** **

**FORM 10-Q**

** **

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**QuarterlyReport Under Section 13 or 15 (d)**

**ofthe Securities Exchange Act of 1934**

 

**For the Quarterly Period Ended  June 30, 2003**

 

**Commission file number  0-15886**

 

**The Navigators Group, Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                                         |   | **13-3138397**                     |
|--------------------------------------------------------------------------------------|--------|------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                      |   | (IRS Employer  Identification No.) |
|                                                                                 |   |                               |
| **One Penn Plaza, New York, New York**                                               |   | **10119**                          |
| (Address of principal executive offices)                                             |   | (Zip Code)                         |
|                                                                                 |   |                               |
| **(212)   244-2333**                                                            |
| (Registrant’s telephone number, including  area code)                           |
|                                                                                 |
|                                                                                 |
| (Former name, former address and former  fiscal year, if changed since last report.) |

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15 (d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 
| Yes         ý |   | No           o |
|------------------------------------------------------------|--------|------------------------------------------------------------------|

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

 
| Yes         ý |   | No           o |
|------------------------------------------------------------|--------|------------------------------------------------------------------|

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock as of the latest practicable date.

 

On August 6, 2003, there were 8,529,360 shares of $0.10 par valuecommon stock issued and outstanding.

 

 

----

 

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

 

**INDEX**

 

 
| Part I.  FINANCIAL  INFORMATION:                                                                                              |
|------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                               |
| Item 1.  Financial Statements                                                                                                 |
|                                                                                                                               |
| Consolidated Balance Sheets  June 30, 2003 (unaudited) and December 31, 2002                                                       |
|                                                                                                                               |
| Consolidated Statements of Income  (unaudited)  Three Months Ended June 30, 2003 and 2002  Six Months Ended June 30, 2003 and 2002 |
|                                                                                                                               |
| Consolidated Statements of Cash Flows (unaudited)  Six Months Ended June 30, 2003 and 2002                                         |
|                                                                                                                               |
| Notes to Interim Consolidated Financial  Statements (unaudited)                                                                    |
|                                                                                                                               |
| Item 2.  Management’s  Discussion and Analysis of Financial  Condition and Results of Operations                         |
|                                                                                                                               |
| Item 3.  Quantitative and  Qualitative Disclosures  About Market Risk                                                         |
|                                                                                                                               |
| Item 4.  Controls and  Procedures                                                                                             |
|                                                                                                                               |
| Part II.  OTHER INFORMATION                                                                                                   |
|                                                                                                                               |
| Signature                                                                                                                          |
|                                                                                                                               |
| Index of Exhibits                                                                                                                  |

 

2

----

 

#### **Part1.    Financial Information**

##### **Item 1.    FinancialStatements**

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCESHEETS**

*(In thousands, except share data)*

** **
|                                                                                                                                                                     |   | **June 30,  2003** |      | **December  31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|-----------|-------------------------|--------|
|                                                                                                                                                                     |   | **(Unaudited)**    |      |                    |   |
| **ASSETS**                                                                                                                                                               |   |               |      |                    |   |
| Investments and cash:                                                                                                                                                    |   |               |      |                    |   |
| Fixed maturities, available-for-sale, at  fair value                                                                                                                     |   |               |      |                    |   |
| (amortized cost: 2003, $419,489; 2002,  $351,821)                                                                                                                        |   | $                  | 438,913   |                    | $      | 366,676 |   |
|                                                                                                                                                                     |   |               |      |                    |   |
| Equity securities, available-for-sale, at  fair value (cost: 2003, $11,969; 2002, $12,286)                                                                               |   | 12,550             |      | 11,674                  |   |
| Short-term investments, at cost which  approximates fair value                                                                                                           |   | 62,957             |      | 61,092                  |   |
| Cash                                                                                                                                                                     |   | 4,950              |      | 13,443                  |   |
| Total investments and cash                                                                                                                                               |   | 519,370            |      | 452,885                 |   |
|                                                                                                                                                                     |   |               |      |                    |   |
| Premiums in course of collection                                                                                                                                         |   | 146,709            |      | 108,672                 |   |
| Commissions Receivable                                                                                                                                                   |   | 2,946              |      | 3,112                   |   |
| Prepaid reinsurance premiums                                                                                                                                             |   | 102,048            |      | 58,902                  |   |
| Reinsurance receivable on paid and unpaid  losses and loss adjustment expenses                                                                                           |   | 254,850            |      | 243,153                 |   |
| Federal income tax recoverable                                                                                                                                           |   |            |      | 826                     |   |
| Net deferred income tax benefit                                                                                                                                          |   | 5,768              |      | 6,470                   |   |
| Deferred policy acquisition costs                                                                                                                                        |   | 26,052             |      | 23,632                  |   |
| Accrued investment income                                                                                                                                                |   | 4,610              |      | 3,309                   |   |
| Goodwill                                                                                                                                                                 |   | 5,238              |      | 5,167                   |   |
| Other assets                                                                                                                                                             |   | 13,586             |      | 11,791                  |   |
| Total assets                                                                                                                                                             |   | $                  | 1,081,177 |                    | $      | 917,919 |   |
|                                                                                                                                                                     |   |               |      |                    |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                            |   |               |      |                    |   |
| Liabilities:                                                                                                                                                             |   |               |      |                    |   |
| Reserves for losses and loss adjustment  expenses                                                                                                                        |   | $                  | 543,390   |                    | $      | 489,642 |   |
| Unearned premium                                                                                                                                                         |   | 230,862            |      | 167,372                 |   |
| Reinsurance balances payable                                                                                                                                             |   | 91,423             |      | 55,574                  |   |
| Notes payable to banks                                                                                                                                                   |   | 11,000             |      | 14,500                  |   |
| Payable for securities                                                                                                                                                   |   | 4,619              |      | 5,327                   |   |
| Federal income tax payable                                                                                                                                               |   | 89                 |      |                 |   |
| Accounts payable and other liabilities                                                                                                                                   |   | 12,663             |      | 14,229                  |   |
| Total liabilities                                                                                                                                                        |   | 894,046            |      | 746,644                 |   |
|                                                                                                                                                                     |   |               |      |                    |   |
| Stockholders’ equity:                                                                                                                                               |   |               |      |                    |   |
| Preferred stock, $.10 par value; 1,000,000  shares authorized; none issued                                                                                               |   |            |      |                 |   |
| Common stock, $.10 par value; 20,000,000  shares authorized for 2003 and 2002; issued and outstanding 8,515,535 for  2003 and 8,486,272 (net of treasury stock) for 2002 |   | 852                |      | 851                     |   |
| Additional paid-in  capital                                                                                                                                              |   | 40,617             |      | 40,141                  |   |
| Treasury stock held at cost (shares: 16,423 for 2002)                                                                                                                    |   |            |      | (236                    | )      |
| Accumulated other  comprehensive income                                                                                                                                  |   | 13,767             |      | 9,732                   |   |
| Retained earnings                                                                                                                                                        |   | 131,895            |      | 120,787                 |   |
| Total stockholders’ equity                                                                                                                                          |   | 187,131            |      | 171,275                 |   |
| Total liabilities and stockholders’ equity                                                                                                                          |   | $                  | 1,081,177 |                    | $      | 917,919 |   |

 

#### **Seeaccompanying notes to interim consolidated financial statements.**

#### ** **

3

----

 

#### **THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTSOF INCOME**

*(In thousands, except net income per share)*

 
|                                              |   | **Three  Months Ended  June 30,** |   |
|---------------------------------------------------|--------|-----------------------------------|--------|
|                                              |   | **2003**                          |   | **2002** |   |
|                                              |   | **(Unaudited)**                   |   |
| Revenues:                                         |   |                              |   |   |   |
| Net earned premium                                |   | $                                 | 65,264 |   | $ | 50,923 |   |
| Commission income                                 |   | 1,486                             |   | 993 |   |
| Net investment income                             |   | 4,552                             |   | 4,162 |   |
| Net realized capital gains                        |   | 669                               |   | 201 |   |
| Other income                                      |   | 415                               |   | 641 |   |
| Total revenues                                    |   | 72,386                            |   | 56,920 |   |
|                                              |   |                              |   |   |   |
| Operating expenses:                               |   |                              |   |   |   |
| Net losses and loss adjustment expenses  incurred |   | 43,291                            |   | 32,406 |   |
| Commission expense                                |   | 8,876                             |   | 10,328 |   |
| Other operating expenses                          |   | 12,237                            |   | 8,983 |   |
| Interest expense                                  |   | 87                                |   | 145 |   |
| Total operating expenses                          |   | 64,491                            |   | 51,862 |   |
|                                              |   |                              |   |   |   |
| Income before income tax expense                  |   | 7,895                             |   | 5,058 |   |
|                                              |   |                              |   |   |   |
| Income tax expense  (benefit):                    |   |                              |   |   |   |
| Current                                           |   | 3,437                             |   | 1,344 |   |
| Deferred                                          |   | (1,816                            | )      | (60 | ) |
| Total income tax expense                          |   | 1,621                             |   | 1,284 |   |
|                                              |   |                              |   |   |   |
| Net income                                        |   | $                                 | 6,274  |   | $ | 3,774 |   |
|                                              |   |                              |   |   |   |
| Net income per common share:                      |   |                              |   |   |   |
| Basic                                             |   | $                                 | 0.74   |   | $ | 0.45 |   |
| Diluted                                           |   | $                                 | 0.72   |   | $ | 0.43 |   |
|                                              |   |                              |   |   |   |
| Average common shares outstanding:                |   |                              |   |   |   |
| Basic                                             |   | 8,516                             |   | 8,457 |   |
| Diluted                                           |   | 8,757                             |   | 8,677 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

4

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#### **THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

*(In thousands, except net income per share)*

 
|                                              |   | **Six Months  Ended**

**June 30,** |    |
|---------------------------------------------------|--------|-------------------------------------|---------|
|                                              |   | **2003**                            |    | **2002** |   |
|                                              |   | **(Unaudited)**                     |    |
| Revenues:                                         |   |                                |    |   |   |
| Net earned premium                                |   | $                                   | 131,578 |   | $ | 90,772 |   |
| Commission income                                 |   | 2,725                               |    | 2,094 |   |
| Net investment income                             |   | 9,213                               |    | 9,104 |   |
| Net realized capital gains (losses)               |   | 887                                 |    | (92 | ) |
| Other income                                      |   | 588                                 |    | 851 |   |
| Total revenues                                    |   | 144,991                             |    | 102,729 |   |
|                                              |   |                                |    |   |   |
| Operating expenses:                               |   |                                |    |   |   |
| Net losses and loss adjustment expenses  incurred |   | 87,331                              |    | 56,189 |   |
| Commission expense                                |   | 19,503                              |    | 17,986 |   |
| Other operating expenses                          |   | 23,824                              |    | 18,870 |   |
| Interest expense                                  |   | 184                                 |    | 305 |   |
| Total operating expenses                          |   | 130,842                             |    | 93,350 |   |
|                                              |   |                                |    |   |   |
| Income before income tax expense                  |   | 14,149                              |    | 9,379 |   |
|                                              |   |                                |    |   |   |
| Income tax expense  (benefit):                    |   |                                |    |   |   |
| Current                                           |   | 4,571                               |    | 2,662 |   |
| Deferred                                          |   | (1,530                              | )       | (507 | ) |
| Total income tax expense                          |   | 3,041                               |    | 2,155 |   |
|                                              |   |                                |    |   |   |
| Net income                                        |   | $                                   | 11,108  |   | $ | 7,224 |   |
|                                              |   |                                |    |   |   |
| Net income per common share:                      |   |                                |    |   |   |
| Basic                                             |   | $                                   | 1.31    |   | $ | 0.86 |   |
| Diluted                                           |   | $                                   | 1.27    |   | $ | 0.84 |   |
|                                              |   |                                |    |   |   |
| Average common shares outstanding:                |   |                                |    |   |   |
| Basic                                             |   | 8,505                               |    | 8,446 |   |
| Diluted                                           |   | 8,741                               |    | 8,617 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

5

----

 

