13.3 Premium Basis, Experience Modification, and Classification
Key Takeaways
- WC premium = (Payroll / 100) x Rate; the rate is per $100 of payroll and varies by classification code.
- Premium starts as an estimate and is trued up by a premium audit using actual payroll.
- The experience modification factor compares actual to expected losses: below 1.00 is a credit, above 1.00 is a debit.
- The e-mod multiplies manual premium, rewarding safe employers and penalizing loss-prone ones.
- Other plans include retrospective rating, schedule rating, and premium discounts.
How Workers Comp Premium Is Built
WC premium is unique among P&C lines because it is based on payroll, not on a coverage limit. The standard formula is:
Premium = (Payroll / 100) x Rate
The rate is expressed per $100 of payroll and varies by the job's hazard. A clerical worker has a low rate; a roofer has a high rate. Each job is assigned a classification code by NCCI (or the state bureau), and the rate attaches to that class.
Worked Example - Manual (Base) Premium
A contractor has $500,000 of payroll in a class with a rate of $6.50 per $100.
Premium = ($500,000 / 100) x $6.50 = 5,000 x $6.50 = $32,500 manual premium.
If the same employer also has $200,000 of clerical payroll at a $0.40 rate, that adds (200,000 / 100) x 0.40 = $800, for a combined manual premium of $33,300 before any modifications.
Audit and Estimated Premium
Because final payroll is not known until the year ends, WC premium starts as an estimated (deposit) premium and is adjusted by a premium audit after the policy expires. If actual payroll was higher, the insured owes more; if lower, a refund is due. Cooperating with the audit is a condition of the policy.
- Estimated premium - charged up front from projected payroll.
- Audited premium - the true cost based on actual payroll.
Experience Modification Factor
Larger employers qualify for experience rating. The Experience Modification Factor (EMR or e-mod) compares the employer's actual losses to the expected losses for its class.
- e-mod = 1.00 - average loss experience.
- e-mod < 1.00 (a credit) - better than average; premium goes down.
- e-mod > 1.00 (a debit) - worse than average; premium goes up.
The e-mod multiplies the manual premium. It rewards safe employers and penalizes loss-prone ones - a strong incentive for safety programs.
Worked Example - Applying the E-Mod
Manual premium is $33,300. The employer's e-mod is 0.85 (a credit for good safety results).
Modified premium = $33,300 x 0.85 = $28,305.
If instead the e-mod were 1.20 (a debit), the premium would be $33,300 x 1.20 = $39,960. Exam trap: a factor below 1.00 lowers premium; do not assume a higher number is always charged.
Other Rating Plans
- Retrospective rating (retro) - final premium is adjusted within a min/max band based on the insured's own losses during the policy term; suits very large employers.
- Schedule rating - credits/debits for specific risk characteristics (safety equipment, management).
- Premium discount - a volume discount for large premiums.
Classification Codes and Payroll Limitations
NCCI assigns a four-digit class code to each type of work based on its hazard. An employer is generally placed in a single governing classification that best describes its business, with separately rated standard exceptions such as clerical office (8810), outside sales (8742), and drivers (7380). Payroll for rating excludes some items and caps others - for example, overtime is counted at the straight-time portion only, and executive officers' payroll is capped within a state min/max. Misclassifying high-hazard payroll into a low-rate code is a common audit dispute and a tested integrity issue.
How the Experience Mod Is Calculated (Concept)
The e-mod blends two ratios: it weighs actual primary losses (the predictable, frequency-driven first slice of each claim) more heavily than excess losses (large, severity-driven amounts), because frequency predicts future cost better than a single shock loss. The result is that many small claims hurt an employer's mod more than one large claim. This is why insurers stress early reporting, return-to-work programs, and frequency control - reducing the count of claims lowers the primary losses that drive the mod upward.
Minimum Premium and Expense Constant
Every WC policy carries a minimum premium (the least the insurer will charge to put the policy on the books) and an expense constant - a flat dollar charge added to cover fixed issuance and audit costs regardless of size. A tiny employer whose payroll-times-rate calculation falls below the minimum still pays the minimum premium. Putting it together, the full build-up is: manual premium, times e-mod, times schedule rating, less premium discount, plus expense constant, with the minimum premium as a floor.
An employer has $800,000 of payroll in a class rated at $4.00 per $100, and an experience modification factor of 0.90. What is the modified premium (ignore other adjustments)?
A Full Premium Build-Up Example
Work through a complete calculation. An employer has $1,000,000 of payroll at a $5.00 rate, an e-mod of 0.95, schedule credits of 10 percent, a premium discount of 5 percent, and a $250 expense constant.
- Manual premium = (1,000,000 / 100) x 5.00 = $50,000.
- Apply e-mod: 50,000 x 0.95 = $47,500.
- Apply schedule credit (x 0.90): 47,500 x 0.90 = $42,750.
- Apply premium discount (x 0.95): 42,750 x 0.95 = $40,612.50.
- Add expense constant: 40,612.50 + 250 = $40,862.50 total.
Note the order matters and each factor multiplies the running total - a common exam stumbling point.
Dividend Plans and Retrospective Rating Detail
Participating (dividend) plans return a portion of premium to the insured if the insurer's loss experience for the group is favorable; dividends are not guaranteed and cannot be promised in advance, a regulated marketing point. Retrospective rating instead adjusts the insured's own final premium after the term using a formula bounded by a minimum and maximum premium, with a loss conversion factor, basic premium, and tax multiplier built in.
Retro suits large, stable accounts willing to bet on their own loss control; a low-loss year can drop the premium toward the minimum, while a bad year pushes it to the maximum - never beyond it.
A workers compensation policy was issued on estimated payroll. After the year, a premium audit shows actual payroll was significantly higher than estimated. What happens?