Two malpractice policies cover the same surgeon for the same year. One pays for injuries that happen this year; the other pays for claims reported this year. Same doctor, different coverage trigger, different price.
Losses are the dollars paid to or for insureds. Loss adjustment expense (LAE) is the cost of investigating and settling those claims. LAE has two flavors.
ALAE is allocated loss adjustment expense: cost you can assign to one specific claim file. Defense attorneys, expert witnesses, and independent adjusters on a named claim are ALAE. The word "allocated" is the memory hook: you can allocate it to a claim.
ULAE is unallocated loss adjustment expense: general claims-department overhead that no single claim owns. Salaried in-house adjusters, claim-office rent, and claims software are ULAE.
Ratemaking leans on four ratios, and each one is defined by a choice of relevant statistics, an aggregation method, an accounting period, and a valuation date. Take a book with 10,000 exposures, 1,500 reported claims, $4,500,000 of losses, and $6,000,000 of premium.
Common mistakes
- Confusing ALAE and ULAE. Defense counsel on a named claim is ALAE; salaried in-house adjusters are ULAE. Loading a claim-specific expert fee as ULAE double-counts.
- Sequencing adjustments by rote. There is no universal order. Cap shock losses on trended losses or with a trend-indexed threshold, and add any catastrophe provision stated at a future cost level after trending and developing so you do not over-adjust it.
- Mismatching frequency and severity. Frequency's claim count and severity's claim count must use the same claim definition, including the same treatment of closed-without-payment claims.
Bottom line
- Frequency, severity, pure premium, and loss ratio are the four common ratios; keep the claim definition consistent between numerator and denominator.
- Losses fed into a rate indication are developed to ultimate, trended to the future cost level, and adjusted for catastrophes, shock claims, and benefit-level changes before you divide by exposures.
- Sequence develop, smooth, and trend to match how each provision was derived; develop-smooth-trend is one common arrangement, not a fixed rule.
- Trending and developing the same losses does not double count: trend moves the cost level, development moves the trended claim to settlement.
Exam shortcut
Build the loss input as one chain of develop, smooth, and trend, but do not treat that order as a law. Sequence each step to match how its provision was derived, cap shock losses on trended losses, and add a future-level catastrophe provision after trending and developing. When you see "ULAE ratio" or "LAE factor," multiply it against ultimate losses (plus ALAE) and add the product.
The full lesson (about 3,659 words, 24 min read) adds 4 worked examples, all 7 common mistakes, a self-check, free in the app.
Learning objectives
- A6
Browse all free Exam 5 lessons or jump into free Exam 5 practice questions.