(June 2019)
Rating commercial property exposures is a very exacting process. Each coverage and cause of loss is rated separately. The most exacting part is determining the correct fire rate. All other causes of loss are rated using a "one-size-fits-all" approach but the fire rate is unique and specific to the risk. There are three primary rating approaches used in fire rating:
After evaluating fire, this article evaluates developing premium for all covered causes of loss using the rate and value approach. However, before beginning to analyze fire, it is important to review the concept of loss costs and individual company expense factors.
Rating advisory boards and bureaus developed and filed rates on behalf of their member companies many years ago. These rates were developed in two steps. In the first, the rating board or bureau collected large quantities of credible loss and statistical information from its member companies, such as losses, construction data, details of different occupancies, and public protection class. They then used this data to develop loss costs for various classes of business. At this point, the second step came into play. It was based on aggregate data on its members’ reported expenses, contingencies, and profits. Combining the two factors resulted in a final rate.
At the present time, final rates as determined in the past are not published. The Insurance Services Office (ISO) provides only the first factor, the loss cost. The individual insurance company must then multiply that loss cost by its own expense modification factor to develop the final rate. This approach encourages competition because each company must control its own expenses in order for its loss cost multiplier to be competitive.
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Example: Based on losses for a particular risk, the loss cost is 1.25. Three companies are interested in quoting on this risk. Company A's filed loss cost multiplier is 1.50, Company B's is 1.75 and Company C has a 2.00 multiplier. Using this approach, Company A's rate is 1.875 (1.25 X 1.50), Company B's is 2.188 (1.25 X 1.75) and Company C's is 2.50 (1.25 X 2.00). In this example, Company A has a pricing advantage because of its lower expenses, expressed as a lower loss cost multiplier. |
The class rating procedure in the ISO Commercial Lines Manual (CLM) provides a uniform and standard way to develop rates for small commercial buildings and habitational risks that are not eligible for dwelling rating programs. The Basic Group I class rated loss cost approach applies to habitational risks, hotels, motels, mercantile, warehouse, and non-manufacturing classes as well as to a few specific manufacturing classes. Special class loss costs apply to all property in the open and to other special property. ISO Commercial Risk Services, Inc. (CRS) does not inspect or provide specific loss costs for properties eligible for class rating.
The Class Rate section of the CLM applies a simplified rating approach for property coverages on eligible commercial and habitational risks. The procedure is based on building construction and the type of occupancy. The loss costs the Basic Group I Class Rate section of the manual provides are the 80% coinsurance loss costs per $100 of insurance value or limit. An additional factor that reflects the public protection class at risk must be applied to the loss cost. This section also includes those factors.
Rules and forms contained in the rate section for each state apply to those classes or risks eligible for class rating. Protection class and territorial multipliers that apply to Basic Group I loss costs are in the state exception pages.
Risks eligible for class rating are not subject to inspection by either ISO or CRS in order to establish rates or determine eligibility.
The types of construction are described in Rule 15 of the CLM. Six types of construction are used in class rating:
This construction has exterior walls of wood or other combustible materials. Frame also includes mixed construction, such as brick veneer, stone veneer, wood-iron clad, or stucco on wood. Floors and roof materials are also combustible.
This construction has exterior walls constructed of masonry materials, such as adobe, brick, concrete, gypsum block, hollow concrete block, stone, and tile. Floors and roof materials are combustible.
This construction has exterior walls, floors, and roof constructed of and supported by metal, asbestos, gypsum, or other noncombustible materials.
Note: These three types of construction are sometimes referred to as inferior
construction because they have limited ability to contain a fire.
This construction has exterior walls constructed of masonry materials as described under the joisted masonry category above. The difference is that the floors and roof construction is metal or any of a number of other noncombustible materials.
This construction has exterior walls, floors, and roof constructed of masonry or fire resistive materials with a fire resistance rating of at least one hour but less than two hours.
This construction has exterior walls, floors, and roof constructed of masonry or fire resistive materials that have a fire resistance rating of more than two hours.
The following types of buildings and occupancies are eligible for Basic Group I class loss costs:
The following buildings or occupancies are not eligible for Basic Group I class loss costs:
The general class rates contemplate properties in average condition. Because some otherwise acceptable properties may not meet that standard, surcharges are available to apply to them. A loss cost surcharge is applied to the general class loss cost if any of the following conditions is present:
CSP class codes are listed in the ISO Commercial Statistical Plan (CSP) manual. They are also in the Division Five Fire and Allied Lines Classification Table pages by type of occupancy. In some cases, the building CSP class code is different than the one for business personal property. However, the loss cost is based on the building class code, not the business personal property class code.
