Technical Line: Deferred acquisition costs

What you need to know

• Insurance companies’ deferrable acquisition costs are limited to costs directly related

to the successful acquisition of insurance contracts.

• Companies need to capture and analyze information to identify costs that meet the

definition of acquisition costs.

Overview

Under Accounting Standards Codification (ASC) 944-30,

insurance companies can capitalize

only the following costs related to the acquisition of new and renewal insurance contracts:

•

Incremental direct costs of a successful contract acquisition

•

Portions of employees’ salaries and benefits directly related to time spent performing

specified acquisition activities for a contract that has been acquired

•

Other costs directly related to the specified acquisition activities that would not have been

incurred had that acquisition contract transaction not occurred

The guidance was issued

by the Financial Accounting Standards Board (FASB) to address

concerns that insurance companies were capitalizing a wide range of costs when issuing or

renewing insurance contracts and that the types of costs being capitalized varied from

company to company. In addition, the Securities and Exchange Commission (SEC) staff had

questioned in particular the deferral of advertising and overhead costs.

No. 2011-04

Updated 12 April 2023

Technical Line

FASB — final guidance

Deferred acquisition costs —

less is more

In this issue:

Overview ............................ 1

Key amendments................ 2

Successful efforts ............. 2

Incremental direct costs .... 2

Salaries, benefits and

other costs directly

related to acquisition

activities ........................ 2

Advertising costs .............. 4

Non-deferrable costs......... 4

Appendix: Questions

and answers ..................... 5

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Technical Line

Deferred acquisition costs — less is more Updated 12 April 2023

The guidance was effective for fiscal years, and interim periods within those fiscal years,

beginning on or after 15 December 2011, through prospective or retrospective application. o

Key amendments

Successful efforts

Under the guidance, only acquisition costs resulting from the actual acquisition of a contract

(i.e., successful efforts) can be capitalized as deferred acquisition costs (DAC). Previously,

insurance companies may have capitalized certain costs relating to acquisition activities

(e.g., underwriting-related costs), regardless of whether a contract was acquired.

How we see it

The successful efforts concept results in fewer costs being capitalized than under previous

US GAAP. Companies need to track the time spent by employees on specified activities

associated with successful contract issuance, which requires effective analyses.

Incremental direct costs

Incremental direct costs result directly from and are essential to the contract transaction and

would not have been incurred by the insurance company had the transaction not occurred.

Examples of incremental direct costs subject to deferral include:

•

Employee, agent or broker commissions for successful contract acquisitions

•

Renewal commissions and bonuses to agents or brokers

•

Third-party medical or inspection fees for successful contract acquisitions

•

Premium-related taxes and assessments

This is not an all-inclusive list. A company should evaluate all costs it incurs when issuing a new

or renewal contract to determine whether the costs qualify for capitalization.

Salaries, benefits and other costs directly related to acquisition activities

Under the guidance, a company defers a portion of employees’ salaries and benefits relating

to defined acquisition activities that lead to the successful issuance or renewal of an insurance

contract (excluding incremental compensation).

Acquisition activities are defined as underwriting, contract issuance and processing activities,

medical and inspection activities and sales force contract selling.

Benefits include payroll-related fringe benefits, such as:

•

Payroll taxes

•

Dental and medical insurance

•

Group life insurance

•

Retirement plans

•

401(k) plans and stock compensation plans

•

Overtime meal allowances

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Technical Line

Deferred acquisition costs — less is more Updated 12 April 2023

A portion of total compensation of any employee who spends time approving successful

insurance contracts may be capitalized as DAC. To capitalize a portion of salaries and benefits

for executives and supervisors, two criteria are required to be met:

•

The employee has a direct role in acquisition activities

•

The activity is an essential activity resulting in the contract being issued

Illustration 1 — Deferrable compensation

Life Company A has established an underwriting approval authorization policy based on an

underwriter’s experience level and the size of the insurance contract.

