** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

** **

**FORM 10-Q**

 

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

**of theSecurities Exchange Act of 1934**

 

**For theQuarterly Period Ended     September 30,2006**

 

**Commissionfile number      0-15886**

 

**The Navigators Group, Inc.**

(Exact name of Registrant as specified in its charter)

 

| **Delaware**                             | ** ** | **13-3138397**      |
|------------------------------------------|------------|---------------------|
| (State or other jurisdiction of          |       | (IRS Employer       |
| incorporation or organization)           |       | Identification No.) |
|                                     |       |                |
| **One Penn Plaza, New York, New York**   | ** ** | **10119**           |
| (Address of principal executive offices) |       | (Zip Code)          |

 

**(212) 244-2333**

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and formerfiscal year, if changed since last report.)

 

Indicate by check mark whetherthe Registrant: (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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  x         No  o

 

Indicate by check mark whetherthe registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

 
| Large  Accelerated Filer o | Accelerated  Filer x | Non-Accelerated  Filer o |
|----------------------------|----------------------|--------------------------|

 

Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct). Yes  o    No  x

 

The number of common sharesoutstanding as of October 20, 2006 was 16,703,779.

 

 

----

 

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

 

**INDEX**

 
| Part I.  FINANCIAL INFORMATION: |                                                                 |
|---------------------------------|----------------------------------------------------------------------|
|                            |                                                                 |
|                            | Item 1.  Financial Statements                                        |   |
|                            |                                                                 |   |
|                            |                                                                 | Consolidated  Balance Sheets |   |
|                            |                                                                 | September 30, 2006 (Unaudited) and December 31, 2005 |   |
|                            |                                                                 |   |   |
|                            |                                                                 | Consolidated  Statements of Income (Unaudited) |   |
|                            |                                                                 | Three Months Ended September 30, 2006 and  2005 |   |
|                            |                                                                 | Nine Months Ended September 30, 2006 and 2005 |   |
|                            |                                                                 |   |   |
|                            |                                                                 | Consolidated  Statements of Stockholders’ Equity (Unaudited) |   |
|                            |                                                                 | September 30, 2006 and 2005 |   |
|                            |                                                                 |   |   |
|                            |                                                                 | Consolidated  Statements of Comprehensive Income (Unaudited) |   |
|                            |                                                                 | Three Months Ended September 30, 2006 and  2005 |   |
|                            |                                                                 | Nine Months Ended September 30, 2006 and 2005 |   |
|                            |                                                                 |   |   |
|                            |                                                                 | Consolidated Statements of Cash Flows  (Unaudited) |   |
|                            |                                                                 | Nine Months Ended September 30, 2006 and 2005 |   |
|                            |                                                                 |   |   |
|                            |                                                                 | Notes to  Interim Consolidated Financial Statements (Unaudited) |   |
|                            |                                                                 |   |
|                            | Item 2.  Management’s Discussion and Analysis of Financial      |   |
|                            | Condition and  Results of Operations                                 |   |
|                            |                                                                 |   |
|                            | Item 3.  Quantitative and Qualitative Disclosures                    |   |
|                            | About Market  Risk                                                   |   |
|                            |                                                                 |   |
|                            | Item 4.  Controls and Procedures                                     |   |
|                            |                                                                 |   |
| Part II. OTHER INFORMATION      |                                                                 |
|                            |                                                                 |   |
|                            | Item 1. Legal Proceedings                                            |   |
|                            |                                                                 |   |
|                            | Item 1A. Risk  Factors                                               |   |
|                            |                                                                 |   |
|                            | 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

----

 

**Part 1.    FinancialInformation**

##### **Item 1.    Financial Statements**

##### ** **

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

**CONSOLIDATEDBALANCE SHEETS**

*($ in thousands, except share data)*
| ** **                                                                                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                          | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                          | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
| Investments and cash:                                                                                                                                               | ** ** | ** **             | ** ** | ** **            | ** ** |
| Fixed maturities, available-for-sale, at  fair value   (amortized cost: 2006, $1,178,056; 2005, $986,726)                                                           |       | $                      | 1,174,196  |                  | $          | 984,113 |   |
| Equity securities, available-for-sale, at  fair value (cost: 2006, $28,853; 2005, $19,667)                                                                          |       | 32,524                 |       | 20,911                |       |
| Short-term investments, at cost which  approximates fair value                                                                                                      |       | 199,470                |       | 164,047               |       |
| Cash                                                                                                                                                                |       | 1,891                  |       | 13,165                |       |
| Total investments and cash                                                                                                                                          |       | 1,408,081              |       | 1,182,236             |       |
|                                                                                                                                                                |       |                   |       |                  |       |
| Premiums in course of collection                                                                                                                                    |       | 181,897                |       | 155,977               |       |
| Commissions receivable                                                                                                                                              |       | 2,661                  |       | 3,467                 |       |
| Prepaid reinsurance premiums                                                                                                                                        |       | 183,458                |       | 136,341               |       |
| Reinsurance receivable on paid losses                                                                                                                               |       | 110,429                |       | 37,055                |       |
| Reinsurance receivable on unpaid losses and  loss adjustment expenses                                                                                               |       | 962,687                |       | 979,015               |       |
| Net deferred income tax benefit                                                                                                                                     |       | 29,558                 |       | 28,317                |       |
| Deferred policy acquisition costs                                                                                                                                   |       | 43,458                 |       | 29,697                |       |
| Accrued investment income                                                                                                                                           |       | 12,109                 |       | 10,297                |       |
| Goodwill and other intangible assets                                                                                                                                |       | 7,769                  |       | 7,341                 |       |
| Other assets                                                                                                                                                        |       | 19,889                 |       | 13,506                |       |
|                                                                                                                                                                |       |                   |       |                  |       |
| Total assets                                                                                                                                                        |       | $                      | 2,961,996  |                  | $          | 2,583,249 |   |
|                                                                                                                                                                |       |                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                      | ** ** | ** **             | ** ** | ** **            | ** ** |
| Liabilities:                                                                                                                                                        | ** ** | ** **             | ** ** | ** **            | ** ** |
| Reserves for losses and loss adjustment  expenses                                                                                                                   |       | $                      | 1,619,450  |                  | $          | 1,557,991 |   |
| Unearned premium                                                                                                                                                    |       | 423,419                |       | 316,516               |       |
| Reinsurance balances payable                                                                                                                                        |       | 201,606                |       | 180,059               |       |
| Senior notes                                                                                                                                                        |       | 123,533                |       | —                |       |
| Federal income tax payable                                                                                                                                          |       | 5,511                  |       | 1,274                 |       |
| Payable for securities purchased                                                                                                                                    |       | 846                    |       | 823                   |       |
| Accounts payable and other liabilities                                                                                                                              |       | 60,116                 |       | 56,348                |       |
| Total liabilities                                                                                                                                                   |       | 2,434,481              |       | 2,113,011             |       |
|                                                                                                                                                                |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
| Preferred stock, $.10 par value, authorized  1,000,000 shares, none issued                                                                                          |       | —                 |       | —                |       |
| Common stock, $.10 par value, shares  authorized: 50,000,000 for 2006 and 20,000,000 for 2005; issued and  outstanding: 16,700,279 for 2006 and 16,616,781 for 2005 |       | 1,670                  |       | 1,662                 |       |
| Additional paid-in capital                                                                                                                                          |       | 285,616                |       | 282,463               |       |
| Retained earnings                                                                                                                                                   |       | 238,857                |       | 186,901               |       |
| Accumulated other comprehensive income  (loss)                                                                                                                      |       | 1,372                  |       | (788                  | )          |
| Total stockholders’ equity                                                                                                                                     |       | 527,515                |       | 470,238               |       |
| ** **                                                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
| Total liabilities and stockholders’ equity                                                                                                                     |       | $                      | 2,961,996  |                  | $          | 2,583,249 |   |

 

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

 

3

----

 

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

**CONSOLIDATEDSTATEMENTS OF INCOME**

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

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **September 30,**           | ** ** |
| ** **                                         | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                         | ** ** | **(Unaudited)**                  | ** ** |
|                                               |       |                             |       |   |   |
| Gross written premium                              |       | $                                | 221,667    |   | $ | 188,114 |   |
| Revenues:                                          |       |                             |       |   |   |
| Net written premium                                |       | $                                | 119,037    |   | $ | 76,049 |   |
| (Increase) in unearned premium                     |       | (3,341                           | )          | (1,315 | ) |
| Net earned premium                                 |       | 115,696                          |       | 74,734 |   |
| Commission income                                  |       | 639                              |       | 1,025 |   |
| Net investment income                              |       | 14,691                           |       | 9,196 |   |
| Net realized capital gains (losses)                |       | (151                             | )          | 344 |   |
| Other income (expense)                             |       | (884                             | )          | 459 |   |
| Total revenues                                     |       | 129,991                          |       | 85,758 |   |
|                                               |       |                             |       |   |   |
| Operating expenses:                                |       |                             |       |   |   |
| Net losses and loss adjustment expenses  incurred  |       | 64,456                           |       | 76,836 |   |
| Commission expense                                 |       | 13,769                           |       | 11,656 |   |
| Other operating expenses                           |       | 22,683                           |       | 17,482 |   |
| Interest expense                                   |       | 2,214                            |       | — |   |
| Total operating expenses                           |       | 103,122                          |       | 105,974 |   |
|                                               |       |                             |       |   |   |
| Income (loss) before income tax expense  (benefit) |       | 26,869                           |       | (20,216 | ) |
|                                               |       |                             |       |   |   |
| Income tax expense (benefit):                      |       |                             |       |   |   |
| Current                                            |       | 8,126                            |       | (5,605 | ) |
| Deferred                                           |       | 410                              |       | (1,886 | ) |
| Total income tax expense (benefit)                 |       | 8,536                            |       | (7,491 | ) |
|                                               |       |                             |       |   |   |
| Net income (loss)                                  |       | $                                | 18,333     |   | $ | (12,725 | ) |
|                                               |       |                             |       |   |   |
| Net income (loss) per common share:                |       |                             |       |   |   |
| Basic                                              |       | $                                | 1.10       |   | $ | (0.99 | ) |
| Diluted                                            |       | $                                | 1.09       |   | $ | (0.99 | ) |
|                                               |       |                             |       |   |   |
| Average common shares outstanding:                 |       |                             |       |   |   |
| Basic                                              |       | 16,685                           |       | 12,791 |   |
| Diluted                                            |       | 16,827                           |       | 12,791 |   |

 

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

 

4

----

 
| ** **                                        | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------|------------|---------------------------------|------------|
| ** **                                        | ** ** | **September 30,**          | ** ** |
| ** **                                        | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                                        | ** ** | **(Unaudited)**                 | ** ** |
| ** **                                        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Gross written premium                             |       | $                               | 737,816    |   | $ | 595,243 |   |
| Revenues:                                         |       |                            |       |   |   |
| Net written premium                               |       | $                               | 391,711    |   | $ | 286,396 |   |
| (Increase) in unearned premium                    |       | (57,752                         | )          | (48,292 | ) |
| Net earned premium                                |       | 333,959                         |       | 238,104 |   |
| Commission income                                 |       | 2,465                           |       | 3,809 |   |
| Net investment income                             |       | 41,244                          |       | 25,779 |   |
| Net realized capital gains (losses)               |       | (767                            | )          | 927 |   |
| Other income (expense)                            |       | (654                            | )          | 1,826 |   |
| Total revenues                                    |       | 376,247                         |       | 270,445 |   |
|                                              |       |                            |       |   |   |
| Operating expenses:                               |       |                            |       |   |   |
| Net losses and loss adjustment expenses  incurred |       | 193,200                         |       | 176,668 |   |
| Commission expense                                |       | 41,098                          |       | 30,502 |   |
| Other operating expenses                          |       | 61,018                          |       | 52,554 |   |
| Interest expense                                  |       | 4,034                           |       | — |   |
| Total operating expenses                          |       | 299,350                         |       | 259,724 |   |
|                                              |       |                            |       |   |   |
| Income before income tax expense                  |       | 76,897                          |       | 10,721 |   |
|                                              |       |                            |       |   |   |
| Income tax expense (benefit):                     |       |                            |       |   |   |
| Current                                           |       | 27,492                          |       | 7,636 |   |
| Deferred                                          |       | (2,551                          | )          | (5,169 | ) |
| Total income tax expense                          |       | 24,941                          |       | 2,467 |   |
|                                              |       |                            |       |   |   |
| Net income                                        |       | $                               | 51,956     |   | $ | 8,254 |   |
|                                              |       |                            |       |   |   |
| Net income per common share:                      |       |                            |       |   |   |
| Basic                                             |       | $                               | 3.12       |   | $ | 0.65 |   |
| Diluted                                           |       | $                               | 3.09       |   | $ | 0.64 |   |
|                                              |       |                            |       |   |   |
| Average common shares outstanding:                |       |                            |       |   |   |
| Basic                                             |       | 16,664                          |       | 12,744 |   |
| Diluted                                           |       | 16,812                          |       | 12,849 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

5

----

 

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

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

*($ in thousands)*

 
| ** **                                               | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **September 30,**          | ** ** |
| ** **                                               | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                                               | ** ** | **(Unaudited)**                 | ** ** |
| Preferred Stock                                          |       |                            |       |   |   |
| Balance at beginning and end of period                   |       | $                               | —     |   | $ | — |   |
|                                                     |       |                            |       |   |   |
| Common stock                                             |       |                            |       |   |   |
| Balance at beginning of year                             |       | $                               | 1,662      |   | $ | 1,266 |   |
| Shares issued under stock plans                          |       | 8                               |       | 13 |   |
| Balance at end of period                                 |       | $                               | 1,670      |   | $ | 1,279 |   |
|                                                     |       |                            |       |   |   |
| Additional paid-in capital                               |       |                            |       |   |   |
| Balance at beginning of year                             |       | $                               | 282,463    |   | $ | 154,670 |   |
| Effect of SFAS 123 for stock options                     |       | 761                             |       | 784 |   |
| Shares issued under stock plans                          |       | 2,392                           |       | 2,163 |   |
| Balance at end of period                                 |       | $                               | 285,616    |   | $ | 157,617 |   |
|                                                     |       |                            |       |   |   |
| Retained earnings                                        |       |                            |       |   |   |
| Balance at beginning of year                             |       | $                               | 186,901    |   | $ | 163,337 |   |
| Net income                                               |       | 51,956                          |       | 8,254 |   |
| Balance at end of period                                 |       | $                               | 238,857    |   | $ | 171,591 |   |
|                                                     |       |                            |       |   |   |
| Accumulated other comprehensive income  (loss)           |       |                            |       |   |   |
| Net unrealized gains (losses) on  securities, net of tax |       |                            |       |   |   |
| Balance at beginning of year                             |       | $                               | (884       | ) | $ | 7,416 |   |
| Change in period                                         |       | 707                             |       | (6,043 | ) |
| Balance at end of period                                 |       | (177                            | )          | 1,373 |   |
| Cumulative translation adjustments, net of  tax          |       |                            |       |   |   |
| Balance at beginning of year                             |       | 96                              |       | 1,889 |   |
| Net adjustment for period                                |       | 1,453                           |       | (834 | ) |
| Balance at end of period                                 |       | 1,549                           |       | 1,055 |   |
| Balance at end of period                                 |       | $                               | 1,372      |   | $ | 2,428 |   |
|                                                     |       |                            |       |   |   |
| Total stockholders’ equity at end of period         |       | $                               | 527,515    |   | $ | 332,915 |   |

 

See accompanying notes to interim consolidated financial statements.

 

6

----

 

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

**CONSOLIDATED STATEMENTS OFCOMPREHENSIVE INCOME**

*($ in thousands)*

 
| ** **                                                                                                                                      | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                      | ** ** | **September 30,**           | ** ** |
| ** **                                                                                                                                      | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                                                                                      | ** ** | **(Unaudited)**                  | ** ** |
|                                                                                                                                            |       |                             |       |   |   |
| Net income (loss)                                                                                                                               |       | $                                | 18,333     |   | $ | (12,725 | ) |
| Other comprehensive income (loss):                                                                                                              |       |                             |       |   |   |
| Change in net unrealized gains (losses) on  securities, net of tax expense (benefit) of $9,371 and ($3,652) in 2006 and  2005, respectively (1) |       | 17,249                           |       | (6,885 | ) |
| Change in foreign currency translation  gains (losses), net of tax expense (benefit) of $135 and ($58) in 2006 and  2005, respectively          |       | 252                              |       | (107 | ) |
| Other comprehensive income (loss)                                                                                                               |       | 17,501                           |       | (6,992 | ) |
|                                                                                                                                            |       |                             |       |   |   |
| Comprehensive income (loss)                                                                                                                     |       | $                                | 35,834     |   | $ | (19,717 | ) |
|                                                                                                                                            |       |                             |       |   |   |
|                                                                                                                                                 |       |                             |       |   |   |
| (1) Disclosure of reclassification amount,  net of tax:                                                                                         |       |                             |       |   |   |
| Unrealized holding gains (losses) arising during  period                                                                                        |       | $                                | 17,145     |   | $ | (6,661 | ) |
| Less: reclassification adjustment for net gains  (losses) included in net income                                                                |       | (104                             | )          | 224 |   |
| Change in net unrealized gains (losses) on  securities                                                                                          |       | $                                | 17,249     |   | $ | (6,885 | ) |

 

See accompanying notes to interim consolidated financial statements.

 

7

----

 
| ** **                                                                                                                                   | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **September 30,**          | ** ** |
| ** **                                                                                                                                   | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                                                                                                                                   | ** ** | **(Unaudited)**                 | ** ** |
|                                                                                                                                         |       |                            |       |   |   |
| Net income                                                                                                                                   |       | $                               | 51,956     |   | $ | 8,254 |   |
| Other comprehensive income (loss):                                                                                                           |       |                            |       |   |   |
| Change in net unrealized gains (losses) on  securities, net of tax expense (benefit) of $462 and ($3,198) in 2006 and  2005, respectively(1) |       | 707                             |       | (6,043 | ) |
| Change in foreign currency translation  gains (losses), net of tax expense (benefit) of $782 and ($449) in 2006 and  2005, respectively      |       | 1,453                           |       | (834 | ) |
| Other comprehensive income (loss)                                                                                                            |       | 2,160                           |       | (6,877 | ) |
|                                                                                                                                         |       |                            |       |   |   |
| Comprehensive income                                                                                                                         |       | $                               | 54,116     |   | $ | 1,377 |   |
|                                                                                                                                         |       |                            |       |   |   |
|                                                                                                                                              |       |                            |       |   |   |
| (1) Disclosure of reclassification amount,  net of tax:                                                                                      |       |                            |       |   |   |
| Unrealized holding gains (losses) arising during  period                                                                                     |       | $                               | 187        |   | $ | (5,440 | ) |
| Less: reclassification adjustment for net gains  (losses) included in net income                                                             |       | (520                            | )          | 603 |   |
| Change in net unrealized gains (losses) on  securities                                                                                       |       | $                               | 707        |   | $ | (6,043 | ) |

 

See accompanying notes to interim consolidated financial statements.

