INTRODUCTION

An explanation of the American Association of Insurance Services (AAIS) formula for calculating commercial liability exposures can be found in the AAIS Commercial Liability Manual (CLM), Rule 7, Premium Development. This document provides an overview of the rating process as outlined in Rule 7 and offers a comprehensive understanding of how the premium is determined based on the insured’s operations.

A. CLASSIFICATIONS

The most challenging part of the rating process is determining the classification for a specific risk. It is during this initial step that understanding what exposures make up the risk is essential. Classifications can be found in the CLM, under Classification Table.

Understanding how to classify the risk is the most important part of rating.

o If a risk encompasses multiple operations, it may require multiple classifications. See Rule 6 – Risk Classification in the CLM.

o The same classification must be applied to both the premises/operations and the products/completed operations exposures.

It is crucial to thoroughly review the classification descriptions to fully understand how to use the classification correctly.

o If there are any conflicts between the descriptions and other rules, the descriptions will take precedence.

o Some classification descriptions include endorsement numbers and titles that must be included in the rated risk.

Some operations, such as parking areas, do not have separate ratings assigned when they are incorporated as part of another operation.

o These operations are referred to as Included Operations under Rule 6.2.

Ten operations are always rated separately, as specified in Rule 6.3 – Separately Rated Operations. Even if they appear to fall under the main classification, they still must be rated separately.

o For example: Swimming pools and athletic facilities commercially operated, or draft and saddle animals.

B. EXPOSURE BASE

Each classification determines what should be used as the rating basis. A symbol appears in the classification table beside the code.

· These symbols include measures, such as (a) area, (s) sales, or (p) payroll.

· In some cases, a flat fee may be used, such as a $15,000 flat fee for three flea market events.

NOTE: Rule 7 on Premium Development explains what to include and exclude in each premium base. This guidance is especially important when reviewing payroll and gross sales premium bases.

C. BASIC LIMITS RATES (LOSS COSTS)

The basic liability limit and the corresponding factor (loss cost) set the basic rate. The rates are determined by the insurance company and published in their rating manual. The loss costs for each classification are listed in the state pages.

Premises/operations loss costs vary by territory; however, the loss cost for products/completed work stays consistent within a state. The same class code applies to both premises/operations and products/completed work for rating purposes.

Sometimes exposures are rated as an “a” rate. In these cases, an “a” replaces the rate, and the company underwriter must determine the specific rate for the corresponding class. Each insurer creates its own judgment loss cost or final rate based on an assessment of the risk's exposures.

D. LOSS COST TO RATE

The loss cost must be converted into a rate factor (not an “a” rate). Each company is responsible for creating and filing the loss cost rates with each admitted state. Then this filed rate is used to determine the base rate by multiplying it with the base liability limit factor to determine the starting rate.

This rate can be further modified using coverage change factors to account for specific exclusions or limitations. Examples of situations where these factors are applicable include:

Personal And Advertising Injury Exclusion
Fire Damage Liability Exclusion
Medical Payments Exclusion

E. INCREASED LIMITS ADJUSTMENTS

Rates calculated in Step D – Loss Cost to Rate are multiplied by the increased limits factor. These factors can be found in the Countrywide Rating Information section of the Commercial Liability Manual. There are three tables for premises/operations rating and three tables for products/completed operations rating. The appropriate table is chosen based on the class and is listed with the loss costs.

NOTE: Refer to company underwriter to determine the applicable table.

F. EXPERIENCE AND SCHEDULE RATING

This step in the rating process also includes applying any other relevant rating modification factors, with experience rating and schedule rating being the most common. These factors customize the rate based on experience and loss history. Factors like the condition of the premises, safety measures, and loss control programs can be applied as credit factors for favorable experiences, while debit factors may apply in cases with less favorable experiences, frequent losses, or inadequate safety protocols.

AAIS provides the rules governing the experience and schedule rating plans. However, many insurance companies create and use their own factors and rating criteria in the calculations. These factors and criteria must be applied consistently and without discrimination.

Many insurance companies submit their own IRPM (Individual Risk Premium Modification), SRP (Supplemental Rating Plans), and similar rating adjustment plans. Typically, they use only one modification plan for each standard or specialty program. In most states, using both Schedule Rating and IRPM/SRP plans is not permitted, as this could be viewed as stacking modifications since they are based on the same judgment criteria.

G. DEDUCTIBLE

This factor is applied after the above calculations. Deductibles share the loss burden with the insured and can reduce the final rate, leading to a lower premium. While liability exposures often do not have deductibles, they can be applied to tailor the risk further.

NOTE: At the end of this step, the rate should be rounded to three decimal places. Up to this point, any loss cost or rate calculations are not rounded. This final rate is used for both premium calculation and auditing purposes.

H. EXPOSURE UNITS

This method quantifies the exposure basis. For example, payroll might be measured in units of $100, sales in increments of $1,000, and area in square feet. Other exposure units can be found next to each risk’s classification code.

The exposure unit outlined in Step B – Exposure Base above is multiplied by the final rate determined in Step E – Increased Limits Adjustments above.

Example: The rate is $0.50. The premium base applies to every $100 of payroll (p).

If the payroll is $500,000, it is calculated as follows:

$500,000 / $100 = $5,000 exposure base

The base premium calculation is .50 X 5,000 = $2,500.

NOTE: This is the final step in determining the premium.

I. MINIMUM PREMIUMS

Rule 7 outlines the method for determining the minimum premium applicable to a specific risk. Minimum premiums apply separately to premises/operations and products/completed operations. The insurance company provides the base minimum premium as shown on the applicable increased limits table.

NOTE: The process for determining minimum premiums does not apply to "if any" classifications.

J. ADDITIONAL PREMIUMS

Other premium charges may apply. These include charges for additional insured endorsements, enhanced coverage endorsements, and any additional endorsements for which additional premiums are charged.

K. TOTAL POLICY PREMIUM

The premium in Step J – Additional Premiums above is added to the larger premium determined in either Step H – Exposure Units or Step I – Minimum Premiums. This is the total estimated premium, subject to final audit and any necessary premium adjustments.

L. FINAL PREMIUM

The premium established in Step K – Total Policy Premium above is compared to the policy-writing minimum premium established by the insurance company. The larger of the two is the premium used.