Chapter 4 | Manufacturing and Processing Risks

Educational Objectives
Upon completion of this section, you should be able to:

  1. Know how to treat each named insured and the sales between the named insureds
  2. Know when to use multiple classifications
  3. Define wholesale value
  4. Identify the special inclusions and exclusions
  5. Identify component parts and how are they treated

CLASSIFICATION ASSIGNMENT

Manufacturing and processing risks are classified according to the specific procedures detailed in Rule 27.

The two important principles involved in classifying manufacturing or processing risks are: (1) separately classifying each named insured and (2) classifying by final product, not by component part or interim process.

Classifying By Named Insured
Each named insured listed in the declaration, or subsequently endorsed, are to be classified independent of one another.

The reasoning behind this is that the named insureds are generally separate legal entities, and as such they may sue other named insureds. The CGL policy coverage applies "as if each named insured were the only named insured" (Section IV.7 - Separation of Insureds).

Example 1:
The following three companies are listed as named insureds on the same policy:
Company A - Manufactures motorcycle frames.
Company B - Manufactures motorcycle engines.
Company C - Assembles motorcycles using components from A and B.
From the information given, each of the three companies may be separately classified.
Company A - Metal Goods Mfg., NOC - Code 56911
Company B - Engine or Turbine Mfg. NOC - Code 52619
Company C - Motorcycle Mfg. - Code 57202
Example 2:
Yahoo Motorcycle Company has the following three manufacturing divisions:
Division A - Manufactures motorcycle frames.
Division B - Manufactures motorcycle engines.
Division C - Assembles motorcycles using components from A and B.

Since the three divisions are part of a single legal entity producing one final product, only one classification applies: Motorcycle, Moped or Motor Scooter Mfg., Code 57202.
Classifying by Final Product
Separate classifications are to be applied to the final product or process and not the intermediate component or process.

In Example 1 component parts manufactured by Company B, for instance, would be separately classified, as the motorcycle engines are the final product for that entity.

In Example 2, the Motorcycle Mfg. classification applies to all of the divisions, even if they are at separate locations, because it describes the final product of that named insured - motorcycles.

Multiple Classifications
The above is not intended to imply that only one classification may be applied to a manufacturer.

Example:
Assume in example 2 above that Division B, not only provided the motorcycle engines to Division C, but also sold them to other manufacturers as well. Two classifications would be applied to this risk:
  • Engines sold to others - Engine or Turbine Mfg., Code 52619.
  • Motorcycles sold to others - Motorcycle Mfg., Code 57202.
The use of Code 52619 is allowed since the engines are final products when sold to others.

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SPECIAL CLASSIFICATION INCLUSIONS AND EXCLUSIONS

In addition to the general classification inclusions and exclusions discussed earlier ( Rule 26.B.1 and 26.B.2), the following special classification inclusions and exclusions apply.

Special Inclusions
  1. Manufacturing of containers such as bags, barrels, bottles, boxes, cans, cartons or packing cases unless sold to others, including other named insureds.
  2. Installation, servicing or repair of the named insured's products. This is an important inclusion. A manufacturer who installs its own products would not require a separate classification for the installation operation. This special inclusion applies even when the operation is one which does not normally prevail in this business. This is an exception to the multiple business operation principle.
Example:
A company manufacturing various types of industrial lighting fixtures would be properly classified under: Lighting Fixtures Mfg., NOC -Code 56391.

If this company has a separate division or crew installing and servicing its products on the customer's premises, Code 56391 would still be applicable under this rule.

However, if a separately named insured listed on the policy does the installation and servicing or if products other than those manufactured by the insured are installed, Code 92478, Electrical Work - within buildings would apply as well.

