Mega-Trends Influencing the Workers Compensation

Insurance Industry

62nd Annual Workers CompensationEducational Conference

Orlando, FL

August 13, 2007

Robert P. Hartwig, Ph.D., CPCU, PresidentInsurance Information Institute 110 William Street New York, NY 10038

Tel: (212) 346-5520 Fax: (212) 732-1916 bobh@iii.org www.iii.org

IT’S EASY TO FEEL GOOD ABOUT

WORKERS COMP TODAY

Once Disastrous Line, Now Makes Healthy Profit

Workers Comp Calendar Year – Private Carriers

101

97

111

110

107

103

97

100

101

107

115 11

8 122

80

8590

95

100105

110

115120

125

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006p

Percent

p Preliminary AY figure. Accident Year data is evaluated as of 12/31/2006 and developed to ultimateSource: Calendar Years 1994-2005, A.M. Best Aggregates & Averages; Calendar Year 2006p and Accident Years 1994-2006pbased on NCCI Annual Statement Analysis.Includes dividends to policyholders

Workers Comp Combined Ratios, 1994-2006P

WC insurers lopped 25 points off the

combined ratio in just 5 years

115.8

107.4

100.198.3

100.7

92.4

97.095.0

91.7

90

100

110

120

01 02 03 04 05 06 07:Q1 07F 08F

P/C Insurance Combined Ratio, 2001-2008F

Sources: A.M. Best; ISO, III. *III estimates for 2007/8.

2005 figure benefited from heavy use of reinsurance which lowered net losses

2006 produced the best underwriting result

since the 91.2 combined ratio in 1949

As recently as 2001, insurers were paying out nearly $1.16 for

every dollar they earned in premiums

2007/8 deterioration due primarily to falling rates, but results still strong assuming

normal CAT activity

Pre-Tax Operating Gain Ratio (%)

1.3 -0.1 0.9

8.4

13.5

-4.2

-8.6 -7.8

-3.2

7.5

12.7

19.717.9

19.8

13.9

5.2 4.4

-15

-10

-5

0

5

10

15

20

25

90* 91* 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06p

WC profitability is on the rise, but is

it sustainable?

Calendar Year

Percent

Workers Comp Profitability Is Improving

Source: NCCI

P/C Net Income After Taxes1991-2007F ($ Millions)*$1

4,17

8

$5,8

40

$19,

316

$10,

870

$20,

598

$24,

404 $3

6,81

9

$30,

773

$21,

865

$3,0

46

$30,

029

$63,

252

-$6,970

$63,

695

$44,

155

$20,

559

$38,

501

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

07F

*ROE figures are GAAP; 1Return on avg. surplus. 2007F figure is annualized actual Q1 net income of $15.813B **Actual first quarter 2007 result. Sources: A.M. Best, ISO, Insurance Information Inst.

2001 ROE = -1.2%2002 ROE = 2.2%2003 ROE = 8.9%2004 ROE = 9.4%2005 ROE= 9.4%2006 ROAS1 = 14.0%2007F ROAS = 12.9%**

Insurer profits peaked in 2006/7. “Normal” CAT year,

average investment gain imply flattening

WHY YOU SHOULD FEEL GOOD ABOUT

WHAT YOU DO Saving Lives, Increasing

Productivity and Much More

It’s Not Just About the Money

Did You Know That When You Prevent a Workplace Injury You…

• Keeping Workers Comp Costs Down is Just the Beginning• You Help Companies Remain Productive1

Permanently Disabling Injuries 565 Lost Future Work Days on Avg. Fatal Injuries 5,850 Lost Future Work Days on Average

• You Increase/Preserve Worker Incomes Seriously Injured Workers Have Lower Lifetime Earnings, on Average Reduced Likelihood of Filing Bankruptcy Less Likely to Need Public Assistance

• You Maintain/Improve the Quality of Worker’s Home Life Higher Incidence of Divorce, Substance Abuse, Depression Among Seriously

Injured

ALL REASONS TO BE PROUD OF WHAT YOU DO!!

