                        T.C. Memo. 1998-114



                      UNITED STATES TAX COURT



            CHARLES C. DOCKERY, DONOR, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14915-96.                     Filed March 19, 1998.



     Philip Cook, Michelle Henkel, and Timothy J. Peaden, for

petitioner.

     Willie Fortenberry, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:   Respondent determined that petitioner has

gift tax deficiencies of $3,189 for 1992 and $512,073 for 1993.

     The issues for decision are:
                                  -2-

     1.     Whether the fair market value in 1992 of Crossroads

Insurance, Inc.'s stock that petitioner gave to his children was

$628,619 ($704 per share), as respondent contends; zero, as

petitioner contends; or some other amount.      We hold that it was

$303 per share.

     2.     Whether the fair market value in 1993 of Crossroads

Insurance, Inc.'s stock that petitioner gave to his children was

$1,286,961 ($1,010 per share), as respondent contends; $274,101

($215 per share), as petitioner contends; or some other amount.

We hold that it was $303 per share.

     Unless otherwise specified, section references are to the

Internal Revenue Code in effect for the years in issue.     Rule

references are to the Tax Court Rules of Practice and Procedure.

                        I.   FINDINGS OF FACT

A.   Petitioner

     Petitioner is Charles Dockery.     Petitioner's mailing address

was Lakeland, Florida, when he filed the petition.

     Paula Dockery is petitioner's wife.    Mavis Dockery is

petitioner's former wife.    Carl Dockery is petitioner's son.

Michele Jones (formerly Michele Renwald) is petitioner's

daughter.

B.   Crossroads Insurance, Inc.

     Petitioner incorporated Crossroads Insurance, Inc.

(Crossroads), under the Companies Law of the Cayman Islands on

June 27, 1978.    Petitioner has been the majority shareholder and
                                  -3-

chairman of the board of Crossroads since 1978.      At all times

relevant to this case:    (1) The outstanding shares of stock of

Crossroads consisted of 10,000 shares of common stock and 750,000

shares of 10 percent, noncumulative, redeemable preferred stock;

and (2) the members of Crossroads' board of directors were

petitioner and four minority shareholders:      Paula Dockery, Mavis

Dockery, Carl Dockery, and Michele Jones.

     Crossroads is managed in Georgetown, Grand Cayman.      It has

no office in the United States.    It is a controlled foreign

corporation under section 957(b).       Crossroads' customers are all

in the United States.

     Crossroads is licensed to write insurance in Florida and

Louisiana.    Each year, Crossroads files annual statements with

Florida and Louisiana reporting the financial condition of its

operations.

     1.   The Reinsurance Industry

     Crossroads is a reinsurer.1    It is engaged in the business

of providing aggregate "stop loss" workers' compensation

reinsurance2 to self-insurer pools (also referred to as funds).

     1
       A reinsurer is an insurer who agrees to provide coverage
of risks that a primary insurer has already assumed under an
insurance contract with another party. 1 Couch on Insurance 3d,
sec. 1:4, at 1-8 to 1-9 (1995).
     2
       Reinsurance is an agreement between an insurer (the ceding
company) and a second insurer (the reinsurer), under which the
ceding company passes to the reinsurer some or all of the risks
that the ceding company assumes through the direct underwriting
                                                   (continued...)
                                -4-

     An aggregate stop loss reinsurance agreement subjects

Crossroads to liability for workers' compensation claims above a

preestablished "retention percentage".   The retention percentage

is the point at which Crossroads' liability on a reinsurance

contract matures.   For example, if a self-insurer fund collects

$10 million in premiums and Crossroads' reinsurance agreement

provides for an 80-percent retention point, the primary carrier's

losses would be limited to $8 million, and Crossroads would pay

all claims exceeding $8 million.

     Self-insurer pools are formed under State law as an

alternative to conventional insurance.   Members of trade

associations can form, and pay premiums to, pools owned by the

members (rather than to an insurance company).   Any profits are

returned to the members.

