1997 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

4-24-1997

Atl Mutl Ins Co v. Commissioner IRS

Precedential or Non-Precedential:

Docket 96-7424

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"Atl Mutl Ins Co v. Commissioner IRS" (1997). 1997 Decisions. Paper 89.

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1

 UNITED STATES COURT OF APPEALS 

 FOR THE THIRD CIRCUIT 

 ___________ 

 No. 96-7424 

 ___________ 

 ATLANTIC MUTUAL INSURANCE COMPANY, and 

 Includible Subsidiaries 

 vs. 

 COMMISSIONER OF INTERNAL REVENUE 

 Appellant

 ___________ 

 Appeal from the United States Tax Court 

 (Tax Court No. 93-25767) 

 ___________ 

 

Argued 

 March 13, 1997 

 Before: MANSMANN and LEWIS, Circuit Judges, 

 and MICHEL, Circuit Judge.* 

 (Filed April 24, 1997) 

 ___________ 

John S. Breckinridge, Jr., Esquire (ARGUED) 

James H. Kenworthy, Esquire 

LeBoeuf, Lamb, Greene & MacRae 

125 West 55th Street 

New York, NY 10019 

Frederick B. Lacey, Esquire 

LeBeouf, Lamb, Greene & MacRae 

One Riverfront Plaza 

Newark, NJ 07102 

 COUNSEL FOR APPELLEE 

* Honorable Paul R. Michel of the United States Court of 

Appeals for the Federal Circuit, sitting by designation. 
2

Gary R. Allen, Esquire 

David I. Pincus, Esquire 

Edward T. Perelmuter, Esquire (ARGUED) 

Loretta C. Argrett 

 Assistant Attorney General 

United States Department of Justice 

Tax Division 

P.O. Box 502 

Washington, D.C. 20044 

 COUNSEL FOR APPELLANT 

 ___________ 

 OPINION OF THE COURT 

 __________ 

MANSMANN, Circuit Judge. 

 In this appeal, we address the "fresh start" provision 

of section 1023(e)(3) of the Tax Reform Act of 1986. There 

Congress permitted property & casualty insurers a one-time 

forgiveness of income resulting from the change in computing 

"losses incurred deductions" from undiscounted to a discounted 

basis as mandated by newly enacted section 846 of the Internal 

Revenue Code. Specifically, the Commissioner challenges the 

decision of the Tax Court which invalidated Treas. Reg. § 1.846-

3(c) to the extent that it defines all additions to a property & 

casualty insurer's loss reserves as "reserve strengthening." 

 We find that the meaning of the term "reserve 

strengthening" in section 1023(e)(3)(B) of the Tax Reform Act of 

1986 is ambiguous. We thus turn to the legislative history to 

determine Congress' intent. Utilizing the deference principles 

of Chevron U.S.A., Inc. v. Natural Resources Defense Council, 

Inc., 467 U.S. 837 (1984), we conclude that Treas. Reg. § 1.846-

3(c) is based on a permissible construction of the Act and 
3

implements the intent of Congress in some reasonable manner. 

Accordingly, we will reverse the decision of the Tax Court. 

I. 

 The statutory provision at issue is section 1023 of 

Pub. L. No. 99-514, 100 Stat. 2085, 2399, of the Tax Reform Act 

of 1986 (TRA 1986), which added new section 846 of the Internal 

Revenue Code. In enacting section 846, Congress included two 

relief provisions--the "transition rule" and the "fresh start"--

to facilitate a smooth transition to the new rules. Atlantic 

Mutual Insurance Co. v. Commissioner, 71 T.C.M. (CCH) 2154, 2156 

(1996). The transition rule, set forth in section 1023(e)(2) of 

TRA 1986, provided that for purposes of computing the losses 

incurred deduction for 1987, the year-end 1986 reserves would be 

discounted.1 Absent this relief provision, section 846 would 

 

1. Property & casualty companies are taxed pursuant to 

I.R.C. §§ 831 through 835. Under section 832(a), the taxable 

income of such a company is defined as the gross income minus 

allowable deductions. Section 832(c)(4) provides that these 

deductions include "losses incurred" as defined in section 

832(b)(5). Prior to 1986, section 832(b)(5) defined "losses 

incurred" for all relevant purposes as the amount of "losses 

paid" during the year plus the increase (or minus the decrease) 

in "unpaid losses." In practice, the P&C company would deduct 

the full amount of the estimated total loss in the year of the 

loss-event, even though the claim might not be paid for several 

years. When the claim was paid, the company would not receive 

any additional deduction (assuming that the payment equalled the 

original estimate) because the payment would be offset by a 

corresponding reduction it its unpaid-loss reserve. 

