Definition — What DAC (Deferred Acquisition Costs) means
– Deferred acquisition costs (DAC) are acquisition-related expenses that an insurance company records as an asset instead of expensing immediately. These costs are then recognized as expenses over the related insurance contract’s life so that costs are matched with the revenues they help produce.
Why insurers use DAC
– Writing new policies often requires large up-front spending (e.g., commissions to agents or brokers, underwriting and medical exams). In many contracts early premium receipts are small relative to those initial outlays. Capitalizing qualifying acquisition costs prevents a heavy expense spike in the first year and produces smoother reported earnings over the policy term.
Typical items that insurers may defer
– Sales commissions paid to distributors or brokers
– Underwriting-related costs (e.g., medical exams, policy issue costs)
– Other incremental costs directly tied to obtaining a contract
How DAC is reported and recognized
– On the balance sheet: DAC appears as an intangible or deferred asset.
– On the income statement: DAC is reduced over time through amortization (the process of converting the asset into expense).
– Amortization must follow an established basis; under U.S. GAAP the Financial Accounting Standards Board (FASB) requires amortization on a “constant level” pattern over the expected term of the contracts.
– If an insurance contract terminates unexpectedly, remaining DAC related to that contract is written off (removed), rather than undergoing a periodic impairment test.
Rules and standard-setting background (short)
– Historically, the line between expense and deferrable DAC was imprecise, which led to inconsistent practices. FASB clarified the criteria in Accounting Standards Update (ASU) 2010-26, tightening when acquisition costs can be capitalized and how they are amortized