Cross-cutting issues involving other accounting rules appear to be impeding the Financial Accounting Standards Board and the International Accounting Standards Board from wrapping up discussions on how acquisition costs will be accounted for under an insurance contracts standard.

The accounting of acquisition costs is important to insurers because they incur costs in acquiring and originating insurance contracts and these costs can be very high at contract inception.

The boards May 24 redeliberated on the issue of how an insurer should account for the cash flows relating to the recovery of acquisition costs in the building block approach, including the presentation of information about those cash flows but did not conclude discussions on the topic which will continue in July. Suggestions included:

• Record it as an asset and amortize it over time;
• Include it as part of the margin but only then recognize that net margin in the income statements;
• Gross up the income statements; expense the amortized cost;
• Recognize it as one amount in the balance sheet (no differentiation) and recognize premium in the income statement for the amount of asset point in time when the costs are actually incurred; and
• Include it all as one balance sheet item but don't recognize it when the costs are incurred but rather recognize it in some other fashion.

Among issues that prevented the boards from moving forward in deliberations included current revenue recognition standard being developed, according to comments made by board members. Specifically, the implication that acquisition costs meet the criteria for an asset—one that raises issues of inconsistency within the insurance contracts discussions.

Some board members said that acquisition costs should be dealt with consistently among accounting standards—pointing out that it was on the table for review. "I don't think we can answer the expense of an asset until we talk about revenue recognition," said FABB member Russell Golden. "…..it seems like if we're going to go down the [asset] route we ought to decide if it's an asset for all or an expense [but we] cannot decide today. Today we can decide do you want these in the margin or do you want these out of the margin," he said.

Resolve Premiums.

There are other issues, including guidance under U.S. GAAP to be considered to ensure consistency—that are also cross-cutting. Within the insurance industry direct acquisition costs (DAC) were always accounted for as an asset (basically allowing certain costs to acquire the business to be accounted for an asset). In the U.S. however—effective this year—there was a change in what could be included in that asset and what would be required to be expensed.

The guidance, ASU No. 2010-26, Accounting for Costs Associated With Originating or Renewing Service Contracts, amends the guidance for insurance entities that apply the industry-specific guidance in ASC 944-30. It narrows the types of acquisition costs that can be deferred by insurers.

Another issue stems from the accounting guidance under FASB Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases. This indicates that an entity's origination costs of a loan is the same as its acquisition cost (when it looks at what can be included in its origination cost).

Those issues aside, some IASB members said the boards' first need to resolve issues surrounding premiums within the insurance contracts discussions before deciding on acquisition costs.

The issue was all about presentation and is therefore linked very closely with premiums, said IASB member Stephen Cooper.

"We haven't taken a decision yet about premiums," said Cooper. "Strikes me that the answer depends upon that decision; how can we make a decision on this before we can make a decision about premiums. It seems to me the only other question we can answer is whether you want an asset or not—can't answer any of the other questions," he said.

Proposed Alternatives.

The staff paper included the following as potential approaches (as written in the board handout) for the boards to consider:

• Alternative A: an approach which recognizes the right to recover acquisition costs as an asset.
• Alternative B: an approach which includes acquisition costs in the cash flows used to determine the margin and which would require an insurer to recognize a reduction in the margin when the acquisition costs are incurred, with no effect in the statement of comprehensive income. The acquisition costs would be shown net against the residual/single margin and allocated to profit or loss in the same way as the single/residual margin. Changes in the insurance contract liability arising from acquisition costs would be shown with the release of margin and not as changes in the cash flows. This is a variant of FASB's view in developing the 2010 discussion paper.
• Alternative C: an approach which includes acquisition costs in the cash flows used to determine the margin and would require an insurer to expense the acquisition costs and recognize income equal to, and offsetting, those costs when the acquisition costs are incurred. Changes in the insurance contract liability arising from acquisition costs would be shown in the same way as change in the cash flows. This alternative is consistent with the IASB's view in developing its 2010 exposure draft.

The IASB completely ruled out ever voting for Alternative A and the FASB completely ruled out ever voting for Alternative C.

Potential Solution.

In fact, all three alternatives were potentially problematic. "If we have premiums written I think C is the only way to do it B doesn't make any sense, said Cooper. "If we're going to have premiums earned neither of them make any sense," he said.

He stated moreover that the problem with "C" is that "you have day revenue when you've done nothing—that doesn't make any sense…problem with B is your revenue is less than the premiums you actually receive—and you have no expense."

One potential solution, said Cooper, would be a combination of B and C. "In fact you can get the same as alternative B under the premium allocation approach model or what Jennifer [Weiner] was getting at with the gross up but I would then still have an element of C which would be how you would measure the liability in the first place…so…none of the approaches I don't think work with an earned premium," he said.

In the final wrap up the boards appeared to be willing to tentatively lean (though no formal vote was taken)—for the sake of convergence—towards an approach which includes acquisition costs in the cash flows used to determine the margin and which would require an insurer to recognize a reduction in the margin when the acquisition costs are incurred, with no effect in the statement of comprehensive income (Alternative B).

Based on a board handout, the acquisition costs would be shown net against the residual/single margin and allocated to profit or loss in the same way as the single/residual margin. Changes in the insurance contract liability arising from acquisition costs would be shown with the release of margin and not as changes in the cash flows.

Another alternative?

There is still one potential path for the boards to follow—as suggested by IASB member, Jan Engstro¨m, who threw out a challenge to the boards to sum up the discussions and move ahead to seek for ways to field test the issue.

"Put them into a real life experience to get at the profit and loss statement; [the] balance sheet, [some] disclosures, and for us to see what is this nice animal that we are building," said Engstro¨m. "[And present it to non-insurance analysts]—and say lets discuss this [because] I think this starts to be really ugly," he stated.

Engstrom's viewpoint was not completely dismissed by other board members—in fact aspects were touted as positive. "It presents on the balance sheet a number that people look at," said FASB member Lawrence Smith.

Smith however also added that the boards would end up losing information that analysts are focusing on by going through some of the other suggested approaches without coming up with appropriate disclosures or supplemental displays on the balance sheet.

He stated moreover that in addition to the consistency with the revenue recognition decision "and some other decisions that our predecessors have made over the years in terms of what can be reported as an asset there's an important aspect of what users are going to be looking at that we ought to consider before we just quash it."

Users are interested in how much insurers spend to acquire contracts as a percentage of premium, staff members said. In addition, they also compare acquisition costs to the number of new contracts enforced to determine how efficient the insurer is in spending money to acquire new contracts. Moreover, they pay attention to when acquisition costs are written off.

By Denise Lugo
Staff Correspondent