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6 th Annual National Workers Compensation ExecuSummit Uncasville, CT February 2, 2009

Mega-Trends Affecting the Workers Compensation Insurance Industry Challenges Amid the Economic Crisis. 6 th Annual National Workers Compensation ExecuSummit Uncasville, CT February 2, 2009. Robert P. Hartwig, Ph.D., CPCU, President

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6 th Annual National Workers Compensation ExecuSummit Uncasville, CT February 2, 2009

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  1. Mega-Trends Affecting the Workers Compensation Insurance IndustryChallenges Amid theEconomic Crisis 6th Annual National Workers Compensation ExecuSummit Uncasville, CT February 2, 2009 Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346-5520 Fax: (212) 732-1916 bobh@iii.org  www.iii.org

  2. Presentation Outline • Economic Factors Affecting Exposure in WC • Economic Downturn and Inflation • Overall P/C Insurance Industry Performance Cycles • Profitability • Underwriting • Premium Growth Drivers • Investment Performance • Workers Comp Performance Review • Underwriting performance • Premium Drivers • Frequency & Severity Trends • Predictive Modeling and Workers Comp • Mega-Trends/Emerging Issues Affecting Workers Comp • The Aging Workforce • The Obesity Epidemic Non-English Speaking Workers • Other Trends & Concerns • Q&A

  3. THE ECONOMIC STORMWhat a Weakening Economy & Rising Unemployment Mean for Workers Comp Insurers

  4. Real GDP Growth* Recession began in December 2007. Economic toll of credit crunch, housing slump, labor market contraction is growing The Q4:2008 decline was the steepest since the Q1:1982 drop of 6.4% *Yellow bars are Estimates/Forecasts from Blue Chip Economic Indicators. Source: US Department of Commerce, Blue Economic Indicators 1/09; Insurance Information Institute.

  5. Length of US Recessions,1929-Present* Months in Duration Current recession began in Dec. 2007 and is already the longest since 1981. If it extends beyond April, it will become the longest recession since the Great Depression. * As of February 2009 Sources: National Bureau of Economic Research; Insurance Information Institute.

  6. Workplace Injury Incidence Rates Declined in Last 4 Economic Downturns p Preliminary Source: US Department of Labor, Bureau of Labor Statistics (BLS), National Bureau of Economic Research; NCCI Frequency and Severity Analysis

  7. Unemployment Rate:On the Rise January 2000 through December 2008 Dec. 2008 unemployment jumped to 7.2%, exceeding the 6.3% peak during the previous cycle Previous Peak: 6.3% in June 2003 Trough: 4.4% in March 2007 Unemployment will likely peak above 8% or 9% during this cycle, impacting payroll sensitive p/c and non-life exposures Average unemployment rate 2000-07 was 5.0% Dec-08 Source: US Bureau of Labor Statistics; Insurance Information Institute.

  8. U.S. Unemployment Rate,(2007:Q1 to 2010:Q4F)* Rising unemployment will erode payrolls and workers comp’s exposure base. Unemployment is expected to peak above 8% in the second half of 2009. * Blue bars are actual; Yellow bars are forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (1/09); Insurance Info. Inst.

  9. Monthly Change Employment*(Thousands) Job losses in 2008 totaled 2.589 million, the highest since 1945 at WW II’s end; 11.1 million people are now defined as unemployed. The Nov./Dec. 2008 losses were the largest since May 1980 loss of 431,000, but less than the Dec. 1974 loss of 602,000 Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Info. Institute

  10. Years With Job Losses: 1939-2008*(Thousands) The US has seen net job losses in only 16 of the 70 years since 1939 2008’s job losses were exceeded only by 1945, at the conclusion of WW II Source: Insurance Information Institute research from US Bureau of Labor Statistics data: http://www.bls.gov/ces/home.htm.

  11. New Private Housing Starts,1990-2010F (Millions of Units) Exposure growth forecast for HO insurers is dim for 2009 with some improvement in 2010. Impacts also for comml. insurers with construction risk exposure New home starts plunged 34% from 2005-2007; Drop through 2009 trough is 65% (est.)—a net annual decline of 1.35 million units I.I.I. estimates that each incremental 100,000 decline in housing starts costs home insurers $87.5 million in new exposure (gross premium). The net exposure loss in 2009 vs. 2005 is estimated at about $1.2 billion. Source: US Department of Commerce; Blue Chip Economic Indicators (1/09); Insurance Information Inst.

