13.3 Premium Basis, Experience Modification, and Classification

How workers compensation premium is built

Workers compensation premium is based on payroll, not on sales or square footage. Premium is developed per $100 of payroll within each governing classification code. The basic formula:

Manual Premium = (Payroll / 100) x Rate per $100

The rate reflects the hazard of the job classification — a clerical class has a much lower rate than a roofing class.

Classification codes

Every exposure is assigned a four-digit NCCI class code (e.g., 8810 Clerical Office Employees, 5645 Carpentry). Most businesses have one governing classification (the highest-payroll operative class) plus standard exception classes (clerical, drafting, outside sales) that are rated separately. Misclassification — putting carpenters in the clerical class — is a serious audit problem.

Worked example: manual premium

A contractor has $400,000 of carpentry payroll at a rate of $8.50 per $100, plus $100,000 of clerical payroll at $0.30 per $100.

• Carpentry: ($400,000 / 100) x $8.50 = 4,000 x $8.50 = $34,000
• Clerical: ($100,000 / 100) x $0.30 = 1,000 x $0.30 = $300
• Total manual premium = $34,300

Note how the high-hazard class drives nearly all of the premium. Payroll moved into the wrong class can swing premium by tens of thousands of dollars.

Premium audit

Workers comp premium at inception is an estimate based on projected payroll (a deposit premium). After the policy period the insurer performs a premium audit of actual payroll and issues an additional or return premium. This is why WC is an auditable, adjustable premium line. The insured must keep accurate payroll records (Part Five and Part Four duties).

Experience modification (the mod)

Employers with enough premium qualify for experience rating. The experience modification factor (mod) compares the employer's actual loss history to the average for its class:

• Mod = 1.00 — average losses (neutral).
• Mod below 1.00 (credit) — better-than-average loss experience; premium is reduced.
• Mod above 1.00 (debit) — worse-than-average losses; premium is surcharged.

The mod is multiplied against manual premium.

Worked example: applying the mod

Using the $34,300 manual premium above, suppose the employer earns an experience mod of 0.85 (a 15% credit for good loss history).

Modified premium = $34,300 x 0.85 = $29,155

If instead the mod were 1.20 (a debit for poor losses): $34,300 x 1.20 = $41,160. The mod rewards safety and penalizes frequent claims — a key selling point producers use to motivate loss control. Schedule credits/debits and premium discounts may apply after the mod.

Premium Discount and the Rating Sequence

Larger policies receive a premium discount because fixed expenses spread over a bigger premium base. The full WC rating sequence, in order, is: manual premium → experience mod → schedule rating (credits/debits) → premium discount → expense constant → terrorism/catastrophe charges. Apply the mod before the premium discount — a frequent ordering trap.

Loss-Sensitive and Self-Insured Options

A retrospectively rated plan suits employers confident in their loss control: a good year drops premium toward the minimum, a bad year pushes it to the maximum. The exam contrasts retro rating (variable) with guaranteed cost (fixed).

Why Misclassification Is Audited

Because the rate gap between a clerical class (low) and a roofing or carpentry class (high) is enormous, deliberately coding high-hazard payroll into a clerical class is a serious premium-fraud exposure caught at audit. The auditor reviews payroll records, job duties, and overtime (only straight-time portion of overtime counts as payroll for WC).

What Counts as Payroll

WC payroll generally includes wages, salaries, commissions, bonuses, holiday/vacation pay, and the straight-time portion of overtime — but the premium (extra) portion of overtime is excluded to avoid penalizing employers for paying time-and-a-half. Certain payments (tips reported, employer 401(k) match, severance) may be excluded by manual rule. The overtime-premium exclusion is a classic audit detail.

Split-Point and the Mod Calculation Logic

The experience mod weighs primary losses (the predictable, frequent portion of each claim below a split point) more heavily than excess losses (the large, less predictable portion). This is why frequency hurts the mod more than severity — many small claims signal poor safety culture and drive the mod up faster than one large fluke loss. Producers use this to sell loss-control: cutting small, frequent claims is the fastest way to lower the mod and the premium.

Estimated vs. Audited Premium Flow

WC premium begins as a deposit (estimated) premium based on projected payroll, then is trued-up at the final audit against actual payroll, producing an additional or return premium. Because exposure (payroll) is unknown until the period ends, WC is the textbook auditable line. An insured who refuses the audit can be charged an estimated/penalty audit premium under the policy. The estimate-then-audit cycle is a standard exam fact.

Assigned Risk and the Residual Market

Employers unable to buy WC voluntarily (poor loss history, hazardous class) obtain it through the assigned-risk plan / residual market, where coverage is guaranteed but priced higher, often with a surcharge. This residual mechanism ensures the compulsory WC requirement can always be met. Matching "can't get coverage in the open market" to the assigned-risk pool is a common question.