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Insurance Rating

( Originally Published 1911 )

Early forms of rating.—From what data or how the first tables of rates for fire insurance were compiled is not known. But it is known that they were not based, as is the practice of to-day, on the amount of property insured but on its rental value. Barbon in 1667 made his tables from such a basis. Although the earliest tables known are those of the year 1681, yet there is evidence to show their derivation from Barbon's office and that they were based on the rental value of property. The tables show the rate from one pound to ten and from ten pounds up to one hundred.

There has never been a time in the history of fire insurance when the same rates were charged for all classes of property. In the beginning a difference was made between buildings of brick and stone and buildings of wood, the rates for the latter being nearly double those of the former. The first policies were written usually for seven, fourteen, twenty-one, and thirty-one years, corresponding closely to the leasehold periods in England. Term policies apparently came into force at the beginning of the business, and policies written for twenty-one years did not take three times the rate for each term of seven years but twice the rate for that period of time. The difference of rate between the brick and stone and the wooden building was the crude beginning of the present minute system of differential rating.

Classification system.—As already mentioned Barbon insured houses only, Povey being the first to insure the contents. The rate charged for the contents was at first the same as for the building itself and apparently continued in force for some years. After a period of flat rates—the same rate was charged for a brick and stone building and its contents or a wooden building and its contents—an advance was made by the Union Fire Office in 1714 or 1715. This introduced a classification system for determining rates, a system still in force to a certain extent to-day. Risks were divided into Common Insurance, Hazardous Insurance, and Doubly Hazardous Insurance. Between these three divisions was also introduced One-Half Hazardous Insurance. Between the first and second: divisions, for instance, there would be Common Insurance One-Half Hazardous, and between the second and third Hazardous Insurance One-Half Doubly Hazardous, thus making practically a fivefold classification.

Prospectuses.— A few years later, in 1720, when the Royal Exchange and the London Assurance were incorporated, the practice of publishing prospectuses had become established and was extended by these companies. Thus, the Royal Exchange stated that it would insure any college hall, house, or any other building, and all goods, wares and merchandise, except notes, bills, tallies, books of account, ready money, china and glass ware, jewels, plate, pictures, writing, corn, hay and straw not in trade, to their full value, the insured paying five shillings for every £250 on brick and stone buildings and the goods and mechanic disc therein, and eight shillings on timber, plaster and thatched buildings and the goods and merchandise therein. If the sum insured did not exceed £1,500 the rates quoted above were the first in force, but if the insurance exceeded that amount the rates were seven shillings and sixpence for each X150 of value in the brick and stone class, and twelve shillings in the other building classes.

Segregation of trades.—At this time certain trades began to be segregated and classed as coming within certain limits. Thus the risks of brewers, distillers, chemists, apothecaries, powder men, ship and tallow chandlers, sugar and bread makers, dyers, soap boilers, oil and color men were considered more hazardous than others and paid a proportionately higher rate. Also the glass trade, including looking-glass, and china ware trades, being more hazardous, were grouped with this division.

The foregoing paragraph calls attention to the practise then prevailing of increasing the rate of premium when the insurance passed a certain amount. The application of this principle became quite common in Great Britain and lasted until about 1848, when it apparently passed away. It seems never to have secured more than a slight foothold in this country.

Down to 1848, the above were the methods of rating in Great Britain, and for that matter practically in the United States also, the system in other words being nothing more than a rough grouping of the different businesses into a few classes and rates being charged accordingly.

In 1848 a tariff of fire rates corresponding in a measure to the modern manufacturing schedule was introduced into Great Britain. It applied to woolen mills. From that time up to 1906 various other tariffs have been put in force, generally applying to the whole of Great Britain, although occasionally only to parts.

Philadelphia Contributionship.—In the United States the early insurance practises followed very closely the methods which prevailed in England. One company, whose experience has come down to us, was the Philadelphia Contributionship. It insured houses for a minimum period of seven years. If the building was of brick, the charge was twenty shillings for X100. If the building was of wood, the charge was sixty shillings. In addition to this payment there was a charge for the policy itself of one shilling and two-pence for brick buildings and two shillings and sixpence for frame. This practise of charging for the policy continued in force for a long time.

Green Tree Company.—The third insurance company was founded in Pennsylvania, the occasion of its organization being interesting as it furnishes an early instance of a charge being made for a specific increase of hazard.

