Income Taxes

12 Months Ended

Dec. 31, 2019

Components of Income Tax Expense (Benefit), Continuing Operations [Abstract]

Income tax provision

The Company and its subsidiaries file a consolidated federal income tax return. The income tax expense (benefit) consisted of the following components:



	Year Ended December 31,
	2019			2018			2017
	(Amounts in thousands)
Federal
Current	$	18,109		$	14,190		$	10,898
Deferred	40,413			(39,244		)	10,934
	$	58,522		$	(25,054	)	$	21,832
State
Current	$	(1,430	)	$	1,982		$	955
Deferred	890			(1,815		)	(579		)
	$	(540	)	$	167		$	376
Total
Current	$	16,679		$	16,172		$	11,853
Deferred	41,303			(41,059		)	10,355
Total	$	57,982		$	(24,887	)	$	22,208

As a result of the Tax Cuts and Jobs Act of 2017 (the "Act"), the Company’s deferred tax assets and liabilities were measured using the new corporate tax rate of 21% at December 31, 2019, 2018 and 2017. For the years ended December 31, 2019 and 2018, the Company measured its current income taxes using the new corporate tax rate of 21%, rather than the pre-enactment corporate tax rate of 35%. Additionally in 2018, as a result of a determination made by the Office of Management and Budget, the Company reversed the previously recorded provisional 6.6% sequestration reduction to its alternative minimum tax (“AMT”) credit that originally resulted from repeal of the corporate AMT and reclassification of AMT credit carryforwards to current taxes receivable as a refundable credit.

In computing taxable income, property and casualty insurers reduce underwriting income by losses and loss adjustment expenses incurred. The amount of the deduction for losses incurred associated with unpaid losses is discounted at the interest rates and for the loss payment patterns prescribed by the U.S. Treasury. The Act changes the prescribed interest rates to rates based on corporate bond yield curves and extends the applicable time periods for the loss payment pattern. These changes are effective for tax years beginning after 2017 and are subject to a transition rule that spreads the additional tax payments from the amount determined by applying these changes versus the previous calculated amount over the subsequent eight years beginning in 2018. The Company recorded a total deferred tax liability adjustment of approximately $8.6 million at December 31, 2018 related to the changes in discounting of unpaid losses included in the Act based on the guidance published in 2018 by the Internal Revenue Service. As of December 31, 2019, the balance of the deferred tax liability related to changes in discounting of unpaid losses was $6.7 million.

The following table presents a reconciliation of the tax expense (benefit) based on the statutory rate to the Company's actual tax expense (benefit) in the consolidated statements of operations:



	Year Ended December 31,
	2019			2018			2017
	(Amounts in thousands)
Computed tax expense (benefit) at 21% for 2019 and 2018 and 35% for 2017	$	79,394		$	(6,429	)	$	58,480
Tax-exempt interest income	(12,909		)	(13,507		)	(26,038		)
Dividends received deduction	(1,276		)	(1,082		)	(2,296		)
State tax (benefit) expense	(869		)	439			158
Nondeductible expenses	526			390			348
Change in federal tax contingency reserve	(2,588		)	—			—
Cumulative impact from change in federal tax rate	—			—			(11,449		)
(Reversal in 2018) reduction of AMT credit carryforward due to sequestration in 2017	—			(4,088		)	4,088
Other, net	(4,296		)	(610		)	(1,083		)
Income tax expense (benefit)	$	57,982		$	(24,887	)	$	22,208

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-planning 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.

The following table presents the significant components of the Company’s net deferred tax assets and liabilities:



	December 31,
	2019			2018
	(Amounts in thousands)
Deferred tax assets:
20% of net unearned premiums	$	58,448		$	52,644
Discounting of loss reserves and salvage and subrogation recoverable for tax purposes	12,769			9,245
Write-down of impaired investments	314			356
Expense accruals	8,099			7,019
Tax asset on net unrealized loss on securities carried at fair value	—			1,055
Other deferred tax assets	3,348			3,257
Total gross deferred tax assets	82,978			73,576

Deferred tax liabilities:
Deferred policy acquisition costs	(48,964		)	(45,178		)
Tax liability on net unrealized gain on securities carried at fair value	(41,273		)	—
Tax depreciation in excess of book depreciation	(8,105		)	(4,594		)
Undistributed earnings of insurance subsidiaries	(2,855		)	(3,017		)
Tax amortization in excess of book amortization	(3,264		)	(2,729		)
Other deferred tax liabilities	(6,481		)	(4,719		)
Total gross deferred tax liabilities	(110,942		)	(60,237		)

Net deferred tax (liabilities) assets	$	(27,964	)	$	13,339

Uncertainty in Income Taxes

The Company recognizes tax benefits related to positions taken, or expected to be taken, on its tax returns, only if the positions are "more-likely-than-not" 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 $4.6 million decrease to the total amount of unrecognized tax benefits related to tax uncertainties during 2019. The decrease was the result of tax positions taken regarding research and development federal tax credits and state tax apportionment issues based on management’s judgment and latest information available. The Company does not expect any changes in unrecognized tax benefits to have a material impact on its consolidated financial statements within the next 12 months.

The Company and its subsidiaries file income tax returns with the Internal Revenue Service and the taxing authorities of various states. Tax years that remain subject to examination by major taxing jurisdictions are 2016 through 2018 for federal taxes and 2011 through 2018 for California state taxes. For tax years 2003 through 2010, the Company achieved a resolution with the California Franchise Tax Board (“FTB”) in December 2017 and paid a $4.6 million negotiated settlement amount in accordance with the settlement agreement provided by the FTB and signed by the Company. The settlement agreement was approved by the California attorney general in 2018. The Company believes that resolution of tax years 2003 through 2010 has the potential to establish guidance for future audit assessments proposed by the FTB for future tax years.

The Company is currently under examination by the FTB for tax years 2011 through 2016. For tax years 2011 through 2013, the FTB issued Notices of Proposed Assessments ("NPAs") to the Company, for which the Company submitted a formal protest in 2018. If a reasonable settlement is not reached, the Company intends to pursue other options, including a formal hearing with the FTB, an appeal with the California Office of Tax Appeals, or litigation in Superior Court. For tax years 2014 through 2016, the Company received Audit Issue Presentation Sheets (“AIPS”) related to the Company’s California apportionment factor. The Company accepted the proposed adjustments in December 2019.

The Company believes that the resolution of these examinations and assessments will not have a material impact on the consolidated financial statements.

The following table presents a reconciliation of the beginning and ending balances of unrecognized tax benefits:



	December 31,
	2019			2018
	(Amounts in thousands)
Balance at January 1	$	10,615		$	9,674
Additions (reductions) based on tax positions related to:
Current year	—			662
Prior years	(4,564		)	279
Balance at December 31	$	6,051		$	10,615

If unrecognized tax benefits were recognized, $7.2 million and $11.5 million, including accrued interest, penalties and federal tax benefit related to unrecognized tax benefits, would impact the Company’s effective tax rate at December 31, 2019 and 2018, respectively.

The Company recognizes interest and penalties related to unrecognized tax benefits as a part of income taxes. The Company recognized an accrued net expense (benefit) related to interest and penalty of approximately $(0.1) million, $0.5 million, and $(1.1) million for the years ended December 31, 2019, 2018 and 2017, respectively. The net benefit for the years ended 2019 and 2017 is largely due to reversal of accrued interest and penalty following the recent updates from the FTB for tax years 2014 through 2016, and the settlement with the FTB for tax years 2003 through 2010, respectively. The Company carried an accrued interest and penalty balance of approximately $2.8 million and $2.9 million at December 31, 2019 and 2018, respectively.