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NAVG > SEC Filings for NAVG > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for NAVIGATORS GROUP INC


8-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

NOTE ON FORWARD-LOOKING STATEMENTS

Some of the statements in this Quarterly Report on Form 10-Q for The Navigators Group, Inc. and its subsidiaries ("the Company", "we", "us", and "our") are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact included in or incorporated by reference in this Quarterly Report are forward-looking statements. Whenever used in this report, the words "estimate," "expect," "believe" or similar expressions or their negative are intended to identify such forward-looking statements. Forward-looking statements are derived from information that we currently have and assumptions that we make. We cannot assure that anticipated results will be achieved, since actual results may differ materially because of both known and unknown risks and uncertainties which we face. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Factors that could cause actual results to differ materially from our forward-looking statements include, but are not limited to, the factors discussed in the "Risk Factors" section of our 2012 Annual Report on Form 10-K as well as:

continued volatility in the financial markets and the current recession;

risks arising from the concentration of our business in marine and energy, general liability and professional liability insurance, including the risk that market conditions for these lines could change adversely or that we could experience large losses in these lines;

cyclicality in the property and casualty insurance business generally, and the marine insurance business specifically;

risks that we face in entering new markets and diversifying the products and services that we offer, including risks arising from the development of our new specialty lines or our ability to manage effectively the rapid growth in our lines of business;

changing legal, social and economic trends and inherent uncertainties in the loss estimation process, which could adversely impact the adequacy of loss reserves and the allowance for reinsurance recoverables;

risks inherent in the preparation of our financial statements, which require us to make many estimates and judgments;

our ability to continue to obtain reinsurance covering our exposures at appropriate prices and/or in sufficient amounts;

the counterparty credit risk of our reinsurers, including risks associated with the collection of reinsurance recoverable amounts from our reinsurers, who may not pay losses in a timely fashion, or at all;

the effects of competition from other insurers;

unexpected turnover of our professional staff and our ability to attract and retain qualified employees;

increases in interest rates during periods in which we must sell fixed-income securities to satisfy liquidity needs may result in realized investment losses;

our investment portfolio is exposed to market-wide risks and fluctuations, as well as to risks inherent in particular types of securities;

exposure to significant capital market risks related to changes in interest rates, credit spreads, equity prices and foreign exchange rates which may adversely affect our results of operations, financial condition or cash flows;

capital may not be available in the future, or may not be available on favorable terms;

our ability to maintain or improve our insurance company ratings, as downgrades could significantly adversely affect us, including reducing our competitive position in the industry, or causing clients to choose an insurer with a certain rating level to use higher-rated insurers;

risks associated with continued or increased premium levies by Lloyd's of London ("Lloyd's) for the Lloyd's Central Fund and cash calls for trust fund deposits, or a significant downgrade of Lloyd's rating by the A.M. Best Company ("A.M. Best");


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changes in the laws, rules and regulations that apply to our insurance companies;

the effect of the European Union Directive on Solvency II on how we manage our business, capital requirements and costs associated with conducting business, including the impact of the delay in the implementation of Solvency II;

the inability of our subsidiaries to pay dividends to us in sufficient amounts, which would harm our ability to meet our obligations;

weather-related events and other catastrophes (including man-made catastrophes) impacting our insureds and/or reinsurers;

volatility in the market price of our common stock;

exposure to recent uncertainties with regard to European sovereign debt holdings;

the determination of the impairments taken on our investments is subjective and could materially impact our financial position or results of operations;

if we experience difficulties with our information technology and telecommunications systems and/or data security, our ability to conduct our business might be adversely affected;

compliance by our Marine business with the legal and regulatory requirements to which they are subject is evolving and unpredictable. In addition, compliance with new sanctions and embargo laws could have a material adverse effect on our business; and

other risks that we identify in current and future filings with the Securities and Exchange Commission ("SEC").

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 refer to "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 company focusing on specialty products within the overall property and casualty insurance market. Our largest product line and most long-standing area of specialization is ocean marine insurance. We have also developed other specialty insurance lines such as commercial primary and excess liability as well as specialty niches in professional liability, and have expanded our specialty reinsurance business since launching Navigators Re in the fourth quarter of 2010.

We conduct operations through our Insurance Companies and our Lloyd's Operations segments. The Insurance Companies segment consists of Navigators Insurance Company, which includes a United Kingdom Branch (the "U.K. Branch"), and Navigators Specialty Insurance Company, which underwrites specialty and professional liability insurance on an excess and surplus lines basis. All of the insurance business written by Navigators Specialty Insurance Company is fully reinsured by Navigators Insurance Company pursuant to a 100% quota share reinsurance agreement. The insurance and reinsurance business written by our Insurance Companies is underwritten through our wholly-owned underwriting management Companies, Navigators Management Company, Inc. ("NMC") and Navigators Management (UK) Ltd. ("NMUK").


