Loss and Loss Adjustment Expenses
In finance, a loss refers to a negative income. It is the state that transpires when the business does not succeed in generating sufficient returns to cover all the expenses in line with its operations. Thus, costs exceed revenues resulting to a negative income.
In insurance, losses incurred, or simply pure losses, are the net losses paid at the current year along with the change of loss reserves from the previous year. Losses outstanding characterize the losses incurred but not yet paid, while losses paid represent the sums paid to claimants to settle an insurance claim.
Furthermore, in insurance, there exists the so called loss adjustment expenses. This represents expenses incurred for investigating, defending, managing, and settling of losses. This may include costs to acquire police reports and other court costs alike. This cost no longer needs to be allocated to a specific claim. However, if this is allocated, then it is called “allocated loss adjustment expenses” (ALAE). Loss adjustment expenses do not take into account unallocated loss adjustment expenses. The latter includes salaries, employee costs, office costs, and similar overhead expenses.
The account loss and loss-adjustment expenses contain the reserves in total for the losses unpaid, plus other supplemental reserves set up by the business. It embodies the total business lines as well as all its accident years. Companies having significant increases in such reserves relative to its surplus face higher risks for probable deficiencies. This is due to the reserve’s inadequacy in meeting future claim settlements. However, many companies believe that reserves for loss and loss adjustment expenses are sufficient enough to pay off ultimate costs for claims and losses until its present time.
If the multiple of the reserves for losses is higher as against surplus, a business’s solvency is likely to be more dependent on having and sustaining the adequacy for reserves. This scenario can be identified using the loss and loss-adjustment reserves to policyholder surplus ratio.
The estimation of loss and loss adjustment expenses is based on the undiscounted source, which employs statistical analyses, distinct case-based valuations, and other actuarial procedures. The adjustments for these estimates are included in the expenses that took place in the same period as it was adjusted. Additionally, claim payments for the future is projected and reported based on the business’ historical data as well as the loss data of the industry it belongs.
Nonetheless, some reserves may not coincide with the assumptions utilized in the estimation. This may be due to several uncertainties, such as changes in economic and legislation conditions, judicial decisions, patterns in claims settlement, and reporting models.
Companies may fix a specific fee for every claim for in-house litigation. Half of this fee is then allocated for the expenses at the beginning of a litigation, while the other half is for those at the close of such litigation. This fees are determined based on the estimated number of litigated claims, as well as the expected schemes at the start of the year. It also takes into account the company’s proposed budget for in-house attorneys. These amounts are required to be adjusted once in every quarter basing from the company’s actual experience.