(11) Income Taxes

On December 22, 2017, the Tax Reform Act was enacted in the United States, which includes a broad range of tax reforms affecting businesses, including corporate tax rates, business deductions, and international tax provisions. Under U.S. GAAP, the effects of new legislation are recognized upon enactment, which, for federal legislation, is the date the president signs a bill into law. Accordingly, we have recognized the tax effects of the Tax Reform Act during the year ended December 31, 2017. Amounts recognized as of December 31, 2017 represent reasonable estimates based on obtaining, preparing, and analyzing the information necessary to account for the tax effects of the Tax Reform Act under Accounting Standards Codification Topic 740 (“ASC 740”). However, the breadth and complexity of reforms included in the Tax Reform Act combined with the lack of precedent in its application may result in changes to the tax effects recognized when interpretations of the legislation are finalized, including the Company’s application of any additional guidance that may be issued by U.S. tax authorities. The Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118 which allows companies to recognize provisional amounts for the tax effects resulting from the enactment of the Tax Reform Act for which the accounting under ASC 740 is incomplete but a reasonable estimate can be determined. Adjustments to these provisional amounts, if any, are to be completed within a measurement period not to exceed one year. Specifically, the Company identified the following areas that are incomplete and susceptible to adjustment when the necessary information is available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting:

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The Company does not have the information necessary to make a policy election for whether it will account for any taxes, to which it may be subject, in regard to global intangible low-taxed income, as recognized as incurred or recognized as deferred taxes. As such, no tax effects have been recognized as of December 31, 2017 for the global intangible low-taxed income provisions of the Tax Reform Act.

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A provisional amount for the mandatory deemed repatriation of Canadian earnings has been recognized as of December 31, 2017. However, the provisional amount could be subject to change upon completion of the Company’s total post-1986 foreign earnings and profits calculation and foreign tax credit determination as of the dates specified in the Tax Reform Act.

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A provisional amount has been recognized for the timing difference for the haircut on deductibility of future policy benefit reserves prescribed in the Tax Reform Act. However, the provisional amount could be subject to change upon the Company’s final computation of the prescribed haircut as it relates to insurance contracts identified with cash value features. Adjustments to the provisional amount are not expected to impact the Company’s effective income tax rate or net deferred tax liability position but could impact the timing of when such temporary differences are eliminated.

We expect to finalize our analysis of the incomplete areas and make any necessary adjustments during the second half of 2018.

Income tax expense. Income tax expense (benefit) consists of the following:

	Current		Deferred			Total
	(In thousands)
Year ended December 31, 2017
Federal	$	53,084	$	(46,622	)	$	6,462
Foreign		28,613		(7,166	)		21,447
State and local		1,356		-			1,356
Total tax expense	$	83,053	$	(53,788	)	$	29,265

Year ended December 31, 2016
Federal	$	47,980	$	50,758		$	98,738
Foreign		23,102		(4,710	)		18,392
State and local		2,783		(1,732	)		1,051
Total tax expense	$	73,865	$	44,316		$	118,181

Year ended December 31, 2015
Federal	$	46,175	$	36,723		$	82,898
Foreign		14,600		3,161			17,761
State and local		2,043		(1,592	)		451
Total tax expense	$	62,818	$	38,292		$	101,110

Effective tax rate reconciliation. Total income tax expense is different from the amount determined by multiplying income before income taxes by the U.S. statutory federal tax rate of 35% in effect through December 31, 2017.

The reconciliation for such difference follows:

	Year ended December 31,
	2017						2016						2015
	Amount			Percentage			Amount			Percentage			Amount			Percentage
	(Dollars in thousands)
Computed tax expense	$	132,832			35.0	%	$	118,158			35.0	%	$	101,843			35.0	%
Difference between foreign statutory rate and U.S. statutory rate		(6,668	)		(1.8	)%		(5,665	)		(1.7	)%		(5,531	)		(1.9	)%
Residual U.S. income taxes on foreign earnings not permanently reinvested – prior to the enactment of the Tax Reform Act		4,212			1.1	%		3,855			1.1	%		3,810			1.3	%
Excess tax benefits recognized on share-based compensation		(6,051	)		(1.6	)%		-			—	%		-			—	%
Transition impact of the Tax Reform Act		(95,457	)		(25.1	)%		-			—	%		-			—	%
Recognition of foreign tax credits		(40,386	)		(10.6	)%		-			—	%		-			—	%
Change in valuation allowance on foreign tax credits		40,386			10.6	%		-			—	%		-			—	%
Other		397			0.1	%		1,833			0.6	%		988			0.3	%
Total tax expense / effective rate	$	29,265			7.7	%	$	118,181			35.0	%	$	101,110			34.7	%

Deferred tax assets and liabilities. The main components of deferred income tax assets and liabilities were as follows:

	December 31,
	2017			2016
	(In thousands)
Deferred tax assets:
Future policy benefit reserves and unpaid policy claims	$	206,794		$	223,845
Intangibles and tax goodwill		19,436			36,261
Future deductible liabilities		10,235			19,831
Share-based compensation		7,288			15,592
State income taxes		12,521			11,425
Foreign tax credits		40,386			-
Other		2,857			103
Total deferred tax assets before valuation allowance		299,517			307,057
Valuation allowance on foreign tax credits		(40,386	)		-
Total deferred tax assets after valuation allowance	$	259,131		$	307,057

Deferred tax liabilities:
Deferred policy acquisition costs	$	(275,388	)	$	(366,144	)
Timing difference for haircut on deductibility of future policy benefit reserves prescribed in the Tax Reform Act		(22,307	)		-
Investments		(9,884	)		(16,769	)
Unremitted earnings on foreign subsidiaries		(2,614	)		(2,700	)
Reinsurance deposit asset		(45,641	)		(70,852	)
Other		(7,255	)		(11,864	)
Total deferred tax liabilities		(363,089	)		(468,329	)
Net deferred tax liabilities	$	(103,958	)	$	(161,272	)

The majority of total deferred tax assets are attributable to future policy benefit reserves and unpaid policy claims, which represents the difference between the financial statement carrying value and tax basis for liabilities related to future policy benefits. The tax basis for future policy benefit reserves and unpaid policy claims is actuarially determined in accordance with guidelines set forth in the Internal Revenue Code. The majority of total deferred tax liabilities are attributable to DAC, which represents the difference between the policy acquisition costs capitalized for U.S. GAAP purposes and those capitalized for tax purposes, as well as the difference in the resulting amortization methods.

