Wilbur, Judge:
Respondent determined deficiencies in petitioner’s Federal income tax as follows:
Year Deficiency
1970 . $788.05
1971 . 2,476.09
1972 . 2,121,986.69
After concessions,1 the sole issue for decision is whether petitioner qualified as a life insurance company under section 801(a)2 during the years 1973, 1974, and 1975. The resolution of this issue turns on whether certain of petitioner’s individual health and accident insurance policies, with respect to which petitioner valued mid-terminal reserves on the 2-year preliminary term basis, qualified as "noncancellable” or "guaranteed renewable” within the meaning of sections 1.801-3(c) and 1.801-3(d), Income Tax Regs.
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly. The stipulations of fact, together with the exhibits attached thereto, are incorporated herein by this reference.
United Fire Insurance Co. (hereinafter referred to as petitioner) is a stock fire and casualty insurance corporation organized under New York law. Its principal place of business was Chicago, Ill., when the petition herein was filed. Petitioner filed its original Federal income tax returns for the calendar years 1970 through 1976 with the Internal Revenue Service Center at Kansas City, Mo. A copy of petitioner’s annual convention statement (hereinafter referred to as the annual statement) was attached to each of its original returns.3 After filing its original returns for 1970, 1971, and 1972, petitioner filed amended returns for each year and a second amended return for 1972, all with the Internal Revenue Service Center at Kansas City, Mo. At all times here pertinent, petitioner’s primary and predominant business activity has been the issuance of policies or contracts of insurance and the reinsurance of risks underwritten by other insurance companies.
Prior to 1969, petitioner was a specialty insurer, writing exclusively policies covering risks of fire and extended coverage on weekly or industrial debit plans. In early 1969, petitioner adopted a policy of expansion and diversification under which it planned to enter into the accident and health insurance field. In 1968, pursuant to this plan, petitioner commenced, inter alia, to issue and reinsure individual policies of accident and health insurance.
During the years 1973 through 1975, a substantial portion of its business consisted of issuing and reinsuring policies of accident and health insurance. Most of the accident and health insurance policies issued or reinsured by petitioner contained a rider, clause, or provision which entitled the insured, at his option, to renew or continue the policy in force either for life or to a specified age of at least 60 years. All of these renewable policies were "level premium” policies; that is, the premium rate throughout the duration of each policy was required to be determined by reference to the age and underwriting classification4 of the insured at the time the policy was first issued.
A small percentage of these policies guaranteed the insured the right to renew the policy at a specific, unadjustable premium rate; in the terminology of the insurance industry, this type of policy is known as "noncancellable.” Under most such policies, however, petitioner reserved the right to adjust the premium rates by policy class in accordance with its experience under the type of policy involved, to take into account such items as increased medical costs, but not changes in the age or underwriting classification of the insured. This type of policy is commonly known in the insurance industry as "guaranteed renewable.”5
Noncancelable and guaranteed renewable accident and health policies are recognized product types in the insurance industry. For purposes of classification by the insurance industry, the contractual provisions described in the preceding paragraph distinguish noncancelable and guaranteed renewable individual accident and health policies from other forms of accident and health insurance. All of petitioner’s individual noncancelable and guaranteed renewable policies satisfy the industry definition of that product type from the date those policies are issued, since the terms of those policies afford the insured the option to renew at level premiums until he or she reaches at least the age of 60.
The actuarial risks assumed by petitioner under its renewable policies increase with the age of the insured. Since petitioner may not adjust the premium rate to reflect these increased risks in the later years of such policies, the premium rate initially established represents, in effect, an actuarial average cost of insurance over the entire renewable period. During the early years of petitioner’s renewable policies, the level premiums charged are therefore larger than the actuarially anticipated cost of claims for those years, and during the later years of such policies, the level premiums are insufficient to cover actuarially anticipated claims for those years.