  12. Auto/Light Truck Sales,1999-2010F (Millions of Units) Weakening economy, credit crunch are hurting auto sales; Gas prices less of a factor now. New auto/light trick sales are expected to experience a net drop of 5.7 million units annually by 2009 compared with 2005, a decline of 20.7% Impacts of falling auto sales will have a less pronounced effect on auto insurance exposure growth than problems in the housing market will on home insurers Source: US Department of Commerce; Blue Chip Economic Indicators (1/09); Insurance Information Inst.

  13. Total Industrial Production,(2007:Q1 to 2010:Q4F) Obama stimulus program is expected benefit impact industrial production and therefore insurance exposure both directly and indirectly Industrial production began to contract sharply during H2 2008 and is expected to shrink through the first half of 2009 Figures for H2:09 and 2010 revised sharply upwards to reflect expected impact of Obama stimulus program Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (1/09); Insurance Info. Inst.

  14. Wage & Salary Disbursements (Payroll Base) vs. Workers Comp Net Written Premiums Wage & Salary Disbursement (Private Employment) vs. WC NWP $ Billions $ Billions 12/07-? 7/90-3/91 3/01-11/01 Weakening wage and salary growth is expected to cause a deceleration in workers comp exposure growth Shaded areas indicate recessions *9-month data for 2008 Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books

  15. U.S. $825B Economic Stimulus Package, By Category $ Billions I.I.I. Estimate Every 1 million jobs created or preserved will increase (or preserve) as much as $1 billion in workers comp premium. Obama stimulus target is 3-4 million jobs. Commercial insurance lines that will benefit from the Obama stimulus plan include workers comp, commercial property, commercial auto, surety, inland marine and others Sources: House Appropriations Committee; Wall Street Journal, January 16, 2009

  16. Real GDP Growth vs. Real P/C Premium Growth: Modest Association P/C insurance industry’s growth is influenced modestly by growth in the overall economy Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 8/08; Insurance Information Inst.

  17. Total Private Employment* Grew by25½ Million Workers from 1991 to 2008 Millions The US economy added 25.5 million jobs between 1991 and 2008, but job growth has recently stagnated, impacted payrolls and the workers comp exposure base *seasonally adjusted at mid-yearSource: U.S. Bureau of Labor Statistics, at http://data.bls.gov/cgi-bin/surveymost

  18. Average Weekly Real Earnings in Private Employment Were Flat from 1999 to 2008 (at mid-year) Constant 1982 dollars Virtually all of the real wage growth occurred between 1995 and 1999 and has now stagnated Sources: U.S. Bureau of Labor Statistics; I.I.I.

  19. New Private Housing Starts,1990-2014F (Millions of Units) Exposure growth forecast for HO insurers is dim for 2008/09 Impacts also for comml. insurers with construction risk exposure New home starts plunged 34% from 2005-2007; Drop through 2008 trough is 54% (est.)—a net annual decline of 1.11 million units I.I.I. estimates that each incremental 100,000 decline in housing starts costs home insurers $87.5 million in new exposure (gross premium). The net exposure loss in 2008 vs. 2005 is estimated at $971 million. Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 8/08 edition of BCEF; Insurance Info. Institute

  20. Total Industrial Production,(2007:Q1 to 2009:Q4F) Industrial production affects exposure both directly and indirectly Industrial production shrank during Q1 2008 and is expected to shrink again in Q2, growing very slowly thereafter Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (7/08); Insurance Info. Inst.

  21. Medical & Tort Cost Inflation Amplifiers of Inflation, Major Insurance Cost Driver

  22. Consumer Price Index for Medical Care vs. All Items, 1960-2008 (Base: 1982-84=100) Inflation for Medical Care has been surging ahead of general inflation (CPI) for 25 years. Since 1982-84, the cost of medical care has more than tripled Soaring medical inflation is among the most serious long-term challenges facing casualty, disability and LTC insurers Source: Department of Labor (Bureau of Labor Statistics; Insurance Information Institute.

  23. Tort Cost Growth & Medical Cost Inflation vs. Overall Inflation (CPI-U), 1961-2008* Tort costs move with inflation but at twice the rate Tort System is an Inflation Amplifier Avg. Ann. Change: 1961-2008* Torts Costs: +8.4% Med Costs: +6.0% Overall Inflation: +4.2% *Medical cost and CPI-U from BLS. Tort figure is for full-year 2008 from Tillinghast. Sources: US Bureau of Labor Statistics, Tillinghast-Towers Perrin, 2007 Update on U.S. Tort Costs; Insurance Info. Inst.