Experience level

Authorization level

— Less than 1 year

up to $50,000 coverage

— 1 year through 5 years

up to $200,000 coverage

— Greater than 5 years

up to $500,000 coverage

Any contract greater than $500,000 requires approval from an underwriting vice president

(VP).

Any contract greater than $1,000,000 requires approval from the Contracts Approval

Committee.

Example 1: A $750,000 contract has been received, and Underwriter A, C and the VP

process and approve the contract for issuance.

A portion of whose salary and benefits should be included in the DAC?

Salaries and benefits relating to Underwriter A, C and the VP should be included in the

determination of DAC, because each of those employees had a direct role in the underwriting

process, and it was essential for all those levels to be included in the approval process.

Example 2: A $200,000 contract application has been received, and Underwriter B is

assigned to review and approve the contract. Underwriter B asks Underwriter C several

questions about the applicant’s medical history. Underwriter C assists Underwriter B with

determining questions to ask the applicant and whether the contract application should be

approved. The contract is ultimately approved. In addition, this contract was reviewed as

part of the monthly underwriting quality review process after it is issued.

A portion of whose salary and benefits should be included in the DAC?

Only a portion of Underwriter B’s salary and benefits would be included in the DAC.

Although Underwriter C assisted in the review of the contract, Underwriter C’s activities

were not essential to the contract’s issuance but were more supervisory in nature (their

approval was not required).

Should a portion of the salary and benefits of the person performing the monthly quality

review be included as DAC?

Costs related to the person performing the quality review should be expensed. Quality

reviews may be part of the underwriting department’s controls over appropriate contract

issuance, but they are not essential to contract acquisition.

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Deferred acquisition costs — less is more Updated 12 April 2023

Other costs directly related to the specified acquisition activities that would not have been

incurred had the contract not been issued also are deferrable (e.g., travel costs for employees

making onsite risk inspections).

Advertising costs

ASC 944-30 indicates that direct-response advertising costs should be capitalized only if the

following criteria are met:

•

The primary purpose of the advertising is to elicit sales to customers who could be shown

to have responded specifically to the advertising.

•

The direct-response advertising results in probable future benefits.

To capitalize direct-response advertising costs, the estimated future revenue attributable to a

specific advertisement has to be sufficient to recover the future costs incurred to realize those

revenues, including the deferrable advertising costs.

How we see it

ASC 944-30 intentionally established a high hurdle for the capitalization of direct-response

advertising costs. The direct-response advertising has to be aimed primarily at eliciting

sales from customers that can be shown to have responded to a specific advertisement.

In addition, a company has to demonstrate that the advertisement will result in probable

future benefits. Companies are required to maintain supporting documentation that identifies

the customer(s) and the specific advertisement that elicited the response to justify the

cost deferrals.

Non-deferrable costs

Costs that are considered indirect such as administrative costs, rent, depreciation, occupancy

and equipment costs and other general overhead costs are required to be expensed as incurred.

Costs related to a company’s administration system or data processing equipment, even if

dedicated to underwriting insurance contracts, do not qualify for capitalization but are

categorized as equipment costs because they would have been incurred regardless of

whether any contracts were issued.

All other acquisition-related costs, such as costs incurred by the insurer for soliciting potential

customers and for market research, training, administration, unsuccessful contract

acquisition efforts and product development, are charged to expense as incurred.

Endnotes:

_________________________

ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

ASC 944-30, Acquisition Costs

EY | Building a better working world

SCORE No. XXXXX-231US

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The t

ime that

supervisors and

executives spend

general supervision,

oversight or

training

of employees

are

considered indirect

costs and

thus

expensed as

incurred.

EY | Building a better working world

SCORE No. BB2102

(Updated 12 April 2023)

ey.com/en_us/assurance/accountinglink

EY exists to build a better working world, helping to create long-term value for clients, people and society and build trust in the capital markets.

Enabled by data and technology, diverse EY teams in over 150 countries provide trust through assurance and help clients grow, transform and operate.

