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Financial reporting is necessary for finance and insurance companies to comply with legal regulations. These organizations also rely on financial reporting to inform current and future stakeholders on the status of their financial health.
As vital as financial reporting is, without a framework in place in the form of regulations and accounting principles, accurately and consistently comparing financial statements across organizations would be difficult. That’s where statutory accounting principles (SAP) come in.
What are Statutory Accounting Principles?
Statutory accounting principles (SAP) are standards provided by the National Association of Insurance Commissioners (NAIC) for the preparation of insurance financial statements. The main focus of statutory accounting principles is to show stakeholders the financial health of insurance companies, their compliance with regulations, and their solvency. Solvency is the ability of a company to pay its long-term debts and legal obligations based on its asset-to-liability ratio.
What is the Difference Between Statutory Accounting Principles (SAP) and Generally Accepted Accounting Principles (GAAP)?
Generally Accepted Accounting Principles (GAAP) are a uniform set of accounting principles that U.S. companies are mandated to follow by the Securities and Exchange Commission (SEC). The GAAP rules and accounting standards are largely set by the Financial Accounting Standards Board (FASB). Similarly, the Government Accounting Standards Board (GASB) sets GAAP standards for local and state governments, and the Federal Accounting and Standards Advisory Board (FASAB) publishes the accounting principles for federal agencies.
The U.S. uses GAAP as its accounting principles while more than 120 other countries, including the European Union, use the International Financial Reporting Standards (IFRS) accounting principles issued by the International Accounting Standards Board (IASB).
While SAP is constructed under the framework of GAAP, statutory accounting practices are specific to insurance companies. As a result, SAP focuses more on proving financial solvency and regulatory compliance to stakeholders rather than just financial health. Solvency is an especially important quality for insurance companies because it enables them to always deliver promised benefits to policyholders.
Core Values of Statutory Accounting Principles
The National Association of Insurance Commissioners (NAIC) developed the statutory accounting principles to adhere to three core values. These include the following:
1. Conservatism
This principle requires insurance companies to take a conservative approach when reporting their financial condition. Assets should be valued at or below market value, while liabilities are valued at the higher end of the estimate range. This conservative stance helps ensure sufficient reserves to pay claims.
2. Recognition
Under statutory accounting, revenue and expenses are recognized as they are incurred or earned during the current accounting period. This differs from GAAP, which allows some accruals and estimations. The recognition principle provides a more current view of an insurer's financial position and ensures the company has enough liquid assets to pay policyholder obligations when they are due. Examples of liquid assets include cash money, market instruments, and marketable securities.
Any assets of economic value that cannot be quickly converted into cash due to economic encumbrances or other third-party interests should not be recognized. Instead, such assets should be charged against surplus.
3. Consistency
Insurers must use consistent accounting practices from year to year to allow for meaningful analysis of trends overtime. Statutory accounting does not allow frequent changes to accounting policies unless approved by regulators. Consistency makes financial reports more reliable for regulators and policyholders.
Core Elements of Statutory Accounting Principles
There are also three core elements of SAP:
Balance Sheet
A balance sheet is a document containing an organization's current assets, liabilities, and equity. Certain assets, such as goodwill or deferred tax assets, may need to be excluded from statutory account reports due to their lack of liquidity and, thus, non-solvent nature. In addition, liabilities such as credit losses must be recorded more prudently in SAP than in GAAP.
Income Statement
SAP income financial statements report revenues earned and expenses incurred in a specific time period. This allows insurance companies to maintain sufficient reserves to fulfill their legal obligations to policyholders.
Cash Flow Statement
Cash flow statements report all the cash coming in and out of a company pertaining to financing activities, operating activities, such as sales and purchases, and investing activities, such as made and received loans, within a designated time period.
Best Practices for Financial Reporting Under Statutory Accounting Principles
When conducting financial reporting under SAP, you should adhere to best practices. Some best statutory accounting practices for financial reporting are detailed below.
Establish Internal Control Systems
For accurate and timely financial reporting that complies with SAP rules, it’s best to implement a system of internal controls. Establishing a robust internal control system when creating financial statements for statutory accounting reports can even help you prevent fraud, as you’ll be able to notice immediately when details in your report are not correct.
Educate Finance Teams on SAP Requirements
One of the other best statutory accounting practices is to provide accounting and reporting guidance to your finance teams regarding SAP guidelines and industry-specific regulations beforehand. That way, when the time comes for them to conduct statutory account reporting, they can do so quickly, efficiently, and precisely.
Maintain Up-to-Date Documentation
Keeping an up-to-date, organized record of all transactions, contracts, financial statements and credit losses will make financial reporting under statutory accounting principles much easier. It will also make it easier to conduct audits and regulatory examinations quickly, accurately, and effectively.
Leverage Technology Solutions
Not only can technology like software help expedite the statutory account reporting process by automating certain aspects of it, but it can also help you accurately conduct complex calculations on financial statements. For example, cloud software allows teams to tailor statutory accounting processes to their needs. You can even use Fluence Technologies’ disclosure management software to quicken the statutory filing process.
Benefits of Mastering Statutory Accounting Principles
If you adhere to all of the best financial reporting practices under statutory accounting standards and incorporate all of the core SAP elements and values we’ve discussed in this article, you’re well on your way to mastering the statutory accounting process, which can have a variety benefits:
Better Transparency
While statutory accounting principles tend to focus more on solvency, showing transparency through clear and precise financial reporting still attracts quality stakeholders. Furthermore, transparency in your financial reporting also makes it easier for stakeholders to make well-informed business decisions.
Increased Credibility
The more accurate and precise your statutory accounts are, the more credible your insurance company becomes, allowing you to build a better reputation with customers, investors, regulators, and stakeholders.
Less Likely to Have Incurring Penalties Due to Noncompliance
By consistently achieving full disclosure and compliance with statutory accounting standards, you’ll lessen the chance of having to pay legal fees or penalties.
Easier Audits and Examinations
Finally, mastering compliance with statutory accounting principles will allow you to stay on top of your organization’s financial health. Maintaining up-to-date, organized documents, establishing internal control systems, educating oneself on SAP, leveraging technology, and keeping the core elements and values of SAP will make it much quicker and easier to conduct audits and financial exams in the future.
Adhere to the Statutory Accounting Principles and Best Practices Today
If you work for an insurance company and want to protect policyholders by providing a reliable source of emergency funds, one of the best things you can do is adhere to SAP. Statutory accounting principles focus on creating solvency and help insurance companies maintain regulatory compliance and financial health.
Adhering to SAP will prevent your insurance company from wasting money on legal fees due to bankruptcy or not complying with regulations. Statutory accounting principles help your insurance company gain funds by attracting stakeholders.
The best way to keep your insurance company running effectively is to adhere to SAP best practices as soon as possible. Learn how your statutory account reporting could benefit from financial consolidation software here.
