CAS Ratemaking Seminar

1. New Catastrophe Exposure For Workers Compensation CAS Ratemaking Seminar Barry Lipton NCCI March 28, 2003

2. Impact of 9/11 on Workers Compensation • Initial WC Loss Estimates (6,000 deaths) • Morgan Stanley: $3 billion Tillinghast: $3 billion–$5 billion • Current NCCI WC Loss Estimates (3,047 deaths excl hijackers; 2,250 injuries) • Self-insured losses 15% (includes NY Firefighters/PD) • Losses not covered by WC 5% • Fatalities w/o dependents 20% (lump-sum $50k payment per person) • Ultimate Direct Losses $1.3 B–$2.0 B • Ultimate Net Losses $0.3 B–$1.2 B • Impact on Net Acc Yr Combined Ratio 1%–4%

3. Unique Challenges of Workers Compensation and Terrorism Coverage • Coverage mandated by law, exclusions are not possible • Benefits are defined by law, limits aren’t possible • Risks that aren’t written voluntarily will be backed by the entire market through the involuntary pool

4. Objectives of NCCI’s Terrorism Modeling Efforts • Support the industry in developing a course of action for terrorism response • Develop actuarial methods for technical analysis of extreme events other than natural disasters

5. NCCI’s Partner in Terrorism Modeling • NCCI’s partner is EQECAT, an Oakland firm with a strong track record in catastrophe modeling • They do the modeling for the California earthquake authority • They are certified by the Florida DOI to do hurricane modeling in support of rate filings • EQECAT is a subsidiary of ABS consulting, one of the largest risk management firms who has been assessing terrorist threats for many years • EQECAT is the ABS consulting division serving the insurance/reinsurance/financial markets

6. What NCCI/EQECAT Terrorism Modeling Demonstrates • Although predicting frequency is difficult, modeling is a strong analytic tool to help us understand these extreme events • The workers compensation losses alone from a single event could have a devastating impact on segments of the Property/Casualty Industry • This is a problem for all regions of the country—not just major metropolitan areas

7. Overview of Modeling Method • Modeled at the local level, peril by peril • Provisional nationwide assessment of frequency done by ABS consulting with outside expert input • Provisional local assessment of frequency made by allocation of nationwide frequency to state

8. Overview of Modeling Method (Continued) • Many scenarios run at local level to get distribution of expected losses for a given event • Scenarios aggregated to get statewide expected losses • Aggregation can be extrapolated to get regional results and then combined to get nationwide results

9. Perils Modeled • Blasts • Chemical agents • Biological agents • Radiological agents • Dam breaks

10. Size of Events • Only large events modeled (a priori expectation of $15 million to $20 million in WC losses) • Large is defined by the size of agent rather than dollar threshold • 400 lbs. equivalent TNT rather than 1 stick • One ounce of anthrax (letters have significantly less)

11. Blasts • Car bombs • Small truck bombs • Large truck bombs • 1 kiloton nuclear bomb • 10 kiloton nuclear bomb • Aircraft impact

12. Frequency • Frequency is extremely difficult to assess • EQECAT estimates that the frequency of a large terrorist event is between 1 and 5 per year nationwide • The model was calibrated to one nationwide event per year and the result was scaled as necessary • EQECAT analyzed potential target locations, difficulty of using a given weapon, and various theories on how terrorists choose their targets to develop the stochastic event set.

13. Frequency • National threat level allocated to state based on state characteristics (urban density, industrial targets, etc). • State threat level distributed to peril categories based on past terrorist events, degree of difficulty and potential impact

14. From Peril Event to Injury • A footprint is established for each peril • The footprint defines the intensity of peril based on distance, size of source and wind conditions • Injury distributions (as a function of peril intensity) are combined with worker density to get the number of injuries • Calculations done at the census block level

15. Location specific Local Conditions Location of hazards facilities Location of high profile facilities Frequency • Blast or explosion outside buildings • Blast or explosion inside buildings • Chemical release outside buildings • Chemical release inside buildings • Biological release outside buildings • Biological release inside buildings • Radioactive material release #of Employees by zip code by SIC class by construction class Severity 1 Injury/Death Rate Severity 2 Severity 3 Employment Database Building Stock Database Severity 4 severity Hazard Severity % Losses Blast Biological Employment Data Radioactive Frequency - Severity Chemical Event Footprint Terrorism Model Overview Stochastic Event Set

