The subsequent accounting for deferred acquisition costs (DAC), including the basis or method of DAC amortization, the amortization period, and recoverability assessment, is dependent on whether the contract is classified as short-duration, long-duration, or an investment contract. ASU 2018-12 does not change the subsequent accounting for DAC for short-duration contracts.

3.5.1 Short-duration contracts – subsequent accounting for DAC

Deferred acquisition costs (DAC) for short-duration contracts are required to be charged to expense in proportion to premium revenue recognized in accordance with ASC 944-30-35-1A. In practice, an insurer may accomplish this by calculating a ratio and applying this ratio to unearned premiums. This ratio, sometimes referred to as the “equity in unearned premiums” ratio, is computed as DAC divided by written premiums. ASC 944-30-35-2 indicates that if short-duration contract acquisition costs are determined based on a percentage relationship of costs incurred to premiums from contracts issued or renewed for a specified period, the percentage relationship and the period used, once determined, are required to be applied to applicable unearned premiums throughout the period of the contracts. Example IG 3-6 illustrates how this guidance could be applied in practice.
EXAMPLE IG 3-6
Amortization of short-duration DAC
On December 31, 20X1, Insurance Company has an unearned premium balance of \$300 and DAC balance of \$45 for a group of contracts (Grouping A). Insurance Company determines that qualifying acquisitions costs for deferral are 15% of written premium on January 1, 20X2 consistent with the previous period for Grouping A. On January 1, 20X2, new contracts are issued in Grouping A for a written premium of \$1,000.
At the end of the first quarter, Grouping A has an unearned premium balance of \$900.
How would Insurance Company derive the amount of ending DAC and related amortization for the first quarter for contract Grouping A?
Analysis
Insurance Company would calculate the ending DAC balance by multiply the period-end unearned premiums balance of \$900 by 15%, which is the percentage relationship of costs incurred to premiums for contracts issued or renewed for this grouping of contracts (resulting in DAC at period end of \$135).
To compute the amortization of deferred acquisitions costs to be recognized in current period earnings, Insurance Company would calculate the change in DAC. Acquisition costs deferred in the period were \$150 (written premium of \$1,000 X 15%). Therefore, the current period expense is \$60 (\$45 beginning balance, plus \$150 new DAC, less the ending balance of \$135).

In accordance with ASC 944-30-35-63, unamortized DAC for short-duration contracts are subject to premium deficiency testing in accordance with the provisions of ASC 944-60. See IG 7.2 for guidance on premium deficiency testing.

3.5.2 Long-duration contracts – subsequent accounting of DAC

The DAC amortization model for all insurance contracts classified as long duration is the same and impacts the following types of contracts, as noted in ASC 944-20-05-14 and further discussed in IG 2:
• Traditional fixed and variable annuity and life insurance contracts
• Universal life-type contracts
• Nontraditional fixed and variable annuity and life insurance contracts
• Participating life insurance contracts
• Group participating pension contracts
DAC is amortized on a straight-line basis over the expected term of the related contracts. No interest accrues on unamortized DAC. This is consistent with other industries’ amortization methods for deferred costs that are not measured using present value techniques. The principle is that deferred costs represent historical rather than future cash flows and therefore are not monetary items.
DAC is not subject to impairment testing. DAC is viewed similar to debt issuance costs, which are amortized over the debt term as part of the cost of funding and are not subject to impairment testing. Therefore, for traditional long-duration insurance contracts and limited-payment contracts, DAC balances are excluded from the net premium ratio. The premium deficiency test for other long-duration insurance contracts will also exclude the DAC balance. There is no separate DAC recoverability test for any type of investment contract.
There is no concept of “shadow DAC” adjustments recorded in AOCI as the amortization method is not impacted by realized gains and losses.