Thus, in establishing the premium rate to be charged for its renewable policies, petitioner must include both the actuarial cost of insuring the policyholder for the current periodic premium term as well as the long-term risks, actuarially computed, represented by petitioner’s promise to renew the policy at a level premium. In addition, petitioner must take into account the non-insurance costs associated with these policies in establishing the premium rate to be charged. In insurance industry parlance, the total premium charged for a policy of insurance (the "gross premium”) thus consists of two computational factors: the "net premium” and "loading.” The net premium is the actuarially computed amount of the gross premium designed to cover the cost of the insurance risk under the policy. Loading is the portion of the gross premium designed to cover petitioner’s non-insurance costs, such as commissions and administrative expenses, and also includes a margin for profit.
The insurance industry is regulated by State authority. One of the primary objectives of such State regulatory authority is to assure that companies falling within their jurisdiction are able to meet claims of policyholders as they fall due. In furtherance of this objective, such authorities establish minimum reserve requirements which insurance companies must comply with, and require such companies which engage in the insurance business in the State to file an annual statement reflecting such reserves.
One type of reserve here pertinent that State regulatory authority requires petitioner to establish with respect to its renewable policies is the "active life reserve,” which is a reserve maintained for claims which have not yet been incurred. The active life reserve consists of two components, carried and stated separately in the annual statement used by petitioner. The first component of the active life reserve is the "unearned premium reserve.” The second component of the active life reserve is the "additional reserve.”
The unearned premium reserve is established on the annual statement date (i.e., December 31) to provide for claims and benefits which may be incurred during the remainder of the current policy term. That is, an insurer will generally have received premium payments during a year on policies for periods extending beyond the annual statement date. Such premiums will therefore not be fully earned by the company on December 31. The unearned premium reserve covers the period beyond the annual statement date and expires (with respect to any particular policy) on the last day of the policy term.
Subject to certain allowable assumptions, the dollar amount of the unearned premium reserve for a particular class of policies represents the pro rata amount of either the gross or net premiums received with respect to that class which has not been earned by the company as of the annual statement date. Thus, if a company issues a policy on July 1 for a premium of $100, the gross pro rata unearned premium with respect to that policy as of December 31 will be $50.6 The unearned premium reserve diminishes as a function of the mere passage of time as the premiums are earned by the company, and at the end of a policy year, the amount contained in the reserve for a class of policies is reduced to zero. Although the company will be required to carry an unearned premium reserve on the next following annual statement date with respect to policies that are renewed, the unearned premium with respect to any given year does not accumulate, but expires at the end of the policy year.
Additional reserves, the second component of the active life reserve, on the other hand, are intended to cover claims and benefits which will arise after the end of the current periodic premium period. The purpose of the additional resérve is to supplement premiums received in the later years' of level premium policies when actuarially estimated claim costs will exceed net premiums received in those years.
Under applicable State regulatory provisions, a permissible form or basis for the unearned premium reserve is the gross pro rata unearned premium, and a permissible form or basis for the additional reserve is the mid-terminal reserve. Permissible methods of computing the additional or mid-terminal reserve, under pertinent State regulatory authority, include both the "net level method” and the "preliminary term method.” Under the latter method, a preliminary term of 2 years is permissible.
At all times pertinent herein, petitioner utilized the gross pro rata unearned premium basis for computing its unearned premium reserve with respect to its renewable policies and utilized the mid-terminal basis for its additional reserve with respect to such policies. Petitioner computed its additional (mid-terminal) reserves under the 2-year preliminary term method with respect to its renewable policies.
The gross pro rata unearned premium includes both the loading factor and the cost of carrying the insurance risk for the unexpired term of the current premium period. The net unearned premium is the portion of the premium attributable to the unexpired term of the premium period which covers the cost of carrying the insurance risk. The gross pro rata unearned premium reserve as reflected on petitioner’s annual statement, subject to certain permissible assumptions,7 included that portion of the gross premium paid on its renewable accident and health policies in force, proportionate to the unexpired portion of the current term of such policies, regardless of the length of time the policies had been in force.
