# Average Severity

## What Is Average Severity?

Average severity is the amount of loss associated with an average insurance claim. It is calculated by dividing the total amount of losses an insurance company receives by the number of claims made against policies that it underwrites.

### Key Takeaways

• Average severity is the amount of loss associated with an average insurance claim.
• It is calculated by dividing the total amount of losses an insurance company receives by the number of claims made against policies that it underwrites.
• Insurance companies rely on actuaries and the models they create to predict future claims, as well as losses those claims may result in.
• Insurers use this information to determine the premiums they must charge in order to break even.

## Understanding Average Severity

Insurance companies make money by charging premiums in exchange for coverage against loss, and then reinvesting those periodic payments into interest-generating assets. In order to generate as much profit as possible, insurers must have a grasp of their liabilities and limit the number of claims they payout.

Severity, or the cost of claims, is closely monitored during the underwriting process for each type of policy. Past data is scrutinized to show the observed amount of loss for the average claim, or to estimate the amount of loss an insurer should expect from the average claim in the future.

Insurance companies use this information to determine the premiums they must charge in order to break even. The insurer will then add a percentage to this premium to so it can make a profit.

The pure premium, calculated by multiplying frequency by severity, represents the amount of money the insurer will need to pay in estimated losses over the life of the policy.

## Average Severity Methods

Insurance companies rely on actuaries and the models they create to predict future claims, as well as the losses those claims may result in. These models are dependent on a number of factors, including the type of risk being insured, the demographic and geographic information of the individual or business that bought a policy, and the number of claims that are made.

Actuaries look at past data to determine if any patterns exist and then compare this data to the industry at large. They also pay careful attention to external dynamics, such as the environment, government legislation, and the economy.

## Example of Average Severity

### Auto Insurance Claims

As the economy strengthens, more new cars are sold. During boom years, average claim severity rises, too, due to more cars being on the road, people generally driving further and the higher costs associated with repairing the most modern technology.

### Important

The average collision repair cost tends to rise as vehicles become more complex and feature more special materials.

Between 2007 and 2011, when fewer new vehicles were being sold as a result of the impact of the Great Recession, average annual severity for auto coverage increased only 0.27 percent. Then, as more new vehicles hit the roads between 2011 and 2015, average annual severity jumped to 3.10 percent.﻿﻿

Bodily injury claims, meanwhile, proved to be relatively stable before and after the recession. While bodily injury had a significant impact on profitability for years, it was the rise in frequency and severity on the physical damage side that weighed on margins across the insurance industry. The safer, more economically-friendly models demanded by regulators were costlier to repair. This, alongside increasingly adverse weather conditions, hurt insurers and contributed to a rise in auto premiums.﻿﻿

Article Sources
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1. Verisk. "Auto Claims Frequency, Severity: What’s Behind the Rise?" Accessed Dec. 5, 2020.