                        T.C. Memo. 2001-304



                      UNITED STATES TAX COURT



PHYSICIANS INSURANCE COMPANY OF WISCONSIN, INC. AND SUBSIDIARIES,
   Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3192-99.                    Filed November 21, 2001.


     Michael R. Schlessinger, Michael A. Clark, Jason K. Francl,

Jay H. Zimbler, and William M. Sneed (specially recognized) for

petitioner.

     Avery B. Cousins III and J. Paul Knap, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:   Respondent determined deficiencies in

petitioner’s Federal income taxes as follows:

                    Year       Deficiency

                    1993       $8,209,201
                    1994        1,293,762
                               - 2 -

     After concessions, the sole issue for decision is the amount

of unpaid losses and loss adjustment expenses (collectively,

unpaid losses) that petitioner is entitled to deduct pursuant to

section 832.1

                         FINDINGS OF FACT

     The parties have stipulated some of the facts, which we

incorporate in our findings by this reference.

Petitioner

     Petitioner, a Wisconsin corporation, is a property and

casualty (P&C) insurance company whose predominant line of

business is providing medical malpractice insurance for doctors

and hospitals.   From its incorporation in 1986 through the years

in issue, petitioner sold insurance only in Wisconsin.

     In the 1970s, the health-care industry experienced dramatic

increases in medical malpractice lawsuits and resulting damage

awards.   In 1975, the State of Wisconsin responded with various

legislative reforms, including the creation of the Wisconsin

Patient’s Compensation Fund (the Fund) to provide Wisconsin

health-care providers unlimited malpractice coverage in excess of

the primary coverage that each health-care provider was required

to carry as a condition of State licensing.   Despite these



     1
       Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the taxable years in issue,
and Rule references are to the Tax Court Rules of Practice and
Procedure.
                               - 3 -

reforms, continuing increases in the frequency and severity of

medical malpractice claims resulted in an affordability crisis

for medical malpractice insurance coverage.   In the 1980s,

certain large commercial carriers withdrew from the market.     The

Wisconsin State Medical Society proposed the establishment of a

physician-owned medical malpractice insurer to provide the

requisite primary coverage for its members, resulting in

petitioner’s incorporation in 1986.2

Petitioner’s Insurance Policies

     On November 1, 1986, petitioner began issuing “claims-made”

medical malpractice insurance policies–-i.e., policies that cover

alleged acts of malpractice for which a claim is filed while the

policy is in force, provided that the alleged act of malpractice

to which the claim relates occurred after the “retroactive date”

(typically the date on which the insured first purchases

coverage).   Petitioner’s policies also included an option to

provide “tail coverage”--i.e., coverage for claims relating to

events that occurred before the retroactive date.   During the

years in issue, about 85 percent of petitioner’s policies were

issued on a claims-made basis; the remainder were “occurrence-


     2
       Initially, petitioner was capitalized by a $3.25 million
contribution from the Physicians Insurance Co. of Ohio (PICO) and
a $250,000 contribution from the State Medical Society. During
the first 3 years of petitioner’s operations, physicians whom
petitioner insured were required to purchase stock in petitioner.
The capital raised from policyholder-owners was used to redeem
nearly all of PICO’s interest in petitioner.
                                - 4 -

based” policies–-i.e., policies that cover alleged acts of

malpractice committed while the policy is in force, regardless of

when the injury is discovered or the claim is reported.

     Under petitioner’s policies, no formal claim was required to

establish coverage within a given policy period.   Rather, to

establish coverage, it sufficed for an insured to notify

petitioner of an incident that might ultimately give rise to a

claim.   Petitioner referred to such informal notifications as

“incident reports”.

     To discourage frivolous claims and protect the reputations

of its physician insureds, petitioner maintained an aggressive

defense policy with respect to any claim that was viewed as

nonmeritorious.   The existence of the Fund, which covered

indemnity payments above petitioner’s statutorily mandated policy

limits, constrained petitioner’s risk exposure.3   Petitioner was

statutorily required, however, to defend the interests of the

Fund for claims that might involve indemnity payments above the

policy limits.    Because of the existence of the Fund, petitioner

did not secure any reinsurance protection concerning its medical

malpractice risks.


     3
       By Wisconsin statute, the policy limits for property and
casualty (P&C) companies issuing malpractice policies were
$200,000 per claim arising from an occurrence (and $600,000
aggregate per year) for occurrences before July 1, 1987; $300,000
for each such claim ($900,000 aggregate) for occurrences between
July 1, 1987, and June 30, 1988; and $400,000 for each such claim
($1 million aggregate) for occurrences after June 30, 1988.
                                - 5 -

Annual Statement Requirements

     Since its incorporation, petitioner has been regulated by

the Wisconsin Commissioner of Insurance (WCI).   The WCI is

responsible for, among other things, examining financial

practices and market conduct of Wisconsin insurance companies.

Petitioner is required to file annual statements with the WCI and

to deliver each year a statement of actuarial opinion regarding

the adequacy of its reserves.

     The National Association of Insurance Commissioners (NAIC),

an organization of State insurance commissioners, promulgates

standard forms for insurance companies to use in preparing their

annual statements.   Insurance companies are required to prepare

their annual statements using a system of accounting known as the

statutory or annual statement method, which does not necessarily

conform to generally accepted accounting principles that govern

the preparation of an insurance company’s financial statements.

Annual statement reporting requires insurance companies to

estimate their unpaid losses as of the close of each calendar

year.   These estimates of unpaid losses are intended to reflect

the insurer’s liability for future payments on incurred claims,

which include insured events for which a claim has been filed

(reported losses) as well as insured events for which no claim

has yet been filed (incurred but not reported losses).
                                - 6 -

Petitioner’s Actuaries

     Petitioner employed no in-house actuary.    Instead, beginning

in 1986 and continuing through the years in issue, petitioner

retained the firm of Tillinghast-Towers Perrin (Tillinghast) to

perform all its actuarial services, including estimation of its

unpaid losses as part of its reserve reports.

     In the course of preparing its various actuarial reports and

analyses for petitioner, Tillinghast representatives met with

petitioner’s management and exchanged information periodically.

     In analyzing petitioner’s unpaid losses, Tillinghast’s

techniques and methods changed over time as petitioner’s business

grew and matured.    For the years 1987 through 1989, petitioner

lacked historical claims data, and so Tillinghast relied almost

exclusively on industry data to estimate petitioner’s unpaid

losses.    Thereafter, it gradually increased its reliance on

petitioner’s data.    For the years in issue, Tillinghast relied

heavily on petitioner’s data.

     In 1991, Tillinghast began to use five specific actuarial

methods (the five methods) in estimating petitioner’s unpaid

losses.4   It relied upon the five methods consistently throughout

the years in issue.


