Usaa Life Insurance Company v. Commissioner
| Decision Date | 14 January 1993 |
| Docket Number | Docket No. 18187-88. |
| Citation | 65 T.C.M. 1756 |
| Parties | USAA Life Insurance Company v. Commissioner. |
| Court | U.S. Tax Court |
Richard Bromley, Glen H. Kanwit, Michael A. Clark, and R. Lee Christie, Three First National Plaza, Chicago, Ill., for the petitioner. Avery Cousins III, for the respondent.
In our original opinion, USAA Life Insurance Co. v. Commissioner [Dec. 46,487], 94 T.C. 499 (1990), revd. without published opinion 937 F.2d 606 (5th Cir. 1991), we held that the total cash surrender value of petitioner's universal life insurance policies represented a life insurance reserve as defined in section 801(b). We further held that petitioner was not entitled to compute its section 809(d)(2) deduction for increased reserves pursuant to the revaluation formula contained in section 818(c)(2) on the ground that petitioner calculated its life insurance reserves under the net level premium method, as opposed to a preliminary term method.
As indicated above, the United States Court of Appeals for the Fifth Circuit reversed our decision in an unpublished opinion.1 USAA Life Insurance Co. v. Commissioner, revd. without published opinion 937 F.2d 606 (5th Cir. 1991). The Fifth Circuit held that petitioner calculated its reserves under a preliminary term method and that petitioner therefore was entitled to a section 809(d)(2) deduction based on a revaluation of those reserves pursuant to section 818(c)(2). USAA Life Insurance Co. v. Commissioner, id. (Slip op. at 2). The Fifth Circuit remanded the case to this Court for consideration of other issues not initially considered by us as a consequence of our holding on the first issue.
The primary issue for decision is whether petitioner is entitled to a further deduction pursuant to sections 809(d)(2) and 810(c) for the portion of petitioner's reserves that are not life insurance reserves under section 801(b). If we find for petitioner on this issue, petitioner will concede the remaining issues. However, if we hold against petitioner, we must decide: (1) Whether petitioner may now correct the computational errors first identified in our original opinion (USAA Life Insurance Co. v. Commissioner [Dec. 46,487], 94 T.C. at 510-511) and (2) if so, what the correct amounts are.
Our original opinion includes detailed findings of fact. Those facts, to the extent they are consistent with the Fifth Circuit's opinion, are incorporated herein by this reference. A summary of the facts relevant to the disposition of this case follows. As in our prior Opinion, we will generally focus on the 1983 year to the extent the parties have stipulated that our holding for 1983 will also apply to 1982.
Petitioner, a life insurance company within the meaning of section 801(a), has its principal place of business in San Antonio, Texas. As discussed in more detail below, the issue for decision in this case relates to reserves that the Texas State Board of Insurance required petitioner to maintain with respect to its outstanding universal life policies.
Generally, life insurance companies apply one of two methods for determining reserves: the net level reserve method or a preliminary term method. Those two methods are discussed at length in USAA Life Insurance Co. v. Commissioner [Dec. 46,487], 94 T.C. at 504-511. For our purposes, it is important to recognize that historically insurance companies calculating reserves under the net level reserve method enjoyed greater tax benefits than those employing a preliminary term method. Section 818(c), enacted as part of the Life Insurance Company Income Tax Act of 1959, Pub. L. 86-69, 73 Stat. 112, was intended to equalize the tax benefits between the two methods. USAA Life Insurance Co. v. Commissioner [Dec. 46,487], 94 T.C. at 519-520. The effect of section 818(c) is to allow those insurance companies that calculate their life insurance reserves under a preliminary term method to revalue those reserves so as to approximate reserves computed under the net level reserve method.
The reserves that an insurance company is required to maintain directly impact the amount of gain or loss the company must report for Federal income tax purposes. Specifically, section 809(d)(2) provides that, in computing its annual gain or loss from operations under section 809(b), a life insurance company may claim a deduction for the net increase in its reserves as determined under section 810. Section 810(b) provides that the deduction for increased reserves referred to in section 809(d)(2) consists of the net annual increase in reserve items described in section 810(c), reduced by the policyholder's share of investment income excluded from the life insurance company's gross income by reason of section 809(a)(1). The items that may be taken into account, as relevant here, are listed in section 810(c) as follows:
(c) ITEMS TAKEN INTO ACCOUNT. — The items referred to in subsections (a) and (b) are as follows:
(1) The life insurance reserves (as defined in section 801(b)).
