13.3 Premium Basis, Experience Modification, and Classification
Key Takeaways
- Premium basis is payroll; manual premium = (payroll / 100) x rate, summed by NCCI class code.
- The experience modification factor compares actual to expected losses: below 1.00 reduces premium, above 1.00 increases it.
- NCCI experience rating weights claim frequency more heavily than severity.
- Workers comp is an auditable policy: a deposit premium is charged on estimated payroll, then adjusted to actual at a year-end audit.
- Order of operations: classify, compute manual premium, apply mod, schedule rate, premium discount, expense constant, minimum premium.
How Workers Comp Premium Is Built
Workers comp premium is the most formula-driven topic on the National P&C exam. The premium basis is payroll (remuneration), the rate is per $100 of payroll, and the rate varies by classification code. Master the order of operations and you can answer almost any premium question.
Step One: Classification
The National Council on Compensation Insurance (NCCI) assigns each occupation a four-digit class code with a manual rate reflecting that work's hazard. A clerical worker (class 8810) carries a far lower rate than a roofer (class 5551). The governing classification is the basic operation of the business; standard exception classes (clerical, outside sales, drivers) are carved out separately. Misclassifying high-hazard employees as clerical is both a fraud trap and an audit adjustment.
Step Two: Manual Premium
Manual premium = (Payroll / 100) x Rate, summed across class codes.
Worked example. A contractor has $400,000 of carpentry payroll (rate $8.50) and $100,000 of clerical payroll (rate $0.40):
- Carpentry: ($400,000 / 100) x $8.50 = 4,000 x $8.50 = $34,000
- Clerical: ($100,000 / 100) x $0.40 = 1,000 x $0.40 = $400
- Manual premium = $34,400
Note payroll is counted in hundreds, so always divide by 100 before multiplying by the rate. Overtime is generally counted at straight-time wages only (the premium portion of overtime pay is excluded).
Step Three: The Experience Modification Factor
Eligible employers (those whose premium exceeds a state threshold) receive an experience modification factor (the 'mod' or EMR) that compares the employer's actual losses to the losses expected for a business of its size and class.
- A mod of 1.00 is average.
- A mod below 1.00 (a credit mod, e.g., 0.85) means better-than-expected loss experience and reduces premium.
- A mod above 1.00 (a debit mod, e.g., 1.20) means worse-than-expected experience and increases premium.
The formula multiplies manual premium by the mod. NCCI's actual rating plan weights frequency of claims more heavily than severity — many small claims hurt the mod more than one large claim, because frequent losses are seen as more controllable and predictive. This is a favorite exam nuance.
Worked example. Take the $34,400 manual premium above. With a debit mod of 1.15: $34,400 x 1.15 = $39,560. With a credit mod of 0.85: $34,400 x 0.85 = $29,240. The mod is applied before schedule rating, premium discount, and expense constant.
Step Four: Other Premium Adjustments
| Adjustment | Effect |
|---|---|
| Schedule rating | Debit/credit for risk-specific factors (safety program, housekeeping) |
| Premium discount | Volume discount on larger premiums (expense savings) |
| Expense constant | Flat charge added to small policies to cover fixed costs |
| Minimum premium | Floor below which premium cannot drop |
Step Five: Audit
Workers comp is an auditable (estimated) policy. At inception the insurer charges a deposit premium based on estimated payroll. At expiration a payroll audit determines actual payroll, and the insured is billed or refunded the difference. If actual payroll exceeds the estimate, an additional premium is due; if lower, the insured gets a return. The exam tests that final premium is based on actual, audited payroll — never the estimate.
Putting It Together
Order: classify -> manual premium (payroll/100 x rate) -> apply experience mod -> schedule rating -> premium discount -> add expense constant -> compare to minimum premium -> audit at expiration. Knowing the divide-by-100 step and that the credit mod reduces while the debit mod increases premium answers the bulk of premium questions.
Payroll Inclusions, Exclusions, and Caps
The exam tests exactly what counts as payroll. Included: wages, salaries, commissions, bonuses, holiday/vacation/sick pay, and the value of housing or meals provided as compensation. Excluded or limited: the premium portion of overtime (only straight-time is counted), tips, severance, and employer contributions to qualified benefit plans.
Executive officers' payroll is subject to a minimum and maximum weekly payroll cap set by the state — a high-salary owner's reportable payroll is capped, so you do not multiply their full $300,000 salary by the rate. Sole proprietors and partners, when they elect coverage, are assigned a fixed statutory payroll amount rather than their actual draw.
Worked example. An officer earns $5,200/week but the state caps officer payroll at $2,600/week. For a 52-week year you report 52 x $2,600 = $135,200, not the $270,400 actual salary. At a clerical rate of $0.40, the premium is ($135,200/100) x $0.40 = $540.80, far less than using uncapped pay.
Retrospective Rating
Larger insureds may choose a retrospective (retro) rating plan, where the final premium is based on the insured's own losses during the policy period, subject to a maximum and minimum premium and a loss-conversion factor. Retro plans give the insured a direct financial incentive to control losses: good loss experience yields a premium near the minimum, while poor experience pushes premium toward the maximum. Distinguish retro rating (uses this year's actual losses) from experience rating (uses prior years' losses to set the mod) — the exam frequently contrasts the two.
Dividend Plans and Assigned Risk
Participating insurers may pay a dividend after the policy year based on the insurer's or the insured's experience, but a dividend can never be guaranteed in advance. Employers unable to obtain coverage in the voluntary market are placed in the assigned risk pool (the residual market), administered by NCCI in most states, where coverage is mandatory for licensed carriers to provide but is typically more expensive.
A business has $300,000 of payroll in a class with a manual rate of $6.00 per $100 of payroll and qualifies for an experience modification factor of 0.90. Ignoring other adjustments, what is the modified premium?
Under the NCCI experience rating plan, which type of loss experience generally has the greatest impact on raising an employer's experience modification factor?