UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2007

 

 

OR

For the transition period from        to        .

 

 

Commission File No. 0-15886

THE NAVIGATORS GROUP, INC.

(Exact name of the Registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (212) 244-2333

 

 

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

 

 

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 o  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 o  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 o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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

 

                                (Do not check if a 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 o  No x

 

The aggregate market value of voting stock held by non-affiliates as of June 30, 2007 was $726,934,000.

 

The number of common shares outstanding as of February 8, 2008 was 16,876,174.

 

Documents Incorporated by reference

Portions of the Company’s 2008 Proxy Statement are incorporated by reference in Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.

 

TABLE OF CONTENTS

 

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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 that anticipated results will be achieved, since actual results may differ materially because of both known and unknown risks and uncertainties which we face. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Factors that could cause actual results to differ materially from our forward-looking statements include, but are not limited to, the factors discussed in the ”Risk Factors” section of this Form 10-K as well as:

In light of these risks, uncertainties and assumptions, any forward-looking events discussed in this Form 10-K may not occur. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of their respective dates.

The discussion and analysis of our financial condition and results of operations contained herein should be read in conjunction with our consolidated financial statements and accompanying notes which appear elsewhere in this Form 10-K. It contains forward-looking statements that involve risks and uncertainties. Please see ”Note on Forward-Looking Statements” for more information. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Form 10-K.

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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 mean The Navigators Group, Inc. and its subsidiaries, unless the context otherwise requires. The term “Parent” or “Parent Company” is used to mean The Navigators Group, Inc. without its subsidiaries.

We are an international insurance holding company focusing on specialty products for niches within the overall property/casualty insurance market. The Company’s underwriting segments consist of insurance company operations and operations at Lloyd’s of London. Our largest product line and most long-standing area of specialization is ocean marine insurance. We have also developed specialty niches in professional liability insurance and in specialty liability insurance primarily consisting of contractors’ liability and primary and excess liability coverages. We conduct operations through our Insurance Companies and, our Lloyd’s Operations. The Insurance Companies consist of Navigators Insurance Company, which includes 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 fully reinsured by Navigators Insurance Company. Our Lloyd’s Operations include Navigators Underwriting Agency Ltd. (“NUAL”), a Lloyd’s of London (“Lloyd’s”) underwriting agency which manages Lloyd’s Syndicate 1221 (“Syndicate 1221”). We participate in the capacity of Syndicate 1221 through two wholly-owned Lloyd’s corporate members.

 

Marine Insurance

Our marine insurance business is underwritten both through our Insurance Companies and our Lloyd’s Operations. Navigators Insurance Company obtained marine business through participation with other unaffiliated insurers in a marine insurance pool managed by the Navigators Agencies which are wholly-owned insurance agency subsidiaries of the Company. Commencing with the 2006 underwriting year, the marine pool was eliminated and, therefore, substantially all of the marine business generated by the Navigators Agencies for the marine pool is exclusively for Navigators Insurance Company. Navigators Insurance Company’s net participation in the marine pool for the 2005 underwriting year was 85%.

Within Navigators Insurance Company’s marine business, there are a number of different product lines. The largest is marine liability, which protects business from liability to third parties for bodily injury or property damage stemming from their marine-related operations, such as terminals, marinas and stevedoring. We insure the physical damage to offshore oil platforms along with other offshore operations related to oil exploration and production. Another significant product line is bluewater hull, which provides coverage to the owners of ocean-going vessels against physical damage to the vessels. We also underwrite insurance for harbor craft and other small craft such as fishing vessels, providing physical damage and third party liability coverage. We underwrite cargo insurance, which provides coverage for physical damage to goods in the course of transit, whether by water, air or land. During 2004, our U.K. Branch commenced writing primary marine P&I, or protection and indemnity business. This complements our marine liability business, which is generally written above the primary layer on an excess basis. Commencing in 2005 we also began to insure customs bonds.