     "Unpaid claims", commonly called reserves for unpaid losses,

are an insurer's estimate of the amount expected to be paid in

the future to settle claims reported and incurred.

     Workers' compensation reinsurance is "long-tail" insurance

coverage because of the length of time before a reinsurer's

obligations mature.   Crossroads may not know if it had losses for

aggregate stop loss workers' compensation reinsurance until 3 to

4 years after a policy year because it may take that long for


     2
      (...continued)
of insurance policies. See Trans City Life Ins. Co. v.
Commissioner, 106 T.C. 274, 278 (1996).
                                -5-

Crossroads to review payments made by the primary carrier.

Crossroads may not make reinsurance payments until 5 to 6 years

after a policy year because it does not pay until the primary

carrier's paid claims reach the retention point.    Crossroads may

be paying claims for 8 to 10 years after the policy period ends.

     2.   Crossroads' Reinsurance Agreements With Self-Insurer
          Funds

     From October 1, 1982, to October 1, 1987, Crossroads wrote

stop loss workers' compensation reinsurance agreements for three

self-insurer funds:   The Oklahoma Retail Merchants Group Self-

Insurers Association, the Oklahoma Employers Safety Group Self-

Insurers Association, and the Florida Foliage Association Self-

Insurers Fund.

     Since October 1, 1987, Crossroads has written stop loss

workers' compensation reinsurance agreements for four self-

insurer funds:   the Florida Retail Federation Self-Insurers Fund,

the Employers Self-Insurers Fund (Florida) (ESIF), the Louisiana

Retailers Association Self-Insurers Fund, and the Louisiana

Employers Safety Association Self-Insurers Fund.    These

agreements have each generally been for 1 year.    These self-

insurer funds were established by Summit Consulting, Inc. (Summit

Consulting).

     On May 4, 1988, Florida's Treasurer and Department of

Insurance issued a consent order restricting Crossroads from
                                  -6-

reinsuring any Florida fund other than the Florida Retail

Federation Self-Insurers Fund and ESIF.

     3.   Crossroads' Retrocession Agreements

     A reinsurance company can reinsure itself above an

established retention point with another reinsurance or third-

party insurance company.     The third-party insurer assumes the

risks for the retroceded policies (i.e., those policies the

reinsurer retrocedes to the third insurer).     This is a

"retrocession" agreement.3

     Beginning in 1988, Crossroads retroceded 50 percent of the

risks of ESIF to U.S. Employers Insurance, Inc. (U.S. Employers),

a company incorporated in the Cayman Islands and owned by ESIF.

Petitioner has served on the board of directors of U.S. Employers

since it was incorporated.     Crossroads has also retroceded

policies to Lloyds of London.

     As of January 1, 1992, Crossroads had retroceded 45 percent

of the risks of Florida Retail Federation Self-Insurers Fund,

Louisiana Retailers Association Self-Insurers Fund, and Louisiana

Employers Safety Association Self-Insurers Fund to Gulf Insurance

Co., Ltd. (Gulf), a company incorporated in the Cayman Islands on




     3
       See Trans City Life Ins. Co. v. Commissioner, 106 T.C. at
278-279.
                                -7-

January 10, 1992, and owned by petitioner and Crossroads'

minority shareholders.

     4.   Crossroads' Annual Statements

     Crossroads reported on its 1991 and 1992 annual statements

that it had surpluses of $6,372,038 for 1991 and $8,720,809 for

1992.

          a.   KPMG Peat Marwick's Actuarial Reports

     Crossroads began using KPMG Peat Marwick as an actuary to

prepare Crossroads' loss reserves around 1988.   KPMG Peat Marwick

also audited Crossroads' financial statements.   A different

office of KPMG Peat Marwick audited Gulf's financial statements.

     In analyzing Crossroads' reserves, KPMG Peat Marwick

reviewed the following underlying claims data for each of the

self-insurer funds:   (i) Accident year cumulative amount of paid

and incurred losses, at historical development points; (ii)

accident year cumulative number of closed and reported claims, at

historical development points; (iii) earned normal premium by

accident year; (iv) recoveries from subrogation, second injury

funds, and specific excess insurance, by accident year; and (v)

all reinsurance policies with loss exposure.