A building insured in the Philadelphia Contribution-ship was ignited from a fire in the trees in front of the house. The companies declared that all insurance would be canceled on such properties unless the shade trees were cut down. The insured protested and answered that if the company did not abolish its rule they would withdraw their insurance and form another organization. The company held to its position and the seceders formed the Green Tree Company. This new company established two sets of rates, one for houses having no trees in front of them and a somewhat higher rate for those having them.

Early charges.—There are no exact data as to how charges were first determined for fire insurance in the United States. It is sufficient to state that the method was a duplicate of the English system with some increases to meet conditions then existing in the United States. It is known, however, that when the Mutual Fire Insurance Company was organized in Boston in 1797 an extensive research was made to determine the number of buildings destroyed by fire within a period of thirty-eight years, statistics apparently having been available for that number of years. These records show that the average number of buildings standing throughout the period was three thousand and the loss eighteen and a fraction per cent per annum. On these statistics the company's rates were based. The original insurance companies, of course, could not have had any such data as it was not available.

The early rates were based on certain classes or groups. Class one was 35 cents, the rates then increasing 2½ cents for each class up to the fifth. The sixth class bore an advance of 5 cents over class five. In Virginia there were eight classes; in New York, and Norwich, Connecticut, seven. This method of rating by a division into classes continued in force for many years. There was also adopted in this country the grouping of "Not Hazardous," "Hazardous," "Extra Hazardous," and "Specially Hazardous," the goods embraced under each of these classes being as follows :

Not Hazardous. Coffee, flour, household furniture, linen, paints ground in oil, etc.
Hazardous. Chinaware, plate glass, cotton in bales, and fire-crackers.
Extra Hazardous Apothecaries', fur dressers', printers', and rag stores.
Specially Hazardous. Barbers', .gas makers', and other heavy manufacturing risks.

The building was rated according to one of the foregoing classes, and then to determine the rate on the contents a charge was made accordingly as the contents fell into the "Not Hazardous," "Hazardous," "Extra Hazardous," and "Specially Hazardous" groups. In the first class an addition of 5 cents was made; in the second group an addition of 10 cents ; in the third 25 cents ; and in the fourth a much higher rate was charged, a special table of additional charges applying thereto. Such was the system of rating fire insurance up to about 1850.

Special ratings.—There had been adopted in England a tariff applying to cotton mills. This had its effect in this country and other special methods of rating also began to be adopted, first applying to mills like cotton, woolen, etc. This system of rating manufacturing risks corresponds in a measure to the manufacturing schedule used in different parts of the country to-day and has never been wholly and success-fully superseded. It starts with a base rate according to the business done in the mill, sundry charges being added thereto.

Summary.—Before entering on the subject of schedule rating it is well to summarize the successive steps leading to the present development of rating.

(a) There is no certain knowledge of how the early rates were made.
(b) They were probably based on the rental value of the property.
(c) They were divided into two classes according to the construction of the building.
(d) The contents were insured at the same rate as the building.
(e) There was a segregation of certain classes of risks and a higher rate charged for building and con-tents if such risks were in the building.
(f) Classification introduced of "Common insurance," "Hazardous insurance," and "Doubly Hazardous insurance" with the classification of "One-half" and "Doubly Hazardous insurance" between the first and second and second and third, thus making five classes.
(g) The first steps for schedule rating arose when the first tariffs were adopted for sundry mills.

The classifications in paragraph "f" were the English divisions ; in this country they were "Not Hazardous," "Hazardous," "Extra Hazardous," and "Specially Hazardous."

The following is a brief sketch of the origin and growth of our modern system of rating:

National Board of Fire Underwriters.—This board was organized in 1866. The necessity for some form of co-operation had been obvious for many years. A practically successful effort was made to establish such a body in New York City as early as 1826. This body was charged with the general supervision of the business, or rather with the drafting of policy forms, the fixing of rates, and the determination of general con-duct. The early organization was more or less tentative in its nature and did not exert a very strong influence. In 1852 a meeting of all the companies en-gaged in an agency business was held in New York City. There were eight or ten companies represented at the meeting, the questions taken up being much the same as those considered at the present time.

On July 4, 1866, in Portland, Me., occurred one of the most disastrous fires in the history of the United States, excepting those in New York City of 1835 and 1845 and some early fires in San Francisco. It was only a few days previous to this fire that a call had been issued for a general meeting to consider the question of organizing a national board of fire underwriters. The fire naturally lent great impetus to the movement, as a loss of $10,000,000 in those days was almost as difficult to meet as the fifteen times larger loss at San Francisco forty years later.