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

*(In thousands)*

** **
|                                                                                         |   | **Six Months  Ended  June 30,** |   |
|----------------------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                                         |   | **2003**                        |   | **2002** |   |
|                                                                                         |   | **(Unaudited)**                 |   |
| Operating activities:                                                                        |   |                            |   |   |   |
| Net income                                                                                   |   | $                               | 11,108 |   | $ | 7,224 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |   |                            |   |   |   |
| Depreciation & amortization                                                              |   | 656                             |   | 427 |   |
| Net deferred income tax                                                                      |   | (1,530                          | )      | (507 | ) |
| Net realized capital (gains) losses                                                          |   | (887                            | )      | 92 |   |
| Changes in assets and liabilities:                                                           |   |                            |   |   |   |
| Reinsurance receivable on paid and unpaid  losses and loss adjustment expenses               |   | (11,697                         | )      | 17,240 |   |
| Reserve for losses and loss adjustment  expenses                                             |   | 53,748                          |   | 13,905 |   |
| Prepaid reinsurance premiums                                                                 |   | (43,146                         | )      | (19,781 | ) |
| Unearned premium                                                                             |   | 63,490                          |   | 57,393 |   |
| Premiums in course of collection                                                             |   | (38,037                         | )      | (19,904 | ) |
| Commissions receivable                                                                       |   | 166                             |   | (1,003 | ) |
| Deferred policy acquisition costs                                                            |   | (2,420                          | )      | (9,434 | ) |
| Accrued investment income                                                                    |   | (1,301                          | )      | (179 | ) |
| Reinsurance balances payable                                                                 |   | 35,849                          |   | 2,652 |   |
| Federal income tax                                                                           |   | 915                             |   | 478 |   |
| Other                                                                                        |   | (1,364                          | )      | (815 | ) |
|                                                                                         |   |                            |   |   |   |
| Net cash provided by operating activities                                                    |   | 65,550                          |   | 47,788 |   |
|                                                                                         |   |                            |   |   |   |
| Investing activities:                                                                        |   |                            |   |   |   |
| Fixed maturities, available-for-sale                                                         |   |                            |   |   |   |
| Redemptions and maturities                                                                   |   | 2,316                           |   | 1,522 |   |
| Sales                                                                                        |   | 116,323                         |   | 97,446 |   |
| Purchases                                                                                    |   | (185,809                        | )      | (94,470 | ) |
| Equity securities, available-for-sale                                                        |   |                            |   |   |   |
| Sales                                                                                        |   | 476                             |   | 3,703 |   |
| Purchases                                                                                    |   | (423                            | )      | (2,400 | ) |
| Change in receivable/payable for securities                                                  |   | (709                            | )      | 4,135 |   |
| Net change in short-term investments                                                         |   | (1,865                          | )      | (52,813 | ) |
| Purchase of property and equipment                                                           |   | (872                            | )      | (272 | ) |
|                                                                                         |   |                            |   |   |   |
| Net cash (used in) investing activities                                                      |   | (70,563                         | )      | (43,149 | ) |
|                                                                                         |   |                            |   |   |   |
| Financing activities:                                                                        |   |                            |   |   |   |
| Repayment of bank loan                                                                       |   | (3,500                          | )      | (3,000 | ) |
| Proceeds from exercise of stock options                                                      |   | 20                              |   | 321 |   |
| Net cash (used in) financing activities                                                      |   | (3,480                          | )      | (2,679 | ) |
| Increase (Decrease)  in cash                                                            |   | (8,493                          | )      | 1,960 |   |
| Cash at beginning of year                                                                    |   | 13,443                          |   | 5,816 |   |
| Cash at end of period                                                                        |   | $                               | 4,950  |   | $ | 7,776 |   |
|                                                                                         |   |                            |   |   |   |
| Supplemental disclosures of cash flow  information:                                          |   |                            |   |   |   |
| Federal, state and local income tax paid                                                     |   | $                               | 3,709  |   | $ | 2,311 |   |
| Interest paid                                                                                |   | 184                             |   | 303 |   |
| Issuance of stock to directors                                                               |   | 72                              |   | 60 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

6

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###### **THE NAVIGATORSGROUP, INC.  AND SUBSIDIARIES**

 

**Notes to Interim** Consolidated FinancialStatements

*(Unaudited)*

 

(1)                Accounting Policies

 

The interim consolidated financial statements are unaudited but reflectall adjustments which, in the opinion of management, are necessary to provide afair statement of the results of The Navigators Group, Inc. and itssubsidiaries (the “Company”) for the interim periods presented on the basis ofaccounting principles generally accepted in the United States of America(“GAAP”).  All such adjustments are of anormal recurring nature.  Allsignificant intercompany transactions and balances have been eliminated.  The preparation of these financialstatements requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosures of contingentassets and liabilities at the date of the financial statements and the reportedrevenues and expenses during the reporting periods.  The results of operations for any interim period are notnecessarily indicative of results for the full year.  These financial statements should be read in conjunction with theconsolidated financial statements and notes contained in the Company’s 2002Annual Report on Form 10-K.  Certainamounts for prior periods have been reclassified to conform to the currentperiod’s presentation.  As a result, theamounts previously classified as *Funds due from Lloyd’s syndicate*have beenreclassified to their separate components in the financial statements.

 

(2)                Reinsurance Ceded

 

The Company’s ceded earned premiums were $62,015,000 and $37,460,000for the three months ended June 30, 2003 and 2002, respectively, and were$109,115,000 and $66,244,000 for the six months ended June 30, 2003 and 2002,respectively. The Company’s ceded incurred losses were $35,968,000 and$24,885,000 for the three months ended June 30, 2003 and 2002, respectively,and were $63,505,000 and $40,450,000 for the six months ended June 30, 2003 and2002, respectively.

 

(3)                Segments of anEnterprise

 

The Company’s subsidiaries are primarily engaged in the underwritingand management of property and casualty insurance.  The Company’s segments include the Insurance Companies, the NavigatorsAgencies and the Lloyd’s Operations, each of which is managed separately.  The Insurance Companies consist ofNavigators Insurance Company (“Navigators Insurance”) and NIC Insurance Companywhich are primarily engaged in underwriting marine insurance and related linesof business, general liability insurance and professional liabilityinsurance.  The Navigators Agencies areunderwriting management companies which produce, manage and underwriteinsurance and reinsurance for the Insurance Companies and non-affiliatedcompanies.  The Lloyd’s Operationsconsist primarily of a Lloyd’s managing agency and two Lloyd’s corporatemembers which underwrite marine and related lines of business at Lloyd’s ofLondon.

 

The results of the Insurance Companies and the Lloyd’s Operations aremeasured taking into account net earned premiums, incurred losses and lossexpenses, commission expense and other underwriting expenses.  The Navigators Agencies’ results includecommission income less other operating expenses.  Each segment maintains its own investments on which it earnsincome and realizes capital gains or losses. Other operations include intersegment income and expense in the form ofaffiliated commissions, income and expense from corporate operations, and consolidatingadjustments.

 

7

----

 

The following tables present financial data by segment for the periodsindicated:

 

 
|                                                                               |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                                               |   | **2003**                          |   | **2002**                        |   | **2003** |   | **2002** |   |
|                                                                               |   | **(In thousands)**                |   | **(In  thousands)**             |   |
|                                                                               |   |                              |   |                            |   |   |   |   |   |
| Revenue, excluding net investment income  and net realized capital gains (losses): |   |                              |   |                            |   |   |   |   |   |
| Insurance Companies:                                                               |   |                              |   |                            |   |   |   |   |   |
| Marine                                                                             |   | $                                 | 21,417 |                            | $      | 14,068 |   | $ | 44,153 |   | $ | 30,162 |   |
| General Liability                                                                  |   | 19,381                            |   | 15,268                          |   | 42,291 |   | 27,949 |   |
| Professional Liability                                                             |   | 2,078                             |   | 263                             |   | 3,505 |   | 379 |   |
| Surety                                                                             |   | 80                                |   | —                          |   | 120 |   | — |   |
| Other                                                                              |   | (350                              | )      | (327                            | )      | 121 |   | (219 | ) |
| Insurance Companies Total                                                          |   | 42,606                            |   | 29,272                          |   | 90,190 |   | 58,271 |   |
| Lloyd’s Operations:                                                           |   |                              |   |                            |   |   |   |   |   |
| Marine                                                                             |   | 21,252                            |   | 21,245                          |   | 38,890 |   | 32,035 |   |
| Engineering and Construction                                                       |   | 497                               |   | 189                             |   | 776 |   | 196 |   |
| Onshore Energy                                                                     |   | 972                               |   | 267                             |   | 1,808 |   | 284 |   |
| Other                                                                              |   | 416                               |   | 469                             |   | 516 |   | 574 |   |
| Lloyd’s Operations Total                                                      |   | 23,137                            |   | 22,170                          |   | 41,990 |   | 33,089 |   |
| Navigators Agencies                                                                |   | 8,563                             |   | 6,224                           |   | 16,302 |   | 12,332 |   |
| Other operations                                                                   |   | (7,141                            | )      | (5,109                          | )      | (13,591 | ) | (9,975 | ) |
| Total                                                                              |   | $                                 | 67,165 |                            | $      | 52,557 |   | $ | 134,891 |   | $ | 93,717 |   |
|                                                                               |   |                              |   |                            |   |   |   |   |   |
| Income (loss) before tax expense (benefit):                                        |   |                              |   |                            |   |   |   |   |   |
| Insurance Companies                                                                |   | $                                 | 5,849  |                            | $      | 4,577 |   | $ | 10,893 |   | $ | 9,503 |   |
| Lloyd’s Operations                                                            |   | 2,926                             |   | 735                             |   | 4,841 |   | 1,607 |   |
| Navigators Agencies                                                                |   | 759                               |   | 742                             |   | 1,121 |   | 1,132 |   |
| Other operations                                                                   |   | (1,639                            | )      | (996                            | )      | (2,706 | ) | (2,863 | ) |
| Total                                                                              |   | $                                 | 7,895  |                            | $      | 5,058 |   | $ | 14,149 |   | $ | 9,379 |   |
|                                                                               |   |                              |   |                            |   |   |   |   |   |
| Income tax expense (benefit):                                                      |   |                              |   |                            |   |   |   |   |   |
| Insurance Companies                                                                |   | $                                 | 1,827  |                            | $      | 1,414 |   | $ | 3,386 |   | $ | 2,945 |   |
| Lloyd’s Operations                                                            |   | —                            |   | —                          |   | — |   | — |   |
| Navigators Agencies                                                                |   | 226                               |   | 218                             |   | 353 |   | 312 |   |
| Other operations                                                                   |   | (432                              | )      | (348                            | )      | (698 | ) | (1,102 | ) |
| Total                                                                              |   | $                                 | 1,621  |                            | $      | 1,284 |   | $ | 3,041 |   | $ | 2,155 |   |
|                                                                               |   |                              |   |                            |   |   |   |   |   |
| Net income (loss):                                                                 |   |                              |   |                            |   |   |   |   |   |
| Insurance Companies                                                                |   | $                                 | 4,022  |                            | $      | 3,163 |   | $ | 7,507 |   | $ | 6,558 |   |
| Lloyd’s Operations                                                            |   | 2,926                             |   | 735                             |   | 4,841 |   | 1,607 |   |
| Navigators Agencies                                                                |   | 533                               |   | 524                             |   | 768 |   | 820 |   |
| Other operations                                                                   |   | (1,207                            | )      | (648                            | )      | (2,008 | ) | (1,761 | ) |
| Total                                                                              |   | $                                 | 6,274  |                            | $      | 3,774 |   | $ | 11,108 |   | $ | 7,224 |   |

 

8

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(4)                Comprehensive Income

 

Comprehensive income encompasses all changes in stockholders’ equityincluding net income, net unrealized capital gains and losses on available forsale securities, and foreign currency translation adjustments.

 

The following table summarizes comprehensive income for the threemonths ended June 30, 2003 and 2002:

 
|                                                                                                                       |   | **Three  Months Ended  June 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                                       |   | **2003**                          |   | **2002** |   |
|                                                                                                                       |   | **(In  thousands)**               |   |
|                                                                                                                       |   |                              |   |   |   |
| Net income                                                                                                                 |   | $                                 | 6,274  |   | $ | 3,774 |   |
| Other comprehensive income, net of tax:                                                                                    |   |                              |   |   |   |
| Net unrealized gains on securities  available for sale:                                                                    |   |                              |   |   |   |
| Unrealized holding gains arising during period (net of  tax expense of  $2,150 for 2003 and $1,669 for 2002)     |   | 4,257                             |   | 3,687 |   |
| Less: reclassification adjustment for gains included in net income  (net of tax expense of $108 for 2003 and $77 for 2002) |   | 561                               |   | 124 |   |
| Net unrealized gains on securities                                                                                         |   | 3,696                             |   | 3,563 |   |
| Foreign currency translation gain adjustment  (net of tax expense of $199 for 2003 and $103 for 2002)                      |   | 368                               |   | 191 |   |
| Other comprehensive income                                                                                                 |   | 4,064                             |   | 3,754 |   |
|                                                                                                                       |   |                              |   |   |   |
| Comprehensive income                                                                                                       |   | $                                 | 10,338 |   | $ | 7,528 |   |

 

The following table summarizes comprehensive income for the six monthsended June 30, 2003 and 2002:

 
|                                                                                                                                    |   | **Six Months  Ended  June 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                                                                                    |   | **2003**                        |   | **2002** |   |
|                                                                                                                                    |   | **(In  thousands)**             |   |
|                                                                                                                                    |   |                            |   |   |   |
| Net income                                                                                                                              |   | $                               | 11,108 |   | $ | 7,224 |   |
| Other comprehensive income, net of tax:                                                                                                 |   |                            |   |   |   |
| Net unrealized gains on securities  available for sale:                                                                                 |   |                            |   |   |   |
| Unrealized holding gains arising during  period (net of  tax expense of  $2,222 for 2003 and $630 for 2002)                   |   | 4,479                           |   | 1,077 |   |
| Less: reclassification adjustment for gains  included in net income (net of tax expense (benefit) of $149 for 2003 and  $(21) for 2002) |   | 738                             |   | (71 | ) |
| Net unrealized gains on securities                                                                                                      |   | 3,741                           |   | 1,148 |   |
| Foreign currency translation gain  adjustment (net of tax expense (benefit) of $158 for 2003 and $(159) for  2002)                      |   | 294                             |   | (296 | ) |
| Other comprehensive income                                                                                                              |   | 4,035                           |   | 852 |   |
|                                                                                                                                    |   |                            |   |   |   |
| Comprehensive income                                                                                                                    |   | $                               | 15,143 |   | $ | 8,076 |   |

