Full opinion text
OPINION AND ORDER OF THE COURT GIGNOUX, District Judge. This is a suit for refund of some $535,-946.24 federal income taxes and interest alleged to have been erroneously assessed to and collected from plaintiff for the calendar years 1958 through 1968. Plaintiff (the taxpayer) is a mutual life insurance company incorporated under the laws of the State of Maine and having its principal office at Portland. It is subject to taxation under Sections 801-820 of the Internal Revenue Code of 1954, as amended (the Code), 26 U.S.C. §§ 801-820 (1970), which sections were added to the Code by the Life Insurance Company Income Tax Act of 1959, 73 Stat. 112 (the 1959 Act). It is stipulated that the taxpayer has complied with procedures governing exhaustion of its administrative remedies and that it has properly invoked the jurisdiction of this Court under 28 U.S.C. § 1346(a)(1970). By its amended complaint, the taxpayer has presented in six counts six distinct and separate challenges to determinations affecting the taxpayer’s federal income tax liability made by the Commissioner of Internal Revenue. In addition, the United States has raised as a counterclaim a seventh issue as grounds for an offsetting adjustment against any recovery by the taxpayer. All seven issues presented arise under the 1959 Act. The action has been tried to the Court, without a jury, and has been fully briefed and argued by counsel. The following opinion contains the Court’s findings of fact and conclusions of law as required by Fed.R. Civ.P. 52(a). INTRODUCTION: THE TAXING FORMULA A description of the purposes and framework of the 1959 Act is needed at the outset to set the context of the issues presented by this action. The purpose of the 1959 Act was to come to grips with certain difficulties inherent in the income taxation of life insurance companies. The two principal difficulties identified by Congress were (1) the need to determine what portion of a company’s investment income is properly allocable to reserves which the company must hold for the purpose of meeting the company’s future obligations to policyholders, and what portion is properly considered income taxable to the company and (2) the problem of calculating underwriting income on a yearly, as opposed to a long-term basis. See S.Rep. No. 291, 86th Cong., 1st Sess., 1959 U.S.Code & Ad.News 1577-82. The first step in Congress’ approach to these difficulties was to decide that a life insurance company’s taxable income would be calculated in three distinct parts or “phases.” Id. at 1576. In Phase I the taxable portion of the company’s investment income — its “taxable investment income” — is computed. Sections 804-806. In Phase II the company’s gain (or loss) from operations — its “underwriting gain” — is computed. Sections 809-812. In Phase III the company’s taxable income owing to certain distributions to stockholders is computed. Section 815. Once each of these amounts has been computed, the company’s taxable income is then computed under Section 802(b) to equal the sum of (1) the lesser of Phase I or Phase II income; (2) 50% of the excess, if any, of Phase II income over Phase I income; and (3) Phase III taxable income, if any. The sum thus calculated— the company’s “life insurance company taxable income” — is then taxed at the normal corporate rate. Sections 802(a), 11. The issues presented in the instant case directly concern only Phase I of the overall computation, that is, the computation of the company’s taxable investment income. The purpose of Phase I, simply stated, is to divide the company’s investment income into two parts, that portion which is allocable to reserves held to meet the company’s obligations to policyholders, which is not taxed; and that portion which is available to the company for other purposes, which is taxed. The Phase I computation proceeds as follows: (1) For the taxable year in question, the company calculates its “gross investment income” by adding together interest, dividends, rents, royalties and other income derived from investments or any trade or business other than the insurance business. Section 804(b). From this amount the company deducts items allowed as deductions, such as investment and investment-related expenses. Section 804(c). The result is the company’s “investment yield” for that taxable year. Idem. (2) The company then calculates its “assets,” Section 805(b)(4), as of the beginning and end of the taxable year and computes the mean thereof. (3) The company then calculates its “current earnings rate” by dividing its investment yield by the mean of its assets. Section 805(b)(2). It also calculates its “average earnings rate” by computing the average of its current earnings rates for the present and last four taxable years. Section 805(b)(3). The lower of the current and the average earnings rates is the company’s “adjusted reserves rate.” Section 805(b)(1). (4) The company then calculates its “adjusted life insurance reserves.” Section 805(c). To do this: (a) The company first calculates the mean of its “life insurance reserves,” as defined by Section 801(b), as of the beginning and end of the taxable year. Section 805(c)(1)(A). (b) The company then calculates the weighted average of the interest rates which it has assumed for the purpose of calculating its life insurance reserves. Section 805(c)(2). This figure, which may be termed the company’s “average rate of assumed interest,” is then deducted from the adjusted reserves rate. (c) The company then determines its “adjusted life insurance reserves” by reducing its life insurance reserves by 10% for each 1% by which the adjusted reserves rate exceeds the average rate of assumed interest. Section 805(c)(1). (5) The company then multiplies its adjusted life insurance reserves by its adjusted reserves rate. The result, with certain adjustments not at issue here, is the company’s “policy and other contract liability requirements” (policy liability requirements) for the taxable year. Section 805(a)(1). (6) The company then divides its policy liability requirements by its investment yield. The result is the percentage of investment income which the company may allocate to reserves held for the purpose of meeting its obligations to policyholders. Section 804(a)(1). The remaining portion of the investment yield, less certain deductions not at issue here, represents the company’s taxable investment income. Sections 802(b)(1), 804(a)(2). This process is well illustrated by the following example drawn from the Senate Finance Committee’s report on the 1959 Act, S.Rep. No. 291, supra, 1959 U.S.Code Cong. & Ad.News 1593-94: Assume the following with respect to a life insurance company: Assets____________________________$1,000,000 Reserves __________________________ $900,000 Investment yield (or net investment income before small business deduction under the House bill)___________ $40,000 Company's current earnings rate____ percent__________________________ 4 Company's average earnings rate (for the current and 4 prior years)_____ percent__________________________ 3.75 Company's assumed rate______do_____ 2.5 . [T]he average earnings rate of 3.75 percent would be used in determining the policy and other contract liability requirements. . . . [F]or every 1 percent of increase in the interest rate used, over the company’s own assumed rate, the reserve is adjusted downward by 10 percent. Since here the 3.75 percent average