DAC

[Roto]

What the hell is this?

I've been aware of its existence for awhile... I understand the concept that it is a mechanism to spread the acquisition costs associated with a new contract over a long period of time.

What I don't understand is that DAC represents acquisition costs that are capitalized at issue. I think my basic problem in life right now is that I don't know what it means to Capitalize ____ . Insert whatever word you like (e.g. "DAC")

I think we need to know a little bit about this concept because the DACAmort(t) is a component of PreTaxStockEarn(t).

Could someone please explain this concept (in particular capitalization) like you would to your grandmother (unless gramma is an actuary)?

[inexactuary]

The concept of DAC is is where you set up an asset in the amount of your deferrable acquisition costs (this is what it means to capitalize). It is not like a normal asset that is invested, it is just an accounting mechanism. Over time, the asset decreases to zero according to the accounting rules of the contract. The decrease in the asset decreases your earnings in that period (just like reserve increases decrease earnings), so it is in that way that you are recognizing the expense. The concepts of reserves, DAC, and deferred taxes are all related. They are all mechanisms to adjust the timing of earnings so the pattern is more reasonable. Death benefits and taxes are more heavily weighted in later durations, so reserves and the deferred tax liability are used to shift earnings in the early years out to the later years. Acquisition costs are the opposite, since they are all weighted up front. The DAC asset is used to increase earnings in the first year while decreasing earnings in later years when the expenses are lower.

Hopefully I haven't confused you more than you were before.

[Swan]

What the hell is this?
It's an acquisition cost that is capitalized over time.

I've been aware of its existence for awhile... I understand the concept that it is a mechanism to spread the acquisition costs associated with a new contract over a long period of time.

What I don't understand is that DAC represents acquisition costs that are capitalized at issue. I think my basic problem in life right now is that I don't know what it means to Capitalize ____ . Insert whatever word you like (e.g. "DAC")
To capitalize X means to capitalize the expenditures related to purchasing (or, say, upgrading) an asset X. You do this when the asset in question has a useful life that is longer than the current year (or accounting period). Accounting rules do not allow you to claim the entire costs associated with the asset in the year that it was purchased (or upgraded). They must be spread out over the useful life of the asset (or some arbitrary period, as in the case of the DAC).

In the case where X = DAC, then it doesn't make much sense to talk about capitalizing DAC, because DAC is not an asset. Rather, the insurance product that was sold (for which acquisition costs were incurred in the process) is the asset. Nevertheless, same principle: these acquisition costs must be recognized, and -- because the useful life of the asset (in this case, the insurance product) extends over a longer period than the current year -- must be capitalized, i.e., spread out into the future.

Here's how it's done:

The company sets up a phantom asset -- let's call it the DAC asset -- that, say, has a value of $100, and includes it in its taxable earnings for the current year. Thus, in the first year, the company ends up paying higher taxes, since it has increased its tax base by 100.

But then the company sort of makes up for this by "capitalizing" this $100 (over, say, a 10-year period) -- by reducing its taxable earnings by $10 every year for the next 10 years.

The end result (since 10 x 10 = exactly 100) is something of an interest-free loan to the gummit.

Damn gummit! :evil:

[rekrap]

Could someone please explain this concept (in particular capitalization) like you would to your grandmother (unless gramma is an actuary)?

Hopefully I haven't confused you more than you were before.

It's an acquisition cost that is capitalized over time.

Damn gummit! :evil:

Let me try a haiku for you:

Capitalize means
expense becomes an asset;
DAC is an expense.

[wat?]

And for the record, the DAC, as is being discussed here, along with the discussion of amortizing the cost and holding the present value as an asset, has almost nothing to do with the DACTax that's discussed at the end of the Taxes chapter (chap. 9?) in LIPF. The LIPF text discusses this DACTax that uses seemingly arbitrary figures of 7.7% of Life insurance premium, 2.0% of group life premium (I'm probably getting it wrong, I don't have the text in front of me) and other additional taxes applied, which are then amortized over 10 years.

At least, that's how it was explained to me when I first took Course 5. The DAC that's popular in GAAP and valuation is not the same as this DACTax we run into.

[inexactuary]

I think the reason for the name is that it follows the same pattern as the DAC asset because it increases taxable earnings in the first year and decreases in the following years.

[rekrap]

At least, that's how it was explained to me when I first took Course 5. The DAC that's popular in GAAP and valuation is not the same as this DACTax we run into.

Are you talking about this thread (http://www.actuarialoutpost.com/actuarial_discussion_forum/showthread.php?t=37518)?

[wat?]

Are you talking about this thread (http://www.actuarialoutpost.com/actuarial_discussion_forum/showthread.php?t=37518)?

rekrap does it again, with the recollection abilities of an elephant.

[inexactuary]

Yep, the most I can hope to be is the guy people turn to for help when rekrap is on the can.