We are an international insurance holding company focusing on specialty products within the overall property/casualty insurance market. The Company’s underwriting segments consists of insurance company operations and operations at Lloyd’s of London. Our largest product line and most long-standing area of specialization is ocean marine insurance. We have also developed specialty niches in professional liability insurance and in specialty liability insurance primarily consisting of contractors liability and primary and excess liability coverages. We conduct operations through our Insurance Companies and our Lloyd’s Operations. The Insurance Companies consist of Navigators Insurance Company, which includes our U.K. Branch, and Navigators Specialty Insurance Company, which underwrites specialty and professional liability insurance on an excess and surplus lines basis fully reinsured by Navigators Insurance Company. Our Lloyd’s Operations include NUAL, a wholly-owned Lloyd’s underwriting agency which manages Syndicate 1221. We participate in the capacity of Syndicate 1221 through our wholly-owned Lloyd’s corporate member.
As a result of the substantial insurance industry losses resulting from Hurricanes Katrina and Rita, the marine insurance market experienced diminished capacity and rate increases through the end of 2006, particularly for the offshore energy risks located in the Gulf of Mexico. Since the end of 2006, competitive market conditions have returned as available capacity has increased. The 2008 average renewal premium rates for our Insurance Companies marine business increased approximately 0.4% for the fourth quarter and decreased approximately 2.1% for the twelve month period, including offshore energy 2008 average renewal premium rates which increased approximately 2.3% for the fourth quarter and decreased approximately 9.6% for the twelve months. The 2008 average renewal rates for our Lloyd’s Operations marine business decreased approximately 9.9% for the fourth quarter and 6.2% for the twelve month period, including offshore energy 2008 average renewal rates which increased approximately 4.0% for the fourth quarter and decreased approximately 10.4% for the twelve months. The 2007 average renewal premium rates for our Insurance Companies marine business decreased approximately 1.2% for the fourth quarter and 0.1% for the twelve month period, including offshore energy 2007 average renewal premium
rates which decreased approximately 14.2% for the fourth quarter and 2.4% for the twelve months. The 2007 average renewal rates for our Lloyd’s Operations marine business decreased approximately 5.1% for the fourth quarter and 1.2% for the twelve month period, including offshore energy 2007 average renewal rates which decreased approximately 5.5% for the fourth quarter and 3.7% for the twelve months. We expect continuing overall declines in 2009 pricing for most marine lines of business, except offshore energy and marine liability which may strengthen due to the 2008 storm losses, as additional capacity continues to re-enter the marine market.
Specialty liability losses in 2001 to 2003, particularly for construction liability business, resulted in diminished capacity in the market in which we compete, as many former competitors who lacked the expertise to selectively underwrite this business were forced to withdraw from the market resulting in approximate premium rate increases of 13.5% in 2004 and 49.1% in 2003. This was followed by a slight decline in rates of approximately 1.0% in 2005. The 2006 year average renewal rates for the construction liability business declined approximately 5.6%, primarily due to additional competition in the marketplace. This decline continued into 2007 with average renewal premium rates declining approximately 9.7% for the fourth quarter and 10.7% for the twelve months. In 2008, average renewal premium rates declined approximately 10.2% for the fourth quarter and 11.9% for the twelve months. We expect competitive conditions will continue into 2009 resulting in continued but slowing rate of declines in pricing for construction liability and excess liability business.
We are in the process of reassessing the way in which we manage our Gulf of Mexico exposures and the reinsurance protection that is purchased to protect those risks. We are taking steps to reduce our aggregate exposures and to increase profitability moving forward. The estimated probable maximum pre-tax gross and net loss exposure in a so-called or theoretical one in two hundred and fifty year hurricane event in the Gulf of Mexico could be significantly different in 2009 depending on the market conditions and reinsurance protection we purchase. The primary policies that create exposure in the Gulf of Mexico renew largely in April and July. We will evaluate the adequacy of the pricing and terms on these policies at that time. If we do not find the pricing and terms to be acceptable our exposure to catastrophic windstorm in the Gulf of Mexico could reduce substantially.