     4
       The five specific actuarial methods (the five methods)
Tillinghast used were: (1) The Bornhuetter-Ferguson method
applied to incurred losses; (2) the Bornhuetter-Ferguson method
applied to paid losses; (3) the development method applied to
incurred losses; (4) the development method applied to paid
losses; and (5) rating model development.
                               - 7 -

     In addition to using the five methods, in arriving at each

of its ultimate loss estimates for year ends 1993 and 1994,

Tillinghast also factored in (to a greater degree for 1994 than

for 1993) ultimate loss estimates that it had selected in the

preceding year (prior selections).5    Because the prior selections

were significantly higher than the estimates indicated by any of

the five methods, the effect of factoring in the prior selections

was to significantly increase Tillinghast’s ultimate loss

estimates for each of the years 1993 and 1994.

     Tillinghast’s point estimates of petitioner’s unpaid losses

for the years in issue were as follows:

                             Tillinghast Unpaid
                    Year       Loss Estimate

                    1993       $74,027,009
                    1994       $77,029,796


Petitioner’s Add-Ons to Tillinghast’s Point Estimates

     David L. Maurer (Maurer), petitioner’s treasurer and vice

president of finances, was responsible for selecting an estimate

of unpaid losses to be recommended to petitioner’s board of

directors and, following approval, reported on petitioner’s

annual statement.   For the years in issue, Maurer reviewed each


     5
       For example, in its analysis of petitioner’s unpaid losses
for yearend 1993, Tillinghast first estimated losses by each of
the five methods for each report year. Rather than simply blend
these results to select ultimate losses for each report year,
Tillinghast factored in the higher estimates of ultimate losses
that had been selected in its yearend 1992 analysis.
                                - 8 -

of Tillinghast’s draft reports and concluded that for annual

statement purposes petitioner should report estimated unpaid

losses that were almost 10 percent higher than Tillinghast’s

estimates.   Consistent with these recommendations, in its 1993

and 1994 annual statements, petitioner reported estimated unpaid

losses that differed from Tillinghast’s estimates as shown below:

                                            1993         1994
     Unpaid loss reserves
       on petitioner’s
       annual statement                 $81,391,000   $84,559,000

     Tillinghast’s
       recommended reserves              74,027,009    77,029,796

       Difference                         7,363,991     7,529,204

     Percentage                                9.95          9.77

Tillinghast’s Final Reports

     Tillinghast’s final reports for yearends 1993 and 1994,

dated February 10, 1994, and February 8, 1995, respectively, show

its original estimates of petitioner’s yearend loss reserves as

well as the higher amounts of petitioner’s “carried” loss

reserves, noting the difference between these estimates in both

dollars and percentages.    The Tillinghast reports do not

otherwise discuss the variations between its loss reserve

estimates and the reserves that petitioner carried on its annual

statements, which were almost 10 percent higher.

     The 1993 and 1994 Tillinghast reports state identically in

their prefatory “Conditions and Limitations” sections:
                               - 9 -

     While we believe that the reserve indications and
     methods used to determine the reserve indications are
     reasonable, the development of these indications
     requires the projection of future contingent events;
     thus, it is not possible to guarantee that these
     reserves will prove to be adequate or not excessive.

Petitioner’s Representation Letters to Tillinghast

     Before Tillinghast prepared its final reserve reports each

year, it required petitioner to provide a representation letter.

In connection with Tillinghast’s review of petitioner’s loss

reserves at yearend 1993, petitioner’s February 1994

representation letter to Tillinghast confirmed, among other

things, that petitioner had not knowingly withheld from

Tillinghast any “relevant information which would materially

affect the loss and loss adjustment expense reserves”, that

information furnished to Tillinghast for the calculation of the

loss and loss adjustment expense reserves was “complete and

accurate”, and that Tillinghast had been advised of “all known

changes in internal methods or procedures which would materially

affect the determination of needed loss and loss adjustment

expense reserves”.   Petitioner’s February 1995 representation

letter, in connection with Tillinghast’s review of petitioner’s

loss reserves at yearend 1994, was substantially identical.

Third-Party Reviews of Petitioner’s Loss Reserves

     Coopers & Lybrand

     The accounting firm of Coopers & Lybrand (Coopers) reviewed

petitioner’s 1993 and 1994 annual statements.   Coopers also
                                - 10 -

conducted a yearend audit of petitioner’s 1993 and 1994 financial

statements.

          1993 Audit

     In connection with the Coopers yearend 1993 audit of

petitioner’s financial statements, Coopers actuary Chris Nelson

(Nelson) reviewed a draft of Tillinghast’s 1993 report,

Tillinghast’s 1993 rate review, and certain underlying exposure

data from petitioner.   On the basis of his review, Nelson

concluded that Tillinghast’s actuarial methodologies and

assumptions in estimating petitioner’s unpaid losses were

“appropriate and reasonable.”    In addition, Nelson reviewed

petitioner’s carried unpaid losses for 1993.    Nelson noted that

these carried unpaid losses were 9.9 percent above the

Tillinghast point estimate.   Nelson concluded that this deviation

was acceptable from an actuarial perspective, indicating that a

reserve range of minus 5 percent to plus 10 percent was common

for Tillinghast analyses.

     After consulting with Nelson, Coopers’s nonactuarial

auditors concluded that petitioner’s unpaid losses on its 1993

annual statement exceeded the range suggested under Coopers’s in-

house guidelines.   These guidelines specified a mechanical

formula which the Coopers auditors used to test whether

petitioner’s recorded reserves were realistic and meaningful.

After further assessment, however, the Coopers auditors
                                - 11 -

determined that no unpaid loss adjustment was necessary for

financial statement purposes.    As stated in an undated Coopers

working paper, the somewhat “conservative” nature of petitioner’s

carried reserves for financial statement purposes was supported

by several factors, including the following:

     [Petitioner] is a relatively young company with
     adequate, but not extremely significant, amounts of
     historical results to access the adequacy of loss
     reserves.

     [Petitioner] writes only medical malpractice liability
     policies * * * [which are] considered extremely
     volatile and may be subject to significant swings in
     experience between years. * * * [Petitioner’s]
     management has stated that as recently as the first
     quarter of 1993 their reserve projections indicated
     deficiencies for the first time in Company history.

     Although the impact on current year net income is
     considered significant, the impact on retained earnings
     (slightly over 5%) is not considered overly
     significant.

     The establishment of reserves does not effect [sic] the
     trend in earnings and does not have a significant
     impact on management incentive or other bonus plans.

     The Company is not publicly traded and there is
     currently no active market for the existing outstanding
     shares.

