Annual Report Insuring A World In Motion

Transcription

1 Annual Report 2002 Insuring A World In Motion

2 Insuring A World In Motion Uncertainty is the most basic reason for the existence of the insurance industry. In 2002, the world became a far more uncertain place. New risks emerged. Conventional wisdom about exposure to loss was challenged. Multinational corporations had to re-evaluate their exposure to terrorism losses on a global basis. Many found that terrorism coverage, once a throw-in, was now expensive or unavailable. Earnings restatements and accounting irregularities caused the executives of several previously admired corporations to go from being heroes to poster children for greed and fraud. In response, the government developed new legislation that increased the uncertainty of corporate officers and directors. The most effective response to dealing with new or increased risk is insurance. In 2002, Navigators responded to a world in motion with an enhanced array of insurance products to transfer risk. As a specialty underwriting organization, our product line specialists identify opportunities to respond to the insurance needs of a changing world. We have endeavored to capture our theme Insuring A World In Motion throughout this Annual Report. TABLE OF CONTENTS Navigators At A Glance Five Year Summary of Operations Chairman s Letter Navigators Core Values Executive Management Team Corporate Data Form 10-K Management s Discussion and Analysis Independent Auditors Report Consolidated Financial Statements Notes to Consolidated Financial Statements

3 Navigators at a glance The Navigators Group is an international insurance holding company with insurance company operations, underwriting management companies, and operations at Lloyd s of London. Headquartered in New York City, Navigators has offices in major insurance centers in the United States and the United Kingdom. Navigators, one of the largest marine insurers in the world, is committed to the principles of underwriting excellence and to providing quality service to its clients. Navigators Marine & Energy Navigators Specialty Marine insurance has been our specialty since the inception of Navigators. The origins of the Group date back to 1974, when New York Marine Managers was formed in New York City. Now known as Navigators Marine and Energy, Navigators underwrites ocean marine and energy insurance products in New York, London, Houston, Chicago, Seattle and Oakland. Marine insurance protects companies engaged in the diverse aspects of shipping, international trade and transportation. Navigators Specialty provides property and casualty insurance products for specific niche businesses. Based in San Francisco, the largest component of Navigators Specialty s business consists of general liability insurance for contractors. In addition, the division offers other specialty insurance products, including personal umbrella and surety bonds. Navigators Pro Lloyd s of London Navigators Pro provides niche insurance solutions for management and professional liability exposures of businesses. Products include directors and officers (D&O) liability, fiduciary liability, errors and omissions (E&O) liability, employment practices liability and crime insurance. Navigators Pro focuses on small to mid-cap public corporations, as well as privately held companies. Navigators conducts its operations at Lloyd s through its wholly-owned underwriting agency, Navigators Underwriting Agency Ltd., and by managing and providing the majority of the capacity to Millennium Syndicate By accessing Lloyd s unique licenses and distribution system, Navigators has the global reach to insure clients worldwide, resulting in Navigators underwriting one of the largest specialist marine portfolios at Lloyd s. A NNUAL R EPORT

4 T HE N AVIGATORS G ROUP, I NC. F IVE Y EAR S UMMARY OF O PERATIONS Year Ended December 31, (In thousands, except per share and ratio data) GAAP Operating Information: Gross written premium $447,838 $278,194 $188,425 $167,112 $172,211 Net earned premium , ,244 97,240 89,442 91,203 Net investment income ,058 19,354 18,447 15,985 15,209 Total revenues , , , , ,120 Income (loss) before income taxes ,216 5,360 10,338 (5,392) 15,153 Net income (loss) ,397 3,668 7,032 (3,652) 11,489 Net income (loss) per share: Basic $ 1.94 $ 0.44 $ 0.84 $ (0.43) $ 1.37 Diluted $ 1.89 $ 0.43 $ 0.84 $ (0.43) $ 1.36 Average common shares: Basic ,463 8,419 8,414 8,419 8,414 Diluted ,676 8,547 8,414 8,419 8,459 Combined loss & expense ratio % 103.7% 101.1% 111.2% 95.7% GAAP Balance Sheet Information (at end of period): Total investments & cash $452,885 $333,090 $293,480 $270,169 $281,079 Total assets , , , , ,086 Loss and LAE reserves , , , , ,444 Notes payable ,500 19,000 22,000 24,000 23,500 Stockholders equity , , , , ,266 Book value per share $ $ $ $ $ Navigators and NIC Insurance Companies Combined Statutory Results: Net income $ 9,499 $ 11,219 $ 13,834 $ 9,320 $ 17,987 Net loss and LAE reserves , , , , ,657 Surplus , , , , ,658 Loss ratio % 60.7% 53.5% 76.4% 60.7% Expense ratio % 31.4% 37.6% 34.3% 31.9% Combined ratio % 92.1% 91.1% 110.7% 92.6% 2 A NNUAL R EPORT 2002

