Pan-American Life Insurance Company v. Commissioner of Internal Revenue

• Decision Date: 23 December 1938
• Docket Number: Docket No. 84638.
• Parties: PAN-AMERICAN LIFE INSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Board of Tax Appeals

38 B.T.A. 1430 (1938)

PAN-AMERICAN LIFE INSURANCE COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 84638.

Board of Tax Appeals.

Promulgated December 23, 1938.

Eugene J. McGivney, Esq., Solomon S. Goldman, Esq., and Edwin J. Prinz, Esq., for the petitioner.

Allen T. Akin, Esq., for the respondent.

This proceeding is for the redetermination of a deficiency in income tax for the taxable year 1933 in the amount of $4,245.10. The issues remaining for decision after certain concessions made by both parties are as follows:

(1) Is petitioner entitled under section 203 (a) (2) of the Revenue Act of 1932 to deduct from its gross income an amount equal to 3¾ per centum of the mean of its reserve for incurred but not yet accrued disability benefits held at the beginning and end of the taxable year?

2. Is petitioner entitled under section 203 (a) (8) of the Revenue Act of 1932 to deduct from its gross income, as "interest paid or accrued within the taxable year on its indebtedness," the amounts, hereinafter more fully described, of $9,282.31 and $257.88, in connection with certain ordinary life policies, and trust agreements, respectively?

The concessions made by petitioner consist simply of the withdrawal and abandonment of certain assignments of error relating to depreciation of furniture and fixtures and to the deductibility of 3¾ per centum of the mean of two reserves, namely, a reserve for supplementary contracts and a reserve for policies upon which a surrender value may be demanded. The concessions made by the respondent consist of admissions in his brief that petitioner is entitled under section 203 (a) (8) of the Revenue Act of 1932 to deduct from its gross income, as "interest paid or accrued within the taxable year on its indebtedness," the amounts of $4,615.05, $160.98, and $40.28 in connection with certain trust agreements and installment certificates other than the policies and trust agreements referred to in issue (2) above. These concessions made by the respondent and petitioner will be given effect under Rule 50.

FINDINGS OF FACT.

Petitioner is a life insurance company, incorporated under the laws of the State of Louisiana, with its principal office in the city of New Orleans. Its taxable year 1933 is the calendar year 1933. More than 50 per centum of its total reserve funds held during the taxable year were held for the fulfillment of its life insurance and annuity contracts. Among the states in which it transacted business during the taxable year were Louisiana, Oklahoma, Indiana, and Illinois.

During the taxable year petitioner issued life insurance policies some of which carried additional provisions relating to certain noncancelable benefits in case the insured became totally and permanently disabled by accident or disease. These noncancelable benefits, for which in each case the insured obligated himself to pay an additional premium, were of two kinds — (1) waiver of premiums by petitioner in case of total and permanent disability, and (2) both waiver of premiums and payment of monthly income by petitioner in case of total and permanent disability.

Policies which carried additional provisions relating to waiver of premiums only, in case the insured became totally and permanently disabled, provided in part that:

PAN-AMERICAN LIFE INSURANCE COMPANY * * * HEREBY AGREES, that upon receipt by the Company * * * of due proof * * * that the Insured has, while said policy * * * are in full force and prior to the anniversary date of said policy nearest to the sixtieth birthday of the Insured, become totally disabled, as the result of bodily injury or disease occurring after the issuance of said policy, so as to be wholly and continuously prevented thereby from engaging in his own or any other business or occupation and from performing any work for compensation or profit * * * and that such disability has already continued uninterruptedly for a period of at least six months (such disability of such duration being deemed to be permanent only for the purpose of determining the commencement of liability hereunder), the Company during the continuance of such disability will waive the payment of each premium under said policy * * * beginning with the premium, the due date of which next succeeds the date of commencement of such disability, provided that no premium shall be waived the due date of which is more than one year prior to the date of receipt at the Home Office of the Company of written notice of claim hereunder. * * * Notwithstanding that proof of disability may have been accepted by the Company as satisfactory, the Insured shall at any time, on demand from the Company, furnish due proof of the continuance of such disability, but after such disability shall have continued for two full years, the Company will not demand such proof more often than once in each subsequent year.

