How Is Workers' Compensation Calculated?

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How Is Workers' Compensation Calculated?

Written by Brian Greenberg
CEO / Founder & Licensed Insurance Agent

Last updated: November 25th, 2022

Reviewed by Paige Geisler
Licensed Insurance Agent

Whether you’re an owner or CFO, the impact of workers’ comp insurance is something to take into consideration during the planning phases of your business endeavor because you’re legally required to cover your workers. Given the diversity of businesses using workers’ comp, the costs are adjusted to accommodate different industries and the associated costs and liabilities.

What Are the Key Factors in Determining a Workers’ Compensation Premium?

When you’re shopping for workers’ comp insurance, you’re looking to purchase a policy that will help your employees cover daily expenses should they be unable to perform their job due to a workplace accident or sickness. The insurance helps cover medical costs, missed wages, and even funeral expenses if an employee dies on the job. Workers’ comp insurance is sold by private companies, but it’s required by law for businesses that meet certain requirements to protect employees.

The cost of workers’ comp premiums is determined using a simple formula that takes into account the payroll, the worker’s compensation class rate, and the experience modification factor. Each of these plays a role in making sure the coverage and premiums you get with your policy align with the type of business you own and the work your employees do.

What Is a Workers’ Compensation Classification Rate?

Every job currently on the market falls under a specific compensation classification code with an assigned rate. Each class code is four digits long and comes with a description of the job it represents and the classification rate, which is an amount per every $100 that each type of employee should pay toward premiums. Even similar positions may have slightly different responsibilities that require separate codes, which makes thorough and correct job descriptions crucial in obtaining the right coverage.

Take Christmas tree farms in North Carolina as an example of how detailed classification rates can be. A code of 0106 is for tree harvesters and drivers only. Farmers and customer service representatives at the same farm each have their own different codes. You can typically verify class rate codes online depending on the state your employees are working in.

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What Is an Experience Modification Factor (EMF)?

The EMF for your company is based on your industry and its overall workers’ comp claim history compared to that of your business. Industry trends are speculated to anticipate the number of claims that could happen the following year, with the factor range commonly falling between 0.75 and 1.25. Anything below 1.0 decreases the cost, while anything above 1.0 increases it.

If you have no workers’ comp history due to being a new business, you will likely be given a flat rate of 1.0 for the first few years, barring any claims that go above the forecasted amount for your industry. The higher or lower the risk your business poses compared to the industry standard determines your premiums.

How Does a Business’s Payroll Affect Workers’ Comp Premiums?

The last piece of the workers’ comp equation is payroll. Since each employee’s compensation classification rate is based on every $100 they earn, it’s important to understand what wages and other forms of compensation are considered payroll. Items included in payroll consist of:

  • Gross wages
  • Overtime and holiday differentials
  • Bonuses
  • Sick pay

Payroll does NOT include the following:

  • Tips, communal or individual
  • Group insurance
  • Per diem and travel reimbursement
  • Severance pay

If your insurance company projected an employee’s payroll as being higher than it ended up being at the end of the fiscal year, you would be reimbursed for the excess in premiums paid.

Does the Location of a Business Impact Its Workers’ Comp Premiums?

Yes. A majority of states are part of the NCCI, or the National Council on Compensation Insurance, which means they all share the same comp class rate codes that determine the base amount of insurance cost. Some states opt to have their own independent council that sets rates. One example is California.

States such as Washington have publicly funded workers’ comp insurance through the state’s marketplace. Private workers’ comp insurance isn’t available in these monopolistic states. The differences in wages and classification rates between states can greatly impact the premium costs as well, a consideration for new businesses that have the flexibility to change locations before opening their doors.

How Can Employers Reduce the Cost of Workers’ Comp Coverage?

The easiest way to reduce insurance costs for workers’ comp is to increase safety awareness and reduce claims. As with other insurance plans, the more claims you have, the higher the premiums are. A clear, concise, and regularly updated safety program is an excellent way to prepare your employees to perform their jobs as safely as possible.

Return-to-work programs are another option you can use to create accommodations for injured employees to get them back to work as soon as safely possible, reducing the length and cost of their comp claim.

Key Takeaways About How Workers’ Comp Premiums Are Calculated

You can get a general estimate of what your workers’ comp premium for an employee will cost by taking their payroll, dividing it by $100, then multiplying it by their class rate and EMF. This will be the premium calculation with the exact variables per your state and your assigned EMF.

Workers’ compensation insurance may be offered through different marketplaces depending on the state, but having coverage is a federal requirement.

You can reduce costs for workers’ comp premiums by reducing claims. You can maintain strict safety guidelines and protocols that come with disciplinary action should they not be met. Also, hiring a third-party or full-time safety advisor can help you revamp your safety measures and limit your claims.

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