The Hidden Cost of Saving on Workers’ Comp Premium

How Misclassifying Payroll Can Create Unintended Consequences

Saving money on workers’ compensation premium sounds like an obvious opportunity to cut costs. However, inappropriately assigning employees a lower-rate classification can actually make an employer less competitive.

Workers’ compensation classification disputes have always been common, particularly in the construction industry.

Contractors understandably want to control insurance costs, and payroll classification can have a meaningful impact on premium. But an exclusive focus only on the immediate savings can overlook a less obvious consequence: the potential impact on an employer’s Experience Modification Rating (EMR).

Classification Isn’t About Finding the Lowest Rate

The premium audit process remains an important part of the workers’ compensation policy life cycle. The audit verifies the actual payroll exposure for the policy period and ensures that employees have been assigned to the appropriate classifications. The objective isn’t to find the classification that produces the lowest premium but rather to actually identify the classification that accurately reflects the work being performed.

The distinction matters because an employee’s job title does not necessarily determine the appropriate classification. The actual duties and responsibilities matter. This can become particularly challenging when an employee’s responsibilities overlap between multiple classifications.

One example that frequently creates questions in the construction industry is Code 5606 — Contractor–Project Manager, Construction Executive, Construction Manager, or Construction Superintendent. Code 5606 can be attractive to contractors because it is generally a lower-rated classification than many “construction” classifications, but the fact that an employee has “manager,” “superintendent,” or “project manager” in their title does not, by itself, make the employee eligible for the classification.

The employee’s actual responsibilities are what matter.

Where the Problem Begins

Consider a construction company with employees whose responsibilities overlap project management and jobsite supervision. If actual duties are more consistent with direct jobsite supervision or construction operations, assigning that employee’s payroll to a lower-rated management classification may reduce the company’s workers’ compensation premium.

On the surface, that can look like a win. However, the problem is that the premium savings are only one part of the equation. The lower-rated classification also carries a substantially lower Expected Loss Rate (ELR), which means the same payroll generates substantially fewer expected losses for experience-rating purposes.

Simply stated, this can negatively impact their EMR.

Consider a simple example using the National Council on Compensation Insurance’s Missouri rating values effective January 1, 2027 and assuming that a contractor has $1 million of payroll that properly belongs in Code 5403 but instead is reported under Code 5606.

The difference is significant. The same $1 million of payroll generates $15,090 less in expected losses when assigned to Code 5606 rather than Code 5403.The difference in expected primary losses is also substantial: approximately $5,053 less under Code 5606.

Why This Matters

Experience rating considers an employer’s actual loss experience in relation to the expected losses associated with its classifications. Primary losses also receive greater weight in the experience-rating calculation than excess losses.

Now assume the same $1 million payroll exposure produces a $20,000 loss during the experience period. The loss didn’t change because of the classification, but the expected loss benchmark did.

Under Code 5403, the $1 million of payroll generates $18,780 of expected losses, including approximately $6,197 of expected primary losses. Under Code 5606, that same payroll generates only $3,690 of expected losses, including approximately $1,144 of expected primary losses.

The policyholder didn’t make the loss smaller by using Code 5606; instead, the expected loss benchmark became smaller. That difference can materially change the account’s experience-rating calculation and can result in a much less favorable EMR than the employer would have had if the payroll had been properly classified.

The Hidden Trade-Off

The important distinction for policyholders, not just contractors, to understand: There is nothing inherently wrong with having payroll in a lower-rated classification, but only when the employee’s actual duties meet the requirements of that classification. The issue arises when a lower-rated classification is selected because it produces a lower premium even though the employee’s actual work belongs in another classification.

The temptation is understandable.

A policyholder sees immediate premium savings, but workers’ compensation costs don’t end with premium payment. The classification assigned to payroll also affects the expected loss component used in determining the employer’s experience modification. When losses occur, the relationship between those losses and the expected losses becomes important.

The Consequences Can Extend Beyond Insurance Premium

For some policyholders, the consequences of a higher EMR go well beyond the workers’ compensation policy. Certain policyholders may be required to maintain an EMR below a particular threshold to bid on or perform certain work.

In those situations, an increase in EMR can potentially affect a company’s ability to compete for work.

For a policyholder whose business depends on maintaining an EMR below 1.00, an avoidable increase in the experience modification factor can have consequences that extend well beyond the premium paid on the current workers’ compensation policy. Immediate premium savings today may ultimately prove insignificant when compared with the potential cost of a less favorable EMR as a result.

What Should Policyholders Do?

The answer isn’t to automatically select the higher-rated classification. To ensure that payroll is being classified correctly, you should:

• Classify employees based on their actual job duties and not their titles.
• Review classifications before the premium audit, particularly when employees perform multiple functions.
• Discuss questionable classifications with your agent and carrier rather than making assumptions based solely on the rate.
• Consider both the immediate premium impact and the potential long-term impact on the company’s Experience Modification Factor.

When legitimate ambiguity exists, the policyholder, agent, and carrier should work together to understand the applicable classification rules and determine the best possible long-term solution. The goal should be accuracy—not simply finding the lowest rate—because in workers’ compensation, a lower premium doesn’t create savings if it comes at the expense of a higher EMR.