NAVIGATORS GROUP INC – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Edgar Online, Inc.

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

Overview

  We are an international insurance company focusing on specialty products within the overall property and casualty insurance market. Our largest product line and most long-standing area of specialization is ocean marine insurance. We have also developed specialty niches in professional liability insurance and in specialty liability insurance primarily consisting of contractors' liability and commercial primary and excess casualty coverages.  

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

  We conduct operations through our Insurance Companies and our Lloyd's Operations segments. The Insurance Companies segment consists of Navigators Insurance Company, which includes a United Kingdom Branch (the "U.K. Branch"), and Navigators Specialty Insurance Company, which underwrites specialty and professional liability insurance on an excess and surplus lines basis. All of the insurance business written by Navigators Specialty Insurance Company is fully reinsured by Navigators Insurance Company pursuant to a 100% quota share reinsurance agreement. Our Lloyd's Operations segment includes Navigators Underwriting Agency Ltd. ("NUAL"), a Lloyd's of London ("Lloyd's") underwriting agency which manages Lloyd's Syndicate 1221 ("Syndicate 1221"). Our Lloyd's Operations primarily underwrite marine and related lines of business along with offshore energy, professional liability insurance and construction coverages for onshore energy business at Lloyd's through Syndicate 1221. We controlled 100% of Syndicate 1221's stamp capacity for the 2011, 2010 and 2009 underwriting years through our wholly-owned subsidiary, Navigators Corporate Underwriters Ltd. which is referred to as a corporate name in the Lloyd's market. 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.  While management takes into consideration a wide range of factors in planning our business strategy and evaluating results of operations, there are certain factors that management believes are fundamental to understanding how we are managed. First, underwriting profit is consistently emphasized as a primary goal, above premium growth. Management's assessment of our trends and potential growth in underwriting profit is the dominant factor in its decisions with respect to whether or not to expand a business line, enter into a new niche, product or territory or, conversely, to contract capacity in any business line. In addition, management focuses on controlling the costs of our operations. Management believes that careful monitoring of the costs of existing operations and assessment of costs of potential growth opportunities are important to our profitability. Access to capital also has a significant impact on management's outlook for our operations. The Insurance Companies' operations and ability to grow their business and take advantage of market opportunities are constrained by regulatory capital requirements and rating agency assessments of capital adequacy. Similarly, the ability to grow our operations at Lloyd's is subject to capital and operating requirements of Lloyd's and the U.K. regulatory authorities.                                           37 

--------------------------------------------------------------------------------

Table of Contents

  Management's decisions are also greatly influenced by access to specialized underwriting and claims expertise in our lines of business. We have chosen to operate in specialty niches with certain common characteristics which we believe provide us with the opportunity to use our technical underwriting expertise in order to realize underwriting profit. As a result, we have focused on underserved markets for businesses characterized by higher severity and lower frequency of loss where we believe our intellectual capital and financial strength bring meaningful value. In contrast, we have avoided niches that we believe have a high frequency of loss activity and/or are subject to a high level of regulatory requirements, such as workers compensation and personal automobile insurance, because we do not believe our technical underwriting expertise is of as much value in these types of businesses. Examples of niches that have the characteristics we look for include bluewater hull which provides coverage for physical damage to, for example, highly valued cruise ships, and Directors and Officers ("D&O") insurance which covers litigation exposure of a corporation's directors and officers. These types of exposures require substantial technical expertise. We attempt to mitigate the financial impact of severe claims on our results by conservative and detailed underwriting, prudent use of reinsurance and a balanced portfolio of risks.  

For additional information regarding our business, refer to "Business-Overview", included herein.

  Ratings  Our ability to underwrite business is dependent upon the financial strength of the Insurance Companies and Lloyd's. Financial strength ratings represent the opinions of the rating agencies on the financial strength of a company and its capacity to meet the obligations of insurance policies. Independent ratings are one of the important factors that establish our competitive position in the insurance markets. The rating agencies consider many factors in determining the financial strength rating of an insurance company, including the relative level of statutory surplus necessary to support the business operations of the company. These ratings are based upon factors relevant to policyholders, agents and intermediaries and are not directed toward the protection of investors. Such ratings are not recommendations to buy, sell or hold securities. We could be adversely impacted by a downgrade in the Insurance Companies' or Lloyd's financial strength ratings, including a possible reduction in demand for our products, higher borrowing costs and our ability to access the capital markets.  For the Insurance Companies, Navigators Insurance Company and Navigators Specialty Insurance Company utilize the financial strength ratings from A.M. Best Company ("A.M. Best") and Standard and Poor's Rating Services ("S&P") for underwriting purposes. Navigators Insurance Company and Navigators Specialty Insurance Company are both rated "A" (Excellent - stable outlook) by A.M. Best and "A" (Strong-negative outlook) by S&P. Syndicate 1221 utilizes the ratings from A.M. Best and S&P for underwriting purposes which apply to all Lloyd's syndicates. Lloyd's is rated "A" (Excellent - stable outlook) by A.M. Best and A+ (Strong - stable outlook) by S&P.  Debt ratings apply to short-term and long-term debt as well as preferred stock. These ratings are assessments of the likelihood that we will make timely payments of the principal and interest for our senior debt. It is possible that, in the future, one or more of the rating agencies may reduce our existing debt ratings. If one or more of our debt ratings were downgraded, we could incur higher borrowing costs and our ability to access the capital markets could be impacted.  

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

Critical Accounting Policies

  It is important to understand our accounting policies in order to understand our financial statements. Management considers certain of these policies to be critical to the presentation of the financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the financial reporting date and throughout the reporting period. Certain of the estimates result from judgments that can be subjective and complex and, consequently, actual results may differ from these estimates, which would be reflected in future periods.  Our most critical accounting policies involve the reporting of the reserves for losses and LAE (including losses that have occurred but were not reported to us by the financial reporting date), reinsurance recoverables, written and unearned premium, the recoverability of deferred tax assets, the impairment of investment securities and accounting for Lloyd's results.                                           38

--------------------------------------------------------------------------------

Table of Contents

Reserves for Losses and Loss Adjustment Expenses

  Reserves for losses and LAE represent an estimate of the expected cost of the ultimate settlement and administration of losses, based on facts and circumstances then known. Actuarial methodologies are employed to assist in establishing such estimates and include judgments relative to estimates of future claims severity and frequency, length of time to develop to ultimate, judicial theories of liability and other third party factors which are often beyond our control. No assurance can be given that actual claims made and related payments will not be in excess of the amounts reserved. During the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Even after such adjustments, ultimate liability may exceed or be less than the revised estimates.  The numerous factors that contribute to the inherent uncertainty in the process of establishing loss reserves include: interpreting loss development activity, emerging economic and social trends, inflation, changes in the regulatory and judicial environment and changes in our operations, including changes in underwriting standards and claims handling procedures. The process of establishing loss reserves is complex and imprecise as it must take into account many variables that are subject to the outcome of future events. As a result, informed subjective judgments as to our ultimate exposure to losses are an integral component of our loss reserving process.  Our actuaries calculate indicated IBNR loss reserves for each line of business by underwriting year for major products principally using two standard actuarial methodologies which are projection or extrapolation techniques: the loss ratio method and the Bornheutter-Ferguson method. In general the loss ratio method is used to calculate the IBNR for more recent underwriting years while the Bornheutter-Ferguson method is used to calculate the IBNR for more mature underwriting years. When appropriate such methodologies are supplemented by the loss development method and the frequency/severity method, which are used to analyze and better comprehend loss development patterns and trends in the data when making selections and judgments. Each of these methodologies, which are described below, are generally applicable to both long tail and short tail lines of business depending on a variety of circumstances. In utilizing these methodologies to develop our IBNR loss reserves, a key objective of management in making their final selections is to deliberate with our actuaries to identify aberrations and systemic changes occurring within historical experience and accurately adjust for them. This process requires the substantial use of informed judgment and is inherently uncertain as it can be influenced by numerous factors including:    

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

          losses;          •   Judicial, regulatory, legislative, and legal decisions that affect          insurers' liabilities;       •   Changes in the frequency and severity of losses;       •   Changes in the underlying loss exposures of our policies;       •   Changes in our claims handling procedures.   There are instances in which facts and circumstances require a deviation from the general process described above. Three such instances relate to the IBNR loss reserve processes for our 2008 Hurricanes losses, our 2005 Hurricanes losses and our asbestos exposures, where extrapolation techniques are not applied, except in a limited way, given the unique nature of hurricane losses and limited population of marine excess policies with potential asbestos exposures. In such circumstances, inventories of the policy limits exposed to losses coupled with reported losses are analyzed and evaluated principally by claims personnel and underwriters to establish IBNR loss reserves.  

A brief summary of each actuarial method discussed above follows:

  Loss ratio method: This method is based on the assumption that ultimate losses vary proportionately with premiums. Pursuant to the loss ratio method, IBNR loss reserves are calculated by multiplying the earned premium by an expected ultimate loss ratio to estimate the ultimate losses for each underwriting year, then subtracting the reported losses, consisting of paid losses and case loss reserves, to determine the IBNR loss reserve amount. The ultimate loss ratios applied are the Company's best estimates for each underwriting year and are generally determined after evaluating a number of factors which include: information derived by underwriters and actuaries in the initial pricing of the business, the ultimate loss ratios established in the prior accounting period and the related judgments applied, the ultimate loss ratios of previous underwriting years, premium rate changes, underwriting and coverage changes, changes in terms and conditions, legislative changes, exposure trends, loss development trends, claim frequency and severity trends, paid claims activity, remaining open case reserves and industry data where deemed appropriate. Such factors are also evaluated when selecting ultimate loss ratios and/or loss development factors in the methods described below.                                           39

--------------------------------------------------------------------------------

Table of Contents

  Bornheutter-Ferguson method: The Bornheutter-Ferguson method calculates the IBNR loss reserves as the product of the earned premium, an expected ultimate loss ratio, and a loss development factor that represents the expected percentage of the ultimate losses that have been incurred but not yet reported. The loss development factor equals one hundred percent less the expected percentage of losses that have thus far been reported, which is generally calculated as an average of the percentage of losses reported for comparable reporting periods of prior underwriting years. The expected ultimate loss ratio is generally determined in the same manner as in the loss ratio method.  Loss development method: The loss development method, also known as the chainladder or the link-ratio method, develops the IBNR loss reserves by multiplying the paid or reported losses by a loss development factor to estimate the ultimate losses, then subtracting the reported losses, consisting of paid losses and case loss reserves, to determine the IBNR loss reserves. The loss development factor is the reciprocal of the expected percentage of losses that have thus far been reported, which is generally calculated as an average of the percentage of losses reported for comparable reporting periods of prior underwriting years.  Frequency/severity method: The frequency/severity method calculates the IBNR loss reserves by separately projecting claim count and average cost per claim data on either a paid or incurred basis. It estimates the expected ultimate losses as the product of the ultimate number of claims that are expected to be reported and the expected average amount of these claims.  Annual actuarial loss studies are conducted by the Company's actuaries at various times throughout the year for major lines of business employing the methodologies as described above. Additionally, a review of the emergence of actual losses relative to expectations for each line of business, generally derived from the annual loss studies, is conducted each quarter to determine whether the assumptions used in the reserving process continue to form a reasonable basis for the projection of liabilities for each product line. Such reviews may result in maintaining or revising assumptions regarding future loss development based on various quantitative and qualitative considerations. If actual loss activity differs from expectations, an upward or downward adjustment to loss reserves may occur. As time passes, estimated loss reserves for an underwriting year will be based more on historical loss activity and loss development patterns rather than on assumptions based on underwriters' input, pricing assumptions or industry experience.  

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

  Marine: Generally, two key assumptions are used by our actuaries in setting IBNR loss reserves for major products in this line of business. The first assumption is that our historical experience regarding paid and reported losses for each product where we have sufficient history can be relied on to predict future loss activity. The second assumption is that our underwriters' assessments as to potential loss exposures are reliable indicators of the level of our expected loss activity. The specific loss reserves for marine are then analyzed separately by product based on such assumptions, except where noted below, with the major products including marine liability, cargo, P&I, transport and bluewater hull.                                           40 

--------------------------------------------------------------------------------

Table of Contents

  The claims emergence patterns for various marine product lines vary substantially. Our largest marine product line is marine liability, which has one of the longer loss development patterns. Marine liability protects an insured's business from liability to third parties stemming from their marine-related operations, such as terminal operations, stevedoring and marina operations. Since marine liability claims generally involve a dispute as to the extent and amount of legal liability that our insured has to a third party, these claims tend to take a longer time to develop and settle. Other longer-tail marine product lines include P&I insurance, which provides coverage for third party liability as well as injury to crew for vessel operators, and transport insurance, which provides both property and third party liability on a primary basis to businesses such as port authorities, marine terminal operators and others engaged in the infrastructure of international transportation. Other marine product lines have considerably shorter periods in which losses develop and settle. Ocean cargo insurance, for example, provides physical damage coverage to goods in the course of transit by water, air or land. By their nature, cargo claims tend to be reported quickly as losses typically result from an obvious peril such as fire, theft or weather. Similarly, bluewater hull insurance provides coverage against physical damage to ocean-going vessels. Such claims for physical damage generally are discovered, reported and settled quickly. The Company currently has extensive experience for all of these products and thus the IBNR loss reserves for all of the marine products are determined using the key assumptions and actuarial methodologies described above. Prior to 2007, however, as discussed below, the Company did not have sufficient experience in the transport product line and instead used its hull and liability products loss development experience as a key assumption in setting the IBNR loss reserves for its transport product.  Property Casualty: The reserves for property and casualty are established separately by product with the major product being contractors' liability insurance. Other products include offshore energy, commercial middle markets, primary casualty, excess casualty and specialty reinsurance. Our actuaries generally utilize two key assumptions in this line of business: first, that our historical loss development patterns are reasonable predictors of future loss patterns and second, that our claims personnel's assessment of our claims exposures and our underwriters' assessment of our expected losses are reliable indicators of our loss exposure. However, this line of business includes a number of newer products where there is insufficient Company historical experience to project loss reserves and/or loss development is sparse or erratic, which makes extrapolation techniques for those products extremely difficult to apply, and in those circumstances we typically rely more on industry data and our underwriters' input in setting assumptions for our IBNR loss reserves as opposed to historical loss development patterns. In addition, as discussed in more detail below with respect to construction defect reserves, our actuaries may take other market trends or events into account in setting IBNR loss reserves.  The substantial majority of the property and casualty loss reserves are for the contractors' liability business, which insures mostly general and artisan contractors. Contractor liability claims are categorized into two claim types: construction defect and other general liability. Other general liability claims typically derive from workplace accidents or from negligence alleged by third parties, and frequently take a long time to report and settle. Construction defect claims involve the discovery of damage to buildings that was caused by latent construction defects. These claims take a very long time to report and to settle compared to other general liability claims. Since construction defect claims report much later than other contractor liability claims, they are analyzed separately in an annual actuarial loss study.  We have extensive history in the contractors' liability business upon which to perform actuarial analyses and we use the key assumption noted above relating to our own historical experience as a reliable indicator of the future for this product. However, there is inherent uncertainty in the loss reserve estimation process for this line of business given both the long-tail nature of the liability claims and the continuing underwriting and coverage changes, claims handling and reserve changes, and legislative changes that have occurred over a several year period. Such factors are judgmentally taken into account in this line of business in specific periods. The underwriting and coverage changes include the migration to a non-admitted business from admitted business in 2003, which allowed us to exclude certain exposures previously permitted (for example, exposure to construction work performed prior to the policy inception), withdrawals from certain contractor classes previously underwritten and expansion into new states beginning in 2005. Claims changes include bringing the claim handling in-house in 1999 and changes in case reserving practices in 2003, 2006 and 2011.                                           41 

