13.3 Premium Basis, Experience Modification, and Classification
Key Takeaways
- Workers comp premium = (payroll per $100) x classification rate, then adjusted by the experience modification factor.
- Payroll is the exposure base; premium is estimated at inception and audited at expiration.
- Each job is assigned an NCCI classification code reflecting its hazard level.
- An experience mod (ex-mod) above 1.00 surcharges premium; below 1.00 credits it; 1.00 is average.
- The mod compares the insured's actual losses to expected losses for its class, rewarding safety.
How Premium Is Built
Workers compensation is a payroll-rated, auditable line. The exposure base is remuneration (payroll), and the manual premium formula is:
Manual premium = (Payroll / 100) x Class rate
Because actual payroll is unknown when the policy starts, the carrier charges a deposit (estimated) premium at inception and performs a premium audit at expiration to charge or refund the difference.
Classification Codes
NCCI assigns each type of work a classification code reflecting its hazard. A clerical office worker (low code rate) costs far less per $100 of payroll than a roofer (high code rate). Most employers have a governing classification plus standard exceptions like clerical and outside sales.
| Job | Sample rate per $100 payroll |
|---|---|
| Clerical office | $0.15 |
| Retail store | $1.80 |
| Carpentry | $9.50 |
| Roofing | $22.00 |
Exam trap: payroll is divided by 100, not 1,000. A rate of $9.50 means $9.50 of premium for each $100 of payroll.
Worked Manual Premium
A carpentry shop has $400,000 of payroll at a carpentry rate of $9.50 per $100.
- Payroll units = $400,000 / 100 = 4,000.
- Manual premium = 4,000 x $9.50 = $38,000.
If the firm also has a clerk earning $50,000 at $0.15:
- Clerk premium = (50,000 / 100) x $0.15 = $75.
- Total manual premium = $38,000 + $75 = $38,075.
The Experience Modification Factor
Employers large enough to qualify receive an experience modification factor (ex-mod, or EMR). It compares the employer's actual losses to the expected losses for businesses in its class over a rating period (typically three years, excluding the most recent year).
- Mod = 1.00 is exactly average.
- Mod above 1.00 is a debit (surcharge), signaling worse-than-average losses.
- Mod below 1.00 is a credit (discount), rewarding good safety experience.
Applying the Mod
The ex-mod multiplies the manual premium:
Modified premium = Manual premium x Experience mod
Using the carpentry shop's $38,075 manual premium:
- With a favorable mod of 0.85: $38,075 x 0.85 = $32,364 (a $5,711 saving).
- With an unfavorable mod of 1.25: $38,075 x 1.25 = $47,594 (a $9,519 surcharge).
The spread between those two outcomes shows why loss control drives the largest premium swings in this line.
Other Premium Modifiers
- Premium discount: a volume discount that lowers the rate per unit as total premium rises (large accounts are cheaper to administer).
- Schedule rating / scheduled credits: subjective credits or debits for specific risk characteristics where allowed.
- Retrospective rating: a plan where final premium adjusts within a min/max band based on the insured's own losses during the policy term, used by large accounts willing to bear loss volatility.
Exam trap: the ex-mod is retrospective in spirit but prospective in application — it is built from past losses but applied to the upcoming policy's premium, whereas a retro plan adjusts the current term's premium after the fact.
Audit and the Estimated Premium
Because payroll is the exposure base, the policy is always auditable. At inception the carrier collects a deposit premium based on the insured's payroll estimate. At expiration the premium audit measures actual payroll.
If the business grew, actual payroll exceeds the estimate and the insured owes additional premium. If it shrank, the insured receives a return premium. An employer that refuses to cooperate with the audit can be charged an estimated audit premium, often at the highest applicable class rate.
| Audit finding | Result |
|---|---|
| Actual payroll above estimate | Additional premium billed |
| Actual payroll below estimate | Return premium issued |
| Audit refused | Estimated premium charged |
This audit mechanism is why understating payroll never saves money long-term: the true exposure surfaces at audit and the premium follows it.
What counts as remuneration
The payroll base is remuneration, which is broader than base wages. It generally includes salaries, hourly pay, commissions, bonuses, overtime (often at straight-time after backing out the premium portion), holiday and vacation pay, and the value of certain in-kind compensation such as lodging. It typically excludes items like reimbursed business expenses, employer contributions to qualified benefit plans, and certain severance. Misjudging what to include is a common source of audit disputes, so producers should set the deposit premium on a realistic remuneration estimate rather than an artificially low one.
The experience-rating window and unit statistical data
The ex-mod is calculated by the rating bureau (NCCI in most states) from unit statistical reports the insurer files, using a rating period that typically spans three years but drops the most recent policy year so the data is mature. The formula weights frequency (number of claims) more heavily than severity (size of a single claim), because frequent small losses predict future losses better than one large shock loss. This is why an employer with many minor recordable injuries can carry a higher mod than one with a single catastrophic claim - a counterintuitive point the exam likes to test.
Exam Tip: Manual premium = (payroll/100) x rate; modified premium = manual x ex-mod; a mod below 1.00 is a credit and above 1.00 a debit; and the audit, not the deposit, sets the final premium based on actual remuneration.
A contractor has $600,000 of payroll at a rate of $7.00 per $100 and an experience mod of 1.10. What is the modified premium?
What does an experience modification factor of 0.80 indicate about an employer?