Differences Between GAAP and Statutory Premiums

Generally accepted accounting principles (GAAP), and statutory accounting principles (SAP) are separate accounting systems insurance companies use for reporting services. As part of both accounting methods, insurance companies must report premiums, or income exchanged for assuming policyholder risk. Several differences exist between premiums reported under GAAP and SAP.

SAP accounting rules are developed by the National Association of Insurance Commissioners (NAIC). This organization regulates the practices of insurance companies and evaluates companies for continued solvency. The Securities Exchange Commission (SEC) requires publicly traded insurance companies to use GAAP when reporting income and liabilities in financial reports available to investors. Consequently, all insurance companies must report SAP premiums to the NAIC, and publicly traded insurance companies must report GAAP premiums to the SED.

Reporting of GAAP and SAP premiums serve different purposes for determining the financial strength of an insurance company. The NAIC uses statutory premiums to determine the ability of an insurance company to pay for claims it may incur. It compares the premiums the company has earned to the amount it would potentially pay if all of its policyholders simultaneously filed claims meeting their policy limits. The SEC uses GAAP premiums, as well as an insurance company's other assets such as investments and real estate, to compare income to total expenses. This strategy helps investors evaluate the company's potential to continue operations in the future.

Insurance companies incur acquisition costs, such as marketing expenses, agent commissions and underwriting expenses, when attracting and securing new policyholders. Under GAAP, premiums are offset by expenses as they are earned. For example, if a policyholder pays auto insurance premiums monthly, the insurance company can apply one-twelfth of the acquisition costs to each installment payment. Conversely, under SAP rules, insurance companies must report acquisition expenses as they are incurred. If the company issues a policy for which it does not receive all premiums during the accounting period, SAP rules may result in lower profits than reported under GAAP rules.

Premiums reported under SAP rules, when reduced by the company's potential liabilities, can reduce a company's ability to assume more risks. The NAIC or a state's insurance regulatory may use a low income-to-liability ratio to prevent a company from entering a new region and acquiring new policyholders. Because the NAIC does not evaluate premiums under GAAP rules, these premiums do not affect growth from a regulatory standpoint.