NAVIGATORS INSURANCE COMPANY NAVIGATORS SPECIALTY INSURANCE COMPANY. New York, New York

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1 NAVIGATORS INSURANCE COMPANY NAVIGATORS SPECIALTY INSURANCE COMPANY A A New York, New York A Printed September 19, Page 1 of 17

2 Ultimate Parent: The Navigators Group, Inc NAVIGATORS INSURANCE COMPANY New York, NY 400 Atlantic Street, 8th Floor, Stamford, CT Web: Tel: Fax: AMB#: NAIC#: Ultimate Parent#: FEIN#: BEST S CREDIT RATING Best s Financial Strength Rating: A Outlook: Stable Best s Financial Size Category: XII RATING RATIONALE Rating nale: The ratings reflect Navigators Insurance Group s leading position as a global provider of insurance to the marine sector, the group s well-diversified book of business, its modest net windstorm exposure, management s conservative approach to risk management, underwriting and claims handling in addition to the group s solid level of capitalization and historical profitability. These positive factors are somewhat offset by the group s underwriting results in a few recent years that were not in line with the group s historical profit levels, its elevated (although declining) ceded reinsurance leverage and growth in relatively new lines of business. The outlooks reflect A.M. Best s expectation that the group will continue to maintain its solid level of capitalization and operating performance, generating overall profitable results throughout market cycles. The positive rating factors are derived from the group s historically favorable operating performance which, together with capital-raising initiatives, has supported growth and enhanced overall capitalization. The strong operating performance, as evidenced by positive returns on both revenue and surplus, has been driven by periods of underwriting profitability and consistent investment earnings. The group remains committed to underwriting excellence in terms of risk selection, contract terms and conditions and pricing discipline. This underwriting focus has produced loss ratios that have outperformed the average posted by its industry peers. Such discipline and expertise, which have been critical to profitability in the severity-driven ocean marine, casualty and energy lines, are a reflection of the strong risk management culture that remains a part of the Navigators Insurance Group. Despite the group s strong overall underwriting performance, underwriting results were below average in two of the last five years due to a combination of recent large industry-wide losses, reinstatement premiums, adverse loss development on certain lines and run-off operations. Increased loss ratios among specific products have led the group to discontinue or re-underwrite certain lines. As such, the group is susceptible to execution risk as it seeks to balance its overall underwriting risk with non-marine-related products. The group s relatively high ceded leverage, although declining more recently, reflects its risk management approach wherein reinsurance is strategically utilized to protect its balance sheet. Partially mitigating the elevated ceded reinsurance leverage is the high credit quality of Navigators reinsurers as well as the presence of letters of credit provided by some reinsurers. In addition, financial flexibility is afforded through the publicly traded parent, The Navigators Group Inc. (NASDAQ: NAVG), demonstrated by a $50 million capital contribution in While close to 17% of Navigators gross premium writings are in the marine sector, diversification of risk is achieved as its remaining premiums are spread across a diverse product line, including general liability coverage for small general and artisan contractors, professional liability, and specialty coverages. The group has expanded its geographic spread of risk through opening regional offices in select cities and over the last five years introduced the following new assumed reinsurance products: Accident and Health, Agriculture, Latin American Property and Surety, and Professional Liability. While the ratings are stable, positive rating actions could occur if there were a sustained favorable trend in operating results relative to industry peers and continuation of strong risk-adjusted capitalization. Negative rating actions could occur if there were a sustained deterioration in underwriting and operating results over a period of several years, an occurrence of a sudden large or catastrophic loss event that materially hinders risk-adjusted capitalization or if there was any material deviation from the company s submitted financial projections. FIVE-YEAR RATING HISTORY Date Best s FSR Date Best s FSR 07/21/16 A 06/07/13 A 06/03/15 A 06/19/12 A 06/04/14 A KEY FINANCIAL INDICATORS ($000) Statutory Data Direct Premiums Written Premiums Written Pre-tax Operating Income Income Total Admitted Assets Policyholders Surplus , ,391 6,110 12,964 1,903, , , ,956 6,174 25,230 2,102, , , ,008 60,803 56,605 2,215, , , ,773 88,843 72,411 2,454, , , ,117 75,838 58,683 2,568, ,266 Printed September 19, Page 2 of 17

