Atlantic Mutual Insurance Company v. Commissioner of Internal Revenue

PETITIONER:Atlantic Mutual Insurance Company
RESPONDENT:Commissioner of Internal Revenue
LOCATION:National Endowment for the Arts

DOCKET NO.: 97-147
DECIDED BY: Rehnquist Court (1986-2005)
LOWER COURT: United States Court of Appeals for the Third Circuit

CITATION: 523 US 382 (1998)
ARGUED: Mar 02, 1998
DECIDED: Apr 21, 1998

ADVOCATES:
George R. Abramowitz – for Petitioner
Kent L. Jones – for Respondent

Facts of the case

The Internal Revenue Code allowed property and casualty insurers to fully deduct “loss reserves,” or unpaid losses. The Tax Reform Act of 1986 altered the deduction formula. Under the Act, increases in loss reserves that constitute “reserve strengthening,” or additions to the loss reserve, were excepted from a one time tax benefit because it would result in a tax deficiency. Treasury regulation and the Commissioner of Internal Revenue interpreted the law to say that any increase in loss reserves constituted reserve strengthening. The Commissioner then determined Atlantic Mutual Insurance Company had engaged in reserve strengthening. The Tax Court disagreed with the government’s interpretation. It held reserve strengthening referred only to increases resulting from computational methods. The Court of Appeals reversed the decision. It held reserve strengthening to encompass any increase in loss reserves.

Question

Is the government’s interpretation of reserve strengthening correct in determining property and casualty insurers’ liability?

William H. Rehnquist:

We’ll hear argument next in Number 97-147, Atlantic Mutual Insurance Company v. Commissioner of Internal Revenue.

Mr. Abramowitz, you may proceed whenever you’re ready.

George R. Abramowitz:

Mr. Chief Justice, and may it please the Court–

The setting for this statutory interpretation case is, alas, subchapter L of the Internal Revenue Code, which contains, as this Court has recognized, highly specialized, carefully crafted rules for determining the taxable income of insurance companies.

The petitioner’s position in this case is straightforward and very simply stated.

In connection with a transition rule that Congress adopted in 1986 with respect to a change in the taxations methodology for unpaid losses of insurance companies, it provided fresh start relief, a very favorable provision, but excluded from that fresh start relief reserve strengthening.

Reserve strengthening was the term of art that Congress used in the statute.

Reserve strengthening had, in 1986, a decades old meaning in insurance tax law.

Ruth Bader Ginsburg:

But isn’t that a disputed point?

I mean, the Government tells us it didn’t, and said we have witnesses to say it didn’t have.

George R. Abramowitz:

The… I… it’s unclear, actually, Justice Ginsburg, the extent to which the Government disputes the history of the meaning of reserve strengthening in insurance tax law.

In this case below and in the Western National case the Government conceded that the term, reserve strengthening had a clear meaning in the context of life insurance taxation.

It disputed whether the meaning was clear in the context of property and casualty tax–

Ruth Bader Ginsburg:

Which is what we’re talking about here, and they had two witnesses to say in property and casualty, at least, the meaning is not a term of art.

There are multiple meanings.

So–

George R. Abramowitz:

–The Government–

Ruth Bader Ginsburg:

–I’m just bringing that up to say that it isn’t… can’t be clear that it is a term of art in the kind of insurance we’re talking about.

George R. Abramowitz:

–In the context of this case it is petitioner’s position that the term, reserve strengthening, was a tax term of art, that Congress knew precisely what the term meant when it used it, that in fact the distinction between life insurance and property casualty insurance in this context is really not at all relevant.

The… subchapter L of the Internal Revenue Code covers both types of companies.

This provision applied to both… it’s been loosely called a provision that applies to property and casualty companies but, in fact, it applies to both life insurance companies and property and casualty companies and, indeed, the difference between life and… what we’re calling life insurance companies and property casualty companies really, in subchapter L of the Internal Revenue Code, is only a question of the relationship between the amount of reserves they hold to qualify as life insurance reserves and the amount of reserves they hold that are–

Sandra Day O’Connor:

Well, what are the differences in reserve accounting between the life insurance and the property and casualty insurance businesses?

George R. Abramowitz:

–Insofar as relevant to this case, Justice O’Connor, there are none.

There are differences, because obviously a life insurance policy covers one sort of risk and a property casualty insurance policy covers a different sort of risk.

Stephen G. Breyer:

Well, I thought there was a big difference.

I thought the difference with life insurance is, if I sell a policy today and I take the income in and I’m going to have to pay it out in 30 years, I use a bunch of statistical tables that tell me people’s life expectancy.

If I’m in the casualty business, at the end of the year in which I’ve received the premium I have to make what I’d call an educated guess about how many tornadoes… there were some tornadoes, but I mean, how many houses actually were flattened and how many people are out there with television sets that they haven’t put their property claim in yet, and there aren’t some tables I can go to.

I thought people sit there and they make educated guesses about to what extent the policy that was sold in year one is going to result in a claim for that year that I’ll have to pay out in year 10.

I thought that’s quite a big difference, so that seemed to me difference one, and difference two is that you had a sentence in the bill that would… they have a sentence in the bill that says, in the life insurance case, you know, strengthening is… does not… you know the sentence I’m referring to.

It’s right there.

Stephen G. Breyer:

It wins your case if you were in the life insurance, and it’s gone in your case, and they put it in in the Senate in your bill, and the House took it out.

So there we are.

We have a difference in practice, we have a difference in language in the bill, and we have a difference in the legislative history where you won your battle in the Senate and you lost it in the House.

Now, given that, how do you win the case?

George R. Abramowitz:

All right, I need to back up just a step, Justice Breyer.