earnings rate is 1.25 percentage points above the company’s assumed rate of 2.5 percent, the reserve is adjusted downward by 12.5 percent. Thus, the $900,000 of reserves is reduced for purposes of this computation to $787,500. As a result, the reserve requirements in this case would be $787,500 multiplied by 3.75 percent or $29,531. . . . [T]his $29,-531 is the policy . . . liability requirement. The next step is to express this requirement of $29,531 as a percentage of the $40,000 of investment yield. This is 73.8 percent of investment yield and, therefore, the life insurance company’s share of the investment yield is 26.2 percent. That percentage of the investment yield (26.2 percent of $40,000) is $10,469. . . . [After subtraction of deductions allowed by Section 804(a),] the company’s share of investment yield results in a phase 1 tax base of $6,364. Each of the seven issues presented in this action by the six counts of the amended complaint and the counterclaim relates to one or more of the six steps of the Phase I computations: 1. Count I poses the question whether certain mortgage escrow accounts are “assets” of the taxpayer within the meaning of Section 805(b)(4). See Step (2). 2. Count II poses the question whether the taxpayer must include in its gross investment income “unearned interest” on loans made against the cash surrender value of policies issued by it. See Section 804(b)(1)(A); Step (1). 3. Count III poses the question whether the taxpayer may deduct from gross investment income certain expenses incurred in the process of investigating possible real estate investment opportunities. See Section 804(c)(1); Step (1). 4. Counts IV through VI pose questions regarding whether the taxpayer may include certain items in its life insurance reserves. See Sections 801(b), 805(c); Step (4)(a). 5. The Government’s counterclaim poses the question whether deferred and uncollected premiums on life insurance policies issued by the taxpayer are properly included in the assets and life insurance reserves of the taxpayer. See Sections 801(c), 805(b)(4), (c); Steps (2), (4)(a). I. MORTGAGE ESCROW FUNDS (COUNT I) A. STATEMENT OF FACTS During the years in issue the taxpayer invested substantial sums in mortgage loans. These loans were evidenced by notes and secured by mortgages on real property. By their terms the mortgage notes were payable in periodic installments, usually monthly, of principal and interest. In addition, most mortgagors, pursuant to the terms of the loan or mortgage documents, made monthly payments of amounts estimated to be necessary to pay real estate taxes and hazard insurance premiums on the mortgaged property. These additional payments are referred to as “mortgage escrow funds.” The taxpayer acquired its mortgage loan investments in either of two ways: by direct negotiation with the prospective borrower, or subsequent to negotiation of the mortgage loan by an independent mortgage firm, referred to as a “mortgage correspondent.” In these latter instances, the mortgage correspondent offered the negotiated loan investment to the taxpayer either before or after the closing. If it accepted the offer, the taxpayer either provided the loan funds and closed the loan in its own name or purchased the loan subsequent to the closing, in which event the debt and mortgage were endorsed and assigned by the mortgage correspondent to the taxpayer. Under either arrangement it was customary that the mortgage correspondent thereafter had the responsibility for servicing the loan. During the years in issue the taxpayer had agreements with a number of mortgage correspondents providing that the correspondent would service each loan produced by it. Under the terms of these agreements, the correspondents agreed to collect and remit to the taxpayer, after deducting the servicing fee, the payments of principal and interest received by the correspondents from the mortgagors. In addition, the correspondents agreed to collect the required payments from the mortgagors for the payment of real estate taxes and hazard insurance premiums and to pay these items as they became due. All such amounts were paid directly by the mortgagors to the mortgage correspondents, and none of these amounts was remitted to the taxpayer at any time. The monthly payments made by the mortgagors representing the real estate taxes and hazard insurance premiums were deposited by the mortgage correspondents in local bank accounts upon which the correspondents would from time to time draw checks to pay, when due, the real estate taxes and hazard insurance premiums on the properties whose mortgages they were servicing. Typically, no interest on the funds held by the correspondents was paid to the mortgagors. No interest on these funds was paid to the taxpayer. B. DISCUSSION The issue presented by Count I is whether these mortgage escrow funds are includible in the “assets” of the taxpayer as defined by Section 805(b)(4). On its tax return for each of the years 1958 through 1968, the taxpayer did not include these funds in assets. The Commissioner determined, however, that the taxpayer should have included these funds and recomputed the taxpayer’s Phase I taxable income accordingly. The taxpayer challenges this determination. Section 805(b)(4) provides, in pertinent part: For purposes of this part, the term “assets” means all assets of the company (including nonadmitted assets), other than real and personal property (excluding money) used by it in carrying on an insurance trade or business. . The taxpayer does not rely on the Section’s exclusion of property “used by it in carrying on an insurance trade or business.” Rather, it contends that the escrow funds are simply not “assets of the company.” For the purpose of determining whether mortgage escrow funds are “assets of the company” within the meaning of Section 805(b)(4), the Court is persuaded that the proper test is that adopted by the Court of Appeals for the Fifth Circuit in Liberty National Life Insurance Co. v. United States, 463 F.2d 1027 (5th Cir. 1972). There, the court ruled that such assets included, id. at 1030, only . . . those assets of a life insurance company which are available to be, even though not actually, invested. This interpretation has been endorsed by the Tax Court. Bankers Union Life Insurance Co. v. Commissioner, 62 T.C. 661, 676-77 (1974). It is plainly in accord with the scheme of the 1959 Act: the purpose of calculating a company’s assets is to determine accurately its rate of return on its investment assets, Section 805(b); if funds not available for investment were included in assets, the result would be a distortion of the company’s rate of return. In addition, the interpretation adopted in Liberty National is in accord with the ordinary meaning of the term “assets”; and absent a legislative direction to the contrary or a danger that the purpose of a statute will be undermined, neither of which is present here, ordinary meaning will govern. Malat v. Riddell, 383 U.S. 569, 571-72, 86 S.Ct. 1030, 16 L.Ed.2d 102 (1966); Crane v. Commissioner of Internal Revenue, 331 U.S. 1, 6, 67 S.Ct. 1047, 91 L.Ed. 1301 (1947). Whether by application of the Liberty National rule or otherwise, every other court to consider the question has also held that mortgage escrow funds are not assets of a life insurance company within the meaning of Section 805(b)(4). Bankers Life Co. v. United States, 412 F.Supp. 62, 71-73 (S.D.Iowa 1976); Southwestern Life Insurance Co. v. United States, 75-1 U.S.T.C. ¶ 9321 (N.D.Tex.1975); Ohio National Life Insurance Co. v. United States, 75-1 U.S. T.C. ¶ 9125 (S.D.Ohio 1974); Franklin Life Insurance Co. v. United States, 67-2 U.S. T.C. ¶ 9515 (S.D.Ill.1967), rev’d on other issues, 399 F.2d 757 (7th Cir. 1968), cert. denied, 393 U.S. 1118, 89 S.Ct. 989, 22 L.Ed.2d 122 (1969); Jefferson Standard Life Insurance Co. v. United States, 272 F.Supp. 97, 125 (M.D.N.C.1967), aff’d, rev’d and remanded on other issues, 408 F.2d 842 (4th Cir.), cert. denied, 396 U.S. 828, 90 S.Ct. 77, 24 L.Ed.2d 78 (1969); National Life Insurance Co. v. United States, 521 F.2d 1406 (Ct.Cl.1975); Bankers Union Life Insurance Co. v. Commissioner, supra. The Government disagrees with the conclusion reached in the above cases. It argues that the mortgage escrow funds were within the control of the taxpayer and hence available for investment by it because, pursuant to the mortgage agreements with the mortgagors, the taxpayer, as mortgagee, was entitled to receive the escrow funds directly from the mortgagors. The record does not contain a typical mortgage agreement executed by or assigned to the taxpayer. The record does suggest that the taxpayer acknowledges that it had the right, as mortgagee, to receive the payments in question itself and was not obligated by the express terms of the mortgage agreements to hold these payments in trust for the mortgagors or to pay interest thereon to the mortgagors. The evidence clearly establishes, however, that the taxpayer nonetheless recognized an obligation to use these funds solely for the purpose of paying the mortgagor’s property taxes and hazard insurance premiums. To this end, the taxpayer contracted with the mortgage correspondents to have the correspondents retain these funds “in trust, as trustee for the mortgagor” and use them to make these payments as they fell due. The taxpayer received no interest from these funds, and the uncontroverted testimony was that this arrangement with its mortgage correspondents in no way reduced the servicing fees which the taxpayer paid the correspondents. The Government also argues that the taxpayer received an investment benefit from the mortgage escrow funds in that they helped make its loans more secure. But any such beneficial effect is merely incidental to the fact that the funds are paid and held to meet obligations of the mortgagors and cannot afford any basis for a finding that they were available for investment by the taxpayer. Bankers Union Life Insurance Co. v. Commissioner, supra, at 677. The evidence further establishes that the funds did not in any way have the effect of freeing other assets of the taxpayer not otherwise available for such purposes. See Liberty National Life Insurance Co. v. United States, supra, at 1031; Bankers Union Life Insurance Co. v. Commissioner, supra, at 677. The record in the present case clearly establishes that the mortgage escrow funds here under consideration were held in trust by the mortgage correspondents for the purpose of paying obligations of the mortgagors, that they were never held or available for investment by the taxpayer, and that they in fact belonged to the mortgagors and not to the taxpayer. The Court holds that the mortgage escrow funds held by the taxpayer’s mortgage correspondents do not constitute “assets” of the taxpayer within the meaning of Section 805(b)(4). II. UNEARNED POLICY LOAN INTEREST (COUNT II) A. STATEMENT OF FACTS Life insurance policies issued by the taxpayer which have cash surrender values provide that a loan may be obtained on the sole security of the policy at any time when a cash value is available and the policy is in force. Such loans are termed “policy loans.” The most common type of policy loan made by the taxpayer is the automatic premium loan, by which the premium is paid by borrowing against the cash surrender value of the policy. In addition, the policyholder may borrow against the cash surrender value for any other purpose he may choose. At the time a policy loan is made, the taxpayer charges the policyholder interest in advance for the period from that date to the next policy anniversary date. Thereafter, on each succeeding anniversary date, the taxpayer charges the policyholder one year’s interest in advance. For example, if a loan secured by a policy with an April 1 anniversary date is made on January 1, the policyholder is charged interest from January 1 through March 31. On each succeeding April 1 that any portion of the loan remains outstanding, the taxpayer charges the policyholder interest in advance for the ensuing policy year on the outstanding amount. When these interest charges are made, the taxpayer bills the policyholder for the interest. If the policyholder does not pay the advance interest in cash, the taxpayer makes a book entry, adding the advance interest charge to the loan balance through a method known as a loan discount. The taxpayer continues to add the interest to the loan balance on policy anniversary dates so long as the loan balance does not exceed the cash surrender value of the policy. With respect to automatic premium loans, the advance interest charge is never in cash and is always represented by a book entry. With respect to other types of loans, the first interest payment is in most cases a book entry. Thereafter, the annual interest charges are approximately evenly divided between cash payments and book entries. The policyholder has the right to repay a loan at any time, and, if he does so, the taxpayer calculates the exact number of days the loan has been outstanding and retains or collects from the policyholder only the interest for that many days. The “unearned interest,” that portion attributable to the remaining period of the policy year, whether paid in cash or entered on the taxpayer’s books, is refunded or credited to the insured, as the case may be. If the policyholder surrenders his policy for its cash value, the taxpayer similarly calculates the amount of interest attributable to the time prior to the date of surrender and refunds or rebates the remaining interest. If the policyholder dies, the principal amount of the loan plus the exact amount of interest attributable to the time prior to the date of death are deducted from the death benefit and the remaining interest is refunded or abated. The abatement or refunding of unearned interest in the event of repayment, surrender of the policy or death of the insured is required by the terms of the contract of loan. The parties have stipulated that the amount of unearned interest at the end of the calendar year which will actually become earned by the taxpayer in the following year is not determinable at that time with respect to any particular policy loan, as it is dependent upon whether the policyholder continues to live and whether he elects to repay the loan or surrender the policy for its cash value. For any loan which has not been earlier repaid, the taxpayer on December 31 of each year determines the amount of unearned interest, that is, the amount of interest previously paid or entered on its books which the taxpayer will earn between December 31 and the next anniversary date of the underlying policy. In the annual statement forms filed by the taxpayer with state supervisory officials for each of the years involved, unearned interest was excluded from gross investment income. The parties have