When it comes to the underwriting of insurance, there is a particular method insurer’s use when calculating how much the average claim costs. This method is called the frequency-severity method.
What Is the Frequency-Severity Method?
Overall, the frequency-severity method is a method for determining the expected number of claims that an insurer will receive during a given time period and how much the average claim will cost (Investopedia). The method takes historical data to estimate the average number of claims and overall average cost of each claim. In regard to frequency, the insurer is effectively anticipating the number of claims over a given period of time. If the frequency is high, it is indicative that a large number of claims is expected to occur.
Severity refers to the cost of the claim. A high-severity claim is more expensive than an average claim and a low-severity claim is less expensive than the average claim. The average costs of claims are estimated based on historical data. Homes and businesses in Florida, as an example, are frequently hit with hurricanes. Using the frequency-severity method, potential insurance companies would be mindful that the cost of the claim could be very high should total destruction occur.
One of the best things you can do as a business owner is to try and mitigate risk. By doing so, you are not only protecting your business but appearing more favorable in the eyes of the insurance company. While this topic can be convoluted at times, it is important to understand how insurance companies determine costs/claims. At Ramey King Insurance, our Commercial Agents are experts in this topic and would be happy to discuss the frequency-severity method and how it applies to your business. Contact us today for more information.