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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petitioners Brief
- **Published:** January 1, 1935
- **Citation:** 294 U.S. 686

## Text

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386009_0197%3A3. Public record. Not legal advice.