** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

** **

**FORM 10-Q**

 

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

 

**For theQuarterly Period Ended   September 30,2005**

 

**Commissionfile number      0-15886**

 

**TheNavigators Group, Inc.**

(Exact name of Registrant as specified in its charter)

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

 

**(212) 244-2333**

(Registrant’s telephone number, including area code)

 

 

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

 

Indicate by check mark whetherthe Registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes   ý    No   o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes   ý    No   o

 

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

 

The number of common sharesoutstanding as of October 18, 2005 was 16,587,257.

 

 

----

 

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

 

**INDEX**

 
| Part I. FINANCIAL INFORMATION:                                  |                                                           |
|----------------------------------------------------------------------|----------------------------------------------------------------|
|                                                                 |                                                           |
| Item 1. Financial Statements                                         |                                                           |
|                                                                 |                                                           |
| Consolidated Balance Sheets                                          |                                                           |
|                                                                 | September 30, 2005 (unaudited) and December 31, 2004 |   |
|                                                                 |                                                           |
| Consolidated Statements of Income  (unaudited)                       |                                                           |
|                                                                 | Three Months Ended September 30, 2005 and 2004            |   |
|                                                                 | Nine Months Ended September 30, 2005 and 2004             |   |
|                                                                 |                                                           |
| Consolidated Statements of Stockholders’  Equity                |                                                           |
|                                                                 | September 30, 2005 and 2004 (unaudited)                   |   |
|                                                                 |                                                           |
| Consolidated Statements of Comprehensive  Income (unaudited)         |                                                           |
|                                                                 | Three Months Ended September 30, 2005 and 2004            |   |
|                                                                 | Nine Months Ended September 30, 2005 and 2004             |   |
|                                                                 |                                                           |
| Consolidated Statements of Cash Flows  (unaudited)                   |                                                           |
|                                                                 | Nine Months Ended September 30, 2005 and 2004             |   |
|                                                                 |                                                           |
| 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 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. Financial Information**

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

##### ** **

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

*($ in thousands,except share data)*

 
| ** **                                                                                                                        | ** **   | **September 30,  2005** | ** **   | **December 31,  2004** | ** **   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------------|------------------------------|--------------|-----------------------------|--------------|
| *** ***                                                                                                                      | *** *** | **(Unaudited)**              | *** *** | *** ***                | *** *** |
| **ASSETS**                                                                                                                        |         |                         |         |                        |         |
| Investments  and cash:                                                                                                            |         |                         |         |                        |         |
| Fixed maturities, available-for-sale, at  fair value (amortized cost: 2005, $854,288; 2004, $713,049)                             |         | $                            | 854,621      |                        | $            | 722,434 |   |
| Equity securities, available-for-sale, at  fair value (cost: 2005, $19,081; 2004, $19,101)                                        |         | 20,917                       |         | 21,170                      |         |
| Short-term investments, at cost which  approximates fair value                                                                    |         | 136,520                      |         | 96,653                      |         |
| Cash                                                                                                                              |         | 11,806                       |         | 14,676                      |         |
| Total investments and cash                                                                                                        |         | 1,023,864                    |         | 854,933                     |         |
|                                                                                                                              |         |                         |         |                        |         |
| Premiums in course of collection                                                                                                  |         | 163,156                      |         | 176,720                     |         |
| Commissions receivable                                                                                                            |         | 3,663                        |         | 3,062                       |         |
| Prepaid reinsurance premiums                                                                                                      |         | 146,422                      |         | 130,761                     |         |
| Reinsurance receivable on paid losses                                                                                             |         | 46,418                       |         | 20,955                      |         |
| Reinsurance receivable on unpaid losses and  loss adjustment expenses                                                             |         | 979,107                      |         | 502,329                     |         |
| Federal income tax recoverable                                                                                                    |         | 1,493                        |         | —                      |         |
| Net deferred income tax benefit                                                                                                   |         | 26,164                       |         | 17,348                      |         |
| Deferred policy acquisition costs                                                                                                 |         | 32,000                       |         | 23,882                      |         |
| Accrued investment income                                                                                                         |         | 8,638                        |         | 7,303                       |         |
| Goodwill                                                                                                                          |         | 5,072                        |         | 5,282                       |         |
| Other assets                                                                                                                      |         | 15,059                       |         | 14,103                      |         |
|                                                                                                                              |         |                         |         |                        |         |
| Total assets                                                                                                                      |         | $                            | 2,451,056    |                        | $            | 1,756,678 |   |
|                                                                                                                              |         |                         |         |                        |         |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                     |         |                         |         |                        |         |
| Liabilities:                                                                                                                      |         |                         |         |                        |         |
| Reserves for losses and loss adjustment  expenses                                                                                 |         | $                            | 1,526,027    |                        | $            | 966,117 |   |
| Unearned premium                                                                                                                  |         | 333,359                      |         | 270,970                     |         |
| Reinsurance balances payable                                                                                                      |         | 180,574                      |         | 143,427                     |         |
| Federal income tax payable                                                                                                        |         | —                       |         | 5,614                       |         |
| Payable for securities purchased                                                                                                  |         | 27,094                       |         | 3,027                       |         |
| Accounts payable and other liabilities                                                                                            |         | 51,087                       |         | 38,945                      |         |
| Total liabilities                                                                                                                 |         | 2,118,141                    |         | 1,428,100                   |         |
|                                                                                                                              |         |                         |         |                        |         |
| Stockholders’  equity:                                                                                                       |         |                         |         |                        |         |
| Preferred stock, $.10 par value, authorized  1,000,000 shares, none issued                                                        |         | —                       |         | —                      |         |
| Common stock, $.10 par value, 20,000,000  shares authorized; issued and outstanding: 12,792,257 for 2005 and 12,657,160  for 2004 |         | 1,279                        |         | 1,266                       |         |
| Additional paid-in capital                                                                                                        |         | 157,617                      |         | 154,670                     |         |
| Retained earnings                                                                                                                 |         | 171,591                      |         | 163,337                     |         |
| Accumulated other comprehensive income                                                                                            |         | 2,428                        |         | 9,305                       |         |
| Total stockholders’ equity                                                                                                   |         | 332,915                      |         | 328,578                     |         |
|                                                                                                                              |         |                         |         |                        |         |
| Total liabilities and stockholders’ equity                                                                                   |         | $                            | 2,451,056    |                        | $            | 1,756,678 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

3

----

 

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

**CONSOLIDATED STATEMENTS OF INCOME**

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

 
| ** **                                         | ** **   | **Three Months Ended** | ** **   |
|----------------------------------------------------|--------------|------------------------|--------------|
| ** **                                         | ** **   | **September 30,** | ** **   |
| ** **                                         | ** **   | **2005**               | ** **   | **2004** | ** ** |
| *** ***                                       | *** *** | **(Unaudited)**        | *** *** |
|                                               |         |                   |         |   |   |
| Gross  written premium                             |         | $                      | 188,114      |   | $ | 151,178 |   |
| Revenues:                                          |         |                   |         |   |   |
| Net written premium                                |         | $                      | 76,049       |   | $ | 65,992 |   |
| (Increase) decrease in unearned premium            |         | (1,315                 | )            | 9,145 |   |
| Net earned premium                                 |         | 74,734                 |         | 75,137 |   |
| Commission income                                  |         | 1,025                  |         | 1,121 |   |
| Net investment income                              |         | 9,196                  |         | 6,881 |   |
| Net realized capital gains                         |         | 344                    |         | 271 |   |
| Other income (expense)                             |         | 459                    |         | (127 | ) |
| Total revenues                                     |         | 85,758                 |         | 83,283 |   |
|                                               |         |                   |         |   |   |
| Operating  expenses:                               |         |                   |         |   |   |
| Net losses and loss adjustment expenses  incurred  |         | 76,836                 |         | 49,247 |   |
| Commission expense                                 |         | 11,656                 |         | 8,773 |   |
| Other operating expenses                           |         | 17,482                 |         | 16,014 |   |
| Total operating expenses                           |         | 105,974                |         | 74,034 |   |
|                                               |         |                   |         |   |   |
| Income  (loss) before income tax expense (benefit) |         | (20,216                | )            | 9,249 |   |
|                                               |         |                   |         |   |   |
| Income tax  expense (benefit):                     |         |                   |         |   |   |
| Current                                            |         | (5,605                 | )            | 4,225 |   |
| Deferred                                           |         | (1,886                 | )            | (1,256 | ) |
| Total income tax expense (benefit)                 |         | (7,491                 | )            | 2,969 |   |
|                                               |         |                   |         |   |   |
| Net income  (loss)                                 |         | $                      | (12,725      | ) | $ | 6,280 |   |
|                                               |         |                   |         |   |   |
| Net income  (loss) per common share:               |         |                   |         |   |   |
| Basic                                              |         | $                      | (0.99        | ) | $ | 0.50 |   |
| Diluted                                            |         | $                      | (0.99        | ) | $ | 0.50 |   |
|                                               |         |                   |         |   |   |
| Average  common shares outstanding:                |         |                   |         |   |   |
| Basic                                              |         | 12,791                 |         | 12,612 |   |
| Diluted                                            |         | 12,791                 |         | 12,679 |   |

 

See accompanying notes to interim consolidatedfinancial statements.

 

4

----

 
| ** **                                        | ** **   | **Nine Months Ended**  | ** **   |
|---------------------------------------------------|--------------|------------------------|--------------|
| ** **                                        | ** **   | **September 30,** | ** **   |
| ** **                                        | ** **   | **2005**               | ** **   | **2004** | ** ** |
| *** ***                                      | *** *** | **(Unaudited)**        | *** *** |
|                                              |         |                   |         |   |   |
| Gross  written premium                            |         | $                      | 595,243      |   | $ | 508,756 |   |
| Revenues:                                         |         |                   |         |   |   |
| Net written premium                               |         | $                      | 286,396      |   | $ | 235,616 |   |
| (Increase) in unearned premium                    |         | (48,292                | )            | (10,989 | ) |
| Net earned premium                                |         | 238,104                |         | 224,627 |   |
| Commission income                                 |         | 3,809                  |         | 3,608 |   |
| Net investment income                             |         | 25,779                 |         | 19,408 |   |
| Net realized capital gains                        |         | 927                    |         | 588 |   |
| Other income                                      |         | 1,826                  |         | 267 |   |
| Total revenues                                    |         | 270,445                |         | 248,498 |   |
|                                              |         |                   |         |   |   |
| Operating  expenses:                              |         |                   |         |   |   |
| Net losses and loss adjustment expenses  incurred |         | 176,668                |         | 138,391 |   |
| Commission expense                                |         | 30,502                 |         | 29,840 |   |
| Other operating expenses                          |         | 52,554                 |         | 44,066 |   |
| Total operating expenses                          |         | 259,724                |         | 212,297 |   |
|                                              |         |                   |         |   |   |
| Income  before income tax expense                 |         | 10,721                 |         | 36,201 |   |
|                                              |         |                   |         |   |   |
| Income tax  expense (benefit):                    |         |                   |         |   |   |
| Current                                           |         | 7,636                  |         | 14,184 |   |
| Deferred                                          |         | (5,169                 | )            | (2,213 | ) |
| Total income tax expense                          |         | 2,467                  |         | 11,971 |   |
|                                              |         |                   |         |   |   |
| Net income                                        |         | $                      | 8,254        |   | $ | 24,230 |   |
|                                              |         |                   |         |   |   |
| Net income  per common share:                     |         |                   |         |   |   |
| Basic                                             |         | $                      | 0.65         |   | $ | 1.93 |   |
| Diluted                                           |         | $                      | 0.64         |   | $ | 1.91 |   |
|                                              |         |                   |         |   |   |
| Average  common shares outstanding:               |         |                   |         |   |   |
| Basic                                             |         | 12,744                 |         | 12,584 |   |
| Diluted                                           |         | 12,849                 |         | 12,688 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

5

----

 

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

*($ inthousands)*

 
| ** **                                               | ** **   | **Nine Months Ended**  | ** **   |
|----------------------------------------------------------|--------------|------------------------|--------------|
| ** **                                               | ** **   | **September 30,** | ** **   |
| ** **                                               | ** **   | **2005**               | ** **   | **2004** | ** ** |
| *** ***                                             | *** *** | **(Unaudited)**        | *** *** |
| Preferred  Stock                                         |         |                   |         |   |   |
| Balance at beginning and end of period                   |         | $                      | —       |   | $ | — |   |
|                                                     |         |                   |         |   |   |
| Common stock                                             |         |                   |         |   |   |
| Balance at beginning of year                             |         | $                      | 1,266        |   | $ | 1,254 |   |
| Shares issued under stock plans                          |         | 13                     |         | 9 |   |
| Balance at end of period                                 |         | $                      | 1,279        |   | $ | 1,263 |   |
|                                                     |         |                   |         |   |   |
| Additional  paid-in capital                              |         |                   |         |   |   |
| Balance at beginning of year                             |         | $                      | 154,670      |   | $ | 151,765 |   |
| Effect of SFAS 123 for stock options                     |         | 784                    |         | 754 |   |
| Shares issued under stock plans                          |         | 2,163                  |         | 1,362 |   |
| Balance at end of period                                 |         | $                      | 157,617      |   | $ | 153,881 |   |
|                                                     |         |                   |         |   |   |
| Retained  earnings                                       |         |                   |         |   |   |
| Balance at beginning of year                             |         | $                      | 163,337      |   | $ | 128,472 |   |
| Net income                                               |         | 8,254                  |         | 24,230 |   |
| Balance at end of period                                 |         | $                      | 171,591      |   | $ | 152,702 |   |
|                                                     |         |                   |         |   |   |
| Accumulated  other comprehensive income                  |         |                   |         |   |   |
| Net unrealized gains (losses) on  securities, net of tax |         |                   |         |   |   |
| Balance at beginning of year                             |         | $                      | 7,416        |   | $ | 7,871 |   |
| Change in period                                         |         | (6,043                 | )            | 139 |   |
| Balance at end of period                                 |         | 1,373                  |         | 8,010 |   |
| Cumulative translation adjustments, net of  tax          |         |                   |         |   |   |
| Balance at beginning of year                             |         | 1,889                  |         | 666 |   |
| Net adjustment for period                                |         | (834                   | )            | 76 |   |
| Balance at end of period                                 |         | 1,055                  |         | 742 |   |
| Balance at end of period                                 |         | $                      | 2,428        |   | $ | 8,752 |   |
|                                                     |         |                   |         |   |   |
| Total  stockholders’ equity at end of period        |         | $                      | 332,915      |   | $ | 316,598 |   |

 

See accompanying notes to interim consolidatedfinancial statements.

 

6

----

 

**THE NAVIGATORS GROUP, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME**

*($ in thousands)*

 
| ** **                                                                                                                                         | ** **   | **Three Months Ended** | ** **   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------------|------------------------|--------------|
| ** **                                                                                                                                         | ** **   | **September 30,** | ** **   |
| ** **                                                                                                                                         | ** **   | **2005**               | ** **   | **2004** | ** ** |
| *** ***                                                                                                                                       | *** *** | **(Unaudited)**        | *** *** |
|                                                                                                                                               |         |                   |         |   |   |
| Net income  (loss)                                                                                                                                 |         | $                      | (12,725      | ) | $ | 6,280 |   |
| Other  comprehensive income (loss):                                                                                                                |         |                   |         |   |   |
| Change in net unrealized gains or (losses)  on securities, net of tax expense (benefit) of $(3,652) and $4,073 in 2005  and 2004, respectively (1) |         | (6,885                 | )            | 7,564 |   |
| Change in foreign currency translation  gains or (losses), net of tax expense (benefit) of $(58) and $(89) in 2005  and 2004, respectively         |         | (107                   | )            | (165 | ) |
| Other comprehensive income (loss)                                                                                                                  |         | (6,992                 | )            | 7,399 |   |
|                                                                                                                                               |         |                   |         |   |   |
| Comprehensive  income (loss)                                                                                                                       |         | $                      | (19,717      | ) | $ | 13,679 |   |
|                                                                                                                                               |         |                   |         |   |   |
|                                                                                                                                                    |         |                   |         |   |   |
| (1)  Disclosure  of reclassification amount, net of tax:                                                                                      |         |                   |         |   |   |
| Unrealized holding gains (losses) arising during period                                                                                            |         | $                      | (6,661       | ) | $ | 7,740 |   |
| Less: reclassification adjustment for net gains (losses) included in  net income                                                                   |         | 224                    |         | 176 |   |
| Change in net unrealized gains (losses) on securities                                                                                              |         | $                      | (6,885       | ) | $ | 7,564 |   |

 

See accompanying notes to interim consolidatedfinancial statements.

 

7

----

 
| ** **                                                                                                                                     | ** **   | **Nine Months Ended**  | ** **   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------------|------------------------|--------------|
| ** **                                                                                                                                     | ** **   | **September 30,** | ** **   |
| ** **                                                                                                                                     | ** **   | **2005**               | ** **   | **2004** | ** ** |
| *** ***                                                                                                                                   | *** *** | **(Unaudited)**        | *** *** |
|                                                                                                                                           |         |                   |         |   |   |
| Net income                                                                                                                                     |         | $                      | 8,254        |   | $ | 24,230 |   |
| Other  comprehensive income:                                                                                                                   |         |                   |         |   |   |
| Change in net unrealized gains or (losses)  on securities, net of tax expense (benefit) of $(3,198) and $75 in 2005 and  2004, respectively(1) |         | (6,043                 | )            | 139 |   |
| Change in foreign currency translation  gains or (losses), net of tax expense (benefit) of $(449) and $41 in 2005 and  2004, respectively      |         | (834                   | )            | 76 |   |
| Other comprehensive income (loss)                                                                                                              |         | (6,877                 | )            | 215 |   |
|                                                                                                                                           |         |                   |         |   |   |
| Comprehensive  income                                                                                                                          |         | $                      | 1,377        |   | $ | 24,445 |   |
|                                                                                                                                           |         |                   |         |   |   |
|                                                                                                                                                |         |                   |         |   |   |
| (1)  Disclosure  of reclassification amount, net of tax:                                                                                  |         |                   |         |   |   |
| Unrealized holding gains or (losses) arising during period                                                                                     |         | $                      | (5,440       | ) | $ | 521 |   |
| Less: reclassification adjustment for net gains included in net  income                                                                        |         | 603                    |         | 382 |   |
| Net unrealized gains (losses) on securities                                                                                                    |         | $                      | (6,043       | ) | $ | 139 |   |

 

See accompanying notes to interimconsolidated financial statements.

