13.3 Premium Basis, Experience Modification, and Classification

The Premium Formula

Workers' comp premium is payroll-based. The core formula is:

Premium = (Payroll / 100) x Rate x Experience Modification Factor

Payroll is divided by 100 because the manual Rate is quoted per $100 of payroll. Each component:

• Payroll - the exposure base, estimated at inception and verified at audit.
• Rate - a dollar charge per $100 of payroll, set per class code.
• Experience Modification Factor - the employer's own loss-history adjustment (its 'e-mod' or EMR).

Included payroll is gross wages: salaries, commissions, bonuses, holiday/vacation pay, and the straight-time portion of overtime. Overtime is counted at straight-time only - the extra premium portion (the 'half' in time-and-a-half) is excluded. Tips, severance, and reimbursed business expenses are also generally excluded.

Classification by NCCI Class Code

The National Council on Compensation Insurance (NCCI) assigns each kind of work a four-digit class code with a rate reflecting its hazard. A roofer's code carries a much higher rate than a clerical code because roofing claims are more frequent and severe.

Governing class and payroll splitting: an employer's payroll is divided among the class codes that fit the actual work performed. Standard exceptions like clerical (8810), outside sales (8742), and drivers (7380) are separated out at their own (usually lower) rates rather than being lumped into the higher governing manufacturing or construction class.

Misclassifying a roofer as clerical is both a serious underpayment of premium and, in many states, insurance fraud.

Most employers have a single governing classification describing their main business, plus the standard exceptions broken out separately. To move payroll into a lower-rated standard exception, NCCI rules generally require that the work be physically separate and that the employee not be exposed to the operative hazard - a clerk who occasionally walks the shop floor may not qualify for the 8810 clerical rate.

Construction work adds dual wage and payroll-limitation rules in some states, where higher-paid skilled workers earn a lower rate than the base trade. The takeaway for the exam is that classification follows the actual hazard the worker faces, not the worker's job title or where they sit at a desk.

Premium Audit and the Estimated-vs-Final Premium

Workers compensation premium is estimated at inception from projected payroll, then trued up by a payroll audit after the term. Because the rate is applied per $100 of remuneration, a business that grows during the year owes additional premium at audit, while one that shrinks receives a return.

The exam tests that the insured must keep accurate payroll records by class code and that overtime is generally counted at straight-time wages, not the premium portion. An employer who refuses to permit the audit can face an estimated audit at the insurer's discretion, usually at a punitive level — a frequent compliance-themed question.

The Experience Modification Factor (E-Mod)

The experience modification factor (e-mod or EMR) personalizes premium by comparing an employer's actual losses to the expected losses for a business of its size and class:

E-Mod ratio = Actual Losses / Expected Losses

• 1.00 = average - the employer's losses match expectations.
• Below 1.00 = a CREDIT (debit-free) - better-than-average safety lowers premium (e.g., 0.85 = a 15% discount).
• Above 1.00 = a DEBIT - worse-than-average losses raise premium (e.g., 1.20 = a 20% surcharge).

The e-mod weights frequency more heavily than severity - many small claims hurt an e-mod more than one large claim, which is why insurers push loss-control and safety programs. Only employers above a state premium threshold are 'experience rated'; smaller employers pay manual rates without an individualized mod.

Worked Example: Applying the E-Mod and Audit

Setup: $500,000 estimated payroll, rate $4.00 per $100, e-mod 0.90.

• Manual premium = ($500,000 / 100) x $4.00 = 5,000 x $4.00 = $20,000.
• After e-mod: $20,000 x 0.90 = $18,000 (the 0.90 mod gives a 10% credit).

Audit adjustment: workers' comp policies are auditable. The insured pays a deposit premium at inception on estimated payroll. At expiration, the insurer audits actual payroll:

• If actual payroll was $600,000, premium recomputes to ($600,000 / 100) x $4.00 x 0.90 = $21,600, and the insured owes an additional $3,600.
• If actual payroll was only $400,000, premium recomputes to $14,400, and the insured gets a $3,600 return.

This true-up is why accurate payroll records matter and why concealing payroll is treated as fraud.

Minimum Premium, Expense Constant, and Schedule Rating

Beyond the core formula, several modifiers can adjust the final bill:

• Minimum premium - every policy carries a floor so the insurer recovers fixed costs even on tiny payrolls; a very small employer pays the minimum regardless of the formula result.
• Expense constant - a flat dollar charge added to cover issuance and audit expenses.
• Premium discount - large premiums earn a graduated discount, since fixed expenses are a smaller share of a big account.
• Schedule rating - in some states, an underwriter may apply credits or debits for risk characteristics (housekeeping, safety equipment, management) the e-mod does not capture.

The order of operations matters: the manual premium is computed first, the experience modification is applied next, and then discounts, schedule credits/debits, and the expense constant adjust the standard premium into the final premium. A common exam distractor reverses this order or applies the e-mod after discounts.