The opinion
T.C. Memo. 1996-75
UNITED STATES TAX COURT
ATLANTIC MUTUAL INSURANCE COMPANY AND INCLUDIBLE SUBSIDIARIES,
Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 25767-93. Filed February 22, 1996.
John S. Breckinridge, Jr., and James H. Kenworthy, for
petitioners.
Phillip A. Pillar and Maureen Nelson, for respondent.
MEMORANDUM OPINION
FOLEY, Judge: Respondent determined a deficiency of
$519,987 in petitioners' Federal income tax for the 1987 taxable
year as a result of alleged "reserve strengthening". Under the
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Tax Reform Act of 1986 (TRA '86), Pub. L. 99-514, sec. 1023, 100
Stat. 2085, 2404, any increases in the loss reserves maintained
by property and casualty insurance companies that constitute
"reserve strengthening" do not qualify for a one-time tax
benefit. In this case, respondent contends that the term
"reserve strengthening" refers to all increases in loss reserves,
while petitioners maintain that the term refers to only those
increases in loss reserves that are attributable to changes in
computation methods or assumptions. Respondent's interpretation
of the term "reserve strengthening" is set forth in section
1.846-3(c), Income Tax Regs. The deficiency in this case is
based on that regulation. In light of this Court's decision in
Western Natl. Mut. Ins. Co. v. Commissioner, 102 T.C. 338 (1994),
affd. 65 F.3d 90 (8th Cir. 1995), we hold for petitioners.
Background
The facts have been fully stipulated under Rule 122 of the
Tax Court Rules of Practice and Procedure and are so found.
Unless otherwise indicated, all section references are to the
Internal Revenue Code in effect for the year in issue.
Atlantic Mutual Insurance Co. (Atlantic) is the common
parent of an affiliated group of corporations within the meaning
of section 1504(a). Atlantic filed consolidated income tax
returns on behalf of the group for all relevant years. At the
time the petition in this case was filed, Atlantic's principal
place of business was in Madison, New Jersey.
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Atlantic was organized in 1842 under the laws of the State
of New York as a mutual marine insurer. Over the years, Atlantic
has expanded its insurance underwriting activities to include
most lines of insurance business available to a property and
casualty (P&C) insurer. Centennial Insurance Co. (Centennial), a
wholly owned subsidiary of Atlantic, is a P&C insurance company
included in Atlantic's consolidated return. Because respondent's
notice of deficiency relates to the activities of both Atlantic
and Centennial, we will refer to the two corporations together as
petitioner.
From 1985 through 1993, petitioner filed an annual statement
with the insurance department of each State in which petitioner
was licensed to conduct insurance business. Each annual
statement was prepared in the format prescribed by the National
Association of Insurance Commissioners (NAIC). A primary purpose
of the annual statement is to provide State insurance
commissioners with information concerning a P&C insurer's
financial condition. The accounting principles on which the
NAIC-prescribed annual statement is based generally have been
incorporated into the Internal Revenue Code sections applicable
to P&C insurers.
On the annual statement, P&C insurers are required to report
estimates of amounts they expect to pay to cover losses that have
already occurred. These estimates are commonly referred to as
"loss reserves" (or simply "reserves"). Petitioner maintained
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three categories of loss reserves: (1) Case reserves, which
reflect estimates of amounts to be paid to resolve claims that
have been reported to petitioner; (2) incurred but not yet
reported (IBNR) reserves, which reflect estimates of amounts to
be paid to resolve claims statistically presumed to have been
incurred but not yet reported to petitioner; and (3) loss
adjustment expense (LAE) reserves, which reflect estimates of
administrative costs to be paid in settling or otherwise
resolving claims. For the years in issue, case reserves
constituted the majority of petitioner's loss reserves.
Petitioner established its case reserves by assigning a
claims adjuster to examine each reported claim and estimate the
ultimate amount, if any, that would be paid to resolve it. Case
reserves simply comprised the aggregate of those estimates.
Overall, petitioner's case reserves totaled $255,655,141 at
yearend 1985 and $277,705,661 at yearend 1986.
