Your workers compensation premium is calculated by multiplying a rate times your payroll and dividing the result by 100. The rates you pay depend on the classifications assigned to your business and the state in which you operate. A workers compensation classification represents a group of employers that conduct similar types of businesses. Examples of classifications are Dairy Farm and Beauty Supply Store - Wholesale. All employers assigned to the same classification pay an identical rate (if they are located in the same state).
Purpose of Classification Systems
A workers compensation classification system is intended to distribute the cost of insurance equitably among employers. The system ensures that employers with high risks of worker injuries pay more for insurance than employers with low risks. If such systems did not exist, all employers would pay the same rate for workers compensation coverage. Employers with low risks of injuries would subsidize those with high risks.
Classification systems are used to categorize businesses, not individual employees. Employers with similar operations are assigned to the same classification.
Classification systems are based on the idea that workers employed by similar businesses are prone to similar types of injuries. For example, employees who install roofs are subject to injuries caused by falls, burns, sun exposure, and lifting heavy objects. The types of injuries these workers sustain are relatively consistent from one roofer to another. Thus, all employers whose business consists of roofing installation are assigned to the same workers compensation classification.
NCCI System Versus Independent Systems
The most widely used classification system was developed by the NCCI. This system is used in thirty-five states. In these states (called NCCI states), the insurance department has designated the NCCI as its official rating and statistical organization. The remaining fifteen states have devised their own systems for classifying employers. These states are referred to as independent states.
The NCCI classification system consists of written descriptions of business operations and four-digit classification codes (or class codes). Two examples are Plumbing NOC & Drivers, code 5183 and Restaurant Fast Food, code 9083 (NOC means not otherwise classified).
The classification systems developed by the independent states serve the same functions and have many of the same features as the NCCI's. For instance, most utilize four-digit codes. The exceptions are Pennsylvania and Delaware, which use three-digit codes, and Wyoming, which uses NAICS codes to classify employers. Many independent states utilize similar (or even identical) classification descriptions and numeric codes as the NCCI.
The NCCI has devised rules and procedures that workers compensation insurers must follow when classifying employers' business operations. These help ensure that businesses are classified correctly.
I. Basic Classification
Your company is assigned a Basic Classification that describes the nature of your business. The basic classification is determined by the type of business you operate. It does not reflect the operations performed or functions served by individual employees.
For example, say that you own a company that manufactures hard candy. You employ two workers that perform janitorial work. You also employ sixteen workers who make, sort and package candy. Your business is candy manufacturing, not janitorial work so all of your workers are classified as Confection Manufacturing, code 2041.
II. Standard Exceptions
Generally, the workers employed by your business are assigned the basic classification. However, some workers perform functions that are common to many types of businesses. These functions are assigned separate classifications called Standard Exceptions. Two examples are clerical office workers (code 8810) and outside sales employees or collectors (code 8742). Because clerical and sales employees perform low-risk work, they less likely to be injured on the job than other workers. Consequently, the rates assigned to the clerical and sales class codes are relatively low.
To be rated as clerical workers, employees must perform clerical duties only. An employee who spends half his workday filing and the remainder of the day boxing candy cannot be classified as a clerical worker. Also, clerical employees must be physically separated from other workers. This means that a clerical worker must be located in an office or behind a partition, not at a desk in the middle of the factory. Workers are classified and rated as outside salespersons if they spend their workday making sales calls or doing collection work away from the employer's premises.
Note that the standard exceptions don't apply to workers that are included in the description of the basic classification. For example, the phraseology attached to code 8723, Insurance Companies, specifically includes clerical workers and salespersons. As a result, workers who perform clerical or sales work at an insurance company are assigned code 8723, not 8810 or 8742.
III. Governing Classification
The term Governing Classification refers to the classification, other than a Standard Exception, which generates the most payroll. For a small business, the Governing Classification may be the same as the Basic Classification. The Governing Classification provides a description of the operations performed by the employer's business.
What if all of your employees are classified as a Standard Exception (clerical or outside sales workers)? In that case, the Standard Exception classification is your Governing Classification.
IV. General Exclusions
Some operations present risks that are not included in the Basic Classification. Called General Exclusions, these activities are separately classified and rated.
Examples of General Exclusions are aviation, new construction or alterations, and sawmill operations. Also considered a General Exclusion is a daycare center run by the employer for the benefit of employees.
V. General Inclusions
Some types of operations might appear to be separate but are included in the Basic Classification. Examples are an employee cafeteria and an on-site medical facility operated for employees. Employees that operate these facilities are assigned the Basic Classification.
While the NCCI states have adopted the NCCI's classification system, each has implemented certain state exceptions. Examples of state exceptions are class descriptions, class codes, and experience rating rules that differ from the NCCI's. Some states have developed endorsements that deviate from the NCCI's. For instance, many states have devised their own endorsements for covering leased workers.