Income Taxes

Continuing Operations

Significant components of the provision for income taxes from continuing operations are as follows for the years ended December 31:



	2013			2012			2011
	(Dollars in millions)
Current tax expense:
Federal	$	79.0		$	(3.4	)	$	77.8
State	12.5			(1.2		)	14.5
Total current tax expense	91.5			(4.6		)	92.3
Deferred tax expense (benefit):
Federal	15.0			11.1			5.1
State	(6.4		)	(2.2		)	2.7
Total deferred tax expense (benefit)	8.6			8.9			7.8
Interest expense, gross of related tax effects	(0.3		)	1.7			0.6
Total income tax provision	$	99.8		$	6.0		$	100.7

A reconciliation of the statutory federal income tax rate and the effective income tax rate on income from continuing operations is as follows for the years ended December 31:



	2013	2012	2011
Statutory federal income tax rate	35.0%	35.0%	35.0%
State and local taxes, net of federal income tax effect	1.5	(6.9)	6.9
Valuation allowance (release) against capital losses, net operating losses or tax credits	—	(26.5)	21.9
Non-deductible compensation	3.6	17.7	2.3
Tax exempt interest income	(2.4)	(12.7)	(2.2)
Sale of subsidiaries	—	1.8	(3.9)
Interest expense	(0.1)	5.3	0.5
Lobbying expense	0.4	3.4	0.8
Other, net	(1.0)	1.8	1.0
Effective income tax rate	37.0%	18.9%	62.3%

The effective income tax rate from continuing operations was 37.0%, 18.9% and 62.3% for the years ended December 31, 2013, 2012 and 2011, respectively. Our effective income tax rate for the year ended December 31, 2013 varies from the statutory federal rate of 35% primarily due to state income taxes, tax exempt investment income, and non-deductible compensation. During the year ended December 31, 2011, a judgment was rendered in the AmCareco litigation (see Note 13) that resulted in deferred tax assets of $51.1 million. Realization of these deferred tax assets was uncertain and therefore, a valuation allowance for the full amount was established. The most significant change in the effective income tax rate from 2011 to 2012 is as a result of the absence of such litigation effects in 2012. Our effective income tax rate for the year ended December 31, 2012 is lower than the statutory federal rate of 35% primarily due to the effect of tax-exempt income and reductions of valuation allowances against deferred assets, which resulted from the utilization of capital loss carryforwards against gains on sale of marketable securities. Such beneficial impacts are partially offset by the effect of certain compensation treated as non-deductible under the ACA.

Significant components of our deferred tax assets and liabilities as of December 31 are as follows:



	2013			2012
	(Dollars in millions)
DEFERRED TAX ASSETS:
Accrued liabilities	$	87.8		$	92.7
Accrued compensation and benefits	67.1			70.5
Net operating and capital loss carryforwards	22.2			22.9
Unrealized losses on investments	16.7			—
Insurance loss reserves and unearned premiums	12.7			15.4
Deferred gain and revenues	6.6			12.4
Other	8.8			2.4
Deferred tax assets before valuation allowance	221.9			216.3
Valuation allowance	(23.3		)	(19.7		)
Net deferred tax assets	$	198.6		$	196.6
DEFERRED TAX LIABILITIES:
Depreciable and amortizable property	$	77.1		$	63.6
Prepaid expenses	14.9			17.7
Deferred revenue	13.2			25.8
Unrealized gains on investments	—			22.9
Other	4.0			1.9
Deferred tax liabilities	$	109.2		$	131.9

During 2013, our total valuation allowance increased by a net $3.6 million, primarily resulting from a change in our investment portfolio to an unrealized loss position. The unrealized losses could produce capital losses that we expect would be subject to limitations on use for state tax reporting.

For 2013, 2012 and 2011 the income tax benefit realized from share-based award exercises was $6.1 million, $16.6 million and $8.7 million, respectively. Of the tax benefits realized, $(1.4) million, $5.1 million and $0.8 million were allocated to stockholders’ equity in 2013, 2012 and 2011, respectively.