3 Profitability Leverage Liquidity Comb. Inv. Yield (%) Pre-tax ROR (%) NA Inv Lev NPW to Overall Liq. (%) Oper. Cash flow (%) Yr (*) Within several financial tables of this report, this company is compared against the Commercial Casualty Composite. (*) Data reflected within all tables of this report has been compiled from the company-filed statutory statement. BUSINESS PROFILE In 2010, the group began reinsuring both accident and health coverages as well as multi-peril crop insurance. Latin America property reinsurance was added in 2011, professional liability reinsurance in 2012, and an international property reinsurance treaty in In recent years, the group has also opened a number of regional offices (e.g., Pittsburgh and Philadelphia) to market its existing products. TOTAL PREMIUM COMPOSITION & GROWTH ANALYSIS Reinsurance Reinsurance DPW Prem Assumed Prem Ceded ($000) (% Chg) ($000) (% Chg) ($000) (% Chg) , , , , , , , , , , , , , , , Yr CAGR Navigators Insurance Group (Navigators), through its lead operating unit, Navigators Insurance Company, specializes in underwriting marine and energy, specialty lines and professional liability business. Navigators Specialty Insurance Company underwrites property/casualty business on a non-admitted basis for those types of risks requiring greater flexibility in rating or policy terms and conditions. The group s multi-channel distribution platform utilizes global, national and regional brokers as well as wholesalers. Navigators has a long-standing reputation for expertise in the marine and energy sector, which includes property and excess liability coverages for marine-related business, offshore energy risks, related transportation and cargo exposures as well as a modest amount of business written in other facets of the marine and energy field. Specialty operations have underwritten general liability coverages for small general and artisan contractors since 1995, mostly in California, and represent a post-montrose book of business with tight terms and conditions in place to limit or avoid significant construction defect claims. Coverages are generally written on a non-admitted basis and have included construction wrap-up products since Challenging economic conditions in recent years have driven a reduction in the size of this book. Excess casualty risks are diversified among a large number of industry groups. The remaining portion of the specialty gross premiums includes primary casualty and commercial middle market accounts. The group also enters specialty niche lines, which management believes can produce profitable underwriting results. The group also writes professional director and officer coverages for a variety of market niches, including lawyers, architects and a variety of public and private companies. This coverage is largely offered to small and mid-size companies as opposed to Fortune 1000 companies. The group restructured its D&O program by introducing a credit scoring function into its underwriting process. Beginning in 2011, this program was quota-shared with other insuring participants. NPW NPE ($000) (% Chg) ($000) (% Chg) , , , , , , , , , , Yr CAGR Territory: The company is licensed in the District of Columbia, Puerto Rico and all states. It also operates on a surplus lines or non-admitted basis in U.S. Virgin Islands. This company is also licensed in the United Kingdom BY-LINE BUSINESS ($000) Reinsurance Reinsurance DPW Prem Assumed Prem Ceded Product Line ($000) (%) ($000) (%) ($000) (%) Oth Liab Occur 235, , , Ocean Marine 132, , , Group A & H 87, Oth Liab CM 93, , , Surety 3, , Inland Marine 14, , Comm l Auto Liab 15, , All Other 7, , , Total 502, , , Printed September 19, Page 3 of 17

4 Business NPW Retention Product Line ($000) (%) (%) Oth Liab Occur 413, Ocean Marine 97, Group A & H 87, Oth Liab CM 78, Surety 17, Inland Marine 12, Comm l Auto Liab 11, All Other 39, Total 757, BY-LINE RESERVES ($000) Product Line Oth Liab Occur 640, , , , ,641 Ocean Marine 197, , , , ,150 Group A & H 44,928 41,830 34,723 32,306 10,665 Oth Liab CM 125, , , , ,454 Surety 9,363 6,313 5,960 2,961 2,608 Inland Marine 5,077 6,225 10,159 13,818 6,638 Comm l Auto Liab 5,920 3,122 2,942 3,110 7,016 All Other 38,958 59,448 60,490 64,965 61,057 Total 1,067, , , , ,229 GEOGRAPHIC BREAKDOWN BY DIRECT PREMIUM WRITINGS ($000) New York 125, ,884 93,054 59,905 41,027 California 47,217 51,227 57,650 60,256 75,712 Texas 35,818 36,976 39,518 33,219 26,947 Aggregate Alien 32,794 73,207 83,253 94, ,632 Washington 28,513 26,851 27,033 23,546 20,296 New Jersey 22,915 16,965 14,385 13,063 12,904 Illinois 17,275 13,677 13,587 11,073 10,585 Pennsylvania 16,109 15,310 13,352 13,015 10,646 Florida 12,311 14,292 14,146 16,608 14,634 Ohio 10,341 11,213 9,557 7,324 5,919 All Other 153, , , , ,051 Total 502, , , , ,353 RISK MANAGEMENT sub-committees consisting of underwriting and claims, operational risk, finance and credit risk and compliance and governance risk. Each committee is managed by a member of the steering committee. The group has mapped out its key risks each of which are assigned to sub-committees for monitoring and mitigation with the board having ultimate oversight. Risks are evaluated across a diagram that tracks the potential impact relative to the group s degree of control. The group s investment portfolio remains conservative, and liquidity measures are strong. A well-diversified book of specialized coverages help to mitigate against concentration risk. A relatively high dependence on reinsurance is maintained as the group writes high gross limits, consistent with that of typical commercial marine and energy insurers. Following the group s Katrina loss in 2005, management made a decision to limit its Gulf Coast wind exposure, effectively reducing its gross catastrophe exposure from this book of business. This strategy was tested in 2008 with both Hurricane Ike and Hurricane Gustav with the group incurring $69 million in gross losses. However, pre-tax net losses (including reinstatement premiums from both catastrophes) were $21 million, or approximately 3% of surplus. Since 2009, the group has further reduced its net Gulf Coast exposure, issuing total net limits of less than $10 million. A significant portion of the group s reinsurance program is placed with foreign reinsurers, primarily in the London market. The majority of reinsurance balances with unauthorized carriers is covered by letters of credit, which helps to mitigate associated credit risk exposure. OPERATING PERFORMANCE Operating Results: Navigators generated pre-tax operating income in each of the last five years resulting from