The Workers Compensation Marketplace: Focus on North Carolina

1. The Workers Compensation Marketplace:Focus on North Carolina North Carolina Workers Compensation Insurance Symposium Winston, NC August 2, 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 • Measures of Production and Capacity Utilization • 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. US Real GDP Growth* The Q4:2008 decline was the steepest since the Q1:1982 drop of 6.8% 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 late 2009 with rebuilding of inventories and stimulus. More moderate growth expected in 2010/11 Demand for Energy and Commercial Insurance Have Been Impacted by Sluggish Economic Conditions * Estimates/Forecasts from Blue Chip Economic Indicators. Source: US Department of Commerce, Blue Economic Indicators 7/10; Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

5. 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

6. 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

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

8. Unemployment and Underemployment Rates: Rocketed Up in 2008-09; Stabilizing in 2010? January 2000 through June 2010, Seasonally Adjusted (%) U-6 went from 8.0% in March 2007 to 17.5% in Oct 2009; Stood at 16.5% in June 2010 Recession ended in November 2001 Unemployment kept rising for 19 more months Recession began in December 2007 Unemployment rate was 9.5% in June 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. 12 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

9. 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 are being revised downward for the first time in years * = actual; = forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (7/10); Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

10. Unemployment Rates by State, June 2010:Highest 25 States* In June the majority of states (39 and DC) recorded a decrease in unemployment rates, while just 5 out of 50 states had increases. NC’s unemployment rate in June was 10.0% compared to 9.5% for the US *Provisional figures for June 2010, seasonally adjusted. Sources: US Bureau of Labor Statistics; Insurance Information Institute.

11. Unemployment Rates By State, June 2010: Lowest 25 States* In June the majority of states (39 and DC) recorded a decrease in unemployment rates, while just 5 out of 50 states had increases. *Provisional figures for June 2010, seasonally adjusted. Sources: US Bureau of Labor Statistics; Insurance Information Institute.

12. Monthly Change Employment* January 2008 through June 2010* (Thousands) May’s gain of 433,000 jobs was distorted by the hiring of 411,000 temporary Census workers. June’s loss of 125,000 jobs was distorted by the end of 225,000 Census jobs. Private sector employment was up 41,000 in May and 83,000 in June. 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 7.4 Million Through June 2010; 14.6 Million People are Now Defined as Unemployed *Estimate based on Reuters poll of economists. Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Information Institute 17 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

13. 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

14. 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).

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

16. U.S. Employment in the DirectP/C Insurance Industry: 1990–2010* Thousands As of May 2010, P/C insurance industry employment was down by 28,600 or 5.8% to 462,500 since the recession began in Dec. 2007 (compared to overall US employment decline of 7.2%) *As of May 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. 27 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

17. U.S. Employment in the DirectLife Insurance Industry: 1990–2010* As of May 2010, Life insurance industry employment was down by 11,100 or 3.1% to 343,300 since the recession began in Dec. 2007 (compared to overall US employment decline of 7.2%) Thousands *As of May 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. 28 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

18. U.S. Employment in the Direct Health-Medical Insurance Industry: 1990–2010* Thousands As of May 2010, Health-Medical insurance industry employment was down by 5,400 or 1.2% to 436,500 since the recession began in Dec. 2007 (compared to overall US employment decline of 7.2%) *As of May 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. 29 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

19. U.S. Employment in Insurance Agencies & Brokerages: 1990–2010* Thousands As of May 2010, employment at insurance agencies and brokerages was down by 50,100 or 7.4% to 629,500 since the recession began in Dec. 2007 (compared to overall US employment decline of 7.2%) *As of May 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. 31 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

20. Crisis and Recovery-Driven Exposure Drivers in WC Myriad of Impacts on Workers Comp Exposure Filling the Economic Crater 34

21. Business Bankruptcy Filings,1980-2010:Q1 % Change Surrounding Recessions 1980-82 58.6% 1980-87 88.7% 1990-91 10.3% 2000-01 13.0% 2006-09 208.9%* There were 60,837 business bankruptcies in 2009, up 40% from 2008 and the most since 1993. 2010:Q1 bankruptcies totaled 14,607, up 18% from Q1:2009 Significant Exposure Implications for All Commercial Lines Source: American Bankruptcy Institute; Insurance Information Institute 35 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

