Income Taxes

Net deferred tax assets and liabilities as of December 31, 2015 and 2014 are as follows:



(In thousands)	2015			2014
Total deferred tax assets	$	791,286		$	933,576
Total deferred tax liabilities	(29,206		)	(33,789		)
Net deferred tax asset before valuation allowance	762,080			899,787
Valuation allowance	—			(902,289		)
Net deferred tax asset (liability)	$	762,080		$	(2,502	)

The components of the net deferred tax asset (liability) as of December 31, 2015 and 2014 are as follows:



(In thousands)	2015			2014
Unearned premium reserves	$	33,262		$	12,296
Benefit plans	(14,283		)	(13,900		)
Federal net operating loss	680,975			845,616
Loss reserves	15,536			23,069
Unrealized (appreciation) depreciation in investments	8,904			(2,800		)
Mortgage investments	17,386			15,346
Deferred compensation	12,927			11,955
Premium deficiency reserves	—			8,313
Other, net	7,373			(108		)
Net deferred tax asset before valuation allowance	762,080			899,787
Valuation allowance	—			(902,289		)
Net deferred tax asset (liability)	$	762,080		$	(2,502	)

We review the need to maintain the deferred tax asset valuation allowance on a quarterly basis. We analyze several factors, among which are the severity and frequency of operating losses, our capacity for the carryback or carryforward of any losses, the existence and current level of taxable operating income, operating results on a three year cumulative basis, the expected occurrence of future income or loss, the expiration dates of the carryforwards, the cyclical nature of our operating results, and available tax planning strategies. Based on our analysis, we reduced our benefit from income tax through the recognition of a valuation allowance from the first quarter of 2009 through the second quarter of 2015.

In the third quarter of 2015, based on our analysis, as described more fully below, we concluded that it was more likely than not that our deferred tax assets would be fully realizable and that the valuation allowance was no longer necessary. Therefore, we reversed the valuation allowance. For the year ended December 31, 2015, we reversed $161.1 million of our valuation allowance based on income from 2015. The portion of the valuation allowance reversed related to deferred tax assets that are expected to be realized in future years, totaling $747.5 million, is treated as a discrete period item and is recognized as a component of the tax provision in continuing operations in the period of release. Furthermore, in determining the discrete period impact from the reversal, we removed the prior period disproportionate tax effects that had arisen in other comprehensive income because of the valuation allowance. This reduced the amount of tax benefit included in net income and resulted in an allocation of tax benefit of $60.8 million to components of other comprehensive income.

The following table provides a rollforward of our deferred tax asset valuation allowance for the year ended December 31, 2015.



(In millions)	For the year ended December 31, 2015
Balance at December 31, 2014	$	902.3

Reduction in tax provision in current year	(161.1		)
Amounts recorded in other comprehensive income in the current year	6.3
Change in valuation allowance for deferred tax assets in the current year	(154.8		)

Reduction in tax provision for amounts to be realized in future years	(686.7		)
Amounts recorded in other comprehensive income to be realized in future years	(60.8		)
Change in valuation allowance for deferred tax assets realizable in future years	(747.5		)

Balance at December 31, 2015	$	—

In our analysis we evaluated both subjective and objective evidence and assigned a weight to each. Significant weight was given to our most recent operating results and our ability to sustain them. We have experienced a significant reduction in losses incurred as our level of default notices received and in inventory has declined, as the effects of the financial crisis continue to ebb. New insurance written in recent years has been of high quality and is expected to be profitable well into the future. Historically, the results of mortgage insurers have been cyclical, where periods of operating losses have been followed by significant amounts of income. All of these factors have had a positive effect on operating results. Our level of pre-tax income for each quarter of 2015 was at least $100 million. We viewed the recurring nature of our income as very important, objectively verifiable evidence and gave it great weight in our analysis. Based on the above, we believe that we will have significant sources of pre-tax income which will allow for utilization of our deferred tax assets.

