How to Underwrite Property Exposures
The terms "Fire and Allied Lines" or "Fire and Allied Perils" include the major cause of loss as fire. They also include other insurable causes of loss to property commonly included with fire. These causes of loss include collapse, hail, lightning, smoke, and vehicle damage that are not generally specifically underwritten, plus some that are singled out for individual consideration or exclusion such as crime, earthquake and wind.
The Process of Proper Risk Selection (COPE)
Property underwriting is the process of proper risk selection, determination of amount of risk to be retained by the Company, and determination of the proper premium.
The most important decision an underwriter must make is whether or not to accept an individual risk. Poor risk selection decisions cannot be offset by subsequent decisions regarding pricing or retentions. This is a key fundamental of underwriting to understand. Pricing can never make a 'bad' account 'good', but it can make a 'good' account 'bad'.
It has been said many times, "never let the perfume of the premium outweigh the stench on the risk", meaning no matter how much premium is collected it will not out weigh the risk of writing the account.
Profitable growth can be attained only through selection of risks which offer a reasonable chance for good loss experience. Certain elements common to all fire risks have proven to be characteristics which are indicative of the quality of a particular risk. They are:
• construction (C)
• occupancy (O)
• protection (P)
• exposure (E)
Underwriters insure people against financial loss from damage to property when caused by insured perils. Consideration of the people involved is the necessary first element of underwriting. It is expected that an insured exercise good judgment to recognize and minimize hazards and control losses.
Experience has shown that people who run businesses which are profitable, operated efficiently, and exhibit pride of ownership (evidenced by good housekeeping and maintenance) experience far fewer losses than people who operate otherwise.
The hazard associated with people is called moral hazard. Moral hazard is the increased propensity for loss due to the considered, or ill-considered acts of people.
There are three distinct types of moral hazard.
- The first is criminal moral hazard, which is the likelihood (or degree thereof) of the commission of deliberate arson.
- The second type of moral hazard is indifference and/or neglect - allowing known deficiencies to exist uncorrected. This often indicates an attitude that a fire, while not actively initiated, would be welcomed.
- The third type of moral hazard is that of ignorance - failure or inability to recognize the inherent danger of existing conditions or practices.
A number of circumstances can contribute to the degree to which any of the described types of moral hazard can exist. The state of the economy (specifically, current demand for the insured's products or services) can directly Influence the first two types of moral hazard. Inexperience in any given business can affect all three types of moral hazard. Historically, a majority of business failures occur within the first five years of the business' existence. Additionally, inexperienced insureds are more apt to fail to recognize inherent dangers in their operations.
Because a failing business substantially increases the degree to which the first two types of moral hazards exist, it is extremely Important to know the financial condition of every insured business.
The construction of a risk is important for two reasons.
- First, type of construction will either contribute to or help contain the loss.
- Secondly, it must be determined whether or not the construction is proper for the fire load (the nature and amount of the contents) and the operations conducted within the building.
For fire insurance purposes, building construction is classified in the Commercial Lines Manual (CLM) as follows:
Class 1 - Frame (Wooden structure, may have brick veneer or metal exterior sheathing/covering)
Class 2 - Joisted Masonry (Masonry walls, combustible floors and roof)
Class 3 - Noncombustible (All metal) such as a Butler Building
Class 4 - Masonry Noncombustible (Masonry walls; non-combustible, usually steel, roof; floors usually concrete
Class 5 - Modified Fire Resistive (Fire resistance of between 1 & 2 hours; no exposed steel in frame, floors or roof).
Class 6 - Fire Resistive (Fire resistance of at least 2 hours; usually reinforced concrete floors and roof on rein forced concrete or concrete-enclosed steel frame).
Special structures such as underground property, tanks, towers, tents and signs are treated individually.
Property - Building Coverage
Occupancy is a major underwriting consideration . The hazards of occupancy greatly influence both the probability and severity of loss. Occupancy presents two types of hazards: common and special. Common hazards are those which exist in virtually every type of occupancy, i.e ., heat, light, power and air conditioning.
Special hazards are those which are unique to a given risk, or a class of risks. Special hazards include such things as cooking operations in a restaurant, painting operations in a manufacturer of metal goods, woodworking operations in manufacturing of furniture, storage of flammable liquids and so forth. The underwriter must fully consider all hazards of occupancy, both common and special, the degree to which they exist, and the degree to which they are properly controlled.
Control of hazards may also be accomplished by passive means. Segregation of ignition sources from combustibles by locating them away from each other is one example. Or, hazardous operations may be isolated by Interior walls that will confine a fire, delaying its spread until active protection can be implemented.