  24. Comparative 2008 Inflation Statistics Important to Insurers( %) CPI and “Core” CPI are not representative of many of the costs insurers face Medical/Legal costs typically run well ahead of inflation *Core CPI is the Consumer Price Index for all Urban Consumers (CPI-U) less food and energy costs. Source: US Bureau of Labor Statistics; Insurance Information Institute.

  25. P/C INSURANCE FINANCIAL PERFORMANCEA Resilient Industry in Challenging Times

  26. P/C Net Income After Taxes1991-2009F ($ Millions)* • 2001 ROE = -1.2% • 2002 ROE = 2.2% • 2003 ROE = 8.9% • 2004 ROE = 9.4% • 2005 ROE= 9.4% • 2006 ROE = 12.2% • 2007 ROAS1 = 12.3% • 2008 ROAS = 1.1%* Insurer profits peaked in 2006. *ROE figures are GAAP; 1Return on avg. surplus.2008 numbers are annualized based on 9-mos. Actual of $4.066 billion. Sources: A.M. Best, ISO, Insurance Information Inst. 29

  27. P/C Insurance Industry ROEs,1975 – 2008E* 1987:17.3% 1977:19.0% 2006:12.2% 1997:11.6% 10 Years 10 Years 9 Years 2008F: 1.1% 1975: 2.4% 1984: 1.8% 1992: 4.5% 2001: -1.2% Note: 2008 figure is actual 9-month result. Sources: ISO;Insurance Information Institute. 30

  28. ROE vs. Equity Cost of Capital:US P/C Insurance:1991-2008:Q3 The p/c insurance industry fell well short of is cost of capital in 2008 +2.3 pts -1.7 pts -9.0 pts -13.2 pts -9.7 pts US P/C insurers missed their cost of capital by an average 6.7 points from 1991 to 2002, but on target or better 2003-07 The cost of capital is the rate of return insurers need to attract and retain capital to the business 31 *Excludes mortgage and financial guarantee insurers. Source: The Geneva Association, Ins. Information Inst.

  29. P/C Insurance Combined Ratio, 1970-2008F* Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.8 2000s: 102.0* 32 Sources: A.M. Best; ISO, III *A.M. Best year end estimate of 103.2; Actual 9-mos. result was 105.6.

  30. P/C Insurance Industry Combined Ratio, 2001-2009E As recently as 2001, insurers paid out nearly $1.16 for every $1 in earned premiums Relatively low CAT losses, reserve releases Including Mortgage & Fin. Guarantee insurers 2005 ratio benefited from heavy use of reinsurance which lowered net losses Cyclical Deterioration Best combined ratio since 1949 (87.6) 33 *Includes Mortgage & Financial Guarantee insurers. Sources: A.M. Best.

  31. Commercial Lines Combined Ratio, 1993-2009F Commercial coverages have exhibited significant variability over time. Mortgage and financial guarantee may account for up to 4 points on the commercial combined ratio in 2008 2006/07 benefited from favorable loss cost trends, improved tort environment, low CAT losses, WC reforms and reserve releases. Most of these trends reversed in 2008 and mortgage and financial guarantee segments have big influence. 2009 is transition year. Sources: A.M. Best (historical and forecasts)

  32. Underwriting Gain (Loss)1975-2008:Q3* Insurers earned a record underwriting profit of $31.7 billion in 2006, the largest ever but only the second since 1978. Cumulative underwriting deficit from 1975 through 2007 is $422 billion. $ Billions $19.877 Bill underwriting loss in 08:9M incl. mort. & FG insurers Source: A.M. Best, ISO; Insurance Information Institute * Includes mortgage & finl. guarantee insurers 36

  33. Number of Years With Underwriting Profits by Decade, 1920s –2000s Number of Years with Underwriting Profits Underwriting profits were common before the 1980s (40 of the 60 years before 1980 had combined ratios below 100)—but then they vanished. Not a single underwriting profit was recorded in the 25 years from 1979 through 2003. 37 Note: Data for 1920 – 1934 based on stock companies only. Sources: Insurance Information Institute research from A.M. Best Data. *2000 through 2008.