We participate in the marine and related insurance lines of the Lloyd’s market through NUAL, which manages Syndicate 1221. Navigators provided 100% of Syndicate 1221’s capacity for the 2007 and 2006 underwriting years through its wholly-owned subsidiaries, Millennium Underwriting Ltd. and Navigators Corporate Underwriters Ltd. Navigators provided 97.5% of Syndicate 1221’s capacity for the 2005 underwriting year. We purchased the remaining 2.5% of Syndicate 1221’s capacity in 2005 which gave us the ability to provide 100% of Syndicate 1221’s capacity in the 2006 and subsequent underwriting years. Our share of the premiums, losses and expenses from Syndicate 1221 is included in our consolidated results. The largest product line within our Lloyd’s marine business is currently cargo and specie, and the other significant product lines include marine liability, offshore energy, bluewater hull, and assumed reinsurance of other marine insurers on an excess of loss basis. Our regional agency operation, Navigators Underwriting Limited, generates cargo and engineering business primarily in the Manchester area of England, which is not traditionally served by Lloyd’s. In January 2005, we formed Navigators NV, a wholly-owned subsidiary of NUAL. Navigators NV is located in Antwerp, Belgium, and produces transport liability, cargo and marine liability business on behalf of Syndicate 1221. In late 2005, Navigators NV began to produce similar business for Navigators Insurance Company. We established a Coral Gables, Florida office in 2007 to write marine and energy business in Latin America.

Beginning with the 2006 underwriting year, the Navigators Agencies are reimbursed for their costs by the Insurance Companies and the Lloyd’s Operations. For the 2005 and prior underwriting years, the Navigators Agencies, which produced business for the marine pool, received management fee commissions on the gross marine premium earned and are entitled to receive a 20% profit commission on the net underwriting profits of the pool. The Navigators Agencies received management fee commissions equal to 8.75% of the gross premium earned on marine business written by the pool for the 2005 underwriting year and 7.5% for the prior underwriting years. The Navigators Agencies’ offices writing marine business for Navigators Insurance Company are located in

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major insurance or port locations in Chicago, Houston, London, New York, San Francisco and Seattle. In addition NUAL, a Navigators Agency located in London, which manages Syndicate 1221, had received expense reimbursement and a profit commission for underwriting years prior to 2006.

 

Specialty

Navigators Specialty, a division of one of the Navigators Agencies, was acquired in 1999 and primarily writes general liability insurance focusing on small general and artisan contractors and other targeted commercial risks. We have developed underwriting and claims expertise which 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 coverages provided to larger contractors who work on condominiums, cooperative developments and other large housing developments. Consistent with our approach of emphasizing underwriting profit over market share, we direct our capacity to small to medium-sized general contractors as well as artisan contractors. Commencing in 2005, we expanded our product line in this area by writing a limited number of construction wrap-up policies which are general liability policies for owners and developers of larger residential homes.

In late 2002, Navigators Specialty began to write commercial multiple peril and commercial automobile insurance business from our Midwest office. Our commercial multi-peril products include general liability and a small amount of property insurance. We do not underwrite workers compensation coverage. We generally avoid writing property risks in areas with high exposure to earthquake or windstorm losses, such as California and Florida. In 2002, we also began underwriting personal umbrella insurance. This product is typically purchased by individuals who seek higher limits of liability than are provided in their homeowners or personal automobile policies. When personal umbrella coverage is desired and these two primary coverages are placed with different insurers, there is a need to place the personal umbrella insurance policy on a stand-alone basis. At the end of 2004, we hired a small team of experienced underwriters to target excess casualty, and commercial and personal umbrella business for Navigators Insurance Company.

Navigators Specialty also provides general liability insurance for the hospitality business which includes liquor law liability coverage for commercial establishments such as bars, restaurants and night clubs and commenced writing a limited amount of first party personal lines business. On May 17, 2006, the Company announced the establishment of a Primary Casualty Division focusing on primary casualty business produced by wholesale insurance brokers. The Primary Casualty Division writes construction business east of the Rocky Mountains and non-construction risks nationwide.

