Amicus Brief — Commissioner v. Standard Life & Accident Insurance
Supreme Court brief1977
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No. 75-1771
In Tue
Supreme Court of the United States
Octroser Term, 1976
COMMISSIONER OF INTERNAL REVENUE,
Petitioner,
v.
STANDARD LIFE & ACCIDENT INSURANCE
COMPANY,
Respondent.
On Wait or CertTiornari To THE Untrep States
Court or APPEALS FOR THE TENTH CIRCUIT
BRIEF AS AMICUS CURIAE OF
1730 Pennsylvania Avenue, N.W.
Washington, D.C. 20006
Franois A. GoopHus, JR.
Dewey, Batiantine, Bussey,
Patmer & Woop
Martruew J. Zinn
Sreproz: & Jonnson
Of Counsel
INDEX
Interest of the Amicus Curiae _._.._______________
Ee Gee, Se nn ai
Statement A 5 eee ge ey NS
I. Since 1909, Life Insurance Reserves ‘‘ Required
by Law’’ for Purposes of Federal Income
Taxation Have Been the Reserves Certified To
by the State Regulatory Authorities Without
Reduction on Account of Deferred and Un-
collected Premiums ____._______
A. Tax recognition of life insurance reserves
B.
based on state requirements _____________
Prudential v. Herold—Life insurance re-
serves and deferred and uncollected pre-
. From 1921 through 1957, life insurance
companies were taxed on their investment
income with an allowance for interest on
reserves required by law, without reduc-
tion on account of deferred and uncollected
The 1959 Act: The changes that Congress
made and those it did not make __________
10
10
10
12
13
II. Congress Intended Life Insurance Companies
to Account for Deferred and Uncollected Pre-
miums in Determining Their Assets and In-
come Under the 1959 Act in the Same Manner
as Those Items Are Accounted For in the
NAIC Annual Statement _______
D. The Government’s Principal Position Pro-
duces Anomalous and Inconsistent Results
FREE PSE MeN FE RET Ae) Se,
CrraTIons
CaSsEs:
Bankers Ltfe Co. v. United States, 412 F.Supp. 62
(i tone
Bankers Union Life Ins. Co., 62 T.C. 661 (1974) __
Brown v. Helvering, 291 U.S. 193 (1934) ________
Commissioner v. Court Holding Co., 324 U.S. 331
ST SEE ET Sat ee Re ee
Commissioner v. Idaho Power Co., 418 U.S. 1
) | Se
Connecticut General Life Ins. Co. v. Eaton, 218
Me , ieeeeeaee
Federal Life Ins. Co. v United States, 527 F.2d
RR ee ne
Franklin Life Ins. Co. v. United States, 399 F.2d
757 (7th Cir. 1968), rev’g 19 AF TR 2d 1734, 67-2
U.S.T.C. 7 9515 (S.D. ILL 1967), cert. denied, 393
eS Ree eran
Great Commonwealth Life Ins. Co. v. United
States, 491 F.2d 109 (5th Cir. 1974) ___________
PAGE
21
21
32
2,3
Ree PO a
Helvering v. New Haven & Shore Line Ry. Co.,
Inc., 121 F.2d 985 (2d Cir. 1941), cert. denied,
I I IID no cccrsenscheniorlic Sianesdiantbiiaioemenienedey
Jefferson Standard Life Ins. Co. v. United States,
408 F.2d 842 (4th Cir. 1969), aff’g im part, rev’g
in part, 272 F.Supp. 97 (D. N.C. 1967), cert.
denied, 396 U.S. 828 (1969) ~._--_-___________
Lincoln Nat’l Life Ins. Co. v. United States, 38
AFTR 2d 76-6126, 76-2 U.S.T.C. § 9772 (Ct. Cl.
EES SS aE ae eer Seats ee ee
Maryland Casualty Co. v. United States, 251 U.S.
SE SD ncietiiiniinetics oe
McCoach v. Ins. Co. of North America, 244 U.S.
IEE ibicih tdcnten in cicinetaiaimeebihatianiniaibtindmatin
Midland Nat’! Life Ins. Co. v. Commissioner, 66
A GED cide tirwcidcncaii
Monumental Life Ins. Co. v. United States, 39
AFTR 2d 77-306, 76-2 U.S.T.C. 9 9787 (Ct. Cl.
Se sien 7
Mutual Benefit Life Ins. Co. v. Herold, 198 F. 199
7 06 a oo
North American Life & Casualty Co. v. Commis-
sioner, 533 F.2d 1046 (8th Cir. 1976), aff’g 63
- i 2 | Serre
Prudential Ins. Co. of America v. Herold, 247
i EE, Se dele NE: chcntinenhabiiiieemen
Republic Nat’l Life Ins. Co. v. United States, 77-1
U.S.T.C. J 9133 (N.D. Tex. 1976) _-_-_.._-____-
Robertson v. California, 328 U.S. 440 (1946) ____-
United Life & Accident Ins. Co. v. Commissioner,
329 F.Supp. 765 (D. N.H. 1971) ~--..--------
United States v. Atlas Life Ins. Co., 381 U.S. 233
Er
PAGE
11, 24
13
iv
PAGE
Western and Southern Life Ins. Co. v. Commis-
sioner, 460 F.2d 8 (6th Cir. 1972), rev’g 55 T.C.
1036 (1971), cert. denied, 409 U.S. 1063 (1972) _. 2,3
Western Nat'l Life Ins. Co. v. Commissioner, 432
F.2d 298 (5th Cir. 1970), rev’g 51 T.C. 824
(1969), modifying 50 T.C, 285 (1968) _.....-_. 2, 3, 23
Sratures AND ReeguLaTiIons:
Administrative Procedure Act, Section 3(b), 5
U.S.C. Section 668(b) ....................-...- 19
Corporation Excise Tax of 1909, ch. 6, Section 38,
EE as Rn ee 12
Income Tax Act of 1913, ch. 16 I1(G)(b), 38 Stat.
Tl. .cuhoesntnietninamie sinalonehinbanentnnaanedaiiinia 12
Internal Revenue Code of 1939, section 201(¢c)(2) 17
Internal Revenue Code of 1954:
I 24
TREE TEED Annictcraiestesdbiiannsntatreptemnniiitutinmbinbtasteiies 4
a es 17, 21
a | a ee 15
Uy Ge dlacieciniteentnttaiminitnnateintintnibittiintens 18
I TD tpsicntecicinicietecnaidiiatiaidinienmigititntuitin 7,11
IED cccnsaetnsntcinintncsntnaniaialaiiein 81
Section 805(b)(4) ~...------------ 19, 20, 21, 25, 26
EE Se RSE Yo wee 16
RCS an aioe Nene ees 16
I ica 16
5 one 7
SE I - i acinenisintdaciicient linda demidaicatinetaiaie 21, 28
ED ciecinc cccntictteessintitteeldaaitcdentinaahiecichiion 28
I SE cecrericieptnccheritesdeeidetecaedieneteteeete 30
YL CS a ee eee 11
I SD A ndincnisisnsiniidnismectiohin 16
RCE Ea Re: ES! 18
v
PAGE
TN RESTON SS Pay Cer eee ae 22, 27
RE CI i denpthitbocdeocdnentakpannits 4, 9, 24, 25, 28
Section 818(¢c) ~....- SR: Re ee ee 16
gS TS eR ae 20
McCarran-Ferguson Act, 15 U.S.C. Sections 1011-
SUTIIIIITIIIT everteripsteinietheniaumalteninainintintamiamnaalenbene 10
‘Revenue Act of 1921, ch. 136, Section 245(a) (2),
gp SRE MR SS ll 12
Revenue Act of 1942, ch. 619, Section 163(a), 56
EE eel FT Set «SER ST We 17
Treasury Regulations No. 62, Art. 681 (1921) .... 18
Treasury Regulations on Income Tax (26 C.F.R.) :
GD 6 cncnnnencanmemnenniinnen 27
Section 1.451-1 —...... sisi Deindioniaiiahiaiineieee 26
CE EE Sn 20
Se Sr 18
EE EE a Oe oe a 18
Section 1.805-5(a) (4) (ii) .....-.-----------.. 26
CEE ee 21
EEN eee ee ee 11
ee ee 18, 25
MISCELLANEOUS:
105 Cong. Rec. 2569, 2576-77 (1959) _....------ 17
Hearings before the Subcommittee on Internal
Revenue Taxation of the Committee on Ways
and Means, 85th Cong., 2d Sess. (1958) ~....-. 15, 28
Hearings before the Committee on Finance, 86th
en 15, 28
H.R. Rep. No. 2833, 77th Cong., 1st Sess. 109
(1942), 1942-2 Cum. Bull. 372, 454 _....------. 17
H.R. Rep. No. 34, 86th Cong., Ist Sess. (1959),
1959-2 Cum. Bull. 736 e#, seqg........-.-..----. 16,17
PAGE
Report on The Taxation of Life Insurance Com-
panies, Subcommittee on Internal Revenue Tax-
ation, House Committee on Ways and Means
[URED Se) GENE cennusancuncesmineitboes 14
S. Rep. No, 1631, 77th Cong., 2d Sess. 145 (1942),
1942-2 Cum. Bull. 504, 612 _...............__. 17
S. Rep. No. 291, 86th Cong., 1st Sess. (1959),
1959-2 Cum. Bull. 770 et. seg, .........---. 6, 16, 17
Treasury Dept., Bureau of Internal Revenue, Bul-
letin H, Income Tax Rulings Peculiar to Life
Insurance Companies (1921) —___. SEI ch 13, 18
In Ten
Supreme Court of the United States
Ocroszr Term, 1976
No, 75-1771
ComMIssioner oF InTreRNAL Revenue,
: Petitioner,
v.
