The Company's administrative offices are occupied pursuant to a lease from an unaffiliated company which expires June 30, 2010 in a building located at One Penn Plaza, New York, New York. Several of the Company's subsidiaries have noncancellable operating leases for their respective office locations.
The following table sets forth summary consolidated financial information of the Company for each of the years in the five-year period ended December 31, 2002 derived from the Company's
audited consolidated financial statements. See the Consolidated Financial Statements of the Company including notes thereto included herein.
The Company is a holding company with twelve active wholly owned subsidiaries. See BUSINESS-General included herein for a description of the Company.
Loss Reserves and LAE. The Company's loss reserves are discussed under the BUSINESS-Reserves section and Note 6 to the Company's consolidated financial statements, both included herein. Loss reserves represent an estimate of the expected cost of the ultimate settlement and administration of losses, based on facts and circumstances then known. Actuarial methodologies are employed to assist in establishing such estimates and include judgments relative to estimates of future claims severity and frequency, length of time to develop to ultimate, judicial theories of liability and other third party factors which are often beyond our control. Due to the inherent uncertainty associated with the reserving process, the ultimate liability may be different from the original estimate. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year's results.
Reinsurance Recoverables. Reinsurance recoverables are established for the portion of the loss reserves that are ceded to reinsurers. Reinsurance recoverables are determined based upon the terms and conditions of reinsurance contracts which could be subject to interpretations that differ from our own based on judicial theories of liability. In addition, we bear credit risk with respect to our reinsurers which can be significant considering that certain of the reserves remain outstanding for an extended period of time. The Company is required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. See the BUSINESS-Reinsurance Ceded section and Note 7 to the Company's consolidated financial statements, included herein.
Written and Unearned Premium. Written premium is recorded based on the insurance policies that have been reported to the Company and the policies that have been written by agents but not yet reported to the Company. The Company must estimate the amount of written premium not yet reported based on judgments relative to current and historical trends of the business being written. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year's results. An unearned premium reserve is established to reflect the unexpired portion of each policy at the financial reporting date. See Note 1 to the Company's consolidated financial statements, included herein.
Historically, the Company reported Funds due from Lloyd's syndicate as a separate line item on its balance sheets. The balance consisted primarily of investments, cash and premiums receivables resulting from the Company's participation in Lloyd's Syndicate 1221. Commencing in 2002, the Company has recorded the amounts due from Lloyd's Syndicate 1221 as part of their separate components in its financial statements. As a result, the amounts previously classified as Funds due from Lloyd's syndicate have been reclassified to conform to the current year's presentation.
Goodwill. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards 142 ("SFAS 142"), Goodwill and Other Intangible Assets, effective January 1, 2002. SFAS 142 changes the accounting for goodwill and intangible assets that have indefinite useful lives from an amortization approach to an impairment-only approach that requires that those assets be tested at least annually for impairment. The Company completed its impairment review resulting in no impairment of goodwill as of January 1, 2002. See Note 1 to the Company's consolidated financial statements, included herein.
Revenues. Gross written premium increased to $447.8 million in 2002 from $278.2 million in 2001 and from $188.4 million in 2000. The following table sets forth the Company's gross written premium
Marine Premium. The 2002 and 2001 marine premium increased 64.8% and 32.5%, respectively, due to the increase in premium rates resulting in higher premiums on new and renewal business. The improved pricing environment resulted in Navigators Insurance increasing its writing of new business. The increased premium in 2002 of $70.1 million resulted from $49.2 million of new business and $20.9 million from rate increases which averaged 21%. Navigators Insurance obtains its marine business through participation in the marine pool managed by the Navigators Agencies. Its participation in the marine pool was 75% in 2002, 2001 and 2000.
General Liability Premium. This business consists primarily of general liability insurance for general contractors and small artisans as well as small commercial risks. The general liability premium increased 109.7% from 2001 to 2002 and 94.4% from 2000 to 2001 due to increased rates and expansion of the business. The increased premium in 2002 of $60.5 million resulted from $48.9 million of new business and $11.6 million of rate increases which averaged 30%. The new business and the rate increases resulted from a tightening market for California contractors' liability insurance and expansion of the artisan business.
Professional Liability Insurance. In late 2001, the Insurance Companies began to write professional liability insurance primarily consisting of directors and officers liability insurance for privately held and publicly traded corporations. More recently, the professional liability business has been expanded to include errors and omissions insurance and employment practices liability coverages.
The Company also purchased an additional £7,379,000 ($11,018,000) of capacity for 2001 through an annual auction process in 2000 at a total cost of £133,000 ($199,000).
