The Workers Compensation Marketplace: Strategic Overview and Outlook

1. The Workers Compensation Marketplace:Strategic Overview and Outlook Insurance Information Institute March 25, 2010 Download at www.iii.org/presentations 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 • Labor Market Trends • Crisis-Driven Exposure Drivers in Workers Comp • Trends in Business Bankruptcies and New Business Formation • Sources of Growth in Workers Compensation • Industry and Occupation Growth Analysis through 2018 • Key Issues Facing Workers Comp Insurers in the Decade Ahead • Investment Outlook, Regulation, Torts, Terrorism, Healthcare Reform • Workers Compensation Operating Environment • Premium Growth • Underwriting Performance • Medical and Indemnity Claims Cost Trends • P/C Financial Overview • Q&A 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. Real GDP Growth* The Q1:2009 decline was the steepest since the Q1:1982 drop of 6.4% Real GDP Growth (%) Recession began in Dec. 2007. Economic toll of credit crunch, housing slump, labor market contraction has been severe but modest recovery is underway Economic growth up sharply in Q4:09 with rebuilding of inventories and stimulus. More moderate growth expected in 2010/11 Personal and Commercial Lines Exposure Base Have Been Hit Hardand Will Be Slow to Come Back * Estimates/Forecasts from Blue Chip Economic Indicators. Source: US Department of Commerce, Blue Economic Indicators 3/10; 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 Duration (Months) Average Duration** Recession = 10.4 Mos Expansion = 60.5 Mos * Through June 2009 (likely the “official end” of recession) ** 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. 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, 3/10; Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

7. 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 7

8. State Economic Growth Varied Tremendously in 2008 Percent Change in Real GDP by State, 2007–2008 Mountain, Plains States Growing the Fastest New England1.0 Rocky Mountain2.2 Plains2.0 Great Lakes-0.4 WA2.0 ME1.4 MT1.8 ND7.3 VT1.7 MN2.0 NH1.8 OR1.6 MA1.9 WI0.7 ID0.0 SD3.5 MI-1.5 NY1.6 RI-0.9 WY4.4 CT-0.4 IA2.1 OH-0.7 NV-0.6 NE1.3 IN-0.6 PA1.1 NJ0.6 IL0.3 Mideast1.3 UT1.4 DE-1.6 CO2.9 MD1.3 CA0.4 MO1.3 KS2.2 DC3.0 WV2.5 VA1.3 KY-0.1 Far West0.6 NC0.1 OK2.7 AZ-0.6 TN0.5 US = 0.7 NM2.0 AR0.7 SC0.6 Highest Quintile Fourth Quintile Third Quintile Second Quintile Lowest Quintile GA-0.6 AL0.7 MS1.7 TX2.0 LA0.3 AK-2.0 FL-1.6 HI0.7 Southeast0.0 Southwest1.7 US Bureau of Economic Analysis eSlide – P6466 – The Financial Crisis and the Future of the P/C

9. Fastest Growing States in 2008:Plains, Mountain States Lead Real State GDP Growth (%) Natural Resource and Agricultural States Have Done Better Than Most Others Recently, Helping Insurance Exposure in Those Areas Source: US Bureau of Economic Analysis; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

10. Slowest Growing States in 2008: Diversity of States Suffering Real State GDP Growth (%) States in the North, South, East and West All Represented Among Hardest Hit, But for Differing Reasons Source: US Bureau of Economic Analysis; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

11. Labor Market Trends Massive Job Losses Sapped the Economy and the Workers Comp Payroll Exposure Base The Long Road to Recovery 11

12. Unemployment Rate: Has it Peaked? January 2000 through January 2010* (%) Jan. 2010 Unemployment Was 9.7%; Peak (so far) was 10.1% in Oct. 2009 Previous Peak: 6.3% in June 2003 Trough: 4.4% in March 2007 Avg. Unemployment Rate 2000-07 = 5.0% Unemployment Will Likely Rise Again During This Cycle, Impacting Payroll Sensitive P/C and L/H Exposures Source: US Bureau of Labor Statistics; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

