Hon. William A. Harrison          Opinion No. Ww-167
Commissioner of Insurance
International Life Building       Rc: Whether the "reserve" men-
Austin, Texas                     tioncd In Section  7 of Article
                                  3.44, Texas Insurance Code, in-
                                  cludes therein the deficiency
                                  reserve described in Section 2
                                  of Article 3.28,  Texas Insur-
                                  ance Code.
Dear Sir:
          In your request for an opinion, you posed the fol-
lowing question:
          "We respectfully request your opinion as to
     whether the terms 'the reserve (exclusive  of any
     reserve for disability or accidental death bene-
     fits)' and 'the reserve on the olicy,' which ap-
     pear in Section 7 of Article 3. E4 include in such
     reserve the so-called deficiency reserve described
     in Section 2 of Article 3.28.   In other words,
     must the cash, loan, amount of extended insurance,
     and other non-forfeiture values of the policy be
     increased by including therein the amounts in the
     deficiency reserve allocated or attributable to
     the particular policy involved?"
          Article 3.28 of the Texas Insurance Code deals with
the computation of reserves for legal reserve life insurance
companies. Section 1 of this Article requires the State Board
of Insurance to compute the reserve liability of every com-
pany authorized to do business In this State as of December
31, of the preceding year. With the exception of group in-
surance and policies of Insurance Issued by Chapter 11 com-
panies, Section 1 requires "that the reserve liability on all
outstand.lngpolicies of insurance and annuity contracts shall
be computed upon the net premium basis and in accordance with
their terms," with certain rules as to the proper rates of
Interest and mortality tables to be used.
            Section 2 of Article 3.28   provides as follows:
Hon. William A. Harrison, page 2 (~~-167)


          "If the gross premium charged by any life
     Insurance company on any policy or contract is
     less than the net premium for the policy or Gn-
     tract, according to the mortality table, rate
     of interest and method used In computing the re-
     serve liability thereon as aforesaid, there shall
     be maintained on such policy or contract a defl-
     ciency reserve in addition to all other reserves
     required by law. For each such policy or con-
     tract the deficiency reserve shall be the prc-
     sent value, according to such:standard, of an
     annuity, the amount of which shall equal the dif-
     ference between the premium charged and such net
     premium required by the rules above stated and
     the term of which In years shall equal the num-
     ber of annual premiums for the remainder of the
     premium paying eriod." (Rnphasis added through-
     out the opinionP .
          Section 7 of Article 3.44 provides that all life
Insurance policies issued in this State must contain:
           "A provision which, in the event of default 1
     in the premium payments after premiums shall have
     been paid for three (3) full years, shall secure
     a stipulated form of insurance on the life of the
     insured, the net value of which shall be equal
     to the reserve (exclusive of any reserve for dls-
     ability or accidental death benefits) at the date
     of default on the oolicv.  and on anv dividend ad-
     ditions thereto, according to the mortality table,
     rate of interest and method adopted for computing
     such reserve, less a sum of not more than two and
     one-half (25) percent of the amount insured by
     the policy and of any existing dividend additions
     thereto, and less any existing indebtedness to the
     company on the policy;. . . The policy shall state:
     (1) The amount and term of the stipulated form of
     insurance calculated.upon the assumption of no in-
     debtedness on the policy and no dividend additions
     thereto; and (2) the method, rate of interest, and
     mortality table for computing the policy reserve
     which may be such as may be authorized by law -for
     use in computing the reserve liability of the com-
     pany on such policy. Such provision shall also
     stipulate that the policy may be surrendered to
     the company at its home office within one month
     from the due date of any premium for its cash val-
     ue, which shall be specified in the policy and
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          Hon. William A. Harrison, page 3 (~~-167)


               which shall be at least equal to the sum which
               would otherwise be available for the purchase
               of insurance, as aforesaid, but not more than
               the reserve for the policy. 7

