10-K 1 d447988d10k.htm 10-K 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

Commission File no. 0-15886

 

 

THE NAVIGATORS GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   13-3138397

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

6 International Drive, Rye Brook, New York   10573
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (914) 934-8999

Securities registered pursuant to section 12(b) of the Act:

 

Title of each class:

 

Name of each exchange on which registered:

Common Stock, $.10 Par Value   The NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of voting stock held by non-affiliates as of June 30, 2012 was $519,726,107.

The number of common shares outstanding as of February 27, 2013 was 14,072,677.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company’s 2013 Proxy Statement are incorporated by reference in Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

Description

   Page
Number
 

Note on Forward-Looking Statements

     3   
PART I   

Item 1. Business

     3   

Overview

     3   

Business Lines

     5   

Loss Reserves

     9   

Catastrophe Risk Management

     14   

Superstorm Sandy and Hurricanes Gustav, Ike, Katrina and Rita

     15   

Reinsurance Recoverables

     15   

Investments

     18   

Regulation

     20   

Competition

     24   

Employees

     25   

Available Information

     25   

Item 1A. Risk Factors

     26   

Item 1B. Unresolved Staff Comments

     35   

Item 2. Properties

     35   

Item 3. Legal Proceedings

     35   

Item 4. Mine Safety Disclosures

     35   
PART II   

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     36   

Item 6. Selected Financial Data

     39   

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     40   

Overview

     40   

Ratings

     41   

Critical Accounting Estimates

     41   

Results of Operations

     49   

Segment Information

     66   

Off-Balance Sheet Transactions

     74   

Tabular Disclosure of Contractual Obligations

     75   

Capital Resources

     75   

Liquidity

     77   

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

     89   

Item 8. Financial Statements and Supplementary Data

     90   

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     90   

Item 9A. Controls and Procedures

     91   

Item 9B. Other Information

     93   
PART III   

Item 10. Directors, Executive Officers and Corporate Governance

     93   

Item 11. Executive Compensation

     93   

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     93   

Item 13. Certain Relationships and Related Transactions, and Director Independence

     93   

Item 14. Principal Accountant Fees and Services

     93   
PART IV   

Item 15. Exhibits and Financial Statement Schedules

     94   

Signatures

     95   

Index to Consolidated Financial Statements and Schedules

     F-1   

 

2


Table of Contents

NOTE ON FORWARD-LOOKING STATEMENTS

Some of the statements in this Annual Report on Form 10-K 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 Annual Report are forward-looking statements. Whenever used in this report, the words “estimate”, “expect”, “believe”, “may”, “will”, “intend”, “continue” 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 you that anticipated results will be achieved, since actual results may differ materially because of both known and unknown risks and uncertainties which we face. Factors that could cause actual results to differ materially from our forward-looking statements include, but are not limited to, the factors described in Part I, Item 1A, “Risk Factors” of this report. In light of these risks, uncertainties and assumptions, any forward-looking events discussed in this report may not occur. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of their respective dates. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

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 report. They contain forward-looking statements that involve risks and uncertainties. Please refer to the above “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 above and elsewhere in this report.

PART I

Item 1. Business

Overview

The accompanying Consolidated Financial Statements, consisting of the accounts of The Navigators Group, Inc., a Delaware holding company established in 1982, and its wholly-owned subsidiaries, are prepared on the basis of U.S. generally accepted accounting principles (“GAAP” or “U.S. GAAP”). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting periods along with related disclosures. The terms “we”, “us”, “our” and “the Company” as used herein are used to mean The Navigators Group, Inc. and its wholly-owned subsidiaries, unless the context otherwise requires. The terms “Parent” or “Parent Company” as used herein are used to mean The Navigators Group, Inc. without its subsidiaries.

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 (“NavRe”) in the fourth quarter of 2010.

Our revenue is primarily comprised of premiums and investment income. We derive our premiums primarily from business written by wholly-owned underwriting management companies which produce, manage and underwrite insurance and reinsurance for us. Our products are distributed through multiple channels, utilizing global, national and regional retail and wholesale insurance brokers.

 

3


Table of Contents

We conduct operations through our Insurance Companies and our Lloyd’s Operations underwriting 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”).

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, construction coverages for onshore energy business and professional liability insurance at Lloyd’s through Syndicate 1221. We controlled 100% of Syndicate 1221’s stamp capacity for the 2012, 2011 and 2010 underwriting years through our wholly-owned subsidiary, Navigators Corporate Underwriters Ltd. 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. For financial information by segment, refer to Note 3, Segment Information, in the Notes to Consolidated Financial Statements, included herein.

While management takes into consideration a wide range of factors in planning our business strategy and evaluating results of operations, there are certain factors that management believes are fundamental to understanding how we are 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 controlling 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 their business and take advantage of market opportunities are constrained by regulatory capital requirements and rating agency assessments of capital adequacy. Similarly, the ability to grow our operations at Lloyd’s is subject to capital and operating requirements of Lloyd’s and the U.K. regulatory authorities.

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 and personal automobile insurance, because we do not believe our technical underwriting 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.

 

4


Table of Contents

Business Lines

Marine

We have been providing high-quality insurance protection for global marine clients since 1974. We offer insurance for companies engaged in the diverse aspects of shipping, trade and transportation. A summary of our business line divisions and primary products within those divisions, by underwriting segment:

Insurance Companies

Marine

 

   

Marine liability

 

   

Craft/fishing vessels

 

   

Protection & indemnity

 

   

Cargo

 

   

Bluewater hull

 

   

War

 

   

Marine energy liability

 

   

Transport

 

   

Customs bonds

Inland Marine

 

   

Commercial output policy

 

   

Construction

 

   

Transportation

 

   

Specialty

Lloyd’s Operations

Marine

 

   

Cargo

 

   

Marine liability

 

   

Transport

 

   

Specie

 

   

Marine energy liability

 

   

Marine excess-of-loss reinsurance

 

   

Bluewater hull

 

   

War

Our Insurance Companies’ Marine business consists of a number of different product lines. The largest is marine liability, which protects businesses from liability to third parties for bodily injury or property damage stemming from their marine-related operations, such as terminals, marinas and stevedoring. We also underwrite insurance for harbor craft and other small craft such as fishing vessels, providing physical damage and third party liability coverage as well as customs bonds. Our U.K. Branch underwrites primary marine protection and indemnity business, which complements our marine liability business, which is generally written above the primary layer on an excess basis. We also underwrite cargo insurance, which provides coverage for physical damage to goods in the course of transit, whether by water, air or land. Another significant product line is bluewater hull, which provides coverage to the owners of ocean-going vessels against physical damage to the vessels.

Our Insurance Companies’ Marine business is written from offices located in major insurance or port locations in New York, Seattle, San Francisco, Houston, Chicago, Miami and London.

Our Inland Marine division focuses on traditional inland marine insurance products including builders’ risk, contractors’ tools and equipment, commercial output policy, fine arts, computer equipment and warehouse legal liability.

 

5


Table of Contents

Our Lloyd’s Operations Marine business primarily consists of cargo, marine liability, transport and specie. Other key product lines include marine energy liability, assumed reinsurance of other marine insurers on an excess-of-loss basis, and bluewater hull.

Property Casualty

Our property casualty business focuses on specialty products within the overall property and casualty insurance and reinsurance market. A summary of our business line divisions and primary products within those divisions, by underwriting segment, is as follows.

Insurance Companies

Assumed Reinsurance

 

   

Accident & health

 

   

Agriculture

 

   

Latin American & Caribbean property, casualty and surety

 

   

Professional liability

Excess Casualty

 

   

Umbrella & excess liability (wholesale brokerage and retail agency)

Primary Casualty

 

   

General liability

 

   

Product liability

Energy & Engineering

 

   

Offshore energy

 

   

Operational engineering

 

   

Construction

Other Property & Casualty

 

   

Environmental liability

 

   

Life Sciences

 

   

Commercial Surety

 

   

Commercial Auto

 

   

Global exporters package liability

Lloyd’s Operations

Energy & Engineering

 

   

Offshore energy

 

   

Onshore energy

 

   

Engineering and construction

 

   

U.S. direct and facultative property (commencing January 1, 2013)

Casualty

 

   

U.S. Casualty written through Lloyd’s

 

6


Table of Contents

Our specialty assumed reinsurance business is written by NavRe, an underwriting unit managed by NMC. The specialty products on which the unit is currently focused are proportional and excess-of-loss treaty reinsurance covering medical health care exposures, agriculture exposures in the U.S. and Canada, and property and surety treaty exposures in Central and South America and the Caribbean. In the first quarter of 2012, we also began to offer reinsurance of U.S. professional liability exposures.

The Excess Casualty division provides commercial umbrella and excess casualty insurance coverage. Areas of specialty include manufacturing and wholesale distribution, commercial construction, residential construction, construction project and wrap-up covers, business services, hospitality and real estate and niche programs.

The Primary Casualty division writes general liability insurance tailored to fit the needs of the construction market with underwriting expertise in contractors, products and real estate. Our general liability for contractors is offered to commercial, residential and industrial general and sub contractors on an annual renewable basis as well as project specific basis. In addition, we write a number of limited construction wrap-up policies that are general liability policies for owners and developers of residential construction projects. Our general liability for product manufacturers and distributors focuses on non-frequency, commercial and industrial products, as well as consumer based products that are considered based on exposure and loss history. The real estate liability is offered to a wide variety of real estate lessors and habitational accounts including but not limited to shopping centers, strip malls, office buildings, industrial or warehouse locations, and apartments. We have developed underwriting and claims expertise that we believe has allowed us to minimize our exposure to many of the large losses sustained in the past several years by other insurers, including losses stemming from coverage provided to larger contractors who work on condominiums, cooperative developments and other large housing developments.

Our energy & engineering business is written by Navigators Technical Risk (“NavTech”) an underwriting unit of our wholly owned underwriting agencies. Our onshore and offshore energy insurance principally focuses on the oil and gas, chemical and petrochemical industries, with coverage primarily for property damage and business interruption. Our engineering and construction business consists of coverage for construction projects including damage to machinery and equipment and loss of use due to delays.

In addition to the above, our property casualty business provides environmental coverage, including liability insurance for contractors and environmental consultants and site pollution coverage, as well as products liability insurance to life sciences firms, commercial automobile coverage and global exporters package liability products. In the third quarter of 2012, we launched our commercial surety business that focuses on offering transactional, account, and program business throughout the country.

 

7


Table of Contents

Professional Liability

A summary of our business line divisions and products within those divisions, by underwriting segment, is as follows:

Insurance Companies

Management Liability

 

   

Directors & officers liability

 

   

Fiduciary liability

 

   

Crime liability

 

   

Employment practices liability

 

   

Non profit directors & officers liability

Errors & Omissions

 

   

Errors and omissions miscellaneous professional liability

 

   

Real estate agent liability

 

   

Lawyers professional liability

 

   

Design professionals liability

 

   

Accountants professional liability

 

   

Insurance agents errors & omissions

 

   

Technology, media & cyber liability

Lloyd’s Operations

Management Liability

 

   

Directors & officers liability

Errors and Omissions

 

   

Lawyers professional liability

 

   

Miscellaneous professional liability

Our professional liability insurance is written by Navigators Pro (“NavPro”), an underwriting unit of our wholly-owned underwriting agencies. Our management liability insurance primarily is written on a primary and excess basis and consists of directors and officers’ liability insurance, which we offer for both privately held and publicly traded corporations listed on national exchanges. Our public D&O business is primarily written on an excess basis. In addition, we provide fiduciary liability, crime insurance liability, and employment practices liability to our directors and officers liability insurance clients. Our errors and omissions business is also written on a primary and excess basis. Miscellaneous professional liability is offered to all non-medical service providers, including, but not limited to consulting firms, third party administrators, staffing firms, and trustees. Our real estate agent liability provides coverage to real estate agents, brokers and appraisers. Our current target market for lawyers’ professional liability is smaller law firms.

 

8


Table of Contents

Loss Reserves

We maintain reserves for unpaid losses and unpaid loss adjustment expenses (“LAE”) for all lines of business. Loss reserves consists of both reserves for reported claims, known as case reserves, and reserves for losses that have occurred but have not yet been reported, known as incurred but not reported losses (“IBNR”). Case reserves are established when notice of a claim is first received. Reserves for such reported claims are established on a case-by-case basis by evaluating several factors, including the type of risk involved, knowledge of the circumstances surrounding such claim, severity of injury or damage, the potential for ultimate exposure, experience with the insured and the broker on the line of business, and the policy provisions relating to the type of claim. Reserves for IBNR are determined in part on the basis of statistical information and in part on the basis of industry experience. To the extent that reserves are deficient or redundant, the amount of such deficiency or redundancy is treated as a charge or credit to earnings in the period in which the deficiency or redundancy is identified. These reserves are intended to cover the probable ultimate cost of settling all losses incurred and unpaid, including those incurred but not reported. The determination of reserves for losses and LAE is dependent upon the receipt of information from insureds, brokers and agents.

There is a lag between the time premiums are written and related losses and LAE are incurred, and the time such events are reported to us. Our loss reserves include amounts related to short tail and long tail classes of business. Short tail business refers to claims that are generally reported quickly upon occurrence of an event and involve little or no litigation, making estimation of loss reserves less complex. Our long tail business includes our marine liability, casualty and professional liability insurance products. For the long tail lines, significant periods of time, ranging up to several years or more, may elapse between the occurrence of the loss, the reporting of the loss and the settlement of the claim. Generally, the longer the time span between the incidence of a loss and the settlement of the claim, the more likely the ultimate settlement amount will vary from the original estimate. Refer to the Casualty and Professional Liability section below for additional information.

Loss reserves are estimates of what the insurer or reinsurer expects to pay on claims, based on facts and circumstances then known. It is possible that the ultimate liability may exceed or be less than such estimates. In setting our loss reserve estimates, we review statistical data covering several years, analyze patterns by line of business and consider several factors including trends in claims frequency and severity, changes in operations, emerging economic and social trends, inflation and changes in the regulatory and litigation environment. We also consult with experienced claims professionals. Based on this review, we make a best estimate of our ultimate liability. We do not establish a range of reasonable loss estimates around the best estimate we use to establish our reserves and loss adjustment expenses. During the loss settlement period, which, in some cases, may last several years, additional facts regarding individual claims may become known and, accordingly, it often becomes necessary to refine and adjust the estimates of liability on a claim upward or downward. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s earnings. Even then, the ultimate liability may exceed or be less than the revised estimates. The reserving process is intended to provide implicit recognition of the impact of inflation and other factors affecting loss payments by taking into account changes in historical payment patterns and perceived probable trends. There is generally no precise method for the subsequent evaluation of the adequacy of the consideration given to inflation, or to any other specific factor, because the eventual deficiency or redundancy of reserves is affected by many factors, some of which are interdependent.

Another factor related to reserve development is that the estimate of ultimate losses is based on the ratio of ultimate losses to ultimate premiums. For all our segments a certain, relatively stable, percentage of premium is reported after the close of the fiscal year. These amounts relate to lags in reporting of premium, premium audits, endorsements and cancellations. Losses are projected to an ultimate level. The ratio of ultimate loss to ultimate premium is then applied to the booked earned premium to match revenue with expense for GAAP purposes.

 

9


Table of Contents

As part of our risk management process, we purchase reinsurance to limit our liability on individual risks and to protect against catastrophic loss. We purchase both quota share reinsurance and excess-of-loss reinsurance in order to limit our net retention per risk and event. Net retention represents the risk that we keep for our own account. Once our initial reserve is established and our net retention is exceeded, any adverse development will directly affect the gross loss reserve, but would generally have no impact on our net retained loss unless the aggregate limits available under the impacted excess-of-loss reinsurance treaty are exhausted. Reinstatement premiums triggered under our excess-of-loss reinsurance by such additional loss development could have a potential impact on our net premiums during the period in which such additional loss development is recognized. Generally, our limits of exposure are known with greater certainty when estimating our net loss versus our gross loss. This situation tends to create greater volatility in the deficiencies and redundancies of the gross reserves as compared to the net reserves.

The following table summarizes our reserves for losses and LAE activity for the years ended December 31, 2012, 2011 and 2010:

 

     Year Ended December 31,  

In thousands

   2012     2011     2010  

Net reserves for losses and LAE at beginning of year

   $ 1,237,234      $ 1,142,542      $ 1,112,934   

Provision for losses and LAE for claims occurring in the current year

     542,724        474,852        434,957   

Increase (decrease) in estimated losses and LAE for claims occurring in prior years

     (45,291     2,145        (13,802
  

 

 

   

 

 

   

 

 

 

Incurred losses and LAE

     497,433        476,997        421,155   

Losses and LAE paid for claims occurring during:

      

Current year

     (110,373     (73,242     (76,982

Prior years

     (407,385     (309,063     (314,565
  

 

 

   

 

 

   

 

 

 

Losses and LAE payments

     (517,758     (382,305     (391,547
  

 

 

   

 

 

   

 

 

 

Net reserves for losses and LAE at end of year

     1,216,909        1,237,234        1,142,542   

Reinsurance recoverables on unpaid losses and LAE

     880,139        845,445        843,296   
  

 

 

   

 

 

   

 

 

 

Gross reserves for losses and LAE at end of year

   $ 2,097,048      $ 2,082,679      $ 1,985,838   
  

 

 

   

 

 

   

 

 

 

The following table presents the development of the loss and LAE reserves for 2002 through 2012. The line “Net reserves for losses and LAE” reflects the net reserves at the balance sheet date for each of the indicated years and represents the estimated amount of losses and loss adjustment expenses arising in all prior years that are unpaid at the balance sheet date. The “Reserves for losses and LAE re-estimated” lines of the table reflect the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The reserve estimates may change as more information becomes known about the frequency and severity of claims for individual years. The net and gross cumulative redundancy (deficiency) lines of the table reflect the cumulative amounts developed as of successive years with respect to the aforementioned reserve liability. The cumulative redundancy or deficiency represents the aggregate change in the estimates over all prior years.

The table calculates losses and LAE reported and recorded in subsequent years for all prior years starting with the year in which the loss was incurred. For example, assuming that a loss occurred in 2002 and was not reported until 2003, the amount of such loss will appear as a deficiency in both 2002 and 2003. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on the table.

A significant portion of the favorable or adverse development on our gross reserves has been ceded to our excess-of-loss reinsurance treaties. As a result of these reinsurance arrangements, our gross losses and related reserve deficiencies and redundancies tend to be more sensitive to favorable or adverse developments such as those described above than our net losses and related reserve deficiencies and redundancies.

 

10


Table of Contents

Our gross loss reserves include estimated losses related to the 2005 Hurricanes Katrina and Rita, the 2008 Hurricanes Ike and Gustav and the 2012 Superstorm Sandy and totaling approximately 4.6% and 2.4% of gross loss reserves as of December 31, 2012 and 2011, respectively. In addition, 3.3% and 3.7% of our gross loss reserves as of December 31, 2012 and 2011, respectively, include estimated losses related to the Deepwater Horizon loss event. When recording these losses, we assess our reinsurance coverage, potential reinsurance recoverable and the recoverability of those balances.

Losses incurred on business recently written are primarily covered by reinsurance agreements written by companies with whom we are currently doing reinsurance business and whose credit we continue to assess in the normal course of business. Refer to “Management’s Discussion of Financial Condition and Results of Operations—Results of Operations—Expenses—Net Losses and Loss Adjustment Expenses” and Note 5, Reserves for Losses and Loss Adjustment Expenses, in the Notes to Consolidated Financial Statements, both of which are included herein, for additional information regarding Hurricanes Katrina, Rita, Ike, Gustav, Superstorm Sandy and our asbestos exposure.

