Central Reserve Life Corporation and Subsidiaries v. Commissioner

113 T.C. No. 19

UNITED STATES TAX COURT

CENTRAL RESERVE LIFE CORPORATION AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21390-96. Filed October 12, 1999.

P's subsidiary, L, writes cancelable accident and
health (CA&H) insurance. R argues that L is not a
“life insurance company" under sec. 816(a), I.R.C.,
because L's accrued unpaid losses on CA&H insurance are
“unpaid losses" for purposes of ascertaining its “total
reserves" under sec. 816(c), I.R.C. P argues that L is
a life insurance company under sec. 816(a), I.R.C.,
because the term “unpaid losses", as used in sec.
816(c), I.R.C., does not include accrued unpaid losses
on CA&H insurance.
Held: L is a life insurance company under sec.
816(a), I.R.C.; its accrued unpaid losses on CA&H
insurance are not “unpaid losses” for purposes of sec.
816(c), I.R.C.
 - 2 -

Michael R. Schlessinger and Michael A. Clark, for

petitioner.

Katherine Lee Wambsgans, for respondent.

OPINION

LARO, Judge: This case is before the Court fully

stipulated. See Rule 122. Central Reserve Life Corporation and

Subsidiaries petitioned the Court to redetermine respondent's

determination of deficiencies of $1,936,766 and $225,070 in its

consolidated Federal income tax for 1991 and 1992, respectively.

Following the parties' concessions, we must decide whether the

phrase “unpaid losses * * * not included in life insurance

reserves” as used to define the term “total reserves” in section

816(c)(2) includes accrued unpaid losses on cancelable accident

and health (CA&H) insurance policies.1 We hold it does not.

Unless otherwise stated, section references are to the Internal

Revenue Code in effect for the subject years. Rule references

1
An “unpaid loss” generally is an insurer's estimate of its
liability for claims arising out of injuries which have already
occurred. Unpaid losses may be accrued or unaccrued. Assume,
for example, that a policyholder fractures his pelvis in an
automobile accident and is transported to the emergency room by
ambulance. The expenses incurred in the emergency room are
accrued because reimbursement may be claimed at any time. Future
rehabilitation expenses are unaccrued; although these expenses
may be estimated before they are incurred, the insurer need not
pay for them until they are incurred. See Harco Holdings, Inc.
v. United States, 977 F.2d 1027, 1029 (7th Cir. 1992).
 - 3 -

are to the Tax Court Rules of Practice and Procedure. We use the

term “petitioner” to refer solely to Central Reserve Life

Corporation.

Background

All facts have been stipulated. The stipulation of facts

and the exhibits submitted therewith are incorporated herein by

this reference. Petitioner's principal place of business was in

Strongsville, Ohio, when its petition was filed.

Petitioner is the parent corporation of an affiliated group

of corporations that files consolidated Federal income tax

returns. Central Reserve Life Insurance Company (Central Life)

is petitioner's wholly owned subsidiary. Central Life writes

life insurance and accident and health (A&H) insurance.

Insurance regulators require that insurance companies

maintain defined levels of assets to guarantee that they can pay

their claims when the claims become due. These asset reserves

generally must equal the amount of funds which, when increased at

a stated rate of interest, will allow the company to pay its

claims at their actuarially estimated due dates.

Insurance companies must report their anticipated

obligations for claims on a standard annual statement promulgated

by the National Association of Insurance Commissioners (NAIC) and

adopted by all 50 States. The annual statement characterizes an

insurer's life and A&H obligations as either “reserves” or
 - 4 -

“liabilities”, and it uses the word “accrual” to distinguish

current obligations from future obligations.2 A reserve is an

unaccrued claim for which the insurer will become liable in the

future; e.g., the future rehabilitation expenses described supra

note 1. A liability is an accrued claim for which the insurer is

liable now; e.g., the emergency room expenses described supra

note 1. Exhibit 8 of the annual statement lists an insurer's

“Aggregate Reserve for Life Policies and Contracts”. Exhibit 9

lists an insurer's “Aggregate Reserve for Accident and Health

Policies”. Exhibit 11 lists an insurer's “Policy and Contract

Claims”; data on these claims is listed separately as to yearend

liabilities for life insurance and A&H insurance.

Central Life filed its 1990 through 1992 annual statements

with the Ohio Department of Insurance. As relevant herein,

Central Life reported its claim obligations on life insurance

policies and annuities on exhibits 8 and 11, and it reported its

claim obligations on A&H insurance policies on exhibits 9 and 11.

Central Life reported its unaccrued claim obligations for life

insurance and A&H insurance as reserves on exhibits 8 and 9,

respectively, and it reported all of its accrued claim

obligations as liabilities on exhibit 11. During 1990 and 1991,

2
The use of the word “accrual” in the insurance industry
does not conform to the definition of that word under Generally
Accepted Accounting Principles.
 - 5 -

Central Life wrote primarily guaranteed renewable A&H insurance.

In the latter year, Central Life qualified as a life insurance

company under the ratio (reserve ratio) set forth in section

816(a). In 1991, Central Life properly included unpaid losses

with respect to its guaranteed renewable A&H insurance in the

reserve ratio's numerator and denominator.