Sranparo Lire & Accipent Insurance Company,
| Respondent.
ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF
APPEALS FOR THE TENTH CIRCUIT
BRIEF AS AMICUS CURIAE OF
AMERICAN COUNCIL OF LIFE INSURANCE
This brief is submitted with the written consent of coun-
sel to both parties filed with the Clerk of the Court.
Interest of the Amicus Curiae
The American Council of Life Insurance is a trade asso-
ciation with a membership of 444 companies engaged in the
life insurance business.' These companies account for 92
percent of the legal reserve life insurance in force in the
United States. |
The issue here involves the treatment of deferred and
uncollected premiums under the Life Insurance Company
Income Tax Act of 1959 (sections 801-820 of the Internal
Revenue Code of 1954, as amended)? (the ‘1959 Act’’). This
is a question of major importance affecting the federal in-
come taxation of every life insurance company.
Lower Court Decisions
No fewer than five different results have been reached
in seeking to resolve the issue presented here. For the
convenience of the Court, we describe them:
(1) The first result, that reached by the Tenth Circuit
in this case and advocated by the taxpayer, would include
no portion of deferred and uncollected premiums in either
assets or income,
(2) The second result, that favored by the Tax Court,
reached by one district court and advocated by the amicus,
would include no more than net deferred and uncollected
premiums in both assets and income.’
(3) The third result, that reached initially by the Fourth,
Fifth, Sixth and Seventh Circuits and advocated by the gov-
' The American Council of Life Insurance came into being through
merger in 1976 of the American Life Insurance Association (suc-
cessor to the American Life Convention and the Life Insurance Asso-
ciation of America) and the Institute of Life Insurance.
2 Unless otherwise indicated, section references are to the Internal
Revenue Code of 1954 (the “Code”’),
3 Vestern Nat'l Life Ins. Co., 50 T.C, 285 (1968), mod., 51 T.C.
824 (1969), rev'd, 432 F.2d 298 (Sth Cir. 1970); Western and
Southern Life Ins., Co., 55 T.C. 1036 (1971), rev'd, 460 F.2d 8 (6th
Cir. 1972), cert. denied, 409 U.S, 1063 (1972) ; cf. Bunkers Union Life
Ins. Co., 62 T.C. 661 (1974); Franklin Life Ins. Co. v. U.S., 19
AFTR2d 1734, 67-2 U.S.T.C. 9 9515 (S.D. Ill. 1967), rev'd, 399 F.2d
757 (7th Cir. 1968), cert. denied, 393 U.>. 1118 (1969),
3
ernment as its ‘‘primary position’’, would include gross de-
ferred and uncollected premiums in both assets and income.‘
(4) The fourth result, that reached more recently by a
number of lower court (including the Fifth and Seventh
' Cireuits) would include gross deferred and uncollected pre-
miums in income’ and assets®, but would allow a reduction
for expenses associated with their collection,
(5) The fifth result, that recommended by one trial
judge in the Court of Claims and advocated by the govern-
ment as its “alternative position’’, would include no por-
tion of deferred and uncollected premiums in either assets
or income but would reduce reser’ es by amounts equal to
the net valuation portion of such premiums.’
4 Franklin Life Ins. Co. v. U.S., 399 F.2d 757 (7th Cir. 1968),
rev'g 19 AFTR2d 1734, 67-2 U.S.T.C. 9515 (S.D, Ill. 1967), cert.
enied, 393 U.S, 1118 (1969) ; Jefferson Standard Life Ins. Co. v.
‘S., 408 F.2d 842 (4th Cir, 1969), aff'g in part, rev'g in part, 272
F.Supp. 97 (D. N.C, 1967), cert. denied, 396 U.S. 828 vail,
Western Nat'l Life Ins. Co. v. Commissioner, 432 F.2d 298 (Sth Cir.
1970), rev'g 51 T.C. 824 (1969), modifying 50 T.C, 285 (1968) ;
Western and Southern Life Ins. Co. v. Commissioner, 460 F.2d 8
(6th Cir, 1972), rev’'g 55 T.C. 1036 (1971), cert. denied, 409 U.S.
1063 (1972).
5Great Commonwealth Life Ins. Co. v. U.S., 491 F.2d 109
a Cir, 1974) ; Federal of Ins. Co. v. U.S., 527 F.2d 1096 (7th
ir, 1975) ; North American Life & Casualty Co. vy. Commissioner, 533
F.2d 1046 (8th Cir. 1976), aff’g 63 T.C. (1974) ; accord, United
Life & Accident Ins, Co. v. Commissioner, 329 F.Supp. 765 (D. N.H.
19785 Midland Nat'l Life Ins. Co. v. Commissioner, 66 T.C. 550
(
®In Bankers Life Co. v. U.S., 412 F.Supp. 62 (S.D. Iowa, 1976),
the excess of gross over net deferred and uncollected premiums
(i.¢., the loading) was held to have been excludable from assets on the
round that such excess constituted an asset used in ¢n insurance
siness. But see Republic Nat'l Life Ins. Co. v. U.S., 77-1 U.S.T.C,
| 9133 (N.D, Tex. 1976).
7 Monumental Life Ins. Co. v. U.S., 39 AFTR2d §] 77-306, 76-2
U.S.T.C, §] 9787 (Ct. Cl. 1976). On the other hand, a week earlier,
another trial judge of the Court of Claims recommended that gross
deferred and uncollected premiums be included in income, that a
deduction be allowed for estimated expenses of collection and that,
absent a statutory change, reserves could not be reduced, Lincoln
Nat'l Life les, Co, v. U.S., 38 AFTR2d 76-6126, 76-2 U.S.T.C.
| 9772 (Ct.Cl. 1976). The Court of Claims itself has not passed on
any aspect of the question.
4
Thus, no court has allowed the government to make any
reduction in reserves. Rather, the differences of opinion
that have arisen have largely been with respect to the treat-
ment of deferred and uncollected premiums in calculating
assets and income.
Position of the Amicus Curiae
First and foremost, it is our position that Congress
meant to afford full tax recognition to aggregate life insur-
ance reserves as certified by the various state regulatory
authorities and that, apart from certain exceptions speci-
fied in the statute, it meant no change in this regard from
prior law. Regardless of how deferred and uncollected
premiums are treated for asset and income purposes,
whether includible in full, in part, or not at all, reserves
as defined in section 801 of the Code should not be reduced
on account of deferred and uncollected premiums,
Beyond this, whether Congress intended to include de-
ferred and uncollected premiums in ‘‘assets’’ and ‘‘income”’
turns on whether it contemplated the application of normal
tax rules and meanings to them, or whether it intended a
special accounting treatment of these items because of their
uniqueness to life insurance companies. If it intended that,
in the computation of ‘‘taxable investment income’’ and
‘‘vain from operations’’, ‘‘assets’’ and ‘‘ineome’’ are to
retain their normal tax meanings, the conclusic« is inescap-
able that deferred and uncollected premiums are neither
assets nor income and the decision below should be affirmed.
