13.3 Premium Basis, Experience Modification, and Classification

Premium Is Built on Payroll

Workers' compensation premium is payroll-based. The carrier files a manual rate for each job classification, expressed as a dollar amount per $100 of payroll. The basic premium formula is:

Manual Premium = (Payroll / 100) x Rate

Worked example: a clerical class rate is $0.40 per $100 of payroll, and clerical payroll is $300,000. Manual premium = (300,000 / 100) x 0.40 = 3,000 x 0.40 = $1,200. Each classification on the policy is rated separately and the results are summed.

Estimated vs. Audited Premium

Because payroll is not known until the period ends, premium is charged in two steps:

• Estimated (deposit) premium is collected at inception based on projected payroll.
• Audited premium is calculated after the policy expires when an auditor reviews actual payroll records.

If actual payroll exceeded the estimate, the insured owes additional premium; if it was lower, the insured receives a return premium. This premium audit is mandatory on WC policies, which is why honest payroll records matter and why misclassification surfaces at audit.

Classification Codes and the Governing Class

NCCI (or an independent state bureau) assigns four-digit class codes describing the work. Each employee's payroll is mapped to the code that fits their actual duties. Two universal standard exceptions are split out at lower rates regardless of business type:

• Clerical (8810) — office staff physically separated from operations.
• Outside Sales (8742) — salespeople away from the premises.

The governing classification is the basic class with the largest payroll (excluding standard exceptions). Misclassifying a high-rate manufacturing worker as low-rate clerical is the classic premium-evasion trap auditors catch — and it triggers retroactive additional premium.

The Experience Modification Factor

Larger employers are experience rated: their actual loss history adjusts manual premium up or down through an experience modification factor (the "mod" or EMR).

• A mod of 1.00 is average — no adjustment.
• A mod below 1.00 (a credit mod) means better-than-average losses and lowers premium.
• A mod above 1.00 (a debit mod) means worse-than-average losses and raises premium.

The formula applies the mod to manual premium:

Modified Premium = Manual Premium x Experience Mod

Worked Experience-Mod Numeric

An employer's total manual premium is $50,000 and its experience mod is 0.85.

Modified premium = $50,000 x 0.85 = $42,500, a $7,500 credit for good loss experience.

Now a different employer with the same $50,000 manual premium has a debit mod of 1.20: modified premium = $50,000 x 1.20 = $60,000, a $10,000 surcharge. The mod multiplies AFTER classifications are summed but BEFORE schedule/premium-discount adjustments. Exam trap: a mod above 1.00 increases cost; candidates sometimes assume any mod is a discount.

How the Mod Is Calculated

The experience mod compares an employer's actual losses to the expected losses for a business of its size and class, using three years of history (excluding the most recent year, which is still developing). A central rating bureau collects this data and publishes the factor.

A crucial feature is the primary/excess split. Each claim is divided into a primary portion (the first slice of every loss, capped at a split point) and an excess portion (the remainder of large claims). Primary losses are weighted fully, while excess losses are heavily discounted. The practical lesson: frequency (many small claims) damages the mod far more than a single severe claim, because every small claim contributes full primary value. This is why loss-control programs that prevent minor injuries move the mod most.

Premium-Determination Order

The full premium build-up follows a fixed sequence the exam expects you to know:

1. Manual premium = sum of (payroll / 100) x rate for each class.
2. Apply the experience mod to get modified premium.
3. Schedule rating / scheduled credits for risk-specific features (where permitted).
4. Premium discount for size (large premiums get a volume discount).
5. Expense constant and any terrorism / catastrophe charges added.

Minimum premium rules ensure a tiny policy still carries enough premium to cover fixed expenses. Memorize that the mod is applied to manual premium, not to the final billed figure.

Payroll, Class Codes, and a Worked Experience-Mod

Workers comp premium is built on payroll, the best proxy for exposure. The formula is (payroll / 100) x rate per class code x experience modification factor, adjusted by schedule/dividend plans. Each job is assigned a classification code; an employer with several operations uses the predominant governing classification for general workers, with separate codes for clerical and outside sales.

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

• Mod = 1.00 -> average; mod < 1.00 -> better than average (credit, lower premium); mod > 1.00 -> worse than average (debit, higher premium).

Worked example: Payroll $1,500,000, manual rate $2.00 per $100, experience mod 0.85. Manual premium = (1,500,000 / 100) x $2.00 = $30,000; modified premium = $30,000 x 0.85 = $25,500. A mod of 1.20 instead would raise it to $36,000.

Audit point: the policy is written on estimated payroll and audited at year-end; if actual payroll exceeded the estimate, the insured owes additional premium, and if it was lower, the insured receives a return. Misclassifying high-hazard workers into a cheaper code is fraud and is corrected at audit.