Petitioner established its IBNR reserves by applying a
"counts and averages" methodology to each line of insurance
business. Under this method, petitioner computed its IBNR
reserves by multiplying (1) the number of claims that it presumed
would be reported after the accident year by (2) the average cost
it projected to resolve each late-reported claim. Petitioner
based its estimate of these numbers on its experience in prior
accident years and then adjusted the results to reflect actuarial
quarterly reviews of the loss reserves for the preceding year.
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Senior management had discretion in determining the size of the
adjustments. Management made downward adjustments to
petitioner's IBNR reserves of $1,200,000 for 1985 and $100,000
for 1986. Overall, petitioner's IBNR reserves totaled
$93,713,687 at yearend 1985 and $111,708,986 at yearend 1986.
Petitioner established its LAE reserves through a
combination of individual case estimates, formulas, and
judgmental factors. To arrive at an estimate of LAE reserves,
petitioner calculated the ratio of LAE it paid during a preceding
3-year period to total losses it paid during the same period and
used that ratio as a component in certain formulas. Petitioner
maintained two categories of LAE reserves: (1) Allocated loss
adjustment expenses (ALAE), which consisted of expenses
assignable to individual claims (e.g., legal fees and costs), and
(2) unallocated loss adjustment expenses (ULAE), which consisted
of expenses not assignable to individual claims (e.g., rent
allocable to the claims department). Petitioner used different
formulas to compute each category of its LAE reserves.
Petitioner's management then adjusted the ALAE (but not the ULAE)
estimate based on quarterly loss and LAE reviews. Overall,
petitioner's LAE reserves totaled $72,317,450 at yearend 1985 and
$84,066,519 at yearend 1986.
Respondent tested for "reserve strengthening" by applying
the formula set forth in section 1.846-3(c)(3), Income Tax Regs.,
to each of petitioner's lines of insurance business for pre-1986
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accident years. Under the formula, petitioner's reserves at
yearend 1985 were reduced by the claims and the LAE paid in 1986
with respect to those reserves. To the extent that, at yearend
1986, a reserve was greater than the amount determined under the
formula, the excess was treated as a net increase to that reserve
account (i.e., "reserve strengthening"). To the extent that, at
yearend 1986, a reserve was less than the amount determined under
the formula, the difference was treated as a net decrease to that
reserve account (i.e., "reserve weakening").
Respondent determined that, at yearend 1986, petitioner's
"reserve strengthening" totaled the following amounts:
Reserve Strengthening
Line of Business (Weakening)
Auto liability ...................... ($10,559,423)
Other liability ..................... (1,279,374)
Workers' compensation ............... 4,691,659
Multiple peril ...................... 15,585,877
Schedule O1 (1985) .................. (3,870,000)
Schedule O (pre-1985) ............... 1,984,000
Net total ........................ 6,552,739
1
Schedule 0, a part of the annual statement filed with the
National Association of Insurance Commissioners, contains
combined loss data on several lines of insurance business with
respect to which claims are filed and settled within a relatively
short period.
Respondent then discounted, pursuant to section 846, the
amount determined as "reserve strengthening" in order to
calculate the effect on petitioner's gross income.1 After
1
For a discussion of sec. 846 and discounting generally, see
sec. I.A., "The Change from Undiscounted to Discounted Reserve
Accounting", in the Discussion section of this opinion.
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discounting the amounts shown in the foregoing chart, respondent
determined that petitioner understated its 1987 income as
follows:
Line of Business Income Adjustment
Auto liability ...................... ($1,211,842)
Other liability ..................... (309,970)
Workers' compensation ............... 1,211,652
Multiple peril ...................... 1,783,897
Schedule O (1985) ................... (239,446)
Schedule O (pre-1985) ............... 104,748
Net total ........................ 1,339,039
Respondent further determined that this $1,339,039 understatement
of petitioner's 1987 income resulted in a $519,987 understatement
of petitioner's 1987 income tax liability.
