rp-02-74.pdf

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Part III

Administrative, Procedural, and Miscellaneous

26 CFR 601.204: Changes in accounting periods and methods of accounting.
(Also Part I, §§ 832, 846; 1.832-4, 1.846-1(b))

Rev. Proc. 2002-74

SECTION 1. PURPOSE

This revenue procedure clarifies that for certain insurance companies subject to
tax under § 831 of the Internal Revenue Code the composite method set forth in Notice
88-100, section V, 1988-2 C.B. 439, for computing discounted unpaid losses is
permitted but not required. This revenue procedure further provides alternative
methods for computing discounted unpaid losses that are permitted for insurance
companies not using the composite method, and sets forth a procedure for insurance
companies to obtain automatic consent of the Commissioner to change to one of the
methods described in this revenue procedure.

SECTION 2. BACKGROUND
.01 Section 831 imposes a tax for each taxable year on the taxable income of

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every insurance company other than a life insurance company. Section 832(a) provides
that, in the case of an insurance company subject to the tax imposed by § 831, the term
“taxable income” means gross income, as defined in § 832(b)(1), less the deductions
allowed by § 832(c).
.02 Section 832(b)(1) provides that the gross income of an insurance company
subject to the tax imposed by § 831 includes the combined gross amount earned during
the taxable year from investment income and from underwriting income, computed on
the basis of the National Association of Insurance Commissioners (NAIC) annual
statement. For this purpose, § 832(b)(3) defines underwriting income as premiums
earned on insurance contracts during the taxable year less losses incurred and
expenses incurred.
.03 Section 832(b)(5) defines losses incurred during the taxable year on
insurance contracts as follows: (1) from losses paid during the taxable year, deduct
salvage and reinsurance recovered; (2) to the results so obtained, add all unpaid losses
on life insurance contracts plus all discounted unpaid losses (as defined in § 846)
outstanding at the end of the taxable year and deduct all unpaid losses on life insurance
contracts plus all discounted unpaid losses outstanding at the end of the preceding
taxable year; (3) to the results so obtained, add estimated salvage and reinsurance
recoverable as of the end of the preceding taxable year and deduct estimated salvage
and reinsurance recoverable as of the end of the taxable year. The amount of
estimated salvage recoverable is determined on a discounted basis in accordance with
procedures established by the Secretary. See § 1.832-(4)(c) of the Income Tax
Regulations.
.04 Section 846(a)(2) provides that the amount of discounted unpaid losses as of
the end of any taxable year attributable to any taxable year is equal to the present value
of the losses (as of such time) determined by using (1) the amount of the undiscounted
unpaid losses as of such time; (2) the applicable interest rate; and (3) the applicable

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loss payment pattern.
.05 Section 846(d) instructs the Secretary to determine a loss payment pattern
for insurance companies to use for each line of business by reference to the historical
payment pattern applicable to such line of business. Section 846(d)(2) and (3) provide
rules for the Secretary and insurance companies to use in determining the loss payment
patterns. Each year, the Secretary publishes tables in the Internal Revenue Bulletin
setting forth the loss payment patterns and discount factors for that accident year. See,
e.g., Rev. Proc. 2001- 60, 2001-53 I.R.B. 643. Alternatively, § 846(e) permits insurance
companies to elect to use their own historical payment pattern for purposes of
computing discounted unpaid losses.
.06 After Congress enacted § 846, the Treasury Department published Notice
88-100, 1988-2 C.B. 439, to provide guidance with respect to several issues expected
to be addressed in forthcoming regulations under § 846. Section V of Notice 88-100
stated that regulations under § 846 would provide that taxpayers cannot use information
not appearing on their NAIC annual statements to allocate aggregate unpaid losses
among several accident years. Instead, the notice set forth a method for computing a
composite discount factor by (i) determining the fraction of losses unpaid at year-end for
each such accident year includible in the payment pattern for a given line of business,
(ii) determining the discounted fraction of losses unpaid for each of these accident
years, and (iii) dividing the sum of the fractions determined under (ii) by the sum of the
fractions determined under (i). The notice provided an example to illustrate the
operation of this formula.
.07 Sections 1.846-1, 1.846-2, and 1.846-3 of the regulations were promulgated
by T.D. 8433 in 1992. These regulations provided guidance on several issues
addressed in Notice 88-100. Accordingly, portions of Notice 88-100 were obsoleted in
1992 by the publication of T.D. 8433. Section V of Notice 88-100 was not, however,
obsoleted.

