Standard Life & Acc. Ins. Co. v. C. I. R.

• Decision Date: 06 November 1975
• Docket Number: No. 75--1075,75--1075
• Citation: 525 F.2d 786
• Court: U.S. Court of Appeals — Tenth Circuit
• Parties: 75-2 USTC P 9811 STANDARD LIFE & ACCIDENT INSURANCE COMPANY, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

Page 786

525 F.2d 786

75-2 USTC P 9811

STANDARD LIFE & ACCIDENT INSURANCE COMPANY, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 75--1075.

United States Court of Appeals Tenth Circuit.

Nov. 6, 1975.

Rehearing Denied Jan. 8, 1976.

Gene A. Castleberry, Oklahoma City, Okl., for appellant.

Meade Whitaker and Gary R. Allen, Attys., Tax Div., Dept. of Justice, Washington, D.C. (Scott P. Crampton, Asst. Atty. Gen., Washington, D.C., Gilbert E. Andrews and Bennet N. Hollander, Attys., Tax Div., Dept. of Justice, Washington, D.C., on the brief), for appellee.

Before HOLLOWAY, McWILLIAMS and BARRETT, Circuit Judges.

BARRETT, Circuit Judge.

Standard Life & Accident Insurance Company (taxpayer) appeals a Tax Court decision ¹ which upheld the Commissioner's deficiency determination against taxpayer for the years 1958, 1959 and 1961. A recitation of the pertinent facts, which were fully stipulated to, will facilitate our review.

Taxpayer, an Oklahoma corporation, is a life insurance company as defined by the Internal Revenue Code, 26 U.S.C.A. §§ 801-820. Taxpayer's operations are subject to regulations adopted by the Insurance Commissioner of Oklahoma. It is further subject to periodic audit by the National Association of Insurance Commissioners (NAIC), which acts on behalf of the insurance departments of the various states.

Taxpayer receives income in the form of premiums which are the agreed price for assuring and carrying a particular risk. The 'gross premium' is the amount actually charged an insured. It includes the 'net valuation premium' and 'loading'. The 'net valuation premium' equals that sum of money necessary under applicable mortality tables to provide the benefits of the policy. This sum is required by Oklahoma law to be added to the policy reserve each year. 'Loading' is that amount added to the 'net valuation premium' for acquisition, management, and operating expenses, profits, and dividends. ² Policyholders pay their premiums in semi-annual, quarterly, or monthly installments.

'Deferred premiums' are premiums due on policies with installment payments. They become due after December 31st of each calendar year but before the anniversary date of the policy. 'Due and unpaid premiums' or 'uncollected premiums' are premiums which are due and payable before the end of the year but which have not been paid. These policies have a 31-day grace period, or longer, for the payment of premiums, during which the policy is carried in full force and effect. There is no obligation, legal or otherwise, on an insured to pay the insurer taxpayer deferred, due and unpaid or uncollected premiums. Nonpayment merely causes the policy to lapse.

Taxpayer is required by the State of Oklahoma and the NAIC to compute its reserves on the majority of its policies as though all premiums are paid up one year in advance of the policy's anniversary date, even though, in actuality, this is generally not the case. These reserves are treated as a liability to an insurance company and considered in making computations under 26 U.S.C.A. §§ 805 (assets) and 809 (gain from operations) of the Life Insurance Company Income Tax Act of 1959.

In filing its tax return for 1958 taxpayer did not include any amount of deferred and uncollected or due and unpaid premiums in computing its assets under Section 805. In filing its return for 1959 and 1961, taxpayer included in its assets only the net valuation premiums (loading was excluded) with respect to its deferred and uncollected and due and unpaid premiums. Furthermore, in 1958, 1959 and 1961, taxpayer also claimed deductions for the increases in loading in computing its gains from operations under Section 809.

On October 31, 1957, taxpayer purchased a block of insurance policies from United Founders Life Insurance Company at a net cost of $219,524.21. Thereafter, taxpayer purchased a block of insurance policies from Commonwealth Life Insurance Company at a net cost of $247,098.22. On October 1, 1960 taxpayer also purchased a block of insurance policies from Great Western Life Insurance Company at a net cost of $77,280.29. On its respective returns, taxpayer deducted as expenses in the years paid, the current costs of the purchase of the blocks of insurance.

The Commissioner held that deferred and uncollected, and due and unpaid premiums must be included under Section 805 as assets and that none of said premiums may be deducted in determining gain from operations under Section 809. The Commissioner also ruled that no portion of the acquisition costs of the blocks of insurance bought in 1957, 1960 and 1961 was deductible.

