Income Taxes

The following is a reconciliation of income taxes at the statutory rate of 35% to the provision for income taxes as shown in AFG’s Statement of Earnings (dollars in millions):



	2016					2015					2014
	Amount			% of EBT		Amount			% of EBT		Amount			% of EBT
Earnings before income taxes (“EBT”)	$	787				$	565				$	626

Income taxes at statutory rate	$	275		35	%	$	198		35	%	$	219		35	%
Effect of:
Tax exempt interest	(24		)	(3	%)	(27		)	(5	%)	(25		)	(4	%)
Change in valuation allowance	52			7	%	23			4	%	7			1	%
Stock-based compensation	(9		)	(1	%)	1			—	%	1			—	%
Subsidiaries not in AFG’s tax return	3			—	%	2			1	%	1			—	%
Acquisition of noncontrolling interest in NATL	(66		)	(8	%)	—			—	%	—			—	%
Neon restructuring	(111		)	(14	%)	—			—	%	—			—	%
Losses of managed investment entities	—			—	%	—			—	%	18			3	%
Other	(1		)	(1	%)	(2		)	—	%	(1		)	—	%
Provision for income taxes as shown in the statement of earnings	$	119		15	%	$	195		35	%	$	220		35	%

The changes in valuation allowance in the table above are primarily increases in the valuation allowance on tax benefits related to losses in the Neon Lloyd’s insurance business. AFG maintains a full valuation allowance against the deferred tax benefits associated with losses related to Neon.

As discussed in Note B — “Acquisitions and Sale of Businesses,” AFG acquired the noncontrolling interest in NATL in November 2016. This transaction allowed NATL and its subsidiaries to become members of the AFG consolidated tax group, which resulted in a tax benefit of $66 million to AFG during the fourth quarter of 2016.

In January 2008, AFG paid $75 million in cash to acquire approximately 67% of Neon Underwriting Limited (“Neon”, formerly known as Marketform Group Limited), a United Kingdom-based Lloyd’s insurer. During 2012, AFG acquired the then-remaining shares of Neon that it did not already own for $17 million. Neon has recorded underwriting losses in each period from the date of AFG’s initial investment, including adverse prior year reserve development related to Italian public hospital medical malpractice business which Neon ceased writing in 2008, as well as other lines of business. AFG’s investment in Neon includes the cost of acquiring the company as well as additional capital provided to Neon since the date of acquisition.

In 2011, cumulative losses at Neon across multiple lines of business resulted in uncertainty concerning the realization of the deferred tax benefits associated with the losses. Consequently, AFG began maintaining a full valuation allowance against the deferred tax assets related to the Lloyd’s insurance business in 2011.

In connection with the ongoing reorganization of the Neon Lloyd’s business, in December 2016, AFG undertook a restructuring that included the liquidation for tax purposes of the foreign subsidiary that is the parent of the Neon Lloyd’s operations, resulting in a taxable loss for U.S. tax purposes. AFG reported the $111 million tax benefit associated with this loss in the fourth quarter of 2016. Approximately $29 million of the $111 million tax benefit reduced current taxes payable while the remaining tax benefit will be received from the carry-back of the tax-basis capital loss to offset capital gains in prior tax years.

Excluding a $65 million charge related to the exit of certain lines of business within Neon and the tax benefits related to the acquisition of the noncontrolling interest in NATL and the Neon restructuring, AFG’s effective tax rate for the year ended December 31, 2016, was 35%.

AFG’s 2012 — 2016 tax years remain subject to examination by the IRS.

Total earnings before income taxes include losses subject to tax in foreign jurisdictions of $160 million in 2016, $66 million in 2015 and $4 million in 2014.

The total income tax provision (credit) consists of (in millions):



	2016			2015			2014
Current taxes:
Federal	$	299		$	216		$	265
State	12			8			8
Deferred taxes:
Federal	(192		)	(29		)	(53		)
Provision for income taxes	$	119		$	195		$	220

For income tax purposes, AFG and its subsidiaries had the following carryforwards available at December 31, 2016 (in millions):



	Expiring	Amount
Operating Loss – U.S.	2017 - 2022	$	143
Operating Loss – United Kingdom	indefinite	139		(*)
Capital Loss – U.S.	2021	237


(*)	£112 million

Deferred income tax assets and liabilities reflect temporary differences between the carrying amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. The significant components of deferred tax assets and liabilities included in AFG’s Balance Sheet at December 31 were as follows (in millions):



