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| NAVG > SEC Filings for NAVG > Form 10-Q on 1-May-2009 | All Recent SEC Filings |
1-May-2009
Quarterly Report
• changes in the laws, rules and regulations which apply to our insurance companies;
• the effects of emerging claim and coverage issues on our business, including adverse judicial or regulatory decisions and rulings;
• the effects of competition from banks and other insurers and the trend toward self-insurance;
• risks that we face in entering new markets and diversifying the products and services we offer;
• risk that the bank consortium does not renew the credit facility, which would cause us to find other sources to provide the letters of credit or other collateral required to continue our participation in Syndicate 1221;
• unexpected turnover of our professional staff;
• changing legal and social trends and inherent uncertainties in the loss estimation process that can adversely impact the adequacy of loss reserves and the allowance for reinsurance recoverables, including our estimates relating to ultimate asbestos liabilities and related reinsurance recoverables;
• risks inherent in the collection of reinsurance recoverable amounts from our reinsurers over many years into the future based on the reinsurers' financial ability and intent to meet such obligations to the Company;
• risks associated with our continuing ability to obtain reinsurance covering our exposures at appropriate prices and/or in sufficient amounts and the related recoverability of our reinsured losses;
• weather-related events and other catastrophes (including acts of terrorism) impacting our insureds and/or reinsurers, including, without limitation, the impact of Hurricanes Katrina, Rita, and Wilma in 2005 and Hurricanes Gustav and Ike in 2008 and the possibility that our estimates of losses from such hurricanes will prove to be materially inaccurate;
• our ability to attain adequate prices, obtain new business and retain existing business consistent with our expectations and to successfully implement our business strategy during "soft" as well as "hard" markets;
• our ability to maintain or improve our ratings to avoid the possibility of downgrades in our claims-paying and financial strength ratings significantly adversely affecting us, including reducing the number of insurance policies we write generally, or causing clients who require an insurer with a certain rating level to use higher-rated insurers;
• the inability of our internal control framework to provide absolute assurance that all incidents of fraud or unintended material errors will be detected and prevented;
• changes in accounting principles or policies or in our application of such accounting principles or policies;
• the risk that our investment portfolio suffers reduced returns or investment losses which could reduce our profitability; and
• other risks that we identify in future filings with the Securities and Exchange Commission (the "SEC"), including without limitation the risks described under the caption "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2008.
In light of these risks, uncertainties and assumptions, any forward-looking
events discussed in this Form 10-Q may not occur. You are cautioned not to place
undue reliance on any forward-looking statements, which speak only as of their
respective dates.
Overview
The discussion and analysis of our financial condition and results of operations
contained herein should be read in conjunction with our consolidated financial
statements and accompanying notes which appear elsewhere in this Form 10-Q. It
contains forward-looking statements that involve risks and uncertainties. Please
see "Note on Forward-Looking Statements" for more information. Our actual
results could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those discussed below and
elsewhere in this Form 10-Q.
We are an international insurance holding company focusing on specialty products
for niches within the overall property/casualty insurance market. The Company's
underwriting segments consist of insurance company operations and operations at
Lloyd's of London. Our largest product line and most long-standing area of
specialization is ocean marine insurance. We have also developed specialty
niches in professional liability insurance and in specialty liability insurance
primarily consisting of contractors liability and primary and excess liability
coverages. We conduct operations through our Insurance Companies and our Lloyd's
Operations. The Insurance Companies consist of Navigators Insurance Company,
which includes our U.K. Branch, and Navigators Specialty Insurance Company,
which underwrites specialty and professional liability insurance on an excess
and surplus lines basis fully reinsured by Navigators Insurance Company. Our
Lloyd's Operations include NUAL, a wholly-owned Lloyd's underwriting agency
which manages Syndicate 1221. Our Lloyd's Operations primarily underwrite marine
and related lines of business, professional liability insurance, and
construction coverages for onshore energy business at Lloyd's through Syndicate
1221. The European property business written by the Lloyd's Operations and the
U.K. Branch beginning in 2006 was discontinued during the 2008 second quarter.
We participate in the capacity of Syndicate 1221 through our wholly-owned
Lloyd's corporate member (we utilized two wholly-owned Lloyd's corporate members
prior to the 2008 underwriting year). During the 2008 second quarter the Company
closed two small underwriting agencies in Manchester and Basingstoke, England.
The discontinuance of the European property business and the closing of the
underwriting agencies did not have any significant effect on the Company's
financial condition or results of operations. In July 2008, the Company opened
an underwriting office in Stockholm, Sweden to write professional liability
business. In September 2008, Syndicate 1221 began to underwrite professional and
general liability insurance coverage in China through the Navigators
Underwriting Division of Lloyd's Reinsurance Company (China) Ltd.
While management takes into consideration a wide range of factors in planning
the Company's business strategy and evaluating results of operations, there are
certain factors that management believes are fundamental to understanding how
the Company is managed. First, underwriting profit is consistently emphasized as
a primary goal, above premium growth. Management's assessment of our trends and
potential growth in underwriting profit is the dominant factor in its decisions
with respect to whether or not to expand a business line, enter into a new
niche, product or territory or, conversely, to contract capacity in any business
line. In addition, management focuses on managing the costs of our operations.
