WORKERS COMPENSATION - CURRENT ISSUES - (SESSION WCP-16) Barry Lipton, FCAS, MAAA– NCCI Nancy Treitel, FCAS, MAAA– Liberty Mutual Casualty Actuarial Society 2002 Seminar on Ratemaking Tampa, FL March 7-8, 2002

© 2002 National Council on Compensation Insurance, Inc. 2 WC Remains the Third Largest P&C Line Net Written Premium Volume by Line Commercial Auto Other Liability (Incl Prod Liab) All Other Lines $299.6 B $119.6 B %$326.4 BTotal All Lines Fire & Allied Lines (Incl Earthquake) Commercial Multiple Peril Workers Compensation Homeowners 4.6%$125.1 B Personal Auto Change2001p Line of Business p Preliminary. WC & Total All Lines excludes state funds. Source for lines other than 2001p Workers Compensation: Best's Aggregates & Averages, Property/Casualty, 2001 Edition and Best’s Review Preview, Property/Casualty, January 2002 © A. M. Best Company—used with permission

© 2002 National Council on Compensation Insurance, Inc. 3 Results Deteriorated for Most Lines Combined Ratios by Line Commercial Auto Other Liability (Incl Prod Liab) 108 % % %110 %Total All Lines Fire & Allied Lines (Incl Earthquake) Commercial Multiple Peril Workers Compensation Homeowners 107 %109 % Personal Auto 2001p2000 Line of Business p Preliminary. WC & Total All Lines excludes state funds. Source: Best's Aggregates & Averages, Property/Casualty, 2001 Edition and Best’s Review Preview, Property/Casualty, January 2002 © A. M. Best Company—used with permission

© 2002 National Council on Compensation Insurance, Inc. 4 Source: Value-Line, latest estimates as of 1/2002. P/C projected 2001 ROS from AM Best Review/Preview. Return on Equity for P&C Appears to Be Well Below Average and Below the Cost of Capital Estimated 2001 After-Tax ROE for Public Companies

© 2002 National Council on Compensation Insurance, Inc. 5 Workers Compensation Premium Volume: We Have Shifted to a Period of Growth Workers Compensation Net Written Premium—Private Carriers p Preliminary. $ Billions $ Trillions

© 2002 National Council on Compensation Insurance, Inc. 6 Adjusted WC Premium Volume Has Remained Relatively Flat Over the Last Few Years Calendar Year WC Premiums & Premium Equivalents NCCI States

© 2002 National Council on Compensation Insurance, Inc. 7 WC Loss Ratio Deterioration Continues - By How Much? Countrywide - Net - Private Carriers Source: 2001 A.M. Best Aggregates & Averages, 2001 Edition, page 275 8% Due to Sept. 11

© 2002 National Council on Compensation Insurance, Inc. 8 WC Loss Ratios - Impact of Large Deductible Policies First Large DollarDeductible Loss$ 75 $ 15 Expense$ 25 $ 23 Premium$100 $ 38 Loss Ratio 75% 40% Expense Ratio 25% 60%

© 2002 National Council on Compensation Insurance, Inc. 9 LAE Ratios to Premium Appears to Have Leveled Off WC Loss Adjustment Expense Ratio to Net Earned Premiums Excluding State Funds Source: 2001 A.M. Best Aggregates & Averages, 2001 Edition, page 275

© 2002 National Council on Compensation Insurance, Inc. 10 The Upward Trend in LAE Ratios to Losses Has Reversed WC Loss Adjustment Expense Ratio to Losses Excluding State Funds Source: 2001 A.M. Best Aggregates & Averages, 2001 Edition, page 275

© 2002 National Council on Compensation Insurance, Inc. 11 For the First Time in Many Years the Expenses Ratios Have Declined WC Ratio of Underwriting Expenses to NWP (Excl Divs) Excluding State Funds Source: 2001 A.M. Best Aggregates & Averages, 2001 Edition, page 275