Special Exclusions
  1. Office operations of manufacturing risks which are located away from the premises where the insured's manufacturing, processing or assembling operations are conducted.
  2. A manufacturer who sells its own products through its own retail operations should be separately classified from the manufacturing or processing operation (Rule 27.A.3).
Example:
An automobile tire manufacturer who owns and operates a chain of retail stores selling and installing the tires manufactured would be classified:
  • Tire Manufacturing - auto, bus or truck - Code 59750, and
  • Tire Dealer - Code 18616.
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BASIS OF PREMIUM - PREMIUM COMPUTATION

The basis of premium for manufacturing and processing classifications is Gross Sales.

Rule 27.B provides some additional guidance in the application of gross sales to manufacturing and processing classifications.

  • Includes all sales of goods or products from one company to another, including sales from one named insured to another. The intent of this section is for the inclusion of intercompany sales. All the sales between named insureds should be included and assigned to the final product.
Exception:
When intercompany suits are excluded from the coverage by Endorsement CG 21 41, the sales of goods or products from one named insured to another should not be included in the premium computation for Products/Completed Operations coverage.

Example:
Company I and Company II are both named insureds on the same policy. Company I manufactures metal pipes which are sold to others and Company II. Company II makes plumbing fixtures.

Company I - Sales to others - $100,000
  Sales to Co. II - 900,000
  Total $1,000,000
Company II - Sales to others - $5,000,000

The chargeable gross sales for Company I is $1,000,000, which includes the amount sold to Company II. The chargeable gross sales for Company II is $5,000,000, which includes the value of the pipe purchased from Company I.

It is important to remember that the reason we include the sales from one named insured to another is that the policy provides coverage separately to each named insured recognizing the potential of suits between named insureds on the same policy.

  • Do not include the value of any transfers of component parts or interim processes within the same named insured (from operations described in Rule 27.A.2). The value of a part within the manufacturing process of a named insured should not be used in determining the gross sales.

Example: Assume that Company I and II from the above example are now Division I and II within this one named insured. The amounts developed for gross sales are quite different.

The gross sales for Division I would be $100,000, since that amount represents the value of a final product sold - metal pipe.

The gross sales for Division II would be $5,000,000, since that also represents the sales of a final product - plumbing fixtures.

  • Include the wholesale value of goods transferred to the retail operation (for risks classified in accordance with Rule 27.A.3).
As was mentioned previously, the price charged or the value of the final products should be included in the gross sales for premium determination. A product transferred to a store by a manufacturer is a final product for the manufacturer since there is no further processing being done on the product by the store. Therefore, the manufacturer's value of the final product is to be included, regardless of whether it is transferred to the insured's store or sold to someone else's store.

Goods sold to a retail store are sold at a wholesale price as opposed to the retail price charged to the consumers. This wholesale price is the amount normally recorded in the insured's records. The difficulty arises when a wholesale price is not shown in the insured's records for goods transferred to their own store.

  • If the insured sells to others and has its own store, the wholesale price used on the goods sold outside may be applied to goods transferred to its own store.
  • If goods are sold exclusively by the insured's retail operation, the wholesale value development can become more difficult to determine. It may be possible to use the values reported on a property or inland marine policy.
The policy clearly establishes the insured's responsibility to maintain the necessary records: "The first named insured must keep records of the information we need for premium computation and send us copies at such times as we may request: (Section IV.5). As premium auditors, it is our responsibility to inform and educate the policyholders on what records we need. Obviously, lacking the proper records to determine the wholesale value, the retail value must be used.

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RATING

The territory to which the applicable sales should be applied is where:
  • The products as classified are produced or assembled, or
  • The processing as classified takes place.
The fact that a named insured has component parts produced in states different than the final assembly point does not affect the territory to which the exposure is assigned.

Example:
Yahoo Motorcycle Company has the following three manufacturing divisions (one named insured):

Division A - Manufactures motorcycle frames in Michigan.
Division B - Manufactures motorcycle engines in Pennsylvania.
Division C - Assembles motorcycles in New York, using the frames and engines from Divisions A and B.

Since this is a single named insured producing only one final product, Motorcycle Manufacturing, Code 57202, would apply. Likewise, the gross sales of motorcycles would be assigned to New York and the appropriate New York rates applied.

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