 Prior to TRA 1986, property & casualty insurers 

received an unsolicited benefit because the tax laws failed to 

take into consideration the time value of money in calculating 

the deduction for losses incurred. Congress addressed this 

problem by enacting I.R.C. § 846 as part of TRA 1986, which 

provides for the discounting of unpaid losses. The new 

discounting rules apply to all taxable years commencing after 
4

have required property & casualty ("P&C") insurers to compare 

undiscounted 1986 reserves with discounted 1987 reserves for 

purposes of computing their losses incurred deductions for 1987. 

 As the Tax Court explained, "Such an `apples-to-oranges' 

comparison would have significantly reduced the losses incurred 

deduction for the 1987 tax year." Id. 

 Notwithstanding the relief provided by the transition 

rule, P&C insurers were still obligated to include in their 1987 

taxable income the excess of the undiscounted year-end 1986 loss 

reserves over the discounted year-end 1986 loss reserves, due to 

the application of I.R.C. § 481.2 To avoid the application of 

section 481, Congress allowed P&C insurers a one-time 

"forgiveness" of income under the "fresh start" provision of 

section 1023(e)(3) of TRA 1986. That section provides: 

(3) Fresh Start.-- 

 (A) In General.--Except as otherwise provided 

in this paragraph, any difference between-- 

 (i) the amount determined to be the 

unpaid losses and expenses unpaid 

for the year preceding the 1st 

taxable year of an insurance 

company beginning after December 

31, 1986, determined without regard 

to paragraph (2), [i.e., without 

discounting] and 

 (ii) such amount determined with 

regard to paragraph (2) [i.e., with 

discounting], 

(..continued) 

December 31, 1986. Tax Reform Act of 1986, Pub. L. No. 99-514, 

100 Stat. 2085, 2404. 

2. Normally, section 481 would require a taxpayer to 

recognize the excess as income, because the change in the basis 

for computing losses incurred deductions from an undiscounted to 

a discounted methodology constitutes a change in accounting 

method. In this circumstance, I.R.C. § 481 requires the taxpayer 

to make an appropriate adjustment to prevent it from obtaining a 

double deduction created by the change in accounting method. 
5

shall not be taken into account for purposes of the 

Internal Revenue Code of 1986. 

In substance, the fresh start rule overrides section 481 by 

excluding from taxable income the difference between the amount 

of the year-end 1986 undiscounted loss reserves and the 

discounted amount of such reserves. 

 Congress anticipated, however, the potential for abuse 

created by the fresh start provision -- that insurers could 

manipulate the fresh start provision by inflating their reserves. 

 To prevent such abuse, Congress enacted section 1023(e)(3)(B) to 

exclude any increases in loss reserves due to "reserve 

strengthening." Section 1023(e)(3)(B) provides: 

 (B) RESERVE STRENGTHENING IN YEARS AFTER 

1985.--Subparagraph (A) shall not apply to 

any reserve strengthening in a taxable year 

beginning in 1986, and such strengthening 

shall be treated as occurring in the 

taxpayer's 1st taxable year beginning after 

December 31, 1986. 

The meaning of the term "reserve strengthening," as used in 

section 1023(e)(3)(B), lies at the heart of the controversy 

before us. We turn now to the particular facts of this case. 

II. 

 The parties fully stipulated to the following facts 

before the United States Tax Court. Atlantic Mutual Insurance 

Co. (Atlantic) is the common parent of an affiliated group of 

corporations whose principal place of business is located in 

Madison, New Jersey. Organized in 1842 under the laws of the 

State of New York as a mutual marine insurer, Atlantic eventually 
6

expanded its insurance underwriting activities to include 

property & casualty insurance. Centennial Insurance Company, a 

wholly owned subsidiary of Atlantic, is a P&C insurance company 

included in Atlantic's consolidated income tax return. The 

Commissioner's notice of deficiency relates to the activities of 

both Atlantic and Centennial (collectively the "taxpayer"). 

 From 1985 through 1993, the taxpayer filed annual 

financial statements with the appropriate state insurance 

departments.3 P&C insurers are required to report estimates of 

amounts they expect to pay for losses that have already occurred 

on the annual statement. These estimates are commonly referred 

to as "loss reserves" (or simply "reserves"). 

 For the years in issue, case reserves constituted the 

majority of the taxpayer's loss reserves.4 The taxpayer set up 

its case reserves by assigning a claims adjuster to examine each 

reported claim and to estimate the amount, if any, that would be 

paid to resolve it. For all years at issue, the taxpayer's case 

 

3. Each annual statement was prepared in the format 

prescribed by the National Association of Insurance Commissioners 

(NAIC) in order to provide state insurance commissioners with 

information concerning a P&C insurer's financial condition. The 

accounting principles on which the NAIC-prescribed annual 

statement is based generally have been incorporated into the 

Internal Revenue Code sections applicable to P&C insurers. 