There are a number of significant assumptions and variables related to such an estimate including the size, force and path of the hurricane, the various types of the insured risks exposed to the event at the time the event occurs and the estimated costs or damages incurred for each insured risk. There can be no assurances that the gross and net loss amounts that the Company could incur in such an event or in any hurricanes that may occur in the Gulf of Mexico would not be materially higher than the estimates discussed above given the significant uncertainties with respect to such an estimate.
Hurricanes Gustav and Ike (the “2008 Hurricanes”) which occurred in the 2008 third quarter and Hurricanes Katrina and Rita (the “2005 Hurricanes”) which occurred in the 2005 third quarter generated substantial losses to the property and casualty industry and the marine and energy insurance market due principally to offshore energy losses. There were no significant hurricane losses in 2007 or 2006 that impacted the marine and energy lines of business of the Company.
Management believes that should any adverse loss development for gross claims occur from the 2008 Hurricanes or the 2005 Hurricanes, it would be contained within our reinsurance program. Our actual losses from such hurricanes may differ materially from our estimated losses as a result of, among other things, the receipt of additional information from insureds or brokers, the attribution of losses to coverages that for the purposes of our estimates we assumed would not be exposed and inflation in repair costs due to the limited availability of labor and materials. If our actual losses from the 2008 Hurricanes or the 2005 Hurricanes are materially greater than our estimated losses, our business, results of operations and financial condition could be materially adversely affected.
See “Business - Loss Reserves” included herein for a discussion of the impact of the 2008 Hurricanes and the 2005 Hurricanes on our financial results.
It is important to understand our accounting policies in order to understand our financial statements. Management considers certain of these policies to be critical to the presentation of the financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the financial reporting date and throughout the reporting period. Certain of the estimates result from judgments that can be subjective and complex and, consequently, actual results may differ from these estimates, which would be reflected in future periods.
Written and Unearned Premium. Written premium is recorded based on the insurance policies that have been reported to us and the policies that have been written by agents but not yet reported to us. We 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. Reinsurance reinstatement premium is earned in the period in which the event occurred which created the need to record the reinstatement premium. Additional information regarding our written and unearned premium can be found in Note 1, Organization and Summary of Significant Accounting Policies, and Note 6, Reinsurance, to our consolidated audited financial statements, both included herein.
A portion of the Company’s premium is estimated for unreported premium, mostly for the marine business written by our U.K. Branch and Lloyd’s Operations. We generally do not experience any significant backlog in processing premiums. Such premium estimates are generally based on submission data received from brokers and agents and recorded when the insurance policy or reinsurance contract is written or bound. The estimates are regularly reviewed and updated taking into account the premium received to date versus the estimate and the age of the estimate. To the extent that the actual premium varies from the estimates, the difference, along with the related loss reserves and underwriting expenses, is recorded in current operations.
Impairment of Investment Securities. Impairment of investment securities results in a charge to operations when a market decline below cost is other-than-temporary. Management regularly reviews our fixed maturity and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. In general, we focus our attention on those securities whose market value was less than 80% of their cost or amortized cost, as appropriate, for six or more consecutive months. Factors considered in evaluating potential impairment include, but are not limited to, the current fair value as compared to cost or amortized cost of the security, as appropriate, the length of time the investment has been below cost or amortized cost and by how much, our intent and ability to retain the investment for a period of time sufficient to allow for an anticipated recovery in value, specific credit issues related to the issuer and current economic conditions. Other-than-temporary impairment losses result in a permanent reduction of the cost basis of the underlying investment. Significant changes in the factors we consider when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the consolidated financial statements. For additional detail regarding our investment portfolio, including disclosures regarding other-than-temporary declines in investment value, see the “Business-Investments” section and Note 4, Investments, to our consolidated audited financial statements, both included herein.
As mentioned above, the Company considers its intent and ability to hold a security until the value recovers as part of the process of evaluating whether a security’s unrealized loss represents an other-than-temporary decline. The Company’s ability to hold such securities is supported by sufficient cash flow from its operations and from maturities within its investment portfolio in order to meet its claims payment and other disbursement obligations arising from its underwriting operations without selling such investments. With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information and market conditions. Management of the Company’s investment portfolio is outsourced to third party investment managers. While these investment managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses that are considered temporary until such losses are recovered, the dynamic nature of the portfolio management may result in a subsequent decision to sell the security and realize the loss, based upon a change in market and other factors described above. The Company believes that subsequent decisions to sell such securities are consistent with the classification of the Company’s portfolio as available-for-sale.