 

11


Table of Contents
    Year Ended December 31,  

In thousands

  2002     2003     2004     2005     2006     2007     2008     2009     2010     2011      2012  

Net reserves for losses and LAE

  $ 264,647      $ 374,171      $ 463,788      $ 578,976      $ 696,116      $ 847,303      $ 999,871      $ 1,112,934      $ 1,142,542      $ 1,237,234       $ 1,216,909   

Reserves for losses and

                      

LAE re-estimated as of:

                      

One year later

    323,282        370,335        460,007        561,762        649,107        796,557        990,930        1,099,132        1,144,687        1,191,943      

Two years later

    328,683        360,964        457,769        523,541        589,044        776,845        971,048        1,065,382        1,068,344        

Three years later

    321,213        377,229        432,988        481,532        555,448        767,600        943,231        1,037,233          

Four years later

    334,991        362,227        401,380        461,563        559,368        749,905        925,756            

Five years later

    325,249        343,182        391,766        469,195        539,327        745,489              

Six years later

    314,332        333,857        401,071        451,807        538,086                

Seven years later

    305,051        336,790        387,613        449,395                  

Eight years later

    308,593        323,608        389,520                    

Nine years later

    301,868        325,254                      

Ten years later

    302,510                        

Net cumulative redundancy (deficiency)

    (37,863     48,917        74,268        129,581        158,030        101,814        74,115        75,701        74,198        45,291      

Net cumulative paid as of:

                      

One year later

    84,385        80,034        96,981        133,337        142,938        180,459        263,523        314,565        309,063        407,385      

Two years later

    133,911        140,644        180,121        219,125        233,211        322,892        460,058        517,125        552,881        

Three years later

    170,236        195,961        238,673        264,663        300,328        441,267        591,226        682,051          

Four years later

    208,266        223,847        262,425        302,273        359,592        526,226        688,452            

Five years later

    226,798        239,355        283,538        337,559        401,102        583,434              

Six years later

    234,284        251,006        305,214        356,710        427,282                

Seven years later

    241,083        263,072        318,539        372,278                  

Eight years later

    248,850        266,355        328,842                    

Nine years later

    253,852        274,235                      

Ten years later

    258,766                        

Gross liability-end of year

    489,642        724,612        966,117        1,557,991        1,607,555        1,648,764        1,853,664        1,920,286        1,985,838        2,082,679         2,097,048   

Reinsurance recoverable

    224,995        350,441        502,329        979,015        911,439        801,461        853,793        807,352        843,296        845,445         880,139   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net liability-end of year

    264,647        374,171        463,788        578,976        696,116        847,303        999,871        1,112,934        1,142,542        1,237,234         1,216,909   

Gross re-estimated latest

    629,568        682,794        860,702        1,342,622        1,350,585        1,507,874        1,725,512        1,798,761        1,848,331        2,002,454      

Re-estimated recoverable latest

    327,058        357,540        471,182        893,227        812,499        762,385        799,756        761,528        779,987        810,511      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net re-estimated latest

    302,510        325,254        389,520        449,395        538,086        745,489        925,756        1,037,233        1,068,344        1,191,943      

Gross cumulative redundancy (deficiency)

    (139,926     41,818        105,415        215,369        256,970        140,890        128,152        121,525        137,507        80,225      

 

12


Table of Contents

The following tables identify the approximate gross and net cumulative redundancy (deficiency) as of each year-end balance sheet date for the Insurance Companies and Lloyd’s Operations contained in the preceding ten year table:

 

     Gross Cumulative Redundancy (Deficiency)  
     Consolidated     Insurance Companies     Lloyd’s
Operations
 

In thousands

   Grand
Total
    Excluding
Asbestos
    Total     Asbestos     All Other (1)     Total  

2011

     80,225        79,890        4,028        335        3,693        76,197   

2010

     137,507        137,300        5,448        207        5,241        132,059   

2009

     121,525        122,291        9,638        (766     10,404        111,887   

2008

     128,152        129,847        4,989        (1,695     6,684        123,163   

2007

     140,890        143,381        37,137        (2,491     39,628        103,753   

2006

     256,970        258,681        105,452        (1,711     107,163        151,518   

2005

     215,369        217,326        93,169        (1,957     95,126        122,200   

2004

     105,415        89,963        74,630        15,452        59,178        30,785   

2003

     41,818        27,549        17,839        14,269        3,570        23,979   

2002

     (139,926     (76,358     (144,951     (63,568     (81,383     5,025   

 

(1) Contains cumulative loss development for all active and run-off lines of business exclusive of asbestos losses.

 

     Net Cumulative Redundancy (Deficiency)  
     Consolidated     Insurance Companies     Lloyd’s
Operations
 

In thousands

   Grand
Total
    Excluding
Asbestos
    Total     Asbestos     All Other (1)
    Total  

2011

     45,291        45,219        (1,896     72        (1,968     47,187   

2010

     74,198        72,776        (10,065     1,422        (11,487     84,263   

2009

     75,701        74,557        3,347        1,144        2,203        72,354   

2008

     74,115        72,946        11,750        1,169        10,581        62,365   

2007

     101,814        100,908        48,211        906        47,305        53,603   

2006

     158,030        158,903        92,456        (873     93,329        65,574   

2005

     129,581        130,683        84,268        (1,102     85,370        45,313   

2004

     74,268        75,899        47,091        (1,631     48,722        27,177   

2003

     48,917        50,953        16,857        (2,036     18,893        32,060   

2002

     (37,863     (4,147     (53,056     (33,716     (19,340     15,193   

 

(1) — Contains cumulative loss development for all active and run-off lines of business exclusive of asbestos losses.

Property Casualty

The majority of our Property Casualty business involves general liability, umbrella and excess liability policies which generate third party liability claims that are long tail in nature. A significant portion of our general liability reserves relate to construction defect claims. The balance consists of short tail exposures from our assumed reinsurance business, which includes our agriculture, A&H, Latin American & Caribbean property casualty and surety, and professional liability lines, as well as property exposures on energy related risks from our energy and engineering business.

 

13


Table of Contents

Professional Liability

The Professional Liability business generates third party claims, which are also longer tail in nature. The professional liability policies mainly provide coverage on a claims-made basis, whereby coverage is generally provided for those claims that are made during the policy period. The substantial majority of our claims-made policies provide coverage for one year periods. We have also issued a limited number of multi-year claims-made professional liability policies known as “project policies” or “tail coverage” that provide for insurance protection for wrongful acts prior to the run-off date. Such multi-year policies provide insurance protection for several years.

Our professional liability loss estimates are based on expected losses, an assessment of the characteristics of reported losses at the claim level, evaluation of loss trends, industry data, and the legal, regulatory and current risk environment because anticipated loss experience in this area is less predictable due to the small number of claims and/or erratic claim severity patterns. We believe that we have made a reasonable estimate of the required loss reserves for professional liability. The expected ultimate losses may be adjusted up or down as the accident years mature.

Additional information regarding our loss and loss adjustment expenses incurred and loss reserves can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Expenses—Net Losses and Loss Adjustment Expenses” and Note 5, Reserves for Losses and Loss Adjustment Expenses, in the Notes to Consolidated Financial Statements, both of which are included herein.

Catastrophe Risk Management

We have exposure to losses caused by hurricanes, earthquakes, and other natural and man-made catastrophic events. The frequency and severity of catastrophic events is unpredictable.

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 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 an earthquake on the west coast of the United States. As of December 31, 2012, we estimate that our probable maximum pre-tax gross and net loss exposure from such an earthquake event would be approximately $163.0 million and $30.0 million, respectively, including the cost of reinsurance reinstatement premiums.

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.

 

14


Table of Contents

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.

Superstorm Sandy and Hurricanes Gustav, Ike, Katrina and Rita

Superstorm Sandy, which occurred in the fourth quarter 2012, Hurricanes Gustav and Ike, which occurred in the 2008 third quarter and Hurricanes Katrina and Rita, which occurred in the 2005 third quarter, generated substantial losses in our marine, inland marine and energy lines of business. The total estimated net loss for Superstorm Sandy in the fourth quarter of 2012 was $20.4 million, inclusive of $8.3 million in reinsurance reinstatement premiums. Gross of reinsurance our loss related to Superstorm Sandy was $66.7 million. There were no significant hurricane losses in 2011, 2010, 2009, 2007 or 2006 that impacted our marine, inland marine and energy lines of business.

We monitor the development of paid and reported claims activities in relation to the estimate of ultimate losses established for Superstorm Sandy and Hurricanes Gustav, Ike, Katrina, and Rita. Management believes that should any adverse loss development for gross claims occur from the aforementioned Superstorm and Hurricanes, it would be contained within our reinsurance program. Our actual losses from such loss events 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. In particular, in developing our loss estimate, we have assumed that the wreckage of certain oil rigs damaged by Hurricane Rita will not be required to be removed as a result of the federal “Rigs To Reef” program. If our actual losses from the aforementioned losses are materially greater than our estimated losses, our business, results of operations and financial condition could be materially adversely affected.

Refer to “Management’s Discussion of Financial Condition and Results of Operations—Results of Operations and Overview—Operating Expenses—Net Losses and Loss Adjustment Expenses Incurred” and Note 5, Reserves for Losses and Loss Adjustment Expenses, in the Notes to Consolidated Financial Statements, both of which are included herein, for additional information regarding the 2012 Superstorm and the aforementioned hurricanes.

Reinsurance Recoverables

We utilize reinsurance principally to reduce our exposure on individual risks, to protect against catastrophic losses and to stabilize loss ratios and underwriting results. We are protected by various treaty and facultative reinsurance agreements. The reinsurance is placed either directly by us or through reinsurance intermediaries. The reinsurance intermediaries are compensated by the reinsurers.

Although reinsurance makes the reinsurer 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. 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. Our credit risk exposure to our reinsurers has significantly increased over the past couple of years as a result of reinsurance recoverables for significant marine, inland marine and offshore energy losses incurred during 2012, 2011 and 2010.

We have established a reserve for uncollectible reinsurance in the amount of $11.5 million, which was determined by considering reinsurer specific default risk as indicated by their financial strength ratings. Actual uncollectible reinsurance could potentially exceed our estimates.

 

15


Table of Contents

Our exposure to credit risk from any one reinsurer is managed through diversification by reinsuring with a number of different reinsurers, principally in the United States and European reinsurance markets. When reinsurance is placed, our standards of acceptability generally require that a reinsurer must have a rating from A.M. Best Company (“AMB”) and/or Standard & Poor’s (“S&P”) of “A” or better, or an equivalent financial strength if not rated, plus at least $500 million in policyholders’ surplus. Our Reinsurance Security Committee, which is included within our Enterprise Risk Management Finance and Credit Sub-Committee, monitors the financial strength of our reinsurers and the related reinsurance recoverables and periodically reviews the list of acceptable reinsurers.

The credit quality distribution of the Company’s reinsurance recoverables of $1.15 billion as of December 31, 2012 for ceded paid and unpaid losses and LAE and ceded unearned premiums based on insurer financial strength ratings from AMB or S&P were as follows:

 

In thousands

   Rating    Carrying Value  (2)      Percent of
Total (3)
 

A.M. Best Rating description (1):

        

Superior

   A++, A+    $ 567,903         49

Excellent

   A, A-      568,630         50

Very good

   B++, B+      67         0

Not rated

   NR      13,836         1
     

 

 

    

 

 

 

Total

      $ 1,150,436         100
     

 

 

    

 

 

 

 

(1) — Equivalent S&P rating used for certain companies when an A.M. Best rating was unavailable.
(2) — Net of reserve for uncollectible reinsurance of approximately $11.5 million. The carrying value consists of reinsurance recoverables on paid losses due within 30-45 days and reinsurance on unpaid losses which by nature of our reserving process is our best estimate of the value as of December 31, 2012.
(3) — The Company holds offsetting collateral of approximately 19.7%, including 17.6% for B++ and B+ companies and 54.4% from non rated companies which includes letters of credit, ceded balances payable and other balances held by our Insurance Companies and our Lloyd’s Operations.

The Company’s ceded earned premiums were $396.6 million, $346.2 million and $338.6 million for the years ended December 31, 2012, 2011 and 2010, respectively. The increase in ceded earned premiums from 2011 to 2012 is primarily due to a lower retention on our NavTech business as a result of a new quota share program for the offshore energy book and reinsurance reinstatement premiums recognized in our Marine business as a result of significant large loss activity during the year. The increase in ceded earned premiums from 2010 to 2011 is primarily due to growth and mix of business trends, partially offset by a reduction in reinsurance reinstatement premiums in 2011 as compared to 2010 related to specific losses for each year.

The Company’s ceded incurred losses were $262.6 million, $213.4 million and $281.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. The increase in ceded incurred losses from 2011 to 2012 is primarily related to Superstorm Sandy as well as several large losses from our Marine business, including the grounding of the cruise ship Costa Concordia, off the coast of Italy. The decrease in ceded loss from 2010 to 2011 is driven by large ceded incurred losses from 2010, such as Deepwater Horizon and West Atlas.

 

16


Table of Contents

The following table lists our 20 largest reinsurers measured by the amount of reinsurance recoverable for ceded losses and LAE and ceded unearned premium (constituting 72.7% of the total recoverable), together with the reinsurance recoverable and collateral as of December 31, 2012, and the reinsurers’ ratings from AMB or S&P:

 

     Reinsurance Recoverables                   

In thousands

   Unearned
Premium
     Paid/Unpaid
Losses
     Total (1)      Collateral
Held (2)
     AMB    S&P

National Indemnity Company

   $ 41,004       $ 58,215       $ 99,219       $ 27,976       A++    AA+

Swiss Reinsurance America Corporation

     4,708         89,842         94,550         9,916       A+    AA-

Munich Reinsurance America Inc.

     10,005         81,982         91,987         5,356       A+    AA-

Transatlantic Reinsurance Company

     17,763         73,221         90,984         8,219       A    A+

Everest Reinsurance Company

     19,098         70,097         89,195         8,003       A+    A+

Lloyd’s Syndicate #2003

     7,946         38,757         46,703         10,909       A    A+

Partner Reinsurance Europe

     9,811         34,859         44,670         17,168       A+    A+

Allied World Reinsurance

     10,017         24,749         34,766         3,577       A    A

Scor Global P&C SE

     12,521         21,505         34,026         7,139       A    A+

General Reinsurance Corporation

     468         27,134         27,602         789       A++    AA+

Tower Insurance Company

     11,363         15,271         26,634         7,195       A-      NR

Validus Reinsurance Ltd.

     2,719         22,357         25,076         13,830       A    A

Berkley Insurance Company

     1,675         19,402         21,077         88       A+    A+

Scor Holding (Switzerland) AG

     877         16,139         17,016         9,080       A    A+

Ace Property and Casualty Insurance Company

     867         15,979         16,846         —         A+    AA-

AXIS Re Europe

     3,084         12,566         15,650         2,530       A    A+

Sirius America Insurance Company

     59         15,457         15,516         21       A    A-  

Platinum Underwriters Re

     405         14,653         15,058         1,594       A    A-  

Lloyd’s Syndicate #4000

     2,407         12,323         14,730         1,772       A    A+

Star Insurance Company

     7,812         6,830         14,642         2,837       A-      BBB
  

 

 

    

 

 

    

 

 

    

 

 

       

Top 20 Total

   $ 164,609       $ 671,338       $ 835,947       $ 137,999         

All Others

     56,406         258,083         314,489         89,166         
  

 

 

    

 

 

    

 

 

    

 

 

       

Total

   $ 221,015       $ 929,421       $ 1,150,436       $ 227,165         
  

 

 

    

 

 

    

 

 

    

 

 

       

 

(1) — Net of reserve for uncollectible reinsurance of approximately $11.5 million.
(2) — Collateral of $227.2 million consists of $165.8 million in ceded balances payable, $57.2 million in letters of credit, and $4.2 million of other balances held by the Company’s Insurance Companies and Lloyd’s Operations.

 

17


Table of Contents

Approximately 25% of the collateral held consists of letters of credit obtained from reinsurers in accordance with New York Insurance Regulation Nos. 20 and 133. Regulation 20 requires collateral to be held by the ceding company from reinsurers not licensed in New York State in order for the ceding company to take credit for the reinsurance recoverables on its statutory balance sheet. The specific requirements governing the letters of credit are contained in Regulation 133 and include a clean and unconditional letter of credit and an “evergreen” clause which prevents the expiration of the letter of credit without due notice to the Company. Only banks considered qualified by the National Association of Insurance Commissioners (“NAIC”) may be deemed acceptable issuers of letters. In addition, based on our credit assessment of the reinsurer, there are certain instances where we require collateral from a reinsurer even if the reinsurer is licensed in New York State, generally applying the requirements of Regulation No. 133. The contractual terms of the letters of credit require that access to the collateral is unrestricted. In the event that the counterparty to our collateral would be deemed not qualified by the NAIC, the reinsurer would be required by agreement to replace such collateral with acceptable security under the reinsurance agreement. There is no assurance, however, that the reinsurer would be able to replace the counterparty bank in the event such counterparty bank becomes unqualified and the reinsurer experiences significant financial deterioration. Under such circumstances, we could incur a substantial loss from uncollectible reinsurance from such reinsurer. In November 2010, Regulation No. 20 was amended to provide the New York Superintendent of Financial Services (the “New York Superintendent”) discretion to allow a reduction in collateral that qualifying reinsurers must post in order for New York domestic ceding insurers such as Navigators Insurance Company and Navigators Specialty Insurance Company to receive full financial statement credit. The “collateral required” percentages range from 0% – 100%, are based upon the New York Superintendent’s evaluation of a number of factors, including the reinsurer’s financial strength ratings, and apply to contracts entered into, renewed or having an anniversary date on or after January 1, 2011. In November 2011, the NAIC adopted similar amendments to its Credit for Reinsurance Model Act that would apply to certain non-U.S. reinsurers. States will have the option to retain a 100% funding requirement if they so choose and it remains to be seen whether and when states will amend their credit for reinsurance laws and regulations in accordance with such model act.

Approximately $54.6 million of the reinsurance recoverables for paid and unpaid losses as of December 31, 2012 was due from reinsurers as a result of Superstorm Sandy while approximately $33.6 million of the reinsurance recoverables for paid and unpaid losses as of December 31, 2012 was due from reinsurers as a result of the losses from the 2008 and 2005 Hurricanes. In addition, as of December 31, 2012, reinsurance recoverables for paid and unpaid losses of approximately $64.0 million was due from reinsurers in connection with the Deepwater Horizon incident.

Investments

The objective of our investment policy, guidelines and strategy is to maximize total investment return in the context of preserving and enhancing shareholder value and statutory surplus of the Insurance Companies. Secondarily, we seek to optimize after-tax investment income.

Our investments are managed by outside professional fixed-income and equity portfolio managers. We seek to achieve our investment objectives by investing in cash equivalents and money market funds, municipal bonds, U.S. Government bonds, U.S. Government agency guaranteed and non-guaranteed securities, corporate bonds, mortgage-backed and asset-backed securities and common and preferred stocks.

Our investment guidelines require that the amount of our consolidated fixed-income portfolio rated below “A-” but no lower than “BBB-” by S&P or below “A3” but no lower than “Baa3” by Moody’s Investors Service (“Moody’s”) shall not exceed 10% of our total investment portfolio. Fixed-income securities rated below “BBB-” by S&P or “Baa3” by Moody’s combined with any other investments not specifically permitted under our investment guidelines, cannot exceed 2% of our total investment portfolio. Investments in equity securities that are actively traded on major U.S. stock exchanges cannot exceed 20% of consolidated stockholders’ equity. Finally, our investment guidelines prohibit investments in derivatives other than as a hedge against foreign currency exposures or the writing of covered call options on our equity portfolio.

 

18


Table of Contents

The Insurance Companies’ investments are subject to the oversight of their respective Boards of Directors and our Finance Committee of the Parent Company’s Board of Directors. The investment portfolio and the performance of the investment managers are reviewed quarterly. These investments must comply with the insurance laws of New York State, the domiciliary state of Navigators Insurance Company and Navigators Specialty Insurance Company. These laws prescribe the type, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred stocks, common stocks, real estate mortgages and real estate. The U.K. Branch’s investments must also comply with the regulations set forth by the Financial Services Authority (“FSA”) in the U.K.

