13.3 Premium Basis, Experience Modification, and Classification

Premium Basis — Remuneration (Payroll)

Workers compensation premium is not based on property value or liability limits. The exposure base is remuneration — essentially payroll. Premium is computed per $100 of payroll in each job classification. The basic premium formula:

Premium = (Payroll / 100) x Rate, summed across all classifications

Because future payroll is unknown at inception, the WC policy is an auditable policy: it is written on an estimated payroll, and an end-of-term payroll audit (Part Five — Premium) adjusts to the actual payroll. The estimated premium charged at inception is the deposit premium. Refusal to permit the audit allows the insurer to estimate payroll and bill accordingly.

Classification System

Each type of work has a four-digit NCCI class code with its own rate reflecting hazard. A clerical office worker (low hazard) carries a far lower rate than a roofer (high hazard). Misclassification is a major audit issue. The exam tests that payroll is split by class, and certain items are included or excluded from remuneration:

Note the overtime trap: only the straight-time equivalent of overtime is included; the excess (premium) portion of overtime pay is removed.

A second payroll trap involves executive officers, sole proprietors, and partners who elect coverage: their payroll is included at a state-set minimum and maximum payroll figure rather than their actual (often very high) compensation. The rating bureau caps the officer's includable payroll so a $400,000-salary owner is not rated as if all $400,000 were exposed at the construction class rate.

Worked Numeric — Basic Premium by Class

A contractor has two classes:

• Clerical (code 8810): payroll $200,000, rate $0.30 per $100.
• Carpentry (code 5403): payroll $500,000, rate $7.00 per $100.

Compute each:

• 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
• Manual premium = $600 + $35,000 = $35,600

This manual premium is then modified by the experience modification factor (below).

Notice the clerical class drives almost no premium despite a large payroll, because its rate is tiny — this is why misclassifying a roofer as a clerk is the classic audit fraud the exam flags. The auditor reassigns payroll to the correct (higher-rated) class and bills the difference as additional premium.

Experience Modification (Experience Rating)

Eligible employers receive an experience modification factor (the "mod" or EMR) that compares the employer's actual losses to expected losses for its class. The mod multiplies the manual premium:

Modified Premium = Manual Premium x Experience Mod

• A mod of 1.00 is the average/expected baseline (neither credit nor debit).
• A mod below 1.00 (e.g., 0.85) is a credit — better-than-expected loss history, lower premium.
• A mod above 1.00 (e.g., 1.20) is a debit — worse-than-expected losses, higher premium.

Experience rating is mandatory for employers meeting a premium-size threshold and uses several years of past loss data (typically the prior three years, excluding the most recent). It rewards safety and penalizes frequent losses, which is why it appears constantly on the exam as a loss-control incentive.

Worked Numeric — Applying the Mod

Using the manual premium of $35,600 above:

• Employer A has a strong safety record, mod = 0.85: $35,600 x 0.85 = $30,260 (a $5,340 credit).
• Employer B has frequent claims, mod = 1.25: $35,600 x 1.25 = $44,500 (a $8,900 debit).

Same work, same payroll, same rates — but loss experience changes the premium by over $14,000. After the mod, further adjustments such as premium discounts, schedule rating, or an expense constant may apply, but the mod is the most heavily tested adjustment.

Trap: Frequency of small claims hurts the mod more than a single large claim of equal total cost, because experience rating weights claim frequency heavily (primary losses count fully).

Additional Premium Adjustments and Plans

After the experience mod, larger policies receive a premium discount that recognizes lower per-dollar expenses on big accounts (administrative costs do not rise proportionally with premium). Smaller policies pay an expense constant — a flat dollar charge covering fixed issuance and audit costs. Some accounts also use schedule rating, applying judgment credits or debits for risk characteristics such as management safety programs, equipment, and training.

Very large employers may move beyond guaranteed-cost pricing into loss-sensitive plans:

• Retrospective rating — final premium is computed after the term based on the insured's actual losses within a minimum and maximum band, rewarding good loss control directly.
• Large deductible plans — the employer reimburses losses below a deductible, lowering up-front premium.
• Self-insurance — qualified employers retain the risk entirely, posting security with the state.

The exam tests that retrospective rating is loss-sensitive (your own losses drive cost), whereas the experience mod uses prior-period losses to set the current rate. Do not confuse the two.