NOTE ON FORWARD-LOOKING STATEMENTS
Some of the statements in this Quarterly Report on Form 10-Q for The Navigators
Group, Inc. and its subsidiaries ("the Company," "we," "us," and "our") are
"forward-looking statements" as defined in the Private Securities Litigation
Reform Act of 1995. All statements other than statements of historical fact
included in or incorporated by reference in this Quarterly Report are
forward-looking statements. Whenever used in this report, the words "estimate,"
"expect," "believe" or similar expressions or their negative are intended to
identify such forward-looking statements. Forward-looking statements are derived
from information that we currently have and assumptions that we make. We cannot
assure that anticipated results will be achieved, since actual results may
differ materially because of both known and unknown risks and uncertainties
which we face. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. Factors that could cause actual results to differ
materially from our forward-looking statements include, but are not limited to,
the factors discussed in the "Risk Factors" section of our 2011 Annual Report on
Form 10-K as well as:
• continued volatility in the financial markets and the current recession;
• risks arising from the concentration of our business in marine and energy,
general liability and professional liability insurance, including the risk
that market conditions for these lines could change adversely or that we
could experience large losses in these lines;
• cyclicality in the property and casualty insurance business generally, and
the marine insurance business specifically;
• risks that we face in entering new markets and diversifying the products and services that we offer, including risks arising from the development
of our new specialty lines or our ability to manage effectively the rapid
growth in our lines of business;
• changing legal, social and economic trends and inherent uncertainties in
the loss estimation process, which could adversely impact the adequacy of
loss reserves and the allowance for reinsurance recoverables;
• risks inherent in the preparation of our financial statements, which requires us to make many estimates and judgments;
• our ability to continue to obtain reinsurance covering our exposures at
appropriate prices and/or in sufficient amounts;
• the counterparty credit risk of our reinsurers, including risks associated
with the collection of reinsurance recoverable amounts from our
reinsurers, who may not pay losses in a timely fashion, or at all;
• the effects of competition from other insurers;
• unexpected turnover of our professional staff and our ability to attract
and retain qualified employees;
• increases in interest rates during periods in which we must sell fixed-income securities to satisfy liquidity needs may result in realized
investment losses;
• our investment portfolio is exposed to market-wide risks and fluctuations,
as well as to risks inherent in particular types of securities;
• exposure to significant capital market risks related to changes in
interest rates, credit spreads, equity prices and foreign exchange rates which may adversely affect our results of operations, financial condition
or cash flows;
• capital may not be available in the future, or may not be available on
favorable terms;
• our ability to maintain or improve our insurance company ratings, as
downgrades could significantly adversely affect us, including reducing our
competitive position in the industry, or causing clients to choose an
insurer with a certain rating level to use higher-rated insurers;
• risks associated with continued or increased premium levies by Lloyd's of
London ("Lloyd's) for the Lloyd's Central Fund and cash calls for trust
fund deposits, or a significant downgrade of Lloyd's rating by the A.M.
Best Company ("A.M. Best");
29
--------------------------------------------------------------------------------
Table of Contents
• changes in the laws, rules and regulations that apply to our insurance
companies;
• the effect of the European Union Directive on Solvency II on how we manage our business, capital requirements and costs associated with conducting
business;
• the inability of our subsidiaries to pay dividends to us in sufficient
amounts, which would harm our ability to meet our obligations;
• weather-related events and other catastrophes (including man-made catastrophes) impacting our insureds and/or reinsurers;
• volatility in the market price of our common stock;
• exposure to recent uncertainties with regard to European sovereign debt
holdings; and
• other risks that we identify in current and future filings with theSecurities and Exchange Commission ("SEC").
In light of these risks, uncertainties and assumptions, any forward-looking
events discussed in this Form 10-Q may not occur. You are cautioned not to place
undue reliance on any forward-looking statements, which speak only as of their
respective dates.
OVERVIEW
The discussion and analysis of our financial condition and results of operations
contained herein should be read in conjunction with our consolidated financial
statements and accompanying notes which appear elsewhere in this Form 10-Q. It
contains forward-looking statements that involve risks and uncertainties. Please
refer to "Note on Forward-Looking Statements" for more information. Our actual
results could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those discussed below and
elsewhere in this Form 10-Q.
We are an international insurance company focusing on specialty products within
the overall property and casualty insurance market. Our largest product line and
most long-standing area of specialization is ocean marine insurance. We have
also developed other specialty insurance lines, such as commercial primary and
excess liability as well as specialty niches in professional liability, and have
recently expanded our specialty reinsurance business.
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 ("Navigators Specialty"), which
underwrites specialty and professional liability insurance on an excess and
surplus lines basis. All of the insurance business written by Navigators
Specialty 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 underwriting agency which manages Navigators Syndicate 1221
at Lloyd's ("Syndicate 1221"). Our Lloyd's Operations primarily underwrite
marine and related lines of business along with offshore energy insurance,
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 and 2011 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 also maintain an underwriting presence in Brazil and China
through contractual arrangements with local affiliates of Lloyd's.
30
--------------------------------------------------------------------------------
Table of Contents
Catastrophe Risk Management
We have exposure to losses caused by hurricanes and other natural 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
June 30, 2012 we estimate that our probable maximum pre-tax gross and net loss
exposure from such an earthquake event would be approximately $181.8 million and
$30.1 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.
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.
31
--------------------------------------------------------------------------------
Table of Contents
CRITICAL ACCOUNTING POLICIES
The Company's Annual Report on Form 10-K for the year ended December 31, 2011
discloses our critical accounting policies (refer to Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Critical Accounting Policies). Certain of these policies are critical to the
portrayal of our financial condition and results since they require management
to establish estimates based on complex and subjective judgments, including
those related to our estimates for losses and loss adjustment expenses ("LAE")
(including losses that have occurred but were not reported to us by the
financial reporting date), reinsurance recoverables, written and unearned
premium, the recoverability of deferred tax assets, the impairment of investment
securities and accounting for Lloyd's results. For additional information
regarding our critical accounting policies, refer to our Annual Report on Form
10-K for the year ended December 31, 2011.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 2, Recent Accounting Pronouncements, in the Notes to Interim
Consolidated Financial Statements included herein for a discussion about
accounting standards recently adopted by the Company, as well as recent
accounting developments relating to standards not yet adopted by the Company.
RESULTS OF OPERATIONS
The following is a discussion and analysis of our consolidated and segment
results of operations for the three and six months ended June 30, 2012 and 2011.
Our financial results are presented on the basis of United States generally
accepted accounting principles ("GAAP"). However, in presenting our financial
results, we discuss our performance with reference to operating earnings, book
value per share, underwriting profit or loss, and the combined ratio, all of
which are non-GAAP financial measures of performance and/or underwriting
profitability. Operating earnings is calculated as net income less after-tax net
realized gains (losses) and net other-than-temporary impairment ("OTTI") losses
recognized in earnings. Book value per share is calculated by dividing
stockholders' equity by the number of outstanding shares at any period end.
Underwriting profit or loss is calculated from net earned premiums, less the sum
of net losses and LAE, commission expenses, other operating expenses and other
income (expense). The combined ratio is derived by dividing the sum of net
losses and LAE, commission expenses, other operating expenses and other income
(expense) by net earned premiums. A combined ratio of less than 100% indicates
an underwriting profit and greater than 100% indicates an underwriting loss. We
consider such measures, which may be defined differently by other companies, to
be important in the understanding of our overall results of operations by
highlighting the underlying profitability of our insurance business.
Summary of Consolidated Results
The following table presents a summary of our consolidated financial results for
the three and six months ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30, Percentage ChangeIn thousands, except per share amounts 2012 2011 2012
2011 QTD YTD
Gross written premiums $ 322,987 $ 278,714 $ 666,136 $ 574,997 15.9 % 15.9 %
Net written premiums 190,252 183,363 433,297 376,439 3.8 % 15.1 %
Total revenues 215,902 194,253 412,878 363,476 11.1 % 13.6 %
Total expenses 194,778 179,717 380,569 361,326 8.4 % 5.3 %
Pre-tax income (loss) $ 21,124 $ 14,536 $ 32,309 $ 2,150 45.3 % NM
Provision (benefit) for income taxes 6,225 5,032 9,506 539 23.7 % NM
Net income (loss) $ 14,899 $ 9,504 $ 22,803 $ 1,611 56.8 % NM
Net income (loss) per common share:
Basic $ 1.06 $ 0.62 $ 1.63 $ 0.10
Diluted $ 1.05 $ 0.60 $ 1.60 $ 0.10
NM - Percentage change not meaningful
32
--------------------------------------------------------------------------------
Table of Contents
Net income for the three months ended June 30, 2012 was $14.9 million or $1.05
per diluted share compared to $9.5 million or $0.60 per diluted share for the
three months ended June 30, 2011. Operating earnings for the three months ended
June 30, 2012 were $12.5 million or $0.88 per diluted share compared to $8.0
million or $0.51 per diluted share for the comparable period in 2011. In
comparison to net income, operating earnings excludes after-tax net realized
gains of $2.7 million and after-tax OTTI losses of $0.3 million for the three
months ended June 30, 2012. For the three months ended June 30, 2011 operating
earnings excluded after tax net realized gains of $1.9 million and after-tax
OTTI losses of $0.4 million. The increase in our operating earnings for the
three months ended June 30, 2012 was largely attributable to stronger
underwriting results.
Net income for the six months ended June 30, 2012 was $22.8 million or $1.60 per
diluted share compared to $1.6 million or $0.10 per diluted share for the six
months ended June 30, 2011. Operating earnings for the six months ended June 30,
2012 were $19.3 million or $1.35 per diluted share compared to $1.2 million or
$0.08 per diluted share for the comparable period in 2011. In comparison to net
income, operating earnings excludes after-tax net realized gains of $3.9 million
and after-tax OTTI losses of $0.4 million for the six months ended June 30,
2012. For the six months ended June 30, 2011 operating earnings excluded
after-tax net realized gains of $0.9 million and after-tax OTTI losses of $0.5
million. The increase in our operating earnings for the six months ended
June 30, 2012 was largely attributable to stronger underwriting results,
partially offset by a decrease in net investment income driven by $4.5 million
of investment expenses related to the settlement of a dispute with Equitas over
foregone interest on amounts that were due on certain reinsurance contracts. The
results for the first six months of the year include net losses of $11.3 million
related to several large losses from our marine business, including the
grounding of the cruise ship Costa Concordia off the coast of Italy.
Our book value per share as of June 30, 2012 was $60.08, increasing from $57.57
as of December 31, 2011. The increase in book value per share primarily resulted
from our increased results of operations and improvements in the value of our
consolidated investment portfolio. Our consolidated stockholders' equity
increased 4.8% to $841.8 million as of June 30, 2012 compared to $803.4 million
as of December 31, 2011.