--------------------------------------------------------------------------------

Table of Contents

  Most recently, in setting the IBNR loss reserves for construction defect claims, our actuaries have begun to consider a new qualitative factor based on their evolving concern with the recent decline in home values caused by the subprime home mortgage crisis and its possible impact on the frequency and severity of construction defect claims. As a result, our actuaries acknowledge this uncertainty and anticipate claims arising from alleged construction defects contributing to housing value declines on policies written on newly constructed homes in our portfolio. We believe our reserves remain adequate to address such potential exposure, but we can give no assurances with respect thereto.  Offshore energy provides physical damage coverage to offshore oil platforms along with offshore operations related to oil exploration and production. The significant offshore energy claims are generally caused by fire or storms, and thus tend to be large, infrequent, quickly reported, but occasionally not quickly settled because the damage is often extensive but not always immediately known.  Our commercial middle markets or Nav Pac business consists of general liability, auto liability and property exposures for a variety of commercial middle market businesses, principally hospitality, manufacturing and garages. Commencing in 2007, our actuaries are segmenting and analyzing the components of the loss development for this business among the property, liability and auto exposures which had been previously combined. As mentioned in Part I, on January 14, 2011, we announced that we entered into a transaction for the sale of the renewal rights for our middle market commercial package and commercial automobile businesses underwritten through our Nav Pac division. This transaction did not include our Life sciences and exporters package liability products.  Primary casualty insurance provides primary general liability coverage principally to corporations in the construction and manufacturing sector. Excess casualty insurance is purchased by corporations which seek higher limits of liability than are provided in their primary casualty policies. Our specialty reinsurance provides proportional and excess-of-loss treaty reinsurance covering medical health care exposures, property treaty exposures in Central and South America and the Caribbean and agriculture exposures in the U.S. and Canada. Neither of the product lines has a significant amount of loss activity reported to date. Because we have limited historical experience in these products, the IBNR loss reserves for these products are primarily established using the loss ratio method primarily based on our underwriters' input and industry loss experience.  Loss reserves include our European property business written by the U.K. Branch which was discontinued in 2008. We have limited loss history and rely primarily on assumptions based on underwriters' input and industry experience. In addition, loss reserves for aviation, property and assumed reinsurance business, in run-off since 1999, are periodically monitored and evaluated by claims and actuarial personnel.  Professional Liability: The professional liability policies mainly provide coverage on a claims-made basis mostly for a one-year period. The reserves for professional liability are analyzed separately by product. The major products are D&O liability coverage and E&O liability coverage for lawyers and other professionals.  The losses for D&O business are generally very large and infrequent, and often involve securities class actions. D&O claims report reasonably quickly, but may take several years to settle. Our loss estimates are based on expected losses, an assessment of the characteristics of reported losses at the claim level, evaluation of loss trends, industry data, and the legal, regulatory and current risk environment. Significant judgment is involved because anticipated loss experience in this area is less predictable due to the small number of claims and/or erratic claim severity patterns. As time passes for a given underwriting year, we place additional weight on assumptions relating to our actual experience and claims outstanding. The expected ultimate losses may be adjusted up or down as the underwriting years mature. The E&O IBNR loss reserve process is similar to the process for D&O, with the exception of a particular book of business of the U.K. Branch written from 2004 through 2006. For the U.K Branch E&O business, we assume the claims, while similar in nature to the claims in the U.S. E&O business, are larger, more frequent and have a longer loss development pattern. The IBNR loss reserves for the U.K. Branch E&O business are determined judgmentally after reviewing recent loss activity relative to the remaining in-force policy count and the loss activity for similar insureds.                                           42

--------------------------------------------------------------------------------

Table of Contents

  Lloyd's Operations: Reserves for the Company's Lloyd's Operations are reviewed separately for the marine and professional liability lines by product. The major marine products are marine liability, offshore energy, cargo, specie and marine reinsurance, and the major products for professional liability are international D&O and international E&O.  The marine liability, offshore energy and cargo products and related loss exposures are similar in nature to that described for marine business above. Specie insurance provides property coverage for chattel, such as jewelry, fine art and cash in transit. Claims tend to be from theft or damage, quick to report and, in most cases, quick to settle. Marine reinsurance is a diversified global book of reinsurance, the majority of which consists of excess-of-loss reinsurance policies for which claims activity tends to be large and infrequent with loss development somewhat longer than for such products written on a direct basis. Marine reinsurance reinsures liability, cargo, hull and offshore energy exposures that are similar in nature to the marine business described above.  The process for establishing the IBNR loss reserves for the marine and professional liability lines of the Lloyd's Operations, and the assumptions used as part of this process, are similar in nature to the process employed by the Insurance Companies.  The Lloyd's Operations products also include property coverages for engineering and construction projects and onshore energy business, which are substantially reinsured. Losses from engineering and construction projects tend to result from loss of use due to construction delays while losses from onshore energy business are usually caused by fires or explosions. Large losses tend to be catastrophic in nature and are heavily reinsured. IBNR loss reserves for attritional losses are established based on the Syndicate's extensive loss experience.  

Sensitivity Analysis

  We do not calculate a range of reasonable loss reserve estimates. We believe that ranges may not be a true reflection of the potential volatility between carried loss reserves and the ultimate settlement amount of losses incurred prior to the balance sheet date.  The actual losses may not emerge as expected, which would cause the ranges to expand or contract from year to year. The impact of these shifts in the ranges will be greater in lines with longer emergence patterns. The individual lines will also have greater variance than the range for the entire book of business. The boundaries of the reasonably likely ranges do not have a symmetrical relationship with our carried reserves and intentionally reflect a wider variation in the increases than for the decreases and, correspondingly, a wider deviation in the deficiency than in the redundancy.  Set forth below is a sensitivity analysis that estimates the effect on our net loss reserve position of using alternative expected loss ratios for the underwriting years 2003 to 2011 and alternative loss development factors for underwriting years beginning in the late 1990's to 2011 rather than those loss ratios and factors actually used in determining our best estimates as of December 31, 2011. The analysis addresses each major line of business and underwriting year for which a material deviation to our overall reserve position is believed reasonably possible, and uses what we believe is a reasonably likely range of potential deviation for each line of business. There can be no assurance, however, that actual reserve development will be materially consistent with either the original or the adjusted expected loss ratios or loss development factor assumptions, or with other assumptions made in the reserving process.  For the selected alternative expected loss ratios, our actuaries observed the range of ultimate loss ratios recorded for the underwriting years 2003 to 2011 for each major line of business as of December 31, 2011.                                           43

--------------------------------------------------------------------------------

Table of Contents

  The reasonably likely ranges of potential deviation in the loss ratios for each line of business for the 2003 to 2011 underwriting years expressed in loss ratio points are as follows:                        Reasonably likely loss ratio point variances                                                 Decrease        Increase             Insurance Companies:             Marine                                      5 %             7 %             Property Casualty                           6 %             8 %             Professional Liability                     13 %            16 %             Lloyd's Operations                          6 %             8 %   For the loss development factor variance, our actuaries employed a standard technique which is based on the historical development factors observed for each line of business from the paid and incurred loss development triangles with the latest evaluation as of December 31, 2011. The historical factors are used to generate alternative outcomes which could arise in the ultimate development due to the random variability inherent in future development. The alternative outcomes are generated by a stochastic simulation. The ranges may contract or expand if future development deviates from historical experience. The reasonably likely ranges of potential deviations in the aggregate or overall loss development factors applicable to the total of all underwriting years for each line of business are as follows:                  Reasonably likely ultimate loss development factor ratios                                                    Decrease           Increase       Insurance Companies:       Marine                                               9 %               11 %       Property Casualty                                    7 %               11 %

      Professional Liability                              27 %             

 36 %       Lloyd's Operations                                  10 %               14 %   Such sensitivity analysis was performed in the aggregate for all products within each line of business. The use of aggregate data was considered more stable and reliable compared to a product-by-product analysis. We cannot assure, however, that such use of aggregate data will provide a more accurate range of the actual variations in loss development. The loss ratio sensitivity analysis uses loss ratios for the 2003 to 2011 underwriting years, which are believed to be more representative compared to years prior to 2003 given our evolving mix of business, product changes and other factors. There can be no assurances, however, that the use of such recent history is more predictive of actual development as compared to employing longer periods of history. In addition, while the net loss reserves include the net loss reserves for asbestos exposures, such amounts were excluded from the sensitivity analysis given the nature of how such reserves are established by the Company. While we believe such net reserves are adequate, we cannot assure that material loss development may not arise in the future from asbestos losses given the complex nature of such exposures.                                           44 

--------------------------------------------------------------------------------

Table of Contents

  The total Company range amounts below were determined by combining the simulated results for each line of business into one analysis which estimates a company-wide range reflecting the fact that the individual lines of business are not perfectly correlated. This calculation reflects the reduced volatility benefit from a diversified portfolio of loss exposures. Such amounts may not be representative of the actual aggregate favorable or unfavorable loss development amounts that may occur over time.                                                                                   Reasonably Likely Range of Deviation                                                     Total Net          Redundancy                     Deficiency In thousands, except per share amounts             Loss Reserve          Amount            %            Amount           % Insurance Companies: Marine                                            $      249,787      $     22,481           9 %     $     27,477         11 % Property Casualty                                        481,999            33,740           7 %           53,020         11 % Professional Liability                                   140,443            37,920          27 %           50,559         36 %  Total Insurance Companies                                872,229            94,141                        131,056 Total Lloyd's Operations                                 365,005            36,501          10 %           51,101         14 %  Subtotal                                               1,237,234           130,642                        182,157 Portfolio effect                                              -            (56,408 )                      (83,178 )  Total Company                                     $    1,237,234      $     74,234           6 %     $     98,979          8 %  Increase (decrease) to net income Amount                                                                $     48,252                   $    (64,336 ) Per Share (1)                                                         $       3.18                   $      (4.24 )      

(1)-Calculated using average diluted shares of 15,183,285 for the year ended December 31, 2011.

  Reinsurance Recoverable  Reinsurance recoverables are established for the portion of the loss reserves that are ceded to reinsurers. Reinsurance recoverables are determined based upon the terms and conditions of reinsurance contracts which could be subject to interpretations that differ from our own based on judicial theories of liability. In addition, we bear credit risk with respect to our reinsurers which can be significant considering that certain of the reserves remain outstanding for an extended period of time. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. Additional information regarding our reinsurance recoverables can be found in the "Business-Reinsurance Recoverables" section and Note 6, Reinsurance, to our consolidated financial statements, both included herein.  

Written and Unearned Premium

  Written premium is recorded based on the insurance policies that have been reported to us and the policies that have been written by agents but not yet reported to us. We must estimate the amount of written premium not yet reported based on judgments relative to current and historical trends of the business being written. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year's results. An unearned premium reserve is established to reflect the unexpired portion of each policy at the financial reporting date. Reinsurance reinstatement premium is earned in the period in which the event occurred which created the need to record the reinstatement premium. Additional information regarding our written and unearned premium can be found in Note 1, Organization and Summary of Significant Accounting Policies, and Note 6, Reinsurance, in the Notes to Consolidated Financial Statements, both included herein.                                           45

--------------------------------------------------------------------------------

Table of Contents

  Substantially all of our business is placed through agents and brokers. Since the majority of our gross written premiums are primary or direct, as opposed to assumed, the delays in reporting assumed premiums generally do not have a significant effect on our financial statements, as we record estimates for both unreported direct and assumed premium. We also record the ceded portion of the estimated gross written premium and related acquisition costs. The earned gross, ceded and net premiums are calculated based on our earning methodology which is generally pro-rata over the policy period. Losses are also recorded in relation to the earned premium. The estimate for losses incurred on the estimated premium is based on an actuarial calculation consistent with the methodology used to determine incurred but not reported loss reserves for reported premiums.  A portion of our premium is estimated for unreported premium, mostly for the Marine business written by our U.K. Branch and Lloyd's Operations as well as the Accident and Health reinsurance business written by our recently established reinsurance division Nav Re. We generally do not experience any significant backlog in processing premiums. Such premium estimates are generally based on submission data received from brokers and agents and recorded when the insurance policy or reinsurance contract is written or bound. The estimates are regularly reviewed and updated taking into account the premium received to date versus the estimate and the age of the estimate. To the extent that the actual premium varies from the estimates, the difference, along with the related loss reserves and underwriting expenses, is recorded in current operations.  

