Amicus Brief — Commissioner v. Standard Life & Accident Insurance

MOTION FILED

MAR 23 1977

| No. 75-1771

IN THE

Supreme Court of the United States

OCTOBER TERM, 1976

COMMISSIONER OF INTERNAL REVENUE,

Petitioner,

STANDARD LIFE & ACCIDENT INSURANCE COMPANY,

Respondent.

On Writ of Certiorari to the United States

Court of Appeals for the Tenth Circuit

MOTION FOR LEAVE TO FILE BRIEF AMICUS CURIAE,

WITH BRIEF ATTACHED, AND SUGGESTION OF LACK

OF JURISDICTION

THOMAS F. FIELD

2369 North Taylor Street

Arlington, Virginia 22207

Attorney for Amicus Curiae,

March 1977 Tax Analysts and Advocates

a

THE CASILLAS PRESS, INC.-1717 K Street, N. W.—Weshington, 0. C.-223-1220

TABLE OF CONTENTS

Motion for Leave to File Brief Amicus Curiae

Brief for Tax Analysts and Advocates, Amicus Curiae .

Que ‘ons Discussed by Amicus Curiae

Interest of Amicus Curiae .

ob

Factual Background .

Argument .

1. Deferred and uncollected premiums are not part

of an insurer’s life insurance reserves and cannot

be reported as life insurance reserves for tax

purposes

Neither the Commissioner nor the taxpayer has

an election to include amounts in “‘life insurance

reserves” as defined in Section 801(b) of the Inter-

nal Revenue Code when such amounts are not

in fact reserves

This case is not presented in an adversary con-

text to the extent that the Government seeks

to achieve a compromise settlement of the

deferred and uncollected premium issue

Conclusion .

16

24

27

(ii)

Page

CITATIONS

Cases:

Bankers Union Life Ins. Co. v. Commissioner,

“eon <a 4. @ ee eee ena ee eke) ee

Flast v. Cohen,

ck 4 es ee ae ea oe gle oe |

Franklin Life Insurance Co. v. United States,

399 F.2d 757, certiorari denied, 393 US.1118. . . . . 22

Great Commonwealth Life Ins. Co. v. United States,

Pes « ¢ 3 a4 3 bee oS oo 8s 2

Helvering v. Inter-Mountain Life Ins. Co.,

Dh 3 6 wae a oe oe eee ae ee ee

Jefferson Standard Life Insurance Co. v. United States,

408 F.2d 842, certiorari denied, 396U.S.828 . . . . 22,23

Monumental Life fnsurance Co. v. United States,

76-2 U.S.T.C. 99787 (Ct. Cl.) decided November 19,

1976 (No. 71-73). . . 3,4;9, 12,13, 14, 17, 18, 19, 26, 28, 29

Moore v, Charlotte-Mecklenberg Board of Education,

PF ee

New York Life Ins. Co. v. Bowers,

rt. a 28 2 bie wb eo he oe ore 6a - Oe

New York Life Ins. Co, v. Edwards,

A ee ee a ee ee ee ee ee ee

United States v. Atlas Life Ins. Co.,

4 eee er eee ee

(iii)

Page

Western National Life Insurance Co, of Texas v.

Commissioner, 50 T.C. 285, modified 51 T.C. 824,

reversed, 432 F.2d298. ...... . . . 20,21, 22,23

Williams v. Union Central Life Insurance Co.,

EL ee a ee

Statutes and Regulations:

Internal Revenue Code of 1954, as amended (26 U.S.C.

(1958 ed., Supp. I1)):

ee 6 GE og 6. ee ce we ee 18

<< -s5 6 6 & 6 6° «5 6 See

ES ee er ae a ae a

Ee a a ee

<4 6 5 6 ee ee ee eee

I a ee

i '. i «2% @ « « « « + » » Cee

Te il tes | fh ei ge ee ~S 18

Ce ee en a |

ne. 6 . os se euse 6 6.‘ 6 @ + See

Life Insurance Company Income Tax Act of 1959 3, 8,9

26 Oklahoma Statutes Annotated Section 1510(E)(2)

ns « i a 4 8 hice tee 10

36 Oklahoma Statutes Annotated Section 4003(1958) . . . 12

36 Oklahoma Statutes Annotated Section 4029H(1958) . . 13

Treasury Regulations on Income Tax (26 C.F.R.):

ee a er

ED ee a eee ee ee ew

~~ a4

(iv)

Miscellaneous: Page

Beardsley , Life Company Annual Statement Handbook IN THE

aay ac ee aa hn Supreme Court of the United States

Ernst & Ernst, GAAP-Stock Life Companies(1974) . . . . 15 OCTOBER TERM, 1976

MacLean, Life Insurance (9thed. 1962) . . . ..... 15

Official Report of the Proceedings of the National No. 75-1771

Insurance Convention of the United States(1871). . . 15,18

Wightman, Life Insurance Statements and Accounts COMMISSIONER OF INTERNAL REVENUE,

ER ge a Oo eee

Petitioner,

STANDARD LIFE & ACCIDENT INSURANCE COMPANY,

Respondent.

