Certain acquisition costs should not be capitalized (refer to ASC 944-30-25-4). They should instead be considered as maintenance or other period costs, and should be expensed as incurred. For example, trail commissions that are calculated as a percent of account balance rather than based on new premium deposits are typically not deferrable. In addition, the amortization basis for universal life-type contracts differs from the methods used for other long-duration contracts. Deferred acquisition costs for universal life-type contracts are to be amortized over the life of a book of business at a constant rate, based on the present value of estimated gross profits (EGPs) for the book. The discount rate to be used is the “contract rate,” which is defined as the rate of interest that accrues to policyholder account balances. For some products, such as variable annuities which also offer general account options, there is diversity in practice in terms of using the general account rate, the expected separate account return, or a blended rate. Interest will accrue to the unamortized balance of DAC at the same rate. If significant negative gross profits are expected in any period, another base for amortization must be selected: gross revenues (contract charges), gross costs, or insurance in force.

When an entity switches from amortizing DAC based on EGPs to another base, the issue arises as to whether the change should be adopted on a retrospective or a prospective basis. AICPA Audit and Accounting Guide Life and Health Insurance Entities section 9.76 notes that: "A change in the basis for amortizing DAC that is required as a result of significant unanticipated negative gross profits involves a change in the method of applying an accounting principle. However, because the cumulative effect attributable to the change in accounting principle cannot be separated from the current or future effects of the change in estimate, the change is reported as a change in accounting estimate, as defined by the FASB ASC glossary. Following the change, the new basis of amortization should be consistently applied in future periods."

Estimated gross profits are based upon the best estimate of the following elements, without provision for adverse deviation:

The guidance does not explicitly mention whether the cost of reinsurance, including reinsurance recoveries, should be included in estimated gross profits. One acceptable view is that purchased reinsurance is akin to an investment. Under this view, the premiums and reimbursements over the life of the reinsurance contract coverage would be components in estimated gross profits. Another acceptable view is that reinsurance is separate from the direct contracts and should be excluded from EGPs.

Estimates of gross profits are to be periodically reviewed and, when the estimates change, inception to date amortization should be adjusted to reflect the amortization that would have been recorded had the revised estimates been in place. For most companies, these estimates should be evaluated at each reporting period for significant changes in key elements of the gross profits calculation, such as a change in interest rates credited to policyholders. GAAP guidance for long-duration contracts does not specifically address the appropriate disclosures when an adjustment is made to DAC. However, the disclosure guidance for "changes in estimates" would normally apply (refer to ASC 250, Accounting Changes and Error Corrections).

In accordance with ASC 944-30-35-7, a company is allowed to make a binding election for the method of choosing the discount rate to use in a revised present value of estimated gross profits calculation. A company can either "lock in" the discount rate (i.e., always use the rate in effect at the inception of the book) or "prospectively float" the rate (i.e., use the latest rate for the book). If a company chooses to have the rate float, the revised rate is only applied to the discount of remaining gross profits; gross profits already earned are discounted at the rate in effect when they were earned. This is appropriate, since interest was accrued to the unamortized DAC balance in those prior periods at such rate.

We can expect to encounter varying degrees of sophistication in the calculation of estimated gross profits. We should determine that the methods used are consistent with the objective of amortizing the deferred policy acquisition costs based on the present value of the expected profit sources of the company's products.

Unamortized DAC relating to traditional insurance contracts in force that are replaced with universal life-type contracts ("internal replacements") are to be written off, as required by ASC 944-30-25-11. The acquisition costs associated with the replacement contract would be deferred and amortized according to the criteria and methods described above.