Working across assurance, consulting, law, strategy, tax and transactions, EY teams ask better questions to find new answers for the complex issues facing

our world today.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited,

a UK company limited by guarantee, does not provide services to clients. Information about how EY collects and uses personal data and a description of the rights individuals have under data

protection legislation are available via ey.com/privacy. EY member firms do not practice law where prohibited by local laws. For more information about our organization, please visit ey.com.

Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US.

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Technical Line

Deferred acquisition costs — less is more Updated 12 April 2023

Appendix: Questions and answers

This appendix provides questions and interpretive responses on issues companies may

encounter when applying or considering the effect of the DAC guidance. The questions and

answers are grouped into the following categories:

•

Deferrable costs

•

Successful efforts

•

Advertising costs

•

Accounting policy election

Deferrable costs

Question 1 Is a company required to track costs at the contract level to determine what is deferrable?

No. The guidance does not specify how deferrable costs are determined, but rather what

costs should be deferred.

Companies need to have processes and systems in place that enable them to identify costs

that meet the direct, incremental and essential requirements of the guidance for each class of

business. In addition, companies need to have processes to determine potentially deferrable

acquisition costs relating to contracts that were actually issued. This could be accomplished by

tracking costs at the contract level, but we believe that other reasonable methods could be used.

Establishing a reasonable method of determining deferrable acquisition costs will be a matter

of judgment based on the characteristics of the specific contracts and costs in question.

Careful consideration should be given to factors such as the complexity of the underwriting

process, the nature of other underwriting costs and other factors distinguishing the relative

effort and costs for contracts accepted versus rejected.

For contract classes where the effort and relative costs are generally similar regardless of the

outcome, a process based on standard costs or applications processed and issued may be

appropriate. For classes of contracts where the underwriting effort and costs vary

significantly from contract to contract, it may be more appropriate to track time and costs at

the contract level.

No matter what method is used, a company should periodically analyze its continuing validity.

Question 2 How should a company account for costs incurred for pending contracts that have not yet

been acquired?

As discussed in the previous question, a company may track costs by using one of several

methods such as identifying costs at the contract level or using a reasonable estimate based

on standard costs or applications processed and issued. Regardless of the method used, a

company needs to assess whether contracts pending as of the balance sheet date are deemed

unsuccessful before its financial statements are issued.

If the company is tracking deferrable costs at the contract level, one approach is to

temporarily defer the costs incurred on all contracts in process in a suspense-like account

until either the contract is acquired or considered to be an unsuccessful effort.

When using this approach, the company expenses any temporarily deferred costs relating to

any contracts deemed unsuccessful after the balance sheet date but before the financial

statements are issued. This approach is consistent with the guidance for origination costs

incurred for loans in process.

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Deferred acquisition costs — less is more Updated 12 April 2023

Another approach is to estimate a successful efforts ratio and apply it to the costs incurred for

contracts in process. This approach would work when a company defers costs relating to a group

of contracts through an allocation method. A periodic reevaluation of the successful efforts ratio

is necessary to assess whether it accurately estimates costs that eventually are deferred.

Question 3 Are overriding or overwrite commissions paid to independent third parties deferrable?

Overriding or overwrite commissions are paid on sales someone else makes. They generally

are commissions paid to a broker, master general agent, general agent or another agent. For

example, a company may have an agent with a 5% commission. This person may have a manager

who receives 1% of the sales by all the people reporting to the manager as compensation. The

1% to the manager is an override.

When considering whether overriding commissions are deferrable, companies may analogize

to the FASB’s view

on overriding commissions contemplated for loan origination costs in

ASC 310-20. The FASB decided that loan origination costs incurred by the lender in transactions

with independent third parties should be deferred. The FASB noted that lenders would not be

in a position to determine the portion of time spent on each activity and therefore would be

unable to determine the specific amount of cost related to origination activities. Because of

that difficulty, as well as the presumption that costs paid to an independent third party represent

a reliable measure of the lender’s economic sacrifice to acquire a specific loan, the FASB

concluded that the costs should be deferred as incremental direct costs of loan origination.