1 US Census Bureau: http://www.census.gov/compendia/statab/tables/07s0639.xls

Lost-Time Claims

-4.2 -4.4

-6.9

-4.5 -4.1 -3.9

-6.8

-9.2

0.3

-6.5

-4.5

0.5

-3.9

-2.3

-4.5

-6.6

-10

-8

-6

-4

-2

0

2

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06p

Cumulative Change of –52.1%since 1991 means that lost work

time claims have been cut by more than half

Accident Year

Percent Change

Workers Comp Lost-Time Claim Frequency Down More than 50% Since 1991

2006p: Preliminary based on data valued as of 12/31/20061991-2005: Based on data through 12/31/2005, developed to ultimateBased on the states where NCCI provides ratemaking servicesExcludes the effects of deductible policiesSource: NCCI

Number of Fatal Work Injuries is Continues to Fall, 1992 – 2006p

6,05

56,23

8

6,20

2

6,27

5

6,63

2

6,33

1

6,21

7

6,05

4

5,92

0

5,91

5

5,53

4

5,57

5 5,76

4

5,73

4

5,70

3

4,800

5,000

5,200

5,400

5,600

5,800

6,000

6,200

6,400

6,600

6,800

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06pSource: US Bureau of Labor Statistics, US Department of Labor; Insurance Information Institute.

Workers comp insurers & the entire workplace safety

community have contributed to the 14% decline in workplace

fatalities since 1994

Rate of Fatal Work InjuriesContinues to Drop, 1992 – 2006p

4.5

4.84.84.9

5.35.25.2

4.54.3 4.3

4.0 4.04.1

4.03.9

3

4

4

5

5

6

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06pSource: US Bureau of Labor Statistics ; Insurance Information Institute.

Fatality rates are down 26.4% since 1994—

nearly double the 14% decline in the number of

on the job fatalities

Fatal Work Injuries per 100,000 Workers

Lives Saved Due to Reduction inFatal Work Injury Rate, 1995–2006p

1,8951,717

1,6231,7581,757

357

585 610

833

1,0771,210

1,382

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

95 96 97 98 99 00 01 02 03 04 05 06pSource: Insurance Information Institute from BLS data.

Workers comp insurers are a major force in saving worker lives

Reduction in Occupational Deaths Due to Fall in Fatality Rate from 5.3 per 100,000 Workers in 1994 to 3.9 in 2006

Nearly 2,000 work lives are saved annually due to

improved workplace safety!

Cumulative Lives Saved Due toReduction in Fatal Work Injury Rate

357 9421,552

2,3853,463

4,6736,055

7,811

9,569

11,192

12,909

14,803

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

95 96 97 98 99 00 01 02 03 04 05 06pSource: Insurance Information Institute from BLS data.

Saving a Life, Saves a Family

Cumulative Lives Saved Due to Fall in Fatality Rate from 5.3 per 100,000 Workers in 1994 to 3.9 in 2006

Since 1995, nearly 15,000 worker lives have been saved due to improved

workplace safety!

565 590547 582 579

520585 571 553

505 531 559 567516

618665 651

691734

810719 696

822770

809

1,0741,0801,036

927860

643559 567

516

1,242

1,3431,3461,3461,393

1,4421,365

1,4091,3731,3531,398

1,437

1,329

557

721706

716600 632

609677651

714

1,044

1,496

1,158

400

600

800

1000

1200

1400

1600

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Struck by Object Falls Homicides Highway Incidents

Four Most Frequent Work-Related Fatal Events, 1992-

2006

There has been a 52% decrease in work-related homicides since

1994.Vehiculat deaths are #1 killer.

Source: US Bureau of Labor Statistics, US Department of Labor; Insurance Information Institute.

