1. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Workers Compensation Overview AASCIF Austin Workshop Bruce R. Hockman Towers Watson Bruce.hockman@towerswatson.com T 215 246 1629 October 19, 2010 © 2010 Towers Watson. All rights reserved.

2. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview This Business SUCKS!!! Any questions??? 1

3. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview No two carriers, public or private, approach the business the same way, but there are common issues which, as they say in consulting speak, are “Keeping company leaders awake at night”. 2 Reduced Top-Line Revenue Loss Ratio Deterioration Expense Ratio Pressure Medical InflationPersonnel Development Sluggish Investment Market Federal Intervention Economy Market Consolidation CompetitionIndiscriminate Hair Loss

4. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview 3 Reminder: Unless you are a national writer, with proportional premium distribution in each state, National Statistics are: a) dated b) wrong c) of little value for strategic decision making →Trust your own data whenever possible as it is likely to be a)timely b) accurate c) strategically reliable

5. Market Consolidation towerswatson.com 4 © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

6. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview State Fund Private Market Our Cozy little world of workers comp is getting smaller, and at the same time more crowded. Market Consolidation 14.3B 39.7B 10.4B 43.6B 6.2B 33.8B 4 2004 $54 Billion 2006 $54 Billion 2009 $40 Billion

7. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview For the last four years, the workers compensation market has been consolidating. Zenith (14) → Fairfax Holdings (49) PMA (16) → Old Republic (15) First Comp (61) → Markel (0) Why: — Organic growth is not available — Move towards “specialization” — Existing market opportunities have “topped out” Market Consolidation 5 Product Pointer: Be mindful of ongoing consolidation among your distribution system.

8. Top Line Revenue Slippage towerswatson.com 7 © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

9. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview Top Line Revenue Slippage The NCCI provided a detailed breakdown explaining the rationale for this market collapse. But change was not uniform across the country? California and Florida account for $6.5 billion of that lost business. 6 Change in loss costs-7% Change in carrier pricing-4% Change in total payroll-4% Change in industry mix-5% “Other”-6%

10. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C 7 A National Overview ($ Billions) Sources: A.M. Best (1973-2009); Insurance Information Institute calculations and estimates for 2010. Premiums rise and fall for many reasons – and they will in the future. Top Line Revenue Slippage +36.3% -27.8% +17.1% -24.0% Cumulative Rate Change →

11. Lagging Investment Opportunities towerswatson.com 10 © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

12. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A Natural Overview In 2008, Investment Gains Fell by 50% Due to Lower Yields and Nearly $20B of Realized Capital Losses 2009 Saw Smaller Realized Capital Losses But Declining Investment Income 1 Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. * 2005 figure includes special one-time dividend of $3.2B. Sources: ISO; Insurance Information Institute. ($ Billions) Property/Casualty Insurance Industry Investment Gain: 1994–2010:Q11 Lagging Investment Opportunities 8

13. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 12/01/09 - 9pmeSlide – P6466 – The Financial Crisis and the Future of the P/C 9 A Natural Overview Treasury yield curve is near its most depressed level in at least 45 years. Investment income is falling as a result Sources: Board of Governors of the United States Federal Reserve Bank; Insurance Information Institute. Treasury Yield Curves: Pre-Crisis (July 2007) vs. July 2010 Lagging Investment Opportunities

14. Expense Ratio Pressure towerswatson.com 13 © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

15. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview Like it or not, when income falls someone is going to check on how much free coffee is being consumed! →In my experience, I have never seen a company go broke because of too high an expense ratio. Expense Ratio Pressure 10 Product Pointer: Expenses should be properly managed in good times and times like today. Remember, technology is terrific, but when was the last time that a computer got an injured worker back to work?

16. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview  Cash flow in any business is important, in ours it is critical. Expense Ratio Pressure PC Industry20082009 Premium Collected $434.5 $423.4 Losses Paid 260.9 250.6 Underwriting Expenses Paid 167.7 168.2 Dividends to Policy Holders 2.6 2.7 Underwriting Cash Flow ($3.2) ($1.9) Net Investment Income $53.7 50.3 Other income 0.9 0.7 Pre-tax Operating Cash Flow $57.9 $53.0 (Billions) 11 Product Pointer: Model your cash flow situation under various scenarios.

