Revenue Offset Understanding
Is the following the correct understanding of revenue offset? Sorry if this seems redundant but it helps to put it in my own words and write out how I think about it.
Acquisition costs are not deferred and instead are incurred at the onset of the policy, which in the text example is a $20 loss. Since this is a loss, typically a company could claim a tax credit on the loss. Instead what is done is 20% of UEP is moved to Earned Premium and that 20% is not taxed. So while the loss itself doesn’t receive a tax credit, this is made up for in moving 20% of UEP directly to EP untaxed.
Is this correct?
Comments
I'm not sure what you wrote is exactly right.
The way I understand it is that the revenue-offset is a substitute for deferring acquisition costs. The effect of the revenue-offset may not quite equal the effect of deferring acquisition costs but it's considered close enough. Deferring acquisition costs makes sense because it matches revenue and expenses. When they can't be deferred, revenue and expenses are no longer matched so the revenue-offset procedure tries to "correct" this mismatch.
This helps a lot, thank you!
Agreed, that was a very helpful explanation!
I was able to follow everything up to the last bullet point as my head was stuck with the TBI formula presented in the wiki that equals to TBEP + InvInc - TBIL and wondering where the heck is reducing taxable income by acquisition costs comes into play here to offset the early recognition of it in EP.
Then I finally got my head around it that the above formula is just based on past exam problems and the real-life TBI calculation would also include the deduction of U/W expense, where acquisition costs belong to. So in the end, this increase in taxable income would be cancelled out.
Am I understanding this correctly now?
Yes, correct.
If insurers recognize acquisition cost immediately which reduces their taxable income, why would they get a tax refund only later?
Tax refunds are not related to tax-based income calculation. Where do you find it said that they get a tax refund only later?