Why Insurance Companies use Statutory Accounting (SAP) Instead of the GAAP
According to insurance industry accounting standards, insurance companies are unique and therefore, have different financial transactions than most businesses. Insurance companies create value by doing several activities such as paying claims up front and then trying to collect a reimbursement, paying a portion of a claim and sharing responsibility with another insurer or even collecting premiums from customers who never file a claim.
What is Statutory Accounting (SAP)?
Because of how unique insurance companies are, statutory accounting principles are the procedures used in the industry. According to the National Association of Insurance Commissioners, all insurance companies must follow SAP. Unlike traditional businesses, an insurance company’s annual statement indicates its value as if it were in liquidation rather than continuing in business.
What is GAAP?
Generally accepted accounting principles (GAAP) is the method that the majority of businesses use. The main difference with statutory accounting is that GAAP assumes that the company is going to stay in business rather than liquidate.
Why do insurance companies use SAP?
Insurance commissioners require SAP because the insurance industry plays the odds when selling policies. A good example would be a general physician who pays a premium of $5,000 per month for a $5 million life insurance policy. The insurance companies know they will have to pay out on some of the policies, but they are betting the amount awarded by juries will not be more than anticipated. In the case of having to award higher amounts, the insurance company might deplete its financial reserves, with the possibility of filing bankruptcy. Therefore, they must file annual reports that reflect the health of the company on the last day of the fiscal year.
Other Accounting Requirements
In the case of an insurance company being a stock corporation, as most are, the accountants will file GAAP with the Securities and Exchange Commission, as well as SAP for quarterly filings and the annual report. Both SAP and GAAP filings are public, so investors can get an accurate estimate of outstanding claims versus revenue.
Via the Small Business Chronicle