harbor (in Treasury Regulation 1.832-4(e)) a taxpayer will be
deemed to have taken salvage recoverable into account only if the taxpayer files a statement by
September 16, 1991 with the insurance regulatory authority of the taxpayer's state of domicile
disclosing the extent to which losses incurred for each line of business reported on the 1989
annual statement were reduced by estimated salvage recoverable. The revenue procedure
provided that if the taxpayer complied with this requirement, then the amount claimed as a special
deduction would not be adjusted by the district director absent fraud.
21

In January of 1992, the IRS issued final regulations concerning the safe harbor provision,
Treasury Regulation 1.832-4(f)(2). The safe harbor provision in the final regulations was nearly
identical to the proposed regulation, but the "absence of fraud" language was taken out and the
regulation provided the following: the requirements of this section are deemed satisfied and the
amount that the company reports as bona fide estimated salvage recoverable is not subject to
adjustment by the district director if certain requirements are met.10 (Emphasis added).
The Tax Court held that Blue Cross' letter did not meet the safe harbor requirements
because it did not begin to disclose to Texas insurance regulators the extent to which Blue Cross'
losses that were incurred for each line of business, as reported in its 1989 annual statement, were
reduced by estimated salvage recoverable. The Tax Court explained that no separate lines of
business were disclosed and the words "estimated salvage recoverable" were not even used in the
letter.
Blue Cross argues that its disclosure letter was adequate despite the fact that it did not list
separate lines of business because Blue Cross only had one line of business�health insurance.
Additionally, Blue Cross argues that the regulation did not require specific language to be used in
the disclosure letter and, therefore, Blue Cross' failure to use the term "estimated salvage
10 The final regulation reads as follows:
(2) Safe Harbor. The requirements of paragraph (f)(1)
of this section are deemed satisfied and the amount that the company
reports as bo na fide estimated salvage recoverable is not subject to
adjustment by the district director, if �
(i) the company filed with the insurance
regulatory authority of the company's state of domicile, on or before
September 16, 1991, a statement disclosing the extent to which losses
incurred for each line of business reported on its 1989 annual
statement were reduced by estimated salvage recoverable.
22

recoverable" did not render the disclosure letter inadequate. According to Blue Cross, the
language it used was more easily understood by an insurance regulator, who may not be familiar
with specialized tax terms such as "estimated salvage recoverable," and the language used in Blue
Cross' letter fulfilled the purpose of the requirement, to disclose the extent to which losses
incurred as listed on its 1989 annual statement were reduced by estimated salvage recoverable.
On the other hand, Appellee argues that Blue Cross' disclosure letter was inadequate for
the reasons cited by the Tax Court. It is Appellee's position that although Blue Cross only had
one line of business, that did not excuse it from the requirement of disclosing the line of business.
Furthermore, the Appellee argues that the letter did not show the extent to which losses incurred
were reduced by estimated salvage recoverable on its 1989 annual statement. Rather, the letter
stated that the "sole purpose" was to notify the insurance department of the amount of the special
deduction Blue Cross claimed; however, there is no evidence that the insurance regulators had
sufficient knowledge of the special tax deduction at issue to understand that taxpayer's reference
to it meant that it had reduced its losses incurred by estimated salvage recoverable. Finally,
Appellee asserts that the general language Blue Cross used, "for recoveries related to our losses
incurred deduction," could have been referring to actual recoveries affecting the losses paid part
of the losses incurred deduction. According to Appellee, the language used does not clearly
indicate the recoveries are estimated amounts of anticipated future recoveries and, therefore,
does not even fulfill the purpose of the regulation as Blue Cross asserts.
As Blue Cross points out, because the implementing regulation did not require that certain
language be used in the disclosure letter in order to be in compliance, it would appear that as long
as the purpose of the regulations was accomplished, that is, putting insurance regulators on notice
23

