SAP v GAAP Flashcards
Objectives/Focus
SAP: based on the liquidity ie liquidation based accounting where is important to give approp valuation of surplus during event of liquidation. The focus is on the balance sheet
-regulators
GAAP: based on on-going concern ie aim to match inflows and outflows in order to provide more accurate measure of profit. The focus is on the income statement
-investors, shareholders, creditors, management
Assets
SAP: values more conservatively; does not admit value of certain assets (non-admitted)
GAAP: does not have non-admitted assets
Bonds Valued
SAP: Valued according to the grade
- Investment grade Bonds: amortized cost
- Non-Investment grade Bonds: min(amortized cost, market value)
*interpret “good standing” as class 1/class 2
GAAP: Valued according to the purpose
- Available for Sale=purchased with the intention to sell before maturity, but after a year: fair value
- Held to Maturity=intent & ability to hold till maturity: amortized cost
- Held for Trading=purchased with the intention of selling within hours or days: fair value
*change in MV have no effect on bonds valued at amortized ie no unrealized capital gain
Reserves
SAP: Reserves are held net of reinsurance recoverables on unpaid losses. The recoverables on paid losses are held separately as an asset.
GAAP: reserves are held gross of reinsurance recoverables. The reinsurance recoverables are reflected as an asset (ceded recoverables are asset)
-Unpaid losses under high deductible policies are treated as an asset and loss reserves are grossed up for high deductible losses
Reinsurance
SAP: has a formula based Provision for Reinsurance (liab) to account for the recoverables that may not be collectible; includes amount to recognize penalty for unauthorized that is unsecured as well as unauthorized that is overdue or in dispute (reduces surplus to degree to acct for unauthorized reins)
GAAP: has no provision; relies on management estimates bc usually more accurate indication than what is provided by a formula (need reason to believe something is uncollectible)
-SAP avoids situation when insurers are in trouble and more likely to underestimate uncollectible in order to hide how bad sitch is
Retroactive Reinsurance
SAP: recognizes undiscounted ceded reserves as negative write in liability; any gain is treated as write-in gain in other income and restricted as special surplus until actual paid recovery is excess of consideration paid
GAAP: requires ceded reserves to be recorded as a reinsurance asset. Any gain is deferred, thereby resulting in no immediate income or surplus benefit
S&S
SAP: insurer has the option about whether to record the reserves in Schedule P gross or net of anticipated S&S
GAAP: reserves must be recorded net of anticipated S&S
Policy Acq costs
cost to write policy incl commissions, prem taxes, other acq expenses
SAP: expensed as incurred (not available to pay PH liabilities so treatment consistent with objective)
GAAP: are amortized to match the revenue recognition (ie expenses them in prop to prem earned). unamortized portion is the deferred acquisition cost and is asset and created at inception of policy (produces more accurate indication of income)
-deferred acq cost must be reduced by any PDR
Discounting
SAP: does not allow discounting apart from tabular or if regulator permits non-tabular; by not recognizing time value of $, implicitly create margin in event of liquidation
GAAP: allows SAP discount to be used but rate can differ from risk free rate used in SAP as long as the alt rate “is reasonable on the facts and circumstances applicable to the registrant at the times the claims are settled”; necessary to factor in time value of $ bc aim to provide accurate measurement of earnings
Federal Income Tax
SAP: recognize deferred taxes if it is more likely than not that they will be realized but imposes limits
GAAP: recognize deferred taxes if it is more likely than not that they will be realized
DTA
SAP: recognize amounts which are more certain of immediately recoverable, strict admissibility test
GAAP: recognized and valuation allowance established when it is more likely than not to be realized
DTA=tax%*[loss reserve discount-(DAC-20% of net UEPR)-unrealized cap gains-accrual of market discount not for tax purposes]
Goodwill
(difference between purchase price of company and its book value)
SAP: goodwill = purchase price – statutory surplus; capped at 10% of acquiring firm’s capital&surplus; amortized to unrealized capital gains over period in which acquiring firm benefits economically (up to 10yrs); value of company is dependent on stat accounting (value may be lot smaller bc conservative nature so higher amount of GW)
GAAP: goodwill = purchase price – (FV assets – FV liabilities), balance tested for impairment annually; value of company is dependent on fair value accounting
Surplus vs GAAP equity
GAAP Equity = SAP surplus + diff in val of bonds + DAC + non-admitted assets – special surplus from retroactive reins
“only timing differences”
Timing differences means that ultimately the difference between GAAP and SAP will unwind. For example if bonds are amortized under SAP and at market value under GAAP, when they are sold or redeemed the SAP/GAAP differences will be resolved.
Renting Furniture benefits
-can expense so can reduce income tax rather than reducing surplus from non-admitted asset
Structured Settlements
SAP: When a release is signed by the claimant upon agreement to settle for the future annuity payments, the purchase price of the annuity is recorded as a paid loss and the claim is closed
-When a full release is not provided, accounting under SAP is the same as when a full release is obtained, but requires that the insurance company disclose the amount of these contingent liabilities in the Notes to Financial Statements
GAAP: When release is signed by the claimant, purchase price of the annuity is recorded as a paid loss and the claim is closed.
- When a full release is not provided, treats the settlement like a reinsurance contract, thus retaining the loss reserve and establishing an equivalent reinsurance recoverable
Adjustments to statutory Loss reserves to fair value basis
- Incorporate cash flows for the cost of capital
- Use payout pattern and risk free rate to discount cash flows
- Incorporate illiquidity adjustment into discounting
- Calculate unbiased estimate of expected payments
- Calculate adjustment for time value of money
Low investment yields effect on FV vs stat reserves
- discount factor will be small
- possible that increase to SAP reserve from risk margin > reduction to reserve due to discounting so possible fair reserve will be higher than SAP
Total Fair Value Reserve
Risk cost of capital = cost of capital-risk free rate-illiquidity prem
Payments in period (expected future nominal payments related to liab incurred at time of acq)
Payment duration (0.5, 1.5, 2.5,… if payments made midyr)
Discount rate
PV of payment=payment/(1+discount)^duration
Undiscounted future payments (sum of future payments)
Required capital ratio
Avg required capital (using req capital ratio and undiscounted future payments)
Risk cost of capital
Cost of capital in period
Duration (1,2,3,.. if return on capital is paid to investors at year end)
Discount rate
Associated risk margin=cost of capital in period/(1+discount)^duration
Total fair value=PV payments + associated risk margin
10-K 10yr loss development table
- use part2 and part3 of schedule P
- calc net reserves originally estimated by CY (sum(part2-part3) for each CY)
- calc amounts paid as of 1, 2, & 3 years later(subtract columns in part3 where part3 is original)
- calc reserves re-estimated as of 1, 2, & 3 years later (part2-part3 where part3 is original)
- calc deficiency=net reserves original estimated-reserves re-estimated (newest)