3.5.2.1 Long-duration contacts – method of DAC amortization

DAC is amortized to expense on a straight-line basis, either at the individual or grouped contract level over the expected term of the related contracts in accordance with ASC 944-30-35-3A. Contracts may be grouped as long as the amortization approximates straight-line amortization at an individual contract level. Contracts should be grouped consistent with the grouping used to estimate the liability for future policy benefits (or other related balances) for the corresponding contracts. The amortization method should be applied consistently over the expected term of the related contracts. If contracts within a group are different sizes, they may need to be weighted to achieve the straight-line pattern.
Question IG 3-5 addresses the DAC amortization on a group basis.
Question IG 3-5
How should an insurance entity evaluate if the grouped contract method "approximates" amortization at an individual contract level?
PwC response
The group level amortization method needs to create a “straight-line pattern” to meet the objective of amortizing the DAC over the expected life of the group. The amortization method needs to reflect (1) DAC as derecognized when a policy is no longer in force and (2) that contracts within a group may be of different sizes (e.g., face value or notional). The assumptions used in the amortization method need to be updated when the expected life of the group changes. An insurance entity is not required to demonstrate that the dollar amount of group basis amortization would be the same as on an individual contract basis. In fact, the amortization amount between the two bases is expected to be different when actual experience differs from expectations. This interpretation is consistent with the views expressed by the FASB staff on their November 2018 webcast, IN FOCUS: FASB Accounting Standards Update on Insurance.

The new guidance does not require a specific method to achieve the approximate straight-line amortization of grouped contracts. For example, while insurance in force may be an appropriate basis to weight contracts within a group for certain types of business (such as whole life and renewable term insurance), a different basis may be needed for other types of coverage, such as long-term care or when multiple in-force amounts are involved (such as additional accidental death benefits). However, under ASC 944-30-35-3A, amortization amounts are not permitted to be a function of revenue or profit emergence. The amortization method is required to be applied consistently over the expected term of the related contracts. All assumptions (e.g., terminations) should be consistent with those used to determine the liability for future policy benefits or related balances for the associated contracts.
Question IG 3-6 addresses if grouping is an entity-wide decision.
Question IG 3-6
Does grouping of policies versus individual policies (i.e., seriatim) for DAC amortization purposes need to be an entity-wide decision or can it vary by product or other level of grouping?
PwC response
The guidance requires that the amortization be charged to expense on a constant level basis (either grouped or individual) over the expected term. Grouping is allowed as long as it approximates straight-line amortization. ASC 944-30-35-3A notes that the method should be applied consistently over the term of the contracts. Therefore, the method should not be switched from seriatim to grouping (or vice versa) over the term of those contracts.

Question IG 3-7 addresses the DAC amortization on a group basis.
Question IG 3-7
What basis may be used to weight a group of universal life insurance policies when determining DAC amortization?
PwC response
DAC should be amortized on a straight-line basis (considering expected terminations). Therefore, any method that achieves that pattern would be acceptable. Net amount at risk, which would typically decrease over the life of a universal life product, and account balances that change with interest crediting and fees over the life of a contract would not be appropriate bases for weighting. Using premium deposits as a base may result in an acceptable approximation of the straight-line requirement.

ASC 944-30-35-3B requires that unamortized DAC be reduced for actual experience in excess of expected experience. As a result, contract terminations (e.g., due to lapse or death) would result in a write off of the DAC associated with the terminated contracts, causing an additional charge to income if terminations are more than what was assumed. Changes in future assumptions (e.g., about the expected duration of contracts or amount of coverage expected to be in force) are applied by adjusting the amortization rate prospectively rather than through a retrospective catch up adjustment.
Question IG 3-8 addresses updating the DAC amortization assumptions.
Question IG 3-8
Can an insurance entity update its DAC amortization for actual insurance in force changes in an interim period when such changes were not updated for the calculation of the liability for future policy benefits (i.e., updating the net premium ratio for the associated cohort)?
PwC response
Yes. DAC must be amortized using assumptions that are consistent with the related liability for future policy benefits. ASC 944-40-35-6 requires that the liability for future policy benefits be updated for actual experience at least on an annual basis and more frequently if cash flow assumptions are being updated. Cash flow assumptions need only be updated in interim reporting periods if evidence suggests that the assumptions should be revised. If an entity has determined that the actual experience incurred in the period was not significant enough to warrant an update to the net premium ratio, reflecting the actual insurance in force for the period within the DAC would not alter the decision that no update to the liability for future policy benefits was needed. If the entity chooses to update insurance in force for the insignificant change for DAC, it would not violate the principle that the assumptions be consistent between the two measurements as the differences in assumptions are insignificant.