Beginning in late 1991, Central Life added a rider to its

existing guaranteed renewable A&H insurance policies, which

allowed it to terminate any of these policies upon 90 days’

notice. By virtue of this rider, Central Life's A&H insurance

policies issued after late 1991 were no longer guaranteed

renewable policies; they were nonguaranteed renewable or CA&H

insurance policies. Because Central Life stopped issuing

guaranteed renewable A&H insurance policies in late 1991,

unearned premiums and unpaid losses with respect to those

policies were no longer properly includable in the reserve

ratio's numerator in 1992 and years thereafter. Central Life's

A&H insurance business in 1992 consisted almost exclusively of

CA&H insurance; it also wrote a small amount of guaranteed

renewable group A&H insurance.

The parties agree that unpaid losses with respect to Central

Life's CA&H insurance policies are not includable in the reserve

ratio's numerator. The parties dispute whether those amounts

must be included in the reserve ratio’s denominator. Respondent
 - 6 -

determined and argues that the denominator includes these

amounts. Petitioner argues that the denominator does not include

these amounts. If petitioner is correct, Central Life qualifies

as a life insurance company under section 816(a). If respondent

is correct, Central Life fails to qualify as a life insurance

company for Federal income tax purposes, and petitioner's taxable

income would include Central Life's policyholder surplus of

$2,869,768. Central Life also would not be entitled to the small

life insurance company deduction in the amounts that it reported

for the subject years.

Discussion

The parties dispute whether Central Life qualifies as a life

insurance company for Federal income tax purposes. Congress has

enacted in the Internal Revenue Code different rules of taxation

for insurance companies that are life insurance companies as

opposed to nonlife insurance companies such as property and

casualty (P&C) insurance companies. Compare secs. 801-818 (rules

applicable to life insurance companies) with secs. 831-835 (rules

applicable to nonlife insurance companies). The rules that apply

to life insurance companies are more favorable to insurance

companies from a tax point of view than are the rules which apply

to nonlife insurance companies. See United States v. Consumer

Life Ins. Co., 430 U.S. 725, 727-728 (1977).
 - 7 -

An insurance company is a life insurance company for Federal

income tax purposes if it meets the definition set forth in

section 816. Section 816 provides in part:

SEC. 816. LIFE INSURANCE COMPANY DEFINED.

(a) Life Insurance Company Defined.--For purposes
of this subtitle, the term “life insurance company”
means an insurance company which is engaged in the
business of issuing life insurance and annuity
contracts (either separately or combined with accident
and health insurance), or noncancellable contracts of
accident and health insurance, if--

(1) its life insurance reserves (as
defined in subsection (b)), plus

(2) unearned premiums, and unpaid losses
(whether or not ascertained), on
noncancellable life, accident or health
policies not included in life insurance
reserves,

comprise more than 50 percent of its total reserves (as
defined in subsection (c)). * * *

(b) Life Insurance Reserves Defined.--

(1) In general. For purposes of this
part, the term “life insurance reserves”
means amounts--

(A) which are computed or
estimated on the basis of
recognized mortality or morbidity
tables and assumed rates of
interest, and

(B) which are set aside to
mature or liquidate, either by
payment or reinsurance, future
unaccrued claims arising from life
insurance, annuity, and
noncancellable accident and health
insurance contracts (including life
 - 8 -

insurance or annuity contracts
combined with noncancellable
accident and health insurance)
involving, at the time with respect
to which the reserve is computed,
life, accident, or health
contingencies.

(2) Reserves must be required by law.--Except--

(A) in the case of policies
covering life, accident, and health
insurance combined in one policy
issued on the weekly premium
payment plan, continuing for life
and not subject to cancellation, *
* *

in addition to the requirements set forth in
paragraph (1), life insurance reserves must
be required by law.

* * * * * * *

(4) Amount of reserves. For purposes of
this subsection, subsection (a), and
subsection (c), the amount of any reserve (or
portion thereof) for any taxable year shall
be the mean of such reserve (or portion
thereof) at the beginning and end of the
taxable year.

(c) Total Reserves Defined.--For purposes of
subsection (a), the term “total reserves” means--

(1) life insurance reserves,

(2) unearned premiums, and unpaid losses
(whether or not ascertained), not included in
life insurance reserves, and

(3) all other insurance reserves
required by law.

In a case of first impression in this Court, we must decide

whether the phrase “unpaid losses * * * not included in life
 - 9 -

insurance reserves” as used in section 816(c)(2) to define an

insurer’s “total reserves” includes accrued unpaid losses on CA&H

insurance policies. The Court of Appeals for the Seventh Circuit

has concluded it does not. See Harco Holdings, Inc. v. United

States, 977 F.2d 1027 (7th Cir. 1992), revg. 754 F. Supp. 130

(N.D. Ill. 1990). The Court of Appeals for the Ninth Circuit has

concluded that the term “unpaid losses” did include accrued

unpaid losses for purposes of section 806(c), before its repeal

by section 2 of the Life Insurance Company Income Tax Act of

1959, Pub. L. 86-69, 73 Stat. 112.3 See United States v.

Occidental Life Ins. Co., 385 F.2d 1, 6 (9th Cir. 1967), revg. on

this issue 250 F. Supp. 130 (S.D. Cal. 1965). The United States

Court of Claims also considered this issue in the context of

former section 806(c)'s predecessor. That court reached a

conclusion consistent with the view of the Court of Appeals for

the Ninth Circuit. See Prudential Ins. Co. v United States, 162

Ct. Cl. 55, 319 F.2d 161, 165-166 (1963).