Prior to the enactment of the Tax Reform Act, deferred income tax assets and liabilities were measured using the 35% U.S. federal statutory tax rate that was expected to be applicable when those temporary differences were recognized in taxable income. The Tax Reform Act reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. The reduction in the U.S. federal statutory tax rate used to measure our net deferred tax liabilities as of the enactment date of approximately $98.5 million was recorded as a benefit to income tax expense during the year ended December 31, 2017.

Deferred tax liabilities associated with net unrealized gains from our AFS investments were originally established through OCI. Under ASC 740, the remeasurement of all deferred taxes, even those associated with net unrealized gains from AFS investments, resulting from the change in the statutory tax rate are recognized through income tax expense. As a result, we recognized an income tax benefit of approximately $7.8 million during the year ended December 31, 2017 to remeasure our U.S. deferred tax liabilities associated with net unrealized gains from AFS investments at the newly enacted 21% U.S. federal statutory tax rate. The stranded component, which is also equal to $7.8 million, remains in accumulated OCI as of December 31, 2017. On February 14, 2018, the FASB issued Accounting Standards Update No. 2018-02 (“ASU 2018-02”), Income Statement – Reporting Comprehensive Income (Topic 220)- Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, a narrow-scoped accounting standards update that allows companies to make an election to eliminate the stranded component within accumulated OCI by reclassifying this amount to retained earnings upon adoption. We expect to adopt ASU 2018-02 in the first quarter of 2018 and reclassify the stranded component from accumulated OCI to retained earnings at that time.

The Company has state net operating losses resulting in a deferred tax asset of approximately $12.2 million, which are available for use through 2035. The Company has no other material net operating loss or credit carryforwards other than foreign tax credit carryforwards.

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, carryback and carryforward periods, and tax planning strategies in making this assessment. As of December 31, 2017, management identified excess foreign tax credits of approximately $40.4 million that could not be used to offset the mandatory deemed repatriation of foreign earnings tax stipulated by the Tax Reform Act and believes it will not be able to utilize these foreign tax credits in the future. Therefore, the Company established a deferred tax asset for these foreign tax credits with a corresponding full valuation allowance. With the exception of these foreign tax credits, management believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize its deferred tax assets. Therefore, there were no other deferred tax asset valuation allowances at December 31, 2017 or 2016.

Controlled foreign corporations. The Company has direct ownership of a group of controlled foreign corporations in Canada. During the year ended December 31, 2017, we have recognized a one-time charge of approximately $3.0 million for the inclusion of mandatory deemed repatriation of foreign earnings payable to the U.S. government due to the enactment of the Tax Reform Act. This charge represents the provisional amount of incremental tax expense recognized for the mandatory deemed repatriation of Canadian earnings for which we had asserted a position of permanent reinvestment prior to the enactment of the Tax Reform Act. In response to the provisions of the Tax Reform Act, we have not made a permanent reinvestment assertion for any unremitted earnings in Canada as of December 31, 2017; therefore, we have also established a deferred tax liability to account for Canadian withholding taxes that will occur upon repatriation of such earnings.

The Company has not provided for any additional outside basis difference for the amount of book basis in excess of tax basis in its Canadian subsidiaries, as there are no intentions to sell or substantially liquidate our Canadian operations. Furthermore, it is not practicable to determine the amount of the unrecognized deferred tax liability related to any additional outside basis difference in these entities.

Unrecognized tax benefits. The total amount of unrecognized benefits on uncertain tax positions that, if recognized, would affect our effective tax rate was approximately $13.4 million and $11.7 million as of December 31, 2017 and 2016, respectively. We recognize interest expense related to unrecognized tax benefits in tax expense net of federal income tax. As of December 31, 2017 and 2016, the total amount of accrued interest and penalties in the consolidated balance sheets was approximately $1.9 million and $2.1 million, respectively. Additionally, we recognized interest related to unrecognized tax benefits in the consolidated statements of income of less than $0.3 million of expense in 2017, 2016, and 2015.

A reconciliation of the change in the unrecognized income tax benefit for the years ended December 31, 2017 and 2016 is as follows:

	December 31,
	2017			2016
	(In thousands)
Unrecognized tax benefits, beginning of period	$	14,811		$	13,939
Change in prior period unrecognized tax benefits		91			8
Change in current period unrecognized tax benefits		2,855			2,840
Reductions as a result of a lapse in statute of limitations		(3,372	)		(1,976	)
Unrecognized tax benefits, end of period	$	14,385		$	14,811

We have no penalties included in calculating our provision for income taxes. There is no significant change that is reasonably possible to occur within twelve months of the reporting date.

The major tax jurisdictions in which we operate are the United States and Canada. We are currently open to tax audit by the Internal Revenue Service for the year ended December 31, 2014 and thereafter for federal income tax purposes. We are currently open to audit in Canada for tax years ended December 31, 2013 and thereafter for federal and provincial income tax purposes.