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SECTION 3. APPLICATION
.01 Insurance companies are permitted to use the method of section V of Notice
88-100 (the composite method) to compute discounted unpaid losses with respect to
accident years not separately reported on the NAIC annual statement. Beginning in
2002, the Secretary will publish composite discount factors for use by insurance
companies who use the composite method and have not elected under § 846(e) to use
their historical payment patterns. These factors will be published annually along with
the Secretary’s tables containing the § 846 loss payment patterns and discount factors
and the § 832 salvage discount factors. Insurance companies that have elected under
§ 846(e) to use their historical payment patterns should apply the composite method
based on their historical payment patterns.
.02 Insurance companies that do not use a composite method described in
section 3.01 should instead use the discount factors for the appropriate year in the
Secretary’s table for the appropriate line of business. If insurance companies have
unpaid losses relating to an accident year that is older than the last accident year for
which a discount factor is presented in the Secretary’s table, those unpaid losses should
be discounted using the factor for the last accident year in the Secretary’s table.
Insurance companies that have elected under § 846(e) to use their historical payment
patterns should compute the appropriate discount factors in accordance with § 846(e)
based on their historical payment patterns.
.03 An insurance company using a method provided in section 3.01 or a method
provided in section 3.02 to compute discounted unpaid losses, must use the same
method to compute discounted estimated salvage recoverable.
SECTION 4. SCOPE
This revenue procedure applies to insurance companies that are required to
discount unpaid losses under § 846.
SECTION 5. AUDIT PROTECTION FOR TAXPAYERS CURRENTLY USING A

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METHOD PROVIDED IN SECTION 3
An insurance company within the scope of this revenue procedure that is using a
method provided in section 3 of this revenue procedure on December 4, 2002, may
continue to use that method without filing a Form 3115, Application for Change in
Accounting. The use of a method provided in section 3 will not be raised as an issue in
any taxable year. Moreover, if an insurance company’s use of a method provided in
section 3 is already an issue under consideration (within the meaning of section 3.09 of
Rev. Proc. 2002-9, 2002-3 I.R.B. 327 (as modified and amplified by Rev. Proc. 2002-19,
2002-13 I.R.B. 696, modified and clarified by Announcement 2002-17, 2002-8 I.R.B.
561, and amplified, clarified, and modified by Rev. Proc. 2002-54, 2002-35 I.R.B. 432)
in a taxable year that ends before December 4, 2002, the issue will not be further
pursued by the Service.
SECTION 6. CHANGE IN METHOD OF ACCOUNTING
.01 In general. A change in an insurance company’s method of discounting
unpaid losses and estimated salvage recoverable to a method described in section 3 is
a change in method of accounting to which §§ 446 and 481 apply. An insurance
company that wants to change its method of accounting to a method consistent with this
revenue procedure must follow the automatic change in method of accounting
provisions in Rev. Proc. 2002-9, 2002-3 I.R.B. 327 (as modified and amplified by Rev.
Proc. 2002-19, 2002-13 I.R.B. 696, modified and clarified by Announcement 2002-17,
2002-8 I.R.B. 561, and amplified, clarified, and modified by Rev. Proc. 2002-54, 2002-
35 I.R.B. 432) with the following modifications:
(1) The scope limitations in section 4.02 of Rev. Proc. 2002-9 do not apply to an
insurance company that wants to make the change for its first taxable year ending on or
after December 4, 2002, provided the insurance company’s method of discounting
unpaid losses addressed in this revenue procedure is not an issue under consideration
for taxable years under examination, within the meaning of section 3.09 of Rev. Proc.

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2002-9, at the time the Form 3115 is filed with the national office.
(2) To assist the Service in processing changes in method of accounting under
this section of the revenue procedure, and to ensure proper handling, section 6.02(4)(a)
of Rev. Proc. 2002-9 is modified to require that a Form 3115 filed under this revenue
procedure include the statement: “Automatic Change Filed Under Rev. Proc. 2002-74.”
This statement should be legibly printed or typed on the appropriate line on any Form
3115 filed under this revenue procedure.
.02 Pending applications with national office. If an insurance company filed an
application or ruling request with the national office to make a change in method of
accounting to a method provided in section 3, and the application or ruling request is
pending with the national office on December 4, 2002, the insurance company may
change its method of accounting in accordance with this procedure. However, the
national office will process the application or ruling request in accordance with the
authority under which it was filed (including the year of change) unless, prior to the later
of March 4, 2003, or the issuance of the letter ruling granting or denying the requested
change, the insurance company notifies the national office that it wants to change its
method of accounting under this revenue procedure. If the insurance company timely
notifies the national office that it wants to change its method of accounting in
accordance with this revenue procedure, any user fee that was submitted with the
application or ruling request will be returned.
SECTION 7. EFFECTIVE DATE
This revenue procedure is effective for taxable years ending on or after
December 4, 2002.
SECTION 8. EFFECT ON OTHER DOCUMENTS
Rev. Proc. 2002-9 is modified and amplified to include this automatic change in
section 5 of the APPENDIX.
Section V of Notice 88-100 is obsolete to the extent it provides the composite

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method for computing discounted unpaid losses is mandatory.
DRAFTING INFORMATION
The principal author of this revenue procedure is Katherine A. Hossofsky of the
Office of Associate Chief Counsel (Financial Institutions & Products). For further
information regarding this revenue procedure, contact Ms. Hossofsky at (202) 622-3477
(not a toll-free call).