BUT ALAS, THERE ARE MANY CONCERNS

Operational, Demographic &

Regulatory

THE SHRINKING PREMIUM BASE Competition, Leakage Conspire to Shrink WC

31.0 31.3 29.8 30.5 29.126.3 25.2 24.2 23.3 22.3

25.0 26.129.2 31.1

34.738.637.8

31.0 31.329.8 30.5

29.126.3

28.226.9 25.8 24.9

28.4

31.9

37.3

41.8

45.9 4647.2

0

10

20

30

40

50

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006p

State Funds ($ B)Private Carriers ($ B)

Total Workers Compensation Premium Declined in 2006

Net Written Premium

Calendar Year

$ Billions

p Preliminary

Source: 1990–2005 Private Carriers, A.M. Best Aggregates & Averages; 2006p, NCCI 1996–2006p State Funds: AZ, CA, CO, HI, ID, KY, LA, MO, MT, NM, OR, RI, TX, UT Annual Statements State Funds available for 1996 and subsequent

Average Commercial Rate Change by Line: 4Q99 – 1Q07

Source: Council of Insurance Agents & Brokers

Workers Comp rates (red line) along with most major

commercial coverages is renewing down about 10%

during 2007

Alternative Risk Transfer MarketSaps Traditional WC Carriers

Automobile, 12%

Property, 10%Workers Comp,

43%

Liability (excl. Auto), 35%

Source: MarketStance.

Workers Comp account for the

largest share of the alternative market,

particularly captives

$ Billions

Workers Compensation: Large Deductible Market Share

1%

33%

43%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1990 2000 2003Sources: National Council on Compensation Insurance; Insurance Information Institute.

Employers have become very

accustomed to accepting a greater share of risk and claim frequency has decreased

-10%

-5%

0%

5%

10%

15%

20%

25%

19

70

19

71

19

72

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

F2

00

8F

20

09

F2

01

0F

Note: Shaded areas denote hard market periods.Source: A.M. Best, Insurance Information Institute

Strength of Recent Hard Markets by NWP Growth*

1975-78 1984-87 2001-04

*2007-10 figures are III forecasts/estimates. 2005 growth of 0.4% equates to 1.8% after adjustment for a special one-time transaction between one company and its foreign parent. 2006-2008 figures from III Groundhog Survey.

2006-2010 (post-Katrina) period could resemble 1993-97

(post-Andrew)

2005: biggest real drop in premium since early 1980s

Growth in Net Written Premium, 2000-2008F

*2007 figure based 2007:Q1 result of 0.8%.Source: A.M. Best; Forecasts from the Insurance Information Institute.

5.1%

8.1%

14.1%

9.8%

4.7%

0.3%

4.3%

0.8% 1.0%

2000 2001 2002 2003 2004 2005 2006 2007F* 2008F

P/C insurers will experience their slowest growth rates since the late 1990s…but underwriting results are

expected to remain healthy

MEDICAL CLAIM COST INFLATION

The Problem That Will Never Go Away

4.5%3.6%

2.8% 3.2% 3.5%4.1%

4.6% 4.7%4.0% 4.4% 4.2% 4.0%

5.1%

7.4%

10.1%

8.3%

10.6%

8.2%

14.0%

7.4%

9.0%

6.8%

11.7%

7.5%

0%

2%

4%

6%

8%

10%

12%

14%

16%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Change in Medical CPIChange Med Cost per Lost Time Claim

WC Medical Severity Rising Far Faster than Medical CPI

Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states.