Realized gains and losses resulting from foreign currency transactions are recorded in other income (expense) in the Company’s Consolidated Statements of Income.
The following is a discussion and analysis of our consolidated and segment results of operations for the years ended December 31, 2008, 2007 and 2006. All earnings per share data is presented on a per diluted share basis.
Effective in 2008, the Company has reclassified certain of its business for this Management’s Discussion and Analysis of Financial Condition and Results of Operations. The inland marine business, formerly included in other business, is now included in marine business. Middle markets business, formerly included in the specialty business, is now broken out separately. Underwriting data for prior periods has been reclassified to reflect these changes.
Consolidated stockholders’ equity increased 4.1% to $689.3 million or $40.89 per share at December 31, 2008 compared to $662.1 million or $39.24 per share at December 31, 2007. The increase was primarily due to 2008 net income of $51.7 million partially offset by the increase in unrealized losses in the Company’s investment portfolio.
The underwriting results benefited from increased net premium revenues despite continuing softening market conditions, and the recording of a net redundancy of prior years’ loss reserves of $50.7 million, or $1.94 per share, which reduced the 2008 combined ratio of 93.8% by 7.9 loss ratio points.
Net investment income increased 24.2% due to the cash flow from operations. The pre-tax investment yield was 4.4% in 2007 and 2006.
The 2006 results of operations reflect improved financial performance compared to 2005 (excluding the 2005 Hurricanes) due to a combination of improved underwriting results and the growth in net investment income.
Revenues. Gross written premium increased to $1.08 billion in 2008 from $1.07 billion in 2007 and from $970.8 million in 2006, increases of 1.3%, 10.2% and 25.0% in 2008, 2007 and 2006, respectively. The growth in gross premiums over the three year period reflects a combination of business expansion in both new and existing lines of business coupled with premium rate changes on renewal policies.
Specialty Premium. The gross written premium for each of the years in the three-year period ended December 31, 2008 consisted of the following:
The gross written premium for 2008 increased 16.3% compared to 2007 due to product and geographic expansion. The gross written premiums for 2007 increased 13.7% compared to 2006. The average renewal premium rate during 2008 decreased approximately 3.9%.
Property/Other Premium. Property/ Other premium includes European property business written by the U.K. Branch beginning in 2006 and run-off business. The European property business written by the U.K. Branch was discontinued in the 2008 second quarter. Such action did not have any material impact on the U.K. Branch.
Marine Premium. The gross written premium for each of the years in the three-year period ended December 31, 2008 consisted of the following:
An increased retention from $0.5 million to $1.0 million effective April 1, 2007 for the contractors liability business which reduced the amount of premium ceded.
Increases in our net retentions on the professional liability pro rata reinsurance treaty which renewed April 1, 2006.
Net Earned Premium. Net earned premium increased 7.0% in 2008 compared to 2007 and increased 28.5% in 2007 compared to 2006. The 2008 and 2007 net earned premium increases reflect the changes in written premiums discussed above. The 2008 net earned premium was reduced by $12.2 million of reinstatement premium as a result of the losses from the 2008 Hurricanes. Excluding the effects of ceded reinstatement premiums as a result of the 2008 Hurricanes, net earned premium increased 9.0% in 2008 compared to 2007.
The 2008 and 2007 net realized capital losses include provisions of $37.0 million and $0.7 million, respectively, for declines in the market value of securities which were considered to be other than temporary. The after-tax effects of such provisions on the 2008 and 2007 net income were $24.1 million or $1.42 per share and $0.4 million or $0.3 per share, respectively.
Other Income/(Expense). Other income/(expense) for 2008, 2007 and 2006 consisted primarily of foreign exchange gains and losses from our Lloyd’s Operations and inspection fees related to our specialty insurance business.
With the recording of gross losses, the Company assesses its reinsurance coverage, potential receivables, and the recoverability of the receivables. Losses incurred on business recently written are primarily covered by reinsurance agreements written by companies with whom the Company is currently doing reinsurance business and whose credit the Company continues to assess in the normal course of business.
