Income Taxes

12 Months Ended

Dec. 31, 2019

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,
	2019		2018
Deferred tax assets:
Loss and loss expense reserves	$	66	$	60
Unearned premiums	113		105
Deferred international earnings	51		—
Other	39		33
Deferred tax assets before valuation allowance	269		198
Valuation allowance for international operations	41		—
Deferred tax assets net of valuation allowance	228		198
Deferred tax liabilities:
Investment gains and other, net	995		542
Deferred acquisition costs	139		131
Life policy reserves	120		117
Investments	23		18
Other	30		17
Total gross deferred tax liabilities	1,307		825
Net deferred income tax liability	$	1,079	$	627

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 on our U.S. domestic operations will be realized. As a result, we have no valuation allowance as of December 31, 2019 and 2018 for our U.S. domestic operations. As more fully discussed below, we do carry a valuation allowance on the deferred tax assets related to Cincinnati Global, which we acquired in 2019.

For financial reporting purposes, income before income taxes includes the following components:



(Dollars in millions)	For the years ended December 31,
	2019		2018		2017
United States	$	2,440	$	251	$	730
International	32		—		—
Total income before income taxes	$	2,472	$	251	$	730

The provision (benefit) for income taxes consists of:



(Dollars in millions)	For the years ended December 31,
	2019			2018			2017
Provision (benefit) for income taxes:
Current – United States federal	$	137		$	11		$	129
International	(5		)	—			—
Total current	132			11			129
Deferred – United States federal	338			(47		)	(444		)
International	5			—			—
Total deferred	343			(47		)	(444		)
Total provision (benefit) for income taxes	$	475		$	(36	)	$	(315	)

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



(Dollars in millions)	Years ended December 31,
	2019					2018					2017
Tax at statutory rate:	$	519		21.0	%	$	53		21.0	%	$	256		35.0	%
Increase (decrease) resulting from:
Tax-exempt income from municipal bonds	(19		)	(0.8	)	(20		)	(8.0	)	(36		)	(4.9	)
Dividend received exclusion	(16		)	(0.6	)	(15		)	(6.0	)	(34		)	(4.7	)
Tax accounting method changes	—			—		(50		)	(19.9	)	—			—
Deferred tax benefit due to tax rate change	—			—		—			—		(495		)	(67.8	)
Other	(9		)	(0.4	)	(4		)	(1.4	)	(6		)	(0.8	)
Provision (benefit) for income taxes	$	475		19.2	%	$	(36	)	(14.3	)%	$	(315	)	(43.2	)%

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 basis 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 21% tax rate and the 2017 tax rate of 35% for the related items. This reduced our effective tax rate by 19.9% for the year ended December 31, 2018.

On December 22, 2017, the Tax Cuts and Jobs Act (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% to a flat rate of 21%. 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% (the rate at which the deferred items are expected to be reversed) versus the 35% 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.

The provision for federal income taxes is based upon the filing of a consolidated income tax return for the company and its domestic subsidiaries within the United States. As of December 31, 2019, 2018 and 2017, we have no operating loss carryforwards in the United States. The life group operating loss carryforward from our 2017 tax year was fully utilized in our 2018 tax year resulting in a tax benefit of less than one million. For the years ended December 31, 2019, 2018 and 2017, we have no capital loss carryforwards in the United States. As more fully discussed below, Cincinnati Global which we acquired in 2019, has operating loss carryforwards in the United Kingdom.

Unrecognized Tax Benefits

As of December 31, 2019 and 2018, we had a gross unrecognized tax benefit of $34 million. We carried no amounts for unrecognized tax benefits for the year ended December 31, 2017. The following is a tabular reconciliation of the total amounts of unrecognized tax benefits.



(Dollars in millions)	Years ended December 31,
	2019		2018		2017
Gross unrecognized tax benefits at January 1	$	34	$	—	$	—
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	$	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, 2019 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. We do not expect any changes to our unrecognized tax benefit liability in the next twelve months.

The statute of limitations for federal tax purposes has closed for tax years ended December 31, 2015 and earlier. In 2019, the IRS began its examination of the tax year ended December 31, 2017. At this time, no adjustments have been proposed. 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 ended December 31, 2015 and earlier.

Cincinnati Global operates in the United Kingdom and as such, is subject to tax in that jurisdiction. The statute of limitation for tax return review by Her Majesty’s Revenue and Customs (HMRC) has closed for tax years ended December 31, 2017 and earlier. There are currently no tax returns under review by HMRC.

Income taxes paid in our consolidated statements of cash flows are shown net of refunds received. We received refunds of $94 million in 2019, none in 2018 and $18 million in 2017.

Acquisition of Cincinnati Global

As more fully discussed in Note 1, Accounting Policies and Note 20, Acquisition, we closed on the acquisition of Cincinnati Global during the first quarter of 2019. As a result of this acquisition, $59 million of net deferred tax assets were acquired or established at the acquisition date with an offsetting valuation allowance of $55 million.

As of December 31, 2019, Cincinnati Global had $41 million of net deferred tax assets with an offsetting valuation allowance of $41 million.

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 related to the Cincinnati Global operations, we believe it was appropriate to set up a valuation allowance for purposes of our opening Cincinnati Global balance sheet and is appropriate to carry a valuation allowance as of December 31, 2019.

The following is a tabular reconciliation of the total amounts of our Cincinnati Global valuation allowance.



(Dollars in millions)	Years ended December 31,
	2019			2018		2017
Valuation allowance at January 1	$	—		$	—	$	—
Acquisition accounting amount	55			—		—
Current year operations	(14		)	—		—
Valuation allowance at December 31	$	41		$	—	$	—

As of December 31, 2019, Cincinnati Global had operating loss carryforwards of $147 million in the United Kingdom. These Cincinnati Global losses can only be utilized within the Cincinnati Global group in the United Kingdom and cannot offset the income of our CFC group domestic operations in the United States.