4. In its P&C insurance business, the taxpayer maintained 

three categories of loss reserves: (1) case reserves, which 

reflect estimates of amounts to be paid to resolve claims that 

have been reported to the taxpayer; (2) incurred but not yet 

reported (IBNR) reserves, which consists of estimates of amounts 

to be paid to resolve claims statistically presumed to have been 

incurred but not yet reported to the taxpayer; and (3) loss 

adjustment expense (LAE) reserves, which reflect estimates of 

administrative costs to be paid in settling or otherwise 

resolving claims. 
7

reserves totalled $255,655,141 at year-end 1985 and $277,705,661 

at year-end 1986. 

 The Commissioner tested for "reserve strengthening" by 

applying the formula set forth in Treas. Reg. § 1.846-3(c)(3) to 

each of the taxpayer's lines of P&C insurance for pre-1986 

accident years. Under the formula, the taxpayer's reserves at 

year-end 1985 were reduced by the claims and the loss adjustment 

expense (LAE) paid in 1986 with respect to those reserves. To 

the extent that, at year-end 1986, a reserve was greater than the 

amount determined under the formula, the excess was treated as a 

net increase to that reserve account (i.e., "reserve 

strengthening"). Where, at year-end 1986, a reserve was less 

than the amount determined under the formula, the difference was 

treated as a net decrease to that reserve account (i.e., "reserve 

weakening"). 

 The Commissioner determined that, at year-end 1986, the 

taxpayer's net "reserve strengthening" totalled $6,552,739. 

Pursuant to I.R.C. § 846, the Commissioner then discounted the 

$6,552,739, resulting in an understatement of the taxpayer's 1987 

income of $1,339,039. The Commissioner further determined that 

this understatement caused a deficiency of $519,987 in the 

taxpayer's 1987 income tax liability and, accordingly, issued a 

Notice of Deficiency on September 23, 1993. In response, the 

taxpayer petitioned the Tax Court for a redetermination of the 

deficiency. 

 After considering all of the evidence, the Tax Court, 

on February 22, 1996, issued its decision concluding that the 
8

taxpayer was not liable for the asserted deficiency. In reaching 

this conclusion, the Tax Court held the taxpayer's reserve 

increases did not constitute "reserve strengthening." Atlantic 

Mutual, 71 T.C.M. at 2159. The Tax Court found that the doctrine 

of stare decisis obligated it to reach the same result as that 

obtained in Western National Mutual Ins. Co. v. Commissioner, 102 

T.C. 338 (1994), aff'd 65 F.3d 90 (8th Cir. 1995), which the 

court found to be factually indistinguishable from this case. 

The Commissioner filed this timely appeal. 

 We have jurisdiction pursuant to 26 U.S.C. § 7482(a) 

and we exercise plenary review over a legal challenge to the 

validity of a treasury regulation. Tate & Lyle, Inc. v. 

Commissioner, 87 F.3d 99, 102 (3d Cir. 1996) (citing Mazzochi Bus 

Co., Inc. v. Commissioner, 14 F.3d 923, 927 (3d Cir. 1994)). 

III. 

 Initially, we must determine whether the meaning of 

"reserve strengthening" is clear from the plain language of 

section 1023(e)(3)(B). Our review of an agency's interpretation 

of a statute that it is empowered to administer is guided by the 

well-established principles of Chevron U.S.A., Inc. v. Natural 

Resources Defense Council, Inc., 467 U.S. 837 (1984); see also, 

Appalachian States Low-Level Radioactive Waste Commission v. 

O'Leary, 93 F.3d 103, 108 (3d Cir. 1996). The two-step inquiry 

in Chevron requires us to first determine "whether Congress has 

directly spoken to the precise question at issue." 467 U.S. at 

842. If the intent of Congress is clear from the plain language 
9

of the statute, then our inquiry ends there. If we conclude, 

however, that Congress is silent or the statute is ambiguous 

regarding the issue, then the second step of our inquiry is to 

determine whether the agency's interpretation is based on a 

permissible construction of the statute. Id. at 843. 

 Addressing the first prong of Chevron, we turn to the 

plain language of section 1023(e)(3)(B). Clearly absent from the 

text of the statute is any explanation of the meaning of the term 

"reserve strengthening." We must determine, therefore, whether 

Congress intended the meaning of reserve strengthening, as used 

in the life insurance industry, to apply to P&C insurers. The 

Tax Court, bound by its previous decision in Western National 

which concluded that reserve strengthening as employed in section 

1023(e)(3)(B) is a term of art adopted from the life insurance 

industry, rejected the Commissioner's argument that the meaning 

of "reserve strengthening" in the P&C insurance industry is 

ambiguous. We note the distinction, however, that the 

Commissioner did not present expert witnesses in Western 

National. 

