13.3 Premium Basis, Experience Modification, and Classification

How Workers Compensation Premium Is Built

Workers compensation premium is payroll-based. The exposure base is remuneration (payroll) per $100 of payroll, broken out by job classification. NCCI assigns each type of work a four-digit class code with its own manual rate (rate per $100 of payroll). Riskier classes (roofers, loggers) carry far higher rates than clerical classes. The basic premium formula tested on exams:

Manual Premium = (Payroll / 100) x Manual Rate, summed across all class codes.

A Manual Premium Calculation

An employer has two classes:

• Clerical (code 8810): $300,000 payroll at a rate of $0.30 per $100.
• Carpentry (code 5403): $200,000 payroll at a rate of $8.00 per $100.

Compute each:

• Clerical: ($300,000 / 100) x $0.30 = 3,000 x $0.30 = $900
• Carpentry: ($200,000 / 100) x $8.00 = 2,000 x $8.00 = $16,000
• Total manual premium = $16,900

Notice the carpentry payroll is smaller yet drives almost all the premium — classification accuracy matters enormously.

Experience Modification (the Mod)

Larger employers receive an experience modification factor (the "mod" or EMR) that adjusts manual premium up or down based on the employer's actual past losses versus expected losses for its class. The mod is computed from a three-year window (excluding the most recent policy year).

• Mod = 1.00 — losses exactly as expected (average).
• Mod below 1.00 — better-than-average loss experience: a credit (premium decreases).
• Mod above 1.00 — worse-than-average experience: a debit (premium increases).

The mod rewards good safety records and penalizes poor ones, the core incentive in experience rating.

Applying the Mod

Using the $16,900 manual premium above, suppose the employer earns a 0.85 mod (15% credit for good experience):

• Modified premium = $16,900 x 0.85 = $14,365

If instead the employer had a 1.20 mod (poor experience):

• Modified premium = $16,900 x 1.20 = $20,280

Experience rating uses actual losses, so frequent small claims hurt the mod more than a single large one, because the rating formula weights frequency heavily (primary losses count more than excess losses).

Premium Discounts, Audit, and Other Adjustments

Several additional steps appear in order:

1. Schedule rating / premium credits for specific risk characteristics (safety programs).
2. Premium discount for larger premiums (volume discount; expenses are proportionally lower on big accounts).
3. Expense constant added to small policies to cover fixed issuance costs.
4. Audit. WC premium is an estimate at inception because final payroll is unknown. After the policy expires, the insurer performs a premium audit of actual payroll and issues an additional or return premium. The policy condition obligating the insured to keep records and allow inspection is the Premium / audit condition.

Classification Traps

• The governing classification is the highest-payroll class other than standard exception classes (clerical, drivers, salespersons), which are split out at their own rates.
• Overtime is generally counted at the straight-time portion only (the premium portion of overtime is excluded) when records separate it.
• Payroll for sole proprietors, partners, and executive officers is included at a statutory minimum/maximum, not actual draw.
• Misclassifying high-risk payroll into a cheap clerical code is a common audit reversal and a fraud red flag.

Classification Codes and the Manual Rate

Each type of work is assigned an NCCI classification code with a manual rate per $100 of payroll reflecting that job's hazard — a clerical class carries a low rate, a roofing class a high one. Premium begins as: (payroll / 100) x manual rate, summed across all classes, then adjusted by the experience modifier and other factors.

The Experience Modification Factor

The experience modification (mod) compares an employer's actual losses to the expected losses for its class and size:

A mod of 0.85 cuts premium 15%; a mod of 1.20 adds 20%. The mod rewards safety and penalizes frequent claims, giving employers a direct financial incentive to reduce losses.

Premium Audit and Worked Calculation

Workers comp premium is an estimate at inception based on projected payroll, then audited at year-end against actual payroll, generating additional or return premium. Worked example: A $600,000 clerical payroll at a $0.40 manual rate = (600,000 / 100) x 0.40 = $2,400; apply a 0.90 mod = $2,160. If audited payroll proves to be $700,000, the insurer bills the difference. The exam tests the payroll-based formula, the credit/debit nature of the mod, and the fact that comp premium is auditable — unlike a flat-rated personal policy.

Premium Discount, Retrospective, and Dividend Plans

Beyond the manual-rate-times-mod calculation, large employers can use alternative rating plans the exam names: a premium discount for size, a retrospective rating plan where final premium is adjusted within a min/max range based on actual losses during the period, and participating (dividend) plans that return premium when loss experience is favorable. Retro plans shift more risk to the employer in exchange for the chance of a lower final cost. Recognizing that comp premium can be experience-rated, retrospectively adjusted, and dividend-eligible distinguishes the workers-comp line from flat-rated personal coverages.