THG 2018 Annual Report

The provision for income taxes from continuing operations was an expense of $43.5 million, $76.8 million, and a benefit of $1.0 million in 2018, 2017 and 2016, respectively. These amounts resulted in consolidated effective tax rates of 15.4% and 26.2% on pre-tax income for 2018 and 2017, respectively, and a benefit of 1.5% on pre-tax income for 2016. The provision for 2018 reflects a tax benefit related to prior years of $4.3 million, primarily due to a $40.0 million contribution to our U.S. pension plan made in September 2018 and reflected as a deduction in our 2017 U.S. income tax return at the then higher statutory tax rate. The provision for the 2017 tax year further reflects a tax benefit of $3.9 million related to the revaluation of our net deferred tax liabilities as a result of the enactment of the Tax Cuts DQG -REV $FW ³7&-$´ ´8 6 7D[ 5HIRUP´ RU ³WKH $FW´ 6HH WKH GLVFXVVLRQ RI WKH QHZ WD[ ODZ ³8 6 7D[ 5HIRUP´ EHORZ The provisions in 2018 and 2017 also included excess tax benefits related to stock-based compensation of $2.3 million and $5.3 million, respectively. The adoption of ASC Update No. 2016-09 on January 1, 2017 required the inclusion of excess tax benefits from stock- based compensation in the income statement, whereas prior to the adoption, these excess tax benefits were recognized in additional paid- in capital. Lastly, the provisions in 2018, 2017, and 2016 reflect benefits related to tax planning strategies implemented in prior years of $9.2 million, $12.7 million, and $20.7 million, respectively. Absent these items, the provision for income taxes for 2018, 2017, and 2016 would have been expenses of $59.3 million, or 21.0%, $98.7 million, or 33.7%, and $19.7 million, or 29.8%, respectively. The lower effective tax rate in 2018 is primarily due to the aforementioned decrease in the U.S. statutory rate and the lower effective tax rate in 2016 is primarily due to lower underwriting income. The income tax provision on operating income was an expense of $69.3 million, $89.5 million and $46.3 million for 2018, 2017 and 2016, respectively. These provisions resulted in effective tax rates for operating income of 19.2%, 31.7% and 32.7% in 2018, 2017 and 2016, respectively. The provisions for 2018 and 2017 reflect the aforementioned excess tax benefit related to stock-based compensation of $2.3 million and $5.3 million, respectively. In addition, the 2018 provision included the aforementioned tax benefit related to prior years of $4.3 million. Absent these items, the provision for income taxes for 2018 and 2017 would have been expense of $75.9 million, or 21.0% and $94.8 million, or 33.6%. The income tax provision on the Chaucer business was an expense of $4.7 million, $21.7 million and $37.2 million for 2018, 2017 and 2016, respectively. The provision for 2017 reflects a one-time expense of $26.2 million related to the enactment of the TCJA. This expense included a revaluation of our net deferred tax assets and the recognition of federal income tax on previously untaxed earnings from foreign operations of $13.5 million and $12.7 million, respectively. Absent these items, the provision for income tax for 2017 would have been a benefit of $4.5 million. The income tax provision on the gain from the disposal of Chaucer business was an expense of $42.5 million. This provision includes a write off of $8.0 mil OLRQ RI GHIHUUHG WD[ DVVHWV SULPDULO\ DWWULEXWDEOH WR /OR\G¶V XQGHUZULWLQJ ORVVHV During 2017, we recorded an increase to our uncertain tax positions of $0.9 million related to the recognition of federal income taxes on previously untaxed earnings from foreign operations. This amount is partially offset by a decrease in our uncertain tax positions of $0.6 million due to the expiration of a statute of limitation, for a net change of $0.3 million. We are subject to U.S. federal and state examinations and foreign examinations for years after 2014. There are no ongoing audits on our open tax years. In prior years, we completed several transactions which resulted in the realization, for tax purposes only, of unrealized gains in our investment portfolio. As a result of these transactions, we were able to realize capital losses carried forward and release the valuation allowance recorded against the deferred tax asset related to those losses. The releases of valuation allowances were recorded as a benefit in accumulated other comprehensive income. Previously unrealized benefits of $9.2 million, $12.7 million and $20.7 million attributable to non-operating income, are recognized as part of our income from continuing operations during 2018, 2017 and 2016, respectively. The remaining amount of $35.6 million in accumulated other comprehensive income will be released into income from continuing operations in future years, as the investment securities subject to these transactions are sold or mature. U.S. TAX REFORM On December 22, 2017, the TCJA was enacted in the U.S. The Act substantially changed many aspects of the U.S. Tax code, including reducing the U.S. corporate income tax rate from 35% to 21%. While the new corporate rate is effective on January 1, 2018, we have recognized the impact of the rate change on our deferred tax balances as of the enactment date. The effect of this re-measurement of our deferred tax balances is a provision of $9.4 million for the year ended December 31, 2017. This provision is recorded as a component of income tax expense in continuing operations and within discontinued operations as a component of income from Chaucer business. A tax benefit of $4.1 million was recognized in continuing operations and an expense of $13.5 million was recognized in discontinued operations. This amount includes the revaluation of deferred taxes initially recorded through other comprehensive income and recorded through discontinued operations, such as unrealized appreciation on investments, employee benefit plan-related items, foreign currency translation adjustments and reserve adjustments for discontinued business. Deferred taxes related to the revaluation of our pension plans at December 31, 2017, as well as changes in unrealized gains and losses occu UULQJ DIWHU WKH $FW¶V HQDFWPHQW GDWH DUH UHFRUGHG DW in other comprehensive income. The Act also created a territorial tax system, which will generally allow companies to repatriate future non-U.S. sourced earnings without incurring additional U.S. taxes, by providing a 100% exemption on dividends received from certain non-U.S. subsidiaries. Although most of our non-U.S. income had been previously subject to U.S. taxes, a portion of our non-U.S. income had been indefinitely reinvested 65 2018 ANNUAL REPORT | THE HANOVER INSURANCE GROUP