                    The question to be decided is whether the non-
          forfeiture benefits and values mentioned in Article 3.44
          must be increased by the amount of the deficiency reserve
          required to be maintained by Section 2 of Article 3.28
          when the policy Is sold for a gross premlun~lcss than the
          net premium. More specifically, does the word "reserve"
          in Article 3.44 necessarily include therein the deficiency
          reserve provided for in Article 3.28?
                     The premium charged for a life insurance contract
          Is supposed to cover all contingencies a company is likely
          to meet, and these may be conveniently grouped into three
          classes, viz., mortality, interest and expenses. In com-
          .puting the mortality tables, which are the basis upon which
          the liability of the company is calculated, the matter of
          expenses, which includes such costs as salaries, rents, com-
          missions, etc., Is omitted. The premium computed by such a
          table is referred to as the "net" premium while the premium
          loaded with the expense factors is termed "gross" premium.
          The gross premium is the premium known to the policyholder,
          but before it is obtained an actuary must have ascertained
          the net premium.
                     Before we are able to define the term "reserve"
          referred to in Section 7 of Article 3.44,  it is necessary
          to discuss the meaning of that term In connection with
          Article 3.28.
                    The legal reserve required to be maintained by
          life insurance companies by the terms of Article 3.28 re-
          presents the liability of the issuing company because of
          its outstanding policy obligations. The reserve may be
          stated to be the difference between the present value of
          the benefits to be paid, less the present value of the pre-
          miums yet to be collected. This formula is contrived from
          the theory that in a level premium plan policy, the com-
          pany meets its ultimate obligation to the policyholder by
          setting aside the premiums collected and placing them at
          interest. When a policy is issued, the present value of
          all of the premiums yet to be collected is exactly equal
          to the present value of the death benefits promised to be
          paid in the policy in actuarial theory. At any time after
          the'date of issue, the value of the remaining net pre-
          miums will be less than at the date of issue, since fewer
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Hon. William A. Harrison, page 4’(WW-167)


of such payments remain to be paid while the value of in-
surance has increased because the date of Its payment has
drawn nearer. The difference between the increased value
of the insurance and the decreased value of the future
net premiums must be represented by funds in hand; other-
wise, the company will not be able to meet its liability.
The difference, or fund in hand, Is the reserve with which
the company meets that liability.
          Under the provisions of Article 3.28 of the Texas
Insurance Code, this reserve or liability is calculated on
the basis of a mortality table. These tables are calculated
on the basis of assumed rates of mortality, and not on the
basis of actual mortality experience of the company. As
the actual rate of death claims is normally lower than that
assumed by the table, the USC of such mortality table sup-
plies a safety factor which protects the policyholders by
requiring the companies to accumulate greater reserves than
in all probability will be required to pay the claims.     .
          A mortality table is constructed by calculating the
amount of level premium which, together with the interest
accumulated on such premium, will be sufficient to aggregate
the amount of the benefits to be paid at the end of the life
expectancy. This premium is calculated by taking into con-
sideration the amount of the benefi,tsto be paid, the as-
sumed rate of interest, and the assumed rate of mortality.
Out of this calculation is derived the policy reserve in
accordance with the formula above stated.
          If a company Should charge a gross premium actually
less than the net premium as calculated to be required by the
mortality table used In building up the particular policy, it
necessarily follows that the reserve as calculated by such
table will be insufficient to reflect the actual liability
of the company on the particular policy. The reserve, having
been determined to be the present value of the benefits to
be paid, less the present value of the premiums to be paid,
is based on the assumption that the actual premiums collected
will be at least equal to the net premium as calculated by
the given mortality table.
          For this reason, the legislature provided in what
is now Section 2 of Article 3.28 of the Insurance Code, that
if the premium charged the policyholder be less than the net
premium according to the mortality table used, then the com-
pany must set up an additional reserve termed a "deficiency
reserve." Since the premium collected, plus accumulated
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           Hon. William A. Harrison, Page 5 (~~-167)


           interest, would not be sufficient to build up a reserve adc-
           quatc to meet the company's liability as calculated by the
           table used, the company must be able to meet this additional
           liability from its surplus funds.

