13.3 Premium Basis, Experience Modification, and Classification
Key Takeaways
- Manual premium = (payroll / 100) x class rate; payroll is the EXPOSURE BASE and rate is dollars per $100 of payroll, so a $50,000 payroll at a $4.50 rate yields $2,250
- Each job is assigned an NCCI classification code with its own rate reflecting injury frequency and severity; the governing classification is the highest-payroll non-standard class
- The experience modification factor (mod) is a debit/credit above or below 1.00: a mod over 1.00 surcharges premium, under 1.00 is a credit; it is applied AFTER manual premium
- The mod weights ACTUAL losses against EXPECTED losses for the class, and primary (first dollars of each claim) losses count more heavily than excess losses - so frequency hurts more than one severe claim
- Coverage is written on ESTIMATED payroll and audited at year-end; the premium audit adjusts to actual payroll, and overtime is counted at straight-time wages only
Premium Is a Moving Target
Workers' comp is one of the few lines where premium is not fixed at issue. The exam expects you to know the mechanics and to run the arithmetic.
Step 1: Classification
Each job type is assigned a National Council on Compensation Insurance (NCCI) classification code with its own rate per $100 of payroll. The rate reflects the injury frequency and severity of that occupation: a clerical class may be a few dollars; a roofer's class many times higher.
| Job Class | Illustrative Rate (per $100 payroll) |
|---|---|
| Clerical office (code 8810) | $0.20 |
| Retail store | $2.50 |
| Carpentry / framing | $9.00 |
| Roofing | $20.00 |
When an employer has several classes, the governing classification is generally the standard (non-clerical, non-standard-exception) class with the largest payroll. Clerical, drivers, and outside salespersons are 'standard exceptions' rated separately.
Step 2: Manual (Exposure) Premium
The exposure base is payroll, and rate is quoted per $100 of payroll:
Manual Premium = (Payroll / 100) x Rate
Worked Example: A shop with $50,000 of payroll in a class rated at $4.50 per $100:
- $50,000 / 100 = 500 units
- 500 x $4.50 = $2,250 manual premium
If the employer also has $200,000 of clerical payroll at $0.20:
- $200,000 / 100 = 2,000 units
- 2,000 x $0.20 = $400
- Combined manual premium = $2,250 + $400 = $2,650
Step 3: Experience Modification (the Mod)
The experience modification factor is a debit/credit applied to manual premium. It compares the employer's actual losses to the expected losses for its size and class over an experience period (usually three years, excluding the most recent year).
| Mod | Meaning | Effect on Premium |
|---|---|---|
| Above 1.00 | Worse than average losses | Surcharge (debit) |
| Exactly 1.00 | Average | No change |
| Below 1.00 | Better than average losses | Credit |
Worked Example: Manual premium $2,650, experience mod 1.25:
- $2,650 x 1.25 = $3,312.50 modified premium (a 25% surcharge)
A mod of 0.80 on the same premium yields $2,650 x 0.80 = $2,120 (a 20% credit).
Why Frequency Hurts More Than Severity
The mod formula splits each claim into a primary portion (the first dollars, capped at a split point) and an excess portion. Primary losses count at full weight; excess losses are heavily discounted. The result: many small claims (high frequency) drive the mod up more than a single large claim, because each claim contributes a full primary amount. This is a favorite exam point - the system penalizes frequency to push loss prevention.
Step 4: Schedule and Other Modifications
After the mod, insurers may apply:
- Schedule credits/debits for risk characteristics (premises, management, safety devices)
- Premium discount for size (large premiums get volume discounts)
- Expense constant and minimum premium for small accounts
Step 5: The Premium Audit
Coverage is written on estimated payroll at inception. At year-end the insurer conducts a premium audit to determine actual payroll, then adjusts the premium up or down. Audit rules to remember:
- Overtime is counted at straight-time (base) wages only - the premium portion of overtime is excluded
- Tips, severance, and certain reimbursements may be excluded per the basic manual
- Payroll for sole proprietors/officers who elect coverage is included at a statutory minimum/maximum
Exam Key: If actual payroll exceeded the estimate, the audit produces an additional premium; if it fell short, a return premium.
Putting the Steps Together
| Step | Action | Running Figure |
|---|---|---|
| 1 | Classify each job, find the rate | Rate per $100 |
| 2 | Multiply (payroll / 100) x rate | Manual premium |
| 3 | Apply experience mod | Modified premium |
| 4 | Apply schedule credits/discounts | Standard premium |
| 5 | Audit to actual payroll | Final premium |
The direct line from loss experience to the mod, and from the mod to premium, is why workers' comp is described as a line that prices safety.
Eligibility and the Promulgated Mod
Not every account is experience-rated. An employer must generate enough premium over the experience period to be credible before NCCI (or the state's independent rating bureau) will issue a mod. Below the eligibility threshold the account simply pays manual premium at 1.00. Once eligible, the mod is promulgated by the bureau, not chosen by the insurer, and follows the employer across carriers - a poor mod cannot be escaped by changing insurers.
Two further refinements appear on the exam: a merit rating plan for smaller, not-yet-experience-rated risks that grants a flat credit/debit based on claim count, and retrospective rating, in which a large insured's final premium is adjusted after the term based on its actual losses within a maximum and minimum.
Assigned Risk and the Residual Market
An employer that cannot buy coverage in the voluntary market - typically because of a high mod, severe loss history, or a hazardous class - is placed in the assigned risk plan (the residual market), where coverage is guaranteed but priced higher and the experience mod still applies. The residual market is administered by NCCI in most states. This guarantees the statutorily required Part One coverage is always obtainable, the same way auto assigned-risk plans guarantee mandatory auto coverage.
The Premium Audit Visit
At the premium audit, the auditor reviews payroll records, tax filings, and certificates of insurance for subcontractors. Uninsured subcontractors are charged to the policy as if they were the insured's own payroll - a frequent source of unexpected additional premium. The insured must cooperate; refusing the audit lets the insurer estimate payroll and bill accordingly, and is grounds for cancellation.
An employer has $80,000 of payroll in a class rated at $6.00 per $100 of payroll and an experience modification factor of 1.10. Ignoring other modifications, what is the modified premium?
Why does a series of several small workers' compensation claims typically raise an employer's experience mod more than one large claim of the same total dollar value?