5 T HE N AVIGATORS G ROUP, I NC. To Our Shareholders: I am pleased to report that 2002 was a year of profitable growth for Navigators. Net income for the year was $16.4 million or $1.89 per share, an increase of 347% over Investment assets increased 36% to $453 million. Shareholders equity increased 16% to $171 million and book value was $20.18 per share at year end. Insurance rates strengthened across all our specialty lines in 2002 for the second consecutive year. With a strong underwriting performance from our marine agencies, and our Lloyd s syndicate returning to profitability, we made a solid underwriting gain. Our Group combined ratio of 97.5% is evidence of management s commitment to achieving an underwriting profit. Navigators Insurance Company s statutory combined ratio of 93.6% once again compared favorably to the U.S. property and casualty industry average of 105.7%. When it comes to underwriting, Navigators continues to outperform the industry. As a result of a much improved underwriting environment, we were able to increase our premium volume considerably, with all operating divisions enjoying strong growth. Overall, the Group s gross written premium was $448 million, up 61% from 2001, and net written premium grew 57% to $271 million. Marine Agencies Anchoring our specialty businesses, we produced an exceptional underwriting result in our largest and most longstanding area of specialization, marine insurance. What makes this result even more satisfying is that marine claims activity was particularly severe in 2002 and underwriting profit in the international marine market was rare. While we had our fair share of losses, our marine agencies were able to produce their twenty-ninth consecutive year of underwriting profit, a remarkable achievement. While it is pleasing to report this result, the marine market generally still needs further increases to get premiums back to profitable levels overall. From 1994 to mid 2000 some marine rates had fallen by as much as two thirds. This means that to get back to their 1994 levels, rates in those sectors needed to triple. In certain lines, for example, offshore energy, this has happened, but most need still further rounds of rate increases. We are optimistic that this will happen, as the losses in the fourth quarter alone were enough to put many marine underwriters accounts into a deficit for yet another year. The political uncertainty in the world today should also help keep the insurance market hard. For marine underwriters, the risks from terrorism were clearly defined by the attack on the French tanker Limburg off the coast of Yemen in October. Fortunately, Navigators only had a minor involvement in this loss which the industry settled for approximately $70 million, but with cruise ships insured for more than ten times this amount, plus the potential liability for injury to passengers, one shudders at some of the exposures in today s unsettled world. Reinsurers have a strong influence in driving prices upward. Over the past decade, the number of reinsurers has reduced significantly and those willing to write marine business has dropped off even more. Those remaining are far more selective and charge more for their capacity. Because of the very size and nature of the risks involved, marine underwriters rely heavily on reinsurers for capacity. At Navigators, we have always sought continuity with our reinsurance partners and our claims record for the past several years has generally been a good one. Nevertheless, the cost of our reinsurance program has increased considerably over the past three years. We are far from happy having to pay more, but a tight reinsurance environment can only help keep the market firm. The current hard market will have to last several more years for the majority of marine insurers to produce satisfactory returns to investors. Lloyd s Lloyd s is the world s premier market for marine insurance and Navigators is now reaping the rewards of the investments we have made since acquiring our own syndicate five years ago. Our Syndicate 1221 contributed $2.7 million to the Group s bottom line in Under the Lloyd s method of reporting, underwriting year results are closed after three years. In the figures published in 2002, Syndicate 1221 ranked the second best performing marine syndicate in that market. We have the longest serving team of marine underwriters at Lloyd s and that stability is paying off handsomely. A NNUAL R EPORT