As illustrated in the following table, our overall reinsurance recoverable amounts for paid and unpaid losses have increased during 2008 as the Company recorded reinsurance recoverables for the 2008 Hurricanes, while the reinsurance recoverable amounts for paid losses have declined as the Company continues to bill and collect its recoverables for the 2005 Hurricanes loss payments:
The following table sets forth gross reserves for losses and LAE reduced for reinsurance recoverable on such amounts resulting in net loss and LAE reserves (a non-GAAP measure reconciled in the following table) for the periods indicated:
Our reserving practices and the establishment of any particular reserve reflect management’s judgment concerning sound financial practice and do not represent any admission of liability with respect to any claims made against us. No assurance can be given that actual claims made and related payments will not be in excess of the amounts reserved. During the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Even after such adjustments, ultimate liability may exceed or be less than the revised estimates.
The Company’s actuaries generally calculate the IBNR loss reserves for each line of business by underwriting year for major products principally using two standard actuarial methodologies which are projection or extrapolation techniques: the loss ratio method and the Bornheutter-Ferguson method. The loss ratio method is used to calculate the IBNR for the two most current underwriting years while the Bornheutter-Ferguson method is used to calculate the IBNR for all prior underwriting years, except as otherwise described below. Such methodologies are supplemented in most instances by the loss development method and the frequency/severity method which are used to analyze and better comprehend loss development patterns and trends in the data when making selections and judgments under the loss ratio method and the Bornheutter-Ferguson method. In utilizing these methodologies, each of which is generally applicable to both long-tail and short-tail lines of business and all of which are described below, to develop our IBNR loss reserves, a key objective of our actuaries is to identify aberrations and systemic changes occurring within historical experience and accurately adjust for them so that the future can be projected more reliably. This process requires the substantial use of informed judgment and is inherently uncertain.
Frequency/severity method: The frequency/severity method calculates the IBNR loss reserves by separately projecting claim count and average cost per claim data on either a paid or incurred basis. It estimates the expected ultimate losses as the product of the ultimate number of claims that are expected to be reported and the expected average amount of these claims.
Specialty: The reserves for specialty are established separately by product with the major product being contractors liability insurance. Other products include commercial middle markets, personal umbrella, primary casualty and excess casualty. Our actuaries generally utilize two key assumptions in this line of business: first, that our historical loss development patterns are reasonable predictors of future loss patterns and second, that our claims personnel’s assessment of our claims exposures and our underwriters’ assessment of our expected losses are reliable indicators of our loss exposure. However, this line of business includes a number of newer products where there is insufficient Company historical experience to project loss reserves and/or loss development is sparse or erratic, which makes extrapolation techniques for those products extremely difficult to apply, and in those circumstances we typically rely more on industry data and our underwriters’ input in setting assumptions for our IBNR loss reserves as opposed to historical loss development patterns. In addition, as discussed in more detail below with respect to construction defect reserves, our actuaries may take other market trends or events into account in setting IBNR loss reserves.
Professional liability: The professional liability policies mainly provide coverage on a claims-made basis mostly for a one-year period. The reserves for professional liability are analyzed separately by product with the major products being directors and officers (“D&O”) liability coverage and errors and omissions (“E&O”) liability coverage for lawyers and other professionals.
The E&O IBNR loss reserve process is similar to the process for D&O, with the exception of a particular book of business of the U.K. Branch written from 2004 through 2006. For the U.K Branch E&O business, we assume the claims, while similar in nature to the claims in the U.S. E&O business, are larger, more frequent and have a longer loss development pattern. The IBNR loss reserves for the U.K. Branch E&O business are determined judgmentally after reviewing recent loss activity relative to the remaining in-force policy count and the loss activity for similar insureds.
The process for establishing the IBNR loss reserves for the marine and professional liability lines of the Lloyd’s Operations, and the assumptions used as part of this process, are similar in nature to the process employed by the Insurance Companies. Other business for the Lloyd’s Operations includes European property and inland marine products, each of which is a new line of business where we have limited loss history and rely primarily on assumptions based on our underwriters’ input and industry loss experience.