On Writ of Certiorari to the United States

Court of Appeals for the Tenth Circuit

MOTION FOR LEAVE TO FILE BRIEF

AMICUS CURIAE

? Amicus curiae, Tax Analysts and Advocates, respectfully

requests this Court, pursuant to Rule 42, to allow it to

file the attached Brief Amicus Curiae in this case. This

brief argues, contrary to the position advanced by Standard

Life, that deferred and uncollected premiums are not part

of life insurance reserves and cannot be reported as such

for federal tax purposes. In addition, contrary to the posi-

tion advanced by the Government, this brief argues that the

Internal Revenue Code does not permit an election to in-

clude amounts in “life insurance reserves” when such amounts

are not in fact reserves.

The brief also suggests that the Government’s attempt

to use its brief in this case to achieve a compromise set-

tlement with the insurance industry, through provision of

an election not authorized by statute, prevents this case

from being presented in a fully adversary context. Given

that fact, it appears that the Court may lack jurisdiction

to consider the Government’s proposed settlement, under

which the Commissioner would accept the insurance in-

dustry’s fictional assumption of full premium payment

and consequent overstatement of reserves as long as the

same assumption is consistently applied in computing

other elements of the tax formula.

Because this brief does not support either party before

the Court, it appears that the only portion of Rule 42(2)

and (3) which is applicable is the statement that “A brief

of an amicus curiae in cases before the court on the mer-

its may be filed only after order of the court... .” The

following information is nevertheless supplied for the con-

venience of the Court, as if this brief supported one or

the other party:

a. Interest of the Amicus Curiae. The amicus curiae

is a public interest tax law firm, which seeks to represent

the interests of ordinary taxpayers before the Executive

Branch and in the courts. Among other things, it opposes

the shifting of tax burdens which takes place when erro-

neous or illegal interpretations of the tax law relieve cer-

tain taxpayers, such as the members of the life insurance

industry, of tax burdens which must then be paid by others.

3

The amicus curiae believes that the government’s posi-

tion in the present case fails to defend the interests of

ordinary taxpayers adequately. More specifically, it ap-

pears that the Government’s position will result in revenue

losses of $300 million or more, due to an erroneous in-

terpretation of the provisions of the Life Insurance Com-

pany Income Tax Act of 1959. These losses will have

to be recouped through higher tax payments by others,

either immediately or, in the longer run, through higher

service charges on an enlarged national debt.

The amicus also believes that it is important to present

cases for judicial consideration in a fully adversary con-

text, in accordance with the dictates of Article III of the

Constitution. Since the nonadversary nature of the Gov-

ernment’s proposed settlement of the deferred and uncol-

lected premium issue may be obscured by the factual and

legal complications surrounding this proceeding, the amicus

is filing this brief to suggest the likelihood that the Court

may lack jurisdiction, to the extent that the Government

seeks to use its brief to propose a settlement not author-

ized by statute.

b. Reasons Why the Parties’ Presentation of the Facts

and Law is Inadequate. At the time the Treasury Regu-

lations were promulgated under the Life Insurance Com-

pany Income Tax Act of 1959, and during the initial

litigation of the deferred and uncollected premium issue

(including the lower court proceedings in the instant case),

the Government erroneously assumed (1) that net deferred

and uncollected premiums were actually a portion of an

insurer’s life insurance reserves, and (2) that the annual

statement form prescribed in all states provided for an

accrual of the deferred and uncollected premiums. It

was not until the trial judge’s decision in Monumental Life

4

Insurance Co. v. United States, 76-2 U.S.T.C. 99787 (Ct.

Cl.), filed November 19, 1976, that the courts recognized

the Government’s error. In that case, the trial judge pointed

out that net deferred and uncollected premiums are not

actually insurance reserves, and that the accounting on the

annual state insurance statement is designed to totally elim-

inate their impact upon the company’s financial position.

However, because four circuits have upheld the Govern-

ment’s regulations that erroneously included net deferred

and uncollected premiums in reserves, the Government ap-

parently refuses to recognize its error. Instead, in its brief

. in the present case, it has merely corrected its presenta-

tion of the facts to indicate, in conformity with the facts

demonstrated in Monumental Life, that the net deferred

and uncollected premiums are not actually reserves and

that the annual statement does not, in any way, accrue

them.

In addition, however, the Government has advanced the

novel suggestion that a life insurance company has the

choice of including or excluding net deferred and uncol-

lected premiums from reserves. If the Court adopts this

position, the Government’s prior errors will not be ex-

posed and corrected, but will be effectively obscured and

perpetuated.

Life insurance companies will be financially benefitted

by the inclusion of net deferred and uncollected premiums

in reserves for tax purposes. Hence, they cannot be counted

on to present the contrary point of view, and the facts

supporting that view. Meanwhile, the Government appears

wedded to its erroneous regulations, which permit the in-

clusion. Accordingly, the amicus curiae is filing this brief

to assure presentation of the facts and law in an adversary

context, and to protect the interest of ordinary taxpayers.

c. Consents. Neither party consents to the filing of

this brief. In this connection, counsel for Standard Life

states that he declines to consent unless the Court gives

leave to file a response within 30 days to the questions

presented herein.

Respectfully submitted,

THOMAS F. FIELD

2369 North Taylor Street

Arlington, Virginia 22207

Attorney for Amicus Curiae,

March 1977 Tax Analysts and Advocates

IN THE

Supreme Court of the United States

OCTOBER TERM, 1976

No. 75-1771

COMMISSIONER OF INTERNAL REVENUE,

Petitioner,

STANDARD LIFE & ACCIDENT INSURANCE COMPANY,

Respondent.

