** **

**FORM 10-Q**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**Quarterly Report Under Section 13 or 15 (d)**

**of the Securities Exchange Act of 1934**

 

**For theQuarterly Period Ended September 30, 2002**

 

**Commissionfile number 0-15886**

 

**The Navigators Group, Inc.**

(Exact name of registrantas 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 telephonenumber, including area code)

 

 

(Former name, formeraddress and former fiscal year, if changed since last report.)

 

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

 

Yes         ý         No         o

 

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

 

On November 11, 2002, there were 8,484,272 shares of $0.10 par valuecommon stock issued and outstanding.

 

 

----

 

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

 

**INDEX**

 
| Part I.  FINANCIAL  INFORMATION:                                                                     |   |
|-----------------------------------------------------------------------------------------------------------|--------|
|                                                                                                      |   |
| Item 1.  Financial Statements                                                                        |   |
|                                                                                                      |   |
| Consolidated  Balance Sheets  September 30, 2002 (unaudited) and December 31, 2001                        | 3      |
|                                                                                                      |   |
| Consolidated  Statements of Income (Loss) (unaudited)Three Months  Ended September 30, 2002 and 2001      | 4      |
| Nine Months  Ended September 30, 2002 and 2001                                                            | 5      |
|                                                                                                      |   |
| Consolidated Statements of  Cash Flows (unaudited)  Nine Months Ended September 30, 2002 and 2001         | 6      |
|                                                                                                      |   |
| Notes to Interim Consolidated  Financial Statements (unaudited)                                           | 7      |
|                                                                                                      |   |
| Item 2.  Management’s Discussion and Analysis of Financial  Condition and Results of Operations | 13     |
|                                                                                                      |   |
| Item 3.  Quantitative and Qualitative Disclosures   About Market Risk                                | 20     |
|                                                                                                      |   |
| Item 4.  Controls and Procedures                                                                     | 20     |
|                                                                                                      |   |
| Part II.  OTHER INFORMATION                                                                          | 20     |
|                                                                                                      |   |
| Signature                                                                                                 | 21     |
|                                                                                                      |   |
| Certifications of  Chief Executive Officer and Chief Financial Officer                                    | 22-23  |
|                                                                                                      |   |
| Index of  Exhibits                                                                                        | 24     |

 

2

----

 

#### **Part 1**.    Financial Information

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

** **

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

**CONSOLIDATED BALANCESHEETS**

*(In thousands, except share data)*

 
|                                                                                                                                                                                            |   | **September  30,  2002** |       | **December  31,  2001** |       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-------------------------|------------|
|                                                                                                                                                                                            |   | ***(Unaudited)***        |       |                    |       |
| **ASSETS**                                                                                                                                                                                      |   |                     | ** ** |                    | ** ** |
| Investments  and cash:                                                                                                                                                                          |   |                     |       |                    |       |
| Fixed  maturities, available-for-sale, at fair value (amortized cost: 2002,  $254,815; 2001, $237,745)                                                                                          |   | $                        | 269,262    |                    | $          | 240,660 |   |
| Equity  securities, available-for-sale, at fair value (cost: 2002, $10,401; 2001,  $7,225)                                                                                                      |   | 9,086                    |       | 7,675                   |       |
| Short-term  investments, at cost which approximates fair value                                                                                                                                  |   | 74,378                   |       | 27,534                  |       |
| Cash                                                                                                                                                                                            |   | 10,339                   |       | 2,430                   |       |
| Total  investments and cash                                                                                                                                                                     |   | 363,065                  |       | 278,299                 |       |
|                                                                                                                                                                                            |   |                     |       |                    |       |
| Premiums  in course of collection                                                                                                                                                               |   | 62,079                   |       | 43,307                  |       |
| Funds  due from Lloyd’s syndicate                                                                                                                                                          |   | 122,609                  |       | 92,523                  |       |
| Commissions  receivable                                                                                                                                                                         |   | 3,236                    |       | 3,482                   |       |
| Accrued  investment income                                                                                                                                                                      |   | 2,977                    |       | 3,416                   |       |
| Prepaid  reinsurance premiums                                                                                                                                                                   |   | 60,545                   |       | 35,124                  |       |
| Reinsurance  receivable on paid and unpaid losses and loss adjustment expenses                                                                                                                  |   | 218,250                  |       | 219,907                 |       |
| Federal  income tax recoverable                                                                                                                                                                 |   |                  |       | 969                     |       |
| Net  deferred income tax benefit                                                                                                                                                                |   | 7,590                    |       | 10,023                  |       |
| Deferred  policy acquisition costs                                                                                                                                                              |   | 24,858                   |       | 13,656                  |       |
| Goodwill                                                                                                                                                                                        |   | 5,100                    |       | 4,915                   |       |
| Other  assets                                                                                                                                                                                   |   | 4,051                    |       | 4,877                   |       |
|                                                                                                                                                                                            |   |                     |       |                    |       |
| Total  assets                                                                                                                                                                                   |   | $                        | 874,360    |                    | $          | 710,498 |   |
|                                                                                                                                                                                            |   |                     |       |                    |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                  |   |                     |       |                    |       |
| Liabilities:                                                                                                                                                                                    |   |                     |       |                    |       |
| Reserves  for losses and loss adjustment expenses                                                                                                                                               |   | $                        | 440,052    |                    | $          | 401,177 |   |
| Unearned  premium                                                                                                                                                                               |   | 175,764                  |       | 97,035                  |       |
| Reinsurance  balances payable                                                                                                                                                                   |   | 53,220                   |       | 39,676                  |       |
| Notes  payable to banks                                                                                                                                                                         |   | 14,500                   |       | 19,000                  |       |
| Payable  for securities                                                                                                                                                                         |   | 17,146                   |       | —                  |       |
| Federal  income tax payable                                                                                                                                                                     |   | 754                      |       | —                  |       |
| Accounts  payable and other liabilities                                                                                                                                                         |   | 5,836                    |       | 6,404                   |       |
| Total  liabilities                                                                                                                                                                              |   | 707,272                  |       | 563,292                 |       |
|                                                                                                                                                                                            |   |                     |       |                    |       |
| Stockholders’ equity:                                                                                                                                                                      |   |                     |       |                    |       |
| Preferred  stock, $.10 par value; authorized 1,000,000 shares; none issued                                                                                                                      |   | —                   |       | —                  |       |
| Common  stock, $.10 par value; authorized shares 20,000,000 for 2002 and 10,000,000  for 2001; issued and outstanding shares (net of treasury stock) 8,482,272 for  2002 and 8,427,262 for 2001 |   | 851                      |       | 847                     |       |
| Additional paid–in  capital                                                                                                                                                                |   | 40,100                   |       | 39,511                  |       |
| Treasury stock held at  cost (shares: 16,423 for 2002 and 35,908 for 2001)                                                                                                                      |   | (236                     | )          | (516                    | )          |
| Accumulated other  comprehensive income                                                                                                                                                         |   | 9,488                    |       | 2,974                   |       |
| Retained  earnings                                                                                                                                                                              |   | 116,885                  |       | 104,390                 |       |
| Total  stockholders’ equity                                                                                                                                                                |   | 167,088                  |       | 147,206                 |       |
|                                                                                                                                                                                            |   |                     |       |                    |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                |   | $                        | 874,360    |                    | $          | 710,498 |   |

 

#### **See accompanying notes to interimconsolidated financial statements.**

#### ** **

3

----

 

**THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME (LOSS)**

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

 
|                                              |   | **Three Months Ended****September 30,** |   |
|---------------------------------------------------|--------|-----------------------------------------|--------|
|                                              |   | **2002**                                |   | **2001** |   |
|                                              |   | ***(Unaudited)***                       |   |
| Revenues:                                         |   |                                    |   |   |   |
| Net  earned premium                               |   | $                                       | 65,839 |   | $ | 35,364 |   |
| Commission  income                                |   | 1,188                                   |   | 1,118 |   |
| Net  investment income                            |   | 4,390                                   |   | 4,740 |   |
| Net  realized capital gains                       |   | 1,264                                   |   | 389 |   |
| Other  income (expense)                           |   | 363                                     |   | (2,341 | ) |
| Total  revenues                                   |   | 73,044                                  |   | 39,270 |   |
|                                              |   |                                    |   |   |   |
| Operating expenses:                               |   |                                    |   |   |   |
| Net  losses and loss adjustment expenses incurred |   | 43,430                                  |   | 28,068 |   |
| Commission  expense                               |   | 12,837                                  |   | 7,671 |   |
| Other  operating expenses                         |   | 9,127                                   |   | 6,602 |   |
| Interest  expense                                 |   | 158                                     |   | 289 |   |
| Total  operating expenses                         |   | 65,552                                  |   | 42,630 |   |
|                                              |   |                                    |   |   |   |
| Income  (loss) before income tax expense          |   | 7,492                                   |   | (3,360 | ) |
|                                              |   |                                    |   |   |   |
| Income tax expense  (benefit):                    |   |                                    |   |   |   |
| Current                                           |   | 2,588                                   |   | 116 |   |
| Deferred                                          |   | (367                                    | )      | (555 | ) |
| Total  income tax expense (benefit)               |   | 2,221                                   |   | (439 | ) |
|                                              |   |                                    |   |   |   |
| Net  income (loss)                                |   | $                                       | 5,271  |   | $ | (2,921 | ) |
|                                              |   |                                    |   |   |   |
| Net  income (loss) per common share:              |   |                                    |   |   |   |
| Basic                                             |   | $                                       | 0.62   |   | $ | (0.35 | ) |
| Diluted                                           |   | $                                       | 0.61   |   | $ | (0.35 | ) |
|                                              |   |                                    |   |   |   |
| Average  common shares outstanding:               |   |                                    |   |   |   |
| Basic                                             |   | 8,473                                   |   | 8,420 |   |
| Diluted                                           |   | 8,678                                   |   | 8,420 |   |

 

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

#### ** **

4

----

 

#### **THENAVIGATORS GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

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

 
|                                              |   | **Nine Months Ended****September 30,** |    |
|---------------------------------------------------|--------|----------------------------------------|---------|
|                                              |   | **2002**                               |    | **2001** |   |
|                                              |   | ***(Unaudited)***                      |    |
| Revenues:                                         |   |                                   |    |   |   |
| Net  earned premium                               |   | $                                      | 157,964 |   | $ | 99,897 |   |
| Commission  income                                |   | 3,282                                  |    | 2,918 |   |
| Net  investment income                            |   | 13,494                                 |    | 14,481 |   |
| Net  realized capital gains                       |   | 1,172                                  |    | 996 |   |
| Other  income (expense)                           |   | 1,214                                  |    | (3,256 | ) |
| Total  revenues                                   |   | 177,126                                |    | 115,036 |   |
|                                              |   |                                   |    |   |   |
| Operating expenses:                               |   |                                   |    |   |   |
| Net  losses and loss adjustment expenses incurred |   | 99,619                                 |    | 69,670 |   |
| Commission  expense                               |   | 32,176                                 |    | 21,708 |   |
| Other  operating expenses                         |   | 27,997                                 |    | 19,443 |   |
| Interest  expense                                 |   | 463                                    |    | 1,108 |   |
| Total  operating expenses                         |   | 160,255                                |    | 111,929 |   |
|                                              |   |                                   |    |   |   |
| Income  before income tax expense                 |   | 16,871                                 |    | 3,107 |   |
|                                              |   |                                   |    |   |   |
| Income tax expense  (benefit):                    |   |                                   |    |   |   |
| Current                                           |   | 5,249                                  |    | 2,402 |   |
| Deferred                                          |   | (873                                   | )       | (739 | ) |
| Total  income tax expense                         |   | 4,376                                  |    | 1,663 |   |
|                                              |   |                                   |    |   |   |
| Net  income                                       |   | $                                      | 12,495  |   | $ | 1,444 |   |
|                                              |   |                                   |    |   |   |
| Net  income per common share:                     |   |                                   |    |   |   |
| Basic                                             |   | $                                      | 1.48    |   | $ | 0.17 |   |
| Diluted                                           |   | $                                      | 1.45    |   | $ | 0.17 |   |
|                                              |   |                                   |    |   |   |
| Average  common shares outstanding:               |   |                                   |    |   |   |
| Basic                                             |   | 8,455                                  |    | 8,419 |   |
| Diluted                                           |   | 8,642                                  |    | 8,532 |   |

 

See accompanyingnotes to interim consolidated financial statements.

 

5

----

 

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

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

*(In thousands)*

** **
|                                                                                          |   | **Nine Months Ended  September 30,** |   |
|-----------------------------------------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                                                          |   | **2002**                             |   | **2001** |   |
|                                                                                          |   | ***(Unaudited)***                    |   |
| Operating  activities:                                                                        |   |                                 |   |   |   |
| Net  income                                                                                   |   | $                                    | 12,495 |   | $ | 1,444 |   |
| Adjustments  to reconcile net income to net cash provided by (used in) operating  activities: |   |                                 |   |   |   |
| Depreciation  & amortization                                                              |   | 740                                  |   | 886 |   |
| Net  deferred income tax                                                                      |   | (873                                 | )      | (739 | ) |
| Net  realized capital (gains)                                                                 |   | (1,172                               | )      | (996 | ) |
| Changes  in assets and liabilities:                                                           |   |                                 |   |   |   |
| Reinsurance  receivable on paid and unpaid losses and loss adjustment expenses                |   | 1,657                                |   | (15,164 | ) |
| Reserve  for losses and loss adjustment expenses                                              |   | 38,875                               |   | 28,881 |   |
| Prepaid  reinsurance premiums                                                                 |   | (25,421                              | )      | (10,745 | ) |
| Unearned  premium                                                                             |   | 78,729                               |   | 39,339 |   |
| Premiums  in course of collection                                                             |   | (18,772                              | )      | (10,949 | ) |
| Commissions  receivable                                                                       |   | 246                                  |   | (20,289 | ) |
| Funds  due from Lloyd’s syndicate                                                        |   | (30,086                              | )      | (1,711 | ) |
| Deferred  policy acquisition costs                                                            |   | (11,202                              | )      | (8,276 | ) |
| Accrued  investment income                                                                    |   | 439                                  |   | (129 | ) |
| Reinsurance  balances payable                                                                 |   | 13,544                               |   | 7,808 |   |
| Federal  income tax                                                                           |   | 1,723                                |   | (324 | ) |
| Other                                                                                         |   | 849                                  |   | 4,610 |   |
| Net  cash provided by operating activities                                                    |   | 61,771                               |   | 13,646 |   |
|                                                                                          |   |                                 |   |   |   |
| Investing  activities:                                                                        |   |                                 |   |   |   |
| Fixed  maturities, available-for-sale                                                         |   |                                 |   |   |   |
| Redemptions  and maturities                                                                   |   | 2,419                                |   | 700 |   |
| Sales                                                                                         |   | 163,127                              |   | 66,175 |   |
| Purchases                                                                                     |   | (183,277                             | )      | (83,094 | ) |
| Equity  securities, available-for-sale                                                        |   |                                 |   |   |   |
| Sales                                                                                         |   | 4,886                                |   | 2,119 |   |
| Purchases                                                                                     |   | (6,556                               | )      | (2,891 | ) |
| Change  in payable for securities                                                             |   | 17,146                               |   | 1,868 |   |
| Net  change in short-term investments                                                         |   | (46,844                              | )      | 2,378 |   |
| Purchase  of property and equipment                                                           |   | (692                                 | )      | (164 | ) |
| Net  cash (used in) investing activities                                                      |   | (49,791                              | )      | (12,909 | ) |
|                                                                                          |   |                                 |   |   |   |
| Financing  activities:                                                                        |   |                                 |   |   |   |
| Repayment  of bank loan                                                                       |   | (4,500                               | )      | — |   |
| Proceeds  from exercise of stock options                                                      |   | 429                                  |   | — |   |
| Net  cash (used in) financing activities                                                      |   | (4,071                               | )      | — |   |
|                                                                                          |   |                                 |   |   |   |
| Increase  in cash                                                                             |   | 7,909                                |   | 737 |   |
| Cash  at beginning of year                                                                    |   | 2,430                                |   | 1,602 |   |
| Cash  at end of period                                                                        |   | $                                    | 10,339 |   | $ | 2,339 |   |
|                                                                                          |   |                                 |   |   |   |
| Supplemental  disclosures of cash flow information:                                           |   |                                 |   |   |   |
| Federal,  state and local income tax paid                                                     |   | $                                    | 3,611  |   | $ | 2,653 |   |
| Interest  paid                                                                                |   | 436                                  |   | 1,112 |   |
| Issuance  of stock to directors                                                               |   | 60                                   |   | 72 |   |

 

See accompanying notes tointerim consolidated financial statements.