          1994 Audit

     In connection with Coopers’s 1994 yearend audit of

petitioner’s 1994 financial statements, Coopers actuary Don

Skrodenis (Skrodenis) reviewed a draft of Tillinghast’s 1994

report, Tillinghast’s 1994 rate review, and certain underlying

exposure data from petitioner.    On the basis of his review,
                              - 12 -

Skrodenis concluded that the actuarial methodologies and

assumptions used to develop Tillinghast’s point estimate were

“reasonable”.   In addition, Skrodenis reviewed petitioner’s

unpaid loss estimate for 1994.    Skrodenis noted that petitioner’s

carried loss reserves at yearend 1994 were 9.8 percent above the

Tillinghast point estimate.   Skrodenis concluded that this 9.8

percent “redundancy” was acceptable from an actuarial

perspective.

     After consulting with Skrodenis, Coopers’s auditors

determined that Tillinghast’s point estimate was likely the

midpoint of a range whose width was plus 10 percent or minus 5

percent of the best point estimate.    These auditors concluded

that petitioner’s unpaid losses on its 1994 annual statement

exceeded the range suggested under Coopers’s in-house guidelines.

As in 1993, the 1994 guidelines specified a mechanical formula

which the auditors used to test the reasonableness of

petitioner’s recorded reserves.   Ultimately, after further

assessment, the Coopers auditors determined that no unpaid loss

adjustment was required for financial statement purposes.     As

stated in an undated Coopers working paper, the somewhat

“conservative” nature of petitioner’s carried reserve was

supported by several factors, including the following:
                              - 13 -

     [Petitioner’s] loss * * * reserves fall within the
     range established by Tillinghast of +10% of their best
     point estimate.[6]

     [Petitioner] is a relatively young company with
     adequate, but not extremely significant, amounts of
     historical results to assess the adequacy of loss
     reserves.

     [Petitioner] writes only medical malpractice liability
     policies. This line is considered extremely volatile
     and may be subject to significant swings in experience
     between years.

     A write-down of the current year reserves would effect
     [sic] the Company’s trend in earnings. Management’s
     incentive or bonus plans are not directly effected
     [sic] by current year earnings.

     The Company is not publicly traded and there is
     currently no active market for the existing outstanding
     shares.

     A portion of the reserve redundancy is maintained to
     offset potential tax exposure.

     With regard to the last factor listed above, the Coopers

working paper noted that as a result of an audit of petitioner’s

1991 and 1992 tax returns, the Internal Revenue Service (IRS) had

proposed various adjustments, including adjustments arising from

a determination that petitioner’s loss reserves were excessive.

The Coopers working paper notes that for petitioner’s taxable

years 1991 and 1992, these proposed tax adjustments totaled

approximately $6.1 million.



     6
       This observation is unsupported by the evidence, which
does not indicate that Tillinghast ever “established” or
communicated the existence of any particular range around its
point estimates.
                               - 14 -

     AMI Risk Consultants, Inc.

     The WCI retained the actuarial firm AMI Risk Consultants,

Inc. (AMI), to review petitioner’s 1993 annual statement unpaid

losses.   In an opinion letter dated November 30, 1994, AMI

determined that petitioner’s unpaid loss reserves, as reported on

petitioner’s 1993 annual statement, “Make a reasonable provision,

in the aggregate, for all unpaid loss and loss adjustment expense

obligations of the Company under the terms of its policies and

agreements.”   In support of this conclusion, AMI conducted its

own analysis of petitioner’s unpaid losses.   The AMI analysis

made use of data through June 30, 1994, that was not available to

Tillinghast as of January 1994.    Like Tillinghast, AMI used paid

and incurred loss development methods as well as a paid

Bornhuetter-Ferguson method.   Unlike Tillinghast, AMI did not

factor in any prior selections.7

     The AMI report estimated petitioner’s 1993 unpaid losses at

$87,419,000.   The AMI report concluded that petitioner’s 1993

annual statement unpaid loss reserves were “reasonable”, falling

within a range that AMI determined had a “low end” of $81,300,000

and a “high end” of $93,539,000.   The AMI report stated that its




     7
       Since AMI Risk Consultants, Inc. (AMI), had not prepared
any previous report for petitioner, it would not have had
available any prior selections of its own.
                              - 15 -

conclusion “appears to be consistent” with Tillinghast’s 1993

yearend reserves study.

Petitioner’s Operating Experience

     Petitioner has recorded a surplus every year since it was

incorporated in 1986.   From its inception through the years in

issue, petitioner’s ultimate losses have proved each year to be

significantly lower than it originally estimated for annual

statement purposes in earlier years.8   For the years in issue,

petitioner’s redundancies (excesses as determined by hindsight)

in its loss reserves were also significantly higher

than the average redundancies in loss reserves for the medical

malpractice industry as a whole.

     With respect to each of the years in issue, A.M. Best Co.

(Best)9 rated petitioner’s consolidated financial condition and



     8
       For example, on its 1994 annual statement, petitioner
revised downward its original estimates of unpaid losses for
prior coverage years as follows:

Coverage    As Originally     As Estimated on 1994    Percentage
  Year        Reported          Annual Statement       Decrease

  1987       $3,379,000            $1,658,000               51
  1988       10,580,000             4,183,000               60
  1989       17,276,000             8,507,000               51
  1990       25,746,000            13,266,000               48
  1991       29,166,000            16,445,000               44
  1992       27,948,000            19,820,000               29
  1993       30,003,000            28,819,000                4

     9
       A.M. Best Co., a rating agency specializing in the
insurance industry, rates the financial condition of P&C
companies each year.
                              - 16 -

operating performance as B++ (Very Good).    Best’s 1994 report

(with reference to petitioner’s 1993 annual statement) indicated

that in 1993 petitioner had recorded its largest net operating

gain of the last 5 years and stated:   “Based on favorable

development of its conservatively stated loss reserves,

[petitioner’s] management took down $4.5 million of aggregate

reserves in 1993.”   Best’s 1995 report (with reference to

petitioner’s 1994 annual statement) indicated that petitioner

“has generated very profitable operating results in recent years

as net investment income was enhanced by favorable loss reserve

development” and predicted that petitioner’s strong earnings

would continue in the near term, partly because petitioner

“conservatively reserves for its underwriting exposures”.

Petitioner’s Tax Returns and Respondent’s Determinations

     On its Federal income tax returns for taxable years 1993 and

1994, petitioner reported undiscounted unpaid losses in the same

amounts shown on its annual statements.