Generally, a significant component of any analysis for the recognition of deferred tax assets includes the objective observation of operating results for a period of time. In this regard, we considered the level of cumulative operating income, as adjusted for any permanent tax differences. There is no specific requirement that indicates the time span for this evaluation. In our evaluation, we used a three year period. Prior to the third quarter of 2015, this three year cumulative total had been materially negative for an extended period of time, which we considered to be objectively verifiable negative evidence which would not support the reversal of the valuation allowance. In the third quarter, this amount became positive, which we believe provided additional objectively verifiable evidence which supported the reversal of the valuation allowance. The three year cumulative pre-tax income is $687.3 million as of December 31, 2015.

In the fourth quarter of 2013, our net operating loss carryforward (“NOL”) for U.S. federal regular income tax purposes reached $2.6 billion, which was the highest amount it attained. As of December 31, 2015, the estimated remaining NOLs total $1.9 billion, a reduction of $670 million in two years. At this rate, and without taking into account any improvement in earnings, we would utilize the NOL within six years. In addition to this history of the utilization of our NOLs, we considered that the amount of income that we have been generating has been increasing over time. In 2015, we reduced our NOLs by $471 million, whereas in 2014 that amount was $199 million. At the 2015 rate, we would utilize the NOLs on our return by the end of 2020. The earliest current expiration date for our NOLs is 2029. This recent history of positive earnings trends indicates that it is more likely than not that the NOLs would be utilized well before they expire. Further, we currently have no limitations under the change in control provisions of Internal Revenue Code Section 382, which would reduce our ability to utilize our NOLs. We have taken steps, primarily through our Amended and Restated Rights Agreement, to attempt to prevent any change in control which would limit the utilization of our NOLs.

The effect of the change in valuation allowance on the provision for (benefit from) income taxes was as follows:



(In thousands)	2015			2014			2013
Provision for (benefit from) income taxes before valuation allowance	$	163,497		$	91,607		$	(17,239	)
Change in valuation allowance	(161,158		)	(88,833		)	20,935
Reversal of the valuation allowance	(686,652		)	—			—
(Benefit from) provision for income taxes	$	(684,313	)	$	2,774		$	3,696

The change in the valuation allowance that was included in other comprehensive income was a decrease of $54.5 million, a decrease of $13.1 million, and an increase of $17.3 million for the years ended December 31, 2015, 2014 and 2013, respectively. The remaining valuation allowance was reversed in the third quarter of 2015. The total valuation allowance as of December 31, 2014 and 2013 was $902.3 million and $1,004.2 million, respectively.

Giving full effect to the carryback of net operating losses for federal income tax purposes, we have approximately $1,946 million of net operating loss carryforwards on a regular tax basis and $1,051 million of net operating loss carryforwards for computing the alternative minimum tax as of December 31, 2015. Any unutilized carryforwards are scheduled to expire at the end of tax years 2029 through 2033.

The following summarizes the components of the provision for (benefit from) income taxes:



(In thousands)	2015			2014		2013
Current Federal	$	8,067		$	2,391	$	916
Deferred Federal	(686,652		)	1		7
Other	(5,728		)	382		2,773
(Benefit from) provision for income taxes	$	(684,313	)	$	2,774	$	3,696

We paid $5.4 million, $1.3 million, and $0.1 million in federal income tax in 2015, 2014 and 2013, respectively.

The reconciliation of the federal statutory income tax rate to the effective tax rate (benefit) provision is as follows:



	2015		2014		2013
Federal statutory income tax rate	35.0	%	35.0	%	(35.0	)%
Valuation allowance	(173.8	)%	(34.9	)%	45.4	%
Tax exempt municipal bond interest	(0.8	)%	(0.4	)%	(3.7	)%
Other, net	(0.7	)%	1.4	%	1.3	%
Effective tax rate (benefit) provision	(140.3	)%	1.1	%	8.0	%

As previously disclosed, the Internal Revenue Service (“IRS”) completed examinations of our federal income tax returns for the years 2000 through 2007 and issued proposed assessments for taxes, interest and penalties related to our treatment of the flow-through income and loss from an investment in a portfolio of residual interests of Real Estate Mortgage Investment Conduits (“REMICs”). The IRS indicated that it did not believe that, for various reasons, we had established sufficient tax basis in the REMIC residual interests to deduct the losses from taxable income. We appealed these assessments within the IRS and in August 2010, we reached a tentative settlement agreement with the IRS which was not finalized.