 

6

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###### **THENAVIGATORS GROUP, INC.  AND SUBSIDIARIES**

 

**Notes** to Interim Consolidated Financial Statements

*(Unaudited)*

 

(1)     AccountingPolicies

 

The interim consolidatedfinancial statements are unaudited but reflect all adjustments which, in theopinion of management, are necessary to provide a fair statement of the resultsof The Navigators Group, Inc. and its subsidiaries (the “Company”) for theinterim periods presented on the basis of accounting principles generallyaccepted in the United States of America (“GAAP”).  All such adjustments are of a normal recurring nature.  All significant intercompany transactionsand balances have been eliminated.  Thepreparation of these financial statements requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities and disclosuresof contingent assets and liabilities at the date of the financial statementsand the reported revenues and expenses during the reporting periods.  The results of operations for any interimperiod are not necessarily indicative of results for the full year.  These financial statements should be read inconjunction with the consolidated financial statements and notes contained inthe Company’s 2001 Annual Report on Form 10-K. Certain amounts for prior periods have been reclassified to conform to thecurrent period’s presentation.

 

(2)     ReinsuranceCeded

 

The Company’s cededearned premiums were $40,028,000 and $22,405,000 for the three months endedSeptember 30, 2002 and 2001, respectively, and were $104,918,000 and$67,181,000 for the nine months ended September 30, 2002 and 2001, respectively.  The Company’s ceded incurred losses were$13,841,000 and $38,561,000 for the three months ended September 30, 2002 and2001, respectively, and were $54,290,000 and $76,543,000 for the nine monthsended September 30, 2002 and 2001, respectively.  The 2001 ceded incurred losses include $13,561,000 from theSeptember 11, 2001 terrorist attacks on the World Trade Center.

 

(3)     Segmentsof an Enterprise

 

The Company’ssubsidiaries are primarily engaged in the underwriting and management ofproperty and casualty insurance.  TheCompany’s segments include the Insurance Companies, the Navigators Agencies andthe Lloyd’s Operations, each of which is managed separately.  The Insurance Companies consist ofNavigators Insurance Company (“Navigators Insurance”) and NIC Insurance Companywhich are primarily engaged in underwriting marine insurance and related linesof business, contractors’ general liability insurance, and directors &officers professional liability insurance. The Navigators Agencies are underwriting management companies whichproduce, manage and underwrite insurance and reinsurance for the InsuranceCompanies and four non-affiliated companies. The Lloyd’s Operations consist primarily of a Lloyd’s managing agencyand two Lloyd’s corporate members which underwrite marine and related lines ofbusiness at Lloyd’s of London.

 

The Insurance Companiesand the Lloyd’s Operations are measured taking into account net earnedpremiums, incurred losses and loss expenses, commission expense and otherunderwriting expenses.  The NavigatorsAgencies’ results include commission income less other operating expenses.  Each segment maintains its own investmentson which it earns income and realizes capital gains or losses.  Other operations include intersegment incomeand expense in the form of affiliated commissions, income and expense fromcorporate operations, and consolidating adjustments.

 

7

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

 

 
|                                                                      |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|---------------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                      |   | **2002**                               |   | **2001**                              |   | **2002** |   | **2001** |   |
|                                                                      |   | ***(In thousands)***                   |   |
|                                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Revenue,  excluding net investment income and net realized capital gains: |   |                                   |   |                                  |   |   |   |   |   |
| Insurance  Companies                                                      |   | $                                      | 41,971 |                                  | $      | 19,097 |   | $ | 100,242 |   | $ | 51,757 |   |
| Navigators  Agencies                                                      |   | 7,806                                  |   | 4,144                                 |   | 20,138 |   | 11,395 |   |
| Lloyd’s  Operations                                                  |   | 24,090                                 |   | 16,330                                |   | 58,532 |   | 48,435 |   |
| Other  operations                                                         |   | (6,477                                 | )      | (5,430                                | )      | (16,452 | ) | (12,028 | ) |
| Total                                                                     |   | $                                      | 67,390 |                                  | $      | 34,141 |   | $ | 162,460 |   | $ | 99,559 |   |
|                                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Income  (loss) before tax expense (benefit):                              |   |                                   |   |                                  |   |   |   |   |   |
| Insurance  Companies                                                      |   | $                                      | 5,860  |                                  | $      | 5,187 |   | $ | 15,363 |   | $ | 16,984 |   |
| Navigators  Agencies                                                      |   | 1,577                                  |   | 99                                    |   | 2,709 |   | (607 | ) |
| Lloyd’s  Operations                                                  |   | 404                                    |   | (5,344                                | )      | 2,011 |   | (6,413 | ) |
| Other  operations                                                         |   | (349                                   | )      | (3,302                                | )      | (3,212 | ) | (6,857 | ) |
| Total                                                                     |   | $                                      | 7,492  |                                  | $      | (3,360 | ) | $ | 16,871 |   | $ | 3,107 |   |
|                                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Income  tax expense (benefit):                                            |   |                                   |   |                                  |   |   |   |   |   |
| Insurance  Companies                                                      |   | $                                      | 1,850  |                                  | $      | 1,599 |   | $ | 4,795 |   | $ | 5,301 |   |
| Navigators  Agencies                                                      |   | 566                                    |   | (806                                  | )      | 878 |   | (1,188 | ) |
| Lloyd’s  Operations                                                  |   | —                                 |   | —                                |   | — |   | — |   |
| Other  operations                                                         |   | (195                                   | )      | (1,232                                | )      | (1,297 | ) | (2,450 | ) |
| Total                                                                     |   | $                                      | 2,221  |                                  | $      | (439 | ) | $ | 4,376 |   | $ | 1,663 |   |
|                                                                      |   |                                   |   |                                  |   |   |   |   |   |
| Net  income (loss):                                                       |   |                                   |   |                                  |   |   |   |   |   |
| Insurance  Companies                                                      |   | $                                      | 4,010  |                                  | $      | 3,588 |   | $ | 10,568 |   | $ | 11,683 |   |
| Navigators  Agencies                                                      |   | 1,011                                  |   | 905                                   |   | 1,831 |   | 581 |   |
| Lloyd’s  Operations                                                  |   | 404                                    |   | (5,344                                | )      | 2,011 |   | (6,413 | ) |
| Other  operations                                                         |   | (154                                   | )      | (2,070                                | )      | (1,915 | ) | (4,407 | ) |
| Total                                                                     |   | $                                      | 5,271  |                                  | $      | (2,921 | ) | $ | 12,495 |   | $ | 1,444 |   |

 

8

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(4)           ComprehensiveIncome

 

Comprehensive incomeencompasses all changes in stockholders’ equity including net income, netunrealized capital gains and losses on available for sale securities, andforeign currency translation adjustments.