The… first with respect to the comparability of the businesses, they surely cover two different types of risk.

I think Justice O’Connor’s question had to do with the nature of the reserves, and the reserves in both cases are based upon assumptions and methodologies, and that is the relevant point, because that is a point that is embedded in the definition of the term, reserve strengthening, and let me go to the question, if I may, of the sentence, because backing all the way up–

Anthony M. Kennedy:

I think that’s very important, and I think we should stay with the format of Justice Breyer’s question, but just taking the first part of his question to help us to understand these things, isn’t it true that in the life area reserves are usually changed because of methodologies and in the casualty area because of empirical reports that there have been… that there have been losses and so forth?

In the life area, people don’t say, oh, you know, this policyholder has just been diagnosed with cancer, we’re going to change the risk.

They don’t do that.

But in the casualty area, I take it they do.

Now, tell me if that’s wrong, but–

George R. Abramowitz:

–Well, in fact… that is correct, but in fact the comparable… when they make that change in the property casualty area that is the normal reserve increase.

When they make a change in the life area, the normal increase is the adjustment year by year that the actuaries have built in for additional interest assumptions and mortality adjustments and so on, but the–

Anthony M. Kennedy:

–So that, as a general matter, reserve changes… other than for the addition of new policies reserve changes are made in the life area because of methodology changes and in the casualty area because of empirical assessments about actual losses.

George R. Abramowitz:

–No, Justice Kennedy, I think actually I’m disagreeing with that point, because in the life area there are regular, routine, normal reserve changes each and every year, increases in reserves, adjustments to reserves.

Anthony M. Kennedy:

For what reasons?

George R. Abramowitz:

The formula for determining life insurance reserves has to do with determining the present value… the relationship between the present value of future benefits and the present value of future net premiums, and those things really adjust every year.

They simply have normal adjustments every year.

Anthony M. Kennedy:

And those are different than methodology changes.

George R. Abramowitz:

Exactly, and that’s the very important point I’m trying to make, that there is a fundamental comparability and certainly Congress was aware of this, because I want to go back to Justice Breyer’s question, that in the normal adjustments to reserves, things that happen without anything extraordinary, anything untoward or mischievous, potentially mischievous, and adjustments to reserves that result from changes in methods and assumptions.

It’s the latter item that really is the adjustment item that can produce distortion, and I think both in the context of 1984 and in the context of 1986 the well known reserve strengthening kind of standard was the protection that Congress built in to protect against distortion, to protect against anybody taking undue advantage of the fresh start rule.

David H. Souter:

Okay.

The plausibility of what you say about the comparability of the way adjustments are made depends, I guess, on understanding the kinds of nonmethodological adjustments that are made in the life insurance area and you gave that rather a quick treatment, as if we understood, and I don’t.

Could you explain some of those nonmethodological adjustments in the reserves in the life insurance area that make it comparable to the kind of adjustments, nonmethodological adjustments that are made in the property and casualty?

George R. Abramowitz:

Actually, it’s easier to think about it from the other side, Justice Souter.

The methodological assumptions happen in both cases, because actuaries determine reserves and actuaries determine formulas and actuaries change formulas and assumptions.

On the property casualty side, and I’m using that term in a… not an attack sense, just in the nature of that business… there are adjustments to reserves that result every year in a normal fashion by virtue of the existing formulas and existing methods that are used to determine those reserves.

David H. Souter:

Because insurance adjusters call in and they say, you know, there was a big loss, the roof fell in, things like that.

That’s the–

George R. Abramowitz:

That–

David H. Souter:

–The empirically based adjustments, in other words.

George R. Abramowitz:

–There is certainly that element, but that is just–

David H. Souter:

Okay.

Is there any comparable element in life insurance?

George R. Abramowitz:

–No.

On that element there is not.

David H. Souter:

Okay.

George R. Abramowitz:

On that element there is not, but that is just one element of a determination of property and casualty reserves.

In this case the petitioner had a substantial portion of its reserves determined on the basis of the formulas and methods that actuaries had in place for determining the incurred but not reported losses of the insurance company and for determining loss adjustment expenses of the insurance company, and those formulas are formulas that… there are many possibilities for those formulas, but the actuaries in this company simply selected a formula and a method to apply, and it’s that sort of formula that is… that was susceptible of being changed, adjusted, in manipulating the fresh start rule.

Antonin Scalia:

The formula’s not the problem.

That’s right, yes.

I’m still waiting to hear what nonformula factors exist in the life insurance area.

George R. Abramowitz:

Each and every year, life insurance reserves increase as a result… probably the simplest way to put this, of the insured becoming closer to death, or–

David H. Souter:

Right, but that’s… that’s considered in the formula, isn’t it?

I mean, that’s a function of the methodology that they use, and that kind… if I understand what you’re saying, that kind of adjustment does not reflect a change in methodology, it reflects an implementation of the methodology, and what I want to know is, what kind of reserve changes in the life area do not reflect implementations of previous methodology?

George R. Abramowitz:

–I would think those… the kinds that do not reflect implementations of previous methodology are the kind that involve changes in methods and assumptions.

I think–

Stephen G. Breyer:

I mean, isn’t this the case, that suppose I have an insurance company and I insure people in Jacksonville, Florida, for life insurance, and through some kind of total fluke a terrible disease breaks out, unpredictable, in Florida, not elsewhere.

Then I guess I could discover that through that fluke of happenstance my reserves were understated, and I guess that’s an example where you might need to strengthen reserves in life insurance without changing methodology.

Am I right?

I’m testing out my understanding of it.

George R. Abramowitz:

–I’m not sure… in your example, you simply discovered there was some… I’m sorry, I need to–

Stephen G. Breyer:

Suddenly you happen to be in a city where your insurance company is, and suddenly a lot more people died there than you’d think.

