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When it comes to ensuring the longevity and financial security of your business, commercial property insurance is an important risk management tool. Natural disasters, industrial accidents, fires, and vandalism all threaten to destroy everything you’ve worked so hard to achieve. That’s why investing in commercial property insurance can be a wise decision for small business owners.
When it comes to purchasing commercial property insurance, it’s important to understand how insurance companies underwrite and price this type of insurance. Knowing how insurers evaluate property risk can help you save money on your policy by helping you to improve what’s known as your Commercial Property Insurance Rating. Whether you are looking to buy a new building or improve upon your current one, knowing about the Commercial Property Insurance Rating system used by your insurance company is an important step in understanding how your premiums are set.
What is a Commercial Property Insurance Rating and COPE?
Before insurance companies will agree to sell you property insurance, they calculate a Commercial Property Insurance Rating, which is specific to the building or property you’re looking to insure. Insurance carriers do this by either (a) giving the property a class rating, or (b) assigning the property a specific rating. When an insurance carrier decides to calculate a specific rating, they assess the construction, occupancy, protection, and exposure of your building, otherwise known as the property’s “COPE.” Buildings that have better COPE scores are less likely to suffer serious damage in the event of a fire or natural disaster. This reduced risk means that insurance carriers are less likely to lose a significant amount of money by insuring you. For this reason, businesses that are insuring properties with good COPE scores are often awarded lower insurance premiums.
Class Rating vs Specific Rating
There are two ways that insurance companies assign Commercial Property Insurance Ratings: a more general class rating or a more customized specific rating. With class ratings, properties with similar characteristics are grouped into the same class, and all properties within that class share the same insurance rate.
Insurers generally assign your property a class rating if it meets these qualifications:
- The property has less than 25,000 square feet
- It doesn’t contain a sprinkler system
- It’s not fire-resistive
- It’s not used for manufacturing
If your building deviates from these guidelines, your carrier will typically calculate a specific rating for your property, which is a customized rating for your property based on the particular characteristics of that property. Insurers pay attention to four key characteristics of a property: Construction, Occupancy, Protection, and Exposure, also known as COPE.
How do insurance companies evaluate Construction?
The most important characteristic of a Commercial Property Insurance Rating is the construction of the building. The three key aspects of construction are the following:
- What material is the building constructed from?
- What is the square footage of the building?
- What is the age of the building?
What material is a structure built from and how will that material affect its combustibility and susceptibility to damage? The Insurance Services Office (ISO), an insurance advisory firm that provides data and analysis for the insurance industry, has developed six construction classifications (ranked from 1 to 6) for materials used to construct the major structural features of a building. This rating system is commonly used by insurers to categorize buildings.
The classification scale attempts to predict how your building’s structural integrity will fare in a fire. It ranges from one to six, with one being the worst and six being the best. Generally, wood-based buildings receive worse ratings, while properties made of concrete and other noncombustible materials receive higher ones.
Most buildings are made of a combination of combustible and noncombustible materials, so insurance companies divide and rate your building based on separate components like the frame, roof, and exterior walls. The scores are added together to create your overall Construction class.
The six building classes are, from worst to best:
- Class 1, Frame—Generally used if a building’s exterior walls are made from wood or another combustible material.
- Class 2, Joisted Masonry—Generally used for buildings with exterior walls that are not combustible (e.g. brick, stone, concrete block). Buildings in Class 2 will usually have combustible floors and roofs.
- Class 3, Noncombustible—Generally used for buildings with exterior walls, floors, and roofs made with noncombustible or slow-burning materials, including metal, asbestos, and gypsum. Buildings in Class 3 often feature steel frames.
- Class 4, Masonry Noncombustible—Generally used for buildings with exterior walls made of brick, concrete block, or another type of masonry. Floors and roofs will be constructed from a noncombustible material such as metal.
- Class 5, Modified Fire Resistive—Generally used for buildings that have walls, floor, and a roof made of solid masonry at least four inches thick. These buildings are very fire resistant and can earn a fire rating of at least two hours.
- Class 6, Fire Resistive—Generally used for buildings with walls, floors, and roofs with a fire rating of at least two hours. The walls, floor, and roof will consist of reinforced concrete at least four inches thick. Structural steel used in the buildings will be load bearing and have a fire rating of no less than two hours.
- You own a business that manufactures party supplies for children’s birthday parties. The roof and floor of your building are made of wood, the frame is made of concrete, and the exterior walls are made of stone. Your insurance company gives the building an overall rating of Class 2, Joisted Masonry. Many years later, your roof falls apart. Unhappy with your insurance premiums, you decide to rebuild the roof and floor using a noncombustible material such as metal. Your insurance company reappraises your building as Class 4, Masonry Noncombustible, and lowers your insurance premiums.