 

The following tablesummarizes comprehensive income for the three months ended September 30, 2002and 2001:

 
|                                                                                                                        |   | **September  30,**   |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|----------------------|--------|
|                                                                                                                        |   | **2002**             |   | **2001** |   |
|                                                                                                                        |   | ***(In thousands)*** |   |
|                                                                                                                        |   |                 |   |   |   |
| Net  income (loss)                                                                                                          |   | $                    | 5,271  |   | $ | (2,921 | ) |
| Other  comprehensive income, net of tax:                                                                                    |   |                 |   |   |   |
| Net  unrealized gains on securities available for sale:                                                                     |   |                 |   |   |   |
| Unrealized holding  gains arising during period (net of   tax expense of  $3,124 for 2002  and $1,796 for 2001)   |   | 6,545                |   | 3,972 |   |
| Less:  reclassification adjustment for gains included in net income (net of tax  expense of $337 for 2002 and $27 for 2001) |   | 927                  |   | 362 |   |
| Net  unrealized gains on securities                                                                                         |   | 5,618                |   | 3,610 |   |
| Foreign  currency translation gain adjustment (net of tax expense of $23 for 2002 and  $26 for 2001)                        |   | 44                   |   | 49 |   |
| Other  comprehensive income                                                                                                 |   | 5,662                |   | 3,659 |   |
|                                                                                                                        |   |                 |   |   |   |
| Comprehensive  income                                                                                                       |   | $                    | 10,933 |   | $ | 738 |   |

 

The following table summarizes comprehensive incomefor the nine months ended September 30, 2002 and 2001:

 
|                                                                                                                               |   | **September  30,**   |   |
|------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|--------|
|                                                                                                                               |   | **2002**             |   | **2001** |   |
|                                                                                                                               |   | ***(In thousands)*** |   |
|                                                                                                                               |   |                 |   |   |   |
| Net  income                                                                                                                        |   | $                    | 12,495 |   | $ | 1,444 |   |
| Other  comprehensive income, net of tax:                                                                                           |   |                 |   |   |   |
| Net  unrealized gains on securities available for sale:                                                                            |   |                 |   |   |   |
| Unrealized holding  gains arising during period (net of tax expense of $3,754 for 2002 and $1,326  for 2001)                       |   | 7,622                |   | 3,508 |   |
| Less:  reclassification adjustment for gains  included in net income (net of tax expense of $316 for 2002 and $149 for  2001) |   | 856                  |   | 847 |   |
| Net  unrealized gains on securities                                                                                                |   | 6,766                |   | 2,661 |   |
| Foreign  currency translation (loss) adjustment (net of tax (benefit) of $(136) for  2002 and $(87) for 2001)                      |   | (252                 | )      | (161 | ) |
| Other  comprehensive income                                                                                                        |   | 6,514                |   | 2,500 |   |
|                                                                                                                               |   |                 |   |   |   |
| Comprehensive  income                                                                                                              |   | $                    | 19,009 |   | $ | 3,944 |   |

 

9

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The following table summarizes the components of accumulatedother comprehensive income:

 
|                                                                                                              |   | **September 30,  2002** | ** ** | **December 31,  2001** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|------------|
|                                                                                                              |   |                    | ** ** | ***(audited)***        | ** ** |
|                                                                                                              |   | ***(In thousands)***    | ** ** |
|                                                                                                              |   |                    |       |                   |       |
| Net  unrealized gains on securities available-for-sale (net of tax expense of  $4,616 in 2002 and $1,177 in 2001) |   | $                       | 9,338      |                   | $          | 2,572 |   |
| Foreign  currency translation adjustment (net of tax expense of $81 in 2002 and $216  in 2001)                    |   | 150                     |       | 402                    |       |
|                                                                                                              |   |                    |       |                   |       |
| Accumulated  other comprehensive income                                                                           |   | $                       | 9,488      |                   | $          | 2,974 |   |

 

(5)           Adoptionof Accounting Standards

 

The Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) 141, *Business Combinations*, and SFAS 142, *Goodwill and Other Intangible Assets*.  The Company adopted both SFAS 141 and SFAS142 effective January 1, 2002. SFAS 141 requires that the purchase method ofaccounting be used for all business combinations initiated after September 30,2001.  It also specifies that intangibleassets acquired in a purchase method business combination be recognized andreported apart from goodwill.  SFAS 142changes the accounting for goodwill and intangible assets that have indefiniteuseful lives from an amortization approach to an impairment-only approach thatrequires that those assets be tested at least annually for impairment.  Intangible assets that have finite usefullives will continue to be amortized over their useful lives, but without anarbitrary ceiling on their useful lives. The Company completed its impairment review resulting in no impairmentas of January 1, 2002.  In addition, noother intangible assets were required to be reclassified and accounted for asan asset apart from goodwill upon adoption of SFAS 142.  No expense for amortization of goodwill hasbeen recorded in the first nine months or third quarter of 2002 compared to anafter tax expense of $183,000 and $61,000 recorded in the first nine months andthird quarter of 2001, respectively. Net income (loss) for the nine months and three months ended September30, 2001, excluding the amortization of goodwill expense, would have been$1,627,000 and ($2,860,000), respectively, and both basic and diluted earningsper share for the nine months and three months ended September 30, 2001 wouldhave increased by $0.02 per share and $0.01 per share, respectively.  Goodwill of $1,978,000 was recorded for theNavigators Agencies’ segment at both September 30, 2002 and December 31, 2001,and $3,122,000 and $2,937,000 for the Lloyd’s Operations’ segment at September30, 2002 and December 31, 2001, respectively. Goodwill on the Company’s consolidated balance sheets may fluctuate dueto changes in the foreign currency rates between the U.S. dollar and theBritish pound.  The adoption of SFAS 141had no impact on the Company’s consolidated financial statements.

 

Effective January 1,2002, the Company also adopted SFAS 144, *Accounting for the Impairment or Disposal of LongLived Assets*.  The adoptionof SFAS 144 had no impact on the Company’s consolidated financialstatements.  This statement requiresthat long lived assets to be held and used be reviewed for impairment wheneverevents or circumstances indicate that the carrying amount of an asset may notbe recoverable from undiscounted cash flows.

 

10

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(6)           Lloyd’sParticipation

 

The Company participatesfor, and records in its consolidated financial statements, its portion ofLloyd’s Syndicate 1221’s assets, liabilities, revenues and expenses.  Such participation was 68.1% of the portionof Syndicate 1221’s £75.0 million ($111.0 million) of capacity utilized for the2002 underwriting year and 67.4% of the portion of Syndicate 1221’s £66.3million ($95.4 million) of capacity utilized for the 2001 underwritingyear.  Syndicate 1221’s capacity isexpressed net of commission (as is standard at Lloyd’s) of approximately 21%.

 

At September 30, 2002, byLloyd’s definition, the Company controlled an additional 20.3% of Syndicate1221’s capacity through non-affiliated insurance companies (the“Non-affiliates”).  The portion ofSyndicate 1221’s premium written and recorded by the Non-affiliates was$24,017,000 and $22,472,000 for the nine months ended September 30, 2002 and2001, respectively, and $8,599,000 and $5,343,000 for the three months endedSeptember 30, 2002 and 2001, respectively. 

 

If the Company were tocontrol more than 90% of Syndicate 1221’s capacity by Lloyd’s definition,Lloyd’s Major Syndicate Transactions Byelaw (No. 18 of 1997) allows for aminority buy-out to be effected.  Insuch a transaction, the remaining participants are required to give up theircapacity in return for compensation which must be at least equal to the offerprice preceding the buy-out.  The costof such a buy-out is not considered to be material to the Company’sconsolidated financial statements.

 

The Company providesletters of credit to Lloyd’s to support its 68.1% participation in Syndicate1221’s capacity.  If the Companyincreases its participation in Syndicate 1221’s capacity, or if Lloyd’s changesthe collateral requirements, the Company may be required to supply additionalletters of credit or other collateral acceptable to Lloyd’s, or to reduce thecapacity of Syndicate 1221.

