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Companies Start To Feel Toll Of New FASB Rule on DAC

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A new accounting requirement affecting treatment of deferred acquisition costs will be costing insurance companies millions of dollars, according to quarterly earnings reports.

Two major life insurers, Lincoln Financial Group, Philadelphia, and The Hartford, Hartford, Conn., addressed the cost in earnings releases.

Effective Jan. 1, 2007, companies are required to comply with Statement of Position 05-1 adopted by the Financial Accounting Standards Board, Norwalk, Conn.

SOP 05-1, Accounting by Insurance Enterprises for Deferred Acquisition costs in Connection with Modifications or Exchanges of Insurance Contracts, was adopted by the FASB on Jan. 30 in a 4-3 vote. The SOP is retroactive to Jan. 1, 2007.

The SOP addresses how DAC and the value of business acquired should be treated. Costs for contracts are spread out over the life of a policy, but SOP 05-01 specifically addresses internal replacement of life insurance contracts.

Lincoln Financial says the adoption of SOP 05-1 impacts lapsation assumptions used in the amortization of DAC and the value of business acquired on certain blocks of business. Consequently, according to Lincoln Financial, it is estimated that DAC and VOBA assets will be reduced by between $75 million and $100 million, pre-tax. The deduction will be taken from retained earnings with no impact on net income or income from operations.

Lincoln Financial also says that in 2007, SOP 05-01 is expected to have an impact of an additional DAC and VOBA amortization of $15 million to $20 million, pre-tax. The impact will largely be in the individual annuities and group protection businesses. This estimation is based on the assumption that replacement activity as defined under SOP 05-1 is comparable to recent years, Lincoln Financial says.

In its Jan. 25 earnings report, The Hartford notes that the estimated after-tax expense of the adoption of SOP 05-01 will range from $15 million to $25 million during 2007. The company says this estimate assumes that exchange activity will be comparable to previous years.

In addition, according to information provided by Dave Potter, a company spokesman, SOP 05-01 will result in an after-tax estimated cumulative effect adjustment of between $50 million and $65 million, which will be recorded as a reduction to retained earnings as of Jan. 1, 2007. There will be no impact on net income or core earnings.

The impact on variable annuities, according to Hartford information provided by Potter, will have “relatively little impact” because “The Hartford historically has experienced very little replacement activity. If this low level of exchange activity continues, there is going to be little impact from SOP 05-01.”

The group benefits business, according to The Hartford, accounts for “the majority of the expense.” The company says it expects that SOP 05-01 “will require us to amortize the cost of these policies over 1 to 3 years instead of 5 years.”

The action will come at great cost to the industry both in terms of money and systems implementation, according to Douglas Barnert of Barnert Associates, New York. “Theoretical concepts rather than practicality” is being given consideration, according to Barnert.