consistent investment income, and in the last three years, underwriting profits. Even with underwriting results from 2010 to 2012 that were not consistent with the group s historical performance levels, return measures remained positive. Significant improvement was observed in the last three years, with double digit return on revenue measures posted in two of those years. Realized gains over the last five years helped to enhance total returns and offset years with underwriting shortfalls. Navigators has a formalized, documented enterprise risk management (ERM) program in place, and its risk management approach is well suited to the group s overall risk profile. Navigators has established an enterprise risk management steering committee composed of its most senior management team including its CEO, CFO and CRO. Reporting to that committee are four Printed September 19, Page 4 of 17

5 PROFITABILITY ANALYSIS ($000) Company its business interruption coverages and significantly restricted its available Gulf of Mexico net wind aggregates. Pre-tax After-tax UNDERWRITING EXPERIENCE Operating Operating Total Income Income Income Return Undrw Loss s Expense s Ind Income Pure ,110 2,116 12,964 16,043 ($000) Loss LAE Loss & Other Total Div. Comb. LAE Comm. Exp. Exp. Pol. Comb , ,230 24, , ,803 42,867 56,605 65, , ,843 63,483 72,411 78, , ,838 52,286 58,683 56, , Yr Total 237, , , , , Yr Total/Avg -4, Company Industry Composite Pre-tax Return Operating Pre-tax Return Operating ROR (%) on (%) (%) ROR (%) on (%) (%) BY-LINE LOSS RATIO Product Line Yr Avg Oth Liab Occur Ocean Marine Group A & H Oth Liab CM Yr Avg Surety Inland Marine Underwriting Results: The group s five- and ten-year average combined Comm l Auto Liab ratios outperform its commercial casualty peers. These results are largely due All Other to the group s disciplined underwriting approach, which has led to profitable Total or near break-even underwriting results in most years. While the group s loss and loss adjustment expense (LAE) ratio is well below its peer composite, its DIRECT LOSS RATIO BY STATE underwriting expense ratio remains modestly elevated relative to that group Yr Avg The group s underwriting results modestly deteriorated between 2010 and New York , with significant improvement in the last three years. Loss ratio California improvement was reported across the majority of the group s business Texas segments in the last three years. Both 2014 and 2015 benefited from favorable Aggregate Alien prior year loss reserve development. In 2012, results were impacted by Washington industry-wide events, including the U.S. drought, Superstorm Sandy and New Jersey Costa Concordia. Further, 2012 was impacted by adverse development in Illinois specific lines of business. The increased underwriting loss in 2011 resulted Pennsylvania from a combination of several large losses in the group s marine business Florida (including related reinstatement premium expenses), adverse development of Ohio loss reserves (particularly those related to its D&O business for underwriting All Other years 2006 through 2009) which impacted both pure losses and the loss adjustment expense ratio, and an increase in underwriting expenses (although Total it is noted that underwriting expenses increased by a lower percentage than net Investment Results: Navigators portfolio has produced a five-year average written premiums, resulting in a decline in the group s expense ratio). yield on invested assets that falls below that of the commercial casualty Given the adverse loss reserve development within its specialty liability line composite. Due to the depressed interest rate environment experienced in in several of the last five years, management discontinued writing specific recent years, management has cut back on the duration of its assets, staying niches (including its small lawyers segment), restricted available coverages, short term while rates remain low. The investment strategy remains focused increased attachment points and formalized a multi-variant rating platform to on high-quality, liquid assets. improve its pricing accuracy. Over the longer term, Navigators strategy has produced favorable levels of In light of storm losses experienced prior to 2009, the group imposed policy investment income on an annual basis with varying levels of realized capital restrictions on its marine policies, including lower policy limits and limiting gains generated over the years from its equity portfolio. investment income has increased in each of the past three years, primarily due to the Printed September 19, Page 5 of 17

6 growth in invested assets driven by strong operating cash flows. This was partially offset by spread widening and lower investment yields. In 2015, the group invested a portion of its operating cash flows in equity securities, to compensate for lower yields in fixed maturity securities. In recent years, the group s total return has benefited from realized gains and generally positive changes in its unrealized gain position. INVESTMENT GAINS ($000) Company Realized Unrealized Inv Capital Capital Year Income Gains Gains ,417 10,847 3, ,073 24, ,890 13,738 8, ,805 8,927 5, ,833 6,397-2,450 5-Yr Total 247,017 64,309 14,494 combined basis. Further, the group offers business interruption coverage only on a limited basis. The group s catastrophe exposure is largely credit related, as its net exposure has been significantly reduced. Historically, significant surplus growth has been derived from capital contributions from the publicly traded parent, The Navigators Group, Inc. (Navigators Inc.). Following the debt offering in 2013, $50 million was contributed to Navigators Insurance Company. In the fourth quarter of 2005, Navigators Inc. issued an equity offering that led to a $120 million contribution to its domestic insurance