 

8

----

 

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

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

*($ in thousands)*

 
| ** **                                                                                   | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                   | ** ** | **September 30,**          | ** ** |
| ** **                                                                                   | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                                                                                   | ** ** | **(Unaudited)**                 | ** ** |
| Operating activities:                                                                        |       |                            |       |   |   |
| Net income                                                                                   |       | $                               | 51,956     |   | $ | 8,254 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                            |       |   |   |
| Depreciation & amortization                                                              |       | 1,990                           |       | 1,332 |   |
| Net deferred income tax (benefit)                                                            |       | (2,551                          | )          | (5,169 | ) |
| Net realized capital (gains) losses                                                          |       | 767                             |       | (927 | ) |
| Changes in assets and liabilities:                                                           |       |                            |       |   |   |
| Reinsurance receivable on paid and unpaid losses  and loss adjustment expenses               |       | (57,046                         |  )    | (502,241 | ) |
| Reserve for losses and loss adjustment  expenses                                             |       | 61,459                          |       | 559,910 |   |
| Prepaid reinsurance premiums                                                                 |       | (47,117                         | )          | (15,661 | ) |
| Unearned premium                                                                             |       | 106,903                         |       | 62,389 |   |
| Premiums in course of collection                                                             |       | (25,920                         | )          | 13,564 |   |
| Commissions receivable                                                                       |       | 806                             |       | (601 | ) |
| Deferred policy acquisition costs                                                            |       | (13,761                         | )          | (8,118 | ) |
| Accrued investment income                                                                    |       | (1,812                          | )          | (1,335 | ) |
| Reinsurance balances payable                                                                 |       | 21,547                          |       | 37,147 |   |
| Federal income tax                                                                           |       | 4,237                           |       | (7,107 | ) |
| Other                                                                                        |       | (8,743                          | )          | 26,510 |   |
| Net cash provided by operating activities                                                    |       | 92,715                          |       | 167,947 |   |
|                                                                                         |       |                            |       |   |   |
| Investing activities:                                                                        |       |                            |       |   |   |
| Fixed maturities, available-for-sale                                                         |       |                            |       |   |   |
| Redemptions and maturities                                                                   |       | 95,288                          |       | 18,316 |   |
| Sales                                                                                        |       | 114,343                         |       | 255,002 |   |
| Purchases                                                                                    |       | (390,619                        | )          | (428,139 | ) |
| Equity securities, available-for-sale                                                        |       |                            |       |   |   |
| Sales                                                                                        |       | 3,431                           |       | 4,169 |   |
| Purchases                                                                                    |       | (12,121                         | )          | (3,739 | ) |
| Change in payable for securities                                                             |       | 23                              |       | 24,067 |   |
| Net change in short-term investments                                                         |       | (35,423                         | )          | (39,873 | ) |
| Purchase of property and equipment                                                           |       | (3,559                          | )          | (2,233 | ) |
| Net cash (used in) investing activities                                                      |       | (228,637                        | )          | (172,430 | ) |
|                                                                                         |       |                            |       |   |   |
| Financing activities:                                                                        |       |                            |       |   |   |
| Net proceeds from senior notes                                                               |       | 123,511                         |       | — |   |
| Proceeds of stock issued from employee  stock purchase plan                                  |       | 536                             |       | 419 |   |
| Proceeds of stock issued from exercise of  stock options                                     |       | 601                             |       | 1,194 |   |
| Net cash provided by financing activities                                                    |       | 124,648                         |       | 1,613 |   |
|                                                                                         |       |                            |       |   |   |
| (Decrease) in cash                                                                           |       | (11,274                         | )          | (2,870 | ) |
| Cash at beginning of year                                                                    |       | 13,165                          |       | 14,676 |   |
| Cash at end of period                                                                        |       | $                               | 1,891      |   | $ | 11,806 |   |
|                                                                                         |       |                            |       |   |   |
| Supplemental disclosures of cash flow  information:                                          |       |                            |       |   |   |
| Federal, state and local income tax paid                                                     |       | $                               | 20,533     |   | $ | 13,366 |   |
| Issuance of stock to directors                                                               |       | 140                             |       | 123 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

9

----

 

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

###### ** **

**Notes to Interim Consolidated Financial Statements**

*(Unaudited)*

 

**Note 1. Accounting Policies**

 

The interim consolidated financial statements are unaudited but reflectall adjustments which, in the opinion of management, are necessary to provide afair statement of the results of The Navigators Group, Inc. and itssubsidiaries for the interim periods presented on the basis of accountingprinciples generally accepted in the United States of America (“GAAP” or “U.S.GAAP”). All such adjustments are of a normal recurring nature. All significantintercompany transactions and balances have been eliminated. The preparation ofthese financial statements requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosures ofcontingent assets and liabilities at the date of the financial statements andthe reported revenues and expenses during the reporting periods. The results ofoperations for any interim period are not necessarily indicative of results forthe full year. The terms “we”, “us”, “our” and “the Company” as used hereinmean The Navigators Group, Inc. and its subsidiaries, unless the contextotherwise requires. The term “Parent” or “Parent Company” is used to mean TheNavigators Group, Inc. without its subsidiaries. These financial statementsshould be read in conjunction with the consolidated financial statements andnotes contained in the Company’s 2005 Annual Report on Form 10-K. Certainamounts for the prior year have been reclassified or restated to conform to thecurrent year’s presentation.

 

**Note 2. Reinsurance Ceded**

 

The Company’s ceded earned premiums were$106.0 million and $119.0 million for the three months ended September 30, 2006and 2005, respectively, and were $330.5 million and $292.6 million for the ninemonths ended September 30, 2006 and 2005, respectively. The Company’s cededincurred losses were $61.4 million and $514.4 million for the three monthsended September 30, 2006 and 2005, respectively, and were $186.2 million and$598.0 million for the nine months ended September 30, 2006 and 2005,respectively.

 

**Note 3. Segment Information**

 

The Company’s subsidiaries are primarilyengaged in the underwriting and management of property and casualty insurance.

 

Effective in 2006, the Company classifies itsbusiness into two underwriting segments consisting of the Insurance Companiesand the Lloyd’s Operations, which are separately managed, and a Corporatesegment. Segment data for each of the two underwriting segments includeallocations of revenues and expenses of the Navigators Agencies’ and ParentCompany’s expenses and related income tax amounts previously reportedseparately. The Corporate segment consists of the Parent Company’s investmentincome, interest expense and the related tax effect. Each segment maintains itsown investments, on which it earns income and realizes capital gains or losses.Income tax expense is recorded based on the respective income of each segment. Segmentdata for prior periods has been restated to reflect this change in segmentreporting.

 

The Insurance Companies consist of NavigatorsInsurance Company with its U.K. Branch and NIC Insurance Company. They areprimarily engaged in underwriting marine insurance and related lines ofbusiness, specialty lines of business including contractors’ general liabilityinsurance, commercial and personal umbrella and excess casualty businesses, andprofessional liability insurance. The Lloyd’s Operations primarily underwritemarine and related lines of business at Lloyd’s of London through Lloyd’sSyndicate 1221 (“Syndicate 1221”). The Navigators Agencies are underwritingmanagement companies which produce, manage and underwrite insurance andreinsurance for the Company. All segments are evaluated based on their GAAPresults.

 

10

----

 

The Insurance Companies’ and the Lloyd’sOperations’ performances are measured based on underwriting results and therelated combined ratio, which are both non-GAAP measures of underwritingprofitability. Underwriting profit or loss is calculated from net earnedpremiums, less net losses and LAE, commission expense and other operatingexpenses related to underwriting activities. The combined ratio is derived bytaking such net losses and LAE and operating expenses divided by net earnedpremiums. A combined ratio of less than 100% indicates an underwriting profitand over 100% indicates an underwriting loss.

 

Financial data by segment forthe three months ended September 30, 2006 and 2005 was as follows:

 
| ** **                                    | ** ** | **Three Months Ended September 30, 2006** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **Insurance**                                                      | ** ** | **Lloyd’s** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Companies**                                                      | ** ** | **Operations** | ** ** | **Corporate** | ** ** | **Total (1)** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**                                     | ** ** |
| ** **                                    | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross written premium                         |       | $                                                                  | 163,673    |   | $ | 57,780 |   |   |   | $ | 221,667 |   |
| Net written premium                           |       | 91,188                                                             |       | 27,849 |   |   |   | 119,037 |   |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Net earned premium                            |       | 85,494                                                             |       | 30,202 |   |   |   | 115,696 |   |
| Net losses and loss adjustment expenses       |       | (47,926                                                            | )          | (16,530 | ) |   |   | (64,456 | ) |
| Commission expense                            |       | (9,889                                                             | )          | (3,880 | ) |   |   | (13,769 | ) |
| Other operating expenses                      |       | (16,697                                                            | )          | (5,986 | ) |   |   | (22,683 | ) |
| Commission income and other income  (expense) |       | 661                                                                |       | (906 | ) |   |   | (245 | ) |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Underwriting profit                           |       | 11,643                                                             |       | 2,900 |   |   |   | 14,543 |   |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Investment income                             |       | 12,345                                                             |       | 1,774 |   | $ | 572 |   | 14,691 |   |
| Net realized capital gains (losses)           |       | (29                                                                | )          | (122 | ) | — |   | (151 | ) |
| Interest expense                              |       | —                                                             |       | — |   | (2,214 | ) | (2,214 | ) |
| Income (loss) before income taxes             |       | 23,959                                                             |       | 4,552 |   | (1,642 | ) | 26,869 |   |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Income tax expense (benefit)                  |       | 7,658                                                              |       | 1,627 |   | (749 | ) | 8,536 |   |
| Net income (loss)                             |       | $                                                                  | 16,301     |   | $ | 2,925 |   | $ | (893 | ) | $ | 18,333 |   |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Identifiable assets                           |       | $                                                                  | 2,050,833  |   | $ | 855,348 |   | $ | 50,276 |   | $ | 2,961,996 |   |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Loss and loss expenses ratio                  |       | 56.1                                                               | %          | 54.7 | % |   |   | 55.7 | % |
| Commission expense ratio                      |       | 11.6                                                               | %          | 12.8 | % |   |   | 11.9 | % |
| Other operating expense ratio (2)             |       | 18.8                                                               | %          | 22.8 | % |   |   | 19.8 | % |
| Combined ratio                                |       | 86.5                                                               | %          | 90.3 | % |   |   | 87.4 | % |

 

----

(1)Certain amounts included in thesegment columns include inter-segment transactions causing certain rows not tocrossfoot.

(2)Includes *otheroperating expenses* and *commission income andother income (expense).*

 

11

----

 
| ** **                                    | ** ** | **Three Months Ended September 30, 2005** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **Insurance**                                                      | ** ** | **Lloyd’s** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Companies**                                                      | ** ** | **Operations** | ** ** | **Corporate** | ** ** | **Total (1)** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**                                     | ** ** |
| ** **                                    | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross written premium                         |       | $                                                                  | 133,718    |   | $ | 54,142 |   |   |   | $ | 188,114 |   |
| Net written premium                           |       | 59,093                                                             |       | 16,956 |   |   |   | 76,049 |   |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Net earned premium                            |       | 53,778                                                             |       | 20,956 |   |   |   | 74,734 |   |
| Net losses and loss adjustment expenses       |       | (47,332                                                            | )          | (29,504 | ) |   |   | (76,836 | ) |
| Commission expense                            |       | (6,465                                                             | )          | (5,191 | ) |   |   | (11,656 | ) |
| Other operating expenses                      |       | (13,284                                                            | )          | (4,198 | ) |   |   | (17,482 | ) |
| Commission income and other income  (expense) |       | 704                                                                |       | 780 |   |   |   | 1,484 |   |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Underwriting profit (loss)                    |       | (12,599                                                            | )          | (17,157 | ) |   |   | (29,756 | ) |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Investment income                             |       | 7,694                                                              |       | 1,439 |   | $ | 63 |   | 9,196 |   |
| Net realized capital gains (losses)           |       | 401                                                                |       | (57 | ) | — |   | 344 |   |
| Income (loss) before income taxes             |       | (4,504                                                             | )          | (15,775 | ) | 63 |   | (20,216 | ) |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Income tax expense (benefit)                  |       | (1,992                                                             | )          | (5,521 | ) | 22 |   | (7,491 | ) |
| Net income (loss)                             |       | $                                                                  | (2,512     | ) | $ | (10,254 | ) | $ | 41 |   | $ | (12,725 | ) |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Identifiable assets                           |       | $                                                                  | 1,682,149  |   | $ | 809,870 |   | $ | 17,802 |   | $ | 2,451,056 |   |
|                                          |       |                                                               |       |   |   |   |   |   |   |
| Loss and loss expenses ratio                  |       | 88.0                                                               | %          | 140.8 | % |   |   | 102.8 | % |
| Commission expense ratio                      |       | 12.0                                                               | %          | 24.8 | % |   |   | 15.6 | % |
| Other operating expense ratio (2)             |       | 23.4                                                               | %          | 16.3 | % |   |   | 21.4 | % |
| Combined ratio                                |       | 123.4                                                              | %          | 181.9 | % |   |   | 139.8 | % |

 

----

(1)Amounts included in the segmentcolumns include inter-segment transactions causing certain rows not tocrossfoot.

(2)Includes *otheroperating expenses* and *commission income andother income (expense).*

 

12

----

 

Financial data by segment for the nine months ended September 30, 2006and 2005 was as follows:

 
| ** **                                    | ** ** | **Nine Months Ended September 30, 2006** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **Insurance**                                                     | ** ** | **Lloyd’s** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Companies**                                                     | ** ** | **Operations** | ** ** | **Corporate** | ** ** | **Total (1)** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**                                    | ** ** |
| * *                                      | * *   | * *                                                          | * *   | * * | * * | * * | * * | * * | * * |
| Gross written premium                         |       | $                                                                 | 496,216    |   | $ | 241,600 |   |   |   | $ | 737,816 |   |
| Net written premium                           |       | 273,277                                                           |       | 118,434 |   |   |   | 391,711 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Net earned premium                            |       | 231,334                                                           |       | 102,625 |   |   |   | 333,959 |   |
| Net losses and loss adjustment expenses       |       | (135,556                                                          | )          | (57,644 | ) |   |   | (193,200 | ) |
| Commission expense                            |       | (24,925                                                           | )          | (16,173 | ) |   |   | (41,098 | ) |
| Other operating expenses                      |       | (44,096                                                           | )          | (16,922 | ) |   |   | (61,018 | ) |
| Commission income and other income  (expense) |       | 2,661                                                             |       | (850 | ) |   |   | 1,811 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Underwriting profit                           |       | 29,418                                                            |       | 11,036 |   |   |   | 40,454 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Investment income                             |       | 34,778                                                            |       | 5,448 |   | $ | 1,018 |   | 41,244 |   |
| Net realized capital (losses)                 |       | (329                                                              | )          | (438 | ) | — |   | (767 | ) |
| Interest expense                              |       | —                                                            |       | — |   | (4,034 | ) | (4,034 | ) |
| Income (loss) before income taxes             |       | 63,867                                                            |       | 16,046 |   | (3,016 | ) | 76,897 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Income tax expense (benefit)                  |       | 20,442                                                            |       | 5,650 |   | (1,151 | ) | 24,941 |   |
| Net income (loss)                             |       | $                                                                 | 43,425     |   | $ | 10,396 |   | $ | (1,865 | ) | $ | 51,956 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Identifiable assets                           |       | $                                                                 | 2,050,833  |   | $ | 855,348 |   | $ | 50,276 |   | $ | 2,961,996 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Loss and loss expenses ratio                  |       | 58.6                                                              | %          | 56.2 | % |   |   | 57.9 | % |
| Commission expense ratio                      |       | 10.8                                                              | %          | 15.8 | % |   |   | 12.3 | % |
| Other operating expense ratio (2)             |       | 17.9                                                              | %          | 17.3 | % |   |   | 17.7 | % |
| Combined ratio                                |       | 87.3                                                              | %          | 89.3 | % |   |   | 87.9 | % |

 

----

(1)Amounts included in the segment columns include inter-segment transactionscausing certain rows not to crossfoot.

(2)Includes *other operating expenses*and*commission income and other income (expense)*.

 

13

----

 
| ** **                                    | ** ** | **Nine Months Ended September 30, 2005** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **Insurance**                                                     | ** ** | **Lloyd’s** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Companies**                                                     | ** ** | **Operations** | ** ** | **Corporate** | ** ** | **Total (1)** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**                                    | ** ** |
| ** **                                    | ** ** | ** **                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross written premium                         |       | $                                                                 | 393,686    |   | $ | 200,519 |   |   |   | $ | 595,243 |   |
| Net written premium                           |       | 199,349                                                           |       | 87,047 |   |   |   | 286,396 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Net earned premium                            |       | 160,248                                                           |       | 77,856 |   |   |   | 238,104 |   |
| Net losses and loss adjustment expenses       |       | (114,856                                                          | )          | (61,812 | ) |   |   | (176,668 | ) |
| Commission expense                            |       | (15,597                                                           | )          | (14,905 | ) |   |   | (30,502 | ) |
| Other operating expenses                      |       | (37,540                                                           | )          | (15,014 | ) |   |   | (52,554 | ) |
| Commission income and other income  (expense) |       | 3,599                                                             |       | 2,036 |   |   |   | 5,635 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Underwriting profit (loss)                    |       | (4,146                                                            | )          | (11,839 | ) |   |   | (15,985 | ) |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Investment income                             |       | 22,037                                                            |       | 3,642 |   | $ | 100 |   | 25,779 |   |
| Net realized capital gains (losses)           |       | 1,348                                                             |       | (421 | ) | — |   | 927 |   |
| Income before income taxes                    |       | 19,239                                                            |       | (8,618 | ) | 100 |   | 10,721 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Income tax expense (benefit)                  |       | 5,449                                                             |       | (3,017 | ) | 35 |   | 2,467 |   |
| Net income (loss)                             |       | $                                                                 | 13,790     |   | $ | (5,601 | ) | $ | 65 |   | $ | 8,254 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Identifiable assets                           |       | $                                                                 | 1,682,149  |   | $ | 809,870 |   | $ | 17,802 |   | $ | 2,451,056 |   |
|                                          |       |                                                              |       |   |   |   |   |   |   |
| Loss and loss expenses ratio                  |       | 71.7                                                              | %          | 79.4 | % |   |   | 74.2 | % |
| Commission expense ratio                      |       | 9.7                                                               | %          | 19.1 | % |   |   | 12.8 | % |
| Other operating expense ratio (2)             |       | 21.2                                                              | %          | 16.7 | % |   |   | 19.7 | % |
| Combined ratio                                |       | 102.6                                                             | %          | 115.2 | % |   |   | 106.7 | % |

 

----

(1) Amountsincluded in the segment columns include inter-segment transactions causingcertain rows not to crossfoot.

(2) Includes *other operating expenses* and *commissionincome and other income (expense).*

 

The Insurance Companies’ net earned premium includes $12.9 million and$6.9 million of net earned premium from the U.K. Branch for the three monthsended September 30, 2006 and 2005, respectively, and $34.2 million and $27.5million of net earned premium from the U.K. Branch for the nine months endedSeptember 30, 2006 and 2005, respectively.

 

**Note 4. Comprehensive Income**

 

Comprehensive income encompasses net income, net unrealized capitalgains and losses on available for sale securities, and foreign currencytranslation adjustments, all of which are net of tax. Please refer to the *Consolidated Statements of Stockholders’ Equity* and the *Consolidated Statements of Comprehensive Income*, includedherein, for the components of *accumulated othercomprehensive income (loss)* and of *comprehensiveincome (loss)*, respectively.

 

14

----

 

**Note 5. Stock-Based Compensation**

 

Stock based compensation is expensed as the stock awards vest with theexpense being included in *other operating expenses*for the periods indicated. The amount charged to expense for stock grants was$1.8 million and $405,000 for the three months ended September 30, 2006 and2005, respectively, and $3.1 million and $1.1 million for the nine months endedSeptember 30, 2006 and 2005, respectively. The amount charged to expense forstock options was $292,000 and $267,000 for the three months ended September30, 2006 and 2005, respectively, and $761,000 and $785,000 for the nine monthsended September 30, 2006 and 2005, respectively. Stock appreciation rightsresulted in an expense of $541,000 and $440,000 for the three months endedSeptember 30, 2006 and 2005, respectively, and $563,000 and $774,000 for thenine months ended September 30, 2006 and 2005, respectively.

 

In addition, $46,000 and $35,000 was expensed in each of the threemonth periods ended September 30, 2006 and 2005 and $133,000 and $105,000 wasexpensed in each of the nine month periods ended September 30, 2006 and 2005for stock issued annually to non-employee directors as part of their directors’compensation for serving on the Company’s Board of Directors.

 

**Note 6. Application of New Accounting Standards**

 

In December 2004, the Financial Accounting Standards Board (the “FASB”)issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised2004), *Share Based Payment*, which is a revisionof SFAS 123, *Accounting for Stock-Based Compensation*,eliminating the alternative use of APB 25. The adoption of SFAS No. 123(revised 2004) on January 1, 2006 had no material effect on the Company’sresults of operations or financial condition since the Company adopted the fairvalue recognition provisions of SFAS No. 123 in 2003.

 

In February 2006, the FASB issued SFAS No. 155, *Accountingfor Certain Hybrid Financial Instruments*. SFAS No. 155 amends SFASNo. 133, *Accounting for Derivative Instruments and HedgingActivities*, and SFAS No. 140, *Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities*,and allows an entity to remeasure at fair value a hybrid financial instrumentthat contains an embedded derivative that otherwise would require bifurcationfrom the host, if the holder irrevocably elects to account for the wholeinstrument on a fair value basis. Subsequent changes in the fair value of theinstrument would be recognized in earnings. SFAS No. 133 also removed anexception included in an interpretation of SFAS No. 133 (Implementation IssueNo. B39) that kept holders of mortgage-backed securities from testing for theneed to bifurcate the value embedded in the mortgage-backed securities relatedto the ability to prepay. The FASB is currently reviewing the removal of suchexception. Statement 155 is effective for financial instruments acquired orissued after the beginning of an entity’s first fiscal year that begins afterSeptember 15, 2006. The Company has not yet determined the estimated impact onits financial condition or results of operations, if any, of adopting SFAS No.155 which becomes effective in 2007.

 

In July 2006, the FASB issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes* (“FIN 48”), aninterpretation of FASB Statement No. 109. FIN 48 establishes the threshold forrecognizing the benefits of tax-return positions in the financial statements asmore-likely-than-not to be sustained by the taxing authorities, and prescribesa measurement methodology for those positions meeting the recognition threshold.The Company has not yet determined the estimated impact on its financialcondition or results of operations, if any, of adopting FIN 48 which becomeseffective in 2007.

