** **

**FORM 10-Q**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

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

**of the Securities Exchange Act of1934**

 

 

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

 

**Commissionfile 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 whetherthe registrant: (1) has filed all reports required to be filed by Section 13 or15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.

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

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange 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 October 31, 2003, there were 12,526,735 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  September 30, 2003 (unaudited) and December 31, 2002                                                             |
|                                                                                                                                          |
| Consolidated Statements of Income  (unaudited)  Three Months Ended September 30, 2003 and 2002  Nine Months Ended September 30, 2003 and 2002 |
|                                                                                                                                          |
| Consolidated Statements of Cash Flows  (unaudited)  Nine Months Ended September 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

----

 

#### **Part 1.**        FinancialInformation

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

 

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCESHEETS**

*(In thousands, except share data)*

** **
|                                                                                                                                                                     |   | **September  30,  2003** |      | **December  31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|-----------|-------------------------|--------|
|                                                                                                                                                                     |   | **(Unaudited)**          |      |                    |   |
| **ASSETS**                                                                                                                                                               |   |                     |      |                    |   |
| Investments and cash:                                                                                                                                                    |   |                     |      |                    |   |
| Fixed maturities, available-for-sale, at  fair value (amortized cost: 2003, $442,370; 2002, $351,821)                                                                    |   | $                        | 456,359   |                    | $      | 366,676 |   |
| Equity securities, available-for-sale, at  fair value (cost: 2003, $11,999; 2002, $12,286)                                                                               |   | 12,360                   |      | 11,674                  |   |
| Short-term investments, at cost which  approximates fair value                                                                                                           |   | 88,734                   |      | 61,092                  |   |
| Cash                                                                                                                                                                     |   | 4,164                    |      | 13,443                  |   |
| Total investments and cash                                                                                                                                               |   | 561,617                  |      | 452,885                 |   |
|                                                                                                                                                                     |   |                     |      |                    |   |
| Premiums in course of collection                                                                                                                                         |   | 130,623                  |      | 108,672                 |   |
| Commissions Receivable                                                                                                                                                   |   | 2,911                    |      | 3,112                   |   |
| Prepaid reinsurance premiums                                                                                                                                             |   | 116,948                  |      | 58,902                  |   |
| Reinsurance receivable on paid and unpaid  losses and loss adjustment expenses                                                                                           |   | 285,047                  |      | 243,153                 |   |
| Federal income tax recoverable                                                                                                                                           |   | —                   |      | 826                     |   |
| Net deferred income tax benefit                                                                                                                                          |   | 9,663                    |      | 6,470                   |   |
| Deferred policy acquisition costs                                                                                                                                        |   | 22,842                   |      | 23,632                  |   |
| Accrued investment income                                                                                                                                                |   | 4,795                    |      | 3,309                   |   |
| Goodwill                                                                                                                                                                 |   | 4,917                    |      | 5,167                   |   |
| Other assets                                                                                                                                                             |   | 13,547                   |      | 11,791                  |   |
| Total assets                                                                                                                                                             |   | $                        | 1,152,910 |                    | $      | 917,919 |   |
|                                                                                                                                                                     |   |                     |      |                    |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                            |   |                     |      |                    |   |
| Liabilities:                                                                                                                                                             |   |                     |      |                    |   |
| Reserves for losses and loss adjustment  expenses                                                                                                                        |   | $                        | 582,430   |                    | $      | 489,642 |   |
| Unearned premium                                                                                                                                                         |   | 241,997                  |      | 167,372                 |   |
| Reinsurance balances payable                                                                                                                                             |   | 103,111                  |      | 55,574                  |   |
| Notes payable to banks                                                                                                                                                   |   | 9,000                    |      | 14,500                  |   |
| Payable for securities                                                                                                                                                   |   | 9,292                    |      | 5,327                   |   |
| Federal income tax payable                                                                                                                                               |   | 2,311                    |      |                 |   |
| Accounts payable and other liabilities                                                                                                                                   |   | 14,368                   |      | 14,229                  |   |
| Total liabilities                                                                                                                                                        |   | 962,509                  |      | 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 8,548,985 for  2003 and 8,486,272 (net of treasury stock) for 2002 |   | 855                      |      | 851                     |   |
| Additional paid-in  capital                                                                                                                                              |   | 41,024                   |      | 40,141                  |   |
| Treasury stock held at cost (shares: 16,423 for 2002)                                                                                                                    |   | —                   |      | (236                    | )      |
| Accumulated other  comprehensive income                                                                                                                                  |   | 10,204                   |      | 9,732                   |   |
| Retained earnings                                                                                                                                                        |   | 138,318                  |      | 120,787                 |   |
| Total stockholders’ equity                                                                                                                                          |   | 190,401                  |      | 171,275                 |   |
| Total liabilities and stockholders’ equity                                                                                                                          |   | $                        | 1,152,910 |                    | $      | 917,919 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

3

----

 

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

**CONSOLIDATED STATEMENTSOF INCOME**

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

 

 
|                                              |   | **Three  Months Ended  September 30,** |   |
|---------------------------------------------------|--------|----------------------------------------|--------|
|                                              |   | **2003**                               |   | **2002** |   |
|                                              |   | **(Unaudited)**                        |   |
| Revenues:                                         |   |                                   |   |   |   |
| Net earned premium                                |   | $                                      | 74,537 |   | $ | 64,520 |   |
| Commission income                                 |   | 23                                     |   | 1,188 |   |
| Net investment income                             |   | 4,634                                  |   | 4,390 |   |
| Net realized capital gains                        |   | 348                                    |   | 1,264 |   |
| Other income                                      |   | 140                                    |   | 363 |   |
| Total revenues                                    |   | 79,682                                 |   | 71,725 |   |
|                                              |   |                                   |   |   |   |
| Operating expenses:                               |   |                                   |   |   |   |
| Net losses and loss adjustment expenses  incurred |   | 48,526                                 |   | 43,430 |   |
| Commission expense                                |   | 9,195                                  |   | 11,518 |   |
| Other operating expenses                          |   | 13,364                                 |   | 9,127 |   |
| Interest expense                                  |   | 66                                     |   | 158 |   |
| Total operating expenses                          |   | 71,151                                 |   | 64,233 |   |
|                                              |   |                                   |   |   |   |
| Income before income tax expense                  |   | 8,531                                  |   | 7,492 |   |
|                                              |   |                                   |   |   |   |
| Income tax expense  (benefit):                    |   |                                   |   |   |   |
| Current                                           |   | 4,195                                  |   | 2,588 |   |
| Deferred                                          |   | (2,087                                 | )      | (367 | ) |
| Total income tax expense                          |   | 2,108                                  |   | 2,221 |   |
|                                              |   |                                   |   |   |   |
| Net income                                        |   | $                                      | 6,423  |   | $ | 5,271 |   |
|                                              |   |                                   |   |   |   |
| Net income per common share:                      |   |                                   |   |   |   |
| Basic                                             |   | $                                      | 0.75   |   | $ | 0.62 |   |
| Diluted                                           |   | $                                      | 0.73   |   | $ | 0.61 |   |
|                                              |   |                                   |   |   |   |
| Average common shares outstanding:                |   |                                   |   |   |   |
| Basic                                             |   | 8,535                                  |   | 8,473 |   |
| Diluted                                           |   | 8,771                                  |   | 8,678 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

4

----

 

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

**CONSOLIDATEDSTATEMENTS OF INCOME**

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

 

 
|                                              |   | **Nine  Months Ended  September 30,** |    |
|---------------------------------------------------|--------|---------------------------------------|---------|
|                                              |   | **2003**                              |    | **2002** |   |
|                                              |   | **(Unaudited)**                       |    |
| Revenues:                                         |   |                                  |    |   |   |
| Net earned premium                                |   | $                                     | 206,115 |   | $ | 155,292 |   |
| Commission income                                 |   | 2,748                                 |    | 3,282 |   |
| Net investment income                             |   | 13,847                                |    | 13,494 |   |
| Net realized capital gains                        |   | 1,235                                 |    | 1,172 |   |
| Other income                                      |   | 728                                   |    | 1,214 |   |
| Total revenues                                    |   | 224,673                               |    | 174,454 |   |
|                                              |   |                                  |    |   |   |
| Operating expenses:                               |   |                                  |    |   |   |
| Net losses and loss adjustment expenses  incurred |   | 135,857                               |    | 99,619 |   |
| Commission expense                                |   | 28,698                                |    | 29,504 |   |
| Other operating expenses                          |   | 37,188                                |    | 27,997 |   |
| Interest expense                                  |   | 250                                   |    | 463 |   |
| Total operating expenses                          |   | 201,993                               |    | 157,583 |   |
|                                              |   |                                  |    |   |   |
| Income before income tax expense                  |   | 22,680                                |    | 16,871 |   |
|                                              |   |                                  |    |   |   |
| Income tax expense  (benefit):                    |   |                                  |    |   |   |
| Current                                           |   | 8,766                                 |    | 5,249 |   |
| Deferred                                          |   | (3,617                                | )       | (873 | ) |
| Total income tax expense                          |   | 5,149                                 |    | 4,376 |   |
|                                              |   |                                  |    |   |   |
| Net income                                        |   | $                                     | 17,531  |   | $ | 12,495 |   |
|                                              |   |                                  |    |   |   |
| Net income per common share:                      |   |                                  |    |   |   |
| Basic                                             |   | $                                     | 2.06    |   | $ | 1.48 |   |
| Diluted                                           |   | $                                     | 2.01    |   | $ | 1.45 |   |
|                                              |   |                                  |    |   |   |
| Average common shares outstanding:                |   |                                  |    |   |   |
| Basic                                             |   | 8,515                                 |    | 8,455 |   |
| Diluted                                           |   | 8,728                                 |    | 8,642 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

5

----

 