In May 24, 2007, the Company announced the establishment of a Specialty Program Division. The division focuses on developing portfolios in a variety of specialty industry niches produced through program administrators. Products that the division expects to underwrite include property, general liability and commercial automobile insurance.

 

Professional Liability

We commenced underwriting professional liability insurance in the fourth quarter of 2001 after attracting a team of experienced professionals. This business is produced through Navigators Pro, a division of one of the Navigators Agencies. Our principal product in this division is directors and officers liability insurance, which we offer for both privately held and small to mid-size publicly traded corporations. With respect to public corporations, we currently target corporations with a market capitalization of $2 billion or less for this business. In addition, we provide fiduciary liability and crime insurance to our directors and officers liability insurance clients. In 2002, we began offering employment practices liability, lawyers professional liability and miscellaneous professional liability coverages. Our current target market for lawyers professional liability is law firms comprised of 150 or fewer attorneys. Our U.K. Branch began writing professional liability coverages for U.K. solicitors in October 2004 and exited this business in 2007. In 2005, we commenced writing professional liability coverages for architects and engineers in our Insurance Companies and international directors and officer liability business in our Lloyd’s Operations.

 

Engineering and Construction

The Lloyd’s Operations write engineering and construction business consisting of coverage for construction projects including damage to machinery and equipment and loss of use due to delays. We believe this coverage, together with the cargo coverage related to the project provided through our Lloyd’s Operations’ marine business unit, provides our policyholders with risk management protection for key exposures throughout a project’s construction and operation.

 

Onshore Energy

The Lloyd’s Operations also write onshore energy insurance which principally focuses on the oil and gas, chemical and petrochemical industries with coverages primarily for property damage and business interruption.

 

Inland Marine

On May 9, 2006, the Company announced the establishment of an Inland Marine Division of Navigators Insurance Company focusing on traditional inland marine insurance products including builders’ risk, contractors’ tools and equipment, fine arts, computer equipment and motor truck cargo.

 

European Property Business

On October 10, 2006, the Company announced the establishment of a U.K. based property team to generate specialty business lines in the U.K. and throughout Europe. The team’s focus is on U.K. property-related commercial lines in targeted business sectors. The business is written by Syndicate 1221 and by the U.K. Branch of Navigators Insurance Company.

We utilize reinsurance principally to reduce our exposure on individual risks, to protect against catastrophic losses, and to stabilize loss ratios and underwriting results. Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred or

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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. We are required to pay the losses even if the reinsurer fails to meet its obligations under the reinsurance agreement. Hurricanes Katrina and Rita in 2005 significantly increased our reinsurance recoverables which increased our credit risk.

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. To meet our standards of acceptability, when the reinsurance is placed, a reinsurer generally must have a rating from A.M. Best Company (“A.M. Best”) and/or Standard & Poor’s Rating Services (“S&P”) of ”A” or better, or an equivalent financial strength if not rated, plus at least $250 million in policyholders’ surplus. Our Reinsurance Security Committee, which was recently combined with our Enterprise Risk Management Reinsurance Sub-Committee, monitors the financial strength of our reinsurers and the related reinsurance receivables and periodically reviews the list of acceptable reinsurers. The reinsurance is placed either directly by us or through reinsurance intermediaries. The reinsurance intermediaries are compensated by the reinsurers.

The credit quality distribution of the Company’s reinsurance recoverables of $1.09 billion at December 31, 2007 for ceded paid and unpaid losses and loss adjustment expenses and ceded unearned premiums based on insurer financial strength ratings from A.M. Best was as follows:

 

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The following table lists our 20 largest reinsurers measured by the amount of reinsurance recoverable for ceded paid and unpaid losses and loss adjustment expense and ceded unearned premium (constituting approximately 76.2% of our total recoverables) together with the collateral held by us at December 31, 2007, and the reinsurers’ financial strength rating from the indicated rating agency:

 

 

 

The largest portion of the Company’s collateral consists of letters of credit obtained from reinsurers in accordance with New York Insurance Department Regulation No. 133. Such regulation 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 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 of credit by the New York Insurance Department. 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 133. The contractual terms of the letters of credit require that access to the collateral is unrestricted. In the event that the counter-party 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 counter-party bank in the event such counter-party bank becomes unqualified and the reinsurer experiences significant financial deterioration or becomes insolvent. Under such circumstances, the Company could incur a substantial loss from uncollectible reinsurance from such reinsurer.