  34. Strength of Recent Hard Marketsby NWP Growth 1975-78 1984-87 2000-03 Shaded areas denote “hard market” periods Net written premiums fell 1.0% in 2007 (first decline since 1943) and by 0.4% in 2008, the first back-to-back decline since 1930-33 38 Sources: A.M. Best, ISO, Insurance Information Institute

  35. Year-to-Year Change in Net Written Premium, 2000-2008E* P/C insurers are experiencing their slowest growth rates since 1930-33 Slow growth means retention is critical Protracted period of negative or slow growth is possible due to soft markets and slow economy 39 *2008 figure is 9-month actual result from ISO. Source: A.M. Best (historical)

  36. Distribution of P/C Insurance Industry’s Investment Portfolio As of December 31, 2007 Portfolio Facts • Invested assets totaled $1.3 trillion as of 12/31/07 • Insurers are generally conservatively invested, with 2/3 of assets invested in bonds as of 12/31/07 • Only about 18% of assets were invested in common stock as of 12/31/07 • Even the most conservative of portfolios was hit hard in 2008 40 Source: NAIC; Insurance Information Institute research;.

  37. Property/Casualty Insurance Industry Investment Gain:1994- 2008:Q3 1 Investment gains are off sharply in 2008 due to lower yields and poor equity market conditions. 1Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. 2006 figure consists of $52.3B net investment income and $3.4B realized investment gain. *2005 figure includes special one-time dividend of $3.2B. Sources: ISO; Insurance Information Institute. 41

  38. P/C Insurer Net Realized Capital Gains, 1990-2008:Q3 $ Billions Realized capital gains exceeded $9 billion in 2004/5 but fell sharply in 2006 despite a strong stock market. Nearly $9 billion again in 2007, but $-9.7 billion in 2008 through Q3. 42 Sources: A.M. Best, ISO, Insurance Information Institute.

  39. Workers Compensation Review:Underwriting andOperating Performance

  40. Workers Comp Combined Ratios, (Calendar Year, Private Carriers) 1994-2007p WC insurers lopped 30 points off the combined ratio in just 5 years Percent p Preliminary. Sources: Calendar Years 1994-2006, A.M. Best Aggregates & Averages; Calendar Year 2007p NCCI Includes dividends to policyholders

  41. Workers Comp Combined Ratios, 1994-2008F* Percent A.M. Best expects 2008 combined ratio to rise by 2.5 points p Preliminary AY figure. Accident Year data is evaluated as of 12/31/2007 and developed to ultimate Source: Calendar Years 1994-2006, A.M. Best Aggregates & Averages; Calendar Year 2007p and Accident Years 1994-2007pbased on NCCI Annual Statement Analysis. Includes dividends to policyholders *2008 figure from A.M. Best.

  42. Calendar Year Reserve Deficiencies Continue to Decline $ Billions WC Loss and LAE Reserve Deficiency: Private Carriers 2007 Tabular Discount Is $5.5 Billion Calendar Year Considers all reserve discounts as deficiencies Loss and LAE figures are based on NAIC Annual Statement data for each valuation date and NCCI latest selections Source: NCCI analysis

  43. Workers CompCost DriversMedical/Indemnity Frequency & Severity Trends

  44. Workers Compensation Medical Claim Trends

  45. Workers Comp Medical Claims Costs Continue to Climb Medical Claim Cost ($000s) Annual Change 1991–1993: +1.9% Annual Change 1994–2001: +8.9% Annual Change 2002-2006: +7.8% Cumulative Change = +200% (1993-2007p) Accident Year 2007p: Preliminary based on data valued as of 12/31/2007 1991-2006: Based on data through 12/31/2006, developed to ultimate Based on the states where NCCI provides ratemaking services; Excludes the effects of deductible policies

  46. WC Medical Severity Rising at Double the Medical CPI Rate Average annual increase in WC medical severity from 1995 through 2007 was more than twice the medical CPI rate (8.2% vs. 4.0%) Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states.

  47. Med Costs Share of Total Costs is Increasing Steadily 2007p 1997 1987 Source: NCCI (based on states where NCCI provides ratemaking services).

  48. WC Med Cost Will Equal 70% of Total by 2017 if Trends Hold 2017 Estimate This trend will likely be supported by the increased labor force participation of workers age 55 and older. Source: Insurance Information Institute.

  49. Indemnity Claim Cost Trends

  50. Workers Compensation IndemnityClaim Costs Growth Is ModerateLost-Time Claims Indemnity Claim Cost ($ 000s) Annual Change 1991–1993: -1.7% Annual Change 1994–2001: +7.3% Annual Change 2002–2006: +3.1% Accident Year 2007p: Preliminary based on data valued as of 12/31/2007 1991–2006: Based on data through 12/31/2006, developed to ultimate Based on the states where NCCI provides ratemaking services Excludes the effects of deductible policies

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