94 T.C. 499 (1990), 18187-88, Usaa Life Insurance Co. v. C.I.R.

Docket Nº:18187-88.
Citation:94 T.C. 499
Attorney:Glen H. Kanwit, Richard Bromley, Michael A. Clark, and R. Lee Christie, for the petitioner. Avery Cousins. III, for the respondent.
Case Date:March 26, 1990
Court:United States Tax Court

Page 499

94 T.C. 499 (1990)




No. 18187-88.

United States Tax Court

March 26, 1990

State regulatory authorities required P to maintain a minimum reserve for its universal life insurance policies equal to the total cash surrender value of the policies. P complied with this requirement by listing, in its annual statement filed with the States, two separate reserve amounts that together equaled the total cash surrender value. The annual statement represented one reserve amount as a preliminary term reserve and the other as an excess miscellaneous reserve. P contends that the purported preliminary term reserve was subject to the revaluation provisions of sec. 818(c), I.R.C. 1954, as in effect in 1982 and 1983.

HELD, the total cash surrender value of P's universal life policies was a life insurance reserve within the meaning of sec. 801(b), I.R.C. 1954. HELD FURTHER, P maintained what was essentially a net level reserve for these policies, rather than a preliminary term reserve, and thus was not eligible for a revaluation under sec. 818(c), I.R.C. 1954.

Glen H. Kanwit, Richard Bromley, Michael A. Clark, and R. Lee Christie, for the petitioner.

Avery Cousins. III, for the respondent.


Respondent determined deficiencies in petitioner's Federal income tax in the amounts of $391,571.79 for 1982 and $2,225,593.60 for 1983. After

Page 500

concessions by petitioner, the principal issue for decision is (1) whether petitioner for 1983 was entitled to revalue, under section 818(c), [1] certain of the reserves that corresponded to its universal life insurance policies. If petitioner was so entitled, the issue then becomes (2) whether petitioner's computations relating to the revaluation were correct. If petitioner's computations were incorrect, the issues become (3) whether petitioner may now correct its mistakes and, if so, (4) what the correct amounts are. If it becomes necessary to resolve all of the foregoing issues, the final issue is (5) whether the portion of petitioner's universal life reserves not subject to revaluation is deductible under sections 809(d)(2) and 810(c).

The parties have stipulated that our decision for 1983, apart from the specific amounts involved, will also apply to 1982.


Petitioner, USAA Life Insurance Company, is a Texas insurance company with its principal place of business, at the time its petition was filed, in San Antonio, Texas. Petitioner filed its Federal income tax returns for calendar years 1982 and 1983 with the Internal Revenue Service Center at Austin, Texas.

During the years at issue, petitioner was a life insurance company within the meaning of section 801(a). Petitioner was licensed to do business and did business in all 50 States and the District of Columbia.


So-called ‘ universal life‘ insurance policies are relative newcomers to the insurance industry, having first been issued in the United States in the late 1970s. Typical universal life insurance differs from traditional permanent insurance, known as whole life, largely in terms of its relative variability and flexibility.

Page 501

A whole life policy ordinarily provides for a face amount of insurance that, at the time of issue, is known for the range of possible durations of the policy. Further, although whole life premiums are not necessarily level over the life of the insured, the premium is fixed at issue relative to the face amount of coverage. Based on these predetermined values for face amount and premiums, the insurance issuer is able to fix the cash values at issue. In short, a whole life policy is normally characterized by guaranteed premiums, guaranteed death benefits, and guaranteed cash values.

Universal life insurance, in contrast to whole life, typically has flexible premiums and death benefits, and explicit interest credits, expense charges, and cost-of-insurance charges. This type of insurance allows for varying premiums that do not necessarily maintain a fixed relationship between premiums and face amount. In other words, a policyholder may be able to change the premium without changing the amount of insurance coverage or the amount of insurance may change in a different proportion than a change in premiums. At the time of issue, therefore, the amount of insurance and the premiums are unknown for future durations. The cash values also cannot be forecast with any certainty.

