Phoenix Mut. Life Ins. Co. v. Comm'r of Internal Revenue, Docket No. 31993-87.
| Decision Date | 26 March 1991 |
| Docket Number | Docket No. 31993-87. |
| Citation | 96 T.C. No. 18,96 T.C. 497 |
| Parties | PHOENIX MUTUAL LIFE INSURANCE CO., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
P, a life insurance company, issued group term life insurance policies that provided extended life insurance coverage without further payment of premiums for employees who became totally disabled. P set aside a reserve for employees who had become disabled and eligible for the extended insurance. HELD: The reserve qualifies as a ‘life insurance reserve‘ under section 801(b).
P utilized an annual premium assumption for its group term life insurance policies, resulting in the inclusion of net deferred and uncollected premiums in reserves, assets, and premium income. HELD: The portion of P's reserves attributable to net deferred and uncollected premiums on such policies qualifies as a life insurance reserve under sections 801(b) and 818(a).
P sold ordinary life insurance policies through agents whose responsibilities included explanation of the policy loan features of the policies. P treated the agents' commissions as a general expense and assigned a portion of such commissions to investment expenses. HELD: A portion of such commissions may be assigned to investment expenses under section 804(c)(1). HELD FURTHER: Amount of commissions properly allocable to investment expenses redetermined. Arthur L. Bailey, Gerald A. Kafka, and J. Walker Johnson, for the petitioners.
Diane D. Helfgott, for the respondent.
SUPPLEMENTAL FINDINGS OF FACT AND OPINION
Respondent determined a deficiency in petitioner's Federal income tax for the year ended December 31, 1980, in the amount of $6,223,612. The issues we consider in this supplemental opinion1 are: (1) Whether a reserve set aside by petitioner for insureds who were eligible, under group term life insurance policies, for extended insurance coverage without further payment of premiums by reason of their disability, qualifies as a ‘life insurance reserve‘ under section 801(b),2 (2) whether, in the context of group term life insurance policies, the portion of petitioner's reserves attributable to net deferred and uncollected premiums qualifies as a life insurance reserve under sections 801(b) and 818(a), and (3) whether a portion of the agents' commissions paid by petitioner with respect to ordinary life insurance policies may be treated as a general expense assigned to investment expenses under section 804(c)(1), and, if so, what portion.
Some of the facts have been stipulated for trial pursuant to Rule 91. The stipulations and accompanying exhibits are incorporated in this Opinion irrespective of any restatement below. When the petition in the instant case was filed, petitioner had its principal place of business in Hartford, Connecticut. Because the issues are complex, our remaining findings of fact and opinion are set forth below under separate headings for each issue.
Prior to and during the year in issue, petitioner issued group term life insurance policies to multiple-employer trusts (the trusts) (the memberships of which consisted of various employers) and to single employers. The policies insured the lives of each participating employee (hereinafter employee) of such employers during the period that the policy remained in force, and, in the case of trust policies, while the employer remained a participating member of the trust. The group term life insurance policies were for 1-year periods, and petitioner reserved the right to change the premium rates annually. Some of the policies could be discontinued by petitioner at the annual policy ‘anniversary‘ date upon the giving of 60 days' notice; other policies provided for termination by petitioner upon notice on any premium due date when there were less than a certain number or percentage of employees insured under the policies.
The policies contained special provisions for covered employees who became totally disabled and unable to work prior to reaching the age of 60. Under those provisions (denominated in the policies under the heading ‘Continuation of Insurance Provisions; Extended Insurance‘ and referred to herein as Extended Insurance provisions 3), life insurance coverage would remain in effect beyond the term of the policy, without further payment of premiums, during the period of the employee's total disability. A typical Extended Insurance provision stated in relevant part:
EXTENDED INSURANCE: If, while insured by these Life Insurance Provisions and prior to his sixtieth birthday, an employee becomes and remains totally disabled from an injury or a sickness which completely prevents him from engaging in any work for remuneration or profit, his insurance will continue for one year after cessation of Premium payments thereon. If the employee dies within such year, due proof of the uninterrupted existence of such disability until death must be furnished Phoenix Mutual within one year after death.
