Federal Income Taxes
(a) On December 22, 2017, the Tax Cuts and Jobs Act of 2017 ("Tax Reform") was signed into law, which among other implications, will reduce our statutory corporate tax rate from 35% to 21% beginning with our 2018 tax year. We revalued our deferred tax inventory as of December 31, 2017 in anticipation of this reduction, which resulted in a $20.2 million charge to income as illustrated in the rate reconciliation table below. This charge included a $5.7 million benefit related to net unrealized gains on our investment portfolio and pension plan, which were originally recorded through AOCI.
Our accounting for the impact of Tax Reform on our deferred tax assets and liabilities is complete with the exception of amounts related to loss reserve discounting. Prior to Tax Reform, we had elected to use our own loss reserve payment patterns in determining the factors that we use in our discounting calculation. Under Tax Reform, this election has been eliminated and we are required to use an industry experience approach that includes a discount rate based on a corporate bond yield curve for which the IRS has not yet issued any guidance. Considering this, we have recorded a $7.5 million provisional increase to our deferred tax asset that is based on the industry experience approach under the tax law that existed prior to Tax Reform. We believe this is a reasonable estimate for the elimination of the company experience method election. We have not estimated a provisional amount based on the revised Tax Reform industry experience approach. Based on a Tax Reform transition rule that allows for this type of change in accounting method to be amortized into expense over an eight-year period beginning in 2018, we have established an offsetting deferred tax liability of $7.5 million as of December 31, 2017. During 2018, we will obtain, prepare, and analyze the necessary information to complete the accounting for loss reserve discounting.
(b) A reconciliation of federal income tax on income at the corporate rate to the effective tax rate is as follows:
|
| | | | | | | | | | |
($ in thousands) | | 2017 | | 2016 | | 2015 |
Tax at statutory rate of 35% | | $ | 91,689 |
| | 76,984 |
| | 81,442 |
|
Tax-advantaged interest | | (11,510 | ) | | (12,126 | ) | | (13,164 | ) |
Dividends received deduction | | (1,961 | ) | | (1,114 | ) | | (1,817 | ) |
Stock based compensation | | (4,281 | ) | | — |
| | — |
|
Tax reform rate change | | 20,205 |
| | — |
| | — |
|
Other | | (1,000 | ) | | (2,284 | ) | | 370 |
|
Federal income tax expense from continuing operations | | $ | 93,142 |
| | 61,460 |
| | 66,831 |
|
In addition to the impact of Tax Reform discussed above, our rate reconciliation for 2017 was also impacted by the $4.3 million impact of new accounting literature requiring that the tax effects of share-based compensation be recognized in the income tax provision. Previously, these amounts were recorded in additional paid-in capital. See Note 3. "Adoption of Accounting Pronouncements" for additional information regarding this literature change.
(c) The tax effects of the significant temporary differences that gave rise to deferred tax assets and liabilities were as follows:
|
| | | | | | | |
($ in thousands) | | 2017 | | 2016 |
Deferred tax assets: | | |
| | |
|
Net loss reserve discounting | | $ | 38,771 |
| | 70,065 |
|
Net unearned premiums | | 50,267 |
| | 78,201 |
|
Employee benefits | | 8,606 |
| | 17,881 |
|
Long-term incentive compensation plans | | 12,221 |
| | 17,750 |
|
Temporary investment write-downs | | 1,044 |
| | 2,475 |
|
Other investment related items, net | | — |
| | 1,484 |
|
Net operating loss | | 54 |
| | 771 |
|
Other | | 5,784 |
| | 8,344 |
|
Total deferred tax assets | | 116,747 |
| | 196,971 |
|
Deferred tax liabilities: | | |
| | |
|
Deferred policy acquisition costs | | 47,484 |
| | 75,310 |
|
Unrealized gains on investment securities | | 26,183 |
| | 22,681 |
|
Other investment-related items, net | | 2,500 |
| | — |
|
Accelerated depreciation and amortization | | 8,590 |
| | 14,140 |
|
Total deferred tax liabilities | | 84,757 |
| | 112,131 |
|
Net deferred federal income tax asset | | $ | 31,990 |
| | 84,840 |
|
Net deferred federal income tax assets decreased by $52.9 million during 2017. As mentioned above, net deferred federal income tax assets were reduced by $20.2 million in relation to Tax Reform. In addition to this charge, net deferred assets decreased by $21.4 million resulting from additional unrealized gains generated during the year on our investment portfolio.
After considering all evidence, both positive and negative, with respect to our federal tax loss carryback availability, expected levels of pre-tax financial statement income, and federal taxable income, we believe it is more likely than not that the existing deductible temporary differences will reverse during periods in which we generate net federal taxable income or have adequate federal carryback availability. As a result, we had no valuation allowance recognized for federal deferred tax assets at December 31, 2017 or 2016.
As of December 31, 2017, we had federal tax net operating loss ("NOL") carryforwards of $0.3 million. These NOLs, which are subject to an annual limitation of $1.9 million, will expire between 2030 and 2031.
Stockholders' equity reflects tax benefits related to compensation expense deductions for share-based compensation awards of $23.8 million at December 31, 2017 and December 31, 2016, and $22.0 million at December 31, 2015. As mentioned above, beginning in 2017, all excess tax benefits and tax deficiencies on share-based payment awards are recognized as income tax expense or benefit on the Consolidated Statements of Income.
We have analyzed our tax positions in all open tax years, which as of December 31, 2017 were 2014 through 2016, and we believe our tax positions will more likely than not be sustained upon examination, including related appeals or litigation. In the event we had a tax position that did not meet the more likely than not criteria, any tax, interest, and penalties incurred related to such a position would be reflected in "Total federal income tax expense" on our Consolidated Statements of Income. We are not currently under a federal income tax audit for any tax year.