Losses and loss adjustment expense is the portion of an insurance company’s reserves set aside for unpaid losses and the costs of investigation and adjustment for losses. 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 a reserve 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 over a period of time, meaning that the reserves could be adequate or may fall short of covering its liabilities. Estimating the amount of reserves requires actuarial projections based upon the types of policies underwritten. Insurers have several goals when processing a claim: ensure that they comply with the contract benefits outlined in the policies that they underwrite, limit the prevalence and impact of fraudulent claims and make a profit from the premiums they receive.
Expenses associated with a particular 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 so that a mechanic can assess the damage. In the case of a third-party review 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 evaluate whether an injured driver is injured.
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 called net reserves for losses and loss adjustment expenses. The insurer then adjusts this figure by expenses incurred; expenses paid; acquisitions, divestments, and transfers; and foreign currency translation effects. These calculations provide the net reserves for losses and loss adjustment expenses that remain at the end of the year.