Discussion
I. Overview
TRA '86 substantially revised the rules that govern the
taxation of P&C insurance companies by requiring P&C insurers to
discount loss reserves for purposes of section 832(b)(5)
(discussed below). The change from undiscounted to discounted
methodology eliminated a tax benefit attributable to the time
value of money. It also required taxpayers to change their
accounting methods. To facilitate a smooth transition to the new
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rules, Congress included two relief provisions in the
legislation--the "transition rule" and the "fresh start".
A. The Change From Undiscounted to Discounted Reserve
Accounting
Section 832(c)(4) permits P&C insurers to deduct "losses
incurred", as defined in section 832(b)(5), in each taxable year.
Under section 832(b)(5), losses incurred are defined as the
excess of (1) the sum of (a) losses paid during the current tax
year and (b) yearend reserves in the current tax year over
(2) yearend reserves in the preceding tax year. Prior to 1986,
section 832 provided P&C insurers with a significant tax benefit.
It permitted them to take current deductions for future payments
without requiring them to make any adjustments for the time value
of money. To eliminate this benefit, TRA '86 added section 846.
Section 846 requires reserves for taxable years beginning after
December 31, 1986, to be discounted and thus reduces the losses
incurred deduction (as calculated under section 832(b)(5)) to
reflect the time value of money.
Without a relief provision, section 846 would have required
P&C insurers to compare undiscounted 1986 reserves with
discounted 1987 reserves for purposes of computing their losses
incurred deductions for 1987. Such an "apples-to-oranges"
comparison would have significantly reduced the losses incurred
deduction for the 1987 tax year. To illustrate, assume a P&C
insurer had loss reserves of $100 million at the end of 1986 and
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$125 million at the end of 1987. But for section 846, the losses
incurred deduction attributable to unpaid losses would have been
$25 million (i.e., $125 million - $100 million). If pursuant to
section 846 the $125 million of reserves at the end of 1987 were
discounted to $110 million, the P&C insurer's losses incurred
deduction would have been reduced from $25 million to $10 million
(i.e., $110 million - $100 million).
To address this problem, Congress included a transition rule
in TRA '86. The transition rule provided that, for purposes of
computing the losses incurred deduction at yearend 1987, 1986
reserves also would be discounted. TRA '86 sec. 1023(e)(2), 100
Stat. 2404. As a result of this transition rule, discounted 1987
reserves were compared with discounted 1986 reserves in computing
the losses incurred deduction for the 1987 taxable year.
B. The Application of Section 481
Even with the transition rule described above, P&C insurance
companies remained subject to adverse tax consequences due to the
application of section 481. When a taxpayer changes its method
of accounting, section 481 generally requires that the taxpayer
make adjustments to prevent amounts from being duplicated in or
omitted from its taxable income. Compliance with the requirement
that P&C insurers change the basis for computing their losses
incurred deductions from an undiscounted to a discounted
methodology constituted a change in accounting method. Thus,
section 481 would have required P&C insurers to recognize as
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income the difference between (1) the undiscounted amount of loss
reserves, as of yearend 1986, included in the computation of the
losses incurred deduction for 1986 and (2) the discounted amount
of such loss reserves.
To avoid triggering section 481 adjustments, Congress
provided P&C insurers with a "fresh start" pursuant to section
1023(e)(3) of TRA '86. TRA '86 sec. 1023(e)(3)(A), 100 Stat.
2404. This section provides as follows:
(3) Fresh start.--
(A) In general.--Except as otherwise provided in
this paragraph, any difference between--
(i) the amount determined to be the unpaid
losses and expenses unpaid for the year preceding the
1st taxable year of an insurance company beginning
after December 31, 1986, determined without regard to
paragraph (2) [i.e., without discounting], and
(ii) such amount determined with regard to
paragraph (2) [i.e., with discounting],
shall not be taken into account for purposes of the Internal
Revenue Code of 1986.
In essence, the fresh start provision overrode section 481 by
excluding from taxable income the difference between the amount
of the yearend 1986 undiscounted loss reserves and the discounted
amount of such reserves. In its report, the Committee of
Conference (conference committee) described the effect of the
fresh start provision as a "forgiveness of income". H. Conf.
