Income Taxes

12 Months Ended

Dec. 31, 2011

Income Taxes

Income Taxes

11. Income Taxes

Accounting Policy

        The provision for income taxes consists of an amount for taxes currently payable and an amount for deferred taxes. Deferred income taxes are provided for temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities, using enacted rates in effect for the year in which the differences are expected to reverse. A valuation allowance is recorded to reduce the deferred tax asset to an amount that is more likely than not to be realized.

        Non-interest-bearing tax and loss bonds are purchased to prepay the tax benefit that results from deducting contingency reserves as provided under Internal Revenue Code Section 832(e). The Company records the purchase of tax and loss bonds in deferred taxes.

        The Company recognizes tax benefits only if a tax position is "more likely than not" to prevail.

Provision for Income Taxes

        The Company and its Bermuda Subsidiaries, which include AG Re, Assured Guaranty Re Overseas Ltd. ("AGRO"), Assured Guaranty (Bermuda) Ltd. (formerly Financial Security Assurance International Ltd.) and Cedar Personnel Ltd., are not subject to any income, withholding or capital gains taxes under current Bermuda law. The Company has received an assurance from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, AGL and its Bermuda Subsidiaries will be exempt from taxation in Bermuda until March 31, 2035. The Company's U.S. and United Kingdom ("U.K.") subsidiaries are subject to income taxes imposed by U.S. and U.K. authorities, respectively, and file applicable tax returns. In addition, AGRO, a Bermuda domiciled company and Assured Guaranty (Europe) Ltd., a U.K. domiciled company, have elected under Section 953(d) of the U.S. Internal Revenue Code to be taxed as a U.S. domestic corporation.

        In conjunction with the AGMH Acquisition, AGMH has joined the consolidated federal tax group of AGUS, AGC, and AG Financial Products Inc. ("AGFP"). For the periods beginning on July 1, 2009 and forward, AGMH files a consolidated federal income tax return with AGUS, AGC, AGFP and AG Analytics Inc. ("AGUS consolidated tax group"). In addition a new tax sharing agreement was entered into effective July 1, 2009 whereby each company in the AGUS consolidated tax group will pay or receive its proportionate share of taxable expense or benefit as if it filed on a separate return basis with current period credit for net losses to the extent used in consolidation. Assured Guaranty Overseas US Holdings Inc. and its subsidiaries AGRO, Assured Guaranty Mortgage Insurance Company and AG Intermediary Inc., have historically filed their own consolidated federal income tax return. Each company, as a member of its respective consolidated tax return group, pays its proportionate share of the consolidated federal tax burden for its group as if each company filed on a separate return basis with current period credit for net losses to the extent used in consolidation.

        The effective tax rates reflect the proportion of income recognized by each of the Company's operating subsidiaries, with U.S. subsidiaries taxed at the U.S. marginal corporate income tax rate of 35%, U.K. subsidiaries taxed at the U.K. blended marginal corporate tax rate of 26.5%, and no taxes for the Company's Bermuda holding company and Bermuda subsidiaries, with the exception of AGRO. For periods subsequent to April 1, 2011, the U.K. corporation tax rate has been reduced to 26%, for periods prior to April 1, 2011 the U.K. corporation tax rate was 28%, resulting in a blended tax rate of 26.5%. The Company's overall corporate effective tax rate fluctuates based on the distribution of taxable income across these jurisdictions.

        A reconciliation of the difference between the provision for income taxes and the expected tax provision at statutory rates in taxable jurisdictions is presented below:

Effective Tax Rate Reconciliation

	Year Ended December 31,
	2011			2010			2009
	(in millions)
Expected tax provision (benefit) at statutory rates in taxable jurisdictions	$	316.0		$	179.2		$	111.9
Tax-exempt interest		(61.6	)		(61.4	)		(42.6	)
True-up from tax return filings(1)		(3.2	)		(51.6	)		—
Goodwill		—			—			(51.5	)
Change in liability for uncertain tax positions(1)		2.1			(5.6	)		9.5
Change in valuation allowance		—			(7.0	)		—
Other		5.5			2.0			4.8
Total provision (benefit) for income taxes	$	258.8		$	55.6		$	32.1
Effective tax rate		25.0	%		10.1	%		27.5	%

(1)

For the year ended December 31, 2010, the Company recorded a $55.8 million tax benefit related to an amended return for a period prior to the AGMH Acquisition, $9.2 million was related to a change in liability for uncertain tax positions.

