13.3 Premium Basis, Experience Modification, and Classification

How Workers Comp Premium Is Built

Workers comp premium is payroll-based, not based on units or square footage. The manual premium for each classification is:

(Payroll / 100) x Rate = Manual Premium

The rate is expressed as dollars per $100 of payroll and varies by classification code — the hazard of the work performed. NCCI publishes the classification system (roughly 600 codes). A few high-payroll, low-hazard groups (clerical office 8810, outside salespersons 8742) carry very low rates, while roofing or logging carry high rates.

Estimated vs. Audited Premium

Because payroll is not known until the year ends, comp policies charge an estimated (deposit) premium up front based on estimated payroll, then conduct a final premium audit after expiration. The auditor reviews actual payroll records and the insurer issues an additional premium bill or a return premium credit. Key audit rules:

• Overtime is included at straight-time wages only — the premium portion (the extra half or full of OT) is excluded.
• Payroll caps apply to certain classes (e.g., executive officers, sole proprietors) between a state minimum and maximum.
• Uninsured subcontractors are charged to the policy as if their workers were the insured's employees.

Experience Modification (the Mod)

Eligible employers receive an experience modification factor (EMR or "mod") that adjusts manual premium based on the employer's own loss history versus the average for its class. The mod is multiplicative:

Manual Premium x Experience Mod = Modified Premium

• A mod of 1.00 is average.
• A mod below 1.00 is a credit (better-than-average losses) — premium goes down.
• A mod above 1.00 is a debit (worse-than-average losses) — premium goes up.

The mod weighs frequency more heavily than severity: many small claims hurt the mod more than a single large claim, because frequency predicts future losses better. This is why loss-control and prompt return-to-work programs lower the mod.

Worked Premium Example

A shop has two classes of payroll:

Apply an experience mod of 0.85 (a credit):

• Modified premium = $36,300 x 0.85 = $30,855

Now apply a schedule credit of 5% and a premium discount afterward as applicable. Notice the carpentry payroll drives almost all the cost despite clerical payroll being significant — rate-by-hazard is the core idea. A mod of 0.85 saved this employer $5,445 versus average.

Other Rating Plans

• Retrospective rating — final premium adjusts up or down based on the insured's actual losses during the policy term, between a minimum and maximum premium. Suits large accounts willing to share risk.
• Dividend plans — participating policies may return a dividend if the group's or insured's results are favorable (never guaranteed).
• Premium discount — large policies receive a graduated discount reflecting lower per-dollar expense on big accounts.
• Assigned risk / state fund — employers unable to buy in the voluntary market obtain coverage through a residual-market mechanism, usually at higher cost.

Premium Basis and Classification

Workers compensation premium is based on payroll, expressed as a rate per $100 of payroll for each job classification code. Each occupation carries a rate reflecting its hazard - clerical office work has a low rate, roofing a high one. The insurer sets an estimated premium at inception using projected payroll, then conducts a premium audit at the end of the policy period to compute the actual premium from real payroll, generating an additional or return premium. Proper classification matters because misclassifying a roofer as clerical understates premium and constitutes a serious audit and fraud issue.

The Experience Modification Factor

The experience modification factor (e-mod) adjusts an employer's premium up or down based on its actual loss history versus the expected losses for businesses of its size and class. An e-mod of 1.00 is average; below 1.00 (a credit) lowers premium for better-than-average loss experience, and above 1.00 (a debit) raises it. The mod is calculated by a rating bureau (NCCI in most states) using several years of data, weighting frequency of claims more than severity. A worked point: a $100,000 manual premium with a 0.85 e-mod yields $85,000; with a 1.20 e-mod it becomes $120,000 - rewarding safety programs.

Retrospective Rating and Premium Discount Plans

Larger employers may use retrospective rating, where the final premium is calculated after the period based on actual losses incurred, subject to a minimum and maximum premium - the employer effectively shares risk with the insurer. Premium discount plans reduce the rate as premium size grows (economies of scale), and dividend plans return premium when group loss experience is favorable. Combined with the e-mod, these plans give employers a strong financial incentive to control losses, since both past losses (e-mod) and current-period losses (retro) directly drive cost.

Audit Mechanics and a Worked Premium Calculation

Because premium is based on estimated payroll, the year-end premium audit trues up the cost using actual payroll by classification. A worked example: a contractor projected $500,000 of payroll in a class rated at $6.00 per $100, for an estimated manual premium of ($500,000 / 100) x $6.00 = $30,000. If actual payroll came in at $560,000, the audited premium rises to ($560,000 / 100) x $6.00 = $33,600, generating a $3,600 additional premium - before applying the experience modification and any schedule credits. Refusing to cooperate with the audit can let the insurer estimate payroll or cancel, so audit cooperation is a policy condition.