How workers' comp premiums are calculated

Workers' comp premium is a rate per $100 of payroll, set by job classification, multiplied by your experience modification and then adjusted for credits, discounts and fees. The policy starts with an estimate and ends with an audit, so the figure you pay at the start is a deposit against the figure the carrier calculates from actual payroll. The mechanics are standard; the rates, rules and surcharges are state-specific.

The basic formula

For each class code on the policy:

Payroll ÷ 100 × rate = manual premium for that class.

Add the classes together, and you have manual premium. Then:

1. Multiply by the experience mod to get modified premium.
2. Apply schedule credits or debits and any other rating plan factors your state allows.
3. Apply a premium discount for larger policies, where the state permits it.
4. Add the expense constant, any state or federal assessments, surcharges and terrorism or catastrophe charges the state requires.
5. Compare the result with the policy's minimum premium.

NCCI gives a worked version of the first steps in its published training material. In its illustration, a roofing company with $200,000 of roofer payroll and $70,000 of clerical payroll, at example rates of $63.171 and $0.750 per $100, pays $126,342 and $525 for the two classes. The total of $126,867 times a 1.25 mod gives $158,584 modified premium. The rates are illustrative only; what matters is the structure. Run your own figures through the workers' comp premium calculator.

Step one: payroll, the exposure base

Payroll is the exposure base for workers' comp. The policy charges on remuneration, but not every dollar counts. Under the NCCI Basic Manual rules that most states follow, premium payroll generally includes wages, salaries, commissions, bonuses and the value of lodging or meals provided, and excludes items such as the extra pay for overtime hours, employer contributions to health and retirement plans, tips in many states, and certain reimbursed expenses. The overtime point matters: where overtime is excluded, only the premium portion (the "half" of time-and-a-half) is removed, and the payroll records must show it separately or the auditor will count the whole amount. Each state adjusts the list, so ask your agent for the exclusions that apply to you. See ordinary payroll.

Executive officers are handled differently. Most states set a minimum and maximum annual payroll for officers regardless of actual pay, and some states let officers be excluded entirely (can owners and officers exclude themselves from workers' comp?).

Payroll also includes uninsured subcontractors in many states: if a subcontractor lacks its own coverage or a certificate, the carrier may add the subcontract cost to your payroll at the class rate (managing subcontractor insurance and certificates).

Step two: class codes and rates

Every employee is assigned to a class code that describes the business's operations or the employee's duties, with the rate per $100 reflecting the loss experience for that class. Most states use NCCI codes; California, New York, Pennsylvania, Michigan and several other states use their own bureaus. A few "standard exception" classes, such as clerical office employees (generally 8810) and outside salespeople (8742), apply across industries for people who meet the definition. Governing classification rules put a business's main operations in one code and prevent splitting employees into cheaper codes unless the rules allow it. The details are in workers' comp class codes and why they matter.

Where do rates come from? In many states NCCI files loss costs, the expected claim cost per $100 of payroll, and each insurer applies its own loss cost multiplier for expenses, profit and competitive position. In other states the bureau files complete rates (Florida is described in its state guide as a full-rate state, and California uses advisory pure premium rates from the WCIRB). That is why two carriers in the same state may quote different rates for the same class.

Step three: the experience mod

The experience modification factor compares your claim history with the average for your classes. NCCI describes it as a factor that may increase, decrease or leave unchanged your premium: a mod of 0.75 turns $100,000 of premium into $75,000, and 1.25 turns it into $125,000. Experience rating applies when a state's premium eligibility threshold is met; new businesses and those below the threshold carry a 1.00 unity mod. The calculation is explained in The experience modification rate (EMR) explained, and you can estimate yours with the Experience mod (EMR) calculator.

Step four: other adjustments

• Schedule rating. Many states allow underwriters to apply a credit or debit within a limit for characteristics not captured by the mod, such as safety programs, management cooperation or premises. Limits vary by state, and some states prohibit it (schedule rating).
• Premium discount. On larger policies, a sliding discount reflects the lower relative expense of writing big premiums. It does not apply to small accounts.
• Expense constant and fees. A flat per-policy charge, plus assessments for guaranty funds, second-injury funds or state funds, and terrorism charges.
• Dividends and retrospective plans. Some carriers offer dividend programs, and large accounts may choose retrospective rating or deductible structures.
• Minimum premium. The policy states a floor, which applies even if payroll is low (minimum earned premium).

Step five: the audit

The deposit premium is based on your estimated payroll. After the policy ends, the carrier examines your records and charges the actual payroll under the correct class codes. Under the NCCI policy form WC 00 00 00, the insurer may audit your records during the policy period and within three years after it ends. An audit can raise or lower the premium, and it can also change class codes. Details and tips are in premium audits: how they work and how to prepare.

A hypothetical example

Say a 12-employee fabrication shop's estimate is $480,000 of shop payroll in a class at $4.00 per $100 and $90,000 of clerical payroll at $0.30 (all figures invented for the exercise).

If the audit shows shop payroll of $540,000 because of a late hire and overtime recorded as straight time, the shop premium rises to $21,600 and the bill rises with it. If the owner separates the overtime premium in payroll records, part of that increase falls away. The example shows why the level of payroll detail is as important as the rate.

What you can influence

Rate is set by class and state, so your leverage is in the other terms: accurate class assignment, payroll records that separate excluded pay, a documented safety and return-to-work program, early claim reporting and, for larger accounts, deductible or retro programs. how to lower your workers' comp costs covers each. If you are small, workers' comp for small businesses covers the minimum-premium and audit issues in context. The overall coverage picture is in workers' compensation insurance: how it works.

Key takeaways

• Premium is payroll divided by 100, times a class rate, times your experience mod, then adjusted for credits, discounts, fees and minimums.
• Payroll is audited after the policy ends, so the deposit is only an estimate; record overtime premium, subcontractors and class duties carefully.
• Rates differ by state, bureau and carrier because states file either loss costs or full rates.
• A mod above 1.00 raises the whole premium; below 1.00 lowers it; new or small businesses may carry 1.00.
• Schedule rating, premium discount and dividend programs vary by state and carrier, so ask which apply.