16. Event Footprints • EQE proprietary software is used to generate footprints • BLAST • Midas AT Software

17. Blast Effects AnalysisComputer Graphic Software • Blast software enables rapid, accurate, effective analyses of overpressures and structural damage

18. Terrorist Risk—MIDAS-ATTM Software • Agents that MIDAS-AT can model releases of: • Chemical Agents • Biological Agents • Radiological • Used in nuclear power and chemical industry; and by US Marine Corps and US Embassies • Installed at over 70 sites worldwide and in use for over 20 years 17

19. Chemical Agent Event Footprints Different Footprints for Different Type/amount of agent

20. Nuclear Scenarios1 K-ton Device (Suitcase Bomb)50,000+ prompt deaths, Area of total destruction Area of Extensive damage

21. From Injury to Losses • Injury rates are combined with distribution of losses by injury type to get overall loss • Distribution of losses are those underlying NCCI ELFs in Retrospective Rating Program • State specific average benefits are used

24. From Event Losses to Annual Aggregate Losses • Census blocks are aggregated to get total loss for the event • The conditional severity of the event is multiplied by its frequency to get its annual cost • Events are aggregated to get statewide expected losses for representative states

25. NCCI Response To Terrorism Risk Insurance Act • NCCI filed terrorism loss costs in the 36 jurisdictions where we provide ratemaking services • We shared the model results and analysis with the independent workers compensation bureaus • We priced the impact of the backstop on statewide expected workers compensation losses

26. States Modeled • New York–Pennsylvania • New Jersey–Texas • California–Ohio • Washington D.C.–Georgia • Illinois–Indiana • Florida–Arizona • Michigan–Iowa • Massachusetts –North Carolina

27. NCCI Terrorism Loss Cost Filing • The filing relied on EQECAT results in modeled states • Proxy states were used for the other non-modeled states • Voluntary loss costs were filed in most NCCI states • Rates were filed in Florida, Idaho, Arizona, Illinois, Rhode Island and Iowa • Assigned Risk rates were filed in all NCCI states

28. NCCI Terrorism Loss Cost Filing • For the voluntary market, the effective date was December 20, 2002 • For the residual market, most states have an effective date was January 1, 2003 • The loss costs apply to new and renewal policies only • The rates/loss costs are for foreign terrorism only (net of anticipated federal recoveries)

29. NCCI Terrorism Loss Cost Filing • NCCI filed one voluntary in rate/loss cost for terrorism exposure in each state and one for the involuntary market • Rates/loss costs were filed on the Miscellaneous Values Page of NCCI’s Basic Manual • It is a rate/loss cost per $100 of total payroll • It is not subject to premium discount, experience rating, schedule rating or retrospective rating or deductible credits • Because the non-terrorism rate/loss cost for clerical risks is lower than other risks, the terrorism charge has a larger percent impact on their premium

30. Other NCCI Actions • NCCI has established a new statistical class code (9740) for these premium charges • The new code facilitates the tracking of premiums charged for terrorism exposure as defined in the federal Act • We filed a Terrorism Risk Insurance Act Endorsement for carriers to use to satisfy their policyholder disclosure obligations under the Act • The new endorsement also addresses an insurer’s limit of liability for certified terrorism losses when aggregate losses exceed $100 billion

31. Cost per Worker prior to backstop * EQECAT’s estimates assume universal Workers Compensation coverage. However, loss per worker is independent of whether the worker is covered or not.

32. What’s Next • NCCI will continue to support industry initiatives to address the unique Workers Compensation problems presented by the terrorist threat • We will annually review the terrorism loss costs • We will address domestic terrorism • We will complete our work with EQECAT to address earthquake and tsunami’s potential impact on Workers Compensation • We will expand our modeling efforts with EQECAT to address accidental disasters such as fires, industrial explosions and chemical release