COMPARISON OF ACCOUNTING FRAMEWORKS Flashcards
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
KEY CONCEPTS OF ACCOUNTING FRAMEWORKS
- Liquidation vs going concern – users
• Liquidation/run-off view => regulators
• Ongoing business view => investors - Fair value vs historical cost – value
• Fair value – value traded in open market
(+) accurate; consistent with market value
• Historical cost = depreciated cost
(+) reliable; objectively verifiable - Principle vs rule-based – interpretation of input
• Principle – users need to interpret
(+) adaptable to business changes
• Rule – specific guidance users must follow
(+) easier to interpret, audit, compare against competitors
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
ACCOUNTING FRAMEWORKS
- Generally accepted accounting principles (GAAP)
• For all companies - Statutory accounting principles (SAP)
• Insurance companies only
• More conservative to protect insureds - International financial reporting standards (IFRS)
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
FOCUS
• GAAP: measuring earning emergence o Income statement o Going-concern basis • SAP: insurer’s ability to pay claims (PHS adequacy) o Balance sheet o liquidity • IFRS:
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
RESERVES
- GAAP: gross of reinsurance
- SAP: net of reinsurance
- IFRS:
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
PREMIUM
- GAAP: earned over duration of contract
- SAP: earned over duration of contract
- IFRS: recognizes PV of all premium as soon as contract is signed (even before effective date)
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
ACQUISITION COSTS
- GAAP: deferred (DAC) to match EP
- SAP: expensed as incurred (no DAC) – unable to get “unearned” acquisition cost back in liquidation
- IFRS: recognizes PV of all expenses as soon as contract is signed (even before effective date)
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
NON-ADMITTED ASSETS
- GAAP: N/A
- SAP: exclude value of highly illiquid assets (furniture, fixtures, equipment)
- IFRS:
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
DEFERRED TAX ASSETS (DTA)
• Temporary difference between accounting and tax treatment of assets and liabilities
• GAAP: fully recognized
o If unlikely that DTA will be recognized, a valuation allowance is created
• SAP: strict admissibility test to recognize DTA in addition to valuation allowance
o Include valuation allowance if it is expected to be reversed in the coming year
• IFRS:
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
INVESTED ASSETS
• GAAP:
o Available for sale = fair value
o Held for trading = fair value
o Held to maturity = amortized cost
• SAP:
o Investment-grade bonds & higher-rated redeemable stocks = amortized cost
o Lower-rated bonds & preferred stocks = min [amortized cost, fair value]
o Common stocks & higher-rated non-redeemable preferred stock = fair value
• IFRS:
o Available for sale = changes in market value recorded as reserves
o Held for trading = changes in market value recorded as income
o Held to maturity = historical cost less amortization
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
REINSURANCE COLLECTIBILITY
- GAAP: management estimates
- SAP: provision for reinsurance
- IFRS:
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
PROSPECTIVE REINSURANCE
- GAAP: asset to recognize ceded recoverables
- SAP: reserves net of anticipated recoverables
- IFRS: no offsetting allowed for the recoverables
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
RETROACTIVE REINSURANCE
• GAAP: ceded reserves treated as reinsurance recoverable asset
o Gain is deferred
• SAP: undiscounted ceded reserves recorded as negative write-in liability
o Gain is immediately recognized
o Schedule P is not impacted
• IFRS:
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
STRUCTURED SETTLEMENTS
• GAAP:
o Release of liability signed – purchase price of annuit is recorded as paid loss and claim closed
o Release not signed – settlement treated like reinsurance contract (create reinsurance recoverable asset)
• SAP:
o Purchase price of annuit is recorded as paid loss and claim closed
o Disclose any unsigned releases of liability
• IFRS:
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
ANTICIPATED S&S
- GAAP: amounts recorded net of S&S
- SAP: option to record Schedule P as gross or net
- IFRS:
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
RESERVE DISCOUNTING
• GAAP: use SAP or other reasonable discount rate
• SAP:
o Only tabular discounting allowed; otherwise, undiscounted
o Tabular – usually 3.5%
o Non-tabular – capped at min [investment yield – 1.5%, US Treasury debt yield]
• IFRS: reserves must be discounted, but risk margin must be added
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
GOODWILL
• Generated in a business combination (M&A)
• GAAP = Purchase price – [fair value of assets – fair value of liability]
• SAP = Purchase price – Statutory surplus
o Capped at 10% of aging company, amortized over 10 years
• IFRS:
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
CATASTROPHE RESERVES
- GAAP: not allowed to maintain reserves for unknown future cats
- SAP:
- IFRS: not allowed to maintain reserves for unknown future cats
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
RISK MARGIN
- GAAP: none
- SAP: none
- IFRS: required
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
DESIRABLE CHARACTERISTICS OF RISK MARGINS
- Consistent methodology of contract lifetime
- Consistent assumptions to those made int eh calculation of liability
- Consisted with sound insurance pricing
- Vary by product to reflect difference in risk of different products
- Higher when
a. Less is known about the estimate
b. Low frequency/high severity
c. Longer duration
d. Wide probability distribution
e. Emerging experience increases uncertainty
SECT C: COMPARISON OF ACCOUNTING FRAMEWORKS
TYPES OF BONDS/STOCKS
- Available for sale – purchased with the intention of selling before maturity, but after 1 year
- Held for trading – purchased with the intention of selling within hours or days
- Held to maturity – purchased with intention and ability of holding until maturity
