Mega-Trends Influencing the Workers Compensation Insurance Industry 5th Annual National Workers’ Compensation Insurance ExecuSummit New York, NY February.

Mega-Trends Influencing the Workers Compensation Insurance Industry 5th Annual National Workers’ Compensation Insurance ExecuSummit New York, NY February 5, 2008 Steven N. Weisbart, Ph.D., CLU, Vice President & Chief Economist Insurance Information Institute  110 William Street  New York, NY 10038 Tel: (212) 346-5540  Fax: (212) 732-1916  stevenw@iii.org  www.iii.org

Six Mega-Trends to Watch 1.Falling Lost-Time Claim Frequency and Fatality Rates 2.A Shrinking Premium Base? 3.Medical Claim Cost Inflation 4.Indemnity Claim Cost Inflation 5.The Aging Workforce 6.The Obesity Epidemic

But First, Some Context: Employment, Real Wages, and Workers Comp Experience

Total Private Employment Grew by 26 Million Workers from 1991 to 2007 *Source: U.S. Bureau of Labor Statistics, at http://data.bls.gov/cgi-bin/surveymosthttp://data.bls.gov/cgi-bin/surveymost Millions (at mid-year) Total private employment rose 29%

Average Weekly Real Earnings in Private Employment Grew by 8.5% from 1991 to 2007 *Source: U.S. Bureau of Labor Statistics, at http://data.bls.gov/cgi-bin/surveymost http://data.bls.gov/cgi-bin/surveymost (at mid-year) Constant 1982 dollars Virtually all of the real wage growth occurred between 1996 and 2002. Real weekly wages grew 0.6% from 1991-1996 and 0.6% from 2002-2007.

Combined Ratio p Preliminary AY figure. Includes dividends to policyholders Accident Year data is evaluated as of 12/31/2006 and developed to ultimate Sources: Calendar Years 1994-2005, A.M. Best Aggregates & Averages; Calendar Year 2006p and Accident Years 1994-2006p based on NCCI Annual Statement Analysis. Workers Comp Underwriting Results: A Tale of Two Trends WC insurers lopped 25 points off the combined ratio in just 5 years! WC insurers added 25 points to the combined ratio in just 6 years!

WC profitability is on the rise, but is it sustainable? Hint: see 1998-2002. Calendar Year Percent Investment Gains Have Improved Workers Comp Profitability Source: NCCI

WC Investment Income Has Been Less Helpful Lately in Producing Profits * Adjusted Combined Ratio (ACR) translates combined ratio into typical percentage terms. For example, a combined ratio of 107.0 becomes a -7.0% ACR. Source: NCCI As u/w results strengthened, investment results weakened, producing only a modest operating gain ratio

P/C Insurance Combined Ratio, 2000-2007E Sources: A.M. Best; ISO, III. *III estimate for 2007 based on actual first three quarters. 2005 figure benefited from heavy use of reinsurance which lowered net losses The best underwriting result since 1949 (91.2 combined ratio) As recently as 2001, insurers paid out nearly $1.16 for every earned premium dollar 2007 deterioration due mainly to falling rates, but results still strong due to favorable CAT activity

P/C Net Income After Taxes 1991-2007F ($ Millions)* *ROE figures are GAAP; 1 ROAS is statutory Return On Average Surplus. 2007E figure of $63.5B is annualized actual 9-month statutory net income of $49.4B adjusted for Q4 catatrophe losses. **Actual 9- month 2007 result. Sources: A.M. Best, ISO, Insurance Information Inst.  2001 ROE = -1.2%  2002 ROE = 2.2%  2003 ROE = 8.9%  2004 ROE = 9.4%  2005 ROE= 9.4%  2006 ROE = 12.2%  2007E ROAS 1 = 13.1%** P/C insurer profits exceeded $60 billion in 2006/7.