Conversely, the additional reserve is intended to cover claims and benefits which will arise after the end of the current premium-paying period. The additional reserve arises from petitioner’s long-term obligation to renew its policies. This reserve is the measurement of petitioner’s liability for future contingent claims — those not yet incurred under its individual policies — and is equal to the present value of future benefits payable under those policies minus the present value of future net level premiums receivable.
When the additional reserve is actually computed at the end of a completed policy year on a group of policies that all renew on the same date, it is referred to as the "terminal reserve.” However, the mid-terminal reserve is often utilized since policies are normally issued on various dates over the course of a particular calendar year, and it is generally impracticable to compute precise terminal reserves. The mid-terminal reserve is simply an average of two terminal reserves which is computed by assuming the issue dates of all policies in a particular class to be evenly distributed over the calendar year. The effect of using mid-terminal reserves is that all policies are treated as having been issued on July 1 of the calendar year so that, on the annual statement date (i.e., December 31), the actuarially computed reserves fall exactly halfway between two successive terminal reserve values.
Under the net level method of valuing mid-terminal reserve for a class of policies, the dollar amount of the reserve is arrived at by calculating the excess of the present value of future benefits payable under policies within the class over the present value of future net valuation premiums under such policies. Under this method, the above computation must be made with respect to all policies in force on the valuation date, irrespective of the length of time the policies have been in existence. To the extent that the present value of future benefits payable- exceed the present value of future net valuation premiums, funds must be retained out of premiums and accumulated at the relevant assumed rate of interest in the mid-terminal reserve.
The 2-year preliminary term method of computing reserves is a recognized and accepted actuarial method, and has been accepted and approved by the National Association of Insurance Commissioners and by the pertinent regulatory agencies of those States in which petitioner does business. It is the method most commonly used for valuing reserves on individual noncancelable and guaranteed renewable accident and health policies. At all times here pertinent, petitioner computed the mid-terminal reserves on its renewable policies on the 2-year preliminary term basis, using appropriate valuation tables and based on recognized mortality and morbidity tables and an assumed rate of interest at 3 percent.
The preliminary term method of valuation recognizes that an insurer’s administrative expenses in the first years of a policy are much higher than those in renewal years, and that, conversely, claims costs will increase with age. Thus, for 2 policy years or even longer, the insurer may have a substantial unliquidated initial expense before setting up reserves. For these reasons, the recommendation of the NAIC Task Force 4, and of the NAIC Industry Advisory Committee on Reserves for Individual Health Insurance Policies, provides for a preliminary period of 2 years as the minimum reserve basis for individual accident and health policies.
Under the 2-year preliminary term method of valuing mid-terminal reserves, the dollar amount of the reserve is the excess of the present value of future benefits over the present value of future net valuation premiums on all of petitioner’s renewable policies which have been in force for more than 2 years as of the annual statement date, but does not include any amount representing the excess of the present value of future benefits over the present value of future net valuation premiums on those renewable policies which have been in force for less than 2 years. At the end of the preliminary term (i.e., when a policy enters its third year), the excess of the future benefits over the future net valuation premiums on such policy then becomes part of the mid-terminal reserve. Such amount is computed as though the policy had been issued 2 years after its actual date of issue to a person 2 years older than the age of the insured at the actual issue date of the policy (and therefore at a higher rate), and as though the net level method was then being used.
For example, if an insured purchased a policy in 1971 at the age of 30, petitioner would have added zero with respect to such policy to the mid-terminal reserves computed as of December 31,1971, and December 31,1972. Commencing with the December 31, 1973, valuation date (assuming renewal), petitioner would have added to the mid-terminal reserves that amount (not less than zero) which would have been required on a net level reserve basis had the policy been issued in 1973 to the insured at the age of 32. In this manner, the preliminary term method accumulates reserves at a faster rate than the net level method after the expiration of the preliminary term and ultimately results in the same established reserve as the net level method at or by the end of the full policy term.
