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| NAVG > SEC Filings for NAVG > Form 10-K on 24-Feb-2009 | All Recent SEC Filings |
24-Feb-2009
Annual Report
Although not a financial measure, management's decisions are also greatly
influenced by access to specialized underwriting and claims expertise in our
lines of business. We have chosen to operate in specialty niches with certain
common characteristics which we believe provide us with the opportunity to use
our technical underwriting expertise in order to realize underwriting profit. As
a result, we have focused on underserved markets for businesses characterized by
higher severity and low frequency of loss where we believe our intellectual
capital and financial strength bring meaningful value. In contrast, we have
avoided niches that we believe have a high frequency of loss activity and/or are
subject to a high level of regulatory requirements, such as workers compensation
and personal automobile insurance, because we do not believe our technical
expertise is of as much value in these types of businesses. Examples of niches
that have the characteristics we look for include bluewater hull which provides
coverage for physical damage to, for example, highly valued cruise ships, and
directors and officers liability ("D&O") insurance which covers litigation
exposure of a corporation's directors and officers. These types of exposures
require substantial technical expertise. We attempt to mitigate the financial
impact of severe claims on our results by conservative and detailed
underwriting, prudent use of reinsurance and a balanced portfolio of risks.
Our revenue is primarily comprised of premiums and investment income. The
Insurance Companies and Lloyd's Operations derive their premiums primarily from
business written by wholly-owned underwriting management companies which
produce, manage and underwrite insurance and reinsurance for the Company. The
Company's products are distributed through multiple channels, utilizing global,
national and regional brokers as well as wholesalers.
The premium rate increases or decreases as noted below for marine, specialty and
professional liability are calculated primarily by comparing premium amounts on
policies that have renewed. The premiums are judgmentally adjusted for exposure
factors when deemed significant and sometimes represent an aggregation of
several lines of business. The rate change calculations provide an indicated
pricing trend and are not meant to be a precise analysis of the numerous factors
that affect premium rates or the adequacy of such rates to cover all
underwriting costs and generate an underwriting profit. The calculation can also
be affected quarter by quarter depending on the particular policies and the
number of policies that renew during that period. Due to market conditions,
these rate changes may or may not apply to new business which generally would be
more competitively priced compared to renewal business.
As a result of the substantial insurance industry losses resulting from
Hurricanes Katrina and Rita, the marine insurance market experienced diminished
capacity and rate increases through the end of 2006, particularly for the
offshore energy risks located in the Gulf of Mexico. Since the end of 2006,
competitive market conditions have returned as available capacity has increased.
The 2008 average renewal premium rates for our Insurance Companies marine
business increased approximately 0.4% for the fourth quarter and decreased
approximately 2.1% for the twelve month period, including offshore energy 2008
average renewal premium rates which increased approximately 2.3% for the fourth
quarter and decreased approximately 9.6% for the twelve months. The 2008 average
renewal rates for our Lloyd's Operations marine business decreased approximately
9.9% for the fourth quarter and 6.2% for the twelve month period, including
offshore energy 2008 average renewal rates which increased approximately 4.0%
for the fourth quarter and decreased approximately 10.4% for the twelve months.
The 2007 average renewal premium rates for our Insurance Companies marine
business decreased approximately 1.2% for the fourth quarter and 0.1% for the
twelve month period, including offshore energy 2007 average renewal premium
rates which decreased approximately 14.2% for the fourth quarter and 2.4% for
the twelve months. The 2007 average renewal rates for our Lloyd's Operations
marine business decreased approximately 5.1% for the fourth quarter and 1.2% for
the twelve month period, including offshore energy 2007 average renewal rates
which decreased approximately 5.5% for the fourth quarter and 3.7% for the
twelve months. We expect continuing overall declines in 2009 pricing for most
marine lines of business, except offshore energy and marine liability which may
strengthen due to the 2008 storm losses, as additional capacity continues to
re-enter the marine market.
Specialty liability losses in 2001 to 2003, particularly for construction
liability business, resulted in diminished capacity in the market in which we
compete, as many former competitors who lacked the expertise to selectively
underwrite this business were forced to withdraw from the market resulting in
approximate premium rate increases of 13.5% in 2004 and 49.1% in 2003. This was
followed by a slight decline in rates of approximately 1.0% in 2005. The
2006 year average renewal rates for the construction liability business declined
approximately 5.6%, primarily due to additional competition in the marketplace.
