13.3 Premium Basis, Experience Modification, and Classification

Premium Is Built on Payroll

The premium basis for workers compensation is payroll (remuneration), measured per $100 of payroll. The carrier estimates payroll at inception, charges a deposit/estimated premium, and audits the actual payroll at the end of the term to develop the final premium. If actual payroll exceeds the estimate, the insured owes additional premium; if lower, a return premium is due.

Exam Key: Workers comp is an auditable, payroll-based line. The estimated premium is provisional — the final premium is set by audit of actual remuneration.

The Classification System

NCCI assigns each type of work a four-digit class code with a manual rate per $100 of payroll reflecting that occupation's hazard. A clerical class (e.g., 8810) carries a tiny rate; a roofing class carries a large one. The basic manual premium is:

Manual Premium = (Payroll ÷ 100) × Manual Rate

Worked example: A contractor has $800,000 of payroll in a class rated $6.50 per $100.

• $800,000 ÷ 100 = 8,000 units
• 8,000 × $6.50 = $52,000 manual premium

Experience Modification (the Mod)

Larger employers receive an experience modification factor (the "mod" or EMR) that compares their actual losses to the expected losses for their class. The mod is then multiplied against the manual premium:

Modified Premium = Manual Premium × Experience Mod

• A mod of 1.00 is average — actual equals expected.
• A mod below 1.00 (a credit) means better-than-average loss experience → lower premium.
• A mod above 1.00 (a debit) means worse-than-average experience → higher premium.

Worked example: Manual premium $52,000 with a mod of 0.85 (a 15% credit):

• $52,000 × 0.85 = $44,200 modified premium — a $7,800 saving.

With a mod of 1.20 (a 20% debit): $52,000 × 1.20 = $62,400 — a $10,400 surcharge.

Exam Trap: The mod rewards frequency control more than severity. NCCI weights the count of small claims heavily, so an employer with many tiny claims is often modded worse than one with a single large claim. This is why loss-control and prompt return-to-work programs matter.

Premium Discount and the Full Calculation Order

After the mod, large policies receive a premium discount (a volume discount, distinct from the experience mod) and may add schedule rating credits/debits. The standard order of operations is:

1. Payroll ÷ 100 × manual rate = manual premium
2. × experience mod = modified premium
3. × schedule rating factors
4. − premium discount
5. • expense constant and taxes

The Audit — Estimated vs. Earned Premium

Because payroll changes throughout the year, the premium charged at inception is only a deposit (estimated) premium. At the end of the term the insurer conducts a payroll audit — examining payroll records, tax filings, and job classifications — to determine earned premium. The difference is billed or refunded.

Worked example: A policy is bound on estimated payroll of $600,000 at a $5.00 rate, producing an estimated premium of $30,000. The year-end audit finds actual payroll of $720,000. Earned premium = ($720,000 ÷ 100) × $5.00 = $36,000, so the insured owes an additional $6,000. Had actual payroll fallen to $540,000, earned premium would be $27,000 and the insured would receive a $3,000 return.

Exam Trap: If an insured refuses to permit the audit, the policy lets the insurer estimate the payroll and bill accordingly — often at the highest reasonable figure. Cooperation with audit is a policy condition.

What Counts as Remuneration

Auditable remuneration is broader than base wages. It generally includes salary, hourly wages, commissions, bonuses, holiday and vacation pay, and the value of lodging or meals furnished as part of pay. It generally excludes tips, severance pay, and the employer's contributions to qualified benefit plans. Overtime is included but typically only at the straight-time portion — the premium (extra) half of time-and-a-half is excluded so the employer is not penalized for paying overtime.

Classification Rules

NCCI assigns most employees to the class that describes the business, not each individual's task — the governing classification. Certain functions are standard exceptions rated separately regardless of industry, notably clerical office (8810), outside sales (8742), and drivers. Misclassifying a high-hazard worker into a low-rate clerical code is both a rating error and a compliance violation the auditor will reverse.

Why the Mod Promotes Safety

The experience mod is the single most powerful safety incentive in workers comp because it converts loss history directly into dollars. An employer with a 0.75 mod pays 25% less than the manual premium; one with a 1.40 mod pays 40% more — on the same payroll and class. Over a multimillion-dollar program the swing is enormous, which is why contractors guard their mod closely (many job bids require a mod at or below 1.00).

Worked example: Two firms each have $1,000,000 of payroll at a $3.00 rate, giving a $30,000 manual premium. Firm A's mod is 0.80 → $24,000. Firm B's mod is 1.25 → $37,500. The $13,500 gap is purely the price of loss experience, and it follows the employer across renewals because the mod is built from a rolling three-year window of losses.

Exam Key: The mod uses prior policy periods (typically the three years ending one year before the rating effective date), so this year's claims affect future premiums, not the current one. A single bad year can raise the mod for three years.