The discussions that follow include tables, which contain both our consolidated and segment operating results for each of the years in the three-year period ended December 31, 2006. In presenting our financial results we have discussed our performance with reference to underwriting profit or loss and the related combined ratio, both of which are non-GAAP measures of underwriting profitability. We consider such measures, which may be defined differently by other companies, to be important in the understanding of our overall results of operations. Underwriting profit or loss is calculated from premiums earned, less net losses and LAE, commission expense and other operating expenses and other income and expenses related to underwriting activities. The combined ratio is derived by taking such net losses and LAE, commission expense, other operating expenses and other income and expenses divided by earned premiums. A combined ratio of less than 100% indicates an underwriting profit and over 100% indicates an underwriting loss.
Our business is cyclical and influenced by many factors. These factors include price competition, economic conditions, interest rates, weather-related events and other catastrophes including natural and man-made disasters (for example hurricanes and terrorism), state regulations, court decisions and changes in the law. The incidence and severity of catastrophes are inherently unpredictable. Although we will attempt to manage our exposure to such events, the frequency and severity of catastrophic events could exceed our estimates, which could have a material adverse effect on our financial condition. Additionally, because our insurance products must be priced, and premiums charged, before costs have fully developed, our liabilities are required to be estimated and recorded in recognition of future loss and settlement obligations. Due to the inherent uncertainty in estimating these liabilities, we cannot assure you that our actual liabilities will not exceed our recorded amounts.
The Company believes that all of its reinsurance transactions meet the risk transfer requirements to be accounted for as prospective reinsurance in its financial statements, and also believes it has no separate side agreements that would limit the insurance risk transferred to the reinsurer under its reinsurance agreements. The Company is unable to determine any reinsurance industry financial reporting changes that could occur as a result of such investigations and the effects, if any, on its financial reporting of reinsurance transactions.
During the 2006 first quarter, the Company entered into an agreement to acquire the renewal rights to the D&O and employment practices liability policy portfolios of Genesis Professional Liability Managers, Inc. ("Genesis"). The transaction does not include any past or existing liabilities of the policy portfolios. The Company will pay an annual override or fee to Genesis based on gross written premium for a two year period to the extent the Genesis business is underwritten and renewed by the Company. The Company believes that it may renew up to $10 million of premium from such business over an annual period. However, the amount renewed may be a lesser or greater amount than expected. Through December 31, 2006, $6.6 million of the Genesis business has been renewed.
Net Realized Capital Gains (Losses). Pre-tax net income included $1.0 million of net realized capital losses for 2006 compared to net realized capital gains of $1.2 million for 2005 and $0.9 million for 2004. On an after-tax basis, the net realized capital losses were $0.7 million or $0.04 per share for 2006 compared to net realized capital gains of $0.8 million or $0.06 per share and $0.6 million or $0.05 per share for 2005 and 2004, respectively.
reinsurance recoverable amounts related to losses from the 2005 Hurricanes at December 31, 2006 were $319.2 million and $309.2 million, respectively.
Prior year reserve redundancies of $17.2 million, $3.8 million and $3.8 million were recorded in 2006, 2005 and 2004, 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 $4.8 million of net prior years' savings for 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.
Given the lack of sufficient historical experience, professional liability reserves are established using industry loss ratios and development patterns. The ultimate loss ratio for an underwriting year is initially set to an industry average level and then subsequently adjusted. Expected loss emergence is then calculated using industry average development patterns, and expected emergence is replaced by actual experience as it emerges. Estimates of ultimate liability could be redundant or deficient if the adjusted selected ultimate loss ratios are inappropriate or if the adjusted development pattern is not representative of our book of business. If the ultimate loss ratios for the professional liability business develop 10% higher than the adjusted ultimate loss ratios used by our actuaries, then gross and net loss reserves would increase by approximately $14.6 million and $6.3 million, respectively, compared to the professional liability loss reserves established at December 31, 2006.
(1)Includes other operating expenses and commission income and other income (expense).
Excluding the losses from the 2005 Hurricanes, underwriting results generally reflect the favorable industry market conditions since 2001 coupled with satisfactory loss trends in the aforementioned periods. The Insurance Companies experienced premium growth in all three active lines of business as reflected in the above tables. Overall, the net earned premium increased 43.3%, 0.6% and 9.9% in 2006, 2005 and 2004, respectively. This growth has been driven by the increase in
net written premiums which has resulted from growth in gross premiums coupled with the reduction of ceded premiums across most lines of business.
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. NUAL owns Navigators Underwriting Ltd., an underwriting managing agency with its principal office in Manchester, England, which 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 on behalf of Syndicate 1221. The Lloyd's Operations and Navigators Management (UK) Limited, a Navigators Agency which produces business for the U.K. Branch, are subsidiaries of Navigators Holdings (UK) Limited located in the United Kingdom.
The 2005 net earned premium and incurred losses were increased by $2.5 million as a result of the RITC transaction for the 2003 year of account. The 2004 net earned premium and incurred losses were increased by $12.8 million as a result of the RITC transaction for the 2002 year of account. The RITC recorded in 2004 when compared to 2003 reflects the increase in our participation in Syndicate 1221 to 97.4% for the 2003 year of account from 68.1% for the 2002 year of account. Two participants in Syndicate 1221 for the 2002 year of account changed their status for the 2003 year of account from participants to reinsurers. Upon closing the 2002 year of account at the end of 2004, substantially all of the RITC assumed on a gross basis for the 2002 year of account was ceded to these reinsurers for the 2003 year of account. One of these reinsurers ceded a large portion of their reinsurance participation for the 2003 year of account to Navigators Insurance Company.