This decline continued into 2007 with average renewal premium rates declining
approximately 9.7% for the fourth quarter and 10.7% for the twelve months. In
2008, average renewal premium rates declined approximately 10.2% for the fourth
quarter and 11.9% for the twelve months. We expect competitive conditions will
continue into 2009 resulting in continued but slowing rate of declines in
pricing for construction liability and excess liability business.
In the professional liability market, the enactment of the Sarbanes-Oxley Act of
2002, together with financial and accounting scandals at publicly traded
corporations and the increased frequency of securities-related class action
litigation, has led to heightened interest in professional liability insurance
generally. Following substantial average professional liability renewal rate
increases in 2002 and 2003, particularly for D&O insurance, average renewal
rates decreased approximately 3.2% in 2004 and then remained relatively level in
2005 and 2006 followed by an approximate 6.6% decrease in 2007. Average 2008
professional liability renewal premium rates increased approximately 0.2% for
the fourth quarter and decreased approximately 4.5% for the twelve months. The
2008 D&O insurance renewal premium rates increased approximately 0.5% for the
fourth quarter and decreased approximately 2.7% for the twelve months. The 2007
D&O insurance renewal premium rates decreased approximately 7.9% following
decreases of approximately 1.7% for 2006 and 2.3% for 2005 and 9.5% for 2004. We
anticipate a stabilization in 2009 pricing given the industry dislocation.
Our business is cyclical and influenced by many factors. These factors include
price competition, economic conditions, interest rates, weather-related events
and other catastrophes including natural and man-made disasters (for example
hurricanes and terrorism), state regulations, court decisions and changes in the
law. The incidence and severity of catastrophes are inherently unpredictable.
Although we will attempt to manage our exposure to such events, the frequency
and severity of catastrophic events could exceed our estimates, which could have
a material adverse effect on our financial condition. Additionally, because our
insurance products must be priced, and premiums charged, before costs have fully
developed, our liabilities are required to be estimated and recorded in
recognition of future loss and settlement obligations. Due to the inherent
uncertainty in estimating these liabilities, we cannot assure you that our
actual liabilities will not exceed our recorded amounts.
For additional information regarding our business, see "Business-General",
included herein.
Catastrophe Risk Management
Our Insurance Companies and Lloyd's Operations have exposure to losses caused by
hurricanes and other natural and man-made catastrophic events. The frequency and
severity of catastrophes are unpredictable.
The extent of losses from a catastrophe is a function of both the total amount
of insured exposure in an area affected by the event and the severity of the
event. We continually assess our concentration of underwriting exposures in
catastrophe exposed areas globally and attempt to manage this exposure through
individual risk selection and through the purchase of reinsurance. We also use
modeling and concentration management tools that allow us to better monitor and
control our accumulations of potential losses from catastrophe exposures.
Despite these efforts, there remains uncertainty about the characteristics,
timing and extent of insured losses given the nature of catastrophes. The
occurrence of one or more severe catastrophic events could have a material
adverse effect on the Company's results of operations, financial condition or
liquidity.
The Company has significant catastrophe exposures throughout the world with the
largest catastrophe exposure coming from offshore energy risks exposed to
hurricanes in the Gulf of Mexico. Following the 2008 hurricane season many
offshore energy accounts that suffered claims from Hurricanes Gustav and Ike now
have either reduced limits or have used up the entire windstorm limit of the
policy. To take account of this in assessing our overall Gulf of Mexico
exposure, we have remodeled the offshore energy exposure with these reduced
windstorm limits. Based on this assessment, the Company estimates that our
probable maximum pre-tax gross and net loss exposure in a theoretical one in two
hundred and fifty year hurricane event in the Gulf of Mexico would approximate
$163 million and $27 million, respectively, including the cost of reinsurance
reinstatement premiums. In the absence of the aforementioned policy limits being
exhausted, our probable maximum pre-tax gross and net loss exposure would
approximate $233 million and $29 million, respectively, including the cost of
reinsurance reinstatement premiums.
We are in the process of reassessing the way in which we manage our Gulf of
Mexico exposures and the reinsurance protection that is purchased to protect
those risks. We are taking steps to reduce our aggregate exposures and to
increase profitability moving forward. The estimated probable maximum pre-tax
gross and net loss exposure in a so-called or theoretical one in two hundred and
fifty year hurricane event in the Gulf of Mexico could be significantly
different in 2009 depending on the market conditions and reinsurance protection
we purchase. The primary policies that create exposure in the Gulf of Mexico
renew largely in April and July. We will evaluate the adequacy of the pricing
and terms on these policies at that time. If we do not find the pricing and
terms to be acceptable our exposure to catastrophic windstorm in the Gulf of
Mexico could reduce substantially.
