Income Taxes
Through December 31, 2017, the statutory income tax rates of the countries where the Company does business are 35% in the United States and 0.0% in Bermuda. The statutory income tax rate of each country is applied against the taxable income from each country to calculate the income tax expense. On December 22, 2017, the “Tax Cuts and Jobs Act” (“TCJA”) was enacted. The provisions of TCJA include broad tax reforms that are applicable to the Company, including a reduction in the U.S. statutory corporate income tax rate from 35% to 21% effective January 1, 2018. This change in tax rates required us to remeasure our deferred tax assets and liabilities as of the enactment date resulting in a one-time $85.1 million income tax benefit for the year ended December 31, 2017.
Income tax expense consists of the following components for the years ended December 31:
|
| | | | | | | | | | | | |
(In thousands) | | 2017 | | 2016 | | 2015 |
Current | | $ | 38,252 |
| | $ | 31,712 |
| | $ | 18,910 |
|
Deferred | | 65,660 |
| | 57,564 |
| | 52,157 |
|
Remeasurement of net deferred tax liability for enacted changes in tax law | | (85,091 | ) | | — |
| | — |
|
Total income tax expense | | $ | 18,821 |
| | $ | 89,276 |
| | $ | 71,067 |
|
For the year ended December 31, 2017 pre-tax income attributable to Bermuda and U.S. operations was $86.3 million and $312.3 million, respectively, as compared to $51.6 million and $260.3 million, respectively, for the year ended December 31, 2016 and $21.4 million and $207.0 million, respectively, for the year ended December 31, 2015.
Income tax expense is different from that which would be obtained by applying the applicable statutory income tax rates to income before taxes by jurisdiction (i.e. U.S. 35%; Bermuda 0.0%). The reconciliation of the difference between income tax expense and the expected tax provision at the weighted average tax rate was as follows for the years ended December 31:
|
| | | | | | | | | | | | | | | | | | | | | |
($ in thousands) | | 2017 | | % of pretax income | | 2016 | | % of pretax income | | 2015 | | % of pretax income |
Tax provision at weighted average statutory rates | | $ | 109,309 |
| | 27.4 | % | | $ | 91,092 |
| | 29.2 | % | | $ | 72,461 |
| | 31.7 | % |
Change in valuation of net deferred tax liability | | (85,091 | ) | | (21.3 | ) | | — |
| | — |
| | — |
| | — |
|
Excess tax benefits from stock-based compensation | | (3,227 | ) | | (0.8 | ) | | — |
| | — |
| | — |
| | — |
|
Tax exempt interest, net of proration | | (2,608 | ) | | (0.7 | ) | | (2,181 | ) | | (0.7 | ) | | (1,741 | ) | | (0.8 | ) |
Non-deductible expenses | | 392 |
| | 0.1 |
| | 378 |
| | 0.1 |
| | 381 |
| | 0.2 |
|
Other | | 46 |
| | 0.0 |
| | (13 | ) | | 0.0 |
| | (34 | ) | | 0.0 |
|
Total income tax expense | | $ | 18,821 |
| | 4.7 | % | | $ | 89,276 |
| | 28.6 | % | | $ | 71,067 |
| | 31.1 | % |
We provide deferred taxes to reflect the estimated future tax effects of the differences between the financial statement and tax bases of assets and liabilities using currently enacted tax laws. The net deferred tax liability was comprised of the following at December 31:
|
| | | | | | | | |
(In thousands) | | 2017 | | 2016 |
Deferred tax assets | | $ | 28,696 |
| | $ | 43,291 |
|
Deferred tax liabilities | | (156,332 | ) | | (185,878 | ) |
Net deferred tax liability | | $ | (127,636 | ) | | $ | (142,587 | ) |
The components of the net deferred tax liability were as follows at December 31:
|
| | | | | | | | |
(In thousands) | | 2017 | | 2016 |
Contingency reserves | | $ | (151,586 | ) | | $ | (181,031 | ) |
Unearned premium reserve | | 14,454 |
| | 19,722 |
|
Nonvested shares | | 6,442 |
| | 8,445 |
|
Deferred policy acquisition costs | | (3,224 | ) | | (4,690 | ) |
Unearned ceding commissions | | 2,815 |
| | 3,568 |
|
Fixed assets | | 2,529 |
| | 4,702 |
|
Start-up expenditures, net | | 1,951 |
