Petitioners Brief — Helvering v. Inter-Mountain Life Ins. Co.

INDEX

Se SE cweovccesucoeeesouceypocses eecneneesnesenened 1

Jurisdiction - - - - - _ popendeone : eatiatqniaammendiasdsaiasdal 1

Question presented - - --. -.-- , ibadaoeasieabnen 2

Statutes and regulations involved -- - : a oe 2

Statement. pubesooees angie inbekeiatban 2

Specification of errors to be urged : seta = 7

Summary of argument. - .— 8

Argument:

I. The term “reserve funds required by law” to be main-

tained by a life-insurance company within the

meaning of Section 245 (a) (2) of the Revenue Act

of 1921 and corresponding provisions of prior Reve-

nue Acts means that fund which, with accretions

from interest, is held ‘“‘reserved’’ to mature or

liquidate, either by payment or reinsurance with

other companies, future unaccrued and contingent

claims on existing obligations of life insurance in

force and unmatured. It does not include «mounts .

held to satisfy accrued liabilities. _...........---- 13

Il. The amount in controversy in the present case is not

allowable as a deduction under Section 245 (a) (2)

of the Revenue Act of 1921__..._....-.-.-.--.---- 22

III. The adverse decisions of the courts and the Board of

Tax Appeals are based upon misconceptions of the

character of the reserve required by law and its

relation to the amount in issue ; 32

Conclusion . . a 42

Appendix, = : rece. 43

CITATIONS

Cases

Atlas Life Insurance Co. v. Commissioner, 29 B. T. A. 750. 12

Brown y. Helvering, 291 U.S. 193... . - 26

Commissioner v. Great American Life Ins. Co., 70 F (2d)

, — ‘ : : .. 12, 32, 35, 36

Commissioner ¢. Standard Life Ins. Co. of America, 47 F. (2d)

218. : 12, 37

- Commissioner v. Western Union Life Ins. Co., 61 F. (2d)

207 12, 37

Continental Assur. Co. v. United States, 8 F. Supp. 474. 10, 13, 31, 41

- 110896—5 1 (1)

Cases—Cohtinued. Page

Duffy v. Mutual Benefit Co., 272 U. 8. 613 21, 24, 38

Farmers Life Insurance Co. v. Commissioner, 27 B. T. A. 423. 12

-Great Southern Life Ins. Co. v. Jones, 35 F. (2d) 122

McCoach v. Insurance Co.-of N. Amer., 244 U.S. 585_ 9, 14, 15, 34,

36

Maryland Casualty Co. v. United States, 251 U. 8. 342. 15, 17, 18,

34, 37

Massachus-tts Mut. Life Ins.- &. v. United States, 56 F. (2d)

Massachusetts Mut. Life Ins. Co. v. United States, 59 F. (2d) ©

116, affirmed, 288 U. S. 269

Midland Mutual Life Insurance Co. v. Commissioner, 19

' Minnesota Mutual Life Ins. Co. v. United States, 66 Ct. Cis.

481, certioraskdenied, 279 U. 8. 856

Missouri State Life Insurance Co. v. Commissioner, 29 B. T.

Nat'l. Life Ins. Co. v. United States, 277 U. 8. 508 3

New York Ins. Co. vy. Edwards, 271 U. 8. 109_- .9, 17, 19, 36, 38, 39

Reserve Loan Life Insurance Co. v. Commissioner, 18 B. T. A.

Tilctcantwadsddeadngudaneiuiians budnvsenpaade 6-77 12

Standard Life Insurance Co. of America vy. Commissioner, ;

13 B. T. A. 13, affirmed; 47 F (2d) 218 ‘_. 12, 21, 36, 37

United States v. Boston Insurance Co., 269 U. 8. 197. 9, 16, 34, 36, 37

Williams v. Union Central Co., 291 U_S.170 35

. Statutes ——

: Act of August 5, 1909, c. 16, 36 Stat. 11, Sec. 38 13

Act of October 3, 1913, c. 16, 38 Stat. 114, Sec. II G. (b)---- 13

_ Revenue Act of 1916, c. 463, 39 Stat. 756, Sec. 12 (a) Second_ 13

Revenue Act of 1918, c. 18, 40 Stat. 1057, Sec. 234 (a) (10) - - 13

Revenue Act of 1921, c. 136, 42 Stat: 227:

Section 244 (a) . 20

Section 245 (a) : 43

Revenue Act of 1926, c. 27, 44 Stat. 9:

Section 245 (a) (U. 8S. C. App., Title 26, Sec, 1004)... . 40

Revised Statutes of Utah (1933), Title 43, chap. 3:

Section 4 - 45

8. R. 9610, V-2 Cumulative Bulletin 189

Treasury Regulations 62, Art. 681

Willey, Principles and Practice of Life Insurance (8th Ed.):

Inthe Supreme Gourt of the Bnited States

OCTOBER TERM, 1934

No. 537

'

Guy T. HELVERING, COMMISSIONER OF INTERNAL

Revenue, petitioner

Vv.

INTER-MOUNTAIN LiFE INSURANCE COMPANY

ON WRIT OF CERTIORARI TO THE UNITED STATES CIRCUIT

COURT OF APPEALS FOR THE TENTH CIRCUIT

BRIEF FOR THE PETITIONER

OPINION BELOW

The Board of Tax- Appeals rendered no opinion.

(See R. 19.) The opinion of the Circuit Court of

Appeals (R. 25-26) is reported in 71 F. (2d) 962.

. JURISDICTION

The judgment of the Circuit Court of Appeals

was entered June 25, 1934 (R. 26). By an order

entered by a Justice of this Court on September

21, 1934, the time for filing a petition for a writ of

certiorari was extended for a period of sixty days

from September 25, 1934 (R. 27). The petition for

(1)

’

/

{

\

“~

2

a writ of certiorari was filed November 22, 1934,

and the writ was granted January 7, 1935 (R. 27).

The jurisdiction of this Court rests on Section 240

(a) of the Judicial Code, as amended by the Act of

February 13, 1925.

QUESTION PRESENTED

Whether amounts ‘held by respondent, a life in-

surance company, at the beginning and end of the

calendar year 1922, to meet its liabilities to the

holders of matured, unsurrendered, and unpaid ,

coupons attached to certain of its lifinsurance |

policies constituted ‘‘reserve funds required by

law’* within the meaning of Section 245 (a) (2) of

the Revenue Act of 1921.

STATUTES AND REGULATIONS INVOLVED ’

‘The statutes and regulations involved will be

found in the Appendix, infra, pp. 43-46.

STATEMENT

“ss

The facts in the case were stipulated (R..8-19),

and may be summarized as follows:

Respondent is a capital stock life insurance

company, organized in the year 1911 under the

laws of the State of Utah, and during the year

1922 and prior thereto was engaged in the busi-

ness of issuing life insurance contracts in Utah,

Idaho, and Arizona (R. 8).

‘ , 3

Among the policies of life insurance issued by

respondent were certain policies denominated ‘‘20- _

Payment Life Coupon Poliey—nonparticipating’’,

each of said policies having nineteen coupons

attached thereto, maturing serially on anniversary

dates of the policy, ‘beginning with the first and

ending with the nineteenth, provided the premiums

for the policy year beginning on the date of the .

coupon are paid and all premiums previously due

have been paid (R. 8). The first coupon is: not

part of the first year’s premium, which is solely

for term insurance for the year (R. 11).

Each coupon is a promise that at its maturity,

aud upon the payment-of the premium then due,

respondent will pay the amount of the coupon te

the owner (R. 8). A specimen copy of such cou-

- pon reads on itsface (R. 14):

Coupon No. 1 = $78.90

INTER-MounTAIN Lire InsuRANCE CoMPANY

Salt Lake City, Utah

Will pay to the owner of this policy

. at its home office

Seventy-eight dollars and 90 cents

Upon presentation of this coupon with

annual premium due —

December 1, 1920

Provided all premiums previously due

have been paid

Policy No. Sample.