     After reviewing the historical data, KPMG Peat Marwick:    (i)

Applied standard actuarial loss development techniques, including
                                 -8-

the Bornheutter-Ferguson method4 to project ultimate values, by

accident year, of each self-insurer fund; (ii) determined

frequency and severity components; (iii) performed Monte Carlo

simulations5 of the underlying net losses to obtain the potential

liability of each self-insurer fund at various confidence levels;

and (iv) compared simulation results to the policy retention

points and claim payments.   KPMG Peat Marwick estimated that

Crossroads' reserves were $22,000,000 as of December 31, 1991,

and $30,400,000 as of December 31, 1992.   KPMG Peat Marwick's

reserve estimates included losses for retroceded policies.

          b.   Crossroads' Reserves for Unpaid Losses

     Crossroads' management established its reserves based on its

analysis of the business environment and industry trends, claims

experience, and the KPMG Peat Marwick actuarial reports.

Crossroads recorded reserves in the amounts of $19,410,000 as of

December 31, 1991, and $22,994,000 as of December 31, 1992, on

its financial statements.    These reserves were net of losses for

retroceded policies.   Crossroads' financial statements were


     4
       The Bornheutter-Ferguson method is an actuarial technique
used to estimate the value of a company's reserves by subtracting
its paid losses from its reserves.
     5
       Using the Monte Carlo simulation technique, KPMG Peat
Marwick estimated Crossroads' potential liability by performing
500 simulations of Crossroads' underlying net ultimate losses for
each fund year and sorting the results of the simulations from
lowest to highest to estimate confidence levels.
                                 -9-

prepared according to generally accepted accounting principles

and statutory accounting principles.

C.   Summit Consulting, Inc.

     Petitioner organized Summit Consulting in 1978 and was its

president and majority shareholder until 1984 when he sold it to

Alexander & Alexander Services, a worldwide brokerage firm.    As a

condition of the sale, petitioner continued as president until

January 1, 1986.   Summit Consulting is a third-party

administrator of group self-insurance funds.

     In October 1984, petitioner hired William B. Bull (Bull) to

work for Summit Consulting.    From 1984 to 1986, Bull served as

assistant to the president, vice president of operations, and

executive vice president.   Bull became Summit Consulting's

president and chief executive officer (CEO) on January 1, 1987.

As president and CEO, Bull was responsible for the profitability

and management of the company.    Bull's experience in the

insurance industry had focused predominantly on workers'

compensation.   In the early 1990's, Bull was appointed to the

Governor's Workers' Compensation Task Force in Florida to help

reform the workers' compensation industry.

     From 1978 to 1981, Summit Consulting established each of the

four self-insurer funds reinsured by Crossroads in 1992 and 1993.

Summit Consulting was the third-party administrator of these
                               -10-

funds in 1992 and 1993.   Summit Consulting administered the self-

insurer funds, for which it received a fee of about 30 percent of

the insurance premiums.   It bought 1-year (accident year)6

aggregate reinsurance policies from Crossroads for each of the

self-insurer funds except ESIF.   Crossroads sold reinsurance

policies to Summit Consulting for the Florida Retail Federation

Self-Insurers Fund, the Louisiana Retailers Association Self-

Insurers Fund, and the Louisiana Employers Safety Association

Self-Insurers Fund.   Summit Consulting paid the reinsurance

premiums for these three funds out of the money that it received

as the funds' third-party administrator.   Crossroads sold

reinsurance policies directly to ESIF.

     Petitioner was not part of Summit Consulting's management on

January 1, 1992, or January 1, 1993.

     In January 1996, ESIF bought Summit Consulting.

D.   Gulf Insurance Co.

     Gulf was incorporated under the Companies Law of the Cayman

Islands on January 10, 1992.   Gulf was owned by petitioner and

Paula Dockery, Mavis Dockery, Carl Dockery, and Michele Jones.

