Basics of General Liability Rating

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Larry Larson owns Larson Locks, a locksmith business. Larry recently switched general liability insurers and his new policy arrived in the mail yesterday. Larry has been perusing the policy and is now focused on the General Liability Declarations. The latter contains a section entitled Classification and Premium. This section shows how Larry's premium was derived but Larry can't make head or tail of it.

This article will shed some light on how insurers typically calculate general liability premiums. Many (but not all) insurers that offer general liability insurance utilize a rating system developed by the Insurance Services Office (ISO). This system is outlined below.

Elements of the Rating System

Under the standard general liability rating system, your premium is largely determined by three  factors:

  • the classifications assigned to your business
  • the rates assigned to those classifications
  • the exposure base (such as sales or payroll) to which the rates are applied

Classifications

Many insurers begin the rating process by classifying your business based on the ISO classification system. This system includes over a thousand separate liability classifications. Each classification represents a specific type of business operation. Examples are Drywall or Wallboard Installation, Locksmiths, and Gas Stations--Self Service.

 

The classification system is used to categorize your business based on the type of operations you conduct. Businesses with similar operations are assigned to the same classification. The idea is that companies operating the same types of businesses are subject to similar types of liability claims. Since similar businesses have similar risks, they are charged the same rate.

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).

Class Codes

Each general liability classification is assigned two five-digit numbers called class codes. (As explained later, some classifications are assigned only one class code.) One applies to premises and operations coverage and the other applies to products and completed operations coverage. For many classifications, the same five-digit number is used for both class codes.

Premises and operations coverage applies to claims filed against you by third parties (such as your customers) for bodily injury or property damage they sustain due to accidents that occur on your premises. An example is a typical slip and fall claim. This coverage also applies to injury or damage you accidentally cause to others while performing business operations away from your premises.

For example, you could cause property damage to a customer's warehouse while performing work there. 

Products and completed work coverage means coverage for claims filed against you for accidental injury or damage to others caused by your faulty products or by defective work or operations you have completed.

Some types of businesses produce no products or completed work (or what little they do produce is unlikely to generate claims). Examples are barber shops and book stores. Most liability claims against barber shops and book stores stem from accidents that occur on their premises. Thus, the classifications assigned to these businesses have only a premises and operations class code.  No separate products and completed operations class code is needed.

Here are examples of liability classifications and class codes.

For each of these classifications, the premises and operations class code and the products and completed work class code are the same.

Class Code DescriptionClass Code
Drywall or Wallboard Installation92338
Locksmiths14913
Gasoline Stations - Self Service13454

 

Rates

The rates used by insurers can vary widely from one to another. 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.

Depending on the nature and complexity of your operations, your business may be assigned one or more classifications. For most classifications, two separate rates will apply: one for premises and operations coverage and one for products and completed operations coverage.

Basis of Premium

Depending on the nature of your business, your liability premium may be based on 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 or payroll. For these classifications the premium is typically calculated by multiplying the rate times gross sales or payroll 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 differ. Moreover, the NCCI classification system is based on four-digit class codes while the liability system uses five-digit codes.