CLASSIFYING RISK–WHY PROPER RISK CLASSIFICATION IS IMPORTANT

(October 2013)

A competent physician never treats a new patient based solely on the contents of the previous physician’s patient files. He requires a new examination. Similarly, a competent insurance agent should never accept the classifications on a new customer’s prior policy without independently evaluating that customer’s exposures.

The agent should examine the prior policy, much as a physician refers to the information in the previous physician's file. However, the agent should consider three reasons that classifications may have to be changed.

• The information concerning who last classified the risk and the criterion used is usually not readily available. The previous producer or the party responsible for classifying the risk may have been extremely knowledgeable and proficient. However, that person may have had a bad day, and made poor decisions. That person may have relied on even older information that another previous producer developed. It is also possible that the party who prepared the information may not have had any idea what he or she was doing and just threw something together that looked right. A new agent should never blindly duplicate the efforts and thought processes of a previous producer without thoroughly evaluating and analyzing the risk.
• Most successful commercial operations respond to changes in their marketplace or environment. When market or economic conditions are difficult, and normal product lines do not perform as they should or did when times were better, the successful enterprise may decide to develop, manufacture, and market additional product lines as a hedge against the difficult market conditions. On the other hand, another enterprise might specialize in a particular product during economic boom times and diversify if needed during economic downturns in order to enhance and increase its cash flow and to utilize excess manufacturing or storage capacity.
• ISO regularly changes classifications but the changes may not be predictable or even logical. An applicant may have been accurately classified in the past and even up to the present time. However, a new classification approach renders the old classification obsolete and it may require using completely new classifications. The new approach may even require that an old classification be split into two or more classifications or that previously separate classifications be combined into one entirely new classification.

The insurance agent is the customer's representative to the insurance company. As such, he or she is responsible for providing appropriate and accurate classifications that should be based on the risk’s current business operations.

Accurate classification information allows the insurance company to develop the proper premium for the specific risk. Not doing so can lead to serious pricing errors that can also affect the risk’s desirability and acceptability from the underwriting standpoint. This problem almost always tends to compound itself. If the initial classification and rating is wrong, subsequent attempts to correct the errors usually result in the error getting worse instead of better.

If an incorrectly classified risk is sold based on a lower premium, the error will eventually be revealed, corrections made, and the client disappointed by the unpleasant surprise due to the correction. In many cases, the agent loses the customer and the cycle begins all over again.

In addition, the insurance company’s relationship with a specific agent can become strained when it discovers a pattern of misclassification errors from that agent. This can lead to remedial actions, such as removing binding and pricing authority from that agent, as well as other restrictions.

CLASSIFYING RISK–HABITATIONAL PROPERTIES

(October 2013)

INTRODUCTION

Everyone lives in a habitational property. Personal lines coverage forms and policies insure a habitational property occupied by the same person who owns it. However, commercial lines coverage forms and policies insure such properties that a business or person owns that others occupy.

CLASSIFICATIONS

Assigning residential classifications is subject to Commercial General Liability Rule 31. It states that the proper classification is the one that best describes either the occupancy or the ownership of the particular premises.

The Insurance Services Office (ISO) developed these classifications to recognize the many different types of commercial habitational exposures:

• Class Code 60010: Apartment Buildings (NOC)
• Class Code 60011: Apartment Buildings–Garden
• Class Code 60012: Apartment Buildings or Hotels–Time Sharing–Less Than Four Stories
• Class Code 60013: Apartment Buildings or Hotels–Time Sharing–Four Stories or More
• Class Code 60015: Apartment Hotels–Less Than Four Stories
• Class Code 60016: Apartment Hotels–Four Stories or More
• Class Code 61000: Boarding or Rooming Houses
• Class Code 63010: Dwellings–One-Family (Lessor's Risk Only)
• Class Code 63011: Dwellings–Two-Family (Lessor's Risk Only)
• Class Code 63012: Dwellings–Three-Family (Lessor's Risk Only)
• Class Code 63013: Dwellings–Four-Family (Lessor's Risk Only)
• Class Code 64500: Housing Projects–Federal, State, Local

HOUSING PROJECTS

Class Code 64500: Housing Projects–Federal, State, Local is the most inclusive category. This classification is used if a federal, state, or local governmental unit or entity owns or manages the premises, regardless of the type of residential occupancy. This applies even if the particular building fits within one or more of the other habitational classifications. This classification is used exclusively in cases where a federal, state, or local governmental unit owns and manages the housing project being considered.

GARDEN APARTMENTS

The notes for Class Code 60011: Apartment Buildings–Garden in the General Liability Classification Tables explain when to use this code. All buildings must be two stories or less. In addition, all building must be subject to the same management and access to the same community facilities. The buildings may contain single or multiple units.

Another classification must be considered if the risk does not meet all of the criteria.

APARTMENT HOTELS

There is a distinction between apartment buildings and apartment hotels. Simply stated, apartment hotels rent some or all of its habitational units on a daily basis. If the number of units so rented is not more than 15% of all units in the building, one of the apartment building class codes is used. If the number of units so rented exceeds this percentage, the risk is classified as an apartment hotel.

BOARDING OR ROOMING HOUSES

There are no footnotes that explain when Class Code 61000: Boarding or Rooming Houses is used instead of apartments or apartment hotels. This means that the ISO PAAS manual must be examined to review the operations this code contemplates. The main difference is bathrooms. Boarding houses have shared facilities. Apartment hotels units have private facilities.

DWELLINGS

Dwellings that the named insured owns and rents to others are rated using one of the dwelling codes above. However, this is only if they do not meet the criteria established in the Garden Apartments classification. It is important to note that, according to the footnotes, a dwelling may be an apartment or dwelling that a corporation owns and provides to employees or others for use without a lease and without payment. It also includes time-share apartments that corporations own that are used exclusively by their employees and executives.

NOT OTHERWISE CLASSIFIED

Class Code 60010: Apartment Buildings (NOC) can be used if all of the listed habitational classes have been reviewed and a particular risk does not fit into a class based on the footnotes and operations that PAAS contemplates. The not otherwise classified class codes are not used until all other selections have been considered and rejected.

SUMMARY

What seems to be a dwelling might actually be a garden apartment and what appears to be an apartment building could actually be an apartment hotel. The only way to be certain is to know your insured, the way it does business, and pay close attention to the classifications and notes in the General Liability Classification Tables.