On the other hand, if Congie «* meant to supersede those
meanings, the statutory reference 4 section 818(a) to ‘‘com-
putations ... in a manner consistent with the manner
required for purposes of the annual statement approved
by the National Association of Insurance Commissioners’’
(hereinafter ‘‘NAIC’’) should control, since it is the only
statutory provision sanctioning a departure from normal
tax rules. The Annual Statement, a mandatory and uni-
form accounting system for life insurance companies, has
5
for over 100 years required the inclusion of net (as opposed
to gross as contended for by the government) deferred and
uncollected premiums in assets. It follows that if Congress
meant to depart from normal tax principles and require
the inclusion of deferred and uncollected premiums in
assets and income, it meant to adopt the Annual Statement
treatment pursuant to which only net deferred and unco!-
lected premiums are included ia assets and income.
It is, and consistently has been, the position of the amicus
and its predecessors that Congress intended that the NAIC
treatment be followed. While the position of the amicus
constitutes the position of the industry organization as a
whole, not all companies subscribe to the view that we urge
here. Some companies (including, of course, the taxpayer)
believe that there are strong legal arguments to support the
result reached by the court below.
Because we continue to believe that the correct result
under the statute is that net deferred and uncollected pre-
miums should be included in assets and income, our argu-
ments here are directed to this point. Should this Court
not agree, we respectfully suggest that the most appropriate
result is the one reached by the Tenth Circuit below.
Statement
The applicable Code provisions and the facts of this case
are recited in the government’s brief. (P. Br. 3-15).* The
amicus submits, however, that the government’s statement
is misleading in at least three significant respects.
First, the government suggests that the amount of a life
insurance company’s reserve is dependent on the amount
of premiums actually received. The fact is that life insur-
ance reserves are required to be computed with respect to
all policies in force at the end of the year on the basis of
the net premiums that are assumed to have been received,
8 References herein to “P. Br.” are to the government’s brief.
irrespective of what gross premiums may have in fact been
paid by the policyholders. It is stipulated that the taxpayer
in this case was ‘‘required . . . to compute its reserves...
on the assumption that premiums were paid up one year in
advance on each anniversary date . . . of the policy, even
though premiums were not usually paid in this manner.’’
(Stip. par. 11,-p. 17; Pet. App. A 3a, App. B lla).’ The
reserves so computed are the required reserves both for
purposes of Oklahoma law and for purposes of the Code.
Second, the government states that the insurer has no
obligation to continue the insurance coverage beyond the
period for which premiums have been paid. This ignores
the fact that whether the insurance will be continued is a
matter wholly beyond the control of the company. Accord-
ingly, so long as a policy is in force, the company’s con-
' tingent liability (‘‘risk’’) is for the entire life of the
insured."®
Third, the government wrongly states that the com-
putation of taxable investment income is controlled by the
ratio of reserves to assets." The government goes on
to argue that it is justified in adding loading to the net
deferred and uncollected premiums shown in assets on
the balance sheet by the necessity of maintaining its
erroneous ratio in the computation of taxable investment
income. This is a complete non sequitur because there is
no correlation whatever between the ratio of net to gross
premiums and the ratio of reserves to assets.
9 References herein to “Pet.” are to the petition for a writ of
certiorari.
10 Moreover, if a premium is not paid, under the non-forfeiture
provisions the company may remain liable for the full coverage for
an extended period of time without receiving any future premiums
at all.
11 While it is true that an increase in reserves decreases the tax
and an increase in assets increases the tax, the faulty algebra used
by the government to derive its erroneous ratio (P> Br. 6, 40) is
apparent if one follows the statutory provisions which it more ac-
curately describes in n. 6 (P. Br. 6). gre also the example set forth
in S. Rep. No. 291, 86th Cong., Ist sess. 18 (1959), 1959-2 Cum.
Bull. 770, 783. —
7
The government argues that if it does not prev iil
on its primary position, then alternatively the reserves
required by state law should be reduced on account of de-
ferred and uncollected premiums. There is no basis for that
extreme position, and, in the amicus’ view, it should be
rejected out of hand.” But since the government has
seen fit to inject it into the case, the amicus has no choice
but to respond. We do so not only because the government’s
alternative would unsettle what has been settled since the
very beginnings of the income tax, but also because it would
have a most serious financial impact on the entire life
insurance industry. Accordingly, the amicus addresses the
government’s alternative position first. Thereafter, we
address those issues that are genuinely in controversy, i.e.,
the proper treatment of deferred and uncollected premiums
in calculating assets and income.
Summary of Argument
I
In 1909, Congress provided a deduction for federal ex-
cise tax purposes based on reserves of a life insurance
company required by state law. It adopted the same ap-
proach in the first income tax act, that of 1913, and in every
successive income tax statute, including the Life Insurance
Company Income Tax Act of 1959. Among the reserves
required by state law are reserves for all policies in force,
including those on which premiums are deferred or uncol-
lected. Thus, as to such policies, it was stipulated here that
state law requires reserves to be computed on the assump-
tion that all premiums are paid on the anniversary date of
a policy, regardless of when premiums have actually been
received.
121It was stipulated that taxpayer’s “reserves [computed on the
assumption that premiums were paid annually in advance] were re-
flected as a liability of [ yer] and, as required by the [Code],
were taken into account in the computations required under sections
805 and 809 on the . . . tax returns”. Stip. par. 11, p. 17, supra.
There can be no doubt at this late date that, in keeping
with Congress’ overall approach to reserves that the fed-
eral tax law is to follow state law, reserves for tax purposes
are not to be reduced on account of deferred and un<ollected
premiums. This precise issue was raised and decided as
early as 1918, and the Bureau of Internal Revenue itself
concurred in that result in 1921. Furthermore, Congress
on numerous occasions from 1921 through 1957, and in the
1959 Act itself, changed the provisions for reserve deduc-
tions and prescribed certain specific exceptions to the gen-
eral rule that reserves for tax purposes are those required
by state law. But it at no time intimated that there was to
be any change in the established treatment of reserves for
policies with deferred and uncollected premiums.
Despite Congress’ unequivocal record over a period of
50 years, the government contends in the alternative that,
if gross deferre | and uncollected premiums are not included
in assets and income, reserves must be reduced accordingly.
The government claims no support for th.s argument in the
statute, the legislative history, applicable state law, or
industry practice, and there is none. Rather, the govern-
ment relies on a regulation which purports to mandate this
result. By no stretch of the imagination can this regula-
tion be considered an interpretation of the 1959 Act; nor
is there basis for respectable argument that Congress
authorized the promulgation of any such rule. For these
reasons, the regulation is invalid.
In any case, the regulation is inapplicable because, by its
terms, it applies only if deferred and uncollected premiums
are excluded entirely from assets and income. Our position
here, however, is that such premiums should not be ex-
cluded entirely, but that the net amount thereof is properly
includible in assets and income.
The government’s ‘‘primary position’’—that gross de-
ferred and uncollected premiums must be included in assets
and income—similarly has no merit. Under normal tax
accounting rules, it is clear that since an insurance company
has no legal right to such premiums, they constitute neither
assets nor accruable income. The government does not con-
tend otherwise.
_ Our position is that, but for the reference in section
818(a) of the Code to the NAIC Annual Statement, normal
tax accounting rules would apply and deferred and uncol-
lected premiums would be excludable in their entirety from
assets and income. It is further our position that, in view
of that reference, any departure from normal tax account-
ing rules must accord with the prescribed NAIC treatment.
Under consistently applicable NAIC rules, only the net por-
tion of deferred and uncollected premiums is includible in
assets and income and, therefore, only that portion should
be includible in assets and income for tax purposes.
