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CLASSIFYING RISK–COMPONENT PARTS

(April 2019)

INTRODUCTION

Many tragedies are caused when a small part malfunctions and starts a chain reaction. It may be a valve, a bolt, or another seemingly minor part that fails causing the rest of the product to not operate correctly, resulting in the entire product failing.

Who is responsible if the product fails and an injury occurs? Today’s manufacturing processes involve multiple parts manufactured by multiple component parts manufacturers that are finally assembled by the company with its name on the product. Who is responsible? Most courts state that anyone and everyone who contributed to the failure and the injury is culpable.

How should the manufacturing or processing of these component parts be classified for underwriting and rating purposes? Because a valve is a part used in aircraft, automotive, and machinery products we will use it as an example as we explore how to classify component parts.

CLASSIFICATION PROCEDURES

The Insurance Services Office (ISO) Commercial Lines Manual (CLM) General Liability Rules define how to begin the classifying process. There are general rules that apply to all classifications and then specific rules that apply to a specific category of risks. General Liability Rule 27, Manufacturing and Processing Risks–Classification Assignment and Premium Computation Procedures is our starting place. It begins by stating that the classification selected must “best describe” the named insured’s final product.

It goes on to state that if the named insured manufactures components that go into its own final product, there is no charge made for the component. As an example, if an aircraft manufacturer manufactures both the valve and the aircraft, there is no separate premium charge for the valve. However, if the aircraft manufacturer manufactures valves for its planes and for others, a separate charge is made for the valves sold to others but not the ones put in the aircraft manufacturer’s own product.

Class Code 59892: Valves Manufacturing is the classification that applies to valve manufacturing. The classification does not have any accompanying notes or instructions on how to apply it. Because it is not a Not Otherwise Classified (NOC) code, its use appears to be unlimited. However, a valve used in aircraft is the not the same as a valve used in automobile engines or in domestic plumbing systems. Therefore, should a valve that is a component part of a product be classified the same as that final product?

Let’s consider a few of the classifications that could be used instead of Valve Manufacturing:

Class Code 51201: Aircraft or Aircraft Parts Manufacturing might be used for valves that are manufactured as parts for the aircraft industry. This classification does not have any accompanying notes or instructions on how to apply it. Because it is not a Not Otherwise Classified (NOC) code, its use also appears to be unlimited.

When a valve is manufactured specifically for the automotive industry, one of the following classifications could be considered:

• Class Code 51252: Automobile, Bus, or Truck Parts Manufacturing–Not Operating Parts
• Class Code 51253: Automobile, Bus, or Truck Parts Manufacturing–Operating Parts

Class code 51253 contains a footnote that lists several parts that make up an automobile which qualify under this classification. The note specifically states that component parts of those parts are also part of this classification. Brakes, batteries, tires, inner tubes, and bodies and engines are not part of this class and must be classified and rated separately.

When a valve is manufactured to be part of a machine, one of the following classifications could be considered:

• Class Code 56654: Machinery or Machinery Parts Manufacturing.

This is a Not Otherwise Classified (NOC) classification.

• Class Code 56650: Machinery or Machinery Parts Manufacturing–Construction, Mining, or Materials Handling Type
• Class Code 56651: Machinery or Machinery Parts Manufacturing–Farm Type
• Class Code 56652: Machinery or Machinery Parts Manufacturing–Industrial Type
• Class Code 56653: Machinery or Machinery Parts Manufacturing–Metalworking

Note: None of these classifications contain any notes.

Because valve manufacturing does not have any accompanying notes, and the valve is the final product to a valve manufacturer, it could be argued that valve manufacturing is the only option. Some might agree but that would appear to negate the serious loss exposure differences between products that use the valve.

If we agree that the final product could be either a valve or an aircraft part, a decision must be made with respect to the classification that “best describes” the final product. Neither the rules nor the accompanying notes direct what should be done when two classes appear to apply equally to a final product. ISO does not address the issue directly so the old axiom of "the premium must follow the exposure" would seem to apply.

The insurance company must decide if the exposure is from a valve malfunction or an aircraft malfunction. So, the question must be, “What happens if the valve malfunctions?”

If the malfunction causes the aircraft to stop operating, veer, disintegrate, or in any way cause injury or damage, Class Code 51201: Aircraft or Aircraft Parts Manufacturing appears most appropriate. However, if a valve malfunction does not result in any of these or related events affecting the safe and normal operation of the aircraft Class Code 59892: Valves Manufacturing would more reflect the exposure.

This same analytical approach and exposure analysis also applies to the automobile and machinery parts classifications described above and to any other separately classified component parts, such as screws, nuts and bolts.

SUMMARY

Many classifications are very precise in their description and application and their accompanying notes state the exceptions that apply. However, certain classes require the same analytical approach and exposure analysis used in the example above to select the classification that best describes each named insured's final product or process. The "Classification Detective" must "follow the exposure" to accurately analyze and classify risks and exposures instead of just “following the money to the highest premium.”