DAC

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• Jon Lavi F.I.A.,F.Il.A.A.
• Israel Association of Actuaries
• Course 8/3/2005

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Introduction and Description

• Pre-1999 Statutory type system with Zillmerised
  Net Premium Reserves
• Accounting system for Life Insurance changed from
  1999
• One set of accounts to be produced to serve both
  Regulatory and Profit reporting purposes
• Inspiration for Deferred Acquisition Costs from
  US GAAP
• Existing gross reserves unchanged
• Mandatory deferred of acquisition costs
  creation of DAC asset.
• Designed to give fairer picture of profit
  emergence

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Application of the new system

• Expenses to be deferred supervisors
  instructions
• amounts involved in the production of new
  policies (eg commissions, underwriting and
  marketing expenses and management and general
  expenses originating in the production of new
  policies)
• Definitely includes
• Direct agents and supervisors commissions
• Direct sales underwriting expenses
• Differences of interpretation between companies
  re allocation of non-direct expenses,
  advertising, management overheads etc.

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Introduction and Description

• 2 method of depreciation -gt 2 DAC assets
• Book DAC for reported profits depreciation
  over 15 years from policy commencement
• Tax DAC / Stat DAC for tax and adopted for
  solvency purposes depreciation over 4 years
  from incurral of expense
• DAC written off on lapse
• Difference between Book DAC Tax DAC
• 45 to Deferred Tax Reserve
• 55 unrecognised asset i.e. added to minimum
  solvency margin requirement
• Only tax TAC could be held against life
  insurance liabilities

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Example 1 PL
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Example 1 Balance Sheet
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Application of the new system

• Supervisor left choice between application per
  policy or by broad model by main plan type
• In practice wide range of methods in use,
  including both of above and combinations of them,
  and additionally by model-office software
• DAC Recoverability Actuary must certify that DAC
  is recoverable from future margins. The
  Supervisor gave no indication of basis to be
  used, so the IAA produced guidance note. De facto
  gross premium cash flow valuation

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Introduction and Description

• Treatment of net reserve less than zero or
  surrender value
• Managers Insurance which has high guaranteed
  surrender values on leaving work reserve
  increased for partial cover of guaranteed SV
• Other business excess DAC disallowed as asset
  against Life Insurance liabilities ie have to
  find real assets to cover SV. Excess DAC can be
  held against minimum solvency requirement, but
  considered illiquid asset.

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Example 2 Balance sheet
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Application of the new system

• Same logic applied by supervisor to Unit Linked
  plan with reduced initial allocation. Despite
  good match between income acquisitions
  expenses, initial income creates Unearned Revenue
  Liability (URL), written down over period of DAC
• URL was not raised for 2004 products allocation
  rates were more level than previous products

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Profit
As a result 4 different measures of profit
Suppose P profit in ??? ???? ????? ???? before
DAC Then P1 ???? ???? ???? ????? ???? ???? ??
P ?bookdac P2 ???? ????? ?? P
?taxdac P3 net profit reported profit less
tax less increase in deferred tax reserve P1
0.45P2 0.45?(bookdac taxdac), and since
?(bookdac taxdac) ?bookdac ?taxdac P1
P2 P1 0.45P2 0.45(P1 P2) 0.55P1 P4
statutory profit distributable profit
net profit less change in unadmitted asset P3
0.55?(bookdac taxdac) 0.55P1 0.55(P1
P2) 0.55P2
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Profit Emergence
Comparison of Profit Emergence under different
systems for one years business
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Profit Emergence
Difference in Profit Emergence between old new
systems
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Criticisms

• No coherent philosophy
• Removed DAC from context and imposed it on
  existing Net Premium Reserves
• Uneven incidence of initial expenses in profit
  and loss account
• Lack of consistency and comparability between
  companies
• No restatement of previous business
• Negative reserve or reserve less than SV
• Part of supervisors plan to put pressure on
  commissions, but in practice enabled increase in
  commission.

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Effect on Results

• Effect of DAC (cumulative)
• DAC asset
• Less extra reserve for SV guarantee
• Less Zillmer on previous basis
• In 1999 (first full year) Industry reported life
  profits increased from NIS 695m to NIS 1,504m
• Of this NIS 388m due to DAC

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Changes in 2004

• DAC introduced for Health Business
• 6 year depreciation period
• Life DAC Solvency Requirement
• 100 of DAC from new policies
• 100 DAC from 2005 deposits from old policies
• Approaching 85 of old DAC from old policies
• New DAC cannot be held against life insurance
  liabilities

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Example 2004 balance sheet
Example shows increased financing from
shareholders of 283 loss before DAC 200
taxation 45 38 DAC 385 less net profit 102
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Changes in 2004 - Implications

• "???? ??? ??????? ??"
• "???? ??? ????? ????? ??"
• Company records full acquisition expense but pays
  tax as if expense were deferred
• Would prefer no DAC
• Logical conclusion of DAC process companies
  punished for paying acquisition costs
• Change in commission patterns in industry lower
  upfront commissions, more level commissions
• Can still pay initial commissions, but actuary
  must price taking account of cost of solvency
  capital.

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Thank You