There are a number of significant assumptions and variables related to such an
estimate including the size, force and path of the hurricane, the various types
of the insured risks exposed to the event at the time the event occurs and the
estimated costs or damages incurred for each insured risk. There can be no
assurances that the gross and net loss amounts that the Company could incur in
such an event or in any hurricanes that may occur in the Gulf of Mexico would
not be materially higher than the estimates discussed above given the
significant uncertainties with respect to such an estimate.
The occurrence of large loss events could reduce the reinsurance coverage that
is available to us and could weaken the financial condition of our reinsurers,
which could have a material adverse effect on our results of operations.
Although the reinsurance agreements make the reinsurers liable to us to the
extent the risk is transferred or ceded to the reinsurer, ceded reinsurance
arrangements do not eliminate our obligation to pay claims to our policyholders.
We are required to pay the losses even if a reinsurer fails to meet its
obligations under the reinsurance agreement. Accordingly, we bear credit risk
with respect to our reinsurers. Specifically, our reinsurers may not pay claims
made by us on a timely basis, or they may not pay some or all of these claims.
Either of these events would increase our costs and could have a material
adverse effect on our business.
Hurricanes Gustav, Ike, Katrina and Rita
Hurricanes Gustav and Ike (the "2008 Hurricanes") which occurred in the 2008
third quarter and Hurricanes Katrina and Rita (the "2005 Hurricanes") which
occurred in the 2005 third quarter generated substantial losses to the property
and casualty industry and the marine and energy insurance market due principally
to offshore energy losses. There were no significant hurricane losses in 2007 or
2006 that impacted the marine and energy lines of business of the Company.
The Company monitors the development of paid and reported claims activities in
relation to the estimate of ultimate losses established for the 2008 Hurricanes
and the 2005 Hurricanes.
Management believes that should any adverse loss development for gross claims
occur from the 2008 Hurricanes or the 2005 Hurricanes, it would be contained
within our reinsurance program. Our actual losses from such hurricanes may
differ materially from our estimated losses as a result of, among other things,
the receipt of additional information from insureds or brokers, the attribution
of losses to coverages that for the purposes of our estimates we assumed would
not be exposed and inflation in repair costs due to the limited availability of
labor and materials. If our actual losses from the 2008 Hurricanes or the 2005
Hurricanes are materially greater than our estimated losses, our business,
results of operations and financial condition could be materially adversely
affected.
See "Business - Loss Reserves" included herein for a discussion of the impact of
the 2008 Hurricanes and the 2005 Hurricanes on our financial results.
Critical Accounting Policies
It is important to understand our accounting policies in order to understand our
financial statements. Management considers certain of these policies to be
critical to the presentation of the financial results, since they require
management to make estimates and assumptions. These estimates and assumptions
affect the reported amounts of assets, liabilities, revenues, expenses, and
related disclosures at the financial reporting date and throughout the reporting
period. Certain of the estimates result from judgments that can be subjective
and complex and, consequently, actual results may differ from these estimates,
which would be reflected in future periods.
Our most critical accounting policies involve the reporting of the reserves for
losses and LAE (including losses that have occurred but were not reported to us
by the financial reporting date), reinsurance recoverables, written and unearned
premium, the recoverability of deferred tax assets, the impairment of invested
assets, accounting for Lloyd's results and the translation of foreign
currencies.
Reserves for Losses and LAE. Reserves for losses and LAE represent an estimate
of the expected cost of the ultimate settlement and administration of losses,
based on facts and circumstances then known. Actuarial methodologies are
employed to assist in establishing such estimates and include judgments relative
to estimates of future claims severity and frequency, length of time to develop
to ultimate, judicial theories of liability and other third party factors which
are often beyond our control. Due to the inherent uncertainty associated with
the reserving process, the ultimate liability may be different from the original
estimate. Such estimates are regularly reviewed and updated and any resulting
adjustments are included in the current year's results. Additional information
regarding our loss reserves can be found in "-Results of Operations-Operating
Expenses-Net Losses and Loss Adjustment Expenses Incurred," "Business-Reserves,"
and Note 5, Reserves for Losses and Loss Adjustment Expenses, to our
consolidated audited financial statements, all of which are included herein.