In general, we expect overriding commissions paid to independent third parties to qualify for

capitalization since the commissions are incremental direct costs related to a successful

contract acquisition. However, a company should consider whether there are contracts or

agreements that state that the purpose of the overriding commission is to cover costs that

would not qualify for capitalization under the guidance (e.g., maintenance, overhead).

Question 4 Are bonuses payable upon achievement of selling a specified number of contracts or dollar

amounts of contracts deferrable?

Yes. Volume-related sales bonuses related to achieving a certain threshold of contracts or

dollar amounts of contracts meet the definition of incremental direct costs of contract

acquisitions. The bonus would not have been incurred had the contracts not been acquired

and are directly related to the sales of contracts.

Question 5 Are sales conference costs deferrable?

It depends. A company should use judgment in determining whether sales conference costs

meet the definition of incremental direct costs of contract acquisitions. For example, if sales

conferences are akin to volume-related bonuses, whereby sales agents who meet certain

sales thresholds are rewarded with all-expense paid trips instead of cash commissions, a

company may consider the cost to be deferrable.

Only the costs associated with the agents being rewarded are eligible for deferral. For

example, costs for airfare, meals and entertainment might be eligible for deferral, while other

costs, such as speaker fees, may be expensed as training costs. But if the sales conference is

not a reward, is for all sales agents and includes non-deferrable activities, we do not believe it

meets the requirements to be capitalized.

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Deferred acquisition costs — less is more Updated 12 April 2023

Question 6 Are premium-related taxes and assessments deferrable?

Yes. Premium taxes are payments to a state or municipality by an insurance company based

on premiums paid by resident contract holders. Premium taxes and certain premium-related

assessments qualify for capitalization because they result directly from the acquisition of a

contract and would not have been incurred had the contract not been acquired.

The guidance on deferrable acquisition costs does not affect ASC 944-30-25-5, which

addresses certain costs related to universal life-type products. Essentially, it provides that

costs such as recurring premium taxes and ultimate level commissions, which vary with

premium revenue, be charged to expense in the periods incurred.

Successful efforts

Question 7 Should a company consider free look provisions to determine when a contract is considered

successfully issued?

A free look provision is a period of time immediately following the issuance of an insurance

contract, generally between 10 and 30 days, during which a contract holder may legally

cancel a contract with a full refund. The free look period differs depending on the terms of the

insurance contract or the laws in a particular state.

Generally, for purposes of determining successful efforts, we believe that a contract that is

cancelled by the contract holder during the free look period would not be considered

successfully acquired. Therefore, a company should consider the duration of the free look

period and the likelihood of contract holders cancelling their policies during the free look

period to determine whether the free look provision could have a material effect on DAC.

Question 8 What should be considered when a company is determining the portion of salaries and benefits

related to time spent performing specified acquisition activities for successful contracts?

Companies should consider two main steps:

•

Determine the time spent on specific acquisition activities that would be considered

deferrable time

•

Determine and apply an appropriate successful efforts factor to the costs relating to the

deferrable time

Companies may perform surveys, time studies or other analyses to determine how

employees’ time is spent. Idle time and time spent on activities for which costs cannot be

deferred, regardless of successful or unsuccessful efforts, should be identified and excluded

from deferrable time spent. These adjustments might include holiday, vacation and sick time,

as well as training and general administrative time. Companies should assess the continued

appropriateness of how employees’ time is spent, including periodic updates to those surveys,

time studies or other analyses.

Once the pool of costs relating to the deferrable time has been identified, the company could

apply a ratio of number of successful contracts to total contracts (i.e., successful efforts factor).

After establishing the successful efforts factor, a company will need to periodically assess it to

determine whether it is still appropriate. We expect the factor to be assessed at least annually

and more frequently depending on sales seasonality or changes in products/processes.