 The expert testimony here makes clear that the term 

"reserve strengthening" as used in section 1023(e)(3)(B) is 

subject to more than one interpretation.5 Indeed, the Tax Court 

 

5. The Commissioner and the taxpayer introduced expert reports 

in the Tax Court proceedings concerning the meaning of "reserve 

strengthening" within the P&C industry. The taxpayer's first 

expert, Irene R. Bass, construed "reserve strengthening" as 

involving "a one-time (or, at least, unusual and non-periodic), 

significant change in the assumptions and/or methodologies used 

to compute the reserves which results in a material change to the 

relative level of adequacy of the total reserve inventory." Bass 

conceded, however, that "[w]ithin the context of the reserve 
10

(..continued) 

setting process, the term reserve strengthening is not a welldefined PC insurance or actuarial term of art to be found in PC 

actuarial, accounting, or insurance regulatory literature." She 

then opined that "the lack of a well recognized definition of 

reserve strengthening in PC insurance literature can be 

attributed to the recursive nature of the reserve setting process 

and the fact that identification of reserve strengthening is not 

a requirement of the normal process of setting reserves." 

 The taxpayer's second expert, W. James MacGinnitie, 

concurred with the expert opinion of Irene Bass. MacGinnitie 

then described the concept of reserve strengthening in terms of 

the adequacy of reserves to satisfy future claims, equating 

adequacy to reserve strengthening and inadequacy to reserve 

weakening. He further opined that this determination was one 

that could not be definitively made until all claims covered by 

the reserves in question had been finally settled. According to 

MacGinnitie, in order to determine whether reserve strengthening 

has occurred one must compare the adequacy of the current reserve 

for a line of business to the adequacy of a previous reserve for 

that same line of business. 

 The Commissioner submitted expert reports prepared by 

Raymond S. Nichols and Ruth Salzmann. In his report, Nichols 

stated: "In the property-casualty industry the term `reserve 

strengthening' has various meanings, rather than a single 

universal meaning. However, in determining a property-casualty 

insurer's underwriting income, `reserve strengthening' generally 

refers to a positive amount resulting from the difference between 

calendar year incurred losses and accident year incurred losses." 

 Nichols opined that "[a]ny definition of `reserve strengthening' 

that restricts the words to the idiosyncrasies of individual 

company reserve assumptions and methods will miss the impact of 

reserve strengthening during underwriting cycles. For this 

reason alone, the common definition of `reserve strengthening' 

does not restrict the meaning to changes in reserve assumptions 

and methods." 

 Finally, the Commissioner's second expert, Ruth 

Salzmann, proffered her definition of reserve strengthening: 

"Reserve strengthening (or reserve weakening) is a term used in 

connection with P/C income statements. It refers to the dollar 

change in the margin of adequacy in the beginning and ending 

reserves for unpaid losses for that accounting period. The 

change can be for whatever reason and for any amount. If ending 

reserves are more adequate (or less inadequate) than the 

beginning reserves, there is reserve strengthening in the 

accounting period and net income is understated; conversely, if 

ending reserves are less adequate (or more inadequate), there is 

reserve weakening and net income for the accounting period is 

overstated." 
11

in Western National commented that the opinions and testimony of 

the numerous expert witnesses failed to establish a "universal 

and precise definition of reserve strengthening." 102 T.C. at 

351 n.10. The Tax Court nonetheless found that it was able to 

glean from the expert testimony the conceptual elements of 

reserve strengthening as they are commonly used in the insurance 

industry; it concluded that the concept of reserve strengthening 

has the same meaning in the context of the P&C and life insurance 

business. Id. at 351 n. 10 and 354. We part company with the 

Tax Court's holding in this regard. 

 In determining that "reserve strengthening" has the 

same meaning for both life and P&C insurers, the Tax Court in 

Western National focused on the fact that Congress, in drafting 

the language of Subchapter L of the Internal Revenue Code, 

recognized the unique and highly specialized nomenclature of the 

insurance industry. Moreover, the court observed that "[i]n 

enacting the fresh-start provision of the DEFRA [Deficit 

Reduction Act of 1984], Congress used an industry term of art in 

a manner consistent with its traditional definition[]" within the 

life insurance business.6 102 T.C. at 359. Accordingly, the Tax 

Court concluded that "reserve strengthening" was a term of art 

 

6. When Congress enacted the fresh start provision for 

certain life insurance rules in DEFRA, it specifically defined 

"reserve strengthening" to include only changes in assumptions 

and methodology. The Commissioner argued that "reserve 

strengthening" has a different meaning in the P&C insurance 

industry. In rejecting this argument, the Tax Court "concluded 

that `Congress could not have expected a different quantitative 

or qualitative meaning for the term' depending on the type of 

insurer." Atlantic Mutual, 71 T.C.M. at 2158 (quoting Western 

Nat'l, 102 T.C. at 354). 
12

adopted from the insurance industry. Opining that the 

legislative history contained contradictory explanations and, in 

part, supported the Commissioner's regulatory position, the Tax 

Court nonetheless concluded that Congress intended "reserve 

strengthening" to be interpreted in a manner consistent with 

industry usage. Id. at 360.7

 The Tax Court's reliance on cases, revenue rulings and 

legislation involving life insurance reserves is misplaced. For 

federal income tax purposes, life insurance companies and P&C 

insurers are taxed in entirely separate manners. Gross income as 

well as loss reserves are computed on different bases and 

assumptions. Actuarial assumptions about interest rates and 

mortality rates are an integral part of computing future losses 

which form the basis of the loss reserves in life insurance. On 

the other hand, P&C loss reserves are determined primarily based 

 