The size of a property also affects the Construction component of the Commercial Property Insurance Rating. In property insurance, your insurance carrier will assess the size of the building to calculate your maximum possible loss (MPL) and probable maximum loss (PML). Your MPL refers to the largest possible loss that could occur on your property, i.e. total destruction of your buildings. Your PML attempts to estimate the largest loss that is likely to happen. The larger the size of the building, the less likely the building will be completely destroyed by a single event.
- A one million square foot office tower has a Maximum Possible Loss of $110 million. However, since the building is so large, it’s Probable Maximum Loss is only $50 million, thus making it less costly to insure.
Age of Building
The age of the structure is also taken into account in the Construction component of the Commercial Property Insurance Rating. Buildings with well-maintained and up-to-date systems will be less risky to insure. Older buildings that no longer comply with the most recent building codes will be more costly to insure.
- An apartment complex was built decades ago before building codes required all bathroom exhaust fans to vent air to the outside. Since the bathroom ventilation in the apartments would need to be upgraded if the apartment complex was damaged, it will receive a lower score under the Construction element of COPE.
How do insurance companies evaluate Occupancy?
Your building’s Occupancy refers to the type of business that you run on your property and how the property is used. A building that’s used to rent corporate office space will be less risky to insure than a building that’s used to manufacture lithium batteries. Depending on the risks of various industries or uses (retailing, manufacturing, office, etc.), underwriters will price commercial property insurance differently.
Your insurance company assesses not only the type of business that you operate, but also the actions that you are taking to mitigate risks. Once your insurer has determined these hazards, they will calculate your overall Occupancy score by combining the estimated strength of the hazard with the estimated strength of the safety precautions you have already taken. Businesses with better Occupancy ratings will have lower premiums on their property insurance.
- You own a business that sells lighter fluid. You know that you work in a dangerous field, so you install fire alarms and an automatic sprinkler system that reaches every corner of the building. You decide to store most of the fluid in a separate back room, with specially lined fire-proof walls. Your insurance carrier takes your precautionary measures into account when calculating your Occupancy score, and as a result, you have lower insurance premiums than any of your competitors in the lighter fluid sales industry.
How do insurance companies evaluate Protection?
Protection refers to the resources that will be available to your business property in the event of a fire. Public protection and private protection are both considered for this rating.
Protection that comes from a fire department or other public resource is referred to as “public protection.” Insurance carriers typically use a scale from the ISO to rate the strength of local fire departments, the adequacy of the water supply, and the effectiveness of the fire alarm and communication system. This scale is similar to the one used to evaluate Construction, but ranges from one to ten, with one being the best and ten being the worst. Companies with a building near a highly rated fire department, i.e. number “1” or “2” on the scale, will save money on their property insurance.
- Your building is located in a fire district with mainly volunteer fire departments that are struggling to retain firefighters, which has affected the speed of their response times. This will lead to a lower rating for Protection.
Besides fire department ratings, you can also improve your Protection score by installing fire alarms, sprinkler systems, and other safety precautions. Devices and systems that you install yourself and use inside and around your building are collectively referred to as “private protection.”
Examples of private protection that you can use on your property include:
- Fire extinguishers
- Automatic sprinklers
- Alarm systems
- Fire doors
- Fire walls
Insurance companies will be evaluating not only the presence of these features, but their condition, type, effectiveness, and the infrastructure surrounding it. As you are constructing a new building or installing fire protection systems, understanding what insurance companies will be looking for will help you obtain better rates for commercial property insurance.
- Your office building has installed a new state-of-the-art sprinkler system but the number of sprinklers will not be enough to effectively mitigate large fires. Additionally, the location of the sprinklers is not optimally placed in the building. You receive a slightly lower rating for Protection than you expected.
How do insurance companies evaluate Exposure?
The final variable that makes up COPE is Exposure. This refers to the likelihood that your building will be affected by an external hazard. These hazards can be both natural and man-made. Potential hazards can include other businesses, people, and environmental factors like rivers or dry foliage.
- You own a paper supply manufacturing company one block down from an electric power substation with many transformers. Though the station has a track record for safe practices, your insurance company believes that there is still a possibility that an accident could occur, sparking a fire that completely destroys your business. The total destruction of your property would be very expensive for the insurance company. Because of this heightened exposure, you must pay higher property insurance premiums.
Examples of external hazards that can cause insurance carriers to classify your property as a high Exposure risk include:
- Location in an area known for wildfires, earthquakes, or other natural disasters
- High possibility of serious water or wind damage
- Located near special flood hazard area (SFHA)
- High local crime rates
- High vandalism rates
- High civil unrest
- High pollution from nearby businesses or transportation
Commercial Property Insurance Ratings are calculated by your insurance company to help them decide whether to take you on as a client and how much they should charge you. Though many properties are organized based on a “class system,” those properties that don’t fit into the box are assessed with a COPE score. Construction, Occupancy, Protection, and Exposure are the four factors that insurance companies think are most important in predicting your property’s risk level. Understanding what these terms mean and how insurers price property risk can help you to better evaluate commercial property insurance and improve your property’s safety systems.