DAC is amortized to expense on a straight-line basis, either at the individual or grouped contract level over the expected term of the related contracts. The expected term of the contract considers the entire accounting term of the contract in which there are contractual cash flows, including the period over which claims are expected to be paid. For example, this would include the claims settlement period for contracts such as long-term care or disability. Prior to ASU 2018-12 adoption, DAC is amortized in proportion to premium revenue recognized for traditional long-duration contracts such as these.
When determining the expected term of the accounting contracts for amortization of DAC relating to deferred annuity contracts, the payout phase should not be combined with the accumulation phase in accordance with ASC 944-30-35-3 because the payout phase is required to be accounted for as a separate contract if and when annuitization is elected. Therefore, only the expected term of the accumulation phase is considered for DAC amortization.
For immediate annuities, any DAC generated on the immediate annuity sale is amortized over the period in which annuity payments are expected to be made on a straight-line basis. Prior to ASU 2018-12, DAC related to immediate annuities is amortized in proportion to premium revenue recognized.
Question IG 3-9 addresses the DAC amortization contract period.
Question IG 3-9
For a contract with a GMWB feature, is the “expected term of the related contract(s)” noted in ASC 944-30-35-3A the term of the accounting contract or the legal contract?
PwC response
The “expected term of the related contract(s)” is referring to the accounting contract term. The guidance on liability valuation (ASC 944-40-35-8B) provides that upon extinguishment of the account balance (i.e., when the account balance goes to zero) for a GMWB feature, the related contract has ended for accounting purposes, even if the legal contract survives. That date marks the end of one accounting contract (the deferred annuity contract with an MRB recorded at fair value) and the beginning of a new contract (the payout annuity). The payout phase is viewed as a separate contract and is not combined with the accumulation phase, as noted in ASC 944-30-35-3. Therefore, the DAC should be amortized over the accounting contract term with no unamortized DAC remaining for policies in the payout annuity accounting contract.

Example 2 in ASC 944-30-55-7 illustrates the amortization method for a group of 5-year term products with \$80 of DAC when there are no expected terminations. Straight-line amortization results in \$16 of DAC being amortized in each of the 5 years. In Example IG 3-7, we have modified the ASC 944-30-55-7 example to assume a declining persistency rate. When terminations are expected, amortizing on a straight-line basis over the expected life of the group yields a declining amortization pattern as policies lapse, as illustrated in Example IG 3-7.
EXAMPLE IG 3-7
DAC amortization with a declining persistency rate
Insurance Company insures a group of long-duration guaranteed-renewable 5-year term life insurance products that are grouped and amortized in proportion to the amount of insurance in force with a declining persistency rate. The persistency rate assumption is expected to be 90% at 12/31/20X1, 80% at 12/31/20X2, 70% at 12/31/20X3, 60% at 12/31/20X4, and 0% at 12/31/20X5. In 20X1, \$80 of acquisition costs were deferred. This example assumes all lapses and deaths occur on the last day of the year.
For simplicity, it is assumed that the insurance entity has no interim reporting and issues only annual financial statements. If the entity instead issued quarterly financial statements, the beginning of the period would be the beginning of the current quarter for purposes of both the interim and annual financial statements.
How should Insurance Company calculate annual DAC amortization?
Analysis
Insurance Company should calculate annual amortization expense as follows. The adjusted face amounts at 12/31 of each year end are also the amounts at 1/1 of each succeeding year.
 Year Adjusted face amount (D) Annual amortization (D)*(C) DAC balance 1/1/20X1 \$1,000 \$0 \$80 12/31/20X1 900 20 60 12/31/20X2 800 18 42 12/31/20X3 700 16 26 12/31/20X4 600 14 12 12/31/20X5 0 12 0 Total units 4,000* (A) DAC \$80 (B) Amortization rate (B/A) = 2% (C) *4,000 represents the total beginning of 20X1 units (1,000) plus the ending units for years 20X1 through 20x5 (i.e., 1,000 + 900 + 800 + 700 + 600 + 0)

