12. INCOME TAXES

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). The estimated effects of enactment of TCJA are reflected in the net deferred tax asset and current tax liability that are reported on the Company's balance sheet at December 31, 2017.

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)	2017			2016			2015

Composition of income tax expense included in the consolidated statements of income
Current expense:
Federal	$	314		$	899		$	1,144
Impact of TCJA at enactment		21			—			—
Foreign		56			21			29
State		4			8			9

Total current tax expense		395			928			1,182

Deferred expense (benefit):
Federal		229			110			117
Impact of TCJA at enactment		108			—			—
Foreign		(58	)		1			2

Total deferred tax expense		279			111			119

Total income tax expense included in the consolidated statements of income		674			1,039			1,301
Composition of income tax expense (benefit) included in shareholders' equity
Expense (benefit) relating to share-based compensation, the changes in unrealized gain on investments, unrealized loss on foreign exchange and other items in other comprehensive income (loss)		110			(289	)		(448	)

Total income tax expense included in the consolidated financial statements	$	784		$	750		$	853

Total income tax expense for 2017 included a net charge of $129 million to reflect the change in tax laws and tax rates included in TCJA at the date of enactment, resulting primarily from revaluing the Company's deferred tax assets and liabilities and the tax imposed on accumulated foreign earnings.

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 statements of income:

(for the year ended December 31, in millions)	2017			2016			2015

Income (loss) before income taxes
U.S.	$	2,798		$	3,946		$	4,621
Foreign		(68	)		107			119

Total income before income taxes		2,730			4,053			4,740
Effective tax rate
Statutory tax rate		35	%		35	%		35	%

Expected federal income tax expense		956			1,419			1,659
Tax effect of:
Nontaxable investment income		(297	)		(323	)		(345	)
TCJA at enactment		129			—			—
Other, net		(114	)		(57	)		(13	)

Total income tax expense	$	674		$	1,039		$	1,301



Effective tax rate		25	%		26	%		27	%

The Company paid income taxes of $514 million, $892 million and $1.21 billion during the years ended December 31, 2017, 2016 and 2015, respectively. The current income tax refundable of $65 million at December 31, 2017 was included in other assets in the consolidated balance sheet. The current income tax payable of $72 million at December 31, 2016 was included in other liabilities 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 changes the prescribed interest rates to rates based on corporate bond yield curves and extends the applicable time periods for the claim payment pattern. These changes are 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 has no direct impact on total tax expense for 2017 and future years. The required additional tax payments are currently estimated to approximate $70 million per year over the eight-year period and will result in a modest reduction in net investment income. The Company's tax payments will reflect the amounts due under the transition rule beginning in 2018.

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

(at December 31, in millions)	2017		2016

Deferred tax assets
Claims and claim adjustment expense reserves	$	930	$	664
Unearned premium reserves		478		760
Compensation-related liabilities		61		268
Other		191		272

Total gross deferred tax assets		1,660		1,964
Less: valuation allowance		6		3

Adjusted gross deferred tax assets		1,654		1,961

Deferred tax liabilities
Claims and claim adjustment expense reserve discounting (transition rule)		560		—
Deferred acquisition costs		376		604
Investments		454		592
Internally developed software		97		157
Other		97		143

Total gross deferred tax liabilities		1,584		1,496

Net deferred tax asset	$	70	$	465

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 $3 million in 2017 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, 2017, the Company had net operating loss (NOL) carryforwards in Brazil 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

Brazil	$	15	None
United Kingdom	$	156	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.

The Company has 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. As a result of the Company's normal U.S. income tax return preparation process, the Company expects taxes related to accumulated foreign earnings and partnerships to be adjusted as final earnings from foreign operations and partnership investments (Form K-1's) are received in 2018 for preparation of the Company's 2017 U.S. income tax return that will be filed in 2018. The amounts payable under the transition rules related to discounting have been estimated but are subject to change once the U.S. Treasury issues guidance sometime in 2018. Adjustments to temporary differences will result from the reduced income tax rate applied to the deferred taxes associated with these items. Provisional amounts may also be adjusted to the extent future clarifications of TCJA are provided.

The following is a reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2017 and 2016:

(in millions)	2017			2016

Balance at January 1	$	13		$	16
Additions for tax positions of prior years		—			3
Reductions for tax positions of prior years		(1	)		(6	)
Reductions based on tax positions related to current year		(6	)		—

Balance at December 31	$	6		$	13

Included in the balances at December 31, 2017 and 2016 were $3 million and $7 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 $3 million and $6 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, 2017, 2016 and 2015, the Company recognized approximately $(33) million, $31 million and $(32) million in interest, respectively. The Company had approximately $25 million and $57 million accrued for the payment of interest at December 31, 2017 and 2016, 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.