What is an Adjustment Index

An adjustment index is a modification that can be applied to a data set to update that set or make it a better representation of external conditions. It can be a formula-based modification or a single number derived from an external set of observations.

BREAKING DOWN Adjustment Index

Adjustment index is a term with applications in a wide range of contexts. On its own, adjustment index refers to a numerical alteration of given data to improve the accuracy or utility of a dataset. Such improvement might aim to remove distortions such as seasonal ebbs and flows in a particular data set or to account for a relatively small sample size. An adjustment can update an out-of-date piece of data to better represent present-day conditions. It can also improve the comparability of distinct data sets. In business transactions, parties can use an adjustment index to allow for modifications based on prevailing market conditions. Ultimately, an adjustment index can provide context for a stand-alone data set and thus maximize the applicability of that information. Indices do this in a huge variety of situations, as demonstrated by the following series of examples.

Three Examples of an Adjustment Index in Action

Perhaps the most widely known adjustment index is the one that lenders use to reset adjustable-rate mortgages (ARMs) after the initial period has expired. Typically this takes place three to 10 years into the life an ARM. At that point, the lender uses an adjustment index to reconcile the loan’s initial rate with prevailing market rates. The most frequently used such rate is the London Interbank Offered Rate (LIBOR). The lender will take that index and add a margin to set a new interest rate for the loan.

A second example demonstrates how researchers can use an adjustment index to compare a variety of data sets. The United Nations Development Program (UNDP)  maintains a Human Development Index (HDI) to track countries’ achievements in health, education and income. The HDI of various countries can be compared to demonstrate those countries’ relative levels of progress on those measures. However, this index failed to account for levels of gender- or race-based inequalities which the UNDP decided were relevant to the measure of HDI. To address this disparity across countries, the UNDP developed an inequality index which it then applied to the HDI to create an inequality-adjusted HDI (IHDI). This adjustment index allowed the UNDP to chart the progress of countries with high inequality problems relative to those without such challenges.

A third type of adjustment clause allows parties to a business or personal contract modify that agreement according to external economic variables. The Consumer Price Index (CPI), published monthly by the Bureau of Labor Statistics (BLS), is a commonly used adjustment index that parties to a contract will use to structure an escalation clause. This is common in a wide variety of agreements ranging from commercial leases to alimony payments. As the CPI rises or falls, the payer’s financial obligation will rise and fall.