CAS Sample #17
When calculating the FCF, we + (Deferred acquisition cost - Net of Cancellation) - (Deferred acquisition cost - Gross of Cancellation).
Is that step correct? I would have only added (Deferred acquisition cost - Net of Cancellation). For example if there is no cancellation, the terms above would cancel each other and it would not make sense to simply ignore DAC when calculating LRC.
Also, it seems that we do not discount DAC at all. For example, when we calculate the Future Acquisition cost, net, it is not discounted
Comments
Yes, so this is tricky - This is largely consistent with the sample GMA calculation provided by the CAS where DAC is also not included (Beyond the same adjustment we see here) so I do not think this is a mistake. In my mind, I would also include the DAC net of cancellations too as that's what is logical but this doesn't seem to be the case. I did some digging and looked at this article
So it seems like DAC is only considered at Initial recognition , which is why you see that future acquisition costs are included in the FCF but not DAC. I think this is the explanation for what is being showed here. As for why there we are adding the difference between net and gross DAC of cancellations, it is just to account for the fact that we don't expect to incur all of the expenses expected due to cancellations
Thanks for your response @Staff-T1.
If I understand what you are saying here, if we have no cancelation, then the DAC would not be part of the calculation at all (The above two terms cancel each other)? However, Future acquisition cost would still be included?
Yes. But also note the difference between groups in which future acquisition costs are considered and those where they are not. Future acquisition costs for the FCF are only considered for those policies where coverage has not yet been provided
could you explain the treatment of acquisition cost in FCF calculation? +DAC net of cancellation - DAC gross of cancellation + future AC net of cancellation
Why 1) net - gross?
2) future AC not deducted by "future AC gross of cancellation"?
This question is a carbon copy of the LRC example provided by the CAS.
1) You need to account for the fact there there are expected cancellations in the future, which means you have too much DAC if these cancellations are not accounted for.
2) My assumption is that those future acquisition costs are already an expected amount net of projected cancellations
Thanks for your explanation.
For the first one, I get it we need to account for future cancellations. So I was thinking "DAC net of cancellation" instead of "DAC net of cancellation - DAC gross of cancellation" why deducted by gross?
By taking out the entire net DAC, you are removing too much. You only want to remove the portion of DAC associated with the cancellations which is the difference between net and gross