 

In September 2006, the FASB issued SFAS No. 157, *Fair ValueMeasurements*. SFAS No. 157 defines fair value, establishes aframework for measuring fair value in GAAP, and enhances disclosures about fairvalue measurements. SFAS No. 157 applies when other accounting pronouncementsrequire fair value measurements; it does not require new fair value measurements.The Company has not yet determined the estimated impact on its financialcondition or results of operations, if any, of adopting SFAS No. 157 whichbecomes effective in 2007.

 

15

----

 

In September 2006, the SEC released SEC Staff Accounting Bulletin (“SAB”)No. 108, *Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements*,which addresses how uncorrected errors in previous years should be consideredwhen quantifying errors in current-year financial statements. SAB No. 108requires registrants to consider the effect of all carry over and reversingeffects of prior-year misstatements when quantifying errors in current-year financialstatements. SAB 108 does not change the SEC staff’s previous guidance onevaluating the materiality of errors. It allows registrants to record theeffects of adopting the guidance as a cumulative-effect adjustment to retainedearnings. This adjustment must be reported as of the beginning of the firstfiscal year ending after November 15, 2006 (January 1, 2006 forcalendar-year-end companies in either the 2006 year end Form 10-K or thirdquarter Form 10-Q). The Company has not yet determined the estimated impact onits financial condition or results of operations, if any, of adopting SAB No.108.

 

**Note 7.  Lloyd’s Syndicate**

** **

We record our pro rata share of 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 adjustmentsrelate to income recognition. Lloyd’s syndicates determine underwriting resultsby year of account at the end of three years. We record adjustments to recognize underwriting results as incurred,including the expected ultimate cost of losses incurred.  These adjustments to losses are based onactuarial analysis of syndicate accounts, including forecasts of expectedultimate losses provided by the Syndicate 1221. At the end of the Lloyd’s three yearperiod for determining underwriting results for an account year, the Syndicate1221 will close the account year by reinsuring outstanding claims on thataccount year with the participants for the account’s next underwritingyear.  The amount to close anunderwriting year into the next year is referred to as the “reinsurance toclose”.  The reinsurance to closetransaction is recorded in the fourth quarter as additional written and earnedpremium, losses incurred, loss reserves and receivables, all in the sameamount.  No gain or loss is recorded on the reinsurance toclose transaction.

 

Syndicate 1221’s stamp capacity is £123.5 million ($224.8 million) in2006 compared to £135.0 million ($246.0 million) 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. 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 100% and 97.5% of Syndicate 1221’s capacity for the 2006 and 2005underwriting years, respectively.  TheLloyd’s Operations included in the consolidated financial statements representthe Company’s participation in Syndicate 1221.

 

The Company provides letters of credit to Lloyd’s to support itsSyndicate 1221 capacity.  If the Companyincreases its participation or if Lloyd’s changes the capital requirements, theCompany may be required to supply additional letters of credit or othercollateral acceptable to Lloyd’s, or reduce the capacity of Syndicate1221.  The letters of credit are providedthrough a credit facility which the Company maintains with a consortium ofbanks.  The credit facility agreementrequires that the banks vote periodically whether or not to renew the creditfacility.  If the banks decide not to renewthe credit facility, the Company will need to find other sources to provide theletters of credit or other collateral in order to continue to participate inSyndicate 1221.  The renewal amendmentexecuted in January 2005 renewed the letter of credit facility until June 30,2007.  The bank facility iscollateralized by all of the common stock of Navigators Insurance Company.

 

**Note 8.  Income Tax - ValuationAllowance**

** **

The Company had state and local operating loss carryforwards amountingto potential future tax benefits of $5.9 million and $5.0 million at September30, 2006 and December 31, 2005, respectively. A valuation 

 

16

----

 

allowance was established forthe full amount of these potential future tax benefits due to the uncertaintyassociated with their realization.

 

**Note 9.  Commitments andContingencies**

** **

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

 

At the end of April 2006, the Company was served as a defendant in anaction in the United States District Court for the Northern District of Georgiacaptioned *New Cingular Wireless Headquarters, LLC, et al. v.March & McLennan Companies, Inc., et al.*, along withapproximately 100 other defendants.  OnMay 31, 2006, this action was conditionally transferred to the United StatesDistrict Court for the District of New Jersey by the Judicial Panel onMultidistrict Litigation.  While it isnot possible at this very preliminary stage to predict the outcome of thislitigation, the Company believes the allegations, which involve contingentcommissions and bid-rigging in the insurance industry, to be without merit andintends to vigorously defend itself against them.

 

**Note 10.  Senior Notes Due May 1,2016       **

** **

On April 17, 2006, the Company completed a public debt offering of $125million principal amount of 7% senior unsecured notes due May 1, 2016 (the “SeniorNotes”) and received net proceeds of $123.5 million.  The Company contributed $100 million of theproceeds to the capital and surplus of Navigators Insurance Company andretained the remainder at the Parent Company for general corporatepurposes.  Interest will be paid on theSenior Notes each May 1 and November 1 with the first payment due on November1, 2006.  The effective interest raterelated to the Senior Notes, based on the proceeds net of discount and allissuance costs, is approximately 7.17%.

 

The Senior Notes, the Company’s only senior unsecured obligation, willrank equally with future senior unsecured indebtedness.  The Company may redeem the Senior Notes atany time and from time to time, in whole or in part, at a “make-whole”redemption price.  The terms of theSenior Notes contain various restrictive business and financial covenantstypical for debt obligations of this type, including limitations on mergers,and liens or dispositions of the common stock of certain subsidiaries.  As of September 30, 2006, the Company was incompliance with all such covenants.

 

The interest expense from April 17, 2006 to September 30, 2006 was $4.0million.  The fair value, which is basedon the quoted market price at September 30, 2006, was $127.5 million.

 

17

----

 

**Item 2.****                       Management’sDiscussion and Analysis 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. We cannot assure that anticipated results will be achieved, sinceresults may differ materially because of both known and unknown risks anduncertainties which we face.  Weundertake no obligation to publicly update or revise any forward-looking statements,whether as a result of new information, future events or otherwise.  Factors that could cause actual results todiffer materially from our forward-looking statements include, but are notlimited 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 andother insurers 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 liabilities and relatedreinsurance recoverables;

 

•      risks inherent in 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,including, without limitation, the impact of Hurricanes Katrina, Rita, andWilma and the possibility that our estimates of losses from Hurricanes Katrina,Rita and Wilma will prove to be materially inaccurate;

 

•      our ability to attain adequate prices, obtainnew business and 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;

 

18

----

 

•      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”), includingwithout limitation the risks described under the caption “Risk Factors” in ourAnnual Report on Form 10-K for the year ended December 31, 2005.

 

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 undue reliance on any forward-lookingstatements, which speak only as of their respective dates.

 

*The discussion and analysis of our financialcondition and results of operations contained herein should be read inconjunction with our consolidated financial statements and accompanying noteswhich appear elsewhere in this Form 10-Q. It contains forward-looking statements that involve risks anduncertainties.  Please see “Note onForward-Looking Statements” for more information.  Our actual results could differ materiallyfrom those anticipated in these forward-looking statements as a result ofvarious factors, including those discussed below and elsewhere in this Form10-Q.*

* *

**Overview**

 

Weare an international insurance holding company focusing on specialty productsfor niches within the overall property/casualty insurance market.  The Company’s underwriting segmentsconsists of insurance company operations and operations at Lloyd’s ofLondon.  Our largest product line and most long-standing area of specializationis ocean marine insurance.  We have alsodeveloped specialty niches in professional liability insurance, and inspecialty liability insurance primarily consisting of contractors’ liabilitycoverages.  We conduct operations throughour insurance company subsidiaries, our operations at Lloyd’s of London (the “Lloyd’sOperations”) and our underwriting agencies (the “Navigators Agencies”).  Our insurance company subsidiaries (the “InsuranceCompanies”) consist of Navigators Insurance Company, which includes a UnitedKingdom Branch (the “U.K. Branch”), and NIC Insurance Company, whichunderwrites specialty and professional liability insurance on an excess andsurplus lines basis fully reinsured by Navigators Insurance Company.  Our Lloyd’s Operations include NavigatorsUnderwriting Agency Ltd. (“NUAL”), a Lloyd’s of London (“Lloyd’s”) underwritingagency which manages Lloyd’s Syndicate 1221 (“Syndicate 1221”).  We participate in the capacity of Syndicate1221 through two wholly-owned Lloyd’s corporate members.  The Navigators Agencies consist ofwholly-owned insurance underwriting agencies which produce, manage andunderwrite insurance and reinsurance for the Company and are reimbursed fortheir costs by the Insurance Companies and the Lloyd’s Operations.

 

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.  The Insurance Companies’ operations andability to grow their business and take advantage of market opportunities areparticularly constrained by regulatory capital requirements and rating agencyassessments of capital adequacy.

 

Thediscussions that follow include tables, which contain both our consolidated andsegment operating results for each of the three and nine month periods endedSeptember 30, 2006 and 2005.  Inpresenting our financial results we have discussed our performance withreference to underwriting profit or loss and the related 

 

19

----

 

combined ratio, both of which are non-GAAPmeasures of underwriting profitability. We consider such measures, which may be defined differently by othercompanies, to be important in the understanding of our overall results of operations.  Underwriting profit or loss is calculatedfrom premiums earned, less net losses and loss adjustment expenses (“LAE”),commission expense and other operating expenses related to underwritingactivities.  The combined ratio isderived by taking such net losses and LAE and expenses divided by earnedpremiums.  A combined ratio of less than100% indicates an underwriting profit and over 100% indicates an underwritingloss.

 

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 aresult, we have focused on underserved markets for businesses characterized byhigher severity and lower frequency of loss where we believe our intellectual capitaland financial strength bring meaningful value. In contrast, we have avoided niches that we believe have a highfrequency of loss activity and/or are subject to a high level of regulatorycoverage requirements, such as workers compensation and personal automobileinsurance, because we do not believe our technical expertise is of as muchvalue in these types of businesses. Examples of niches that have the characteristics we look for includebluewater hull which provides coverage for physical damage to, for example,highly valued cruise ships, and directors and officers liability insurance (“D&O”)which covers litigation exposure of a corporation’s directors andofficers.  These types of exposuresrequire substantial technical expertise. 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 and investment income.  The Insurance Companies derive their premiumsprimarily from business written by the Navigators Agencies.  The Lloyd’s Operations derive their premiumsfrom business written by NUAL.  Beginningin 2006, the Navigators Agencies produce and manage business only for theInsurance Companies and are reimbursed for actual costs.  Prior to 2006, the Navigators Agenciesreceived commissions and, in some cases, profit commissions on the businessproduced on behalf of the Insurance Companies and other unaffiliated insurers.  NUAL is reimbursed for its actual costs and,where applicable, profit commissions on the business produced for Lloyd’sSyndicate 1221.

 

Overthe past three to four years, we have experienced generally beneficial marketchanges in our lines of business.  As aresult of several large industry losses in the second quarter of 2001, themarine insurance market began to experience diminished capacity and rateincreases, initially in the offshore energy line of business.  The marine rate increases began to level offin 2004 and into 2005.  As a result ofthe substantial insurance industry losses resulting from Hurricanes Katrina andRita, the marine insurance market is experiencing diminished capacity and rateincreases, particularly for the offshore energy risks located in the Gulf ofMexico.  The 2006 third quarter and ninemonth average renewal rate increases for all marine lines of business includingoffshore energy approximated 13% for each of the periods in the InsuranceCompanies, and 11% and 14%, respectively, in the Lloyd’s Operations.  Included in the marine rate increases for thefirst nine months of 2006 are offshore energy rate increases of approximately66% in the Insurance Companies and 53% in the Lloyd’s Operations.  Specialty liability losses over the pastseveral years, particularly for our California construction liability business,also resulted in diminished capacity in the market in which we compete, as manyformer competitors who lacked the expertise to selectively underwrite thisbusiness have been forced to withdraw from the market resulting in approximaterate increases of 13% in 2004 and 49% in 2003. This was followed by a slight decline in rates of approximately 1% in2005.  The third quarter and nine monthrenewal rates for the California construction liability business declinedapproximately 3% and 5%, respectively, primarily due to additional competitionin the marketplace.  In the professionalliability market, the enactment of the Sarbanes-Oxley Act of 2002, togetherwith financial and accounting scandals at publicly traded corporations and theincreased frequency of securities-related class action litigation, has led toheightened interest in professional liability insurance generally.  Average professional liability renewalpremium rates decreased approximately 4% in the 2006 third quarter andincreased approximately 1% for the 2006 nine months, compared to relativelylevel rates in 2005 and a decrease of approximately 3% in 2004 which followedsubstantial rate increases in 2003 and 2002, particularly for D&O 

 

20

----

 

insurance. The D&O insurance premium rates decreased approximately 8% in the2006 third quarter and decreased approximately 1% for the 2006 nine months,after decreases of approximately 2% in 2005 and 10% in 2004.

 

Ourbusiness is cyclical and influenced by many factors.  These factors include price competition,economic conditions, interest rates, weather-related events and othercatastrophes including natural and man-made disasters (for example hurricanesand terrorism), state regulations, court decisions and changes in the law.  The incidence and severity of catastrophesare inherently unpredictable.  Althoughwe will attempt to manage our exposure to such events, the frequency andseverity of catastrophic events could exceed our estimates, which could have amaterial adverse effect on our financial condition.  Additionally, because our insurance productsmust be priced, and premiums charged, before costs have fully developed, ourliabilities are required to be estimated and recorded in recognition of futureloss and settlement obligations.  Due tothe inherent uncertainty in estimating these liabilities, we cannot assure youthat our actual liabilities will not exceed our recorded amounts.

 

**CatastropheRisk Management**

** **

OurInsurance Companies and Lloyd’s Operations have exposure to losses caused byhurricanes and other natural and man-made catastrophic events.  The frequency and severity of catastrophesare unpredictable.

 

Theextent of losses from a catastrophe is a function of both the total amount ofinsured exposure in an area affected by the event and the severity of theevent.  We continually assess ourconcentration of underwriting exposures in catastrophe exposed areas globally andattempt to manage this exposure through individual risk selection and throughthe purchase of reinsurance.  We also usemodeling technologies and concentration management tools that allow us tobetter monitor and control our accumulations of potential losses fromcatastrophe exposures.  Despite theseefforts, there remains uncertainty about the characteristics, timing and extentof insured losses given the nature of catastrophes.  The occurrence of one or more severecatastrophic events could have a material adverse effect on the Company’s resultsof operations, financial condition or liquidity.

 

Asa result of the offshore energy losses suffered by the marine and energy marketin 2005 stemming from Hurricanes Katrina and Rita, the 2006 marine reinsurancecapacity has declined, reinsurance terms and conditions have tightened andreinsurance costs have dramatically increased, particularly for excess of lossreinsurance protection.  As a result,through the first nine months of 2006, the Company has achieved significantimprovements in pricing, terms and conditions for the offshore energy businessas it renews while reducing its aggregate loss exposures in the Gulf ofMexico.  The Company also has anincreased net retention and increased reinstatement premium cost for acatastrophic offshore energy loss in 2006 compared to 2005 as a result of lessavailable reinsurance protection at an increased reinsurance cost.

 

Theoccurrence of additional large loss events could reduce the reinsurancecoverage that is available to us and could further weaken the financialcondition of our reinsurers, which could have a material adverse effect on ourresults of operations.  Although thereinsurance agreements make the reinsurers liable to us to the extent the riskis transferred or ceded to the reinsurer, ceded reinsurance arrangements do noteliminate our obligation to pay claims to our policyholders.  Accordingly, we bear credit risk with respectto our reinsurers.  Specifically, our reinsurersmay not pay claims made by us on a timely basis, or they may not pay some orall of these claims. Either of these events would increase our costs and couldhave a material adverse effect on our business. We are required to pay the losses even if a reinsurer fails to meet itsobligations under the reinsurance agreement. Hurricanes Katrina and Rita increased our reinsurance recoverablessignificantly, which increased our credit risk.

 

21

----

 

**Corporateand Industry Investigations**

** **

Publiccompanies have become the subject of increasing scrutiny regarding the timingand dating of employee stock option awards. The Securities and Exchange Commission and the U.S. Department ofJustice have been investigating stock option award practices at a number ofpublic companies.  The Company has undertakenits own internal review with respect to its stock option award practices.  In this recently completed internal inquiry,the Company did not find any evidence that it has engaged in any of the stockoption award practices that are at the center of these corporateinvestigations.

 

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 could result in legal precedents and newindustry-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. The Company is supportive of industry efforts to encourage transparencyin the disclosure of contingent commissions paid to brokers by insurers.  

 

Thereinsurance industry has also become the subject of increasing scrutiny withrespect to the alleged improper use of reinsurance agreements to manipulatefinancial reporting results.  The NewYork State Attorney General and other state and federal regulators havecommenced investigations and other proceedings related to reinsuranceagreements in which the insurance risk transferred between the ceding companyand reinsurer may have been insufficient to properly account for suchtransactions as reinsurance in financial statements filed with insuranceregulatory authorities and the SEC.  Suchtransactions may include separate or “side” agreements that reduce, limit ormitigate the indemnification against loss or liability relating to theinsurance risk transferred 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 also believes it has no separate side agreements thatwould limit the insurance risk transferred to the reinsurer under its reinsuranceagreements.  The Company is unable todetermine any reinsurance industry financial reporting changes that could occuras a result of 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 assumptions affect the reported amounts of assets,liabilities, revenues, expenses, and related disclosures at the financialreporting date and throughout the reporting period.  Certain of the estimates result fromjudgments that can be subjective and complex, and consequently actual resultsmay differ from these estimates, which would be reflected in future periods.

 

22

----

 

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.  Actuarialmethodologies are employed to assist in establishing such estimates and includejudgments relative to estimates of future claims severity and frequency, lengthof time to develop to ultimate, judicial theories of liability and other thirdparty factors which are often beyond our control.  Due to the inherent uncertainty associatedwith the reserving process, the ultimate liability may be different from theoriginal estimate.  Such estimates areregularly reviewed and updated and any resulting adjustments are included inthe current year’s results.

 

***Reinsurance Recoverables.*** Reinsurance recoverables are established for the portion of the lossreserves that are ceded to reinsurers. Reinsurance recoverables are determined based upon the terms andconditions of reinsurance contracts which could be subject to interpretationsthat differ from our own based on judicial theories of liability.  In addition, we bear credit risk with respectto our reinsurers which can be significant considering that certain of thereserves remain outstanding for an extended period of time.  We are required to pay losses even if areinsurer fails to meet its obligations under the applicable reinsuranceagreement.

 

***Written and Unearned Premium.*** Written premium is recorded based on the insurance policies that havebeen reported to us and the policies that have been written by agents but notyet reported to us.  We must estimate theamount of written premium not yet reported based on judgments relative tocurrent and historical trends of the business being written.  Such estimates are regularly reviewed andupdated and any resulting adjustments are included in the current year’sresults.  An unearned premium reserve isestablished to reflect the unexpired portion of each policy at the financialreporting date.

 

Substantially all of ourbusiness is placed through agents and brokers. Since the vast majority of the Company’s gross written premium isprimary or direct as opposed to assumed, the delays in reporting assumedpremium generally do not have a significant effect on the Company’s financialstatements, since we record estimates for both unreported direct and assumedpremium.  We also record the cededportion of the estimated gross written premium and related acquisitioncosts.  The earned gross, ceded and netpremiums are calculated based on our earning methodology which is generallypro-rata over the policy period.  Lossesare also recorded in relation to the earned premium.  The estimate for losses incurred on theestimated premium is based on an actuarial calculation consistent with themethodology used to determine incurred but not reported loss reserves forreported premiums.

 

A portion of the Company’spremium is estimated for unreported premium, mostly for the marine businesswritten by our U.K. Branch and Lloyd’s Operations.  We generally do not experience anysignificant backlog in processing premiums. Such premium estimates are generally based on submission data receivedfrom brokers and agents and recorded when the insurance policy or reinsurancecontract is written or bound.  Theestimates are regularlyreviewed and updated taking into account the premium received to date versusthe estimate and the age of the estimate. To the extent that the actual premium varies from the estimates, thedifference, along with the related loss reserves and underwriting expenses, isrecorded in current operations.

 

***Deferred Tax Assets.***  Weapply the asset and liability method of accounting for income taxes wherebydeferred assets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax basis.  In assessing the realization of deferred taxassets, management considers whether it is more likely than not that thedeferred tax assets will be realized.

 

***Impairment of Investment Securities.*** Impairment of investment securities results in a charge to operationswhen a market decline below cost is other-than-temporary.  Management regularly reviews our fixed 

 

23

----

 

maturity and equity securities portfolios toevaluate the necessity of recording impairment losses for other-than-temporarydeclines in the fair value of investments. In general, we focus our attention on those securities whose marketvalue was less than 80% of their cost or amortized cost, as appropriate, forsix or more consecutive months.  Factorsconsidered in evaluating potential impairment include, but are not limited to,the current fair value as compared to cost or amortized cost of the security,as appropriate, the length of time the investment has been below cost oramortized cost and by how much, our intent and ability to retain the investmentfor a period of time sufficient to allow for an anticipated recovery in value,specific credit issues related to the issuer and current economic conditions.  Other-than-temporary impairment losses resultin a permanent reduction of the cost basis of the underlying investment.  Significant changes in the factors weconsider when evaluating investments for impairment losses could result in asignificant change in impairment losses reported in the consolidated financialstatements.

 

Asmentioned above, the Company considers its intent and ability to hold asecurity until the value recovers as part of the process of evaluatingwhether a security’s unrealized loss represents an other-than- temporarydecline.  The Company’s ability to holdsuch securities is supported by sufficient cash flow from its operations andfrom maturities within its investment portfolio in order to meet its claimspayment and other disbursement obligations arising from its underwritingoperations without selling such investments. With respect to securities where the decline in value is determined tobe temporary and the security’s value is not written down, a subsequentdecision may be made to sell that security and realize a loss.  Subsequent decisions on security sales aremade within the context of overall risk monitoring, changing information,market conditions and assessing value relative to other comparablesecurities.  Management of the Company’sinvestment portfolio is outsourced to third party investment managers.  While these investment managers may, at agiven point in time, believe that the preferred course of action is to holdsecurities with unrealized losses that are considered temporary until suchlosses are recovered, the dynamic nature of the portfolio management may resultin a subsequent decision to sell the security and realize the loss, based upona change in market and other factors described above.  The Company believes that subsequentdecisions to sell such securities are consistent with the classification of theCompany’s portfolio as available for sale.

 

***Accounting for Lloyd’s Results.***  Werecord our pro rata share of Syndicate 1221’s assets, liabilities, revenues andexpenses, after making adjustments to convert Lloyd’s accounting to U.S.GAAP.  The most significant GAAPadjustments 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 syndicate.  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 (“RITC”).  The RITC transaction is recorded in thefourth quarter as additional written and earned premium, losses incurred, lossreserves and receivables, all in the same amount.  There are no gains or losses recorded on theRITC transaction.

 

***Translation of Foreign Currencies****. *Financialstatements of subsidiaries expressed in foreign currencies are translated intoU.S. dollars in accordance with SFAS No. 52, *ForeignCurrency Translation,* issued by the FASB.  Under SFAS 52, functional currency assets andliabilities are translated into U.S. dollars using period end rates of exchangeand the related translation adjustments are recorded as a separate component of*accumulated**othercomprehensive income*. Functional currencies are generally the currencies of the localoperating environment.  Statement ofincome amounts expressed in functional currencies are translated using averageexchange rates.  Gains and lossesresulting from foreign currency transactions are recorded in *other income (expense)* in the Company’s ConsolidatedStatements of Income.

 

24

----

 

**Results of Operations and Overview**

** **

Thefollowing is a discussion and analysis of our consolidated and segment resultsof operations for the three and nine month periods ended September 30, 2006 and2005.  All earnings per share data ispresented on a per diluted share basis.

 

Netincome for the three month period ended September 30, 2006 was $18.3 million or$1.09 per share compared to a net loss of $12.7 million or $0.99 per share forthe three month period ended September 30, 2005.  Included in these results were net realizedcapital gains (losses) of $(0.01) per share and $0.02 per share for the threemonths ended September 30, 2006 and 2005, respectively.

 

Netincome for the nine month period ended September 30, 2006 was $52.0 million or$3.09 per share compared to $8.3 million or $0.64 per share for the nine monthperiod ended September 30, 2005. Included in these results were net realized capital gains (losses) of$(0.03) per share and $0.05 per share for the nine months ended September 30,2006 and 2005, respectively.

 

The2005 third quarter and nine month results were adversely affected by HurricanesKatrina and Rita.  The 2005 after-taxloss from the hurricanes was $23.9 million or approximately $1.87 per share.

 

Cashflow from operations was $92.7 million for the nine months of 2006 compared to$168.0 million for the comparable period in 2005.  The positive cash flow contributed to thegrowth in invested assets and net investment income.  The 2006 cash flow was reduced by gross losspayments of approximately $114.5 million for the 2005 hurricane losses and$19.9 million for settled asbestos claims of which $67.2 million and $10.7million, respectively, are expected to be collected from reinsurers insubsequent accounting periods.  The 2005cash flow included approximately $24 million attributable to the settlement ofthe 2002 underwriting year reinsurance to close premium recorded by Syndicate1221 in the 2004 fourth quarter.

 

Consolidated stockholders’equity increased 12% to $527.5 million or $31.59 per share at September 30,2006 compared to $470.2 million or $28.30 per share at December 31, 2005.  The increase was primarily due to net incomeof $52.0 million for the first nine months of 2006.

 

On April 17, 2006, the Company completed a public debt offering of $125million principal amount of 7% senior unsecured notes due May 1, 2016 andreceived net proceeds of $123.5 million of which $100 million was contributedto the capital and surplus of Navigators Insurance Company.

 

On May 9, 2006, the Companyannounced the establishment of an Inland Marine Division focusing ontraditional inland marine insurance products including builders’ risk,contractors’ tools and equipment, fine arts, EDP equipment and motor truckcargo.  On May 17, 2006, the Companyannounced the establishment of a Primary Casualty Division focusing on primarycasualty business produced by wholesale insurance brokers.  The Primary Casualty Division writesconstruction business east of the Rocky Mountains and non-construction risksnationwide.  On October 10, 2006, theCompany announced the establishment of a U.K. based property team to generatespecialty business lines in the U.K. and Europe.  The new team will focus on U.K.property-related commercial lines in targeted business sectors.

 

**Revenues****.**  Grosswritten premium increased to $221.7 million and $737.8 million in the thirdquarter and first nine months of 2006, respectively, from $188.1 million and$595.2 million in the third quarter and first nine months of 2005, increases of18% and 24%, respectively.  The growth ingross written premium reflects a combination of business expansion in both newand existing lines of business coupled with premium rate changes on renewalpolicies.  The marine business decreased1% in the 2006 third quarter, but experienced growth of 18% in the first ninemonths of 2006 compared to the same periods in 2005 primarily as a result ofsignificant rate increases in the offshore energy line of business coupled witha more modest net increase in premiums in the 

 

25

----

 

other classes of business.  Gross written premium for professionalliability business written both in the Insurance Companies and Lloyd’sOperations increased 29% in the 2006 third quarter and 24% for the first ninemonths of 2006 compared to the same periods in 2005 primarily as a result ofdiversification and expansion of the business written by our Lloyd’sOperations.  Specialty business grew 44%in both the third quarter and first nine months of 2006 compared to the sameperiods in 2005 primarily due to continued product diversification and domesticgeographic expansion.

 

Thepremium rate changes discussed above and below for marine, specialty andprofessional liability are calculated primarily by comparing premium amounts onpolicies that have renewed.  The premiumsare judgmentally adjusted for exposure factors when deemed significant andsometimes represent an aggregation of several lines of business.  The rate change calculations provide anindicated pricing trend and are not meant to be a precise analysis of thenumerous factors that affect premium rates or the adequacy of such rates tocover all underwriting costs and generate an underwriting profit.  The calculation can also be affected quarterby quarter depending on the particular policies and the number of policies thatrenew during that period.  Due to marketconditions, these rate changes may or may not apply to new business which maybe more competitively priced compared to renewal business.  The following table sets forth our gross andnet written premium and net earned premium by segment and line of business forthe periods indicated:

 

26

----

 
| ** **                    | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                    | ** ** | **Gross**                                                | ** ** | ** ** | ** ** | **Net** | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** | **Net** | ** ** |
| ** **                    | ** ** | **Written**                                              | ** ** | ** ** | ** ** | **Written** | ** ** | **Earned** | ** ** | **Written** | ** ** | ** ** | ** ** | **Written** | ** ** | **Earned** | ** ** |
| ** **                    | ** ** | **Premium**                                              | ** ** | **%** | ** ** | **Premium** | ** ** | **Premium** | ** ** | **Premium** | ** ** | **%** | ** ** | **Premium** | ** ** | **Premium** | ** ** |
| ** **                    | ** ** | **($ in thousands)**                           | ** ** |
| Insurance Companies:          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                        |       | $                                                        | 54,116     |   | 24.3 | % | $ | 24,566 |   | $ | 29,291 |   | $ | 53,084 |   | 28.2 | % | $ | 11,378 |   | $ | 14,391 |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty                     |       | 85,675                                                   |       | 38.7 | % | 52,923 |   | 45,234 |   | 59,307 |   | 31.6 | % | 38,313 |   | 31,965 |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Professional Liability        |       | 22,848                                                   |       | 10.3 | % | 13,450 |   | 10,938 |   | 21,528 |   | 11.4 | % | 9,823 |   | 7,786 |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Assumed from Lloyd’s     |       | 850                                                      |       | 0.4 | % | 224 |   | 83 |   | (261 | ) | -0.1 | % | (413 | ) | (356 | ) |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other                         |       | 184                                                      |       | 0.1 | % | 25 |   | (52 | ) | 60 |   | 0.0 | % | (8 | ) | (8 | ) |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Insurance Companies Total     |       | 163,673                                                  |       | 73.8 | % | 91,188 |   | 85,494 |   | 133,718 |   | 71.1 | % | 59,093 |   | 53,778 |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s Operations:      |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                        |       | 44,962                                                   |       | 20.3 | % | 23,743 |   | 29,126 |   | 47,338 |   | 25.2 | % | 14,602 |   | 19,453 |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Professional Liability        |       | 9,015                                                    |       | 4.1 | % | 3,381 |   | 1,525 |   | 3,131 |   | 1.7 | % | 1,231 |   | 545 |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other                         |       | 3,803                                                    |       | 1.7 | % | 725 |   | (449 | ) | 3,673 |   | 1.9 | % | 1,123 |   | 958 |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s Operations Total |       | 57,780                                                   |       | 26.1 | % | 27,849 |   | 30,202 |   | 54,142 |   | 28.8 | % | 16,956 |   | 20,956 |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Intercompany elimination      |       | 214                                                      |       | 0.1 | % | — |   | — |   | 254 |   | 0.1 | % | — |   | — |   |
|                          |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                         |       | $                                                        | 221,667    |   | 100.0 | % | $ | 119,037 |   | $ | 115,696 |   | $ | 188,114 |   | 100.0 | % | $ | 76,049 |   | $ | 74,734 |   |

 

27

----

 
| ** **                    | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------|------------|---------------------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                    | ** ** | **Gross**                                               | ** ** | ** ** | ** ** | **Net** | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** | **Net** | ** ** |
| ** **                    | ** ** | **Written**                                             | ** ** | ** ** | ** ** | **Written** | ** ** | **Earned** | ** ** | **Written** | ** ** | ** ** | ** ** | **Written** | ** ** | **Earned** | ** ** |
| ** **                    | ** ** | **Premium**                                             | ** ** | **%** | ** ** | **Premium** | ** ** | **Premium** | ** ** | **Premium** | ** ** | **%** | ** ** | **Premium** | ** ** | **Premium** | ** ** |
| ** **                    | ** ** | **($ in thousands)**                          | ** ** |
| Insurance Companies:          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                        |       | $                                                       | 209,928    |   | 28.5 | % | $ | 101,891 |   | $ | 80,679 |   | $ | 181,500 |   | 30.5 | % | $ | 68,189 |   | $ | 57,600 |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty                     |       | 219,843                                                 |       | 29.8 | % | 136,246 |   | 121,133 |   | 152,454 |   | 25.6 | % | 107,991 |   | 81,429 |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Professional Liability        |       | 65,164                                                  |       | 8.9 | % | 34,894 |   | 29,494 |   | 60,708 |   | 10.2 | % | 24,333 |   | 21,493 |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Assumed from Lloyd’s     |       | 1,070                                                   |       | 0.1 | % | 241 |   | 100 |   | (1,066 | ) | -0.2 | % | (1,209 | ) | (320 | ) |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other                         |       | 211                                                     |       | 0.0 | % | 5 |   | (72 | ) | 90 |   | 0.0 | % | 45 |   | 46 |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Insurance Companies Total     |       | 496,216                                                 |       | 67.3 | % | 273,277 |   | 231,334 |   | 393,686 |   | 66.1 | % | 199,349 |   | 160,248 |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s Operations:      |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                        |       | 202,074                                                 |       | 27.4 | % | 107,026 |   | 99,029 |   | 168,458 |   | 28.3 | % | 77,392 |   | 74,643 |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Professional Liability        |       | 16,104                                                  |       | 2.1 | % | 6,326 |   | 2,130 |   | 4,718 |   | 0.8 | % | 1,855 |   | 711 |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other                         |       | 23,422                                                  |       | 3.2 | % | 5,082 |   | 1,466 |   | 27,343 |   | 4.6 | % | 7,800 |   | 2,502 |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s Operations Total |       | 241,600                                                 |       | 32.7 | % | 118,434 |   | 102,625 |   | 200,519 |   | 33.7 | % | 87,047 |   | 77,856 |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Intercompany elimination      |       | —                                                  |       | 0.0 | % | — |   | — |   | 1,038 |   | 0.2 | % | — |   | — |   |
|                          |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                         |       | $                                                       | 737,816    |   | 100.0 | % | $ | 391,711 |   | $ | 333,959 |   | $ | 595,243 |   | 100.0 | % | $ | 286,396 |   | $ | 238,104 |   |

 

28

----

 

**Gross Written Premium**

 

Insurance Companies’ Gross Written Premium

 

*Marine Premium.*  Thegross written premium for the first nine months of 2006 consisted of 32% marineliability, 21% offshore energy, 10% cargo, 9% transport, 9% protection andindemnity (P&I) and 8% bluewater hull with the remainder in several othermarine related classes of business.

 

Themarine gross written premium for the 2006 third quarter and first nine monthsincreased 2% and 16%, respectively, compared to the same periods in 2005 reflectinggrowth across several lines of business including offshore energy, liabilityand P&I.  The average renewal premiumrates during the third quarter and first nine months of 2006 increased byapproximately 13% in each of the periods. Navigators Insurance Company has in the past obtained its marinebusiness through participation in the marine pool managed by the NavigatorsAgencies.  Commencing in 2006, the marinepool has been eliminated and, therefore, all of the marine business generatedby the Navigators Agencies is exclusively for the Insurance Companies.  Navigators Insurance Company participated for85% of the marine pool in 2005.

* *

*Specialty Premium.* The gross written premium written in thefirst nine months of 2006 consisted of 53% general liability business for smallgeneral and artisan contractors, 19% excess casualty business, 11% personalumbrella business and 17% other targeted commercial risks.  The specialty gross written premium increased44% in both the third quarter and first nine months of 2006, compared to thesame 2005 periods reflecting growth across all lines of business includingpremiums generated from our excess casualty business which started in the firstquarter of 2005.  The average renewalpremium rates decreased by approximately 3% and 5% for the contractors’liability business in the 2006 third quarter and first nine months,respectively.

 

*Professional Liability Premium.*  Thegross written premium for the first nine months of 2006 consisted of 67%D&O liability coverage for privately held and publicly traded corporations,25% professional liability coverage for lawyers and other professionals and 8%professional liability coverage for architects and engineers. In 2002, theprofessional liability business was expanded to include errors and omissionsinsurance and employment practices liability coverages.  Commencing in October 2004, our U.K. Branchbegan writing professional liability coverages for U.K. solicitors and, in2005, we began writing professional liability coverages for architects andengineers.  The professional liabilitygross written premium for the 2006 third quarter and first nine monthsincreased 6% and 7%, respectively, compared to the same periods in 2005.  Approximately $5.0 million of internationalprofessional liability business written by the Insurance Companies in 2005 hasbeen renewed in the Lloyd’s Operations in 2006. Average overall renewal premium rates for the professional liabilitybusiness decreased by approximately 4% in the 2006 third quarter and increasedapproximately 1% in the first nine months of 2006.  D&O renewal premium rates, included inthe overall professional liability rate change, decreased by approximately 8%in the 2006 third quarter and approximately 1% in the first nine months of2006.

 

Duringthe 2006 first quarter, the Company entered into an agreement to acquire therenewal rights to the D&O and employment practices liability policyportfolios of Genesis Professional Liability Managers, Inc. (“Genesis”).  The transaction does not include any past orexisting liabilities of the policy portfolios. The Company will pay an annual override or fee to Genesis based on grosswritten premium for a two year period to the extent the Genesis business isunderwritten and renewed by the Company. The Company believes that it may renew between $5 million to $10 millionof premium from such business over an annual period.  However, the amount renewed may be a lesser orgreater amount than expected.  ThroughSeptember 30, 2006, $4.2 million of the Genesis business has been renewed.

 

29

----

 

Lloyd’s Operations’Gross Written Premium

 

*Marine Premium.*The gross written premium for the first ninemonths of 2006**consisted of 40% cargo and specie, 25%offshore energy and 21% marine liability with the remainder in several othermarine related classes of business.

 

Our gross written premium is based on the stampcapacity of Syndicate 1221 and the percentage of such stamp capacity weprovide.  Our percentage of participationin the stamp capacity is 100% for 2006 compared to 97.5% for 2005.  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 wasinitially reduced to £112.5 million ($204.8 million) in 2006 from £135 million($246.0 million) in 2005.  During 2006, the Company has increasedSyndicate 1221’s stamp capacity to £123.5 million ($224.8 million).  The marine gross written premium for the 2006third quarter and first nine months decreased 5% and increased 20%,respectively, compared to the same periods in 2005.  Excluding inwards reinstatement premiums onassumed business of $4.5 million recorded for Hurricanes Katrina and Rita inthe third quarter of 2005, the marine gross written premium for the 2006 thirdquarter and first nine months increased 5% and 23%, respectively, reflectinggrowth across several lines of business, but primarily in offshore energy.  The average renewal premium rates during thethird quarter and first nine months of 2006 increased by approximately 11% and14%, respectively.

 

*Professional Liability Premium.*  Our Lloyd’s Operations commenced writinginternational professional liability business during the 2005 second quarterand produced $9.0 million and $16.1 million of gross written premium in the2006 third quarter and first nine months, respectively, versus $3.1 million and$4.7 million for the third quarter and first nine months of 2005.

 

*Other Premium. *Other premiumconsists of premium for engineering and construction business which providescoverage for construction projects including machinery, equipment and loss ofuse due to delays and of premium for onshore energy business which principallyfocuses on the oil and gas, chemical and petrochemical industries withcoverages primarily for 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 the Insurance Companies or the Lloyd’s Operations.

