REVENUE RULING 80-115
1980-1 C.B. 138

[IRS Annotation]
Life insurance companies; reserves; combined disability and life coverage; cancellable. Reserves held by a life insurance company for payment of disability benefits under one-year group term life insurance contracts, which provide both disability insurance and term life insurance coverage that may be terminated at any time by the insurance company, do not qualify [139] as life insurance reserves within the meaning of section 801(b) of the Code; Rev. Rul. 70-190 clarified.

Rev. Rul. 80-115

ISSUE
Do reserves held by the taxpayer for payment of disability benefits under 1-year group term life insurance policies that provide both disability and term life insurance benefits qualify as life insurance reserves within the meaning of section 801(b) of the Internal Revenue Code?

FACTS
The taxpayer is a life insurance company taxable under section 802 of the Code. The taxpayer issues, among other types of insurance, 1-year group term life insurance contracts that provide, in addition to life insurance benefits, disability benefits. If the policy is renewed at the end of its 1-year term, the renewal premium will be recomputed based upon the accumulated experience of the group. The taxpayer may terminate the policies upon written notice to the named insured, but in no event shall a termination of policy adversely affect any claim incurred prior to the date of such termination.

When the policy is issued the taxpayer establishes two reserves, namely, a reserve for basic life insurance benefits and a reserve entitled Disability Benefits-Active Lives. The portion of the premiums received for the basic life insurance benefits funds the basic life reserve and the portion of the premiums received for the disability benefits funds the Disability Benefits-Active Lives reserve. When an insured employee becomes disabled and entitled to the monthly income payments specified in the contract, a third reserve, entitled Disability Benefits-Disabled Lives, is established. This reserve is funded out of the Disability Benefits-Active Lives reserve, and the disability income payments to the insured employee are paid out of this reserve.

The Disability Benefits-Active Lives reserve and Disability Benefits-Disabled Lives reserve established under the policy are computed on the basis of recognized mortality and morbidity tables, at assumed rates of interest, and are required by law. At the end of the policy term, whatever balance remains in the Disability Benefits-Active Lives reserve is released to the income of the taxpayer and the reserve is zero. The disabled employee's recovery or death terminates the taxpayer's obligation to pay disability benefits to that employee. Amounts in the Disability Benefits-Disabled Lives reserve that are attributable to the terminated obligation are then released to the income of the taxpayer. The question presented is whether both disability benefits reserves are life insurance reserves as that term is defined by section 801(b) of the Code.

LAW AND ANALYSIS
Section 801(b)(1) of the Code provides as follows:

(b) Life Insurance Reserves Defined.—

(1) In General.—For proposes of this part, the term "life insurance reserves" means amounts—

(A) which are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest, and

(B) 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 . . . involving, at the time with respect to which the reserve is computed, life, health, or accident contingencies.

Section 801(b)(2) of the Code provides that, with exceptions not here pertinent, life insurance reserves must also be required by law.

As early as 1942, Congress indicated that cancellable and noncancellable health and accident insurance were to be accorded different treatment for income tax purposes. Because cancellable health and accident insurance does not entail long-term risks but noncancellable health and accident insurance does, Congress recognized that the noncancellable long-term risk variety was more like life insurance and that a company issuing such contracts would have to have a reserve in addition to the unearned premiums in order to provide for the increasing actuarial risk under such contracts. It also provided for unearned premiums and unpaid losses on noncancellable health and accident insurance to be in the numerator of the qualification fraction under section 801(a) of the Code to insure that insurance companies engaged primarily in this type of business could qualify as life insurance companies for federal income tax purposes. S. Rep. No. 1631, 77th Cong., 2d Sess. 145-49 (1942), 1942-2 C.B. 504; H.R. Rep. No. 2333, 77th Cong., 2d Sess. 109-12 (1942), 1942-2 C.B. 372.

Section 1.801-2(c) of the Income Tax Regulations provides that:

The term "noncancellable life, health, or accident insurance policy" means a health and accident contract, or a health and accident contract combined with a life insurance or annuity contract, which the insurance company is under an obligation to renew or continue at a specified premium and with respect to which a reserve in addition to the unearned premium (as defined in paragraph (e) of this section) must be carried to cover that obligation. Such a health and accident contract shall be considered noncancellable even though it states a termination date at a stipulated age, if, with respect to the health and accident contract, such age termination date is 60 or over.

Section 1.801-3(d) of the regulations describes a guaranteed renewable life, health, and accident insurance policy as a policy that is not cancellable by the company but under which the company reserves the right to adjust premium rates by classes in accordance with its experience under the type of policy involved and with respect to which a reserve in addition to the unearned premiums must be carried. In accordance with section 801(e) of the Code, guaranteed renewable policies are treated in the same manner as noncancellable life, health, and accident insurance policies.

[140]

In United Benefit Life Insurance Company v. McCrory, 414 F.2d 928 (8th Cir. 1969), the court held that reserves set aside by a taxpayer for the payment of claims for permanent and total disability under policies not arising from noncancellable health and accident insurance contracts cannot qualify as life insurance reserves.

The type of policy described in this revenue ruling may be terminated at any time by the insurance company upon written notice to the named insured. This policy is not, therefore, a noncancellable health and accident policy or guaranteed renewable policy within the meaning of sections 1.801-3(c) and (d) of the regulations because the taxpayer is not under an obligation to renew or continue the policy either at a specified premium or premium rates adjusted by classes and does not have to maintain a reserve in addition to the unearned premiums. See Group Life & Health Ins. Co. v. United States, 434 F.2d 115 (5th Cir. 1970).

HOLDING
The disability reserves set aside under 1-year group life insurance policies, which provide both disability and term life insurance benefits, do not qualify as life insurance reserves under section 801(b) of the Code.

EFFECT ON OTHER REVENUE RULINGS
In Rev. Rul. 70-190, 1970-1 C.B. 150, the Service concluded that a reserve for payment of disability benefits established after the disability claim has been incurred and approved qualifies as a life insurance reserve under section 801(b) of the Code. The facts in that ruling indicated that the disability reserve was established from premiums on contracts providing both ordinary life and disability benefits without specifying that the latter benefits were being provided under contracts that were noncancellable. Rev. Rul. 70-190 is clarified by stating that the health and accident benefits provided in combination with ordinary life insurance under the contracts described therein were, in effect, noncancellable.