State of the Workers Compensation Insurance Industry: Calm Amid the Storms?

1. State of theWorkers Compensation Insurance Industry:Calm Amid the Storms? 2006 AASCIF Annual Conference Branson, MO June 19, 2006 Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist 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 • P/C Insurance Industry Financial Update • Profitability • Underwriting, Pricing Trends &Investment • Ratings, Solvency & Financial Strength • Capacity, Capital & Policyholder Surplus • Workers Comp Operating Environment • Calm Amid the Storm? • Emerging Issue in Workers Comp • TRIA/Terrorism Update • Q & A

3. P/C FINANCIALOVERVIEW Mega-CATs Affect theEntire Industry

4. Highlights: Property/Casualty,2005 vs. 2004 Growth rate lowest since late 1990s Investment Income Rebound? Source: ISO, Insurance Information Institute *Comparison is with year-end 2004 value.

5. Strength of Recent Hard Markets by NWP Growth* 1975-78 1984-87 2001-04 2006-2010 (post-Katrina) period will resemble 1993-97 (post-Andrew) 2005: biggest real drop in premium since early 1980s *2006-10 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. Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute

6. P/C Net Income After Taxes1991-2005 ($ Millions) • 2001 ROE = -1.2% • 2002 ROE = 2.2% • 2003 ROE = 8.9% • 2004 ROE = 9.4% • 2005 ROAS** = 10.5% 2005 Net Income only now exceeding levels of mid-1990s *ROE figures are GAAP; **Return on avg. surplus. ROAS = 9.8% after adj. for one-time special dividend paid by the investment subsidiary of one company. Sources: A.M. Best, ISO, Insurance Information Inst.

7. ROE vs. Equity Cost of Capital: US P/C Insurance:1991 – 2005E The p/c insurance industry achieved will come close to achieving its cost of capital in 2005 +/-0.5 pts -1.7 pts -0.5 pts -13.2 pts US P/C insurers missed their cost of capital by an average 6.7 points from 1991 to 2002, but just 0.6 pts from 2003-05E -9.0 pts Source: The Geneva Association, Ins. Information Inst.

8. ROE: P/C vs. All Industries 1987–2005 2004/5 ROEs excl. hurricanes Sept. 11 Hugo Katrina, Rita, Wilma Lowest CAT losses in 15 years Andrew Northridge 4 Hurricanes Source: Insurance Information Institute; Fortune

9. RETURN ON EQUITY (Fortune):Stock & Mutual vs. All Companies* Stock insurer ROEs consistently above mutuals The gap between stock and mutual profitability has been narrowing *Fortune 1,000 group. Source: Fortune Magazine, Insurance Information Institute.

10. RNW for Major P/C Lines,1995-2004 Average Workers Comp performance has been about average in recent years, though now superior relative to CAT-impacted lines Source: NAIC; Insurance Information Institute

11. Workers’ Comp Underwriting Performance and Profitability *2005 ROE figure is III estimate; 2005 Combined Ratio is NCCI estimate Source: A.M. Best, NCCI

12. CATASTROPHEREVIEW Workers Comp is Lost in the Background

13. U.S. InsuredCatastrophe Losses ($ Billions)* $ Billions $100 Billion CAT year is coming soon 2005 was by far the worst year ever for insured catastrophe losses in the US, but the worst has yet to come. *Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita. Note: 2001 figure includes $20.3B for 9/11 losses reported through 12/31/01. Includes only business and personal property claims, business interruption and auto claims. Non-prop/BI losses = $12.2B. Source: Property Claims Service/ISO; Insurance Information Institute

14. Insured Property Catastrophe Losses as % Net Premiums Earned, 1983–2005E US CAT losses were a record 13.8% of net premiums earned in 2005 and were 4.2 times the 1984-2004 average of 3.3%. Anything left to pay WC claims? *Insurance Information Institute figure of 13.8% for 2005 based estimated 2005 DPE of $417.7B and insured CAT losses of $57.7B. Sources: ISO, A.M. Best, Swiss Re Economic Research & Consulting; Insurance Information Institute.

15. Top 10 Most Costly Hurricanes in US History, (Insured Losses, $2005) Seven of the 10 most expensive hurricanes in US history occurred in the 14 months from Aug. 2004 – Oct. 2005: Katrina, Rita, Wilma, Charley, Ivan, Frances & Jeanne Sources: ISO/PCS; Insurance Information Institute.

16. Insured Loss & Claim Count for Major Storms of 2005* Hurricanes Katrina, Rita, Wilma & Dennis produced a record 3.3 million claims *Property and business interruption losses only. Excludes offshore energy & marine losses. Source: ISO/PCS as of June 8, 2006; Insurance Information Institute.