Petitioner, on the recommendation of its actuary and in accordance with State law, determined the adequacy of its reserves on the basis of its long-term liability with respect to all its policies. The use of the preliminary term method permitted petitioner to compute a reserve of zero for those policies in force less than 2 years. However, beginning in the third year of the policy, the increase in the reserve computations are greater under the preliminary term method than under the net level method. Over time, the reserves accumulated under either method are comparable, and regardless of which method is employed, reserves must be adequate in view of the liabilities on all of petitioner’s renewable policies— including policies over and under 2 years of age.
While the reserve is mechanically developed by applying unit reserve factors to unit benefits of single policies, separate reserves are not held on single policies. Rather, the additional reserve is an aggregate reserve, and has actuarial meaning only with respect to an entire group of policies. Mortality and morbidity tables are used in the calculation of unit reserve values, and such tables assume that a large population of policy holders are expected to die or become ill according to certain yearly rates. The additional reserves are an aggregate amount which, together with future net premiums, will meet the benefit payments arising from the group policies valued as such benefits accrue in the future. The application of a formula for the calculation of such reserves to an individual policy (or small group of policies) does not produce a meaningful result, since few policyholders will experience average morbidity. The New York Minimum Valuation Standard was based on this concept of the aggregate nature of reserving as described in the 1964 report of the Industry Advisory Committee on Reserves for Individual Health Insurance Policies.
There are no differences in the terms and provisions of petitioner’s renewable policies, or in the nature of its obligations thereunder, based on how long the policies have been in force. Specifically, with respect to the obligation to renew, petitioner is contractually bound to precisely the same extent under a renewable policy that has been in force for 2 years or less, as it is under a similar policy in force for a longer period.
Petitioner’s exposure to long-term morbidity risks under its renewable policies was the same with respect to policies in force for 2 years. Both its policies of less than 2 years’ duration and its policies over 2 years’ duration carried long-term morbidity risks, based on one and the same provision obligating the company to renew.
Respondent determined (a) that petitioner’s use of the 2-year preliminary term method of valuing mid-terminal reserves precluded petitioner’s renewable policies from being classified as noncancelable or guaranteed renewable policies for Federal tax purposes for the first 2 years the policies were in force.
As a result, respondent determined (b) that petitioner did not qualify as a life insurance company for the years 1973 through 1976 within the meaning of section 801(a), since, with the unearned premiums and unpaid losses on such policies for the first 2 years of their lives excluded from the total of such amounts computed under section 801(a)(2), such remaining amounts, plus its life insurance reserves, were less than 50 percent of petitioner’s total reserves, as required by section 801(a).
As a further result, respondent then determined (c) that the remaining balance in petitioner’s policyholders’ surplus account at the end of 1972 should be added back to its taxable income as reported for that year, pursuant to the provisions of sections 802(b) and 815(d)(2).
After the allowance of an additional deduction, not claimed in petitioner’s 1972 return and not here in dispute, the present contested deficiency resulted.8
In its petition, petitioner disputes respondent’s first determination, and contends (a) that its renewable accident and health policies qualified as noncancelable or guaranteed renewable policies for Federal tax purposes for all policy years, in spite of its use of the 2-year preliminary term method of reserving.
From this, petitioner contends (b) that it meets the over-50percent test of section 801(a) with respect to its reserves for the years 1973-76, and is therefore a life insurance company within the meaning of that section during those years.
Petitioner therefore contends (c) that respondent’s action in adding back the balance of its policyholders’ surplus account at December 31, 1972, to its taxable income for that year was erroneous, and that the deficiency determined thereby was incorrect.