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Our Lloyd's Operations segment includes Navigators Underwriting Agency Ltd. ("NUAL"), a Lloyd's of London ("Lloyd's") underwriting agency which manages Lloyd's Syndicate 1221 ("Syndicate 1221"). Our Lloyd's Operations primarily underwrite marine and related lines of business along with offshore energy, professional liability insurance and construction coverages for onshore energy business at Lloyd's through Syndicate 1221. We controlled 100% of Syndicate 1221's stamp capacity for the 2013 and 2012 underwriting years through our wholly-owned subsidiary, Navigators Corporate Underwriters Ltd. ("NCUL"), which is referred to as a corporate name in the Lloyd's market. We have also established underwriting agencies in Antwerp, Belgium, Stockholm, Sweden, and Copenhagen, Denmark, which underwrite risks pursuant to binding authorities with NUAL into Syndicate 1221. We have also established a presence in Brazil and China through contractual arrangements with local affiliates of Lloyd's.

Catastrophe Risk Management

Our Insurance Companies and Lloyd's Operations have exposure to losses caused by natural and man-made catastrophic events. The frequency and severity of catastrophes are unpredictable. The extent of covered 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 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 events. Despite these efforts, there remains uncertainty about the characteristics, timing and extent of insured losses given the unpredictable nature of catastrophes. The occurrence of one or more catastrophic events could have a material adverse effect on our results of operations, financial condition and/or liquidity.

We have significant natural catastrophe exposures throughout the world. We estimate that our largest exposure to loss from a single natural catastrophe event comes from a potential earthquake on the west coast of the United States. As of September 30, 2013, we estimate that our probable maximum pre-tax gross and net loss exposure from such an earthquake event would be approximately $90.3 million and $36.7 million, respectively, including the cost of reinsurance reinstatement premiums ("RRPs").

Like all catastrophe exposure estimates, the foregoing estimate of our probable maximum loss is inherently uncertain. This estimate is highly dependent upon numerous assumptions and subjective underwriting judgments. Examples of significant assumptions and judgments related to such an estimate include the intensity, depth and location of the earthquake, 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. The composition of our portfolio also makes such estimates challenging due to the non-static nature of the exposures covered under our policies in lines of business such as cargo and hull. There can be no assurances that the gross and net loss amounts that we could incur in such an event or in any natural catastrophe event would not be materially higher than the estimates discussed above given the significant uncertainties with respect to such an estimate. Moreover, our portfolio of insured risks changes dynamically over time and there can be no assurance that our probable maximum loss will not change materially over time.

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 as we are required to pay the losses 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.


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CRITICAL ACCOUNTING ESTIMATES

The Company's Annual Report on Form 10-K for the year ended December 31, 2012 discloses our critical accounting estimates (refer to Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates). Certain of these estimates are critical to the portrayal of our financial condition and results since they require management to establish estimates based on complex and subjective judgments, including those related to our estimates for losses and loss adjustment expenses ("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 investment securities and accounting for Lloyd's results. For additional information regarding our critical accounting estimates, refer to our Annual Report on Form 10-K for the year ended December 31, 2012.

RECENT ACCOUNTING PRONOUNCEMENTS

Refer to Note 2, Recent Accounting Pronouncements, in the Notes to Interim Consolidated Financial Statements included herein for a discussion about accounting standards recently adopted by the Company, as well as recent accounting developments relating to standards not yet adopted by the Company.

RESULTS OF OPERATIONS

The following is a discussion and analysis of our consolidated and segment results of operations for the three and nine months ended September 30, 2013 and 2012. Our financial results are presented on the basis of U.S. GAAP. However, in presenting our financial results, we discuss our performance with reference to operating earnings, book value per share, underwriting profit or loss, and the combined ratio, all of which are non-GAAP financial measures of performance and/or underwriting profitability. Operating earnings is calculated as net income less after-tax net realized gains (losses) and net other-than-temporary impairment ("OTTI") losses recognized in earnings. Book value per share is calculated by dividing stockholders' equity by the number of outstanding shares at any period end. Underwriting profit or loss is calculated from net earned premiums, less the sum of net losses and LAE, commission expenses, other operating expenses and other income (expense). The combined ratio is derived by dividing the sum of net losses and LAE, commission expenses, other operating expenses and other income (expense) by net earned premiums. A combined ratio of less than 100% indicates an underwriting profit and greater than 100% indicates an underwriting loss. We consider such measures, which may be defined differently by other companies, to be important in the understanding of our overall results of operations by highlighting the underlying profitability of our insurance business.

