| 10. | Income Taxes |
As of December 31, 2017, the statutory income tax rates of the countries where the Company conducts or conducted business are 35% in the United States, 0% in Bermuda, 0% in the Cayman Islands, 0% in Gibraltar, 27.08% in the Duchy of Luxembourg (for Luxembourg City), 0.25% to 2.5% in Barbados, and 25% on non-trading income, 33% on capital gains and 12.5% on trading income in the Republic of Ireland. The statutory income tax rate of each country is applied against the annual taxable income of each country to calculate the annual income tax expense.
The Company’s income before income taxes from its non-U.S. subsidiaries and U.S. subsidiaries, including the results of the quota share between Global Indemnity Reinsurance and the Insurance Operations, for the years ended December 31, 2017, 2016, and 2015 were as follows:
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Year Ended December 31, 2017: (Dollars in thousands) |
Non-U.S. Subsidiaries |
U.S. Subsidiaries |
Eliminations | Total | ||||||||||||
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Revenues: |
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Gross premiums written |
$ | 212,386 | $ | 462,453 | $ | (158,505 | ) | $ | 516,334 | |||||||
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Net premiums written |
$ | 212,432 | $ | 237,748 | $ | — | $ | 450,180 | ||||||||
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Net premiums earned |
$ | 201,165 | $ | 236,869 | $ | — | $ | 438,034 | ||||||||
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Net investment income |
56,890 | 24,609 | (42,176 | ) | 39,323 | |||||||||||
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Net realized investment gains (losses) |
(641 | ) | 2,217 | — | 1,576 | |||||||||||
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Other income |
216 | 6,366 | — | 6,582 | ||||||||||||
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Total revenues |
257,630 | 270,061 | (42,176 | ) | 485,515 | |||||||||||
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Losses and Expenses: |
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Net losses and loss adjustment expenses |
94,903 | 174,309 | — | 269,212 | ||||||||||||
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Acquisition costs and other underwriting expenses |
89,153 | 94,580 | — | 183,733 | ||||||||||||
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Corporate and other operating expenses |
17,399 | 8,315 | — | 25,714 | ||||||||||||
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Interest expense |
16,740 | 42,342 | (42,176 | ) | 16,906 | |||||||||||
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Income (loss) before income taxes |
$ | 39,435 | $ | (49,485 | ) | $ | — | $ | (10,050 | ) | ||||||
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Year Ended December 31, 2016: (Dollars in thousands) |
Non-U.S. Subsidiaries |
U.S. Subsidiaries |
Eliminations | Total | ||||||||||||
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Revenues: |
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Gross premiums written |
$ | 201,726 | $ | 506,061 | $ | (141,942 | ) | $ | 565,845 | |||||||
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Net premiums written |
$ | 201,690 | $ | 269,250 | $ | — | $ | 470,940 | ||||||||
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Net premiums earned |
$ | 212,325 | $ | 256,140 | $ | — | $ | 468,465 | ||||||||
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Net investment income |
48,807 | 19,341 | (34,165 | ) | 33,983 | |||||||||||
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Net realized investment gains (losses) |
(89 | ) | 21,810 | — | 21,721 | |||||||||||
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Other income (loss) |
(224 | ) | 10,569 | — | 10,345 | |||||||||||
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Total revenues |
260,819 | 307,860 | (34,165 | ) | 534,514 | |||||||||||
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Losses and Expenses: |
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Net losses and loss adjustment expenses |
95,812 | 168,191 | — | 264,003 | ||||||||||||
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Acquisition costs and other underwriting expenses |
94,749 | 101,901 | — | 196,650 | ||||||||||||
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Corporate and other operating expenses |
9,035 | 8,303 | — | 17,338 | ||||||||||||
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Interest expense |
8,312 | 34,758 | (34,165 | ) | 8,905 | |||||||||||
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Income (loss) before income taxes |
$ | 52,911 | $ | (5,293 | ) | $ | — | $ | 47,618 | |||||||
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Year Ended December 31, 2015: (Dollars in thousands) |
Non-U.S. Subsidiaries |
U.S. Subsidiaries |
Eliminations | Total | ||||||||||||
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Revenues: |
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Gross premiums written |
$ | 345,392 | $ | 540,500 | $ | (295,659 | ) | $ | 590,233 | |||||||
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Net premiums written |
$ | 345,342 | $ | 155,902 | $ | — | $ | 501,244 | ||||||||
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Net premiums earned |
$ | 283,448 | $ | 220,695 | $ | — | $ | 504,143 | ||||||||