© 2002 National Council on Compensation Insurance, Inc. 12 Use of Dividends Continued to be Steady, at Least Through 2000… WC Ratio of Policyholder Dividends to Net Earned Premium Excluding State Funds Source: 2001 A.M. Best Aggregates & Averages, 2001 Edition, page 275

© 2002 National Council on Compensation Insurance, Inc. 13 The Deterioration in WC Calendar Year Combined Ratios Continues p Preliminary from AM Best. 8% Due to Sept. 11

© 2002 National Council on Compensation Insurance, Inc. 14 Investment Income Has Declined WC Ratio of Investment Gain and Other Income to Premium p Preliminary. Investment gain includes investment income and realized gains. * Adjusted to include realized capital gains to be consistent with 1992 and after.

© 2002 National Council on Compensation Insurance, Inc Appears to Have Been the Worst Year for WC Reported Profits in Over a Decade WC Pretax Operating Gain/Loss Ratio p Preliminary. * Adjusted to include realized capital gains to be consistent with 1992 and after.

© 2002 National Council on Compensation Insurance, Inc. 16 CY 2001p estimate from AM Best Review/Preview, January, 2002; AY 2001p estimate from NCCI AM Best Aggregates & Averages (Historical CY Ratios) Includes dividends to policyholders. Accident year data is evaluated as of 12/31/00 and developed to ultimate. Combined Ratio 8-15% Due to Sept WC AY Combined Ratio Reached a Record Level Despite Stable Loss Costs - What Does 2001 Look Like? Calendar Year vs. Ultimate Accident Year Countrywide—Private Carrier

© 2002 National Council on Compensation Insurance, Inc. 17 What Have Been The Key Factors Impacting Workers Compensation Results? + Terrorism - World Trade Center + Carrier Reserves + Carrier Pricing + Loss Severity Trends + Frequency Trends

© 2002 National Council on Compensation Insurance, Inc. 18 From 1994 through 1999, Reserves on Prior AYs Were Lowered Dollar Amount of Reserve Adjustments on Prior AYs (WC Countrywide - Net - Private Carriers) Loss and LAE reserves.

© 2002 National Council on Compensation Insurance, Inc. 19 These Reserve Releases Have More Than Offset the Upward Development on More Recent Accident Years for WC Accident Year Loss Ratios including LAE Reserve Releases Reported Loss and LAE reserves from Schedule P.

© 2002 National Council on Compensation Insurance, Inc. 20 WC Reserve Deficiencies Have Grown Larger in Recent Years Difference between NCCI estimated ultimate losses and LAE as of 12/2000 and reported Schedule P incurred losses and LAE. Approximately ¼ of Reserve Deficiency is due to Tabular Reserves

© 2002 National Council on Compensation Insurance, Inc. 21 How Are Final WC Premiums Determined? ADVISORY ORGANIZATION Advisory Loss Costs Assigned Risk Rates Experience Rating Values Experience Mods Rating Plans and Classifications INSURANCE COMPANY Final Rate Determination: – Expense Multiplier – Loss Cost Deviations Individual Risk Modifications: – Schedule Rating – Retrospective Rating

© 2002 National Council on Compensation Insurance, Inc. 22 p Preliminary Countrywide approved changes in advisory rates, loss costs and assigned risk rates as filed by the applicable rating organization. Filed Rates/Loss Costs Are Basically Stable History of Average Bureau Rate/Loss Cost Level Changes

© 2002 National Council on Compensation Insurance, Inc. 23 Impact of Discounting on Premium NCCI States—Private Carriers Based on data through 12/31/2000 for the 37 states where NCCI provides ratemaking services. Dividend ratios are based on calendar year statistics.