President.

4

The reverse side of the couron reads (R. 14):

PAID-UP ADDITION FOR ‘HIS COUPON

Two Hundred Twenty Dollars

Payable at death in additiomto ,

the principal sum insured but

RECO IBLE AT ANY TIME

. into its cash value

By the terms of th€se coupon policies the insured

is given certain elections, and options respecting

such coupons, among which it is provided that re-

spondent will credit to the insured the face amount

of any matured coupon, as said coupon becomes

due, and will pay compound interest thereon at the

rate of 3% per centum per annum, thereby creating .”

a fund to the credit of the insured, which amount

may be applied to the payment of premiums or

withdrawn in cash at any time by the insured, and

if not so applied or withdrawn by the insured prior

to his death, the values represented by the coupons, -

with interest to date of death, will, in the event of

the death of the insured while thefolicy is in force,

be paid to the beneficiary, in addition to the face

améunt of the policy, upon surrender to the re-

spondent of the policy and all coupons issued

therewith and unpaid or unmatured prior to the

date of said death (R. 8-9):

Pursuant to the terms of these coupon policies,

the insured, at any time during the first policy year

or within one month after the due date of the

-second annual premium, may, in writing, elect to

convert the coupons originally attached to such

policies, as such coupons mature, into paid-up life

ares remneememreres —@~—_—

5

additions to the policy for the amount shown on

the reyerse side of each coupon, and each coupon

must then be surrendered to the respondent within |

one month after its due date, and payment of the

annual premium due on the same date made in full

in cash. ‘When the coupon is so surrendered for

paid-up additions to the policy and full premiums

paid, respondent issues to insured & letter of ac-

knowledgment of his remittance and coupon in

which it is stated that the ameunt of the paid-up

life insuranée. has been effected. The paid-up ad-

dition to thé policy is then only reconvertible into

its cash surrender value. (R. 9.)

During the calendar year 1922 respondent paid

to holders of matured coupons surrendered during

that year the face amounts of such coupons, to-

gether with accrued interest thereon in the sum of

$897.58.. The Commissioner of Internal Revenue,

in auditing respondent’s income-tax return: for

1922, allowed as a deduction the amount of interest

paid, i. e., $897.58, on coupons theretofore left to

accumulate at interest and surrendered during the

tax year 1922.’ (R. 10.)

Said coupon policies further contained the fol-

lowing (R. 11): |

GUARANTEED OPTIONS AT THE END OF TWENTY

| YEARS

If all the premiums due hereon as stated

in the consideration paragraph herein are

paid to the company in full in cash, and if

as each coupon attached hereto matures, the

amount thereof has been left with the com-

6

‘pany to accumulate at interest, then upon

the surrender of this policy and all coupons |

which are attached hereto at date. of issue,

the insured shall select one of the following

options at the end of twenty years from the

date hereof:

1. A guaranteed cash payment of eight

thousand dollars.

2. A paid-up policy for life of fourteen,

thousand one hundred thirty’ dollars, sub-

ject to satisfactory evidence of insurability.

for the excess over the original face amount |

of this policy,

3. A guaranteed annual income of four

hundred ninety dollars, to.continue for at.

least twenty years and as many years there-

after as the insured shall survive.

4. A paid-up policy for life of ten thou-

sand dollars, without -medical reexamina-

tion, and an annual income of $174.40, pay-

able arinually thereafter during the life of |

the insured.

And the following (R. i2):

Fully paid-up benefit: If all of the values

represented by the-first fourteen coupons

attached to this policy at issue, are left on

\ deposit with the company at compound in-

terest as aforesaid, the company will, upon

written request of the insured hereunder,

issue in lieu of this polity a fully paid-up

policy for ten thousand dollars ($10,000) at

the end of fifteen years from the date of this

policy, upon the surrender to the company

of this policy and all of the coupons orig-

inally attached hereto.

7

On January 1, 1922, the amount of respondent’s

“liability to the holders of matured, unsurrendgered,

-and wipaid coupons, which had been left with re-

spondent to aceumulate at interest (in accordance

‘with one of the options contained in the policies

. ‘so to do), with accrued compound interest thereon, —

amounted to the sum of $126,949.03, and at Decém-

ber 31, 1922,-to the sm of,$146,097.75. The mean

of these sums is $136,523.39, and this sum the Com-

missioner of Internal Revenue refused’ to inelude

in respondent’s ‘‘reserve funds required by law’

for the year 1922. (R. 9:)

The Board of Tax Appeals sustained the conten-

tion of the respondent that the amounts held to

meet its liabilities.to the holders of matured,*un-—

surrendered, and unpaid coupens constituted ‘‘re-

serve funds required by law” within the meaning —

of the Revenue Act, and the Circuit ae of

t

Appeals denied the Commissioner’ s petittgn for

review. |

SPECIFICATION OF ERRORS TO BE URGED

The Circuit Court of Appeals erred:

1. In holding that a liability which may be con-

verted into life insurance at the option of the in-

sured, but which has not been so converted during

the tax year, is one against which a technical insur-

" ance reserve, such as is contemplated by Section

245 (a) (2) of the Revenue Act of 1921, may be

set up and maintained.

110896—35——-2 © ‘

8

2. In holding that amounts which had become *

unconditionally due and payable during the year

1922 to the holders of matured, unsurrendered, and

unpaid coupons, and which: had been left during

said year with respondent to accumulate at inter-

est, and accrued interest thereon, constituted ‘‘re-

serve funds required by law’’ within the meaning

of Section 245 (a) (2) of the Revenue Act of 1921. .

3. In holding that the “‘legal reserves’’ required

to be maintained by respondent during the year

1922 under the.laws of the State of: Utah included

the amounts, with accrued interest thereon, held

by respondent to meet its liabilities during said

year to the holders of matured, unsurrendered, and

unpaid coupons. .

4. In affirming the decision of the Board of Tax

Appeals.

SUMMARY OF ARGUMENT

The case deals solely with coupons attached

to life insurance policies; which had become un-

conditionally due and payable simultaneously

upon the payment of an annual premium by the

insured, and which, after their maturity, had

been left with the company to accumulate at in-

terest, thereby creating a fund which might be

applied to the payment of premiums.or with-

drawn in cash at any time by the insured. We .

contend that the Board of Tax Appeals and the

Circuit Court of Appeals were in error in hold-

ing that the amount of such matured coupons’ and

interest constituted a part of the ‘‘reserve funds

°

9.

required by law’’ within the meaning of Section

245 (a) (2) of the Revenue Act of 1921.

A consideration of the decisions of this Court

in McCoach v. Insurance Co. of N. Amer., 244

U. 8S. 585, United States v. Boston Insurance Co.,

269 U. 8. 197, and New York Ins. Co. v. Edwards,

271 U. S. 109, shows that the legal reserve for

life insurance companies intended by Congress

has a special technical meaning, contemplating

a fund actuarily computed to meet unmatured

life risks on .existing policies; that it does not

include funds held to satisfy accrued liabilities

due to individual policyholders, even though such

a fund may be required by State law for solvency

purposes. The changes made by Congress in

the Revenue Act of 1921 in the method of com-

putation of the gross income and deductions of

life insurance companies evidence no purpose to

give the term “reserve funds required by law’’

a new meaning.

The amounts here in controversy are not. em-

braced within the legal reserves forming the

basis of the deduction afforded by Section 245

(a) (2) of the Revenue Act of 1921. The ma-

tured unpaid coupons involved had not been used

to pay insurance premiums or to purchase paid-

up additions to the policy. ‘During the taxable

year involved they represented an accrued lia-

bility of the respondent and a present indebted-

ness td the individual policyholder, thus differing

clearly from the insurance ‘‘reserve’’ held for

10

the group, which does not become an indebted-

ness to the individual until the policy matures.

