IRS PUBLISHES DISCOUNT FACTORS AND SALVAGE RECOVERY PATTERNS FOR INSURANCE COMPANIES.

Rev. Proc. 91-48

                              CONTENTS

This revenue procedure sets forth a series of discount factors and salvage recovery patterns that property and casualty insurance companies must use to discount estimated salvage recoverable for 1990 and prior accident years, as required by the Revenue Reconciliation Act of 1990 (the "1990 Act"). Guidance is also provided with respect to the section 481 adjustment under section 11305(c)(2) of the 1990 Act, the special deduction under section 11305(c)(3) of the 1990 Act, the special rule for overestimates under section 11305(c)(4) of the 1990 Act, and changes in estimates of salvage recoverable.

SEC. 2. BACKGROUND

01 Section 832(b) of the Internal Revenue Code defines "gross income" for a property and casualty insurance company subject to tax under section 831. Section 832(b)(3) defines the "underwriting income" of a property and casualty insurance company as premiums earned on insurance contracts during the taxable year less "losses incurred" and expenses incurred. Under section 832(b)(5)(A), losses incurred are computed by taking into account paid losses reduced by salvage and reinsurance recovered, the change in discounted unpaid losses, and the change in salvage and reinsurance recoverable. For taxable years beginning before January 1, 1990, former section 832(b)(5)(A) required salvage and reinsurance recoverable to be taken into account as a reduction to paid losses. For those taxable years, the regulations under former section 832(b)(5)(A) required salvage recoverable to be taken into account only to the extent that salvage was allowed to be treated as an asset for state statutory accounting purposes.

02 Section 11305 of the 1990 Act amended section 832(b)(5)(A) of the Code with respect to the treatment of salvage and reinsurance recoverable for taxable years beginning after December 31, 1989. Under section 832(b)(5)(A), as amended, paid losses are reduced by salvage and reinsurance recovered during the taxable year. The resulting amount is adjusted to reflect changes in discounted unpaid losses on nonlife insurance contracts and in unpaid losses on life insurance contracts, and is then decreased by the discounted amount of estimated salvage recoverable and reinsurance recoverable as of the end of the taxable year and increased by the discounted amount of estimated salvage recoverable and reinsurance recoverable as of the end of the preceding taxable year. For purposes of these rules, the term "salvage" includes subrogation claims. The adjustment for reinsurance recoverable attributable to paid losses is not discounted.

03 Section 11305(c)(2)(A) of the 1990 Act treats any change required by the Act in computing losses incurred as a change in method of accounting. However, section 11305(c)(2)(B) of the Act provides that only 13 percent of the section 481 adjustment that would otherwise result from the change in method of accounting is taken into income. The section 481 adjustment is to be taken into account ratably over a period not to exceed the taxpayer's first four taxable years beginning after December 31, 1989.

04 Section 11305(c)(3) of the 1990 Act provides that a taxpayer that took salvage recoverable into account in determining losses incurred for the last taxable year beginning before January 1, 1990, may deduct (as a "special deduction") 87 percent of the discounted amount of estimated salvage recoverable as of the end of that taxable year. This amount is to be deducted ratably over the taxpayer's first four taxable years beginning after December 31, 1989.

05 Section 1.832-4 of the Proposed Income Tax Regulations, published in the Federal Register on March 15, 1991 (56 Fed. Reg. 11,127), contains a paragraph (e) concerning the special deduction. Paragraph (e) states, in part, that a taxpayer that claims this deduction must be able to establish to the satisfaction of the district director that it took estimated salvage recoverable into account for the last taxable year before January 1, 1990. The proposed regulations indicate that this requirement is deemed to be satisfied if a taxpayer discloses to the relevant state regulatory authority on or before July 15, 1991, the extent to which the taxpayer took estimated salvage recoverable into account in computing underwriting income on its 1989 annual statement. See Announcement 91-106, 1991-30 I.R.B. 33 (postponing the date to September 16, 1991).

06 Section 846(d) of the Code requires that the Internal Revenue Service redetermine in 1992 the loss payment pattern for purposes of section 846, for the 1992 through 1996 accident years. In connection with that redetermination, the Service expects to redetermine salvage recovery patterns for purposes of section 832(b)(5)(A).

SEC. 3. SCOPE

This revenue procedure applies to any taxpayer that is required to include in income an estimate of salvage recoverable under section 832(b)(5) of the Code. The methodology set forth in section 4 applies to all taxpayers, regardless of their election under section 4.04 to use either (1) the published salvage discount factors or (2) the discount factors used by the taxpayer under section 846 (to discount unpaid losses) as a proxy for salvage discount factors.