Approximately $167.7 million and $375.8 million of the reinsurance recoverables for paid and unpaid losses at December 31, 2007 and 2006, respectively, were due from reinsurers as a result of the losses from Hurricanes Katrina and Rita.

Also included in reinsurance recoverable for paid and unpaid losses is approximately $10.5 million due from reinsurers in connection with our asbestos exposures of which $6.2 million is due from Equitas (a separate United Kingdom authorized reinsurance company established to reinsure outstanding liabilities of all Lloyd’s members for all risks written in the 1992 or prior years of account). The remaining reinsurance recoverable amounts for asbestos losses are due from various domestic and international reinsurers with no one balance greater than $0.6 million due from a single reinsurer.

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Insurance companies and Lloyd’s syndicates are required to maintain reserves for unpaid losses and unpaid loss adjustment expenses for all lines of business. Loss reserves consist 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”). 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 loss adjustment expenses (“LAE”) for insurance companies such as Navigators Insurance Company and Navigators Specialty Insurance Company, and Lloyd’s corporate members such as Navigators Corporate Underwriters Ltd. and Millennium Underwriting Ltd., is dependent upon the receipt of information from insureds, brokers and agents. Generally, there is a lag between the time premiums are written and related losses and loss adjustment expenses are incurred, and the time such events are reported to Navigators Insurance Company, Navigators Specialty Insurance Company, Navigators Corporate Underwriters Ltd. and Millennium Underwriting Ltd.

Loss reserves are established by our Insurance Companies and Syndicate 1221 for reported claims when notice of the 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.

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. Based on this review, we make a best estimate of our ultimate liability. We do not establish a range of 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 income statement. 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 we record those premiums which are reported to us through the end of each calendar year and accrue estimates for premiums and loss reserves where there is a time lag between when the policy is bound and the recording of the policy. A substantial portion of the estimated premium is from international business where there can be significant time lags. To the extent that the actual premium varies from estimates, the difference, along with the related loss reserves and underwriting expenses, is recorded in current operations.

 

The following table presents an analysis of losses and loss adjustment expenses for each year in the three-year period ended December 31, 2007:

 

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The segment and line of business breakdown of prior years’ net reserve deficiency (redundancy) were as follows:

 

 

The following table presents the development of the loss and LAE reserves for 1997 through 2007. 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 estimate changes 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 allocates losses and loss adjustment expenses reported and recorded in subsequent years to all prior years starting with the year in which the loss was incurred. For example, assume that a loss occurred in 1997 and was not reported until 1999, the amount of such loss will appear as a deficiency in both 1997 and 1998. 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.

The increase in gross loss reserves on the Company’s 2007 and 2006 balance sheets of $41.2 million and $49.6 million, respectively, primarily relate to incurred losses for events occurring in those years less loss payments. The amount of the increase was reduced by a decrease in gross loss reserves related to Hurricanes Katrina and Rita of $177.4 million in 2007 compared to 2006 and $146.5 million in 2006 compared to 2005. The gross loss reserves related to Hurricanes Katrina and Rita were approximately 8.6% of the total December 31, 2007 gross loss reserves and 19.9% of the total December 31, 2006 gross loss reserves. With the recording of these losses, the Company assessed its reinsurance coverage, potential receivables, and the recoverability of the receivables. Losses incurred on business recently written are primarily covered by reinsurance agreements written by companies with whom the Company is currently doing reinsurance business and whose credit the Company continues to assess in the normal course of business.

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. Quota share reinsurance is often utilized on the lower layers of risk and excess of loss reinsurance is used above the quota share reinsurance to limit our net retention per risk. Net retention means the amount of losses 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. 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.

