The objectives of GAAP reporting differ from the objectives of SAP

Comparison of Generally Accepted Accounting Principles and Statutory Accounting Practices

3.60 The objectives of GAAP reporting differ from the objectives of SAP

The primary focus of financial reporting in accordance with GAAP is informa-tion about earnings and its components. GAAP financial reporting assumes the continuation of an entity as a going concern in the absence of significant infor-mation to the contrary. Statutory financial statements are designed to address the concerns of the regulators, who are the primary users of statutory finan-cial statements and emphasize the measurement of ability to pay all current and future contract holder obligations. For example, under SAP, contract ac-quisition costs are expensed in the period incurred because the funds are no longer available to pay future liabilities. However, under GAAP, in view of the long term nature of the life insurance contract, these same acquisition costs are capitalized and amortized over varying periods (such as the premium paying period of the contract) so that expenses and related revenues are recognized in the same accounting period (that is, matching revenue to expense). Table 3-1,

"Summary of Statutory Accounting Practices and Generally Accepted Account-ing Principles," presents a summarized comparison of the major difference in accounting treatment between GAAP and codified SAP for selected financial statement components. The reader ordinarily should, however, refer to the ac-tual pronouncements for explicit guidance in accounting for transactions in each of the areas.

Table 3-1

Summary of Statutory Accounting Practices and Generally Accepted Accounting Principles

The following are highlights of significant differences in accounting treatment between codified SAP and GAAP for certain financial statement components.

As described in paragraph 3.06, statutory accounting may vary by state. SAP and GAAP references pertaining to each area are not necessarily inclusive of all guidance applicable to the subject matter.

Area

Codified Statutory Accounting Practices

Generally Accepted Accounting Principles⁽¹⁾ Bonds Debt securities should be carried

at amortized cost, except for those with a NAIC designation of 6, which shall be reported at the lower of amortized cost or fair value. For reporting entities that do not maintain AVR, debt securities with an NAIC designation of 1 or 2 shall be reported at amortized cost, while all other debt securities (NAIC designation 3–6) shall be reported at the lower of amortized cost or fair value. See Statement of Statutory Accounting Principles (SSAP) No. 26, Bonds, Excluding Loan-backed and Structured Securities and SSAP No. 43, Loan-backed and Structured Securities, as amended.

Classified as trading securities or securities available for sale at fair value; classified as held-to-maturity at amortized cost, if positive intent and ability to hold to maturity exists. See Financial Standards Accounting Board (FASB) Accounting Standards Codification (ASC) 320, Investments—Debt and Equity Securities.

Common stock Investments in unaffiliated common stock are generally reported at the fair value as stated by the NAIC's Securities Valuation Office. See SSAP No.

30, Investments in Common Stock (excluding investments in common stock of subsidiary, controlled, or affiliated entities)

Fair value. See FASB ASC 320.

Nonredeemable preferred stock

Preferred stock⁽²⁾shall be valued based on the underlying

characteristics of the security, the quality rating as designated by the NAIC, and whether an asset valuation reserve is maintained by the reporting entity. See SSAP No. 32, Investments in Preferred Stock (including investments in preferred stock of subsidiary, controlled, or affiliated entities)

Fair value. See FASB ASC 320.

Sources of Accounting Principles and Reporting Requirements

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Mortgages First mortgages that are not in

default with regard to principal or interest are carried at outstanding principal balance, or amortized cost if acquired at a discount or premium. See SSAP No. 37, Mortgage Loans

Unpaid balance plus unamortized loan origination fees less impairment as prescribed by FASB ASC 310, Receivables, Purchased loans with evidence of credit quality deterioration are accounted for under FASB ASC 310.

Real estate Reported at depreciated cost less encumbrances.

See SSAP No. 90, Accounting for the Impairment or Disposal of Real Estate Investments, as amended by SSAP No. 95, Exchanges of Nonmonetary Assets A Replacement of SSAP No.

28—Nonmonetary Transactions.

Additional information can be found in SSAP No. 40, Real Estate Investments.

Depreciated cost, after impairment write-down as per FASB ASC 360, Property, Plant, and Equipment.

Held for Sale Lower of depreciated cost or fair value less encumbrances and estimated costs to sell the property. See SSAP No. 90, Accounting for the Impairment or Disposal of Real Estate

Investments, as amended by SSAP No. 95, Exchanges of Nonmonetary Assets, A Replacement of SSAP No.

28—Nonmonetary Transactions.

Additional information can be found in SSAP No. 40, Real Estate Investments.

Lower of carrying value or fair value less cost to sell. See FASB ASC 360.

Investments in affiliates

Investments in subsidiary, controlled or affiliated (SCA) entities should be reported using either a market valuation approach or statutory equity methods.