Reinsurance Recoverables. Reinsurance recoverables are established for the
portion of the loss reserves that are ceded to reinsurers. Reinsurance
recoverables are determined based upon the terms and conditions of reinsurance
contracts which could be subject to interpretations that differ from our own
based on judicial theories of liability. In addition, we bear credit risk with
respect to our reinsurers which can be significant considering that certain of
the reserves remain outstanding for an extended period of time. We are required
to pay losses even if a reinsurer fails to meet its obligations under the
applicable reinsurance agreement. Additional information regarding our
reinsurance recoverables can be found in the "Business-Reinsurance Ceded"
section and Note 6, Reinsurance, to our consolidated audited financial
statements, both included herein.
Written and Unearned Premium. Written premium is recorded based on the insurance
policies that have been reported to us and the policies that have been written
by agents but not yet reported to us. We must estimate the amount of written
premium not yet reported based on judgments relative to current and historical
trends of the business being written. Such estimates are regularly reviewed and
updated and any resulting adjustments are included in the current year's
results. An unearned premium reserve is established to reflect the unexpired
portion of each policy at the financial reporting date. Reinsurance
reinstatement premium is earned in the period in which the event occurred which
created the need to record the reinstatement premium. Additional information
regarding our written and unearned premium can be found in Note 1, Organization
and Summary of Significant Accounting Policies, and Note 6, Reinsurance, to our
consolidated audited financial statements, both included herein.
Substantially all of our business is placed through agents and brokers. Since
the vast majority of the Company's gross written premium is primary or direct as
opposed to assumed the delays in reporting assumed premium generally do not have
a significant effect on the Company's financial statements, since we record
estimates for both unreported direct and assumed premium. We also record the
ceded portion of the estimated gross written premium and related acquisition
costs. The earned gross, ceded and net premiums are calculated based on our
earning methodology which is generally pro-rata over the policy period. Losses
are also recorded in relation to the earned premium. The estimate for losses
incurred on the estimated premium is based on an actuarial calculation
consistent with the methodology used to determine incurred but not reported loss
reserves for reported premiums.
A portion of the Company's premium is estimated for unreported premium, mostly
for the marine business written by our U.K. Branch and Lloyd's Operations. We
generally do not experience any significant backlog in processing premiums. Such
premium estimates are generally based on submission data received from brokers
and agents and recorded when the insurance policy or reinsurance contract is
written or bound. The estimates are regularly reviewed and updated taking into
account the premium received to date versus the estimate and the age of the
estimate. To the extent that the actual premium varies from the estimates, the
difference, along with the related loss reserves and underwriting expenses, is
recorded in current operations.
Deferred Tax Assets. We apply the asset and liability method of accounting for
income taxes whereby deferred assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. In assessing the realization of deferred tax assets,
management considers whether it is more likely than not that the deferred tax
assets will be realized. Additional information regarding our deferred tax
assets can be found in Note 1, Organization and Summary of Significant
Accounting Policies, and Note 7, Income Taxes, to our consolidated audited
financial statements, both included herein.
Impairment of Investment Securities. Impairment of investment securities results in a charge to operations when a market decline below cost is other-than-temporary. Management regularly reviews our fixed maturity and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. In general, we focus our attention on those securities whose market value was less than 80% of their cost or amortized cost, as appropriate, for six or more consecutive months. Factors considered in evaluating potential impairment include, but are not limited to, the current fair value as compared to cost or amortized cost of the security, as appropriate, the length of time the investment has been below cost or amortized cost and by how much, our intent and ability to retain the investment for a period of time sufficient to allow for an anticipated recovery in value, specific credit issues related to the issuer and current economic conditions. Other-than-temporary impairment losses result in a permanent reduction of the cost basis of the underlying investment. Significant changes in the factors we consider when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the consolidated financial statements. For additional detail regarding our investment portfolio, including disclosures regarding other-than-temporary declines in investment value, see the "Business-Investments" section and Note 4, Investments, to our consolidated audited financial statements, both included herein. As mentioned above, the Company considers its intent and ability to hold a security until the value recovers as part of the process of evaluating whether a security's unrealized loss represents an other-than-temporary decline. The Company's ability to hold such securities is supported by sufficient cash flow from its operations and from maturities within its investment portfolio in order to meet its claims payment and other disbursement obligations arising from its underwriting operations without selling such investments. With respect to securities where the decline in value is determined to be temporary and the security's value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information and market conditions. Management of the Company's investment portfolio is outsourced to third party investment managers. While these investment managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses that are considered temporary until such losses are recovered, the dynamic nature of the portfolio management may result in a subsequent decision to sell the security and realize the loss, based upon a change in market and other factors described above. The Company believes that subsequent decisions to sell such securities are consistent with the classification of the Company's portfolio as available-for-sale. Investment managers are required to notify management of rating agency . . .
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