Classification Codes – Vital Indicators that Impact Premium
In the world of insurance, one misstep with your Classification Codes can multiply the concerns of all involved – agencies, clients, or auditors. At worst, it could lead to a costly premium audit outcome or a denial of coverage when a loss occurs.
TL;DR
- Classification Codes are used to categorize the type of work a business does, which assists in determining insurance premiums.
- These codes are crucial in agency work due to their role in calculating appropriate coverage and rates.
- Misunderstandings often arise over code correctness, leading to costly audit surprises.
- The best practice is to continuously verify the accuracy of these codes during the policy lifecycle, not just at renewal.
What Is Classification Codes in Insurance?
Plain-language definition: In insurance, a Classification Code is a number that represents the type of work a business does. This helps insurance companies decide how much to charge for insurance.
Technical definition: Classification Codes are specific codes derived from systems like NAICS (North American Industry Classification System) or SIC (Standard Industrial Classification) used in the insurance industry to categorize the business operations of policyholders. They typically appear within policy declarations and are used to calculate premium based on the level of risk associated with each class of business.
Key Related Terms to Know
- NAICS Code – a six-digit system established by the federal Government for classifying business establishments.
- Standard Industrial Classification (SIC) Code – an older system used by federal agencies to classify industry areas. Although it has been largely replaced by NAICS, some insurers and agencies still use SIC codes.
- Industry Code – a broader term for any type of classification code, like NAICS, SIC, or others used outside the US.
- Industrial Classification – the process of categorizing companies by the type of economic activity they engage in, using classification codes.
- Class Code – a simpler term often used to refer to classification codes.
Common Questions About Classification Codes
What’s the difference between the NAICS and the SIC system?
NAICS replaced the SIC system in the U.S. during the late 1990s because it provides a more detailed classification structure. The SIC system is still used in some cases, particularly by insurers and agencies that have not made the change yet.
How often should a business’s class code be reviewed?
Class codes should be reviewed at every renewal and any time there’s a significant business change. Don’t wait for the premium audit – that’s too late. For example, if you know a restaurant started offering delivery due to COVID-19 restrictions, that’s a substantial change in exposure and might warrant a different class code.
Are premiums largely impacted by these codes?
Definitely. Classification codes directly impact the workers’ compensation rates because they reflect the likelihood of workplace injury. A wrong class code can result in incorrect premiums – either higher or lower than what they should be.
Wait, my client’s business does more than one thing, how is this handled?
A business can have multiple class codes. If you look at a contractor, they might have one code for carpentry work, one for masonry work, and another code for clerical office workers.
Classification Codes vs. NAICS Code
Many often confuse NAICS codes and Classification codes as being synonymous, but it’s important to recognize the nuanced difference between them.
Comparison Area | Classification Codes | NAICS Code
|
Primary Use Case | Used primarily by the insurance industry to assess and categorize risk | Internationally recognized system to categorize businesses and economic activities. |
Coverage/ Concept Type | Specifically for assessing risk and determining premiums | Used across various federal and non-federal agencies for statistical, economic and financial analysis. |
Typical Exclusions | Doesn’t include organizational and geographical exclusions | Does include exclusions based on business function and geography. |
Who is most affected by errors | Insureds, as it impacts directly premiums and insurance coverages | Affects a broader set of businesses and government agencies. |
Common Mistakes | Misclassification resulting in wrong premiums and coverage | Wrong classification can lead to incorrect economic, financial and market research. |
Real Claim Examples Involving Classification Codes
Scenario 1: A small construction company primarily did insulation work, and their class code reflected this. They took a big project which involved roofing work but didn’t inform their agent. During the project, a worker fell off the roof and sustained severe injuries. The claim was initially denied because roofing was not covered under their class code.
Scenario 2: A restaurant with a primary classification code for operations without liquor was incorrectly classified as such because they added a sports bar. Failing to update their class code led to a significant liquor liability claim being denied as the insurer had rated and issued a policy on incorrect information.
Scenario 3: A manufacturing business had grown from a single operation to multiple disparate operations, including a separate delivery service. The company was still paying premiums appropriate for a manufacturing operation – a relatively lower risk. A vehicle accident resulted in a substantial claim, and the insurer questioned why they weren’t informed about the delivery operation. The audit led to a significant premium increase.
Limitations and Common Mistakes
- Incorrectly assuming one class code covers all of a business’s operations.
- Failing to update the classification codes when business operations change.
- Only checking class codes at renewal and not part of ongoing account management.
- Ignoring the distinction between clerical office workers and other types of employees in a company.
How to Explain Classification Codes to Clients
Personal Lines client: “Think of classification codes as a way to tell insurers exactly what your business does. These codes help insurance companies understand the risks they’re insuring and how much to charge for coverage.”
Small Business owner: “You know how categories work, right? Imagine if Amazon had one category for all products! That’s what classification codes are for us in insurance – they help categorize your business activities, and based on the perceived risk involved, we work out the insurance rates.”
CFO or Risk Manager: “Classification codes are an essential part of our risk assessment and premium calculation process. By precisely classifying each aspect of your operation, we can provide more accurate pricing and coverage. We need to review and verify these codes to ensure their accuracy consistently.”