See SSAP No. 97, Investments in Subsidiary, Controlled, or Affiliated Entities, A Replacement of SSAP No. 88.^(∗)

Consolidated, equity basis, or cost as appropriate. See FASB ASC 970-323.^(†)

Asset Valuation Reserve (AVR)

Formula driven reserve balance to offset potential credit or equity related investment losses.

Changes reflected as a component of surplus.

See SSAP No. 7, Asset Valuation Reserve and Interest Maintenance Reserve and the NAIC Annual Statement Instructions.

Not applicable.

(continued)

Area gains or losses, deferred and amortized to investment income (net of tax) over the remaining life of the investments sold.

See SSAP No. 7, Asset Valuation Reserve and Interest Maintenance Reserve and the NAIC Annual Statement Instructions. comes from a variety of sources, including but not limited to, SSAP Nos. 7, 26, 30, 32, 43, and 86.

Recorded in income statement.

See FASB ASC 320 and FASB ASC 944, Financial

Services—Insurance.

Unrealized gains (losses) for securities

For reporting entities required to maintain an AVR, the accounting for unrealized gains and losses shall be in accordance with SSAP No. 7, Asset Valuation Reserve and Interest Maintenance Reserve. For reporting entities not required to maintain an AVR, unrealized gains and losses shall be recorded as a direct credit or charge to unassigned funds (surplus) net of income taxes. Guidance comes from a variety of sources,

including but not limited to, SSAP Nos. 26, 30, 32, 43, 46, 72, and 86.

Recorded in net income or other comprehensive income, as appropriate (except for held-to-maturity). See FASB ASC 320 and FASB ASC 220, Comprehensive Income.

Debt securities If it is determined that a decline in fair value of a bond is other-than-temporary, an impairment loss shall be

recognized as a realized loss equal to the entire difference between the bonds carrying value and its fair value at the balance sheet date of the reporting period for which the assessment is made.

See SSAP No. 26, as amended by SSAP No. 99.

For loan backed and structured securities, the cost basis of the security is written down to the undiscounted estimated future cash flows and the write down accounted for as a realized loss.

See SSAP No. 43, Loan-backed and Structured Securities, as amended by SSAP No. 99.^(‡) See also NAIC Interpretation 06-7, Definition of Phrase "Other Than Temporary."

Write-down for impairment of value that is other than temporary and accounted for as a realized loss, as described in FASB ASC 320.

Sources of Accounting Principles and Reporting Requirements

57

For any decline in the fair value of preferred stocks, that is deemed other than temporary, an impairment loss shall be recognized as a realized loss equal to the entire difference between the carrying value and its fair value at the balance sheet date of the reporting period for which the assessment is made.

See SSAP No. 30, Investments in Common Stock (excluding investments in common stock of subsidiary, controlled, or affiliated entities); and No. 32, Investments in Preferred Stock (including investments in preferred stock of subsidiary, controlled, or affiliated entities), as amended by SSAP No. 99. See also NAIC Interpretation 06-7, Definition of Phrase "Other Than Temporary."

For any decline in the fair value of common or preferred stocks, that is deemed other than temporary, the equity security shall be written down to fair value as the new cost basis. The amount of the write down should be accounted for as a realized loss. See FASB ASC 320.

Nonadmitted assets

Excluded from the statutory balance sheet and charged directly to unassigned surplus.

See SSAP No. 4, Assets and Nonadmitted Assets; No. 20,

See SSAP No. 51, Life Contracts, and applicable appendices, SSAP No. 54, Individual and Group Accident and Health Contracts, and SSAP No. 59, Credit Life and Accident and Health Insurance made for adverse deviation for contracts on a net level premium basis; for universal life-type contracts—retrospective deposit method of accounting is required.

Additional liabilities for insurance and annuitization benefits may be required by FASB ASC 944.

For long duration insurance or investment contracts that are subject to FASB ASC 944

(continued)

Area

Codified Statutory Accounting Practices

Generally Accepted Accounting Principles⁽¹⁾ (paragraphs 15 and 17[a]) the accrued account balance equals a. deposits, net of withdrawals b. plus amounts credited

pursuant to the contract;

c. less fees and charges assessed;

d. plus additional interest accrued but not yet credited (for example, persistency 944-40-25 to the extent not already credited and included

Gross premium amounts that are due on or before the valuation date but have not been received.

To the extent that there is no related unearned premium, any uncollected premium balances that are over ninety days due shall be nonadmitted.

See SSAP No. 6, Uncollected Premium Balances, Bills Receivable for Premiums, and Amounts Due From Agents and Brokers; No. 51, Life Contracts;

and No. 54, Individual and Group Accident and Health Contracts.