The Lloyd’s Operations’ investments are subject to the direction and control of the Board of Directors and the Investment Capital Committee of NUAL, as well as the Parent Company’s Board of Directors and Finance Committee. These investments must comply with the rules and regulations imposed by Lloyd’s and the FSA.

The table set forth below reflects our total investment balances, net investment income earned thereon and the related average yield for the last three calendar years:

 

     Year Ended December 31,  

In thousands

   2012     2011     2010  

Invested Assets and Cash:

      

Insurance Companies

   $ 1,899,309      $ 1,767,190      $ 1,675,725   

Lloyd’s Operations

     507,919        457,994        425,386   

Parent Company

     15,026        8,314        53,217   
  

 

 

   

 

 

   

 

 

 

Consolidated

   $ 2,422,254      $ 2,233,498      $ 2,154,328   
  

 

 

   

 

 

   

 

 

 

Net Investment Income:

      

Insurance Companies

   $ 46,549      $ 54,164      $ 62,792   

Lloyd’s Operations

     7,551        8,955        8,286   

Parent Company

     148        381        584   
  

 

 

   

 

 

   

 

 

 

Consolidated

   $ 54,248      $ 63,500      $ 71,662   
  

 

 

   

 

 

   

 

 

 

Average Yield (amortized cost basis):

      

Insurance Companies

     2.6     3.2     3.8

Lloyd’s Operations

     1.3     2.2     2.2

Parent Company

     1.7     1.4     1.2

Consolidated

     2.4     3.0     3.5

As of December 31, 2012, the average quality of the investment portfolio was rated “AA” by S&P and “Aa” by Moody’s. All of the Company’s mortgage-backed and asset-backed securities were rated investment grade by S&P and by Moody’s except for 45 securities with a fair value approximating $12.1 million. There was no collateralized debt obligations (“CDO’s”), collateralized loan obligations (“CLO’s”), asset-backed commercial paper or credit default swaps in our investment portfolio. As of December 31, 2012, 2011 and 2010, all fixed-maturity and equity securities held by us were classified as available-for-sale.

Refer to “Management’s Discussion of Financial Condition and Results of Operations—Investments” and Note 4, Investments, in the Notes to Consolidated Financial Statements, both of which are included herein, for additional information regarding investments.

 

19


Table of Contents

Regulation

United States

We are subject to regulation under the insurance statutes, including holding company statutes of various states and applicable regulatory authorities in the United States. These regulations vary but generally require insurance holding companies, and insurers that are subsidiaries of holding companies, to register and file reports concerning their capital structure, ownership, financial condition and general business operations. Such regulations also generally require prior regulatory agency approval of changes in control of an insurer and of certain transactions within the holding company structure. The regulatory agencies have statutory authorization to enforce their laws and regulations through various administrative orders and enforcement proceedings.

Navigators Insurance Company is licensed to engage in the insurance and reinsurance business in 50 states, the District of Columbia and Puerto Rico. Navigators Specialty Insurance Company is licensed to engage in the insurance and reinsurance business in the State of New York and is an approved surplus lines insurer or meets the financial requirements where there is not a formal approval process in all other states and the District of Columbia.

The State of New York Department of Financial Services (the “New York Department”) is our principal regulatory agency. New York insurance law provides that no corporation or other person may acquire control of us, and thus indirect control of our insurance company subsidiaries, unless it has given notice to our insurance company subsidiaries and obtained prior written approval from the New York Superintendent for such acquisition. Any purchaser of 10% or more of the outstanding shares of our common stock would be presumed to have acquired control of us, unless such presumption is rebutted.

Under New York insurance law, Navigators Insurance Company and Navigators Specialty Insurance Company may only pay dividends out of their statutory earned surplus. Generally, the maximum amount of dividends Navigators Insurance Company and Navigators Specialty Insurance Company may pay without regulatory approval in any twelve-month period is the lesser of adjusted net investment income or 10% of statutory surplus. For a discussion of our current dividend capacity, refer to “Management’s Discussion of Financial Condition and Results of Operations—Capital Resources” in Item 7 of this report.

As part of its general regulatory oversight process, the New York Department conducts detailed examinations of the books, records and accounts of New York insurance companies every three to five years. In 2011, the New York Department conducted an examination of Navigators Insurance Company and Navigators Specialty Insurance Company for the years 2005 through 2009.

Under insolvency or guaranty laws in most states in which Navigators Insurance Company and Navigators Specialty Insurance Company operate, insurers doing business in those states can be assessed up to prescribed limits for policyholder losses of insolvent insurance companies. Neither Navigators Insurance Company nor Navigators Specialty Insurance Company was subject to any material assessments under state insolvency or guaranty laws in the last three years.

 

20


Table of Contents

The Insurance Regulatory Information System, or IRIS, was developed by the NAIC and is intended primarily to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies thirteen industry ratios and specifies “usual values” for each ratio. Departure from the usual values on four or more of the ratios can lead to inquiries from individual state insurance commissioners as to certain aspects of an insurer’s business. As of December 31, 2012, the results for Navigators Insurance Company were within the usual values for all IRIS ratios except for one, and the results for Navigators Specialty Insurance Company were within the usual values for all IRIS ratios. The one ratio outside the usual values for the Navigators Insurance Company was related to the investment yield. The investment yield for the Navigators Insurance Company for the year ended December 31, 2012 was 2.4%, which was below the expected range of 3.0% – 6.5% due to a general decline in investment yields and increased investment expenses, which include $4.5 million of interest expense related to the settlement of a dispute with Equitas over foregone interest on amounts that were due on certain reinsurance contracts. In the dispute Equitas alleged that we failed to make timely payments to them under certain reinsurance agreements in connection with subrogation recoveries received by us with respect to several catastrophe losses that occurred in the late 1980’s and early 1990’s. The investment yield for Navigators Insurance Company also includes a $1.7 million allocation of the $2.8 million investment performance fee charged to the Company. Excluding the impact of the aforementioned interest expense and investment performance fee, the investment yield for the Navigators Insurance Company would have been 2.7%.

State insurance departments have adopted a methodology developed by the NAIC for assessing the adequacy of statutory surplus of property and casualty insurers which includes a risk-based capital formula that attempts to measure statutory capital and surplus needs based on the risks in a company’s mix of products and investment portfolio. The formula is designed to allow state insurance regulators to identify weakly capitalized companies. Under the formula, a company determines its “risk-based capital” by taking into account certain risks related to the insurer’s assets (including risks related to its investment portfolio and ceded reinsurance) and the insurer’s liabilities (including underwriting risks related to the nature and experience of its insurance business). The risk-based capital rules provide for different levels of regulatory attention depending on the ratio of a company’s total adjusted capital to its “authorized control level” of risk-based capital. Based on calculations made by Navigators Insurance Company and Navigators Specialty Insurance Company, their risk-based capital levels exceed the level that would trigger regulatory attention or company action. In their respective 2012 statutory financial statements, Navigators Insurance Company and Navigators Specialty Insurance Company have complied with the NAIC’s risk-based capital reporting requirements.

Both the NAIC and the New York Department have increased their focus on risks within an insurer’s holding company system that may pose enterprise risk to the insurer. “Enterprise risk” is defined as any activity, circumstance, event or series of events involving one or more affiliates of an insurer that, if not remedied promptly, is likely to have a material adverse effect upon the financial condition or the liquidity of the insurer or its insurance holding company system as a whole. The New York Department recently issued a circular letter announcing its expectations for the establishment and maintenance of an enterprise risk management (ERM) function by New York domestic insurers, while the NAIC recently adopted amendments to its Model Insurance Holding Company System Regulatory Act and Regulations, which include, among other amendments, a requirement for the ultimate controlling person to file an enterprise risk report.

The NAIC has also adopted the Risk Management and Own Risk and Solvency Assessment Model Act (the “Model Act”), requiring insurers to maintain a framework for identifying, assessing, monitoring, managing and reporting on the “material and relevant risks” associated with the insurer’s or insurance group’s business plans. The Model Act will become effective January 1, 2015. Under the Model Act, insurers will be required to submit an Own Risk and Solvency Assessment (“ORSA”) Summary Report to their lead regulator at least annually.

In addition to regulations applicable to insurance agents generally, NMC is subject to managing general agents’ acts in its state of domicile and in certain other jurisdictions where it does business.

 

21


Table of Contents

In 2002, in response to the tightening of supply in certain insurance and reinsurance markets resulting from, among other things, the September 11, 2001 terrorist attacks, the Terrorism Risk Insurance Act, or TRIA, was enacted. TRIA was intended to ensure the availability of insurance coverage for “acts of terrorism” (as defined) in the United States of America committed by or on behalf of foreign persons or interests. This law established a federal program through the end of 2005 to help the commercial property and casualty insurance industry cover claims related to future losses resulting from acts of terrorism and requires insurers to offer coverage for acts of terrorism in all commercial property and casualty policies. As a result, we are prohibited from adding certain terrorism exclusions to those policies written by insurers in our group that write business in the U.S. On December 22, 2005, the Terrorism Risk Insurance Extension Act of 2005, or TRIEA, was enacted. TRIEA extended TRIA through December 31, 2007 and made several changes in the program, including the elimination of several previously covered lines. The deductible for each insurer was increased to 17.5% and 20% of direct earned premiums in 2006 and 2007, respectively. For losses in excess of an insurer’s deductible, the Insurance Companies will retain an additional 10% and 15% of the excess losses in 2006 and 2007, respectively, with the balance to be covered by the Federal government up to an aggregate cap of insured losses of $25 billion in 2006 and $27.5 billion in 2007. Also, TRIEA established a new program trigger under which Federal compensation will become available only if aggregate insured losses sustained by all insurers exceed $50 million from a certified act of terrorism occurring after March 31, 2006 and $100 million for certified acts occurring on or after January 1, 2007. On December 26, 2007, the Terrorism Risk Insurance Program Reauthorization Act of 2007 (“TRIPRA”) was enacted. TRIPRA, among other provisions, extends for seven years the program established under TRIA, as amended. The imposition of these TRIA deductibles could have an adverse effect on our results of operations. Potential future changes to TRIA, including the increases in deductibles and co-pays and elimination of domestic terrorism coverage proposed by the current administration, could also adversely affect us by causing our reinsurers to increase prices or withdraw from certain markets where terrorism coverage is required. As a result of TRIA, we are required to offer coverage for certain terrorism risks that we may normally exclude. Occasionally in our marine business, such coverage falls outside of our normal reinsurance program. In such cases, our only reinsurance would be the protection afforded by TRIA.

Our Lloyd’s Operations are subject to regulation in the United States in addition to being regulated in the United Kingdom, as discussed below. The Lloyd’s market is licensed to engage in insurance business in Illinois, Kentucky and the U.S. Virgin Islands and operates as an eligible excess and surplus lines insurer in all states and territories except Kentucky and the U.S. Virgin Islands. Lloyd’s is also an accredited reinsurer in all states and territories of the United States. Lloyd’s maintains various trust funds in the state of New York to protect its United States business and is therefore subject to regulation by the New York Department, which acts as the domiciliary department for Lloyd’s U.S. trust funds. There are deposit trust funds in other states to support Lloyd’s reinsurance and excess and surplus lines insurance business.

From time to time, various regulatory and legislative changes have been proposed in the insurance and reinsurance industry. Among the proposals that have in the past been or are at present being considered are the possible introduction of federal regulation in addition to, or in lieu of, the current system of state regulation of insurers and proposals in various state legislatures (some of which have been enacted) to conform portions of their insurance laws and regulations to various model acts adopted by the NAIC. We are unable to predict whether any of these laws and regulations will be adopted, the form in which any such laws and regulations would be adopted, or the effect, if any, these developments would have on our operations and financial condition.

 

22


Table of Contents

United Kingdom

Our United Kingdom subsidiaries and our Lloyd’s Operations are subject to regulation by the FSA, as established by the Financial Services and Markets Act 2000. Our Lloyd’s Operations are also subject to supervision by the Council of Lloyd’s. The FSA has been granted broad authorization and intervention powers as they relate to the operations of all insurers, including Lloyd’s syndicates, operating in the United Kingdom. Lloyd’s is authorized by the FSA and is required to implement certain rules prescribed by the FSA, which it does by the powers it has under the Lloyd’s Act 1982 relating to the operation of the Lloyd’s market. Lloyd’s prescribes, in respect of its managing agents and corporate members, certain minimum standards relating to their management and control, solvency and various other requirements. The FSA directly monitors Lloyd’s managing agents’ compliance with the systems and controls prescribed by Lloyd’s. If it appears to the FSA that either Lloyd’s is not fulfilling its delegated regulatory responsibilities, or that managing agents are not complying with the applicable regulatory rules and guidance, the FSA may intervene at its discretion.

The United Kingdom coalition government has commenced a restructuring of the regulatory regime for financial services in the United Kingdom by enacting the Financial Services and Markets Act 2012 (amending the Financial Services and Markets Act 2000). Seen as a response to the financial crisis, the amendments involve the abolition of the FSA and the establishment in its place of a new system based on the following components: a new macro prudential regulator, the Financial Policy Committee, to be established within the Bank of England, responsible for setting macro financial services policy and monitoring systemic risks; a new prudential regulator, the Prudential Regulation Authority (“PRA”), to be established as a subsidiary of the Bank of England with the intention that it can draw on the financial sector expertise of the Bank but remain operationally independent; a new conduct of business regulator, called the Financial Conduct Authority (“FCA”) to focus on ensuring confidence on the wholesale and retail financial markets with particular focus on protection of consumers; and the creation of a new single agency responsible for tackling serious economic crime. Insurers and reinsurers will be regulated both by the PRA (for prudential issues) and the FCA (for conduct of business issues). Consistent with this, The Society of Lloyd’s and Lloyd’s managing agents will be regulated both by the PRA and the FCA. The new system of regulation will begin operating on April 1, 2013. In the meantime, the FSA has moved towards a new regulatory structure by replacing its Risk and Supervision Business Unit with a Consumer and Markets Business Unit.

We participate in the Lloyd’s market through our ownership of NUAL and Navigators Corporate Underwriters Ltd. NUAL is the managing agent for Syndicate 1221. We controlled 100% of Syndicate 1221’s stamp capacity for the 2011, 2010 and 2009 underwriting years through our wholly-owned subsidiary, Navigators Corporate Underwriters Ltd., which is referred to as a corporate name in the Lloyd’s market. By entering into a membership agreement with Lloyd’s, Navigators Corporate Underwriters Ltd. undertakes to comply with all Lloyd’s by-laws and regulations as well as the provisions of the Lloyd’s Acts and the Financial Services and Markets Act that are applicable to it. The operation of Syndicate 1221, as well as Navigators Corporate Underwriters Ltd. and their respective directors, is subject to the Lloyd’s supervisory regime.

Underwriting capacity of a member of Lloyd’s must be supported by providing a deposit (referred to as “Funds at Lloyd’s”) in the form of cash, securities or letters of credit in an amount determined by Lloyd’s equal to a specified percentage of the member’s underwriting capacity. The amount of such deposit is calculated by each member through the completion of an annual capital adequacy exercise. The results of this exercise are submitted to Lloyd’s for approval. Lloyd’s then advises the member of the amount of deposit that is required. The consent of the Council of Lloyd’s may be required when a managing agent of a syndicate proposes to increase underwriting capacity for the following underwriting year.

The Council of Lloyd’s has wide discretionary powers to regulate members’ underwriting at Lloyd’s. It may, for instance, change the basis on which syndicate expenses are allocated or vary the Funds at Lloyd’s ratio or the investment criteria applicable to the provision of Funds at Lloyd’s. Exercising any of these powers might affect the return on an investment of the corporate member in a given underwriting year. Further, it should be noted that the annual business plans of a syndicate are subject to the review and approval of the Lloyd’s Franchise Board. The Lloyd’s Franchise Board was formally constituted on January 1, 2003. The Franchise Board is responsible for setting risk management and profitability targets for the Lloyd’s market and operates a business planning and monitoring process for all syndicates.

 

23


Table of Contents

Corporate members continue to have insurance obligations even after all their underwriting years have been closed by reinsurance to close. In order to continue to perform these obligations, corporate members are required to stay in existence; accordingly, there continues to be an administrative and financial burden for corporate members between the time their memberships have ceased and the time their insurance obligations are extinguished, including the completion of financial accounts in accordance with the Companies Act 2006.

If a member of Lloyd’s is unable to pay its debts to policyholders, such debts may be payable by the Lloyd’s Central Fund, which acts similarly to state guaranty funds in the United States. If Lloyd’s determines that the Central Fund needs to be increased, it has the power to assess premium levies on current Lloyd’s members. The Council of Lloyd’s has discretion to call or assess up to 3% of a member’s underwriting capacity in any one year as a Central Fund contribution.

A European Union (“E.U.”) directive covering the capital adequacy, risk management and regulatory reporting for insurers, known as Solvency II, was adopted by the European Parliament in April 2009. Solvency II will introduce a new system of regulation for insurers operating in the E.U. (including the United Kingdom) and presents a number of risks to us. Although Solvency II was originally stated to have become effective by October 31, 2012, the European Union approved a directive extending the implementation date until January 1, 2014, although this implementation date is also in doubt. In December 2012, the European Insurance and Occupational Pensions Authority (“EIOPA,” which is a European Union supervisory authority for insurance and occupational pensions), proposed an outline to have certain elements of Solvency II in place by the beginning of 2014, including systems of governance, pre-application of internal models and reporting to supervisors. The Company’s implementation plans are based on its current understanding of the Solvency II requirements, which may change. During the next few years, we expect to undertake a significant amount of work to ensure that we meet the new requirements, which may divert finite resources from other business related tasks. Although the details of how Solvency II (or individual elements thereof) will apply to Navigators Insurance Company, NUAL and Syndicate 1221 are not yet fully known, it is clear that Solvency II will impose new requirements with respect to capital structure, technical provisions, solvency calculations, governance, disclosure and risk management. There is also a risk that Solvency II may increase our capital requirements for our U.K. Branch and Syndicate 1221. These new regulations have the potential to adversely affect the profitability of Navigators Insurance Company, NUAL and Syndicate 1221, and to restrict their ability to carry on their businesses as currently conducted. A significant unanswered question about how Solvency II will be implemented is whether the new regulations will apply only to Navigators Insurance Company’s U.K. Branch or to all of its operations, both within and outside of the United Kingdom and the other E.U. countries in which it operates. If the regulations are applied to Navigators Insurance Company in its entirety, we could be subject to even more onerous requirements under the new regulations. Such requirements could have a significant adverse effect on our ability to operate profitably and could impose other significant restrictions on our ability to carry on our insurance business in the E.U. (including the United Kingdom) as it is now conducted.

Competition

The property and casualty insurance industry is highly competitive. We face competition from both domestic and foreign insurers, many of whom have longer operating histories and greater financial, marketing and management resources. Competition in the types of insurance in which we are engaged is based on many factors, including our perceived overall financial strength, pricing, other terms and conditions of products and services offered, business experience, marketing and distribution arrangements, agency and broker relationships, levels of customer service (including speed of claims payments), product differentiation and quality, operating efficiencies and underwriting. Furthermore, insureds tend to favor large, financially strong insurers, and we face the risk that we will lose market share to higher rated insurers.

Another competitive factor in the industry is the entrance of other financial services providers such as banks and brokerage firms into the insurance business. These efforts pose new challenges to insurance companies and agents from financial services companies traditionally not involved in the insurance business.

 

24


Table of Contents

Employees

As of December 31, 2012, we had 567 full-time employees of which 450 were located in the United States, 110 in the United Kingdom, 3 in Sweden, 2 in Belgium and 2 in Denmark.