	2016									2015
	Excluding Unrealized Gains			Impact of Unrealized Gains			Total			Excluding Unrealized Gains			Impact of Unrealized Gains			Total
Deferred tax assets:
Federal net operating loss carryforwards	$	50		$	—		$	50		$	50		$	—		$	50
Foreign underwriting losses	120			—			120			77			—			77
Capital loss carryforwards	83			—			83			32			—			32
Insurance claims and reserves	774			27			801			691			22			713
Employee benefits	131			—			131			115			—			115
Other, net	40			(5		)	35			33			(4		)	29
Total deferred tax assets before valuation allowance	1,198			22			1,220			998			18			1,016
Valuation allowance against deferred tax assets	(173		)	—			(173		)	(130		)	—			(130		)
Total deferred tax assets	1,025			22			1,047			868			18			886
Deferred tax liabilities:
Subsidiaries not in AFG’s tax return	—			—			—			(63		)	—			(63		)
Investment securities	29			(336		)	(307		)	23			(281		)	(258		)
Deferred policy acquisition costs	(448		)	96			(352		)	(418		)	82			(336		)
Total deferred tax liabilities	(419		)	(240		)	(659		)	(458		)	(199		)	(657		)
Net deferred tax asset (liability)	$	606		$	(218	)	$	388		$	410		$	(181	)	$	229

AFG’s net deferred tax asset at December 31, 2016 and 2015 is included in other assets in AFG’s Balance Sheet.

The likelihood of realizing deferred tax assets is reviewed periodically; any adjustments required to the valuation allowance are made in the period during which developments requiring an adjustment become known.

“Foreign underwriting losses” in the table above include the net operating loss carryforward and other deferred tax assets related to the Neon Lloyd’s insurance business. Due to uncertainty concerning the realization of the deferred tax benefits associated with these losses, AFG maintains a full valuation allowance of $120 million against these deferred tax assets at December 31, 2016. In addition to the valuation allowance related to the Neon Lloyd’s insurance business, the gross deferred tax asset has also been reduced by a $50 million valuation allowance related to a portion of AFG’s net operating loss carryforwards (“NOL”) subject to the separate return limitation year (“SRLY”) tax rules. A SRLY NOL can be used only by the entity that created it and only in years that both it and the consolidated group have taxable income.

“Subsidiaries not in AFG’s tax return” in the table above represents a deferred tax liability related to AFG’s investment in NATL during the time that it was a less than 80%-owned subsidiary of AFG. In November 2016, AFG completed the acquisition of the noncontrolling interest in NATL. This transaction allowed NATL and its subsidiaries to become members of AFG’s consolidated tax group, which enabled AFG to release the deferred tax liability ($66 million at the transaction date) associated with its investment in NATL.

AFG increased its liability for uncertain tax positions by $1 million in 2015 due to uncertainty in state taxation of its surplus lines insurance subsidiaries.

In July 2014, AFG finalized a settlement with the IRS related to tax years 2008 and 2009. As a result, AFG’s uncertain tax positions were effectively settled, allowing AFG to reduce its liability for previously uncertain tax positions by $19 million in the third quarter of 2014. Although AFG agreed to pay $11 million to the IRS, the majority of the reduction in this liability resulted in offsetting adjustments to AFG’s deferred tax liability and did not impact AFG’s effective tax rate. The portion of the reduction in this liability that favorably impacted the effective tax rate was approximately $4 million including interest. The reduction of the liability for previously uncertain tax positions includes $17 million related to the timing of recognition of investment income on certain debt securities and $2 million related to the deductibility of certain financing expenses.

A progression of the liability for uncertain tax positions, excluding interest and penalties, follows (in millions):



	2016		2015		2014
Balance at January 1	$	1	$	—	$	19
Additions for tax positions of prior years	—		1		—
Reductions for tax positions of prior years	—		—		(8		)
Additions for tax positions of current year	—		—		—
Settlements	—		—		(11		)
Balance at December 31	$	1	$	1	$	—

AFG’s provision for income taxes included an expense of less than $1 million in 2016 and 2015 and a benefit of $1 million in 2014 of interest (net of federal benefit or expense). AFG’s liability for interest related to unrecognized tax benefits was less than $1 million at December 31, 2016 and December 31, 2015 (net of federal benefit); no interest was accrued at December 31, 2014. AFG’s provision for income taxes in 2016 included an expense of less than $1 million for penalties; no penalties were recorded in 2015 or 2014. AFG’s liability for penalties related to unrecognized tax benefits was less than $1 million at December 31, 2016; no penalties were accrued at December 31, 2015 or December 31, 2014.

Cash payments for income taxes, net of refunds, were $308 million, $234 million and $347 million for 2016, 2015 and 2014, respectively.