Marine Premium. In 2002, marine premium increased 10.5% from 2001 partially due to the increase in premium rates resulting in higher premiums on renewal and new business and due to the capacity provided to Syndicate 1221 by NCUL and Millennium increasing from 67.4% in 2001 to 68.1% in 2002. The higher premium rates averaging approximately 26% made the business more attractive resulting in the Lloyd's Operations increasing its writings of new business. The increased premium volume in 2001 compared to 2000 was also due to the increase in premium rates and to the capacity provided to Syndicate 1221 by NCUL and Millennium increasing from 64.5% in 2000 to 67.4% in 2001.
Engineering and Construction Premium. The business consists of coverage for construction projects including machinery, equipment and loss of use due to delays. The increases in the gross written premium in 2002 and 2001 were due to new business.
Ceded Written Premium. In the ordinary course of business, the Company reinsures certain insurance risks with unaffiliated insurance companies for the purpose of limiting its maximum loss exposure, protecting against catastrophic losses, and maintaining desired ratios of net premiums written to statutory surplus. The relationship of ceded premium to gross written premium varies based upon the types of business written and whether the business is written by the Insurance Companies or the Lloyd's Operations. The amount of ceded premium in 2002 increased over 2001 due to the increase in gross written premium and the increase in reinsurance rates in 2002. The percentage of the Lloyd's Operations' ceded premium increased from 28.5% in 2001 to 30.5% in 2002 due to additional quota share reinsurance. The percentage of the Insurance Companies' premium which was ceded decreased from 44.1% in 2001 to 43.1% in 2002 primarily due to the increase in the general liability insurance premium of which the Insurance Companies retain more of the premium than in the other lines of business. The increase in ceded premium in the Lloyd's Operations from 27.4% in 2000 to 28.5% in 2001 was due to slightly higher reinsurance rates. The Insurance Companies' percentage of ceded premium decreased from 53.3% in 2000 to 44.1% in 2001 primarily due to the increase in the specialty insurance.
Net Earned Premium. Net earned premium increased due to the increase in the net written premium.
Commission Income. The increases in commission income from 2001 to 2002 of 13.9% and from 2000 to 2001 of 11.9% were due to the increase in marine premium for which the Company receives commission from unaffiliated insurers.
Net Investment Income. Net investment income decreased 6.7% in 2002 from the previous year due to lower interest rates during 2002 partially offset by increased invested assets. Investment income increased 4.9% during 2001 from 2000 primarily due to an increase in investment income allocated to NCUL and Millennium from the investments at the Lloyd's syndicates due to their increased participation in Syndicate 1221, reduction in the Insurance Companies' municipal portfolio, reduction in the expenses to manage the portfolio and the increase in the size of the portfolio. See BUSINESS-Investments, included herein, for additional information regarding the Company's net investment income.
Other Income/(Expense). Other income/(expense) for 2002 consisted primarily of foreign exchange gains, and fees related to the general liability insurance business. Other income/(expense) for 2001 consists primarily of a $3,800,000 charge related to the Company's former investment in Riverside Corporate Underwriters, Ltd. ("RCUL"), a Lloyd's corporate name. Lloyd's informed the Company in 2001 that it was liable for part of the adverse development in the Lloyd's syndicates in which RCUL provided capacity in 1999 and 1998. The Company had provided a letter of credit to RCUL in order for RCUL to participate on various Lloyd's syndicates. The Company believes that it has no further exposure to RCUL.
The following table sets forth the Company's net loss reserves by segment and line of insurance business as of the date indicated:
The increases in the loss reserves for the marine and general liability insurance was primarily due to the reserves on the increased premium volume. The Company started writing professional liability insurance in late 2001.
The Company's Reinsurance Security Committee monitors the financial strength of its reinsurers and the amounts of reinsurance receivables from those reinsurers. A reserve is established for any amounts considered uncollectible. At December 31, 2002 and 2001, the Company had an allowance for uncollectible reinsurance of $8,534,000 and $6,905,000, respectively.
The following table lists our 10 largest reinsurers measured by the amount of reinsurance recoverable for ceded losses, ceded loss adjustment expense and ceded unearned premium (constituting 49% of the total recoverable), together with the reinsurance recoverables and collateral (including
See the Reinsurance Ceded, and Reserves sections under BUSINESS, included herein.