stipulated that this treatment of unearned interest is consistent with the requirements of the annual statement prescribed by the National Association of Insurance Commissioners (N.A.I.C.) and required by Maine law, and is in accord with generally accepted accounting principles. B. DISCUSSION The question presented is whether Section 804(b)(1)(A) requires the taxpayer to report as gross investment income cash payments and book entry payments of policy loan interest which has not yet been earned as of the close of the taxable year. On its tax returns for each of the taxable years 1958 through 1968, the taxpayer computed its gross investment income from policy loans under the same method as used on its N.A.I.C. annual statement, and did not include its unearned policy loan interest. For each year the Commissioner determined that the taxpayer’s unearned interest on policy loans should have been included in gross investment income under Section 804(b)(1)(A) and accordingly increased the taxpayer’s gross investment income for each of the years in question. The taxpayer contests that determination. Section 804(b)(1)(A) defines a life insurance company’s “gross investment income” to include the gross amount of any interest income. The interest which the taxpayer earns on policy loans is eoncededly gross investment income within the meaning of the statute. The present dispute between the parties is a matter of timing, an instance of “the protracted problem of the time certain items are to be recognized as income for [tax] purposes.” Schlude v. Commissioner of Internal Revenue, 372 U.S. 128, 129, 83 S.Ct. 601, 602, 9 L.Ed.2d 633 (1962). Resolution of this dispute is governed by the accounting provisions of the Code, particularly Section 818(a). See also Sections 446, 451. The taxpayer is required under Section 818(a) to report its income under the accrual method of accounting. Section 818(a) provides: Method of accounting. — All computations entering into the determination of the taxes imposed by this part shall be made— (1) under an accrual method of accounting, or (2) to the extent permitted under regulations prescribed by the Secretary or his delegate, under a combination of an accrual method of accounting with any other method permitted by this chapter (other than the cash receipts and disbursements method). Except as provided in the preceding sentence, all such computations shall be made in a manner consistent with the manner required for purposes of the annual statement approved by the National Association of Insurance Commissioners. The accrual method of accounting referred to in Section 818(a) is defined in Treasury Regulation (26 CFR) 1.446-l(c)(l)(ii) (emphasis supplied): Accrual method. Generally, under an accrual method, income is to be included for the taxable year when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. The taxpayer contends that in reporting only the “earned interest” on policy loans, it was following the accrual method of accounting, as well as adhering to the accounting method required by the N.A.I.C. The taxpayer notes that interest is “compensation for the use or forebearance of money,” Deputy v. du Pont, 308 U.S. 488, 498, 60 S.Ct. 363, 368, 84 L.Ed. 416 (1939), and is necessarily earned only with the passage of time. Inasmuch as a portion of the full interest charged in advance to a policyholder will have to be repaid or returned to the policyholder’s account on the happening of any of several contingencies, the taxpayer argues, the right to receive such income cannot be regarded as “fixed” until earned. The Government contends that under its contracts with policyholders the taxpayer’s right to receive interest for the full period until the next policy anniversary date was indeed “fixed” at the date charged (albeit unearned and subject to partial repayment or reduction on the occurrence of a contingency). The accrual method of accounting, in the Government’s view, thus required that the unearned interest be included in the taxpayer’s gross investment income for the year in which it was charged. The Court agrees with the Government that at the time a policy loan is made the taxpayer acquires a “fixed right to receive” interest in advance and therefore the income has accrued within the meaning of Section 818(a) and Regulation 1.466-1(c)(1)(h). The policy loan provisions of the life insurance policies issued by the taxpayer provide for policy loans on the following terms: Loan interest shall be calculated at 5.65% a year, in advance, or at such lower rate as the Company shall determine, and shall be payable on each policy anniversary. Any interest not paid when due shall be added to the loan and bear interest at the same rate. Thus, under the terms of its loan contracts with its policyholders, the taxpayer’s right to receive the interest payments is fixed at the time the loan is made and on each subsequent policy anniversary date. The parties have stipulated that the taxpayer in fact bills policy loan borrowers for interest in advance covering the full period of the loan until the next policy anniversary date. If this bill is not paid, the taxpayer makes an entry in its books signifying that the interest is due and payable (albeit “unearned”) and deductible from the cash surrender value of the underlying policy. Furthermore, the loan contracts place no restriction on the taxpayer’s use of any interest payments received in advance and do not appear to provide expressly for abatement or repayment of interest in the event that the policyholder repays the loan prior to the next anniversary date. Two Courts of Appeals have held that where, as here, the full interest on a policy loan is due and payable in advance, and an accrual-basis taxpayer receives it free of any trust or other restriction on its use, the taxpayer’s right to receive it must be regarded as “fixed” and therefore as accrued within the meaning of Regulation 1.446-1(c)(1)(ii). Jefferson Standard Life Insurance Co. v. United States, supra, 408 F.2d at 856-57; Franklin Life Insurance Co. v. Commissioner, supra, 399 F.2d at 761-63. This conclusion is consistent with the general rule of accrual accounting that the right to receive an item of income must be regarded as fixed when due and payable to the taxpayer. See Schlude v. Commissioner of Internal Revenue, supra, 372 U.S. at 136-37, 83 S.Ct. 601 (payment for dance studio lessons); Spring City Foundry Co. v. Commissioner of Internal Revenue, 292 U.S. 182, 184-85, 54 S.Ct. 644, 78 L.Ed. 1200 (1934) (accounts receivable arising from sales); Brown v. Helvering, 291 U.S. 193, 198-99, 54 S.Ct. 356, 78 L.Ed. 725 (1934) (commissions from prepaid insurance premiums). See also American Automobile Association v. United States, 367 U.S. 687, 81 S.Ct. 1727, 6 L.Ed.2d 1109 (1961) (prepaid annual membership dues). In each of these cases, the Supreme Court held that the income in question was fully taxable in the year of receipt, despite the fact that a portion of the income represented payment for services to be performed in a subsequent year. The authorities advanced by the taxpayer are inapposite. Each concerned the proper method of reporting finance charges on installment sales of automobiles or other equipment. Luhring Motor Co. v. Commissioner, 42 T.C. 732 (1964); Gunderson Bros. Engineering Corp. v. Commissioner, 42 T.C. 419 (1964); Smith Motors, Inc. v. United States, 61-2 U.S.T.C. ¶ 9627 (D.Vt.1961). In each of these