As part of our regular review of prior reserves, the Company’s actuaries may determine, based on their judgment, that certain assumptions made in the reserving process in prior years may need to be revised to reflect various factors, likely including the availability of additional information. Based on their reserve analyses, our actuaries may make corresponding reserve adjustments.
Prior year reserve redundancies of $50.7 million, $47.0 million and $17.2 million net of reinsurance were recorded in 2008, 2007 and 2006, respectively, as discussed below. The relevant factors that may have a significant impact on the establishment and adjustment of loss and LAE reserves can vary by line of business and from period to period.
The Insurance Companies recorded $9.3 million of net prior year savings for marine business, primarily comprised of $4.7 million of savings in the marine liability business, $3.8 million of savings in the offshore energy business, $2.8 million of savings in the protection and indemnity business, $1.4 million of savings in the transport business and $1.4 million of savings due to a review of reinsurance recoverable in the second quarter of 2008, partially offset by $2.7 million of strengthening in the cargo business, $1.4 million of strengthening in the craft and hull businesses, and $0.7 million recorded for a commutation with a reinsurer. The favorable development for marine liability, offshore energy, protection and indemnity, and transport was primarily due to reduced claims activity for underwriting years 2003 through 2006 as well as IBNR loss reserve reductions that resulted from the reduced claims activity. The adverse development for cargo, craft and hull was primarily due to several large claims in underwriting years 2005 and 2006. The adverse development recorded for the commutation is due to the fact that the discounted reserves were assumed from the reinsurer but the undiscounted reserves were recorded in the financials.
The Insurance Companies recorded $27.0 million of net prior year savings for specialty business, which is comprised of $31.6 million savings in the contractors liability business, $1.4 million of savings in the commercial umbrella business, $1.0 million of savings in the personal umbrella business, and $0.8 million of savings in the primary E&S business; partially offset by $7.1 million of strengthening due to greater than expected loss activity in a discontinued liquor liability program and $0.8 million of strengthening in the program business. The favorable development for contractors liability, commercial umbrella, personal umbrella and primary E&S were primarily due to reduced claims activity in underwriting years 2003 through 2006. The adverse development for the liquor liability business was due to a discontinued program and the adverse development on the programs business was due to an active program.
The Insurance Companies recorded $3.6 million of net prior year savings for professional liability. This was primarily due to the reduction in case and IBNR reserves for the directors and officers business in underwriting years 2004 through 2006 resulting from reported losses being less than anticipated. Directors and officers coverage is claims-made, so no new claims can be reported for underwriting years 2006 and prior after December 31, 2008. The Company reviews the IBNR loss reserves for these underwriting years relative to the open claims to determine if there is potential for development in the open claims. Since there are a lower than expected number of open claims remaining for underwriting years 2006 and prior, the IBNR loss reserves were reduced.
The Insurance Companies have historically reserved for the professional liability business using ultimate loss ratios based on industry experience for this line of business given the Company’s limited claims history. Such industry experience is heavily influenced by the historical frequency and severity of large securities class action lawsuits. During 2007 the Insurance Companies reduced the net reserves for such claims-made policies compared to year-end 2006 by $10.4 million, mostly related to policies issued in 2004 and 2005. The reductions were made to recognize both the low level of open claim counts and the lack of claim severity compared to expectations at the time the reserves were initially established using industry experience.
The Insurance Companies recorded $4.8 million of net prior years’ savings in the marine business consisting of $7.9 million for business written in 2004 and 2005 mostly for favorable loss experience in cargo and marine liability business, partially offset by net prior years’ reserve deficiencies of $3.1 million for 2003 and prior years.
The Insurance Companies recorded $6.1 million of net prior years’ savings in the specialty business of which $18.6 million was for favorable loss trends for construction liability business written in 2005 and 2004 offset by net prior years’ reserve deficiencies of $12.5 million principally for business written from 2000 to 2003 which was mostly for construction defect claims emergence in those years.
The Company’s actuaries use various assumptions in determining a best estimate of reserves for each line of business. The importance of any specific assumption can vary by both individual product within a line of business and underwriting year. If actual experience differs from key assumptions used in establishing reserves, there is potential for significant variation in the development of loss reserves, particularly for long-tail casualty classes of business.
