**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**Quarterly Report Under Section 13 or 15(d)of the Securities Exchange Act of 1934**

 

**For the Quarterly Period Ended    March 31, 2005**

 

**Commission file number   0-15886**

 

**TheNavigators Group, Inc.**

(Exactname of Registrant as specified in its charter)

 
| **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’stelephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed sincelast report.)

 

Indicate by check mark whether theRegistrant: (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 (orfor such shorter period that the Registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.  Yes     ý  No     o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes     ý  No     o

 

The number of common shares outstanding as ofApril 25, 2005 was 12,760,833.

 

 

----

 

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

 

**INDEX**

 
| Part I.  FINANCIAL INFORMATION:                                                                       |   |
|------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                       |   |
| Item 1.  Financial Statements                                                                         |   |
|                                                                                                       |   |
| Consolidated Balance Sheets  March 31, 2005 and December 31, 2004                                          |   |
|                                                                                                       |   |
| Consolidated  Statements of Income Three Months Ended March 31, 2005 and 2004                              |   |
|                                                                                                       |   |
| Consolidated  Statements of Stockholders’ Equity March 31, 2005 and 2004                              |   |
|                                                                                                       |   |
| Consolidated  Statements of Comprehensive Income Three Months Ended March 31, 2005 and 2004                |   |
|                                                                                                       |   |
| Consolidated  Statements of Cash Flows Three Months Ended March 31, 2005 and 2004                          |   |
|                                                                                                       |   |
| Notes  to Interim Consolidated Financial Statements                                                        |   |
|                                                                                                       |   |
| 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                                                                           |   |
|                                                                                                       |   |
| Item 1.  Legal Proceedings                                                                            |   |
|                                                                                                       |   |
| Item  2.  Unregistered Sales of Equity  Securities and Use of Proceeds                                |   |
|                                                                                                       |   |
| Item 3.  Defaults Upon Senior Securities                                                              |   |
|                                                                                                       |   |
| Item  4.  Submissions of Matters to a Vote of  Security Holders                                       |   |
|                                                                                                       |   |
| Item 5.  Other Information                                                                            |   |
|                                                                                                       |   |
| Item 6.  Exhibits                                                                                     |   |
|                                                                                                       |   |
| Signature                                                                                                  |   |
|                                                                                                       |   |
| Index of Exhibits                                                                                          |   |

 

2

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**Part1. Financial Information**

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

#####  

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

**CONSOLIDATED BALANCE SHEETS**

*($ in thousands, except share data)*

 
| ** **                                                                                                                        | ** **   | **March 31,**   | ** **   | **December 31,** | ** **   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------------|-----------------|--------------|------------------|--------------|
| ** **                                                                                                                        | ** **   | **2005**        | ** **   | **2004**         | ** **   |
| ** **                                                                                                                        | ** **   | **(Unaudited)** | ** **   | ** **       | ** **   |
| **ASSETS**                                                                                                                        | *** *** | *** ***    | *** *** | *** ***     | *** *** |
| Investments and cash:                                                                                                             |         |            |         |             |         |
| Fixed maturities, available-for-sale, at  fair value (amortized cost: 2005, $771,506; 2004, $713,049)                             |         | $               | 771,307      |             | $            | 722,434 |   |
| Equity securities, available-for-sale, at  fair value (cost: 2005, $19,254; 2004, $19,101)                                        |         | 20,884          |         | 21,170           |         |
| Short-term investments, at cost which  approximates fair value                                                                    |         | 107,574         |         | 96,653           |         |
| Cash                                                                                                                              |         | 7,652           |         | 14,676           |         |
| Total investments and cash                                                                                                        |         | 907,417         |         | 854,933          |         |
|                                                                                                                              |         |            |         |             |         |
| Premiums in course of collection                                                                                                  |         | 179,181         |         | 176,720          |         |
| Commissions receivable                                                                                                            |         | 3,138           |         | 3,062            |         |
| Prepaid reinsurance premiums                                                                                                      |         | 147,012         |         | 130,761          |         |
| Reinsurance receivable on paid losses                                                                                             |         | 18,861          |         | 20,955           |         |
| Reinsurance receivable on unpaid losses and  loss adjustment expenses                                                             |         | 520,262         |         | 502,329          |         |
| Net deferred income tax benefit                                                                                                   |         | 21,427          |         | 17,348           |         |
| Deferred policy acquisition costs                                                                                                 |         | 35,935          |         | 23,882           |         |
| Accrued investment income                                                                                                         |         | 7,341           |         | 7,303            |         |
| Goodwill                                                                                                                          |         | 5,241           |         | 5,282            |         |
| Other assets                                                                                                                      |         | 19,218          |         | 14,103           |         |
|                                                                                                                              |         |            |         |             |         |
| Total assets                                                                                                                      |         | $               | 1,865,033    |             | $            | 1,756,678 |   |
|                                                                                                                              |         |            |         |             |         |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                    |         |            |         |             |         |
| Liabilities:                                                                                                                      |         |            |         |             |         |
| Reserves for losses and loss adjustment  expenses                                                                                 |         | $               | 999,766      |             | $            | 966,117 |   |
| Unearned premium                                                                                                                  |         | 326,571         |         | 270,970          |         |
| Reinsurance balances payable                                                                                                      |         | 140,451         |         | 143,427          |         |
| Federal income tax payable                                                                                                        |         | 9,270           |         | 5,614            |         |
| Payable for securities purchased                                                                                                  |         | 2,695           |         | 3,027            |         |
| Accounts payable and other liabilities                                                                                            |         | 52,524          |         | 38,945           |         |
| Total liabilities                                                                                                                 |         | 1,531,277       |         | 1,428,100        |         |
|                                                                                                                              |         |            |         |             |         |
| Stockholders’ equity:                                                                                                        |         |            |         |             |         |
| Preferred stock, $.10 par value, authorized  1,000,000 shares, none issued                                                        |         | —          |         | —           |         |
| Common stock, $.10 par value, 20,000,000  shares authorized; issued and  outstanding: 12,759,958 for 2005 and 12,657,160 for 2004 |         |            |         |             |         |
|                                                                                                                              |         | 1,276           |         | 1,266            |         |
| Additional paid-in capital                                                                                                        |         | 156,514         |         | 154,670          |         |
| Retained earnings                                                                                                                 |         | 173,036         |         | 163,337          |         |
| Accumulated other comprehensive income                                                                                            |         | 2,930           |         | 9,305            |         |
| Total stockholders’ equity                                                                                                   |         | 333,756         |         | 328,578          |         |
|                                                                                                                              |         |            |         |             |         |
| Total liabilities and stockholders’ equity                                                                                   |         | $               | 1,865,033    |             | $            | 1,756,678 |   |

 

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

 

3

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

**CONSOLIDATED STATEMENTS OF INCOME**

*($ and shares in thousands, except net income per share)*

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **March 31,**          | ** ** |
| ** **                                        | ** ** | **2005**               | ** ** | **2004** | ** ** |
| ** **                                        | ** ** | **(Unaudited)**        | ** ** |
|                                              |       |                   |       |   |   |
| Gross written premium                             |       | $                      | 216,996    |   | $ | 195,951 |   |
| Revenues:                                         |       |                   |       |   |   |
| Net written premium                               |       | $                      | 117,090    |   | $ | 95,935 |   |
| (Increase) in unearned premium                    |       | (39,552                | )          | (21,760 | ) |
| Net earned premium                                |       | 77,538                 |       | 74,175 |   |
| Commission income                                 |       | 1,270                  |       | 1,127 |   |
| Net investment income                             |       | 7,622                  |       | 5,902 |   |
| Net realized capital gains                        |       | 167                    |       | 422 |   |
| Other income                                      |       | 897                    |       | 128 |   |
| Total revenues                                    |       | 87,494                 |       | 81,754 |   |
|                                              |       |                   |       |   |   |
| Operating expenses:                               |       |                   |       |   |   |
| Net losses and loss adjustment expenses  incurred |       | 46,221                 |       | 43,752 |   |
| Commission expense                                |       | 9,604                  |       | 11,028 |   |
| Other operating expenses                          |       | 17,444                 |       | 13,432 |   |
| Total operating expenses                          |       | 73,269                 |       | 68,212 |   |
|                                              |       |                   |       |   |   |
| Income before income tax expense                  |       | 14,225                 |       | 13,542 |   |
|                                              |       |                   |       |   |   |
| Income tax expense (benefit):                     |       |                   |       |   |   |
| Current                                           |       | 5,172                  |       | 5,007 |   |
| Deferred                                          |       | (646                   | )          | (378 | ) |
| Total income tax expense                          |       | 4,526                  |       | 4,629 |   |
|                                              |       |                   |       |   |   |
| Net income                                        |       | $                      | 9,699      |   | $ | 8,913 |   |
|                                              |       |                   |       |   |   |
| Net income per common share:                      |       |                   |       |   |   |
| Basic                                             |       | $                      | 0.77       |   | $ | 0.71 |   |
| Diluted                                           |       | $                      | 0.76       |   | $ | 0.70 |   |
|                                              |       |                   |       |   |   |
| Average common shares outstanding:                |       |                   |       |   |   |
| Basic                                             |       | 12,677                 |       | 12,554 |   |
| Diluted                                           |       | 12,760                 |       | 12,654 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

4

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

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’EQUITY**

*($ in thousands)*

 
| ** **                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                               | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                                               | ** ** | **(Unaudited)**                   | ** ** |
| Preferred Stock                                          |       |                              |       |   |   |
| Balance at beginning and end of period                   |       | $                                 | —     |   | $ | — |   |
|                                                     |       |                              |       |   |   |
| Common stock                                             |       |                              |       |   |   |
| Balance at beginning of year                             |       | $                                 | 1,266      |   | $ | 1,254 |   |
| Shares issued under stock plans                          |       | 10                                |       | 5 |   |
| Balance at end of period                                 |       | $                                 | 1,276      |   | $ | 1,259 |   |
|                                                     |       |                              |       |   |   |
| Additional paid-in capital                               |       |                              |       |   |   |
| Balance at beginning of year                             |       | $                                 | 154,670    |   | $ | 151,765 |   |
| Effect of SFAS 123 for stock options                     |       | 246                               |       | 200 |   |
| Shares issued under stock plans                          |       | 1,598                             |       | 1,069 |   |
| Balance at end of period                                 |       | $                                 | 156,514    |   | $ | 153,034 |   |
|                                                     |       |                              |       |   |   |
| Retained earnings                                        |       |                              |       |   |   |
| Balance at beginning of year                             |       | $                                 | 163,337    |   | $ | 128,472 |   |
| Net income                                               |       | 9,699                             |       | 8,913 |   |
| Balance at end of period                                 |       | $                                 | 173,036    |   | $ | 137,385 |   |
|                                                     |       |                              |       |   |   |
| Accumulated other comprehensive income                   |       |                              |       |   |   |
| Net unrealized gains (losses) on  securities, net of tax |       |                              |       |   |   |
| Balance at beginning of year                             |       | $                                 | 7,416      |   | $ | 7,871 |   |
| Change in period                                         |       | (6,487                            | )          | 4,770 |   |
| Balance at end of period                                 |       | 929                               |       | 12,641 |   |
| Cumulative translation adjustments, net of  tax          |       |                              |       |   |   |
| Balance at beginning of year                             |       | 1,889                             |       | 666 |   |
| Net adjustment for period                                |       | 112                               |       | 219 |   |
| Balance at end of period                                 |       | 2,001                             |       | 885 |   |
| Balance at end of period                                 |       | $                                 | 2,930      |   | $ | 13,526 |   |
|                                                     |       |                              |       |   |   |
| Total stockholders’ equity at end of period         |       | $                                 | 333,756    |   | $ | 305,204 |   |

 

See accompanying notes to interim consolidated financial statements.

 

5

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

**CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**

*($ in thousands)*

 
| ** **                                                                                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| ** **                                                                                                                                         | ** ** | **(Unaudited)**                   | ** ** |
|                                                                                                                                               |       |                              |       |   |   |
| Net income                                                                                                                                         |       | $                                 | 9,699      |   | $ | 8,913 |   |
| Other comprehensive income (loss):                                                                                                                 |       |                              |       |   |   |
| Change in net unrealized gains or (losses)  on securities, net of tax expense (benefit) of $(3,493) and $2,568 in 2005  and 2004, respectively (1) |       | (6,487                            | )          | 4,770 |   |
| Change in foreign currency translation  gains, net of tax expense of $60 and $118 in 2005 and 2004, respectively                                   |       | 112                               |       | 219 |   |
| Other comprehensive income (loss)                                                                                                                  |       | (6,375                            | )          | 4,989 |   |
|                                                                                                                                               |       |                              |       |   |   |
| Comprehensive income                                                                                                                               |       | $                                 | 3,324      |   | $ | 13,902 |   |
|                                                                                                                                               |       |                              |       |   |   |
|                                                                                                                                                    |       |                              |       |   |   |
| (1)   Disclosure  of reclassification amount, net of tax:                                                                                |       |                              |       |   |   |
| Unrealized holding gains (losses) arising during  period                                                                                           |       | $                                 | (6,378     | ) | $ | 5,044 |   |
| Less: reclassification adjustment for net gains  included in net income                                                                            |       | 109                               |       | 274 |   |
| Change in net unrealized gains (losses) on  securities                                                                                             |       | $                                 | (6,487     | ) | $ | 4,770 |   |

 

Seeaccompanying notes to interim consolidated financial statements.