Deferred Tax Assets

  We apply the asset and liability method of accounting for income taxes whereby deferred assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that the deferred tax assets will be realized. Additional information regarding our deferred tax assets can be found in Note 1, Organization and Summary of Significant Accounting Policies, and Note 7, Income Taxes, in the Notes to Consolidated Financial Statements, both included herein.  

Impairment of Invested Assets

Management regularly reviews our fixed maturity and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments.

  For fixed maturity securities, we consider our intent to sell a security and whether it is more likely than not that we will be required to sell a security before the anticipated recovery as part of the process of evaluating whether a security's unrealized loss represents an other-than-temporary decline. We assess whether the amortized cost basis of a fixed maturity security will be recovered by comparing the present value of cash flows expected to be collected to the current book value. Any shortfalls of the present value of the cash flows expected to be collected in relation to the amortized cost basis is considered the credit loss portion of other-than-temporary impairment ("OTTI") losses and is recognized in earnings. All non-credit losses are recognized as changes in OTTI losses within Other Comprehensive Income ("OCI").  For equity securities, in general, we focus our attention on those securities whose fair value was less than 80% of their cost for six or more consecutive months. If warranted as the result of conditions relating to a particular security, we will focus on a significant decline in fair value regardless of the time period involved. Factors considered in evaluating potential impairment include, but are not limited to, the current fair value as compared to cost of the security, the length of time the investment has been below cost and the impact of the amount. If an equity security is deemed to be other-than-temporarily impaired, the cost is written down to fair value with the loss recognized in earnings.  For equity securities, we also consider our intent to hold securities as part of the process of evaluating whether a decline in fair value represents an other-than-temporary decline in value. For fixed maturity securities, we consider our intent to sell a security and whether it is more likely than not that we will be required to sell a security before the anticipated recovery as part of the process of evaluating whether a security's unrealized loss represents an other-than-temporary decline. Our ability to hold such securities is evaluated by the Company and is based on whether there is sufficient cash flow from operations and from maturities within our investment portfolio in order to meet claims payment and other disbursement obligations arising from our underwriting operations without selling such investments. With respect to securities where the decline in value is determined to be temporary and the security's value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information and market conditions.                                           46 

--------------------------------------------------------------------------------

Table of Contents

  The day to day management of our investment portfolio is outsourced to third party investment managers. While these investment managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses that are considered temporary until such losses are recovered, the dynamic nature of the portfolio management may result in a subsequent decision to sell the security and realize the loss based upon a change in the market and other factors described above. Investment managers are required to notify management of rating agency downgrades of securities in their portfolios as well as any potential investment valuation issues at the end of each quarter. Investment managers are also required to notify management, and receive approval, prior to the execution of a transaction or series of related transactions that may result in a realized loss above a certain threshold. Additionally, management monitors the execution of a transaction or series of related transactions that may result in any realized loss up until a certain period beyond the close of a quarterly accounting period.  

Accounting for Lloyd's Results

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

Results of Operations

  The following is a discussion and analysis of our consolidated and segment results of operations for the years ended December 31, 2011, 2010 and 2009. 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 losses recognized in earnings. Book value per share is calculated by dividing shareholders' 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 over 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.                                           47

--------------------------------------------------------------------------------

Table of Contents

Summary of Consolidated Results

The following table presents a summary of our consolidated financial results for the years ended December 31, 2011, 2010 and 2009:

                                                         Year Ended December 31,                  Percentage Change                                                                                             2011 vs.        2010 vs. In thousands, except for per share amounts      2011           2010           2009            2010            2009 Gross written premiums                       $ 1,108,216     $ 987,201     $ 1,044,918           12.3 %          -5.5 % Net written premiums                             753,798       653,938         701,255           15.3 %          -6.7 %  Total revenues                                   766,385       776,975         762,880           -1.4 %           1.8 % Total expenses                                   733,651       678,146         676,032            8.2 %           0.3 %  Pre-tax income (loss)                        $    32,734     $  98,829     $    86,848          -66.9 %          13.8 % Provision (benefit) for income taxes               7,137        29,251      

23,690 -75.6 % 23.5 %

  Net income (loss)                            $    25,597     $  69,578     

$ 63,158 -63.2 % 10.2 %

  Net income (loss) per common share: Basic                                        $      1.71     $    4.33     $      3.73 Diluted                                      $      1.69     $    4.24     $      3.65   Net income for the year ended December 31, 2011 was $25.6 million or $1.69 per diluted share compared to net income of $69.6 million or $4.24 per diluted share for the year ended December 31, 2010. Operating earnings for the year ended December 31, 2011 were $19.1 million or $1.26 per diluted share compared to $43.4 million or $2.65 per diluted for the comparable period in 2010. In comparison to net income, operating earnings excludes after-tax net realized gains of $7.8 million and $26.9 million and after-tax other-than-temporary impairment losses of $1.3 million and $0.7 million for the years ended December 31, 2011 and 2010, respectively. The decrease in our operating earnings was largely attributable to unfavorable underwriting results related to large loss activity from our energy business and significant current year loss emergence from our Professional Liability division, and to a lesser extent a decrease in net investment income.  Net income for the year ended December 31, 2010 was $69.6 million or $4.24 per diluted share compared to net income of $63.2 million or $3.65 per diluted share for the year ended December 31, 2009. Operating earnings for the year ended December 31, 2010 were $43.4 million or $2.65 per diluted share compared to $65.2 million or $3.76 per diluted share for the comparable period in 2009. In comparison to net income, operating earnings excludes after-tax net realized gains of $26.9 million and $5.8 million and after-tax other-than-temporary impairment losses recognized in earnings of $0.7 million and $7.8 million for the years ended December 31, 2010 and 2009, respectively. The decrease in our operating earnings was largely attributable to unfavorable underwriting results related to large loss activity from our energy business in connection with the Deepwater Horizon and West Atlas events.  Our book value per share as of December 31, 2011 was $57.57, increasing 9% from $52.68 as of December 31, 2010. The increase in book value per share primarily resulted from an improvement in the value of our consolidated investment portfolio as well as the repurchase of 1,979,107 shares of our common stock at an aggregate purchase price of $90.9 million and an average share price of $45.91 during 2011, which represented 3% of the increase. Primarily because of the share repurchases, our consolidated stockholders' equity decreased 3% to $803.4 million as of December 31, 2011 compared to $829.4 million as of December 31, 2010.  Cash flow from operations was $118.3 million, $118.2 million and $103.9 million for the years ended December 31, 2011, 2010 and 2009, respectively. The increase in cash flow from operations was due to improved collections on reinsurance recoverables as well as premium receivables.                                           48

--------------------------------------------------------------------------------

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 for the years ended December 31, 2011, 2010 and 2009:                                                    Year Ended December 31,                     Percentage Change                                                                                         2011 vs.        2010 vs. In thousands                             2011             2010            2009            2010            2009 Gross written premiums                $ 1,108,216      $  987,201      $ 1,044,918           12.3 %          -5.5 % Net written premiums                      753,798         653,938          701,255           15.3 %          -6.7 %  Net earned premiums                       691,645         659,931          683,363            4.8 %          -3.4 % Net losses and loss adjustment expenses                                 (476,997 )      (421,155 )       (435,998 )         13.3 %          -3.4 % Commission expenses                      (110,437 )      (109,113 )        (98,908 )          1.2 %          10.3 % Other operating expenses                 (138,029 )      (139,743 )       (132,671 )         -1.2 %           5.3 % Other income (expenses) (2)                 1,229           5,186            3,665          -76.3 %          41.5 %  Underwriting profit (loss)            $   (32,589 )    $   (4,894 )    $    19,451             NM              NM  Net investment income                      63,500          71,662           75,512          -11.4 %          -5.1 % Net other-than-temporary impairment losses recognized in earnings              (1,985 )        (1,080 )        (11,877 )         83.8 %         -90.9 % Net realized gains (losses)                11,996          41,319            9,217          -71.0 %            NM Gain on debt repurchase (2)                    -               -             3,000             NM              NM Interest expense                           (8,188 )        (8,178 )         (8,455 )          0.1 %          -3.3 %  Income (loss) before income taxes     $    32,734      $   98,829      $    86,848          -66.9 %          13.8 %  Income tax expense (benefit)                7,137          29,251           23,690          -75.6 %          23.5 %  Net income (loss)                     $    25,597      $   69,578      $    63,158          -63.2 %          10.2 %   Losses and loss adjustment expenses ratio                                        69.0 %          63.8 %           63.8 % Commission expense ratio                     16.0 %          16.5 %           14.5 % Other operating expense ratio (1)            19.7 %          20.4 %           18.9 %  Combined ratio                              104.7 %         100.7 %           97.2 %       

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

(2) - Reported within "Other income (expense)" on the Consolidated Statements of Income

NM-Percentage change not meaningful

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

• Large current accident year energy losses with a net adverse impact of

$25.6 million, inclusive of $8.2 million in reinsurance reinstatement

         premiums, related to drilling operations in the North Sea, Gulf of Mexico          and Russia, as well as an onshore industrial site.    

• Current accident year loss emergence of approximately $11.0 million

related to our Professional Liability business, of which approximately

$8.0 million was specific to our D&O liability insurance for both publicly

and privately held corporations. The remaining $3.0 million of emergence

was specific to our small lawyers and miscellaneous professional liability

         coverages.                                            49 

--------------------------------------------------------------------------------

Table of Contents

• An increase in our reinsurance reinstatement premium accrual of $5.2

million. This accrual was driven by the recognition of the effect of a

shift in our Marine reinsurance protections to an excess of loss program

from a quota share program. As a result of this shift and the increased

frequency of severity losses in recent periods, a greater portion of our

IBNR was attributable to marine and energy losses that are or will be

ceded to our Marine Excess-of-Loss Reinsurance program and such cession

         will trigger additional reinstatement premiums.    

• Net adverse loss development of $2.1 million driven by significant loss

emergence in our Professional Liability business mostly offset by

redundancies from our Property Casualty business.

   In addition to the net adverse impacts noted above, the increase in our pre-tax underwriting loss in 2011 and 2010 was affected by the mix of business and loss trends, partially offset by $8.7 million of net adverse activity recorded in 2010. The net adverse activity recorded in 2010 primarily relates to a combined $22.5 million in reinstatement premiums related to the Deepwater Horizon and West Atlas losses, respectively, partially offset by net prior period reserve redundancies of $13.8 million. The net prior period reserve redundancies were driven by significant redundancies from our Property Casualty business partially offset by loss emergence from our Professional Liability business.  The combined ratio for the year ended December 31, 2010 was 100.7% compared to 97.2% for the comparable period in 2009. Our pre-tax underwriting profit declined by $24.4 million to a $4.9 million underwriting loss for the year ended December 31, 2010 compared to $19.5 million of underwriting profit for the same period in 2009. The decrease in pre-tax underwriting profit was primarily attributable to large loss activity, namely Deepwater Horizon and West Atlas, as well as reduced rates across all lines due to the soft market conditions, partially offset by net prior period redundancies.  

Revenues

The following tables set forth our gross written premiums, net written premiums and net earned premiums by segment and line of business for the years ended December 31, 2011, 2010, and 2009:

                                                228,500         228,500        228,500       228,500       228,500       228,500        228,500       228,500       228,500         228,500        228,500       228,500                                                                                                                     Year Ended December 31,                                                                     2011                                                      2010                                                      2009                                               Gross                          Net           Net          Gross                         Net           Net           Gross                          Net           Net                                              Written                       Written       Earned        Written                      Written       Earned         Written                       Written       Earned In thousands                                Premiums           %          Premiums      Premiums      Premiums          %          Premiums      Premiums       Premiums           %          Premiums      Premiums Insurance Companies: Marine                                     $   228,500            21 %    $ 170,642$ 169,018$ 223,061            23 %    $ 151,059$ 155,846$   241,438            23 %    $ 171,289$ 157,534 Property Casualty                              445,287            40 %      293,758       231,297       312,651            31 %      197,845       200,741         352,285            34 %      227,234       246,143 Professional Liability                         114,632            10 %       77,991        72,148       129,793            13 %       80,451        82,264         137,053            13 %       79,150        75,444  Insurance Companies Total                      788,419            71 %      542,391       472,463       665,505            67 %      429,355       438,851         730,776            70 %      477,673       479,121  Lloyd's Operations: Marine                                         167,562            16 %      137,206       145,659       182,723            19 %      149,340       149,225         191,959            19 %      156,153       142,958 Property Casualty                              115,138            10 %       56,249        55,903        94,799            10 %       54,049        49,852          78,151             7 %       45,097        39,330 Professional Liability                          37,097             3 %       17,952        17,620        44,174             4 %       21,194        22,003          44,032             4 %       22,332        21,954  Lloyd's Operations Total                       319,797            29 %      211,407       219,182       321,696            33 %      224,583       221,080         314,142            30 %      223,582       204,242  Total                                      $ 1,108,216           100 %    $ 753,798$ 691,645$ 987,201           100 %    $ 653,938$ 659,931$ 1,044,918           100 %    $ 701,255$ 683,363    Gross Written Premiums  Gross written premiums increased $121.0 million, or 12.3%, to $1.11 billion for the year ended December 31, 2011 compared to $987.2 million for the same period in 2010. The increase in gross written premiums were primarily attributed growth in our Property Casualty business, which includes $101.5 million related to our newly established Nav Re division which writes Accident & Health, Agriculture and Latin American reinsurance lines of business. The increase within Property Casualty is also attributable to growth of $34.2 million and $22.1 million Excess and Primary Casualty business, respectively, resulting from strong production, partially offset by the run-off of our middle market commercial package business. The increase in gross written premiums was offset by a $22.2 million decrease in our Professional Liability business attributable to our Directors and Officer Liability lines. This decrease reflects a change in our underwriting strategy that focuses on a planned shift toward underwriting excess layers.                                           50 