 

(7)           IncomeTax - Valuation Allowance

 

The Company’s valuationallowance in the nine months and three months ended September 30, 2002decreased by $1,041,000 and $358,000, respectively, relating to the reductionin the loss carryforward at the Company’s foreign operations resulting fromincome generated by these operations in 2002. At September 30, 2002 and 2001, the Company had loss carryforwardsremaining at its foreign operations amounting to potential future tax benefitsof $4,755,000 and $6,689,000, respectively, along with a valuation allowanceequal to these benefits.  The Companyneeds to generate $15,850,000 of future foreign pretax income in order to fullyutilize the foreign loss carryforwards which can be carried forwardindefinitely.

 

The Company also had netstate and local loss carryforwards amounting to potential future tax benefitsof $2,099,000 and $1,443,000 at September 30, 2002 and 2001, respectively,along with a valuation allowance equal to these benefits.  The Company needs to generate $11,545,000 offuture state and local pretax income in order to fully utilize the losscarryforwards which expire from 2019 to 2022.

 

(8)           TreasuryStock

 

During the first quarterof 2002 and 2001, the Company issued 2,985 and 5,406 shares of treasury stock,respectively, to the non-employee directors as part of the directors’ annualcompensation for the prior year.  TheCompany expensed $60,000 and $72,000 in each of the prior two years relating tothe issuance of these shares and has accrued $54,000 for the nine months of2002.  In addition, during the secondquarter of 2002, the Company issued 16,500 shares to the Company’s Presidentrepresenting the vested portion of a 2001 stock grant.  The Company expensed $219,000 and $455,000in the nine months ended September 30, 2001 and 2002, respectively, related tothis grant.

 

11

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(9)           FutureApplication of Accounting Standards

 

In June 2001, the FASBissued SFAS 143 *Accounting for Asset Retirement Obligations*.  SFAS 143 addresses financial accounting andreporting for obligations associated with the retirement of tangible long-livedassets and the associated asset retirement costs.  The provisions of SFAS 143 are effective for financial statementsissued for fiscal years beginning after September 15, 2002, with earlyapplication encouraged.  The adoption ofthis statement is not expected to have a material effect on the Company’sresults of operations or financial condition.

 

In July 2002, the FASBissued SFAS 146, *Obligations Associated with Disposal Activities*.  SFAS 146 addresses financial accounting andreporting for costs associated with a disposal activity.  This statement requires a liability for adisposal obligation be recognized and measured at its fair value when it isincurred and that the guidance of SFAS 5, *Accounting for Contingencies*, and FASBInterpretation No. 14, *Reasonable Estimation of the Amount of Loss*,do not apply to the recognition and measurement of the liability.  The provisions of SFAS 146 are effective fordisposal activities initiated after December 31, 2002, with early applicationencouraged.  The adoption of thisstatement is not expected to have a material effect on the Company’s results ofoperations or financial condition.

 

(10)         LegalProceedings

 

The Company is not aparty to or the subject of any material pending legal proceedings which departfrom the ordinary routine litigation incident to the kinds of businessconducted by the Company, except that in the third quarter of 2002, the Companywas notified that a legal proceeding had been brought against NavigatorsInsurance by the liquidator of one of its former reinsurers.  The suit alleges that certain letters ofcredit amounting to $3.7 million provided to Navigators Insurance as collateralconstituted a preferential transaction. The Company believes that the suit is totally without merit and intendsto vigorously defend its position.

 

(11)         SubsequentEvent

 

In October 2002, themembers of Lloyd’s Syndicate 1221 (“Syndicate 1221”) entered into a QualifyingQuota Share Agreement (QQS) with a major insurance company (“Reinsurer”).  The Company participates for 68.1% of Syndicate1221’s £75.0 million ($111.0 million) of underwriting year 2002’s capacitythrough two wholly-owned subsidiaries in its Lloyd’s Operations.  Including the QQS, Syndicate 1221’sunderwriting year 2002’s capacity will be increased to £85.0 million ($125.8million) of which £10.0 million ($14.8 million) will be ceded under the QQS tothe Reinsurer.  Navigators InsuranceCompany, a wholly-owned subsidiary of the Company, will assume from theReinsurer 50% of the business ceded to the Reinsurer under the QQS.  The result of these transactions is expectedto increase the Company's underwriting capacity by approximately £5 million($7.4 million) in the fourth quarter of 2002.

 

12

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

###### ** **

**Item2****.****                       Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

**Forward-looking statements**

 

Some of the statements inthis Form 10-Q are “forward-looking statements” as defined in the PrivateSecurities Litigation Act of 1995.  Wederive forward-looking statements from information which we currently have andfrom assumptions which we make.  Wecannot assure that results which we anticipate will be achieved since resultsmay differ materially because of both known and unknown risks and uncertaintieswhich we face.  The Company is notrequired to update any forward looking statements.  Factors which could cause actual results to differ materiallyfrom our forward looking statements include, but are not limited to:

 

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

•                    laws, rulesand regulations which apply to insurance companies;

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

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

•                    risksassociated with the volatility of the reinsurance market and the relatedrecoverability of our reinsured losses;

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

•                    our ability toobtain rate increases and to retain business; and

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

 

## **General**

 

The accompanyingconsolidated financial statements consisting of the accounts of The NavigatorsGroup, Inc., a Delaware holding company, and its twelve active wholly ownedsubsidiaries, are prepared on the basis of accounting principles generallyaccepted in the United States of America (“GAAP”).  Unless the context otherwise requires, the term “Company” as usedherein means The Navigators Group, Inc. and its subsidiaries.  The term “Parent Company” is used to meanthe Company without its subsidiaries. All significant intercompany transactions and balances have beeneliminated.

 

The Company’s twoinsurance company subsidiaries are Navigators Insurance Company (“NavigatorsInsurance”), which includes a United Kingdom Branch (“UK Branch”), and NICInsurance Company (“NIC”).  NavigatorsInsurance is the Company’s largest insurance subsidiary and has been activesince 1983.  It specializes primarily inunderwriting marine insurance and related lines of business, contractors’general liability insurance, and directors & officers professionalliability insurance.  NIC, a whollyowned subsidiary of Navigators Insurance, began operations in 1990.  It underwrites a small book of surplus linesinsurance fully reinsured by Navigators Insurance.  Navigators Insurance and NIC are collectively referred to hereinas the “Insurance Companies”.

 

Five of the Company’swholly owned insurance agencies (the “Navigators Agencies” or individually, a“Navigators Agency”), specialize in writing marine and related lines ofbusiness.  The marine business iswritten through a pool of five insurance companies, Navigators Insurance havinga 75% net participation in the pool.

 

13

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The Navigators Agencies derivetheir revenue from commissions, service fees and cost reimbursementarrangements from their Parent Company, Navigators Insurance, NIC and the fourunaffiliated insurers in the marine pool. Commissions are earned both on afixed percentage of premiums and on underwriting profits from business placedwith the participating insurance companies within the pool.  A Navigators Agency manages the InsuranceCompanies.

 

Navigators Specialty, adivision of a Navigators Agency located in San Francisco, California, producesbusiness exclusively for the Insurance Companies.  It specializes in underwriting general liability insurancecoverage for small artisan and general contractors located primarily on thewest coast of the U.S.

 

Navigators Pro, adivision of a Navigators Agency located in New York, specializes inunderwriting professional liability insurance and began producing directors& officers liability insurance exclusively for the Insurance Companies inthe fourth quarter of 2001.

 

Navigators Holdings (UK)Limited is a holding company for the Company’s UK subsidiaries consisting ofthe Lloyd’s Operations, and Navigators Management (UK) Limited, a NavigatorsAgency, which produces business for the UK Branch of Navigators Insurance andthe unaffiliated pool members.  TheLloyd’s Operations consist of Navigators Underwriting Agency Ltd. (“NUAL”), aLloyd’s of London (“Lloyd’s”) marine underwriting managing agency which managesLloyd’s Syndicate 1221, Millennium Underwriting Ltd. (“Millennium”) andNavigators Corporate Underwriters Ltd. (“NCUL”).  Both Millennium and NCUL are Lloyd’s corporate members withlimited liability and provide capacity to Lloyd’s Syndicate 1221.  NUAL owns Pennine Underwriting Ltd., anunderwriting managing agency with offices in Manchester and Leeds, England,which underwrites cargo and engineering business for Lloyd’s Syndicate 1221.

