Navigators (NAVG) 10-Q 2006 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly Report Under Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Quarterly Period Ended     September 30, 2006

Commission file number      0-15886

The Navigators Group, Inc.

(Exact name of Registrant as specified in its charter)

Delaware	13-3138397
(State or other jurisdiction of	(IRS Employer
incorporation or organization)	Identification No.)
One Penn Plaza, New York, New York	10119
(Address of principal executive offices)	(Zip Code)

(212) 244-2333

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x         No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large Accelerated Filer o Accelerated Filer x Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o    No  x

The number of common shares outstanding as of October 20, 2006 was 16,703,779.

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

INDEX

Part I. FINANCIAL INFORMATION:
	Item 1. Financial Statements
		Consolidated Balance Sheets
		September 30, 2006 (Unaudited) and December 31, 2005
		Consolidated Statements of Income (Unaudited)
		Three Months Ended September 30, 2006 and 2005
		Nine Months Ended September 30, 2006 and 2005
		Consolidated Statements of Stockholders’ Equity (Unaudited)
		September 30, 2006 and 2005
		Consolidated Statements of Comprehensive Income (Unaudited)
		Three Months Ended September 30, 2006 and 2005
		Nine Months Ended September 30, 2006 and 2005
		Consolidated Statements of Cash Flows (Unaudited)
		Nine Months Ended September 30, 2006 and 2005
		Notes to Interim Consolidated Financial Statements (Unaudited)
	Item 2. Management’s Discussion and Analysis of Financial
	Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures
	About Market Risk
	Item 4. Controls and Procedures
Part II. OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 1A. Risk Factors
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
	Item 3. Defaults Upon Senior Securities
	Item 4. Submissions of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits
	Signature
	Index of Exhibits

2

Part 1.    Financial Information

Item 1.    Financial Statements

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

($ in thousands, except share data)

	September 30,		December 31,
	2006		2005
	(Unaudited)
ASSETS
Investments and cash:
Fixed maturities, available-for-sale, at fair value (amortized cost: 2006, $1,178,056; 2005, $986,726)	$	1,174,196	$	984,113
Equity securities, available-for-sale, at fair value (cost: 2006, $28,853; 2005, $19,667)	32,524		20,911
Short-term investments, at cost which approximates fair value	199,470		164,047
Cash	1,891		13,165
Total investments and cash	1,408,081		1,182,236
Premiums in course of collection	181,897		155,977
Commissions receivable	2,661		3,467
Prepaid reinsurance premiums	183,458		136,341
Reinsurance receivable on paid losses	110,429		37,055
Reinsurance receivable on unpaid losses and loss adjustment expenses	962,687		979,015
Net deferred income tax benefit	29,558		28,317
Deferred policy acquisition costs	43,458		29,697
Accrued investment income	12,109		10,297
Goodwill and other intangible assets	7,769		7,341
Other assets	19,889		13,506
Total assets	$	2,961,996	$	2,583,249
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Reserves for losses and loss adjustment expenses	$	1,619,450	$	1,557,991
Unearned premium	423,419		316,516
Reinsurance balances payable	201,606		180,059
Senior notes	123,533		—
Federal income tax payable	5,511		1,274
Payable for securities purchased	846		823
Accounts payable and other liabilities	60,116		56,348
Total liabilities	2,434,481		2,113,011
Stockholders’ equity:
Preferred stock, $.10 par value, authorized 1,000,000 shares, none issued	—		—
Common stock, $.10 par value, shares authorized: 50,000,000 for 2006 and 20,000,000 for 2005; issued and outstanding: 16,700,279 for 2006 and 16,616,781 for 2005	1,670		1,662
Additional paid-in capital	285,616		282,463
Retained earnings	238,857		186,901
Accumulated other comprehensive income (loss)	1,372		(788		)
Total stockholders’ equity	527,515		470,238
Total liabilities and stockholders’ equity	$	2,961,996	$	2,583,249

See accompanying notes to interim consolidated financial statements

3

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

($ and shares in thousands, except net income per share)

	Three Months Ended
	September 30,
	2006			2005
	(Unaudited)
Gross written premium	$	221,667		$	188,114
Revenues:
Net written premium	$	119,037		$	76,049
(Increase) in unearned premium	(3,341		)	(1,315		)
Net earned premium	115,696			74,734
Commission income	639			1,025
Net investment income	14,691			9,196
Net realized capital gains (losses)	(151		)	344
Other income (expense)	(884		)	459
Total revenues	129,991			85,758
Operating expenses:
Net losses and loss adjustment expenses incurred	64,456			76,836
Commission expense	13,769			11,656
Other operating expenses	22,683			17,482
Interest expense	2,214			—
Total operating expenses	103,122			105,974
Income (loss) before income tax expense (benefit)	26,869			(20,216		)
Income tax expense (benefit):
Current	8,126			(5,605		)
Deferred	410			(1,886		)
Total income tax expense (benefit)	8,536			(7,491		)
Net income (loss)	$	18,333		$	(12,725	)
Net income (loss) per common share:
Basic	$	1.10		$	(0.99	)
Diluted	$	1.09		$	(0.99	)
Average common shares outstanding:
Basic	16,685			12,791
Diluted	16,827			12,791

See accompanying notes to interim consolidated financial statements.

4

	Nine Months Ended
	September 30,
	2006			2005
	(Unaudited)
Gross written premium	$	737,816		$	595,243
Revenues:
Net written premium	$	391,711		$	286,396
(Increase) in unearned premium	(57,752		)	(48,292		)
Net earned premium	333,959			238,104
Commission income	2,465			3,809
Net investment income	41,244			25,779
Net realized capital gains (losses)	(767		)	927
Other income (expense)	(654		)	1,826
Total revenues	376,247			270,445
Operating expenses:
Net losses and loss adjustment expenses incurred	193,200			176,668
Commission expense	41,098			30,502
Other operating expenses	61,018			52,554
Interest expense	4,034			—
Total operating expenses	299,350			259,724
Income before income tax expense	76,897			10,721
Income tax expense (benefit):
Current	27,492			7,636
Deferred	(2,551		)	(5,169		)
Total income tax expense	24,941			2,467
Net income	$	51,956		$	8,254
Net income per common share:
Basic	$	3.12		$	0.65
Diluted	$	3.09		$	0.64
Average common shares outstanding:
Basic	16,664			12,744
Diluted	16,812			12,849

See accompanying notes to interim consolidated financial statements.

5

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

($ in thousands)

	Nine Months Ended
	September 30,
	2006			2005
	(Unaudited)
Preferred Stock
Balance at beginning and end of period	$	—		$	—
Common stock
Balance at beginning of year	$	1,662		$	1,266
Shares issued under stock plans	8			13
Balance at end of period	$	1,670		$	1,279
Additional paid-in capital
Balance at beginning of year	$	282,463		$	154,670
Effect of SFAS 123 for stock options	761			784
Shares issued under stock plans	2,392			2,163
Balance at end of period	$	285,616		$	157,617
Retained earnings
Balance at beginning of year	$	186,901		$	163,337
Net income	51,956			8,254
Balance at end of period	$	238,857		$	171,591
Accumulated other comprehensive income (loss)
Net unrealized gains (losses) on securities, net of tax
Balance at beginning of year	$	(884	)	$	7,416
Change in period	707			(6,043		)
Balance at end of period	(177		)	1,373
Cumulative translation adjustments, net of tax
Balance at beginning of year	96			1,889
Net adjustment for period	1,453			(834		)
Balance at end of period	1,549			1,055
Balance at end of period	$	1,372		$	2,428
Total stockholders’ equity at end of period	$	527,515		$	332,915

See accompanying notes to interim consolidated financial statements.

6

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

($ in thousands)

	Three Months Ended
	September 30,
	2006			2005
	(Unaudited)
Net income (loss)	$	18,333		$	(12,725	)
Other comprehensive income (loss):
Change in net unrealized gains (losses) on securities, net of tax expense (benefit) of $9,371 and ($3,652) in 2006 and 2005, respectively (1)	17,249			(6,885		)
Change in foreign currency translation gains (losses), net of tax expense (benefit) of $135 and ($58) in 2006 and 2005, respectively	252			(107		)
Other comprehensive income (loss)	17,501			(6,992		)
Comprehensive income (loss)	$	35,834		$	(19,717	)
(1) Disclosure of reclassification amount, net of tax:
Unrealized holding gains (losses) arising during period	$	17,145		$	(6,661	)
Less: reclassification adjustment for net gains (losses) included in net income	(104		)	224
Change in net unrealized gains (losses) on securities	$	17,249		$	(6,885	)

See accompanying notes to interim consolidated financial statements.

7

	Nine Months Ended
	September 30,
	2006			2005
	(Unaudited)
Net income	$	51,956		$	8,254
Other comprehensive income (loss):
Change in net unrealized gains (losses) on securities, net of tax expense (benefit) of $462 and ($3,198) in 2006 and 2005, respectively(1)	707			(6,043		)
Change in foreign currency translation gains (losses), net of tax expense (benefit) of $782 and ($449) in 2006 and 2005, respectively	1,453			(834		)
Other comprehensive income (loss)	2,160			(6,877		)
Comprehensive income	$	54,116		$	1,377
(1) Disclosure of reclassification amount, net of tax:
Unrealized holding gains (losses) arising during period	$	187		$	(5,440	)
Less: reclassification adjustment for net gains (losses) included in net income	(520		)	603
Change in net unrealized gains (losses) on securities	$	707		$	(6,043	)

See accompanying notes to interim consolidated financial statements.

8

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

($ in thousands)

	Nine Months Ended
	September 30,
	2006			2005
	(Unaudited)
Operating activities:
Net income	$	51,956		$	8,254
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation & amortization	1,990			1,332
Net deferred income tax (benefit)	(2,551		)	(5,169		)
Net realized capital (gains) losses	767			(927		)
Changes in assets and liabilities:
Reinsurance receivable on paid and unpaid losses and loss adjustment expenses	(57,046		)	(502,241		)
Reserve for losses and loss adjustment expenses	61,459			559,910
Prepaid reinsurance premiums	(47,117		)	(15,661		)
Unearned premium	106,903			62,389
Premiums in course of collection	(25,920		)	13,564
Commissions receivable	806			(601		)
Deferred policy acquisition costs	(13,761		)	(8,118		)
Accrued investment income	(1,812		)	(1,335		)
Reinsurance balances payable	21,547			37,147
Federal income tax	4,237			(7,107		)
Other	(8,743		)	26,510
Net cash provided by operating activities	92,715			167,947
Investing activities:
Fixed maturities, available-for-sale
Redemptions and maturities	95,288			18,316
Sales	114,343			255,002
Purchases	(390,619		)	(428,139		)
Equity securities, available-for-sale
Sales	3,431			4,169
Purchases	(12,121		)	(3,739		)
Change in payable for securities	23			24,067
Net change in short-term investments	(35,423		)	(39,873		)
Purchase of property and equipment	(3,559		)	(2,233		)
Net cash (used in) investing activities	(228,637		)	(172,430		)
Financing activities:
Net proceeds from senior notes	123,511			—
Proceeds of stock issued from employee stock purchase plan	536			419
Proceeds of stock issued from exercise of stock options	601			1,194
Net cash provided by financing activities	124,648			1,613
(Decrease) in cash	(11,274		)	(2,870		)
Cash at beginning of year	13,165			14,676
Cash at end of period	$	1,891		$	11,806
Supplemental disclosures of cash flow information:
Federal, state and local income tax paid	$	20,533		$	13,366
Issuance of stock to directors	140			123

See accompanying notes to interim consolidated financial statements.

9

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

Notes to Interim Consolidated Financial Statements

(Unaudited)

Note 1. Accounting Policies

The interim consolidated financial statements are unaudited but reflect all adjustments which, in the opinion of management, are necessary to provide a fair statement of the results of The Navigators Group, Inc. and its subsidiaries for the interim periods presented on the basis of accounting principles generally accepted in the United States of America (“GAAP” or “U.S. GAAP”). All such adjustments are of a normal recurring nature. All significant intercompany transactions and balances have been eliminated. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting periods. The results of operations for any interim period are not necessarily indicative of results for the full year. The terms “we”, “us”, “our” and “the Company” as used herein mean The Navigators Group, Inc. and its subsidiaries, unless the context otherwise requires. The term “Parent” or “Parent Company” is used to mean The Navigators Group, Inc. without its subsidiaries. These financial statements should be read in conjunction with the consolidated financial statements and notes contained in the Company’s 2005 Annual Report on Form 10-K. Certain amounts for the prior year have been reclassified or restated to conform to the current year’s presentation.

Note 2. Reinsurance Ceded

The Company’s ceded earned premiums were $106.0 million and $119.0 million for the three months ended September 30, 2006 and 2005, respectively, and were $330.5 million and $292.6 million for the nine months ended September 30, 2006 and 2005, respectively. The Company’s ceded incurred losses were $61.4 million and $514.4 million for the three months ended September 30, 2006 and 2005, respectively, and were $186.2 million and $598.0 million for the nine months ended September 30, 2006 and 2005, respectively.

Note 3. Segment Information

The Company’s subsidiaries are primarily engaged in the underwriting and management of property and casualty insurance.

Effective in 2006, the Company classifies its business into two underwriting segments consisting of the Insurance Companies and the Lloyd’s Operations, which are separately managed, and a Corporate segment. Segment data for each of the two underwriting segments include allocations of revenues and expenses of the Navigators Agencies’ and Parent Company’s expenses and related income tax amounts previously reported separately. The Corporate segment consists of the Parent Company’s investment income, interest expense and the related tax effect. Each segment maintains its own investments, on which it earns income and realizes capital gains or losses. Income tax expense is recorded based on the respective income of each segment. Segment data for prior periods has been restated to reflect this change in segment reporting.

The Insurance Companies consist of Navigators Insurance Company with its U.K. Branch and NIC Insurance Company. They are primarily engaged in underwriting marine insurance and related lines of business, specialty lines of business including contractors’ general liability insurance, commercial and personal umbrella and excess casualty businesses, and professional liability insurance. The Lloyd’s Operations primarily underwrite marine and related lines of business at Lloyd’s of London through Lloyd’s Syndicate 1221 (“Syndicate 1221”). The Navigators Agencies are underwriting management companies which produce, manage and underwrite insurance and reinsurance for the Company. All segments are evaluated based on their GAAP results.

10

The Insurance Companies’ and the Lloyd’s Operations’ performances are measured based on underwriting results and the related combined ratio, which are both non-GAAP measures of underwriting profitability. Underwriting profit or loss is calculated from net earned premiums, less net losses and LAE, commission expense and other operating expenses related to underwriting activities. The combined ratio is derived by taking such net losses and LAE and operating expenses divided by net earned premiums. A combined ratio of less than 100% indicates an underwriting profit and over 100% indicates an underwriting loss.

