In January 2000, the Company purchased a `flat' in London to accommodate visitors to its London operations. The cost of the flat was(pound)507,375 ($820,000) for a 75 year lease.
The Company's revenue is primarily comprised of premiums, commissions and investment income. The Insurance Companies derive the majority of their premium from business written by the Navigators Agencies. The Insurance Companies are managed by Navigators Management Company, Inc. The Lloyd's Operations derive their premium from business written by MTC.
General. The Company's 1998, 1999 and 2000 results of operations reflect intense market competition in the marine business which started to ease slightly in 2000.
The 1999 results include a charge against earnings of approximately $6.6 million pretax resulting in an after tax charge of approximately $4.3 million as the result of unrecoverable reinsurance from New Cap Reinsurance Corporation Limited ("New Cap Re") which participated in the Company's 1997 and 1998 reinsurance programs.
Total Net Written Premium....... $ 108,093 $ 94,084 $ 88,482 ======== ======== ========
The Lloyd's premium is generated as the result of NCUL and Millennium providing capacity to Lloyd's Syndicate 1221 which is managed by MTC. The premiums, losses and expenses from the Lloyd's Operations are included in the Company's consolidated financials but are not included in the Insurance Companies' results.
Marine Premium. In 2000, marine premium increased 20.7% from 1999 due to the capacity provided to Syndicate 1221 by NCUL and Millennium in the aggregate increasing from 52.5% in 1999 to 64.5% in 2000. The capacity provided to Syndicate 1221 by NCUL and Millennium increased from 39.5% in 1998 to 52.5% in 1999 resulting in the increase in premium volume.
Engineering and Construction Premium. In 1999, the Robertson Consortium managed by MTC began writing engineering and construction business for Syndicate 1221. The business consists of coverage for construction projects including machinery, equipment and loss of use due to delays. Previously, the engineering and construction business was written for Navigators Insurance.
The Company controlled 75.6% of Syndicate 1221's capacity for the 2000 underwriting year. The actual capacity was (pound)66,297,000 ($95,985,000) of which the Company directly controlled(pound)42,772,000 ($61,925,000) or 64.5% and indirectly controlled(pound)7,340,000 ($10,627,000) or 11.1%. Since the controlled capacity exceeded 75% in 2000, Lloyd's Mandatory Byelaw (No. 5 of 1999) required the Company to make a mandatory offer to noncontrolled participants for their capacity at the first Lloyd's capacity auctions beginning in July 2000. As a result, the Company purchased an additional(pound)7,379,000 ($11,018,000) of capacity for 2001 through the auction process in 2000 at a total cost of(pound)133,000 ($199,000).
Aviation Premium. Navigators Insurance withdrew from aviation business effective October 1998, other than a small amount of war and satellite business, due to inadequate pricing in the aviation insurance market.
Engineering and Construction Premium. In 1997, Navigators Insurance began writing engineering and construction business consisting of coverage for construction projects including the machinery, equipment and loss of use due to delays. Beginning in 1999, the engineering and construction business was written through the Company's facilities at Lloyd's. In early 1999, the Company closed its Somerset Asia Pacific Limited office in Australia which, along with Navigators Management UK, had previously produced this business for Navigators Insurance.
Net Written Premium. Net written premium increased 14.9% from 1999 to 2000 primarily due to the increases in the Lloyd's marine business and the program business. Net written premium increased 6.3% from 1998 to 1999 primarily due to increases in the marine premium partially offset by decreases in other lines of business as described above.
Income Taxes. The income tax expense (benefit) was $3.3 million, ($1.7) million, and $3.7 million for 2000, 1999, and 1998, respectively. The effective tax rates for 2000, 1999, and 1998 were 32.0%, 32.3% and 24.2%, respectively. The tax benefit in 1999 compared to the tax expense in 1998 was primarily due to operating losses in 1999. The Company had alternative minimum tax ("AMT") carryforwards of $5.3 million, $6.4 million and $4.7 million at December 31, 2000, 1999, and 1998, respectively. The AMT carryforwards were primarily attributable to the tax benefits from municipal bond interest. The Company began reducing its municipal bond portfolio in 1997.
As of December 31, 2000 and 1999, the net deferred Federal, foreign, state and local tax asset was $9.0 million and $12.9 million, respectively. At December 31, 2000 the Company had a $5.8 million valuation allowance against its deferred tax asset compared to a $4.5 million valuation allowance at December 31, 1999. The valuation allowance is necessitated by the uncertainty associated with the realization of the deferred tax asset for the carryforward of operating losses from certain of the Company's foreign, state and local operations.
Cash flow provided by (used in) operations was $1.6 million, $8.9 million and ($3.0) million for 2000, 1999 and 1998, respectively. Operating cash flow in 1999 and 2000 was used primarily to acquire additional investment assets and to reduce debt. The negative operating cash flow in 1998 was primarily due to the payment of loss reserves on runoff business and less premiums received, partially due to Lloyd's disbursing cash only after an underwriting year has closed, normally three years later.
The decrease in reserves for losses and loss adjustment expenses and the related decrease in the reinsurance receivable on paid and unpaid losses and loss adjustment expenses at December 31, 2000 as compared to 1999 was primarily due to the payment of reserves and recovery of reinsurance during 2000 on various large energy and aviation claims.
The bank credit facility is collateralized by shares of common stock of the Company's major subsidiary. 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 total stockholders' equity, statutory surplus, minimum liquidity, loss reserves and other financial ratios. At December 31, 2000, the Company complied with all covenants.
The Company's reinsurance has been placed with various U.S. companies rated "A-" or better by A.M. Best Company, as well as with foreign insurance companies and with selected syndicates of Lloyd's. Pursuant to the implementation of Lloyd's Plan of Reconstruction and Renewal, a portion of the Company's recoverables are now reinsured by Equitas (a separate UK 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).
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 the majority 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.
The carrying value of the Company's investment portfolio as of December 31, 2000 was $251.2 million of which 89.6% was invested in fixed maturity securities. The primary market risk to the investment portfolio is interest rate risk associated with investments in fixed maturity securities. The Company's exposure to equity price risk and foreign exchange risk is not significant. The Company has no commodity risk.
For the Company's investment portfolio, there were no significant changes in the Company's primary market risk exposures or in how those exposures are managed compared to the year ended December 31, 1999. 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.
The sensitivity analysis model used by the Company produces a loss in fair value of market sensitive instruments of $11.0 million based on a 100 basis point increase in interest rates as of December 31, 2000. This loss amount only reflects the impact on an interest rate increase on the fair value of the Company's fixed maturities and short-term investments, which constitute approximately 39.6% of total assets as of December 31, 2000.