SERVICE ISSUES PREVAILING STATE ASSUMED INTEREST RATES FOR USE IN DETERMINING LIFE INSURANCE RESERVES.

Rev. Rul. 87-26

For purposes of sections 807(d)(4) and 807(d)(5) of the Internal Revenue Code, this ruling sets forth in an attached schedule the prevailing state assumed interest rates and prevailing commissioners' standard tables of mortality and morbidity to be used by insurance companies, for taxable years beginning after December 31, 1983, in computing their reserves for (1) life insurance and supplementary total and permanent disability benefits, (2) individual annuities and pure endowments, and (3) group annuities and pure endowments. In addition, the ruling discusses four issues under sections 807(d)(4) and 807(d)(5) of the Code.

ISSUES

(1) For purposes of section 807(d)(4)(B) of the Code, what is the prevailing state assumed interest rate for contracts issued in a calendar year if fewer than 26 states have adopted a new rate as of the beginning of that year but additional states, making a total of at least 26 states, adopt the new rate during the year and make the rate retroactive to the beginning of the year?

(2) For purposes of section 807(d)(5)(A) of the Code, if a commissioners' standard table has been adopted by a least 26 states and thus becomes a prevailing table during a calendar year, may it be used only for contracts issued after the 26th state has adopted the table or for all contracts issued in that year?

(3) For purposes of section 807(d)(5)(B) of the Code, for how many calendar years after the calendar year before the end of which at least 26 states have adopted a new table may a taxpayer use the former prevailing table in computing life insurance reserves with respect to contracts issued in those years?

(4) For purposes of section 807(d)(5)(B) of the Code, for which calendar years may a taxpayer use either the 1958 Commissioners' Standard Ordinary (C.S.O.) tables or the 1980 C.S.O. tables in computing life insurance reserves with respect to contracts issued in those years?

LAW AND ANALYSIS--ISSUE (1)

Section 807(d)(4)(A) of the Code defines the term "prevailing state assumed interest rate" for an insurance or annuity contract as the highest assumed interest rate permitted to be used in computing life insurance reserves for such contract under the insurance laws of at least 26 states.

Except as provided in section 807(d)(4)(C) of the Code, section 807(d)(4)(B) provides that the prevailing state assumed interest rate is determined as of the beginning of the calendar year in which the contract was issued.

Section 807(d)(4)(C) of the Code provides that the issuer of a nonannuity contract may elect to determine the prevailing state assumed interest rate as of the beginning of the calendar year preceding the calendar year in which the contract was issued.

Section 807(d)(4)(B) of the Code provides that the prevailing state assumed interest rate is determined as of the beginning of the calendar year in which the contract was issued. This statutory provision is unclear, however, whether a determination "as of" January 1 reflects only state action taken on or before January 1 or also reflects state action taken during the year that was by its terms effective on January 1. The Supplemental Report of the Committee on Ways and Means of the United States House of Representatives (the "House Supplemental Report") states: "If the highest assumed interest rate is actually determined by the States during the year but declared effective as of the beginning of the calendar year, such rate would be considered so effective for tax purposes, also." H.R. Rep. No. 432, Pt. 2, 98th Cong., 2d Sess. 1415 (1984).

Therefore, except as provided in section 807(d)(4)(C) of the Code, the "prevailing state assumed interest rate" to be used for all contracts issued in a calendar year is the rate that is prevailing as of the beginning of the year in which the contract is issued. If a new a rate has been adopted by a total of at least 26 states before the end of a calendar year (for example, 1985), that rate generally becomes effective as of January 1 of the subsequent year (January 1, 1986), with respect to any contract issued during that subsequent year (1986). However, there is a situation in which a new prevailing rate becomes effective for any contract issued during the year in which the 26th state adopted that new rate. This occurs if fewer than 26 states adopted (either prospectively or retroactively) a new interest rate by the end of a calendar year (for example, 1984) and by the end of the following year enough states retroactively adopted this new rate so that a total of at least 26 states acted to make the new interest rate effective as of the beginning of that second year (in this example, 1985). In such a situation the new interest rate becomes effective as of January 1 of the year of the adoption by the 26th state (here, January 1, 1985) with respect to any contract issued during that year.