cases an accrual-basis taxpayer entered into an installment sales contract providing for a down payment plus future monthly payments comprised of principal plus a finance charge (interest plus a servicing fee); and in each case the court held that the taxpayer could properly report the finance charges as income only as each monthly charge fell due. The basis of this holding was stated by the court in Luhring, 42 T.C. at 743: As in the case of interest, petitioner’s right to receive the collection on handling charges only became fixed and the amount determinable with reasonable accuracy upon the passage of time and servicing of the customers’ outstanding debts by the petitioner; and such right matured only at the time each installment was due and payable. Spring City Foundry Co. v. Commissioner [of Internal Revenue] [supra]. These decisions do not apply where, as here, the governing contract provides that interest is “due and payable in advance.” Nor does the fact that the taxpayer is obligated to refund or abate a portion of the advance interest if the policyholder preterminates the loan in some manner change the result. The parties have stipulated that the taxpayer in fact refunded or abated less than one-seventh of its “unearned” interest. There is no reason to believe that this rate of refunding or abatement is any greater than the chances of other contingencies, such as the general risk of uncollectibility, which the courts have found insufficient to justify deferral of income due and payable. E. g., Spring City Foundry Co. v. Commissioner of Internal Revenue, supra. The Court agrees with the Government that the possibility that a portion of the interest will have to be repaid or credited to the policyholder in a subsequent year does not remove advance interest from the category of income which the taxpayer has a “fixed right to receive.” See Brown v. Helvering, supra, 291 U.S. at 199, 54 S.Ct. 356; Jefferson Standard Life Insurance Co. v. United States, supra, at 856-57; Franklin Life Insurance Co. v. United States, supra, at 762-63; Fowler v. Commissioner, supra note 16, at 179-80. The Court holds that Section 804(b)(1)(A) requires the taxpayer to include in gross investment income interest on policy loans charged in advance but not yet earned. III. INVESTMENT EXPENSES (COUNT III) A. STATEMENT OF FACTS The taxpayer regularly invests substantial sums of money in real estate, both through loans secured by real estate mortgages and by direct ownership of real estate. As a part of its real estate investment business, the taxpayer constantly watches for investment opportunities, and regularly reviews a variety of opportunities. The vast majority of opportunities which the taxpayer reviews never materialize. Two such aborted opportunities are at issue here: (1) In 1967 the taxpayer became interested in a proposed real estate development in Newton, Massachusetts. The taxpayer decided to invest in the project, but only if the necessary rezoning could be obtained. Under the proposed arrangement, a corporation, Pentland Development Corporation (Pentland) was formed, which entered into a contract to purchase from the owner the parcel of real estate which was to be the site for the project. Pursuant to the terms of the taxpayer’s agreement with Pentland, Pentland then assigned to the taxpayer its rights under the purchase agreement with the owner. Pentland’s attempt to secure the necessary rezoning of the property was unsuccessful. As a result, the taxpayer executed a release of the assignment of the right to acquire the property. Pentland had expended the sum of $14,632.56 in the attempt to secure the necessary rezoning and sought to have the taxpayer reimburse it for these expenses. The taxpayer denied any liability for these expenses. Ultimately, this dispute was resolved by the taxpayer paying to Pent-land the sum of $10,000 as reimbursement of its expenses. The taxpayer received no direct investment income from the expenses for which it reimbursed Pentland. (2) In 1966 the taxpayer examined the feasibility of developing a new home office location and a shopping and business complex in the Monument Square area of Portland, Maine. For this purpose, the taxpayer hired a development consultant, Spencer M. Hurtt Associates, Inc., and an architectural firm, Geddes Brecher Qualls Cunningham, to study the Portland downtown area, to survey the space needs of a number of downtown businesses, and to make reports and recommendations to the taxpayer concerning the development of the area. The taxpayer also expended sums in attempting to acquire options to purchase land in the Monument Square area, for soil studies and for the reproduction of maps. A preliminary plan and a model of the area showing the preliminary development plans were prepared, as were architectural drawings detailing three or four of the potential buildings in the project. In 1967 the taxpayer determined the Monument Square project to be unfeasible, and the project was discontinued. The taxpayer had expended the sum of $50,638.01 on the project as follows: (a) $32,867.26 to the development consultant; (b) $17,000 to the architectural firm for architectural studies and a wood model of the proposed development; (c) $500 to a consultant for attempting to obtain options to purchase real estate properties in the project area; (d) $262.41 to an engineering consultant for soil studies; and (e) $8.34 for reproducing maps of the project area. The taxpayer received no direct investment income from its expenditures in connection with the Monument Square project. Had the project been completed as planned, 80% of it would have constituted an investment asset of the taxpayer and the remaining 20% its home office facility. B. DISCUSSION The principal question presented is whether any of the amounts expended by the taxpayer in connection with the proposed Pentland and Monument Square real estate development projects are deductible as investment expenses under Section 804(c)(1). If they are so deductible, a further question is presented as to the proper year of deductibility of certain of the Monument Square expenses. These issues concern only the taxpayer’s 1967 return. On its federal income tax return for 1967, the taxpayer deducted from its gross investment income as “investment expenses” within the meaning of Section 804(c)(1) the sum of $10,000 expended in connection with the proposed Pentland project and the sum of $50,638.01 expended in connection with the proposed Monument Square project. The Commissioner disallowed both deductions, on the ground that the expenses in question are not deductible as investment expenses under Section 804(c)(1), but are deductible, if at all, only as abandonment losses pursuant to Section 809(d)(12). In its brief, the Government also has raised for the first time the contention that even if these expenditures are determined to be investment expenses deductible under Section 804(c)(1), the sum of $16,700 paid to the development consultant and the sum of $17,000 paid to the architectural firm, both in connection with the Monument Square project, were for services rendered in 1966 and should have been deducted in 1966 rather than in 1967. 