Cash flow from operations was $15.0 million for the six months ended June 30,
2012 compared to $14.4 million for the comparable period in 2011. The increase
in cash flow from operations was due to improved collections on premium
receivables and reinsurance recoverables, offset by an increase in paid losses
and current income taxes paid.
33
--------------------------------------------------------------------------------
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 net
loss for the three and six months ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30, Percentage Change
In thousands 2012 2011 2012 2011 QTD YTD
Gross written premiums $ 322,987 $ 278,714 $ 666,136 $ 574,997 15.9 % 15.9 %
Net written premiums 190,252 183,363 433,297 376,439 3.8 % 15.1 %
Net earned premiums 196,017 173,777 379,136 326,255 12.8 % 16.2 %
Net losses and loss adjustment
expenses (123,407 ) (113,863 ) (241,392 ) (230,651 ) 8.4 % 4.7 %
Commission expenses (29,503 ) (28,030 ) (58,953 ) (54,230 ) 5.3 % 8.7 %
Other operating expenses (39,819 ) (35,777 ) (76,126 ) (72,352 ) 11.3 % 5.2 %
Other income (expense) 387 573 1,298 1,564 -32.5 % -17.0 %
Underwriting profit (loss) $ 3,675 $ (3,320 ) $ 3,963 $ (29,414 ) NM NM
Net investment income 15,777 17,429 27,035 34,813 -9.5 % -22.3 %
Net other-than-temporary impairment
losses recognized in earnings (496 ) (532 ) (650 ) (774 ) -6.8 % -16.0 %
Net realized gains (losses) 4,217 3,006 6,059 1,618 40.3 % NM
Interest expense (2,049 ) (2,047 ) (4,098 ) (4,093 ) 0.1 % 0.1 %
Income (loss) before income taxes $ 21,124$ 14,536 $
32,309 $ 2,150 45.3 % NM
Income tax expense (benefit) 6,225 5,032 9,506 539 23.7 % NM
Net income (loss) $ 14,899 $ 9,504 $ 22,803 $ 1,611 56.8 % NM
Losses and loss adjustment expenses
ratio 63.0 % 65.5 % 63.7 % 70.7 %
Commission expense ratio 15.1 % 16.1 % 15.5 % 16.6 %
Other operating expense ratio (1) 20.0 % 20.3 % 19.8 % 21.7 %
Combined ratio 98.1 % 101.9 % 99.0 % 109.0 %
(1) - Includes Other operating expenses & Other income (expense)
NM - Percentage change not meaningful
The combined ratio for the three months ended June 30, 2012 was 98.1% compared
to 101.9% for the same period in 2011. Our pre-tax underwriting results
increased $7.0 million to a $3.7 million underwriting profit for the three
months ended June 30, 2012 compared to an underwriting loss of $3.3 million for
the same period in 2011.
Our underwriting results for the current quarter include $3.0 million of
reinsurance reinstatement premiums related to several large losses from our
marine business, as well as net prior period reserve redundancies of $6.0
million from our Lloyd's Operations. Our underwriting results for the same
period in 2011 included a large loss from a Gulf of Mexico drilling operation
resulting in a net loss of $6.9 million, inclusive of $4.0 million in
reinsurance reinstatement premiums.
The combined ratio for the six months ended June 30, 2012 was 99.0% compared to
109.0% for the same period in 2011. Our pre-tax underwriting results increased
$33.4 million to a $4.0 million underwriting profit for the six months ended
June 30, 2012 compared to an underwriting loss of $29.4 million for the same
period in 2011.
Our underwriting results for the first six months of 2012 reflect net losses of
$11.3 million inclusive of $10.0 million of reinsurance reinstatement premiums,
related to several large losses from our marine business, including the
grounding of the cruise ship Costa Concordia off the coast of Italy. The results
also include net prior period reserve redundancies of $12.2 million primarily
driven by our Lloyd's Operations.
34
--------------------------------------------------------------------------------
Table of Contents
Our underwriting results for the same period in 2011 included net losses of
$30.8 million consisting of $17.6 million of large losses from our energy
business, inclusive of $7.9 million of reinsurance reinstatement premiums, $5.2
million in accrued reinstatement premiums reflecting our shift to excess-of-loss
reinsurance protection in our Marine business, $5.4 million of prior year
development in our Lloyd's Professional Liability business, and $2.6 million in
sliding scale commission adjustments related to large loss activity that reduced
our ceding commission benefit on a large quota share treaty.
Revenues
Gross Written Premiums
The following tables set forth our gross written premiums, net written premiums
and net earned premiums by segment and line of business for the three and six
months ended June 30, 2012 and 2011:
Three Months Ended June 30,
2012 2011
Gross Net Net Gross Net Net
Written Written Earned Written Written Earned
In thousands Premiums % Premiums Premiums Premiums % Premiums Premiums
Insurance Companies:
Marine $ 49,896 15 % $ 31,786 $ 35,535 $ 58,323 21 % $ 41,802 $ 41,877
Property Casualty 130,627 41 % 76,842 82,175 100,131 36 % 62,015 55,351
Professional Liability 33,541 10 % 25,437 23,867 28,313 10 % 19,387 17,759
Insurance Companies Total 214,064 66 % 134,065 141,577 186,767 67 % 123,204 114,987
Lloyd's Operations:
Marine 46,482 15 % 33,025 32,927 39,451 14 % 32,042 37,734
Property Casualty 49,533 15 % 16,172 16,617 42,122 15 % 22,682 16,259
Professional Liability 12,908 4 % 6,990 4,896 10,374 4 % 5,435 4,797
Lloyd's Operations Total 108,923 34 % 56,187 54,440 91,947 33 % 60,159 58,790
Total $ 322,987 100 % $ 190,252 $ 196,017 $ 278,714 100 % $ 183,363 $ 173,777
Six Months Ended June 30,
2012 2011
Gross Net Net Gross Net Net
Written Written Earned Written Written Earned
In thousands Premiums % Premiums Premiums Premiums % Premiums Premiums
Insurance Companies:
Marine $ 111,761 17 % $ 74,651 $ 70,810 $ 128,671 22 % $ 96,020 $ 82,436
Property Casualty 286,546 43 % 191,374 156,543 213,019 37 % 124,922 98,286
Professional Liability 64,095 10 % 49,290 45,772 51,853 9 % 33,002 33,085
Insurance Companies Total 462,402 70 % 315,315 273,125 393,543 68 % 253,944 213,807
Lloyd's Operations:
Marine 108,812 16 % 81,550 67,536 100,606 18 % 81,713 74,712
Property Casualty 73,274 11 % 25,060 29,774 61,424 11 % 31,068 28,153
Professional Liability 21,648 3 % 11,372 8,701 19,424 3 % 9,714 9,583
Lloyd's Operations Total 203,734 30 % 117,982 106,011 181,454 32 % 122,495 112,448
Total $ 666,136 100 % $ 433,297 $ 379,136 $ 574,997 100 % $ 376,439 $ 326,255
35
--------------------------------------------------------------------------------
Table of Contents
Gross written premiums increased $44.3 million, or 15.9%, to $323.0 million for
the three months ended June 30, 2012 compared to $278.7 million for the same
period in 2011. Gross written premiums increased $91.1 million, or 15.9%, to
$666.1 million for the six months ended June 30, 2012 compared to $575.0 million
for the same period in 2011. The increases in gross written premiums is
primarily attributed to growth within our Property Casualty business,
specifically our Nav Re 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
attributable to growth within our Excess Casualty division resulting from strong
production attributable to expansion of our underwriting team and dislocation
among certain competitors, as well as strong production from our NavTech
division.
Average renewal premium rates for our Insurance Companies segment increased for
the three months ended June 30, 2012 as compared to the same period in 2011
across all segments. Our Marine business has realized a 3.4% and 8.4% increase
in rates for the marine liability and inland marine divisions, respectively.
Within our Property Casualty business we have realized a 2.3% increase in rates
for the NavTech division and a 0.8% increase for the Excess Casualty division
offset by a 3.1% decrease in the Primary Casualty division. Our Professional
Liability business has experienced an overall increase in renewal rates of 5.5%,
consisting of 7.0% and 3.1% for the Errors & Omissions ("E&O") and the
Management Liability divisions, respectively.
For the three months ended June 30, 2012 average renewal premium rates for our
Lloyd's Operations segment include increases for Lloyd's Marine and Lloyd's
NavTech of approximately 7.1% and 5.1%, respectively. Our Lloyd's Professional
Liability business experienced an average decrease of 0.9%.
Average renewal premium rates for our Insurance Companies segment also increased
for the six months ended June 30, 2012 as compared to the same period in 2011
across all segments. Our Marine business has realized a 4.7% and 4.3% increase
in rates for the marine liability and inland marine divisions, respectively.
Within our Property Casualty business we have realized a 3.3% increase in rates
for the NavTech division and a 1.0% increase for the Excess Casualty division
offset by a 2.6% decrease in the Primary Casualty division. Our Professional
Liability business has experienced an overall increase in renewal rates of 4.0%,
consisting of 5.1% and 2.1% for the E&O and the Management Liability divisions,
respectively.
For the six months ended June 30, 2012 average renewal premium rates for our
Lloyd's segment include increases for Lloyd's Marine and Lloyd's NavTech of
approximately 4.5% and 5.4%, respectively. Our Lloyd's Professional Liability
business experienced an average decrease of 1.5%.
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
judgmentally adjusted for exposure factors when deemed significant and sometimes
represent an aggregation of several lines of business. The rate change
calculations provide an indicated pricing trend and are not meant to be a
precise analysis of the numerous factors that affect premium rates or the
adequacy of such rates to cover all underwriting costs and generate an
underwriting profit. The calculation can also be affected quarter by quarter
depending on the particular policies and the number of policies that renew
during that period. Due to market conditions, these rate changes may or may not
apply to new business 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.
36--------------------------------------------------------------------------------
Table of Contents
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 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). The number of reinsurance reinstatements available
varies by contract.
We record an estimate of the expected reinsurance reinstatement premiums for
losses ceded to excess-of-loss agreements where this feature applies.
We incurred $5.0 million and $16.4 million in reinsurance reinstatement premiums
for the three and six months ended June 30, 2012, respectively, primarily
related to several large losses on our marine business, including the grounding
of the cruise ship Costa Concordia off the coast of Italy. The net amount
recorded for the three and six months ended June 30, 2011 was $1.5 million and
$13.0 million, respectively, primarily related to the large energy losses and
the establishment of our reinstatement premium accrual reflective of our shift
to excess-of-loss protection in our Marine business.