HOLDING--ISSUE (1)

If a total of at least 26 states have adopted a new interest rate before the end of a calendar year and made it effective, on either a prospective or a retroactive basis, before or as of January 1 of the year in which the 26th state adopted the rate, the new rate will become effective as of the beginning of that year for any contracts issued in that year.

LAW AND ANALYSIS--ISSUE (2)

Section 807(d)(5)(A) of the Code provides that the term "prevailing commissioners' standard tables" means, with respect to any contract, the most recent commissioners' standard tables prescribed by the National Association of Insurance Commissioners (NAIC) that are permitted to be used in computing reserves for that type of contract under the insurance laws of at least 26 states "when the contract was issued." The standard tables referred to in section 807(d)(5)(A) are the tables that are permitted by the states to be used in computing the minimum reserves that may be held for the respective policies.

By defining the prevailing commissioners' standard table for a contract in terms of state law "when the contract was issued," section 807(d)(5)(A) allows a standard table to be used under section 807(d)(2)(C) for contracts issued after the table becomes a prevailing commissioners' standard table. The House Supplemental Report, however states: "If a table becomes a prevailing commissioners' standard table during a calendar year, the table shall be such as of the beginning of the calendar year." H.R. Rep. No. 432, Pt. 2, 98th Cong., 2d Sess. 1416 (1984).

Thus, the legislative history of section 807(d)(5)(A) shows that Congress intended to permit the use of a new prevailing commissioners' standard table as of the beginning of the year before the end of which it was adopted by a total of at least 26 states, even if the applicable state laws do not provide for such retroactive treatment. Therefore, unlike the situation with the change in the prevailing state assumed interest rate, a new prevailing commissioners' standard table may be used, regardless of whether the laws of any newly adopting states are retroactive, for all contracts issued in the calendar year in which the table becomes a "prevailing commissioners' standard table."

HOLDING--ISSUE (2)

When a commissioners' standard table has been adopted by at least 26 states and thus becomes a "prevailing commissioners' standard table" during a calendar year, the table may be used for all contracts issued in that year.

LAW AND ANALYSIS--ISSUE (3)

Section 807(d)(5)(B) of the Code provides that if the prevailing commissioners' standard tables as of the beginning of a calendar year are different from the prevailing commissioners' standard tables as of the beginning of the preceding calendar year, the insurance company may use the former tables with respect to any contracts issued after the change in tables and for the three-year period beginning with January 1 of the year of change. The term "year of change" is defined as any calendar year in which the prevailing commissioners' standard table as of the beginning of that year is different from the prevailing commissioners' standard table as of the beginning of the preceding calendar year.

Although, as concluded in Issue 2 above, a new table that becomes prevailing during a calendar year is treated for purposes of section 807(d)(5)(A) of the Code as effective as of the beginning of that year, Congress did not intend that such treatment would affect the determination of the year of change under section 807(d)(5)(B). Rather, the actual effective date of the action by the 26th state to adopt the new tables is intended to determine the year of change.

Congressional intent concerning application of the former prevailing table and the new prevailing table is illustrated by the following statement from the House Supplemental Report:

Generally, when mortality and morbidity tables are being updated and adopted by the States, companies will have three full years after a particular set of tables becomes the prevailing view of the States before such table becomes mandatory for computing reserves for tax purposes. For example, it is the understanding of the committee that the 1980 C.S.O. tables for life insurance contracts have now been adopted by at least 26 States. Thus, although companies will be able to use either the 1958 C.S.O. tables for taxable years 1984, 1985, and 1986 for computing tax reserves, the 1980 C.S.O. tables will have to be used for contracts issued after 1986. H.R. Rep. No. 432, Pt. 2, 98th Cong., 2d Sess. 1416 (1984). Congress believed that the 1980 C.S.O. tables for life insurance contracts were adopted by at least 26 states before the end of 1983. See the General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (Public Law, 98-369), prepared by the Staff of the Joint Committee on Taxation, at page 602. (In fact, as discussed in Issue 4, the tables were so adopted before the end of 1982.) Thus, on the assumption that the 1980 tables were adopted by a 26th state in 1983, the House Supplemental Report expected both the 1958 and the 1980 tables to be available for use with respect to contracts issued in the three subsequent calendar years, 1984, 1985, and 1986. That fact demonstrates congressional intent that, unless the action by the 26th state was effective on January 1, the period provided in section 807(d)(5)(B) ends on December 31 of the third calendar year following the calendar year before the end of which at least 26 states have adopted a new table and made it a prevailing table.

