Rev. Rul. 70-480

Advice has been requested whether amounts held in a "stabilization reserve" can be taken into account as unearned premiums in computing premiums earned as described in section 832(b)(4) of the Internal Revenue Code of 1954.

The taxpayer is a stock casualty insurance company subject to tax imposed by section 831 of the Code. In addition to writing property and casualty insurance, it also writes group term health and accident insurance contracts, subject to a retrospective rate credit. Under the provisions of its group health insurance contracts if, at the end of a policy year when the risk has expired and the premiums called for by the contracts have been fully earned, there is an excess of premiums received over the cost of providing the insurance coverage for that policy year, then such excess up to 10 percent of the premium is retained by the taxpayer in a "stabilization reserve" and the balance is refunded to the policy-holder. The "stabilization reserve" is available for use by the taxpayer in future renewal terms to pay for extraordinary losses under the contract or benefits added thereto, thus obviating the necessity for increasing the premiums on subsequent renewals of the contract. In this fashion such "reserve" helps to stabilize the premium charged upon renewal of the contract. The funds in the "reserve" are refundable to the policyholder only upon nonrenewal of the policy.

The gross income of a stock casualty insurance company includes, among other things, the gross amount of underwriting income. Section 832(b)(1) of the Code. Underwriting income means the premiums earned during the taxable year, less losses and expenses incurred. Section 832(b)(3) of the Code.

Section 832(b)(4) of the Code provides for the computation of premiums earned on insurance contracts during the taxable year as follows:

(A) From the amount of gross premiums written on insurance contracts during the taxable year, deduct return premiums and premiums paid for reinsurance.

(B) To the result so obtained, add unearned premiums on outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year. * * *.

Unearned premiums are that portion of the premium over and above the actual cost of insurance for the period for which the premium is paid, proportioned to the part of the period that has not yet expired. They are earned ratably as the term of the policy expires and therefore are fully earned at the end of the period for which the premium has been paid. See Massachusetts Protective Assn. v. U.S., 114 F. 2d 304 (1940), Ct. D. 1483, C.B. 1941-1, 383.

The amounts held in the "stabilization reserve" come into being after the related risk period has expired and thus are fully earned premiums. Once the premiums for the risk period are earned, they cannot thereafter become unearned. Rev. Rul. 67-225, C.B. 1967-2, 238. Rather the excess of earned premiums over costs and expenses constitute part of the surplus of the company available for dividends to policyholders.

Accordingly, amounts in the "stabilization reserve" may not be taken into account as unearned premiums in computing earned premiums pursuant to section 832(b)(4) of the Code.