subsidiary. In April of 2006, the parent issued a $125 million debt offering of which $100 million was contributed to Navigators Insurance Company, a portion of which were retired early at a gain. The remaining $114 million of senior notes were retired following the issuance of $265 million 10 year senior notes, due to mature in October of 2023, with a coupon of 5.75%. Consolidated financial leverage is currently 19.7% (debt-to-total-capital), and interest coverage ratios more than support the group s current rating level. In addition to modest debt service, profits from the domestic insurance companies have been utilized to further the group s expansion overseas, primarily in London. Company Industry Composite Pre-tax Invest Inv Inc Inv Return on Total Inv Inc Inv Growth Yield Inv Assets Return Growth Yield Year (%) (%) (%) (%) (%) (%) Yr Avg BALANCE SHEET STRENGTH Capitalization: Navigators risk-adjusted capitalization is solid, as measured by Best s Capital Adequacy (BCAR), and supportive of its current rating. With the increases in surplus over several years, underwriting leverage has declined below the average of the commercial casualty composite and favorable levels of risk-adjusted capitalization have been sustained even as net premiums written have grown. Navigators has internally generated capital over the last five years, and in 2013 received a capital contribution from its parent company. The group has significantly reduced its Gulf Coast wind exposure by lowering its gross limits and ceding the majority of risk to third-party reinsurers. While individual insureds could purchase net limits of over $200 million at year-end 2008, net offered limits have been significantly reduced. Current maximum available limits on such policies are (on a gross basis) less than $10 million for both property damage and business interruption on a Current BCAR: CAPITAL GENERATION ANALYSIS ($000) Source of Surplus Growth Pre-tax Realized Unrealized Operating Capital Income Capital Year Income Gains Taxes Gains ,110 10,847 3,993 3, ,174 24,399 5, ,803 13,738 17,936 8, ,843 8,927 25,360 5, ,838 6,397 23,553-2,450 5-Yr Total 237,768 64,309 76,184 14,494 Source of Surplus Growth Change % Chg Contrib. Other in in Year Capital Changes ,000 4,199-24, ,000 10,948 20, ,000 5, , ,787 89, , Yr Total -10,000 32, , Printed September 19, Page 6 of 17

7 QUALITY OF SURPLUS ($000) Surplus Other Contributed Unassigned Year Notes Debt Capital Surplus , , , , , , , , , ,144 Year-End Conditional Adjusted Year Reserves ,162 19, , ,881 21, , ,073 14, , ,946 15, , ,266 12, ,537 Underwriting Leverage: Although declining most recently, ceded leverage is somewhat elevated compared to the commercial casualty composite as a result of the extensive utilization of reinsurance to mitigate exposure to certain high limit risks. Credit risk is mitigated through the use of a diversified group of highly rated reinsurers and letters of credit received from foreign reinsurers. While overall premiums and liabilities, both net and gross, have grown over a five-year period, surplus has also grown. LEVERAGE ANALYSIS Company Industry Composite Res. Res. NPW to to Gross NPW to to Gross CEDED REINSURANCE ANALYSIS ($000) Company Bus. Reins. Ceded Ret. Recov. to Reins. to (%) (%) (%) Industry Composite Bus. Reins. Ceded Ret. Recov. to Reins. to (%) (%) (%) Ceded Reins. Total ,021, ,147, ,134, ,128, ,074, REINSURANCE RECOVERABLES ($000) Paid & Unpaid Losses IBNR Unearned Premiums Other Recov* Total Reins Recov Foreign Affiliates US Insurers , , , ,083 Pools/Associations Other Non-US... 50,962 64,583 35,057-3, ,964 Total (ex US Affils) , , ,261-4, ,108 Grand Total , , ,261-4, ,108 * Includes Commissions less Funds Withheld Loss Reserves: Favorable development of prior year net reserves as recorded in the group s annual statutory filing totaled $58.2 million in The estimated costs of loss and loss adjustment expenses attributable to insured events of prior years decreased in Most notably, the marine business had favorable loss emergence across all product lines including marine liability and inland marine. In 2014, the group recorded $46 million of favorable development of prior year net reserves. In prior years, adverse development of the group s professional liability reserves adversely impacted results, although these lines have improved development trends more recently. LOSS & ALAE RESERVE DEVELOP.: CALENDAR YEAR ($000) Orig. Developed Develop. Develop. Develop. Unpaid Unpaid Loss Reserves to to to Reserves Res. to Reserves Thru 15 Orig. (%) (%) NPE Develop. (%) Calendar Year , , , , , , , , , , , , , , , , , , LOSS & ALAE RESERVE DEVELOP.: ACCIDENT YEAR ($000) Accident Year Orig. Loss Reserves Developed Reserves Thru 15 Develop. to Orig. (%) Unpaid Acc. Yr Loss Acc. Yr Comb , , , , , , , , , , , , , , , , , , Printed September 19, Page 7 of 17

8 ASBESTOS & ENVIRONMENTAL (A&E) RESERVE ANALYSIS Company Industry Composite Year A&E Reserve ($000) Reserve Retention (%) IBNR Mix (%) Survival (3 yr) Comb. Impact (1 yr) Comb. Impact (3 yr) Survival (3 yr) Comb. Impact (1 yr) Comb. Impact (3 yr) , XX -0.1 XX XX 1.3 XX , XX 0.0 XX XX 1.3 XX , , , Liquidity: The group maintains a very sound liquidity position with quick and current liquidity ratios above industry averages. Positive underwriting and operating cash flows have been produced in each of the past five years, enhancing the group s invested asset and liquidity position. The group s asset portfolio, though largely invested in government, corporate and municipal bonds, includes sufficient allocation to cash and short-term securities to supply sound liquidity. LIQUIDITY ANALYSIS Company Industry Composite Gross Gross Quick Current Overall Agents Bal. Quick Current Overall Agents Bal. Liq. (%) Liq. (%) Liq. (%) to (%) Liq. (%) Liq. (%) Liq. (%) to (%) CASH FLOW ANALYSIS ($000) Company Industry Composite Underw Oper Underw Oper Underw Oper Cash Cash Cash Cash Cash Cash Cash Year Flow Flow Flow Flow (%) Flow (%) Flow (%) Flow (%) ,333 86,601 75, ,624 60,816-31, ,738 95,906 38, , ,933-71, , ,232 10, Yr Total 439, ,487 20,980 INVESTMENT LEVERAGE ANALYSIS (% OF ) Industry Company Composite Class 3-6 Bonds Real Estate/ Mtg. Other Invested Assets Common Stocks Non-Affil. Inv. Affil. Inv. Class 3-6 Bonds Common Stocks INVESTMENTS - SECURITIES Current Year Distribution of Bonds By Maturity Years Yrs-Avg Maturity Government Gov t Agencies & Muni Industrial & Misc Hybrid Securities Total Bonds (000) 1,779,093 1,726,741 1,505,614 1,486,405 1,333,144 US Government Foreign Government Foreign - All Other State/Special Revenue - US Industrial & Misc - US Private Issues Public Issues Bond Quality (%) Class Class Class INVESTMENTS - EQUITIES Stocks (000) 454, , , , ,353 Unaffiliated Common Affiliated Common Unaffiliated Preferred Printed September 19, Page 8 of 17

9 INVESTMENTS - MORTGAGE LOANS & REAL ESTATE Mortgage Loans & Real Estate (000) 1,090 1,122 1,153 1,185 1,217 Property Occupied by Co INVESTMENTS - OTHER INVESTED ASSETS Other Inv Assets (000) 75,875 65, , , ,546 Cash Short-Term All Other HISTORY The company was incorporated under the laws of New York on July 16, Active underwriting operations began on March 10, At December 31, 2015, paid-in capital of $416.1 million consisted of 100 shares of common stock at a par value of $50,000 per share and $411.1 million of contributed surplus. All authorized shares are outstanding. MANAGEMENT The Navigators Group, Inc., the ultimate Parent company of Navigators Insurance Company & Navigators Specialty Insurance Company, is a publicly owned holding company which trades on the NASDAQ stock exchange under the symbol NAVG. Approximately 20% of the stock is owned by Terence N. Deeks and family. The affairs of the company are under the direction of Navigators Management Company, Inc., which is reimbursed for its expenses. Terence N. Deeks served as chairman of the board of The Navigators Group, Inc., from its roots in 1974 until May 2013, when Mr. Deeks retired from the chairman role. Mr. Deeks continues to serve as a director. Robert V. Mendelsohn was appointed chairman of the board upon Mr. Deeks retirement. Mr. Mendelsohn has served on the board since 2010 and has extensive insurance industry experience. He formerly served as chief executive of Royal & Sun Alliance Insurance Group, plc in London and as chief executive officer of Royal Insurance Group, Inc., president and chief operating officer of W.R. Berkley Corp. and chairman of the American Insurance Association. Stanley A. Galanski serves as president and CEO of The Navigators Group, Inc. and as president, CEO and chairman of Navigators Insurance Company. Mr. Galanski has been active in the insurance industry since Officers: Chairman, President and Chief Executive Officer, Stanley A. Galanski; Senior Vice President and Chief Financial Officer, Ciro M. DeFalco; Senior Vice President and Chief Underwriting Officer, H. Clay Bassett, Jr.; Senior Vice President and Chief Administrative Officer, R. Scott Eisdorfer; Senior Vice President, Secretary, General Counsel and Chief Compliance Officer, Emily B. Miner; Senior Vice President and Chief Actuary, Mark A. Yunque; Senior Vice President and Controller, Carole V. Kirk (Group); Vice President and Chief Risk Officer, Arya M. Yarpezeshkan; Vice President and Treasurer, Ellen K. Dion; Vice Presidents, Glen M. Bronstein (Claims), Joann L. DeBlasis (Underwriting - Reinsurance), George R. Iacono (Finance, Operations), Paul C. Kluga (Reinsurance), Sherry J. Little (Regulatory Compliance), Michael J. McKenna (Underwriting - Reinsurance), Paul T. McNamara (Claims), Daniel P. Reale (IT), William C. Redington, Jr. (Underwriting - Reinsurance), Ruth E. Roberts (Claims), Jeff L. Saunders (Underwriting), Ivan F. Vega Neathery (Underwriting - Reinsurance). Directors: H. Clay Bassett, Jr., Stephen R. Coward, Ciro M. DeFalco, R. Scott Eisdorfer, Stanley A. Galanski (Chairman), Noel Higgitt, Christopher A. Johnson, Russell J. Johnson, Denise M. Lowsley, Emily B. Miner, Gregory D. Olson, Jeff L. Saunders, Vincent C. Tizzio, Arya M. Yarpezeshkan, Mark A. Yunque. REGULATORY An examination of the financial condition was made as of December 31, 2014, by the insurance department of New York. The 2015 annual independent audit of the company was conducted by KPMG, LLP. The annual statement of actuarial opinion is provided by Carl X. Ashenbrenner, FCAS, MAAA, Milliman. REINSURANCE Navigators Insurance Co. maintains proportional and non-proportional reinsurance with U.S. domestic reinsurers, Lloyd s of London, and other international companies. The marine and offshore energy excess of loss program attaches at $10 million and $7.5 million respectively for risk/non-cat occurrence events and $10 million per occurrence for all catastrophe losses. Quota share marine treaties are in place for primary liability, offshore energy, cargo, craft, transport, inland marine and war business at various cessions. The company maintains catastrophe reinsurance to protect against all catastrophic events emanating from the marine and non-gulf of Mexico offshore energy portfolios within an acceptable range of expected outcomes on a PML basis. The Gulf of Mexico offshore energy windstorm exposures are currently contained within our retention. Navigators other lines of business are reinsured on either a quota-share or excess of loss basis. Primary casualty business is reinsured above the company s $2 million retention on an excess of loss basis. The excess casualty, environmental and life science lines of business are subject to a hybrid quota share and excess of loss program. A variable quota share is in place for the D&O business, and the E&O program is protected by an excess of loss with a $2 million retention. The surety business is protected by an excess of loss with a $1 million retention. The property business is reinsured with a combination of per risk excess of loss basis above a $1.5 million retention and a catastrophe excess of loss. Maximum retention under the inland marine excess of loss program is $2.0 million. Printed September 19, Page 9 of 17