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTSOF CASH FLOWS**

*(In thousands)*

 
|                                                                                         |   | **Nine  Months Ended  September 30,** |   |
|----------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                         |   | **2003**                              |   | **2002** |   |
|                                                                                         |   | **(Unaudited)**                       |   |
| Operating activities:                                                                        |   |                                  |   |   |   |
| Net income                                                                                   |   | $                                     | 17,531 |   | $ | 12,495 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |   |                                  |   |   |   |
| Depreciation & amortization                                                              |   | 1,222                                 |   | 740 |   |
| Net deferred income tax                                                                      |   | (3,617                                | )      | (873 | ) |
| Net realized capital (gains)                                                                 |   | (1,235                                | )      | (1,172 | ) |
| Changes in assets and liabilities:                                                           |   |                                  |   |   |   |
| Reinsurance receivable on paid and unpaid  losses and loss adjustment expenses               |   | (41,894                               | )      | 2,853 |   |
| Reserve for losses and loss adjustment  expenses                                             |   | 92,788                                |   | 38,875 |   |
| Prepaid reinsurance premiums                                                                 |   | (58,046                               | )      | (25,421 | ) |
| Unearned premium                                                                             |   | 74,625                                |   | 78,729 |   |
| Premiums in course of collection                                                             |   | (21,951                               | )      | (27,366 | ) |
| Commissions receivable                                                                       |   | 201                                   |   | 246 |   |
| Deferred policy acquisition costs                                                            |   | 790                                   |   | (11,202 | ) |
| Accrued investment income                                                                    |   | (1,486                                | )      | (318 | ) |
| Reinsurance balances payable                                                                 |   | 47,537                                |   | 15,707 |   |
| Federal income tax                                                                           |   | 3,137                                 |   | 1,723 |   |
| Other                                                                                        |   | 1,331                                 |   | (3,227 | ) |
| Net cash provided by operating activities                                                    |   | 110,933                               |   | 81,789 |   |
|                                                                                         |   |                                  |   |   |   |
| Investing activities:                                                                        |   |                                  |   |   |   |
| Fixed maturities, available-for-sale                                                         |   |                                  |   |   |   |
| Redemptions and maturities                                                                   |   | 5,677                                 |   | 2,419 |   |
| Sales                                                                                        |   | 191,899                               |   | 163,127 |   |
| Purchases                                                                                    |   | (287,825                              | )      | (197,969 | ) |
| Equity securities, available-for-sale                                                        |   |                                  |   |   |   |
| Sales                                                                                        |   | 1,607                                 |   | 4,886 |   |
| Purchases                                                                                    |   | (1,480                                | )      | (6,556 | ) |
| Change in payable for securities                                                             |   | 3,965                                 |   | 17,146 |   |
| Net change in short-term investments                                                         |   | (27,642                               | )      | (55,556 | ) |
| Purchase of property and equipment                                                           |   | (1,339                                | )      | (692 | ) |
| Net cash (used in) investing activities                                                      |   | (115,138                              | )      | (73,195 | ) |
|                                                                                         |   |                                  |   |   |   |
| Financing activities:                                                                        |   |                                  |   |   |   |
| Repayment of bank loan                                                                       |   | (5,500                                | )      | (4,500 | ) |
| Proceeds from exercise of stock options                                                      |   | 426                                   |   | 429 |   |
| Net cash (used in) financing activities                                                      |   | (5,074                                | )      | (4,071 | ) |
| Increase (decrease) in cash                                                                  |   | (9,279                                | )      | 4,523 |   |
| Cash at beginning of year                                                                    |   | 13,443                                |   | 5,816 |   |
| Cash at end of period                                                                        |   | $                                     | 4,164  |   | $ | 10,339 |   |
|                                                                                         |   |                                  |   |   |   |
| Supplemental disclosures of cash flow  information:                                          |   |                                  |   |   |   |
| Federal, state and local income tax paid                                                     |   | $                                     | 5,761  |   | $ | 3,611 |   |
| Interest paid                                                                                |   | 252                                   |   | 436 |   |
| Issuance of stock to directors                                                               |   | 72                                    |   | 60 |   |

 

Seeaccompanying notes to interim consolidated financial statements.

 

6

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

 

**Notes to InterimConsolidated Financial Statements**

*(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, including the amounts previously classified as *Funds duefrom Lloyd’s syndicate*whichhave been reclassified to their separate components in the financialstatements.

 

(2)     Reinsurance Ceded

 

The Company’s ceded earned premiums were $65,184,000 and $41,346,000for the three months ended September 30, 2003 and 2002, respectively, and were$174,299,000 and $107,590,000 for the nine months ended September 30, 2003 and2002, respectively. The Company’s ceded incurred losses were $32,888,000 and$13,841,000 for the three months ended September 30, 2003 and 2002,respectively, and were $96,393,000 and $54,290,000 for the nine months endedSeptember 30, 2003 and 2002, respectively.

 

(3)     Segment Information

 

The Company’s subsidiaries are primarily engaged in the underwritingand management of property and casualty insurance.  The Company’s segments include the Insurance Companies, theNavigators Agencies and the Lloyd’s Operations, each of which is managedseparately.  The Insurance Companiesconsist of Navigators Insurance Company (“Navigators Insurance”) and NICInsurance Company which are primarily engaged in underwriting marine insuranceand related lines of business, general liability insurance and professionalliability insurance.  The NavigatorsAgencies are underwriting management companies which produce, manage andunderwrite insurance and reinsurance for the Insurance Companies andnon-affiliated companies.  The Lloyd’sOperations consist primarily of a Lloyd’s managing agency and two Lloyd’scorporate members which underwrite marine and related lines of business atLloyd’s of London (“Lloyd’s”).

 

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, andconsolidating adjustments.

 

7

----

 

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

 

 
|                                                                      |   | **Three  Months Ended   September 30,** |   | **Nine  Months Ended   September 30,** |   |
|---------------------------------------------------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|
|                                                                      |   | **2003**                                |   | **2002**                               |   | **2003** |   | **2002** |   |
|                                                                      |   | **(In  thousands)**                     |   | **(In  thousands)**                    |   |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Revenue, excluding net investment income  and net realized capital gains: |   |                                    |   |                                   |   |   |   |   |   |
| Insurance Companies:                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Marine                                                                    |   | $                                       | 27,587 |                                   | $      | 21,953 |   | $ | 71,740 |   | $ | 52,115 |   |
| General Liability                                                         |   | 19,619                                  |   | 19,348                                 |   | 61,910 |   | 47,297 |   |
| Professional Liability                                                    |   | 2,681                                   |   | 502                                    |   | 6,186 |   | 881 |   |
| Surety                                                                    |   | 281                                     |   | 4                                      |   | 401 |   | 4 |   |
| Other                                                                     |   | 458                                     |   | 164                                    |   | 579 |   | (55 | ) |
| Insurance Companies Total                                                 |   | 50,626                                  |   | 41,971                                 |   | 140,816 |   | 100,242 |   |
| Lloyd’s Operations:                                                  |   |                                    |   |                                   |   |   |   |   |   |
| Marine                                                                    |   | 20,929                                  |   | 21,575                                 |   | 59,819 |   | 53,610 |   |
| Engineering and Construction                                              |   | 1,313                                   |   | 674                                    |   | 2,089 |   | 870 |   |
| Onshore Energy                                                            |   | 1,589                                   |   | 377                                    |   | 3,397 |   | 661 |   |
| Other                                                                     |   | 80                                      |   | 145                                    |   | 596 |   | 719 |   |
| Lloyd’s Operations Total                                             |   | 23,911                                  |   | 22,771                                 |   | 65,901 |   | 55,860 |   |
| Navigators Agencies                                                       |   | 8,392                                   |   | 7,806                                  |   | 24,694 |   | 20,138 |   |
| Other operations                                                          |   | (8,229                                  | )      | (6,477                                 | )      | (21,820 | ) | (16,452 | ) |
| Total                                                                     |   | $                                       | 74,700 |                                   | $      | 66,071 |   | $ | 209,591 |   | $ | 159,788 |   |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Income (loss) before tax expense (benefit):                               |   |                                    |   |                                   |   |   |   |   |   |
| Insurance Companies                                                       |   | $                                       | 8,001  |                                   | $      | 5,860 |   | $ | 18,894 |   | $ | 15,363 |   |
| Lloyd’s Operations                                                   |   | 2,177                                   |   | 404                                    |   | 7,018 |   | 2,011 |   |
| Navigators Agencies                                                       |   | (219                                    | )      | 1,577                                  |   | 902 |   | 2,709 |   |
| Other operations                                                          |   | (1,428                                  | )      | (349                                   | )      | (4,134 | ) | (3,212 | ) |
| Total                                                                     |   | $                                       | 8,531  |                                   | $      | 7,492 |   | $ | 22,680 |   | $ | 16,871 |   |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Income tax expense (benefit):                                             |   |                                    |   |                                   |   |   |   |   |   |
| Insurance Companies                                                       |   | $                                       | 2,555  |                                   | $      | 1,850 |   | $ | 5,941 |   | $ | 4,795 |   |
| Lloyd’s Operations                                                   |   | —                                  |   | —                                 |   | — |   | — |   |
| Navigators Agencies                                                       |   | (146                                    | )      | 566                                    |   | 207 |   | 878 |   |
| Other operations                                                          |   | (301                                    | )      | (195                                   | )      | (999 | ) | (1,297 | ) |
| Total                                                                     |   | $                                       | 2,108  |                                   | $      | 2,221 |   | $ | 5,149 |   | $ | 4,376 |   |
|                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Net income (loss):                                                        |   |                                    |   |                                   |   |   |   |   |   |
| Insurance Companies                                                       |   | $                                       | 5,446  |                                   | $      | 4,010 |   | $ | 12,953 |   | $ | 10,568 |   |
| Lloyd’s Operations                                                   |   | 2,177                                   |   | 404                                    |   | 7,018 |   | 2,011 |   |
| Navigators Agencies                                                       |   | (73                                     | )      | 1,011                                  |   | 695 |   | 1,831 |   |
| Other operations                                                          |   | (1,127                                  | )      | (154                                   | )      | (3,135 | ) | (1,915 | ) |
| Total                                                                     |   | $                                       | 6,423  |                                   | $      | 5,271 |   | $ | 17,531 |   | $ | 12,495 |   |

 

