Continental Assur. Co. v. United States, 42523.

• Decision Date: 15 October 1934
• Docket Number: No. 42523.,42523.
• Parties: CONTINENTAL ASSUR. CO., Inc., v. UNITED STATES.
• Court: U.S. Claims Court

8 F. Supp. 474

CONTINENTAL ASSUR. CO., Inc., v. UNITED STATES.

No. 42523.

Court of Claims.

October 15, 1934.

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Jay C. Halls, of Chicago, Ill. (Albert L. Hopkins, Stephen M. Reynolds, and Hopkins, Sutter, Halls & De Wolfe, all of Chicago, Ill., on the brief), for plaintiff.

Guy Patten and Edward H. Horton, both of Washington, D. C., and Frank J. Wideman, Asst. Atty. Gen., for the United States.

Before BOOTH, Chief Justice, and GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.

LITTLETON, Judge.

The question presented in this case is whether the amounts of $107,620 and $127,407.73 held by plaintiff at the beginning and end, respectively, of the year 1927 to meet its liability to holders of matured unsurrendered and unpaid coupons attached to certain twenty-payment life policies, styled "special-coupon accumulative additions policy" and ordinary life policies, styled "acceleration-coupon options policy," constituted "reserve funds required by law" within the meaning of section 245 (a) (2) of the Revenue Act of 1926 (26 USCA § 1004 (a) (2).

The amount of each coupon was subject upon the date it matured and became payable by plaintiff to certain options by the holder thereof, as hereinbefore set forth in the findings, one of the privileges being that the matured coupons with interest could be withdrawn in cash without surrender of the policy. No portion of the amount of the matured coupons involved had been withdrawn in cash or otherwise disposed of under other options but it had been allowed by the holders thereof to remain with the company at interest.

Plaintiff contends that the reserve maintained by it to equal the aggregate face amount of all outstanding matured unsurrendered and unpaid coupons was a reserve required by law within the meaning of the taxing statute; that the amount so set aside represented amounts necessary to meet policy obligations, and even though the obligation was represented by a coupon attached to the policy it was just as much a part of the policy as if set out in the body thereof; and that defendant erred in refusing to allow a deduction of $4,700.56, being 4 per cent. of the mean of the amounts held to pay the amount of such matured coupons in the event payment was demanded.

On the other hand, the defendant contends: (1) That the only reserves recognized for purposes of federal taxation are those set up out of premiums when paid to meet contingent obligations of life insurance, computed, in the case at bar, on the American Experience Table of Mortality, plus interest at 3½ per cent. per annum, and held by the company to meet future unaccrued and contingent obligations on its outstanding policies of life insurance; and (2) that the coupon reserves here in issue were not reserves held against future unaccrued and contingent liabilities but ordinary solvency reserves held to cover its fixed liabilities at January 1 and December 31, 1927, to the holders of matured unsurrendered and unpaid coupons which had become absolute and unconditional liabilities of the company.