of the amount by which losses incurred was reduced by estimated salvage recoverable for 1989,
the requirements were met. However, it is not clear in this case that Blue Cross fulfilled the
purpose of the requirements. Blue Cross' disclosure letter cannot be fairly deemed to be in
compliance with the regulation because the language it used was too broad to adequately inform
the insurance regulator of the extent that Blue Cross' incurred losses were reduced by estimated
salvage recoverable. Blue Cross' disclosure letter simply stated the following: "[T]he sole
purpose of this letter is to notify you that we have determined our special tax deduction to be
87% of $74,780,518 discounted at 96.1538% for recoveries related to our losses incurred
deduction prior to 1990 and reported in the 1989 annual statement." This language simply fails to
make it clear that the $74,780,518 figure represents estimated amounts of anticipated future
recoveries that was factored into its losses incurred calculation for 1989. Therefore, Blue Cross
did not meet the requirements of the implementing regulation because its disclosure letter did not
inform the state regulators of the extent to which its losses incurred deduction was reduced by
estimated salvage recoverable.
As an additional reason why Blue Cross did not meet the safe harbor provision, the Tax
Court explained that Blue Cross' calculation of its estimated salvage recoverable did not reflect
"bona fide" or genuine salvage recoverable and, therefore, Blue Cross' disclosure of that
calculation would not satisfy the disclosure required for safe harbor relief. The Tax Court applied
the final regulation containing the safe harbor and made no mention of the changes in the
wording of the safe harbor provision as set forth above.
Blue Cross argues that its disclosure letter did meet the requirements for the safe harbor
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because it was prepared in good faith, in reliance upon professional tax advisors,11 and contained
sufficient information to notify the Texas Department of Insurance of the extent to which Blue
Cross reduced its losses incurred by anticipated salvage. According to Blue Cross, at the time the
disclosure letter was prepared and due to the state insurance department, the proposed revenue
procedure provided that if the taxpayer met the disclosure requirement, the taxpayer will be
deemed to have taken salvage recoverable into account before 1990 and the amount claimed as a
deduction will not be adjusted "in the absence of fraud." Blue Cross asserts that it was not until
four months after the deadline for filing the safe harbor disclosure statements that the IRS issued
final regulations as to the implementation of the one time tax benefit. The safe harbor in the final
regulations was identical to that of the proposed regulation, except that the "absence of fraud"
language was replaced with the notation that the amount the taxpayer reported as "bona fide
estimated salvage recoverable" would not be adjusted if the requirements of the regulations were
met. The Tax Court applied the regulation as it appeared in its final form, requiring bona fide
estimated salvage recoverable and, in doing so, Blue Cross argues that the Tax Court held its
disclosure letter to a different, more restrictive standard than the standard in effect at the time the
disclosure letter was filed by defining bona fide to mean genuine. It is Blue Cross' position that
bona fide should have been interpreted to mean in good faith or without fraud, in which case,
11 The Blue Cross and Blue Shield Association filed an amicus brief essentially making the
same arguments as Appellant Blue Cross. In support of the argument that Blue Cross qualified
for safe harbor relief, the Association describes in great detail the planning and meeting of various
tax experts who crafted a sample letter, which was later relied on and used by various Blue Cross
plans throughout the country. Appellee contends that this should not be considered because it
contains new facts not contained in the record, citing Smith v. United States, 343 F.2d 539, 541
(5th Cir. 1965) for the proposition that a court of appeals cannot consider new factual material
included in the brief of an amicus.
25

Blue Cross' reasonable good faith beliefs put it well within the bona fide requirement of the safe
harbor. Even if defining bona fide as genuine is an appropriate standard for the safe harbor
provision, Blue Cross argues that it cannot be held to the more restrictive standard when it relied
on a published ruling at the time it submitted its disclosure letter.
With regard to the standard of review, Blue Cross argues that the safe harbor issue is not a
factual issue, but a legal one and, therefore, the standard of review is de novo for this issue. It is
Blue Cross' position that all relevant facts are undisputed and the Tax Court erred in interpreting
the language of Revenue Procedure 91-48 and Proposed Treasury Regulation 1.832-4(e)(2),
which provided the requirements to meet the safe harbor rule.
If Blue Cross' argument is followed that "absence of fraud" should be the standard, it
would mean that companies that claimed the deduction for salvage recoverable for items that
were not legally salvage recoverable would nevertheless be entitled to the deduction absent any
fraud in claiming the item as salvage recoverable. Appellee argues that the safe harbor was
intended to eliminate factual disputes about the amounts of salvage recoverable estimated, not to
change for tax purposes, items that were not salvage recoverable into salvage recoverable.
According to the Appellee, the safe harbor relied on the adverse consequences that would result
to an insurance company from disclosing an adjustment to its reserves for estimated salvage
recoverable, an item insurance regulators considered a fictional asset. The safe harbor thus
considered a disclosure having potential adverse consequences for state regulatory purposes as a
sufficient basis for dispensing with a challenge as to the amount of salvage recoverable claimed as
a special deduction for federal tax purposes. Appellee explains that the final regulations did not
change the standard, as Blue Cross argues, but rather clarified that the safe harbor could not
26

extend the deduction for estimated salvage recoverable to estimates of items that were not in fact
salvage recoverable. Finally, Appellee criticizes Blue Cross' argument that the disclosure letter
met requirements of the safe harbor because it was crafted in good faith by experts. Regardless of
whether experts wrote the letter, Appellee contends that the disclosure letter simply does not
meet the safe harbor requirements as described above, and experts' involvement has no effect on
that determination. Additionally, Appellee asserts that the standard of review for this issue is
clearly erroneous because it is an issue of fact.
The issue of whether "absence of fraud" or "bona fide" should be the appropriate standard
is a legal issue. Adoption of the "absence of fraud" standard as Blue Cross argues it should be
applied, would result in a safe harbor provision that allowed companies to take a deduction for
items that were not under the law "estimated salvage recoverable," but nonetheless would qualify
for the benefits as such because the claiming party believed in good faith that such items were
estimated salvage recoverable. A safe harbor should not be applied in such a way that it results in
changing the legal status of an item; rather, safe harbor provisions should be applied to allow
parties to qualify for a benefit despite technical errors in the amount claimed, not the item claimed.
Therefore, whether the standard is bona fide or absence of fraud, the safe harbor provision
should be applied to protect discrepancies in amounts claimed, not items. Because Blue Cross did
not claim items that legally constitute estimated salvage recoverable, it is not entitled to the
deduction on the sole basis that it believed in good faith and without fraud that such items were
estimated salvage recoverable. Applying the safe harbor in this way leads to the conclusion that
the standard was not changed, but only clarified to reflect the purpose of a safe harbor provision.
27

CONCLUSION
Having reviewed the record of this case and the parties' respective briefing and for the
reasons set forth above, we conclude that Blue Cross was not entitled to the special deduction for
its "estimated salvage recoverable" consisting of COB savings under the pay and pursue method
and Blue Cross did not qualify for protection under the safe harbor provision. We accordingly
AFFIRM the Tax Court's decision.
AFFIRMED.
28