As of December 31, 2013, we had federal and state net operating loss carryforwards of approximately $6.1 million and $162.9 million, respectively. The net operating loss carryforwards expire at various dates through 2032.

Limitations on utilization may apply to all of the federal and state net operating loss carryforwards. Accordingly, valuation allowances have been provided to account for the potential limitations on utilization of these tax benefits. No portion of the 2013 valuation allowance was allocated to reduce goodwill.

We maintain a liability for unrecognized tax benefits that includes the estimated amount of contingent adjustments that may be sustained by taxing authorities upon examination. A reconciliation of the beginning and ending amount of unrecognized tax benefits, exclusive of related interest, is as follows:



	2013			2012			2011
	(Dollars in millions)
Gross unrecognized tax benefits at beginning of year	$	57.3		$	47.1		$	21.9
Increases in unrecognized tax benefits related to the current year	4.4			2.4			25.2
Increases in unrecognized tax benefits related to prior years	—			8.0			—
Decreases in unrecognized tax benefits related to a prior year	(0.2		)	(0.2		)	—
Settlements with taxing authorities	(1.9		)	—			—
Lapse in statute of limitation for assessment	(4.0		)	—			—
Gross unrecognized tax benefits at end of year	$	55.6		$	57.3		$	47.1

Of the $59.3 million total liability at December 31, 2013 for unrecognized tax benefits, including interest and penalties, approximately $9.7 million would, if recognized, impact the Company’s effective tax rate. The remaining $49.6 million would impact deferred tax assets. Of the $62.7 million total liability at December 31, 2012 for unrecognized tax benefits, including interest and penalties, approximately $13.3 million would, if recognized, impact the Company’s effective tax rate. The remaining $49.4 million would impact deferred tax assets.

We recognized interest and any applicable penalties which could be assessed related to unrecognized tax benefits in income tax provision expense. Accrued interest and penalties are included within the related tax liability in the consolidated balance sheet. During 2013, 2012 and 2011, ($0.3) million, $1.7 million and $0.6 million of interest was recorded as income tax (benefit) provision, respectively. We reported interest accruals of $3.7 million and $4.1 million at December 31, 2013 and 2012, respectively. Provision expense and accruals for penalties were immaterial in all reporting periods.

We file tax returns in the federal as well as several state tax jurisdictions. As of December 31, 2013, tax years subject to examination in the federal jurisdiction are 2008 and forward. The most significant state tax jurisdiction for us is California, and tax years subject to examination by that jurisdiction are 2008 and forward. Presently we are under examination by various state taxing authorities. We do not believe that any ongoing examination will have a material impact on our consolidated balance sheet and results of operations.

In the next twelve months, it is reasonably possible that our unrecognized tax benefits could change due to the closure of federal and state statutes of limitations for assessment and examination settlements. These resolutions could reduce our unrecognized tax benefits by approximately $3.1 million.

Discontinued Operation

On April 1, 2012, we completed the sale of our Medicare PDP business to CVS Caremark. For the year ended December 31, 2012, we recorded tax expense of $18.0 million net against the gain on sale of discontinued operation. See Note 3 for additional information regarding the sale of our Medicare PDP business. The effective tax rate differs from the federal statutory rate of 35% due primarily to the impact of non-deductible goodwill impairment and a reduction in the valuation allowance against deferred tax assets, which resulted from the utilization of capital loss carryforwards against the gain on the sale of our Medicare PDP business. We had no income or loss and no tax expense or benefit for discontinued operation for the year ended December 31, 2013.

As a result of the sale, the operating results of our Medicare PDP business have been classified as discontinued operation in our consolidated statements of operations for the year ended December 31, 2012, and accordingly, reclassified our results of operations for the year ended December 31, 2011. We recorded a tax benefit of $10.3 million net against the loss from discontinued operation for the year ended December 31, 2012. We recorded tax expense of $6.2 million net against income from discontinued operation for the year ended December 31, 2011. The effective income tax rates related to income or loss from discontinued operation remained relatively constant throughout 2011 and 2012 at slightly above the federal statutory tax rate of 35% due to state income taxes.