Insurance in Your Quality of Earnings Review: What to Adjust and Ask

A quality of earnings review can test insurance in three places. First, does the seller's premium reflect what the business will really cost to insure under you? Second, are claims, recoveries and refunds one-time items to remove from adjusted earnings before interest, taxes, depreciation and amortization (EBITDA)? Third, did the seller pay for losses itself in ways that will keep happening? Not every review covers all three, so ask your provider what is in scope. This guide is for buyers in diligence and for owners using the findings after closing.

What is a quality of earnings review, and where does insurance show up?

A quality of earnings report is independent financial diligence on how reliable and sustainable a business's earnings are. Its core output is adjusted EBITDA (EBITDA after normalizing adjustments), which drives the price, the loan size and the investor case.

For deals financed with a Small Business Administration (SBA) 7(a) loan, the SBA's current lender rules require one in Initial Acquisition and Business Expansion deals with a business purchase price of $3 million or more. The report must include a cash proof (a check that the cash in the books ties to bank records), and the lender must use its findings to calculate debt service coverage. Outside SBA deals, the buyer, the lender or investors set the scope. See insurance after an SBA acquisition loan for the lender side.

Insurance touches the income statement in more places than one expense line:

• Premiums, sometimes split between cost of sales (workers' comp for field staff) and overhead.
• Workers' comp and general liability audit bills or refunds, which can land in a different year than the payroll or sales they relate to.
• Claim recoveries, often booked in other income.
• Repairs, settlements and legal fees for losses that were not insured or fell within a deductible.
• Owner personal policies run through the business.
• Prepaid premium and any accrued or expected audit balance, which can sit in net working capital. Ask your accountant and deal counsel how they are treated in the working capital target and who keeps any return premium.

How do you restate premium to what you will really pay?

Quality of earnings providers make normalizing adjustments that restate an expense as if it had been at its current, normal rate for the whole period. One accounting firm lists normalizing insurance cost over the historical period as an example of this kind of adjustment, though not every review makes it. Providers also make pro forma adjustments that restate results as if expected changes had already happened.

Applied to insurance, the go-forward cost can differ from the seller's historical expense for several reasons:

Whether a particular review makes a go-forward insurance adjustment depends on the provider and the engagement. The practical fix is to get indicative quotes for the program you will actually need before the numbers are final. Quotes depend on underwriting and are not coverage until a carrier binds them, but they give the model and the lender a real number. For building that number into the model, see budgeting insurance in your acquisition model.

How should one-time claims, recoveries and refunds be treated?

Quality of earnings reports typically remove non-recurring items in both directions. A one-time insurance recovery is usually subtracted as a non-recurring gain, and an uninsured casualty loss is often added back as a one-time loss. The questions are whether each item really is one-time and whether it sits in the right period.

Treatment varies by provider and engagement, so confirm each adjustment with your quality of earnings provider and your accountant.

Check every claim-related adjustment against five years of loss runs. A "one-time" loss that shows up in three of five years is a pattern. If loss runs are new to you, see how to read loss runs after you buy a business.

What about losses the seller paid for itself?

Owner-run businesses often absorb losses without involving an insurer: paying a customer directly for damaged property, fixing fleet dents out of pocket, carrying high deductibles, or settling an employee dispute with no employment practices coverage. These self-insured losses (losses the business pays itself, by choice or because no policy applied) are part of the real cost of operating the business.

• They tend to recur. If the business has paid small claims itself every year, a new owner will likely face similar costs, whether as retained losses or as premium for coverage that picks them up.
• They hide in other accounts. Look at repairs, legal, settlements, customer credits and miscellaneous expense, not just the insurance line.
• Some are a warning sign. Employee injuries handled off the books can breach workers' comp policy conditions and state reporting rules. Raise them with deal counsel.

Treating recurring self-insured losses as one-time add-backs can overstate adjusted EBITDA. The broader concept, all the costs of risk in one number, is covered in total cost of risk for small holding companies.

What should you ask about insurance during diligence?

