
    574 F.2d 1067
    THE CENTRAL NATIONAL LIFE INSURANCE COMPANY OF OMAHA v. THE UNITED STATES
    [No. 194-70.
    Decided April 19, 1978]
    
      
      Patrick A. Heffernan for plaintiff; William A. Cromartie, attorney of record. Richard Bromley, Francis O. Mc-Dermott, Hopkins, Sutter, Mulroy, Davis & Cromartie, of counsel.
    
      Herbert Grossman, with whom was Assistant Attorney General M. Carr Ferguson, for defendant. Theodore D. Peyser and Donald H. Olson, of counsel.
    Before Nichols, Kashiwa, and Kunzig, Judges.
    
   Per Curiam:

This case was referred to Trial Judge Kenneth R. Harkins with directions to make findings of fact and recommendation for conclusion of law. The trial judge has done so in an opinion and report filed on February 23, 1977. Exceptions to the trial judge’s findings and recommended conclusion of law were filed by the defendant and the case has been submitted to the court on oral argument of counsel and the briefs of the parties. Since the court agrees with the trial judge’s findings, opinion, and recommended conclusion of law, with modifications by the court, it hereby adopts the same, as modified, as the basis for its judgment in this case, as hereinafter set forth. Plaintiff is, therefore, entitled to recover and judgment is entered for plaintiff with the amount of recovery to be determined pursuant to Rule 131(c).

Trial Judge Harkins’ opinion, as modified by the court, is as follows:

In this tax refund case, The Central National Life Insurance Company of Omaha contests the determination by the Internal Revenue Service (IRS) that the company did not qualify as a life insurance company for federal income tax purposes. Plaintiff seeks to recover income tax principal in the amount of $9,063.26 and interest in the amount of $1,889.25 paid for the taxable year ended December 31, 1964.

Substantially all of plaintiffs business, in the year 1964, consisted of the issuance of life insurance policies and health and accident disability coverages incidental to such life insurance. In 1964, most of plaintiffs premium income was derived from credit life insurance and related credit health and accident coverages. In Alinco, this court concluded that an insurance company that specialized in the reinsuring of credit life insurance could qualify under section 801, provided it met the 50 percent test.

In the Alinco case, the life insurance policies involved were single premium term insurance, with an average term of 2 or 3 years, on the lives of debtors with the creditor as beneficiary. Reserves for the credit life insurance involved in the Alinco case were computed on the customary tabular basis for life insurance reserves — from recognized mortality tables and assumed rates of interest. This case differs in that Central National presents a further problem on the method used to compute life insurance reserves and its effect on eligibility for inclusion in the numerator of the qualification fraction. Plaintiff utilized the gross unearned premium method to compute its reserves for its credit life insurance policies.

Although the broad legal issue to be decided is whether plaintiff was a life insurance company under the qualification formula in section 801(a) of the Internal Revenue Code of 1954, as amended, and, although the IRS has challenged plaintiffs treatment of a number of its reserves for both its life policies and its accident and health policies, proper characterization of the credit life reserves in this case is the central and dispositive issue. Reserves for the credit accident and health coverage written by plaintiff, in comparison, would not affect one way or another plaintiffs qualification as a life insurance company in 1964. The 1963-64 mean amount of plaintiffs reserves for life policies and contracts (net of reinsurance) was a total of $3,059,041 and for health and accident policies (net of reinsurance) was a total of $1,296,697. The mean amount of plaintiffs credit life insurance reserves in dispute for 1964 is $1,292,566, when computed on the gross unearned premium basis. If all other contested issues were resolved in defendant’s favor, inclusion of plaintiffs credit life reserves in the numerator of the qualification fraction would confirm plaintiffs life insurance company status for 1964.

Facts.

Plaintiff incorporated on April 29, 1953, in Nebraska as a capital stock legal reserve life insurance company, It is a wholly owned subsidiary of The Central National Insurance Company of Omaha, a casualty insurance company prohibited by law from writing life insurance. At all relevant times, plaintiff was licensed by the Director of Insurance of the State of Nebraska to engage only in the life insurance, annuities, and accident and health insurance business. During 1964, plaintiff was licensed to transact its insurance business in every state of the United States except New York and Massachusetts.

Exclusive of federal employees’ group life insurance on which no reserves were required, plaintiff sold four basic types of life insurance and established reserves thereon: (1) individual life insurance; (2) employee group life insurance; (3) credit individual term life insurance; and (4) credit group life insurance. The credit group life policies insured the lives of debtors of the group policyholder, a financial institution. In general, the amount of life insurance coverage was equal to the balance of the unpaid debt and the term was coextensive with the term of the debt, which would normally vary from 6 months to 5 years. The credit group life policies provided that no insurance would be granted on the life of any debtor whose indebtedness to the group policyholder was repayable over a period exceeding 60 months; the average initial term was approximately 20 months. Credit group life policies were either single premium term insurance or monthly premium renewable term insurance.

Plaintiffs credit individual term life policies were for a term coextensive with the term of the insured’s debt, which varied from 6 months to as much as 5 years, with an average term of coverage of approximately 20 months. The amount of life insurance coverage was approximately equal to the unpaid balance of the principal of the related indebtedness. In all cases, a single premium was paid in advance for the entire term of the coverage.

With respect to both credit group and credit individual term life insurance policies, plaintiff reserved no right to cancel or otherwise terminate any coverage subsequent to the payment of premiums, within the terms for which they were written.

With respect to its individual and group credit life insurance policies, plaintiff established reserves, as required by the applicable Nebraska insurance laws, to liquidate future unaccrued death claims. Each of plaintiffs credit life policies required that plaintiff establish a life insurance reserve computed in accordance with one of the following recognized mortality tables:

(a) American Experience Table, with 3 percent interest per annum;
(b) Commissioners’ 1941 Standard Ordinary Mortality Table, with 3 percent interest per annum; or
(c) Commissioners’ 1958 Standard Ordinary Mortality Table, with 3 percent interest per annum.

Rather than compute its credit life reserves in accordance with the mortality tables specified in plaintiffs credit life policies, however, plaintiff utilized the gross unearned premium method of computing these reserves. This method was acceptable to the Insurance Department of the State of Nebraska.

The reserves computed by plaintiff, pursuant to the gross unearned premium method of computation, were never less than those which would have been computed on the basis of the mortality tables specified in plaintiffs credit life policies. Utilization of the gross unearned premium method of computation produced a reserve, with respect to plaintiffs individual and group credit life policies for the beginning and end of 1964, in the mean amount of $1,292,566. At trial, plaintiffs evidence showed that the appropriate mortality table computation, adjusted to meet the 130 percent requirement of the Illinois Insurance Department, would have produced a reserve for its credit life policies for 1964 in the mean amount of $911,010, or 70.5 percent of the amount computed on the gross unearned premium basis. Defendant contends plaintiffs credit life reserves, if computed on a tabular basis at 100 percent of the amount thus computed rather than at 130 percent, would have been in the mean amount of $700,777, or 54 percent of the amount computed on the gross unearned premium basis.

Plaintiff, at least since 1957, had used the gross unearned premium method to compute reserves for its credit life policies. At the time plaintiff started to use the gross unearned premium method, the only type of life insurance plaintiff wrote was credit life insurance. Although plaintiff had the statistical detail required to calculate mortality reserves on computer cards and tapes, plaintiff did not have a computer program that would have enabled it to calculate reserves for its credit life policies on the basis of mortality tables. It was more convenient and economical for plaintiff to apply the computer program that was maintained by associated companies that were writing casualty insurance, which companies computed the gross unearned premium reserve through the application of the Rule of 78 formula.

Plaintiffs use of the gross unearned premium method to compute its reserves on its credit life policies was known by the examiners for the Insurance Department of the State of Nebraska and was acceptable to the Nebraska insurance regulators. Many credit life insurance companies, in addition to plaintiff, used the gross unearned premium method, rather than mortality tables, to compute credit life reserves. The gross unearned premium method produced reserves which approximated those which would have been produced through the use of mortality tables.

All of the states have adopted the standard form developed by the National Association of Insurance Commissioners (NAIC) for the use of insurance companies in their annual financial reports. This standard form is known as the NAIC Convention Blank or the Annual Statement. Life insurance companies are required to file both their Annual Statements and their annual income tax returns on the basis of the calendar year; December 31 is referred to as the "valuation date” for the particular year involved.

In its Annual Statements for 1963 and 1964, plaintiff reported credit life reserves in exhibit 8 (Aggregate Reserve for Life Policies and Contracts), part A (Life Insurance), under the label "American Experience — 2%% Net Level.” To the extent that this label designated a precise computation, it was incorrect because it did not reflect that the gross unearned premium method actually was used. The Nebraska insurance examiners, however, were aware of plaintiffs method of computation and were not misled by the label. Plaintiffs Annual Statement was submitted with its tax returns to the Internal Revenue Service. Plaintiff did not inform the IRS that the label used to identify its credit life reserves was incorrect and the IRS, at the time of filing, apparently was not informed of plaintiffs actual method of computation.

On January 11, 1963, the Insurance Department of the State of Illinois, a state in which plaintiff wrote a small portion of its credit life insurance, issued a letter that permitted "All Companies Writing Credit Life Insurance” to establish reserves on their credit life business on the basis of 130 percent of the appropriate mortality table. There is no evidence that plaintiffs determination to utilize the gross unearned premium method of calculating its reserves for its credit life insurance in 1963 and 1964 resulted from this directive from the Illinois Insurance Department. At the time this letter was issued, however, the Illinois Insurance Department had jurisdiction over plaintiff as a company doing business in Illinois and plaintiff was included in the classification of companies to which the letter was addressed. There is no evidence that the method plaintiff actually used in 1963 and 1964 to compute its gross unearned premium reserves included computations which were based upon 130 percent of the appropriate mortality table.

Plaintiff had no computer program prior to 1968 by which it could calculate its credit life reserves on the basis of mortality tables and assumed rates of interest. As a consequence, in its annual examinations, plaintiff did not submit any mortality reserve computations for verification or approval to the Nebraska insurance examiners. In 1968, plaintiff obtained from Fidelity Bankers Life Insurance Company, which had become affiliated with plaintiff in 1967, a computer program which Fidelity used to calculate mortality reserves on credit life, accident and health, and disability insurance. This computer program was used by plaintiff to apply actuarial formulae to raw data on its own policies which had been accumulated and placed on computer cards in 1963 and 1964 to generate plaintiffs Annual Statements. Plaintiffs access to the new computer program enabled it to calculate what the reserves for 1964 would have been if based upon the American Experience, the 1941 Commissioners’ Standard Ordinary, or the 1958 Commissioners’ Standard Ordinary tables of mortality. In these computations, plaintiff included the 130 percent factor of the mean of the tabular reserves.

According to plaintiffs witnesses, the computer program obtained by plaintiff from the Fidelity Bankers Life Insurance Company has been in use since 1968 to calculate plaintiffs current life reserves on a tabular basis. Since 1968, examiners from the Nebraska Insurance Department have been able to verify plaintiffs mortality reserves for credit life insurance as calculated by the use of this computer program, and plaintiffs method of calculation has been accepted by the examiners.

Qualification.

To qualify as a life insurance company for federal income tax purposes, plaintiff must show that its credit life policy reserves, although computed as gross unearned premium reserves in the manner customarily employed for casualty insurance instead of for life insurance, are life insurance reserves as defined in the Internal Revenue Code of 1954, as amended. The historical development of the function and content of life insurance reserves, for federal tax purposes, provides perspective on the meaning of the statutory definition.

Since 1921, insurance companies have been divided into three income tax categories: life insurance companies, mutual insurance companies, and other insurance (principally stock casualty) companies. Life insurance companies receive certain tax benefits over other insurance companies and are distinguished from the other categories of insurance companies by the proportion their life insurance reserves bear to all other reserves required by law.

