NCCI’s classification ratemaking methodology involves analyzing employer payroll and loss data (e.g., wage replacement benefits and medical costs) reported to NCCI by workers compensation (WC) insurers. The data is organized by individual job classification and reported to NCCI on an individual policy basis. Job classifications represent groupings of employers with similar types of business that have similar exposures to risk. Classifying employers in this way allows for an equitable distribution of the overall cost of WC insurance among the different types of businesses.
Over time, new industries arise, existing industries evolve, and some industries fade away. In response, NCCI establishes new classifications, modifies existing ones, and eliminates those that are obsolete.
Characteristics of Effective Job Classifications
NCCI’s class ratemaking methodology is designed to balance responsiveness to the changing environment and year-to-year stability. Two critical aspects that promote an effective analysis of loss costs for a classification are the size of the classification and the similarity of the employers within the classification (i.e., homogeneity).
- Size: It is important to consider the number of employers and volume of payroll in an individual job classification. A classification’s size helps determine the credibility assigned to the payroll and loss information for the classification. In general, the larger the size of a classification, the more credibility its data is assigned.
Classifications with less credibility may experience relatively higher levels of year-to-year volatility due to the limited amount of available data. When the data volume is relatively low, a single large loss may have a significant impact on the classification’s results.
- Similarity of risks: It is important that the employers within a classification have similar exposure to loss. This is referred to as “homogeneity.” Homogeneity within a classification allows assumptions to be made about the similarity of the data across all the employers in that classification. In well-functioning classification systems, the high level of similarity within each job classification results in more accurate measures of overall risk exposure and greater credibility.
To help maintain stability of WC coverage costs, there has been a national movement toward eliminating classifications that are obsolete or have less credibility and reassigning their operations to other similar classifications.
Considerations for a New Classification
For example, suppose supervisors, as a group, believe they have less risk than nonsupervisors even though both supervisors and nonsupervisors are currently categorized in the same job classification. Would it make sense to reassign all supervisors into a new classification code? To answer this question, one would need to determine whether the
- size of each of the two classifications is expected to be large enough to produce stable and predictive year-to-year results, or
- supervisors’ risk characteristics are more similar to each other than to the larger combined group of supervisors and nonsupervisors
Without careful consideration of classification size and homogeneity, the data reported in a newly established classification could have relatively low credibility and result in greater year-to-year cost volatility for the employers involved.
Occasionally, requests are made to establish a “state-special” classification. This may occur, for example, when a type of industry only exists in a limited number of states or if growth in a specific industry results in a compelling need to separate out a group of employers from its current classification. As such, a specific state-special classification would only exist in one or a small number of jurisdictions.
As discussed above, creating classifications that have too little data is typically avoided. When a new state-special classification is established, initial expected costs for employers within the classification are generally based on established costs for one or more existing classifications that are deemed to be similar in nature. Over time, as data is collected for the new state-special classification, its costs will increasingly reflect its own payroll and loss experience.
State-special classifications are periodically reviewed to determine whether the support on which they were originally established still exists. For example, if the state-special classification’s industry has expanded, this may allow for the creation of a new national classification or indicate the need to combine the state-special classification into another existing classification with similar employer characteristics.
NCCI’s current classification system contains more than 600 individual job classifications, and it is routinely reviewed and updated so that the classifications remain relevant. From 2012 to 2018 we added approximately 30 national and state-special classifications and removed more than 150. In addition to adding and removing classifications, existing classifications have been reviewed and phraseologies updated to adapt to changes within the industry. These actions collectively result in job classifications with high credibility and greater homogeneity—promoting an equitable distribution of overall costs across the WC industry.
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