Income Taxes. The income tax expense was $5.8 million, $1.7 million and $3.3 million for 2002, 2001 and 2000, respectively. The effective tax rates for 2002, 2001 and 2000 were 26.2%, 31.6% and 32.0%, respectively. The Company had alternative minimum tax ("AMT") carryforwards of $1.0 million, $3.9 million and $5.3 million at December 31, 2002, 2001, and 2000, respectively. The AMT carryforwards were primarily attributable to the tax benefits from municipal bond interest.
Net Income. The Company had net income of $16.4 million in 2002, $3.7 million in 2001 and $7.0 million in 2000. The increase in net income from 2001 to 2002 was primarily due to overall improved profitability in the insurance operations. The decrease in net income from 2000 to 2001 was
primarily due to the losses resulting from the September 11, 2001 terrorist attack on the World Trade Center.
Invested assets and cash increased to $452.9 million at December 31, 2002 from $333.1 million at December 31, 2001. The increase was primarily due to the positive cash flow. Net investment income was $18.1 million in 2002, $19.4 million in 2001 and $18.4 million in 2000. The average yield of the portfolio, excluding net realized capital gains, was 4.78% in 2002, 6.14% in 2001 and 6.55% in 2000 reflecting the prevailing interest rates during those years. As of December 31, 2002, all fixed maturity securities and equity securities held by the Company were classified as available-for-sale.
The average rating of the Company's fixed maturity investments is AA by Standard & Poor's and Aa by Moody's. The Company has no significant exposure to credit risk since the fixed maturity investment portfolio consists of investment grade bonds. The portfolio has an average maturity of 5.1 years and a duration of 3.7 years. Management continually monitors the composition and cash flow of the investment portfolio in order to maintain the appropriate levels of liquidity to ensure the Company's ability to satisfy claims. The Company incurred impairment losses of $2.9 million in 2002 and $1.6 million in 2001 on asset backed securities.
The increase in reserves for losses and loss adjustment expenses and the related increase in the reinsurance receivable on paid and unpaid losses and loss adjustment expenses at December 31, 2002 as compared to 2001 was primarily due to the reserves on the increase in the earned premium in 2002 compared to 2001.
The bank credit facility is collateralized by the common stock of Navigators Insurance. It contains covenants common to transactions of this type, including restrictions on indebtedness and liens, limitations on mergers and the sale of assets, maintaining certain consolidated tangible net worth, statutory surplus, and other financial ratios. At December 31, 2002, the Company complied with all covenants.
The Company had annual rental commitments at December 31, 2002 under various noncancellable operating leases for the Company's office facilities, which expire at various dates through 2013. The commitments by year are $2.1 million for 2003, $2.2 million for 2004, $2.1 million for 2005, $2.0 million for 2006 and $5.7 million for 2007 and subsequent.
Management considers the potential impact of these economic trends in estimating loss reserves. Management believes that the underwriting controls it maintains, and the fact that a significant amount of the Company's business is in lines of insurance which have relatively short loss payout patterns, assist in estimating ultimate claim costs more reasonably and lessen the potential adverse impact of the economy on the Company.
Market risk is the risk of loss arising from adverse changes in market rates and prices, such as interest rates, foreign currency exchange rates, and other relevant market rate or price changes. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying assets are traded. The following is a discussion of the Company's primary market risk exposures and how those exposures are currently managed as of December 31, 2002. The Company's market risk sensitive instruments are entered into for purposes other than trading.
There were no significant changes regarding the investment portfolio in the Company's primary market risk exposures or in how those exposures were managed compared to the year ended December 31, 2001, other than the impairment losses of $2.9 million in 2002 and $1.6 million in 2001
recorded on three of the Company's asset backed securities. The Company does not currently anticipate significant changes in its primary market risk exposures or in how those exposures are managed in future reporting periods based upon what is known or expected to be in effect in future reporting periods.
For invested assets, modified duration modeling is used to calculate changes in fair values. Durations on invested assets are adjusted for call, put and interest rate reset features. Duration on tax exempt securities is adjusted for the fact that the yield on such securities is less sensitive to changes in interest rates compared to Treasury securities. Invested asset portfolio durations are calculated on a market value weighted basis, including accrued investment income, using holdings as of December 31, 2002.
The sensitivity analysis model used by the Company produces a loss in fair value of market sensitive instruments of $16.0 million based on a 100 basis point increase in interest rates as of December 31, 2002. This loss amount only reflects the impact of an interest rate increase on the fair value of the Company's fixed maturities and short-term investments, which constitute approximately 46.6% of total assets as of December 31, 2002. The loss in fair value of market sensitive instruments, as a result of a 100 basis point increase in interest rates as of December 31, 2002, is not material.