Odomirok 22-23 GAAP

Question 1

SAP vs GAAP - oversight

Answer 1

SAP: individual states with assistance from NAIC
GAAP: SEC (but SEC has delegated responsibility to FASB)

SEC: Securities & Exchange Commission
FASB: Financial Accounting Standards Board

Question 2

Areas of difference between GAAP and SAP

Answer 2

BASIC - D3NG + PDR
* Balance sheet presentation of reinsurance
* Anticipated salvage/subrogation
* Structured settlements
* Invested assets
* Ceded reinsurance
* DAC (Deferred Acquisition Expense)
* DTA (Deferred Tax Asset)
* Discounting loss reserves
* Non-admitted assets
* Goodwill
* PDR (Premium Deficiency Reserve)

Question 3

Balance sheet presentation of reinsurance - diff

Answer 3

SAP: liabilities are shown NET of reinsurance
GAAP: liabilities are shown GROSS of reinsurance (with an offsetting asset for anticipated reinsurance recoveries)

Question 4

Anticipated salvage/subrogation - diff

Answer 4

SAP: Schedule P reserves show net OR gross of salvage/subrogation
GAAP: subtract salvage/subrogation from unpaid losses (i.e. net basis)

Question 5

Structured settlements - diff

Answer 5

(when release from claimant not obtained)

SAP: record annuity cost as paid loss (disclose in Notes to Financial Statements)
GAAP: record annuity costs as reinsurance (retain loss reserves & book payments as recoverables)

Question 6

SAP Invested Assets treatment

Answer 6

Fair value
* common stocks
* non-redeemable preferred stocks
* SVO-identified investments (Securities Valuation Office)

Amortized cost
* investment-grade bonds (NAIC Class 1-2) long & short-term

MIN(amortized cost, fair value)
* non-investment grade bonds (NAIC Class 3-6) long & short-term

Question 7

Invested Assets (Bonds) - diff

Answer 7

SAP: values bond based on bond class
* investment-grade bonds = Amortized Cost
* below investment-grade bonds = min(Amortized Cost, Fair Value)

GAAP: values bonds based on intended use
* HFT - held for trading = Fair Value
* HTM - held to maturity = Amortized Cost
* AFS - available for sale = Fair Value

Question 8

Ceded reinsurance - diff

Answer 8

retroactive reinsurance

SAP:
* record ceded reserves as negative write-in liability
* Schedule P is unchanged
* gain is recorded as a write-in gain [gain = (negative write-in liability) - (cost of reinsurance)]
* goes into other income
* no change to regular surplus because change goes into special surplus

GAAP:
* record ceded reserves as reinsurance asset
* gain is deffered (amortized over time)
* no immediate impact on income
* no immediate impact on surplus

Question 9

Deferred Acquisition Costs - diff

Answer 9

SAP:
* recognize immediately (no DAC asset under SAP)
* supports SAP purpose because money has been spent
* funds would not be available to policyholders if company goes insolvent

GAAP:
* defer & amortize over life of asset (create a DAC asset)
* supports GAAP purpose because assets & liabilities are matched
* gives more accurate picture of company as a going-concern

Question 10

Deferred Tax Assets (DTAs) - diff

Answer 10

SAP: DTAs subject to strict admissibility test
GAAP: DTAs fully recognized

Question 11

Discounting loss reserves - diff

Answer 11

(no discounting except in certain cases)

SAP:
* tabular discount rate - few state regulations
* non-tabular discount rate - formula-based & capped
* supports SAP purpose because cross-company comparison is easier

GAAP:
* options: use SAP rate or reasonable alternative
* supports GAAP purpose because it can be more tailored to company

Question 12

Non-admitted Assets - diff

Answer 12

SAP:
* disallows certain assets of low liquidity
* supports SAP purpose because non-admitted assets are not liquid after an insolvency

GAAP:
* all assets are admitted
* supports GAAP purpose because all assets should be considered in evaluating a company as a going-concern

Question 13

Admitted Assets misc.

Answer 13

• agents’ balances > 90 days past due are not admitted
• bond values - depends on rating of bond
• amortization period for goodwill is at most 10 years
• DAC doesn’t exist in SAP
• DTA must be netted out by subtracting DTL

Question 14

GAAP Goodwill formula

Answer 14

GAAP goodwill = P - (net assets) = P - [FV(assets) - FV(liabilities)]
* P = purchase price
* if > 0: establish an asset equal to the amount of goodwill
* if < 0: immediately recognize this amount as operating income gain
* Evaluated for impairment

Question 15

SAP Goodwill formula

Answer 15

SAP goodwill = min(P - S2, 10% * S1)
S1 = statutory suplus of acquiring company
S2 = statutory surplus of acquired company
Amortized to unrealized gains for no more than 10 years

Question 16

Fair Value of Liabilities under GAAP

components & calculation

Answer 16

1. Nominal future cash flows of liabilities
   Calculate using LDFs
2. Discounted component #1 + (load for illiquid nature of liabilities)
   Calculate using risk-free rate
3. Risk margin to compensate for uncertainty of liabilities)
   Calculate using cost-of-capital approach

Question 17

Risk Margin formula

Answer 17

risk margin = (R - i) x Sum[avg(Ct, Ct+1) / (1+i)^(t+1)]
t = time
R = pre-tax cost-of-capital
i = risk-free rate that includes illiquidity premium
Ct = capital carried at time to support liability

Question 18

Premium Deficiency Reserve - calculation diff

Answer 18

SAP:
* premium deficiency is either included in the UPR balance or reported as a write-in liability item
* commissions and other acquisition costs should not be included if those amounts have been expensed rather than established as an asset
GAAP:
* DAC is established as an asset and is presented net of ceded DAC
* if a PDR is calculated, it first lowers the recorded DAC asset
* once the DAC asset is exhausted, a separate PDR liability is established

Question 19

GAAP vs. SAP Surplus formulas

Answer 19

GAAP surplus = SAP surplus + (provision for reinsurance) + DAC

If non-admitted assets were provided, you’d have to include these in the sum on the right side