They have… they discover some genetic feature.

They discover some kind of a disease that breaks… forget it.

It’s not important.

You don’t have to answer.

I just–

George R. Abramowitz:

–I mean, I would think that ultimately that may require a change in methods and assumptions, but many of the things, underlying facts do require that–

Stephen G. Breyer:

–Okay.

You’re saying in life insurance it always requires changes in methods and assumptions, and in casualty it doesn’t, and therefore–

George R. Abramowitz:

–There–

Stephen G. Breyer:

–that’s probably your problem.

George R. Abramowitz:

–There are corrections of errors.

I think the respondent issued a ruling in 1994 that really addressed a variety of things that distinguished changes in methods from corrections of errors and other types of adjustments, but I think there is… from that direction there is clearly some distinction between the normal adjustments in property and casualty and normal adjustments in life.

But that is really I think the wrong direction to be looking at this case on, because I think if you assume that this is… this being the reserve strengthening exclusion from the fresh start benefit that Congress intended, and if you attribute to it an objective to prevent mischievous, artificial things, you know you’ve accomplished that, I think, when you have caught people who have adjusted their methods and assumptions.

I think frankly that is what Congress had to have meant when it used the term that it was well aware of.

I think you always have to keep in mind here that the respondent’s position and the regulation it wrote simply took the words, reserve strengthening, read them out of the Internal Revenue Code, read them out of the act and substituted the word, all increases.

It’s–

Ruth Bader Ginsburg:

Mr. Abramowitz, if we could go back to the second part of Justice Breyer’s question, that is, if one looked only at that Senate report one would say, you win, but the conference report seems to be much more inclusive than what you are now describing to us.

George R. Abramowitz:

–Justice Ginsburg, the conference report has, for all intents and purposes, the identical carve out from the fresh start rule.

Reserve strengthening is carved out.

The sentence in the Senate report that respondent has pointed out that Justice Breyer referred to had nothing whatever to do with the definition of reserve strengthening in a general way.

The sentence that the respondents pointed out and that Justice Breyer referred to is a sentence that relates specifically to the treatment of… in the life area, which is the comparable sentence, the treatment of reserves on newly issued contracts.

It in no way was intended by Congress to infuse the term reserve strengthening with its general, historic, longstanding meaning.

And in fact in 1984, when this provision, the fresh start, the carve out all appeared in DefRA, in the House bill there was no comparable sentence.

You didn’t need the sentence to define the term, reserve strengthening–

John Paul Stevens:

Well, am I correct… I just want to be sure about my memory.

Is it not correct that the 1984 statute didn’t use the term reserve strengthening?

George R. Abramowitz:

–No, Justice Stevens.

That is exactly the term it used.

John Paul Stevens:

Pardon me again?

Does it use the term, reserve strengthening–

George R. Abramowitz:

Yes, Justice Stevens.

John Paul Stevens:

–in the 1984 statute?

George R. Abramowitz:

Yes, precisely.

John Paul Stevens:

And it defined it as a change in methodology?

George R. Abramowitz:

No, it didn’t define it.

There was a sentence–

John Paul Stevens:

–I’ve got the statutes… the life insurance statute.

That’s the 1984–

George R. Abramowitz:

–Yes.

The life insurance… I’m sorry.

The life insurance statute had virtually the identical provision, an exception for reserve strengthening from the fresh start rule.

John Paul Stevens:

–And did it define the term, reserve strengthening?

George R. Abramowitz:

No, it did not.

There was a sentence that followed it that addressed the treatment of reserves on contracts issued during 1984, because Congress was concerned that there was some reason in that case to deal with people who… it had a mid year effective date, the 1984 act, and there was some reason to have a special rule to identify–

Antonin Scalia:

What was that–

–Which sentence made it clear that reserve strengthening meant what you say it means.

That sentence made that clear.

Your position is simply that the purpose of the sentence was not to make it clear.

The purpose of the sentence was not to define it, but you don’t deny that the sentence, whatever it was meant to do as a practical matter, makes it clear what reserve strengthening meant?

George R. Abramowitz:

–That sentence in 1984 was consistent with the notion that reserve practices were… were… changes in reserve practices involved reserve strengthening.

Antonin Scalia:

Changes in methodology.

George R. Abramowitz:

Yes.

John Paul Stevens:

Are those provisions of the 1984 statute quoted in any of the papers before us?

George R. Abramowitz:

Yes, Justice Stevens, on page–

John Paul Stevens:

Is it A-51?

George R. Abramowitz:

–A-51 in the petition for certiorari.

David H. Souter:

What was the reason for having a special rule with respect to the ’83 contracts?

You say that was what the sentence addressed, but I’ve never understood why it needed to address it.

George R. Abramowitz:

First off, it’s peculiar because it’s stated as a negative rule.

It is not stated as if one were expecting a definition of a reserve strengthening, reserve strengthening is, and it’s not stated that way even in the context of the 1984 context.

It says, reserve strengthening shall not include–

David H. Souter:

Right.

George R. Abramowitz:

–reserves on, and then what it really related to was reserve strengthening at the end of 1984, that that was consistent with practices at the end of ’83, and while I am… I can point to evidence that the sentence, and we have pointed to evidence that the sentence was not intended to define reserve strengthening, there really is no actual evidence as to what particular case Congress had in mind under that rule, but–

David H. Souter:

All right, then why… what is your answer, then, to this argument.

I mean, the argument is… would normally be raised, and the Government raises it, that the very fact that that sentence is in there saying, it shall not refer to this, implies that in the absence of that proviso it would refer to these kinds of practices.

