Adjusted Earnings: Meaning, Overview, Benefits
Adjusted earnings is a financial performance statistic used in the insurance sector. Profits plus increases in loss reserves, new business, deficiency reserves, deferred tax liabilities, and capital gains from the previous time period to the present time period equal adjusted earnings. Adjusted earnings measure how current performance compares to previous years' performance
Understanding Adjusted Earnings
Investors and regulators can assess an insurance business's performance in a variety of ways, and they frequently employ various analytical methodologies to achieve a full examination of an insurance firm. Adjusted earnings can be used to compare an insurance company's financial performance to that of other insurers in the industry. Adjusted earnings allow for the analysis of core earnings by excluding one-time events such as a one-time gain or loss from the sale of an asset.
The method for calculating adjusted earnings varies depending on the type of insurance sold. Because outside investors may not have access to the same amount of information as internal personnel, determining an insurer's adjusted profitability can be tricky. The methods used to examine expenses and premiums may differ. An insurance premium is the amount of money paid to an insurer by the policyholder on a monthly basis.
For example, a property and casualty insurance firm will calculate adjusted profits by adding its net income (or profit), catastrophe reserves, and price change reserves, then subtracting gains or losses from investing activities. Reserves, known as catastrophe reserves, are a pool of money retained by the insurer in the event of a catastrophe hazard, such as a storm or flood. A life insurance firm, on the other hand, may deduct capital transactions, such as increases in capital or money, from increases in premiums written.
Qualitative Analysis
A qualitative study examines a company's growth prospects and performance using non-quantifiable data such as managerial expertise and industry cycles. A qualitative examination of an insurance firm would most likely reveal how the company intends to expand in the future, how it compensates personnel, and how it manages its tax obligations. The analysis would also assess how effective the management team is in running the business's operations.
Quantitative Analysis
A quantitative analysis, which employs a statistical approach to profitability, demonstrates how a corporation manages its investments and determines the premiums to charge for policies underwritten by it.
Quantitative analysis can also reveal how a corporation manages risk through reinsurance treaties, which are insurance policies purchased from another insurer. The company that provides or cedes insurance policies to another insurer is effectively passing or surrendering the risk of claims being filed on such policies to the other insurer. The firm that purchases the insurance is known as the reinsurer, and in exchange, it receives the premiums from those policies minus a percentage that is handed back to the cedent insurer.
Reduced risk, when handled appropriately, can assist insurers in minimizing claim damage and increasing earnings. If the policies are not adequately ceded, or if the reinsurer takes on too many risky policies, it may indicate that earnings will suffer if claims are lodged against those policies. The ability to manage the correct mix of income and risk from reinsurance treaties is a significant driver of adjusted profitability.
Quantitative research also reveals how much it costs to keep existing consumers and gain new ones. Investors will also consider the insurer's adjusted earnings and adjusted book value, which is the company's value after liquidating all of its assets and paying off all of its liabilities or debts. The book value of a corporation is simply its net worth.
Benefits of Adjusted Earnings
In general, adjusted earnings can be used to determine the value of a company to new owners. The statistic is used to evaluate many aspects of a company's financial strength. This is required because unadjusted earnings statements based on generally accepted accounting principles (GAAP) may not always accurately reflect a company's financial performance. The Securities and Exchange Commission (SEC), which oversees corporate financial reporting, mandates public businesses to employ GAAP accounting for their reported financial statements.
Adjusted earnings metrics, on the other hand, are not GAAP-compliant and will produce different earnings figures than unadjusted earnings. Earnings or net income is GAAP compliant and indicates a company's bottom line profit after all expenses and costs have been deducted from sales. Calculating adjusted earnings, on the other hand, would include adding or subtracting financial factors from net income to arrive at earnings from running the core business.
A firm, for example, may write down an asset or restructure its organization. These are usually big, one-time expenses that affect a company's profits. To put it another way, the write-down would reduce net income. An "adjusted" profits figure would exclude nonrecurring charges, implying that the write-down cost would be included back into earnings to assist demonstrate how well the company is functioning without distortions from one-time transactions.
As a result, adjusted profits can be combined with GAAP-compliant earnings, such as net income, to provide a more complete picture of an insurance company's financial performance.