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 September 30, 2003 and 2002:

 
|                                                                                                                                    |   | **Three  Months Ended  September 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|--------|
|                                                                                                                                    |   | **2003**                               |   | **2002** |   |
|                                                                                                                                    |   | **(In  thousands)**                    |   |
|                                                                                                                                    |   |                                   |   |   |   |
| Net income                                                                                                                              |   | $                                      | 6,423  |   | $ | 5,271 |   |
| Other comprehensive income (losses), net of  tax:                                                                                       |   |                                   |   |   |   |
| Net unrealized gains (losses) on securities  available-for-sale:                                                                        |   |                                   |   |   |   |
| Unrealized holding  gains (losses) arising during period (net of tax expense (benefit) of  ($1,983) for 2003 and $3,124 for  2002) |   | (3,477                                 | )      | 6,545 |   |
| Less: reclassification adjustment for gains  included in net income (net of tax expense of $76 for 2003 and $337 for 2002)              |   | 272                                    |   | 927 |   |
| Net unrealized gains (losses) on securities                                                                                             |   | (3,749                                 | )      | 5,618 |   |
| Foreign currency translation gain  adjustment (net of tax expense of $100 for 2003 and $23 for 2002)                                    |   | 186                                    |   | 44 |   |
| Other comprehensive income (loss)                                                                                                       |   | (3,563                                 | )      | 5,662 |   |
|                                                                                                                                    |   |                                   |   |   |   |
| Comprehensive income                                                                                                                    |   | $                                      | 2,860  |   | $ | 10,933 |   |

 

 

The following table summarizes comprehensive income for the nine monthsended September 30, 2003 and 2002:

 
|                                                                                                                         |   | **Nine  Months Ended  September 30,** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                                                                         |   | **2003**                              |   | **2002** |   |
|                                                                                                                         |   | **(In  thousands)**                   |   |
|                                                                                                                         |   |                                  |   |   |   |
| Net income                                                                                                                   |   | $                                     | 17,531 |   | $ | 12,495 |   |
| Other comprehensive income (losses), net of  tax:                                                                            |   |                                  |   |   |   |
| Net unrealized gains on securities  available-for-sale:                                                                      |   |                                  |   |   |   |
| Unrealized holding  gains arising during period (net of tax expense of $390 for 2003 and $3,754 for  2002)                   |   | 1,002                                 |   | 7,622 |   |
| Less: reclassification adjustment for gains  included in net income (net of tax expense of $225 for 2003 and $316 for  2002) |   | 1,010                                 |   | 856 |   |
| Net unrealized gains (losses) on securities                                                                                  |   | (8                                    | )      | 6,766 |   |
| Foreign currency translation gain (loss)  adjustment (net of tax expense (benefit) of $258 for 2003 and ($136) for  2002)    |   | 480                                   |   | (252 | ) |
| Other comprehensive income                                                                                                   |   | 472                                   |   | 6,514 |   |
|                                                                                                                         |   |                                  |   |   |   |
| Comprehensive income                                                                                                         |   | $                                     | 18,003 |   | $ | 19,009 |   |

 

9

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The following table summarizes the components of accumulated othercomprehensive income:

 
|                                                                                                             |   | **September  30,  2003** |   | **December  31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                                                                                             |   | **(In  thousands)**      |   |
|                                                                                                             |   |                     |   |                    |   |
| Net unrealized gains on securities  available-for-sale (net of tax expense of $4,859 in 2003 and $4,693 in 2002) |   | $                        | 9,491  |                    | $      | 9,499 |   |
| Foreign currency translation adjustment  (net of tax expense of $384 in 2003 and $125 in 2002)                   |   | 713                      |   | 233                     |   |
|                                                                                                             |   |                     |   |                    |   |
| Accumulated other comprehensive income                                                                           |   | $                        | 10,204 |                    | $      | 9,732 |   |

 

(5)     Stock-based Compensation

 

The Company’s stock option plans are accounted for under therecognition and measurement principles of the Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issued to Employees*, which requirescompensation expense to be recognized only if the fair value of the underlyingstock at the grant date exceeds the exercise price of the option.  Accordingly, compensation expense of $15,000and $46,000 has been recognized for stock options in the three months and ninemonths ended September 30, 2003, respectively. Although no amounts were expensed in the three months and nine monthsended September 30, 2002, had expense been recorded as described above, theamount would have been approximately $15,000 and $30,000, respectively.  The following table illustrates the effecton net income and earnings per share if the Company had applied the fair valuerecognition provisions of the Financial Accounting Standards Board (“FASB”) inthe Statement of Financial Accounting Standards (“SFAS”) No. 123, *Accounting for Stock-Based Compensation*tostock-based employee compensation:

 
|                                                                                                                         |   | **Three  Months Ended   September 30,** |   | **Nine  Months Ended   September 30,** |   |
|------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|----------------------------------------|--------|
| **(In thousands, except per share data)**                                                                                    |   | **2003**                                |   | **2002**                               |   | **2003** |   | **2002** |   |
|                                                                                                                         |   |                                    |   |                                   |   |   |   |   |   |
| Net income:                                                                                                                  |   |                                    |   |                                   |   |   |   |   |   |
| As reported                                                                                                                  |   | $                                       | 6,423  |                                   | $      | 5,271 |   | $ | 17,531 |   | $ | 12,495 |   |
| Add:                                                                                                                         |   |                                    |   |                                   |   |   |   |   |   |
| Total stock-based compensation expense  included in net income, net of related tax effects                                   |   | 10                                      |   | —                                 |   | 30 |   | — |   |
| Deduct:                                                                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| Total stock-based compensation expense  determined under fair value based method for all awards, net of related tax  effects |   | 124                                     |   | 91                                     |   | 369 |   | 232 |   |
|                                                                                                                         |   |                                    |   |                                   |   |   |   |   |   |
| Pro-forma                                                                                                                    |   | $                                       | 6,309  |                                   | $      | 5,180 |   | $ | 17,192 |   | $ | 12,263 |   |
|                                                                                                                         |   |                                    |   |                                   |   |   |   |   |   |
| Basic income per share:                                                                                                      |   |                                    |   |                                   |   |   |   |   |   |
| As reported                                                                                                                  |   | $                                       | 0.75   |                                   | $      | 0.62 |   | $ | 2.06 |   | $ | 1.48 |   |
| Pro-forma                                                                                                                    |   | $                                       | 0.74   |                                   | $      | 0.61 |   | $ | 2.02 |   | $ | 1.45 |   |
| Diluted income per share:                                                                                                    |   |                                    |   |                                   |   |   |   |   |   |
| As reported                                                                                                                  |   | $                                       | 0.73   |                                   | $      | 0.61 |   | $ | 2.01 |   | $ | 1.45 |   |
| Pro-forma                                                                                                                    |   | $                                       | 0.72   |                                   | $      | 0.60 |   | $ | 1.97 |   | $ | 1.42 |   |

 

10

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Stock grants are expensed as they vest.  The amount charged to expense was $309,000 and $101,000 for thethree months ended September 30, 2003 and 2002, respectively.  The expense for the nine months endedSeptember 30, 2003 and 2002 was $795,000 and $514,000, respectively.  In addition, $72,000 was expensed for eachof the nine month periods ended September 30, 2003 and 2002, respectively, forstock issued annually to non-employee directors as part of the directors’ compensationfor serving on the Company’s Board of Directors.

 

(6)     Application of NewAccounting Standards

 

The FASB issued SFAS 141, *BusinessCombinations*, and SFAS 142, *Goodwill and Other Intangible Assets*.  The Company adopted both SFAS 141 and SFAS142 effective January 1, 2002. SFAS 141 requires that the purchase method ofaccounting be used for all business combinations initiated after September 30,2001.  It also specifies that intangibleassets acquired in a purchase method business combination be recognized andreported apart from goodwill.  SFAS 142changes the accounting for goodwill and intangible assets that have indefiniteuseful lives from an amortization approach to an impairment-only approach thatrequires that those 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 for amortizationof goodwill has been recorded in the first nine months of 2003 or 2002.  Goodwill of $2,534,000 was carried for theNavigators Agencies’ segment at both September 30, 2003 and December 31, 2002,and $2,383,000 and $2,633,000 for the Lloyd’s Operations’ segment at September30, 2003 and December 31, 2002, respectively. Goodwill on the Company’s consolidated balance sheets may fluctuate dueto changes in the foreign currency rates between the U.S. dollar and theBritish pound.  The adoption of SFAS 141did not have any effect on the Company’s results of operations or financialcondition.

 

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—Transition and Disclosure—anamendment of FASB Statement No. 123*.  The provisions of this statement provide alternative methods oftransition for a voluntary change to the fair value based method of accountingfor stock-based employee compensation. The provisions are effective for financial statements for fiscal yearsending after December 15, 2002.  Wefollow the disclosure provisions of SFAS 123, *Accountingfor Stock Based Compensation*, as amended by SFAS 148.  These require pro forma net income andearnings per share information, which is calculated assuming we had accountedfor our stock option plans under the “fair value method” described in thosestatements.

 

In January 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities.*  Interpretation No. 46 requires certainvariable interest entities to be consolidated by their primarybeneficiaries.  The adoption of thisinterpretation did not have any effect on the Company’s financial condition orresults of operations.

 

11

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In April 2003, the FASB Derivative Implementation Group adopted IssueNo. B36, *EmbeddedDerivatives:  Modified CoinsuranceArrangements and Debt Instruments That Incorporate Credit Risk Exposures ThatAre Unrelated or Only Partially Related to the Creditworthiness of the Obligorunder Those Instruments* (“B36”). B36 addresses the recognition of embedded derivatives present in certainreinsurance agreements with funds held provisions and is applicable forquarters beginning after September 15, 2003. The Company has not yet determined the estimated impact on its financialcondition or results of operations, if any, of adopting B36.

 

(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 ($200.3 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 partieswho provide letters of credit used as collateral at Lloyd’s.

 

The Company provides letters of credit to Lloyd’s to support itsparticipation in Syndicate 1221’s capacity. If the Company increases its participation or if Lloyd’s changes thecapital requirements, the Company may be required to supply additional lettersof credit or other collateral acceptable to Lloyd’s, or reduce the capacity ofSyndicate 1221.  The letters of creditare provided through the credit facility which the Company maintains with aconsortium of banks.  The creditfacility agreement requires that the banks vote by November 19th ofeach year whether or not to renew the letter of credit portion of thefacility.  In early November 2003, wecompleted the renewal of the letter of credit facility increasing the facilityfrom $55 million to $80 million.  Theeffective date of the facility was changed to November 10, 2003 and it issubject to renewal in two years.  If thebanks decide not to renew the letter of credit facility in 2005, the Companywill need to find other sources to provide the letters of credit or othercollateral in order to continue to participate in Syndicate 1221 for subsequentyears.  At September 30, 2003, lettersof credit with an aggregate face amount of $55 million were issued under theletter of credit facility.

