13.3 Premium Basis, Experience Modification, and Classification

Premium Basis, Experience Modification, and Classification

Workers compensation premium is payroll-driven. The premium base is the employer's estimated remuneration (payroll), not a flat charge, because payroll is the best proxy for the number of workers exposed to injury and the wages that drive benefits. The policy is written on estimated payroll and then audited at the end of the term to determine actual exposure, so the final premium can go up (additional premium) or down (return premium).

The rate-per-$100 mechanic

Manual premium is computed by classification. Each type of work has a four-digit class code and a published manual rate expressed as dollars per $100 of payroll. The formula:

Manual Premium = (Payroll ÷ 100) × Manual Rate

Worked example. A roofing crew (a high-hazard class) has $400,000 of annual payroll at a manual rate of $12.50 per $100, and a clerical class has $250,000 of payroll at $0.40 per $100:

• Roofing: ($400,000 ÷ 100) × $12.50 = 4,000 × $12.50 = $50,000
• Clerical: ($250,000 ÷ 100) × $0.40 = 2,500 × $0.40 = $1,000
• Total manual premium = $51,000

The huge gap shows why proper classification matters: misclassifying roofers as clerical would massively underprice the risk, and a class code is assigned by the business's governing operation, not by an individual's job title.

Payroll inclusions and limitations

Not every dollar of compensation counts the same way. Typical rules:

Overtime trap: when an employee works overtime at time-and-a-half, only the regular (straight-time) portion is counted; the extra one-third premium is excluded. Executive officers and sole proprietors who elect coverage are included at a state-set minimum/maximum payroll, not their actual (often very high) salaries.

Premium-modifying programs

After manual premium is set, several factors adjust it: schedule rating (credits/debits for risk characteristics), premium discount (volume credit for large policies), expense constant, and minimum premium. The most heavily tested adjustment is the experience modification factor.

The experience modification factor (the "mod" or EMR)

The experience modification factor compares an individual employer's actual losses to the expected losses for businesses of its size and classification, using roughly three prior years of data (excluding the most recent year). It is published by the rating bureau (NCCI or an independent state bureau).

Modified Premium = Manual Premium × Experience Modification Factor

• A mod of 1.00 is exactly average — no credit or debit.
• A mod below 1.00 (e.g., 0.85) means better-than-expected loss experience — a credit.
• A mod above 1.00 (e.g., 1.20) means worse-than-expected experience — a debit.

Worked example: a manufacturer with $200,000 manual premium and a mod of 0.85 pays $200,000 × 0.85 = $170,000 (a $30,000 saving). If its mod rose to 1.20, it would pay $200,000 × 1.20 = $240,000. The mod creates a powerful incentive for loss control and safety. Small employers below a state premium threshold are not experience-rated at all. Frequency of claims affects the mod more sharply than severity, because the formula weights the expected number of losses heavily.

The order of premium calculation

The pieces apply in a fixed sequence, which the exam loves to test. Start with payroll × rate by class to get manual premium; apply the experience modification; then apply schedule rating credits/debits and any premium discount; add the expense constant; and check against the minimum premium. A simplified flow:

1. Manual premium = (payroll ÷ 100) × rate, summed across classes.
2. × Experience modification factor = modified premium.
3. × Schedule rating factor, then apply premium discount for size.
4. • Expense constant, subject to the minimum premium.

Audit, estimates, and the assigned-risk market

Because the policy is issued on estimated payroll, the year-end audit reconciles to actual exposure and produces an additional or return premium. An employer who refuses the audit can be charged an estimated audit premium. Employers rejected by the voluntary market obtain coverage through the assigned-risk (residual) plan, which generally charges higher rates and offers fewer dividends or credits — another reason accurate classification and strong loss control matter to the bottom line.

Standard vs. modified premium and dividends

The terms have precise meanings the exam distinguishes. Manual (standard) premium is payroll times the class rate before the mod. Modified premium applies the experience modification. The standard premium is generally the figure after the mod is applied (used as the base for premium discounts and dividends).

Some insurers issue participating policies that pay a dividend after the term if the insurer's overall results are favorable — a dividend is never guaranteed and is declared at the insurer's discretion. A retrospective rating plan, by contrast, sets final premium based on the insured's own losses during the period, within a minimum and maximum, rewarding good loss experience even more directly than the prospective mod.