--------------------------------------------------------------------------------

Table of Contents

  Gross written premiums decreased 5.5% to $987.2 million for the year ended December 31, 2010 compared to $1.04 billion for the same period in 2009. The decreases in gross written premiums were primarily attributable to our Marine and Property Casualty businesses. The decline in Marine gross written premiums is attributed to significant competition in this line of business coupled with excess capacity. Property Casualty gross written premiums declined primarily due to weak economic conditions that had reduced demand for construction liability insurance.  Our Marine division saw increases in the average renewal premium rates in our Inland Marine and Lloyd's lines of approximately 7.3% and 0.9%, respectively, for the year ended December 31, 2011 compared to the same period in 2010. U.S. Marine premiums rates decreased 0.3% while U.K. Branch Marine premiums rates increased 1.9% for the year ended December 31, 2011 compared to the same period in 2010. For our Navigators Technical Risk ("NavTech") and Primary Casualty lines we experienced an average renewal premium rate increases of approximately 4.2% and 7.4% for the year ended December 31, 2011 compared to the same period in 2010, which was offset by a decline in our Excess Casualty lines of 1.2%, respectively. The Insurance Companies and Lloyd's Professional Liability division overall experienced approximately a 1.5% decrease in average renewal premium rates for the year ended December 31, 2011 compared to 2010.  Our Marine division saw increases in the average renewal premium rates in our U.S. Marine, U.K. Branch Marine and Lloyd's lines of approximately 0.1%, and 2.4%, respectively, for the year ended December 31, 2010 compared to the same period in 2009. For our Property Casualty division, we experienced an average renewal premium rate increase in our NavTech line of approximately 3.6% for the year ended December 31, 2010 compared to the same period in 2009, which was offset by declines in our Primary and Excess Casualty lines of 0.5% and 3.1%, respectively. The Insurance Companies and Lloyd's Professional Liability division overall experienced approximately 3.0% decrease in average renewal premium rates for the year ended December 31, 2010 compared to 2009.  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 written premium varies based upon the types of business written and whether the business is written by the Insurance Companies or the Lloyd's Operations.  Our reinsurance program includes contracts for proportional reinsurance, per risk and whole account excess-of-loss reinsurance for both property and casualty risks and property catastrophe excess-of-loss reinsurance. In recent years we have increased our utilization of excess-of-loss reinsurance for marine, property and 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 reinstatement premiums). The number of reinstatements available varies by contract.  

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

                                       51

--------------------------------------------------------------------------------

Table of Contents

The following table sets forth our ceded written premiums by segment and major line of business for the years ended December 31, 2011, 2010 and 2009:

                                                                  Year Ended December 31,                                            2011                          2010                          2009                                                   % of                          % of                          % of                                    Ceded         Gross           Ceded         Gross           Ceded         Gross                                   Written       Written         Written       Written         Written       Written In thousands                     Premiums       Premiums       Premiums       Premiums       Premiums       Premiums Insurance Companies: Marine                           $  57,858             25 %    $  72,002             32 %    $  70,149             29 % Property Casualty                  151,529             34 %      114,806             37 %      125,051             36 % Professional Liability              36,641             32 %       49,342             38 %       57,903             42 %  Total Insurance Companies          246,028             31 %      236,150             36 %      253,103             35 %   Lloyd's Operations: Marine                              30,356             18 %       33,383             18 %       35,806             19 % Property Casualty                   58,889             51 %       40,750             43 %       33,054             42 % Professional Liability              19,145             52 %       22,980             52 %       21,700             49 %  Total Lloyd's                      108,390             34 %       97,113             30 %       90,560             29 %  Total                            $ 354,418             32 %    $ 333,263             34 %    $ 343,663             33 %    The decrease in the percentage of total ceded written premiums to total gross written premiums for the year ended December 31, 2011 compared to the same period of 2010 was primarily due to a change in the mix of business resulting from new business within our recently established Nav Re division, a reduction in reinsurance reinstatement premiums in 2011 compared to 2010 related to large loss activity for each year and, to a lesser extent, the expansion of products offered by our Professional liability business where our retention ratios are higher, partially offset by a reduction in the retention of our Lloyd's Property Casualty business.  The increase in the percentage of total ceded written premiums to total gross written premiums for the year ended December 31, 2010 compared to the same period in 2009 was primarily due to the shift in business mix toward lines with lower cessions, offset by the impact of reinsurance reinstatement costs of $19.0 million and $3.5 million resulting from the Deepwater Horizon and West Atlas losses, respectively.  Net Written Premiums  Net written premiums increased 15.3% for the year ended December 31, 2011 compared to the same period in 2010. The increase is due to the impact of higher gross written premiums for the year ended December 31, 2011, and to a lesser extent lower premium cessions, as discussed above. Net written premiums decreased 6.7% for the year ended December 30, 2010 compared to the same period in 2009 due to the reduction in gross written premiums partially offset by the decline in ceded written premiums discussed above.  

Net Earned Premiums

  Net earned premiums increased 4.8% for the year ended December 31, 2011 compared to the same period in 2010 primarily as a result of significant ceded reinstatement premiums associated with large losses in 2010. As noted above, we recorded approximately $22.5 million in reinstatement premiums associated with large losses in 2010 compared to $8.2 million in 2011. The impact of reinstatement premiums was partially offset by a change in the mix of business in 2011 written by Nav Re, specifically the Accident and Health lines, which are recognized in earnings over a longer exposure period that our other lines of business. Net earned premiums decreased 3.4% for the year ended December 31, 2010 compared to the same period in 2009 primarily due to the changes reflected in written premiums discussed above.                                           52

--------------------------------------------------------------------------------

Table of Contents

Net Investment Income

Our net investment income was derived from the following sources:

                                     Year Ended December 31,                 

Percentage Change

                                                                       2011 

vs. 2010 vs.

  In thousands                2011          2010          2009           2010            2009  Fixed maturities          $ 65,060      $ 69,996      $ 74,779            

-7.1 % -6.4 %

  Equity securities            5,071         3,028         2,464            

67.5 % 22.9 %

  Short-term investments         964           965           811            

-0.1 % 19.0 %

   Total investment income   $ 71,095      $ 73,989      $ 78,054            

-3.9 % -5.2 %

Investment expenses (7,595 ) (2,327 ) (2,542 ) 226.4 % -8.5 %

Net investment income $ 63,500$ 71,662$ 75,512 -11.4 % -5.1 %

    The decrease in total investment income before investment expenses for all years presented was primarily due to lower investment yields and shorter portfolio duration. The annualized pre-tax investment yield, excluding net realized gains and losses and net other-than-temporary impairment losses recognized in earnings, was 3.0%, 3.5% and 3.8% for the years ended December 31, 2011, 2010 and 2009, respectively. The portfolio duration was 3.6 years, 4.4 years and 4.2 years for the years ended December 31, 2011, 2010 and 2009.  Investment expenses for the year ended December 31, 2011 of $7.6 million included $4.7 million accrual of estimated interest expense reflecting the summary judgment order entered against the Company in its dispute with Resolute in which the Court awarded $4.7 million in interest to Resolute on previously paid balances that were allegedly overdue under certain reinsurance agreements. The Company is appealing the Court's ruling. For information on the Equitas legal proceedings refer to Note 12, Commitments and Contingencies, in the Notes to Consolidated Financial Statements, included herein. Excluding the impact of the Resolute interest award, investment expenses for the year ended December 31, 2011, 2010 and 2009 were relative to the increased fair value of total invested assets through December 31, 2011.  

Net Other-Than-Temporary Impairment Losses Recognized In Earnings

Our net other-than-temporary impairment ("OTTI") losses recognized in earnings for the periods indicated were as follows:

                                                    Year Ended December 31,                 Percentage Change                                                                                     2011 vs.        2010 vs. In thousands                               2011          2010          2009           2010            2009 Fixed maturities                         $ (1,093 )    $   (693 )    $  (3,102 )         57.7 %         -77.7 % Equity securities                            (892 )        (387 )       (8,775 )        130.5 %         -95.6 %  OTTI recognized in earnings              $ (1,985 )    $ (1,080 )    $ 

(11,877 ) 83.8 % -90.9 %

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

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

  Net OTTI losses for the year ended December 31, 2009 of $8.8 million primarily related to additional impairments on a total of 56 equity securities that were previously impaired in 2008, as well as impairments on non-agency mortgage and asset backed securities and corporate bonds.                                           53

--------------------------------------------------------------------------------

Table of Contents

  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.  

Net Realized Gains and Losses

Our realized gains and losses for the periods indicated were as follows:

                                                      Year Ended December 31,                 Percentage Change                                                                                       2011 vs.        2010 vs. In thousands                                  2011          2010          2009          2010            2009 Fixed maturities: Gains                                       $ 11,678      $ 42,932      $ 18,312          -72.8 %         134.4 % Losses                                        (7,044 )      (3,239 )      (9,676 )        117.5 %         -66.5 %  Fixed maturities, net                       $  4,634      $ 39,693      $  8,636          -88.3 %         359.6 %  Equity securities: Gains                                       $  9,319      $  1,867      $  2,110             NM           -11.5 % Losses                                        (1,957 )        (241 )      (1,529 )           NM           -84.2 %  Equity securities, net                      $  7,362      $  1,626      $    581             NM           179.9 %  Net realized gains (losses)                 $ 11,996      $ 41,319      $  9,217          -71.0 %         348.3 %     

NM - Percentage change not meaningful.

  We generate realized gains and losses as part of the normal ongoing management of our investment portfolio. Net realized gains for the year ended December 31, 2011 primarily included the sale of corporate bonds and equity mutual funds. Net realized gains for the year ended December 31, 2010 included the sale of the majority of our general obligation municipal bond obligations, the proceeds of which were reinvested in corporate bonds and agency mortgage-backed securities.  

Other Income (Expense)

  Total other income for the years ended December 31, 2011, 2010 and 2009 was $1.2 million, $5.1 million, and $6.7 million, respectively, and primarily includes foreign exchange gains and losses from our Lloyd's Operations, commission income and inspection fees related to our specialty insurance business. For the year ended December 31, 2009, other income also included an approximate $3.0 million gain on the $10.0 million repurchase of our Senior Notes.  

Expenses

Net Losses and Loss Adjustment Expenses

The ratio of net losses and LAE to net earned premiums ("loss ratios") for the years ended December 31, 2011, 2010 and 2009 is presented in the following table:

                                                         Year Ended December 

31,

         Net Loss and LAE Ratio                     2011         2010        

2009

         Net Loss and LAE Payments                    55.3 %      59.3 %     

47.3 %

         Current year reserves                        13.4 %       6.6 %     

17.8 %

          Subtotal-current year loss ratio             68.7 %      65.9 %     

65.1 %

Prior year deficiencies (redundancies) 0.3 % -2.1 %

-1.3 %

          Net loss and LAE ratio                       69.0 %      63.8 %      63.8 %                                             54 

--------------------------------------------------------------------------------

Table of Contents

  The net loss and LAE ratio for the year ended December 31, 2011 increased 5.2 percentage points to 69.0% from 63.8% for both the years ended December 31, 2010 and 2009. The increase for the current year was primarily due to current accident year loss emergence of approximately $11.0 million related to our Professional Liability business of which approximately $8.0 million was specific to our D&O liability insurance for both publicly and privately held corporations. The remaining $3.0 million was specific to our small lawyers and miscellaneous professional liability coverages. In addition, the increase for the current year included net losses of $17.4 million related to four energy events compared to net losses of $11.0 million in 2010 related to Deepwater Horizon and West Atlas.  

The segment and line of business breakdown of the net loss and LAE ratios for the years ended December 31, 2011, 2010 and 2009 are as follows:

                                                Year Ended December 31,                 In thousands               2011         2010        2009                 Insurance Companies:                 Marine                       65.8 %      64.5 %      69.8 %                 Property Casualty            65.7 %      55.2 %      50.3 %                 Professional Liability      108.8 %      83.4 %      94.1 %                  Insurance Companies          72.3 %      63.8 %      63.6 %                 Lloyd's Operations           61.8 %      63.8 %      64.3 %                  Net loss and LAE ratio       69.0 %      63.8 %      63.8 %   

Prior Year Reserve Deficiencies/Redundancies

  The relevant factors that may have a significant impact on the establishment and adjustment of losses and LAE reserves can vary by line of business and from period to period. As part of our regular review of prior reserves, management, in consultation with our actuaries, may determine, based on their judgment that certain assumptions made in the reserving process in prior year periods may need to be revised to reflect various factors, likely including the availability of additional information. Based on their reserve analyses, management may make corresponding reserve adjustments.  The segment and line of business breakdowns of prior period net reserve deficiencies (redundancies) for the years ended December 31, 2011, 2010 and 2009 are as follows:                                                      Year Ended December 31,        In thousands                          2011          2010           2009        Insurance Companies:        Marine                              $  1,348      $  (4,155 )    $  11,893        Property Casualty                     (6,828 )      (14,923 )      (35,658 )        Professional Liability                17,582         13,623         20,686 

Subtotal Insurance Companies $ 12,102 $ (5,455 ) $ (3,079 )

       Lloyd's Operations                    (9,957 )       (8,347 )      

(5,862 )

Total deficiencies (redundancies) $ 2,145 $ (13,802 ) $ (8,941 )

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

  The adverse development of $1.3 million for our Insurance Companies Marine business was driven by $4.0 million of unfavorable loss emergence in Inland Marine in accident years 2009 and 2010 which was offset by $2.7 million favorable development in Ocean Marine. The Ocean Marine development was driven by $5.8 million of favorable development in accident years 2008 to 2010 and was partially offset by $3.2 million of adverse development for accident years 2007 and prior. Ocean Marine's favorable development was driven by the Craft, P&I and Transport classes with partial offsets from the Specie and Liability classes.                                           55 

--------------------------------------------------------------------------------

Table of Contents

  Our Insurance Companies Property Casualty business experienced $6.8 million of favorable development overall which was driven by favorable development of $8.4 million from Offshore Energy across several accident years and was partially offset by adverse development from runoff Liquor Liability in accident years 2008 and 2009.  Our Insurance Companies Professional Liability business had overall adverse development of $17.6 million, which consisted of adverse development of $14.5 million and $3.1 million from Management Liability and Errors and Omissions, respectively. The Management Liability development was primarily driven by liability coverage of Public Company directors and officers for accident years 2009 and 2010. The Errors and Omissions development was driven by Small Lawyers Professional Liability and Miscellaneous Professional Liability classes for accident year 2010.  Our Lloyd's operations experienced $10.0 million of favorable development. This was driven by favorable development of $10.3 million and $5.5 million from the Marine and Nav Tech divisions respectively, which was partially offset by $5.8 million of unfavorable development from Professional Liability. The favorable development in Marine was primarily from the Cargo, Liability and Specie classes for accident years 2008 and prior. The favorable development in Nav Tech was from Offshore Energy primarily in accident years 2007 to 2009. The adverse development in Professional Liability was mostly from Errors and Omissions in accident years 2006 to 2008.  

