Rev. Rul. 69-302

Advice has been requested whether the reserves maintained by an insurance company, under the circumstances described below, can qualify as life insurance reserves as defined in section 801(b) of the Internal Revenue Code of 1954 and, if not, whether the insurance company can recompute or adjust such reserves retroactively in order to qualify them as "life insurance reserves."

The insurance company is engaged solely in the business of reinsuring credit life insurance contracts. At the end of each taxable year it computes its reserves with respect to the policies in force on that date by a method commonly used to compute unearned premiums in the casualty insurance area where gross premiums written are earned ratably as the period of risk expires. Generally, the computation of the pro rata earned and unearned portions of the gross premiums involves the assumption of an even distribution of policy anniversaries throughout the year. In the case of level term insurance written for 12 months the unearned portion is one half the gross annual premium. In the case of decreasing term insurance, a "sum of the years-digits" computation is used. Where the contracts are written for 12 months, this computation is known as the "Rule of 78."

Section 801(b)(1) of the Code defines life insurance reserves as amounts which are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest, and which are set aside to mature or liquidate future unaccrued claims arising from life insurance, annuity, and noncancellable health and accident insurance contracts involving (at the time with respect to which the reserve is computed) life, health, or accident contingencies. With exceptions not here applicable, such reserves must be required by law.

By definition, therefore, a life insurance reserve must be calculated or estimated on an actuarial basis, that is, by the use of a recognized table of mortality and an assumed rate of interest. This does not prevent the recognition as life insurance reserves of amounts computed or estimated on the basis of premiums computed according to a recognized mortality table and an assumed rate of interest, or reserves computed or estimated on the basis of an average age representative of the group of insured persons. See Revenue Ruling 68-185, C.B. 1968-1, 317. The reserve so computed or estimated is not earned ratably as the period of risk expires. See Massachusetts Protective Assn., Inc. v. United States, 114 F. 2d 304 (1940); Commissioner v. Monarch Life Insurance Company, 114 F. 2d 314 (1940); United Benefit Life Insurance Co., v. McCrory, 242 F. Supp. 845 (1965).

As stated above, the insurance company in the instant case computes its reserves with respect to the policies in force at the end of the taxable year by a method commonly applicable in determining the pro rata earned and unearned portions of the gross premiums written for 12-month casualty insurance contracts. That method of calculating the pro rata earned and unearned portions of premiums written is not an actuarial computation or estimation of a reserve on the basis of recognized mortality tables and assumed rates of interest.

Moreover, since reserves held with respect to the policies in force at the end of the taxable year are based on available information at the time they are established, they may not be retroactively recomputed or adjusted for corrections of errors of judgment. See Pacific Mutual Insurance Company v. Commissioner, 48 T.C. 118, at 129 (1967); Massachusetts Protective Assn., Inc. v. United States, at page 313.

Accordingly, the reserves maintained by the insurance company for the credit life contracts it has reinsured do not qualify as life insurance reserves as defined in section 801(b) of the Code.

Revenue Ruling 68-441, C.B. 1968-2, 293, is hereby superseded since the position set forth therein is restated in this Revenue Ruling.