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Misclassification Inflates Workers Compensation Insurance Premiums For Employers

Recently, the insurance trade magazine Insurance Journal wrote about how widespread the problem of payroll misclassification is in Workers Compensation insurance.

Of course, some of us have been pointing this out for decades. After all, Advanced Insurance Management has been helping employers fight these kinds of Workers Comp payroll misclassifications since 1987.

In fact, our very first client back in 1987 had suffered from misclassification of one of their subsidiaries, and AIM was able to get the resulting premium overcharges refunded from four years worth of past policies.

And in all the ensuing years, misclassification of payroll has remained one of the most common, and one of the most expensive kinds of Workers Compensation overcharges that we find and fix for employers.

For example, one of our most recent cases involved a Chicago area meat processing company that had been misclassified for years. Their insurance company had been misclassifying them as a company that cooks meat, when in fact they properly belonged in a less expensive classification for companies that merely slice meat.

Correcting this misclassification ended up with AIM recovering $80,000 in past premium overcharges for this client.

Payroll misclassification occurs because the insurance industry makes the rules regarding Workers Comp classifications just complicated enough that the industry itself makes errors routinely.

This classification system is one of the fundamental aspects of pricing Workers Compensation insurance in the United States.

This system assigns different workplace exposures into a system of codes, each one with a manual rate commensurate with the risk associated with that kind of work in a particular state. 

Misclassification of workplace exposures is one of the most common mistakes that A.I.M. finds and corrects for clients. 

For example, how about a worker who just goes out and does estimates for roofing work? In most states, NCCI insists those workers also go into the roofing class code 5551 because they have to go up on roofs to do the estimates.

But many roofing companies now use a system for estimating roof work that doesn't require the sales person to go up on the roof, using ground based tools and satellite imagery. Yet insurers still routinely assume such estimators must be going up on roofs and automatically move their payroll to the roofing class.

And just to complicate this example further, remember that a few NCCI states have what are called "State Special" rules about this classification, so in those states the details of which workers get put into the roofing class can vary. Even the Code number may vary, with the use of State Specials.  And some states don't use the NCCI system (although most do.)

Again, in most states, the classification system used is one devised and maintained by NCCI, the National Council on Compensation Insurance. NCCI is an independent organization, an "Advisory Organization", to use the current preferred term. (Most insurance people still refer to it as a "Rating Bureau"). Generally, insurance companies don't develop their own classification systems for Workers Comp, but instead find it more convenient to use a system developed by such a rating bureau.

NCCI is largely funded by insurance companies, and insurance company executives make up a majority of its board members. But NCCI is independent of those insurance companies, or at least as independent as any organization can be that has such close financial and management ties with the insurance industry.

NCCI has devised a classification system used by insurance companies to of approximately 550 "National" classification codes, intended to cover workplace exposures. NCCI devises the manuals and rules regarding classification that are used in most states, and also is responsible for determining the correct classifications for particular employers (in those states that use the NCCI system).

These National classifications are supplemented by what NCCI terms "State Specials", classifications or classification definitions that apply in only one state.

NCCI details what kinds of work are intended to be included in each classification code in the "Scopes manual". The Scopes manual is published and updated regularly by NCCI. The Scopes manual is copyrighted by NCCI, so the only way to obtain a copy of this manual is to order one from NCCI.

There are a handful of states that do not use the NCCI classification system: California, New Jersey, New York, Delaware, and Pennsylvania are states that have their own classification systems.

Texas until 2014 had their Department of Insurance operate independently of NCCI, but Texas now has fully adopted NCCI classifications and manual rules, subject to some "State Specials".

Many other states also have some "state special" classifications that vary significantly from NCCI definitions for certain workplace exposures. To see which states are NCCI jurisdictions and which have independent rating bureaus, consult our state-by-state directory.

In The Real World...

