What Are Adjusted Earnings?
Adjusted earnings are the sum of earnings and increases in loss reserves, new business, deficiency reserves, deferred tax liabilities and capital gains from the previous time period to the current time period. Adjusted earnings provide a measurement of how current performance compares with performance in previous years.
Understanding Adjusted Earnings
Calculating adjusted earnings can vary according to the type of insurance being sold. Because outside investors do not have access to the same amount of information as internal employees, it can be difficult to ascertain an insurer’s adjusted earnings. Approaches may vary according to how they examine expenses and premiums. A property and casualty insurance company, for example, will calculate adjusted earnings by taking the sum of its net income, catastrophe reserves, and reserves for price changes, then subtracting gains or losses from investment activities. A life insurance company will subtract capital transactions, such as increases in capital, from increases in premiums written.
Investors and regulators can examine the performance of an insurance company in a number of ways, and they often use multiple analytical approaches to ensure a thorough review of an insurance company. A qualitative analysis of the insurer’s operations will show how the company plans on growing in the future, how it compensates employees, how it manages tax obligations and how effective management is in directing operations. A quantitative analysis will show how it manages its investments, how it determines the premiums to charge for policies that it underwrites, how it manages risk through reinsurance treaties and how much it requires to retain business and acquire new customers. Investors will also look at the insurer’s adjusted earnings, net worth, and adjusted book value.
The Reason for Adjusted Earnings
In general, adjusted earnings could be regarded as an indicator of the value of a business to new owners. The metric is used to assess different aspects of financial strength in a company. This is necessary because unadjusted earnings statements based on generally accepted accounting principles (GAAP) don't always reflect the true financial performance of a company. The Securities and Exchange Commission (SEC) requires public companies to use GAAP accounting for their reported financial statements. Adjusted earnings are not GAAP-compliant and will show different earnings numbers than unadjusted earnings. For example, a company may write-down an asset or restructure its organization. These actions are typically large, one-time costs that distort company profits. An "adjusted" earnings number typically excludes these nonrecurring items. Adjusted earnings account for these factors and more in addition to a company's bottom line.