How to Explain Net Rates to Your Clients

Buying workers’ compensation insurance is confusing to many business owners. Luckily, insurance agents like you can use your expertise and guidance to help them understand the underwriting process and find suitable coverage. But, along the way, you may also need to break down some of the mysteries of insurance—like workers’ compensation insurance coverage pricing. 

To clarify policy pricing to your policyholders, you’ll need to explain the essential factors in these calculations, like the net rate. Here we’ll cover how to explain net rate to your client and help them understand the elements that make up their premium cost.  

What is Your Workers’ Comp Net Rate?

All insurance agents know that insurance companies don't directly offer an accurate rate upfront on workers' compensation policies. So, to help the client identify the actual price of their insurance premiums, you’ll first need to have them look at the base rate.  

Base Rate Explained 

You’ll want to direct them to the base rate located next to the matching class codes on your declaration page. Class codes are used to define the amount of risk with a given job, which helps determine pricing for specific employees. Just like it sounds, base rates are just that, a base. A base rate is the rate the insurance company files for each class code with their state-chartered agency, like the Workers’ Compensation Insurance Rating Bureau (WCIRB) for California or the National Council on Compensation Insurance (NCCI) for other states. Some states like Florida and Wisconsin set all base rates for class codes. While others let private insurers set their base rates as long as they follow specific guidelines. 

New York allows insurance carriers to set their own base rates, yet additional credits or debits are not permitted. We will circle back to debits and credits later. For right now, let’s focus on rates. 

Breakdown Net Rates 

Now that the policyholder has a grasp on base rates, you can move on to breaking down how net rates work. First, explain that a net rate is the policyholder's rate for every $100 of payroll on a workers' comp insurance contract. This is after all discounts and surcharges are applied to their base rate. 

Insurers use several factors when assessing the net rate, and the amount of money policyholders pay for coverage. These factors can make your net rate fluctuate (move up or down). Which means, insurance cost can increase or decrease depending on the discounts the insurer applies. 

Some factors that affect rates include:

• Payroll
• Experience Modification Factor
• Discounts
• Surcharges 
• State credits 
• State and federal taxes

What is a Net Premium?

Another important term worth explaining to your client is what a net premium is. To understand this concept, you need first to explain what a gross premium is. A gross premium is an amount that the client is expected to pay the insurance company during the insurance contract term. So, if the total premiums amount to $10,000 for a workers’ compensation policy, the gross premium is $10,000. 

A net premium is an amount the policyholder pays to an insurance company, except it doesn’t include any expenses the insurance company incurs due to insuring the plan. For example, one expense insurers may not include in the net premium is the cost of reinsurance. Many insurance companies purchase reinsurance to protect themselves against large claims that can result in significant financial losses. In other words, the policyholder isn’t responsible for the reinsurance cost. 

It’s also important to point out that all policies are subject to premium taxes based on the gross premium rate, not the net rate. This tax is considered a form of sales tax on the insurance policy. While premium taxes vary, they are typically 2.5 percent but no more than 4 percent. It’s essential to note municipalities can also apply taxes.

So, why does this taxation matter to the client? Well, it raises workers’ comp insurance rates, which they will want to know.  

How To Calculate Workers’ Comp Net Rate

Does this seem confusing? Not to worry, showing business owners how to calculate their workers’ compensation net rate isn’t as complicated as it seems. Here’s a breakdown of the components and steps you’ll need to explain a client's net rate and net premium. 

Step 1: Identify Class Codes

A state-charted agency determines rates. They create a unique set of class codes for every insurance industry. So, you’ll want to help your policyholder find the class codes used for their business practices. For example, restaurants in California have a primary 9079 class code. After you help your client identify the class codes used for their workers’ compensation calculations, you can take a look at the base rate for each class code. 

Base rates are determined for every class code by a state-charted agency. The loss information is gathered and included in a report that insurance companies use to determine the expected loss per $100 of payroll for each of their class codes. From there, insurance companies compare premium rates with the losses they've experienced in each particular industry or class.  

