11. INCOME TAXES

Under Bermuda law, no income or capital gains taxes are imposed on Group and its Bermuda subsidiaries. The Minister of Finance of Bermuda has assured Group and its Bermuda subsidiaries that, pursuant to The Exempted Undertakings Tax Protection Amendment Act of 2011, they will be exempt until 2035 from imposition of any such taxes.

All the income of Group's non-Bermuda subsidiaries is subject to the applicable federal, foreign, state and local taxes on corporations. Additionally, the income of foreign branches of the Company's insurance operating companies, in particular the UK branch of Bermuda Re, is subject to various income taxes. The provision for income taxes in the consolidated statement of operations and comprehensive income (loss) has been determined in accordance with the individual income of each entity and the respective applicable tax laws. The provision reflects the permanent differences between financial and taxable income relevant to each entity. The significant components of the provision are as follows for the periods indicated:


	Years Ended December 31,
(Dollars in thousands)	2011			2010			2009
Current tax expense (benefit):
U.S.	$	27,257		$	(57,073	)	$	(25,964	)
Non-U.S.		14,388			35,056			29,445
Total current tax expense (benefit)		41,645			(22,016	)		3,481
Total deferred U.S. tax expense (benefit)		(195,106	)		2,500			128,851
Total income tax expense (benefit)	$	(153,461	)	$	(19,516	)	$	132,332

(Some amounts may not reconcile due to rounding.)

The weighted average expected tax provision has been calculated using the pre-tax income (loss) in each jurisdiction multiplied by that jurisdiction's applicable statutory tax rate. Reconciliation of the difference between the provision for income taxes and the expected tax provision at the weighted average tax rate for the periods indicated is provided below:


	Years Ended December 31,
(Dollars in thousands)	2011					2010					2009
	U.S.			Non-U.S.		U.S.			Non-U.S.		U.S.			Non-U.S.
Pre-tax income (loss)	$	(395,206	)	$	161,260	$	141,142		$	450,097	$	422,027		$	517,294

Expected tax provision at the applicable statutory rate(s)		(138,322	)		12,216		49,436			33,716		147,758			28,600
Increase (decrease) in taxes resulting from:
Tax exempt income		(33,672	)		-		(56,457	)		-		(60,378	)		-
Dividend received deduction		(6,893	)		-		(2,784	)		-		(1,409	)		-
Proration		5,080			-		8,510			-		9,139			-
Tax audit settlement		(710	)		-		(48,867	)		-		(9,690	)		-
Other		6,668			2,172		(4,410	)		1,340		17,467			845
Total income tax provision	$	(167,849	)	$	14,388	$	(54,572	)	$	35,056	$	102,887		$	29,445

During the fourth quarter of 2011, the Company identified an understatement in its Deferred tax asset account of $12,232 thousand. The understatement resulted from differences between filed and recorded amounts that had accumulated over several prior periods. The Company corrected this understatement in its 2011 financial statements, resulting in an additional $12,232 thousand income tax benefit included in the income tax expense (benefit) caption in the Consolidated Statements of Operations and Comprehensive Income (Loss) and increased net income for the same amount for the year ended December 31, 2011 and for the fourth quarter 2011. The Company also increased its Deferred tax asset in its Consolidated Balance Sheets by the same amount. The Company believes that this out of period adjustment is immaterial to its full year 2011 financial statements, its fourth quarter 2011 financial statements, and to all prior periods. As such, the Company has not restated any prior period amounts.

Deferred income taxes reflect the tax effect of the temporary differences between the value of assets and liabilities for financial statement purposes and such values as measured by the U.S. tax laws and regulations. The principal items making up the net deferred income tax asset are as follows for the periods indicated:


	Years Ended December 31,
(Dollars in thousands)	2011		2010
Deferred tax assets:
Loss reserve	$	183,883	$	177,237
Net operating loss carryforward		167,089		-
Foreign tax credits		74,253		55,026
Unearned premium reserve		43,020		46,146
Unfunded pension liability		29,903		14,045
Alternative minimum tax credits		21,438		41,693
Deferred expenses		19,351		17,447
Deferred compensation		15,437		14,189
Uncollectible reinsurance reserve		5,675		5,675
Investment impairments		4,620		4,129
Other assets		17,724		14,254
Total deferred tax assets		582,393		389,841

Deferred tax liabilities:
Net unrealized investment gains		79,450		56,095
Deferred acquisition costs		58,571		64,487
Net unrealized foreign currency gains		46,738		45,251
Net fair value income		29,633		29,002
Gain on tender of debt		27,395		27,395
Bond market discount		2,183		2,609
Other liabilities		5,640		15,901
Total deferred tax liabilities		249,610		240,740

Net deferred tax assets	$	332,783	$	149,101

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:


(Dollars in thousands)	2011		2010			2009
Balance at January 1	$	23,773	$	29,010		$	34,366
Additions based on tax positions related to the current year		8,139		7,119			6,997
Additions for tax positions of prior years		-		-			-
Reductions for tax positions of prior years		-		-			-
Settlements with taxing authorities		-		(12,356	)		(12,353	)
Lapses of applicable statutes of limitations		-		-			-
Balance at December 31	$	31,912	$	23,773		$	29,010

The entire amount of unrecognized tax benefits would affect the effective tax rate if recognized.

In 2010, the Company favorably settled a 2003 and 2004 IRS audit. During the years ended December 31, 2011 and 2010, the Company recorded a net overall tax benefit including accrued interest of $710 thousand and $25,920 thousand, respectively. In addition, in 2010, the Company was also able to take down a $12,356 thousand FIN 48 reserve that had been established regarding the 2003 and 2004 IRS audit. The Company is no longer subject to U.S. federal, state and local or foreign income tax examinations by tax authorities for years before 2007.

The Company recognizes accrued interest related to net unrecognized tax benefits and penalties in income taxes. During the years ended December 31, 2011, 2010, and 2009, the Company accrued and recognized a net expense/(benefit) of approximately $957 thousand, $(9,938) thousand and $1,563 thousand, respectively, in interest and penalties. Included within the 2010 net expense (benefit) of $(9,938) thousand is $(10,591) thousand of accrued interest related to the 2003 and 2004 IRS audit.

The Company is not aware of any positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within twelve months of the reporting date.

For U.S. income tax purposes the Company has foreign tax credit carry forwards of $74,253 thousand that begin to expire in 2017 and net operating loss carryforwards of $477,397 thousand that began to expire in 2030. In addition, for U.S. income tax purposes the Company has $21,438 thousand of Alternative Minimum Tax credits that do not expire. Management believes that it is more likely than not that the Company will realize the benefits of its net deferred tax assets and, accordingly, no valuation allowance has been recorded for the periods presented.

Tax benefits of $4,071 thousand and $629 thousand to share-based compensation deductions for stock options exercised in 2011 and 2010, respectively, are reflected in additional paid-in capital the shareholders' equity section of the consolidated balance sheets.