 

The Company’s revenue isprimarily comprised of premiums, commissions and investment income.  The Insurance Companies derive the majorityof their premium from business written by the Navigators Agencies.  The Lloyd’s Operations derive their premiumfrom business written by NUAL.

 

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

 

**Critical Accounting Policies**

 

It is important tounderstand the Company’s accounting policies in order to understand itsfinancial statements.  Managementconsiders certain of these policies to be critical to the presentation of thefinancial results since they require management to make estimates andassumptions.  These estimates andassumptions affect the reported amounts of assets, liabilities, revenues,expenses, and related disclosures at the financial reporting date andthroughout the period being reported upon. Certain of the estimates result from judgments that can be subjectiveand complex, and consequently actual results may differ from these estimates.

 

The Company’s mostcritical accounting policies involve the reporting of the reserves for lossesand loss adjustment expenses (including losses that have occurred but were notreported to the Company by the financial reporting date), reinsurancerecoverables, written and unearned premium, the recoverability of deferred taxassets, the impairment of invested assets, and goodwill.

 

Loss reserves representan estimate of the expected cost of the ultimate settlement and administrationof losses, based on facts and circumstances then known.  Actuarial methodologies are employed toassist in establishing such estimates and include judgments relative toestimates of future claims severity and frequency,

 

14

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length of time to developto ultimate, judicial theories of liability and other third party factors whichare often beyond our control.  Due tothe inherent uncertainty associated with the reserving process, the ultimateliability may be different from the original estimate.  Such estimates are regularly reviewed andupdated and any resulting adjustments are included in the current year’sresults.

 

Reinsurance recoverablesare established for the portion of the loss reserves that are ceded toreinsurers.  Reinsurance recoverablesare determined based upon the terms and conditions of the reinsurance contractswhich could be subject to judicial theories of liability.  In addition, a credit risk exists with thereinsurer particularly considering that certain of the reserves remainoutstanding for an extended period of time. The Company is required to pay the losses even if the reinsurer fails tomeet its obligations under the reinsurance agreement.

 

Written premium isrecorded based on the insurance policies that have been reported to the Companyand the policies that have been written by the agents but not yet reported tothe Company.  The Company must estimatethe amount of written premium not yet reported based on judgments relative tocurrent and historical trends of the business being written.  Such estimates are regularly reviewed andupdated and any resulting adjustments are included in the current year’sresults.  An unearned premium reserve isestablished to reflect the unexpired portion of each policy at the financialreporting date.

 

The Company has recordedvaluation allowances related to deferred tax assets resulting from netoperating loss carryforwards due to the uncertainty associated with therealization of the deferred tax asset related to certain of the Company’sforeign, state and local operations. The Company has released in 2002 the amount of the valuation allowanceto the extent of income generated by such operations.

 

Impairment of investmentsecurities results in a charge to operations when a market decline below costis other than temporary.  Managementregularly reviews each investment security for impairment based on criteriathat include the extent to which cost exceeds market value, the duration ofthat market decline and the financial health of and specific prospects for theissuer.

 

The Company tests, atleast annually, the impairment of goodwill. If the Company's carrying amount of goodwill exceeds its implied fairvalue, an impairment loss will be recognized.

 

**Results of Operations**

 

Revenues.  Gross written premium for the nine monthsended September 30, 2002 increased 64.6% to $339,718,000 from $206,427,000 forthe nine months ended September 30, 2001. Gross written premium for the three months ended September 30, 2002increased 114.1% to $126,857,000 from $59,253,000 for the same period in 2001.

 

15

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The following table setsforth the Company’s gross written premium by segment and line of business, andceded and net written premium by segment for the periods indicated:

 
|                          |   | **Nine  Months Ended September 30,** |    |
|-------------------------------|--------|--------------------------------------|---------|
|                          |   | **2002**                             |    | **2001** |   |
|                          |   | ***(Dollars in thousands)***         |    |
|                          |   |                                 |    |   |   |   |   |   |   |
| Lloyd’s  Operations:     |   |                                 |    |   |   |   |   |   |   |
| Marine                        |   | $                                    | 91,084  |   | 27 | % | $ | 84,300 |   | 41 | % |
| Engineering  and Construction |   | 4,002                                |    | 1 |   | 2,355 |   | 1 |   |
| Onshore  Energy               |   | 3,020                                |    | 1 |   | 1,264 |   | 1 |   |
| Gross  Written Premium        |   | 98,106                               |    | 29 |   | 87,919 |   | 43 |   |
| Ceded  Written Premium        |   | (27,524                              | )       |   |   | (27,155 | ) |   |   |
| Net  Written Premium          |   | 70,582                               |    |   |   | 60,764 |   |   |   |
|                          |   |                                 |    |   |   |   |   |   |   |
| Insurance  Companies:         |   |                                 |    |   |   |   |   |   |   |
| Marine                        |   | 137,836                              |    | 41 |   | 77,843 |   | 38 |   |
| Specialty  Insurance          |   | 85,148                               |    | 25 |   | 38,716 |   | 18 |   |
| Professional  Liability       |   | 14,133                               |    | 4 |   | — |   | — |   |
| Other                         |   | 4,495                                |    | 1 |   | 1,949 |   | 1 |   |
| Gross  Written Premium        |   | 241,612                              |    | 71 |   | 118,508 |   | 57 |   |
| Ceded  Written Premium        |   | (102,722                             | )       |   |   | (50,771 | ) |   |   |
| Net  Written Premium          |   | 138,890                              |    |   |   | 67,737 |   |   |   |
|                          |   |                                 |    |   |   |   |   |   |   |
| Total  Gross Written Premium  |   | 339,718                              |    | 100 | % | 206,427 |   | 100 | % |
|                          |   |                                 |    |   |   |   |   |   |   |
| Total  Ceded Written Premium  |   | (130,246                             | )       |   |   | (77,926 | ) |   |   |
|                          |   |                                 |    |   |   |   |   |   |   |
| Total  Net Written Premium    |   | $                                    | 209,472 |   |   |   | $ | 128,501 |   |   |   |

 

### **Lloyd’s Operations’ Gross WrittenPremium**

 

The Lloyd’s premium isgenerated as the result of NCUL and Millennium providing capacity to Lloyd’sSyndicate 1221 managed by NUAL.  TheCompany participates for, and records in its consolidated financial statements,its portion of Lloyd’s Syndicate 1221’s premium and related losses andexpenses.  Such participation was 68.1%of the portion of Syndicate 1221’s £75.0 million ($111.0 million) of capacityutilized for the 2002 underwriting year and 67.4% of the portion of Syndicate1221’s £66.3 million ($95.4 million) of capacity utilized for the 2001 underwritingyear.  Syndicate 1221’s capacity isexpressed net of commission (as is standard at Lloyd’s) of approximately21%.  Lloyd’s presents its results on anunderwriting year basis, generally closing each underwriting year after threeyears.  The Company makes estimates foreach year and timely accrues the expected results.

 

At September 30, 2002, byLloyd’s definition, the Company controlled an additional 20.3% of Syndicate1221’s capacity through non-affiliated insurance companies (the “Non-affiliates”).  The portion of Syndicate 1221’s premiumwritten and recorded by the Non-affiliates was $24,017,000 and $22,472,000 forthe nine months ended September 30, 2002 and 2001, respectively, and $8,599,000and $5,343,000 for the three months ended September 30, 2002 and 2001,respectively.  

