SAP Accounting (Statutory Accounting Principles) refers to standards issued by the National Association of Insurance Commissioners (NAIC) that require insurers to follow a set of accounting principles while preparing their books of accounts.
The main objective of SAP accounting is to ensure that the insurers are solvent and can meet their current and future obligations with the assets they have in hand. In this article, we’ll discuss SAP accounting in detail, including its cornerstone concepts and its key differences from GAAP accounting.
Core Components of the SAP Accounting System
SAP accounting has three pillars: Conservatism, Recognition, and Consistency. Let’s discuss these three principles in detail.
Conservatism
Conservatism requires insurers to take a defensive approach to bookkeeping. The books must reflect the financial position in the “worst-case scenario.” The principle states that all losses should be recognized as soon as they are identified, whether certain or uncertain.
Recognition
Liquid assets can be converted into cash to help meet current and future obligations. However, due to possible encumbrances, liquid assets can’t always readily be turned into cash. Hence, they do not play a significant role in determining an insurance company’s solvency—which is the entire objective of SAP accounting.
Consistency
For example, if you have been depreciating your assets on the written-down value (WDV) method, you should continue to do so for all the accounting periods for which your books are made. This ensures that the financial statements are comparable across periods and that there are no inconsistencies.
Let’s say you change your method of depreciation from the WDV method to the straight-line method. In that case, the data of two years cannot be compared since you’ve applied different treatments to the same transaction.
Advantages and Limitations of SAP Accounting
Let’s look into some important pros and cons of SAP accounting:
Pros
- Helps regulators ensure insurers are solvent and can pay off their liabilities.
- Provides a degree of public assurance about the insurance company.
- Adds the entry barrier for new insurers, which is required in sensitive industries like insurance.
- Ensures that the insurance can’t fabricate or decorate their account to show legitimate profits.
Cons
SAP vs GAAP Accounting
GAAP and SAP are both accounting standards used to prepare companies’ financial statements. However, there are a few differences between them. Here are the key ones to note:
Applicability
GAAP accounting standards are issued by the Financial Accounting Standards Board and must be followed by every company preparing their financial accounts. All listed public companies in the US reporting to the Securities and Exchange Commission must follow all GAAP accounting principles in their periodic filings.
Conversely, SAP accounting standards are industry-specific and only apply to insurance companies operating in the United States.
Objective
GAAP accounting focuses more on a company’s profit and loss. It stresses matching principles and correctly recording every financial transaction so that a company’s financial position and overall profitability can be known. GAAP accounting helps businesses arrive at a company’s correct value.
On the other hand, SAP accounting focuses on how solvent insurance companies are. These principles are designed so that investors and stakeholders can determine whether the insurer is solvent enough to pay off all its current and future claims.
Asset
Under GAAP accounting, all the assets are recorded in the balance sheet, including tangible and intangible assets, current and noncurrent assets, and financial and non-financial assets. However, SAP accounting requires insurance companies to record only liquid assets. All illiquid assets are excluded so that regulators can quickly determine their solvency.
Equity
Equity under GAAP accounting is known as stakeholder equity and is calculated as a difference between all assets and liabilities. However, under SAP, this is known as “surplus” and is calculated as a difference between admitted assets (liquid assets that can be converted into cash) and liabilities.
Some assets not taken into account include furniture and equipment, prepaid expenses, and unsecured loans.
Matching Principle
This principle requires companies to only record expenses that were incurred to earn the recorded revenue.
For example, if a company sold 2,000 units of its product in a month, the income statement should apportion the cost of only those 2,000 units. Similarly, expenses incurred, the benefit of which will be reaped for years to come, should be charged to the income statement on a pro-rata basis.
However, SAP accounting doesn’t follow the matching principle—this is why they need to record all the expenses related to a policy as soon as it’s sold, irrespective of whether premiums are earned.
Conclusion
SAP and GAAP are both part of accounting standards. However, they’re meant for different purposes:
- GAAP applies to all US-listed public companies
- SAP applies to insurance companies
While the scope of both standards may differ, the end goal remains the same – to ensure fair preparation of financial statements so that stakeholders get the correct information. Moreover, these standards aren’t recommendary in nature but apply compulsorily to their respective companies, leaving no scope for financial foul play.
Non-compliance can lead to financial penalties.
FAQs
What is NAIC?
The NAIC is an organization consisting of chief insurance regulators from 50 US states, Columbia, and 5 US territories. Their objective is to assist insurance regulators with best practices and regulatory support. They keep a check on insurance operating in the US so that they work in the best interest of the public.
Do insurance companies follow GAAP?
Which financial statements should be prepared under SAP accounting?
References
- Depreciation (North Campus.edu)
- The Small Business’s Guide to Straight Line Depreciation (Chamber of Commerce)
- Securities and Exchange Commission (USA.gov)
Mark has been writing about tech and online subjects since 2004, as well as English teaching and writing over 20 spy thriller fiction novels. He has been managing editor to 5 tech websites, the biggest being MakeUseOf.com which he helped grow from 9,000 monthly visitors to over 500,000 by the end of his 6-year tenure.
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Mark also does consulting work for companies looking to improve their online presence and profits. Since 2017, Mark has been writing and self-publishing over 20 bestselling spy fiction novels, three of which became Amazon top sellers.