     Using a computer program known as Exhibitmaker, which was

developed by Coopers, respondent determined that petitioner’s

undiscounted unpaid losses were overstated and should be reduced

to the levels shown below:

                       As Reported          As Determined
          Year        by Petitioner         by Respondent

          1993         $81,391,000          $46,508,000
          1994          84,559,000           45,549,000
                               - 17 -

                              OPINION

     The issue for decision is whether petitioner correctly

reported its undiscounted unpaid losses for purposes of computing

its deduction for losses incurred, pursuant to section

832(b)(5).10   Petitioner contends that because it reported the

same estimates of unpaid losses on its annual statements and tax

returns, and because it estimated these unpaid losses in a

reasonable manner, using sound business practices, these

estimates should be accorded deference for Federal income tax

purposes.   Respondent contends that petitioner’s estimates of

unpaid losses were not fair and reasonable.

Applicable Law

     Petitioner, as a nonlife insurance company, must compute its

taxable income under section 832.   See sec. 831.   Under these

statutory provisions, gross income includes amounts earned from

investment and underwriting income, “computed on the basis of the

underwriting and investment exhibit of the annual statement

approved by the National Association of Insurance Commissioners”.

Sec. 832(b)(1)(A).   Underwriting income is defined as “the

premiums earned on insurance contracts during the taxable year

less losses incurred and expenses incurred.”   Sec. 832(b)(3).


     10
       For each year in issue, petitioner claimed deductions for
increases in its discounted unpaid losses pursuant to sec.
832(b)(5) after discounting the amounts reported as undiscounted
unpaid losses. The parties have not raised any issue regarding
the method of discounting these losses.
                                - 18 -

“Losses incurred” means losses incurred during the taxable year

on insurance contracts and includes increases for the year in

“discounted unpaid losses (as defined in section 846)”.    Sec.

832(b)(5)(A).11    As defined in section 846(b)(1), “unpaid losses”

generally means “unpaid losses shown in the annual statement

filed by the taxpayer for the year ending with or within the

taxable year of the taxpayer.”    Unpaid losses include any unpaid

loss adjustment expenses.    Sec. 832(b)(6).

     Taxable income equals gross income, as described above, less

various deductions allowed pursuant to section 832(c).    Sec.




     11
          Sec. 832(b)(5)(A) provides in relevant part:

     In general.--The term “losses incurred” means losses
     incurred during the taxable year on insurance contracts
     computed as follows:

                  (i) To losses paid during the taxable year, deduct
            salvage and reinsurance recovered during the taxable
            year.

                 (ii) To the result so obtained, add all unpaid
            losses on life insurance contracts plus all discounted
            unpaid losses (as defined in section 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.

                 (iii) 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.
                              - 19 -

832(a).   One of the deductions allowed is for “losses incurred”

as defined in section 832(b)(5).12   Sec. 832(c)(4).

     The applicable regulations, which have remained

substantively unchanged since their promulgation in 1944, require

the taxpayer to establish that its estimate of unpaid losses is

“fair and reasonable” and represents “only actual unpaid losses.”

Sec. 1.832-4(b), Income Tax Regs. (the applicable regulations);

see State of Md. Deposit Ins. Fund v. Commissioner, 88 T.C. 1050,

1059 (1987).   The applicable regulations provide as follows:

          (5) In computing “losses incurred” the
     determination of unpaid losses at the close of each
     year must represent actual unpaid losses as nearly as
     it is possible to ascertain them.

          (b) Losses incurred. Every insurance company to
     which this section applies must be prepared to
     establish to the satisfaction of the district director
     that the part of the 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


     12
       Although such a deduction would appear potentially
duplicative of losses incurred that are taken into account in
determining the underwriting income component of gross income
under sec. 832(b)(3), the statute specifically prohibits the same
item from being deducted more than once. See sec. 832(d).
                              - 20 -

     necessary to establish the reasonableness of the
     deduction for “losses incurred.” [Sec. 1.832-4(a)(5)
     and (b), Income Tax Regs.]

     Petitioner does not dispute the validity of the applicable

regulations but argues that they must be construed so as to

accord deference to the unpaid loss estimates reflected on the

taxpayer’s annual statement, provided the taxpayer has used “good

faith business judgment” in preparing those estimates.

Petitioner’s contention is at bottom a rehashing of long-rejected

arguments that the Code reflects a congressional expectation that

the estimates of unpaid losses used for tax purposes should

conform to the precise figures shown on the annual statement.    In

rejecting such arguments and upholding the validity of the

applicable regulations, the Court of Appeals for the First

Circuit stated:

     Congress’s requirement that the N.A.I.C. [annual
     statement] form be followed as the only acceptable
     method for computing an insurance company’s gross
     income * * * [provides] no support * * * for the
     contention that the mere inclusion of certain figures
     on the congressionally-approved annual statement can
     prevent the Commissioner’s adjustment for the purpose
     of identifying tax deficiencies. * * * [Hanover Ins.
     Co. v. Commissioner, 598 F.2d 1211, 1217 (1st Cir.
     1979), affg. 69 T.C. 260, 272 (1977).]

The Court of Appeals for the First Circuit noted that accepting

such a contention would be “tantamount to a sanctification of the

estimated figures as well as the form itself, no matter how

unfair or unreasonable.”   Id. (quoting Hanover Ins. Co. v.

Commissioner, 65 T.C. 715, 719 (1976)); see also Pac. Employers
                             - 21 -

Ins. Co. v. Commissioner, 89 F.2d 186, 187 (9th Cir. 1937)

(“While the amount of a reserve set up in the [annual statement]

exhibit might coincide with the amount of ‘losses incurred’ as

computed according to the statute * * *, the mere fact that the

reserve is designated for ‘losses incurred’ does not establish

that the amount of such reserve is the amount of ‘losses

incurred’ within the meaning of the federal statute.”), affg. 33

B.T.A. 501 (1935); Hanover Ins. Co. v. Commissioner, 65 T.C. at

719.13




     13
       Petitioner cites various cases to support its contention
that the Code requires conformity between the estimates of unpaid
losses shown on its annual statement and on its tax return. As
this Court has previously stated in rejecting similar arguments,
“the cited cases which held the annual statement to be conclusive
did not involve the reasonableness of the estimated figures
appearing on such statement, but rather the format or methodology
of such statement”. Hanover Ins. Co. v. Commissioner, 65 T.C.
715, 719 (1976). For instance, N.H. Fire Ins. Co. v.
Commissioner, 2 T.C. 708 (1943), cited by petitioner, addressed
the issue of whether certain reinsurance transactions should be
taken into account, and Bituminous Cas. Corp. v. Commissioner, 57
T.C. 58 (1971), addressed the issue of whether the taxpayer
correctly deducted reserves for policyholder dividends, in
accordance with annual statement methodology. Similarly, in
Sears, Roebuck & Co. v. Commissioner, 972 F.2d 858 (7th Cir.
1992), affg. in part and revg. in part 96 T.C. 61 (1991), the
Court of Appeals for the Seventh Circuit held that the taxpayer
was entitled to rely upon the annual statement method of
accounting for losses on certain mortgage loans. The Court of
Appeals suggested, however, that the precise figures shown on the
annual statement were not conclusive, stating that on remand the
Tax Court was free to consider the Commissioner’s argument that
the taxpayer’s returns for the years in issue “did not use a
proper case-based method of approximating its loss reserves.”
Id. at 868.
                              - 22 -