The fact that certain options were afforded by

which the policyholder might use the coupons |

and interest in the future to purchase additional

insurance benefits does not convert the funds

held against the coupon liability into a legal re-

serve in the taxable year when the options had

uot been exercised. ‘The legal reserve provides

for insurance risks already undertaken and can-

not be extended to inelude insuranee which may

or may not be purchased in the future. Further-

more, even if these options are exercised, the cash

accumulations to the credit of the individual poli- .

cyholder upon the coupons are sufficient to com-

pensate the company for any additional risk un-

dertaken. Until the policyholder has exercised

his option the amount held against matured cou-

pons represents a pure accrued liability, not the

subject of the legal reserve. This reserve is com-

puted with reference to a large number of policy-

holders as a group and cannot include an account

of the company with an individual policyholder

in which the group does not share.

The adverse decisions of the courts and the Board

of Tax Appeals are based upon misconceptions of

the character of the reserve required by law and its

relation to the amount in issue. The decision of

the Court of Claims in Continental Assur. Co. vy.

United States, 8 F. Supp. 474, represents ‘the cor-

rect view.

11

ARGUMENT

The instant case deals solely with matured, un-

surrendered, and unpaid coupons which by their

maturity and the payment of the required pre-

miums on the policies to which they were attached

had become unconditionally due and payable on de-

mand by their respective holders. The so-called

coupons are not coupons in the sense in which that

- term is ordinarily used, that is, as representing

interest due or to become due on a principal obli-

gation. Instead, each represents a principal

amount, paid in as part of the premium required

. and paid on the due date of the coupon, and imme-

diately due and payable on demand, simultaneously

with the payment of the money. They are in effect

receipts for money deposited—demand obligations.

The amounts represented had been left by the hold-

ers with the company to accumulate at compound

interest at the rate of 342%, thereby creating a fund

which might be applied to the payment of premiums

or withdrawn in cash at any time by the insured

(R. 12). The insured was also afforded certain

other options with respect to these coupons (R.

11-12), none of which had been exercised or could

have been exercised during the taxable year in-

volved. Until one of these options was exercised the

money represented by the coupons remained with

the company, payable on demand to the insured.

The amounts of the matured coupons thus left

.to accumulate, and interest thereon, aggregated

12

$126,949.03 at the beginning, and $146,097.75 at the

end ofthe taxable year. The mean of these two

amounts is the sum which the Board of Tax Ap-

peals and the Cireuit Court of Appeals held con-

stituted part of the ‘‘reserve funds required by

law’’, within the meaning of Section 245 (a) (2)

of the Revenue Act of 1921, infra, p. 43." We con-

tend that the sum was during the taxable year a

matured liability which should not be so included.

The position of the court below is in accordance

with its own decision in Commissioner v. Great

American Life Ins. Co., 70 F. (2d) 133, and with

the decisions in Commissioner v. Standard Life

Ins. Co. of America, 47 F. (2d) 218 (C. C. A. 3d),

and Commissioner v. Western Union Lifé Ins. Co.,

61 F. (2d) 207 (C. C. A. 9th). The Board of Tax

Appeals has consistently held to the same effect.

See Standard Life Ins. Co. of America’v. Commis-:

sioner, 13 B. T. A. 133-Reserve Loan Life Insur-

ance Co, v. Commissioner, 18 B. T. A. 359; Farm-

ers Life Insurance Co. v. Commissioner, 27 B. T. A.

423; Missouri State Life Insurance Co. v. Commis-

sioner, 29 B. T. A. 401; Atlas Life Insurance Co..

v. Commissioner, 29 B. T. A. 750, The position of

‘A 4% deduction of the mean of the reserve funds was

originally diminished by the amount of tax-exempt interest -

received (R. 5). Subsequently, and following this Court’s

decision in Natl Life Ina. Co. v. United States, 277 U. S.

508, it was stipulated before the Board of Tax. Appeals that

the net income should be reduced by the amount of such tax-

‘exempt interest (R. 9-10).

13

the Government has been sustained in a recent de-

cision of the Court of Claims in Continental Assur.

Co. V. United States, 8 F. Supp. 474, whete that

court, in an exhaustive opinion, held that the re-

serve required by Iaw does not include amounts

held to meet the obligations on matured. unsurren-

dered coupons.

I

THE TERM “RESERVE FUNDS REQUIRED BY LAW” TO BE

MAINTAINED BY A LIFE INSURANCE COMPANY WITHIN

THE MEANING OF SECTION 245 (A) (2) OF THE REVENUE

ACT OF 1921 AND CORRESPONDING PROVISIONS OF PRIOR

REVENUE ACTS, MEANS THAT FUND WHICH, WITH ACORE-

TIONS FROM INTEREST, IS HELD “ RESERVED” TO MA-

TURE OR LIQUIDATE, EITHER BY PAYMENT OR REINSUR-

ANCE WITH OTHER COMPANIES, FUTURE UNACCRUED

AND CONTINGENT CLAIMS ON EXISTING OBLIGATIONS OF

LIFE INSURANCE'IN FORCE AND UNMATURED. IT DOES

NOT INCLUDE AMOUNTS HELD TO SATISFY ACCRUED

LIABILITIES

Under the Revenue Acts prior to the Revenue

Act of 1921 insurance companies were entitled to

deduct the net addition to reserve funds required

by law.» The Revenue Act of 1921 inaugurated a

new method of taxation with respect to life insur-

ance companies and permitted a deduction of 4%

of the mean of the reserve funds required by law

and held at the beginning and end of the taxable

year. The term ‘‘reserve funds’required by law’’

was not defined in any of the various Acts, but the

—s

* Act of August 5, 1909, c. 6, 36. Stat. 11, 112, Sec. 38;

Act of October 3, 1913, c.°16, 38 Stat. 114, 166, 172, Sec. II

G. (b); Revenue Act of 1916, c. 463, 39 Stat. 756, 767-768,

Sec. 12 (a) Second; Revenue Act of 1918, c. 18, 40 Stat. 1057,

1077-1079, Sec. 234 (a) (10),

14

decisions of this Court on the subject show that it

has a special technical and peculiar meaning in the.

law of insurance, and does not include the amounts

in controversy here.

. The first case to reach this Court on the subject

was McUoach v. Insurance Co. of N. Amer., 244

U. 8. 585, involving a deduction claimed for re- -

serves on account of incurred but unpaid policy loss

claims of a fire insurance company. The respon-

dent had been required by administrative practice

in Pennsylvania to hold assets against such liabili-

ties. In ‘denying the Coduction this Court said

(p. 589) :

The object is to exercise abundant caution

to maintain the companies in a secure finan-

cial position.

The act of Congress, on the other hand,

deals with reserves not particularly in their |

bearing upon the solvency of the company,

but as they aid in determining what part of

the gross income ought to be treated as net

income for purposes of taxation. There is

a specific provision for deducting ‘‘all losses

actually sustained within the year and not

compensated by insurance or otherwise.’’

And this is a sufficient indication that losses

in immediate contemplation, but not as yet

actually sustained, were not intended to be

treated as part of the reserve funds; that

term rather having reference to the funds.

ordinarily held as against the contingent

9 on outstanding policies.

;

— an

a i eatasnaetitint inant

15

_ In the foregoing, language this Court clearly

indicated that all reserves required by law were

not intended by Congress as deductions; that “‘the

reserve’’ allowed represents funds held on account

of insurance in force and unmatured during the

taxable year, as distinguished from those held to

meet matured policy obligations. In the McCoach

case losses actually sustained and paid were al-

lowed under another specific provision of the Act,

and this Court held that losses in immediate con-

templation but not yet actually paid were not

deductible as a part of the legal reserve. In the

instant case the only loss-actually sustained is rep-

resented by interest actually paid, the deduction

of which is permitted by Section 245 (a) (8) of

the Revenue Act of 1921 (infra, p. 43), and has

been allowed by the Commissioner (R. 9). At the

moment of payment of the premium the obliga-

tion of repayment evidenced -by the coupon ac-

erued, becoming, in analogy to the McCoach case,

' a loss in immediate contemplation, not yet paid

and not deductible as a legal reserve.