As discussed above, our actuaries generally apply the loss ratio method to calculate the IBNR loss reserve for the two most current underwriting years while the Bornhuetter-Ferguson method is used to calculate the IBNR loss reserves for all prior underwriting years except in certain situations such as when limited or insufficient historical data is available.
For the selected alternative expected loss ratios, our actuaries observed the range of ultimate loss ratios recorded for the underwriting years 2001 to 2008 for each major line of business at December 31, 2008.
For the selected alternative loss development factors for the 2001 to 2007 underwriting years, our actuaries observed the range of historical loss development factors recorded for such underwriting years for each major line of business at December 31, 2008. After evaluating the range of loss development factor variances for each underwriting year, our actuaries judgmentally selected a range of reasonably likely variations to determine alternative IBNR loss reserve amounts compared to the amounts recorded for each line of business for the underwriting years 2001 to 2007 out of the range of reasonably possible variations for such underwriting years. Such variations represent the differences in the time that it takes for losses to develop for an underwriting year.
Such sensitivity analysis was performed in the aggregate for all products in each line of business. The use of aggregate data was considered more stable and reliable compared to a product-by-product analysis. We cannot assure you, however, that such use of aggregate data will provide a more accurate range of the actual variations in loss development. The sensitivity analysis uses loss ratios and loss development patterns for the 2001 to 2008 underwriting years, which are believed to be more representative compared to years prior to 2001 given the Company’s evolving mix of business, product changes and other factors. There can be no assurances, however, that the use of such recent history is more predictive of actual development as compared to employing longer periods of history. In addition, while the net loss reserves include the net loss reserves for asbestos exposures, such amounts were excluded from the sensitivity analysis given the nature of how such reserves are established by the Company. While we believe such net reserves are adequate, we cannot assure you that material loss development may not arise in the future from asbestos losses given the complex nature of such exposures.
A significant factor influencing the results of the sensitivity analysis has been the generally favorable loss trends experienced in the most recent four calendar years. Future loss activity may in fact deviate substantially from recent experience by becoming less favorable or, in fact, unfavorable. In such event, future loss activity could lead to smaller than reasonably likely loss reserve savings or larger than reasonably likely loss reserve deficiencies as identified below.
The sensitivity analysis also reflects a likely range of impact on reported financial results by aggregating calculated redundancy amounts and deficiency amounts for each line of business. The total Company range amounts below were determined by adding the reasonably likely range amounts for each line of business, which are uncorrelated to each other, and therefore such amounts may not be representative of the actual aggregate favorable or unfavorable loss development amounts that may occur over time.
Used 17.0 million average diluted shares outstanding for the year ended December 31, 2008.
We evaluate the performance of each segment based on its underwriting and net income results. The Insurance Companies’ and the Lloyd’s Operations’ results are measured by taking into account net earned premium, net losses and loss adjustment expenses, commission expense, other operating expenses and commission income and other income (expense). The corporate segment consists of the Parent Company’s investment income, interest expense and the related tax effect. Each segment also maintains its own investments, on which it earns income and realizes capital gains or losses. Our underwriting performance is evaluated separately from the performance of our investment portfolios.
The Insurance Companies consist of Navigators Insurance Company, including its U.K. Branch, and its wholly-owned subsidiary, Navigators Specialty Insurance Company. Navigators Insurance Company is our largest insurance subsidiary and has been active since 1983. It is primarily engaged in underwriting marine insurance and related lines of business, professional liability insurance, specialty lines of business including contractors general liability insurance, commercial and personal umbrella and primary and excess casualty businesses, and middle markets business consisting of general liability, commercial automobile liability and property insurance for a variety of commercial middle markets businesses. Navigators Specialty Insurance Company underwrites specialty and professional liability insurance on an excess and surplus lines basis fully reinsured by Navigators Insurance Company. Wholly-owned underwriting agencies produce, manage and underwrite insurance and reinsurance business for the Insurance Companies.