Your answer to that was, well, there apparently was a need to have a particular rule with respect to contracts for this particular year, but if we don’t know what that reason was for a particular rule, then we’re back to the negative implication, and the negative implication seems to support, clearly supports the Government.

David H. Souter:

So I don’t understand in the… if you don’t have a particular explanation for why there was a need for that sentence for those… for contracts of those years, I don’t see how you get out of the negative implication.

George R. Abramowitz:

–Well, several things to point out.

The House bill in 1984 did not have the sentence.

The sentence came in, I believe, in the Senate bill with a view to accommodating the mid year effective date that existed for, or target date, announcement date for the change in 1984, and what the sentence I think had to do with was a need to provide some relief for some actions during 1984 that would have been captured under a normal definition of reserve strengthening.

But because they were taken and then adjusted by the end of 1984, Congress… the Senate first, and then ultimately the whole congress was providing a measure of relief for that situation, as long as the reserves did not exceed what the method… what reserves on the same method would have produced–

David H. Souter:

Well, maybe I don’t understand, but I… it seems to me that the companies could be taking those kinds of actions with respect to contracts entered into in any year, and why did they… why did they single out contracts entered into in one particular year?

George R. Abramowitz:

–Companies could take those actions with respect to contracts and enter into any year and, indeed, those are the very actions that are prescribed by the reserve strengthening rule.

I think there must have been a unique set of circumstances that existed with respect to particular companies and particular taxpayers for new contracts in 1984.

David H. Souter:

But we don’t know what it is.

George R. Abramowitz:

Congress didn’t tell you what it was, but they didn’t tell you in the House bill and they really didn’t… in 1986, when they got rid of the mid year effective date, in effect, the trigger, which started out in the Senate bill as a March… reserve strengthening after March 1, and the final conference bill modified that treatment.

It was going to be effective for reserve strengthening during calendar year 1986, and when they did that, they eliminated the sentence, because they eliminated the need to respond to certain actions during that year.

Sandra Day O’Connor:

Mr. Abramowitz, if we apply the Treasury regulation at issue here, does it answer the question of how we deal with this in the property and casualty context?

George R. Abramowitz:

Well, it provides a rule.

The problem is–

Yes.

George R. Abramowitz:

–Pardon?

Sandra Day O’Connor:

Yes.

It would answer the question–

George R. Abramowitz:

But it would–

Sandra Day O’Connor:

–if we apply the regulation, I assume.

George R. Abramowitz:

–Yes.

It would… you would apply the respondent’s interpretation and, I believe, frustrate the intent of Congress, because you would have cut back from effective date at the end of 1986 to effective date at the end of 1985–

Sandra Day O’Connor:

What deference do we owe in the income tax context to a Treasury regulation?

Is it an ordinary Chevron deference?

George R. Abramowitz:

–I think–

Sandra Day O’Connor:

You do not quarrel with that?

George R. Abramowitz:

–I do not quarrel with that.

I think that is the same standard that the Third Circuit applied.

I think the Third Circuit erred because it simply failed to give proper credit to the plain meaning of the term, reserve strengthening, and failed to–

John Paul Stevens:

May I… have you finished your answer to Justice O’Connor?

John Paul Stevens:

I want to ask you this question, looking at the statute.

I fumbled it a little bit before.

What if one read the words reserve strengthening in the life insurance statute to have exactly the same meaning that the Government says they have in the property casualty insurance and then reads the subparagraph saying, but we’re taking out of that broader definition those that do not involve a change in methodology.

Isn’t that the way… then the two… reserve strengthening would have the same meaning in both statutes.

George R. Abramowitz:

–You would, except you would have… you would have eliminated from the fresh start relief in the life area the vast… the overwhelming majority of reserve increases that were protected and intended to be the beneficiary of the fresh start relief, because you would have captured, as we were discussing earlier, all the increases, all the ordinary increases in life reserves.

Antonin Scalia:

No–

–You say there aren’t any.

They’re all methodological increases.

George R. Abramowitz:

No, I–

Antonin Scalia:

In the life area you haven’t given us any that would not come under the narrow meaning of reserve strengthening that you argue for.

George R. Abramowitz:

–All of the increases… life reserves, as I suggested earlier, grow each and every year by virtue of the formulas that are in place.

Antonin Scalia:

Right.

George R. Abramowitz:

In answering Justice Stevens’ question, if I apply the respondent’s rule to the life area, all those ordinary increases, all of them would have been denied and separated–

Antonin Scalia:

No.

George R. Abramowitz:

–from the fresh start.

Antonin Scalia:

No.

They wouldn’t, because of the proviso that follows right after.

It says, it shall not apply if such computation employs the reserve practice used in the past.

George R. Abramowitz:

That rule, Justice Stevens, only applies to newly issued contracts, the contracts issued during 1984.

John Paul Stevens:

It doesn’t limit it to ’84, does it?

George R. Abramowitz:

The word issued appears in the… in the statute as it is written.

John Paul Stevens:

Any contract issued.

It doesn’t say issued in 1984.

George R. Abramowitz:

The Senate report, the Senate bill which first contained that sentence–

John Paul Stevens:

Well, stick with the text for a minute.

Let me be a Justice Scalia for a minute and just work with the text and nothing else for a second.

[Laughter]

If you have the text, why doesn’t that completely protect all changes that result from changes in methodology, because it excludes those that employ the same reserve practice.

George R. Abramowitz:

–It would if you read the word… if you read the word issued out of the statute.

The word issued is… Congress simply wouldn’t have used the word issued.

George R. Abramowitz:

It doesn’t add anything to the equation.

John Paul Stevens:

Do you have reserves on anything except issued contracts?

George R. Abramowitz:

You do not, but you have reserves–

John Paul Stevens:

Well, all reserves are reserves on contracts that have been issued.