The following table sets forth our ceded written premiums by segment and major
line of business for the three and six months ended June 30, 2012 and 2011:
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
% of % of % of % of
Ceded Gross Ceded Gross Ceded Gross Ceded Gross
Written Written Written Written Written Written Written Written
In thousands Premiums Premiums Premiums Premiums Premiums Premiums Premiums Premiums
Insurance Companies:
Marine $ 18,110 36 % $ 16,521 28 % $ 37,110 33 % $ 32,651 25 %
Property Casualty 53,785 41 % 38,116 38 % 95,172 33 % 88,097 41 %
Professional Liability 8,104 24 % 8,926 32 % 14,805 23 % 18,851 36 %
Total Insurance Companies 79,999 37 % 63,563 34 % 147,087 32 % 139,599 35 %
Lloyd's Operations:
Marine 13,457 29 % 7,409 19 % 27,262 25 % 18,893 19 %
Property Casualty 33,361 67 % 19,440 46 % 48,214 66 % 30,356 49 %
Professional Liability 5,918 46 % 4,939 48 % 10,276 47 % 9,710 50 %
Total Lloyd's 52,736 48 % 31,788 35 % 85,752 42 % 58,959 32 %
Total $ 132,735 41 % $ 95,351 34 % $ 232,839 35 % $ 198,558 35 %
The increase in percentage of total ceded written premiums to total gross
written premiums for the three months ended June 30, 2012 compared to the same
period of 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,
partially offset by a change in the mix of business resulting in the growth of
our assumed reinsurance business written by Nav Re, and to a lesser extent, the
expansion of products offered by our Professional Liability division where our
retention ratios are higher.
Net Written Premiums
Net written premiums increased 3.8% and 15.1% for the three and six months ended
June 30, 2012 compared to the same periods in 2011. The increases are due to the
impact of higher gross written premiums for the three and six months ended
June 30, 2012, and to a lesser extent higher premium cessions as a result of mix
changes in business, as discussed above.
Net Earned Premiums
Net earned premiums increased 12.8% and 16.2% for the three and six months ended
June 30, 2012 compared to the same periods in 2011 as result of a change in the
mix of business driven by the growth of our Nav Re division, specifically the
A&H lines, which are recognized in earnings over a longer exposure period than
our other lines of business.
37
--------------------------------------------------------------------------------
Table of Contents
Net Investment Income
Our net investment income was derived from the following sources:
Three Months Ended June 30, Six Months Ended June 30,
In thousands 2012 2011 2012 2011
Fixed maturities $ 15,006 $ 16,844 $ 30,416 $ 34,034
Equity securities 994 859 1,941 1,642
Short-term investments 701 274 1,014 542
Total investment income 16,701 17,977 33,371 36,218
Investment expenses (924 ) (548 ) (6,336 ) (1,405 )
Net investment income $ 15,777 $ 17,429 $ 27,035 $ 34,813
The total investment income before investment expenses decreased 7.1% and 7.9%
for the three and six months ended June 30, 2012 compared to the same periods in
2011, primarily due to lower investment yields. The annualized pre-tax
investment yield, excluding net realized gains and losses and net OTTI losses
recognized in earnings, was 2.8% and 2.4% for the three and six months ended
June 30, 2012 compared to 3.3% for the same periods during 2011. The portfolio
duration was 3.9 years for the six months ended June 30, 2012 compared to 3.6
years for the comparable period during 2011.
The 2.4% annualized pre-tax yield for the six months ended June 30, 2012
includes investment expenses of $4.5 million for 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. Excluding
the impact of the aforementioned interest expense, the annualized pre-tax yield
for the six months ended June 30, 2012 would have been 2.8%, reflective of the
general decline in market yields.
Net Other-Than-Temporary Impairment Losses Recognized In Earnings
Our net OTTI losses recognized in earnings for the periods indicated were as
follows:
Three Months Ended June 30, Six Months Ended June 30,
In thousands 2012 2011 2012 2011
Fixed maturities $ - $ 215 $ 11 $ 226
Equity securities 496 317 639 548
OTTI recognized in earnings $ 496 $ 532 $ 650 $ 774
The significant inputs used to measure the amount of credit loss recognized in
earnings 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.
38--------------------------------------------------------------------------------
Table of Contents
Net Realized Gains and Losses
Realized gains and losses, excluding net OTTI losses recognized in earnings, for
the periods indicated were as follows:
Three Months Ended June 30, Six Months Ended June 30,
In thousands 2012 2011 2012 2011
Fixed maturities:
Gains $ 4,717 $ 4,443 $ 7,858 $ 7,312
Losses (231 ) (2,277 ) (1,530 ) (6,534 )
Fixed maturities, net $ 4,486 $ 2,166 $ 6,328 $ 778
Equity securities:
Gains $ 204 $ 840 $ 204 $ 840
Losses (473 ) - (473 ) -
Equity securities, net $ (269 ) $ 840 $ (269 ) $ 840
Net realized gains (losses) $ 4,217 $ 3,006 $ 6,059 $ 1,618
Net realized gains and losses are generated as part of the normal ongoing
management of our investment portfolio. Net realized gains of $4.2 million and
$6.1 million for the three and six months ended June 30, 2012 are due to the
sale of corporate bonds and Treasury bonds. Net realized gains of $3.0 million
and $1.6 million for the three and six months ended June 30, 2011 are due to the
sale of corporate and municipal bonds.
Other Income/Expense
Other income (expense) for the three and six months ended June 30, 2012 and 2011
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
three and six months ended June 30, 2012 and 2011 is presented in the following
table:
Three Months Ended Six Months Ended
June 30, June 30,
Net Loss and LAE Ratio 2012 2011 2012 2011
Net Loss and LAE Payments 61.7 % 59.8 % 63.1 % 59.0 %
Current year reserves 4.0 % 5.2 % 3.8 % 10.4 %
Subtotal-current year loss ratio 65.7 % 65.0 % 66.9 % 69.4 %
Prior year deficiencies (redundancies) -2.7 % 0.5 % -3.2 % 1.3 %
Net loss and LAE ratio 63.0 % 65.5 % 63.7 % 70.7 %
The net loss and LAE ratio for the three months ended June 30, 2012 decreased
2.5 percentage points to 63.0% from 65.5% for the three months ended June 30,
2011. The improvement in the loss ratio reflects $5.4 million of net prior year
reserve redundancies driven mostly by our Lloyd's Operations, partially offset
by several large losses from our Marine business.
The net loss and LAE ratio for the six months ended June 30, 2012 decreased 7.0
percentage points to 63.7% from 70.7% for the six months ended June 30, 2011.
The improvement in the loss ratio reflects improved loss experience due to the
lack of large energy losses in our NavTech business and $12.2 million of net
prior year reserve redundancies driven mostly by our Lloyd's Operations. The
improvements in the loss ratio were partially offset by several large losses
from our Marine business, including the grounding of the cruise ship off Costa
Concordia off the coast of Italy.
39
--------------------------------------------------------------------------------
Table of Contents
The segment and line of business breakdown of the net loss and LAE ratios for
the three and six months ended June 30, 2012 and 2011 are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
Net Loss and LAE Ratio 2012 2011 2012 2011
Insurance Companies:
Marine 85.2 % 64.0 % 82.0 % 66.5 %
Property Casualty 60.5 % 69.4 % 62.5 % 75.7 %
Professional Liability 83.8 % 68.1 % 77.0 % 69.4 %
Insurance Companies 70.6 % 67.3 % 70.0 % 71.2 %
Lloyd's Operations:
Marine 38.7 % 67.7 % 50.8 % 67.5 %
Property Casualty 46.5 % 37.5 % 39.5 % 54.6 %
Professional Liability 60.3 % 102.2 % 47.7 % 132.8 %
Lloyd's 43.0 % 62.1 % 47.4 % 69.8 %
Net loss and LAE ratio 63.0 % 65.5 % 63.7 % 70.7 %
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 period 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 three months ended June 30, 2012 and 2011
are as follows:
Three Months Ended June 30,
In thousands 2012 2011
Insurance Companies:
Marine $ (94 ) $ (171 )
Property Casualty (2,951 ) 231
Professional Liability 3,671 (197 )
Insurance Companies $ 626 $ (137 )
Lloyd's Operations:
Marine $ (4,026 ) $ (1,324 )
Property Casualty (1,272 ) 1,110
Professional Liability (700 ) 1,166
Lloyd's $ (5,998 ) $ 952
Total deficiencies (redundancies) $ (5,372 ) $ 815
The following is a discussion of relevant factors related to the $5.4 million
prior period net reserve redundancies recorded for the three months ended
June 30, 2012:
The Insurance Companies recorded $0.6 million of net prior period reserve
deficiency. The net reserve deficiency includes adverse development from our
Professional Liability business related to our lawyers and accountants products,
partially offset by favorable development from our Property Casualty business
related to our Primary Casualty and NavTech divisions.
Our Lloyd's Operations recorded $6.0 million of net prior period reserve
redundancies driven by the Marine and Property Casualty businesses.
40
--------------------------------------------------------------------------------
Table of Contents
The following is a discussion of relevant factors related to the $0.8 million
prior period net reserve deficiency recorded for the three months ended June 30,
2011:
For the three months ended June 30, 2011, the Insurance Companies recorded $0.1
million of prior period net reserve redundancies. Within our Property Casualty
business we experienced adverse development in our run-off liquor liability
business within our Primary Casualty division due to case reserve development,
partially offset by favorable development in our Excess Casualty division due to
loss emergence that was lower than anticipated.
For the three months ended June 30, 2011, the Lloyd's Operations recorded $0.9
million of prior period net reserve deficiencies resulting from adverse
development in our Professional Liability business driven by adverse claims
movements in the E&O division.
The Segment and line of business breakdowns of prior period net reserve
deficiencies (redundancies) for the six months ended June 30, 2012 and 2011 are
as follows:
Six Months Ended June 30,
In thousands 2012 2011
Insurance Companies:
Marine $ (588 ) $ 577
Property Casualty (6,280 ) 984
Professional Liability 4,778 (476 )
Insurance Companies $ (2,090 ) $ 1,085
Lloyd's Operations:
Marine $ (3,970 ) $ (2,213 )
Property Casualty (4,010 ) (31 )
Professional Liability (2,168 ) 5,407
Lloyd's $ (10,148 ) $ 3,163
Total deficiencies (redundancies) $ (12,238 ) $ 4,248
The following is a discussion of relevant factors related to the $12.2 million
prior period net reserve redundancies recorded for the six months ended June 30,
2012:
The Insurance Companies recorded $2.1 million of net prior period reserve
redundancies driven by net favorable development from our Property Casualty
business related to our Primary Casualty and NavTech divisions, partially offset
by adverse development from our Professional Liability business across multiple
products within our Management Liability and E&O divisions.