 

6

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

*($ in thousands)*

 
| ** **                                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                   | ** ** | **2005**                          | ** ** | **2004** | ** ** |
| **\**                                                                                        | ** ** | **(Unaudited)**                   | ** ** |
| Operating activities:                                                                        |       |                              |       |   |   |
| Net income                                                                                   |       | $                                 | 9,699      |   | $ | 8,913 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                              |       |   |   |
| Depreciation & amortization                                                              |       | 349                               |       | 271 |   |
| Net deferred income tax (benefit)                                                            |       | (646                              | )          | (378 | ) |
| Net realized capital (gains)                                                                 |       | (167                              | )          | (422 | ) |
| Changes in assets and liabilities:                                                           |       |                              |       |   |   |
| Reinsurance receivable on paid and unpaid losses  and loss adjustment expenses               |       | (15,839                           | )          | (32,519 | ) |
| Reserve for losses and loss adjustment  expenses                                             |       | 33,649                            |       | 61,476 |   |
| Prepaid reinsurance premiums                                                                 |       | (16,251                           | )          | (28,204 | ) |
| Unearned premium                                                                             |       | 55,601                            |       | 51,206 |   |
| Premiums in course of collection                                                             |       | (2,461                            | )          | (57,125 | ) |
| Commissions receivable                                                                       |       | (76                               | )          | 89 |   |
| Deferred policy acquisition costs                                                            |       | (12,053                           | )          | (9,734 | ) |
| Accrued investment income                                                                    |       | (38                               | )          | (482 | ) |
| Reinsurance balances payable                                                                 |       | (2,976                            | )          | 29,402 |   |
| Federal income tax                                                                           |       | 3,656                             |       | 4,930 |   |
| Other                                                                                        |       | 12,743                            |       | (690 | ) |
| Net cash provided by operating activities                                                    |       | 65,190                            |       | 26,733 |   |
|                                                                                         |       |                              |       |   |   |
| Investing  activities:                                                                       |       |                              |       |   |   |
| Fixed maturities, available-for-sale                                                         |       |                              |       |   |   |
| Redemptions and maturities                                                                   |       | 7,795                             |       | 52,720 |   |
| Sales                                                                                        |       | 77,968                            |       | 45,059 |   |
| Purchases                                                                                    |       | (147,561                          | )          | (131,950 | ) |
| Equity securities, available-for-sale                                                        |       |                              |       |   |   |
| Sales                                                                                        |       | —                            |       | — |   |
| Purchases                                                                                    |       | (117                              | )          | (6,785 | ) |
| Change in payable for securities                                                             |       | (332                              | )          | (4,013 | ) |
| Net change in short-term investments                                                         |       | (10,921                           | )          | 15,818 |   |
| Purchase of property and equipment                                                           |       | (145                              | )          | (266 | ) |
| Net cash (used in) investing activities                                                      |       | (73,313                           | )          | (29,417 | ) |
|                                                                                         |       |                              |       |   |   |
| Financing  activities:                                                                       |       |                              |       |   |   |
| Proceeds of stock issued from Employee Stock  Purchase Plan                                  |       | 212                               |       | 215 |   |
| Proceeds of stock issued from exercise of  stock options                                     |       | 887                               |       | 175 |   |
| Net cash provided by financing activities                                                    |       | 1,099                             |       | 390 |   |
|                                                                                         |       |                              |       |   |   |
| (Decrease) in cash                                                                           |       | (7,024                            | )          | (2,294 | ) |
| Cash at beginning of year                                                                    |       | 14,676                            |       | 8,399 |   |
| Cash at end of period                                                                        |       | $                                 | 7,652      |   | $ | 6,105 |   |
|                                                                                         |       |                              |       |   |   |
| Supplemental disclosures of cash flow  information:                                          |       |                              |       |   |   |
| Federal, state and local income tax paid                                                     |       | 1,506                             |       | 77 |   |
| Issuance of stock to directors                                                               |       | 123                               |       | 60 |   |

 

See accompanying notes to interim consolidated financial statements.

 

7

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

 

**Notes to Interim Consolidated Financial Statements**

*(Unaudited)*

 

**Note 1.  Accounting Policies**

 

The interim consolidatedfinancial statements are unaudited but reflect all adjustments which, in theopinion of management, are necessary to provide a fair statement of the resultsof The Navigators Group, Inc. and its subsidiaries for the interim periodspresented on the basis of accounting principles generally accepted in theUnited States of America (“GAAP”).  Allsuch adjustments are of a normal recurring nature.  All significant intercompany transactions andbalances have been eliminated.  Thepreparation of these financial statements requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities at the date of the financialstatements and the reported revenues and expenses during the reportingperiods.  The results of operations forany interim period are not necessarily indicative of results for the fullyear.  The terms “we”, “us”, “our” and “theCompany” as used herein mean The Navigators Group, Inc. and its subsidiaries,unless the context otherwise requires. These financial statements should be read in conjunction with theconsolidated financial statements and notes contained in the Company’s 2004Annual Report on Form 10-K.

 

**Note 2.  Reinsurance Ceded**

 

The Company’s ceded earnedpremiums were $83,464,000 and $73,379,000 for the three months ended March 31,2005 and 2004, respectively.  The Company’sceded incurred losses were $53,435,000 and $64,818,000 for the three monthsended March 31, 2005 and 2004, respectively.

 

**Note 3.  Segment Information**

 

The Company’s subsidiariesare primarily engaged in the writing and management of property and casualtyinsurance.  The Company’s segmentsinclude the Insurance Companies, the Lloyd’s Operations and the NavigatorsAgencies, each of which is managed separately. The Insurance Companies consist of Navigators Insurance Company, whichincludes a branch in the U.K. (the “U.K. Branch”), and NIC Insurance Companyand are primarily engaged in underwriting marine insurance and related lines ofbusiness, contractors’ general liability insurance, and professional liabilityinsurance.  The Lloyd’s Operationsunderwrite marine and related lines of business at Lloyd’s of London.  The Navigators Agencies are underwritingmanagement companies which produce, manage and underwrite insurance andreinsurance for both affiliated and unaffiliated companies.  All segments are evaluated based on theirGAAP results.

 

The Insurance Companies andthe Lloyd’s Operations are measured by taking into account net premiums earned,incurred losses and loss adjustment expenses (“LAE”), commission expense andother underwriting expenses.  TheNavigators Agencies’ results include commission income less other operatingexpenses.  Parent and other operationsinclude inter-segment income and expense in the form of affiliated commissions,income and expense from corporate operations and consolidatingadjustments.  Each segment also maintainsits own investments, on which it earns income and realizes capital gains orlosses.

 

8

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Financialdata by segment for the three months ended March 31, 2005 and 2004 was asfollows:

 
| ** **                                         | ** ** | **Three Months Ended March 31, 2005** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **Insurance  Companies**              | ** ** | **Lloyd’s  Operations** | ** ** | **Navigators  Agencies** | ** ** | **Parent &  Other  Operations (1)** | ** ** | **Consolidated  Total** | ** ** |
| ** **                                         | ** ** | **($ in thousands)**             | ** ** |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Gross written premium                              |       | $                                     | 129,288    |   | $ | 87,830 |   |   |   | $ | (122 | ) | $ | 216,996 |   |
| Net written premium                                |       | 73,581                                |       | 43,509 |   |   |   | — |   | 117,090 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Revenues:                                          |       |                                  |       |   |   |   |   |   |   |   |   |
| Net earned premium                                 |       | 47,363                                |       | 30,175 |   |   |   | — |   | 77,538 |   |
| Commission income                                  |       | —                                |       | 268 |   | $ | 9,750 |   | (8,748 | ) | 1,270 |   |
| Net investment income                              |       | 6,855                                 |       | 749 |   | 2 |   | 16 |   | 7,622 |   |
| Net realized capital gains (losses                 |       | 266                                   |       | (99 | ) | — |   | — |   | 167 |   |
| Other income (expense)                             |       | (2                                    | )          | 628 |   | 271 |   | — |   | 897 |   |
| Total revenues                                     |       | 54,482                                |       | 31,721 |   | 10,023 |   | (8,732 | ) | 87,494 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Operating expenses:                                |       |                                  |       |   |   |   |   |   |   |   |   |
| Net losses and LAE                                 |       | 28,842                                |       | 17,379 |   | — |   | — |   | 46,221 |   |
| Commission expense                                 |       | 12,586                                |       | 4,881 |   | — |   | (7,863 | ) | 9,604 |   |
| Other operating expenses                           |       | 2,112                                 |       | 4,761 |   | 10,996 |   | (425 | ) | 17,444 |   |
| Total operating expenses                           |       | 43,540                                |       | 27,021 |   | 10,996 |   | (8,288 | ) | 73,269 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Income (loss) before income tax expense  (benefit) |       | 10,942                                |       | 4,700 |   | (973 | ) | (444 | ) | 14,225 |   |
| Income tax expense (benefit)                       |       | 3,399                                 |       | 1,645 |   | (362 | ) | (156 | ) | 4,526 |   |
| Net income (loss)                                  |       | $                                     | 7,543      |   | $ | 3,055 |   | $ | (611 | ) | $ | (288 | ) | $ | 9,699 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Identifiable assets (2)                            |       | $                                     | 1,339,245  |   | $ | 579,464 |   | $ | 16,192 |   | $ | 11,915 |   | $ | 1,865,033 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Loss and LAE ratio                                 |       | 60.9                                  | %          | 57.6 | % |   |   |   |   | 59.6 | % |
| Commission expense ratio                           |       | 26.6                                  | %          | 16.2 | % |   |   |   |   | 22.5 | % |
| Other operating expense ratio                      |       | 4.5                                   | %          | 15.8 | % |   |   |   |   | 8.9 | % |
| Combined ratio                                     |       | 92.0                                  | %          | 89.6 | % |   |   |   |   | 91.0 | % |

 

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(1)Includes inter-segment eliminations.

(2)Does not cross-foot due to inter-segment eliminations.

 

9

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| ** **                                         | ** ** | **Three Months Ended March 31, 2004** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **Insurance  Companies**              | ** ** | **Lloyd’s  Operations** | ** ** | **Navigators  Agencies** | ** ** | **Parent &  Other  Operations (1)** | ** ** | **Consolidated  Total** | ** ** |
| ** **                                         | ** ** | **($ in thousands)**             | ** ** |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Gross written premium                              |       | $                                     | 111,829    |   | $ | 87,158 |   |   |   | $ | (3,036 | ) | $ | 195,951 |   |
| Net written premium                                |       | 54,145                                |       | 41,790 |   |   |   | — |   | 95,935 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Revenues:                                          |       |                                  |       |   |   |   |   |   |   |   |   |
| Net earned premium                                 |       | 53,182                                |       | 20,993 |   |   |   | — |   | 74,175 |   |
| Commission income                                  |       | —                                |       | 62 |   | $ | 7,932 |   | (6,867 | ) | 1,127 |   |
| Net investment income                              |       | 5,484                                 |       | 404 |   | 3 |   | 11 |   | 5,902 |   |
| Net realized capital gains                         |       | 205                                   |       | 217 |   | — |   | — |   | 422 |   |
| Other income (expense)                             |       | (61                                   | )          | 4 |   | 185 |   | — |   | 128 |   |
| Total revenues                                     |       | 58,810                                |       | 21,680 |   | 8,120 |   | (6,856 | ) | 81,754 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Operating expenses:                                |       |                                  |       |   |   |   |   |   |   |   |   |
| Net losses and LAE                                 |       | 32,710                                |       | 11,042 |   | — |   | — |   | 43,752 |   |
| Commission expense                                 |       | 14,145                                |       | 3,750 |   | — |   | (6,867 | ) | 11,028 |   |
| Other operating expenses                           |       | 1,198                                 |       | 3,036 |   | 8,605 |   | 593 |   | 13,432 |   |
| Total operating expenses                           |       | 48,053                                |       | 17,828 |   | 8,605 |   | (6,274 | ) | 68,212 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Income (loss) before income tax expense  (benefit) |       | 10,757                                |       | 3,852 |   | (485 | ) | (582 | ) | 13,542 |   |
| Income tax expense (benefit)                       |       | 3,478                                 |       | 1,348 |   | (140 | ) | (57 | ) | 4,629 |   |
| Net income (loss)                                  |       | $                                     | 7,279      |   | $ | 2,504 |   | $ | (345 | ) | $ | (525 | ) | $ | 8,913 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Identifiable assets (2)                            |       | $                                     | 1,114,640  |   | $ | 447,860 |   | $ | 16,876 |   | $ | 32,514 |   | $ | 1,535,348 |   |
|                                               |       |                                  |       |   |   |   |   |   |   |   |   |
| Loss and LAE ratio                                 |       | 61.5                                  | %          | 52.6 | % |   |   |   |   | 59.0 | % |
| Commission expense ratio                           |       | 26.6                                  | %          | 17.9 | % |   |   |   |   | 24.1 | % |
| Other operating expense ratio                      |       | 2.3                                   | %          | 14.4 | % |   |   |   |   | 5.7 | % |
| Combined ratio                                     |       | 90.4                                  | %          | 84.9 | % |   |   |   |   | 88.8 | % |

 

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(1)Includes inter-segment eliminations.

(2)Does not cross-foot due to inter-segment eliminations.

 

10

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The Insurance Companies’ netearned premium includes $7,028,000 and $7,425,000 of net earned premium fromthe U.K. Branch for the three months ended March 31, 2005 and 2004,respectively.

 

**Note 4.  ComprehensiveIncome**

 

Comprehensive income encompassesnet income, net unrealized capital gains and losses on available for salesecurities, and foreign currency translation adjustments.  Please refer to the ‘Consolidated Statementsof Stockholders’ Equity’ and the ‘Consolidated Statements of ComprehensiveIncome’, included herein, for the components of accumulated other comprehensiveincome and of comprehensive income, respectively.

 

**Note 5.  Stock-BasedCompensation**

 

Stockbased compensation is expensed as the awards vest and included in *other operating expenses* for the periodsindicated.  The amount charged to expensefor stock grants was $378,000 and $362,000 for the three months ended March 31,2005 and 2004, respectively.  The amountcharged to expense for stock options was $246,000 and $200,000 for the threemonths ended March 31, 2005 and 2004, respectively.  Stock appreciation rights resulted in expenseof $75,000 for the three months ended March 31, 2005 and income of $329,000 forthe three months ended March 31, 2004.

 

Inaddition, $35,000 and $30,000 were expensed for the three months ended March31, 2005 and 2004, respectively, for stock issued annually to non-employeedirectors as part of their directors’ compensation for serving on the Company’sBoard of Directors.

 

**Note 6.  Application ofNew Accounting Standards**

 

InSeptember 2004, the FASB approved issuing a Staff Position to delay therequirement to record impairment losses under Emerging Issues Task Force IssueNo. 03-1 (“EITF 03-1”).  The approveddelay applies to certain provisions relating to the recognition of other thantemporary impairments for all securities within the scope of EITF 03-1 and isexpected to end when new guidance is issued and becomes effective.  The Company will review the new guidance whenit becomes available.

 

InDecember 2004, the FASB issued SFAS 123 (revised 2004), *Share Based Payment*, which is a revisionof SFAS 123, *Accounting for Stock-BasedCompensation,* eliminating the alternative use of APB 25.  SFAS 123 (revised 2004) has no effect on theCompany’s results of operations or financial condition since the Companyadopted the fair value recognition provisions of SFAS 123 in 2003.

 

**Note 7.  Lloyd’sSyndicate**

 

Werecord our pro rata share of Lloyd’s Syndicate 1221’s assets, liabilities,revenues and expenses, after making adjustments to convert Lloyd’s accountingto U.S. GAAP.  The most significant U.S.GAAP adjustments relate to income recognition. Lloyd’s syndicates determineunderwriting results by year of account at the end of three years.  We record adjustments to recognizeunderwriting results as incurred, including the expected ultimate cost oflosses incurred.  These adjustments tolosses are based on actuarial analysis of syndicate accounts, includingforecasts of expected ultimate losses provided by the syndicates.  At the end of the Lloyd’s three year periodfor determining underwriting results for an account year, the syndicate willclose the account year by reinsuring outstanding claims on that account yearwith the participants for the account’s next underwriting year.  The amount to close an underwriting year intothe next year is referred to as the reinsurance to close.  The reinsurance to close transaction isrecorded in the fourth quarter as additional written and earned premium, lossesincurred, loss reserves and receivables, all in the same amount.  No gain or loss is recorded on thereinsurance to close transaction.

 

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OurLloyd’s Syndicate 1221’s stamp capacity is £135.0 million ($255.3 million) in2005 compared to £150.0 million ($275.0 million) in 2004.  Stamp capacity is a measure of the amount ofpremium a Lloyd’s syndicate is authorized to write based on a business planapproved by the Council of Lloyd’s. Syndicate 1221’s capacity is expressed net of commission (as is standardat Lloyd’s) of approximately 21%.  TheSyndicate 1221 premium recorded in the Company’s financial statements is grossof commission.  The Company participatesfor 97.5% and 97.4% of Syndicate 1221’s capacity for the 2005 and 2004underwriting years, respectively.  TheLloyd’s operations included in the consolidated financial statements representthe Company’s participation in Syndicate 1221.

