Royal Highlanders v. Com'r of Internal Revenue, 12621.
| Decision Date | 25 October 1943 |
| Docket Number | No. 12621.,12621. |
| Citation | 138 F.2d 240 |
| Parties | ROYAL HIGHLANDERS v. COMMISSIONER OF INTERNAL REVENUE. |
| Court | U.S. Court of Appeals — Eighth Circuit |
Leonard A. Flansburg, of Lincoln, Neb., (Charles H. Flansburg, of Lincoln, Neb., on the brief), for petitioner.
F. E. Youngman, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and J. Louis Monarch, Sp. Assts. to Atty. Gen., on the brief), for respondent.
Before SANBORN and RIDDICK, Circuit Judges, and DELEHANT, District Judge.
The questions for decision are: (1) whether the amounts carried by the petitioner, a mutual legal reserve life insurance company of Nebraska, in a "Premium Reduction Credit Reserve" should be included in "the reserve funds required by law" in determining the mean of such funds deductible from gross income under § 203 (a) (2) of the Revenue Acts of 1936 and 1938, 49 Stat. 1648, 52 Stat. 447, 26 U.S. C.A.Int.Rev.Code, § 203(a) (2); and (2) whether the petitioner proved that certain amounts which had been included in gross income in its income tax returns for 1937 and 1938 were the net proceeds from the sale of cattle, and, therefore, not a part of its gross income under § 202(a) of the Revenue Acts of 1936 and 1938, 26 U.S.C.A. Int.Rev.Code, § 202(a).
The petitioner was organized as a fraternal society or association in 1896. It issued policies or benefit certificates upon the assessment plan until 1930. Its rates for these policies were inadequate. It maintained two funds, an "Expense Fund" in which it set up the portion of the assessments to be used for expenses, and a mortality fund, know as the "Fidelity Fund", which represented the portion of the assessments held to meet its policy liabilities. Although the society was actuarially insolvent, it had an accumulation in its "Fidelity Fund" representing the excess of assessments paid into the fund over claims paid out of it.
The State of Nebraska in 1927 authorized any fraternal society to issue legal reserve policies, provided that it maintained, with respect thereto, reserves required by the American Experience Table of Mortality with an interest assumption of more than four per cent or by some higher standard. Neb. Session Laws 1927, c. 138, page 379. In September, 1929, the petitioner amended its by-laws to provide for the issuance of legal reserve policies (with cash surrender and loan values) called "Ideal Reserve Policies", at the rates and with the reserves required by the American Experience Table of Mortality, with an interest assumption of 3½%. The amended by-laws provided:
In 1930 the petitioner commenced writing legal reserve policies called "Ideal Reserve Policies", and permitted its members to exchange their old assessment certificates for the new policies. The reserve set up with respect to the legal reserve policies was called the "Ideal Reserve Fund". The petitioner determined the actuarial credit of its assessment members in the mortality fund ("Fidelity Fund"). When a member exchanged his benefit certificate for a new legal reserve policy, he was granted the reduction of premium justified by his actuarial credit, and the credit was transferred by the petitioner from the "Fidelity Fund" to the "Ideal Reserve Fund", but was set up in a "Premium Reduction Credit Reserve" account.
During the time that the petitioner remained a fraternal society, it was not subject to Federal income tax. On May 4, 1937, it became a mutual legal reserve life insurance company under the laws of Nebraska, and was thereafter liable for the federal tax imposed upon the income of such life insurance companies. In its income tax returns for the years 1937 and 1938, in calculating the deduction to which it was entitled under § 203(a) (2) of the Revenue Acts of 1936 and 1938, namely 3¾% "of the mean of the reserve funds required by law and held at the beginning and end of the taxable year,"1 it included in its "reserve funds required by law" its "Premium Reduction Credit Reserve". The respondent disallowed the deduction of the mean of the "Premium Reduction Credit Reserve" on the ground that it was not a reserve fund required by law. Upon review, the Tax Court, after a hearing, affirmed the Commissioner.
Apparently there is no controversy as to the basic facts, as to the applicable law, or as to what constitutes a life insurance reserve. The question is whether the amounts set up in the "Premium Reduction Credit Reserve" represented money or assets of the petitioner which, under the law of Nebraska, it was required to include in its reserves.
The amount of the reserve which a life insurance company is required to set up against its policy liabilities can always be actuarially determined with mathematical accuracy by a valuation of its policies. The reserve on a policy represents the difference between the present value of the future benefits promised the insured and the present value of the future net premiums (the premium specified in the policy less the "loading" for expenses) the insured is to pay. The value of the benefits and the value of future net premiums is never equal except at the instant before the policy becomes effective. At that moment the scales are evenly balanced. With advancing age the value of the future benefits increases, and with the payment of premiums the value of the future net premiums decreases. Therefore, the insurer must maintain a reserve sufficient to equalize the values of what it is to give and what it is to receive, if it is to remain solvent and meet its policy obligation when it matures.
The requirements of the Nebraska law at all the times here material — as is conceded by the parties — relating to the issuance of legal reserve policies by fraternal societies and the exchange therefor of assessment policies, are to be found in Section 44-347 of the Compiled Statutes of Nebraska, Supp.1941.2 That statute requires any fraternal society issuing legal reserve policies (with cash surrender values) to provide and maintain reserves for their payment "on the basis of the American Experience Table of Mortality with an interest assumption of not more than four per cent, or some higher standard." The statute requires the society to show by an annual valuation made by a competent actuary, approved by the Department of Trade and Commerce of the State, that the society is maintaining, as to such policies, the necessary reserves. The statute requires the society to carry as a liability the reserves so determined and to hold the assets represented by such reserves separate and in trust for the legal reserve policyholders. The statute provides that any member of a fraternal society may exchange his benefit certificate "for any other form of certificate issued by such association or society," and that he shall not thereby "lose his accumulated actuarial credit in the funds of the association, but he shall be entitled to the transfer of such funds to the amount of such credit to the funds held for the benefit of such new certificate and shall be entitled to a deduction justified by such credit upon the assessments and payments he shall be required to make for such new certificate." Italics supplied.
It is certain that the laws of Nebraska required the petitioner to maintain reserves on the basis of the American Experience Table of Mortality with an interest assumption of 3½% with respect to the legal reserve policies issued by it. It is, perhaps, not so certain that the laws required the petitioner to transfer the actuarial credit of one of its members in the "Fidelity Fund" to the "Ideal Reserve Fund" when that member exchanged his certificate for a legal reserve policy. It would seem, however, that, by necessary implication, such a transfer was required for the reason that the credit must be "held for the benefit of" the new policy, although used to purchase a reduction of premium, and, unless the credit was transferred to the reserve, there would be an immediate impairment of the reserve required, since the present value of the future benefits would, at the inception of the policy, exceed the present value of the future reduced net premiums.
We think, however, that the important question is whether the reserves, including the "Premium Reduction Credit Reserve", set up by the petitioner against its policy liabilities were in excess of the reserve requirements of the laws of Nebraska. In other words, did the reserves carried exceed those required by the American Experience Table of Mortality with an interest assumption of 3½%? If the reserves set up were not excessive, then they were "reserves required by law."
At the hearing before the Tax Court, Mr. B. B. Gribble, who, for about fifteen years, had been the actuary of the Department of Insurance of the State of Nebraska, which has supervision of insurance in the state, testified that he was familiar with the petitioner and with the transfers of portions of its "Fidelity Fund" to its reserve fund for the legal reserve policies, when benefit certificates were exchanged for such policies; that it was not only necessary mathematically, but a matter of state law, for the petitioner to hold the amounts so transferred as a part of its...
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