7. The Court of Appeals for the Eight Circuit affirmed the 

decision of the Tax Court, holding that Treas. Reg. § 1.846-3(c) 

was invalid to the extent that it defines "reserve strengthening" 

in a manner contrary to industry usage. Western National Mutual 

Ins. Co. v. Commissioner, 65 F.3d 90, 93 (8th Cir. 1995). In 

reaching this conclusion, the court of appeals opined that 

Congress intended to deny the fresh start deduction only to those 

property & casualty companies that computed their 1986 unpaid 

loss reserves on the basis of methodologies or assumptions that 

were different from those employed in calculating the same 

reserves in prior years. Id. at 93. As a corollary to this 

conclusion, the court of appeals also found that the term 

"reserve strengthening" was not ambiguous. Id. (footnote 

omitted). Accordingly, the court held that it was not required 

to consider the legislative history to divine the meaning of 

"reserve strengthening." Id. The court of appeals nonetheless 

proceeded to examine the legislative history, "out of an 

abundance of caution," and determined that it failed to provide 

persuasive rationale for interpreting "reserve strengthening" 

contrary to industry usage. Id. We respectfully disagree. 
13

on past claims experience and the judgments of the individual 

claims adjusters. 

 In the life insurance industry, reserve strengthening 

constitutes an unusual increase resulting generally from a change 

in one of the fundamental reserve assumptions (i.e., interest 

rate, mortality rate, method), as contrasted to normal increases 

in life insurance reserves, which result from the receipt of 

additional premiums or accrued interest. We find it illogical to 

apply the life insurance definition of reserve strengthening to 

P&C insurers -- whose reserves are not predicated upon the same 

actuarial assumption. If we did so apply it, arguably there 

would never be any reserve strengthening in the P&C area since 

interest rates, mortality assumptions and methodologies are not 

underlying components of the P&C loss reserves. The Commissioner 

makes a persuasive argument that the differences between life 

insurance and P&C loss reserves "render the wholesale importation 

of life insurance concepts into the P&C unpaid-loss reserve area 

quite dubious at best." 

 The revenue rulings cited by the Tax Court and the 

taxpayer8 are inapposite to the issue of reserve strengthening by 

P&C insurers. These revenue rulings address life insurance 

reserves maintained by P&C insurers who also write life 

insurance. In both rulings, the taxpayers requested advice on 

how to compute life insurance reserves in a given factual 

situation. The rulings do not define reserve strengthening with 

 

8. Rev. Rul. 65-240, 1965-2 C.B. 236, Rev. Rul. 78-354, 

1978-2 C.B. 190. 
14

respect to P&C loss reserves in the context of life insurance 

reserves. 

 Moreover, we find that the reserve strengthening 

provision in DEFRA differs from the provision in TRA 1986 and, 

thus, supports the Commissioner's argument that Congress did not 

intend to import the life insurance definition of reserve 

strengthening into section 1023(e)(3)(B). The 1984 statute 

specifically links reserve strengthening by life insurance 

companies to changes in the reserve practice used on the most 

recent annual financial statement. A similar limitation was 

contained in the Senate amendment to section 1023(e)(3)(B) but 

was intentionally eliminated by the Conference Committee. The 

Supreme Court addressed a similar situation involving the RICO 

statute and held: 

[W]here Congress includes particular language in one 

section of a statute, but omits it in another 

section of the same Act, it is generally 

presumed that Congress acts intentionally and 

purposely in the disparate inclusion or 

exclusion. Had Congress intended to restrict 

§ 1963(a)(1) to an interest in an enterprise, 

it presumably would have done so expressly as 

it did in the immediately following 

subsection (a)(2). * * * The short answer is 

that Congress did not write the statute that 

way. We refrain from concluding here that 

the differing language in the two subsections 

has the same meaning in each. We would not 

presume to ascribe this difference to a 

simple mistake in draftsmanship. 

Russello v. United States, 464 U.S. 16, 23-24 (1983). 

Accordingly, the reserve strengthening provision of DEFRA does 

not support the taxpayer's position here. 
15

 Given the lack of an explicit statutory definition of 

reserve strengthening, the conflicting definitions of reserve 

strengthening provided by the expert witnesses, and our finding 

that the meaning attributed to reserve strengthening in the life 

insurance industry is not applicable to P&C insurers, we conclude 

that the meaning of "reserve strengthening" is ambiguous. 

Accordingly, we find the Tax Court erred as a matter of law in 

holding that the meaning of reserve strengthening in section 

1023(e)(3)(B) was plain. 
16

IV. 