 

TheCompany provides letters of credit to Lloyd’s to support its Syndicate 1221capacity.  If the Company increases itsparticipation or if Lloyd’s changes the capital requirements, the Company maybe required to supply additional letters of credit or other collateralacceptable to Lloyd’s, or reduce the capacity of Syndicate 1221.  The letters of credit are provided through thecredit facility which the Company maintains with a consortium of banks.  The credit facility agreement requires thatthe banks vote whether or not to renew the letter of credit portion of thefacility periodically.  If the banksdecide not to renew the letter of credit facility, the Company will need tofind other sources to provide the letters of credit or other collateral inorder to continue to participate in Syndicate 1221.  The renewal amendment executed in January2005 renewed the letter of credit facility until June 30, 2007.  The bank facility is collateralized by all ofthe common stock of Navigators Insurance Company.

 

**Note 8.  Income Tax -Valuation Allowance**

 

TheCompany had state and local operating loss carryforwards amounting to potentialfuture tax benefits of $5,409,000 and $4,493,000 at March 31, 2005 and December31, 2004, respectively.  A valuationallowance was established for the full amount of these potential future taxbenefits due to the uncertainty associated with their realization.

 

**Note 9.  Commitmentsand Contingencies**

 

TheCompany is not a party to, or the subject of, any material pending legalproceedings which depart from the ordinary routine litigation incident to thekinds of business it conducts.

 

TheCompany was recently informed by a lead reinsurer participating on excess ofloss reinsurance agreements that it may formally dispute a loss paymentrecovery when billed.  The recovery isfor the 2004 settlement of a class action suit involving a large asbestos claimwhich settlement will be paid over seven years starting in June 2005.  The reinsurer has not indicated any disputewith respect to recoveries on related pro rata reinsurance agreements.

 

TheCompany believes such a dispute, if it should arise, is without merit andintends to vigorously pursue collection of its reinsurance recoveries.  While it is too early to predict with anycertainty the outcome of this matter, the Company believes that the ultimateoutcome of this matter would not be expected to have a significant adverseeffect on results of operations, financial condition or liquidity, although anunexpected adverse resolution could have a material adverse effect on theCompany’s results of operations in a particular fiscal quarter or year.

 

**Item 2.****                      ****Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

**Note on Forward-Looking Statements**

 

Someof the statements in this Quarterly Report on Form 10-Q are ‘‘forward-lookingstatements’’ as defined in the Private Securities Litigation Reform Act of1995.   Whenever used in this report, thewords “estimate”, “expect”, “believe” or similar expressions are intended toidentify such forward-looking statements. Forward-looking statements are derived from information that wecurrently have and assumptions that we make. 

 

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We cannot assure that anticipated resultswill be achieved, since results may differ materially because of both known andunknown risks and uncertainties which we face. We undertake no obligation topublicly update or revise any forward-looking statements, whether as a resultof new information, future events or otherwise. Factors that could cause actualresults to differ materially from our forward-looking statements include, butare not limited to:

 

•                  the effects of domestic and foreign economicconditions, and conditions which affect the market for property and casualtyinsurance;

 

•                  changes in the laws, rules and regulationswhich 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 competition from banks, otherinsurers and the trend toward self-insurance;

 

•                  risks that we face in entering new marketsand diversifying the products and services we offer;

 

•                  unexpected turnover of our professionalstaff;

 

•                  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,including our estimates relating to ultimate asbestos and environmentalliabilities and related reinsurance recoverables;

 

•                  risks inherent with the collection ofreinsurance recoverable amounts from our reinsurers over many years into thefuture based on their financial ability and intent to meet such obligations tothe Company;

 

•                  risks associated with our continuing abilityto obtain reinsurance covering our exposures at appropriate prices and/or insufficient amounts and the related recoverability of our reinsured losses;

 

•                  weather-related events and other catastrophes(including acts of terrorism) impacting our insureds and/or reinsurers;

 

•                  our ability to attain adequate prices, obtainnew business and to retain existing business consistent with 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 inability of our internal controlframework to provide absolute assurance that all incidents of fraud orunintended material errors will be detected and prevented;

 

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

 

•                  other risks that we identify in futurefilings with the Securities and Exchange Commission (the “SEC”).

 

Inlight of these risks, uncertainties and assumptions, any forward-looking eventsdiscussed in this Form 10-Q may not occur. You are cautioned not to place unduereliance on any forward-looking statements, which speak only as of theirrespective dates.

 

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*The discussion and analysis of our financial condition andresults of operations contained herein should be read in conjunction with ourconsolidated financial statements and accompanying notes which appear elsewherein this Form 10-Q. It contains forward-looking statements that involve risksand uncertainties. Please see ‘‘Note on Forward-Looking Statements’’ for moreinformation. Our actual results could differ materially from those anticipatedin these forward-looking statements as a result of various factors, includingthose discussed below and elsewhere in this Form 10-Q.*

 

**Overview**

 

Weare an international insurance holding company focusing on specialty productsfor niches within the overall property/casualty insurance market. Our largestproduct line and most long-standing area of specialization is ocean marineinsurance. We have also developed specialty niches in professional liabilityinsurance, and in specialty liability insurance primarily consisting ofcontractors’ liability coverages. We conduct operations through our insurancecompany subsidiaries, the Navigators Agencies and our Lloyd’s Operations.  Our insurance company subsidiaries consist ofNavigators Insurance Company, which includes a United Kingdom Branch (the “U.K.Branch”), and NIC Insurance Company which writes excess and surplus lines.  The Navigators Agencies consist of fivewholly-owned insurance underwriting agencies which produce business for ourinsurance subsidiaries.  Our Lloyd’soperations include Navigators Underwriting Agency Ltd. (“NUAL”), a Lloyd’s ofLondon (“Lloyd’s”) marine underwriting agency which manages Lloyd’s Syndicate1221.  We participate in the capacity ofSyndicate 1221 through two wholly owned Lloyd’s corporate members.

 

Whilemanagement takes into consideration a wide range of factors in planning theCompany’s business strategy and evaluating results of operations, there arecertain factors that management believes are fundamental to understanding howthe Company is managed.   First,underwriting profit is consistently emphasized as a primary goal, above premiumgrowth.  Management’s assessment of ourtrends and potential growth in underwriting profit is the dominant factor inits decisions with respect to whether or not to expand a business line, enterinto a new niche, product or territory or, conversely, to contract capacity inany business line.  In addition,management focuses on managing the costs of our operations.  Management believes that careful monitoringof the costs of existing operations and assessment of costs of potential growthopportunities are important to our profitability.  Access to capital also has a significantimpact on management’s outlook for our operations.  Our insurance company subsidiaries’operations and ability to grow their business and take advantage of marketopportunities are particularly constrained by regulatory capital requirementsand rating agency assessments of capital adequacy.

 

Althoughnot a financial measure, management’s decisions are also greatly influenced byaccess to specialized underwriting and claims expertise in our lines ofbusiness.  We have chosen to operate inspecialty niches with certain common characteristics which we believe provideus with the opportunity to use our technical underwriting expertise in order torealize underwriting profit. As a result, we have focused on underservedmarkets for businesses characterized by higher severity and low frequency of losswhere we believe our intellectual capital and financial strength bringmeaningful value. In contrast, we have avoided niches that we believe have ahigh frequency of loss activity and/or are subject to a high level ofregulatory coverage requirements, such as workers compensation and personalautomobile insurance, because we do not believe our technical expertise is ofas much value in these types of businesses. Examples of niches that have thecharacteristics we look for include bluewater hull (which provides coverage forphysical damage to, for example, highly valued cruise ships) and directors andofficers liability (which covers litigation exposure of a corporation’sdirectors and officers). These types of exposures require substantial technicalexpertise. We attempt to mitigate the financial impact of severe claims on ourresults by conservative and detailed underwriting, prudent use of reinsuranceand a balanced portfolio of risks.

 

Ourrevenue is primarily comprised of premiums, commission and investment income.Our insurance company subsidiaries derive their premiums primarily frombusiness written by the Navigators Agencies. The Lloyd’s Operations derivetheir premiums from business written by NUAL. The Navigators Agencies and NUAL 

 

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receive commissions and, in some cases,profit commissions and service fees on the business produced on behalf of ourinsurance company subsidiaries and others.

 

Overthe past three years, we have experienced generally beneficial market changesin our lines of business. As a result of several large industry losses in thesecond quarter of 2001, the marine insurance market began to experiencediminished capacity and rate increases, initially in the offshore energy line ofbusiness.  The marine rate increasesbegan to level off in 2004 and into 2005. Specialty liability losses, particularly for our California constructionliability business, also resulted in diminished capacity in the market in whichwe compete, as many former competitors who lacked the expertise to selectivelyunderwrite this business have been forced to withdraw from the market.  Rates for the California constructionliability business have started to level off in 2005 after rate increases in2004 and 2003.  In the professionalliability market, the enactment of the Sarbanes-Oxley Act of 2002, togetherwith recent financial and accounting scandals at publicly traded corporationsand increased frequency of securities-related class action litigation, has leadto an invigorated interest in professional liability insurance generally. Theseconditions resulted in rate increases in 2002 and 2003 as well as an overallimprovement in policy terms and conditions for our professional liability lineof business.  The professional liabilitybusiness experienced single digit premium rate decreases in 2004 and levelrates in the 2005 first quarter.

 

Ourbusiness is cyclical and influenced by many factors.  These factors include price competition,economic conditions, interest rates, natural or man-made disasters (for examplehurricanes and terrorism), state regulations, court decisions and changes inthe law. Additionally, because our insurance products must be priced, andpremiums charged, before costs have fully developed, our liabilities arerequired to be estimated and recorded in recognition of future loss andsettlement obligations. Due to the inherent uncertainty in estimating theseliabilities, we cannot assure you that our actual liabilities will not exceedour recorded amounts.

 

**Industry Investigations**

 

Theinsurance industry has become the subject of increasing scrutiny with respectto insurance broker and agent compensation arrangements, and certain salespractices.  The New York State AttorneyGeneral and other state and federal regulators have commenced investigationsand other proceedings relating to the payment of contingent commissions byinsurance companies to insurance brokers and agents and the extent to whichsuch compensation has been disclosed, and the solicitation and provision offictitious or inflated quotes.  Theseinvestigations and proceedings are expected to continue, and new investigativeproceedings may be commenced, in the future. These investigations and proceedings could result in legal precedentsand new industry-wide practices or legislation, rules or regulations that couldsignificantly affect our industry and may also cause stock price volatility forcompanies in the insurance industry.

 

TheCompany has completed its own internal review with respect to such contingentcommission arrangements and the anti-competitive sales practices discussedabove.  In this internal inquiry, theCompany did not find any evidence that it has engaged in the bid-rigging andprice-fixing activities that are at the core of the industry investigationsinto these anti-competitive practices. In addition, as a result of this internal inquiry, the Company isdeveloping guidelines with respect to its future commission paymentarrangements.

 

Largelyas a result of these industry investigations, contingent commission and othercommission practice standards are currently evolving.  For example, in December 2004 the NationalAssociation of Insurance Commissioners adopted an amendment to its ProducerLicensing Model Act with respect to producer compensation disclosureobligations, and is considering further amendments to this Model Act.  The Company is supportive of industry effortsto encourage transparency in the disclosure of contingent commissions paid tobrokers by insurers and does not expect to be adversely impacted by legislativedevelopments in this area.

 

The reinsurance industry hasalso become the subject of increasing scrutiny with respect to the allegedimproper use of reinsurance agreements to manipulate financial reportingresults.  The New York State AttorneyGeneral and other state and federal regulators have commenced investigationsand other proceedings 

 

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related to reinsurance agreements in whichthe insurance risk transferred between the ceding company and reinsurer mayhave been insufficient to properly account for such transactions as reinsurancein financial statements filed with insurance regulatory authorities and theSEC.  Such transactions may includeseparate or “side” agreements that reduce, limit or mitigate theindemnification against loss or liability relating to the insurance risktransferred to the reinsurer in a reinsurance agreement.

 

Asa result of these industry investigations, accounting and reportingrequirements for reinsurance transactions, including risk transfer guidanceused to determine when sufficient insurance risk has been transferred by theceding company to properly account for such transactions as reinsurance, maychange.

 

TheCompany believes that all of its reinsurance transactions meet the risktransfer requirements to be accounted for as prospective reinsurance in itsfinancial statements, and has no separate side agreements that would limit theinsurance risk transferred to the reinsurer under its reinsuranceagreements.  The Company is unable todetermine the reinsurance industry financial reporting changes that could occurresulting from such investigations and the effects, if any, on its financialreporting of reinsurance transactions.

 

**Critical Accounting Policies**

 

Itis important to understand our accounting policies in order to understand ourfinancial statements. Management considers certain of these policies to becritical to the presentation of the financial results, since they requiremanagement to make estimates and assumptions. These estimates and assumptionsaffect the reported amounts of assets, liabilities, revenues, expenses, andrelated disclosures at the financial reporting date and throughout the reportingperiod. 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.

 

Ourmost critical accounting policies involve the reporting of the reserves forlosses and loss adjustment expenses (“LAE”) (including losses that haveoccurred but were not reported to us by the financial reporting date),reinsurance recoverables, written and unearned premium, the recoverability ofdeferred tax assets, the impairment of invested assets, accounting for Lloyd’sresults and the translation of foreign currencies.

 

***Reserves for Losses and LAE.*** Reserves for losses and LAE represent an estimate of the expected costof the ultimate settlement and administration of losses, based on facts andcircumstances then known. Actuarial methodologies are employed to assist inestablishing such estimates and include judgments relative to estimates offuture claims severity and frequency, length of time to develop to ultimate,judicial theories of liability and other third party factors which are oftenbeyond our control. Due to the inherent uncertainty associated with thereserving process, the ultimate liability may be different from the originalestimate. Such estimates are regularly reviewed and updated and any resultingadjustments are included in the current year’s results.

 

***Reinsurance Recoverables.*** Reinsurance recoverables are established forthe portion of the loss reserves that are ceded 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 withrespect to our reinsurers which can be significant considering that certain ofthe reserves remain outstanding for an extended period of time. We are requiredto pay losses even if a reinsurer fails to meet its obligations under theapplicable reinsurance agreement.

 

***Written and Unearned Premium.*** Written premium is recorded based on theinsurance policies that have been reported to us and the policies that havebeen written by agents but not yet reported to us. We must estimate the amountof written premium not yet reported based on judgments relative to current andhistorical trends of the business being written. Such estimates are regularlyreviewed and updated and any resulting adjustments are included in the currentyear’s results. An unearned premium reserve is established to reflect theunexpired portion of each policy at the financial reporting date.

 

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***Deferred Tax Assets.*** We apply the asset and liability method ofaccounting for income taxes whereby deferred assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax basis.

