IRC 807 Life Insurance Reserves: Formula, Tax Method, and 70/30 Split

Under IRC 807, life insurance reserves for federal income tax purposes are computed contract by contract using a three-step formula: take the reserve produced by the NAIC-prescribed valuation method for the contract type, multiply it by 92.81 percent, and then set that amount against two boundaries — it cannot fall below the contract’s net surrender value, and it cannot exceed the statutory reserve required under state law. The change between the opening and closing balances of these reserves during the year becomes either a deduction or an income inclusion on the company’s return.

The Three-Part Formula for Each Contract

IRC 807(d)(1) applies the same test to every qualifying contract. Start with the reserve computed under the tax reserve method (described below). Multiply that amount by 92.81 percent. Compare the result to the contract’s net surrender value and take the greater of the two. Then check that figure against the statutory reserve the company is required to hold under state law, and cap it there.¹

The 92.81 percent factor is the Tax Cuts and Jobs Act’s replacement for the old system of prescribed interest rates and mortality tables. Instead of rebuilding the reserve with different actuarial inputs, Congress accepted the NAIC methodology and applied a flat haircut of roughly 7.2 percent.

The net surrender value floor matters most for cash-value life insurance policies where the surrender value has grown large relative to the computed reserve. If a policy’s net surrender value exceeds 92.81 percent of the reserve produced by the tax method, the surrender value becomes the tax reserve.

The statutory cap keeps the federal calculation from producing a larger deductible reserve than the state-mandated liability. In practice the cap rarely binds, because the 92.81 percent factor typically pushes the tax reserve below the statutory amount already.

Variable Contracts

Variable life insurance and variable annuity contracts use a modified version of the formula under IRC 807(d)(1)(B) because part of the reserve sits in a segregated account whose value moves with the market. The company first takes the greater of the contract’s net surrender value or the portion of the reserve separately accounted for under IRC 817. The 92.81 percent factor is then applied only to any excess of the full tax reserve method amount over that first piece. The two components add together, and the statutory cap still applies.¹

IRC 817 also requires the company to separately account for all income, deductions, assets, reserves, and liabilities tied to variable contracts, and to strip out the effect of asset appreciation and depreciation in the segregated account when computing reserve adjustments. Guarantee obligations that exceed what the contract would require without the guarantee are treated as general account liabilities.²

Which Reserves Qualify

Not every liability on an insurer’s books runs through the IRC 807 calculation. A reserve must first meet the definition of a “life insurance reserve” under IRC 816(b): it has to be computed using recognized mortality or morbidity tables and assumed interest rates, set aside for future unaccrued claims involving life, accident, or health contingencies, and required by state law (with limited exceptions for certain assessment companies).³

Section 807(c) then enumerates the specific items that go into the opening-and-closing-balance comparison:

Life insurance reserves as defined in 816(b) — amounts held for future death benefits, annuity payouts, and similar obligations.
Unearned premiums and unpaid losses.
Amounts needed to satisfy insurance and annuity obligations that don’t involve life, accident, or health contingencies at the time of computation, discounted at the appropriate interest rate.
Policyholder dividends and other amounts held at interest in connection with insurance and annuity contracts.
Premiums received before they’re due and liabilities for premium deposit accounts.
Reasonable special contingency reserves under group term life or group accident and health contracts maintained for retired-lives coverage or premium stabilization.

Anything outside this list is not part of the IRC 807 calculation. Asset adequacy reserves and other supplemental reserves that state regulators may require don’t appear in Section 807(c) and are not deductible through this provision.¹

How the Tax Reserve Method Is Set

The “tax reserve method” defined in Section 807(d)(3) is the starting point before the 92.81 percent factor is applied. The method depends on the contract type:

Life insurance contracts use the Commissioners’ Reserve Valuation Method (CRVM) as prescribed by the NAIC and in effect on the date the reserve is determined.
Annuity contracts use the Commissioners’ Annuities Reserve Valuation Method (CARVM), under the same timing rule.
Noncancellable accident and health contracts use whatever reserve method the NAIC prescribes for that contract type as of the valuation date.
All other contracts use the applicable NAIC-prescribed method, or, if none exists, a method consistent with the CRVM, CARVM, or other applicable method.