The following table sets forth the results of operations for the Insurance Companies for each of the years in the three-year period ended December 31, 2008:
The following table sets forth the underwriting results for the Insurance Companies for each of the years in the three-year period ended December 31, 2008:
The 2008 underwriting results were favorably impacted by $41.9 million or 9.0 loss ratio points for net prior year savings, which is discussed in the prior year reserve redundancies/deficiencies section. The 2008 pre-tax net loss to the Insurance Companies as the result of losses caused by Hurricanes Gustav and Ike of approximately $16.3 million, including $7.2 million of reinstatement costs, increased the Insurance Companies 2008 combined ratio by 10.1 combined ratio points. The after tax effect reduced net income by $10.6 million.
The approximate annualized pre-tax yields on the Insurance Companies’ investment portfolio, excluding net realized capital gains and losses, approximated 4.3%, 4.5% and 4.6% for 2008, 2007 and 2006, respectively. The increase in the 2007 investment income compared to 2006 was primarily due to the investment of new funds from cash flow. The increase in the 2006 investment income compared to 2005 was primarily due to the investment of new funds from cash flow, increase in the portfolio’s yield and the Company’s $100 million statutory surplus contribution from the net proceeds of the Company’s April 2006 debt offering, in an environment of gradually increasing interest rates. The portfolio’s duration was 4.8 years at both December 31, 2008 and 2007, respectively.
The Lloyd’s Operations consist of NUAL, which manages Syndicate 1221, Millennium Underwriting Ltd. and Navigators Corporate Underwriters Ltd. Both Millennium Underwriting Ltd. and Navigators Corporate Underwriters Ltd. are Lloyd’s corporate members with limited liability and provide capacity to Syndicate 1221. Navigators Underwriting Ltd., a wholly-owned underwriting managing agency, underwrites cargo and engineering business for Syndicate 1221. In January 2005, we formed Navigators NV in Antwerp, Belgium, a wholly-owned subsidiary of NUAL. Navigators NV produces transport liability, cargo and marine liability premium for Syndicate 1221. In July 2008, we opened an underwriting office in Stockholm, Sweden to write professional liability business for Syndicate 1221. The companies comprising our Lloyd’s Operations and Navigators Management (UK) Limited, which produces business for the U.K. Branch, are subsidiaries of Navigators Holdings (UK) Limited located in the United Kingdom. In September 2008, Syndicate 1221 began to underwrite insurance coverage in China through the Navigators Underwriting Division of Lloyd’s Reinsurance Company (China) Ltd. The Company’s focus in China is on opportunities in professional and general liability lines of business.
The 2008 underwriting results were favorably impacted by approximately $8.8 million or 4.9 loss ratio points for net prior years’ savings due to favorable loss development trends, primarily in the liability and offshore energy lines in underwriting years 2006 and prior, which is discussed in the prior year reserve redundancies/deficiencies section.
The 2007 earnings in the Lloyd’s Operations reflect the continued favorable loss development trends. The 2007 underwriting results were favorably impacted by approximately $13.2 million or 8.3 loss ratio points for net prior years’ savings due to favorable loss development trends, primarily in our 2004 and 2005 underwriting years.
Reviews of our Lloyd’s Operations Hurricanes Katrina and Rita exposures during 2007 resulted in a reduction to the storm loss estimates and increased pre-tax income by $4.1 million consisting of $3.4 million of decreases to incurred losses and a $0.7 million reduction in our reinstatement cost estimates. A portion of this impact was the result of reallocating our net retention for these events between our Insurance Companies and Lloyd’s Operations.
The following table sets forth our known contractual obligations with respect to the items indicated at December 31, 2008:
The amounts determined are estimates which are subject to a high degree of variation and uncertainty, and are not subject to any specific payment schedule since the timing of these obligations are not set contractually. The amounts in the above table exclude reinsurance recoveries of $854 million. See “Business - Loss Reserves” included herein.
The approximate pre-tax yields of the investment portfolio, excluding net realized capital gains and losses, were 4.1% for 2008 and 4.4% for both 2007 and 2006.