 

***Impairment of Investment Securities.*** Impairment of investment securities resultsin a charge to operations when a market decline below cost isother-than-temporary. Management regularly reviews our fixed maturity andequity securities portfolios to evaluate the necessity of recording impairmentlosses for other-than-temporary declines in the fair value of investments. Anumber of criteria are considered during this process including, but notlimited to: the current fair value as compared to cost or amortized cost, asappropriate, of the security; the length of time the security’s fair value hasbeen below cost or amortized cost, and by how much; and specific credit issuesrelated to the issuer and current economic conditions. In general, we focus ourattention on those securities whose market value was less than 80% of theircost or amortized cost, as appropriate, for six or more consecutive months.Other factors considered in evaluating potential impairment include the currentfair value as compared to cost or amortized cost, as appropriate, our intentand ability to retain the investment for a period of time sufficient to allowfor an anticipated recovery in value, specific credit issues related to theissuer and current economic conditions. Other-than-temporary impairment lossesresult in a permanent reduction of the cost basis of the underlying investment.Significant changes in the factors we consider when evaluating investments forimpairment losses could result in a significant change in impairment lossesreported in the consolidated financial statements.

 

***Accounting for Lloyd’s Results.*** We record our pro rata share of Lloyd’sSyndicate 1221 assets, liabilities, revenues and expenses, after makingadjustments to convert Lloyd’s accounting to U.S. GAAP. The most significantGAAP adjustments relate to income recognition. Lloyd’s syndicates determineunderwriting results by year of account at the end of three years. We recordadjustments to recognize underwriting results as incurred, including theexpected ultimate cost of losses incurred. These adjustments to losses arebased on actuarial analysis of syndicate accounts, including forecasts ofexpected ultimate losses provided by the syndicate. At the end of the Lloyd’sthree-year period for determining underwriting results for an account year, thesyndicate will close the account year by reinsuring outstanding claims on thataccount year with the participants for the account’s next underwriting year.The amount to close an underwriting year into the next year is referred to asthe reinsurance to close (“RITC”).  TheRITC transaction is recorded in the fourth quarter as additional written andearned premium, losses incurred, loss reserves and receivables, all in the sameamount. There are no gains or losses recorded on the RITC.

 

***Translation of Foreign Currencies****.*Financial statements of subsidiariesexpressed in foreign currencies are translated into U.S. dollars in accordancewith SFAS No. 52 *Foreign CurrencyTranslation* issued by the FASB. Under SFAS 52, functional currency assets and liabilities are translatedinto U.S. dollars using period end rates of exchange and the relatedtranslation adjustments are recorded as a separate component of *accumulated other comprehensive income*.  Functional currencies are generally thecurrencies of the local operating environment. Statement of income amounts expressed in functional currencies aretranslated using average exchange rates. Gains and losses resulting from foreign currency transactions arerecorded in *other income (expense)*in the Company’s Consolidated Statements of Income.

 

**Results of Operations and Overview**

 

Thefollowing is a discussion and analysis of our consolidated and segment resultsof operations for the three months ended March 31, 2005 and 2004.  All earnings per share data is presented on aper diluted share basis.

 

Our2005 and 2004 first quarters’ overall results of operations reflect improvedmarket conditions beginning in late 2000 through 2003 that continued at areduced rate through 2004 and are showing signs of softening in 2005.  Net income for the three months ended March31, 2005 and 2004 was $9.7 million or $0.76 per share and $8.9 million or $0.70per share, respectively.

 

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Weexperienced premium growth as measured by net earned premium in the firstquarter of 2005 of $77.5 million compared to $74.2 million in the first quarterof 2004, a 4.5% increase.  The Company’scombined ratio, which is a measure of underwriting profitability, for the firstquarter of 2005 was 91.0% compared to 88.8% for the first quarter of 2004.

 

Cashflow from operations increased in the first quarter of 2005 to $65.2 millionfrom $26.7 million in the first quarter of 2004, a 144.2% increase,contributing to the growth in invested assets and net investment income.  Included in the 2005 first quarter cash flowis approximately $24 million attributable to the settlement of the RITC premiumrecorded by Lloyd’s Syndicate 1221 in the 2004 fourth quarter representing thetransfer of assets and liabilities from the participants of the 2002underwriting year to the participants of the 2003 underwriting year.  We had increased our participation inSyndicate 1221 to 97.4% for the 2003 underwriting year from 68.1% for the 2002underwriting year.  Approximately 70% ofthe RITC settlement has been recorded as interest-earning funds withheld forreinsurers of the syndicate or will be distributed to third party participantsof the 2002 year of account.

 

Consolidatedstockholders’ equity increased 1.6% to $333.8 million or $26.16 per share atMarch 31, 2005 compared to $328.6 million or $25.96 per share at December 31,2004.  The increase was primarily due tonet income of $9.7 million for the first quarter of 2005, partially offset by a$6.4 million o*ther comprehensive loss*consisting of $6.5 million of decreases in unrealized gains on securities,resulting from higher interest rates, and $0.1 million increase in currencytranslation gains.  *Other comprehensive income (loss)* consistsof the change in both after-tax unrealized gains and losses on investments andafter-tax currency translation gains on the Company’s foreign operations.

 

**Revenues****.**  Grosswritten premium increased to $217.0 million in the first quarter of 2005, from$196.0 million in the first quarter of 2004, a 10.7% increase for the threemonths.  The growth in gross writtenpremium reflects a combination of business expansion in both new and existinglines of business coupled with premium rate changes on renewal policies.  The premium rate increases or decreases notedbelow for marine, specialty and professional liability are calculated primarilyby comparing premium amounts on policies that have renewed.  The premiums are judgmentally adjusted forexposure factors when deemed significant and sometimes represent an aggregationof several lines of business.  The ratechanges calculations provide an indicated pricing trend and are not meant to bea precise analysis of the numerous factors that affect premium rates or theadequacy of such rates to cover all underwriting costs and generate anunderwriting profit.  The calculation canalso be affected quarter by quarter depending on the particular policies andthe number of policies that renew during that period.  Due to market conditions, these rate changesmay or may not apply to new business which may be more competitively pricedcompared to renewal business.  Thefollowing table sets forth our gross and net written premium and net earnedpremium by segment and line of business for the periods indicated:

 

18

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| ** **                    | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------|------------|----------------------------------|------------|
| ** **                    | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                    | ** ** | **Gross  Written  Premium**      | ** ** | **%** | ** ** | **Net  Written  Premium** | ** ** | **Net  Earned  Premium** | ** ** | **Gross  Written  Premium** | ** ** | **%** | ** ** | **Net  Written  Premium** | ** ** | **Net  Earned  Premium** | ** ** |
| ** **                    | ** ** | **($ in thousands)**        | ** ** |
| Insurance Companies:          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                        |       | $                                | 68,284     |   | 31.5 | % | $ | 30,347 |   | $ | 19,879 |   | $ | 59,426 |   | 30.3 | % | $ | 25,258 |   | $ | 20,428 |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty                     |       | 42,949                           |       | 19.8 | % | 36,398 |   | 20,022 |   | 34,230 |   | 17.5 | % | 20,511 |   | 21,539 |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Professional Liability        |       | 17,930                           |       | 8.2 | % | 6,679 |   | 6,717 |   | 15,033 |   | 7.7 | % | 5,473 |   | 3,811 |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Assumed from Lloyd’s     |       | 125                              |       | 0.1 | % | 126 |   | 711 |   | 3,054 |   | 1.6 | % | 2,906 |   | 7,405 |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other (includes run-off)      |       | —                           |       | 0.0 | % | 31 |   | 34 |   | 86 |   | 0.0 | % | (3 | ) | (1 | ) |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Insurance Companies Total     |       | 129,288                          |       | 59.6 | % | 73,581 |   | 47,363 |   | 111,829 |   | 57.1 | % | 54,145 |   | 53,182 |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s Operations:      |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                        |       | 73,931                           |       | 34.1 | % | 40,060 |   | 29,627 |   | 79,316 |   | 40.5 | % | 39,059 |   | 20,518 |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other                         |       | 13,899                           |       | 6.4 | % | 3,449 |   | 548 |   | 7,842 |   | 4.0 | % | 2,731 |   | 475 |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s Operations Total |       | 87,830                           |       | 40.5 | % | 43,509 |   | 30,175 |   | 87,158 |   | 44.5 | % | 41,790 |   | 20,993 |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Intercompany elimination      |       | (122                             | )          | -0.1 | % | — |   | — |   | (3,036 | ) | -1.6 | % | — |   | — |   |
|                          |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                         |       | $                                | 216,996    |   | 100.0 | % | $ | 117,090 |   | $ | 77,538 |   | $ | 195,951 |   | 100.0 | % | $ | 95,935 |   | $ | 74,175 |   |
|                               |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

19

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**Gross Written Premium**

 

Insurance Companies’ Gross Written Premium

 

*Marine Premium.* The marine gross written premium for thefirst quarter of 2005 increased 14.9% compared to the first quarter of 2004,reflective of growth across several lines of business including marineliability, hull, cargo, and protection and indemnity.  The average increase in renewal premium ratesduring the 2005 first quarter was flat. Navigators Insurance Company obtains its marine business throughparticipation in the marine pool managed by the Navigators Agencies.

 

*Specialty Premium.* This business consists of 69% generalliability business for small general and artisan contractors, 12% personal umbrellabusiness and 19% other targeted commercial risks.  The specialty gross written premium for thefirst quarter of 2005 increased 25.5% compared to the first quarter of 2004reflective of growth across all lines of business.  The average renewal rates were flat in thecontractors’ liability business in the first quarter of 2005.

 

*Professional Liability Premium.* Our insurance company subsidiaries writeprofessional liability insurance, of which 54% represents directors andofficers liability insurance (“D&O”) for privately held and publicly tradedcorporations. In 2002, the professional liability business was expanded toinclude errors and omissions insurance and employment practices liabilitycoverages.  Commencing in October 2004,our U.K. Branch began writing professional liability coverages for U.K.solicitors and, in 2005, we began writing professional liability coverages forarchitects and engineers.  Theprofessional liability gross written premium for the first quarter of 2005increased 19.3% compared to the first quarter of 2004, reflecting the expansionof this business for all lines except for D&O which was flat.  Average overall renewal premium rates forthis business increased approximately 2% with D&O rates decliningapproximately 2% in the first quarter of 2005.

 

*Assumed from Lloyd’s Operations Premium. *During 2002 and 2003, the Insurance Companies participated in quotashare treaties written by the Company’s Lloyd’s operations.  The participations included marine and energybusiness.

 

Lloyd’s Operations’ Gross Written Premium

 

*Marine Premium.*Our gross written premium is based on thestamp capacity of Syndicate 1221 and the percentage of such stamp capacity weprovide.  Our percentage of participationin the stamp capacity is 97.5% for 2005 compared to 97.4% for 2004.  Stamp capacity is a measure of the amount ofpremium a Lloyd’s syndicate is authorized to write as determined based on abusiness plan approved by the Council of Lloyd’s.  The stamp capacity for Syndicate 1221 hasbeen reduced to £135 million ($255.3 million) in 2005 from £150 million ($275.0million) in 2004, reflective of unused stamp capacity in 2004 coupled withanticipated declining market conditions in 2005.  The**marinegross written premium for the first quarter of 2005 declined 6.8% compared tothe first quarter of 2004.  The averagerenewal premium rates for the three months ended March 31, 2005 increasedapproximately 2%.

 

*Other Premium. *Other premiumconsists of engineering and construction gross written premium which providescoverage for construction projects including machinery, equipment and loss ofuse due to delays and of onshore energy premium which principally focuses onthe oil and gas, chemical and petrochemical industries with coverages primarilyfor property damage and business interruption.

 

**Ceded Written Premium****.**  Inthe ordinary course of business, we reinsure certain insurance risks withunaffiliated insurance companies for the purpose of limiting our maximum lossexposure, protecting against catastrophic losses, and maintaining desiredratios of net premiums written to statutory surplus. The relationship of cededto written premium varies based upon the types of business written and whetherthe business is written by our insurance company subsidiaries or the Lloyd’sOperations.

 

20

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Thefollowing table sets forth our ceded written premium by segment and major linesof business for the periods indicated:

 

| ** **                | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| ** **                | ** ** | **Ceded  Written  Premium**      | ** ** | **% of  Gross  Written  Premium** | ** ** | **Ceded  Written  Premium** | ** ** | **% of  Gross  Written  Premium** | ** ** |
| ** **                | ** ** | **($ in thousands)**        | ** ** |
|                      |       |                             |       |   |   |   |   |   |   |
| Insurance Companies:      |       |                             |       |   |   |   |   |   |   |
| Marine                    |       | $                                | 37,937     |   | 55.6 | % | $ | 34,168 |   | 57.5 | % |
| Specialty                 |       | 6,551                            |       | 15.3 | % | 13,719 |   | 40.1 | % |
| Professional Liability    |       | 11,251                           |       | 62.8 | % | 9,560 |   | 63.6 | % |
| Assumed from Lloyd’s |       | (1                               | )          | -0.8 | % | 148 |   | 4.8 | % |
| Other (includes run-off)  |       | (31                              | )          | NM |   | 89 |   | NM |   |
| Subtotal                  |       | 55,707                           |       | 43.1 | % | 57,684 |   | 51.6 | % |
|                      |       |                             |       |   |   |   |   |   |   |
| Lloyd’s Operations:  |       |                             |       |   |   |   |   |   |   |
| Marine                    |       | 33,871                           |       | 45.8 | % | 40,257 |   | 50.8 | % |
| Other                     |       | 10,450                           |       | 75.2 | % | 5,111 |   | 65.2 | % |
| Subtotal                  |       | 44,321                           |       | 50.5 | % | 45,368 |   | 52.1 | % |
|                      |       |                             |       |   |   |   |   |   |   |
| Intercompany elimination  |       | (122                             | )          | NM |   | (3,036 | ) | NM |   |
|                      |       |                             |       |   |   |   |   |   |   |
| Total                     |       | $                                | 99,906     |   | 46.0 | % | $ | 100,016 |   | 51.0 | % |

 

----

NM = Not Meaningful

 

Thedecline in the ratio of ceded written premium to gross written premium to 46%from 51% resulted primarily from the cancellation of a quota share reinsuranceagreement for specialty business effective March 31, 2005.  The cancellation resulted in a reduction ofapproximately $14.5 million in ceded unearned premium that has been retainedand will be earned over the next 12 months by the Company.

 

**Net Written Premium**.*** ***Netwritten premium increased 22% in the first quarter of 2005 compared to thefirst quarter of 2004.  The increase inthe net written premium resulted principally from the cancellation of thespecialty quota share treaty effective March 31, 2005 discussed above, businessexpansion, and the increase in Navigators Insurance Company’s portion of themarine pool to 85% in 2005 from 80% in 2004.

 

**Net Earned Premium**.  Netearned premium which generally lags the increase in net written premiumincreased 5% in the first quarter of 2005 compared to the first quarter of 2004as a result of the increased net written premium.

 

**Commission Income****.** Commission income from unaffiliated business increased 12.7% to $1.3million in the first quarter of 2005 from $1.1 million in the first quarter of2004.  The increase resulted from theincreased profit commissions recorded by the Lloyd’s Operations.