13. Unemployment and UnderemploymentRates: Rocketing Up in 2008-09 January 2000 through February 2010, Seasonally Adjusted (%) U-6 went from 8.0% in March 2007 to 17.5% in Oct 2009; Stood at 16.8% in Feb. 2010 Recession ended in November 2001 Unemployment kept rising for 19 more months Recession began in December 2007 10.1% Oct 2009 unemployment rate (U-3) was the highest monthly rate since 1983. Peak rate in the last 30 years: 10.8% in Nov - Dec 1982 Stood at 9.7% in Feb. 2010. Source: US Bureau of Labor Statistics; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

14. Length of Unemployment,Monthly, Nov 2008–Present* 59% of unemployed have been so for 15 weeks or more Number of People(Thousands) Mean Duration Nov 2008 = 18.9 Weeks Feb 2010 = 29.7 Weeks Number of long-term (27+) unemployed dropped by 200,000 in February 2010 *Through Feb. 2010; Seasonally adjusted Sources: Bureau of Labor Statistics; Insurance Information Institute. 15 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

15. Unemployment Rates by State, January 2010:Highest 25 States* The unemployment rate has been rising across the country (up in 30 out of 50 states in Jan.), but some states are doing much better than others. *Provisional figures for January 2010, seasonally adjusted. Sources: US Bureau of Labor Statistics; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

16. Unemployment Rates By State, January 2010: Lowest 25 States* The unemployment rate has been rising across the country (up in 30 out of 50 states in Jan.), but some states are doing much better than others. At 8.8% in January, NY’s unemployment rates was actually below the US unemployment rate of 9.7%c *Provisional figures for January 2010, seasonally adjusted. Sources: US Bureau of Labor Statistics; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

17. US Unemployment Rate 2007:Q1 to 2011:Q4F* Rising unemployment is eroding payrolls and workers comp’s exposure base. Unemployment likely at 10% in late 2009. Unemployment forecasts are being revised downward for the first time in years * = actual; = forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (3/10); Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

18. 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 Hurt theWorkers Comp’s Exposure Base Sources: Blue Chip Economic Indicators (3/10); Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

19. Monthly Change Employment* January 2008 through February 2010 (Thousands) February’s loss of 36,000 jobs was a better than expected; Labor market recoveries are often erratic. Monthly Losses in Dec–May Were the Largest in the Post-WW II Period but Pace of Loss is Diminishing Job Losses Since the Recession Began in Dec. 2007 Total 8.4 Million; 14.9 Million People are Now Defined as Unemployed Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

20. US Nonfarm Private Employment Monthly, Nov 2007 – Feb 2010 (Millions) Employment Peak; Recession Starts The US Economy Lost About 8.4 Million Jobs in Just Over 2 Years Seasonally adjusted. Source: US Bureau of Labor Statistics eSlide – P6466 – The Financial Crisis and the Future of the P/C

21. Unemployment and Educational Attainment: More Education = Less Unemployment Unemployment Rate (%), January 2009 vs. January 2010 WC Payroll Exposure Increasing Skewed in Favor of Workers with Higher Level of Educational Attainment Source: US Bureau of Labor Statistics accessed at ftp://ftp.bls.gov/pub/suppl/empsit.cpseea17.txt . eSlide – P6466 – The Financial Crisis and the Future of the P/C

22. Unemployment Rate by Gender: The “Mancession” Can Impact Exposure Too Unemployment Rate (%), January 2010 Higher Male Unemployment Rate Is Skewing Workers Comp Exposure Toward Payroll Derived from Employment of Women Source: US Bureau of Labor Statistics accessed at ftp://ftp.bls.gov/pub/suppl/empsit.cpseea17.txt . eSlide – P6466 – The Financial Crisis and the Future of the P/C

23. Wage & Salary Disbursements (Payroll Base) vs. Workers Comp Net Written Premiums Wage & Salary Disbursement (Private Employment) vs. WC NWP ($ Billions) 12/07-? 7/90-3/91 3/01-11/01 Weakening Payrolls Have Eroded $2B+ in Workers Comp Premiums * Average Wage and Salary data as of 10/1/2009. Shaded areas indicate recessions 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

24. 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).

