Income Taxes

12 Months Ended

Dec. 31, 2012

Income Taxes [Abstract]

Income Taxes

Note 20 — Income Taxes

A. Income Tax Expense

The components of income taxes for the years ended December 31 were as follows:

(In millions)	2012		2011		2010
Current taxes
U.S. income	$	604	$	320	$	267
Foreign income		72		58		45
State income		43		20		19
		719		398		331
Deferred taxes (benefits)
U.S. income		131		193		187
Foreign income		4		23		8
State income		(1)		1		(7)
		134		217		188
Total income taxes	$	853	$	615	$	519

Total income taxes for the years ended December 31 were different from the amount computed using the nominal federal income tax rate of 35% for the following reasons:

(In millions)	2012		2011		2010
Tax expense at nominal rate	$	867	$	657	$	631
Tax-exempt interest income		(28)		(29)		(31)
Effect of permanently invested foreign earnings		(37)		(17)		(11)
Dividends received deduction		(3)		(4)		(3)
Resolution of federal tax matters		-		(30)		-
State income tax (net of federal income tax benefit)		28		14		9
Change in valuation allowance		6		5		(93)
Other		20		19		17
Total income taxes	$	853	$	615	$	519

Effect of Permanently Invested Foreign Earnings

The Company provides for income taxes on the undistributed earnings of certain foreign operations using the foreign jurisdictions' tax rate, as compared to the higher U.S. statutory tax rate. Commencing in the first quarter of 2012, the Company began using this approach to compute income taxes attributable to its China and Indonesia operations, based upon a determination that the related earnings would be permanently invested overseas. The Company continues to evaluate the permanent investment of foreign earnings for additional jurisdictions.

Shareholders' net income for the year ended December 31, 2012 increased by $37 million related to this method of providing for income taxes including $13 million attributable to the first quarter implementation of this method for the Company's China and Indonesia operations. Permanent investment of foreign operation earnings has resulted in cumulative unrecognized deferred tax liabilities of $116 million through December 31, 2012. The year-to-date change in the cumulative unrecognized deferred tax liability includes anincrease of $10 million associated with unrecorded deferred tax liabilities reported through other comprehensive income.

Change in Valuation Allowance

The significant decline in the 2010 valuation allowance primarily reflects the resolution of a disputed federal income tax matter specific to the run-off reinsurance operations.

B.Deferred Income Taxes

Deferred income tax assets and liabilities as of December 31 are shown below.

(In millions)	2012		2011
Deferred tax assets
Employee and retiree benefit plans	$	765	$	829
Investments, net		95		108
Other insurance and contractholder liabilities		486		443
Deferred gain on sale of businesses		28		46
Policy acquisition expenses		147		151
Loss carryforwards		9		8
Other accrued liabilities		164		109
Bad debt expense		21		17
Other		33		37
Deferred tax assets before valuation allowance		1,748		1,748
Valuation allowance for deferred tax assets		(42)		(45)
Deferred tax assets, net of valuation allowance		1,706		1,703
Deferred tax liabilities
Depreciation and amortization		704		377
Foreign operations, net		147		128
Unrealized appreciation on investments and foreign currency translation		481		395
Total deferred tax liabilities		1,332		900
Net deferred income tax assets	$	374	$	803

Management believes consolidated taxable income expected to be generated in the future will be sufficient to support realization of the Company's net deferred tax assets.This determination is based upon the Company's consistent overall earnings history and future earnings expectations. Other than deferred tax benefits attributable to operating loss carryforwards, there are no time constraints within which the Company's deferred tax assets must be realized.

The Company's deferred tax asset is net of federal, state, and foreign valuation allowances. The foreign valuation allowance was initially recorded in connection with the Company's 2011 acquisition of FirstAssist, for which there was a year over year decline of $7 million. This reduction did not impact shareholder's net income. The valuation allowance reflects management's assessment that certain deferred tax assets may not be realizable.

C. Uncertain Tax Positions

A reconciliation of unrecognized tax benefits for the years ended December 31 is as follows:

(In millions)	2012		2011		2010
Balance at January 1,	$	52	$	177	$	214
Decrease due to prior year positions		(5)		(113)		(55)
Increase due to current year positions		7		7		34
Reduction related to settlements with taxing authorities		-		(17)		(13)
Reduction related to lapse of applicable statute of limitations		(3)		(2)		(3)
Balance at December 31,	$	51	$	52	$	177

There was minimal change in the level of unrecognized tax benefits during 2012.

The December 31, 2012 unrecognized tax benefit balance included $29 million that would increase shareholders' net income if recognized. The Company has determined it is at least reasonably possible that within the next twelve months there could be a significant change in the level of unrecognized tax benefits specific to development in ongoing IRS examinations. These changes are not expected to have a material impact on shareholders' net income.

The Company classifies net interest expense on uncertain tax positions and any applicable penalties as a component of income tax expense, but excludes these amounts from the liability for uncertain tax positions. The Company's liability for net interest and penalties was $3 million at December 31, 2012, $2 million at December 31, 2011 and $14 million at December 31, 2010. The 2011 decline included $11 million associated with the completion of the 2007 and 2008 IRS examinations.

During the first quarter of 2011, the IRS completed its examination of the Company's 2007 and 2008 consolidated federal income tax returns, resulting in an increase to shareholders' net income of $24 million ($33 million reported in income tax expense, partially offset by a $9 million pre-tax charge). The increase in shareholders' net income included a reduction in net unrecognized tax benefits of $11 million and a reduction of interest expense of $11 million (reported in income tax expense).

D. Federal Income Tax Examinations, Litigation and Other Matters

The Company has had a continuing dispute with the IRS for tax years 2004 through 2006 regarding the appropriate reserve methodology for certain reinsurance contracts. Trial was held before the United States Tax Court for the 2004 tax year in September 2011. Prior to trial, the IRS conceded the underlying adjustments but continued to challenge the Company's reserve methodology as a matter of law. The United States Tax Court issued its opinion for the 2004 year on September 13, 2012. While declining to rule on the broader legal issue, the opinion confirmed the Company's tax reserve calculation and referenced an IRS representation that it would not challenge the Company's reserving methodology in future tax years, thereby providing certainty that the Company may continue to use its current reserve methodology prospectively. Tax computations for the 2004 tax year have been reviewed by the staff of the Joint Committee of Taxation and the parties are currently awaiting entry of the Tax Court's decision, that is expected shortly. On January 9, 2013 the Tax Court entered its decision on this issue for the 2005 and 2006 tax years, ordering and deciding that the Company has no tax deficiency.

The IRS continues to be engaged in its examination of the Company's 2009 and 2010 consolidated federal income tax returns. This review is expected to be competed in 2013, and is not expected to have a material impact on shareholder's net income. The Company conducts business in numerous state and foreign jurisdictions, and may be engaged in multiple audit proceedings at any given time. Generally, no further state audit activity is expected for tax years prior to 2008, and prior to 2001for foreign audit activity.

The American Taxpayer Act of 2012 was signed into law on January 2, 2013. This legislation retroactively extended for 2012, as well as for 2013,several otherwise expired corporate tax provisions from which the Company benefits. Tax benefits specific to extension of these provisions for 2012 will be recorded in the first quarter of 2013, and are not expected to have a material impact on shareholder's net income.