In the Revenue Act of 1921, life insurance companies were taxable only on that part of investment income derived from the difference between the statutory assumed rates of interest and the going rates of interest; casualty insurance companies, on the other hand, were taxed on both underwriting income and investment income.

In the 1921 act, a "life insurance company” was one whose reserve funds for its life insurance and annuity contracts (including contracts of combined life, health, and accident insurance) comprised "more than 50 per centum of its total reserve funds.”

Use of the 50 percent formula permitted an insurance company to qualify as a life insurance company even though a substantial part of its business was the sale of health and accident insurance, a casualty-type coverage. Once a company had satisfied the 50 percent qualification formula, it obtained a deduction in the amount of the statutory interest on all of its technical insurance reserves for both its life policies and its accident and health policies.

Contract terminology and actuarial concepts differ in life insurance from casualty insurance. In life insurance, the premium is considered to be wholly earned when paid, and since a life policy is noncancellable by the insurer or insured, no provision need be made for premium refunds. In casualty insurance, however, the premium, although paid in advance, is "earned” only for the expired term for which insurance protection has been provided; the "unearned” premium is the portion the insurer has not had time to earn. Both parties have cancellation rights, and reserves must be maintained to cover premium refunds. The casualty insurance industry traditionally determined its reserve requirements on the basis that the full amount of the premiums would have to be refunded if all policies in force were simultaneously canceled.

Life insurance reserves are computed from recognized mortality tables and assumed rates of interest on the valuation premium, and the loading factor for administrative expenses is excluded. Casualty insurance reserves are calculated on the basis of gross unearned premiums, which include loading charges, and on the basis of unpaid losses.

In the Revenue Act of 1942, Congress, to permit noncancellable health and accident insurance reserves to qualify as life insurance reserves, amended the definition of a life insurance company so as to incorporate terms historically associated with the casualty insurance business. Revision of the life insurance company definition to accommodate reserves on noncancellable health and accident insurance resulted in a blurring of the traditional differences in the methods for reserving for life policies as contrasted to those for casualty-type health and accident policies. For the first time, the life insurance company definitions included the casualty insurance terms "unearned premiums,” "unpaid losses,” and "noncancellable.” In addition, Congress added to the definition the provision that life insurance reserves are amounts based on "recognized mortality or morbidity” tables. The changes made in 1942 in the definition of a life insurance company and in the qualification formula are incorporated in the 1954 Code with no change in substance. The Life Insurance Income Tax Act of 1959 made no change in the relevant definitions in section 801, and the definitions and terminology of the 1942 act are controlling.

The statutory terms culminating in code section 801 are the product of a long history of development in statutory and case law. The requirement that life insurance reserves be "required by law,” for example, stems from an act of 1909. The analogy of noncancellable health and accident insurance to life insurance, in the necessity to accumulate substantial reserves against increased future risks, had been noted by the courts prior to the 1942 act. The section 801 definitions encompass efforts to accommodate changing industry practices and developing actuarial concepts with the gloss of prior judicial decisions and to combine the mixture with static principles of income taxation. As a result, the section 801 definitions embody an idiom peculiar to a specialized business and administrative practice and ambiguities that stem from draftsmanship by accretion. The definitions combine the "labyrinthine composition” of the tax law with the "mystic processes” in life insurance reserves; they were not "written for ordinary folk.”

The numerator of the qualification fraction — reserves that satisfy the requirements of the life insurance business — is defined in section 801(b). All reserves so defined are "life insurance reserves.”

The denominator of the qualification fraction is the total of all technical insurance reserves (as distinguished from ordinary business liability reserves) and is set forth in section 801(c). Both parties agree that plaintiffs reserves, on its credit life policies, notwithstanding the method of computation, are eligible "total reserves” and must be included in the denominator of the qualification fraction.

To satisfy the definition of life insurance reserves and to be included in the numerator, the amounts reserved on plaintiffs credit life policies must be derived from the following elements:

(1) The amounts are computed or estimated;
(2) The coihputation or estimation is based on recognized mortality tables and assumed rates of interest;
(3) The amounts are set aside for future unaccrued claims;
(4) Eligible claims must arise from insurance contracts that involve life contingencies; and
(5) The reserves must be required by law.

Plaintiff contends that reserves for its credit life policies, although computed through the gross unearned premium method of computation, for purposes of section 801, are life insurance reserves because they were estimated on a tabular basis. Plaintiff alternatively contends that inasmuch as the reserve actually established on its books and reported in its Annual Statements exceeded the amounts that would have been computed by the tabular method, plaintiff at least is entitled to treat as reserves the lesser included amount that could be derived from a tabular computation.

Plaintiff points out that the reserves were established to satisfy the provisions of policies which concededly are for life insurance, and which specified that reserves would be computed in accordance with recognized mortality tables and assumed rates of interest. Plaintiff also points out that the estimate was made on a gross unearned premium reserve method for reasons of business convenience and economy; that the method utilized and the amounts so derived were acceptable to the Nebraska Insurance Department; and that the amounts produced were not less than the reserves which would have been computed on the basis of the mortality tables specified in the insurance contracts.

Defendant does not contend that establishing gross unearned premium reserves for credit life policies was improper from a business point of view or from the point of view of state requirements. Defendant’s only position is that reserves so computed do not qualify as life insurance reserves under section 801; that reserves so computed constitute "other reserves required by law”; and that the reserves cannot be retroactively recomputed pursuant to methods required for life insurance reserves.

In 1942, the Revenue Act was modified to expand the definition of life insurance to include, as qualifying reserves, unearned premiums and unpaid losses on noncan-cellable health and accident insurance. The purpose of these changes was to benefit life insurance companies and permit additional kinds of reserves to qualify.

When the 1942 amendments were adopted, there was no suggestion that the addition of terms customarily used in casualty insurance was intended to limit or diminish traditional life insurance concepts. The "unearned premiums” and "unpaid losses” were terms added solely to apply to health and accident coverages, not to life policies. The distinction between cancellable-noncancellable policies has significance only in an accident and health insurance context. Accordingly, plaintiffs contention that its credit life policy reserves qualify as unearned premiums on noncancellable life policies has no support in either industry practice or legislative history.

The 1942 expansion of the Internal Revenue Code to include noncancellable health and accident reserves was an effort to adapt to changing industry conditions. At that time, the volume of credit life insurance was of limited significance in the life insurance business. In 1940, with total life insurance in force of $115 billion, credit life insurance amounted to only approximately $380 million, or 0.3 percent. Between 1940 and the end of 1973, the volume of credit life insurance in force increased 263 times from $380 million to $100 billion, and was approximately 5.6 percent of the total $1,778 billion life insurance in force. This phenomenal change was not foreseen in 1942 and the impact of the words used to expand section 801’s coverage on this type of life coverage was not contemplated.

Defendant concedes that credit life insurance is life insurance for federal income tax purposes and has abandoned its former position that credit life insurance reserves could not qualify at all because the insurance more closely resembled casualty insurance. Defendant, however, distinguishes credit life insurance reserves from other life insurance reserves in that they apply to short-term policies only. Defendant claims credit life is not "ordinary” life insurance as that term is used in the industry and equates "ordinary” life with "whole” life. Whole life insurance provides for payment on death of the insured without reference to a specified period of years and, where premiums are to be paid throughout the lifetime of the insured, it is referred to as "ordinary,” as distinguished from limited payment life. Defendant acknowledges that the term "ordinary life” in use has been broadened to include term policies. Defendant contends, however, that "ordinary life” still primarily covers long-term policies, and that credit life policies, with regard to their duration, resemble only a small portion of the "ordinary” policies.

This distinction is without merit. Credit life insurance policies are comparable to ordinary individual term life insurance contracts that have an equivalent term. The amounts needed to be reserved for each type of life insurance policy would be the same. Ordinary term life insurance, since it is life insurance, cannot be canceled; there is no reason to distinguish credit life insurance in this regard. Credit life insurance is equally "noncancella-ble,” to the extent such a concept has meaning in life insurance, as ordinary term life insurance with an equivalent period. Credit life insurance reserves would have the same components as ordinary term life insurance reserves.

Insurance contract premiums consist of two components — a loading factor and the net, or valuation, premium. The loading factor covers a portion of the insurer’s general business expenses and the specific administrative expense anticipated to be incurred in providing the contracted coverage. The size of the loading factor is arbitrarily determined through competitive considerations in the administration of the business. The net premium component is the sum which, actuarily computed on the basis of mortality or morbidity tables and an assumed rate of interest, will be sufficient to provide the benefits guaranteed under the policy.

At any point in a policy year, the annual gross premium may be considered to have an "earned” portion and an "unearned” portion. The terms "unearned premium” and "unearned premium reserves” reflect the liability of the company for premiums collected but not yet earned. Gross unearned premium reserves include a portion of the loading factor, and, consequently, are not limited to calculations designed to compute life, health, or accident contingencies. The gross unearned premium reserve in-eludes more than the reserve liabilities on which the contract is based.

In the insurance industry, "reserves” embody concepts that differ from conventional accounting reserves. Insurance reserves are not trust funds or assets in escrow; they are liability accounts that involve no representation that specific assets are held to meet any particular claim or class of claims. Life insurance reserves are liability accounts established in the annual statement to represent the company’s potential liability to pay guaranteed benefits on its insurance policies.

The life insurance resérve is a number that is reflected on the company’s balance sheet as a liability. It measures the portion of the company’s present assets which the company actuarially must assume will be required to meet obligations to policyholders. For this reason, the amount reserved may not be used for other purposes. If it were not recorded as a liability, the company’s earnings would be increased and a greater amount of .its assets would be available for distribution to stockholders.

A life insurance policy reserve is the excess, at the valuation date, of the present value of future guaranteed benefits over the present value of future net premiums with respect to life insurance policies in force, both of which are determined according to appropriate mortality tables and assumed rates of interest. Insurance reserves are established with respect to policies currently in force for the purpose of paying claims that have not yet been incurred. Life insurance reserves also may be viewed as the accumulation of net premiums at interest in excess of death claims assumed to have been paid out.

A life insurance reserve has two fundamental components: First, the portion (the unearned premium) on a net basis of the amount of the valuation premium collected on the last anniversary date to cover a period which has not expired on the valuation date; second, another portion (the additional reserve) which represents an accumulation from the date the policy was issued through the valuation date of the portions of premium excesses paid in early years, increased by interest and reduced by claims, assumed paid during the interim, for the purpose of meeting premium deficits in later years. The gross unearned premium reserves computed by plaintiff for use with its credit life policies were sufficient to include a net unearned premium and the additional reserve that would have been computed for ordinary life policies with equivalent periods of coverage.

Nebraska, in common with all states, has a statutory provision that requires the Department of Insurance to "annually value, or cause to be valued, the reserve liabilities (hereinafter called reserves) for all outstanding life insurance policies * * *.” The mortality tables which may be used in determining a life insurance reserve are subject to minimum standards imposed by state statutes and the rules and regulations of state insurance departments. The maximum interest rates which may be used are also governed by state statutory and regulatory authorities. An insurance company has a choice of methods in determining its life insurance reserves provided that it follows the guidelines of the state statutes, rules, and regulations setting the minimum standards as to the selection of tables and maximum interest rates. Even using the minimum mortality tables specified in the standard valuation law with regard to ordinary life insurance, it is possible to arrive at 45 different amounts of reserves by varying the interest rates and utilizing three different reserving methods. Moreover, there are an infinite number of reserving methods that could be utilized to arrive at different results.