 

9

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The following table summarizes the components of accumulated othercomprehensive income:

 
|                                                                                                             |   | **June 30,  2003**  |   | **December  31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|-------------------------|--------|
|                                                                                                             |   | **(In  thousands)** |   |
|                                                                                                             |   |                |   |                    |   |
| Net unrealized gains on securities  available-for-sale (net of tax expense of $6,767 in 2003 and $4,693 in 2002) |   | $                   | 13,240 |                    | $      | 9,499 |   |
| Foreign currency translation adjustment  (net of tax expense of $284 in 2003 and $125 in 2002)                   |   | 527                 |   | 233                     |   |
|                                                                                                             |   |                |   |                    |   |
| Accumulated other comprehensive income                                                                           |   | $                   | 13,767 |                    | $      | 9,732 |   |

 

(5)                Stock-based Compensation

 

At June 30, 2003, the Company’s stock option plans are accounted forunder the recognition and measurement principles of the Accounting PrinciplesBoard Opinion No. 25, *Accounting for Stock Issued to Employees*,which requires compensation expense to be recognized only if the fair value ofthe underlying stock at the grant date exceeds the exercise price of theoption.  Accordingly, compensationexpense of $15,000 and $31,000 has been recognized for stock options in thethree months and six months ended June 30, 2003, respectively.  Although no amounts were expensed in thethree months and six months ended June 30, 2002, had expense been recorded asdescribed above, the amount would have been approximately $11,000 and $15,000,respectively.  The following tableillustrates the effect on net income and earnings per share if the Company hadapplied the fair value recognition provisions of the Financial AccountingStandards Board (“FASB”) in the Statement of Financial Accounting Standards(“SFAS”) No. 123, Accounting for Stock-Based Compensation to stock-basedemployee compensation:

 
|                                                                                                                         |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
| **(In thousands, except per share data)**                                                                                    |   | **2003**                          |   | **2002**                        |   | **2003** |   | **2002** |   |
|                                                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Net income:                                                                                                                  |   |                              |   |                            |   |   |   |   |   |
| As reported                                                                                                                  |   | $                                 | 6,274  |                            | $      | 3,774 |   | $ | 11,108 |   | $ | 7,224 |   |
| Add:                                                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Total stock-based compensation expense  included in net income, net of related tax effects                                   |   | 10                                |   | —                          |   | 20 |   | — |   |
| Deduct:                                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| Total stock-based compensation expense  determined under fair value based method for all awards, net of related tax  effects |   | 127                               |   | 66                              |   | 245 |   | 141 |   |
|                                                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Pro-forma                                                                                                                    |   | $                                 | 6,157  |                            | $      | 3,708 |   | $ | 10,883 |   | $ | 7,083 |   |
|                                                                                                                         |   |                              |   |                            |   |   |   |   |   |
| Basic income per share:                                                                                                      |   |                              |   |                            |   |   |   |   |   |
| As reported                                                                                                                  |   | $                                 | 0.74   |                            | $      | 0.45 |   | $ | 1.31 |   | $ | 0.86 |   |
| Pro-forma                                                                                                                    |   | $                                 | 0.72   |                            | $      | 0.44 |   | $ | 1.28 |   | $ | 0.84 |   |
| Diluted income per share:                                                                                                    |   |                              |   |                            |   |   |   |   |   |
| As reported                                                                                                                  |   | $                                 | 0.72   |                            | $      | 0.43 |   | $ | 1.27 |   | $ | 0.84 |   |
| Pro-forma                                                                                                                    |   | $                                 | 0.70   |                            | $      | 0.43 |   | $ | 1.24 |   | $ | 0.82 |   |

 

Stock grants are expensed as they vest.  The amount charged to expense was $210,000 and $197,000 for thethree months ended June 30, 2003 and 2002, respectively.  The expense for the six months ended June30, 2003 and 2002 was $486,000 and $413,000, respectively.  In addition, $36,000 was expensed for eachof the

 

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six month periods ended June 30, 2003 and 2002, respectively, for stockissued annually to non-employee directors as part of the directors’compensation for serving on the Company’s Board of Directors.

 

(6)                Application of New AccountingStandards

 

The FASB issued SFAS 141, *Business Combinations*, and SFAS 142, *Goodwill andOther Intangible Assets*.  TheCompany adopted both SFAS 141 and SFAS 142 effective January 1, 2002. SFAS 141requires that the purchase method of accounting be used for all businesscombinations initiated after September 30, 2001.  It also specifies that intangible assets acquired in a purchasemethod business combination be recognized and reported apart fromgoodwill.  SFAS 142 changes theaccounting for goodwill and intangible assets that have indefinite useful livesfrom an amortization approach to an impairment-only approach that requires thatthose assets be tested at least annually for impairment.  The Company completed its annual impairmentreview of goodwill resulting in no impairment as of January 1, 2003.  No other intangible assets were required tobe reclassified and accounted for as an asset apart from goodwill upon adoptionof SFAS 142.  No expense foramortization of goodwill has been recorded in the first six months of 2003 or2002.  Goodwill of $2,534,000 wascarried for the Navigators Agencies’ segment at both June 30, 2003 and December31, 2002, and $2,703,000 and $2,633,000 for the Lloyd’s Operations’ segment atJune 30, 2003 and December 31, 2002, respectively.  Goodwill on the Company’s consolidated balance sheets mayfluctuate due to changes in the foreign currency rates between the U.S. dollarand the British pound.  The adoption ofSFAS 141 did not have any effect on the Company’s results of operations orfinancial condition.

 

In November 2002, the FASB issued Interpretation No. 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*.  This Interpretation clarifies therequirements for a guarantor’s accounting for the disclosures of certainguarantees issued and outstanding.  Thedisclosure requirements in Interpretation No. 45 are effective for financialstatements of interim or annual periods ending after December 15, 2002.  The adoption of this interpretation did nothave any effect on the Company’s results of operations or financial condition.

 

In December 2002, the FASB issued SFAS 148, *Accounting for Stock-Based Compensation, Amendment of FASB StatementNo. 123*.  The provisions ofthis statement provide alternative methods of transition for a voluntary changeto the fair value based method of accounting for stock-based employeecompensation.  The provisions areeffective for financial statements for fiscal years ending after December 15,2002.  We follow the disclosureprovisions of SFAS 123, *Accounting for StockBased Compensation*, as amended by SFAS 148.  These require pro forma net income and earningsper share information, which is calculated assuming we had accounted for ourstock option plans under the “fair value method” described in those statements.

 

In January 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities.*  Interpretation No. 46 requires variableinterest entities to be consolidated by their primary beneficiaries.  The adoption of this interpretation did nothave any effect on the Company’s financial condition or results of operations.

 

In January 2003, the FASB’s Derivative Implementation Group adoptedIssue No. B36, *Embedded Derivatives: Bifurcation of a Debt Instrument That Incorporates Both Interest RateRisk and Credit Risk Exposures That Are Unrelated or Only Partially Related tothe Creditworthiness of the Issuer of That Instrument* (“B36”).  B36 addresses the recognition of embeddedderivatives present in certain reinsurance agreements with funds heldprovisions and is applicable for quarters beginning after September 15, 2003.  The Company has not yet determined theestimated impact on its financial condition or results of operations, if any,of adopting B36.

 

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(7)                Lloyd’s Participation

 

The Company records in its consolidated financial statements, itsproportionate share of Lloyd’s Syndicate 1221’s assets, liabilities and resultsof operations.  Such participation was97.4% of the portion of Syndicate 1221’s £125.0 million ($199.7 million) ofcapacity utilized for the 2003 underwriting year and 68.1% of the portion ofSyndicate 1221’s £75.0 million ($112.7 million) of capacity utilized for the2002 underwriting year.  Syndicate1221’s capacity is expressed net of commission (as is standard at Lloyd’s) ofapproximately 21%.  In 2003, the Companyparticipates in a larger percentage of the gross capacity and is reinsuring15.4% of its capacity under quota share reinsurance agreements to third partieswhich provide letters of credit used as collateral at Lloyd’s.

 

The Company provides letters of credit to Lloyd’s to support itsSyndicate 1221 capacity.  If the Companyincreases its participation or if Lloyd’s changes the capital requirements, theCompany may be required to supply additional letters of credit or othercollateral acceptable to Lloyd’s, or reduce the capacity of Syndicate1221.  The letters of credit areprovided through the credit facility which the Company maintains with aconsortium of banks.  The credit facilityagreement requires that the banks vote by November 19th of each yearwhether or not to renew the letter of credit portion of the facility.  If the banks decide not to renew the letterof credit facility, the Company will need to find other sources to provide theletters of credit or other collateral in order to continue to participate inSyndicate 1221 for underwriting year 2004 and subsequent years.  At June 30, 2003, letters of credit with anaggregate face amount of $54,783,000 were issued under the letter of creditfacility.

 

(8)                Income Tax - Valuation Allowance

 

The Company’s valuation allowance relating to its foreign operationsdecreased by $854,000 in the three months ended June 30, 2003 and $1,484,000 inthe six months ended June 30, 2003 relating to the reduction in the losscarryforward at the Company’s foreign operations resulting from incomegenerated by these operations in 2003. At June 30, 2003 and 2002, the Company had loss carryforwards remainingat its foreign operations amounting to potential future tax benefits of $3,046,000and $5,113,000, respectively, along with a valuation allowance equal to thesebenefits.  Although the foreignoperations were profitable in 2003, the valuation allowance was released onlyto the extent of the 2003 profits since future profitability remainsuncertain.  The Company needs to generate$10,152,000 of future foreign pretax income in order to fully utilize theforeign loss carryforward which can be carried forward indefinitely.

 

The Company also had net state and local loss carryforwards amountingto potential future tax benefits of $2,220,000 and $1,899,000 at June 30, 2003and 2002, respectively, along with a valuation allowance equal to thesebenefits.  The Company needs to generate$12,368,000 of future state and local pretax income in order to fully utilizethe loss carryforwards which expire from 2019 to 2023.

 

The Company had  alternativeminimum tax carryforwards of $0 and $2,304,000 at June 30, 2003 and June 30,2002, respectively.

 

(9)          Treasury Stock

 

During the first six months of 2003, the Company issued the remaining16,423 shares of Treasury stock representing the vested portion of stock grantsto the Company’s President and a senior officer of a subsidiary.  The effect of the issuance reduced Treasurystock by $236,000 in the six months ended June 30, 2003.  During the first six months of 2002, theCompany issued 2,985 shares of Treasury stock to the non-employee directors aspart of the directors’ annual compensation for the prior year.  The effect of the issuance reduced Treasurystock by $43,000 in the first six months of 2002.

 

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(10)    Legal Proceedings

 

The Company is not a party to or the subject of, any material pendinglegal proceedings which depart from the ordinary routine litigation incident tothe kinds of business conducted by the Company, except for a suit concerningthe draw down of letters of credit.  In1997 and 1998, Navigators Insurance entered into certain reinsurance contractswith an Australian reinsurer.  Inaccordance with normal business practice, Navigators Insurance had secured thisexposure with letters of credit.  InApril 1999, in good faith and consistent with the terms of the letters ofcredit, Navigators Insurance drew down $3.2 million of the letters ofcredit.  The liquidator of the reinsurerhas commenced suit in Australia seeking to void the draw downs.  Although the Company believes it has strongdefenses against these claims and that the liquidators’ assertions run counterto prevailing Australian and U.S. law, there can be no assurance as to theoutcome of this litigation.  The Companyis vigorously defending its position.

 

13

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###### **THE NAVIGATORSGROUP, INC. AND SUBSIDIARIES**

 

 

**Item 2****.****                       Management’sDiscussion and Analysis of**

**FinancialCondition and Results of Operations**

 

**Forward-lookingStatements**

 

Some of the statements in this Form 10-Q are “forward-lookingstatements” as defined in the Private Securities Litigation Reform Act of1995.  We derive forward-lookinginformation from information which we currently have and from assumptions whichwe make.  We cannot assure that resultswhich we anticipate will be achieved since results may differ materiallybecause of both known and unknown risks and uncertainties which we face.  The Company undertakes no obligation topublicly update or revise any forward looking statements.  Factors which could cause actual results todiffer materially from our forward looking statements include, but are notlimited to:

 

•                  the effects ofdomestic and foreign economic conditions, and conditions which affect themarket for property and casualty insurance;

•                  changes in thelaws, rules and regulations which apply to our insurance companies;

•                  the effects of emerging claim and coverageissues on our business, including adverse judicial or regulatory decisions andrulings;

•                  the effects ofcompetition from banks, other insurers and the trend toward self-insurance;

•                  risks which weface in entering new markets and diversifying the products and services weoffer;

•                  unexpectedturnover of our professional staff;

•                  changing legal and social trends and inherentuncertainties in the loss estimation process that can adversely impact theadequacy of loss reserves and the allowance for reinsurance recoverables;

•                  risks associatedwith our continuing ability to obtain reinsurance covering our exposures atappropriate prices and/or in sufficient amounts and the related recoverabilityof our reinsured losses;

•                  weather-relatedevents and other catastrophes (including acts of terrorism) impacting ourinsureds and/or reinsurers;

•                  our ability toattain adequate prices, obtain new business and to retain existing businessconsistent with our expectations;

•                  the possibility of downgrades in ourclaims-paying and financial strength ratings adversely affecting us, includingreducing the number of insurance policies we write generally, or causingclients who require an insurer with a certain rating level to use higher-ratedinsurers;

•                  the risk that our investment portfoliosuffers reduced returns or investment losses which could reduce ourprofitability; and

•                  other riskswhich we identify in future filings with the Securities and ExchangeCommission.