6 T HE N AVIGATORS G ROUP, I NC. Our Pennine subsidiary, which we launched in 1999, writes primarily a cargo and engineering account from two offices in the North of England. As that business grows, we plan to expand our regional presence to other cities in the UK. While insurers worldwide have seen their market capitalization reduced by over $100 billion, Lloyd s market capacity has never been greater. For 2003 it has been increased again to a record $23 billion. Nevertheless, there is still a lack of underwriting capacity in certain sectors which should help keep rates firm. Navigators Specialty Our specialty insurance operations headquartered in San Francisco, with a regional office in Chicago, also experienced very strong growth in Much of this was due to higher rates and more favorable underwriting terms in its core business of providing general liability insurance for contractors. The California market for contractors liability has been very difficult for most insurers due to both frequency and severity of construction defects litigation. Many insurers, particularly those involved in this segment in the early 1990 s, have experienced severe loss activity and disastrous underwriting results. This has led to a significant restriction of capacity to the market, and has allowed us to develop coverage terms and pricing that we believe to be consistent with underwriting profit. While we are pleased with the performance of this segment of our business, we are actively seeking to diversify our specialty property/casualty portfolio both geographically and through the addition of new product lines. In the first half of 2002, we opened a regional operation of Navigators Specialty in our existing suburban Chicago office to develop business in Illinois, Wisconsin and Minnesota. This office also serves as the hub for the Surety Division. Surety bonds have traditionally been purchased by contractors to guarantee the condition of work awarded to them. With our existing focus on small to medium contractors, contract surety is a natural expansion of our product offerings for this segment, and one that presents good long term profit potential. Navigators Pro The timing of our entry into the management and professional liability market, with the formation of Navigators Pro in September 2001, has been optimal. This new unit has demonstrated a disciplined underwriting approach and met its goals. At this early stage, underwriting results are not mature, however, there have been no surprises and NavPro is making a positive contribution to cash flow. Our focused niche strategy has enabled us to benefit from this profitable growth opportunity unencumbered by past liabilities. Directors and officers liability, for many years a profitable line of business for the insurance industry, began experiencing unprecedented claim frequency and severity from policies written in the late 1990 s. Most often this has taken the form of class action lawsuits, of which 260 were filed in 2002, resulting from earnings restatements, accounting fraud, and allegations of insider trading. The effect is that policies are now written with significantly higher exposure-based premiums coupled with more restrictive coverage terms. Price increases in 2002 ranged from double digits for loss free accounts to triple digits for unprofitable risks. NavPro is opportunistically benefiting from this market dynamic. The near term outlook is that rate increases do not appear to be abating. Investments Navigators produced $108 million in cash flow in 2002, substantially up from $41 million in At year end, our cash and invested assets totaled $453 million. However, because of the lower interest rates available, the average yield on the portfolio decreased from 6.1% to 4.8% and overall investment income for the year was down 7%. While this hurt our earnings, the good news is that low interest rates will continue to pressure insurers to achieve underwriting profit rather than pursue market share through cash flow underwriting. This should help keep the market firm. We continue to maintain a conservative investment philosophy. We believe in taking risk, at the right price, in our underwriting operations rather than with our investment portfolio. Less than 3% of our assets are invested in equities. The vast majority of the bonds in our portfolio are rated A or better by Standard & Poor s or Moody s and we have no junk bonds. Corporate Organization With the growth of our business over the past three years, we found that we had outgrown our office space in midtown Manhattan. After exploring various real estate options in Manhattan and the suburbs, we elected to take additional space in Rye Brook, New York, which is about 30 miles north of Manhattan in Westchester County. One Penn Plaza will continue to be our Corporate Headquarters, and our marine underwriters and claims staff, as well as Navigators Pro, will 4 A NNUAL R EPORT 2002

7 T HE N AVIGATORS G ROUP, I NC. remain in Manhattan. The headquarters of Navigators Management Company, consisting of our executive, administrative, accounting and IT staff, is now in Rye Brook. Over time we expect to achieve substantial cost savings and productivity gains from this move. The well publicized financial and accounting disasters at major corporations were headline news in 2002 and ultimately resulted in the passage of legislation known as Sarbanes- Oxley. Our management team has taken a number of steps, well in advance of the provisions of this law, to insure the integrity of our financial reporting and to emphasize good corporate governance. This is, and will continue to be, a corporate priority. For 2003 we have split the office of Chief Executive Officer and Chairman. Stanley A. Galanski has taken over from me as president and CEO, while I will continue as chairman. Stan and I have a close working relationship, communicate frequently, and collaborate regularly on strategy and major issues. We have a shared vision of the future and are both committed to executing our strategies. Due to other demands on his time, one of our longstanding directors, Robert M. DeMichele, has elected to retire from the Board at the end of his current term. Bob has served Navigators since its formation and he has been a great source of counsel and support to me. I thank him for his dedicated service to the Company. executives and boards will focus their organizations on the achievement of profitable underwriting results. This would require the market to continue to harden for the foreseeable future and we intend to make the most of the many exciting opportunities which are presenting themselves. I would like to conclude this letter by thanking our dedicated employees for all their hard work this past year, and I wish to thank you, our shareholders, for your continued support and confidence. For a more detailed review of Navigators business activities, a copy of our 10-K is included in this Report. I hope you will find this interesting and useful. Sincerely, TERENCE N. DEEKS Chairman Navigating a World in Motion The world in motion bodes well for Navigators. We are not exposed to some of the major issues plaguing the insurance industry. Many insurers, especially the large national carriers, are having to add to reserves for claims such as asbestos and pollution on business written years ago. Some of the results and reserve strengthening announced over the past few months have been staggering. Further, in today s low interest rate environment, insurers can no longer rely on a strong investment performance to bail out poor underwriting results. Interest rates are at thirty year lows and equities have lost money for the past three years. With our emphasis on underwriting profitability, we cut back our writings drastically during the last down cycle. Having done so, when the market turned in mid 2000 we were in the enviable position of starting with a profitable underwriting base. We were not faced with cutting back an unprofitable book, but rather building on a profitable one. With insurers continuing to suffer losses and having to add to reserves for old years, we expect that responsible insurance A NNUAL R EPORT

