13.3 Premium Basis, Experience Modification, and Classification

How Workers Comp Premium Is Built

Workers comp premium is payroll-driven. The premium basis is remuneration (payroll) — not number of employees, not square footage. The carrier estimates payroll at inception, charges a deposit premium, and at year-end conducts a payroll audit to true up to actual payroll. If audited payroll exceeds the estimate, an additional premium is owed; if less, a return premium is issued.

The basic formula every exam tests is:

Premium = (Payroll ÷ 100) × Rate

Because the rate is expressed per $100 of payroll, you divide payroll by 100 before multiplying. Certain pay is capped or excluded — overtime is counted at straight-time wages only (the premium portion of overtime is excluded), and executive officers are included subject to minimum and maximum payroll caps.

Classification Codes

NCCI assigns each job a four-digit classification code reflecting its hazard. A clerical office worker (code 8810) carries a far lower rate than a roofer or a structural-steel erector. The governing classification is the single code describing the employer's principal business; standard-exception classes (clerical 8810, drivers 7380, outside sales 8742) are carved out and rated separately. Misclassifying a high-hazard worker into a low-rate code is a serious audit finding.

Worked Premium Example

A contractor has $600,000 of carpentry payroll rated at $8.50 per $100, plus $200,000 of clerical (8810) payroll rated at $0.30 per $100.

The manual premium ($51,600) is the starting point. Next, apply the experience modification.

Experience Modification (Mod)

The experience modification factor ("mod" or EMR) compares an employer's actual losses to the expected losses for its class and payroll over a three-year window. The result adjusts manual premium:

• Mod = 1.00 → average; no change.
• Mod < 1.00 (a credit, e.g., 0.85) → better-than-average safety record; premium is reduced 15%.
• Mod > 1.00 (a debit, e.g., 1.20) → worse-than-average losses; premium is increased 20%.

Using the example above: manual premium $51,600 × a 0.85 mod = $43,860 modified premium. A 1.20 mod would instead yield $61,920. The mod is the single biggest financial incentive for workplace safety — frequency of small claims drives it up more than one large claim, because the formula weights frequency heavily.

Retrospective Rating and Dividend Plans

Large employers may choose a retrospective rating (retro) plan, where final premium is adjusted up or down based on actual losses during the policy period, between a stated minimum and maximum premium. A loss-free year approaches the minimum; a bad year hits the maximum. Retro plans reward safety even faster than the experience mod, which lags three years behind.

Smaller insureds may instead receive a dividend under a participating policy — a partial return of premium declared after a profitable year. Dividends can be flat, variable (sliding with the loss ratio), or sliding-scale. Dividends are never guaranteed; the carrier's board declares them, so an exam answer promising a 'guaranteed dividend' is wrong.

Premium Discount and the Expense Constant

Workers comp also applies a premium discount for larger policies, recognizing that fixed acquisition expenses spread over a bigger premium cost proportionally less per dollar. The discount grows in tiers as premium rises. Tiny policies, by contrast, carry an expense constant — a flat charge added to cover the minimum cost of issuing and servicing any policy regardless of size.

The full premium-build order is therefore: manual premium → experience mod → schedule credits/debits → premium discount → expense constant, with retro or dividend adjustments settled after the period closes. Knowing that the mod is applied to manual premium before discounts prevents a common calculation error.

Audit Mechanics and Misclassification

The physical or voluntary payroll audit at the end of the term is where most disputes arise. The auditor reviews payroll records, tax filings, and job descriptions to confirm each worker sat in the correct class code and that overtime was counted at straight-time only. If a clerical-coded (8810) worker actually spent time on the shop floor, the auditor reclassifies that payroll into the higher-rated governing class, generating a large additional premium.

Worked illustration: suppose $50,000 originally booked at clerical $0.30/$100 ($150) is reclassified to carpentry $8.50/$100. New charge = ($50,000 ÷ 100) × $8.50 = $4,250, an additional premium of $4,100 on that payroll alone. Accurate classification at inception — not at audit — is the cheapest path.

The Experience Modification Factor (Worked)

The experience modification (e-mod) compares an employer's actual losses to the expected losses for its class. An e-mod of 1.00 is average. Below 1.00 (a credit mod, e.g., 0.85) lowers premium 15%; above 1.00 (a debit mod, e.g., 1.20) raises it 20%.

Worked: Manual premium = (payroll ÷ 100) × rate. If payroll is $2,000,000 in a class rated $3.50 per $100, manual premium = 20,000 × $3.50 = $70,000. Apply an e-mod of 0.85: 70,000 × 0.85 = $59,500. A schedule credit or premium discount may then further adjust the figure.

Audit, Classification, and Payroll Basis

Workers' comp premium is estimated at inception using projected payroll and audited after the policy period against actual payroll — the insured then owes additional premium or receives a return. Each employee is assigned a classification code reflecting the hazard of the duties performed; clerical and outside-sales codes carry far lower rates than manufacturing or roofing. Misclassification (placing a roofer in a clerical code) is a serious premium-fraud and audit issue, and the audit reconciles class assignments as well as payroll totals.