 

8

----

 

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

*($ inthousands)*

 
| ** **                                                                                   | ** **   | **Nine Months Ended**  | ** **   |
|----------------------------------------------------------------------------------------------|--------------|------------------------|--------------|
| ** **                                                                                   | ** **   | **September 30,** | ** **   |
| ** **                                                                                   | ** **   | **2005**               | ** **   | **2004** | ** ** |
| *** ***                                                                                 | *** *** | **(Unaudited)**        | *** *** |
| Operating  activities:                                                                       |         |                   |         |   |   |
| Net income                                                                                   |         | $                      | 8,254        |   | $ | 24,230 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |         |                   |         |   |   |
| Depreciation & amortization                                                         |         | 1,332                  |         | 893 |   |
| Net deferred income tax (benefit)                                                            |         | (5,169                 | )            | (2,213 | ) |
| Net realized capital (gains)                                                                 |         | (927                   | )            | (588 | ) |
| Changes in assets and liabilities:                                                           |         |                   |         |   |   |
| Reinsurance receivable on paid and unpaid losses  and loss adjustment expenses               |         | (502,241               | )            | (110,504 | ) |
| Reserve for losses and loss adjustment  expenses                                             |         | 559,910                |         | 184,895 |   |
| Prepaid reinsurance premiums                                                                 |         | (15,661                | )            | (36,816 | ) |
| Unearned premium                                                                             |         | 62,389                 |         | 48,647 |   |
| Premiums in course of collection                                                             |         | 13,564                 |         | (26,533 | ) |
| Commissions receivable                                                                       |         | (601                   | )            | 1,141 |   |
| Deferred policy acquisition costs                                                            |         | (8,118                 | )            | (3,820 | ) |
| Accrued investment income                                                                    |         | (1,335                 | )            | (1,360 | ) |
| Reinsurance balances payable                                                                 |         | 37,147                 |         | 41,935 |   |
| Federal income tax                                                                           |         | (7,107                 | )            | 10,568 |   |
| Other                                                                                        |         | 26,510                 |         | 11,273 |   |
| Net cash provided by operating activities                                                    |         | 167,947                |         | 141,748 |   |
|                                                                                         |         |                   |         |   |   |
| Investing  activities:                                                                       |         |                   |         |   |   |
| Fixed maturities, available-for-sale                                                         |         |                   |         |   |   |
| Redemptions and maturities                                                                   |         | 18,316                 |         | 118,753 |   |
| Sales                                                                                        |         | 255,002                |         | 225,858 |   |
| Purchases                                                                                    |         | (428,139               | )            | (457,892 | ) |
| Equity securities, available-for-sale                                                        |         |                   |         |   |   |
| Sales                                                                                        |         | 4,169                  |         | 3,646 |   |
| Purchases                                                                                    |         | (3,739                 | )            | (8,916 | ) |
| Change in payable for securities                                                             |         | 24,067                 |         | (120 | ) |
| Net change in short-term investments                                                         |         | (39,873                | )            | (15,123 | ) |
| Purchase of property and equipment                                                           |         | (2,233                 | )            | (1,446 | ) |
| Net cash (used in) investing activities                                                      |         | (172,430               | )            | (135,240 | ) |
|                                                                                         |         |                   |         |   |   |
| Financing  activities:                                                                       |         |                   |         |   |   |
| Proceeds of stock issued from Employee  Stock Purchase Plan                                  |         | 419                    |         | 434 |   |
| Proceeds of stock issued from exercise of  stock options                                     |         | 1,194                  |         | 688 |   |
| Net cash provided by financing activities                                                    |         | 1,613                  |         | 1,122 |   |
|                                                                                         |         |                   |         |   |   |
| Increase  (decrease) in cash                                                                 |         | (2,870                 | )            | 7,630 |   |
| Cash at  beginning of year                                                                   |         | 14,676                 |         | 8,399 |   |
| Cash at end  of period                                                                       |         | $                      | 11,806       |   | $ | 16,029 |   |
|                                                                                         |         |                   |         |   |   |
| Supplemental  disclosures of cash flow information:                                          |         |                   |         |   |   |
| Federal, state and local income tax paid                                                     |         | $                      | 13,366       |   | $ | 3,597 |   |
| Issuance of stock to directors                                                               |         | 123                    |         | 60 |   |

 

See accompanying notes tointerim consolidated financial statements.

 

9

----

 

###### **THE NAVIGATORS GROUP, INC.  ANDSUBSIDIARIES**

###### ** **

**Notes to Interim Consolidated Financial Statements**

*(Unaudited)*

 

**Note 1.  Accounting Policies**

 

The interimconsolidated financial statements are unaudited but reflect all adjustmentswhich, in the opinion of management, are necessary to provide a fair statementof the results of The Navigators Group, Inc. and its subsidiaries for theinterim periods presented on the basis of accounting principles generallyaccepted in the United States of America (“GAAP” or “U.S. GAAP”).  All such adjustments are of a normalrecurring nature.  All significantintercompany transactions and balances have been eliminated.  The preparation of these financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosures of contingent assets andliabilities at the date of the financial statements and the reported revenuesand expenses during the reporting periods. The results of operations for any interim period are not necessarilyindicative of results for the full year. The terms “we”, “us”, “our” and “the Company” as used herein mean TheNavigators Group, Inc. and its subsidiaries, unless the context otherwiserequires.  The term “Parent” or “ParentCompany” is used to mean The Navigators Group, Inc. without itssubsidiaries.  These financial statementsshould be read in conjunction with the consolidated financial statements andnotes contained in the Company’s 2004 Annual Report on Form 10-K.

 

**Note 2.  Reinsurance Ceded**

 

The Company’sceded earned premiums were $118,984,000 and $84,858,000 for the three monthsended September 30, 2005 and 2004, respectively, and were $292,608,000 and$237,565,000 for the nine months ended September 30, 2005 and 2004,respectively.  The Company’s cededincurred losses were $514,387,000 and $69,907,000 for the three months ended September 30,2005 and 2004, respectively, and were $597,985,000 and $194,095,000 for the ninemonths ended September 30, 2005 and 2004, respectively.

 

**Note 3.  SegmentInformation**

 

The Company’s subsidiaries are primarilyengaged in the writing and management of property and casualty insurance.  The Company’s segments include the InsuranceCompanies, the Lloyd’s Operations and the Navigators Agencies, each of which ismanaged separately.  The InsuranceCompanies consist of Navigators Insurance Company, which includes a branch inthe U.K. (the “U.K. Branch”), and NIC Insurance Company and are primarilyengaged in underwriting marine insurance and related lines of business,contractors’ general liability insurance, and professional liabilityinsurance.  The Lloyd’s Operations underwritemarine and related lines of business at Lloyd’s of London.  The Navigators Agencies are underwritingmanagement companies which produce, manage and underwrite insurance andreinsurance for both affiliated and unaffiliated companies.  All segments are evaluated based on theirGAAP results.

 

The Insurance Companies’ and the Lloyd’s Operations’results are measured by taking into account net premiums earned, incurredlosses and loss adjustment expenses (“LAE”), commission expense and otherunderwriting expenses.  The NavigatorsAgencies’ results include commission income less other operating expenses.  Results of the Parent and Other Operations includeinter-segment income and expense in the form of affiliated commissions, incomeand expense from corporate operations and consolidating adjustments.  Each segment also maintains its owninvestments, on which it earns income and realizes capital gains or losses.

 

10

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Financial data by segmentfor the three months ended September 30, 2005 and 2004 was as follows:

 
| ** **                          | ** **   | **Three Months Ended September 30, 2005** | ** **   |
|-------------------------------------|--------------|------------------------------------------------|--------------|
| ** **                          | ** **   | **Insurance  Companies**                       | ** **   | **Lloyd’s  Operations** | ** ** | **Navigators  Agencies** | ** ** | **Parent &  Other  Operations (1)** | ** ** | **Consolidated  Total** | ** ** |
| *** ***                        | *** *** | **($ in thousands)**                      | *** *** |
|                                |         |                                           |         |   |   |   |   |   |   |   |   |
| Gross  written premium              |         | $                                              | 133,718      |   | $ | 54,142 |   |   |   | $ | 254 |   | $ | 188,114 |   |
| Net written  premium                |         | 59,093                                         |         | 16,956 |   |   |   | — |   | 76,049 |   |
|                                |         |                                           |         |   |   |   |   |   |   |   |   |
| Revenues:                           |         |                                           |         |   |   |   |   |   |   |   |   |
| Net earned premium                  |         | 53,778                                         |         | 20,956 |   |   |   | — |   | 74,734 |   |
| Commission income                   |         | —                                         |         | 534 |   | $ | 7,858 |   | (7,367 | ) | 1,025 |   |
| Net investment income               |         | 7,692                                          |         | 1,439 |   | 2 |   | 63 |   | 9,196 |   |
| Net realized capital gains (losses) |         | 401                                            |         | (57 | ) | — |   | — |   | 344 |   |
| Other income                        |         | 31                                             |         | 246 |   | 182 |   | — |   | 459 |   |
| Total revenues                      |         | 61,902                                         |         | 23,118 |   | 8,042 |   | (7,304 | ) | 85,758 |   |
|                                |         |                                           |         |   |   |   |   |   |   |   |   |
| Operating  expenses:                |         |                                           |         |   |   |   |   |   |   |   |   |
| Net losses and LAE                  |         | 47,332                                         |         | 29,504 |   | — |   | — |   | 76,836 |   |
| Commission expense                  |         | 13,068                                         |         | 5,191 |   | — |   | (6,603 | ) | 11,656 |   |
| Other operating expenses            |         | 2,449                                          |         | 4,670 |   | 9,787 |   | 576 |   | 17,482 |   |
| Total operating expenses            |         | 62,849                                         |         | 39,365 |   | 9,787 |   | (6,027 | ) | 105,974 |   |
|                                |         |                                           |         |   |   |   |   |   |   |   |   |
| (Loss)  before income tax (benefit) |         | (947                                           | )            | (16,247 | ) | (1,745 | ) | (1,277 | ) | (20,216 | ) |
| Income tax  (benefit)               |         | (894                                           | )            | (5,687 | ) | (464 | ) | (446 | ) | (7,491 | ) |
| Net (loss)                          |         | $                                              | (53          | ) | $ | (10,560 | ) | $ | (1,281 | ) | $ | (831 | ) | $ | (12,725 | ) |
|                                |         |                                           |         |   |   |   |   |   |   |   |   |
| Identifiable  assets (2)            |         | $                                              | 1,667,213    |   | $ | 809,870 |   | $ | 14,936 |   | $ | 17,802 |   | $ | 2,451,056 |   |
|                                |         |                                           |         |   |   |   |   |   |   |   |   |
| Loss and LAE  ratio                 |         | 88.0                                           | %            | 140.8 | % |   |   |   |   | 102.8 | % |
| Commission  expense ratio           |         | 24.3                                           | %            | 24.8 | % |   |   |   |   | 24.4 | % |
| Other  operating expense ratio      |         | 4.6                                            | %            | 22.3 | % |   |   |   |   | 9.5 | % |
| Combined  ratio                     |         | 116.9                                          | %            | 187.9 | % |   |   |   |   | 136.7 | % |

 

----

(1)Includesinter-segment eliminations.

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

 

11

----

 
| ** **                                         | ** **   | **Three Months Ended September 30, 2004** | ** **   |
|----------------------------------------------------|--------------|------------------------------------------------|--------------|
| ** **                                         | ** **   | **Insurance  Companies**                       | ** **   | **Lloyd’s  Operations** | ** ** | **Navigators  Agencies** | ** ** | **Parent &  Other  Operations (1)** | ** ** | **Consolidated  Total** | ** ** |
| *** ***                                       | *** *** | **($ in thousands)**                      | *** *** |
|                                               |         |                                           |         |   |   |   |   |   |   |   |   |
| Gross  written premium                             |         | $                                              | 107,318      |   | $ | 45,004 |   |   |   | $ | (1,144 | ) | $ | 151,178 |   |
| Net written  premium                               |         | 44,904                                         |         | 21,088 |   |   |   | — |   | 65,992 |   |
|                                               |         |                                           |         |   |   |   |   |   |   |   |   |
| Revenues:                                          |         |                                           |         |   |   |   |   |   |   |   |   |
| Net earned premium                                 |         | 51,541                                         |         | 23,596 |   |   |   | — |   | 75,137 |   |
| Commission income                                  |         | —                                         |         | 300 |   | $ | 7,797 |   | (6,976 | ) | 1,121 |   |
| Net investment income                              |         | 6,225                                          |         | 649 |   | 2 |   | 5 |   | 6,881 |   |
| Net realized capital gains (losses)                |         | 326                                            |         | (55 | ) | — |   | — |   | 271 |   |
| Other income                                       |         | (7                                             | )            | (378 | ) | 258 |   | — |   | (127 | ) |
| Total revenues                                     |         | 58,085                                         |         | 24,112 |   | 8,057 |   | (6,971 | ) | 83,283 |   |
|                                               |         |                                           |         |   |   |   |   |   |   |   |   |
| Operating  expenses:                               |         |                                           |         |   |   |   |   |   |   |   |   |
| Net losses and LAE                                 |         | 35,401                                         |         | 13,846 |   | — |   | — |   | 49,247 |   |
| Commission expense                                 |         | 11,682                                         |         | 4,067 |   | — |   | (6,976 | ) | 8,773 |   |
| Other operating expenses                           |         | 1,780                                          |         | 3,425 |   | 9,616 |   | 1,193 |   | 16,014 |   |
| Total operating expenses                           |         | 48,863                                         |         | 21,338 |   | 9,616 |   | (5,783 | ) | 74,034 |   |
|                                               |         |                                           |         |   |   |   |   |   |   |   |   |
| Income (loss) before income tax expense  (benefit) |         | 9,222                                          |         | 2,774 |   | (1,559 | ) | (1,188 | ) | 9,249 |   |
| Income tax  expense (benefit)                      |         | 2,871                                          |         | 971 |   | (460 | ) | (413 | ) | 2,969 |   |
| Net income  (loss)                                 |         | $                                              | 6,351        |   | $ | 1,803 |   | $ | (1,099 | ) | $ | (775 | ) | $ | 6,280 |   |
|                                               |         |                                           |         |   |   |   |   |   |   |   |   |
| Identifiable  assets (2)                           |         | $                                              | 1,247,123    |   | $ | 467,998 |   | $ | 15,721 |   | $ | 33,039 |   | $ | 1,692,503 |   |
|                                               |         |                                           |         |   |   |   |   |   |   |   |   |
| Loss and LAE  ratio                                |         | 68.7                                           | %            | 58.7 | % |   |   |   |   | 65.5 | % |
| Commission  expense ratio                          |         | 22.7                                           | %            | 17.2 | % |   |   |   |   | 21.0 | % |
| Other  operating expense ratio                     |         | 3.4                                            | %            | 14.5 | % |   |   |   |   | 6.9 | % |
| Combined  ratio                                    |         | 94.8                                           | %            | 90.4 | % |   |   |   |   | 93.4 | % |

 

----

(1)Includesinter-segment eliminations.

(2)Doesnot cross-foot due to inter-segment eliminations.

 

12

----

 

Financial data by segmentfor the nine months ended September 30, 2005 and 2004 was as follows:

 
| ** **                                         | ** **   | **Nine Months Ended September 30, 2005** | ** **   |
|----------------------------------------------------|--------------|-----------------------------------------------|--------------|
| ** **                                         | ** **   | **Insurance  Companies**                      | ** **   | **Lloyd’s  Operations** | ** ** | **Navigators  Agencies** | ** ** | **Parent &  Other  Operations (1)** | ** ** | **Total** | ** ** |
| *** ***                                       | *** *** | **($ in thousands)**                     | *** *** |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Gross  written premium                             |         | $                                             | 393,686      |   | $ | 200,519 |   |   |   | $ | 1,038 |   | $ | 595,243 |   |
| Net written  premium                               |         | 199,349                                       |         | 87,047 |   |   |   | — |   | 286,396 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Revenues:                                          |         |                                          |         |   |   |   |   |   |   |   |   |
| Net earned  premium                                |         | 160,248                                       |         | 77,856 |   |   |   | — |   | 238,104 |   |
| Commission  income                                 |         | —                                        |         | 1,161 |   | $ | 29,039 |   | (26,391 | ) | 3,809 |   |
| Net  investment income                             |         | 22,032                                        |         | 3,642 |   | 5 |   | 100 |   | 25,779 |   |
| Net realized  capital gains (losses)               |         | 1,348                                         |         | (421 | ) | — |   | — |   | 927 |   |
| Other income  (expense)                            |         | 238                                           |         | 875 |   | 713 |   | — |   | 1,826 |   |
| Total  revenues                                    |         | 183,866                                       |         | 83,113 |   | 29,757 |   | (26,291 | ) | 270,445 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Operating  expenses:                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Net losses  and LAE                                |         | 114,856                                       |         | 61,812 |   | — |   | — |   | 176,668 |   |
| Commission  expense                                |         | 39,522                                        |         | 14,905 |   | — |   | (23,925 | ) | 30,502 |   |
| Other  operating expenses                          |         | 6,570                                         |         | 13,741 |   | 31,946 |   | 297 |   | 52,554 |   |
| Total  operating expenses                          |         | 160,948                                       |         | 90,458 |   | 31,946 |   | (23,628 | ) | 259,724 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Income (loss) before income tax expense  (benefit) |         | 22,918                                        |         | (7,345 | ) | (2,189 | ) | (2,663 | ) | 10,721 |   |
| Income tax  expense (benefit)                      |         | 6,550                                         |         | (2,571 | ) | (581 | ) | (931 | ) | 2,467 |   |
| Net income  (loss)                                 |         | $                                             | 16,368       |   | $ | (4,774 | ) | $ | (1,608 | ) | $ | (1,732 | ) | $ | 8,254 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Identifiable  assets (2)                           |         | $                                             | 1,667,213    |   | $ | 809,870 |   | $ | 14,936 |   | $ | 17,802 |   | $ | 2,451,056 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Loss and LAE  ratio                                |         | 71.7                                          | %            | 79.4 | % |   |   |   |   | 74.2 | % |
| Commission  expense ratio                          |         | 24.7                                          | %            | 19.1 | % |   |   |   |   | 22.9 | % |
| Other  operating expense ratio                     |         | 4.0                                           | %            | 17.7 | % |   |   |   |   | 8.5 | % |
| Combined  ratio                                    |         | 100.4                                         | %            | 116.2 | % |   |   |   |   | 105.6 | % |

 

----

(1)Includesinter-segment eliminations.

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

 

13

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| ** **                                         | ** **   | **Nine Months Ended September 30, 2004** | ** **   |
|----------------------------------------------------|--------------|-----------------------------------------------|--------------|
| ** **                                         | ** **   | **Insurance  Companies**                      | ** **   | **Lloyd’s  Operations** | ** ** | **Navigators  Agencies** | ** ** | **Parent &  Other  Operations****(1)** | ** ** | **Consolidated  Total** | ** ** |
| *** ***                                       | *** *** | **($ in thousands)**                     | *** *** |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Gross  written premium                             |         | $                                             | 326,755      |   | $ | 186,471 |   |   |   | $ | (4,470 | ) | $ | 508,756 |   |
| Net written  premium                               |         | 145,614                                       |         | 90,002 |   |   |   | — |   | 235,616 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Revenues:                                          |         |                                          |         |   |   |   |   |   |   |   |   |
| Net earned  premium                                |         | 156,506                                       |         | 68,121 |   |   |   | — |   | 224,627 |   |
| Commission  income                                 |         | —                                        |         | 863 |   | $ | 23,884 |   | (21,139 | ) | 3,608 |   |
| Net  investment income                             |         | 17,538                                        |         | 1,844 |   | 6 |   | 20 |   | 19,408 |   |
| Net realized  capital gains (losses)               |         | 707                                           |         | (119 | ) | — |   | — |   | 588 |   |
| Other income                                       |         | 6                                             |         | (368 | ) | 629 |   | — |   | 267 |   |
| Total  revenues                                    |         | 174,757                                       |         | 70,341 |   | 24,519 |   | (21,119 | ) | 248,498 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Operating  expenses:                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Net losses  and LAE                                |         | 100,669                                       |         | 37,722 |   | — |   | — |   | 138,391 |   |
| Commission  expense                                |         | 39,069                                        |         | 11,910 |   | — |   | (21,139 | ) | 29,840 |   |
| Other  operating expenses                          |         | 3,967                                         |         | 9,654 |   | 27,314 |   | 3,131 |   | 44,066 |   |
| Total  operating expenses                          |         | 143,705                                       |         | 59,286 |   | 27,314 |   | (18,008 | ) | 212,297 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Income (loss) before income tax expense  (benefit) |         | 31,052                                        |         | 11,055 |   | (2,795 | ) | (3,111 | ) | 36,201 |   |
| Income tax  expense (benefit)                      |         | 9,892                                         |         | 3,869 |   | (852 | ) | (938 | ) | 11,971 |   |
| Net income  (loss)                                 |         | $                                             | 21,160       |   | $ | 7,186 |   | $ | (1,943 | ) | $ | (2,173 | ) | $ | 24,230 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Identifiable  assets (2)                           |         | $                                             | 1,247,123    |   | $ | 467,998 |   | $ | 15,721 |   | $ | 33,039 |   | $ | 1,692,503 |   |
|                                               |         |                                          |         |   |   |   |   |   |   |   |   |
| Loss and LAE  ratio                                |         | 64.3                                          | %            | 55.4 | % |   |   |   |   | 61.6 | % |
| Commission  expense ratio                          |         | 25.0                                          | %            | 17.5 | % |   |   |   |   | 22.7 | % |
| Other  operating expense ratio                     |         | 2.5                                           | %            | 14.2 | % |   |   |   |   | 6.1 | % |
| Combined  ratio                                    |         | 91.8                                          | %            | 87.1 | % |   |   |   |   | 90.4 | % |

 

----

(1)Includesinter-segment eliminations.