Available Information

This report and all other filings made by the Company with the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are made available to the public by the SEC. All filings can be read and copied at the SEC Public Reference Room, located at 100 F Street, NE, Washington, DC 20549. Information pertaining to the operation of the Public Reference Room can be obtained by calling 1-800-SEC-0330. We are an electronic filer, so all reports, proxy and information statements, and other information can be found at the SEC website, www.sec.gov. Our website address is http://www.navg.com. Through our website at http://www.navg.com/Pages/sec-filings.aspx, we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The annual report to stockholders, press releases and recordings of our earnings release conference calls are also provided on our website.

 

25


Table of Contents

Item 1A. Risk Factors

You should carefully consider each of the risks and uncertainties described below and elsewhere in this Annual Report on Form 10-K, as well as any amendments or updates reflected in subsequent filings with the SEC. We believe these risks and uncertainties, individually or in the aggregate, could cause our actual results to differ materially from expected and historical results and could materially and adversely affect our business operations. Further, additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our results and business operations.

The continuing volatility in the financial markets and the risk of another recession could have a material adverse effect on our results of operations and financial condition.

The financial market experienced significant volatility worldwide from the third quarter of 2008 through 2012. Although the U.S., European and other foreign governments have taken various actions to try to stabilize the financial markets, it is unclear whether those actions will be effective. Therefore, the financial market volatility and the resulting negative economic impact could continue.

Although we continue to monitor market conditions, we cannot predict future market conditions or their impact on our stock price or investment portfolio. Depending on market conditions, we could incur future additional realized and unrealized losses, which could have a material adverse effect on our results of operations and financial condition. These economic conditions have had an adverse impact on the availability and cost of credit resources generally, which could negatively affect our ability to obtain letters of credit utilized by our Lloyd’s Operations to support business written through Lloyd’s.

In addition, the continuing financial market volatility and economic downturn could continue to have a material adverse effect on our insureds, agents, claimants, reinsurers, vendors and competitors. Certain of the actions U.S., European and other foreign governments have taken or may take in response to the financial market crisis have impacted certain property and casualty insurance carriers. The U.S., European and other foreign governments continue to actively take steps to implement measures to stabilize the financial markets and stimulate the economy, and it is possible that these measures could further affect the property and casualty insurance industry and its competitive landscape.

Our business is concentrated in marine and energy, specialty liability and professional liability insurance, and if market conditions change adversely, or we experience large losses in these lines, it could have a material adverse effect on our business.

As a result of our strategy to focus on specialty products in niches where we have underwriting and claims handling expertise and to decrease our business in areas where pricing does not afford what we consider to be acceptable returns, our business is concentrated in the marine and energy, specialty liability and professional liability lines of business. If our results of operations from any of these lines are less favorable for any reason, including lower demand for our products on terms and conditions that we find appropriate, flat or decreased rates for our products or increased competition, the impact of a reduction could have a material adverse effect on our business.

We are exposed to cyclicality in our business that may cause material fluctuations in our results.

The property and casualty insurance business generally, and the marine insurance business specifically, have historically been characterized by periods of intense price competition due to excess underwriting capacity as well as periods when shortages of underwriting capacity have permitted attractive premium levels. We have reduced business during periods of severe competition and price declines and grown when pricing allowed an acceptable return. The cyclical trends in the property and casualty insurance and reinsurance industries and the profitability of these industries can also be significantly affected by volatile and unpredictable developments, including what we believe to be a trend of natural disasters, fluctuations in interest rates, changes in the investment environment that affect market prices of investments and inflationary pressures that may tend to affect the size of losses experienced by insureds. We cannot predict with accuracy whether market conditions will remain constant, improve or deteriorate. We expect that our business will continue to experience the effects of this cyclicality which, over the course of time, could result in material fluctuations in our premium volume, revenues or expenses.

 

26


Table of Contents

We may not be successful in developing our new specialty lines which could cause us to experience losses.

Since 2001, we have entered into a number of new specialty lines of business, primarily professional liability, excess casualty, primary casualty, inland marine, property catastrophe, agriculture reinsurance, and accident and health reinsurance. We continue to look for appropriate opportunities to diversify our business portfolio by offering new lines of insurance in which we believe we have sufficient underwriting and claims expertise. However, as we enter into these new specialties, because of our limited history in these new lines, there is limited financial information available to help us estimate sufficient reserve amounts for these lines and to help evaluate whether we will be able to successfully develop these new lines or the likely ultimate losses and expenses associated with these new lines. Due to our limited history in these areas, we may have less experience managing their development and growth than some of our competitors. Additionally, there is a risk that the lines of business into which we expand will not perform at the levels we anticipate.

We may be unable to manage effectively our rapid growth in our lines of business, which may adversely affect our results.

To control our growth effectively, we must successfully manage our new and existing lines of business. This process will require substantial management attention and additional financial resources. In addition, our growth is subject to, among other risks, the risk that we may experience difficulties and incur expenses related to hiring and retaining a technically proficient workforce. Accordingly, we may fail to realize the intended benefits of expanding into new specialty lines and we may fail to realize value from such lines relative to the resources that we invest in them. Any difficulties associated with expanding our current and future lines of business could adversely affect our results of operations.

We may incur additional losses if our loss reserves are insufficient.

We maintain loss reserves to cover our estimated ultimate unpaid liability for losses and LAE with respect to reported and unreported claims incurred as of the end of each accounting period. Reserves do not represent an exact calculation of liability, but instead represent estimates, generally utilizing actuarial projection techniques and judgment at a given accounting date. These reserve estimates are expectations of what the ultimate settlement and administration of claims will cost based on our assessment of facts and circumstances then known, review of historical settlement patterns, estimates of trends in claims severity, frequency, legal theories of liability and other factors. Both internal and external events, including changes in claims handling procedures, economic inflation, legal trends and legislative changes, may affect the reserve estimation process. Many of these items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant lags between the occurrence of the insured event and the time it is actually reported to us. We continually refine reserve estimates in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. Adjustments to reserves are reflected in the results of the periods in which the estimates are changed. Because establishment of reserves is an inherently uncertain process involving estimates, currently established reserves may not be sufficient. If estimated reserves are insufficient, we will incur additional charges to earnings which could have a material adverse effect on future results of operations, financial position or cash flows.

Our loss reserves include amounts related to short tail and long tail classes of business. Short tail business means that claims are generally reported quickly upon occurrence of an event, making estimation of loss reserves less complex. For the long tail lines, significant periods of time, ranging up to several years or more, may elapse between the occurrence of the loss, the reporting of the loss and the settlement of the claim. The longer the time span between the incidence of a loss and the settlement of the claim, the more likely the ultimate settlement amount will vary. Our longer tail business includes general liability, including construction defect claims, as well as historical claims for asbestos exposures through our marine and aviation businesses and claims relating to our run-off businesses. Our professional liability business, though long tail with respect to settlement period, is produced on a claims-made basis (which means that the policy in-force at the time the claim is filed, rather than the policy in-force at the time the loss occurred, provides coverage) and is therefore, we believe, less likely to result in a significant time lag between the occurrence of the loss and the reporting of the loss. There can be no assurance, however, that we will not suffer substantial adverse prior period development in our business in the future.

 

27


Table of Contents

In addition, reinsurance reserves are subject to greater uncertainty than insurance reserves primarily because a reinsurer relies on the original underwriting decisions made by ceding companies. As a result, in relation to our reinsurance business, we are subject to the risk that our ceding companies may not have adequately evaluated the risks reinsured by us and the premiums ceded may not adequately compensate us for the risks we assume. In addition, reinsurance reserves may be less reliable than insurance reserves because there is generally a longer lapse of time from the occurrence of the event to the reporting of the loss or benefit to the reinsurer to the ultimate resolution or settlement of the loss.

In addition to loss reserves, preparation of our financial statements requires us to make many estimates and judgments.

In addition to loss reserves discussed above, the Consolidated Financial Statements contain estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures. On an ongoing basis we evaluate our estimates based on historical experience and other assumptions that we believe to be reasonable under the circumstances. Any significant change in these estimates could adversely affect our results of operations and/or our financial condition.

We may not have access to adequate reinsurance to protect us against losses.

We purchase reinsurance by transferring part of the risk we have assumed to a reinsurance company in exchange for part of the premium we receive in connection with the risk. The availability and cost of reinsurance are subject to prevailing market conditions, both in terms of price and available capacity, which can affect our business volume and profitability. Our reinsurance programs are generally subject to renewal on an annual basis. If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase, which could increase our costs, or, if we were unwilling to bear an increase in net exposures, we would have to reduce the level of our underwriting commitments, especially catastrophe exposed risks, which would reduce our revenues and possibly net income.

Our reinsurers may not pay on losses in a timely fashion, or at all, which may increase our costs.

Although reinsurance makes the reinsurer 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. 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.

Intense competition for our products could harm our ability to maintain or increase our profitability and premium volume.

The property and casualty insurance industry is highly competitive. We face competition from both domestic and foreign insurers, many of whom have longer operating histories and greater financial, marketing and management resources. Competition in the types of insurance in which we are engaged is based on many factors, including our perceived overall financial strength, pricing and other terms and conditions of products and services offered, business experience, marketing and distribution arrangements, agency and broker relationships, levels of customer service (including speed of claims payments), product differentiation and quality, operating efficiencies and underwriting. Furthermore, insureds tend to favor large, financially strong insurers, and we face the risk that we will lose market share to higher rated insurers. We may have difficulty in continuing to compete successfully on any of these bases in the future. If competition limits our ability to write new business at adequate rates, our ability to transact business would be materially and adversely affected and our results of operations would be adversely affected.

We may be unable to attract and retain qualified employees.

We depend on our ability to attract and retain qualified executive officers, experienced underwriters, claims professionals and other skilled employees who are knowledgeable about our specialty lines of business. If the quality of our executive officers, underwriting or claims team and other personnel decreases, we may be unable to maintain our current competitive position in the specialty markets in which we operate and be unable to expand our operations into new specialty markets.

 

28


Table of Contents

Increases in interest rates may cause us to experience losses.

Because of the unpredictable nature of losses that may arise under insurance policies, we may require substantial liquidity at any time. Our investment portfolio, which consists largely of fixed-income investments, is our principal source of liquidity. The market value of our fixed-income investments is subject to fluctuation depending on changes in prevailing interest rates and various other factors. We do not hedge our investment portfolio against interest rate risk. Increases in interest rates during periods when we must sell fixed-income securities to satisfy liquidity needs may result in substantial realized investment losses.

Our investment portfolio is subject to certain risks that could adversely affect our results of operations, financial condition or cash flows.

Although our investment policy guidelines emphasize total investment return in the context of preserving and enhancing shareholder value and statutory surplus of the insurance subsidiaries, our investments are subject to market-wide risks and fluctuations, as well as to risks inherent in particular types of securities. Due to these risks we may not be able to realize our investment objectives. In addition, we may be forced to liquidate investments at times and prices that are not optimal, which could have an adverse effect on our results of operations. Investment losses could significantly decrease our asset base, thereby adversely affecting our ability to conduct business and pay claims.

We are exposed 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.

We are exposed to significant capital markets risk related to changes in interest rates, credit spreads, equity prices and foreign currency exchange rates. If significant, declines in equity prices, changes in interest rates, changes in credit spreads and the strengthening or weakening of foreign currencies against the U.S. dollar, individually or in tandem, could have a material adverse effect on our consolidated results of operations, financial condition or cash flows.

Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. Our investment portfolio contains interest rate sensitive instruments, such as fixed income securities, which may be adversely affected by changes in interest rates from governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A rise in interest rates would reduce the fair value of our investment portfolio. It would also provide the opportunity to earn higher rates of return on funds reinvested. Conversely, a decline in interest rates would increase the fair value of our investment portfolio. We would then presumably earn lower rates of return on assets reinvested. We may be forced to liquidate investments prior to maturity at a loss in order to cover liabilities. Although we take measures to manage the economic risks of investing in a changing interest rate environment, we may not be able to mitigate the interest rate risk of our assets relative to our liabilities.

Included in our fixed income securities are asset-backed and mortgage-backed securities. Changes in interest rates can expose us to prepayment risks on these investments. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities are prepaid more quickly, requiring us to reinvest the proceeds at the then current rates.

Our fixed income portfolio is invested in high quality, investment-grade securities. However, we are generally permitted to invest up to 2% of our total investment portfolio in below investment-grade high yield fixed income securities. These securities, which pay a higher rate of interest, also have a higher degree of credit or default risk. These securities may also be less liquid in times of economic weakness or market disruptions. While we have put in place procedures to monitor the credit risk and liquidity of our invested assets, it is possible that, in periods of economic weakness, we may experience default losses in our portfolio. This may result in a reduction of net income, capital and cash flows.

We invest a portion of our portfolio in common stock or preferred stocks. The value of these assets fluctuates with the equity markets. In times of economic weakness, the market value and liquidity of these assets may decline, and may impact net income, capital and cash flows.

 

29


Table of Contents

The functional currencies of the Company’s principal insurance and reinsurance subsidiaries are the U.S. dollar, U.K. pound and Canadian dollar. Exchange rate fluctuations relative to the functional currencies may materially impact our financial position. Certain of our subsidiaries maintain both assets and liabilities in currencies different than their functional currency, which exposes us to changes in currency exchange rates. In addition, locally-required capital levels are invested in local currencies in order to satisfy regulatory requirements and to support local insurance operations regardless of currency fluctuations.

Despite our mitigation efforts, an increase in interest rates or a change in foreign exchange rates could have a material adverse effect on our results of operations, financial position and cash flows.

Capital may not be available to us in the future or may only be available on unfavorable terms.

The capital needs of our business are dependent on several factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover our losses. If our current capital becomes insufficient for our future plans, we may need to raise additional capital through the issuance of stock or debt. Otherwise, in the case of insufficient capital, we may need to limit our growth. The terms of an equity or debt offering could be unfavorable, for example, causing dilution to our current shareholders or such securities may have rights, preferences and privileges that are senior to our existing securities. If we were in a situation of having inadequate capital and if we were not able to obtain additional capital, our business, results of operations and financial condition could be adversely affected to a material extent.

A downgrade in our ratings could adversely impact the competitive positions of our operating businesses or negatively affect our ability to implement our business strategy successfully.

Ratings are a critical factor in establishing the competitive position of insurance companies. The Insurance Companies are rated by A.M. Best and S&P. A.M. Best’s and S&P’s ratings reflect their opinions of an insurance company’s financial strength, operating performance, strategic position and ability to meet its obligations to policyholders, and are not evaluations directed to investors. Our ratings are subject to periodic review by A.M. Best and S&P. Our rating with S&P is subject to a negative outlook. Because these ratings have become an increasingly important factor in establishing the competitive position of insurance companies, if these ratings are reduced, our competitive position in the industry, and therefore our business, could be adversely affected in a material manner. A significant downgrade could result in a substantial loss of business as policyholders might move to other companies with higher ratings. In addition, a significant downgrade could subject us to higher borrowing costs and our ability to access the capital markets could be negatively impacted. If we were to be downgraded below an “A-” an event of default would occur under our letter of credit facility. Refer to Note 8, Credit Facility, in the Notes to Consolidated Financial Statements for additional information regarding our credit facility.

There can be no assurance that our current ratings will continue for any given period of time. For a further discussion of our ratings, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Ratings” included herein.

Continued or increased premium levies by Lloyd’s for the Lloyd’s Central Fund and cash calls for trust fund deposits or a significant downgrade of Lloyd’s A.M. Best rating could materially and adversely affect us.

The Lloyd’s Central Fund protects Lloyd’s policyholders against the failure of a member of Lloyd’s to meet its obligations. The Central Fund is a mechanism which in effect mutualizes unpaid liabilities among all members, whether individual or corporate. The fund is available to back Lloyd’s policies issued after 1992. Lloyd’s requires members to contribute to the Central Fund, normally in the form of an annual contribution, although a special contribution may be levied. The Council of Lloyd’s has discretion to call up to 3% of underwriting capacity in any one year.

Policies issued before 1993 have been reinsured by Equitas Insurance Limited (“Equitas”), an independent insurance company authorized by the Financial Services Authority. However, if Equitas were to fail or otherwise be unable to meet all of its obligations, Lloyd’s may take the view that it is appropriate to apply the Central Fund to discharge those liabilities Equitas failed to meet. In that case, the Council of Lloyd’s may resolve to impose a special or additional levy on the existing members, including Lloyd’s corporate members, to satisfy those liabilities.

 

30


Table of Contents

Additionally, Lloyd’s insurance and reinsurance business is subject to local regulation, and regulators in the United States require Lloyd’s to maintain certain minimum deposits in trust funds as protection for policyholders in the United States. These deposits may be used to cover liabilities in the event of a major claim arising in the United States and Lloyd’s may require us to satisfy cash calls to meet claims payment obligations and maintain minimum trust fund amounts.

Any premium levy or cash call would increase the expenses of Navigators Corporate Underwriters Ltd., our corporate members, without providing compensating revenues, and could have a material adverse effect on our results.

We believe that in the event that Lloyd’s rating is downgraded, the downgrade could have a material adverse effect on our ability to underwrite business through our Lloyd’s Operations and therefore on our financial condition or results of operations.

Our businesses are heavily regulated, and changes in regulation may reduce our profitability and limit our growth.

Our insurance subsidiaries are subject to extensive regulation and supervision in the jurisdictions in which they conduct business. This regulation is generally designed to protect the interests of policyholders, as opposed to insurers and their stockholders and other investors, and relates to authorization for lines of business, capital and surplus requirements, investment limitations, underwriting limitations, transactions with affiliates, dividend limitations, changes in control, premium rates and a variety of other financial and non-financial components of an insurance company’s business.

Virtually all states require insurers licensed to do business in that state to bear a portion of the loss suffered by some insureds as the result of impaired or insolvent insurance companies through the operation of guaranty funds. The effect of these arrangements could reduce our profitability in any given period or limit our ability to grow our business.

In recent years, the state insurance regulatory framework has come under increased federal scrutiny, and some state legislatures have considered or enacted laws that may alter or increase state authority to regulate insurance companies and insurance holding companies. Further, the NAIC and state insurance regulators are re-examining existing laws and regulations, specifically focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws. Additionally, the Dodd-Frank Wall Street Reform and Consumer Protection Act, which became effective on July 21, 2010, established a Federal Insurance Office to, among other responsibilities, identify issues or gaps in the regulation of insurers that could contribute to a systemic crisis in the insurance industry or the United States financial system. Any proposed or future legislation or NAIC initiatives may be more restrictive than current regulatory requirements or may result in higher costs.

In response to the September 11, 2001 terrorist attacks, the United States Congress has enacted legislation designed to ensure, among other things, the availability of insurance coverage for terrorist acts, including the requirement that insurers provide such coverage in certain circumstances. Refer to “Business—Regulation – United States” included herein for a discussion of the TRIA, TRIEA and TRIPRA legislation.

Extensive changes to the regulatory regime for financial services in the United Kingdom have been enacted. Refer to “Business – Regulation – United Kingdom” included herein for a discussion of such proposals.

 

31


Table of Contents

The E.U. Directive on Solvency II may affect how we manage our business, subject us to higher capital requirements and cause us to incur additional costs to conduct our business in the E.U. (including the United Kingdom) and possibly elsewhere.

