REVENUE RULING 63-241
1963-2 C.B. 231

[IRS Annotation]
A mandatory security valuation reserve maintained by life insurance companies to level off fluctuations in the value of certain securities [232] pursuant to requirements of the insurance departments of various states, is not includible in "total reserves" within the meaning of section 801(c) of the Internal Revenue Code of 1954.

[Rev. Rul. 63-241]
Advice has been requested whether mandatory security valuation reserves maintained by life insurance companies pursuant to requirements of the insurance departments of various states are includible in "total reserves" within the purview of section 801(c) of the Internal Revenue Code of 1954.

A mandatory security valuation reserve is an accumulation, over a stated period of time, of specified percentages of the annual statement value of certain stocks and bonds held by a life insurance company. Additions to and deductions from the reserve, which do not enter into the computation of taxable income for Federal income tax purposes, must conform with rules adopted by the National Association of Insurance Commissioners. The size of the reserve in a given company depends on the amount of the company's assets which fall within certain categories rather than on the amount of the company's liabilities under its contracts.

The reserve is required to be shown as a liability instead of part of surplus for annual statement purposes. This liability is required to be shown "below the line" and is not to be included with policy reserves which are shown "above the line." However, for purposes of valuing stockholders' equities in life insurance companies, it is common practice to treat the mandatory security valuation reserve as part of surplus.

The reserve is intended to level off fluctuations in surplus which may occur in the event of future realized losses on securities. It is not available for use in connection with abnormal losses, such as might occur with respect to mortality or disability. Thus, in effect, the reserve serves to reduce the admitted asset values of the securities.

In accordance with section 801(c) of the Code, 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.

Section 801(b)(1) of the Code defines the term "life insurance reserves" to include 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, either by payment or reinsurance, future unaccrued claims arising from life insurance, annuity, and noncancellable health and accident insurance contracts (including life insurance or annuity contracts combined with noncancellable health and accident insurance) involving, at the time with respect to which the reserve is computed, life, health, or accident contingencies.

The term "unearned premiums" is defined by section 1.801-3(e) of the Income Tax Regulations as those amounts which shall cover the cost of carrying the insurance risk for the period for which the premiums have been paid in advance.

Section 1.801-3(g) defines the term "unpaid losses (whether or not ascertained)" as a reasonable estimate of unpaid losses which have either been reported and ascertained, reported but not ascertained, or occurred but not reported at the end of the taxable year.

A mandatory security valuation reserve clearly does not fall within the scope of life insurance reserves, unearned premiums, or unpaid [233] losses. Thus, if such a reserve is to be included in "total reserves," it would necessarily have to fall within the classification of all other insurance reserves required by law.

Insurance reserves represent liabilities under contracts with policyholders which the insurance company must set aside for the fulfillment of benefits payable under those contracts. The mandatory security valuation reserve is not such a reserve but instead is analogous to a surplus reserve for Federal income tax purposes. Such a surplus reserve is distinguishable from an insurance reserve in that it is computed separately and apart from the liability which a company must set aside for the fulfillment of its policy obligations and has no effect on the amount of that liability.

Accordingly, it is held that a mandatory security valuation reserve maintained by life insurance companies to level off fluctuations in the value of certain securities, pursuant to requirements of the insurance departments of various states, is not includible in "total reserves" within the meaning of section 801(c) of the Code.