Mega-Trend #1: Falling Lost-Time Claim Frequency and Falling Fatality Rates

Accident Year Percent Change Workers Comp Lost-Time Claim Frequency Down Over 50% Since 1991 1991-2005: Based on data through 12/31/2005, developed to ultimate. 2006p: Preliminary based on data valued as of 12/31/2006. Based on the states where NCCI provides ratemaking services. Excludes the effects of deductible policies Source: NCCI

Rate of Fatal Work Injuries Continues to Drop Source: US Bureau of Labor Statistics ; Insurance Information Institute. Fatality rates are down 26.4% since 1994. Fatal Work Injuries per 100,000 Workers

Number of Fatal Work Injuries Continues to Fall Source: US Bureau of Labor Statistics, US Department of Labor; Insurance Information Institute. The 14% decline in workplace fatalities since 1994 occurred despite the substantial growth in the size of the labor force since then.

Four Most Frequent Work- Related Fatal Events, 1992-2006 Work-related homicides down 52% since 1994; in 2006 homicides equal fatal “struck by object. Source: US Bureau of Labor Statistics, US Department of Labor; Insurance Information Institute. Highway Incidents Work-related homicides

But Not All Mega-Trends are Favorable

Mega-Trend #2: A Shrinking Premium Base?

Competition, Slow Payroll Growth, Large Retentions, Growth of State Funds & Captives Limit Private WC Premium Growth Calendar Year $ Billions P=Preliminary Sources: 1996–2005 Private Carriers, A.M. Best Aggregates & Averages; 2006p, NCCI 1996–2006p State Funds: AZ, CA, CO, HI, ID, KY, LA, MO, MT, NM, OR, RI, TX, UT Annual Statements Total Workers Compensation Premium Declined in 2006

Note: Shaded areas denote hard market periods. Source: A.M. Best, ISO, Insurance Information Institute P/C NWP Growth is Cyclical; We’ve Seen Slow Growth Since 2004 1975-781984-87 2000-04 2007E is actual 9-month result. 2007: Premium growth through the first 9 months of 2007 was 0%, the lowest reading since 1943

WC Rates Began Dropping in mid-2003 Source: Council of Insurance Agents & Brokers

WC Rates Have Retreated to Levels Last Seen in 2002 Source: Council of Insurance Agents & Brokers WC – red line – has generally followed the pattern for other commercial lines WC rates– red line – have generally followed the pattern for other commercial lines

Employers are Increasingly Accepting a Greater Share of Risk Sources: National Council on Compensation Insurance; Insurance Information Institute. The growing use of large deductibles is part of the explanation for decreased claim frequency Market Share of Plans with Large Deductibles

The Alternative-Risk-Transfer Market Draws WC Premiums from Traditional Carriers Source: MarketStance. Workers Compensation accounts for the largest share of the alternative market, particularly captives

Mega-Trend #3: Medical Claim Cost Inflation

WC Medical Severity Rising Far Faster than Medical CPI Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states. 3.5 pts WC medical severity rose more than twice as fast as the medical CPI (8.8% vs. 4.0%) from 1995 through 2006

Annual Change 1991–1996: +4.1% Annual Change 1997–2005: +9.5% Accident Year Medical Claim Cost ($000) 2006p: Preliminary based on data valued as of 12/31/2006 1991-2005: Based on data through 12/31/2005, developed to ultimate Based on the states where NCCI provides ratemaking services; Excludes the effects of deductible policies Workers Comp Medical Claim Costs Continue to Climb Cumulative Change = +200% (1993-2006p)

Med Costs Share of Total Costs is Increasing Steadily Source: NCCI (based on states where NCCI provides ratemaking services). 1986 1996 2006p

WC Med Cost Will Equal 70% of Total by 2016 if Trends Hold Source: Insurance Information Institute. 2016 Estimate If this happens, claims severity will accelerate relative to today claims management will become more difficult and complex but even more important

Mega-Trend #4: Indemnity Claim Cost Inflation

Indemnity Claim Cost (000s) Annual Change 1991–1996: +1.2% Annual Change 1997–2005: +6.6% Source: NCCI 2005p: Preliminary based on data valued as of 12/31/2006 1991-2005: Based on data through 12/31/2005, developed to ultimate, from states where NCCI provides ratemaking services. Excludes the effects of deductible policies Accident Year Workers Comp Indemnity Claims Costs Have Accelerated, 1993-2006p Cumulative Change = +108.5% (1993-2006p)