There is no way to arrive at a single "correct” number for a life insurance reserve. There is no way of knowing, with respect to any policy, if and when the policy benefits ultimately will be payable and how many future premiums and how much future income will be received in the interim. These contingencies are provided for by assumptions made by the company (1) as to when the persons insured are likely to die and (2) the rate at which investment income may accrue. These assumptions are based, respectively, on tables of mortality and assumed rates of interest. The variety of assumptions and calculations permissible under the state statutes and regulations is extensive. Insurance companies, are free to pick and choose, in accordance with business dictates, among these various variations, subject only to the requirement that the selected method does not produce a reserve which, in the judgment of the regulatory authorities, is unreasonably low or that an unreasonably high assumption is not made as to the amounts that will be provided out of future premiums and future investment income. Every company’s life reserve basically is only an estimate which can be arrived at by a wide variety of ways.

Life insurance companies are required to report aggregate life insurance reserves in exhibit 8 of the Annual Statement. The two fundamental components of a life insurance reserve (the net unearned premium and the additional reserve) are not separately stated in exhibit 8. Exhibit 8 is divided into various sections in which the life insurance company reports reserves held with respect to its various life insurance and annuity coverages and which, with respect to certain additional benefits (including certain disability benefits), are written as part of, or in conjunction with, its life insurance coverages. The reserves reported in exhibit 8 of the Annual Statement have in common the fact that they all involve probabilities, either mortality or morbidity, and interest discount factors.

Liabilities for life insurance claims which are outstanding or which have accrued as of the valuation date, including estimates of claims which have accrued but which have not been reported to the company as of the subject date, are reported in exhibit 11 of the Annual Statement. Unlike insurance reserves reported in exhibit 8, the amounts reported in exhibit 11 have no probabilities or interest discount factors, but are fully accrued and payable as of the valuation date.

Accident and health insurance, accident and sickness insurance, and disability insurance are synonymous terms as to benefits payable. The benefit is payable as the result of disablement, whether occasioned by accident or sickness. The term "disability insurance” generally signifies that the coverage is written as a rider to a basic policy. The terms "accident and health insurance” and "accident and sickness insurance” signify that the coverage is written as a separate policy. Reserves for accident and health insurance issued separately from life coverages are not reported in the Annual Statement in the same manner as life insurance reserves.

Reserves and accident and health' insurance benefits that are issued separately from life coverages are reported on exhibit 9 of the Annual Statement. Disability provisions issued in conjunction with short-term life coverages may be reported in exhibit 8 or in exhibit 9.

Exhibit 9 was added to the life insurance company’s Annual Statement subsequent to the late 1930’s. It was derived from the fire and casualty insurance company statements in which life companies had previously reported their accident and health business. The report of unearned premiums on a gross basis that includes a loading element is a holdover from the fire and casualty insurance company’s statement from which exhibit 9 was derived.

Exhibit 9 is divided into two parts: Part 1 sets forth reserves representing future unaccrued liabilities, and part 2, in general, sets forth claims that have become fully accrued and payable as of the valuation date. Part 1 of exhibit 9 involves probabilities, based on morbidity tables and interest discount factors, relative to accident and health reserves, and reserves there reported are comparable, in general, to life insurance reserves reported in exhibit 8. Part 2 of exhibit 9 has no counterpart in exhibit 8, but is analogous to the liabilities for fully accrued and payable life claims reported in exhibit 11.

Part 1 of exhibit 9 has two divisions that permits the unearned premium component and the additional reserve component to be reported separately. Line 1 of part 1 sets forth the unearned premium reserve on a gross basis that includes both a loading element and a morbidity element. Cancellable health and accident policies have only the gross unearned premium reserve reported on line 1. The computation of the gross unearned premiums shown on line 1 of part 1 does not involve direct application of mortality or morbidity factors and interest discounts; it is a pro rata portion of the contract premium that reflects the fact that only a portion of the policy year has expired. Tabular factors are reflected only indirectly from the fact that when the original premium was constructed, the tabular factors, plus other considerations, were involved.

Line 2 of exhibit 9’s part 1 sets forth the additional reserve for level premium, guaranteed renewable accident and health policies. This reserve provides for an accumulation of premiums that are in excess of those required on a net basis in the early years of coverage, where the accumulation is held for premium deficits in the later years. The reserve reported on line 2 of part 1 is exactly comparable to the additional reserve component of a life insurance reserve.

The additional reserve component reported on line 2 of part 1 takes into account the increase in mortality or morbidity risk over the term of the policy when the premium remains level. Plaintiffs expert asserted that an actuary computing premiums on a 2-year accident and health policy would take into account the increasing risk over the 2-year period in constructing a single premium contract, or a contract that called for two level premiums. Where the term is short, however, the additional reserve component is not required to be separately stated since the excess of the gross unearned premium reserve over its morbidity element normally would be sufficient to cover the increasing mortality or morbidity risk.

Defendant contends that the dollar numbers reported as reserves for plaintiffs credit life policies are not eligible for inclusion in the numerator of the qualification fraction because the state regulatory authorities could not verify at the time of the annual or triennial examinations that the amounts reported had been computed on a tabular basis. Suffice it to note that plaintiffs reserves for its credit life policies were acceptable at the annual and triennial examinations. At the time of the examinations, the state officials knew that the credit life reserves were computed by the gross unearned premium reserve method. In these examinations, the examiners are obligated to assure that the reserved amounts are sufficient to fund the risk involved and must test their adequacy for that purpose. The amount of risk involved is determined on the basis of morbidity and mortality tables. The adequacy of the amounts reserved is tested through the use of mortality and morbidity factors.

Irrespective of the method used to compute the life insurance reserve, the end result is a specific dollar number, identified for the purposes for which the reserve is required. This amount is carried in the company’s records and reported in its Annual Statements as the life insurance reserve required by statute and regulation. In this case, plaintiffs 1963 and 1964 Annual Statements reflected that the reserves here in question for its credit life insurance policies were included in exhibit 8, subsection A, and were based upon the American Experience Table of Mortality with 2y2 percent net level interest. The dollar amount reported for the credit life reserves totaled $1,260,950 for 1963 and $1,324,182 for 1964. These amounts were the amounts that were designated as its insurance reserves for its credit life policies.

Section 801(b) permits a life insurance reserve to be an amount "computed or estimated.” The use of alternative descriptions of the method by which an acceptable reserve may be determined has historical recognition. Each term was purposefully included and each is to be given meaning. "Computed” signifies a more precise methodology and a more exact mathematical calculation. "Estimated” permits greater flexibility in method and reasonable approximations in the result.

Plaintiff supports its contention that its credit life reserves were estimated tabular reserves on two grounds. First, according to plaintiffs expert, in constructing the contract premium in the first instance, the actuary must take into account mortality and morbidity factors and interest discounts. Since the gross unearned premium reserve is derived from the original contract premium, the reserve involves an indirect application of the tabular factors. If the gross unearned premium reserve were less than would be required by the tabular factors, an additional reserve equal at least to the deficiency would have to be set up. In this way, the actuary is required to take into account the tabular factors in constructing the contract premium and, therefore, the tabular factors are underlying elements of the gross unearned premium reserve.

Although the tabular factors thus may be said to underlie the gross unearned premium reserve, it does not follow that the reserve itself is "estimated on the basis of’ the tabular factors. In the estimating process, the reserve is not derived from a direct application of mortality and morbidity factors and interest discounts.

For its second ground in support of the claim that the reserve is "estimated,” plaintiff asserts it used the unearned premium method of computation for its credit life policy reserves as a means to approximate the reserves which would have been produced through the use of precise calculations based on recognized mortality tables. On this ground, plaintiffs contention has merit and its credit life reserves can be said to be "estimated on the basis of’ the tabular factors.

Plaintiff, at trial, introduced evidence to compare the amounts of reserves that were computed on the gross unearned premium method to the amounts of reserves that would be computed directly on the tabular method. This comparison was based upon plaintiffs policies in force in 1963 and in 1964 which were issued subsequent to December 31, 1959. The policies involved in the comparison accounted for over 90 percent of the total unearned premiums attributable to the total insurance in force. Computation of the hypothetical tabular mortality reserve in the comparison was on the basis of 130 percent of the amount derived from the appropriate mortality table.

In this comparison, plaintiffs computation of the hypothetical tabular mortality reserve utilized the mortality table appropriate to the particular policy. Each policy prescribed the use of one of three mortality tables: 1941 C.S.O., 1958 C.S.O., or American Experience. Although all of plaintiffs unearned premium reserves on both credit individual term and credit group life insurance were reported in the Annual Statements under the label "American Experience,” not all such policies in effect would have been subject to the American Experience table in 1963 and in 1964. In 1963, plaintiff had no policies in force subject to the American Experience table.

Plaintiffs comparison shows that, in fact, credit life policy reserves computed on the gross unearned premium method are reasonably approximate to reserves that would have been computed on the basis of the appropriate mortality tables. With respect to the policies in force in 1964 that were subject to the American Experience Table of Mortality, plaintiffs comparisons show that its decreasing term policies required tabular reserves of $1,490.24 when computed at 130 percent of the table, and the gross unearned premium reserves for those policies would be $1,477.79. Level term policies subject to the American Experience table in 1964 required tabular reserves of $565.12, when computed at 130 percent of the table, and the gross unearned premium reserves for those policies would be $612.42.

In 1963, the total tabular mortality reserves that would have been required at 130 percent of the appropriate table for the policies involved in the comparison would have been $950,257.41; plaintiffs gross unearned premium reserves on those policies would have been $1,415,281.76. In 1964, the comparison policies would have required total tabular mortality reserves in the amount of $944,953.27; plaintiffs gross unearned premium reserves on those policies for 1964 would have been $1,281,203.52.

Since the policies for which computerized data was available represented only about 90 percent of the total unearned premiums for all policies in force, an adjustment was made in plaintiffs comparison. The ratios of the tabular mortality reserves to the unearned premium reserves on the tabulated policies were applied to the unearned premium reserves on all credit life policies and tabular mortality reserves on all credit life policies were thus derived. After the adjustment, tabular mortality reserves which would have been required for plaintiffs credit life policies for 1963-64 were calculated to be in the mean amount of $911,010. The total gross unearned premium reserves reported by plaintiff for its credit life insurance policies for these years were in the mean amount of $1,292,566.

Defendant contends that the dollar amount ($1,292,566) of the gross unearned premium reserve that plaintiff reported is not a close approximation of the tabular reserve that would have been required in 1964. Defendant also asserts that plaintiff may not use the Illinois standard that permits credit life reserves be based on 130 percent of the appropriate mortality table. Defendant asserts that the gross unearned premium reserves plaintiff reported were approximately 184 percent of the amount the tabular reserve would have been if computed at 100 percent rather than at 130 percent of the appropriate mortality table.

The Illinois Insurance Department’s directive that authorized use of the 130 percent factor was to all insurance companies writing credit life insurance in Illinois and was not limited in scope to business written in Illinois. Plaintiff is permitted to use the highest aggregate reserve requirement of any state in which it transacts business for the purpose of computing its reserves. This principle is incorporated in Treasury regulations insofar as it affects computation of total reserves. Accordingly, in 1964, plaintiff was required, with respect to its Illinois business, to compute its credit life reserves on the basis of 130 percent of the appropriate mortality table. Plaintiffs use of the 130 percent factor in its computation of hypothetical tabular reserves as a basis for comparison with its gross unpaid premium reserve was appropriate.

The dollar amounts that plaintiff reported as its credit life reserves were reasonably approximate to the amounts that would have been derived from computations from the appropriate mortality tables. The amounts reported satisfy the requirement that the reserve be estimated on a tabular basis. In any event, the dollar amount of reserves established by plaintiff on its credit life policies included the lesser amount which would have been derived from a computation based upon 130 percent of the appropriate table, which, when included in the numerator of the qualification fraction, would also confirm plaintiffs status as a life insurance company in 1964.

On the basis of the foregoing, plaintiffs reserves on its credit life policies satisfy tie requirements of the statutory definition in section 801(b). Other reserve items are in dispute, and the parties have briefed their respective positions thereon. As to these other items, decision has been requested to resolve status questions for years not now pending before the court. Inasmuch as disposition of the credit life reserve question resolves plaintiffs status as a life insurance company for purposes of this case, no decision is made on the other items in dispute.