10 BALANCE SHEET ADMITTED ASSETS ($000) 12/31/15 12/31/14 15% 14% Bonds... 1,779,093 1,726, Preferred stock ,880 70, Common stock , , Cash & short-term invest... 75,869 65, Other non-affil inv asset Investments in affiliates , , Real estate, offices... 1,090 1, Total invested assets... 2,310,950 2,124, Premium balances , , Accrued interest... 12,947 11, All other assets , , Total assets... 2,568,520 2,454, LIABILITIES & SURPLUS ($000) 12/31/15 12/31/14 15% 14% Loss & LAE reserves... 1,067, , Unearned premiums , , Conditional reserve funds... 12,271 15, All other liabilities... 88, , Total liabilities... 1,618,254 1,560, Capital & assigned surplus , , Unassigned surplus , , Total policyholders surplus , , Total liabilities & surplus... 2,568,520 2,454, SUMMARY OF 2015 OPERATIONS ($000) Funds Provided from Statement of Income 12/31/15 Operations 12/31/15 Premiums earned ,750 Premiums collected ,111 Benefit & loss-related pmts Losses incurred , ,014 LAE incurred ,563 Undrw expenses incurred LAE & undrw expenses paid 252, ,065 underwriting income 18,697 Undrw cash flow ,033 investment income... 57,833 Investment income... 67,252 Other income/expense Other income/expense Pre-tax cash operations Pre-tax oper income... 75, ,593 Realized capital gains... 6,397 Income taxes incurred... 23,553 Income taxes pd (recov)... 32,362 income... 58,683 oper cash flow ,232 Ultimate Parent: The Navigators Group, Inc NAVIGATORS SPECIALTY INSURANCE COMPANY New York, NY 400 Atlantic Street, 8th Floor, Stamford, CT Web: Tel: Fax: AMB#: NAIC#: Ultimate Parent#: FEIN#: BEST S CREDIT RATING Best s Financial Strength Rating: A Outlook: Stable Best s Financial Size Category: XII The company s rating reflects its reinsurance agreement with Navigators Insurance Company (AMB# ) as a member of the Navigators RATING RATIONALE Rating nale: The ratings reflect Navigators Insurance Group s leading position as a global provider of insurance to the marine sector, the group s well-diversified book of business, its modest net windstorm exposure, management s conservative approach to risk management, underwriting and claims handling in addition to the group s solid level of capitalization and historical profitability. These positive factors are somewhat offset by the group s underwriting results in a few recent years that were not in line with the group s historical profit levels, its elevated (although declining) ceded reinsurance leverage and growth in relatively new lines of business. The outlooks reflect A.M. Best s expectation that the group will continue to maintain its solid level of capitalization and operating performance, generating overall profitable results throughout market cycles. The positive rating factors are derived from the group s historically favorable operating performance which, together with capital-raising initiatives, has supported growth and enhanced overall capitalization. The strong operating performance, as evidenced by positive returns on both revenue and surplus, has been driven by periods of underwriting profitability and consistent investment earnings. The group remains committed to underwriting excellence in terms of risk selection, contract terms and conditions and pricing discipline. This underwriting focus has produced loss ratios that have outperformed the average posted by its industry peers. Such discipline and expertise, which have been critical to profitability in the severity-driven ocean marine, casualty and energy lines, are a reflection of the strong risk management culture that remains a part of the Navigators Insurance Group. Despite the group s strong overall underwriting performance, underwriting results were below average in two of the last five years due to a combination of Printed September 19, Page 10 of 17

11 recent large industry-wide losses, reinstatement premiums, adverse loss development on certain lines and run-off operations. Increased loss ratios among specific products have led the group to discontinue or re-underwrite certain lines. As such, the group is susceptible to execution risk as it seeks to balance its overall underwriting risk with non-marine-related products. The group s relatively high ceded leverage, although declining more recently, reflects its risk management approach wherein reinsurance is strategically utilized to protect its balance sheet. Partially mitigating the elevated ceded reinsurance leverage is the high credit quality of Navigators reinsurers as well as the presence of letters of credit provided by some reinsurers. In addition, financial flexibility is afforded through the publicly traded parent, The Navigators Group Inc. (NASDAQ: NAVG), demonstrated by a $50 million capital contribution in While close to 17% of Navigators gross premium writings are in the marine sector, diversification of risk is achieved as its remaining premiums are spread across a diverse product line, including general liability coverage for small general and artisan contractors, professional liability, and specialty coverages. The group has expanded its geographic spread of risk through opening regional offices in select cities and over the last five years introduced the following new assumed reinsurance products: Accident and Health, Agriculture, Latin American Property and Surety, and Professional Liability. While the ratings are stable, positive rating actions could occur if there were a sustained favorable trend in operating results relative to industry peers and continuation of strong risk-adjusted capitalization. Negative rating actions could occur if there were a sustained deterioration in underwriting and operating results over a period of several years, an occurrence of a sudden large or catastrophic loss event that materially hinders risk-adjusted capitalization or if there was any material deviation from the company s submitted financial projections. FIVE-YEAR RATING HISTORY Date Best s FSR Date Best s FSR 07/21/16 A 06/07/13 A 06/03/15 A 06/19/12 A 06/04/14 A KEY FINANCIAL INDICATORS ($000) Statutory Data Direct Premiums Written Premiums Written Pre-tax Operating Income Income Total Admitted Assets Policyholders Surplus ,358 4,795 3, , , ,586 4,439 3, , , ,619 4,153 2, , , ,194 3,953 3, , , ,343 4,011 3, , ,036 Profitability Leverage Liquidity Comb. Inv. Yield (%) Pre-tax ROR (%) NA Inv Lev NPW to Overall Liq. (%) Oper. Cash flow (%) Yr 3.3 (*) Within several financial tables of this report, this company is compared against the Surplus Lines Composite. (*) Data reflected within all tables of this report has been compiled from the company-filed statutory statement. BUSINESS PROFILE Navigators Insurance Group (Navigators), through its lead operating unit, Navigators Insurance Company, specializes in underwriting marine and energy, specialty lines and professional liability business. Navigators Specialty Insurance Company underwrites property/casualty business on a non-admitted basis for those types of risks requiring greater flexibility in rating or policy terms and conditions. The group s multi-channel distribution platform utilizes global, national and regional brokers as well as wholesalers. Navigators has a long-standing reputation for expertise in the marine and energy sector, which includes property and excess liability coverages for marine-related business, offshore energy risks, related transportation and cargo exposures as well as a modest amount of business written in other facets of the marine and energy field. Specialty operations have underwritten general liability coverages for small general and artisan contractors since 1995, mostly in California, and represent a post-montrose book of business with tight terms and conditions in place to limit or avoid significant construction defect claims. Coverages are generally written on a non-admitted basis and have included construction wrap-up products since Challenging economic conditions in recent years have driven a reduction in the size of this book. Excess casualty risks are diversified among a large number of industry groups. The remaining portion of the specialty gross premiums includes primary casualty and commercial middle market accounts. The group also enters specialty niche lines, which management believes can produce profitable underwriting results. The group also writes professional director and officer coverages for a variety of market niches, including lawyers, architects and a variety of public and private companies. This coverage is largely offered to small and mid-size companies as opposed to Fortune 1000 companies. The group restructured its D&O program by introducing a credit scoring function into its underwriting process. Beginning in 2011, this program was quota-shared with other insuring participants. Printed September 19, Page 11 of 17

12 In 2010, the group began reinsuring both accident and health coverages as well as multi-peril crop insurance. Latin America property reinsurance was added in 2011, professional liability reinsurance in 2012, and an international property reinsurance treaty in In recent years, the group has also opened a number of regional offices (e.g., Pittsburgh and Philadelphia) to market its existing products. TOTAL PREMIUM COMPOSITION & GROWTH ANALYSIS Reinsurance Reinsurance DPW Prem Assumed Prem Ceded ($000) (% Chg) ($000) (% Chg) ($000) (% Chg) , , , , , , , , , , Yr CAGR NPW NPE ($000) (% Chg) ($000) (% Chg) Territory: The company is licensed in New York. It also operates on a surplus lines or non-admitted basis in the District of Columbia, AL, AK, AZ, AR, CA, CO, CT, DE, FL, GA, HI, ID, IL, IN, IA, KS, KY, LA, ME, MD, MA, MI, MN, MS, MO, MT, NE, NV, NH, NJ, NM, NC, ND, OH, OK, OR, PA, RI, SC, SD, TN, TX, UT, VT, VA, WA, WV, WI and WY BY-LINE BUSINESS ($000) Reinsurance Reinsurance DPW Prem Assumed Prem Ceded Product Line ($000) (%) ($000) (%) ($000) (%) Oth Liab Occur 312, , Oth Liab CM 40, , All Other 3, , Total 357, , Business NPW Retention Product Line ($000) (%) (%) Oth Liab Occur Oth Liab CM All Other Total GEOGRAPHIC BREAKDOWN BY DIRECT PREMIUM WRITINGS ($000) California 98,556 82,708 74,139 66,725 57,528 Texas 38,625 34,682 24,206 17,972 9,588 Florida 20,015 13,996 12,078 12,297 8,202 Illinois 19,248 20,774 17,274 12,721 8,230 New Jersey 19,061 16,379 8,808 7,795 3,796 Pennsylvania 14,216 11,031 8,750 7,130 4,436 Massachusetts 14,002 8,177 5,162 4,347 3,308 Washington 13,778 9,919 6,104 5,818 5,864 Georgia 9,716 7,205 5,166 3,235 1,806 Arizona 8,970 8,416 6,055 6,032 3,006 All Other 101, ,907 86,877 63,515 44,593 Total 357, , , , ,358 RISK MANAGEMENT Navigators has a formalized, documented enterprise risk management (ERM) program in place, and its risk management approach is well suited to the group s overall risk profile. Navigators has established an enterprise risk management steering committee composed of its most senior management team including its CEO, CFO and CRO. Reporting to that committee are four sub-committees consisting of underwriting and claims, operational risk, finance and credit risk and compliance and governance risk. Each committee is managed by a member of the steering committee. The group has mapped out its key risks each of which are assigned to sub-committees for monitoring and mitigation with the board having ultimate