E.   Crossroads' Claims Paid and Reserves for Unpaid Losses

     As of December 31, 1995, Crossroads' claims paid, reserves,

and total expected losses for reinsurance policies written as of



     6
       An accident year policy covers accidents that occur from
Jan. 1 to Dec. 31.
                                     -11-

December 31, 1991, net of losses for retroceded policies, were as

follows:

  Taxable year         Cumulative        Reserves for      Total expected
     ending           claims paid1      unpaid losses2         losses3
 Dec. 31, 1991         $3,473,000           $19,410,000      $22,883,000
 Dec. 31, 1992          4,183,000            19,258,000       23,441,000
 Dec. 31, 1993          9,348,000            14,094,000       23,442,000
 Dec. 31, 1994         12,135,000            12,756,000       24,891,000
 Dec. 31, 1995         16,939,000             6,908,000       23,847,000


      1
        Cumulative claims paid were obtained from part 1 of schedule P of
Crossroads' annual statements filed with the Departments of Insurance for the
States of Florida and Louisiana for 1991 to 1995. For each year, cumulative
claims paid is the net of columns 5 and 6 for policy years before 1992.
Policy years after 1991 are excluded to obtain the relevant information for
reinsurance policies written as of Dec. 31, 1991.

      2
        Reserves for unpaid losses were obtained from part 1 of schedule P of
Crossroads' annual statements filed with the Departments of Insurance for the
States of Florida and Louisiana for 1991 to 1995. For each year, reserves for
unpaid losses are the total of column 23 (column 22 for 1991 and 1992) reduced
by reserves for policy years after 1991. Policy years after 1991 are excluded
to obtain the relevant information for reinsurance policies written as of Dec.
31, 1991.

      3
        Total expected losses are the sum of cumulative claims paid and
reserves for unpaid losses.

      As of December 31, 1995, Crossroads' claims paid, reserves,

and total expected losses for reinsurance policies written as of

December 31, 1992, net of retroceded policies, were as follows:
                                     -12-

     Taxable year      Cumulative        Reserves for         Total expected
        ending        claims paid4      unpaid losses5            losses6
 Dec. 31, 1992         $4,376,000           $22,994,000        $27,370,000
 Dec. 31, 1993          9,541,000            18,441,000         27,982,000
 Dec. 31, 1994         12,983,000            17,149,000         30,132,000
 Dec. 31, 1995         18,531,000             8,920,000         27,451,000


      4
        Cumulative claims paid were obtained from part 1 of   schedule P of
Crossroads' annual statements filed with the Departments of   Insurance for the
States of Florida and Louisiana for 1992 to 1995. For each    year, cumulative
claims paid are the net of columns 5 and 6 for policy years   before 1993.
Policy years after 1992 are excluded to obtain the relevant   information for
reinsurance policies written as of Dec. 31, 1992.

       5
        Reserves for unpaid losses were obtained from part 1 of schedule P of
Crossroads' annual statements filed with the Departments of Insurance for the
States of Florida and Louisiana for 1992 to 1995. For each year, reserves for
unpaid losses are the total of column 23 (column 22 for 1992) reduced by
reserves for policy years after 1992. Policy years after 1992 are excluded to
obtain the relevant information for reinsurance policies written as of Dec.
31, 1992.
       6
        Total expected losses are the sum of cumulative claims paid and
reserves for unpaid losses.

       Crossroads' shareholders are liable for tax on its income

from selling reinsurance policies to self-insurer funds in the

United States.      Sec. 957(b).    Crossroads pays dividends to its

shareholders partly to enable them to pay taxes on their

Crossroads' income.

