Income Taxes

The significant components of deferred tax assets and liabilities included in the consolidated balance sheets at December 31 were as follows:



(Dollars in millions)	At December 31,
	2018		2017
Deferred tax assets:
Loss and loss expense reserves	$	60	$	123
Unearned premiums	105		100
Other	33		27
Total gross deferred tax assets	198		250
Deferred tax liabilities:
Investment gains and other, net	542		740
Deferred acquisition costs	131		123
Life policy reserves	117		111
Investments	18		10
Other	17		11
Total gross deferred tax liabilities	825		995
Net deferred income tax liability	$	627	$	745

Deferred tax assets and liabilities reflect temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount recognized for tax purposes.

Deferred tax assets are reduced by a valuation allowance when management believes it is more likely than not that some, or all, of the deferred tax assets will not be realized. After considering all positive and negative evidence of taxable income in the carryback and carryforward periods as permitted by law, we believe it is more likely than not that all of the deferred tax asset will be realized. As a result, we have no valuation allowance as of December 31, 2018 and 2017.

The differences between the 21 percent and 35 percent statutory federal income tax rate and our effective income tax rate were as follows:



(Dollars in millions)	Years ended December 31,
	2018					2017					2016
Tax at statutory rate:	$	53		21.0	%	$	256		35.0	%	$	284		35.0	%
Increase (decrease) resulting from:
Tax-exempt income from municipal bonds	(20		)	(8.0	)	(36		)	(4.9	)	(34		)	(4.2	)
Dividend received exclusion	(15		)	(6.0	)	(34		)	(4.7	)	(33		)	(4.1	)
Tax accounting method changes	(50		)	(19.9	)	—			—		—			—
Deferred tax benefit due to tax rate change	—			—		(495		)	(67.8	)	—			—
Other	(4		)	(1.4	)	(6		)	(0.8	)	4			0.5
Provision for income taxes	$	(36	)	(14.3	)%	$	(315	)	(43.2	)%	$	221		27.2	%

On December 22, 2017, the Tax Act was enacted and represented one of the most comprehensive changes in U.S. corporate income taxation since 1986. The Tax Act revised the U.S. corporate income tax by lowering the corporate income tax rate from a top marginal rate of 35 percent to a flat rate of 21 percent. In addition to lowering tax rates, changes were made to the amount of the dividends received deduction and the required proration addback for qualified dividend income and tax exempt municipal interest. The Tax Act was effective January 1, 2018. The reduction in corporate income tax rate decreased our net deferred tax liability as of December 22, 2017, by $495 million. The effect of the rate change was recorded as a one-time noncash benefit to income tax expense in our consolidated statements of income for the year ended December 31, 2017. This benefit results from re-measuring our net deferred tax liability at the newly enacted corporate income tax rate of 21 percent (the rate at which the deferred items are expected to be reversed) versus the 35 percent rate at which the net deferred tax benefits were previously carried. Of this $495 million benefit, $492 million relates to net unrealized gains on investments and other AOCI amounts. The remainder relates to differences in the recognition of deferred acquisition costs, unearned premiums, insurance reserves and basis differences in the carrying value of investments held.

In 2018, we received approval from the IRS to change our method of tax accounting for certain items applicable for the 2017 tax year and tax return, primarily related to the valuation of our tax base unpaid losses. Accounting guidance does not allow recognition of the impact of certain tax accounting method changes until approved by the IRS. As a result, we recognized a $50 million income tax benefit in 2018 for the difference between the current tax rate and the 2017 tax rate for the related items. This reduced our effective tax rate by 19.9 percent for the twelve months ended December 31, 2018.

Our accounting for all elements of the Tax Act is now complete, consistent with the closing of the SAB 118 measurement period on December 22, 2018. As a result of guidance released by the IRS during the measurement period, we have adjusted our deferred tax balances related to property casualty tax base loss and loss expense reserve liabilities, tax base life policy reserve liabilities, and the transition liability associated with both property-casualty and life reserves. The recorded adjustments resulted in no impact on our recorded net deferred income tax liability. The recorded adjustments had no impact on our effective tax rate.

The provision for federal income taxes is based upon filing a consolidated income tax return for the company and its subsidiaries. As of December 31, 2018, 2017 and 2016, we have less than one million of life group operating loss carryforwards which we expect to receive benefit from in our 2018 tax return which will be filed in 2019. For the years ended December 31, 2018, 2017 and 2016, we have no capital loss carryforwards.

Unrecognized Tax Benefits

As of December 31, 2018, we had a gross unrecognized tax benefit of $34 million. We carry no amounts for unrecognized tax benefits for the years 2017 and 2016. The following is a tabular reconciliation of the total amounts of unrecognized tax benefits.



(Dollars in millions)	Years ended December 31,
	2018		2017		2016
Gross unrecognized tax benefits at January 1	$	—	$	—	$	—
Gross increase in prior year positions	—		—		—
Gross decrease in prior year positions	—		—		—
Gross increase in current year positions	34		—		—
Settlements with tax authorities	—		—		—
Lapse of statute of limitations	—		—		—
Gross unrecognized tax benefits at December 31	$	34	$	—	$	—

The unrecognized tax benefit liability is carried in other liabilities in the consolidated balance sheets. Included in the unrecognized tax benefit liability as of December 31, 2018 is $34 million, if recognized, would affect the effective tax rate. Although no interest and penalties currently are accrued, if incurred, they would be recognized as a component of income tax expense. When the IRS processes our income tax return filing for the 2018 tax year, it is possible that a decrease for the full amount of our $34 million of unrecognized tax benefits, all of which relates to our property-casualty tax base insurance claims and reserve deduction, may be necessary within the coming year.

The statute of limitations for federal tax purposes has closed for tax years 2014 and earlier. There are no federal returns under examination and we have not been notified of any upcoming IRS examinations. In addition to our IRS filings, we file income tax returns with immaterial amounts in various state jurisdictions. The statute of limitations for state income tax purposes has closed for tax years 2014 and earlier. There are no state income returns under examination and we have not been notified of any upcoming state examinations.

Income taxes paid in our consolidated statements of cash flows are shown net of refunds received. We received no refunds in 2018, $18 million in 2017 and $2 million in 2016.