     In Hanover, 65 T.C. at 719, this Court concluded that the

applicable regulations were deemed to have received congressional

approval and acquired the force of law by virtue of having been

“long continued without substantial change, applying to unamended

or substantially reenacted statutes”.    This tacit congressional

approval was made overt when, as part of the Tax Reform Act of

1986, Pub. L. 99-514, sec. 1023(c), 100 Stat. 2085, 2399,

Congress added section 846 (requiring that unpaid losses be

discounted to reflect the time value of money for claims that

would not be paid until future years).   In explaining these

changes, the conference report accompanying this legislation

described prior law as follows:

          The amount of the deduction for losses incurred
     must be reasonable. See Reg. sec. 1.832-4(b) and
     Hanover Insurance Co. v. Commissioner, 598 F.2d 1121
     (1st Cir. 1979), cert. denied, 444 U.S. 915. Thus,
     under present law, the Internal Revenue Service may
     review, and, if appropriate, adjust the amount of the
     deduction for unpaid losses and unpaid loss adjustment
     expenses. [H. Conf. Rept. 99-841 (Vol. II), at II-357
     (1986), 1986-3 C.B. (Vol. 4) 1, 357.]

     Petitioner argues that various technical aspects of certain

1986 and 1990 Code amendments relating to P&C companies

“continued, and in some ways strengthened, deference to the

Annual Statement”.   Without a protracted discussion of

petitioner’s highly technical arguments in this regard, suffice

it to say that we have reviewed them carefully and find them

unpersuasive.   Even if we were to assume, arguendo, that Congress
                              - 23 -

demonstrated an intent to “continue” deference to the annual

statement, Congress also explicitly stated its understanding, as

described above, that such deference does not preclude the IRS

from adjusting the estimates used on the annual statement.     We

are unconvinced that Congress intended to “strengthen” deference

to the annual statement by expanding it beyond the limits

reflected in the applicable regulations and judicial precedents,

as expressly referenced in the legislative history.

     The applicable regulations “give notice to the taxpayer that

the Code will be enforced”, by restating the principle that

taxpayers must prove their entitlement to deductions.     Hanover

Ins. Co. v. Commissioner, 598 F.2d at 1219.   These procedural

aspects of the applicable regulations are consistent with general

burden of proof concepts that obtain in this Court.    Whether a

taxpayer’s estimates of its unpaid losses are fair and reasonable

is essentially a valuation issue and thus a question of fact.

Hanover Ins. Co. v. Commissioner, 69 T.C. at 270.     The burden of

proof is upon the taxpayer.   Id.; see Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933); Pittman v. Commissioner, 100 F.3d

1308, 1313 (7th Cir. 1996), affg. T.C. Memo. 1995-243.

     Consistent with the requirements of the applicable

regulations, this Court has stated that when the annual statement

methodology is predicated on estimates, those estimates must be

the “best possible.”   Bituminous Cas. Corp. v. Commissioner, 57
                               - 24 -

T.C. 58, 78 (1971); Minn. Lawyers Mut. Ins. Co. v. Commissioner,

T.C. Memo. 2000-203.   This does not mean that there is (or could

be, except in hindsight) a single “correct” estimate.14    It does

mean, however, that the taxpayer must be prepared to objectively

validate that the methods and assumptions it relied upon to make

its estimate are reasonable.   See Minn. Lawyers Mut. Ins. Co. v.

Commissioner, supra (the taxpayer failed to establish the

necessity or appropriateness of a bulk “adverse development

reserve” that its management established as an addition to the

case reserves determined by its claim department); cf. Vinson &

Elkins v. Commissioner, 99 T.C. 9, 57 (1992) (in the context of

pension plan regulation, the section 412(c)(3) requirement that

actuarial estimates be reasonable and offer the actuary’s “best

estimate” of actuarial experience does not connote a single “best

estimate” but instead requires validation of actuarial

assumptions in choosing a reasonable range and in selecting a

value within the range), affd. 7 F.3d 1235 (5th Cir. 1993).

The Expert Witnesses

     Both parties called expert witnesses to offer their opinions

regarding the reasonableness of petitioner's unpaid loss

estimates.   We evaluate expert opinions in light of all the



     14
       For example, this Court has rejected an argument that the
midpoint of an actuarially sound range is the only fair and
reasonable estimate. See Utah Med. Ins. Association v.
Commissioner, T.C. Memo. 1998-458.
                                - 25 -

evidence in the record, and we may accept or reject the expert

testimony, in whole or in part, according to our independent

evaluation of the evidence in the record.       See Helvering v. Natl.

Grocery Co., 304 U.S. 282, 295 (1938); Malachinski v.

Commissioner, 268 F.3d 497 (7th Cir. 2001); Estate of Davis v.

Commissioner, 110 T.C. 530, 538 (1998).

     Petitioner offered expert testimony of Owen Gleeson

(Gleeson), Robert Sanders (Sanders), and James Hurley (Hurley).

Petitioner called Hurley to rebut certain conclusions of

respondent’s experts.    Respondent offered expert testimony of

Frederick Kilbourne (Kilbourne) and David Otto (Otto), each

affiliated with the Kilbourne Co., who jointly submitted the

expert report of the Kilbourne Co. on behalf of respondent.

     Owen Gleeson

     Gleeson analyzed the reports that Tillinghast prepared for

petitioner for 1993 and 1994.    He concluded that Tillinghast’s

reserve analyses were performed in a reasonable manner, employing

methodologies that were “appropriate to the lines of business

being analyzed.”    In particular, he opined that in estimating

unpaid losses for each of the years 1993 and 1994, Tillinghast

appropriately gave weight to the prior year’s selected ultimate

losses.   Gleeson opined that it was reasonable for petitioner to

rely upon the Tillinghast reports.       He did not specifically

address the appropriateness of petitioner’s almost 10-percent
                               - 26 -

addition to Tillinghast’s point estimates of unpaid

losses.   Gleeson offered no independent estimates of petitioner’s

unpaid losses for either year in issue.