Petitioner's Universal Life Policies [2]

In 1981, petitioner submitted policy specifications and an actuarial memorandum for a universal life policy to the State Board of Insurance for the State of Texas. The actuarial memorandum stated in part that ‘ It is proposed to hold total reserves equal to the accumulated cash values of the policies.‘ The Texas Commissioner of Insurance approved a form universal life policy for petitioner that

Page 502

same year. In 1982, petitioner began selling universal life policies and, by the end of the year, had issued about 1,500 policies with an aggregate face amount of approximately $100 million. The following year, 1983, petitioner issued about 7,000 universal life policies with an aggregate face amount of approximately $513 million.

The death benefit in a universal life policy issued by petitioner was originally computed under one of two possible options. Under one option, the death benefit was equal to the greater of (a) the face amount of the policy or (b) the cash value plus $25,000. Under the other option, the death benefit was equal to the face amount plus the cash value. After issuance, a policyholder was permitted to change the death benefit option or the face amount, subject to evidence of insurability for a death benefit increase.

Petitioner later modified the death benefit provisions, intending that any death benefit paid would be excluded from gross income under section 101(f), as added by the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, sec. 266, 96 Stat. 547. Under the first option, the death benefit became the greater of the face amount or the minimum amount required to qualify as excludable under section 101(f). Similarly, under the second option, the death benefit became the greater of the face amount plus the cash value or the minimum amount required to qualify as excludable under section 101(f).

Petitioner's universal life policies provided a formula for the monthly calculation of a cash value. This cash value affected not only the death benefit, but also the amount a policyholder received upon surrender of the policy and the amount a policyholder could borrow against the policy. Under this formula, greatly simplified, the last computed cash value was increased by premiums received and interest credited and decreased by the cost-of-insurance charge and guaranteed expense charges.

The guaranteed expense charges were equal to three percent of premiums received, plus a $50 front-end charge per policy that was assessed in equal monthly amounts over the first 12 months of the policy. Interest was guaranteed to be credited to the cash value at an annual rate of at least 4-1/2 percent, compounded annually. The policies, however, allowed

Page 503

petitioner to credit interest in excess of this guaranteed rate, which petitioner did throughout 1982 and 1983. Cost-of-insurance charges were guaranteed not to exceed those based on the 1958 Commissioners Standard Ordinary (CSO) mortality table. The policies, however, allowed petitioner to charge a lesser amount, which it did during 1982 and 1983.

Petitioner's universal life policyholders generally made ‘ Planned Periodic Premium Payments‘ in accordance with a schedule in the policy instead of treating the policy as a single-premium investment or insurance contract. Premiums paid in accordance with petitioner's recommendations were intended to supply insurance protection, based on the death benefit selected, for the life of the insured to age 95, at which point the policy would terminate and the cash value would become payable to the policyholder. Petitioner's sales personnel recommended that planned premiums be equal to the premiums charged for participating whole life policies of comparable face amount and age at issue, and that the minimum planned premium be equal to two-thirds of the recommended planned premium.

With petitioner's consent, a policyholder could increase the amount or change the frequency of scheduled premium payments. In addition, a policyholder generally could make unscheduled premium payments, subject to petitioner's right to limit their number and amount.

Assuming that a policyholder complied with the terms of the universal life policy, petitioner had a contractual obligation to accept and apply premium payments as detailed in the policy. On the other hand, as with any insurance policy, petitioner's universal life policyholders did not have a contractual obligation to make any premium payments. Moreover, if payments were discontinued, petitioner was obligated to provide renewable monthly term insurance coverage for so long as the cash value of the policy, less any offsetting indebtedness, was sufficient to cover the monthly cost-of-insurance charges and the remaining monthly assessments, if any, of the $50 front-end charge.

As required by the applicable law for the State of Texas and other States, petitioner's universal life policies allowed a policyholder to receive the cash value if the policy was

Page 504

surrendered to petitioner before its termination. If a policyholder made only a partial surrender, then only a part of the cash value was paid. Although petitioner charged no fee for a total...

To continue reading