An E.U. directive covering the capital adequacy, risk management and regulatory reporting for insurers, known as Solvency II, was adopted by the European Parliament in April 2009. Solvency II will introduce a new system of regulation for insurers operating in the E.U. (including the United Kingdom) and presents a number of risks to us. Although Solvency II was originally stated to have become effective by October 31, 2012, implementation has been delayed several times. On December 3, 2012, the European Parliament decided to delay a vote on its Omnibus II directive until June 10, 2013. The Omnibus II directive is expected to set forth the implementation schedule for Solvency II. In addition, the Omnibus II directive is expected (among other things) to introduce a series of transitional provisions in specific areas that may extend beyond the initial implementation date of Solvency II. The details of the Solvency II project will be set out in so-called “delegated acts” and binding technical standards which will be issued by the European Commission and will be legally binding. No official drafts for any of these measures have been released. Consequently the Company’s implementation plans are based on its current understanding of the Solvency II requirements, which may change. During the next few years, we expect to undertake a significant amount of work to ensure that we meet the new requirements, which may divert finite resources from other business related tasks. Although the details of how Solvency II will apply to Navigators Insurance Company, NUAL and Syndicate 1221 are not yet fully known, it is clear that Solvency II will impose new requirements with respect to capital structure, technical provisions, solvency calculations, governance, disclosure and risk management. There is also a risk that Solvency II may increase our capital requirements for our U.K. Branch and Syndicate 1221. These new regulations have the potential to adversely affect the profitability of Navigators Insurance Company, NUAL and Syndicate 1221, and to restrict their ability to carry on their businesses as currently conducted. A significant unanswered question about how Solvency II will be implemented is whether the new regulations will apply only to Navigators Insurance Company’s U.K. Branch or to all of its operations, both within and outside of the United Kingdom and the other E.U. countries in which it operates. If the regulations are applied to Navigators Insurance Company in its entirety, we could be subject to even more onerous requirements under the new regulations. Such requirements could have a significant adverse effect on our ability to operate profitably and could impose other significant restrictions on our ability to carry on our insurance business in the E.U. (including the United Kingdom) as it is now conducted.

The inability of our subsidiaries to pay dividends to us in sufficient amounts would harm our ability to meet our obligations.

The Parent Company is a holding company and relies primarily on dividends from our subsidiaries to meet our obligations for payment of interest and principal on outstanding debt obligations and corporate expenses. The ability of our insurance subsidiaries to pay dividends to the Parent Company in the future will depend on their statutory surplus, on earnings and on regulatory restrictions. For a discussion of our insurance subsidiaries’ current dividend-paying ability, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources”, included herein. The Parent Company, as an insurance holding company, and our underwriting subsidiaries are subject to regulation by some states. Such regulation generally provides that transactions between companies within our consolidated group must be fair and equitable. Transfers of assets among affiliated companies, certain dividend payments from underwriting subsidiaries and certain material transactions between companies within our consolidated group may be subject to prior notice to, or prior approval by, state regulatory authorities. Our underwriting subsidiaries are also subject to licensing and supervision by government regulatory agencies in the jurisdictions in which they do business. These regulations may set standards of solvency that must be met and maintained, such as the nature of and limitations on investments, the nature of and limitations on dividends to policyholders and stockholders and the nature and extent of required participation in insurance guaranty funds. These regulations may affect our subsidiaries’ ability to provide us with dividends.

 

32


Table of Contents

Catastrophe losses could materially reduce our profitability.

We are exposed to claims arising out of catastrophes, particularly in our marine insurance line of business and our NavTech and NavRe businesses. We have experienced, and will experience in the future, catastrophe losses which may materially reduce our profitability or harm our financial condition. Catastrophes can be caused by various natural events, including, but not limited to, hurricanes, windstorms, earthquakes, tornadoes, floods, hail, severe winter weather and fires. Catastrophes can also be man-made, such as war, explosions or the World Trade Center attack, or caused by unfortunate events such as the Deepwater Horizon oil rig disaster or the grounding of the cruise ship Costa Concordia. In addition, changing climate conditions could result in an increase in the frequency or severity of natural catastrophes, which could increase our exposure to such losses. 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.

The market price of Navigators common stock may be volatile.

There has been significant volatility in the market for equity securities. The price of Navigators common stock may not remain at or exceed current levels. In addition to the other risk factors detailed herein, the following factors may have an adverse impact on the market price of Navigators common stock:

 

   

actual or anticipated variations in our quarterly results of operations, including the result of catastrophes,

 

   

changes in market valuations of companies in the insurance and reinsurance industry,

 

   

changes in expectations of future financial performance or changes in estimates of securities analysts,

 

   

issuances of common shares or other securities in the future,

 

   

a downgrade in our credit ratings,

 

   

the addition or departure of key personnel, and

 

   

announcements by us or our competitors of acquisitions, investments or strategic alliances.

Stock markets in the United States often experience price and volume fluctuations. Market fluctuations, as well as general political and economic conditions such as a recession or interest rate or currency rate fluctuations, could adversely affect the market price of Navigators common stock.

There is a risk that we may be directly or indirectly exposed to recent uncertainties with regard to European sovereign debt holdings.

We are protected by various treaty and facultative reinsurance agreements. Our exposure to credit risk from any one reinsurer is managed through diversification by reinsuring with a number of different reinsurers, principally in the United States and European reinsurance markets. Consequently, we may be indirectly exposed to recent uncertainties with regard to European sovereign debt holdings through certain of our reinsurers. A table of our 20 largest reinsurers by the amount of reinsurance recoverable for ceded losses and LAE and ceded unearned premium is presented in “Business” along with their rating from two rating agencies. The 20 largest reinsurers from the United States and Europe represent 72.7% of our Reinsurance Recoverables at December 31, 2012.

In addition, we invest primarily in non-sovereign fixed maturities in the European Union. As of December 31, 2012, the fair value of such securities was $83.2 million, with an amortized cost of $80.8 million representing 3.7% of our total fixed income and equity portfolio. Our largest exposure is in France with a total of $37.4 million followed by Netherlands with a total of $33.2 million. We have no direct material exposure to Greece, Portugal, Italy or Spain as of December 31, 2012.

Nonetheless, the failure of the European Union member states to successfully resolve this crisis could result in the devaluation of the Euro, the abandonment of the Euro by one or more members of the European Union or the dissolution of the European Union and it is impossible to predict all of the consequences that this could have on the global economy in general or more specifically on our business. Any or all of these events could have a material adverse effect on the results of our operations, liquidity and financial condition.

 

33


Table of Contents

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

The determination of the impairments taken on our investments varies by investment type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects impairments in operations as such evaluations are revised. We cannot assure you that we have accurately assessed the level of impairments taken in our financial statements. Furthermore, additional impairments may need to be taken in the future, which could materially impact our financial position or results of operations. Historical trends may not be indicative of future impairments.

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.

We rely heavily on the successful, uninterrupted functioning of our information technology (“IT”) and telecommunications systems. Our business and continued expansion is highly dependent upon our ability to perform, in an efficient and uninterrupted fashion, necessary business functions, such as pricing, quoting and processing policies, paying claims, performing actuarial and other modeling functions. A failure of our IT and telecommunication systems or the termination of third-party software licenses we rely on in order to maintain such systems could materially impact our ability to write and process business, provide customer service, pay claims in a timely manner or perform other necessary actuarial, legal, financial and other business functions. Computer viruses, hackers and other external hazards, as well as internal exposures such as potentially dishonest employees, could expose our IT and data systems to security breaches that may result in liability to us, cause our data to be corrupted and cause us to commit resources, management time and money to prevent or correct security breaches. If we do not maintain adequate IT and telecommunications systems, we could experience adverse consequences, including inadequate information on which to base critical decisions, the loss of existing customers, difficulty in attracting new customers, litigation exposures and increased administrative expenses. As a result, 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.

Our marine business, like our other business lines, is required to comply with a wide variety of laws and regulations, including economic sanctions and embargo laws and regulations, applicable to insurance or reinsurance companies, both in the jurisdictions in which they are organized and where they sell their insurance and reinsurance products, and that implicate the conduct of our insureds. The insurance industry, in particular as relates to international insurance and reinsurance companies, has become subject to increased scrutiny in many jurisdictions, including the United States, various states within the United States and the United Kingdom. For example, in 2012, President Obama signed into law the Iran Threat Reduction and Syria Human Rights Act of 2012 (the “Act”) which created new sanctions and strengthened existing sanctions against Iran. Among other things, the Act intensifies existing sanctions regarding the provision of goods, services, infrastructure or technology to Iran’s petroleum or petrochemical sector, and included provisions relating to persons that engage in certain insurance or re-insurance activities.

Increased regulatory focus on us, such as in connection with the matters discussed above, may result in costly compliance burdens and/or may otherwise increase our costs, which could materially and adversely impact our financial performance. The introduction of new or expanded economic sanctions applicable to marine insurance could also force us to exit certain geographic areas or product lines, which could have an adverse impact our profitability.

 

34


Table of Contents

Although we intend to maintain compliance with all applicable sanctions and embargo laws and regulations, and have established protocols, policies and procedures reasonably tailored to ensure compliance with all applicable embargo laws and regulations, there can be no assurance that we will be in compliance in the future, particularly as the scope of certain laws may be unclear and may be subject to changing interpretations. Any such violation could result in fines, penalties or other sanctions that could severely impact our ability to access U.S. capital markets and conduct our business, and could result in some investors deciding, or being required, to divest their interest, or not to invest, in us. In addition, certain institutional investors may have investment policies or restrictions that prevent them from holding securities of companies that have contracts with countries identified by the U.S. government as state sponsors of terrorism. The determination by these investors not to invest in, or to divest from, investing in our common stock may adversely affect the price at which our common stock trades.

Moreover, our subsidiaries, such as our Lloyd’s Operations, may be subject to different sanctions and embargo laws and regulations. Our reputation and the market for our securities may be adversely affected if our Lloyd’s Operations engages in certain activities, even though such activities are lawful under applicable sanctions and embargo laws and regulations.

Item 1B. Unresolved Staff Comments

None

Item 2. Properties

Our executive and administrative office is located at 6 International Drive in Rye Brook, NY. Our lease for this space expires in February 2014. Our underwriting operations are in various locations with non-cancelable operating leases including Alpharetta, GA, Charlotte, NC, Chicago, IL, Coral Gables, FL, Danbury, CT, Ellicott City, MD, Exton, PA, Houston, TX, Irvine, CA, Los Angeles, CA, New York City, NY, Parsippany, NJ, Philadelphia, PA, Pittsburgh, PA, San Francisco, CA, Schaumburg, IL, Seattle, WA, London, England, Manchester, England, Antwerp, Belgium, Copenhagen, Denmark, Stockholm, Sweden.

Item 3. Legal Proceedings

In the ordinary course of conducting business, our subsidiaries are involved in various legal proceedings, either indirectly as insurers for parties or directly as defendants. Most of the these proceedings consist of claims litigation involving our subsidiaries as either (a) liability insurers defending or providing indemnity for third party claims brought against insureds or (b) insurers defending first party coverage claims brought against them. We account for such activity through the establishment of unpaid loss and loss adjustment reserves. Our management believes that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and cost of defense, will not be material to our consolidated financial condition, results of operations, or cash flows.

Our subsidiaries are also from time to time involved with other legal actions, some of which assert claims for substantial amounts. These actions include claims asserting extra contractual obligations, such as claims involving allegations of bad faith in the handling of claims or the underwriting of policies. In general, we believe we have valid defenses to these cases. Our management expects that the ultimate liability, if any, with respect to such extra-contractual matters will not be material to our consolidated financial position. Nonetheless, given the large or indeterminate amounts sought in certain of these matters, and the inherent unpredictability of litigation, an adverse outcome in such matters could, from time to time, have a material adverse outcome on our consolidated results of operations or cash flows in a particular fiscal quarter or year.

Item 4. Mine Safety Disclosures

Not applicable.

 

35


Table of Contents

PART II

Item  5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

The Company’s common stock is traded over-the-counter on NASDAQ under the symbol NAVG. Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.

The high, low and closing trade prices for the four quarters of 2012 and 2011 were as follows:

 

     2012      2011  
     High      Low      Close      High      Low      Close  

First Quarter

   $ 51.84       $ 44.43       $ 47.24       $ 54.59       $ 48.13       $ 51.50   

Second Quarter

   $ 51.45       $ 44.95       $ 50.05       $ 52.90       $ 44.73       $ 47.00   

Third Quarter

   $ 54.22       $ 46.41       $ 49.22       $ 50.03       $ 38.36       $ 43.21   

Fourth Quarter

   $ 54.00       $ 49.22       $ 51.07       $ 49.20       $ 40.71       $ 47.68   

Information provided to us by our transfer agent and proxy solicitor indicates that there are approximately 156 holders of record and 3,520 beneficial holders of our common stock, as of January 14, 2013.

 

36


Table of Contents

Five Year Stock Performance Graph

The Five Year Stock Performance Graph and related Cumulative Indexed Returns table, as presented below, reflects the cumulative return on the Company’s common stock, the Standard & Poor’s 500 Index (“S&P 500 Index”) and the S&P Property and Casualty Insurance Index (the “Insurance Index”) assuming an original investment in each of $100 on December 31, 2007 (the “Base Period”) and reinvestment of dividends to the extent declared. Cumulative returns for each year subsequent to 2007 are measured as a change from this Base Period.

The comparison of five year cumulative returns among the Company, the companies listed in the S&P 500 Index and the Insurance Index are as follows:

 

LOGO

 

     Cumulative Indexed Returns
Year Ended December 31,
 

Company / Index

   Base Period
2007
     2008      2009      2010      2011      2012  

The Navigators Group, Inc.

     100.00         84.48         72.47         77.46         71.78         76.52   

S&P 500 Index

     100.00         63.00         79.67         91.67         93.61         108.58   

S&P Property & Casualty Insurance Index

     100.00         70.59         79.21         86.52         86.29         103.65   

 

37


Table of Contents

The following Annual Return Percentage table reflects the annual return on the Company’s common stock, the S&P 500 Index and the Insurance Index including reinvestment of dividends to the extent declared.

 

     Annual Return Percentage
Year Ended December 31,
 

Company / Index

   2008      2009      2010      2011      2012  

The Navigators Group, Inc.

     -15.52         -14.21         6.88         -7.33         6.60   

S&P 500 Index

     -37.00         26.46         15.06         2.11         16.00   

S&P Property & Casualty Insurance Index

     -29.41         12.21         9.23         -0.26         20.11   

Dividends

We have not paid or declared any cash dividends on our common stock. While there presently is no intention to pay cash dividends on the common stock, future declarations, if any, are at the discretion of our Board of Directors and the amounts of such dividends will be dependent upon, among other factors, our results of operations and cash flow, financial condition and business needs, restrictive covenants under our credit facility, the capital and surplus requirements of our subsidiaries and applicable government regulations.

Refer to Note 14, Dividends and Statutory Financial Information, in the Notes to Consolidated Financial Statements for additional information regarding dividends, including dividend restrictions and net assets available for dividend distribution.

Recent Sales of Unregistered Securities

None

Use of Proceeds from Public Offering of Debt Securities

None

Purchases of Equity Securities by the Issuer

None

 

38


Table of Contents

Item 6. Selected Financial Data

The following table sets forth selected consolidated financial data including consolidated financial information of the Company for each of the last five calendar years, derived from the Company’s audited Consolidated Financial Statements. You should read the table in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and Item 8, “Financial Statements and Supplementary Data”, included herein.

 

           Year Ended December 31,  

In thousands, except share and per share amounts

   2012     2011     2010     2009     2008  

Operating Information:

          

Gross written premiums

   $ 1,286,465      $ 1,108,216      $ 987,201      $ 1,044,918      $ 1,084,922   

Net written premiums

     833,655        753,798        653,938        701,255        661,615   

Net earned premiums

     781,964        691,645        659,931        683,363        643,976   

Net investment income

     54,248        63,500        71,662        75,512        76,554   

Net other-than-temporary impairment losses

     (858     (1,985     (1,080     (11,876     (37,045

Net realized gains (losses)

     41,074        11,996        41,319        9,216        (1,254

Total revenues

     877,916        766,385        776,975        762,880        683,666   

Income (loss) before income taxes

     91,736        32,734        98,829        86,848        68,731   

Net income (loss)

     63,762        25,597        69,578        63,158        51,692   

Net income per share:

          

Basic

   $ 4.54      $ 1.71      $ 4.33      $ 3.73      $ 3.08   

Diluted

   $ 4.45      $ 1.69      $ 4.24      $ 3.65      $ 3.04   

Average common shares outstanding:

          

Basic

     14,052,311        14,980,429        16,064,770        16,935,488        16,801,713   

Diluted

     14,327,820        15,183,285        16,415,266        17,322,020        16,991,711   

Combined loss and expense ratio (1):

          

Loss ratio

     63.6     69.0     63.8     63.8     61.0

Expense ratio

     35.7     35.7     36.9     33.4     32.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     99.3     104.7     100.7     97.2     93.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance sheet information:

          

Total investments and cash

   $ 2,422,254      $ 2,233,498      $ 2,154,328      $ 2,056,587      $ 1,917,715   

Total assets

     4,007,670        3,670,007        3,531,459        3,453,994        3,349,580   

Gross losses and LAE reserves

     2,097,048        2,082,679        1,985,838        1,920,286        1,853,664   

Net losses and LAE reserves

     1,216,909        1,237,234        1,142,542        1,112,934        999,871   

Senior Notes

     114,424        114,276        114,138        114,010        123,794   

Stockholders’ equity

     879,485        803,435        829,354        801,519        689,317   

Common shares outstanding

     14,046,666        13,956,235        15,743,511        16,846,484        16,856,073   

Book value per share (2)

   $ 62.61      $ 57.57      $ 52.68      $ 47.58      $ 40.89   

Statutory surplus of Navigators

          

Insurance Company

   $ 682,881      $ 662,162      $ 686,919      $ 645,820      $ 581,166   

 

(1) — Calculated based on earned premiums.
(2) — Calculated as stockholders’ equity divided by actual shares outstanding as of the date indicated.

 

39


Table of Contents

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and accompanying notes which appear elsewhere in this Form 10-K. It contains forward-looking statements that involve risks and uncertainties. Please refer to “Note on Forward-Looking Statements” and “Risk Factors” 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-K.

Overview

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.

Our revenue is primarily comprised of premiums and investment income. We derive our premiums primarily from business written by wholly-owned underwriting management companies which produce, manage and underwrite insurance and reinsurance for us. Our products are distributed through multiple channels, utilizing global, national and regional retail and wholesale insurance brokers.

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”).

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 2012, 2011 and 2010 underwriting years through our wholly-owned subsidiary, Navigators Corporate Underwriters Ltd. 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.

While management takes into consideration a wide range of factors in planning our business strategy and evaluating results of operations, there are certain factors that management believes are fundamental to understanding how we are 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 controlling the costs of our operations. Management believes that careful monitoring of the costs of existing operations and assessing the 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 their business and take advantage of market opportunities are constrained by regulatory capital requirements and rating agency assessments of capital adequacy. Similarly, the ability to grow our operations at Lloyd’s is subject to capital and operating requirements of Lloyd’s and the U.K. regulatory authorities.

 

40


Table of Contents

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 and personal automobile insurance, because we do not believe our technical underwriting expertise is of as much value in these types of businesses. Examples of niches that have the characteristics we look for include offshore energy which provides coverage for physical damage to, for example, high value offshore oil drilling rigs, and Directors and Officers (“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.

For additional information regarding our business, refer to “Business—Overview”, included herein.

Ratings

Our ability to underwrite business is dependent upon the financial strength of the Insurance Companies and Lloyd’s. Financial strength ratings represent the opinions of the rating agencies on the financial strength of a company and its capacity to meet the obligations of insurance policies. Independent ratings are one of the important factors that establish our competitive position in the insurance markets. The rating agencies consider many factors in determining the financial strength rating of an insurance company, including the relative level of statutory surplus necessary to support the business operations of the company. These ratings are based upon factors relevant to policyholders, agents and intermediaries and are not directed toward the protection of investors. Such ratings are not recommendations to buy, sell or hold securities. We could be adversely impacted by a downgrade in the Insurance Companies’ or Lloyd’s financial strength ratings, including a possible reduction in demand for our products, higher borrowing costs and our ability to access the capital markets.