                     The non-forfeiture ValUCB or benefits of a given
           policy, are provided for in Article 3.44 and are based on
           the "reserve on the policy." These non-forfeiture values
           are the cash surrender or loan value, the amount of paid-up
           life insurance available at a given period, or the term for
           which a certain amount of insurance will be available for a
           given policy. The theory upon which these benefits are af-
           forded in a particular policy is that from the aucumulated
           premiums on insurance paid by the policyholder the company
           has on hand a fund paid In by the policyholder which it
           holds to honor the company's contract with that policyholder.
           WC have previously ascertained that the amount of the "de-
           ficiency reserve" which a company Is required to maintain
           on the type of policy In question is not derived from funds
           contributed by the particular policyholder, but rather from
           the other surplus funds of the company. If it should be con-
           oludcd that the "deficiency reserve' was part of the reserve
           under the provisions of Section 7 of Article 3.44, the rc-
           suit would be that the amount of these non-forfeiture values
           or benefits would be increased In relation to the disparity
           between the premiums actually collected and the net premiums
           as calculated by the mortality table. In other words, the
           policyholder by paying less premium receives greater non-
           forfeiture benefits.
                     We are of the opinion that the word "reserve" men-    '
           tioned in Section 7 of Article 3.44 Is solely the reserve
           calculated "according to the mortality table, rate of inter-
           est" as specified in the policy. It Is to be noted in this
           connection that Section 'fprovides in part that "the policy
           shall state*         .The amount and term of the stipulated
           form of in&raG!:   *and (2) the method, rate of interest,
           and mortality table for computing the policy reserve, which
           must be such as may be authorized by law for use in com-
           puting the reserve liability of the company on such policy."
                     It Is true that by virtue of the requirement In
           Section 7 of Article 3.44 that the method, rate,of interest
           and mortality table must be such as may be authorized by
           law for use in computing the reserve liability of the com-
           pany, and the requirement in l(c) of Article 3.28 that the
           reserve liability of the company be computed on the basis
           of the mortality table in interest rates specified in the
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Hon. William A. Harrison, page,6 (~~-167)


policy, that these two articles are to some extent inter-
related. 'In ,the case of Qilley v. Missouri State Life
Insurance, 116 Tex. 43, 2855                       scussed
the relation of these two provisions'in the Insurance Law,
and stated: "It is true that a method of computin the net
values of policies, etc., is set forth in Article f+498 (a
predecessor to Article 3.28)  but this is obviously a sol-
vency provision and has no reference whatsoever to what the
policy form must contain." We would also draw your atten-
tion to Attorney General's Opinion No. 0-5255-A approved
March 3, 1944, In which it was stated, "We think it clear
that Subdivisions (7) and (8) (of then Article 4732, Rev.
Stat. of 1925--the predecessor of Article 3.44 of the
Insurance Code) referred to the mortality table and rate
of interest specified in the polic and not to the standard
of solvency provisions in Article 5 682 {the predecessor of
Article 1.10 of the Insurance Code) and 'Article4688 (Artl-
cle 3.28 of the Insurance Code) of Vernon's Annotated Civil
Statutes of 1925."
          You are therefore advised that the "reserve" men-
tioned in Article 3.44 does not embrace nor include the de-
ficiency reserve required in Section 2 of Article 3.28.

                          SUMMARY
          The "reserve" mentioned in Section 7~of
     Article 3.44 does not refer to ncr include
     therein the deficiency reserve required to be
     maintained by the company under the provisions
     of Section 2 of Article 3.28.
                          Yours very truly,
                           WILL WILSON
                           Attorney General of Texas


FBW:nh
APPROVED:                      Fred B. Werkenthin
OPINION COMMITTEE:             Assistant Attorney General
Geo. P. Blackburn, Chairman
Wallace P. Finfrock
Morgan Nesbitt
Richard Stone
REVIEWED FOR THE ATTORNEY GENERAL
BY: W. V. Geppert