Who determines the classification codes used on an employer's Workers Compensation insurance policy? It can be a bit of a complicated process involving multiple parts of the insurance system. Consider:

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  • The Insurance Agent/Broker - Workers compensation class codes are often suggested by or applied on the insurance application initially by the insurance producer who is selling workers compensation insurance to the employer. The agent will typically ask some questions of the employer to try and determine exactly what operations the employer's business performs. Typically the agent will look at past policies of the employer for guidance. Then the agent/broker may discuss things with an insurance company underwriter to try and determine the correct class code for an employer. But agents/brokers typically have widely varying levels of experience and expertise in the fine points of the classification system. The classification system can be complicated and tricky and the best advice of an insurance agent may sometimes be misleading or misinformed. Most importantly, the agent's views on classification do not bind the insurance company.
  • The Insurance Company Underwriter - After the insurance producer submits the workers compensation application to the insurance company it will be reviewed by an underwriter who may or may not agree with the agent regarding the classifications--unless the Workers Comp coverage is being placed in an Assigned Risk plan. Initial underwriting in assigned risk plans is often less than careful, which can set up the employer for unpleasant surprises down the road.
  • The Insurance Company Auditor - After the policy has ended and an audit is done by the insurance company's auditor, the auditor (or the auditor's manager) may make changes in classifications--but these changes are made after the policy has expired, which can produce a very expensive and alarming "shock audit" where ultimate costs of the coverage are far higher than the policy itself would indicate.
  • NCCI and other Rating Bureaus - NCCI and other Rating Bureaus have the responsibility to apply their own classification systems, sometimes overriding underwriters and auditors at the insurance company. Sometimes these organizations are requested to perform inspections to come up with an official classification verdict for a particular employer when questions have been raised. Remember that the various states also maintain appeal systems that can overturn a classification decision by a rating bureau like NCCI.

The insurance industry doesn't make it easy for an employer to figure out classifications rules, either. The insurance manuals can be difficult to understand, or in some jurisdictions relatively lacking in detail, even when an employer can get access to them. Insurance jargon like NOC (Not Otherwise Classified) or NPD (Non Premium Divisible) can also make it difficult for an employer to understand these insurance manuals. Consult our glossary for definitions of these and other terms.

There can be other complications that enter into the equation as well. Each legal entity in a state is supposed to be separately classified. And if there isn't a specific classification that neatly fits an employer, then "classification by analogy" is done, assigning the existing classification that seems to best fit the employer's operations. Such situations often lead to disputes between insurer and employer.

Because Workers Compensation insurance is, to a very great extent, a state-by-state matter, not only can the classification rules vary from one state to another, so too can the mechanisms for disputing or appealing a classification decision by an insurer or rating bureau.

AIM has experience helping clients in all states that allow insurance for Workers Compensation (and even in Ohio, which maintains a monopoly state fund for Workers Compensation, but where the NCCI classification system is now used.) So we are experienced in working with and appealing classification decisions by NCCI and also by other independent state systems, such as California, Delaware, Pennsylvania, Michigan, New Jersey and New York. 

Often, we find employers misclassified into a more expensive classification for years, in spite of competitive bidding by various agents and insurers.  And we've helped employers successfully appeal and reverse classification decisions by NCCI and other rating bureaus.

We here at AIM are often asked by employers if they can find details of this NCCI classification system online. The answer, surprisingly, is no. One would think that such information would be publicly available somewhere on the internet, as it is so fundamental to the pricing of Workers Comp insurance. But NCCI views that manual, known as the Scopes manual, as proprietary and copyrighted material, which they sell. So NCCI doesn't want that material available freely. To get that information, one must purchase a copy of the manual from NCCI, either a hard copy or an electronic subscription.

An employer may be able to get information about specific classification entries in the Scopes manual from their agent, but not all agents have up-to-date copies of this manual.

Advanced Insurance Management LLC doesn't sell insurance. Instead, we consult with employers about proper Workers Compensation insurance classifications, experience modifiers, payroll audits, and other technical aspects that determine Workers Compensation insurance premiums.

AIM helps employers successfully dispute classifications used by insurance companies. We also provide expert witness services in legal disputes with insurance companies over proper classifications, rates, experience modifiers, and audit premium charges.

Find out if your employees have been misclassified by emailing Advanced Insurance Management at aim@cutcomp.com.

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