Part I: Rating Commercial Property

These days, it’s easy to access all kinds of data with a click of the mouse. But when we’re faced with information overload, we can forget the basics.

The Basics of Commercial Lines Rating will help you brush up on the fundamentals. In Part I of this series , we’ll review the necessary components for developing a commercial property premium.

Rating commercial property is a multi-step process, controlled by seven factors:

1. Coverage form (building, contents, business income, etc.)
2. Cause of Loss form (Basic Form, Broad Form, Special Form, Earthquake Form)
3. Construction of the building
4. Occupancy of the building
5. Location of the property
6. Amount of insurance being written
7. Applicable coinsurance requirement

Incorporating all seven factors into your calculation allows you
to more accurately develop premiums.

Related:
WSRB's Essential Guide to Commercial Property Risk Assessment

Let’s take a look at these elements, one by one

1. Coverage form: These are the specifics of what your customer wants to insure. They can include tangibles like the building and its contents, and intangibles such as lost revenue following a business disruption.
2. Cause of loss form : This outlines the risks your customer wants to insure against. They can include fire, flood, earthquake, vandalism, smoke, lightning — anything that could cause a loss. Some customers are fine with minimal coverage. Others are more risk-averse and demand maximum coverage for multiple causes of loss. Read more about the Basic , Broad, and Special C ause of Loss forms.
3. Building construction : The extent of damage a building can incur greatly depends on the materials used in its construction. This is especially true when it comes to the peril of fire. Learn more about the construction classes in our blog series.
4. Occupancy: Who else is using the building you’re writing? A standalone clothing store may have a different risk than the same store in a strip mall, especially if it’s sharing a wall with a glass-blowing studio or restaurant with multiple deep fryers. Building occupants affect the property’s risk, and the premiums will reflect this.
5. Property location: Risks can also depend on where the building is located. If it’s near a river or ocean, flooding or tsunami may be a concern. If it’s out in the country, fire protection services could be limited. Even the neighborhood can matter. Some areas have a high incidence of vandalism and break-ins, which could increase the risk of damage.
6. Amount of insurance being written: This one is self-explanatory.
7. Applicable coinsurance requirement : The National Association of Insurance Commissioners (NAIC) defines coinsurance as “a clause contained in most property insurance policies to encourage policyholders to carry a reasonable amount of insurance. If the insured fails to maintain the amount specified in the clause (usually at least 80%), the insured shares a higher proportion of the loss.”

Coinsurance isn’t always required, and it’s frequently misunderstood. To help clear it up, here’s an example from a typical Building and Personal Property coverage form, comparing an underinsured property to one with adequate insurance.

The value of this property is $250,000. The coinsurance is 80%, and the amount of loss is $40,000.

Example 1 (Underinsurance)

Example 2 (Adequate Insurance)

The limit of insurance is $100,000

The limit of insurance is $200,000

Step 1: $250,000 x 80% = $200,000

(the minimum amount of insurance to meet the co-insurance requirements)

Step 2: $100,000 ÷ $200,000 = .50

Step 3: $40,000 x .50 = $20,000

Step 1: $250,000 x 80% = $200,000

(the minimum amount of insurance to meet the co-insurance requirements)

Step 2: $200,000 ÷ $200,000 = 1.00

Step 3: $40,000 x 100% = $40,000

No more than $20,000 of the loss will be paid. The insured is penalized and is responsible for the remaining $20,000.

$40,000 of the loss will be paid.

Related:
To Be Class Rated or Not to Be: Rule 85

Basic Group 1: Specific versus Class Rating

Once you’ve established the seven basic elements of your commercial risk, you need to review it for its Group 1 loss cost. Group 1 refers to a group of perils (causes of loss) that can be rated specifically (individually), or by class (grouping of similar types of businesses). The rating mechanics are the same for both.

Specific rating

This method is for risks not eligible for class rating and applies to an individual building and its contents. Specific loss costs are usually associated with larger businesses or those involved in hazardous operations.

Visit WSRB’s Subscriber Solutions website to find specifically rated properties and their loss costs, searchable by street address. Loss costs are developed as the result of an on-site inspection. When underwriting a building that needs an inspection, simply login and submit your inspection request.

Class rating

Many businesses can be rated on a class basis since similar businesses have similar exposure to loss and probabilities of sustaining damage. Exposures and probabilities are statistically analyzed, and the loss costs produced reflect the chance of loss for a typical business in each Commercial Statistical Plan (CSP) classification.

A few important things to know about class rating:

• Class loss costs contemplate average conditions of occupancy and typical construction.
• Class loss costs can be modified to reflect how an individual business may differ from others in its class.
• Washington class loss costs in the Commercial Lines Manual (CLM) are shown at Protection Class (PC) 5 and at a general location within the state.
• To calculate the loss cost for your particular risk, you will apply a PC multiplier to provide for the PC of the property being rated, and a territorial multiplier to provide for the location of the property.

Once you figure out the seven basic factors for premium development and determine its Group 1 loss cost, you’ll have the information you need to develop a Basic Group I premium for your customer.

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Terry Krueger was WSRB's Senior Subscriber Services Analyst until her recent retirement. She joined WSRB in 2005 after many years in the insurance industry, working in commercial lines rating and underwriting.