1. Deductibility of the expenditures as investment expenses under Section 804(c)(1). For the reasons to be stated, the Court concludes that the expenditures in question are deductible as “investment expenses” under Section 804(c)(1). Section 804(c)(1) provides that, in order to determine a life insurance company’s “investment yield” for the purpose of computing the Phase I portion of its taxable income, the taxpayer may deduct from gross investment income “investment expenses for the taxable year.” The terms “investment yield” and “investment expenses” are defined in Treasury Regulation 1.804-4, which provides, in pertinent part: § 1.804-4 Investment yield of a life insurance company. (a) Investment yield defined. . Investment yield means gross investment income (as defined in section 804(b) and paragraph (a) of § 1.804-3), less the deductions provided for investment expenses [and other items]. However, such expenses are deductible only to the extent that they relate to investment income and the deduction of such expenses is not disallowed by any other provision of subtitle A of the Code. For example, investment expenses are not allowable unless they are ordinary and necessary expenses within the meaning of section 162 . ... (b) Deductions from gross investment income — (1) Investment expenses, (i) “Investment expenses” are those expenses of the taxable year which are fairly chargeable against gross investment income. For example, investment expenses include salaries and expenses paid exclusively for work in looking after investments, and amounts expended for printing, stationery, postage, and stenographic work incident to the collection of interest. Thus, there are essentially two tests for determining whether a particular expenditure is deductible as an investment expense under Section 804(c)(1): first, it must “relate to” and be “fairly chargeable against” investment income (and its deduction not be disallowed by any provision of Subtitle A of the Code); second, it must be an “ordinary and necessary expense” within the meaning of Section 162. The expenditures here in issue meet both of these tests. The taxpayer concedes that 20% of its expenditures in connection with the Monument Square project are properly allocable to the proposed construction of a home office facility, which would not constitute an investment asset and therefore would not be deductible as an investment expense under Section 804(c)(1). With respect to the remaining 80% of its Monument Square expenditures and its total expenditures on the Pentland project, however, it is clear that these expenditures were made in connection with an investment activity. If the projects had been completed, the taxpayer would have received rental and interest income and would have acquired an investment asset. These expenses therefore meet the “related to” aspect of the first test. The Government argues that because the taxpayer received no direct investment income from its expenditures on either of these projects, the expenses cannot meet the “fairly chargeable” aspect of the first test. Viewing the taxpayer’s real estate investment operations as a whole, however, it is evident that the expenditures in question were incurred in connection with investment activity of a type customarily engaged in by the taxpayer for the purpose of generating investment income. So viewed, the expenses were “fairly chargeable” against the taxpayer’s overall investment income, even though the particular expenditures did not directly generate any such income. It is also clear that the expenditures in question qualify as “ordinary and necessary expenses” within the meaning of Section 162 as those terms have been defined by the courts. In Commissioner of Internal Revenue v. Tellier, 383 U.S. 687, 689-90, 86 S.Ct. 1118, 1120, 16 L.Ed.2d 185 (1966), the Supreme Court defined these terms as used in Section 162(a) as follows (citations omitted): Our decisions have consistently construed the term “necessary” as imposing only the minimal requirement that the expense be “appropriate and helpful” for “the development of the [taxpayer’s] business.” The principal function of the term “ordinary” in § 162(a) is to clarify the distinction, often difficult, between those expenses that are currently deductible and those that are in the nature of capital expenditures, which, if deductible at all, must be amortized over the useful life of the asset. In Deputy v. du Pont, supra, 308 U.S. at 495-96, 60 S.Ct. at 367, the Supreme Court defined the term “ordinary” as follows (citations omitted): Ordinary has the connotation of normal, usual, or customary. To be sure, an expense may be ordinary though it happen but once in the taxpayer’s lifetime. Yet the transaction which gives rise to it must be of common or frequent occurrence in the type of business involved. . It is the kind of transaction out of which the obligation arose and its normalcy in the particular business which are crucial and controlling. Finally, this Court has stated the test to be whether or not the expenditures “can be characterized as ‘normal, usual, or customary’ in the life of the taxpayer, or ‘of common or frequent occurrence’ in the taxpayer’s type of business.” Consumers Water Co. v. United States, 369 F.Supp. 939, 944 (D.Me.1974). It is evident that these expenditures meet the foregoing tests. It is undisputed that making investments, in real property and otherwise, is an integral part of the taxpayer’s business and that, of the substantial number of investment opportunities reviewed and considered, only a small fraction materializes. In an investment operation of the magnitude engaged in by the taxpayer, expenditures for investigation and preliminary work on numerous proposed projects which are not ultimately funded are necessarily incurred. In the language of the Supreme Court, such expenses are “ ‘appropriate and helpful’ for ‘the development of the [taxpayer’s] business,’ ” Commissioner of Internal Revenue v. Tellier, supra, and “of common or frequent occurrence in the type of business involved,” Deputy v. du Pont, supra. In short, the expenditures incurred by the taxpayer in connection with the proposed Pentland and Monument Square projects were clearly “ordinary and necessary expenses” of the taxpayer’s real estate investment business. The Government contends that the taxpayer must treat the expenditures in question as abandonment losses deductible under Section 809(d)(12). It cites three cases in support of this position. Two of these cases, Champlain Coach Lines, Inc. v. Commissioner of Internal Revenue, 138 F.2d 904 (2d Cir. 1943), and Stanley, Inc. v. Schuster, 295 F.Supp. 812 (S.D.Ohio 1969), aff’d per curiam, 421 F.2d 1360 (6th Cir.), cert. denied, 400 U.S. 822, 91 S.Ct. 43, 27 L.Ed.2d 51 (1970), did not rule on, or even discuss, the question of the deductibility of the expenses in question as ordinary and necessary business expenses. In these two cases the taxpayers had not sought to deduct the expenditures as ordinary and necessary expenses within the meaning of Section 162(a), but as losses within the meaning of Section 165(a). The third case cited by the Government, Equitable Life Insurance Co. of Iowa v. United States, 340 F.2d 9 (8th Cir. 1965), also did not address the present question. Moreover, to allow a life insurance company such as the taxpayer, which is in the business of making investments, to deduct the expenses of investigating ventures which do not later materialize is particularly appropriate in view of the overall scheme of the 1959 Act. It is the function of the Phase I computation, of which the deduction allowed by Section 804(c)(1) is a part, to assess a