when an insurer receives a claim it doesn t open its checkbook immediately it first does its due diligence to ensure that the damages claimed by a policyholder are accurate this involves an investigation of an incident and claim the absence of an investigation could lead to losses from fraudulent claims 
loss adjustment expenses can include the costs of adjusters investigators attorneys mediators and more 1laes will vary widely depending upon how difficult a claim is to investigate even in cases where the lae is high insurance companies deem the expense worth it to avoid being bilked by fraudulent claims the investigation of claims can be a deterrent to those who might file fraudulent claims for an easy payday fraudulent insurance claims are believed to cost insurers billions of dollars these claims drive up insurance premiums for the rest of the customers as insurance companies must count fraudulent claims in their cost of doing business 2special considerationssome commercial liability policies contain endorsements that require policyholders to reimburse their insurance company for loss adjustment expenses it is important to carefully read the endorsement language which may indicate that a loss adjustment expense doesn t include the policyholder s attorney fees and costs if an insurer denies coverage and a policyholder successfully sues the insurer thus when there s no actual adjusting of the claim the insurance company shouldn t be allowed to use its deductible to cover policyholder expenses incurred when the policyholder defends the claim dismissed by the insurance company 3using lae to calculate the combined ratiothe combined ratio also known as the combined ratio after policyholder dividends ratio is one of the key profitability measures in the insurance industry it measures profits earned through daily underwriting activities and excludes investment related income the calculation includes the lae as shown below combined ratio incurred losses loss adjustment expense lae other underwriting expenses earned premiumsthe combined ratio essentially compares expenses to revenue a ratio below 100 means that the company is making an underwriting profit a ratio above 100 indicates an underwriting loss so when it comes to the combined ratio the lower the result the better as you can see from the above formula loss adjustment expense is one of the components used in the combined ratio formula all things being equal the higher the loss adjustment expense the higher the company s combined ratio and vice versa let s say for example insurance company abc incurred underwriting losses of 5 million loss adjustment expenses of 3 million and 2 million in underwriting expenses in q1 for a total of 10 million dollars in the same period the company earned 11 million in premiums thus abc s combined ratio for the quarter is 91 or 91 10 million 11 million it s making a profit as the 11 million in earned premiums outpaced the underwriting costs generally speaking a combined ratio in the range of 75 90 over the long run is considered healthy types of loss adjustment expenseloss adjusted expenses that are allocated to a specific claim are called allocated loss adjustment expenses alae while expenses not allocated to a specific claim are called 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 or 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 the cost associated with hiring that professional is an allocated loss adjustment expense other allocated expenses include the cost of obtaining police reports and the cost required to evaluate whether an injured driver is really injured insurance companies can also incur unallocated loss adjustment expenses unallocated expenses could be related to the salaries of the home office personnel maintenance costs of the fleet of vehicles used by in house investigators and other expenses incurred in the regular course of operations an insurance company that maintains a staff to evaluate claims but is fortunate enough to never have a claim filed will have salary and overhead as unallocated loss adjustment expenses but will not have any allocated loss adjustment expenses 