 

 

 

(8)     Income Tax - ValuationAllowance

 

The Company’s valuation allowance relating to its foreign operationsdecreased by $573,000 in the three months ended September 30, 2003 and$2,056,000 in the nine months ended September 30, 2003 relating to thereduction in the loss carryforward at the Company’s foreign operationsresulting from income generated by these operations in 2003.  At September 30, 2003 and 2002, the Companyhad loss carryforwards remaining at its foreign operations amounting topotential future tax benefits of $2,473,000 and $4,755,000, respectively, alongwith a valuation allowance equal to these benefits.  Although the foreign operations were profitable in 2003, thevaluation allowance was released only to the extent of the 2003 profits sincefuture profitability remains uncertain. The Company needs to generate $8,244,000 of future foreign pretax incomein order to fully utilize the foreign loss carryforward which can be carriedforward indefinitely.

 

The Company also had net state and local loss carryforwards amountingto potential future tax benefits of $2,486,000 and $2,099,000 at September 30,2003 and 2002, respectively, along with a valuation allowance equal to thesebenefits.  The Company needs to generate$13,854,000 of future state and local pretax income in order to fully utilizethe loss carryforwards which expire from 2019 to 2022.

 

The Company had alternative minimum tax carryforwards of $0 and$1,115,000 at September 30, 2003 and September 30, 2002, respectively.

 

12

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(9)   Treasury Stock

 

During the first nine 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 nine months ended September 30, 2003.  During the first nine 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 nine months of 2002.

 

 

(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 $3.7 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.

 

(11)Subsequent Event

 

During October 2003, the Company completed the sale of 3,977,500 sharesof its common stock in an underwritten public offering.  Certain trusts for the benefit of thechildren of Terence N. Deeks, the Company’s founder and chairman, alsoparticipated in this offering and sold 450,000 shares of the Company’s commonstock owned by such trusts.  The publicoffering price for all of these shares was $29.50 per share.  The combined net proceeds the Companyreceived from the offering, after deducting underwriting commissions and otherfees, were approximately $110.8 million, of which $70 million was contributedto the statutory surplus of Navigators Insurance and $9.0 million was used torepay the full amount of indebtedness outstanding under the revolving creditportion of our credit facility.

 

13

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

 

**Item 2****.****        Management’sDiscussion and Analysis of Financial Condition 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.  Forward-looking statements arederived from information that we currently have and from assumptions that wemake.  We cannot assure that anticipatedresults will be achieved, since results may differ materially because of bothknown and unknown risks and uncertainties which we face.  We undertake no obligation to publiclyupdate or revise any forward-looking statements, whether as a result of newinformation, future events or otherwise. Factors that could cause actual results to differ materially from ourforward-looking statements include, but are not limited to:

 

•      the effects of domestic andforeign economic conditions, and conditions which affect the market forproperty and casualty insurance;

•      changes in the laws, rulesand 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 of competitionfrom banks, other insurers and the trend toward self-insurance;

•      risks which we face inentering new markets and diversifying the products and services we offer;

•      unexpected turnover of ourprofessional 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 associated with ourcontinuing ability to obtain reinsurance covering our exposures at appropriateprices and/or insufficient amounts and the related recoverability of ourreinsured losses;

•      weather-related events andother catastrophes (including acts of terrorism) impacting our insureds and/orreinsurers;

•      our ability to attainadequate prices, obtain new business and to retain existing business consistentwith our expectations;

•      the possibility of downgrades in ourclaims-paying and financial strength ratings significantly adversely affectingus, including reducing the number of insurance policies we write generally, orcausing clients who require an insurer with a certain rating level to usehigher-rated insurers;

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

•      otherrisks which we identify in future filings with the Securities and ExchangeCommission.

 

## **General**

 

The accompanying consolidated financial statements consisting of theaccounts of The Navigators Group, Inc., a Delaware holding company, and itstwelve active wholly owned subsidiaries, are prepared on the basis ofaccounting principles generally accepted in the United States of America(“GAAP”).  Unless the context otherwiserequires, the terms “Company”, “we” or “our” as used herein means TheNavigators Group, Inc. and its subsidiaries. All significant intercompany transactions and balances areeliminated.  Certain amounts for prioryears have been reclassified to conform to the current year’s presentation.

 

14

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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 our largest insurance subsidiary and has beenactive since 1983.  It specializesprincipally in underwriting marine insurance and related lines of business,general liability insurance, and professional liability 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”.

 

Fiveof our wholly owned insurance underwriting agencies (the “Navigators Agencies”)produce business for the Insurance Companies. They specialize in writing marine and related lines of business, generalliability insurance and professional liability coverages.

 

Eachof the Navigators Agencies writes marine and related business for NavigatorsInsurance and three unaffiliated insurance companies.  The four insurance companies comprise a marine insurancepool.  Marine insurance policies areissued by Navigators Insurance with the business shared with other poolmembers.  Navigators Insurance had a 75%participation in the pool for business written with effective dates in 2002 andhas an 80% participation in 2003.  InSeptember 2003, Navigators Insurance increased its participation in the poolfor the 2003 underwriting year to 80% from 70% as a result of a commutationagreement with one of the pool members. The effect of the commutation for the three and nine months endedSeptember 30, 2003 was to increase net written premium by $12.1 million.

 

NavigatorsSpecialty, a division of a Navigators Agency located in San Francisco,California, produces business exclusively for the Insurance Companies.  It specializes in underwriting generalliability insurance coverage for small general and artisan contractors as wellas other targeted commercial risks, with the majority of the business locatedin California.

 

NavigatorsPro, a division of a Navigators Agency located in New York, specializes inunderwriting professional liability insurance and began producing directors& officers liability insurance exclusively for the Insurance Companies inthe fourth quarter of 2001.  In late2002, Navigators Pro introduced additional products to complement its directors& officers liability coverage.  Theproducts include employment practices liability, lawyers professional liabilityand miscellaneous professional liability 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.

 

TheCompany’s revenue is primarily comprised of premiums, commissions andinvestment income.  The InsuranceCompanies derive their premiums primarily from business written by theNavigators Agencies.  The Lloyd’sOperations derive their premiums primarily from business underwritten by NUAL.  The Navigators Agencies and NUAL receivecommissions and in some cases, profit commissions and service fees on businessproduced.

 

Propertyand casualty insurance premiums historically have been cyclical in nature and,accordingly, during a “hard market” demand for property and casualty insuranceexceeds supply or capacity and, as a result, premiums and commissions mayincrease.  On the downturn of theproperty and casualty cycle, supply exceeds demand and, as a result, premiumsand commissions may decrease.

 

15

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**CriticalAccounting Policies**

 

It is important to understand the Company’s accounting policies inorder to understand its financial statements. Management considers certain of these policies to be critical to thepresentation of the financial results since they require management to makeestimates and assumptions.  Theseestimates and assumptions affect the reported amounts of assets, liabilities,revenues, expenses, and related disclosures at the financial reporting date andthroughout the period being reported upon. Certain of the estimates result from judgments that can be subjectiveand complex and consequently actual results may differ from these estimates,which would be reflected in future periods.

 

The Company’scritical accounting policies involve the reporting of the reserves for lossesand loss adjustment expenses (including losses that have occurred but were notreported to the Company by the financial reporting date), reinsurance recoverables,written and unearned premium, the recoverability of deferred tax assets, theimpairment of invested assets, accounting for Lloyd’s results, and goodwill.

 

*Loss Reserves and Loss Adjustment Expenses.*  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 Tax Assets. *The Company hasrecorded valuation allowances related to deferred tax assets resulting from netoperating loss carryforwards due to the uncertainty associated with therealization of the deferred tax asset related to certain of the Company’sforeign, state and local operations.  Although the Company’s foreign operations wereprofitable in 2003, the valuation allowance was released only to the extent ofthe 2003 profits since future profitability remains uncertain.

 

16

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*Impairment of Invested 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 economic conditions.  In general, we focus our attention on thosesecurities whose market value was less than 80% of their amortized cost orcost, as appropriate, for six or more consecutive months.  Other-than-temporary impairment lossesresult in a permanent reduction of the cost basis of the underlyinginvestment.  Significant changes in thefactors the Company considers when evaluating investments for impairment lossescould result in a significant change in impairment losses reported in theconsolidated financial statements.

 

*Accountingfor Lloyd’s Results*.  We record our pro rata share of Lloyd’ssyndicate assets, liabilities, revenues and expenses, after making adjustmentsto convert Lloyd’s accounting to U.S. GAAP. The most significant U.S. GAAP adjustments relate to income recognition.Lloyd’s syndicates determine underwriting results by year of account at the endof three years.  We record adjustmentsto recognize underwriting results as incurred, including the expected ultimatecost of losses incurred.  Theseadjustments to losses are based on actuarial analysis of syndicate accounts,including forecasts of 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**

 

General.  In September 2003, following receipt of therequired regulatory approval, all of the reinsurance obligations andliabilities of Trenwick America Re Corporation and two of its subsidiaries,Chartwell Insurance Company and The Insurance Corporation of New York(collectively referred to as Trenwick), to Navigators Insurance were commutedeffective as of the beginning of the 2003 underwriting year.  Prior to the commutation, these obligationsand liabilities were collateralized through a trust agreement established on October28, 2002.  Under the commutation agreement,in addition to a lump-sum transfer of funds from the trust account toNavigators Insurance, Trenwick also assigned rights against Somerset InsuranceLimited, its reinsurer, including rights to additional trust assets, toNavigators Insurance.  Although noassurances can be given, it is expected that this transaction will be protectedfrom subsequent challenge as a preference in the event of a Trenwickliquidation or rehabilitation proceeding. The results of the commutation did not have a material impact on ouroperating results. Terence N. Deeks and a member of his family own in theaggregate 98% of the outstanding voting stock of Somerset InsuranceLimited.  In connection with thecommutation, Somerset Insurance Limited reinsures approximately 3.1% ofNavigators Insurance's participation in the marine pool for the 2003underwriting year.

 

17

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Revenues. Gross written premium for the first nine months of 2003 increased 34.1%to $455,526,000 from $339,718,000 for the first nine months of 2002.