SEC. 4. REQUIRED METHOD OF ACCOUNTING FOR SALVAGE RECOVERABLE

01 This section describes the required method of accounting for estimated salvage recoverable in taxable years beginning after December 31, 1989. For taxpayers that do not claim the special deduction under section 11305(c)(3) of the 1990 Act, the required method must be applied to estimated salvage recoverable attributable to all accident years, including accident years prior to 1990. For taxpayers claiming the special deduction, the required method applies only to estimated salvage recoverable attributable to post-1989 accident years. If a taxpayer claiming the special deduction makes the election in section 11, the required method applies only to estimated salvage recoverable attributable to post-1990 accident years.

02 In computing the deduction for losses incurred under section 832(b)(5)(A) of the Code, as amended by the 1990 Act, a taxpayer must add the discounted amount of estimated salvage recoverable as of the end of the preceding taxable year and must subtract the discounted amount of estimated salvage recoverable as of the end of the taxable year. A taxpayer must calculate the discounted amount of estimated salvage recoverable for each line of business as of the end of a taxable year. Within each line of business, calculations must be made separately for each accident year for which salvage is expected to remain recoverable as of the end of the current taxable year and for each accident year for which salvage was estimated to remain recoverable as of the end of the previous taxable year.

In post-1990 taxable years, a taxpayer must use, as the estimate of salvage recoverable as of the end of the preceding taxable year, the estimate of salvage recoverable actually used in that preceding taxable year. However, for the 1990 taxable year, except for those taxpayers that claim the special deduction under section 11305(c)(3) of the 1990 Act (see section 10), the estimate of salvage recoverable as of the end of the preceding taxable year (that is, the 1989 taxable year) will be an estimate prepared as part of the federal income tax return for the 1990 taxable year. Taxpayers that claim the special deduction may not take estimates of salvage recoverable attributable to pre-1990 accident years into account. If a taxpayer makes the election in section 11, the taxpayer may not take estimates of salvage recoverable for pre-1991 accident years into account.

03 To determine the discounted amount of estimated salvage recoverable as of the end of a taxable year for each accident year within each line of business, a taxpayer must first estimate the undiscounted amount of salvage recoverable as of the end of that taxable year for each accident year within each line of business. The undiscounted amount of estimated salvage recoverable for each accident year within each line of business must then be multiplied by the appropriate salvage discount factor to determine the discounted amount of estimated salvage recoverable.

04 A taxpayer is permitted to use either of the following methods to determine the factors that must be used to discount estimated salvage recoverable for the 1990 and prior accident years.

Alternative (1) -- the applicable salvage discount factors by line of business and accident year published in section 15.09 that are derived from (i) the salvage recovery patterns set forth in that section and (ii) the applicable interest rate for the 1990 accident year (see section 15.01); or

Alternative (2) -- the applicable discount factors by line of business and accident year used by the taxpayer in discounting unpaid losses under section 846 of the Code, as a proxy for the salvage discount factors.

Under Alternative (2), the taxpayer must use the same discount factors that the taxpayer is using under section 846 of the Code (that is, factors published by the Secretary or factors based on the company's historical loss payment experience). See sections 846(d) and 846(e). A taxpayer that claims the special deduction pursuant to section 11305(c)(3) of the 1990 Act must use Alternative (2) to discount estimated salvage recoverable for the 1990 and 1991 accident years.

05 The discounting method elected by the taxpayer will apply to all lines of business; consequently, the taxpayer may not elect Alternative (1) for some lines and Alternative (2) for other lines. The election applies to all accident years prior to the 1992 determination year within all lines of business.

06 For any line of business that is not specifically referenced in this revenue procedure, a taxpayer shall use the "Miscellaneous Casualty" discount factors to determine discounted estimated salvage recoverable for that line of business.

07 All the discount factors and examples presented in this revenue procedure assume that the taxpayer is a calendar year taxpayer. A taxpayer that has a taxable year other than a calendar year (that is, a short taxable year or a fiscal taxable year) must make appropriate adjustments to the discount factors to reflect the difference between the end of the taxpayer's taxable year and the end of the accident year, which is based on a calendar year.

SEC. 5. ALTERNATIVE (1)

01 For taxpayers that elect to discount estimated salvage recoverable for a line of business using Alternative (1) of section 4.04, the tables set forth in section 15.09 provide discount factors by line of business and by accident year within each line of business. Each set of discount factors applies to all pre-1991 accident years, but not to post-1990 accident years. New discount factors by line of business will be published annually for each new accident year after 1990.