Rept. 99-841 (Vol. II), at II-367 (1986), 1986-3 C.B. (Vol. 4) 1,
367.
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The fresh start provision, however, created the potential
for abuse. Because the difference between the undiscounted and
discounted loss reserves as of yearend 1986 is excluded from
taxation, P&C insurers could manipulate the fresh start provision
by inflating their reserves. To prevent this abuse, Congress
excluded "reserve strengthening" from the fresh start.
TRA '86, however, did not define "reserve strengthening".
Generally, a P&C insurer's loss reserves may increase due to
either of two factors: (1) Additions required to fund existing
and increasing obligations under policies in force, or
(2) additions required when a method or assumption used in
calculating reserves is changed to produce higher reserves. As
discussed in more detail below, respondent argues that "reserve
strengthening" encompasses both types of additions, while
petitioner contends that the term refers solely to additions
resulting from changes in reserving methods or assumptions.
II. The Statute, Legislative History, and Regulations
The House of Representatives initiated the provision
requiring P&C insurers to discount their loss reserves. H.R.
3838, 99th Cong., 1st Sess. secs. 1021-1027 (1985). The Senate
amended the House's proposal to include both (1) the fresh start
provision and (2) the exclusion of "reserve strengthening" from
the fresh start. See S. Rept. 99-313, at 510 (1986), 1986-3 C.B.
(Vol. 3) 1, 510. Ultimately, the conference committee
substantially revised the "reserve strengthening" language
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contained in both the Senate bill and in the accompanying Senate
Finance Committee report.
The Senate bill contained the following provision:
(B) Reserve Strengthening After March 1, 1986.--
* * * [the fresh start provision] shall not apply to
any reserve strengthening reported for Federal income
tax purposes after March 1, 1986, for a taxable year
beginning before January 1, 1987, and such
strengthening shall be treated as occurring in the
taxpayer's 1st taxable year beginning after December
31, 1986. The preceding sentence shall not apply to
the computation of reserves on any contract if such
computation employs the reserve practice used for
purposes of the most recent annual statement filed on
or before March 1, 1986, for the type of contract with
respect to which such reserves are set up. [H.R. 3838,
99th Cong., 2d Sess., sec. 1022(e)(3)(B), as reported
by the Senate Finance Committee on May 29, 1986.]
The Finance Committee report stated that "reserve
strengthening" consisted of "any adjustments to reserves that are
attributable to changes in reserves on account of changes in the
basis for computing reserves (i.e., reserve strengthening or
reserve weakening) in a taxable year beginning before January 1,
1987". S. Rept. 99-313, supra at 510, 1986-3 C.B. (Vol. 3) at
510.
The differences between the House and Senate versions of
H.R. 3838 were reconciled by the conference committee. The final
bill adopted by the conference committee and enacted into law did
not define "reserve strengthening". It provided as follows:
(B) Reserve Strengthening In Years After 1985.--
* * * [the fresh start provision] shall not apply to
any reserve strengthening in a taxable year beginning
in 1986, and such strengthening shall be treated as
occurring in the taxpayer's 1st taxable year beginning
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after December 31, 1986. [H. Conf. Rept. 99-841 (Vol.
I), at I-338 (1986), 1986-3 C.B. (Vol. 1) 1, 321.]
The conference committee report accompanying the final bill,
however, did provide a definition of "reserve strengthening" and,
in fact, provided a more expansive definition of the term than
that contained in the Finance Committee report. The conference
committee report stated:
Reserve strengthening is considered to include all
additions to reserves attributable to an increase in an
estimate of a reserve established for a prior accident
year (taking into account claims paid with respect to
that accident year), and all additions to reserves
resulting from a change in the assumptions (other than
changes in assumed interest rates applicable to
reserves for the 1986 accident year) used in estimating
losses for the 1986 accident year, as well as all
unspecified or unallocated additions to loss reserves.
This provision is intended to prevent taxpayers from
artificially increasing the amount of income that is
forgiven under the fresh start provision. [H. Conf.
Rept. 99-841 (Vol. II), supra at II-367, 1986-3 C.B.
