Basics of General Liability Rating

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Like many small business owners, you have probably insured your company under a general liability policy. Your liability premium should be listed in the General Liability Declarations under the heading Classification and Premium. This section explains how your premium was calculated but the numbers can be confusing. The calculations will be easier to comprehend if you have a basic understanding of the system insurers use to rate general liability coverage.

Elements of the Rating System

Many (but not all) insurers calculate general liability premiums using a classification and rating system developed by the Insurance Services Office (ISO). Under this system, your premium is largely based on the following three factors:

  • the classifications assigned to your business
  • the rates assigned to those classifications (adjusted for the limits you have chosen)
  • the exposure base (such as sales or payroll) to which the rates are applied

1. Classifications

The first step in the rating process is to classify your business. ISO provides hundreds of classifications, each of which is identified by a description and a five-digit number called a class code. Here are some examples:

  • Locksmiths, class code 14913
  • Food Products Manufacturing, class code 53374
  • Drywall or Wallboard Installation, class code 92338

Each business is assigned a classification that reflects its industry and type of operation. The idea is that businesses with similar operations face comparable risks and generate similar types of claims. Thus, similar types of businesses are assigned the same classification.

For example, Larson Locks operates out of a storefront where it sells door locks, padlocks, safes, and other security-related products. The company also dispatches employees to customers' homes, businesses or vehicles to solve lock-related problems. Most locksmiths perform the same types of services as Larson Locks. Thus, general liability insurers typically assign businesses like Larson Locks to the same classification (Locksmiths).

Depending on the nature and complexity of your operations, your business may be assigned one or more classifications. Each classification has a corresponding class code.

Class codes are arranged into groups. For instance, all mercantile businesses are assigned a class code between 10000 and 19999. Likewise, all businesses that conduct manufacturing or processing operations are assigned a class code between 50000 and 59999.

2. Rates

The second element of the rating process is the rate. Rates may vary widely from one insurer to the next. Some insurers develop their own rates "from scratch." Others devise rates based on loss cost data obtained from ISO. No matter how your insurer calculates your rates, they should be listed in the Liability Declarations.

Note that the rate you pay will reflect the limits you have chosen for liability coverage. This means that you will pay a higher rate for a $1 million per occurrence limit than you would for a $100,000 limit.

A general liability policy includes two types of coverage: premises and operations coverage and products and completed work coverage. For many classifications, these coverages are rated separately. That is, one rate applies to premises and operations coverage and another rate applies to products and completed work coverage.

Premises and Operations

Premises and operations coverage applies to claims against your business for bodily injury or property damage caused by accidents that arise out of your premises. An example is a claim filed by a customer of yours who was injured in a slip and fall incident at your business office.

Premises and operations coverage also applies to claims for injury or damage caused by an accident that arises out of your company's ongoing operations. The operations may be performed at your premises (such as a manufacturing facility) or elsewhere (such as a job site). For instance, suppose an employee of yours accidentally breaks a piece of artwork while installing computer equipment at a customer's office location. If the customer files a property damage claim against your company, the claim should be covered by your premises and operations coverage.

Products and Completed Work

Products and completed work coverage apply to third-party claims for accidental injury or damage caused by your faulty products or by defective work or operations you have completed. For instance, a customer files a product liability claim against your bakery business after she breaks a tooth on a cherry pit contained in a pie she purchased at your store. As another example, a customer sues your concrete company for property damage after a wall you completed two months ago collapsed, damaging his truck.

Some types of businesses produce no products or completed work (or only negligible amounts). Examples are barber shops and bookstores. Most liability claims against barber shops and bookstores stem from accidents that occur on their premises. These businesses are charged for premises and operations coverage only. No charge is made for products and completed operations coverage

3. Exposure Base

The third element of general liability rating is the exposure base. Depending on the nature of your business, your exposure base may be the area of your building, the amount of gross sales you expect to generate during the policy year, your projected payroll, or some other factor.

Many classifications are rated based on sales. For these classifications, the premium is typically calculated by multiplying the rate times gross sales divided by 1000. For example, suppose that Larry expects Larson Locks to generate $5,000,000 in gross sales during his policy period. The rates shown on his policy are $1.00 for premises and operations and $1.50 for products and completed operations. Larry's premium is 1.00 X (5,000,000 / 1,000) plus 1.50 X (5,000,000 / 1,000) = 5000 plus 7,500 or $12,500.

Suppose that Larry's projected sales were only $5000. Since his calculated premium is so low (only $12.50) his insurer would charge him a minimum premium. This is the minimum amount for which an insurer is willing to issue a policy.

Workers Compensation Classifications

The classifications system used in general liability rating is not the same as the NCCI classification system used to rate workers compensation insurance. The classifications in the two systems are completely different. The NCCI classification system is based on four-digit class codes while the liability system uses five-digit codes.