     Robert Sanders

     Sanders opined that the unpaid claim liabilities that

petitioner established for the years in issue were “reasonably

stated based on facts known at the time.”   He opined that

Tillinghast used appropriate methodologies and that its point

estimates of petitioner’s unpaid losses for the years in issue

were “reasonable estimates.”

     Sanders opined that it was reasonable for petitioner to

estimate its unpaid losses at amounts almost 10 percent above

Tillinghast’s point estimates because he believed it was

reasonable to imply a range around the Tillinghast point estimate

of plus or minus 10 percent.   In support of this conclusion,

Sanders cited various factors, including:   (1) The historically

volatile nature of the medical malpractice insurance industry,

leading to inherent uncertainty in estimates for this line of

business; (2) petitioner’s “relative immaturity”; and

(3) “growing evidence” of a “deteriorating claims environment”.

His report also lists various “relevant factors that could impact

* * * [petitioner’s] exposure to loss that were not explicitly

recognized in Tillinghast’s actuarial methods”, including, inter

alia, the size of the company, the lack of geographic spread of
                              - 27 -

risk, and increased claims and litigation being threatened

against petitioner.

     Sanders testified that he knew of no actuarial standard of

practice or guideline that suggests a 10-percent tolerance on

either side of a best estimate, stating that it was a “very

judgmental area.”

     To prepare his report, Sanders examined petitioner’s annual

statements for 1993 and 1994; Tillinghast’s yearend 1993 and

yearend 1994 reports; Tillinghast’s rate reviews prepared in

October 1993 and September 1994; reports drafted by respondent’s

experts; and various publicly accessible documents and filings.

Sanders never met with Tillinghast personnel to discuss

Tillinghast’s reports, however, nor did he review any of

Tillinghast’s pre-1993 reports for petitioner or any of

Tillinghast’s working papers beyond the exhibits supporting

Tillinghast’s reports.

     Kilbourne and Otto

     In their joint report, Kilbourne and Otto concluded that

petitioner’s estimates of its unpaid losses for 1993 and 1994

were too high.   They stated that they had reviewed Tillinghast’s

reports and work papers and had concluded that Tillinghast’s work

“violates professional actuarial standards then in place”,

particularly as regards its reliance upon “prior selections”.

They also opined that petitioner’s almost 10-percent add-ons
                              - 28 -

“contradict the actuarial work done by Tillinghast.”    On the

basis of their independent analyses, Kilbourne and Otto concluded

that fair and reasonable estimates of petitioner’s unpaid losses

were $50 million for 1993 and $39 million for 1994.

     Kilbourne and Otto also reviewed the AMI report and

concluded that it relied upon “erroneous calculations and

unsupportable assumptions”.   They stated that if these defects

had been cured, the results of the AMI analysis would corroborate

their own conclusions.

     James D. Hurley

     The Hurley rebuttal report responded to three criticisms

that Kilbourne and Otto made of the AMI analysis:    (1) The use of

incorrect premium data in AMI’s application of the Bornhuetter-

Ferguson actuarial method; (2) inappropriate interpolation of

loss development factors in AMI’s application of the paid loss

development actuarial method; and (3) inappropriate selection of

factors generally in the AMI analysis.

     Hurley concluded that the first criticism noted above was

valid and that if the AMI analysis were adjusted to correct this

error, AMI’s point estimate of petitioner’s 1993 unpaid losses

should be reduced from $87,419,000 to $82,544,000.    Hurley

concluded that the second-mentioned criticism “involves a matter

of actuarial judgment” but stated nonetheless that if one were to

adjust the AMI report for this issue as well as the first-
                                - 29 -

mentioned issue, AMI’s point estimate of petitioner’s 1993 unpaid

losses should be reduced to $71,915,000.     Hurley concluded that

the third-mentioned criticism “involves purely actuarial

judgment” and offered no conclusion as to how adjusting for this

issue might affect the AMI point estimates.

Analysis

     On the basis of all the evidence in the record, we conclude

that petitioner has failed to establish that it made fair and

reasonable estimates of its actual unpaid losses for the years in

issue.     In particular, petitioner has failed to establish that

its add-ons of almost 10 percent to Tillinghast’s point estimates

were reasonable or appropriate.

     On brief, petitioner argues that its management’s decisions

to increase Tillinghast’s point estimate were “not actuarial in

nature” but instead were based on certain “qualitative concerns”,

particularly regarding “the basic actuarial assumption that past

experience will replicate itself in the future.”     Consequently,

petitioner argues, the 10-percent add-ons resulted in “an

appropriate expression of conservatism based on the implied range

around Tillinghast’s unchanged point estimate.”

     Petitioner offered no evidence to show how it arrived at the

precise amounts of its add-ons to Tillinghast’s point
                               - 30 -

estimates.15   Petitioner offered no contemporaneous documentary

evidence supporting the basis for its add-ons to Tillinghast’s

point estimate.   Petitioner introduced into evidence an undated

and untitled document that Maurer contends is a list of

“qualitative factors” that he relied upon to justify petitioner’s

increments to Tillinghast’s point estimates.16   Petitioner has

not established, however, that this list, which Maurer created

after the fact, relates to the years in issue.17   Consequently,

the list is of little probative value.   Even if we were to

assume, for sake of argument, that the list accurately reflects

factors that petitioner contemporaneously relied upon in arriving

at its add-ons to Tillinghast’s point estimates, petitioner has

not established that these factors do not duplicate factors that


     15
       Although David L. Maurer (Maurer) testified that he
selected his estimates of unpaid losses as a point that was “ten
percent above Tillinghast’s initial point estimate”, his
testimony was vague and evasive as to why the unpaid loss
estimates were not in fact exactly 10 percent greater than
Tillinghast’s point estimate, but rather 9.95 percent greater in
1993 and 9.77 percent greater in 1994.
     16
       The list notes the following “qualitative factors”: A
trend toward increased claims against corporations; possible
liability to the Wisconsin Patients Compensation Fund for
settlements or bad faith claims; turnover in clients; pending
tort reform legislation; greater uncertainty with “new states”
and other lines of business recently offered; and increased
litigation resulting from petitioner’s aggressive claims defense.
     17
       Maurer testified that he did not recall when he prepared
the list, but he believed it was in 1997. He testified that he
did not “recall exactly what period of time * * * [the list]
relates to”. According to his testimony, he spent 10 or 15
minutes putting this document together.
                             - 31 -

Tillinghast had already considered in its actuarial analyses.18

To the contrary, Maurer testified that “many of these items were

discussed with Tillinghast at one time or another.”   Maurer

testified that Tillinghast “did know, in general terms, about

some of the factors we were considering” in arriving at their

increments to Tillinghast’s point estimates.   Maurer testified

that although he looked at the Tillinghast reports, “I did not

look specifically at their methodologies or their selections”.