8 T HE N AVIGATORS G ROUP, I NC. Specialization The business culture of The Navigators Group is built upon specialization. Our underwriters have defined areas of product line or geographic expertise that enable them to outperform their competitors. Thus, one marine underwriter may specialize in marine liability insurance while another has developed high level technical expertise in offshore energy risks. This is perhaps most evident at our Lloyd s operation where specialization allows our cargo team to be recognized as a leader in the London market for the specie segment of cargo insurance. Commitment to specialization led us to establish a global center of excellence in our New York City office for bluewater hull insurance, in order to more fully capitalize on the strengths of the New York underwriting and claims experts. Specialization has been essential to Navigators expansion in non-marine business units. Navigators Pro, our management and professional liability unit, specializes in private and small to mid-cap size public companies. This unit employs individual specialist underwriters in the fields of directors & officers liability, employment practices liability and professional indemnity. Navigators Specialty has a well-established expertise in underwriting liability insurance for contractors and has added specialists in surety and personal umbrella products. Each of our business units is supported by a claims team consisting of claims specialists with substantial experience in their dedicated area of expertise. This commitment to specialization helps Navigators to perform at a level that is among the best in each of our chosen niches. 6 A NNUAL R EPORT 2002

9 T HE N AVIGATORS G ROUP, I NC. No event in cycling is as pure and technical as the Olympic Sprint event. On a bike, with no brakes or gears, in an event that lasts just 200 meters, the sprint specialist must be the most efficient, most singularly focused and most committed of riders. He has but one objective: to be the best. Navigators reigning Olympic Sprint Gold Medalist Marty Nothstein. A NNUAL R EPORT

10 T HE N AVIGATORS G ROUP, I NC. Teamwork Teamwork allows the employees of The Navigators Group to perform at their highest level and maximizes returns to shareholders. Teamwork between underwriting and claims personnel allows us to serve as the leader for slips that require substantial limits of insurance that go well beyond the capacity of any single insurer. The strength of the team and the results of teamwork engender the confidence of other insurers who will follow by supporting the pricing, terms and conditions, and, in the event of a loss, the claims settlement practices of the leader. Teamwork drives leadership. Teamwork between our claims staff, reinsurance personnel, and third party reinsurers and brokers allows us to effectively settle major claims in a timely fashion for our insureds. This is the true test of an insurer the ability to settle claims in a prompt and fair manner. Teamwork is a key to successful settlement of large and complex claims. Teamwork with professional insurance brokers and well-managed insureds and prospective clients allows us to understand and assess the complex risks associated with the insured s operations and to respond with an appropriate insurance solution. In financial lines, such as directors & officers liability and surety, a thorough understanding of the insured s financial condition and operations is essential. Not only is the job easier when everyone is pulling in the same direction, but the effort yields the best possible results for our customers, employees, vendors and shareholders. 8 A NNUAL R EPORT 2002

11 T HE N AVIGATORS G ROUP, I NC. Every member of the Navigators Professional Cycling Team knows that he can depend on his teammates to do their part. Every team member is important, and each one has to contribute his best in order for the team to be successful. The job is easier when everyone is pulling in the same direction; efficiently, effectively taking full advantage of the energy created by the team. Members of the Navigators Professional Cycling Team rely on teamwork to control the front of the peloton in preparation for a sprint finish. A NNUAL R EPORT

12 T HE N AVIGATORS G ROUP, I NC. Strength Strength is exhibited in many forms by an insurer. First and foremost is financial strength and balance sheet integrity. This has emerged as a paramount concern in 2002, as 38 U.S. insurance companies were placed into regulatory supervision or liquidation, and rating agencies downgraded many wellestablished, brand name, insurers. Navigators Insurance Companies are rated A (Excellent) by A.M. Best and A (Strong) by Standard & Poor s, two prominent rating agencies that monitor the property/casualty insurance industry. These ratings reflect a track record of solid underwriting results, a conservative investment philosophy and a hands-on management team that works hard to avoid surprises. Strength is also reflected in the capability to handle a customer s insurance risks globally. Our Lloyd s syndicate provides Navigators with the capability to issue locally admitted policies in Europe, Asia, Australasia, and North and South America, while our customers are secure in the knowledge that their risks are backed by Navigators. Strength comes not merely from financial resources, but from intellectual capital. Our business is created by the talented employees that make up Navigators, and we believe the caliber and tenure of our team to be a major reason for our success. We will continue to focus on the professional development of our existing employees as we continue to strengthen our team. A championship team does not rest on its laurels. 10 A NNUAL R EPORT 2002

13 T HE N AVIGATORS G ROUP, I NC. Strength is exhibited in many forms in professional cycling. Strength is measured by endurance, power and speed. Each athlete has his own combination of strengths, and it is the extraordinary rider that has the perfect combination of all three. The champion is the one with the mental toughness to stay focused on the finish line through the adversity and turmoil that surrounds him. Marty Nothstein exudes physical strength as he navigates a corner. A NNUAL R EPORT

14 T HE N AVIGATORS G ROUP, I NC. Results The bottom line for The Navigators Group is results, and our primary measure of results is the achievement of an underwriting profit. While the insurance business is complex, we believe the fundamental result required of a successful insurer is profitable underwriting, which is achieved when incurred losses and operating expenses are less than 100% of the premium collected. This simple measure recognizes that underwriting is the true business of an insurance company. Navigators underwriting results speak for themselves. In 2002, our combined loss and expense ratio was 97.5%. We have achieved an underwriting profit in our core marine agency business for 29 consecutive years. Our employees incentive compensation is based upon results, determined by the profitability of the Corporation, as well as the underwriting results of the respective business unit. By linking compensation to results, we aim to have the entire Company focused on the attainment of profitable underwriting. 12 A NNUAL R EPORT 2002

