DAC is amortized to expense on a straight-line basis, either at the individual or grouped contract level over the expected term of the related contracts.
The expected term of the contract considers the entire accounting term of the contract in which there are contractual cash flows, including the period over which claims are expected to be paid. For example, this would include the claims settlement period for contracts such as long-term care or disability.
Prior to ASU adoption, DAC is amortized in proportion to premium revenue recognized for traditional long-duration contracts such as these. When determining the expected term of the accounting contracts for amortization of DAC relating to deferred annuity contracts, the payout phase should not be combined with the accumulation phase in accordance with ASC because the payout phase is required to be accounted for as a separate contract if and when annuitization is elected. Therefore, only the expected term of the accumulation phase is considered for DAC amortization.
For immediate annuities, any DAC generated on the immediate annuity sale is amortized over the period in which annuity payments are expected to be made on a straight-line basis.
The guidance on liability valuation ASC B provides that upon extinguishment of the account balance i. That date marks the end of one accounting contract the deferred annuity contract with an MRB recorded at fair value and the beginning of a new contract the payout annuity. The payout phase is viewed as a separate contract and is not combined with the accumulation phase, as noted in ASC Therefore, the DAC should be amortized over the accounting contract term with no unamortized DAC remaining for policies in the payout annuity accounting contract.
When terminations are expected, amortizing on a straight-line basis over the expected life of the group yields a declining amortization pattern as policies lapse, as illustrated in Example IG Insurance Company insures a group of long-duration guaranteed-renewable 5-year term life insurance products that are grouped and amortized in proportion to the amount of insurance in force with a declining persistency rate. This example assumes all lapses and deaths occur on the last day of the year.
For simplicity, it is assumed that the insurance entity has no interim reporting and issues only annual financial statements. If the entity instead issued quarterly financial statements, the beginning of the period would be the beginning of the current quarter for purposes of both the interim and annual financial statements.
Insurance Company should calculate annual amortization expense as follows. Adjusted face amount D. Total units. Example IG demonstrates an acceptable method of recording the change in current period persistency and the impact on DAC expense. Deaths and lapses are assumed to occur on the last day of the year. How should Insurance Company calculate the impact on DAC expense of the actual experience in Year 2 and of future changes to persistency assumptions in Years ?
One approach that Insurance Company may adopt to calculate the impact on DAC of the actual experience different than expected and the annual amortization expense, consistent with the methodology used in Example 2 in ASC B , is as follows. DAC balance. Total beginning and ending units in remaining years 20X3- 20X5. As illustrated, the amortization pattern is revised on a prospective basis beginning in year 20X3.
This approach is consistent with the FASB illustration in Example 2 in ASC , which determines the current period amortization based on the beginning of the period estimates of persistency. Other approaches may also be acceptable as long as they meet the FASB principle to approximate a seriatim straight-line basis, cannot have unamortized DAC remaining for policies that have terminated, and cannot recapture previously amortized DAC.
Example IG discusses an alternative acceptable method of recording the change in current period persistency and the impact on DAC expense. Rather than follow the method illustrated in Example IG , Insurance Company may calculate the year 2 amortization expense based on observed persistency in the current period as follows.
Total beginning and ending units in remaining years 20XX5. This alternative approach determines the current period amortization based on the end of the period estimates of persistency. That is, unlike the approach shown in IG , under the alternative approach the units in the denominator of the allocation formula have been adjusted to reflect known changes in persistency during the current year from to as well as the decreased persistency expected for future periods from and down to and Under this approach, Insurance Company would utilize known information and current best estimates at the end of the period for purposes of calculating the current period DAC amortization.
The current period amortization rate would take into account all adjustments for changes in actual and expected persistency including 1 experience variances i. Question IG discusses whether the estimate of persistency should be the same for all products. Question IG May an entity determine the current period DAC amortization based on the beginning of the period estimate of persistency for some products, but use an end of the period estimate of persistency for other products?
Example 2 in ASC illustrates an approach that determines the current period DAC amortization based on the beginning of the period estimates of persistency. However as noted in Example IG , there is an alternative acceptable approach to calculate DAC amortization in the current period taking into account the actual persistency observed in the current period. The selection of a beginning of the period or end of the period approach is an accounting policy choice that should be applied on a consistent basis to similar transactions.
Amortization including or excluding actual persistency in the period is an allocation methodology that would typically be unaffected by different product provisions, and therefore, we expect an entity to have a consistent policy for all its long-duration products that are subject to the DAC guidance.
See IG 2. However, the new guidance does not apply to certain other investment contracts accounted for as interest bearing or other financial instruments, as noted in ASC If the surrender charges are similar in effect to banks' and other financial institutions' "early withdrawal penalties" for certificate of deposits CDs or other time deposits, the charges should be accounted for in a manner similar to banks' accounting for early withdrawal penalties.
However, if the surrender charges have a greater effect than early withdrawal penalties on the revenue anticipated to recover acquisition costs, they are more similar to surrender charges on universal life-type insurance contracts than to banks' early withdrawal penalties. Different types of investment contracts issued by one company may fall into either category. Consideration should be given to the period during which the charges may be imposed; early withdrawal penalties normally apply to the entire life of a CD, while insurance contract surrender charges normally phase-out over a stated time period.
Consideration should also be given to the economic effects of the surrender charge. Accordingly, as required by ASC , deferred acquisition costs for these other investment contracts should be amortized using the interest method under ASC effective yield method.
The incidence of surrenders can be anticipated for purposes of determining the amortization period if the surrenders are probable and can be reasonably estimated and the rate of amortization is adjusted for changes in the incidence of surrenders consistent with the handling of principal prepayments under ASC The objective of the interest method is to arrive at periodic interest income, net of fees and costs, that reflects a constant effective yield on the net policy liabilities.
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Resend activation Please enter the email address you registered with us. Select personalised content. Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Your Money. Personal Finance. Your Practice. Popular Courses. Personal Finance Insurance. Key Takeaways Deferred acquisition costs DAC is an accounting method that is applicable in the insurance industry.
Using this accounting method tends to reduce the first-year strain of policy and produces a smoother pattern of earnings. Companies may only defer costs associated with the successful placement of new business and cannot amortize all back-office expenses.
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Investopedia does not include all offers available in the marketplace. A regulatory asset is a specific cost of service recovery that a regulatory agency permits a U. What is an Adjusting Journal Entry? An adjusting journal entry occurs at the end of a reporting period to record any unrecognized income or expenses for the period. Policy Year Experience Policy year experience describes the relationship between the premiums and losses of an insurance underwriter within a given time period.
Capitalization Definition Capitalization is an accounting method in which a cost is included in the value of an asset and expensed over the useful life of that asset. What Is a Liability? A liability is something a person or company owes, usually a sum of money.
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