SAP vs GAAP

Question 1

Deferred Acquisition Costs

SAP vs GAAP

Answer 1

GAAP: create a DAC asset to defer the recognition of acquisition expenses, to match the recognition of earned premium

SAP: does not allow deferring the expenses

Question 2

Non-admitted Assets

SAP vs GAAP

Answer 2

SAP: do not count as assets for calculating surplus
GAAP: include as assets in surplus calculation

Question 3

Deferred Tax Assets

SAP vs GAAP

Answer 3

GAAP: fully recognizes DTA, but creates a valuation allowance if it is more likely than not that the DTAs will not be recognized

SAP: strict admissibility test to recognize DTA, in addition to the valuation allowance. The admitted portion =

• the amount of DTA expected to reverse in the upcoming year, that can be applied to taxes paid on profits in the prior 3 years
• the amount of DTA expected to reverse in the upcoming year, limited to a % of surplus ( % = ratio of authorized capital to the ACL)
• the amount of DTA beyond that calculated above that can be offset against the existing DTLs

Question 4

Invested Assets

SAP vs GAAP

Answer 4

SAP:
investment grade bonds - amortized cost
lower rated bonds / preferred stocks - min (amortized cost, fair value)
common stocks / non-redeemable preferred stock: fair value

GAAP:
Available for Sale (AFS) - market value
Held for Trading (HFT) - market value
Held to Maturity (HTM) - amortized cost

Question 5

Salvage and Subrogation

SAP vs GAAP

Answer 5

SAP: the insurer has the option about whether to record the reserves in Schedule P gross or net of anticipated salvage and subrogation

GAAP: The insurer must subtract the anticipated balances

Question 6

Objectives and Focus of SAP and GAAP

Answer 6

SAP is based on the liquidity. The focus is on the balance sheet.

GAAP is based on on-going concern. The focus is on the income statement.

Question 7

Policy Acquisition Costs

SAP vs GAAP

Answer 7

SAP: the policy acquisition costs are expensed as incurred.

GAAP: a deferred policy acquisition cost asset is set up and reduced over the term of the contract to match the earning of acquisition expenses with the earning of premiums.

Question 8

Unauthorized Reinsurance

SAP vs GAAP

Answer 8

SAP: A liability, “Provision for reinsurance” is recognized. This provision includes an amount to recognize a penalty for unauthorized reinsurance that is unsecured as well as unauthorized reinsurance that is overdue or in dispute.

GAAP: Unauthorized reinsurance is reflected in GAAP only if the company has no reason to believe it is not recoverable.
No provision for reinsurance.

Question 9

Federal Income Taxes

SAP vs GAAP

Answer 9

SAP: recognize the deferred taxes if it is more likely than not that they will be realized, but SAP does impose limits on these taxes

GAAP: recognize deferred taxes if it is more likely than not that they will be realized

Question 10

Goodwill

SAP vs GAAP

Answer 10

SAP: Purchase price - Statutory Surplus
capped at 10% of the acquiring firm’s capital and surplus. It is amortized to unrealized capital gains over the period in which the acquiring firm benefits economically (up to 10 years)

GAAP: Purchase price - (fair value of assets - fair value of liabilities)
This goodwill balance is tested for impairment annually

Question 11

Prospective reinsurance recoveries

SAP vs GAAP

Answer 11

SAP: reserves are net of reinsurance recoverables

GAAP: ceded recoverables are shown as assets

Question 12

Retrospective reinsurance recoveries

SAP vs GAAP

Answer 12

SAP: undiscounted ceded reserves recorded as negative write in liability

(a gain may be generated if the reinsurance premium is less than the negative write in liability. This is treated as a write-in gain as part of other income; and the surplus benefit is treated as special surplus until the paid reinsurance recovery exceeds the premium paid)

GAAP: treated as a reinsurance recoverable asset. Any gain is deferred, no immediate income or surplus benefit. Gain is amortized over time.

Question 13

Describe the different intended users of SAP vs GAAP

Answer 13

SAP: used primarily by regulators, and therefore focuses on the insurers ability to pay claims (surplus adequacy)

GAAP: used mainly by investors and creditors, and is therefore focuses on the measurement of earnings emergence

Question 14

Compare the GAAP & SAP treatment of structured settlements if the claimant signs a release

Answer 14

• the purchase price of the annuity is recorded as a paid loss
• the claim is closed

Question 15

Compare the GAAP & SAP treatment of structured settlements if a release is not signed

Answer 15

SAP: treatment is the same as the case where there is a release. However, the insurer must also disclose the contingent liability in the Notes to the Financial Statements

GAAP: the settlement is treated like a reinsurance contract, which involves creating a reinsurance recoverable asset

Question 16

Describe the 8-K form

Answer 16

Filed to disclose certain material events, including:

• change in principal officers or directors
• change in the company’s certified accountant
• entering/ terminating a material definitive agreement

Question 17

List 2 regulations that outline the SEC reporting requirements

Answer 17

• regulation S-X: Form & Content of financial statements

- regulation S-K: Integrated Disclosure rules

Question 18

3 components of the fair value of reserves, according to the mark-to-model approach

Answer 18

1. Expected value of nominal future cash flows
2. A reduction to reflect the time value of money at the risk free rate, plus a load to reflect the illiquid nature
3. A risk adjustment to compensate for the risk associated with the liabilities (Cost of capital approach, estimates the required capital to support the reserves at each future evaluation date)

Question 19

2 methods to estimate the cash flows from the nominal reserves

Answer 19

1. Use a payout pattern based on the loss reserve development
2. Use the implied pattern based on the ratio of paid losses to ultimate losses by accident year

Question 20

Value of Business In-force (VBIF) in P-GAAP

Answer 20

• used instead of deferred acquisition costs
• determine the fair value of the liabilities expected to be incurred in connection with the UEPR, and subtracting this from the UEP.