Understanding Commercial Property Underwriting and ‘COPE’

Construction, Occupancy, Protection and Exposure (COPE) are the same four basic elements of underwriting data that real property underwriters have used for nearly 300 years.

So what are these time-honored elements? The following paragraphs briefly explain each element of COPE.

For underwriting analysis, construction is broken down into three sub-parts:

• Construction materials;
• Square footage; and
• Age of the structure.

Insurance Services Office (ISO) defines six construction classifications (from “1” to “6”) based on the combustibility and damageability of the materials used to construct the structures “major structural features.” The lower the number, the more susceptible the structure is to damage by fire. Construction class codes are a function of the “major structural features”: exterior load-bearing walls combined with roof and floor(s).

Assigning a construction class code is first a function of the load-bearing wall material and secondarily a function of the floor and roof materials. Four exterior, load-bearing wall types are considered along with four floor and roof types. Combining the wall type with one the floor/roof types produces the structure’s construction class.

What effect does a combination of building materials and assemblies have on a commercial property’s construction classification? Factually, mixing construction material can be detrimental to the building’s ultimate construction class and loss cost/rate.

Simply, to qualify for a higher construction class rating, the superior construction must equal or exceed 66 2/3 percent of the ratable structural feature. This 2/3 requirement applies first to the walls and separately to the combined area of the floors and roofs.

Structure size influences many aspects of the underwriting process related to the “construction” element of “COPE.” Square footage also factors into the “protection” section of COPE (i.e. the need for a sprinkler system, etc.). But the main aspect of structure size from the underwriting aspect is in the comparison of the building’s “maximum possible loss” (MPL) versus its “probable maximum loss.” (PML)

Essentially, it is “possible” that the entire structure may be destroyed in any one loss; thus the MPL is the entire structure (100 percent). However, the chances that the building will suffer a total loss are inversely proportional to the size of the structure. Basically, the larger the building, the less likely the entire structure will be destroyed in a single event. Thus, the PML percentage decreases as building size increases (subject to the protection (“P”) used in the building).

Aging structures create concerns and questions in the underwriter’s mind. Specifically, underwriters concern themselves with the building’s major systems (roofing, plumbing, HVAC and wiring) when underwriting an older structure. The older the structure, the more likely a major system will malfunction, leading to a possible claim due mostly to an internal issue rather than caused by an external force.

Have the systems been maintained and updated as necessary? When were the last updates? What was the extent of those updates? Who did the updates? These are all questions underwriters may ask when evaluating older structures.

Agents should concern themselves with the age issue as well. Many construction-related ordinances and laws may have been updated or enacted since the building’s original construction. Any increased cost related to bringing a structure into compliance with local building codes following a covered cause of loss is specifically excluded in the un-endorsed commercial property policy.

Taken on its own, “construction” may ultimately be the most important element in property underwriting. Although the second element, “occupancy” (what the insured does), is often seen as primarily important among the four elements; occupancy really is secondary to construction when the risk is a class of business the underwriter normally writes.

Granted, construction and occupancy can each be seen as a function of the other in regard to underwriting decisions, often times the decision comes back to construction. For example, an underwriter may offer coverage to a restaurant in a masonry/non-combustible building (construction class “4”); but may not be willing to offer coverage to the same operation located in a joisted/masonry building (construction class “2”).

Class on Understanding Commercial Property Underwriting and COPE

“Occupancy” information is comprised of two parts: 1) what the insured does; and 2) how the insured manages the hazards associated with what they do. Determining what the insured does is rather simple; determining how they manage their “hazards of occupancy” requires closer investigation (either by the agent, insurance carrier staff, or independent inspection firm).

Each class of insured (retail, office, wholesale, manufacturing, service, etc.) presents its own relative risk of first party property loss. The greater the risk of loss, the more closely the underwriter analyzes the operations (occupancy) and the higher the relational cost of coverage. An office, for example, presents less of an operational hazard than does a paint and body shop; resulting in a lower property occupancy rate factor for the office.

Beyond merely knowing the insured’s operations/occupancy, the insurer must also investigate how the insured manages those operations (part two of the occupancy review). Similar insureds do not necessarily manage operations in the same manner. Since each insured manages its exposures and hazards differently, each has its own “hazards of occupancy” that must be considered in the underwriting process.

Underwriters and building code officials are often jointly interested in the property protection aspects of structures, but for different reasons. Property underwriters view property protection measures in regards to their ability to lessen the amount of property damage; building code officials generally view protection from a general public and personnel protection angle.

Sprinkler systems, fire extinguishers, alarm systems, fire doors and fire walls, and public fire protection are the primary protection mechanisms evaluated by underwriters. A particular structure’s construction and occupancy may dictate which property protection mechanisms are required or desired by the underwriter.

Is the insured property exposed to any external hazards? Not all hazards are related to the insured structure or operation; some come from outside the premises or are simply geographic in nature. A few external exposures relevant to property underwriters include:

• The insured structure’s proximity to a high-hazard operation;
• The local wildfire risk;
• The possibility for damaging winds and/or water;
• The structure’s flood zone location (located in or near a special flood hazard area (SFHA));
• The structures earthquake exposure; and
• The jurisdictions building code requirements.

Understanding COPE fosters better planning during the property underwriting process. Knowing what to provide and why to provide specific information makes the underwriting process smoother and, hopefully, quicker. Also, knowing COPE can assist clients when planning upgrades to current structures or constructing new buildings.

The Academy of Insurance is hosting a two-part series this week with Christopher J. Boggs detailing all aspects of COPE briefly presented in this article. This class delves much deeper into COPE’s four elements.

Related:

• Understanding Commercial Property Underwriting and COPE
• When P/C Insurance Carriers Can Cancel: The ‘Underwriting Period’ by State