Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 76-56

1976-1 C.B. 185

Section 832

IRS Headnote

Fire insurance company reserves required by state law. A percentage of gross premiums that is called "unearned premium reserves," required by a state law to be maintained on certain industrial fire insurance premiums collected and determined without regard to the unexpired terms of fire insurance policies, may not be treated as unearned premiums for purposes of section 832(b)(4) of the Code.

Full Text

Rev. Rul. 76-56

Advice has been requested whether a percentage of gross premiums that a fire insurance company is required to segregate under a state statute may be treated as unearned premiums as defined in section 832(b)(4) of the Internal Revenue Code of 1954.

The taxpayer is a stock industrial fire insurance company that is subject to the tax imposed by section 831(a)(1) of the Code. The taxpayer does business in state X and is subject to the requirements of that state applicable to industrial fire insurance. State X has a statute requiring that "unearned premium reserves" be maintained on industrial fire premiums collected during each year. The amount of such reserve for any particular year is determined by applying the fixed percentage set forth in the statute for that year to the amount of premiums in force for that year. The fixed percentage in the statute bears no relationship to the portion of premiums attributable to the unexpired terms of fire insurance company policies.

In addition to the reserve required by the state X statute, the taxpayer maintains an unearned premium reserve computed on the basis of premiums attributable to the unexpired terms of policies in force. However, because of the state X statute the taxpayer is required to maintain larger amounts in its unearned premium reserve than it would maintain if its unearned premium reserve were computed solely on the basis of premiums attributable to the unexpired terms of fire insurance company policies.

The specific question presented is whether the state X statute requiring the unearned premium reserve of industrial fire premiums in fact confers upon the amounts in such reserves all the attributes of unearned premiums for purposes of section 832(b)(4) of the Code.

Section 832(b)(4) of the Code provides, in part, that the term "premiums earned on insurance contracts during the taxable year" means an amount computed as follows:

From the amount of gross premiums written on insurance contracts during the taxable year deduct return premiums and premiums paid for reinsurance. To the result so obtained, add unearned premiums on the outstanding business at the end of the preceding taxable year and deduct unearned premiums on outstanding business at the end of the taxable year.

Although section 832(b)(4) of the Code does not define unearned premiums, in Buckeye Union Casualty Co. v. Commissioner, 448 F. 2d 228 (6th Cir. 1971), aff'g 54 T.C. 13 (1970), the United States Court of Appeals indicated that "unearned premiums" for purposes of section 832(b)(4) is generally defined to mean that portion of net premiums that the insurance company has not yet had time to earn or, more precisely, that portion of the premiums paid by the policyholder that must be returned to him on cancellation of the policy, and that is in direct proportion to the unexpired term that the policy has to run. See also Rev. Rul. 61-167, 1961-2 C.B. 130.

Exceptions to this general rule are limited to two specialized segments of the insurance industry. One of these exceptions is found in section 832(e)(1) by which Congress specifically amended section 832 to grant unearned premium status to reserves required by state law to cover mortgage guaranty insurance losses. Another exception to the general rule is illustrated in Rev. Rul. 71-598, 1971-2 C.B. 261. Prior to Rev. Rul. 71-598, the Service allowed title insurance companies no unearned premium reserves on the theory that a title insurance company's premiums are earned in full at the time title insurance services are rendered. In Rev. Rul. 71-598, the Service recognized that in the presence of properly worded state statutes requiring unearned premium reserves with respect to title insurance, an exception was warranted to the Service's position that all of a title insurance company's premiums are earned in full at the time their services are rendered. The amount of premiums reserved by state statute and recognized for purposes of section 832(b)(4) by Rev. Rul. 71-598 clearly are not in the nature of amounts reserved for catastrophic losses.

Since the taxpayer's normal unearned premiums reserve in the instant case is sufficient to protect the taxpayer's policyholders and provide for reinsurance in the event of taxpayer's liquidation, and since the amount of the statutory reserve is not computed on the basis of premiums attributable to the unexpired terms of policies in force, the amount of surplus required to be segregated under state X's statute are in the nature of reserves for catastrophic losses. In this connection Rev. Rul. 67-435, 1967-2 C.B. 232, holds that while speculative losses may be a solvency concern of the states in which an insurance company does business, these conecrns have no bearing on what part of the taxpayer's gross income ought to be treated as net income for tax purposes.

Accordingly, the state X statute requiring the segregated surplus reserve of industrial fire premiums does not in fact confer upon the amounts in such reserves all the attributes of unearned premiums, for purposes of section 832(b)(4) of the Code. Therefore, the percentage of gross premiums required by state X to be segregated from the taxpayer's surplus may not be treated as unearned premiums for purposes of section 832(b)(4).