Conclusions and Implications
Insurance acquisition costs in the United States are capitalized–amortized when directly related to the sales volume of insurance policies, but in practice, are often expensed. We hypothesize that even though the expensed commissions may not be attributable to an individual policy, they are directly related to the generation of premiums at least at the portfolio level. Usually, the payment of such commissions is designed to maintain the premium inflows from existing policies as well as to promote the development of long-term customer relationships and the generation of future policies.
Based on data from U.S. stock insurance firms from 1995 to 2012, we assess the relative explanatory powers of accounting metrics when DAC is capitalized–amortized (as compared with when it is directly expensed), and the Vuong’s Z-statistic confirms that the current capitalization–amortization method of DAC provides more informative metrics than the direct-expensing method. Second, the currently directly expensed commissions are converted into capital assets based on the amortization schedule derived from the Almon lag procedure. Then, using the Ohlson model, we find robust evidence showing that (a) both DAC and the as-if asset balances of directly expensed commissions are positively related to the equity market value, and the difference in their coefficients is weakly significant. (b) DAC amortization is negatively associated with the market value, while the reported directly expensed commissions show an insignificant coefficient, implying that the immediate expensing treatment may not be appropriate for valuation purposes. Additional analyses indicate that both the coefficients on DAC and the as-if asset balance of directly expensed commissions are positively related to subsequent earned premiums, while the coefficient on DAC is slightly larger than that of the as-if asset balance of expensed commissions. Meanwhile, the coefficient on the as-if asset balance of expensed commissions is ‘‘less negative’’ than that of DAC in explaining the volatility of subsequent premiums, suggesting that the economic benefits from DAC are more stable than those from directly expensed commissions. In brief, the empirical results are consistent with the directly expensed insurance commissions contributing to the generation of subsequent economic benefits.