For the Insurance Companies, Navigators Insurance Company and Navigators Specialty Insurance Company utilize the financial strength ratings from A.M. Best and S&P for underwriting purposes. Navigators Insurance Company and Navigators Specialty Insurance Company are both rated “A” (Excellent – stable outlook) by A.M. Best and “A” (Strong—negative outlook) by S&P. Syndicate 1221 utilizes the ratings from A.M. Best and S&P for underwriting purposes which apply to all Lloyd’s syndicates. Lloyd’s is rated “A” (Excellent – stable outlook) by A.M. Best and A+ (Strong – stable outlook) by S&P.

Debt ratings apply to short-term and long-term debt as well as preferred stock. These ratings are assessments of the likelihood that we will make timely payments of the principal and interest for our senior debt. It is possible that, in the future, one or more of the rating agencies may reduce our existing debt ratings. If one or more of our debt ratings were downgraded, we could incur higher borrowing costs and our ability to access the capital markets could be impacted.

We utilize the senior debt ratings from S&P. Our senior debt is rated BBB (Adequate – negative outlook) by S&P.

Critical Accounting Estimates

We prepare our financial statements in accordance with GAAP, which requires the use of estimates and assumptions. The following accounting estimates are viewed by management to be critical because they require significant judgment on the part of management. Management has discussed and reviewed the development, selection, and disclosure of critical accounting estimates with the Company’s Audit Committee. Financial results could be materially different if other methodologies were used or if management modified its assumptions.

 

41


Table of Contents

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 investment securities and accounting for Lloyd’s results.

Reserves for Losses and Loss Adjustment Expenses

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 less the amount paid to date. 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. No assurance can be given that actual claims made and related payments will not be in excess of the amounts reserved. During the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Even after such adjustments, ultimate liability may exceed or be less than the revised estimates.

The numerous factors that contribute to the inherent uncertainty in the process of establishing loss reserves include: interpreting loss development activity, emerging economic and social trends, inflation, changes in the regulatory and judicial environment and changes in our operations, including changes in underwriting standards and claims handling procedures. The process of establishing loss reserves is complex and imprecise as it must take into account many variables that are subject to the outcome of future events. As a result, informed subjective judgments as to our ultimate exposure to losses are an integral component of our loss reserving process.

Our actuaries calculate indicated IBNR loss reserves for each line of business by underwriting year for major products principally using standard actuarial methodologies which are projection or extrapolation techniques: the loss ratio method, the loss development method and the Bornheutter-Ferguson method. In general the loss ratio method is used to calculate the IBNR for only the most recent underwriting years or in the absence of any statistical data upon which to estimate ultimate losses while the Bornheutter-Ferguson method is used to calculate the IBNR for recent years where a statistical basis exists for that computation with the loss development method used for more mature underwriting years. When appropriate such methodologies are supplemented by the frequency/severity method, which are used to analyze and better comprehend loss development patterns and trends in the data when making selections and judgments. Each of these methodologies, which are described below, are generally applicable to both long tail and short tail lines of business depending on a variety of circumstances. In utilizing these methodologies to develop our IBNR loss reserves, a key objective of management in making their final selections is to deliberate with our actuaries to identify aberrations and systemic changes occurring within historical experience and accurately adjust for them. This process requires the substantial use of informed judgment and is inherently uncertain as it can be influenced by numerous factors including:

 

   

Inflationary pressures (medical and economic) that affect the size of losses;

 

   

Judicial, regulatory, legislative, and legal decisions that affect insurers’ liabilities;

 

   

Changes in the frequency and severity of losses;

 

   

Changes in the underlying loss exposures of our policies;

 

   

Changes in our claims handling procedures.

For non-statistical claim events, i.e., where historical patterns are not available for applicable, expert judgment by claims professionals with input from underwriting and management are used. Such instances relate to the IBNR loss reserve processes for our Hurricanes losses and our asbestos exposures.

 

42


Table of Contents

A brief summary of each actuarial method discussed above follows:

Loss ratio method

This method is based on the assumption that ultimate losses vary proportionately with premiums. Pursuant to the loss ratio method, IBNR loss reserves are calculated by multiplying the earned premium by an expected ultimate loss ratio to estimate the ultimate losses for each underwriting year, then subtracting the reported losses, consisting of paid losses and case loss reserves, to determine the IBNR loss reserve amount. The ultimate loss ratios applied are the Company’s best estimates for each underwriting year and are generally determined after evaluating a number of factors which include: information derived by underwriters and actuaries in the initial pricing of the business, the ultimate loss ratios established in the prior accounting period and the related judgments applied, the ultimate loss ratios of previous underwriting years, premium rate changes, underwriting and coverage changes, changes in terms and conditions, legislative changes, exposure trends, loss development trends, claim frequency and severity trends, paid claims activity, remaining open case reserves and industry data where deemed appropriate. Such factors are also evaluated when selecting ultimate loss ratios and/or loss development factors in the methods described below.

Bornheutter-Ferguson method

The Bornheutter-Ferguson method calculates the IBNR loss reserves as the product of the earned premium, an expected ultimate loss ratio, and a loss development factor that represents the expected percentage of the ultimate losses that have been incurred but not yet reported. The loss development factor equals one hundred percent less the expected percentage of losses that have thus far been reported, which is generally calculated as an average of the percentage of losses reported for comparable reporting periods of prior underwriting years. The expected ultimate loss ratio is generally determined in the same manner as in the loss ratio method.

Loss development method

The loss development method, also known as the chainladder or the link-ratio method, develops the IBNR loss reserves by multiplying the paid or reported losses by a loss development factor to estimate the ultimate losses, then subtracting the reported losses, consisting of paid losses and case loss reserves, to determine the IBNR loss reserves. The loss development factor is the reciprocal of the expected percentage of losses that have thus far been reported, which is generally calculated as an average of the percentage of losses reported for comparable reporting periods of prior underwriting years.

Frequency/severity method

The frequency/severity method calculates the IBNR loss reserves by separately projecting claim count and average cost per claim data on either a paid or incurred basis. It estimates the expected ultimate losses as the product of the ultimate number of claims that are expected to be reported and the expected average amount of these claims.

Actuarial loss studies are conducted by the Company’s actuaries at various times throughout the year for major lines of business employing the methodologies as described above. Additionally, a review of the emergence of actual losses relative to expectations for each line of business, generally derived from the annual loss studies, is conducted each quarter to determine whether the assumptions used in the reserving process continue to form a reasonable basis for the projection of liabilities for each product line. Such reviews may result in maintaining or revising assumptions regarding future loss development based on various quantitative and qualitative considerations. If actual loss activity differs from expectations, an upward or downward adjustment to loss reserves may occur. As time passes, estimated loss reserves for an underwriting year will be based more on historical loss activity and loss development patterns rather than on assumptions based on underwriters’ input, pricing assumptions or industry experience.

The following discusses the method used for calculating the IBNR for each line of business and key assumptions used in applying the actuarial methods described.

 

43


Table of Contents

Marine

Generally, two key assumptions are used by our actuaries in setting IBNR loss reserves for major products in this line of business. The first assumption is that our historical experience regarding paid and reported losses for each product where we have sufficient history can be relied on to predict future loss activity. The second assumption is that our underwriters’ assessments as to potential loss exposures are reliable indicators of the level of our expected loss activity. The specific loss reserves for marine are then analyzed separately by product based on such assumptions, except where noted below, with the major products including marine liability, cargo, P&I, transport and bluewater hull.

The claims emergence patterns for various marine product lines vary substantially. Our largest marine product line is marine liability, which has one of the longer loss development patterns. Marine liability protects an insured’s business from liability to third parties stemming from their marine-related operations, such as terminal operations, stevedoring and marina operations. Since marine liability claims generally involve a dispute as to the extent and amount of legal liability that our insured has to a third party, these claims tend to take a longer time to develop and settle. Other longer-tail marine product lines include P&I insurance, which provides coverage for third party liability as well as injury to crew for vessel operators, and transport insurance, which provides both property and third party liability on a primary basis to businesses such as port authorities, marine terminal operators and others engaged in the infrastructure of international transportation. Other marine product lines have considerably shorter periods in which losses develop and settle. Ocean cargo insurance, for example, provides physical damage coverage to goods in the course of transit by water, air or land. By their nature, cargo claims tend to be reported quickly as losses typically result from an obvious peril such as fire, theft or weather. Similarly, bluewater hull insurance provides coverage against physical damage to ocean-going vessels. Such claims for physical damage generally are discovered, reported and settled quickly. The Company currently has extensive experience for all of these products and thus the IBNR loss reserves for all of the marine products are determined using the key assumptions and actuarial methodologies described above. Prior to 2007, however, as discussed below, the Company did not have sufficient experience in the transport product line and instead used its hull and liability products loss development experience as a key assumption in setting the IBNR loss reserves for its transport product.

Property Casualty

The reserves for property and casualty are established separately by product with the major product being contractors’ liability insurance. Other products include offshore energy, commercial middle markets, primary casualty, excess casualty and specialty reinsurance. Our actuaries generally utilize two key assumptions in this line of business: first, that our historical loss development patterns are reasonable predictors of future loss patterns and second, that our claims personnel’s assessment of our claims exposures and our underwriters’ assessment of our expected losses are reliable indicators of our loss exposure. However, this line of business includes a number of products where there is insufficient Company historical experience to project loss reserves and/or loss development is sparse or erratic, which makes extrapolation techniques for those products extremely difficult to apply, and in those circumstances we typically rely more on industry data and our underwriters’ input in setting assumptions for our IBNR loss reserves as opposed to historical loss development patterns. In addition, as discussed in more detail below with respect to construction defect reserves, our actuaries may take other market trends or events into account in setting IBNR loss reserves.

The substantial portion of the property and casualty loss reserves are for the contractors’ liability business, which insures mostly general and artisan contractors. Contractor liability claims are categorized into two claim types: construction defect and other general liability. Other general liability claims typically derive from workplace accidents or from negligence alleged by third parties, and frequently take a long time to report and settle. Construction defect claims involve the discovery of damage to buildings that was caused by latent construction defects. These claims take a very long time to report and to settle compared to other general liability claims. Since construction defect claims report much later than other contractor liability claims, they are analyzed separately in an annual actuarial loss study.

 

44


Table of Contents

We have extensive history in the contractors’ liability business upon which to perform actuarial analyses and we use the key assumption noted above relating to our own historical experience as a reliable indicator of the future for this product. However, there is inherent uncertainty in the loss reserve estimation process for this line of business given both the long-tail nature of the liability claims and the continuing underwriting and coverage changes, claims handling and reserve changes, and legislative changes that have occurred over a several year period. Such factors are judgmentally taken into account in this line of business in specific periods. The underwriting and coverage changes include the migration to a non-admitted business from admitted business in 2003, which allowed us to exclude certain exposures previously permitted (for example, exposure to construction work performed prior to the policy inception), withdrawals from certain contractor classes previously underwritten and expansion into new states beginning in 2005. Claims changes include bringing the claim handling in-house in 1999 and changes in case reserving practices in 2003, 2006 and 2011. During 2010 and 2011, we also significantly increased our claims staff and improved our claims procedures, which has allowed the Company to respond more quickly to reported construction defect claims. The Company is closely monitoring the impact of these effects on the adequacy of our case and IBNR loss reserves. After analysis of the factors above, Management believes that our reserves remain adequate to address our exposure to construction defect losses, but given the uncertainties noted above, there is a risk that our reserves for construction defect losses may ultimately prove to be inadequate, perhaps in a material manner.

Offshore energy provides physical damage coverage to offshore oil platforms along with offshore operations related to oil exploration and production. The significant offshore energy claims are generally caused by fire or storms, and thus tend to be large, infrequent, quickly reported, but occasionally not quickly settled because the damage is often extensive but not always immediately known.

Primary casualty insurance provides primary general liability coverage principally to corporations in the construction, real estate and manufacturing sector. Excess casualty insurance is purchased by corporations which seek higher limits of liability than are provided in their primary casualty policies.

Specialty assumed reinsurance provides proportional and excess of loss treaty coverage for several niche lines: Accident & Health (“A&H”), Agriculture, Latin America, and Professional Liability. The A&H reinsurance line primarily provides reinsurance coverage for large individual medical claims that occur with small frequency. The Agriculture reinsurance line primarily provides reinsurance coverage related to crop insurance schemes, most of which are sponsored by governmental bodies in the U.S. and Canada. The Latin America line primarily provides reinsurance coverage for individual risk and catastrophic property exposures, liability exposures, and surety bonds in Central and South America and the Spanish-speaking Caribbean. The Professional Liability line primarily provides reinsurance coverage for exposure related to medical malpractice and other miscellaneous professional liability policies.

Professional Liability

The professional liability policies mainly provide coverage on a claims-made basis mostly for a one-year period. The reserves for professional liability are analyzed separately by product. The major products are D&O liability coverage and E&O liability coverage for lawyers and other professionals.

The losses for D&O business are generally very large and infrequent, and with some cases involving securities class actions. D&O claims report reasonably quickly, but take years to settle. Our loss estimates are based on expected losses, an assessment of the characteristics of reported losses at the claim level, evaluation of loss trends, industry data, and the legal, regulatory and current risk environment. Significant judgment is involved because anticipated loss experience in this area is less predictable due to the small number of claims and/or erratic claim severity patterns. As time passes for a given underwriting year, we place additional weight on assumptions relating to our actual experience and claims outstanding. The expected ultimate losses may be adjusted up or down as the underwriting years mature.

 

45


Table of Contents

Lloyd’s Operations

Reserves for the Company’s Lloyd’s Operations are reviewed separately for the marine, property and casualty, and professional liability lines by product. The major marine products are marine liability, transport, marine energy liability, offshore energy, cargo, specie and marine reinsurance. The major property and casualty products are offshore energy, engineering, onshore energy and operational engineering. The major products for professional liability are international D&O and international E&O.

The marine liability, offshore energy and cargo products and related loss exposures are similar in nature to that described for marine business above. Specie insurance provides property coverage for jewelry, fine art, vault and cash in transit risks. Claims tend to be from theft or damage, quick to report and, in most cases, quick to settle. Marine reinsurance is a diversified global book of reinsurance, the majority of which consists of excess-of-loss reinsurance policies for which claims activity tends to be large and infrequent with loss development somewhat longer than for such products written on a direct basis. Marine reinsurance reinsures liability, cargo, hull and offshore energy exposures that are similar in nature to the marine business described above.

The process for establishing the IBNR loss reserves for the marine and professional liability lines of the Lloyd’s Operations, and the assumptions used as part of this process, are similar in nature to the process employed by the Insurance Companies.

The Lloyd’s Operations products also include property coverages for engineering and construction projects and onshore energy business, which are substantially reinsured. Losses from engineering and construction projects tend to result from loss of use due to construction delays while losses from onshore energy business are usually caused by fires or explosions. Large losses tend to be catastrophic in nature and are heavily reinsured. IBNR loss reserves for attritional losses are established based on the Syndicate’s extensive loss experience.

Sensitivity Analysis

A range of reasonable estimates has been developed based on the historical volatility of held reserves vs. current estimates. The actuarial history indicates that Navigators held reserves tend to be 10% redundant with a standard deviation of 11%. We have ignored the historical conservatism and built a range around the current held amounts. The Company’s lines of business, the market pricing adequacy and the Company’s underwriting strategies have changed dynamically over the past eleven years. There is thus a significant risk that the potential volatility of the current reserve estimates could differ in a material manner from the historical trends.

Actual emergence will vary and may exceed the historical variation. The actual losses may not emerge as expected which would cause the ranges to expand or contract from year to year. The impact from the shift on ranges will be greater for lines with longer emergence patterns. The individual lines will also have greater variance than the range for the entire book of business. The statistical variation is expected to have a somewhat higher range of deterioration than savings. The history in itself is only a rough estimate of the potential volatility. The ranges have been refined by reserve segment in three categories – Marine, Property Casualty and Professional Liability. These groupings give a sense of the volatility by sub-group but are not intended to be rigorous estimates even if such were possible. The total reserve variability is not equal to the sum of the segment variability due to the benefit of diversification.

 

46


Table of Contents

The range of ultimate unpaid amounts determined as described above as follows:

 

            Reasonably Likely Range of Deviation  

In thousands, except per share amounts

   Total Net
Loss Reserve
     Redundancy
Amount
    %     Deficiency
Amount
    %  

Insurance Companies:

           

Marine

   $ 252,170       $ 22,443        8.9   $ 24,460        9.7

Property Casualty

     495,443         51,031        10.3     56,976        11.5

Professional Liability

     138,585         36,032        26.0     48,782        35.2
  

 

 

    

 

 

     

 

 

   

Total Insurance Companies (1)

     886,198         83,303        9.4     91,278        10.3

Lloyd’s Operations:

           

Marine

     221,006         9,282        4.2     9,724        4.4

Property Casualty

     56,366         2,762        4.9     2,875        5.1

Professional Liability

     53,339         6,881        12.9     7,894        14.8
  

 

 

    

 

 

     

 

 

   

Total Lloyd’s Operations (1)

     330,711         14,551        4.4     15,213        4.6
  

 

 

    

 

 

     

 

 

   

Subtotal

     1,216,909         97,854          106,491     

Portfolio effect

     —           (13,887       (15,223  
  

 

 

    

 

 

     

 

 

   

Total Company

   $ 1,216,909       $ 83,967        6.9   $ 91,268        7.5
  

 

 

    

 

 

     

 

 

   

Increase (decrease) to net income

           

Amount

      $ 54,579        $ (59,324  

Per Share (2)

      $ 3.81        $ (4.14  

 

(1) — The totals for each segment are adjusted for portfolio effect. The portfolio effect is the reduction in risk which arises out of diversification in the portfolio.
(2) — Calculated using average diluted shares of 14,327,820 for the year ended December 31, 2012.

Reinsurance Recoverable

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 Recoverables” section and Note 6, Reinsurance, to our consolidated financial statements, both included herein.

 

47


Table of Contents

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, in the Notes to Consolidated Financial Statements, both included herein.

Substantially all of our business is placed through agents and brokers. 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 our premium is estimated for unreported premium, mostly for the Marine business written by our U.K. Branch and Lloyd’s Operations as well as the Accident & Health and Latin American & Caribbean property casualty and surety reinsurance business written by NavRe. 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, in the Notes to Consolidated Financial Statements, both included herein.

Impairment of Invested Assets

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.

For fixed maturity securities, we consider our intent to sell a security and whether it is more likely than not that we will be required to sell a security before the anticipated recovery as part of the process of evaluating whether a security’s unrealized loss represents an other-than-temporary decline. We assess whether the amortized cost basis of a fixed maturity security will be recovered by comparing the present value of cash flows expected to be collected to the current book value. Any shortfalls of the present value of the cash flows expected to be collected in relation to the amortized cost basis is considered the credit loss portion of other-than-temporary impairment (“OTTI”) losses and is recognized in earnings. All non-credit losses are recognized as changes in OTTI losses within Other Comprehensive Income (“OCI”).

 

48


Table of Contents

For equity securities, in general, the Company focuses its attention on those securities with a fair value less than 80% of their cost for six or more consecutive months. If warranted as the result of conditions relating to a particular security, the Company will focus on a significant decline in fair 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 of the security, the length of time the investment has been below cost and by how much the investment is below cost. If an equity security is deemed to be other-than-temporarily impaired, the cost is written down to fair value with the loss recognized in earnings.

For equity securities, the Company also considers its intent to hold securities as part of the process of evaluating whether a decline in fair value represents an other-than-temporary decline in value. For fixed maturity securities, the Company considers its intent to sell a security and whether it is more likely than not that the Company will be required to sell a security before the anticipated recovery 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.

The day to day management of our 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 the market and other factors described above. Investment managers are required to notify management of rating agency downgrades of securities in their portfolios as well as any potential investment valuation issues at the end of each quarter. Investment managers are also required to notify management, and receive approval, prior to the execution of a transaction or series of related transactions that may result in a realized loss above a certain threshold. Additionally, management monitors the execution of a transaction or series of related transactions that may result in any realized loss up until a certain period beyond the close of a quarterly accounting period.

