Best way to place/mount temperature sensors to optimize thermal conductivity an App note from Silicon Labs. Link here (PDF)
The Si70xx temperature sensors work by measuring the Vbe of an on chip transistor at two currents in a precise ratio to measure temperature. The resulting voltage is digitized, calibrated and linearized such that after conversion the temperature can be easily calculated.
Thus the temperature being measured is the temperature of the die within the Si70xx package. This die is mounted on a metal lead frame. It is useful to think of the leadframe as the thermal input to the die since the thermal resistance from the paddle to die is quite low (a few °C/W) while the thermal resistance through the top of the package is quite high (over 1000 °C/watt for convective heat transfer).