 

The following table sets forth our gross written premium by segment andline of business, and ceded and net written premium by segment for the periodsindicated:

 
|                         |   | **Nine  Months Ended September 30,** |    |
|------------------------------|--------|--------------------------------------|---------|
|                         |   | **2003**                             |    | **2002** |   |
|                         |   | **(Dollars  in thousands)**          |    |
| Insurance Companies:         |   |                                 |    |   |   |   |   |   |   |
| Marine                       |   | $                                    | 149,076 |   | 33 | % | $ | 137,836 |   | 41 | % |
| General Liability            |   | 95,697                               |    | 21 |   | 85,148 |   | 25 |   |
| Professional Liability       |   | 37,986                               |    | 9 |   | 14,133 |   | 4 |   |
| Surety                       |   | 1,777                                |    | — |   | 47 |   | — |   |
| Other                        |   | 1,522                                |    | — |   | 4,448 |   | 1 |   |
| Gross Written Premium        |   | 286,058                              |    | 63 |   | 241,612 |   | 71 |   |
| Ceded Written Premium        |   | (151,025                             | )       |   |   | (102,722 | ) |   |   |
| Net Written Premium          |   | 135,033                              |    |   |   | 138,890 |   |   |   |
|                         |   |                                 |    |   |   |   |   |   |   |
| Lloyd’s Operations:     |   |                                 |    |   |   |   |   |   |   |
| Marine                       |   | 145,708                              |    | 32 |   | 91,084 |   | 27 |   |
| Engineering and Construction |   | 13,542                               |    | 3 |   | 4,002 |   | 1 |   |
| Onshore Energy               |   | 10,218                               |    | 2 |   | 3,020 |   | 1 |   |
| Gross Written Premium        |   | 169,468                              |    | 37 |   | 98,106 |   | 29 |   |
| Ceded Written Premium        |   | (81,206                              | )       |   |   | (30,891 | ) |   |   |
| Net Written Premium          |   | 88,262                               |    |   |   | 67,215 |   |   |   |
|                         |   |                                 |    |   |   |   |   |   |   |
| Total Gross Written Premium  |   | 455,526                              |    | 100 | % | 339,718 |   | 100 | % |
|                         |   |                                 |    |   |   |   |   |   |   |
| Total Ceded Written Premium  |   | (232,231                             | )       |   |   | (133,613 | ) |   |   |
|                         |   |                                 |    |   |   |   |   |   |   |
| Total Net Written Premium    |   | $                                    | 223,295 |   |   |   | $ | 206,105 |   |   |   |

 

Insurance Companies’ Gross Written Premium

 

*Marine Premium. *The marine premium for the first ninemonths ended September 30, 2003 increased 8.2% compared to the first ninemonths of 2002 due primarily to the increase in premium rates resulting inhigher premiums on new and renewal business, partly offset by a reduction ofbusiness in certain areas due to pricing concerns.  Navigators Insurance obtained price increases on renewal businessof approximately 15.3% in the first nine months of 2003 amounting to approximately$11.0 million of premium from rate increases. 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 12.4% from the first nine months of 2002 to 2003due to new business and increased rates. Rate increases on renewal business for the contractors liabilitypolicies averaged 45.9%, resulting in approximately $11.9 million of premiumfrom rate increases.  During the firstnine months of 2003, the number of construction liability in-force policiesdecreased by approximately 51.0% primarily as a result of our efforts to scaleback the number of small artisan policies we write.  The new business and the rate increases resulted from atightening market for California contractors’ liability insurance.

 

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*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 was expanded to include errors and omissions insurance andemployment practices liability coverages. The professional liability premium increased to $38.0 million for thefirst nine months of 2003 from $14.1 million for the first nine months of 2002reflecting 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$2.0 million or less.

 

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

 

The Lloyd’spremium is generated as the result of NCUL and Millennium providing capacity toLloyd’s Syndicate 1221 which is managed by NUAL.

 

Lloyd’s Syndicate 1221’s 2003 stamp capacity of £125.0 million ($200.3million) compared to £75.0 million ($112.7 million) in 2002.  Syndicate 1221’s capacity is expressed netof 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 Company participatesin a larger percentage of the gross capacity and is reinsuring 15.4% of itscapacity under quota share reinsurance agreements to third parties whichprovide letters of credit used as collateral at Lloyd’s.  The Lloyd’s marine business had been subjectto a deteriorating pricing beginning in the mid-1990’s.  The pricing competition showed some signs ofstabilizing in 2000 and prices increased in 2001, 2002 and in the first ninemonths of 2003.  Lloyd’s presents itsresults on an underwriting year basis, generally closing each underwriting yearafter three years.  The Company makesestimates for each underwriting year and timely accrues the expectedresults.  The Lloyd’s Operationsincluded in the consolidated financial statements represent the Company’sparticipation in Syndicate 1221.

 

Lloyd’ssyndicates report the amounts of premiums, claims, and expenses recorded in anunderwriting account for a particular year to the companies or individuals thatparticipate in the syndicates.  Thesyndicates 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.

 

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The Company provides letters of credit to Lloyd’s to support itsparticipation in Syndicate 1221’s capacity. If the Company increases its participation or if Lloyd’s changes thecapital requirements, the Company may be required to supply additional lettersof credit or other collateral acceptable to Lloyd’s, or reduce the capacity ofSyndicate 1221.  The letters of creditare provided through the credit facility which the Company maintains with aconsortium of banks.  The creditfacility agreement requires that the banks vote by November 19th ofeach year whether or not to renew the letter of credit portion of thefacility.  In early November 2003, theletter of credit facility was increased from $55 million to $80 million andrenewed for a two year period.  If thebanks decide not to renew the letter of credit facility in 2005, the Companywill need to find other sources to provide the letters of credit or othercollateral in order to continue to participate in Syndicate 1221 for subsequentyears.

 

*Marine Premium.*  In the first nine months of 2003, marine premium increased 60.0%from the first nine 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 $13.8 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 nine months of 2003 compared to 2002 was due tonew business 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 nine months of 2003 compared to 2002 wasprimarily due to new business and the increase in capacity provided toSyndicate 1221.

 

Ceded Written Premium*.*  In the ordinary course of business, we reinsure certain insurancerisks with unaffiliated insurance companies for the purpose of limiting ourmaximum loss exposure, protecting against catastrophic losses, and maintainingdesired 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 nine months ended September 30,2003 to the same period in 2002.  First,rate increases on our business resulted in higher premium levels, andconsequently more ceded premiums.  Thesecond is the cost of “excess of loss” reinsurance which is purchased to limitthe Company’s exposure to an individual large loss. This reinsurance costincreased in the marine and general liability business.  Effective April 1, 2003, the reinsurancetreaty for our general liability business was amended to incorporate cededcommission from the reinsurer and a rate increase. Third, we increased theamount of quota share reinsurance for certain product lines, based uponmanagement’s assessment of expected loss activity.  Fourth, Navigators Pro experienced substantial premium growth,resulting in increased amounts of premium ceded to its quota share reinsuranceprogram.  Additionally, the Companyentered into quota share reinsurance agreements to reinsure 15.4% of itsSyndicate 1221 capacity to third parties which provide letters of credit usedas collateral at Lloyd’s.

 

Net Written Premium*.* Net written premium increased 8.3% when comparing the first ninemonths of 2003 to the same period in 2002, as a result of the increase in thegross written premium and the recording of the commutation with Trenwick duringthe third quarter of 2003, partially offset by the increased ceded premium, asdiscussed above.  Net written premiumdecreased 11.3% in the three months ended September 30, 2003 compared to thesame period in 2002 due to scaling back certain types of marine business due topricing concerns and due to the increased ceded premium as discussed above,partially offset by the Trenwick commutation.

 

Net Earned Premium.  Net earned premium increased 15.5% and 32.7% for the three andnine months ended September 30, 2003, respectively, compared to the sameperiods in 2002.  Net earned premiumincreased across all major product lines as a result of rate increases and newbusiness generated in 2002 and 2003 and the recording of the commutation withTrenwick during the third quarter of 2003.

 

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Commission Income*. *Commission income generated by the Navigators Agenciesdecreased to $2,748,000 for the first nine months of 2003 from $3,282,000 forthe same period in 2002, and decreased to $23,000 for the three months endedSeptember 30, 2003 from $1,188,000 for the 2002 third quarter, primarily theresult of the decrease in the unaffiliated insurance companies’ share of themarine pool from 30% to 20% and the recording of the commutation with Trenwickduring the third quarter of 2003.

 

Net Investment Income*. *Net investment income increased 5.6% and 2.6%  for the three and the nine months endedSeptember 30, 2003 compared to the same periods in 2002.  The earnings from the increase in investedassets were partially offset by the general decrease in interest rates.

 

Net Realized Capital Gains*. *Pre-tax net income for the first nine months of 2003 included$1,235,000 of net realized capital gains compared to $1,172,000 of net realizedcapital gains for the same period last year. On an after tax basis, the net realized capital gains were $1,010,000 or$0.12 per share for the first nine months of 2003 and the net realized capitalgains were $856,000 or $0.10 per share for the same period of 2002. Included innet realized capital gains for the nine months ended September 30, 2002 were$2,905,000 of impairment losses recorded on one of the Company’s asset backedsecurities.

 

Pre-tax net income included $348,000 and $1,264,000 of net realizedcapital gains for the third quarters of 2003 and 2002, respectively.  On an after tax basis, the net realizedcapital gains were $272,000 or $0.03 per share for the third quarter of 2003compared to $927,000 or $0.11 per share for the third quarter of 2002.  Included in net realized capital gains inthe third quarter of 2002 were $787,000 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 nine months and third quarter of 2003 and2002 consisted primarily of fees related to the general liability business andforeign exchange gains and losses.

 

Operating Expenses.

 

*Net Losses and Loss Adjustment Expenses Incurred.*  Theamount recorded for net losses and loss adjustment expenses (“LAE”) reflectsmanagement’s estimate of dollar amounts required to pay all claims as well asrelated expenses to adjust and settle claims. The estimates include payments made during the period, reservesestablished for future payment on known claims (“case reserves”) and reservesestablished for claims that are anticipated but that have not yet been reportedto the Company  (“IBNR” or “incurred butnot reported”).  Insurance companiestypically evaluate their loss experience by calculating a “loss ratio”, whichis the ratio of losses and loss adjustment expenses incurred to the net earnedpremium for the period.  The Company’sloss ratio for the first nine months of 2003 was 65.9%, compared to 64.1% forthe first nine months of 2002.  Themajority of this increase was due to an increase in the loss ratio ofNavigators Insurance increasing from 60.7% for the first nine months of 2002 to66.4% for the first nine months of 2003 with the largest factor being anincrease in incurred losses for the Navigators Insurance’s U.S. marine businessin the first three months of 2003. The increase in the Navigators Insuranceloss ratio was affected by the growth in the general liability and professionalliability lines of business for which we generally estimate a higher ultimateloss ratio than the marine business and a change in the general liabilityexcess of loss reinsurance program which increased the loss ratio and decreasedthe commission expense ratio.   Also, weexperienced adverse development on an assumed reinsurance line of businesscurrently in runoff and, as a result, strengthened our loss reserves on suchbusiness by $1,645,000 in the first six months of 2003. The Company’s lossratio for the three months ended September 30, 2003 decreased to 65.1% comparedto 67.3% for the third quarter of 2002 primarily due to rate increases in 2003.