Accounting for Lloyd’s Results

We record Syndicate 1221’s assets, liabilities, revenues and expenses under U.S. GAAP. Additional information regarding our accounting for Lloyd’s results can be found in Note 1, Organization and Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements, included herein.

Results of Operations

The following is a discussion and analysis of our consolidated and segment results of operations for the years ended December 31, 2012, 2011 and 2010. 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 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 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.

 

49


Table of Contents

Summary of Consolidated Results

The following table presents a summary of our consolidated financial results for the years ended December 31, 2012, 2011 and 2010:

 

     Year Ended December 31,      Percentage Change  

In thousands, except for per share amounts

   2012      2011      2010      2012 vs.
2011
    2011 vs.
2010
 

Gross written premiums

   $ 1,286,465       $ 1,108,216       $ 987,201         16.1     12.3

Net written premiums

     833,655         753,798         653,938         10.6     15.3

Total revenues

     877,916         766,385         776,975         14.6     -1.4

Total expenses

     786,180         733,651         678,146         7.2     8.2
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Pre-tax income (loss)

   $ 91,736       $ 32,734       $ 98,829         NM        -66.9

Provision (benefit) for income taxes

     27,974         7,137         29,251         NM        -75.6
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss)

   $ 63,762       $ 25,597       $ 69,578         149.1     -63.2
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net income (loss) per common share:

             

Basic

   $ 4.54       $ 1.71       $ 4.33        

Diluted

   $ 4.45       $ 1.69       $ 4.24        

 

NM — Percentage change not meaningful

Net income for the year ended December 31, 2012 was $63.8 million or $4.45 per diluted share compared to net income of $25.6 million or $1.69 per diluted share for the year ended December 31, 2011. Operating earnings for the year ended December 31, 2012 were $37.6 million or $2.63 per diluted share compared to $19.1 million or $1.26 per diluted share for the comparable period in 2011. In comparison to net income, operating earnings excludes after-tax net realized gains of $26.7 million and $7.8 million and after-tax OTTI losses of $0.6 million and $1.3 million for the years ended December 31, 2012 and 2011, respectively. The increase in our operating earnings was largely attributable to stronger underwriting results, partially offset by a decrease in net investment income driven by lower investment yields. The underwriting results for the year ended December 31, 2012 include net losses of $20.4 million related to Superstorm Sandy, $14.5 million from our Agriculture business driven by significant drought related crop losses across the U.S., and $13.9 million related to significant large losses from our Marine business, including the grounding of the cruise ship Costa Concordia off the coast of Italy.

Net income for the year ended December 31, 2011 was $25.6 million or $1.69 per diluted share compared to net income of $69.6 million or $4.24 per diluted share for the year ended December 31, 2010. Operating earnings for the year ended December 31, 2011 were $19.1 million or $1.26 per diluted share compared to $43.4 million or $2.65 per diluted share for the comparable period in 2010. In comparison to net income, operating earnings excludes after-tax net realized gains of $7.8 million and $26.9 million and after-tax OTTI losses of $1.3 million and $0.7 million for the years ended December 31, 2011 and 2010, respectively. The decrease in our operating earnings was largely attributable to unfavorable underwriting results related to large loss activity from our energy business, including losses arising from the Deepwater Horizon oil drilling platform, and significant current year loss emergence from our Professional Liability division, and to a lesser extent a decrease in net investment income.

Our book value per share as of December 31, 2012 was $62.61, increasing 8.8% from $57.57 as of December 31, 2011. The increase in book value per share primarily resulted from our increased results of operations and to a lesser extent, improvements in the value of our consolidated investment portfolio. Our consolidated stockholders’ equity increased 9.5% to $879.5 million as of December 31, 2012 compared to $803.4 million as of December 31, 2011.

Cash flow from operations for the year ended December 31, 2012 was $96.7 million compared to approximately $118 million for the years ended December 31, 2011 and 2010. The decrease in cash flow from operations was primarily due to an increase in claim payments, partially offset by improved collections on reinsurance recoverables as well as premiums receivables.

 

50


Table of Contents

The following table presents our consolidated underwriting results and provides a reconciliation of our underwriting profit or loss to GAAP net income or loss for the years ended December 31, 2012, 2011 and 2010:

 

     Year Ended December 31,     Percentage Change  

In thousands

   2012     2011     2010     2012 vs.
2011
    2011 vs.
2010
 

Gross written premiums

   $ 1,286,465      $ 1,108,216      $ 987,201        16.1     12.3

Net written premiums

     833,655        753,798        653,938        10.6     15.3

Net earned premiums

     781,964        691,645        659,931        13.1     4.8

Net losses and loss adjustment expenses

     (497,433     (476,997     (421,155     4.3     13.3

Commission expenses

     (121,470     (110,437     (109,113     10.0     1.2

Other operating expenses

     (159,079     (138,029     (139,743     15.3     -1.2

Other income (expenses) (2)

     1,488        1,229        5,186        21.1     -76.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting profit (loss)

   $ 5,470      $ (32,589   $ (4,894     NM        NM   

Net investment income

     54,248        63,500        71,662        -14.6     -11.4

Net other-than-temporary impairment losses recognized in earnings

     (858     (1,985     (1,080     -56.8     83.8

Net realized gains (losses)

     41,074        11,996        41,319        NM        -71.0

Interest expense

     (8,198     (8,188     (8,178     0.1     0.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

   $ 91,736      $ 32,734      $ 98,829        NM        -66.9

Income tax expense (benefit)

     27,974        7,137        29,251        NM        -75.6
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 63,762      $ 25,597      $ 69,578        149.1     -63.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Losses and loss adjustment expenses ratio

     63.6     69.0     63.8    

Commission expense ratio

     15.5     16.0     16.5    

Other operating expense ratio (1)

     20.2     19.7     20.4    
  

 

 

   

 

 

   

 

 

     

Combined ratio

     99.3     104.7     100.7    
  

 

 

   

 

 

   

 

 

     

 

(1) — Includes Other operating expenses & Other income (expense)
(2) — Reported within “Other income (expense)” on the Consolidated Statements of Income
NM — Percentage change not meaningful

 

51


Table of Contents

The combined ratio for the year ended December 31, 2012 was 99.3%. Our pre-tax underwriting profit increased $38.1 million to a $5.5 million underwriting profit for December 31, 2012 compared to an underwriting loss of $32.6 million for the same period in 2011. Our pre-tax underwriting profit for 2012 includes the following:

 

   

Net loss of $20.4 million, inclusive of $8.3 million in reinsurance reinstatement premiums (“RRPs”), related to Superstorm Sandy. Gross of reinsurance our loss related to Superstorm Sandy was approximately $66.7 million. Refer to subsection “Net Losses and Loss Adjustment Expenses” within this section of the MD&A for additional disclosure related to Superstorm Sandy.

 

   

Current accident year loss emergence of $14.5 million from our Agriculture business that was driven by significant drought related crop losses across the U.S.

 

   

Net losses of $13.9 million, inclusive of $11.1 million in RRPs, related to several large losses from our Marine business, including the grounding of the cruise ship Costa Concordia off the coast of Italy.

 

   

Net reserve redundancies of $47.2 million from our Lloyd’s Operations across all businesses and all divisions, most notably Lloyd’s Marine.

In addition to the above, the increase in our pre-tax underwriting profit in 2012 was affected by the mix of business and loss trends.

The combined ratio for the year ended December 31, 2011 was 104.7% compared to 100.7% for the comparable period in 2010. Our pre-tax underwriting loss increased by $27.7 million to $32.6 million for the year ended December 31, 2011 compared to a $4.9 million loss for the same period in 2010. Our pre-tax underwriting profit for 2011 includes the following:

 

   

2011 accident year energy losses with a net loss of $25.6 million, inclusive of $8.2 million in RRPs, related to drilling operations in the North Sea, Gulf of Mexico and Russia, as well as an onshore industrial site.

 

   

2011 accident year loss emergence of approximately $11.0 million related to our Professional Liability business, of which approximately $8.0 million was specific to our D&O liability insurance for both publicly and privately held corporations. The remaining $3.0 million of emergence was specific to our small lawyers and miscellaneous professional liability coverages.

 

   

An increase in our RRP accrual of $5.2 million. This accrual was driven by the recognition of the effect of a shift in our Marine reinsurance protections to an excess of loss program from a quota share program. As a result of this shift and the increased frequency of severity losses in recent periods, a greater portion of our IBNR was attributable to marine and energy losses that are or will be ceded to our Marine Excess-of-Loss Reinsurance program and such cession will trigger additional reinstatement premiums.

 

   

Net adverse loss development of $2.1 million driven by significant loss emergence in our Professional Liability business mostly offset by redundancies from our Property Casualty business.

In addition to the net adverse impacts noted above, the increase in our pre-tax underwriting loss in 2011 was affected by the mix of business and loss trends.

The combined ratio for the year ended December 31, 2010 was 100.7% and the pre-tax loss was $4.9 million mostly driven by a combined $22.5 million in RRPs related to the Deepwater Horizon and West Atlas losses, respectively. The RRPs were partially offset by net prior period reserve redundancies of $13.8 million. The net prior period reserve redundancies were driven by significant redundancies from our Property Casualty business partially offset by loss emergence from our Professional Liability business.

 

52


Table of Contents

Revenues

The following table sets forth our gross written premiums, net written premiums and net earned premiums by segment and line of business for the years ended December 31, 2012, 2011, and 2010:

 

    Year Ended December 31,  
    2012     2011     2010  

In thousands

  Gross
Written
Premiums
    %     Net
Written
Premiums
    Net
Earned
Premiums
    Gross
Written
Premiums
    %     Net
Written
Premiums
    Net
Earned
Premiums
    Gross
Written
Premiums
    %     Net
Written
Premiums
    Net
Earned
Premiums
 

Insurance Companies:

                       

Marine

  $ 200,095        16   $ 133,210      $ 142,181      $ 228,500        21   $ 170,642      $ 169,018      $ 223,061        23   $ 151,059      $ 155,846   

Property Casualty

    590,741        46     390,168        332,782        445,287        40     293,758        231,297        312,651        31     197,845        200,741   

Professional Liability

    130,489        10     99,578        96,476        114,632        10     77,991        72,148        129,793        13     80,451        82,264   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Insurance Companies Total

    921,325        72     622,956        571,439        788,419        71     542,391        472,463        665,505        67     429,355        438,851   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Lloyd’s Operations:

                       

Marine

    194,423        15     143,600        136,898        167,562        16     137,206        145,659        182,723        19     149,340        149,225   

Property Casualty

    127,028        10     43,824        52,951        115,138        10     56,249        55,903        94,799        10     54,049        49,852   

Professional Liability

    43,689        3     23,275        20,676        37,097        3     17,952        17,620        44,174        4     21,194        22,003   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Lloyd’s Operations Total

    365,140        28     210,699        210,525        319,797        29     211,407        219,182        321,696        33     224,583        221,080   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 1,286,465        100   $ 833,655      $ 781,964      $ 1,108,216        100   $ 753,798      $ 691,645      $ 987,201        100   $ 653,938      $ 659,931   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross Written Premiums

Gross written premiums increased $178.2 million, or 16.1%, to $1.29 billion for the year ended December 31, 2012 compared to $1.11 billion for the same period in 2011. The increases in gross written premiums are primarily attributed to growth within our Property Casualty business, specifically our Assumed Reinsurance division, which writes Accident & Health (“A&H”), Agriculture, Latin American and Professional Liability reinsurance lines of business, as the division continues to achieve successful growth since its establishment in late 2010. The increase within Property Casualty is also attributed to growth within our Excess Casualty division resulting from strong production attributable to an expansion of our underwriting team and dislocation among certain competitors.

Gross written premiums increased $121.0 million, or 12.3%, to $1.11 billion for the year ended December 31, 2011 compared to $987.2 million for the same period in 2010. The increase in gross written premiums were primarily attributed growth in our Property Casualty business, which includes $101.5 million related to our newly established Assumed Reinsurance division which writes Accident & Health, Agriculture and Latin American reinsurance lines of business. The increase within Property Casualty is also attributable to the growth of our Excess Casualty, Environmental Liability and Primary Casualty divisions of $34.2 million, $11.5 million and $10.6 million, respectively, resulting from strong production, partially offset by the run-off of our middle market commercial package business. The increase in gross written premiums was offset by a $22.2 million decrease in our Professional Liability business attributable to our Directors and Officer Liability lines. This decrease reflects a change in our underwriting strategy that focuses on a planned shift toward underwriting excess layers.

Average renewal premium rates for our Insurance Companies segment also increased for the year ended December 31, 2012 as compared to the same period in 2011 across all segments. Our Marine business has realized a 4.4% and 4.5% increase in rates for the Marine Liability and Inland Marine divisions, respectively. Within our Property Casualty business we have realized a 2.9% increase in rates for the Energy and Engineering division, a 2.2% increase for the Excess Casualty division and a 7.9% increase in the Primary Casualty division. Our Professional Liability business has experienced an overall increase in its renewal rates of 5.1%, consisting of 5.7% and 4.2% for the E&O and the Management Liability divisions, respectively. For the year ended December 31, 2012, average renewal premium rates for our Lloyd’s Operations segment include increases for Lloyd’s Marine and Lloyd’s Energy and Engineering for approximately 3.6% and 7.4%, respectively. Our Lloyd’s Professional Liability business experienced an average decrease of 1.4%.

 

53


Table of Contents

Our Marine division saw increases in the average renewal premium rates in our Inland Marine and Lloyd’s lines of approximately 7.3% and 0.9%, respectively, for the year ended December 31, 2011 compared to the same period in 2010. U.S. Marine premiums rates decreased 0.3% while U.K. Branch Marine premiums rates increased 1.9% for the year ended December 31, 2011 compared to the same period in 2010. For our Energy and Engineering and Primary Casualty lines we experienced an average renewal premium rate increases of approximately 4.2% and 7.4% for the year ended December 31, 2011 compared to the same period in 2010, which was offset by a decline in our Excess Casualty lines of 1.2%, respectively. The Insurance Companies and Lloyd’s Professional Liability division overall experienced approximately a 1.5% decrease in average renewal premium rates for the year ended December 31, 2011 compared to 2010.

The average premium rate increases or decreases as noted above for the Marine, Property Casualty and Professional Liability businesses are calculated primarily by comparing premium amounts on policies that have renewed. The premiums are adjusted for changes in exposures 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 that generally would be more competitively priced compared to renewal business. The calculation does not reflect the rate on business that we are unwilling or unable to renew due to loss experience or competition.

Ceded Written Premiums

In the ordinary course of business, we reinsure certain insurance risks with unaffiliated insurance companies for the purpose of limiting our maximum loss exposure, protecting against catastrophic losses and maintaining desired ratios of net premiums written to statutory surplus. The relationship of ceded to gross written premium varies based upon the types of business written and whether the business is written by the Insurance Companies or the Lloyd’s Operations.

Our reinsurance program includes contracts for proportional reinsurance, per risk and whole account excess-of-loss reinsurance for both property and casualty risks and property catastrophe excess-of-loss reinsurance. In recent years we have increased our utilization of excess-of-loss reinsurance for marine, property and certain casualty risks. Our excess-of-loss reinsurance contracts generally provide for a specific amount of coverage in excess of an attachment point and sometimes provides for reinstatement of the coverage to the extent the limit has been exhausted for payment of additional premium (referred to as reinsurance reinstatement premiums or RRPs). The number of reinsurance reinstatements available varies by contract.

We record an estimate of the expected RRPs for losses ceded to excess-of-loss agreements where this feature applies.

We incurred $26.9 million, $14.8 million, and $24.0 million of RRPs for the years ended December 31, 2012, 2011, and 2010, respectively. The $26.9 million in RRPs recorded in 2012 includes $11.1 million from several large losses on our marine business, including the grounding of the cruise ship Costa Concordia off the coast of Italy as well as $8.3 million in connection with our loss on Superstorm Sandy. The $14.8 million in RRPs recorded in 2011 are due to the large energy losses from our NavTech business and the accrual for large losses from our Marine business reflective of our shift to excess-of-loss reinsurance protection. The $24.0 million in RRPs recorded in 2010 is largely attributable to the Deepwater and West Atlas losses.

 

54


Table of Contents

The following table sets forth our ceded written premiums by segment and major line of business for the years ended December 31, 2012, 2011 and 2010:

 

     Year Ended December 31,  
     2012     2011     2010  

In thousands

   Ceded
Written
Premiums
     % of
Gross
Written
Premiums
    Ceded
Written
Premiums
     % of
Gross
Written
Premiums
    Ceded
Written
Premiums
     % of
Gross
Written
Premiums
 

Insurance Companies:

               

Marine

   $ 66,885         33   $ 57,858         25   $ 72,002         32

Property Casualty

     200,573         34     151,529         34     114,806         37

Professional Liability

     30,911         24     36,641         32     49,342         38
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Insurance Companies

     298,369         32     246,028         31     236,150         36
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Lloyd’s Operations:

               

Marine

     50,823         26     30,356         18     33,383         18

Property Casualty

     83,204         66     58,889         51     40,750         43

Professional Liability

     20,414         47     19,145         52     22,980         52
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total Lloyd’s

     154,441         42     108,390         34     97,113         30
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 452,810         35   $ 354,418         32   $ 333,263         34
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The increase in percentage of total ceded written premiums to total gross written premiums for the year ended December 31, 2012 compared to the same period in 2011 was primarily due to a lower retention ratio on our NavTech business as a result of a new quota share program for the offshore energy book and the RRPs recognized in our Marine business as a result of significant large loss activity during the year. The aforementioned increases were partially offset by a change in the mix of business resulting in the growth of our assumed reinsurance business written by NavRe and the continued growth of the real estate products offered by our Professional liability business where our retention ratios are higher.

The decrease in the percentage of total ceded written premiums to total gross written premiums for the year ended December 31, 2011 compared to the same period of 2010 was primarily due to a change in the mix of business resulting from new business within our recently established NavRe division, a reduction in RRPs in 2011 compared to 2010 related to large loss activity for each year and, to a lesser extent, the expansion of products offered by our Professional liability business where our retention ratios are higher, partially offset by a reduction in the retention of our Lloyd’s Property Casualty business.

Net Written Premiums

Net written premiums increased 10.6% for the year ended December 31, 2012 compared to the same period in 2011. The increase is due to higher gross written premiums and the mix of business driven by our assumed reinsurance business written by NavRe, partially offset by higher premium cessions on our NavTech business and the additional RRPs recognized in our Marine business as discussed above. Net written premiums increased 15.3% for the year ended December 31, 2011 compared to the same period in 2010, due to the impact of higher gross written premiums, a reduction in RRP’s in comparison to those recorded in 2010, and to a lesser extent lower premium cessions, as discussed above.

 

55


Table of Contents

Net Earned Premiums

Net earned premiums increased 13.1% for the year ended December 31, 2012 compared to the same period in 2011 as a result of continued growth in gross written premiums as well as a change in our mix of business driven by our assumed reinsurance business, which includes the A&H lines that are recognized in earnings over a longer exposure period than our other lines of business, and to a lesser extent, the expansion of products offered by our Professional Liability division where our retention ratios are higher. The increase in net earned premiums was partially offset by the additional RRPs in connection with loss activity in our Marine business, as discussed above. Net earned premiums increased 4.8% for the year ended December 31, 2011 compared to the same period in 2010 primarily as a result of significant ceded RRPs associated with large losses in 2010. The impact of reinstatement premiums was partially offset by a change in the mix of business in 2011 written by our assumed reinsurance business, specifically the A&H lines, which are recognized in earnings over a longer exposure period than our other lines of business.