Due and uncollected premiums are reported as assets. See FASB ASC 944.

Deferred premiums

Deferred premiums are recorded as assets.

See SSAP No. 51, Life Contracts.

Deferred premiums offset against liabilities for future policy benefits. See FASB ASC 944.

Contract holder dividend liability

Provision for dividends expected to be paid over the year subsequent to the date of the financial statements, whether or not declared or apportioned.

See SSAP No. 51, Life Contracts.

If limitations exist on the amount of net income from participating insurance contracts of life insurers that may be distributed to stockholders, provision is made for accumulated earnings expected to be paid to contract holders, including pro rata portion of dividends incurred to valuation date. If there are no net income restrictions, the future dividends are accrued over the premium paying period of the contract. See FASB ASC 944.

Sources of Accounting Principles and Reporting Requirements

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Reinsurance Full credit generally given for

authorized reinsurers; net reporting generally required;

reinsurance recognized based on adequate risk transfer as defined by statutory guidance; changes in liability for unauthorized reinsurers in excess of approved collateral mediums recorded directly to surplus. See SSAP No.

61, Life, Deposit-Type and Accident and Health Reinsurance.

Reinsurance recognized based on adequate transfer of risk;^(#) provision for uncollectible reinsurance and gross reporting of balance sheet amounts required under FASB ASC 944, net reporting is not allowed unless a right of offset exists as defined in FASB ASC 210-20^(#)

Deferred taxes Balance sheet should include deferred income tax assets (DTAs) and liabilities (DTLs), the expected future tax consequences of temporary differences generated by statutory accounting, as defined in FASB ASC 740, Income Taxes. Changes in DTAs and DTLs, including changes attributable to changes in tax rates and changes in tax status, if any, shall be recognized as a separate component of gains and losses in unassigned funds (surplus). See SSAP No. 10, Income Taxes.

Provision made for temporary differences, net operating losses, and credit carryforwards under FASB ASC 740^(∗∗)

Leases All leases, except leveraged leases should be considered operating leases.

See SSAP No. 22, Leases.

Classified as capital or operating according to the provisions of FASB ASC 840, Leases.

Liability for postretirement benefits other than pensions

An employer shall account for its postretirement benefits for vested employees only, on an accrual basis.

See SSAP No. 14, Postretirement Benefits Other Than Pensions, which adopts FASB ASC 715, Compensation—Retirement Benefits with some modifications.

Expected postretirement benefit obligations are recognized over the working life of employees;

liability based on vested and nonvested benefits under FASB ASC 715.^(††)

Pension benefits For defined benefit plans, reporting entities should adopt FASB ASC 715, with a

modification to exclude nonvested employees. The excess of plan assets over obligations should be treated as a nonadmitted asset.

Net plan obligations must be accrued irrespective of funding.

For defined contribution plans, the reporting entity should

Pension costs calculated based on the projected unit credit method under FASB ASC 715.^(††)

(continued)

Area

by the plan over the period in which the employee vests in those contributions. Contributions to plan participants' accounts made prior to vesting shall be treated as a prepaid asset that is nonadmitted. Contributions required after participants terminate or retire shall be accrued and an expense shall be recorded over the working lives of the participants.

See SSAP No. 89, Accounting for Pensions, A Replacement of SSAP No. 8, which adopts FASB ASC 715 with some modifications.

Universal life revenue

Premiums and cost of insurance, and other contract charges are recognized as revenue. See SSAP No. 51, Life Contracts.

Premiums and deposits included in contract holder liabilities;

revenues represent amounts assessed against policyholders and shall be reported in the period that the amounts are assessed unless evidence indicates that the amounts are for future periods, as per FASB ASC 944.

Contract acquisition costs

Charged to expense when incurred. See SSAP No. 71, Policy Acquisition Costs and

Commissions.

Deferred and amortized (with interest) in relation to the revenue generated (premiums or estimated gross profit, as appropriate) if recoverable from such revenue. See FASB ASC 944.

Consolidation Generally on an unconsolidated, individual reporting entity basis with subsidiaries on a modified equity method basis. See SSAP No. 97, Investments in

(1) FASB ASC 820 establishes a framework for measuring fair value that applies broadly to financial and nonfinancial assets and liabilities and improves the consis-tency, comparability, and reliability of the measurements. For further information, see http://asc.fasb.org and chapter 11, "Investments."

(2)The NAIC Financial Condition Committee had previously adopted a short term reso-lution for hybrid securities classification. At the summer 2008 NAIC meeting, the NAIC decided not to adopt the short term "notching solution", but instead to adopt a 2007 report from the American Academy of Actuaries, and look for a long term solution to improve indentification, classification and accounting guidance for new structured investments.