 Because we find the meaning of the term "reserve 

strengthening" ambiguous with regard to P&C insurers, we turn to 

the second prong of the Chevron inquiry. In so doing, we are 

required to take a deferential approach to ascertaining whether 

the agency's interpretation is a permissible one. Appalachian 

States Low-Level Radioactive Waste Commission v. O'Leary, 93 F.3d 

at 110. Thus, "we must determine `whether the regulation 

harmonizes with the plain language of the statute, its origin, 

and purpose. So long as the regulation bears a fair relationship 

to the language of the statute, reflects the views of those who 

sought its enactment, and matches the purpose they articulated, 

it will merit deference.'" Id. (quoting Sekula v. F.D.I.C., 39 

F.3d 448, 452 (3d Cir. 1994)). 

 We begin our analysis by turning to the legislative 

history of section 1023(e)(3)(B). The provision requiring P&C 

insurers to discount their loss reserves originated in a House 

bill. H.R. 3838, 99th Cong., 1st Sess., §§ 1021-1027 (1985). In 

the Senate version, the provision was amended to include the 

fresh start provision as well as the exclusion for reserve 

strengthening. The pertinent language of the Senate bill states: 

 (3) FRESH START.-- 

(A) IN GENERAL.--Except as otherwise provided in 

this paragraph, any difference between the 

amount determined to be the unpaid losses and 

expenses unpaid for the year preceding the first 

taxable year of an insurance company beginning 

after December 31, 1986, determined without 

regard to paragraph (2), and such amount 

determined with regard to paragraph (2), shall 

not be taken into account for purposes of the 

Internal Revenue code of 1954. 
17

 (B) RESERVE STRENGTHENING AFTER MARCH 1, 1986. 

[The fresh start provision] shall not apply to any reserve 

strengthening reported for Federal income tax 

purposes after March 1, 1986, for a taxable year 

beginning before January 1, 1987, and such 

strengthening shall be treated as occurring in 

the taxpayer's 1st taxable year beginning after 

December 31, 1986. The preceding sentence shall 

not apply to the computation of reserves on any 

contract if such computation employs the reserve 

practice used for purposes of the most recent 

annual statement filed on or before March 1, 

1986, for the type of contract with respect to 

which reserves are set up.

H.R. 3838, 99th Cong., 2d Sess., § 1022(e) (as reported by the 

Senate Finance Committee, May 29, 1986) (emphasis added). The 

Senate Finance Committee explained this provision as follows: 

Any reserve strengthening after March 1, 1986, is to be 

treated as reserve strengthening for the 

first taxable year beginning after December 

31, 1986. The committee intends that any 

adjustments to reserves that are attributable 

to changes in reserves on account of changes 

in the basis for computing the reserves 

(i.e., reserve strengthening or reserve 

weakening) in a taxable year beginning before 

January 1, 1987, are not taken into account 

in determining taxable income after the 

effective date. 

S. Rep. No. 99-313, 1986-3 C.B. (Vol. 3) 510. 

 The Conference Committee reconciled the differences 

between the House and Senate versions of H.R. 3838 by eliminating 

the last sentence of the Senate amendment (section 1022(e)(3)(B)) 

that linked reserve strengthening to changes in reserve setting 

practices. Although the final bill did not define "reserve 

strengthening," the Conference Committee report accompanying the 

final bill did, in fact, provide a definition of that term. The 

Conference Committee's definition, which was more expansive than 
18

that contained in the Senate Finance Committee report, reads as 

follows: 

Reserve strengthening is considered to include all 

additions to reserves attributable to an 

increase in an estimate of a reserve 

established for a prior accident year (taking 

into account claims paid with respect to that 

accident year), and all additions to reserves 

resulting from a change in the assumptions 

(other than changes in assumed interest rates 

applicable to reserves for the 1986 accident 

year) used in estimating losses for the 1986 

accident year, as well as all unspecified or 

unallocated additions to loss reserves. This 

provision is intended to prevent taxpayers 

from artificially increasing the amount of 

income that is forgiven under the fresh start 

provision. 

H.R. Conf. Rep. No. 99-841, 99th Cong., 2d Sess., at II-367 

(1986), reprinted in 5 U.S.C.C.A.N. 4075, 4455 (1986).9 Further 

evidence of the Conference Committee's expansion of the 

definition of reserve strengthening is found in Senator Wallop's 

criticism of the Committee's action: 

 Presumably, the intent is to prevent insurers 

from artificially increasing the opening 

reserve in order to increase income forgiven 

under fresh start. Implicit in this 

provision is the notion that reserve 

strengthening actions taken by insurance 

companies during 1986 for prior accident 

years is heavily motivated by the desire to 

avoid Federal income taxes. Nothing could be 

further from the truth. While it certainly 

can be acknowledged that increases in 

reserves decrease an insurance company's 

Federal tax burden, there are substantial and 

legitimate nontax reasons10 for increasing 

 

9. The Tax Court here acknowledged that the Conference 

Committee's definition of reserve strengthening was more 

expansive than that contained in the Finance Committee report. 