 

## **General**

 

The accompanyingconsolidated financial statements consisting of the accounts of The NavigatorsGroup, Inc., a Delaware holding company, and its twelve active wholly ownedsubsidiaries, are prepared on the basis of accounting principles generallyaccepted in the United States of America (“GAAP”).  Unless the context otherwise requires, the term “Company” as usedherein means The Navigators Group, Inc. and its subsidiaries.  All significant intercompany transactionsand balances are eliminated.  Certainamounts for prior years have been reclassified to conform to the current year’spresentation.

 

TheCompany’s two insurance 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 andhas been active since 1983.  Itspecializes principally in underwriting marine insurance and related lines ofbusiness, general liability insurance, and professional liability

 

14

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insurance.  NIC, a wholly owned subsidiary of NavigatorsInsurance, began operations in 1990.  Itunderwrites similar types of business but on a “non-admitted” or surplus linesbasis and is fully reinsured by Navigators Insurance.  Navigators Insurance and NIC are collectively referred to hereinas 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 andrelated lines of business, general liability insurance and professionalliability coverages.

 

Each of the Navigators Agencies write marine and related business forNavigators Insurance and four unaffiliated insurance companies.  The five insurance companies comprise amarine insurance pool.  Marine insurancepolicies are issued by Navigators Insurance with the business shared with otherpool members.  Navigators Insurance hada 75% participation in the pool for business written with effective dates in2002 and has a 70% participation in 2003. For 2003, Navigators Insurance expects to increase its participation inthe pool to 80%, subject to the expected finalization of a commutationagreement with one of the pool members. Although no assurances can be given, it is expected that this agreementwill be entered into during 2003. If the pool participation had been recordedat 80% for the 2003 underwriting year premium, the effect would have increasednet written premium by approximately $4.9 million.

 

Navigators Specialty, a division of a Navigators Agency located in SanFrancisco, California, produces business exclusively for the InsuranceCompanies.  It specializes inunderwriting general liability insurance coverage for small general and artisancontractors as well as other targeted commercial risks, with the majority ofthe business located in California.

 

Navigators Pro, a division of a Navigators Agency located in New York,specializes in underwriting professional liability insurance and beganproducing directors & officers liability insurance exclusively for theInsurance Companies in the fourth quarter of 2001.  In late 2002, Navigators Pro introduced additional products tocomplement its directors & officers liability coverage.  The products include employment practicesliability, lawyers professional liability and miscellaneous professionalliability coverages.

 

NavigatorsHoldings (UK) Limited is a holding company for the Company’s UK subsidiariesconsisting of the Lloyd’s Operations and Navigators Management (UK) Limited, aNavigators Agency, which produces business for the UK Branch of NavigatorsInsurance.  The Lloyd’s Operationsconsist of Navigators Underwriting Agency Ltd. (“NUAL”), a Lloyd’s of London(“Lloyd’s”) marine underwriting managing agency which manages Lloyd’s Syndicate1221, Millennium Underwriting Ltd. (“Millennium”) and Navigators CorporateUnderwriters Ltd. (“NCUL”).  BothMillennium and NCUL are Lloyd’s corporate members with limited liability andprovide capacity to Lloyd’s Syndicate 1221. NUAL owns Pennine Underwriting Ltd., an underwriting managing agencywith offices in Manchester and Leeds, England, which underwrites cargo andengineering business for Lloyd’s Syndicate 1221.

 

The Company’s revenue is primarily comprised of premiums, commissionsand investment income.  The InsuranceCompanies derive their premiums primarily from business written by theNavigators Agencies.  The Lloyd’sOperations derive their premiums primarily from business underwritten byNUAL.  The Navigators Agencies and NUALreceive commissions and in some cases, profit commissions and service fees onbusiness produced.

 

Property and casualty insurance premiums historically have beencyclical in nature and, accordingly, during a “hard market” demand for propertyand casualty insurance exceeds supply or capacity and, as a result, premiumsand commissions may increase.  On thedownturn of the property and casualty cycle, supply exceeds demand and, as aresult, premiums and commissions may decrease.

 

**CriticalAccounting Policies**

 

Itis important to understand the Company’s accounting policies in order tounderstand its financial statements. Management considers certain of these policies to be critical to thepresentation of the financial results

 

15

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sincethey require management to make estimates and assumptions.  These estimates and assumptions affect thereported amounts of assets, liabilities, revenues, expenses, and relateddisclosures at the financial reporting date and throughout the period beingreported upon.  Certain of the estimatesresult from judgments that can be subjective and complex, and consequentlyactual results may differ from these estimates, which would be reflected infuture periods.

 

The Company’s most critical accounting policies involve the reportingof the reserves for losses and loss adjustment expenses (including losses thathave occurred but were not reported to the Company by the financial reportingdate), reinsurance recoverables, written and unearned premium, therecoverability of deferred tax assets, the impairment of invested assets,accounting for Lloyd’s results, and goodwill.

 

*Loss Reserves and LAE.*  Loss reserves represent an estimate of theexpected cost of the ultimate settlement and administration of losses, based onfacts and circumstances then known. Actuarial methodologies are employed to assist in establishing suchestimates and include judgments relative to estimates of future claims severityand frequency, length of time to develop to ultimate, judicial theories ofliability and other third party factors which are often beyond ourcontrol.  Due to the inherentuncertainty associated with the reserving process, the ultimate liability maybe greater or less than the original estimate. Such estimates are regularly reviewed and updated and any resultingadjustments are included in the current year’s results.  Additional information regarding theCompany’s loss reserves can be found in *“Resultsof Operations-Operating Expenses-Net Losses and Loss Adjustment ExpensesIncurred”*.

 

*Reinsurance Recoverables. *Reinsurancerecoverables are established for the portion of the loss reserves that areceded to reinsurers.  Reinsurancerecoverables are determined based upon the terms and conditions of reinsurancecontracts which could be subject to interpretations that differ from our ownbased on judicial theories of liability. In addition, we bear credit risk with respect to our reinsurers whichcan be significant considering that certain of the reserves remain outstandingfor an extended period of time.  TheCompany is required to pay losses even if a reinsurer fails to meet itsobligations under the applicable reinsurance agreement.

 

*Written and Unearned Premium. *Writtenpremium is recorded based on the insurance policies that have been reported tothe Company and the policies that have been written by agents but not yetreported to the Company.  The Companymust estimate the amount of written premium not yet reported based on judgmentsrelative to current and historical trends of the business being written.  Such estimates are regularly reviewed andupdated and any resulting adjustments are included in the current year’sresults.  An unearned premium reserve isestablished to reflect the unexpired portion of each policy at the financialreporting date.

 

*Deferred TaxAssets. *TheCompany has recorded valuation allowances related to deferred tax assetsresulting from net operating loss carryforwards due to the uncertaintyassociated with the realization of the deferred tax asset related to certain ofthe Company’s foreign, state and local operations.  Although the Company’sforeign operations were profitable in 2003, the valuation allowance wasreleased only to the extent of the 2003 profits since future profitabilityremains uncertain.

 

*Impairment ofInvested Assets. *Impairment of investment securities resultsin a charge to operations when a market decline below cost isother-than-temporary.  Managementregularly reviews its fixed maturity and equity securities portfolios toevaluate the necessity of recording impairment losses for other-than-temporarydeclines in the fair value of investments. A number of criteria are consideredduring this process including, but not limited to, the current fair value ascompared to amortized cost or cost, as appropriate, of the security, the lengthof time the security’s fair value has been below amortized cost or cost, and byhow much, the Company’s intent and ability to retain the investment for aperiod of time sufficient to allow for an anticipated recovery in value,specific credit issues related to the issuer and current economicconditions.  In general, we focus ourattention on those securities whose market value was less than 80% of theiramortized cost or cost, as appropriate, for six or more consecutivemonths.  Other-than-temporary impairmentlosses result in a permanent reduction of the cost basis of the underlyinginvestment.  Significant changes in thefactors the Company considers when evaluating investments for

 

16

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impairment losses could result in asignificant change in impairment losses reported in the consolidated financialstatements.

 

*Accountingfor Lloyd’s Results*.  We record our pro rata share of Lloyd’s syndicateassets, liabilities, revenues and expenses, after making adjustments to convertLloyd’s accounting to U.S. GAAP.  Themost significant U.S. GAAP adjustments relate to income recognition. Lloyd’ssyndicates determine underwriting results by year of account at the end ofthree years.  We record adjustments torecognize underwriting results as incurred, including the expected ultimatecost of losses incurred.  These adjustmentsto losses are based on actuarial analysis of syndicate accounts, including forecastsof expected ultimate losses provided by the syndicate.  At theend of the Lloyd’s three year period for determining underwriting results foran account year, the syndicate will close the account year by reinsuringoutstanding claims on that account year with the participants for the account’snext underwriting year.  The amount toclose an underwriting year into the next year is referred to as the reinsurance to**close.  Thereinsurance to close transactions are recorded as additional written and earnedpremium, losses incurred, loss reserves and receivables, all in the sameamount.  There are no gains or lossesrecorded on the reinsurance to closetransactions.

 

Historically, the Companyreported *Funds due from Lloyd’s syndicate*as a separate line item on its balance sheets. The balance consisted primarily of investments, cash and premiumsreceivable resulting from the Company’s participation in Lloyd’s Syndicate1221.  Commencing at December 31, 2002,the Company recorded the amounts due from Lloyd’s Syndicate 1221 as part oftheir separate components in its financial statements.  As a result, the amounts previouslyclassified as *Funds due from Lloyd’s syndicate* have been reclassified toconform to the current year’s presentation.

 

*Goodwill. *The Financial Accounting Standards Boardissued Statement of Financial Accounting Standards 142 (“SFAS 142”), *Goodwill and Other Intangible Assets*, effectiveJanuary 1, 2002.  SFAS 142 changes the accounting for goodwilland intangible assets that have indefinite useful lives from an amortizationapproach to an impairment-only approach that requires that those assets betested at least annually for impairment. The Company completed its annual impairment review of goodwill resultingin no impairment as of January 1, 2003. If the carrying amount of goodwill exceeds its implied fair value, animpairment loss will be recognized.

 

**Results of Operations**

 

Revenues. Gross written premium for the first six months of 2003 increased 48.4%to $315,894,000 from $212,861,000 for the six months of 2002.

 

The following table sets forth the Company’s gross written premium bysegment and line of business, and ceded and net written premium by segment forthe periods indicated:

 
|                         |   | **Six Months  Ended June 30,** |    |
|------------------------------|--------|--------------------------------|---------|
|                         |   | **2003**                       |    | **2002** |   |
|                         |   | **(Dollars  in thousands)**    |    |
| Insurance Companies:         |   |                           |    |   |   |   |   |   |   |
| Marine                       |   | $                              | 103,440 |   | 33 | % | $ | 83,540 |   | 39 | % |
| General Liability            |   | 62,826                         |    | 20 |   | 50,512 |   | 24 |   |
| Professional Liability       |   | 25,558                         |    | 8 |   | 7,709 |   | 4 |   |
| Surety                       |   | 788                            |    | — |   | — |   | — |   |
| Other                        |   | 823                            |    | — |   | 3,046 |   | 1 |   |
| Gross Written Premium        |   | 193,435                        |    | 61 |   | 144,807 |   | 68 |   |
| Ceded Written Premium        |   | (105,753                       | )       |   |   | (63,812 | ) |   |   |
| Net Written Premium          |   | 87,682                         |    |   |   | 80,995 |   |   |   |
|                         |   |                           |    |   |   |   |   |   |   |
| Lloyd’s Operations:     |   |                           |    |   |   |   |   |   |   |
| Marine                       |   | 106,465                        |    | 34 |   | 63,931 |   | 30 |   |
| Engineering and Construction |   | 8,485                          |    | 3 |   | 1,893 |   | 1 |   |
| Onshore Energy               |   | 7,509                          |    | 2 |   | 2,230 |   | 1 |   |
| Gross Written Premium        |   | 122,459                        |    | 39 |   | 68,054 |   | 32 |   |
| Ceded Written Premium        |   | (57,477                        | )       |   |   | (22,606 | ) |   |   |
| Net Written Premium          |   | 64,982                         |    |   |   | 45,448 |   |   |   |
|                         |   |                           |    |   |   |   |   |   |   |
| Total Gross Written Premium  |   | 315,894                        |    | 100 | % | 212,861 |   | 100 | % |
|                         |   |                           |    |   |   |   |   |   |   |
| Total Ceded Written Premium  |   | (163,230                       | )       |   |   | (86,418 | ) |   |   |
|                         |   |                           |    |   |   |   |   |   |   |
| Total Net Written Premium    |   | $                              | 152,664 |   |   |   | $ | 126,443 |   |   |   |

 

17

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Insurance Companies’ Gross Written Premium

 

*Marine Premium. *The marine premiumfor the first six months ended June 30, 2003 increased 23.8% compared to thefirst six months of 2002 due primarily to the increase in premium ratesresulting in higher premiums on new and renewal business.  Navigators Insurance obtained priceincreases on renewal business of approximately 19% in the first six months of2003 amounting to approximately $9.5 million. Navigators Insurance obtains its marine business through participationin the marine pool managed by the Navigators Agencies.

