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U.S. Tax Court Says Insurer Failed To Show It Made Fair And Reasonable Estimates Of Actual Unpaid Losses


HLD, v. 30, n. 2 (February 2002)

U.S. Tax Court Says Insurer Failed To Show It Made Fair And Reasonable Estimates Of Actual Unpaid Losses

The U.S. Internal Revenue Service (IRS) determined that, for tax years 1993 and 1994, Physicians Insurance Company of Wisconsin (petitioner) had overestimated its unpaid losses. Accordingly, the IRS adjusted petitioner's taxes to reflect the deficiencies. In its tax documents, petitioner had included the estimates that appeared in its annual reports. These numbers were almost 10% higher than the estimated unpaid losses calculated by petitioner's actuary, Tillinghast-Towers Perrin (Tillinghast). Petitioner had utilized a standard form required by the National Association of Insurance Commissioners (NAIC) in preparing its annual reports.

The U.S. Tax Court agreed with the IRS, concluding that petitioner had failed to "correctly report[ ] its undiscounted unpaid losses for purposes of computing its deduction for losses incurred," pursuant to Internal Revenue Code � 832(b)(5). In so holding, the tax court rejected petitioner's assertion that deference should be accorded to petitioner's estimates because it "reported the same estimates of unpaid losses on its annual statements and tax returns, and because it estimated these unpaid losses in a reasonable manner, using sound business practices." The tax court characterized petitioner's argument as "at bottom a rehashing of long-rejected arguments that the Code reflects a congressional expectation that the estimates of unpaid losses used for tax purposes should conform to the precise figures shown on the annual statement." In rejecting this argument, the tax court reasoned that to hold otherwise would sanctify estimated figures and the form itself, despite any unfairness or unreasonableness in calculating the figures. See Hanover Ins. Co. v. Commissioner, 65 T.C. 715, 719 (1976). Rather than blind deference to estimates included in annual reports, the tax court emphasized that a review of estimates of unpaid losses was "essentially a valuation issue and thus a question of fact," and that the burden was on a taxpayer to show reasonableness. The tax court determined that petitioner had not met this burden and had particularly failed to establish that its nearly 10% increases to Tillinghast's estimates were reasonable or appropriate. Reviewing the record, the tax court found "no evidence . . . of any actuarial standard that supports an 'implied range' of plus or minus 10 percent around an actuary's point estimate." Accordingly, the tax court ruled in favor of the IRS.

Physicians Ins. Co. v. Commissioner, No. 3192-99 (T.C. Nov. 21, 2001) (40 pages).

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