F.     Economic Conditions in 1991-92

       The workers' compensation market in Florida in 1991 and 1992

was chaotic.     Insurance rates were rising about 20-25 percent per

year and claims exceeded premiums.
                                -13-

G.   Petitioner's Gifts of Crossroads' Stock

     On December 31, 1991, petitioner owned 9,600 of the 10,000

shares of common stock of Crossroads and all of the 750,000

shares of preferred stock of Crossroads.    The remaining 400

shares of the common stock were owned equally by Paula Dockery,

Mavis Dockery, Carl Dockery, and Michele Jones.    On January 1,

1992, and January 1, 1993, petitioner gave the following number

of shares of Crossroads' stock to his children:

     Donee               Date of gift           Common shares

Carl Dockery                1/1/92                   448
Michele Jones               1/1/92                   445
Carl Dockery                1/1/93                   637
Michele Jones               1/1/93                   637

These shares represented a minority interest in Crossroads.

H.   Gift Tax Returns and Notice of Deficiency

     Based on a June 22, 1992, appraisal by KPMG Peat Marwick,

petitioner reported on his 1992 and 1993 gift tax returns that

the fair market value of Crossroads' stock was $303 per share on

January 1, 1992, and January 1, 1993.     Petitioner paid gift tax

of $16,749 for 1993.

     Respondent determined that the fair market value of

Crossroads' common stock was $704 per share on January 1, 1992,

and $1,010 per share on January 1, 1993.

                          II.   OPINION

     The sole issue for decision is the fair market value of

Crossroads' stock that petitioner gave to his children on January

1, 1992, and January 1, 1993.
                                -14-

A.   Background

     Section 2501 imposes a tax on gifts of property by an

individual.   Gift tax is based on the fair market value of the

property on the date of the gift.      Sec. 2512(a).   Fair market

value is the price at which the property would change hands

between a willing buyer and a willing seller, neither being under

any compulsion to buy or to sell and both having reasonable

knowledge of the relevant facts.    United States v. Cartwright,

411 U.S. 546, 551 (1973); sec. 25.2512-1, Gift Tax Regs.

     The fair market value of stock is a question of fact.       Hamm

v. Commissioner, 325 F.2d 934, 938 (8th Cir. 1963), affg. T.C.

Memo. 1961-347.    If selling prices for stock in a closely held

corporation which is not listed on any exchange are not

available, then we decide its fair market value by considering

factors such as the company's net worth, earning power, dividend-

paying capacity, management, goodwill, position in the industry,

the economic outlook in its industry, and the values of publicly

traded stock of comparable corporations.      See sec. 20.2031-2(f),

Estate Tax Regs.

     Petitioner has the burden of proving that respondent's

determinations in the notice of deficiency are erroneous.7      Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).



     7
       We need not decide whether to shift the burden of proof to
respondent or modify it, as petitioner contends because we would
reach the same result regardless of which party bears the burden
of proof.
                                    -15-

B.   Fair Market Value of the Gifts From Petitioner to His
     Children

     1.      Expert Testimony

     Petitioner called an expert witness to give his opinion

about the value of the gifts of Crossroads' stock petitioner made

to his children in 1992 and 1993.          We may accept or reject expert

testimony according to our own judgment, and we may be selective

in deciding what parts of an expert's opinion, if any, we will

accept.     Estate of Newhouse v. Commissioner, 94 T.C. 193, 217

(1990); Parker v. Commissioner, 86 T.C. 547, 562 (1986).

     Respondent did not call an expert to testify.         Raymond T.

Wise, Jr. (Wise), is an Internal Revenue Service (IRS) estate and

gift tax attorney who appraised Crossroads' common stock in this

case.     His appraisal is the basis for respondent's trial

position.

     The opinions of petitioner's and respondent's appraisers and

the positions of the parties are as follows:

                                Petition/
               Petitioner's     petitioner's        Deficiency notice and
               returns          expert Gallagher         answer/Wise
Jan. 1,          $303 per           0 per share        $704 per share
1992, gift        share
Jan. 1,           303 per        $215 per share       1,010 per share
1993, gift         share
                               -16-

     Crossroads' projected reserves made by Gallagher,

Crossroads' management, KPMG Peat Marwick, and respondent were as

follows:

Crossroads' reserves as
  estimated by--                      As of 12/31/91     As of 12/31/92