On Writ of Certiorari to the United States

Court of Appeals for the Tenth Circuit

-

BRIEF FOR TAX ANALYSTS AND ADVOCATES

AS AMICUS CURIAE

QUESTIONS DISCUSSED BY AMICUS CURIAE

1. Whether net deferred and uncollected premiums, which

are universally admitted to be an overstatement of legally

required insurance reserves, are nevertheless includable in

“life insurance reserves” for tax purposes, as defined by

Section 801(b) of the Internal Revenue Code of 1954 (as

amended)?

8

2. Whether the Commissioner, even though deferred

and uncollected premiums are not “life insurance reserves”

within the scope of Section 801(b) of the Internal Rev-

enue Code, may nevertheless permit a life insurance com-

pany to include them in reserves for tax purposes?

3. Whether the Government’s proposed compromise

settlement of the deferred and uncollected premium issue

is presented to this Court in an adversary context, so as

to constitute a “case or controversy” within the scope of

Article Ill of the Constitution?

INTEREST OF THE AMICUS CURIAE

The amicus curiae is a public interest tax law firm,

founded in 1970. It seeks to represent the interests of

ordinary taxpayers before the Executive Branch and in

the courts. Among other things, it opposes the shifting

of tax burdens which takes place when erroneous or ille-

gal interpretations of the tax law relieve certain taxpay-

ers, such as the members of the life insurance industry,

of tax burdens which must then be paid by others.

The amicus curiae believes that the Government’s posi-

tion in the present case fails to defend the interests of

ordinary taxpayers adequately. More specifically, it ap-

pears that the Government’s position will result in revenue

losses of $300 million or more, due to an erroneous in-

terpretation of the provisions of the Life Insurance Com-

pany Income Tax Act of 1959. These losses will have to

be recouped through higher tax payments by others, eithe;

immediately or, in the longer run, through higher service

charges on an enlarged national debt.

9

At the time the Treasury Regulations were promulgated

under the Life Insurance Company Income Tax Act of

1959, and during the initial litigation of the deferred and

uncollected premium issue (including the lower court pro-

ceedings in the instant case), the Government erroneously

assumed (1) that net deferred and uncollected premiums

were actually a portion of an insurer’s life insurance re-

serves, and (2) that the annual statement form prescribed

in all states provided for an accrual of the deferred and

uncollected premiums. It was not until the trial judge’s

decision in Monumental Life Insurance Co. v. United

States, 76-2 U.S.T.C. 99787 Ct. Cl1.), filed November 19,

1976, that the courts recognized the Government’s error.

In that case, the trial judge pointed out that net deferred

and uncollected premiums are not actually insurance re-

serves, and that the accounting on the annual state insur-

ance statement is designed to totally eliminate their im-

pact upon the company’s financial position.

However, because four circuits have upheld the Govern-

ment’s regulations that erroneously included net deferred

and uncollected premiums in reserves, the Government ap-

parently refuses to recognize its error. Instead, in its brief

in the present case, it has merely corrected its presentation

of the facts to indicate, in conformity with the facts dem-

onstrated in Monumental Life, that the net deferred and

uncollected premiums are not actually reserves and that

the annual statement does not, in any way, accrue them.

In addition, however, the Government has advanced the

novel suggestion that a life insurance company has the

choice of including or excluding net deferred and uncol-

lected premiums from reserves. If the Court adopts this

position, the Government’s prior errors will not be ex-

posed and corrected, but will be effectively obscured and

perpetuated.

10

Life insurance companies will be financially benefited by

the inclusion of net deferred and uncollected premiums in

reserves for tax purposes. Hence, they cannot be counted

on to present the contrary point of view, and the facts

supporting that view. Meanwhile, the Government appears

wedded to its erroneous regulations, which permit the in-

clusion. Accordingly, the amicus curiae is filing this brief

to assure presentation of the facts and law in an adversary

context, and to protect the interest of ordinary taxpayers.

FACTUAL BACKGROUND

1. The Government’s brief (Br. 32) correctly describes

life insurance reserves as a calculation of projected liabili-

ties established as a measuring device to determine the as-

sets that the company must maintain in order to meet its

future commitments under the policies it has issued. This

is in accordance with the prospective definition of life in-

surance reserves contained in the Standard Valuation Law

in effect in all states (see, e.g, 26 Oklahoma Statutes An-

notated, Section 1510(E)(2) (1958)), which states, in part,

that

* * * reserves for the life insurance and endow-

ment benefit policies providing for a uniform

amount of insurance and requiring the payment

of uniform premiums shall be the excess, if any,

of the present value, at the date of valuation, of

such future guaranteed benefits provided by such

policies, over the then present value of any fu-

ture modified net premiums therefor.

Under this prospective view, the reserve represents the

amount that the company must have in hand in its assets

at the present time, to cover the difference between what

1]

it will pay out in future benefits over what it will receive

in future net premiums. Each payment of a premium re-

duces the amount of future net premiums that the com-

pany anticipates will be received to help finance the pay-

ment of future claims, and the company must correspondingly

increase its reserve.

When a premium has not yet been paid, whether it is

a future annual premium or a deferred or uncollected pre-

mium, it does not increase the reserve, because the cur-

rently unpaid premium is a premium that must be paid

in the future to keep the contract in force and will, when

paid, defray the cost to the company of future benefits.