3
Former sec. 806(c) provided:

In the case of a life insurance company writing
contracts other than life insurance or annuity
contracts (either separately or combined with
noncancellable health and accident insurance), the term
“adjustment for certain reserves” means an amount equal
to 3 1/4 percent of the unearned premiums and unpaid
losses on such other contracts which are not included
in life insurance reserves * * *.
 - 10 -

We agree with the Court of Appeals for the Seventh Circuit

that the phrase “unpaid losses * * * not included in life

insurance reserves” as used in section 816(c)(2) to define an

insurer’s “total reserves” does not include accrued unpaid losses

on CA&H insurance policies. Our analysis starts with the

statutory text, and we construe that text in accordance with its

ordinary, everyday meaning. We refer to the legislative history

primarily to learn the purpose of the statute in which the

language appears and to resolve any ambiguity in the words used

in the text. See Landgraf v. USI Film Prods., 511 U.S. 244

(1994); Commissioner v. Soliman, 506 U.S. 168, 174 (1993);

Consumer Prod. Safety Commn. v. GTE Sylvania, Inc., 447 U.S. 102,

108 (1980); Crane v. Commissioner, 331 U.S. 1, 6 (1947); Venture

Funding, Ltd. v. Commissioner, 110 T.C. 236, 241-242 (1998);

Booth v. Commissioner, 108 T.C. 524, 568-569 (1997); Trans City

Life Ins. Co. v. Commissioner, 106 T.C. 274, 299 (1996).

The ordinary, everyday meaning of text is usually the

meaning of the words or phrases therein that is commonly

understood by the public in general; e.g., the most common

dictionary definitions. See, e.g., Mallard v. United States

Dist. Court for S. Dist., 490 U.S. 296, 301 (1989); National

Muffler Dealers Association, Inc. v. United States, 440 U.S. 472,

480 (1979); Crane v. Commissioner, supra at 6; Hefti v.

Commissioner, 97 T.C. 180, 193 (1991), affd. 983 F.2d 868 (8th
 - 11 -

Cir. 1993). In the case at hand, however, the text of section

816 is found in subchapter L of the Code. Congress drafted

subchapter L and its predecessors using the specialized language

of the insurance industry, and Congress understood that language

to have the technical meaning given to it by that industry. See

Helvering v. Independent Life Ins. Co., 292 U.S. 371, 379 (1934);

Alinco Life Ins. Co. v. United States, 178 Ct. Cl. 813, 373 F.2d

336, 352 (1967); see also United States v. American Trucking

Associations, Inc., 310 U.S. 534, 543-544 (1940). It is only

appropriate, therefore, to construe the subject text in the light

of its usage in the insurance industry, to the extent that it has

an established meaning in that industry. See Atlantic Mut. Ins.

Co. v. Commissioner, 523 U.S. 382 (1998); Hedden v. Richard, 149

U.S. 346, 348-349 (1893); South Jersey Sand Co. v. Commissioner,

30 T.C. 360, 368 (1958), affd. 267 F.2d 591 (3d Cir. 1959). The

meaning of the words in the insurance industry may be gleaned

from their use in the annual statement which contains,

references, and incorporates many of the industry’s terms of art.

The annual statement is instructive in understanding the peculiar

meaning of those words, which, in turn, may make it most helpful

in construing the provisions of subchapter L. See Commissioner

v. Standard Life & Accident Ins. Co., 433 U.S. 148, 157-163

(1977); Harco Holdings, Inc. v. United States, supra at 1033.
 - 12 -

We turn to the evolution of the term “unpaid losses”, taking

into account the taxation of insurance companies in general and

the authorities that Congress had before it at the time it added

the term to section 201 of the Internal Revenue Code of 1939 in

section 163(a) of the Revenue Act of 1942 (1942 Act), ch. 619, 56

Stat. 798, 867. Whereas respondent asks the Court to ascertain

Congress' intent for the relevant provisions of the 1942 Act by

considering legislation that was enacted 40 and more years

thereafter, we limit our analysis of that intent to the materials

which were before Congress in 1942. “It is emphatically the

province and duty of the judicial department to say what the law

is”, Marbury v. Madison, 5 U.S. (1 Cranch) 137, 177 (1803); see

also United States v. American Trucking Associations, Inc., supra

at 544, and the views of one Congress as to the meaning of prior

legislation have little bearing on a court's furtherance of that

duty, see Consumer Prod. Safety Commn. v. GTE Sylvania, Inc.,

supra at 117-118; Haynes v. United States, 390 U.S. 85, 87 n.4

(1968); United States v. Philadelphia Natl. Bank, 374 U.S. 321,

348-349 (1963); United States v. United Mine Workers, 330 U.S.

258, 281-282 (1947); see also United States v. Price, 361 U.S.

304, 313 (1960) (“the views of a subsequent Congress form a

hazardous basis for inferring the intent of an earlier one”).

Such is especially true in the instant case where few of the

legislators who voted on the subsequent legislation in the 1980's
 - 13 -

were members of Congress in 1942. See, e.g., United States v.

United Mine Workers, supra at 281-282.

Life insurance companies became subject to Federal income

tax when the Sixteenth Amendment to the United States

Constitution was ratified in 1913. Before that time, insurance

companies which were corporations were subject to an annual

excise tax of 1 percent of their net income over $5,000. See

Federal Corporation Excise Tax Act of 1909, ch. 6, sec. 38, 36

Stat. 112. Unlike other corporations, an insurance company's net

income included a deduction for the “net addition, if any,

required by law to be made within the year to reserve funds”.

Id. This deduction was the subject of much litigation by

casualty companies, and the judicial interpretations on the

breadth of that deduction were not always easily harmonized.