 

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Insurance companies and Lloyd’s syndicates are required to maintainreserves for unpaid losses and unpaid loss adjustment expenses (“LAE”) for alllines of business.  These reserves areintended to cover the probable ultimate cost of settling all losses incurred andunpaid, including those incurred but not reported.  The determination of reserves for losses and LAE for insurancecompanies such as Navigators Insurance and NIC, and Lloyd’s corporate memberssuch as NCUL and Millennium is dependent upon the receipt of information fromthe pools and syndicates in which such companies participate.  Generally, there is a lag between the timepremiums are written and related losses and LAE are incurred, and the time suchevents are reported to the pools and syndicates and, subsequently, toNavigators Insurance, NIC, NCUL and Millennium.

 

Reserves areestablished for the Insurance Companies and Lloyd’s Syndicate 1221 for reportedclaims when notice of the claim is first received.  Reserves for such reported claims are established on acase-by-case basis by evaluating several factors, including the type of riskinvolved, knowledge of the circumstances surrounding such claim, severity ofinjury or damage, the potential for ultimate exposure, experience with theinsured and the broker on the line of business, and the policy provisionsrelating to the type of claim.  Reservesfor incurred but not reported losses are determined in part on the basis ofstatistical information and in part on industry experience and the judgment ofour senior management.

 

Loss reserves are estimates of what the insureror reinsurer expects to pay on claims, based on facts and circumstances thenknown.  It is possible that the ultimateliability may exceed or be less than such estimates.  In setting its loss reserve estimates, the Company reviewsstatistical data covering several years, analyzes patterns by line of businessand 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.  Tothe extent reserves are inadequate and strengthened, the amount of suchincrease is treated as a charge to earnings in the period in which thedeficiency is recognized.

 

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

 
|                           |   | **September  30,****2003** |    | **December  31,****2002** | *** *** |
|--------------------------------|--------|----------------------------|---------|---------------------------|--------------|
|                           |   | **(In thousands)**         |    |
| Insurance  Companies:          |   |                       |    |                      |         |
| Marine                         |   | $                          | 89,859  |                      | $            | 73,521 |   |
| General  Liability             |   | 94,528                     |    | 64,949                    |         |
| Professional  Liability        |   | 5,105                      |    | 1,240                     |         |
| Surety                         |   | 95                         |    | 7                         |         |
| Other                          |   | 25,334                     |    | 26,690                    |         |
| Total  Insurance Companies     |   | 214,921                    |    | 166,407                   |         |
|                           |   |                       |    |                      |         |
| Lloyd’s  Operations:      |   |                       |    |                      |         |
| Marine                         |   | 109,719                    |    | 97,018                    |         |
| Engineering  and Construction  |   | 1,087                      |    | 726                       |         |
| Onshore  Energy                |   | 2,049                      |    | 496                       |         |
| Total  Lloyd’s Operations |   | 112,855                    |    | 98,240                    |         |
|                           |   |                       |    |                      |         |
| Total  Net Loss Reserves       |   | $                          | 327,776 |                      | $            | 264,647 |   |

 

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Ourloss reserves include amounts related to short tail and long tail classes ofbusiness.  Short tail business meansthat claims are generally reported quickly upon occurrence of an event, makingestimation of loss reserves less complex. Our longer tail business includes general liability and professionalliability insurance.  For the long taillines, significant periods of time, ranging up to several years or more, mayelapse between the occurrence of the loss, the reporting of the loss and thesettlement of the claim. The longer the time span between the incidence of aloss and the settlement of the claim, the more likely the ultimate settlementamount can vary.

 

*General Liability and ProfessionalLiability*

 

Thegeneral liability business generates third party liability claims that arelonger tail in nature.  A significantportion of our general liability reserves relate to California constructiondefect claims.  Reserves and claimfrequency on this business may be impacted by legislation recently implementedin California, which generally provides consumers who experienced constructiondefects a method other than litigation to obtain construction defectrepairs.  This legislation may impactclaim severity, frequency and length of settlement assumptions underlying ourreserves.  Accordingly, our ultimateliability may exceed or be less than current estimates due to this variable,among others.

 

Forgeneral liability, a relatively small proportion of net losses in the morerecent accident years are reported claims and an even smaller proportion arepaid losses. Therefore, a relatively large proportion of our general liabilitynet losses are reserves for IBNR losses. In fact, approximately 76% of ourgeneral liability net loss reserves at September 30, 2003 were for IBNR losses.  As of September 30, 2003, the Company had1,556 open claims relating to general liability business compared to 1,275 openclaims as of December 31, 2002.  Duringthe first nine months of 2003, 1,530 new claims were made and 1,249 existingclaims were settled or dismissed.  TheCompany’s net loss and loss adjustment expense reserves for its generalliability business as of September 30, 2003 was $94,528,000.

 

Theprofessional liability class generates third party liability claims, which alsoare longer tail in nature.  The professionalliability policies provide coverage on a “claims made” basis, whereby coverageis generally provided only for those claims that are reported during the policyperiod.  Navigators professionalliability business is relatively immature, with Navigators first writing thebusiness in late 2001.  Accordingly,given the relative immaturity of this business, it will take some time tobetter understand the reserve trends on this business.  Where anticipated loss experience is lesspredictable because of the small number of claims and/or erratic claim severitypatterns, our loss estimates are based on expected losses, actual reportedlosses, evaluation of loss trends, and the legal, regulatory and current riskenvironment.  Navigators has made a reasonable estimate ofthe required loss reserves for professional liability. The expected ultimate losses may be adjustedup or down as the accident years mature.

 

Virtuallyall of the professional liability net loss reserves at September 30, 2003 werefor IBNR losses.  As of September 30,2003, the Company had 81 open claims for professional liability coveragecompared to 7 open claims as of December 31, 2002.  During the first nine months of 2003, 98 new claims were made and24 claims were closed.  The Company’s netloss and LAE reserves for professional liability coverage as of September 30,2003 were $5,105,000.

 

*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

 

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exposures, many of the policies on whichNavigators participates have exclusions that may preclude coverage.  In addition, many of these claims have beeninactive for several years and may be closed in the near future.

 

Managementbelieves that the Company’s reserves for such claims are adequate because theCompany’s participation in such risks is generally in the higher excess layersand, based on a continuing review of such claims, management believes that amajority of these claims will be unlikely to penetrate such high excess layersof coverage; however, due to significant assumptions inherent in estimatingthese 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 managementbelieves is subject to uncertainties greater than those presented by othertypes of claims:

 
| **(Dollars in thousands)** |   | **Net Loss  & LAE  Reserves** |   | **Net Losses  & LAE  incurred for  the nine months** |   | **Net Paid  Losses & LAE  for the nine** |   |
|----------------------------|--------|-----------------------------------|--------|----------------------------------------------------------|--------|----------------------------------------------|--------|
| **Type of Business**       |   | **September  30,  2003**          |   | **December  31,  2002**                                  |   | **ended  September 30,  2003**               |   | **months  ended  September 30, 2003** |   |
|                       |   |                              |   |                                                     |   |                                         |   |   |   |
| Environmental              |   | $                                 | 1,262  |                                                     | $      | 1,072                                        |   | $ | 719 |   | $ | 530 |   |
| Asbestos/Toxic Tort        |   | 489                               |   | 441                                                      |   | 112                                          |   | 65 |   |
| Total                      |   | $                                 | 1,751  |                                                     | $      | 1,513                                        |   | $ | 831 |   | $ | 595 |   |

 

 
| **Type of Business** |   | **Claim  Count  January 1, 2003** |   | **New Claims  During Period** |   | **Claims  Settled  or Resolved  During Period** |   | **Claim  Count  September 30, 2003** |   |
|----------------------|--------|-----------------------------------|--------|-------------------------------|--------|-------------------------------------------------|--------|--------------------------------------|--------|
|                 |   |                              |   |                          |   |                                            |   |                                 |   |
| Environmental        |   | 202                               |   | 15                            |   | 131                                             |   | 86                                   |   |
| Asbestos/Toxic Tort  |   | 275                               |   | 26                            |   | 210                                             |   | 91                                   |   |
| Total                |   | 477                               |   | 41                            |   | 341                                             |   | 177                                  |   |

 

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 apercentage of net earned premium was 13.9% and 19.0% for the nine months endedSeptember 30, 2003 and 2002, respectively. The commission expense was 12.3% and 17.9% for the third quarter of 2003and 2002, respectively.  The commissionexpense tends to fluctuate with changes in the mix of business.  The decrease during the nine and threemonths ended September 30, 2003 compared to the same periods in 2002 wasprimarily the result of reinsurance ceding commissions from a change in thegeneral liability excess of loss reinsurance program and from the professionalliability and Lloyd’s marine operations.

 

*Other Operating Expenses. *Other operatingexpenses increased to $37,188,000 for the first nine months ended September 30,2003 from $27,997,000 during the corresponding period of 2002, primarily due tothe increase in employee related expenses resulting from expansion of thebusiness.  The percentage of otheroperating expenses to net earned premium was 18.0% for the first nine months ofboth 2003 and 2002.  Other operatingexpenses increased to $13,364,000 from $9,127,000 for the three months endedSeptember 30, 2003 and 2002, respectively. The increases resulted primarily from employee related expensesresulting from expansion of the business.

 

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*Interest Expense. *Interest expense decreased to $250,000for the nine months ended September 30, 2003 from $463,000 for thecorresponding period of 2002, and decreased to $66,000 from $158,000 whencomparing the third quarters of 2003 and 2002. These declines were due to a smaller loan balance and lower interestrates on the loan.

