Tax Court - Insurance company’s carried loss reserves were fair and reasonable 

September 4: The U.S. Tax Court today issued a memorandum opinion concluding that the taxpayer (a mutual property and casualty insurance company) had presented substantial evidence establishing that its carried loss reserves of approximately $660 million were fair and reasonable, and represented only actual unpaid losses pursuant to Reg. section 1.832-4(a)(14) and (b). Acuity, a Mutual Insurance Company v. Commissioner, T.C. Memo 2013-209 (September 4, 2013)

The Tax Court found the insurance company computed its reserves in accordance with the rules of the National Association of Insurance Commissioners (NAIC) and the Actuarial Standards of Practice (ASOPs) and that the reserves were within a range of reasonable reserve estimates as determined by the company’s appointed actuary in accordance with the ASOPs.

Read the Tax Court opinion [PDF 324 KB]


The IRS determined deficiencies of $1.072 million for 2005 and $30.7 million for 2006 in the taxpayer / insurance company’s federal income tax.

The issue before the Tax Court was whether the insurance company’s year-end reserves for unpaid losses and loss adjustment expenses (carried loss reserves) of $660 million for 2006, as used in computing “losses incurred” within the meaning of section 832(b)(5), were a “fair and reasonable” estimate and represented “only actual unpaid losses” within the meaning of Reg. section 1.832-4(a)(14) and (b).

Tax Court’s opinion

The Tax Court noted that a determination of whether a taxpayer’s loss reserves are a fair and reasonable estimate of the taxpayer’s unpaid losses is essentially a valuation issue and a question of fact.

In making its factual determination whether the insurance company’s loss reserves were fair and reasonable and represented only actual unpaid losses, the Tax Court stated that it assigned “substantial weight” to evidence that the loss reserves: (1) were actuarially computed in accordance with the NAIC rules and ASOPs; and (2) fell within a range of reasonable reserve estimates as determined by the insurance company’s appointed actuary in accordance with the ASOPs measures. Here, the court concluded that the the taxpayer’s carried reserves were reasonable under those standards.

KPMG observation

Judge Vasquez’s opinion sturdily rejects the IRS’s attempt to set up a “battle of the experts” around unpaid losses, and to re-litigate the same unpaid loss issue that was decided in a trilogy of Tax Court cases over a decade ago (Physicians Ins. Co. of Wis., Inc. v. Commissioner, 82 T.C.M. 918 (2001); Minn. Lawyers Mut. Ins. Co. v. Commissioner, 79 T.C.M. 2234, aff’d, 285 F.3d 1086 (8th Cir. 2002); Utah Med. Ins. Ass’n v. Commissioner, 76 T.C.M. 1100 (1998)). Today’s opinion relies solidly on, and squares with, the principles established in those cases.

While not blindly following statutory and actuarial principles, the Tax Court opinion accords appropriate deference to the NAIC and actuarial standards that were applied diligently by the taxpayer’s actuaries in determining the taxpayer’s unpaid loss reserves, and concludes: “[w]e decline to substitute respondent’s judgment for [taxpayer’s actuary’s] professional judgment.” (citing Physicians Ins. Co. of Wisconsin).

Importantly, the opinion also clarifies that taxpayers are not required to “disprove” the “fairness and reasonableness” of IRS experts’ reserve computations: “[t]he applicable regulations do not require a taxpayer to show that the amount espoused by the Commissioner as a fair and reasonable loss reserve estimate is, in fact, not fair or reasonable.”

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