Note 10. Income Taxes

The Company and its eligible subsidiaries file a consolidated federal income tax return. The Company has entered into a separate tax allocation agreement with CNA, a majority-owned subsidiary in which its ownership exceeds 80%. The agreement provides that the Company will: (i) pay to CNA the amount, if any, by which the Company's consolidated federal income tax is reduced by virtue of inclusion of CNA in the Company's return, or (ii) be paid by CNA an amount, if any, equal to the federal income tax that would have been payable by CNA if it had filed a separate consolidated return. The agreement may be canceled by either of the parties upon thirty days written notice.

For 2009 through 2011, the Company has participated in the Compliance Assurance Process ("CAP"), which is a voluntary program for a limited number of large corporations. Under CAP, the Internal Revenue Service ("IRS") conducts a real-time audit and works contemporaneously with the Company to resolve any issues prior to the filing of the tax return. The Company believes this approach should reduce tax-related uncertainties, if any. Although the outcome of tax audits is always uncertain, the Company believes that any adjustments resulting from audits will not have a material impact on its results of operations, financial position and cash flows. The Company and/or its subsidiaries also file income tax returns in various state, local and foreign jurisdictions. These returns, with few exceptions, are no longer subject to examination by the various taxing authorities before 2007.

Diamond Offshore, which is not included in the Company's consolidated federal income tax return, files income tax returns in the U.S. federal, various state and foreign jurisdictions. Diamond Offshore's 2009 and 2010 U.S. federal income tax returns remain subject to examination. Tax years that remain subject to examination by the various other jurisdictions include years 2003 to 2010.

The current and deferred components of income tax expense (benefit), excluding taxes on discontinued operations, are as follows:


Year Ended December 31	2011		2010		2009
(In millions)

Income tax expense (benefit):
Federal:
Current	$	127	$	154	$	3
Deferred		250		466		149
State and city:
Current		10		21		7
Deferred		14		15		(9)
Foreign		135		239		195
Total	$	536	$	895	$	345

The components of U.S. and foreign income before income tax and a reconciliation between the federal income tax expense at statutory rates and the actual income tax expense is as follows:


Year Ended December 31	2011			2010			2009
(In millions)

Income before income tax:
U.S.	$	1,472		$	2,236		$	989
Foreign		760			666			741
Total	$	2,232		$	2,902		$	1,730


Income tax expense at statutory rate	$	781		$	1,016		$	606
Increase (decrease) in income tax expense resulting from:
Exempt investment income		(76	)		(85	)		(120)
Foreign related tax differential		(203	)		(105	)		(195)
Amortization of deferred charges associated with intercompany rig sales to other tax jurisdictions		30			30			12
Taxes related to domestic affiliate		55			34			49
Partnership earnings not subject to taxes		(27	)		(33	)		(16)
Unrecognized tax benefit		(8	)		31			8
Other (a)		(16	)		7			1
Income tax expense	$	536		$	895		$	345

(a)	Includes state and local taxes, adjustments to prior year estimates and other non-deductible expenses.

Provision has been made for the expected U.S. federal income tax liabilities applicable to undistributed earnings of subsidiaries, except for certain subsidiaries for which the Company intends to invest the undistributed earnings indefinitely, or recover such undistributed earnings tax-free. Except for certain foreign sourced activities which Diamond Offshore plans to distribute, it is Diamond Offshore's intention to indefinitely reinvest future earnings of the subsidiary to finance foreign activities. At December 31, 2011, the Company is not required to provide deferred taxes on undistributed earnings related to a domestic affiliate. The determination of the amount of the unrecognized deferred tax liability related to the undistributed earnings of foreign subsidiaries is not practicable.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:


Year Ended December 31	2011			2010

(In millions)

Balance at January 1	$	46		$	27
Additions based on tax positions related to the current year		1			3
Additions for tax positions related to a prior year					16
Reductions for tax positions related to a prior year		(2	)
Lapse of statute of limitations		(4	)

Balance at December 31	$	41		$	46

At December 31, 2011 and 2010, there were $41 million and $46 million of tax benefits related to Diamond Offshore that if recognized would affect the effective rate.

The Company recognizes interest accrued related to: (i) unrecognized tax benefits in Interest expense and (ii) tax refund claims in Other revenues on the Consolidated Statements of Income. The Company recognizes penalties in Income tax expense on the Consolidated Statements of Income. Penalties and interest amounts recorded by the Company were insignificant for the years ended December 31, 2011, 2010 and 2009.

The following table summarizes deferred tax assets and liabilities:


December 31	2011			2010

(In millions)

Deferred tax assets:
Insurance reserves:
Property and casualty claim and claim adjustment expense reserves	$	419		$	525
Unearned premium reserves		142			127
Receivables		75			99
Employee benefits		449			375
Life settlement contracts		61			64
Investment valuation differences		3			70
Net loss and tax credits carried forward		135			126
Basis differential in investment in subsidiary		29			32
Other		224			200

Deferred tax assets		1,537			1,618


Deferred tax liabilities:
Deferred acquisition costs		(283	)		(284)
Net unrealized gains		(516	)		(326)
Property, plant and equipment		(790	)		(644)
Basis differential in investment in subsidiary		(490	)		(477)
Other liabilities		(117	)		(160)

Deferred tax liabilities		(2,196	)		(1,891)


Net deferred tax liability	$	(659	)	$	(273)

Amounts recognized in the Consolidated Balance Sheets consist of:


December 31	2011			2010

(In millions)

Other assets				$	289
Deferred income taxes payable	$	(659	)		(562	)

Net amount recognized	$	(659	)	$	(273	)

As of December 31, 2011, the Company has federal loss carryforwards with a tax effect of approximately $29 million which expire in 2014 and 2030 and federal tax credit carryforwards of $68 million, of which $63 million expire between 2019 and 2021. Diamond Offshore has foreign operating loss carryforwards with a tax effect of approximately $27 million, of which $8 million have an indefinite life with the remaining benefits expiring between 2014 and 2021.

Although realization of deferred tax assets is not assured, management believes it is more likely than not that the recognized deferred tax assets will be realized through recoupment of ordinary and capital taxes paid in prior carryback years and through future earnings, reversal of existing temporary differences and available tax planning strategies.