 

**Net Investment Income****.* ***Net investment income increased 29.1% in the2005 first quarter compared to the first quarter of 2004 due to the increase ininvested assets as a result of the positive cash flow from the increasedpremium volume.

 

21

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**NetRealized Capital Gains****(Losses)****.**  Pre-taxnet income included $167,000 of net realized capital gains for the threemonths ended March 31, 2005 compared to capital gains of $422,000 for the 2004first quarter.  On an after-tax basis,the net realized capital gains were $109,000 or $0.01 per share and $274,000 or$0.02  per share for the 2005 and 2004 first quarters,respectively.

 

**OtherIncome/(Expense)****.** Other income/(expense) for the first quartersof 2005 and 2004 consisted primarily of foreign exchange gains and losses fromour Lloyd’s Operations and inspection fees related to the specialty insurancebusiness.

 

**OperatingExpenses**

 

*NetLosses and Loss Adjustment Expenses Incurred. *The ratios of net losses and loss adjustmentexpenses incurred to net earned premium (loss ratios) for the 2005 and 2004first quarters were 59.6% and 59.0%, respectively.

 

The following tables set forth our net loss and LAE reservesby segment and line of insurance business and the total case reserves andincurred but not reported (“IBNR”) reserves as of March 31, 2005 and December 31,2004:

 
| ** **                            | ** ** | **March 31,  2005**  | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **($ in thousands)** | ** ** |
| Insurance  Companies:                 |       |                      |       |                        |       |
| Marine                                |       | $                         | 134,936    |                        | $          | 130,439 |   |
| Specialty                             |       | 155,313                   |       | 150,347                     |       |
| Professional  Liability               |       | 22,871                    |       | 19,001                      |       |
| Assumed from  Lloyd’s Operations |       | 36,078                    |       | 37,790                      |       |
| Other  (primarily run-off business)   |       | 21,334                    |       | 22,512                      |       |
| Total  Insurance Companies            |       | 370,532                   |       | 360,089                     |       |
|                                  |       |                      |       |                        |       |
| Lloyd’s  Operations:             |       |                      |       |                        |       |
| Marine                                |       | 104,214                   |       | 99,565                      |       |
| Other                                 |       | 4,758                     |       | 4,134                       |       |
| Total Lloyd’s  Operations        |       | 108,972                   |       | 103,699                     |       |
|                                  |       |                      |       |                        |       |
| Total net  loss reserves              |       | $                         | 479,504    |                        | $          | 463,788 |   |
|                                  |       |                      |       |                        |       |
| Total net  case loss reserves         |       | $                         | 198,632    |                        | $          | 189,746 |   |
| Total net  IBNR loss reserves         |       | 280,872                   |       | 274,042                     |       |
|                                  |       |                      |       |                        |       |
| Total net  loss reserves              |       | $                         | 479,504    |                        | $          | 463,788 |   |

 

At March 31, 2005, the IBNR net loss reserves were58.6% of our total loss reserves compared to 59.1% at December 31, 2004.

 

At March 31, 2005, a 10% change in the net lossreserves would equate to $48.0 million which would represent an after-taxcharge to net income of $31.2 million or 9.3% of stockholders’ equity.  Loss reserve estimates are reviewed eachquarter to evaluate whether the assumptions made continue to beappropriate.  Any adjustments that resultfrom this review are recorded in the quarter in which they are identified.

 

22

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Our reserving practices and the establishment of anyparticular reserve reflect management’s judgment concerning sound financialpractice and do not represent any admission of liability with respect to anyclaims made against us.  No assurance canbe given that actual claims made and related payments will not be in excess ofthe amounts reserved.  During the losssettlement period, it often becomes necessary to refine and adjust theestimates of liability on a claim either upward or downward.  Even after such adjustments, ultimateliability may exceed or be less than the revised estimates.  The increase in net loss reserves is also afunction of the growth in premium volume over the past two years.

 

Our loss reserves include amounts related to shorttail and long tail classes of business. Short tail business refers to businesswhere claims are generally reported quickly upon occurrence of an event, makingestimation of loss reserves less complex. Our longer tail business includes ourspecialty liability and professional liability 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.  Generally, thelonger the time span between the incidence of a loss and the settlement of theclaim, the more likely the ultimate settlement amount can vary from the originalestimate.

 

*Specialty Liability andProfessional Liability.*Substantially all of our specialty liability business involves generalliability policies which generate third party liability claims that are longtail in nature. A significant portion of our general liability reserves relatesto California construction liability claims. Reserves and claim frequency onthis business may be impacted by legislation implemented in California, whichgenerally provides consumers who experience construction defects a method otherthan litigation to obtain construction defect repairs. The law, which becameeffective July 1, 2002 with a sunset provision effective January 1,2011, provides for an alternative dispute resolution system that attempts toinvolve all parties to the claim at an early stage. This legislation may impactclaim severity, frequency and length of settlement assumptions underlying ourreserves. Accordingly, our ultimate liability may exceed or be less thancurrent estimates due to this variable, among others.  There were 1,011 specialty liability claims openat March 31, 2005.

 

The professional liability class generates thirdparty claims, which also are longer tail in nature. The professional liabilitypolicies provide coverage on a claims-made basis, whereby coverage is generallyprovided only for those claims that are made during the policy period. Ourprofessional liability business is relatively immature, as we first began writingthe business in late 2001. Accordingly, it will take some time to betterunderstand the reserve trends on this business. Our professional liability loss estimates are based on expected losses,actual reported losses, evaluation of loss trends, industry data, and thelegal, regulatory and current risk environment because anticipated lossexperience in this area is less predictable due to the small number of claimsand/or erratic claim severity patterns. We believe that we have made areasonable estimate of the required loss reserves for professional liability.The expected ultimate losses may be adjusted up or down as the accident yearsmature.  There were 431 professionalliability claims open at March 31, 2005.

 

23

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The following tables set forth our net loss and LAEreserves for our specialty liability and professional liability businesses forthe periods indicated:

 
| ** **                        | ** ** | **March 31, 2005**    | ** ** |
|-----------------------------------|------------|----------------------------|------------|
| **Type of  Business**             | ** ** | **Net Reported  Reserves** | ** ** | **Net  IBNR** | ** ** | **Total  Net Loss  Reserves** | ** ** | **% of IBNR  to Total Net  Loss Reserves** | ** ** |
|                              |       |                       |       |   |   |   |   |   |   |
| Specialty  construction liability |       | $                          | 22,945     |   | $ | 112,410 |   | $ | 135,355 |   | 83.0 | % |
| Professional  liability           |       | 2,755                      |       | 20,116 |   | 22,871 |   | 88.0 | % |
|                              |       |                       |       |   |   |   |   |   |   |
| Total                             |       | $                          | 25,700     |   | $ | 132,526 |   | $ | 158,226 |   | 83.8 | % |

 
| ** **                        | ** ** | **December 31, 2004** | ** ** |
|-----------------------------------|------------|----------------------------|------------|
| **Type of  Business**             | ** ** | **Net Reported  Reserves** | ** ** | **Net  IBNR** | ** ** | **Total  Net Loss  Reserves** | ** ** | **% of IBNR  to Total Net  Loss Reserves** | ** ** |
|                              |       |                       |       |   |   |   |   |   |   |
| Specialty  construction liability |       | $                          | 21,338     |   | $ | 110,263 |   | $ | 131,601 |   | 83.8 | % |
| Professional  liability           |       | 1,166                      |       | 17,835 |   | 19,001 |   | 93.9 | % |
|                              |       |                       |       |   |   |   |   |   |   |
| Total                             |       | $                          | 22,504     |   | $ | 128,098 |   | $ | 150,602 |   | 85.1 | % |

 

*Asbestos and EnvironmentalLiability.* Ourexposure to asbestos and environmental liability principally stems from marineliability insurance written on an occurrence basis during the mid-1980s. Ingeneral, our participation on such risks is in the excess layers, whichrequires the underlying coverage to be exhausted prior to coverage beingtriggered in our layer. In many instances we are one of many insurers whoparticipate in the defense and ultimate settlement of these claims, and we aregenerally a minor participant in the overall insurance coverage and settlement.

 

The reserves we have established for asbestos exposuresare for:  (i) estimated losses forexcess insurance policy limits exposed to class actions suits against twoinsureds involved in the manufacturing or distribution of asbestos products; (ii) otherinsureds not directly involved in the manufacturing or distribution of asbestosproducts, but that have more than incidental asbestos exposure for theirpurchase or use of products that contained asbestos; (iii) attritionalasbestos claims that could be expected to occur over time; and (iv) the 2004settlement of a large claim exposed to a class action suit which settlement willbe paid over seven years starting in June 2005.

 

The following tables set forth our gross and netloss and LAE reserves, and claim counts for our asbestos and environmentalexposures, which we believe are subject to uncertainties greater than thosepresented by other types of claims:

 

24

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| ** **                      | ** ** | **Three Months Ended  March 31, 2005** | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|
| ** **                      | ** ** | **Asbestos**                                | ** ** | **Environmental** | ** ** | **Total** | ** ** |
| ** **                      | ** ** | **($ in thousands)**                   | ** ** |
| ** **                      | ** ** | ** **                                  | ** ** |
| **Gross of  Reinsurance**       |       |                                        |       |   |   |   |   |
| Beginning  Reserve              |       | $                                           | 78,421     |   | $ | 7,513 |   | $ | 85,934 |   |
| Incurred  Losses & LAE |       | 251                                         |       | 1,498 |   | 1,749 |   |
| Calendar  Year Payments         |       | 109                                         |       | 662 |   | 771 |   |
| Ending  Reserves                |       | $                                           | 78,563     |   | $ | 8,349 |   | $ | 86,912 |   |
|                            |       |                                        |       |   |   |   |   |
| **Net of  Reinsurance**         |       |                                        |       |   |   |   |   |
| Beginning  Reserve              |       | $                                           | 31,394     |   | $ | 1,494 |   | $ | 32,888 |   |
| Incurred  Losses & LAE |       | 199                                         |       | 900 |   | 1,099 |   |
| Calendar  Year Payments         |       | 3                                           |       | 569 |   | 572 |   |
| Ending  Reserves                |       | $                                           | 31,590     |   | $ | 1,825 |   | $ | 33,415 |   |

 
| **Type of Business** | ** ** | **Claim Count  March 31, 2005** | ** ** | **New Claims  During Period** | ** ** | **Claims Settled  or Resolved  During Period** | ** ** | **Claim Count  December 31, 2004** | ** ** |
|----------------------|------------|--------------------------------------|------------|-------------------------------|------------|------------------------------------------------|------------|-----------------------------------------|------------|
| ** **           | ** ** | ** **                           | ** ** | ** **                    | ** ** | ** **                                     | ** ** | ** **                              | ** ** |
| Environmental        |       | 98                                   |       | 17                            |       | 8                                              |       | 89                                      |       |
| Asbestos             |       | 135                                  |       | 12                            |       | 6                                              |       | 129                                     |       |
| Total                |       | 233                                  |       | 29                            |       | 14                                             |       | 218                                     |       |

 

Loss development activity for asbestos relatedexposures in the first quarter of 2005 has not been significant.

 

Loss development activity on environmental losses inthe first quarter of 2005 has generally consisted of oil spill claims on marineliability policies written in the ordinary course of business.

 

Our management believes that the reserves for lossesand loss adjustment expenses are adequate to cover the ultimate cost of lossesand loss adjustment expenses on reported and unreported claims.

 

*CommissionExpense.* Commissionexpense paid to brokers and agents is generally based on a percentage of thegross written premium and is reduced by ceding commissions the Company mayreceive on the ceded written premium. Commissions are generally deferred and recorded to deferred policyacquisition costs to the extent that they relate to unearned premium.  Commission expense as a percentage of earnedpremium in the first quarter of 2005 was 12.4% compared to 14.9% in the first quarterof 2004  as the result of a decline incommissions paid to brokers and agents coupled with the receipt of cedingcommissions from reinsurers.  Thedecrease in the commission percentage reflects lower commission rates and atrend among the major brokers to charge a flat fee to some of their majorclients as opposed to a percentage of the premium.  Under flat fee arrangements, the amount ofpremium normally is correspondingly reduced since no commission is being paidto the broker by the Company.

 

*OtherOperating Expenses.*The 29.9% increase in other operating expenses in the first quarter of 2005compared to the same period in 2004 is attributable primarily to employee-relatedexpenses resulting from expansion of the business coupled with the increasedcosts incurred to comply with Section 404 of the Sarbanes-Oxley Act of2002.  Included in the three months endedMarch 31, 2005 and 2004, were $699,000 and $233,000, respectively, in theaggregate for employee stock option, stock grant and stock appreciation rightsexpense.

 

25

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**Income Taxes**. The income tax expensewas $4.5 million and $4.6 million for the first quarters of 2005 and 2004,respectively.  The effective tax ratesfor the 2005 and 2004 first quarters were 31.8% and 34.2%, respectively.  As of March 31, 2005 and December 31,2004, the net deferred Federal, foreign, state and local tax assets were $21.4 millionand $17.3 million, respectively.

 

Weare subject to the tax regulations of both the United States and the UnitedKingdom.  The Company files aconsolidated federal tax return, which includes all domestic subsidiaries andthe U.K. branch.  The income from theforeign operations is designated as either U.S connected income or non-U.S.connected income.  The U.S. connectedincome under the Subpart F regulations of the Internal Revenue Code is taxed inthe year earned for tax purposes and recorded in the Company’s tax return.  It is also included in the tax provision atthe corporate 35% rate.  Foreign taxcredits, where available, are utilized to offset as much of the U.S. tax aspermitted on the U.S. connected income. Non-U.S. connected income from a foreign subsidiary is subject to U.S.taxation only when distributed.  U.S.taxes are not accrued when the earnings are considered to be permanentlyreinvested in the foreign subsidiary. The Company has demonstrated its intention that the foreign earnings arepermanently reinvested in the foreign subsidiary, and therefore anydistribution is postponed indefinitely. The foreign earnings are subject to taxation in foreign jurisdictionswhich, in the case of the Company, approximates a rate of 35%.

 

Wehave not provided for U.S. deferred income taxes or foreign withholding taxeson the undistributed earnings of approximately $13.3 million of our foreignsubsidiaries earnings since these earnings are intended to be reinvestedindefinitely.  However, in the future, ifwe planned to distribute such earnings to the Company, taxes of approximately $1.0million would be reflected in the tax provision and would then be payable inthe year distributed assuming all foreign tax credits are realized.

 

TheAmerican Jobs Creation Act of 2004, enacted October 22, 2004, allows adeduction of 85% of certain foreign earnings that are repatriated by December 31,2005.  If the Company were to repatriate the$13.3 million of earnings from its foreign subsidiaries under this provision, incometax of approximately $150,000 would be reflected in the 2005 taxprovision.  The Company does not expectto repatriate any foreign earnings under the American Jobs Creation Act of2004.

 

The Company had state and local operatingloss carryforwards amounting to potential future tax benefits of $5.4 million and $4.5 million at March 31,2005 and December 31, 2004, respectively. A valuation allowance was established for the full amount of thesepotential future tax benefits due to the uncertainty associated with theirrealization.  The Company’s state andlocal tax carryforwards at March 31, 2005 expire from 2019 to 2025.