The basic requirements of the reserves required

‘ by law announced in the McCoach case have not

been changed in subsequent decisions of this

Court. In Maryland Casualty Co. v. United —

States, 251 U. 8S. 342, the Court apparently de-

parted somewhat from the rule of the McCoach

case and allowed certain sums to be added to re-

serves on: the strength of the requirement of the

110896—35——-3

16

State Insurance Department, although they rep-

resented accrued claims. Even in‘ that case, how-

ever, this Court said: (p. 350):

The term ‘‘reserve’’ or ‘‘reserves’’ has a

special meaning in the law of insurance.

While its scope varies under different: laws,

in general it means a sum of money, vari-

ously computed or estimated, which with

accretions from interest, is. set aside, ‘‘re-

served,’’ as a fund with which to mature or

_ ‘liquidate, either by payment or reinsurance

- with other companies, future unaccrued and

contingent claims, and claims accrued, but

contingent and indefinite as to amount or

time of payment. (Italics supplied.)

While the italicized portion of this quotation

would seem to indicate that accrued claims were

-to be allowed as a reserve deduction, the next de-

. cision of the Court in United States v. Boston In-

_ surance Co., 269 U. 8. 191, expressly disapproved

this departure and reaffirmed the principles of the

‘McCoach ease... This Court said in' part (p. 202): .

It. follows from McCoach v. Insurance Co.

that the permitted deductions specified by

§ 12, Act’ 1916, do not necessarily include

anything which may be denominated ‘‘re-

serve fund ”’ by state statute or officer. We

there distinctly ruled that the ‘‘reserve

fund”’ of the Federal Act did not include

something held by a fire and marine insur-

ance company to cover accrued’ but un-

settled claims for losses. We adhere to and

reaffirm that doctrine. How fay it must be

17

modified, if at all, in respect of insurance

conmipanies which issue casualty, surety or

liability policies or similar obligations is not

now before us.

Referring to the decision in the Maryland Casualty

Co. case, supra, this Court said (p. 203) : e

Upon a reexamination of the record it be-

comes plain that we misapprehended the

opinion and ruling ef the lower court; also-

that the reason advanced to support our

conclusion is insufficient. * * *, The

finding that the Insurance Department of

. Pennsylvania, pursuant to statute, had at

all times since and including 1909 required

claimant to keepeon hand, as a condition of

doing business in the State, “assets as re-

serves sufficient to cover outstanding

losses,”’ without more, was not sufficient to

justify the deduction df the reserve as one

required by law to be maintained, within the

meaning of the Act of Congress. This had

been announced by McCoach v. Insurance

Co.

The meaning of the term was next discussed by

this Court in New York Ins. Co. v. Edwards, 271

U.8. 109. There the Superintendent of Insurance

of the State of New York required the company

to set aside a special fund to meet unreported

death losses for amounts due policyholders who

had died during the. calendar year, and to carry a

fund to meet liabilities for the payment of annui-

ties to former soliciting agents as provided by their :

contracts of employment. The company claimed

18

the deduction of both of these amounts as net addi-

tions to reserve funds required by law. In deny-

ing the claim the Court said (pp. 119, 120):

We think this claim was properly rejected

by the Commissioriér, althongh the courts

-below held otherwise. McCoach v. Insur-

ance Co. of North America, 244 U. 8. 585,

and United States v. Boston Insurance Co.,

269 U. 8. inted out that ‘‘the net

addition, i

year to reserve furids,’’ does not

hecessa ly inelude whatever a state official

Ymay so designate; that ‘‘reserve funds’’ has

a technical meaning. It is unnecessary now

to amplify what was there said. The item

under cgnsideration represented a liability

and not something reserved from premiums

to meet policy obligations, at maturity.

7 7. * * *

As pointed out above; the term ‘‘reserve

funds,’’ in the taxing Act, has a technical

meaning. The compensation which an in-

surance company agrees to pay soliciting

agents has no relation to the reserve held

to meet maturing ‘policies; and when it sets

aside a fund to provide payments to such

agents this cannot be regarded as a reserve

within intendment of the statute. -

In each of the foregoing cases the taxpayer eon-

tended that accrued liabilities constituted ‘‘re-

_ serves’’ within the meaning of the Federal stat-

utes. In each case the contention was denied, save

only in the. Maryland Casualty Co. case, supra,

19

which in effect was later disapproved upon the

ground that the claims were no longer unacerued

and contingent. So while the company in the New —

York Ins. Co, case was required by the laws of the

Ptate of New ‘York to hold ‘‘reserves’” for ‘future

unaccrued and\ contingent death claims, the so-

called “reserves” which the company was required

to maintain for accrued but unreported death

claims were not ‘‘the reserves” required by law

within the meaning of the Federal statutes.

The foregoing cases were decided under Acts

prior to thé“Revenue Act of 1921. While Congress

adopted a new plan for the taxation of life insur-

anée companies in the latter Act, there is no indi-

cation of a purpose to give-the term ‘reserve funds

required by law’? a new meaning. Under prior

Acts the gross income of life insurance companies

inclided their premium receipts and they were per-

mitted to deduct the amounts paid on policies (ex-

cept as dividends},.and amounts required by law to

be added to their legal reserves, The inclusion of

premium receipts with corresponding deductions

was found to be unsatisfactory, and in the Revenue

Act of 1921, with the approval of at least most of

the life insurance companies, Congress substituted

a new basis for computing the tax. See dissenting ,

opinion of Mr. Justice Brandeis in Nat’! Life Ins.

Co. v. United States, 277 U. 8. 508, 522-523. It

was provided that the gross income should consist.

of investment income, that is, income from “‘inter-

a ia ine,

20

ests, dividends, and rents” (Sec. 244 (ay, Revenue

Act of 1921), and in order to ascertain the net tax-

able income nine classes of deductions were al-

lowed, one of which is that here in issue, permitted

by Section 245 (a) (2), infra, p. 43.

Since: underwriting income (premium receipts)

was not included in gross income, the deduction of

the mortality content in the *‘net orsmathematical,

premium” could no longer be permitted; accord-

ingly the deduction of the net addition’ to reserves

‘required by l4w was eliminated. There still re-

mained for consideration, however, the interest con-

tent in the ‘‘net or mathematical premium”’, since

it was clear that a portion of the interest, dividends

and rents received by a life insurance company

must be used each year in maintaining the legal

reserve, that is. in adding to it on the basis of a

eertain interest rate, varying from 3% to 4%, ac-

cording to the requirements of the statutes of the

several States. Since gross income included all in-

terest, dividends and rents received, it was proper

to permit the deduction of that portion thereof in-

eluded in the gross inftome which was required to

mature the policy as a life risk, namely, the interest

element. Accordingly Congress provided for the

deduction of 4 per centum of the mean of the re-

serve (the highest percent required to be credited

thereto by any of the State laws), and based the

deduction upon the mean of the reserves held at the

beginning and end of the taxable year.

21

The deduction allowed by Section 245 (a) (2) of.

the Revenue Act of 1921 was perfectly consistent

with that permitted by prior Acts, to wit, the net

addition to reserves required by law, and under the

new Act no different meaning is to be attributed

to the term “‘reserve funds.’’ See Massachusetts

Mut. Life Ins. Co. v. United States, 56 F. (2d) 897

(C, Cls.) ; Standard Life Insurance Co. of Amer-

ica, v. Commissioner, 13 B. T. A. 13,27. We submit

that the term as it is used in the Revenue Act of

1921 does not embrace everything required as a re-

serve by State statute or State official; that its

special meaning for life insurance purposes con-

templates a fund actuarily computed, set aside

- from premiums, and built up with accretions from

interest to meet unmatured life risks upon existing

policies ; and that it does not ‘include funds held to

satisfy matured accrued liabilities due to individual

policyholders. Any such fund, although it may be

required by State law, is merely a solvency reserve,

_ and not the special technical reserve peculiar to in-

surance contracts contemplated by the Act. The

reserve required by law is not a present liability.

