Income Taxes

12 Months Ended

Dec. 31, 2011

NOTE 7. Income Taxes

OBH and its subsidiaries are domiciled in the United States. The majority of OB Holdings’ operations are taxed in the United States.

OBH and its subsidiaries join in the filing of a federal consolidated tax return. The consolidated parent, which is not included in these financial statements, is OBFS. For all years, the companies included within the U.S. consolidated tax return are parties to a tax sharing agreement which provides that each company pays the amount of income taxes or estimated tax or receives refunds that it would have to make or be entitled to if it filed its own separate tax return. As a result, certain companies have made payments, and received refunds from the consolidated parent that are different than amounts payable to the Internal Revenue Service (“IRS”). In addition, OB Holdings has a separate agreement with the consolidated parent which provides that OB Holdings will be paid for their tax benefits (losses and credits) the earlier of when they would be able to utilize such benefits on a stand-alone basis or when the parent utilizes such losses on a consolidated basis.

The total income tax expense from continuing operations for the years ended December 31, 2011, 2010 and 2009 consisted of the following:

	Year ended December 31,
	2011			2010			2009
	($ in millions)
Current tax expense:
Federal	$	(6.1	)	$	(11.3	)	$	(97.2	)
State	(1.3		)	(1.0		)	(1.1		)
Non-U.S.	(0.2		)	(0.1		)	(0.1		)
Total current tax expense	(7.6		)	(12.4		)	(98.4		)
Deferred tax expense:
Federal	(21.0		)	(29.6		)	(74.7		)
State	—			—			—
Non-U.S.	—			—			—
Total deferred tax expense	(21.0		)	(29.6		)	(74.7		)
Total income tax expense	$	(28.6	)	$	(42.0	)	$	(173.1	)

A reconciliation of taxes calculated using the 35% U.S. statutory rate (the tax rate at which the majority of OB Holdings’ operations are taxed) to the income tax (expense) benefit on pre-tax income from continuing operations follows:

	Year ended December 31,
	2011			2010			2009
	($ in millions)
Tax expense at the U.S. statutory rate	$	(29.0	)	$	(51.8	)	$	(180.5	)
Differences in taxes resulting from:
Tax reserve adjustments	(1.9		)	(1.6		)	2.0
Tax exempt interest and dividends	2.1			1.8			1.6
Change in valuation allowance	(0.7		)	5.9			5.0
Sale of subsidiaries	—			4.3			—
Other, net	0.9			(0.6		)	(1.2		)
Total income tax expense on pre-tax income from continuing operations	$	(28.6	)	$	(42.0	)	$	(173.1	)

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for tax purposes. An outline of the significant components of OB Holdings’ deferred tax assets and liabilities follows:

	December 31,
	2011			2010
	($ in millions)
Deferred income tax assets related to:
U.S. net operating loss and tax credit carryforwards	$	75.0		$	75.3
Discounting of loss and LAE reserves	54.6			81.7
Unearned premiums	36.6			35.3
Compensation and bonus accruals	18.0			22.0
Investment basis differences	12.7			15.1
Impairment from AutoOne	10.4			—
Deferred compensation plans	9.5			10.8
Pension and benefit accruals	5.6			0.5
Accrued rent	4.1			5.0
Allowance for doubtful accounts	1.3			1.4
Other accrued compensation	1.2			1.3
Involuntary pool and guaranty fund accruals	0.2			0.2
Fixed assets	0.1			4.3
Other items	4.5			0.7
Total gross deferred income tax assets	233.8			253.6
Less valuation allowance	(6.9		)	(6.2		)
Total net deferred income tax assets	226.9			247.4
Deferred income tax liabilities related to:
Deferred acquisition costs	43.2			40.1
Net unrealized investment gains	33.9			50.1
Other items	4.8			5.7
Total deferred income tax liabilities	81.9			95.9
Net deferred tax asset	$	145.0		$	151.5

The total net deferred tax asset relates solely to the U.S. consolidated return group.

At December 31, 2011 and 2010, a valuation allowance of $6.9 million and $6.2 million, respectively, was established for the net deferred tax assets of Houston General Insurance Exchange, an insurance reciprocal, which files its own tax return.

