Calculating workers' compensation is not always straightforward.
And, it can be pricy if you miscalculate it as well. Making an error on workers' compensation calculations could end up costing you a lot more, especially if an audit reveals you had underpaid.
In this article, we’re going to explain how workers' compensation is typically calculated so you can rest easy knowing you haven’t overpaid, or even worse, underpaid on workers' compensation insurance.
How to Calculate Workers’ Compensation
Workers' compensation calculations can get complex, especially if you have a lot of employees doing different types of jobs. Taking advice from any old source on the internet is not always a good idea. It’s important to know you’re getting that advice from a trusted source who knows what they are talking about.
How do you know that we know what we’re talking about?
As a small business payroll service, we’ve navigated a lot of issues with a lot of different small businesses. While we’re not an insurance broker, and we don’t sell workers' compensation, we work with a lot of local workers’ compensation experts. We connect our clients with local brokers they can trust who will manage workers' compensation insurance for them.
While it’s good to have knowledge of how it’s done, the best advice we can give when it comes to calculating workers' compensation is to work with a local broker you can trust and let them do this for you.
With that said, let’s talk about how workers' compensation insurance pricing works.
The State Variables
When you’re talking about workers' compensation, the rules change from state to state. That’s why getting advice from the internet could be a bad idea. General advice for one state could be completely wrong except in very particular instances.
In general, there are three types of states when it comes to workers' compensation insurance.
- NCCI States - states base their regulations on the National Council for Compensation Insurance. This is the majority of the United States.
- Independent Bureaus - states have their own system of rating and regulating workers' compensation. These are referred to as independent bureau states, which include California - the largest single-state workers' compensation market.
- Monopolistic States - states that prohibit private workers' compensation insurance coverage. Washington, for example, is a monopolistic state.
Working with a local broker is critical because they will understand, more than anyone else, the local requirements your company has to measure up to.
The Experience Modification Rate Variables
Businesses deemed less risky than others are given a modification on their workers' compensation premiums. This is a way of rewarding companies that take employee safety a little more seriously than others and maintain a track record of lower workers' compensation claims compared to industry averages.
The Experience Modification Rate (EMR) is a mathematical formula, comparing your company with the industry average to predict the likelihood and amount of future claims. Those companies that score lower risks will see their insurance rates go down.
The ideal EMR rate is 0.95 and lower. These companies have little to no significant workers' compensation claims. If your business sees an EMR rate at 1.05 or higher, it means your company is considered a high-risk employer, usually with several recent, serious claims.
The Class Code Variables
When a broker is calculating workers' compensation rates, the class codes of each employee are taken into account.
Workers’ compensation class codes identify categories of work to help insurance companies better understand their customers. These codes allow companies to categorize areas of work based on an estimated level of risk.
A crane operator on a high-rise construction project will be considered at a higher risk of injury than a receptionist. Those are two extreme examples, but there is a wide range of risk calculations across the spectrum of job types.
Not all states do class codes the same way. The most common classification codes are from the National Council on Compensation Insurance. You can learn more about their classification codes here.
Again, working with a local insurance broker will ensure your classifications are correctly ascribed to your employees, so you’re paying the right amount and nothing more.
The Workers’ Compensation Price Formula
Not to be too repetitive, but it’s very important to let your local insurance broker make these calculations for you. If you underpay on workers' compensation insurance, a surprise audit could end up costing a lot of money you were not expecting to pay.
The Basic Formula:
Premium = Class Code Rate X (Payroll/$100) X Experience Rate Modification
How to Get (and Keep) the Best Rates
One of the reasons we push our clients to work with local brokers is manifold, but the biggest benefits are: the broker will be knowledgeable of the local laws concerning workers' compensation, and they will continually shop for the best rates.
One of the hallmarks of the insurance industry is a gradual increase in rates over time. The only way to ensure you keep your premiums low is to take advantage of competition. Partnering with a local broker will ensure you are always competitive with your insurance premiums.
We also recommend working with a broker who can set you up on Pay As You Go Workers’ Compensation insurance. Every business owner knows the pain of paying those large up-front payments and even the surprise payments after an audit. The crunch on cash flow can be frustrating when up-front estimates prove inaccurate.
Pay as you go alleviates most of the pain business owners have faced with paying for workers' compensation. Not only is it always accurate (based on actual payroll numbers), but the payments are spread out, so your cash flow can be much more consistent.
As a small business payroll provider, we work hand-in-hand with local insurance brokers to not only solve for workers' compensation but also solve payroll for good. If you would like to talk to a payroll specialist about your company’s payroll needs and get pricing based on the payroll services you need (and nothing more), click here.