The Surety Industry and Workers Compensation Guarantees Casualty Actuarial Society Presentation by: Marsh Surety Practice Drew Brach, Managing Director

2 Three Things to Discuss State of the Surety Industry Workers Compensation Issue from a Surety Perspective Workers Compensation Bond Forecast

3 Surety Industry Direct Written Premiums: – $3,473,100,578 Direct Earned Premiums: – $3,330,170,608 Direct Losses Incurred: – $2,748,411,932 Direct Loss Ratio: – 82.5%

4 Surety Industry Direct Written Premiums: – $3,473,100,578 Direct Loss Ratio: – 82.5% Expense Ratio – 50% Combined Ratio – 132.5%

5 Surety Industry What happened? – Economy changed – Banks tightened credit policies – Bankruptcies increased – Enron – Kmart – Telecommunications Losses

6 Surety Industry Reduced capacity Reinsurance problems - specific bonds Industry Losses Underwriting tightening Sureties refocusing on core business

7 Commercial Surety Risk Profile Back to the Fundamentals Capital Capacity Ongoing Management Character Commercial Surety Risk Profile Financial Analysis Profitability Bank Line of Credit Working Capital Net Worth Financial Ratios Benchmarking Off Balance Sheet items Hidden Net Worth Rating Agency Reports Timely Payment of Bills Balance Sheet Strategy Operations Ability to perform Bond Form Terms Length of Obligation International Environmental True Risk of the guarantee Organization Management Team Integrity Honesty Trust Reputation Customer base Philosophy Continuity Plan Credit Report Business Plan References Supplier Relationships Single Bond and Total Aggregate Program Surety Rate

8 Surety Industry Problems our Clients face – Bond program cancellations – Rate increases up to 500% as credit/capital market pricing driving surety rates – Very conservative underwriting – No markets for risks with exposure over 5 years – Primary Surety companies increasingly asking for collateral to underwrite a bond

9 Marsh Surety Business Survey Business that cannot be placed – 175 Risk Management – 770 Middle Market accounts Risk Management Accounts – 35% reclamation/landfill closure – 35% workers compensation and insurance premium bonds – 15% energy supply bonds – rest are all types of bonds for basically financially difficult companies Middle Market Accounts – 70% workers compensation, insurance premium and other long tail bonds – remaining 30% are for financially difficult companies

10 Workers Compensation Example Old Reality – Triple B plus S&P rated company – $150 million in WC guarantees – no collateral requirement from Surety Company – priced at 20 basis points New Reality – $45 million capacity in marketplace – no collateral required by the Surety Company – 100 basis points

11 Workers Compensation Guarantees Today’s Surety Market – Underwriting and Rates based on:  Credit Risk  Workers Compensation Risk  Reinsurance Costs  Collateral provided

12 Workers Compensation Guarantees Underwriting - Workers Compensation Risk – Type of Guarantee – Bond Form / Cancellation provision – Type of workers compensation claims – Expected life of obligation – Actuarial analysis of claims data – Law requiring the bond

13 Workers Compensation Guarantees Acceptable Worker Compensation Risks – Investment Grade Firms in acceptable sectors Unacceptable Risks – everyone else

14 Workers Compensation Guarantees Workers Compensation Surety Underwriting Issues – long tail nature of obligation – cancellation provision in bond – understanding true risk exposure – funding of workers compensation exposure

15 Workers Compensation Bond Forecast Sureties to provide guarantees for high investment grade companies in acceptable business sectors No new capacity for these guarantees in the next several years

16 Workers Compensation Bond Forecast Sureties will continue to explore different types of collateral for these risks – Letters of Credit – Escrow account – Bank of New York Trust – Trusts – Stocks – Bonds – Property – Credit Default Swaps – Accounts Receivable – Equipment – Other Assets – Finite Risk

17 Workers Compensation Bond Forecast In order to get the Surety Industry to reconsider their stance on Workers Compensation Guarantees – reduce the life of the obligation – negotiate an acceptable bond form

18 Workers Compensation Bond Forecast Reduce the life of the obligation – Surety covers the first 3 to 5 years of the credit risk – Bank Letter of Credit covers the longer term credit risk

19 Workers Compensation Bond Forecast $10 million Deductible Guarantee – Surety covers the first 3 to 5 years of the credit risk at $6,000,000 – Bank Letter of Credit covers the longer term credit risk at $4,000,000

20 Workers Compensation Bonds Questions