2019 Spring Q14C
If there is a decrease in DPAE, then shouldn't the expenses on the financial sheet also decrease since the purpose of DPAE is to recognize prepaid expenses?
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If there is a decrease in DPAE, then shouldn't the expenses on the financial sheet also decrease since the purpose of DPAE is to recognize prepaid expenses?
Comments
Hi,
This is not necessarily true. As an example, DPAE could decrease if your ELR in the future period increases, while your expenses remain the same.
Referring to the example in this exam directly, DPAE calculated by the actuary will decrease as expenses increase because higher expenses will lead to lower equity in the UEP. (recall how expenses are handled in the DPAE calculation, your high DPAE from accounting will be capped by the DPAE calculated by the AA)
"shouldn't the expenses on the financial sheet also decrease since the purpose of DPAE is to recognize prepaid expenses?" I think theoretically you can make this argument.
DPAE = Min(DPAE from accounting, Equity in UEP)
If expenses decrease, it is possible that DPAE from accounting will decrease, while Equity in the UEP will increase.
I would assume that properly phrased, you could make an argument here.
I'm still confused with this question. If the DPAE decreases, then there is more premium acquisition recognized in the current period. (This is due to a decrease in the expenses). So far so good.
However, if more premium acquisition is recognized, then why does the net income decrease?
Shouldn't the net income increase if there is more premium recognized since a part of the formula for net income is NEP - NET CAE?
Your initial premise is not correct. A decrease in DPAE does NOT guarantee a decrease in Expenses.
To your next point, it's not premium acquisition but premium acquisition expenses that are being recognized. The only purpose of a DPAE is to add an asset to the balance sheet to account for expenses that we have prepaid but want to amortize through the life of the policy. Think about this -> A DPAE decrease means I am recognizing MORE of the prepaid expense in a period. How does that impact your net income?