oversight. Risks are evaluated across a diagram that tracks the potential impact relative to the group s degree of control. The group s investment portfolio remains conservative, and liquidity measures are strong. A well-diversified book of specialized coverages help to mitigate against concentration risk. A relatively high dependence on reinsurance is maintained as the group writes high gross limits, consistent with that of typical commercial marine and energy insurers. Following the group s Katrina loss in 2005, management made a decision to limit its Gulf Coast wind exposure, effectively reducing its gross catastrophe exposure from this book of business. This strategy was tested in 2008 with both Hurricane Ike and Hurricane Gustav with the group incurring $69 million in gross losses. However, pre-tax net losses (including reinstatement premiums from both catastrophes) were $21 million, or approximately 3% of surplus. Since 2009, the group has further reduced its net Gulf Coast exposure, issuing total net limits of less than $10 million. A significant portion of the group s reinsurance program is placed with foreign reinsurers, primarily in the London market. The majority of reinsurance balances with unauthorized carriers is covered by letters of credit, which helps to mitigate associated credit risk exposure. Printed September 19, Page 12 of 17

13 OPERATING PERFORMANCE Operating Results: Navigators generated pre-tax operating income in each of the last five years resulting from consistent investment income, and in the last three years, underwriting profits. Even with underwriting results from 2010 to 2012 that were not consistent with the group s historical performance levels, return measures remained positive. Significant improvement was observed in the last three years, with double digit return on revenue measures posted in two of those years. Realized gains over the last five years helped to enhance total returns and offset years with underwriting shortfalls. PROFITABILITY ANALYSIS ($000) Company Pre-tax After-tax Operating Operating Total Income Income Income Return ,795 3,299 3,355 3, ,439 2,758 3,334 3, ,153 2,704 2,819 2, ,953 2,569 3,266 3, ,011 2,855 3,051 3,051 5-Yr Total 21,352 14,185 15,826 15,821 from a combination of several large losses in the group s marine business (including related reinstatement premium expenses), adverse development of loss reserves (particularly those related to its D&O business for underwriting years 2006 through 2009) which impacted both pure losses and the loss adjustment expense ratio, and an increase in underwriting expenses (although it is noted that underwriting expenses increased by a lower percentage than net written premiums, resulting in a decline in the group s expense ratio). Given the adverse loss reserve development within its specialty liability line in several of the last five years, management discontinued writing specific niches (including its small lawyers segment), restricted available coverages, increased attachment points and formalized a multi-variant rating platform to improve its pricing accuracy. In light of storm losses experienced prior to 2009, the group imposed policy restrictions on its marine policies, including lower policy limits and limiting its business interruption coverages and significantly restricted its available Gulf of Mexico net wind aggregates. DIRECT LOSS RATIO BY STATE Yr Avg California Texas Florida Illinois New Jersey Pennsylvania Massachusetts Washington Georgia Arizona All Other Company Industry Composite Pre-tax Return Operating Pre-tax Return Operating ROR (%) on (%) (%) ROR (%) on (%) (%) Total Investment Results: Navigators portfolio has produced a five-year average yield on invested assets that falls below that of the commercial casualty composite. Due to the depressed interest rate environment experienced in recent years, management has cut back on the duration of its assets, staying short term while rates remain low. The investment strategy remains focused 5-Yr Avg on high-quality, liquid assets. Over the longer term, Navigators strategy has produced favorable levels of Underwriting Results: The group s five- and ten-year average combined investment income on an annual basis with varying levels of realized capital ratios outperform its commercial casualty peers. These results are largely due gains generated over the years from its equity portfolio. investment to the group s disciplined underwriting approach, which has led to profitable income has increased in each of the past three years, primarily due to the or near break-even underwriting results in most years. While the group s loss growth in invested assets driven by strong operating cash flows. This was and loss adjustment expense (LAE) ratio is well below its peer composite, its partially offset by spread widening and lower investment yields. In 2015, the underwriting expense ratio remains modestly elevated relative to that group. group invested a portion of its operating cash flows in equity securities, to The group s underwriting results modestly deteriorated between 2010 and compensate for lower yields in fixed maturity securities. In recent years, the 2012, with significant improvement in the last three years. Loss ratio group s total return has benefited from realized gains and generally positive improvement was reported across the majority of the group s business changes in its unrealized gain position. segments in the last three years. Both 2014 and 2015 benefited from favorable prior year loss reserve development. In 2012, results were impacted by industry-wide events, including the U.S. drought, Superstorm Sandy and Costa Concordia. Further, 2012 was impacted by adverse development in specific lines of business. The increased underwriting loss in 2011 resulted Printed September 19, Page 13 of 17