        The expected tax provision at statutory rates in taxable jurisdictions is calculated as the sum of pretax income in each jurisdiction multiplied by the statutory tax rate of the jurisdiction by which it will be taxed. Pretax income of the Company's subsidiaries which are not U.S. domiciled but are subject to U.S. tax by election or as controlled foreign corporations is included at the U.S. statutory tax rate. Where there is a pretax loss in one jurisdiction and pretax income in another, the total combined expected tax rate may be higher or lower than any of the individual statutory rates.

        In addition, during the year ended December 31, 2010, a net tax benefit of $55.8 million was recorded by the Company due to the filing of an amended tax return which included the AGMH and Subsidiaries tax group. The amended return filed in September 2010 was for a period prior to the AGMH Acquisition and consequently, the Company no longer has a deferred tax asset related to net operating losses ("NOL") or alternative minimum tax ("AMT") credits associated with the AGMH Acquisition. Instead, the Company has recorded additional deferred tax assets for loss reserves and foreign tax credits and has decreased its liability for uncertain tax positions. The event giving rise to this recognition occurred after the measurement period as defined by acquisition accounting and thus the amount is included in the year ended December 31, 2010 net income.

        The following table presents pretax income and revenue by jurisdiction for the year ended December 31, 2011, 2010 and 2009.

Pretax Income (Loss) by Tax Jurisdiction(1)

	Year Ended December 31,
	2011		2010		2009
	(in millions)
United States	$	902.7	$	511.6	$	319.6
Bermuda		131.4		37.3		(202.8	)
UK		0.3		0.4		0.1
Total	$	1,034.4	$	549.3		116.9

Revenue by Tax Jurisdiction(1)

	Year Ended December 31,
	2011		2010		2009
	(in millions)
United States	$	1,518.0	$	1,094.5	$	719.8
Bermuda		301.3		219.0		197.3
UK		—		—		—
Total		1,819.3		1,313.5		917.1

(1)

In the above tables, pretax income and revenues of the Company's subsidiaries which are not U.S. domiciled but are subject to U.S. tax by election or as controlled foreign corporations are included in the U.S. amounts.

        Pretax income by jurisdiction may be disproportionate to revenue by jurisdiction to the extent that insurance losses incurred are disproportionate.

Components of Net Deferred Tax Assets

	As of December 31,
	2011		2010
	(in millions)
Deferred tax assets:
Unrealized losses on credit derivative financial instruments, net	$	266.9	$	401.6
Unearned premium reserves, net		424.2		641.6
Loss and LAE reserve		—		72.2
Tax and loss bonds		71.2		56.7
NOL carry forward		9.4		15.0
AMT credit		32.0		11.4
Tax basis step-up		6.0		6.7
Foreign tax credit		30.2		22.3
DAC		4.7		—
FG VIEs		220.9		199.2
Other		112.1		63.0
Total deferred income tax assets		1,177.6		1,489.7
Deferred tax liabilities:
DAC		—		2.3
Contingency reserves		75.6		61.1
Loss and LAE reserve		1.0		—
Tax basis of public debt		104.8		107.1
Unrealized appreciation on investments		135.9		18.3
Unrealized gains on CCS		19.1		6.6
Other		70.3		35.2
Total deferred income tax liabilities		406.7		230.6
Net deferred income tax asset	$	770.9	$	1,259.1

        As of December 31, 2011, the Company had foreign tax credits carried forward of $30.2 million which expire in 2018 through 2021. As of December 31, 2011, the Company had AMT credits of $32.0 million which do not expire. Foreign tax credits of $22.3 million are from its acquisition of AGMH. The Internal Revenue Code limits the amounts of foreign tax credits available from the acquisition of AGMH that the Company may utilize each year. Management believes sufficient future taxable income exists to realize the full benefit of these tax credits.

        As of December 31, 2011, AGRO had a standalone NOL of $27.0 million, compared with $42.9 million as of December 31, 2010, which is available to offset its future U.S. taxable income. The Company has $6.3 million of this NOL available through 2019 and $20.7 million available through 2023. AGRO's stand alone NOL may not permit to offset the income of any other members of AGRO's consolidated group with very limited exceptions. At December 31, 2009, the Company had a valuation allowance of $7.0 million related to AGRO's NOLs. During 2010 and 2011, management had reassessed the likelihood of realization of all of its deferred tax assets. Management believes it is more likely than not that there will be sufficient future taxable income to offset the AGRO NOLs before expiration and released the $7.0 million valuation allowance in 2010.