If the employee has become totally disabled under the conditions stated above and furnishes Phoenix Mutual, within the year after cessation of premium payments, due proof that such disability has existed uninterruptedly for nine months (herein called ‘initial proof‘), HIS INSURANCE WILL CONTINUE DURING THE PERIOD OF SUCH DISABILITY, subject to (a) annual submission of due proof of the uninterrupted existence of such disability within three months preceding each anniversary of receipt of initial proof, and (b) submission by the employee to examination by a physician, as provided below. However, this continuance of insurance will terminate upon the earliest of (a) cessation of total disability, or (b) failure to submit the required proof of the uninterrupted existence of total disability, or (c) failure to submit to examination by a physician, as provided below, in which event, the employee shall then be entitled to the Conversion Privilege just as if employment had then terminated, unless he returns to work for the Employer within the period allowed for conversion and is again insured by this policy. If the employee dies during this continuance of insurance, due proof must be furnished Phoenix Mutual within one year after death that such disability had existed uninterruptedly from the last anniversary of receipt of initial proof until death. [Emphasis supplied.4]
Thus, if a disabled employee covered by Extended Insurance died before having recovered from his disability, a death benefit would be paid by petitioner. Upon an employee's recovery from disability, however, Extended Insurance protection would terminate, and petitioner would not be liable to pay a death benefit with respect to such employee unless the employee were otherwise covered under one of petitioner's life insurance policies. Because the group policies which provided Extended Insurance were 1-year term policies, the employees covered by Extended Insurance at any particular time might be individuals whose employers no longer were insured with petitioner. The premiums charged by petitioner for group term policies that included Extended Insurance provisions were higher than the amounts charged under identical policies that did not include Extended Insurance provisions. Petitioner did not offer or sell Extended Insurance as an independent ‘contract‘ separate from its group term life insurance contracts.
During the year in issue, petitioner established and maintained a reserve for the Extended Insurance provisions covering employees that had become disabled, in addition to reserves for the basic death benefits under its group term life insurance contracts. On its annual statement filed with the State of Connecticut for the year in issue, the reserve for Extended Insurance was denominated a ‘Disability- Disabled Lives‘ reserve (hereinafter referred to as the Disabled Lives Reserve). The Disabled Lives Reserve reflected a contingent liability for death benefit payments with respect to employees who had ALREADY become totally disabled as of the annual statement date, and was the actuarially determined amount necessary to satisfy future claims for such death benefits. The computation of the Disabled Lives Reserve took into account factors such as the age at which each disabled employee became disabled, the duration of the disability as of the date of computation of the reserve, probabilities of death, and probabilities of recovery from disability.
On its Federal income tax return for the year in issue, petitioner reported the Disabled Lives Reserve as a ‘life insurance reserve‘ under section 801(b). Respondent, in his notice of deficiency, determined that the Disabled Lives Reserve did not qualify as a life insurance reserve, thereby increasing petitioner's taxable investment income.
OPINIONThe issue we must decide concerns section 801(b)(1)(B).
Section 801(b) provides in relevant part:
(b) Life insurance reserves defined. --
(1) In general. -- For purposes of this part, the term ‘life insurance reserves‘ means amounts --
(A) which are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest, and
(B) which are set aside to mature or liquidate, either by payment or reinsurance, future unaccrued claims arising from life insurance, annuity, and noncancellable health and accident insurance contracts (including life insurance or annuity contracts combined with noncancellable health and accident insurance) involving, at the time with respect to which the reserve is computed, life, health, or accident contingencies.
(2) Reserves must be required by law -- * * *
* * *
in addition to the requirements set forth in paragraph (1), life insurance reserves must be required by law.
Respondent concedes that the Disabled Lives Reserve was computed on the basis of recognized mortality or morbidity tables and...
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