7. INCOME TAXES
Provisions for income taxes have been calculated in accordance with the provisions of ASC 740. A summary of the components of income before income taxes and income tax expense in the Consolidated Statements of Income are shown below:
|
YEARS ENDED DECEMBER 31 |
|
2017 |
|
|
2016 |
|
|
2015 |
|
|||
|
(in millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. |
|
$ |
295.1 |
|
|
$ |
70.8 |
|
|
$ |
220.9 |
|
|
Non-U.S. |
|
|
6.4 |
|
|
|
121.5 |
|
|
|
218.5 |
|
|
|
|
$ |
301.5 |
|
|
$ |
192.3 |
|
|
$ |
439.4 |
|
Income tax expense includes the following components:
|
YEARS ENDED DECEMBER 31 |
|
2017 |
|
|
2016 |
|
|
2015 |
|
|||
|
(in millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Current: |
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. |
|
$ |
27.4 |
|
|
$ |
16.8 |
|
|
$ |
32.7 |
|
|
Non-U.S. |
|
|
30.0 |
|
|
|
35.3 |
|
|
|
23.1 |
|
|
Total current |
|
|
57.4 |
|
|
|
52.1 |
|
|
|
55.8 |
|
|
Deferred: |
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. |
|
|
82.3 |
|
|
|
(20.4) |
|
|
|
44.0 |
|
|
Non-U.S. |
|
|
(41.2 |
) |
|
|
4.5 |
|
|
|
8.8 |
|
|
Total deferred |
|
|
41.1 |
|
|
|
(15.9) |
|
|
|
52.8 |
|
|
Total income tax expense |
|
$ |
98.5 |
|
|
$ |
36.2 |
|
|
$ |
108.6 |
|
The income tax expense attributable to the consolidated results of continuing operations is different from the amount determined by multiplying income from continuing operations before income taxes by the U.S. statutory federal income tax rate of 35%. The sources of the difference and the tax effects of each were as follows:
|
YEARS ENDED DECEMBER 31 |
|
2017 |
|
|
2016 |
|
|
2015 |
|
|||
|
(in millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected income tax expense |
|
$ |
105.5 |
|
|
$ |
67.3 |
|
|
$ |
153.7 |
|
|
Effect of the enactment of the Tax Cuts and Jobs Act |
|
|
22.3 |
|
|
|
— |
|
|
|
— |
|
|
Tax difference related to investment disposals and maturities |
|
|
(12.7 |
) |
|
|
(20.7 |
) |
|
|
(13.3 |
) |
|
Effect of foreign operations |
|
|
(6.5 |
) |
|
|
(6.6 |
) |
|
|
(7.8 |
) |
|
Stock-based compensation windfall benefit |
|
|
(5.3 |
) |
|
|
— |
|
|
|
— |
|
|
Dividend received deduction |
|
|
(3.2 |
) |
|
|
(3.3 |
) |
|
|
(3.1 |
) |
|
Nondeductible expenses |
|
|
1.6 |
|
|
|
1.4 |
|
|
|
1.6 |
|
|
Tax-exempt interest |
|
|
(0.9 |
) |
|
|
(1.1 |
) |
|
|
(1.4 |
) |
|
Foreign tax credits |
|
|
(0.9 |
) |
|
|
(0.6 |
) |
|
|
(5.6 |
) |
|
Change in liability for uncertain tax positions |
|
|
(0.5 |
) |
|
|
— |
|
|
|
1.7 |
|
|
Gain on disposal of U.K. motor business exempt from tax |
|
|
— |
|
|
|
— |
|
|
|
(17.3 |
) |
|
Other, net |
|
|
(0.9 |
) |
|
|
(0.2 |
) |
|
|
0.1 |
|
|
Income tax expense |
|
$ |
98.5 |
|
|
$ |
36.2 |
|
|
$ |
108.6 |
|
|
Effective tax rate |
|
|
32.7 |
% |
|
|
18.8 |
% |
|
|
24.7 |
% |
The following are the components of the Company’s deferred tax assets and liabilities (excluding those associated with its discontinued operations).
|
DECEMBER 31 |
|
2017 |
|
|
2016 |
|
||
|
(in millions) |
|
|
|
|
|
|
|
|
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
|
Loss, LAE and unearned premium reserves, net |
|
$ |
115.7 |
|
|
$ |
183.9 |
|
|
Employee benefit plans |
|
|
23.8 |
|
|
|
44.4 |
|
|
Tax credit carryforwards |
|
|
23.1 |
|
|
|
94.6 |
|
|
Deferred Lloyd's underwriting loss |
|
|
16.6 |
|
|
|
— |
|
|
Other |
|
|
29.6 |
|
|
|
54.9 |
|
|
|
|
|
208.8 |
|
|
|
377.8 |
|
|
Less: Valuation allowance |
|
|
0.2 |
|
|
|
— |
|
|
|
|
|
208.6 |
|
|
|
377.8 |
|
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
|
Deferred acquisition costs |
|
|
90.2 |
|
|
|
141.0 |
|
|
Investments, net |
|
|
48.3 |
|
|
|
27.9 |
|
|
Software capitalization |
|
|
18.0 |
|
|
|
28.9 |
|
|
Deferred Lloyd's underwriting income |
|
|
— |
|
|
|
32.7 |
|
|
Other |
|
|
22.9 |
|
|
|
32.2 |
|
|
|
|
|
179.4 |
|
|
|
262.7 |
|
|
Net deferred tax asset |
|
$ |
29.2 |
|
|
$ |
115.1 |
|
Deferred tax assets are reduced by a valuation allowance if it is more likely than not that all or some portion of the deferred tax assets will not be realized.
