A National Workers Compensation Overview

1. A National Workers Compensation Overview AASCIF Austin Workshop Bruce R. Hockman Towers Watson Bruce.hockman@towerswatson.com T 215 246 1629 October 19, 2010 © 2010 Towers Watson. All rights reserved.

2. A National Overview • This Business SUCKS!!! Any questions??? 1

3. A National Overview No two carriers, public or private, approach the business the same way, but there are common issues which, as they say in consulting speak, are “Keeping companyleadersawakeatnight”. Loss Ratio Deterioration Reduced Top-Line Revenue Expense Ratio Pressure Medical Inflation Personnel Development Sluggish Investment Market Market Consolidation Federal Intervention Economy Competition Indiscriminate Hair Loss 2

4. A National Overview Reminder: Unless you are a national writer, with proportional premium distribution in each state, National Statistics are: a) dated b) wrong c) of little value for strategic decision making • →Trust your own data whenever possible as it is likely to be • timely • b) accurate • c) strategically reliable 3

5. Market Consolidation 4 towerswatson.com © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

6. 10.4B 6.2B 14.3B 43.6B 33.8B 39.7B State Fund Private Market Market Consolidation A National Overview Our Cozy little world of workers comp is getting smaller, and at the same time more crowded. 2006 $54 Billion 2004 $54 Billion 2009 $40 Billion 4

7. Market Consolidation A National Overview • For the last four years, the workers compensation market has been consolidating. • Zenith (14) → Fairfax Holdings (49) • PMA (16) → Old Republic (15) • First Comp (61) → Markel (0) • Why: • Organic growth is not available • Move towards “specialization” • Existing market opportunities have “topped out” Product Pointer: Be mindful of ongoing consolidation among your distribution system. 5

8. Top Line Revenue Slippage 7 towerswatson.com © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

9. Top Line Revenue Slippage A National Overview The NCCI provided a detailed breakdown explaining the rationale for this market collapse. Change in loss costs -7% Change in carrier pricing -4% Change in total payroll -4% Change in industry mix -5% “Other” -6% • But change was not uniform across the country? • California and Florida account for $6.5 billion of that lost business. 6

10. A National Overview +17.1% -24.0% -27.8% +36.3% Top Line Revenue Slippage Premiums rise and fall for many reasons – and they will in the future. ($ Billions) Cumulative Rate Change→ Sources: A.M. Best (1973-2009); Insurance Information Institute calculations and estimates for 2010. 7 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

11. Lagging Investment Opportunities 10 towerswatson.com © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

12. A Natural Overview Lagging Investment Opportunities Property/Casualty Insurance Industry Investment Gain: 1994–2010:Q11 ($ Billions) In 2008, Investment Gains Fell by 50% Due to Lower Yields and Nearly $20B of Realized Capital Losses 2009 Saw Smaller Realized Capital Losses But Declining Investment Income 1 Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. * 2005 figure includes special one-time dividend of $3.2B. Sources: ISO; Insurance Information Institute. 8

13. A Natural Overview Lagging Investment Opportunities Treasury Yield Curves: Pre-Crisis (July 2007) vs. July 2010 Treasury yield curve is near its most depressed level in at least 45 years. Investment income is falling as a result Sources: Board of Governors of the United States Federal Reserve Bank; Insurance Information Institute. 9 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

14. Expense Ratio Pressure 13 towerswatson.com © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

15. Expense Ratio Pressure A National Overview • Like it or not, when income falls someone is going to check on how much free coffee is being consumed! • In my experience, I have never seen a company go broke because of too high an expense ratio. • Product Pointer: • Expenses should be properly managed in good times and times like today. Remember, technology is terrific, but when was the last time that a computer got an injured worker back to work? 10

16. Expense Ratio Pressure A National Overview Cash flow in any business is important, in ours it is critical. (Billions) Product Pointer: Model your cash flow situation under various scenarios. 11

17. Loss Ratio Deterioration 16 towerswatson.com © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

18. Loss Ratio Deterioration A National Overview • Whether we look at calendaryear data, or accidentyear data, the arrows keep pointing in the wrong direction. • 2009 data showed the 4th consecutive year of marked deterioration in combined ratios. We have seen nothing in 2010 to suggest that it will not be the markets worst results since 2001. Pricing Levels Frequency Severity Medical Inflation 12

19. Loss Ratio Deterioration A National Overview • Workers compensation loss results have always raised the industry’s loss ratio average. →Medical inflation, increased severity, increased litigation, all play a role, but price deterioration is playing a larger part. 13

20. Loss Ratio Deterioration A National Overview • We cannot talk about calendar year results without looking at reserve development (positive or negative), and adequacy. → A.M. Best: Workers compensation reserves are $1.8BB inadequate → NCCI: $4BB deficient after discounting • Most “redundant” reserves built up between 2005 – 2009 have already been released. →Reserve inadequacy over any sustained period of time will put your company in jeopardy. • Product Pointer: • Watch for those “hidden bombs” • a) settled indemnity claims with open medical • b) cases in litigation 14

21. The Economy 20 towerswatson.com © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

22. A National Overview The Economy Length of US Business Cycles,1929–Present* Length of Expansions Greatly Exceeds Contractions Duration (Months) Average Duration** Recession = 10.4 Mos Expansion = 60.5 Mos *August 2010 (likely the “official end” of recession was June 2009) Sources: National Bureau of Economic Research; Insurance Information Institute. 15 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

23. A National Overview The Economy US Unemployment Rate 2007:Q1 to 2011:Q4F* * = actual; = forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (8/10); Insurance Information Institute 16 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

24. A Natural Overview The Economy US Unemployment Rate Forecasts Quarterly, 2010:Q1 to 2011:Q4 Unemployment will remain high even under the most optimistic of scenarios, but forecasts are being revised downwards Stubbornly High Unemployment Will Slow the Recovery of the Workers Compensation Exposure Base Sources: Blue Chip Economic Indicators (8/10); Insurance Information Institute 17 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

25. A Natural Overview The Economy U.S. Nonfarm Employment, Monthly, 1990 - 2010 Millions The number of employed people in the US today is approximately the same as it was in late 2004 *As of July 2010; Not seasonally adjusted Note: Recessions indicated by gray shaded columns. Sources: US Bureau of Labor Statistics; National Bureau of Economic Research (recession dates); Insurance Information Institutes. 18 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

26. What is next? 25 towerswatson.com © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

27. A National Overview What is next? Historically, hard markets follow when surplus “growth” is negative* The industry has excess capacity, but it is unevenly distributed. Surplus growth is now positive but premiums continue to fall, a departure from the historical pattern (Percent) * 2010 NWP and Surplus figures are % changes as of H1:10 vs H1:09. Sources: A.M. Best, ISO, Insurance Information Institute 19 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

28. A National Overview • To take just a longer view of things, here is some direction over the next year or three: • Survive • Do the rightthings, regardless of short term pain • Keep good people, doing good work, on good business • Remember, you are not alone, and you have staying power • Remain vital and relevant in your markets • You grew substantially just a few years ago • Fight the “commodity” syndrome – add value to your offerings • Thrive • There is an end to every cycle, but everyone will not be positioned to take advantage of it. • Leadership is the key, followers fall by the wayside. 20