13.3 Premium Basis, Experience Modification, and Classification

Premium Is Payroll-Based

Workers compensation is one of the few lines where premium is a moving target settled by audit. The premium basis is remuneration (payroll), expressed per $100 of payroll. Each job is assigned a classification code with its own rate reflecting that work's hazard.

Quick Answer: Manual premium = (Payroll / 100) x rate, summed across classifications. The estimated premium is charged at inception; a payroll audit at policy end trues it up to actual payroll.

Classification System

NCCI maintains roughly 600 class codes. A clerical worker carries a far lower rate than a roofer because the loss exposure differs. Rules to remember:

• Most employers have one governing classification (the main business) plus standard exceptions that are always separately rated, chiefly clerical (8810), outside sales (8742), and drivers (7380).
• Payroll for overtime is counted at the straight-time portion only; the premium portion of overtime pay is excluded.
• Executive officers and partners may be included or excluded subject to state min/max payroll caps.

When an employee splits time between two jobs, the payroll is divided only if proper records are kept; otherwise NCCI assigns the entire payroll to the highest-rated classification. This is a frequent audit dispute and a tested point: poor recordkeeping defaults to the most expensive class.

Premium Discounts and Constants

Beyond the mod, two more adjustments commonly appear on the policy and the exam:

• An expense constant (a flat charge, often around $160) is added to every policy to cover fixed issuance costs.
• A premium discount reduces the rate per dollar of premium as size increases, because expenses are proportionally lower on large accounts. The order of operations is fixed: manual premium, then experience mod, then schedule/expense modifications, then premium discount, then expense constant.

Knowing the sequence matters because applying the mod after a discount would produce the wrong number — the mod always applies to manual premium first.

Worked Manual Premium

A contractor has two classifications:

Compute each line, then sum:

• Carpentry: ($400,000 / 100) x $9.50 = 4,000 x $9.50 = $38,000.
• Clerical: ($100,000 / 100) x $0.30 = 1,000 x $0.30 = $300.
• Manual premium = $38,000 + $300 = $38,300.

The lesson: misclassifying carpentry payroll as clerical would understate premium massively, which is why auditors scrutinize class assignments.

Experience Modification (Mod)

Larger employers receive an experience modification factor (the mod) that compares their actual losses to the losses expected for their class and size. The mod multiplies manual premium:

Modified premium = Manual premium x Experience Mod

The mod rewards safety. NCCI's split-rating gives primary losses (the first portion of each claim) more weight than excess losses, so many small claims hurt the mod more than one large claim — a frequently tested nuance.

Worked Modified Premium and Audit

Using the contractor's $38,300 manual premium and an experience mod of 0.85:

• Modified premium = $38,300 x 0.85 = $32,555 (an $5,745 credit for good loss history).

Now apply a premium discount and audit. Suppose a scheduled credit/expense constant nets out, and the policy was bound on estimated carpentry payroll of $400,000. The year-end audit shows actual carpentry payroll of $460,000:

• Additional carpentry premium = ($60,000 / 100) x $9.50 = 600 x $9.50 = $5,700 manual.
• Apply the 0.85 mod: $5,700 x 0.85 = $4,845 additional modified premium billed at audit.

The audit can produce either an additional bill or a return premium depending on whether actual payroll exceeded or fell short of the estimate. If the insured refuses the audit, the insurer may estimate payroll and bill a penalty, or cancel for nonreporting. Most states also set a minimum premium below which the policy cannot be priced regardless of small payroll, protecting the carrier's fixed issuance cost.

Finally, note the audit type: a physical audit sends an auditor to inspect records, while a voluntary (mail/phone) audit lets the insured self-report. Large or high-hazard accounts get physical audits; small clerical accounts often self-report.

How WC Premium Is Built

WC premium is payroll-based: each job is assigned a classification code with a rate per $100 of payroll. The basic formula is:

Premium = (Payroll / 100) x Rate x Experience Modification x other factors

Experience Modification (Mod)

The experience modification factor compares an employer's actual losses to expected losses for its class:

• Mod = 1.00 -> average for the class
• Mod > 1.00 (e.g., 1.25) -> worse-than-average losses, premium increases 25%
• Mod < 1.00 (e.g., 0.80) -> better-than-average losses, premium decreases 20%

The mod rewards safety and penalizes frequent claims, giving employers a financial incentive to control losses.

Classification and Audit

Each business has a governing classification plus standard exceptions (clerical, outside sales, drivers) rated separately. Because premium is estimated on projected payroll, the insurer performs a final audit after the term to true up premium against actual payroll - the insured may owe additional premium or get a refund.

Worked Example

A roofing contractor has $500,000 of roofing payroll at a manual rate of $12 per $100 and an experience mod of 1.20 (worse-than-average losses). Premium = ($500,000 / 100) x $12 x 1.20 = 5,000 x $12 x 1.20 = $72,000 before discounts. If the contractor improved safety and earned a 0.85 mod, the premium would fall to 5,000 x $12 x 0.85 = $51,000 - a $21,000 savings illustrating why loss control directly lowers WC cost. The payroll-times-rate-times-mod computation is a frequently tested WC math problem.