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Combating misclassification of risk, whether accidental or purposeful, is increasingly important given the current insurance landscape. And to guard against the very real possibility of “insurance deserts,” it’s top of mind for Victor Insurance’s Small Business group

THROUGHOUT HIS time in the industry, Michael Ferber has seen a lot of trends come and go. But what he’s seeing lately when it comes to misclassification of risk has Ferber, head of Victor Small Business, on a mission. “Our organization prioritizes ensuring, on behalf of everybody involved and especially with the high-risk policies we’re placing, that information is accurate and everyone is getting what they need out of the placement transaction,” Ferber says. “If the transaction isn’t done accurately, our belief is that ‘insurance deserts’ will form. These are geographies, or high-risk classes of business that will be harder, if not impossible, to cover. In the end, doing this wrong hurts everyone.”

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“Our organization prioritizes ensuring, on behalf of everybody involved and especially with the high-risk policies we’re placing, that information is accurate and everyone is getting what they need out of the placement transaction”

Michael Ferber, Victor Small Business

Misclassifications fall into two main categories: undervaluation of coverage needs and true misclassification of risk. Just as it sounds, undervaluation is not buying enough insurance to cover the types of exposures a business owner might have. For example, an owner may have a $2 million building but their property coverage is $1 million. Another undervaluation scenario is not buying the right policies to cover the types of losses a business may have. That could be as simple as operating in a state where workers’ compensation coverage is not mandatory, so the business decides not to carry a policy. “I was a small business owner myself and I’ve seen it play out: you have a crunch, want to save money, and insurance feels like somewhere you can cut back,” Ferber says. “It’s incumbent upon the agent to help the business owner buy the right coverage for the types of losses they may actually see.”

When it comes to true misclassification, Ferber breaks it down to two subcategories. With accidental misclassification of risk, again, it’s essentially as it sounds: The business owner may not think about incidental exposures they might have. Maybe they’re a drywall installer who infrequently does light electrical or plumbing jobs. If they don’t disclose these riskier types of business and have a loss related to them, possibly the carrier will not cover it. Then there’s the more egregious, purposeful misclassification that can occur on behalf of the business owner who omits or misrepresents their operation or on the side of the agent who tries to get a cheaper rate to sell a policy. For the business owner, misclassification can be costly in terms of time and money. Beyond the impact of sustaining an uncovered loss, carriers will sometimes conduct a quality review of the bound policy, and, if things are misrepresented or misclassified, an underwriter can cancel it or increase the premiums, sometimes significantly.

Agents face a similar repercussion in that placing a policy once is time-intensive. Having to place the policy again due to an underwriting cancellation can prove costly to the agent. If there is a loss where the business owner represented themselves correctly but it comes to light that the agent didn’t represent the client correctly to the carrier, the carrier can bring an E&O claim against the agent. “There’s a reputational risk if it gets out that carriers don’t want to work with you and you’re seen as having messed around with someone’s small business,” Ferber says. “A lot of our agents live in the communities they work in and don’t want that to happen.” While there is a tolerance for innocent misclassifications – “They happen all the time and brokers, agents, and carriers are happy to work with businesses to correct them,” Ferber notes – the concern is the more purposeful misclassification happening in high-risk classes where premiums are higher. “There seems to be an incentive for some to try and manage down the premium they’re paying by not being as accurate with the classification of the risk,” Ferber says.

Wherever losses are sustained in concentrated areas, whether due to high-risk geographies or classes of business, carriers increase their focus on mitigating that loss. That tightening trickles down to agents, who are left with fewer and fewer markets, and then, in turn is passed on to business owners, who see premiums go up. Take a business in the wind-exposed state of Florida, for example, where carriers are pulling back. Making sure risk is represented appropriately becomes even more important because that gives the carriers who are offering coverage the best shot at pricing appropriately and covering losses when they happen. “If carriers sustain a lot of misclassification, they can just exit,” Ferber says, adding that as capacity dries up and supply of insurance comes down but demand stays steady, prices spike for everybody involved – and that’s bad news for all stakeholders.

The best way to minimize the risk of misclassification is due diligence. As soon as someone walks into your office, interview them: ask questions, visit their business website, check out their social media. It takes minutes to do a cursory look and see if the information you’re given seems accurate. Victor offers a quoting platform to help with this process, where agents can grab a questionnaire listing all the things carriers need to know about certain types of business to price risk appropriately. “If you don’t know an answer, don’t guess – ask the client and get the answer directly from them,” Ferber advises. “Filing away a signed, complete application from the business helps protect the agent. Be sure, as the agent, to provide complete information to the carrier.”

Business owners are savvy buyers of product. Once they’ve bought insurance a few times, business owners can get “smart” about how they discuss their business to game the system. Saying a taekwondo studio provides “after-school childcare,” for example, is not false but misrepresents the true risk. The bottom line: it’s a zero-sum game. If you are not being accurate, you are pushing the risk to someone else. “This is a bit of a plea for everybody to act responsibly in the role they’re playing in the chain,” Ferber says, adding that accuracy in coverage needs and in classification will ensure the overall insurance system is working the way it should. “Taking care not to misclassify gives the carrier the best shot at staying in the market. They’re going to take losses – everybody does – but if they don’t capture enough premium to recover the loss, that’s when those deserts will appear, and it becomes a cycle. Less suppliers means higher prices. We’re all in this together. Let’s be truthful, accurate, and place good risk at appropriate premium levels.”

What is misclassification and its repercussions?

How can agents minimize risk?

Published May 20, 2024

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“Taking care not to misclassify gives the carrier the best shot at staying in the market. We’re all in this together. Let’s be truthful, accurate, and place good risk at appropriate premium levels”

Michael Ferber, Victor Small Business

The threat of insurance deserts – and how tech can save the day

Victor Insurance believes that in the end, technology will save the day. Many tools in the market are constantly evolving, including AI-driven solutions that collect information from available sources such as social media, online reviews, and granted permits. This paints an impressively complete and, most importantly, objective picture of what a business does. For example, if someone is writing a restaurant, the technology could predetermine if the establishment serves alcohol by finding a drink menu online. “Every class of business has something that is driving the rate; every business has its thing that factors into the premium,” Ferber says. “For restaurants, it’s alcohol. For contractors, it’s what kind of work. For beauty salons, it’s whether they provide cosmetic procedures. These kinds of operations drive rate, and it is important to not be afraid to disclose them to the carrier. When there is a claim, they will typically find out anyway. This is when you need the carrier on your side. ”

99.9% of all American businesses are small businesses The US has 33.1 million small businesses Small businesses employ 61.7 million Americans, nearly half of the American workforce, representing 43.5% of America’s GDP A record-breaking 5.5 million new business applications were filed in 2023 90% of small business owners aren’t confident their companies are adequately insured

Proliferation of small business

Sources: Forbes, US Chamber of Commerce