After the Crisis: Workers Compensation Overview and Outlook for 2011 & Beyond

1. After the Crisis:Workers Compensation Overview and Outlook for 2011 & Beyond Business Insurance Virtual Workers Compensation Conference Keynote Presentation December 16, 2011 Robert P. Hartwig, Ph.D., CPCU, President & Economist Insurance Information Institute  110 William Street  New York, NY 10038 Tel: 212.346.5520  Cell: 917.453.1885  bobh@iii.org  www.iii.org

2. Presentation Outline • Workers Compensation and the Economy • Regional Differences in Recession and Recovery • Labor Markets: Overview & Outlook • Payroll/Employment Exposure Trends • Workers Compensation Operating Environment • Premium & Rate Trends • Profitability • Underwriting Performance • Medical & Indemnity Claim Cost Trends • Residual Market and State Fund Market Share and Performance • Investment Market Impacts • P/C Insurance Industry Overview • The Global Economic Storm: Financial Crisis & Recession • Crisis-Driven Exposure Issues: Commercial Lines • Exposure, Growth & Profitability eSlide – P6466 – The Financial Crisis and the Future of the P/C

3. Workers Compensation and the Economy Workers Comp Exposure and Performance is Intimately Linked to the Economy and Labor Market 3

4. US Real GDP Growth* The Q4:2008 decline was the steepest since the Q1:1982 drop of 6.8% Real GDP Growth (%) Economic growth up sharply in late 2009 with rebuilding of inventories and stimulus. More moderate growth expected in 2010/11 but no “double dip” Recession began in Dec. 2007. Economic toll of credit crunch, housing slump, labor market contraction has been severe but modest recovery is underway Demand Commercial Insurance Continues To Be Impacted by Sluggish Economic Conditions, but the Benefits of Even Slow Growth Will Compound and Gradually Benefit the Economy Broadly * Estimates/Forecasts from Blue Chip Economic Indicators. Source: US Department of Commerce, Blue Economic Indicators 10/10; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

5. Length of US Business Cycles,1929–Present* Length of Expansions Greatly Exceeds Contractions The “Great Recession” lasted 19 months, longest since Great Depression Duration (Months) Average Duration** Recession = 10.4 Mos Expansion = 60.5 Mos *Through Nov. 2010. Most recent recession began Dec. 2007 and ended June 2009. ** Post-WW II period through end of most recent expansion. Sources: National Bureau of Economic Research; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

6. Wage & Salary Disbursements (Payroll Base) vs. Workers Comp Net Written Premiums Wage & Salary Disbursement (Private Employment) vs. WC NWP ($ Billions) 12/07-6/09** 7/90-3/91 3/01-11/01 WC net premiums written were down $13.7B or 28.7% to $34.1B in 2009 after peaking at $47.8B in 2005 Weakening Payrolls Have Eroded $2B+ in Workers Comp Premiums; Nearly 29% of NPW Has Been Eroded Away by the Soft Market and Weak Economy * Average Wage and Salary data as of 10/1/2009. Shaded areas indicate recessions. **Estimated “official” end of recession June 2009. 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 eSlide – P6466 – The Financial Crisis and the Future of the P/C

7. Estimated Effect of Recessions* on Payroll (Workers Comp Exposure) (All Post WWII Recessions) (Percent Change) The Dec. 2007 to mid-2009 recession caused the largest impact on WC exposure in 60 years Recessions in the 1970s and 1980s saw smaller exposure impacts because of continued wage inflation, a factor not present during the 2007-2009 recession Recession Dates (Beginning/Ending Years) *Data represent maximum recorded decline over 12-month period using annualized quarterly wage and salary accrual data Source: Insurance Information Institute research; Federal Reserve Bank of St. Louis (wage and salary data); National Bureau of Economic Research (recession dates).