KPMG Peat Marwick,8
  including losses for
  retroceded policies                  $22,000,000       $30,400,000
Crossroads' reserves, net of
  losses for retroceded policies        19,410,000        22,994,000
Gallagher, net of losses
  for retroceded policies               36,011,000        31,805,000
Respondent, net of losses
  for retroceded policies               13,587,000        16,095,800



           2.   KPMG Peat Marwick

     KPMG Peat Marwick annually reviewed the reinsurance policies

and historical claims data for each of the self-insurer funds

reinsured by Crossroads to estimate the value of each fund for

each year.   It used standard actuarial loss development methods

to estimate the size of Crossroads' reserves for 1991 and 1992.

     On June 22, 1992, KPMG Peat Marwick appraised Crossroads'

common stock.   The appraisal was based on the discounted present

value of the future dividend stream available to a U.S. owner of

its stock; KPMG Peat Marwick used a discount rate based on the

     8
       KPMG Peat Marwick's reserve estimates reflect all claims
liabilities and are gross of retroceded policies on the gift
dates.
                                   -17-

then-current market hurdle rate9 for investments of comparable

risk.       KPMG Peat Marwick made various assumptions, including that

Crossroads' reserves should be restated to reflect the gross

reserve estimate (that is, the reserve estimate gross of

retroceded policies) stated in KPMG Peat Marwick's 1991 review of

reserve estimates.       KPMG Peat Marwick estimated that Crossroads'

stock was worth $505 per share, applied a 40-percent discount for

minority interest and lack of marketability, and concluded that

the fair market value of the Crossroads' common stock that

petitioner gave to his children in 1992 and 1993 was $303 per

share.

     3.        Petitioner's Trial Expert:   Thomas Gallagher

        Petitioner hired Thomas L. Gallagher (Gallagher), a property

and casualty actuary with Tillinghast-Towers Perrin, to appraise

Crossroads' common stock as of January 1, 1992, and January 1,

1993, in connection with the trial of this case.        Gallagher has

worked extensively in the workers' compensation industry.

        Gallagher projected a reserve for each of the self-insurer

funds reinsured by Crossroads.       He reviewed the underlying claims

data and extrapolated the historical results for the individual



        9
       A hurdle rate is the minimum rate of return required by an
investor for a proposed investment. Rosenberg, Dictionary of
Banking and Financial Services 344 (2d ed. 1985).
                                 -18-

funds.   He found that the average value of claims increased by

18.7 percent per year from 1981 to 1991.

     Gallagher analyzed Crossroads' balance sheets as of December

31, 1991, and December 31, 1992.    He projected Crossroads' future

distributable earnings from policies in effect on the gift dates

by reviewing the policies' past results and analyzing Crossroads'

loss reserves (embedded value).    He also projected distributable

earnings from policies he expected Crossroads to write after the

gift dates, based on a review of Crossroads' historical results

and market expectations (goodwill value).

     Gallagher assessed market conditions for Crossroads and its

competitors.   He concluded that Crossroads had poor underwriting

experience in most of the years since it began operations.

Gallagher projected that Crossroads' premiums would grow by 5

percent per year for the 5 years after the gift dates, the loss

ratio would be 160 percent for the first year and would decrease

over the next 4 years, and that underwriting expenses would be

12.5 percent of earned premium for all 5 years.

     He discounted the distributable earnings by 20 percent using

risk-adjusted rates of return.    He estimated that Crossroads had

understated its reserves by $16,600,000 on January 1, 1992, and

by $8,800,000 on January 1, 1993.       Using these amounts for

Crossroads' reserves, he estimated that the fair market value of
                                -19-

Crossroads' common stock was zero on January 1, 1992, and

$3,312,000 ($331 per share) on January 1, 1993.

     4.     Respondent's Appraiser:    Raymond Wise

     Wise calculated the value of Crossroads' stock using two

methods:    the book value method and the price/earnings method.

He used Crossroads' assets and liabilities from its December 31,

1991, balance sheet as a starting point to estimate the book

value.    He did not review any of the reinsurance policies or the

underlying claims experience for the self-insurer funds.