George R. Abramowitz:

–That is certainly correct, Justice Stevens.

However, we know from the title to that sentence that when it was added in the Senate report, that it was intended to covered newly issued contracts, because it said, reserves on newly issued contracts.

Anthony M. Kennedy:

Does the Government agree with that?

Newly means what?

George R. Abramowitz:

Issued during the calendar year 1984.

That is exactly what the–

Antonin Scalia:

Issued during… I see.

George R. Abramowitz:

–I’m sorry, 1983.

I’m sorry.

Anthony M. Kennedy:

Does the Government agree with that interpretation?

George R. Abramowitz:

I do not think they agree with that interpretation.

Anthony M. Kennedy:

I’m… as to the contracts to which it’s applicable.

George R. Abramowitz:

I’m sorry?

Anthony M. Kennedy:

As to the insurance contracts to which it’s applicable.

George R. Abramowitz:

I… in their brief they cited that without the word issued in there, so I think maybe they don’t.

Stephen G. Breyer:

Okay.

Is… just to go back to your general point, as a tax lawyer, I’m curious… you are, I’m not, but the… is it proper to give Chevron deference to the IRS?

If that’s right, what do we do… do we give Chevron deference to the tax court?

Does the tax court give Chevron deference to the IRS?

Why do we have a tax court, then?

I mean, I’m worried about this conceptual point.

I’d like to get it right, and I’m not certain what the answer is, and it has much more implication that this case, and I just wondered what the tax court, which I guess was the Board of Tax Appeals, what their role is in all this if suddenly total Chevron authority is being given to the IRS.

George R. Abramowitz:

I think when I answered Justice O’Connor’s question I was really answering in the broad sense that at least in the past 5 or 6 years most courts interpreting… many courts interpreting tax regulations have, indeed, applied the Chevron standard.

If the intent in Congress is clear, they–

Stephen G. Breyer:

But I just think that has quite a lot of implication and I don’t know what the right answer to that is.

George R. Abramowitz:

–I think even the tax court–

Stephen G. Breyer:

And the tax court just defers to the IRS?

George R. Abramowitz:

–The tax court–

Is that… why do we have them, then?

Anyone could do–

George R. Abramowitz:

–Well, they’re a court.

They’re not an agency or a, you know, agency making… rulemaking enterprise.

John Paul Stevens:

–Let me just ask one more question.

If you’re… if you are correct that reserve strengthening has well settled meaning in the industry and in the statute, it would seem to me that the proviso is unnecessary, the clause-2-shall-not-apply language.

In other words, it says clause 2 shall not apply if the computation was the same.

You wouldn’t need that proviso if reserve strengthening had the clear settled meaning that you say it had.

George R. Abramowitz:

Justice Stevens, you wouldn’t need it in the ordinary course.

You didn’t have it in the ordinary course.

You didn’t have it in the House bill and I think the only explanation I can give is that it appears that it is responsive to a set of circumstances where there were changes made during 1983 by a particular taxpayers and Congress… they still let them have their relief as long as their reserves at the end of 1983 were the same as they were at the end of 1982.

I would simply suggest that when you state a sentence… it would be extraordinary for Congress to state a sentence in the negative if that was their intended positive rule.

If there are no further questions, with the Court’s permission I’d like to reserve the remainder–

William H. Rehnquist:

Very well, Mr. Abramowitz.

Mr. Jones, we’ll hear from you.

Kent L. Jones:

Thank you, Mr. Chief Justice, and may it please the Court–

The term reserve strengthening has no plain and obvious meaning.

It is not defined in any dictionary or in any statute.

It lacks a consistent industry usage.

The scope and meaning of the term depends upon its context, and in the context of the Tax Reform Act of 1986 it is manifest that Congress consciously employed the term in its broadest sense to encompass any and all increases to existing reserves made during that year, the year that that act was pending before Congress.

Anthony M. Kennedy:

Now, I take it there’s a reason under your theory of the case that Congress used the term strengthen rather than increase.

Kent L. Jones:

Yes.

Anthony M. Kennedy:

And I… tell me if this is right.

It might not be right.

If it had used the word increase, then that wouldn’t have done the trick, because then any reduction for actual loss payments would have absorbed some real increases.

Kent L. Jones:

That’s absolutely right.

Reserves can… the dollar amount of reserves can change without us knowing, in the abstract, whether that strengthened or weakened the reserves.

The conference committee made that point.

Kent L. Jones:

It’s quoted at page 14 of our brief.

It says, in describing the types of additions to the reserves that the reserve strengthening provision in the ’86 act covers, the first example that it gives is an increase in an estimate of a reserve and then it says, paren, taking into account the amount of claims paid you have to take into account the amount of claims paid to know whether the reserve has been increased or strengthened.

You might know whether it had been increased, but you wouldn’t know whether it’s been strengthened.

Antonin Scalia:

Mr. Jones, could you tell me, the one thing that puzzles me about this is what is the evil that the statute is directed at on your interpretation of it?

I mean, I can see that it’s an evil if you’re… you know, if you’re playing games with the methodology and the Government wants to come down on that.

Kent L. Jones:

The–

Antonin Scalia:

If you’re just taking account of verifiable real life occurrences, what… why would the Government not want that to be taken into account?

Kent L. Jones:

–I wouldn’t want to use the word evil.

The problem that the statute addresses is a problem that Congress created in the ’86 act.

In the ’86 act, Congress did something very uncharacteristic.

They gave property and casualty insurance companies a double deduction.

That’s extraordinary in the tax law.

It’s extremely generous.

The only function of the reserve strengthening clause is never to deny a deduction.