Compare McCoach v. Insurance Co. of North Am., 244 U.S. 585

(1917) (reserve against unpaid losses was not required by law),

with Maryland Cas. Co. v. United States, 251 U.S. 342 (1920)

(approving liability reserve for accrued indefinite liabilities

and loss claim reserve for other accrued losses).

After the Sixteenth Amendment was ratified, life insurance

companies continued to be taxed in the early years of our tax

system under the same general rules that applied to noninsurance

companies. Both types of companies were taxed on their gross

income, which, in the case of a life insurance company, consisted
 - 14 -

mainly of underwriting income, investment income, and capital

gains. Life insurance companies, however, continued to be

allowed to deduct the net addition required by law to be made

within the year to reserve funds. Life insurance companies also

could deduct that portion of their net investment income that was

credited to policyholders' reserves as required by law.

Actuarial concepts governed the application of the reserve

deduction provision of the revenue acts up until 1921. See,

e.g., Income Tax Act of 1913, ch. 16, sec. II(G)(b), 38 Stat.

114, 173; Revenue Act of 1916, ch. 463, sec. 12(a) Second, 39

Stat. 756, 768; Revenue Act of 1918, ch. 18, sec. 234(a)(10), 40

Stat. 1057, 1079; see also Commissioner v. Standard Life and

Accident Ins. Co., supra at 152; Union Cen. Life Ins. Co. v.

Commissioner, 77 T.C. 845, 849-850 (1981), vacated and remanded

on another issue 720 F.2d 420 (6th Cir. 1983).

By 1921, Congress recognized that the rules which applied to

life insurance companies were inequitable. Adequate revenues

were not being raised from the insurance industry, and life

insurance companies were constantly litigating issues concerning

their taxability; e.g., as to whether premiums constituted

taxable income. See S. Rept. 275, 67th Cong., 1st Sess. 14

(1921), 1939-1 C.B. (Part 2) 181, 195; H. Rept. 350, 67th Cong.,

1st Sess. 14 (1921), 1939-1 C.B. (Part 2) 168, 178; see also

Union Cen. Life Ins. Co. v. Commissioner, supra at 849-850. The
 - 15 -

Revenue Act of 1921 (1921 Act), ch. 136, sec. 247(a)(4), 42 Stat.

263, changed favorably to life insurance companies the law under

which life insurance companies were taxed by providing a system

under which life insurance companies were taxed only on their net

investment income. Investment income, for this purpose, did not

include premiums, losses and expenses incurred in underwriting

operations, and gains and losses from the sale of investment

assets. The portion of investment income set aside in reserves

to satisfy a company’s obligations to its policyholders under its

insurance contracts also was excluded from taxation. See id.

Before the 1921 Act, the same statutory provisions applied

to tax both life and P&C insurers. The 1921 Act changed this

uniformity by providing for life insurance companies rules which

were different and generally more favorable than the rules under

which a P&C insurer was taxed. The 1921 Act taxed P&C insurers

on both their investment and premium income and did not allow

them to deduct their reserve funds. P&C insurers, however, could

deduct their “losses incurred”, see 1921 Act sec. 247(a)(4), 42

Stat. 263, a deduction that required a calculation of the P&C

insurer's unpaid losses at the end of the year, see 1921 Act sec.

246(b)(6), 42 Stat. 227. For the purpose of this calculation,

the unpaid losses of a P&C company included its accrued

liabilities. See Retailers Fire Ins. Co. v. Commissioner, 3
 - 16 -

B.T.A. 1186, 1193 (1926) (accrued liability for fire loss is

deductible unpaid loss).

An insurance company was a life insurance company under the

1921 Act if more than half of its total reserves were life

insurance reserves. See 1921 Act sec. 242, 42 Stat. 261. This

qualification fraction, which is the genesis of the reserve

ratio, meant that an insurance company could not qualify as a

life insurance company for Federal income tax purposes unless

more than 50 percent of its total insurance reserves was

attributable to life insurance or analogous contracts. See

Alinco Life Ins. Co. v. United States, 178 Ct. Cl. 813, 373 F.2d

336, 347 (1967).

An application of the qualification test under the 1921 Act

was difficult because the 1921 Act failed to define many relevant

terms. Section 163(a) of the 1942 Act addressed this concern by

defining the term “life insurance reserves”, adding the term

“unpaid losses on noncancellable life, health, or accident

policies” to “life insurance reserves” in the numerator of the

reserve ratio, and defining the term “total reserves” in the

denominator of the reserve ratio to include the term at issue;

i.e.,”unpaid losses”. Those provisions were carried forward

substantially unchanged into section 816 as applicable herein.4

4
Sec. 2 of the Life Insurance Company Income Tax Act of
(continued...)
 - 17 -

With this backdrop in mind, we turn to the respective

arguments of the parties. Respondent looks to the subject term,

“unpaid losses”, and argues that a plain reading of this term

includes all unpaid losses, accrued or unaccrued. That reading,

respondent continues, comports with the definitions of “unpaid

losses” and “reserves” which were prevalent in the P&C insurance

industry at the time of the 1942 Act. Respondent argues that

Congress, in the 1942 Act, used the P&C meaning of “unpaid

losses” to refer to unpaid losses in the industry of life and A&H

insurance. Respondent argues that the insurance industry treats

an accrued unpaid loss as substantively the same as an unaccrued

unpaid loss and a reserve as substantively the same as a

liability. Respondent acknowledges that the insurance industry

distinguishes between accrued and unaccrued unpaid losses for

purposes of the annual statement but asserts that this

distinction is meaningless for Federal income tax purposes.

