An Examination of How Workers’ Compensation Premiums Are Determined 

 Because Workers’ Compensation insurance takes such a big bite out of an insurance budget, it is important to understand exactly how Workers’ Compensation premium is calculated. Some buyers still do not understand that the manner in which a premium is calculated can result in a substantially different net cost for identical coverage.  

Insurance Rating Classifications

 In each state, all enterprises are divided for rating purposes into groups or classes based on industry, trade, service, process, etc. Actually, employers are grouped into about 500 separate insurance classes. Similar organizations are assigned to the same group or classification, each with its own class code number. (Bakeries, for example, have the code number 2003; clothing manufacturers, 2501 ; etc.) In any given state the manual rate -per $100 of payroll- applies identically to all risks within the class.  The object of the classification procedure is to assign one basic classification which best describes the business of the employer. Subject to certain exceptions, each classification includes all of the various types of labor that might be performed in a business. It is the business which is classified, not the various types of work or operations conducted by that business. (If an employer operates a secondary business within a state, manual rules spell out the conditions under which an additional basic classification may be assigned.)  The exceptions to this general rule are extremely important. Certain operations -clerical work, for example -may be separately classified; and a different and often lower rate applied to the payroll for that work. Clerical employees, salesmen and drivers generally are rated separately according to their own classification codes. There are few classifications, however, that include such employees while not allowing for division of payroll.  

Determining the Basic Manual Premium

 Over the years, Workers’ Compensation rates and rating plans have been rather strictly controlled by rating bureaus, which were in turn, closely supervised by state insurance departments. Basic manual rates were the same, regardless of which company one chose as the insurer; however, during the past few years, rate regulation in many states has allowed insurers to deviate from bureau rates.  Deviations in the development of retrospective rating plan factors have also been allowed in a number of states; and loss sensitive rating plans of many types, using dividends or participation, have been developed by insurers in order to overcome the rigid Workers’ compensation rating structure that existed for many years. While these deviations generally favor insureds during soft market conditions, they have also been used by some underwriters to obtain additional premiums. Accordingly, in many states an insurance buyer can no longer feel confident that rate control will assure him of a reasonable Workers’ Compensation premium.  

Importance of Proper Classification

 Whether a company is large or small, Compensation insurance costs basically depend on how the company and its employees are classified for premium purposes. Far too often mistakes, such as the improper classification of an operation, happen. That can be costly. For example, firms working with metal goods or machinery are often misclassified. An operation described as Tool Manufacturing carries a relatively low manual rate. Machine Shop N.O.C. carries a higher class rate, and Metal Goods Mfg. N.O.C. carries a still higher rate in most states. It is not uncommon to find Tool Manufacturing misclassified as Machine Shop or even Metal Goods. The bureau is the ultimate classification authority.  All firms need to keep payroll records in such a way that they indicate clearly the particular classification to which each job belongs. If payroll has been improperly classified in the past, a firm may be entitled to a refund from its insurer. Such refunds are not at all uncommon.  Since one of the major factors in the determination of the Workers’ Compensation premium is payroll, it is important to be sure that the proper amount is assigned to the correct classification when the audit is invoiced, as well as when the policy is issued.  This may seem too obvious to warrant checking, but in a recent case, even though the auditor had correctly itemized the payroll figures, the underwriter decided to reassign the payroll. As might be expected, the result was a higher premium.  Another often overlooked area of payroll is the proper assignment of overtime pay. In most states, manual rules require elimination of premium overtime pay from the payroll calculations. In other words, an employee’s pay for overtime hours is included only at the employee’s normal hourly rate.  In many cases the payroll report included the premium portion of overtime pay, thereby unnecessarily escalating the Workers’ compensation premium.  

Experience Rating -Its Bearing on Premium

 A key factor in the calculation of the Workers’ Compensation premium is a firm’s experience rating modification. The higher it is, the greater the premium. As it drops, so does cost. Failure to understand the impact of this experience modification -the steps a firm can take to improve it and the need for action at the right time -can cost thousands of dollars!  To cite one example: A medium-sized manufacturer had an experience modification of 1.75. His premium for that year: $102,645. One year later, his experience modification improved to 1.20. The result: a drop in premium of $31,917.  Essentially, the experience rating modification is a factor which is used to modify manual premium in such a way that a firm’s actual premium reflects its own actual loss experience. While bakeries within a single state will all have the same classification code and the same manual rate, the loss experience of one bakery may differ sharply from that of another, depending on: Different safety and loss prevention standards, different equipment and techniques of operation, the experience and physical condition of employees, etc.  To establish rates which are fair and to recognize the better or worse loss experience of companies of the same class, the actual losses of a company are used to increase or decrease the manual premium.  In most states a firm will qualify for this type of experience rating if the Compensation premium- developed at manual rates -is at least $750 a year. Basically, it works this way: Actual losses are compared with the losses expected from a similarly sized firm and then classified. This ratio of actual losses to expected losses is the basis on which the experience modification factor is computed.  For example, if losses are lower- during the experience period -than the average of similar organizations, the consequence may be an experience modification of .80 or a credit of 20 percent. If losses are higher than expected, the result may be an experience modification of 1.20 or a debit of 20 percent.  

Loss History Is a Major Rating Component

 Generally, the larger the firm, the more reliable are actual losses as a gauge of future losses. In practice, the formula for calculating the experience modification includes elements which create the following effects:  1. Frequency of loss is generally punished more than severity- particularly for small and middle-size firms. Thus, 15 or 20 losses of $750 to $1,000 each would have a more unfavorable effect on an experience modification than a single loss of $15,000 or $20,000.  2. Losses in excess of$750 are not counted at their full value. In effect, they are discounted in various degrees depending on the size of the loss before they are used in the rating formula. Thus, a firm is spared the shock effect of heavy losses.  

William R. Roof

Workers’ Compensation Handbook/The John Liner Organization, Chapter 4. Pages 1 and 2



2 Responses to “Other stuff”

  1. 2 K Williams January 17, 2010 at 10:42 am

    Hi Bob

    This is me, another kwil on the internet. You have just gotten a few unsuccessful attempts to log in to your blog, by me. It’s because I originally registered but never did anything with it and just came back to it to see if I could start something. And now I see that somehow you have it.

    Anyway, I just wanted to explain the login attempts. Good luck with your nice blog.


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