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

 

14

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The Insurance Companies’ net earned premiumincludes $6,863,000 and $7,670,000 of net earned premium from the U.K. Branchfor the three months ended September 30, 2005 and 2004, respectively, and$27,498,000 and $23,849,000 of net earned premium for the nine months ended September 30,2005 and 2004, respectively.

 

**Note 4. Comprehensive Income**

 

Comprehensive income encompasses net income,net unrealized capital gains and losses on available for sale securities, andforeign currency translation adjustments. Please refer to the *Consolidated Statements ofStockholders’ Equity* and the *Consolidated Statements ofComprehensive Income*, included herein, for the components of *accumulated other comprehensive income* and of *comprehensive income*, respectively.

 

**Note 5. Stock-Based Compensation**

 

Stock based compensation is expensed as the stockawards vest with the expense being included in *otheroperating expenses* for the periods indicated.  The amount charged to expense for stockgrants was $405,000 and $275,000 for the three months ended September 30,2005 and 2004, respectively, and $1,141,000 and $922,000 for the nine monthsended September 30, 2005 and 2004, respectively.  The amount charged to expense for stockoptions was $267,000 and $276,000 for the three months ended September 30,2005 and 2004, respectively, and $785,000 and $754,000 for the nine monthsended September 30, 2005 and 2004, respectively.  Stock appreciation rights resulted in expenseof $440,000 and $107,000 for the three months ended September 30, 2005 and2004, respectively, and $774,000 of expense and $152,000 of income for the ninemonths ended September 30, 2005 and 2004, respectively.

 

In addition, $35,000 and $30,000 wereexpensed for the three months ended September 30, 2005 and 2004,respectively, and $105,000 and $90,000 were expensed for the nine months ended September 30,2005 and 2004, respectively, for stock issued annually to non-employeedirectors as part of their directors’ compensation for serving on the Company’sBoard of Directors.

 

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

 

In September 2004, the FASB approved the issuance of a Staff Positionto delay the requirement to record impairment losses under Emerging Issues TaskForce Issue No. 03-1 (“EITF 03-1”). The approved delay applies to certain provisions relating to therecognition of other-than-temporary impairments for all securities within thescope of EITF 03-1.  At its June 29,2005 meeting, the FASB decided not to provide additional guidance on themeaning of other-than-temporary impairment. Instead, the FASB will issue proposed FSP EITF 03-1-a, *Implementation Guidance for the Application of Paragraph 16 of EITFIssue No. 03-*1, as final. The Company will review the final documents as they become available.

 

In December 2004, the FASB issued SFAS 123 (revised 2004), *Share Based Payment*, which is a revision of SFAS 123, *Accounting for Stock-Based Compensation,* eliminating thealternative use of APB 25.  SFAS 123(revised 2004) has no effect on the Company’s results of operations orfinancial condition since the Company adopted the fair value recognitionprovisions of SFAS 123 in 2003.

 

**Note 7. Lloyd’s Syndicate**

 

We record our pro rata share of Lloyd’sSyndicate 1221’s assets, liabilities, revenues and expenses, after makingadjustments to convert Lloyd’s accounting to U.S. GAAP.  Themost significant U.S. GAAP adjustments relate to income recognition. Lloyd’ssyndicates determine underwriting results by year of account at the end ofthree years.  We record adjustments torecognize underwriting results as incurred, including the expected ultimatecost of losses incurred.  These adjustmentsto losses are based on actuarial analysis of syndicate accounts,

 

15

----

 

including forecasts of expected ultimatelosses provided by the syndicates.  At the end of the Lloyd’s three year period fordetermining underwriting results for an account year, the syndicate will closethe account year by reinsuring outstanding claims on that account year with theparticipants for the account’s next underwriting year.  The amount to close an underwriting year intothe next year is referred to as the “reinsurance to close”.  The reinsurance to close transaction is recordedin the fourth quarter as additional written and earned premium, lossesincurred, loss reserves and receivables, all in the same amount.  No gain or loss is recorded on the reinsurance to close transaction.

 

Our Lloyd’s Syndicate 1221’s stamp capacity is£135.0 million ($248.9 million) in 2005 compared to £150.0 million ($275.0million) in 2004.  Stamp capacity is ameasure of the amount of premium a Lloyd’s syndicate is authorized to write basedon a business plan approved by the Council of Lloyd’s.  Syndicate 1221’s capacity is expressed net ofcommission (as is standard at Lloyd’s) of approximately 21%.  The Syndicate 1221 premium recorded in theCompany’s financial statements is gross of commission.  The Company participates for 97.5% and 97.4% ofSyndicate 1221’s capacity for the 2005 and 2004 underwriting years,respectively.  The Lloyd’s operationsincluded in the consolidated financial statements represent the Company’sparticipation in Syndicate 1221.  In September 2005,the Company purchased the remaining outstanding minority interest and will own100% of the Syndicate 1221 capacity for the 2006 underwriting year.

 

The Company provides letters of credit toLloyd’s to support its Syndicate 1221 capacity. If the Company increases its participation or if Lloyd’s changes thecapital requirements, the Company may be required to supply additional lettersof credit or other collateral acceptable to Lloyd’s, or reduce the capacity ofSyndicate 1221.  The letters of creditare provided through the credit facility which the Company maintains with aconsortium of banks.  The credit facilityagreement requires that the banks vote whether or not to renew the letter ofcredit portion of the facility periodically. If the banks decide not to renew the letter of credit facility, theCompany will need to find other sources to provide the letters of credit orother collateral in order to continue to participate in Syndicate 1221.  The renewal amendment executed in January 2005renewed the letter of credit facility until June 30, 2007.  The bank facility is collateralized by all ofthe common stock of Navigators Insurance Company.

 

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

 

The Company had state and local operatingloss carryforwards amounting to potential future tax benefits of $5,779,000 and$4,493,000 at September 30, 2005 and December 31, 2004,respectively.  A valuation allowance wasestablished for the full amount of these potential future tax benefits due tothe uncertainty associated with their realization.

 

**Note 9. Commitments and Contingencies**

 

Other than as set forth below, the Company isnot a party to, or the subject of, any material legal proceedings which departfrom the ordinary routine litigation incident to the kinds of business itconducts.

 

The Company was recently advised informallyby Equitas, a lead reinsurer participating on excess of loss reinsuranceagreements, that it does not intend to satisfy a loss payment recovery demandthat the Company presented to it on June 1, 2005.  The Company has not yet received a formalwritten response to its demand.  Therecovery is for the 2004 settlement of a class action suit involving a largeasbestos claim (the “Settled Claim”) which settlement is being paid over sevenyears starting in June 2005. Equitas has not indicated any dispute with respect to recoveries onrelated pro rata reinsurance agreements.

 

Equitas also participates as a lead reinsurerin respect of the Company’s two other large asbestos claims that involve classaction lawsuits.  The Company believes itis likely that Equitas will take a similar position when such claims areeventually settled and presented to Equitas for payment.

 

16

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The aggregate amount of excess of lossrecoveries due from Equitas on all three of these claims is approximately $9million, and represents approximately 50% of the total excess of lossrecoveries for such claims.  The Companyhas not been advised of any disputes by other excess of loss reinsurers withrespect to such asbestos claims.

 

The Company has filed a demand forarbitration against Equitas in New York with respect to the Settled Claim inaccordance with the applicable provisions of the excess of loss reinsuranceagreements.  The Company believes thatthe refusal of Equitas to satisfy the Company’s payment demand is without meritand it intends to vigorously pursue collection of its reinsurancerecoveries.   While it is too early topredict with any certainty the outcome of this matter, the Company believesthat the ultimate outcome would not be expected to have a significant adverseeffect on its results of operations, financial condition or liquidity, althoughan unexpected adverse resolution could have a material adverse effect on theCompany’s results of operations in a particular fiscal quarter or year.

 

**Note 10. Share Capital**

 

In October 2005, the Company completedan underwritten public offering of 3,795,000 shares of common stock at $34.50per share, including the over-allotment option, and received net proceeds ofapproximately $124 million.  Approximately$120 million of the net proceeds was contributed to the capital of NavigatorsInsurance Company of which $50 million was contributed to the capital of NICInsurance Company.

 

**Item 2.****                       Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Note on Forward-Looking Statements**

 

Some of the statements in this Quarterly Report on Form 10-Qare ‘‘forward-looking statements’’ as defined in the Private SecuritiesLitigation Reform Act of 1995.   Wheneverused in this report, the words “estimate”, “expect”, “believe” or similarexpressions are intended to identify such forward-looking statements.  Forward-looking statements are derived frominformation that we currently have and assumptions that we make. We cannotassure that anticipated results will be achieved, since results may differmaterially because of both known and unknown risks and uncertainties which weface. We undertake no obligation to publicly update or revise anyforward-looking statements, whether as a result of new information, futureevents or otherwise. Factors that could cause actual results to differmaterially from our forward-looking statements include, but are not limited to:

 

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

 

•      changes in the laws, rules andregulations which apply to our insurance companies;

 

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

 

•      the effects of 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 and environmentalliabilities and related reinsurance recoverables;

 

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•      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 and Wilmaand the possibility that our estimates of losses from Hurricanes Katrina, Rita andWilma 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;

 

•      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”), including withoutlimitation the risks described under the caption “Risk Factors” in our AnnualReport on Form 10-K for the year ended December 31, 2004.

 

In light of these risks, uncertainties andassumptions, any forward-looking events discussed in this Form 10-Q maynot 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 ourfinancial condition and results of operations contained herein should be readin conjunction with our consolidated financial statements and accompanyingnotes which appear elsewhere in this Form 10-Q. It containsforward-looking statements that involve risks and uncertainties. Please see ‘‘Noteon Forward-Looking Statements’’ for more information. Our actual results coulddiffer materially from those anticipated in these forward-looking statements asa result of various factors, including those discussed below and elsewhere in thisForm 10-Q.*

 

**Overview**

 

We are an international insurance holding companyfocusing on specialty products for niches within the overall property/casualtyinsurance market. Our largest product line and most long-standing area ofspecialization is ocean marine insurance. We have also developed specialtyniches in professional liability insurance, and in specialty liabilityinsurance primarily consisting of contractors’ liability coverages. We conductoperations through our insurance company subsidiaries, the Navigators Agenciesand our Lloyd’s Operations.  Ourinsurance company subsidiaries (the “Insurance Companies”) consist ofNavigators Insurance Company, which includes a United Kingdom Branch (the “U.K.Branch”), and NIC Insurance Company which writes excess and surplus lines.  The Navigators Agencies consist of fivewholly-owned insurance underwriting agencies which produce business for ourinsurance subsidiaries and unaffiliated insurers.  Our Lloyd’s operations include NavigatorsUnderwriting Agency Ltd. (“NUAL”), a Lloyd’s of London (“Lloyd’s”) marineunderwriting agency which manages Lloyd’s Syndicate 1221.  We participate in the capacity of Syndicate1221 through two wholly owned Lloyd’s corporate members.

 

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While management takes into consideration a widerange of factors in planning the Company’s business strategy and evaluatingresults of operations, there are certain factors that management believes arefundamental to understanding how the Company is managed.   First, underwriting profit is consistentlyemphasized as a primary goal, above premium growth.  Management’s assessment of our trends andpotential growth in underwriting profit is the dominant factor in its decisionswith respect to whether or not to expand a business line, enter into a newniche, product or territory or, conversely, to contract capacity in anybusiness line.  In addition, managementfocuses on managing the costs of our operations.  Management believes that careful monitoringof the costs of existing operations and assessment of costs of potential growthopportunities are important to our profitability.  Access to capital also has a significantimpact on management’s outlook for our operations.  Our insurance company subsidiaries’ operationsand ability to grow their business and take advantage of market opportunitiesare particularly constrained by regulatory capital requirements and ratingagency assessments of capital adequacy.

 

Although not a financial measure, management’sdecisions are also greatly influenced by access to specialized underwriting andclaims expertise in our lines of business. We have chosen to operate in specialty niches with certain commoncharacteristics which we believe provide us with the opportunity to use ourtechnical underwriting expertise in order to realize underwriting profit. As aresult, we have focused on underserved markets for businesses characterized byhigher severity and low frequency of loss where we believe our intellectualcapital and financial strength bring meaningful value. In contrast, we haveavoided niches that we believe have a high frequency of loss activity and/orare subject to a high level of regulatory coverage requirements, such asworkers compensation and personal automobile insurance, because we do notbelieve our technical expertise is of as much value in these types ofbusinesses. Examples of niches that have the characteristics we look forinclude bluewater hull (which provides coverage for physical damage to, forexample, highly valued cruise ships) and directors and officers liability(which covers litigation exposure of a corporation’s directors and officers).These types of exposures require substantial technical expertise. We attempt tomitigate the financial impact of severe claims on our results by conservativeand detailed underwriting, prudent use of reinsurance and a balanced portfolioof risks.

 

Our revenue is primarily comprised of premiums,commission and investment income. Our insurance company subsidiaries derivetheir premiums primarily from business written by the Navigators Agencies. TheLloyd’s Operations derive their premiums from business written by NUAL. TheNavigators Agencies and NUAL receive commissions and, in some cases, profitcommissions and service fees on the business produced on behalf of ourinsurance company subsidiaries and others.

 

Over the past three years, we have experienced generallybeneficial market changes in our lines of business. As a result of several largeindustry losses in the second quarter of 2001, the marine insurance marketbegan to experience diminished capacity and rate increases, initially in theoffshore energy line of business.  Themarine rate increases began to level off in 2004 and into 2005.  As a result of the substantial insuranceindustry losses resulting from Hurricanes Katrina and Rita, the marineinsurance market may experience diminished capacity and rate increases,particularly in the offshore energy line of business.  Specialty liability losses, particularly forour California construction liability business, also resulted in diminishedcapacity in the market in which we compete, as many former competitors wholacked the expertise to selectively underwrite this business have been forcedto withdraw from the market.  Rates forthe California construction liability business leveled off in the first sixmonths and began to decline in the 2005 third quarter after rate increases in2004 and 2003.  In the professionalliability market, the enactment of the Sarbanes-Oxley Act of 2002, togetherwith recent financial and accounting scandals at publicly traded corporationsand the increased frequency of securities-related class action litigation, hasled to heightened interest in professional liability insurance generally. Theseconditions resulted in rate increases in 2002 and 2003 as well as an overallimprovement in policy terms and conditions for our professional liability lineof business.  The professional liability businessexperienced low single digit premium rate decreases in 2004 and in the 2005 thirdquarter.  Overall, the rates wererelatively level for the first nine months of 2005.

 

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Our business is cyclical and influenced by manyfactors.  These factors include pricecompetition, economic conditions, interest rates, weather-related events andother catastrophes including natural and man-made disasters (for examplehurricanes and terrorism), state regulations, court decisions and changes inthe law. The incidence and severity of catastrophes are inherentlyunpredictable.  Although we will attemptto manage our exposure to such events, the frequency and severity ofcatastrophic events could exceed our estimates, which could have a materialadverse effect on our financial condition. Additionally, because our insuranceproducts must be priced, and premiums charged, before costs have fullydeveloped, our liabilities are required to be estimated and recorded inrecognition of future loss and settlement obligations. Due to the inherentuncertainty in estimating these liabilities, we cannot assure you that ouractual liabilities will not exceed our recorded amounts.

 

**Hurricanes Katrina, Rita and Wilma**

 

On August 29, 2005, Hurricane Katrina struckLouisiana, Mississippi, Alabama and surrounding areas, causing significantdestruction in those areas. Our estimate of after-tax net losses, inclusive ofexpected reinsurance recoveries and related reinsurance reinstatement premiums,is approximately $15.0 million or $1.17 per share in the 2005 third quarter.  Our estimate of net losses related toHurricane Katrina was developed from a combination of preliminary claimsnotifications received from brokers and insureds, portfolio modeling based uponthe storm track of Hurricane Katrina and the Company’s own internal assessmentof the exposures insured under individual policies. A substantial portion ofthe Company’s anticipated loss is due to offshore energy exposures in the Gulfof Mexico. Based upon management’s estimate of ultimate loss, we believe thatthe Company’s gross claims are contained within our reinsurance program. Ouractual losses from Hurricane Katrina may differ materially from our estimatedlosses as a result of, among other things, the receipt of additional informationfrom insureds or brokers, the attribution of losses to coverages that for thepurpose of our estimates we assumed would not be exposed and inflation inrepair costs due to the limited availability of labor and materials. If ouractual losses from Hurricane Katrina are materially greater than our estimatedlosses, our business, results of operations and financial condition could bematerially adversely affected.

 

On September 24, 2005, Hurricane Rita struckTexas and Louisiana, causing significant destruction in those areas.  Our estimate of after-tax net losses,inclusive of expected reinsurance recoveries and related reinsurancereinstatement premiums, is approximately $9.0 million or $0.70 per share in the2005 third quarter.  Our estimate of netlosses related to Hurricane Rita was developed from a combination ofpreliminary claims notifications received from brokers and insureds, portfoliomodeling based upon the storm track of Hurricane Rita and the Company’s owninternal assessment of the exposures insured under individual policies. Asubstantial portion of the Company’s anticipated loss is due to offshore energyexposures in the Gulf of Mexico. Based upon management’s current estimate ofultimate loss, we believe that the Company’s gross claims are contained withinour reinsurance program. Our actual losses from Hurricane Rita may ultimatelydiffer materially from our estimated losses as a result of, among other things,the receipt of additional information from insureds or brokers, the attributionof losses to coverages that for the purpose of our estimates we assumed wouldnot be exposed and inflation in repair costs due to the limited availability oflabor and materials. If our actual losses from Hurricane Rita are materiallygreater than our estimated losses, our business, results of operations andfinancial condition could be materially adversely affected.

 

We purchase reinsurance for our insurance operationsin order to mitigate the volatility of losses upon our financial results.  The occurrence of additional large lossevents could reduce the reinsurance coverage that is available to us and couldweaken the financial condition of our reinsurers, which could have a materialadverse effect on our results of operations. Although reinsurance makes the reinsurer liable to us to the extent therisk is transferred or ceded to the reinsurer, ceded reinsurance arrangementsdo not eliminate our obligation to pay claims to our policyholders.Accordingly, we bear credit risk with respect to our reinsurers. Specifically,our reinsurers may not pay claims made by us on a timely basis, or they may notpay some or all of these claims. Either of these events would increase ourcosts and could have a material adverse effect on our business.  We are required to pay the losses even if a reinsurerfails to meet its obligations under the reinsurance agreement.  Hurricanes Katrina and Rita increased ourreinsurance recoverables significantly, which increased our credit risk.

 

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Financial strength ratings by rating agencies are acritical factor in maintaining the competitive position of our insurancecompanies and establishing the market value of our common stock. Our ratingsare subject to periodic review by, and may be revised downward at the solediscretion of, the rating agencies. If our actual losses from HurricanesKatrina and Rita exceed our current estimates, or if additional large lossevents occur, our ratings could be revised downward, which could result in a substantialloss of business and a reduction in the market value of our common stock.

 

We believe that our net loss from Hurricane Wilma,which occurred in October 2005, will not be significant.

 

**Industry Investigations**

 

The insurance industry has become the subject ofincreasing scrutiny with respect to insurance broker and agent compensationarrangements, and certain sales practices. The New York State Attorney General and other state and federalregulators have commenced investigations and other proceedings relating to thepayment of contingent commissions by insurance companies to insurance brokersand agents and the extent to which such compensation has been disclosed, and thesolicitation and provision of fictitious or inflated quotes.  These investigations and proceedings areexpected to continue, and new investigative proceedings may be commenced, inthe future.  These investigations andproceedings could result in legal precedents and new industry-wide practices orlegislation, rules or regulations that could significantly affect ourindustry and may also cause stock price volatility for companies in theinsurance industry.

