The Company's administrative offices are occupied pursuant to a lease which expires May 14, 2000, from an unaffiliated company, in a building located at 123 William Street, New York, New York. Each of the Somerset Companies has various noncancellable operating leases for its office facilities. The Company does not own any real estate.
The Company is a holding company with twelve active wholly-owned subsidiaries. See "BUSINESS-General" included herein for a description of the Company.
The Company's revenue is primarily comprised of premiums, commissions and investment income. Navigators derives substantially all of its business from direct participation in, or by reinsuring certain members of, insurance pools managed by the Somerset Companies. The insurance business and operations of Navigators are managed by NMC, one of the Somerset Companies.
General The 1994 results of operations of the Company were dominated by the Northridge, California earthquake, which occurred on January 17, 1994 (the "Northridge Earthquake"). The Company's pre-tax loss (including direct property losses of $35,388,000, reinsurance reinstatement premiums of $1,925,000 and reinsurance assumed losses of $1,952,000, but net of reinsurance) in 1994 from the Northridge Earthquake totalled $39,265,000. As a result of this loss, management restructured the Company by withdrawing from the large commercial and industrial property business which produced most of the earthquake loss, emphasizing its core ocean marine and aviation business, and developing its inland marine business as well as a new non-marine program book of business.
Aviation Premiums. Navigators' aviation gross written premium increased 6% from 1994 to 1995 reflecting the increase in Navigators' participation in the aviation pool from approximately 56% for the first nine months of 1995 to 100% beginning October 1, 1995. The 20% reduction in Navigators' aviation gross written premium from 1995 to 1996 was due to Navigators withdrawing from the general aviation business in order to concentrate on the major airlines and manufacturers, to price competition and to a general decrease in the amount of exposure per risk.
Onshore Energy. In 1996, Navigators began to underwrite onshore energy business which principally focuses on the oil and gas, chemical and petrochemical, and power generation industries with coverages primarily for property damage and machinery breakdown.
Specialty Reinsurance and Non-Marine Insurance Premium. During the early part of 1996, Navigators' management decided to discontinue writing assumed reinsurance, with the exception of a few specialty contracts. The reduction in reinsurance premium was partially offset in 1996 by an expansion of the specialty program business.
Net Earned Premium. The 3% decrease in net earned premium from 1994 to 1995 was due to the decrease in the net written premium partially offset by the run-off of the property business cancelled in 1994 and 1995. The 10% decrease in net earned premium from 1995 to 1996 was primarily due to the decrease in the 1995 net written premium and the effect that the property business run-off had on the 1995 net earned premium.
Commission expense as a percentage of net earned premium was 15.5%, 13.9% and 19.0% for 1996, 1995 and 1994, respectively. The decrease in 1995 compared to 1994 was due primarily to a reduction in the amount of Northridge Earthquake reinstatement premiums incurred during the year. The reinstatement premiums in 1994 caused earned premiums to decline but did not result in corresponding ceding commissions. The increase in the 1996 commission expense ratio compared to 1995 was primarily due to the reversal of approximately $519,000 of contingent commissions receivable recorded in 1995 on certain ceded contracts which had loss development during 1996.
Other operating expenses as a percentage of net earned premium were 24.5%, 25.6% and 24.0% for 1996, 1995 and 1994, respectively. Severance charges as a result of a reduction in staff accounted for approximately $968,000 of the operating expenses in 1995 partially offset by a commensurate decrease in salary expense. The decrease from 1995 to 1996 reflected the staff cuts in 1995 partially offset by the opening of the new offices in London and Australia in late 1996.
Income Taxes. The income tax expense was $4.7 million for 1996 and $3.0 million for 1995. There was an income tax benefit of $11.0 million for 1994 primarily attributable to the losses from the Northridge Earthquake. The effective tax rates for 1996, 1995 and 1994 were 20%, 19% and (35%), respectively. The Company had net operating loss carryforwards of $4.9 million at December 31, 1994 and $3.0 million at December 31, 1995 which was fully utilized in 1996. The Company had alternative minimum tax ("AMT") carryforwards of $5.8 million, $3.1 million and $0.8 million at December 31, 1996, 1995 and 1994, respectively. The AMT carryforwards were primarily attributable to the tax benefits from the municipal bond interest. The Company is reviewing its investment philosophy and will most likely reduce its municipal bond portfolio.
As of December 31, 1996 the net deferred Federal tax asset was $9.5 million as compared to $8.9 million at December 31, 1995. At December 31, 1995 the Company had a $775,000 valuation allowance against its deferred Federal tax asset. Management believes that it is more likely than not that the net deferred Federal tax asset recorded at December 31, 1996 is realizable and therefore, has not provided for any valuation allowance at December 31, 1996. This belief stems from a long history of taxable income prior to the Northridge Earthquake in 1994, the immediate actions management took to prevent another loss of such magnitude, and the inclusion of taxable income generated by the Somerset Companies in the Federal income tax return beginning July 1, 1994.
Equity Income in Affiliated Company. The Company holds an equity interest in Riverside, which through its wholly-owned subsidiary, Riverside Corporate Underwriters Limited, is admitted to underwrite at Lloyd's of London as a corporate name with limited liability. The Company records its share of Riverside's underwriting results when sufficient information becomes available to provide reasonable estimates of earned premiums and losses. During 1996, primarily in the third quarter, the Company recorded its share of the 1994 and 1995 underwriting earnings amounting to $1,387,942 after tax.
Net Income. The Company's net income improved in 1995 to income of $12.6 million from a loss of $20.5 million in 1994. The 1994 loss was primarily attributable to the Northridge Earthquake which also adversely impacted 1995 earnings as previously discussed. The 1996 net
income of $16.8 million reflects more normal experience even with the rate decreases in the marine business.
The majority of the invested assets are in municipal bonds rated "A" or better by Standard & Poor's or Moody's, or are in U.S. Treasury Bonds. Navigators has avoided investing in high yield bonds. Therefore, the Company has no significant exposure to credit risk since the Company's fixed maturity investment portfolio does not contain any non-investment grade bonds. The portfolio has an average maturity of less than seven years. Management continually monitors the composition and cash flow of the investment portfolio in order to maintain the appropriate levels of liquidity. This ensures the Company's ability to satisfy claims or expenses as they become due.
Total stockholders' equity was $115.5 million at December 31, 1996, a 16.6% increase for the year primarily as the result of the Company's earnings in 1996.
The Company's reinsurance has been placed with various U.S. companies rated "A" or better by A.M. Best Company, Inc., as well as with foreign insurance companies and with selected syndicates of Lloyd's of London ("Lloyd's"). Certain syndicates at Lloyd's ("Loss Syndicates") and the Lloyd's market as a whole have reported significant losses in recent years. The Company has not placed any material amounts of reinsurance with these Loss Syndicates. Pursuant to the implementation of Lloyd's Plan of Reconstruction and Renewal, a significant portion of the Company's recoverables from the Loss Syndicates are now reinsured by Equitas (a separate U.K. Department of Trade authorized reinsurance company established to reinsure outstanding liabilities of all Lloyd's members for all risks written in the 1992 or prior years of account).
The Company believes that the cash flow generated by the operating activities of the Company's subsidiaries, including the Somerset Companies, will provide sufficient funds for the Company to meet its liquidity needs over the next twelve months. Beyond the next twelve months, cash flow available to the Company may be influenced by a variety of factors, including general economic conditions and conditions in the insurance and reinsurance markets, as well as fluctuations from year to year in claims experience.