Duffy v. Mutual Benefit Co., 272 U. 8. 613. The

special meaning of the legal reserve excludes

amounts held on account of matured obligations and

also those held by insurance companies which do not

represent insurance in existence and in féree dur-

ing the taxable year. In the one case the reserve

has already served its purpose and the amounts

.

.

.

hoe —s tet teeeere ~~, ee ee 22 ew

.

.

22

held have become aecrued liabilities, uncondition-

‘ally due and payable; in the other, since there is no

insurance as yet in existence, there cam be no re-

_serve of the character Sntemplated by the Act.

0

THE AMOUNT IN CONTROVERSY IN THE PRESENT CASE IS

NOT ALLOWABLE AS A DEDUCTION UNDER SECTION 245

(a) (2) OF THE REVENUE ACT OF 1921

It is conceded that assets equal to the amounts:

in issue were required by the State law to be held

by the company. Under the Utah statute (Revised

Statutes, 1933, Title 43, c. 3, See. 4,.infra, p. 45),

the respondent was required to maintain assets

equal to or exceeding all of its ‘‘outstanding lia-

bilities’’,- including .“‘legal reserves’’, as provided

in Section 12 of Title. 43, c. 3, of the Utah Revised

Statutes, infra p. 46. Consequently the respond-

ent was required to have on hand not only the legal

rederves peculiar to life insurance contracts cal-

culated upon the basis of the American Experience

Table of Mortality, with interest at 3'2% per an-

num, but in addition thereto, assets in an amount

equal to all of its outstanding liabilities, including

the amount of the matured unpaid coupons here in

issue, together with accrued interest thereon. The

question, however, is not whether respondent was

required under the law of the State to maintain

assets equal to all of its liabilities, but whether the

amount here involved constituted a legal reserve

within the meaning of the Federal statute. We

contend that it did not.

23

The correct answer to the question would seem

to depend upon whether the coupons in this case

involved life insurance during the taxable year. If

they did not, then there is no insurance liability

with respect to these coupons against which the

insurance reserve is required to be maintained. It

is not disputed that the amounts in controversy

are represented by unpaid matured coupons which

have been Jeft with the company to accumulate at

interest (R. 9). They had not been used to pay

insurance premiums. If they had been so used this

case would not be here. Also they had-not been

used, nor could they be used, to purchase paid-up

life additions to the policy (R. 9, 14); since the

terms of the policy provide that the election must .

have been made within one month after the due

date of the second annual premium (R. 14) ; in any

event, any such coupon so used must have been

surrendered to the company within one month of

its due date (R. 14), and such coupon would jot

be here in issue. Since none of the options men-

tioned had been exercised, the matured coupons,

together with interest, constituted by the express

terms of the policy a fund to the credit of the

policyholder which might be withdrawn in cash at

any time (R. 9, 12), or which, if not withdrawn,

upon the death of the insured would be payable

to th beneficiary in cash in addition to the face

amount of the policy (R.9). Upon default in pay-

ment of premiums the amount was payable to the

24

insured in addition to the rights granted with

respect to his insurance (R. 14).

The coupons thus represented, during the year

1922, a pure liability of the respondent. The pol-

icyholder’s election to leave them with the com-

pany at the time they became due and payable

does not change their character as liabilities of

the company, inasmuch as they are subject to his

right to demand payment at any time. They evi-

dence a pure debtor and creditor relationship.

They are as much a direct liability to the policy-

holder as a deposit in a bank. They represent a

present indebtedness to the individual policy-

holder, and thus differ clearly from the insurance

‘reserve’ held for the group, which does not be-

come an indebtedness to the individual until the

policy matures. Duffy v. Mutual Benefit Co., 272

U. S. 613, 618-619.

The fact that certain options were afforded by

which the policyholder might in the future use his °

accrued matured coupons and interest as cash for

the purchase of additional insurance benefits does

not serve to convert the funds held to meet the ac-

crued coupon obligations into an insurance reserve

for the year 1922 when the options had not been

exercised. One of these options permits the

amount of each, of the nineteen coupons as it ma-

tures to be left with the company to accumulate

at interest and to be surrendered together with the

policy at the end of twenty years, in which event

'. the policyholder may elect to receive one of the

25

following: (1) A cash payment of $8,000; (2) a

paid-up policy for life of $14,130, subject to satis-

factory evidence of insurability for the excess over

the original face amount of the policy; (3) a guar-

- anteed annual income of $490 for at least 20 ‘years;

(4) a paid-up policy for life of $10,000, without

medical re-examination, and an annuity of $174.40

(R. 11). The remaining option provides that if

all of the values represented by the first fourteen

coupons are left on deposit with the company at

interest, the company will, upon written request

of the insured, issue a full paid-up policy for $10,-_

000 at the end of 15 years upon surrender of the

policy -and all of the coupons originally ree,

(R. 12).

' None of the above options was exercised, nor

could any have been exercised, during the year

1922 to convert the matured unpaid coupons then

payable on demand into amounts then held at life

risk, that is, into life insurance. The resporident

was not organized until 1911 and accordingly none

‘ of the above options to convert accrued liability

into an insurance risk could have been exercised

until 1926, fifteen years later.

Moreover, whether or not the conversion could

have taken place in the year 1922, the fact remains

that it had not occurred and no insurance liability

existed upon the .respondent’s part save the obliga-

tion to pay the face amount of the policy, the re-

serves for which are not in dispute in this case. -

: a Gem were

26

The fact that the coupons might be used in the

future to acquire additional insurance benefits is

immaterial. The Revenue Acts generally are con-

cerned with certainties, not conjectures. So in

Brown v. Helvering, 291 U. 8. 193, the taxpayer

was not allowed to set up a reserve to meet can-

cellations which might reasonably be expected to

occur in the future. Here a reserve allowed to

provide for insurance risks already undertaken

may not. be extended to include insurance which

may or may not be purchased in the future. It

would be just as logical to permit the respondent

to establish, as part of its legal reserve, funds set

aside in anticipation of a possibility that some or

all of ‘its policyholders might later pay in addi-

tional amounts, either to increase the amount of

their insurance or to shorten the premium-paying

period. The income of the company for-the year .

1922 must be taxable then or not at all. It cannot

be reduced by’a deduction given for a specific pur-

- pose when the purpose itself is absent and may

never come irito existence.

Furthermore, none of the possibilities presented

in the options referred to will increase the insur-

ance risk beyond the face amount of the policy or

principal amount insured until actually exercised,

in which event the cash accumulations to the credit

of the individual policyholder are sufficient to com-

pensate the company for any additional risk un-

dertaken. For example, where the policyholder |

allows his coupons to mature and remain at inter-

27

est until all premiums are paid, he may, if then

insurable, receive a paid-up policy fof the sum of

$14,130. This amount exactly equals the face |

value of the policy plus the amount of insurance

* which may be purchased at age 55 by a net single

premium of $2,340, the face value of the matured

coupons with interest at the end of 20 years.’

Similarly, the sum of $8,000 payable in cash at the

end of 20 years upon surrender of. the policy and

the coupons equals $5,660, the cash or loan value

of the policy at that time (R. 15), plus the value

of the coupons with interest. _

A similar situation obtains with respect to the

‘right of the policyholder at the end of the fif-

teenth policy year to surrender his policy and all

coupons originally attached thereto, including the

value of the first fourteen coupons with accrued

interest thereon, and in lieu thereof to receive a

fully paid-up policy for $10,000—in other words,

to apply his matured unpaid coupons with accrued

interest thereon to convert his 19-payment life

policy into a 14-payment life policy at the end of

the fifteenth policy year. (See “Fully paid-up

benefit”, R. 12.) The “‘reserve” on a 19-payment

life policy at the end of the fourteenth year (here

the fifteenth policy year, since: the first year is

preliminary term insurance) is actually $377 per

* This statement may be verified by reference to the Amer-

ican Experience Table ‘of Mortality, with interest at 314%.