02 The discounted amount of estimated salvage recoverable as of the end of a taxable year is determined by multiplying the undiscounted amount of estimated salvage recoverable as of the end of that taxable year for each accident year of a line of business (from section 4.03) by the applicable discount factor for that accident year and that line of business from section 15.09.

03 The separate accident year calculations of discounted estimated salvage recoverable as of the end of a taxable year for each line of business are aggregated to determine the taxpayer's total discounted amount of estimated salvage recoverable for all lines of business and accident years as of the end of that taxable year.

SEC. 6. ALTERNATIVE (2)

01 This section applies only to those taxpayers that elect or are required to use Alternative (2) of section 4.04 (that is, to use the applicable loss reserve discount factors under section 846 of the Code as a proxy for the salvage discount factors).

02 Taxpayers that determine discounted unpaid losses using the published discount factors issued under authority of section 846(d) of the Code should substitute the applicable loss reserve discount factors from the applicable revenue ruling for the salvage discount factors (from section 15.09) wherever salvage discount factors are referenced in this revenue procedure. The last discount factor in any table shall be used as the discount factor for calculations involving all accident years preceding the oldest accident year covered by that table. For the 1990 accident year, the applicable revenue ruling is 90-26, 1990-1 C.B. 125. For the 1989 accident year the applicable revenue ruling is 89-66A, 1989-1 C.B. 220. For the 1988 accident year the applicable revenue ruling is 88-63, 1988-2 C.B. 130. For the 1987 and all prior accident years the applicable revenue ruling is 87-34, 1987-1 C.B. 168.

The published loss reserve discount factors for use by taxpayers electing Alternative (2) are presented in the column labelled "Reserve discount factor (percent)" of the applicable revenue ruling. The discount factors in this column are labelled by reference to the number of years that the taxable year succeeds the accident year ("AY"). For example, for the 1990 taxable year, the discount factor for accident year 1985 is found in the row "AY + 5", since 1990 is equal to 1985 plus 5.

03 Taxpayers electing under section 846(e) of the Code to use discount factors based on their own historical loss payment experience must substitute those reserve discount factors for the published reserve discount factors referenced in section 6.02. The last discount factor in any table shall be used as the discount factor for calculations involving all accident years preceding the oldest accident year covered by that table.

SEC. 7. MANNER OF ELECTING ALTERNATIVE DISCOUNT METHODS

01 To elect between Alternative (1) and Alternative (2) under section 4.04, a taxpayer must attach an election statement to its timely filed federal income tax return (determined with regard to extensions) for its first taxable year beginning after December 31, 1989. If the taxpayer has already filed its federal income tax return for that taxable year as of September 25, 1991, then the taxpayer may attach the election statement to an amended return filed within 180 days of September 25, 1991. The election statement must contain the heading "ELECTION OF DISCOUNTING METHOD UNDER SECTION 4.04 OF REV. PROC. 91-48" and must state whether Alternative (1) or (2) is elected for discounting estimated salvage recoverable. If a taxpayer has already filed its federal income tax return as of September 25, 1991 and has discounted salvage recoverable using the applicable interest rate and loss payment pattern under section 846 of the Code, the taxpayer will be deemed to have elected Alternative (2) as the discounting method for pre-1992 accident years. The taxpayer will not be deemed to have elected Alternative (2), however, if it attaches an election statement designating its election of Alternative (1) on an amended return filed within 180 days of September 25, 1991.

SEC. 8. ACCOUNTING METHOD CHANGE BY A TAXPAYER THAT DOES NOT CLAIM THE SPECIAL DEDUCTION UNDER SECTION 11305(c)(3) UNDER THE 1990 ACT.

01 Under section 11305(c)(2)(A) of the 1990 Act, the change in treatment of estimated salvage recoverable in the determination of losses incurred under section 832(b)(5)(A) of the Code is a change in method of accounting. A taxpayer that does not claim the special deduction under section 11305(c)(3) of the Act is required to change its method of accounting for the first taxable year beginning after December 31, 1989, with respect to salvage recoverable attributable to the 1990 accident year and all prior accident years in accordance with section 4 of this revenue procedure. Under section 481(a) of the Code, a taxpayer that changes its method of accounting (but does not claim the special deduction) must take into account those adjustments that are necessary to prevent amounts from being duplicated or omitted as a result of the change. However, section 11305(c)(2)(B) of the Act provides that a taxpayer must take into account only 13 percent of the section 481(a) adjustment that is required as a result of the change in method of accounting.