Our Lloyd's Operations recorded $10.1 million of net prior period reserve
redundancies across all businesses and divisions.
The following is a discussion of relevant factors related to the $4.2 million
prior period net reserve deficiency recorded for the six months ended June 30,
2011:
For the six months ended June 30, 2011, the Insurance Companies recorded $1.1
million of prior period net reserve deficiencies which was driven by adverse
development in the Marine and Property Casualty divisions. Within our Marine
division we experienced adverse development related to a series of reported
losses that exceeded our expectations within our inland marine business,
partially offset by favorable development on marine liability and craft business
due to favorable loss emergence relative to expectations. Within the Property
Casualty division we experienced adverse development on personal umbrella lines
and our liquor liability lines, both of which are in run-off.
For the six months ended June 30, 2011, the Lloyd's Operations recorded $3.1
million of prior period net reserve deficiencies resulting from adverse
development in Professional Liability driven by adverse claims movements for
prior underwriting years in the E&O division.
41
--------------------------------------------------------------------------------
Table of Contents
Commission Expenses
Commission expenses paid to brokers and agents are generally based on a
percentage of gross written premiums and are partially offset by ceding
commissions we may receive on ceded written premiums. Commissions are generally
deferred and recorded as deferred policy acquisition costs to the extent they
relate to unearned premium. The percentage of commission expenses to net earned
premiums ("commission expense ratio") for the three and six months ended
June 30, 2012 was 15.1% and 15.5%, respectively, compared to 16.1% and 16.6% for
the comparable periods during 2011. The decrease in the commission expense ratio
for the three and six months ended June 30, 2012 when compared to the same
periods in 2011 can be attributed to a change in the mix of business.
Other Operating Expenses
Other operating expenses increased 11.3% and 5.2% for the three and six months
ended June 30, 2012 compared to the same periods in 2011 primarily due to
increases in expected payout percentages of stock-based compensation driven by
projected growth in book value per share. As a percentage of net earned
premiums, operating expenses remained flat for the three months ended June 30,
2012 and 2011 and slightly decreased 1.9 percentage points to 19.8% for the six
months ended June 30, 2012 as compared to the same period in 2011.
Interest Expense
Interest expense relates to our Senior Notes due May 1, 2016. Interest on these
Senior Notes is due each May 1 and November 1 and the effective interest rate,
based on the proceeds net of discount and all issuance costs, is approximately
7.17%. Interest expense for the three and six months ended June 30, 2012 was
$2.0 million and $4.1 million, respectively, and remained flat with the same
periods in 2011.
Income Taxes
We recorded income tax expense of $6.2 million and $9.5 million for the three
and six months ended June 30, 2012, respectively, compared to $5.0 million and
$0.5 million for the comparable periods in 2011, resulting in effective tax
rates of 29.5% and 29.4%, respectively. The effective tax rate on net investment
income was 28.2% and 26.9% for the three and six months ended June 30, 2012,
respectively, compared to 28.7% and 28.6% for the same periods during 2011.
As of June 30, 2012, the net deferred Federal, foreign, state and local tax
liabilities were $3.1 million, compared to net deferred tax liabilities of $6.3
million as of December 31, 2011, with the change primarily due to fluctuations
in the value of our investment portfolio.
We had net state and local deferred tax assets amounting to potential future tax
benefits of $0.6 million and $0.2 million as of June 30, 2012 and December 31,
2011, respectively. Included in the deferred tax assets are state and local net
operating loss carry-forwards of $0.2 million as of both June 30, 2012 and
December 31, 2011. A valuation allowance was established for the full amount of
these potential future tax benefits due to uncertainty associated with their
realization. Our state and local tax carry-forwards as of June 30, 2012 expire
from 2024 to 2031.
Segment Information
We classify our business into two underwriting segments consisting of the
Insurance Companies and the Lloyd's Operations, which are separately managed,
and a Corporate segment. Segment data for each of the two underwriting segments
include allocations of the operating expenses of the wholly-owned underwriting
management companies and The Navigators Group, Inc.'s (the "Parent Company's")
operating expenses and related income tax amounts. The Corporate segment
consists of the Parent Company's investment income, interest expense and the
related tax effect.
We evaluate the performance of each segment based on its underwriting and GAAP
results. The underwriting results of the Insurance Companies and the Lloyd's
Operations are measured by taking into account net earned premium, net loss and
LAE, commission expenses, other operating expenses and other income (expense).
Each segment also maintains its own investments, on which it earns income and
realizes capital gains or losses. Our underwriting performance is evaluated
separately from the performance of our investment portfolios.
42
--------------------------------------------------------------------------------
Table of Contents
Following are the financial results of our two underwriting segments.
Insurance Companies
The Insurance Companies consist of Navigators Insurance Company, including its
U.K. Branch, and its wholly-owned subsidiary, Navigators Specialty. They are
primarily engaged in underwriting marine insurance and related lines of
business, specialty lines of business, including contractors general liability
insurance, commercial umbrella and primary and excess casualty businesses,
specialty reinsurance, and professional liability insurance. Navigators
Specialty underwrites specialty and professional liability insurance on an
excess and surplus lines basis. Navigators Specialty is 100% reinsured by
Navigators Insurance Company.
The following table sets forth the results of operations for the Insurance
Companies for the three and six months ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30, Percentage Change
In thousands 2012 2011 2012 2011 QTD YTDGross written premiums $ 214,064 $ 186,767 $ 462,402 $ 393,543 14.6 % 17.5 %
Net written premiums 134,065 123,204 315,315 253,944 8.8 % 24.2 %
Net earned premiums 141,577 114,987 273,125 213,807 23.1 % 27.7 %
Net losses and loss adjustment
expenses (100,003 ) (77,330 ) (191,180 ) (152,127 ) 29.3 % 25.7 %
Commission expenses (21,117 ) (16,402 ) (40,418 ) (28,742 ) 28.7 % 40.6 %
Other operating expenses (28,914 ) (26,516 ) (54,259 ) (53,315 ) 9.0 % 1.8 %
Other income (expense) 879 626 2,521 2,317 40.4 % 8.8 %
Underwriting profit (loss) $ (7,578 ) $ (4,635 ) $ (10,211 ) $ (18,060 ) 63.5 % -43.5 %
Net investment income 13,286 14,989 22,221 29,972 -11.4 % -25.9 %
Net realized gains (losses) 2,325 3,100 4,200 2,855 -25.0 % 47.1 %
Income (loss) before income taxes $ 8,033$ 13,454$ 16,210$ 14,767 -40.3 % 9.8 %
Income tax expense (benefit) 2,101 4,617 3,980 4,845 -54.5 % -17.9 %
Net income (loss) $ 5,932 $ 8,837 $ 12,230 $ 9,922 -32.9 % 23.3 %
Losses and loss adjustment
expenses ratio 70.6 % 67.3 % 70.0 % 71.2 %
Commission expense ratio 14.9 % 14.3 % 14.8 % 13.4 %
Other operating expense ratio (1) 19.9 % 22.4 % 18.9 % 23.8 %
Combined ratio 105.4 % 104.0 % 103.7 % 108.4 %
(1) - Includes Other operating expenses & Other income (expense)
NM - Percentage change not meaningful
Our Insurance Companies reported net income of $5.9 million for the three months
ended June 30, 2012 compared to $8.8 million for the same period in 2011. The
decrease in net income for the three months ended June 30, 2012 as compared to
the same period in 2011 was largely driven by unfavorable underwriting results
for the quarter and a decrease in net investment income due to lower investment
yields.
Our Insurance Companies combined ratio for the three months ended June 30, 2012
was 105.4% compared to 104.0% for the same period in 2011. Our Insurance
Companies pre-tax underwriting results decreased by $3.0 million to a $7.6
million pre-tax underwriting loss for the three months ended June 30, 2012
compared to an underwriting loss of $4.6 million for the same period in 2011.
43
--------------------------------------------------------------------------------
Table of Contents
Our Insurance Companies underwriting results for the current quarter includes
$3.9 million of reinsurance reinstatement premiums related to several large
losses from our Marine business. Our underwriting results for the same period in
2011 included a large loss from a Gulf of Mexico drilling operation resulting in
a loss of $4.7 million, inclusive of $2.8 million in reinsurance reinstatement
premiums.
Our Insurance Companies reported net income of $12.2 million for the six months
ended June 30, 2012 compared to $9.9 million for the same period in 2011. The
increase in net income for the six months ended June 30, 2012 as compared to the
same period in 2011 was largely attributable to stronger underwriting results,
partially offset by a reduction in net investment income driven by $4.5 million
of investment expenses related to the settlement of a dispute with Equitas over
foregone interest on amounts that were due on certain reinsurance contracts.
Our Insurance Companies combined ratio for the six months ended June 30, 2012
was 103.7% compared to 108.4% for the same period in 2011. Our Insurance
Companies pre-tax underwriting results increased by $7.9 million to a $10.2
million pre-tax underwriting loss for the six months ended June 30, 2012
compared to an underwriting loss of $18.1 million for the same period in 2011.
Our Insurance Companies underwriting results for the first six months of the
year reflect net losses of $9.6 million related to several large losses from our
marine business, including the grounding of the cruise ship Costa Concordia off
the coast of Italy.
Our underwriting results for the same period in 2011 included net losses of
$13.7 million consisting of $10.8 million of large losses from our energy
business, inclusive of $5.5 million of reinsurance reinstatement premiums, and
$2.9 million in accrued reinstatement premiums reflecting our shift to
excess-of-loss reinsurance protection in our Marine business.
Insurance Companies' Gross Written Premiums
Marine Premiums. The gross written premiums for our Marine business for the
three and six months ended June 30, 2012 and 2011 consisted of the following:
Three Months Ended Six Months Ended
June 30, June 30, Percentage Change
In thousands 2012 2011 2012 2011 QTD YTD
Marine liability $ 16,562 $ 20,039 $ 34,805 $ 43,456 -17.4 % -19.9 %
Inland marine 9,404 7,705 21,242 18,356 22.0 % 15.7 %
Craft/fishing vessel 6,000 5,781 14,244 12,361 3.8 % 15.2 %
Cargo 4,988 5,874 13,446 12,385 -15.1 % 8.6 %
P&I 3,838 3,500 10,454 12,363 9.7 % -15.4 %
Bluewater hull 4,701 5,634 8,260 10,192 -16.6 % -19.0 %
Transport 917 5,563 1,331 9,839 -83.5 % -86.5 %
Other 3,486 4,227 7,979 9,719 -17.5 % -17.9 %
Total Marine $ 49,896 $ 58,323 $ 111,761 $ 128,671 -14.4 % -13.1 %
The Insurance Companies Marine gross written premiums for the three and six
months ended June 30, 2012 decreased by 14.4% and 13.1%, respectively, compared
to the same periods during 2011 primarily due to the Transport and Marine
liability products previously written by our U.K. Branch, now are being written
through our Lloyd's Operations, effective this year. The aforementioned
decreases were slightly offset by growth in Inland marine as a result of new
business and an increase in renewal rates. Inland marine related renewal rates
increased 8.4% and 4.3% for the three and six months ended June 30, 2012.
44
--------------------------------------------------------------------------------
Table of Contents
Property Casualty Premiums. The gross written premiums for our Property Casualty
business for the three and six months ended June 30, 2012 and 2011 consisted of
the following:
Three Months Ended Six Months Ended
June 30, June 30, Percentage Change
In thousands 2012 2011 2012 2011 QTD YTD
Nav Re $ 20,375 $ 10,457 $ 93,796 $ 48,575 94.8 % 93.1 %
Excess casualty 51,425 35,633 89,079 61,893 44.3 % 43.9 %
Primary casualty:
Construction liability 17,002 21,205 30,966 41,203 -19.8 % -24.8 %
Other primary casualty 9,549 5,716 19,510 10,548 67.0 % 85.0 %
Environmental 6,310 6,782 11,520 10,626 -7.0 % 8.4 %
Total primary casualty 32,861 33,703 61,996 62,377 -2.5 % -0.6 %
Offshore energy 20,160 13,668 33,388 25,630 47.5 % 30.3 %
Other 5,806 6,670 8,287 14,544 -13.0 % -43.0 %
Total Property Casualty $ 130,627 $ 100,131 $ 286,546 $ 213,019 30.5 % 34.5 %
The Insurance Companies Property Casualty gross written premiums for the three
and six months ended June 30, 2012 increased by 30.5% and 34.5%, respectively,
compared to the same periods during 2011. The increases were primarily driven by
our Nav Re division as the division continues to achieve successful growth since
its establishment in late 2010. Additionally, we saw growth in our Excess
Casualty division resulting from strong production attributable to the expansion
of our underwriting team and dislocation among certain competitors as well as
strong production from our NavTech division. Contributing to the increase in our
NavTech division is a 2.3% and 3.3% increase in average renewal rates for the
three and six months ended June 30, 2012.
Professional Liability Premiums. The gross written premiums for our Professional
Liability business for the three and six months ended June 30, 2012 and 2011
consisted of the following:
Three Months Ended Six Months Ended
June 30, June 30, Percentage Change
In thousands 2012 2011 2012 2011 QTD YTD
E&O $ 22,229 $ 15,756 $ 44,162 $ 29,573 41.1 % 49.3 %
D&O (public and private) 11,312 12,512 19,934 21,425 -9.6 % -7.0 %
Other - 45 (1 ) 855 NM NM
Total Professional Liability $ 33,541 $ 28,313 $ 64,095 $ 51,853 18.5 % 23.6 %
NM - Percentage change not meaningful
The Insurance Companies Professional Liability gross written premiums for the
three and six months ended June 30, 2012 increased by 18.5% and 23.6%,
respectively, compared to the same periods during 2011. The increases are
related to our E&O division and they are driven by our real estate program which
was established in the third quarter of 2011 and wrote $5.8 million and $12.4
million in gross written premium for the three and six months ended June 30,
2012. Additionally, the increase in E&O is also attributed to an overall 7.0%
and 5.1% increase in average renewal rates for the three and six months ended
June 30, 2012.
45
--------------------------------------------------------------------------------
Table of Contents
Lloyd's Operations
The Lloyd's Operations primarily underwrite marine and related lines of business
along with professional liability insurance, and construction coverage for
onshore energy business at Lloyd's through Syndicate 1221. Our Lloyd's
Operations includes NUAL, a Lloyd's underwriting agency that manages Syndicate
1221.
The following table sets forth the results of operations of the Lloyd's
Operations for the three and six months ended June 30, 2012 and 2011:
Three Months Ended Six Months Ended
June 30, June 30, Percentage Change
In thousands 2012 2011 2012 2011 QTD YTD
Gross written premiums $ 108,923 $ 91,947 $ 203,734 $ 181,454 18.5 % 12.3 %
Net written premiums 56,187 60,159 117,982 122,495 -6.6 % -3.7 %
Net earned premiums 54,440 58,790 106,011 112,448 -7.4 % -5.7 %
Net losses and loss adjustment
expenses (23,404 ) (36,533 ) (50,212 ) (78,524 ) -35.9 % -36.1 %
Commission expenses (8,938 ) (12,042 ) (19,824 ) (26,449 ) -25.8 % -25.0 %
Other operating expenses (10,905 ) (9,261 ) (21,867 ) (19,037 ) 17.8 % 14.9 %
Other income (expense) 60 361 66 208 -83.3 % -68.2 %
Underwriting profit (loss) $ 11,253 $ 1,315 $ 14,174 $ (11,354 ) NM NM
Net investment income 2,454 2,320 4,737 4,575 5.8 % 3.5 %
Net realized gains (losses) 1,396 (798 ) 1,209 (2,183 ) NM NM
Income (loss) before income taxes $ 15,103$ 2,837$ 20,120 $ (8,962 )
NM NM
Income tax expense (benefit) 5,207 1,029 6,933 (3,027 ) NM NM
Net income (loss) $ 9,896 $ 1,808 $ 13,187 $ (5,935 ) NM NM
Losses and loss adjustment
expenses ratio 43.0 % 62.1 % 47.4 % 69.8 %
Commission expense ratio 16.4 % 20.5 % 18.7 % 23.5 %
Other operating expense ratio (1) 19.9 % 15.2 % 20.5 % 16.8 %
Combined ratio 79.3 % 97.8 % 86.6 % 110.1 %
(1) - Includes Other operating expenses & Other income (expense)
NM - Percentage change not meaningful
Our Lloyd's Operations reported net income of $9.9 million for the three months
ended June 30, 2012 compared to $1.8 million for the same period in 2011. The
increase in net income was largely attributable to stronger underwriting
results.
Our Lloyd's Operations combined ratio for the three months ended June 30, 2012
was 79.3% compared to 97.8% for the same period in 2011. Our Lloyd's Operations
pre-tax underwriting results increased by $10.0 million to an $11.3 million
pre-tax underwriting profit for the three months ended June 30, 2012 compared to
underwriting profit of $1.3 million for the same period in 2011. The increase in
pre-tax underwriting results is primarily related to net prior period reserve
redundancies from the Marine business.
Our Lloyd's Operations reported net income of $13.2 million for the six months
ended June 30, 2012 compared to a net loss of $5.9 million for the same period
in 2011. The increase in net income was largely attributable to stronger
underwriting results.
46
--------------------------------------------------------------------------------
Table of Contents
Our Lloyd's Operations combined ratio for the six months ended June 30, 2012 was
86.6% compared to 110.1% for the same period in 2011. Our Lloyd's Operations'
pre-tax underwriting results increased by $25.6 million to a $14.2 million
pre-tax underwriting profit for the six months ended June 30, 2012 compared to
underwriting loss of $11.4 million for the same period in 2011. The increase in
pre-tax underwriting results is primarily related to net prior period reserve
redundancies across all businesses.
Lloyd's Operations' Gross Written Premiums
We have controlled 100% of Syndicate 1221's stamp capacity since 2006. Stamp
capacity is a measure of the amount of premium a Lloyd's syndicate is authorized
to write based on a business plan approved by the Council of Lloyd's. Syndicate
1221's stamp capacity is £184 million ($289 million) in 2012 compared to
£175 million ($280 million) in 2011.
Marine Premiums. The gross written premiums for our Marine business for the
three and six months ended June 30, 2012 and 2011 consisted of the following:
Three Months Ended Six Months Ended
June 30, June 30, Percentage Change
In thousands 2012 2011 2012 2011 QTD YTD
Marine and energy liability $ 21,747 $ 14,057 $ 50,681 $ 39,920 54.7 % 27.0 %
Cargo and specie 17,005 16,074 36,979 36,083 5.8 % 2.5 %
Assumed reinsurance 4,066 4,339 11,139 12,114 -6.3 % -8.0 %
War 2,687 2,198 5,973 6,375 22.2 % -6.3 %
Hull 1,532 2,783 4,040 6,114 -44.9 % -33.9 %
Other (555 ) - - - NM NM
Total Marine $ 46,482 $ 39,451 $ 108,812 $ 100,606 17.8 % 8.2 %
NM - Percentage change not meaningful
The Lloyd's Operations Marine gross written premiums for the three and six
months ended June 30, 2012 increased by 17.8% and 8.2%, respectively, compared
to the same periods during 2011. The increase in Lloyd's Marine and energy
liability is primarily related to new business, part of which is due to the
transfer to Syndicate 1221 of the Marine and Transport businesses that was
previously written by the U.K. Branch, and an increase in average renewal rates.
Property Casualty Premiums. The gross written premiums for our Property Casualty
business for the three and six months ended June 30, 2012 and 2011 consisted of
the following:
Three Months Ended Six Months Ended
June 30, June 30, Percentage Change
In thousands 2012 2011 2012 2011 QTD YTD
Offshore energy $ 20,411 $ 17,300 $ 31,731 $ 27,585 18.0 % 15.0 %
Engineering and construction 12,402 9,290 20,598 13,746 33.5 % 49.8 %
Onshore energy 14,694 14,280 18,920 18,647 2.9 % 1.5 %
Other 2,026 1,252 2,025 1,446 61.8 % 40.0 %
Total Property Casualty $ 49,533 $ 42,122 $ 73,274 $ 61,424 17.6 % 19.3 %
The Lloyd's Operations Property Casualty gross written premiums for the three
and six months ended June 30, 2012 increased by 17.6% and 19.3%, respectively,
compared to the same periods in 2011. The increases are primarily due to growth
in Engineering and construction as a result of rate increases prompted by a
contraction in the market as well as a slight increase in Offshore energy
resulting from an average increase in renewal rates of 5.1% and 5.4% for the
three and six months ended June 30, 2012, respectively.
47
--------------------------------------------------------------------------------
Table of Contents
Professional Liability Premiums. The gross written premiums for our Professional
Liability business for the three and six months ended June 30, 2012 and 2011
consisted of the following:
Three Months Ended Six Months Ended
June 30, June 30, Percentage Change
In thousands 2012 2011 2012 2011 QTD YTD
D&O (public and private) $ 9,309 $ 7,944 $ 15,739 $ 14,253 17.2 % 10.4 %
E&O 3,599 2,430 5,909 5,171 48.1 % 14.3 %
Total Professional Liability $ 12,908 $ 10,374 $
21,648 $ 19,424 24.4 % 11.4 %
The Lloyd's Operations Professional Liability gross written premiums for the
three and six months ended June 30, 2012 increased by 24.4% and 11.4%,
respectively, compared to the same periods in 2011 primarily as a result of new
business in both lines.