Net Investment Income

Our net investment income was derived from the following sources:

 

     Year Ended December 31,     Percentage Change  

In thousands

   2012     2011     2010     2012 vs.
2011
    2011 vs.
2010
 

Fixed maturities

   $ 58,995      $ 65,060      $ 69,996        -9.3     -7.1

Equity securities

     3,945        5,071        3,028        -22.2     67.5

Short-term investments

     1,694        964        965        75.7     -0.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment income

   $ 64,634      $ 71,095      $ 73,989        -9.1     -3.9

Investment expenses

     (10,386     (7,595     (2,327     36.7     NM   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net investment income

   $ 54,248      $ 63,500      $ 71,662        -14.6     -11.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

NM — Percentage change not meaningful

The decrease in total investment income before investment expenses for all years presented was primarily due to lower investment yields and shorter portfolio duration. The annualized pre-tax investment yield, excluding net realized gains and losses and net other-than-temporary impairment (“OTTI”) losses recognized in earnings, was 2.4%, 3.0% and 3.5% for the years ended December 31, 2012, 2011 and 2010, respectively. The portfolio duration was 3.6 years for both the years ended December 31, 2012 and 2011, and was 4.4 years for the year ended December 31, 2010.

The 2.4% and 3.0% annualized pre-tax yields for the years ended December 31, 2012 and 2011, include investment expenses of $4.5 million and $4.7 million, respectively, for a total of $9.2 million, of interest expense related to the settlement of a dispute with Equitas over foregone interest on amounts that were due on certain reinsurance contracts. In the dispute Equitas alleged that we failed to make timely payments to them under certain reinsurance agreements in connection with subrogation recoveries received by us with respect to several catastrophe losses that occurred in the late 1980’s and early 1990’s. In addition, investment expenses for the year ended December 31, 2012 includes a $2.8 million investment performance fee. Excluding the impact of the aforementioned interest expense and investment performance fee, the annualized pre-tax yield for the years ended December 31, 2012 and 2011 would have been 2.7% and 3.2%, reflective of the general decline in market yield.

 

56


Table of Contents

Net Other-Than-Temporary Impairment Losses Recognized In Earnings

Our net OTTI losses recognized in earnings for the periods indicated were as follows:

 

     Year Ended December 31,     Percentage Change  

In thousands

   2012     2011     2010     2012 vs.
2011
    2011 vs.
2010
 

Fixed maturities

   $ (11   $ (1,093   $ (693     -99.0     57.7

Equity securities

     (847     (892     (387     -5.0     130.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

OTTI recognized in earnings

   $ (858   $ (1,985   $ (1,080     -56.8     83.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The significant inputs used to measure the amount of credit loss recognized in earnings for fixed maturity securities were actual delinquency rates, default probability assumptions, severity assumptions and prepayment assumptions. Projected losses are a function of both loss severity and probability of default. Default probability and severity assumptions differ based on property type, vintage and the stress of the collateral. We do not intend to sell any of these securities and it is more likely than not that we will not be required to sell these securities before the recovery of the amortized cost basis.

Net OTTI losses for the year ended December 31, 2012 primarily consists of $0.8 million for three equity securities which were previously impaired.

Net OTTI losses for the year ended December 31, 2011 consisted of $1.0 million of additional impairments for residential mortgage-backed securities that were previously impaired and $0.9 million for two equity securities for which fair value was less than 80% of amortized cost for at least six months.

Net OTTI losses for the year ended December 31, 2010 were primarily related to residential mortgage-backed securities.

Net Realized Gains and Losses

Realized gains and losses, excluding net OTTI losses recognized in earnings, for the periods indicated were as follows:

 

     Year Ended December 31,     Percentage Change  

In thousands

   2012     2011     2010     2012 vs.
2011
    2011 vs.
2010
 

Fixed maturities:

          

Gains

   $ 28,789      $ 11,678      $ 42,932        146.5     -72.8

Losses

     (1,915     (7,044     (3,239     -72.8     117.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fixed maturities, net

   $ 26,874      $ 4,634      $ 39,693        NM        -88.3

Equity securities:

          

Gains

   $ 14,673      $ 9,319      $ 1,867        57.5     NM   

Losses

     (473     (1,957     (241     -75.8     NM   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity securities, net

   $ 14,200      $ 7,362      $ 1,626        92.9     NM   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net realized gains (losses)

   $ 41,074      $ 11,996      $ 41,319        NM        -71.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

NM — Percentage change not meaningful

 

57


Table of Contents

Net realized gains and losses are generated as part of the normal ongoing management of our investment portfolio. Net realized gains of $41.1 million for the year ended December 31, 2012 are primarily due to the sale of municipal bonds and equity securities in anticipation of continued market uncertainty, the proceeds of which were reinvested in U.S. Government Treasury bonds and equities. Net realized gains of $12.0 million for the year ended December 31, 2011 primarily included the sale of corporate bonds and equity mutual funds. Net realized gains of $41.3 million for the year ended December 31, 2010 included the sale of the majority of our general obligation municipal bond obligations, the proceeds of which were reinvested in corporate bonds and agency mortgage-backed securities.

Other Income/Expense

Total other income for the years ended December 31, 2012, 2011 and 2010 was $1.5 million, $1.2 million and $5.1 million, respectively, and consists of foreign exchange gains and losses from our Lloyd’s Operations, commission income and inspection fees related to our specialty insurance business.

Expenses

Net Losses and Loss Adjustment Expenses

The ratio of net losses and LAE to net earned premiums (“loss ratios”) for the years ended December 31, 2012, 2011 and 2010 is presented in the following table:

 

     Year Ended December 31,  

Net Loss and LAE Ratio

   2012     2011     2010  

Net Loss and LAE Payments

     66.2     55.3     59.3

Change in reserves

     3.2     13.4     6.6
  

 

 

   

 

 

   

 

 

 

Subtotal—current year loss ratio

     69.4     68.7     65.9

Prior year deficiencies (redundancies)

     -5.8     0.3     -2.1
  

 

 

   

 

 

   

 

 

 

Net loss and LAE ratio

     63.6     69.0     63.8
  

 

 

   

 

 

   

 

 

 

The net loss and LAE ratio for the year ended December 31, 2012 decreased 5.4 percentage points to 63.6% from 69.0% for the year ended December 31, 2011. The decrease in the loss ratio reflects improved loss experience due to net prior year reserve redundancies of $47.2 million, or 6 loss ratio points, from our Lloyd’s Operations and loss ratio trends driven by mix of business. The improvement in the loss ratio was partially offset by $14.5 million, or 1.9 loss ratio points of current year loss emergence from our Agriculture reinsurance business, and specific large loss events that occurred in the current year. The current year loss ratio includes a net loss of $12.1 million, exclusive of RRPs, or 1.5 loss ratio points, related to Superstorm Sandy and net losses of $2.8 million, exclusive of RRPs, or 0.4 loss ratio points, related to several large losses from our Marine business, including the grounding of the cruise ship Costa Concordia off the coast of Italy.

The net loss and LAE ratio for the year ended December 31, 2011 increased 5.2 percentage points to 69.0% from 63.8% for the year December 31, 2010. The increase for the year ended December 31, 2011 was primarily due to 2011 accident year loss emergence of approximately $11.0 million related to our Professional Liability business of which approximately $8.0 million was specific to our D&O liability insurance for both publicly and privately held corporations. The remaining $3.0 million was specific to our small lawyers and miscellaneous professional liability coverages. In addition, the increase for the year ended December 31, 2011 included net losses of $17.4 million related to four energy events compared to net losses of $11.0 million in 2010 related to Deepwater Horizon and West Atlas.

 

58


Table of Contents

The segment and line of business breakdown of the net loss and LAE ratios for the years ended December 31, 2012, 2011 and 2010 are as follows:

 

     Year Ended December 31,  

In thousands

   2012     2011     2010  

Insurance Companies:

      

Marine

     77.4     65.8     64.5

Property Casualty

     70.8     65.7     55.2

Professional Liability

     73.8     108.8     83.4
  

 

 

   

 

 

   

 

 

 

Insurance Companies

     73.0     72.3     63.8

Lloyd’s Operations

      

Marine

     37.3     60.0     66.2

Property Casualty

     44.7     48.7     55.6

Professional Liability

     26.8     118.3     66.2
  

 

 

   

 

 

   

 

 

 

Lloyd’s Operations

     38.2     61.8     63.8
  

 

 

   

 

 

   

 

 

 

Net loss and LAE ratio

     63.6     69.0     63.8
  

 

 

   

 

 

   

 

 

 

Prior Year Reserve Deficiencies/Redundancies

The relevant factors that may have a significant impact on the establishment and adjustment of losses and LAE reserves can vary by line of business and from period to period. As part of our regular review of prior reserves, management, in consultation with our actuaries, may determine, based on their judgment that certain assumptions made in the reserving process in prior year periods may need to be revised to reflect various factors, likely including the availability of additional information. Based on their reserve analyses, management may make corresponding reserve adjustments.

The segment and line of business breakdowns of prior period net reserve deficiencies (redundancies) for the years ended December 31, 2012, 2011 and 2010 are as follows:

 

     Year Ended December 31,  

In thousands

   2012     2011     2010  

Insurance Companies:

      

Marine

   $ (10,010   $ 1,348      $ (4,155

Property Casualty

     4,293        (6,828     (14,923

Professional Liability

     7,613        17,582        13,623   
  

 

 

   

 

 

   

 

 

 

Insurance Companies

   $ 1,896      $ 12,102      $ (5,455

Lloyd’s Operations:

      

Marine

     (30,735     (10,311     (3,152

Property Casualty

     (6,890     (5,434     (5,236

Professional Liability

     (9,562     5,788        41   
  

 

 

   

 

 

   

 

 

 

Lloyd’s

     (47,187     (9,957     (8,347
  

 

 

   

 

 

   

 

 

 

Total deficiencies (redundancies)

   $ (45,291   $ 2,145      $ (13,802
  

 

 

   

 

 

   

 

 

 

The following is a discussion of relevant factors related to the $45.3 million prior period net reserve redundancies recorded for the year ended December 31, 2012:

The Insurance Companies recorded $1.9 million net prior period reserve deficiencies. The Marine business had $10.0 million of net reserve redundancies, which were primarily driven by:

 

   

an IBNR adjustment of 4.0 million to reflect the actual emergence of claims for underwriting year “(UY)” 2010, which was more favorable than the expected emergence.

 

   

case reserve releases of $3.4 million due to the favorable settlement of several large losses; and

 

   

a favorable IBNR adjustment of $2.6 million attributable to changes in our assumptions for salvage and subrogation from our short tail marine lines that was based on our observation of a consistent and persistent historical pattern of favorable savings attributable to salvage and subrogation.

The Marine reserve redundancies were partially offset by net reserve deficiencies of $7.6 million from the small lawyer and accountants lines within our Professional Liability business. This deficiency was primarily driven by IBNR increases of $3.4 million made to recognize the severity impact of several large losses that caused the actual claims emergence for these lines to exceed the expected emergence pattern. We also incurred net reserve deficiencies of $4.3 million within our Property Casualty segment, which were primarily attributable to two large hemophiliac claims from UY 2011 arising from our A&H business.

 

59


Table of Contents

Our Lloyd’s Operations recorded $47.2 million of net prior period reserve redundancies across all businesses and divisions. In connection with the Company’s implementation of the Solvency II technical provisions in its Lloyd’s operation, the Company’s actuaries undertook a comprehensive review during 2012 of the historical claims emergence patterns for all lines of business underwritten through Syndicate 1221. As a result of this review, the Company updated the loss emergence patterns used to project ultimate losses for all such lines of business, aligning these loss emergence factors with the historical median. This caused a reduction in ultimate loss estimates for all Lloyd’s segments other than certain lines of business in Property Casualty segment, which increased. The Lloyd’s Operation also experienced significant reserve redundancies in several large claims. The amount of reserve redundancies attributable to these settlements was $5.0 million, consisting of $4.1 million from the Lloyd’s Marine business and $0.9 million from Lloyd’s Professional Liability business. A summary of the resulting prior period redundancies for each business within our Lloyd’s Operations by prior UY is set forth below:

 

In thousands

   Marine      Property
Casualty
     Professional
Liability
     Total  

2010

     3,492         378         1,157         5,027   

2009

     14,792         4,170         6,072         25,034   

2008 and Prior

     12,451         2,342         2,333         17,126   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Redundancy

   $ 30,735       $ 6,890       $ 9,562       $ 47,187   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following is a discussion of relevant factors related to the $2.1 million net reserve deficiency for the year ended December 31, 2011:

The adverse development of $1.3 million for our Insurance Companies Marine business was driven by $4.0 million of unfavorable loss emergence in Inland Marine in accident years 2009 and 2010 which was offset by $2.7 million favorable development in Ocean Marine. The Ocean Marine development was driven by $5.8 million of favorable development in accident years 2008 to 2010 and was partially offset by $3.2 million of adverse development for accident years 2007 and prior. Ocean Marine’s favorable development was driven by the Craft, protection and indemnity, and Transport classes with partial offsets from the Specie and Liability classes.

Our Insurance Companies Property Casualty business experienced $6.8 million of favorable development overall which was driven by favorable development of $8.4 million from Offshore Energy across several accident years and was partially offset by adverse development from runoff Liquor Liability in accident years 2008 and 2009.

Our Insurance Companies Professional Liability business had overall adverse development of $17.6 million, which consisted of adverse development of $14.5 million and $3.1 million from Management Liability and Errors and Omissions, respectively. The Management Liability development was primarily driven by liability coverage of Public Company directors and officers for accident years 2009 and 2010. The Errors and Omissions development was driven by Small Lawyers Professional Liability and Miscellaneous Professional Liability classes for accident year 2010.

Our Lloyd’s operations experienced $10.0 million of favorable development. This was driven by favorable development of $10.3 million and $5.5 million from the Marine and NavTech divisions respectively, which was partially offset by $5.8 million of unfavorable development from Professional Liability. The favorable development in Marine was primarily from the Cargo, Liability and Specie classes for accident years 2008 and prior. The favorable development in NavTech was from Offshore Energy primarily in accident years 2007 to 2009. The adverse development in Professional Liability was mostly from Errors and Omissions in accident years 2006 to 2008.

 

60


Table of Contents

The following is a discussion of relevant factors impacting our $13.8 million net reserve redundancies for the year ended December 31, 2010:

The Insurance Companies recorded $4.2 million of net prior year favorable development for the marine business, of which $2.6 million arose in the marine liability business due to favorable loss emergence relative to our expectations and $1.4 million in Hull as we eliminated IBNR in older underwriting years where we determined the year had been fully reported and saw case reserve reductions on a number of claims.

The Insurance Companies recorded $14.9 million of net prior year redundancies for Property Casualty business in total. The favorable development included:

 

  $29.2 million for West Coast contractors’ liability due to an internal actuarial review conducted in 2010 which indicated that loss development on underwriting years 2006 to 2008 has been more favorable than our prior expectations with a partial offset for underwriting years 2004 and prior.

 

  $2.9 million of favorable development on our offshore energy (NavTech) book due to favorable claims trends across a number of prior underwriting years.

 

  $1.8 million of favorable development on the Somerset Re run-off book of business where we concluded the IBNR was no longer required and $1.5 million on our Agriculture reinsurance book where the reported activity was lower than our initial estimate for the 2009 treaty year.

Partially offsetting these favorable developments were adverse development of:

 

  $16.5 million in our Specialty run-off books of business, including $13.3 million in our personal umbrella lines across multiple underwriting years where loss activity has exceeded our expectations and $2.0 million of adverse development in our Liquor business due to reported claim activity.

 

  $1.7 million for New York construction liability due to unfavorable loss emergence.

The Insurance Companies recorded $13.6 million of net prior year unfavorable development for professional liability:

 

  The directors and officers liability book of business had $15.7 million of adverse development, which was primarily attributable to a severity study of our open claims. This study showed our IBNR to be significantly deficient if current trends continued and we raised our loss estimates for underwriting years 2002 to 2009. This was partially offset by $1.4 million of favorable development on a run-off lawyers book of business written from London where we saw favorable settlements of outstanding claims and $0.7 million of favorable development on other lawyers business mostly due to a favorable claim reserve settlement.

The Lloyd’s Operations recorded $8.3 million in favorable loss development for prior years during 2010. This included favorable development of $3.2 million in Marine, $4.8 million in NavTech, and $0.5 million in all other areas. The Marine favorable development was primarily from the 2007 and 2008 underwriting years and was driven by loss development on these underwriting years being more favorable than our expectations, particularly in marine liability, assumed reinsurance, and specie classes. NavTech’s favorable development was mostly from the 2006 through 2008 underwriting years driven by favorable claims trends in the offshore energy.

 

61


Table of Contents

Superstorm Sandy

The net loss in connection with Superstorm Sandy was $20.4 million, or 2.6 points on our combined ratio, inclusive of $8.3 million in RRPs. Excluding the impact of RRPs, the gross and net loss was $66.7 million and $12.1 million, respectively.

The following table sets forth our gross and net loss and LAE reserves, incurred loss and LAE, and payments for Superstorm Sandy for the year ended December 31, 2012:

 

     Year Ended  

(In thousands)

   December 31, 2012  

Gross of Reinsurance

  

Incurred loss & LAE

     66,674   

Calendar year payments

     3,827   
  

 

 

 

Ending gross reserves

   $ 62,847   
  

 

 

 

Gross case loss reserves

   $ 26,294   

Gross IBNR loss reserves

     36,553   
  

 

 

 

Ending gross reserves

   $ 62,847   
  

 

 

 

Net of Reinsurance

  

Incurred loss & LAE

     12,087   

Calendar year payments

     3,459   
  

 

 

 

Ending net reserves

   $ 8,628   
  

 

 

 

Net case loss reserves

   $ 7,455   

Net IBNR loss reserves

     1,173   
  

 

 

 

Ending net reserves

   $ 8,628   
  

 

 

 

 

62


Table of Contents

Hurricanes Gustav and Ike

The following table sets forth our gross and net loss and LAE reserves, incurred loss and LAE, and payments for the 2008 Hurricanes Gustav and Ike for the periods indicated:

 

     Year Ended December 31,  

In thousands

   2012     2011     2010  

Gross of Reinsurance

      

Beginning gross reserves

   $ 31,170      $ 40,095      $ 59,509   

Incurred loss & LAE

     (12,551     (77     (1,997

Calendar year payments

     2,842        8,848        17,417   
  

 

 

   

 

 

   

 

 

 

Ending gross reserves

   $ 15,777      $ 31,170      $ 40,095   
  

 

 

   

 

 

   

 

 

 

Gross case loss reserves

   $ 2,404      $ 7,317      $ 17,987   

Gross IBNR loss reserves

     13,373        23,853        22,108   
  

 

 

   

 

 

   

 

 

 

Ending gross reserves

   $ 15,777      $ 31,170      $ 40,095   
  

 

 

   

 

 

   

 

 

 

Net of Reinsurance

      

Beginning net reserves

   $ 1,150      $ 569      $ 2,683   

Incurred loss & LAE

     (58     141        1,257   

Calendar year payments

     248        (440     3,371   
  

 

 

   

 

 

   

 

 

 

Ending net reserves

   $ 844      $ 1,150      $ 569   
  

 

 

   

 

 

   

 

 

 

Net case loss reserves

   $ 344      $ 951      $ 569   

Net IBNR loss reserves

     500        199        —     
  

 

 

   

 

 

   

 

 

 

Ending net reserves

   $ 844      $ 1,150      $ 569   
  

 

 

   

 

 

   

 

 

 

 

63


Table of Contents

Hurricanes Katrina and Rita

The following tables set forth our gross and net loss and LAE reserves, incurred loss and LAE, and payments for the 2005 Hurricanes Katrina and Rita for the periods indicated:

 

     Year Ended December 31,  

In thousands

   2012     2011     2010  

Gross of Reinsurance

      

Beginning gross reserves

   $ 19,527      $ 22,599      $ 67,038   

Incurred loss & LAE

     (894     (1,102     (2,300

Calendar year payments

     419        1,970        42,139   
  

 

 

   

 

 

   

 

 

 

Ending gross reserves