02 To determine the amount of the section 481(a) adjustment, a taxpayer must determine the discounted amount of estimated salvage recoverable as of the end of the 1989 taxable year, based on the assumption that the discounted amount of estimated salvage recoverable had always been taken into account in determining taxable income. The section 481(a) adjustments for each accident year of each line of business are aggregated to determine the taxpayer's total section 481(a) adjustment for all lines of business. The section 481 adjustment is not reduced by the amount of salvage recoverable that the taxpayer may have considered in the estimation of undiscounted unpaid losses under section 846(b)(1) of the Code. The taxpayer may not, in determining the section 481(a) adjustment, take into account salvage in the course of liquidation that was taken into account in computing paid losses.

03 Pursuant to section 11305(c)(2)(B) of the 1990 Act, 13 percent of the section 481(a) adjustment (from section 8.02) must be taken into account ratably over a period not to exceed four taxable years, beginning in the 1990 taxable year. The remaining 87 percent of the section 481(a) adjustment is not taken into account in computing taxable income. This forgiveness of 87 percent of the section 481(a) adjustment under section 11305(c)(2)(B) of the 1990 Act applies only to a change of method of accounting initiated by the taxpayer on its federal income tax return for the first taxable year beginning after December 31, 1989. If a taxpayer fails to change its method of accounting for estimated salvage recoverable for the first taxable year beginning after December 31, 1989, the taxpayer must obtain the consent of the Commissioner to make the change pursuant to Rev. Proc. 84-74, 1984-2 C.B. 736.

04 If, during the adjustment period, the taxpayer ceases to be an insurance company subject to tax under section 831 of the Code, the balance of the section 481(a) adjustment not previously taken into account must be included in income in the last taxable year that the taxpayer is taxable as an insurance company under section 831. If, prior to the 1990 taxable year, the taxpayer was subject to tax as an insurance company under section 831 for less than four taxable years, the number of years over which the section 481 adjustment is taken into account may not exceed the number of years prior to the 1990 taxable year that the taxpayer was taxable as an insurance company under section 831.

SEC. 9. ACCOUNTING METHOD CHANGES BY A TAXPAYER THAT CLAIMS THE SPECIAL DEDUCTION UNDER SECTION 11035(c)(3) OF THE 1990 ACT.

01 Except as provided in section 11, for the first taxable year after December 31, 1989, a taxpayer claiming the special deduction is required to change its method of accounting with respect to the inclusion in taxable income of estimated salvage recoverable for all lines of business attributable to 1990 and succeeding accident years in accordance with section 4 of this revenue procedure. The taxpayer must make this accounting method change pursuant to a cut-off method, without a section 481 adjustment with respect to estimated salvage recoverable attributable to pre-1990 accident years. A change in method of accounting made in accordance with this section 9 is treated as having been made with the consent of the Commissioner. For taxable years after 1989, a taxpayer that claims the special deduction must continue to discount any estimated salvage recoverable attributable to pre-1990 accident years using the same method of accounting as used in computing discounted unpaid losses under section 846(c) for the 1989 taxable year. For estimated salvage recoverable attributable to pre-1990 accident years, no change in accounting method will take place in the 1990 or subsequent taxable years, and there is no section 481 adjustment. Therefore, changes in estimate of salvage recoverable attributable to pre-1990 accident years are only taken into account as part of the change in discounted unpaid losses during the taxable year.

02 A taxpayer that does not claim the special deduction must change its method of accounting in accordance with section 8.

03 For taxpayers claiming the special deduction, any change in the method of computing undiscounted unpaid losses attributable to pre-1990 accident years to exclude estimated salvage recoverable is a change in method of accounting within the meaning of section 446 of the Code, but is not a change required by the 1990 Act. Accordingly, the 87 percent forgiveness provided by section 11305(c)(2)(8) of the 1990 Act does not apply to any section 481(a) adjustment resulting from this change.

SEC. 10. SPECIAL DEDUCTION FOR A TAXPAYER THAT TOOK ESTIMATED SALVAGE RECOVERABLE INTO ACCOUNT IN THE 1989 TAXABLE YEAR

01 The special deduction under section 11305(c)(3) of the 1990 Act is determined separately for each accident year within each line of business. The special deduction can be claimed only with respect to the discounted amount of estimated salvage recoverable which was taken into account in determining the deduction for losses incurred under section 832(b)(5) of the Code as of the last taxable year beginning before January 1, 1990. The taxpayer may not, in determining the special deduction, take into account salvage in the course of liquidation that was taken into account in computing paid losses. Except as provided in section 10.06, a taxpayer claiming the special deduction must establish to the satisfaction of the district director that the deduction represents only the discounted amount of estimated salvage recoverable that was actually taken into account by the taxpayer in computing losses incurred for that taxable year.