Financial data by segment for the three months ended September 30, 2006 and 2005 was as follows:

	Three Months Ended September 30, 2006
	Insurance			Lloyd’s
	Companies			Operations			Corporate			Total (1)
	($ in thousands)
Gross written premium	$	163,673		$	57,780					$	221,667
Net written premium	91,188			27,849						119,037
Net earned premium	85,494			30,202						115,696
Net losses and loss adjustment expenses	(47,926		)	(16,530		)				(64,456		)
Commission expense	(9,889		)	(3,880		)				(13,769		)
Other operating expenses	(16,697		)	(5,986		)				(22,683		)
Commission income and other income (expense)	661			(906		)				(245		)
Underwriting profit	11,643			2,900						14,543
Investment income	12,345			1,774			$	572		14,691
Net realized capital gains (losses)	(29		)	(122		)	—			(151		)
Interest expense	—			—			(2,214		)	(2,214		)
Income (loss) before income taxes	23,959			4,552			(1,642		)	26,869
Income tax expense (benefit)	7,658			1,627			(749		)	8,536
Net income (loss)	$	16,301		$	2,925		$	(893	)	$	18,333
Identifiable assets	$	2,050,833		$	855,348		$	50,276		$	2,961,996
Loss and loss expenses ratio	56.1		%	54.7		%				55.7		%
Commission expense ratio	11.6		%	12.8		%				11.9		%
Other operating expense ratio (2)	18.8		%	22.8		%				19.8		%
Combined ratio	86.5		%	90.3		%				87.4		%

(1) Certain amounts included in the segment columns include inter-segment transactions causing certain rows not to crossfoot.

(2) Includes other operating expenses and commission income and other income (expense).

11

	Three Months Ended September 30, 2005
	Insurance			Lloyd’s
	Companies			Operations			Corporate		Total (1)
	($ in thousands)
Gross written premium	$	133,718		$	54,142				$	188,114
Net written premium	59,093			16,956					76,049
Net earned premium	53,778			20,956					74,734
Net losses and loss adjustment expenses	(47,332		)	(29,504		)			(76,836		)
Commission expense	(6,465		)	(5,191		)			(11,656		)
Other operating expenses	(13,284		)	(4,198		)			(17,482		)
Commission income and other income (expense)	704			780					1,484
Underwriting profit (loss)	(12,599		)	(17,157		)			(29,756		)
Investment income	7,694			1,439			$	63	9,196
Net realized capital gains (losses)	401			(57		)	—		344
Income (loss) before income taxes	(4,504		)	(15,775		)	63		(20,216		)
Income tax expense (benefit)	(1,992		)	(5,521		)	22		(7,491		)
Net income (loss)	$	(2,512	)	$	(10,254	)	$	41	$	(12,725	)
Identifiable assets	$	1,682,149		$	809,870		$	17,802	$	2,451,056
Loss and loss expenses ratio	88.0		%	140.8		%			102.8		%
Commission expense ratio	12.0		%	24.8		%			15.6		%
Other operating expense ratio (2)	23.4		%	16.3		%			21.4		%
Combined ratio	123.4		%	181.9		%			139.8		%

(1) Amounts included in the segment columns include inter-segment transactions causing certain rows not to crossfoot.

(2) Includes other operating expenses and commission income and other income (expense).

12

Financial data by segment for the nine months ended September 30, 2006 and 2005 was as follows:

	Nine Months Ended September 30, 2006
	Insurance			Lloyd’s
	Companies			Operations			Corporate			Total (1)
	($ in thousands)
Gross written premium	$	496,216		$	241,600					$	737,816
Net written premium	273,277			118,434						391,711
Net earned premium	231,334			102,625						333,959
Net losses and loss adjustment expenses	(135,556		)	(57,644		)				(193,200		)
Commission expense	(24,925		)	(16,173		)				(41,098		)
Other operating expenses	(44,096		)	(16,922		)				(61,018		)
Commission income and other income (expense)	2,661			(850		)				1,811
Underwriting profit	29,418			11,036						40,454
Investment income	34,778			5,448			$	1,018		41,244
Net realized capital (losses)	(329		)	(438		)	—			(767		)
Interest expense	—			—			(4,034		)	(4,034		)
Income (loss) before income taxes	63,867			16,046			(3,016		)	76,897
Income tax expense (benefit)	20,442			5,650			(1,151		)	24,941
Net income (loss)	$	43,425		$	10,396		$	(1,865	)	$	51,956
Identifiable assets	$	2,050,833		$	855,348		$	50,276		$	2,961,996
Loss and loss expenses ratio	58.6		%	56.2		%				57.9		%
Commission expense ratio	10.8		%	15.8		%				12.3		%
Other operating expense ratio (2)	17.9		%	17.3		%				17.7		%
Combined ratio	87.3		%	89.3		%				87.9		%

(1) Amounts included in the segment columns include inter-segment transactions causing certain rows not to crossfoot.

(2) Includes other operating expenses and commission income and other income (expense).

13

	Nine Months Ended September 30, 2005
	Insurance			Lloyd’s
	Companies			Operations			Corporate		Total (1)
	($ in thousands)
Gross written premium	$	393,686		$	200,519				$	595,243
Net written premium	199,349			87,047					286,396
Net earned premium	160,248			77,856					238,104
Net losses and loss adjustment expenses	(114,856		)	(61,812		)			(176,668		)
Commission expense	(15,597		)	(14,905		)			(30,502		)
Other operating expenses	(37,540		)	(15,014		)			(52,554		)
Commission income and other income (expense)	3,599			2,036					5,635
Underwriting profit (loss)	(4,146		)	(11,839		)			(15,985		)
Investment income	22,037			3,642			$	100	25,779
Net realized capital gains (losses)	1,348			(421		)	—		927
Income before income taxes	19,239			(8,618		)	100		10,721
Income tax expense (benefit)	5,449			(3,017		)	35		2,467
Net income (loss)	$	13,790		$	(5,601	)	$	65	$	8,254
Identifiable assets	$	1,682,149		$	809,870		$	17,802	$	2,451,056
Loss and loss expenses ratio	71.7		%	79.4		%			74.2		%
Commission expense ratio	9.7		%	19.1		%			12.8		%
Other operating expense ratio (2)	21.2		%	16.7		%			19.7		%
Combined ratio	102.6		%	115.2		%			106.7		%

(1) Amounts included in the segment columns include inter-segment transactions causing certain rows not to crossfoot.

(2) Includes other operating expenses and commission income and other income (expense).

The Insurance Companies’ net earned premium includes $12.9 million and $6.9 million of net earned premium from the U.K. Branch for the three months ended September 30, 2006 and 2005, respectively, and $34.2 million and $27.5 million of net earned premium from the U.K. Branch for the nine months ended September 30, 2006 and 2005, respectively.

Note 4. Comprehensive Income

Comprehensive income encompasses net income, net unrealized capital gains and losses on available for sale securities, and foreign currency translation adjustments, all of which are net of tax. Please refer to the Consolidated Statements of Stockholders’ Equity and the Consolidated Statements of Comprehensive Income, included herein, for the components of accumulated other comprehensive income (loss) and of comprehensive income (loss), respectively.

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Note 5. Stock-Based Compensation

Stock based compensation is expensed as the stock awards vest with the expense being included in other operating expenses for the periods indicated. The amount charged to expense for stock grants was $1.8 million and $405,000 for the three months ended September 30, 2006 and 2005, respectively, and $3.1 million and $1.1 million for the nine months ended September 30, 2006 and 2005, respectively. The amount charged to expense for stock options was $292,000 and $267,000 for the three months ended September 30, 2006 and 2005, respectively, and $761,000 and $785,000 for the nine months ended September 30, 2006 and 2005, respectively. Stock appreciation rights resulted in an expense of $541,000 and $440,000 for the three months ended September 30, 2006 and 2005, respectively, and $563,000 and $774,000 for the nine months ended September 30, 2006 and 2005, respectively.

In addition, $46,000 and $35,000 was expensed in each of the three month periods ended September 30, 2006 and 2005 and $133,000 and $105,000 was expensed in each of the nine month periods ended September 30, 2006 and 2005 for stock issued annually to non-employee directors as part of their directors’ compensation for serving on the Company’s Board of Directors.

Note 6. Application of New Accounting Standards

In December 2004, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004), Share Based Payment, which is a revision of SFAS 123, Accounting for Stock-Based Compensation, eliminating the alternative use of APB 25. The adoption of SFAS No. 123 (revised 2004) on January 1, 2006 had no material effect on the Company’s results of operations or financial condition since the Company adopted the fair value recognition provisions of SFAS No. 123 in 2003.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments. SFAS No. 155 amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and allows an entity to remeasure at fair value a hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation from the host, if the holder irrevocably elects to account for the whole instrument on a fair value basis. Subsequent changes in the fair value of the instrument would be recognized in earnings. SFAS No. 133 also removed an exception included in an interpretation of SFAS No. 133 (Implementation Issue No. B39) that kept holders of mortgage-backed securities from testing for the need to bifurcate the value embedded in the mortgage-backed securities related to the ability to prepay. The FASB is currently reviewing the removal of such exception. Statement 155 is effective for financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company has not yet determined the estimated impact on its financial condition or results of operations, if any, of adopting SFAS No. 155 which becomes effective in 2007.

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretation of FASB Statement No. 109. FIN 48 establishes the threshold for recognizing the benefits of tax-return positions in the financial statements as more-likely-than-not to be sustained by the taxing authorities, and prescribes a measurement methodology for those positions meeting the recognition threshold. The Company has not yet determined the estimated impact on its financial condition or results of operations, if any, of adopting FIN 48 which becomes effective in 2007.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP, and enhances disclosures about fair value measurements. SFAS No. 157 applies when other accounting pronouncements require fair value measurements; it does not require new fair value measurements. The Company has not yet determined the estimated impact on its financial condition or results of operations, if any, of adopting SFAS No. 157 which becomes effective in 2007.

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In September 2006, the SEC released SEC Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements, which addresses how uncorrected errors in previous years should be considered when quantifying errors in current-year financial statements. SAB No. 108 requires registrants to consider the effect of all carry over and reversing effects of prior-year misstatements when quantifying errors in current-year financial statements. SAB 108 does not change the SEC staff’s previous guidance on evaluating the materiality of errors. It allows registrants to record the effects of adopting the guidance as a cumulative-effect adjustment to retained earnings. This adjustment must be reported as of the beginning of the first fiscal year ending after November 15, 2006 (January 1, 2006 for calendar-year-end companies in either the 2006 year end Form 10-K or third quarter Form 10-Q). The Company has not yet determined the estimated impact on its financial condition or results of operations, if any, of adopting SAB No. 108.

Note 7.  Lloyd’s Syndicate

We record our pro rata share of Syndicate 1221’s assets, liabilities, revenues and expenses, after making adjustments to convert Lloyd’s accounting to U.S. GAAP.  The most significant U.S. GAAP adjustments relate to income recognition. Lloyd’s syndicates determine underwriting results by year of account at the end of three years.  We record adjustments to recognize underwriting results as incurred, including the expected ultimate cost of losses incurred.  These adjustments to losses are based on actuarial analysis of syndicate accounts, including forecasts of expected ultimate losses provided by the Syndicate 1221.  At the end of the Lloyd’s three year period for determining underwriting results for an account year, the Syndicate 1221 will close the account year by reinsuring outstanding claims on that account year with the participants for the account’s next underwriting year.  The amount to close an underwriting year into the next year is referred to as the “reinsurance to close”.  The reinsurance to close transaction is recorded in the fourth quarter as additional written and earned premium, losses incurred, loss reserves and receivables, all in the same amount.  No gain or loss is recorded on the reinsurance to close transaction.

Syndicate 1221’s stamp capacity is £123.5 million ($224.8 million) in 2006 compared to £135.0 million ($246.0 million) in 2005.  Stamp capacity is a measure of the amount of premium a Lloyd’s syndicate is authorized to write based on a business plan approved by the Council of Lloyd’s.  Syndicate 1221’s capacity is expressed net of commission (as is standard at Lloyd’s) of approximately 21%.  The Syndicate 1221 premium recorded in the Company’s financial statements is gross of commission.  The Company participates for 100% and 97.5% of Syndicate 1221’s capacity for the 2006 and 2005 underwriting years, respectively.  The Lloyd’s Operations included in the consolidated financial statements represent the Company’s participation in Syndicate 1221.

The Company provides letters of credit to Lloyd’s to support its Syndicate 1221 capacity.  If the Company increases its participation or if Lloyd’s changes the capital requirements, the Company may be required to supply additional letters of credit or other collateral acceptable to Lloyd’s, or reduce the capacity of Syndicate 1221.  The letters of credit are provided through a credit facility which the Company maintains with a consortium of banks.  The credit facility agreement requires that the banks vote periodically whether or not to renew the credit facility.  If the banks decide not to renew the credit facility, the Company will need to find other sources to provide the letters of credit or other collateral in order to continue to participate in Syndicate 1221.  The renewal amendment executed in January 2005 renewed the letter of credit facility until June 30, 2007.  The bank facility is collateralized by all of the common stock of Navigators Insurance Company.

Note 8.  Income Tax - Valuation Allowance

The Company had state and local operating loss carryforwards amounting to potential future tax benefits of $5.9 million and $5.0 million at September 30, 2006 and December 31, 2005, respectively.  A valuation

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allowance was established for the full amount of these potential future tax benefits due to the uncertainty associated with their realization.

Note 9.  Commitments and Contingencies

Except as follows, the Company is not a party to, or the subject of, any material legal proceedings which depart from the ordinary routine litigation incident to the kinds of business it conducts.

At the end of April 2006, the Company was served as a defendant in an action in the United States District Court for the Northern District of Georgia captioned New Cingular Wireless Headquarters, LLC, et al. v. March & McLennan Companies, Inc., et al., along with approximately 100 other defendants.  On May 31, 2006, this action was conditionally transferred to the United States District Court for the District of New Jersey by the Judicial Panel on Multidistrict Litigation.  While it is not possible at this very preliminary stage to predict the outcome of this litigation, the Company believes the allegations, which involve contingent commissions and bid-rigging in the insurance industry, to be without merit and intends to vigorously defend itself against them.

Note 10.  Senior Notes Due May 1, 2016       

On April 17, 2006, the Company completed a public debt offering of $125 million principal amount of 7% senior unsecured notes due May 1, 2016 (the “Senior Notes”) and received net proceeds of $123.5 million.  The Company contributed $100 million of the proceeds to the capital and surplus of Navigators Insurance Company and retained the remainder at the Parent Company for general corporate purposes.  Interest will be paid on the Senior Notes each May 1 and November 1 with the first payment due on November 1, 2006.  The effective interest rate related to the Senior Notes, based on the proceeds net of discount and all issuance costs, is approximately 7.17%.

The Senior Notes, the Company’s only senior unsecured obligation, will rank equally with future senior unsecured indebtedness.  The Company may redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price.  The terms of the Senior Notes contain various restrictive business and financial covenants typical for debt obligations of this type, including limitations on mergers, and liens or dispositions of the common stock of certain subsidiaries.  As of September 30, 2006, the Company was in compliance with all such covenants.

The interest expense from April 17, 2006 to September 30, 2006 was $4.0 million.  The fair value, which is based on the quoted market price at September 30, 2006, was $127.5 million.