We are of opinion that the defendant is correct in its contentions and were it not for the decisions hereinafter discussed rendered by the United States Board of Tax Appeals in Standard Life Insurance Co. of America v. Commissioner of Internal Revenue, 13 B. T. A. 13, affirmed in Commissioner of Internal Revenue v. Standard Life Ins. Co. of America (C. C. A.) 47 F.(2d) 218, and followed by the Board of Tax Appeals and the Circuit Courts in subsequent decisions, involving the same question, we would be content to rest our decision approving the action of the Commissioner of Internal Revenue in this case upon McCoach v. Insurance Company of North America, 244 U. S. 585, 37 S. Ct. 709, 61 L. Ed. 1333; Maryland Casualty Co. v. United States, 251 U. S. 342, 40 S. Ct. 155, 64 L. Ed. 297, as modified and explained in United States v. Boston Insurance Company, 269 U. S. 197, 46 S. Ct. 97, 70 L. Ed. 232; New York Life Insurance Company v. Edwards, 271 U. S. 109, 46 S. Ct. 436, 70 L. Ed. 859; Minnesota Mutual Life Insurance Co. v. United States, 66 Ct. Cl. 481; Massachusetts Mutual Life Insurance Co. v. United States, 56 F.(2d) 897, 901, 74 Ct. Cl. 162, and Midland Mutual Life Insurance Co. v. Commissioner of Internal Revenue, 19 B. T. A. 765. Properly interpreted we think these last-mentioned cases establish the principle that the term "reserve" has a special meaning in the law of insurance and means a sum of money variously computed or estimated which, with accretions from interest, is set aside, "reserved," as a fund with which to mature or liquidate, either by payment or reinsurance with other companies, future unaccrued and contingent claims. Also, that reserves for matured accrued claims which are payable in cash or subject to certain options cannot be included in the "reserve required by law" within the meaning of the taxing act. In the case of life-insurance companies, the computation of the reserve, in connection with which the deduction is allowable, is to be made upon the basis of an experience table of mortality and an assumed rate of interest, the calculation of which is an actuarial function, and the reserve intended by the taxing act as a deduction is the amount set aside from premiums and built up by interest accretions to meet existing unmatured insurance, whether fire, marine, or life insurance. This principle excludes, as reserves within the meaning of the federal taxing act, amounts held on account of matured obligations and also amounts held by insurance companies which do not represent insurance in existence during the taxable year for the reason that, in the one case, the reserve has served its purpose and the amounts held have become pure liabilities, and, in the other, there being no insurance as yet in existence, there can be no reserve of the character required by the foregoing rules. In both instances the amounts held represent matured obligations payable or pure liabilities. Any reserves for such matured obligations therefore are solvency reserves required to be maintained as a condition precedent to the doing of business and do not enter into the reserve required to be maintained for the purpose of maturing the insurance risk when the contingency forming the basis of insurance occurs.

The matured unsurrendered and unpaid coupons involved herein and attached to certain of the plaintiff's policies of life insurance had by lapse of time and payment of the required premiums become unconditionally due and payable in cash with interest on demand to their respective holders. The amounts of these coupons were subject to certain options under which the holders could use them in the payment of premiums on the policies to which they were attached or in the purchase of additional paid-up insurance. Such matured, unsurrendered, and unpaid coupons had, however, been left by the holders with the company to accumulate at compound interest at the rate of 3½ per cent. per annum, thereby creating a fund to the credit of the insured which might be applied by him to the payment of premiums or withdrawn in cash at any time. None of the extended options had been exercised. For this reason the company could not and did not carry the amounts reserved to take care of these matured unsurrendered coupons in its life reserves for the face amount of the policies in the annual statement of the above-named company above line seven of the convention edition entitled "net reserve (paid-for basis)," which life reserves were entirely separate and apart from the matured coupon liability reserve. See findings 10 and 11.

It is well established, we think, that not every reserve required by state statute or state officer is a "reserve required by law" within the meaning of the Federal statutes, and it will be helpful, therefore, to examine into the nature and character of the reserve made the subject of the reserve deduction granted by Congress as distinguished from the matured coupon reserves here in question and similar solvency reserves to provide for the payment or discharge, when payment is demanded, of the matured obligations constituting pure liabilities. Such consideration will require a discussion of the underlying characteristics of life insurance reserves in the light of decisions upon the subject. None of the revenue acts has defined the meaning of the term "reserve" required by the law, but the meaning of this term as employed by Congress in the taxing acts has been considered in a number of decided cases involving either fire, marine, casualty, or life insurance companies, under the revenue acts in force prior and subsequent to the Revenue Act of 1921 (42 Stat. 227). The act of 1921 was the statute in which a material change was made in the provisions relating to the taxation of insurance companies. See Massachusetts Mutual Life Ins. Co. v. United States, supra. In McCoach v. Insurance Co. of North America, supra, the question was whether the incurred but unpaid claims of a fire-insurance company were "reserves" required by law. In denying the company's claim that such reserves came within the provision of the taxing statute, the court, at page 589 of 244 U. S., 37 S. Ct. 709, 711, said: "Conceding full effect to this that loss claim reserves were required to be maintained by the State insurance commissioner, it still does not answer the question whether the amounts required to be held against unpaid losses, in the case of fire and marine insurance companies, are held as `reserves,' within the meaning of the Pennsylvania law or of the act of Congress, however they may be designated upon the official forms. As already appears, the Pennsylvania act specifically requires debts and claims of all kinds to be included in the statement of liabilities, and treats them as something distinct from reserves. The object is to exercise abundant caution to maintain the companies...