02 A taxpayer claiming the special deduction must attach a schedule to its federal income tax return for the 1990 taxable year. This schedule must set forth, by accident year within each line of business, the following:

(1) the tax reserves for discounted unpaid losses, including the reduction in those reserves for estimated salvage recoverable, as of the end of the 1988 taxable year that were used in determining the deduction for losses incurred in the 1989 taxable year;

(2) the tax reserves for discounted unpaid losses, including the reduction in those reserves for estimated salvage recoverable, as of the end of the 1989 taxable year that were used in determining the deduction for losses incurred in the 1989 taxable year;

(3) the amount of discounted estimated salvage recoverable as of the end of the 1988 taxable year that was included in (1);

(4) salvage recovered during taxable year 1989;

(5) the amount of discounted estimated salvage recoverable as of the end of the 1989 taxable year that was included in (2);

(6) the tax reserves for discounted unpaid losses as of the end of the 1988 taxable year that would have been used in determining the deduction for losses incurred in the 1989 taxable year if estimated salvage recoverable had not been taken into account; and

(7) the tax reserves for discounted unpaid losses as of the end of the 1989 taxable year that would have been used in determining the deduction for losses incurred in the 1989 taxable year if estimated salvage recoverable had not been taken into account.

For each accident year within each line of business, the following conditions must be met: item (6) must equal item (1) plus item (3); and, item (7) must equal item (2) plus item (5).

03 To determine the special deduction, a taxpayer first must sum the amounts in section 10.02(5) for each accident year of each line of business eligible for the special deduction (see section 10.01 and 10.06). Totals by line of business are then aggregated.

04 The special deduction is 87 percent of the amount of salvage recoverable as of the end of 1989 from section 10.03.

05 The special deduction is taken into account ratably over four taxable years beginning in the 1990 taxable year.

06 TAXPAYER ELECTING SAFE HARBOR UNDER SECTION 1.832-4(e)(2) OF THE PROPOSED REGULATIONS. For purposes of the safe harbor, a taxpayer will be deemed to have taken salvage recoverable into account only if the taxpayer (1) files a statement by September 16, 1991, with the insurance regulatory authority of the taxpayer's state of domicile disclosing the extent to which losses incurred for each line of business reported on the 1989 annual statement were reduced by estimated salvage recoverable, and (2) attaches a statement to its federal income tax return filed for the first taxable year beginning after December 31, 1989, agreeing to apply the special rule for overestimates in section 11304(c)(4) of the 1990 Act (see section 13) to the amount of estimated salvage recoverable for which it has taken the special deduction. Each insurance company subject to tax under section 831 of the Code included in a consolidated group must agree to apply the special rule for overestimates to its special deduction, if any, in order for any insurance company included in the consolidated group to qualify for the safe harbor. The statement attached to the taxpayer's federal income tax return must contain the heading "AGREEMENT TO APPLY RULE FOR OVERESTIMATES TO THE AMOUNT OF SPECIAL DEDUCTION PURSUANT TO SECTION 10 OF REV. PROC. 91-48."

If a taxpayer complies with the above requirements, the amount claimed as a special deduction will not be adjusted by the district director in the absence of fraud.

SEC. 11. ELECTION BY A TAXPAYER CLAIMING SPECIAL DEDUCTION TO DEFER ACCOUNTING CHANGE

01 If a taxpayer claims the special deduction under section 11305(c)(3) of the 1990 Act, and included estimated salvage recoverable in determining the undiscounted unpaid losses (as defined in section 846(b)(1) of the Code) for the 1990 accident year as shown on its 1990 annual statement, then the taxpayer may defer the accounting method change for estimated salvage recoverable for one year. Beginning with the 1991 accident year, however, the taxpayer will be required to discount estimated salvage recoverable for all lines of business in accordance with section 4 and to take such discounted estimated salvage recoverable into account in computing losses incurred. This accounting method change must be made for all lines of business pursuant to a cut-off method, without a section 481 adjustment for estimated salvage recoverable attributable to pre-1991 accident years.