15 T HE N AVIGATORS G ROUP, I NC. The bottom line in professional cycling is results the Navigators Professional Cycling Team measures success with victories. In cycling, results just don t happen, you have to make them happen. The team must be prepared, have a plan and be able to execute the plan with the resources available at race time. Most importantly, each rider must have confidence in the team s leader so as to maximize his potential during the ever changing race conditions. Only then can the team succeed. Navigators Mark Walters wins the 2002 U.S. Pro Championship in Philadelphia, the biggest cycling event in North America. A NNUAL R EPORT

16 T HE N AVIGATORS G ROUP, I NC. Executive Management Team (seated left to right) Terence N. Deeks; Stanley A. Galanski; Douglas Poetzsch and R. Scott Eisdorfer (standing left to right) Christopher C. Duca; Bradley D. Wiley; Noel Higgitt; Michael L. Civisca and David E. Hope 14 A NNUAL R EPORT 2002

17 T HE N AVIGATORS G ROUP, I NC. C ORPORATE D ATA THE NAVIGATORS GROUP, INC. Board of Directors TERENCE N. DEEKS 3 Chairman of the Board The Navigators Group, Inc. ROBERT M. DeMICHELE 3, 4 President and Chief Executive Officer Strategy Asset Managers LLC ROBERT W. EAGER, JR. 1, 2 Executive Vice President (retired) General Reinsurance Corporation STANLEY A. GALANSKI President and Chief Executive Officer The Navigators Group, Inc. 2, 3, 4 LEANDRO S. GALBAN, JR. Vice Chairman and Managing Director Credit Suisse First Boston LLC MARC M. TRACT 2, 5 Partner Katten Muchin Zavis Rosenman GEORGE T. VAN GILDER 1, 4 Insurance Consultant 1, 2, 4, 5 ROBERT F. WRIGHT President and Chief Executive Officer Robert F. Wright Associates, Inc. 1 Audit Committee 2 Compensation Committee 3 Executive Committee 4 Finance Committee 5 Nominating Committee Officers TERENCE N. DEEKS Chairman STANLEY A. GALANSKI President and Chief Executive Officer BRADLEY D. WILEY Senior Vice President, Chief Financial Officer and Secretary R. SCOTT EISDORFER Senior Vice President and Chief Information Officer SALVATORE A. MARGARELLA Vice President and Treasurer NAVIGATORS INSURANCE COMPANY Board of Directors MICHAEL L. CIVISCA TERENCE N. DEEKS CHRISTOPHER C. DUCA R. SCOTT EISDORFER STANLEY A. GALANSKI NOEL HIGGITT DAVID E. HOPE CHRISTOPHER A. JOHNSON RUSSELL J. JOHNSON JOHN W. JONES SALVATORE A. MARGARELLA GREGORY D. OLSON DOUGLAS POETZSCH RICHARD C. F. REA BRADLEY D. WILEY A NNUAL R EPORT

18 T HE N AVIGATORS G ROUP, I NC. C ORPORATE D ATA NAVIGATORS COMPANIES Navigators Management Company, Inc. STANLEY A. GALANSKI President and Chief Executive Officer MICHAEL L. CIVISCA Senior Vice President President Marine Division CHRISTOPHER C. DUCA Senior Vice President President Navigators Pro Division RUSSELL J. JOHNSON Senior Vice President DOUGLAS POETZSCH Senior Vice President and Chief Claims Officer Navigators California Insurance Services, Inc. NOEL HIGGITT President CHRISTOPHER A. JOHNSON President Marine Division Navigators Insurance Services of Texas, Inc. JOHN W. JONES President Navigators Holdings (UK) Ltd. DAVID E. HOPE Director Navigators Management (UK) Ltd. RICHARD C. F. REA Managing Director PAUL F. CLAYDEN Finance Director LLOYD S OPERATIONS Navigators Underwriting Agency Ltd. DAVID E. HOPE Managing Director COLIN T. DINGLEY Active Underwriter JACQUELINE HEDGES Director and Secretary DOMINIC J. KIRBY Director IAN P. STEWART Finance Director Navigators Insurance Services of Washington, Inc. GREGORY D. OLSON President 16 A NNUAL R EPORT 2002

19 SECURITIES AND EXCHANGE COMMISSION Washington, D.C FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002 Commission File No THE NAVIGATORS GROUP, INC. (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of (I.R.S. employer identification no.) incorporation or organization) One Penn Plaza, New York, New York (Address of principal executive offices) (Zip code) Registrant s telephone number, including area code: (212) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.10 Par Value (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes No The aggregate market value of voting stock held by non-affiliates as of June 28, 2002 was $113,016,000. The number of common shares outstanding as of March 21, 2003 was 8,492,535. A NNUAL R EPORT

