Losses and Loss-Adjustment Expense: What it is, How it Works

Losses and loss adjustment expense is the portion of an insurance company’s reserves for unpaid losses and the costs of investigation and adjustment. Reserves for losses and loss adjustment expenses are treated as liabilities. This figure also includes estimates for losses for insurance ceded to reinsurers.

Breaking Down Losses and Loss-Adjustment Expense

Insurance companies set aside reserves to cover losses and loss adjustment expenses. It’s like an insurance company’s rainy day fund. The reserves are based on an estimate of the losses an insurer may face, meaning that the reserves could be adequate or may fall short. Estimating the reserves requires actuarial projections based on the types of policies underwritten. Insurers have several goals when processing a claim: ensure compliance with the contract benefits outlined in the policies, limit fraudulent claims, and make a profit from premiums.

Expenses associated with a claim are considered “allocated,” also known as allocated loss adjustment expenses (ALA), while reserves not associated with a claim are referred to as unallocated loss adjustment expenses (ULAE). Allocated loss adjustment expenses occur when the insurance company pays for an investigator to survey claims made on a specific policy. For example, a driver with an automobile insurance policy may be required to take a damaged vehicle to an authorized third-party shop for a mechanic to assess the damage. In the case of a third-party review of the vehicle, the cost of hiring that professional is an allocated loss adjustment expense. Other allocated expenses include obtaining police reports or evaluating an injured driver.

Losses and Loss-Adjustment Expense Accounting

At the end of the year, the insurance company submits its financial information to insurance regulators. Part of the reports submitted includes changes to the reserves for losses and loss adjustment expenses over the course of the year. To calculate what remains, the insurer takes the gross reserves for losses and loss adjustment expenses and removes the share of reserves going to reinsurers. The remainder is the net reserves for losses and loss adjustment expenses. The insurer then adjusts this figure by incurred expenses, expenses paid, acquisitions, divestments, transfers, and foreign currency translation effects. These calculations provide the net reserves for losses and loss adjustment expenses at the end of the year.

At the end of the year, the insurance company submits its financial information to insurance regulators. Part of the reports submitted includes changes to the reserves for losses and loss adjustment expenses over the course of the year. To calculate what remains, the insurer takes the gross reserves for losses and loss adjustment expenses and removes the share of reserves going to reinsurers. The remainder is the net reserves for losses and loss adjustment expenses. The insurer then adjusts this figure by incurred expenses, expenses paid, acquisitions, divestments, transfers, and foreign currency translation effects. These calculations provide the net reserves for losses and loss adjustment expenses at the end of the year.