WC Indemnity Severity vs. Wage Inflation 2.1 pts 2006p: Preliminary based on data valued as of 12/31/2006; 1991-2005: Based on data through 12/31/2005, developed to ultimate. Based on the states where NCCI provides ratemaking services. Excludes the effects of deductible policies. CPS = Current Population Survey. Source: NCCI WC indemnity severity is once again outpacing wage inflation

Mega-Trend #5: The Aging Workforce

US Population: 2007 vs. 2025 Projection* Source: National Projections Program, Population Division, U.S. Census Bureau *Using the Census Bureau’s Middle (i.e., most probable) projections Population in each age group (in thousands) There will be nearly as many 85+ people in 2025 as there are 70-74 today

How accurate are these forecasts?

In 1996 the Census Bureau Projected the 2006 U.S. Population Source: U.S. Bureau of the Census, (NP-T3-C) Population Projections Program, Population Projections of the Total Resident Population by 5-year age groups, middle series, released January 13, 2000. U.S. Bureau of the Census Low Projection Middle Projection High Projection

In 2000 the Census Bureau Increased Its Middle Projection for 2006 Source: U.S. Bureau of the Census, (NP-T3-C) Population Projections Program, Population Projections of the Total Resident Population by 5-year age groups, middle series, released January 13, 2000. U.S. Bureau of the Census Instead of Low, Middle, and High forecasts, future Census Bureau projections will be probabilistic distributions. Middle projection was raised from 288 million to 290 million.

The Actual 2006 Population Exceeded the “High” 1996 and the “Middle” 2000 Projections Source: U.S. Bureau of the Census, (NP-T3-C) Population Projections Program, Population Projections of the Total Resident Population by 5-year age groups, middle series, released January 13, 2000. U.S. Bureau of the Census The actual 2006 population was just under 300 million

How Does This Mega-Trend Apply to Workers Compensation?

Quarterly Labor Force Participation Rate, Ages 65-69, 1998-2007 Source: US Bureau of Labor Statistics, US Department of Labor; Insurance Information Institute. The labor force participation rate for workers 65-69 might grow even faster in the future as seniors find they can’t fully retire on their meager retirement savings. Labor Force participation rate

Quarterly Labor Force Participation Rate, Ages 70-74, 1998-2007 Source: US Bureau of Labor Statistics, US Department of Labor; Insurance Information Institute. The labor force participation rate for workers 70-74 has grown by about 50% since 1998. It too might grow even faster in the future as seniors find they can’t fully retire on their meager retirement savings. Labor Force participation rate

Self Employment Among Workers, by Age Group: 2002 Source: Growing Older in America, US Department of Health and Human Services, p 46. In general, self-employed people have higher household incomes than wage earners but are less likely to have pensions and health insurance. Percent self-employed among persons working for pay

Why Elderly Stop Working, by Age Group: 2002 Source: Growing Older in America, US Department of Health and Human Services, p 47. Percent who stop working Age 80+ workers not retiring due to poor health!

Older Workers Have More Lost Time from Work Due to Injury or Illness Source: US Bureau of Labor Statistics, US Department of Labor There will be more lost time as the workforce ages in the future. Median Days Away From Work (2005) Age 65+ workers median lost time is 50% greater than workers age 35-44

Distribution of Non-Fatal Work Injury Days Away From Work, by Length of Period and Age group, Ages 45 and over, 2005 Source: US Bureau of Labor Statistics, US Department of Labor, Table 8 from 2005 Survey of Nonfatal Occupational Injuries and Illnesses Requiring Days Away from Work, Revised data released 11-17-2006. Percentage of cases Workers 65+ more likely to be out a month or more Workers 65+ more likely to be out two weeks than one

Fatal Work Injury Rates Climb Sharply With Age Source: US Bureau of Labor Statistics, US Department of Labor; Insurance Information Institute. The fatality rate for workers 65 and older is triple that of workers age 35-44. The workplace of the future will have to be completely redesigned to accommodate the surge in older workers. Fatal Work Injuries per 100,000 Workers (2006)

