Loss Adjustment Expense (LAE)

What Is Loss Adjustment Expense (LAE)?

A loss adjustment expense (LAE) is a cost insurance companies incur while investigating and settling an insurance claim.

How Loss Adjustment Expense (LAE) Works

At the point when insurers receive a claim, they don't open their checkbooks right away. They do their due diligence to guarantee the number of damages claimed by the policyholder is accurate. They convey investigators to guarantee what was claimed really occurred. Not conducting an investigation could lead to losses from fraudulent claims.

The LAE will change widely depending upon how troublesome a claim is to investigate. Even in cases where the LAE is very high, insurance companies actually consider the expense worth it since knowing claims are being investigated acts as a hindrance to the people who could file fraudulent claims for a simple payday.

The information that companies are investigating claims will stop many individuals from filing false claims. With that in mind, paying the LAE is worth it to the companies that in any case may be bilked by fraudulent claims.

Fraudulent insurance claims are accepted to cost insurers billions of dollars. These claims drive up insurance premiums until the end of the customers as insurance companies must count fraudulent claims in their cost of doing business.

Special Considerations

Some commercial liability policies contain endorsements that expect policyholders to repay their insurance company for loss adjustment expenses. These expenses can include fees charged by attorneys, investigators, specialists, judges, middle people, and different fees or expenses incidental to adjusting a claim.

It is important to carefully peruse the endorsement language, which might indicate that a loss adjustment expense isn't intended to include the policyholder's attorney fees and costs assuming that an insurer denies coverage and a policyholder effectively sues the insurer.

In this situation, where the insurance company has done no real "adjusting" of the claim, it ought not be qualified for apply its deductible to expenses incurred by the policyholder in defending the claim abandoned by the insurance company.

Using LAE to Calculate Combined Ratios

The combined ratio, or "the combined ratio after policyholder dividends ratio," is one of the key profitability measures in the insurance industry. It just measures profits earned through daily underwriting activities and bars investment-related income.

The combined ratio is calculated by dividing the total of incurred losses and expenses by the earned premium:

Combined Ratio = (Incurred Losses + Loss Adjustment Expense (LAE) + Other Underwriting Expenses)/Earned Premiums

A ratio below 100 means that the company is making an underwriting profit, while a ratio over 100 says that it is underwriting at a loss. So with regards to combined ratio, the lower the better.

As you can see from the above formula, loss adjustment expense is one of the key parts utilized in the combined ratio formula. Everything equivalent, the higher (lower) the loss adjustment expense, the higher (lower) the company's combined ratio.

Suppose, for instance, insurance company ABC incurred underwriting losses of $5 million, loss adjustment expenses of $3 million, and $2 million in underwriting expenses in Q1 (for a total of $10 million dollars). In Q1, company ABC additionally earned $11 million in premiums. In this way, company ABC's combined ratio for the quarter is 91% ($10 million/$11 million).

Generally speaking, a combined ratio that midpoints in the scope of 75%-90% for a really long time is thought of as sound.

Types of Loss Adjustment Expense (LAE)

Loss-changed expenses that are allocated to a specific claim are called allocated loss adjustment expenses (ALAE), while expenses not allocated to a specific claim are called unallocated loss adjustment expenses (ULAE).

Allocated loss adjustment expenses happen when the insurance company pays for an investigator to survey claims made on a specific policy. For instance, a driver with an automobile insurance policy might be required to take a damaged vehicle to an authorized third-party shop so a repairman can survey the damage.

In the case of a third-party survey of the vehicle, the cost associated with hiring that professional is an allocated loss adjustment expense. Other allocated expenses include the cost of obtaining police reports, or the cost required to assess whether an injured driver is truly injured.

Insurance companies can likewise incur unallocated loss adjustment expenses. Unallocated expenses could be connected with the salaries of the [home office](/work space) faculty, maintenance costs of the fleet of vehicles utilized by in-house investigators, and different expenses incurred in the ordinary course of operations.

An insurance company that maintains a staff to assess claims, yet is sufficiently lucky to never have a claim filed, will have salary and overhead as unallocated loss adjustment expenses, however won't have any allocated loss adjustment expenses.

LAE FAQs

How Do You Calculate a Loss Ratio?

The loss ratio is calculated by dividing the total incurred losses by the total collected insurance premiums. It doesn't include underwriting and loss adjustment expenses, just like with the combined ratio.

What's the significance here If a Company's LAE Increases Each Year?

Assuming that a company's LAE increases every year, it could mean that management is excessively aggressive in its financial reporting. Specifically, they may be constantly under-reserving for losses and overstating income.

What Is the Difference Between an Incurred Loss and a LAE?

Incurred loss is essentially the amount of money an insurance company paid out in claims. Loss-changed expense, meanwhile, is the expense associated with investigating and settling those claims.

Highlights

• A loss adjustment expense is a cost insurance companies shoulder to investigate and settle insurance claims.
• Some loss adjustment expenses can be recovered by insurance companies by requiring the policyholder to pay them.
• Allocated costs are those accumulated during the active investigation of a claim. Unallocated costs are those made by the overhead of having to do investigations.
• In spite of the fact that loss adjustment expenses cut into an insurance company's primary concern, they pay them so they can try not to pay out for fraudulent claims.
• There are two types of loss adjustment expenses — allocated and unallocated.