Loss Adjustment Expense (LAE)

What is LAE?

Loss adjustment expense (LAE) is the cost an insurer incurs to investigate, defend, and settle claims. These costs include payments for claims adjusters, outside investigators, attorneys, mediators, experts, and administrative support related to claims handling. LAE helps insurers detect and deter fraud and ensures claims are properly evaluated before payment.

How LAE works

• When a claim is reported, insurers conduct investigations and evaluations before paying.
• LAE covers the resources used to verify the claim, determine coverage, and negotiate or litigate settlements.
• The level of LAE varies by claim complexity; insurers generally consider the investigation cost justified to avoid fraudulent or inflated payouts.
• Fraudulent claims raise overall insurance costs for everyone, since insurers factor such losses into premiums.

Types of LAE

• Allocated Loss Adjustment Expenses (ALAE): Costs that can be attributed to a specific claim. Examples:
• Hiring an outside investigator or expert for a particular claim
• Obtaining police reports or accident reconstructions
• Payments to a repair shop for a vehicle appraisal tied to a claim
• Unallocated Loss Adjustment Expenses (ULAE): Overhead and general claim-handling costs not tied to a single claim. Examples:
• Salaries of in-house claims staff
• Office and fleet maintenance for claims personnel
• General claims administration expenses

Combined ratio and profitability

The combined ratio measures an insurer’s underwriting profitability; it includes incurred losses, LAE, and other underwriting expenses compared with earned premiums.

Formula:
Combined ratio = (Incurred Losses + Loss Adjustment Expense + Other Underwriting Expenses) / Earned Premiums

Interpretation:
– A combined ratio below 100% indicates an underwriting profit (premiums exceed underwriting costs).
– A ratio above 100% indicates an underwriting loss.
– Over the long run, ratios roughly in the 75–90% range are generally considered healthy.

Example:
– Underwriting losses: $5 million
– LAE: $3 million
– Other underwriting expenses: $2 million
– Earned premiums: $11 million
Combined ratio = ($5M + $3M + $2M) / $11M = $10M / $11M = 91% (underwriting profit)

How LAE differs from related measures

• Loss ratio = Incurred losses / Earned premiums. It excludes LAE and other underwriting expenses.
• Incurred loss refers to amounts paid or reserved for claim payments. LAE is the expense of handling those claims.

Implications of rising LAE

• Increasing LAE can signal higher claim complexity, more litigation, or increased fraud.
• It may also indicate inadequate reserving practices—if reserves are systematically low, management might be under-reserving losses and overstating profitability.
• Rising LAE reduces underwriting profitability and can push the combined ratio upward.

Key considerations for policyholders

• Some commercial liability policies allow insurers to seek reimbursement from policyholders for certain LAE. Read endorsements carefully.
• Endorsements may specify whether the insurer will cover policyholders’ attorney fees if coverage is denied and the policyholder successfully litigates.
• If a claim is dismissed without adjustment, insurers generally should not apply the policy deductible to recover defense costs incurred by the policyholder.

Key takeaways

• LAE are the expenses insurers incur to investigate, defend, and settle claims.
• Allocated LAE apply to specific claims; unallocated LAE cover general claims operations.
• LAE factor into the combined ratio, a primary measure of underwriting profitability.
• Managing LAE is important for maintaining insurer financial health and keeping premiums stable.