It is only to limit the scope of this uncharacteristic double deduction.

What Congress did in 1986 was to say, well, you can have a double deduction for a portion of your insurance reserves, but we’re not going to let you increase that double deduction by increasing your reserves in 1986, the year that this bill was pending.

As Judge Halperin pointed out in his dissent in the Western Mutual case, what is anomalous about this statute is not the broad mechanical rule that Congress plainly intended to apply to reserve strengthening.

What was anomalous was that Congress allowed a double deduction in the first place, and that the breadth of the mechanical rule that Congress adopted for reserve strengthening is simply designed to reduce that anomaly that they created by permitting a double deduction in the first place.

Sandra Day O’Connor:

What kind of deference do you think we owe to a regulation of this kind?

Kent L. Jones:

Well, we have taken a position in this case that this is an interpretive regulation.

The standard that this Court has applied for interpretive Treasury regulations is set out in its opinions in the National Muffler Dealers case and United States v. Correll, and that is that interpretive regulation must be sustained if it is not plainly inconsistent with the statute and is not unreasonable in light of what Congress sought to do.

We–

Ruth Bader Ginsburg:

And that was a pre Chevron case.

Kent L. Jones:

–Yes.

Ruth Bader Ginsburg:

And it’s been working okay in the tax area.

Kent L. Jones:

Absolutely, and I’m… I’m not familiar of a reason why you shouldn’t cite Chevron on this case.

I’m just pointing out that you have–

Antonin Scalia:

You like that other test better.

Kent L. Jones:

–You have long applied another test, and I think that other test has… even if it has a different emphasis it has the same conclusion, but I think that there is a particular practical side to the National Muffler Dealers and Correll test.

And the practical side is that this agency really does make a careful study not only of the statute and the history of this provision but of the complicated surrounding and related provisions, and what the Court has said is that the agency is the master of the rules and it’s appropriate to give it special deference to recognize the function that it serves and to provide certainty.

Antonin Scalia:

Any other agencies we should treat specially?

Kent L. Jones:

I’m not representing any other–

Antonin Scalia:

And have sort of a super Chevron–

Kent L. Jones:

–I don’t really think it’s a super Chevron.

I think it’s a practical approach to the deference question.

I think the Court takes a practical approach to Treasury regulations and realizes that this agency is entitled to special deference because of its extraordinary intricacy of the details, and this case I think may well be a prime example of that.

Stephen G. Breyer:

–It’s a variation of Skidmore, possibly.

You said we give them the deference that they’re due in light of their power to persuade.

Kent L. Jones:

Well… okay.

I think the deference that’s due is in light of the subject matter, I frankly do, and I wouldn’t want to call it a super Chevron deference.

I just think it’s an application of the same principle in this specific context.

Ruth Bader Ginsburg:

Academic writers have said it’s Chevron minus.

Kent L. Jones:

Yes.

I think you could argue either side of it, and I certainly don’t think it’s been applied as a Chevron minus.

I don’t think the words are stronger, but I think the application of it is at least as strong as Chevron.

Sandra Day O’Connor:

Can we get the meaning of reserve strengthening from the statute alone?

Kent L. Jones:

I–

Sandra Day O’Connor:

Or do we have to look at that regulation to know what it means?

Kent L. Jones:

–I think you can get the meaning of the statute by the ordinary application of interpretive principles that the Court applies.

The text of the regulation makes clear the broad intent simply by the fact that the Court’s already discussed, which is that the Senate version of the bill had enclosed… included a limiting clause that would have made it applicable only to changes in reserves due to changes in methodologies.

That provision from the Senate bill was, of course, derived from the ’84 reserve strengthening provision that had applied that same language in describing the transitional rule for life insurance provisions.

Congress rejected that, took that provision out, and explained why they did so in the conference committee report and also Senator Wallop acknowledged the same thing.

Congress wanted a broad prophylactic cook book, mechanical rule to prevent any increases in existing reserves to be added to the double deduction that was otherwise permitted.

Sandra Day O’Connor:

Mr. Jones, if your position is the right one here, what differences are there at bottom between the life insurance reserve strengthening and the property and casualty reserve strengthening?

Kent L. Jones:

Well, the ’84 act governs the life insurance reserve strengthening provision, and it is limited to changes in reserves caused by changes in the reserve methodologies.

The ’86 act, as Congress could not have been more clear than stating in the conference report, and as the changes in the text also show, was designed to be much broader.

It was designed to cover three categories that the conference committee report discusses, changes in estimates of a particular reserve, changes in reserve methodology like in the ’84 area, and then to make the breadth of its intent perfectly clear said, any other unspecified or unallocated additions to reserves.

So yes, there would be a different application of the property and casualty reserve strengthening provision in the ’86 act than the prior provision for life–

William H. Rehnquist:

So for that period of time no increases of reserves qualify for the double deduction.

Kent L. Jones:

–For the eighty… in… no reserve strengthening in ’86, no reserve increases for existing reserves get the double deduction under the ’86 act.

Kent L. Jones:

That’s what this case is about.

Anthony M. Kennedy:

Now, you changed your position on the equivalence of the statutes in your brief to this Court or the lower court, or is that a mischaracterization?

Kent L. Jones:

I don’t… I don’t follow the question.

We haven’t changed our characterization of the statutes.

I think I know what you’re referring to.

Petitioner says in its reply brief that we’ve changed our pitch, if you will, about whether there had been a prior usage in the life insurance industry, about what in the life insurance industry reserve strengthening was used.

That’s a misrepresentation of our position.

What we have done in our brief is respond to a new argument that petitioner is making.

In the courts below, petitioner relied on the proposition that industry usage showed the plain meaning of the term, but the record in this case and its own witnesses don’t support that.