02 Manner of making the election. To elect the special treatment under this section, the taxpayer must attach a statement to its 1990 federal income tax return identifying the amount of estimated salvage recoverable taken into account in determining the undiscounted unpaid losses for the 1990 accident year as shown on its annual statement. In addition, the statement must set forth the taxpayer's agreement to apply the special rule for overestimates in section 11305(c)(4) of the 1990 Act (see section 13) to the amount of the undiscounted estimated salvage recoverable for which the taxpayer claims the special deduction. Each insurance company subject to tax under section 831 of the Code included in a consolidated group must agree to apply the special rule for overestimates to its special deduction, if any, in order for any insurance company in the consolidated group to qualify for this special treatment. The statement must contain the heading "ELECTION FOR TAXPAYERS CLAIMING SPECIAL DEDUCTION THAT ALSO TOOK SALVAGE RECOVERABLE INTO ACCOUNT IN DETERMINING UNDISCOUNTED UNPAID LOSSES FOR THE 1990 ACCIDENT YEAR PURSUANT TO SECTION 11 OF REV. PROC. 91-48."

SEC. 12. CHANGES IN ESTIMATES OF SALVAGE RECOVERABLE

01 In general, for each accident year within each line of business, the undiscounted amount of salvage recoverable as of the end of any taxable year must equal the undiscounted amount of salvage recoverable as of the end of the previous taxable year minus salvage recovered during the taxable year. (See section 4.04.)

02 If, in any taxable year as a result of additional information pertaining to expected salvage recoveries, a taxpayer changes its estimate of the undiscounted amount of salvage recoverable associated with an accident year of a line of business from the estimate used in the prior taxable year, the following rules apply.

03 Any changes in a taxpayer's estimate of the undiscounted amount of salvage recoverable for an accident year for a line of business which defers the application of the special rule for overestimates (see section 13) will be disallowed.

04 A change in the estimate of the undiscounted amount of salvage recoverable associated with an accident year for a line of business is treated as a change in estimate rather than as a change in accounting method. Thus, the new estimate of undiscounted salvage recoverable is taken into account in determining the adjustment for discounted estimated salvage recoverable as of the end of the taxable year, without recomputing the corresponding estimate of discounted estimated salvage recoverable as of the end of the preceding taxable year.

SEC. 13. SPECIAL RULE FOR OVERESTIMATES

01 This section applies to: (1) any taxpayer that is required to compute a section 481 adjustment under section 8 of this revenue procedure, and (2) any taxpayer that both claims the special deduction under section 11305(c)(3) of the 1990 Act and pursuant to section 10 or 11 of this revenue procedure agrees to apply the special rule for overestimates under section 11305(c)(3) of the 1990 Act to the special deduction.

02 For each line of business and each pre-1990 accident year within each line of business, the taxpayer must determine the undiscounted amount of salvage recoverable as of the end of the 1989 taxable year. (See section 4.02 or section 10.01.)

The amounts obtained for all pre-1990 accident years of all lines of business must be added together to determine the total undiscounted amount of estimated salvage recoverable as of the end of the 1989 taxable year.

03 For each pre-1990 accident year within each line of business, the taxpayer must determine the amount of salvage recovered in each post-1989 taxable year, including the current year. The obtained results must be added together.

04 For each pre-1990 accident year within each line of business, the taxpayer must determine the undiscounted amount of salvage recoverable as of the end of the current taxable year.

05 The amounts obtained in sections 13.03 and 13.04 must be added together.

06 The amount obtained in section 13.05 must be subtracted from the amount obtained in section 13.02. If the amount is positive, there is an overestimate.

07 The taxpayer must determine the total discounted amount, for all pre-1990 accident years within all lines of business, of salvage recoverable as of the end of the 1989 taxable year that is subject to the section 481 adjustment. This is the total amount from section 8.02.

For those taxpayers that have agreed to apply the rule in this section to the special deduction (see sections 10 and 11), determine the total discounted estimated salvage recoverable as of the end of the 1989 taxable year that is eligible for the special deduction under section 10. This is the amount in section 10.03.

08 The amount from section 13.07 is divided by the amount obtained in section 13.02. The result of this division should be a fraction between zero and one.

09 The fraction obtained in section 13.08 is multiplied by the amount obtained in section 13.06.

10 The amount obtained in section 13.09 is multiplied by 87 percent. This amount is the adjustment for overestimates under section 11305(c)(4) of the 1990 Act except as provided in section 13.11.

11 The amount obtained in section 13.10 is reduced, but not below zero, by the sum of all the adjustments for overestimates under section 11305(c)(4) of the 1990 Act calculated for all taxable years that are prior to the current taxable year and that began after December 31, 1989. For the 1990 taxable year, this adjustment does not apply.