 

The Company has completed its own internal reviewwith respect to such contingent commission arrangements and the anti-competitivesales practices discussed above.  In thisinternal inquiry, the Company did not find any evidence that it has engaged inthe bid-rigging and price-fixing activities that are at the core of the industryinvestigations into these anti-competitive practices.

 

Largely as a result of these industryinvestigations, contingent commission and other commission practice standardsare currently evolving.  For example, in December 2004the National Association of Insurance Commissioners adopted an amendment to itsProducer Licensing Model Act with respect to producer compensation disclosureobligations, and is considering further amendments to this Model Act.  The Company is supportive of industry effortsto encourage transparency in the disclosure of contingent commissions paid tobrokers by insurers and does not expect to be adversely impacted by legislativedevelopments in this area.

 

The reinsurance industry has also become the subjectof increasing scrutiny with respect to the alleged improper use of reinsurance agreementsto manipulate financial reporting results. The New York State Attorney General and other state and federalregulators have commenced investigations and other proceedings related toreinsurance agreements in which the insurance risk transferred between theceding company and reinsurer may have been insufficient to properly account forsuch transactions 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.

 

As a result of these industry investigations,accounting and reporting requirements for reinsurance transactions, includingrisk transfer guidance used to determine when sufficient insurance risk hasbeen transferred by the ceding company to properly account for suchtransactions as reinsurance, may change.

 

The Company believes that all of its reinsurancetransactions meet the risk transfer requirements to be accounted for asprospective reinsurance in its financial statements, and also believes it hasno separate side agreements that would limit the insurance risk transferred tothe reinsurer under its reinsurance agreements. The Company is unable to determine any reinsurance industry financialreporting changes that could occur as a result of such investigations and theeffects, if any, on its financial reporting of reinsurance transactions.

 

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**Critical Accounting Policies**

 

It is important to understand our accountingpolicies in order to understand our financial statements. Management considerscertain of these policies to be critical to the presentation of the financialresults, since they require management to make estimates and assumptions. Theseestimates and assumptions affect the reported amounts of assets, liabilities,revenues, expenses, and related disclosures at the financial reporting date andthroughout the reporting period. Certain of the estimates result from judgmentsthat can be subjective and complex, and consequently actual results may differfrom these estimates, which would be reflected in future periods.

 

Our most critical accounting policies involve thereporting of the reserves for losses and loss adjustment expenses (“LAE”) (includinglosses that have occurred but were not reported to us by the financialreporting date), reinsurance recoverables, written and unearned premium, therecoverability of deferred tax assets, the impairment of invested assets,accounting for Lloyd’s results and the translation of foreign currencies.

 

***Reserves forLosses and LAE.***  Reserves for losses and LAE represent anestimate of the expected cost of the ultimate settlement and administration oflosses, based on facts and circumstances then known. Actuarial methodologiesare employed to assist in establishing such estimates and include judgmentsrelative to estimates of future claims severity and frequency, length of timeto develop to ultimate, judicial theories of liability and other third partyfactors which are often beyond our control. Due to the inherent uncertaintyassociated with the reserving process, the ultimate liability may be differentfrom the original estimate. Such estimates are regularly reviewed and updatedand any resulting adjustments are included in the current year’s results.

 

***ReinsuranceRecoverables.***Reinsurance recoverables are established for the portion of the loss reservesthat are ceded to reinsurers. Reinsurance recoverables are determined basedupon the terms and conditions of reinsurance contracts which could be subjectto interpretations that differ from our own based on judicial theories ofliability. In addition, we bear credit risk with respect to our reinsurerswhich can be significant considering that certain of the reserves remainoutstanding for an extended period of time. We are required to pay losses evenif a reinsurer fails to meet its obligations under the applicable reinsuranceagreement.

 

***Written andUnearned Premium.***Written premium is recorded based on the insurance policies that have beenreported to us and the policies that have been written by agents but not yetreported to us. We must estimate the amount of written premium not yet reportedbased on judgments relative to current and historical trends of the businessbeing written. Such estimates are regularly reviewed and updated and anyresulting adjustments are included in the current year’s results. An unearnedpremium reserve is established to reflect the unexpired portion of each policyat the financial reporting date.

 

***Deferred TaxAssets.*** We applythe asset and liability method of accounting for income taxes whereby deferredassets 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 InvestmentSecurities.***Impairment of investment securities results in a charge to operations when amarket decline below cost is other-than-temporary. Management regularly reviewsour fixed maturity and equity securities portfolios to evaluate the necessityof recording impairment losses for other-than-temporary declines in the fairvalue of investments. A number of criteria are considered during this processincluding, but not limited to: the current fair value as compared to cost oramortized cost, as appropriate, of the security; the length of time thesecurity’s fair value has been below cost or amortized cost, and by how much;and specific credit issues related to the issuer and current economicconditions. 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. Other factors considered in evaluatingpotential impairment include the current fair value as compared to cost oramortized cost, as appropriate, our intent and ability to retain the investmentfor a

 

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periodof time sufficient to allow for an anticipated recovery in value, specificcredit issues related to the issuer and current economic conditions.Other-than-temporary impairment losses result in a permanent reduction of thecost 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 financial statements.

 

***Accounting forLloyd’s Results.***We record our pro rata share of Lloyd’s Syndicate 1221 assets, liabilities,revenues and expenses, after making adjustments to convert Lloyd’s accountingto U.S. GAAP. The most significant GAAP adjustments relate to incomerecognition. Lloyd’s syndicates determine underwriting results by year ofaccount at the end of three years. We record adjustments to recognizeunderwriting results as incurred, including the expected ultimate cost oflosses incurred. These adjustments to losses are based on actuarial analysis ofsyndicate accounts, including forecasts of expected ultimate losses provided bythe syndicate. At the end of the Lloyd’s three-year period for determiningunderwriting results for an account year, the syndicate will close the accountyear by reinsuring outstanding claims on that account year with theparticipants for the account’s next underwriting year. The amount to close anunderwriting year into the next year is referred to as the reinsurance to close(“RITC”).  The RITC transaction is recordedin the fourth quarter as additional written and earned premium, lossesincurred, loss reserves and receivables, all in the same amount. There are nogains or losses recorded on the RITC.

 

***Translation of ForeignCurrencies****.*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.

 

**Results of Operations and Overview**

 

The following is a discussion and analysis of ourconsolidated and segment results of operations for the three and nine monthperiods ended September 30, 2005 and 2004. All earnings per share data is presented on a per diluted share basis.

 

The Company recorded a net loss of $12.7 million or$0.99 per share for the 2005 third quarter compared to net income of $6.3million or $0.50 per share for the 2004 third quarter.  Net income (loss) for the 2005 and 2004 thirdquarters included net realized capital gains of $0.02 per share and $0.01 pershare, respectively.

 

Net income for the nine month period ended September 30,2005 was $8.3 million or $0.64 per share compared to $24.2 million or $1.91 pershare for the nine month period ended September 30, 2004.  Included in these results were net realizedcapital gains of $0.05 per share and $0.03 per share for the nine months ended September 30,2005 and 2004, respectively.

 

The 2005 third quarter and nine month period wereadversely affected by Hurricanes Katrina and Rita.  The impact of such hurricanes on the 2005financial results compared to the impact of Hurricane Ivan on the 2004financial results are as follows:

 

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| ** **                                                | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|
| ** **                                                | ** ** | **September 30,** | ** ** |
| ** **                                                | ** ** | **2005**               | ** ** | **2004** | ** ** |
|                                                      |       |                   |       |   |   |
| Reduction in net earned  premiums for reinstatement costs |       | $                      | 14,465     |   | $ | 2,273 |   |
|                                                      |       |                   |       |   |   |
| Increase in incurred  losses                              |       | 22,288                 |       | 2,874 |   |
| Underwriting loss                                         |       | $                      | 36,753     |   | $ | 5,147 |   |
| After-tax loss                                            |       | $                      | 23,889     |   | $ | 3,345 |   |
| Reduction in earnings per  share                          |       | $                      | 1.87       |   | $ | 0.26 |   |
|                                                      |       |                   |       |   |   |
| Combined ratio increase:                                  |       |                   |       |   |   |
| Loss and loss expense  ratio                              |       | 41.7                   | %          | 5.6 | % |
| Other operating expense  ratio                            |       | 5.5                    | %          | .9 | % |
|                                                      |       | 47.2                   | %          | 6.5 | % |

 

The increases in the 2005 and 2004 nine month combinedratios attributable to hurricane losses were 14.9% (13.1% for losses and 1.8%for expenses) and 2.2% (1.9% for losses and 0.3% for expenses), respectively.

 

Excluding the hurricanes, our 2005 and 2004 third quarters’and nine months’ overall results of operations reflect improved marketconditions from late 2000 through 2003 that continued at a reduced rate through2004 and were showing signs of softening through the 2005 third quarter.  As a result of the substantial insuranceindustry losses resulting from Hurricanes Katrina and Rita, the marineinsurance market may experience diminished capacity and rate increases,particularly in the offshore energy line of business.

 

Cash flow from operations increased to $168.0 millionfor the first nine months of 2005 compared to $141.7 million for the 2004 firstnine months.  The positive cash flowcontributed to the growth in invested assets and net investment income.

 

Consolidatedstockholders’ equity increased 1% to $332.9 million or $26.02 per share at September 30,2005 compared to $328.6 million or $25.96 per share at December 31, 2004.  The increase was primarily due to net incomeof $8.3 million for the first nine months of 2005.

 

**Revenues****.**  Grosswritten premium increased to $188.1 million and $595.2 million in the third quarterand first nine months of 2005, respectively, from $151.2 million and $508.8million in the third quarter and first nine months of 2004, respectively, a 24.4%increase for the third quarter and a 17.0% increase for the first nine months.  The growth in gross written premium reflects acombination of business expansion in both new and existing lines of businesscoupled with premium rate changes on renewal policies.  The premium rate increases or decreases notedbelow for marine, specialty and professional liability are calculated primarilyby comparing premium amounts on policies that have renewed.  The premiums are judgmentally adjusted forexposure factors when deemed significant and sometimes represent an aggregationof several lines of business.  The ratechange calculations provide an indicated pricing trend and are not meant to bea precise analysis of the numerous factors that affect premium rates or theadequacy of such rates to cover all underwriting costs and generate anunderwriting profit.  The calculation canalso be affected quarter by quarter depending on the particular policies andthe number of policies that renew during that period.  Due to market conditions, these rate changesmay or may not apply to new business which may be more competitively pricedcompared to renewal business.  Thefollowing table sets forth our gross and net written premium and net earnedpremium by segment and line of business for the periods indicated:

 

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| ** **                    | ** ** | **Three Months Ended September 30,** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|
| ** **                    | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                    | ** ** | **Gross**                                 | ** ** | ** ** | ** ** | **Net** | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** | **Net** | ** ** |
| ** **                    | ** ** | **Written**                               | ** ** | ** ** | ** ** | **Written** | ** ** | **Earned** | ** ** | **Written** | ** ** | ** ** | ** ** | **Written** | ** ** | **Earned** | ** ** |
| ** **                    | ** ** | **Premium**                               | ** ** | **%** | ** ** | **Premium** | ** ** | **Premium** | ** ** | **Premium** | ** ** | **%** | ** ** | **Premium** | ** ** | **Premium** | ** ** |
| ** **                    | ** ** | **($ in thousands)**                 | ** ** |
| Insurance Companies:          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                        |       | $                                         | 53,084     |   | 28.2 | % | $ | 11,378 |   | $ | 14,391 |   | $ | 48,413 |   | 32.0 | % | $ | 15,576 |   | $ | 17,862 |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty                     |       | 59,307                                    |       | 31.5 | % | 38,313 |   | 31,965 |   | 39,025 |   | 25.8 | % | 20,677 |   | 22,824 |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Professional Liability        |       | 21,528                                    |       | 11.4 | % | 9,823 |   | 7,786 |   | 18,723 |   | 12.4 | % | 6,703 |   | 5,692 |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Assumed from Lloyd’s     |       | (261                                      | )          | -0.1 | % | (413 | ) | (356 | ) | 1,056 |   | 0.7 | % | 1,056 |   | 4,271 |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other (includes run-off)      |       | 60                                        |       | 0.0 | % | (8 | ) | (8 | ) | 101 |   | 0.1 | % | 892 |   | 892 |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Insurance Companies Total     |       | 133,718                                   |       | 71.0 | % | 59,093 |   | 53,778 |   | 107,318 |   | 71.0 | % | 44,904 |   | 51,541 |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s Operations:      |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                        |       | 47,338                                    |       | 25.2 | % | 14,602 |   | 19,453 |   | 39,807 |   | 26.4 | % | 18,941 |   | 22,075 |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Professional Liability        |       | 3,131                                     |       | 1.7 | % | 1,231 |   | 545 |   | — |   | 0.0 | % | — |   | — |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other                         |       | 3,673                                     |       | 2.0 | % | 1,123 |   | 958 |   | 5,197 |   | 3.4 | % | 2,147 |   | 1,521 |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s Operations Total |       | 54,142                                    |       | 28.9 | % | 16,956 |   | 20,956 |   | 45,004 |   | 29.8 | % | 21,088 |   | 23,596 |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Intercompany elimination      |       | 254                                       |       | 0.1 | % | — |   | — |   | (1,144 | ) | -0.8 | % | — |   | — |   |
|                          |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                         |       | $                                         | 188,114    |   | 100.0 | % | $ | 76,049 |   | $ | 74,734 |   | $ | 151,178 |   | 100.0 | % | $ | 65,992 |   | $ | 75,137 |   |

 

25

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| ** **                     | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------|------------|------------------------------------------|------------|
| ** **                     | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **                     | ** ** | **Gross**                                | ** ** | ** ** | ** ** | **Net** | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** | **Net** | ** ** |
| ** **                     | ** ** | **Written**                              | ** ** | ** ** | ** ** | **Written** | ** ** | **Earned** | ** ** | **Written** | ** ** | ** ** | ** ** | **Written** | ** ** | **Earned** | ** ** |
| ** **                     | ** ** | **Premium**                              | ** ** | **%** | ** ** | **Premium** | ** ** | **Premium** | ** ** | **Premium** | ** ** | **%** | ** ** | **Premium** | ** ** | **Premium** | ** ** |
| ** **                     | ** ** | **($ in thousands)**                | ** ** |
| Insurance  Companies:          |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                         |       | $                                        | 181,500    |   | 30.5 | % | $ | 68,189 |   | $ | 57,600 |   | $ | 159,412 |   | 31.3 | % | $ | 61,219 |   | $ | 59,124 |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Specialty                      |       | 152,454                                  |       | 25.6 | % | 107,991 |   | 81,429 |   | 110,739 |   | 21.8 | % | 60,229 |   | 65,728 |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Professional  Liability        |       | 60,708                                   |       | 10.2 | % | 24,333 |   | 21,493 |   | 51,982 |   | 10.2 | % | 19,080 |   | 14,199 |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Assumed from  Lloyd’s     |       | (1,066                                   | )          | -0.2 | % | (1,209 | ) | (320 | ) | 4,398 |   | 0.9 | % | 4,191 |   | 16,554 |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other  (includes run-off)      |       | 90                                       |       | 0.0 | % | 45 |   | 46 |   | 224 |   | 0.0 | % | 895 |   | 901 |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Insurance  Companies Total     |       | 393,686                                  |       | 66.1 | % | 199,349 |   | 160,248 |   | 326,755 |   | 64.2 | % | 145,614 |   | 156,506 |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s  Operations:      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                         |       | 168,458                                  |       | 28.3 | % | 77,392 |   | 74,643 |   | 168,564 |   | 33.1 | % | 81,979 |   | 64,918 |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Professional  Liability        |       | 4,718                                    |       | 0.9 | % | 1,855 |   | 711 |   | — |   | 0.0 | % | — |   | — |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other                          |       | 27,343                                   |       | 4.6 | % | 7,800 |   | 2,502 |   | 17,907 |   | 3.5 | % | 8,023 |   | 3,203 |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Lloyd’s  Operations Total |       | 200,519                                  |       | 33.7 | % | 87,047 |   | 77,856 |   | 186,471 |   | 36.7 | % | 90,002 |   | 68,121 |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Intercompany  elimination      |       | 1,038                                    |       | 0.2 | % | — |   | — |   | (4,470 | ) | -0.9 | % | — |   | — |   |
|                           |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                          |       | $                                        | 595,243    |   | 100.0 | % | $ | 286,396 |   | $ | 238,104 |   | $ | 508,756 |   | 100.0 | % | $ | 235,616 |   | $ | 224,627 |   |

 

26

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**GrossWritten Premium**

 

Insurance Companies’ GrossWritten Premium

 

*Marine Premium.* The marine gross written premium for the 2005third quarter increased 9.6% compared to the 2004 third quarter, reflecting growthacross several lines of business including liability and offshore energy.  The marine gross written premium for the firstnine months of 2005 increased 13.9% compared to the first nine months of 2004, againdue to growth across several lines of business including cargo, offshore energyand liability.  The average renewal premiumrates during the third quarter and first nine months of 2005 increased byapproximately 3% and 1%, respectively. Navigators Insurance Company obtains its marine business throughparticipation in the marine pool managed by the Navigators Agencies.  Its participation is 85% for the 2005underwriting year compared to 80% for the 2004 underwriting year.

 

*Specialty Premium.* The nine months business consists of 64% generalliability business for small general and artisan contractors, 12% personalumbrella business and 24% other targeted commercial risks.  The specialty gross written premium for the 2005third quarter increased 52.0% compared to the 2004 third quarter reflecting growthacross all lines of business and premiums generated from our excess casualtybusiness, which started in the first quarter of 2005.  The specialty gross written premium for thefirst nine months of 2005 increased 37.7% compared to the first nine months of2004 for the same reasons stated for the 2005 third quarter increase.  The average renewal premium rates decreasedby approximately 7% and 1% in the contractors’ liability business in the third quarterand first nine months of 2005, respectively.

 

*Professional Liability Premium.* Our insurance company subsidiaries writeprofessional liability insurance, of which 68% represents directors andofficers liability insurance (“D&O”) for privately held and publicly tradedcorporations. In 2002, the professional liability business was expanded toinclude errors and omissions insurance and employment practices liabilitycoverages.  Commencing in October 2004,our U.K. Branch began writing professional liability coverages for U.K.solicitors and, in 2005, we began writing professional liability coverages forarchitects and engineers.  Theprofessional liability gross written premium for the 2005 third quarter increased15.0% compared to the 2004 third quarter, reflecting the expansion of thisbusiness for all lines.  The professionalliability gross written premium for the first nine months of 2005 increased16.8% compared to the first nine months of 2004 for the same reasons stated forthe 2005 third quarter increase. Average overall renewal premium rates for thisbusiness decreased by approximately 2% in the 2005 third quarter and 1% in the firstnine months of 2005, with D&O rates declining by approximately 5% in the 2005third quarter and 4% in the first nine months of 2005.

 

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

 

Lloyd’sOperations’ Gross Written Premium

 

*Marine Premium.*Our gross writtenpremium is based on the stamp capacity of Syndicate 1221 and the percentage ofsuch stamp capacity we provide.  Ourpercentage of participation in the stamp capacity is 97.5% for 2005 compared to97.4% for 2004.  Stamp capacity is ameasure of the amount of premium a Lloyd’s syndicate is authorized to write asdetermined based on a business plan approved by the Council of Lloyd’s.  The stamp capacity for Syndicate 1221 hasbeen reduced to £135 million ($248.9 million) in 2005 from £150 million ($275.0million) in 2004, reflective of unused stamp capacity in 2004 coupled with anticipateddeclining market conditions in 2005.  The**marine gross written premium for the third quarter of 2005 increased 18.9%compared to the third quarter of 2004 and was flat for the first nine months of2005 compared to the first nine months of 2004. The average renewal premium rates increased approximately 3% in the 2005third quarter and 1% in the first nine months of 2005.

