From Bloomberg:
How many legs would a calf have if we called its tail a leg?Four, of course. Calling a tail a leg wouldn’t make it a leg, as Abraham Lincoln famously said.
Nor does calling an expense an asset make it an asset. This brings us to the odd accounting rules for the insurance industry, including Lincoln National Corp., which uses Honest Abe as its corporate mascot.
Look at the asset side of Lincoln National’s balance sheet, and you’ll see a $10.5 billion item called “deferred acquisition costs,” without which the company’s shareholder equity of $9.1 billion would disappear. The figure also is larger than the company’s stock-market value, now at $7 billion.
These costs are just that -- costs. They include sales commissions and other expenses related to acquiring and renewing customers’ insurance-policy contracts. At most companies, such costs would have to be recorded as expenses when they are incurred, hitting earnings immediately.
Because it’s an insurance company selling policies that may last a long time, however, Lincoln is allowed to put them on its books as an asset and write them down slowly -- over periods as long as 30 years in some cases -- under a decades-old set of accounting rules written exclusively for the industry.
Rule Overhaul
Those days may be numbered, under a unanimous decision in May by the U.S. Financial Accounting Standards Board that has received little attention in the press. The board is scheduled to release a proposal during the fourth quarter to overhaul its rules for insurance contracts. If all goes according to plan, insurers no longer would be allowed to defer policy-acquisition costs and treat them as assets.
One question the board hasn’t addressed yet is what to do with the deferred acquisition costs, or DAC, already on companies’ books. While there’s been no decision on that point, it stands to reason that insurers probably would have to write them off, reducing shareholder equity. The board already has decided such costs aren’t an asset and should be expensed. If that holds, it wouldn’t make sense to let companies keep their existing DAC intact.
The impact of such a change would be huge. A few examples: As of June 30, Hartford Financial Services Group Inc. showed DAC of $11.8 billion, which represented 88 percent of its shareholder equity, or assets minus liabilities. By comparison, the company’s stock-market value is just $7.3 billion....MORE
