Unallocated loss adjustment expenses (ULAE) are expenses that are not attributed to the processing of a specific insurance claim. Unallocated loss adjustment expenses are part of an insurer’s expense reserves. These are among the largest expenses for which an insurer has to set aside funds, behind allocated loss adjustment expenses and contingent commissions.
Unallocated loss adjustment expenses, along with allocated loss adjustment expenses, represent an insurer's estimate of the money it will pay out in claims, as well as expenses associated with processing those claims.
Breaking Down Unallocated Loss Adjustment Expenses (ULAE)
In contrast to unallocated loss adjustment expenses (ULAE), allocated loss adjustment expenses (ALAE) are those expenses linked directly to the processing of a specific claim. Insurers that use third parties to investigate the veracity of claims or to act as loss adjusters may include this expense in its allocated loss adjustment expenses. Expenses associated with ULAE are more general and may include overhead, investigations, and salaries. The most common unallocated loss adjustment expenses are for operations and field adjusters.
Because unallocated loss adjustment expenses are not allocated, they do not apply to a specific claim, so there's no loss date or report date. This makes calculations tricky. There are several methods available for calculating ULAE.
The transaction-based method allocates costs to each claim transaction, using an average cost for each type of transaction. This is the most accurate method, but it is also the most difficult to calculate. Another method is to use a percentage of an average year’s ULAE paid out. This method does not account for growth or changes to how often claims are made. Insurers may also use a ratio of the amount of paid ULAE to paid losses, calculated from a certain number of years of data. This method does not include inflation adjustments.
Analysts can tell how accurate an insurance company has been at estimating its reserves by examining its loss reserve development. Loss reserve development involves an insurer adjusting estimates to its loss and loss-adjustment expense reserves over a period of time.
Reimbursement for Unallocated Loss Adjustment Expenses
Some commercial liability policies contain endorsements that require the policyholder to reimburse its insurance company for unallocated loss adjustment expenses or ALAE. These expenses can include fees charged by attorneys, investigators, experts, arbitrators, mediators, and other fees or expenses incidental to adjusting a claim.
It is important to carefully read the endorsement language, which may say that a loss adjustment expense is not intended to include the policyholder’s attorney fees and costs if an insurer denies coverage and a policyholder successfully sues the insurer. In this situation, where the insurance company has done no actual adjusting of the claim, it should not be entitled to apply its deductible to the expenses incurred by the policyholder in defending the claim abandoned by the insurance company.