 

16

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If the Company were tocontrol more than 90% of Syndicate 1221’s capacity by Lloyd’s definition,Lloyd’s Major Syndicate Transactions Byelaw (No. 18 of 1997) allows for aminority buy-out to be effected.  Insuch a transaction, the remaining participants are required to give up theircapacity in return for compensation which must be at least equal to the offerprice preceding the buy-out.  The costof such a buy-out is not considered to be material to the Company’sconsolidated financial statements.

 

The Company providesletters of credit to Lloyd’s to support its 68.1% participation in Syndicate1221’s capacity.  If the Companyincreases its participation in Syndicate 1221’s capacity, or if Lloyd’s changesthe collateral requirements, the Company may be required to supply additionalletters of credit or other collateral acceptable to Lloyd’s, or to reduce thecapacity of Syndicate 1221.

 

*Marine Premium.*Marine gross written premiumincreased 8.0% for the nine months and 38.9% for the three months endedSeptember 30, 2002 compared to the same periods in 2001, due to new businessand rate increases.

* *

*Engineering and ConstructionPremium. *NUALunderwrites engineering and construction business for Syndicate 1221.  The business consists of coverage forconstruction projects including machinery, equipment and loss of use due todelays.

 

*Onshore Energy Premium.*NUAL also underwrites onshoreenergy business for Syndicate 1221.  Thebusiness principally focuses on the oil and gas, chemical and petrochemicalindustries with coverages primarily for property damage and businessinterruption.

 

Insurance Companies’Gross Written Premium

 

*Marine Premium. *Marine gross writtenpremium increased 77.1% when comparing the nine months ended September 30, 2002to the nine months ended September 30, 2001, and increased 134.9% for the threemonths ended September 30, 2002 compared to the same period last year.  The increases were due to new business andrate increases.  Navigators Insurance’sparticipation in the marine pools was 75% in both years.

 

*Specialty Insurance**Premium.*  The specialty insurance consists primarilyof general liability insurance for contractors as well as small commercial risks.The120.0% increase in the gross written premium when comparing the nine monthsended September 30, 2002 and 2001, and the 132.0% increase when comparing thethree months ended September 30, 2002 and 2001, resulted from new business andrate increases.

 

*Professional**Liability Premium.* In late 2001, the Insurance Companies began to write professionalliability insurance consisting primarily of directors & officers liabilitycoverages for privately held and publicly traded corporations.  For the first nine months of 2002, theCompany produced $14.1 million of gross written premium.

 

Ceded Written Premium*.*  In the ordinary course of business, theCompany reinsures certain insurance risks with unaffiliated insurance companiesfor the purpose of limiting its maximum loss exposure, protecting againstcatastrophic losses, and maintaining desired ratios of net premiums written tostatutory surplus.  The relationship ofceded to written premium varies based upon the types of business written andwhether the business is written by the Insurance Companies or the Lloyd’sOperations.  The increase in cededpremium when comparing the  nine monthsended September 30, 2002 to the same period in 2001, and the third quarter of2002 to the third quarter of 2001, resulted from the increase in the grosswritten premium, the increase in the 2002 excess of loss reinsurance rates andan 85% quota share reinsurance treaty on the professional liability premium.

 

17

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Net Written Premium*.* Net written premium increased 63.0% whencomparing the nine months ended September 30, 2002 to the same period in 2001,and increased 113.7% when comparing the third quarter of 2002 to the thirdquarter of 2001, due to the increase in the gross written premium.

 

Net Earned Premium.  Net earned premium increased 58.1% for thenine months ended September 30, 2002 to $157,964,000 as compared to $99,897,000for the nine months ended September 30, 2001. Net earned premium increased 86.2% for the third quarter of 2002compared to the third quarter of 2001. The increase in net earned premium resulted from the increase in netwritten premium in 2001 and the nine months of 2002.

 

Commission Income*. *Commission income generated bythe Navigators Agencies increased to $3,282,000 for the nine months endedSeptember 30, 2002 from $2,918,000 for the same period in 2001, and increasedto $1,188,000 for the third quarter of 2002 from $1,118,000 for the thirdquarter of 2001, primarily as the result of the increased earned premium on themarine business produced by the Navigators Agencies.

 

Net Investment Income*. *Net investment income decreased6.8% to $13,494,000 for the nine months ended September 30, 2002 from$14,481,000 for the corresponding period in 2001 primarily due to the decreasein interest rates in 2002.  Theinvestments at NCUL and Millennium are presented as funds due from Lloyd’sSyndicate 1221 to the Company and have a relatively short duration.

 

Net Realized CapitalGains (Losses)*. *Pre-taxnet income included $1,172,000 of net realized capital gains for the ninemonths ended September 30, 2002 compared to $996,000 of net realized capitalgains for the same period last year. Included in pre-tax net realized capital gains for 2002 were $2,118,000and $787,000 of impairment losses recorded in the second and third quarters,respectively, on one of the Company’s asset backed securities.  Included in pre-tax net realized capitalgains for 2001 were impairment losses of $718,000 recorded in the third quarterof 2001.  On an after tax basis, the netrealized capital gains were $856,000 or $0.10 per share for the nine monthsended September 30, 2002 and $847,000 or $0.10 per share for the same period of2001.  Pre-tax net income included$1,264,000 and $389,000 of net realized capital gains for the third quarter of2002 and 2001, respectively.  On anafter tax basis, the net realized capital gains were $927,000 or $0.11 pershare for the third quarter of 2002 compared to $361,000 or $0.04 per share forthe third quarter of 2001.

 

Other Income (Expense).  Other income (expense) for the nine monthsand three months ended September 30, 2001 consisted primarily of $3,800,000 and$2,500,000, respectively, of charges related to the Company’s former investmentin Riverside Corporate Underwriters, Ltd. (“RCUL”), a Lloyd’s corporatename.  Lloyd’s informed the Company in2001 that it was liable for part of the adverse development in the Lloyd’ssyndicates in which RCUL provided capacity in 1999 and 1998.  The Company had provided a letter of creditto RCUL in order for RCUL to participate on various Lloyd’s syndicates.  The charge represented the Company’s bestestimate of its potential exposure based upon then available information.

 

Operating Expenses.

 

*Net Losses and Loss AdjustmentExpenses Incurred.* The ratio of net losses and loss adjustment expenses incurred to netearned premium (the “loss ratio”) was 63.1% and 69.7% for the nine months endedSeptember 30, 2002 and 2001, respectively. The loss ratio was 66.0% for the third quarter of 2002 compared to 79.4%for the 2001 third quarter.  The higherloss ratios in 2001 were primarily due to the September 11, 2001 terroristattack on the World Trade Center which accounted for 4.3 points and 12.3 pointsof the loss ratio for the nine months and the third quarter of 2001,respectively.  There was no developmentin the Company’s incurred losses in 2002 related to the World Trade Center.

 

*Commission Expense. *Commission expense as apercentage of net earned premium was 20.4% and 21.7% for the nine months endedSeptember 30, 2002 and 2001, respectively, and 19.5% and 21.7% for the thirdquarters of 2002 and 2001, respectively. The commission expense tends to fluctuate with changes in the mix ofbusiness.

 

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*Other Operating Expenses. *Other operating expensesincreased to $27,997,000 during the nine months ended September 30, 2002 from$19,443,000 during the corresponding period of 2001, and to $9,127,000 duringthe third quarter of 2002 from $6,602,000 in the third quarter of 2001,primarily due to the increase in employee related expenses resulting fromexpansion of the business.  No expensefor amortization of goodwill has been recorded in the nine and three monthsended September 30, 2002 compared to an after tax expense of $183,000 and$61,000 recorded in the nine and three months ended September 30, 2001,respectively.

 

*Interest Expense. *Interest expense was$463,000 for the nine months ended September 30, 2002 compared to $1,108,000during the corresponding period of 2001. This decrease was due to a smaller loan balance and lower interest rateson the loan.  The interest expense forthe three months ended September 30, 2002 decreased to $158,000 from $289,000for the same period in 2001.

 

Income Taxes*.*  The effective tax rate was 25.9% and 53.5%for the nine months ended September 30, 2002 and 2001, respectively.  The rates differed from the Federalstatutory income tax rate primarily due to the change in the valuation allowanceto the extent of income or loss generated in certain of its foreign operations,and also to tax-exempt interest income.

 

The Company’s valuationallowance for the nine and three month periods ended September 30, 2002decreased by $1,041,000 and $358,000, respectively, relating to the reductionin the loss carryforward at the Company’s foreign operations resulting fromincome generated by those operations in 2002. At September 30, 2002 and 2001, the Company had loss carryforwardsremaining at its foreign operations amounting to potential future tax benefitsof $4,755,000 and $6,689,000, respectively, along with a valuation allowanceequal to these benefits.  The Companyneeds to generate $15,850,000 of future foreign pretax income in order to fullyutilize the foreign loss carryforwards which can be carried forwardindefinitely.

 

The Company also had netstate and local loss carryforwards amounting to potential future tax benefitsof $2,099,000 and $1,443,000 at September 30, 2002 and 2001, respectively,along with a valuation allowance equal to these benefits.  The Company needs to generate $11,545,000 offuture state and local pretax income in order to fully utilize the losscarryforwards which expire from 2019 to 2022.

 

The Company hadalternative minimum tax carryforwards of $1,115,000 and $4,025,000 at September30, 2002 and 2001, respectively.

 

Net Income (Loss)*.* The Company had net income of $12,495,000 forthe nine months ended September 30, 2002 compared to $1,444,000 for the sameperiod last year.  On a diluted pershare basis, this represented net income per share of $1.45 and $0.17 for thenine months ended September 30, 2002 and 2001, respectively.  Net income in the third quarter of 2002 was$5,271,000, or $0.61 per share, compared to a net (loss) in the third quarterof 2001 of $(2,921,000), or $(0.35) per share.

 

**Liquidity and Capital Resources**

 

Cash flow provided byoperations was $61,771,000 and $13,646,000 for the nine months ended September30, 2002 and 2001, respectively. The increase in the 2002 operating cash flowwas primarily due to increases in net written premium and reductions inreinsurance recoverables.  Operatingcash flow was used primarily to acquire additional investment assets and toreduce debt.

 

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The Company has a creditfacility provided through a consortium of banks.  The credit facility provides for a $14.5 million revolving lineof credit facility, which reduces each quarter by amounts totaling $4.5 millionin 2002, $5.5 million in 2003 and $9.0 million in 2004 until it terminates onNovember 19, 2004, and a $55.0 million letter of credit facility.  At September 30, 2002, $14,500,000 in loanswere outstanding under the revolving line of credit facility at an interestrate of 3.2%.  The letter of creditfacility is utilized primarily by NCUL and Millennium for its participation inLloyd’s Syndicate 1221.  The creditfacility agreement requires that the banks vote whether or not to renew theletter of credit portion of the facility each year.  If the banks decide to not renew the letter of credit portion ofthe facility, the Company will need to find other sources to provide theletters of credit or other collateral in order to continue its participation inSyndicate 1221.  At September 30, 2002,letters of credit with an aggregate face amount of $51,996,000 were issuedunder the letter of credit facility.

 

At September 30, 2002,the Company’s consolidated stockholders’ equity was $167,088,000 compared to$147,206,000 at December 31, 2001.  Theincrease was primarily due to the net income for the nine months endedSeptember 30, 2002 and the increase in the unrealized gains in the investmentportfolio.

 

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

 

There have been nomaterial changes in the information concerning market risk as stated in theCompany’s 2001 Annual Report on Form 10-K.

 

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

 

(a)            Evaluation ofDisclosure Controls and Procedures. The Company’s Chief Executive Officer and Chief Financial Officercompleted an evaluation of the effectiveness of its disclosure controls andprocedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), within 90days prior to the filing date of this quarterly report (the “EvaluationDate”).  Based on this evaluation, theCompany’s Chief Executive Officer and Chief Financial Officer have concludedthat, as of the Evaluation Date, the Company’s disclosure controls andprocedures are effective in alerting them on a timely basis to materialinformation relating to the Company and its consolidated subsidiaries requiredto be included in the Company’s periodic filings under the Exchange Act.

 

(b)           Changes in InternalControls.  Since the EvaluationDate, there have not been any significant changes in the Company’s internalcontrols or in other factors that could significantly affect suchcontrols.  There were no significantdeficiencies or material weaknesses identified in the evaluation and therefore,no corrective actions were taken.

 

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

 

Item 1.    Legal Proceedings:

 

The Company is not a party to or the subject of anymaterial pending legal proceedings which depart from the ordinary routinelitigation incident to the kinds of business conducted by the Company, exceptthat in the third quarter of 2002, the Company was notified that a legalproceeding had been brought against Navigators Insurance by the liquidator ofone of its former reinsurers.  The suitalleges that certain letters of credit amounting to $3.7 million provided toNavigators Insurance as collateral constituted a preferential transaction.  The Company believes that the suit istotally without merit and intends to vigorously defend its position.

 

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Item 2.    Changes in Securities:

 

None.

 

Item 3.    DefaultsUpon Senior Securities:

 

None.

 

Item 4.    Submissionsof Matters to a Vote of Securities Holders:

 

None.

 

Item 5.    OtherInformation:

 

None.

 

Item 6.    Exhibitsand Reports on Form 8-K:

 

(a)           Exhibits:

 
| Exhibit No. |   | Description of Exhibit                                               |
|-------------|--------|----------------------------------------------------------------------|
| 10-21       |   | Amendment No. 4 dated October 18, 2002 to the 1998  Credit Agreement |
| 99-1        |   | Certification of CEO                                                 |
| 99-2        |   | Certification of CFO                                                 |

 

(b)           Reportson Form 8-K:

 

There were no reports on Form 8-K filed for the ninemonths ended September 30, 2002.

 

 

SIGNATURE

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                                       |   | The Navigators Group,  Inc.                                    |   |
|--------------------------------------------|--------|----------------------------------------------------------------|--------|
|                                       |   | (Registrant)                                                   |   |
|                                       |   |                                                           |
|                                       |   |                                                           |
| Dated:    November 14, 2002 |   | /s/ Bradley D.  Wiley                                     |   |
|                                       |   | Bradley D. Wiley                                               |
|                                       |   | Senior Vice President,   Chief Financial Officer and Secretary |

 

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**CERTIFICATION****OF CHIEFEXECUTIVE OFFICER PER**

**SECTION 302 OF THE SARBANES-OXLEY ACT**

 

I, Terence N. Deeks,certify that:

 

1.               I have reviewedthis quarterly report on Form 10-Q of The Navigators Group, Inc.

 

2.               Based on my knowledge,this quarterly report does not contain any untrue statement of a material factor omit to state a material fact necessary to make the statements made, inlight of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date:  November 14, 2002 | /s/  Terence N. Deeks |   |
|-------------------------------|----------------------------|--------|
|                          | Terence N. Deeks           |
|                          | Chief Executive Officer    |

 

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**CERTIFICATION OF CHIEF FINANCIALOFFICER PER**

**SECTION 302 OF THE SARBANES-OXLEY ACT**

 

I, Bradley D. Wiley, certifythat:

 

1.               I have reviewedthis quarterly report on Form 10-Q of The Navigators Group, Inc.

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information included inthis quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)              designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)             evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)              presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)              all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)             any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date:  November 14, 2002 | /s/  Bradley  D. Wiley |   |
|-------------------------------|----------------------------------|--------|
|                          | Bradley D. Wiley                 |
|                          | Chief Financial Officer          |

 

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**INDEX OF EXHIBITS**

 
| Exhibit No. |   | Description of Exhibit                                               |
|-------------|--------|----------------------------------------------------------------------|
| 10-21       |   | Amendment No. 4 dated  October 18, 2002 to the 1998 Credit Agreement |
| 99-1        |   | Certification of CEO                                                 |
| 99-2        |   | Certification of CFO                                                 |

 

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