On de novo review, the Tax Court relied upon Bankers Union Life Insurance Co., 62 T.C. 661 (1974), in holding that deferred and uncollected premiums and due and unpaid premiums must be considered assets and that the premiums could not be excluded from taxpayer's gain from operation under Section 809. The Tax Court relied upon International Life Insurance Co. v. Commissioner of Internal Revenue, 51 T.C. 765, 773 (1969), affirmed per curiam, 427 F.2d 137 (6th Cir. 1970), in its holding that no portion of the cost of acquiring the blocks of cancellable accident and health policies was deductible.

On appeal, taxpayer presents three issues: (1) Whether unpaid premiums ³ and, a fortiori, loading portions thereof are not assets of a life insurance company; (2) Whether unpaid premiums are included in a life insurance company's underwriting income; and (3) Whether purchased blocks of cancellable accident and health insurance policies are wasting assets, the costs of which may be amortizable over their useful lives.

I.

Taxpayer contends that unpaid premiums and, a fortiori, the loading portions thereof, are not assets of a life insurance company, and accordingly should not be considered assets includable under 26 U.S.C.A. § 805. Taxpayer argues that previous cases have erroneously held that because unpaid premiums are included in reserves, giving rise to a liability, such premiums must also be included as an asset in computing a life insurance company's taxable investment income. Taxpayer recognizes authority contrary to its position, e.g. Franklin Life Insurance Company v. United States, 399 F.2d 757 (7th Cir. 1968), cert. denied 393 U.S. 1118, 89 S.Ct. 989, 22 L.Ed.2d 122 (1969), Jefferson Standard Life Insurance Company v. United States, 408 F.2d 842 (4th Cir. 1969), cert. denied 396 U.S. 828, 90 S.Ct. 77, 24 L.Ed.2d 78 (1969), Western National Life Insurance Company of Texas v. Commissioner of Internal Revenue, 432 F.2d 298 (5th Cir. 1970), and Western & Southern Life Insurance Company v. Commissioner of Internal Revenue, 460 F.2d 8 (6th Cir. 1972), cert. denied 409 U.S. 1063, 93 S.Ct. 555, 34 L.Ed.2d 517 (1972). Taxpayer argues that these decisions are in error because 'courts have uniformly overlooked or failed to give sufficient thought to the fact a company cannot be required to include as assets funds which it does not have.'

Taxpayer persuasively contends that although it is obligated to establish reserves for each of its policies, and that the reserves actually exist as a liability, the unpaid premiums do not exist until actually paid. Taxpayer pointedly observes that while the law requires the reserves, it does not require the payment of the premiums which generate the reserves.

The Commissioner of Internal Revenue (Commissioner) contends that the 'Tax Court's determination that such premiums (unpaid) must be included in full in the company's 'assets' for the purposes of computing its 'taxable investment income' under Sections 804 and 805--and must similarly be taken into account in full, without offset or deduction for the loading thereon, in calculating gross premiums for the purpose of computing the company's 'gain from operations' under Section 809, 'is in accord with the pertinent Treasury Regulations and also with the decisions of the four courts of appeal that have previously considered the questions presented herein."

In considering the cases supportive of the Commissioner's position, and recognized by taxpayer, supra, it is significant, we believe, that one of those courts acknowledged that declaring unpaid premiums to be assets was a fiction:

The assumption that the annual premium has been received in full is, of course, a fiction, since annual premiums on all policies have not been received as of the end of the taxable year; rather, a portion thereof remains deferred and uncollected. (It being stipulated in our immediate case that there is no obligation, legal or otherwise, on an insured to pay - - - unpaid premiums.) Franklin Life Insurance Company, supra, 399 F.2d at 760--761.

It is abundantly clear that the other three courts concentrated on uniformity in accounting for reserves (which are required by state law) and in accounting for unpaid premiums (which the Commissioner contends must be considered in determining the income tax due) in upholding the imposition of higher taxes for the insurance companies involved, irrespective of the fact that they did not realize additional income:

Thus, if taxpayer treats its reserve liabilities for tax purposes with a full year's net valuation - - - it should be required to include gross annual premiums . . .

Jefferson Standard Life Insurance Co., supra, 408 F.2d at 856.

We agree with the other two courts that once the accrual method is used (as for reserves as required by state law) it must be applied uniformly (to unpaid premiums), even though the result would be that the asset figure resulting from applying the accrual basis to the gross premiums would not balance with the policyholders' share of the 'net valuation premiums' (giving rise to an inflated asset figure). Western National Life Insurance Company of Texas, supra, 432 F.2d at 301. Thus, if potential liability is to be accrued (reserves as required by state law), we conclude that potential profitability (assets under the pertinent...