Statutory Opinions

Unallocated Loss Adjustment Expenses

The ULAE is a provision for the expenses that are expected to be incurred in the course of running off the insurance business underwritten to date but that aren’t allocated directly to the cost of a claim.  An example would be professional fees or rent on the premises used by the claims handlers.  An example of an expense that is not ULAE, since it is directly allocated is the legal cost of defending a liability claim.

Often, the insurance entity’s accounting department will perform their own calculation, based on actual projected costs.  However, there is a duty for the SAO for us to ensure that we are happy with the total provision (including ULEAE), which means having an independent view on the adequacy of the ULAE provision.

There are a number of ways of estimating ULAE actuarially.  They rest on the idea that indirect expenses will be driven largely by:

• Size of the reserve; a larger reserve requires more work to understand the nature of the liabilities
• Number of claims handled; for example the size of the claims handling staff will be directly related to this figure
• Complexity of business; exposures to complicated and costly issues require greater spend on professional advice as well as in-house staff.
• Volume of business written; Although underwriting expense is an initial cost rather than an ongoing cost, there will be costs associated with adjustment and reinstatement premiums.
• Volume of reinsurance; larger reinsurance programs will require a larger staff spend to take care of the program.

A common technique for approaching ULAE reasonability checks is to treat the size of the reserve and paydown of that reserve as a proxy for all of the above issues other than the last one.  The idea behind this is that:

• The size of the reserve is the dominant factor in determining expenses;
• That the number of claims handled will be related to the volume of claim payments.  The total future claim payments, which by definition has an expected value equal to the reserve, is therefore related to the total number of claims handled;
• The complexity of the business will be reflected in the length of the tail, which in turn is reflected by the size of the reserve and the paydown of that reserve.
• Reinstatement premiums will be a function of claim payments.  Adjustment premiums will be a function of exposure changes, which should be related to claim payments

As such, the technique involves investigating the recent and anticipated near future expenses as a proportion of claim payments.  If the technique is reasonable, there should be a fair degree of stability in this proportion.  We may then select an overall proportion that should apply to all future claim payments, i.e. the total gross reserve.

Adjustments to this technique may be made to allow for changing proportions, one-off events, particular “trigger” events (such as the changing nature of a business as it shrinks or grows) and the relationship of the expenses with the reinsurance spend.

What Statutory Work do we do?

Items Opined Upon Within the SAO