Accounting Procedures, Market Data, Cash-Flow Figures, and Insolvency Classification: The Case of the Insurance Industry

The property-liability (P&L) insurance industry uses statutory accounting principles (SAP) for measuring and monitoring solvency, but disputes have arisen concerning differences between SAP and generally accepted accounting principles (GAAP) and their applications to the P&L industry. A study was undertaken to compare the usefulness of 3 different accounting procedures for the prediction of insolvency among P&L insurers: 1. GAAP, 2. SAP, which include the use of market prices for valuation of equity portfolios and the matching of revenues and expenses, and 3. the market value- and cash-flow-based principles (MVA), which use market data for valuation of both stock and bond prices and cash flow for earnings. Both MVA and SAP procedures outperformed GAAP procedures for all classification and prediction comparisons. Although MVA slightly dominated SAP procedures for several comparisons, the differences were often not significant.