© 2002 National Council on Compensation Insurance, Inc. 24 Change in WC Average Reported Rate for All Policies Increased During NCCI States Avg Reported Rate Chg Average 2000 Change 2.9% Average 2001 Change through Oct %

© 2002 National Council on Compensation Insurance, Inc. 25 WC New Business Policies Experienced Greater Average Reported Rate Changes Compared to Renewals NCCI States “Matched” Renewals New Business Avg Reported Rate Chg

© 2002 National Council on Compensation Insurance, Inc. 26 What are Some Key Components and Factors for WC Premiums? Loss Cost = f (customer, company, and/or industry losses, inflation, interest rate, medical technology, economy, etc.) + Risk Charge + Expenses + Tax Premium

© 2002 National Council on Compensation Insurance, Inc. 27 The Rate of Change in WC Indemnity Claim Costs Has Accelerated Since 1995 Private Carriers Based on data through 12/31/2000, developed to ultimate. Based on the states where NCCI provides ratemaking services. Excludes the effects of deductible policies : +2.0% annual change : +6.8% annual change

© 2002 National Council on Compensation Insurance, Inc. 28 WC Indemnity Severity Has Begun to Outpace Wage Inflation

© 2002 National Council on Compensation Insurance, Inc. 29 WC Medical Claim Costs Have Also Continued Their Consistent Upward Trend Private Carriers : +5.0% annual change : +6.8% annual change Based on data through 12/31/2000, developed to ultimate. Based on the states where NCCI provides ratemaking services. Excludes the effects of deductible policies.

© 2002 National Council on Compensation Insurance, Inc. 30 WC Medical Severity Has Also Been Growing Faster than the Medical CPI

© 2002 National Council on Compensation Insurance, Inc. 31 The Impact of Inflation is More Sensitive on Excess Policies

© 2002 National Council on Compensation Insurance, Inc. 32 With Medical Technology, How Big Can a WC Claim Become? Consider a 25-year old making $450 per week whose injury results in quadriplegia requiring 24-hour attendant care. $ amounts are in millions.

© 2002 National Council on Compensation Insurance, Inc. 33 The Frequency of Lost-Time Claims Has Continued to Fall Through 2000 Private Carriers Based on data through 12/31/2000, developed to ultimate. Based on the states where NCCI provides ratemaking services. Excludes the effects of deductible policies. Cumulative decrease of 22.5% since 1993

© 2002 National Council on Compensation Insurance, Inc. 34 Why Frequency Has Improved So Much – Preliminary Results from NCCI Research + Safety awareness is a likely driver + Shifts in occupational mix and under-reporting of claims do NOT explain the decline + State legislative reforms may have been a significant contributor + Other possibilities include economic factors, technology, and increases in average age of worker + Additional research is underway

© 2002 National Council on Compensation Insurance, Inc. 35 The Annual Change in Lost-Time Claim Costs per Worker Has Been Growing Steadily Private Carriers Based on data through 12/31/2000, developed to ultimate. Based on the states where NCCI provides ratemaking services. Excludes the effects of deductible policies.

© 2002 National Council on Compensation Insurance, Inc. 36 To Date, Frequency Has Obscured Rising Claim Costs Accident Year Lost-Time Claim Costs Based on indemnity and medical data through 12/31/2000, developed to ultimate.

© 2002 National Council on Compensation Insurance, Inc. 37 Issues Potentially Impacting Loss Costs + Medical inflation – is Group Health a leading indicator? + Indemnity trends accelerating - are durations lengthening? + Cost containment initiatives - have we hit the saturation point? + Frequency - will it flatten or begin to increase? + Economy - what impact will it have on trends? + Terrorism/catastrophes - how to handle?

© 2002 National Council on Compensation Insurance, Inc. 38 * Excludes Maine Residual Market Pool. ** Projected to ultimate. Residual Market Premium Volume on the Rise... as of 9/30/2001

© 2002 National Council on Compensation Insurance, Inc. 39 Residual Market Shares - Also on the Rise Plan Premium as a Percentage of Direct Written Premium p Preliminary.

© 2002 National Council on Compensation Insurance, Inc. 40 * Excludes Maine Residual Market Pool. ** Projected to ultimate. Residual Market Combined Ratios Continue to Grow as of 9/30/2001

© 2002 National Council on Compensation Insurance, Inc. 41 * Excludes Maine Residual Market Pool. ** Projected to ultimate. Residual Market Underwriting Results Are Starting to Turn Negative as of 9/30/2001

© 2002 National Council on Compensation Insurance, Inc. 42 Changing Development Patterns 1st to 2nd Development – Indemnity Accident Year Development. First is at 12 months. Source: NCCI's Loss Development Exhibits.

