INCOME TAXES

Tax Cuts and Jobs Act of 2017

On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act of 2017 (TCJA) which, among other changes, reduced the U.S. federal tax rate from 35% to 21% beginning on January 1, 2018 and imposed a tax on undistributed and previously untaxed post-1986 foreign earnings and profits (accumulated foreign earnings). Total income tax expense for 2017 included a net charge of $129 million to reflect the estimated impacts of the changes in tax laws and tax rates included in TCJA at the date of enactment, primarily reflecting the revaluation of the Company's deferred tax assets and liabilities at the new statutory federal tax rate of 21%, and the recognition of tax imposed on accumulated foreign earnings. The estimated effects of enactment of TCJA were reflected in the Company's net deferred tax asset and current income tax receivable reported on the Company’s consolidated balance sheet at December 31, 2017.

Components of Income Tax Expense

The following table presents the components of income tax expense included in the amounts reported in the Company’s consolidated financial statements:



(for the year ended December 31, in millions)	2018			2017			2016
Composition of income tax expense included in the consolidated statement of income
Current expense:
Federal	$	424		$	314		$	899
Impact of TCJA at enactment	—			21			—
Foreign	41			56			21
State	8			4			8
Total current tax expense	473			395			928
Deferred expense (benefit):
Federal	(13		)	229			110
Impact of TCJA at enactment	—			108			—
Foreign	(22		)	(58		)	1
Total deferred tax expense (benefit)	(35		)	279			111
Total income tax expense included in the consolidated statement of income	438			674			1,039
Composition of income tax expense (benefit) included in shareholders’ equity
Expense (benefit) relating to changes in the unrealized gain (loss) on investments, unrealized loss on foreign exchange and other items in other comprehensive income (loss)	(349		)	110			(289		)
Total income tax expense included in the consolidated financial statements	$	89		$	784		$	750

The following is a reconciliation of income tax expense at the U.S. federal statutory income tax rate to the income tax expense reported in the Company’s consolidated statement of income:



(for the year ended December 31, in millions)	2018			2017			2016
Income (loss) before income taxes
U.S.	$	3,039		$	2,798		$	3,946
Foreign	(78		)	(68		)	107
Total income before income taxes	2,961			2,730			4,053
Effective tax rate
Statutory tax rate	21		%	35		%	35		%
Expected federal income tax expense	622			956			1,419
Tax effect of:
Nontaxable investment income	(150		)	(297		)	(323		)
TCJA at enactment	—			129			—
Other, net	(34		)	(114		)	(57		)
Total income tax expense	$	438		$	674		$	1,039
Effective tax rate	15		%	25		%	26		%

The Company paid income taxes of $408 million, $514 million and $892 million during the years ended December 31, 2018, 2017 and 2016, respectively. The current income tax receivable of $12 million and $65 million at December 31, 2018 and 2017, respectively, was included in other assets in the consolidated balance sheet.

In computing taxable income, property and casualty insurers reduce underwriting income by claims and claim adjustment expenses incurred. The deduction for claims incurred is discounted at the interest rates and for the claim payment patterns prescribed by the U.S. Treasury. TCJA changed the prescribed interest rates to rates based on corporate bond yield curves and extended the applicable time periods for the claim payment pattern. These changes were effective for tax years beginning after 2017 and are subject to a transition rule that spreads the additional tax payment from the amount determined by applying these changes over the subsequent eight years beginning in 2018. This item is a taxable temporary difference and had no direct impact on total tax expense for 2017 and will not directly impact total tax expense in future years. The required additional tax payments are currently estimated to approximate $23 million per year over the eight-year period through 2025 and will result in a modest reduction in net investment income over that period.

