Income Taxes

Income tax provision

The Company and its subsidiaries file a consolidated federal income tax return. The provision for income tax expense consists of the following components:



	Year Ended December 31,
	2013			2012		2011
	(Amounts in thousands)
Federal
Current	$	30,266		$	9,340	$	31,390
Deferred	(14,970		)	6,238		20,518
	$	15,296		$	15,578	$	51,908
State
Current	$	5,234		$	2,079	$	2,934
Deferred	(577		)	742		(907		)
	$	4,657		$	2,821	$	2,027
Total
Current	$	35,500		$	11,419	$	34,324
Deferred	(15,547		)	6,980		19,611
Total	$	19,953		$	18,399	$	53,935

The income tax provision reflected in the consolidated statements of operations is reconciled to the federal income tax on income before income taxes based on a statutory rate of 35% as shown in the table below:



	Year Ended December 31,
	2013			2012			2011
	(Amounts in thousands)
Computed tax expense at 35%	$	46,234		$	47,359		$	85,785
Tax-exempt interest income	(26,381		)	(27,789		)	(31,414		)
Dividends received deduction	(2,239		)	(1,482		)	(1,704		)
State tax expense	4,944			1,918			1,299
Other, net	(2,605		)	(1,607		)	(31		)
Income tax expense	$	19,953		$	18,399		$	53,935

Deferred Income Taxes

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial reporting basis and the respective tax basis of the Company's assets and liabilities, and expected benefits of utilizing net operating loss, capital loss, and tax-credit carryforwards. The ultimate realization of deferred tax assets is dependent upon generating sufficient taxable income of the appropriate character within the carryback and carryforward periods available under the tax law. Management considers the reversal of deferred tax liabilities, projected future taxable income of an appropriate nature, and tax-planing strategies in making this assessment. The Company believes that through the use of prudent tax planning strategies and the generation of capital gains, sufficient income will be realized in order to maximize the full benefits of its deferred tax assets. Significant components of the Company’s net deferred tax assets and liabilities are as follows:



	December 31,
	2013			2012
	(Amounts in thousands)
Deferred tax assets:
20% of net unearned premium	$	68,586		$	66,353
Discounting of loss reserves and salvage and subrogation recoverable for tax purposes	12,810			15,019
Write-down of impaired investments	1,714			1,723
Tax credit carryforward	40,309			37,557
Expense accruals	12,497			10,910
Other deferred tax assets	5,653			4,860
Total gross deferred tax assets	141,569			136,422
Deferred tax liabilities:
Deferred acquisition costs	(68,063		)	(65,069		)
Tax liability on net unrealized gain on securities carried at fair value	(33,964		)	(48,483		)
Tax depreciation in excess of book depreciation	(9,667		)	(10,191		)
Undistributed earnings of insurance subsidiaries	(4,024		)	(4,499		)
Tax amortization in excess of book amortization	(1,447		)	(914		)
Other deferred tax liabilities	(9,184		)	(7,711		)
Total gross deferred tax liabilities	(126,349		)	(136,867		)
Net deferred tax assets (liabilities)	$	15,220		$	(445	)

Uncertainty in Income Taxes

The Company recognizes tax benefits related to positions taken, or expected to be taken, on a tax return only if, “more-likely-than-not” the positions are sustainable. Once this threshold has been met, the Company's measurement of its expected tax benefits is recognized in its financial statements.

There was a $4.9 million increase to the total amount of unrecognized tax benefits related to tax uncertainties during 2013. The increase was the result of tax positions taken regarding federal tax credit carryforwards and state tax apportionment issues based on management's best judgment given the facts, circumstances and information available at the reporting date. The Company does not expect any changes in such unrecognized tax benefits to have a significant impact on its consolidated financial statements within the next 12 months.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states. Tax years that remain subject to examination by major taxing jurisdictions are 2010 through 2012 for federal taxes and 2003 through 2012 for California state taxes. The Company is currently under examination by the California Franchise Tax Board (“FTB”) for tax years 2003 through 2010. The FTB issued Notices of Proposed Assessments to the Company for tax years 2003 through 2006, which were affirmed following an administrative protest process with the FTB examination. The Company is considering its options for resolving the case. No assessments have been received for tax years 2007 through 2010. Management believes that the resolution of these examinations and assessments will not have a material impact on the consolidated financial statements.

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



	2013		2012
	(Amounts in thousands)
Balance at January 1	$	5,926	$	4,567
Additions based on tax positions related to:
Current year	1,225		330
Prior years	3,633		1,539
Additions (reductions) based on tax positions related to prior years	0		(308		)
Additions (reductions) as a result of as lapse of the applicable statute of limitations	0		(202		)
Balance at December 31	$	10,784	$	5,926

As presented above, the balances of unrecognized tax benefits were $10.8 million and $5.9 million at December 31, 2013 and 2012, respectively. Of these totals, $8.4 million and $3.5 million represent unrecognized tax benefits, net of federal tax benefit and accrued interest expense which, if recognized, would impact the Company’s effective tax rate.

Management does not expect the Company’s total amount of unrecognized tax benefits to materially increase within the next twelve months related to its ongoing California state tax apportionment factor issues.

The Company recognizes interest and penalties related to unrecognized tax benefits as a part of income taxes. During the years ended December 31, 2013, 2012, and 2011, the Company recognized net interest and penalty expense, excluding refunds, of $1,119,000, $111,000, and $106,000, respectively. The Company carried an accrued interest and penalty balance of $2,065,000 and $945,000 at December 31, 2013 and 2012, respectively.