The government claims that neither normal tax ac-
counting rules nor established NAIC rules should be fol-
lowed. Its principal argument is that, since it is assumed in
computing reserves that all net premiums are paid on the
anniversary date of a policy, consistency and symmetry
demand that, in calculating assets and income, it be as-
sumed that all gross premiums are paid annually in advance.
Accordingly, the government would require the inclusion
of gross deferred and uncollected premiums in assets and
income.
In advancing this contention, the government ignores
the fact that a life insurance company necessarily will incur
expenses in the process of collecting deferred and uncol-
lected premiums, and that these expenses will reduce assets
and income. Yet the government nowhere states that it
would permit a reduction in assets and income to reflect such
expenses. In consequence, the government ’s theory would
produce the bizarre result that a company with deferred
and uncollected premiums will have greater assets and in-
come than one that has in fact received an equivalent amount
of premiums in cash.
10
Finally, while the linchpin of the government’s argument
is the need for consistency, the government itself refuses to
be consistent. To be totally consistent, both assets and in-
come would have to be reduced by estimated expenses of
collection of deferred and uncollected premiums. However,
as indicated above, the view of the amicus is that Congress
intended to adopt the well-understood approach of the
NAIC. It did so, not to achieve the notion of symmetry
advocated by the government, but because that approach
was practical, in accord with longstanding requirements of
state regulatory authorities and clearly reflects income.
Argument
I. Since 1909, Life Insurance Reserves “Required
by Law” for Purposes of Federal Income Taxation Have
Been the Reserves Certified To by the State Regulatory
Authorities Without Reduction on Account of Deferred
and Uncollected Premiums -
A. Tax recognition of life insurance reserves based on state
requirements
The computation of life insurance reserves has long been
the exclusive province of state law. Congress confirmed
the preeminent role of the states in life insurance matters
when it enacted the McCarran-Ferguson Act (15 U.S.C.
§§ 1011-1015), and this Court has acknowledged the states’
authority to set ‘‘reasonable minimum reserve standards
for the protection of policyholders.’’ Robertson v. Cali-
fornia, 328 U.S. 440, 459 (1946).
This is no less so in tax matters than in substantive life
insurance matters. The cornerstone of life insurance com-
pany tax treatment in each of the statutes covering life
insurance companies since 1909 has been recognition that
‘‘life insurance companies are required by law to maintain
policyholder reserves to meet future claims, that they
normally add to these reserves a large portion of their
investment income and that these annual reserve increments
, 11
should not be subjected to tax.’’ United States v. Atlas Life
Ins. Co., 381 U.S. 233, 236 (1965)." |
The legally required life insurance reserve, a creature
of state law and a product of actuarial science, is an estimate
of the present value of unaccrued policy obligations. State
laws and regulations impose standards governing the as-
sumptions and estimates that underlie the valuation of
legally required life insurance reserves. Amounts of insur-
ance in force at year-end are multiplied by reserve factors
that are established on the basis of a number of state
approved actuarial assumptions. In the case of ordinary
life insurance, these have customarily included, in addition
to mortality and interest rates, the assumption that all net
valuation premiums on policies in force are paid annually
at the beginning of their respective policy years. Thus, as
the government states (P.Br. 4), it was found below (Pet.
3a) : ‘*Pursuant to Oklahoma law, respondent was required
to compute its reserves on its policies on the assumption
that the annual premiums had been paid as of the anni-
versary date of the policy, whether or not this was the case.’’
In our view, nothing more is necessary to dispose
of this aspect of the case. “-he reserves shown on the An-
nual Statement are the reserves required by law and con-
stitute the ‘‘life insurance reserves’’ to be used for tax
purposes under sections 805 and 810.
13 See also Maryland Casualty Co. v. U.S., 251 U.S. 342 (1920),
in which this Court expressly acknowledged the overriding import-
ance of state regulatory authority in the recognition of reserves for
tax purposes.
14 Procedurally, life insurance reserves are computed by the
company itself by applying factors, derived from published actuarial
tables, to amounts of insurance in force by policy type at year-end.
The figures are then submitted to the regulatory authority of the
state of domicile. When and if approved, the domiciliary State
regulatory authority issues a “certification of valuation of policies
which sets forth the dollar value of the aggregate of each type of
reserve categorized with reference to the various standards
and interest assumptions previously approved by the state for the
licies in question. The NAIC has prescribed a form to be used
- an insurance company in preparing its Annual Statement. This
form, which must be filed with a life insurance company’s income
tax return (see Treas. Reg. § 1.6012-2), Tagen for the setting
forth of the life insurance reserves so certified.
12
B. Prudential v. Herold—Life insurance reserves and deferred
and uncollected premiums
From the enactment of the Corporation Excise Tax of
1909"° through the Income Tax Act of 1913" and until the
Revenue Act of 1921," life insurance companies were taxed
on their total income with a deduction for ‘‘the net addi-
tion... required by law to be made within the year to
reserve funds.’’ Nearly 60 years ago, in Prudential Ins.
Co. of America v. Herold, 247 F. 681 (D. N. J. 1918),
the government challenged the assumption that underlies
the present controversy. The taxpayer there computed its
deduction for ‘the net addition ... required by law to be
made within the year to reserve funds’’ with reference to
the reserve valuation certified by the New Jersey Com-
missioner, which included policies having premiums that
were deferred and uncollected, The government argued that
since the taxpayer was on the cash basis of accounting, it
was not entitled to credit for the full value of the reserves
on such policies because the deferred and uncollected pre-
miums had not Leen included in taxable income. The court
examined and rejected this argument, setting the precedent
for full recognition of life insurance reserves without re-
duction on account of deferred and uncollected premiums
under all ensuing income tax statutes:
‘*The question to be decided, therefore, is whether the
plaintiff, in figuring its net addition to the reserve funds
which it was required by law to make, was justified in
including the value of such policies. The argument
upon which the defendant’s contention in this respect
is based seems to be that as part of the assets making
up the plaintiff’s ‘reserve’ consisted of these unc \llected
and deferred premiums, and as they are not included
in the plaintiff’s gross income (as, clearly, they should
not be so included, Mutual Benefit Life Ins. Co. v.
Herold ... [198 F. 199 (D. N. J. 1912)]; Conn. Gen.
Life Ins. Co. v. Eaton .. . [218 F. 188 (D. Conn.
'S Act of August 5, 1909, ch. 6, § 38, 36 Stat. 113.
6 Act of October 3, 1913, ch. 16 II1(G) (b), 38 Stat. 114.
17 Ch. 136, § 245(a) (2), 42 Stat. 227.
13
1914)]), that the value of such policies should not be
included, for purposes of taxation, in its net addition
to reserve funds. But this argument, | think, begs the
question, which is, as clearly defined by the Supreme
Court in MeCoach v. Insurance Co. of North America,
244 U.S. 585, 37 Sup. Ct. 709, 61 L. Ed. 1333, what sum
or sums in the aggregate did the state laws require the
plaintiff to maintain as a ‘reserve fund,’ not the char-
acter of the assets making up the actual ‘reserve funds,’
No matter what their character, they were as effectively
withdrawn from the plaintiff’s use as if they had been
expended. If therefore the law of New Jersey, or any
other state in which it did business, made it obligatory
on the part of the plaintiff to maintain a ‘reserve’ on
account of the policies of the character in question, it
is of no materiality what the ‘reserve funds’ actually
consisted of, whether cash, securities, real estate, or due
and uncollected premiums.’’ 247 F. at 685-86 [Cita-
tions added].
Subsequently, the Bureau of Internal Revenue acquiesced
in this reasoning and ruled not only that ‘‘ generally speak-
ing... [the aggregate reserve shown on] . . . the liability
page of the [NAIC] annual statement . . . will be considered
reserves as contemplated by the statute’’ but also specifically
that ‘‘uncollected and deferred premiums cannot reduce
reserves’, Treas. Dept., Bureau of Internal Revenue, Bul-
letin H, Income Tax Rulings Peculiar to Life Insurance
Companies (1921), Rulings 8 and 14, pp. 7 and 9.""
