13.3 Premium Basis, Experience Modification, and Classification

Premium Is a Moving Target

Workers' comp is one of the few lines where the final premium is not known until after the policy expires. Coverage is written on estimated payroll and adjusted by a year-end premium audit. The basic formula:

Manual Premium = Σ (Payroll ÷ 100) × Class Rate

The exposure base is payroll, expressed per $100 of payroll. Each job is assigned an NCCI classification code with its own rate reflecting that work's injury frequency and severity. A retail clerk (low-hazard) may carry a rate of a few dollars per $100 of payroll; a roofer (high-hazard) may carry many times that.

Worked Example — Manual Premium

A contractor has two payroll classes:

Note how the same payroll dollar costs vastly more in the carpentry class. This is why misclassifying a carpenter as clerical is a serious audit finding — and why payroll segregation by class is essential. Only properly maintained records let the carrier rate clerical at the low rate; un-segregated payroll is charged at the highest-rated class the employee touches.

Experience Modification (the Mod)

The experience modification factor (the "mod" or "EMR") adjusts manual premium up or down based on the employer's actual loss history versus expected losses for its class:

Standard Premium = Manual Premium × Experience Mod

• A mod above 1.00 is a debit (surcharge) — worse-than-average losses
• A mod below 1.00 is a credit — better-than-average losses
• A mod of exactly 1.00 is average for the class

Worked Example: Manual premium $45,600; mod 1.20 → standard premium = $45,600 × 1.20 = $54,720 (a 20% surcharge). With a 0.85 mod instead: $45,600 × 0.85 = $38,760 (a credit).

Mods are computed by a rating bureau (NCCI in most states) from at least three years of data, excluding the most recent year. Frequency of small claims drives the mod up more than a single large claim, because expected-loss formulas cap the impact of severity — a heavily tested concept that rewards reporting fewer, smaller claims.

From Manual Premium to Final Premium

The build-up order matters on the exam:

1. Manual premium = payroll × rates by class
2. × Experience mod = standard premium
3. Apply schedule rating debits/credits (underwriter judgment) and premium discount (large-account volume discount)
4. Add expense constant and any terrorism / catastrophe charges
5. Result = estimated annual premium (subject to audit)

Trap: The experience mod uses past (locked) loss data; retrospective rating uses the current policy term's actual losses. Do not confuse them.

Classification Rules and the Premium Audit

Workers' comp uses a governing classification approach: most employees are assigned to the single class that best describes the employer's overall business, with a few standard exception classes (clerical 8810, outside sales 8742, drivers 7380) rated separately when payroll is properly recorded.

At the premium audit, the carrier examines payroll records, tax filings, and job duties to set the final earned premium. Common audit adjustments:

• Additional premium when actual payroll exceeded the estimate
• Return premium when payroll came in lower
• Reclassification of employees charged to the wrong code
• Inclusion of uninsured subcontractors' payroll (the hiring employer pays for subs who lack their own coverage)

Exam Key: Overtime pay is generally included in payroll at straight-time (base) wages only — the premium portion of overtime (the extra half) is excluded. Severance pay and certain reimbursed expenses are also excluded from the audit payroll.

Combination Worked Problem

Put the pieces together the way the exam does. A landscaping firm has these audited figures:

• Grounds-keeping payroll $400,000 at a rate of $5.00 per $100
• Clerical payroll $100,000 at a rate of $0.40 per $100
• Experience mod of 1.10

Step 1 — manual premium by class:

Step 2 — apply the mod: $20,400 × 1.10 = $22,440 standard premium.

A 1.10 mod means this firm's loss history runs 10% worse than average for its classes, so it pays a 10% surcharge. Had the firm earned a 0.90 mod through better safety, standard premium would fall to $20,400 × 0.90 = $18,360 — a $4,080 swing driven entirely by claims experience. This direct link between safety and price is the system's built-in loss-prevention incentive, and it is why employers fight to keep claim frequency down.

Assigned Risk and Loss-Sensitive Plans

An employer that cannot find voluntary coverage (poor losses, hazardous class, new venture) is placed in the assigned risk plan — the state's residual market — where a carrier is assigned to write the risk, usually at higher cost. Large employers may instead choose loss-sensitive programs:

Trap: The experience mod uses three years of locked, past losses set by the bureau; retrospective rating uses the current policy term's actual losses. Both reward good experience, but at different times and through different mechanics.