 

27

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*Professional Liability Premium.*  The Syndicate commenced writing internationalD&O business during the 2005 second quarter and produced $3.1 million ofgross written premium in the 2005 third quarter and $4.7 million for the firstnine months of 2005.

 

*Other Premium. *Other premium consists of premium for engineering and construction businesswhich provides coverage for construction projects including machinery,equipment and loss of use due to delays and of premium for onshore energy businesswhich principally focuses on the oil and gas, chemical and petrochemicalindustries with coverages primarily for property damage and businessinterruption.

 

**CededWritten 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 desired ratiosof net premiums written to statutory surplus. The relationship of ceded towritten premium varies based upon the types of business written and whether thebusiness is written by our insurance company subsidiaries or the Lloyd’s Operations.

 

The following tables set forth our ceded writtenpremium by segment and major lines of business for the periods indicated:

 
| ** **                 | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------|------------|-------------------------------------------|------------|
| ** **                 | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                 | ** ** | ** **                                | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                 | ** ** | **Ceded**                                 | ** ** | **Gross** | ** ** | **Ceded** | ** ** | **Gross** | ** ** |
| ** **                 | ** ** | **Written**                               | ** ** | **Written** | ** ** | **Written** | ** ** | **Written** | ** ** |
| ** **                 | ** ** | **Premium**                               | ** ** | **Premium** | ** ** | **Premium** | ** ** | **Premium** | ** ** |
|                       |       | **($ in thousands)**                 |       |
|                       |       | ** **                                |       |   |   |   |   |   |   |
| Insurance  Companies:      |       |                                      |       |   |   |   |   |   |   |
| Marine                     |       | $                                         | 41,706     |   | 78.6 | % | $ | 32,837 |   | 67.8 | % |
| Specialty                  |       | 20,994                                    |       | 35.4 | % | 18,348 |   | 47.0 | % |
| Professional  Liability    |       | 11,705                                    |       | 54.4 | % | 12,020 |   | 64.2 | % |
| Assumed from  Lloyd’s |       | 152                                       |       | NM |   | — |   | 0.0 | % |
| Other  (includes run-off)  |       | 68                                        |       | NM |   | (791 | ) | NM |   |
| Subtotal                   |       | 74,625                                    |       | 55.8 | % | 62,414 |   | 58.2 | % |
|                       |       |                                      |       |   |   |   |   |   |   |
| Lloyd’s  Operations:  |       |                                      |       |   |   |   |   |   |   |
| Marine                     |       | 32,736                                    |       | 69.2 | % | 20,866 |   | 52.4 | % |
| Professional  Liability    |       | 1,900                                     |       | 60.7 | % | — |   | NM |   |
| Other                      |       | 2,550                                     |       | 69.4 | % | 3,050 |   | 58.7 | % |
| Subtotal                   |       | 37,186                                    |       | 68.7 | % | 23,916 |   | 53.1 | % |
|                       |       |                                      |       |   |   |   |   |   |   |
| Intercompany elimination   |       | 254                                       |       | NM |   | (1,144 | ) | NM |   |
|                       |       |                                      |       |   |   |   |   |   |   |
| Total                      |       | $                                         | 112,065    |   | 59.6 | % | $ | 85,186 |   | 56.3 | % |

 

28

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| ** **                | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------|------------|-------------------------------------------|------------|
| ** **                | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                | ** ** | ** **                                | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                | ** ** | **Ceded**                                 | ** ** | **Gross** | ** ** | **Ceded** | ** ** | **Gross** | ** ** |
| ** **                | ** ** | **Written**                               | ** ** | **Written** | ** ** | **Written** | ** ** | **Written** | ** ** |
| ** **                | ** ** | **Premium**                               | ** ** | **Premium** | ** ** | **Premium** | ** ** | **Premium** | ** ** |
|                      |       | **($ in thousands)**                 |       |
|                      |       |                                      |       |   |   |   |   |   |   |
| Insurance Companies:      |       |                                      |       |   |   |   |   |   |   |
| Marine                    |       | $                                         | 113,311    |   | 62.4 | % | $ | 98,193 |   | 61.6 | % |
| Specialty                 |       | 44,463                                    |       | 29.2 | % | 50,510 |   | 45.6 | % |
| Professional Liability    |       | 36,375                                    |       | 59.9 | % | 32,902 |   | 63.3 | % |
| Assumed from Lloyd’s |       | 143                                       |       | -13.4 | % | 207 |   | 4.7 | % |
| Other (includes run-off)  |       | 45                                        |       | NM |   | (671 | ) | NM |   |
| Subtotal                  |       | 194,337                                   |       | 49.4 | % | 181,141 |   | 55.4 | % |
|                      |       |                                      |       |   |   |   |   |   |   |
| Lloyd’s Operations:  |       |                                      |       |   |   |   |   |   |   |
| Marine                    |       | 91,066                                    |       | 54.1 | % | 86,585 |   | 51.4 | % |
| Professional Liability    |       | 2,863                                     |       | 60.7 | % | — |   | NM |   |
| Other                     |       | 19,543                                    |       | 71.5 | % | 9,884 |   | 55.2 | % |
| Subtotal                  |       | 113,472                                   |       | 56.6 | % | 96,469 |   | 51.7 | % |
|                      |       |                                      |       |   |   |   |   |   |   |
| Intercompany elimination  |       | 1,038                                     |       | NM |   | (4,470 | ) | NM |   |
|                      |       |                                      |       |   |   |   |   |   |   |
| Total                     |       | $                                         | 308,847    |   | 51.9 | % | $ | 273,140 |   | 53.7 | % |

 

----

NM = not meaningful

 

The ratio of ceded written premium to gross writtenpremium in the 2005 third quarter and nine month periods was 59.6% and 51.9%,respectively, compared to the 2004 third quarter and nine month periods of 56.3%and 53.7%.  The increase in the ratio ofceded written premium to gross written premium in the 2005 third quarter comparedto the same period in 2004 resulted primarily from the ceded reinstatementpremium costs related to Hurricanes Katrina and Rita.  The Insurance Companies’ marine and Lloyd’sOperations 2005 third quarter ceded written premium includes $9.1 million and$5.3 million, respectively, of reinstatement premium related to the losses fromHurricanes Katrina and Rita.  TheInsurance Companies’ marine and Lloyd’s Operations 2004 third quarter cededwritten premium includes $1.5 million and $0.8 million, respectively, ofreinstatement premium related to the losses from Hurricane Ivan.

 

Excluding the effects of ceded reinstatementpremiums on both 2005 and 2004, the ratio of ceded written premium to grosswritten premium in the 2005 third quarter and nine month periods was 50.7% and49.1%, respectively, compared to the 2004 third quarter and nine month periodsof 54.8% and 53.2%.  The decreases in2005 are primarily related to the March 31, 2005 cancellation of a quotashare reinsurance agreement for the specialty business.  The cancellation resulted in a reduction ofapproximately $14.5 million in ceded unearned premium in the 2005 first quarter.  This amount has been retained by the Companyand will be earned over a 12 to 15 month period.  The 2004 nine month net written premium is netof approximately $14 million of ceded written premium related to this agreementfor the second and third quarters.

 

**NetWritten Premium**.*** ***Net written premium increased 15.2% in the 2005 third quarterand increased 21.6% in the first nine months of 2005 compared to the third quarterand first nine months of 2004.  The

 

29

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increases in the 2005third quarter and the first nine months would have been 32.6% and 26.5% whenexcluding the effect of the reinstatements. The increase in net written premium in 2005 is principally due to the March 31,2005 cancellation of the specialty quota share treaty discussed above, businessexpansion, and the increase in Navigators Insurance Company’s portion of themarine pool to 85% in 2005 from 80% in 2004.

 

**Net Earned Premium**.  Net earned premium, which generally lags theincrease in net written premium, decreased 0.5% in the 2005 third quarter andincreased 6.0% in the first nine months of 2005 compared to the third quarter andfirst nine months of 2004 as a result of the increased net written premium.  The Insurance Companies’ marine and Lloyd’sOperations marine 2005 third quarter net earned premium was reduced by $9.1million and $5.3 million, respectively, due to reinstatement premium related tothe ceded losses from Hurricanes Katrina and Rita.  The increases in earned premium for the 2005 thirdquarter and the first nine months would have been 15.2% and 11.3%,respectively, when excluding the effect of the reinstatement premium.

 

**CommissionIncome****.** Commission income from unaffiliated business was $1.0 million and $3.8million compared to $1.1 million and $3.6 million in the third quarter andfirst nine months of 2004, respectively.

 

**NetInvestment Income****.* ***Net investmentincome increased 33.6% in the 2005 third quarter and 32.8% in the first nine monthsof 2005 compared to the same periods in 2004 due to the increase in investedassets as a result of the positive cash flow from the increased premium volume.

 

**NetRealized Capital Gains****(Losses)****.**  Pre-taxnet income included net realized capital gains of $344,000 for the three monthsended September 30, 2005 compared to $271,000 for the 2004 third quarter.  On an after-tax basis, the net realized capitalgains were $224,000 or $0.02 per share and $177,000 or $0.01 per share for the 2005and 2004 third quarters, respectively. Pre-tax net income included $927,000 of net realized capital gains forthe nine months ended September 30, 2005 compared to $588,000 for thefirst nine months of 2004.  On anafter-tax basis, the net realized capital gains were $603,000 or $0.05 pershare and $382,000 or $0.03 per share for the first nine months of 2005 and2004, respectively.

 

**OtherIncome/(Expense)****.** Other income/(expense) for the third quarterand first nine months of both 2005 and 2004 consisted primarily of foreignexchange gains and losses from our Lloyd’s Operations and inspection feesrelated to the specialty insurance business.

 

**OperatingExpenses**

 

*Net Lossesand Loss Adjustment Expenses Incurred. *The ratios of net losses and loss adjustment expenses incurred to netearned premium (loss ratios) for the 2005 and 2004 third quarters were 102.8%and 65.5%, respectively, and for the first nine months of 2005 and 2004 were 74.2%and 61.6%, respectively.  The 2005 thirdquarter was adversely impacted by $22.3 million of net losses from HurricanesKatrina and Rita which, along with the effect of the $14.5 million ofreinstatement premium caused by the ceded losses from Hurricanes Katrina andRita.  These net losses increased theloss ratio for the third quarter and first nine months of 2005 by 41.7 and 13.1loss ratio points, respectively.  The2004 third quarter was adversely impacted by $2.9 million of net losses fromHurricane Ivan which, along with the effect of the $2.2 million ofreinstatement premium caused by the ceded losses from Hurricane Ivan.  These net losses increased the loss ratio forthe third quarter and first nine months of 2004 by 5.6 and 1.9 loss ratiopoints, respectively.  The loss ratiosfor the third quarter and first nine months of 2004 were favorably impacted by1.6 and 2.3 loss ratio points, respectively, for a redundancy of prior yearloss reserves in our Lloyd’s operations.

 

Theprovision for loss adjustment expenses includes defense cost containmentexpenses for outside adjustors, attorneys’ fees and internal operating expensesconsisting principally of claims department costs incurred in the processingand settlement of claims.  Commencing in2005, the Company allocated paid claims department costs in losses incurredwhile previously such payments were included in other operating expenses.  Such payments included in incurred losses forthe 2005 third quarter and nine month period were $1.1 million and $3.6 million,respectively, compared to $0.7 million and $2.1 million for the comparable 2004periods

 

30

----

 

included in otheroperating expenses.  Such reclassificationshave no impact on net income and the combined loss and expense ratios for all currentand prior periods.

 

The following tables set forth our net loss and LAE reservesby segment and line of insurance business and the total case reserves andincurred but not reported (“IBNR”) reserves as of September 30, 2005 and December 31,2004:

 
| ** **                            | ** ** | **September 30,**    | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|---------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2005**                  | ** ** | **2004**              | ** ** |
| ** **                            | ** ** | **($ in thousands)** | ** ** |
| Insurance  Companies:                 |       |                      |       |                  |       |
| Marine                                |       | $                         | 154,800    |                  | $          | 130,439 |   |
| Specialty                             |       | 179,443                   |       | 150,347               |       |
| Professional  Liability               |       | 30,926                    |       | 19,001                |       |
| Assumed from  Lloyd’s Operations |       | 28,578                    |       | 37,790                |       |
| Other  (primarily run-off business)   |       | 19,330                    |       | 22,512                |       |
| Total  Insurance Companies            |       | 413,077                   |       | 360,089               |       |
|                                  |       |                      |       |                  |       |
| Lloyd’s  Operations:             |       |                      |       |                  |       |
| Marine                                |       | 123,642                   |       | 99,565                |       |
| Other                                 |       | 10,201                    |       | 4,134                 |       |
| Total Lloyd’s  Operations        |       | 133,843                   |       | 103,699               |       |
|                                  |       |                      |       |                  |       |
| Total net  loss reserves              |       | $                         | 546,920    |                  | $          | 463,788 |   |
|                                  |       |                      |       |                  |       |
| Total net  case loss reserves         |       | $                         | 205,161    |                  | $          | 189,746 |   |
| Total net  IBNR loss reserves         |       | 341,759                   |       | 274,042               |       |
|                                  |       |                      |       |                  |       |
| Total net  loss reserves              |       | $                         | 546,920    |                  | $          | 463,788 |   |

 

At September 30, 2005, the IBNR net lossreserves were 62.5% of our total loss reserves compared to 59.1% at December 31,2004.  Substantially all of the $36.8million of net loss reserves recorded for Hurricanes Katrina and Rita areincluded in IBNR at September 30, 2005.

 

At September 30, 2005, a 10% increase in thenet loss reserves would equate to $54.7 million which would represent anafter-tax charge to net income of $35.5 million or 10.7% of stockholders’equity.  Loss reserve estimates arereviewed each quarter to evaluate whether the assumptions made continue to beappropriate.  Any adjustments that resultfrom this review are recorded in the quarter in which they are identified.

 

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 the Company.  Noassurance can be given that actual claims made and related payments will not bein excess of the amounts reserved. During the loss settlement period, it often becomes necessary to refineand adjust the estimates of liability on a claim either upward or downward.  Even after such adjustments, ultimate liabilitymay exceed or be less than the revised estimates.  The increase in net loss reserves is also afunction of the growth in premium volume over the past two years.  See “Overview-Hurricanes Katrina, Rita andWilma” included herein.

 

Our loss reserves include amounts related to shorttail and long tail classes of business. Short tail business refers to businesswhere claims are generally reported quickly upon occurrence of an event, making

 

31

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estimationof loss reserves less complex. Our longer tail business includes our specialtyliability and professional liability insurance. For the long tail lines,significant periods of time, ranging up to several years or more, may elapsebetween the occurrence of the loss, the reporting of the loss and thesettlement of the claim.  Generally, thelonger the time span between the incidence of a loss and the settlement of theclaim, the more likely the ultimate settlement amount can vary from theoriginal estimate.

 

*Specialty Liability andProfessional Liability.*Substantially all of our specialty liability business involves generalliability policies which generate third party liability claims that are longtail in nature. A significant portion of our general liability reserves relatesto California construction liability claims. Reserves and claim frequency onthis business may be impacted by legislation implemented in California, whichgenerally provides consumers who experience construction defects a method otherthan litigation to obtain construction defect repairs. The law, which becameeffective July 1, 2002 with a sunset provision effective January 1,2011, provides for an alternative dispute resolution system that attempts toinvolve all parties to the claim at an early stage. This legislation may impactclaim severity, frequency and length of settlement assumptions underlying ourreserves. Accordingly, our ultimate liability may exceed or be less thancurrent estimates due to this variable, among others.  There were 1,250 specialty liability claimsopen at September 30, 2005 compared to 1,028 at December 31, 2004.

 

The professional liability class generates thirdparty claims, which also are longer tail in nature. The professional liabilitypolicies provide coverage on a claims-made basis, whereby coverage is generallyprovided only for those claims that are made during the policy period.  The substantial majority of our claims madepolicies provide coverage for one year periods. The Company has also issued a limited number of multi-year claims madeprofessional liability policies known as “tail coverage” that provide forinsurance protection for wrongful acts prior to the runoff date.  Such multi-year policies provide insuranceprotection for several years.

 

Loss development of our professional liabilitybusiness is relatively immature, as we first began writing the business in late2001.  Accordingly, it will take sometime to better understand the reserve trends on this business.  Our professional liability loss estimates arebased on expected losses, actual reported losses, evaluation of loss trends,industry data, and the legal, regulatory and current risk environment becauseanticipated loss experience in this area is less predictable due to the smallnumber of claims and/or erratic claim severity patterns. We believe that wehave made a reasonable estimate of the required loss reserves for professionalliability. The expected ultimate losses may be adjusted up or down as theaccident years mature.  There were 586 professionalliability claims open at September 30, 2005 compared to 337 at December 31,2004.

 

32

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The following tables set forth our net loss and LAEreserves for our specialty liability and professional liability businesses asof September 30, 2005 and December 31, 2004:

 
| ** **                        | ** ** | **September 30, 2005** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | ** **                  | ** ** | ** ** | ** ** | **Total** | ** ** | **% of IBNR** | ** ** |
| **Type of**                       | ** ** | **Net Reported**            | ** ** | **Net** | ** ** | **Net Loss** | ** ** | **to Total Net** | ** ** |
| **Business**                      | ** ** | **Reserves**                | ** ** | **IBNR** | ** ** | **Reserves** | ** ** | **Loss Reserves** | ** ** |
|                              |       |                        |       |   |   |   |   |   |   |
| Specialty  construction liability |       | $                           | 26,551     |   | $ | 129,781 |   | $ | 156,332 |   | 83.0 | % |
| Professional liability            |       | 5,407                       |       | 26,288 |   | 31,695 |   | 82.9 | % |
|                              |       |                        |       |   |   |   |   |   |   |
| Total                             |       | $                           | 31,958     |   | $ | 156,069 |   | $ | 188,027 |   | 83.0 | % |

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

 

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

 

The reserves we have established for asbestos exposuresare for: (i) estimated losses for excess insurance policy limits exposedto class action suits against two insureds involved in the manufacturing ordistribution of asbestos products; (ii) other insureds not directlyinvolved in the manufacturing or distribution of asbestos products, but thathave more than incidental asbestos exposure for their purchase or use ofproducts that contained asbestos; (iii) attritional asbestos claims thatcould be expected to occur over time; and (iv) the 2004 settlement of alarge claim exposed to a class action suit which settlement will be paid overseven years starting in June 2005.