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

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

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

• $29.2 million for West Coast contractors' liability due to an internal

actuarial review conducted in 2010 which indicated that loss development

on underwriting years 2006 to 2008 has been more favorable than our prior

expectations with a partial offset for underwriting years 2004 and prior.

This internal review includes a more detailed analysis than is included in

          our regular quarterly reserving process.          •   $2.9 million of favorable development on our offshore energy (NavTech)

book due to favorable claims trends across a number of prior underwriting

          years.          •   $1.8 million of favorable development on the Somerset Re run-off book of

business where we concluded the IBNR was no longer required and

$1.5 million on our Agriculture reinsurance book where the reported

activity was lower than our initial estimate for the 2009 treaty year.

Partially offsetting these favorable developments were adverse development of:

• $16.5 million in our Specialty run-off books of business, including $13.3

million in our personal umbrella lines across multiple underwriting years

where loss activity has exceeded our expectations and $2.0 million of

adverse development in our Liquor business due to reported claim activity.

          •   $1.7 million for New York construction liability due to unfavorable loss          emergence.                                            56 

--------------------------------------------------------------------------------

Table of Contents

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

• The directors and officers liability book of business had $15.7 million of

adverse development, which was primarily attributable to a severity study

         of our open claims completed during the fourth quarter. This study showed          our IBNR to be significantly deficient if current trends continued and we

raised our loss estimates for underwriting years 2002 to 2009. This was

partially offset by $1.4 million of favorable development on a run-off

lawyers book of business written from London where we saw favorable

         settlements of outstanding claims and $0.7 million of favorable          development on other lawyers business mostly due to a favorable claim          reserve settlement.   The Lloyd's Operations recorded $8.3 million in favorable loss development for prior years during 2010. This included favorable development of $3.2 million in Marine, $4.8 million in NavTech, and $0.5 million in all other areas. The Marine favorable development was primarily from the 2007 and 2008 underwriting years and was driven by loss development on these underwriting years being more favorable than our expectations, particularly in marine liability, assumed reinsurance, and specie classes. NavTech's favorable development was mostly from the 2006 through 2008 underwriting years driven by favorable claims trends in the offshore energy.  

The following is a discussion of relevant factors impacting our $8.9 million net reserve redundancies for the year ended December 31, 2009:

  The Insurance Companies recorded $11.9 million of net prior year unfavorable development for the marine business, of which $10.6 million arose in the marine liability business due to large loss activity in excess of our prior expectations mostly across underwriting years 2005 to 2008 that we recognized by reserve strengthening.  

The Insurance Companies recorded $35.7 million of net prior year savings for property casualty business in total. The favorable development included:

• <money>$36.5 million for contractors' liability due to an actuarial review

conducted in 2009 which indicated that loss development on the 2006 and

         prior underwriting years has been more favorable than our prior          expectations for those underwriting years    

• $9.3 million from our primary E&S lines and $6.2 million in excess

casualty business due to favorable loss trends in underwriting years 2007

          and prior          •   $8.0 million of favorable development on our offshore energy (NavTech)

book due to favorable claims trends across a number of prior underwriting

years

Partially offsetting these favorable developments were adverse development of:

• $12.0 million in our Nav Pac business due to reported loss activity in

excess of our prior expectations from most underwriting years resulting

from reviews of open claims in the auto and liability lines of business

       •   $6.4 million from our liquor business, which is now in run-off          •   $5.9 million in our personal umbrella books of business across most

underwriting years where large loss activity has exceeded our expectations

The Insurance Companies recorded $20.7 million of net prior year unfavorable development for professional liability:

• The directors and officers liability book of business had $12.4 million of

adverse development, which was primarily attributable to the unexpected

         development of previously reported claims in the 2006 and prior          underwriting years. This loss activity was inconsistent with the loss          emergence trends that we observed in calendar years 2007 and 2008 and it

caused us to increase our ultimate loss projections in the 2006 and prior

underwriting years, as well as those in the more current underwriting

         years.          •   The lawyers' liability book of business had adverse development of

$8.3 million due to reported loss activity in underwriting years 2005 to

         2008 in excess of our prior expectations.                                            57 

--------------------------------------------------------------------------------

Table of Contents

  The Lloyd's Operations recorded $5.9 million of net favorable development which included $11.0 million on Marine business concentrated in the liability, specie and cargo books due to reported losses being less than our expectations in underwriting years 2004 to 2008 and $2.5 million on offshore energy business due to favorable loss trends in several years, partially offset by $4.7 million of adverse loss development in the professional liability books due to reported loss activity in excess of our expectations in the lawyers liability book of business for losses occurring in 2007 and $3.0 million in the property book due to an extension in the loss development pattern for the 2006 and 2007 underwriting years.  

Hurricanes Gustav and Ike

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

                                                  Year Ended December 31,              In thousands                 2011          2010          2009              Gross of Reinsurance              Beginning gross reserves   $ 40,095      $ 59,509      $ 107,399              Incurred loss & LAE             (77 )      (1,997 )        1,039              Calendar year payments        8,848        17,417         48,929               Ending gross reserves      $ 31,170      $ 40,095      $  59,509                Gross case loss reserves   $  7,317      $ 17,987      $  34,015              Gross IBNR loss reserves     23,853        22,108         25,494               Ending gross reserves      $ 31,170      $ 40,095      $  59,509                Net of Reinsurance              Beginning net reserves     $    569      $  2,683      $  12,923              Incurred loss & LAE             141         1,257            978              Calendar year payments         (440 )       3,371         11,218               Ending net reserves        $  1,150      $    569      $   2,683                Net case loss reserves     $    951      $    569      $   1,793              Net IBNR loss reserves          199            -             890               Ending net reserves        $  1,150      $    569      $   2,683                                             58 

--------------------------------------------------------------------------------

Table of Contents

Hurricanes Katrina and Rita

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

                                                 Year Ended December 31,              In thousands                 2011          2010          2009              Gross of Reinsurance              Beginning gross reserves   $ 22,599      $ 67,038      $ 97,732              Incurred loss & LAE          (1,102 )      (2,300 )         671              Calendar year payments        1,970        42,139        31,365               Ending gross reserves      $ 19,527      $ 22,599      $ 67,038                Gross case loss reserves   $ 19,105      $ 19,164      $ 49,291              Gross IBNR loss reserves        422         3,435        17,747               Ending gross reserves      $ 19,527      $ 22,599      $ 67,038                Net of Reinsurance              Beginning net reserves     $     90      $  3,536      $  3,667              Incurred loss & LAE            (148 )      (3,559 )         114              Calendar year payments          (98 )        (113 )         245               Ending net reserves        $     40      $     90      $  3,536                Net case loss reserves     $      4      $     44      $    183              Net IBNR loss reserves           36            46         3,353               Ending net reserves        $     40      $     90      $  3,536    The reduction in net incurred loss and LAE shown for the 2005 Hurricanes was due to the release of a reinsurance bad debt reserve established when the events occurred due to the large ceded balances. As those balances have run off and the amounts were fully realized the bad debt reserve has been released back into our general reserve with no change to the overall balance, it has just been reclassified.  

Asbestos Liability

  Our exposure to asbestos liability principally stems from marine liability insurance written on an occurrence basis during the mid-1980s. In general, our participation on such risks is in the excess layers, which requires the underlying coverage to be exhausted prior to coverage being triggered in our layer. In many instances we are one of many insurers who participate in the defense and ultimate settlement of these claims, and we are generally a minor participant in the overall insurance coverage and settlement.  The reserves for asbestos exposures as of December 31, 2011 are for: (i) one large settled claim for excess insurance policy limits exposed to a class action suit against an insured involved in the manufacturing or distribution of asbestos products being paid over several years (two other large settled claims were fully paid in 2007); (ii) other insureds not directly involved in the manufacturing or distribution of asbestos products, but that have more than incidental asbestos exposure for their purchase or use of products that contained asbestos; and (iii) attritional asbestos claims that could be expected to occur over time. Substantially all of our asbestos liability reserves are included in our marine loss reserves.  We believe that there are no remaining known claims where we would suffer a material loss as a result of excess policy limits being exposed to class action suits for insureds involved in the manufacturing or distribution of asbestos products.                                           59 

--------------------------------------------------------------------------------

Table of Contents

There can be no assurances, however, that material loss development may not arise in the future from existing asbestos claims or new claims given the evolving and complex legal environment that may directly impact the outcome of the asbestos exposures of our insureds.

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

                                                 Year Ended December 31,              In thousands                 2011          2010         2009              Gross of Reinsurance              Beginning gross reserves   $ 20,513      $ 20,556     $ 21,774              Incurred loss & LAE             128           638         (663 )              Calendar year payments          811           681          555               Ending gross reserves      $ 19,830      $ 20,513     $ 20,556                Gross case loss reserves   $ 13,565      $ 14,248     $ 14,291              Gross IBNR loss reserves      6,265         6,265        6,265               Ending gross reserves      $ 19,830      $ 20,513     $ 20,556                Net of Reinsurance              Beginning net reserves     $ 15,161      $ 15,172     $ 16,683              Incurred loss & LAE            (780 )         278       (1,616 )              Calendar year payments         (708 )         289         (105 )               Ending net reserves        $ 15,089      $ 15,161     $ 15,172                Net case loss reserves     $  9,029      $  9,101     $  9,112              Net IBNR loss reserves        6,060         6,060        6,060               Ending net reserves        $ 15,089      $ 15,161     $ 15,172   

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 that they relate to unearned premium. The percentage of commission expenses to net earned premiums ("commission expense ratio") for the years ended December 31, 2011, 2010 and 2009 were 16.0%, 16.5% and 14.5%, respectively. The slight decrease in the commission expense ratio for the year ended December 31, 2011 when compared to the same period in 2010 can be attributed to the impact of reinsurance reinstatement premiums recorded in 2010, which reduce net earned premiums and in turn increase the commission expense ratio in 2010. The increase in commission expense ratio for the year ended December 31, 2010 when compared to the same period in 2009 was mostly attributable to greater retentions for net premiums earned in 2010 for the 2009 underwriting year, particularly on our marine quota share treaties, which have reduced the ceding commission benefit, as well as the impact of reinsurance reinstatement premiums related to large loss activity in 2010.  Other Operating Expenses  Other operating expenses were $138.0 million for the year ended December 31, 2011 compared to $139.7 million for the same period in 2010. The decrease was primarily due to a reduction in stock grant expense related to performance based awards that are not expected to vest partially offset by increased expenses for continued investments in new underwriting teams. Other operating expenses for the year ended December 31, 2010 increased 5.3%, or $7.0 million compared to 2009 due to investments in new underwriting teams, additional letter of credit fees due to the increased size of our facility, higher Lloyd's charges due to greater capacity and higher compliance costs due to Solvency II.                                           60

--------------------------------------------------------------------------------

Table of Contents

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 years ended December 31, 2011 and 2010 was $8.2 million, a $0.3 million decrease from the same period in 2009. The decrease is directly related to the $10.0 million of repurchases that were made in 2009.  

Income Taxes

  We recorded income tax expense of $7.1 million, $29.3 million and $23.7 million for the years ended December 31, 2011, 2010 and 2009 respectively. The effective tax rates were 21.8%, 29.6% and 27.3% for the years ended December 31, 2011, 2010 and 2009, respectively. The effective tax rate on net investment income was 27.6%, 27.0% and 25.0% for the years ended December 31, 2011, 2010 and 2009 respectively. As of December 31, 2011, the net deferred federal, foreign, state and local tax liabilities were $6.3 million, compared to net deferred tax assets of $15.1 million as of December 31, 2010 with the change primarily due to the increase in the deferred tax liability for net unrealized gains on securities. Refer to Footnote 7, Income Taxes, included herein, for further detail on the temporary differences that give rise to federal, foreign, state and local deferred tax assets or liabilities.  We had net state and local deferred tax assets amounting to potential future tax benefits of $0.2 million and $2.2 million as of December 31, 2011 and 2010, respectively. Included in the deferred tax assets are state and local net operating loss carry-forwards of $0.2 million and $1.4 million as of December 31, 2011 and 2010, respectively. 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 December 31, 2011 expire from 2024 to 2030.  

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 Navigator's 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 Insurance Companies' and the Lloyd's Operations' results are measured by taking into account net earned premium, net loss and loss adjustment expenses, commission expenses, other operating expenses and other income (expense). The Corporate segment consists of the Parent Company's investment income, interest expense and the related tax effect. 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.  

Following are the financial results of our two underwriting segments.

Insurance Companies

The Insurance Companies consist of Navigators Insurance, 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, professional liability insurance and specialty lines of business including contractors general liability insurance, commercial umbrella and primary and excess casualty businesses. Navigators Specialty underwrites specialty and professional liability insurance on an excess and surplus lines basis. Navigators Specialty is 100% reinsured by Navigators Insurance.