C. From 1921 through 1957, life insurance companies were
taxed on their investment income with an allowance for
interest on reserves required by law, without reduction on
account of deferred and uncollected premiums
In 1921, the ‘‘total income’’ approach for life insurance
companies was abandoned, and Congress substituted a tax
18 Because of the limited availability of “Bulletin H” amicus
has lodged with the Clerk, for the convenience of the Court, 40 xerox
copies of the pages of “Bulletin H” pertaining to life insurance com-
panies. In addition to the pages cited above, see 20 and 26.
14
based solely on investment income. Through 1957, this base
remained the sole basis for taxation of income from the life
insurance business. For most of these 37 years, the reserve
interest allowance was computed by applying a specified
interest rate to each company’s reserves required by law.
However, in no fewer than five instances, Congress altered
the manner in which the allowance was to be computed.'”
But critical for present purposes is the fact that, de-
spite these alterations, Congress at no time departed from
the principle that, for tax purposes, life insurance company
reserves are not to be reduced on account of deferred and
uncollected premiums. This principle thus was well settled
when Congress considered the bill which became the Life
Insurance Company Income Tax Act of 1959.
'° From 1921 to 1931 each company deducted 4% of its own
reserves without reduction on account of deferred and uncollected
premiums, From 1932 to 1941 each company deducted 3.75% of its
own reserves, again, without reduction on account of deferred and
uncollected premiums. In 1942 this company-by-company ap-
proach was dropped and an industry-wide method of determining
the deduction was substituted. There was no change, however, in
— of deferred and uncollected premiums, From 1942 to 1948
each company deducted a fixed percentage of its net income (the
“Secretary's ratio” ) —— by the Secretary of the Treasury for
the entire industry based in part (65%) on the prior year’s actual
reserve requirements for the industry computed without reduction
on account of deferred and uncollected premiums and in part (35% )
on the assumption that an investment income rate of return —
to 34% was required for the entire industry, For 1949 and 1950
the deduction was determined by the Secretary of the Treasury based
entirely (instead of 65%) on the average reserve requirements for
the industry for the preceding year. Here too the ratio was derived
from reserves computed on the basis of net valuation premiums with
no reduction on account of deferred and uncollected premiums. For
the years 1951 through 1957 Congress in effect continued to tax the
life insurance industry on a uniform percentage of net investment
income. See generally Report on the Taxation of Life Insurance Com-
nies, Subcommittee on Internal Revenue Taxation, Committee on
ays and Means, U.S. House of Representatives, December 31, 1958.
=>.
15
D. The 1959 Act: The changes that Congress made and those
it did not make
The provisions of the 1959 Act as well as the exhaustive
studies, hearings and reports accompanying it give no hint
of any departure frcm the established pattern of accepting
state certified life insurance reserves without any reduction
on account of net deferred and uncollected premiums. This
is important because in responding to Congressional re-
quests for a more permanent basis for taxing life insurance
companies, the Secretary of the Treasury, after specifically
commenting on two possible adjustments to reserves, said:
‘*At this time we have no recommendations for or
against other specific reserve adjustments. .. . How-
ever, every departure from the allowance for policy re-
serves used in determining the net gain from opera-
tions reported in the annual statement to the State
insurance departments would represent a complication
which could be justified only by persuasive equity and
technical considerations.’’°
On this record, without more, the only reasonable con-
clusion is that Congress, in enacting the 1959 Act, intended
that life insurance reserves not be reduced on account of
deferred and uncollected premiums in determining life
insurance company taxable income.
This conclusion is reinforced by the fact that Congress,
in the 1959 Act, provided for five adjustments to life in-
surance company reserves as determined for state regu-
latory purposes?! It did so only after the most careful
20 Hearings before the Subcommittee on Internal Revenue Taxa-
tion of the Committee on Ways and Means, 85th Cong., 2d Sess., 5,
November 17-20, 1958; Hearings before the Committee on Finance,
86th Cong., Ist Sess., 513, March 3-5, 17-19, 1959,
21 Four of these adjustments are mandatory: the elimination of
deficiency reserves by section 801(b)(4); the “10 for 1” rule set
(footnote continued )
16
consideration and the reasons for each of these changes
are fully documented in the reports of the tax-writing
committees,”
Thus, although Congress in 1959 comprehensively ex-
amined the functions and purposes of life insurance re-
serves for tax purposes, it did not provide for any adjust-
ment to reserves required by law on account of deferred
and uncollected premiums.
Given these circumstances, it seems clear that if Con-
gress had intended such an adjustment it would have said
so. This is underscored by the realization that any reduc-
tion of reserves on account of deferred and uncollected
premiums would have had a very substantial tax impact.
The proponents of the 1959 Act repeatedly emphasized
that, except for the changes specified, the Act was not
intended to disturb the traditional assumptions underlying
reserve valuations. Thus, the Chairman of the House Ways
and Means Committee, in introducing the legislation to
the full House, stated:
‘*(T]he committee has no intention of placing jurisdic-
tion of the management of insurance company reserves
within the hands or powers of the Commissioner of
Internal Revenue.* * *
‘‘We are trying to preserve as best we can in this
bill the management of this industry in the hands of
(footnote continued)
forth in section 805(c); the adjustments for certain transfers of
liabilities in section (a); and the treatment of changes of basis
in computing reserves set forth in sections 806(b) and 810(d). The
other adjustment, which is optional, is set forth in section 818(c),
and permits a life insurance company computing its reserves on a
— term basis to revalue such reserves on a net level premium
is,
22 H.R. Rep. No. 34, 86th Cong., Ist Sess. 11, 17-19, 22, 26-27,
29, 32, 42 (1959), 1959-2 Cum. Bull. 736 et seq.; S. Rep. No, 291,
86th Cong., Ist Sess. 15, 19, 30-31, 34, 42, 49, 51-52, 57, 73 (1959),
1959-2 Cum. Bull. 770 et seq.
17
the State regulatory agencies and not to change in
any way that situation so as to turn over to the Com-
missioner of Internal Revenue, the Secretary of the
Treasury, or anyone else in Washington the regula-
tory authority.
‘*. . . We are not saying that a company may not
accumulate reserves if the state regulatory body tells
it to accumulate reserves. We are not levying a tax
on the accumulation of those reserves.’’ 105 Cong.
Rec, 2569, 2476-77 (1959).
The Senate report accompanying the new law confirms
that, except for the changes specified, the definition of
life insurance reserves (section 801(b) of the Code, as
amended) ‘‘is the same as that contained in... existing
law.’ Prior to the 1959 Act, the definition of life insur-
ance reserves derived from section 201(c)(2) of the 1939
Code, added by the Revenue Act of 1942. The committee
reports accompanying the 1942 Act both state that the
statutory definition ‘‘is substantially that contained for
many years in the regulations.’ Accordingly, there is
no indication of a shift in congressional policy with respect
to these reserves, and there is strong evidence that no
shift was intended.
The 1959 Act Regulations continue to use language com-
parable to that contained in regulations going back through
the Revenue Act of 1921 to the effect that:
‘*In determining total reserves, a company is permitted
to make use of the highest aggregate reserve required
by any State or Territory or the District of Columbia
in which it transacts business, but the reserve must
= S. Rep. No. 291, supra, at 42; see also H.R. Rep. No. 34, supra,
at <2.
4 H.R. Rep. No. 2333, 77th Cong., Ist Sess. 109 (1942), 1942-2
Cum, Bull, 372, 454; S. Rep. No. 1631, 77th Cong., 2d Sess, 145
(1942), 1942-2 Cum. Bull. 504, 612.
18
have been actually held during the taxable year for
which the reserve is claimed.’’ Treas. Reg. §1.801-5(a).
Moreover, ‘‘reserves required by law’’ are defined as
‘‘reserves which are required either by express statu-
tory provisions or by rules and regulations of the
insurance department of a State, Territory, or the
District of Columbia when promulgated in the exercise
of a power conferred by statute and which are re-
ported in the annual statement of the company and
accepted by state regulatory authorities as held for
the fulfillment of the claims of policyholders or bene-
ficiaries.’’ Treas. Reg. § 1.80! -5(b).
If more were needed, it is found in the very explicit
language of Treas. Reg. § 1.6012-2(c) which provides in
part:
‘*(¢) Insurance companies.—(1) Life insurance
companies.—A life insurance company subject to tax
under section 802 or 811 shall make a return on Form
1120L. There shall be filed with the return (i) a copy
of the annual statement, the form of which has been
approved by the National Association of Insurance
Commissioners, which is filed by the company for the
year covered by such return with the Insurance De-
partments of States, Territories, and the District of
Columbia, and which shows the reserves used by the
company in computing the taxable income reported
on its return, and (ii) copies of Schedule A (real
estate) and Schedule D (bonds and stocks) of such
annual statement.’’
Overall, the regulations exemplify and implement the intent
of Congress to continue recognition of those life insurance
reserves certified by the states.”
% Compare the 1959 Act regulations with Reg. 62., Art. 681
(issued under the 1921 Act), and Bulletin H, supra, 20.
19
The five Courts of Appeals that have considered the
question presented here have made no adjustment in life
insurance reserves on account of deferred and uncollected
premiums. This result is solidly supported by the statute,
its legislative history, prior statutes and applicable case
law.
In the face of this evidence, the government’s primary
position concedes that reserves are not to be reduced on
account of deferred and uncollected premiums. The gov-
ernment contends in the alternative, however, that if de-
ferred and uncollected premiums are not included at gross
in assets and income, the net deferred and uncollected
premiums are to be subtracted from reserves. In advancing
this alternative the government relies on Treas. Reg. § 1.801-
4(f) which provides:
**In the event it is determined on the basis of the
facts of a particular case that premiums deferred and
uncollected and premiums due and unpaid are not
properly accruable for the taxable year under section
809 and, accordingly, are not properly includible under
assets (as defined in section 805(b)(4)) for the taxable
year, appropriate reduction shall be made in the life
insurance reserves. This reduction shall be made when
the insurance company has calculated life insurance re-
serves on the assumption that the premiums on all
policies are paid annually or that all premiums due on
or prior to the date of the annual statement have been
paid.”’
The government cites no basis for this strongarm regu-
lation, and we know of none. Quite apart from the fact that
it was promulgated without prior notice,” this regulation
disregards a half-century of uniform tax treatment of re-
serves. It is unsupported by even a single word of the 1959
Act. Indeed, not even the voluminous legislative history of
26 See Administrative Procedure Act, § 3(b), 5 U.S.C. §553(b).
20
the 1959 Act provides any justification for the government’s
alternative claim. Worse still, the regulation is punitive in
its effect. By imposing a sanction, it discourages a life
insurance company from having its tax liability determined
in accordance with the les as Congress wrote it, rather
than as the Treasury Department would have written it.
It is, in short, a pernicious and, so far as we are aware,
unique regulatory provision that should not be sustained.
If the Internal Revenue Service is dissatisfied with the tax
consequences under the 1959 Act, it should ask the Congress
to change them. It bas not been given blanket authority to
rewrite the law.”
While we believe that the regulation is invalid—and
patently so—we do not think it is necessary for the Court
to reach this question, because, in our view, the regulation is
by its own terms inapplicable in the circumstances presented
here. Under Treas. Reg. § 1.801-4(f), a reduction in reserves
is to be made only if deferred and uncollected premiums
‘fare not properly accruable for the taxable year under
section 809 and, accordingly, are not properly includible
under assets (as defined in section 805(b)(4)). .. .’’ But
our position here is that net deferred and uncollected pre-
miums are properly accruable and hence includible in assets
under the correct interpretation of sections 805 and 809. This
being the case, there is neither cause nor need to invoke the
27 The government cannot justify the regulation on the ground
that it is needed to preclude what is perceived by the government
to be an improper result. Congress was very much aware when
it enacted the Life Insurance Company Income Tax Act of 1959
of the need to preclude improper results under the intricate scheme
which it mandated—and it took careful and painstaking oo to pre-
vent this. Thus, in section 818(e), Congress declared: “Nothing in
this part shall it the same item to be deducted more than once
under subpart B and once under subpart C.” Congress did not enact
a second provision to the effect that, if gross deferred and uncollected
premiums are not included in assets and income, life insurance reserves
must be reduced by an amount equal to net deferred and uncollected
premiums. Nor did it empower the Treasury Department to promul-
gate such a provision.
oo we ——
21
sanction of a reduction in the reserves which a life insur-
ance company is required by law to maintain.”
Given the invalidity or the inapplicability of the regu-
lation, the only question is whether and, if so, to what ex-
tent life insurance companies must include deferred and
uncollected premiums, which they have no legally enforce-
able right to collect, in ‘‘assets’’ and ‘‘ premiums’”’ (as those
terms are defined in sections 805(b)(4) and 809(c)(1)) for
purposes of determining respectively their ‘‘ taxable invest-
ment income”’ and ‘‘gain from operations.’’ We turn now
to this question.
II. Congress Intended Life Insurance Companies
to Account for Deferred and Uncollected Premiums in
Determining Their Assets and Income Under the 1959
Act in the Same Manner as Those Items Are Accounted
For in the NAIC Annual Statement
A. Background
In 1959, Congress returned to a total income approach
to the taxation of life insurance companies. Taxable invest-
ment income, the sole tax base from 1921 to 1957, became
the base for the Phase I tax. Within that phase, the defini-
tion of taxable investment income began, as before, with
net investment income. The reserve interest allowance, how-
ever, was to be computed under a formula that took into
account a company’s own investment ‘‘earnings rates’’
rather than industry-wide reserve interest requirements.
28 Indeed, the concept of subjecting life insurance reserves to tax
accruability requirements is based on a non sequitur because by defi-
nition life insurance reserves are held for “future unaccrued claims
. .. involving . . . life . . . contingencies” [emphasis added] (Section
801(b)) and because they are from the accounting rules
provided for other items. See Treas. Reg. § 1.806-4, providing that a
change in the basis for valuing reserves is not subject to rules for
changes in accounting method. See also Brown v. Helvering, 291
U.S. 193 (1934), in which this Court noted that normal rules of
.crual accounting do not apply to life insurance reserves.
‘*Gain from operations’’ became the base for the new Phase
II and Phase III taxes. Such gain was defined as including
both premium income and investment income.
The 1959 Act also added section 818 to the Code con-
taining ‘‘ Accounting Provisions’’ specifically applicable to
life insurance companies. These provisions, among other
things, required the companies to discontinue the use of
the cash method of reporting for tax purposes.” The per-
tinent provisions of this section are as follows:
**Sec. 818. Accounting Provisions.
(a) Method of Accounting. All computations enter-
ing into the determination of the taxes imposed by
this part shall be made
(1) under an accrual method of accounting,
or
(2) to the extent permitted under regulations
prescribed by the Secretary, under a combination
of an accrual method of accounting with any other
method permitted by this chapter (other than the
cash receipts and disbursements method).
Except as provided in the preceding sentence, all such
computations shall be made in a manner consistent
with the manner required for purposes of the annual
statement approved by the National Association of
Insurance Commissioners.”’
It has generally been recognized by all of the courts
that have considered the matter that deferred and un-
collected premiums, which a life insurance company has no
legally enforceable right to collect, are not assets in the
ordinary sense of the word nor in an ‘‘investment’’ sense,
and would not accrue as receivables under the generally
29 Since 1951, the NAIC has required inclusion in the Annual
Statement of a “Summary of Operations” prepared on “an accrual
basis.”
—
<r e wee
23
applicable rules of tax accrual accounting.° If Congress
intended such rules to apply to deferred and uncollected
premiums it seems inescapable that the court below cor-
rectly concluded that nothing is includible in either assets
or premium income on account of deferred and uncollected
premiums.
The terms ‘‘assets’’ and ‘‘gain from operations’’ had
not been of critical importance in the taxation of life
insurance companies prior to the 1959 Act. Nevertheless,
the terms had previously been used and understood, in con-
nection with the treatment of deferred and uncollected
premiums, by insurance companies and state regulatory
bodies in the Annual Statement prescribed by the NAIC.
Since 1871, ‘‘assets’’, as reflected in the Annual State-
ment, have included only net deferred and uncollected
premiums. Reserves for policies in force, including those
on which premiums are deferred and uncollected, are com-
puted on the basis of net annual premiums and are reflected
on the Annual Statement at Exhibit 8. The Statement
requires, however, that net premiums (i.e., deferred and
uncollected premiums excluding loading) also be reflected
as assets. Where, as in this case, there are reserves
reflected in the Annual Statement on account of policies
with deferred and uncollected premiums, net deferred and
uncollected premiums are reflected as assets on the balance
sheet. Reserves are not dependent to any extent on loading.
Accordingly, there is no inclusion of loading in assets.
In 1951, ‘‘gain from operations’’ was first reflected in
the Annual Statement. Since that time, net gain from
operations shown in the ‘‘Summary of Operations’’ likewise
has reflected only net deferred and uncollected premiums.
This means, that because the deduction for increases in
3% The Tax Court initially found this result consistent with its
concept of the purpose of the formula for determining taxable invest-
ment income, i.¢., that only assets producing investment income were
includible. Western Nat'l Life Ins. Co., supra, 50 T.C. at 285.
24
reserves involves only net premiums, there is included in
income, on account of policies with deferred and uncollected
premiums, only the net portions of such premiums. Since
loading on premiums does not enter into the computation
of reserves, loading on deferred and uncollected premiums
is not included in income.
The legislative history of the 1959 Act, as well as the
language of Section 818(a), leaves no doubt that Congress
was aware of the importance of Annual Statement practices
in life insurance company accounting, particularly as they
relate to problems generated by regulatory requirements.”
Accordingly, it seems reasonable to infer that Congress in-
tended that the Annual Statement treatment of deferred and
uncollected premiums should be followed for purposes of
determining assets and gain from operations under the 1959
Act. This is underscored by the lack of any discernible con-
trary legislative intent that would authorize a departure
from the practice and understanding of the industry with
respect to this important item. For this reason, it is the
position of the amicus that it is proper to include the net
amount of such premiums in assets and income, notwith-
standing generally applicable tax rules (which would ex-
clude them) or the government’s ill-conceived notion of
‘*symmetry’’.*?
B. Assets
That Congress intended this treatment reasonably fol-
lows, in amicus’ view, not only from the express reference
31 Nor is the Annual Statement new to this Court. In Maryland
Casualty Co. v. U.S., supra, it agreed that the “distinction between
the ‘reserves’ and general assets of a company is obvious and familiar
and runs through the statements of claimant and every other insurance
company.” (251 U.S. 342, 351 (1920)). ;
32 Following the NAIC treatment is, of course, consistent with the
general rule stated in section 446(a) that “taxable income shall be
computed under the method of accounting on the basis of which the
taxpayer regularly computes his income in keeping his books”.
25
to the NAIC Statement in section 818(a), but also from the
statutory definition of assets added to the Code by the 1959
Act. A careful reading of section 805(b)(4) shows that it
was drafted with reference to the items reflected on the
balance sheet in the Annual Statement prescribed by the
NAIC (and required by Treas. Reg. § 1.6012-2(c) to be filed
with the federal income tax return) except to the extent
that the section specifically provides otherwise.”
Section 805(b)(4) begins by providing that ‘‘the term
‘assets’ means all assets of the company (including non-
admitted assets).’’ ‘‘Nonadmitted assets’’ is a term that
appears outside the statute only in the Annual Statement
to describe certain assets of a life insurance company.
‘‘Nonadmitted assets’’ are eliminated in Exhibit 13 of the
Annual Statement from the total assets, and only admitted
assets are carried to the asset page of the balance sheet.
The parenthetical inclusion in the statute of ‘‘non-ad-
mitted assets’’ is a specific adjustment which Congress
obviously intended to make to the assets shown on the
balance sheet. Exclusion of property (other than money)
used in an insurance trade or business is another specific
adjustment. A third is the requirement that real property .
and stock shall be included at fair market value. ,
In the face of the reference to the balance sheet shown
in the Annual Statement and the specific adjustments to
certain of the items shown there, it is not reasonable to
conclude that Congress without specific language intended
gross deferred and uncollected premiums, that do not
33 Section 805(b) (4) provides:
“AsseTs—For purposes of this part, the term ‘assets’ means all
assets of the company (including nonadmitted assets), other than
real and personal property (excluding money) used by it in carrying
on an insurance trade or business. For purposes of this paragrap>
the amount attributable to—
(A) real property and stock shall be the fair market value
thereof, and
(B) any other asset shall be the adjusted basis of such asset for
purposes of determining gain on sale or other disposition.”
26
appear as assets on the balance sheet and are not assets
in the ordinary sense of the word, to be substituted for
net deferred and uncollected premiums that are shown as
assets in the balance sheet.
The government’s position that gross deferred and un-
collected premiums should be included in assets is, more-
over, contrary to its own regulations. They contemplate
the inclusion in assets of the net deferred and uncollected
premiums shown on the balance sheet. In Example (1) set
forth in Treas, Reg. § 1.805-5(a) (4) (ii) it is said:
**Included in the statement of assets of P, a life in-
surance company, are the following items: . . . pre-
miums deferred and uncollected.... Accordingly, since
..+ premiums deferred and uncollected . .. are not con-
sidered as being used by P in carrying on an insurance
trade or business, they are included within the term
‘assets’ and, therefore, shall be taken into account by
P in determining its current earnings rate.’’ [Em-
phasis added. ]
This could refer to no ‘‘statement of assets’’ of a life
insurance company other than the one prescribed by the
NAIC, In that statement the ‘‘deferred and uncollected
premiums’’ that are included have always been net de-
ferred and uncollected premiums and nothing else. If the
Treasury Department, in giving this example, had had
any idea that section 805(b)(4) required a life insurance
company to take into account any amount of deferred and
uncollected premiums other than the amount of di ferred
and uncollected premiums ‘‘included in the statement of
assets’’, it presumably would have said so.
C. Income
The general rule for the inclusion of items of income
by accrual basis taxpayers is set forth in Treas. Reg.
§ 1.451-1 as follows:
‘*Under an accrual method of accounting, income is
includible in gross income when all the events have
27
occurred which fix the right to receive such income and
the amount thereof can be determined with reasonable
accuracy.’’
If this rule is applicable, the result reached by the court
below in this case would, as in the case of assets, clearly
be correct. However, another general rule of tax accounting
is set forth in Treas. Reg. § 1.446-1(a)(2), which provides
as follows:
‘*A method of accounting which reflects the consistent
application of generally accepted accounting principles
in a particular trade or business in accordance with
accepted conditions or practices in that trade or busi-
ness will ordinarily be regarded as clearly reflecting
income, provided all items of gross income and expenses
are treated consistently from year to year.’’
This Court in Commissioner v. Idaho Power Company,
418 U.S. 1, 15 (1974), said:
‘‘where a taxpayer’s generally accepted method of ac-
counting is made compulsory by the regulatory agency
and that method clearly reflects income, it is almost
presumptively controlling of federal income tax con-
sequences, ’’
The amicus submits that the argument in favor of following
the Annual Statement treatment of deferred and uncol-
lected preiuiums in computing gain from operations is even
stronger than was the government’s argument in the Jdaho
Power case. Here, the method of accounting has not only
been prescribed ‘‘by the regulatory agency’’, but it has
also been prescribed by section 818 of the Code.
Moreover, just as there is evidence in the statutory
definition of assets that Congress intended the NAIC An-
nual Statement to be the starting point for computing
‘Cassets’’, so there is evidence that the Statement is the
starting point for computing ‘‘gain from operations’’.
‘‘Gain from operations’’ is a term of art which appears
outside the statute only in NAIC accounting and is clearly
derived from page 4 of the Annual Statement.”
The government has argued on numerous occasions that
gross deferred and uncollected premiums must be included
in income because section 809(c)(1) requires the inclusion
of gross premiums in income and no deduction is authorized
under any paragraph of section 809(d) for the increase
in loading. Section 809(c)(1), however, does not specifi-
cally mention deferred and uncollected premiums, and only
reference to the NAIC accounting treatment justifies the
accrual of anything at all on account of deferred and un-
collected premiums.” If the last sentence of section 818(a),
4 On this the Secretary of the Treasury wrote Congress ;
“We suggest that the — for measuring the net
earnings should be the figure for “Net gain from operations after
dividends to policyholders’ which appears in each company’s
annual statement to the State insurance departments and which
summarizes the operating results for the year. This figure is
based on carefully developed life insurance accounting practices
which have general acceptance in the industry.” Hearings be-
fore the Subcommittee on Internal Revenue Taxation of the
Committee on Ways and Means, 85th Cong., 2nd Sess., 4, Novem-
ber 17-20, 1958; Hearings before the Committee on Finance,
86th Cong., 1st Sess., 512, March 3-5, 17-19, 1959.
Comments of witnesses quoted by the government (P. Br. 50, n. 35)
on the significance of the Summary of ne gree were made in
the course of vehement opposition to a total income approach, The
final form of the statute, of course, reflects a number of substantial
and specific modifications of gain from operations shown on the
NAIC statement, designed to meet some of the objections of the
industry witnesses. Inclusion of loading in assets and premium
income was not among these modifications.
As the government recognizes (P. Br, 12-13 and n. 13),
elimination of adler from gain from operations is not a deduction,
but merely a means of limiting premium income ‘o the increase in
net deferred and uncollected premiums. The lower courts that con-
cluded that Congress could not have intended “to relegate the sub-
stantive matter of offsetting or excluding loading” to the NAIC have
missed the point. Congress did not delegate discretion to the NAIC.
It has incorporated the NAIC method of computation in the tax law
where the statute does not specifically provide otherwise.
which contains the reference to the NAIC Annual Statement,
was not intended to resolve issues such as those presented
here, it is hard to see why Congress included it in the
statute.
D. The Government’s Principal Position Produces Anomalous
and Inconsistent Results
Because premium taxes, commissions and other ex-
penses must be paid when premiums are received, the
government’s contention that gross deferred and uncol-
lected premiums must be included in assets and gain from
operations (without reduction for the increase in loading)
would produce the anomalous result that a company that
has not collected all of its premiums will have greater
ass¢is and income than one that has. This anomaly was
recognized by the Fifth, Seventh and Eighth Circuits in the
Great Commonwealth, Federal, and North American cases
and by the district court in Bankers Life® They attempted
to rectify it by permitting reductions in income or assets
for estimated expenses that would be incurred in the pro-
cess of collecting deferred and uncollected premiums, The
amicus would agree that if there were any basis for includ-
ing the gross amount of deferred and uncollected premiums
in assets and income, there would be equal justification for
reducing both assets and income by the amount of related
expenses. We see no necessity, however, for adopting this
approach when assets and income are already clearly re-
flected by the NAIC method.
To support its claim that the gross amount of deferred
and uncollected premiums should be included in assets
and income, the government reiterates the proposition that,
% See n. 5 and 6, supra. Reductions in assets were not claimed
by the taxpayers in the Great Commonwealth, Federal, and North
merican cases.
30
because a life insurance company ccmputes its reserves
by assuming collection of net valuation premiums annually
in advance, it must include in assets and accrue as premium
income the gross amount of deferred and uncollected
premiums.”’
In the first place, the government has never adequately
explained how an assumption that is made with respect
to net premiums in the appraisal of a contingent liability
can cause inclusion of a larger amount in assets or income.
A company’s liability to its policyholders under policies
in force on the statement date is transformed from future
unaccrued contingent liabilities into a fixed liability by
state law. This liability is taken into account in caleu-
lating reserves pursuant to section 801(b). Deductions for
increases in the state statutory reserve liability are allowed
because section 809(d)(2) says they shall be. These pro-
visions do not create assets or income. Increases in assets
or income on account of deferred and uncollected premiums
occur, if at all, because section 818(#) requires that tax
computations be made in a manner consistent with the
NAIC Annual Statement.
The government asserts more than twenty times in its
brief that the assumption of full payment of annual pre-
miums on policy anniversary dates must be applied con-
sistently to assets and income, as well as to reserves. In
view of these repeated references to the need for consist-
ency, it would seem reasonable to expect that the govern-
ment itself would see fit to be consistent. But the govern-
7 Thus, the government tells this Court that (P. Br. 29) deferred
and uncollected “premiums must be consistently deemed to have
been paid for all purposes”; that (P. Br. 38) “the selfsame assump-
tion” must be made in calculating “gain from operations” and “assets”
as is used in calculating reserves; that (P. Br. 49) “these premiums
be taken into account consistently for assets as well as liabilities”;
that (P. Br. 53) “[t}he integrity of a computation of net income
requires that uniform assumptions be made with res to both
income and deduction items”; and that (P. Br. 18) “[s]ymmetry
would require . . . that both sides of the equation by which taxable
income is determined be treated alike.” See also P. Br. 13, 14, 19,
20, 25, 26-27, 28, 36, 37, 43, 44-45, 48, 51, 52; Pet. 18-19,
1 ee 6 ee
ee es
31
ment apparently adheres to this principle only up to a point.
It fails to recognize that when a life insure» ce company
receives premium income, it necessarily will pay deductible
expenses associated with the collection of that income, in-
cluding agents’ commissions, premium taxes and clerical
expenses. If it were to be assumed that gross premiums have
been received in cash—-as the government insists it must
be—it would be only fair and reasonable to assume also
that, by year-end,** concomitant expenses of collection would —
have been paid in cash, In short, even under the govern-
ment’s theory, both assets and income would be reduced by
expenses associated with the collection of deferred and
uncollected premiums,
The government’s primary position rests entirely on the
argument that (P. Br. 29) ‘‘[rJespondent cannot take those
premiums into account in its ‘reserves’ when it suits its
purposes of reducing its tax base but turn its back on them
when their inclusion in ‘assets’ and ‘gross amount of
premiums’ would increase its tax liability.’’ It is enough
to point out in response that it will not do for the govern-
ment to take those premiums into account when it suits its
purpose of increasing respondent’s tax base but turn its
back on related expenses when their payment would de-
crease respondent’s tax liability.”
From the standpoint of consistency, if the gross amount
of deferred and uncollected premiums were to be included
% The current earnings rate is computed with reference to the
mean of the taxpayer's assets at the beginning and end of the taxable
year. Section 8(b) (2) (B). Hence, what is important for asset
ses is not what is received during the year but what remains
at the end of the year.
% In other contexts, the courts have held that the substance of
a transaction must be determined Bagg each step of the trans-
action in relation to the whole. , €.g., Commissioner v. Court
Holding Co., 324 U.S. 331, 334 (1945). Just as a taxpayer may
not divide a single transaction into separate parts in order to minimize
tax, so the government should not be permitted to ignore integral
s of a single transaction in order to maximize tax, Helvering v.
New Haven & Shore Line wY, Inc., 121 F.2d 985, 988 (2d Cir.
1941), cert. denied, 315 U.S. 803 (1942).
32
in assets and income, it would be reasonable to allow a re-
duction of both for related expenses. However, such a solu-
tion does not have the express statutory authority that the
NAIC method does. It is, moreover, unnecessarily complex
and offers no demonstrable advantage over the NAIC
method that we urge should be followed here. Based on
the provisions of the 1959 Act, we submit that Congress
decided to leave undisturbed the NAIC treatment of de-
ferred and uncollected premiums. Congress did so, we
believe, not because of some recently conceived government
theory of symmetry, but because it clearly reflects income
and is consistent with what had always been—and remains
today—the practice and understanding of the life insurance
industry.
Conclusion
For the foregoing reasons, the case should be remanded
to the Tax Court with directions to enter judgment for the
taxpayer on the basis of the NAIC Annual Statement
computations with respect to deferred and uncollected
premiums. Alternatively the judgment of the Court of
Appeals should be affirmed,
Respectfully submitted,
Wri B. Harman, Jp.
WiuiuM P. Gres
Kennetu L. Kimaie
1730 Pennsylvania Avenue, N.W.
Washington, D.C. 20006
Francis A, Goopnur, Jr.
Dewey, BaLiantine, Busney,
Patmer & Woop
Matruew J. Zinn
Sreptor & Jounson
Of Counsel
February, 1977
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.