The company does not presently have to constrain its

own assets to insure that it will have sufficient resources

to pay future claims. Consequently, under the Standard

Valuation Law, the net deferred or uncollected premiums

cannot be included in the reserve, because they would

overstate the company’s actual liability and encumber an

excessive portion of the company’s assets.

Similarly, although not so described by state statute,

reserves are often viewed retrospectively as being equiva-

lent to the amount of net valuation premiums paid by

the group of insureds, plus interest at the assumed rate,

less assumed death claims for the group. Since the net

valuation premiums are established at the inception of

the policy in exactly the amount needed to pay the fu-

ture death claims prescribed by the assumed mortality

tables, the reserves will be the same if calculated retro-

spectively or prospectively. The amount assumed to re-

main in the company’s assets from the prior premium

payments under the retrospective calculation will always

be equal to the amount the company anticipates it must

have in assets in order to cover the difference between

12

the future benefits it will pay out and the amount it will

receive in future net premiums. As in the case of the

prospective calculation under the prospective view, the

deferred or uncollected gross contract premiums have not

yet been received and, consequently, the net portion thereof

would not be included in the reserves, because it has not

yet gone into the company’s assets.

2. From a conceptual standpoint, too, without reliance

on the prospective ‘definition contained in the governing

state statutes or on the equivalent retrospective calcula-

tion, net deferred and uncollected premiums are not con-

sidered to be reserves. As both the Government’s brief

(Br. 32) and the trial judge’s opinion in Monumental Life

Insurance Co. v. United States, 76-2 U.S.T.C. 99787 (Ct.

Cl.), filed November 19, 1976, indicate, a reserve repre-

sents an estimate of the company’s liabilities to its policy-

holders, and the company simply does not have an exist-

ing risk exposure or other liability in connection with a

deferred or uncollected premium. If a policyholder dies

during the 31-day grace period when the policy is still in

force, the state statutes permit the company to deduct

the uncollected premium from the policy proceeds. See,

e.g., 36 Oklahoma Statutes Annotated, Section 4003 (1958).

Where the premium is deferred, rather than due and un-

collected, and the insured dies, the insurer, typically, will

also deduct the deferred premium from the policy proceeds.

From a conceptual standpoint, therefore, the basic policy

reserves in either case should not include any amount to

represent a liability (which does not in fact exist) with re-

spect to the premiums that remain unpaid at the death

of the insured.

Similarly, in the event the policyholder fails to pay the

deferred or uncollected premium when due, or within the

grace period permitted by law, the insurer would nevertheless

13

not have any liability with regard to it. Upon the lapse

of the policy, state law requires the company to credit

the cash surrender value to the account of the policy-

holder. The cash surrender value is calculated on the basis

of premiums actually paid to the date of the lapse. See,

e.g., 36 Oklahoma Statutes Annotated, Section 4029H (1958).

It is only because the insurer has not actually incurred

a liability with respect to deferred and uncollected premi-

ums that the state insurance commissioners not only per-

mit, but uniformly require, that the apparent liability be

cancelled through an offsetting entry in assets, as more

fully described below. At the heart of the present con-

troversy is the method by which life insurance companies

compute these offsetting entries and their life insurance

reserves and report them on the annual statement of the

National Association of Insurance Commissioners (NAIC).

In calculating reserves, insurance companies have tradi-

tionally indulged in a fictitious assumption. Through a

series of related and offsetting entries, companies first in-

troduce and then neutralize an assumption of full an-

nual premium payment. ~<4Jnder this assumption, the pre-

miums on all of the ordinary™iife policies currently out-

standing are considered to have

premiums may be deferred or uncollected. The ficti

that the deferred and uncollected premiums have been -.

prepaid is reflected on the balance sheet by including the

net valuation portion of such premiums on the liability

side in the figure entitled “‘Aggregate reserve for life pol-

icies and contracts.”” A companion entry is then made

adding an equivalent amount to assets. From a solvency

standpoint, the net effect of this exercise is absolutely nil,

14

since the amount of real assets charged with responsibility

for meeting the insurer’s actual liability for policyholder

benefits remains exactly the same. Monumental Life In-

surance Co., supra, p. 85,553.

There is a similar system of related and offsetting en-

tries made in the “Summary of Operations” schedule of

the annual statement by which the life insurance company

first introduces and then neutralizes the fictitious assump-

tion that the premiums on all of the ordinary life policies

have been paid up one year in advance on the policy’s an-

niversary date. The gross deferred and uncollected premi-

ums are first included in income, and are then offset by

two separate deductions. The net valuation portion of

the gross premiums included in income is partially offset

by the inclusion of that amount in the overall deduction

taken by the company for its increase in reserves. At that

point, income is still overstated by the loading portion of

the deferred and uncollected premiums. The remaining

overstatement is offset by a further deduction called “‘In-

crease in loading on and cost of collection in excess of

loading on deferred and uncollected premiums.” Monu-

mental Life Insurance Co., supra, p. 85,553. The net ef-

fect of this series of overstatements and offsetting adjust-

ments in the “Summary of Operations” schedule (as in

the balance sheet) is to totally eliminate any impact that

the deferred or uncollected premium might have upon

the life insurance company’s financial statement.

