Best Life Assur. Co. of California v. C.I.R., 00-71082.

• Decision Date: 11 February 2002
• Docket Number: No. 00-71082.,00-71082.
• Citation: 281 F.3d 828
• Parties: BEST LIFE ASSURANCE COMPANY OF CALIFORNIA, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

281 F.3d 828

BEST LIFE ASSURANCE COMPANY OF CALIFORNIA, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 00-71082.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted December 3, 2001.

Filed February 11, 2002.

Michael A. Clark, Robert N. Hochman, Sidley & Austin, Chicago, IL, for petitioner-appellee Best Life Assurance Company.

David I. Pincus, Robert W. Metzler, United States Department of Justice, Tax Division, Washington DC, for respondent-appellant Commissioner of Internal Revenue.

On Petition for Review of an Order of the United States Tax Court; Stephen J. Swift, Tax Court Judge, Presiding.

Before: BROWNING, REINHARDT, and TALLMAN, Circuit Judges.

OPINION

TALLMAN, Circuit Judge.

The Commissioner of Internal Revenue challenges the Tax Court's determination that, because the term "unpaid losses" in Internal Revenue Code ("I.R.C." or "Code") § 816(c)(2) includes only unaccrued unpaid losses, taxpayer Best Life Assurance Company of California ("Best") qualifies as a life insurance company under § 816(a). A qualified life insurance company is entitled to special tax treatment under the Code. We have jurisdiction under I.R.C. § 7482(a)(1), and we affirm.

I

Best is a California company that writes life insurance contracts and cancellable accident and health insurance contracts. States require insurance companies such as Best to maintain defined levels of solvency to assure the payment of future claims. In addition to their annual tax returns, in California these companies are required to file reports of their anticipated liabilities and reserves with the Insurance Department on Annual Statement Forms promulgated by the National Association of Insurance Commissioners ("NAIC"). In its present form, the Annual Statement characterizes reserves as claims for which the insurer will become liable in the future, i.e., unaccrued claims, and it characterizes liabilities as claims for which the insurer is presently liable, i.e., accrued claims.¹

Special rules of taxation are applied to companies that are classified as life insurance companies under the Tax Code. Section 816(a) defines a "life insurance company" as an insurance company engaged in the business of issuing certain specified types of insurance if "(1) its life insurance reserves (as defined in [§ 816(b)]²), plus (2) unearned premiums and unpaid losses (whether or not ascertained), on noncancellable life, accident or health policies not included in life insurance reserves, comprise more than 50 percent of its total reserves (as defined in [§ 816(c)] )." 26 U.S.C. § 816(a) (2001). Section 816(c) defines total reserves as "(1) life insurance reserves, (2) unearned premiums, and unpaid losses (whether or not ascertained), not included in life insurance reserves, and (3) all other insurance reserves required by law." 26 U.S.C. § 816(c) (2001).³

As used in the statute at issue, an unpaid loss can be described as an estimate of the insurance company's liability for claims arising out of injuries that have already occurred. Unpaid losses can be both accrued, for example where medical expenses from an injury have already been incurred, or unaccrued, for example where future expenses from that injury will be incurred but are not yet known.

On its 1991 and 1992 federal income tax returns, Best claimed that it was a life insurance company as defined in § 816(a). Best applied the § 816(a) formula to both its returns and its Annual Statement and determined that its ratio of qualifying reserves to total reserves exceeded 50% for both 1991 and 1992. In making this determination, Best excluded accrued unpaid losses from the "unpaid losses" portion of the denominator figure of the reserve ratio.

Based on its audit of Best's 1991 and 1992 returns, the Commissioner determined that Best had incorrectly computed the reserve ratio. The Commissioner stated that Best should not have excluded its accrued unpaid losses from the denominator of the qualification fraction. When these amounts were included, the ratio for both years dropped below 50%. Thus, the Commissioner determined that Best did not qualify as a life insurance company under the statute and asserted deficiencies in Best's income tax for 1991 and 1992.

The Tax Court agreed with Best. Relying heavily on the Seventh Circuit's decision in Harco Holdings, Inc. v. United States, 977 F.2d 1027 (7th Cir.1992), as well a prior Tax Court opinion, the court determined that "the term `unpaid losses' has acquired a specialized meaning in the[life and accident and health insurance] industry that includes only ... unaccrued unpaid losses." The Tax Court further stated that it was not bound by our statements and analysis in United States v. Occidental Life Ins. Co., 385 F.2d 1 (9th Cir.1967), since that decision did not "clearly establish a position on the meaning of the term `unpaid losses' under current section 816 that signals to us an inevitable reversal upon appeal."