OB Holdings believes that, based upon its prior earnings history, expected future earnings and capacity for carry-back of losses, it is more likely than not that the deferred tax asset balances (net of valuation allowance) carried at December 31, 2011 and 2010 will be realized.

Net operating loss and capital loss carryforwards as of December 31, 2011 and the expiration dates are as follows:

	December 31, 2011
	United States
	($ in millions)
2012	$	—
From years 2012 to 2016	6.0
From years 2017 to 2021	0.4
From years 2022 to 2030	208.1
No expiration date	—
Totals	$	214.5

Gross deferred tax asset	$	75.0
Valuation allowance	(1.8		)
Net deferred tax asset	$	73.2

At December 31, 2011, there were net operating losses of $5.4 million related to Houston General Insurance Exchange, which files its own tax return as described above. Under the tax sharing agreement, the Company and its subsidiaries have net operating loss and capital loss carryforwards that begin to expire in 2015.

Under ASC 740-10, recognition of the benefit of a given tax position is based upon whether or not a company determines that it is more likely than not that a tax position will be sustained upon examination based upon the technical merits of the position. In evaluating the more-likely-than-not recognition threshold, OB Holdings must presume that the tax position will be subject to examination by a taxing authority with full knowledge of all relevant information. If the recognition threshold is met, then the tax position is measured at the largest amount of benefit that is more than 50% likely of being realized upon ultimate settlement.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

	Permanent differences(1)			Temporary differences(2)			Interest and penalties(3)			Total
	($ in millions)
January 1, 2009	$	6.8		$	8.4		$	1.6		$	16.8
Changes in prior year tax positions	5.8			43.9			2.4			52.1
Tax positions taken during the current year	—			12.7			—			12.7
Lapse in statute of limitations	(1.0		)	—			(0.2		)	(1.2		)
Settlements with tax authorities	(3.3		)	2.1			(0.6		)	(1.8		)
December 31, 2009	$	8.3		$	67.1		$	3.2		$	78.6
Changes in prior year tax positions	—			(8.6		)	1.6			(7.0		)
December 31, 2010	$	8.3		$	58.5		$	4.8		$	71.6
Changes in prior year tax positions	—			—			1.9			1.9
Tax positions taken during the current year	—			(21.0		)	—			(21.0		)
December 31, 2011	$	8.3		$	37.5		$	6.7		$	52.5

(1) Represents the amount of unrecognized tax benefits that, if recognized, would impact the effective tax rate.

(2) Represents the amount of unrecognized tax benefits that, if recognized would create a temporary difference between the reported amount of an item in OB Holdings’ Consolidated Balance Sheet and its tax basis.

(3) Net of tax benefit.

If recognized, $15.0 million (tax on permanent differences plus interest and penalties) would be recorded as a reduction to income tax expense. Also included in the balance at December 31, 2011 are $37.5 million of tax positions for which ultimate deductibility is highly certain but the timing of deductibility is uncertain. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.

OB Holdings classifies all interest and penalties on unrecognized tax benefits as part of income tax expense. During the years ended December 31, 2011, 2010 and 2009, OB Holdings recognized $1.9 million, $1.6 million and $1.6 million, respectively, in interest expense, net of federal benefit. The balance of accrued interest at December 31, 2011 and 2010 is $6.7 million and $4.8 million, respectively, net of any tax benefit.

With few exceptions, OB Holdings is no longer subject to U.S. federal, state or non-U.S. income tax examinations by tax authorities for years before 2005. On October 14, 2009, a settlement was reached with the IRS on the 2003 and 2004 federal tax examination, which resulted in an assessment of $24.9 million of additional tax, or a total assessment of $51.7 million including interest, withholding tax and utilization of tax credits. The portion of the assessment that related to OB Holdings was $5.9 million of tax. The total assessment relating to OB Holdings, including interest, was $6.4 million. OBIG and its subsidiaries’ overall liability for tax assessments for 2003 and 2004 was limited due to the Tax Make Whole Arrangements with White Mountains, which fixed the liability for these items at the amount recorded on OBIG’s consolidated books. OBIG and its subsidiaries recorded a tax benefit in the consolidated statement of operations of $15.5 million offset by a capital distribution of $8.4 million, reflected in common shareholders’ equity, which resulted in a net increase to book value of $7.1 million in the fourth quarter of 2009 from the settlement of the 2003 and 2004 tax examination.