Audits

        AGUS has open tax years with the U.S. Internal Revenue Service ("IRS") of 2006 forward. AGUS is currently under audit by the IRS for the 2006 through 2009 tax years. Assured Guaranty Oversees US Holdings Inc. ("AGOUS") has open tax years of 2009 forward. AGOUS is currently under audit by the IRS for the 2009 tax year. AGMH and subsidiaries have separate open tax years with the IRS of 2008 through the July 1, 2009 when they joined the AGUS consolidated group. AGMH and subsidiaries are under audit for 2008 while members of the Dexia Holdings Inc. consolidated tax group. The Company is indemnified by Dexia for any potential liability associated with this audit of any periods prior to the AGMH Acquisition. The Company's U.K. subsidiaries are not currently under examination and have open tax years of 2010 forward.

Uncertain Tax Positions

        The following table provides a reconciliation of the beginning and ending balances of the total liability for unrecognized tax benefits. The Company does not believe it is reasonably possible that this amount will change significantly in the next twelve months.

	2011		2010			2009
	(in millions)
Balance as of January 1,	$	18.3	$	23.9		$	5.1
Impact from AGMH Acquisition		—		—			9.3
True-up from tax return filings		—		(7.7	)		—
Increase in unrecognized tax benefits as a result of position taken during the current period		2.1		2.1			9.5
Balance as of December 31,	$	20.4	$	18.3		$	23.9

        The Company's policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. At December 31, 2011, the Company has accrued $0.6 million of interest in 2011 and $2.8 million as of December 31, 2011.

        The total amount of unrecognized tax benefits as at December 31, 2011, that would affect the effective tax rate, if recognized, is $20.4 million.

Liability For Tax Basis Step-Up Adjustment

        In connection with the IPO, the Company and ACE Financial Services Inc. ("AFS"), a subsidiary of ACE, entered into a tax allocation agreement, whereby the Company and AFS made a "Section 338 (h)(10)" election that has the effect of increasing the tax basis of certain affected subsidiaries' tangible and intangible assets to fair value. Future tax benefits that the Company derives from the election will be payable to AFS when realized by the Company.

        As a result of the election, the Company has adjusted its net deferred tax liability, to reflect the new tax basis of the Company's affected assets. The additional basis is expected to result in increased future income tax deductions and, accordingly, may reduce income taxes otherwise payable by the Company. Any tax benefit realized by the Company will be paid to AFS. Such tax benefits will generally be calculated by comparing the Company's affected subsidiaries' actual taxes to the taxes that would have been owed by those subsidiaries had the increase in basis not occurred. After a 15 year period, to the extent there remains an unrealized tax benefit, the Company and AFS will negotiate a settlement of the unrealized benefit based on the expected realization at that time.

        As of December 31, 2011 and December 31, 2010, the liability for tax basis step-up adjustment, which is included in the Company's balance sheets in "Other liabilities," was $6.9 million and $8.0 million, respectively. The Company has paid ACE and correspondingly reduced its liability by $1.1 million in 2011.

Tax Treatment of CDS

        The Company treats the guaranty it provides on CDS as insurance contracts for tax purposes and as such a taxable loss does not occur until the Company expects to make a loss payment to the buyer of credit protection based upon the occurrence of one or more specified credit events with respect to the contractually referenced obligation or entity. The Company holds its CDS to maturity, at which time any unrealized fair value loss in excess of credit- related losses would revert to zero.

        The tax treatment of CDS is an unsettled area of the law. The uncertainty relates to the IRS determination of the income or potential loss associated with CDS as either subject to capital gain (loss) or ordinary income (loss) treatment. In treating CDS as insurance contracts the Company treats both the receipt of premium and payment of losses as ordinary income and believes it is more likely than not that any CDS credit related losses will be treated as ordinary by the IRS. To the extent the IRS takes the view that the losses are capital losses in the future and the Company incurred actual losses associated with the CDS, the Company would need sufficient taxable income of the same character within the carryback and carryforward period available under the tax law.

Valuation Allowance

        The Company came to the conclusion that it is more likely than not that its net deferred tax asset will be fully realized after weighing all positive and negative evidence available as required under GAAP. The positive evidence that was considered included the cumulative operating income the Company has earned over the last three years, and the significant unearned premium income to be included in taxable income. The positive evidence outweighs any negative evidence that exists. As such, the Company believes that no valuation allowance is necessary in connection with this deferred tax asset. The Company will continue to analyze the need for a valuation allowance on a quarter-to quarter basis.