FINDINGS OF FACT

The facts, as stipulated by the parties, follow: Plaintiff’s History.

1. The Central National. Life Insurance Company of Omaha, plaintiff, was incorporated under the laws of the State of Nebraska on April 29,1953, as a capital stock legal reserve life insurance company, which was also authorized to transact accident and health insurance business. Throughout 1964, plaintiff was a wholly owned subsidiary of The Central National Insurance Company of Omaha, a casualty insurance company prohibited by law from writing life insurance.

2. Plaintiff commenced business June 3, 1953, and since that time has been engaged in the writing of ordinary and credit life insurance under both individual and group life insurance policies. Plaintiff has also engaged in the writing of ordinary and credit individual ánd group accident and health insurance policies. During the year 1964 and at all other times pertinent hereto, plaintiff was authorized to write the following types of insurance described in subsections (2) and (3) of section 44-201, Reissue, Revised Statutes of Nebraska:

(2) LIFE INSURANCE — Upon lives of persons, including endowments and annuities, and every insurance pertaining thereto and disability benefits;
(3) SICKNESS AND ACCIDENT INSURANCE— Against loss or expense resulting from the sickness of the insured, or from bodily injury or death of the insured by accident, or both, and every insurance pertaining thereto, including quarantine[.]

3. At all times pertinent hereto plaintiff was licensed by the Director of Insurance of the State of Nebraska to engage only in the life insurance, annuities, and accident and health insurance business. During 1964, plaintiff was licensed to transact its insurance business in every state of the United States, except New York and Massachusetts.

4. For each of the years pertinent hereto (including 1964), plaintiff, as required by the Nebraska insurance laws, filed with the Insurance Department of the State of Nebraska an Annual Statement on the form prescribed by the National Association of Insurance Commissioners (formerly called the National Convention of Insurance Commissioners). For each year since its formation in 1953,' plaintiff filed its federal income tax return on the premise that it was a life insurance company, within the meaning of section 801(a) of the Internal Revenue Code of 1954 (hereinafter "code”) and its statutory predecessors, and plaintiff consistently computed its income tax liability and paid its income taxes on that basis.

Policies.

5. During 1964, and at all times pertinent hereto, plaintiffs life insurance (excluding Federal Employee Group Life Insurance on which no reserves were required) was of four basic types: (a) ordinary life insurance; (b) employee group life insurance; (c) credit term life insurance; and (d) credit group life insurance. In addition, plaintiff issued some endowment, retirement, and family plan policies.

6. Plaintiffs ordinary life policies comprised most of the customary forms of term and whole life coverage. Premiums were payable in advance on annual, semi-annual, quarterly, monthly, and special mpnthly bases. The coverage under these policies terminated upon the failure of the insured to pay the requisite premiums as they became due, or within the grace period provided. Apart from incontestability or similar clauses, plaintiff retained no right to cancel or otherwise terminate the life insurance coverage under these policies within the terms for which they were written.

7. Plaintiffs employee group life policies were issued on a 1-year renewable term basis, subject to the right of termination whenever the number of employees, or percentage of eligible employees, insured fell below the number, or percentage, stated in the application. In addition, the employer could terminate the insurance coverage by failing to pay the requisite premiums as they became due and within the following applicable grace period. The group life coverage of an individual employee terminated upon his failure to make the required contribution toward the cost of his insurance (contributory plan), the termination of his employment, the termination of membership in an eligible class, the termination of the insurance for the class of employees of which he was a member, the date he entered the military, naval, or air forces of any country at war (declared or undeclared), or the termination of the master policy (subject, where applicable, to conversion privileges and provisions for extended insurance coverage, without premium payment, in the case of total disability). Apart from the incontestability clause, plaintiff retained no right to cancel, or otherwise terminate, the insurance coverage under these employee group life policies within the terms for which they were written. The amount of coverage could be modified in the case of a misstatement of age by the insured. Premiums were determined by the plaintiff on an annual basis, and could be paid annually, semiannually, quarterly, monthly, or other mutually agreeable mode, but were payable, in any event, in advance by the employer.

8. Plaintiffs credit group life policies insured the lives of debtors of the group policyholder — generally, a financial institution. The amount of life insurance coverage, with respect to each insured debtor, was equal to the lesser of an amount specified or the unpaid balance of the principal of the related debt obligation at the time of the debtor’s death and the term of the coverage, in general, was coextensive with the term of the debt, which would normally vary from 6 months to 5 years. However, the policies also provided that no insurance would be granted on the life of any debtor whose indebtedness to the group policyholder was repayable over a period exceeding 60 months. The average initial term of coverage under plaintiffs credit group life was approximately 20 months. The life insurance coverage provided under these credit group life policies could be divided into two categories, depending upon the method of premium payment thereunder:

(a) Single Premium Term Insurance. The insured debtor paid, at the outset of coverage, a single premium covering the entire term of the coverage. Apart from the incontestability clause, plaintiff retained no right to cancel, or otherwise terminate, the life insurance coverage of any insured debtor subsequent to the payment of the premiums as they became due and within the following applicable grace period. However the term of coverage terminated upon the earliest of the following dates:

(i) the date (the maturity date of the related indebtedness, or the date of cancellation of the related indebtedness by a new loan or refinancing, whichever was the earlier) of expiration of the period for which the single premium payment was made on account of the insured debtor’s insurance;
(ii) if the insured debtor’s indebtedness was secured by a mortgage, the date suit was filed for foreclosure or repossession of the mortgaged property, if by judicial proceeding, or the date of repossession, if not by judicial proceeding; and
(iii) the date on which any contractual payment on the related indebtedness became in arrears for the period (2 months, for example) set out in the group policy.

(b) Monthly Premium Renewable Term Insurance. The insured debtor paid, on a monthly basis, a premium for the following month’s life insurance coverage. Apart from the incontestability clause, plaintiff retained no right to cancel, or otherwise terminate, the life insurance coverage of any insured debtor within the 1-year period for which the group policy was written. However, plaintiff did reserve the right to change on any of the following dates, the premium rate basis upon which the amounts of further premiums, including the one then due, were to be computed: (1) any policy anniversary, (2) any premium due date provided the then current premium rate basis had been in effect for at least 12 months and provided further that plaintiff notified the group policyholder at least 31 days in advance of such premium due date, and (3) whenever the terms of the policy were changed. The term of coverage terminated upon the earliest of the following dates:

(i) at the end of the month for which the last premium payment was made on account of the insured debtor’s insurance;
(ii) the date of termination of the group policy;
(iii) if the insured debtor’s indebtedness was secured by a mortgage, the date suit was filed for foreclosure or repossession of the mortgaged property, if by judicial proceeding, or the date of repossession, if not by judicial proceeding;
(iv) the date on which any contractual payment on the indebtedness became in arrears for the period (2 months, for example) set out in the group policy; and
(v) upon the premium due date if written notice that the policy would not be renewed was given the insurer by the insured on or before said due date, upon receipt of such notice by the insurer if given during the 31-day grace period following the first day of the policy month, otherwise at the end of the grace period if the premium was not paid.

9. Plaintiffs credit term life policies were similar to its ordinary term life policies, except that the term of an insured debtor’s coverage was coextensive with the term of his debt, which varied from 6 months to as much as 5 years and the amount of life insurance coverage was approximately equal to the unpaid balance of the principal of the related indebtedness. The average term of coverage under plaintiffs credit term policies was approximately 20 months. In all cases of plaintiffs credit term life policies, a single premium was paid, in advance, for the entire term of coverage. Many of plaintiffs credit term life policies combined life insurance with accident and health insurance. Plaintiff retained no right to cancel, or otherwise terminate, the life insurance coverage under its credit term life policies within the terms for which they were written; there was an incontestability clause for disability benefits.

10. During 1964, and at all times pertinent hereto, plaintiffs accident and health insurance (excluding the Federal Employees Accident and Health program and its credit disability insurance) was of four basic types: (a) individual accident and health insurance, including guaranteed renewable and noncancellable policies; (b) employee group accident and health insurance; (c) credit individual accident and health insurance; and (d) credit group accident and health insurance.

11. Plaintiffs individual noncredit accident and health insurance included short-term (1 to 3 years in duration) policies which were renewable at the option of plaintiff and which provided the usual types of accident and health monthly indemnity and hospitalization-surgical expense coverages. In addition, plaintiff issued a noncancellable disability income policy, as well as guaranteed renewable forms of disability income and hospital-surgical policies, under none of which, apart from rights reserved in incontestability clauses, could plaintiff terminate the insurance coverage prior to the insured’s reaching 65 years of age. Such coverage would terminate, however, upon the insured’s failure to pay the requisite premiums as they became due.

12. Plaintiffs employee group accident and health insurance was issued under 1-year renewable term policies. The employer could terminate the insurance coverage by failing to pay the requisite premiums as they became due. The coverage of an individual employee was terminable at his option, upon his failure to make the required contribution toward the cost of his insurance, upon his failure to remain within the class of persons eligible for coverage under the policy, upon his entry into the armed forces on full-time active duty, and upon the discontinuance of the master policy. Apart from the incontestability clause, plaintiff retained no right to cancel, or otherwise terminate, the insurance coverage under these employee group accident and health insurance policies within the 1-year terms for which they were written. Premiums were determined by the plaintiff on an annual basis; after the first policy year they could be changed on any premium due date after 31 days’ written notice to the policyholder, but not more often than once every 12 months. Premiums were payable monthly, quarterly, semi-annually, yearly, or on any other mutually agreeable mode, in advance by the employer.

13. (a) Plaintiffs credit individual accident and health insurance generally was written in combination with the life portion of its credit term life policies and provided, during the insured debtor’s total disability, monthly benefits equal to the monthly payments due under the related loan obligations. In the States of Illinois and Kansas, plaintiffs credit individual accident and health insurance was written under separate policies without being combined with credit life insurance. The term of the credit individual accident and health coverage (and the credit life coverage, if any, with which it was combined) was coextensive with the term of the related debt, which varied from 6 months to as much as 5 years. The average term of coverage was approximately 20 months. Plaintiff could not terminate its credit individual accident and health coverage (or the credit life coverage, if any, with which it was combined) during the respective policy term. In all cases, a single premium was paid, in advance, for the entire term covered by the policies.

(b) Plaintiffs credit group accident and health insurance was written in combination with the life portion of its credit group life policies and provided, during the insured debtor’s total disability, monthly benefits equal to the monthly payments due under the related loan obligations. The term of the credit group accident and health coverage (and the credit life coverage with which it was combined) was coextensive with the term of the related debt, which varied from 6 months to as much as 5 years. The average term of coverage was approximately 20 months. Plaintiff could not terminate its credit group accident and health coverage (or the credit life coverage, with which it was combined) during the respective policy terms. In some cases, a single premium was paid, in advance, for the entire term covered by the policies. In other cases, the insured debtor paid, on a monthly basis, a premium for the following month’s coverage.

Reports.

14. (a) In 1871, The National Association of Insurance Commissioners ("NAIC”), originally called the National Convention of Insurance Commissioners, was organized for the purpose of promoting uniformity among the states, increasing the efficiency of officials charged with administering the insurance laws, and protecting the interests of policy owners and their beneficiaries. All of the states have adopted a uniform blank developed by the NAIC for the insurance companies’ annual financial reports, known as the NAIC Convention Blank, or, simply, the Annual Statement. The Annual Statement is completed by the insurance company, executed by its responsible officers, and submitted to the insurance department of the state in which the company is domiciled.