Summary of Consolidated Results

The following table presents a summary of our consolidated financial results for
the three and nine months ended September 30, 2013 and 2012:



                                                Three Months Ended September 30,            Nine Months Ended September 30,           Percentage Change
In thousands, except for per share amounts         2013                   2012                 2013                   2012             QTD           YTD
Gross written premiums                       $        312,076       $        298,742     $       1,037,426       $      964,878           4.5 %        7.5 %
Net written premiums                                  196,556                188,046               664,477              621,343           4.5 %        6.9 %
Total revenues                                        224,970                220,409               668,835              633,287           2.1 %        5.6 %
Total expenses                                        193,880                202,269               596,971              582,838          -4.1 %        2.4 %

Pre-tax income (loss)                        $         31,090       $         18,140     $          71,864       $       50,449          71.4 %       42.4 %
Provision (benefit) for income taxes                    9,804                  5,225                22,731               14,731          87.6 %       54.3 %

Net income (loss)                            $         21,286       $         12,915     $          49,133       $       35,718          64.8 %       37.6 %

Net income (loss) per common share:
Basic                                        $           1.50       $           0.92     $            3.48       $         2.55
Diluted                                      $           1.48       $           0.90     $            3.42       $         2.51


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Net income for the three months ended September 30, 2013 was $21.3 million or $1.48 per diluted share compared to $12.9 million or $0.90 per diluted share for the three months ended September 30, 2012. Operating earnings for the three months ended September 30, 2013 were $23.1 million or $1.60 per diluted share compared to $9.8 million or $0.69 per diluted share for the comparable period in 2012. In comparison to net income, operating earnings excluded after-tax net realized losses of $0.6 million and after-tax other-than-temporary impairment losses of $1.2 million for the three months ended September 30, 2013. For the three months ended September 30, 2012, operating earnings excluded $3.1 million of after-tax net realized gains. The increase in our operating earnings was largely attributable to stronger underwriting results.

Net income for the nine months ended September 30, 2013 was $49.1 million or $3.42 per diluted share compared to $35.7 million or $2.51 per diluted share for the nine months ended September 30, 2012. Operating earnings for the nine months ended September 30, 2013 were $45.7 million or $3.18 per diluted share compared to $29.1 million or $2.04 per diluted share for the comparable period in 2012. In comparison to net income, operating earnings excluded after-tax net realized gains of $4.6 million and after-tax other-than-temporary impairment losses of $1.2 million for the nine months ended September 30, 2013. For the nine months ended September 30, 2012, operating earnings excluded $7.0 million of after-tax net realized gains and after-tax other-than-temporary impairment losses of $0.4 million. The increase in our operating earnings was largely attributable to stronger underwriting results.

Our book value per share as of September 30, 2013 was $63.61, increasing from $62.61 as of December 31, 2012. The increase in book value per share primarily resulted from stronger underwriting results offset by a decrease in our unrealized gains on our investment portfolio across all fixed income classes due to an increase in interest rates. Our consolidated stockholders' equity increased 2.3% to $899.9 million as of September 30, 2013 compared to $879.5 million as of December 31, 2012.

Cash flow provided by operations was $130.0 million for the nine months ended September 30, 2013 compared to $69.1 million for the comparable period in 2012. The increase in cash flow from operations was due to improved collection on premium receivables as well as a reduction in losses paid in connection with lower loss activity.


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The following table presents our consolidated underwriting results and provides a reconciliation of our underwriting profit to GAAP net income for the three and nine months ended September 30, 2013 and 2012:

                                                     Three Months Ended September 30,               Nine Months Ended September 30,            Percentage Change
In thousands                                           2013                     2012                  2013                   2012               QTD           YTD
Gross written premiums                           $        312,076         $        298,742      $      1,037,426        $       964,878            4.5 %        7.5 %
Net written premiums                                      196,556                  188,046               664,477                621,343            4.5 %        6.9 %
Net earned premiums                                       213,895                  201,262               622,037                580,398            6.3 %        7.2 %
Net losses and loss adjustment expenses                  (125,086 )               (128,850 )            (387,576 )             (370,242 )         -2.9 %        4.7 %
Commission expenses                                       (27,685 )                (31,258 )             (82,631 )              (90,211 )        -11.4 %       -8.4 %
Other operating expenses                                  (39,056 )                (40,112 )            (120,608 )             (116,238 )         -2.6 %        3.8 %
Other income (expenses)                                      (210 )                    789                  (507 )                2,087             NM           NM

