S&P Announces: Navigators Insurance Co. and NIC Insurance Co. Ratings Affirmed; Outlook Remains Negative

Business Wire, July 8, 2004

NEW YORK -- On July 8, 2004, Standard & Poor's Ratings Services affirmed its 'A' counterparty credit and financial strength ratings on Navigators Insurance Co. and NIC Insurance Co. (collectively referred to as Navigators).

The outlook remains negative.

The ratings on Navigators reflect its strong competitive position in the marine insurance market, very strong capitalization, strong and improving operating performance, and good financial flexibility. Offsetting these positive factors are the company's implementation risk of its diversification strategy, extensive use of reinsurance, and asbestos adverse loss-reserve developments.

Outlook

Even though Navigators is expected to grow its gross premiums written at a less aggressive rate of 10%-15% in 2004 compared with prior years, Standard & Poor's maintains a negative outlook to reflect the short track record of Navigators in the new lines of business such as general liability, surety, directors and officers (D&O), and errors and omissions (E&O). In addition, the diversification strategy initiated in 2001 outside the marine insurance, which is Navigators' longstanding area of specialization, has not been tested yet in a difficult cycle.

Despite the softening of the overall pricing environment of property/casualty (P/C) insurance, Standard & Poor's expects that Navigators will continue to benefit from moderate rate increases and generate a strong operating performance in 2004 with a 10%-15% ROR and a 90%-95% combined ratio.

In 2004, Navigators' capitalization is expected to remain very strong above the rating level and should further strengthen from expected strong earnings. These positive factors should provide a capital cushion for both the severity risk associated with the company's core marine insurance business and any potential reserve deficiency.

Major Rating Factors

--Strong competitive position. Navigators has a strong competitive position within the marine insurance segment of the P/C industry. The company has strong underwriting expertise in its specialized niche and is a leading writer in the marine insurance market in the U.S. and globally. In 2003, Navigators was the eighth largest ocean marine insurer in the U.S. with a 5% market share, based on its $152 million of direct premiums written.

--Very strong capitalization. Navigators' capital adequacy ratio improved in 2003 to 172% from 141% in 2002, mostly due to the capital contribution of $95 million from its parent in October 2003 due to a successful secondary equity offering. Therefore, the company's statutory surplus increased by 64% to $210 million in 2003 from $129 million in 2002, which helped improve its operating leverage to 1.1x from 1.5x, respectively.

--Strong and improving operating performance. The 2003 results were negatively affected because of the fourth-quarter gross and net asbestos reserve strengthening of $78 million and $32 million, respectively, (statutory net after-tax charge of $24 million). Therefore, the combined ratio jumped to 106.4% in 2003 from 93.6% in 2002, and the ROR deteriorated to 0.2% from 8.4%, respectively. The 2003 statutory combined ratio and ROR would have been 91.2% and 14.2%, respectively, excluding the effect of reserve strengthening. On the other hand, in the first quarter of 2004, Navigators dramatically improved its operating results to $12 million pretax operating income from $3 million in the prior period as it continues to benefit from rate increases in most of its lines of business. It also improved its expense ratio to 24.3% from 28.5% because of the benefits realized through the economies of scale. In addition, the company's results profited from an increase of 34% in net investment income. The confluence of these factors helped Navigators produce an extremely strong ROR of 20.6% versus 4.7%, and significantly reduced its combined ratio by 9.7 percentage points to 87.1% from 96.8%, respectively.

--Good financial flexibility. Navigators enjoys good financial flexibility. The company has access to both the equity and debt markets through its publicly traded parent company as shown by the holding company's successful raising of $111 million from the secondary public common stock offering in October 2003.

--Implementation risk of the diversification strategy. To diversify its stream of revenues and reduce its exposure to the ocean marine insurance cycle, in 2001, Navigators branched out to other lines of business such as specialty products (general liability, surety, D&O, and E&O). To implement its diversification strategy, the company is relying on its experienced management team, which is willing to shrink the top line growth if rates and conditions are not favorable. Navigators has a short track record in these new lines of business and its ability to execute a profitable diversification strategy in the long run remains unproven.

--Extensive use of reinsurance. Navigators' net reinsurance recoverables increased by 62% to $330 million in 2003 from $203 million in 2002 as the company continued to grow its business and reduce its retention (reinsurance utilization ratio increased to 46% from 42%, respectively). The extensive use of reinsurance increases Navigators' recoverability risk as shown by a $26 million allowance established in 2003 for uncollectible reinsurance, as a result of loss reserves established for asbestos exposures on marine and aviation business written mostly before 1986. The company's net recoverables constituted about 157% of its surplus as of year-end 2003. However, 80% of Navigators' reinsurers carry at least an 'A' rating, and the company had $122 million of collaterals in 2003 (secured letters of credit and trust funds on unpaid balances), which mitigate some of its potential recoverability risk.