Two employers in the same trade can pay very different workers compensation premiums on the same payroll. The difference is produced by the experience modification factor.
The starting point is a class rate
Premium begins as payroll multiplied by a rate set for the occupational classification, reflecting the expected loss cost for that kind of work.
Classifications are assigned by the nature of the work performed rather than by the industry an employer identifies with.
Misclassification is a common source of overpayment, and it persists because the code is rarely revisited once the policy has been written.
The class rate describes the average employer in that classification and says nothing about the individual one.
The modifier compares actual losses with expected losses
An experience modification factor compares an employer's own loss history with what an employer of that size and classification would be expected to incur.
A factor above one raises the premium and a factor below one lowers it, applied across the whole calculation.
The comparison uses several years of past experience, excluding the most recent period so that claims have time to develop.
That lag means a safety improvement takes a couple of years to show in the factor, and a bad year lingers for about as long.
Frequency counts for more than severity
Rating formulas weight the number of claims more heavily than their total cost, because frequency predicts future losses more reliably than size does.
Large individual claims are capped within the calculation so that one catastrophic injury does not dominate the factor for years afterwards.
Several small claims can therefore raise a modifier more than a single serious one would.
That is why reporting practices and early management of minor injuries affect premium as much as safety outcomes do.
Open claims are valued at reserves
A claim still open enters the calculation at the insurer's reserve estimate rather than at whatever is eventually paid on it.
Reserves set conservatively early in a claim can inflate a modifier for years before the final cost becomes known.
Reviewing open reserves before the rating date is one of the few ways an employer can influence the figure directly.
The factor is calculated by a rating bureau
Modifiers are produced by independent rating organisations from data insurers submit, rather than by the insurer writing the policy.
The worksheet showing the calculation is available to the employer and lists each claim entering the formula.
Errors in that data are corrected through the bureau, and the thresholds and rules involved vary by state and change over time.