25. 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

26. Job Growth Needed* to Returnto “Pre-Recession” Employment Level Since the start of the recession in December 2007, an estimated 8.6 million jobs have been lost. To keep up with population growth, the economy needs to add roughly 130,000 jobs every month. This means the labor market is currently 12 million jobs below the level needed to restore the pre-recession employment rate. *as of February 2010Source: Heidi Shierholz, “Signs of Healing in the Labor Market, Though Unemployment Remains in Double Digits,” Economic Policy Institute, December 4, 2009, at http://www.epi.org/analysis_and_opinion/entry/signs_of_healing_in_the_labor_market_though_unemployment_remains_in_double_/ 27 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

27. Job Growth Needed (cont’d) Even if no more jobs are lost, if we are to return to the equivalent of pre-recession employment levels in 5 years’ time—by the start of 2015—we would have to average adding 330,000 jobs per month every month until then. This is not likely. The Obama Administration’s latest forecast for average monthly job growth is 95,000 in 2010 190,000 in 2011 251,000 in 2012 274,000 in 2013 267,000 in 2014 Source: Economic Report of the President, at http://www.whitehouse.gov/sites/default/files/microsites/economic-report-president.pdf (Table 2-3, p. 75) 28 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

28. When Might All of the Lost JobsBe Regained? 2016? Source: Wall Street Journal, October 9, 2009, p. A3 eSlide – P6466 – The Financial Crisis and the Future of the P/C

29. Insurance Industry Employment Trends Soft Market, Difficult Economy, Outsourcing Have Contributed to Industry’s Job Losses 30

30. U.S. Employment in the DirectP/C Insurance Industry: 1990–2010* Thousands As of Jan. 2010, P/C insurance industry employment was down by 24,200 or 4.9% to 466,900 since the recession began in Dec. 2007 (compared to overall US employment decline of 6.1%) *As of January 2010; Not seasonally adjusted; Does not including agents & brokers Note: Recessions indicated by gray shaded columns. Sources: US Bureau of Labor Statistics; National Bureau of Economic Research (recession dates); Insurance Information Institutes. 31 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

31. U.S. Employment in Insurance Agencies & Brokerages: 1990–2010* Thousands As of Jan. 2010, employment at insurance agencies and brokerages was down by 44,200 or 6.5% to 635,400 since the recession began in Dec. 2007 (compared to overall US employment decline of 6.1%) *As of January 2010; Not seasonally adjusted. Includes all types of insurance. Note: Recessions indicated by gray shaded columns. Sources: US Bureau of Labor Statistics; National Bureau of Economic Research (recession dates); Insurance Information Institutes. 33 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

32. Crisis and Recovery-Driven Exposure Drivers in WC Myriad of Impacts on Workers Comp Exposure Filling the Economic Crater 35

33. Business Bankruptcy Filings,1980-2009* % Change Surrounding Recessions 1980-82 58.6% 1980-87 88.7% 1990-91 10.3% 2000-01 13.0% 2006-09 204.2%* There were 45,510 business bankruptcies during the first three quarters of 2009, up 52% from 2008:Q3 and on track for about 60,000 for all of 2009, the most since 1993. Current recession will generate 200%+ surge Significant Implications for all Commercial Lines *2009 is annualized estimate based on actual business bankruptcies in first three quarters of 2009 Source: American Bankruptcy Institute,http://www.abiworld.org/AM/Template.cfm?Section=Business_Bankruptcy_Filings1&Template=/TaggedPage/TaggedPageDisplay.cfm&TPLID=59&ContentID=36301. 36 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

34. Private Sector Business Starts,1993:Q2 – 2009:Q2* (Thousands) 177,000 businesses started in 2009:Q2, the lowest level since 1993 Business Starts Are Down Nearly 20% in the Current Downturn, Holding Back Most Types of Commercial Insurance Exposure *Latest available as of March 2010, seasonally adjusted Source: Bureau of Labor Statistics, http://www.bls.gov/news.release/cewbd.t07.htm. 38 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

35. Amount of Outstanding Loans byFDIC-Insured Institutions, 2009 vs. 2008 $Billions Down $128.5B (-6.3%) Down $273.2B (-18.3%) Down $139.4B (-13.1%) FDIC-Insured Institutions Had $541.1B (-13.1%) Less in Outstanding Loans in These Three Categories at Year-end 2009 vs. 2008 Source: FDIC Quarterly Banking Profile, Fourth Quarter 2009, Table I-A 39 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

36. New Private Housing Starts, 1990-2011F New home starts plunged 34% from 2005-2007; drop through 2009 was 72% (est.); A net annual decline of 1.49 million units, lowest since records beganin 1959 (Millions of 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 $1.3 billion Little Exposure Growth Likely for Homeowners InsurersDue to Weak Home Construction Forecast for 2010-2011.Also Affects Commercial Insurers with Construction Risk Exposure, Surety Source: U.S. Department of Commerce; Blue Chip Economic Indicators (3/10); Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