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The following tables identify the approximate gross and net cumulative redundancy (deficiency) at 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)

 

 

Net Cumulative Redundancy (Deficiency)

 

 

 

The 2006 consolidated grand total gross cumulative redundancy of $96.1 million consisted of prior year savings of $47.6 million from the Insurance Companies and $48.5 million from business written by the Lloyd’s Operations. The Insurance Companies’ prior year savings was generated across most lines of business, but was concentrated in the specialty construction liability business due to favorable loss trends and professional liability business from favorable loss experience in years 2005 and 2004, which was partially offset by an increase in the 2005 Katrina and Rita hurricane gross loss estimates of $23.6 million. The redundancy in the Lloyd’s Operations was principally due to reductions in the 2005 Katrina and Rita hurricane gross loss estimates of $52.9 million.

The 2006 consolidated grand total net cumulative redundancy of $47.0 million consisted of prior year savings of $33.8 million from the Insurance Companies and $13.2 million from business written by the Lloyd’s Operations. The Insurance Companies’ net redundancy was generated mainly from prior year savings of: $12.1 million in the specialty construction liability business due to favorable loss trends across most underwriting years and lower than expected frequency in the 2003 to 2006 underwriting years, $10.7 million for marine and energy business mostly from the transport and liability products partially offset by $1.9 million of net deficiency on our 2005 Katrina and Rita hurricane estimates, and $10 million in professional liability business from favorable D&O loss experience in underwriting years 2005 and 2004. The net redundancy from the Lloyd’s Operations of $13.2 million included $3.4 million due to a review of the 2005 Hurricane Katrina and Rita loss estimates, a release of approximately $2.0 million following a review of open claim files for the

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years 1998 to 2001, a $4.6 million reduction in our 2004 underwriting year estimates for the liability book due to favorable loss trends, and the remaining $3.2 million was mostly for offshore energy and liability business on business underwritten during 2002.

The 2005 consolidated grand total gross cumulative redundancy of $107.4 million consisted of prior year savings of $48.7 million from the Insurance Companies and $58.7 million from business written by the Lloyd’s Operations. The Insurance Companies’ redundancy was generated mainly from prior year savings in the specialty construction liability and professional liability business partially offset by the increase in the 2005 Katrina and Rita hurricane gross loss estimates during 2007. The redundancy in the Lloyd’s Operations was mostly due to prior years’ savings from the offshore energy business written in 2005 and 2004 and reductions to our Hurricane Katrina and Rita gross loss estimates.

The 2005 consolidated grand total net cumulative redundancy of $55.4 million was mostly due to prior year savings of $38.8 million from the Insurance Companies due to the favorable loss development in the specialty construction liability and professional liability businesses, and $16.6 million from marine and energy business written by the Lloyd’s Operations, including the $3.4 million decrease in the Hurricane Katrina and Rita net loss estimates.

The 2004 consolidated grand total gross cumulative reserve redundancy of $76.1 million consisted of prior years’ savings of $68.0 million from the Insurance Companies and $8.1 million from marine and energy business written by the Lloyd’s Operations. The Insurance Company’s 2004 gross loss reserve redundancy of $68.0 million was again due to favorable development in the specialty construction liability and professional liability businesses, and also included prior years’ savings of $17.9 million for the reduction of asbestos liabilities principally due to the 2005 settlements of two large claims coupled with a reevaluation of our remaining asbestos exposures. Such 2004 gross loss reserve savings in asbestos reserves were also the principal contributor to the 2003 gross consolidated reserve savings of $18.4 million for 2003.

The 2004 consolidated grand total net cumulative reserve redundancy of $30.8 million was generated mostly from the professional liability business written by the Insurance Companies and the marine and energy business written by the Lloyd’s Operations.

The 2003 grand total net cumulative reserve redundancy of $11.9 million was principally generated from a cumulative redundancy of $16.3 million from the marine and energy business written by the Lloyd’s Operations.

The 2002 consolidated grand total gross and net cumulative reserve deficiencies of $158.2 million and $60.6 million, respectively, were generated mainly from reserve actions taken in the 2003 fourth quarter for the Insurance Companies as discussed below:

Gross and net asbestos loss reserves were increased $77.8 million and $31.6 million, respectively, as a result of a review of asbestos exposures conducted by the Company in the 2003 fourth quarter. This gross asbestos loss deficiency was subsequently reduced by $17.4 million during 2005. Such cumulative gross and net deficiency amounts are also contained in all years prior to 2002 in the above table since the increased reserves relate primarily to policies underwritten by the Navigators Agencies in the late 1970’s and first half of the 1980’s.

Gross and net specialty business reserves were increased by $52.3 million and $22.2 million, respectively, mostly for contractors liability business written from 1999 to 2002 in reaction to loss development trends for those years. Approximately $39.5 million, $24.9 million and $16.7 million of the gross specialty reserve increase and $20.7 million, $12.4 million and $9.4 million of the net specialty reserve increase recorded in 2003 are contained, respectively, in the 2001, 2000 and 1999 Insurance Companies cumulative amounts.

The remaining gross and net cumulative reserve deficiencies for the Insurance Companies in the ‘All Other’ column for the years 2002 through 2000 are mainly from the marine and run-off lines of business recorded over several years that was not related to any specific reserve action.

The 2000 Lloyd’s Operations’ gross and net cumulative reserve deficiencies of $30.6 million and $9.6 million, respectively, resulted from our Lloyd’s Operations establishing reserves against premiums from prior years which were received in excess of our original premium estimates and strengthening the Lloyd’s Operations’ reserves related to the 1999 underwriting year. Such amounts also affected the 1999 and 1998 year-end reserves for the Lloyd’s Operations in the above table.

The 1997 gross cumulative deficiency of $10.1 million for the Insurance Companies in the ‘All Other’ column mostly resulted from adverse development in the onshore energy business and from one large 1989 claim from a run-off book of business which also adversely affected the years prior to 1997.

For 1998 and 1999 years, exclusive of the 2003 asbestos and environmental reserves strengthening, the Company experienced net cumulative reserve redundancies on a consolidated basis principally due to favorable development from marine business.

The favorable or adverse development on our gross reserves has mostly been ceded to our excess of loss reinsurance treaties. As a result of these reinsurance arrangements, while our gross losses and related reserve deficiencies and redundancies are very sensitive to favorable or adverse developments such as those described above, our net losses and related reserve deficiencies and redundancies tend to be less sensitive to such developments.

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, making estimation of loss reserves less complex. Our longer tail business includes our specialty liability and professional liability insurance. 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.

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Specialty Liability and Professional Liability. Substantially all of our specialty liability business involves general 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. Reserves and claim frequency on this business may be impacted by legislation implemented in California, which generally provides consumers who experience construction defects a method other than litigation to obtain construction defect repairs. The law, which became effective July 1, 2002 with a sunset provision effective January 1, 2011, provides for an alternative dispute resolution system that attempts to involve all parties to the claim at an early stage. This legislation may impact claim severity, frequency and length of settlement assumptions underlying our reserves. Accordingly, our ultimate liability may exceed or be less than current estimates due to this variable, among others. We had 1,100 open claims on our specialty construction liability policies at December 31, 2007 compared to 1,060 at December 31, 2006.

The professional liability class generates third party claims, which also are longer tail in nature. The professional liability policies mainly provide coverage on a claims-made basis, whereby coverage is generally provided only for those claims that are made during the policy period. The substantial majority of our claims-made policies provide coverage for one year periods. The Company has also issued a limited number of multi-year claims-made professional liability policies known as “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.

Loss development of our professional liability business is relatively immature, as we first began writing the business in late 2001. Accordingly, it will take some time to better understand the reserve trends on this business. Our professional liability loss estimates are based on expected losses, actual reported losses, 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. There were 1,047 professional liability claims open at December 31, 2007 compared to 944 at December 31, 2006.

 

The following table sets forth claims data and other information related to subprime exposure for our professional liability business. Our management believes that its reserves for losses and loss adjustment exposure are adequate to cover the ultimate costs for such loss contingencies related to subprime exposure for our professional liability business.

