MALPRACTICE INSURERS CAN USE COMPOSITE SCHEDULE P.

Rev. Proc. 91-21

SECTION 1. PURPOSE

This revenue procedure provides an administrative procedure under which an eligible taxpayer may elect, for purposes of section 846 of the Internal Revenue Code, to discount certain unpaid losses using a schedule of composite discount factors (described in section 2.02 of this revenue procedure). The election applies to unpaid losses relating to insurance contracts written on a claims-made basis for the medical malpractice and similar professional liability lines of business.

SEC. 2. BACKGROUND

01 Section 846 of the Code provides rules for determining the discounted unpaid losses of property and casualty insurance companies. Discounted unpaid losses are a component of the losses incurred deduction of section 832(b)(5). Section 846(a) provides that discounted unpaid losses are separately computed for each accident year of each line of business. In this computation, an annual interest rate determined under section 846(c) and the appropriate loss payment pattern are applied to the amount of undiscounted unpaid losses (and unpaid loss adjustment expenses) measured as of the end of the tax year.

Section 846(f) of the Code defines the term "line of business" as a category for the reporting of loss payment patterns on the annual statement for fire and casualty companies approved by the National Association of Insurance Commissioners.

02 Section 845(d) of the Code directs the Secretary periodically to determine a loss payment pattern for each line of business. The pattern is applicable to unpaid losses attributable to the accident year ending with a determination year (calendar year 1987 and each fifth calendar year thereafter) and to each of the four succeeding accident years. The Secretary has determined a loss payment pattern for the medical malpractice line of business that is applicable to unpaid losses attributable to accident years through the 1991 accident year.

Section 846(d)(3)(E) also directs the Secretary to determine a payment pattern based on the combined losses for several specified lines of business. The Internal Revenue Service annually publishes a series of composite discount factors, under the heading "Composite Schedule P," based on this payment pattern. These composite discount factors, as well as discount factors based on the payment pattern determined for the medical malpractice line of business, have been published annually by the Service in Rev. Rul. 87-34, 1987-1 C.B. 168, and successor revenue rulings.

03 To a significant degree, the discount factors that have been published by the Service for the medical malpractice line of business for accident years prior to 1992 were computed on the basis of the loss payment history of insurance contracts written on an occurrence basis. Application of these factors to unpaid losses that relate to contracts written on a claims-made basis may result in an overstated discount because the period of time separating the payment of a loss from the occurrence of the event giving rise to the claim of loss (occurrence basis) is longer than the period of time separating the payment of a loss from the filing of the claim of loss (claims-made basis).

The discount factors that the Service publishes under the heading "Composite Schedule P" are based on a payment pattern that is more similar to the payment pattern for medical malpractice insurance contracts written on a claims-made basis.

04 Section 845(e) of the Code permits certain taxpayers to make an election in each determination year to use their own historical experience to determine a loss payment pattern for each accident year of each line of business. Notice 88-100, 1988-2 C.B. 439, provides the requirements for making this election.

SEC. 3. SCOPE

01 An "eligible taxpayer" is a taxpayer that, under section 846(e) of the Code and Notice 88-100, was not permitted for the 1987 determination year to elect to use its own historical loss payment pattern for its qualified line or lines of business (as defined in section 3.02 below) and either --

(1) Elected to use its own experience for those lines of business (if any) for which it was permitted to elect to use its own experience; or

(2) Within the time prescribed in section 5.02(3) of this revenue procedure, amends its return for 1987 to make the election for all lines of business for which it was permitted to elect to use its own experience.

Additionally, a taxpayer is an eligible taxpayer if there was no line of business for which the taxpayer was allowed to use its own historical experience.

If, for purposes of the 1987 determination year, the taxpayer had sufficient years of experience in a line of medical malpractice or similar professional liability insurance to use its own historical loss payment pattern in determining discounted loss reserves for that line of business but the taxpayer had written claims-made policies for that line of business for less than 10 of those years, then, for purposes of this section 3.01, that line of business is treated as a line of business for which the taxpayer was not permitted to elect to use its own historical experience.

02 For any accident year, a "qualified line of business" is medical malpractice or a similar professional liability line of business if at least 70% of the gross premiums written by the taxpayer in that accident year for the line represent claims-made coverage. A premium represents "claims-made coverage" if the underlying policy protects only against losses reported by the insured to the taxpayer during the period of coverage.

SEC. 4. EFFECT OF ELECTION

An eligible taxpayer may elect to discount unpaid losses for a qualified line of business using "Composite Schedule P" discount factors published by the Secretary. The election applies to all unpaid losses for the qualified line that are attributable to all accident years beginning with the first accident year in which the line of business is a qualified line of business. However, the election under this revenue procedure does not apply to unpaid losses attributable to the 1992 accident year or any subsequent accident year.

SEC. 5. TIME AND MANNER OF MAKING THE ELECTION

01 The election to apply "Composite Schedule P" discount factors is made on a timely filed return (including extensions) for the first tax year beginning after December 31, 1989.

02 In order to make the election, a taxpayer must --

(1) Print or type "Rev. Proc. 91-21 Election" at the top left corner of the first page of the return;

(2) Use "Composite Schedule P" discount factors in discounting all unpaid losses to which the election applies (see section 4 of this revenue procedure); and

(3) File amended returns for any tax year beginning before the tax year described in section 5.01 of this revenue procedure if the taxable income for that tax year is affected by either the election to use "Composite Schedule P" discount factors or the election described in section 3.01(2) of this revenue procedure (concerning use of the taxpayer's own experience for certain lines of business beginning with the 1987 determination year). The amended returns must be filed before expiration of the statute of limitations for filing a claim for refund or credit.

SEC. 6. INQUIRIES

Inquiries concerning this revenue procedure should refer to its number and be addressed to the Office of the Assistant Chief Counsel (Financial Institutions and Products), Branch 4 (CC:FI&P:4), P.O. Box 7609, Ben Franklin Station, Washington, D.C. 20044.

SEC. 7. EFFECTIVE DATE

This revenue procedure is effective March 4, 1991.

DRAFTING INFORMATION

The principal author of this revenue procedure is William L. Blagg of the Office of the Assistant Chief Counsel (Financial Institutions and Products). For further information regarding this revenue procedure contact Katherine A. Hossofsky on (202) 566-4336 (not a toll-free call).