Subchapter L: Life Insurance Reserves Need Not Always Be "Life Insurance Reserves"

The Internal Revenue Code (the “Code”) permits life insurance companies to deduct on a reserve basis six categories of “items” listed in I.R.C. § 807(c). The first item is “life insurance reserves (as defined in section 816(b)).” In general, I.R.C. § 816(b) limits the definition of “life insurance reserves” to amounts that are set aside on the annual statement for future unaccrued claims under life insurance, annuity, and noncancellable accident and health insurance contracts, and are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest. Thus, on its face the Code could be read to condition the deduction for reserves with respect to the designated types of contracts on satisfaction of computational requirements for statutory reserves. As explained below, this is not what the cross-reference to I.R.C. § 816(b) in the list of deductible reserves really means. Instead, Congress intended that statu- tory reserves for future unaccrued claims under the types of contracts specified in I.R.C. § 816(b) should be deducted as life insurance reserves subject to I.R.C. § 807(d) whether or not they flunk the computational requirements for life insurance reserves in I.R.C. § 816(b).

This apparent inconsistency in the treatment of life insurance reserves is a result of the addition of I.R.C. § 807(d) in the Deficit Reduction Act of 1984 (the “1984 Act”). Under I.R.C. § 807(d), for purposes of determining the deduction or income from changes in tax reserves, “life insurance reserves” are required to be recomputed using the National Association of Insurance Commissioners (NAIC) prescribed method applicable for the type of contract and specified interest and mortality or morbidity assumptions. The drafters of I.R.C. § 807(d) understood that the cross-reference to the I.R.C. § 816(b) definition of life insurance reserves in the listing of deductible reserves created an ambiguity as to the treatment of non-qualifying statutory reserves. Can the company argue that the statutory reserves are deductible in full as another I.R.C. § 807(c) item and avoid the I.R.C. § 807(d) rules by intentionally establishing statutory reserves that do not satisfy the I.R.C. § 816(b) computational requirements? Can the Internal Revenue Service (IRS) argue in these circumstances that no reserve deduction at all is available?