Petitioner argues that the industry of life and A&H insurance,

unlike the P&C insurance industry, makes a meaningful distinction

between an unpaid loss that has accrued and an unpaid loss that

has not accrued, and petitioner asserts that the industry of life

and A&H insurance considers a reserve to be different from a

4
(...continued)
1959, Pub. L. 86-69, 73 Stat. 112, added the parenthetical phrase
“whether or not ascertained” now found in sec. 816(a)(2).
 - 18 -

liability. Petitioner argues that the meaning of the subject

term as given to it by the industry of life and A&H insurance is

the meaning that applies here.

We agree with petitioner that the specific industry at the

focus of our inquiry is life and A&H insurance and that the life

and A&H insurance industry distinguishes meaningfully a reserve

from a liability and an accrued unpaid loss from an unaccrued

unpaid loss. We also agree with petitioner that an unaccrued

unpaid loss, which the industry treats as a reserve and not a

liability, is substantively different for purposes of section 816

from an accrued unpaid loss, which the industry treats as a

liability and not a reserve.

As we read the applicable text with its lengthy history in

mind, we believe that Congress meant for the term “unpaid losses”

to reach only those unpaid losses which are technical reserves in

the NAIC sense; to wit, unaccrued unpaid losses. According to

the NAIC, an unaccrued unpaid loss is considered a reserve for

annual statement purposes, and an accrued unpaid loss is

considered a liability.5 We, like the Court of Appeals for the

5
As we understand the nomenclature of the life and A&H
industry, an A&H insurer incurs a loss upon the happening of an
insured event, and, when it does, the estimated liability on the
portion of the loss that represents services yet to be received
is called an unaccrued unpaid loss or a reserve. The estimated
liability of the portion that represents services already
received is called an accrued unpaid loss or an accrued
(continued...)
 - 19 -

Seventh Circuit in Harco Holdings, Inc. v. United States, 977

F.2d 1027, 1033 (7th Cir. 1992), believe that the NAIC's

treatment of an item in the annual statement is an “authoritative

interpretive guide” as to the item’s treatment for Federal income

tax purposes, and that, when placed in the context of this case,

the item known as accrued unpaid losses does not fall within the

meaning of the term “unpaid losses” for purposes of section

816(c). See also Gulf Life Ins. Co. v. United States, 35 Fed.

Cl. 12 (1996), affd. 118 F.3d 1563 (Fed. Cir. 1997). To be sure,

the legislative purpose of the reserve ratio is to define

mechanically the term “total reserves”, and the fact that an

accrued unpaid loss is not a reserve within the meaning of the

term in the industry of life and A&H insurance leads to the

conclusion that the legislators did not intend for accrued unpaid

losses to enter into “total reserves”.

Respondent relies on Occidental Life Ins. Co. v. United

States, 385 F.2d 1 (9th Cir. 1967), to support his assertion that

the annual statement’s distinction between accrued and unaccrued

items is meaningless for Federal income tax purposes. We, for

the reasons stated by the Court of Appeals for the Seventh

Circuit in Harco Holdings, Inc. v. United States, supra, find

Occidental Life Ins. Co. unhelpful to us in construing the term

5
(...continued)
liability.
 - 20 -

“unpaid losses” for purposes of section 816(c)(2). In Occidental

Life Ins. Co., the Court of Appeals for the Ninth Circuit was

asked to decide whether the use of the term “unpaid losses” in

former section 806(c) included accrued unpaid losses. The Court

of Appeals for the Ninth Circuit held it did. The parties in

that case had stipulated that the term had the same meaning in

former sections 801 and 806(c), and the court construed section

816's predecessor (former section 801) merely as support for its

ultimate conclusion. See Occidental Life Ins. Co. v. United

States, supra at 5. The court stated that the term “unpaid

losses” in former section 801 included accrued unpaid losses.6

See id. at 6. The court reasoned that most unaccrued unpaid

losses fall within the meaning of “life insurance reserves” for

purposes of former section 801(a)(1), (b), and (c)(1), and that

the reference to “unpaid losses” in former section 801(a)(2) and

(c)(2) would be meaningless were the term not to include both

accrued and unaccrued unpaid losses. Id.

The Court of Appeals for the Seventh Circuit noted that this

rationale of the Court of Appeals for the Ninth Circuit was based

6
In this regard, the Court of Appeals for the Ninth
Circuit's analysis of the subject term under former sec. 801 was
dicta. The court acknowledged as much when it stated that “an
examination of section 801 along these comparative lines is not
required for a conclusion as to the meaning of 'unpaid losses' in
section 806". Occidental Life Ins. Co. v. United States, 385
F.2d 1, 5 (9th Cir. 1967).
 - 21 -

on a “false premise”: “unaccrued unpaid losses are generally not

included in 'life insurance reserves' because they are not

'computed or estimated on the basis of recognized mortality or

morbidity tables. * * *' Sec. 801(b). * * * Thus, the

provisions for 'unpaid losses' need not be superfluous, even if

they include only unaccrued unpaid losses.” Harco Holdings, Inc.

v. United States, supra at 1036; fn. ref. omitted. The Court of

Appeals for the Seventh Circuit also noted that the Court of

Appeals for the Ninth Circuit’s reasoning had a “logical flaw”:

“If ‘unpaid losses’ means all unpaid losses, and ‘life insurance

reserves’ includes unaccrued unpaid losses, then the statute

counts unaccrued unpaid losses twice. Thus the court avoided

making the provisions for ‘unpaid losses’ superfluous by making

them redundant.” Id. at 1036 n.14. The Court of Appeals for the

Seventh Circuit concluded:

