Statutory Accounting Principles

Study guides: Exam 6U, Exam CP-341, Exam ILA-101, Exam ILA-201U

Statutory Accounting Principles (SAP) are the accounting rules U.S. insurers follow in the financial statements they file with state regulators. Codified by the NAIC in the Accounting Practices and Procedures Manual (effective January 1, 2001) and adopted by the states, they exist to measure solvency — an insurer's ability to pay policyholders — so they value conservatively, count only assets available to pay claims, and expense costs as they are incurred.

\text{Admitted assets} = \text{Total assets} - \text{Nonadmitted assets}

\text{Statutory surplus} = \text{Admitted assets} - \text{Liabilities}

• The Manual holds a Preamble (the statement of concepts, the statutory hierarchy and materiality) and the Statements of Statutory Accounting Principles (SSAPs), the highest level of authoritative guidance. Its three concepts are conservatism (a cautious approach to valuing assets and estimates), consistency (so regulators can compare insurers) and recognition (only assets available to meet policyholder obligations count). SSAPs central to P&C work: 5R liabilities and contingencies, 9 subsequent events, 53 premiums, 55 unpaid losses and LAE, 62R reinsurance, 63 underwriting pools, 65 P&C contracts, 66 retrospectively rated contracts.
• Prescribed and permitted practices. A state may prescribe a rule for all its domestic insurers or permit one insurer an exception; both are disclosed, with their effect on surplus and income, in the notes.
• Nonadmitted assets — such as furniture and equipment, prepaid expenses, uncollected premium more than 90 days overdue, and deferred tax assets beyond the admissibility limit — are excluded from the balance sheet, and changes in them go straight to surplus.
• Main differences from GAAP:
  • acquisition costs are expensed as incurred, while GAAP defers and amortises them, so statutory surplus omits the equity in the unearned premium reserve;
  • loss and unearned premium reserves are reported net of reinsurance, with a provision for unsecured and overdue reinsurance (Schedule F), where GAAP shows gross liabilities and a recoverable asset;
  • most bonds are carried at amortised cost rather than the fair value GAAP uses for available-for-sale securities;
  • surplus notes count as surplus rather than debt;
  • reporting is by legal entity, not consolidated group;
  • loss reserves are undiscounted unless a specific SSAP permits otherwise (Loss Reserve Discounting).
• The third basis on the syllabus, IFRS (through IFRS 17), discounts insurance liabilities and adds an explicit risk adjustment, where SAP and U.S. GAAP both generally carry P&C loss reserves undiscounted.
• Why the actuary cares. Statutory surplus drives Risk-Based Capital, the IRIS Ratios, premium-to-surplus leverage and dividend capacity; the Appointed Actuary opines on statutory reserves (Appointed Actuary Responsibilities); and pricing must fund the surplus strain of expensing acquisition costs up front — fast growth consumes statutory surplus even when the business is profitable. See Capital and Surplus and NAIC Annual Statement.

Equity in the Unearned Premium Reserve An insurer writes \$12{,}000{,}000 of annual policies, all effective July 1. Acquisition costs (commissions, premium tax and other acquisition) are 20\% of written premium, paid at issue. Ignoring losses and tax, compare the year-end statutory and GAAP positions.

Answer

\begin{align*}
\text{Unearned premium} &= 0.5 \times \$12{,}000{,}000 \\
&= \$6{,}000{,}000 \\[4pt]
\text{Acquisition cost} &= 0.20 \times \$12{,}000{,}000 \\
&= \$2{,}400{,}000 \\[4pt]
\text{GAAP DAC} &= 0.20 \times \$6{,}000{,}000 \\
&= \$1{,}200{,}000
\end{align*}

Under SAP the full \$2{,}400{,}000 is expensed this year, while the unearned premium reserve is held at the full \$6{,}000{,}000. Under GAAP only \$1{,}200{,}000 is expensed and the other \$1{,}200{,}000 is an asset. GAAP equity is therefore \$1{,}200{,}000 higher before tax — the equity in the unearned premium reserve.

At inception the gap was the whole \$2{,}400{,}000: writing the business drained statutory surplus by that amount on day one. That is the surplus strain that limits how fast a statutory-constrained insurer can grow.

From Total Assets to Statutory Surplus An insurer's total assets are \$950M and liabilities \$700M. Included in assets are furniture and equipment \$6M, prepaid expenses \$3M, uncollected premium more than 90 days overdue \$5M, and \$8M of deferred tax assets above the admissibility limit. Compute statutory surplus.

Answer

\begin{align*}
\text{Nonadmitted} &= 6 + 3 + 5 + 8 \\
&= \$22\text{M} \\[4pt]
\text{Admitted assets} &= 950 - 22 \\
&= \$928\text{M} \\[4pt]
\text{Statutory surplus} &= 928 - 700 \\
&= \$228\text{M}
\end{align*}

Had every asset been admitted, surplus would have been \$250M; nonadmission removes 8.8\% of it. Each excluded item is real, but none can be relied on to pay a claim in a wind-up — the recognition concept at work.