Capital Resources
We monitor our capital adequacy to support our business on a regular basis. The
future capital requirements of our business will depend on many factors,
including our ability to write new business successfully and to establish
premium rates and reserves at levels sufficient to cover losses. Our ability to
underwrite is largely dependent upon the quality of our claims paying and
financial strength ratings as evaluated by independent rating agencies. In
particular, we require (1) sufficient capital to maintain our financial strength
ratings, as issued by various ratings agencies, at a level considered necessary
by management to enable our Insurance Companies to compete, (2) sufficient
capital to enable our Insurance Companies to meet the capital adequacy tests
performed by statutory agencies in the United States and the United Kingdom and
(3) letters of credit and other forms of collateral that are necessary to
support the business plan of our Lloyd's Operations.
Our capital resources consist of funds deployed or available to be deployed to
support our business operations. As of June 30, 2012 and December 31, 2011, our
capital resources were as follows:
June 30, December 31,
In thousands 2012 2011
Senior Notes $ 114,348 $ 114,276
Stockholders' equity 841,808 803,435
Total capitalization $ 956,156 $ 917,711
Ratio of debt to total capitalization 12.0 %
12.5 %
As part of our capital management program, we may seek to raise additional
capital or may seek to return capital to our stockholders through share
repurchases, cash dividends or other methods (or a combination of such methods).
Any such determination will be at the discretion of the Parent Company's Board
of Directors and will be dependent upon our profits, financial requirements and
other factors, including legal restrictions, rating agency requirements, credit
facility limitations and such other factors as our Board of Directors deems
relevant.
In June 2012, we filed a universal shelf registration statement with the SEC.
This registration statement, which expires in June 2015, allows for the future
possible offer and sale by the Company of up to $500 million in the aggregate of
various types of securities including common stock, preferred stock, debt
securities, depositary shares, warrants, units or stock purchase contracts and
stock purchase units. The shelf registration statement enables us to efficiently
access the public equity or debt markets in order to meet future capital needs,
if necessary. This report is not an offer to sell or the solicitation of an
offer to buy nor shall there be any sale of these securities in any state in
which such offer, solicitation or sale would be unlawful prior to registration
or qualification under the securities laws of such state.
48
--------------------------------------------------------------------------------
Table of Contents
We primarily rely upon dividends from our subsidiaries to meet our Parent
Company's obligations. Since the issuance of the senior debt in April 2006, the
Parent Company's cash obligations primarily consist of semi-annual interest
payments on the senior debt, which are currently $4.0 million. Going forward,
the interest payments and any share repurchases may be made from funds currently
at the Parent Company or dividends from its subsidiaries. The dividends have
historically been paid by Navigators Insurance Company. Based on the June 30,
2012 surplus of Navigators Insurance Company, the approximate maximum amount
available for the payment of dividends by Navigators Insurance Company during
the preceding 12 month period without prior regulatory approval is $60.9
million. During the preceding 12 month period Navigators Insurance Company
declared and paid $35.0 million of dividends to the Parent Company, $10.0
million of which were declared and paid in the first quarter of 2012.
Condensed Parent Company balance sheets as of June 30, 2012 (unaudited) and
December 31, 2011 are shown in the table below:
June 30, December 31,
In thousands 2012 2011
Cash and investments $ 13,402 $ 8,315
Investments in subsidiaries 923,850 895,047
Goodwill and other intangible assets 2,534
2,534
Other assets 18,049 13,806
Total assets $ 957,835 $ 919,702
Senior Notes $ 114,348 $ 114,276 Accounts payable and other liabilities 337
649
Accrued interest payable 1,342
1,342
Total liabilities $ 116,027 $ 116,267
Stockholders' equity $ 841,808 $ 803,435
Total liabilities and stockholders' equity $ 957,835 $ 919,702
On April 1, 2011, we entered into a $165 million credit facility agreement with
ING Bank N.V., London Branch, individually and as Administrative Agent, and a
syndicate of lenders. The credit facility, which is denominated in U.S. dollars,
is utilized to fund our participation in Syndicate 1221 through letters of
credit for the 2012 and 2011 underwriting years, as well as open prior years.
The letters of credit issued under the facility are denominated in British
pounds and their aggregate face amount will fluctuate based on exchange
rates. If any letters of credit remain outstanding under the facility after
December 31, 2012, we would be required to post additional collateral to secure
the remaining letters of credit. As of June 30, 2012, letters of credit with an
aggregate face amount of $154.5 million were outstanding under the credit
facility.
This credit facility contains customary covenants for facilities of this type,
including restrictions on indebtedness and liens, limitations on mergers,
dividends and the sale of assets, and requirements as to maintaining certain
consolidated tangible net worth, statutory surplus and other financial ratios.
The credit facility also provides for customary events of default, including
failure to pay principal, interest or fees when due, failure to comply with
covenants, any representation or warranty made by the Company being false in any
material respect, default under certain other indebtedness, certain insolvency
or receivership events affecting the Company and its subsidiaries, the
occurrence of certain material judgments, or a change in control of the Company.
The letter of credit facility is secured by a pledge of the stock of certain
insurance subsidiaries of the Company. To the extent the aggregate face amount
issued under the credit facility exceeds the commitment amount, we are required
to post collateral with the lead bank of the consortium. We were in compliance
with all covenants under the credit facility as of June 30, 2012.
The applicable margin and applicable fee rate payable under the credit facility
are based on a tiered schedule that is based on the Company's then-current
ratings issued by Standard & Poor's ("S&P") and Moody's Investor Services
("Moody's") with respect to the Company's Senior Notes without third-party
credit enhancement, and the amount of the Company's own collateral utilized to
fund its participation in Syndicate 1221.
49
--------------------------------------------------------------------------------
Table of Contents
Time lags do occur in the normal course of business between the time gross loss
reserves are paid by the Company and the time such gross paid losses are billed
and collected from reinsurers. Reinsurance recoverable amounts related to gross
loss reserves as of June 30, 2012 are anticipated to be billed and collected
over the next several years as the gross loss reserves are paid by the Company.
Generally, for pro rata or quota share reinsurers, we issue quarterly settlement
statements for premiums less commissions and paid loss activity, which are
expected to be settled within 45 days. We have the ability to issue "cash calls"
requiring such reinsurers to pay losses whenever paid loss activity for a claim
ceded to a particular reinsurance treaty exceeds a predetermined amount
(generally $0.5 million to $1.0 million) as set forth in the pro rata treaty.
For the Insurance Companies, cash calls must generally be paid within 30
calendar days. There is generally no specific settlement period for the Lloyd's
Operations cash call provisions, but such billings have historically on average
been paid within 45 calendar days.
Generally, for excess-of-loss reinsurers we pay quarterly deposit premiums based
on the estimated subject premiums over the contract period (usually one year)
that are subsequently adjusted based on actual premiums determined after the
expiration of the applicable reinsurance treaty. Paid losses subject to
excess-of-loss recoveries are generally billed as they occur and are usually
settled by reinsurers within 30 calendar days for the Insurance Companies and 30
business days for the Lloyd's Operations.
We sometimes withhold funds from reinsurers and may apply ceded loss billings
against such funds in accordance with the applicable reinsurance agreements.
Liquidity
Consolidated Cash Flows
Net cash provided by operating activities was $15.0 million for the six months
ended June 30, 2012 compared to $14.4 million for the same period in 2011. The
increase in cash flow from operations was due to improved collections on premium
receivables and reinsurance recoverables, offset by an increase in paid losses
and current income taxes paid.
Net cash used in investing activities was $97.0 million for the six months ended
June 30, 2012 compared to net cash provided by investing activities of $34.5
million for the same period in 2011. The increase in cash used by investing
activities is primarily due to the ongoing management of our investment
portfolio.
Net cash provided by financing activities was $0.4 million for the six months
ended June 30, 2012 compared to net cash used in financing activities of $40.3
million for the comparable period in 2011. The reduction in cash used by
financing activities relates to our share repurchase program, which expired at
the end of 2011.
We believe that the cash flow generated by the operating activities of our
subsidiaries will provide sufficient funds for us to meet our liquidity needs
over the next twelve months. Beyond the next twelve months, cash flow available
to us may be influenced by a variety of factors, including general economic
conditions and conditions in the insurance and reinsurance markets, as well as
fluctuations from year to year in claims experience.
We believe that we have adequately managed our cash flow requirements related to
reinsurance recoveries from its positive cash flows and the use of available
short-term funds when applicable. However, there can be no assurances that we
will be able to continue to adequately manage such recoveries in the future or
that collection disputes or reinsurer insolvencies will not arise that could
materially increase the collection time lags or result in recoverable write-offs
causing additional incurred losses and liquidity constraints to the Company. The
payment of gross claims and related collections from reinsurers with respect to
large losses could significantly impact our liquidity needs. However, we expect
to collect our paid reinsurance recoverables generally under the terms described
above.
50
--------------------------------------------------------------------------------
Table of Contents
Investments
As of June 30, 2012, the weighted average rating of our fixed maturity
investments was "AA" by S&P and "Aa" by Moody's. The entire fixed maturity
investment portfolio, except for investments with a fair value of $18.1 million,
consists of investment grade bonds. As of June 30, 2012, our portfolio had a
duration of 3.9 years. Management periodically projects cash flow of the
investment portfolio and other sources in order to maintain the appropriate
levels of liquidity in an effort to ensure our ability to satisfy claims. As of
June 30, 2012 and December 31, 2011, all fixed maturity securities and equity
securities held by us were classified as available-for-sale.
The following tables set forth our cash and investments as of June 30, 2012 and
December 31, 2011. The tables below includes OTTI securities recognized within
other comprehensive income.
