13.3 Premium Basis, Experience Modification, and Classification
Key Takeaways
- Workers' comp premium is rate per $100 of payroll multiplied by payroll divided by 100, applied to each NCCI classification code; payroll, not headcount, is the exposure base.
- Each job is assigned a governing classification code with its own loss-cost/rate; a roofer's rate dwarfs a clerical rate, and misclassification is a leading audit dispute.
- Coverage is written on ESTIMATED payroll and audited at year-end; the premium audit trues up the deposit premium to actual exposure with an additional or return premium.
- The experience modification factor (mod) is a credit below 1.00 or a debit above 1.00 that compares an employer's actual losses to expected losses for its class.
- Employers below a premium-size threshold are non-rated (mod fixed at 1.00); above it they are experience-rated, and frequency of small claims hurts the mod more than one large loss.
Payroll Is the Exposure Base
Workers' comp is one of the few lines where premium is a moving target. The exposure base is payroll, not headcount or revenue. The core formula:
Manual Premium = Rate per $100 of payroll x (Payroll / 100), summed across every classification, then adjusted by the experience modification factor and any schedule or expense modifications.
Payroll for rating generally includes wages, salaries, commissions, bonuses, and most overtime (often at straight-time value), with statutory caps on owner/officer payroll.
Classification Codes
Each job type is assigned an NCCI classification code carrying its own rate or loss cost reflecting that work's injury frequency and severity. A clerical class may run a fraction of a dollar per 100 dollars of payroll, while a roofer's class can run many dollars.
| Class (illustrative) | Rate per $100 payroll | Why |
|---|---|---|
| Clerical office | very low | Low injury frequency and severity |
| Retail store | moderate | Some lifting, slip-and-fall exposure |
| Roofing | high | High fall frequency and severe injuries |
Most businesses have a governing classification for the principal operation, plus standard exceptions such as clerical, outside sales, and drivers that are separately rated when records allow. Misclassification, deliberate or accidental, is a leading source of audit disputes.
Worked Manual-Premium Example
A contractor has two classes:
- Carpentry payroll 600,000 dollars at a rate of 8.00 per 100 = 600,000 / 100 x 8.00 = 48,000 dollars.
- Clerical payroll 100,000 dollars at a rate of 0.30 per 100 = 100,000 / 100 x 0.30 = 300 dollars.
- Manual premium = 48,000 + 300 = 48,300 dollars before the mod.
Estimated Payroll and the Premium Audit
Because final payroll is unknown when the policy starts, coverage is written on estimated payroll that produces a deposit (estimated) premium. At the end of the term the insurer performs a premium audit, examines actual payroll records, and trues up the premium:
| Audit Result | Effect |
|---|---|
| Actual payroll above estimate | Additional premium billed |
| Actual payroll below estimate | Return premium to insured |
| Records not provided | Insurer may estimate or apply audit-noncompliance charge |
The Experience Modification Factor
The experience modification factor (the mod, or EMR) compares an individual employer's actual losses to the expected losses for businesses of its size and class.
- Mod below 1.00 is a credit: better-than-average loss history lowers premium.
- Mod equal to 1.00 is average.
- Mod above 1.00 is a debit: worse-than-average history raises premium.
Worked Example: Manual premium 48,300 dollars with a mod of 0.85 yields 48,300 x 0.85 = 41,055 dollars. The same premium with a mod of 1.20 yields 48,300 x 1.20 = 57,960 dollars — a roughly 17,000-dollar swing driven entirely by loss history.
Frequency Beats Severity
A frequently tested subtlety: experience rating weights claim frequency more heavily than a single large claim. The mod formula caps the impact of any one severe loss (a per-claim limit) but counts the number of claims more fully, because frequent small losses predict future losses better than one catastrophe. The practical lesson: many small lost-time claims damage a mod more than one large but isolated claim.
Who Is Experience Rated
An employer must generate enough premium over the rating period to qualify. Below the state's eligibility threshold the employer is non-rated and carries a mod fixed at 1.00; above it the employer is experience rated. Other adjustments may follow the mod, including schedule rating (debits/credits for risk-specific characteristics) and premium discount for larger accounts.
Common Premium Traps
- "Headcount drives the premium." Wrong: the exposure base is payroll.
- "A mod of 1.15 is a discount." Wrong: above 1.00 is a debit/surcharge.
- "One big claim wrecks the mod more than several small ones." Wrong: experience rating weights frequency above a single capped severe loss.
A business has carpentry payroll of $600,000 at a rate of $8.00 per $100 and clerical payroll of $100,000 at $0.30 per $100. Before any mod, the manual premium is:
An employer's experience modification factor is 0.85. What does this indicate, and what is its effect on a $48,300 manual premium?
How Workers' Comp Premium Is Built
Comp premium uses payroll, not headcount, as the exposure base. The core formula is:
Premium = (Rate per $100 of payroll) x (Payroll / 100), applied to each NCCI classification code.
Each job carries a governing classification with its own loss cost - a roofer's rate dwarfs a clerical rate because roofing losses are far more frequent and severe. Misclassification (calling a roofer a clerk) is a leading audit dispute because it understates premium. Coverage is written on estimated payroll and audited at year-end; the premium audit trues up the deposit premium to actual exposure, generating an additional or return premium.
A worked example: a clerical class rated $0.30 per $100 on $200,000 payroll = 0.30 x ($200,000 / 100) = 0.30 x 2,000 = $600, while a roofing class rated $25 per $100 on the same payroll = 25 x 2,000 = $50,000 - illustrating why classification accuracy matters.
The Experience Modification Factor
The experience modification factor (mod) adjusts manual premium up or down by comparing an employer's actual losses to the expected losses for its class and size:
- A mod below 1.00 is a credit (better-than-average loss experience) that reduces premium.
- A mod above 1.00 is a debit (worse-than-average experience) that increases premium.
Employers below a premium-size threshold are non-rated, with the mod fixed at 1.00; above the threshold they are experience-rated. A crucial exam nuance: the mod weights frequency more heavily than severity, so many small claims hurt the mod more than a single large loss of equal total dollars. This is why loss-control programs that reduce the number of minor claims can meaningfully lower premium through a better mod, and why the mod is a powerful sales and retention tool.
Two employers have identical total workers' comp losses of $60,000. Employer A had one $60,000 claim; Employer B had twelve $5,000 claims. How does this typically affect their experience mods?