Policies which carried provisions relating to both waiver of premiums and payment of monthly income in case the insured became totally and permanently disabled carry substantially the same provision as above and in addition another provision which reads as follows:

2. Pay to the insured * * * a monthly income of $10 for each $1,000 of face amount of said policy * * * such monthly income to be paid for each completed month of such continuous disability beginning with the fourth such month, provided, however, that in no case shall any monthly income be paid for the first three months of disability nor for any fractional part of a month of disability, nor for any period of disability more than one year prior to the date of receipt at the Home Office of the Company of written notice of claim hereunder. * * * Notwithstanding that proof of disability may have been accepted by the Company as satisfactory, the Insured shall at any time, on demand from the Company, furnish due proof of the continuance of such disability, but after such disability shall have continued for two full years, the Company will not demand such proof more often than once in each subsequent year.

During the taxable year petitioner maintained a reserve for unpaid and unresisted claims incurred under these disability provisions, which is referred to herein as the "Reserve for Incurred Disability Benefits", in the amounts set forth in the following table:

                ------------------------------------------------------------------------------
                                                                  | Beginning of |
                                                                  |    year      | End of year
                --------------------------------------------------|--------------|------------
                Reserve for premium waiver benefits _____________ | $93,375.27   | $113,674.60
                Reserve for monthly income benefits _____________ | 217,875.64   |  265,240.76
                                                                  | __________   |  __________
                    Total _______________________________________ | 311,250.91   |  378,915.36
                ------------------------------------------------------------------------------
                

The mean of the above reserve amounts to $345,083.13, and 3¾ per centum thereof equals $12,940.62.

The purpose of the reserve for incurred disability benefits is to enable petitioner to pay the benefits which have occurred but which have not yet become due. It is based upon a table which shows the rates of death and recovery from disability. The name of this table is "Hunter's Rates of Termination of Disability on Disabled Lives." The manner of setting up the reserve is to set up the present value of the probable future benefits. This is done by discounting the probable future benefits (either the waiver of premiums or both the waiver of premiums and the payment of a monthly income) at 3½ per centum compound interest, and reducing that amount with the aid of Hunter's table by the probability of the insured living and still being totally and permanently disabled on the premium due date. This manner of setting up the reserve for incurred disability benefits does not differ from the manner in which reserves are set up on noncancelable health and accident insurance policies. The provisions in the policies which carried the noncancelable disability benefits involve life contingencies and differ from provisions of supplemental contracts which involve no life contingency. The reserve for incurred disability benefits is set up only in those policies where the insured has sustained total and permanent disability, and the waiver of premiums or both the waiver of premiums and the payment of a monthly income, depending upon the type of policy, is subject in all cases to the continuance of such disability. The amount in the reserve at the beginning and end of the taxable year is reconciled as follows: To the reserve at the beginning of the year, add the present value of probable future benefits on claims incurred during the year, less reserves released on recoveries during the year, plus compound interest at 3½ per centum per annum. The recoveries occur either by the death of the person who is disabled or by his actually recovering from his disability.

The reserve for incurred disability benefits held by petitioner at the beginning and end of the taxable year was required by the laws of the States of Oklahoma (secs. 10501 and 10502, Oklahoma Statutes, 1931; title 36, secs. 184 and 185, Oklahoma Statutes Annotated) and Illinois (sec. 10, Acts of 1869 as amended in 1907 and 1919; ch. 73, sec. 331, Illinois Revised Statutes, 1935; ch. 73, sec. 221, Smith-Hurd Illinois Annotated Statutes; repealed by Act of 1937, June 29, Laws 1937, p. 696, sec. 453, effective July 1, 1937), two of the states in which petitioner transacted business during the taxable year.

The source of the reserve was premium payments and income from the investments thereof.

Facts relating to interest question. — (We omit from these findings that part of the stipulation which relates to interest deductions which respondent has...