As of January 1, 2009, the notching solution will expire, and hyprid securities should be reported in Schedule D with a separate line number and the annual statement note

Sources of Accounting Principles and Reporting Requirements

61

disclosure for these holdings would be eliminated. A definition of hybrid securities was also added to the investment schedules instructions. For additional specifics, see chap-ter 11.

(∗)Per SSAP No. 96, Settlement Requirements for Intercompany Transactions, An Amend-ment of SSAP No. 25—Accounting for and Disclosures about Transactions with Affiliates and Other Related Parties, related party transactions are now required to be in the form of a written agreement that specifies a due date. Amounts receivable from related par-ties over 90 days passed due from the due date or if the due date is not specified in the agreement, are now nonadmitted.

(†)FASB ASC 810 addresses the topic of consolidation. The objective of which is to im-prove comparability and transparency of consolidated financial statements by establish-ing accountestablish-ing and reportestablish-ing standards and is effective fiscal years beginnestablish-ing on or after December 15, 2008. Early adoption is prohibited. For more information, see chapter 11.

(‡)The NAIC issued SSAP No. 98, Treatment of Cash Flows when Quantifying Changes in Valuation and Impairments, An Amendment to SSAP No. 43, Loan Backed and Struc-tured Securities. SSAP No. 98 requires that for loan backed and strucStruc-tured securities, if it is determined that the decline in fair value of the security is other than temporary, then the cost basis (carrying value) of the security should be written down to fair value and accounted for as a realized loss. SSAP No. 98 is effective for periods ending on or after September 30, 2009, with early adoption permitted. See paragraphs 11.21–.22 of this guide for additional information.

(||)The NAIC adopted various changes to appendix-010 and conforming changes to SSAP No. 59, Credit Life and Accident and Health Insurance Contracts. The changes modify the methodologies for establishing reserves for individual and group disability income claims incurred after January 1, 2007, contract reserves for single premium credit disability in-surance policies and long-term care inin-surance individual policies or group certificates issued after January 1, 2007.

(#)FASB ASC 815-10-45-5 permits a reporting entity to offset fair value amounts recog-nized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement that have been offset in accordance with that paragraph.

(∗∗)The Statutory Accounting Working Group is currently evaluating the effects of FASB ASC 740 on statutory accounting. Readers should remain alert to any final pronounce-ment.

(†† )FASB ASC 715 does not address the measurement and recognition issues related to changes in the fair value of plan assets and benefit obligations. These issues are relegated to a forthcoming phase II project planned for 2009. Additionally, the Statutory Account-ing WorkAccount-ing Group is currently evaluatAccount-ing the effects of FASB ASC 715 on statutory accounting. Readers should remain alert to any final pronouncement.

Exhibit 3-1

Evaluation of the Appropriateness of Informative Disclosures in Insurance Enterprises' Financial Statements Prepared

on a Statutory Basis¹

Question. Insurance enterprises issue financial statements prepared in accor-dance with accounting practices prescribed or permitted by insurance regula-tors (a "statutory basis") in addition to, or instead of, financial statements pre-pared in accordance with GAAP. Most states have adopted a comprehensively updated Accounting Practices and Procedures Manual, as revised by the NAIC's Codification project. The updated Accounting Practices and Procedures Manual, along with any subsequent revisions, is referred to as the revised manual. The revised manual contains extensive disclosure requirements. As a result, after a state adopts the new Accounting Practices and Procedures manual, its statu-tory basis of accounting will include informative disclosures appropriate for that basis of accounting. The NAIC Annual Statement Instructions prescribe the financial statements to be included in the annual audited financial report.

Some states may not adopt the revised manual or may adopt it with significant departures. How should auditors evaluate whether informative disclosures in financial statements prepared on a statutory basis are appropriate?²

Interpretation. Financial statements prepared on a statutory basis are fi-nancial statements prepared on a comprehensive basis of accounting other than GAAP according to AU section 623, Special Reports, paragraph .04 (AICPA, Pro-fessional Standards, vol. 1). AU section 623 paragraph .09 states that "When reporting on financial statements prepared on a comprehensive basis of ac-counting other than GAAP, the auditor should consider whether the financial statements (including the accompanying notes) include all informative disclo-sures that are appropriate for the basis of accounting used. The auditor should apply essentially the same criteria to financial statements prepared on an other comprehensive basis of accounting as he or she does to financial statements prepared in conformity with GAAP. Therefore, the auditor's opinion should be based on his or her judgment regarding whether the financial statements,

In document Life and health insurance entities, with conforming changes as of May 1, 2009; Audit and accounting guide (Page 85-97)