 

*General Liability**Premium.*  This business consists primarily of generalliability insurance for small general and artisan contractors as well as othertargeted commercial risks.  The generalliability premium increased 24.4% from the first six months of 2002 to 2003 dueto new business and increased rates. Rate increases on renewal business for the contractors liabilitypolicies averaged 50.9%, resulting in approximately $7.8 million ofpremium from rate increases.  During thefirst six months of 2003, the number of construction liability in-forcepolicies decreased by approximately 39%. The new business and the rate increases resulted from a tighteningmarket for California contractors’ liability insurance.

 

*Professional Liability Insurance. *In late 2001, the Insurance Companies began towrite professional liability insurance primarily consisting of directors andofficers liability insurance for privately held and publicly tradedcorporations.  In 2002, the professionalliability business has been expanded to include errors and omissions insuranceand employment practices liability coverages. The professional liability premium increased to $25.6 million forthe first six months of 2003 from $7.7 million for the first six months of2002 reflecting growth and the expansion of this business.

 

*Surety.* In late 2002, Navigators Insurance began to write surety business whichconsists of bonds guaranteeing the performance of a specific obligation.  Our focus is on providing bid andperformance bonds to small contractors requiring contract bonds for projects of$2 million or less.

 

### **Lloyd’s Operations’ Gross Written Premium**

 

The Lloyd’s premium is generated as the result of NCUL and Millenniumproviding capacity to Lloyd’s Syndicate 1221 which is managed by NUAL.

 

18

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Lloyd’s Syndicate 1221’s 2003 stamp capacityof £125 million ($199.7 million) compared to £75.0 million ($112.7 million) in2002.  Syndicate 1221’s capacity is expressednet of commission (as is standard at Lloyd’s) of approximately 21%.  The Company participates for 97.4% and 68.1%of Syndicate 1221’s capacity for the 2003 and 2002 underwriting years,respectively.  In 2003, the Companyparticipates in a larger percentage of the gross capacity and is reinsuring15.4% of its capacity under quota share reinsurance agreements to third partieswhich provide letters of credit used as collateral at Lloyd’s.  The Lloyd’s marine business had been subjectto deteriorating pricing beginning in the mid-1990’s.  The pricing competition showed some signs of stabilizing in 2000and prices increased in 2001, 2002 and in the first six months of 2003.  Lloyd’s presents its results on anunderwriting year basis, generally closing each underwriting year after threeyears.  The Company makes estimates foreach underwriting year and timely accrues the expected results.  The Lloyd’s Operations included in theconsolidated financial statements represent the Company’s participation in Syndicate1221.

 

Lloyd’s syndicates report the amounts of premiums, claims, and expensesrecorded in an underwriting account for a particular year to the companies orindividuals that participate in the syndicates.  The syndicates generally keep accounts open for three years.  Traditionally, three years have beennecessary to report substantially all premiums associated with an underwritingyear and to report most related claims, although claims may remain unsettledafter the account is closed.  A Lloyd’ssyndicate typically closes an underwriting account by reinsuring outstandingclaims on that account with the participants for the next underwritingyear.  The ceding participants pay theassuming participants an amount based on the unearned premiums and outstandingclaims in the underwriting account at the date of the assumption.  Our participation in Lloyd’s Syndicate 1221is represented by and recorded as our proportionate share of the underlyingassets and liabilities and results of operations of the syndicate since, (a) wehold an undivided interest in each asset, (b) we are proportionately liable foreach liability and (c) Syndicate 1221 is not a separate legal entity.  At Lloyd’s, the amount to close anunderwriting year into the next year is referred to as the reinsurance to close*.* The reinsurance to close amounts represent the transfer of the assetsand liabilities from the participants of a closing underwriting year to theparticipants of the next underwriting year. To the extent our participation in the syndicate changes as a result ofthis transfer, the reinsurance to close amounts vary accordingly.  The reinsuranceto close transactions are recorded as additional written and earnedpremium, losses incurred, loss reserves and receivables, all in the sameamount.  There are no gains or lossesrecorded on the transactions.

 

The Company provides letters of credit toLloyd’s to support its participation in Syndicate 1221’s capacity.  If the Company increases its participationor if Lloyd’s changes the capital requirements, the Company may be required tosupply additional letters of credit or other collateral acceptable to Lloyd’s,or reduce the capacity of Syndicate 1221. The letters of credit are provided through the credit facility which theCompany maintains with a consortium of banks. The credit facility agreement requires that the banks vote by November19th of each year whether or not to renew the letter of creditportion of the facility each year.  Ifthe banks decide not to renew the letter of credit facility, the Company willneed to find other sources to provide the letters of credit or other collateralin order to continue to participate in Syndicate 1221 for underwriting year2004 and subsequent years.

 

*Marine Premium.*  In the first six months of 2003, marine premium increased 66.5%from the first six months of 2002 partially due to the increase in premiumrates resulting in higher premiums on renewal and new business and due to thecapacity provided to Syndicate 1221 by NCUL and Millennium increasing from68.1% in 2002 to 97.4% in 2003.  Theincreased premium in 2003 included approximately $11.4 million of rateincreases.

 

*Engineering and Construction Premium.*  The business consists of coverage forconstruction projects including machinery, equipment and loss of use due todelays.  The increase in the grosswritten premium in the first six months of 2003 compared to 2002 was due to newbusiness and the increase in capacity provided to Syndicate 1221.

 

*Onshore Energy.*  The business principally focuses on the oil and gas, chemical andpetrochemical industries with coverages primarily for property damage andbusiness interruption.  The increase inthe gross written premium in the first six months of 2003 compared to 2002 wasprimarily due to new business and the increase in capacity provided toSyndicate 1221.

 

19

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Ceded Written Premium*.*  In the ordinary course of business, the Company reinsures certaininsurance risks with unaffiliated insurance companies for the purpose oflimiting its maximum loss exposure, protecting against catastrophic losses, andmaintaining desired ratios of net premiums written to statutory surplus.  The relationship of ceded to written premiumvaries based upon the types of business written and whether the business iswritten by the Insurance Companies or the Lloyd’s Operations.  There are several factors contributing to anincrease in ceded premium when comparing the six months ended June 30, 2003 tothe same period in 2002.  First, rateincreases on our business resulted in higher premium levels, and consequentlymore ceded premiums.  The second is thecost of “excess of loss” reinsurance which is purchased to limit the Company’sexposure to an individual large loss. This reinsurance cost increased in themarine and general liability business. Effective April 1, 2003, the reinsurance treaty for our generalliability business was amended to incorporate ceded commission from thereinsurer and a rate increase. Third, we increased the amount of quota sharereinsurance for certain product lines, based upon management’s assessment ofexpected loss activity.  Fourth,Navigators Pro experienced substantial premium growth, resulting in increasedamounts of premium ceded to its quota share reinsurance program.  Additionally, the Company entered into quotashare reinsurance agreements to reinsure 15.4% of its Syndicate 1221 capacityto third parties which provide letters of credit used as collateral at Lloyd’s.

 

Net Written Premium*.* Net written premium increased 20.7% when comparing the first sixmonths of 2003 to the same period in 2002, as a result of the increase in thegross written premium partially offset by the increased ceded premium, each ofwhich is discussed above.

 

Net Earned Premium.  Net earned premium increased 28.2% and 45.0% for the three andsix months ended June 30, 2003, respectively, compared to the same periods in2002.  Net earned premium increasedacross all major product lines as a result of rate increases and new businessgenerated in 2002 and 2003.

 

Commission Income*. *Commission income generated by the Navigators Agenciesincreased to $2,725,000 for the first six months of 2003 from $2,094,000 forthe same period in 2002,  and increasedto $1,486,000 for the three months ended June 30, 2003 from $993,000 for the2002 second quarter, primarily as the result of the increased earned premium onthe marine business produced by the Navigators Agencies and an increase in theunaffiliated insurance companies’ share of the marine pool from 25% to 30%.

 

Net Investment Income*. *Net investment income was substantially the same for the sixmonths ended June 30, 2003 and 2002. The earnings from the increase in investment assets were offset by thegeneral decrease in interest rates.

 

Net Realized Capital Gains (Losses)*. *Pre-tax net income for the firstsix months of 2003 included $887,000 of net realized capital gains compared to$92,000 of net realized capital losses for the same period last year.  On an after tax basis, the net realizedcapital gains were $738,000 or $0.08 per share for the first six months of 2003and the net realized capital losses were $71,000 or $0.01 per share for thesame period of 2002.

 

Pre-tax net income included $669,000 and $201,000 of net realized capitalgains for the second quarters of 2003 and 2002, respectively.  On an after tax basis, the net realizedcapital gains were $561,000 or $0.06 per share for the second quarter of 2003compared to $124,000 or $0.01 per share for the second quarter of 2002.  Included in net realized capital gains in thesecond quarter of 2002 was $2,118,000 of impairment losses recorded on one ofthe Company’s asset backed securities. There have been no impairment losses on securities in 2003.

 

Other Income. Other income for the first six months and second quarter of 2003 and2002 consisted primarily of fees related to the general liability business andforeign exchange gains and losses.

 

Operating Expenses.

 

*Net Losses and LossAdjustment Expenses Incurred.*  The amount recorded for netlosses and loss adjustment expenses reflects management’s estimate of dollaramounts required to pay all claims as well as related

 

20

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expensesto adjust and settle claims.  Theestimates include payments made during the period, reserves established forfuture payment on known claims (“case reserves”) and reserves established forclaims that are anticipated but that have not yet been reported to Navigators(“IBNR” or “incurred but not reported”). Insurance companies typically evaluate their loss experience bycalculating a “loss ratio”, which is the ratio of losses and loss adjustmentexpenses incurred to the net earned premium for the period.  Navigators loss ratio for the first sixmonths of 2003 was 66.4%, compared to 61.9% for the first six months of2002.  The majority of this increase wasdue to an increase in the loss ratio of Navigators Insurance increasing from58.5% for the first six months of 2002 to 66.9% for the first six months of 2003.  The largest factor impacting this was anincrease in incurred losses for the Navigators Insurance’s U.S. marine businessin the first three months of 2003.  To alesser extent, the increase in the loss ratio was affected by the growth in thegeneral liability and professional liability lines of business for which wegenerally estimate a higher ultimate loss ratio than the marine business and achange in the general liability excess of loss program which increased the lossratio and decreased the commission expense ratio.  Also, the Company experienced adverse development on an assumedreinsurance line of business currently in runoff and, as a result, strengthenedits loss reserves on such business by $1,645,000.

 

Insurance companies and Lloyd’s syndicatesare required to maintain reserves for unpaid losses and unpaid loss adjustmentexpenses (“LAE”) for all lines of business. These reserves are intended to cover the probable ultimate cost ofsettling all losses incurred and unpaid, including those incurred but notreported.  The determination of reservesfor losses and LAE for insurance companies such as Navigators Insurance andNIC, and Lloyd’s corporate members such as NCUL and Millennium is dependentupon the receipt of information from the pools and syndicates in which suchcompanies participate.  Generally, thereis a lag between the time premiums are written and related losses and LAE areincurred, and the time such events are reported to the pools and syndicatesand, subsequently, to Navigators Insurance, NIC, NCUL and Millennium.

 

Reserves are established for the Insurance Companies and Lloyd’sSyndicate 1221 for reported claims when notice of the claim is firstreceived.  Reserves for such reportedclaims are established on a case-by-case basis by evaluating several factors,including the type of risk involved, knowledge of the circumstances surroundingsuch claim, severity of injury or damage, the potential for ultimate exposure,experience with the insured and the broker on the line of business, and thepolicy provisions relating to the type of claim.  Reserves for incurred but not reported losses are determined inpart on the basis of statistical information and in part on industry experienceand the judgement of our senior management.

 

Loss reserves are estimates of what theinsurer or reinsurer expects to pay on claims, based on facts and circumstancesthen known.  It is possible that theultimate liability may exceed or be less than such estimates.  In setting its loss reserve estimates, the Companyreviews statistical data covering several years, analyzes patterns by line ofbusiness and considers several factors including trends in claims frequency andseverity, changes in operations, emerging economic and social trends, inflationand changes in the regulatory and litigation environment.  Based on this review, the Company makes abest estimate of its ultimate liability. During the loss settlement period, which, in some cases, may lastseveral years, additional facts regarding individual claims may become knownand, accordingly, it often becomes necessary to refine and adjust the estimatesof liability on a claim upward or downward. Such estimates are regularlyreviewed and updated and any resulting adjustments are included in the currentyear’s income statement.  Even then, theultimate liability may exceed or be less than the revised estimates.  The reserving process is intended to provideimplicit recognition of the impact of inflation and other factors affectingloss payments by taking into account changes in historical payment patterns andperceived probable trends.  There isgenerally no precise method for the subsequent evaluation of the adequacy ofthe consideration given to inflation, or to any other specific factor, becausethe eventual deficiency or redundancy of reserves is affected by many factors,some of which are interdependent.