 

The following tables set forth our gross and netloss and LAE reserves, and claim counts for our asbestos and environmentalexposures, for the periods indicated, which we believe are subject touncertainties greater than those presented by other types of claims:

 

33

----

 
| ** **                      | ** ** | **Three Months Ended**      | ** ** |
|---------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **September 30, 2005** | ** ** |
| ** **                      | ** ** | **Asbestos**                | ** ** | **Environmental** | ** ** | **Total** | ** ** |
| ** **                      |       | **($ in thousands)**   |       |
| **Gross of  Reinsurance**       |       |                        |       |   |   |   |   |
| Beginning Reserve               |       | $                           | 74,743     |   | $ | 8,892 |   | $ | 83,635 |   |
| Incurred Losses &  LAE |       | 174                         |       | 294 |   | 468 |   |
| Calendar Year Payments          |       | 118                         |       | 665 |   | 783 |   |
| Ending Reserves                 |       | $                           | 74,799     |   | $ | 8,521 |   | $ | 83,320 |   |
|                            |       |                        |       |   |   |   |   |
| **Net of  Reinsurance**         |       |                        |       |   |   |   |   |
| Beginning Reserve               |       | $                           | 30,191     |   | $ | 1,510 |   | $ | 31,701 |   |
| Incurred Losses &  LAE |       | 120                         |       | 169 |   | 289 |   |
| Calendar Year Payments          |       | 90                          |       | 207 |   | 297 |   |
| Ending Reserves                 |       | $                           | 30,221     |   | $ | 1,472 |   | $ | 31,693 |   |

 
| ** **                      | ** ** | **Nine Months Ended**       | ** ** |
|---------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | **September 30, 2005** | ** ** |
| ** **                      | ** ** | **Asbestos**                | ** ** | **Environmental** | ** ** | **Total** | ** ** |
| ** **                      |       | **($ in thousands)**   |       |
| **Gross of  Reinsurance**       |       |                        |       |   |   |   |   |
| Beginning Reserve               |       | $                           | 78,421     |   | $ | 7,513 |   | $ | 85,934 |   |
| Incurred Losses &  LAE |       | 479                         |       | 3,787 |   | 4,266 |   |
| Calendar Year Payments          |       | 4,101                       |       | 2,779 |   | 6,880 |   |
| Ending Reserves                 |       | $                           | 74,799     |   | $ | 8,521 |   | $ | 83,320 |   |
|                            |       |                        |       |   |   |   |   |
| **Net of  Reinsurance**         |       |                        |       |   |   |   |   |
| Beginning Reserve               |       | $                           | 31,394     |   | $ | 1,494 |   | $ | 32,888 |   |
| Incurred Losses &  LAE |       | 356                         |       | 1,206 |   | 1,562 |   |
| Calendar Year Payments          |       | 1,529                       |       | 1,228 |   | 2,757 |   |
| Ending Reserves                 |       | $                           | 30,221     |   | $ | 1,472 |   | $ | 31,693 |   |

 
| ** **           | ** ** | ** **                  | ** ** | ** **        | ** ** | **Claims Settled** | ** ** | ** **                 | ** ** |
|----------------------|------------|-----------------------------|------------|-------------------|------------|--------------------|------------|----------------------------|------------|
| ** **           | ** ** | **Claim Count**             | ** ** | **New Claims**    | ** ** | **or Resolved**    | ** ** | **Claim Count**            | ** ** |
| **Type of Business** | ** ** | **September 30, 2005** | ** ** | **During Period** | ** ** | **During Period**  | ** ** | **December 31, 2004** | ** ** |
| ** **           | ** ** | ** **                  | ** ** | ** **        | ** ** | ** **         | ** ** | ** **                 | ** ** |
| Environmental        |       | 119                         |       | 49                |       | 19                 |       | 89                         |       |
| Asbestos             |       | 146                         |       | 26                |       | 9                  |       | 129                        |       |
| Total                |       | 265                         |       | 75                |       | 28                 |       | 218                        |       |

 

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

 

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

 

34

----

 

Our management believes that the estimates for the reservesfor losses and loss adjustment expenses are adequate to cover the ultimate costof losses and loss adjustment expenses on reported and unreported claims.  However, it is possible that the ultimateliability may exceed or 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 are generally recorded as deferredpolicy acquisition costs to the extent that they relate to unearnedpremium.  Commission expense as apercentage of earned premium in the third quarter and first nine months of 2005was 15.6% and 12.8%, respectively, compared to 11.7% and 13.3% for the 2004comparable periods.  Excluding thereduction in 2005 and 2004 of $14.5 million and $2.3 million, respectively, inearned premiums for reinstatement premiums related to the hurricane losses, thecommission expense ratios for the third quarter and first nine months of 2005 were13.1% and 12.1% compared to 11.3% and 13.2% for the 2004 comparable periods.  The commission ratios were affected byseveral factors in 2005, including a reduction in ceding commissions with theelimination of the specialty quota share treaty effective March 31, 2005and a general reduction in commissions to agents.

 

*OtherOperating Expenses.*The 9.2% and 19.3% increases in other operating expenses in the third quarter andfirst nine months of 2005, respectively, compared to the same periods in 2004 areattributable primarily to employee-related expenses resulting from expansion ofthe business.  Included in the three and ninemonths ended September 30, 2005 were $1.1 million and $2.7 million, respectively,in the aggregate for employee stock options, stock grants and stockappreciation rights expense compared to $658,000 and $1.8 million,respectively, for the same periods in 2004.

 

**Income Taxes**. The income tax expense(benefit) was ($7.5) million and $3.0 million for the third quarters of 2005 and2004, respectively.  The effective taxrates for the 2005 and 2004 third quarters were (37.1%) and 32.1%, respectively.  The first nine months of 2005 and 2004 hadincome tax expense of $2.5 million and $12.0 million, respectively, resultingin an effective tax rate of 23.2% and 33.1%, respectively.  The fluctuations in the effective tax ratesare due to the tax benefits related to the losses from Hurricanes Katrina andRita which are included in the calculation of the 2005 effective taxrates.  As of September 30, 2005 andDecember 31, 2004, the net deferred Federal, foreign, state and local taxassets were $26.2 million and $17.3 million, respectively.

 

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

 

Wehave not provided for U.S. deferred income taxes or foreign withholding taxeson the undistributed earnings of approximately $7.1 million of our foreignsubsidiaries earnings since these earnings are intended to be reinvestedindefinitely.  However, in the future, ifwe planned to distribute such earnings to the Company, taxes of approximately $400,000would be reflected in the tax provision and would then be payable in the yeardistributed assuming all foreign tax credits are realized.

 

35

----

 

TheAmerican Jobs Creation Act of 2004, enacted October 22, 2004, allows adeduction of 85% of certain foreign earnings that are repatriated by December 31,2005.  If the Company were to repatriate the$7.1 million of earnings from its foreign subsidiaries under this provision, incometax of approximately $60,000 would be reflected in the 2005 tax provision.  The Company does not expect to repatriate anyforeign earnings under the American Jobs Creation Act of 2004.

 

The Company had state and local operatingloss carryforwards amounting to potential future tax benefits of $5.8 million and $4.5million at September 30, 2005 and December 31, 2004,respectively.  A valuation allowance wasestablished for the full amount of these potential future tax benefits due tothe uncertainty associated with their realization.  The Company’s state and local taxcarryforwards at September 30, 2005 expire from 2019 to 2025.

 

**Segment Information**

 

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

 

***Insurance Companies***

 

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

 

36

----

 

Following are the results ofoperations for the Insurance Companies for the three and nine months endedSeptember 30, 2005 and 2004:

 
| ** **                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                              | ** ** | **($ in thousands)**                  | ** ** |
| Revenues:                               |       |                                       |       |                                      |       |   |   |   |   |
| Net earned premium                      |       | $                                          | 53,778     |                                      | $          | 51,541 |   | $ | 160,248 |   | $ | 156,506 |   |
| Net investment income                   |       | 7,692                                      |       | 6,225                                     |       | 22,032 |   | 17,538 |   |
| Net realized capital gains              |       | 401                                        |       | 326                                       |       | 1,348 |   | 707 |   |
| Other income                            |       | 31                                         |       | (7                                        | )          | 238 |   | 6 |   |
| Total  revenues                         |       | 61,902                                     |       | 58,085                                    |       | 183,866 |   | 174,757 |   |
|                                    |       |                                       |       |                                      |       |   |   |   |   |
| Operating expenses:                     |       |                                       |       |                                      |       |   |   |   |   |
| Net losses and LAE                      |       | 47,332                                     |       | 35,401                                    |       | 114,856 |   | 100,669 |   |
| Commission expense                      |       | 13,068                                     |       | 11,682                                    |       | 39,522 |   | 39,069 |   |
| Other operating expenses                |       | 2,449                                      |       | 1,780                                     |       | 6,570 |   | 3,967 |   |
| Total  operating expenses               |       | 62,849                                     |       | 48,863                                    |       | 160,948 |   | 143,705 |   |
|                                    |       |                                       |       |                                      |       |   |   |   |   |
| Income (loss) before income tax expense |       | (947                                       | )          | 9,222                                     |       | 22,918 |   | 31,052 |   |
|                                    |       |                                       |       |                                      |       |   |   |   |   |
| Income tax  expense (benefit)           |       | (894                                       | )          | 2,871                                     |       | 6,550 |   | 9,892 |   |
|                                    |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss)                       |       | $                                          | (53        | )                                         | $          | 6,351 |   | $ | 16,368 |   | $ | 21,160 |   |
|                                    |       |                                       |       |                                      |       |   |   |   |   |
| Loss and LAE ratio                      |       | 88.0                                       | %          | 68.7                                      | %          | 71.7 | % | 64.3 | % |
| Commission expense ratio                |       | 24.3                                       | %          | 22.7                                      | %          | 24.7 | % | 25.0 | % |
| Other operating expense ratio           |       | 4.6                                        | %          | 3.4                                       | %          | 4.0 | % | 2.5 | % |
| Combined ratio                          |       | 116.9                                      | %          | 94.8                                      | %          | 100.4 | % | 91.8 | % |

 

37

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Following are theunderwriting results of the Insurance Companies for the three months endedSeptember 30, 2005 and 2004:

 
| ** **                             | ** ** | **Three Months Ended September 30, 2005** | ** ** |
|----------------------------------------|------------|------------------------------------------------|------------|
| ** **                             | ** ** | **($ in thousands)**                      | ** ** |
| ** **                             | ** ** | **Net  Earned  Premium**                       | ** ** | **Losses  and LAE  Incurred** | ** ** | **Underwriting  Expenses** | ** ** | **Underwriting  Gain(Loss)** | ** ** | **Loss  Ratio** | ** ** | **Expense  Ratio** | ** ** | **Combined  Ratio** | ** ** |
|                                   |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                                 |       | $                                              | 14,391     |   | $ | 23,850 |   | $ | 3,914 |   | $ | (13,373 | ) | 165.7 | % | 27.1 | % | 192.8 | % |
| Specialty                              |       | 31,965                                         |       | 19,184 |   | 8,985 |   | 3,796 |   | 60.0 | % | 28.1 | % | 88.1 | % |
| Professional Liability                 |       | 7,786                                          |       | 5,205 |   | 2,451 |   | 130 |   | 66.9 | % | 31.5 | % | 98.4 | % |
| Assumed from  Lloyd’s Operations  |       | (356                                           | )          | (575 | ) | 170 |   | 49 |   | NM |   | NM |   | NM |   |
| Other (includes run-off)               |       | (8                                             | )          | (332 | ) | (3 | ) | 327 |   | NM |   | NM |   | NM |   |
| Total                                  |       | $                                              | 53,778     |   | $ | 47,332 |   | $ | 15,517 |   | $ | (9,071 | ) | 88.0 | % | 28.9 | % | 116.9 | % |
| Impact of Hurricanes Katrina and Rita: |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                                 |       | $                                              | (9,147     | ) | $ | 7,430 |   | $ | — |   | $ | (16,577 | ) | 96.0 | % | 10.6 | % | 106.5 | % |
| Total                                  |       | $                                              | (9,147     | ) | $ | 7,430 |   | $ | — |   | $ | (16,577 | ) | 24.6 | % | 4.2 | % | 28.8 | % |

 
| ** **                            | ** ** | **Three Months Ended September 30, 2004** | ** ** |
|---------------------------------------|------------|------------------------------------------------|------------|
| ** **                            | ** ** | **($ in thousands)**                      | ** ** |
| ** **                            | ** ** | **Net  Earned  Premium**                       | ** ** | **Losses  and LAE  Incurred** | ** ** | **Underwriting  Expenses** | ** ** | **Underwriting  Gain(Loss)** | ** ** | **Loss  Ratio** | ** ** | **Expense  Ratio** | ** ** | **Combined  Ratio** | ** ** |
|                                  |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                                |       | $                                              | 17,862     |   | $ | 13,222 |   | $ | 4,785 |   | $ | (145 | ) | 74.0 | % | 26.8 | % | 100.8 | % |
| Specialty                             |       | 22,824                                         |       | 15,749 |   | 6,516 |   | 559 |   | 69.0 | % | 28.5 | % | 97.5 | % |
| Professional Liability                |       | 5,692                                          |       | 3,450 |   | 915 |   | 1,327 |   | 60.6 | % | 16.1 | % | 76.7 | % |
| Assumed from  Lloyd’s Operations |       | 4,271                                          |       | 1,997 |   | 1,241 |   | 1,033 |   | 46.7 | % | 29.1 | % | 75.8 | % |
| Other (includes run-off)              |       | 892                                            |       | 983 |   | 5 |   | (96 | ) | 110.2 | % | 0.6 | % | 110.8 | % |
| Total                                 |       | $                                              | 51,541     |   | $ | 35,401 |   | $ | 13,462 |   | $ | 2,678 |   | 68.7 | % | 26.1 | % | 94.8 | % |
| Impact of Hurricane Ivan:             |       |                                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                                |       | $                                              | (1,522     | ) | $ | 1,598 |   | $ | — |   | $ | (3,120 | ) | 14.1 | % | 2.1 | % | 16.2 | % |
| Total                                 |       | $                                              | (1,522     | ) | $ | 1,598 |   | $ | — |   | $ | (3,120 | ) | 5.0 | % | 0.7 | % | 5.7 | % |

 

----

NM = Not meaningful

 

38

----

 

Following are the underwriting results of the Insurance Companies forthe nine months ended September 30, 2005 and 2004:

 
| ** **                             | ** ** | **Nine Months Ended September 30, 2005** | ** ** |
|----------------------------------------|------------|-----------------------------------------------|------------|
| ** **                             | ** ** | **($ in thousands)**                     | ** ** |
| ** **                             | ** ** | **Net  Earned  Premium**                      | ** ** | **Losses  and LAE  Incurred** | ** ** | **Underwriting  Expenses** | ** ** | **Underwriting  Gain(Loss)** | ** ** | **Loss  Ratio** | ** ** | **Expense  Ratio** | ** ** | **Combine  Ratio** | ** ** |
|                                   |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                                 |       | $                                             | 57,600     |   | $ | 52,461 |   | $ | 15,026 |   | $ | (9,887 | ) | 91.1 | % | 26.1 | % | 117.2 | % |
| Specialty                              |       | 81,429                                        |       | 49,639 |   | 24,736 |   | 7,054 |   | 61.0 | % | 30.3 | % | 91.3 | % |
| Professional Liability                 |       | 21,493                                        |       | 14,676 |   | 6,378 |   | 439 |   | 68.3 | % | 29.7 | % | 98.0 | % |
| Assumed from Lloyd’s Operations   |       | (320                                          | )          | (890 | ) | 476 |   | 94 |   | NM |   | NM |   | NM |   |
| Other (includes run-off)               |       | 46                                            |       | (1,030 | ) | (524 | ) | 1,600 |   | NM |   | NM |   | NM |   |
| Total                                  |       | $                                             | 160,248    |   | $ | 114,856 |   | $ | 46,092 |   | $ | (700 | ) | 71.7 | % | 28.7 | % | 100.4 | % |
| Impact of Hurricanes Katrina and Rita: |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                                 |       | $                                             | (9,147     | ) | $ | 7,430 |   | $ | — |   | $ | (16,577 | ) | 23.6 | % | 3.7 | % | 27.2 | % |
| Total                                  |       | $                                             | (9,147     | ) | $ | 7,430 |   | $ | — |   | $ | (16,577 | ) | 8.3 | % | 1.5 | % | 9.8 | % |

 
| ** **                           | ** ** | **Nine Months Ended September 30, 2004** | ** ** |
|--------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **($ in thousands)**                     | ** ** |
| ** **                           | ** ** | **Net  Earned  Premium**                      | ** ** | **Losses  and LAE  Incurred** | ** ** | **Underwriting  Expenses** | ** ** | **Underwriting  Gain(Loss)** | ** ** | **Loss  Ratio** | ** ** | **Expense  Ratio** | ** ** | **Combine  Ratio** | ** ** |
|                                 |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                               |       | $                                             | 59,124     |   | $ | 37,691 |   | $ | 16,044 |   | $ | 5,389 |   | 63.7 | % | 27.2 | % | 90.9 | % |
| Specialty                            |       | 65,728                                        |       | 44,551 |   | 19,361 |   | 1,816 |   | 67.8 | % | 29.5 | % | 97.3 | % |
| Professional Liability               |       | 14,199                                        |       | 8,581 |   | 2,661 |   | 2,957 |   | 60.4 | % | 18.7 | % | 79.1 | % |
| Assumed from Lloyd’s Operations |       | 16,554                                        |       | 8,942 |   | 4,963 |   | 2,649 |   | 54.0 | % | 30.0 | % | 84.0 | % |
| Other (includes run-off)             |       | 901                                           |       | 904 |   | 7 |   | (10 | ) | 100.3 | % | 0.8 | % | 101.1 | % |
| Total                                |       | $                                             | 156,506    |   | $ | 100,669 |   | $ | 43,036 |   | $ | 12,801 |   | 64.3 | % | 27.5 | % | 91.8 | % |
| Impact of Hurricane Ivan:            |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Marine                               |       | $                                             | (1,522     | ) | $ | 1,598 |   | $ | — |   | $ | (3,120 | ) | 4.2 | % | 0.8 | % | 5.0 | % |
| Total                                |       | $                                             | (1,522     | ) | $ | 1,598 |   | $ | — |   | $ | (3,120 | ) | 1.6 | % | 0.3 | % | 1.9 | % |

 

----

NM = Not meaningful

 

The Insurance Companies 2005third quarter marine net earned premium was reduced by $9.1 million due toreinstatement premiums related to the ceded losses from Hurricanes Katrina andRita.  The 2005 third quarter net lossesand LAE incurred increased by $7.4 million related to such hurricanelosses.  The reinstatement premiums andincurred losses resulting from Hurricanes Katrina and Rita increased theInsurance Companies’ third quarter and first nine months of 2005 combinedratios by 28.8 and 9.8 points, respectively.

 

39

----

 

Net earned premiums of theInsurance Companies increased 4.3% and 2.4% in the 2005 third quarter and ninemonth periods, respectively, compared to the same periods last year.  Such increases were not of the same magnitudeas the increases in the 2005 net written premium of 31.6% and 36.9% compared tothe same 2004 as the earnings growth from the retention of the specialty quotashare will lag the written premium growth.

 

Excluding hurricane lossesthe 2005 and 2004 nine month underwriting results generally reflect thefavorable industry market conditions over the last three years coupled withsatisfactory loss trends in the aforementioned quarterly periods. 

 

The approximate annualizedpre-tax yields on the Insurance Companies’ investment portfolio, excluding netrealized capital gains and losses, for the 2005 third quarter and nine monthperiod were 4.1% and 4.2%, respectively, compared to 4.1% and 4.0% for thecomparable 2004 periods, reflecting the prevailing interest rates.  Net investment income increased in the firstnine months of 2005 compared to the same period in 2004 due to the increase inthe yield and the strong cash flows resulting in a larger investment portfolio.

 

***Lloyd’s Operations***

*** ***

The Lloyd’s Operationsconsist of NUAL, which manages Lloyd’s Syndicate 1221, Millennium UnderwritingLtd. and Navigators Corporate Underwriters Ltd. Both Millennium UnderwritingLtd. and Navigators Corporate Underwriters Ltd. are Lloyd’s corporate memberswith limited liability and provide capacity to Lloyd’s Syndicate 1221. NUALowns Navigators Underwriting Ltd. (formerly Pennine Underwriting Ltd.), anunderwriting managing agency with offices in Manchester, Leeds and Basingstoke,England, which underwrites cargo and engineering business for Lloyd’s Syndicate1221.  In January 2005, we formedNavigators NV in Antwerp, Belgium, a wholly owned subsidiary of NUAL.  Navigators NV produces transport liability,cargo and marine liability premium on behalf of Syndicate 1221.  The Lloyd’s Operations and NavigatorsManagement (UK) Limited, a Navigators Agency which produces business for theU.K. Branch, are subsidiaries of Navigators Holdings (UK) Limited located inthe United Kingdom.

 

Lloyd’s Syndicate 1221 hasstamp capacity of £135 million ($248.9 million) in 2005 compared to £150million ($275.0 million) in 2004.  Thereduction in the 2005 stamp capacity compared to 2004 is reflective of unusedstamp capacity in 2004 coupled with declining market conditions in 2005.  Stamp capacity is a measure of the amount ofpremium a Lloyd’s syndicate is authorized to write based on a business planapproved by the Council of Lloyd’s. We provide 97.5% and 97.4% of Syndicate1221’s total stamp capacity in 2005 and 2004, respectively.  In September 2005 the Company purchased theremaining outstanding minority interest and will provide 100% of the Syndicate1221’s capacity for the 2006 underwriting year.

