This article is part of a larger series on General Liability Insurance.
Ever wonder why your general liability premium is more than your buddy’s business insurance costs? It’s not an unreasonable question to wonder this and try to determine how general liability insurance is calculated. Depending on the unique factors of your business, insurance companies will rate the risk and determine your premium. Here are some insights into how that is done.
Key Components of General Liability Rating Systems
Every insurance company rates risk, and most of them do so based on uniform industry classifications found in one of the common coding databases, such as the Insurance Services Office’s (ISO) Commercial Lines Manual.
The purpose of the manual―or any classification tool―is “to group insureds into classifications so that the rate for each classification reflects the hazards common to those insureds.” In other words, based on what your company does, there will be a standard rate defined as the starting point for insurance carriers to use.
It’s important to note that it is just a starting point since every carrier prefers certain industries over others and will price policies accordingly. Most carriers start with the ISO rating or one of the other common databases, such as:
- North American Industry Classification System (NAICS)
- National Council on Compensation Insurance (NCCI)
- Standard Industrial Classifications (SIC)
Industry classifications can be found on the declarations page of your insurance policy. It’s wise to review the classification assigned to your business to make sure you are not overpaying for insurance based on a riskier industry.
Classifications start with the industry and then get more granular with sub-classifications for specific types of businesses within the industry. With the ISO, the classification code that defines the industry is a five-digit code.
For example, the following five-digit codes pertain to common industries with the ISO:
- 10000-19999: Mercantile
- 40000-49999: Miscellaneous
- 50000-59999: Manufacturing or Processing
- 60000-69999: Building or Premises
- 90000-99999: Contracting or Servicing
NAICs codes start with a two-digit code and expand the category up to six digits depending on how granular you want to get. For example, Construction is code 23, with Residential Building Construction being code 2361 and New Single-Family Housing Construction being code 236115.
The rates are defined based on the classification code. These are generalized rates and serve as the starting point based on the risk that the industry has. This is referred to as the “premium basis.”
The premium basis, sometimes called an exposure basis, is based on a value per $1,000 of gross sales, payroll, or another defined metric. For example, the premium basis in the manufacturing sector is based on gross sales while the premium basis in contracting is based on payroll. Mercantile classifications might be based on the square footage of the business. Every business classification has its own premium basis determined once the classification code is established.
Additional Factors in General Liability Rating
Each insurance carrier will also incorporate its own proprietary rating of other factors used in the calculation of premium.
Premises and Operations
The premises and operations will play a role in your premium calculation. This includes where the building is, how big it is, the amount of foot traffic to your establishment, and the hours of operation. This is important in determining general liability costs because it speaks to the potential claims that may occur.
For example, a bigger facility with more foot traffic is at a higher exposure for slip-and-fall accident claims. Another example of how operations will affect your rate is if you run something like a car wash that might lead to damage of personal property—the more likely you are to have a claim come from damaging someone’s property, the higher your premiums will be.
While the physical size of your business likely is covered in the premises portion of the rate calculation, how much business you do and how many customers you serve will affect the rate. This might be defined by business revenue or gross sales. The higher your revenues, the higher your risk classification will be.
The rationale behind this makes sense. A new business without much in revenues isn’t selling many products or services and is, therefore, less likely to have more interactions that can lead to a claim. As revenues grow, so does the exposure. Additionally, big companies tend to be targets for those who want to make fraudulent claims or go after larger dollar amounts to settle real claims simply because of the perception that the company can afford it.
One of the questions that many underwriting applications will ask is how many years the company has been in business and what is the industry experience of management. Newer companies or those with management that is less seasoned suggest a higher risk since the company may not have the resources or understanding to avoid claims. Simply put, the more experience a company has, even by virtue of its management, the less risky it is seen by the insurance company, and premiums reflect that.
There is no secret that the insurance industry uses claims history to rate insurance policies. Those with no claims often get a claim-free discount. The fewer claims a company has, the more favorable of a rate it will get. Conversely, the more claims a company has, not only is it more expensive, but it may be hard to find an insurance carrier willing to underwrite the risk.
The price of the policy will be related to the type of coverage you have included in the policy. This means that if you choose to double liability coverage, you can expect to see the premium increase―although double coverage does not equal a double premium. You may also have added coverage, such as an increase in coverage for something like money and valuable papers.
All the little inclusions will add to the policy premium. Talk to your insurance representative about whether or not a specific coverage is necessary for your business. If it isn’t, you can eliminate that additional cost.
While you won’t be able to estimate your general liability premium, you can get a good idea of the costs that affect the premium. Understanding why something affects costs helps you manage risk better in your business to reduce liabilities and, as a result, the premium. All premium calculations start with the class code and then factors things like location, revenues, and claims history.