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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

Note on Forward-Looking Statements

Some of the statements in this Quarterly Report on Form 10-Q are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995.  Whenever used in this report, the words “estimate”, “expect”, “believe” or similar expressions are intended to identify such forward-looking statements.  Forward-looking statements are derived from information that we currently have and assumptions that we make.  We cannot assure that anticipated results will be achieved, since results may differ materially because of both known and unknown risks and uncertainties which we face.  We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.  Factors that could cause actual results to differ materially from our forward-looking statements include, but are not limited to:

•the effects of domestic and foreign economic conditions, and conditions which affect the market for property and casualty insurance;

•changes in the laws, rules and regulations which apply to our insurance companies;

•the effects of emerging claim and coverage issues on our business, including adverse judicial or regulatory decisions and rulings;

•the effects of competition from banks and other insurers and the trend toward self-insurance;

•risks that we face in entering new markets and diversifying the products and services we offer;

•unexpected turnover of our professional staff;

•changing legal and social trends and inherent uncertainties in the loss estimation process that can adversely impact the adequacy of loss reserves and the allowance for reinsurance recoverables, including our estimates relating to ultimate asbestos liabilities and related reinsurance recoverables;

•risks inherent in the collection of reinsurance recoverable amounts from our reinsurers over many years into the future based on their financial ability and intent to meet such obligations to the Company;

•risks associated with our continuing ability to obtain reinsurance covering our exposures at appropriate prices and/or in sufficient amounts and the related recoverability of our reinsured losses;

•weather-related events and other catastrophes (including acts of terrorism) impacting our insureds and/or reinsurers, including, without limitation, the impact of Hurricanes Katrina, Rita, and Wilma and the possibility that our estimates of losses from Hurricanes Katrina, Rita and Wilma will prove to be materially inaccurate;

•our ability to attain adequate prices, obtain new business and retain existing business consistent with our expectations;

•the possibility of downgrades in our claims-paying and financial strength ratings significantly adversely affecting us, including reducing the number of insurance policies we write generally, or causing clients who require an insurer with a certain rating level to use higher-rated insurers;

•the inability of our internal control framework to provide absolute assurance that all incidents of fraud or unintended material errors will be detected and prevented;

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•the risk that our investment portfolio suffers reduced returns or investment losses which could reduce our profitability; and

•other risks that we identify in future filings with the Securities and Exchange Commission (the “SEC”), including without limitation the risks described under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005.

In light of these risks, uncertainties and assumptions, any forward-looking events discussed in this Form 10-Q may not occur.  You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of their respective dates.

The discussion and analysis of our financial condition and results of operations contained herein should be read in conjunction with our consolidated financial statements and accompanying notes which appear elsewhere in this Form 10-Q.  It contains forward-looking statements that involve risks and uncertainties.  Please see “Note on Forward-Looking Statements” for more information.  Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Form 10-Q.

Overview

We are an international insurance holding company focusing on specialty products for niches 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 coverages.  We conduct operations through our insurance company subsidiaries, our operations at Lloyd’s of London (the “Lloyd’s Operations”) and our underwriting agencies (the “Navigators Agencies”).  Our insurance company subsidiaries (the “Insurance Companies”) consist of Navigators Insurance Company, which includes a United Kingdom Branch (the “U.K. Branch”), and NIC 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 Navigators Underwriting Agency Ltd. (“NUAL”), a Lloyd’s of London (“Lloyd’s”) underwriting agency which manages Lloyd’s Syndicate 1221 (“Syndicate 1221”).  We participate in the capacity of Syndicate 1221 through two wholly-owned Lloyd’s corporate members.  The Navigators Agencies consist of wholly-owned insurance underwriting agencies which produce, manage and underwrite insurance and reinsurance for the Company and are reimbursed for their costs by the Insurance Companies and the Lloyd’s Operations.

While management takes into consideration a wide range of factors in planning the Company’s business strategy and evaluating results of operations, there are certain factors that management believes are fundamental to understanding how the Company is managed.  First, underwriting profit is consistently emphasized as a primary goal, above premium growth.  Management’s assessment of our trends and potential growth in underwriting profit is the dominant factor in its decisions with respect to whether or not to expand a business line, enter into a new niche, product or territory or, conversely, to contract capacity in any business line.  In addition, management focuses on managing the costs of our operations.  Management believes that careful monitoring of the costs of existing operations and assessment of costs of potential growth opportunities are important to our profitability.  Access to capital also has a significant impact on management’s outlook for our operations.  The Insurance Companies’ operations and ability to grow their business and take advantage of market opportunities are particularly constrained by regulatory capital requirements and rating agency assessments of capital adequacy.

The discussions that follow include tables, which contain both our consolidated and segment operating results for each of the three and nine month periods ended September 30, 2006 and 2005.  In presenting our financial results we have discussed our performance with reference to underwriting profit or loss and the related

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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 loss adjustment expenses (“LAE”), commission expense and other operating expenses related to underwriting activities.  The combined ratio is derived by taking such net losses and LAE and expenses divided by earned premiums.  A combined ratio of less than 100% indicates an underwriting profit and over 100% indicates an underwriting loss.

Although not a financial measure, management’s decisions are also greatly influenced by access to specialized underwriting and claims expertise in our lines of business.  We have chosen to operate in specialty niches with certain common characteristics which we believe provide us with the opportunity to use our technical underwriting expertise in order to realize underwriting profit.  As a result, we have focused on underserved markets for businesses characterized by higher severity and lower frequency of loss where we believe our intellectual capital and financial strength bring meaningful value.  In contrast, we have avoided niches that we believe have a high frequency of loss activity and/or are subject to a high level of regulatory coverage requirements, such as workers compensation and personal automobile insurance, because we do not believe our technical expertise is of as much value in these types of businesses.  Examples of niches that have the characteristics we look for include bluewater hull which provides coverage for physical damage to, for example, highly valued cruise ships, and directors and officers liability insurance (“D&O”) which covers litigation exposure of a corporation’s directors and officers.  These types of exposures require substantial technical expertise.  We attempt to mitigate the financial impact of severe claims on our results by conservative and detailed underwriting, prudent use of reinsurance and a balanced portfolio of risks.

Our revenue is primarily comprised of premiums and investment income.  The Insurance Companies derive their premiums primarily from business written by the Navigators Agencies.  The Lloyd’s Operations derive their premiums from business written by NUAL.  Beginning in 2006, the Navigators Agencies produce and manage business only for the Insurance Companies and are reimbursed for actual costs.  Prior to 2006, the Navigators Agencies received commissions and, in some cases, profit commissions on the business produced on behalf of the Insurance Companies and other unaffiliated insurers.  NUAL is reimbursed for its actual costs and, where applicable, profit commissions on the business produced for Lloyd’s Syndicate 1221.

Over the past three to four years, we have experienced generally beneficial market changes in our lines of business.  As a result of several large industry losses in the second quarter of 2001, the marine insurance market began to experience diminished capacity and rate increases, initially in the offshore energy line of business.  The marine rate increases began to level off in 2004 and into 2005.  As a result of the substantial insurance industry losses resulting from Hurricanes Katrina and Rita, the marine insurance market is experiencing diminished capacity and rate increases, particularly for the offshore energy risks located in the Gulf of Mexico.  The 2006 third quarter and nine month average renewal rate increases for all marine lines of business including offshore energy approximated 13% for each of the periods in the Insurance Companies, and 11% and 14%, respectively, in the Lloyd’s Operations.  Included in the marine rate increases for the first nine months of 2006 are offshore energy rate increases of approximately 66% in the Insurance Companies and 53% in the Lloyd’s Operations.  Specialty liability losses over the past several years, particularly for our California construction liability business, also resulted in diminished capacity in the market in which we compete, as many former competitors who lacked the expertise to selectively underwrite this business have been forced to withdraw from the market resulting in approximate rate increases of 13% in 2004 and 49% in 2003.  This was followed by a slight decline in rates of approximately 1% in 2005.  The third quarter and nine month renewal rates for the California construction liability business declined approximately 3% and 5%, respectively, primarily due to additional competition in the marketplace.  In the professional liability market, the enactment of the Sarbanes-Oxley Act of 2002, together with financial and accounting scandals at publicly traded corporations and the increased frequency of securities-related class action litigation, has led to heightened interest in professional liability insurance generally.  Average professional liability renewal premium rates decreased approximately 4% in the 2006 third quarter and increased approximately 1% for the 2006 nine months, compared to relatively level rates in 2005 and a decrease of approximately 3% in 2004 which followed substantial rate increases in 2003 and 2002, particularly for D&O

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insurance.  The D&O insurance premium rates decreased approximately 8% in the 2006 third quarter and decreased approximately 1% for the 2006 nine months, after decreases of approximately 2% in 2005 and 10% in 2004.

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.

Catastrophe Risk Management

Our Insurance Companies and Lloyd’s Operations have exposure to losses caused by hurricanes and other natural and man-made catastrophic events.  The frequency and severity of catastrophes are unpredictable.

The extent of losses from a catastrophe is a function of both the total amount of insured exposure in an area affected by the event and the severity of the event.  We continually assess our concentration of underwriting exposures in catastrophe exposed areas globally and attempt to manage this exposure through individual risk selection and through the purchase of reinsurance.  We also use modeling technologies and concentration management tools that allow us to better monitor and control our accumulations of potential losses from catastrophe exposures.  Despite these efforts, there remains uncertainty about the characteristics, timing and extent of insured losses given the nature of catastrophes.  The occurrence of one or more severe catastrophic events could have a material adverse effect on the Company’s results of operations, financial condition or liquidity.

As a result of the offshore energy losses suffered by the marine and energy market in 2005 stemming from Hurricanes Katrina and Rita, the 2006 marine reinsurance capacity has declined, reinsurance terms and conditions have tightened and reinsurance costs have dramatically increased, particularly for excess of loss reinsurance protection.  As a result, through the first nine months of 2006, the Company has achieved significant improvements in pricing, terms and conditions for the offshore energy business as it renews while reducing its aggregate loss exposures in the Gulf of Mexico.  The Company also has an increased net retention and increased reinstatement premium cost for a catastrophic offshore energy loss in 2006 compared to 2005 as a result of less available reinsurance protection at an increased reinsurance cost.

The occurrence of additional large loss events could reduce the reinsurance coverage that is available to us and could further weaken the financial condition of our reinsurers, which could have a material adverse effect on our results of operations.  Although the reinsurance agreements make the reinsurers liable to us to the extent the risk is transferred or ceded to the reinsurer, ceded reinsurance arrangements do not eliminate our obligation to pay claims to our policyholders.  Accordingly, we bear credit risk with respect to our reinsurers.  Specifically, our reinsurers may not pay claims made by us on a timely basis, or they may not pay some or all of these claims. Either of these events would increase our costs and could have a material adverse effect on our business.  We are required to pay the losses even if a reinsurer fails to meet its obligations under the reinsurance agreement.  Hurricanes Katrina and Rita increased our reinsurance recoverables significantly, which increased our credit risk.

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Corporate and Industry Investigations

Public companies have become the subject of increasing scrutiny regarding the timing and dating of employee stock option awards.  The Securities and Exchange Commission and the U.S. Department of Justice have been investigating stock option award practices at a number of public companies.  The Company has undertaken its own internal review with respect to its stock option award practices.  In this recently completed internal inquiry, the Company did not find any evidence that it has engaged in any of the stock option award practices that are at the center of these corporate investigations.

The insurance industry has become the subject of increasing scrutiny with respect to insurance broker and agent compensation arrangements, and certain sales practices.  The New York State Attorney General and other state and federal regulators have commenced investigations and other proceedings relating to the payment of contingent commissions by insurance companies to insurance brokers and agents and the extent to which such compensation has been disclosed, and the solicitation and provision of fictitious or inflated quotes.  These investigations and proceedings could result in legal precedents and new industry-wide practices or legislation, rules or regulations that could significantly affect our industry and may also cause stock price volatility for companies in the insurance industry.

The Company has completed its own internal review with respect to such contingent commission arrangements and the anti-competitive sales practices discussed above.  In this internal inquiry, the Company did not find any evidence that it has engaged in the bid-rigging and price-fixing activities that are at the core of the industry investigations into these anti-competitive practices.  The Company is supportive of industry efforts to encourage transparency in the disclosure of contingent commissions paid to brokers by insurers. 

The reinsurance industry has also become the subject of increasing scrutiny with respect to the alleged improper use of reinsurance agreements to manipulate financial reporting results.  The New York State Attorney General and other state and federal regulators have commenced investigations and other proceedings related to reinsurance agreements in which the insurance risk transferred between the ceding company and reinsurer may have been insufficient to properly account for such transactions as reinsurance in financial statements filed with insurance regulatory authorities and the SEC.  Such transactions may include separate or “side” agreements that reduce, limit or mitigate the indemnification against loss or liability relating to the insurance risk transferred to the reinsurer in a reinsurance agreement.

As a result of these industry investigations, accounting and reporting requirements for reinsurance transactions, including risk transfer guidance used to determine when sufficient insurance risk has been transferred by the ceding company to properly account for such transactions as reinsurance, may change.

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.

Critical Accounting Policies

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.

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Our most critical accounting policies involve the reporting of the reserves for losses and loss adjustment expenses (“LAE”) (including losses that have occurred but were not reported to us by the financial reporting date), reinsurance recoverables, written and unearned premium, the recoverability of deferred tax assets, the impairment of invested assets, accounting for Lloyd’s results and the translation of foreign currencies.

Reserves for Losses and LAE.  Reserves for losses and LAE represent an estimate of the expected cost of the ultimate settlement and administration of losses, based on facts and circumstances then known.  Actuarial methodologies are employed to assist in establishing such estimates and include judgments relative to estimates of future claims severity and frequency, length of time to develop to ultimate, judicial theories of liability and other third party factors which are often beyond our control.  Due to the inherent uncertainty associated with the reserving process, the ultimate liability may be different from the original estimate.  Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year’s results.

Reinsurance Recoverables.  Reinsurance recoverables are established for the portion of the loss reserves that are ceded to reinsurers.  Reinsurance recoverables are determined based upon the terms and conditions of reinsurance contracts which could be subject to interpretations that differ from our own based on judicial theories of liability.  In addition, we bear credit risk with respect to our reinsurers which can be significant considering that certain of the reserves remain outstanding for an extended period of time.  We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement.

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.

Substantially all of our business is placed through agents and brokers.  Since the vast majority of the Company’s gross written premium is primary or direct as opposed to assumed, the delays in reporting assumed premium generally do not have a significant effect on the Company’s financial statements, since we record estimates for both unreported direct and assumed premium.  We also record the ceded portion of the estimated gross written premium and related acquisition costs.  The earned gross, ceded and net premiums are calculated based on our earning methodology which is generally pro-rata over the policy period.  Losses are also recorded in relation to the earned premium.  The estimate for losses incurred on the estimated premium is based on an actuarial calculation consistent with the methodology used to determine incurred but not reported loss reserves for reported premiums.

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.

Deferred Tax Assets.  We apply the asset and liability method of accounting for income taxes whereby deferred assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.  In assessing the realization of deferred tax assets, management considers whether it is more likely than not that the deferred tax assets will be realized.

