Guide to Workers' Compensation Insurance
For most business owners, it's a mystery and a burden. But the truth is, there are a lot of advantages to understanding your workers' compensation policy
by Samantha Harrison

If you have workers' compensation insurance, you probably understand that it covers job-related injuries and illnesses. You may also know that it is the most expensive commercial line of insurance. Additionally, you know that you are mandated by your home state to carry workers' compensation insurance. While these are very pertinent facts, how much more about your policy or premium are you knowledgeable about?

For most business owners, workers' compensation insurance is a mystery and a burden. But the truth is, there are a lot of advantages to understanding your workers' compensation policy. By learning how your premium is calculated, you can learn how to lower the cost of your coverage. By understanding how claims affect your policy, you can understand how to better prevent them. By knowing common policy mistakes, you can know how to avoid them. And by reviewing the audit process, you can review ways to prepare for a successful audit. With this simple guide, you can actively make the most of your workers' compensation insurance.

How Premiums are Calculated?

A workers' compensation insurance premium is actually easier to understand than most other lines of insurance. For workers' compensation, there are three main components that create the premium: payroll, class codes and experience modification.

Payroll The first component of a workers' compensation premium is payroll. Your payroll is the constant component in your workers' compensation premium. Insurance companies need an estimated annual payroll when setting up a new policy. That initial estimate is used to calculate your premium. Even though it is only an estimate, it is critical that the payroll predicted is as accurate as possible. If the payroll is underestimated, you will pay the insurance company for the unpaid premium after the end of the policy. If the payroll is overestimated, the insurance company will refund you for the overpaid premium.

Class Codes The next components of a workers' compensation premium are class codes. These codes identify specific job categories. A code is assigned for each type of job or employee operation. For example, insurance companies recognize a registered nurse at a home care agency in California as class code 8827.

Each class code is then assigned a base rate. This rate is the cost for workers' compensation insurance per $100 of payroll. Different class codes have different rates depending on how risky each type of work is. For example, plastics manufacturing employees (California class code 4496) have a higher compensation rate than clerical office employees (California class code 8810). This is because the plastics manufacturing employees are more likely to become injured on the job and report a claim.

Experience Modification The third component of a workers' compensation insurance premium is your experience modification. An experience modification, or experience rating, is essentially a rating that represents whether a company has more or less claims than average for that industry. The Workers' Compensation Insurance Rating Bureau (WCIRB) administers the Experience Rating Plan. For each business, they compare the actual losses incurred to the expected losses for that class code. That ratio, or percentage, is the experience rating. If the actual losses are the same as the expected losses, the experience modification is 100. Companies that do not meet requirements to have an experience modification have the equivalent of a 100 experience modification. With a 100 experience modification, the premium cost is not affected.

If a company has fewer claims than average, the experience modification will be under 100. This is called a credit experience modification because it will result in a credit, or decrease, to the workers' compensation insurance premium. If a company has more losses than average, the experience modification will be over 100. This is called a debit experience modification because it will result in a debit, or increase, to the workers' compensation insurance premium.

Workers' Compensation Premium Equation

Workers' compensation insurance premiums are calculated as follows—multiply the payroll for each individual class code by the base rates assigned to that class code. Divide that number by 100, since each rate is per $100 in payroll. Then multiply the entire equation by the experience modification. Examples have been provided below.

Example 1: With no experience modification

  • Payroll for class code 8810: $100,000
  • Base rate for class code 8810: 2.00
  • Experience modification: 1.00

[($100,000 x 2.00)/100] x 1.00 = $2,000 Example 2: With a credit experience modification

  • Payroll for class code 8810: $100,000
  • Base rate for class code 8810: 2.00
  • Experience modification: .88

[($100,000 x 2.00)/100] x .88 = $1,760 Example 3: With a debit experience modification

  • Payroll for class code 8810: $100,000
  • Base rate for class code 8810: 2.00
  • Experience modification: 1.30

[($100,000 x 2.00)/100] x 1.30 = $2,600

In these examples, you can clearly see how nothing affects the cost of a premium like the experience modification. As such, claims prevention and management are the most effective ways to lower workers' compensation premium.


Workers' compensation claims are going to happen. After all, the goal of workers' compensation insurance is to protect employees from paying for injuries and illness caused by the workplace. Nevertheless, claims not only have the strongest impact on the cost of coverage, but they can cause your business to have a bad reputation or even legal issues if preventative measures are ignored.