SEC. 14. EXAMPLES

EXAMPLE (1). X is a property and casualty insurance company. Since 1981, X has written insurance policies in the fire line of business. X did not take salvage recoverable for the fire line of business into account in determining the underwriting income shown on its 1989 annual statement, or in determining the deduction for losses incurred for that taxable year. As of December 31, 1989, X had undiscounted estimated salvage recoverable for the fire line of business of $5,000, whim was allocated by accident year as follows: $3,000 for the 1989 accident year, $1,500 for the 1988 accident year, and $500 for the 1987 accident year. X determined that it had no salvage recoverable for 1986 or prior accident years. As of December 31, 1990, X had undiscounted salvage recoverable for the fire line of business of $6,000, which was allocated by accident year as follows: $3,500 for the 1990 accident year, $1,750 for the 1989 accident year, $600 for the 1988 accident year, and $150 for the 1987 accident year. See Illustration 1 for the applicable discount factors from section 15.09 that X would use to determine the adjustment for discounted estimated salvage recoverable under section 832(b)(5)(A) of the Code at the beginning and end of the 1990 taxable year.

                            Illustration 1

As X had not previously taken salvage recoverable into account in determining losses incurred for the last taxable year beginning prior to January 1, 1990, the discounted estimated salvage recoverable as of December 31, 1989 is the section 481 adjustment that would otherwise be taken into account as a result of the statutory change in accounting method regarding the treatment of salvage recoverable. Under section 11305(c)(2)(B) of the 1990 Act, however, 87 percent of this section 481 adjustment is forgiven. Thus, in computing taxable income for the 1990 taxable year and the three succeeding taxable years, X would take into income only $553 ($4,252 x .13 = $553).

EXAMPLE (2). The facts are the same as in example (1), except that in 1992, X determines that the sum of the actual amount of salvage recovered and the estimate of remaining undiscounted salvage recoverable with respect to 1989 and prior accident years is $4,500. As X had previously used the December 31, 1989 estimate of undiscounted salvage recoverable of $5,000 to calculate the section 481 adjustment and to determine the forgiveness (87 percent exclusion) under section 11305(c)(2)(B) of the 1990 Act, X must compute a recapture amount under the rule for overestimates in section 11305(c)(4).

To determine the inclusion in taxable income required by section 11305(c)(4) of the 1990 Act, X first multiplies the overestimate of undiscounted salvage recoverable of $500 ($5,000 undiscounted estimated salvage recoverable as of December 31, 1989 less $4,500 salvage recovered and recoverable with respect to 1989 and prior accident years) by a ratio. This ratio (.85) is determined by dividing the section 481 adjustment determined without regard to the forgiveness of section 11305(c)(2)(B) ($4,252) by the undiscounted amount of salvage recoverable as of the end of the 1989 taxable year ($5,000). The ratio adjusts the overestimate of undiscounted salvage recoverable to reflect the discounting of the section 481 adjustment ($500 x .85 = $425). Of this amount, 87 percent, or $370, must be included in X's taxable income for the 1992 taxable year.

EXAMPLE (3). The facts are the same as in example (1), except that X took estimated salvage recoverable into account in determining the undiscounted unpaid losses shown on its 1989 and 1990 annual statements, and in determining discounted unpaid losses under section 846 as of the end of the 1989 taxable year. X has not made an election under section 846(e) to use its historical loss payment pattern. As X took estimated salvage recoverable into account in determining the deduction for losses incurred for the last taxable year beginning before January 1, 1990, X is entitled to claim the special deduction under section 11305(c)(3) of the 1990 Act. The amount of the special deduction is determined by applying the applicable published discount factor under section 846(d) to the undiscounted amount of salvage recoverable included in undiscounted unpaid losses as of December 31, 1989. See Illustration 2 for the applicable discount factors that X would apply to the undiscounted salvage recoverable as of December 31, 1989 to determine the amount of the special deduction.

                            Illustration 2

X must determine discounted estimated salvage recoverable for the 1990 accident year in accordance with the methodology set forth in section 4 of this revenue procedure. Consistent with the discounting method used to discount salvage recoverable for pre-1990 accident years, X must discount estimated salvage recoverable for the 1990 accident year using Alternative (2). Thus, X's estimate of undiscounted salvage recoverable for the 1990 accident year as of December 31, 1990 ($3,500) would be discounted by applying the (AY+0) factor from Rev. Rul. 90-36 (90.1078).

