13.3 Premium Basis, Experience Modification, and Classification

How Workers Compensation Premium Is Built

Workers compensation premium is payroll-based. The insurer assigns each job a classification code with a rate per $100 of payroll, multiplies by estimated payroll, then adjusts for the employer's loss history. Because final payroll is unknown at inception, the policy is auditable: the company estimates premium up front and performs a payroll audit after expiration to set the actual premium.

Classification

Each occupation receives a classification code reflecting its hazard. A clerical worker has a low rate; a roofer has a high one. The governing classification is the main business operation. Misclassification is a frequent audit dispute and a common exam trap: payroll must be reported under the correct class, and certain payroll (overtime premium portion) may be adjusted.

Manual Premium Calculation

Manual (base) premium uses this formula:

(Payroll / 100) x Rate = Manual Premium

Example: a contractor has $600,000 of payroll in a class rated at $4.50 per $100.

• $600,000 / 100 = 6,000 units.
• 6,000 x $4.50 = $27,000 manual premium.

If payroll is split across classes, calculate each class separately and add the results before applying the experience modifier.

Experience Modification (the Mod)

The experience modification factor (Mod) compares the employer's actual losses to expected losses for its class.

• A Mod of 1.00 is average.
• Below 1.00 (a credit Mod) means better-than-average losses and lowers premium.
• Above 1.00 (a debit Mod) means worse-than-average losses and raises premium.

Example: $27,000 manual premium x a 0.85 Mod = $22,950. A 1.20 Mod would instead produce $32,400. The Mod rewards safety and is the strongest selling point for loss control.

Premium Discount and Deductibles

Large accounts may earn a premium discount for size, or use a deductible plan. Retrospective rating (retro) adjusts final premium to actual losses within a min/max range. Smaller employers often use guaranteed cost with a flat audited premium.

Multi-Class Worked Example

A contractor has two classes: $300,000 of carpentry payroll rated $5.00 per $100 and $200,000 of clerical payroll rated $0.40 per $100.

• Carpentry: ($300,000 / 100) x $5.00 = $15,000.
• Clerical: ($200,000 / 100) x $0.40 = $800.
• Manual premium = $15,000 + $800 = $15,800.

Apply a 1.10 debit mod: $15,800 x 1.10 = $17,380. Exam trap: clerical payroll must be kept separate and properly documented, or the auditor may apply the higher governing class rate to all payroll.

The Audit and Estimated Premium

Because payroll changes during the year, the up-front premium is a deposit based on estimated payroll. After expiration the insurer conducts a payroll audit (physical or voluntary) and issues an additional bill or a refund. The minimum charge to issue any policy is the expense constant plus a state-set minimum premium. An employer that refuses an audit may be charged an estimated premium up to a multiple of the deposit. Accurate records protect the employer from costly audit adjustments.

Full Premium Build-Up Sequence

Workers comp premium is built in a fixed order, and the exam may ask which step comes when:

1. Manual premium = (payroll / 100) x rate, summed across classes.
2. Apply the Experience Modification (Mod) — multiply the manual premium by the Mod factor.
3. Apply schedule rating credits/debits for risk-specific features (not all states).
4. Apply the premium discount for size (larger premium earns a bigger percentage discount).
5. Add the expense constant and test against the state minimum premium.

The Mod always applies before the premium discount. A common distractor reverses these, producing the wrong number.

How the Experience Mod Is Computed

The Mod compares the employer's actual losses over a three-year experience period (excluding the most recent year) to the expected losses for businesses in the same class. A formula weights primary losses (the first slice of each claim — frequency) more heavily than excess losses (severity), because the rating system penalizes frequent small claims more than one large one. This is why a contractor with many minor strains can have a worse Mod than one with a single catastrophic claim. A debit Mod above 1.00 also drives eligibility for construction credit programs in some states.

Worked Example — Discount After the Mod

A manufacturer has $1,000,000 of payroll at a $6.00 rate: manual premium = ($1,000,000 / 100) x $6.00 = $60,000. Apply a credit Mod of 0.90: $60,000 x 0.90 = $54,000 (modified premium). Now apply a size premium discount of, say, 9% on the standard premium: $54,000 x (1 − 0.09) = $49,140. Reversing the order — applying the discount before the Mod — would yield a different, incorrect figure, which is why the sequence matters. After the policy expires, the payroll audit trues up the estimated $1,000,000 payroll to the actual figure and bills or refunds the difference.

Payroll Inclusions, Exclusions, and the Overtime Rule

Knowing what counts as "payroll" is an audit and exam staple. Included: wages, salaries, commissions, bonuses, holiday and vacation pay, and the value of certain non-cash compensation. Excluded or limited: the premium portion of overtime (the extra half of time-and-a-half is removed, so only straight-time counts), tips, certain employer contributions, and severance. Executive officer payroll is capped between a state-set minimum and maximum per week when they elect coverage.

The auditor will reclassify payroll to the governing class if the employer cannot produce records segregating, say, clerical from field labor — which is why clean payroll records directly protect premium. Misreporting that converts a high-rated roofer's hours to a low-rated clerical class is the kind of error the audit is designed to catch.