Since there may be meaningful differences in the processes, systems and reporting for

different products or at different reporting locations, companies should determine multiple

successful efforts factors. For example, if a company has multiple locations, each location

may have different processes and spend a different amount of time on each contract.

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Companies also may consider different successful efforts factors because the steps that occur

earlier in the underwriting process may be assigned a lower successful efforts factor (e.g., the

person who processes the initial application likely touches fewer successful contracts than an

underwriter who reviews information after the medical inspection).

Advertising costs

Question 9 How does a company demonstrate that the primary purpose of a specific advertising

campaign is to elicit sales?

Companies are required to maintain supporting documentation that identifies the contract

holder(s) and the specific advertisement that elicited the response to justify the deferral of

the costs. Companies l need to determine that the advertising led directly to sales and was

not a general solicitation of individuals that required further sales efforts to complete the

contract issuance.

Examples of documentation that could link a customer response by name to a specific

advertisement include a coded order form, coupon, response card or phone log.

Question 10 How does a company demonstrate probable future benefits from direct-

response advertising?

Probable future benefits of direct-response advertising activities are probable future revenues

generated from a specific advertising campaign. The estimated future revenue attributable to

a specific advertisement has to be sufficient to recover the future costs to be incurred to

realize those revenues, as well as the advertising costs deferred.

Question 11 Can a company consider past advertising efforts to determine if current advertising for a

new product is eligible for capitalization as direct-response advertising?

Yes. However, to demonstrate such a benefit for new advertisements, a company needs to

have a reasonable basis, including persuasive evidence, for concluding that the effects of the

advertising costs incurred will be similar to those of past direct-response advertising that did

result in a future benefit. The company needs to have verifiable information that supports the

historical response rate.

Attributes to consider in determining whether responses to the new advertising will be similar

to the responses to the old advertising include:

•

Demographics of the audience

•

Method of advertising

•

Product being sold

•

Economic conditions

The evidence a company develops to support the future benefits of its direct-response

advertising costs has to be based on its own operating history. Response rates based on

industry statistics are not acceptable. A company marketing a new product can look at the

response rate on direct-response advertising for one of its other products, but only if it can

demonstrate that response rates for the two products are likely to be highly correlated.

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Accounting policy election

Question 12 Is a company required to capitalize all costs defined as deferrable under ASC 944-30?

No. ASC 944-30 contains an election that permits a company to continue using its current

accounting policy if it results in fewer costs being capitalized than under the guidance, provided

that all the costs currently capitalized by the company would qualify for capitalization under the

revised model.

For example, a company that currently defers minimal acquisition costs (e.g., a property and

casualty company that defers only commissions and premium taxes) may choose not to revise

its capitalization policy to defer additional costs relating to other direct costs or a portion of

employees’ salaries or benefits for qualifying acquisition activities.

Question 13 Is a company permitted to develop an accounting policy under which it would capitalize

only direct and incremental costs that can be easily identified with successful insurance

contract acquisitions and renewals?

It depends. As noted in the previous question, a company may retain its current accounting

policy if it results in fewer costs being capitalized than under the guidance, provided that the

costs qualify for deferral. However, the guidance states only companies that expense costs that

it defines as deferrable before implementing the guidance can expense those “types of costs”

after implementing it. Therefore, if a company has an existing deferral policy that includes

capitalizing certain salary-related underwriting costs, it would not be able to expense the

component of underwriting salaries that would qualify for deferral since it previously deferred

that type of cost. Judgment is required when determining what “types of costs” are deferred

under companies’ current accounting policies since the term is not defined in the guidance.

The questions and answers in this category pertain to companies that have not previously adopted US GAAP and are

now adopting this guidance.

Paragraph BC8 of the Basis for Conclusions for ASU 2010-26, Accounting for Costs Associated with Acquiring or

Renewing Insurance Contracts