The timing rule is important. Since the TCJA, the method is determined as of the date the reserve is calculated, not the date the contract was issued.¹ Under the prior rules, a policy issued in 1995 would permanently use the valuation standards in effect then. Now, when the NAIC updates its methods, those updates flow through to the tax reserve calculation for existing contracts too.⁴

The CRVM itself computes the difference between two present values: the present value of the insurer’s future guaranteed benefits minus the present value of future modified net premiums.⁵ The modified net premium adjusts for the higher cost of insurance in the first policy year, producing a reserve that starts low and builds over the life of the contract. Mortality inputs come from NAIC-adopted tables; the 2017 Commissioners Standard Ordinary tables have largely replaced the 2001 CSO tables for recently issued policies.

How Reserve Changes Move Taxable Income

IRC 807(a) and (b) turn the year-over-year change in reserves into either an income inclusion or a deduction. The company compares its opening balance for the items listed in Section 807(c) against the closing balance (reduced by the policyholders’ share of tax-exempt interest and certain policy cash value increases). If the closing balance is larger, the excess is deductible. If the opening balance is larger, the excess is gross income.¹

When reserves grow, the company has committed more money to future policyholder obligations, and the code treats that commitment as a cost. When reserves shrink because policies lapse, claims are paid, or actuarial assumptions change, the released funds are taxed.

The reserve amount used for any taxable year is the mean of the reserve at the beginning and end of the year, under IRC 816(b)(4).³ This averaging keeps year-end policy transactions from distorting a single-day snapshot.

Reporting happens on Schedule F of Form 1120-L. Schedule F walks through each category of reserve from Section 807(c), computing opening and closing balances to arrive at a net increase or decrease. A net decrease flows to the income section of Form 1120-L (line 2); a net increase flows to the deductions section (line 10).⁶ Separate lines capture adjustments under Section 807(f) for changes in reserve computation methods.⁷

The 70/30 Company/Policyholder Split

The reserve deduction doesn’t flow through at full value. IRC 812 splits a life insurance company’s income and deductions between a “company’s share” and a “policyholder’s share.” Since 2018, the company’s share has been fixed at 70 percent and the policyholder’s share at 30 percent.⁸ The policyholder’s share reduces the closing balance of reserves under Section 807(b) for purposes of computing the net change, which limits the deduction accordingly.

Changes in Reserve Computation Method

When the basis for computing any Section 807(c) item changes from one year to the next, Section 807(f) treats the difference as a change in accounting method. The company computes the reserve at year-end under both the old and new methods, and the difference attributable to contracts issued before the current tax year is taken into account under IRC 481 as an adjustment requiring IRS consent.¹

This provision had large practical consequences when the TCJA took effect. Every life insurer shifted from the prior prescribed-rate calculation to the new 92.81 percent approach, generating a one-time reserve adjustment across the entire book of business. Section 807(f) channeled those adjustments through the Section 481 framework rather than letting the full impact hit a single tax year. If a company ceases to qualify as a life insurance company, any remaining balance of the 807(f) adjustment accelerates into the final year of life-insurance-company status.

The provision also comes into play whenever the NAIC updates its prescribed valuation methods. Because the tax reserve method references the NAIC standard in effect on the date the reserve is determined, an NAIC update to the CRVM or CARVM triggers a reserve recomputation for existing contracts, and the resulting difference is processed as an accounting method change.

1
Office of the Law Revision Counsel. 26 U.S. Code 807 – Rules for Certain Reserves
2
Office of the Law Revision Counsel. 26 U.S. Code 817 – Treatment of Variable Contracts
3
Office of the Law Revision Counsel. 26 U.S. Code 816 – Life Insurance Company Defined
4
Federal Register. Computation and Reporting of Reserves for Life Insurance Companies
5
National Association of Insurance Commissioners. Standard Valuation Law – Model Law 820
6
Internal Revenue Service. Instructions for Form 1120-L
7
Internal Revenue Service. Form 1120-L – U.S. Life Insurance Company Income Tax Return
8
Office of the Law Revision Counsel. 26 U.S. Code 812 – Definition of Companys Share and Policyholders Share