Management believes that careful monitoring of the costs of existing operations
and assessment of costs of potential growth opportunities are important to our
profitability. Access to capital also has a significant impact on management's
outlook for our operations. The Insurance Companies' operations and ability to
grow the business and take advantage of market opportunities must take into
account regulatory capital requirements and rating agency assessments of capital
adequacy.
The discussions that follow include tables that contain both our consolidated
and segment operating results for the three month period ended March 31, 2009
and 2008. In presenting our financial results we have discussed our performance
with reference to underwriting profit or loss and the related combined ratio,
both of which are non-GAAP measures of underwriting profitability. We consider
such measures, which may be defined differently by other companies, to be
important in the understanding of our overall results of operations.
Underwriting profit or loss is calculated from net earned premium, less the sum
of net losses and LAE, commission expense, other operating expenses and
commission income and other income (expense). The combined ratio is derived by
dividing the sum of net losses and LAE, commission expense, other operating
expenses and commission income and other income (expense) by net earned
premiums. A combined ratio of less than 100% indicates an underwriting profit
and over 100% indicates an underwriting loss.
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 lower
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 insurance 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 insurance ("D&O"), 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 derive their premiums primarily from business written by
Navigators Management Company, Inc. ("NMC"), a wholly-owned underwriting
management company which produces, manages and underwrites insurance and
reinsurance for the Company. During the 2008 second quarter, Navigators
California Insurance Services, Inc. and Navigators Special Risk, Inc., also
wholly-owned underwriting management companies, were merged into NMC. Navigators
Management (UK) Ltd. produces, manages and underwrites insurance and reinsurance
for the U.K. Branch. Both NMC and Navigators Management (UK) Ltd. are reimbursed
for their actual costs. The Lloyd's Operations derive their premiums from
business written by NUAL which is reimbursed for its actual costs and, where
applicable, profit commissions on the business produced for Syndicate 1221.
From 2003 through 2006, we experienced generally beneficial market changes in
our lines of business. The marine rate increases began to level off in 2004 and
into 2005, however 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 average renewal premium rates for our Insurance Companies' marine business
increased approximately 4.2% for the 2009 first quarter. The average renewal
premium rates for our Lloyd's Operations marine business increased approximately
8.1% for the 2009 first quarter period.
Within our Property / Casualty lines, the contractors liability business saw
several years of favorable rate changes resulting from diminished capacity in
the market in which we compete, as many former competitors who lacked the
expertise to selectively underwrite this business have been forced to withdraw
from the market and the average renewal premium rate increases were
approximately 13.5% in 2004 and 49.1% in 2003. This was followed by declines in
rates of approximately 1.0% in 2005 and 5.6% in 2006, primarily due to
additional competition in the marketplace. This decline continued into 2007 and
2008 with average renewal premium rates declining approximately 10.7% and 11.9%
respectively. We expect competitive conditions to continue during 2009 resulting
in continuing declines in pricing for contractors liability and excess liability
business and the average renewal premium rates for the contractors liability
business declined approximately 4.3% in the 2009 first quarter. Offshore energy
average renewal premium rates increased approximately 5.7% for the 2009 first
quarter.
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. Professional liability average renewal premium rates decreased
approximately 6.6% in 2007 compared to relatively level average renewal premium
rates in 2006 and 2005 after decreasing approximately 3% in 2004 which followed
substantial average renewal premium rate increases in 2003 and 2002,
particularly for D&O insurance. The 2007 D&O insurance average renewal premium
rates decreased approximately 7.9% following decreases of approximately 1.7% in
2006, 2.3% in 2005 and 9.5% in 2004. The average renewal premium rates for the
professional liability business increased approximately 2.3% in the 2009 first
quarter including D&O insurance average renewal premium rates which declined
approximately 0.2% for the 2009 first quarter.
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.
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 policies that were in-force during 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
$147 million and $26 million, respectively, including the cost of reinsurance
reinstatement premiums, which emanates from 2008 underwriting year risks that
have yet to expire.
We have taken steps to reduce our aggregate exposures and to increase
profitability moving forward, and 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 will be significantly lower in 2009
based on the aggregate exposure to which we are managing, and the reinsurance
protection we have purchased. The primary policies that create exposure in the
Gulf of Mexico renew largely in April and July. We are evaluating the adequacy
of the pricing and terms on these policies and in many cases we are finding that
market pricing and terms do not meet our threshold as acceptable. If this
continues, our exposure to catastrophic windstorm in the Gulf of Mexico could
reduce even further.
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.
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 significant 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.
Reinsurance Recoverables. The most significant 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 that 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.
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 and brokers 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.
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, as 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.
The portion of the Company's premium that is estimated is 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 agents and
brokers 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.
Impairment of Invested Assets. Impairment of invested assets 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.
Equity securities are impaired when the fair value is less than 80% of the cost
for at least six months and in other cases where more severe declines occur for
less than six months.
With respect to fixed maturity securities, 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. If warranted as the result
of conditions relating to a particular security, we will focus on a significant
decline in market value regardless of the time period involved. 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 not to sell and more likely than not that we
will not be required to sell before the anticipated recovery of its remaining
amortized cost basis, 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.
As mentioned above, the Company considers its intent not to sell and more likely
than not that we will not be required to sell before the anticipated recovery as
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