Moreover, to allow the retroactive treatment of the new table to advance the year of change to the year in which the new table becomes prevailing would mean that a taxpayer would not be permitted to use the prior table for contracts issued during three full calendar years AFTER the new table is adopted. Permissible use of the old table for three full years after the new table is adopted is intended by section 807(d)(5)(B) of the Code and the House Supplemental Report. Accordingly, unless the action by the 26th state was effective on January 1, the year of change, for purposes of section 807(d)(5)(B), means the first calendar year after the calendar year before the end of which a commissioners' standard table was adopted by at least 26 states and thus became prevailing.

HOLDING--ISSUE (3)

Unless a new table is adopted by the 26th state on January 1, a taxpayer may use the former prevailing table in lieu of the new prevailing table for contracts issued during a total of four calendar years. This option is available to a taxpayer for contracts issued during the calendar year of adoption of the new prevailing table and during the three years following the calendar year of adoption of the new prevailing table.

LAW AND ANALYSIS--ISSUE (4)

As indicated above, Congress believed that the 1980 C.S.O. tables had been adopted by at least 26 states before the end of 1983 and that use of the 1980 C.S.O. tables would become mandatory for policies issued after 1986. The Service, however, had determined that the 1980 Amendments to the Standard Valuation Law, which contain the 1980 C.S.O. tables, were adopted by at least 26 states before the end of 1982, not 1983.

HOLDING--ISSUE (4)

In accordance with the holding in Issue 3 above, a taxpayer may use either the 1958 C.S.O. tables (designated as C.S.O. 58(b) in the tables at the end of this revenue ruling) or the 1980 C.S.O. tables for contracts issued in the year of adoption of the 1980 C.S.O. tables (1982) and in the three years following the year of adoption (1983, 1984, and 1985). Use of the 1980 C.S.O. tables is mandatory for contracts issued after 1985.

        Schedule of Prevailing State Assumed Interest Rates and

** Pursuant to section 807(d)(4)(C), the issuer of a nonannuity contract may elect to determine the prevailing State assumed rate of interest as of the beginning of the calendar year preceding the calendar year in which the contract was issued.

*** Pursuant to section 807(d)(5)(A), the specified table may be used as the prevailing table from the beginning of the calendar year in which the table becomes prevailing. Instead of the prevailing table, section 807(d)(5)(B) permits the use of the former table as the prevailing table for such calendar year and three subsequent years.

+ For 1982 only, 5.5% is the prevailing State assumed interest rate for single premium life insurance.

NOTES

¹ Highest interest rate and most recent mortality table permitted as of January 1 of the year stated in the schedule, for valuation of contracts of the specified type issued in that year, under the valuation laws of at least 26 states. For policies issued prior to 1948, the mortality and morbidity tables used in computing statutory reserves shall be used; prior to 1946 the prevailing interest rate is 4%, in 1946 and 1947 the prevailing interest rate is 3.5%.

² Interest rates for all life insurance, including ordinary, industrial, group and credit. For non-cancellable accident and health insurance there are no prevailing rates under section 807(d)(4)(A). Therefore, interest rates used in calculating non-cancellable accident and health insurance reserves are those applicable to whole life insurance, in accordance with section 807(d)(4)(D).

³

 CSO 41:   Commissioners' 1941 Standard Ordinary Mortality Table

                          Schedule for Note 4