(Vol. 4) at 367.]
In 1992, the U.S. Treasury Department issued regulations
under section 846 that are based upon the definition of "reserve
strengthening" contained in the conference committee report.
Section 1.846-3(c), Income Tax Regs., provides in relevant part:
(c) Rules for determining the amount of reserve
strengthening (weakening).--(1) In general. The amount
of reserve strengthening (weakening) is the amount that
is determined under paragraph (c)(2) or (3) to have
been added to (subtracted from) an unpaid loss reserve
in a taxable year beginning in 1986. For purposes of
* * * [the fresh start], the amount of reserve
strengthening (weakening) must be determined separately
for each unpaid loss reserve by applying the rules of
this paragraph (c). This determination is made without
regard to the reasonableness of the amount of the
unpaid loss reserve and without regard to the
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taxpayer's discretion, or lack thereof, in establishing
the amount of the unpaid loss reserve. The amount of
reserve strengthening for an unpaid loss reserve may
not exceed the amount of the reserve, including any
undiscounted strengthening amount, as of the end of the
last taxable year beginning before January 1, 1987.
For purposes of this section, an "unpaid loss reserve"
is the aggregate of the unpaid loss estimates for
losses (whether or not reported) incurred in an
accident year of a line of business.
* * * * * * *
(3) Accident years before 1986. (i) In
general. For each taxable year beginning in 1986, the
amount of reserve strengthening (weakening) for an
unpaid loss reserve for an accident year before 1986 is
the amount by which the reserve at the end of the
taxable year exceeds (is less than)--
(A) The reserve at the end of the
immediately preceding taxable year; reduced by
(B) Claims paid and loss adjustment
expenses paid ("loss payments") in the taxable year
beginning in 1986 with respect to losses that are
attributable to the reserve. * * *
III. The Western National Decision
In Western Natl. Mut. Ins. Co. v. Commissioner, 102 T.C. 338
(1994), a Court-reviewed decision, this Court considered facts
virtually identical to those presented in this case. The Court
ruled for the taxpayer, holding that section 1.846-3(c), Income
Tax Regs., is invalid to the extent that it treats all net
additions in 1986, to pre-1986 loss reserves, as "reserve
strengthening". As in the present case, the taxpayer in Western
National had a higher loss reserve balance, for pre-1986 years,
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at yearend 1986 than at yearend 1985, but had not changed its
reserve assumptions or methodology in computing that balance.
The Commissioner argued that all increases in reserves
constituted "reserve strengthening" and that the taxpayer's
increase therefore should have been excluded from the fresh
start. In rejecting the Commissioner's position, the Court cited
the following six factors:
(1) The statute is not ambiguous and uses a term of art
in a portion of the Internal Revenue Code which has
been specially designed for a particular industry and
generally contains industry jargon; (2) the legislative
history materials are internally contradictory in that
there are references to all increases to reserves and
explanations regarding artificial increases or a
specific type of increase; (3) the regulatory
definition of the term "reserve strengthening" does not
comport with insurance industry usage; (4) the
regulatory definition of the term "reserve
strengthening" does not harmonize with its
congressional use 2 years earlier in related and
parallel statutes involving life, rather than PC,
insurance companies; (5) the regulatory approach would
result in anomalous results; and (6) the traditional
industry definition of the term comports with the
concept that Congress was attempting to limit any
attempts by taxpayers to take advantage of the fresh-
start provisions by means of artificial increases to
reserves. * * * [Id. at 360-361.]
The Court placed particular emphasis on several of these
factors. It stated that subchapter L, which sets forth rules
governing the taxation of insurance companies, "is a highly
specialized portion of the Internal Revenue Code which is replete
with the unique nomenclature of the insurance industry." Id. at
342-343. The Court acknowledged that the statute did not provide
a definition of "reserve strengthening" but found that the term
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refers to "a change in the formula or mechanism for calculating a
reserve". Id. at 352. Moreover, the Court noted, Congress had
defined the term as including only changes in assumptions or
methodology when it enacted certain life insurance rules and a
fresh start provision in the Deficit Reduction Act of 1984, Pub.