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

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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.

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, market conditions and assessing value relative to other comparable securities.  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.

Accounting for Lloyd’s Results.  We record our pro rata share of Syndicate 1221’s assets, liabilities, revenues and expenses, after making adjustments to convert Lloyd’s accounting to U.S. GAAP.  The most significant GAAP adjustments relate to income recognition. Lloyd’s syndicates determine underwriting results by year of account at the end of three years.  We record adjustments to recognize underwriting results as incurred, including the expected ultimate cost of losses incurred.  These adjustments to losses are based on actuarial analysis of syndicate accounts, including forecasts of expected ultimate losses provided by the syndicate.  At the end of the Lloyd’s three-year period for determining underwriting results for an account year, the syndicate will close the account year by reinsuring outstanding claims on that account year with the participants for the account’s next underwriting year.  The amount to close an underwriting year into the next year is referred to as the reinsurance to close (“RITC”).  The RITC transaction is recorded in the fourth quarter as additional written and earned premium, losses incurred, loss reserves and receivables, all in the same amount.  There are no gains or losses recorded on the RITC transaction.

Translation of Foreign Currencies.  Financial statements of subsidiaries expressed in foreign currencies are translated into U.S. dollars in accordance with SFAS No. 52, Foreign Currency Translation, issued by the FASB.  Under SFAS 52, functional currency assets and liabilities are translated into U.S. dollars using period end rates of exchange and the related translation adjustments are recorded as a separate component of accumulated other comprehensive income.  Functional currencies are generally the currencies of the local operating environment.  Statement of income amounts expressed in functional currencies are translated using average exchange rates.  Gains and losses resulting from foreign currency transactions are recorded in other income (expense) in the Company’s Consolidated Statements of Income.

24

Results of Operations and Overview

The following is a discussion and analysis of our consolidated and segment results of operations for the three and nine month periods ended September 30, 2006 and 2005.  All earnings per share data is presented on a per diluted share basis.

Net income for the three month period ended September 30, 2006 was $18.3 million or $1.09 per share compared to a net loss of $12.7 million or $0.99 per share for the three month period ended September 30, 2005.  Included in these results were net realized capital gains (losses) of $(0.01) per share and $0.02 per share for the three months ended September 30, 2006 and 2005, respectively.

Net income for the nine month period ended September 30, 2006 was $52.0 million or $3.09 per share compared to $8.3 million or $0.64 per share for the nine month period ended September 30, 2005.  Included in these results were net realized capital gains (losses) of $(0.03) per share and $0.05 per share for the nine months ended September 30, 2006 and 2005, respectively.

The 2005 third quarter and nine month results were adversely affected by Hurricanes Katrina and Rita.  The 2005 after-tax loss from the hurricanes was $23.9 million or approximately $1.87 per share.

Cash flow from operations was $92.7 million for the nine months of 2006 compared to $168.0 million for the comparable period in 2005.  The positive cash flow contributed to the growth in invested assets and net investment income.  The 2006 cash flow was reduced by gross loss payments of approximately $114.5 million for the 2005 hurricane losses and $19.9 million for settled asbestos claims of which $67.2 million and $10.7 million, respectively, are expected to be collected from reinsurers in subsequent accounting periods.  The 2005 cash flow included approximately $24 million attributable to the settlement of the 2002 underwriting year reinsurance to close premium recorded by Syndicate 1221 in the 2004 fourth quarter.

Consolidated stockholders’ equity increased 12% to $527.5 million or $31.59 per share at September 30, 2006 compared to $470.2 million or $28.30 per share at December 31, 2005.  The increase was primarily due to net income of $52.0 million for the first nine months of 2006.

On April 17, 2006, the Company completed a public debt offering of $125 million principal amount of 7% senior unsecured notes due May 1, 2016 and received net proceeds of $123.5 million of which $100 million was contributed to the capital and surplus of Navigators Insurance Company.

On May 9, 2006, the Company announced the establishment of an Inland Marine Division focusing on traditional inland marine insurance products including builders’ risk, contractors’ tools and equipment, fine arts, EDP equipment and motor truck cargo.  On May 17, 2006, the Company announced the establishment of a Primary Casualty Division focusing on primary casualty business produced by wholesale insurance brokers.  The Primary Casualty Division writes construction business east of the Rocky Mountains and non-construction risks nationwide.  On October 10, 2006, the Company announced the establishment of a U.K. based property team to generate specialty business lines in the U.K. and Europe.  The new team will focus on U.K. property-related commercial lines in targeted business sectors.

Revenues.  Gross written premium increased to $221.7 million and $737.8 million in the third quarter and first nine months of 2006, respectively, from $188.1 million and $595.2 million in the third quarter and first nine months of 2005, increases of 18% and 24%, respectively.  The growth in gross written premium reflects a combination of business expansion in both new and existing lines of business coupled with premium rate changes on renewal policies.  The marine business decreased 1% in the 2006 third quarter, but experienced growth of 18% in the first nine months of 2006 compared to the same periods in 2005 primarily as a result of significant rate increases in the offshore energy line of business coupled with a more modest net increase in premiums in the

25

other classes of business.  Gross written premium for professional liability business written both in the Insurance Companies and Lloyd’s Operations increased 29% in the 2006 third quarter and 24% for the first nine months of 2006 compared to the same periods in 2005 primarily as a result of diversification and expansion of the business written by our Lloyd’s Operations.  Specialty business grew 44% in both the third quarter and first nine months of 2006 compared to the same periods in 2005 primarily due to continued product diversification and domestic geographic expansion.

The premium rate changes discussed above and below for marine, specialty and professional liability are calculated primarily by comparing premium amounts on policies that have renewed.  The premiums are judgmentally adjusted for exposure factors when deemed significant and sometimes represent an aggregation of several lines of business.  The rate change calculations provide an indicated pricing trend and are not meant to be a precise analysis of the numerous factors that affect premium rates or the adequacy of such rates to cover all underwriting costs and generate an underwriting profit.  The calculation can also be affected quarter by quarter depending on the particular policies and the number of policies that renew during that period.  Due to market conditions, these rate changes may or may not apply to new business which may be more competitively priced compared to renewal business.  The following table sets forth our gross and net written premium and net earned premium by segment and line of business for the periods indicated:

26

	Three Months Ended September 30,
	2006									2005
	Gross				Net		Net			Gross					Net			Net
	Written				Written		Earned			Written					Written			Earned
	Premium		%		Premium		Premium			Premium			%		Premium			Premium
	($ in thousands)
Insurance Companies:
Marine	$	54,116	24.3	%	$	24,566	$	29,291		$	53,084		28.2	%	$	11,378		$	14,391
Specialty	85,675		38.7	%	52,923		45,234			59,307			31.6	%	38,313			31,965
Professional Liability	22,848		10.3	%	13,450		10,938			21,528			11.4	%	9,823			7,786
Assumed from Lloyd’s	850		0.4	%	224		83			(261		)	-0.1	%	(413		)	(356		)
Other	184		0.1	%	25		(52		)	60			0.0	%	(8		)	(8		)
Insurance Companies Total	163,673		73.8	%	91,188		85,494			133,718			71.1	%	59,093			53,778
Lloyd’s Operations:
Marine	44,962		20.3	%	23,743		29,126			47,338			25.2	%	14,602			19,453
Professional Liability	9,015		4.1	%	3,381		1,525			3,131			1.7	%	1,231			545
Other	3,803		1.7	%	725		(449		)	3,673			1.9	%	1,123			958
Lloyd’s Operations Total	57,780		26.1	%	27,849		30,202			54,142			28.8	%	16,956			20,956
Intercompany elimination	214		0.1	%	—		—			254			0.1	%	—			—
Total	$	221,667	100.0	%	$	119,037	$	115,696		$	188,114		100.0	%	$	76,049		$	74,734

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	Nine Months Ended September 30,
	2006									2005
	Gross				Net		Net			Gross					Net			Net
	Written				Written		Earned			Written					Written			Earned
	Premium		%		Premium		Premium			Premium			%		Premium			Premium
	($ in thousands)
Insurance Companies:
Marine	$	209,928	28.5	%	$	101,891	$	80,679		$	181,500		30.5	%	$	68,189		$	57,600
Specialty	219,843		29.8	%	136,246		121,133			152,454			25.6	%	107,991			81,429
Professional Liability	65,164		8.9	%	34,894		29,494			60,708			10.2	%	24,333			21,493
Assumed from Lloyd’s	1,070		0.1	%	241		100			(1,066		)	-0.2	%	(1,209		)	(320		)
Other	211		0.0	%	5		(72		)	90			0.0	%	45			46
Insurance Companies Total	496,216		67.3	%	273,277		231,334			393,686			66.1	%	199,349			160,248
Lloyd’s Operations:
Marine	202,074		27.4	%	107,026		99,029			168,458			28.3	%	77,392			74,643
Professional Liability	16,104		2.1	%	6,326		2,130			4,718			0.8	%	1,855			711
Other	23,422		3.2	%	5,082		1,466			27,343			4.6	%	7,800			2,502
Lloyd’s Operations Total	241,600		32.7	%	118,434		102,625			200,519			33.7	%	87,047			77,856
Intercompany elimination	—		0.0	%	—		—			1,038			0.2	%	—			—
Total	$	737,816	100.0	%	$	391,711	$	333,959		$	595,243		100.0	%	$	286,396		$	238,104

28

Gross Written Premium

Insurance Companies’ Gross Written Premium

Marine Premium.  The gross written premium for the first nine months of 2006 consisted of 32% marine liability, 21% offshore energy, 10% cargo, 9% transport, 9% protection and indemnity (P&I) and 8% bluewater hull with the remainder in several other marine related classes of business.

The marine gross written premium for the 2006 third quarter and first nine months increased 2% and 16%, respectively, compared to the same periods in 2005 reflecting growth across several lines of business including offshore energy, liability and P&I.  The average renewal premium rates during the third quarter and first nine months of 2006 increased by approximately 13% in each of the periods.  Navigators Insurance Company has in the past obtained its marine business through participation in the marine pool managed by the Navigators Agencies.  Commencing in 2006, the marine pool has been eliminated and, therefore, all of the marine business generated by the Navigators Agencies is exclusively for the Insurance Companies.  Navigators Insurance Company participated for 85% of the marine pool in 2005.

Specialty Premium. The gross written premium written in the first nine months of 2006 consisted of 53% general liability business for small general and artisan contractors, 19% excess casualty business, 11% personal umbrella business and 17% other targeted commercial risks.  The specialty gross written premium increased 44% in both the third quarter and first nine months of 2006, compared to the same 2005 periods reflecting growth across all lines of business including premiums generated from our excess casualty business which started in the first quarter of 2005.  The average renewal premium rates decreased by approximately 3% and 5% for the contractors’ liability business in the 2006 third quarter and first nine months, respectively.

Professional Liability Premium.  The gross written premium for the first nine months of 2006 consisted of 67% D&O liability coverage for privately held and publicly traded corporations, 25% professional liability coverage for lawyers and other professionals and 8% professional liability coverage for architects and engineers. In 2002, the professional liability business was expanded to include errors and omissions insurance and employment practices liability coverages.  Commencing in October 2004, our U.K. Branch began writing professional liability coverages for U.K. solicitors and, in 2005, we began writing professional liability coverages for architects and engineers.  The professional liability gross written premium for the 2006 third quarter and first nine months increased 6% and 7%, respectively, compared to the same periods in 2005.  Approximately $5.0 million of international professional liability business written by the Insurance Companies in 2005 has been renewed in the Lloyd’s Operations in 2006.  Average overall renewal premium rates for the professional liability business decreased by approximately 4% in the 2006 third quarter and increased approximately 1% in the first nine months of 2006.  D&O renewal premium rates, included in the overall professional liability rate change, decreased by approximately 8% in the 2006 third quarter and approximately 1% in the first nine months of 2006.

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 between $5 million 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 September 30, 2006, $4.2 million of the Genesis business has been renewed.

29

Lloyd’s Operations’ Gross Written Premium

Marine Premium. The gross written premium for the first nine months of 2006 consisted of 40% cargo and specie, 25% offshore energy and 21% marine liability with the remainder in several other marine related classes of business.

Our gross written premium is based on the stamp capacity of Syndicate 1221 and the percentage of such stamp capacity we provide.  Our percentage of participation in the stamp capacity is 100% for 2006 compared to 97.5% for 2005.  Stamp capacity is a measure of the amount of premium a Lloyd’s syndicate is authorized to write as determined based on a business plan approved by the Council of Lloyd’s.  The stamp capacity for Syndicate 1221 was initially reduced to £112.5 million ($204.8 million) in 2006 from £135 million ($246.0 million) in 2005.  During 2006, the Company has increased Syndicate 1221’s stamp capacity to £123.5 million ($224.8 million).  The marine gross written premium for the 2006 third quarter and first nine months decreased 5% and increased 20%, respectively, compared to the same periods in 2005.  Excluding inwards reinstatement premiums on assumed business of $4.5 million recorded for Hurricanes Katrina and Rita in the third quarter of 2005, the marine gross written premium for the 2006 third quarter and first nine months increased 5% and 23%, respectively, reflecting growth across several lines of business, but primarily in offshore energy.  The average renewal premium rates during the third quarter and first nine months of 2006 increased by approximately 11% and 14%, respectively.

Professional Liability Premium.  Our Lloyd’s Operations commenced writing international professional liability business during the 2005 second quarter and produced $9.0 million and $16.1 million of gross written premium in the 2006 third quarter and first nine months, respectively, versus $3.1 million and $4.7 million for the third quarter and first nine months of 2005.

Other Premium.  Other premium consists of premium for engineering and construction business which provides coverage for construction projects including machinery, equipment and loss of use due to delays and of premium for onshore energy business which principally focuses on the oil and gas, chemical and petrochemical industries with coverages primarily for property damage and business interruption.

Ceded Written Premium.  In the ordinary course of business, we reinsure certain insurance risks with unaffiliated insurance companies for the purpose of limiting our maximum loss exposure, protecting against catastrophic losses, and maintaining desired ratios of net premiums written to statutory surplus. The relationship of ceded to written premium varies based upon the types of business written and whether the business is written by the Insurance Companies or the Lloyd’s Operations.