Atlantic Mutual, 71 T.C.M. at 2157. 

10. Senator Wallop offered two legitimate nontax reasons 

for increasing reserves: (1) reserves are based on estimates 

computed from statistical models that are subject to error and, 
19

the provision for unpaid losses in prior 

accident years. . . . 

 . . . 

The reserve strengthening definition as currently 

written in the conference report is 

arbitrary and inconsistent with one of the 

goals of tax reform, that is, fostering 

positive behavioral response from corporate 

and individual taxpayers toward the Federal 

tax system. 

 The Senate bill's reserve strengthening 

provision was fair. The Internal Revenue 

Service, as it does under current law, would 

combat abusive reserving practices. The 

conference modification substitutes a 

simplistic, cookbook approach that is 

entirely inappropriate and will likely create 

tensions causing companies to underreserve to 

the potential detriment of their 

policyholders. 

132 Cong. Rec. 32625 (daily ed. October 16, 1986). 

 Treas. Reg. § 1.846-3(c) (1992),11 which is predicated 

on the definition of "reserve strengthening" set forth in the 

Conference Committee report, provides in pertinent part: 

 (c) Rules for determining the amount of 

reserve strengthening (weakening)--(1) In 

general. The Amount of reserve strengthening 

(weakening) is the amount that is determined 

under paragraph (c)(2) or (3) to have been 

added to (subtracted from) an unpaid loss 

reserve in a taxable year beginning in 1986. 

 For purposes of [the fresh start], the 

amount of reserve strengthening (weakening) 

must be determined separately for each unpaid 

loss reserve by applying the rules of this 

(..continued) 

thus, must be reevaluated from time to time; and (2) P&C insurers 

have historically been underreserved and reserve strengthening 

for them occurs is a normal part of doing business. 

11. In 1988, the IRS issued a notice of forthcoming 

regulations regarding the application of section 1023(e)(3)(B). 

I.R.S. Notice 88-100, 1988-2 C.B. 439. Proposed regulations were 

issued in 1991, Proposed Treas. Reg. § 1.846-3, 56 F.R. 20161 

(May 2, 1991), and eventually, final regulations were promulgated 

on September 4, 1992. 
20

paragraph (c). this determination is made 

without regard to the reasonableness of the 

amount of the unpaid loss reserve and without 

regard to the taxpayer's discretion, or lack 

thereof, in establishing the amount of the 

unpaid loss reserve. The amount of reserve 

strengthening for an unpaid loss reserve may 

not exceed the amount of the reserve, 

including any undiscounted strengthening 

amount, as of the end of the last taxable 

year beginning before January 1, 1987. For 

purposes of this section, an "unpaid loss 

reserve" is the aggregate of the unpaid loss 

estimate for losses (whether or not reported) 

incurred in an accident year of a line of 

business. 

 . . . 

 (3) Accident years before 1986--(i) In 

general. For each taxable year beginning in 

1986, the amount of reserve strengthening 

(weakening) for an unpaid loss reserve for an 

accident year before 1986 is the amount by 

which the reserve at the end of that taxable 

year exceeds (is less than)-- 

 (A) The reserve at the end of the immediately 

preceding taxable year; reduced by 

 (B) Claims paid and loss adjustment expenses 

paid ("loss payments") in the taxable year 

beginning in 1986 with respect to losses that 

are attributable to the reserve. . . . 

In the explanation accompanying the final regulations, the IRS 

noted its reason for not adopting the commentators' suggested 

alternatives to the mechanical test: 

Congress did not limit the imposition of the reserve 

strengthening rule to tax motivated 

transactions. The legislative history 

indicates that for purposes of the fresh 

start adjustment the term "reserve 

strengthening" includes "all additions to 

reserves attributable to an increase in an 

estimate of reserves established for a prior 

accident year (taking into account claims 

paid with respect to that accident year), and 

all additions to reserves resulting from a 

change in the assumptions (other than changes 
21

in the assumed interest rates applicable to 

reserves for the 1986 accident year) used in 

estimating losses for the 1986 accident year, 

as well as all unspecified or unallocated 

additions to loss reserves". See 2 H.R. 

Conf. Rep. 841, 99th Cong., 2d Sess. II-367 

(1986), 1986-3 (Vol. 4) C.B. 367. Thus, 

Congress adopted an expansive and mechanical 

definition of reserve strengthening that is 

reflected in the final regulations. 

1992-2 C.B. 146, 148. 

 A close examination of Treas. Reg. § 1.846-3(c)(3) 

reveals that virtually all additions to reserves constitute 

reserve strengthening. The regulation also contains two narrow 

exceptions, neither of which applies here. The regulation can be 

reconciled with the Conference Committee's description of reserve 

strengthening which is all-inclusive: "all additions to reserves 

attributable to an increase in an estimate of a reserve 

established for a prior accident year (taking into account claims 

paid with respect to that accident year). . . ." H.R. Conf. Rep. 