No Help from Medicare … Medicare law has long specified that If Workers Compensation is available, Medicare will pay nothing, Medicare will pay if costs remain after all WC medical benefits are exhausted, and If Medicare does pay a bill, it has a right of recovery from the employer or WC insurer. Workers Compensation and Medicare Source: Title 42 Code of Federal Regulations, Section 411 et seq.

and Maybe a Fight from Medicare Medicare is worried that, for workers who are covered by, or eligible for, Medicare, it will be stuck with costs shifted from those responsible for paying WC costs. So, in those cases, It wants to review, and maybe disapprove, Workers Compensation settlements, if it believes there is insufficient WC money to pay for future medical costs, This may align Medicare with workers against employers and WC insurers This will increase WC administration costs Workers Compensation and Medicare

Effect on WC Claims of Social Security Retirement Income When a SS DI recipient reaches the “full benefit” retirement age, the DI benefit becomes a retirement benefit Social Security Retirement Income is not offset for WC indemnity payments  So disabled workers age 66 and over can collect both – moral hazard? Workers Compensation and Social Security

One paper studied people age 59-69 who were working or not in 2000 and alive in 2002. It found that those who had paid work reduced the likelihood of reporting fair/poor health in 2002 by 6% had a modest but significant positive impact on actual health in 2002:  2% fewer cases of ADL limitations,  2% fewer cases of IADL limitations,  2% fewer cases of reporting negative mood indicators, and  1% less mortality. Interestingly, these findings (except the mood indicators) apply even to people in “undesirable” and “high stress” jobs Implication: improvements in the working environment for older workers will lessen their impact on employer-sponsored health and other insurance plans Continuing to Work is Associated with (leads to?) Better Health Esteban Calvo, “Does Working Longer Make People Healthier and Happier,” Center for Retirement Research, Boston College, Series 2, February 2006.

Mega-Trend #6: The Obesity Epidemic

Definitions: Obesity  Having a very high amount of body fat in relation to lean body mass  Body Mass Index of 30 or higher Body Mass Index (BMI)  A measure of an adult’s weight in relation to his or her height,  Specifically, the adult’s weight in kilograms divided by the square of his or her height in meters What Do We Mean by “Obesity” and How Do We Measure It? Note: This slide and the next 23 slides are courtesy of the Centers for Disease Control and Prevention.

Obesity Trends* Among U.S. Adults BRFSS, 1985 (*BMI ≥30, or ~ 30 lbs. overweight for 5’ 4” person) No Data <10% 10%–14% BRFSS is the CDC’s Behavioral Risk Factor Surveillance System. Each year, state health departments use standard procedures to collect data through a series of monthly telephone interviews with U.S. adults. Not a complete picture; many states didn’t provide data then.

Obesity Trends* Among U.S. Adults BRFSS, 1986 (*BMI ≥30, or ~ 30 lbs. overweight for 5’ 4” person) No Data <10% 10%–14%

Obesity Trends* Among U.S. Adults BRFSS, 1991 (*BMI ≥30, or ~ 30 lbs. overweight for 5’ 4” person) No Data <10% 10%–14% 15%–19%

Obesity Trends* Among U.S. Adults BRFSS, 1997 (*BMI ≥30, or ~ 30 lbs. overweight for 5’ 4” person) No Data <10% 10%–14% 15%–19% ≥20%

Obesity Trends* Among U.S. Adults BRFSS, 2001 (*BMI ≥30, or ~ 30 lbs. overweight for 5’ 4” person) No Data <10% 10%–14% 15%–19% 20%–24% ≥25%

(*BMI ≥30, or ~ 30 lbs. overweight for 5’ 4” person) Obesity Trends* Among U.S. Adults BRFSS, 2002 No Data <10% 10%–14% 15%–19% 20%–24% ≥25%

Obesity Trends* Among U.S. Adults BRFSS, 2005 (*BMI ≥30, or ~ 30 lbs. overweight for 5’ 4” person) No Data <10% 10%–14% 15%–19% 20%–24% 25%–29% ≥30%

Obesity Trends* Among U.S. Adults BRFSS, 2006 (*BMI ≥30, or ~ 30 lbs. overweight for 5’ 4” person) No Data <10% 10%–14% 15%–19% 20%–24% 25%–29% ≥30%

