Rev. Rul. 89-43

1989-1 C.B. 213, 1989-15 I.R.B. 12.

                       Internal Revenue Service

                                 Revenue Ruling

                       INSURANCE; LIFE INSURANCE RESERVES

                           Published: March 21, 1989

26 CFR 1.801-4, Life insurance reserves.

  Insurance; life insurance reserves. Certain reserves set aside for a level premium, guaranteed renewable, group long-term care policy that provides indemnity benefits for an impaired individual qualify as life insurance reserves under section 816(b) of the Code.

ISSUE

  If a policy provides coverage for long-term care in the event an individual becomes chronically impaired, do certain reserves set aside for the policy qualify as life insurance reserves under section 816(b) of the Internal Revenue Code?

FACTS

  IC, a life insurance company as defined in section 816(a) of the Code, issues level premium, guaranteed renewable, group long-term care policies (Policies). The Policies provide indemnity benefits for the cost of some or all of the necessary diagnostic, preventive, therapeutic, rehabilitative, and maintenance or personal care services required by an individual in the event the individual becomes chronically impaired. The Policies do not contain any nonforfeiture provisions.

  The Policies are guaranteed renewable by class, and no individual may be singled out for cancellation or a rate increase. Rate increases may be made only for all insureds belonging to a class, based upon actual and anticipated experience of the class. These adjustments may not reflect increases in morbidity risks due merely to the advancing age of insured members of the class.

  Each individual covered by the Policies is issued a certificate evidencing such coverage. Although IC may not cancel the Policies, it may end enrollment of new members at any time. If a policyholder terminates the Policies or if the plan sponsor terminates its sponsorship of the Policies in a situation where the plan sponsor is not the policyholder, IC guarantees each certificate holder the right to continue the coverage provided under the Policies without the individual providing evidence of insurability.

  If a certificate holder leaves the group covered by the Policies or otherwise terminates his or her relationship with the plan sponsor, IC guarantees that individual the right to continue the coverage provided under the Policies without providing evidence of insurability. The premiums for the continued coverage will remain level and are based on the insured individual's age at the time that individual became covered under the original Policies. These premiums may only be changed on a class basis for all covered persons in the same class as determined by IC. No premium change may be made on an individual basis. The continued coverage provides benefits as similar to those under the original Policies as allowed by state law. All time limits on certain defenses and pre- existing-condition periods run from the date of the insured individual's coverage under the original Policies.

  IC maintains an active lives reserve, in addition to the unearned premium reserve, to cover its obligation to renew the Policies at level premiums notwithstanding the increasing age of the insureds. Other reserves that IC maintains with regard to the Policies include a waiver of premium reserve, a group conversion guaranteed insurability reserve, and a disability disabled lives reserve covering the liability for losses that were incurred on or before the valuation date and that have not accrued as of the valuation date. These reserves are set aside to mature or liquidate future unaccrued claims arising out of the Policies. As morbidity experience tables for these types of Policies have not been developed, IC computes reserves other than the unearned premium reserve using either a recognized morbidity table reasonably adjusted to reflect the Policies' risks that are not otherwise taken into account or a morbidity table based on IC's experience (provided IC has adequate experience upon which to construct a reasonable table). In addition, these reserves are based on assumed interest rates and a recognized mortality table. All of the above reserves are required by law.

LAW AND ANALYSIS

  Section 816(b) of the Code defines the term 'life insurance reserves' as amounts that are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest and that are set aside to mature or liquidate, either by payment or reinsurance, future unaccrued claims arising from life insurance, annuity, and noncancellable accident and health insurance contracts (including life insurance or annuity contracts combined with noncancellable accident and health insurance) involving at the time with respect to which the reserve is computed, life, accident or health contingencies. Section 816(e) provides that guaranteed renewable life, accident, and health insurance shall be treated in the same manner as noncancellable life, accident, and health insurance policies.

  Section 1.801-4(a) of the regulations under the predecessor of section 816 of the Code defines the term 'life insurance reserves' to mean those amounts -- (1) which are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest; (2) 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; and (3) which are required by law. Because the language of section 816 is similar to that in former section 801 of the Code, the definition in section 1.801-4 provide guidance for the interpretation of the current provision. See H.R. Rep. No. 432, Part 2, 98th Cong., 2d Sess. 1401 (1984); Senate Comm. on Finance, 98th Cong., 2d Sess., Deficit Reduction Act of 1984: Explanation of the Provision Approved by the Committee on March 21, 1984, at 524 (Comm. Print 1984).