Although we are not persuaded by the Ninth
Circuit’s reasoning, * * * we need not reject
Occidental Life * * * out of hand. Instead, we note
that identical language in sections 806 and 801 need
not have the same meaning. Section 806 governs a tax
deduction, while section 801 is a definitional
provision. Deductions are a matter of legislative
grace, to be construed strictly against taxpayers.
Definitional provisions, like section 801, get a
somewhat more liberal reading. United States v.
Consumer Life Ins. Co., 430 U.S. 725, 752-53 n.38, 97
S.Ct. 1440, 1454 n. 38, 52 L.Ed.2d 4 (1977)
(restrictive interpretation given to tax deductions
should not be applied to section 801); Swift, 151 F.2d
at 628-29 (rejecting argument that the predecessor
statutes to sections 801 and 806 should be construed
 - 22 -

identically). * * * [Id. at 1036-1037; fn. refs. and
some citations omitted.]

Our conclusion that the term “total reserves” does not

include accrued unpaid losses is also supported by examining the

structure of the statute. The applicable statute, section 816,

treats the class of “unpaid losses” as a subset of a much larger

class of items called “reserves”. An insurer’s “total reserves”

are defined by section 816(c) to include its “unpaid losses”, and

the latter term is followed in the text by a clause that reads

“and * * * all other insurance reserves required by law”, sec.

816(c)(3). The fact that an accrued unpaid loss is not a reserve

in the pertinent insurance industry means that it cannot be

included in a subset of reserves, nor followed by “other

insurance reserves”. Moreover, an insurer’s “unpaid losses” are

added to its “life insurance reserves” under section 816(a) to

reach a sum that must “comprise more than 50 percent of its total

reserves”. Sec. 816(a).

Our interpretation is further supported by the fact that the

word “reserves” had acquired a fixed and definite meaning in the

life and A&H industry at the time of the 1942 Act. The 1942 Act,

as discussed above, added the term “unpaid losses” to the Code,

and the legislative history surrounding the 1942 Act contains no

indication that Congress intended to use the word “reserves” in

other than the meaning that was then crystallized in the life and
 - 23 -

A&H industry and in the courts. As discussed infra, courts had

held repeatedly before the 1942 Act that the word “reserves” in

the life and A&H industry included unaccrued unpaid losses and,

more importantly, that the meaning of the word did not include

accrued unpaid losses. Whereas respondent asks the Court to

conclude that Congress intended for the word to carry a contrary

meaning prevalent in the P&C insurance industry, we decline to do

so.7 The P&C insurance industry is substantively different from

the industry of life and A&H insurance, and we read nothing in

the 1942 Act or the legislative history thereunder that would

persuade us that Congress meant for the word “reserves” in the

context of life and A&H insurance to have the meaning given to it

by the P&C insurance industry. To be sure, the most logical

conclusion from the fact that Congress used the word in the

relevant parts of the statute in the setting of life and A&H

insurance is that Congress meant for that word to have the

established meaning in the life and A&H industry.

As to the history of the meaning of the word “reserves”, the

first regulatory definition of that word in the setting of life

and A&H insurance is found in Regs. 62, Art. 681 (1921 Act).

7
The P&C meaning of the term “unpaid losses” included
accrued unpaid losses. See, e.g., Pacific Employers Ins. Co. v.
Commissioner, 33 B.T.A. 501, 504 (1935), affd. 89 F.2d 186 (9th
Cir. 1937); Retailers Fire Ins. Co. v. Commissioner, 3 B.T.A 1186
(1926).
 - 24 -

Those regulations, which govern the reserve deduction under the

1921 Act, state:

The reserve deduction 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 exercise of a power
conferred by statute; * * * Only reserves peculiar to
insurance companies are to be taken into consideration.
* * * Generally speaking, the following will be
considered reserves as contemplated by the law: Items
7, 8, 9, 10, and 11 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 statement
for miscellaneous stock companies, if a life insurance
company is also transacting other kinds of insurance
business. * * *

The accompanying regulations which controlled the calculation of

the reserve ratio stated that the definition in Article 681 would

also apply for purposes of that ratio. See Regs. 62, Art. 661

(1921 Act). Subsequent regulations under the Revenue Act of

1924, ch. 234, 43 Stat. 253, the Revenue Act of 1926, ch. 27, 44

Stat. 9, the Revenue Act of 1928, ch. 852, 45 Stat. 791, and the

Revenue Act of 1932, ch. 209, 48 Stat. 680, continued this

treatment by carrying forward the language in the 1921

regulations as to the definition of a “reserve” and the

computation of the reserve ratio.

With the passage of the Revenue Act of 1934 (1934 Act), ch.

277, 48 Stat. 680, the Commissioner changed his view on the

meaning of the word “reserves” as applied to the industry of life

and A&H insurance. The Commissioner adopted in the regulations
 - 25 -

thereunder a meaning for the word “reserves” that was more

restrictive than the previous definition, stating in the

regulations that only a reserve that related to a “future

unaccrued and contingent” claim would qualify as a reserve for

purposes of the reserve deduction. Regs. 86, sec. 203(a)(2)-1

(1934 Act). The regulations went on to provide that the word

“reserves” did not include “reserves required to be maintained to

provide for the ordinary running expenses of a business * * *

such as * * * accrued but unsettled policy claims”. Id. The

regulations, unlike their predecessors, did not reference any

specific items of the liability page of the annual statement that

would generally constitute a reserve for Federal income tax

purposes.