8. Contributions to WCNet Written Premium DeclineCalendar Years 2007–2009 Source: NCCI

9. Total Wages, California2001-2009 Billions Private sector wages fallen sharply in hard hit states like California--$43B or 6.5% Recessions Cause Payrolls to Shrink. The 2001 Recession Saw a 2.0% Decline in Private Wages; the 2008-09 Dropoff was 6.3%. Source: http://data.bls.gov 9 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

10. Real GDP Growth vs. Real P/CPremium Growth: Modest Association Real GDP Growth vs. Real P/C (%) P/C Insurance Industry’s Growth is Influenced Modestlyby Growth in the Overall Economy Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 10/10; Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

11. Regional Differences Will Significantly Impact P/C Markets Recovery in Some Areas Will Begin Years Ahead of Others and Speed of Recovery Will Differ by Orders of Magnitude 11

12. Labor Market Trends Massive Job Losses Sapped the Economy and Commercial/Personal Lines Exposure, But Trend is Improving 16

13. Unemployment and Underemployment Rates: Rocketed Up in 2008-09; Stabilized in 2010 January 2000 through October 2010, Seasonally Adjusted (%) U-6 went from 8.0% in March 2007 to 17.5% in Oct 2009; Stood at 17.0% in Sep. 2010 Recession ended in November 2001 Unemployment kept rising for 19 more months Recession began in December 2007 Unemployment rate was 9.6% in October Unemployment peaked at 10.1% in Oct. 2009, highest monthly rate since 1983. Peak rate in the last 30 years: 10.8% in Nov - Dec 1982 Source: US Bureau of Labor Statistics; Insurance Information Institute. 17 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

14. US Unemployment Rate 2007:Q1 to 2011:Q4F* Rising unemployment eroded payrolls and workers comp’s exposure base. Unemployment likely peaked at 10% in late 2009. Unemployment forecasts remain stubbornly high through 2011 * = actual; = forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (10/10); Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

15. Monthly Change in Employment January 2008 through October 2010* (Thousands) The job gain and loss figures for much of 2010 were severely distorted by the hiring and termination of temporary Census workers. So far in 2010, 874,000 nonfarm jobs have been created. 151,000 jobs were created in October and losses in Sept. and Aug. were revised sharply downward Monthly Losses in Dec. 08–Mar. 09 Were the Largest in the Post-WW II Period Job Losses Since the Recession Began in Dec. 2007 Peaked at 8.4 Mill in Dec. 09; Stands at 7.5 Million Through October 2010; 14.8 Million People are Now Defined as Unemployed Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Information Institute

16. US Nonfarm Private Employment Monthly, Nov 2007 – October 2010 (Millions) The US Economy Lost About 8.4 Million Jobs in the Two Years from Dec. 07 – Dec. 09. As employment expands, workers comp will be among the first lines to see exposure gains Employment Peak; Recession Starts Seasonally adjusted. Source: US Bureau of Labor Statistics 23 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

17. Monthly Change in Employment: Total vs. Private Employment January 2010 through October 2010* (Thousands) The job gain and loss figures for much of 2010 were severely distorted by the hiring and termination of temporary Census workers. So far in 2010, 874,000 nonfarm jobs have been created. Job Creation: Jan. – Oct. 2010 Total: 874,000 Private: 1,115,000 159,000 private jobs were created in October while 8,000 government jobs were lost The Private Sector Posted Job Gains Every Month in 2010—Totaling 1.115 Million through October. The Government Sector Continues to Lose Jobs. Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Information Institute

18. Change in Employment Level for Select Industries, Oct. 2010 vs. Sept. 2010 Change in Thousands Health, Leisure, Professional Business Services and Retail Trade are the job growth leaders today. There is a great deal of variation in employment growth by industry, indicating a very uneven and slow recovery Sources: US Bureau of Labor Statistics; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

19. Total Wages, California2001-2009 Billions Private sector wages paid in CA fell $43 billion 6.5% in 2009 Recessions Cause Payrolls to Shrink. The 2001 Recession Saw a 2.0% Decline in Private Wages; the 2008-09 Dropoff was 6.3%. Source: http://data.bls.gov 27 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

20. 2006-2010: 3-Month Percent Changein Average Hourly Earnings* Percent Average Hourly Earnings* Grew Every Month Throughout the Recession. Weakest Growth Was April-June 2010, But That Weakness Appears to be Over. *3-month net change, seasonally adjustedSource: http://data.bls.gov/PDQ/servlet/SurveyOutputServlet 28 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

21. Workers Compensation Operating Environment The Weak Economy and Soft Market Have Made the Workers Comp Operating Increasingly Challenging 31

22. Workers Compensation Premium Continues Its Sharp DeclineNet Written Premium $ Billions p Preliminary Source: 1990–2008 Private Carriers, Best's Aggregates & Averages; 2009p, NCCI 1996–2009p State Funds: AZ, CA, CO, HI, ID, KY, LA, MD, MO, MT, NM, OK, OR, RI, TX, UT Annual Statements State Funds available for 1996 and subsequent Calendar Year