Then the insurance carriers go to their department of insurance (DOI) to file their own rates that they want to charge and wait for approval from the DOI. 

So, let’s suppose your policyholder has an annual estimated payroll of $400,000 and a base rate of 4.5. Then, using the formula below, this is how you would help your client estimate their premium. 

Payroll/$100 x Base Rate = Premium  

$400,000/$100 x 4.5 = $18,000

Step 2: Apply Your Experience Modification Factor 

Next, you’ll want to explain the loss experience modification factor and show how to apply it to the base rate.

The Experience Modification Factor (EMF) is used to compare the company’s loss experience to every other business in the specific industry that uses that class code. Typically, the median modification factor is 1.0, which means the rate would be the same as the base rate. 

However, if loss history is better than the rest of the industry, the experience modification factor will be lower than 1.0. On the other hand, if the business’s losses are more significant than most businesses in the industry, their experience modification factor will be higher than 1.00.   

Let’s say your policyholder’s experience modification factor is 0.75. In this case, you can use the formula below to explain how it is applied to the base rate. 

Premium x Experience Modifier = Modified Premium 

$18,000 x 0.75= $13,500

Step 3: Apply Discounts and Surcharges 

Lastly, you'll want to explain discounts and surcharges. Again, most states allow insurers to use discounts and surcharges for workers' compensation policies, potentially increasing or decreasing the policyholder's premium payments. Insurance companies can debit or credit an account as much as they want/need to as long as they are staying within the rates filings that the DOI approved for them.

For example, some insurance companies may apply a 50 percent credit off the base premium. On the other hand, other insurance companies may apply a 40 percent debit. Private insurers have much more flexibility in how they want to price an account.

Insurance companies can file to apply discounts or surcharges, including:

• The premium size. The greater the payroll amount and number of employees, the more policyholders likely have to pay in premiums. So, when the policyholder adds new employees, inform them they should expect a premium increase. 
• Claim history. Since your policyholder's claim history is compared to other businesses' claim history within the same class codes, having more claims than the average will likely increase their premium. 
• Safety programs. Implementing safety programs such as requiring heavy lifting protocols, forklift training, and wellness programs helps decrease the number and severity of accidents in the workplace. Because these programs lower your experience mod, policyholders can expect to see a decrease in their rate.  

Make sure your policyholder knows that the insurance company is allowed to use discounts and surcharges at their discretion. In other words, the underwriter (professional who assesses the risk of each policy) can manipulate policy cost based on business conditions. Fortunately, states usually set debit and credit limits at 15 to 25 percent of the base premium. 

States also require insurers to offer automatic discounts and surcharges to businesses actively trying to reduce workers' comp claims. So, for businesses with drug or safety programs, it's possible to receive a 3 to 5 percent credit on their premiums. Although there are limits, discounts and surcharges can significantly impact the price you pay for workers' compensation coverage. Every little bit counts!

To help your policyholder easily calculate their net rate, combine these factors into one.

Premium x Discount = Modified Premium 

$13,500 x .90 = $12,150

So, your final premium will be $12,150.

In summary, you can multiply the base rate by experience modifiers as well as discounts and surcharges to find your policyholder's net rate premium. It would look like:

Base Rate x Experience Modifier x Discounts and Surcharges = Net Rate 

4.5 x 0.75 x 0.90=3.0375

Payroll/$100 x Net Rate = Net Rate Premium 

$400,000/$100 x 3.0375= $12,150

Putting It Altogether

Taking the time to explain the net rate and how pricing is calculated to your clients sets you apart from other insurance agents. While others may gloss over the inner workings of insurance pricing, that’s not you. Your policyholder will feel more confident using your insurance services when they see you have a firm grasp of how the insurance market works. It's definitely worth the time and energy to explain (in detail) the factors that influence their workers’ comp pricing.