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Chapter 1 Risk and insurance 1/9 Chapter

E2A Frequency 1

Imagine a house situated by the side of a river which is prone to overflowing its banks. There is doubt as
to the future outcome because it is uncertain whether the river will overflow again and, if it does, when
this will happen. The fact that the river is prone to overflowing increases the chance that damage will
occur.

Imagine a second house 100 metres away from the river bank and on a slight hill. This house is less at
risk from flooding because of its position.

E2B Severity
Our judgment as to the level of risk posed may change if we consider the potential amount of loss,
damage or destruction. For example, if the first house close to the river is valued at US$1.5m and the
second house, further away, is valued at US$4m, we might modify our view as to which house represents
the higher risk, in view of the higher potential severity of loss. Therefore, factors relating to both
frequency and severity must be taken into account in our assessment of risk. The relationship between
frequency and severity varies from one risk to another.
High frequency and low severity
In a large number of different risk situations, there is a high frequency and low severity of loss where
there are a large number of small losses and relatively few large losses. This is illustrated in figure 1.1.
This could relate to motor insurance, where there are many losses for vehicle damage at a fairly modest
level, but relatively few costly third party personal injury claims.

Figure 1.1: High frequency and low severity losses

Frequency Reference copy for CII Face to Face Training

Severity

Question 1.2
Consider water damage caused by a leaking washing machine in relation to the loss profile shown in figure 1.1.
What do you imagine is the relationship between frequency and severity for this type of claim? Draw a graph to
illustrate your conclusions.
Think of two other insurable risks for property which would fit this same profile.

This relationship between high frequency and low severity losses is not limited to property damage. In
fact, research into industrial injury incidents has shown a very similar pattern.
The Heinrich Triangle (given in figure 1.2) shows that, for every major injury at work, there are 30 minor
ones and 300 non-injury incidents. The triangle was created as the result of looking at several thousand
incidents at work and similar studies have given similar results. The pattern shows few serious incidents
and very many minor ones.