 

Thefollowing table sets forth the Company’s net loss reserves by segment and byline of business as of the date indicated:

 

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|                           |   | **June 30,  2003**     |       | **December 31,  2002** |       |
|--------------------------------|--------|------------------------|------------|------------------------|------------|
|                           |   | **Net Loss  Reserves** |       | **Net Loss  Reserves** | ** ** |
|                           |   | **(In thousands)**     | ** ** |
|                           |   |                   |       |                   |       |
| Insurance  Companies:          |   |                   |       |                   |       |
| Marine                         |   | $                      | 77,294     |                   | $          | 73,521 |   |
| General  Liability             |   | 85,290                 |       | 64,949                 |       |
| Professional  Liability        |   | 3,512                  |       | 1,240                  |       |
| Surety                         |   | 35                     |       | 7                      |       |
| Other                          |   | 26,377                 |       | 26,690                 |       |
| Total  Insurance Companies     |   | 192,508                |       | 166,407                |       |
|                           |   |                   |       |                   |       |
| Lloyd’s  Operations:      |   |                   |       |                   |       |
| Marine                         |   | 106,286                |       | 97,018                 |       |
| Engineering  and Construction  |   | 1,071                  |       | 726                    |       |
| Onshore  Energy                |   | 2,179                  |       | 496                    |       |
| Total  Lloyd’s Operations |   | 109,536                |       | 98,240                 |       |
|                           |   |                   |       |                   |       |
| Total  Net Loss Reserves       |   | $                      | 302,044    |                   | $          | 264,647 |   |

 

Our loss reserves include amounts related to short tail and long tailclasses of business.  Short tailbusiness means that claims are generally reported quickly upon occurrence of anevent, making estimation of loss reserves less complex.  Our longer tail business includes generalliability and professional liability insurance.  For the long tail lines, significant periods of time, ranging upto several years or more, may elapse between the occurrence of the loss, thereporting of the loss and the settlement of the claim. The longer the time spanbetween the incidence of a loss and the settlement of the claim, the morelikely the ultimate settlement amount can vary.

 

*General Liability and ProfessionalLiability*

 

The general liability business generates third party liability claimsthat are longer tail in nature.  Asignificant portion of Navigators’ general liability reserves relate toCalifornia construction defect claims. Reserves and claim frequency on this business may be impacted bylegislation recently implemented in California, which generally providesconsumers who experienced construction defects a method other than litigationto obtain construction defect repairs. This legislation may impact claim severity, frequency and length tosettlement assumptions underlying our reserves.  Accordingly, Navigators ultimate liability may exceed or be lessthan current estimates due to this variable, among others.

 

For general liability, a relatively small proportion of net losses inthe more recent accident years are reported claims and an even smallerproportion are paid losses. Therefore, a relatively large proportion of ourgeneral liability net losses are reserves for IBNR losses. In fact,approximately 75% of our general liability net loss reserves at June 30, 2003were for IBNR.  As of June 30, 2003, theCompany had 1,450 open claims relating to general liability business comparedto 1,275 open claims as of December 31, 2002. During the first six months of 2003, 1,022 new claims were made and 847existing claims were settled or dismissed. The Company’s net loss and LAE reserves for its general liabilitybusiness as of June 30, 2003 was $85,290,000.

 

The professional liability class generates third party liabilityclaims, which also are longer tail in nature. The professional liability policies provide coverage on a “claims made”basis, whereby coverage is generally provided only for those claims that aremade during the policy period. Navigators professional liability business is relatively immature, withNavigators first writing the business in late 2001.  Accordingly, given the relative immaturity of this business, itwill take some time to better understand the reserve trends on thisbusiness.  Where anticipated lossexperience is less predictable because of the small number of claims and/orerratic claim severity patterns, our loss estimates are based on expected losses,actual reported losses, evaluation of loss trends, and the legal, regulatoryand current risk environment.  Navigators has made areasonable estimate of the required loss reserves for professional liability. The expected ultimate losses may be adjustedup or down as the accident years mature.

 

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Virtuallyall of the professional liability net loss reserves at June 30, 2003 were forIBNR.  As of June 30, 2003, the Companyhad 43 open claims for professional liability coverage compared to 7 openclaims as of December 31, 2002.  Duringthe first six months of 2003, 41 new claims were made and 5 claims wereclosed.  The Company’s net loss and LAEreserves for professional liability coverage as of June 30, 2003 were$3,512,000.

 

*Asbestos and EnvironmentalLiability*

 

Navigatorshas minimal exposure to asbestos and environmental liability, largely stemmingfrom marine liability insurance written on an occurrence basis during themid-1980’s.  In general, ourparticipation on such risks is in the higher excess layers, which requires theunderlying coverage to be exhausted prior to coverage being triggered in ourlayer.  In many instances we are one ofmany insurers who participate in the defense and ultimate settlement of theseclaims, and we are generally a minor participant in the overall insurancecoverage and settlement.  Further, sincemost of Navigators’ policies were issued after the industry was apprised ofasbestos exposures, many of the policies on which Navigators participates haveexclusions that may preclude coverage. In addition, many of these claims have been inactive for several yearsand may be closed in the near future.

 

Managementbelieves that its reserves for such claims are adequate because the Company’sparticipation in such risks is generally in the higher excess layers and, basedon a continuing review of such claims, it believes that a majority of theseclaims 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.

 

The following tables set forth the Company’s net loss reserves andclaim counts for its environmental and asbestos exposure, which it believes issubject to uncertainties greater than those presented by other types of claims:

 

 
|                                         |   |                              |   |                    |   | **Net Losses  & LAE  incurred for  the six months  ended  June 30, 2003** | ** ** | **Net Paid  Losses & LAE  for the six  months ended  June 30, 2003** |   |
|----------------------------------------------|--------|-----------------------------------|--------|-------------------------|--------|-------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|--------|
|                                         |   | **Net Loss  & LAE  Reserves** |   |
| **(Dollars in thousands)  Type of Business** |   | **June 30,  2003**                |   | **December  31,  2002** |   |
|                                         |   |                              |   |                    |   |                                                                          |       |                                                                     |   |
| Environmental                                |   | $                                 | 721    |                    | $      | 1,072                                                                         |       | $                                                                        | 160    |   | $ | 511 |   |
| Asbestos                                     |   | 475                               |   | 441                     |   | 99                                                                            |       | 65                                                                       |   |
| Total                                        |   | $                                 | 1,196  |                    | $      | 1,513                                                                         |       | $                                                                        | 259    |   | $ | 576 |   |

 
| **Type of Business** |   | **Claim  Count  January 1, 2003** | ** ** | **New Claims  During Period** | ** ** | **Claims  Settled  or Resolved  During Period** | ** ** | **Claim  Count  June 30, 2003** | ** ** |
|----------------------|--------|-----------------------------------|------------|-------------------------------|------------|-------------------------------------------------|------------|---------------------------------|------------|
|                 |   |                              |       |                          |       |                                            |       |                            |       |
| Environmental        |   | 202                               |       | 10                            |       | 128                                             |       | 84                              |       |
| Asbestos             |   | 275                               |       | 18                            |       | 209                                             |       | 84                              |       |
| Total                |   | 477                               |       | 28                            |       | 337                                             |       | 168                             |       |

 

Approximately 310 files were closed following a review by in-housecounsel, which resulted in management concluding that there is no reasonableprospect of exposure to the Company on such matters.  No other material trends or developments were noted in the abovenet loss reserve and claim count tables.

 

*Commission Expense. *Commission expense as a percentage ofnet earned premium was 14.8% and 19.8% for the six months ended June 30, 2003and 2002, respectively.  The commissionexpense was 13.6% and 20.3% for the second quarter of 2003 and 2002,respectively.  The commission expensetends to fluctuate with

 

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changes in the mix ofbusiness.  The decrease during the firstsix months of 2003 was primarily the result of reinsurance ceding commissionsfrom a change in the general liability reinsurance program and from theprofessional liability and Lloyd’s marine operations.

 

*Other Operating Expenses. *Other operatingexpenses increased to $23,824,000 for the first six months ended June 30, 2003from $18,870,000 during the corresponding period of 2002, primarily due to theincrease in employee related expenses resulting from expansion of thebusiness.  The percentage of otheroperating expenses to net earned premium decreased to 18.1% for the first sixmonths of 2003 from 20.8% for the corresponding 2002 period due to the expensesbeing spread over a larger premium base. Other operating expenses increased to $12,237,000 from $8,983,000 forthe three months ended June 30, 2003 and 2002, respectively.  The increase also resulted primarily fromemployee related expenses resulting from expansion of the business.

 

*Interest Expense. *Interest expense decreased to $184,000for the six months ended June 30, 2003 from $305,000 for the correspondingperiod of 2002, and decreased to $87,000 from $145,000 when comparing thesecond quarters of 2003 and 2002.  Thesedeclines were due to a smaller loan balance and lower interest rates on theloan.

 

Income Taxes*.*  The effective tax rate was 21.5% and 23.0% for the six monthsended June 30, 2003 and 2002, respectively, and 20.5% versus 25.4% for thesecond quarters of 2003 and 2002, respectively..  The rates differed from the Federal statutory income tax rateprimarily due to the change in the valuation allowance to the extent of incomeor loss generated in certain of its foreign operations, and also to tax-exemptinterest income.

 

The Company’s valuation allowance relating to its foreign operationsdecreased by $1,484,000 for the six months ended June 30, 2003 relating to thereduction in the loss carryforward at the Company’s foreign operationsresulting from income generated by these operations in the first six months of2003.  At June 30, 2003 and 2002, theCompany had loss carryforwards remaining at its foreign operations amounting topotential future tax benefits of $3,046,000 and $5,113,000, respectively, alongwith a valuation allowance equal to these benefits.  Even though the foreign operations were profitable in the firstsix months of 2003, the valuation allowance was released only to the extent ofthe 2003 profits since future profitability remains uncertain.  The Company needs to generate $10,152,000 offuture foreign pretax income in order to fully utilize the foreign losscarryforward which can be carried forward indefinitely.

 

The Company also had net state and local loss carryforwards amountingto potential future tax benefits of $2,220,000 and $1,899,000 at June 30, 2003and 2002, respectively, along with a valuation allowance equal to thesebenefits.  The Company needs to generate$12,368,000 of future state and local pretax income in order to fully utilizethe loss carryforwards which expire from 2019 to 2023.

 

The Company had alternative minimum tax carryforwards of $0 and$2,304,000 at June 30, 2003 and 2002, respectively.

 

Net Income*.* The Company had net income of $11,108,000 for the six months endedJune 30, 2003 compared to $7,224,000 for the same period last year.  On a diluted per share basis, this representednet income per share of $1.27 and $0.84 for the six months ended June 30, 2003and 2002, respectively.  Net income forthe second quarter of 2003 was $6,274,000, or $0.72 per share, compared to netincome in the second quarter of 2002 of $3,774,000, or $0.43 per share.

 

**Investments**

 

Theinvestments of the Insurance Companies must comply with the insurance laws ofNew York State, the domiciliary state of Navigators Insurance and NIC.  These laws prescribe the type, quality andconcentration of investments which may be made by insurance companies.  In general, these laws permit investments,within specified limits and subject to certain qualifications, in federal,state and municipal obligations, corporate bonds,

 

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preferred stocks, commonstocks, real estate mortgages and real estate. The Insurance Companies’ investment guidelines prohibit investments inderivatives other than as a hedge against a foreign currency.

 

The Insurance Companies’ investments are subject to the direction andcontrol of its Board of Directors and are reviewed on a quarterly basis.  The investments are managed by outsideprofessional fixed income and equity portfolio managers.  Current investment objectives are tomaximize annual after tax income in the context of preserving and enhancing capitaland statutory surplus.  The InsuranceCompanies seek to attain these objectives by investing in municipal bonds, U.S.Government obligations, corporate bonds and mortgage and asset backedsecurities and common stocks.  TheInsurance Companies’ investment guidelines require that at least 90% of thefixed income portfolio be rated “A-” or better by a nationally recognizedrating organization.  Up to 25% of thetotal portfolio may be invested in equity securities that are actively tradedon major U.S. stock exchanges.

 

The Lloyd’s Operations investments are subject to the direction andcontrol of the Board of Directors and Investment Committee of NUAL andrepresent the Company’s share of the investments held by Syndicate 1221.  The investments must comply with the rulesand regulations imposed by Lloyd’s of London and by certain overseasregulators.  The investments are managedby outside professional fixed income managers. The performance of the investment managers is reviewed quarterly.  Current investment objectives are tomaximize pre-tax income in the context of preserving and enhancingcapital.  The investment managers forSyndicate 1221 seek to attain these objectives by investing in Governmentobligations, corporate bonds and mortgage and asset backed securities.

 

The majorityof the investment income of the Navigators Agencies is derived from fiduciaryfunds invested in accordance with the guidelines of various state insurancedepartments.  These guidelines typicallyrequire investments in short-term instruments. This investment income is paid to the pool members, including NavigatorsInsurance.

 

Fixed maturity securitiesinclude bonds and mortgage and asset backed securities. All fixed maturity andequity securities are carried at fair value. The fair value is based on quoted market prices or dealer quotesprovided by independent pricing services.

 

At June 30, 2003 and December 31, 2002, all fixed maturity and equitysecurities held by the Company were classified as available-for-sale.

 

The following table presentsthe amortized cost or cost, as applicable, gross unrealized gains and lossesand fair value for all fixed maturity and equity securities:

 
| **June 30, 2003**                                 |   | **Amortized  Cost or Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  (Losses)** |   | **Fair  Value** | ** ** |
|---------------------------------------------------|--------|-----------------------------|------------|------------------------------|------------|---------------------------------|--------|-----------------|------------|
|                                              |   | **(In  thousands)**         | ** ** |
| Fixed maturities:                                 |   |                        |       |                         |       |                            |   |            |       |
|                                              |   |                        |       |                         |       |                            |   |            |       |
| U.S. Government Treasury Bonds and GNMAs          |   | $                           | 195,785    |                         | $          | 7,489                           |   | $               | (147       | ) | $ | 203,127 |   |
| States, municipalities and political subdivisions |   | 59,061                      |       | 3,326                        |       | (43                             | )      | 62,344          |       |
| Mortgage and asset backed (excluding GNMAs)       |   | 69,663                      |       | 2,765                        |       | (25                             | )      | 72,403          |       |
| Corporate bonds                                   |   | 94,980                      |       | 6,138                        |       | (79                             | )      | 101,039         |       |
|                                              |   |                        |       |                         |       |                            |   |            |       |
| Total fixed maturities                            |   | $                           | 419,489    |                         | $          | 19,718                          |   | $               | (294       | ) | $ | 438,913 |   |
|                                              |   |                        |       |                         |       |                            |   |            |       |
| Equity securities - common stocks                 |   | $                           | 11,969     |                         | $          | 960                             |   | $               | (379       | ) | $ | 12,550 |   |

 

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| **December 31, 2002**                             |   | **Gross  Amortized  Cost or Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Unrealized  (Losses)** |   | **Fair  Value** | ** ** |
|---------------------------------------------------|--------|------------------------------------|------------|------------------------------|------------|--------------------------|--------|-----------------|------------|
|                                              |   | **(In  thousands)**                | ** ** |
| Fixed maturities:                                 |   |                               |       |                         |       |                     |   |            |       |
|                                              |   |                               |       |                         |       |                     |   |            |       |
| U.S. Government Treasury Bonds and GNMAs          |   | $                                  | 159,729    |                         | $          | 7,113                    |   | $               | —     |   | $ | 166,842 |   |
| States, municipalities and political subdivisions |   | 47,709                             |       | 2,463                        |       | (45                      | )      | 50,127          |       |
| Mortgage and asset backed (excluding GNMAs)       |   | 63,830                             |       | 1,664                        |       | (7                       | )      | 65,487          |       |
| Corporate bonds                                   |   | 80,553                             |       | 4,017                        |       | (350                     | )      | 84,220          |       |
|                                              |   |                               |       |                         |       |                     |   |            |       |
| Total fixed maturities                            |   | $                                  | 351,821    |                         | $          | 15,257                   |   | $               | (402       | ) | $ | 366,676 |   |
|                                              |   |                               |       |                         |       |                     |   |            |       |
| Equity securities - common stocks                 |   | $                                  | 12,286     |                         | $          | 245                      |   | $               | (857       | ) | $ | 11,674 |   |

 

The Company regularlyreviews its fixed maturity and equity securities portfolios to evaluate thenecessity of recording impairment losses for other-than-temporary declines inthe fair value of investments.  Ingeneral, we focus our attention on those securities whose market value was lessthan 80% of their amortized cost or cost, as appropriate, for six or moreconsecutive months.  Other factorsconsidered in evaluating potential impairment include the current fair value ascompared to amortized cost or cost, as appropriate, the Company’s intent andability to retain the investment for a period of time sufficient to allow foran anticipated recovery in value, specific credit issues related to the issuerand current economic conditions.

 

When a security in theCompany’s investment portfolio has an unrealized loss that is deemed to beother-than-temporary, the Company writes the security down to fair valuethrough a charge to operations. Significant changes in the factors the Company considers when evaluatinginvestments for impairment losses could result in a significant change inimpairment losses reported in the consolidated financial statements.

 

The following table showsthe Company’s impairment losses recorded in its fixed maturity and equityportfolios for the periods indicated:

 
|                              |   | **Total  Write-downs** |       | **Write-downs  On Securities  Sold During  Period** | ** ** | **Write-downs  On Securities  Held at  Period End** | ** ** |
|-----------------------------------|--------|------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
|                              |   | **(In thousands)**     | ** ** |
| Three Months Ended June  30, 2003 |   |                   |       |                                                |       |                                                |       |
|                              |   |                   |       |                                                |       |                                                |       |
| Fixed maturities                  |   | $                      | —     |                                                | $          | —                                              |       | $ | — |   |
| Equity securities                 |   | —                 |       | —                                              |       | —                                              |       |
| Total Portfolio                   |   | $                      | —     |                                                | $          | —                                              |       | $ | — |   |
|                              |   |                   |       |                                                |       |                                                |       |
| Three Months Ended June  30, 2002 |   |                   |       |                                                |       |                                                |       |
|                              |   |                   |       |                                                |       |                                                |       |
| Fixed maturities                  |   | $                      | 2,118      |                                                | $          | —                                              |       | $ | 2,118 |   |
| Equity securities                 |   | —                 |       | —                                              |       | —                                              |       |
| Total Portfolio                   |   | $                      | 2,118      |                                                | $          | —                                              |       | $ | 2,118 |   |

 

26

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|                            |   | **Total  Write-downs** |       | **Write-downs  On Securities  Sold During  Period** | ** ** | **Write-downs  On Securities  Held at  Period End** | ** ** |
|---------------------------------|--------|------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|
|                            |   | **(In thousands)**     | ** ** |
| Six Months Ended June 30,  2003 |   |                   |       |                                                |       |                                                |       |
|                            |   |                   |       |                                                |       |                                                |       |
| Fixed maturities                |   | $                      | —     |                                                | $          | —                                              |       | $ | — |   |
| Equity securities               |   | —                 |       | —                                              |       | —                                              |       |
| Total Portfolio                 |   | $                      | —     |                                                | $          | —                                              |       | $ | — |   |
|                            |   |                   |       |                                                |       |                                                |       |
| Six Months Ended June 30,  2002 |   |                   |       |                                                |       |                                                |       |
|                            |   |                   |       |                                                |       |                                                |       |
| Fixed maturities                |   | $                      | 2,118      |                                                | $          | —                                              |       | $ | 2,118 |   |
| Equity securities               |   | —                 |       | —                                              |       | —                                              |       |
| Total Portfolio                 |   | $                      | 2,118      |                                                | $          | —                                              |       | $ | 2,118 |   |

 

As of June 30, 2003, theCompany’s total portfolio had $20.7 million in gross unrealized gains and $0.7million in gross unrealized losses, compared to $15.5 million in grossunrealized gains and $1.3 million in gross unrealized losses at December 31,2002.

 

Thefollowing table summarizes all securities in an unrealized loss position atJune 30, 2003 and December 31, 2002 showing the aggregate fair value and grossunrealized loss by the length of time those securities have continuously beenin an unrealized loss position:

 
|                                              |   | **June 30,  2003** |       | **December  31, 2002**     |       |
|---------------------------------------------------|--------|--------------------|------------|----------------------------|------------|
|                                              |   | **Fair  Value**    |       | **Gross  Unrealized Loss** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized Loss** | ** ** |
|                                              |   | **(In thousands)** | ** ** |
| Fixed Maturities:                                 |   |               |       |                       |       |   |   |   |   |
| U.S. Government Treasury Bonds and GNMAs          |   |               |       |                       |       |   |   |   |   |
| 0-6 Months                                        |   | $                  | 16,118     |                       | $          | 147 |   | $ | — |   | $ | — |   |
| 7-12 Months                                       |   | —             |       | —                     |       | — |   | — |   |
| > 12 Months                                    |   | —             |       | —                     |       | — |   | — |   |
| Subtotal                                          |   | 16,118             |       | 147                        |       | — |   | — |   |
|                                              |   |               |       |                       |       |   |   |   |   |
| States, municipalities and political subdivisions |   |               |       |                       |       |   |   |   |   |
| 0-6 Months                                        |   | 1,800              |       | 27                         |       | 1,144 |   | 16 |   |
| 7-12 Months                                       |   | —             |       | —                     |       | — |   | — |   |
| > 12 Months                                    |   | 407                |       | 16                         |       | 894 |   | 29 |   |
| Subtotal                                          |   | 2,207              |       | 43                         |       | 2,038 |   | 45 |   |
|                                              |   |               |       |                       |       |   |   |   |   |
| Mortgage and asset backed (excluding GNMAs)       |   |               |       |                       |       |   |   |   |   |
| 0-6 Months                                        |   | 1,381              |       | 18                         |       | 221 |   | 1 |   |
| 7-12 Months                                       |   | 59                 |       | 1                          |       | — |   | — |   |
| > 12 Months                                    |   | 177                |       | 6                          |       | 218 |   | 6 |   |
| Subtotal                                          |   | 1,617              |       | 25                         |       | 439 |   | 7 |   |
|                                              |   |               |       |                       |       |   |   |   |   |
| Corporate bonds                                   |   |               |       |                       |       |   |   |   |   |
| 0-6 Months                                        |   | 6,882              |       | 43                         |       | 2,037 |   | 72 |   |
| 7-12 Months                                       |   | 1,075              |       | 36                         |       | 515 |   | 7 |   |
| > 12 Months                                    |   | —             |       | —                     |       | 1,841 |   | 271 |   |
| Subtotal                                          |   | 7,957              |       | 79                         |       | 4,393 |   | 350 |   |
|                                              |   |               |       |                       |       |   |   |   |   |
| Total Fixed Maturities                            |   | $                  | 27,899     |                       | $          | 294 |   | $ | 6,870 |   | $ | 402 |   |
|                                              |   |               |       |                       |       |   |   |   |   |
| Equity securities — common stocks            |   |               |       |                       |       |   |   |   |   |
| 0-6 Months                                        |   | $                  | 820        |                       | $          | 68 |   | $ | 3,378 |   | $ | 254 |   |
| 7-12 Months                                       |   | 1,817              |       | 72                         |       | 2,736 |   | 446 |   |
| > 12 Months                                    |   | 1,333              |       | 239                        |       | 987 |   | 157 |   |
|                                              |   |               |       |                       |       |   |   |   |   |
| Total Equity Securities                           |   | $                  | 3,970      |                       | $          | 379 |   | $ | 7,101 |   | $ | 857 |   |

 

27

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The above unrealized losseshave been determined to be temporary and resulted from changes in marketconditions.  We will continue to analyzethe unrealized losses quarterly to determine if any of them areother-than-temporary.

 

The following table showsthe composition by National Association of Insurance Commissions (“NAIC”)rating and the generally equivalent S&P and Moody’s ratings of the fixedmaturity securities in the Company’s portfolio with gross unrealized losses atJune 30, 2003.  Not all of thesecurities are rated by S&P and/or Moody’s.

 

(Dollarsin thousands)

 
| **NAIC  Rating** |   | **Equivalent  S&P  Rating** |   | **Equivalent  Moody’s  Rating** |   | **Unrealized  Loss** |   | **Percent  to Total** |   | **Fair  Value** |   | **Percent  to Total** |   |
|------------------|--------|---------------------------------|--------|--------------------------------------|--------|----------------------|--------|-----------------------|--------|-----------------|--------|-----------------------|--------|
|             |   |                            |   |                                 |   |                 |   |                  |   |            |   |                  |   |
| 1                |   | AAA/AA/A                        |   | Aaa/Aa/A                             |   | $                    | (280   | )                     | 95     | %               | $      | 25,741                |   | 92 | % |
| 2                |   | BBB                             |   | Baa                                  |   | (14                  | )      | 5                     |   | 2,158           |   | 8                     |   |
| 3                |   | BB                              |   | Ba                                   |   | —               |   | —                |   | —          |   | —                |   |
| 4                |   | B                               |   | B                                    |   | —               |   | —                |   | —          |   | —                |   |
| 5                |   | CCC or lower                    |   | Caa  or lower                        |   | —               |   | —                |   | —          |   | —                |   |
| 6                |   |                            |   |                                 |   | —               |   | —                |   | —          |   | —                |   |
|             |   |                            |   | Total                                |   | $                    | (294   | )                     | 100    | %               | $      | 27,899                |   | 100 | % |

 

At June 30, 2003, the grossunrealized losses in the table directly above are on fixed maturity securitiesthat are rated investment grade, which is defined by the Company as a security havinga National Association of Insurance Commissioners rating of 1 or 2, a S&Prating of BBB- or higher, or a Moody’s rating of Baa3 or higher.  Unrealized losses on investment gradesecurities principally relate to changes in interest rates or changes insector-related credit spreads since the securities were acquired.  Any such unrealized losses are recognized inincome, if the securities are sold, or if the decline in fair value is deemedother-than-temporary.

 

The scheduled maturity datesfor fixed maturity securities in an unrealized loss position at June 30, 2003are shown below.