17. Outlook for 2006 Hurricane Season Just 16 left to go!! *Average over the period 1950-2000. Source: Dr. William Gray, Colorado State University, May 31, 2006.

18. WALL STREET:MAINTAINING THE CONFIDENCE OF WALL STREET IS CRITICAL FOR MANY INSURERS

19. Change in YTD Stock Performance by Sector Pre- & Post-Katrina/Rita/Wilma P/C & reinsurer stocks hurt but now fully recovered. Brokers rose on expectation of tighter conditions and demand for broker services; closure of Spitzer issues. Katrina: Aug. 29 Rita comes ashore Sept. 24 Wilma landfall Oct. 24 Source: SNL Securities; Insurance Information Institute

20. P/C Insurance Stocks Off to a Slow Start in 2006 Total YTD Returns Through June 16, 2006 P/C insurer stocks are flat so far in 2006. Investors worried about potential hurricane losses, price weakness. Source: SNL Securities, Standard & Poor’s, Insurance Information Institute

21. UNDERWRITINGSurprisingly Strong in 2005, Stage is Set for a Good 2006!

22. P/C Industry Combined Ratio 2005 figure reflects heavy use of reinsurance which lowered net losses, but still a substantial deterioration from first half 2005 Expectation is for an underwriting profit in 2006 Sources: A.M. Best; ISO, III. *III forecast for 2006

23. Commercial Lines Combined Ratio, 1993-2006E* Outside CAT-affected lines, commercial insurance is doing fairly well. Caution is required in underwriting long-tail commercial lines. 2006 results dependent on a return to “normal” catastrophe loss levels Source: A.M. Best; Insurance Information Institute *Fitch estimate for 2005. Actual 1H05 combined ratio all lines was 92.7.

24. Impact of Reserve Changes on Combined Ratio Reserve adequacy is improving substantially Source: A.M. Best, Lehman Brothers for years 2005E-2007F

25. 2004 Prior Year Reserve Development by Line ($ Millions) Longer-tail casualty coverages have been the source of most reserve problems in recent years Reserve Strengthening Reserve Releases Source: A.M. Best, Lehman Brothers.

26. Underwriting Gain (Loss)1975-2005 $ Billions Insurers sustained a $5.9 billion underwriting loss in 2005. Before Katrina, p/c insurers were on track for only the second underwriting profit in 27 years; U/W profit in 2006 is likely. Source: A.M. Best, Insurance Information Institute

27. Combined Ratio: Reinsurance vs. P/C Industry Sept. 11 2004/5 Hurricanes HurricaneAndrew Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute

28. A 100 Combined Ratio Isn’t What it Used to Be: 95 is Where It’s At Combined ratios today must be below 95 to generate Fortune 500 ROEs * 2005 figure is return on average statutory surplus. Source: Insurance Information Institute from A.M. Best and ISO data.

29. Workers Comp Pure Loss Ratio: 1993–2005E WC losses ratios have improved substantially since 2001 WC is a relative bright spot in most states Source: NAIC; Insurance Information Institute; 2005 estimate from NCCI.

30. Workers Comp Combined Ratios, 1994-2005P Percent 1.9% due to 9/11 p Preliminary AY figure. Accident Year data is evaluated as of 12/31/2005 and developed to ultimate Source: Calendar Years 1994-2004, A.M. Best Aggregates & Averages; Calendar Year 2005p and Accident Years 1994-2005pbased on NCCI Annual Statement Analysis. Includes dividends to policyholders

31. Workers Comp Calendar YearNet Combined Ratios Private Carriersand State Funds Percent WC state fund underwriting performance is now on par with private industry Calendar Year 1.9% due to 9/11 p Preliminary Source: 1996-2004 Private Carriers, A.M. Best Aggregates & Averages; 2005p, NCCI1996-2005p State Funds: AZ, CA, CO, HI, ID, KY, LA, ME, MO, MT, NM, OK, OR, RI, TX, UT Annual Statements Source: National Council on Compensation Insurance

32. Workers Comp Calendar Year U/W Expense Ratio, 1990-2005p Private Carriers Percent Underwriting expense ratio benefited from run-up in premiums, but likely to turn up again as premium growth slows Calendar Year p PreliminarySource: 1990-2004, A.M. Best Aggregates & Averages; 2005p, NCCI

33. Cost of Risk vs. Commercial Lines Operating Ratio* • 2005 operating ratio is III estimate • **Per $1,000 Revenue. Source: RIMS, A.M. Best; Insurance Information Institute

34. UNDERWRITING AFFECTS FINANCIAL STRENGTHIs There Causefor Concern?

35. P/C Company Insolvency Rates,1993 to 2004 • Insurer insolvencies are decreasing • 12-yr industry failure rate: 0.71% • Failure rating for B+ or better rating: 0.49%* • Failure rate for D through B rating: 1.29%* 12-yr Failure Rate = 0.71% 30 30 38 21 10 Source: A.M. Best; Insurance Information Institute *1993-2003

