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, 1995. The information for the five years ended December 31, 1995 has been derived from the audited consolidated financial statements of the Company. See the Consolidated Financial Statements of the Company including notes thereto included herein.
(1) Net income from 1992 through 1995 reflects the adoption of FASB Statement No. 109 and from 1993 through 1995 reflects the adoption of FASB Statement No. 113 and EITF Issue No. 93-6.
(2) Investments and stockholders' equity for 1995 and 1994 reflect the adoption of FASB Statement No. 115.
Two of the Company's subsidiaries are insurance companies: Navigators Insurance Company and NIC Insurance Company. Navigators Insurance Company is the Company's largest insurance company subsidiary and has been active since 1983. It specializes principally in underwriting marine, aviation and property (primarily inland marine) insurance and certain lines of specialty reinsurance and non-marine insurance. NIC Insurance Company is a wholly owned subsidiary of Navigators Insurance Company, was licensed in 1989 and began operations in 1990. It underwrites a small book of property insurance in certain states and, pursuant to an intercompany reinsurance pooling agreement, cedes 100% of its gross direct writings from this business to Navigators Insurance Company in exchange for assuming 10% of the total retained business of Navigators Insurance Company.
Eight of the Company's subsidiaries, the Somerset Companies, are a group of underwriting management companies. The Somerset Companies produce, manage and underwrite insurance and reinsurance for Navigators and nine other unrelated insurance companies.
The Somerset Companies were acquired by the Company in 1994 pursuant to the Mergers that were approved by the stockholders of the Company at a special meeting held June 30, 1994. The Company accounted for the transfer of the Somerset Companies' assets and liabilities at historical cost under a method of accounting similar to "pooling of interests" and, accordingly, has reported results of operations as if the Company and the Somerset Companies had been combined since inception.
The 1993 financial statements included herein reflect the Mergers by including the historical accounts of the Somerset Companies.
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 one of the Somerset Companies, NMC.
Navigators and the Somerset Companies earn investment income on cash balances and invested assets. The Somerset Companies also earn investment income on fiduciary funds. Such fiduciary funds are invested, subject to applicable insurance regulations, primarily in short-term instruments.
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 account losses of $1,952,000, but net of reinsurance) in 1994 from the Northridge Earthquake totalled $39,265,000.
The Company's net after tax income of $21.6 million for 1993 decreased largely as a result of the Northridge Earthquake to an after tax loss of $20.5 million in 1994 and increased to after tax income of $12.6 million in 1995, primarily due to return to normal experience in comparison to the losses from the Northridge Earthquake. On a per share basis, this represents after tax income of $2.59 in 1993, a net loss of $2.50 in 1994 and after tax income of $1.53 in 1995. Included in pre-tax income were net realized capital gains of $521,000 in 1993, a net realized loss of $863,000 in 1994, and a net realized gain of $291,000 in 1995. Excluding these capital gains and losses, after tax earnings were $21.2 million in 1993, there was an after tax loss of $19.9 million in 1994, and after tax earnings were $12.4 million in 1995.
Marine Premiums. Navigators' gross marine premium decreased 9% from 1993 to 1994 and a further 5% from 1994 to 1995. The decrease in 1994 was due primarily to decreases in premium rates during the second part of the year. The 1995 decrease was due to Navigators' reduced participation in the marine pool. Management believes pricing in marine premium is now subject to increased competition and significant increases in marine premium may be difficult to achieve in the near term.
Specialty Reinsurance and Non-Marine Insurance Premium. Reinsurance premium has decreased 3% since 1993. The decrease was due primarily to management's decision to decrease writing proportional reinsurance. Management is now developing non-marine program business to augment its reinsurance book and anticipates modest growth.
Total Premium. Net earned premium in 1993 was $96.8 million, in 1994 $90.5 million, and in 1995 $87.9 million. Net earned premium remained fairly level from 1994 to 1995 even though net written premium declined. This is primarily due to the Company's decision to cease writing the property line during 1994; however, the amortization of the property unearned premium reserve during the year resulted in only a slight decline in earned premium.
Investment Income. Investment income increased 9% to $14.1 million during 1995 from approximately $13.0 million, and 12% from approximately $11.6 million during 1994. This increase is due primarily to an increased amount of invested assets.
Reinsurance Ceded. In the ordinary course of business, Navigators 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. Ceded written premium decreased from $109.8 million in 1993 to $98.0 million in 1994 to $67.6 million in 1995 reflecting decreases in gross written premium.
Commission expense as a percentage of net premiums earned was 13.9%, 19.0% and 6.4% during 1995, 1994 and 1993, respectively. The increase from 1993 to 1994 is reflective of increased reinstatement premium payments to reinsurers as a result of the Northridge Earthquake. The decrease in 1995 is due primarily to fewer reinstatement premiums paid during the year. The reinstatement premiums in 1994 caused earned premiums to decline but did not result in corresponding ceding commissions.
Other operating expenses increased 1.4% in 1995 from 1994 and increased 6.7% in 1994 from 1993. Severance charges as a result of a reduction in staff accounted for approximately $968,000 of the operating expenses in 1995. These severance charges were offset by a commensurate decrease in salary expenses and a decrease in guaranty fund assessments.