 

Professional Liability
Reported Claims or Notices of Potential Claims
Related to Subprime Exposure(1)
December 31, 2007
($ in thousands)

 

 

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The following tables set forth our net reported loss and LAE loss reserves and net IBNR reserves by segment and line of business as of December 31, 2007 and 2006:

 

 

 

 

Asbestos Liability. Our exposure to asbestos liability principally stems from marine liability insurance written on an occurrence basis during the mid-1980s. In general, our participation on such risks is in the excess layers, which requires the underlying coverage to be exhausted prior to coverage being triggered in our layer. In many instances we are one of many insurers who participate in the defense and ultimate settlement of these claims, and we are generally a minor participant in the overall insurance coverage and settlement.

The reserves for asbestos exposures at December 31, 2007 are for: (i) one large settled claim for excess insurance policy limits exposed to a class action suit against an insured involved in the manufacturing or distribution of asbestos products being paid over several years (two other large settled claims were fully paid in 2007); (ii) other insureds not directly involved in the manufacturing or distribution of asbestos products, but that have more than incidental asbestos exposure for their purchase or use of products that contained asbestos; and (iii) attritional asbestos claims that could be expected to occur over time. Substantially all of our asbestos liability reserves are included in our marine loss reserves.

The Company believes that there are no remaining known claims where it would suffer a material loss as a result of excess policy limits being exposed to class action suits for insureds involved in the manufacturing or distribution of asbestos products. There can be no assurances, however, that material loss development may not arise in the future from existing asbestos claims or new claims given the evolving and complex legal environment that may directly impact the outcome of the asbestos exposures of our insureds.

 

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The following tables set forth our gross and net loss and LAE reserves for our asbestos exposures for the periods indicated:

 

 

 

To the extent the Company incurs additional gross loss development for its historic asbestos exposure, the Company’s allowance for uncollectible reinsurance would increase for the reinsurers that are insolvent, in run-off or otherwise no longer active in the reinsurance business. The Company continues to believe that it will be able to collect reinsurance on the gross portion of its historic gross asbestos exposure in the above table. Gross loss development for asbestos exposure was not significant in 2007, 2006 and 2005. The reduction in gross incurred loss and LAE in 2005 relates to settlement of large claims discussed above.

At December 31, 2007, the ceded asbestos paid and unpaid recoverables were $10.5 million compared to $23.5 million at December 31, 2006. During 2007, the Company increased its provision for uncollectible reinsurance for asbestos losses by $1.6 million which was recorded in incurred losses. The Company also settled demands for arbitration with two asbestos reinsurers.

Loss reserves for environmental losses generally consist of oil spill claims on marine liability policies written in the ordinary course of business. Net loss reserves for such exposures are included in our marine loss reserves and not separately identified.

Hurricanes Katrina and Rita. During the 2005 third quarter, the Company recorded gross and net loss estimates of $471.0 million and $22.3 million, respectively, exclusive of $14.5 million for the cost of excess of loss reinstatement premiums related to Hurricanes Katrina and Rita.

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

 

 

Our management believes that the estimates for the reserves for losses and loss adjustment expenses are adequate to cover the ultimate cost of losses and loss adjustment expenses on reported and unreported claims. However, it is possible that the ultimate liability may exceed or be less than such estimates. 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. We continue to review all of our loss reserves, including our asbestos reserves and Hurricanes Katrina and Rita reserves, on a regular basis.

Additional information regarding our loss reserves can be found in ”Management’s Discussion and Analysis 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, to our consolidated audited financial statements, both of which are included herein.

The objective of the Company’s 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, an important consideration is to optimize the after-tax book income.

The investments are managed by outside professional fixed-income and equity portfolio managers. The Company seeks to achieve its 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 the consoli dated 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 Investor Services (“Moody’s”) shall not exceed 10% of the of the total fixed income and short-term investments. Securities rated below “BBB−” by S&P or “Baa3” by Moody’s combined with any other investments not specifically permitted under the investment guidelines, can not exceed 5% of consolidated stockholders’ equity. Investments in equity securities that are actively traded on major U.S. stock exchanges can not exceed 20% of consolidated stockholders’ equity. Our investment guidelines prohibit investments in derivatives other than as a hedge against foreign currency exposures or the writing of covered call options on the equity portfolio.

