When you hire employees, one of the most important costs of doing business is insurance. Workers' comp insurance protects your team in the event of a workplace injury. But you might not understand how your insurer calculates your workers' comp premiums or how changes in payroll impact them.
How Are Workers' Compensation Premiums Calculated?
To understand workers comp premiums, you need to understand a few standard industry terms — rate, payroll and experience modification factor.
The insurer will assign your business and each of your employees a class code based on the type of business you operate and the job they perform. Each class code has a corresponding rate that generally denotes the amount of risk each job or work environment may entail. This rate applies to every $100 of payroll. However, there are two exceptions — nannies and domestic help — that use "head count" as opposed to payroll.
Next, your workers' comp premium calculation includes your annual payroll. In this case, "payroll" means remuneration or total compensation, which includes things such as bonuses, commissions, and vacation and sick pay, just to name a few (see more below*). Typically, you give your insurer an estimate of your payroll for the coming year. They use that number to calculate your estimated premium.
At your policy's year-end, the insurer will perform an audit to determine your actual payroll for the year. If you've overestimated payroll, you receive a credit or a refund. If you've underestimated payroll, you owe more.
Experience Modification Factor
Depending on the size and tenure of your business, you may qualify for an experience modification factor (e-mod). The e-mod rewards employers with good safety practices and thus minimal claims. It can also penalize businesses that have had higher-than-average losses.
Your company's previous experience, typically the past three years, forms the foundation of your e-mod. The neutral e-mod is 1.00. If you have fewer claims than the average business in your industry, your e-mod may be less than 1.00 and your premium will be lower. If you have more claims, your e-mod will be greater than 1.00 and your premium will be higher. Those are the e-mod basics, but you can read more on how e-mod works here.
Now that we've covered the basic definitions, pull out your calculators, because your workers' compensation premium equation is Rate x (Payroll/100) x E-mod = Premium.
How Do Payroll Changes Impact Workers' Comp?
When you hire a new employee or give out raises, it's natural to expect your workers' compensation premiums to increase. After all, there is a direct correlation between your payroll and the premium.
But there are other forms of compensation you may not consider that impact premiums. Besides wages and salaries, for workers' comp purposes the definition of payroll includes:
- Overtime pay.
- Holiday, vacation and sick pay.
- Payments by an employer for the employee part of Social Security and Medicare taxes.
- Payments for piecework, profit-sharing or incentive plans.
- The rental value of housing, lodging or meals provided to employees as a part of their pay.
- Payments or allowances for tools used by employees in their work.
- The value of gift cards or merchandise employees receive as part of their pay.
- Prevailing wages.
- Annuity plans.
- Expense reimbursements without a documented, valid business purpose.
- Payment (other than residuals) for filming commercials.
Workers' comp payroll excludes:
- Tips or other gratuities received by employees.
- Payments for group insurance or group pension plans.
- The value of special rewards for individual invention or discovery.
- Severance payments, except for time worked or for accrued vacation.
- Payments for active military duty.
- Employee discounts on goods purchased from the employer.
- Meal payments for late work.
- Uniform allowances.
- Disability payments made by a third party, such as a group insurance carrier.
- Employer-provided fringe benefits, including company vehicles, travel, discounted services or memberships, and tickets to entertainment events.
- Employer contributions to retirement or cafeteria plans.
While paying additional premiums after your policy year has passed isn't ideal, determining your actual payroll for the year is a fundamental part of calculating accurate workers' comp premiums and thus accurate coverage. Fortunately, you might be able to avoid those year-end surprises. Keep an eye on your projected payroll during the year. If you hire new employees, give raises or promote employees into different roles, make sure you update your coverage.
With Pinnacol, you can change payroll estimates up or down by contacting your agent or underwriter. This helps spread the increased cost or savings over the remaining policy term so you can avoid an unexpected change at the policy's year-end.
*For more policy management information, check out this library of resources.