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The following tables set forth our ceded written premium by segment and major lines of business for the periods indicated:

	Three Months Ended September 30,
	2006				2005
			% of				% of
	Ceded		Gross		Ceded		Gross
	Written		Written		Written		Written
	Premium		Premium		Premium		Premium
	($ in thousands)
Insurance Companies:
Marine	$	29,550	54.6	%	$	41,706	78.6	%
Specialty	32,752		38.2	%	20,994		35.4	%
Professional Liability	9,398		41.1	%	11,705		54.4	%
Assumed from Lloyd’s	626		NM		152		NM
Other	159		NM		68		NM
Subtotal	72,485		44.3	%	74,625		55.8	%
Lloyd’s Operations:
Marine	21,219		47.2	%	32,736		69.2	%
Professional Liability	5,634		62.5	%	1,900		60.7	%
Other	3,078		80.9	%	2,550		69.4	%
Subtotal	29,931		51.8	%	37,186		68.7	%
Intercompany elimination	214		NM		254		NM
Total	$	102,630	46.3	%	$	112,065	59.6	%

NM = not meaningful

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	Nine Months Ended September 30,
	2006				2005
			% of				% of
	Ceded		Gross		Ceded		Gross
	Written		Written		Written		Written
	Premium		Premium		Premium		Premium
	($ in thousands)
Insurance Companies:
Marine	$	108,037	51.5	%	$	113,311	62.4	%
Specialty	83,597		38.0	%	44,463		29.2	%
Professional Liability	30,270		46.5	%	36,375		59.9	%
Assumed from Lloyd’s	829		77.5	%	143		-13.4	%
Other (includes run-off)	206		NM		45		NM
Subtotal	222,939		44.9	%	194,337		49.4	%
Lloyd’s Operations:
Marine	95,048		47.0	%	91,066		54.1	%
Professional Liability	9,778		60.7	%	2,863		60.7	%
Other	18,340		78.3	%	19,543		71.5	%
Subtotal	123,166		51.0	%	113,472		56.6	%
Intercompany elimination	—		NM		1,038		NM
Total	$	346,105	46.9	%	$	308,847	51.9	%

NM = not meaningful

The ratios of ceded written premium to gross written premium in the 2006 third quarter and nine month periods were 46.3% and 46.9%, respectively, compared to the 2005 third quarter and nine month periods of 59.6% and 51.9%, respectively.  The decrease in the ratio of ceded written premium to gross written premium in the 2006 periods compared to the same periods in 2005 was due to a combination of factors.

Commencing with the 2006 underwriting year, the marine pool has been eliminated and therefore, all of the marine business generated by the Navigators Agencies is exclusively for the Insurance Companies.  The 2005 underwriting year marine business was ceded 15% to pool members and 85% retained by the Insurance Companies.  In 2005, members shared the 15% pro rata costs and benefits of all quota share and excess of loss reinsurance ceded by the pool which was also eliminated in 2006.

Also commencing with the 2006 underwriting year, our Lloyd’s Operations is retaining more of Syndicate 1221’s business with the 2005 purchase of the 2.5% minority interest in Syndicate 1221 and the replacement of a 5% capacity provider with our own letter of credit funding.

Somewhat offsetting the reduction in ceded premiums due to the marine pool elimination and increased retention of business in Syndicate 1221 were changes in the 2006 reinsurance structure and amounts ceded under marine quota share and excess of loss agreements for the Insurance Companies and the Lloyd’s Operations reflecting higher reinsurance costs resulting from the tightened market conditions for catastrophe loss protection as a result of the 2005 industry-wide hurricane losses.

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The 2005 third quarter and nine months marine ceded premium for the Insurance Companies and Lloyd’s Operations included $9.1 million and $5.3 million, respectively, for ceded reinstatement premiums as a result of Hurricanes Katrina and Rita.

Additionally, as the professional liability business we have been writing since 2001 matures, we have been retaining more of the business by increasing our net retentions on the professional liability pro rata reinsurance treaty renewals each April 1.

The net effects of the items discussed above on the decrease in the ratio of ceded written premium to gross written premium for the nine months ended September 30, 2006 were somewhat offset as the 2005 first quarter ceded premium was reduced by approximately $14.5 million resulting from the cancellation of a quota share reinsurance agreement for specialty business effective March 31, 2005. Such amount represented the unearned portion of the premium ceded to the reinsurance agreement that was retained. This retained amount was offset by $8.2 million of premiums ceded to the reinsurance agreement during the 2005 first quarter.

Net Written Premium. Net written premium increased 57% in the 2006 third quarter and increased 37% in the first nine months of 2006 compared to the same periods in 2005. Net written premium increased 32% in the 2006 third quarter and increased 30% in the first nine months of 2006 compared to the same periods in 2005, when the effects for ceded reinstatement premiums as a result of Hurricanes Katrina and Rita are excluded. The increase in net written premium for the 2006 third quarter and nine month period is principally due to business expansion in all of the Company’s business units coupled with retaining more of the business written.

Net Earned Premium. Net earned premium, which generally lags the increase in net written premium, increased 55% in the 2006 third quarter and increased 40% in the first nine months of 2006 compared to the same periods in 2005 as a result of the increased net written premium discussed above. Net earned premium increased 30% in the 2006 third quarter and increased 32% in the first nine months of 2006 compared to the same periods in 2005, when the effects of ceded reinstatement premium resulting from Hurricanes Katrina and Rita are excluded.

Commission Income. Commission income from unaffiliated business was $0.6 million and $2.5 million in the 2006 third quarter and nine month periods, respectively, compared to $1.0 million and $3.8 million in the third quarter and first nine months of 2005, respectively. The declines are primarily due to the Company eliminating the marine pool beginning with the 2006 underwriting year and therefore not receiving commission income from the unaffiliated pool members on the 2006 marine business.

Net Investment Income. Net investment income increased 60% in both the 2006 third quarter and first nine months of 2006 compared to the same periods in 2005 due to the increase in invested assets as a result of the positive cash flow from the increased premium volume, the $123.8 million of net proceeds from the October 2005 common stock offering and the $123.5 million of net proceeds from the April 2006 7% Senior Notes offering and due to the increase in the portfolio yield.

Net Realized Capital Gains and Losses. Pre-tax net income included a net realized capital loss of $151,000 for the three months ended September 30, 2006 compared to a net realized capital gain of $344,000 for the 2005 third quarter. On an after-tax basis, the net realized capital loss was $104,000 or $0.01 per share compared to a net realized capital gain of $224,000 or $0.02 per share for the 2005 third quarter. Pre-tax net income included a net realized capital loss of $767,000 for the nine months ended September 30, 2006 compared to a net realized capital gain of $927,000 for the first nine months of 2005. On an after-tax basis, the net realized capital loss was $520,000 or $0.03 per share for the first nine months of 2006 compared to a net realized capital gain of $603,000 or $0.05 per share for the first nine months of 2005.

Other Income/(Expense). Other income/(expense) for the third quarters and first nine months of both 2006 and 2005 consisted primarily of foreign exchange gains and losses from our Lloyd’s Operations and inspection fees related to the specialty insurance business.

33

Operating Expenses

Net Losses and Loss Adjustment Expenses Incurred. The ratios of net losses and loss adjustment expenses incurred to net earned premium (loss ratios) for the 2006 and 2005 third quarters were 55.7% and 102.8%, respectively, and 57.9% and 74.2% for the first nine months of 2006 and 2005, respectively. The 2006 third quarter and nine month loss ratios were favorably impacted by 5.1 and 3.8 loss ratio points, respectively, resulting from a redundancy of prior year loss reserves. The 2005 third quarter was adversely impacted by $22.3 million of net losses from Hurricanes Katrina and Rita and the effect of the $14.5 million of reinstatement premium caused by the ceded losses from those two hurricanes, which increased the loss ratio for the first quarter and first nine months of 2005 by 41.7 and 13.1 loss ratio points, respectively.

The following tables set forth our net loss and LAE reserves by segment and line of insurance business and the total case reserves and incurred but not reported (“IBNR”) reserves as of September 30, 2006 and December 31, 2005:

	September 30,		December 31,
	2006		2005
	($ in thousands)
Insurance Companies:
Marine.	$	173,350	$	162,644
Specialty	239,378		193,755
Professional Liability	46,490		33,133
Assumed from Lloyd’s Operations	972		1,218
Other (primarily run-off business)	18,588		19,613
Total Insurance Companies	478,778		410,363
Lloyd’s Operations:
Marine	169,295		161,262
Other	8,690		7,351
Total Lloyd’s Operations	177,985		168,613
Total net loss reserves	$	656,763	$	578,976
Total net case loss and LAE reserves	$	227,202	$	228,423
Total net IBNR loss and LAE reserves	429,561		350,553
Total net loss and LAE reserves	$	656,763	$	578,976

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.

There are a number of factors that could cause actual losses and loss adjustment expenses to differ materially from the amount that we have reserved for losses and loss adjustment expenses.

34

The process of establishing loss reserves is complex and imprecise as it must take into account many variables that are subject to the outcome of future events. As a result, informed subjective judgments as to our ultimate exposure to losses are an integral component of our loss reserving process.

IBNR loss reserves are calculated by the Company’s actuaries using several standard actuarial methodologies, including the paid and incurred loss development and the paid and incurred Bornheutter-Ferguson loss methods. Additional analyses, such as frequency/severity analyses, are performed for certain books of business.

While an annual loss reserve study is conducted for each line of business, the timing of such studies varies throughout the year. Additionally, a review of the emergence of actual losses relative to expectations for each line of business is conducted each quarter. A separate analysis of our asbestos and environmental liability exposures is also performed annually and updated quarterly. Any adjustments that result from this review are recorded in the quarter in which they are identified.

The actuarial methods generally utilize analysis of historical patterns of the development of paid and reported losses for each line of business by underwriting year. This process relies on the basic assumption that past experience, adjusted for the effects of current developments and likely trends, is an appropriate basis for predicting future outcomes. This basic assumption is particularly relevant for our marine and energy business written by our Insurance Companies and Lloyd’s Operations where we generally rely on the substantial loss development data accumulated over many years to establish IBNR loss reserves for immature underwriting years.

For certain long tail classes of business where anticipated loss experience is less predictable because of the small number of claims and/or erratic claim severity patterns, estimates are based on both expected losses and actual reported losses. These classes include our California contractors’ liability business and directors and officers liability business, among others. For these classes, we set ultimate losses for each underwriting year reflecting several factors, including our evaluation of loss trends and the current risk environment. The expected ultimate losses are adjusted as the underwriting year matures.

While we have a significant amount of loss development data that is utilized by our actuaries to establish the IBNR loss reserves for our California contractors’ liability business, there have been significant changes relating to this product and its market that could affect the applicability of our data. For example, one factor that may affect reserves and claim frequency is legislation implemented in California, which generally provides consumers who experience construction defects a method other than litigation to obtain defect repairs. The law, which became effective July 1, 2002 with a sunset provision effective January 1, 2011, provides for an alternative dispute resolution system that attempts to involve all parties to the claim at an early stage. This legislation may impact claim severity, frequency and length of settlement assumptions underlying our reserves. Accordingly, our ultimate liability may exceed or be less than current estimates due to this variable, among others. There were approximately 1,028 specialty construction liability claims open at September 30, 2006 compared to 1,012 at December 31, 2005.

The professional liability business generates third-party claims which also are longer tail in nature. The professional liability policies mostly provide coverage on a claims-made basis, whereby coverage is generally provided only for those claims that are made during the policy period. These claims often involve a lengthy litigation period after being reported. Our professional liability business is relatively immature, as we first began writing the business in late 2001. Accordingly, it will take some time to better understand the reserve trends on this business. Given the limited history of this business, the actuaries generally utilize industry data to initially establish IBNR loss reserves, which are subsequently adjusted based on actual and expected claim emergence as each underwriting year matures. There were approximately 898 professional liability claims open at September 30, 2006 compared to 638 at December 31, 2005.

At the start of each underwriting year, our actuaries and management determine an initial selected ultimate loss ratio for each line of business. Management participation generally includes the underwriter for the

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particular line of business, executive management, and claims and finance personnel. Generally, such determinations are based on prior year history modified where deemed appropriate for observed changes in premium rates, terms, conditions, exposures, and loss trends. Industry data is generally utilized for new lines of business.

As underwriting years age, for each subsequent quarter and following years, our actuaries, with management, continue to update and refine their estimates of selected ultimate loss ratios for each line of business, by underwriting year, using the actuarial methods referred to above and incorporating relevant factors that generally include actual loss development, recent claims activity, number and dollar amount of open claims, risk characteristics of the particular line of business, the potential effects of changes in underwriting and claims procedures, historic performance relative to expectations and the relationship of the IBNR reserve levels across underwriting years and between similar lines of business. The output of this process results in refinements to the ultimate loss ratios. Such refinements to the ultimate loss ratios for the prior underwriting years generate prior year redundancies or deficiencies recorded in the year such refinements are made.

The following tables set forth our net loss and LAE reserves for our specialty construction liability and professional liability businesses as of September 30, 2006 and December 31, 2005:

	September 30, 2006
					Total		% of IBNR
Type of	Net Reported		Net		Net Loss		to Total Net
Business	Reserves		IBNR		Reserves		Loss Reserves
	($ in thousands)
Specialty construction liability	$	32,918	$	161,511	$	194,429	83.1	%
Professional liability	11,771		38,046		49,817		76.4	%
Total	$	44,689	$	199,557	$	244,246	81.7	%

	December 31, 2005
					Total		% of IBNR
Type of	Net Reported		Net		Net Loss		to Total Net
Business	Reserves		IBNR		Reserves		Loss Reserves
	($ in thousands)
Specialty construction liability	$	25,329	$	141,078	$	166,407	84.8	%
Professional liability	6,142		28,079		34,221		82.1	%
Total	$	31,471	$	169,157	$	200,628	84.3	%

Asbestos Liability. Our exposure to asbestos liability principally stems from marine liability insurance written on an occurrence basis during the mid-1980s. In general, our participation on such risks is in the excess layers, which requires the underlying coverage to be exhausted prior to coverage being triggered in our layer. In many instances we are one of many insurers who participate in the defense and ultimate settlement of these claims, and we are generally a minor participant in the overall insurance coverage and settlement.

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The reserves we have established for asbestos exposures at September 30, 2006 and December 31, 2005 are for: (i) the 2005 fourth quarter settlements of two large claims aggregating approximately $28 million for excess insurance policy limits exposed to class action suits against two insureds involved in the manufacturing or distribution of asbestos products, each settlement to be paid over two years; (ii) the 2004 settlement of a large claim approximating $25 million exposed to a class action suit which settlement will be paid over seven years starting in June 2005; (iii) other insureds not directly involved in the manufacturing or distribution of asbestos products, but that have more than incidental asbestos exposure for their purchase or use of products that contained asbestos; and (iv) attritional asbestos claims that could be expected to occur over time.

The Company has now settled the four large asbestos claims where excess policy limits were exposed to class action suits which gave rise to the reserve action taken in the fourth quarter of 2003. The Company believes that there are no remaining known claims where it would suffer a material loss as a result of excess policy limits being exposed to class action suits for insureds involved in the manufacturing or distribution of asbestos products. There can be no assurances, however, that material loss development may not arise in the future from existing asbestos claims or new claims given the evolving and complex legal environment that may directly impact the outcome of the asbestos exposures of our insureds.

Substantially all of our asbestos liability reserves are included in our marine loss reserves.

	Nine Months Ended		Year Ended
	September 30, 2006		December 31, 2005
	($ in thousands)
Gross of Reinsurance
Beginning reserve	$	56,838	$	78,421
Incurred losses & LAE	202		(17,409		)
Calendar year payments	19,861		4,174
Ending reserves	$	37,179	$	56,838
Net of Reinsurance
Beginning reserve	$	30,372	$	31,394
Incurred losses & LAE	187		529
Calendar year payments	9,172		1,551
Ending reserves	$	21,387	$	30,372

Hurricanes Katrina and Rita

During the 2005 third quarter, the Company recorded gross and net loss estimates of $471 million and $22.3 million, respectively, exclusive of $14.5 million for the cost of excess of loss reinstatement premiums related to Hurricanes Katrina and Rita. Such estimates remain unchanged through September 30, 2006.

