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					International Financial Reporting for Insurers

             August 27-29, 2012

                 Hong Kong

              Acquisition Costs


                Peter Duran
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Acquisition Costs

Insurance IFRS Seminar
Hong Kong, August 27, 2012
    g    g, g       ,
Peter Duran
                                                                          Session 11




Agenda
   Definition
   Successful vs. unsuccessful sales
   Relief from acquisition costs
   Implications



Note
Text in gray boxes at the bottom of the slides contain updates from recent IASB/FASB
  joint board meetings since the Exposure Draft




                                             2




                                                                                       1
Definition of acquisition costs
     Acquisition costs were defined in the proposal as the direct and indirect costs of
      selling, underwriting and initiating an insurance contract
     Incremental acquisition costs were defined in the proposal as:
        • The costs of selling, underwriting and initiating an insurance contract that would
                                                                                contract,
           not have been incurred if the insurer had not issued that particular contract but
           no other direct and indirect costs.
        • These costs were to be identified at the level of an individual insurance contract

                      Decisions/Commentary since Exposure Draft
 In June 2011 both Boards agreed that only direct costs should be treated as acquisition
  costs
 Disagreement remains between the Boards on inclusion of unsuccessful sales efforts
     FASB – include only costs associated with successful sales
     IASB – include unsuccessful sales costs on a portfolio basis
 Building block 1 should exclude indirect costs such as:
     - Software dedicated to contract acquisition - Rent and occupancy - Utilities
     - Equipment maintenance and depreciation - Administration             - Advertising
     - Agent and sales staff recruiting and training - Other general overheads



                                                 3




Illustrative impact of successful vs.
unsuccessful sales
     An insurer incurs direct sales-related expenses of $400,000 for portfolio of contracts
     80% of sales efforts are successful
                       $100,000
      Commissions are $100 000 for portfolio of contracts
     Advertising expenses are $125,000

                                          IASB                         FASB
                                 Deferred     Expensed        Deferred       Expensed
     Sales-related                400,000               0       320,000          80,000
     Advertising                          0      125,000                 0      125,000
     Commissions                 $100,000               0      $100,000                 0
     Total                       $500,000        125,000       $420,000         205,000




                                                 4




                                                                                               2
   Treatment of acquisition costs
         Acquisition costs are considered policy cash flows.
         As such they serve to reduce the PV (fulfillment cash flows) as at the issue date, i.e.
          making it more negative than if they were no considered.
         Hence the residual margin is larger than if acquisition costs were not considered
         The ff t i t d f          i iti      t
          Th effect is to defer acquisition costs

     More acquisition cost  more negative PV0(fulfillment cash flows)  higher residual
     margin at issue  more profits to be released



                           Decisions/Commentary since Exposure Draft
    FASB has reconsidered the decision to include acquisition costs in the policy cash flows.
     They now prefer that an explicit DAC be established as an asset.
    This means that the single margin would be a balancing item between the premium less
     acquisition costs and PV0(fulfillment cash flows)




                                                    5




Illustrative example of relief from acquisition costs
(Assume single premium payout annuity for 10 years)
                     Company        Company                              Company         Company
Time = 0                A              B            Time = 1                A               B
Premium                  100            100         Premium                   0               0
Incremental                                         Incremental
Acquisition Costs         10              0         Acquisition Costs         0               0
Non-incremental                                     Non-incremental
Acquisition Costs         0              10         Acquisition Costs         0               0
Total Benefit             60             60         Total Benefit             54             54
Risk Adjustment           10             10         Risk Adjustment           9               9
Current                                             Current
Fulfillment Value        -20             -30        Fulfillment Value         63             63
Residual Margin           20             30         Residual Margin           18             27
Total Liability            0              0         Total Liability           81             90
                       Relief of $9 results from $10 expenses incremental



                                                    6




                                                                                                    3
Illustrative example of relief from acquisition costs
(Assume single premium payout annuity for 10 years)
    Statement of comprehensive income                    Company A          Company B
    Underwriting margin
       Change in risk adjustment                               1                   1
       Release of residual margin                              2                   3


    Losses at initial recognition of an insurance
    contract                                                   0                   0


    Non-incremental acquisition costs                          0                  -10


    Investment income – net                                    4                   4


    Net income before tax                                      7                  -2




                                                    7




  Implications
      The narrow definition of acquisition costs and the role that directly attributable and
       incremental costs will play in the new model may require adjustments in some
       insurer’s expense allocation systems
      Changes to general ledgers and underlying accounting systems will be needed to
       accommodate the new requirements.
      Actuaries need to develop actuarial assumptions for successful contracts?
      Increased use of predictive modeling to reduce unsuccessful sales activity?




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