The Financial Statement Effects of Proposed Changes to the Accounting for Deferred Acquisition Costs in the Insurance Industry

The Financial Accounting Standards Board (FASB) is currently evaluating proposed changes to the manner in which insurance companies account for, and currently capitalise, the costs of selling and initiating insurance contracts. Our study examines the potential effects of these proposed changes on total assets, shareholders' equity, financial leverage and pre-tax income. We include a total of 28 companies with market caps in excess of $3 billion in our sample and use information provided in their 2008 and 2007 10-K annual filings to the Securities and Exchange Commission (SEC).We find that as a result of capitalisation, companies hold on average 4.41 per cent of total assets and 32.65 per cent of shareholders' equity in the form of deferred acquisition costs. If the firms in our sample were forced to write off their deferred acquisition costs, the accompanying reduction in shareholders' equity would increase their average ratio of liabilities to shareholders' equity, a common balance sheet measure of financial leverage, from 9.88 to 63.91. Such an increase in leverage could potentially hurt their credit ratings and put pressure on the firms to raise equity. We also find that pre-tax income would be impacted by the proposed changes. Depending on amounts capitalised relative to amounts amortised, some firms would see declines in pre-tax income of 20 per cent or more, while others would see similar increases. Investors and accounting regulators, including the FASB and the International Accounting Standards Board (IASB), will want to take note of these findings