Use this list with the seller, the quality of earnings provider and your broker:

1. Current declarations pages and the premium for every policy, with renewal dates.
2. Five years of loss runs for every line, dated within the last few months.
3. Workers' comp audit statements for the last three years and the current experience mod worksheet.
4. A list of open claims, their reserves and who is managing them.
5. General ledger detail for repairs, legal, settlements and customer credits, to find self-paid losses.
6. Any insurance recoveries, refunds or audit adjustments booked in the period, and what they related to.
7. Policies paid by the business that cover the owner personally.
8. Premium financing agreements and how finance charges were booked.
9. Contracts, leases and loan terms that set insurance requirements the business must meet.
10. Indicative quotes for the go-forward program, compared with the historical premium.

A quality of earnings provider focuses on the numbers. Whether the coverage itself fits the business is a separate review; see the insurance checklist for buying a business.

How do you use the insurance findings after closing?

The insurance work in a quality of earnings report is a ready-made baseline for your first year as owner.

A hypothetical example. A buyer's review of a business reporting $1,500,000 of EBITDA finds three insurance items: a $40,000 insurance recovery in other income for a prior-year loss, a $15,000 employee theft that no policy covered, and a go-forward program quoted at $30,000 a year more than the seller paid. The higher quote includes a lender-required umbrella and new crime coverage.

The numbers are illustrative, and whether a provider makes each adjustment depends on the engagement. After closing, use the findings to:

• Set the insurance budget from the go-forward cost, not the seller's history.
• Watch covenants. If the lender sized the loan on adjusted EBITDA, an insurance cost above the assumption eats into debt service coverage.
• Fix the gaps the review found, in order of exposure; start with your first 90 days of insurance as a new owner.
• Track savings separately from one-time refunds, so later gains hold up in your own exit diligence; see insurance savings as an EBITDA lever.

Questions about how the purchase agreement handles a pre-closing loss belong with deal counsel. Morrow can review the inherited policies against the go-forward assumptions in your model and request quotes where it makes sense.

Keep reading

• Insurance Savings as an EBITDA Lever: What a Lower Premium Is Worth
• The Seller Was Underinsured, So True EBITDA Is Lower
• Budgeting Insurance in Your Acquisition Model
• Was the Seller Underinsured? How to Tell and What It Costs You
• Insurance After an SBA Acquisition Loan: What SBA and Your Lender Require
• All guides for new business owners

Frequently asked questions

Does a quality of earnings provider check whether the insurance coverage is adequate?

Usually not in depth. The provider focuses on the numbers: whether insurance expense is normal, recurring and in the right period. Whether the policies fit the business, its contracts and its lender is a separate insurance review, ideally done before closing.

When in a deal should I get insurance quotes?

Before the quality of earnings work and the loan sizing are final, so the model uses a real go-forward cost. Quotes depend on underwriting and can change, and no coverage is in force until a carrier binds it.

Does SBA require a quality of earnings report?

Under SBA's current lender rules, a quality of earnings report with a cash proof (a check that the cash in the books ties to bank records) is required in 7(a) Initial Acquisition and Business Expansion deals with a business purchase price of $3 million or more, and the lender must use its findings to calculate debt service coverage. Below that threshold, and in deals outside SBA, whether you need one depends on your lender, investors and your own diligence plan. Ask your lender how it applies to your deal.

The deal closed and insurance costs more than the quality of earnings assumed. What now?

Update the budget and tell your board and lender early if covenants are tight. Then work the controllable items: class codes, payroll estimates, vehicle and property schedules, open claims and remarketing. Whether the purchase agreement gives you any remedy is a question for deal counsel.

Should insurance recoveries count as income in adjusted EBITDA?

Quality of earnings reports usually remove a one-time insurance recovery as a non-recurring gain, and match it against the loss it paid for. Ask your provider and accountant how a specific recovery should be treated.

References

• U.S. Small Business Administration: SOP 50 10 8.1, Lender and Development Company Loan Programs (effective October 1, 2026)
• The Bonadio Group: What to Expect in a Quality of Earnings Analysis
• Pease Bell CPAs: Quality of Earnings Adjustments, How They Change EBITDA in a Deal
• NCCI: Reporting Ownership Change Information

This article is general information, not legal, tax or financial advice, and not a coverage determination. Coverage depends on the actual policy wording, carrier underwriting, your purchase agreement and your contracts. Ask your attorney and accountant about deal and legal questions.