The net deferred tax asset comprises the tax effects of temporary differences related to the following assets and liabilities:



(at December 31, in millions)	2018		2017
Deferred tax assets
Claims and claim adjustment expense reserves	$	571	$	930
Unearned premium reserves	503		478
Compensation-related liabilities	92		61
Other	200		191
Total gross deferred tax assets	1,366		1,660
Less: valuation allowance	8		6
Adjusted gross deferred tax assets	1,358		1,654
Deferred tax liabilities
Claims and claim adjustment expense reserve discounting (transition rule)	159		560
Deferred acquisition costs	397		376
Investments	152		454
Internally developed software	92		97
Depreciation	67		57
Other	46		40
Total gross deferred tax liabilities	913		1,584
Net deferred tax asset	$	445	$	70

If the Company determines that any of its deferred tax assets will not result in future tax benefits, a valuation allowance must be established for the portion of these assets that are not expected to be realized. The net change in the valuation allowance for deferred tax assets was an increase of $2 million in 2018 relating to the Company’s consolidated Brazilian subsidiary. Based upon a review of the Company’s anticipated future taxable income, and also including all other available evidence, both positive and negative, the Company’s management concluded that it is more likely than not that the net deferred tax assets will be realized.

For tax return purposes, as of December 31, 2018, the Company had net operating loss (NOL) carryforwards in the United States, Brazil, Canada and the United Kingdom. The amount and timing of realizing the benefits of NOL carryforwards depend on future taxable income and limitations imposed by tax laws. Only the benefits of the United Kingdom NOL carryforwards have been recognized in the consolidated financial statements and are included in net deferred tax assets. The NOL amounts by jurisdiction and year of expiration are as follows:



(in millions)	Amount		Year of expiration
United States	$	2	2035 - 2036
Brazil	$	19	None
Canada	$	1	2037 - 2038
United Kingdom	$	146	None

The Company recognized $41 million of tax expense resulting from deemed repatriation of foreign earnings as part of the net charge of $129 million to record the effect of TCJA at enactment during December 2017. These undistributed foreign earnings are intended to be permanently reinvested in those operations.

Provisional Tax Amounts

During the fourth quarter of 2017, the Company recorded provisional amounts for the tax imposed on accumulated foreign earnings and partnership investments, as well as the amount due under the transition rule relating to the change in discounting of claims incurred, based on information available at December 31, 2017. In 2018, the Company made minor adjustments to the provisional amounts for taxes related to accumulated foreign earnings based upon final earnings from its foreign operations and the proposed regulations issued by the U.S. Treasury. These minor adjustments were consistent with final regulations issued by the U.S. Treasury in January 2019. The Company also made minor adjustments to the provisional amount for taxes related to partnership investments based upon the latest available information associated with those investments (Form K-1s) that were received in 2018.

In November 2018, the U.S. Treasury issued proposed regulations which would establish the interest rate and discounting methodology to be used in determining the tax discount on claims and claim adjustment expense reserves under TCJA. The proposed regulations significantly reduce the deferred tax assets and liabilities related to the transition rule for discounting of reserves and reduced the estimated additional tax payments associated with the transition rule from $70 million to $23 million per year over the eight years beginning in 2018 as discussed above.

The Company estimated the amounts payable related to the transition rules for discounting of loss reserves using the regulations proposed by the U.S. Treasury during 2018. These amounts are subject to change once the final regulations are issued, which is expected to occur in 2019.

Unrecognized Tax Benefits

The following is a reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2018 and 2017:



(in millions)	2018		2017
Balance at January 1	$	6	$	13
Additions for tax positions of prior years	25		—
Reductions for tax positions of prior years	—		(1		)
Reductions based on tax positions related to current year	—		(6		)
Balance at December 31	$	31	$	6

Included in the balances at December 31, 2018 and 2017 were $29 million and $3 million, respectively, of unrecognized tax benefits that, if recognized, would affect the annual effective tax rate. Also included in the balances at those dates were $2 million and $3 million, respectively, of tax positions for which the ultimate deductibility is certain, but for which there is uncertainty about the timing of deductibility. The timing of such deductibility could affect the annual effective tax rate depending on the year of deduction and tax rate at the time.

The Company recognizes accrued interest and penalties, if any, related to unrecognized tax benefits in income taxes. During the years ended December 31, 2018, 2017 and 2016, the Company recognized approximately $(10) million, $(33) million and $31 million in interest, respectively. The Company had approximately $14 million and $25 million accrued for the payment of interest at December 31, 2018 and 2017, respectively.

The IRS has completed examinations of the Company’s U.S. income tax returns for all years through 2014. The Company does not expect any significant changes to its liability for unrecognized tax benefits during the next twelve months.