13.3 Premium Basis, Experience Modification, and Classification

Premium = Payroll, Classification, and Rate

Workers' comp premium is built from three inputs, shown at Item 4 of the Information Page:

1. Payroll — the exposure base, expressed per $100 of payroll.
2. Classification (class code) — the NCCI four-digit code describing the type of work (e.g., clerical 8810, carpentry 5645).
3. Manual rate — the cost per $100 of payroll for that class.

Manual (estimated) premium = (Payroll ÷ 100) × Rate, summed over all class codes.

Worked example: A roofer with $400,000 payroll at a rate of $18.50 per $100: $400,000 ÷ 100 = 4,000 units; 4,000 × $18.50 = $74,000 manual premium.

Notice the unit math: dividing payroll by 100 converts dollars into 'per-hundred' exposure units, and each unit is then priced at the manual rate for that class. A clerical class at $0.30 per $100 produces trivial premium, while a roofer or steel-erector class at $18 or more drives most of the cost. That spread is why correct classification has such a large dollar impact, and why auditors scrutinize how payroll is split.

Exam Key: The exposure base is payroll, not headcount or sales. Overtime is generally counted at straight-time wages (the premium portion of OT is excluded), so paying time-and-a-half does not inflate the comp premium base.

Classification Rules

Most employers receive one governing classification for the overall business, plus standard exceptions that are separately rated regardless of the governing class:

Dividing payroll across classes is legitimate only when records actually separate the duties; otherwise payroll is assigned to the highest-rated applicable class. Misclassifying a high-hazard worker into a clerical code to cut premium is premium fraud.

Audit Adjusts Estimate to Actual

Premium at inception is an estimate based on projected payroll. After expiration the carrier performs a payroll audit and computes earned premium on actual payroll; the insured pays additional premium or receives a return. This is why comp is an auditable, exposure-rated line.

There is also a minimum premium and an expense constant (a flat charge covering issuance and audit costs) on most policies, so even a tiny payroll generates a floor premium. If an insured refuses to cooperate with the audit, carriers may apply an estimated audit at the highest reasonable payroll, which almost always raises the bill — a practical incentive to keep clean payroll records by class code.

The Experience Modification Factor (E-Mod)

Larger employers are experience rated: an experience modification factor (E-Mod or X-Mod) compares the employer's actual losses to the expected losses for its class and payroll over a three-year window (excluding the most recent year).

• E-Mod = 1.00 → average for the class (neutral)
• E-Mod < 1.00 → better than average → credit (premium reduced)
• E-Mod > 1.00 → worse than average → debit (premium increased)

The mod is applied to manual premium: Modified premium = Manual premium × E-Mod.

Worked example: $74,000 manual premium × E-Mod 0.85 = $62,900 (a 15% credit). With an E-Mod of 1.20 the same risk pays $74,000 × 1.20 = $88,800 (a 20% debit).

Exam Key: Experience rating uses past losses to adjust current premium. The split-plan formula weights frequency (many small claims) more heavily than severity (one large claim), so a pattern of small claims hurts the mod more than a single catastrophic loss.

Plans That Reward Loss Control

Beyond experience rating, several plans tie cost to results:

Order of operations for the exam: payroll × rate = manual premium → × E-Mod → schedule/premium-discount adjustments → expense constant and taxes. Retrospective plans replace the standard final premium with a loss-sensitive calculation.

Trap: The E-Mod is applied to manual premium before premium discount, not after. And a mod below 1.00 is the favorable one — candidates often reverse this.

How Workers' Comp Premium Is Built

WC premium is payroll-based: each employee is assigned a classification code carrying a rate per $100 of payroll, reflecting the hazard of the job. The basic formula is (payroll / 100) x rate, summed across classifications, then adjusted by the experience modifier and other factors. Because exposure (payroll) changes during the year, WC is an auditable policy - a premium audit at year-end reconciles estimated to actual payroll.

Classification and the Governing Class

The Experience Modification Factor

The experience modifier (e-mod or X-Mod) compares an employer's actual loss experience to the expected experience for similar businesses. A mod of 1.00 is average; below 1.00 earns a credit (better-than-average safety) and above 1.00 a debit. The mod weights frequency of claims more heavily than severity, so several small claims hurt more than one large one - a counterintuitive point the exam likes to test, and a powerful incentive for loss control.

Premium Modifiers and Plans

Beyond the e-mod, premium can be adjusted by: schedule rating (credits/debits for individual risk characteristics), premium discount (large policies pay a lower expense load), retrospective rating (final premium varies with actual losses during the term, within a max/min), and dividend plans (participating policies return a dividend in good-loss years). A candidate should know that retrospective rating shifts loss risk back onto a large insured, while guaranteed-cost policies do not, and that the minimum premium floors the cost regardless of low payroll.