13.3 Premium Basis, Experience Modification, and Classification

Premium Basis: Payroll

The premium basis for workers compensation is remuneration — essentially payroll — not sales or square footage. Rates are quoted per $100 of payroll for each occupational class code assigned by NCCI or an independent bureau.

The core formula is:

Manual premium = (Payroll / 100) x Rate, summed over all class codes.

Because payroll is only estimated when the policy is written, the final premium is set by a premium audit after the term ends (see Part Five).

Worked Manual Premium Example

A contractor has two classes:

Manual premium = $36,000 + $400 = $36,400.

Notice how a small high-hazard payroll drives most of the cost. Exam trap: clerical and outside-sales payroll often qualify for standard exception class codes that carry very low rates — do not lump all payroll into the governing class.

Experience Modification Factor (the "Mod")

Larger employers receive an experience modification factor that compares their actual losses to the expected losses for businesses in the same class. The mod is then multiplied against manual premium.

• Mod = 1.00 — average loss experience; no change.
• Mod below 1.00 — a credit (better than average); premium drops.
• Mod above 1.00 — a debit (worse than average); premium rises.

The mod rewards safety and stable loss history, giving employers a financial incentive to control claims.

Applying the Mod

Using the $36,400 manual premium above:

• With a mod of 0.85: $36,400 x 0.85 = $30,940 (a credit risk).
• With a mod of 1.20: $36,400 x 1.20 = $43,680 (a debit risk).

Frequency of small claims usually hurts a mod more than a single large loss, because experience rating weights expected claim counts. After the mod, schedule/premium-discount and expense factors may apply, but the mod is the most heavily tested adjustment.

Exam trap: a mod of 1.00 is not a discount — it is exactly average.

Premium Discount and the Audit

After the mod, large policies may receive a premium discount that grows as premium size increases, reflecting lower per-dollar expenses on big accounts. A schedule rating plan can also apply credits/debits for risk characteristics not captured by class code.

Because payroll is estimated at inception, Part Five — Premium authorizes a premium audit at expiration. The auditor reviews actual payroll, classifications, and any uninsured subcontractors. If actual payroll exceeded the estimate, the insured owes additional premium; if it was lower, a return premium is due.

Exam trap: payroll for overtime is counted at the base (straight-time) rate, not the premium rate, so the overtime premium portion is excluded from the rating basis.

Classification, Standard Exceptions, and Audit Disputes

Each employee's payroll is assigned to an occupational class code. The governing classification is the highest-rated class describing the business's principal operation, but standard exception classes — clerical (8810), outside sales (8742), drafting — are rated separately at much lower rates because their exposure differs from the shop floor.

Exam trap: a construction firm cannot dump its bookkeeper's payroll into the carpentry class; the clerk's payroll is rated at the clerical rate. Conversely, a worker who splits duties between a low and high class is generally assigned entirely to the higher class unless the employer keeps verifiable separate payroll records.

Experience Rating Mechanics

The experience modification factor (mod) compares an individual employer's actual losses to the expected losses for its class over a typically three-year experience period (excluding the most recent year). Critically, experience rating weights claim frequency more heavily than a single large loss — a primary/excess loss split caps how much one catastrophic claim moves the mod, so many small claims hurt more than one big one.

Worked premium chain:

A mod below 1.00 is a credit (safe employer); above 1.00 is a debit; exactly 1.00 is average — not a discount, a favorite trap. The final premium is trued up by premium audit: overtime is counted at the straight-time base (the premium portion of overtime is excluded), and payroll for uninsured subcontractors is added to the insured's basis because the hiring employer becomes their statutory employer.

Audit Outcomes and the Payroll-Basis Rules

Because premium is based on estimated payroll, the premium audit at expiration trues it up. Three audit results recur on the exam:

• Additional premium — actual payroll exceeded the estimate (the business grew).
• Return premium — actual payroll was lower than estimated.
• Reclassification — the auditor moves payroll to the correct class code, changing the rate.

Worked audit example: a roofer estimated $300,000 payroll at a $12.00 rate (manual premium $36,000) but actually paid $360,000. Audited manual premium = ($360,000/100) × $12.00 = $43,200, so the insured owes $7,200 additional premium before applying the mod.

Payroll Inclusions and Exclusions

Overtime trap drill: an employee earns $30/hour straight time and works overtime at $45/hour (time-and-a-half). For comp payroll, the overtime hours are counted at the $30 base, and the extra $15 premium portion is excluded — so an employer who reports the full $45 overpays. Uninsured-sub trap: if a subcontractor cannot produce a certificate of insurance, that sub's payroll is added to the hiring employer's basis because the employer becomes the statutory employer.

Exam recap: premium basis is remuneration (payroll), rated per $100; the governing classification is the principal operation, but standard exceptions (clerical 8810, outside sales 8742) are rated separately; the mod compares actual to expected losses over ~3 years and weights frequency over a single large loss; and a mod of 1.00 is average, not a discount.