L. 98-369, sec. 216(b), 98 Stat. 494, 758. Id. at 353. In
rejecting the Commissioner's argument that "reserve
strengthening" has a different meaning in the P&C insurance
industry than in the life insurance industry, the Court concluded
that "Congress could not have expected a different quantitative
or qualitative meaning for the term" depending on the type of
insurer. Id. at 354.
Although section 1.846-3(c), Income Tax Regs., provided a
definition of "reserve strengthening" consistent with the
conference committee report, the Court in essence concluded that
priority must be accorded to the statute, which "contains a term
of art used in an unconditional manner." Id. at 355. Moreover,
the Court noted, the conference committee report states that the
fresh start was "intended to prevent taxpayers from artificially
increasing the amount of income that is forgiven". Id. at 356
n.19 (quoting H. Conf. Rept. 99-841 (Vol. II), supra at II-367,
1986-3 C.B. (Vol. 4) at 367). The Court concluded that the word
"artificially" refers to changes in assumptions or methodology.
Id. By contrast, the taxpayer in Western National merely had
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made routine adjustments to its loss reserves based on its past
reserving practices. Id. at 357.
The Court of Appeals for the Eighth Circuit affirmed the Tax
Court's decision in Western National. It concluded that the term
"reserve strengthening" when used in the life insurance industry
refers to reserve increases attributable to changes in
computational methods or assumptions. Western Natl. Mut. Ins.
Co. v. Commissioner, 65 F.3d 90, 92-93 (8th Cir. 1995). The
court rejected the Commissioner's argument that the term's
meaning in the P&C insurance industry is ambiguous. Id. at 93.
Having decided that the meaning of "reserve strengthening" is
clear in the industry, the court further concluded that the
legislative history underlying the provision is not controlling.
Id. Nevertheless, the court stated that it had reviewed the
legislative history "out of an abundance of caution" and found
"'no persuasive rationale for interpreting the statutory term
"reserve strengthening" in a manner different from industry
usage.'" Id. (quoting Western Natl. Mut. Ins. Co. v.
Commissioner, 102 T.C. at 355).
IV. Respondent's Position
Respondent urges this Court to reconsider its holding in
Western National. Respondent in the present case, as in Western
National, maintains that "reserve strengthening" encompasses all
net additions in 1986 to pre-1986 loss reserves. Respondent
acknowledges that, in the life insurance industry, the term
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"reserve strengthening" has the meaning petitioner ascribes to
it. Respondent continues to contend, however, that the term's
meaning in the P&C insurance industry is ambiguous.
Respondent has presented expert testimony which indicates
that the term is subject to more than one interpretation. One
expert opined that the regulation's definition provided a valid
measurement of "reserve strengthening". Another expert opined
that the regulation's definition, while not technically accurate,
was consistent with a common usage of the term in nonactuarial
reporting. Moreover, respondent notes that the conference
committee report's definition of "reserve strengthening" is fully
consistent with her position. The report stated:
Reserve strengthening is considered to include all
additions to reserves attributable to an increase in an
estimate of a reserve established for a prior accident
year * * * and all additions to reserves resulting from
a change in the assumptions * * * as well as all
unspecified or unallocated additions to loss reserves.
* * * [H. Conf. Rept. 99-841 (Vol. II), supra at II-
367, 1986-3 C.B. (Vol. 4) at 367; emphasis added.]
Respondent also addresses two points made in Western
National regarding the legislative history of "reserve
strengthening". First, respondent argues that the Court's view--
that the conference committee report "conflicts" with other
portions of the legislative history--does not take into account
the evolution of the statute. Conference committees reconcile
differences between House and Senate versions of legislation and
write the final legislation that is enacted into law. In
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respondent's view, therefore, the decision of the conference
committee to reject the language contained in the Senate report
does not create a "conflict" but instead provides the rationale
for the final legislation.