 

30

----

 

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

 
| ** **                | ** ** | **Three Months Ended September 30,** | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|
| ** **                | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                | ** ** | ** **                                               | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                | ** ** | **Ceded**                                                | ** ** | **Gross** | ** ** | **Ceded** | ** ** | **Gross** | ** ** |
| ** **                | ** ** | **Written**                                              | ** ** | **Written** | ** ** | **Written** | ** ** | **Written** | ** ** |
| ** **                | ** ** | **Premium**                                              | ** ** | **Premium** | ** ** | **Premium** | ** ** | **Premium** | ** ** |
| ** **                | ** ** | **($ in thousands)**                           | ** ** |
| * *                  | * *   | * *                                                 | * *   | * * | * * | * * | * * | * * | * * |
| Insurance Companies:      |       |                                                     |       |   |   |   |   |   |   |
| Marine                    |       | $                                                        | 29,550     |   | 54.6 | % | $ | 41,706 |   | 78.6 | % |
| Specialty                 |       | 32,752                                                   |       | 38.2 | % | 20,994 |   | 35.4 | % |
| Professional Liability    |       | 9,398                                                    |       | 41.1 | % | 11,705 |   | 54.4 | % |
| Assumed from Lloyd’s |       | 626                                                      |       | NM |   | 152 |   | NM |   |
| Other                     |       | 159                                                      |       | NM |   | 68 |   | NM |   |
| Subtotal                  |       | 72,485                                                   |       | 44.3 | % | 74,625 |   | 55.8 | % |
|                      |       |                                                     |       |   |   |   |   |   |   |
| Lloyd’s Operations:  |       |                                                     |       |   |   |   |   |   |   |
| Marine                    |       | 21,219                                                   |       | 47.2 | % | 32,736 |   | 69.2 | % |
| Professional Liability    |       | 5,634                                                    |       | 62.5 | % | 1,900 |   | 60.7 | % |
| Other                     |       | 3,078                                                    |       | 80.9 | % | 2,550 |   | 69.4 | % |
| Subtotal                  |       | 29,931                                                   |       | 51.8 | % | 37,186 |   | 68.7 | % |
|                      |       |                                                     |       |   |   |   |   |   |   |
| Intercompany elimination  |       | 214                                                      |       | NM |   | 254 |   | NM |   |
|                      |       |                                                     |       |   |   |   |   |   |   |
| Total                     |       | $                                                        | 102,630    |   | 46.3 | % | $ | 112,065 |   | 59.6 | % |

 

----

NM = not meaningful

 

31

----

 
| ** **                | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------|------------|---------------------------------------------------------|------------|
| ** **                | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                | ** ** | ** **                                              | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                | ** ** | **Ceded**                                               | ** ** | **Gross** | ** ** | **Ceded** | ** ** | **Gross** | ** ** |
| ** **                | ** ** | **Written**                                             | ** ** | **Written** | ** ** | **Written** | ** ** | **Written** | ** ** |
| ** **                | ** ** | **Premium**                                             | ** ** | **Premium** | ** ** | **Premium** | ** ** | **Premium** | ** ** |
| ** **                | ** ** | **($ in thousands)**                          | ** ** |
| * *                  | * *   | * *                                                | * *   | * * | * * | * * | * * | * * | * * |
| Insurance Companies:      |       |                                                    |       |   |   |   |   |   |   |
| Marine                    |       | $                                                       | 108,037    |   | 51.5 | % | $ | 113,311 |   | 62.4 | % |
| Specialty                 |       | 83,597                                                  |       | 38.0 | % | 44,463 |   | 29.2 | % |
| Professional Liability    |       | 30,270                                                  |       | 46.5 | % | 36,375 |   | 59.9 | % |
| Assumed from Lloyd’s |       | 829                                                     |       | 77.5 | % | 143 |   | -13.4 | % |
| Other (includes run-off)  |       | 206                                                     |       | NM |   | 45 |   | NM |   |
| Subtotal                  |       | 222,939                                                 |       | 44.9 | % | 194,337 |   | 49.4 | % |
|                      |       |                                                    |       |   |   |   |   |   |   |
| Lloyd’s Operations:  |       |                                                    |       |   |   |   |   |   |   |
| Marine                    |       | 95,048                                                  |       | 47.0 | % | 91,066 |   | 54.1 | % |
| Professional Liability    |       | 9,778                                                   |       | 60.7 | % | 2,863 |   | 60.7 | % |
| Other                     |       | 18,340                                                  |       | 78.3 | % | 19,543 |   | 71.5 | % |
| Subtotal                  |       | 123,166                                                 |       | 51.0 | % | 113,472 |   | 56.6 | % |
|                      |       |                                                    |       |   |   |   |   |   |   |
| Intercompany elimination  |       | —                                                  |       | NM |   | 1,038 |   | NM |   |
|                      |       |                                                    |       |   |   |   |   |   |   |
| Total                     |       | $                                                       | 346,105    |   | 46.9 | % | $ | 308,847 |   | 51.9 | % |

 

----

NM = not meaningful

 

Theratios of ceded written premium to gross written premium in the 2006 thirdquarter and nine month periods were 46.3% and 46.9%, respectively, compared tothe 2005 third quarter and nine month periods of 59.6% and 51.9%,respectively.  The decrease in the ratioof ceded written premium to gross written premium in the 2006 periods comparedto the same periods in 2005 was due to a combination of factors.

 

Commencingwith the 2006 underwriting year, the marine pool has been eliminated andtherefore, all of the marine business generated by the Navigators Agencies isexclusively for the Insurance Companies. The 2005 underwriting year marine business was ceded 15% to pool membersand 85% retained by the Insurance Companies. In 2005, members shared the 15% pro rata costs and benefits of all quotashare and excess of loss reinsurance ceded by the pool which was alsoeliminated in 2006.

 

Alsocommencing with the 2006 underwriting year, our Lloyd’s Operations is retainingmore of Syndicate 1221’s business with the 2005 purchase of the 2.5% minorityinterest in Syndicate 1221 and the replacement of a 5% capacity provider withour own letter of credit funding.

 

Somewhatoffsetting the reduction in ceded premiums due to the marine pool eliminationand increased retention of business in Syndicate 1221 were changes in the 2006reinsurance structure and amounts ceded under marine quota share and excess ofloss agreements for the Insurance Companies and the Lloyd’s Operationsreflecting higher reinsurance costs resulting from the tightened marketconditions for catastrophe loss protection as a result of the 2005industry-wide hurricane losses.

 

32

----

 

The 2005 third quarter and nine months marine cededpremium for the Insurance Companies and Lloyd’s Operations included $9.1million and $5.3 million, respectively, for ceded reinstatement premiums as aresult of Hurricanes Katrina and Rita.

 

Additionally, as the professional liability businesswe have been writing since 2001 matures, we have been retaining more of thebusiness by increasing our net retentions on the professional liability prorata reinsurance treaty renewals each April 1.

 

The net effects of the items discussed above on thedecrease in the ratio of ceded written premium to gross written premium for thenine months ended September 30, 2006 were somewhat offset as the 2005first quarter ceded premium was reduced by approximately $14.5 millionresulting from the cancellation of a quota share reinsurance agreement forspecialty business effective March 31, 2005. Such amount represented theunearned portion of the premium ceded to the reinsurance agreement that wasretained. This retained amount was offset by $8.2 million of premiums ceded tothe reinsurance agreement during the 2005 first quarter.

 

**NetWritten Premium**. Net written premiumincreased 57% in the 2006 third quarter and increased 37% in the first ninemonths of 2006 compared to the same periods in 2005. Net written premiumincreased 32% in the 2006 third quarter and increased 30% in the first ninemonths of 2006 compared to the same periods in 2005, when the effects for ceded reinstatement premiums as a resultof Hurricanes Katrina and Rita are excluded. The increase in net written premiumfor the 2006 third quarter and nine month period is principally due to businessexpansion in all of the Company’s business units coupled with retaining more ofthe business written.

 

**Net Earned Premium**. Net earned premium,which generally lags the increase in net written premium, increased 55% in the2006 third quarter and increased 40% in the first nine months of 2006 comparedto the same periods in 2005 as a result of the increased net written premiumdiscussed above. Net earned premium increased 30% in the 2006 third quarter andincreased 32% in the first nine months of 2006 compared to the same periods in2005, when the effects of ceded reinstatement premium resulting fromHurricanes Katrina and Rita are excluded.

 

**CommissionIncome****.**Commission income from unaffiliated businesswas $0.6 million and $2.5 million in the 2006 third quarter and nine monthperiods, respectively, compared to $1.0 million and $3.8 million in the thirdquarter and first nine months of 2005, respectively. The declines are primarilydue to the Company eliminating the marine pool beginning with the 2006underwriting year and therefore not receiving commission income from theunaffiliated pool members on the 2006 marine business.

 

**NetInvestment Income****.**Net investment income increased 60% in both the 2006 third quarter andfirst nine months of 2006 compared to the same periods in 2005 due to theincrease in invested assets as a result of the positive cash flow from theincreased premium volume, the $123.8 million of net proceeds from the October 2005common stock offering and the $123.5 million of net proceeds from the April 20067% Senior Notes offering and due to the increase in the portfolio yield.

 

**NetRealized Capital Gains and Losses****.**Pre-tax net income includeda net realized capital loss of $151,000 for the three months ended September 30,2006 compared to a net realized capital gain of $344,000 for the 2005 thirdquarter. On an after-tax basis, the net realized capital loss was $104,000 or$0.01 per share compared to a net realized capital gain of $224,000 or $0.02per share for the 2005 third quarter. Pre-tax net income included a netrealized capital loss of $767,000 for the nine months ended September 30,2006 compared to a net realized capital gain of $927,000 for the first ninemonths of 2005. On an after-tax basis, the net realized capital loss was$520,000 or $0.03 per share for the first nine months of 2006 compared to a netrealized capital gain of $603,000 or $0.05 per share for the first nine monthsof 2005.

 

**OtherIncome/(Expense)****.**Other income/(expense) for the third quartersand first nine months of both 2006 and 2005 consisted primarily of foreignexchange gains and losses from our Lloyd’s Operations and inspection feesrelated to the specialty insurance business.

 

33

----

 

**OperatingExpenses**

 

*NetLosses and Loss Adjustment Expenses Incurred*. The ratios of net losses and loss adjustment expenses incurred to netearned premium (loss ratios) for the 2006 and 2005 third quarters were 55.7%and 102.8%, respectively, and 57.9% and 74.2% for the first nine months of 2006and 2005, respectively. The 2006 third quarter and nine month loss ratios werefavorably impacted by 5.1 and 3.8 loss ratio points, respectively, resultingfrom a redundancy of prior year loss reserves. The 2005 third quarter wasadversely impacted by $22.3 million of net losses from Hurricanes Katrina andRita and the effect of the $14.5 million of reinstatement premium caused by theceded losses from those two hurricanes, which increased the loss ratio for thefirst quarter and first nine months of 2005 by 41.7 and 13.1 loss ratio points,respectively.

 

The following tables set forth our net loss and LAEreserves by segment and line of insurance business and the total case reservesand incurred but not reported (“IBNR”) reserves as of September 30, 2006and December 31, 2005:

 
| ** **                            | ** ** | **September 30,**         | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2006**                       | ** ** | **2005**              | ** ** |
| ** **                            | ** ** | **($ in thousands)** | ** ** |
| Insurance  Companies:                 |       |                           |       |                  |       |
| Marine.                               |       | $                              | 173,350    |                  | $          | 162,644 |   |
| Specialty                             |       | 239,378                        |       | 193,755               |       |
| Professional  Liability               |       | 46,490                         |       | 33,133                |       |
| Assumed from  Lloyd’s Operations |       | 972                            |       | 1,218                 |       |
| Other  (primarily run-off business)   |       | 18,588                         |       | 19,613                |       |
| Total  Insurance Companies            |       | 478,778                        |       | 410,363               |       |
|                                  |       |                           |       |                  |       |
| Lloyd’s  Operations:             |       |                           |       |                  |       |
| Marine                                |       | 169,295                        |       | 161,262               |       |
| Other                                 |       | 8,690                          |       | 7,351                 |       |
| Total Lloyd’s  Operations        |       | 177,985                        |       | 168,613               |       |
|                                  |       |                           |       |                  |       |
| Total net  loss reserves              |       | $                              | 656,763    |                  | $          | 578,976 |   |
|                                  |       |                           |       |                  |       |
| Total net  case loss and LAE reserves |       | $                              | 227,202    |                  | $          | 228,423 |   |
| Total net  IBNR loss and LAE reserves |       | 429,561                        |       | 350,553               |       |
| ** **                            | ** ** | ** **                     | ** ** | ** **            | ** ** |
| Total net  loss and LAE reserves      |       | $                              | 656,763    |                  | $          | 578,976 |   |

 

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 can be given that actual claims made andrelated payments will not be in excess of the 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 suchadjustments, ultimate liability may exceed or be less than the revisedestimates.

 

There are a number of factors that could causeactual losses and loss adjustment expenses to differ materially from the amountthat we have reserved for losses and loss adjustment expenses.

 

34

----

 

The process of establishing loss reserves is complexand imprecise as it must take into account many variables that are subject tothe outcome of future events. As a result, informed subjective judgments as toour ultimate exposure to losses are an integral component of our loss reservingprocess.

 

IBNR loss reserves are calculated by the Company’sactuaries using several standard actuarial methodologies, including the paidand incurred loss development and the paid and incurred Bornheutter-Fergusonloss methods. Additional analyses, such as frequency/severity analyses, areperformed for certain books of business.

 

While an annual loss reserve study is conducted foreach line of business, the timing of such studies varies throughout the year. Additionally,a review of the emergence of actual losses relative to expectations for eachline of business is conducted each quarter. A separate analysis of our asbestosand environmental liability exposures is also performed annually and updatedquarterly. Any adjustments that result from this review are recorded in thequarter in which they are identified.

 

The actuarial methods generally utilize analysis ofhistorical patterns of the development of paid and reported losses for eachline of business by underwriting year. This process relies on the basicassumption that past experience, adjusted for the effects of currentdevelopments and likely trends, is an appropriate basis for predicting futureoutcomes. This basic assumption is particularly relevant for our marine andenergy business written by our Insurance Companies and Lloyd’s Operations wherewe generally rely on the substantial loss development data accumulated overmany years to establish IBNR loss reserves for immature underwriting years.

 

For certain long tail classes of business whereanticipated loss experience is less predictable because of the small number ofclaims and/or erratic claim severity patterns, estimates are based on bothexpected losses and actual reported losses. These classes include ourCalifornia contractors’ liability business and directors and officers liabilitybusiness, among others. For these classes, we set ultimate losses for eachunderwriting year reflecting several factors, including our evaluation of losstrends and the current risk environment. The expected ultimate losses areadjusted as the underwriting year matures.

 

While we have a significant amount of lossdevelopment data that is utilized by our actuaries to establish the IBNR lossreserves for our California contractors’ liability business, there have beensignificant changes relating to this product and its market that could affectthe applicability of our data. For example, one factor that may affectreserves and claim frequency is legislation implemented in California, whichgenerally provides consumers who experience construction defects a method otherthan litigation to obtain defect repairs. The law, which became effective July 1,2002 with a sunset provision effective January 1, 2011, provides for analternative dispute resolution system that attempts to involve all parties tothe claim at an early stage. This legislation may impact claim severity,frequency and length of settlement assumptions underlying our reserves. Accordingly,our ultimate liability may exceed or be less than current estimates due tothis variable, among others. There were approximately 1,028 specialtyconstruction liability claims open at September 30, 2006 compared to 1,012at December 31, 2005.

 

The professional liability business generatesthird-party claims which also are longer tail in nature. The professionalliability policies mostly provide coverage on a claims-made basis, wherebycoverage is generally provided only for those claims that are made during thepolicy period. These claims often involve a lengthy litigation period afterbeing reported. Our professional liability business is relatively immature, aswe first began writing the business in late 2001. Accordingly, it will takesome time to better understand the reserve trends on this business. Given thelimited history of this business, the actuaries generally utilize industry datato initially establish IBNR loss reserves, which are subsequently adjustedbased on actual and expected claim emergence as each underwriting year matures.There were approximately 898 professional liability claims open at September 30,2006 compared to 638 at December 31, 2005.

 

At the start of each underwriting year, ouractuaries and management determine an initial selected ultimate loss ratio foreach line of business. Management participation generally includes theunderwriter for the 

 

35

----

 

particularline of business, executive management, and claims and finance personnel. Generally,such determinations are based on prior year history modified where deemedappropriate for observed changes in premium rates, terms, conditions,exposures, and loss trends. Industry data is generally utilized for new linesof business.

 

As underwriting years age, for each subsequentquarter and following years, our actuaries, with management, continue to updateand refine their estimates of selected ultimate loss ratios for each line ofbusiness, by underwriting year, using the actuarial methods referred to aboveand incorporating relevant factors that generally include actual lossdevelopment, recent claims activity, number and dollar amount of open claims,risk characteristics of the particular line of business, the potential effectsof changes in underwriting and claims procedures, historic performance relativeto expectations and the relationship of the IBNR reserve levels acrossunderwriting years and between similar lines of business. The output of thisprocess results in refinements to the ultimate loss ratios. Such refinements tothe ultimate loss ratios for the prior underwriting years generate prior yearredundancies or deficiencies recorded in the year such refinements are made.

 

The following tables set forth our net loss and LAEreserves for our specialty construction liability and professional liabilitybusinesses as of September 30, 2006 and December 31, 2005:

 
| ** **                        | ** ** | **September 30, 2006** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | ** **                       | ** ** | ** ** | ** ** | **Total** | ** ** | **% of IBNR** | ** ** |
| **Type of**                  | ** ** | **Net Reported**            | ** ** | **Net** | ** ** | **Net Loss** | ** ** | **to Total Net** | ** ** |
| **Business**                      | ** ** | **Reserves**                     | ** ** | **IBNR** | ** ** | **Reserves** | ** ** | **Loss Reserves** | ** ** |
| ** **                        | ** ** | **($ in thousands)**   | ** ** |
|                              |       |                             |       |   |   |   |   |   |   |
| Specialty  construction liability |       | $                                | 32,918     |   | $ | 161,511 |   | $ | 194,429 |   | 83.1 | % |
| Professional  liability           |       | 11,771                           |       | 38,046 |   | 49,817 |   | 76.4 | % |
|                              |       |                             |       |   |   |   |   |   |   |
| Total                             |       | $                                | 44,689     |   | $ | 199,557 |   | $ | 244,246 |   | 81.7 | % |

 
| ** **                        |       | **December 31, 2005** |       |
|-----------------------------------|------------|----------------------------|------------|
| ** **                        | ** ** | ** **                 | ** ** | ** ** | ** ** | **Total** | ** ** | **% of IBNR** | ** ** |
| **Type of**                       | ** ** | **Net Reported**           | ** ** | **Net** | ** ** | **Net Loss** | ** ** | **to Total Net** | ** ** |
| **Business**                      | ** ** | **Reserves**               | ** ** | **IBNR** | ** ** | **Reserves** | ** ** | **Loss Reserves** | ** ** |
| * *                          |       | **($ in thousands)**  |       |
|                              |       |                       |       |   |   |   |   |   |   |
| Specialty  construction liability |       | $                          | 25,329     |   | $ | 141,078 |   | $ | 166,407 |   | 84.8 | % |
| Professional  liability           |       | 6,142                      |       | 28,079 |   | 34,221 |   | 82.1 | % |
|                              |       |                       |       |   |   |   |   |   |   |
| Total                             |       | $                          | 31,471     |   | $ | 169,157 |   | $ | 200,628 |   | 84.3 | % |

 

*Asbestos Liability.* Our exposure to asbestos liabilityprincipally stems from marine liability insurance written on an occurrencebasis during the mid-1980s. In general, our participation on such risks is inthe excess layers, which requires the underlying coverage to be exhausted priorto coverage being triggered in our layer. In many instances we are one of manyinsurers who participate in the defense and ultimate settlement of theseclaims, and we are generally a minor participant in the overall insurancecoverage and settlement.

 

36

----

 

The reserves we have established for asbestosexposures at September 30, 2006 and December 31, 2005 are for: (i) the2005 fourth quarter settlements of two large claims aggregating approximately$28 million for excess insurance policy limits exposed to class actionsuits against two insureds involved in the manufacturing or distribution ofasbestos products, each settlement to be paid over two years; (ii) the2004 settlement of a large claim approximating $25 million exposed to a class actionsuit which settlement will be paid over seven years starting in June 2005;(iii) other insureds not directly involved in the manufacturing ordistribution of asbestos products, but that have more than incidental asbestosexposure for their purchase or use of products that contained asbestos; and (iv) attritionalasbestos claims that could be expected to occur over time.

 

The Company has now settled the four large asbestosclaims where excess policy limits were exposed to class action suits whichgave rise to the reserve action taken in the fourth quarter of 2003. TheCompany believes that there are no remaining known claims where it would suffera material loss as a result of excess policy limits being exposed to class actionsuits for insureds involved in the manufacturing or distribution of asbestosproducts. There can be no assurances, however, that material loss development may notarise in the future from existing asbestos claims or new claims given theevolving and complex legal environment that may directly impact theoutcome of the asbestos exposures of our insureds.

 

Substantially all of our asbestos liability reservesare included in our marine loss reserves.

 
| ** **                      | ** ** | **Nine Months Ended**  | ** ** | **Year Ended**             | ** ** |
|---------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
| ** **                      | ** ** | **($ in thousands)**   | ** ** |
| * *                        | * *   | * *                         | * *   | * *                        | * *   |
| **Gross of  Reinsurance**       |       |                             |       |                            |       |
| Beginning  reserve              |       | $                                | 56,838     |                            | $          | 78,421 |   |
| Incurred  losses & LAE |       | 202                              |       | (17,409                         | )          |
| Calendar  year payments         |       | 19,861                           |       | 4,174                           |       |
| Ending  reserves                |       | $                                | 37,179     |                            | $          | 56,838 |   |
|                            |       |                             |       |                            |       |
| **Net of  Reinsurance**         |       |                             |       |                            |       |
| Beginning  reserve              |       | $                                | 30,372     |                            | $          | 31,394 |   |
| Incurred  losses & LAE |       | 187                              |       | 529                             |       |
| Calendar  year payments         |       | 9,172                            |       | 1,551                           |       |
| Ending  reserves                |       | $                                | 21,387     |                            | $          | 30,372 |   |

 

*Hurricanes Katrina and Rita*

 

During the 2005 third quarter, the Company recordedgross and net loss estimates of $471 million and $22.3 million, respectively,exclusive of $14.5 million for the cost of excess of loss reinstatementpremiums related to Hurricanes Katrina and Rita. Such estimates remainunchanged through September 30, 2006.