(b) The NAIC also developed a zonal examination system under which a triennial examination of each insurance company is conducted by a team of examiners from various state insurance departments under the general direction of the insurance department of the home state, to review, examine, and verify the information reported in the Annual Statement. Triennial examination reports of plaintiff (officially entitled "Association Examination Report of The Central National Life Insurance Company of Omaha”) were made and submitted as of December 31, 1958, December 31, 1961, and December 31, 1964.

15. Plaintiffs 1963 and 1964 Annual Statements reflect the following items in the "Aggregate Reserve for Life Policies and Contracts” (exhibits 8, pp. 10-11), "Aggregate Reserve and Policy Claim Liability for Accident and Health Policies” (exhibits 9, pp. 11), and "Policy and Contract Claims for * * * [Life] Policies” (exhibits 11, pp. 12), adjusted to reflect reinsurance ceded as set forth (in the case of accident and health policies) in the "Accident and Health Exhibit” (schedules H, pp. 35) and (in the case of life policies) on line 26 of exhibit A of the district director’s 90-day letter of June 27, 1968:

Life Policies and Contracts (net of reinsurance) 1963 1964 Mean
1. 1941 C.S.O. Tabular Reserves $1,219,957 $1,618,421 $1,419,189
2. 1958 C.S.O. Tabular Reserves — 23,414 11,707
3. American Experience-2%%N.L.
Credit Term 1,116,183 1,036,102 1,076,142
Credit Group 144,767 288,080 216,424
4. Total Special Reserves 26,787 28,828 27,808
5. Progressive Annuity Table — 2%%NB 550 275
6. Accidental Death Benefits 9,929 12,296 11,113
7. Disability-Active Lives, Tabular 20,378 24,008 22,193
8. Disability (Group Credit Life)—
Active Lives, U.P. 54,926 248,929 151,928
9. Disability — Disabled Lives
Credit A&H(N.M.) 10,624 7,596 9,110
Ordinary Life — 4,031 2,016
10. Excess Valuation Net Premiums (Deficiency Reserves) 62,551 144,234 103,393
11. Non-deduction Deferred Fractional Premiums 7,405 8,081 7,743
Total Life Policy and Contract Reserves 2,675,548 3,442,529 3,059,041
Less: Policy Loans 64,231 94,125 79,178
Net Life Policy and Contract Reserves 2,611,317 3,348,404 2,979,863
12. Net Policy and Contract Claims 53,096 91,480 72,288
Accident & Health Policies (net of reinsurance) 1963 1964 Mean
13. Aggregate Unearned Premium Reserves
a) Individual Non-Can A&H Unearned Premium Reserve $ 10,398 $ 11,610 $ 11,004
27,505 16,918 22,212 b) Individual G-R A&H Additional Reserves
c) Other A&H Unearned Premium Reserves:
1) Employee Group -q 00 CO lO T — l
2) Ordinary Ind. Other 48,713 4^ to CO -3 rH CO t> co CO
3) Credit Individual:
a) Illinois & Kansas 65,408 74,971 70,190
b) All other states 841,747 754,792 798,269
4) Credit Group 91,310 70,322 80,816
14. PresentValueNotYet Due on Claims
a) Individual Non-Can A&H to 4^ 4* to co
b) Individual G-R A&H 2,298 Ol CO O to o
c) Ordinary Individual (Other) 57,617 34,944 46,280
d) Employee Group 9,522 6,065 7,794
e) Credit Group 28,570 36,018 32,294
f) Credit Individual:
22,279 1) Illinois & Kansas H* 05 4^ to tO f-* O Oi 05 £»-
187,002 2) All other states h-1 ÜT Ü! 05 O 05 tO 4^ tO h-1 h-4
15. Reserve for future benefits 15,634 8,609 12,122
Total Accident and Health Policy Reserves 1,408,003 1,185,390 1,296,697
16. Net Policy & Contract Claims
a) Individual Non-Can A&H 9,068 8,465 8,767
b) Other A&H 225,974 153,190 189,582

16. A description of each of plaintiffs life policy reserves set out in paragraph 15, above, is as follows:

(1) 1941 C.S.O. Tabular Reserves. These reserves were set aside to liquidate future, únaccrued death claims arising from ordinary life insurance contracts and were required by the applicable Nebraska insurance laws. The reserves were estimated or computed on the basis of the Commissioners’ 1941 Standard Ordinary Mortality Tables, with interest at the assumed rates of 2% percent and 3 percent per annum, and said mortality tables are recognized mortality tables.

(2) 1958 C.S.O. Tabular Reserves. These reserves were set aside to liquidate future, unaccrued death claims arising from ordinary life insurance contracts and were required by the applicable Nebraska insurance laws. The reserves were estimated or computed on the basis of the Commissioners’ 1958 Standard Ordinary Mortality Tables, with interest at the assumed rates of 2% percent, 3 percent, and 3% percent per annum, and said mortality tables are recognized mortality tables.

(3) American Experience - 2% Percent N.L. These reserves were set aside as required by the applicable Nebraska insurance laws, to liquidate future, unaccrued death claims arising from two different kinds of credit life insurance contracts, as follows:

(i) Credit Term Life Insurance. The maximum total death benefits payable under plaintiffs credit term life policies at any given time were substantially equal to the total unpaid portions of the related debt obligations. Where the related debt was repayable in installments, and thus decreased ratably over its life, the amount of credit term life coverage correspondingly decreased over the life of the related debt. Each of these policies required, by its terms, that plaintiff maintain a life insurance reserve computed in accordance with one of the following recognized mortality tables:
American Experience Table of Mortality, with 3 percent interest per annum;
Commissioners’ 1941 Standard Ordinary Mortality Table, with 3 percent interst per annum;
Commissioners’ 1958 Standard Ordinary Mortality Table, with 3 percent interest per annum.
Plaintiff utilized the unearned premium method of computing these reserves. Concerning the unearned premium method of computing these reserves:
(a) the reserves thus computed were not less than the reserves which would be computed on the basis of the above mortality tables;
(b) the unearned premium method of computing these reserves was acceptable to the State of Nebraska; and
(c) an example of the unearned premium computation in the case of plaintiffs credit term life premiums, which were paid in advance for the entire term (approximately 2 years on the average) of coverage, is as follows: a premium paid on July 1, 1964, to cover a 1-year monthly installment debt would be 57/78 earned at the end of 1964 and plaintiff would set aside the remaining 21/78 as part of its reserve to satisfy future, unaccrued death claims arising out of its credit term life contracts.
(ii) Credit Group Life Insurance. Under plaintiffs credit group life insurance policies (which were issued to finance companies and related lending institutions), the life coverage provided was similar to that provided under plaintiffs credit term life policies discussed above. Each of these group life policies required, by its terms, that plaintiff maintain a life insurance reserve computed in accordance with one of the following recognized mortality tables:
American Experience Table of Mortality, with 3 percent interest per annum;
Commissioners’ 1941 Standard Ordinary Mortality Table, with 3 percent interest per annum;
Commissioners’ 1958 Standard Ordinary Mortality Table, with 3 percent interest per annum.
Plaintiff utilized the unearned premium method of computing these reserves. Concerning the unearned premium method of computing these reserves:
(a) the reserves thus computed were not less than the reserves which would be computed on the basis of the above mortality tables;
(b) the unearned premium method of computing these reserves was acceptable to the State of Nebraska; and
(c) an example of the unearned premium computation in the case of plaintiffs single premium credit group life policies is as follows: a premium paid on July 1, 1964, on the single premium basis to cover a 1-year related debt would be 57/78 earned at year-end and plaintiff would set aside the remaining 21/78 as part of its unearned premium reserve to satisfy future, unac-crued death claims arising out of its credit group life insurance contracts.'

(4) Total Special Reserves. These reserves were set aside by plaintiff, as required by applicable Nebraska insurance laws, to satisfy future, unaccrued claims arising from a number of its ordinary life insurance policies with respect to the following special mortality and morbidity risks covered thereunder:

(i) Substandard Extra. This reserve was held, in the approximate amount of $23,262 on December 31, 1963, and in the approximate amount of $21,774 on December 31, 1964, to meet the additional mortality risks incurred by plaintiffs issuance of ordinary life policies covering the lives of persons unable to satisfy the normal medical examination, and related insurability, requirements. The amount of this reserve was computed by applying factors to the portion of the ordinary life policy premium received with respect to this "substandard extra” feature which were determined by plaintiffs underwriting department to be appropriate for said feature. In addition to this reserve, plaintiff also maintained the tabular mortality reserve required by the terms of the ordinary life policy in question.
(ii) Juvenile Payor Benefit. This reserve was held, in the approximate amount of $1,240 on December 31,1963, and in the approximate amount of $1,160 on December 31, 1964, with respect to certain ordinary life insurance policies issued by plaintiff covering the lives of minors, the insurance premiums on which were being paid by an adult. This reserve was set aside in an amount sufficient to pay all of the remaining premiums on each of the respective minor’s life insurance policies in the event of the related adult’s death, or total disability. The amount of this reserve was computed by applying factors to the portion of the ordinary life policy premium received with respect to this "juvenile payor benefit” feature which were determined by plaintiffs underwriting department to be appropriate for said feature. In addition to this reserve, plaintiff also maintained the tabular mortality reserve required by the terms of the ordinary life policy on the life of the minor insured in question.
(iii) Group Conversion Reserve. This reserve was held, in the approximate amount of $2,055 on December 31, 1963, and in the amount of $1,727 on December 31, 1964, to meet the additional mortality risk incurred by plaintiffs issuance of ordinary life policies covering the lives of persons exercising the option contained in plaintiffs group life policies to convert such coverage to ordinary life coverage without submitting to a medical examination or producing other proof of insurability. The amount of this reserve was computed on the basis of factors in general use in the life insurance industry for such mortality risk.
(iv) Life Insurance Purchase Option Agreement. This reserve was held, in the approximate amount of $2,271 on December 31,1963, and in the approximate amount of $2,126 on December 31, 1964, to meet the additional mortality risk incurred by plaintiffs issuance of additional amounts of ordinary life coverage to persons exercising the option contained in a number of plaintiffs ordinary life policies to increase the amount of ordinary life insurance coverage thereunder, subject to the conditions set forth in said policies, without submitting to a medical examination or producing other proof of insura-bility. The amount of this reserve was computed by applying factors to the portion of the ordinary life policy premiums received with respect to this "option” feature which were determined by plaintiffs underwriting department to be appropriate for said feature.

(5) Progressive Annuity Table - 2% Percent NB. This reserve was set aside by plaintiff, as required by Nebraska insurance laws, to satisfy future, unaccrued annuity benefits arising out of plaintiffs annuity contracts. The reserve was computed on the basis of the Progressive Annuity Table, with interest assumed at the rate of 21/ percent per annum, and said table is a recognized mortality table.

(6) Accidental Death Benefits. A small number of plaintiffs ordinary life policies incorporated additional death benefits in the event of an accidental death. This reserve was set aside by plaintiff, as required by applicable Nebraska insurance laws, to satisfy the future, unaccrued accidental death benefits arising out of the above ordinary life policies. The reserve was computed on the basis of the Inter-Company Double Indemnity Mortality Table, combined with the Commissioners 1941 Standard Ordinary Mortality Table, with interest assumed at the rates of 2% percent, and 3 percent, per annum, and said tables are recognized mortality tables.

(7) Disability-Active Lives, Tabular. These reserves were set aside by plaintiff, in accordance with applicable Nebraska insurance laws, to satisfy plaintiffs future, unaccrued liability, arising out of disability riders to certain of its ordinary life policies, to pay monthly benefits and to pay (or waive) subsequent premiums on the related life policies as long as the total disability continued with respect to insureds whose total disabilities were unknown to plaintiff at the end of the calendar year. These reserves were based upon plaintiffs estimate of the number of "active” insureds who would become totally disabled during the term of the outstanding coverage and were computed on the basis of the following three mortality and morbidity tables, and rates of interest:

The 165% Class (3) Disability Table (1926) and the Commissioners’ 1941 Standard Ordinary Mortality Table, with 3 percent interest per annum;
The 150% Class (3) Disability Table (1926) and the Commissioners’ 1941 Standard Ordinary Mortality Table, with 3 percent interest per annum;
The 150% Class (3) Disability Table (1926) and the Commissioners’ 1941 Standard Ordinary Mortality Table, with 2% percent interest per annum.