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Net investment income |
44,534 | 18,011 | (27,936 | ) | 34,609 | |||||||||||
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Net realized investment losses |
(1,039 | ) | (2,335 | ) | — | (3,374 | ) | |||||||||
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Other income (loss) |
(93 | ) | 3,493 | — | 3,400 | |||||||||||
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Total revenues |
326,850 | 239,864 | (27,936 | ) | 538,778 | |||||||||||
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Losses and Expenses: |
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Net losses and loss adjustment expenses |
141,444 | 133,924 | — | 275,368 | ||||||||||||
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Acquisition costs and other underwriting expenses |
122,999 | 78,304 | — | 201,303 | ||||||||||||
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Corporate and other operating expenses |
5,928 | 18,520 | — | 24,448 | ||||||||||||
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Interest expense |
4,492 | 28,357 | (27,936 | ) | 4,913 | |||||||||||
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Income (loss) before income taxes |
$ | 51,987 | $ | (19,241 | ) | $ | — | $ | 32,746 | |||||||
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The following table summarizes the components of income tax expense (benefit):
| Years Ended December 31, | ||||||||||||
| (Dollars in thousands) | 2017 | 2016 | 2015 | |||||||||
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Current income tax expense (benefit): |
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Foreign |
$ | 392 | $ | 330 | $ | 263 | ||||||
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U.S. Federal |
127 | 147 | (1,785 | ) | ||||||||
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Total current income tax expense (benefit) |
519 | 477 | (1,522 | ) | ||||||||
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Deferred income tax expense (benefit): |
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U.S. tax rate change |
17,524 | — | — | |||||||||
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U.S. Federal |
(18,542 | ) | (2,727 | ) | (7,201 | ) | ||||||
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Total deferred income tax (benefit) |
(1,018 | ) | (2,727 | ) | (7,201 | ) | ||||||
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Total income tax (benefit) |
$ | (499 | ) | $ | (2,250 | ) | $ | (8,723 | ) | |||
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The weighted average expected tax provision has been calculated using income (loss) before income taxes in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate.
The following table summarizes the differences between the tax provision for financial statement purposes and the expected tax provision at the weighted average tax rate:
| Years Ended December 31, | ||||||||||||||||||||||||
| 2017 | 2016 | 2015 | ||||||||||||||||||||||
| (Dollars in thousands) | Amount | % of Pre- Tax Income |
Amount | % of Pre- Tax Income |
Amount | % of Pre- Tax Income |
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Expected tax provision at weighted average |
$ | (16,928 | ) | (168.4 | %) | $ | (1,496 | ) | (3.1 | %) | $ | (6,434 | ) | (19.6 | %) | |||||||||
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Adjustments: |
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Tax exempt interest |
(213 | ) | (2.1 | ) | (394 | ) | (0.8 | ) | (441 | ) | (1.3 | ) | ||||||||||||
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Dividend exclusion |
(571 | ) | (5.7 | ) | (617 | ) | (1.3 | ) | (784 | ) | (2.4 | ) | ||||||||||||
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Tax rate change |
17,524 | 174.4 | — | — | — | — | ||||||||||||||||||
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Other |
(311 | ) | (3.2 | ) | 257 | 0.5 | (1,064 | ) | (3.3 | ) | ||||||||||||||
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Effective income tax benefit |
$ | (499 | ) | (5.0 | %) | $ | (2,250 | ) | (4.7 | %) | $ | (8,723 | ) | (26.6 | %) | |||||||||
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The effective income tax benefit rate for 2017 was 5.0%, compared with an effective income tax benefit rate of 4.7% and 26.6% for 2016 and 2015, respectively. The increase in the effective income tax benefit rate in 2017 compared to 2016 is due to incurring a provisional tax expense of $17.5 million related to the reduction in the deferred tax asset as a result of the TCJA enacted on December 22, 2017 which lowered the U.S. tax rate from 35% to 21% offset by $18.4 million tax benefit due to an increase in losses incurred in the Company’s U.S. operations for 2017 compared to 2016. The decrease in the effective income tax benefit rate in 2016 compared to 2015 is primarily due to capital gains in 2016.
Financial results for the year ended December 31, 2017 reflect provisional amounts related to the December 22, 2017 enactment of the TCJA. These provisional estimates are based on the Company’s initial analysis and current interpretation of the legislation. Given the complexity of the legislation, anticipated guidance from the U.S. Treasury, and the potential for additional guidance from the Securities and Exchange Commission or the Financial Accounting Standards Board, these estimates may be adjusted during 2018.
