INCOME TAXES

12 Months Ended

Dec. 31, 2019

INCOME TAXES

INCOME TAXES

7. INCOME TAXES

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are summarized below. The adoption of ASU 2016-02, as described in note 1.C., required a right-of-use asset and

lease liability be recognized for operating leases in 2019, which resulted in a corresponding deferred tax liability and deferred tax asset.

(in thousands)	2019		2018
Deferred tax assets:
Tax discounting of unpaid losses and settlement expenses	$	19,143	$	18,327
Unearned premium offset		18,755		17,864
Deferred compensation		2,981		2,700
Stock option expense		2,728		2,702
Lease liability		5,140		—
Other		275		616
Deferred tax assets before allowance	$	49,022	$	42,209
Less valuation allowance		—		—
Total deferred tax assets	$	49,022	$	42,209
Deferred tax liabilities:
Net unrealized appreciation of securities	$	56,532	$	22,177
Deferred policy acquisition costs		17,859		17,836
Lease asset		4,690		—
Discounting of unpaid losses and settlement expenses - Tax Cuts and Jobs Act (TCJA) implementation offset		3,817		5,203
Book/tax depreciation		3,008		3,133
Intangible assets		1,634		1,711
Undistributed earnings of unconsolidated investees		17,673		15,811
Other		536		576
Total deferred tax liabilities	$	105,749	$	66,447
Net deferred tax liability	$	(56,727)	$	(24,238)

Income tax expense (benefit) attributable to income from operations for the years ended December 31, 2019, 2018 and 2017, differed from the amounts computed by applying the U.S. federal tax rate of 21 percent, 21 percent and 35 percent, respectively, to pretax income from continuing operations as demonstrated in the following table:

(in thousands)	2019					2018					2017
Provision for income taxes at the statutory federal tax rates	$	48,874		21.0	%	$	14,192		21.0	%	$	29,606		35.0	%
Increase (reduction) in taxes resulting from:
Enactment of TCJA		—		—	%		(2,268)		(3.4)	%		(32,821)		(38.8)	%
Excess tax benefit on share-based compensation		(3,958)		(1.7)	%		(4,533)		(6.7)	%		(5,798)		(6.9)	%
Dividends received deduction		(823)		(0.4)	%		(775)		(1.1)	%		(2,025)		(2.4)	%
ESOP dividends paid deduction		(1,122)		(0.5)	%		(1,184)		(1.8)	%		(2,905)		(3.4)	%
Tax-exempt interest income		(1,238)		(0.5)	%		(1,795)		(2.7)	%		(4,671)		(5.5)	%
Unconsolidated investee dividends		(1,802)		(0.8)	%		—		—	%		(1,351)		(1.6)	%
Nondeductible expenses		1,649		0.7	%		389		0.6	%		276		0.3	%
Other items, net		(488)		(0.1)	%		(624)		(0.9)	%		(750)		(0.9)	%
Total	$	41,092	​	17.7	%	$	3,402	​	5.0	%	$	(20,439)	​	(24.2)	%

Our effective tax rates were 17.7 percent, 5.0 percent and -24.2 percent for 2019, 2018 and 2017, respectively. Effective rates are dependent upon components of pretax earnings and the related tax effects. The effective rate was higher in 2019 primarily due to higher levels of pretax earnings, which caused the tax-favored adjustments to be smaller on a percentage basis in 2019 compared to 2018. The effective rate was significantly lower in 2017 as a result of the impact of tax reform.

Among other provisions, the TCJA lowered the federal corporate tax rate from 35 percent to 21 percent effective January 1, 2018. Our deferred tax items were revalued as of year-end 2017 to reflect the lower rate, which reduced our net deferred tax liability and income tax expense by $32.8 million and decreased the effective tax rate by 38.8 percent.

Except for two aspects, the accounting for the tax effects of the enactment of the TCJA were completed as of December 31, 2017. The first provisional item recorded in 2017 was related to an expected disallowance of deductions for certain performance based compensation, including bonuses and stock options. At the time of enactment, there was a lack of clarity on

whether some amounts could be grandfathered in as deductible. The Internal Revenue Service (IRS) and Treasury Department provided additional guidance and we were able to finalize the accounting in 2018 by recording a $2.3 million deferred tax benefit to restore the deferred tax assets related to those performance based compensation amounts. The second provisional item related to discount factors on loss reserves that the IRS had not yet published. The IRS published the factors in the fourth quarter of 2018 and we were able to complete the accounting for the effects of the enactment of the TCJA. While there was no net impact to the deferred tax amount that was recorded at December 31, 2017, we implemented the new discounting methodology and will recognize the adjustment ratably over the allowed eight-year period beginning in 2018.

Our net earnings include equity in earnings of unconsolidated investees, Maui Jim and Prime. The investees do not have a policy or pattern of paying dividends. As a result, we record a deferred tax liability on the earnings at the recently revised corporate capital gains rate of 21 percent in anticipation of recovering our investments through means other than through the receipt of dividends, such as a sale. We received a $13.2 million dividend from Maui Jim in 2019 and recognized a $1.8 million tax benefit from applying the lower tax rate applicable to affiliated dividends (7.4 percent in 2019), as compared to the corporate capital gains rate on which the deferred tax liabilities were based. In the fourth quarter of 2017, Maui Jim gave notification that a $9.9 million dividend would be paid in January 2018. Even though no dividend was received in 2017, we were aware that the lower tax rate applicable to affiliated dividends (7.4 percent in 2018) would be applied when the dividend was paid in 2018 and we therefore recorded a $1.4 million tax benefit in 2017. Standing alone, the dividends resulted in a 0.8 percent and 1.6 percent reduction to the 2019 and 2017 effective tax rates, respectively. As no additional dividends were declared from unconsolidated investees in 2018, there was no impact to the 2018 effective tax rate.

Dividends paid to our Employee Stock Ownership Plan (ESOP) also result in a tax deduction. Dividends paid to the ESOP in 2019, 2018 and 2017 resulted in tax benefits of $1.1 million, $1.2 million and $2.9 million, respectively. These tax benefits reduced the effective tax rate for 2019, 2018 and 2017 by 0.5 percent, 1.8 percent and 3.4 percent, respectively.

We have recorded our deferred tax assets and liabilities using the statutory federal tax rate of 21 percent. We believe it is more likely than not that all deferred tax assets will be recovered, given the carry back availability as well as the results of future operations, which will generate sufficient taxable income to realize the deferred tax asset. In addition, we believe when these deferred items reverse in future years, our taxable income will be taxed at an effective rate of 21 percent.

Federal and state income taxes paid in 2019, 2018 and 2017 amounted to $25.6 million, $16.4 million and $10.4 million, respectively.

Although we are not currently under audit by the IRS, tax years 2016 through 2019 remain open and are subject to examination.