Conceptual question about SAP vs. GAAP
Since loss reserves in SAP are recorded net of reinsurance but are recorded gross of reinsurance for GAAP, does this have the effect of making SAP the less conservative framework in this scenario?
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Since loss reserves in SAP are recorded net of reinsurance but are recorded gross of reinsurance for GAAP, does this have the effect of making SAP the less conservative framework in this scenario?
Comments
If you haven't seen 2018.Fall Q19d, you should take a look. It doesn't specifically answer your question but it raises the same issue about whether a particular SAP vs GAAP difference supports the SAP or GAAP framework. (Also, some of what I discuss below is from chapters 22-23 from Odomirok.)
So, the reasons for differences between SAP and GAAP can usually be directly explained by SAP's focus on solvency versus GAAP's focus on profitability, but not always. In other words, it might not always be clear why SAP uses one method and GAAP uses another. That's just something to keep in mind. There are a lot of details related to accounting that probably only an accountant would truly understand.
Anyway, you're right that SAP records liabilities net of reinsurance so it seems to be assuming those ceded liabilities are 100% recoverable which is rather optimistic (versus being conservative.) It seems to undercut the stated purpose of SAP. But remember this is offset by the provision for reinsurance.
Regarding GAAP, it's true that the liabilities are recorded gross of reinsurance, which on the face of it does seem very conservative because it seems to be assuming that none of the ceded reinsurance will be collected. Of course that wouldn't make sense, and what GAAP does is establish an offsetting asset for anticipated reinsurance recoverables.
My Conclusion: I'm not really sure if I could argue convincingly whether the treatment of reinsurance supports or doesn't support the purpose of SAP vs GAAP. Although GAAP does not have a provision for reinsurance, it accounts for uncollectible insurance in a different way - by reducing the value of the offsetting asset. It seems that both SAP and GAAP account for uncollectible reinsurance but whether one method is more conservative than the other, I can't say for sure. Maybe SAP is more conservative because there is a specific formula for the provision for reinsurance whereas the reduction in the value of the offsetting asset in GAAP might rely more on judgment. (And wherever judgment is required, people who have a vested interest in the results tend to make optimistic projections.)