To create a rate for a wholesale cost of a service contract or limited warranty, you enter four (4) values into the calculator.
The first value is the Frequency. The Frequency is the percent of the covered items that are expected to have a claim. For example, if you have 100 widgets, how many will fail in the period of time you are seeking to cover?
The second value is the Severity. The Severity refers to the cost to repair or replace the covered product. For example, if the average cost to repair an item is $250 then the Severity is $250.
The third value is the Target Loss Ratio (TLR). The Target Loss Ratio (TLR)refers to the expected utilization of the funds set aside for future claim payments. For example, if you set aside $100 and you spend $85 on claims then your Loss Ratio is 85%. A provider is going to expect a TLR to allow for a 'cushion' to address a higher frequency or severity than planned.
The fourth value is the Provider's Fee. This is calculated as a percent of the required claim reserve and should include premium tax. If the required claim reserve indicates you need $100 as the reserve, you will multiply that number by the provider's fee. If the fee is 12% including premium tax you would have a $12 Provider's Fee. Premium tax varies depending on how the program is structured and is 2.5% or less.