The perils of construction misclassification

By Sanford Brown  |  November 17, 2014

One factor to consider when underwriting a commercial property insurance policy is fire risk, and a main consideration in determining that risk is assigning the proper construction class to the building. You need to know what materials the building is made of to estimate how much damage it will sustain if a fire occurs.

Verisk defines six construction classes for commercial buildings, listed here from least protective to best:

  • Class 1: frame
  • Class 2: joisted masonry
  • Class 3: noncombustible
  • Class 4: masonry noncombustible
  • Class 5: modified fire resistive
  • Class 6: fire resistive

Obviously, a property’s construction class is a critical data point for underwriting and rating decisions. What isn’t so obvious is how much insurers assume about construction classifications for properties on their books. Many insurers take information from insureds or their agents at face value, and that can make you very vulnerable, as we recently discovered.

Verisk Insurance Solutions – Commercial Property assessed the construction class of buildings in a random sample of 900 policies a client insurer has on its books. Our analysis found that 52 percent of those policies had inaccurate or incomplete construction classes, 42 percent had incorrect designations, and 10 percent had incomplete information that was likely insufficient for underwriting purposes. The insurer was astounded by the flaws we found.

chartWe further determined that 45 percent of the inaccurate policies were misclassified as a lower-risk construction class than we determined and confirmed during on-site visits. The insurer was sustaining significant premium leakage because prices were set lower than warranted, exposing the company to higher risk. In numerous instances, the insurer believed a building was fire resistive — the most favorable classification — when it was actually in the worst classification.

Avoiding premium leakage, minimizing the effect of inadequately priced exposures, and verifying property characteristics are ongoing challenges for insurers. Verisk Commercial Property’s Portfolio Assessment services help you meet those challenges through thorough analyses of your book of business.

For a detailed explanation of construction classifications, visit Construction Briefs on our website. To find out more about all the benefits of Portfolio Assessment, call your account executive directly or Verisk Customer Support at 1-800-444-4554, option 3.

Sanford Brown

Sanford Brown is the director of product development at Verisk – insurance solutions.