How Are Workers’ Compensation Premiums Determined?

Since workers’ compensation insurance is required in most states, it’s no surprise that many business owners feel the need to learn as much as they can about it before settling on a policy.  After all, without the proper coverage, the penalties and fees one’s company could face are quite exorbitant.

But selecting the right insurance of any kind often becomes as much of a question about finances as it is about good coverage. For small businesses especially, the cost of insurance must be taken into consideration—after all, what good is insuring a bankrupt company?

Luckily, there is some flexibility when it comes to workers’ compensation premiums, as the cost is often determined based off of a number of different factors.

So, how are these premiums determined?

Estimated Payroll

The first factor in determining workers’ compensation premiums is based on actual payroll data. Each state has a distinct manual with their own class codes. These class codes are for each job duty within a business and each industry that makes up the business. Employees are classified, but businesses do not classify all employees the same.

For instance, a construction company would typically have construction workers, management, and administrative employees—just to name a few.

The premium rate is calculated at per $100 dollars of payroll and is based on each class code.

There are three factors determining the premiums for workers’ compensation which include:

1. The job classifications of each employee
2. The employer’s payroll size
3. The claims experience of the company (more claims vs less claims)

Job Classification Rates

Workers’ compensation insurance carriers create a base rate for each class code using the same rating manuals. The base rates are originally filed with that same department, but these base rates cannot be increased or decreased without approval by the Department of Insurance in that state.

Experience Modification Factor

The base rate is determined first, followed by each insurance company deciding on the experience modification factor. This is distinctive to the employer and the percentage is calculated based on the following factor called a loss factor. The loss factor is calculated each year and shows whether an employer has a higher or lower rate of loss history than other companies in the same industry. This also helps determine the premiums.

For example, a company with an experience mod factor of 90 could see a 10% savings, whereas one with 100 will more than likely be calculated at the base rate. Of course, those employers with higher than 100 will see a larger premium that is based on the number above the 100.

Other Fees Including Surcharges

Surcharges and state assessments differ for each state and can be included in the premiums. Some of these fees include items such as anti-fraud surcharges and carrier insolvency.

Each state will have their own rules. According to Insurance Journal, “New Jersey law mandates application of separate policyholder surcharges to finance the Second Injury Fund and Uninsured Employers’ Fund.”

Overpayment and Underpayment

The Estimated Annual Premium, or EAP, is calculated and quoted, but instances arise where there may be an overpayment or an underpayment. A yearly audit is done and the company will either receive a refund or receive credit.

In cases where payroll was unreported, an additional premium may be required. This is why it is vital to report everything to the best of your ability so you are not hit with a payment(s) that the company is not expecting.

Keep in mind that you are allowed to choose a pay-as-you-go program where the workers’ compensation premiums are deducted each payroll period. Simply choose a payroll provider that offers this option so your company does not have a large premium at an annual rate. This makes it easier for some companies although it may require more bookkeeping.