In October 2008, the IRS commenced examination of OBFS’ U.S. income tax returns for 2005 and 2006. On January 5, 2011, OBFS received a revised Form 4549-A (Income Tax Discrepancy Adjustments) from the IRS relating to the examination of tax years 2005 and 2006. The estimated total assessment, including interest and utilization of alternative minimum and foreign tax credit carryovers, is $19.6 million. The total assessment relating to OB Holdings, including interest, is $20.4 million. OBFS disagrees with the adjustments proposed by the IRS and intends to defend its position. The timing of the resolution of these issues is uncertain, however, it is reasonably possible that the resolution could occur within the next twelve months. An estimate of the range of potential outcomes cannot be made at this time. When ultimately settled, OB Holdings does not expect the resolution of this examination to result in a material change to its financial position.

On July 28, 2011, the IRS commenced an examination of OBFS’ U.S. income tax returns for 2007, 2008 and 2009. OB Holdings does not expect a resolution of this examination to result in a material change to its financial position.

Net cash payments (refunds) for federal, state and non-U.S. income taxes, including tax sharing payments to related companies, totaled $23.4 million, $(3.9) million and $(1.0) million, respectively, for the years ended December 31, 2011, 2010 and 2009.

For the years ended December 31, 2011 and 2010, OB Holdings had net tax sharing amounts receivable of $6.1 million and $5.5 million, respectively.

- Definition

The entire disclosure for income taxes. Disclosures may include net deferred tax liability or asset recognized in an enterprise's statement of financial position, net change during the year in the total valuation allowance, approximate tax effect of each type of temporary difference and carryforward that gives rise to a significant portion of deferred tax liabilities and deferred tax assets, utilization of a tax carryback, and tax uncertainties information.

+ References

Reference 1: http://www.xbrl.org/2003/role/presentationRef

-Publisher FASB

-Name Accounting Standards Codification

-Topic 740

-SubTopic 10

-Section 50

-Paragraph 2

-URI http://asc.fasb.org/extlink&oid=6907707&loc=d3e32537-109319

Reference 2: http://www.xbrl.org/2003/role/presentationRef

-Publisher FASB

-Name Statement of Financial Accounting Standard (FAS)

-Number 109

-Paragraph 136, 172

-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 3: http://www.xbrl.org/2003/role/presentationRef

-Publisher FASB

-Name Statement of Financial Accounting Standard (FAS)

-Number 109

-Paragraph 43, 44, 45, 46, 47, 48, 49

-LegacyDoc This reference is SUPERSEDED by the Accounting Standards Codification effective for interim and annual periods ending after September 15, 2009. This reference is included to help users transition from the previous accounting hierarchy and will be removed from future versions of this taxonomy.

Reference 4: http://www.xbrl.org/2003/role/presentationRef

-Publisher SEC

-Name Regulation S-X (SX)

-Number 210

-Section 08

-Paragraph h

-Article 4

Reference 5: http://www.xbrl.org/2003/role/presentationRef

-Publisher FASB

-Name Accounting Standards Codification

-Topic 740

-SubTopic 10

-Section 50

-Paragraph 3

-URI http://asc.fasb.org/extlink&oid=6907707&loc=d3e32559-109319

Reference 6: http://www.xbrl.org/2003/role/presentationRef

-Publisher FASB

-Name Accounting Standards Codification

-Topic 740

-SubTopic 10

-Section 50

-Paragraph 9

-URI http://asc.fasb.org/extlink&oid=6907707&loc=d3e32639-109319

Reference 7: http://www.xbrl.org/2003/role/presentationRef

-Publisher FASB

-Name Accounting Standards Codification

-Topic 740

-SubTopic 10

-Section 50

-Paragraph 15

-URI http://asc.fasb.org/extlink&oid=6907707&loc=d3e32718-109319

Reference 8: http://www.xbrl.org/2003/role/presentationRef

-Publisher FASB

-Name Accounting Standards Codification

-Topic 235

-SubTopic 10

-Section S99

-Paragraph 1

-Subparagraph (SX 210.4-08.(h))

-URI http://asc.fasb.org/extlink&oid=6881521&loc=d3e23780-122690

+ Details

OneBeacon U.S. Holdings, Inc. 10-K