3.5

pts

WC medical severity rose more than twice as fast as the medical CPI (8.8% vs. 4.0%)

from 1995 through 2006

$8.3 $8.4 $8.2 $8.9 $9.4 $10.1$11.1

$12.0$13.3

$14.4

$16.4$17.6

$19.2$20.5

$22.9$24.6

$5

$10

$15

$20

$25

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06p

Annual Change 1991–1996: +4.1%Annual Change 1997–2005: +9.5%

Accident Year

MedicalClaim Cost ($000s)

2006p: Preliminary based on data valued as of 12/31/20061991-2005: Based on data through 12/31/2005, developed to ultimateBased on the states where NCCI provides ratemaking services; Excludes the effects of deductible policies

Workers Comp Medical Claims Continue to Climb

Cumulative Change = +200%(1993-2006p)

Med Costs Share of Total Costs is Increasing Steadily

Indemnity55%

Medical45%

Source: NCCI (based on states where NCCI provides ratemaking services).

Indemnity52%

Medical48%

Indemnity41%

Medical59%1986

1996

2006p

WC Med Cost Will Equal 70% of Total by 2016 if Trends Hold

Source: Insurance Information Institute.

Indemnity30%

Medical70%

2016 EstimateWC med costs could equal 70%of system costs by 2016. This means that claims

severity will accelerate relative today and claims management will

become progressively more difficult and

complex

INDEMNITY CLAIM COST INFLATION

The Problem That Can Sometimes Be Tamed

IndemnityClaim Cost (000s)

Lost-Time Claims

$9.9 $9.6 $9.4 $9.8 $10.0$10.6

$11.4$12.4

$13.6

$15.1$16.5$16.9

$17.7$18.0$18.6

$19.6

$5

$7

$9

$11

$13

$15

$17

$19

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06p

Annual Change 1991–1996: +1.2%Annual Change 1997–2005: +6.6%

2005p: Preliminary based on data valued as of 12/31/20061991-2005: Based on data through 12/31/2005, developed to ultimateBased on the states where NCCI provides ratemaking servicesExcludes the effects of deductible policiesSource: NCCI

Accident Year

Workers Comp Indemnity Claims Costs Have Accelerated, 1993-2006p

Cumulative Change = +108.5%(1993-2006p)

3.0%

4.3%5.0%

4.4%5.2%

4.4%

2.4%2.0%

2.4%2.8%

3.4%

5.9%

7.7%

9.0%

10.1%

4.8%

1.9%

3.0%

5.5%

3.0% 2.4%

9.7%10.9%

1.7%

0%

2%

4%

6%

8%

10%

12%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006p

Change in CPS Wage Change in Indemnity Cost per Lost-Time Claim

WC Indemnity Severity vs. Wage Inflation

2.1

pts

2006p: Preliminary based on data valued as of 12/31/2006; 1991-2005: Based on data through 12/31/2005, developed to ultimate. Based on the states where NCCI provides ratemaking services. Excludes the effects of deductible policies. CPS = Current Population Survey.Source: NCCI

WC indemnity severity is once again outpacing

wage inflation

THE AGEING WORKFORCE Working Longer,But Not Stronger

Fatal Work Injury RatesClimb Sharply With Age

4.94.03.63.2

2.72.7

0.8

10.8

0

2

4

6

8

10

12

16-17 18-19 20-24 25-34 35-44 45-54 55-64 65+

Source: US Bureau of Labor Statistics, US Department of Labor; Insurance Information Institute.

Fatality rates for workers 65 and older are triple that of workers age 35-44. The workplace of the future will have to be completely redesigned to accommodate

the surge in older workers.

Fatal Work Injuries per 100,000 Workers (2006)

THE OBESITY EPIDEMIC

Major Cost Driver that WC Has Yet to Address

WC Claims and Lost Workdays by Body Mass Index (BMI)

40.9760.17

75.21

14.19

183.63

117.61

5.53 5.807.05

10.80

8.81

11.65

0

20

40

60

80

100

120

140

160

180

200

BMI <18.5(Underweight)

18.5-24.9(HealthyWeight)

25-29.9(Overweight)

30-34.9 (ObeseClass I)

35-39.9 (ObeseClass II)

40+ (ObeseClass III)

Los

t W

ork

day

s p

er 1

00 F

TE

s

0

2

4

6

8

10

12

14

Cla

ims

per

100

FT

Es

Lost Workdays Claims

Obesity is costing workers comp insurers and employers billions

Source: Ostbye, T., et al, “Obesity and Workers Compensation,” J. of the American Medical Association, April 23, 2007.