  To qualify under section 816(b) of the Code, life insurance reserves must be computed or estimated 'on the basis of recognized mortality or morbidity tables.' Although neither the Code nor the regulations define the term 'recognized mortality or morbidity tables,' the legislative history of the term provides useful guidance. The Revenue Act of 1942 substituted the term 'recognized mortality or morbidity tables' for the term 'recognized experience tables' in prior law. The Senate Finance Committee Report accompanying the Act indicates that the change was designed to expand rather than to restrict the types of morality or morbidity tables that would qualify. See S. Rep. No. 1631, 77th Cong., 2d Sess. 142 (1942), 1942-2 C.B. 510, 610. There was no intent to exclude a table that is based on a company's experience. Cf. section 807(d)(5)(C) (special rule, for contracts where standard tables are not available, requiring that the amount of life insurance reserves for purposes other than section 816 be determined using the mortality and morbidity tables specified in the regulations). See also section 1.807-1T of the temporary Income Tax Regulations (allowing adjustments to mortality and morbidity tables to reflect risks not otherwise taken into account). Accordingly, the term 'recognized mortality or morbidity tables' in section 816(b) includes a table based on an insurance company's experience (provided the company has adequate experience upon which to construct a reasonable table) or a recognized table reasonably adjusted to reflect policy risks not otherwise taken into account. Tax reserves, however, must be computed as provided in section 807.

  Rev. Rul. 70-460, 1970-2 C.B. 135, provides that the additional required reserve under guaranteed renewable health and accident contracts qualifies as a life insurance reserve within the meaning of the predecessor of section 816(b) of the Code if the reserve is computed or estimated on the basis of recognized mortality or morbidity tables and an assumed rate of interest, and is set aside to mature or liquidate unaccrued claims under such contracts.

  In Rev. Rul. 70-190, 1970-1 C.B. 150, clarified in Rev. Rul. 80-115, 1980-1 C.B. 138, an insurance company issued noncancellable policies providing life insurance benefits payable at the death of the insured combined with disability income and waiver of premium benefits. Prior to an insured becoming disabled, the company set aside a disability active lives reserve for its obligation to pay the disability income and waiver of premium benefits. When an insured became disabled and entitled to the disability income and waiver of premium benefits, the company established a disability disabled lives reserve in an amount actuarially computed to provide these benefits during the period of disability. The ruling concludes that the disability disabled lives reserve qualifies as a life insurance reserve under the predecessor of section 816(b) of the Code. Cf. section 807(e)(3) (special rules for determining the amount of life insurance reserves attributable to certain supplemental benefits, including guaranteed insurability benefits, accidental death and disability benefits, convertibility benefits, disability waiver benefits, and any other de minimis benefit prescribed by the regulations).

  An additional reserve for excess mortality under group conversion contracts was present in Rev. Rul. 77-451, 1977-2 C.B. 224. The ruling concludes that the additional reserve did not qualify as a life insurance reserve because the company had used gross premiums in computing the reserve. The reserve, therefore, was not computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest as required by the predecessor of section 816(b) of the Code. Cf. section 807(e)(3).

  IC's active lives, waiver premium, group conversion and disability disabled lives reserves under the Policies are established to liquidate 'future unaccrued claims arising from life insurance, annuity, and noncancellable accident and health insurance contracts (including life insurance or annuity contracts combined with noncancellable accident and health insurance) involving, at the time with respect to which the reserve is computed, life, accident, or health contingencies.' Section 816(b)(1)(B) of the Code. These reserves are computed or estimated on the basis of assumed rates of interest and recognized mortality or morbidity tables. The reserves also are required by law. These reserves, therefore, qualify as life insurance reserves under section 816(b) of the Code.

HOLDING

  The active lives, waiver of premiums, group conversion, and disability disabled lives reserves set aside for the Policies qualify as life insurance reserves under section 816(b) of the Code.

APPLICATION

  The above holding applies to policies issued either to an individual or to a group.

  A characterization of policies or of the insurance company's reserves for purposes of subchapter L does not characterize for federal income tax purposes the benefits received by the insureds. For example, if policies provide annuity benefits, those benefits are taxable under section 72 of the Code notwithstanding any other benefits provided under the policies. Additionally, a characterization of policies or of the underlying reserves does not determine whether the insureds or their employers are allowed any exclusion or deduction for amounts paid to purchase the policies.

DRAFTING INFORMATION

  The principal author of this revenue ruling is Melissa Luxner of the Office of the Assistant Chief Counsel, Financial Institutions & Products. For further information regarding this revenue ruling contact Melissa Luxner on (202)566- 3463 (not a toll-free call).

Rev. Rul. 89-43, 1989-1 C.B. 213, 1989-15 I.R.B. 12.