23. Workers Compensation Net Premiums Written and Annual Growth Rates: 1970-2010P WC premium growth hit a 40+ year low in 2009 at -13%. Improving labor market should help beginning in 2010. ($ Billions) Sources: A.M. Best (1973-2009); Insurance Information Institute calculations and estimates for 2010. eSlide – P6466 – The Financial Crisis and the Future of the P/C

24. Average Approved BureauRates/Loss CostsHistory of Average WC Bureau Rate/Loss Cost Level Changes Percent Cumulative 2000–2003 +17.1% Cumulative 1994–1999 -27.8% Cumulative 2004–2010 -26.7% Cumulative 1990–1993 +36.3% * States approved through 4/23/2010 Countrywide approved changes in advisory rates, loss costs, and assigned risk rates as filed by the applicable rating organization Calendar Year *States approved through 4/23/10. Note: Countrywide approved changes in advisory rates, loss costs and assigned risk rates as filed by applicable rating organization. Source: NCCI.

25. Comparison of State WC rates WC rates, on average, do not appear to be significantly higher or lower in states with workers comp state funds California’s WC rates are about average Source: Oregon Workers’ Compensation Premium Rate Ranking 2008. Rates weighted by Oregon’s distribution of exposures by classification eSlide – P6466 – The Financial Crisis and the Future of the P/C

26. Workers Compensation Combined Ratio: 1973–2012P Workers Comp Underwriting Results Are Deteriorating Markedly Sources: A.M. Best; Insurance Information Institute.

27. Calendar Year Reserve Deficiency Increased in 2009 WC Loss and LAE Reserve Deficiency: Private Carriers $ Billions 2009 Tabular Discount Is $5.3 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

28. Return on Net Worth for Workers Comp: NC vs. US and NC All P-C Lines,1999-2008 (Percent) Workers comp profitability in NC has generally underperformed the US and NC P-C overall Average 1999-2008 US WC: 6.4% NC WC: 4.5% NC All Lines: 10.9% Sources: NAIC. 38

29. WC Residual Market Shares Continue to Decline WC Insurance Plan States* Premium as a Percentage of Direct Written Premiums Percent Calendar Year *NCCI Plan states plus DE, IN, MA MI, NJ, NC p: Preliminary Source: NCCI.

30. WC Residual Market Combined Ratio NCCI-Serviced WC Residual Market Plans as of December 31, 2009 Percent Policy Year *Incomplete policy year projected to ultimate. Source: NCCI.

31. WC Competitive State Fund Market Share,1996 – 2009p Market Share (%) Private insurance markets are highly competitive. State fund market shares have been falling steadily since 2003. Competition, favorable underwriting trends, coverage options, private insurer innovations in risk management have all helped to make the private sector WC insurance the most attractive option in most cases Source: 1990–2008 Private Carriers, Best's Aggregates & Averages; 2009p, NCCI, Insurance Information Institute Market Share calculations 1996–2009p State Funds: AZ, CA, CO, HI, ID, KY, LA, MD, MO, MT, NM, OK, OR, RI, TX, UT Annual Statements State Funds available for 1996 and subsequent; p: Preliminary 41 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

32. Workers Compensation State Fund Market Shares, 2008 State funds market shares among the 21 competitive state funds vary widely, from nearly 90% in WV (in transition from a monopolistic to a competitive fund market) to barely 10% in PA Source: Conning; Insurance Information Institute.

33. Workers Compensation Medical & Indemnity Claim Cost Trends Rising Medical Costs Exert Pressure While Indemnity Costs Rise Well Ahead of Wage Inflation 44

34. Workers Comp Medical Claim Costs Continue to Rise Medical Claim Cost ($000s) Annual Change 1991–1993: +1.9% Annual Change 1994–2001: +8.9% Annual Change 2002-2009: +6.6% Cumulative Change = 224% (1993-2009p) Accident Year 2009p: Preliminary based on data valued as of 12/31/2009 1991-2008: Based on data through 12/31/2008, developed to ultimate Based on the states where NCCI provides ratemaking services; Excludes the effects of deductible policies

35. WC Medical Severity Risingat Twice the Medical CPI Rate Average annual increase in WC medical severity form 1995 through 2009 was nearly twice the medical CPI (7.6% vs. 3.9%). New healthcare reform legislation is unlikely to have any impact on the gap. Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states.