 

28

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| **(Dollars in thousands)**              |   | **Unrealized  Loss** |   | **Percent  To Total** |   | **Fair  Value** |   | **Percent  to Total** |   |
|-----------------------------------------|--------|----------------------|--------|-----------------------|--------|-----------------|--------|-----------------------|--------|
|                                    |   |                 |   |                  |   |            |   |                  |   |
| Due in one  year or less                |   | $                    | — |                  | — | %               | $      | —                |   | — | % |
| Due after one year through five years   |   | (28                  | )      | 10                    |   | 4,121           |   | 15                    |   |
| Due after five years through ten years  |   | (53                  | )      | 18                    |   | 5,127           |   | 18                    |   |
| Due after ten years                     |   | (189                 | )      | 64                    |   | 17,034          |   | 61                    |   |
| Mortgage and asset backed securities(1) |   | (24                  | )      | 8                     |   | 1,617           |   | 6                     |   |
|                                    |   |                 |   |                  |   |            |   |                  |   |
| Total fixed income securities           |   | $                    | (294   | )                     | 100    | %               | $      | 27,899                |   | 100 | % |

 

----

(1)Due to the periodic repayment of principal, the mortgage and asset backedsecurities are estimated to have an effective maturity of approximately sixyears.  Expected maturities may differfrom contractual maturities because issuers may have the right to call orprepay obligations with or without call or prepayment penalties.

 

TheCompany’s realized capital gains and losses were as follows:

 
|                                     |   | **Three  Months Ended June 30,** |       | **Six Months  Ended June 30,** |       |
|------------------------------------------|--------|----------------------------------|------------|--------------------------------|------------|
|                                     |   | **2003**                         |       | **2002**                       | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                     |   | **(In  thousands)**              | ** ** |
|                                     |   |                             | ** ** |                           | ** ** |   | ** ** |   | ** ** |
| Fixed maturities:                        |   |                             |       |                           |       |   |   |   |   |
| Gains                                    |   | $                                | 824        |                           | $          | 3,252 |   | $ | 1,313 |   | $ | 3,472 |   |
| (Losses)                                 |   | (154                             | )          | (3,610                         | )          | (175 | ) | (4,064 | ) |
|                                     |   | 670                              |       | (358                           | )          | 1,138 |   | (592 | ) |
| Equity securities and other investments: |   |                             |       |                           |       |   |   |   |   |
| Gains                                    |   | 1                                |       | 663                            |       | 3 |   | 663 |   |
| (Losses)                                 |   | (2                               | )     | (104                           | )          | (254 | ) | (163 | ) |
|                                     |   | (1                               | )          | 559                            |       | (251 | ) | 500 |   |
|                                     |   |                             |       |                           |       |   |   |   |   |
| Net realized capital gains (losses)      |   | $                                | 669        |                           | $          | 201 |   | $ | 887 |   | $ | (92 | ) |

 

The followingtable details the larger realized losses from sales and impairments during thefirst six months of 2003 and the related circumstances giving rise to the loss:

 
| **Description** |   | **Date of  Sale** | ** ** | **Proceeds  from Sale** | ** ** | **Loss on  Sale** | ** ** | **Impairment** | ** ** | **Holdings  at  June 30, 2003** | ** ** | **Net  Unrealized  Loss** | ** ** | **# of  Months  Unrealized Loss  Exceeded 20  of Cost or  Amortized Cost** | ** ** |
|-----------------|--------|-------------------|------------|-------------------------|------------|-------------------|------------|----------------|------------|---------------------------------|------------|---------------------------|------------|----------------------------------------------------------------------------|------------|
|            |   |              |       |                    |       |              |       |           |       |                            |       |                      |       |                                                                       |       |
| (1)             |   | 2/13/03           |       | $                       | 425        |              | $          | (252           | )          | —                          |       | —                    |       | —                                                                     |       | 6 |   |
|                 |        |                   |            |                         |            |                   |            |                |            |                                 |            |                           |            |                                                                            |            |  |  |

 

----

(1) Major utility company which had adeteriorating balance sheet, underperforming overseas operations and areduction in its dividend. 

 

29

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**Liquidity and CapitalResources**

 

Cash flowprovided by operations was $65,550,000 and $47,788,000 for the first six monthsended June 30, 2003 and 2002, respectively, primarily due to increases in netwritten premium.  Operating cash flowwas used primarily to acquire additional investment assets and to reduce debt.

 

The Companyhas a credit facility provided through a consortium of banks.  The credit facility provides for an $11.0million revolving line of credit facility, which will reduce by an additional$2.0 million in 2003, and $9.0 million in 2004 until it terminates on November19, 2004, and a $55.0 million letter of credit facility.  At June 30, 2003 $11,000,000 in loans wereoutstanding under the revolving line of credit facility at an interest rate of2.4%.  The letter of credit facility isutilized primarily by NCUL and Millennium for its participation in Lloyd’sSyndicate 1221.  The credit facility agreementrequires that the banks vote by November 19th of each year whetheror not to renew the letter of credit portion of the facility.  If the banks decide not to renew the letterof credit portion of the facility, the Company will need to find other sourcesto provide the letters of credit or other collateral in order to continue itsparticipation in Syndicate 1221.  AtJune 30, 2003, letters of credit with an aggregate face amount of $54,783,000were issued under the letter of credit facility.

 

The bankcredit facility is collateralized by the common stock of NavigatorsInsurance.  It contains covenants commonto transactions of this type, including restrictions on indebtedness and liens,limitations on mergers and the sale of assets, maintaining certain consolidatedtangible net worth, statutory surplus, and other financial ratios.  At June 30, 2003, the Company was incompliance with all covenants.

 

At June 30,2003, the Company’s consolidated stockholders’ equity was $187,131,000 comparedto $171,275,000 at December 31, 2002. The increase was primarily due to the net income for the six monthsended June 30, 2003 and the increase in the unrealized gains in the investmentportfolio.

 

The Company relies upon dividends from its subsidiaries to meet its holdingcompany obligations. The dividends have historically come primarily fromNavigators Insurance. At December 31, 2002, the maximum amount availablefor the payment of dividends by Navigators Insurance during 2003 without priorregulatory approval was $12,854,000. During the first six months of 2003,Navigators Insurance paid dividends of $6,000,000 to the Company.

 

##### **Item 3**.  Quantitative and Qualitative DisclosuresAbout Market Risk

 

There havebeen no material changes in the information concerning market risk as stated inthe Company’s 2002 Annual Report on Form 10-K.

 

**Item 4****.  Controls and Procedures**

 

(a)          The Chief Executive Officer and Chief Financial Officer of the Companyhave evaluated the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the endof the period covered by this Quarterly Report.  Based on that evaluation, such officers have concluded that theCompany’s disclosure controls and procedures are effective as of the end ofsuch period.

(b)         There have been no changes during the period covered by this QuarterlyReport in our internal control over financial reporting that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

**Part II - Other Information**

 

**Item1.****                                   LegalProceedings**

 

The Company isnot a party to or the subject of, any material pending legal proceedings whichdepart from the ordinary routine litigation incident to the kinds of businessconducted by the Company, except for a suit concerning the draw down of lettersof credit.  In 1997 and 1998, NavigatorsInsurance entered into certain reinsurance contracts with a reinsurer.  In accordance with normal business practice,Navigators Insurance had secured this exposure with letters of credit.  In April 1999, in good faith and consistentwith the terms of the letters of credit, Navigators Insurance drew down $3.2million of the letters of credit.  Theliquidator of the reinsurer has commenced suit in Australia

 

30

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seeking tovoid the draw downs.  Although theCompany believes it has strong defenses against these claims and that theliquidators’ assertions run counter to prevailing Australian and U.S. law,there can be no assurance as to the outcome of this litigation.  The Company is vigorously defending itsposition.

 

**Item2.****                                   Changesin Securities**

 

None.

 

**Item3.****                                   DefaultsUpon Senior Securities**

 

None.

 

**Item4.****                                   Submissionsof Matters to a Vote of Securities Holders**

 

On May 29, 2003, the Company’s stockholders voted for the followingmatters at the annual stockholders’ meeting:

 

a)              The election of eight (8) directors toserve until the 2004 Annual Meeting of Stockholders or until their respectivesuccessors have been duly elected and qualified.  The results of the voting were as follows:

 
| **Name**               |   | **For**   |   | **Withheld** |
|------------------------|--------|-----------|--------|--------------|
| Peter A. Cheney        |   | 7,950,713 |   | 49,874       |
| Terence N. Deeks       |   | 7,951,013 |   | 49,574       |
| Robert W. Eager, Jr.   |   | 7,951,013 |   | 49,574       |
| Stanley A. Galanski    |   | 7,950,613 |   | 49,974       |
| Leandro S. Galban, Jr. |   | 7,951,013 |   | 49,574       |
| Marc M. Tract          |   | 7,738,816 |   | 261,771      |
| George T. Van Gilder   |   | 7,950,913 |   | 49,674       |
| Robert W. Wright       |   | 7,774,240 |   | 226,347      |

 

b)             The adoption of the Company’s EmployeeStock Purchase Plan which was approved with 7,934,093 votes for, 45,094 votesagainst and 21,400 abstaining.

 

c)              Approval of the Company’s ExecutivePerformance Incentive Plan with 7,908,377 votes for, 41,415 against and 50,795abstaining.

 

d)             The ratification of the appointment ofKPMG LLP as the company’s independent auditors which was ratified with7,995,937 votes for, 1,900 against and 2,750 votes abstaining.

 

**Item5.****                                   OtherInformation**

 

None.

 

31

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**Item6.****                                   Exhibitsand Reports on Form 8-K**

** **
| (a)    |   | Exhibits:                                                                                                                |   |                                                                                                                                                                                                                                                                                                                                                                 |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                     |   |                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | **Exhibit No.**                                                                                                          |   | **Description  of Exhibit**                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                     |   |                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | 10.1                                                                                                                     |   | The Navigators Group, Inc. Employee Stock Purchase Plan (previously  filed as                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                     |   | Appendix B to the Company’s Proxy Statement for the Annual Meeting of  Stockholders for 2003 and incorporated herein by reference thereto).                                                                                                                                                                                                                     |
|   |   | 10.2                                                                                                                     |   | The Navigators Group, Inc. Executive Performance Incentive Plan  (previously filed as Appendix C to the Company’s Proxy Statement for the  Annual Meeting of Stockholders for 2003 and incorporated herein by reference  thereto).                                                                                                                              |
|   |   | 31.1                                                                                                                     |   | Certification of CEO Per Section 302 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                       |
|   |   | 31.2                                                                                                                     |   | Certification of CFO Per Section 302 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                       |
|   |   | 32.1                                                                                                                     |   | Certification of CEO Per Section 906 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                     |   | (This exhibit is intended to be furnished in accordance with  regulation S-K item 601(b)(32)(ii) and shall not be deemed to be filed for  purposes of section 18 of the Securities Exchange Act of 1934, as amended, or  incorporated by reference into any filing under the Securities Act of 1933,  except as shall be expressly set forth by specific reference). |
|   |   | 32.2                                                                                                                     |   | Certification of CFO Per Section 906 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                     |   | (This exhibit is intended to be furnished in accordance with  regulation S-K item 601(b)(32)(ii) and shall not be deemed to be filed for  purposes of section 18 of the Securities Exchange Act of 1934, as amended, or  incorporated by reference into any filing under the Securities Act of 1933,  except as shall be expressly set forth by specific reference). |
|   |   |                                                                                                                     |   |                                                                                                                                                                                                                                                                                                                                                                 |
| (b)    |   | Reports on Form 8-K:                                                                                                     |
|   |   |                                                                                                                     |   |                                                                                                                                                                                                                                                                                                                                                                 |
|   |   | On May 16, 2003, the Company filed a Form 8-K relating to its press  release announcing its first quarter 2003 earnings. |

 

 

SIGNATURE

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                        | The Navigators Group, Inc.             |
|-----------------------------|----------------------------------------|
|                        | (Registrant)                           |
|                        |                                   |
|                        |                                   |
| Date:  August 14, 2003 | /s / Bradley D. Wiley                  |
|                        | Bradley D. Wiley                       |   |
|                        | Senior Vice President, Chief Financial |   |
|                        | Officer and Secretary                  |   |

 

32

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**INDEX OF EXHIBITS**

 
| **Exhibit No.** |   | **Description  of Exhibit**                                                                                                                                                                                                                                                                                                                                           |
|-----------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1            |   | The Navigators Group, Inc. Employee Stock Purchase (previously filed  as Appendix B to the Company’s Proxy Statement for the Annual Meeting of  Stockholders for 2003 and incorporated herein by reference thereto).                                                                                                                                             |
| 10.2            |   | The Navigators Group, Inc. Executive Performance Incentive Plan  (previously filed as Appendix C to the Company’s Proxy Statement for the  Annual Meeting of Stockholders and incorporated herein by reference thereto).                                                                                                                                         |
| 31.1            |   | Certification of CEO per Section 302 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                        |
| 31.2            |   | Certification of CFO per Section 302 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                        |
| 32.1            |   | Certification of CEO per Section 906 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                        |
|            |   | (This exhibit is intended to be furnished in accordance with  regulation S-K item 601(b)(32)(ii) and shall not be deemed to be filed for  purposes of section 18 of the Securities Exchange Act of 1934, as amended ,  or incorporated by reference into any filing under the Securities Act of  1933, except as shall be expressly set forth by specific reference). |
| 32.2            |   | Certification of CFO per Section 906 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                        |
|            |   | (This exhibit is intended to be furnished in accordance with  regulation S-K item 601(b)(32)(ii) and shall not be deemed to be filed for  purposes of section 18 of the Securities Exchange Act of 1934, as amended, or  incorporated by reference into any filing under the Securities Act of 1933,  except as shall be expressly set forth by specific reference).  |

 

33

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