The importance of proper risk classification
What happens if an insured's business is misclassified by the insurer?
Classifying a business correctly is an important step in providing coverage for a risk because proper classification supports the rating structure and allows an insurance carrier to charge a rate that is commensurate with business exposures. If a business is not classified correctly, then a consumer will not be treated fairly.
For instance, when a business is classed incorrectly, the insurance carrier may use rates that are not commensurate with exposures, losses may be reported incorrectly which will skew the rating structure, or the policyholder may unnecessarily under pay or over pay their premium. Additionally, classification errors usually get caught at time of a premium audit which can lead to an unwelcomed surprise for the policyholder.
Some reasons why classifying a business can be challenging are outlined below.
Limited Number of Classifications
There are thousands of different businesses, but only a limited number of classification codes. Workers' compensation has approximately 700 and general liability has about 1,200. This means that a single classification code typically describes more than one specific business type.
For example, the classification of "STORE: RETAIL NOC" is a kind of generic store classification that can probably be applied to about 30 different kinds of store operations ranging from cigar stores to computer stores. Also, there are classifications that are very specific and only apply to one type of business and nothing else such as "ARCHITECTS & ENGINEERS – CONSULTING" which is restricted to businesses that only perform that particular type of work.
Unique Differences between Workers' Compensation and General Liability Classifications
The first Workers' Compensation Rule for Classification Procedures states that we should assign the ONE basic classification that best describes the business of the employer within a state. With some exceptions, Workers' Compensation basic classifications include all of the various types of labor found in that business. The one exception as mentioned above is standard exceptions such as clerical office employees, outside salespersons, drivers, etc. Standard exceptions are named as such as they are standard for most businesses and exceptions to all the Rules that apply to BASIC classifications.
There is no such thing as a basic class for general liability A rule does not exist stating that you have to find the one classification that best describes the business. Also, there is no rule about the classification within a state. Adding a classification is much easier with general liability than it is with workers' compensation. The rules for general liability state that you assign classifications based on the policyholder's business operations, or enterprises. Instead, you simply choose the classification(s) which best describes the operation or operations. More than one classification assignment may be necessary because one business may have multiple business operations or enterprises. A business may only have one legal entity, but may have several classifications based on their exposures to the general public.
What does this mean? A business may have only one classification for workers' compensation, but have several classifications for general liability.
Classifying a business correctly will take some practice and knowledge. Classification errors are usually discovered, so be sure to make every effort to classify the business correctly the first time.