EXAMPLE (4). The facts are the same as in example (3), except that X elects under section 11 of this revenue procedure to take estimated salvage recoverable for the 1990 accident year into account in determining discounted unpaid losses under section 846, rather than as a separate adjustment under section 832(b)(5)(A). By virtue of this election, X is not required to subtract discounted estimated salvage recoverable in computing the deduction for losses incurred for the 1990 accident year. However, X must agree to subject the undiscounted salvage recoverable for which X claimed the special deduction to the rule for overestimates in section 11305(c)(4) of the 1990 Act. Thus, if in a subsequent taxable year cumulative salvage recoveries indicate that the amount of undiscounted estimated salvage recoverable for which X claimed the special deduction was overstated, X must include in taxable income for that subsequent year 87 percent of the overestimate of undiscounted salvage recoverable (adjusted for discounting used in calculating the special deduction). The recapture amount would be determined in accordance with the procedure set forth in example (2), except that in determining the ratio referred to in that example the discounted estimated salvage recoverable used to determine the special deduction ($4,674) would be substituted for the section 481 adjustment.

SEC. 15. TABLES OF DISCOUNT FACTORS

01 The following tables present separately for each line of business the discount factors for use with Alternative (1) of section 4.04. The factors generally reflect aggregate salvage recovery data for the property and casualty insurance industry. Due to insufficient salvage data for certain long-tail lines of business (automobile liability, other liability, workers' compensation, medical malpractice, and the multiple peril lines), the factors set forth for those lines are based on the loss payment patterns published annually under section 846 of the Code as a proxy for salvage received. The loss payment pattern under section 846 is also used as a proxy for salvage received for the cancellable accident and health line of business. The factors are the same as the discount factors published in Rev. Rul. 90-26. See Rev. Rul. 87-34, 1987-1 C.B. 168, Rev. Rul. 88-63, 1988-2 C.B. 130, Rev. Rul. 89-66A, 1989-1 C.B. 220, and Rev. Rul. 90-26, 1990-1 C.B. 125. All the discount factors presented in this section were determined using the applicable interest rate under section 846(c) for 1990, 8.37 percent, and by assuming all salvage recoveries occur in the middle of a calendar year.

02 The cancellable accident and health line of business is not included separately in the tables presented in this section. Using the loss payment pattern for cancellable accident and health under section 846 of the Code (that is, the assumption that losses are paid in the middle of the year following the accident year) as a proxy for the salvage received pattern, the discount factor for this line of business is 96.0606 percent for all pre-1991 accident years.

03 Each discount factor table presents the following information: (1) the salvage receipt pattern; (2) the discounted amounts of salvage recoverable, based on item 1, as of the end of each taxable year starting with the accident year; (3) the undiscounted amounts of salvage recoverable, based on item 1, as of the end of each taxable year starting with the accident year; and (4) the discount factors, based on items 2 and 3, for use under alternative 1 of section 4.04 for each taxable year starting with the accident year.

04 The salvage receipt patterns (item 1) are shown in the column labelled "% of S&S" for "percent of salvage and subrogation received." This column always sums to 100 percent. Each row of this column is designated as zero or more years after the accident year ("AY").

05 The discounted amounts of salvage recoverable (item 2) as of the end of each taxable year starting with the accident year are presented in the row labelled "Discounted." (The numbers above the "Discounted" row are intermediate values from which the discounted amounts are derived. These intermediate values show the discounting of each individual year of salvage received after the accident year. They are presented for informational purposes only.) Each of the columns designated "AY + 0", "AY + 1" and so on represent the results for a taxable year, where each taxable year (column) is referenced by the number of years that the taxable year succeeds the accident year in which the losses were incurred. For example, for calculations involving accident year 1988, the 1990 taxable year is represented by the column marked "AY + 2" because 1990 is two years after 1988, while the 1989 taxable year for calculations involving accident year 1988 is represented by the column marked "AY+1" (since 1989 is only one year after 1988).

06 The undiscounted amounts of salvage recoverable (item 3) as of the end of each taxable year starting with the accident year is presented in the row labelled "Undiscounted." The designation of taxable years by column is the same as described in section 15.05.

07 The salvage discount factors for each taxable year starting with the accident year, for use with alternative 1 of section 4.04, are presented in the row labelled "Discount Factor." The discount factor from the applicable column of this row, when multiplied by the year end undiscounted amount of salvage recoverable from losses incurred in a single accident year (from section 4.03), yields the discounted estimate of salvage recoverable as of the end of the applicable taxable year. The designation of taxable years by column is the same as described in section 15.05.

08 Within each line of business, the discount factor in the last column of the table for that line of business in section 15.09 (that is, the right most column, which factor is 96.0606 percent for every line of business for the 1990 taxable year) shall be used as the discount factor for calculations involving all accident years preceding the oldest accident year covered by that table.

09 Tables.

AUTOMOBILE LIABILITY (Part 1)

                               Salvage Recoverable at Year End