13.3 Premium Basis, Experience Modification, and Classification

How Workers Comp Premium Is Built

Workers compensation premium is the most heavily tested rating topic on the P&C national exam. The premium basis is remuneration (payroll), expressed in units of $100 of payroll. The basic formula is:

Premium = (Payroll / 100) x Rate

The rate is assigned by classification code—each type of work has a class code (e.g., clerical office staff vs. roofers) with its own rate that reflects the hazard of that work. A clerical worker might carry a rate of $0.30 per $100 of payroll, while a roofer's rate could be $25.00 per $100, reflecting the dramatically different injury risk.

Worked Example — Manual Premium

A contractor has two classes of employees:

• Clerical staff: $200,000 payroll, rate $0.40 per $100.
• Roofers: $300,000 payroll, rate $22.00 per $100.

Compute each class, then total the manual premium:

• Clerical: ($200,000 / 100) x $0.40 = 2,000 x $0.40 = $800
• Roofers: ($300,000 / 100) x $22.00 = 3,000 x $22.00 = $66,000
• Manual premium = $800 + $66,000 = $66,800

Notice the roofers drive almost the entire premium even though their payroll is only 60% larger—classification rate is everything.

Experience Modification (Experience Rating)

Larger employers qualify for experience rating, which compares the employer's actual losses to the expected losses for businesses of its size and class. The result is an experience modification factor (the mod or EMR).

• Mod = 1.00 — average; the employer's losses match expectations.
• Mod below 1.00 (credit) — better-than-average losses; premium is reduced.
• Mod above 1.00 (debit) — worse-than-average losses; premium is surcharged.

The mod is applied to the manual premium:

Modified Premium = Manual Premium x Experience Mod

Worked Example — Applying the Mod

Take the $66,800 manual premium from above.

• Employer A has a mod of 0.80 (a credit, good loss history): $66,800 x 0.80 = $53,440. The employer saves $13,360.
• Employer B has a mod of 1.25 (a debit, poor loss history): $66,800 x 1.25 = $83,500. The employer pays $16,700 more.

This is the financial incentive to control losses—safety programs lower future claims, which lower the mod, which lowers premium.

Premium Audit

Because premium is based on actual payroll, the policy is auditable. An estimated (deposit) premium is charged up front; after the policy period the insurer performs a premium audit of actual payroll records and bills or refunds the difference. Misclassifying high-hazard workers as clerical is a common—and illegal—way employers try to lower premium.

The Rating Formula, Step by Step

Workers compensation premium is built in a fixed sequence the exam can ask you to reproduce. First, payroll is divided by 100 because rates are quoted per $100 of payroll. Second, the payroll is split into classification codes set by the rating bureau (the National Council on Compensation Insurance, NCCI, in most states), each carrying its own rate reflecting that job's hazard.

Third, payroll-by-100 times the class rate yields manual premium. Fourth, the experience modification factor is applied to produce modified premium. Fifth, optional schedule rating credits or debits and a premium discount for size may apply, and expense constants and assessments are added.

Worked build-up: a firm has $400,000 of clerical payroll (code rate $0.30) and $600,000 of carpentry payroll (code rate $9.00). Clerical manual premium is (400,000 / 100) x 0.30 = $1,200; carpentry is (600,000 / 100) x 9.00 = $54,000; manual premium totals $55,200. With an experience mod of 1.10, modified premium is $55,200 x 1.10 = $60,720. This illustrates why misclassifying a carpenter as clerical is fraud: it would understate premium by roughly the $8.70 rate difference per $100 of that worker's pay.

The experience modification factor compares the employer's actual losses to the losses expected for a firm of its size and class. A mod below 1.00 is a credit (better-than-average losses); above 1.00 is a debit. Only employers above a state premium threshold are experience-rated; smaller firms pay manual premium. Because the mod uses three years of past losses (excluding the most recent year), safety improvements take time to lower it, and a single large claim can raise it for years.

Key Takeaways

Workers compensation premium equals payroll per $100, times the class rate, times the experience modification factor, with optional schedule credits/debits and discounts. Class codes reflect job hazard, the mod compares actual to expected losses (under 1.00 credit, over 1.00 debit), and the policy is auditable so final premium reflects actual payroll. Misclassifying high-hazard workers to cut premium is illegal.

Retrospective Rating and Dividend Plans

Larger employers may choose alternative rating plans the exam names. Under a retrospective rating (retro) plan, final premium is adjusted after the period based on the employer's actual losses during that same period, between a minimum and maximum premium, so a good year is rewarded immediately rather than years later through the mod. This differs from experience rating, which uses past years' losses.

Dividend plans (participating policies) return a portion of premium as a non-guaranteed dividend when the insurer's results are favorable; a flat dividend is fixed, while a sliding-scale dividend grows as the employer's loss ratio improves. Knowing that retro adjusts on current-period losses while experience modification uses prior-period losses is a classic distinction the test draws.