     Wise concluded that Crossroads' reserves for unpaid claims

should be reduced by 30 percent based on his review of

Crossroads' balance sheet and what he said was an industry

standard requiring a 50-percent ratio between claims paid and

reserves.    Thus, he multiplied Crossroads' unpaid claims by 70

percent and recorded the product on his adjusted balance sheet.

He added the adjusted unpaid claims to Crossroads' other

liabilities to get its total liabilities "corrected".    He

subtracted total liabilities corrected from Crossroads' total

assets, and projected that the book value of Crossroads' stock

was $1,241 per share as of January 1, 1992, and $1,580 per share

as of January 1, 1993.    Wise estimated the price/earnings value

of Crossroads' stock using Rev. Rul. 59-60, 1959-1 C.B. 237

(which suggests using corporate financial statements for the 5-
                                 -20-

year period before the date of each gift), and the formulas

described in Estate of Feldmar v. Commissioner, T.C. Memo. 1988-

429.    He multiplied Crossroads' pretax weighted average income by

a price/earnings capitalization rate of five to estimate the

value for the stock.     Wise calculated Crossroads' average claim

paid to show whether it had enough reserves to pay its historical

claims.     He projected that the price/earnings value of

Crossroads' stock (using weighted average earnings) was $978 per

share as of January 1, 1992, and $1,537 per share as of January

1, 1993.     He weighted the price/earnings method 60 percent and

the book value method 40 percent to estimate the value of

Crossroads' stock on the gift dates.     He estimated that

Crossroads' stock was worth $1,083 per share as of January 1,

1992, and $1,554 per share as of January 1, 1993.     He then

applied a 35-percent discount and estimated that the stock was

worth $704 per share as of January 1, 1992, and $1,010 per share

as of January 1, 1993.

C.     Analysis

       We accept KPMG Peat Marwick's reserve estimate and appraisal

of Crossroads' common stock instead of those of Gallagher or

Wise.

       1.    KPMG Peat Marwick

       Respondent points out that Crossroads did not discount its

1991 and 1992 reserves for the time value of money, and contends
                                -21-

that KPMG Peat Marwick erred in not recommending that Crossroads

discount its reserves for 1991 and 1992 for the time value of

money as it had recommended that Crossroads do for 1989 and 1990.

     We disagree that KPMG Peat Marwick should have considered

the time value of money in estimating Crossroads' reserves.

First, respondent points out that, as of December 31, 1995, and

without considering the time value of money, KPMG Peat Marwick's

estimate of Crossroads' reserves for 1991 and 1992 had been shown

to be almost 100 percent accurate compared to Crossroads' known

claim losses for those years.   Second, Wise did not reduce

Crossroads' reserves based on time value of money principles, nor

did we reduce the reserves in Estate of Feldmar v. Commissioner,

supra, to account for the time value of money.   Third,

respondent's contention that section 846 requires reinsurance

companies to discount their unpaid losses (or reserves) to take

into account the time value of money misses the mark.     We are not

computing Crossroads' reserve for unpaid losses for income tax

purposes; we are valuing the stock of Crossroads.

     Respondent used KPMG Peat Marwick's reserve estimates and

valuation method as a benchmark to discredit Gallagher's report,

and made no convincing argument that we should not adopt KPMG

Peat Marwick's conclusion.   We conclude that KPMG Peat Marwick's

conclusions were reasonable.
                                -22-

     We do not adopt Gallagher's and Wise's values for the

following reasons.