Its own witnesses acknowledge there are many different uses of the term and there is no well defined application of reserve strengthening in the property and casualty industry, so petitioner has abandoned the position about what industry usage means.

What they argue here is that reserve strengthening is what they call a tax term.

It has a tax meaning that somehow exists wholly apart from industry usage and apart from legislative intent.

There isn’t such a thing as a tax term of that ilk.

There are some tax terms like capital gains and ordinary and necessary business expenses that have distinctive meanings.

Reserve strengthening is an industry term.

It draws its meaning from industry usage.

The industry usage is mixed and depends on context and in the context of the ’86 act Congress meant to give it its broadest scope.

Anthony M. Kennedy:

And you have always interpreted the term to mean the same in the ’84 and the ’86 act, subject, of course, to the fact that there’s a qualification in the ’84 act.

Kent L. Jones:

Yes.

We have interpreted the term the same way, but what I thought you were asking me about was, do we accept that in the life insurance industry usage, not this tax term of art idea, but that there was an industry usage in life insurance to refer to reserve strengthening as meaning a change in reserve methodology.

We don’t dispute that.

What we have always disputed is that no such industry usage applies to property and casualty insurance, that the term has different meanings and different contexts, and that’s what the witnesses in this case acknowledged, and that’s certainly what the conference committee report of this legislation indicates.

The–

Anthony M. Kennedy:

Well, let me just do it one more time.

You have always taken the position that the term, reserve strengthening, means the same in each act.

Kent L. Jones:

–The only–

Anthony M. Kennedy:

Subject, of course, to this special clause that’s in the ’84 act.

Kent L. Jones:

–Yes.

It’s only been used twice, so it’s easy to answer that question.

It doesn’t appear anywhere in the Internal Revenue Code.

Kent L. Jones:

The only two times where this term has been used is in the ’84 transitional rule and in the ’86 transitional rule, and in the ’84 rule it was confined by this phrase about it doesn’t apply unless you’ve changed your methodology, and in the ’86 rule that phrase was deleted.

So the term has been used by Congress with the same meaning in both places.

It’s just that in the ’84 act they limit it with the additional language that they didn’t use in ’86.

David H. Souter:

I thought maybe… help me out on this.

I thought at one point you were saying to Justice Kennedy that the difference in agency usage in the life area was such that the proviso simply conformed the term exactly to the way the life people were using it.

That’s not what you mean.

Kent L. Jones:

It may be that that’s the effect of the proviso.

David H. Souter:

Yes.

Kent L. Jones:

But I don’t think that was the object of it.

I mean, you can’t look at the proviso and say… if you look at the proviso in ’84 and you think that reserve strengthening means what petitioner says, well, you don’t need the proviso.

David H. Souter:

That’s right, yes.

Kent L. Jones:

And so it must have meant… if you will, it must have meant something more, and what… it certainly can mean more, and–

David H. Souter:

At least have been capable of meaning more.

Kent L. Jones:

–It’s certainly capable of meaning more, and in the ’86 act, clearly Congress wanted it to mean more to prevent this double deduction from being expanded beyond what they were willing to tolerate.

Stephen G. Breyer:

I don’t know if you can correct my problem with the double deduction.

I couldn’t quite understand it.

The reason I couldn’t understand it when I looked at your example was, I understood the idea of a person having a reserve, and they then discounted it, wrote it down from $10 to $9, and normally that would mean you have to take a dollar into income, but Congress forgave that.

Then time passes, and 2 years go by, and at that point they pay the loss of $10, in which case they deduct that, and then they… they’ve increased their reserve by the 9, so you say, a ha, it’s 9, not 10.

It doesn’t offset.

But it should have grown to 10, so I mean, the whole point of the discount was that… was–

Kent L. Jones:

It doesn’t.

Stephen G. Breyer:

–Why doesn’t it grow to 10, and maybe it’s not worth going into.

Kent L. Jones:

You may be thinking of life reserves instead of property and casualty reserves.

Stephen G. Breyer:

In property and casualty reserves, you didn’t… didn’t they discount it, because they wanted to have an amount here in year one such that it would grow to the point where it equaled the amount that they’d have to pay out in year three?

Wasn’t that the whole purpose of discounting?

Kent L. Jones:

The–

Stephen G. Breyer:

And if that was, why didn’t it grow?

Kent L. Jones:

–The reserve strengthening rule doesn’t cover 30–

Stephen G. Breyer:

No, it has nothing to do with reserve strengthening.

Kent L. Jones:

–Okay.

Stephen G. Breyer:

I’m just trying to figure out this problem of what you call the double deduction in your example in the–

Kent L. Jones:

All right.

Stephen G. Breyer:

–Don’t bother if it’s too complicated.

Kent L. Jones:

It is too complicated, but let me try.

[Laughter]

The double deduction will accrete this additional dollar of deduction over the period that the claim remains outstanding and unpaid, so if you’ve got… if you’ve brought it back to present value over 10 years you will accrete a portion of that over that 10-year–each of that 10-year period, so you get the double deduction as time goes by.

Stephen G. Breyer:

But then, by the time you got to pay it out the reserves should have equaled 10, not 9.

Kent L. Jones:

Well, then you’ve fully gotten the double deduction over the–

Stephen G. Breyer:

Ah, because… because you mean, you took it a little… as it was growing each year.

Kent L. Jones:

–That’s right.

Stephen G. Breyer:

Okay.

I understand.

Thank you.

Kent L. Jones:

The only other point I think I need to address is the suggestion that the mechanical rule reaches absurd or anomalous results.

That argument’s wrong for three reasons.

The first is, what the regulation does is exactly what Congress wanted to be done.