The Company’s deferred tax asset as of December 31, 2017 included assets of $23.1 million related to alternative minimum tax credit (“AMT”) carryforwards. The Company has utilized $71.5 million of its AMT credits in 2017 and may continue to utilize these credits to offset regular federal income taxes due from future income. Although the enactment of TCJA repeals the corporate alternative minimum tax effective January 1, 2018, the remaining AMT credits carried forward will continue to be utilized to offset future taxable income for tax years beginning in 2018. The Company believes it is more likely than not that the remaining deferred tax assets will be realized.
In prior years, the Company completed several transactions which resulted in the realization, for tax purposes only, of unrealized gains in its investment portfolio. As a result of these transactions, the Company was able to realize capital losses carried forward and to release the valuation allowance recorded against the deferred tax asset related to these losses. The releases of valuation allowances were recorded as a benefit in accumulated other comprehensive income. Previously unrealized benefits of $12.7 million, $20.7 million and $13.3 million attributable to non-operating income, are recognized as part of income from continuing operations during 2017, 2016 and 2015, respectively. The remaining amount of $44.8 million in accumulated other comprehensive income will be released into income from continuing operations in future years, as the investment securities subject to these transactions are sold or mature.
The table below provides a reconciliation of the beginning and ending liability for uncertain tax positions as follows:
|
YEARS ENDED DECEMBER 31 |
|
2017 |
|
|
2016 |
|
|
2015 |
|
|||
|
(in millions) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Liability at beginning of year, net |
|
$ |
2.7 |
|
|
$ |
3.0 |
|
|
$ |
1.3 |
|
|
Additions for tax positions of current year |
|
|
0.9 |
|
|
|
0.4 |
|
|
|
1.7 |
|
|
Subtractions as a result of a lapse of the applicable statute of limitations |
|
|
(0.6 |
) |
|
|
(0.7 |
) |
|
|
— |
|
|
Liability at end of year, net |
|
$ |
3.0 |
|
|
$ |
2.7 |
|
|
$ |
3.0 |
|
There are no tax positions at December 31, 2017, 2016 and 2015 for which the ultimate deductibility is highly certain, but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, a change in the timing of deductions would not impact the annual effective tax rate.
The Company recognizes interest and penalties related to unrecognized tax benefits in federal income tax expense. The Company had accrued interest of $0.2 million as of December 31, 2017 and 2016. For the years ended December 31, 2016 and 2015 the Company recognized a release of interest of $0.4 million and expense of $0.1 million, respectively. The Company has not recognized any penalties associated with unrecognized tax benefits.
The Company or its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions, as well as foreign jurisdictions. The Company and its subsidiaries are subject to U.S. federal and state income tax examinations and foreign examinations for years after 2013.
U.S. Tax Reform
On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”, “U.S. Tax Reform”, or “the Act”) was enacted in the U.S. The Act substantially changed many aspects of the U.S. Tax code, including a reduction in the U.S. corporate income tax rate from 35% to 21%. While the new corporate rate is effective on January 1, 2018, the Company has recognized the impact of the rate change on its deferred tax balances as of the enactment date. The effect of this re-measurement of the Company’s deferred tax balances is a provision of $9.4 million, and is recorded as a component of income tax expense in continuing operations for the year ended December 31, 2017. This amount includes the revaluation of deferred taxes initially recorded through other comprehensive income and recorded through discontinued operations, such as unrealized appreciation on investments, employee benefit plan-related items, foreign currency translation adjustments and reserve adjustments for discontinued business. Deferred taxes related to the revaluation of the Company’s pension plans at December 31, 2017, as well as changes in unrealized gains and losses occurring after the Act’s enactment date, are recorded at 21% in other comprehensive income.
The Act also created a territorial tax system, which will generally allow companies to repatriate future non-U.S. sourced earnings without incurring additional U.S. taxes, by providing a 100% exemption on dividends received from certain non-U.S. subsidiaries. Although most of the Company’s non-U.S. income had been previously subject to U.S. taxes, a portion of its non-U.S. income had been indefinitely reinvested overseas and was not subject to U.S. tax until repatriated. These non-U.S. earnings are now subject to a one-time mandatory toll charge totaling $12.7 million, which also is recorded as a component of income tax expense in continuing operations for the year ended December 31, 2017.
In addition, the Act limited various existing deductions such as executive compensation and introduced new income taxes on certain low-taxed non-U.S. income. Under the Act, the exemption from the $1 million limitation on certain executive compensation has been eliminated. As a result, the Company has recognized a provision of $0.2 million for the year ended December 31, 2017. Also, the Company may be subject to a minimum tax on certain foreign earnings effective January 1, 2018. The Company has elected to recognize this minimum tax in the year in which the tax arises. The Company does not expect that this additional tax will have a significant effect on the Company’s results of operations in most years.
The Act modified the provisions applicable to the determination of the tax basis of unpaid loss reserves. These modifications impact the payment pattern and applicable interest rate. The Act instructed the Treasury Department to provide discount factors and other guidance necessary to determine the appropriate transition adjustment. This information has not been released; accordingly, we have applied the law existing prior to the enactment of the Act. These provisions would have no effect on the December 31, 2017 net deferred tax asset or income tax expense.
The cumulative effect of the enactment of TCJA is an expense of $22.3 million for the year ended December 31, 2017, comprising the aforementioned three components. The Company’s estimates are not based upon provisional amounts, as defined in the SEC’s Staff Accounting Bulletin No. 118. However, they are subject to change, as authoritative guidance clarifies how they are determined and recognized.