Each of the above tables is a recognized mortality or morbidity table.

(8) Disability (Group Credit Life)-Active Lives, U.P. These reserves were set aside, in accordance with applicable Nebraska insurance laws, to satisfy plaintiffs future, unaccrued liability, arising out of disability riders to certain of its group credit life policies, to pay all of the installments due on the related debt obligations with respect to insureds whose total disabilities were unknown to plaintiff at the end of the calendar year, such payments to continue throughout the term of coverage, so long as the total disabilities persisted. Plaintiff utilized the unearned premium method of computing these reserves by applying the appropriate unearned premium factors to the portion of the premiums received with respect to this disability benefit feature of plaintiffs group credit life policies. The unearned premium method of computing these reserves was acceptable to the Insurance Department of the State of Nebraska.

(9) Disability-Disabled Lives. These reserves can be subdivided into two classes:

(a) Credit A&H (N.M.). This portion of thej above reserve was set aside by plaintiff, in accordance with applicable Nebraska insurance laws, to satisfy plaintiffs liabilities, arising out of certain individual credit accident and health policies issued in New Mexico which required plaintiff to pay all of the installments due on the related debt obligations with respect to insureds whose total disabilities were known to plaintiff at the end of the calendar year, such payments to continue throughout the term of coverage so long as the total disabilities persisted.
The amounts of this portion of the above reserve for the years 1963 and 1964 were as follows:
12/31/63 - $10,624
12/31/64 - 7,596
but these amounts, together with the amounts of the Disability-Active Lives reserves with respect to such New Mexico credit accident and health policies, should properly be considered as part of the accident and health insurance reserves referred to in paragraph 15, above. The above amounts were computed on the basis of the 165% Class (3) Disability Table (1926) and the Commissioners’ 1941 Standard Ordinary Mortality Table, with interest at the rate of 2 percent per annum, and said tables are recognized mortality or morbidity tables.
(b) Ordinary Life. This portion of the above reserve was set aside by plaintiff, in accordance with applicable Nebraska insurance laws, to satisfy plaintiffs liabilities to pay (or waive) all premiums on its ordinary life policies due thereafter as long as the total disability continued with respect to insureds whose total disabilities were known to plaintiff to have been in existence for not less than 6 months as of the end of the calendar year. The amounts of this portion of the above reserve for the years 1963 and 1964 were as follows:
12/31/63 -
12/31/64 - $4,031
The above amounts were computed on the basis of the Class (3) Disability Table (1926) and the Commissioners’ 1941 Standard Ordinary Mortality Table, with interest at the rate of 2 percent per annum, and said tables are recognized mortality or morbidity tables.

(10) Excess Valuation Net Premiums (Deficiency Reserves). The present value of the amount by which gross premiums to be received are less than the net premiums used to calculate the regular life insurance reserves.

(11) Nondeduction Deferred Fractional Premiums. This reserve was set aside by plaintiff, as required by applicable Nebraska insurance laws, to satisfy future, unaccrued death benefits arising from ordinary life insurance contracts. The future, unaccrued death benefits in question consisted of the deferred premiums which would be outstanding with respect to life policies whose premiums were paid in installments at the time of the death of insureds under plaintiffs ordinary life policies, which premiums plaintiff was obligated to waive. This reserve was computed on the basis of $3.20 per $100 of deferred premiums outstanding on ordinary life policies at year-end, a basis which was in general use in the life insurance industry for computing such reserve.

17. A description of each of the accident and health insurance reserves referred to in paragraph 15 is as follows:

(No. 13) Aggregate Unearned Premium Reserves. These reserves can be subdivided into three classes:

(a) Individual Non-Can A&H Unearned Premium Reserve. Plaintiff issued a number of individual noncancel-lable accident and health insurance policies. Under these policies plaintiff was under an obligation to renew or continue the insurance coverage at a specified premium until the insured reached age 65. In connection with these policies, plaintiff set aside this reserve to satisfy its future, unaccrued liability to pay weekly indemnity benefits to such of the insureds under these policies as might become disabled after year-end. The amount of this reserve was determined under the unearned premium method of computation.
Ob) Individual G-R A&H Additional Reserves. Plaintiff issued a number of individual guaranteed renewable accident and health insurance policies which plaintiff reserved no right to cancel prior to the insured’s reaching 65 years of age, but under whose terms plaintiff reserved the right to adjust premium rates by classes in accordance with its experience with such policies. Plaintiff set aside this reserve to satisfy its future, unaccrued liability to pay indemnity benefits to such of the persons insured under these policies as might become disabled after year-end. The amount of this reserve was determined on the basis of the Conference Modification of the Class (3) Disability Table (1926), combined with the Commissioners’ 1941 Standard Ordinary Mortality Table, with interest assumed at the rate of 2% percent per annum, and said tables are recognized mortality or morbidity tables.
(c) Other A&H Unearned Premium Reserves. These reserves were set aside by plaintiff to satisfy its future, unaccrued liability to pay indemnity benefits to insureds becoming disabled within the term of coverage under its accident and health policies, other than its individual noncancellable and guaranteed renewable accident and health policies, and under the accident and health programs incorporated in its credit term, and credit group, life policies. These reserves were determined under the unearned premium method of computation.

(No. 14) Present Value Not Yet Due on Claims. These reserves can be subdivided into two classes:

(a) & (b) Individual Non-Can and G-R A&H. At year-end plaintiff estimated the number of insureds under its individual noncancellable and guaranteed renewable accident and health insurance policies who were presently disabled (whether or not such disabilities in fact had been reported to plaintiff). Plaintiff set aside these reserves to meet its liability to pay the above disabled insureds’ future indemnity benefits as a result of the disabilities incurred at year-end. The amounts of these reserves were estimated by plaintiff based upon plaintiffs past experience with such liabilities.
(c) — (f) Other A&H. In connection with its accident and health policies, other than its individual noncancellable and guaranteed renewable policies, and in connection with the accident and health programs incorporated in its credit term life policies, plaintiff also set aside reserves at year-end to pay future indemnity benefits to insureds disabled (whether or not the disabilities had been reported to plaintiff) at year-end. The amounts of these reserves were estimated by plaintiff based upon plaintiffs past experience with such liabilities.

(No. 15) Reserve for Future Benefits. This reserve was set aside by plaintiff at year-end to pay future, unaccrued, maternity benefits with respect to insured pregnancies occurring prior to year-end. The amount of this reserve was computed by plaintiff on the basis of the 1956 Inter-company Hospital Table combined with the Commissioners’ 1941 Standard Ordinary Mortality Table, with interest assumed at the rate of 2!4 percent per annum, and these tables are recognized mortality or morbidity tables.

18. The life, and the accident and health, net policy and contract claims referred to in paragraph 15 (items 12 and 16) both consist of:

(a) Claims in course of settlement, representing an estimate of plaintiffs liabilities for life, or accident and health claims (resisted and unresisted) reported prior to, but not paid as of, year-end.
(b) Claims incurred but not reported, representing an estimate of plaintiffs liabilities with respect to deaths, accidents, or sickness occurring prior to, but not reported to plaintiff as of, year-end.

19. As reported in its 1964 Annual Statement (exhibit 1, p. 7, and schedule H) and its amended 1964 federal income tax return (schedule 11), plaintiffs premium income for the taxable year 1964 was derived from the following kinds of insurance:

Tax Controversy.

20. In its tax returns for the years 1963 and 1964, plaintiff reported as life insurance reserves, and unearned premiums and unpaid losses on noncancellable life, health or accident policies not included in life insurance reserves, for purposes of the 50 percent reserve ratio test of section 801(a), the reserves (less reinsurance ceded) listed in lines 1 through 12 in paragraph 15 of this stipulation, with the following adjustments:

Additions — To the amounts shown in lines 1-12, plaintiff added the following reserves:
(a) Group Contingency Reserve (Missouri mass hazard) in the amount of $107,386 in both 1963 and 1964;
(b) the Aggregate Unearned Premium Reserves on Individual Non-Can A&H shown on line 13(a) in the amounts of $10,398 in 1963 and $11,610 in 1964;
(c) the Aggregate Unearned Premium Reserves on Individual G-R A&H shown on line 13(b) in the amounts of $27,505 in 1963 and $16,918 in 1964;
(d) the Present Value Not Yet Due on Claims on Individual Non-Can A&H shown on line 14(a) in the amount of $429 in 1964;
(e) the Present Value Not Yet Due on Claims on Individual G-R A&H shown on line 14(b) in the amounts of $2,298 in 1963 and $2,020 in 1964; and
(f) the Net Policy & Contract Claims on Individual Non-Can A&H shown on line 16(a) in the amounts of $9,068 in 1963 and $8,465 in 1964.
Reductions — These amounts were eliminated from life reserves:
(a) The Excess Valuation Net Premiums (Deficiency Reserves) shown on line 10 in the amounts of $62,551 in 1963 and $144,234 in 1964; and
(b) the Policy Loans netted out in line 11 in the amounts of $64,231 for 1963 and $94,125 for 1964.

21. The Internal Revenue Service determined that plaintiffs life insurance reserves constituted only 32.19 percent of its total reserves for 1964 by reclassifying as nonlife insurance reserves, under sections 801(c)(2) and 801(c)(3), the following reserves reported by plaintiff as life insurance reserves on its tax returns:

(a) The Group Contingency Reserve (Missouri mass hazard) in the amounts of $107,386 in 1963 and 1964;
(b) the American Experience — 21/ Percent N.L. (actually, unearned premium) reserve shown on line 3 in the amounts of $1,116,183 and $144,767 for 1963, and $1,036,102 and $288,080 for 1964;
(c) the Disability (Group Credit Life) — Active Lives, U.P. reserve shown on line 8 in the amounts of $54,926 for 1963 and $248,929 for 1964;
(d) the Disability — Disabled Lives reserves shown on line 9 in the amounts of $10,624 for 1963 and $7,596 and $4,031 for 1964; and
(e) the Net Policy & Contract Claims shown on line 12 in the amounts of $53,096 for 1963 and $91,480 for 1964.

22. On September 6, 1966, plaintiff timely filed an amended federal income tax return for the calendar year 1964 with the District Director of Internal Revenue, Omaha, Nebraska (hereinafter "district director”), showing no tax due, having computed its taxable income (a loss from operations in the amount of $65,951.90) for said year as a life insurance company according to sections 801 et seq. of the code.

23. On June 27,1968, the district director sent plaintiff a statutory notice of deficiency (a so-called "90-day letter”), pursuant to section 6212 of the code, asserting an income tax deficiency for the taxable year 1964 in the amount of $9,063.26, as well as deficiencies for the taxable years 1958, 1959, and 1960, not here in issue. The deficiencies for the taxable years 1958, 1959, 1960, and 1964 were based entirely on the following determination set forth in the 90-day letter:

* * * you do not qualify as a life insurance company as defined in section 801(a) of the Internal Revenue Code for 1954, therefore, the tax liability may not be computed under section 802 * * *.

The above determination was based upon the contention that plaintiffs life insurance reserves, plus unearned premiums and unpaid loss reserves on noncancellable life, health and accident policies, did not comprise more than 50 percent of its total reserves. As a consequence of the above determination that plaintiff did not constitute a life insurance company for the year 1964, plaintiffs 1964 income tax liability was computed in the 90-day letter as if plaintiff were taxable as a nonlife insurance company under sections 831 et seq. of the code.

