[[Actuarial Notes Wiki|Wiki]] / [[Exam 5 (CAS)]] / **Loss Adjustment Expenses (LAE)** ## Definition ==Loss Adjustment Expenses LAE== Loss adjustment expenses (LAE) are the costs incurred by an insurance company to investigate, defend, and settle insurance claims. LAE is a critical component of total claim costs and must be included in ratemaking and reserving. ## Types of LAE ### Allocated Loss Adjustment Expenses (ALAE) Expenses directly attributable to specific claims: - Defense attorney fees - Expert witness fees - Court costs - Independent adjuster fees - Medical examinations - Appraisal costs ### Unallocated Loss Adjustment Expenses (ULAE) Expenses not directly attributable to individual claims: - Claims department salaries - Claims office rent and utilities - General claims administration - Technology and systems - Claims training - File storage ## Importance ### Ratemaking LAE can represent significant portion of total costs: - Auto liability: 10-15% of losses - Workers compensation: 10-20% of losses - Professional liability: 30-50% of losses - Must be included in rate calculations ### Reserving - ALAE reserved with individual claims - ULAE estimated in aggregate - Affects ultimate loss projections - Impacts reserve adequacy ## Treatment in Ratemaking ### Loss Plus LAE Methods **Including LAE in Loss Ratio Method** ``` Loss Ratio = (Losses + LAE) / Earned Premium Target Loss & LAE Ratio = (1 - Expense Ratio - Profit) ``` **Pure Premium Method with LAE** ``` Pure Premium including LAE = (Losses + LAE) / Exposures Rate = Pure Premium / (1 - Expense Ratio - Profit) ``` ### Separate LAE Loading Some methods calculate LAE as percentage: ``` LAE Ratio = LAE / Losses Total Claim Cost = Losses × (1 + LAE Ratio) ``` ## Example Calculation ``` Workers Compensation Rate Indication: Losses: $1,000,000 ALAE: $150,000 ULAE: $100,000 Total LAE: $250,000 Exposures: 1,000 units Earned Premium: $1,500,000 Loss & LAE Ratio: = ($1,000,000 + $250,000) / $1,500,000 = $1,250,000 / $1,500,000 = 83.3% Pure Premium: = $1,250,000 / 1,000 = $1,250 per exposure unit LAE as % of Losses: = $250,000 / $1,000,000 = 25% ``` ## Treatment in Reserving ### ALAE Reserves - Estimated for each claim - Based on expected defense/settlement costs - Developed using triangles - Part of case reserves ### ULAE Reserves - Estimated in aggregate - Typically as ratio to losses - Historical expense ratios - Applied to unpaid loss estimates ### Development Patterns ``` ALAE may have different patterns than losses: - Defense costs may peak later than indemnity - Settlement costs concentrated at closure - Different tail factors may apply ``` ## Variations by Line of Business ### High ALAE Lines **Liability Lines** - Professional liability: 30-50% - General liability: 15-25% - Requires extensive legal defense **Workers Compensation** - Medical case management - Vocational rehabilitation - Legal defense: 10-20% ### Low ALAE Lines **Property Lines** - Homeowners: 5-10% - Commercial property: 5-10% - Mostly appraisal and adjustment ## Trends in LAE ### Increasing Factors - Legal costs rising - Complex claims requiring more expertise - Increased litigation - Technology investments ### Efficiency Opportunities - Claims automation - Predictive analytics - Early intervention programs - Improved case management ## Related Concepts - [[Allocated Loss Adjustment Expenses (ALAE)]] - [[Unallocated Loss Adjustment Expenses (ULAE)]] - [[Pure Premium Method]] - [[Loss Ratio Method]] - [[Case Reserves]] ## References - Werner & Modlin, Chapters 4, 5 - Friedland, Chapter 3