13.3 Premium Basis, Experience Modification, and Classification

Premium Basis: Payroll Per $100

Workers' comp premium is built on remuneration (payroll), not on sales or square footage. The formula every candidate must know:

Manual Premium = (Payroll / 100) x Rate

The payroll is divided by 100 because comp rates are quoted per $100 of payroll. Each job is assigned a four-digit classification code (such as 8810 clerical or 5403 carpentry) with its own rate reflecting that work's hazard. A clerical office worker (low code rate) costs far less per $100 than a roofer (high code rate), so accurate classification is essential to a fair premium.

Because payroll is an estimate at inception, the comp policy is auditable. At expiration the insurer performs a premium audit of actual payroll records and bills or refunds the difference. Overtime is generally counted at the straight-time portion only (the premium portion of overtime is excluded), and certain pay such as tips and severance may be excluded or limited. An employer who refuses the audit can be charged an estimated audit premium, often at the highest applicable rate.

Worked Numeric: Manual Premium

A contractor has two classifications:

• Clerical: (200,000 / 100) x 0.30 = 2,000 x 0.30 = $600
• Carpentry: (500,000 / 100) x 7.00 = 5,000 x 7.00 = $35,000
• Total manual premium = $35,600

Notice how the high-hazard code dominates the bill even though clerical payroll is sizable. Misclassifying carpenters as clerical (rate shaving) is illegal premium fraud and is corrected on audit.

Experience Modification (Mod)

Larger employers are experience rated. Their own loss history adjusts the manual premium up or down through an Experience Modification Factor (the "mod" or EMR) computed by the rating bureau (NCCI or an independent state bureau) by comparing the employer's actual losses to the losses expected for a business of its size and class.

Modified Premium = Manual Premium x Experience Mod

• A mod of 1.00 = exactly average; losses as expected.
• A mod below 1.00 (a credit mod, e.g., 0.85) = better than average — premium is reduced.
• A mod above 1.00 (a debit mod, e.g., 1.20) = worse than average — premium is surcharged.

A mod of 1.20 means the employer pays 20% more than manual; a mod of 0.85 means 15% less. The mod uses three years of loss experience (excluding the most recent year, which is still developing) and is recalculated annually, so a bad year follows the employer for roughly three policy terms. This is why loss control and prompt return-to-work programs have a direct, lasting premium payoff.

Worked Numeric: Applying the Mod and Discounts

Manual premium = $35,600. Experience mod = 1.15. A scheduled credit/debit and premium discount may also apply.

1. Modified premium = 35,600 x 1.15 = $40,940.
2. If a 10% premium discount (volume) applies: 40,940 x 0.90 = $36,846.

The order matters on the exam: apply the experience mod first, then schedule rating, then premium discount, and finally any expense constant. Frequency of small claims hurts the mod more than a single large loss because the formula caps the impact of each large claim (the primary/excess split), so a string of minor injuries can drive a debit mod even without a catastrophic loss.

Trap: The mod reflects the employer's own experience versus expected — it is NOT the statewide loss ratio and NOT the insurer's profit margin.

Premium Basis and Classification

Workers comp premium is built from three inputs: the payroll (per $100 of remuneration), the classification code reflecting the hazard of each job, and the rate for that class. Clerical workers carry a low rate; roofers carry a high one. Payroll is estimated at inception and audited at year-end so premium matches actual exposure. Misclassifying high-hazard employees into a cheaper code is a serious premium-fraud issue tested in ethics.

The Experience Modification Factor

Mid-size and large employers receive an experience modification factor (the "mod" or EMR) that adjusts manual premium up or down based on the employer's actual loss history versus the expected losses for its class.

• A mod of 1.00 is exactly average.
• A mod below 1.00 (a credit) lowers premium — the employer's safety record beats its peers.
• A mod above 1.00 (a debit) raises premium — worse-than-average losses.

Worked example: a $50,000 manual premium with a 0.85 mod produces $42,500; the same premium with a 1.20 mod produces $60,000. The mod rewards loss prevention and is a powerful incentive for safety programs. Retrospective rating and dividend plans further tie final cost to actual losses, while schedule rating adjusts for specific risk features.

Premium Audits and Adjustment Plans

Because initial premium rests on estimated payroll, the policy is auditable: at expiration the insurer reviews actual payroll by class and bills or refunds the difference. An employer that grew during the year owes additional premium; one that shrank gets a return.

Beyond the experience mod, larger employers can choose loss-sensitive plans: retrospective rating, where final premium is calculated from the period's actual losses between a minimum and maximum; dividend plans, paying back a share of premium for good results; and schedule rating, which credits or debits for specific safety features. Each ties cost more closely to the employer's own loss experience, reinforcing the safety incentive the mod creates.