10. Income Taxes

Income tax provision

The Company and its subsidiaries file a consolidated federal income tax return. The provision for income tax expense consists of the following components:


	Year Ended December 31,
	2011			2010			2009
	(Amounts in thousands)
Federal
Current	$	31,390		$	23,699		$	31,676
Deferred		20,518			9,964			131,839

	$	51,908		$	33,663		$	163,515

State
Current	$	2,934		$	(3,225	)	$	1,793
Deferred		(907	)		(246	)		3,161

	$	2,027		$	(3,471	)	$	4,954

Total
Current	$	34,324		$	20,474		$	33,469
Deferred		19,611			9,718			135,000

Total	$	53,935		$	30,192		$	168,469

The income tax provision reflected in the consolidated statements of operations is reconciled to the federal income tax on income before income taxes based on a statutory rate of 35% as shown in the table below:


	Year Ended December 31,
	2011			2010			2009
	(Amounts in thousands)
Computed tax expense at 35%	$	85,785		$	63,837		$	200,039
Tax-exempt interest income		(31,414	)		(33,966	)		(34,210	)
Dividends received deduction		(1,704	)		(1,463	)		(1,689	)
State tax expense (benefit)		1,299			(3,580	)		3,688
Other, net		(31	)		5,364			641

Income tax expense	$	53,935		$	30,192		$	168,469

Deferred Income Taxes

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 used for income tax purposes. Realization of deferred tax assets is dependent on generating sufficient taxable income of an appropriate nature prior to their expiration. The Company believes it has the ability and intent, through the use of prudent tax planning strategies and the generation of capital gains, to generate income sufficient to avoid losing the benefits of its deferred tax assets. Significant components of the Company's net deferred tax assets and liabilities are as follows:


	December 31,
	2011			2010
	(Amounts in thousands)
Deferred tax assets:
20% of net unearned premium	$	61,039		$	60,473
Capital loss carryforward		7,108			14,718
Discounting of loss reserves and salvage and subrogation recoverable for tax purposes		15,034			15,843
Write-down of impaired investments		4,638			5,389
Tax credit carryforward		20,060			16,679
Expense accruals		11,632			14,467
Other deferred tax assets		3,568			4,337

Total gross deferred tax assets		123,079			131,906

Deferred tax liabilities:
Deferred acquisition costs		(60,000	)		(59,702	)
Tax liability on net unrealized gain on securities carried at fair value		(31,997	)		(18,808	)
Tax depreciation in excess of book depreciation		(15,164	)		(16,839	)
Undistributed earnings of insurance subsidiaries		(3,962	)		(4,447	)
Accounting method transition adjustments		0			(112	)
Tax amortization in excess of book amortization		(442	)		(24	)
Other deferred tax liabilities		(5,003	)		(5,475	)

Total gross deferred tax liabilities		(116,568	)		(105,407	)

Net deferred tax assets	$	6,511		$	26,499

The Company has a capital loss carryforward of $20.3 million which, if unused, will begin expiring in 2014.

Uncertainty in Income Taxes

The Company recognizes tax benefits related to positions taken, or expected to be taken, on a tax return once a "more-likely-than-not" threshold has been met. For a tax position that meets the recognition threshold, the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement is recognized in the financial statements.

There was a $0.7 million increase to the total amount of unrecognized tax benefits related to tax uncertainties during 2011. The increase was the result of tax positions taken based on management's best judgment given the facts, circumstances, and information available at the reporting date. The Company does not expect any further changes in such unrecognized tax benefits to have a significant impact on its consolidated financial statements within the next 12 months.

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states. Tax years that remain subject to examination by major taxing jurisdictions are 2005 through 2010 for federal taxes and 2003 through 2010 for California state taxes. Tax years 2005 through 2009 are currently under examination by the Internal Revenue Service.

The Company has been examined by the FTB for tax years 2003 through 2009. While the FTB has formally withdrawn the Notices of Proposed Assessment and closed its audit for tax years 2001 and 2002, it has issued Notices of Proposed Assessments to the Company for tax years 2003 through 2006. The Company has filed protests with the FTB in response to these assessments. In 2011, the FTB commenced its examination of tax years 2007 through 2009. Management believes that the resolution of these examinations and assessments will not have a material impact on the consolidated financial statements.

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


	2011			2010
	(Amounts in thousands)
Balance at January 1	$	3,823		$	6,666
Additions based on tax positions related to the current year		1,011			387
Reductions for tax positions of prior years		(267	)		(3,230	)

Balance at December 31	$	4,567		$	3,823

As presented above, the balances of unrecognized tax benefits were $4.6 million and $3.8 million at December 31, 2011 and 2010, respectively. Of these totals, $3.6 million and $3.0 million represent unrecognized tax benefits, net of federal tax benefit and accrued interest expense which, if recognized, would impact the Company's effective tax rate.

Management does not expect the Company's total amount of unrecognized tax benefits to materially increase within the next twelve months related to its ongoing California state tax apportionment factor issues.

The Company recognizes interest and penalties related to unrecognized tax benefits as a part of income taxes. During the years ended December 31, 2011, 2010, and 2009, the Company recognized net interest and penalty expense or (benefit), excluding refunds, of $106,000, ($872,000), and $266,000, respectively. The Company carried an accrued interest and penalty balance of $834,000 and $728,000 at December 31, 2011 and 2010, respectively.