The following criteria determine the CSP class code that applies to building:
Determine the appropriate building and personal property Basic Group I loss cost from the class loss costs in the state loss cost pages of the Commercial Property manual. It is important to note that the class code rate is based on the building class even when rating only personal property. The personal property CSP is used only to determine if loss cost grouping A, B, or C should be selected.
These are listed by type of construction for each CSP class code. When loss costs listed do not reflect a public protection class, the public protection class multipliers listed on the state protection class and territorial multiplier page are applied.
Certain exceptions may apply. The rules for class rates under Rule 85 must be reviewed to determine if they do.
For auxiliary and secondary buildings, the CSP class code loss costs for the occupancy's CSP class code loss cost are applied.
Some classes are neither eligible for class rates nor specifically rated. These are called Special Class Loss Costs and are listed in the Countrywide Loss Costs under Rule 85. Examples of Special Class Rate properties are property in the open, bridges, signs, and many other auxiliary buildings and structures.
ISO (or the appropriate rating organization that has jurisdiction) must inspect risks that are not eligible for class rates and publish a specific rate or loss cost. Risks that qualify for this treatment fall outside the class rating criteria for reasons such as:
ISO inspects risks that are not eligible for class rates. It uses a survey to calculate a specific loss cost for the property inspected. The specific loss cost is based on the rating schedule ISO establishes and uses. The risk sends one of two application forms to ISO to request that it publish the specific loss cost for a building or structure.
This is an ISO application used to request that ISO assign codes or develop specific loss costs for specific properties.
This is an ISO application used to request publication of tentative or estimated codes and loss costs for a specific property under construction. Final codes and loss costs cannot be developed until construction is complete and the occupancy established.
Note: The insured can obtain copies of ISO's rating survey. It can be used to highlight deficiencies and to work with the insured to reduce its loss costs. In addition, simple changes made during construction can add up to considerable savings later.
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Example: Mary decides to build a restaurant and asks Fred (her insurance agent) for help in projecting her insurance costs. They take the building plans to ISO and it produces a tentative loss cost. The interesting part is that the masonry noncombustible building is given a frame loss cost because the window area combined with the frame overhang represents more than a third of the exterior area. Armed with this information, Mary asks the architect to make a few minor changes in the plans. After the changes are implemented, the final loss cost is considerably lower because the construction is now primarily masonry non-combustible. |
Territorial multipliers are used with only class rated risks. They reflect the differences in loss costs based on locations within a state. These multipliers are in the state loss costs pages.
The rate can be reduced if causes of loss that are part of the Group I rate are excluded. This reduction is a rate credit, not a premium credit.
Loss costs are based on 80% coinsurance. A credit is applied to the rate if a higher coinsurance percentage is selected. A 1.50 surcharge is applied to the rate if the no-coinsurance option is selected.
This factor was added in 2011. It is based on the fact that properties with high values are less likely to sustain a total loss than properties with low values. Therefore, there is a statistical redundancy in the larger rates. ISO introduced this new factor in order to eliminate that redundancy. The Group I factor is based on the building's construction and the covered property's limit of insurance. The Group II factor is similar but does not consider construction to develop the relativity. Buildings use a neutral limit of $250,000. Personal property has a neutral limit of $50,000. Limits below the neutral limit are surcharged while limits above the neutral limit receive a credit.
Group I includes fire, lightning, explosion, vandalism, and sprinkler leakage causes of losses.
The premiums for building and personal property are developed individually using the following formula:
Step 1: Determine the Group I loss cost based on CSP Class code or specific rate described above.
Step 2: Multiply step 1 by the company loss cost multiplier (LCM) in order to develop a rate.
Step 3: If the risk is class rated, multiply step 2 by territory multiplier. Use 1.00 if not class rated
Step 4: Multiply step 3 by the applicable coinsurance factor.
Step 5: Multiply step 4 by the Limit of Insurance Relativity Factor to develop the final rate.
Step 6: Multiply step 5 by the limit of insurance (per $100).
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Example: Charlie insures his building for $300,000 at 90% coinsurance. He insures his personal property for $35,000 at 80% coinsurance. The Group I premium is developed as follows:
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Wind and hail are the two primary Group II causes of loss. However, it also includes smoke, aircraft, vehicles, riot, civil commotion, sinkhole collapse, and volcanic action. A symbol is assigned to a risk either through class rating, special class rating, or specific rating. The symbols are:
AA – Superior Construction
A – Wind Resistive Construction
AB – Semi-wind Resistive Construction
B – Ordinary Construction
In addition, a numeral can be placed before the symbol. For example, symbol 4B means the basic initial loss cost must be multiplied by a factor of 4 to develop the adjusted initial loss cost. The loss cost is listed in the state loss cost tables for the symbol that applies.
The premiums for building and personal property are developed individually using the following formula:
Step 1: Determine the Group II loss cost based on Class Code or specific rate.