1998 Obesity Trends* Among U.S. Adults BRFSS, 1990, 1998, 2006 (*BMI 30, or about 30 lbs. overweight for 5’4” person) 2006 1990 No Data <10% 10%–14% 15%–19% 20%–24% 25%–29% ≥30%

BMI Categories Underweight: BMI <18.5 Healthy Weight: BMI=18.5-24.9 Overweight: BMI=25.0-29.9 Obese  Class I BMI=30.0-34.9  Class II BMI=35.0-39.9  Class III BMI>40.0 For Analysis Purposes, We Create BMI Categories

Among states participating in the CDC’s BRFSS*, In 1990,  10 states had a prevalence of obesity of less than 10% and  no states had prevalence equal to or greater than 15% By 1998,  every state had prevalence of at least 10%,  7 states had a prevalence between 20-24%, and  No state had prevalence equal to or greater than 25% In 2006,  Only 4 states had a prevalence of obesity of less than 20%  22 states had prevalence equal to or greater than 25%  2 of these states had prevalence equal to or greater than 30% Summary: Obesity Trends *Behavioral Risk Factor Surveillance System

The Most Obese Workers (BMI=40+) File Twice as Many WC Claims as Healthy-Weight (BMI=18.5-25) Workers Source: Ostbye, T., et al, “Obesity and Workers Compensation,” Archives of Internal Medicine, April 23, 2007. The most obese have 13 times more lost workdays than healthy weight workers!

WC Medical Claims Costs are 6.8x Higher for the Most Obese Workers Source: Ostbye, T., et al, “Obesity and Workers Compensation,” J. of the American Medical Association, April 23, 2007. Indemnity costs are 11 times higher for the most obese workers than for healthy- weight workers.

Not a Mega-Trend Yet, but … Other things to keep aware of

Regulatory Concerns McCarran-Ferguson  Narrowing could be harmful to WC rating bureaus and smaller insurers who rely most heavily on advisory loss cost information Health Care Reform Déjà Vu—1992  Health Care reform will be a major theme in 2008 elections as in 1992  Back in 1992, it was proposed that workers comp would be rolled into the general health care system  This could happen again  Insurers back then fretted about the “Medical Indemnity Disconnect”

The Terrorism Risk Insurance Program Reauthorization Act of 2007 7-Year Extension, expiring 12/31/14 Keeps Federal government’s cap at $100 billion Keeps 20% Direct Earned Premium Deductible (about $35B) Eliminates  distinction between foreign and domestic acts of terrorism  requirement that terrorist act be on behalf of foreign person or foreign interest  Changes in definition of terrorist act require substantial rate and form filings in states Requires Comptroller General to issue report within 180 days on obstacles in development of private sector market for terror insurance NBCR  NBCR risks remain excluded  Requires Comptroller General to issue report within 1 year on feasibility of NBCR insurance market Source: Insurance Information Institute

Insured Loss Estimates: Large NBCR Terrorist Attack ($ Bill) Type of CoverageNew YorkWashington San Francisco Des Moines Group Life $82.0$22.5$21.5$3.4 General Liability 14.42.93.20.4 Workers Comp 483.7126.787.531.4 Residential Prop. 38.712.722.62.6 Commercial Prop. 158.331.535.54.1 Auto 1.00.60.80.4 TOTAL$778.1$196.8$171.2$42.3 Source: American Academy of Actuaries, Response to President’s Working Group, Appendix II, April 26, 2006.

Summary Workers Compensation Has Benefited from Favorable Underlying Claims Trends, but this might not continue WC Premium Trends have followed the trend for Commercial Insurance generally Trends in Medical and Indemnity Cost are Worrisome The Aging of the Population and the Obesity Epidemic could cause WC claims to explode Q & A

Insurance Information Institute On-Line If you would like a copy of this presentation, please give me your business card with e-mail address

Mega-Trends Influencing the Workers Compensation Insurance Industry 5th Annual National Workers’ Compensation Insurance ExecuSummit New York, NY February.

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Mega-Trends Influencing the Workers Compensation Insurance Industry 5th Annual National Workers’ Compensation Insurance ExecuSummit New York, NY February.

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