The most obese workers file twice as many WC claims and 13 times more lost workdays than healthy weight workers

Medical & Indemnity WC Claims Costs by BMI

$7,1

09

$13,3

38

$19,6

61

$3,9

24

$5,3

96

$13,5

69

$34,2

93

$7,5

03

$51,0

91

$23,3

73

$23,6

33

$59,1

78

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

BMI <18.5(Underweight)

18.5-24.9(HealthyWeight)

25-29.9(Overweight)

30-34.9 (ObeseClass I)

35-39.9 (ObeseClass II)

40+ (ObeseClass II)

Medical Claims Costs Indemnity Claims Costs

Med claims costs are 6.8 times higher for the most obese

workers and indemnity costs are 11 times higher

Source: Ostbye, T., et al, “Obesity and Workers Compensation,” J. of the American Medical Association, April 23, 2007.

REGULATORY NIGHTMARES

WC’s Low Profile Won’t Last Forever

Regulatory Concerns• Political Populism is On the Rise• Eventually WC Trends Will Turn Adverse• New Congress and Populist Governors, Attorneys General and

Insurance Commissioners Will Take Great Interest in WC Which Impacts All Employers and Their Workers

• FLORIDA SCENARIO Governor would react to rising workers comp rates the same way he reacted

to rising property rates Rates would be actively suppressed Proposal to create “competitive” state fund that would also subsume residual

market Would be unlikely to charge actuarially sound rates or set proper reserves Residual market would explode with deficits financed by voluntary mkt. State fund would grow rapidly and market would become progressively more

socialized, possibly substantially so while real problems go unaddressed/ SOUND FAMILIAR???

Regulatory Concerns (cont’d)• McCarran-Ferguson

Narrowing could be harmful to WC rating bureaus and smaller insurers who rely most heavily on advisory loss cost information

• Health Care Reform Déjà Vu—1992 Health Care reform will be a major theme in 2008 elections as in 1992 Back in 1992, it was proposed that workers comp would be rolled into the

general health care system This could happen again Insurers back then fretted about the “Medical Indemnity Disconnect”

• Terrorism Extension virtually assured, but will likely be December House has proposed 15-year extension; Senate and Administration will want

something much shorter NBCR requirement on property side will have negative impact on insurers to

assume workers comp exposure (Senate may excise this)

Insured Loss Estimates: Large NBCR Terrorist Attack ($ Bill)

Type of Coverage New York WashingtonSan

FranciscoDes

Moines

Group Life $82.0 $22.5 $21.5 $3.4

General Liability 14.4 2.9 3.2 0.4

Workers Comp 483.7 126.7 87.5 31.4

Residential Prop. 38.7 12.7 22.6 2.6

Commercial Prop. 158.3 31.5 35.5 4.1

Auto 1.0 0.6 0.8 0.4

TOTAL $778.1 $196.8 $171.2 $42.3

Source: American Academy of Actuaries, Response to President’s Working Group, Appendix II, April 26, 2006.

Summary• Workers Compensation Markets Will Continue to Perform Well but

Operating Results and Profitability Will Begin to Erode• Competition in WC Markets More Intense Than Anytime in Last 15 Years

• WC Market Participants Have Provided One of the Most Valuable Services in the Industry—Saving Lives & Families

• Should be Proud of Achievements at Time When Insurers are Being Attacked by Politicians in Some States and in Washington

• BUT…Threats Abound

• Pressure is Building in a Number of Area Pricing, Leakage to Alternative Markets Medical Costs, Long-Run Regulatory Environment a Problem

• Disciplined Underwriting, Cost Management Key to Long-Run Success

Insurance Information Institute On-Line

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