Example IG 3-8 demonstrates an acceptable method of recording the change in current period persistency and the impact on DAC expense.
EXAMPLE IG 3-8
Impact of a change in current period persistency and expected future persistency on DAC expense
Insurance Company insures a group of long-duration guaranteed-renewable 5-year term life insurance products that are grouped and amortized in proportion to the amount of insurance in force with a declining persistency rate. At inception of the block of contracts, the persistency rate assumption is expected to be 90% at 12/31/20X1, 80% at 12/31/20X2, 70% at 12/31/20X3, 60% at 12/31/20X4, and 0% at 12/31/20X5. In 20X1, \$80 of acquisition costs were deferred. However, actual terminations are in excess of those expected (60% of policies remain at the end of year 20X2 rather than expected persistency of 80%) and future expected persistency assumptions are revised for years 20X3 to 20X5 as shown below. Deaths and lapses are assumed to occur on the last day of the year.
For simplicity, it is assumed that the insurance entity has no interim reporting and issues only annual financial statements. If the entity instead issued quarterly financial statements, the beginning of the period would be the beginning of the current quarter for purposes of both the interim and annual financial statements.
How should Insurance Company calculate the impact on DAC expense of the actual experience in Year 2 and of future changes to persistency assumptions in Years 3-5?
Analysis
One approach that Insurance Company may adopt to calculate the impact on DAC of the actual experience different than expected and the annual amortization expense, consistent with the methodology used in Example 2 in ASC 944-30-55-7B, is as follows. The adjusted face amounts at 12/31 of each year end are also the amounts at 1/1 of each succeeding year.
 Year Adjusted face amount (D) Annual amortization (D)*(C) DAC balance 1/1/20X1 \$1,000 \$0 \$80 12/31/20X1 900 20 60 12/31/20X2 expected 800 18 42 12/31/20X2 actual 600 Experience adjustment *(\$42 X (800-600)/800) 10.5* 31.5 12/31/20X3 500 12.6 18.9 12/31/20X4 400 10.5 8.4 12/31/20X5 0 8.4 0 Total beginning and ending units in remaining years 20X3- 20X5 1,500** (A) Remaining DAC 1/1/20X3 31.5 (B) 20X3 Revised amortization rate (B/A) = 2.1% (C) **1,500 represents the total beginning of 20X3 units (600) plus the revised ending units for the remaining years 20X3 through 20x5 (i.e., 600 + 500 + 400 + 0).
Due to actual terminations in excess of those expected, an experience adjustment of \$10.5 is recorded in addition to the annual amortization of \$18. As illustrated, the amortization pattern is revised on a prospective basis beginning in year 20X3. This approach is consistent with the FASB illustration in Example 2 in ASC 944-30-55-7, which determines the current period amortization based on the beginning of the period estimates of persistency.

Other approaches may also be acceptable as long as they meet the FASB principle to approximate a seriatim straight-line basis, cannot have unamortized DAC remaining for policies that have terminated, and cannot recapture previously amortized DAC. For example, if an entity revises its estimates of persistency during the period, it may decide to calculate the current period’s amortization expense based on observed persistency in the current period reflecting the revised actual persistency in its current period amortization rate, as illustrated in Example IG 3-9.
Example IG 3-9 discusses an alternative acceptable method of recording the change in current period persistency and the impact on DAC expense.
EXAMPLE IG 3-9
Impact of a change in current period persistency and expected future persistency on DAC expense - Alternative acceptable method
Insurance Company insures a group of long-duration guaranteed-renewable 5-year term life insurance products that are grouped and amortized in proportion to the amount of insurance in force with a declining persistency rate. At inception of the block of contracts, the persistency rate assumption is expected to be 90% at 12/31/20X1, 80% at 12/31/20X2, 70% at 12/31/20X3, 60% at 12/31/20X4, and 0% at 12/31/20X5. In 20X1, \$80 of acquisition costs were deferred. However, actual terminations are in excess of those expected (60% of policies remain at the end of year 20X2 rather than expected persistency of 80%) and future expected persistency assumptions are revised for years 20X3 to 20X5 as shown below. Deaths and lapses are assumed to occur on the last day of the year.
Rather than follow the method illustrated in Example IG 3-8, Insurance Company may calculate the year 2 amortization expense based on observed persistency in the current period as follows. The adjusted face amounts at 12/31 of each year end are also the amounts at 1/1 of each succeeding year.
For simplicity, it is assumed that the insurance entity has no interim reporting and issues only annual financial statements. If the entity instead issued quarterly financial statements, the beginning of the period would be the beginning of the current quarter for purposes of both the interim and annual financial statements.
 Year Adjusted face amount (D) Annual amortization (D)*(C) DAC balance 1/1/20X1 \$1,000 \$0 \$80 12/31/20X1 900 20 60 12/31/20X2 expected 800 12/31/20X2 actual 600 22.5 37.5 12/31/20X3 500 15 22.5 12/31/20X4 400 12.5 10 12/31/20X5 0 10 0 Total beginning and ending units in remaining years 20X2-20X5 2,400* (A) Remaining DAC 1/1/20X2 60 (B) 20X2 Revised amortization rate (B/A) = 2.5% (C) *2,400 represents the total beginning of 20X2 units (900) plus the revised ending units for the remaining years 20X2 through 20X5 (i.e., 900 + 600 + 500 + 400 + 0).
This alternative approach determines the current period amortization based on the end of the period estimates of persistency. That is, unlike the approach shown in IG 3-8, under the alternative approach the units in the denominator of the allocation formula have been adjusted to reflect known changes in persistency during the current year (from 800 to 600) as well as the decreased persistency expected for future periods (from 700 and 600 down to 500 and 400). As such, no separate experience adjustment is recorded as the amortization pattern is revised on a prospective basis at the beginning of the period based on the period’s actual experience. Under this approach, Insurance Company would utilize known information and current best estimates at the end of the period for purposes of calculating the current period DAC amortization.
The current period amortization rate would take into account all adjustments for changes in actual and expected persistency including (1) experience variances (i.e., the difference between expected and actual terminations) on current period amortization, (2) the resulting impact on future in force (i.e., the impact of what happened in the current period on remaining periods), and (3) the impact of any future persistency assumption change (i.e., the update of future projections).