In his testimony, Maurer was unable to confirm that Tillinghast

ever checked to see whether the “qualitative factors” might have

already been factored into the Tillinghast point estimates.

     In its representation letters to Tillinghast, petitioner

represented that it had disclosed to Tillinghast all factors that

would materially affect loss reserves.   Kurt Reichle (Reichle),

Tillinghast’s appointed actuary for petitioner during the years

in issue, testified that Tillinghast relied on these letters to

be accurate and complete and stated that he could not recall that




     18
       Moreover, if we were to assume, for the sake of argument,
that Tillinghast declined to consider some of these factors in
its actuarial analyses, petitioner has failed to show that
Tillinghast acted improperly in this regard. We are unpersuaded
that all of these “qualitative factors” should have been
considered in estimating petitioner’s unpaid losses for the years
in issue. For instance, because petitioner did business only in
Wisconsin during the years in issue, it is unclear why
uncertainty regarding business in “new states” should enter into
the estimation of unpaid losses for the years in issue.
                              - 32 -

Tillinghast ever explicitly refused to consider any particular

factor in estimating petitioner’s unpaid losses.

     Furthermore, there is no evidence in the record of any

actuarial standard that supports an “implied range” of plus or

minus 10 percent around an actuary’s point estimate.   To the

contrary, Reichle testified that although the concept of an

implied range of reasonableness is consistent with the

uncertainty inherent in any particular point estimate of unpaid

losses, it is impossible to quantify generally how wide such a

range would be, since the width of the range would depend upon

the confidence level demanded.19

     Reichle testified somewhat tentatively that “I guess in the

case at hand, our view was that * * * If a company carried a

reserve in their annual statement within ten percent of our

estimate, * * * that was reasonable.”   Reichle also testified,

however, that any such implied range had to be determined on a

“company-by-company and case-by-case basis” and that he “wouldn’t

want to quite generalize it * * * within the industry and that

kind of thing”.   Reichle offered no specifics as to what factors

he might have considered in arriving at a conclusion that a 10-

percent implied range was reasonable in the instant case or what

confidence level such a range might imply.   Consequently, the



     19
       In other words, the width of the implied range would
approach infinity as the confidence level approached zero.
                               - 33 -

evidence is inadequate for us to assess the reasonableness of any

conclusion by Tillinghast as to a 10-percent implied range around

their point estimate.    In any event, the evidence does not

establish that Tillinghast contemporaneously communicated with

petitioner about any such implied range.20

     Sanders testified that, in his opinion, it was reasonable

for petitioner to select unpaid loss estimates on the basis of an

implied range of plus or minus 10 percent, but that he knew of no

actuarial standard of practice or guideline that suggests such a

10-percent tolerance.   Although Sanders identified various

factors that might support a 10-percent tolerance, he admitted on

cross-examination that he did not know to what extent Tillinghast

had actually considered such factors in selecting its point

estimates or whether petitioner had considered such factors in

increasing Tillinghast’s point estimates by approximately 10

percent.

     The AMI report addressed only petitioner’s 1993 (and not its

1994) unpaid losses.    The AMI report concluded that petitioner’s

1993 unpaid loss reserves were at the “low end” of a reasonable

range.    Respondent’s experts, Kilbourne and Otto, concluded that

the AMI report contained errors that caused its 1993 unpaid loss


     20
       Kurt Reichle testified that he could not recall that
Tillinghast ever communicated such an implied range to
petitioner. Similarly, Maurer testified that he could not recall
specific conversations that he had with anyone at Tillinghast
about such an implied range.
                               - 34 -

estimates to be significantly overstated.   Petitioner’s rebuttal

expert, Hurley, concurred with key aspects of Kilbourne’s and

Otto’s criticisms of the AMI analysis and opined that if the AMI

analysis were adjusted to reflect certain of their criticisms,

the AMI point estimate for 1993 unpaid losses would be reduced to

$71,915,000–-an amount slightly below Tillinghast’s 1993 point

estimate.21   In light of Hurley’s conclusions, the AMI report

does not support petitioner’s add-ons to Tillinghast’s 1993 and

1994 point estimates.

     Coopers never expressly opined that petitioner’s unpaid loss

estimates were reasonable.   To the contrary, for each of the

years in issue, Coopers concluded that petitioner’s estimates of

its unpaid losses fell outside a reasonable range suggested by

Coopers’s in-house guidelines.   Ultimately, Coopers decided to


     21
       To be more precise, James Hurley (Hurley) agreed with
Frederick Kilbourne (Kilbourne) and David Otto (Otto) that the
AMI report contained certain errors, the adjustment of which
would reduce the AMI point estimate by $4,875,000 to $82,544,000.
Hurley noted that if the AMI analysis were adjusted to account
for certain other of Kilbourne’s and Otto’s criticisms, which
Hurley opined involved “matters of actuarial judgment”, the AMI
point estimate should be reduced by $15,504,000 to $71,915,000.
Hurley did not expressly align himself with the actuarial
judgment of either AMI or Kilbourne and Otto. We note, however,
that Hurley computed the effect of a corresponding adjustment for
this issue, while declining to offer a corresponding adjustment
for another of Kilbourne’s and Otto’s criticisms of the AMI
analysis, which Hurley characterized as involving “purely
actuarial judgment”. We infer that Hurley recognized merit in
those criticisms raised by Kilbourne and Otto for which he
computed corresponding adjustments. Accordingly, to that extent,
we construe Hurley’s report as corroborating Kilbourne’s and
Otto’s criticisms of the AMI analysis.
                              - 35 -

override these in-house guidelines and to require no adjustment

to petitioner’s annual statement estimates, largely because

Coopers did not consider the effects of any overstatement of

these estimates to be “significant” for financial disclosure

purposes.22   The mere fact that a potential overstatement in

unpaid loss estimates is not deemed significant or material for

financial statement purposes, however, does not mean that the

estimates are fair and reasonable within the meaning of the

applicable regulations.   In fact, Coopers specifically noted that

the “impact on current year net income is significant”.    Of

course, failure to clearly reflect net income is at the heart of

our concerns here.

     Regarding petitioner’s 1994 financial statements, Coopers

noted that “A portion of the reserve redundancy is maintained to

offset potential tax exposure” relating to IRS audits of

petitioner for prior years.   This comment strongly suggests that

petitioner’s estimates of its unpaid losses did not comprise

“only actual unpaid losses” on its insurance contracts, as

required by the applicable regulations.   Sec. 1.832-4(a)(5) and

(b), Income Tax Regs.; see State of Md. Deposit Ins. Fund v.