There are two types of workers' compensation insurance claims. The first are frequent claims. Frequent claims are claims that happen a few times a year, but the actual cost of the losses are fairly small. Small, frequent claims may seem like less of a bother to the employer, but they are a red flag for insurance companies because they lead the insurance company to believe that nothing is being done to prevent claims from occurring.

The second type of claim is a severe claim. Severe claims, or shock claims, happen infrequently, but they are more detrimental incidences and consequently more expensive. Severe claims seem more detrimental to the employer, but are less of a red flag for insurance companies. This is because the insurance company can categorize them as a fluke and often that helps the employer down the line.

No matter the type of claim, the most important thing to consider when workplace injuries occur is how to learn from those incidences and prevent them from happening again. This is where a claims prevention program can come into play.

Claims Prevention

Claims prevention programs are designed to help employers monitor the safety of the workplace and employee operations. In addition to a written claims prevention program, you can try the following methods to actively promote a safe, claims-free workplace.

  • Have the correct protective equipment for the job at hand (gloves, goggles, respirators etc.) and require employees use it every time
  • Host monthly safety meetings
  • Create incentive programs for employee safety
  • Set up a Return to Work Program for when injury does occur
  • Have a written workplace injury reporting process
  • Review OSHA Workplace Safety guidelines for your industry
  • Monitor workplace safety standards and keep them up to date
  • Perform pre-employment and/or post-accident drug tests
  • Perform pre-employment and/or post-employment physicals
  • Check references prior to hiring new employees

Common Policy Mistakes

Often the most devastating problems that can occur with workers' compensation are not claims, but policy mistakes. Workers' compensation policies are subject to change—even mid-term—based on a subjective decision of the provider, additional underwriting information, results of loss control surveys and more. As discussed earlier, payroll inaccuracy can lead to debts once a policy is complete. Changes or adjustments to operations can result in dramatic rate changes or even mid-term cancelation if not addressed properly. Another common mistake is the use of the wrong class codes. When this happens, the insured will have to pay the premium owed for the misrepresented payroll after the audit reveals the mistake. To prevent this, be aware of the differences in high-wage and low-wage rates and consult your broker on the operations that are included and excluded from the class codes used. To avoid common policy mistakes in general, remember to report the following changes to your broker:

  • Changes in business operations or product
  • Change in ownership
  • Additional locations
  • Out of state operations
  • Changes in payroll or sales
  • Change in hazards
  • Certificates of insurance required

The Audit

Another stipulation to workers' compensation insurance policies is the audit. Since the policy is set-up using an estimated annual payroll, insurance companies require audits to verify the actual payroll used for the year. After the completion of the audit, the insurance company will send out a Final Audit Statement. This indicates any additional premium you may owe for underestimating your annual payroll when setting up the policy, or any credit you are owed for overestimating your annual payroll when setting up the policy.

There are two main types of audits that the insured may encounter. The first is a physical workers' compensation audit. For this type of audit, an auditor from your insurance company will schedule a time to visit your business within 60 days of the policy expiration. At the time of the audit, the auditor will review the required records to verify the payroll and any renumeration for that year.

The second type of audit is a voluntary workers' compensation audit. With this type of audit, the insurance company will mail a voluntary audit form to you within 30 days of the policy expiration. You are responsible for inputting the actual annual payroll for each class code shown of the policy. You then return the form to the insurance company as promptly as possible.

When preparing for your audit, keep these helpful hints in mind.

  • Separate overtime pay by class code as they are listed on your payroll records.
  • Be sure to have current Certificates of Insurance on file for each subcontractor used.
  • If a single employee can be categorized in multiple class codes, be sure to divide their payroll appropriately for each class code. This should be recorded by the dollar, not by a percentage. If this is not done correctly, the entire payroll for the employee will be placed in the highest rated class code and payroll separation cannot be used.
  • Respect the auditor's strict time schedule. Have the information they requested. Do not reschedule or postpone. Answer the auditors questions correctly, but do not offer information if not requested or asked.
  • Do not let the auditor go home with your information. Review the auditor's work before they leave your office so you are aware of the adjustments they have made. Make sure the auditor's worksheet is complete, sign the auditor's worksheet before they leave and request a copy for your records.

While workers' compensation insurance may seem like a burden, it does have some advantages if you understand what is entailed in your policy. This knowledge cannot eliminate your need for workers' compensation insurance all together, but it can help you reduce the cost and hassle of your coverage.