13.3 Premium Basis, Experience Modification, and Classification
Key Takeaways
- Workers comp premium = (payroll ÷ 100) × classification rate, then adjusted by the experience modification factor and any schedule credits; premium is a moving target finalized by audit.
- Each job is assigned a four-digit NCCI classification code; the governing classification and standard exceptions (clerical 8810, outside sales 8742, drivers 7380) drive the rate.
- The experience modification (mod) factor compares a risk's ACTUAL losses to EXPECTED losses for its class: 1.00 is average, below 1.00 is a credit (debit-mod above 1.00 is a surcharge).
- Frequency of small losses raises the mod more than a single severe loss because the formula weights primary (capped) losses heavily; this is why loss control targets small claims.
- Final premium is set by PAYROLL AUDIT at year end (premium audit), since estimated payroll on the dec rarely matches actual payroll.
The Rating Formula
Workers comp is one of the few lines where the premium is a moving target. The base formula:
Manual premium = (Payroll ÷ 100) × Class rate
The rate is expressed per $100 of payroll. Then adjustments stack:
Standard premium = Manual premium × Experience mod
Final premium = Standard premium × schedule/credits, plus expense constant, then trued up by audit
Worked numeric: A roofing crew has $400,000 payroll at a class rate of $18.00 per $100.
- Manual premium = ($400,000 ÷ 100) × $18.00 = 4,000 × $18.00 = $72,000.
- Apply an experience mod of 0.85 (good loss history): $72,000 × 0.85 = $61,200 standard premium.
- A debit-mod employer with a 1.25 mod would instead pay $72,000 × 1.25 = $90,000.
Classification Codes
The National Council on Compensation Insurance (NCCI) assigns each type of work a four-digit classification code reflecting that job's injury hazard. Higher-hazard work carries a higher rate.
Key classification rules:
- A business gets one governing classification (its main operation) plus standard exceptions for support roles.
- Standard exception codes apply across most industries:
| Code | Standard Exception |
|---|---|
| 8810 | Clerical office employees (lowest rate) |
| 8742 | Outside salespersons / collectors |
| 7380 | Drivers, chauffeurs, and helpers |
Misclassifying a high-hazard worker into clerical 8810 is premium fraud; the audit reclassifies the payroll and back-charges premium. Executive officers and partners may be included or excluded subject to state minimum/maximum payroll caps.
The Experience Modification Factor
The experience mod (E-mod) compares a specific employer's actual losses to the expected losses for businesses of its size and class over a typical three-year experience period (excluding the most recent year).
| Mod Value | Meaning | Premium Effect |
|---|---|---|
| 1.00 | Losses equal expected (average) | No change |
| Below 1.00 | Better than average | Credit (lower premium) |
| Above 1.00 | Worse than average | Debit (higher premium) |
A mod of 0.80 cuts premium 20%; a mod of 1.30 adds 30%. Only employers above a state premium-size threshold qualify for experience rating.
Why Frequency Hurts More Than Severity
The mod formula splits each claim into a primary portion (the first dollars, capped at a split point) and an excess portion. Primary losses are weighted fully; excess losses are discounted. Because every claim contributes a full primary portion, many small claims raise the mod more than one large claim of the same total dollars.
Worked illustration: Two employers each have $90,000 of incurred losses.
- Employer A: one $90,000 claim. Primary capped at, say, $17,000; the remaining $73,000 is discounted excess.
- Employer B: nine $10,000 claims. Each $10,000 is mostly primary and counts in full.
Employer B's mod is higher despite identical total dollars, because nine full primary amounts beat one capped one. This is why workplace safety (cutting claim frequency) is the single best lever to lower the mod.
Premium Audit and Plans
The dec page payroll is an estimate, so the policy is subject to a premium audit at expiration (or interim) that recalculates premium on actual payroll and final classifications.
Other premium plans the exam tests:
- Premium discount — a volume credit on large premiums (reflecting expense economies of scale).
- Retrospective rating (retro) — final premium adjusts up or down based on the insured's own losses during the term, between a minimum and maximum.
- Dividend plans — a participating policy may return a non-guaranteed dividend if loss experience is favorable.
- Assigned risk / residual market — employers who cannot buy voluntary coverage get it through a state pool, usually at higher cost.
How the Premium Formula Works
Workers' comp premium is built from payroll as the exposure base: premium = (payroll / 100) x class rate x experience modification factor x other factors. Each $100 of payroll in a classification is multiplied by that class's rate per $100, then adjusted by the employer's individual loss experience.
The Experience Modification Factor (EMR)
The experience mod compares an employer's actual losses to the expected losses for its class. A mod of 1.00 is average; below 1.00 (a credit) lowers premium and reflects better-than-average loss experience; above 1.00 (a debit) raises it. The formula weights frequency (number of claims) more heavily than severity (size of a single claim), because frequent small claims predict future losses better than one large fluke. This is why "frequency hurts more than severity" is a tested mantra.
Worked Premium Example
| Input | Value |
|---|---|
| Payroll | $2,000,000 |
| Class rate (per $100) | $3.00 |
| Manual premium | (2,000,000 / 100) x 3.00 = $60,000 |
| Experience mod | 0.85 (credit) |
| Modified premium | $60,000 x 0.85 = $51,000 |
A mod of 1.20 instead would raise the premium to $72,000. Premium is estimated at inception on projected payroll and adjusted at audit against actual payroll, so under-reporting payroll triggers an additional premium at audit. Retrospective and dividend plans can further tie final cost to actual losses.
A manufacturer has $600,000 of payroll in a class rated at $9.00 per $100, and an experience mod of 1.20. Ignoring expense constants and schedule credits, what is the standard premium?
Two employers each incurred $80,000 in total workers comp losses over the experience period. Employer A had one $80,000 claim; Employer B had eight $10,000 claims. All else equal, whose experience mod is higher and why?