13.3 Premium Basis, Experience Modification, and Classification

How Workers Comp Premium Is Built

Workers comp premium is not a flat figure. It is built from payroll, a rate per classification, and adjusted by an experience modification factor. Premium is estimated at inception and audited at expiration, because actual payroll is rarely known in advance.

The Premium Formula

The basic manual premium formula tested on the exam is:

Manual Premium = (Payroll / 100) x Rate

Rates are quoted per $100 of payroll. Each job is assigned a classification code (a four-digit NCCI class code) reflecting its hazard. A clerical worker carries a far lower rate than a roofer because the loss exposure differs.

Worked Numeric — Manual Premium by Class

A contractor has two classes of employees:

• Clerical: ($200,000 / 100) x $0.30 = $600
• Carpentry: ($500,000 / 100) x $8.00 = $40,000
• Total manual premium = $40,600

Note payroll for premium usually excludes overtime premium pay (only straight-time portion counts) and is capped for executive officers and sole proprietors.

Experience Modification (Experience Mod / EMR)

Larger employers qualify for experience rating. The experience modification factor (the mod) compares the employer's actual losses to the expected losses for its class.

• Mod = 1.00 -> average; losses as expected
• Mod < 1.00 (credit mod) -> better than average; premium is reduced
• Mod > 1.00 (debit mod) -> worse than average; premium is increased

Worked Numeric — Applying the Mod

Using the $40,600 manual premium above, apply an experience mod of 0.85 (a credit):

• Modified premium = $40,600 x 0.85 = $34,510

Now apply a debit mod of 1.20 instead:

• Modified premium = $40,600 x 1.20 = $48,720

The mod is the lever that rewards good safety records and penalizes poor ones. Frequency of small claims raises a mod more than a single large severe claim, because frequency is treated as a more reliable predictor of future losses.

Other Premium Elements and Audit

• Premium discount — a volume discount for larger premiums (separate from the mod)
• Schedule rating — credits/debits for risk-specific features
• Expense constant / minimum premium — flat charges so small policies remain viable
• Final audit — at policy end the insurer audits actual payroll; an additional or return premium results. If the insured refuses to allow the audit, the insurer may estimate payroll and bill accordingly.

How the Experience Mod Is Calculated

The mod compares an employer's actual losses over a three-year experience period against the expected losses for payroll in its classifications. The NCCI formula weights primary losses (the predictable, lower-dollar portion of each claim) more heavily than excess losses (the catastrophic portion), which is why claim frequency drives the mod up faster than a single large claim of equal total dollars.

The logic is actuarial: many small claims signal a persistent safety problem likely to recur, whereas one severe claim may be a fluke. This is the practical reason employers focus loss-control efforts on eliminating frequent minor injuries - it is the most efficient way to lower the mod and therefore the premium.

Retrospective Rating Plans

Large employers may choose a retrospective (retro) rating plan, where the final premium is adjusted up or down after the policy period based on the insured's actual losses during that period, subject to a minimum and maximum premium and a loss conversion factor.

Retro plans give a financially strong, safety-conscious employer the chance to pay close to its own loss experience, in contrast to guaranteed-cost policies where the premium is fixed regardless of losses. The exam contrasts prospective rating (rates set in advance from past experience, as with the mod) against retrospective rating (premium settled after the fact from current-year losses).

Auditing and Payroll Inclusions

Because premium rides on payroll, the final audit is decisive. Auditors include gross wages, salaries, commissions, bonuses, and the straight-time portion of overtime, but exclude the premium portion of overtime (the extra half in time-and-a-half), tips, and certain reimbursements. Payroll for executive officers, sole proprietors, and partners is subject to statutory minimums and maximums rather than actual pay. Getting these inclusions right matters on the exam because a question may give raw payroll figures and expect you to strip out the overtime premium before applying the rate.

Classification and the Governing Class

Each business is assigned classification codes that reflect the hazard of the operation, not the job title of each worker, with limited exceptions such as standard exceptions for clerical (8810), outside sales, and drivers. Most of a business's payroll falls into its governing classification - the basic class describing its main operation - while genuinely separate operations may be split out.

Manipulating classifications to land payroll in a cheaper code is a serious compliance problem the final audit is designed to catch. On the exam, expect to apply the correct rate to the payroll in each class and sum the results, exactly as in the worked carpentry-plus-clerical example.

Estimated Premium, Deposit, and the Audit Settlement

Because payroll for the coming year is unknown, the insurer charges an estimated (deposit) premium at inception based on projected payroll. At expiration the final audit measures actual payroll, and the difference produces either an additional premium owed by the insured or a return premium owed to the insured.

The audit may be physical, voluntary (self-reported), or by mail; an insured that refuses to cooperate can be charged an estimated or even penalty premium. This estimate-then-audit cycle, combined with the experience mod and any premium discount or schedule credits, is the full chain that turns exposure into final cost - and the exam tests each link.