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13.8 SAP for deferred acquisition costs
Publication date: 31 Jan 2021
us Insurance guide
Under SSAP 71, deferred acquisition costs (DAC) are expensed as incurred as period costs.
SAP generally allows companies to recognize commission income received under reinsurance contracts immediately to the extent it does not exceed the acquisition costs incurred. The excess ceded commission income for both proportional and nonproportional contracts is required to be deferred and a liability equal to the difference between the anticipated acquisition costs and the reinsurance commissions received recognized in the statutory-basis financial statements.
As a result, several questions have arisen with regard to:
- what constitutes the "anticipated acquisition cost" of the business ceded (acquisition costs are defined in SSAP 71)?
- what ceding commission rate (or amount) should be used to determine the liability established when the ceding commission is determined via a function of the experience under the reinsurance contract (such as a sliding scale commission rate or contingent profit provision)?
- whether the wording "to be amortized pro rata over the life of the reinsurance agreement" means to be amortized over the period during which the reinsurance premium is earned, or whether it means something else (such as when losses are ultimately paid), and whether there should be a difference if contingent ceding commissions are involved.
Acquisition costs to be included in the calculation should meet the definition of acquisition costs per SSAP 71. This definition differs from the GAAP definition of deferred acquisition costs under ASC 944-30. Under SAP, costs incurred to acquire new or to renew insurance contracts and costs that vary with and are related to the insurance contracts qualify to be included. Common examples of qualifying acquisition costs include agent and broker commissions, certain underwriting and policy issue costs, and medical and inspection fees.
With respect to the commission rate to be used in the calculation for the "excess ceding commission," the company should use its best estimate of the ceding commission at inception of the reinsurance contract.
SSAP 62R, Property and Casualty Reinsurance, paragraph 55, clarifies that the amortization period for excess ceding commissions is "over the effective period of the reinsurance contract in proportion to the amount of coverage provided under the reinsurance agreement."
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