Unlike most businesses, insurers use Statutory Accounting Principles (SAP) to prepare their financial statements for state regulatory authorities. State governments in the United States require insurers to use SAP because it stresses liquidity. Insurers must maintain a certain amount of liquidity for several reasons, but most importantly to have the ability to pay claims, losses, and expenses quickly. Most other businesses only have to prepare their financial statements using the rules of Generally Accepted Accounting Principles (GAAP). Insurers must prepare both SAP and GAAP statements to satisfy state regulators and the Securities Exchange Commission.
Unlike SAP, GAAP does not concern itself with liquidity but rather with the business as a going concern, its net worth, and potential future profitability. In other words, SAP helps insureds while GAAP helps investors. The National Association of Insurance Commissioners (NAIC) developed SAP while the Financial Accounting Standards Board (FASB) developed GAAP.
SAP excludes illiquid assets. For example, some of the assets SAP excludes include furniture, prepaid expenses, and balances overdue by 3 months. Therefore, an insurer’s assets will appear smaller on a statement prepared with SAP than with GAAP.
SAP requires insurers to recognize their expenses immediately but not their revenues. For example, insurers must amortize (recognize proportionally over time) their premiums but the not the policy acquisition costs incurred due to acquiring those premiums. Insurers set aside reserves for “unearned premiums” because the insurers may collect a full year premium, but can only earn it monthly during the course of the year. Commercial sureties, however, do not have this issue because they always fully earn the first year premium and insureds cannot obtain a refund if their policy expires within the first year.
Speaking of sureties – many insurers have sureties as subsidiaries. Under SAP, an insurer may not consolidate the financial statements of their subsidiaries with itself (the parent). They must prepare separate financial statements for their subsidiaries using SAP. On the contrary, GAAP allows an insurer to consolidate their subsidiaries’ finances with the insurer’s financial statement.