13.3 Premium Basis, Experience Modification, and Classification

Premium basis: remuneration (payroll)

Workers compensation premium is built on payroll (remuneration), not on revenue or headcount. The basic formula is:

Premium = (Payroll / 100) x Rate

The rate is expressed per $100 of payroll for each job classification. Because exposure is payroll, the policy is auditable — at inception the insurer charges an estimated (deposit) premium based on projected payroll, and after the policy period a payroll audit determines actual premium. The insured may owe additional premium or receive a return premium.

Worked manual-premium example

A contractor has two classifications:

• Clerical: ($200,000 / 100) x $0.30 = $600
• Carpentry: ($500,000 / 100) x $6.00 = $30,000
• Manual premium = $30,600

Notice how the same payroll dollar costs far more in a hazardous class. Class 8810 (clerical) is the cheapest benchmark class on most exams; misclassifying a roofer as clerical is both a premium-fraud trap and an audit exposure.

Experience modification (the mod)

Mid-size and larger employers qualify for experience rating, which compares the employer's own loss history to others in the same class and produces an experience modification factor (the mod) applied to manual premium.

• Mod = 1.00 is average for the class.
• Mod below 1.00 (a credit) means better-than-average losses — premium is reduced.
• Mod above 1.00 (a debit) means worse-than-average losses — premium is increased.

The formula becomes: Standard premium = Manual premium x Mod. Experience rating rewards safety and penalizes frequency; frequency of small claims affects the mod more than a single large severe claim because expected losses are capped.

Worked experience-mod example

Using the $30,600 manual premium above:

• Employer A has a 0.85 mod (good safety record): $30,600 x 0.85 = $26,010.
• Employer B has a 1.25 mod (frequent claims): $30,600 x 1.25 = $38,250.

Same work, same payroll — Employer B pays $12,240 more purely due to loss experience. After the mod, premium discount (volume) and schedule rating debits/credits may further adjust the final premium, and a premium discount plan rewards larger premium size.

Classification rules and the governing class

Each business is assigned one or more classification codes that describe the operation's exposure. NCCI publishes the code dictionary. A few rules examiners test:

• Standard exceptions — certain job titles (clerical 8810, outside sales 8742, drivers 7380) are carved out and rated separately at their own lower rates, regardless of the employer's main business.
• Governing classification — the code that produces the largest payroll (excluding standard exceptions) generally describes the business.
• Payroll caps — overtime is usually counted at straight-time (the premium portion of overtime is excluded), and executive payroll is subject to state minimums and maximums.

Misclassifying high-hazard payroll into a low-rate class (or padding clerical) is the classic source of an audit dispute and premium fraud allegations.

Other rating concepts

• Retrospective rating — final premium is adjusted after the period based on the insured's actual losses during the term, between a minimum and maximum premium. Best for large, loss-sensitive accounts.
• Loss-sensitive / dividend plans — return a dividend if losses are low.
• Premium discount — a volume discount applied to larger standard premiums (bigger accounts cost less per dollar to service).
• Schedule rating — judgment debits/credits for risk characteristics (safety program, housekeeping) the experience mod does not capture.
• Assigned risk / residual market — employers refused by the voluntary market obtain coverage through the state's assigned risk pool (often NCCI-administered).

The premium audit

Because estimated payroll is rarely exact, the WC policy is auditable. After expiration the insurer reviews actual payroll records (the physical audit) or relies on a form the insured completes (voluntary/mail audit). Two outcomes:

• Actual payroll exceeded the estimate → the insured owes additional premium.
• Actual payroll was less than the estimate → the insured receives a return premium.

The insured must keep records and cooperate; refusing access can trigger an estimated audit at the highest applicable rate. A worker the employer treated as an independent contractor — but who is really an employee — gets picked up at audit, adding payroll and premium. Audit is the single biggest source of disputed WC premium, so producers should set realistic estimates up front.

Full premium build-up (worked)

Putting the pieces in order shows how the final bill is built. Start from manual premium of $30,600 (from the carpentry/clerical example):

1. Manual premium: $30,600
2. Experience mod 0.90: $30,600 x 0.90 = $27,540 (standard premium)
3. Schedule rating credit 5%: $27,540 x 0.95 = $26,163
4. Premium discount 7% (size): $26,163 x 0.93 = $24,332
5. Expense constant + state assessments: added flat

The order matters: the experience mod is applied to manual premium first, then judgment (schedule) and volume (discount) adjustments. A frequent trap reverses the mod and the discount, or applies the mod to the already-discounted figure. Always: manual → mod → schedule/discount → fees.

How Workers Compensation Premium Is Built

Workers comp premium starts with payroll as the exposure base, divided into classification codes (set by the NCCI or an independent state bureau) that reflect the hazard of each job duty. Each class has a manual rate per $100 of payroll. The base premium is (payroll / 100) x manual rate, summed across classifications. Clerical and outside-sales staff carry low rates; roofers and loggers carry high rates. Because premium is exposure-based and audited, the policy is estimated at inception and adjusted by audit after the period, a defining feature of the line.

The Experience Modification Factor

The experience modification (mod) adjusts premium up or down based on the employer's actual losses versus expected losses for its class over a three-year window (excluding the most recent year). A mod of 1.00 is average; below 1.00 (a credit mod) rewards better-than-expected loss experience and lowers premium, while above 1.00 (a debit mod) penalizes worse experience. The formula weights frequency more heavily than severity, so several small claims can hurt a mod more than one large claim, an incentive for loss control the exam highlights.

Premium Discounts, Audits, and Assigned Risk

Large policies receive premium discounts for size, and many states apply schedule rating for risk-specific credits and debits. The final audit reconciles estimated to actual payroll; misclassifying payroll into a cheaper code is a serious compliance issue. Employers unable to buy coverage in the voluntary market obtain it through the assigned risk plan / residual market, typically at higher cost. Retrospective rating plans, where final premium reflects actual losses within a maximum and minimum, suit large insureds willing to share risk.