Note 11. Income Taxes

The provision for income taxes consists of the following for the years ended December 31:



(in millions)	Erie Insurance Group
	2012			2011			2010
Indemnity
Current income tax expense	$	84		$	85		$	37
Deferred income tax (benefit) expense	(3		)	0			67
Total provision for income taxes – Indemnity	81			85			104
Exchange
Current income tax expense (benefit)	78			110			(43		)
Deferred income tax expense (benefit)	121			(105		)	278
Total provision for income taxes – Exchange	199			5			235
Total provision for income taxes – Erie Insurance Group	$	280		$	90		$	339

The deferred income tax expense in 2012 was primarily driven by unrealized gains on investments. The deferred income tax benefit in 2011 was primarily driven by unrealized losses on common stock. The deferred income tax expense in 2010 was primarily driven by the sale of previously impaired investments and unrealized gains on common stock and limited partnerships. In addition, the deferred tax liability recorded for Indemnity’s investment in EFL increased by $18 million in 2010 as a result of a change in the tax rate used to calculate the liability. This deferred tax charge was required due to Indemnity’s decision to sell its 21.6% ownership interest in EFL, rather than receiving its share of EFL’s earnings in the form of future dividends, which would have been eligible for an 80% dividends received deduction.

A reconciliation of the provision for income taxes, with amounts determined by applying the statutory federal income tax rates to pre-tax income, is as follows for the years ended December 31:



(in millions)	Erie Insurance Group
	2012			2011			2010
Indemnity
Income tax at statutory rates	$	84		$	89		$	93
Tax-exempt interest	(2		)	(3		)	(3		)
Dividends received deduction	(1		)	(1		)	(1		)
Deferred tax valuation allowance	0			0			(2		)
Erie Family Life earnings (losses) (1)	0			(1		)	15
Other, net	0			1			2
Provision for income taxes – Indemnity	81			85			104
Exchange
Income tax at statutory rates	230			37			259
Tax-exempt interest	(13		)	(15		)	(16		)
Dividends received deduction	(14		)	(13		)	(11		)
Deferred tax valuation allowance	0			0			(4		)
Goodwill impairments	0			0			8
Return to provision adjustments	(3		)	(5		)	0
Other, net	(1		)	1			(1		)
Provision for income taxes – Exchange	199			5			235
Provision for income taxes – Erie Insurance Group	$	280		$	90		$	339

(1) In 2010 Indemnity’s tax rate on its share of EFL earnings was adjusted from 7% to 35% due to Indemnity’s decision to sell its 21.6% ownership interest in EFL to the Exchange, which closed on March 31, 2011, rather than receiving its share of EFL’s earnings in the form of future dividends, which would have been eligible for an 80% dividends received deduction.

Temporary differences and carry-forwards, which give rise to consolidated deferred tax assets and liabilities, are as follows for the years ended December 31:



(in millions)	Erie Insurance Group
	2012		2011
Indemnity
Deferred tax assets:
Net allowance for service fees and premium cancellations	$	3	$	3
Other employee benefits	9		9
Pension and other postretirement benefits	65		45
Other	3		1
Total deferred tax assets	80		58
Deferred tax liabilities:
Unrealized gains on investments	6		6
Limited partnerships	13		10
Depreciation	15		13
Prepaid expenses	5		7
Capitalized internally developed software	3		1
Other	1		2
Total deferred tax liabilities	43		39
Net deferred income tax asset – Indemnity	$	37	$	19



(in millions)	Erie Insurance Group (continued)
	2012			2011
Exchange
Deferred tax assets:
Loss reserve discount	$	78		$	81
Liability for future life and annuity policy benefits	7			12
Unearned premiums	179			165
Write-downs of impaired securities	19			29
Other	22			27
Total deferred tax assets	305			314
Deferred tax liabilities:
Deferred policy acquisition costs	165			159
Unrealized gains on investments	443			272
Limited partnerships	43			12
Other	19			18
Total deferred tax liabilities	670			461
Net deferred tax liability – Exchange	$	(365	)	$	(147	)
Net deferred income tax liability – Erie Insurance Group	$	(328	)	$	(128	)

Neither the Indemnity nor the Exchange had a valuation allowance recorded at December 31, 2012 or December 31, 2011.

In 2010, Indemnity generated taxable losses of $38 million and the Exchange generated taxable losses of $175 million on the sale of limited partnerships. These partnerships were sold to recapture tax paid on prior period capital gains that were due to expire. The unrealized losses on these partnerships were previously recorded as a deferred tax asset. Indemnity and the Exchange received $13 million and $61 million, respectively, in tax refunds on these transactions in 2011.

At December 31, 2011, we had one uncertain income tax position for which a current liability was recorded. As a related temporary tax difference was also recognized, there was no impact on our results of operations or financial position. We recognized interest related to this uncertain tax position in income tax expense. The issue was resolved during 2012, at which time the Financial Accounting Standards Board Interpretation No. 48 liability, the deferred tax asset and the accrued interest were reversed. During 2012 we determined there was a new uncertain income tax position for which a current liability was recorded. This item was permanent in nature and therefore, a charge of $0.9 million was recorded in our results for the tax and associated interest expense. The IRS has examined tax filings through 2007 and is currently examining our federal income tax returns for 2008 and 2009. We currently estimate that our unrecognized tax benefits will not change significantly in the next 12 months.

Indemnity is the attorney-in-fact for the subscribers (policyholders) at the Exchange, a reciprocal insurance exchange. In that capacity, Indemnity provides all services and facilities necessary to conduct the Exchange’s insurance business. Indemnity and the Exchange together constitute one insurance business. Indemnity is not subject to state corporation income or franchise taxes in states where the Exchange conducts its business, as a result of the Exchange’s remittance of premium taxes in those states.