     22
       Among the reasons stated for the Coopers & Lybrand
decision that no unpaid loss adjustments were required for
petitioner’s financial statements were the following: “The
impact on retained earnings (slightly over 5%) is not considered
overly significant”; there would be no “significant impact” on
bonus plans; and petitioner “is not publicly traded and there is
currently no active market for the existing shares.”
                                   - 36 -

Commissioner, 88 T.C. at 1059.

     In sum, petitioner has failed to establish that its

selection of unpaid loss estimates almost 10 percent greater than

its actuary’s point estimates was based on reasonable methods or

assumptions.     Cf. Hospital Corp. of Am. v. Commissioner, T.C.

Memo. 1997-482 (insurance company failed to establish the

reasonableness of unpaid losses where it relied upon the

extrapolation of a recommended range from fixed dollar values

contained in its actuary’s reserve analysis reports).

Accordingly, petitioner has failed to establish that its

estimates of unpaid losses, insofar as they include the almost

10-percent add-ons to Tillinghast’s point estimates, are fair and

reasonable within the meaning of the applicable regulations.

Determination of Fair and Reasonable Estimates of Unpaid Losses

     Respondent’s experts’ estimates of petitioner’s unpaid

losses differ in amount not only from Tillinghast’s point

estimates but also (by a smaller margin) from respondent’s

determinations in the statutory notice.23      Contending broadly




     23
       The unpaid loss estimates selected by Tillinghast,
respondent (in the statutory notice), and respondent’s experts
were as follows:

                   Tillinghast        Respondent’s    Respondent’s
          Year   Point Estimates     Determinations     Experts

          1993     $74,027,009        $46,508,000     $50,000,000
          1994      77,029,796         45,549,000      39,000,000
                              - 37 -

that his experts’ estimates confirm the estimates reflected in

the statutory notice, respondent urges us to sustain his

determinations.

     On brief, respondent’s primary criticism of Tillinghast’s

methodology relates to Tillinghast’s use of “prior selections”.

Respondent’s complaint, in essence, is that instead of

calculating petitioner’s unpaid losses by averaging the results

indicated by the five specific actuarial methods that it

employed, Tillinghast improperly inflated the final result by

factoring in the higher ultimate loss estimates that Tillinghast

had selected in the preceding year.

     We are unpersuaded by respondent’s criticisms of

Tillinghast’s actuarial methods.   Reichle and petitioner’s

experts offered credible testimony that the weighing of prior

selections was standard practice in the industry and was

justified in the present circumstances.24   The Coopers auditors

determined that Tillinghast’s estimates and assumptions were

reasonable.   On the basis of the record before us, we decline to

second-guess Tillinghast’s professional judgment that

consideration of prior-year loss estimates was a reasonable guard

against overoptimism where trends in medical malpractice


     24
       For example, Owen Gleeson testified that it would not
have been reasonable for Tillinghast to have stopped with the
results derived from its five specific actuarial methods, and
that it was “necessary” for Tillinghast to consider its prior
selections.
                              - 38 -

experience had recently reversed course from unfavorable to

favorable, and where there was uncertainty about the credibility

of some of petitioner’s current data.25   Tillinghast’s use of

prior selections appears to be analogous to the so-called

lookback method that we found to be proper in Utah Med. Ins.

Association v. Commissioner, T.C. Memo. 1998-458.

     In attacking Tillinghast’s use of prior selections,

respondent relies on the Kilbourne Co. report, which states that

“As a matter of actuarial science” Tillinghast’s reliance on

prior selections was not justified, especially given that

petitioner’s unpaid loss reserve redundancies were higher than

the industry norm.   The general tenor of the Kilbourne Co. report

is adversarial toward Tillinghast, accusing Tillinghast of

consciously violating various actuarial precepts.26   Otto

testified that Tillinghast’s estimates reflected a conscious


     25
       Respondent makes much of the fact that Tillinghast gave
its prior selections greater weight in 1994 than in 1993. The
evidence shows, however, that the increased weight for prior
selections in 1994 was explained by facts specific to 1994,
including changes in petitioner’s incidence reporting and
restatements of petitioner’s data bases that caused Tillinghast
to have greater uncertainty about the integrity and credibility
of petitioner’s current data in 1994.
     26
        The Kilbourne Co. report states, for instance, that
Tillinghast “manipulated their actuarial methods through the
process of relying on ‘prior selections’ in a manner that cannot
be supported by the data.” Similarly, the Kilbourne Co. report
states that in making its actuarial estimates, “Tillinghast
introduced additional and extraneous calculations which we
believe we can show were intended to incorporate margins (i.e.
excessive amounts) into the unpaid losses.”
                               - 39 -

decision to overstate petitioner’s reserves.    At trial, however,

Otto conceded that he had no basis for this conclusion, except

that his actuarial analysis differed from Tillinghast’s.

     We believe that Otto’s unsupported accusations and the

generally adversarial tone of the Kilbourne Co. report are more

indicative of advocacy than of the “detached neutrality” we

demand of expert witnesses.    See Estate of Halas v. Commissioner,

94 T.C. 570, 577-579 (1990).   The usefulness and credibility of

respondent’s experts are accordingly diminished, and we give

their opinions little weight in this regard.    See, e.g., Buffalo

Tool & Die Manufacturing Co. v. Commissioner, 74 T.C. 441, 452

(1980); Anclote Psychiatric Ctr., Inc. v. Commissioner, T.C.

Memo. 1998-273; Podd v. Commissioner, T.C. Memo. 1998-231.

     We are also unpersuaded by respondent’s contentions that

petitioner’s estimates of unpaid losses were unreasonable because

they proved, in hindsight, excessive.   As this Court stated in

Utah Med. Ins. Association v. Commissioner, supra:     “Petitioner’s

reserves for unpaid losses must be fair and reasonable, but are

not required to be accurate based on hindsight.”    The evidence

shows that Tillinghast took into account developing redundancies

in establishing the estimates in question.     Cf. Minnesota Lawyers

Mut. Ins. Co. v. Commissioner, T.C. Memo. 2000-203 (taxpayer

failed to show that it took prior favorable experience into

account in establishing adverse development reserves).
                                - 40 -

Conclusion

     On the basis of all the evidence, we conclude and hold that

the best estimates of petitioner’s unpaid losses for the years in

issue are Tillinghast’s point estimates–-i.e., $74,027,009 for

1993 and $77,029,796 for 1994.

     We have considered all other arguments that the parties have

advanced for different results and find them to be moot,

irrelevant, or without merit.

     To reflect the foregoing and concessions by the parties,


                                          Decision will be entered

                                     under Rule 155.
