Final answer:
The statement is true; severity indeed refers to the average dollar value of a loss per claim occurrence. In insurance, severity is used to set premiums based on the expected cost of claims, ensuring premiums are actuarially fair.
Step-by-step explanation:
The statement that severity refers to the average dollar value of a loss per claim occurrence is true. In the context of insurance, severity measures the average cost of claims within a specific period. Insurance companies use severity, along with frequency, to determine the risk associated with insuring a particular group or individual and set premiums accordingly. For example, if drivers are classified into risk groups based on theexpected losses, the safest group may pay a premium equivalent to the average value of damages they cause, ensuring that the insurance is actuarially fair. Those in higher risk groups would pay higher premiums that reflect their greater potential for filing costly claims. Adverse selection occurs when there is asymmetry of information between the insurance company and the insured parties. If the insurer cannot accurately determine which individuals belong to high, medium, or low-risk groups, they may set premiums based on the average loss, unintentionally prompting only those with a high risk to purchase insurance, which can lead to considerable losses for the insurer.