On September 10, 2014, we received Notices of Deficiency (commonly referred to as “90 day letters”) covering the 2000-2007 tax years. The Notices of Deficiency reflect taxes and penalties related to the REMIC matters of $197.5 million and at December 31, 2015, there would also be interest related to these matters of approximately $182.9 million. In 2007, we made a payment of $65.2 million to the United States Department of the Treasury which will reduce any amounts we would ultimately owe. The Notices of Deficiency also reflect additional amounts due of $261.4 million, which are primarily associated with the disallowance of the carryback of the 2009 net operating loss to the 2004-2007 tax years. We believe the IRS included the carryback adjustments as a precaution to keep open the statute of limitations on collection of the tax that was refunded when this loss was carried back, and not because the IRS actually intends to disallow the carryback permanently.

We filed a petition with the U.S. Tax Court contesting most of the IRS' proposed adjustments reflected in the Notices of Deficiency and the IRS has filed an answer to our petition which continues to assert their claim. Litigation to resolve our dispute with the IRS could be lengthy and costly in terms of legal fees and related expenses. We can provide no assurance regarding the outcome of any such litigation or whether a compromised settlement with the IRS will ultimately be reached and finalized. Depending on the outcome of this matter, additional state income taxes and state interest may become due when a final resolution is reached. As of December 31, 2015, those state taxes and interest would approximate $48.8 million. In addition, there could also be state tax penalties. Our total amount of unrecognized tax benefits as of December 31, 2015 is $107.1 million, which represents the tax benefits generated by the REMIC portfolio included in our tax returns that we have not taken benefit for in our financial statements, including any related interest. We continue to believe that our previously recorded tax provisions and liabilities are appropriate. However, we would need to make appropriate adjustments, which could be material, to our tax provision and liabilities if our view of the probability of success in this matter changes, and the ultimate resolution of this matter could have a material negative impact on our effective tax rate, results of operations, cash flows, available assets and statutory capital. In this regard, see Note 17 – “Capital Requirements – Capital-GSEs.”

In January 2013, we received a Revenue Agent’s Report from the IRS related to the examination of our federal income tax return for the year 2010. In October 2014, we received a Revenue Agent’s Report from the IRS related to the examination of our federal income tax returns for the years 2011 and 2012. The results of these examinations had no material effect on the financial statements.

Under current guidance, when evaluating a tax position for recognition and measurement, an entity shall presume that the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information. The interpretation adopts a benefit recognition model with a two-step approach, a more-likely-than-not threshold for recognition and derecognition, and a measurement attribute that is the greatest amount of benefit that is cumulatively greater than 50% likely of being realized. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:



(In thousands)	2015		2014		2013
Balance at beginning of year	$	106,230	$	105,366	$	104,550
Additions based on tax positions related to the current year	—		—		—
Additions for tax positions of prior years	890		864		816
Reductions for tax positions of prior years	—		—		—
Settlements	—		—		—
Balance at end of year	$	107,120	$	106,230	$	105,366

The total amount of the unrecognized tax benefits, related to our aforementioned REMIC issue, which would affect our effective tax rate is $93.9 million. We recognize interest accrued and penalties related to unrecognized tax benefits in income taxes. During 2015, we recognized $0.9 million in interest. As of December 31, 2015 and 2014, we had $27.8 million and $26.9 million of accrued interest related to uncertain tax positions, respectively. The statute of limitations related to the consolidated federal income tax return is closed for all years prior to 2000. It is reasonably possible that our 2000-2007 federal tax case will be resolved, other than through litigation. If it is resolved under terms similar to our tentative settlement agreement that was not finalized, our total unrecognized tax benefits would be reduced by $107.1 million during 2016. After taking into account prior payments and the effect of available net operating loss carrybacks, any net cash outflows would approximate $26 million.