As of December 31, 1995 the deferred Federal tax asset was $8.9 million, as compared to $13.4 million, at December 31, 1994. At both December 31, 1995 and 1994, the Company was carrying a $775,000 valuation allowance. Management believes the net deferred tax asset recorded at December 31, 1994 is realizable. This belief stems from a long history of taxable income prior to 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 as of June 30, 1994.
At December 31, 1995, there were no material commitments for capital expenditures.
Investment assets (including fiduciary funds held by the Somerset Companies) have grown at a compound rate of 6.7% over the last two years, from $224.2 million at December 31, 1993 to $255.1 million at December 31, 1995. Investment income during this period was $11.6 million in 1993, $13.0 million in 1994 and $14.1 million in 1995. The average yield of the portfolio, excluding net realized capital gains, increased from 5.4% in 1993 to 5.7% in 1994 and to 5.7% in 1995, reflecting the significant change in interest rates during those years as well as increased investments in taxable rather than tax free securities.
In addition, on March 31, 1994, the Company borrowed $23 million from two banks on a short term basis (the "Bridge Notes"). The Company replaced this loan with longer term financing pursuant to a credit agreement dated as of August 5, 1994 (the "Credit Agreement") with three banks. The Credit Agreement provides for (i) revolving credit loans up to $5,000,000 through August 5, 1997 (the "Revolving Credit Loans"), (ii) a term loan of $25,000,000, (the "Term Loan"), and (iii) an irrevocable stand-by letter of credit issued by one of the banks for the benefit of Society of Lloyd's in the amount of (pound)2,585,000 (approximately U.S. $4,014,505 at the exchange rate as of December 31, 1995) for the account of the Company (the "Letter of Credit"). The proceeds of the draw down of the Revolving Credit Loans, $3,000,000, and the Term Loan were used to repay in full all of the Company's obligations under the Bridge Notes and the obligations of a wholly owned subsidiary of the Company, to one of the banks under a demand note issued in connection with the borrowing of $3,000,000 by such subsidiary for working capital. The Revolving Credit Loans, the Term Loan and the Letter of Credit are currently collateralized by shares of common stock of the active subsidiaries of the Company
other than NIC Insurance Company. The Credit Agreement contains covenants common to transactions of this type, including restrictions on indebtedness and liens, limitations on mergers and the sale of assets, and maintenance of consolidated total stockholders' equity, statutory surplus, minimum liquidity and loss reserves. In addition, the covenants prevent the Company from declaring or paying dividends during the term of the loans. See Footnote 4 to the Company's Consolidated Financial Statements.
The majority of the investment 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 investments portfolio does not contain any non-investment grade bonds. Both the municipal and U.S. Treasury Bonds have an average maturity of less than eight 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.
Effective January 1, 1994, the Company adopted Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities." FASB Statement No. 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and all investments in debt securities. Under FASB Statement No. 115, investments are classified into three categories. Held-to-maturity securities are debt securities that the enterprise has the positive intent and ability to hold to maturity and are reported at amortized cost. Trading securities are debt and equity securities that are bought and held principally for the purpose of selling them in the near term and are reported at fair value, with unrealized gains and losses included in earnings. Available-for-sale securities are debt and equity securities not classified as either held-to- maturity securities or trading securities and are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity. As of December 31, 1995, all debt and equity securities held by the Company were classified as available- for-sale securities.
As of January 31, 1996, the Company has paid approximately $107.0 million of claims related to the Northridge Earthquake, of which approximately $78.7 million is subject to indemnification by reinsurers. To date the Company has experienced no significant difficulties collecting reinsured losses.
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. In addition, management of the Company believes that the Central Fund of Lloyd's and other sources of liquidity available to Lloyd's, including the reserves of Lloyd's syndicates and the personal funds of members of Lloyd's, are sufficient to satisfy any obligations of syndicates reinsuring the Company in the event that any such syndicates are unable to directly satisfy such obligations. Accordingly, management of the Company believes that
the significant losses reported by Lloyd's syndicates in recent years will not have a material adverse effect on the Company's liquidity or results of operations.
Effective January 1, 1993, the Company adopted FASB Statement No. 113. FASB Statement No. 113 eliminates the practice of reporting assets and liabilities relating to reinsured contracts net of the effects of reinsurance and provides guidance in assessing transfer of insurance risk in reinsurance, including gain or loss recognition.
The application of FASB Statement No. 113 and EITF 93-6 served to increase income before cumulative effect of change in accounting principle for the year ended December 31, 1993 by $302,000. Net income for the year ended December 31, 1993 was decreased by an amount of $597,000 reflecting the cumulative effect of the Company's adoption of EITF 93-6.
Effective January 1, 1994, the Company adopted FASB Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities." FASB Statement No. 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and all investments in debt securities.
- Held-to-Maturity Securities--Debt securities that the enterprise has the positive intent and ability to hold to maturity; reported at amortized cost.
- Trading Securities--Debt and equity securities that are bought and held principally for the purpose of selling them in the near term; reported at fair value, with unrealized gains and losses included in earnings.
In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-Based Compensation." The Statement establishes financial accounting and reporting standards for stock-based employee compensation plans. The Statement encourages a fair value based method of accounting for employee stock options. The accounting and disclosure requirements of Statement No. 123 are effective for the Company's 1996 financial statements. The Company intends to continue to apply the accounting provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" as allowed and will provide the required disclosures of Statement No. 123 in its 1996 consolidated financial statements.