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Workers’ Compensation Insurance — How Premium Is Calculated

March 9, 2012

Workers’ compensation insurance is mandated in all 50 states and there are significant fines and penalties for non-compliance. Some states allow employers that meet certain criteria to be self-insured but most must obtain coverage through an insurance company. Workers’ compensation insurance is highly regulated and premium is based on actual payroll. In order to develop premium, the following broad criteria are used:

Estimated Payroll by Job Classification — Each state has a rating manual with class codes for every industry and job duty. Classification is based on industry, specific business within that industry, and occupation of employees within that business. An employer may have employees in several different classifications (example: clerical office, warehouse and outside sales). Classifications are assigned by the state and remain constant regardless of the workers’ compensation carrier.  There is a direct relationship between payroll and premium which is why the carrier requires the total payroll by each job class.

Rates by Job Classification — Insurance carriers use the same rating manuals to develop a base rate for each class code. These base rates are filed with the state’s department of insurance (DOI) and increases or decreases must be approved by the DOI.

Experience Modification (Ex-Mod) — Experience modification if a percentage that reflects whether an employer’s loss history is above or below the average for other employers in the same industry. Experience modifiers are normally calculated on an annual basis by independent rating bureaus and rely on actual loss history reported by insurance companies. An employer falling within the statistical average would probably receive an ex-mod of 100 and pay the full base rate. An employer with an ex-mod of 92 would see an 8% savings, whereas an employer with 133 would see a 33% increase on the base rate. Experience modification has a direct impact on premium and provides an incentive to reduce or eliminate accidents.

State Assessments & Surcharges — Common assessments include state guarantee funds to cover carrier insolvency and anti-fraud surcharge.

Premium determination is a straightforward calculation simply expressed as the following formula:

(((Estimated Payroll /100) x Base Rate) x Ex-Mod %) + State Assessments = Total Estimated Premium

Because of the direct connection between payroll and premium, workers’ compensation insurance is offered on an annual basis and premium is expressed as “Estimated Annual Premium” or EAP. In order to reconcile estimated payroll with actual payroll, the carrier will usually perform some type of year-end payroll audit resulting in a refund (or credit) for over payments or additional premium required for under reported payroll. As such it is important that estimated payroll accurately reflect any expected changes such as increased workforce.

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