24. On November 26, 1968, plaintiff paid the district director the total amount of the deficiency asserted for the calendar year 1964 in the aggregate amount of $9,063.26, plus statutory interest alleged to be due thereon in the amount of $1,889.25, a total of $10,952.51.

25. On January 10, 1969, plaintiff filed with the district director a claim for refund of the income taxes in the amount of $9,063.26, and interest in the amount of $1,889.25, paid on November 26, 1968, with respect to calendar year 1964. As the basis for its claim, plaintiff stated:

This Claim for Refund should be allowed for the reason that The Central National Life Insurance Company of Omaha was, throughout calendar year 1964 and at all times pertinent to the present Claim for Refund, a life insurance company under § 801 of the Internal Revenue Code of 1954, as amended, and was, at all such times, entitled to have its Federal income tax computed under § 802 of the Internal Revenue Code of 1954, as amended.

26. Subsequently, under date of May 21, 1969, the district director sent a notice on Form RSC-105 (Rev. 10-68) to plaintiff by certified mail, which notice disallowed in full plaintiffs claim for refund of the income taxes in the amount of $9,063.26, and interest in the amount of $1,889.25, paid on November 26, 1968, with respect to calendar year 1964.

ADDITIONAL FINDINGS NOT STIPULATED

27. A life insurance reserve is the excess, at any given date, of the present value of future liabilities over the present value of future net premiums with respect to insurance in force, both of which are determined according to appropriate mortality tables and assumed rates of interest. Insurance reserves are established with respect to policies currently in force for the purpose of paying claims that have not yet been incurred. Life insurance reserves also may be viewed as the accumulation of net premiums at interest in excess of death claims assumed to have been paid out.

28. A life insurance reserve has two fundamental components: First, the portion (the unearned premium), on a net basis, of the amount of valuation premium collected on the last anniversary date to cover a period which has not expired on the valuation date; second, another portion (the additional reserve) which represents an accumulation from the date the policy was issued through the valuation date of portions of premium excesses paid in early years, increased by assumed interest and reduced by tabular claims assumed paid during the interim, for the purpose of meeting premium deficits in later years. These components are not separately stated in exhibit 8 of the Annual Statement with respect to life insurance reserves.

29. The mortality tables which may be used in determining a life insurance reserve are subject to minimum standards imposed by state statutes and the rules and regulations of state insurance departments; the maximum interest rates which may be used also are governed by state statutes and regulatory authorities. Insurance departments of the various states require life insurance companies to file Annual Statements on or before March 1 of each year for the immediately preceding calendar year. Life insurance companies also are required to file their federal income tax returns on the basis of the calendar year. Thus, December 31 is referred to as the "valuation date.”

30. An insurance company has a choice of methods in determining its life insurance reserves provided that it follows the guidelines of the state statutes, rules, and regulations setting the minimum standards as to the selection of tables and maximum, interest rates. Even utilizing the minimum mortality tables specified in the standard valuation law with regard to ordinary life insurance, it is possible to arrive at 45 different amounts of reserves by varying the interest rates and utilizing three different reserving methods. Moreover, there are an infinite number of reserving methods that could be utilized to arrive at different results.

31. Life insurance companies, such as plaintiff, are required to report their aggregate life insurance reserves in exhibit 8 of the Annual Statement. That exhibit is divided into various sections wherein the life insurance company is required to report the reserves held with respect to its various life insurance and annuity coverages and with respect to certain additional benefits (including certain disability benefits) which are written as part of, or in conjunction with, life insurance coverages. The reserves reported in exhibit 8 of the Annual Statement have in common the fact that they all involve probabilities, either mortality or morbidity, and interest discount factors.

32. Liability for life insurance claims which are outstanding or which have accrued as of the valuation date, including estimates of claims which have accrued but have not been reported to the company as of such date, are reported in exhibit 11 of the Annual Statement. Unlike the life insurance reserves reported in exhibit 8 of the Annual Statement, the amounts reported in exhibit 11 involve no probabilities or interest discount factors, but are fully accrued and payable as of the valuation date.

33. Reserves for accident and health insurance, benefits that are issued separately from life coverages, are reported on exhibit 9 of the Annual Statement. Exhibit 9 is divided into two parts: Part 1 sets forth reserves representing future unaccrued liabilities, and part 2, in general, sets forth claims that have become fully accrued and payable as of the valuation date. Part 1 of exhibit 9 involves probabilities based on morbidity tables and interest discount factors relative to accident and health reserves, and reserves there reported are comparable, in general, to life insurance reserves reported in exhibit 8. Part 2 of exhibit 9 has no counterpart in exhibit 8, but is analogous to the liabilities for fully accrued and payable claims on life insurance policies as reported in exhibit 11 of the Annual Statement.

34. Part 1 of exhibit 9 has two divisions that permit the "unearned premium” component and the "additional reserve” component to be reported separately. Line 1 of part 1 of exhibit 9 sets forth the unearned premium reserve on a gross basis that includes both a loading element and a morbidity element. Cancellable accident and health policies have only the gross unearned premium reserve reported on line 1. Line 2 of part 1 of exhibit 9 sets forth the additional reserve for level premium, guaranteed renewable accident and health policies. This reserve provides for an accumulation of premiums that are in excess of those required on a net basis in the early years of coverage, where the accumulation is held for premium deficits in the later years. The reserve reported on line 2 of part 1 is exactly comparable to the additional reserve component of a life insurance reserve. The additional reserve component reported on line 2 of part 1 takes into account the increase in mortality or morbidity risk over the term of the policy when the premium remains level.

35. An ordinary life insurance contract is generally understood to mean a policy, other than policies sold on an industrial or debit premium basis, sold to an individual covering his life. The term ordinary life originally applied only to policies in which premiums were paid throughout the lifetime of the insured. The term has been broadened in use to include limited payment life and term policies.

36. In 1964, reserves with respect to credit individual life insurance would be reported in exhibit 8 of the Annual Statement under the column titled "Ordinary.” Subsequently, a separate category was established in the Annual Statement for credit life reserves.

37. There is no rationale for excluding credit insurance from the definition of ordinary insurance, nor are there any significant conceptual differences between an individual credit life insurance policy and an individual term insurance policy which is clearly within the category of "ordinary insurance.”

38. At least since 1957 plaintiff used the gross unearned premium method to compute reserves for its credit life policies. At the time plaintiff started to compute reserves on this method, the only type of life insurance plaintiff wrote was credit life insurance. During the years 1963 and 1964, although plaintiff had the statistical detail required to compute mortality reserves on computer cards and tapes, it did not have a computer program which would have enabled it to calculate reserves with respect to its credit life policies on the basis of mortality tables. It was more convenient and economical for plaintiff to apply the computer program that was maintained by associated companies that were writing casualty insurance. These companies computed the gross unearned premium reserve through the Rule of 78 formula. Use of the unearned premium method produced reserves which approximated those which would have been produced through the use of the mortality tables.

39. On January 11, 1963, the Insurance Department of the State of Illinois, in which state plaintiff wrote a small portion of its credit life insurance, issued a letter directed to "All Insurance Companies Writing Credit Life Insurance” in Illinois that permitted reserves on credit life business to be established on the basis of 130 percent of the appropriate mortality table. There is no evidence that the method plaintiff used to compute its gross unearned premium reserves for 1963 and 1964 included computations that were based upon 130 percent of the appropriate mortality table. Additional states, including Virginia, have adopted provisions that permit reserves for credit life insurance be maintained on the basis of 130 percent of mortality factors.

40. In 1968, plaintiff obtained from Fidelity Bankers Life Insurance Company (a Company which became affiliated with plaintiff in 1967) the computer program which Fidelity was using to calculate mortality reserves on credit life, accident and health, and disability insurance. This computer program was used by plaintiff to apply actuarial formulae to raw data concerning its own policies (which data was placed on computer cards in 1963 and 1964 in generating plaintiffs Annual Statements). Plaintiffs access to the computer program enabled it to calculate reserves for 1964 based upon the American Experience, the 1941 Commissioners’ Standard Ordinary, and the 1958 Commissioners’ Standard Ordinary tables of mortality. Built into the program was the 130 percent tabular mortality factor.

41. Plaintiffs comparison of tabular mortality reserves and unearned premium reserves on policies of individual term and group credit life insurance in force as of December 31, 1963, and December 31, 1964, which were issued subsequent to December 31, 1959, is as follows:

1963

Computer Runs Tabular Mortality Reserves Unearned Premium Reserves

Decreasing term policies:

1 — C.S.O. 1941 $852,483.57 $1,277,627.34

2 — C.S.O. 1958 8,029.37 16,786.37

Level term policies:

3 — C.S.O. 1941 89,019.28 119,606.50

4 — C.S.O. 1958 725.19 1,261.55

Total (1963) $950,257.41 $1,415,281.76

1964

Computer Runs Tabular Unearned Mortality Premium Reserves Reserves

Decreasing term policies:

5 — C.S.O. 1941 $899,905.64 $1,227,845.08

6 — C.S.O. 1958 6,578.72 11,247.05

7 — American Experience 1,490.24 1,477.79

Level term policies:

8 — C.S.O. 1941 35,155.46 37,893.28

9 - C.S.O. 1958 1,258.09 2,127.90

10 — American Experience 565.12 612.42

Total (1964) $944,953.27 $1,281,203.52

CONCLUSION OF LAW

Upon the trial judge’s findings of fact and foregoing opinion, which are adopted by the court, the court concludes as a matter of law that plaintiff, for its taxable year 1964, qualifies as a life insurance company and is taxable under section 802 of the Internal Revenue Code of 1954, as amended, and judgment is entered to that effect. The amount of recovery is reserved for further proceedings under Rule 131(c).

In accordance with the opinion of the court, a stipulation of the parties and a memorandum report of the trial judge as to the amount due thereunder, it was ordered on July 7, 1978 that judgment for plaintiff be entered for $9,063.26 in tax principal and $1,889.25 in assessed interest, together with interest according to law. 
      
       The trial judge’s recommended decision and conclusion of law are submitted in accordance with Rule 134(h).
     
      
       The Internal Revenue Code of 1954, as amended, defines a life insurance company as follows:
      "§ 801. Definition of life insurance company.
      "(a) Life insurance company defined.
      "For purposes of this subtitle, the term 'life insurance company’ means an insurance company which is engaged in the business of issuing life insurance and annuity contracts (either separately or combined with health and accident insurance), or noncaneellable contracts of health and accident insurance, if—
      "(1) its life insurance reserves (as defined in subsection ft))), plus
      "(2) unearned premiums, and unpaid losses (whether or not ascertained), on noncaneellable life, health, or accident policies not included in life insurance reserves,
      comprise more than 50 percent of its total reserves (as defined in subsection (c)).”
     
      
       Plaintiffs total premium income from life insurance was $2,988,119, of which 62 percent, or $1,855,403, was derived from credit life policies; accident and health insurance premium income was $1,314,404, of which 55 percent, or $723,046, was derived from credit A&H policies.
     
      
      
        Alinco Life Ins. Co. v. United States, 178 Ct. Cl. 813, 373 F.2d 336 (1967).
     
      
      
        Id. at 839, 875, 373 F.2d at 351.
     
      
       The June 27, 1968, statutory notice of deficiency (26 U.S.C. § 6212) asserted a deficiency of $486,862.39 for 1958, a deficiency of $161,625.25 for 1959, and a deficiency of $187,976.10 for 1960, in addition to the deficiency for 1964, at issue in this case. All deficiencies were based on determinations that plaintiff did not qualify as a life insurance company in the relevant years.
     
      
       Plaintiffs 1963-64 Annual Statements included 16 categories of reserves; two life policy reserves and seven accident and health policy reserves are in dispute, as follows:
      Credit life policies: Mortality reserves (mean amount $1,292,566) and disability benefits - active lives (mean amount $151,928).
      Accident and health policies: Morbidity reserves, credit policies (mean amount $949,275); morbidity reserves, cancellable policies (mean amount $41,315); disability benefits - disabled lives, credit policies (mean amount $213,432); group contingency (Missouri mass hazard, mean amount $107,386).
      Policy and contract claims: Noncancellable A&H (mean amount $8,767); cancellable A&H (mean amount $189,582).
     