June 30, 2012
Gross Gross OTTI
Unrealized Unrealized Amortized Recognized
In thousands Fair Value Gains Losses Cost in OCI
Fixed maturities:
U.S. Treasury bonds, agency
bonds, and foreign government
bonds $ 454,523 $ 10,330 $ (160 ) $ 444,353 $ -
States, municipalities and
political subdivisions 426,218 29,960 (115 ) 396,373 -
Mortgage-backed and asset-backed
securities:
Agency mortgage-backed
securities 398,310 17,393 (44 ) 380,961 -
Residential mortgage obligations 37,805 44 (1,651 ) 39,412 (887 )
Asset-backed securities 54,416 933 (33 ) 53,516 -
Commercial mortgage-backed
securities 209,273 14,456 (55 ) 194,872 -
Subtotal $ 699,804 $ 32,826 $ (1,783 ) $ 668,761 $ (887 )
Corporate bonds 443,884 18,519 (779 ) 426,144 -
Total fixed maturities $ 2,024,429 $ 91,635 $ (2,837 ) $ 1,935,631 $ (887 )
Equity securities-common stocks 103,649 29,709 (517 ) 74,457 -
Short-term investments 161,983 - - 161,983 -
Cash 45,842 - - 45,842 -
Total $ 2,335,903 $ 121,344 $ (3,354 ) $ 2,217,913 $ (887 )
December 31, 2011
Gross Gross OTTI
Unrealized Unrealized Amortized Recognized
In thousands Fair Value Gains Losses Cost in OCI
Fixed maturities:
U.S. Treasury bonds, agency bonds,
and foreign government bonds $ 336,070 $ 8,979 $ (383 ) $ 327,474 $ -
States, municipalities and political
subdivisions 410,836 28,887 (108 ) 382,057 -
Mortgage-backed and asset-backed
securities:
Agency mortgage-backed securities 395,860 17,321 (3 ) 378,542 -
Residential mortgage obligations 23,148 8 (2,848 ) 25,988 (1,682 )
Asset-backed securities 48,934 695 (75 ) 48,314 -
Commercial mortgage-backed
securities 216,034 10,508 (593 ) 206,119 -
Subtotal $ 683,976 $ 28,532 $ (3,519 ) $ 658,963 $ (1,682 )
Corporate bonds 457,187 15,743 (6,772 ) 448,216 -
Total fixed maturities $ 1,888,069 $ 82,141 $ (10,782 ) $ 1,816,710 $ (1,682 )
Equity securities-common stocks 95,849 23,240 (958 ) 73,567 -
Short-term investments 122,220 - - 122,220 -
Cash 127,360 - - 127,360
Total $ 2,233,498 $ 105,381 $ (11,740 ) $ 2,139,857 $ (1,682 )
51
--------------------------------------------------------------------------------
Table of Contents
The fair value of our investment portfolio may fluctuate significantly in
response to various factors such as changes in interest rates, investment
quality ratings, equity prices, foreign exchange rates and credit spreads. We do
not have the intent to sell nor is it more likely than not that we will have to
sell debt securities in unrealized loss positions that are not
other-than-temporarily impaired before recovery. We may realize investment
losses to the extent our liquidity needs require the disposition of fixed
maturity securities in unfavorable interest rate, liquidity or credit spread
environments. Significant changes in the factors we consider when evaluating
investment for impairment losses could result in a significant change in
impairment losses reported in the consolidated financial statements.
Invested assets increased in 2012 since the prior comparable period for 2011
primarily due to unrealized gains and cash flow from operations. The annualized
pre-tax investment yield, excluding net realized gains and losses and net OTTI
losses recognized in earnings, was 2.8% and 2.4% for the three and six months
ended June 30, 2012, respectively, compared to 3.3% for both the three and six
months ended June 30, 2011. The 2.4% annualized pre-tax yield for the six months
ended June 30, 2012 includes investment expenses of $4.5 million for 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. Excluding the impact of the aforementioned
interest expense, the annualized pre-tax yield for the six month ended June 30,
2012 would have been 2.8%, reflective of the general decline in market yields.
The tax equivalent yields for the three and six months ended June 30, 2012 on a
consolidated basis were 3.0% and 2.6%, respectively, compared to 3.5% and 3.5%
for the same periods during 2011. The portfolio duration was 3.9 years for the
six months ended June 30, 2012 and 3.6 years for the same period during 2011,
respectively. Since the beginning of 2012, the tax-exempt portion of our
investment portfolio has increased by $13.9 million to approximately 19% of the
fixed maturities investment portfolio at June 30, 2012 compared to approximately
19.7% at December 31, 2011.
We are a specialty insurance company and periods of moderate economic recession
or inflation tend not to have a significant direct effect on our underwriting
operations. They do, however, impact our investment portfolio. A decrease in
interest rates will tend to decrease our yield and have a positive effect on the
fair value of our invested assets. An increase in interest rates will tend to
increase our yield and have a negative effect on the fair value of our invested
assets.
The contractual maturity dates for fixed maturity securities categorized by the
number of years until maturity as of June 30, 2012 are shown in the following
table:
June 30, 2012
Amortized
In thousands Fair Value Cost
Due in one year or less $ 56,876 $ 56,483
Due after one year through five years 658,027 641,379
Due after five years through ten years 379,158 353,733
Due after ten years 230,564 215,275
Mortgage- and asset-backed securities 699,804 668,761
Total $ 2,024,429 $ 1,935,631
Expected maturities may differ from contractual maturities because issuers may
have the right to call or prepay obligations with or without call or prepayment
penalties. Due to the periodic repayment of principal, the aggregate amount of
mortgage-backed and asset-backed securities is estimated to have an effective
maturity of approximately 3.6 years.
52
--------------------------------------------------------------------------------
Table of Contents
The following table sets forth the amount and percentage of our fixed maturities
as of June 30, 2012 by S&P credit rating or, if an S&P rating is not available,
the equivalent Moody's rating. The table includes fixed maturities at fair
value, and the total rating is the weighted average quality rating.
Percent of
In thousands Rating Fair Value Total
Rating description:
Extremely strong AAA $ 341,094 17 %
Very strong AA 1,150,879 56 %
Strong A 381,490 19 %
Adequate BBB 132,820 7 %
Speculative BB & Below 14,282 1 %
Not rated NR 3,864 0 %
Total $ 2,024,429 100 %
The following table sets forth our U.S. Treasury bonds, agency bonds and foreign
government bonds as of June 30, 2012 and December 31, 2011:
June 30, 2012
Gross Gross
Unrealized Unrealized Amortized
In thousands Fair Value Gains Losses Cost
U.S. Treasury bonds $ 174,130 $ 6,101 $ (59 ) $ 168,088
Agency bonds 206,903 3,395 (3 ) 203,511
Foreign government bonds 73,490 834 (98 ) 72,754
Total $ 454,523 $ 10,330 $ (160 ) $ 444,353
December 31, 2011
Gross Gross
Unrealized Unrealized Amortized
In thousands Fair Value Gains Losses Cost
U.S. Treasury bonds $ 137,228 $ 5,422 $ - $ 131,806
Agency bonds 136,506 2,870 (133 ) 133,769
Foreign government bonds 62,336 687 (250 ) 61,899
Total $ 336,070 $ 8,979 $ (383 ) $ 327,474
The following table sets forth the composition of the investments categorized as
states, municipalities and political subdivisions in our portfolio by generally
equivalent S&P and Moody's ratings (not all securities in our portfolio are
rated by both S&P and Moody's) as of June 30, 2012. The securities that are not
rated in the table below are primarily state bonds.
In thousands Equivalent Net
Equivalent Moody's Unrealized
S&P Rating Rating Fair Value Book Value Gain (Loss)
AAA/AA/A Aaa/Aa/A $ 403,621 $ 374,592 $ 29,029
BBB Baa 18,733 18,067 666
BB Ba - - -
B B - - -
CCC or lower Caa or lower - - -
NR NR 3,864 3,714 150
Total $ 426,218 $ 396,373 $ 29,845
53
--------------------------------------------------------------------------------
Table of Contents
The following table sets forth the municipal bond holdings by sectors as of
June 30, 2012 and December 31, 2011:
June 30, 2012 December 31, 2011
Percent of Percent of
In thousands Fair Value Total Fair Value Total
Municipal Sector:
General obligation $ 74,991 18 % $ 43,195 10 %
Prerefunded 19,925 5 % 18,636 5 %
Revenue 290,448 68 % 309,659 75 %
Taxable 40,854 9 % 39,346 10 %
Total $ 426,218 100 % $ 410,836 100 %
We own $121.9 million of municipal securities which are credit enhanced by
various financial guarantors. As of June 30, 2012, the average underlying credit
rating for these securities is A+. There has been no material adverse impact to
our investment portfolio or results of operations as a result of downgrades of
the credit ratings for several of the financial guarantors.
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"), the Federal Home Loan Mortgage
Corporation ("FHLMC") and the Government National Mortgage Association ("GNMA")
which are Federal government sponsored entities, and the non-FNMA and non-FHLMC
securities broken out by prime, Alternative A-paper ("Alt-A") and subprime
collateral. The securities issued by FNMA and FHLMC are the obligations of each
respective entity. Legislation has provided for guarantees by the U.S.
Government of up to $100 billion each for FNMA and FHLMC.
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.
The following table sets forth our agency mortgage-backed securities and
residential mortgage securities ("RMBS") by those issued by the Government
National Mortgage Association ("GNMA"), FNMA, and FHLMC, and the quality
category (prime, Alt-A and subprime) for all other such investments as of
June 30, 2012:
June 30, 2012
Gross Gross
Unrealized Unrealized Amortized
In thousands Fair Value Gains Losses Cost
Agency mortgage-backed securities:
GNMA $ 112,901 $ 6,673 $ (44 ) $ 106,272
FNMA 214,172 8,589 - 205,583
FHLMC 71,237 2,131 - 69,106
Total agency mortgage-backed
securities $ 398,310 $ 17,393 $ (44 ) $ 380,961
Residential mortgage-backed
securities:
Prime $ 12,537 $ 23 $ (1,251 ) $ 13,765
Alt-A 1,975 - (340 ) 2,315
Subprime - - - -
Non-U.S. RMBS 23,293 21 (60 ) 23,332
Total residential mortgage-backed
securities $ 37,805 $ 44 $ (1,651 ) $ 39,412
54
--------------------------------------------------------------------------------
Table of Contents
The following table sets forth the composition of the investments categorized as
residential mortgage obligations in our portfolio by generally equivalent S&P
and Moody's ratings (not all securities in our portfolio are rated by both S&P
and Moody's) as of June 30, 2012:
June 30, 2012
In thousands Equivalent Net
Equivalent Moody's Unrealized
S&P Rating Rating Fair Value Book Value Gain (Loss)
AAA/AA/A Aaa/Aa/A $ 24,866 $ 25,005 $ (139 )
BBB Baa 1,285 1,392 (107 )
BB Ba 2,042 2,197 (155 )
B B 2,004 2,241 (237 )
CCC or lower Caa or lower 7,608 8,577 (969 )
NR NR - - -
Total $ 37,805 $ 39,412 $ (1,607 )
Details of the collateral of our asset-backed securities portfolio as of
June 30, 2012 are presented below:
Unrealized
Amortized Gain
In thousands AAA AA A BBB BB CCC Fair Value Cost (Loss)
Auto loans $ - $ 9,565 $ - $ - $ - $ - $ 9,565 $ 9,373 $ 192
Credit cards 14,003 - - - - - 14,003 13,548 455
Time share - - 18,284 - - - 18,284 18,080 204
Student loans 6,569 4,333 - - - - 10,902 10,884 18
Miscellaneous 936 724 - - - 2 1,662 1,631 31
Total $ 21,508 $ 14,622 $ 18,284 $ - $ - $ 2 $ 54,416 $ 53,516 $ 900
The following table sets forth the composition of the investments categorized as
commercial mortgage-backed securities in our portfolio by generally equivalent
S&P and Moody's ratings (not all securities in our portfolio are rated by both
S&P and Moody's) as of June 30, 2012:
June 30, 2012
In thousands Equivalent Net
Equivalent Moody's Unrealized
S&P Rating Rating Fair Value Book Value Gain (Loss)
AAA/AA/A Aaa/Aa/A $ 209,273 $ 194,872 $ 14,401
BBB Baa - - -
BB Ba - - -
B B - - -
CCC or lower Caa or lower - - -
NR NR - - -
Total $ 209,273 $ 194,872 $ 14,401
55
--------------------------------------------------------------------------------
Table of Contents
The following table sets forth the composition of the investments categorized as
corporate bonds in our portfolio by generally equivalent S&P and Moody's ratings
(not all securities in our portfolio are rated by both S&P and Moody's) as of
June 30, 2012:
June 30, 2012
In thousands Equivalent Net
Equivalent Moody's Unrealized
S&P Rating Rating Fair Value Book Value Gain (Loss)
AAA/AA/A Aaa/Aa/A $ 328,456 $ 313,466 $ 14,990
BBB Baa 112,801 110,128 2,673
BB Ba 2,627 2,550 77
B B - - -
CCC or lower Caa or lower - - -
NR NR - - -
Total $ 443,884 $ 426,144 $ 17,740
The company holds non-sovereign European securities of $76.0 million at fair
value and $74.5 million at amortized cost, primarily in the investment
portfolio. This represents 3.6% of our total fixed income and equity portfolio.
