13.3 Premium Basis, Experience Modification, and Classification

Premium Is Built on Payroll

Workers compensation premium is not a flat charge — it is built from remuneration (payroll) by classification. The core formula tested on the exam:

Manual premium = (Payroll / 100) x Rate

The rate is expressed per $100 of payroll for each job classification. Higher-hazard classes (roofers, loggers) carry far higher rates than low-hazard clerical classes.

Worked example: A clerical class has a rate of $0.40 per $100 of payroll. Clerical payroll is $500,000. Manual premium = ($500,000 / 100) x $0.40 = 5,000 x $0.40 = $2,000.

Multiple Classifications

Most employers have more than one class code. You compute premium separately for each class, then total. Overtime is generally included at the straight-time (base) rate, not the time-and-a-half rate — only the premium portion of overtime is excluded.

Worked example — two classes:

Carpentry payroll = ($300,000 / 100) x $6.00 = 3,000 x $6.00 = $18,000. Total manual premium = $600 + $18,000 = $18,600.

Experience Modification (the 'Mod')

Larger employers receive an experience modification factor (e-mod) that compares their actual loss history to the expected losses for their size and class. The mod multiplies the manual premium:

Modified premium = Manual premium x Experience Mod

• A mod of 1.00 is average (neither credit nor debit).
• A mod below 1.00 is a credit (better-than-expected losses) and lowers premium.
• A mod above 1.00 is a debit (worse-than-expected losses) and raises premium.

Worked example: Manual premium is $20,000 and the experience mod is 0.85. Modified premium = $20,000 x 0.85 = $17,000 — a $3,000 credit. If the mod were 1.20, modified premium = $20,000 x 1.20 = $24,000 — a $4,000 debit.

Schedule Rating, Retrospective Rating, and Dividends

Beyond experience modification, larger accounts may use schedule rating (debits and credits for specific risk characteristics such as safety programs, premises condition, and management) and retrospective rating, where the final premium is adjusted after the policy period based on the insured's actual losses, subject to a minimum and maximum. Participating (dividend) policies can return a dividend if the carrier's results are favorable, though dividends are never guaranteed.

These plans reward good loss experience and give large employers a financial incentive to control claims, which is why safety and return-to-work programs directly lower premium through a falling experience mod.

Payroll Classification and the Governing Class

Premium begins with assigning each employee to an NCCI (or state-bureau) classification code that reflects the hazard of the work, at a rate per $100 of payroll. Each business has a governing classification (its primary operation) plus standard exceptions (clerical, outside sales, drivers) that are rated separately at lower rates regardless of the governing class. Overtime pay is included at straight-time value only — the premium portion of overtime is excluded so employers are not penalized for paying time-and-a-half.

Misclassifying high-hazard payroll into a low-rate clerical class is a frequent audit finding that produces a large additional premium, and deliberately doing so is premium fraud.

Worked Two-Class Premium

Compute each class separately, then total. Clerical payroll of $300,000 at $0.40 per $100 yields $1,200; warehouse payroll of $500,000 at $4.00 per $100 yields $20,000; manual premium is $21,200. Applying an experience mod of 0.90 gives a standard premium of $19,080, before schedule credits, the expense constant, and the minimum-premium check. Remember the calculation order: manual premium, then experience mod, then schedule rating, then premium discount and expense constant, ending with the minimum-premium floor.

Audit, Deposit Premium, and Why WC Is Auditable

Because payroll is estimated at inception, workers comp is an auditable policy. The insured pays an estimated deposit premium up front; after the term the insurer performs a payroll audit of records and issues an additional or return premium for the difference between estimated and actual payroll. Refusing the audit lets the insurer estimate payroll and bill accordingly.

Other elements include the expense constant (a flat charge added to every policy to cover issuance costs), the minimum premium (the least the insurer will charge regardless of low payroll), and premium discount (a credit for larger premiums reflecting economies of scale). The audit is why an employer that grows during the year owes more premium even though the limits never changed.

Audit, Deposit, and Minimum Premium

Because payroll is an estimate at inception, WC is an auditable (reporting) policy. The insured pays an estimated deposit premium up front; after the policy ends the insurer performs a payroll audit and issues an additional or return premium. Other premium elements:

• Minimum premium — the least the insurer will charge regardless of low payroll.
• Expense constant — a flat charge added to cover fixed handling expenses.
• Premium discount — a volume credit for larger premiums (not the same as the experience mod).
• Schedule rating — debits/credits for risk characteristics not captured by class or mod.

Order of Premium Calculation

The exam may ask the sequence:

1. Compute manual premium = (payroll/100) x rate, per class.
2. Apply the experience modification to get standard premium.
3. Apply schedule rating debits/credits.
4. Apply premium discount and add the expense constant.
5. Verify the result is at least the minimum premium.

Dividends, if any, are paid after the policy period from a participating insurer and are never guaranteed.