13.3 Premium Basis, Experience Modification, and Classification

The Premium Formula

Workers compensation premium starts from payroll (called remuneration) and a manual rate quoted per $100 of payroll. The core calculation is:

Premium = (Payroll / 100) x Manual Rate x Experience Modifier

Further adjustments — schedule rating credits/debits, premium discount for size, and expense constants — refine the result. Because premium depends on actual payroll, the policy is auditable: the insurer estimates payroll at inception and reconciles it after the period ends. If audited payroll exceeds the estimate, the employer owes additional premium; if lower, the employer gets a return.

What Counts as Payroll

Remuneration includes wages, salaries, commissions, bonuses, holiday/vacation/sick pay, and the value of meals or lodging given in lieu of wages. Important exam rules:

• Overtime is counted at the straight-time (regular) rate — the premium portion (the extra half or full) of overtime is excluded.
• Payroll for certain executives, partners, and sole proprietors is included only at a state-set minimum/maximum payroll amount.
• Severance pay and reimbursed business expenses are typically excluded.

Trap: Overtime is included, but only at straight-time. Candidates wrongly exclude all overtime or include it at time-and-a-half.

Classification

NCCI assigns each type of work a numeric classification code reflecting its hazard. The governing classification describes the employer's main business, while clerical, outside sales, and drivers are usually classified separately (standard exceptions). Payroll is divided among the codes that match the actual duties performed.

Misclassification is a frequent audit dispute: putting a roofer in a clerical class understates hazard and premium. The audit can reclassify and recompute. Generally an employee's entire payroll goes to the highest-rated class in which they work, unless the insurer permits division of payroll with proper records.

The Experience Modification Factor (Mod)

The Experience Modification Rate (EMR or mod) compares an employer's actual losses to the expected losses for similar businesses, using roughly three prior years of data (excluding the most recent policy year). It is multiplicative:

• Mod = 1.00 — average; losses equal expected.
• Mod < 1.00 — a credit; better-than-average loss record lowers premium.
• Mod > 1.00 — a debit; worse-than-average record raises premium.

A mod of 0.85 cuts premium 15%; a mod of 1.20 adds 20%. Experience rating is mandatory once an employer's premium exceeds a state-set eligibility threshold, giving larger employers a direct financial incentive to control losses.

Worked Example: Effect of the Mod

Take the prior example — manual premium of $27,000 — and apply two different mods:

• Mod 0.80 (credit): $27,000 x 0.80 = $21,600 (a $5,400 saving).
• Mod 1.25 (debit): $27,000 x 1.25 = $33,750 (a $6,750 surcharge).

The difference between the two employers is $12,150 on identical payroll and classification — driven entirely by loss history. This is why safety programs pay for themselves.

Why Frequency Hurts More Than Severity

Experience rating splits each claim into a primary portion (the first dollars, fully counted) and an excess portion (large amounts, discounted). Because the primary layer drives the mod, many small claims load up far more primary dollars than one large claim, whose excess portion is heavily discounted.

Trap: A business with ten $5,000 claims will usually have a higher mod than a business with one $50,000 claim, even though total dollars are equal. The exam rewards the answer that says frequency hurts the mod more than severity.

Premium Discount, Schedule Rating, and Audit

Several adjustments follow the manual-premium-times-mod step:

• Premium discount: as premium size rises, a declining percentage of the insurer's expenses is needed, so larger accounts receive a graduated discount.
• Schedule rating: an underwriter may apply credits or debits (commonly up to plus or minus 25%) for risk features the class rate ignores — superior housekeeping, formal safety committees, modified-duty return-to-work programs.
• Expense constant and minimum premium: small policies carry a flat charge to cover issuance costs.

At expiration the insurer conducts a payroll audit. If the estimate was $600,000 but the auditor finds $750,000 of actual payroll, additional premium is billed on the extra $150,000. Audit noncompliance (refusing records) can trigger an estimated audit at a much higher payroll, so accurate records protect the insured.