22. Private Sector Business Starts,1993:Q2 – 2009:Q3* (Thousands) 169,000 businesses started in 2009:Q3, actually declining during form the prior quarter. The figure is 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 June 7, 2010, seasonally adjusted Source: Bureau of Labor Statistics, http://www.bls.gov/news.release/cewbd.t07.htm. 36 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

23. Auto/Light Truck Sales, 1999-2011F New auto/light truck sales fell to the lowest level since the late 1960s. Forecast for 2010-11 is still far below 1999-2007 average of 17 million units (Millions of Units) “Cash for Clunkers” generated about $300M in net new personal auto premiums Sharply lower auto sales will have a smaller effect on auto insurance exposure level than problems in the housing market will on home insurers Car/Light Truck Sales Will Recover from the 2009 Low Point, but High Unemployment, Tight Credit Are Still Restraining Sales; Gas Prices Could Once Again Become a Factor, Too Source: U.S. Department of Commerce; Blue Chip Economic Indicators (7/10); Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

24. 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 (7/10); Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

25. 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 Benefited Industrial Production and Insurance Exposure Both Directly and Indirectly, Albeit it Very Modestly; Stimulus Effect is Waning in 2010 and Will Be Gone in 2011. Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (7/10); Insurance Information Institute eSlide – P6466 – The Financial Crisis and the Future of the P/C

26. Recovery in Capacity Utilization is a Positive Sign for Energy & Insurance Percent of Manufacturing Capacity “Full Capacity” Hurricane Katrina Recession began December 2007 Manufacturing capacity stood at 74.7% in May 2010, above the June 2009 low of 68.3% but well below the pre-crisis peak of 80%+ The closer the economy is to operating at “full capacity,” the greater the demand for insurance March 2001-November 2001 recession 43 Source: Federal Reserve Board statistical releases at http://www.federalreserve.gov/releases/g17/Current/default.htm.

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

28. 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

29. 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

30. 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

31. Inflation Trends:Concerns Over Stimulus Spending and Monetary Policy Mounting Pressure on Claim Cost Severities? 51

32. 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 Inflation Should Not Be a Concern Through 2010/11, but Deficits and Monetary Policy Remain Longer Run Concerns Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators, July 10, 2010 (forecasts). eSlide – P6466 – The Financial Crisis and the Future of the P/C

33. P/C Insurers Experience Inflation More Intensely than 2009 CPI Suggests (Percent) Healthcare and Legal/Tort Costs Are a Major P/C Insurance Cost Driver. These Are Expected to Increase Above the Overall Inflation Rate (CPI) Indefinitely Source: CPI is Blue Chip Economic Indicator 2009 estimate, 12/09; Legal services, medical care and motor vehicle body work are avg. monthly year-over-year change from BLS; BI and no-fault figures from ISO Fast Track data for 4 quarters ending 09:Q3. Tort costs is 2009 Towers-Perrin estimate. WC figure is I.I.I. estimate based on historical NCCI data.

34. 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

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. 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. 56 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

37. Workers Compensation Operating Environment The Weak Economy and Soft Market Have Made the Workers Comp Operating Increasingly Challenging 61

38. 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

39. Workers Compensation Combined Ratio: 1973–2010F Workers Comp Underwriting Results Are Deteriorating Markedly Sources: A.M. Best; Insurance Information Institute.

40. 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. 64

41. 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

42. 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.

43. WC Residual Market Shares Continue to Decline NCCI-Serviced WC Residual Market Plans as of December 31, 2009 Percent Policy Year *Incomplete policy year projected to ultimate. Source: NCCI.

44. 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.

45. Workers Compensation Medical & Indemnity Claim Cost Trends Rising Medical Costs Exert Pressure While Indemnity Costs Rise Well Ahead of Wage Inflation 69

46. 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

47. WC Medical Severity Rising at Nearly Twice the Medical CPI Rate Average annual increase in WC medical severity from 1995 through 2008 was nearly double 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.

48. 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

49. Med Costs Share of Total Costs is Increasing Steadily 2008p 1998 1988 Source: NCCI (based on states where NCCI provides ratemaking services).

50. WC Med Cost Will Equal 70% of Total by 2018 if Trends Hold 2018 Estimate This trend will likely be supported by the increased labor force participation of workers age 55 and older. Source: Insurance Information Institute.