company’s taxable investment income. See S.Rep.No. 291, supra, 1959 U.S.Code Cong. & Ad. News at 1576, 1578-81. And it is the function of the Phase II computation, in which the Government would place the deduction for the taxpayer’s Pentland and Monument Square expenses, to assess a company’s taxable underwriting income. See id. at 1576, 1581-82. Surely, a deduction for the expenses incurred in seeking out new ventures more properly belongs in the Phase I computation. Finally, the Government argues that to permit the deduction of these expenses as ordinary and necessary expenses of the taxpayer’s investment business “would fly in the face of the well-established tax principle and rule of accounting that the costs of acquiring a capital asset must be capitalized.” See Commissioner of Internal Revenue v. Idaho Power Co., 418 U.S. 1, 12, 94 S.Ct. 2757, 41 L.Ed.2d 535 (1974); Woodward v. Commissioner of Internal Revenue, 397 U.S. 572, 574-75, 90 S.Ct. 1302, 25 L.Ed.2d 577 (1970); Vestal v. United States, 498 F.2d 487, 494-95 (8th Cir. 1974). There is no question but that, as the taxpayer apparently concedes, expenditures incurred in investigating investment opportunities which ultimately materialize must be treated as capital expenditures. Idem. In such circumstances, the expenses of investigation are logically assimilated into the other costs of acquiring an asset “having a useful life substantially beyond the taxable year,” Treasury Regulation 1.263(a)-2(a), 26 CFR § 1.263(a)-2(a), in compliance with the general principle that the costs of acquiring an asset be treated in a manner which reflects the asset’s continuing production of income to the taxpayer. See generally Commissioner of Internal Revenue v. Idaho Power Co., supra, 418 U.S. at 13, 94 S.Ct. 2757; Commissioner of Internal Revenue v. Lincoln Savings & Loan Association, 403 U.S. 345, 354-55, 91 S.Ct. 1893, 29 L.Ed.2d 519 (1971); Woodward v. Commissioner of Internal Revenue, supra, 397 U.S. at 575-76, 90 S.Ct. 1302. It does not follow, however, that expenses incurred in the process of investigating an investment proposal which does not ultimately materialize as a capital asset must also be capitalized. Cf. York v. Commissioner of Internal Revenue, 261 F.2d 421 (4th Cir. 1958) (real estate developer .permitted Section 162(a) deduction of costs of survey undertaken to determine feasibility of industrial development of a parcel of real estate); Vanderbilt v. Commissioner, 16 T.C.Mem. 1081, 1087-88 (1957) (taxpayer in business of presenting travel movies and lectures permitted Section 162(a) deduction of attorneys’ fees paid in connection with unsuccessful negotiations for a possible television series); Southern Trading Co. v. Commissioner, 15 T.C.Mem. 1259, 1263 (1956) (taxpayer engaged in business of acquiring royalty interests in oil and gas properties permitted Section 162(a) deduction of costs of geological survey of properties in which the taxpayer ultimately decided not to invest). The Court holds that the expenses incurred by the taxpayer for investigation and preliminary work related to the proposed Pentland and Monument Square projects (other than the 20% of the Monument Square project expenditures attributable to the taxpayer’s proposed home office) are properly deductible as “investment expenses” under Section 804(c)(1). 2. Proper year of deductibility. The Government contends that even if the expenditures in question were investment expenses deductible under Section 804(c)(1), $16,700 of the $32,867.26 paid to the development consultant and the $17,-000 paid to the architectural firm in connection with the Monument Square project were for services rendered to the taxpayer in 1966 and cannot be allowed as deductions in 1967. The taxpayer concedes that the services corresponding to the $16,700 paid to the development consultant were for services rendered during 1966, that the taxpayer’s liability for these services was incurred and payment was made in 1966, and that 1966 was therefore the proper year of deduction for the $16,700 expense. See Treasury Regulation 1.461-1(a)(2). With respect to the $17,000 paid to the architectural firm, however, the record discloses that this sum was paid for the production of a wooden scale model which was not delivered to the taxpayer until January 1967. Even though work on the model may have been done in 1966, the model was not received by the taxpayer until 1967; and 1967 was therefore the proper year of deduction. See idem. The Court holds that 1967 was the proper year for deduction of the expenses incurred by the taxpayer for investigation and preliminary work related to the proposed Pent-land and Monument Square projects, other than the sum of $16,700 paid in 1966 to the development consultant, Spencer M. Hurtt Associates, Inc., for services rendered in 1966. IV. ISSUES INVOLVING LIFE INSURANCE RESERVES Each of the remaining three counts of the taxpayer’s complaint concerns the propriety of determinations by the Commissioner disallowing life insurance reserves maintained by the taxpayer. The effect of these determinations was to reduce the taxpayer’s “life insurance reserves,” as defined in Section 801(b), and thereby to increase the proportion of the taxpayer’s investment yield which represented investment income taxable to the taxpayer. See Sections 804(a), 805(a), (c); Introduction: The Taxing Formula, supra. Each of these counts turns on the question whether a particular reserve or portion thereof is a “life insurance reserve” within the meaning of Section 801(b). Section 801(b) provides, in pertinent part: (b) Life insurance reserves defined.— (1) In general. — For purposes of this part, the term “life insurance reserves” means amounts— (A) which are computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest, and (B) which are set aside to mature or liquidate, either by payment or reinsurance, future unaccrued claims arising from life insurance, annuity, and noncancellable health and accident insurance contracts (including life insurance or annuity contracts combined with noncancellable health and accident insurance) involving, at the time with respect to which the reserve is computed, life, health, or accident contingencies. (2) . . . life insurance reserves must be required by law. A life insurance company establishes life insurance reserves for the purpose of assuring that the company will have funds on hand to pay claims on policies as they become due in the future. In United States v. Atlas Life Insurance Co., 381 U.S. 233, 236 n. 3, 85 S.Ct. 1379, 1381, 14 L.Ed.2d 358 (1965), the Court defined life insurance reserves as “that fund which, together with future premiums and interest will be sufficient to pay future claims” of policyholders. These reserves are not actually trust funds or segregated assets, but merely statements of liability. Nonetheless, the company must have assets at least equal to its reserves, and it is only the assets in excess of the reserve liabilities that may be utilized by the company for purposes other than meeting policy obligations. A life insurance company’s reserves come from essentially two sources: (1) a portion of each premium received is set aside for this purpose, and (2) these portions are invested and produce earnings which are added to the reserve. This portion of a premium is called the “net premium” or the “net valuation premium.” This is the amount which, with interest accretions, must be added to the reserve each year so that if the company’s actual experience exactly matches the assumptions made, the amount of the reserve will be exactly sufficient to pay all claims as they come due. The total premium charged a policyholder is called the “gross premium.” The difference between the gross and net premiums is called “loading” and is used to pay the company’s administrative and operating expenses. Mandatory minimum standards for the calculation of a life insurance company’s reserve requirements have been established by the Standard Valuation Law, which has been enacted in all states, including Maine. See 24 Me.Rev.Stat.Ann. §§ 2051-2057 (1965). The Standard Valuation Law requires that the State Commissioner of Insurance annually value the reserve liabilities of each life insurance company doing business in the state and may certify the reserves as adequate. 