| | 3,705 |
|
Unrealized (gain) loss on investments | | (1,403 | ) | | 2,181 |
|
Accrued expenses | | 335 |
| | 775 |
|
Loss reserves | | 158 |
| | 170 |
|
Prepaid expenses | | (119 | ) | | (157 | ) |
Organizational expenditures | | 12 |
| | 23 |
|
Net deferred tax liability | | $ | (127,636 | ) | | $ | (142,587 | ) |
As a mortgage guaranty insurer, we are eligible for a tax deduction, subject to certain limitations, under Section 832(e) of the IRC for amounts required by state law or regulation to be set aside in statutory contingency reserves. The deduction is allowed only to the extent that we purchase T&L Bonds in an amount equal to the tax benefit derived from deducting any portion of our statutory contingency reserves. During the years ended December 31, 2017 and 2016, we had net purchases of T&L Bonds in the amount of $70.9 million and $61.9 million, respectively, and held $252.2 million and $181.3 million of T&L Bonds as of December 31, 2017 and 2016, respectively.
In evaluating our ability to realize the benefit of our deferred tax assets, we consider the relevant impact of all available positive and negative evidence including our past operating results and our forecasts of future taxable income. At December 31, 2017 and 2016, after weighing all the evidence, management concluded that it was more likely than not that our deferred tax assets would be realized.
Under current Bermuda law, the parent company, Essent Group, and its Bermuda subsidiary, Essent Re, are not required to pay any taxes on income and capital gains. In the event that there is a change such that these taxes are imposed, these companies would be exempted from any such tax until March of 2035 pursuant to the Bermuda Exempt Undertakings Tax Protection Act of 1966, and the Exempt Undertakings Tax Protection Amendment Act of 2011.
Essent Holdings and its subsidiaries are subject to income taxes imposed by U.S. law and file a U.S. Consolidated Income Tax Return. Each subsidiary has executed a tax sharing agreement with its parent company, which provides that taxes are settled in cash between parent and subsidiary on a quarterly basis based on separate company pro-forma calculations. Should Essent Holdings pay a dividend to its parent company, Essent Irish Intermediate Holdings Limited, withholding taxes at a rate of 5% under the U.S./Ireland tax treaty would likely apply assuming the Company avails itself of Treaty benefits under the U.S./Ireland tax treaty. Absent treaty benefits, the withholding rate on outbound dividends would be 30%. Currently, however, no withholding taxes are accrued with respect to such unremitted earnings as management has no intention of remitting these earnings. Similarly, no foreign income taxes have been provided on the un-remitted earnings of the Company's U.S. subsidiaries as management has neither the intention of remitting these earnings, nor would any Ireland tax be due, as any Irish tax would be expected to be fully offset by credit for taxes paid to the U.S. An estimate of the cumulative amount of U.S. earnings that would be subject to withholding tax, if distributed outside of the U.S., is approximately $846.8 million. The associated withholding tax liability under the U.S./Ireland tax treaty would be approximately $42.3 million.
Essent is not subject to income taxation other than as stated above. There can be no assurance that there will not be changes in applicable laws, regulations, or treaties which might require Essent to change the way it operates or becomes subject to taxation.
At December 31, 2017 and 2016, the Company had no unrecognized tax benefits. As of December 31, 2017, the U.S. federal income tax returns for the tax years 2014 through 2016 remain subject to examination. The Company has not recorded any uncertain tax positions as of December 31, 2017 or December 31, 2016.