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	Nine Months Ended		Year Ended
	September 30, 2006		December 31, 2005
	($ in thousands)
Gross of Reinsurance
Beginning reserves	$	465,728	$	—
Incurred loss & LAE	—		471,027
Calendar year payments	114,494		5,299
Ending reserves	$	351,234	$	465,728
Net of Reinsurance
Beginning reserves	$	17,800	$	—
Incurred loss & LAE	—		22,288
Calendar year payments	10,474		4,488
Ending reserves	$	7,326	$	17,800

Our management believes that the overall estimates for the reserves for losses and loss adjustment expenses are adequate to cover the ultimate cost of losses and loss adjustment expenses on reported and unreported claims. However, it is possible that the ultimate liability may exceed or be less than such estimates. To the extent that reserves are deficient or redundant, the amount of such deficiency or redundancy is treated as a charge or credit to earnings in the period in which the deficiency or redundancy is identified.

Commission Expense. Commission expense paid to unaffiliated brokers and agents is generally based on a percentage of the gross written premium and is reduced by ceding commissions the Company may receive on the ceded written premium. Commissions are generally deferred and recorded as deferred policy acquisition costs to the extent that they relate to unearned premium. Commission expense as a percentage of earned premium in the 2006 third quarter and nine month period was 11.9% and 12.3%, respectively, compared to 15.6% and 12.8% for the 2005 comparable periods. Commission expense was 13.1% in the 2005 third quarter and 12.1% in the first nine months of 2005 when the effects for ceded reinstatement premiums as a result of Hurricanes Katrina and Rita are excluded.

Other Operating Expenses. The 30% and 16% increase in other operating expenses in the 2006 third quarter and nine month period, respectively, compared to the same periods in 2005 are attributable primarily to employee-related expenses resulting from expansion of the business. Included in the three and nine months ended September 30, 2006 were $2.6 million and $4.4 million in the aggregate for employee stock options, stock grants and stock appreciation rights expense compared to $1.1 million and $2.7 million for the same periods in 2005, respectively.

Income Taxes. The income tax expense (benefit) was $8.5 million and ($7.5) million for the third quarters of 2006 and 2005, respectively. The effective tax rates for the 2006 and 2005 third quarters were 31.8% and (37.1%), respectively. The tax expense for the first nine months of 2006 and 2005 was $24.9 million and $2.5 million, respectively, resulting in effective tax rates of 32.4% and 23.2%, respectively. As of September 30, 2006 and December 31, 2005, the net deferred Federal, foreign, state and local tax assets were $29.6 million and $28.3 million, respectively.

We are subject to the tax regulations of the United States and foreign countries in which we operate. The Company files a consolidated federal tax return, which includes all domestic subsidiaries and the U.K. Branch. The income from the foreign operations is designated as either U.S connected income or non-U.S. connected income. Lloyd’s is required to pay U.S. income tax on U.S. connected income (U.S. source income) written by Lloyd’s syndicates. Lloyd’s and the IRS have entered into an agreement whereby the amount of tax due on U.S. connected income is calculated by Lloyd’s and remitted directly to the IRS. These amounts are then charged to

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the corporate members in proportion to their participation in the relevant syndicates. The Company’s corporate members are subject to this agreement and will receive U.K. tax credits for any U.S. income tax incurred up to the U.K. income tax charge on the U.S. income. The non-U.S. connected insurance income would generally constitute taxable income under the Subpart F income section of the Internal Revenue Code since less than 50% of the Company’s premium is derived within the U.K. and would therefore be subject to U.S. taxation when the Lloyd’s year of account closes. Taxes are accrued at a 35% rate on our foreign source insurance income and foreign tax credits, where available, are utilized to offset U.S. tax as permitted. The Company’s effective tax rate for Syndicate 1221 taxable income could substantially exceed 35% to the extent the Company is unable to offset U.S. taxes paid under Subpart F tax regulations with U.K. tax credits on future underwriting year distributions. U.S. taxes are not accrued on the earnings of the Company’s foreign agencies as these earnings are not subject to the Subpart F tax regulations. These earnings are subject to taxes under U.K. tax regulations at a 30% rate.

We have not provided for U.S. deferred income taxes on the undistributed earnings of approximately $26 million of our non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the foreign subsidiary. However, in the future, if such earnings were distributed to the Company, taxes of approximately $1.1 million would be payable on such undistributed earnings and would be reflected in the tax provision for the year in which these earnings are no longer intended to be permanently reinvested in the foreign subsidiary assuming all foreign tax credits are realized.

The Company had state and local operating loss carryforwards amounting to potential future tax benefits of $5.9 million and $5.0 million at September 30, 2006 and December 31, 2005, respectively. A valuation allowance was established for the full amount of these potential future tax benefits due to the uncertainty associated with their realization. The Company’s state and local tax carryforwards at September 30, 2006 expire from 2021 to 2026.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretation of FASB Statement No. 109. FIN 48, which becomes effective in 2007, establishes the threshold for recognizing the benefits of tax-return positions in the financial statements as more-likely-than-not to be sustained by the taxing authorities, and prescribes a measurement methodology for those positions meeting the recognition threshold. The Company has not yet determined the estimated impact on its financial condition or results of operations, if any, of adopting FIN 48.

Segment Information

Effective in 2006, the Company classifies its business into two underwriting segments consisting of the Insurance Companies and the Lloyd’s Operations, which are separately managed, and a Corporate segment. Segment data for each of the two underwriting segments include allocations of revenues and expenses of Navigators Agencies and the Parent Company’s expenses and related income tax amounts previously reported separately. The Corporate segment consists of the Parent Company’s investment income, interest expense and the related tax effect. Segment data for 2005 and prior periods have been restated to reflect this change in segment reporting.

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 premiums earned, incurred losses and loss adjustment expenses, commission expense and other underwriting expenses. The Corporate segment consists of the Parent Company’s investment income and 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.

Following are the financial results of the Company’s two underwriting segments.

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Insurance Companies

Our Insurance Companies consist of Navigators Insurance Company, including its U.K. Branch, and NIC Insurance Company. Navigators Insurance Company is our largest insurance subsidiary and has been active since 1983. It specializes principally in underwriting marine insurance and related lines of business, specialty liability insurance and professional liability insurance. NIC Insurance Company, a wholly owned subsidiary of Navigators Insurance Company, began operations in 1990. It underwrites specialty and professional liability insurance on an excess and surplus lines basis fully reinsured by Navigators Insurance Company. The Navigators Agencies produce business for the Insurance Companies.

Following are the results of operations for the Insurance Companies for the three and nine months ended September 30, 2006 and 2005:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
	($ in thousands)
Gross written premium	$	163,673		$	133,718		$	496,216		$	393,686
Net written premium	91,188			59,093			273,277			199,349
Net earned premium	85,494			53,778			231,334			160,248
Net losses and LAE	(47,926		)	(47,332		)	(135,556		)	(114,856		)
Commission expense	(9,889		)	(6,465		)	(24,925		)	(15,597		)
Other operating expenses	(16,697		)	(13,284		)	(44,096		)	(37,540		)
Commission income and other income	661			704			2,661			3,599
Underwriting profit (loss)	11,643			(12,599		)	29,418			(4,146		)
Investment income	12,345			7,694			34,778			22,037
Net realized capital gains (losses)	(29		)	401			(329		)	1,348
Income before income taxes	23,959			(4,504		)	63,867			19,239
Income tax expense	7,658			(1,992		)	20,442			5,449
Net income (loss)	$	16,301		$	(2,512	)	$	43,425		$	13,790
Loss and LAE ratio	56.1		%	88.0		%	58.6		%	71.7		%
Commission expense ratio	11.6		%	12.0		%	10.8		%	9.7		%
Other operating expense ratio (1)	18.8		%	23.4		%	17.9		%	21.2		%
Combined ratio	86.5		%	123.4		%	87.3		%	102.6		%

(1)  Includes other operating expenses and commission income and other income (expense).

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Following are the underwriting results of the Insurance Companies for the three and nine months ended September 30, 2006 and 2005:

	Three Months Ended September 30, 2006
	($ in thousands)
	Net			Losses
	Earned			and LAE		Underwriting			Underwriting			Combined Ratio
	Premium			Incurred		Expenses			Profit(Loss)			Loss		Expense		Total
Insurance Companies:
Marine	$	29,291		$	17,064	$	8,696		$	3,531		58.3	%	29.7	%	88.0	%
Specialty	45,234			24,216		13,713			7,305			53.5	%	30.3	%	83.8	%
Professional Liability	10,938			6,417		3,615			906			58.7	%	33.1	%	91.8	%
Assumed from Lloyd’s	83			51		(27		)	59			NM		NM		NM
Other	(52		)	178		(72		)	(158		)	NM		NM		NM
Total	$	85,494		$	47,926	$	25,925		$	11,643		56.1	%	30.4	%	86.5	%

	Three Months Ended September 30, 2005
	($ in thousands)
	Net			Losses
	Earned			and LAE			Underwriting		Underwriting			Combined Ratio
	Premium			Incurred			Expenses		Profit(Loss)			Loss		Expense		Total
Insurance Companies:
Marine	$	14,391		$	23,850		$	6,846	$	(16,305	)	165.7	%	47.6	%	213.3	%
Specialty	31,965			19,184			9,403		3,378			60.0	%	29.4	%	89.4	%
Professional Liability	7,786			5,205			2,617		(36		)	66.9	%	33.6	%	100.5	%
Assumed from Lloyd’s	(356		)	(575		)	163		56			NM		NM		NM
Other	(8		)	(332		)	16		308			NM		NM		NM
Total	$	53,778		$	47,332		$	19,045	$	(12,599	)	88.0	%	35.4	%	123.4	%

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	Nine Months Ended September 30, 2006
	($ in thousands)
	Net			Losses
	Earned			and LAE			Underwriting			Underwriting			Combined Ratio
	Premium			Incurred			Expenses			Profit(Loss)			Loss		Expense		Total
Insurance Companies:
Marine	$	80,679		$	47,609		$	22,038		$	11,032		59.0	%	27.3	%	86.3	%
Specialty	121,133			69,177			35,312			16,644			57.1	%	29.2	%	86.3	%
Professional Liability	29,494			18,715			9,076			1,703			63.5	%	30.8	%	94.3	%
Assumed from Lloyd’s	100			(155		)	(36		)	291			NM		NM		NM
Other	(72		)	210			(30		)	(252		)	NM		NM		NM
Total	$	231,334		$	135,556		$	66,360		$	29,418		58.6	%	28.7	%	87.3	%

	Nine Months Ended September 30, 2005
	($ in thousands)
	Net			Losses
	Earned			and LAE			Underwriting			Underwriting			Combined Ratio
	Premium			Incurred			Expenses			Profit(Loss)			Loss		Expense		Total
Insurance Companies:
Marine	$	57,600		$	52,461		$	17,437		$	(12,298	)	91.1	%	30.3	%	121.4	%
Specialty	81,429			49,639			25,547			6,243			61.0	%	31.4	%	92.4	%
Professional Liability	21,493			14,676			6,710			107			68.3	%	31.2	%	99.5	%
Assumed from Lloyd’s	(320		)	(890		)	466			104			NM		NM		NM
Other	46			(1,030		)	(622		)	1,698			NM		NM		NM
Total	$	160,248		$	114,856		$	49,538		$	(4,146	)	71.7	%	30.9	%	102.6	%

Net earned premium of the Insurance Companies increased 59% and 44% in the 2006 third quarter and nine month period, respectively, compared to the same periods last year reflective of business expansion in all business units coupled with increased retention of the business written. Net earned premium of the Insurance Companies increased 36% in the 2006 third quarter and increased 37% in the first nine months of 2006 compared to the same periods in 2005, when the effects for ceded reinstatement premiums as a result of Hurricanes Katrina and Rita are excluded.

Excluding the 2005 hurricane losses, underwriting results generally reflect the favorable industry market conditions over the last three to four years coupled with satisfactory loss trends in the aforementioned periods. The 2006 third quarter and nine month loss ratios were favorably impacted by prior year loss reserve redundancies of $4.9 million and $9.3 million, respectively, or 5.7 and 4.0 loss ratio points, respectively. The Insurance Companies 2005 third quarter marine net earned premium was reduced by $9.1 million due to reinstatement premiums related to the ceded losses from Hurricanes Katrina and Rita. The 2005 third quarter net losses and LAE incurred increased by $7.4 million as a result of losses from such hurricanes. The reinstatement premiums and incurred losses resulting from Hurricanes Katrina and Rita increased the Insurance Companies’ 2005 third quarter and nine month period combined ratios by 28.8 and 9.8 ratio points, respectively.

The approximate annualized pre-tax yields on the Insurance Companies’ investment portfolio, excluding net realized capital gains and losses, for the 2006 third quarter and nine month period were 4.7% and 4.6%, respectively, compared to 4.1% and 4.2% for the comparable 2005 periods. The average duration of our Insurance Companies’ invested assets at September 30, 2006 was 4.4 years. Net investment income increased in

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the 2006 third quarter and nine month period compared to the same periods in 2005 due to the increase in the yield and the positive cash flows resulting in a larger investment portfolio including the statutory surplus contributions of $120 million from the net proceeds of our October 2005 equity offering and $100 million from the net proceeds of our April 2006 7% Senior Notes offering, in an environment of gradually increasing interest rates as monetary policy tightened.

Lloyd’s Operations

The Lloyd’s Operations consist of NUAL, which manages Lloyd’s 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 Lloyd’s 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 Lloyd’s 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.

Syndicate 1221 has stamp capacity of £123.5 million ($224.8 million) in 2006 compared to £135 million ($246.0 million) in 2005. Stamp capacity is a measure of the amount of premium a Lloyd’s syndicate is authorized to write based on a business plan approved by the Council of Lloyd’s. We provide 100% and 97.5% of Syndicate 1221’s total stamp capacity in 2006 and 2005, respectively. In September 2005, the Company purchased the remaining outstanding minority interest of the Syndicate 1221’s capacity for the 2006 underwriting year.

Syndicate 1221’s stamp capacity is expressed net of commission (as is standard at Lloyd’s) of approximately 21%. The Syndicate 1221 premium recorded in the Company’s financial statements is gross of commission. The Lloyd’s marine business had been subject to deteriorating pricing beginning in the mid-1990’s. The pricing competition showed some signs of stabilizing in 2000 and prices increased from 2001 through 2003. The marine rate increases began to level off in 2004 and into 2005. As a result of substantial insurance industry losses resulting from Hurricanes Katrina and Rita in August and September 2005, the global marine insurance market is experiencing diminished capacity and rate increases, particularly for the Gulf of Mexico offshore energy lines of business. Lloyd’s presents its results on an underwriting year basis, generally closing each underwriting year after three years. We make estimates for each underwriting year and timely accrue the expected results. Our Lloyd’s Operations included in the consolidated financial statements represent our participation in Syndicate 1221.