Much litigation flowed from the Commissioner’s definition of

the word “reserves” as set forth in the 1934 regulations, and

courts held that some of the items which would have qualified

under the prior regulations no longer qualified under the new

definition. See, e.g., Equitable Life Assurance Socy. v.

Commissioner, 44 B.T.A. 293 (1941) (amounts reported on line 9 on

the annual statement were not reserves because they represented

liabilities which had already matured). As to many of the other

items referenced in the pre-1934 regulations, however, such as

the reserves relating to A&H insurance, the courts held that

those amounts continued to be “technical insurance reserves”
 - 26 -

because they were “future, unaccrued and contingent amounts”.

According to these courts, only “future, unaccrued and contingent

amounts” could constitute a “reserve”. See, e.g., Commissioner

v. Monarch Life Ins. Co., 114 F.2d 314, 325 (1st Cir. 1940)

(citing, inter alia, Helvering v. Inter-Mountain Life Ins. Co.,

294 U.S. 686 (1935)), affg. 38 B.T.A. 716 (1938); PanAmerican

Life Ins. Co. v. Commissioner, 38 B.T.A. 1430 (1938), affd. 111

F.2d 366 (5th Cir. 1940); Equitable Life Assurance Socy. v.

Commissioner, 33 B.T.A. 708 (1935). A statement to a similar

effect appeared in an opinion of the United States Supreme Court.

See Helvering v. Oregon Mut. Life Ins. Co., 311 U.S. 267, 271-272

(1940) (unpaid losses are reserves to the extent that they have

not accrued). Moreover, although deductible reserves and the

reserves required for qualification as a life insurance company

under the predecessors to section 816 were not identical, see,

e.g., Commissioner v. Monarch Life Ins. Co., 114 F.2d at 325

(deductible reserves need not be life insurance reserves), there

seems to be no question that the underlying concept of “reserves”

was the same in both provisions. Certainly the Commissioner

thought so. See Regs. 86, sec. 201(a)-1 (1934 Act) (deductible

reserves and qualification reserves are the same).

The 1942 Act added what is now section 816(a)(2), whereby

unclaimed losses on A&H policies are included in the numerator of

the fraction. Congress did so because it recognized that
 - 27 -

noncancelable and certain other types of A&H insurance had

characteristics similar to life insurance and that companies

writing those policies should be allowed to qualify more easily

as life insurance companies. See S. Rept. 1631, 77th Cong., 2d

Sess. (1942), 1942-2 C.B. 504, 611-612. Contrary to respondent’s

arguments, Congress neither amended the reserve ratio intending

to depart from the well-established emphasis on reserves to

determine the nature of an insurance company's business, nor

redefined the reserve ratio by introducing for the first time P&C

insurance terminology into life and A&H products. Congress

merely identified with particularity the reserves that were

required for life and A&H insurance.

Respondent also relies inappropriately on National

Protective Ins. Co. v. Commissioner, 128 F.2d 948 (8th Cir.

1942), affg. 44 B.T.A. 978 (1941), stating that the case is

“eerily similar” to the facts at hand.8 That case has little

8
Respondent also is mistaken by his reliance on the Tax
Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96
Stat. 324, and the Tax Reform Act of 1984, Pub. L. 98-369, 98
Stat. 494, to infer therefrom the meaning of the term “unpaid
losses”. That term was added to the Internal Revenue Code of
1939 by the Revenue Act of 1942, ch. 619, sec. 163(a), 56 Stat.
798, 867, and those subsequent acts have no bearing on its
meaning. Respondent infers from the later acts that the fact
that Congress did not explicitly state therein that accrued
unpaid losses on CA&H insurance were excluded from “unpaid
losses” means that Congress did not intend to exclude those items
from that term when it was enacted in 1942. Respondent cites
West Va. Univ. Hosps., Inc. v. Casey, 499 U.S. 83, 98 (1991),
(continued...)
 - 28 -

relevancy to our analysis herein. There, the insurer derived 98

percent of its premium income from A&H insurance and 2 percent

from life insurance. In contrast to the unpaid losses at issue

in this case, the issue there was whether the insurer’s unearned

premiums were reserves. The taxpayer generally argued that no

A&H obligation could meet the pre-1942 definition of “reserve”,

and it did not distinguish between accrued and unaccrued

obligations, asserting that the unearned premiums were not true

insurance reserves because they were not “required by law”. The

court disagreed, citing Commissioner v. Monarch Life Ins. Co.,

supra, to hold that the reserve deduction is not limited to

reserves that are life insurance reserves. Nor does petitioner

disagree with that holding. In fact, the parties agree that

petitioner included its unearned premiums in the reserve ratio's

denominator. Contrary to respondent's argument, it does not

follow from National Protective Ins. Co. that all A&H obligations

8
(...continued)
with the following parenthetical: “(observing that purpose of
statute includes not only what it sets out to change, but also
what it resolves to leave alone).” In addition to the fact that
respondent could have made the same argument with respect to
every act that postdated the 1942 Act, the fact that Congress did
not change the reserve ratio in the later acts aids respondent's
position only if the reserve ratio meant what respondent says it
did before those acts. As explained herein, it did not. In
fact, the cited case is far more apt as a description of the
events surrounding the 1942 Act, in which Congress set out to
make it easier for companies writing noncancelable A&H insurance
to qualify as life insurance companies.
 - 29 -

are reserves merely because the court held there that some A&H

obligations are reserves.

