Rev. Rul. 65-143

Advice has been requested regarding the tax consequences of a change in basis of computing reserves on life insurance policies issued prior to January 1, 1964, and an election under section 818(c) of the Internal Revenue Code of 1954, to revalue the preliminary term reserves on policies issued subsequent to December 31, 1963.

The R insurance company is a life insurance company subject to tax under section 802 of the Code.

R uses both the preliminary term and net level premium bases for computing reserves on life insurance policies, using various mortality tables and assumed rates of interest. It strengthened the preliminary term reserves on all policies issued prior to January 1, 1964, by using the net level premium basis of computation, with the same mortality tables and interest assumptions previously used.

The adoption of the net level premium basis for computing reserves with respect to all policies issued prior to January 1, 1964, was authorized by R's Board of Directors and approved by the State Insurance Commissioner before the end of the taxable year.

R effected the reserve strengthening program by reporting the reserves with respect to such contracts in its 1964 Annual Statement on the net level premium basis and will thereafter continue to use the net level premium reserves on such policies in subsequent annual statements. In addition, the strengthened reserve liability will be used by R in its reports to stockholders and various other financial reports.

R then elected, for the same taxable year, to revalue preliminary term reserves computed on policies issued on and after January 1, 1964, on the approximate net level premium basis in accordance with section 818(c) of the Code.

Section 806(b) of the Code and section 1.806-4 of the Income Tax Regulations provide that if the basis for determining the amount of any item referred to in section 810(c) of the Code relating to items taken into account, as of the close of the taxable year differs from the basis for such determination as of the beginning of the taxable year, then in determining taxable investment income, the amount of the item as of the close of the taxable year shall be the amount computed on the old basis, and the amount of the item as of the beginning of the next taxable year shall be the amount computed on the new basis. Section 1.806-4 of the regulations also provides that a change of basis in computing any of the items referred to in section 810(c) of the Code is not a change of accounting method requiring the consent of the Secretary or his delegate under section 446(e) of the Code.

Section 810(d)(1) of the Code and section 1.810-3(a) of the regulations provide that if the basis for determining any item referred to in section 810(c) of the Code at the end of the taxable year differs from the basis for such determination at the end of the preceding taxable year, then so much of the difference between the amount of the item at the end of the taxable year, computed on the new basis, and the amount of the item at the end of the taxable year, computed on the old basis, as is attributable to contracts issued before the taxable year shall be taken into account as follows:

(1) If the amount of the item at the end of the taxable year computed on the new basis exceeds the amount of the item at the end of the taxable year computed on the old basis, 1/10 of such excess shall be taken into account, for each of the succeeding 10 taxable years, as a net increase to which section 809(d)(2) of the Code applies; or

(2) if the amount of the item at the end of the taxable year computed on the old basis exceeds the amount of the item at the end of the taxable year computed on the new basis, 1/10 of such excess shall be taken into account, for each of the 10 succeeding taxable years, as a net decrease to which section 809(c)(2) of the Code applies.

Accordingly, it is held that where R strengthens the reserves on all life insurance policies issued prior to January 1, 1964, by changing the basis for determining such reserves from the preliminary term basis to the net level premium basis, such change will constitute a change of basis in computing reserves to which sections 806(b) and 810(d)(1) of the Code apply. Under sections 806(b) of the Code and section 1.806-4 of the regulations, for purposes of determining taxable investment income, the amount of such reserves as of December 31, 1964, shall be the amount computed on the old basis (preliminary term basis) and the amount of such reserves as of January 1, 1965, shall be the amount computed on the new basis (net level premium basis). Under section 810(d)(1) of the Code and section 1.810-3(a) of the regulations, 1/10 of the excess of the amount of such reserves at December 31, 1964, computed on the new basis (net level premium basis) over such reserves at December 31, 1964, computed on the old basis (preliminary term basis) will be taken into account as a net increase to which section 809(d)(2) of the Code applies for the taxable year 1965 and for each of the 9 succeeding taxable years.

Section 818(c) of the Code and section 1.818-4(a) of the regulations provide that a life insurance company issuing contracts with respect to which the life insurance reserves are computed on one of the recognized preliminary term bases may elect to revalue such reserves on a net level premium basis for the purpose of determining the amount which may be taken into account as life insurance reserves for purposes of part I, subchapter L, chapter 1 of the Code, other than section 801 of the Code (relating to the definition of a life insurance company). If such an election is made, the basis to be used in making this revaluation of reserves shall be either the exact revaluation basis, as described in section 818(c)(1) of the Code, or the approximate revaluation basis, as described in section 818(c)(2) of the Code.

Section 1.818-4(d)(1) of the regulations provides as follows:

For the first taxable year for which the election under section 818(c) and paragraph (b) of this section applies, a company making such election must revalue all its life insurance reserves held with respect to contracts for which such reserves are computed on a preliminary term basis at the end of such taxable year on the basis elected under section 818(c) and paragraph (b) of this section. However, for purposes of the preceding sentence, an election under section 818(c) shall not apply with respect to such reserves which would not be treated as being computed on the preliminary term basis at the end of such taxable year except for the provisions of section 810(a) or (b). * * * For example, if S , a life insurance company which computes its life insurance reserves on a recognized preliminary term basis at the beginning of the taxable year 1958, strengthens a portion of such reserves during the taxable year by actually changing to a net level premium basis in computing such reserves, and then makes the election under section 818(c) and paragraph (b) of this section for 1958, such election shall not apply with respect to the strengthened contracts.

Section 1.806-4(a) of the regulations provides that an election under section 818(c) of the Code shall not be treated as a change in basis for determining the amount of an item referred to in section 810(c) of the Code.

Accordingly, it is further held that where, subsequent to the reserve strengthening referred to hereinbefore, R elects under section 818(c) of the Code, effective for the taxable year 1964, to revalue its preliminary term reserves to approximate net level premium reserves, such election shall be applicable only to life insurance reserves on those policies issued subsequent to January 1, 1964, since the reserves on these policies will be the only reserves which at December 31, 1964, are computed on a preliminary term basis.