 

**Segment Information**

 

Following are the financial results of the Company’sthree segments:  Insurance Companies,Lloyd’s Operations and Navigators Agencies. We evaluate the performance of eachsegment based on its underwriting or operating results.  Items of revenue and expenditure, includingnet investment income and realized capital gains and losses, are includedherein based on the legal entity where they are recorded.  Our underwriting performance is evaluatedseparately from the performance of our investment portfolios.

 

***Insurance Companies***

 

Our Insurance Companies consist of NavigatorsInsurance Company, which includes a United Kingdom Branch, and NIC InsuranceCompany. Navigators Insurance Company is our largest insurance subsidiary andhas been active since 1983. It specializes principally in underwriting marineinsurance and related lines of business, specialty liability insurance andprofessional liability insurance. NIC Insurance Company, a wholly ownedsubsidiary of Navigators Insurance Company, began operations in 1990. Itunderwrites similar types of business but on a non-admitted or surplus linesbasis and is fully reinsured by Navigators Insurance Company.  The Navigators Agencies produce business forour insurance company subsidiaries.

 

26

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Following are the results of operations for theInsurance Companies for the three months ended March 31, 2005 and 2004:

 
| ** **                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **($ in thousands)**              | ** ** |
| ** **                        | ** ** | ** **                             | ** ** |
| Revenues:                         |       |                                   |       |   |   |
| Net earned  premium               |       | $                                      | 47,363     |   | $ | 53,182 |   |
| Net  investment income            |       | 6,855                                  |       | 5,484 |   |
| Net realized  capital gains       |       | 266                                    |       | 205 |   |
| Other income  (expense)           |       | (2                                     | )          | (61 | ) |
| Total revenues                    |       | 54,482                                 |       | 58,810 |   |
|                              |       |                                   |       |   |   |
| Operating  expenses:              |       |                                   |       |   |   |
| Net losses  and LAE               |       | 28,842                                 |       | 32,710 |   |
| Commission  expense               |       | 12,586                                 |       | 14,145 |   |
| Other  operating expenses         |       | 2,112                                  |       | 1,198 |   |
| Total  operating expenses         |       | 43,540                                 |       | 48,053 |   |
|                              |       |                                   |       |   |   |
| Income  before income tax expense |       | 10,942                                 |       | 10,757 |   |
|                              |       |                                   |       |   |   |
| Income tax  expense               |       | 3,399                                  |       | 3,478 |   |
|                              |       |                                   |       |   |   |
| Net income                        |       | $                                      | 7,543      |   | $ | 7,279 |   |
|                              |       |                                   |       |   |   |
| Loss and LAE  ratio               |       | 60.9                                   | %          | 61.5 | % |
| Commission  expense ratio         |       | 26.6                                   | %          | 26.6 | % |
| Other  operating expense ratio    |       | 4.5                                    | %          | 2.3 | % |
| Combined  ratio                   |       | 92.0                                   | %          | 90.4 | % |
|                                   |            |                                        |            |  |  |  |  |  |

 

27

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Followingare the underwriting results of the Insurance Companies for the three months endedMarch 31, 2005 and 2004:

 
| ** **                           | ** ** | **Three Months Ended March 31,  2005** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|
| ** **                           | ** ** | **($ in thousands)**                   | ** ** |
| ** **                           | ** ** | **Net  Earned  Premium**                    | ** ** | **Losses  and LAE  Incurred** | ** ** | **Underwriting  Expenses** | ** ** | **Underwriting  Gain(Loss)** | ** ** | **Loss  Ratio** | ** ** | **Expense  Ratio** | ** ** | **Combined  Ratio** | ** ** |
|                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                               |       | $                                           | 19,879     |   | $ | 12,743 |   | $ | 5,520 |   | $ | 1,616 |   | 64.1 | % | 27.8 | % | 91.9 | % |
| Specialty                            |       | 20,022                                      |       | 11,533 |   | 6,850 |   | 1,639 |   | 57.6 | % | 34.2 | % | 91.8 | % |
| Professional Liability               |       | 6,717                                       |       | 4,440 |   | 2,001 |   | 276 |   | 66.1 | % | 29.8 | % | 95.9 | % |
| Assumed from Lloyd’s Operations |       | 711                                         |       | 573 |   | 322 |   | (184 | ) | 80.6 | % | 45.4 | % | 126.0 | % |
| Other (includes run-off)             |       | 34                                          |       | (447 | ) | 5 |   | 476 |   | NM |   | NM |   | NM |   |
| Total                                |       | $                                           | 47,363     |   | $ | 28,842 |   | $ | 14,698 |   | $ | 3,823 |   | 60.9 | % | 31.1 | % | 92.0 | % |

 
| ** **                            | ** ** | **Three Months Ended March 31,  2004** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|
| ** **                            | ** ** | **($ in thousands)**                   | ** ** |
| ** **                            | ** ** | **Net  Earned  Premium**                    | ** ** | **Losses  and LAE  Incurred** | ** ** | **Underwriting  Expenses** | ** ** | **Underwriting  Gain** | ** ** | **Loss  Ratio** | ** ** | **Expense  Ratio** | ** ** | **Combined  Ratio** | ** ** |
|                                  |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                                |       | $                                           | 20,428     |   | $ | 12,046 |   | $ | 5,599 |   | $ | 2,783 |   | 59.0 | % | 27.4 | % | 86.4 | % |
| Specialty                             |       | 21,539                                      |       | 14,317 |   | 6,968 |   | 254 |   | 66.5 | % | 32.3 | % | 98.8 | % |
| Professional  Liability               |       | 3,811                                       |       | 2,299 |   | 776 |   | 736 |   | 60.3 | % | 20.4 | % | 80.7 | % |
| Assumed from  Lloyd’s Operations |       | 7,405                                       |       | 4,217 |   | 1,999 |   | 1,189 |   | 57.0 | % | 27.0 | % | 84.0 | % |
| Other  (includes run-off)             |       | (1                                          | )          | (169 | ) | 1 |   | 167 |   | NM |   | NM |   | NM |   |
| Total                                 |       | $                                           | 53,182     |   | $ | 32,710 |   | $ | 15,343 |   | $ | 5,129 |   | 61.5 | % | 28.9 | % | 90.4 | % |

 

----

NM = Notmeaningful

 

28

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TheInsurance Companies experienced a decline in net earned premium of 10.9% whencomparing the first quarter of 2005 to the first quarter of 2004 principallydue to the decline of business assumed from the Lloyd’s Operations.  Approximately 1.5% and 13.9% of the net earnedpremium recorded in the first quarters of 2005 and 2004, respectively, was theresult of the Insurance Companies participating on reinsurance treatiessupporting the Lloyd’s Operations’ marine and energy business.

 

The2005 and 2004 first quarter underwriting results generally reflect thefavorable industry market conditions over the last three years coupled with satisfactoryloss trends in the aforementioned quarterly periods.

 

Thepre-tax yield on the Insurance Companies’ investment portfolio approximated 4.1%and 3.9% at March 31, 2005 and 2004, respectively.  The increase in the portfolio yield reflectsthe recent increases in interest rates. Net investment income increased in the first quarter of 2005 compared tothe same period in 2004 due to the increase in the yield and the strong cashflows resulting in a larger investment portfolio.

 

***Lloyd’s Operations***

 

The Lloyd’s Operations consist of NUAL, whichmanages Lloyd’s Syndicate 1221, Millennium Underwriting Ltd. and NavigatorsCorporate Underwriters Ltd. Both Millennium Underwriting Ltd. and NavigatorsCorporate Underwriters Ltd. are Lloyd’s corporate members with limitedliability and provide capacity to Lloyd’s Syndicate 1221. NUAL owns Navigators UnderwritingLtd. (formerly Pennine Underwriting Ltd.), an underwriting managing agency withoffices in Manchester, Leeds and Basingstoke, England, which underwrites cargoand engineering business for Lloyd’s Syndicate 1221.  In January 2005, we formed Navigators NVin Antwerp Belgium, a wholly owned subsidiary of NUAL.  Navigators NV produces transport liability,cargo and marine liability premium on behalf of Syndicate 1221.  The Lloyd’s Operations and NavigatorsManagement (UK) Limited, a Navigators Agency which produces business for the U.K.Branch, are subsidiaries of Navigators Holdings (UK) Limited located in theUnited Kingdom.

 

Lloyd’s Syndicate 1221 has stamp capacity of £135million ($255.3 million) in 2005 compared to £150 million ($275.0 million) in2004.  The reduction in the 2005 stampcapacity compared to 2004 is reflective of unused stamp capacity in 2004coupled with declining market conditions in 2005.  Stamp capacity is a measure of the amount ofpremium a Lloyd’s syndicate is authorized to write based on a business planapproved by the Council of Lloyd’s. We provide 97.5% and 97.4% of Syndicate1221’s total stamp capacity in 2005 and 2004, respectively.  Syndicate 1221’s stamp capacity is expressednet of commission (as is standard at Lloyd’s) of approximately 21%. TheSyndicate 1221 premium recorded in the Company’s financial statements is grossof commission.  The Lloyd’s marinebusiness had been subject to deteriorating pricing beginning in the mid-1990’s.The pricing competition showed some signs of stabilizing in 2000 and pricesincreased from 2001 through 2003 and again at a more modest pace in the 2004first quarter. Overall pricing in 2004 remained relatively stable and the 2005first quarter showed a small increase.  Lloyd’spresents its results on an underwriting year basis, generally closing eachunderwriting year after three years. We make estimates for each underwritingyear and timely accrue the expected results. Our Lloyd’s Operations included inthe consolidated financial statements represent our participation in Syndicate1221.

 

Lloyd’s syndicates report the amounts of premiums,claims, and expenses recorded in an underwriting account for a particular yearto the companies or individuals that participate in the syndicates. Thesyndicates generally keep accounts open for three years. Traditionally, threeyears have been necessary to report substantially all premiums associated withan underwriting year and to report most related claims, although claims may remainunsettled after the underwriting year is closed. A Lloyd’s syndicate typicallycloses an underwriting year by reinsuring outstanding claims on thatunderwriting year with the participants for the next underwriting year. Theceding participants pay the assuming participants an amount based on theunearned premiums and outstanding claims in the underwriting year at the dateof the assumption. Our participation in Lloyd’s Syndicate 1221 is representedby and recorded as our proportionate share of the underlying assets andliabilities and results of operations of the syndicate since, (a) we holdan undivided interest in each asset, (b) we

 

29

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areproportionately liable for each liability and (c) Syndicate 1221 is not aseparate legal entity. At Lloyd’s, the amount to close an underwriting yearinto the next year is referred to as the RITC transaction. The RITC amountsrepresent the transfer of the assets and liabilities from the participants of aclosing underwriting year to the participants of the next underwriting year. Tothe extent our participation in the syndicate changes, the RITC amounts varyaccordingly. The RITC transaction is recorded in the fourth quarter asadditional written and earned premium, losses incurred, loss reserves andreceivables, all in the same amount. There were no gains or losses recorded on theRITC transaction.

 

We provide letters of credit to Lloyd’s to supportour participation in Syndicate 1221’s stamp capacity as discussed below underthe caption “Liquidity and Capital Resources”.

 

Following are the results of operations of the Lloyd’sOperations for the three months ended March 31, 2005 and 2004:

 
| ** **                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **($ in thousands)**              | ** ** |
| ** **                           | ** ** | ** **                             | ** ** |
| Revenues:                            |       |                                   |       |   |   |
| Net earned  premium                  |       | $                                      | 30,175     |   | $ | 20,993 |   |
| Commission  income                   |       | 268                                    |       | 62 |   |
| Net  investment income               |       | 749                                    |       | 404 |   |
| Net realized  capital gains (losses) |       | (99                                    | )          | 217 |   |
| Other income                         |       | 628                                    |       | 4 |   |
| Total  revenues                      |       | 31,721                                 |       | 21,680 |   |
|                                 |       |                                   |       |   |   |
| Operating  expenses:                 |       |                                   |       |   |   |
| Net losses  and LAE                  |       | 17,379                                 |       | 11,042 |   |
| Commission  expense                  |       | 4,881                                  |       | 3,750 |   |
| Other  operating expenses            |       | 4,761                                  |       | 3,036 |   |
| Total  operating expenses            |       | 27,021                                 |       | 17,828 |   |
|                                 |       |                                   |       |   |   |
| Income  before income tax expense    |       | 4,700                                  |       | 3,852 |   |
|                                 |       |                                   |       |   |   |
| Income tax  expense                  |       | 1,645                                  |       | 1,348 |   |
|                                 |       |                                   |       |   |   |
| Net income                           |       | $                                      | 3,055      |   | $ | 2,504 |   |
|                                 |       |                                   |       |   |   |
| Loss and LAE  ratio                  |       | 57.6                                   | %          | 52.6 | % |
| Commission  expense ratio            |       | 16.2                                   | %          | 17.9 | % |
| Other  operating expense ratio       |       | 15.8                                   | %          | 14.4 | % |
| Combined  ratio                      |       | 89.6                                   | %          | 84.9 | % |

 

The Lloyd’s Operations have been experiencingbusiness expansion coupled with improving underwriting results as a result ofthe generally favorable market conditions for marine and energy business sincelate 2001 through 2003, and to a lesser extent in 2004 and 2005.  The 2005 net earned premium was reduced by

 

30

----

 

$0.7million and $7.4 million in the first quarters of 2005 and 2004, respectively,for business ceded to the Insurance Companies.

 

The 2005 and 2004 first quarter underwriting resultsgenerally reflect the favorable industry market condition over the last threeyears coupled with satisfactory loss trends in the quarterly periods.  The loss ratio for the first quarter of 2004was favorably impacted by $2.7 million or 12.9 loss ratio points forredundancies in prior years’ Lloyd’s Operations’ loss reserves.

 

The pre-tax yield on funds in the Lloyd’s Operations’investment portfolio approximated 1.6%, and 1.3% at March 31, 2005 and 2004,respectively.  Generally, funds investedat Lloyd’s have been invested with an average duration of approximately 1.4 yearsin order to meet liquidity needs.  Suchyields are net of interest credits to reinsurers for funds withheld by ourLloyd’s Operations.

 

***Navigators Agencies***

 

The Navigators Agencies produce business for ourinsurance company subsidiaries. They specialize in writing marine and relatedlines of business, specialty liability insurance and professional liabilitycoverages.

 

Each of the Navigators Agencies underwrites marineand related lines of business for Navigators Insurance Company and two otherunaffiliated insurance companies, which comprise a marine insurance pool.Marine insurance policies are issued by Navigators Insurance Company with thebusiness shared with other pool members. Navigators Insurance Company had an 85%participation in the marine pool for business written with effective dates in 2005and an 80% participation for business written with effective dates in 2004.

 

Navigators Specialty, a division of a NavigatorsAgency, produces business exclusively for our insurance company subsidiaries.It specializes in underwriting general liability insurance coverage for smallgeneral and artisan contractors and other targeted commercial risks, with themajority of its business located in California. Navigators Specialty also writes commercial multiple peril, excesscasualty, commercial automobile and personal umbrella insurance.