 

37

----

 
| ** **                    | ** ** | **Nine Months Ended**  | ** ** | **Year Ended**             | ** ** |
|-------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
| ** **                    | ** ** | **($ in thousands)**   | ** ** |
| **Gross of  Reinsurance**     |       |                             |       |                            |       |
| Beginning  reserves           |       | $                                | 465,728    |                            | $          | — |   |
| Incurred  loss & LAE |       | —                           |       | 471,027                         |       |
| Calendar  year payments       |       | 114,494                          |       | 5,299                           |       |
| Ending  reserves              |       | $                                | 351,234    |                            | $          | 465,728 |   |
|                          |       |                             |       |                            |       |
| **Net of Reinsurance**        |       |                             |       |                            |       |
| Beginning  reserves           |       | $                                | 17,800     |                            | $          | — |   |
| Incurred  loss & LAE |       | —                           |       | 22,288                          |       |
| Calendar  year payments       |       | 10,474                           |       | 4,488                           |       |
| Ending  reserves              |       | $                                | 7,326      |                            | $          | 17,800 |   |

 

Our management believes that the overall estimatesfor the reserves for losses and loss adjustment expenses are adequate to coverthe ultimate cost of losses and loss adjustment expenses on reported andunreported claims. However, it is possible that the ultimate liability may exceedor be less than such estimates. To the extent that reserves are deficient orredundant, the amount of such deficiency or redundancy is treated as a chargeor credit to earnings in the period in which the deficiency or redundancy isidentified.

 

*CommissionExpense.* Commissionexpense paid to unaffiliated brokers and agents is generally based on apercentage of the gross written premium and is reduced by ceding commissionsthe Company may receive on the ceded written premium. Commissions aregenerally deferred and recorded as deferred policy acquisition costs to theextent that they relate to unearned premium. Commission expense as a percentageof earned premium in the 2006 third quarter and nine month period was 11.9% and12.3%, respectively, compared to 15.6% and 12.8% for the 2005 comparableperiods. Commission expense was 13.1% in the 2005 third quarter and 12.1% in the firstnine months of 2005 when the effects for ceded reinstatement premiums asa result of Hurricanes Katrina and Rita are excluded.

 

*OtherOperating Expenses.*The 30% and 16% increase in other operating expenses in the 2006 third quarterand nine month period, respectively, compared to the same periods in 2005 areattributable primarily to employee-related expenses resulting from expansion ofthe business. Included in the three and nine months ended September 30,2006 were $2.6 million and $4.4 million in the aggregate for employee stockoptions, stock grants and stock appreciation rights expense compared to $1.1million and $2.7 million for the same periods in 2005, respectively.

 

**Income Taxes**. The income tax expense(benefit) was $8.5 million and ($7.5) million for the third quarters of 2006and 2005, respectively. The effective tax rates for the 2006 and 2005 thirdquarters were 31.8% and (37.1%), respectively. The tax expense for the firstnine months of 2006 and 2005 was $24.9 million and $2.5 million, respectively,resulting in effective tax rates of 32.4% and 23.2%, respectively. As of September 30,2006 and December 31, 2005, the net deferred Federal, foreign, state andlocal tax assets were $29.6 million and $28.3 million, respectively.

 

We are subject to the tax regulations of theUnited States and foreign countries in which we operate. The Company files aconsolidated federal tax return, which includes all domestic subsidiaries andthe U.K. Branch. The income from the foreign operations is designated as eitherU.S connected income or non-U.S. connected income. Lloyd’s is required to payU.S. income tax on U.S. connected income (U.S. source income) written by Lloyd’ssyndicates. Lloyd’s and the IRS have entered into an agreement whereby theamount of tax due on U.S. connected income is calculated by Lloyd’s andremitted directly to the IRS. These amounts are then charged to 

 

38

----

 

the corporate members in proportion to their participation in therelevant syndicates. The Company’s corporate members are subject to thisagreement and will receive U.K. tax credits for any U.S. income tax incurred upto the U.K. income tax charge on the U.S. income. The non-U.S. connectedinsurance income would generally constitute taxable income under the Subpart Fincome section of the Internal Revenue Code since less than 50% of theCompany’s premium is derived within the U.K. and would therefore be subject toU.S. taxation when the Lloyd’s year of account closes. Taxes are accrued at a35% rate on our foreign source insurance income and foreign tax credits, whereavailable, are utilized to offset U.S. tax as permitted. The Company’seffective tax rate for Syndicate 1221 taxable income could substantially exceed35% to the extent the Company is unable to offset U.S. taxes paid under Subpart Ftax regulations with U.K. tax credits on future underwriting year distributions.U.S. taxes are not accrued on the earnings of the Company’s foreign agencies asthese earnings are not subject to the Subpart F tax regulations. Theseearnings are subject to taxes under U.K. tax regulations at a 30% rate.

 

We have not provided for U.S. deferred incometaxes on the undistributed earnings of approximately $26 million of our non-U.S. subsidiariessince these earnings are intended to be permanently reinvested in the foreignsubsidiary. However, in the future, if such earnings were distributed to theCompany, taxes of approximately $1.1 millionwould be payable on such undistributed earnings and would be reflected in thetax provision for the year in which these earnings are no longer intended to bepermanently reinvested in the foreign subsidiary assuming all foreign taxcredits are realized.

 

The Company had state and local operatingloss carryforwards amounting to potential future tax benefits of $5.9 million and $5.0 million at September 30, 2006 and December 31,2005, respectively. A valuation allowance was established for the full amountof these potential future tax benefits due to the uncertainty associated withtheir realization. The Company’s state and local tax carryforwards at September 30,2006 expire from 2021 to 2026.

 

In July 2006, the Financial AccountingStandards Board (“FASB”) issued Interpretation No. 48, *Accounting for Uncertainty in Income Taxes*(“FIN 48”),**an interpretation of FASB Statement No. 109. FIN 48,which becomes effective in 2007, establishes the threshold for recognizing thebenefits of tax-return positions in the financial statements as more-likely-than-notto be sustained by the taxing authorities, and prescribes a measurementmethodology for those positions meeting the recognition threshold. The Companyhas not yet determined the estimated impact on its financial condition orresults of operations, if any, of adopting FIN 48.

 

**Segment Information**

 

Effective in 2006, the Company classifies itsbusiness into two underwriting segments consisting of the Insurance Companiesand the Lloyd’s Operations, which are separately managed, and a Corporatesegment. Segment data for each of the two underwriting segments includeallocations of revenues and expenses of Navigators Agencies and the ParentCompany’s expenses and related income tax amounts previously reportedseparately. The Corporate segment consists of the Parent Company’s investmentincome, interest expense and the related tax effect. Segment data for 2005 andprior periods have been restated to reflect this change in segment reporting.

 

Weevaluate the performance of each segment based on its underwriting and netincome results. The Insurance Companies’ and the Lloyd’s Operations’ resultsare measured by taking into account net premiums earned, incurred losses andloss adjustment expenses, commission expense and other underwriting expenses. TheCorporate segment consists of the Parent Company’s investment income andrelated tax effect. Each segment also maintains its own investments, on whichit earns income and realizes capital gains or losses. Our underwritingperformance is evaluated separately from the performance of our investmentportfolios.

 

Followingare the financial results of the Company’s two underwriting segments.

 

39

----

 

***Insurance Companies***

 

Our Insurance Companies consist of Navigators InsuranceCompany, including its U.K. Branch, and NIC Insurance Company. NavigatorsInsurance Company is our largest insurance subsidiary and has been active since1983. It specializes principally in underwriting marine insurance and relatedlines of business, specialty liability insurance and professional liabilityinsurance. NIC Insurance Company, a wholly owned subsidiary of NavigatorsInsurance Company, began operations in 1990. It underwrites specialty andprofessional liability insurance on an excess and surplus lines basis fullyreinsured by Navigators Insurance Company. The Navigators Agencies producebusiness for the Insurance Companies.

 

Following are the results of operations for theInsurance Companies for the three and nine months ended September 30, 2006and 2005:

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                           | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | **($ in thousands)**   | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross  written premium               |       | $                                | 163,673    |                            | $          | 133,718 |   | $ | 496,216 |   | $ | 393,686 |   |
| Net written  premium                 |       | 91,188                           |       | 59,093                          |       | 273,277 |   | 199,349 |   |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Net earned  premium                  |       | 85,494                           |       | 53,778                          |       | 231,334 |   | 160,248 |   |
| Net losses  and LAE                  |       | (47,926                          | )          | (47,332                         | )          | (135,556 | ) | (114,856 | ) |
| Commission  expense                  |       | (9,889                           | )          | (6,465                          | )          | (24,925 | ) | (15,597 | ) |
| Other  operating expenses            |       | (16,697                          | )          | (13,284                         | )          | (44,096 | ) | (37,540 | ) |
| Commission  income and other income  |       | 661                              |       | 704                             |       | 2,661 |   | 3,599 |   |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Underwriting  profit (loss)          |       | 11,643                           |       | (12,599                         | )          | 29,418 |   | (4,146 | ) |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Investment  income                   |       | 12,345                           |       | 7,694                           |       | 34,778 |   | 22,037 |   |
| Net realized  capital gains (losses) |       | (29                              | )          | 401                             |       | (329 | ) | 1,348 |   |
| Income  before income taxes          |       | 23,959                           |       | (4,504                          | )          | 63,867 |   | 19,239 |   |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Income tax  expense                  |       | 7,658                            |       | (1,992                          | )          | 20,442 |   | 5,449 |   |
| Net income  (loss)                   |       | $                                | 16,301     |                            | $          | (2,512 | ) | $ | 43,425 |   | $ | 13,790 |   |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Loss and LAE  ratio                  |       | 56.1                             | %          | 88.0                            | %          | 58.6 | % | 71.7 | % |
| Commission  expense ratio            |       | 11.6                             | %          | 12.0                            | %          | 10.8 | % | 9.7 | % |
| Other  operating expense ratio (1)   |       | 18.8                             | %          | 23.4                            | %          | 17.9 | % | 21.2 | % |
| Combined  ratio                      |       | 86.5                             | %          | 123.4                           | %          | 87.3 | % | 102.6 | % |

 

----

(1) Includes *other operating*expenses and *commission income and other income (expense).*

 

40

----

 

Followingare the underwriting results of the Insurance Companies for the three and ninemonths ended September 30, 2006 and 2005:

 
| ** **                | ** ** | **Three Months Ended September 30, 2006** | ** ** |
|---------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                | ** ** | **($ in thousands)**                                     | ** ** |
| ** **                | ** ** | **Net**                                                            | ** ** | **Losses** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                | ** ** | **Earned**                                                         | ** ** | **and LAE** | ** ** | **Underwriting** | ** ** | **Underwriting** | ** ** | **Combined Ratio** | ** ** |
| ** **                | ** ** | **Premium**                                                        | ** ** | **Incurred** | ** ** | **Expenses** | ** ** | **Profit(Loss)** | ** ** | **Loss** | ** ** | **Expense** | ** ** | **Total** | ** ** |
| Insurance Companies:      |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                    |       | $                                                                  | 29,291     |   | $ | 17,064 |   | $ | 8,696 |   | $ | 3,531 |   | 58.3 | % | 29.7 | % | 88.0 | % |
| Specialty                 |       | 45,234                                                             |       | 24,216 |   | 13,713 |   | 7,305 |   | 53.5 | % | 30.3 | % | 83.8 | % |
| Professional Liability    |       | 10,938                                                             |       | 6,417 |   | 3,615 |   | 906 |   | 58.7 | % | 33.1 | % | 91.8 | % |
| Assumed from Lloyd’s |       | 83                                                                 |       | 51 |   | (27 | ) | 59 |   | NM |   | NM |   | NM |   |
| Other                     |       | (52                                                                | )          | 178 |   | (72 | ) | (158 | ) | NM |   | NM |   | NM |   |
| Total                     |       | $                                                                  | 85,494     |   | $ | 47,926 |   | $ | 25,925 |   | $ | 11,643 |   | 56.1 | % | 30.4 | % | 86.5 | % |

 
| ** **                | ** ** | **Three Months Ended September 30, 2005** | ** ** |
|---------------------------|------------|------------------------------------------------|------------|
| ** **                | ** ** | **($ in thousands)**                      | ** ** |
| ** **                | ** ** | **Net**                                        | ** ** | **Losses** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                | ** ** | **Earned**                                     | ** ** | **and LAE** | ** ** | **Underwriting** | ** ** | **Underwriting** | ** ** | **Combined Ratio** | ** ** |
| ** **                | ** ** | **Premium**                                    | ** ** | **Incurred** | ** ** | **Expenses** | ** ** | **Profit(Loss)** | ** ** | **Loss** | ** ** | **Expense** | ** ** | **Total** | ** ** |
| Insurance Companies:      |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                    |       | $                                              | 14,391     |   | $ | 23,850 |   | $ | 6,846 |   | $ | (16,305 | ) | 165.7 | % | 47.6 | % | 213.3 | % |
| Specialty                 |       | 31,965                                         |       | 19,184 |   | 9,403 |   | 3,378 |   | 60.0 | % | 29.4 | % | 89.4 | % |
| Professional Liability    |       | 7,786                                          |       | 5,205 |   | 2,617 |   | (36 | ) | 66.9 | % | 33.6 | % | 100.5 | % |
| Assumed from Lloyd’s |       | (356                                           | )          | (575 | ) | 163 |   | 56 |   | NM |   | NM |   | NM |   |
| Other                     |       | (8                                             | )          | (332 | ) | 16 |   | 308 |   | NM |   | NM |   | NM |   |
| Total                     |       | $                                              | 53,778     |   | $ | 47,332 |   | $ | 19,045 |   | $ | (12,599 | ) | 88.0 | % | 35.4 | % | 123.4 | % |

 

41

----

 
| ** **                 | ** ** | **Nine Months Ended September 30, 2006** | ** ** |
|----------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                 | ** ** | **($ in thousands)**                                    | ** ** |
| ** **                 | ** ** | **Net**                                                           | ** ** | **Losses** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **Earned**                                                        | ** ** | **and LAE** | ** ** | **Underwriting** | ** ** | **Underwriting** | ** ** | **Combined Ratio** | ** ** |
| ** **                 | ** ** | **Premium**                                                       | ** ** | **Incurred** | ** ** | **Expenses** | ** ** | **Profit(Loss)** | ** ** | **Loss** | ** ** | **Expense** | ** ** | **Total** | ** ** |
| Insurance  Companies:      |       |                                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                     |       | $                                                                 | 80,679     |   | $ | 47,609 |   | $ | 22,038 |   | $ | 11,032 |   | 59.0 | % | 27.3 | % | 86.3 | % |
| Specialty                  |       | 121,133                                                           |       | 69,177 |   | 35,312 |   | 16,644 |   | 57.1 | % | 29.2 | % | 86.3 | % |
| Professional  Liability    |       | 29,494                                                            |       | 18,715 |   | 9,076 |   | 1,703 |   | 63.5 | % | 30.8 | % | 94.3 | % |
| Assumed from  Lloyd’s |       | 100                                                               |       | (155 | ) | (36 | ) | 291 |   | NM |   | NM |   | NM |   |
| Other                      |       | (72                                                               | )          | 210 |   | (30 | ) | (252 | ) | NM |   | NM |   | NM |   |
| Total                      |       | $                                                                 | 231,334    |   | $ | 135,556 |   | $ | 66,360 |   | $ | 29,418 |   | 58.6 | % | 28.7 | % | 87.3 | % |

 
| ** **                | ** ** | **Nine Months Ended September 30, 2005** | ** ** |
|---------------------------|------------|-----------------------------------------------|------------|
| ** **                | ** ** | **($ in thousands)**                     | ** ** |
| ** **                | ** ** | **Net**                                       | ** ** | **Losses** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                | ** ** | **Earned**                                    | ** ** | **and LAE** | ** ** | **Underwriting** | ** ** | **Underwriting** | ** ** | **Combined Ratio** | ** ** |
| ** **                | ** ** | **Premium**                                   | ** ** | **Incurred** | ** ** | **Expenses** | ** ** | **Profit(Loss)** | ** ** | **Loss** | ** ** | **Expense** | ** ** | **Total** | ** ** |
| Insurance Companies:      |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                    |       | $                                             | 57,600     |   | $ | 52,461 |   | $ | 17,437 |   | $ | (12,298 | ) | 91.1 | % | 30.3 | % | 121.4 | % |
| Specialty                 |       | 81,429                                        |       | 49,639 |   | 25,547 |   | 6,243 |   | 61.0 | % | 31.4 | % | 92.4 | % |
| Professional Liability    |       | 21,493                                        |       | 14,676 |   | 6,710 |   | 107 |   | 68.3 | % | 31.2 | % | 99.5 | % |
| Assumed from Lloyd’s |       | (320                                          | )          | (890 | ) | 466 |   | 104 |   | NM |   | NM |   | NM |   |
| Other                     |       | 46                                            |       | (1,030 | ) | (622 | ) | 1,698 |   | NM |   | NM |   | NM |   |
| Total                     |       | $                                             | 160,248    |   | $ | 114,856 |   | $ | 49,538 |   | $ | (4,146 | ) | 71.7 | % | 30.9 | % | 102.6 | % |

 

Netearned premium of the Insurance Companies increased 59% and 44% in the 2006third quarter and nine month period, respectively, compared to the same periodslast year reflective of business expansion in all business units coupled withincreased retention of the business written. Net earned premium of the Insurance Companiesincreased 36% in the 2006 third quarter and increased 37% in the first ninemonths of 2006 compared to the same periods in 2005, when the effects forceded reinstatement premiums as a result of Hurricanes Katrina and Rita areexcluded.

 

Excluding the 2005 hurricane losses, underwritingresults generally reflect the favorable industry market conditions over thelast three to four years coupled with satisfactory loss trends in theaforementioned periods. The 2006 third quarter and nine month loss ratios werefavorably impacted by prior year loss reserve redundancies of $4.9 million and$9.3 million, respectively, or 5.7 and 4.0 loss ratio points, respectively. TheInsurance Companies 2005 third quarter marine net earned premium was reduced by$9.1 million due to reinstatement premiums related to the ceded losses fromHurricanes Katrina and Rita. The 2005 third quarter net losses and LAE incurredincreased by $7.4 million as a result of losses from such hurricanes. Thereinstatement premiums and incurred losses resulting from Hurricanes Katrinaand Rita increased the Insurance Companies’ 2005 third quarter and nine monthperiod combined ratios by 28.8 and 9.8 ratio points, respectively.

 

The approximate annualized pre-tax yields on theInsurance Companies’ investment portfolio, excluding net realized capital gainsand losses, for the 2006 third quarter and nine month period were 4.7% and4.6%, respectively, compared to 4.1% and 4.2% for the comparable 2005 periods. Theaverage duration of our Insurance Companies’ invested assets at September 30,2006 was 4.4 years. Net investment income increased in 

 

42

----

 

the2006 third quarter and nine month period compared to the same periods in 2005due to the increase in the yield and the positive cash flows resulting in alarger investment portfolio including the statutory surplus contributions of$120 million from the net proceeds of our October 2005 equity offering and$100 million from the net proceeds of our April 2006 7% Senior Notesoffering, in an environment of gradually increasing interest rates as monetarypolicy tightened.

 

***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 NavigatorsUnderwriting Ltd., an underwriting managing agency with its principal office inManchester, England, which underwrites cargo and engineering business for Lloyd’sSyndicate 1221. In January 2005, we formed Navigators NV in Antwerp,Belgium, a wholly owned subsidiary of NUAL. Navigators NV produces transportliability, cargo and marine liability premium on behalf of Syndicate 1221. TheLloyd’s Operations and Navigators Management (UK) Limited, a Navigators Agencywhich produces business for the U.K. Branch, are subsidiaries of NavigatorsHoldings (UK) Limited located in the United Kingdom.

 

Syndicate 1221 has stamp capacity of £123.5 million($224.8 million) in 2006 compared to £135 million ($246.0 million) in 2005. Stampcapacity is a measure of the amount of premium a Lloyd’s syndicate is authorizedto write based on a business plan approved by the Council of Lloyd’s. Weprovide 100% and 97.5% of Syndicate 1221’s total stamp capacity in 2006 and2005, respectively. In September 2005, the Company purchased the remainingoutstanding minority interest of the Syndicate 1221’s capacity for the 2006underwriting year.

 

Syndicate 1221’s stamp capacity is expressed net ofcommission (as is standard at Lloyd’s) of approximately 21%. The Syndicate 1221premium recorded in the Company’s financial statements is gross of commission. TheLloyd’s marine business had been subject to deteriorating pricing beginning inthe mid-1990’s. The pricing competition showed some signs of stabilizing in2000 and prices increased from 2001 through 2003. The marine rate increasesbegan to level off in 2004 and into 2005. As a result of substantial insuranceindustry losses resulting from Hurricanes Katrina and Rita in August and September 2005,the global marine insurance market is experiencing diminished capacity and rateincreases, particularly for the Gulf of Mexico offshore energy lines ofbusiness. Lloyd’s presents its results on an underwriting year basis, generallyclosing each underwriting year after three years. We make estimates for eachunderwriting year and timely accrue the expected results. Our Lloyd’sOperations included in the consolidated financial statements represent ourparticipation in Syndicate 1221.

