For business owners, understanding workers compensation insurance costs is the first step to controlling them. But premium calculations can feel like a puzzle, especially without a dedicated risk manager in-house.
“Being a business owner often means that you wear a lot of hats,” explained Scott Costello, President of Tri-County Agency. “Everything from being the janitor to the CEO of your business.”
Controlling costs is crucial, but juggling these different roles often means that business owners don’t have time to sit down and develop cost-saving strategies.
Understanding your premium calculation empowers you to take an active role in controlling your workers compensation costs.
The workers compensation premium formula
You might be curious about how insurance companies arrive at the number on your bill. Calculating premium can be complex, but it doesn’t have to be a mystery.
Three main elements determine your premium:
- Payroll: How big is your workforce?
- Classification rate: What types of work are your employees doing?
- Experience modification factor (e-mod): Do you have a history of work comp claims?
☑️ The bottom line: Payroll * classification rate (per $100 of payroll) * e-mod = premium
6 factors that determine your work comp premium
At a high level, your premium reflects your company’s size and perceived risk level. During the underwriting process, your carrier considers your number of employees, class codes, claims history, and safety policies.
External factors, like legal guidelines and industry-wide trends, can also impact your work comp premium. Let’s break these factors down.
1. Location and state laws
Because workers comp coverage is required by law for most businesses, state regulations can impact premium rates. If your business operates in multiple states, including some that don’t use rates from the National Council on Compensation Insurance (NCCI), you might face varying rates even for similar roles.
➡️ Here’s an example: Reputable Roofing is a Cincinnati-based roofing company. The crew takes jobs in Indiana, Kentucky, and Ohio. All three states have different regulations. Kentucky follows NCCI ratings, while Indiana has an independent bureau, and Ohio is a monopolistic work comp state. These differences make Reputable Roofing’s premium calculation more complex.
2. Industry type
Industries are not created equally when it comes to risk. Businesses in high-risk industries pay higher premiums compared to lower-risk businesses. Where your business sits on this spectrum has a big impact on your premium.
➡️ Our friends at Reputable Roofing are operating in one of the most dangerous industries, construction. The reality is that a construction business is more likely to have work comp claims than the accounting firm down the street. Those claims are also more likely to have higher severity – more serious injuries that require complex care and cost more. This is reflected in their work comp premium.
3. Employee classification
Employee classification also affects premium costs because your employees have different roles with different levels of inherent risk. Classification codes ensure that businesses pay rates that match the risk of the work performed.
➡️ Although Reputable Roofing is in the high-risk construction industry, the company also employs people who don’t perform high-risk work, like office managers and salespeople. This is accounted for in their premium calculation.
Your payroll is multiplied by the base rate for each class code in your business. To determine these base rates, carriers in most states reference actuarial calculations from the NCCI, which maintains more than 600 class codes.
4. Payroll and workforce size
Your number of employees and how much they’re paid directly impact your premium. Premiums are generally calculated per $100 of payroll, so keeping accurate payroll records is vital to ensuring fair premium.
“Payroll is the basis used to calculate premium,” explained Tammy Canton, Underwriting Specialist at MEM, “so this is why it is so important to have correct payroll information at the start of the policy period.”
➡️ Reputable Roofing employs around 70 people. Their payroll is much higher than a contractor with a team of five. With more employees, they’re more likely to have a claim, so they pay a higher premium.
💡 Pro tip: A company like Reputable Roofing might have full-time employees and independent contractors who work as needed. Some business owners think hiring subcontractors means they don’t need work comp, but in reality, an uninsured contractor can be a big liability. Hiring uninsured subcontractors can impact your premium, so collecting Certificates of Insurance is crucial to verify that they have their own work comp policies.
5. Claims history and e-mod
An experience modification factor, or e-mod, uses your past claims to predict whether your future losses will be better or worse than the industry average. In most states, the NCCI calculates e-mods.
Your historical claim costs affect your e-mod, which in turn impacts premium costs. Claim costs include medical costs, lost wages while the employee is unable to work (indemnity), and additional benefits like disability.
Claim frequency and severity both impact your e-mod. “Frequency leads to severity,” explained Becky Duello, MEM Senior Underwriter. “A large number of small claims can negatively affect your risk exposure as much as one or two large claims over time. And they both impact premium.”
➡️ An e-mod lower than 1.0 means your loss experience has been better than the average of your peers. Reputable Roofing’s e-mod is currently 0.8. That means they’re paying less premium than their competitors – nice!
An e-mod higher than 1.0 means your losses are worse than expected for your business type and size, and you can expect to pay higher premium than your peers. A claim continues to impact your e-mod for up to four years, so it’s crucial to take steps to prevent incidents and proactively manage claims today.
📍 Learn more: What Is Your E-Mod Costing You? >
6. Safety program and culture
Building a strong safety culture is a long-term investment that will continue to pay off as long as your business exists. Proactive safety programs can lead to substantial savings by minimizing workplace injuries.
➡️ Reputable Roofing implemented a safety program ten years ago. They’re proud to have significantly reduced their number of work comp claims during that time, and their progress is reflected in their e-mod and premium bill.
Sometimes, a workers compensation insurance company may also offer endorsements or discounts for investing in safety programs and equipment.
MEM policyholders are eligible to apply for safety grants to fund valuable safety initiatives. Here’s how it works.
Understanding estimated vs. audited premium
For many businesses, payroll and even employee classifications evolve throughout the year. Therefore, the work comp premium you pay at the beginning of your policy might not be accurate by the end. You might need an adjustment, which is determined by your premium audit.
At MEM, we often issue work comp policies with estimated payroll figures for the policy period, and then audit them at the end of the period to determine the actual payroll. Then, the difference between the audited and estimated premium is billed or returned.
“The whole point of doing the audit is to get the correct premium,” explained Tina Austin, MEM Premium Consultant Supervisor. “We don’t want to overcharge the customer, and we don’t want to undercharge the customer.”
Premium factors: What you can and cannot control
While you may not be able to directly control factors like class codes or the inherent risk level of your industry, there are steps you can take to reduce your work comp premium.
Factors you can’t control:
- State laws and regulations
- Industry base rates
- Overall market conditions
What you can influence:
☑️ Safety programs help prevent claims that impact your e-mod.
☑️ Claims management can reduce claim costs and severity.
☑️ Accurate, up-to-date payroll records ensure accurate premium calculation.
☑️ A specialized work comp partner offers expertise and value-added services.
Work comp is a valuable business asset
Understanding your work comp premiums is the first step toward taking an active role in controlling them. Remember, the value of a work comp policy goes beyond the premium you pay. As Warren Buffett noted, “Price is what you pay. Value is what you get.” Each component of your policy, from safety services to claims management, should add value to your business and give you a return on your premium investment.
Navigating work comp can be tricky for business owners, but you don’t have to do it alone. At MEM, we’ve spent 30 years helping businesses understand and control their work comp costs. Our A- rating from AM Best reflects our financial stability and commitment to policyholder service.
To learn more about partnering with MEM for work comp, reach out to your agent or find an agent here.