37. Total Industrial Production, monthly, Mar 2001-Feb 2010 (Index 2002=100)* As the recovery takes root, industrial production will expand and eventually translate into higher, payroll expansion and additional WC exposure Index March 2001- Nov. 2001 recession Dec. 2007 “Great Recession” begins Hurricane Katrina June 2009 “Great Recession” ends** 42 Source: http://www.federalreserve.gov/releases/g17/ipdisk/ip_sa.txt. *seasonally adjusted **Official end date not yet determined.

38. Total Industrial Production 2007:Q1 to 2011:Q4F (%) Industrial Production is Aided by a Rebuild of Inventories, Gradual Economic Recovery and Stimulus Program (Q2:09 through 2010) Industrial Production Began to Contract Sharply in Late 2008 and Plunged in 2009:Q1 End of Recession in mid-2009, Stimulus Program Are Benefiting Industrial Production and Therefore Insurance Exposure Both Directly and Indirectly, Albeit Very Modestly Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (3/10); Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

39. Year-Over-Year Change in Quarterly USState Tax Revenues, Inflation Adjusted Nationwide, state-tax collections for fiscal year 2009 declined by a record $63 billion, or 8.2 percent from the previous year. That loss is roughly twice the amount states gained in fiscal relief from the federal stimulus package States Revenues Were Down 10.9% in Q3 2009, the Second Consecutive Quarter of Record Revenue Decline. This Will Impact Public Infrastructure Spending Significantly. Source: US Census Bureau; Nelson A. Rockefeller Institute of Government: http://www.rockinst.org/pdf/government_finance/state_revenue_report/2010-01-07-SRR_78.pdf eSlide – P6466 – The Financial Crisis and the Future of the P/C

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

41. 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

42. 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

43. Numeric Change in Wage and Salary Employment in Goods-Producing Industries: 2008-2018P (Thousands) Employment in high WC frequency/severity occupational classes will be flat over the next decade. Construction is expected to rebound from its recession lows but the long-term decline in US manufacturing employment will continue. 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

44. Numeric Change in Wage and Salary Employment in Service-Providing Industries: 2008-2018P (Thousands) Health, Science and Education will be important sources of exposure growth for WC insurers this decade 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

45. Inflation Trends:Concerns Over Stimulus Spending and Monetary Policy Mounting Pressure on Claim Cost Severities? 50

46. Annual Inflation Rates(CPI-U, %), 1990–2011F Inflation peaked at 5.6% in August 2008 on high energy and commodity crisis. The recession and the collapse of the commodity bubble have reduced inflationary pressures Annual Inflation Rates (%) There is So Much Slack in the US Economy That Inflation Should Not Be a Concern Through 2010/11, but Depreciation of Dollar is Concern Longer Run Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators, Mar. 10, 2010 (forecasts). eSlide – P6466 – The Financial Crisis and the Future of the P/C

47. Forecasts of Annual Inflation Rates(CPI-U, %), 2010–2015F Even the pessimistic forecasts don’t see the CPI rising much above 3% in the next five years Annual Inflation Rates (%) Inflation Will Accelerate Modestly through 2015 but Should Is Not Expected to Become a Major Concern or Threat Sources: Blue Chip Economic Indicators, Oct. 2009 and Mar. 2010. 52 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

48. Top Risks for WC Insurersif Inflation Is Reignited • Rising Claim Severities • Cost of claims settlement rises across the board (property and liability) • Rate Inadequacy • Rates inadequate due to low trend assumptions arising from use of historical data • Reserve Inadequacy • Reserves may develop adversely and become inadequate (deficient) • Burn Through on Retentions • Retentions, deductibles burned through more quickly • Reinsurance Penetration/Exhaustion • Higher costs  risks burn through their retentions more quickly, tapping into reinsurance more quickly and potentially exhausting their reinsurance more quickly Source: Insurance Information Institute. 53 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

49. 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. 54

50. WC Medical Severity Risingat Twice the Medical CPI Rate Average annual increase in WC medical severity form 1995 through 2008 was more than twice the medical CPI (8.1% vs. 4.0%). 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.