                                       61

--------------------------------------------------------------------------------

Table of Contents

The following table sets forth the results of operations for the Insurance Companies for the years ended December 31, 2011, 2010 and 2009:

                                                         Year Ended December 31,                   Percentage Change                                                                                             2011 vs.       2010 vs. In thousands                                   2011            2010            2009           2010           2009 Gross written premiums                      $  788,419      $  665,505      $  730,776           18.5 %         -8.9 % Net written premiums                           542,391         429,355         477,673           26.3 %        -10.1 %  Net earned premiums                            472,463         438,851         479,121            7.7 %         -8.4 %

Net losses and loss adjustment expenses (341,625 ) (280,120 )

  (304,672 )         22.0 %         -8.1 % Commission expenses                            (64,165 )       (59,122 )       (61,949 )          8.5 %         -4.6 % Other operating expenses                      (101,517 )      (106,631 )      (104,801 )         -4.8 %          1.7 % Other income (expense)                           3,955           1,698           3,498          132.9 %        -51.5 %   Underwriting profit (loss)                  $  (30,889 )    $   (5,324 )    $   11,197             NM         -147.5 %  Net investment income                           54,164          62,792          65,717          -13.7 %         -4.5 % Net realized gains (losses)                     12,151          36,057             533          -66.3 %           NM  Income (loss) before income taxes           $   35,426      $   93,525      $   77,447          -62.1 %         20.8 %  Income tax expense (benefit)                     8,271          27,219          19,819          -69.6 %         37.3 %  Net income (loss)                           $   27,155      $   66,306      $   57,628          -59.0 %         15.1 %  

Losses and loss adjustment expenses ratio 72.3 % 63.8 %

       63.6 % Commission expense ratio                          13.6 %          13.5 %          12.9 % Other operating expense ratio (1)                 20.6 %          23.9 %          21.1 %  Combined ratio                                   106.5 %         101.2 %          97.6 %     

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

NM - Percentage change not meaningful

  Our Insurance Companies reported net income of $27.2 million, $66.3 million and $57.6 million for the years ended December 31, 2011, 2010 and 2009, respectively. The decrease in net income for the year ended December 31, 2011 as compared to the same period in 2010 was largely attributable to an increase in our underwriting loss and a reduction in net realized gains. The increase in net income for the year ended December 31, 2010 as compared to the same period in 2009 was primarily as a result of significant net realized gains partially offset by unfavorable underwriting results.  Our Insurance Companies' combined ratio for the year ended December 31, 2011 was 106.5% compared to 101.2% for the same period in 2010. Our Insurance Companies' pre-tax underwriting loss increased by $25.6 million to $30.9 million as of December 31 2011 compared to $5.3 million for the same period 2010. The increase in pre-tax underwriting loss includes the following adverse activity:    

• Large current accident year energy losses with a net adverse impact of

$16.1 million, inclusive of $5.5 million in reinsurance reinstatement

          premiums, related to drilling operations in the North Sea, Gulf of Mexico          and Russia          •   Prior period net reserve deficiencies of $12.1 million largely          attributable to significant emergence in our Profession Liability

business, partially offset by redundancies from our Property Casualty

         business.                                            62 

--------------------------------------------------------------------------------

Table of Contents

• Current accident year loss emergence of approximately $11.0 million

related to our Professional Liability business, of which approximately

$8.0 million was specific to our Directors and Officers liability

insurance for both publicly and privately held corporations. The remaining

$3.0 million of emergence was specific to our small lawyers and

miscellaneous professional liability coverages.

   In addition to the net adverse impacts noted above, the increase in our Insurance Companies' pre-tax underwriting loss in 2011 over 2010 was affected by the mix of business and loss trends, partially offset by $7.6 million of net adverse activity recorded in 2010. The net adverse activity recorded in 2010 is primarily related to a combined $13.1 million in reinstatement premiums related to the Deepwater Horizon and West Atlas losses, respectively, partially offset by net prior period reserve redundancies of $5.5 million driven by significant redundancies from our Property Casualty business partially offset by loss emergence from our Professional Liability business.  Our Insurance Companies' combined ratio for the year ended December 31, 2010 was 101.2% compared to 97.6% for the same period in 2009. Our Insurance Companies' pre-tax underwriting profit decreased $16.5 million to a $5.3 million pretax underwriting loss for the year ended December 31 2010 compared to $11.2 million of pre-tax underwriting profit for the same period in 2009. The decrease in pre-tax underwriting profit was primarily attributable to large loss activity, namely Deepwater Horizon and West Atlas, as well as reduced rates across all lines due to the soft market conditions, partially offset by net prior period redundancies.  

Insurance Companies' Gross Written Premiums

Marine Premiums. The gross written premiums for the years ended December 31, 2011, 2010 and 2009 consisted of the following:

                                    Year Ended December 31,                Percentage Change                                                                     2011

vs. 2010 vs.

    In thousands             2011          2010          2009          2010  

2009

Marine liability $ 74,429$ 77,066$ 83,915 -3.4 % -8.2 %

    Inland marine             33,120        29,986        28,573          10.5 %           4.9 %    Cargo                     23,333        23,179        26,636           

0.7 % -13.0 %

    Craft/fishing vessel      21,714        19,948        19,758           8.9 %           1.0 %    P&I                       20,496        17,479        25,361          17.3 %         -31.1 %    Transport                 19,932        17,876        21,527          11.5 %         -17.0 %    Bluewater hull            18,695        18,610        19,691           

0.5 % -5.5 %

    Other                     16,781        18,917        15,977         

-11.3 % 18.4 %

     Total Marine           $ 228,500     $ 223,061     $ 241,438           

2.4 % -7.6 %

    The Insurance Companies' Marine gross written premiums for the year ended December 31, 2011 increased 2.4% to $228.5 million compared to 2010 primarily due to Inland Marine which increased by 10.5% as a result of new business and a 7.3% increase on renewal rates, and the P&I product which increased by 17.3%, benefiting from reduced competition as a major competitor had stopped writing P&I business. The Transport business also grew from prior year by 11.5% due to an unexpected increase in global trade in 2011. The increases were offset by the reduction of our Customs Bonds business, reported within Other in the table above, which decreased 39.8% from prior year due to the termination of an agency agreement as well as the current economy's impact on the shipping industry. The 2011 Insurance Company Marine average renewal rate increased 1.3% from prior year.  The Insurance Companies' Marine gross written premiums for the year ended December 31, 2010 decreased 7.6% compared to 2009 due to reductions in our P&I, Marine Liability, Transport and Cargo businesses. The competition in this sector remains significant and excess capacity continued to exist. The weak economy had also led to reduced exposure bases which reduced premiums. In addition, the average Marine renewal premium rates during 2009 increased approximately 2% from prior year.                                           63 

--------------------------------------------------------------------------------

Table of Contents

Property Casualty Premiums. The gross written premiums for the years ended December 31, 2011, 2010 and 2009 consisted of the following:

                                      Year Ended December 31,                Percentage Change                                                                       2011 vs.        2010 vs.   In thousands                2011          2010          2009          2010            2009   Excess Casualty           $ 130,166     $  96,015     $  81,405          35.6 %          17.9 %   Nav Re                      106,496         5,031         6,230            NM           -19.2 %   Primary Casualty:   Construction liability       84,622        88,296       108,744          -4.2 %         -18.8 %   Environmental                20,323         8,832         2,932         130.1 %         201.2 %   Other Primary Casualty       24,413        10,122         5,666         141.2 %          78.7 %    Total Primary Casualty      129,358       107,250       117,342          20.6 %          -8.6 %   Offshore energy              57,482        52,148        47,368          10.2 %          10.1 %   Other                        21,785        52,207        99,940         -58.3 %         -47.8 %    Total Property Casualty   $ 445,287     $ 312,651     $ 352,285          42.4 %         -11.3 %     

NM-Percentage change not meaningful

  The Insurance Companies' Property Casualty gross written premiums for the year ended December 31, 2011 increased by 42.4% to $445.3 million compared to the same period in 2010. The increase was primarily driven by our recently established Nav Re division which produced $106.5 million in gross written premiums for the year ended December 31, 2011. Additionally, we saw growth in our Excess Casualty and Primary Casualty lines due to an increase in underwriting activity resulting from an expansion of our underwriting team and competition dislocation in Excess Casualty. The increases were offset by activity within our Specialty Run-off division, reported within Other in the table above, which decreased as a result of the sale of our NavPac business to Tower Insurance Company of New York via a renewal rights transaction.  The Insurance Companies' Property Casualty gross written premiums for the year ended December 31, 2010 decreased 11.3% to $312.7 million when compared to 2009 due primarily to the run-off of our personal umbrella line as well as continuing weak economic conditions that have reduced demand for construction liability insurance. Our Offshore energy line increased by 10.1% due to greater demand as well as an improved pricing environment resulting from the Deepwater Horizon incident. Finally, our commercial umbrella business line experienced growth in 2010 due to the investments we made in 2008 and 2009 in new underwriters. Our Offshore energy line saw average renewal rate increases of approximately 4%, whereas our contractors' liability and Excess Casualty saw average renewal rate decreases of approximately 5% and 3%, respectively. Our Primary Casualty line saw a slight average renewal rate decline from 2009.  

Professional Liability Premiums. The gross written premiums for the years ended December 31, 2011, 2010 and 2009 consisted of the following:

                                                      Year Ended December 31,                Percentage Change                                                                                      2011 vs.        2010 vs. In thousands                                 2011          2010          2009          2010            2009 E&O                                        $  68,368     $  49,694     $  37,304          37.6 %          33.2 % D&O                                           43,451        65,269        89,017         -33.4 %         -26.7 % Other                                          2,813        14,830        10,732         -81.0 %          38.2 %  Total Professional Liability               $ 114,632     $ 129,793     $ 137,053         -11.7 %          -5.3 %                                             64 

--------------------------------------------------------------------------------

Table of Contents

  The Insurance Companies' Professional Liability gross written premiums for the year ended December 31, 2011 decreased by 11.7% to $114.6 million compared to prior year primarily due to the reduction in our D&O business as we have implemented a revised underwriting strategy exiting areas that have been identified as having greater volatility and shifted our public company book by underwriting higher excess layers. Our Noodle business, reported within Other in the table above, decreased by 97.4% from the prior year due to the termination of the agency relationship in 2010. The decreases were offset by the E&O business, which increased 37.6% from the prior year due to the success of the Real Estate product which was established in the third quarter of 2011 and wrote $8.9 million in gross written premium for the year ended December 31, 2011. The average 2011 Professional Liability renewal rate declined 1.4% from prior year.  The Insurance Companies' professional liability gross written premiums decreased 5.3% to $129.8 million in 2010 compared to 2009. The decline in the D&O gross written premiums was driven by the soft market conditions. The D&O market rates have declined to a level that made it difficult to write new business and a challenge to retain renewal policies while maintaining our pricing discipline in adherence to our underwriting guidelines. Average 2010 renewal premium rates for professional liability decreased approximately 4% in 2010 compared to 2009.  

Lloyd's Operations

  The Lloyd's Operations primarily underwrites 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 which manages Syndicate 1221.  

The following table sets forth the results of operations of the Lloyd's Operations for the years ended December 31, 2011, 2010 and 2009:

                                                         Year Ended December 31,                    Percentage Change                                                                                             2011 vs.        2010 vs. In thousands                                   2011            2010            2009           2010            2009 Gross written premiums                      $  319,797      $  321,696      $  314,142           -0.6 %           2.4 % Net written premiums                           211,407         224,583         223,582           -5.9 %           0.4 %  Net earned premiums                            219,182         221,080         204,242           -0.9 %           8.2 %

Net losses and loss adjustment expenses (135,372 ) (141,035 )

  (131,326 )         -4.0 %           7.4 % Commission expenses                            (48,341 )       (49,991 )       (37,727 )         -3.3 %          32.5 % Other operating expenses                       (36,512 )       (33,112 )       (27,896 )         10.3 %          18.7 % Other income (expense)                            (657 )         3,488             961             NM              NM   Underwriting profit (loss)                  $   (1,700 )    $      430      $    8,254             NM           -94.8 %  Net investment income                            8,955           8,286           9,229            8.1 %         -10.2 % Net realized gains (losses)                     (2,354 )         3,323          (3,193 )           NM              NM  Income (loss) before income taxes           $    4,901      $   12,039      $   14,290          -59.3 %         -15.8 %  Income tax expense (benefit)                     1,523           4,389           5,582          -65.3 %         -21.4 %  Net income (loss)                           $    3,378      $    7,650      $    8,708          -55.8 %         -12.1 %  

Losses and loss adjustment expenses ratio 61.8 % 63.8 %

       64.3 % Commission expense ratio                          22.1 %          22.6 %          18.5 % Other operating expense ratio (1)                 16.9 %          13.4 %          13.2 %  Combined ratio                                   100.8 %          99.8 %          96.0 %     

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

NM-Percentage change not meaningful.

                                       65

--------------------------------------------------------------------------------

Table of Contents

  Our Lloyd's Operations reported net income of $3.4 million, $7.7 million and $8.7 million for the years ended December 31, 2011, 2010 and 2009, respectively. The decrease in net income for the year ended December 31, 2011 as compared to the same period in 2010 was largely attributable to adverse underwriting activity and current year net realized losses. The decrease in net income for the year ended December 31, 2010 as compared to the same period in 2009 was primarily as a result adverse underwriting activity, specifically due to large losses such as Deepwater Horizon, partially offset by net realized gains.  Our Lloyd's Operations combined ratio for the year ended December 31, 2011 was 100.8% compared to 99.8% for the same period in 2010. Our Lloyd's Operations pre-tax underwriting profit decreased by $2.1 million to a $1.7 million pre-tax underwriting loss for the year ended December 31, 2011 compared to $0.4 million of underwriting profit for the same period in 2010. The decrease in pre-tax underwriting profit includes the following adverse activity:    

• Large current accident year energy losses with a net adverse impact of

$9.5 million, inclusive of $2.7 million in reinsurance reinstatement

         premiums, related to drilling operations in the North Sea, Gulf of Mexico          and Russia, as well as an onshore industrial site.    