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(3) The amounts (discounted at the rates of interest assumed by the company) necessary to satisfy the obligations under insurance or annuity contracts (including contracts supplementary thereto), but only if such obligations do not involve (at the time with respect to which the computation is made under this paragraph) life, health, or accident contingencies.
(4) Dividend accumulations, and other amounts, held at interest in connection with insurance or annuity contracts (including contracts supplementary thereto).
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The term "life insurance reserves" is defined in section 801(b)(1) as those amounts that are: (1) Computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest, and (2) set aside to mature or liquidate, either by payment or reinsurance, future unaccrued claims arising from life insurance contracts involving, at the time with respect to which the reserve is computed, life, health, or accident contingencies. Section 801(b)(2) generally provides that in order to qualify as such for tax purposes, life insurance reserves must be those required by law.
Section 818(c) provides that life insurance reserves computed on a preliminary term method may be revalued under either an exact revaluation (section 818(c)(1)) or an approximate revaluation (section 818(c)(2)).
As previously mentioned, petitioner was required by the Texas State Board of Insurance (the Board) to maintain reserves with respect to its universal life policies. In particular, petitioner was required to maintain a minimum reserve equal to the greater of the aggregate cash surrender value of its universal life policies or a computed reserve. As of the close of the calendar year 1983, petitioner maintained reserves of $9,136,718 reflecting the total cash surrender value of its outstanding universal life policies.
Petitioner's universal life policies provide that the owner of a policy may surrender all or part of a policy for its cash value at any time before the policy terminates. Termination of a policy occurs: (1) On the first monthly anniversary date after the owner requests termination by written notice, (2) when the insured dies, (3) when a required premium is not received before the end of a grace period, or (4) when the policy matures.
Petitioner's universal life policies provide a formula for the monthly calculation of a cash value. Under this formula, greatly simplified, the cash value of a policy on the prior monthly anniversary date would be increased by premiums received and interest credited, and decreased by the cost-of-insurance charge and guaranteed expense charges.
Interest was guaranteed to be credited to the cash value at an annual rate of at least 4-1/2 percent, compounded annually. However, the policies allowed petitioner to credit interest in excess of the guaranteed rate, which petitioner did throughout 1982 and 1983. Cost-of-insurance charges were guaranteed not to exceed those based on the 1958 Commissioners Standard Ordinary mortality table. However, the policies allowed petitioner to charge a lesser amount, which it did during 1982 and 1983. Guaranteed expense charges equaled 3 percent of premiums received, plus a $50 front-end charge per policy to be assessed in equal monthly amounts over the first 12 months of the policy.
Cash surrender value is not determined under either a preliminary term or net level reserve method. Rather, cash surrender value is calculated based on a formula (described above) set forth in the policies in question.
During the period in question, the Board required every life insurance company doing business in Texas (including petitioner) to file a year-end annual statement regarding its operations. Minimum aggregate reserves for life insurance policies were required to be listed in exhibit 8, parts A through G, of the annual statement.
Petitioner's annual statement for 1983 reflects that petitioner calculated a preliminary term reserve, as of December 31, 1983, by subtracting $3,802,632 (an unamortized expense) from $9,136,718 (petitioner's cash surrender value approximation of a net level reserve). Petitioner reported the resulting $5,334,086 in exhibit 8, part A (titled "Life Insurance") of its 1983 annual statement, on a line petitioner labeled in part "1958 CSO ALB [Age Last Birthday] 4.5-percent CRVM." Petitioner reported the $3,802,632 amount in exhibit 8, part G, line 3 (titled "Miscellaneous Reserves: For surrender values in excess of reserves otherwise required and carried in this schedule.") These amounts will hereinafter be referred to as the 8A reserve and the 8G reserve, respectively.
Petitioner reported both the 8A and 8G reserve amounts on Form 1120L, Schedule E, for...
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