Petitioner further contends that it overpaid its income tax for the year 1972 because of (d) the additional deduction for the year 1972 which it failed to claim in its return, but which respondent allowed in his statutory notice, and (e) that it had a net operating loss for the year 1975 in the amount of $184,238, which it is entitled to carry back to the year 1972 and which will produce a further overpayment of tax in that year.9
OPINION
This is a companion case to National States Insurance Co. v. Commissioner, 81 T.C. 325 (1983) (Court reviewed), also decided by the Court today. Both* are cases of first impression presenting precisely the same issue on virtually identical facts. As in National States Insurance Co., we are asked to determine whether the petitioner is a life insurance company within the meaning of section 801. Section 801 provides the following definition of a life insurance company:
SEC. 801(a). Life INSURANCE Company Defined. — For purposes of this subtitle, the term "life insurance company” means an insurance company which is engaged in the business of issuing life insurance and annuity contracts (either separately or combined with health and accident insurance), or noncancellable contracts of health and accident insurance, if—
(1) its life insurance reserves (as defined in-subsection (b)), plus
(2) unearned premiums, and unpaid losses (whether or not ascertained), on noncancellable life, health, or accident policies not included in life insurance reserves,
comprise more than 50 percent of its total reserves (as defined in subsection (c)).
Section 801(e) provides that "guaranteed renewable life, health, and accident insurance shall be treated in the same manner as noncancellable life, health, and accident insurance.”
Accordingly, petitioner will qualify as a life insurance company if its life insurance reserves, plus unearned premiums and unpaid losses on its renewable policies, exceed 50 percent of its total reserve (hereafter the reserve ratio test). The total reserves, as defined in section 801(c), include life insurance reserves, unearned premiums and unpaid losses not included in life insurance reserves, and all other reserves required by law. In the case of noncancelable and guaranteed renewable health and accident insurance policies, unearned premiums and unpaid losses are inserted in both the numerator and the denominator of this fraction — both above and below the line. If that is done in this case, it is conceded that petitioner easily qualifies as a life insurance company. Respondent contends that unearned premiums and unpaid losses are includable only in the denominator because petitioner’s policies are not noncancelable or guaranteed renewable. Respondent concedes that petitioner’s policies meet the industry definition of noncancelable or guaranteed renewable policies, but argues they are not noncancelable or guaranteed renewable within the meaning of the Federal income tax regulations. Sections 1.801-3(c) and 1.801-3(d) of the regulations provide the definitions of noncancelable and guaranteed renewable policies:
(c) Noncancellable life, health, or accident insurance policy. The term "noncancellable * * * policy” means a * * * contract * * * which the insurance company is under an obligation to renew or continue at a specified premium and with respect to which a reserve in addition to the unearned premiums * * * must be carried to cover that obligation. * * *
(d) Guaranteed renewable life, health, and accident insurance policy. The term "guaranteed renewable * * * policy” means a * * * contract * * * which is not cancellable by the company but under which the company reserves the right to adjust premium rates by classes * * * , and with respect to which a reserve in addition to the unearned premiums * * * must be carried to cover that obligation. * * *
In National States Insurance Co. v. Commissioner, supra, we examined the relevant committee reports from which these regulations were taken almost verbatim. We concluded that the committee reports (and the regulations) identify level premium contracts with long-term obligations that by their nature require reserves and were not intended to specify a particular reserving mechanism. We carefully examined the legislative history of the 1942 Revenue Act, since Congress in that act expanded the definition of a life insurance company to include noncancelable contracts of health and accident insurance, subsequently adding a provision (sec. 801(e) supra) requiring that guaranteed renewable contracts of health and accident insurance receive identical treatment. In referring to the "types” of contracts it was covering, Congress made the following statement:
Since noncancelable contracts of health and accident insurance require the accumulation of substantial reserves against increased future risks, the writing of such insurance is analogous to life insurance and the definition has been changed to permit such companies to be taxed as life insurance companies. [S. Rept. 1631, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 504, 611-612. Emphasis added.]!10]
What we said in National States Insurance Co., bears repeating here:
Congress included noncancelable contracts of health and accident insurance because they "require the accumulation of substantial reserves against future risks” and therefore the writing of such insurance is "analogous to life insurance.” Petitioner’s policies require "the accumulation of substantial reserves against future risks,” and these risks commence on the date the policy is issued. Both of these characteristics make petitioner’s policies "analogous to life insurance” in the specific sense Congress used those words.