The only case that has squarely addressed the meaning of the

subject term in section 816(c)(2) is Harco Holdings, Inc. v.

United States, 977 F.2d 1027 (7th Cir. 1992). There, the

taxpayer’s subsidiary, Association Life, was a chartered life

insurance company that filed annual statements on which it

reported its unaccrued CA&H insurance obligations on exhibit 9

and its accrued CA&H insurance obligations on exhibit 11. The

Commissioner argued that Association Life had to include its

exhibit 11 accrued liabilities (i.e., its accrued unpaid losses)

in the denominator of the reserve ratio. The Court of Appeals

for the Seventh Circuit thoroughly analyzed the statutory text,

the relevant regulations, the administrative history, the case

law, and the legislative history and concluded that the reserve

ratio’s denominator did not include Association Life's exhibit 11

amounts. The court’s analysis and conclusion are persuasive, and

we follow them in this case.

As further support for our conclusion as to accrued unpaid

losses, we turn to the Commissioner's administrative position on

accrued liabilities and the reserve ratio for purposes of life

insurance; that position is contrary to the position respondent

takes here. In Rev. Rul. 72-115, 1972-1 C.B. 200, the

Commissioner ruled that unpaid losses on life insurance policies
 - 30 -

(namely, present liabilities to pay death benefits to the

beneficiaries of insureds who had already died) were excludable

from the reserve ratio because they were accrued liabilities.

Respondent attempts in his brief to narrow the effect of that

ruling in this case:

Respondent concedes that a diligent reader must
carefully parse through the tight language of the
ruling to correctly arrive [sic] at its narrow holding.
* * * upon close reading, it is evident that the
ruling simply holds that reserves for certain unpaid
losses arising from life insurance contracts in
connection with a death claim benefit are not
includible in either the numerator or the denominator
of the qualification fraction.

Respondent's attempt is unavailing. Respondent focuses on the

fact that the term “unpaid losses” appears in section 816(c)(2),

but not section 816(c)(1) or (3), and argues that because the

term “unpaid losses” is used only in connection with A&H

insurance, the reserve ratio must include accrued obligations

with respect to A&H insurance and exclude accrued obligations

with respect to life insurance.9 As the Court of Appeals for the

Seventh Circuit stated:

even if we agree that section 801(c)(2) does not cover
unpaid losses on life insurance and can thereby
reconcile Revenue Ruling 72-115 with the Service's
current position, the reconciliation makes no sense.
For if we accept the position of the IRS, then the
reserve ratio test would not measure accrued unpaid

9
Respondent ignores the fact that the term “unpaid losses”
is also included in sec. 816(a)(2), which does include reference
to life insurance policies.
 - 31 -

losses on life insurance but would measure accrued
unpaid losses on accident and health insurance. The
Service is unable to explain why Congress would want to
treat accrued unpaid losses on the two kinds of
insurance differently. Indeed, the Service concedes
that, if anything, Congress thought that accident and
health insurance (at least when noncancelable) should
be treated just like life insurance. * * * [Harco
Holdings, Inc. v. United States, supra at 1034.]

We are also mindful of section 1.801-3(g), Income Tax Regs.,

which provides:

Sec. 1.801-3. Definitions.

this section defines the following terms, which are to
be used in determining if a taxpayer is a life
insurance company (as defined in section 801(a) and
paragraph (b) of this section):

* * * * * * *

(g) Unpaid losses (whether or not ascertained).
The term “unpaid losses (whether or not ascertained)”
means a reasonable estimate of the amount of the losses
(based upon the facts in each case and the company's
experience with similar cases)--

(1) Reported and ascertained by the end
of the taxable year but where the amount of
the loss has not been paid by the end of the
taxable year,

(2) Reported by the end of the taxable
year but where the amount thereof has not
been either ascertained or paid by the end of
the taxable year, or

(3) Which have occurred by the end of
the taxable year but which have not been
reported or paid by the end of the taxable
year.

Respondent concedes that these regulations do not distinguish

between accrued and unaccrued unpaid losses on CA&H insurance,
 - 32 -

but asserts that the regulations' “broad language certainly

includes the accrued unpaid losses at issue herein”. We

disagree. These regulations have no direct bearing on the issue

at hand. In addition to the fact that respondent concedes that

they do not contemplate a distinction between accrued and

unaccrued losses on CA&H insurance, the regulations were issued

one year after Congress added the parenthetical “(whether or not

ascertained)” to the Code. See Harco Holdings, Inc. v. United

States, supra at 1034-1035.

We hold that Central Life’s accrued unpaid losses on CA&H

insurance are not unpaid losses under section 816(c)(2), and,

hence, that it is a life insurance company for Federal income tax

purposes. In so holding, we have carefully considered all

arguments by respondent for a contrary holding, and, to the

extent not discussed above, find them to be irrelevant or without

merit.10 To reflect the parties' concessions,

Decision will be entered

under Rule 155.

10
Respondent argued in his reply brief for the first time
that United States v. General Dynamics Corp., 481 U.S. 239,
246-247 (1987), may apply to some of Central Life's accrued
unpaid losses to deny their deductibility. This argument raises
a new issue and does so untimely. Accordingly, we do not
consider it. See Palmer v. Commissioner, 62 T.C. 684, 698
(1974), and the cases cited therein, affd. 523 F.2d 1308 (8th
Cir. 1975); see also Estate of Horvath v. Commissioner, 59 T.C.
551, 555 (1973).