Mergers and acquisitions in the insurance industry are complex, high-stakes endeavors, especially since carriers must navigate a market defined by growing economic uncertainty, evolving customer expectations, and increasing competition. While a target company’s balance sheet and income statement provide a starting point for due diligence, they fail to tell the whole story. Financial statement audits provide assurance over historical compliance, but they aren’t designed to assess the sustainability or accuracy of future earnings—the very foundation of a deal’s value. Relying on an audit alone means key risks can go unexamined. 

For buyers, sellers, and investors, a quality of earnings (QoE) review is essential for moving beyond compliance to uncover the true economic performance of a business. It provides the clarity needed to structure a successful deal, mitigate post-acquisition surprises, and ensure the transaction delivers on its strategic promise.

Strategic Value Beyond Compliance

A QoE review transforms diligence from a compliance exercise to a strategic advantage. By providing a clear and objective view of earnings, it empowers leadership teams to negotiate with confidence, reduce post-acquisition risk, and validate strategic fit.

To negotiate with confidence during a merger or acquisition, both buyers and sellers must arm themselves with a deep understanding of the target’s financial health. Net income doesn’t always tell the full story: 

• Did one-off, non-recurring transactions occur during the year? 
• What sort of estimates and non-cash items flow through the income statement? 
• How does operating cash flow compare to net income? 

Such questions become pivotal in evaluating the overall health of an acquisition target. This allows buyers or sellers the negotiating leverage to push for a deal structure that reflects true value and reduces risk.

A key benefit to performing a QoE review prior to a merger is reducing unnecessary  post-acquisition risk. No worthwhile transaction is risk-free; however, a QoE review will help mitigate risk by uncovering potential issues with revenue recognition, reserve adequacy, investment quality and portfolio yield sustainability, internal controls, and other complex areas before the deal closes. This is essential to helping prevent costly surprises. 

An often overlooked component of a merger is strategic fit: 

• Does market alignment exist? 
• Do the combined products and services complement or cannibalize one another? 
• What operational and technological synergies can the merger unlock? 
• Can a merger unlock increased economies of scale? 
• How compatible are the cultures? 

A QoE review involves more than the numbers. It is designed to dive deep into the strategic engine of the target to evaluate both monetary and non-monetary factors. The insights from a QoE analysis can help verify that an acquired entity will perform as expected and align with long-term growth objectives.

What a QoE Review Uncovers

A QoE review is not a financial statement audit. Instead, it’s a detailed analysis focused on evaluating the consistency and quality of a company’s reported earnings. The goal is to determine if historical earnings are sustainable and accurately reflect the company’s ongoing operations.

For insurance organizations, this analysis requires deep industry-specific knowledge. A thorough QoE analysis provides critical insights by evaluating:

• Consistency of Accounting Policies: Assess whether a company’s accounting practices are consistent, appropriate for the industry, and transparently applied.
• Quality of Internal Controls: Examine the quality of internal controls over financial reporting, which directly impacts the reliability of financial data.
• Subjectivity in Estimates: Analyze the degree of judgment used in developing critical accounting estimates, such as loss and loss adjustment expense reserves, which can significantly impact reported earnings.
• Quality of Data: Evaluate the completeness and transparency of the financial statements and related footnotes, including uncertainties and contingencies. Additionally, evaluate the quality of the audit workpapers of the company.
• Impact of Non-Recurring Transactions: Identify and quantify the impact of non-recurring or unusual transactions to normalize earnings and present a clearer picture of future performance.
• Impact of Related Party Transactions: Examine the impact of related party transactions on earnings to ensure they are properly disclosed and understood.
• Subjectivity in Tax Positions: Review the tax positions taken by the company in order to identify potential liabilities and compliance risks.
• Vendor Management Costs: Evaluate the scope of third-party vendor relationships, including the cost associated with vendor contracts.
• Project Post-acquisition Balances: Analyze existing balances and activities to determine whether they will be eliminated, modified, or newly established following the completion of the transaction.

Who Powers the QoE? Designing the Diligence Team

A successful QoE evaluation requires input and analysis from multiple internal stakeholders across the organization. While the Finance team provides the ‘What’ (the data), the Operational and Governance teams provide the ‘Why’ (the context). Without stakeholder alignment, management risks seeing a snapshot of the past rather than a roadmap for the future. This effort ensures the financial data is not only accurate but also reflects the company’s operational reality and provides confidence during the negotiation process.

Establishing the Strategic and Financial Foundation

The core management team provides the high-level strategy and essential financial data that form the basis of the QoE analysis for an acquisition target.

Validating Operational and Functional Context

Subject matter experts translate financial metrics into operational context. They verify that the numbers reflect the realities of the business, its market, and its people.

Driving Governance and Oversight

The governance team provides oversight and approves key findings and decisions based on the diligence report.

The collective effort of these stakeholders drives seamless integration into current systems, people, and processes. Their combined responsibilities and industry expertise is critical for assessing compliance and navigating the complex hurdles that could otherwise jeopardize a transaction.

The result is a fully integrated perspective that moves beyond compliance to deliver a strategic advantage in negotiations.

Plan Your Next Move with Clarity

Whether you are buying, selling, or investing, a quality of earnings evaluation is a powerful tool for risk mitigation and price justification during the merger and acquisition process. It provides the negotiating leverage you need to walk into the room with confidence, ensuring that the price you pay (or receive) is anchored in economic reality.

How Johnson Lambert Can Help

Johnson Lambert’s QoE services are tailored specifically for the complexities of the insurance sector, centering on the drivers of value and risk. We understand the operational realities of the industry, the regulatory environment and pressures, and the nuances of financial reporting for insurers and related organizations. This focus ensures that our analysis is technically sound and also strategically relevant to your business.

Contact us to learn more about how our quality of earnings and advisory services can support your strategic goals.