No. 99-841. As it applies to reserve strengthening for pre-1986 

accident years, Treas. Reg. § 1.846-3(c) does not contradict the 

Conference explanation and is somewhat more generous to the 

taxpayer by providing two, albeit narrow, exceptions. 

 Our remaining inquiry is whether the regulation 

harmonizes with the articulated purpose of section 1023(e)(3)(B). 

 The purpose of the reserve strengthening exception, as 

articulated by the Conference Committee, is "to prevent taxpayers 

from artificially increasing the amount of income that is 

forgiven under the fresh start provision." The Commissioner and 

the taxpayer disagree as to the meaning to be ascribed to the 
22

Committee's use of the word "artificially" in delineating the 

purpose of the limitation. This dispute stems from the Tax 

Court's statement, in Western National, that the word 

"artificial" suggests a dichotomy between routine, normal 

additions to reserves and irregular or nonperiodic increases 

attributable to changes in actuarial assumptions or methodology. 

 The Tax Court's analysis, however, cannot be reconciled with the 

Conference Committee's broad definition of reserve strengthening 

which includes normal additions. Thus, the Conference Committee 

used the term "artificial" in a general sense, to refer to any 

increases in the reserves other than those resulting from the 

difference attributed to the discounting of reserves. To accept 

the Tax Court's construction of "artificial" would mean that the 

Conference Committee intentionally contradicted itself one 

sentence later. 

 In light of the above discussion, we cannot say that 

Treas. Reg. § 1.846-3(c)(3) is inconsistent with Congress' 

intent, as evidenced by the Conference report. Accordingly, we 

find that Treas. Reg. § 1.846-3(c) meets the second prong of the 

Chevron test and, thus, constitutes a valid interpretation of 

section 1023(e)(3)(B). 

 The taxpayer makes several arguments12 suggesting that 

the application of the Treasury regulation will cause anomalous 

 

12. The taxpayer further contends that despite numerous 

comments during the promulgation process as to the proposed 

regulation's infirmities, the Commissioner went forward in 

adopting a mechanical test for determining the amount of reserve 

strengthening. In particular, the taxpayer takes issue with the 

test's reserve-by-reserve approach as opposed to a claim-by-claim 

calculation. The Conference Report, however, supports a reserve-
23

results. These involve unrealistic assumptions about the size 

and number of claims. We agree with the Commissioner that, to 

the extent the mechanical test is flawed, the taxpayer should 

seek relief from Congress and not the courts. "Judges cannot 

override the specific policy judgments made by Congress in 

enacting the statutory provisions with which we are here 

concerned." United States v. Sotelo, 436 U.S. 268, 279 (1978). 

We must not focus on the Act's policy, but rather, on what 

Congress intended in enacting the statute.13 Id. at 280. 

 The Treasury Department considered proposed 

alternatives to Treas. Reg. § 1.846-3 but ultimately concluded 

that the interpretation was consistent with Congress' intent. As 

the Supreme Court observed in United States v. Correll, 389 U.S. 

299, 306-07 (1967): 

Alternatives to the Commissioner's . . . rule are of 

course available. Improvements might be 

imagined. But we do not sit as a committee 

of revision to perfect the administration of 

the tax laws. Congress has delegated to the 

Commissioner, not to the courts, the task of 

prescribing "all needful rules and 

regulations for the enforcement" of the 

(..continued) 

by-reserve approach ("all additions to reserves attributable to 

an increase in an estimate of a reserve established for a prior 

accident year.")(emphasis added). 

13. We agree with the Commissioner that the regulation need 

not provide the "perfect solution in every case to be valid." 

Indeed, in Mourning v. Family Publications Services, Inc., 411 

U.S. 356, 371 (1973), the Court held the fact that another 

remedial provision might be preferred irrelevant to determining 

whether the agency overstepped its authority. The Court stated: 

 "We have consistently held that where reasonable minds may 

differ as to which of several remedial measures should be chosen, 

courts should defer to the informed experience and judgment of 

the agency to whom Congress delegated appropriate authority." 

Id. at 371-72 (citations omitted). 

 
24

Internal Revenue Code. In this area of 

limitless factual variations, "it is the 

province of Congress and the Commissioner, 

not the courts, to make the appropriate 

adjustments." The role of the judiciary in 

cases of this sort begins and ends with 

assuring that the Commissioner's regulations 

fall within his authority to implement the 

congressional mandate in some reasonable 

manner. 

(footnote and citation omitted). Because Treas. Reg. § 1.846-

3(c) implements the intent of Congress in some reasonable manner, 

the Tax Court erred in holding that the regulation was invalid. 

V. 

 For the reasons set forth above, we will reverse the 

decision of the Tax Court. 

_________________________ 

TO THE CLERK: 

 Please file the foregoing opinion. 

 _____________________________ 

 Circuit Judge 
25