36. Reason for P/C Insolvencies(218 Insolvencies, 1993-2002) Reserve deficiencies account for more than half of all p/c insurers insolvencies So far, Katrina appears to have claimed just 1 victim—Rosemont Re—expected to go into run-off Source: A.M. Best, Insurance Information Institute

37. Reasons for US P/C Insurer Impairments, 1969-2005 2003-2005 1969-2005 Deficient reserves, CAT losses are more important factors in recent years *Includes overstatement of assets. Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report,Nov. 2005;

38. Workers Comp Reserve Deficiency,1993-2005p $ Billions Loss and LAE Reserve Deficiency—Private Carriers WC reserve deficiencies have been cut by $12 billion—57% since 2001 Calendar Year p Preliminary Considers all reserve discounts to be deficient. Loss and LAE figures are based on NAIC Annual Statement data for each valuation date and NCCI latest selections. Source: 1995-2005p, NCCI analysis

39. Historical Ratings Distribution,US P/C Insurers, 2000 vs. 2005 2000 2005 A++/A+ shrinkage Ratings agencies increasing emphasis on multiple eventsrequire more capital Source: A.M. Best: Rating Downgrades Slowed but Outpaced Upgrades for Fourth Consecutive Year, Special Report,November 8, 2004 for 2000; 2006 Review & Preview for 2005 distribution. *Ratings ‘B’ and lower.

40. 2006 SRQ CAT Model Reqs.* All Property Exposure Auto Physical Damage Reinsurance Assumed Pools & Assessments All Flood Exposure WC Losses from Quake Fire Following Storm Surge Demand Surge Secondary Uncertainty ALSO “A.M. Best will perform additional “stress-tested” risk-adjusted capital analysis for a second event in order to determine the potential financial condition of an entity post a severe event.” IMPLICATION: Some insurers may be required to carry more capital to maintain the same rating. Ratings Agencies Tightening Requirements for CATs Best currently estimates PML for 100-yr. wind & 250-yr. quake to determine capital adequacy *SRQ = Supplemental Rating Questionnaire Source: A.M. Best Review & Preview, January 2006.

41. INVESTMENTSDoes Investment Performance Affect Discipline?

42. Net Investment Income Growth History 2002: -1.3% 2003: +3.9% 2004: +3.4% 2005: +23.7%** $ Billions Source: A.M. Best, ISO, Insurance Information Institute; **Includes special dividend of $3.2B. Increase is 15.7% excluding dividend.

43. US P/C Net Realized Capital Gains,1990-2005 ($ Millions) Realized capital gains rebounded strongly in 2004/5 but are 46% below their 1998 peak Sources: A.M. Best, ISO, Insurance Information Institute.

44. Total Returns for Large Company Stocks: 1970-2006* S&P 500 is up 0.3% so far in 2006* Markets are moving sideways in 2006 as interest rates rise Source: Ibbotson Associates, Insurance Information Institute. *Through June 16, 2006.

45. The Treasury Yield CurveIs Still Fairly Flat June 2004 May 2006* December 2005 December 2004 June 2005 Source: Board of Governors, Federal Reserve System; Insurance Information Institute. *Week ending 5/26.

46. Property/Casualty Insurance Industry Investment Gain* Investment gains are rising but are only now comparable to gains seen in the late 1990s *Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. **2005 figure includes special one-time dividend of $3.2B. Source: Insurance Services Office; Insurance Information Institute.

47. WC Low Investment Returns Persist: Low Interest Rates Investment Gain on Insurance Transactions to Premium Ratio** Private Carriers Rising interest rates should help WC investment returns over time *Adjusted to include realized capital gains to be consistent with 1992 and after. **Investment Gain on Insurance Transaction includes Other Income. Source: 1990-2004 A.M. Best Aggregates & Averages; 2005p NCCI.

48. Interest Rate Forecast,2006-2017 Fed thinking on future hikes is unclear & depend on economic data over the next few months Source: Blue Chip Economic Indicators, March 2006; Insurance Information Institute.

49. CAPITAL/CAPACITYCan the Industry Efficiently Employ Its Increasing Capital?

50. U.S. Policyholder Surplus: 1975-2005* Capacity TODAY is $427.1B, 9.2% above year-end 2004, 47% above its 2002 trough and 22% above its mid-1999 peak. Sufficient capacity exists to pay all hurricane claims. $ Billions Foreign reinsurance and residual market mechanisms absorbed $27-$32B (57%-67%) of 2005 CAT losses of $57.7B “Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations Source: A.M. Best, ISO, Insurance Information Institute *As of 12/31/05.