20 Forward-looking Statements Some of the statements in this Annual Report on Form 10-K are forward-looking statements as defined in the Private Securities Litigation Act of We derive forward-looking information from information which we currently have and assumptions which we make. We cannot assure that results which we anticipate will be achieved since results may differ materially because of both known and unknown risks and uncertainties which we face. The Company undertakes no obligation to publicly update or revise any forward-looking statement. Factors which could cause actual results to differ materially from our forward-looking statements include, but are not limited to: the effects of domestic and foreign economic conditions, and conditions which affect the market for property and casualty insurance; changes in the laws, rules and regulations which apply to our insurance companies; the effects of emerging claim and coverage issues on our business, including adverse judicial or regulatory decisions and rulings; the effects of competition from banks, other insurers and the trend toward self-insurance; risks which we face in entering new markets and diversifying the products and services we offer; unexpected turnover of our professional staff; changing legal and social trends and inherent uncertainties in the loss estimation process that can adversely impact the adequacy of loss reserves and the allowance for reinsurance recoverables; risks associated with our continuing ability to obtain reinsurance covering our exposures at appropriate prices and/or in sufficient amounts and the related recoverability of our reinsured losses; weather-related events and other catastrophes (including acts of terrorism) impacting our insureds and/or reinsurers; our ability to attain adequate prices, obtain new business and to retain existing business consistent with our expectations; the possibility of downgrades in our claims-paying and financial strength ratings significantly adversely affecting us, including reducing the number of insurance policies we write generally, or causing clients who require an insurer with a certain rating level to use higher-rated insurers; the risk that our investment portfolio suffers reduced returns or investment losses which could reduce our profitability; and other risks which we identify in future filings with the Securities and Exchange Commission. 18 A NNUAL R EPORT 2002

21 BUSINESS General The accompanying consolidated financial statements consisting of the accounts of The Navigators Group, Inc., a Delaware holding company, and its twelve active wholly owned subsidiaries are prepared on the basis of accounting principles generally accepted in the United States of America ( GAAP ). The Company consists of insurance company operations, insurance underwriting agencies and operations at Lloyd s of London. Unless the context otherwise requires, the term Company as used herein means The Navigators Group, Inc. and its subsidiaries. The term Parent Company is used to mean the Company without its subsidiaries. All significant intercompany transactions and balances have been eliminated. The Company s two insurance company subsidiaries are Navigators Insurance Company ( Navigators Insurance ), which includes a United Kingdom Branch ( UK Branch ), and NIC Insurance Company ( NIC ). Navigators Insurance is the Company s largest insurance subsidiary and has been active since It specializes principally in underwriting marine insurance and related lines of business, contractors general liability insurance, and professional liability insurance. NIC, a wholly owned subsidiary of Navigators Insurance, began operations in NIC is a surplus lines insurance company fully reinsured by Navigators Insurance. Surplus lines insurance companies operate on a non-admitted basis, and are not subject to state regulation of rates and forms. Navigators Insurance and NIC are collectively referred to herein as the Insurance Companies. Five of the Company s wholly owned insurance underwriting agencies (the Navigators Agencies ), produce business for the Insurance Companies. They specialize in writing marine and related lines of business, general liability insurance and professional liability coverages. Each of the Navigators Agencies write marine and related business for Navigators Insurance which is pooled with four unaffiliated insurance companies. The five insurance companies comprise a marine insurance pool. Marine insurance policies are issued by Navigators Insurance with the business shared through the pool. Navigators Insurance had a 75% net participation in the pool. Navigators Specialty, a division of a Navigators Agency located in San Francisco, California, produces business exclusively for the Insurance Companies. It specializes in underwriting general liability insurance coverage for general contractors and small artisans as well as small commercial risks with the majority of the business located on the west coast of the U.S. Navigators Pro, a division of a Navigators Agency located in New York, specializes in underwriting professional liability insurance and began producing directors & officers liability insurance exclusively for the Insurance Companies in the fourth quarter of In late 2002, Navigators Pro introduced additional products to complement its directors & officers liability coverage. The products include employment practices liability, lawyers professional liability and miscellaneous professional liability coverages. Navigators Holdings (UK) Limited is a holding company for the Company s UK subsidiaries consisting of the Lloyd s Operations and Navigators Management (UK) Limited, a Navigators Agency, which produces business for the UK Branch of Navigators Insurance. The Lloyd s Operations consist of Navigators Underwriting Agency Ltd. ( NUAL ), a Lloyd s of London ( Lloyd s ) marine underwriting managing agency which manages Lloyd s Syndicate 1221, Millennium Underwriting Ltd. ( Millennium ) and Navigators Corporate Underwriters Ltd. ( NCUL ). Both Millennium and NCUL are Lloyd s corporate members with limited liability and provide capacity to Lloyd s Syndicate NUAL owns Pennine Underwriting Ltd., an underwriting managing agency with offices in Manchester and Leeds, England, which underwrites cargo and engineering business for Lloyd s Syndicate A NNUAL R EPORT

