CLASSIFYING RISK
Agents should not rely on old information
to classify new clients' risks
By Linda S. Ferguson, CPCU
Improper classification always leads to serious pricing errors since classifications form the starting point ... if the starting point is wrong, the price will be wrong too.
Consider this scenario: "Doctor, good to meet you. As a new patient from out of town, I brought along my medical file. You can tell what is going on based on my old doctor's information--so no need to run tests or examine me--just prescribe the medicine I've been taking and let me get out of here. I'll see you when the prescription runs out."
The doctor will:
a) Write the prescription and charge for the visit
b) Laugh hysterically as he escorts you to the door
c) Explain that while the file is important, he needs to make his own examination before prescribing any treatment.
I've moved a lot and every time we meet a new doctor, the old information is never enough. The doctor must be satisfied that the treatment from my former physician is in line with the situation he observes. The doctor is not willing to make a diagnosis based on old information or previous treatment for three reasons:
1. He generally doesn't know the prior physician's skill or ability to accurately diagnose.
2. My physical condition might have changed since the last time I was examined.
3. Research may have developed additional information that would be pertinent and could impact the treatment plan.
Now, the question is--what do you do when a new client walks into your agency? One common practice is to obtain copies of the old policies and complete the application based on this information. This is like the doctor relying on the old file to treat you. The possibility for error is high.
First, you really don't know who classified the old policy. The producer could be a very knowledgeable individual. However, he or she could have been having a bad day or might have relied on what the prior producer had done so you could be continuing a long-term problem. Why rely on the thought process of the agent whose place you're taking?
Second, most successful commercial operations change over the years. Particularly in a market downturn, a business may take on additional lines as a protection. In a booming economy a business can specialize, but many diversify during downturns to add cash flow and utilize excess capacity.
Third, ISO changes classifications regularly. While the applicant may have been accurately classified in years past, changes in the ISO Commercial Lines manual may make available a more accurate classification or require that operations be split or combined.
The key to effective medical treatment is an accurate diagnosis. A physician cannot do anything but treat symptoms until the diagnosis is complete. Similarly, an applicant can never be properly placed and priced until its operations and exposures are understood and accurately classified.
The agent is the person closest to the applicant and the one who should provide the appropriate classification and exposure to the company for pricing.
Improper classification always leads to serious pricing errors since classifications form the starting point. No matter how many corrections are made in the pricing along the way, if the starting point is wrong, the price will be wrong too. Yes, sometimes incorrect classifying brings a lower price; but when correction time comes (just as the stock market correction time has come), a client will have a nasty surprise. The result is that you can lose the client. Consistent misclassification also can strain company relationships and may lead to removal of pricing authorities and other extras.
This column will discuss how to develop accurate general liability classifications based on ISO guidelines.
ISO provides a number of options for an individual risk which can appear close, so the agent might be inclined to throw a dart and take the "cheapest." However, each is different and unique.
Here are the options in the Habitational category:
* Apartment Buildings NOC - 60010
* Apartments Buildings - Garden - 60011
* Apartment Buildings or Hotels - Timesharing - four stories or more - 60013
* Apartments Buildings or Hotels - Timesharing - less than four stories - 60012
* Apartment Hotels - four stories or more - 60016
* Apartment Hotels - less than four stories - 60015
* Boarding or Rooming Houses - 61000
* Dwelling - one family - 63010
* Dwelling - two family - 63011
* Dwelling - three family - 63012
* Dwelling - four family - 63013
* Housing Project - federal, state, local - 64500
Remember the first code is an NOC (not otherwise classified) classification. This means that this code is to be used ONLY if all other possibilities have been exhausted.
The most inclusive class is the housing project class. If the housing units are dwellings, apartments or boarding houses that are owned and managed by federal, state or local authorities, this class MUST be used. Yes, they may be apartments or dwellings and fit into those classifications, but due to the ownership they must move into a different category.
What exactly is a garden apartment? According to the footnotes in the classification manual there are two criteria:
1) The structures may not exceed two stories;
2) There must be common management, control and community facilities.
If an insured owns five dwellings in a courtyard area, maintains all the facilities and provides common community facilities, the insured would be classified as garden apartments instead of dwellings. There is no limitation to number of units or size of complex. As long as all units are two stories or less, this is a garden apartment.
If either of the two criteria is not met, another classification must be used. If a criterion #1 above is met but not #2, the classification would be one of the dwellings classifications. If a criterion #2 is met but not #1, the apartment classification would be more appropriate.
When does an apartment become an apartment hotel? An apartment becomes an apartment hotel when daily rental of apartments becomes part of the operations of the facility. As long as fewer than 15% of the apartments are available for rental, the apartment hotel classification may be used. When more than 15% of the apartments are available for daily rental, the risk becomes a hotel.
So, sometimes what looks like a dwelling is actually a garden apartment, and sometimes what looks like an apartment is actually a hotel. The only way to be sure is to know your insured and check the classification manual. The previous diagnosis could have been wrong. *
The author
Linda Ferguson, CPCU, has 30 years of underwriting experience with national commercial lines carriers. She now operates a consulting business, Pleasant Street Consulting Company, in West Union, Ohio.