 

Syndicate 1221’s stampcapacity is expressed net of commission (as is standard at Lloyd’s) ofapproximately 21%. The Syndicate 1221 premium recorded in the Company’sfinancial statements is gross of commission. The Lloyd’s marine business had been subject to deteriorating pricingbeginning in the mid-1990’s. The pricing competition showed some signs ofstabilizing in 2000 and prices increased from 2001 through 2003. Overallpricing in 2004 remained relatively stable and the 2005 first nine monthsshowed an increase of approximately 1% while the 2005 third quarter indicatedan increase of approximately 3%.  Lloyd’spresents its results on an underwriting year basis, generally closing eachunderwriting year after three years. We make estimates for each underwritingyear and timely accrue the expected results. Our Lloyd’s Operations included inthe consolidated financial statements represent our participation in Syndicate1221.

 

Lloyd’s syndicates reportthe amounts of premiums, claims, and expenses recorded in an underwritingaccount for a particular year to the companies or individuals that participatein the syndicates. The syndicates generally keep accounts open for three years.Traditionally, three years have been necessary to report substantially allpremiums associated with an underwriting year and to report most relatedclaims, although claims may remain unsettled after the underwriting year isclosed. A Lloyd’s syndicate typically closes an underwriting year by reinsuringoutstanding claims on that underwriting year with the participants for the next

 

40

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underwriting year. The ceding participants pay the assumingparticipants an amount based on the unearned premiums and outstanding claims inthe underwriting year at the date of the assumption. Our participation in Lloyd’sSyndicate 1221 is represented by and recorded as our proportionate share of theunderlying assets and liabilities and results of operations of the syndicatesince (i) we hold an undivided interest in each asset, (ii) we areproportionately liable for each liability and (iii) Syndicate 1221 is not aseparate legal entity. At Lloyd’s, the amount to close an underwriting yearinto the next year is referred to as the reinsurance to close (“RITC”)transaction. The RITC amounts represent the transfer of the assets andliabilities from the participants of a closing underwriting year to theparticipants of the next underwriting year. To the extent our participation inthe syndicate changes, the RITC amounts vary accordingly. The RITC transactionis recorded in the fourth quarter as additional written and earned premium,losses incurred, loss reserves and receivables, all in the same amount. Thereare no gains or losses recorded on the RITC transaction.

 

We provide letters of creditto Lloyd’s to support our participation in Syndicate 1221’s stamp capacity asdiscussed below under the caption *Liquidity and CapitalResources*.

 

Following are the results ofoperations of the Lloyd’s Operations for the three and nine months endedSeptember 30, 2005 and 2004:

 

| ** **                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | **($ in thousands)**                  | ** ** |
| Revenues:                                          |       |                                       |       |                                      |       |   |   |   |   |
| Net earned premium                                 |       | $                                          | 20,956     |                                      | $          | 23,596 |   | $ | 77,856 |   | $ | 68,121 |   |
| Commission income                                  |       | 534                                        |       | 300                                       |       | 1,161 |   | 863 |   |
| Net investment income                              |       | 1,439                                      |       | 649                                       |       | 3,642 |   | 1,844 |   |
| Net realized capital gains (losses)                |       | (57                                        | )          | (55                                       | )          | (421 | ) | (119 | ) |
| Other income                                       |       | 246                                        |       | (378                                      | )          | 875 |   | (368 | ) |
| Total  revenues                                    |       | 23,118                                     |       | 24,112                                    |       | 83,113 |   | 70,341 |   |
|                                               |       |                                       |       |                                      |       |   |   |   |   |
| Operating expenses:                                |       |                                       |       |                                      |       |   |   |   |   |
| Net losses and LAE                                 |       | 29,504                                     |       | 13,846                                    |       | 61,812 |   | 37,722 |   |
| Commission expense                                 |       | 5,191                                      |       | 4,067                                     |       | 14,905 |   | 11,910 |   |
| Other operating expenses                           |       | 4,670                                      |       | 3,425                                     |       | 13,741 |   | 9,654 |   |
| Total  operating expenses                          |       | 39,365                                     |       | 21,338                                    |       | 90,458 |   | 59,286 |   |
|                                               |       |                                       |       |                                      |       |   |   |   |   |
| Income  (loss) before income tax expense (benefit) |       | (16,247                                    | )          | 2,774                                     |       | (7,345 | ) | 11,055 |   |
|                                               |       |                                       |       |                                      |       |   |   |   |   |
| Income tax  expense (benefit)                      |       | (5,687                                     | )          | 971                                       |       | (2,571 | ) | 3,869 |   |
|                                               |       |                                       |       |                                      |       |   |   |   |   |
| Net income (loss)                                  |       | $                                          | (10,560    | )                                         | $          | 1,803 |   | $ | (4,774 | ) | $ | 7,186 |   |
|                                               |       |                                       |       |                                      |       |   |   |   |   |
| Loss and LAE ratio                                 |       | 140.8                                      | %          | 58.7                                      | %          | 79.4 | % | 55.4 | % |
| Commission expense ratio                           |       | 24.8                                       | %          | 17.2                                      | %          | 19.1 | % | 17.5 | % |
| Other operating expense ratio                      |       | 22.3                                       | %          | 14.5                                      | %          | 17.7 | % | 14.2 | % |
| Combined ratio                                     |       | 187.9                                      | %          | 90.4                                      | %          | 116.2 | % | 87.1 | % |

 

41

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The Lloyd’s Operations havebeen experiencing business expansion coupled with improving underwritingresults (excluding the effects of Hurricanes Katrina and Rita) as a result ofthe generally favorable market conditions for marine and energy business fromlate 2001 through 2003, and to a lesser extent in 2004 and 2005.  Net earned premium has not been materiallyaffected in 2005 for business ceded to the Insurance Companies while it wasreduced by $4.3 million in the third quarter of 2004 and by $16.6 million inthe first nine months of 2004 for such business.

 

The Lloyd’s Operations 2005third quarter and nine month marine net earned premium was reduced by $5.3million due to reinstatement premiums related to the ceded losses fromHurricanes Katrina and Rita.  The 2005third quarter net losses and LAE incurred increased by $14.9 million related tosuch hurricane losses.  The reinstatementpremiums and incurred losses resulting from Hurricanes Katrina and Ritaincreased the Lloyd’s Operations third quarter and first nine months of 2005combined ratios by 94.6 and 25.3 ratio points, respectively.

 

The net loss to the Lloyd’sOperations from Hurricane Ivan, which approximated $2.0 million, increased theLloyd’s Operations 2004 third quarter and first nine months combined ratios by8.0 and 2.8 ratio points, respectively. Excluding the impact of Hurricanes Katrina, Rita and Ivan, the 2005 and2004 third quarter and nine month underwriting results generally reflect thefavorable industry market conditions over the last three years coupled withsatisfactory loss trends in the quarterly periods.  The Lloyd’s Operations’ loss ratio for thethird quarter and first nine months of 2004 was favorably impacted by $1.2million or 5.1 loss ratio points and $5.2 million or 7.6 loss ratio points,respectively, for redundancies in prior years’ Lloyd’s Operations’ lossreserves.

 

The approximate annualizedpre-tax investment yields on the Lloyd’s Operations’ investment portfolio,excluding net realized capital gains and losses, for the 2005 third quarter andnine month period were 2.7% and 2.4%, respectively, compared to 1.6% and 1.7%for the comparable 2004 periods. Generally, funds invested at Lloyd’s have been invested with an averageduration of approximately 1.6 years in order to meet liquidity needs.  Such yields are net of interest credits tocertain reinsurers for funds withheld by our Lloyd’s Operations.

*** ***

***Navigators Agencies***

*** ***

The Navigators Agenciesproduce business for our insurance company subsidiaries. They specialize in writingmarine and related lines of business, specialty liability insurance andprofessional liability coverages.

 

Each of the NavigatorsAgencies underwrites marine and related lines of business for NavigatorsInsurance Company and two other unaffiliated insurance companies, whichcomprise a marine insurance pool. Marine insurance policies are issued byNavigators Insurance Company with the business shared with other pool members.Navigators Insurance Company had an 85% participation in the marine pool forbusiness written with effective dates in 2005 and an 80% participation forbusiness written with effective dates in 2004. 

 

Navigators Specialty, adivision of a Navigators Agency, produces business exclusively for theInsurance Companies. It specializes in underwriting general liability insurancecoverage for small general and artisan contractors and other targetedcommercial risks, with the majority of its business located in California.  Navigators Specialty also writes commercialmultiple peril, excess casualty, commercial automobile and personal umbrellainsurance.

 

Navigators Pro, a divisionof a Navigators Agency, specializes in underwriting professional liabilityinsurance and began producing directors and officers liability insuranceexclusively for the Insurance Companies in the fourth quarter of 2001. In late2002, Navigators Pro introduced additional products to complement its directorsand officers liability coverage. The products include employment practicesliability, lawyers professional liability and miscellaneous professionalliability coverages.  In 2004, NavigatorsPro began writing professional liability coverage for U.K. solicitors throughour U.K. Branch.  In 2005, it commencedwriting professional liability coverages for architects and engineers.

 

42

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Navigators Specialty andNavigators Pro receive actual cost reimbursement from the Insurance Companiesfor the business produced.  TheNavigators Agencies producing the marine business receive a 20% profitcommission, and a management fee of 8.75% for marine business produced with2005 year effective dates and 7.5% for 2004 and prior year effectivedates.  Operating costs are specificallyidentified to each line of business or allocated based on employee head countsand gross written premium.

 

Following are the results ofoperations of the Navigators Agencies for the three and nine months endedSeptember 30, 2005 and 2004:

 

| ** **                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                          | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                          | ** ** | **($ in thousands)**                  | ** ** |
| Revenues:                           |       |                                       |       |                                      |       |   |   |   |   |
| Commission income                   |       | $                                          | 7,858      |                                      | $          | 7,797 |   | $ | 29,039 |   | $ | 23,884 |   |
| Net investment income               |       | 2                                          |       | 2                                         |       | 5 |   | 6 |   |
| Other income                        |       | 182                                        |       | 258                                       |       | 713 |   | 629 |   |
| Total  revenues                     |       | 8,042                                      |       | 8,057                                     |       | 29,757 |   | 24,519 |   |
|                                |       |                                       |       |                                      |       |   |   |   |   |
| Operating expenses:                 |       |                                       |       |                                      |       |   |   |   |   |
| Other operating expenses            |       | 9,787                                      |       | 9,616                                     |       | 31,946 |   | 27,314 |   |
| Total  operating expenses           |       | 9,787                                      |       | 9,616                                     |       | 31,946 |   | 27,314 |   |
|                                |       |                                       |       |                                      |       |   |   |   |   |
| (Loss)  before income tax (benefit) |       | (1,745                                     | )          | (1,559                                    | )          | (2,189 | ) | (2,795 | ) |
|                                |       |                                       |       |                                      |       |   |   |   |   |
| Income tax  (benefit)               |       | (464                                       | )          | (460                                      | )          | (581 | ) | (852 | ) |
|                                |       |                                       |       |                                      |       |   |   |   |   |
| Net (loss)                          |       | $                                          | (1,281     | )                                         | $          | (1,099 | ) | $ | (1,608 | ) | $ | (1,943 | ) |

 

Commission income generallyconsists of inter-segment management fees and profit commissions received frominsurance premiums of the Insurance Companies for marine, specialty andprofessional liability business as well as business from unaffiliated insurancecompanies in the marine pool.  

 

Other income generallyrepresents fee revenues earned for other services on behalf of third parties.

 

Other operating expensesconsists of compensation and general and administrative expenses incurred inconnection with underwriting, administrative and claims services performed onbehalf of the Insurance Companies and unaffiliated insurers participating inthe marine pool.  Such costs have beenincreasing each year commensurate with servicing the growth in the overallpremium volume.

 

Income tax expense (benefit)includes Federal and state income taxes related to the taxable income or lossof the Navigators Agencies.

 

**Off-Balance Sheet Transactions**

 

There have been no materialchanges in the information concerning off-balance sheet transactions as statedin the Company’s 2004 Annual Report on Form 10-K.

 

43

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**Tabular Disclosure of ContractualObligations**

 

There have been no materialchanges in the operating lease or capital lease information concerningcontractual obligations as stated in the Company’s 2004 Annual Report on Form10-K.

 

Even though total reservesfor losses and LAE increased to $1.5 billion at September 30, 2005 from $966.1million at December 31, 2004, there were no significant changes in the Company’slines of business or claims handling that would create a material change in thepercentage relationship of the projected payments by period to the totalreserves.

 

**Investments**

** **

The objective of the Company’sinvestment policy, guidelines and strategy is to maximize total investmentreturn in the context of preserving and enhancing shareholder value andstatutory surplus of the Insurance Companies. Secondarily, an important consideration is to optimize the after-taxbook income.

 

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

 

The Insurance Companies’investments are subject to the direction and control of their respective boardsof directors and the Finance Committee of the Company’s Board ofDirectors.  The investment portfolio andthe performance of the investment managers 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. In general,these laws permit investments, within specified limits and subject to certainqualifications, in Federal, state and municipal obligations, corporate bonds,preferred stocks, common stocks, real estate mortgages and real estate. 

 

The Lloyd’s Operations’ investmentsare subject to the direction and control of the board of directors and theinvestment committee of NUAL, as well as the board of directors and financecommittee of the Company, and represent our share of the investments held bySyndicate 1221. These investments must comply with the rules and regulationsimposed by Lloyd’s and by certain overseas regulators.  The investment portfolio and the performanceof the investment managers are reviewed quarterly.

 

The majority of theinvestment income of the Navigators Agencies is derived from fiduciary fundsinvested in accordance with the guidelines of various state insurancedepartments. These guidelines typically require investments in short-terminstruments. This investment income is paid to the members of the marine pool,including Navigators Insurance Company.

 

All fixed maturity andequity securities are carried at fair value. The fair value is based on quotedmarket prices or dealer quotes provided by independent pricing services.  The following tables show our cash andinvestments as of September 30, 2005 and December 31, 2004: 

 

44

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| **September 30,  2005**                                                                                  | ** ** | **Fair  Value**           | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  (Losses)** | ** ** | **Cost or  Amortized  Cost** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|------------------------------|------------|---------------------------------|------------|------------------------------|------------|
| ** **                                                                                                    | ** ** | **($ in thousands)** | ** ** |
| Fixed maturities:                                                                                             |       |                      |       |                         |       |                            |       |                         |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| U.S.  Government Treasury Bonds, GNMAs, U.S. Government non-guaranteed Agencies and  foreign government bonds |       | $                         | 248,851    |                         | $          | 2,471                           |       | $                            | (1,652     | ) | $ | 248,032 |   |
| States, municipalities and political  subdivisions                                                            |       | 212,339                   |       | 1,719                        |       | (1,625                          | )          | 212,245                      |       |
| Mortgage-  and asset-backed securities (excluding U.S. Govt.)                                                 |       | 259,855                   |       | 727                          |       | (2,465                          | )          | 261,593                      |       |
| Corporate bonds                                                                                               |       | 133,576                   |       | 2,390                        |       | (1,232                          | )          | 132,418                      |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Total fixed maturities (1)                                                                                    |       | 854,621                   |       | 7,307                        |       | (6,974                          | )          | 854,288                      |       |
| Equity securities - common stocks                                                                             |       | 20,917                    |       | 2,583                        |       | (747                            | )          | 19,081                       |       |
|                                                                                                          |       |                      |       |                         |       |                            |       |                         |       |
| Cash and short-term investments                                                                               |       | 148,326                   |       | —                       |       | —                          |       | 148,326                      |       |
| Total                                                                                                         |       | $                         | 1,023,864  |                         | $          | 9,890                           |       | $                            | (7,721     | ) | $ | 1,021,695 |   |

 

----

(1) Approximately 5.0% and 13.3% of totalfixed maturities investments are direct and collateralized obligations,respectively, of FNMA and FHLMC.

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

 

----

(1) Approximately 6.0% and 11.4% of total fixed maturitiesinvestments are direct and collateralized obligations, respectively, of FNMAand FHLMC.

 

45

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At September 30, 2005 andDecember 31, 2004, all fixed-maturity and equity securities held by us wereclassified as available-for-sale.

 

We regularly review ourfixed maturity and equity securities portfolios to evaluate the necessity ofrecording impairment losses for other-than-temporary declines in the fair valueof investments. In general, we focus our attention on those securities whosemarket value was less than 80% of their cost or amortized cost, as appropriate,for six or more consecutive months. Other factors considered in evaluatingpotential impairment include the current fair value as compared to cost oramortized cost, as appropriate, 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.

 

When a security in ourinvestment portfolio has an unrealized loss that is deemed to beother-than-temporary, we write the security down to fair value through a chargeto operations. Significant changes in the factors we consider when evaluatinginvestments for impairment losses could result in a significant change inimpairment losses reported in the consolidated financial statements.  There were no impairment losses recorded inour fixed maturity or equity securities portfolios in 2005 or 2004.