• Sliding scale commission adjustments of $3.3 million related to large loss

         activity that has reduced our ceding commission benefit on a large loss          quota share treaty.   In addition to the net adverse impacts noted above, the decrease in our Lloyd's Operations pre-tax underwriting profit in 2011 over 2010 was affected by mix of business and loss trends, partially offset by $9.4 million of net adverse activity recorded in 2010 related to the Deepwater Horizon and West Atlas loses.  Our Lloyd's Operations combined ratio for the year ended December 31, 2010 was 99.8% compared to 96.0% for the comparable period in 2009. Our Lloyd's Operations pre-tax underwriting profit declined by $7.9 million to a $0.4 million underwriting profit compared to $8.3 million for the same period in 2009. The decrease in pre-tax underwriting profit was primarily attributable to large loss activity, namely Deepwater Horizon and West Atlas, partially offset by net prior period redundancies.  

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 was £175 million ($271 million) in 2011, £168 million ($264 million) in 2010, £124 million ($194 million) in 2009.  

Marine Premiums. The gross written premiums for the years ended December 31, 2011, 2010 and 2009 consisted of the following:

                                                      Year Ended December 31,                Percentage Change                                                                                      2011 vs.        2010 vs. In thousands                                 2011          2010          2009          2010            2009 Cargo and specie                           $  67,507     $  78,515     $  92,139         -14.0 %         -14.8 % Marine and energy liability                   60,433        61,230        51,204          -1.3 %          19.6 % Assumed reinsurance                           16,730        14,380        19,756          16.3 %         -27.2 % War                                           12,856         9,965        10,163          29.0 %          -1.9 % Hull                                          10,036        18,633        18,697         -46.1 %          -0.3 %  Total Marine                               $ 167,562     $ 182,723     $ 191,959          -8.3 %          -4.8 %                                             66 

--------------------------------------------------------------------------------

Table of Contents

  The 2011 Lloyd's Operations Marine gross written premiums decreased 8.3% to $167.6 million compared to the same period in 2010. The reduction is attributed to a decrease in Cargo and Hull production. Cargo production has decreased as a result of depressed activity and a reduction in commodity prices due to an unfavorable economic environment. Hull gross written premium declined by 46.1% from prior year as we continue our strategy to reduce the book. Partially offsetting the decrease in activity was the War business which produced $12.9 million in gross written premium for the year ended December 31, 2011 due to the widening of hazardous war zones. Average renewal premium rates for 2011 increased approximately 0.9% compared to the same period in 2010, with larger increases on our marine and energy liability products.  The 2010 Lloyd's Operations Marine gross written premiums decreased 4.8% to $182.7 million compared to 2009 due to declines mostly in Cargo and specie lines as a result of the global economic slowdown. Our marine liability lines experienced a 19.6% increase due to improved energy liability activity. The average renewal premium rates increased approximately 3% in 2010 compared to the previous year.  

Property Casualty Premiums. The gross written premiums for the years ended December 31, 2011, 2010 and 2009 consisted of the following:

                                                      Year Ended December 31,               Percentage Change                                                                                      2011 vs.        2010 vs. In thousands                                  2011          2010         2009          2010            2009 Offshore energy                             $  46,212     $ 43,479     $ 34,469            6.3 %          26.1 % Engineering and construction                   32,292       23,411       18,383           37.9 %          27.4 % Onshore energy                                 30,247       17,349       14,055           74.3 %          23.4 % Other                                           6,387       10,560       11,244          -39.5 %          -6.1 %  Total Property Casualty                     $ 115,138     $ 94,799     $ 78,151           21.5 %          21.3 %    The 2011 Lloyd's Operations Property Casualty gross written premiums increased 21.5% compared to the same period in 2010. The increase is primarily due to greater Onshore Energy premiums as a result of steady production and renewal rate increases resulting from reduced competition that has occurred due to recent loss activity. Engineering & Construction has also increased production from prior year primarily due to rate increases prompted by a contraction in the market.  The 2010 Lloyd's Operations Property Casualty gross written premiums of $94.8 million increased 21.3% compared to 2009 due to increases in our offshore energy, onshore energy and engineering and construction lines. The significant increase in our offshore energy lines was due to an increase in demand as well as an improved pricing environment as a result of the Deepwater Horizon incident. We began writing Bloodstock (animal mortality) business during 2009 by participating in a facility originated by another Lloyd's syndicate. Average premium renewal rates in our NavTech lines increased approximately 1% and 10% in 2010 and 2009 compared to the previous years, respectively.  

Professional Liability Premiums. The gross written premiums for the years ended December 31, 2011, 2010 and 2009 consisted of the following:

                                        Year Ended December 31,               Percentage Change                                                                        2011 vs.        2010 vs.  In thousands                     2011         2010         2009         2010            2009  D&O (public and private)       $ 27,895     $ 30,777     $ 26,776          -9.4 %          14.9 %  E&O                               9,202       13,397       17,256         -31.3 %         -22.4 %   Total Professional Liability   $ 37,097     $ 44,174     $ 44,032         -16.0 %           0.3 %                                             67 

--------------------------------------------------------------------------------

Table of Contents

  The 2011 Lloyd's Operations Professional Liability gross written premiums decreased 16.0% compared to the same period in 2010, due to restructuring the E&O and D&O businesses. E&O gross written premium declined 31.3% from the prior year due to exiting areas of business that were deemed unprofitable as well as reducing our number of underwriters. We had also restructured the D&O business by reducing our exposure to certain areas and non-renewing business that no longer fit our underwriting strategy. The 2011 average renewal premium rates for the Professional Liability division decreased approximately 1.8% compared to the same periods in 2010.  The 2010 Lloyd's Operations professional liability gross written premiums increased 0.3% compared to the same period in 2009. We added a team at Lloyd's at the end of 2008 to write excess D&O business. During 2008 and 2009 we began writing professional liability business from our offices in Stockholm, Sweden and Copenhagen, Denmark, respectively.  

Off-Balance Sheet Transactions

  We have no material off-balance sheet transactions with the exception of our letter of credit facility. For a discussion of our letter of credit facility, refer to "Capital Resources".  

Tabular Disclosure of Contractual Obligations

The following table sets forth the best estimate of our known contractual obligations with respect to the items indicated as of December 31, 2011:

                                                                    Payments Due by Period                                                        Less than 1 In thousands                             Total            Year          1-3 Years      3-5 Years       Thereafter Reserves for losses and LAE(1)        $ 2,082,679     $     616,122     $  768,161     $  370,449     $    327,947 7% Senior Notes (2)                       151,225             8,050         16,100        127,075               - Operating Leases                           49,253             9,243         17,008         13,935            9,067  Total                                 $ 2,283,157     $     633,415     $  801,269     $  511,459     $    337,014     

(1) The amounts determined are estimates which are subject to a high degree of

variation and uncertainty, and are not subject to any specific payment

schedule since the timing of these obligations are not set contractually. The

amount in the above table excludes reinsurance recoveries of $845.4 million.

See "Business-Loss Reserves" included herein.

(2) Includes interest payments

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 several 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.                                           68

--------------------------------------------------------------------------------

Table of Contents

  Our capital resources consist of funds deployed or available to be deployed to support our business operations. As of December 31, 2011 and 2010, our capital resources were as follows:                                                            December 31,           In thousands                              2011           2010           Senior debt                             $ 114,276      $ 114,138           Stockholders' equity                      803,435        829,354            Total capitalization                    $ 917,711      $ 943,492             Ratio of debt to total capitalization        12.5 %         12.1 %   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.  For 2011, the Company repurchased 1,979,107 shares of the Parent Company's common stock at an aggregate purchase price of $90.9 million and a weighted average price per share of $45.91 pursuant to the share repurchase program. Since 2007, the Company has repurchased 3,609,721 shares of the Parent Company's common stock at an aggregate purchase price of $161.1 million and a weighted average price per share of $44.64. As of December 31, 2011, authorization for the share repurchase program has expired.  In July 2009, we filed a universal shelf registration statement with the Securities and Exchange Commission. This registration statement, which expires in July 2012, 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, stock purchase units and trust preferred securities guaranteed by the Parent Company. 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.  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 which are now $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 December 31, 2011 surplus of Navigators Insurance Company, the approximate maximum amount available for the payment of dividends by Navigators Insurance Company during 2012 without prior regulatory approval is $59.2 million. During 2011 Navigators Insurance Company declared and paid $45.0 million of dividends to the Parent Company.                                           69

--------------------------------------------------------------------------------

Table of Contents

  Condensed Parent Company balance sheets as of December 31, 2011 and 2010 are shown in the table below:                                                      December 31,       December 31,     In thousands                                      2011               2010     Cash and investments                         $        8,315     $       53,217     Investments in subsidiaries                         895,047            

877,999

    Goodwill and other intangible assets                  2,534            

 2,534     Other assets                                         13,806             12,028      Total assets                                 $      919,702     $      945,778       Senior notes                                 $      114,276     $      114,138

    Accounts payable and other liabilities                  649            

   946     Accrued interest payable                              1,342              1,340      Total liabilities                            $      116,267     $      116,424       Stockholders' equity                         $      803,435     $      829,354 

Total liabilities and stockholders' equity $ 919,702 $ 945,778

    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 is a letter of credit facility and replaces a $140 million credit facility agreement that expired March 31, 2011. The credit facility, which is denominated in U.S. dollars, will be utilized to fund our participation in Syndicate 1221 through letters of credit for the 2011 and 2012 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. The ability to issue new letters of credit expired on December 31, 2011. 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 December 31, 2011, letters of credit with an aggregate face amount of $149.6 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 December 31, 2011.  As a result of the April 1, 2011 replacement of the expiring credit facility, the applicable margin and applicable fee rate payable under the letter of credit facility are now based on a tiered schedule that is based on the Company's then-current ratings issued by S&P and Moody's with respect to the Company's senior unsecured long-term debt securities, without third-party credit enhancement, and the amount of the Company's own 'Funds at Lloyd's' collateral.  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 those gross loss reserves as of December 31, 2011 are anticipated to be billed and collected over the next several years as the gross loss reserves are paid by the Company.                                           70 

--------------------------------------------------------------------------------

Table of Contents

  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 by the end of the subsequent quarter. 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 $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 monthly or 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  

Cash flow from operations was $118.3 million, $118.2 million and $103.9 million for the years ended December 31, 2011, 2010, and 2009, respectively. The increase in cash flow from operations was due to improved collections on reinsurance recoverable as well as premium receivable.

  Net cash provided by investing activities was $66.0 million for the year ended December 31, 2011 primarily due to the sale of securities from the ongoing management of our investment portfolio. For the years ended December 31, 2010 and 2009 we reported net cash used by investing activities of $36.5 million and $92.8 million, respectively. The decrease in net cash used in investing activities is primarily related to the repurchase of the Parent Company's common stock under our share repurchase program.  Net cash used in financing activities was $88.8 million, $50.5 million and $12.1 million for the years ended December 31, 2011, 2010 and 2009. The increase in the use of cash is primarily related to the repurchase of the Parent Company's common stock under our share repurchase program.  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.                                           71 

--------------------------------------------------------------------------------

Table of Contents

Investments

  As of December 31, 2011, 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 $16.5 million, consists of investment grade bonds. As of December 31, 2011, our portfolio had a duration of 3.6 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 December 31, 2011 and 2010, 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 December 31, 2011 and 2010:                                                                          December 31, 2011                                                           Gross            Gross                              OTTI                                                         Unrealized       Unrealized        Amortized       Recognized In thousands                           Fair Value         Gains            Losses            Cost            in OCI Fixed maturities: U.S. Government 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 )                                                                            December 31, 2010                                                           Gross            Gross                              OTTI                                                         Unrealized       Unrealized        Amortized       Recognized In thousands                           Fair Value         Gains            Losses            Cost            in OCI Fixed-maturities: U.S. Government Treasury bonds, agency bonds, and foreign government bonds                                  $   324,145     $      5,229     $     (4,499 )    $   323,415     $         - States, municipalities and political subdivisions                               392,250           11,903           (3,805 )        384,152               - Mortgage-backed and asset-backed securities: Agency mortgage-backed securities          382,628           10,127           (2,434 )        374,935               - Residential mortgage obligations            20,463               24           (2,393 )         22,832           (1,646 ) Asset-backed securities                     46,093              247             (292 )         46,138               - Commercial mortgage-backed securities                                 190,015            4,804           (1,794 )        187,005               -  Subtotal                               $   639,199     $     15,202     $     (6,913 )    $   630,910     $     (1,646 ) Corporate bonds                            526,651           15,075           (5,545 )        517,121               -  Total fixed-maturities                 $ 1,882,245     $     47,409     $    (20,762 )    $ 1,855,598     $     (1,646 ) Equity securities-common stocks             87,258           22,475              (10 )         64,793               - Short-term investments                     153,057               -                -           153,057               - Cash                                        31,768               -                -            31,768               -  Total                                  $ 2,154,328     $     69,884     $    (20,772 )    $ 2,105,216     $     (1,646 )                                             72 

--------------------------------------------------------------------------------

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 over the last year primarily due to unrealized gains in 2011. The consolidated average investment yield of the portfolio for 2011, 2010 and 2009 was 3.0%, 3.5% and 3.8%, respectively due to the general decline in market yields over the period. The tax equivalent yields for 2011, 2010 and 2009 on a consolidated basis were 3.5%, 4.0% and 4.6%, respectively. The portfolio's duration was 3.6 years and 4.4 years as of December 31, 2011 and 2010, respectively. Since the beginning of 2011, the tax-exempt portion of our investment portfolio has increased by $31.0 million to approximately 19.7% of the fixed maturities investment portfolio at December 31, 2011 compared to approximately 18.1% at December 31, 2010.  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 December 31, 2011 are shown in the following table:                                                           December 31, 2011                                                                    Amortized          In thousands                             Fair Value         Cost          Due in one year or less                  $    65,454     $    64,925          Due after one year through five years        551,225         542,238          Due after five years through ten years       372,275         349,061          Due after ten years                          215,139         201,523          Mortgage- and asset-backed securities        683,976         658,963           Total                                    $ 1,888,069     $ 1,816,710    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.                                           73