17. Loss Ratio Deterioration towerswatson.com 16 © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

18. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview Whether we look at calendar year data, or accident year data, the arrows keep pointing in the wrong direction. 2009 data showed the 4 th consecutive year of marked deterioration in combined ratios. We have seen nothing in 2010 to suggest that it will not be the markets worst results since 2001. Loss Ratio Deterioration Pricing Levels Frequency Severity Medical Inflation 12

19. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview Workers compensation loss results have always raised the industry’s loss ratio average. Loss Ratio Deterioration Accident Year Los/LAE Ratios Line2000200120022003200420052006200720082009 Work Comp10910085.574.8 64.63.468.174.980.284.5 Commercial8483.670.561.959.864.158.961.570.767.5 All Lines90.390.76.567.364.369.362.966.175.274.2 →Medical inflation, increased severity, increased litigation, all play a role, but price deterioration is playing a larger part. 13

20. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview We cannot talk about calendar year results without looking at reserve development (positive or negative), and adequacy. → A.M. Best:Workers compensation reserves are $1.8BB inadequate → NCCI:$4BB deficient after discounting Most “redundant” reserves built up between 2005 – 2009 have already been released. → Reserve inadequacy over any sustained period of time will put your company in jeopardy. Loss Ratio Deterioration 14 Product Pointer: Watch for those “hidden bombs” a) settled indemnity claims with open medical b) cases in litigation

21. The Economy towerswatson.com 20 © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

22. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 12/01/09 - 9pmeSlide – P6466 – The Financial Crisis and the Future of the P/C A National Overview *August 2010 (likely the “official end” of recession was June 2009) Sources: National Bureau of Economic Research; Insurance Information Institute. Average Duration** Recession = 10.4 Mos Expansion = 60.5 Mos Length of Expansions Greatly Exceeds Contractions Duration (Months) Length of US Business Cycles,1929–Present* The Economy 15

23. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 12/01/09 - 9pmeSlide – P6466 – The Financial Crisis and the Future of the P/C 16 A National Overview * = actual; = forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (8/10); Insurance Information Institute 2007:Q1 to 2011:Q4F* US Unemployment Rate The Economy

24. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 12/01/09 - 9pmeSlide – P6466 – The Financial Crisis and the Future of the P/C A Natural Overview Unemployment will remain high even under the most optimistic of scenarios, but forecasts are being revised downwards Sources: Blue Chip Economic Indicators (8/10); Insurance Information Institute Stubbornly High Unemployment Will Slow the Recovery of the Workers Compensation Exposure Base Quarterly, 2010:Q1 to 2011:Q4 US Unemployment Rate Forecasts The Economy 17

25. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 12/01/09 - 9pmeSlide – P6466 – The Financial Crisis and the Future of the P/C 18 A Natural Overview *As of July 2010; Not seasonally adjusted Note: Recessions indicated by gray shaded columns. Sources: US Bureau of Labor Statistics; National Bureau of Economic Research (recession dates); Insurance Information Institutes. Millions The number of employed people in the US today is approximately the same as it was in late 2004 U.S. Nonfarm Employment, Monthly, 1990 - 2010 The Economy

26. What is next? towerswatson.com 25 © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. Presentation2

27. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 12/01/09 - 9pmeSlide – P6466 – The Financial Crisis and the Future of the P/C * 2010 NWP and Surplus figures are % changes as of H1:10 vs H1:09. Sources: A.M. Best, ISO, Insurance Information Institute A National Overview (Percent) Surplus growth is now positive but premiums continue to fall, a departure from the historical pattern Historically, hard markets follow when surplus “growth” is negative* The industry has excess capacity, but it is unevenly distributed. What is next? 19

28. © 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com Presentation2 A National Overview To take just a longer view of things, here is some direction over the next year or three: Survive –Do the right things, regardless of short term pain –Keep good people, doing good work, on good business –Remember, you are not alone, and you have staying power Remain vital and relevant in your markets –You grew substantially just a few years ago –Fight the “commodity” syndrome – add value to your offerings Thrive –There is an end to every cycle, but everyone will not be positioned to take advantage of it. –Leadership is the key, followers fall by the wayside. 20