22 The Company s revenue is primarily comprised of premiums, commissions and investment income. The Insurance Companies derive their premium primarily from business written by the Navigators Agencies. The Lloyd s Operations derive their premium from business written by NUAL. The Navigators Agencies and NUAL receive commissions and, in some cases, profit commissions and service fees on the business produced. Property and casualty insurance premiums historically have been cyclical in nature and, accordingly, during a hard market demand for property and casualty insurance exceeds supply or capacity and, as a result, premiums and commissions may increase. On the downturn of the property and casualty cycle, which is referred to as a soft market, supply exceeds demand and, as a result, premiums and commissions may decrease. Lines of Business The Company s two largest lines of business are marine and general liability insurance. It also writes professional liability insurance, onshore energy, engineering and construction insurance. In 2002, the Company began to write surety, commercial multiple peril and commercial automobile from its midwest office and personal umbrella insurance from its California office. Marine insurance includes hull, offshore energy, liability and cargo; general liability insurance is primarily contractors liability; onshore energy insurance focuses on the oil and gas, chemical and petrochemical industries with coverages primarily for property damage and business interruption; and engineering and construction insurance consists of coverage for construction projects including machinery, equipment and loss of use due to delays. In November 2001, the Company formed a new division, Navigators Pro, specializing in professional liability insurance, primarily directors and officers coverages. Marine Insurance Navigators Insurance obtains marine business through participation in the marine pool managed by the Navigators Agencies. The composition of the pool and the level of participation of each member changes from time to time. Navigators Insurance s net participation in the marine pool for 2002, 2001 and 2000 was 75%. The Navigators Agencies generally receive commissions equal to 7.5% of the gross premium earned on marine insurance and are entitled to receive a 20% profit commission on the net underwriting profits of the pool. The Lloyd s marine premium is generated as a result of NCUL and Millennium providing capacity to Lloyd s Syndicate The Company s share of the premiums, losses and expenses from Lloyd s Syndicate 1221 are included in the Company s consolidated results. Engineering and Construction The Lloyd s Operations write engineering and construction business consisting of coverage for construction projects including machinery, equipment and loss of use due to delays. Onshore Energy The Lloyd s Operations also write onshore energy insurance which principally focuses on the oil and gas, chemical and petrochemical industries with coverages primarily for property damage and business interruption. General Liability Navigators Specialty writes primary general liability and excess liability/umbrella insurance for general contractors and small artisans and other small commercial risks. 20 A NNUAL R EPORT 2002

23 Professional Liability In late 2001, the Insurance Companies began to write professional liability insurance through Navigators Pro, a division of one of the Navigators Agencies. Navigators Pro primarily offers directors and officers liability insurance for privately held and publicly traded corporations. More recently, Navigators Pro began offering employment practices liability, lawyers professional liability and miscellaneous professional liability coverages. Surety Beginning in the third quarter of 2002, the Company began producing surety business from its midwest office with a focus on the small to medium contractor market as well as the small general commercial surety risks. Other Property/Casualty Insurance In late 2002, the Company began to write commercial multiple peril and commercial automobile from its midwest office and personal umbrella insurance from its California office. Reinsurance Ceded The Company utilizes reinsurance principally to reduce its exposure on individual risks, to protect against catastrophic losses, to maintain desired ratios of net premium written to statutory surplus and to stabilize loss ratios. Reinsurance does not discharge the original insurer from its primary liability to the policyholder. The ceding company is required to pay the losses even if the assuming company fails to meet its obligations under the reinsurance agreement. Reinsurance is generally written under treaty contracts in which coverage is either on a proportional basis, where the reinsurer shares proportionately in premiums and losses, or on an excess of loss basis, where only losses above a fixed amount are reinsured. The Company is protected by various treaty and facultative reinsurance agreements. The Company s exposure to credit risk from any one reinsurer is managed through diversification by reinsuring with a number of different reinsurers, principally in the United States and European reinsurance markets. To meet our standards of acceptability, when the reinsurance is placed, a reinsurer must have an A.M. Best and/or Standard & Poor s ( S&P ) rating of A or better, or equivalent financial strength if not rated, plus at least $150 million in policyholders surplus. The list of acceptable reinsurers is reviewed periodically by the Reinsurance Security Committee. The reinsurance is placed either directly by the Company or through reinsurance intermediaries. The reinsurance intermediaries are compensated by the reinsurers. The Company s Reinsurance Security Committee monitors the financial strength of its reinsurers and the amounts of reinsurance receivables from those reinsurers. See Management s Discussion and Analysis of Financial Condition and Results of Operations Operating Expenses Net Loss and LAE Incurred for a discussion of the reinsurance recoverables from and financial strength ratings of the Company s primary reinsurers. Reserves Insurance companies and Lloyd s syndicates are required to maintain reserves for unpaid losses and unpaid loss adjustment expenses ( LAE ) for all lines of business. These reserves are intended to cover the probable ultimate cost of settling all losses incurred and unpaid, including those incurred but not reported. The determination of reserves for losses and LAE for insurance companies such as Navigators Insurance and NIC, and Lloyd s corporate members such as NCUL and Millennium is dependent upon the receipt of information from the pools and syndicates in which such companies participate. Generally, A NNUAL R EPORT