--------------------------------------------------------------------------------

Table of Contents

  The following table shows the amount and percentage of our fixed maturities as of December 31, 2011 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.                                                  December 31, 2011                                                                 Percent of             In thousands            Rating     Fair Value         Total             Rating description:             Extremely strong      AAA          $   291,600               15 %             Very strong           AA             1,048,922               56 %             Strong                A                422,777               22 %             Adequate              BBB              108,299                6 %             Speculative           BB & Below        11,665                1 %             Not rated             NR                 4,806                0 %              Total                 AA           $ 1,888,069              100 %   

The following table sets forth our U.S. Treasury bonds, Agency bonds, and Foreign government bonds as of December 31, 2011 and 2010:

                                                       December 31, 2011                                                   Gross            Gross          Cost or                                                 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                                                         December 31, 2010                                                  Gross            Gross           Cost or                                                Unrealized       Unrealized       Amortized   In thousands                Fair Value         Gains           (Losses)           Cost   U.S. Treasury bonds        $    213,544     $      3,552     $     (3,554 )    $  213,546   Agency bonds                     77,229            1,311             (604 )        76,522   Foreign government bonds         33,372              366             (341 )        33,347    Total                      $    324,145     $      5,229     $     (4,499 )    $  323,415                                             74 

--------------------------------------------------------------------------------

Table of Contents

  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 December 31, 2011. The securities that are not rated in the table below are primarily state bonds.          In thousands                                  December 31, 2011                       Equivalent       Equivalent       Moody's                                        Net Unrealized       S&P Rating        Rating       Fair Value       Book Value        Gain (Loss)       AAA/AA/A       Aaa/Aa/A       $    389,598     $    361,431     $        28,167       BBB            Baa                  16,434           15,913                 521       BB             Ba                       -                -                   -       B              B                        -                -                   -       CCC or lower   Caa or lower             -                -                   -       NR             NR                    4,804            4,713                  91                                      $    410,836     $    382,057     $        28,779    The following table sets forth the municipal bond holdings by sectors as of December 31, 2011 and 2010:                                   December 31, 2011                  December 31, 2010                                            Percent of                         Percent of     In thousands          Fair Value         Total           Fair Value         Total     Municipal Sector:     General obligation   $     43,195               10 %    $     13,249                3 %     Prerefunded                18,636                5 %          14,122                4 %     Revenue                   309,659               75 %         313,166               80 %     Taxable                    39,346               10 %          51,713               13 %                           $    410,836              100 %    $    392,250              100 %    We own $135.4 million of municipal securities which are credit enhanced by various financial guarantors. As of December 31, 2011, the average underlying credit rating for these securities is AA-. 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") and the Federal Home Loan Mortgage Corporation ("FHLMC") 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.                                           75

--------------------------------------------------------------------------------

Table of Contents

The following table sets forth our agency mortgage-backed securities and residential mortgage obligations 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 December 31, 2011:

                                                                    December 31, 2011                                                               Gross             Gross                                                             Unrealized        Unrealized        Amortized In thousands                              Fair Value          Gains             Losses             Cost Agency mortgage-backed securities: GNMA                                     $    124,612      $      7,113      $         -        $  117,499 FNMA                                          191,197             8,072                (3 )        183,128 FHLMC                                          80,051             2,136                -            77,915  Total agency mortgage-backed securities                               $    395,860      $     17,321     

$ (3 ) $ 378,542

   Residential mortgage-backed securities: Prime                                    $     12,831      $          8      $     (2,279 )     $   15,102 Alt-A                                           1,926                -               (527 )          2,453 Subprime                                           -                 -                 -                - Non-US RMBS                                     8,391                -                (42 )          8,433  Total residential mortgage-backed securities                               $     23,148      $          8      $     (2,848 )     $   25,988    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 December 31, 2011.           In thousands                                 December 31, 2011                        Equivalent                                           Net        Equivalent       Moody's                                         Unrealized        S&P Rating        Rating       Fair Value       Book Value       Gain (Loss)        AAA/AA/A       Aaa/Aa/A       $     10,675     $     11,099     $        (424 )        BBB            Baa                     810              929              (119 )        BB             Ba                    2,181            2,418              (237 )        B              B                     1,957            2,380              (423 )        CCC or lower   Caa or lower          7,525            9,162            (1,637 )        NR             NR                       -                -                 -                                       $     23,148     $     25,988     $      (2,840 )   

Details of the collateral of our asset-backed securities portfolio as of December 31, 2011 are presented below:

                      $00000       $00000       $00000       $00000       $00000       $00000       $00000        $00000          $00000                                                                                                                             Unrealized                                                                                                 Fair        Amortized          Gain In thousands      AAA           AA           A           BBB           BB          CCC         Value          Cost            (Loss) Auto loans      $     -      $  5,763     $  3,762     $     -      $     -      $     -      $  9,525     $     9,376     $        149 Credit cards      13,905           -            -            -            -            -        13,905          13,597              308 Time Share            -            -        15,723           -            -            -        15,723          15,554              169 Student Loans      5,018        2,868           -            -            -            -         7,886           7,933              (47 ) Miscellaneous      1,893           -            -            -            -             2        1,895           1,854               41  Total           $ 20,816     $  8,631     $ 19,485     $     -      $     -      $      2     $ 48,934     $    48,314     $        620                                             76 

--------------------------------------------------------------------------------

Table of Contents

  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 December 31, 2011.           In thousands                                 December 31, 2011                        Equivalent                                           Net        Equivalent       Moody's                                         Unrealized        S&P Rating        Rating       Fair Value       Book Value       Gain (Loss)        AAA/AA/A       Aaa/Aa/A       $    216,034     $    206,119     $       9,915        BBB            Baa                      -                -                 -        BB             Ba                       -                -                 -        B              B                        -                -                 -        CCC or lower   Caa or lower             -                -                 -        NR             NR                       -                -                 -                                       $    216,034     $    206,119     $       9,915    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 December 31, 2011.        In thousands                                       December 31, 2011                                                                                Net     Equivalent     Equivalent Moody's                                      Unrealized     S&P Rating           Rating          Fair Value       Book Value       Gain (Loss)     AAA/AA/A       Aaa/Aa/A             $    366,132     $    357,462     $       8,670     BBB            Baa                        91,055           90,754               301     BB             Ba                             -                -                 -     B              B                              -                -                 -     CCC or lower   Caa or lower                   -                -                 -     NR             NR                             -                -                 -                                          $    457,187     $    448,216     $       8,971    The company holds securities of $64.9 million at fair value and $65.6 million at amortized cost primarily in non-sovereign fixed maturities in the European Union. This represents 3.3% of our total fixed income and equity portfolio. Our largest exposure is in France with a total of $28.8 million followed by the Netherlands with a total of $26.6 million. We have no exposure to Greece, Portugal, Italy or Spain.                                           77 

--------------------------------------------------------------------------------

Table of Contents

  The following table summarizes all securities in a gross unrealized loss position as of December 31, 2011 and 2010, 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:                                                                      December 31, 2011                                     December 31, 2010                                                                                           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                                                    7      $     58,587      $         98                36      $    163,253      $      4,499 7-12 months                                                                    -                 -                 -                 -                 - > 12 months                                                   2             6,883               285                -                 -                 -  Subtotal                                                      9      $     65,470      $        383                36      $    163,253      $      4,499 States, municipalities and political subdivisions 0-6 months                                                    7      $      5,894      $         72                57      $    112,291      $      3,749 7-12 months                                                   1               216                 1                 1             1,004                20 > 12 months                                                   5             2,420                35                 4             1,317                36  Subtotal                                                     13      $      8,530      $        108                62      $    114,612      $      3,805 Agency mortgage-backed securities 0-6 months                                                    3      $      5,087      $          3                36      $    139,226      $      2,434 7-12 months                                                                    -                 -                 -                 -                 - > 12 months                                                                    -                 -                 -                 -                 -  Subtotal                                                      3      $      5,087      $          3                36      $    139,226      $      2,434 Residential mortgage obligations 0-6 months                                                    6      $      6,672      $        184                 3      $      3,215      $         20 7-12 months                                                   7             5,250               313                -                 -                 - > 12 months                                                  47            10,749             2,351                52            15,939             2,373  Subtotal                                                     60      $     22,671      $      2,848                55      $     19,154      $      2,393 Asset-backed securities 0-6 months                                                    2      $      4,933      $         12                 7      $     28,175      $        292 7-12 months                                                   5             6,645                63                -                 -                 - > 12 months                                                   1                 2                -                  1                 2                -  Subtotal                                                      8      $     11,580      $         75                 8      $     28,177      $        292 Commercial mortgage-backed securities 0-6 months                                                    6      $      5,465      $         29                16      $     78,212      $      1,755 7-12 months                                                   3             6,840               550                -                 -                 - > 12 months                                                   3             1,503                14                 2               491                39  Subtotal                                                     12      $     13,808      $        593                18      $     78,703      $      1,794 Corporate bonds 0-6 months                                                   52      $    135,516      $      4,539                98      $    214,180      $      5,545 7-12 months                                                  18            27,561             1,457                -                 -                 - > 12 months                                                   8            14,898               776                -                 -                 -  Subtotal                                                     78      $    177,975      $      6,772                98      $    214,180      $      5,545  Total fixed maturities                                      183      $    305,121      $     10,782               313      $    757,305      $     20,762   Equity securities - common stocks 0-6 months                                                    4      $      3,320      $        587                 1      $        322      $         10 7-12 months                                                   1             1,629               371                -                 -                 - > 12 months                                                  -                 -                 -                 -                 -                 -  Total equity securities                                       5      $      4,949      $        958                 1      $        322      $         10                                             78 

--------------------------------------------------------------------------------

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 project 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 ultimately incurs 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-based 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 December 31, 2011, the largest single unrealized loss by issuer in the fixed maturities was $1.4 million.

  The following table shows the S&P ratings and equivalent Moody's ratings of the fixed maturity securities in our portfolio with gross unrealized losses as of December 31, 2011. Not all of the securities are rated by S&P and/or Moody's.                                                                                December 31, 2011 In thousands                                      Gross Unrealized Loss                                   Fair Value                      Equivalent Equivalent            Moody's S&P Rating             Rating              Amount                Percent of Total             Amount            Percent of Total AAA/AA/A            Aaa/Aa/A            $       6,573                           61 %         $ 245,941                         81 % BBB                 Baa                         1,901                           18 %            47,561                         15 % BB                  Ba                            245                            2 %             1,703                          1 % B                   B                             423                            4 %             1,957                          1 % CCC or lower        Caa or lower                1,637                           15 %             7,527                          2 % NR                  NR                              3                            0 %               432                          0 %                                          $      10,782                          100 %         $ 305,121                        100 %                                             79 

--------------------------------------------------------------------------------

Table of Contents

  As of December 31, 2011, the gross unrealized losses in the table directly 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 $2.3 million which is rated below investment grade. 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.  The contractual maturity by the number of years until maturity for fixed maturity securities with unrealized losses as of December 31, 2011 is shown in the following table:                                                                         December 31, 2011                                                 Gross Unrealized Losses                       Fair Value                                                                   Percent of                          Percent of In thousands                                   Amount               Total             Amount            Total Due in one year or less                    $            8                   0 %      $   5,570                  2 % Due after one year through five years               4,992                  46 %        190,234                 62 % Due after five years through ten years              1,786                  17 %         42,649                 14 % Due after ten years                                   477                   4 %         13,522                  4 % Mortgage- and asset-backed securities               3,519                  33 %         53,146                 18 %  Total                                      $       10,782                 100 %      $ 305,121                100 %    The following table summarizes the gross unrealized investment losses by length of time where the fair value is less than 80% of amortized cost as of December 31, 2011.                                                                         December 31, 2011                                                           Fixed              Equity In thousands                                            Maturities         Securities         Total Less than three months                                 $         -        $        243       $   243 Longer than three months and less than six months                                  103           103 Longer than six months and less than twelve months               -                  -             - Longer than twelve months                                     1,039                 -          1,039  Total                                                  $      1,039       $        346       $ 1,385                                             80 

--------------------------------------------------------------------------------

Table of Contents

  The table below summarizes our activity related to OTTI losses for the periods indicated:                                                                                   Year Ended December 31,                                                          2011                           2010                            2009                                                 Number of                      Number of                      Number of In thousands, except # of securities            Securities       Amount        Securities       Amount        Securities        Amount Total other than temporary impairment losses: Corporate and other bonds                                 1      $   109                -       $    -                  2      $    564 Commercial mortgage-backed securities                    -            -                 -            -                 -             - Residential mortgage-backed securities                   19        2,616                18        1,835                39        19,783 Asset-backed securities                                  -            -                 -            -                  1           143 Equities                                                  2          892                 2          387                56         8,775  Total                                                    22      $ 3,617                20      $ 2,222                98      $ 29,265 Less: Portion of loss in accumulated other comprehensive income (loss): Corporate and other bonds                                        $    -                         $    -                         $     - Commercial mortgage-backed securities                                 -                              -                               - Residential mortgage-backed securities                             1,632                          1,142                          17,324 Asset-backed securities                                               -                              -                               64 Equities                                                              -                              -                               -  Total                                                            $ 1,632                        $ 1,142                        $ 17,388 Impairment losses recognized in earnings: Corporate and other bonds                                        $   109                        $    -                         $    564 Commercial mortgage-backed securities                                 -                              -                               - Residential mortgage-backed securities                               984                            693                           2,458 Asset-backed securities                                               -                              -                               80 Equities                                                             892                            387                           8,775  Total                                                            $ 1,985                        $ 1,080                        $ 11,877    During 2011, we recognized OTTI losses of $2.0 million related to non-agency mortgage-backed securities, two equity securities and one corporate bond. During the comparable periods in 2010 and 2009, we recognized OTTI losses of $1.1 million and $11.9 million, respectively, 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.                                           81 

--------------------------------------------------------------------------------

Table of Contents

Wordcount:

23687