See Willey, Principles. and Practice of Life Insurance,

Eighth Edition, p. 226.

28

thousand (R. 15). The aggregate value of the

_ first fourteen .coupons with accrued interest

thereon is $153.78 per thousand, and the sum of

the two, $530.78 per thousand. The net single

premium at age 50 or the attained age at the end ;

of the fifteenth policy year is but $508.49 per

thousand.* Thus the actual cash or surrender

value of the policy at the end of the fifteenth

policy year plus the accumulated value of the

fourteen matured and unsurrendered coupons with

accrued interest thereon exceeds the net single pre-

mium on a $1,000 policy at age 50 by $22.29. ;

It has been contended that the presence of these

coupons automatically converts the so-called 20-

payment life policy from the date of issuance

into a defeasible so-called 15-payment life policy.

The provisions of the policy, however, negative.

this contention, since it is therein-provided (R. 12)

that upon the death of the insured before the ac-

tual conversion of the policy at the end of the fif-

teenth policy yedr the face of the policy plus the

‘value of the matured coupons with accrued inter-

, est will be paid to the beneficiary. Obviously ,

only the face of the policy would be payable if the

conversion had actually occurred. Moreover, the

table of cash or loan values attached to the policy

(R. 15) shows that the reserve actually carried is

that required on a 19-payment life policy.

*See Willey, Principles and Practice of Life Insurance,

Eighth Edition, p. 222.

29 -

From the foregoing examples it is apparent

that the liability of the company is not: increased

beyond the face amount of the policy unless and

until an option is exercised to purchase additional

insurance or an annuity, in either of which events

the holder of the coupons is in precisely the same

situation as. any other purchaser ofCinsurance or

of an annuity at age 55 who-has available finds

equal to the matured coupons with accrued in-

terest. So also with respect to the option to re- -

_ duce the premium-paying period. The liability |

-of the company with respect to the face amount

of the policy is not increased, and any individual

with the requisite amount of cash would be per- \

mitted to convert a so-called 20-payment life policy

- into a_ so-called 15-payment life policy. The

greatest possible liability of. the insurer is no

larger than it would be with respect to any per-

son able and willing to devcte the amount of cash

represented by the coupons to an insurance

contract.

It is unimportant, so far as the statutory in-

tendment of reserve funds is concerned, éhat the

excess payment of each year’s premium over the

amount required to carry the outstanding insur-

ance is sufficient when added to what is already

in reserve to purchase insurance on some other

plan. Until the policyholder has exercised his

option the amount held against the coupons rep-

resents no more than deposits at intérest, and

constitutes a pure liability. We submit that any

ee

30

- so-called reserve against such a liability is not an

insurance. reserve within the purview of the

statute. | <

A further argument in support of our conten-

tion rests upon the very nature of the insurance

reserve, which demonstrates that it can never

apply to accrued liabilities due to individual pol-

icyholders in advance of their use for insurance

purposes. The insurance reserve has reference

to a large number of policyholders as a whole or

group, and not to an individual policyholder. By

the reserve funds set up the company is always in

. funds with which to meet an individual policy

claim, irrespective of the time such individual

policy may have been in force. To insure a single

life within a given peridd is a gamble because the

individual must either die or survive that period,

with the result that there is either a great loss or

gain. When a great number of lives are com-

bined in the same group, the.fluctuations in the

rate of deaths from year to year will vary by

only the.smallest fraction of 1 per cent. Hence

by means of the group, uncertainty of life is con-

verted into certainty of death claims. Experi-

ence has shown that among a large group deaths

will occur in accordance with a certain table of

mortality. The ‘Experience Table’’ represents

averages which can be relied upon. Therefore

the ‘“‘legal reserve’’ can never be based upon the

company’s account with an individual in which

the group can never, directly or indirectly, par-

ll

31

ticipate. Once a liability arises to an individual,

as in the case of a policy loss claim, the amount

ceases to be a part of the insurance reserve. It

becomes a pure liability account with the indi-

vidual.

The coupon credits here likewise are liabilities to

individuals, having no reference to the group. To

include them in the reserve for the group violates

the basic principle upon which the insurance re- |

serve is founded. If a sufficient number of per-

sons is insured under all policies and at all different

ages to insure the operation of the law of averages,

_the reserve so determined will be adequate for any

policy. But there is nothing upon which thé law

of averages can operate until the-matured coupon

eredits have been used to put life insurance in

force. Until so used, they are merely accrued

liabilities. , ow

The language of the Court of Claims in Con-.

tinental Assur. Cu. v. United States, supra, is par-

ticularly apposite here. The court said in part

(p. 482) :-§ —--—-—-— | '

The business, however, is-based upon the

law of averages for the group insured and

for this reason the liability on the policy of

life insurance prior to its maturity is not

absolute but contingent. Therefore re-

serves, actuarily determined, must be set up.

out of premiums whén paid to meet future

unaccrued and contingent policy obligations

at maturity. It was the “net value re-

7

, 7

. ‘

—_ 7 » . x eo a ed CET TE erry eee Sian neehdliad .

° >

32

serve,’ ‘‘something reserved from premiums

to meet policy obligations at maturity’’ to

which the Supreme Court referred in New

York Life Ins. Co. v. Edwards, supra, and

the. Court held that the amounts there

claimed were not reserves required by law

within the meaning of the federal statutes

because the liability of the company in that

case Was an accrued and absolute liability.

Itt

THE ADVERSE DECISIONS OF THE COURTS AND THE BOARD

QF TAX APPEALS ARE BASED UPON MISCONCEPTIONS OF

. THE, CHARACTER OF THE RESERVE REQUIRED BY LAW

AND ITS RELATION “TO THE AMOUNT IN ISSUE

The decision of the court below is hased upon its

prior decision in Commissioner v. Great American

Life Ins. Co., 70 F. (2d) 333, and it is necessary to

look to’ the latter case to determine the basis of tiie

court’s, holding that the amounts of matured un-

paid coupons constitute reserves required by

law within the méaning of the Act. In the Great

American Life I ns. Co. case the court conceded that

' in using the word ‘‘reserve’’ Congress ‘had in mind

the technical insurance reserve, and that the com-

pany might not deduct a reserve which doves not

come within the technical meaning merely because

it was required to be maintained by State author-

ity. Its decision seems to be based upon the

ground that the technical reserve is one held as

against a contingent liability on outstanding poli-

cies; that the coupon liabilities meet the test since

the time when they will be demanded in cash is de-

33

pendent upon the will of the insured, and also since

they may later be converted into additional insur- .

ance benefits. From these facts the conclusion is

drawn that the liability is contingent as to time and

manner of payment.

The‘ court has failed to note the real and impor-

tant distinction between the technical reserve and

the matured coupon liabilities. The technical re-

serve is based upon outstanding policies involving

life risks, since. it is only maintained in connection

with all members of the group insured. The funds

necessary to pay the face amount pf the life policy

in a particular case are not withdrawn solely from

the premiums paid by the insured upon that policy,

but from the aggregate funds contributed through

premiums of the group. The contingent liability

before maturity is accordingly general and: not

specific. - |

On the other hand, the funds necessary to pay the

face amount of the matured coupons plus interest

are made up solely from the excess premiums paid °

in by the individual, in which the other mefhbers of

the group have no share, and with which the com-

putation of the aggregate or group liability has no

concern.’ Until the excess premiums represented

‘by the coupons are converted in‘o insurance involy-

ing the element of life risk, they are not properly a

part of the group reserve. When and if they are

80 converted, they immediately become a part of the

technical reserve upon which the deduction will be.

