Best Life Assurance Company of California v. Commissioner
| Decision Date | 12 April 2000 |
| Docket Number | Docket No. 11579-96. |
| Citation | 79 T.C.M. 1909 |
| Parties | Best Life Assurance Company of California v. Commissioner. |
| Court | U.S. Tax Court |
Michael R. Schlessinger and Michael A. Clark, for the petitioner. Milton J. Carter, Jr., Gregory M. Hahn, and Keith G. Medleau, for the respondent.
For 1991 and 1992, respondent determined deficiencies in petitioner's Federal income taxes of $369,255 and $242,132, respectively.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
After settlement of some issues, the issue for decision is whether petitioner (Best Life), in computing under section 816(a) the qualifying fraction for life insurance company tax treatment, should treat accrued unpaid losses on cancelable accident and health (CA & H) insurance policies as part of its total reserves.
This case was submitted fully stipulated under Rule 122, and the facts are not in dispute.
During the years in issue, Best Life operated as an insurance company with its principal place of business located in Irvine, California. Best Life insured the following types of insurance risks: Individual ordinary life, cancelable group-term life, and CA & H.
Insurance companies are required by insurance regulators to maintain certain reserves to assure payment of future claims. All 50 States have adopted model regulations and utilize annual statement forms (Annual Statements) promulgated by the National Association of Insurance Commissioners (NAIC) to calculate the amount and to report minimum reserves that insurance companies are required to maintain with respect to their outstanding individual and group health insurance policies. See, e.g., Cal. Code Regs. tit. 10, secs. 2311-2315 (1999).
Since the 1930's, on December 31 of each year (the valuation date), life and accident and health (LA & H) insurance companies have been required under the above NAIC regulations to report on the Annual Statements the amount of their particular obligations either as "liabilities" or as "reserves".
Liabilities, as reflected on Exhibit 11 of the Annual Statements, correspond to claims for which the insurance companies are currently liable including estimates of claims that as of the valuation date have accrued but that have not yet been reported to the companies.
Reserves, as reflected on Exhibits 8 and 9 of the Annual Statements, correspond to claims (computed using recognized mortality and morbidity tables) for which the insurance companies as of the valuation date are expected to become liable some time in the future. On the Annual Statements, liabilities correspond to accrued claims, and reserves correspond to unaccrued claims.
For the years in issue, the following schedule reflects, as indicated on its Annual Statements, the computation by Best Life of its accrued liabilities and of its unaccrued reserves for 1991 and 1992:
Reported on Annual Statements 1991 1992
Accrued liabilities
Exhibit 11, CA & H/Medical ................................ $2,666,371 $2,494,121
========== ==========
Unaccrued reserves
Exhibit 8, Ordinary & Group-Term Life ..................... 1,669,727 2,089,797
Exhibit 9, CA & H/Disability .............................. 419,786 442,261
__________ __________
Total unaccrued reserves ................................ 2,089,513 2,532,058
Discussion
Since 1921, Congress has enacted separate rules of taxation for life insurance companies and nonlife insurance companies. Compare sections 801 through 818 with sections 831 through 835. Generally, insurance companies qualify as life insurance companies and are entitled to the related special tax treatment if more than 50 percent of their total reserves represent life insurance company reserves as defined in section 816(a). Section 816, in pertinent part below, provides the following description of the elements of the life insurance company qualifying 50-percent fraction and of life insurance total 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.
The equation below summarizes the statutory elements of the section 816(a) life insurance company qualifying fraction:
Numerator Denominator Ratio
Life insurance reserves + Life insurance reserves + Percentage
Unpaid losses on noncancelable life, ÷ Unpaid losses + = of life
health, and accident claims All other reserves insurance reserves
In their computations of total life insurance company reserves, the parties agree that the only dispute herein involves whether the term "unpaid losses" in the denominator of the life insurance company qualifying fraction includes accrued unpaid losses on CA & H insurance policies.1
Best Life argues that the term "unpaid losses" in section 816(c)(2) refers only to unaccrued unpaid losses corresponding to the amounts reflected on Exhibits 8 and 9 of its Annual Statements. Best Life argues that accrued unpaid losses reflect current liabilities, not reserves in the NAIC Annual Statement sense, and that they should not be included in the denominator of the qualifying fraction as part of an insurance company's total reserves. Accordingly, for 1991 and 1992, Best Life calculated that it qualified as a life insurance company under section 816 and timely filed U.S. Life Insurance Company income tax returns claiming life insurance company treatment and deductions under section 806 in the amounts of $615,971 and $712,152, respectively.
On audit, respondent treated the accrued amounts (shown on Exhibit 11 of Best Life's Annual Statements) as unpaid losses in the denominator of Best Life's life insurance company qualifying fraction. Based thereon, respondent determined that Best Life did not qualify as a life insurance company as defined under section 816(a). Accordingly, respondent disallowed the claimed life insurance company deductions under section 806.
We recently decided this same issue in favor of another insurance company in Central Reserve Life Corp. & Subs. v. Commissioner [Dec. 53,581], 113 T.C. 231 (1999), which followed the Court of Appeals for the Seventh Circuit's 1992 opinion and analysis in Harco Holdings, Inc. v. United States [92-2 USTC ¶ 50,390], 977 F.2d 1027, 1029 (7th Cir. 1992), revg. [91-1 USTC ¶ 50,031] 754 F. Supp. 130 (N.D. Ill. 1990). We follow the holdings and the analyses set forth in those two opinions.
Therein, it is recognized that Congress promulgated sections 801 through 818 using the specialized language of the insurance industry and that Congress generally intended the language of sections 801 through 818 to be given the technical meaning used by the insurance industry. See Harco Holdings, Inc. v. United States [92-2 USTC ¶ 50,390], 977 F.2d at 1030; Central Natl. Life Ins. Co. v. United States [78-1 USTC ¶ 9378], 216 Ct. Cl. 290, 574 F.2d 1067, 1074 (1978) () (fn. ref. omitted); Alinco Life Ins. Co. v. United States [67-1 USTC ¶ 9249], 178 Ct. Cl. 813, 373 F.2d 336, 352-353 (1967); Central Reserve Life Corp. & Subs. v. Commissioner, supra at 244.
As we understand the history behind the life insurance company qualifying fraction and the terms "unpaid losses" and "reserves" in the LA & H industry, Congress considered and intended that total reserves under section 816 include only "future, unaccrued, and contingent amounts". Harco Holdings, Inc. v. United States, supra at 1031; Alinco Life Ins. Co. v. United States, supra at 347-349; Commissioner v. Monarch Life Ins. Co. [40-2 USTC ¶ 9647], 114 F.2d 314, 325. (1st Cir. 1940), affg. [Dec. 10,447] 38 B.T.A. 716 (1938). The Supreme Court has specifically held that, in the accident and health insurance industry, unpaid losses constitute reserves only as long as they are not accrued. See Helvering v. Oregon Mut. Life Ins. Co. [40-2 USTC ¶ 9829], 311 U.S. 267, 271-272 (1940); Harco Holdings, Inc. v. United States, supra.
Since the late 1930's, when NAIC first developed the predecessors to current LA & H industry regulations and the Annual Statement forms, the insurance industry and the Annual Statements have consistently separated future policy claim reserves (unaccrued unpaid losses on Exhibits 8 and 9) from accrued losses (on Exhibit 11). Because the distinction between "reserves" and "liabilities" has been present in LA & H accounting throughout the relevant tax provisions, NAIC's treatment of accrued unpaid losses on the Annual Statements represents an "authoritative interpretive guide" as to the item's...
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