Question IG 3-10 discusses whether the estimate of persistency should be the same for all products.
Question IG 3-10
May an entity determine the current period DAC amortization based on the beginning of the period estimate of persistency for some products, but use an end of the period estimate of persistency for other products?
PwC response
Example 2 in ASC 944-30-55-7 illustrates an approach that determines the current period DAC amortization based on the beginning of the period estimates of persistency. However as noted in Example IG 3-9, there is an alternative acceptable approach to calculate DAC amortization in the current period taking into account the actual persistency observed in the current period. The selection of a beginning of the period or end of the period approach is an accounting policy choice that should be applied on a consistent basis to similar transactions. Amortization including or excluding actual persistency in the period is an allocation methodology that would typically be unaffected by different product provisions, and therefore, we expect an entity to have a consistent policy for all its long-duration products that are subject to the DAC guidance.

3.5.3 Investment contracts – subsequent accounting for DAC

ASU 2018-12 simplified the DAC amortization model for certain investment contracts. See IG 2.5.1 for guidance on the classification of investment contracts. Investment contracts that have significant surrender charges or that yield significant revenues from sources other than the investment of contract holders’ funds will follow the new DAC amortization guidance in ASC 944-30-35-3 through ASC 944-30-35-3C (discussed in IG 3.5.2.1). However, the new guidance does not apply to certain other investment contracts accounted for as interest bearing or other financial instruments, as noted in ASC 944-825-25.
The assessment of the significance of the surrender charges and/or other sources of revenue other than the investment of contract holders’ funds is a matter of judgment. If the surrender charges are similar in effect to banks' and other financial institutions' "early withdrawal penalties" for certificate of deposits (CDs) or other time deposits, the charges should be accounted for in a manner similar to banks' accounting for early withdrawal penalties. However, if the surrender charges have a greater effect than early withdrawal penalties on the revenue anticipated to recover acquisition costs, they are more similar to surrender charges on universal life-type insurance contracts than to banks' early withdrawal penalties. Different types of investment contracts issued by one company may fall into either category. Consideration should be given to the period during which the charges may be imposed; early withdrawal penalties normally apply to the entire life of a CD, while insurance contract surrender charges normally phase-out over a stated time period. Consideration should also be given to the economic effects of the surrender charge.

3.5.3.1 Other investment contacts – method of DAC amortization

Other investment contracts that (1) do not include significant surrender charges and (2) the investment of contract holders’ funds are the only significance source of revenue, are accounted for interest bearing or other financial instruments. Accordingly, as required by ASC 944-30-35-20, deferred acquisition costs for these other investment contracts should be amortized using the interest method under ASC 310-20 (effective yield method). The incidence of surrenders can be anticipated for purposes of determining the amortization period if the surrenders are probable and can be reasonably estimated and the rate of amortization is adjusted for changes in the incidence of surrenders consistent with the handling of principal prepayments under ASC 310-20. The objective of the interest method is to arrive at periodic interest income, net of fees and costs, that reflects a constant effective yield on the net policy liabilities.

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