 

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 (i) we holdan undivided interest in each asset, (ii) we are proportionately liablefor each liability and (iii) Syndicate 1221 is not a separate legalentity. At Lloyd’s, the amount to close an underwriting year into the next yearis referred to as the reinsurance to close (“RITC”) transaction. The RITCamounts represent the transfer of the assets and liabilities from theparticipants of a closing underwriting year to the participants of the nextunderwriting year. To the extent our participation in the syndicate changes,the RITC amounts vary accordingly. The RITC transaction is recorded in thefourth quarter 

 

43

----

 

asadditional written and earned premium, losses incurred, loss reserves andreceivables, all in the same amount. There are no gains or losses recorded onthe RITC 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*.

 

Whenever a member of Lloyd’s is unable to pay itsdebts to policyholders, such debts may be payable by the Lloyd’s CentralFund. If Lloyd’s determines that the Central Fund needs to be increased, it hasthe power to assess premium levies on current Lloyd’s members up to 3% of amember’s underwriting capacity in any one year. The Company does not believe thatany assessment is likely in the foreseeable future and has not provided anyallowance for such an assessment. However, based on the Company’s 2006 capacityat Lloyd’s of £123.5 million, the September 30, 2006 exchange rate of £1equals $1.82 and in the event of a maximum 3% assessment, the Company would beassessed approximately $6.7 million. In addition, beginning with the 2005underwriting year, Lloyd’s added a second tier of assets to the existingcentral fund. This second tier is being built up through a compulsory interestbearing loan to the Society of Lloyd’s from the Lloyd’s members based on thestamp capacity of each syndicate for the respective underwriting year. Thefunds are invested in assets eligible for Society of Lloyd’s solvency. The loanswill be repaid on a rolling year basis as each year closes. At September 30,2006, the Company had $3.4 million of assets loaned to this fund.

 

Following are the results of operations of the Lloyd’sOperations for the three and nine months ended September 30, 2006 and2005:

 

44

----

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                    | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | **($ in thousands)**   | ** ** |
| * *                                      | * *   | * *                         | * *   | * *                        | * *   | * * | * * | * * | * * |
| Gross  written premium                        |       | $                                | 57,780     |                            | $          | 54,142 |   | $ | 241,600 |   | $ | 200,519 |   |
| Net written  premium                          |       | 27,849                           |       | 16,956                          |       | 118,434 |   | 87,047 |   |
|                                          |       |                             |       |                            |       |   |   |   |   |
| Net earned  premium                           |       | 30,202                           |       | 20,956                          |       | 102,625 |   | 77,856 |   |
| Net losses  and LAE                           |       | (16,530                          | )          | (29,504                         | )          | (57,644 | ) | (61,812 | ) |
| Commission  expense                           |       | (3,880                           | )          | (5,191                          | )          | (16,173 | ) | (14,905 | ) |
| Other  operating expenses                     |       | (5,986                           | )          | (4,198                          | )          | (16,922 | ) | (15,014 | ) |
| Commission  income and other income (expense) |       | (906                             | )          | 780                             |       | (850 | ) | 2,036 |   |
|                                          |       |                             |       |                            |       |   |   |   |   |
| Underwriting  profit (loss)                   |       | 2,900                            |       | (17,157                         | )          | 11,036 |   | (11,839 | ) |
|                                          |       |                             |       |                            |       |   |   |   |   |
| Investment  income                            |       | 1,774                            |       | 1,439                           |       | 5,448 |   | 3,642 |   |
| Net realized  capital gains (losses)          |       | (122                             | )          | (57                             | )          | (438 | ) | (421 | ) |
| Income  before income taxes                   |       | 4,552                            |       | (15,775                         | )          | 16,046 |   | (8,618 | ) |
|                                          |       |                             |       |                            |       |   |   |   |   |
| Income tax  expense                           |       | 1,627                            |       | (5,521                          | )          | 5,650 |   | (3,017 | ) |
| Net income  (loss)                            |       | $                                | 2,925      |                            | $          | (10,254 | ) | $ | 10,396 |   | $ | (5,601 | ) |
|                                          |       |                             |       |                            |       |   |   |   |   |
| Loss and LAE  ratio                           |       | 54.7                             | %          | 140.8                           | %          | 56.2 | % | 79.4 | % |
| Commission  expense ratio                     |       | 12.8                             | %          | 24.8                            | %          | 15.8 | % | 19.1 | % |
| Other  operating expense ratio (1)            |       | 22.8                             | %          | 16.3                            | %          | 17.3 | % | 16.7 | % |
| Combined ratio                                |       | 90.3                             | %          | 181.9                           | %          | 89.3 | % | 115.2 | % |

 

----

(1)  Includes *otheroperating expenses* and *commission income andother income (expense).*

 

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 fromlate 2001 through 2003, and continuing to a lesser extent in 2004. Premium rateincreases occurred in 2005 and continued into 2006 following Hurricanes Katrinaand Rita, particularly in the offshore energy business.

 

The 2006 third quarter and nine month loss ratioswere favorably impacted by prior year loss reserve redundancies of $1.1 millionand $3.4 million, or 3.6 and 3.3 loss ratio points, respectively. The 2005third quarter and nine month net earned premium was reduced by $5.3 million dueto reinstatement premiums related to the ceded losses from Hurricanes Katrinaand Rita. The 2005 third quarter net losses and LAE incurred increased by $14.9million as a result of losses from such hurricanes. The reinstatement premiumsand incurred losses resulting from Hurricanes Katrina and Rita increased theLloyd’s Operations 2005 third quarter and nine month period combined ratios by94.6 and 25.3 ratio points, respectively.

 

The approximate annualized pre-tax yields on theLloyd’s Operations’ investment portfolio, excluding net realized capital gainsand losses, for the 2006 third quarter and nine month period were 3.2% and3.2%, respectively, compared to 2.7% and 2.4% for the comparable 2005 periods. Generally,funds invested at Lloyd’s have been invested with a relatively short averageduration in order to meet liquidity needs. The average duration 

 

45

----

 

ofour Lloyd’s Operations’ invested assets at September 30, 2006 was 1.2years. Such yields are net of interest credits to certain reinsurers for fundswithheld by our Lloyd’s Operations.

 

**Off-Balance Sheet Transactions**

 

There have been no material changes in theinformation concerning off-balance sheet transactions as stated in the Company’s2005 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 2005 Annual Report on Form 10-K. Total reserves forlosses and LAE were $1.6 billion at both September 30, 2006 and December 31,2005. There were no significant changes in the Company’s lines of business orclaims handling that would create a material change in the percentagerelationship of the projected payments by period to the total reserves.

 

The following table sets forth our contractualobligations with respect to the 7% senior unsecured notes due May 1, 2016discussed in Note 10 to the Notes to Interim Consolidated Financial Statements,included herein:

 
| ** **       | ** ** | **Payments Due by Period** | ** ** |
|------------------|------------|-------------------------------------------|------------|
| ** **       | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| ** **       | ** ** | **Total**                                 | ** ** | **1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **5 Years** | ** ** |
| ** **       | ** ** | **($ in thousands)**            | ** ** |
| * *         | * *   | * *                                  | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| 7% Senior  Notes |       | $                                         | 212,840    |   | $ | 9,090 |   | $ | 17,500 |   | $ | 17,500 |   | $ | 168,750 |   |
|                  |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**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 Companies. Secondarily, an important consideration is to optimize theafter-tax book 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 agency guaranteed andnon-guaranteed 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-” byStandard & Poor’s (“S&P”) or A3 by Moody’s shall not exceed 20% ofthe statutory surplus of the Insurance Companies. Securities rated below BBB-by S&P or Baa3 by Moody’s are not eligible to be purchased. Up to 15% ofthe statutory surplus of the Insurance Companies may be invested in equitysecurities that are actively traded on major U.S. stock exchanges. Ourinvestment guidelines prohibit investments in derivatives other than as a hedgeagainst foreign currency exposures or the writing of covered call options onthe equity portfolio.

 

The Insurance Companies’ investments are subject tothe direction and control of each company’s Board of Directors and our FinanceCommittee. The investment portfolio and the performance of the investmentmanagers are reviewed quarterly. These investments must comply with theinsurance laws of New York State, the domiciliary state of Navigators InsuranceCompany and NIC Insurance Company. These laws prescribe the type, quality andconcentration of investments which may be made by insurance companies. Ingeneral, these laws permit investments, within specified limits and subject tocertain qualifications, in Federal, state and municipal obligations, corporatebonds, preferred stocks, common stocks, mortgages and real estate.

 

46

----

 

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 Company’s Board of Directors and FinanceCommittee, and represent our share of the investments held by Syndicate 1221. Theseinvestments must comply with the rules and regulations imposed by Lloyd’sand by certain overseas regulators. The investment portfolio and theperformance of the investment managers are 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 Navigators Insurance Company.

 

All fixed maturity and equity securities arecarried at fair value. The fair value is based on quoted market prices ordealer quotes provided by independent pricing services. The following tablesshow our cash and investments as of September 30, 2006 and December 31, 2005:

 

47

----

 

 
| ** **                                                          | ** ** | ** **                     | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Cost or** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------|------------|----------------|------------|----------------|------------|------------------|------------|
| ** **                                                          | ** ** | **Fair**                       | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Amortized**    | ** ** |
| **September 30, 2006**                                    | ** ** | **Value**                      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Cost**         | ** ** |
| ** **                                                          | ** ** | **($ in thousands)** | ** ** |
| Fixed maturities:                                                   |       |                           |       |           |       |           |       |             |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| U.S. Government Treasury Bonds, GNMAs and  foreign government bonds |       | $                              | 212,896    |           | $          | 1,158          |       | $                | (2,764     | ) | $ | 214,502 |   |
| States, municipalities and political subdivisions                   |       | 325,500                        |       | 2,881          |       | (1,973         | )          | 324,592          |       |
| Mortgage- and asset-backed securities (excluding  GNMAs)            |       | 426,224                        |       | 1,411          |       | (4,367         | )          | 429,180          |       |
| Corporate bonds                                                     |       | 209,576                        |       | 2,065          |       | (2,271         | )          | 209,782          |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| Total fixed maturities (1)                                          |       | 1,174,196                      |       | 7,515          |       | (11,375        | )          | 1,178,056        |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| Equity securities - common stocks                                   |       | 32,524                         |       | 4,039          |       | (368           | )          | 28,853           |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| Cash and short-term investments                                     |       | 201,361                        |       | —         |       | —         |       | 201,361          |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| Total                                                               |       | $                              | 1,408,081  |           | $          | 11,554         |       | $                | (11,743    | ) | $ | 1,408,270 |   |

 

----

(1)          Approximately6.9% and 14.1% of total fixed maturities investments are direct andcollateralized obligations, respectively, of FNMA and FHLMC.

 
| ** **                                                          | ** ** | ** **                     | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Cost or** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------|------------|----------------|------------|----------------|------------|------------------|------------|
| ** **                                                          | ** ** | **Fair**                       | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Amortized**    | ** ** |
| **December 31, 2005**                                     | ** ** | **Value**                      | ** ** | **Gains**      | ** ** | **(Losses)**   | ** ** | **Cost**         | ** ** |
| ** **                                                          | ** ** | **($ in thousands)** | ** ** |
| Fixed maturities:                                                   |       |                           |       |           |       |           |       |             |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| U.S. Government Treasury Bonds, GNMAs and  foreign government bonds |       | $                              | 244,890    |           | $          | 2,432          |       | $                | (2,249     | ) | $ | 244,707 |   |
| States, municipalities and political subdivisions                   |       | 216,345                        |       | 1,563          |       | (2,115         | )          | 216,897          |       |
| Mortgage- and asset-backed securities (excluding  GNMAs)            |       | 358,062                        |       | 758            |       | (3,682         | )          | 360,986          |       |
| Corporate bonds                                                     |       | 164,816                        |       | 2,115          |       | (1,435         | )          | 164,136          |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| Total fixed maturities (1)                                          |       | 984,113                        |       | 6,868          |       | (9,481         | )          | 986,726          |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| Equity securities - common stocks                                   |       | 20,911                         |       | 1,893          |       | (649           | )          | 19,667           |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| Cash and short-term investments                                     |       | 177,212                        |       | —         |       | —         |       | 177,212          |       |
|                                                                |       |                           |       |           |       |           |       |             |       |
| Total                                                               |       | $                              | 1,182,236  |           | $          | 8,761          |       | $                | (10,130    | ) | $ | 1,183,605 |   |

 

----

(1)          Approximately5.6% and 10.7% of total fixed maturities investments are direct andcollateralized obligations, respectively, of FNMA and FHLMC.

 

48

----

 

AtSeptember 30, 2006 and December 31, 2005, all fixed-maturity and equitysecurities held by us were classified as available-for-sale.

 

Weregularly review our fixed maturity and equity securities portfolios toevaluate the necessity of recording impairment losses for other-than-temporarydeclines in the fair value of investments. In general, we focus our attentionon those securities whose market value was less than 80% of their cost oramortized cost, as appropriate, for six or more consecutive months. Otherfactors considered in evaluating potential impairment include the current fairvalue as compared to cost or amortized cost, as appropriate, our intent andability to retain the investment for a period of time sufficient to allow foran anticipated recovery in value, specific credit issues related to the issuerand current economic conditions.

 

Asmentioned above, the Company considers its intent and ability to hold asecurity until the value recovers as part of the process of evaluating whethera security’s unrealized loss represents an other-than-temporary decline. TheCompany’s ability to hold such securities is supported by sufficient cash flowfrom its operations and from maturities within its investment portfolio inorder to meet its claims payment and other disbursement obligations arisingfrom its underwriting operations without selling such investments. With respectto securities where the decline in value is determined to be temporary and thesecurity’s value is not written down, a subsequent decision may be made to sellthat security and realize a loss. Subsequent decisions on security sales aremade within the context of overall risk monitoring, changing information,market conditions and assessing value relative to other comparable securities. Managementof the Company’s investment portfolio is outsourced to third party investmentmanagers. While these investment managers may, at a given point in time,believe that the preferred course of action is to hold securities withunrealized losses that are considered temporary until such losses arerecovered, the dynamic nature of the portfolio management may result in asubsequent decision to sell the security and realize the loss, based upon achange in market and other factors described above. The Company believes thatsubsequent decisions to sell such securities are consistent with theclassification of the Company’s portfolio as available for sale.

 

Whena security in our investment portfolio has an unrealized loss that is deemed tobe other-than-temporary, we write the security down to fair value through acharge to operations. Significant changes in the factors we consider whenevaluating investments for impairment losses could result in a significantchange in impairment losses reported in the consolidated financial statements. Therewere no impairment losses recorded in our fixed maturity or equity securitiesportfolios in the first nine months of 2006 or 2005.

 

Thefollowing table summarizes all securities in an unrealized loss position atSeptember 30, 2006 and December 31, 2005, showing the aggregate fair value andgross unrealized loss by the length of time those securities have continuouslybeen in an unrealized loss position:

 

49

----

 
| ** **                                                          | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                          | ** ** | **Fair**                         | ** ** | **Gross**                       | ** ** | **Fair** | ** ** | **Gross** | ** ** |
| ** **                                                          | ** ** | **Value**                        | ** ** | **Unrealized Loss**        | ** ** | **Value** | ** ** | **Unrealized Loss** | ** ** |
| ** **                                                          | ** ** | ** **                       | ** ** | **($ in thousands)**  | ** ** | ** ** | ** ** |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Fixed Maturities:                                                   |       |                             |       |                            |       |   |   |   |   |
| U.S. Government Treasury Bonds, GNMAs and foreign  government bonds |       |                             |       |                            |       |   |   |   |   |
| 0-6 Months                                                          |       | $                                | 10,318     |                            | $          | 252 |   | $ | 66,229 |   | $ | 772 |   |
| 7-12 Months                                                         |       | 44,439                           |       | 536                             |       | 52,994 |   | 690 |   |
| > 12 Months                                                      |       | 88,949                           |       | 1,976                           |       | 51,234 |   | 787 |   |
| Subtotal                                                            |       | 143,706                          |       | 2,764                           |       | 170,457 |   | 2,249 |   |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| States, municipalities and political  subdivisions                  |       |                             |       |                            |       |   |   |   |   |
| 0-6 Months                                                          |       | 3,361                            |       | 52                              |       | 82,167 |   | 696 |   |
| 7-12 Months                                                         |       | 7,697                            |       | 56                              |       | 43,875 |   | 776 |   |
| > 12 Months                                                      |       | 132,721                          |       | 1,865                           |       | 24,786 |   | 643 |   |
| Subtotal                                                            |       | 143,779                          |       | 1,973                           |       | 150,828 |   | 2,115 |   |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Mortgage- and asset-backed securities (excluding  GNMAs)            |       |                             |       |                            |       |   |   |   |   |
| 0-6 Months                                                          |       | 5,339                            |       | 16                              |       | 184,145 |   | 1,847 |   |
| 7-12 Months                                                         |       | 64,265                           |       | 529                             |       | 53,485 |   | 942 |   |
| > 12 Months                                                      |       | 200,670                          |       | 3,822                           |       | 52,115 |   | 893 |   |
| Subtotal                                                            |       | 270,274                          |       | 4,367                           |       | 289,745 |   | 3,682 |   |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Corporate bonds                                                     |       |                             |       |                            |       |   |   |   |   |
| 0-6 Months                                                          |       | 2,789                            |       | 11                              |       | 45,995 |   | 576 |   |
| 7-12 Months                                                         |       | 43,400                           |       | 618                             |       | 9,109 |   | 202 |   |
| > 12 Months                                                      |       | 67,522                           |       | 1,642                           |       | 26,904 |   | 657 |   |
| Subtotal                                                            |       | 113,711                          |       | 2,271                           |       | 82,008 |   | 1,435 |   |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Total Fixed Maturities                                              |       | $                                | 671,470    |                            | $          | 11,375 |   | $ | 693,038 |   | $ | 9,481 |   |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Equity securities - common stocks                                   |       |                             |       |                            |       |   |   |   |   |
| 0-6 Months                                                          |       | $                                | 2,157      |                            | $          | 106 |   | $ | 2,200 |   | $ | 167 |   |
| 7-12 Months                                                         |       | 728                              |       | 72                              |       | 3,120 |   | 235 |   |
| > 12 Months                                                      |       | 2,091                            |       | 190                             |       | 756 |   | 247 |   |
|                                                                |       |                             |       |                            |       |   |   |   |   |
| Total Equity Securities                                             |       | $                                | 4,976      |                            | $          | 368 |   | $ | 6,076 |   | $ | 649 |   |

 

Weanalyze the unrealized losses quarterly to determine if any areother-than-temporary. The above unrealized losses have been determined to betemporary and generally result from changes in market conditions.

 

50

----

 

Thefollowing table shows the composition by National Association of InsuranceCommissioners (“NAIC”) rating and the generally equivalent Standard & Poor’s(“S&P”) and Moody’s ratings of the fixed maturity securities in ourportfolio with gross unrealized losses at September 30, 2006. Not all of thesecurities are rated by S&P and/or Moody’s.

 
| ** ** | ** ** | ** **     | ** ** | ** **       | ** ** | **Gross**                | ** ** | ** **                     | ** ** | ** ** | ** ** |
|------------|------------|----------------|------------|------------------|------------|--------------------------|------------|--------------------------------|------------|------------|------------|
| ** ** | ** ** | **Equivalent** | ** ** | **Equivalent**   | ** ** | **Unrealized Loss** | ** ** | **Fair Value**            | ** ** |
| **NAIC**   | ** ** | **S&P**    | ** ** | **Moody’s** | ** ** | ** **               | ** ** | **Percent**                    | ** ** | ** ** | ** ** | **Percent** | ** ** |
| **Rating** | ** ** | **Rating**     | ** ** | **Rating**       | ** ** | **Amount**               | ** ** | **of Total**              | ** ** | **Amount** | ** ** | **of Total** | ** ** |
| ** ** | ** ** | ** **     | ** ** | ** **       | ** ** | ** **               | ** ** | **($ in thousands)** | ** ** | ** ** | ** ** |
|       |       |           |       |             |       |                     |       |                           |       |       |       |   |   |
| 1          |       | AAA/AA/A       |       | Aaa/Aa/A         |       | $                        | 10,516     |                           | 92         | %          | $          | 631,186 |   | 94 | % |
| 2          |       | BBB            |       | Baa              |       | 859                      |       | 8                              | %          | 40,284     |       | 6 | % |
| 3          |       | BB             |       | Ba               |       | —                   |       | —                         |       | —     |       | — |   |
| 4          |       | B              |       | B                |       | —                   |       | —                         |       | —     |       | — |   |
| 5          |       | CCC or lower   |       | Caa or lower     |       | —                   |       | —                         |       | —     |       | — |   |
| 6          |       | N/A            |       | N/A              |       | —                   |       | —                         |       | —     |       | — |   |
|       |       |           |       | Total            |       | $                        | 11,375     |                           | 100        | %          | $          | 671,470 |   | 100 | % |

 

AtSeptember 30, 2006, the gross unrealized losses in the table directly above arerelated to fixed maturity securities that are rated investment grade. Investmentgrade is defined as a security having a NAIC rating of 1 or 2, a S&P ratingof “BBB–” or higher, or a Moody’s rating of “Baa3” or higher. Unrealized losseson investment grade securities principally relate to changes in interest ratesor changes in sector-related credit spreads since the securities were acquired.Any such unrealized losses are recognized in income, if the securities aresold, or if the decline in fair value is deemed other-than-temporary.