The tax effects of temporary differences that give rise to significant portions of the net deferred tax assets at December 31, 2017 and 2016 are presented below:
| (Dollars in thousands) | 2017 | 2016 | ||||||
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Deferred tax assets: |
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Discounted unpaid losses and loss adjustment expenses |
$ | 3,625 | $ | 7,015 | ||||
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Unearned premiums |
5,318 | 8,802 | ||||||
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Section 163(j) carryforward |
7,906 | 8,075 | ||||||
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Alternative minimum tax credit carryover |
— | 10,957 | ||||||
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Net operating loss carryforward |
16,323 | 3,205 | ||||||
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Partnership K1 basis differences |
130 | 238 | ||||||
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Capital gain on derivative instruments |
1,673 | 4,033 | ||||||
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Investment impairments |
1,742 | 3,419 | ||||||
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Stock options |
1,740 | 2,820 | ||||||
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Stat-to-GAAP reinsurance reserve |
1,014 | 1,337 | ||||||
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Intercompany transfers |
317 | 808 | ||||||
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Other |
3,249 | 4,986 | ||||||
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Total deferred tax assets |
43,037 | 55,695 | ||||||
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Deferred tax liabilities: |
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Purchase accounting adjustment for American Reliable |
7,723 | 6,095 | ||||||
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Intangible assets |
2,394 | 3,942 | ||||||
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Unrealized gain on securities available-for-sale and investments in limited partnerships included in accumulated other comprehensive income |
3,105 | 352 | ||||||
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Investment basis differences |
211 | 484 | ||||||
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Deferred acquisition costs |
1,921 | 2,941 | ||||||
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Depreciation and amortization |
285 | 119 | ||||||
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Other |
1,202 | 805 | ||||||
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Total deferred tax liabilities |
16,841 | 14,738 | ||||||
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Total net deferred tax assets |
$ | 26,196 | $ | 40,957 | ||||
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The deferred tax assets and deferred tax liabilities listed in the table above relate to temporary differences between the Company’s accounting and tax carrying values and carryforwards for its companies in the United States. The net deferred tax asset at December 31, 2017 includes a $17.5 million reduction as a result of the TCJA enacted on December 22, 2017. The new tax law reduces the Company’s U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. As a result, the Company reduced its net deferred tax assets at December 31, 2017 and recorded a provisional deferred tax expense of $17.5 million increasing the effective tax rate for the year ending December 31, 2017 by 174.4%.
Management believes it is more likely than not that the remaining deferred tax assets will be completely utilized in future years. As a result, the Company has not recorded a valuation allowance at December 31, 2017 and 2016.
The Company has an alternative minimum tax (“AMT”) credit carryforward of $11.0 million as of December 31, 2017 and 2016. The TCJA repealed the corporate AMT. The AMT credit carryforward of $11.0 million was reclassed to federal income taxes receivable at December 31, 2017 and will be fully refunded by the end of 2021. The Company has a net operating loss (“NOL”) carryforward of $16.3 million as of December 31, 2017, which begins to expire in 2035 based on when the original NOL was generated. The Company’s NOL carryforward as of December 31, 2016 was $3.2 million. The Company has a Section 163(j) (“163(j)”) carryforward of $7.9 million and $8.1 million as of December 31, 2017 and 2016, respectively, which can be carried forward indefinitely. The 163(j) carryforward is for disqualified interest paid or accrued to a related entity that is not subject to U.S. tax.
The Company and some of its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations by tax authorities for tax years before 2014.
Should the Company’s subsidiaries that are subject to income taxes imposed by the U.S. authorities pay a dividend to their foreign affiliates, withholding taxes would apply. The Company has not recorded deferred taxes for potential withholding tax on undistributed earnings. The Company believes, although there can be no assurances, that it qualifies for treaty benefits under the Tax Convention with Luxembourg and would be subject to a 5% withholding tax if it were to pay a dividend. Determination of the unrecognized deferred tax liability related to these undistributed earnings is not practicable because of the complexities with its hypothetical calculation. The Company did not pay any dividends from a U.S. subsidiary to a foreign affiliate during 2017, 2016, or 2015.
The Company applies a more-likely-than-not recognition threshold for all tax uncertainties whereby it only recognizes those tax benefits that have a greater than 50% likelihood of being sustained upon examination by the taxing authorities. The Company had no unrecognized tax benefits during 2017 or 2016.
The Company classifies all interest and penalties related to uncertain tax positions as income tax expense. The Company did not incur any interest and penalties related to uncertain tax positions during the years ended December 31, 2017, 2016 and 2015. As of December 31, 2017, the Company did not record any liabilities for tax-related interest and penalties on its consolidated balance sheets.