How Is Work Comp Calculated?
No matter the size of your company (small, medium or large-size company), you need to purchase workers compensation insurance if you have employees. It is a basic costs of doing business in order to insure your employees against injury on the job. If you want more information about workers compensation insurance in general, please see this page: Workers Compensation Insurance.
But, how is work comp calculated? That is the focus of this article. And, simply put, it's mostly a function of:
Payroll X Rate X Experience Modification Rate
How Is Work Comp Calculated - Payroll
Your payroll directly affects how your work comp is calculated. And you pay premium based on every $100 of payroll. So, your workers' compensation insurance company's rates are charged to you based on your payroll divided by 100.
So, if you pay an employee $60,000 per year, you will divide that by 100 and use $600 as the basis for premium charges for that employee. $600 is what gets entered into the work comp pricing formula (see above).
By the way, payroll used for workers' compensation purposes takes into consideration all your employees; full-time, part-time, temporary, or seasonal
Since you don't know at the beginning of your policy year what your payrolls will be at the end, you will pay based on your estimated annual payroll. You can use the last year's payroll or a recent 12-month period to estimate your total payroll for the upcoming year. Or, you can make other adjustments if anticipate changes in business activity levels that would effect payroll.
At the end of every year an audit is performed to true-up the difference between estimated and actual wages. An additional charge will be assessed for higher than estimated payroll and a refund returned for lower.
When calculating your annual payroll amount it's based on gross wages less certain work comp deductions. For example, one deduction is overtime (premium) pay. If you pay someone $10/hour and $15/hour when working overtime, the extra, premium amount you pay for overtime ($5 - 15 less the 10 regular rate), is deducted from gross wages. As a result, you don't pay work comp on that amount of your annual wages. Premium Overtime is a deduction.
A detailed discussion of work comp payroll deductions is beyond the scope of this article. There are numerous deductions and they differ from state to state. But, needless to say, payroll is the basis of premium for workers comp and important in determining how is work comp is calculated?
How Is Work Comp Calculated - Rate
Your payroll is multiplied by a rate/s that is applied to your business based on your business activity. The application of these rates to businesses is commonly referred to as a business' classification. So, plumbers have a particular classification code as do architects, electricians, welders, auditors, etc. Each workers comp code has a corresponding rate.
Classification codes are very important to how work comp is calculated. Again, each of these classification codes has it's own rate associated with it. And, remember, the rates are multiplied by your payroll. If your work comp insurance carrier determines, correctly, that you are a roofing contractor and your neighbor next door is an accounting firm (8810 workers comp code), your classification code will be different due to the different industries in which you operate. And, since you have more job-related injuries and more severe job-related injuries as a roofing contractor than the accounting firm next door, your rate will be higher. Much higher.
The National Council on Compensation Insurance (NCCI) is the designated workers' compensation "rating bureau" for most states. And, a few (California, New Jersey, New York, Delaware, and Pennsylvania) have their own. These organizations have developed hundreds of classification codes for different industries and job types. While NCCI and the other rating bureaus have developed the classification system, they don't apply this system to businesses. The important job of ensuring your business is properly classified is up to your insurance company and broker. We say important because if you're an accounting firm, you definitely don't want to be mistakenly classified as a roofer!
On this website we have an exhaustive list of NCCI classification codes and estimated rates. Also, we have a list of the construction-related worker comp codes and descriptions of each.
How Is Work Comp Calculated - Experience Modification Rate
When asking how is work comp calculated the Experience Modification Rate (EMod, xmod, experience mod) is both the easiest and most difficult piece of the puzzle.
Although there are common mistakes made in the calculation of Experience Modification Rates, the Experience Mod is easy in the sense that it's calculated for you. You don't have to do anything like, for example, participate in an annual payroll audit to get the correct payroll figures. The Experience Modification Rate is calculated by the NCCI in most states and independent state rating bureaus in a few.
The Experience Modification Rate is difficult, in another sense, because it is calculated by Rating Bureaus using an actuarily developed algorithm. To understand this algorithm at an expert level and possess the ability to identify errors takes a lot of experience.
In a nutshell, the Experience Modification Rate utilizes data from your payroll (indicative of the size of your company) and the rates charged (indicative of how much money in claims your insurance company can expect to pay) to arrive at a number for expected work comp losses. If your actual losses turn out to be worse than your expected losses, you will pay additional premium through the Experience Modification Rate. If your actual losses turn out to be better than your expected losses, your Experience Mod will award you a credit and you will pay less work comp premium.
Her is a very simplistic to illustrate. If the Rating Bureau determines your expected losses to be $75,000 and your actual losses are $100,000, your Experience Modification Rate will be 1.33 (100,000/75,000 = 1.33). That will be inserted into the pricing model (above) and you will pay 33% additional premium to your workers compensation insurance carrier.
On the other hand, if the Rating Bureau determines your expected losses to be $75,000 and your actual losses are $50,000, your Experience Modification Rate will be 0.67 (50,000/75,000 = .67). That will be inserted into the pricing model (above) and you will pay 33% less premium to your workers comp insurance carrier.
How Is Work Comp Calculated - Other
There are a number of other rating elements that contribute to how work comp is calculated. And, many of these elements are state specific and, therefor, too numerous for this article. But, there is one rating element, Schedule Rating or Schedule Modification, that is utilized in all states. As a result, we'll briefly describe it.
In addition, there is a program in several states called the Contractor's Credit Adjustment Program. Although it is only available in several states, it can provide construction risks with substantial savings. Enough so that it's worth mentioning.
How Is Work Comp Calculated - Other - Schedule Rating
Schedule Rating is a program that either charges you additional premium or awards you discounts based on safety characteristics of your organization. The rating bureau, NCCI, has a Schedule Rating Program that most states have adopted. A few states like Missouri and Illinois require insurance companies to file Workers Compensation Schedule Rating Plans directly with their respective Departments of Insurance for approval.
The categories used in the NCCI workers compensation insurance Schedule Rating Plan are:
Employees —Selection, Training, Supervision
Management —Cooperation With Insurance Carrier
Management —Safety Organization
So, your insurance carrier can evaluate your safety operations based on these characteristics. Most states allow a "maximum modification" of +/- 25%. Any business can receive somewhere between a 25% credit and a 25% debit. There are exceptions like: Illinois +/- 75%, Texas +/- 40%, Virginia +/- 15%, New Mexico +/- 15%, and Iowa +/- 15%.
Alaska, Florida, Illinois, Maryland, Missouri and Virginia all have a workers comp Contractors Credit Programs (also called CCPAP & Contractors Credit Premium Adjustment Program).
Contractors in these states are awarded credits based on the wages they pay in relation to their state's average hourly wage. Credits begin to be earned once an employer is paying more than it's state average hourly wage and increase as the difference between average wage and the state average increases. The idea is to not punish a contractor who pays much higher wages through higher workers comp premiums simply because they pay their employees more (Remember from above that payroll is the starting point for premium / price determination).
An insurance companies rate for, say, electricians, is applied equally all of their electrical contractor clients. But, one of their customers could pay much higher workers comp premiums than another simply because their wages are much higher without any difference in risk of workplace injury.
In states like Missouri and Illinois where unions make up a significant portion of this work force these credits are substantial; up to 30%.
How Is Work Comp Calculated - Other - Contractors Credit
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