The Insurance Companies’ investments are subject to the direction and control of their respective Boards of Directors and our Finance Committee. 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 Lloyd’s Operations’ investments are subject to the direction and control of the Board of Directors and the Investment Committee of NUAL, as well as the Company’s Board of Directors and Finance Committee, and represent our share of the investments held by Syndicate 1221. These investments must comply with the rules and regulations imposed by Lloyd’s and by certain overseas regulators. The investment portfolio and the performance of the investment managers are reviewed quarterly.

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The table set forth below reflects investments, the net investment income earned thereon and the related average yield for each of the years in the three-year period ended December 31, 2007:

 

 

Invested assets have increased in 2007 and 2006 due to the combination of cash flows from operations and the investment of net proceeds from a debt issuance in the 2006 second quarter. Investment income has increased in 2007, 2006 and 2005 due to a combination of increased invested assets and rising investment yields in the portfolio. The consolidated average investment yield of the portfolio has increased due to the general increase in market yields over the period and the increase in the duration of the consolidated portfolio from 3.7 years at January 1, 2005 to 4.3 years at December 31, 2007.

Prepayment assumptions associated with the mortgage-backed and asset-backed securities are reviewed on a periodic basis. When changes in prepayment assumptions are deemed necessary as the result of actual prepayments differing from anticipated prepayments, securities are revalued based upon the new prepayment assumptions utilizing the retrospective adjustment method, whereby the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The investment in such securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the security. Such adjustments are included in net investment income for the current period being reported. The adjustments decreased net investment income and net income by immaterial amounts in 2007, 2006 and 2005

All fixed maturity and equity securities are carried at fair value. The fair value is based on market prices provided by independent pricing services. At December 31, 2007 and 2006, all fixed-maturity and equity securities held by us were classified as available-for-sale.

At December 31, 2007, the average quality of the investment portfolio as rated by S&P and Moody’s was AA/Aa with an average duration of 4.3 years. All of the Company’s mortgage-backed and asset-backed securities, except for $0.2 million, are rated AAA/Aaa by S&P and Moody’s. The Company does not own any collateralized debt obligations (CDO’s), collateralized loan obligations (CLO’s) or asset-backed commercial paper.

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The following tables set forth our cash and investments as of December 31, 2007 and 2006:

 

 

 

We analyze our mortgage-backed and asset-backed securities by credit quality of the underlying collateral distinguishing between the securities issued by the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corporation (“FHLMC”) which are Federal government sponsored entities, and the non-FNMA and FHLMC securities broken out by prime, Alt-A and subprime collateral. The securities issued by FNMA and FHLMC are guaranteed by each respective entity but are not guaranteed by the Federal government.

Prime collateral consists of mortgages or other collateral from the most creditworthy borrowers. Alt-A collateral consists of mortgages or other collateral from borrowers which have a risk potential that is greater than prime but less than subprime. The subprime collateral consists of mortgages or other collateral from borrowers with low credit ratings. Such subprime and Alt-A categories are as defined by S&P.

At December 31, 2007, the Company owned three asset-backed securities approximating $0.5 million with subprime mortgage exposures. The securities are rated AAA/Aaa by S&P and Moody’s, respectively, and have an effective maturity of 0.8 years. In addition, the Company owned eleven collateralized mortgage obligations approximating $20.9 million classified as Alt-A which is a credit category between prime and subprime. The Alt-A bonds, also rated AAA/Aaa, have an effective maturity of 2.3 years. The Company is receiving principal and/or interest payments on all of these securities and believes such amounts are fully collectible.

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The following three tables set forth our mortgage-backed securities, collateralized mortgage obligations, and asset-backed securities by those issued by FNMA and FHLMC and the quality category (prime, Alt-A and subprime) for all other such investments at December 31, 2007: