RATE INCREASES MODERATE; WORKERS’ COMPENSATION CREATING CHALLENGES

L O C K T O N C O M P A N I E S

Market Insight May 2013

The 2012 year-end results indicate a property and casualty market that is showing progress with regards to profitability, despite the losses from Superstorm Sandy and a challenging investment environment. According to the Insurance Services Office, Inc., and the Property Casualty Insurers Association of America, net income after taxes rose to $33.5B in 2012, up from $19.5B in 2011; the policyholders’ surplus hit a record $586.9B in 2012; and the industry combined ratio improved to 103.2, from 108.1 percent in 2011.

The improved carrier results come from a combination of two factors: rate increases and a decrease in losses after a catastrophe-filled 2011. However, while carriers are seeing progress, the 5.9 percent overall rate of return on average policyholders’ surplus still lagged below the 8.9 percent average over the last 50+ years.

Facing a combination of constrained investment income as well as the large losses from 2011, underwriters have been under pressure to generate income in other ways, usually by way of rate increases. Lockton is finding that while some areas, particularly workers’ compensation, are providing challenges in this regard, there are a number of sectors where competition is keeping rates to a moderate level. The following pages document insight gained from a roundtable discussion of Lockton property and casualty experts around the country.

Property

Superstorm Sandy was the largest driver of property losses in 2012. After it hit the East Coast in late October of 2012, there was concern in the insurance community about the effect it would have on property insurance rates. At the time, there was speculation that insurers may start quoting Tier 1 deductibles on properties along the Northeast Coast, or that carriers may consider the extension of the Tier 1 Wind Zone to property up the Northeast Coast. It appears the impact may not have been as bad as initially feared.

Greg DiPrato, Senior Vice President in Lockton’s Global Property Practice, says that while there are certainly challenges in this regard, in general, he hasn’t seen the pushback that he expected from carriers regarding deductibles and Tier 1 zones on accounts with large property exposures.

Market Insight, U.S. Property & Casualty Lockton

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DiPrato goes on to say that it appears underwriters are under pressure to write large premium accounts. As a consequence, they may be willing to look at a large account they may have passed on historically. Carriers seem less willing to let a large premium account go due to increased pressure to write business.

Jim Collins, Senior Vice President and Enterprise Team Leader in Lockton’s Kansas City office, says that on his middle market accounts, for property, price increases have been moderate.

Vince Gaffigan, Senior Vice President and Director of Risk Management Services in Lockton’s St. Louis office, agrees. He says that there is a higher demand for information from the carriers, but if you are able to provide the information and get the underwriter comfortable with risk, there are still instances where positive outcomes are available.

Workers’ Compensation

Workers’ compensation continues to be a difficult line of coverage to place. According to the most recent Property/Casualty Market Index Survey from the Council of Insurance Agents & Brokers, brokers across the country are experiencing significant price increases and, in some cases, limited capacity.

All of our experts agreed that workers’ compensation is the line of coverage that is the most problematic. Vince Gaffigan is seeing rate increases between 5 and 8 percent, possibly more if there is significant payroll in Florida, California, or New York. He is seeing a lot more pressure from carriers on retentions as well.

Gaffigan goes on to say that the rate increases are being compounded by exposure increases. “As the economy improves and companies hire more employees, payrolls increase, driving up workers’ compensation prices even more. Workers’ compensation deals are taking longer to get done and they require more competition.”

From a national account perspective, Eric Silverstein, Senior Vice President and National Accounts Team Leader in Lockton’s Southeast office, agrees. “We are seeing workers’ compensation losses on some accounts trend up significantly, and as a consequence, the insurers are applying some fairly conservative development factors, which then impacts the amount of collateral required. So, in certain cases, there is stress on the pricing, the taxes and assessments, and also the collateral position.”

Silverstein says the rate on rate increases being sought by carriers is an area of growing concern to clients, especially those with good risk profiles. “When carriers propose a larger rate increase than they did the previous year, unless the insured has poor loss experience, it’s going to force the insured to test the market. As a result, we are seeing more movement in the marketplace.”

-13.5%-12.9%

-11.0%

-6.4%

-5.1%-4.9%

-5.8%

-5.6%

-5.3%

-6.4%

-5.2%

-5.4%

-2.9%-0.1%

0.9%

2.7%

4.4% 4.3%

3.9%

5.0%

5.2%

-15%

-10%

-5%

0%

5%

10%

2008

Q1

2008

Q2

2008

Q3

2008

Q4

2009

Q1

2009

Q2

2009

Q3

2009

Q4

2010

Q1

2010

Q2

2010

Q3

2010

Q4

2011

Q1

2011

Q2

2011

Q3

2011

Q4

2012

Q1

2012

Q2

2012

Q3

2012

Q4

2013

Q1

AVERAGE COMMERCIAL RATE CHANGE 2008-2013

Source: The Council of Insurance Agents & Brokers

Market Insight, U.S. Property & Casualty Lockton

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Mark Zwickel, Executive Vice President and CID Manager in Lockton’s Southern California office, says, “Middle market workers’ compensation rates continue to go up in California.” However, he says, “If you market an account aggressively and push back on the carrier, in some instances, you will be able to get the increase down to a more moderate level.” Zwickel adds that some carriers will offer a deductible or a retro option in lieu of guaranteed cost.

In the Midwest, Collins’ middle market accounts are seeing increases of 5 to 10 percent, assuming no losses. He points out that monoline workers’ compensation appetite is becoming scarce.

Auto

Auto rates are seeing a slight increases, and Lockton is finding that the makeup of a client’s fleet is a big underwriting factor. Gaffigan estimates that auto placements are seeing increases of between 2 and 4 percent, depending on the size and makeup of the fleet. “For large fleets, we are starting to see buffer layers come back into play in a big way, as many umbrella markets are now demanding attachment points of $5 to 10 million. Much depends, however, on the mix of vehicles and loss history.”

From a national account perspective, Silverstein is also seeing some increases and he agrees that it depends on the composition of the fleet. “The heavier the power units, the more the increase and the more pressure as to what limit may be provided to support the excess.”

Market Insight, U.S. Property & Casualty Lockton

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General Liability

Teams placing general liability coverage are seeing modest increases, and they are facing more questions from carriers. Gaffigan says he is seeing somewhere between 2 and 4 percent rate increases in general liability. “Carriers are asking significantly more questions about indemnification controls, even if it is an incumbent that has been on the program for a long time.”

Gaffigan goes on to say that he is seeing more specialization within industries. “For instance, carriers might write energy companies, but not those involved in fracking. Or in the medical arena, a market might write noninvasive equipment, but not invasive, making it as important as ever to have a comprehensive understanding of the markets and the risk.”

Silverstein is not seeing a tremendous amount of general liability increases in the national accounts arena. He says that carriers are asking a lot of questions, but the moderate tort environment is keeping rates under control.

Excess

Gaffigan says there isn’t a lot of competition for excess with his middle market accounts. Carriers that will write this coverage sometimes want to raise attachment points on the underlying general liability. They are also significantly pushing attachments on auto.

From a national accounts perspective, Silverstein says that on the excess side, he is seeing some single-digit price increases, but they are being somewhat offset in certain cases by a changing attachment point, so the real price increases are probably more significant, particularly in the areas of transportation and energy. He goes on to say that more attention is being paid to large private fleets and their attachment points.

Silverstein also points out that a number of wholesale markets that have been excess and surplus markets in the past are attempting to round out their book of business by opening up a retail strategy, taking on more premium as more companies move to buffer layers. He says, “This could lead to a change in big players a year or two from now. The retail marketplace may end up being significantly impacted by those we currently view as E&S markets.”

The excess market

may end up being

significantly

impacted by those

we currently view as

E&S markets.

Market Insight, U.S. Property & Casualty Lockton

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Executive Risk

Rodger Laurite, Senior Vice President in Lockton’s Financial Services Practice, is seeing a definite push for increased rates from executive lines carriers for both public and private business. He is also seeing a push from carriers for higher retentions for clients with reported losses.

On larger deals, Laurite says increases seem to be confined to the primary lines and maybe the first excess layer. “Above that, rates are between flat and 1 to 2 percent because most of the claims in this space are related to mergers and acquisitions that are only hitting the primary layers and not bleeding into the excess.” It depends on the risk, of course, but overall, there has not been a large increase in the excess.

In the private company space, Laurite says that almost every carrier is looking for rate increases. Sometimes, competition is willing to write new business that is lower than expiring, but in general, incumbents are looking for increases.

INDUSTRY FOCUS: HABITATIONAL REAL ESTATEAs one of Lockton’s larger industry segments, multifamily real estate has its own set of unique challenges in the property and casualty marketplace. Below is insight regarding the current state of the property and casualty insurance market for multifamily real estate from Peter Romano, Senior Vice President and Manager of Lockton’s Real Estate Practice.

As a general rule, property pricing remains firm across the industry. Of late, where Romano has seen rate increases in the multifamily industry, it is primarily dependent on four factors:

� Deductibles—There are very few markets for small-deductible programs. The smaller the deductible, the fewer the markets willing to take on the business. Additionally, since Superstorm Sandy, markets are taking a closer look at wind and flood deductibles, especially in the Northeastern U.S.

� Client losses—As in other sectors, the worse the loss ratio is, the higher the rate increases are. Fire losses continue to be a significant loss driver in the industry.

� Geography—Carriers are paying special attention to portfolios with a high concentration of values in Tier 1 wind zones, A/V flood zones, and California quake zones, as well as putting increased emphasis on hail-prone states, such as Colorado, Oklahoma, and Texas.

� No new capacity—With a few exceptions on larger deals, there are no significant new entrants into the marketplace of late, and at least one carrier that was doing smaller placements (under 5,000 units) has recently pulled out of the market.

Romano believes that smaller clients buying lower deductibles are being impacted the most in this environment. Meanwhile, larger clients can better manage any rate impact by converting some of the fixed cost increases into variable costs and/or through alternative deductible and program structures.

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The general liability and umbrella market continues to adjust to underlying loss trends driven by adverse claims development and outsized jury verdicts. This is especially true for clients with a high concentration of affordable housing units, where losses tend to be higher. In spite of continued rate pressure, clients continue to mostly buy guaranteed cost or small self-insured retentions, around $25,000, primarily due to contract and/or lender requirements. As with property, larger clients are able to look at higher retentions (greater than $100,000) and/or alternative structures to offset rate increases, as well as push back on restrictive contract and lender requirements.

It is a similar situation with workers’ compensation. In the multifamily space, clients are primarily guaranteed cost buyers. As with general liability, adverse historical development and medical inflation continue to put pressure on loss ratios and premium rates. Markets are responding by putting more emphasis on loss rating versus manual rating methods, which in turn is putting upward pressure on premium rates as loss trends deteriorate. Many clients are turning to loss control and claims management practices to help prevent and mitigate claims. The primary focus is on maintenance workers, where the bulk of losses tend to occur.

Overall, Romano believes that recognizing these underlying industry trends is the best way to mitigate their impact on the bottom line. Further, creating proactive loss control and claims programs to help prevent and mitigate loss drivers is a key differentiator for Lockton and its clients. The sheer volume of benchmarking and claims data available across our portfolio allows us to deliver customized solutions for our clients. These initiatives and the results they generate are welcomed by the markets and provide clients a competitive advantage as they gain more control over their total cost of risk.

Conclusion

There was a rebound in the overall profitability of the property and casualty industry in 2012. Despite the large losses from Superstorm Sandy and weak investment results, carriers saw net income after taxes increase to $33.5B in 2012, up from $19.5B in 2011, according to the Insurance Services Office Inc. and the Property Casualty Insurers Association of America.

With the exception of workers’ compensation, Lockton is seeing property and casualty rate increases in the single digits, depending on the makeup and loss history of the insured. In general, carriers are continuing to manage their underwriting profitability and ROE and, as a result, are seeking rate increases. Lockton finds that with a good risk profile, a thorough submission, and good relationships, rates should remain at a reasonable level.

Market Insight, U.S. Property & Casualty Lockton

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After a catastrophe-filled 2011,

2012 saw a decrease in losses and

loss adjustment expenses from

catastrophes. That, combined with

rising premiums, contributed to the

overall improvement of underwriting

results. The net underwriting loss

for 2012 improved to $16.7B, from

$36.2B in 2011.

U.S. PROPERTY & CASUALTY INDUSTRY AT A GLANCE

Net written premium growth

had its largest increase since

2004. This increase is comprised

of both pure rate increase and

growth in exposure.

All charts include mortgage and financial guaranty insurers. Excluding these insurers, the net written premium growth for 2012 was 5.7 percent.

0

8.4%

15.3%

10.0%

4.9%

0.5%

4.2%

-0.6%-1.4%

-3.7%

0.9%

3.3%4.3%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Premiums written are still increasing modestly.

More growth occurring in commercial lines than in personal.

Commercial lines rates are rising by single digits for most lines (assuming a favorable loss history).

Some lines are experiencing more pressure: CAT-exposed property Habitational risks Workers’ compensation Large umbrella with a large fleet as

part of the exposure

Current DynamicsWritten Premium Growth Slowed

Source: Insurance Information Institute

Net Written Premium Growth Year-to-Year Change in NWP 2001 to 2012

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NET WRITTEN PREMIUM GROWTH: MODEST YEAR-TO-YEAR CHANGE IN NWP—2001-2012

1

Current DynamicsUnderwriting Losses Dropped in the First Nine Months

Sources: Insurance Information Institute *Includes mortgage guarantee insurers

Underwriting PerformanceU.S. 2001–2012

Combined RatioU.S. 2007–2012

-60

-50

-40

-30

-20

-10

0

10

20

30

40

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

95.1%

105.1%

101.0%102.4%

108.1%

103.2%

85%

90%

95%

100%

105%

110%

2007 2008 2009 2010 2011 2012

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UNDERWRITING PERFORMANCE: IMPROVING NET UNDERWRITING GAINS (LOSSES)—2001-2012

$ Bi

llion

s

Market Insight, U.S. Property & Casualty Lockton

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8

All charts include mortgage and financial guaranty insurers. Excluding these insurers, the combined ratio for 2012 was 102.4.

The industry combined ratio, a measure of

underwriting profit, improved to 103.2% in

2012, down from 108.1% in 2011.

Challenged by low interest rates,

carriers saw investment gains drop to

$53.9B, compared to $56.2B in 2011,

curbing profitability.

1

Current DynamicsUnderwriting Losses Dropped in the First Nine Months

Sources: Insurance Information Institute *Includes mortgage guarantee insurers

Underwriting PerformanceU.S. 2001–2012

Combined RatioU.S. 2007–2012

-60

-50

-40

-30

-20

-10

0

10

20

30

40

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

95.1%

105.1%

101.0%102.4%

108.1%

103.2%

85%

90%

95%

100%

105%

110%

2007 2008 2009 2010 2011 2012

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Source: Insurance Information Institute

COMBINED RATIO: IMPROVING U.S. 2007-2012

2

$36.0

$45.3 $48.9

$59.4 $55.7

$63.6

$31.4

$38.9

$52.9 $56.2

$53.9

$0

$10

$20

$30

$40

$50

$60

$70

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Dol

lars

in B

illio

ns

Investment income key to carriers’ financial health.

Low interest rates have had an effect on gains.

The first three quarters saw a drop of 9.7% in investment gains compared to the first three quarters of 2011.

Decline in investment results offset insurer profitability.

Current DynamicsInvestment Gains Dropping

Investment gains consist primarily of interest, stock dividends, and realized capital gains and losses. Sources: ISO; Insurance Information Institute.

Investment PerformanceU.S. Property Casualty Investment Gains 2002–2012

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INVESTMENT GAINS: LAGGING 2002–2012

U.S. PROPERTY & CASUALTY INDUSTRY AT A GLANCE