Using the Correct Workers' Compensation Classification
Workers’ compensation premium rates and experience modifiers are based on rates assigned to class codes. Class codes are used to group work activities into groups that have similar frequency, types, and severity of injuries to employees engaged in that activity. This allows the ratemaking body, the National Council on Compensation Insurance (NCCI) in most states, to develop rates that reflect the expected claims costs for each type of employment. Thus, for example, the rates for roofers are higher than the rates for clerical office workers. Two types of rates are developed for each class code, those used for calculating premium and those used for calculating each individual employer’s experience modifier. The premium calculated by applying the rate to the payroll for the class, the manual premium, reflects what the premium would be if every employer has the same loss experience. Multiplying the manual premium by the employer’s experience modifier develops what is known as standard premium. The experience modifier is less than one if the employer’s expected losses are lower than average and greater than one if the employer’s expected losses are higher than average. Thus the lower the experience modifier the lower the premium.
Two cases, both somewhat unusual, highlight the importance of having the correct class code assigned to your risk. The workers’ compensation class code for a new business, or a new, different operation for an existing business is usually determined by the agent/broker when preparing the application submitted to the insurance company. The insurance company may disagree based on what its underwriter knows about the risk. In that case, the agent/broker will negotiate an agreed upon class code. Payrolls upon which the premium is based are audited after the policy expires so that the actual payrolls for the policy period can be used to develop the final premium. The insurance company’s auditor may at that time determine that the wrong class code was used and recalculate the premium based on the class code the auditor thinks is correct. If the insured disagrees and is in a state served by the NCCI, the insured can request that the NCCI inspect its operations and determine the appropriate class code. The NCCI’s determination is final and must be accepted by the insurance company.
In the first case, the insurance company used a class code for an occupation that could have severe losses. Very few employers are in that occupation. Because of the limited historical experience available and the severity of the possible losses, the NCCI does not promulgate a rate for that class but instead allows each insurance company to establish its own rate. In this case the rate the insurance company used developed around $1,000,000 in annual premium.
The NCCI publishes a manual titled Scopes Manual. It describes the types and scope of occupation that each class code represents. The scopes are often subject to interpretation. Upon reviewing the Scopes Manual definition of the class code the insurance company used and similar class codes, it appeared that a different class code fit the insured’s operations better than the one the insurance company used.
Discussions with the insurance company’s underwriter and auditor were fruitless, no agreement could be reached. So the insured agreed to pay the small fee to have its operations inspected. The NCCI inspector agreed that the insurance company had used the wrong class code and assigned the lower rated class code to the employer. The result was that around $900,000 of premium was returned to the employer. The employer would benefit from the lower rates for all policy periods going forward.
The second case is unusual in that the problem was that the class code that had been used incorrectly for years had a lower rate than the correct code. The insured’s main business was as a manufacturer. But it also provided some on site services. Their bid to one potential customer was rejected because their workers’ compensation experience modifier was too high. Some companies require that the contractors that work for them have good safety records. One indication of a contractor’s safety record is its workers’ compensation experience modifier. So the hiring company will set a maximum experience modifier that the contractor can have in order to bid on the job. The insured’s loss experience was relatively good. So, why was the insured’s experience modifier so high?
The insured’s workers’ compensation insurance was written on a high deductible program. The manual rates used in high deductible programs are of little importance because the deductible premium is developed based on the insured’s own loss experience and the insurance company’s expenses. The insurance company was willing to use the lower rate because it was still able to get the premium it needed.
Workers’ compensation experience modifiers are, in the simplest of terms, a comparison of the insured’s loss experience with the expected average loss experience for the each of the employer’s class codes. Premium rates correlate with the expected loss rates used to calculate experience modifiers. For each class code, the higher the premium rate, the higher the expected loss rate and conversely, the lower the premium rate, the lower the expected loss rate. The effect of using a class code that had a lower premium rate, which also means a lower expected loss rate than the correct class for the risk, was that the insured’s actual losses were being compared to expected losses that were lower than those for the correct class. That in turn led to the experience modifier being higher than it should have been.
The problem was solved by having the payrolls for the current policy period and the two prior years revised using the correct class code. Upon receiving the revised data, the NCCI recalculated the workers’ compensation modifier. The recalculated experience modifier was low enough that the insured could now bid on the jobs that they couldn’t have bid on before. It didn’t change the actual premium paid to the insurance company, which simply adjusted its deductible premium rates to keep the premium the same. Any increase in state taxes and assessments that are based on standard premium were negligible in comparison to the additional income the insured gained by having using the correct workers’ compensation class code.