24 Me.Rev.Stat.Ann. § 2052. To this end, the taxpayer each year submits an elaborate annual financial statement prepared according to a form developed and maintained by the National Association of Insurance Commissioners (N.A.I. C.). The annual statements contain exhaustive calculations of the taxpayer’s condition and affairs, including its reserve liabilities. It is stipulated that for each of the years in question the taxpayer prepared its annual statements “under the method of accounting in a manner approved by the N.A.I.C.” for that purpose. Moreover, evidence submitted by the taxpayer shows that for each of the years in question, its annual statement was reviewed by the Maine Commissioner, its reserves were audited by an independent actuary employed by the Commissioner and found to be correct, and its annual statement was so certified by the Commissioner. The theory under which reserves are calculated is stated formulaically in the Standard Valuation Law, 24 Me.Rev.Stat. Ann. § 2054, as the excess ... of the present value, at the date of valuation, of [the] future guaranteed benefits provided for by [outstanding] policies, over the then present value of any future . / . net premiums therefor. That is, assuming that the company will realize a certain rate of return on its investments and assuming that future claims will arise in a manner consistent with the predictions contained in certain mortality tables, the company can calculate a sum which, together with future premiums, will be sufficient precisely to meet its obligations to its policyholders. The sum is the reserve. The critical assumptions used in this calculation — rate of return on investments and policyholder mortality rates — are set by the Standard Valuation Law. That law, prescribes, for example, that the company assume a rate of interest not greater than 3V2 percent and that it utilize the 1958 Commissioner’s Standard Ordinary Mortality Table for the purpose of calculating the reserves required to meet its obligations under “ordinary policies of life insurance.” 24 Me.Rev.Stat.Ann. § 2053(1). The three disputed determinations made by the Commissioner regarding the taxpayer’s reserve liabilities are the following: A. Whether the taxpayer’s reserves for unexercised guaranteed insurability rider options qualify as life insurance reserves under Section 801(b). (Count IV.) This issue concerns the taxpayer’s returns for the years 1962 through 1968. B. Whether the taxpayer’s reserves for yearly-renewable group term and individual term life insurance policies qualify as life insurance reserves under Section 801(b). (Count V.) This issue concerns the taxpayer’s returns for the years 1962 through 1966. C. Whether the taxpayer’s unearned premium reserves for noncancellable accident and health policies qualify as life insurance reserves under Section 801(b). (Count VI.) This issue concerns the taxpayer’s returns for the years 1962 through 1968. A. RIDER OPTION RESERVES (COUNT IV) STATEMENT OF FACTS The taxpayer issues life insurance policies which contain options to purchase additional insurance at the taxpayer’s standard premium rate at specified future dates regardless of whether the policyholder can present evidence of insurability (that is, pass a medical examination) at the time he exercises an option. At the time the policyholder purchases a policy with such a rider, he must provide evidence of insurability. Such evidence indicates that the policyholder is a “select life,” one posing a better-than-average risk to the insurer. The taxpayer knows, however, that as time passes at least some policyholders in the group of select lives will deteriorate, becoming average or below-average risks at the time they reach the attained option ages. If the policyholders who have become below-average risks should exercise their options, the taxpayer will incur greater mortality costs with respect to this additional insurance than it normally would. The parties have stipulated that the present value of the future benefits under life insurance policies issued pursuant to guaranteed insurability riders can be assumed to be greater than under a policy which is identical in all respects but which is issued after receiving evidence of insurability. For the option of requiring the taxpayer to forego its usual requirement that an applicant for insurance present evidence of insurability, the taxpayer charges a surcharge on its usual premium. The taxpayer allocates this surcharge to a reserve designed to cover the greater-than-normal future claims which can be expected to arise on additional insurance purchased pursuant to these options. For the years in question, this reserve was calculated on the basis of three assumptions: (1) an assumed rate of interest of 2V2 percent; (2) assumed mortality calculated on the basis of the 1958 CSO mortality table, the N.A.I.C. table for “ordinary lives”; and (3) an assumed 100 percent rate of exercise of the options. DISCUSSION The issue presented is whether the taxpayer’s reserves for unexercised guaranteed insurability rider options qualify as life insurance reserves under Section 801(b). This issue relates to the taxpayer’s returns for the years 1962 through 1968. In its N.A.I.C. annual statements and federal income tax returns for these years, the taxpayer included reserves for unexpired and unexercised rider options. The Commissioner, however, disallowed the inclusion of these reserves as life insurance reserves within the meaning of Section 801(b). The Government presents two grounds on which it contends that the taxpayer’s reserves for unexercised and unexpired guaranteed insurability rider options are not life insurance reserves within the meaning of Section 801(b). These are: (a) that these reserves are not “computed or estimated on the basis of recognized mortality or morbidity tables and assumed rates of interest,” as required by Section 801(b)(1)(A); and (b) that these reserves are not “required by law,” as required by Section 801(b)(2). (a) The first ground advanced by the Government is without merit. It rests on the contention that no reserve can be included as a life insurance reserve within the meaning of Section 801(b) unless it is based solely on recognized mortality tables and assumed rates of interest. The Government would therefore deem these reserves not to be within the meaning of the Section because the taxpayer included in this calculation the non-actuarial assumption that 100 percent of the unexpired options would be exercised. The wording of the statute does not appear to carry s