Step 2: Multiply step 1 by the preceding numeral (if applicable).
Step 3: Multiply step 2 by the company loss cost multiplier in order to develop the rate.
Step 4: Multiply step 3 by the applicable coinsurance factor.
Step 5: Multiply step 4 by the Limit of Insurance Relativity Factor to develop the final rate.
Step 6: Multiply step 5 by the limit of insurance (per $100).
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Example: Charlie insures his building for $300,000 at 90% coinsurance. He insures his personal property for $35,000 at 80% coinsurance. His Group II symbol is B and Group II premium is developed as follows:
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ENHANCED
WIND RATING PROGRAM
ISO introduced an enhanced wind rating program in 2013. Its use and availability is determined at the state level. In states where it is used, certain buildings are not eligible for the class rated Group II rating described above. Instead, the Group II rate is developed based on its own specific wind hazard characteristics. The determination as to what buildings are specifically rated begins with the county where the building is located. The county is ranked as either low, medium, high, or severe. If the county rating is low, all buildings in that country continue to be class rated.
If the county rating is medium, all buildings with 50,000 or fewer square feet continue to be class rated.
If the county rating is high, all buildings with 25,000 or fewer square feet continue to be class rated.
If the county rating is severe, all buildings with less than 10,000 square feet continue to be class rated.
All buildings that do not fit within the class rating criteria are subject to site-specific rating.
This program’s benefit is that it encourages positive, proactive loss prevention measures by the individual building owner.
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Example: Miles and Fletcher are in a severe geographic wind hazard county. Each owns a commercial building with more than 10,000 square feet. Miles’ building is three stories high, has a significant number of attached outdoor fixtures, large windows, attached signs, and a severely pitched roof with regular roof shingles. Fletcher’s building is one story and is very plain. The small windows are glass block. The roof is flat. Under traditional class rating, both buildings are subject to the same Group II rate. Under the enhanced wind rating program, Fletcher’s building rating is significantly lower than Miles’. |
The rating manual explains the formulas to rate all other causes of loss. While it is important to follow the specific rules, the insurance company must multiply the loss cost factor developed by its loss cost multiplier to determine the final rate.
When a commercial property coverage form insures more than one building or item of property, the insured may want to cover them on a blanket basis. It selects a value sufficiently high to cover all property to be insured on that basis that becomes the coverage limit. This approach avoids coinsurance and underinsuring individual items of property when more than one is insured, as long as the overall limit is adequate.
This approach is a very useful and effective way to cover property that moves from one building to another in the insured’s operation. For example, a manufacturer would probably appreciate this approach in cases where raw material in a warehouse moves to the manufacturing facility and then moves to the finished stock storage building to await sale. In this situation, the values change as the property moves from one building to another. However, the insured is adequately protected as long as the total limit meets the coinsurance requirements for blanket coverage. The insurance company works to develop the blanket rate according to ISO rules.
Note that the basic rating to get to the blanket approach is the same. Each building (and its property limits) is rated the same way as specific coverage. The premiums are then added together and divided by the total limit to determine the blanket rate. This rate is recalculated annually, subject to receipt of a statement of values that lists the values for each building or structure. The insured pays a slight surcharge in the form of a reduced coinsurance credit when blanket treatment is used because this approach is to the insured's advantage, not the insurance company's.
Certain modifications are available to apply to the premiums determined as outlined above. Some of these are based on additional coverage features selected while others are based on restrictions or exclusions added to the coverage. In addition, some modifications are based exclusively on the insurance company underwriter's opinion.
Related Article: ISO Commercial Property Program Underwriting Considerations
Judgment rates are developed for a specific individual risk or situation. The difference between specific rates and judgment rates is that judgment rates are based on the insurance company underwriter's opinion or judgment, not on an ISO (or other rating organization) inspection and rate publication. These rates are usually determined after completing a detailed analysis or inspection of the risk's exposures and hazards. They are most often used in cases where there is no credible background or basis to determine a rate in the usual way and only the underwriter's knowledge and judgment is available. In other cases, they are used to apply to hazards, operations, or occupancies that are new, different, or unusual (or that have some other unique factor that prohibits the risk from being rated in the usual way). These rates are subject to the rules and regulations of the state where the risk is located. An individual rate filing may be required.
Rating's purpose is to develop a rate and premium that is fair, equitable, and credible, based on the exposures relative to the coverage provided. The rate must be adequate for the class, so the insurance company collects sufficient premium to pay losses and expenses. As with any business operation, the rate must also allow for a reasonable amount of profit in order for the carrier to continue operations and attract investors. It must be noted that the insured has the power to influence the initial rate. Even small changes in construction, occupancy, protection, and exposure can significantly affect the premium. As the insured works on reducing its rate, it also works on reducing the chance of sustaining a serious loss.