Second, respondent addresses the Court's concern that the
conference committee's definition of "reserve strengthening" is
internally contradictory. The Court found that the conference
committee's definition of the term is "broader than necessary to
accomplish the stated purpose of preventing abuse from artificial
increases". Western Natl. Mut. Ins. Co. v. Commissioner, 102
T.C. at 350. Respondent contends that this point does not
undermine her position, because Congress sometimes finds it
expedient to adopt bright-line rules that do not in every case
effectuate congressional intent precisely.
Because respondent believes that the statute is ambiguous
and the regulations in issue effectively implement the conference
committee's definition of "reserve strengthening", she maintains
that the regulations reflect a reasonable and permissible
construction of the statute.
Respondent argues in the alternative that, if we hold that
"reserve strengthening" includes only those increases in reserves
attributable to changes in methodology or assumptions, we should
determine a lesser deficiency, because all or some of
petitioner's additions to its IBNR and LAE reserves resulted from
management's discretionary adjustments.
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V. Petitioner's Position
Consistent with this Court's holding in Western National,
petitioner maintains that the term "reserve strengthening" is an
insurance industry term of art with a clearly understood
technical meaning. As used in the insurance industry, petitioner
argues, "reserve strengthening" encompasses only those increases
in loss reserves that are attributable to nonperiodic,
significant changes in the assumptions and/or methodologies used
to establish such loss reserves. Because the increase in
petitioner's 1986 reserves for pre-1986 accident years occurred
without a change in methodology, petitioner contends that the
increase does not constitute "reserve strengthening".
Petitioner further argues that there is no need to consider
the legislative history to interpret the term "reserve
strengthening", because the term is unambiguous. Accordingly,
petitioner argues that the regulatory definition of "reserve
strengthening" is invalid to the extent that it treats all net
additions in 1986, to pre-1986 loss reserves, as "reserve
strengthening".
VI. Analysis and Conclusion
Despite respondent's cogent arguments to the contrary, we
hold that petitioner's reserve increases do not constitute
"reserve strengthening". The facts of Western National are
indistinguishable from the present case. Therefore, the doctrine
of stare decisis leads us to the same result. In each case, the
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taxpayer's reserves, for pre-1986 years, at yearend 1986 exceeded
its reserves at yearend 1985, and that excess reflected routine
adjustments made consistent with past reserving practices. In
each case, the taxpayer did not change its reserving assumptions
or methodology.
Respondent attempts to distinguish the present case from
Western National based on the submission of expert testimony. In
Western National, respondent chose not to submit expert testimony
and instead contended that congressional intent, as expressed in
the conference committee report, was determinative. Having lost
on that argument, respondent has submitted expert testimony in
the present case in her attempt to establish that the term
"reserve strengthening" is subject to more than one
interpretation.
The Court's decision in Western National, however, was not
based solely on expert testimony. In fact, the Court in Western
National acknowledged that the expert testimony submitted in that
case "did not establish a universal and precise definition of
reserve strengthening" but concluded that the testimony did
provide "sufficient guidance to enable our recognition of the
conceptual elements involved in industry jargon." Western Natl.
Mut. Ins. Co. v. Commissioner, 102 T.C. at 351 n.10. Moreover,
several of the factors cited by the Court for its decision in
Western National did not depend on expert testimony. For
example, the Court stated that: (1) Congress previously had used
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the term "reserve strengthening" in a life insurance industry
statute in a manner consistent with the taxpayer's
interpretation; (2) respondent's regulation created anomalous
results; and (3) the taxpayer's interpretation of the term
comported with Congress' objective of preventing willful abuse of
the fresh start provision.
Respondent argues in the alternative that we should
determine a lesser deficiency, because all or some of
petitioner's additions to its IBNR and LAE reserves resulted from
management's discretionary adjustments. We disagree. In both
Western National and the present case, case reserves formed the
majority of petitioner's loss reserves and were not adjusted by
management. Moreover, in both cases senior management retained
some discretion to adjust the reserve amounts arrived at through
formulaic computations, and both taxpayers maintained that the
adjustments were made pursuant to actuarial data to ensure the
adequacy of reserves. There were no increases to the reserves
for the period in question attributable to changes in underlying
assumptions or methodology.
To reflect the foregoing,
Decision will be entered
for petitioners.