New Accounting Rules Could Affect DAC Application

A change in how companies account for their deferred acquisition costs will probably have a greater impact on life and health insurers than property and casualty carriers and will not affect companies' bottom lines, a new report said.

In its weekly credit outlook, Moody's Rating Service said the U.S. Financial Accounting Standards Board (FASB) issued a draft proposal to change the way insurance companies account for deferred acquisition costs (DAC). These are the costs insurers incur in the acquisition or renewal of insurance contracts.

The previous language gave a broad definition for DAC with the phrase "vary with and are primarily related to" the acquisition of insurance contracts.

The current draft, which is still subject to change by the FASB, narrows what insurers can include in their DAC calculations. Under the draft proposal, the revised standard would limit DAC to:

o Successfully acquired new and renewal business.

o Incremental direct costs that result directly from the acquisition of the business and would not have been incurred by the carrier if the contact had not been acquired.

o Costs for underwriting, policy issuance and processing, medical and inspection, and contact selling.

Other costs that in the past were placed under DAC would have to be charged to expense as incurred.

Moody's said life insurers and insurers with a combination of life and p&c business capitalize a wide array of costs, including advertising, marketing and underwriting costs. By contrast, Moody's said, p&c companies are much more conservative in their approach.

Wallace Enman, vice president-senior accounting analyst, said in his analysis that if the new standards are adopted and go into effect with the first quarter of 2012, they would result in "higher incurred underwriting expense in the near term" but would "not affect the underlying economics of the industry."

However, for those that aggressively applied the more liberal interpretation of DAC rules, the change "could affect our view of quality of historic earnings and capital."

Among the p&c insurers with the highest DAC assets relative to the firm's business as compared to unearned premium reserve, Moody's listed Unitrin at 72 percent, Assurant at 49 percent, and CNA Financial at 34 percent.

On the low side, Progressive was at less than 10 percent, Travelers was at 16 percent, and Liberty Mutual was at 20 percent.

Mr. Enman noted that actual impact would depend on the company's capitalization process and that some would be unaffected by the accounting change.