 

Income Taxes*.*  The effective tax rate for the Company was 22.7% and 25.9% forthe nine months ended September 30, 2003 and 2002, respectively, and 24.7%versus 29.6% for the third quarters of 2003 and 2002, respectively.  The rates differed from the Federalcorporate income tax rate of 35% primarily due to the change in the valuationallowance to the extent of income or loss generated in certain of its foreignoperations, and also to tax-exempt interest income.

 

The Company’s valuation allowance relating to its foreign operationsdecreased by $2,056,000 for the nine months ended September 30, 2003 relatingto the reduction in the loss carryforward at the Company’s foreign operationsresulting from income generated by these operations in the first nine months of2003.  At September 30, 2003 and 2002,the Company had loss carryforwards remaining at its foreign operationsamounting to potential future tax benefits of $2,473,000 and $4,755,000,respectively, along with a valuation allowance equal to these benefits.  Even though the foreign operations wereprofitable in the first nine months of 2003, the valuation allowance wasreleased only to the extent of the 2003 profits since future profitabilityremains uncertain.  The Company needs togenerate $8,244,000 of future foreign pretax income in order to fully utilizethe foreign loss carryforward which can be carried forward indefinitely.

 

The Company also had net state and local loss carryforwards amountingto potential future tax benefits of $2,486,000 and $2,099,000 at September 30,2003 and 2002, respectively, along with a valuation allowance equal to thesebenefits.  The Company needs to generate$13,854,000 of future state and local pretax income in order to fully utilizethe loss carryforwards which expire from 2019 to 2022.

 

The Company had alternative minimum tax carryforwards of $0 and$1,115,000 at September 30, 2003 and 2002, respectively.

 

Net Income*.* The Company had net income of $17,531,000 for the nine monthsended September 30, 2003 compared to $12,495,000 for the same period lastyear.  On a diluted per share basis, thisrepresented net income per share of $2.01 and $1.45 for the nine months endedSeptember 30, 2003 and 2002, respectively. Net income for the third quarter of 2003 was $6,423,000, or $0.73 perdiluted share, compared to net income in the third quarter of 2002 of $5,271,000,or $0.61 per diluted 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, preferred stocks, common stocks,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 their respective boards of directors and the Company’s financecommittee and are reviewed on a quarterly basis.  The investments are managed by non-affiliated professional fixedincome and equity portfolio managers. Current investment objectives are to maximize annual after tax income inthe context of preserving and enhancing capital and statutory surplus.  The Insurance Companies seek to attain theseobjectives by investing in municipal bonds, U.S. Government obligations,corporate bonds and mortgage and asset backed securities and commonstocks.  The Insurance Companies’investment guidelines require that at least 90% of the fixed income portfoliobe rated “A-” or better by a nationally recognized rating organization.  Up to 25% of the total portfolio may beinvested in equity securities that are actively traded on major U.S. stockexchanges.

 

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The Lloyd’s Operations’ investments are subject to the direction andcontrol of the board of directors and investment committee of NUAL, as well asthe Company’s finance committee, and represent the Company’s share of theinvestments held by Syndicate 1221.  Theinvestments must comply with the rules and regulations imposed by Lloyd’s ofLondon and by certain overseas regulators. The investments are managed by non-affiliated professional fixed incomemanagers.  The performance of theinvestment managers is reviewed quarterly. Current investment objectives are to maximize pre-tax income in thecontext of preserving and enhancing capital. The investment managers for Syndicate 1221 seek to attain theseobjectives by investing in Government obligations, corporate bonds and mortgageand asset backed securities.

 

The majorityof the investment income of the Navigators Agencies is derived from fiduciary fundsinvested 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.

 

Fixedmaturity securities include bonds and mortgage and asset backed securities. Allfixed maturity and equity securities are carried at fair value.  The fair value is based on quoted marketprices or dealer quotes provided by independent pricing services.

 

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

 

Thefollowing table presents the amortized cost or cost, as applicable, grossunrealized gains and losses and fair value for all fixed maturity and equitysecurities:

 
| **September  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          |   | $                           | 210,263 |                         | $      | 5,539                           |   | $               | (756   | ) | $ | 215,046 |   |
| States, municipalities and political subdivisions |   | 58,784                      |    | 2,584                        |   | (137                            | )      | 61,231          |   |
| Mortgage and asset backed (excluding GNMAs)       |   | 74,740                      |    | 1,860                        |   | (150                            | )      | 76,450          |   |
| Corporate bonds                                   |   | 98,583                      |    | 5,214                        |   | (165                            | )      | 103,632         |   |
|                                              |   |                        |    |                         |   |                            |   |            |   |
| Total fixed maturities                            |   | $                           | 442,370 |                         | $      | 15,197                          |   | $               | (1,208 | ) | $ | 456,359 |   |
|                                              |   |                        |    |                         |   |                            |   |            |   |
| Equity securities – common stocks            |   | $                           | 11,999  |                         | $      | 735                             |   | $               | (374   | ) | $ | 12,360 |   |

 
| **December 31, 2002**                             |   | **Amortized  Cost or Cost** |    | **Gross  Unrealized  Gains** |   | **Gross  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 |   |

 

26

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TheCompany regularly reviews its fixed maturity and equity securities portfoliosto evaluate the necessity of recording impairment losses forother-than-temporary declines in the fair value of investments.  In general, we focus our attention on thosesecurities whose market value was less than 80% of their amortized cost orcost, as appropriate, for six or more consecutive months.  Other factors considered in evaluatingpotential impairment include the current fair value as compared to amortizedcost or cost, as appropriate, the Company’s intent and ability to retain theinvestment for a period of time sufficient to allow for an anticipated recoveryin value, specific credit issues related to the issuer and current economicconditions.

 

Whena security in the Company’s investment portfolio has an unrealized loss that isdeemed to be other-than-temporary, the Company writes the security down to fairvalue through 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.

 

Thefollowing table shows the Company’s impairment losses recorded in its fixedmaturity and equity portfolios 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 September 30, 2003 |   |                   |   |                                                |   |                                                |   |
| Fixed  maturities                      |   | $                      | — |                                                | $      | —                                              |   | $ | — |   |
| Equity  securities                     |   | —                 |   | —                                              |   | —                                              |   |
| Total  Portfolio                       |   | $                      | — |                                                | $      | —                                              |   | $ | — |   |
|                                   |   |                   |   |                                                |   |                                                |   |
| Three  Months Ended September 30, 2002 |   |                   |   |                                                |   |                                                |   |
| Fixed  maturities                      |   | $                      | 787    |                                                | $      | —                                              |   | $ | 787 |   |
| Equity  securities                     |   | —                 |   | —                                              |   | —                                              |   |
| Total  Portfolio                       |   | $                      | 787    |                                                | $      | —                                              |   | $ | 787 |   |

 
|                                  |   | **Total  Write-downs** |   | **Write-downs  On Securities  Sold During  Period** |   | **Write-downs  On Securities  Held at  Period End** |   |
|---------------------------------------|--------|------------------------|--------|-----------------------------------------------------|--------|-----------------------------------------------------|--------|
|                                  |   | **(In thousands)**     |   |
| Nine  Months Ended September 30, 2003 |   |                   |   |                                                |   |                                                |   |
| Fixed  maturities                     |   | $                      | — |                                                | $      | —                                              |   | $ | — |   |
| Equity  securities                    |   | —                 |   | —                                              |   | —                                              |   |
| Total  Portfolio                      |   | $                      | — |                                                | $      | —                                              |   | $ | — |   |
|                                  |   |                   |   |                                                |   |                                                |   |
| Nine  Months Ended September 30, 2002 |   |                   |   |                                                |   |                                                |   |
| Fixed  maturities                     |   | $                      | 2,905  |                                                | $      | —                                              |   | $ | 2,905 |   |
| Equity  securities                    |   | —                 |   | —                                              |   | —                                              |   |
| Total  Portfolio                      |   | $                      | 2,905  |                                                | $      | —                                              |   | $ | 2,905 |   |

 

27

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Asof September 30, 2003, the Company’s total portfolio had $15.9 million in grossunrealized gains and $1.6 million in gross unrealized losses, compared to $15.5million in gross unrealized gains and $1.3 million in gross unrealized lossesat December 31, 2002.

 

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

 

 
|                                               |   | **September  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                                         |   | $                       | 42,880 |                       | $      | 756 |   | $ | — |   | $ | — |   |
| 7-12 Months                                        |   | —                  |   | —                     |   | — |   | — |   |
| > 12 Months                                     |   | —                  |   | —                     |   | — |   | — |   |
| Subtotal                                           |   | 42,880                  |   | 756                        |   | — |   | — |   |
|                                               |   |                    |   |                       |   |   |   |   |   |
| States, municipalities and  political subdivisions |   |                    |   |                       |   |   |   |   |   |
| 0-6 Months                                         |   | 10,335                  |   | 115                        |   | 1,144 |   | 16 |   |
| 7-12 Months                                        |   | 649                     |   | 22                         |   | — |   | — |   |
| > 12 Months                                     |   | —                  |   | —                     |   | 894 |   | 29 |   |
| Subtotal                                           |   | 10,984                  |   | 137                        |   | 2,038 |   | 45 |   |
|                                               |   |                    |   |                       |   |   |   |   |   |
| Mortgage and asset backed  (excluding GNMAs)       |   |                    |   |                       |   |   |   |   |   |
| 0-6 Months                                         |   | 10,832                  |   | 143                        |   | 221 |   | 1 |   |
| 7-12 Months                                        |   | 185                     |   | 7                          |   | — |   | — |   |
| > 12 Months                                     |   | —                  |   | —                     |   | 218 |   | 6 |   |
| Subtotal                                           |   | 11,017                  |   | 150                        |   | 439 |   | 7 |   |
|                                               |   |                    |   |                       |   |   |   |   |   |
| Corporate bonds                                    |   |                    |   |                       |   |   |   |   |   |
| 0-6 Months                                         |   | 6,583                   |   | 165                        |   | 2,037 |   | 72 |   |
| 7-12 Months                                        |   | —                  |   | —                     |   | 515 |   | 7 |   |
| > 12 Months                                     |   | —                  |   | —                     |   | 1,841 |   | 271 |   |
| Subtotal                                           |   | 6,583                   |   | 165                        |   | 4,393 |   | 350 |   |
|                                               |   |                    |   |                       |   |   |   |   |   |
| Total Fixed Maturities                             |   | $                       | 71,464 |                       | $      | 1,208 |   | $ | 6,870 |   | $ | 402 |   |
|                                               |   |                    |   |                       |   |   |   |   |   |
| Equity securities – common stocks             |   |                    |   |                       |   |   |   |   |   |
| 0-6 Months                                         |   | $                       | — |                       | $      | — |   | $ | 3,378 |   | $ | 254 |   |
| 7-12 Months                                        |   | 952                     |   | 64                         |   | 2,736 |   | 446 |   |
| > 12 Months                                     |   | 3,837                   |   | 310                        |   | 987 |   | 157 |   |
|                                               |   |                    |   |                       |   |   |   |   |   |
| Total Equity Securities                            |   | $                       | 4,789  |                       | $      | 374 |   | $ | 7,101 |   | $ | 857 |   |

 

28

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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 atSeptember 30, 2003.  Not all of thesecurities are rated by S&P and/or Moody’s.