      
       Total reserves for 1964 result in a denominator of $4,478,902; credit life reserves at $1,292,566, when combined with $1,467,222 in reserves not in dispute, would make the numerator $2,759,788, or 61.6 percent; and even without a downward adjustment in the denominator, credit life reserves at $911,010 (plaintiffs computation at 130 percent of tabular) would make the numerator $2,378,232, or 53 percent.
     
      
       Plaintiff was authorized to write the following types of insurance as described in subsections (2) and (3) of § 44-201, Reissue, NEB. REV. STAT.:
      "(2) LIFE INSURANCE — Upon lives of persons, including endowments and annuities, and every insurance pertaining thereto and disability benefits;
      "(3) SICKNESS AND ACCIDENT INSURANCE — Against loss or expense resulting from the sickness of the insured, or from bodily injury or death of the insured by accident, or both, and every insurance pertaining thereto, including quarantine.”
     
      
       Under the Rule of 78 or "sum-of-the-digits” method, the unearned premium is computed by applying changing fractions each year (or month) to the premium paid by the insured. The numerator of the fraction changes each year (or month) to a number which corresponds to the sum of the digits of the remaining unexpired term of the policy, and the denominator, which remains constant, is the sum of all the years’ (or months’) digits corresponding to the entire term of insurance coverage. For plaintiffs credit term life premiums which were paid in advance for the entire term (approximately 2 years on the average) of coverage, the unearned premium computation was as follows: A premium paid on July 1, 1964, to cover a 1-year monthly installment debt would be 57/78 earned at the end of 1964 and plaintiff would set aside the remaining 21/78 as part of its reserve to satisfy future unaccrued death claims arising out of its credit term life contracts.
     
      
       In 1963, plaintiffs life insurance premiums from Illinois business was approximately 5.4 percent of plaintiffs total business, less reinsurance ceded.
     
      
       The letter with respect to credit life reserves stated in part:
      "The reserve for outstanding balance, level term advance premium and decreasing term advance premium plans of credit life insurance shall be computed on the basis of the appropriate mortality table except that the reserve for credit life insurance written on the decreasing term advance premium plan shall amount to 130% of the amount thus computed on the basis of the appropriate mortality table.
      "Companies shall maintain separate records for each of its foregoing plans of credit life insurance written by them and the reserves for each plan shall be separately computed. In the event such segregation of business is not accurately maintained, the reserve for all credit life insurance written by any company shall be computed on the basis of 130% of the appropriate mortality table.”
     
      
       In fact, plaintiff had been computing its credit life reserves on the gross unearned premium basis since at least 1957.
     
      
       At trial, plaintiff did not establish that the computer program, as it is currently being used, is identical in application for the year in suit; or that the information available for verification with regard to current years is the same as that for the year in suit.
     
      
       Currently, tax provisions relating to insurance companies are in subchapter L of the code: life insurance companies, 26 U.S.C. §§ 801-20; mutual insurance companies, 26 U.S.C. §§ 821-26; and other insurance companies, 26 U.S.C. §§ 831-32.
     
      
       A concise summary of the development of life insurance company income taxation in the 1921 and the 1942 Revenue Acts is set forth in Alinco Life Ins. Co. v. United States, supra note 3, 178 Ct. Cl. at 831-36, 373 F.2d at 345-49. See also Commissioner v. Monarch Life Ins. Co., 114 F.2d 314, 319-25 (1st Cir. 1940).
     
      
       From 1921 through 1957, life insurance companies were completely exempt from tax on their underwriting income, and currently may defer half of their underwriting income. See 26 U.S.C. § 802(b)(2); Economy Fin. Corp. v. United States, 501 F.2d 466, 475-77 (7th Cir. 1974), cert. denied, 420 U.S. 947, rehearing denied, 421 U.S. 922 (1975).
      The relationship of underwriting income and investment income in life companies and casualty companies was described in Economy Finance as follows:
      "There are two possible sources of income for life insurance companies, from underwriting and from investment. Underwriting income is derived from the excess of gross premiums over expenses and mortality experience. Investment income is derived from the opportunity to invest the long term policy reserve. When the gross premium is calculated, the interest factor at which the policy reserve is required by the regulatory authority to be maintained is employed. This factor is less than normal investments generally return. The company looks at this differential as a source of income.
      “For insurance companies other than life, no such long term reserve is required, because the probability of the occurrence of the event insured against remains constant over time; no residual benefit (e.g., death benefit, annuity) is contracted for. Once the promised protection has been granted, the premium is fully earned. [Footnote omitted.] Thus, when the gross premium is calculated, the short term opportunity to invest unearned premium reserves is not considered significant. Consequently, underwriting income is the primary source of income. * * *” Id. at 474.
     
      
       Revenue Act of 1921, ch. 136, § 242, 42 Stat. 261.
     
      
      
        See Penn Sec. Life Ins. Co. v. United States, 207 Ct. Cl. 594, 600-01, 524 F.2d 1155, 1158 (1975), aff'd, 430 U.S. 725 (1977).
     
      
       See Commissioner v. Monarch Life Ins. Co., supra note 15, 114 F.2d at 320-23; Alinco Life Ins. Co. v. United States, supra note 3, 178 Ct. Cl. at 835, 373 F.2d at 348.
     
      
      
        Alinco Life Ins. Co. v. United States, supra note 3, 178 Ct. Cl. at 833-35, 373 F.2d at 348.
     
      
       S. REP. No. 1631, 77th Cong., 2d Sess. 145, 1942-2 C.B. 504, 612.
     
      
      
        McCoach v. Insurance Co. of North America, 244 U.S. 585, 586 (1917).
     
      
      
        Massachusetts Protective Ass’n v. United States, 114 F.2d 304, 311 (1st Cir. 1940); see also Maryland Casualty Co. v. United States, 251 U.S. 342, 350 (1920), and S. REP. No. 291, 86th Cong., 1st Sess., reprinted in [1959] U.S. CODE CONG. & AD. NEWS 1575 at 1577-78.
     
      
      
        Alinco Life Ins. Co. v. United States, supra note 3, 178 Ct. Cl. at 842, 373 F.2d at 353; Penn Sec. Life Ins. Co. v. United States, supra note 18, 207 Ct. Cl. at 598, 524 F.2d at 1156; Mutual Benefit Life Ins. Co. v. Commissioner, 488 F.2d 1101, 1102 (3d Cir.), cert. denied, 419 U.S. 882 (1974).
     
      
       26 U.S.C. § 801 provides:
      "(b) Life insurance reserves defined.
      "(1) In general.
      "For purposes 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 interests, 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 (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.
      ”(2) * * * in addition to the requirements set forth in paragraph (1), life insurance reserves must be required by law.
      "(4) Deficiency reserves excluded.
      "The term ‘life insurance reserves’ does not include deficiency reserves. * * *
      "(5) Amount of reserves.
      
        "For purposes of this subsection, subsection (a), and subsection (c), the amount of any reserve (or portion thereof) for any taxable year shall be the mean of such reserve (or portion thereof) at the beginning and end of the taxable year.”
     
      
       26 U.S.C. § 801 further provides:
      "(c) Total reserves defined.
      "For purposes of subsection (a), 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.
      "The term 'total reserves’ does not include deficiency reserves (within the meaning of subsection (b)(4)).”
     
      
       Plaintiff also claims the reserves qualify as life insurance reserves because (1) they were computed on a tabular basis, or (2) they constituted unearned premiums on noncancellable life policies.
     
      
      
        Alinco Life Ins. Co. v. United States, supra note 3, 178 Ct. Cl. at 841, 373 F.2d at 352.
     
      
      
        Id. at 845, 373 F.2d at 354. This dispute is an example of the ambiguous drafting in the 1942 amendments. Plaintiff contends the word "noncancellable" may apply to life policies and cites in support the structural differences in section 801. Section 801(a) refers to "noncancellable contracts of health and accident insurance”; section 801(a)(2) refers to "noncancellable life, health, or accident policies”; section 801(b)(1)(B) refers to "noncancellable health and accident insurance” contracts. Plaintiff contends that these differences "clearly indicate” that inclusion of the word "life” in "noncancellable life, health, and accident policies” was not merely an accident.
     
      
       McGILL, Life Insurance 58 (rev. ed. 1967).
     
      
       Defendant’s expert, Robert Zelten, testified that ordinary life insurance included all forms of life insurance other than industrial, group insurance, and credit insurance.
     
      
      
        Mutual Benefit Life Ins. Co. v. Commissioner, supra note 24, 488 F.2d at 1103; Principies of Life Insurance, Vol. 1 by J. GREIDER & W. BEADLES (rev. ed. 1972) at 68-71.
     
      
       Mr. Arthur Crooks Eddy, plaintiffs expert witness, testified:
      "So, theoretically and conceptually, if you are earning your premium on the basis of the sum of the digits then you are realizing the premium too rapidly to cover the risk in the latter part of the period of coverage and should reserve or save back some portion of the net premiums realized in the earlier periods to offset the inadequacy in the proportionate part of the release of the gross premium being the net premiums in the future. Therefore, conceptually you have the reserve requirement which calculated by a different manner, that is calculated using tabular factors applied to the amount of insurance on a declining balance, would give the same results as I have described by adding components 1 and 2, calculated as I have just described, also.
      "So, in the underlying reserve requirement there is a minimum on a mortality basis permitted and at an interest rate permitted would have these component parts which would become some percentage of the gross unearned premiums. And it is determined in Plaintiffs Exhibit 13 the average ratio of the net premium or the net mortality factor to the gross premium charged during that period of time was, that is, 1963 to 1964, was on the average seventy and one-half percent of the gross unearned premium.”
     
      
       NEB. REV. STAT. § 44-402 (1943).
     
      
       Minor adjustments were made by the triennial examiners to move certain health and accident reserves from exhibit 8 to part 1 of exhibit 9.
     
      
       The actual entries in exhibit 8 of the Annual Statement for 1963, with respect to the American Experience Table of Mortality, totaled $1,309,297.83, and, in 1964, the total was $1,403,865.30. These amounts have been adjusted in the stipulation to reflect reinsurance ceded, as set forth on line 26 of exhibit A of the district director’s 90-day letter of June 27,1968.
     
      
      
        General Life Ins. Co. v. Commissioner, 137 F.2d 185, 189 (5th Cir. 1943).
     
      
       Treas. Reg. § 1.801-5(a)(3) states, in part:
      "The term 'total reserves’ does not, however, include deficiency reserves (within the meaning of section 801(b)(4) and paragraph (e)(4) of § 1.801-4), even though such deficiency reserves are required by State law. In determining total reserves, a company is permitted to make use of the highest aggregate reserve required by any State or Territory or the District of Columbia in which it transacts business, but the reserve must have been actually held during the taxable year for which the reserve is claimed. * * *”
      See also Continental Ins. Co. v. United States, 200 Ct. Cl. 552, 564-65, 474 F.2d 661, 668 (1973), where the court states:
      "* * * Courts have explicitly recognized that, for federal tax purposes, state rules on reserves apply across the board to all of a company’s business, in the same way that such rules are applied by the states themselves. * * *”
     
      
       The items set out in the "Mean” column are merely the arithmetic means between the "1963” and the "1964” columns and do not appear in any of plaintiffs Annual Statements.
     
      
       The items set out in the "Mean” column are merely the arithmetic means between the "1963” and the "1964” columns and do not appear in any of plaintiffs Annual Statements.
     
      
       Numerical reference is to plaintiffs exhibit numbers.
     
      
       Numerical reference is to plaintiffs exhibit numbers.
     