Our largest exposure is in France with a total of $36.6 million followed by the
Netherlands with a total of $30.3 million. We have no exposure to Greece,
Portugal, Italy or Spain.
56
--------------------------------------------------------------------------------
Table of Contents
The following table summarizes all securities in a gross unrealized loss
position as of June 30, 2012 and December 31, 2011, showing the aggregate fair
value and gross unrealized loss by the length of time those securities had
continuously been in a gross unrealized loss position as well as the number of
securities:
June 30, 2012 December 31, 2011
Gross Gross
Number of Unrealized Number of Unrealized
In thousands, except # of securities Securities Fair Value Loss Securities Fair Value Loss
Fixed maturities:
U.S. Government Treasury bonds, agency bonds,
and foreign government bonds
0-6 months 13 $ 55,371 $ 71 7 $ 58,587 $ 98
7-12 months - - - - - -
> 12 months 1 4,580 89 2 6,883 285
Subtotal 14 $ 59,951 $ 160 9 $ 65,470 $ 383
States, municipalities and political
subdivisions
0-6 months 5 $ 3,805 $ 48 7 $ 5,894 $ 72
7-12 months 5 3,369 46 1 216 1
> 12 months 2 1,580 21 5 2,420 35
Subtotal 12 $ 8,754 $ 115 13 $ 8,530 $ 108
Agency mortgage-backed securities
0-6 months 2 $ 1,683 $ 44 3 $ 5,087 $ 3
7-12 months - - - - - -
> 12 months - - - - - -
Subtotal 2 $ 1,683 $ 44 3 $ 5,087 $ 3
Residential mortgage obligations
0-6 months 1 $ 18,163 $ 56 6 $ 6,672 $ 184
7-12 months 7 2,673 88 7 5,250 313
> 12 months 48 12,151 1,507 47 10,749 2,351
Subtotal 56 $ 32,987 $ 1,651 60 $ 22,671 $ 2,848
Asset-backed securities
0-6 months 2 $ 7,045 $ 4 2 $ 4,933 $ 12
7-12 months 1 369 1 5 6,645 63
> 12 months 5 4,610 28 1 2 -
Subtotal 8 $ 12,024 $ 33 8 $ 11,580 $ 75
Commercial mortgage-backed securities
0-6 months 3 $ 520 $ 1 6 $ 5,465 $ 29
7-12 months 4 3,754 43 3 6,840 550
> 12 months 4 1,035 11 3 1,503 14
Subtotal 11 $ 5,309 $ 55 12 $ 13,808 $ 593
Corporate bonds
0-6 months 3 $ 18,246 $ 47 52 $ 135,516 $ 4,539
7-12 months 16 35,128 443 18 27,561 1,457
> 12 months 10 13,406 289 8 14,898 776
Subtotal 29 $ 66,780 $ 779 78 $ 177,975 $ 6,772
Total fixed maturities 132 $ 187,488 $ 2,837 183 $ 305,121 $ 10,782
Equity securities - common stocks
0-6 months 1 $ 1,579 $ 469 4 $ 3,320 $ 587
7-12 months 1 1,540 48 1 1,629 371
> 12 months - - - - - -
Total equity securities 2 $ 3,119 $ 517 5 $ 4,949 $ 958
57
--------------------------------------------------------------------------------
Table of Contents
We analyze the unrealized losses quarterly to determine if any are
other-than-temporary. The above unrealized losses have been determined to be
temporary based on our policies.
In the above table the gross unrealized loss for the greater than 12 months
category consists primarily of residential mortgage-backed securities.
Residential mortgage-backed securities are a type of fixed income security in
which residential mortgage loans are sold into a trust or special purpose
vehicle, thereby securitizing the cash flows of the mortgage loans.
To determine whether the unrealized loss on structured securities is
other-than-temporary, we analyze the projections provided by our investment
managers with respect to an expected principal loss under a range of scenarios
and utilize the most likely outcomes. The analysis relies on actual collateral
performance measures such as default rate, prepayment rate and loss severity.
These assumptions are applied throughout the remaining term of the deal,
incorporating the transaction structure and priority of payments, to generate
loss adjusted cash flows. Results of the analysis will indicate whether the
security is expected ultimately to incur a loss or whether there is a material
impact on yield due to either a projected loss or a change in cash flow timing.
A break even default rate is also calculated. A comparison of the break even
default rate to the actual default rate provides an indication of the level of
cushion or coverage to the first dollar principal loss. The analysis applies the
stated assumptions throughout the remaining term of the transaction to forecast
cash flows, which are then applied through the transaction structure to
determine whether there is a loss to the security. For securities in which a
tranche loss is present, and the net present value of loss adjusted cash flows
is less than book value, an impairment is recognized. The output data also
includes a number of additional metrics such as average life remaining, original
and current credit support, over 60 day delinquency and security rating.
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 accounting method.
As of June 30, 2012 and December 31, 2011, the largest single unrealized loss by
a non-government backed issuer in the investment portfolio was $0.4 million and
$1.4 million, respectively.
The following table sets forth the composition of the investments categorized as
fixed maturity securities in our portfolio with gross unrealized losses by
generally equivalent S&P and Moody's ratings (not all of the securities are
rated by S&P and Moody's ) as of June 30, 2012:
Gross Unrealized Loss Fair Value
In thousands Equivalent
NAIC Equivalent Moody's Percent of Percent of
Rating S&P Rating Rating Amount Total Amount Total
1 AAA/AA/A Aaa/Aa/A $ 1,423 50 % $ 169,340 90 %
2 BBB Baa 98 3 % 7,186 4 %
3 BB Ba 172 6 % 1,597 1 %
4 B B 175 6 % 1,757 1 %
5 CCC or lower Caa or lower 140 5 % 1,402 1 %
6 NR NR 829 30 % 6,206 3 %
Total $ 2,837 100 % $ 187,488 100 %
As of June 30, 2012, the gross unrealized losses in the table above were related
to fixed maturity securities that are rated investment grade, which is defined
as a security having an S&P rating of "BBB-" or higher, or a Moody's rating of
"Baa3" or higher, except for $1.3 million which is rated below investment grade
or not rated. Unrealized losses on investment grade securities principally
relate to changes in interest rates or changes in sector-related credit spreads
since the securities were acquired.
58--------------------------------------------------------------------------------
Table of Contents
The contractual maturity for fixed maturity securities categorized by the number
of years until maturity, with a gross unrealized loss as of June 30, 2012 is
presented in the following table:
June 30, 2012
Gross Unrealized Losses Fair Value
Percent of Percent of
In thousands Amount Total Amount Total
Due in one year or less $ 108 4 % $ 11,872 6 %
Due after one year through five years 530 19 % 77,548 41 %
Due after five years through ten years 305 11 % 33,587 18 %
Due after ten years 111 4 % 12,478 7 %
Mortgage- and asset-backed securities 1,783 62 % 52,003 28 %
Total $ 2,837 100 % $ 187,488 100 %
The following table summarizes the gross unrealized investment losses by the
length of time that the fair value continues to be less than 80% of amortized
cost as of June 30, 2012:
June 30, 2012
Fixed Equity
In thousands Maturities Securities Total
Less than three months $ - $ - $ -
Longer than three months and less than six months - 468 468
Longer than six months and less than twelve months - - -
Longer than twelve months 230 - 230
Total $ 230 $ 468 $ 698
The table below summarizes our activity related to OTTI losses for the periods
indicated:
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
Number of Number of Number of Number of
In thousands, except # of securities Securities Amount Securities Amount Securities Amount Securities Amount
Total OTTI losses:
Corporate and other bonds - $ - - $ - - $ - - $ -
Commercial mortgage-backed securities - - - - - - - -
Residential mortgage-backed securities - - 6 516 1 54 7 549
Asset-backed securities - - - - - - - -
Equities 2 496 1 317 3 639 1 547
Total 2 $ 496 7 $ 833 4 $ 693 8 $ 1,096
Less: Portion of loss in accumulated other
comprehensive income (loss):
Corporate and other bonds $ - $ - $ - $ -
Commercial mortgage-backed securities - - - -
Residential mortgage-backed securities - 301 43 322
Asset-backed securities - - - -
Equities - - - -
Total $ - $ 301 $ 43 $ 322
Impairment losses recognized in earnings
Corporate and other bonds $ - $ - $ - $ -
Commercial mortgage-backed securities - - - -
Residential mortgage-backed securities - 215 11 227
Asset-backed securities - - - -
Equities 496 317 639 547
Total $ 496 $ 532 $ 650 $ 774
59
--------------------------------------------------------------------------------
Table of Contents
During the three months ended June 30, 2012, we recognized OTTI losses of $0.5
million related to two equity securities. During the six months ended June 30,
2012, we recognized OTTI losses of $0.7 million related to one non-agency
mortgage-backed security and three equity securities. During the comparable
periods in 2011, we recognized OTTI losses of $0.5 million and $0.8 million
related to residential mortgage backed securities and equity securities. The
significant inputs used to measure the amount of credit loss recognized in
earnings 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.