The nature of the inclusion of the net deferred and un-

collected premiums in the “Aggregate reserve” as consti-

tuting an overstatement of the company’s actual life insur-

ance reserves is not a subject of any controversy within

the insurance industry. The text writers uniformly recog-

nize the “Aggregate reserve” as an overstatement of the

15

actual reserve, and the inclusion in assets of the net de-

ferred and uncollected premiums as a corrective offset to

the overstatement of reserves. Wightman, Life /nsurance

Statements and Accounts 43-44, 155, 545 (1952 ed);

MacLean, Life Insurance 318-319 (9th ed. 1962); Ernst &

Ernst, GAAP [Generally Accepted Accounting Principles] -

Stock Life Companies 449-450 (1974); Beardsley, Life

Company Annual Statement Handbook Ill-15 (1962).

4. As the Government’s brief (Br. 34-35) discloses, the

practice of overstating the reserves and then offsetting them

in the company’s financial statements is an historic prac-

tice adopted by the First Session of the National Insur-

ance Convention in 1871. See, Official Report of the

Proceedings of the National Insurance Convention of the

United States (1871), pp. 68-70. Although the life insur-

ance companies have always had the capability of determin-

ing the exact reserve for each policy by taking into account

the net portion of premiums actually paid to the December

31 reporting date, the actuarial work involved in making such

a computation for each policy was considered “‘burden-

some,” and the Convention’s Report prescribed the sub-

stitute method of overstatement and offset as bringing

“substantially the same result.” At that time, most of

the ordinary life policies were paid by full annual pre-

mium on or before the anniversary date. For simplicity,

it was therefore assumed that all policies were paid by

full annual premium in this fashion. This, of course,

produced an overstatement of reserves with respect to

the policies on which there were deferred or uncollected

premiums outstanding. That overstatement was then cor-

rected by the creation of an artificial offsetting “‘asset.”

The Official Report termed this amount a “quasi-asset,”’

and made it clear that it was included in assets only as

an offset to the overstatement in the reserves. It was to

16

be regarded as a reduction in the “apparent liability [re-

serve] of the company as charged on the opposite side

of the account” and “should not be for any other pur-

pose regarded as an asset of any value.”

Why the report did not recommend actually reducing

the overstatement of the reserves in liabilities instead of

entering corrective offsets in assets is unexplained, but it

was made clear from the outset that the figure entered

in assets was part of the reserve, rather than asset, valu-

ation. Consequently, as the report and the above-cited

text authorities indicate, the company’s reserves are re-

flected in two items entered in the annual statement, not

merely the figure shown in liabilities as the “‘Aggregate re-

serve.” The amount entered in assets as the net deferred

and uncollected premiums is actually a reduction item in

the calculation of the reserves which must be taken into

account by being subtracted from the “Aggregate reserve”

when determining the company’s actual life insurance re-

serves.

ARGUMENT

I. DEFERRED AND UNCOLLECTED PREMIUMS ARE NOT

PART OF AN INSURER’S LIFE INSURANCE RESERVES

AND CANNOT BE REPORTED AS LIFE INSURANCE RE-

SERVES FOR TAX PURPOSES.

Section 801(b)(1)(B) of the Internal Revenue Code of

17

it should be a simple matter to conclude that deferred

and uncollected premiums do not qualify as life insur-

ance reserves. They are not amounts “set aside,” a phrase

which would appear to require that reserves be derived

from premiums already paid by the policyholders, as this

Court has determined in the past.” This view of the

Court apparently coincides with the retrospective calcula-

tion of reserves, which treats reserves as having derived

from the prior payment of premiums.

Furthermore, deferred or uncollected premiums do not

relate to “future unaccrued claims,” as required by the

Internal Revenue Code, since the company does not in-

cur any liability with regard to them, as discussed earlier.

See, Monumental Life Insurance Co. v. United States, 76-2

U.S.T.C. 99787 (Ct. Cl.), filed November 19, 1976. Fi-

nally, they are not life insurance reserves “‘required by

law,’ because they represent an admitted overstatement

of those reserves within the definition of the Standard

Valuation Law and as reserves are universally understood

in the insurance industry.

Nor is there any justification for including the net de-

ferred and uncollected premiums in reserves because of

the treatment given them on the annual statement. Sec-

tion 818(a)(1) of the Code requires that all computations

be made under an accrual method of accounting, and the

NAIC annual statement method of entering overstatements

1954 (as amended) defines the term “life insurance re-

serves” in part, as meaning amounts “‘which are set aside

to mature or liquidate * * * future unaccrued claims.”

Section 801(b)(2) further requires that “life insurance re-

serves must be required by law.” Given these requirements,

* See, e.g., New York Life Ins. Co. v. Edwards, 271 U.S. 109, 115,

119 (1926); New York Life Ins. Co. v. Bowers, 283 U.S. 242, 244

(1931); Helvering v. Inter-Mountain Life Insurance Co., 294 U.S. 686,

690 (1935); Williams v. Union Central Life Insurance Co., 291 U.S.

170, 177 (1934); United States v. Atlas Life Ins. Co., 381 U.S. 233,

247 (1965).

18

and corrective offsets is not such an accrual method. More-

over, Section 801 defines reserves without reference to the

amounts shown in the annual statement and, further, with-

out reference to any overstatement of the reserves. Simi-

larly, Section 805(b)(4) defines “‘assets’”’ without reference

to the annual statement as “assets of the company” —

clearly suggesting that the reference is to real assets, not

“‘quasi-assets”’ that are merely corrective offsets to reserve

overstatements. See, Official Report of the Proceedings

of the National Insurance Convention of the United States

(1871), supra, pp. 68-70. Even though there is a conflict

between the Tenth Circuit in this case and decisions in four

other circuits, one item on which they all agree is that the

NAIC annual statement should not be followed to the ex-

clusion of the definitional sections of the Internal Revenue

Code relating to “assets” and “reserves.”

Perhaps a conclusive indication that Congress rejected the

NAIC method of overstating, and then correcting, the re-

serves is the omission from Section 809(d) of any deduc-

tions relating to the increase in loading on deferred and

uncollected premiums. This deduction in the NAIC an-

nual statement is a necessary and integral part of the en-

tire system of introduction and neutralization of the over-

statement in reserves. Congress has provided specific

deductions pertaining to life insurance in Section 809(d)

(see, in particular, subsections (1)-(3)), and it would

hardly have omitted such a prominent deduction if it had

intended to carry over to the tax return the mechanics of

the NAIC annual statement treatment.

Furthermore, in view of the purpose of the Phase I tax

computation, it is unlikely that Congress would have de-

sired to include the net deferred and uncollected premi-

ums in reserves. In the Phase I computation of taxable

investment income, the larger the figure used for reserves,

19

the larger will be the share of investment income attrib-

uted to policyholders and therefore not taxed to the com-

pany. But because of the additional premiums charged a

policyholder to put his premiums on a fractional mode of

payment, and because of a similar charge permitted under

state statute with regard to recovering an uncollected pre-

mium, the insurer is not obligated to appropriate any part

of the income generated by its own investments to pro-

vide an investment return on deferred and uncollected

premiums. “The standard policy provisions require that

return to come from the pocket of the policyholder when-

ever he pays such a premium and thereby keeps his cov-

erage in force.’”” Monumental Life, supra, p. 85,552. In

that respect, the trial judge in Monumental Life concluded

as follows:

Since, as earlier explained, investment return on

deferred and uncollected premiums is obtained

directly from the policyholder’s pocket by sub-

jecting him to an additional interest charge, the

insurer’s reservoir of investment income need

not be drained in order to provide a commen-

surate return on assets exposed to coverages rep-

resented by such premiums. * * * Thus, no

element of those premiums has any proper place

in either the numerator or the denominator of

the Phase I fraction whose assigned function is

ascertainment of that portion of total investment

income needed to provide a return on those as-

sets that are reserved for the payment of the

future policyholder claims. (/d., p. 85,557).

If the net deferred and uncollected premiums must be

included in reserves, there would clearly be less of a dis-

tortion in investment income if a somewhat greater (rather

20

than equal) amount were also included in assets. This

procedure would tend to minimize the unwarranted attri-

bution of the insurer’s investment yield to policyholder

liability requirements. However, in the absence of any

compelling reason why net deferred and uncollected pre-

miums should be included in reserves in the first instance,

totally eliminating the distortion by excluding deferred

and uncollected premiums from the tax comoutation is

preferable to only lessening the distortion by including a

greater amount in assets.

There is no justification to the Government’s contention

in its Standard Life brief (Br. 41) that including the de-

ferred and uncollected premiums in full in assets produces

an “‘accurate result,” when it merely Jessens the distortion

in investment income. Nor is the Government justified in

contending (Br. 56) that the “alternative approach” of ex-

cluding those premiums completely from the tax formula

does no more than “guarantee the integrity of the tax

computations.” The fact is that completely excluding

the deferred and uncollected premiums is the only method

of producing an accurate result in the Phase I computation.

Had the courts in the earlier cases not mistakenly be-

lieved that net deferred and uncollected premiums are a

part of the life insurance reserves, there is a strong likeli-

hood that they would have required the exclusion of de-

ferred and uncollected premiums from the Phase I tax

computation. We can be reasonably certain that this would

have been the result in the Tax Court and in the Fifth

Circuit.

In his original decision in Western National Life Ins.

Co. v. Commissioner, 50 T.C. 285 (1968), Judge Drennen

excluded the deferred and uncollected premiums in their

entirety from assets and suggested their elimination from

21

reserves pursuant to Treasury Regulations Section 1.801-4(f),

despite his erroneous belief, based upon the submissions

of the parties, that the net deferred and uncollected pre-

miums are part of the life insurance reserves. On rehear-

ing, after the parties (and the life insurance trade associa-

tions appearing as amici curiae) insisted that deferred and

uncollected premiums must be included in life insurance

reserves, he agreed to that inclusion and to the inclusion

of an equal amount in assets. 51 T.C. 824. The Fifth

Circuit reversed the Tax Court and upheld the Commis-

sioner’s position that, although only the net deferred and

uncollected premiums are includable in reserves, the full

gross amount of those premiums is includable in assets.

432 F.2d 298 (1970).

The Court based its opinion upon the mistaken view

that “‘the life insurance industry either because of require-

ments of state regulating agencies or otherwise, universally

considers these deferred and uncollected premiums as ac-

crued at the end of the year” and, further, that there ex-

isted a “state commissioners’ requirement that the policy-

holder’s share [the net valuation portion of the deferred

and uncollected premium] be accrued and added to re-

serves even though not legally collectable.” 432 F.2d, at

300.

That the Fifth Circuit would have eliminated deferred

and uncollected premiums completely from the tax com-

putation — had it been aware that they were not consid-

ered as accrued in the annual statement and were not part

of the reserves under state law — is evidenced by the next

case decided by that Circuit involving deferred and uncol-

. lected premiums. In Great Commonwealth Life Ins. Co.

v. United States, 491 F.2d 109 (Sth Cir. 1974), the Court

was faced with the question of whether, once the deferred

22

and uncollected premiums are treated as fully accrued in

the balance sheet for Phase I purposes as determined in

Western National Life Ins. Co., supra, they also must be

accrued in income for Phase II purposes. The Court held

that they must be fully accrued for Phase II purposes,

but that the company should be entitled to a deduction

for the agent’s commissions that will be incurred upon

payment of the deferred and uncollected premiums. In

so holding, however, the Court stated (p. 116) as follows:

The result we reach is admittedly an imperfect

one. None of the amounts under discussion are

properly accruable under normal accounting prac-

tices. It would be far more accurate, we think,

for the company to disregard deferred and uncol-

lected premiums for all tax purposes, with the

Commissioner’s approval, of course, Section 446

(e); Treas. eg. Sec. 1.446-1(e). This would cre-

ate some variance of accounting between the

N.A.1.C. reports and the tax returns, but it is

well settled that there is no necessary agreement

between the two, as noted by the Courts in

Franklin Life [Insurance Co. v. United States,

399 F.2d 757 (C.A. 7), certiorari denied, 393

U.S. 1118], Jefferson Standard Life [Insurance

Co, v. United States, 408 F.2d 842 (C.A. 4), cer-

tiorari denied, 396 U.S. 828] and Western National

Life |supra|. We hold only that, once the com-

pany accrues the net valuation portion of the

deferred and uncollected premiums, it must ac-

crue the gross amount of those premiums for

all tax purposes, and that it is also entitled to

accrue commissions payable on those premiums.

23

Obviously, because the Court had already decided in West-

ern National that there should be an accrual of deferred

and uncollected premiums in the Phase I computation

(based upon the erroneous assumptions that they were

accrued in the annual statement and included in reserves

pursuant to state requirements), the Court extended that

holding to Phase II, even though it would have preferred

to disregard the deferred and uncollected premiums for

all tax purposes.

The above-quoted portion of the Great Commonwealth

opinion indicating .he Court’s dissatisfaction with includ-

ing deferred and uncollected premiums in the tax compu-

tations, subsequently was quoted with approval by the

Tax Court in Bankers Union Life Ins. Co. v. Commissioner,

62 T.C. 661, 675 fn. 5 (1974). Nevertheless, the Tax Court

reluctantly held that the deferred and uncollected premiums

must be accrued because four circuits had previously so held,

and the court “recognized its obligation to promote uni-

form application of the internal revenue laws” (62 T.C. at

675).

In Standard Life, the Supreme Court is not faced with

its own prior erroneous decision, as was the Fifth Circuit

in Great Commonwealth, supra, nor with the prospect of

promoting an unequal application of the laws, as was the

Tax Court in Bankers Union. Consequently, based upon

a full understanding of the state statutory requirements

and standard insurance accounting, the Court should re-

ject “imperfect” results and should eliminate deferred and

uncollected premiums completely from life insurance com-

pany tax computations.

24

Il. NEITHER THE COMMISSIONER NOR THE TAXPAYERS

HAS AN ELECTION TO INCLUDE AMOUNTS IN “LIFE

INSURANCE RESERVES” AS DEFINED IN SECTION 801

(b) OF THE INTERNAL REVENUE CODE WHEN SUCH

AMOUNTS ARE NOT IN FACT RESERVES.

In its first argument heading (Br. I), the Government

proposes inclusion of gross deferred and uncollected pre-

miums in “assets” and in the “gross amount of premiums”

in cases in which “A life insurance company * * * in-

cludes the net valuation portion of deferred and uncol-

lected premiums in ‘reserves’.”” Thus, the Government in

effect suggests handling deferred and uncollected premi-

ums as though insurance companies had an election to

include or exclude these premiums from reserves when

computing their federal income taxes. But Congress

has not provided an election of this sort.

Similarly, the Government concludes its brief (Br. 57)

with a statement that “despite the logic and simplicity

of total exclusion of deferred and uncollected premiums,

the Commissioner is willing to accept the life insurance

industry’s fictional assumption of full premium payment

and consequent overstatement of reserves as long as the

same assumption is consistently applied in computing the

other elements of the tax formula.” But the Commis-

sioner lacks statutory authorization to make a “deal” of

this sort with the insurance industry.

We have not been able to locate any prior instance in

the extensive litigation involving the deferred and uncol-

lected issue in which the Government has offered the tax-

payer an election to include or exclude deferred and un-

collected premiums from reserves, provided that taxpay-

ers report them in assets and income in accordance with

the Government’s stated positions. There is, however, no

25

justification for such a choice under the statute or the

Government’s own regulations. Only reserves “required

by law”’ can be claimed as life insurance reserves for tax

purposes. Section 801(b)(2) of the Code; Treasury Reg-

ulation Section 1.801-4(a)(3). Since net deferred and

uncollected premiums are not reserves required by law,

neither a life insurance company nor the Commissioner

can choose to treat them as reserves in contravention of

the statute.

Although the Treasury Regulations state alternative po-

sitions with regard to the treatment of deferred and un-

collected premiums (see Treasury Regulation Section

1.801-4(f), the alternatives do not authorize an election,

but merely express the Treasury’s uncertainty with re-

gard to the proper treatment. As Treasury Regulation

Section 1.801-4(f) indicates, “‘In the event it is deter-

mined * * * that premiums deferred and uncollected

and premiums due and unpaid are not properly accru-

able for the taxable years * * * and are not properly

includable under assets * * * for the taxable year, ap-

propriate reduction shall be made in the life insurance

reserve.”” (Emphasis supplied). Since deferred and un-

collected premiums are not properly accruable, are not

properly includable under assets, and are not actually

life insurance reserves, the “appropriate reduction shall

be made” to exclude them from reserves if the taxpayer

had erroneously included them in reserves in the first in-

stance. The Commissioner, as well as the taxpayer, is

required to abide by these regulations.

Although it is true that a taxpayer may “strengthen”

its reserves by changing the mortality and interest assump-

tions upon which they are based (see, Section 810(d) of

the Code), overstating reserves and entering a correspond-

ing offset in assets does not effect a strengthening. The

26

reserves remain the same as if no overstatement had been

made, since the overstatement constrains no additional as-

sets of the company and does not constitute a reserve.

In its brief for this Court, the Government seeks to

treat the deferred and uncollected premium question as

if it were only a matter of “logic and simplicity,” rather

than a matter involving a statutory command. See, é.g.,

Br. 34, 57. On this basis, the Government seeks to dis-

miss the Monumental Life opinion as offering simply one

among many possible solutions to the deferred and un-

collected premium problem.

But Monumental Life is based on more than what the

Government terms (Br. 57) the “dual rationale of logic

and simplicity.”” That opinion is also grounded firmly

on the command of the Internal Revenue Code, which

excludes deferred and uncollected premiums from re-

serves because they are not “‘life insurance reserves’”’ (Sec-

tion 801(b)(1)) or “required by law” (Section 801(b)(2));

from assets because they are not “‘asets of the company”

(Section 801(b)(5)); and from the “gross amount of pre-

miums” because the company has no right tc them (Sec-

tion 809(c)(1)). Furthermore, any inclusion of deferred

and uncollected premiums would violate the accrual method

required under Section 818(a).

The Government’s position in the present case contrasts

starkly with the rationale adopted in Monumental Life.

Not only does the position urged by the Government

lack “logic and simplicity,” but it violates the explicit

provisions of the Internal Revenue Code just as seriously

as do the various positions urged by the life insurance

companies.

27

In short, the Government’s proposed election makes a

hash of a carefully drafted statutory scheme. Only Con-

gress can grant taxpayers in the insurance industry an

election to disregard the provisions of Section 801(b) of

the Internal Revenue Code, and the other Code sections

cited above, by including items in reserves that are not

in fact reserves “required by law.” The Commissioner of

Internal Revenue is not authorized to disregard the statu-

tory command of the legislature by blithely and belatedly

discovering an election provision where none exists.

Ill. THIS CASE IS NOT PRESENTED IN AN ADVERSARY

CONTEXT TO THE EXTENT THAT THE GOVERNMENT

SEEKS TO ACHIEVE A COMPROMISE SETTLEMENT

OF THE DEFERRED AND UNCOLLECTED PREMIUM

ISSUE.

As outlined above, the Government’s brief indicates (Br.

57) that “the Commissioner is willing to accept the life

insurance industry’s fictional assumption of full premium

payment and consequent overstatement of reserves as long

as the same assumption is consistently applied in comput-

ing the other elements of the tax formula.” For the rea-

sons outlined in the previous section of this brief, the

amicus curiae believes that there is no statutory authori-

zation for this proposal.

In addition, however, this attempt by the Government

to achieve a compromise settlement with the insurance

industry raises questions about the adversary nature of

the proceedings in this case. This Court has a right to

expect that the parties before it will present the strong-

est arguments that can legitimately be made in support

of their respective positions. But the Government’s

28 | 29

attempt to use its brief as a means of achieving a com- | CONCLUSION

promise with the life insurance industry prevents this For the reasons stated above, the judgment of the Court

case from being argued in a fully adversary context. | of Appeals should be reversed and judgment entered based

The nonadversary nature of these proceedings is fur- | on the reading of the Internal Revenue Code adopted in

ther shown by the Government’s failure to adopt and ] Monumental Life Insurance Co. v. United States, supra.

support the interpretation of the Internal Revenue Code ) Respectfully submitted,

adopted in the Monumental Life case, supra. The legal |

rationale adopted in that case is clearly the strongest

litigating position that can be advanced by the Govern- THOMAS F. FIELD

ment before this Court. But, inexplicably, the Govern- 2369 North Taylor Street

ment has failed to adopt it, even though the Government Arlington, Virginia 22207

has revised its presentation of the facts to comport Attorney for Amicus Curiae,

with the findings in Monumental Life. March 1977 Tax Analysts and Advocates

These facts raise questions as to whether this case pre-

sents a “case or controversy” within the meaning of Arti-

cle III of the Constitution. Moore v. Charlotte-Mecklenberg

Board of Education, 402 U.S. 47 (1971). Where parties

before a court urge the same solution to a problem, the

case does not present a question “in an adversary context”

as required by the Constitution. Filast v. Cohen, 392 U.S.

83, 95 (1968). Accordingly, to the extent that the Gov-

ernment seeks in this case to achieve a compromise settle-

ment of the deferred and uncollected premium issue, it

appears that this Court may lack jurisdiction to consider

the Government’s proposal.