' allowed. The fact that the time when the accrued

34

liability may be demanded is subject io the policy-

holder’s will does not convert the individual lia-

bility into a group reserve. #3

The foregoing also illustrates.the fact that the

court was in error in likening the coupons to the

cash surrender value of a policy. The amount of

the obligation which the company will repay upon

surrender of the policy is that portion of the group

reserve which will be repaid and which is no longer

necessary as ‘a reserve if the existing life risk is

eancelled. In order to obtain this amount it is nec-

essary to surrender the policy and eliminate the

* face amount as 2 death benefit. But when the cou-

pons are surrendered and cashed the face amount of

the policy is not affected. It remains in existence

as a life risk of the company for which a technical

reserve must be maintained, .

In holding that an accrued liability, the matured

coupons, contingent as to time and method of pay-

ment, is embraced within the technical reserve, the

court has, in effect, adopted that part of the defini-

tion used in Maryland Casualty Co. v. United

States, supra (p. 350), which states that the reserve

includes a fund set aside to liquidate “‘claims ac-

erued, but contingent and indefinite as to amount

or time of payment.’’ As we have contended here-

tofore, that portion of this definition is contrary

to the principles of McCoach v. Insurance Co. of N.

Amer., supra, and was disapproved in United

States v. Boston Insurance Co., supra.

35

It also appears that the court was greatly in-

fluenced by the statement made by this Court in.

Williams v: Union Central Co., 291 U. 8. 170, in

which, speaking of guaranteed “ premium reduc-

tion coupons”’ involved in the case of Great South- —

ern Life Ins. Co. v. Jones, 35 F. (2d) 122 (C. ©. A.

8th), this Court said (p. 182) that they were ‘‘fixed

liabilities requiring a. reserve.”’. But neither case

involved the question as to what constituted a

legal reserve within the meaning of the’ taxing

Acts. The sole point presented was whether an

insurance company is bound to use any funds in

‘its hands due the insured ‘to avoid a forfeiture for

nonpayment of premiums, the answer to which de-

pends largely upon the provisions of the particu-.

lar policy. We submit that the language used in

the Union Central case gives no indication that this

Court was concerned with a technical legal reserve,

and that it cannot be considered authority for the

proposition that accrued liabilities upon the cou-

pons constitute a part of such reserve.

_ In Commissioner v. Great American Life Ins.

Co., supra, the court also thought that the failure

to amend the statute furnished strong evidence

that the Board of Tax Appeals and the courts had

correctly divined the legislative intent as to the

meaning of ‘‘reserve funds required by law.”’ But

the fact that certain decisions have construed the

deduction to include the amounts here involved

does not demonstrate that this was the legislative.

intent. The Commissicner has not acquiesced in,

;

————— a ee

.

36

and has continued to oppose, this construction. —

The first of the decisions, that of the Board of Tax

Appeals in Standard Life Insurance Uo. of Amer-

ica Vv. Commissioner, supra, was promulgated in

1928. In 1926; after the decisions of this Court in ~

United States v. Boston Insurance Co., supra, and

New York Ins. Co. v. Edwards, supra, the Bureau

issued a ruling specifically holding that coupons

left with an insurance company and accrued in-

terest thereon are not to be iricluded in the reserves

' under Section 245 (a) (2) of the Revenue Act of .

1921. 8S. R. 9610, V-2 Cumulative Bulletin 189.

This has never been revoked, and it still represents

the administrative position.

Finally, the: necessity for maintaining reserves

for matured coupons on the ground of solvency,

stressed by the court in the Great American Life

_ Ins. Co. case, supra, is beside the point. That such

a requirement does not furnish the test for the legal

reservetis answered by the language of this Court

in McCoach vy. Insurance Co. of N. Amer., supra

(p. 589) that—

, The act of Congress, on the other hand,

deals with reserves not particularly in their

bearing upon the solvency. of the company,

but’ as they aid in determining what part of

the gross income ought to be treated as net

income for purposes of taxation.

Similarly, the fact that.the company must set

aside amounts from its investment income to meet

‘the interest accruing on matured ‘coupons is not

ead

t 37

sufficient to justifythe deduction asa reserve. For

purposes of solvency it may likewise set aside from

income amounts necessary to satisfy other accrued

unpaid obligations. But this does not mean that —

the amounts necessary to meet such liabilities are

part of the technical, reserve contemplated by the

statute. : ;

The only other adverse decision*in which any

extended discussion of the principle oceurred is

that of the Board of Tax Appeals in Standard Life

Insurance Co. of America vy. Commissioner, supra.

The decisions of thé Cireuit Court of Appeals fox

the Third Circuit in Commissioner v. Standard

Life Ins. Co. of America, 47 F. (2d) 218, and the

Cireuit Court of Appeals for the Ninth Circuit in

Commissioner v. Western Union Life Ins. Co., 61

F, (2d) 207, are based upon that of the Board in

the Standard Life Insurance Coe. of America case.

The only additional reasoning in the Western

Union Life Ins. Co. case is based upon the assump-

tion that the coupon liabilities come within that

part of the definition of a reserve contained in the

Maryland Casualty Co. case (p. 350), but subse-

quently disapproved in United States v. Boston In-

\surance Co., supra, namely, ‘claims accrued, but

contingent and indefinite as to amount or time of

payment.”’ : |

The Board's decision in the Stundard Life In-

surance Co. of America case is based upon certain

assumptions which we contend, are erroneous. The

Board stated’ that the definition of reserves in the

*

‘

— e : P eee ey Re a ap oe ryan a 4 SRA Oe

P °

. °

McCoach case as funds held against the contingent

liability on outstanding policies does not apply to

life-insurarice conipanies, since the life-insurance

company has an absolute and uncontingent lia-

bility in respect of every policy; that the liability

upon unsurrendered coupons is likewise absolute

and the same as the liability to pay any portion of

the principal of the policy; that if the company

pays the face amount of the coupons it is simply

paying a policy obligatica and the insured has

surrendered part of the policy; consequently, a

reserve to meet the coupons is something reserved.

from premiums to. meet. policy obligations at ma-

turity, within the language used by this Court in

New York Ins. Co. v. Edwards, supra, p. 119.

The fundamental error in the Board’s reasoning

lies in the assumption that a life-insurance com-

pany has an absolute liability in respect of every

policy so long as premiums are paid thereon, and

that such liability is not contingent. We have al-

ready pointed out that it is only upon the maturity

of a policy that a policyholder becomes a creditor

of the company; then, for the first time, there ig

an indebtedness (Duffy v. Mutual Benefit Co.,

supra, p. 618). If the life insurance company’s

liability is contingent and not absolute on its life .

contracts, then reserves are required. If the com-

pany’s liability were absolute to the individual

policyholder, as the Board decides, there would be

no need for the use of mortality tables. Since the

business of life insurance is based upon the law of

39

averages for the group insured, the liability on a

policy of life insurance prior to its maturity is not

absolute but contingent. Accordingly, reserves

actuarily determined must be set up out of premi-

ums when paid to meet future unacerued and con- .

tiagent policy obligations at maturity. It was the

net value reserve, ‘something reserved from pre-

miums to meet policy obligations at maturity’’, to

which this Court referred in the New Y ork Ins.

Co. case, supra, and it was because the liability of

the company in that case for death losses, whieh

had occurred but ‘were. unreported, was an accrued

_ and absolute liability that’ the amounts there

claimed as reserves were held not to constitute

‘“reserves’’ required by law within the meaning of

the Federal statutes, _

Another erroneous premise of the Board is that

the company is simply paying off a policy obliga-

tion and that the policyholder has surrendered a

part of his policy when a matured coupon is paid

with interest. Clearly the policyholder, by de-

manding and accepting the amount due him on his

matured coupons with interest, does not surrender

any part of his, life-insurance policy, nor is the

company’s net value reserve held against its life-

insurance obligations at maturity thereby affected

in the slightest degree. The fact is that the com-

pany by the payment of a matured coupon with

interest discharges to that extent a pure liability

which had accrued on the coupon contract, and

which had never represented life insurance in

.

.