Lloyd’s syndicates report the amounts of premiums, claims, and expenses recorded in an underwriting account for a particular year to the companies or individuals that participate in the syndicates. The syndicates generally keep accounts open for three years. Traditionally, three years have been necessary to report substantially all premiums associated with an underwriting year and to report most related claims, although claims may remain unsettled after the underwriting year is closed. A Lloyd’s syndicate typically closes an underwriting year by reinsuring outstanding claims on that underwriting year with the participants for the next underwriting year. The ceding participants pay the assuming participants an amount based on the unearned premiums and outstanding claims in the underwriting year at the date of the assumption. Our participation in Lloyd’s Syndicate 1221 is represented by and recorded as our proportionate share of the underlying assets and liabilities and results of operations of the syndicate since (i) we hold an undivided interest in each asset, (ii) we are proportionately liable for each liability and (iii) Syndicate 1221 is not a separate legal entity. At Lloyd’s, the amount to close an underwriting year into the next year is referred to as the reinsurance to close (“RITC”) transaction. The RITC amounts represent the transfer of the assets and liabilities from the participants of a closing underwriting year to the participants of the next underwriting year. To the extent our participation in the syndicate changes, the RITC amounts vary accordingly. The RITC transaction is recorded in the fourth quarter

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as additional written and earned premium, losses incurred, loss reserves and receivables, all in the same amount. There are no gains or losses recorded on the RITC transaction.

We provide letters of credit to Lloyd’s to support our participation in Syndicate 1221’s stamp capacity as discussed below under the caption Liquidity and Capital Resources.

Whenever a member of Lloyd’s is unable to pay its debts to policyholders, such debts may be payable by the Lloyd’s Central Fund. If Lloyd’s determines that the Central Fund needs to be increased, it has the power to assess premium levies on current Lloyd’s members up to 3% of a member’s underwriting capacity in any one year. The Company does not believe that any assessment is likely in the foreseeable future and has not provided any allowance for such an assessment. However, based on the Company’s 2006 capacity at Lloyd’s of £123.5 million, the September 30, 2006 exchange rate of £1 equals $1.82 and in the event of a maximum 3% assessment, the Company would be assessed approximately $6.7 million. In addition, beginning with the 2005 underwriting year, Lloyd’s added a second tier of assets to the existing central fund. This second tier is being built up through a compulsory interest bearing loan to the Society of Lloyd’s from the Lloyd’s members based on the stamp capacity of each syndicate for the respective underwriting year. The funds are invested in assets eligible for Society of Lloyd’s solvency. The loans will be repaid on a rolling year basis as each year closes. At September 30, 2006, the Company had $3.4 million of assets loaned to this fund.

Following are the results of operations of the Lloyd’s Operations for the three and nine months ended September 30, 2006 and 2005:

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	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
	($ in thousands)
Gross written premium	$	57,780		$	54,142		$	241,600		$	200,519
Net written premium	27,849			16,956			118,434			87,047
Net earned premium	30,202			20,956			102,625			77,856
Net losses and LAE	(16,530		)	(29,504		)	(57,644		)	(61,812		)
Commission expense	(3,880		)	(5,191		)	(16,173		)	(14,905		)
Other operating expenses	(5,986		)	(4,198		)	(16,922		)	(15,014		)
Commission income and other income (expense)	(906		)	780			(850		)	2,036
Underwriting profit (loss)	2,900			(17,157		)	11,036			(11,839		)
Investment income	1,774			1,439			5,448			3,642
Net realized capital gains (losses)	(122		)	(57		)	(438		)	(421		)
Income before income taxes	4,552			(15,775		)	16,046			(8,618		)
Income tax expense	1,627			(5,521		)	5,650			(3,017		)
Net income (loss)	$	2,925		$	(10,254	)	$	10,396		$	(5,601	)
Loss and LAE ratio	54.7		%	140.8		%	56.2		%	79.4		%
Commission expense ratio	12.8		%	24.8		%	15.8		%	19.1		%
Other operating expense ratio (1)	22.8		%	16.3		%	17.3		%	16.7		%
Combined ratio	90.3		%	181.9		%	89.3		%	115.2		%

(1)  Includes other operating expenses and commission income and other income (expense).

The Lloyd’s Operations have been experiencing business expansion coupled with improving underwriting results as a result of the generally favorable market conditions for marine and energy business from late 2001 through 2003, and continuing to a lesser extent in 2004. Premium rate increases occurred in 2005 and continued into 2006 following Hurricanes Katrina and Rita, particularly in the offshore energy business.

The 2006 third quarter and nine month loss ratios were favorably impacted by prior year loss reserve redundancies of $1.1 million and $3.4 million, or 3.6 and 3.3 loss ratio points, respectively. The 2005 third quarter and nine month net earned premium was reduced by $5.3 million due to reinstatement premiums related to the ceded losses from Hurricanes Katrina and Rita. The 2005 third quarter net losses and LAE incurred increased by $14.9 million as a result of losses from such hurricanes. The reinstatement premiums and incurred losses resulting from Hurricanes Katrina and Rita increased the Lloyd’s Operations 2005 third quarter and nine month period combined ratios by 94.6 and 25.3 ratio points, respectively.

The approximate annualized pre-tax yields on the Lloyd’s Operations’ investment portfolio, excluding net realized capital gains and losses, for the 2006 third quarter and nine month period were 3.2% and 3.2%, respectively, compared to 2.7% and 2.4% for the comparable 2005 periods. Generally, funds invested at Lloyd’s have been invested with a relatively short average duration in order to meet liquidity needs. The average duration

45

of our Lloyd’s Operations’ invested assets at September 30, 2006 was 1.2 years. Such yields are net of interest credits to certain reinsurers for funds withheld by our Lloyd’s Operations.

Off-Balance Sheet Transactions

There have been no material changes in the information concerning off-balance sheet transactions as stated in the Company’s 2005 Annual Report on Form 10-K.

Tabular Disclosure of Contractual Obligations

There have been no material changes in the operating lease or capital lease information concerning contractual obligations as stated in the Company’s 2005 Annual Report on Form 10-K. Total reserves for losses and LAE were $1.6 billion at both September 30, 2006 and December 31, 2005. There were no significant changes in the Company’s lines of business or claims handling that would create a material change in the percentage relationship of the projected payments by period to the total reserves.

The following table sets forth our contractual obligations with respect to the 7% senior unsecured notes due May 1, 2016 discussed in Note 10 to the Notes to Interim Consolidated Financial Statements, included herein:

	Payments Due by Period
			Less than						More than
	Total		1 Year		1-3 Years		3-5 Years		5 Years
	($ in thousands)
7% Senior Notes	$	212,840	$	9,090	$	17,500	$	17,500	$	168,750

Investments

The objective of the Company’s investment policy, guidelines and strategy is to maximize total investment return in the context of preserving and enhancing shareholder value and statutory surplus of the Insurance Companies. Secondarily, an important consideration is to optimize the after-tax book income.

The investments are managed by outside professional fixed-income and equity portfolio managers. The Company seeks to achieve its investment objectives by investing in cash equivalents and money market funds, municipal bonds, U.S. Government bonds, U.S. Government agency guaranteed and non-guaranteed securities, corporate bonds, mortgage-backed and asset-backed securities and common and preferred stocks. Our investment guidelines require that the amount of the consolidated fixed-income portfolio rated below “A-” by Standard & Poor’s (“S&P”) or A3 by Moody’s shall not exceed 20% of the statutory surplus of the Insurance Companies. Securities rated below BBB- by S&P or Baa3 by Moody’s are not eligible to be purchased. Up to 15% of the statutory surplus of the Insurance Companies may be invested in equity securities that are actively traded on major U.S. stock exchanges. Our investment guidelines prohibit investments in derivatives other than as a hedge against foreign currency exposures or the writing of covered call options on the equity portfolio.

The Insurance Companies’ investments are subject to the direction and control of each company’s Board of Directors and our Finance Committee. The investment portfolio and the performance of the investment managers are reviewed quarterly. These investments must comply with the insurance laws of New York State, the domiciliary state of Navigators Insurance Company and NIC Insurance Company. These laws prescribe the type, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in Federal, state and municipal obligations, corporate bonds, preferred stocks, common stocks, mortgages and real estate.

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The Lloyd’s Operations’ investments are subject to the direction and control of the Board of Directors and the Investment Committee of NUAL, as well as the Company’s Board of Directors and Finance Committee, and represent our share of the investments held by Syndicate 1221. These investments must comply with the rules and regulations imposed by Lloyd’s and by certain overseas regulators. The investment portfolio and the performance of the investment managers are reviewed quarterly.

The majority of the investment income of the Navigators Agencies is derived from fiduciary funds invested in accordance with the guidelines of various state insurance departments. These guidelines typically require investments in short-term instruments. This investment income is paid to Navigators Insurance Company.

All fixed maturity and equity securities are carried at fair value. The fair value is based on quoted market prices or dealer quotes provided by independent pricing services. The following tables show our cash and investments as of September 30, 2006 and December 31, 2005:

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			Gross		Gross			Cost or
	Fair		Unrealized		Unrealized			Amortized
September 30, 2006	Value		Gains		(Losses)			Cost
	($ in thousands)
Fixed maturities:
U.S. Government Treasury Bonds, GNMAs and foreign government bonds	$	212,896	$	1,158	$	(2,764	)	$	214,502
States, municipalities and political subdivisions	325,500		2,881		(1,973		)	324,592
Mortgage- and asset-backed securities (excluding GNMAs)	426,224		1,411		(4,367		)	429,180
Corporate bonds	209,576		2,065		(2,271		)	209,782
Total fixed maturities (1)	1,174,196		7,515		(11,375		)	1,178,056
Equity securities - common stocks	32,524		4,039		(368		)	28,853
Cash and short-term investments	201,361		—		—			201,361
Total	$	1,408,081	$	11,554	$	(11,743	)	$	1,408,270

(1)Approximately 6.9% and 14.1% of total fixed maturities investments are direct and collateralized obligations, respectively, of FNMA and FHLMC.

			Gross		Gross			Cost or
	Fair		Unrealized		Unrealized			Amortized
December 31, 2005	Value		Gains		(Losses)			Cost
	($ in thousands)
Fixed maturities:
U.S. Government Treasury Bonds, GNMAs and foreign government bonds	$	244,890	$	2,432	$	(2,249	)	$	244,707
States, municipalities and political subdivisions	216,345		1,563		(2,115		)	216,897
Mortgage- and asset-backed securities (excluding GNMAs)	358,062		758		(3,682		)	360,986
Corporate bonds	164,816		2,115		(1,435		)	164,136
Total fixed maturities (1)	984,113		6,868		(9,481		)	986,726
Equity securities - common stocks	20,911		1,893		(649		)	19,667
Cash and short-term investments	177,212		—		—			177,212
Total	$	1,182,236	$	8,761	$	(10,130	)	$	1,183,605

(1)Approximately 5.6% and 10.7% of total fixed maturities investments are direct and collateralized obligations, respectively, of FNMA and FHLMC.

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At September 30, 2006 and December 31, 2005, all fixed-maturity and equity securities held by us were classified as available-for-sale.

We regularly review 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. Other factors considered in evaluating potential impairment include the current fair value as compared to cost or amortized cost, as appropriate, 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.

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, market conditions and assessing value relative to other comparable securities. 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.

When a security in our investment portfolio has an unrealized loss that is deemed to be other-than-temporary, we write the security down to fair value through a charge to operations. 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. There were no impairment losses recorded in our fixed maturity or equity securities portfolios in the first nine months of 2006 or 2005.

The following table summarizes all securities in an unrealized loss position at September 30, 2006 and December 31, 2005, showing the aggregate fair value and gross unrealized loss by the length of time those securities have continuously been in an unrealized loss position:

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	September 30, 2006				December 31, 2005
	Fair		Gross		Fair		Gross
	Value		Unrealized Loss		Value		Unrealized Loss
			($ in thousands)
Fixed Maturities:
U.S. Government Treasury Bonds, GNMAs and foreign government bonds
0-6 Months	$	10,318	$	252	$	66,229	$	772
7-12 Months	44,439		536		52,994		690
> 12 Months	88,949		1,976		51,234		787
Subtotal	143,706		2,764		170,457		2,249
States, municipalities and political subdivisions
0-6 Months	3,361		52		82,167		696
7-12 Months	7,697		56		43,875		776
> 12 Months	132,721		1,865		24,786		643
Subtotal	143,779		1,973		150,828		2,115
Mortgage- and asset-backed securities (excluding GNMAs)
0-6 Months	5,339		16		184,145		1,847
7-12 Months	64,265		529		53,485		942
> 12 Months	200,670		3,822		52,115		893
Subtotal	270,274		4,367		289,745		3,682
Corporate bonds
0-6 Months	2,789		11		45,995		576
7-12 Months	43,400		618		9,109		202
> 12 Months	67,522		1,642		26,904		657
Subtotal	113,711		2,271		82,008		1,435
Total Fixed Maturities	$	671,470	$	11,375	$	693,038	$	9,481
Equity securities - common stocks
0-6 Months	$	2,157	$	106	$	2,200	$	167
7-12 Months	728		72		3,120		235
> 12 Months	2,091		190		756		247
Total Equity Securities	$	4,976	$	368	$	6,076	$	649

We analyze the unrealized losses quarterly to determine if any are other-than-temporary. The above unrealized losses have been determined to be temporary and generally result from changes in market conditions.

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The following table shows the composition by National Association of Insurance Commissioners (“NAIC”) rating and the generally equivalent Standard & Poor’s (“S&P”) and Moody’s ratings of the fixed maturity securities in our portfolio with gross unrealized losses at September 30, 2006. Not all of the securities are rated by S&P and/or Moody’s.

			Gross
	Equivalent	Equivalent	Unrealized Loss				Fair Value
NAIC	S&P	Moody’s			Percent				Percent
Rating	Rating	Rating	Amount		of Total		Amount		of Total
					($ in thousands)
1	AAA/AA/A	Aaa/Aa/A	$	10,516	92	%	$	631,186	94	%
2	BBB	Baa	859		8	%	40,284		6	%
3	BB	Ba	—		—		—		—
4	B	B	—		—		—		—
5	CCC or lower	Caa or lower	—		—		—		—
6	N/A	N/A	—		—		—		—
		Total	$	11,375	100	%	$	671,470	100	%

At September 30, 2006, the gross unrealized losses in the table directly above are related to fixed maturity securities that are rated investment grade. Investment grade is defined as a security having a NAIC rating of 1 or 2, a S&P rating of “BBB–” or higher, or a Moody’s rating of “Baa3” or higher. Unrealized losses on investment grade securities principally relate to changes in interest rates or changes in sector-related credit spreads since the securities were acquired. Any such unrealized losses are recognized in income, if the securities are sold, or if the decline in fair value is deemed other-than-temporary.