Underwriting profit (loss)                       $         21,858         $          1,831      $         30,715        $         5,794             NM           NM
Net investment income                                      14,094                   13,597                41,997                 40,632            3.7 %        3.4 %
Net other-than-temporary impairment losses
recognized in earnings                                     (1,821 )                     -                 (1,863 )                 (650 )           NM           NM
Net realized gains (losses)                                  (988 )                  4,761                 7,171                 10,820             NM        -33.7 %
Interest expense                                           (2,053 )                 (2,049 )              (6,156 )               (6,147 )          0.2 %        0.1 %

Income (loss) before income taxes                $         31,090         $         18,140      $         71,864        $        50,449           71.4 %       42.4 %
Income tax expense (benefit)                                9,804                    5,225                22,731                 14,731           87.6 %       54.3 %

Net income (loss)                                $         21,286         $         12,915      $         49,133        $        35,718           64.8 %       37.6 %

Losses and loss adjustment expenses ratio                    58.5 %                   64.0 %                62.3 %                 63.8 %
Commission expense ratio                                     12.9 %                   15.5 %                13.3 %                 15.5 %
Other operating expense ratio (1)                            18.4 %                   19.6 %                19.5 %                 19.7 %

Combined ratio                                               89.8 %                   99.1 %                95.1 %                 99.0 %

(1) - Includes Other operating expenses & Other income (expense)

NM - Percentage change not meaningful

The combined ratio for the three months ended September 30, 2013 was 89.8% compared to 99.1% for the same period in 2012. Our pre-tax underwriting profit increased $20.1 million to $21.9 million for the three months ended September 30, 2013 compared to $1.8 million for the same period in 2012.

Our pre-tax underwriting results for the three months ended September 30, 2013 was mostly driven by $20.1 million of underwriting profit from our Insurance Companies in connection with favorable underwriting performance from all of our businesses. Specifically, our Insurance Companies Energy & Engineering and Marine businesses produced a net underwriting profit of $7.4 million and $5.8 million, respectively, mostly driven by favorable loss emergence for underwriting years ("UYs") 2011 and prior. In addition, our Primary Casualty business produced an underwriting profit of $4.4 million due in part to the continued strong production attributable to the expansion of those underwriting teams and the dislocation of certain competitors.

Our underwriting results for the three months ended September 30, 2012 included $11.0 million of current year accident loss emergence from our Agriculture reinsurance business that was driven by significant drought related crop losses across the U.S. We also had net prior year reserve redundancies of $9.1 million from our Lloyd's Operations.

The combined ratio for the nine months ended September 30, 2013 was 95.1% compared to 99.0% for the same period in 2012. Our pre-tax underwriting profit increased $24.9 million to $30.7 million for the nine months ended September 30, 2013 compared to $5.8 million for the same period in 2012.


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Our pre-tax underwriting results for the nine months ended September 30, 2013 included an underwriting profit of $20.4 million from our Insurance Companies, inclusive of $10.8 million and $7.6 million of underwriting profit from our Energy & Engineering and Marine businesses, respectively, in connection with favorable loss emergence for UY's 2011 and prior. In addition, our Primary Casualty and Excess Casualty businesses recorded an underwriting profit of $7.5 million and $3.4 million, respectively, due in part to the continued strong production attributable to the expansion of those underwriting teams and the dislocation of certain competitors, partially offset by an underwriting loss of $5.8 million from our D&O business driven by net prior period reserve deficiencies from UYs 2010 and prior. Our pre-tax underwriting results also included $10.4 million of underwriting profit from our Lloyd's Operations due to continued favorable loss emergence from UYs 2011 and prior, partially offset by large current accident year losses from our Lloyd's Marine and Lloyd's Energy & Engineering businesses.

Our underwriting results for the nine months ended September 30, 2012 reflected net losses of $12.9 million, inclusive of $10.8 million of reinsurance reinstatement premiums, related to several large losses from our Marine business including the grounding of the cruise ship Costa Concordia off the coast of Italy. The results also included $11.0 million of current year accident loss emergence from our Agriculture reinsurance business as well as net prior period reserve redundancies of $19.2 million from our Lloyd's Operations.

Revenues

Gross Written Premiums

The following tables set forth our gross written premiums, net written premiums
and net earned premiums by segment and line of business for the three and nine
months ended September 30, 2013 and 2012:



                                                                   Three Months Ended September 30,
                                                       2013                                                 2012
                                   Gross                     Net           Net          Gross                     Net           Net
. . .
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