——- - rere oO —— =, . ce ——

ee — =

ie . :

40

force. It still remains bound to the insured to the

fullest extent of its life-insurance policy obliga-

tion, against which it was required to maintain the

legal reserve. |

In subsequent decisions the Board sas held that

dividends of a mutual company left with the com-

pany are not reserves required by law. See Mid-

land Mutual Life Insurance Co. v. Commissioner,

19 B. T. A. 765, The Court of Claims has held to

the same effect. Minnesota Mutual Life Ins. Co.v.

United States, 66 C, Cls. 481, certiorarndenied, 279

U! S. 856; Massachusetts Mut. Life Ins. Co. v.

United States, 56 F.(2d) 897. It has also been

held that the interest upon such dividends, when —

paid, is deductible as interest under Section 245 ;

(a) (8) of the Revenue Act of 1926 (c. 27, 44 Stat.

9, U. 8. C. App., Title 26, Sec. 1004),gust as the

interest was allowed in this ease. See Massachu-

setts Mut. Life Ins. Co. v. United States, 59 F.(2d)

116 (C. Cls.), affirmed by this Court, 288 U. 8.

269. There is no real distinction in principle,

insofar as the reserve question is concerned, be-

tween such a dividend and a eoupon of the type

here involveg. Each becomes an accrued liability,

the dividend upon its declaration, the coupon upon

its maturity and the payment of the requisite, pre-

mium. Thenceforth each is an accrued liability of

the company, and not a life risk requiring the in-

surance reserve, unless and until it is converted

‘into some form of insurance at life risk requiring

a group reserve. We contend that the decisions

-

41

in the cases just cited represent the correct view

and that the same principle should apply to ma-

tured coupon liabilities.

We submit that the conclusions of the Court of

Claims recited*in its opinion in Continental Assur.

Co. v. United States, 8 F. Supp. 474, 483-484, are

correct and dispose of the contr@versy here,

namely :

(1) That accrued ‘liabilities. are not the

subject of the “‘reserve fund’’ deductions

granted by Congress in any of the revenue

acts; (2) that the ‘‘reserve’’ contemplated

in the Federal statutes is “that fund which

when added to the present value of future

net premiums is equal to the present value .

of future death claims’’; that is, the mathe-

matical equivalent of the obligation in-

curred by the company to pay the sum

“insured at the death of the policyholder or

upon the surrender and cancellation of the

policy ; (3) that the ‘‘reserve’’ contemplated

in the federal statutes is caleulated upon the

basis of a selected table of mortality plus.

an assumed rate of interest; and that re-

serves not so calculated, whether required

by state law or by state officer, are not

! ‘freserve funds required by law’’ within the

. meaning of the federal statutes; and (4) °

that the ‘“‘reserve fund’ required by law

within the meaning of the federal statutes

does not include ‘‘solvency’’ reserves re-

quired to be maintained by state law or a

state officer to keep the company in sound

financial condition.

— et mato

a ee

42

CONCLUSION

It is respectfully submitted that the decision of

the court. below is erroneous and should be reversed.

v J. Crawrorp Biaas,

Solicitor General.

' Frank J. WIDEMAN,

‘Assistant Attorney General.

“James W. Morais,

Norman D. Keiier,

Epwarp H. Horton,

Special Assistants to the Attorney General.

JANUARY 1935.

APPENDIX

Revenue Act of 1921, e. 136, 42 Stat. 227, 261:

Sec. 245. (a) That in the case of a life-in-

surance company the term “net income”’

means the gross income less—

* . * * *

(2) An amount équal to the excess, if any,

over the deduction specified in paragraph

(1) of this subdivision, of 4 per centum of

the mean of the reserve funds required by

-law and held at the beginning and end of the

taxable year, plus (in case of life-insurance

companies issuing policies covering life,

health, and accident insurance combined in ‘

one policy issued on the weekly premium

payment plan, continuing for life and not

subject to cancellation) 4 per centum of the

mean of such reserve funds (not required by

law) held at the beginning and‘end of the

taxable year, as the Commissioner finds to

be necessary for the protection of the hold-

ers of such policies only ; a.

. * * _ *

(8) All interest paid or aecrued within the

taxable year on its indebtedness, except on-

. Indebtedness incurred or continued to pur-

chase or carry obligations or securities

- (other than obligations of the United States

issued after September 24, 1917, and orig-

inally subseribed for by the taxpayer) the

interest upon which is wholly exempt from

taxation under this title:

a: a * * *

(43)

*

44

Treagury Regulations 62, promulgated under the

Revenue Act of 1921:

Art. 681. Reserve funds.—Under para-

graphs (1) and (2) of section 245 (a), life

insurance companies are entitled to deduct

from gross income:. (1) Interest which is -

exempted in the case of other taxpayers by

section 213 (b) (4) and articles 74-83; and

(2) the excess, if any, of the reserve dedue-

tion specified in section 245 (a) (2) over the

amount of such interest. The reserve de-

duction is based upon the reserves required

by express statutory provisions or by the

rules and regulations of the State insurance

departments when promulgated in the exer-

cise of a power conferred by statute; but

such reserveslo not include assets required

to be held for the ordinary running expenses

of the business nor do they ‘include the re-—

serve or net value of risks reinsured in other *

solvent companies to the extent of the rein-

surance. In the case of dife insurance com-

panies issuing policies covering life, health,

and accident insurance combined in one pol-

ley issued on the weekly premium payment

plan, continuing for life and not subject to

cancellation, it, is required that reserves

thereon be based upon recognized tables of

experience covering disability benefits of the

kind contained ‘in policies issued by this par-

ticular class of companies. Only: reserVes

peculiar to insurance companies are to be

‘taken into consideration. eserves “‘main-

tained to provide for the ordinary running

expenses of a business, definite in amount,

and which must be ¢urrently paid by every

s company from its income if its business is

: - to continue, such as taxes, salaries, reinsur-

. ance and unpaid brokerage’’ (Maryland Cas-

walty Co. v. United States, 251 g S. 342),

45

Fwill not be considered. A company is per-

mitted to make use of the highest aggregate

reserve called for by any State in which it

transacts busmess, but the reserve must have

been actually held as shown by the annual

statement. Generally speaking, the follow-

ing will be considered reserves as gontem-

plated by the law: Items 7, 8, 9, 10, and 14 of

the liability page of the annual statement for

life companies, and items 16, 17, 18, 19, and |

26 of the liability page of the annual state-

ment for miscellaneous stock companies, if

a life insurance-company is also- transacting

other kinds of insurance business.. If other

serves are claimed, sufficient information

lust be filed with the return to enable the

Commissioner to determine the validity of

the claim. Reference should he made to the

item in which the reserve appears in the’an- |

nual statement and to thé State statute or

insurance department. ruling requiring that

such reserves be held. :

Revised Statutts of Utah, 1933, Title 43:

CHAPTER 3

. * * . -

Sec. 4. Capitdl to be full-paid and un-

impaircd.—No stock company shall do any

jlife} insurance business in this state be-

ore its capital is fully paid up. Said cap-

ital must he unimpaired, that is, the assets

of such company must equal or exceed all

liabilities’ for. losses reported, expenses,

taxes and other outstanding liabilities, in-

cluding the legal reserves as provided in

sections 43-3-12 * * * (LL, 21, p. 96,

§ 1144 [8]). (Italics supplied: )

* ' * * *

.

46

Sec. 12. Life insurance—Valuation of

policies and reserves.—For the purpose of

making valuations of life insurance poli-

cies and of determining the réserves re-

quired to be maintained therefor under the

provisions of this title the rate of interest

assumed shall be 3% percent per annum,

and the rate of: mortality shall be estab-

lished by the table known as the ‘‘Ameri-

can Experience Table of Mortality’’ for

policies issued after January 1, 1910;

»* * (CC. L. 17, § 1153). (Italics sup-

plied.) . :

a ome

U.S GOVERNAMENT PRINTING OFFICE: t938