© 2002 National Council on Compensation Insurance, Inc. 43 Changing Development Patterns 1st to 2nd Development – Medical Accident Year Development. First is at 12 months. Source: NCCI's Loss Development Exhibits.

© 2002 National Council on Compensation Insurance, Inc. 44 What Are the New Hot Issues Affecting Workers Comp? + Terrorism + Tightening Reinsurance Market + Hardening Marketplace + Company Insolvencies + Privacy Issues + ADA Developments

© 2002 National Council on Compensation Insurance, Inc. 45 WC Issues – Catastrophes/Terrorism + Coverage is Mandated by Statute + Part A has no policy/aggregate limits + Insurers bear most of the risk –experience rating limits losses –retro rating programs have per occurrence and aggregate limits –NCCI rate filing for 4% - no approvals to date + Reinsurance - availability and cost uncertain + Federal terrorism pool does not exist yet

© 2002 National Council on Compensation Insurance, Inc. 46 WC Issues – Insolvencies + Insolvencies still an issue - Reliance + Impacts profitability of remaining insurers + NAIC Codification requires that companies now accrue for ultimate cost of insolvencies + Recoupment typically allowed via one of 3 approaches - future rates/premium, offset to premium tax, or policyholder surcharge + Creates data problems for advisory organizations + Impacts allocation of Pool results to carriers

© 2002 National Council on Compensation Insurance, Inc. 47 WC Issues – Health Information Privacy What is it and What are the Key Concerns? + What is Health Information Privacy? –Protection of individually identifiable health information maintained or transmitted in connection with certain administrative and financial transactions –Concern -- Lack of uniformity among states + Concern -- Unintended Consequences: restricted access to information needed by employers and insurers –Broader application due to practicality –Interpretation of “minimum necessary” standard –Impediment to timely benefit payment –Potential threat to experience rating and ratemaking –Places insurers at competitive disadvantage with state funds/self- insurers –Potential to breach exclusive remedy provision. –Creates additional costly barriers.

© 2002 National Council on Compensation Insurance, Inc. 48 WC Issues – ADA Developments + In a January 8 ruling the Supreme Court clarified the disabilities that employers are required to accommodate in the workplace under the Americans With Disabilities Act (ADA). + Justices ruled that the law is intended to protect only those whose daily lives are substantially limited by their disabilities and not those who may have difficulty performing specific workplace tasks. + The decision overturned a lower federal court's ruling that an assembly line worker at a Toyota plant who suffered from carpal tunnel syndrome qualified for protection under the ADA.

© 2002 National Council on Compensation Insurance, Inc. 49 Legislative Update – Proposals CaliforniaSignificant increases in indemnity benefits; AB 749 has been signed by Governor Davis FloridaVarious proposals for changes in indemnity benefits, med fee schedule, attorneys fees Indiana‘Disabled From Trade Compensation’ bill KansasIncreases to benefits for permanent injuries KentuckyBlack lung bill is primary focus; other proposals include changes to SS offsets, physicians fee schedule MaineCourt ruling on reflecting pre-existing condition in determination of impairment ratings New MexicoCourt ruling potentially widening scope of EL coverage TennesseeNumerous proposals related to: determination of PP impairment ratings; compensation for mental injury; medical fee schedules; attorney fees; drug-free workplaces

© 2002 National Council on Compensation Insurance, Inc. 50 Workers Compensation Key Issues for the Future + How will terrorism exposure be addressed? + Will written premiums continue to increase? + Will severity trends continue to accelerate? + What impact will changes in the economy have, especially on frequency? + Where is the industry capacity headed post WTC? + Will companies address the WC reserve deficiency? + Will potential threats to rollback reforms or expand benefits succeed? + Where are investment returns headed?

© 2002 National Council on Compensation Insurance, Inc. 51 WORKERS COMPENSATION - CURRENT ISSUES - Q&A