Which types of business is DAC normally applied on?

[loadingr]

Is it that DAC normally only applied on Non-profit business but not on With-profit business? I saw DAC as an important part in the NP reporting but not in the WP reporting in practice. Anyone knows why?

Many thanks!

 

[Mike Lewry]

It makes sense for a DAC to be created wherever the uneven incidence of expenses is not dealt with appropriately by the reserving method used, eg a non-Zillmerised net premium valuation method. In theory, this could be used for either NP or WP business.

By contrast, a gross premium valuation method takes credit for future premiums, including the part designed to recoup initial expenses and so there's no obvious need for a DAC in this case. However, I understand you might still see a DAC in such cases - perhaps to counteract the prudence in the valuation basis? Does anyone have experience of this?

 

[dok87]

I do not have experience with DAC but just want to give some underlying background which may be of interest and useful.

DAC is a result of accounting standard - IAS 38: Intangible Assets

General Business perspective:
Consider a business, say drug manufacturer, which incurs significant development costs that leads to successful launch of a drug. We can think of the development cost as an “asset” in that if not incurred then the launch does not happen and no future sales.

The accounting principle for treating such a cost is that, it could be capitalised as an Intangible Asset (similar to goodwill, patent, copyright etc.) and then amortised (written-down) over a reasonable period – similar to recognising an asset in the balance sheet and depreciating it over time into the income statement.

Long-term Insurance Business Perspective:
Initial cost of writing new business is similar to development cost in the above example. However, the above treatment is less familiar to us (actuaries/students) because it’s accounting. Actuarial does it the more actuarial way (below).

Conflict between Accounting and Actuarial
Generally speaking it is worth noting that an item could be treated in one of the following two ways to broadly same effect on the balance sheet over the long-term, but not the short-term:

(a) capitalised as an asset and amortised into income statement over time as in IAS38 above, or
(b) “reserved for as a liability and released into income statement”.

(a)- leans towards accruals concept and is more concerned about short-term distortions and volatility whilst (b) leans towards prudence concept and concerned about the long-term.

It is the latter, (b), which actuarial does in most cases including FSA basis, which is no surprise.

If, however, an appropriate reserving method/basis (e.g. Gross Premium valuation) is adopted in (b) then short-term implications of the two approaches on income statement could be close. This is when no DAC is necessary as Mike clearly explains.

In contrast, for any insurance business written, where accountants are not happy that our long-term view is conflicting with their view (usually the short term) - that is to say if the reserving approach in (b) isn’t dealing with the cost properly, hence creating short term distortions and/or volatility, then they over-write ours to adopt (a) instead. This is the basis of needing DAC.

This probably digresses from your original question but hopefully it gives more background.

Regards