Based on the language and legislative history of the statute, we hold, in accordance with the decision of the Seventh Circuit in Harco Holdings, that the Tax Court correctly concluded that the term "unpaid losses" in § 816(c)(2) of the Internal Revenue Code, as understood in the life and accident and health insurance industry, includes only unaccrued unpaid losses.

II

We review the Tax Court's construction of the tax code de novo. See Leslie v. Commissioner, 146 F.3d 643, 650(9th Cir.1998). Although we presume that the Tax Court correctly applied the law, we give no special deference to the Tax Court's decisions. See Custom Chrome, Inc. v. Commissioner, 217 F.3d 1117, 1121 (9th Cir.2000).

Since 1921, companies classified as life insurance companies have been entitled to special tax treatment under the Code. The statutory test for defining life insurance companies as it existed in 1921 was similar to that in current § 816 — it provided that an insurance company was a life insurance company if more than half of its total reserves were life insurance reserves. Revenue Act of 1921, ch. 136, 42 Stat. 227, § 242 (1921). However, because many of the key terms in this definition were left undefined, Congress amended that provision in 1942 in three significant ways. First, it provided a definition for "life insurance reserves." Second, it added "unpaid losses on noncancellable life, health, or accident policies" to "life insurance reserves" in the numerator of the reserve ratio. Finally, it provided a definition for total reserves, the denominator of the reserve ratio, which included unpaid losses. Revenue Act of 1942, Pub.L. No. 77-753, 56 Stat. 798, § 163(a) (1942).

These provisions have been carried forward, substantially unchanged into the current version of § 816. While these new provisions clarified the application of the reserve ratio, they failed to provide a definition of the term "unpaid losses" as used in the denominator of the ratio.

The first decision to address the scope of "unpaid losses" with reference to § 801, § 816's predecessor, was our decision in United States v. Occidental Life Ins. Co., 385 F.2d 1(9th Cir.1967).⁴ In Occidental Life, we were asked to define the scope of the term "unpaid losses" in the context of the now-repealed § 806. Specifically, we determined whether "accrued but unpaid liabilities" on non-life policies should be included in "unpaid losses" for purposes of computing an "adjustment for certain reserves" under § 806. Id. at 2. We said that we could not accept the view that "[r]eserves in the insurance sense means technical reserves"⁵ because (1) the concept of technical reserves was developed in connection with another provision of the statute, (2) "later developments in the method of life insurance company taxation strengthen belief that this narrow interpretation is incorrect," and (3) changes made by the Revenue Act of 1942 showed that "Congress intended that `unpaid losses,' as used in section 806, should include both unaccrued and accrued claims." Id. at 4-7.

We looked to § 801 to support our holding that "unpaid losses" encompassed more than merely technical reserves. See id. at 5. In doing so, we noted that "[a]lthough an examination of section 801 along these comparative lines is not required for a conclusion as to the meaning of `unpaid losses' in section 806, our interpretation of section 801 is nevertheless persuasive in support of the result which we reach." Id. at 5-6 (emphasis added). Based on our determination that the definition of "life insurance reserves" encompassed more than merely technical reserves, and that "most, if not all, unaccrued unpaid loss claims would be included within the ... definition of life insurance reserves," we held that the term "unpaid losses" must include both accrued and unaccrued claims so as to not render § 801 superfluous. Id. at 6.

Nearly 30 years later, the Seventh Circuit in Harco Holdings, Inc. v. United States, 977 F.2d 1027 (7th Cir.1992), directly addressed the question of whether accrued unpaid losses are considered "unpaid losses" for purposes of § 801. Once again, the Commissioner in Harco Holdings argued, as here, that "unpaid losses" meant all unpaid losses, both accrued and unaccrued, while the taxpayer claimed that "unpaid losses" only included unaccrued unpaid losses. Id. at 1030. The Seventh Circuit sided with the taxpayer in holding that accrued unpaid losses are not included in "unpaid losses" for purposes of determining total reserves in the denominator of the reserve ratio. See id. at 1038.

The Seventh Circuit first recognized that while the plain language of § 801 did not differentiate between accrued and unaccrued unpaid losses, "context is important to explain the meaning of otherwise intelligible terms, especially when referring to a complicated and highly technical portion of the tax code." Id. at 1030. And it noted,"[i]t is well established that the technical provisions of section 801 ...