Private fire protection may help control the hazards of occupancy. Standpipes and hoses, fire extinguishers, automatic sprinkler systems, fire brigades, dry chemical automatic extinguishing systems and paint spray booths are examples. The underwriter must fully consider the hazards of occupancy and the private protection which exists to respond to those hazards.
Public fire protection consists of local fire departments, availability of water supply, number and location of fire hydrants, and accessibility to the property by the fire department. Public protection is categorized into ten (10) different protection grades (number one is best, number ten is worst). The Public Protection Classification Manual should be consulted for specific protection grades for specific localities.
The degree of public fire protection available to a risk, along with occupancy and construction, will greatly determine what percentage of a risk can be expected to be lost in the event of a fire.
The element of exposure pertains to that which is externally adjacent to a risk (usually other buildings or structures). Every exposure must be considered in all the preceding aspects (moral hazard, construction, occupancy, protection) to determine its potential effect on the risk in question. Distance from exposures must be considered in light of the above, expected weather conditions, and whatever exists between the exposure and the risk in question (paved parking lot, vegetation, outside storage, and so forth).
The word "deficiency" can be defined only when related to a specific underwriting consideration.
A "deficiency" is any risk condition which does not meet a Company underwriting standards. Examples: unprotected steel members in a building containing a moderate or heavier fire load is a major construction deficiency; an unapproved paint spray booth is an Occupancy deficiency, the seriousness of which is related to the extent of the painting operation and the specific reasons the booth is unapproved; an inadequate water supply from hydrants on a dead-end water main is a major Protection deficiency.
A Risk Grade is an underwriting judgment which reflects the extent to which the risk meets the Company's underwriting guidelines. Agency or business considerations should not influence the underwriter's analysis and grading of a risk. The extent to which these considerations should play a part in risk acceptance must be determined after the risk is underwritten on its own merits.
Risk Classification and Grading
The first step in the underwriting process is a thorough review of the risk to identify the operations, hazards, and hazard protection. As many sources of information as practical should be used. For larger and more complex risks, the amount of information needed to make an accurate analysis will be greater.
The relative desirability and acceptability of the risk can be expressed as GOOD, FAIR, or POOR.
The terms GOOD, FAIR, and POOR as used for risk grading are defined as:
- GOOD - An above-average risk because of superior features and no major deficiencies.
- FAIR - An average risk with no major deficiencies and few minor deficiencies.
- POOR - A below-average risk by reason of one or more major deficiencies, or several minor deficiencies.
An "average risk" is a risk with good management operating a financial successful business in a building suited to the occupancy with good housekeeping .and reasonable attention to fire hazards. It is a risk which would be found fully acceptable. Admitted Companies anticipate on average, about 80% of accounts will grade FAIR, 10% GOOD, and 10% POOR.
Property in a City
A Risk Grade is an underwriting judgment which reflects the extent to which the risk meets the Company's underwriting guidelines. Agency or business considerations should not Influence the underwriter's analysis and grading of a risk. The extent to which these considerations should play a part in risk acceptance must be determined after the risk is underwritten on its own merits.
The Risk Grade is assigned after analysis and determination of individual GOOD, FAIR, POOR gradings of the following basic underwriting considerations. The description given below includes a brief comment on the important features of each underwriting consideration.
INSURED - Financial stability and resources: Experience and management capabilities; success of present business; personal background; history of previous business ventures.
LOCATION - Suitability for business conducted; external vandalism or arson possibilities.
STRUCTURE - Age of building; maintenance; suitability for occupancy; construction and its relation to fire load and type of occupancy; insurance to value.
OCCUPANCY - Operations. conducted; combustibility and damageability of contents; fire load; housekeeping; common hazards; special hazards; specific protection of individual hazards; storage practices.
EXPOSURE - Presence of exposing building, structures, or yard storage; construction, size and height, occupancy hazards, and distance of exposure from building insured; protection from external hazards.
PROTECTION - Public Protection: Protection grade at location; Adequacy of public water systems; availability of hydrants; distance from fire department.
Private Protection: (that Is general to the premises) Adequacy of automatic extinguishing systems (sprinklers) protecting the entire premises; Inside manual protection (portable fire extinguishers); fire brigade; standpipes and hose.
PRICING - Rate level in the territory for the risk being considered; adequacy of individual risk rate, results of application of flexible rating.
The final Risk Grade should be a composite of the grades assigned each of the underwriting considerations stated above. The underwriting considerations have varying degrees of importance depending on the individual risk. A risk graded POOR as to Insured or Occupancy would normally be unacceptable and should receive an overall grade of POOR.
Any risk with an overall grade of POOR should be given consideration to be declined.
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