The National Board of Fire Underwriters undertook in addition to many other things the determining of the rates of insurance for the entire country, and as the companies' funds were rather low at that time the work in the beginning was fairly successful. The Board's method of fixing the rates was not directly accomplished by its own inspectors and raters but rather through the organizations in the different states and with the voluntary assistance of the special agents of the various companies. The work was very successful for a year or two, but as the companies recovered from the Portland fire, more or less competition again appeared and rates were partly disregarded. This function of the National Board continued to weaken until at the time of the Chicago fire in 1871 it had practically ceased. The loss at Chicago was so overwhelming as to leave no dissenting voice in regard to the necessity of increasing rates not only to, but beyond the point originally fixed by the National Board. The conditions were such that a higher rate was imperative, and the insured, recognizing that a sufficient income must be secured if the companies were to meet losses, were willing to pay.

The Chicago fire was followed a year later by the one in Boston. This fire also served to strengthen the National Board. After a while, however, the policy of rating by a national organization was recognized as unwise. The problem was too large to be handled in that way. The National Board was re-organized and abandoned the rate-making function, but has since done admirable work with the general conditions of the business.

Local organizations.—After the abandonment of rate-making by the National Board, local organizations again assumed the function. By local organization is meant such as might cover a city, a portion of a state, a state, or even several states. It was usually composed of the representatives of the companies in these territories, these representatives being familiar with the local conditions. Such organizations exist in the larger cities, as in Boston, New York, Philadelphia, Chicago, San Francisco, Cincinnati, Louisville, St. Louis, and probably elsewhere.

Attack on organizations.—The organizations charged with the duty of rate making have been attacked in nearly every state. With the exception of some of the larger trusts no form of commercial enter-prise has been subject to such violent denunciation as the so-called insurance trust as typified in its rating organizations.

An organization whose object is to secure a fixed price for the article in which it deals seems at first glance to partake of the nature of a trust; and little distinction has been made in many states between a rate making insurance organization and one whose object is to control the price of commodities.

In the eastern states the rate making organizations have been little disturbed, there being strong organizations in New England, New York, Philadelphia, and Baltimore. Throughout the Middle West 'the conflict has raged fiercely. On the Pacific Coast the function of rate making has been allowed to remain undisturbed in the hands of the companies. In some states the most extreme measures have been adopted, amounting to absolute prohibition of practically any form of organization of the various insurance companies. From prohibition to tolerance there are all forms of control. Thus, in some states the agents of the home companies are permitted to make rates by conference. In other states the local agents of the companies in those states, whether representing a home company or not, are permitted to make the rates. The larger organizations, however, those which control the larger premium paying territories, are volunteer organizations.

Value of organizations.—As a matter of fact the rating organization is an economic organization. Its express purpose is to perform a certain duty for all the companies that otherwise would have to be performed by each individual company. That duty is the inspection of the property, the determination of the rate according to a schedule duly adopted, the regulation of policy contracts within limits permissible by law, and the determination of general practices not covered by the law.

At the time of the San Francisco fire $40,000 of insurance was desired by an insured. In order to secure this amount a broker was compelled to visit forty different offices, since $1,000 only could be placed in each office or company. It is evident that if the inspection and making of the rate on this risk had not been done by means of co-operative bureaus it would have been necessary for each company to send someone to do the work, with the result that this item of expense would have cost forty times what it did. Hence, in its primary essence a rating organization is economical, doing for all what each would have to do for itself.

It is essentially important to the insured that the rates for fire insurance should be the same under like conditions for all parties concerned. Each insured should pay for insurance a rate in accordance with the experience developed in that class of business, and like-wise with the deficiencies and credits shown in his individual plant.

Insurance is a necessity. One may go without oil, without certain forms of groceries, without wearing apparel, if he feels that the price is extortionate and the control a menace to the public; but fire insurance is something which the business man cannot do with-out. That he must purchase, not because he wishes, but because his credit is more or less dependent upon it. Therefore, as it is a fixed charge in his business it is far more important that he should get it at a price based on the same conditions as those of his competitors than that he should secure a temporary advantage ; for he will remain constantly in doubt as to whether his competitor has not after all secured a far greater one.

Rate making in Kansas.—The latest phase of rate making has appeared in the State of Kansas. This state has practically undertaken the business of rate making, or rather it requires the companies to file with the State Department their charges for the insurance of property. If the charges are considered too high the commissioner has authority to hold an investigation. This step would appear to establish an equality of rates among the insured, since the law provides that rebating or any other practices tending to reduce the rate shall be severely punished, even to the extent of loss of license.