24 there is a lag between the time premiums are written and related losses and LAE are incurred, and the time such events are reported to the pools and syndicates and, subsequently, to Navigators Insurance, NIC, NCUL and Millennium. Reserves are established for the Insurance Companies and Lloyd s Syndicate 1221 for reported claims when notice of the claim is first received. Reserves for such reported claims are established on a case-by-case basis by evaluating several factors, including the type of risk involved, knowledge of the circumstances surrounding such claim, severity of injury or damage, the potential for ultimate exposure, experience with the insured and the broker on the line of business, and the policy provisions relating to the type of claim. Reserves for incurred but not reported losses (which are referred to as IBNR) are determined in part on the basis of statistical information and in part on industry experience. Loss reserves are estimates of what the insurer or reinsurer expects to pay on claims, based on facts and circumstances then known. It is possible that the ultimate liability may exceed or be less than such estimates. In setting its loss reserve estimates, the Company reviews statistical data covering several years, analyzes patterns by line of business and considers several factors including trends in claims frequency and severity, changes in operations, emerging economic and social trends, inflation and changes in the regulatory and litigation environment. Based on this review, the Company makes a best estimate of its ultimate liability. The Company does not establish a range of loss estimates around the best estimate it uses to establish its reserves and LAE. During the loss settlement period, which, in some cases, may last several years, additional facts regarding individual claims may become known and, accordingly, it often becomes necessary to refine and adjust the estimates of liability on a claim upward or downward. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year s income statement. Even then, the ultimate liability may exceed or be less than the revised estimates. The reserving process is intended to provide implicit recognition of the impact of inflation and other factors affecting loss payments by taking into account changes in historical payment patterns and perceived probable trends. There is generally no precise method for the subsequent evaluation of the adequacy of the consideration given to inflation, or to any other specific factor, because the eventual deficiency or redundancy of reserves is affected by many factors, some of which are interdependent. Our loss reserves include amounts related to short tail and long tail classes of business. Short tail business means that claims are generally reported quickly upon occurrence of an event, making estimation of loss reserves less complex. Our long tail business includes contractors liability and professional liability insurance. We are also exposed to some asbestos and environmental liability primarily through our marine line of business. Management believes that its reserves for such claims are adequate because the Company s participation in such risks is generally in the higher excess layers and, based on a continuing review of such claims, it believes that a majority of these claims will be unlikely to penetrate such high excess layers of coverage; however, due to significant assumptions inherent in estimating these exposures, actual liabilities could differ from current estimates. For the long tail lines, significant periods of time, ranging up to several years or more, may elapse between the occurrence of the loss, the reporting of the loss and the settlement of the claim. The longer the time span between the incidence of a loss and the settlement of the claim, the more likely the ultimate settlement amount can vary. For the long tail liability classes, a relatively small proportion of net losses in the more recent accident years are reported claims and an even smaller proportion are paid losses. Therefore, a relatively large proportion of our net losses for these classes are reserves for IBNR losses. In fact, approximately 76% of our construction liability net loss reserves at December 31, 2002 were for IBNR. Virtually all of the professional liability net loss reserves at December 31, 2002 were for IBNR. Where anticipated loss experience is less predictable because of the small number of claims and/or erratic claim severity patterns, our loss estimates are based on expected losses, actual reported losses, evaluation of loss trends, and the legal, regulatory and current risk environment. The expected ultimate losses are adjusted as the accident years mature. As of December 31, 2002, there were 495 open claims for construction defect liability insurance and seven open claims for professional liability coverage. Additional information 22 A NNUAL R EPORT 2002

25 regarding the complexity of estimating asbestos and environmental reserves is discussed below under Environmental Pollution and Asbestos Related Claims. The Company does not discount any of its reserves. The Company records those premiums which are reported to it through the end of each calendar year and accrues estimates for amounts where there is a time lag between when the policy is bound and the recording of the policy. A substantial portion of the estimated premiums is from international business where there can be significant time lags. To the extent that the actual premiums vary from estimates, the difference is recorded in current operations. The following table presents an analysis of losses and LAE: Year Ended December 31, (In thousands) Net reserves for losses and LAE at beginning of year... $202,759 $174,883 $170,530 Provision for losses and LAE for claims occurring in the current year ,721 96,664 60,152 Lloyd s Operations reinsurance to close... 1,641 4,196 7,854 Increase (decrease) in estimated losses and LAE for claims occurring in prior years... 7,038 5,385 (4,994) Incurred losses and LAE , ,245 63,012 Losses and LAE payments for claims occurring during: Current year... (16,727) (24,723) (15,358) Prior years... (64,785) (53,646) (43,301) Losses and LAE payments... (81,512) (78,369) (58,659) Net reserves for losses and LAE at end of year , , ,883 Reinsurance receivables on unpaid losses and LAE , , ,791 Gross reserves for losses and LAE at end of year... $489,642 $401,177 $357,674 A NNUAL R EPORT