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Deferred Acquisition Cost
(Section 848)
PDF Version
The National Alliance of Life Companies (NALC) is a national
trade association of more than 250 life and health insurance companies which do
business in all 50 states and the District of Columbia. Smaller insurance
companies suffer under the current system of taxation; specifically, the
following tax provision.
The Deferred Acquisition Cost (DAC Tax), was intended to act
as a proxy for amortization of a portion of acquisition costs. Congress
determined that a certain percentage of net premiums must be amortized for
either 60 or 120 months, depending on the size of the company. This differs
greatly from the method of accounting utilized by state regulators, which
requires accounting on a modified cash basis. Statutory accounting is a modified
cash basis of accounting. Expenses are written off when paid, whether the asset
is admitted or not. For instance, computer software is an example of a
non-admitted asset in most states.
The DAC Tax does not allow insurers to deduct expenses
incurred in putting business on the books, even though the expenses are actual.
These expenses often exceed the premiums paid in the early years of a policy.
Therefore, insurers are taxed on the premiums paid before any profits are made.
This is a phantom tax on nonexistent money. The formula artificially inflates
the taxable income of insurers for the current year by deferring expenses to
future years. In theory, after an insurer starts to recoup the deferred
expenses, a credit is issued toward the current year’s tax bill, which is
inflated as a result of the current year’s DAC. However, the only way for the
insurer to even approach break even is to stop growing. Otherwise, the
dissipation of surplus restricts an insurer’s ability to write new business
and it reduces funds needed for product development.
The impact of this growth-inhibiting, regressive tax on
smaller companies is dramatic. This tax policy has disproportionately retarded
the growth of the smaller insurers. These companies have the ability and need
for greater growth than the larger companies. While larger companies, which have
mature surpluses, may opt for a slow growth or no-growth strategy in order to
counter the effects of the DAC Tax, this option is not available to smaller
companies. In fact, some small companies are paying Federal Income Tax well in
excess of 100% of statutory income.
Small insurance companies have traditionally been the leaders
in product innovation in the marketplace. These companies have filled the niche
markets and forged new channels of distribution that larger companies have not
traditionally pursued. These niche products are vital to many consumers,
particularly those who can afford only modest coverages to protect their
families from loss. The small insurers are traditionally family run companies
which do not lay off workers to trim budgets. As small as they are, they may
even be the largest employer in the town in which they are located. These
smaller companies should be encouraged by Federal tax policy to strengthen their
balance sheets by the growth of their businesses, rather than being prohibited
from doing so by the continued application of this regressive taxation.
The removal of the DAC Tax burden from these insurers will
save jobs, and encourage real growth for the first time since the imposition of
this burden. Therefore, over time, the relief would actually be revenue
positive, which would have the additional benefit of saving, as well as creating
jobs for Americans.
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