Duties of rating organization.—In order to perform its work properly the rating organization must have a reasonable control over the making of the rate, the determination of privileges to be granted on policy forms, a general oversight of the practices with regard to methods of issuing policies, etc. ; otherwise it would be possible for an individual company to issue a policy at a certain rate and then grant privileges so broad as to make it actually low.

Types of risks: If there were nothing to in-sure but dwelling houses the method of computing the rate in fire insurance would be much simpler, as buildings would then be of comparatively uniform occupancy and hence of a uniform hazard. Then the only questions remaining to be considered would be as to materials of construction, the situation with regard to other buildings ; that is, exposure, etc. The rater is con-fronted with a problem bearing no resemblance to this simplicity. Buildings are occupied for all sorts of purposes. The single-family dwelling, detached 100 feet at least from all other properties, is as safe a risk as it is possible to secure. Passing, however, from this type of risk, there comes the dwelling occupied by two families or more. In New York City there are single blocks occupied by hundreds of families. All these risks, however, present something in common—their occupancy; for, while it is a multiple occupancy, nevertheless it is all of one character, that is, dwelling. Hence, the business conducted in these buildings is fairly uniform in character. The statistics for a few years of any company, and especially of a few companies, would suffice if all buildings were occupied for living purposes only to furnish an average on which rates of insurance could easily be based.

Store and dwelling.—The next step from dwelling occupancy is the risk known as store and dwelling. It may be a one story building with a store in front and a dwelling in the rear, or, more usually, it may be a store on the first floor and perhaps in the basement with all dwellings above.

There has been introduced into the dwelling building a type of occupancy that presents several different kinds of conditions. An enumeration of the uses of the basement and first floor occupancy is sufficient to disclose this. It may be a florist's or grocer's store, a paint shop, a printing establishment, an apothecary's or shoe shop, etc. In the early days, when the dwelling and store were combined, these risks were usually rated according to business occupancy and put into their corresponding hazardous groups. For a long time the method continued of regarding a store and dwelling as practically subject to the same rate, but later the practice developed of segregating some of these occupancies (as a paint shop when found in connection with the dwelling) and regarding them as more hazardous than others and charging additional rates for the building and dwelling tenants.

Business building.—After the dwelling, and store and dwelling, comes the building devoted entirely to business purposes. It may be a small corner grocery, totally distinct from any dwelling occupancy. From this small business the type varies through all the groups and sizes and constructions until the modern department store occupying entire blocks is reached, including adjoining blocks with tunnels beneath the street and bridges overhead. In the domain of business buildings there is no limit to the kind of business occupancy and to the problems which the rater may have to solve. Formerly the business building was usually 25 by 100 feet, and 5,000 square feet was an extraordinarily large property. Nowadays the area may be 100,000 square feet, and the problem of how to meet the new condition becomes far more intricate than the mere increase in area would imply.

Groups of risks. Risks fall into certain groups according to the occupancy.

Under (a) may be designated the dwelling class, which includes the private dwelling, the multiple dwelling or apartment house, hotels and clubs. These differ largely, nevertheless their chief purpose is to furnish in some form or other living conditions for tenants.

Under (b) is grouped the class of buildings represented by theaters and churches, each having a different purpose and therefore presenting a specific problem in fire insurance. The theater is typical of any place of amusement, whether a circus, a summer garden or any other place of amusement. Owing to special building requirements the theater presents a problem in regard to the safety of the audience more important than any question of insurance.

Under (c) may be represented stores and dwellings forming a group by themselves and all buildings in which the lower floor is occupied for business purposes and the upper floor for dwellings.

Under (d) may be classed breweries, sugar refineries, manufacturing plants, and risks of like character, rep-resenting types of property erected for a specific purpose and of no use for any other. Such and similar risks represent buildings where even the machinery, being enormous, must be erected in the building while it is in course of construction. It is needless to say that these special types form but a small group of risks and call for the special attention of the rater.

In addition to the manufacturing buildings mentioned under (d) there may be manufacturing buildings used for one purpose to-day and another to-morrow. They are usually loft buildings, where power is furnished for driving the machinery, and differ from business or mercantile buildings where goods are bought and sold. They are not furnished so well nor so ex-pensively built, and should be considered rather as manufacturing plants.

A distinction in the different types of buildings should be made, since the problem of rating a risk in a building of fireproof construction differs from that in a risk of non-fireproof construction.

In brief, the point of emphasis in the foregoing paragraphs is that there are hundreds of classifications used in rating, and that while each building furnishes its own problem that problem may be complicated by each tenant in occupancy.

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