     2.   Gallagher

     Gallagher greatly overestimated Crossroads' reserves for

1992 and 1993 based on a calculation of reserves that was higher

by 86 percent for 1992 and 38 percent for 1993 than Crossroads'

balance sheet reserves.   He testified that his estimate of

reserves was a major factor in his conclusion that Crossroads had

negative economic value as of January 1, 1992, and a lower value

as of January 1, 1993.    We believe his assumption that Crossroads

would have a 160-percent loss ratio for the first year of future

business based on Crossroads' experience loss ratios over the

period 1982-91 did not give enough weight to the 2 years

immediately before the gifts, during which Crossroads showed a

strong trend towards decreasing loss ratios.     Also, Gallagher's

assumed loss ratio of 160 percent is higher than the average loss

ratio from 1982 to 1991 which was about 144 percent.     He

testified that any closely held insurance company the size of

Crossroads would experience or project a loss if it used an

assumed loss ratio of 160 percent.     We conclude that, by using

Gallagher's inflated reserves and loss ratios, Crossroads was

predisposed to have a negative or lower value.     Gallagher's

reserves and loss ratio assumptions skewed the projected values

of Crossroads' stock to make it appear much less valuable than we
                                -23-

find that it was.    The value of Crossroads' assets increased from

about $4.6 million in 1987 to nearly $50 million in 1993, a

tenfold increase.    Crossroads' net income increased from about

$430,000 in 1987 to $4.6 million in 1993, with an average net

income of about $2.5 million from 1987 to 1993.     We find

Gallagher's assertion that Crossroads' stock was worthless as of

January 1, 1992, to be unlikely in view of the fact that

Crossroads was highly profitable and had not showed a loss since

1987.

     3.   Wise

     Wise's appraisal was based on assumptions that we believe

were inaccurate.    Wise reduced Crossroads' reserves for unpaid

losses by 30 percent.    He said he based this on an industry

standard, but he provided no source or other basis to justify

this adjustment.    Respondent argues that Wise's reduction of

Crossroads' reserves was justified because Crossroads did not

discount its reserves for the time value of money.    We disagree.

As discussed above at paragraph II-C-1, Wise did not reduce

Crossroads' reserves for the time value of money.    Thus,

respondent's theory is a belated attempt to bolster Wise's

arbitrary reduction of Crossroads' reserves.

     Wise used the price/earnings and book value methods this

Court used in Estate of Feldmar v. Commissioner, supra.       However,

Wise misapplied the price/earnings capitalization rate of five
                                -24-

used in Estate of Feldmar to convert Crossroads' weighted average

earnings in that the Court in Estate of Feldmar applied the

capitalization rate to posttax earnings and Wise applied it to

pretax earnings.    The corporation in Estate of Feldmar sold life

insurance, individual and family accident and health insurance,

vehicle warranty/service contracts, and collateral protection

services; Crossroads sells only workers' compensation

reinsurance.    Unlike life insurance, workers' compensation

reinsurance is long-tail insurance because of the length of time

before a reinsurer's obligations mature.    See S. Rept. 99-313, at

502 (1986), 1986-3 C.B. (Vol. 3) 502.    This makes the size of the

reinsurer's reserve much more important because the reinsurer's

liability can extend for longer periods.    Id.

D.   Discount

     Petitioner argues that we should apply a 35-percent discount

for minority interest and lack of marketability to Gallagher's

estimate of the value of Crossroads' stock (zero for January 1,

1992 and $331 per share for January 1, 1993), and thus contends

that the stock was worth zero on January 1, 1992, and $215 per

share on January 1, 1993.

     Respondent agrees that petitioner is entitled to lack of

marketability and minority interest discounts.    Respondent

applied a 35-percent discount to the fair market value of
                                 -25-

Crossroads' common stock on the gift dates in the notice of deficiency.

        KPMG Peat Marwick applied a 40-percent discount.   Because we

found KPMG Peat Marwick's appraisal of Crossroads' stock

reliable, we adopt KPMG Peat Marwick's contention that a 40-

percent discount should be applied to value the Crossroads' stock

petitioner gave to his children in 1992 and 1993.

E.      Conclusion

     We conclude that the fair market value per share of the

stock of Crossroads that petitioner gave to his children was $303

per share on January 1, 1992, and $303 per share on January 1,

1993.


                                             Decision will be entered

                                        that there are no deficiencies

                                        due from petitioner, and there

                                        is no overpayment due to

                                        petitioner.