The Company has a credit facility provided through a consortium of banks. The credit facility was amended in February 2007 to increase the letters of credit available under the credit facility from $115 million to $180 million and to increase the line of credit available under the credit facility from $10 million to $20 million. Also, the expiration of the credit facility was extended from June 30, 2007 to March 31, 2009. If at that time the bank consortium does not renew the credit facility, we will need to find other sources to provide the letters of credit or other collateral in order to continue our participation in Syndicate 1221. The credit facility, which is denominated in U.S. dollars, is utilized primarily by Navigators Corporate Underwriters Ltd. and Millennium Underwriting Ltd. to fund our participation in Syndicate 1221 which is denominated in British sterling. At December 31, 2008, letters of credit with an aggregate face amount of $78.4 million were issued under the credit facility. The line of credit was unused at December 31, 2008.
As a result of the amendment, the cost of the letter of credit portion of the credit facility was reduced to 0.75% from 1.00% for the issued letters of credit and to 0.10% from 0.125% for the unutilized portion of the letter of credit facility. The cost of the line of credit portion of the credit facility was also reduced to 0.75% from 1.00% over the Company’s choice of LIBOR or prime for the utilized portion and to 0.10% from 0.125% for the unutilized portion.
At December 31, 2008, ceded asbestos paid and unpaid losses recoverable were $8.9 million of which $4.8 million was due from Equitas. The Company generally experiences significant collection delays for a large portion of reinsurance recoverable amounts for asbestos losses given that certain reinsurers are in run-off or otherwise no longer active in the reinsurance business. Such circumstances are considered in the Company’s ongoing assessment of such reinsurance recoverables.
The Company believes that it has adequately managed its cash flow requirements related to reinsurance recoveries from its positive cash flows and the use of available short-term funds when applicable. However, there can be no assurances that the Company will be able to continue to adequately manage such recoveries in the future or that collection disputes or reinsurer insolvencies will not arise that could materially increase the collection time lags or result in recoverable write-offs causing additional incurred losses and liquidity constraints to the Company. The payment of gross claims and related collections from reinsurers with respect to Hurricanes Gustav, Ike, Katrina and Rita could significantly impact the Company’s liquidity needs. However, we expect to continue to pay these hurricane losses over a period of years from cash flow and, if needed, short-term investments. We expect to collect our paid reinsurance recoverables generally under the terms described above.
Our capital resources consist of funds deployed or available to be deployed to support our business operations. At December 31, 2008 and 2007, our capital resources were as follows:
The increase in stockholders’ equity in 2008 was primarily due to net income of $51.7 million, partially offset by unrealized investment portfolio losses and treasury stock purchases. The increase in stockholders’ equity in 2007 was primarily due to net income of $95.6 million.
In October, 2007 the Company’s Board of Directors adopted a stock repurchase program for up to $30 million of the Company’s common stock. Purchases were made from time to time at prevailing prices in open market or privately negotiated transactions through the expiration of the program on December 31, 2008. The timing and amount of purchases under the program were dependent on a variety of factors, including the trading price of the stock, market conditions and corporate and regulatory considerations. In total, we purchased 224,754 shares of our common stock at an aggregate cost of $11.5 million.
In addition to common share capital, we may need to depend on external sources of finance to support our underwriting activities, which can be in the form (or any combination) of debt securities, preference shares, common equity and bank credit facilities providing loans and/or letters of credit. Any equity or debt financing, if available at all, may be on terms that are unfavorable to us. In the case of equity financings, dilution to our shareholders could result, and, in any case, such securities may have rights, preferences and privileges that are senior to those of our outstanding securities.
We primarily rely upon dividends from our subsidiaries to meet our Parent Company’s obligations. Since the issuance of the senior debt in April 2006, the Parent Company’s cash obligations primarily consist of semi-annual interest payments of $4.4 million. Going forward, the interest payments on the Company’s senior debt will be made from one or a combination of funds at the Parent Company or dividends from its subsidiaries. The dividends have historically been paid by Navigators Insurance Company. Based on the December 31, 2008, surplus of Navigators Insurance Company, the approximate maximum amount available for the payment of dividends by Navigators Insurance Company during 2009 without prior regulatory approval was $58.1 million. Dividends of $20.0 million and $8.0 million were paid by Navigators Insurance Company during 2008 and 2007, respectively. No dividends were paid by Navigators Insurance Company in 2006.
Condensed Parent Company balance sheets as of December 31, 2008 and 2007 are shown in the table below: