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deduction for “losses incurred” which represents unpaid
losses at the close of the taxable year comprises only
actual unpaid losses. See section 846 for rules relating
to the determination of discounted unpaid losses. These
losses must be stated in amounts which, based upon the
facts in each case and the company’s experience with
similar cases, represent a fair and reasonable estimate of
the amount the company will be required to pay. Amounts
included in, or added to, the estimates of unpaid losses
which, in the opinion of the district director, are in
excess of a fair and reasonable estimate will be disallowed
as a deduction. The district director may require any
insurance company to submit such detailed information with
respect to its actual experience as is deemed necessary to
establish the reasonableness of the deduction for “losses
incurred.” [Sec. 1.832-4(a)(5) and (b), Income Tax Regs.]
The validity of these longstanding regulations is well
established, see, e.g., Hanover Ins. Co. v. Commissioner, 69
T.C. 260, 272 (1977), affd. 598 F.2d 1211 (1st Cir. 1979);
Hanover Ins. Co. v. Commissioner, 65 T.C. 715, 719 (1976), and
is not in dispute.
Although the annual statement methodology is normally
controlling for tax purposes, when the annual statement
methodology is predicated upon the use of estimates, those
estimates must be the “best possible.” Bituminous Cas. Corp. v.
Commissioner, 57 T.C. 58, 78 (1971).
A reserve for unpaid losses is an estimate of the insurer’s
liability for claims that it will be required to pay in future
years. See Western Cas. & Sur. Co. v. Commissioner, 65 T.C.
897, 917 (1976), affd. on another issue 571 F.2d 514 (10th Cir.
1978). Unpaid losses may not be based on estimates of potential
losses that might be incurred in future years but instead must
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