Respondent recognizes the long-term' risks involved, but argues that the preliminary term method is defective because reserves are not actually computed under this method during the first 2 years. However, this hardly creates a marked difference from life insurance contracts. The preliminary term method had its origin in, and is used extensively in, the- life insurance field, and the use of the preliminary term method is clearly compatible with a policy’s status as life insurance. Congress identified the long-term risks necessitating reserves as the characteristic that is "analogous to life insurance,” and the preliminary term method has long been extensively used in reserving life insurance policies against those long-term risks. Since this method has been used without any adverse tax consequences to the life insurance status of those policies, the disparity respondent introduces here is at war with the legislative history. Indeed, the analogy to life insurance is enhanced, not diminished by the use of the preliminary term method. In identifying the "types of insurance” it intended to include as "analogous to life insurance,” Congress focused not on a particular reserving mechanism, but on the necessity for reserves arising from long-term risks. [National States Insurance Co. v. Commissioner, 81 T.C. 325, 337-338 (1983).]
In the legislative history of the 1942 Act, Congress, in discussing the "types” of insurance contracts it had in mind, also stated:
As the term is used in the industry, a noncancelable insurance policy means a contract which the insurance company is under an obligation to renew at a specified premium, and with respect to which a reserve in addition to the unearned premium must be carried to cover the renewal obligation. * * * [S. Rept. 1631, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 504, 612. Emphasis added.]
Again our comments in National States Insurance Co. bear repeating here:
Congress focused on, and adopted, the definition of a noncancellable insurance policy "as the term is used in the industry.” Indeed, Congress specifically stated that "As the term, is used in the industry, a noncancellable insurance policy means a contract which the insurance company is under an obligation to renew at a specified premium, and with respect to which a reserve in addition to the unearned premium must be carried to cover the renewal obligation.” S. Rept. 1631, supra, 1942-2 C.B. at 612 (emphasis added). See also H. Rept. 2333, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 372, 454 (using virtually identical language). This definition, which is the same today as when Congress adopted it, applies to GRHA policies with modifications not relevant to the present controversy. We think this is significant (cf. Alinco Life Ins. Co. v. United States, 178 Ct. Cl. 813, 373 F.2d 336, 353 (1967)), for the parties have stipulated and we have found that all of petitioner’s GRHA policies satisfy the industry definition.
The language of the disputed regulation is taken almost verbatim from the 1942 committee reports set out above. It is difficult to see how respondent can stipulate that petitioner’s policies meet the industry definition of a guaranteed renewable contract and at the same time contend that the language of the committee report (as incorporated in the regulations) precludes petitioner from qualifying. We believe the language of the committee report makes it clear that Congress intended to identify a product "type,” and employed the term noncancelable (and guaranteed renewable) "as that term is used in the industry.” The regulation, lifted virtually verbatim from the committee reports, must be interpreted accordingly. [National States Insurance Co. v. Commissioner, supra at 338-340.]
There are other reasons for deciding this issue for petitioner that are more fully set out in National States Insurance Co. v. Commissioner, supra, and need not be repeated here. It is fair to say that in both cases we have relied heavily on the legislative history of the 1942 Act from which the regulations in issue were taken virtually verbatim.11
Accordingly, we hold that petitioner’s renewable policies were "noncancellable” and "guaranteed renewable” within the meaning of sections 1.8Ql-3(c) and 1.801-3(d), Income Tax Regs. Petitioner thus qualified as a "life insurance company” under section 801 during the years in issue.
Decision will be entered under Rule 155.
Reviewed by the Court.