 

Thescheduled maturity dates for fixed maturity securities in an unrealized lossposition at September 30, 2006 are shown in the following table:

 
| ** **                                               | ** ** | **Gross**                | ** ** | ** **                     | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|--------------------------|------------|--------------------------------|------------|------------|------------|
| ** **                                               | ** ** | **Unrealized Loss** | ** ** | **Fair Value**            | ** ** |
| ** **                                               | ** ** | ** **               | ** ** | **Percent**                    | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                                               | ** ** | **Amount**               | ** ** | **of Total**              | ** ** | **Amount** | ** ** | **of Total** | ** ** |
| ** **                                               | ** ** | ** **               | ** ** | **($ in thousands)** | ** ** | ** ** | ** ** |
|                                                     |       |                     |       |                           |       |       |       |   |   |
| Due in one year or less                                  |       | $                        | 407        |                           | 4          | %          | $          | 58,670 |   | 9 | % |
| Due after one year through five years                    |       | 2,760                    |       | 24                             | %          | 163,648    |       | 24 | % |
| Due after five years through ten years                   |       | 1,561                    |       | 14                             | %          | 84,560     |       | 13 | % |
| Due after ten years                                      |       | 2,280                    |       | 20                             | %          | 94,318     |       | 14 | % |
| Mortgage- and asset-backed securities (excluding  GNMAs) |       | 4,367                    |       | 38                             | %          | 270,274    |       | 40 | % |
|                                                     |       |                     |       |                           |       |       |       |   |   |
| Total fixed income securities                            |       | $                        | 11,375     |                           | 100        | %          | $          | 671,470 |   | 100 | % |

 

Expectedmaturities may differ from contractual maturities because issuers may have theright to call or prepay obligations with or without call or prepaymentpenalties. Due to the periodic repayment of principal, the

 

51

----

 

mortgage-backedand asset-backed securities are estimated to have an effective maturity ofapproximately 3.7 years.

 

Ourrealized capital gains and losses for the three and nine months ended September30, 2006 and 2005 were as follows:

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                           | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | ** **                       | ** ** | **($ in thousands)**  | ** ** | ** ** | ** ** |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Fixed maturities:                    |       |                             |       |                            |       |   |   |   |   |
| Gains                                |       | $                                | 8          |                            | $          | 440 |   | $ | 349 |   | $ | 1,699 |   |
| (Losses)                             |       | (198                             | )          | (288                            | )          | (1,605 | ) | (1,245 | ) |
|                                 |       | (190                             | )          | 152                             |       | (1,256 | ) | 454 |   |
| Equity securities:                   |       |                             |       |                            |       |   |   |   |   |
| Gains                                |       | 41                               |       | 192                             |       | 525 |   | 607 |   |
| (Losses)                             |       | (2                               | )          | —                          |       | (36 | ) | (134 | ) |
|                                 |       | 39                               |       | 192                             |       | 489 |   | 473 |   |
|                                 |       |                             |       |                            |       |   |   |   |   |
| Net realized capital gains (losses). |       | $                                | (151       | )                               | $          | 344 |   | $ | (767 | ) | $ | 927 |   |

 

The following table details realized losses in excess of $250,000 fromsales and impairments during the first nine months of 2006 and 2005 and therelated circumstances giving rise to the loss:

** **
| ** **                            | ** ** | ** **                     | ** ** | ** **         | ** ** | ** **         | ** ** | ** **     | ** ** | ** **                       | ** ** | ** **     | ** ** | **# of Months** | ** ** |
|---------------------------------------|------------|--------------------------------|------------|--------------------|------------|--------------------|------------|----------------|------------|----------------------------------|------------|----------------|------------|---------------------------|------------|
| ** **                            | ** ** | ** **                     | ** ** | ** **         | ** ** | ** **         | ** ** | ** **     | ** ** | ** **                       | ** ** | ** **     | ** ** | **Unrealized Loss**  | ** ** |
| ** **                            | ** ** | ** **                     | ** ** | ** **         | ** ** | ** **         | ** ** | ** **     | ** ** | ** **                       | ** ** | **Net**        | ** ** | **Exceeded 20%**     | ** ** |
| ** **                            | ** ** | **Date of**               | ** ** | **Proceeds**       | ** ** | **(Loss) on** | ** ** | ** **     | ** ** | **Holdings at**             | ** ** | **Unrealized** | ** ** | **of Cost or**  | ** ** |
| **Description**                       | ** ** | **Sale**                       | ** ** | **from Sale** | ** ** | **Sale**           | ** ** | **Impairment** | ** ** | **September 30, 2006** | ** ** | **(Loss)**     | ** ** | **Amortized Cost**   | ** ** |
| ** **                            | ** ** | **($ in thousands)** | ** ** |
| Nine months ended September 30, 2006: |       |                           |       |               |       |               |       |           |       |                             |       |           |       |                      |       |
|                                  |       |                           |       |               |       |               |       |           |       |                             |       |           |       |                      |       |
| TIPS (1)                              |       | 3/31/2006                      |       | $                  | 15,418     |               | $          | (305           | )          | —                           |       | —         |       | —                    |       | — |   |
|                                  |       |                           |       |               |       |               |       |           |       |                             |       |           |       |                      |       |
| Nine months ended September 30, 2005: |       |                           |       |               |       |               |       |           |       |                             |       |           |       |                      |       |
|                                  |       |                           |       |               |       |               |       |           |       |                             |       |           |       |                      |       |
| None                                  |       |                           |       |               |       |               |       |           |       |                             |       |           |       |                      |       |
|                                       |            |                                |            |                    |            |                    |            |                |            |                                  |            |                |            |                           |            |  |  |

 

----

(1)                                  Treasuryinflation protection securities (TIPS) were sold during the 2006 first quarterdue to the widening breakeven yield spread between TIPS and Treasuries.

 

**ReinsuranceRecoverables**

 

Weutilize reinsurance principally to reduce our exposure on individual risks, toprotect against catastrophic losses, to maintain desired ratios of net writtenpremium to statutory surplus and to stabilize loss ratios and underwritingresults. Although reinsurance makes the reinsurer liable to us to the extentthe risk is transferred or ceded to the reinsurer, ceded reinsurancearrangements do not eliminate our obligation to pay

 

52

----

 

claimsto our policyholders. Accordingly, we bear credit risk with respect to ourreinsurers. Specifically, our reinsurers may not pay claims made by us on atimely basis, or they may not pay some or all of these claims. Either of theseevents would increase our costs and could have a material adverse effect on ourbusiness. We are required to pay the losses even if the reinsurer fails to meetits obligations under the reinsurance agreement. Hurricanes Katrina and Ritaincreased our reinsurance recoverables significantly which increased our creditrisk.

 

Weare protected by various treaty and facultative reinsurance agreements. Ourexposure to credit risk from any one reinsurer is managed throughdiversification by reinsuring with a number of different reinsurers,principally in the United States and European reinsurance markets. To meet ourstandards of acceptability, when the reinsurance is placed, a reinsurergenerally must have an A.M. Best Company and/or Standard & Poor’s rating of“A” or better, or equivalent financial strength if not rated, plus at least$250 million in policyholders’ surplus. Our Reinsurance Security Committeemonitors the 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.

 

Theincrease in *reinsurance receivable on paid losses*was primarily due to the ceded portion of paid losses resulting from HurricanesKatrina and Rita which are in the process of being collected from variousreinsurers.

 

Charges(recoveries) for uncollectible reinsurance amounts, all of which were recordedto incurred losses, were $218,000 and ($505,000) for the three months endedSeptember 30, 2006 and 2005, respectively, and $516,000 and $109,000 for thenine months ended September 30, 2006 and 2005, respectively.

 

TheCompany continues to periodically monitor the financial condition and ongoingactivities of its reinsurers, in order to assess the adequacy of its allowancefor uncollectible reinsurance.

 

**Liquidity and Capital Resources**

 

Cashflow provided by operations was $ 92.7 million and $167.9 million for the ninemonths ended September 30, 2006 and 2005, respectively. The positive operatingcash flow was primarily due to the increase in net written premium. Operatingcash flow was used primarily to acquire additional investment assets.

 

Thecumulative inception to date payment of gross losses from Hurricanes Katrinaand Rita at September 30, 2006 approximated $119.8 million of which $114.5 millionwas paid in 2006. Such payments reduce cash flow for the gross amount paiduntil the ceded portion of the loss is collected from the reinsurers.

 

Investmentsand cash increased to $1,408 million at September 30, 2006 from $1,182 millionat December 31, 2005. The increase was due to the positive cash flow fromoperations and the $123.5 million of net proceeds from the 7% Senior Notesoffering completed in April 2006. Net investment income was $ 14.7 million and$9.2 million for the three months ended September 30, 2006 and 2005,respectively, and $ 41.2 million and $25.8 million for the nine months endedSeptember 30, 2006 and 2005, respectively.

 

Theapproximate annualized pre-tax investment yields of the portfolio, excludingnet realized capital gains and losses were 4.5% and 4.4% for the 2006 thirdquarter and nine month period, respectively, compared to 3.8% for both the 2005third quarter and nine month period. The increase in the pre-tax investmentyield was due to the increase in interest rates as monetary policy continued totighten until mid 2006 when it leveled off, slightly offset by a small decreasein the duration of the portfolio from 4.0 years at September 30, 2005 to 3.9 yearsat September 30, 2006. The positive cash flow along with the proceeds frommaturities, calls and redemptions were reinvested at the higher prevailinginterest rates. As of September 30, 2006 and December 31, 2005, all fixedmaturity securities and equity securities held by us were classified asavailable-for-sale.

 

53

----

 

AtSeptember 30, 2006, the weighted average rating of our fixed maturityinvestments was “AA” by Standard & Poor’s and “Aa” by Moody’s. We believethat we have no significant exposure to credit risk since virtually all of thefixed maturity investment portfolio consists of investment-grade bonds. AtSeptember 30, 2006, our portfolio had an average maturity of 5.2 years andduration of 3.9 years. Management continually monitors the composition and cashflow of the investment portfolio in order to maintain the appropriate levels ofliquidity in an effort to ensure our ability to satisfy claims.

 

Wehave a credit facility provided through a consortium of banks. The creditfacility was amended in January 2005 to increase the letters of creditavailable under the facility from $80 million to $115 million and to add a $10million line of credit to the facility. The expiration of the credit facilitywas also extended from November 10, 2005 to June 30, 2007. If at that time thebanks do not renew the credit facility, we will need to find other sources toprovide the letters of credit or other collateral in order to continue ourparticipation in Syndicate 1221. The credit facility, which is denominated inU.S. dollars, is utilized primarily by Navigators Corporate Underwriters Ltd.and Millennium Underwriting Ltd. to fund our participation in Syndicate 1221which is denominated in British pounds. At September 30, 2006, letters ofcredit with an aggregate face amount of $86.6 million were issued under thecredit facility. The line of credit was unused at September 30, 2006.

 

Thecredit facility is collateralized by all of the common stock of NavigatorsInsurance Company. The credit agreement contains covenants common totransactions of this type, including restrictions on indebtedness and liens,limitations on mergers and the sale of assets, maintaining certain consolidatedtangible net worth, statutory surplus and other financial ratios. Cashdividends to shareholders are limited to $5.0 million per year. No dividendshave been declared or paid through September 30, 2006. At September 30, 2006,we were in compliance with all covenants.

 

Anamendment to the credit facility was approved by the bank consortium in April2006 for the primary purpose of permitting the Company to issue $125 million ofsenior unsecured notes. The public debt offering of the senior notes wascompleted on April 17, 2006.

 

AtSeptember 30, 2006, our consolidated stockholders’ equity was $527.5 million or$31.59 per share compared to $470.2 million or $28.30 per share at December 31,2005. The increase was primarily due to net income of $52.0 million for thefirst nine months of 2006.

 

Ourreinsurance has been placed with various U.S. and foreign insurance companiesand with selected syndicates at Lloyd’s. Pursuant to the implementation ofLloyd’s Plan of Reconstruction and Renewal, a portion of our recoverables arenow reinsured by Equitas (a separate United Kingdom authorized reinsurancecompany established to reinsure outstanding liabilities of all Lloyd’s membersfor all risks written in the 1992 or prior years of account).

 

Timelags do occur in the normal course of business between the time gross lossesare paid by the Company and the time such gross losses are billed and collectedfrom reinsurers. Recoverable amounts at September 30, 2006 are anticipated tobe billed and collected over the next several years as gross losses are paid bythe Company.

 

Generally,for pro-rata or quota share reinsurers, including pool participants, theCompany issues quarterly settlement statements for premiums less commissionsand paid loss activity, which are expected to be settled by the end of thesubsequent quarter. The Company has the ability to issue “cash calls” requiringsuch reinsurers to pay losses whenever paid loss activity for a claim ceded toa particular reinsurance treaty exceeds a predetermined amount (generally notmore than $1 million) as set forth in the pro-rata treaty. For the InsuranceCompanies, cash calls must generally be paid within 30 calendar days. There isgenerally no specific settlement period for the Lloyd’s Operations cash callprovisions, but such billings are usually paid within 45 calendar days.

 

Generally,for excess of loss reinsurers the Company pays monthly or quarterly depositpremiums based on the estimated subject premiums over the contract period(usually one year) which are subsequently adjusted

 

54

----

 

basedon actual premiums determined after the expiration of the applicablereinsurance treaty. Paid losses subject to excess of loss recoveries aregenerally billed as they occur and are usually settled by reinsurers within 30calendar days for the Insurance Companies and 30 business days for the Lloyd’sOperations.

 

TheCompany sometimes withholds funds from reinsurers and may apply ceded lossbillings against such funds in accordance with the applicable reinsuranceagreements.

 

AtSeptember 30, 2006, ceded asbestos paid and unpaid losses recoverable were$25.7 million of which $14.2 million was due from Equitas. We expect thatapproximately 70% of the gross asbestos reserves will be paid by the Companyover the next two years. The Company generally experiences significantcollection delays for a large portion of such balances given that certain reinsurersare in run-off or otherwise no longer active in the reinsurance business. Suchcircumstances are considered in the Company’s ongoing assessment of suchreinsurance recoverables.

 

TheCompany believes that it has adequately managed its cash flow requirementsrelated to reinsurance recoveries from its positive cash flows and the use ofavailable short-term funds when applicable. However, there can be no assurancesthat the Company will be able to continue to adequately manage such recoveriesin the future or that collection disputes or reinsurer insolvencies will notarise that could materially increase the collection time lags or result inrecoverable write-offs causing additional incurred losses and liquidityconstraints to the Company. The payment of gross claims and related collectionsfrom reinsurers with respect to Hurricanes Katrina and Rita could significantlyimpact the Company’s liquidity needs. However, we expect to pay the 2005hurricane losses over a period of years from cash flow and, if needed,short-term investments and expect to collect our paid reinsurance recoverablesgenerally under the terms described above.

 

Weprimarily rely upon dividends from our subsidiaries to meet our holding companyobligations. The dividends have historically come primarily from NavigatorsInsurance Company. At September 30, 2006, the approximate maximum amountavailable for the payment of dividends by Navigators Insurance Company withoutprior regulatory approval was $50.0 million. No dividends have been paid byNavigators Insurance Company in 2006.

 

Webelieve that the cash flow generated by the operating activities of oursubsidiaries will provide sufficient funds for us to meet our liquidity needsover the next twelve months. Beyond the next twelve months, cash flow availableto us may be influenced by a variety of factors, including general economicconditions and conditions in the insurance and reinsurance markets, as well asfluctuations from year to year in claims experience.

 

InApril 2006, the Company completed a public debt offering of $125 million 7%senior unsecured notes due May 1, 2016 and contributed $100 million of theproceeds to Navigators Insurance Company. The remaining net proceeds wereretained in the Parent Company for general corporate purposes.

 

CondensedParent Company balance sheets as of September 30, 2006 (unaudited) and December31, 2005 are shown in the table below:

 

55

----

 
| ** **                                       | ** ** | **September 30,**         | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2006**                       | ** ** | **2005**              | ** ** |
| ** **                                       | ** ** | **($ in thousands)** | ** ** |
| * *                                         | * *   | * *                       | * *   | * *              | * *   |
| Cash and  investments                            |       | $                              | 40,085     |                  | $          | 16,926 |   |
| Investments  in subsidiaries                     |       | 610,002                        |       | 453,023               |       |
| Goodwill and  other intangible assets            |       | 2,534                          |       | 2,534                 |       |
| Other assets                                     |       | 7,659                          |       | 3,695                 |       |
| Total assets                                     |       | $                              | 660,280    |                  | $          | 476,178 |   |
|                                             |       |                           |       |                  |       |
| Accounts  payable and other liabilities          |       | $                              | 1,137      |                  | $          | 1,800 |   |
| Accrued  interest payable                        |       | 3,986                          |       | —                |       |
| Deferred  compensation payable                   |       | 4,109                          |       | 4,140                 |       |
| 7% Senior  Notes due May 1, 2016            |       | 123,533                        |       | —                |       |
| Total  liabilities                               |       | 132,765                        |       | 5,940                 |       |
|                                             |       |                           |       |                  |       |
| Stockholders’  equity                       |       | 527,515                        |       | 470,238               |       |
| Total  liabilities and stockholders’ equity |       | $                              | 660,280    |                  | $          | 476,178 |   |

 

At September 30, 2006 approximately $4.1million of investments are held in a tax escrow account on behalf of NavigatorsInsurance Company until the two-year tax loss carryback periods expire.

 

Deferred compensation payable representsaccrued costs for employee stock appreciation rights which are paid by theoperating subsidiaries when such stock appreciation rights are exercised.

 

##### **Item 3. Quantitative and QualitativeDisclosures About Market Risk**

#####  

There have been no material changes in theinformation concerning market risk as stated in the Company’s 2005 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-15(e) under of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)), as of the end of the period covered by this quarterly report. Based onsuch evaluation, such officers have concluded that as of the end of such periodthe Company’s disclosure controls and procedures are effective in identifying,on a timely basis, material information required to be disclosed in our reportsfiled or submitted under the Exchange Act.

 

(b)         There have been no changes during our third 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**

 

Except as follows, the Company is not a partyto, or the subject of, any material legal proceedings which depart fromthe ordinary routine litigation incident to the kinds of business it conducts.

 

56

----

 

At the end of April 2006, the Companywas served as a defendant in an action in the United States District Court forthe Northern District of Georgia captioned *New Cingular WirelessHeadquarters, LLC, et al. v. March & McLennan Companies, Inc., etal.*, along with approximately 100 other defendants. On May 31,2006, this action was conditionally transferred to the United States DistrictCourt for the District of New Jersey by the Judicial Panel on MultidistrictLitigation. While it is not possible at this very preliminary stage to predictthe outcome of this litigation, the Company believes the allegations, whichinvolve contingent commissions and bid-rigging in the insurance industry, to bewithout merit and intends to vigorously defend itself against them.

 

**Item 1A.****                          RiskFactors**

 

There have been no material changes from therisk factors as previously disclosed in the Company’s 2005 Annual Report on Form 10-K.

 

**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**

 

Stephen Coward has, subject to regulatory approval,been promoted to Managing Director of Navigators Underwriting Agency Limited (“NUAL”),a wholly-owned subsidiary of the Company that manages Lloyd’s Syndicate 1221.Mr. Coward, who was previously responsible for the non-marine and energybusiness of NUAL, replaces David Hope, who left the Company effective October 23,2006 to pursue other interests.

 

**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 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*.

 

57

----

 

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: November 1, 2006 | /s / Paul J. Malvasio           |   |
|                        | Paul J. Malvasio                |
|                        | Executive Vice President        |
|                        | and Chief Financial Officer     |

 

58

----

 

**INDEX OFEXHIBITS**

 
| **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). |       |       |

 

----

*  *Included herein.*

 

59

----