How workers’ comp premiums are calculated

Workers’ comp premiums are built from three pieces: your payroll, the classification of the work your employees do, and your record of workplace injuries. For each class codeClass codeA class code is a number insurers use to classify what your business does, so your rates reflect the typical risks of businesses doing similar work.Read the definition on the policy, payroll is divided by 100 and multiplied by that code’s rate, the results are added together, and the total is adjusted by your experience modificationExperience modification rateAn experience modification rate (EMR) is a workers’ comp factor that raises or lowers your premium by comparing your past claims with those of similar businesses.Read the definition if you have one. That’s the general structure the National Council on Compensation Insurance (NCCI) and state insurance departments describe, though the rates themselves vary by state, by classification and by insurer.

Payroll and class codes explain most of the bill. The experience mod is the part owners understand least, and it’s the part they can actually move, so it gets the most attention below, though many small employers don’t qualify for a mod yet, and the section on eligibility explains when you do.

The formula, step by step

Here’s the calculation in order, as NCCI’s guide to experience rating and California’s Department of Insurance lay it out.

California’s Department of Insurance describes the same steps in plain terms: the payroll for each classification is estimated and then multiplied, per $100 of payroll, by the applicable rate. So if a made-up class had a rate of $2.00 per $100, every $100 you paid someone in that class would add $2.00 before the mod. That rate is invented to show the arithmetic and isn’t a real or typical rate for any class or state.

Class codes: the business gets classified, not the person

The classification captures how dangerous the work is. NCCI’s own worked example is a roofing company with employees in two classes, where the roofing rate is higher than the clerical rate “because it has a greater potential for injuries.”

What surprises most owners is how codes get assigned. Maine’s Bureau of Insurance states the general rule as “the business is classified, not the individual jobs within the business,” which means a business gets a governing class for what it does and that class is meant to account for the varied duties of the people who work there, so a café’s cooks, servers and dishwashers would typically sit in the café’s classification together. There are exceptions. Maine lists standard exception classifications for jobs common to almost every business, such as clerical office staff, outside salespeople and drivers, which are rated on their own, and it notes that contractors may have trades such as carpentry, concrete, masonry and roofing rated separately, but only if payroll is tracked for each.

In California, classifications usually come from the state’s own Workers’ Compensation Insurance Rating Bureau, according to the state’s commercial insurance guide, which is a reminder that the same principle runs on different machinery from state to state.

If your work changes, your classification may need to change too. A handyman who starts taking roofing jobs or an auto shop that adds towing should tell the insurer, because the class code drives the price, and an auditor who finds roofing payroll under a handyman code can move it and bill the difference.

What counts as payroll

In Maine, a server’s tips don’t count. Neither do severance pay, group insurance and pension contributions, or expense reimbursements your records show were real business expenses, while wages, salaries, commissions, bonuses, and holiday, vacation and sick pay all do. Maine’s guide also leaves out the extra pay for overtime, though not the straight-time portion, as long as your books show overtime separately by employee and by classification.

Those are one state’s rules, and yours may differ. The general point holds everywhere, though: workers’ comp payroll isn’t always the gross wage figure on your tax forms, and the auditor can only apply an exclusion if your records make it visible.

Owners are a separate question. Depending on your state and how the business is set up, sole proprietors, partners, LLC members and corporate officers may be able to include or exclude themselves, and that choice changes the payroll on the policy; do business owners need workers’ comp? covers the trade-offs.

The experience mod: why small claims add up

Seventy percent. That’s how much NCCI’s plan discounts medical-only claims, the ones where an injured employee needs treatment but loses no wages, when it calculates a mod, counting only 30% of each one. In plain English, a minor injury that’s reported properly barely moves your mod, and NCCI says the adjustment exists to reduce the temptation to pay small medical claims yourself without telling your insurer. Most states have approved it.

That number makes more sense once you see how the mod works. NCCI explains that experience rating compares an employer’s payroll and loss records with those of the average employer in the same classification, usually over the latest three available years, leaving out the current policy because its losses haven’t been valued yet. A mod of 1.00 is average. Below 1.00 is a credit for a better-than-average record, and above 1.00 is a debit for a worse one, so on the made-up example above, a 0.90 mod knocks a tenth off the premium and a 1.25 adds a quarter.

Here’s the part that matters most. NCCI’s plan gives more weight to how often injuries happen than to how much any single injury costs, and it splits each loss into a primary part that counts in full and an excess part that counts for much less, so a very large claim is far less likely to dominate the mod. Its reasoning is that the size of an injury is often a matter of chance, while the fact that it happened says more about the workplace, which is why Maine’s guide describes the same calculation as giving more weight to frequency “but does not overly penalize an employer for the seriousness of one particular claim.” So an employer with a steady trickle of lost-time injuries can carry a worse mod than one with a single serious accident, even if the second employer’s total losses were larger.

That changes what’s worth doing. Fewer injuries, reported promptly, matter more than any single claim’s cost, and NCCI says an employer that runs a safe workplace, including safety programs, is in a better position to earn a credit mod, while involvement after an injury, such as helping the employee get back to work, can reduce how severe the loss becomes.

Does every business have a mod?

No. NCCI says experience rating applies only once an employer’s premium reaches an eligibility point that each state sets, and an employer that doesn’t qualify, including a new business with no data, gets a 1.00 factor, which is neither a credit nor a debit. Once you qualify, the mod isn’t optional: NCCI describes the plan as mandatory for employers that meet their state’s requirements.

Who calculates it depends on where you are. NCCI produces mods in the many states that use its plan, while it lists California, Delaware, Michigan, New Jersey, New York and Pennsylvania among the states where its plan doesn’t apply, and four more, North Dakota, Ohio, Washington and Wyoming, that administer their own plans and rates. California’s mods come from its rating bureau.

Your first bill is an estimate

Because next year’s payroll doesn’t exist yet, your premium starts on an estimate, and California’s Department of Insurance says the final premium can’t be calculated until the policy term is over and a payroll audit shows whether the estimate was high or low. If payroll rose, you owe more. If it fell, you’re usually owed a refund, subject to any minimum premium.

Our advice is simple: estimate honestly, tell your insurer when you hire, and read what a premium audit is, and how to prepare before the first one. California notes that corrected payroll estimates during the term can help avoid a large audit bill, and a low estimate never lowers the final price, it only moves the bill to a worse time.

Where state rules come in

Rates themselves are the last moving piece, and they differ from state to state and from insurer to insurer. Maine’s Bureau of Insurance says rates vary by classification and by insurer, and that many insurers have more than one rate level, with the lower rates going to employers with good safety plans and better claims experience than others, and NCCI adds that experience rating isn’t the only pricing tool insurers use.

Whether you must carry workers’ comp, for whom, which owners can opt out and how benefits are paid all depend on your state, and your state’s workers’ compensation agency is the authority. The US Department of Labor keeps a list of state workers’ compensation agencies where you can find yours.

If you already have a Corgi policy, you can add workers’ comp to it without a new application, and if you’re about to make your first hire, our checklist for hiring your first employee covers what else to set up.