Frequency Vs. Severity of Insurance Claims

“I have insurance, I’ll just file a claim.”

Have you heard yourself saying that before? I’m sure you have at least thought it in the past. Unfortunately, a common misconception people have about insurance is that small claims will not affect them since the insurance company is still taking in more money from the premiums that are paid than the amount they are paying out in claims.

In reality, when comparing two businesses against each other, one that has multiple small claims versus one that has had only one large claim, every insurance company will look more favorably upon the business with only one claim. Why is that?

When assessing the risk of a business, insurance companies look at three factors when it comes to their claims; the cause(s) of loss, the frequency of similar incidents and the severity of each. Claims are typically categorize them into these four classifications:

1. Low Frequency – Low Severity
2. High Frequency – Low Severity
3. High Frequency – High Severity
4. Low Frequency – High Severity

With these four classifications in mind, the business owner can decide how to best handle losses to be viewed as a better insurance risk to the insurance companies.

Obviously, we know, the more favorable you look to an insurance company, the lower the premiums you will pay. So the business owner has four different ways to respond. Pssst, this is called Risk Management.

1. Accept the risk and budget for the impact of it
2. Prevent the risk by using loss control or safety measures
3. Avoid the risk all together
4. Transfer the risk to someone else

As you have probably figured out, insurance is for risks that have Low Frequency – High Severity and the reason we need to transfer the financial burden to someone else is because the risks are not predictable.

They can be things like a tornado taking out your shop, or an employee that is struck by a tree while on the jobsite. These risks would lead to claims that could have a huge financial impact on your business and potentially even lead you to close up shop. Insurance companies are comfortable covering these risks due to the law of large numbers, an insurance term meaning that as they add more policyholders, the probability of each one having a severe claim goes down.

What worries the insurance companies the most, is when there are a high frequency of low severity claims. This is simply because the more small claims you have the likelihood of a large claim happening is much greater.

For example, if a tree service has a large number of small fender benders, it likely means safe driving practices aren’t in place, their vehicles are not well maintained or they are employing reckless drivers. Over time, it is inevitable that a larger auto claim will occur.

Consider workers’ comp as well. Does your business have more than a couple laceration claims in the last couple years? Often times we’ll see laceration claims close for around $3,000, but it doesn’t take much more for a small laceration to turn into a permanent partial disability claim where a great employee loses a finger or even hand. And if chainsaws are causing issues, might there be other body parts with some exposure as well?

Telling your team you’ve seen an uptick in claims and explaining the repercussions is a great place to start. Also consider areas like your on-boarding process, safety meetings, and post-accident discussions. Get creative with this as each company likely has different experiences but you should be able to narrow down your problem areas based on previous claims or close calls. Refer to a previous article that I wrote titled “How To Get The Most Out of Your Safety Committee”, as this could be a job for your safety committee to take a deeper look at.

Now you know that when insurance companies asks for loss runs and sees a high frequency of claims, they are not only assuming you will continue to have more claims, they are also assuming that you are likely to have a much larger claim in the near future.

Work with your insurance agent to review your claim history and see if you notice any trends. It helps to write out which type of risks you want to pay attention to with loss control and safety training, which risks you’ll cover by paying out of pocket, and which risks you want to transfer to insurance. Look at that, you just created a Risk Management Plan!

And as always, feel free to reach out to an ArboRisk team member if you have any questions on how to best minimize your exposures to loss and ultimately secure the most competitive insurance rates!

Written by: Malcolm Jeffris, CTSP