It can’t be unreasonable for the agency to have adopted a rule that is precisely in conformance with what the conference committee explained reserve strengthening was supposed to mean.

Antonin Scalia:

You’re saying this is all gravy, so taking away any of it can’t possibly be unreasonable.

Kent L. Jones:

I think that’s… well, I think that’s exactly right.

That is exactly right.

It is not unreasonable… it would not have been unreasonable for Congress to have allowed 1 penny of double deduction.

Anthony M. Kennedy:

In your view, if there’s an old policy and an old loss in the casualty area, and it’s just discovered, can you increase the reserve for that without strengthening the reserve?

Kent L. Jones:

No.

If you had an existing policy… let’s say in 1986 you discovered a claim came up under a 1982 year.

Right.

Kent L. Jones:

Would that cause reserve strengthening in ’86, and the answer is, I don’t know.

The answer… the reason I don’t know is because you’ve got this account called reserve for claims incurred but not reported, and so you might simply transfer a portion of that reserve into a case reserve for this claim that you have now discovered that has now been reported, and if that’s what happened, then there’s been no reserve strengthening in ’86.

It might be that you didn’t do that.

You just created a new case reserve.

There was no corresponding reduction in the reserve for claims incurred but not reported, and yes, that would be reserve strengthening.

Antonin Scalia:

And in a way, if you didn’t do that you are effectively changing your methodology anyhow, aren’t you?

Kent L. Jones:

Well–

Antonin Scalia:

If you have that reserve for that very purpose and you don’t use it for that purpose.

Kent L. Jones:

–Well, that’s… you could look at it that way, but I think frankly that the whole concept of reserve methodologies doesn’t fit comfortably with property and casualty insurance, because property and casualty insurance look backwards.

They are an effort to estimate an indeterminate amount of damages for something that’s already happened.

Anthony M. Kennedy:

Well, if that’s so and we go strictly on an empirical basis, then it seems to me there ought to be an answer to my question one way or the other.

Kent L. Jones:

No, because it’s… a judgment is involved.

When the… in the property and casualty area, when they set up the new account–

Anthony M. Kennedy:

The judgment is, we found the old loss, we didn’t know about it, it hasn’t been included in our account, we’re going to add it.

Is that strengthening?

Kent L. Jones:

–I don’t think I can answer it better than I tried to the first time.

It depends on how you create the reserve.

If you create the reserve by saying, well, I’ve always had this account for claims incurred but not reported, and you use… take $10 out of that and create a case reserve for $10, it’s a wash.

It’s not a reserve strengthening.

You… insurance companies know today that they’re going to get claims coming along over a goodsized period of years, even though the claims have already been incurred, they haven’t been reported, and so they provide for that with a separate reserve for that kind of a claim, that situation.

And as we tried to describe in our brief, the problem with the factual hypotheticals that petitioner gives us is, they don’t give any consideration to that aspect of reserves, and they’re based upon what I think is fairly described as a frivolous suggestion that insurance companies have only two or three claims a year.

We’re supposed to look to the broad company wide data to decide whether reserve strengthening happened under the… under the regulation.

The regulation is designed to let the… or the statute is designed to let these insurance companies have their cake and eat it too.

It’s a double deduction, but it’s not as big a double deduction as they’d like.

It’s not as big a double deduction as Congress plainly wanted… was willing to give them.

All the regulation does is enforce the legislative intent, and under the principles of deference that this Court customarily applies, the agency’s reasonable interpretation should be sustained.

If there are no further questions–

William H. Rehnquist:

Thank you, Mr. Jones.

Mr. Abramowitz, you have 3 minutes remaining.

George R. Abramowitz:

It would not have been unreasonable for Congress to have not provided the reserve strength… the fresh start rule.

But Congress did provide the fresh start rule.

It is unreasonable for this agency, the Internal Revenue Service, to have cut back that rule in a way that frustrated the intent of Congress.

In effect, what this regulation does is make reserves at the end of 1985 subject to the fresh start and not reserves at the end of 1986.

The Congress had a very specific purpose in providing the reserve strengthening exception, whatever their purpose was for the broad relief they were providing, and that very specific purpose that it had had to do with artificial, manipulative advantage taking of the fresh start rule that they were providing.

The historic definition of reserve strengthening, the historic meaning of that term satisfied that congressional objective.

George R. Abramowitz:

Contrary to what respondent counsel just indicated, there was a 30-year history of the term reserve strengthening that began… it first appears in the legislative history for the 1959 act for life insurance companies.

It is in judicial decisions, it is in regulations, it is in revenue rulings for 30 years before Congress had… had it… actually had applied it in the 1984 act.

Now, it didn’t really have much reason to be in the statute before then because generally adjustments go two directions when you change methods or assumptions.

They can reserve increases or reserve decreases.

One is strengthening, one is weakening, so generally when you saw this in the statute from the ’59 act it was referred to as changes in basis, which went both directions.

But when they needed the rule that they adopted in 1984, they looked to a term of art that they understood, this term that they understood and that the Internal Revenue Service understood.

In Commissioner v. Keystone, Consolidated Industries, this Court, at respondent’s suggestion, identified the term, sale or exchange, as a term of art in tax law.

It is true that reserve strengthening doesn’t quite go to the breadth of the term, sale or exchange.

By the same token, for insurance tax lawyers and insurance taxation the term reserve strengthening has a very precise meaning.

That is the meaning that Congress intended.

To the extent that Senator Wallop indicated he had some concern about changes in that meaning, those concerns were reflected in his comments sometime after the act, but the more important point is, he expressed some concern that he certainly didn’t recollect any changes in definition that occurred or were discussed by the conferees.

William H. Rehnquist:

Thank you, Mr. Abramowitz.

The cas is submitted.