36. WC Insurers Experience Inflation More Intensely than 2009 CPI Suggests (Percent increase Dec 08 to Dec 09) Inpatient Services Rose 6.7%; Outpatient Services Rose 7.4% Excludes Food and Energy Healthcare Costs Are a Major WC Insurance Cost Driver. They AreLikely to Increase Faster than the CPI for the Next Few Years, at Least Source: Bureau of Labor Statistics; Insurance Information Institute. 47

37. Workers Compensation Lost-Time Claim Frequency Continues to Decline* (Percent) Lost-Time Claims Cumulative Change of -54.7% (1991 – 2008) Claim frequency fell in 4.0% in 2009, in part due to the recession 2009p: Preliminary based on data valued as of 12/31/2009; *Frequency is defined as the number of lost-time claims per 100,000 workers. 1991-2008: Based on data through 12/31/2008, developed to ultimate Based on the states where NCCI provides ratemaking services including state funds; Excludes the effects of deductible policies

38. Frequency: 1926–2008A Long-Term Drift Downward Manufacturing – Total Recordable CasesRate of Injury and Illness Cases per 100 Full-Time Workers Note: Recessions indicated by gray bars. Sources: NCCI from US Bureau of Labor Statistics; National Bureau of Economic Research eSlide – P6466 – The Financial Crisis and the Future of the P/C

39. Med Costs Share of Total Costs is Increasing Steadily 2009p 1999 1989 Source: NCCI (based on states where NCCI provides ratemaking services).

40. WC Med Cost Will Equal 2/3 of Total by 2019 if Trends Hold 2019 Estimate This trend will likely be supported by the increased labor force participation of workers age 55 and older. Source: Insurance Information Institute.

41. Indemnity Claim Cost Trends Indemnity Costs Continue to Rise at a Pace Above Wage Inflation 52

42. Workers Comp Indemnity Claim Costs Continue to Grow Indemnity Claim Cost ($ 000s) Annual Change 1991–1993: -1.7% Annual Change 1994–2001: +7.3% Annual Change 2002–2008: +4.0% +4.5 +5.8 Accident Year 2009p: Preliminary based on data valued as of 12/31/2009 1991–2008: Based on data through 12/31/2008, developed to ultimate Based on the states where NCCI provides ratemaking services Excludes the effects of deductible policies

43. WC Indemnity Severity vs. Wage Inflation WC indemnity severity is once again outpacing wage inflation 2009p: Preliminary based on data valued as of 12/31/2009; 1991-2008: Based on data through 12/31/2008, developed to ultimate. Based on the states where NCCI provides ratemaking services. Excludes the effects of deductible policies. CPS = Current Population Survey. Source: NCCI

44. Dollar Change* in Average Hourly Earnings, June 2006 – August 2010 The pace of hourly earnings growth has slowed dramatically since the onset of the economic downturn Average Hourly Earnings Grew at Least $0.05in Every 3-Month Period Since June 2006. *3-month net change, seasonally adjustedSource: http://data.bls.gov/PDQ/servlet/SurveyOutputServlet 55 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

45. Where Will the Growth in WC Exposure Come From? Industry and Occupation Growth Analysis 56

46. 11 Industries for the Next 10 Years: Insurance Solutions Needed Health Care Health Sciences Energy (Traditional) Alternative Energy Agriculture Natural Resources Environmental Technology (incl. Biotechnology) Light Manufacturing Export-Oriented Industries Shipping (Rail, Marine) eSlide – P6466 – The Financial Crisis and the Future of the P/C

47. Fastest Growing Occupations, 2008–2018:Health/Science/Tech Dominate WC exposure growth the fastest in the health, science and tech areas Sources: US Bureau of Labor Statistics: Occupational Outlook Handbook, 2010-2011 Edition; Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

48. Occupations with Largest Numerical Growth, 2008–2018: Health, Services Dominate Dollar growth in WC exposures should grow the most (at current rate levels) in the health and services industries Sources: US Bureau of Labor Statistics: Occupational Outlook Handbook, 2010-2011 Edition; Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

49. Investment Performance Investments Are a PrincipleSource of Declining Profitability 61

50. Property/Casualty Insurance Industry Investment Gain: 1994–2010:H11 2009:H1 gain was $12.5B ($ Billions) Investment gains in 2010 are on track to be their best since 2007 In 2008, Investment Gains Fell by 50% Due to Lower Yields andNearly $20B of Realized Capital Losses 2009 Saw Smaller Realized Capital Losses But Declining Investment Income Investment Gains Are Recovering So Far in 2010 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.