ISO's advisory prospective loss costs are accurate projections of average future claim costs and loss-adjustment expenses—overall and by coverage, class, territory, and other categories.
Your company can use ISO's estimates of future loss costs in making independent decisions about the prices you charge for your policies. For most property/casualty insurers, in most lines of business, ISO loss costs are an essential piece of information. You can consider our loss data—together with other information and your own judgment—in determining your competitive pricing strategies.
For most liability lines, ISO aggregates the premium and loss data by policy year. That is, we aggregate all the premiums from all the policies or exposures written during the year and all the losses covered by those policies.
For most other lines of insurance we aggregate the data by accident year. We aggregate all the exposures or premiums earned during the year and all losses on accidents that occur during the year.
In either case, we want to use the most recent available data — the latest available policy or accident years — as the basis for our loss costs. That recent data best reflects the current social, legal, technological, and other conditions that affect losses.
But because it takes time to learn about, settle, and pay claims, the most recent data is always incomplete. Therefore, ISO uses a process called loss development to adjust insurers' early estimates of losses to their ultimate level. We look at historical patterns of the changes in loss estimates from an early evaluation date — shortly after the end of a given policy or accident year — to the time, several or many years later, when the insurers have settled and paid all the losses.
ISO calculates loss development factors that allow us to adjust the data from a number of recent policy or accident years to the ultimate settlement level. We use the adjusted — or developed — data as the basis for the rest of our calculations.
Losses adjusted by loss-development factors and loaded to include loss-adjustment expenses give the best estimates of the costs insurers will ultimately pay for past policies. But you need estimates of losses in the future — when your new policies will be in effect.
To produce those estimates, ISO looks separately at two components of the loss cost — claim frequency and claim severity. We examine recent historical patterns in the number of claims per unit of exposure (the frequency) and in the average cost per claim (the severity).
We also consider changes in external conditions. For example, for auto insurance, we look at changes in speed limits, road conditions, traffic density, gasoline prices, the extent of driver education, and patterns of drunk driving. For just three lines of insurance — commercial auto, personal auto, and homeowners — ISO performs 3,000 separate reviews per year to estimate loss trends.
Through this kind of analysis, we develop trend factors that we use to adjust the developed losses and loss-adjustment expenses to the future period for which you need cost information.