 

Navigators Pro, a division of a Navigators Agency,specializes in underwriting professional liability insurance and beganproducing directors and officers liability insurance exclusively for ourinsurance company subsidiaries in the fourth quarter of 2001. In late 2002,Navigators Pro introduced additional products to complement its directors andofficers liability coverage. The products include employment practicesliability, lawyers professional liability and miscellaneous professionalliability coverages.  In 2004, NavigatorsPro began writing professional liability coverage for U.K. solicitors through ourU.K. Branch.  In 2005, Navigators Procommenced writing professional liability coverages for architects andengineers.

 

NavigatorsSpecialty and Navigators Pro receive actual cost reimbursement from theInsurance Companies for the business produced. The Navigators Agencies producing the marine business receive a 20%profit commission and a management fee of 8.75% for marine business producedwith 2005 year effective dates and 7.5% for 2004 and prior year effectivedates.

 

Followingare the results of operations of the Navigators Agencies for the three monthsended March 31, 2005 and 2004:

 

31

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| ** **                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|
| ** **                          | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                          | ** ** | **($ in thousands)**              | ** ** |
| Revenues:                           |       |                                   |       |   |   |
| Commission  income                  |       | $                                      | 9,750      |   | $ | 7,932 |   |
| Net  investment income              |       | 2                                      |       | 3 |   |
| Other income                        |       | 271                                    |       | 185 |   |
| Total  revenues                     |       | 10,023                                 |       | 8,120 |   |
|                                |       |                                   |       |   |   |
| Operating  expenses:                |       |                                   |       |   |   |
| Other  operating expenses           |       | 10,996                                 |       | 8,605 |   |
| Total  operating expenses           |       | 10,996                                 |       | 8,605 |   |
|                                |       |                                   |       |   |   |
| (Loss)  before income tax (benefit) |       | (973                                   | )          | (485 | ) |
|                                |       |                                   |       |   |   |
| Income tax  (benefit)               |       | (362                                   | )          | (140 | ) |
|                                |       |                                   |       |   |   |
| Net (loss)                          |       | $                                      | (611       | ) | $ | (345 | ) |

 

Commissionincome generally consists of inter-segment management fees and profitcommissions received from insurance premiums of the Insurance Companies formarine, specialty and professional liability business as well as business fromunaffiliated insurance companies in the marine pool.

 

Otherincome generally represents fee revenues earned for other services on behalf ofthird parties.

 

Otheroperating expenses consists of compensation and general and administrativeexpenses incurred in connection with underwriting, administrative and claimsservices performed on behalf of the Insurance Companies and unaffiliatedinsurers participating in the marine pool. Such costs have been increasing each year commensurate with servicingthe growth in the overall increased premium volume.

 

Incometax expense (benefit) includes Federal and state income taxes related to thetaxable income or loss of the Navigators Agencies.

 

**Off-Balance Sheet Transactions**

 

There have been no material changes in theinformation concerning off-balance sheet transactions as stated in the Company’s2004 Annual Report on Form 10-K.

 

**Tabular Disclosure of Contractual Obligations**

 

There have been no material changes in the operatinglease or capital lease information concerning contractual obligations as statedin the Company’s 2004 Annual Report on Form 10-K.  Even though total reserves for losses and LAEincreased to $999.8 million at March 31, 2005 from $966.1 million at December 31,

 

32

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2004,there were no significant changes in the Company’s lines of business or claimshandling that would create a material change in the percentage relationship ofthe projected payments by period to the total reserves.

 

**Investments**

 

The objective of the Company’s investment policy,guidelines and strategy is to maximize total investment return in the contextof preserving and enhancing shareholder value and statutory surplus of theinsurance company subsidiaries. Secondarily, an important consideration is to optimize the after-taxbook income.

 

The investments are managed by outside professionalfixed-income and equity portfolio managers. The Company seeks to achieve itsinvestment objectives by investing in cash equivalents and money market funds,municipal bonds, U.S. Government bonds, U.S. Government guaranteed and U.S.Federal Agency securities, corporate bonds, mortgage-backed and asset-backedsecurities and common and preferred stocks. Our investment guidelines requirethat the amount of the consolidated fixed-income portfolio rated below ‘‘A-’’by Standard & Poor’s (“S&P”) or A3 by Moody’s shall not exceed 20%of the statutory surplus of the Insurance Companies.  Securities rated below BBB- by S&P orBaa3 by Moody’s are not eligible to be purchased. Up to 15% of the statutorysurplus of the Insurance Companies may be invested in equity securities thatare actively traded on major U.S. stock exchanges. Our investment guidelinesprohibit investments in derivatives other than as a hedge against foreigncurrency exposures or the writing of covered call options on the equityportfolio.

 

Our insurance company subsidiaries’ investments aresubject to the direction and control of their respective boards of directorsand our finance committee.  Theinvestment portfolio and the performance of the investment managers arereviewed quarterly.  These investmentsmust comply with the insurance laws of New York State, the domiciliary state ofNavigators Insurance Company and NIC Insurance Company. These laws prescribethe type, quality and concentration of investments which may be made byinsurance companies. In general, these laws permit investments, within specifiedlimits and subject to certain qualifications, in Federal, state and municipalobligations, corporate bonds, preferred stocks, common stocks, real estatemortgages and real estate.

 

The Lloyd’s Operations’ investments are subject tothe direction and control of the board of directors and the investmentcommittee of NUAL, as well as the board of directors and finance committee ofthe Company, and represent our share of the investments held by Syndicate 1221.These investments must comply with the rules and regulations imposed byLloyd’s and by certain overseas regulators. The investment portfolio and the performance of the investment managersare reviewed quarterly.

 

The majority of the investment income of theNavigators Agencies is derived from fiduciary funds invested in accordance withthe guidelines of various state insurance departments. These guidelinestypically require investments in short-term instruments. This investment incomeis paid to the members of the marine pool, including Navigators InsuranceCompany.

 

All fixed maturity and equity securities are carriedat fair value. The fair value is based on quoted market prices or dealer quotesprovided by independent pricing services. The following tables show our cash and investments as of March 31,2005 and December 31, 2004:

 

33

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| **March 31, 2005**                                                                                       | ** ** | **Fair  Value**           | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  (Losses)** | ** ** | **Cost or  Amortized  Cost** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| ** **                                                                                                    | ** ** | **($ in thousands)** | ** ** |
| Fixed  maturities:                                                                                            |       |                      |       |                         |       |                            |       |                         |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| U.S.  Government Treasury Bonds, GNMAs, U.S. Government non-guaranteed Agencies and  foreign government bonds |       | $                         | 239,713    |                         | $          | 2,027                           |       | $                            | (2,137     | ) | $ | 239,823 |   |
| States,  municipalities and political sub divisions                                                           |       | 171,480                   |       | 1,613                        |       | (1,722                          | )          | 171,589                      |       |
| Mortgage-  and asset-backed securities (excluding GNMAs)                                                      |       | 222,052                   |       | 779                          |       | (2,040                          | )          | 223,313                      |       |
| Corporate  bonds                                                                                              |       | 138,062                   |       | 2,629                        |       | (1,348                          | )          | 136,781                      |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Total fixed  maturities (1)                                                                                   |       | 771,307                   |       | 7,048                        |       | (7,247                          | )          | 771,506                      |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Equity  securities - common stocks                                                                            |       | 20,884                    |       | 1,823                        |       | (193                            | )          | 19,254                       |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Cash and  short-term investments                                                                              |       | 115,226                   |       | —                       |       | —                          |       | 115,226                      |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Total                                                                                                         |       | $                         | 907,417    |                         | $          | 8,871                           |       | $                            | (7,440     | ) | $ | 905,986 |   |

 

----

(1) Approximately 13.2% of total fixedmaturities investments are direct or collateralized obligations of FNMA andFHLMC.

 
| **December 31, 2004**                                                                                    | ** ** | **Fair  Value**           | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  (Losses)** | ** ** | **Cost or  Amortized  Cost** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| ** **                                                                                                    | ** ** | **($ in thousands)** | ** ** |
| Fixed  maturities:                                                                                            |       |                      |       |                         |       |                            |       |                         |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| U.S.  Government Treasury Bonds, GNMAs, U.S. Government non-guaranteed Agencies and  foreign government bonds |       | $                         | 247,105    |                         | $          | 3,190                           |       | $                            | (1,451     | ) | $ | 245,366 |   |
| States,  municipalities and political subdivisions                                                            |       | 138,902                   |       | 2,688                        |       | (339                            | )          | 136,553                      |       |
| Mortgage-  and asset-backed securities (excluding GNMAs)                                                      |       | 191,459                   |       | 1,911                        |       | (470                            | )          | 190,018                      |       |
| Corporate  bonds                                                                                              |       | 144,968                   |       | 4,375                        |       | (519                            | )          | 141,112                      |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Total fixed  maturities (1)                                                                                   |       | 722,434                   |       | 12,164                       |       | (2,779                          | )          | 713,049                      |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Equity  securities - common stocks                                                                            |       | 21,170                    |       | 2,157                        |       | (88                             | )          | 19,101                       |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Cash and  short-term investments                                                                              |       | 111,329                   |       | —                       |       | —                          |       | 111,329                      |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Total                                                                                                         |       | $                         | 854,933    |                         | $          | 14,321                          |       | $                            | (2,867     | ) | $ | 843,479 |   |

 

----

(1) Approximately 17.4% of total fixed maturities investments aredirect or collateralized obligations of FNMA and FHLMC.

 

34

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At March 31, 2005 and December 31, 2004,all fixed-maturity and equity securities held by us were classified asavailable-for-sale.

 

We regularly review our fixed maturity and equitysecurities portfolios to evaluate the necessity of recording impairment lossesfor other-than-temporary declines in the fair value of investments. In general,we focus our attention on those securities whose market value was less than 80%of their cost or amortized cost, as appropriate, for six or more consecutivemonths. Other factors considered in evaluating potential impairment include thecurrent fair value as compared to cost or amortized cost, as appropriate, ourintent and ability to retain the investment for a period of time sufficient toallow for an anticipated recovery in value, specific credit issues related tothe issuer and current economic conditions.

 

When a security in our investment portfolio has anunrealized loss that is deemed to be other-than-temporary, we write thesecurity down to fair value through a charge to operations. Significant changesin the factors we consider when evaluating investments for impairment lossescould result in a significant change in impairment losses reported in theconsolidated financial statements.  Therewere no impairment losses recorded in our fixed maturity or equity securitiesportfolios in 2005 or 2004.

 

The following table summarizes all securities in anunrealized loss position at March 31, 2005 and December 31, 2004,showing the aggregate fair value and gross unrealized loss by the length oftime those securities have continuously been in an unrealized loss position:

 

35

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| ** **                                                                                                    | ** ** | **March 31, 2005**   | ** ** | **December 31, 2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|----------------------------|------------|
| ** **                                                                                                    | ** ** | **Fair  Value**           | ** ** | **Gross  Unrealized Loss** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized Loss** | ** ** |
| ** **                                                                                                    | ** ** | **($ in thousands)** | ** ** |
|                                                                                                          |       |                      |       |                       |       |   |   |   |   |
| Fixed  Maturities:                                                                                            |       |                      |       |                       |       |   |   |   |   |
| U.S.  Government Treasury Bonds, GNMAs, U.S. Government non-guaranteed Agencies and  foreign government bonds |       |                      |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                    |       | $                         | 95,450     |                       | $          | 1,028 |   | $ | 97,338 |   | $ | 519 |   |
| 7-12 Months                                                                                                   |       | 57,289                    |       | 652                        |       | 33,916 |   | 283 |   |
| > 12  Months                                                                                               |       | 15,809                    |       | 457                        |       | 24,258 |   | 649 |   |
| Subtotal                                                                                                      |       | 168,548                   |       | 2,137                      |       | 155,512 |   | 1,451 |   |
|                                                                                                          |       |                      |       |                       |       |   |   |   |   |
| States,  municipalities and political subdivisions                                                            |       |                      |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                    |       | 91,263                    |       | 1,245                      |       | 18,966 |   | 94 |   |
| 7-12 Months                                                                                                   |       | 9,920                     |       | 245                        |       | 14,155 |   | 225 |   |
| > 12  Months                                                                                               |       | 7,722                     |       | 232                        |       | 518 |   | 20 |   |
| Subtotal                                                                                                      |       | 108,905                   |       | 1,722                      |       | 33,639 |   | 339 |   |
|                                                                                                          |       |                      |       |                       |       |   |   |   |   |
| Mortgage-  and asset-backed securities (excluding GNMAs)                                                      |       |                      |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                    |       | 143,922                   |       | 1,524                      |       | 64,598 |   | 208 |   |
| 7-12 Months                                                                                                   |       | 24,106                    |       | 436                        |       | 19,536 |   | 232 |   |
| > 12  Months                                                                                               |       | 1,634                     |       | 80                         |       | 774 |   | 30 |   |
| Subtotal                                                                                                      |       | 169,662                   |       | 2,040                      |       | 84,908 |   | 470 |   |
|                                                                                                          |       |                      |       |                       |       |   |   |   |   |
| Corporate  bonds                                                                                              |       |                      |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                    |       | 51,638                    |       | 807                        |       | 29,870 |   | 160 |   |
| 7-12 Months                                                                                                   |       | 15,706                    |       | 276                        |       | 16,069 |   | 189 |   |
| > 12  Months                                                                                               |       | 6,108                     |       | 265                        |       | 4,803 |   | 170 |   |
| Subtotal                                                                                                      |       | 73,452                    |       | 1,348                      |       | 50,742 |   | 519 |   |
|                                                                                                          |       |                      |       |                       |       |   |   |   |   |
| Total Fixed  Maturities                                                                                       |       | $                         | 520,567    |                       | $          | 7,247 |   | $ | 324,801 |   | $ | 2,779 |   |
|                                                                                                          |       |                      |       |                       |       |   |   |   |   |
| Equity  securities - common stocks                                                                            |       |                      |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                    |       | $                         | 1,964      |                       | $          | 63 |   | $ | 3,779 |   | $ | 23 |   |
| 7-12 Months                                                                                                   |       | 666                       |       | 27                         |       | 892 |   | 65 |   |
| > 12  Months                                                                                               |       | 847                       |       | 103                        |       | — |   | — |   |
|                                                                                                          |       |                      |       |                       |       |   |   |   |   |
| Total Equity  Securities                                                                                      |       | $                         | 3,477      |                       | $          | 193 |   | $ | 4,671 |   | $ | 88 |   |

 

We analyze the unrealized losses quarterly todetermine if any of them are other-than-temporary.  The above unrealized losses have beendetermined to be temporary and generally result from changes in marketconditions.