** **

**(Dollars in 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                             |   | $                    | (1,166 | )                     | 97     | %               | $      | 68,538                |   | 96 | % |
| 2                |   | BBB                             |   | Baa                                  |   | (42                  | )      | 3                     |   | 2,926           |   | 4                     |   |
| 3                |   | BB                              |   | Ba                                   |   | —               |   | —                |   | —          |   | —                |   |
| 4                |   | B                               |   | B                                    |   | —               |   | —                |   | —          |   | —                |   |
| 5                |   | CCC  or lower                   |   | Caa  or lower                        |   | —               |   | —                |   | —          |   | —                |   |
| 6                |   |                            |   |                                 |   | —               |   | —                |   | —          |   | —                |   |
|             |   |                            |   | Total                                |   | $                    | (1,208 | )                     | 100    | %               | $      | 71,464                |   | 100 | % |

 

AtSeptember 30, 2003, the gross unrealized losses in the table directly above areon fixed maturity securities that are rated investment grade, which is definedby the Company as a security having a National Association of InsuranceCommissioners’ rating of 1 or 2, an S&P rating of BBB- or higher, or aMoody’s rating of Baa3 or higher. Unrealized losses on investment grade securities principally relate tochanges in interest rates or changes in sector-related credit spreads since thesecurities were acquired.  Any suchunrealized losses are recognized in income, if the securities are sold, or ifthe decline in fair value is deemed other-than-temporary.

 

Thescheduled maturity dates for fixed maturity securities in an unrealized lossposition at September 30, 2003 are shown below.

 

**(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   |   | (131                 | )      | 11                    |   | 6,794           |   | 9                     |   |
| Due after five years through ten years  |   | (160                 | )      | 13                    |   | 12,572          |   | 18                    |   |
| Due after ten years                     |   | (767                 | )      | 63                    |   | 41,082          |   | 57                    |   |
| Mortgage and asset backed securities(1) |   | (150                 | )      | 13                    |   | 11,016          |   | 16                    |   |
| Total fixed income securities           |   | $                    | (1,208 | )                     | 100    | %               | $      | 71,464                |   | 100 | % |

 

----

(1)Dueto 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.

 

29

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

 
|                                     |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                     |   | **2003**                               |   | **2002**                              |   | **2003** |   | **2002** |   |
|                                     |   | **(In thousands)**                     |   |
|                                     |   |                                   |   |                                  |   |   |   |   |   |
| Fixed maturities:                        |   |                                   |   |                                  |   |   |   |   |   |
| Gains                                    |   | $                                      | 376    |                                  | $      | 1,176 |   | $ | 1,689 |   | $ | 4,616 |   |
| (Losses)                                 |   | (134                                   | )      | (886                                  | )      | (309 | ) | (4,917 | ) |
|                                     |   | 242                                    |   | 290                                   |   | 1,380 |   | (301 | ) |
| Equity securities and other investments: |   |                                   |   |                                  |   |   |   |   |   |
| Gains                                    |   | 326                                    |   | 974                                   |   | 329 |   | 1,636 |   |
| (Losses)                                 |   | (220                                   | )      | —                                |   | (474 | ) | (163 | ) |
|                                     |   | 106                                    |   | 974                                   |   | (145 | ) | 1,473 |   |
|                                     |   |                                   |   |                                  |   |   |   |   |   |
| Net realized capital gains               |   | $                                      | 348    |                                  | $      | 1,264 |   | $ | 1,235 |   | $ | 1,172 |   |

 

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

 

**(Dollarsin thousands)**

 
| **Description** |   | **Date of  Sale** |   | **Proceeds  from Sale** |   | **Loss on  Sale** |   | **Impairment** |   | **Holdings  at  September 30, 2003** |   | **Net  Unrealized  Loss** |   | **# of  Months  Unrealized Loss  Exceeded 20%  of Cost or  Amortized Cost** |   |
|-----------------|--------|-------------------|--------|-------------------------|--------|-------------------|--------|----------------|--------|--------------------------------------|--------|---------------------------|--------|-----------------------------------------------------------------------------|--------|
|            |   |              |   |                    |   |              |   |           |   |                                 |   |                      |   |                                                                        |   |
| (1)             |   | 2/13/03           |   | $                       | 425    |              | $      | (252           | )      | —                               |   | —                    |   | —                                                                      |   | 6 |   |
| (2)             |   | 9/3/03            |   | $                       | 357    |              | $      | (222           | )      | —                               |   | —                    |   | —                                                                      |   | 12 |   |

 

----

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

(2)Major tobacco company stock adverselyaffected by concerns over litigation.

 

**Liquidity and CapitalResources**

 

Cash flowprovided by operations was $110,933,000 and $81,789,000 for the first ninemonths ended September 30, 2003 and 2002, respectively, primarily due toincreases in net written premium. Operating cash flow was used primarily to acquire additional investmentassets 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 and a $55.0 million letter of creditfacility.  At September 30, 2003$9,000,000 in loans were outstanding under the revolving line of creditfacility at an interest rate of 2.4%.  Theletter of credit facility is utilized primarily by NCUL and Millennium tosupport their participation in Lloyd’s Syndicate 1221.  The credit facility agreement requires thatthe banks vote by November 19th of each year whether or not to renewthe letter of credit portion of the facility. In early November 2003, we completed the renewal of the letter of creditfacility increasing the facility from $55 million to $80 million.  The effective date of the facility waschanged to November 10, 2003 and it is subject to renewal in two years.  If the banks decide not to renew the letterof credit portion of the facility in 2005, the Company will need to find othersources to provide the letters of credit or other collateral in order tocontinue its participation in Syndicate 1221. At September 30, 2003, letters of credit with an aggregate face amountof $55 million have been issued under the letter of credit facility.

 

30

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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 September 30, 2003, the Company was incompliance with all covenants.

 

At September30, 2003, the Company’s consolidated stockholders’ equity was $190,401,000compared to $171,275,000 at December 31, 2002. The increase was primarily due to the net income and the net increase inthe unrealized gains in the investment portfolio for the nine months endedSeptember 30, 2003.

 

In October2003, the Company completed the sale of 3,977,500 shares of its common stock inan underwritten public offering. Certain trusts for the benefit of the children of Terence N. Deeks, ourfounder and chairman, also participated in this offering and sold 450,000shares of common stock owned by such trusts. The public offering price for all of these shares was $29.50 pershare.  The combined net proceeds theCompany received from the offering, after deducting underwriting commissionsand other fees, were approximately $110.8 million, of which $70 million wascontributed to the statutory surplus of Navigators Insurance and $9.0 millionwas used to repay the full amount of indebtedness outstanding under therevolving credit portion of our credit facility.  The remainder of the Company’s net proceeds has been retained bythe Company to be used for general corporate purposes.

 

The Companyrelies upon dividends from its insurance subsidiaries to meet its holdingcompany obligations.  The dividends havehistorically come primarily from Navigators Insurance.  At December 31, 2002, the maximum amountavailable for the payment of dividends by Navigators Insurance during 2003without prior regulatory approval was $12,854,000.  During the first nine months of 2003, Navigators Insurance paiddividends of $6,000,000 to the Company. Statutory surplus of Navigators Insurance was $136 million as ofSeptember 30, 2003.

 

##### **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 andChief Financial Officer of the Company have evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)under the Exchange Act) as of the end of the period covered by this QuarterlyReport.  Based on that evaluation, suchofficers have concluded that the Company’s disclosure controls and proceduresare effective as of the end of such period.

 

(b)   There have been no changes duringthe period covered by this Quarterly Report in our internal control overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

**Part II****- OtherInformation**

 

**Item1.****            Legal Proceedings**

 

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,

 

31

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except for asuit concerning the draw down of letters of credit.  In 1997 and 1998, Navigators Insurance entered into certainreinsurance contracts with a reinsurer. In accordance with normal business practice, Navigators Insurance hadsecured this exposure with letters of credit. In April 1999, in good faith and consistent with the terms of theletters of credit, Navigators Insurance drew down $3.7 million of the lettersof credit.  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.   TheCompany is vigorously defending its position.

 

**Item2.****            Changes inSecurities**

 

None.

 

**Item3.****            Defaults UponSenior Securities**

 

None.

 

**Item4.****            Submissions ofMatters to a Vote of Securities Holders**

 

None.

 

**Item5.****            Other Information**

 

None.

 

**Item6.****            Exhibits andReports on Form 8-K**

 
| (a)    |   | Exhibits:                                                                                                                   |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                        |   |   |
|   |   | **Exhibit No.**                                                                                                             |   | **Description of Exhibit** |
|   |   |                                                                                                                        |   |   |
|   |   | 10.1                                                                                                                        |   | Amendment No. 5 dated November 10, 2003 to the 1998 Credit Agreement |
|   |   | 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 August 8, 2003, the Company filed a Form 8-K relating to its press  release announcing its second quarter 2003 earnings. |
|        |        |                                                                                                                             |  |  |  |  |

 

32

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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:  November 14, 2003 |   | /s / Bradley D. Wiley                                         |   |
|                          |   | Bradley D. Wiley                                              |   |
|                          |   | Senior Vice President, Chief Financial  Officer and Secretary |

 

33

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**INDEX OF****EXHIBITS**

 
| **Exhibit No.** |   | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                            |
|-----------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1            |   | Amendment No. 5 dated November 10, 2003 to the 1998 Credit Agreement                                                                                                                                                                                                                                                                                                  |
| 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).  |

 

34

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