The scheduled maturity dates for fixed maturity securities in an unrealized loss position at September 30, 2006 are shown in the following table:

	Gross
	Unrealized Loss				Fair Value
			Percent				Percent
	Amount		of Total		Amount		of Total
			($ in thousands)
Due in one year or less	$	407	4	%	$	58,670	9	%
Due after one year through five years	2,760		24	%	163,648		24	%
Due after five years through ten years	1,561		14	%	84,560		13	%
Due after ten years	2,280		20	%	94,318		14	%
Mortgage- and asset-backed securities (excluding GNMAs)	4,367		38	%	270,274		40	%
Total fixed income securities	$	11,375	100	%	$	671,470	100	%

Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Due to the periodic repayment of principal, the

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mortgage-backed and asset-backed securities are estimated to have an effective maturity of approximately 3.7 years.

Our realized capital gains and losses for the three and nine months ended September 30, 2006 and 2005 were as follows:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
				($ in thousands)
Fixed maturities:
Gains	$	8		$	440		$	349		$	1,699
(Losses)	(198		)	(288		)	(1,605		)	(1,245		)
	(190		)	152			(1,256		)	454
Equity securities:
Gains	41			192			525			607
(Losses)	(2		)	—			(36		)	(134		)
	39			192			489			473
Net realized capital gains (losses).	$	(151	)	$	344		$	(767	)	$	927

The following table details realized losses in excess of $250,000 from sales and impairments during the first nine months of 2006 and 2005 and the related circumstances giving rise to the loss:

										# of Months
										Unrealized Loss
									Net	Exceeded 20%
	Date of	Proceeds		(Loss) on				Holdings at	Unrealized	of Cost or
Description	Sale	from Sale		Sale			Impairment	September 30, 2006	(Loss)	Amortized Cost
	($ in thousands)
Nine months ended September 30, 2006:
TIPS (1)	3/31/2006	$	15,418	$	(305	)	—	—	—	—
Nine months ended September 30, 2005:
None

(1)Treasury inflation protection securities (TIPS) were sold during the 2006 first quarter due to the widening breakeven yield spread between TIPS and Treasuries.

Reinsurance Recoverables

We utilize reinsurance principally to reduce our exposure on individual risks, to protect against catastrophic losses, to maintain desired ratios of net written premium to statutory surplus and to stabilize loss ratios and underwriting results. Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred or ceded to the reinsurer, ceded reinsurance arrangements do not eliminate our obligation to pay

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claims to our policyholders. Accordingly, we bear credit risk with respect to our reinsurers. Specifically, our reinsurers may not pay claims made by us on a timely basis, or they may not pay some or all of these claims. Either of these events would increase our costs and could have a material adverse effect on our business. We are required to pay the losses even if the reinsurer fails to meet its obligations under the reinsurance agreement. Hurricanes Katrina and Rita increased our reinsurance recoverables significantly which increased our credit risk.

We are protected by various treaty and facultative reinsurance agreements. Our exposure to credit risk from any one reinsurer is managed through diversification by reinsuring with a number of different reinsurers, principally in the United States and European reinsurance markets. To meet our standards of acceptability, when the reinsurance is placed, a reinsurer generally must have an A.M. Best Company and/or Standard & Poor’s rating of “A” or better, or equivalent financial strength if not rated, plus at least $250 million in policyholders’ surplus. Our Reinsurance Security Committee monitors the financial strength of our reinsurers and the related reinsurance receivables and periodically reviews the list of acceptable reinsurers. The reinsurance is placed either directly by us or through reinsurance intermediaries. The reinsurance intermediaries are compensated by the reinsurers.

The increase in reinsurance receivable on paid losses was primarily due to the ceded portion of paid losses resulting from Hurricanes Katrina and Rita which are in the process of being collected from various reinsurers.

Charges (recoveries) for uncollectible reinsurance amounts, all of which were recorded to incurred losses, were $218,000 and ($505,000) for the three months ended September 30, 2006 and 2005, respectively, and $516,000 and $109,000 for the nine months ended September 30, 2006 and 2005, respectively.

The Company continues to periodically monitor the financial condition and ongoing activities of its reinsurers, in order to assess the adequacy of its allowance for uncollectible reinsurance.

Liquidity and Capital Resources

Cash flow provided by operations was $ 92.7 million and $167.9 million for the nine months ended September 30, 2006 and 2005, respectively. The positive operating cash flow was primarily due to the increase in net written premium. Operating cash flow was used primarily to acquire additional investment assets.

The cumulative inception to date payment of gross losses from Hurricanes Katrina and Rita at September 30, 2006 approximated $119.8 million of which $114.5 million was paid in 2006. Such payments reduce cash flow for the gross amount paid until the ceded portion of the loss is collected from the reinsurers.

Investments and cash increased to $1,408 million at September 30, 2006 from $1,182 million at December 31, 2005. The increase was due to the positive cash flow from operations and the $123.5 million of net proceeds from the 7% Senior Notes offering completed in April 2006. Net investment income was $ 14.7 million and $9.2 million for the three months ended September 30, 2006 and 2005, respectively, and $ 41.2 million and $25.8 million for the nine months ended September 30, 2006 and 2005, respectively.

The approximate annualized pre-tax investment yields of the portfolio, excluding net realized capital gains and losses were 4.5% and 4.4% for the 2006 third quarter and nine month period, respectively, compared to 3.8% for both the 2005 third quarter and nine month period. The increase in the pre-tax investment yield was due to the increase in interest rates as monetary policy continued to tighten until mid 2006 when it leveled off, slightly offset by a small decrease in the duration of the portfolio from 4.0 years at September 30, 2005 to 3.9 years at September 30, 2006. The positive cash flow along with the proceeds from maturities, calls and redemptions were reinvested at the higher prevailing interest rates. As of September 30, 2006 and December 31, 2005, all fixed maturity securities and equity securities held by us were classified as available-for-sale.

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At September 30, 2006, the weighted average rating of our fixed maturity investments was “AA” by Standard & Poor’s and “Aa” by Moody’s. We believe that we have no significant exposure to credit risk since virtually all of the fixed maturity investment portfolio consists of investment-grade bonds. At September 30, 2006, our portfolio had an average maturity of 5.2 years and duration of 3.9 years. Management continually monitors the composition and cash flow of the investment portfolio in order to maintain the appropriate levels of liquidity in an effort to ensure our ability to satisfy claims.

We have a credit facility provided through a consortium of banks. The credit facility was amended in January 2005 to increase the letters of credit available under the facility from $80 million to $115 million and to add a $10 million line of credit to the facility. The expiration of the credit facility was also extended from November 10, 2005 to June 30, 2007. If at that time the banks do 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 pounds. At September 30, 2006, letters of credit with an aggregate face amount of $86.6 million were issued under the credit facility. The line of credit was unused at September 30, 2006.

The credit facility is collateralized by all of the common stock of Navigators 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, maintaining certain consolidated tangible net worth, statutory surplus and other financial ratios. Cash dividends to shareholders are limited to $5.0 million per year. No dividends have been declared or paid through September 30, 2006. At September 30, 2006, we were in compliance with all covenants.

An amendment to the credit facility was approved by the bank consortium in April 2006 for the primary purpose of permitting the Company to issue $125 million of senior unsecured notes. The public debt offering of the senior notes was completed on April 17, 2006.

At September 30, 2006, our consolidated stockholders’ equity was $527.5 million or $31.59 per share compared to $470.2 million or $28.30 per share at December 31, 2005. The increase was primarily due to net income of $52.0 million for the first nine months of 2006.

Our reinsurance has been placed with various U.S. and foreign insurance companies and with selected syndicates at Lloyd’s. Pursuant to the implementation of Lloyd’s Plan of Reconstruction and Renewal, a portion of our recoverables are now reinsured by Equitas (a separate United Kingdom 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).

Time lags do occur in the normal course of business between the time gross losses are paid by the Company and the time such gross losses are billed and collected from reinsurers. Recoverable amounts at September 30, 2006 are anticipated to be billed and collected over the next several years as gross losses are paid by the Company.

Generally, for pro-rata or quota share reinsurers, including pool participants, the Company issues quarterly settlement statements for premiums less commissions and paid loss activity, which are expected to be settled by the end of the subsequent quarter. The Company has the ability to issue “cash calls” requiring such reinsurers to pay losses whenever paid loss activity for a claim ceded to a particular reinsurance treaty exceeds a predetermined amount (generally not more than $1 million) as set forth in the pro-rata treaty. For the Insurance Companies, cash calls must generally be paid within 30 calendar days. There is generally no specific settlement period for the Lloyd’s Operations cash call provisions, but such billings are usually paid within 45 calendar days.

Generally, for excess of loss reinsurers the Company pays monthly or quarterly deposit premiums based on the estimated subject premiums over the contract period (usually one year) which are subsequently adjusted

54

based on actual premiums determined after the expiration of the applicable reinsurance treaty. Paid losses subject to excess of loss recoveries are generally billed as they occur and are usually settled by reinsurers within 30 calendar days for the Insurance Companies and 30 business days for the Lloyd’s Operations.

The Company sometimes withholds funds from reinsurers and may apply ceded loss billings against such funds in accordance with the applicable reinsurance agreements.

At September 30, 2006, ceded asbestos paid and unpaid losses recoverable were $25.7 million of which $14.2 million was due from Equitas. We expect that approximately 70% of the gross asbestos reserves will be paid by the Company over the next two years. The Company generally experiences significant collection delays for a large portion of such balances 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 Katrina and Rita could significantly impact the Company’s liquidity needs. However, we expect to pay the 2005 hurricane losses over a period of years from cash flow and, if needed, short-term investments and expect to collect our paid reinsurance recoverables generally under the terms described above.

We primarily rely upon dividends from our subsidiaries to meet our holding company obligations. The dividends have historically come primarily from Navigators Insurance Company. At September 30, 2006, the approximate maximum amount available for the payment of dividends by Navigators Insurance Company without prior regulatory approval was $50.0 million. No dividends have been paid by Navigators Insurance Company in 2006.

We believe that the cash flow generated by the operating activities of our subsidiaries will provide sufficient funds for us to meet our liquidity needs over the next twelve months. Beyond the next twelve months, cash flow available to us may be influenced by a variety of factors, including general economic conditions and conditions in the insurance and reinsurance markets, as well as fluctuations from year to year in claims experience.

In April 2006, the Company completed a public debt offering of $125 million 7% senior unsecured notes due May 1, 2016 and contributed $100 million of the proceeds to Navigators Insurance Company. The remaining net proceeds were retained in the Parent Company for general corporate purposes.

Condensed Parent Company balance sheets as of September 30, 2006 (unaudited) and December 31, 2005 are shown in the table below:

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	September 30,		December 31,
	2006		2005
	($ in thousands)
Cash and investments	$	40,085	$	16,926
Investments in subsidiaries	610,002		453,023
Goodwill and other intangible assets	2,534		2,534
Other assets	7,659		3,695
Total assets	$	660,280	$	476,178
Accounts payable and other liabilities	$	1,137	$	1,800
Accrued interest payable	3,986		—
Deferred compensation payable	4,109		4,140
7% Senior Notes due May 1, 2016	123,533		—
Total liabilities	132,765		5,940
Stockholders’ equity	527,515		470,238
Total liabilities and stockholders’ equity	$	660,280	$	476,178

At September 30, 2006 approximately $4.1 million of investments are held in a tax escrow account on behalf of Navigators Insurance Company until the two-year tax loss carryback periods expire.

Deferred compensation payable represents accrued costs for employee stock appreciation rights which are paid by the operating subsidiaries when such stock appreciation rights are exercised.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in the information concerning market risk as stated in the Company’s 2005 Annual Report on Form 10-K.

Item 4. Controls and Procedures

(a)The Chief Executive Officer and Chief Financial Officer of the Company have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this quarterly report. Based on such evaluation, such officers have concluded that as of the end of such period the Company’s disclosure controls and procedures are effective in identifying, on a timely basis, material information required to be disclosed in our reports filed or submitted under the Exchange Act.

(b)There have been no changes during our third fiscal quarter in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II - - Other Information

Item 1.Legal Proceedings

Except as follows, the Company is not a party to, or the subject of, any material legal proceedings which depart from the ordinary routine litigation incident to the kinds of business it conducts.

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At the end of April 2006, the Company was served as a defendant in an action in the United States District Court for the Northern District of Georgia captioned New Cingular Wireless Headquarters, LLC, et al. v. March & McLennan Companies, Inc., et al., along with approximately 100 other defendants. On May 31, 2006, this action was conditionally transferred to the United States District Court for the District of New Jersey by the Judicial Panel on Multidistrict Litigation. While it is not possible at this very preliminary stage to predict the outcome of this litigation, the Company believes the allegations, which involve contingent commissions and bid-rigging in the insurance industry, to be without merit and intends to vigorously defend itself against them.

Item 1A.Risk Factors

There have been no material changes from the risk factors as previously disclosed in the Company’s 2005 Annual Report on Form 10-K.

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.Defaults Upon Senior Securities

None.

Item 4.Submissions of Matters to a Vote of Security Holders

None.

Item 5.Other Information

Stephen Coward has, subject to regulatory approval, been promoted to Managing Director of Navigators Underwriting Agency Limited (“NUAL”), a wholly-owned subsidiary of the Company that manages Lloyd’s Syndicate 1221. Mr. Coward, who was previously responsible for the non-marine and energy business of NUAL, replaces David Hope, who left the Company effective October 23, 2006 to pursue other interests.

Item 6.Exhibits

Exhibit No.	Description of Exhibit
11-1	Statement re Computation of Per Share Earnings	*
31-1	Certification of CEO per Section 302 of the Sarbanes-Oxley Act	*
31-2	Certification of CFO per Section 302 of the Sarbanes-Oxley Act	*
32-1	Certification of CEO per Section 906 of the Sarbanes-Oxley Act	*
	(This exhibit is intended to be furnished in accordance with Regulation S-K item 601(b)(32)(ii) and shall not be deemed to be filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, except as shall be expressly set forth by specific reference).
32-2	Certification of CFO per Section 906 of the Sarbanes-Oxley Act	*
	(This exhibit is intended to be furnished in accordance with Regulation S-K item 601(b)(32)(ii) and shall not be deemed to be filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, except as shall be expressly set forth by specific reference).

* Included herein.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	The Navigators Group, Inc.
	(Registrant)
Date: November 1, 2006	/s / Paul J. Malvasio
	Paul J. Malvasio
	Executive Vice President
	and Chief Financial Officer

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INDEX OF EXHIBITS

Exhibit No.	Description of Exhibit
11-1	Statement re Computation of Per Share Earnings	*
31-1	Certification of CEO per Section 302 of the Sarbanes-Oxley Act	*
31-2	Certification of CFO per Section 302 of the Sarbanes-Oxley Act	*
32-1	Certification of CEO per Section 906 of the Sarbanes-Oxley Act	*
	(This exhibit is intended to be furnished in accordance with Regulation S-K item 601(b)(32)(ii) and shall not be deemed to be filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, except as shall be expressly set forth by specific reference).
32-2	Certification of CFO per Section 906 of the Sarbanes-Oxley Act	*
	(This exhibit is intended to be furnished in accordance with Regulation S-K item 601(b)(32)(ii) and shall not be deemed to be filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, except as shall be expressly set forth by specific reference).

*  Included herein.

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