 

36

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The following table shows the composition by NationalAssociation of Insurance Commissioners (“NAIC”) rating and the generallyequivalent Standard & Poor’s (“S&P”) and Moody’s ratings of thefixed maturity securities in our portfolio with gross unrealized losses at March 31,2005.  Not all of the securities arerated by S&P and/or Moody’s.

 
| ** **       | ** ** | **Equivalent**            | ** ** | **Equivalent**            | ** ** | **Unrealized Loss** | ** ** | **Fair Value**        | ** ** |
|------------------|------------|---------------------------|------------|---------------------------|------------|---------------------|------------|-----------------------|------------|
| **NAIC  Rating** | ** ** | **S&P  Rating**       | ** ** | **M oody’s  Rating** | ** ** | **Amount**          | ** ** | **Percent  to Total** | ** ** | **Amount** | ** ** | **Percent  to Total** | ** ** |
| ** **       | ** ** | **($ in thousands)** | ** ** |
|             |       |                      |       |                      |       |                |       |                  |       |   |   |   |   |
| 1                |       | AAA/AA/A                  |       | Aaa/Aa/A                  |       | $                   | 6,879      |                  | 95         | % | $ | 503,875 |   | 97 | % |
| 2                |       | BBB                       |       | Baa                       |       | 368                 |       | 5                     | %          | 16,692 |   | 3 | % |
| 3                |       | BB                        |       | Ba                        |       | —              |       | —                |       | — |   | — |   |
| 4                |       | B                         |       | B                         |       | —              |       | —                |       | — |   | — |   |
| 5                |       | CCC or lower              |       | Caa or lower              |       | —              |       | —                |       | — |   | — |   |
| 6                |       | N/A                       |       | N/A                       |       | —              |       | —                |       | — |   | — |   |
|             |       |                      |       | Total                     |       | $                   | 7,247      |                  | 100        | % | $ | 520,567 |   | 100 | % |
|                  |            |                           |            |                           |            |                     |            |                       |            |  |  |  |  |  |  |  |

 

At March 31, 2005, the gross unrealized lossesin the table directly above are related to fixed maturity securities that arerated investment grade, which is defined as a security having a NAIC rating of1 or 2, a S&P rating of “BBB—” or higher, or a Moody’s rating of “Baa3” orhigher.  Unrealized losses on investmentgrade securities principally relate to changes in interest rates or changes insector-related credit spreads since the securities were acquired.  Any such unrealized losses are recognized inincome, if the securities are sold, or if the decline in fair value is deemedother-than-temporary.

 

The scheduled maturity dates for fixed maturitysecurities in an unrealized loss position at March 31, 2005 are shown inthe following table:

 
| ** **                              | ** ** | **Unrealized Loss**       | ** ** | **Fair Value**        | ** ** |
|-----------------------------------------|------------|---------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **Amount**                | ** ** | **Percent  to Total** | ** ** | **Amount** | ** ** | **Percent  to Total** | ** ** |
| ** **                              | ** ** | **($ in thousands)** | ** ** |
|                                    |       |                      |       |                  |       |   |   |   |   |
| Due in one  year or less                |       | $                         | 978        |                  | 13         | % | $ | 103,369 |   | 20 | % |
| Due after  one year through five years  |       | 1,797                     |       | 25                    | %          | 103,698 |   | 20 | % |
| Due after  five years through ten years |       | 937                       |       | 13                    | %          | 59,072 |   | 11 | % |
| Due after  ten years                    |       | 1,495                     |       | 21                    | %          | 84,766 |   | 16 | % |
| Mortgage-  and asset-backed securities  |       | 2,040                     |       | 28                    | %          | 169,662 |   | 33 | % |
|                                    |       |                      |       |                  |       |   |   |   |   |
| Total fixed  income securities          |       | $                         | 7,247      |                  | 100        | % | $ | 520,567 |   | 100 | % |
|                                         |            |                           |            |                       |            |  |  |  |  |  |  |  |

 

Expected maturities may differ from contractualmaturities because issuers may have the right to call or prepay obligationswith or without call or prepayment penalties. Due to the periodic repayment ofprincipal, the mortgage- and asset-backed securities are estimated to have aneffective maturity of approximately 4.1 years.

 

37

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Our realized capital gains and losses were asfollows:

 
| ** **                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|
| ** **                  | ** ** | **2005**                               | ** ** | **2004** | ** ** |
| ** **                  | ** ** | **($ in thousands)**              | ** ** |
|                        |       |                                   |       |   |   |
| Fixed  maturities:          |       |                                   |       |   |   |
| Gains                       |       | $                                      | 713        |   | $ | 439 |   |
| (Losses)                    |       | (546                                   | )          | (17 | ) |
|                        |       | 167                                    |       | 422 |   |
| Equity  securities:         |       |                                   |       |   |   |
| Gains                       |       | —                                 |       | — |   |
| (Losses)                    |       | —                                 |       | — |   |
|                        |       | —                                 |       | — |   |
|                        |       |                                   |       |   |   |
| Net realized  capital gains |       | $                                      | 167        |   | $ | 422 |   |

 

The following table details realized lossesin excess of $200,000 from sales and impairments during the first three monthsof 2005 and 2004 and the related circumstances giving rise to the loss:

 
| **Description**                     | ** ** | **Date of  Sale**          | ** ** | **Proceeds  from Sale** | ** ** | **Loss on  Sale** | ** ** | **Impairment** | ** ** | **Holdings  at  March 31, 2005** | ** ** | **Net  Unrealized  Loss** | ** ** | **# of  Months  Unrealized Loss  Exceeded 20%  of Cost or  Amortized Cost** | ** ** |
|-------------------------------------|------------|----------------------------|------------|-------------------------|------------|-------------------|------------|----------------|------------|----------------------------------|------------|---------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                          | ** ** | **($ in  thousands)** | ** ** |
| Three months  ended March 31, 2005: |       |                       |       |                    |       |              |       |           |       |                             |       |                      |       |                                                                        |       |
|                                |       |                       |       |                    |       |              |       |           |       |                             |       |                      |       |                                                                        |       |
| None                                |       |                       |       |                    |       |              |       |           |       |                             |       |                      |       |                                                                        |       |
|                                |       |                       |       |                    |       |              |       |           |       |                             |       |                      |       |                                                                        |       |
| Three months  ended March 31, 2004: |       |                       |       |                    |       |              |       |           |       |                             |       |                      |       |                                                                        |       |
|                                |       |                       |       |                    |       |              |       |           |       |                             |       |                      |       |                                                                        |       |
| None                                |       |                       |       |                    |       |              |       |           |       |                             |       |                      |       |                                                                        |       |

 

**Reinsurance Recoverables**

 

We utilize reinsurance principally to reduce ourexposure on individual risks, to protect against catastrophic losses, tomaintain desired ratios of net written premium to statutory surplus and tostabilize loss ratios and underwriting results. The purchase of reinsurance does not discharge us, the original insurer,from our primary liability to the policyholder. We are required to pay thelosses even if the reinsurer fails to meet its obligations under thereinsurance agreement.

 

We are protected by various treaty and facultativereinsurance agreements. Our exposure to credit risk from any one reinsurer ismanaged through diversification by reinsuring with a number of differentreinsurers, principally in the United States and European reinsurance markets.To meet our standards of acceptability, when the reinsurance is placed, areinsurer generally must have an A.M. Best Company and/or Standard &Poor’s rating of ‘‘A’’ or better, or equivalent financial strength if notrated, plus at least $250 million in policyholders’

 

38

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surplus.  Our Reinsurance Security Committee monitorsthe financial strength of our reinsurers and the related reinsurancereceivables and periodically reviews the list of acceptable reinsurers. Thereinsurance is placed either directly by us or through reinsuranceintermediaries. The reinsurance intermediaries are compensated by thereinsurers.

 

The Company was recently informed by a leadreinsurer participating on excess of loss reinsurance agreements that it mayformally dispute a loss payment recovery when billed.  The recovery is for the 2004 settlement of aclass action suit involving a large asbestos claim which settlement will bepaid over seven years starting in June 2005.  The reinsurer has not indicated any disputewith respect to recoveries on related pro rata reinsurance agreements.

 

The Company believes such a dispute, if it shouldarise, is without merit and intends to vigorously pursue collection of itsreinsurance recoveries.  While it is tooearly to predict with any certainty the outcome of this matter, the Companybelieves that the ultimate outcome of this matter would not be expected to havea significant adverse effect on results of operations, financial condition orliquidity, although an unexpected adverse resolution could have a materialadverse effect on the Company’s results of operations in a particular fiscalquarter or year.

 

An allowance for doubtful recoveries is maintainedfor any amounts considered to be uncollectible. At March 31, 2005 and December 31,2004, we had allowances for uncollectible reinsurance of $33.4 million and $32.4million, respectively.  The allowancesinclude $25.7 million for uncollectible reinsurance as a result of lossreserves established in 2003 for asbestos exposures on marine and aviationbusiness written mostly prior to 1986. Charges (recoveries) for uncollectible reinsurance amounts, all of whichwere recorded to incurred losses, were $1.0 million and ($117,000) for thethree months ended March 31, 2005 and 2004, respectively.

 

The Company continues to periodically monitor thefinancial condition and ongoing activities of its reinsurers, in order toassess the adequacy of its allowance for uncollectible reinsurance.

 

**Liquidityand Capital Resources**

 

Cash flow provided by operations was $65.2 million and$26.7 million for the three months ended March 31, 2005 and 2004, respectively.The increase in the operating cash flow in the first three months of 2005 comparedto 2004 was primarily due to the increase in net written premium coupled withthe $24 million RITC settlement discussed in *Results ofOperations and Overview*. Operating cash flow was used primarily to acquire additional investmentassets.

 

Invested assets and cash increased to $907.4 millionat March 31, 2005 from $854.9 million at December 31, 2004. Theincrease was primarily due to the positive cash flow.  Net investment income was $7.6 million and $5.9million for the three months ended March 31, 2005 and 2004, respectively.

 

The average yield of the portfolio, excluding netrealized capital gains, was 3.5% at March 31, 2005 compared to 3.4% at March 31,2004, reflecting the prevailing interest rates. As of March 31, 2005 and December 31,2004, all fixed maturity securities and equity securities held by us wereclassified as available-for-sale.

 

At March 31, 2005, the weighted average ratingof our fixed maturity investments was ‘‘AA’’ by Standard & Poor’s and ‘‘Aa’’by Moody’s. We believe that we have no significant exposure to credit risksince the fixed maturity investment portfolio consists of investment-gradebonds. At March 31, 2005, our portfolio had an average maturity of 5.1 yearsand duration of 3.8 years. Management continually monitors the composition andcash flow of the investment portfolio in order to maintain the appropriate levelsof liquidity to ensure our ability to satisfy claims.

 

39

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We have a credit facility provided through aconsortium of banks.  The credit facility,which is denominated in U.S. dollars, is utilized primarily by NavigatorsCorporate Underwriters Ltd. and Millennium Underwriting Ltd. to fund ourparticipation in Lloyd’s Syndicate 1221 which is denominated in Britishpounds.  At March 31, 2005, lettersof credit with an aggregate face amount of $82.4 million were issued under thecredit facility.

 

The credit facility is collateralized by all of thecommon stock of Navigators Insurance Company. The credit agreement contains covenants common to transactions of thistype, including restrictions on indebtedness and liens, limitations on mergersand the sale of assets, maintaining certain consolidated tangible net worth,statutory surplus and other financial ratios. Cash dividends to shareholders are limited to $2.5 million peryear.  No dividends have been declared orpaid through March 31, 2005.  At March 31,2005, we were in compliance with all covenants.

 

The credit facility was amended in January 2005to increase the letters of credit available under the facility from $80 millionto $115 million and to add a $10 million line of credit facility.  The expiration of the credit facility wasalso extended from November 10, 2005 to June 30, 2007.  If at that time the banks do not renew thecredit facility, we will need to find other sources to provide the letters of creditor other collateral in order to continue our participation in Syndicate 1221.

 

At March 31, 2005, our consolidatedstockholders’ equity was $333.8 million or $26.16 per share compared to $328.6million or $25.96 per share at December 31, 2004. The increase wasprimarily due to net income of $9.7 million for the three months ended March 31,2005, partially offset by a $6.4 million *other comprehensive loss*consisting of $6.5 million of decreases in unrealized gains on securities,resulting from higher interest rates, and $0.1 million of increases in currencytranslation gains.

 

Our reinsurance has been placed with various U.S.and foreign insurance companies and with selected syndicates at Lloyd’s.Pursuant to the implementation of Lloyd’s Plan of Reconstruction and Renewal, aportion of our recoverables are now reinsured by Equitas which is a separateUnited Kingdom authorized reinsurance company established to reinsureoutstanding liabilities of all Lloyd’s members for all risks written in the1992 or prior years of account.

 

We primarily rely upon dividends from oursubsidiaries to meet our holding company obligations. The dividends havehistorically come primarily from Navigators Insurance Company. At December 31,2004, the maximum amount available for the payment of dividends by NavigatorsInsurance Company during 2005 without prior regulatory approval was $23.6million.  Navigators Insurance Company didnot pay any dividends in the first quarter of 2005.

 

We believe that the cash flow generated by theoperating activities of our subsidiaries will provide sufficient funds for usto meet our liquidity needs over the next twelve months. Beyond the next twelvemonths, cash flow available to us may be influenced by a variety of factors,including general economic conditions and conditions in the insurance andreinsurance markets, as well as fluctuations from year to year in claimsexperience.

 

##### **Item 3. Quantitative and Qualitative Disclosures About Market Risk**

#####  

There have been no material changes in theinformation concerning market risk as stated in the Company’s 2004 AnnualReport on Form 10-K.

 

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

#####  

(a)          The Chief Executive Officer and ChiefFinancial Officer of the Company have evaluated the effectiveness of ourdisclosure controls and procedures (as defined in Rules 13a-15(e) and15d-

 

40

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15(e) underof the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as ofthe end of the period covered by this quarterly report. Based on suchevaluation, such officers have concluded that as of the end of such period theCompany’s disclosure controls and procedures are effective in identifying, on atimely basis, material information required to be disclosed in our reportsfiled or submitted under the Exchange Act.

 

(b)         There have been no changes during our first fiscal quarter in ourinternal control over financial reporting that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**Part II - Other Information**

 

**Item 1.****                                 LegalProceedings**

 

The Company is not a party to, or the subject of,any material pending legal proceedings which depart from the ordinary routinelitigation incident to the kinds of business that it conducts.

 

**Item 2.****                                 UnregisteredSales of Equity Securities and Use of Proceeds**

 

None.

 

**Item 3.****                                 DefaultsUpon Senior Securities**

 

None.

 

**Item 4.****                                 Submissionsof Matters to a Vote of Security Holders**

 

None.

 

**Item 5.****                                 OtherInformation**

 

None.

 

**Item 6.****                                 Exhibits**

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                      | ** ** | ** ** |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 11-1                 |       | Statement re Computation of Per Share  Earnings                                                                                                                                                                                                                                                                                                                                 |       | *          |
| 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                                                                                                                                                                           |       |       |

 

41

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|   |   | 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). |   |   |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|

 

----

* *Included herein*.

 

42

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SIGNATURE

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|   | The Navigators Group, Inc. |   |
|--------|---------------------------------|--------|
|   | (Registrant)                    |   |
|   |                            |   |
| Date:  | May 5, 2005                |   | /s / Paul J. Malvasio |   |
|   | Paul J. Malvasio                |   |
|   | Executive Vice President        |   |
|   | and Chief Financial Officer     |   |
|        |                                 |        |  |  |

 

43

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**INDEX OF EXHIBITS**

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                                      | ** ** | ** ** |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| 11-1                 |       | Statement re Computation of Per Share  Earnings                                                                                                                                                                                                                                                                                                                                 |       | *          |
| 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). |       |       |

 

----

*  *Includedherein.*

 

44

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