 

The following tablesummarizes all securities in an unrealized loss position at September 30, 2005and December 31, 2004, showing the aggregate fair value and gross unrealizedloss by the length of time those securities have continuously been in anunrealized loss position:

 

46

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| ** **                                                                                                   | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                                                                                   | ** ** | **Fair  Value**             | ** ** | **Gross  Unrealized Loss** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized Loss** | ** ** |
| ** **                                                                                                   | ** ** | **($ in thousands)**   | ** ** |
|                                                                                                         |       |                        |       |                       |       |   |   |   |   |
| Fixed Maturities:                                                                                            |       |                        |       |                       |       |   |   |   |   |
| U.S. Government Treasury Bonds, GNMAs, U.S.  Government non-guaranteed Agencies and foreign government bonds |       |                        |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                   |       | $                           | 88,914     |                       | $          | 698 |   | $ | 97,338 |   | $ | 519 |   |
| 7-12 Months                                                                                                  |       | 34,759                      |       | 331                        |       | 33,916 |   | 283 |   |
| > 12 Months                                                                                               |       | 39,159                      |       | 623                        |       | 24,258 |   | 649 |   |
| Subtotal                                                                                                     |       | 162,832                     |       | 1,652                      |       | 155,512 |   | 1,451 |   |
|                                                                                                         |       |                        |       |                       |       |   |   |   |   |
| States, municipalities and political  subdivisions                                                           |       |                        |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                   |       | 70,133                      |       | 514                        |       | 18,966 |   | 94 |   |
| 7-12 Months                                                                                                  |       | 50,311                      |       | 716                        |       | 14,155 |   | 225 |   |
| > 12 Months                                                                                               |       | 16,722                      |       | 395                        |       | 518 |   | 20 |   |
| Subtotal                                                                                                     |       | 137,166                     |       | 1,625                      |       | 33,639 |   | 339 |   |
|                                                                                                         |       |                        |       |                       |       |   |   |   |   |
| Mortgage-  and asset-backed securities (excluding U.S. Govt.)                                                |       |                        |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                   |       | 123,396                     |       | 1,091                      |       | 64,598 |   | 208 |   |
| 7-12 Months                                                                                                  |       | 75,999                      |       | 932                        |       | 19,536 |   | 232 |   |
| > 12 Months                                                                                               |       | 20,455                      |       | 442                        |       | 774 |   | 30 |   |
| Subtotal                                                                                                     |       | 219,850                     |       | 2,465                      |       | 84,908 |   | 470 |   |
|                                                                                                         |       |                        |       |                       |       |   |   |   |   |
| Corporate bonds                                                                                              |       |                        |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                   |       | 35,620                      |       | 464                        |       | 29,870 |   | 160 |   |
| 7-12 Months                                                                                                  |       | 21,288                      |       | 377                        |       | 16,069 |   | 189 |   |
| > 12 Months                                                                                               |       | 13,985                      |       | 391                        |       | 4,803 |   | 170 |   |
| Subtotal                                                                                                     |       | 70,893                      |       | 1,232                      |       | 50,742 |   | 519 |   |
|                                                                                                         |       |                        |       |                       |       |   |   |   |   |
| Total Fixed Maturities                                                                                       |       | $                           | 590,741    |                       | $          | 6,974 |   | $ | 324,801 |   | $ | 2,779 |   |
|                                                                                                         |       |                        |       |                       |       |   |   |   |   |
| Equity securities - common stocks                                                                            |       |                        |       |                       |       |   |   |   |   |
| 0-6 Months                                                                                                   |       | $                           | 5,041      |                       | $          | 437 |   | $ | 3,779 |   | $ | 23 |   |
| 7-12 Months                                                                                                  |       | 1,528                       |       | 105                        |       | 892 |   | 65 |   |
| > 12 Months                                                                                               |       | 803                         |       | 205                        |       | — |   | — |   |
|                                                                                                         |       |                        |       |                       |       |   |   |   |   |
| Total Equity Securities                                                                                      |       | $                           | 7,372      |                       | $          | 747 |   | $ | 4,671 |   | $ | 88 |   |

 

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

 

47

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The following table showsthe composition by National Association of Insurance Commissioners (“NAIC”)rating and the generally equivalent Standard & Poor’s (“S&P”) and Moody’sratings of the fixed maturity securities in our portfolio with gross unrealizedlosses at September 30, 2005.  Not all ofthe securities are rated by S&P and/or Moody’s.

 
| ** ** | ** ** | **Equivalent**            | ** ** | **Equivalent**    | ** ** | **Unrealized Loss** | ** ** | **Fair Value** | ** ** |
|------------|------------|---------------------------|------------|-------------------|------------|---------------------|------------|----------------|------------|
| **NAIC**   | ** ** | **S&P**               | ** ** | **M oody’s** | ** ** | ** **          | ** ** | **Percent**    | ** ** | ** ** | ** ** | **Percent** | ** ** |
| **Rating** | ** ** | **Rating**                | ** ** | **Rating**        | ** ** | **Amount**          | ** ** | **of Total**   | ** ** | **Amount** | ** ** | **of Total** | ** ** |
| ** ** | ** ** | **($ in thousands)** | ** ** |
|       |       |                      |       |              |       |                |       |           |       |   |   |   |   |
| 1          |       | AAA/AA/A                  |       | Aaa/Aa/A          |       | $                   | 6,585      |           | 94         | % | $ | 568,385 |   | 96 | % |
| 2          |       | BBB                       |       | Baa               |       | 389                 |       | 6              | %          | 22,356 |   | 4 | % |
| 3          |       | BB                        |       | Ba                |       | —              |       | —         |       | — |   | — |   |
| 4          |       | B                         |       | B                 |       | —              |       | —         |       | — |   | — |   |
| 5          |       | CCC or lower              |       | Caa or lower      |       | —              |       | —         |       | — |   | — |   |
| 6          |       | N/A                       |       | N/A               |       | —              |       | —         |       | — |   | — |   |
|       |       |                      |       | Total             |       | $                   | 6,974      |           | 100        | % | $ | 590,741 |   | 100 | % |

 

At September 30, 2005, thegross unrealized losses in the table directly above are related to fixedmaturity securities that are rated investment grade, which is defined as asecurity having a NAIC rating of 1 or 2, a S&P rating of “BBB—” or higher,or a Moody’s rating of “Baa3” or higher. Unrealized losses on investment grade securities principally relate tochanges in interest rates or changes in sector-related credit spreads since thesecurities were acquired.  Any suchunrealized losses are recognized in income, if the securities are sold, or ifthe decline in fair value is deemed other-than-temporary.  

 

The scheduled maturity datesfor fixed maturity securities in an unrealized loss position at September 30,2005 are shown in the following table:

 
| ** **                             | ** ** | **Unrealized Loss**       | ** ** | **Fair Value** | ** ** |
|----------------------------------------|------------|---------------------------|------------|----------------|------------|
| ** **                             | ** ** | ** **                | ** ** | **Percent**    | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                             | ** ** | **Amount**                | ** ** | **of Total**   | ** ** | **Amount** | ** ** | **of Total** | ** ** |
| ** **                             | ** ** | **($ in thousands)** | ** ** |
|                                   |       |                      |       |           |       |   |   |   |   |
| Due in one year or less                |       | $                         | 703        |           | 10         | % | $ | 99,535 |   | 17 | % |
| Due after one year through five years  |       | 1,894                     |       | 27             | %          | 139,293 |   | 24 | % |
| Due after five years through ten years |       | 570                       |       | 8              | %          | 51,592 |   | 9 | % |
| Due after ten years                    |       | 1,342                     |       | 19             | %          | 80,471 |   | 14 | % |
| Mortgage- and asset-backed securities  |       | 2,465                     |       | 36             | %          | 219,850 |   | 36 | % |
|                                   |       |                      |       |           |       |   |   |   |   |
| Total fixed  income securities         |       | $                         | 6,974      |           | 100        | % | $ | 590,741 |   | 100 | % |
|                                        |            |                           |            |                |            |  |  |  |  |  |  |  |

 

Expected maturities maydiffer from contractual maturities because issuers may have the right to callor prepay obligations with or without call or prepayment penalties. Due to theperiodic repayment of principal, the mortgage-backed and asset-backedsecurities are estimated to have an effective maturity of approximately 5.0years. 

 

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Our realizedcapital gains and losses for the three and nine months ended September 30, 2005and 2004 were as follows:

 
| ** **                 | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------|------------|---------------------------|------------|------------------------|------------|
| ** **                 | ** ** | **September 30,**    | ** ** | **September 30,** | ** ** |
| ** **                 | ** ** | **2005**                  | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                 | ** ** | **($ in thousands)** | ** ** |
|                       |       |                      |       |                   |       |   |   |   |   |
| Fixed maturities:          |       |                      |       |                   |       |   |   |   |   |
| Gains                      |       | $                         | 440        |                   | $          | 271 |   | $ | 1,699 |   | $ | 1,935 |   |
| (Losses)                   |       | (288                      | )          | (45                    | )          | (1,245 | ) | (1,760 | ) |
|                       |       | 152                       |       | 226                    |       | 454 |   | 175 |   |
| Equity securities:         |       |                      |       |                   |       |   |   |   |   |
| Gains                      |       | 192                       |       | 45                     |       | 607 |   | 511 |   |
| (Losses)                   |       | —                    |       | —                 |       | (134 | ) | (98 | ) |
|                       |       | 192                       |       | 45                     |       | 473 |   | 413 |   |
|                       |       |                      |       |                   |       |   |   |   |   |
| Net realized capital gains |       | $                         | 344        |                   | $          | 271 |   | $ | 927 |   | $ | 588 |   |

 

The followingtable details realized losses in excess of $200,000 from sales and impairmentsduring the first nine months of 2005 and 2004 and the related circumstancesgiving 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, 2005** | ** ** | **(Loss)**     | ** ** | **Amortized Cost**  | ** ** |
| **($ in thousands)** | ** ** |
| ** **                | ** ** |
| ** **                | ** ** |
| ** **                | ** ** |

 

Nine months ended September 30,2005 and 2004:

 

None

** **

**ReinsuranceRecoverables**

 

We utilize reinsuranceprincipally to reduce our exposure on individual risks, to protect againstcatastrophic losses, to maintain desired ratios of net written premium tostatutory surplus and to stabilize loss ratios and underwriting results.  Although reinsurance makes the reinsurerliable to us to the extent the risk is transferred or ceded to the reinsurer,ceded reinsurance arrangements do not eliminate our obligation to pay claims toour 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 Rita increased ourreinsurance recoverables significantly which increased our credit risk.

 

We are protected by varioustreaty and facultative reinsurance agreements. Our exposure to credit risk fromany one reinsurer is managed through diversification by reinsuring with anumber of different reinsurers, principally in the United States and Europeanreinsurance markets. To meet our standards of acceptability, when the reinsuranceis placed, a reinsurer generally must have an A.M. Best Company and/or Standard& Poor’s rating of ‘‘A’’ or better, or equivalent financial strength if notrated, plus at least $250 million in policyholders’ surplus.  Our Reinsurance Security Committee monitorsthe financial strength of our reinsurers and the related

 

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reinsurance receivables andperiodically reviews the list of acceptable reinsurers. The reinsurance isplaced either directly by us or through reinsurance intermediaries. Thereinsurance intermediaries are compensated by the reinsurers.  

 

The Company was recentlyadvised informally by Equitas, a lead reinsurer participating on excess of lossreinsurance agreements, that it does not intend to satisfy a loss paymentrecovery demand that the Company presented to it on June 1, 2005.  The Company has not yet received a formalwritten response to its demand.  Therecovery is for the 2004 settlement of a class action suit involving a largeasbestos claim (the “Settled Claim”) which settlement is being paid over sevenyears starting in June 2005.  Equitas hasnot indicated any dispute with respect to recoveries on related pro ratareinsurance agreements.

 

Equitas also participates asa lead reinsurer in respect of the Company’s two other large asbestos claimsthat involve class action lawsuits.  TheCompany believes it is likely that Equitas will take a similar position whensuch claims are eventually settled and presented to Equitas for payment.

 

The aggregate amount ofexcess of loss recoveries due from Equitas on all three of these claims isapproximately $9 million, and represents approximately 50% of the total excessof loss recoveries for such claims.  TheCompany has not been advised of any disputes by other excess of loss reinsurerswith respect to such asbestos claims.

 

The Company has filed ademand for arbitration against Equitas in New York with respect to the SettledClaim in accordance with the applicable provisions of the excess of loss reinsuranceagreements.  The Company believes thatthe refusal of Equitas to satisfy the Company’s payment demand is without meritand it intends to vigorously pursue collection of its reinsurancerecoveries.   While it is too early topredict with any certainty the outcome of this matter, the Company believesthat the ultimate outcome would not be expected to have a significant adverseeffect on its results of operations, financial condition or liquidity, althoughan unexpected adverse resolution could have a material adverse effect on theCompany’s results of operations in a particular fiscal quarter or year.

 

An allowance for doubtfulrecoveries is maintained for any amounts considered to be uncollectible. AtSeptember 30, 2005 and December 31, 2004, we had allowances for uncollectiblereinsurance of $32.1 million and $32.4 million, respectively.  The allowances include $25.7 million foruncollectible reinsurance as a result of loss reserves established in 2003 forasbestos exposures on marine and aviation business written mostly prior to1986.  Charges (recoveries) foruncollectible reinsurance amounts, all of which were recorded to incurredlosses, were ($505,000) and $80,000 for the three months ended September 30, 2005and 2004, respectively, and $109,000 and ($201,000) for the nine months endedSeptember 30, 2005 and 2004, respectively. 

 

The Company continues toperiodically monitor the financial condition and ongoing activities of itsreinsurers, in order to assess the adequacy of its allowance for uncollectiblereinsurance.****

** **

**Liquidity and Capital Resources**

 

Cash flow provided byoperations was $167.9 million and $141.7 million for the nine months endedSeptember 30, 2005 and 2004, respectively. The increase in the operating cashflow in the first nine months of 2005 compared to 2004 was primarily due to theincrease in net written premium in combination with the receipt of an $8million hull loss subrogation recovery collected on behalf of quota sharereinsurers in the 2005 second quarter. Operating cash flow was used primarily to acquire additional investmentassets.

 

Payment of losses, includingthe losses from Hurricanes Katrina and Rita, reduce cash flow by the amount ofthe gross loss until the ceded portion of the loss can be collected from the reinsurers.

 

Invested assets and cashincreased to $1.0 billion at September 30, 2005 from $854.9 million at December31, 2004. The increase was primarily due to the positive cash flow.  Net investment income was $9.2

 

50

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million and $6.9 million forthe three months ended September 30, 2005 and 2004, respectively, and $25.8million and $19.4 million for the nine months ended September 30, 2005 and2004, respectively.

 

The approximate annualizedpre-tax investment yields of the portfolio, excluding net realized capitalgains and losses, for both the 2005 third quarter and nine month period were3.8% compared to 3.5% for both comparable 2004 periods, reflecting theprevailing interest rates. As of September 30, 2005 and December 31, 2004, allfixed maturity securities and equity securities held by us were classified asavailable-for-sale.

 

At September 30, 2005, theweighted average rating of our fixed maturity investments was ‘‘AA’’ byStandard & Poor’s and ‘‘Aa’’ by Moody’s. We believe that we have nosignificant exposure to credit risk since the fixed maturity investmentportfolio consists of investment-grade bonds. At September 30, 2005, ourportfolio had an average maturity of 5.4 years and duration of 4.0 years.Management continually monitors the composition and cash flow of the investmentportfolio in order to maintain the appropriate levels of liquidity to ensureour ability to satisfy claims.

 

We have a credit facilityprovided through a consortium of banks. The credit facility, which is denominated in U.S. dollars, is utilizedprimarily by Navigators Corporate Underwriters Ltd. and Millennium UnderwritingLtd. to fund our participation in Lloyd’s Syndicate 1221 which is denominatedin British pounds.  At September 30,2005, letters of credit with an aggregate face amount of $77.4 million wereissued under the credit facility. 

 

The credit facility iscollateralized by all of the common stock of Navigators Insurance Company.  The credit agreement contains covenantscommon to transactions of this type, including restrictions on indebtedness andliens, limitations on mergers and the sale of assets, maintaining certainconsolidated tangible net worth, statutory surplus and other financial ratios.  Cash dividends to shareholders are limited to$2.5 million per year.  No dividends havebeen declared or paid through September 30, 2005.  At September 30, 2005, we were in compliancewith all covenants.

 

The credit facility wasamended in January 2005 to increase the letters of credit available under thefacility from $80 million to $115 million and to add a $10 million line ofcredit facility.  The expiration of thecredit facility was also extended from November 10, 2005 to June 30, 2007.  If at that time the banks do not renew thecredit facility, we will need to find other sources to provide the letters ofcredit or other collateral in order to continue our participation in Syndicate1221.

 

At September 30, 2005, ourconsolidated stockholders’ equity was $332.9 million or $26.02 per sharecompared to $328.6 million or $25.96 per share at December 31, 2004. Theincrease was primarily due to net income of $8.3 million for the nine monthsended September 30, 2005. 

 

Our reinsurance has beenplaced with various U.S. and foreign insurance companies and with selectedsyndicates at Lloyd’s. Pursuant to the implementation of Lloyd’s Plan ofReconstruction and Renewal, a portion of our recoverables are now reinsured byEquitas which is a separate United Kingdom authorized reinsurance companyestablished to reinsure outstanding liabilities of all Lloyd’s members for allrisks written in the 1992 or prior years of account.

 

We primarily rely upondividends from our subsidiaries to meet our holding company obligations. Thedividends have historically come primarily from Navigators Insurance Company.At December 31, 2004, the maximum amount available for the payment of dividendsby Navigators Insurance Company during 2005 without prior regulatory approvalwas $23.6 million.  Navigators InsuranceCompany paid $3.0 million of dividends to the Company in the first nine monthsof 2005.

 

We believe that the cashflow generated by the operations of our subsidiaries will provide sufficientfunds for us to meet our liquidity needs over the next twelve months. Beyondthe next twelve months, cash flow

 

51

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available to us may beinfluenced by a variety of factors, including general economic conditions andconditions in the insurance and reinsurance markets, as well as fluctuationsfrom year to year in claims experience.

 

In October 2005, the Companycompleted an underwritten public offering of 3,795,000 shares of common stockat $34.50 per share including the over-allotment option, and received netproceeds of approximately $124 million. Approximately $120 million of the net proceeds was contributed to thecapital of Navigators Insurance Company of which $50 million was contributed tothe capital of NIC Insurance Company.

 

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

 

There havebeen no material changes in the information concerning market risk as stated inthe Company’s 2004 Annual Report on Form 10-K.

##### ** **

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

 

(a)          The Chief Executive Officer and Chief Financial Officer of the Companyhave evaluated the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under of the Securities Exchange Actof 1934, as amended (the “Exchange Act”)), as of the end of the period coveredby this quarterly report. Based on such evaluation, such officers haveconcluded that as of the end of such period the Company’s disclosure controlsand procedures are effective in identifying, on a timely basis, materialinformation required to be disclosed in our reports filed or submitted underthe 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**

 

Other than asset forth below, the Company is not a party to, or the subject of, any materiallegal proceedings which depart from the ordinary routine litigation incident tothe kinds of business it conducts.

 

The Companywas recently advised informally by Equitas, a lead reinsurer participating onexcess of loss reinsurance agreements, that it does not intend to satisfy aloss payment recovery demand that the Company presented to it on June 1,2005.  The Company has not yet received aformal written response to its demand. The recovery is for the 2004 settlement of a class action suit involvinga large asbestos claim (the “Settled Claim”) which settlement is being paidover seven years starting in June 2005. Equitas has not indicated any dispute with respect to recoveries onrelated pro rata reinsurance agreements.

 

Equitas alsoparticipates as a lead reinsurer in respect of the Company’s two other largeasbestos claims that involve class action lawsuits.  The Company believes it is likely thatEquitas will take a similar position when such claims are eventually settledand presented to Equitas for payment.

 

The aggregateamount of excess of loss recoveries due from Equitas on all three of theseclaims is approximately $9 million, and represents approximately 50% of thetotal excess of loss recoveries for such claims.  The Company has not been advised of anydisputes by other excess of loss reinsurers with respect to such asbestosclaims.

 

The Companyhas filed a demand for arbitration against Equitas in New York with respect tothe Settled Claim in accordance with the applicable provisions of the excess ofloss reinsurance agreements.  The Company

 

52

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believes thatthe refusal of Equitas to satisfy the Company’s payment demand is without meritand it intends to vigorously pursue collection of its reinsurancerecoveries.   While it is too early topredict with any certainty the outcome of this matter, the Company believesthat the ultimate outcome would not be expected to have a significant adverseeffect on its results of operations, financial condition or liquidity, althoughan unexpected adverse resolution could have a material adverse effect on theCompany’s results of operations in a particular fiscal quarter or year.

 

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

 

None.

 

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

 

None.

 

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

 

None

 

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

 

None.

 

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

 

| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                                                            | ** ** | ** ** |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|            |       |                                                                                                                                                                                                                                                                                                                                                                  |       |       |
| 11-1            |       | Statement re Computation  of Per Share Earnings                                                                                                                                                                                                                                                                                                                       |       | *          |
| 31-1            |       | Certification of CEO per  Section 302 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                       |       | *          |
| 31-2            |       | Certification of CFO per  Section 302 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                       |       | *          |
| 32-1            |       | Certification of CEO per  Section 906 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                       |       | *          |
|            |       | (This exhibit is intended  to be furnished in accordance with Regulation S-K item 601(b)(32)(ii) and  shall not be deemed to be filed for purposes of section 18 of the Securities  Exchange Act of 1934, as amended, or incorporated by reference into any  filing under the Securities Act of 1933, except as shall be expressly set  forth by specific reference). |       |       |
| 32-2            |       | Certification of CFO per  Section 906 of the Sarbanes-Oxley Act                                                                                                                                                                                                                                                                                                       |       | *          |
|            |       | (This exhibit is intended  to be furnished in accordance with Regulation S-K item 601(b)(32)(ii) and  shall not be deemed to be filed for purposes of section 18 of the Securities  Exchange 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*.

 

53

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SIGNATURE

 

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

 
|                    |   | The  Navigators Group, Inc.  |   |
|-------------------------|--------|------------------------------|--------|
|                    |   | (Registrant)                 |   |
|                    |   |                         |   |
| Date:  November 2, 2005 |   | /s / Paul J.  Malvasio       |   |
|                    |   | Paul J.  Malvasio            |   |
|                    |   | Executive  Vice President    |   |
|                    |   | and Chief  Financial Officer |   |

 

54

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** **

**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). |       | *          |

** **

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*  *Included herein.*

 

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